Edgar Filing: Warner Music Group Corp.

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2006

¨	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

13-4271875

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

75 Rockefeller Plaza

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 x No ¨

Indicate by check mark whether the registrant is a large accelerated filer or an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x

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

As of May 1, 2006, the number of shares of the Registrant’s common stock, par value $0.001 per share, outstanding was 148,546,120.787.

WARNER MUSIC GROUP CORP.

INDEX


		Page
Part I.	Financial Information
Item 1.	Financial Statements (unaudited)	2
	Consolidated Balance Sheets as of March 31, 2006 and September 30, 2005	2
	Consolidated Statements of Operations for the Three Months Ended March 31, 2006 and 2005	3
	Consolidated Statements of Operations for the Six Months Ended March 31, 2006 and 2005	4
	Consolidated Statements of Cash Flows for the Six Months Ended March 31, 2006 and 2005	5
	Consolidated Statement of Shareholders’ Equity for the Six Months Ended March 31, 2006	6
	Notes to Consolidated Interim Financial Statements	7
	Supplementary Information—Condensed Consolidating Financial Statements	19
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	49
Item 4.	Controls and Procedures	50
Part II.	Other Information
Item 1.	Legal Proceedings	52
Item 1A.	Risk Factors	53
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	64
Item 3.	Defaults Upon Senior Securities	64
Item 4.	Submission of Matters to a Vote of Security Holders	64
Item 5.	Other Information	65
Item 6.	Exhibits	65
Signatures		66

ITEM 1. FINANCIAL STATEMENTS

Warner Music Group Corp.

Consolidated Balance Sheets


	March 31, 2006			September 30, 2005
	(unaudited)			(audited)
	(in millions)
Assets
Current assets:
Cash and equivalents	$	359		$	288
Short-term investments		61			—
Accounts receivable, less allowances of $230 and $218 million		530			637
Inventories		44			52
Royalty advances expected to be recouped within one year		196			190
Deferred tax assets		32			36
Other current assets		56			39

Total current assets		1,278			1,242
Royalty advances expected to be recouped after one year		196			190
Investments		24			21
Property, plant and equipment, net		147			157
Goodwill		876			869
Intangible assets subject to amortization, net		1,737			1,815
Intangible assets not subject to amortization		100			100
Other assets		106			104

Total assets	$	4,464		$	4,498

Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable	$	211		$	247
Accrued royalties		1,088			1,057
Taxes and other withholdings		43			23
Current portion of long-term debt		17			17
Dividends payable		20			—
Other current liabilities		327			404

Total current liabilities		1,706			1,748
Long-term debt		2,226			2,229
Dividends payable		6			5
Deferred tax liabilities, net		192			201
Other noncurrent liabilities		225			226

Total liabilities		4,355			4,409

Commitments and Contingencies (See Note 9)

Shareholders’ equity:
Common stock ($0.001 par value; 500,000,000 shares authorized; 148,496,538 and 148,455,313 shares issued and outstanding)		—			—
Additional paid-in capital		556			548
Accumulated deficit		(475	)		(480	)
Accumulated other comprehensive income, net		28			21

Total shareholders’ equity		109			89

Total liabilities and shareholders’ equity	$	4,464		$	4,498

See accompanying notes.

Warner Music Group Corp.

Consolidated Statements of Operations (Unaudited)

Three Months Ended March 31, 2006 and 2005


	Three Months Ended March 31, 2006			Three Months Ended March 31, 2005
	(in millions, except per share amounts)
Revenues (b)	$	796		$	767
Costs and expenses:
Cost of revenues (a)		(409	)		(400	)
Selling, general and administrative expenses (a) (b)		(294	)		(293	)
Amortization of intangible assets		(48	)		(47	)

Total costs and expenses		(751	)		(740	)

Operating income		45			27
Interest expense, net		(45	)		(52	)
Equity in the gains of equity-method investees, net		1			—
Unrealized gain on warrants		—			39
Other income, net		2			—

Income before income taxes		3			14
Income tax expense		(10	)		(10	)

Net (loss) income	$	(7	)	$	4

Net (loss) income per common share:
Basic	$	(0.05	)	$	0.04

Diluted	$	(0.05	)	$	(0.28	)

Weighted average common shares:
Basic		141.9			107.7

Diluted		141.9			123.5


(a) Includes depreciation expense of	$	(11	)	$	(14	)

(b) Includes the following expenses resulting from transactions with related companies:
Revenues		4			—
Selling, general and administrative expense		(3	)		(2	)

See accompanying notes.

Warner Music Group Corp.

Consolidated Statements of Operations (Unaudited)

Six Months Ended March 31, 2006 and 2005


	Six Months Ended March 31, 2006			Six Months Ended March 31, 2005
	(in millions, except per share amounts)
Revenues (b)	$	1,840		$	1,855
Costs and expenses:
Cost of revenues (a)		(939	)		(981	)
Selling, general and administrative expenses (a) (b)		(617	)		(624	)
Amortization of intangible assets		(95	)		(93	)

Total costs and expenses		(1,651	)		(1,698	)

Operating income		189			157
Interest expense, net (b)		(90	)		(90	)
Equity in the gains (losses) of equity-method investees, net		1			(1	)
Unrealized gain on warrants		—			17
Minority interest expense (b)		—			(5	)
Other income, net		2			4

Income before income taxes		102			82
Income tax expense		(40	)		(42	)

Net income	$	62		$	40

Net income per common share:
Basic	$	0.44		$	0.37

Diluted	$	0.41		$	0.19

Weighted average common shares:
Basic		141.7			107.6

Diluted		150.6			119.6


(a) Includes depreciation expense of	$	(22	)	$	(28	)

(b) Includes the following expenses resulting from transactions with related companies:
Revenues		4			—
Selling, general and administrative expense		(8	)		(5	)
Interest expense		—			(1	)
Minority interest expense		—			(5	)

See accompanying notes.

Warner Music Group Corp.

Consolidated Statements of Cash Flows (Unaudited)

Six Months Ended March 31, 2006 and 2005


	Six Months Ended March 31, 2006			Six Months Ended March 31, 2005
	(in millions)
Cash flows from operating activities
Net income	$	62		$	40
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		117			121
Non-cash interest expense		26			30
Non-cash, stock-based compensation expense		8			9
Deferred taxes		(2	)		2
Equity in the (gains) losses of equity-method investees, including distributions		(1	)		1
Unrealized gain on warrants		—			(17	)
Minority interest expense		—			5
Changes in operating assets and liabilities:
Accounts receivable		108			103
Inventories		8			1
Royalty advances		(29	)		9
Accounts payable and accrued liabilities		(66	)		(22	)
Other balance sheet changes		(26	)		10

Net cash provided by operating activities		205			292

Cash flows from investing activities
Investments and acquisitions		(18	)		(48	)
Investments in short-term investments		(61	)		—
Investment proceeds		—			1
Capital expenditures		(12	)		(14	)

Net cash used in investing activities		(91	)		(61	)

Cash flows from financing activities
Borrowings		—			696
Financing costs of borrowings		—			(17	)
Quarterly debt repayments		(8	)		(6	)
Proceeds from the issuance of restricted shares		—			1
Repurchase of subsidiary preferred stock		—			(209	)
Dividends and returns of capital paid		(37	)		(807	)

Net cash used in financing activities		(45	)		(342	)
Effect of foreign currency exchange rate changes on cash		2			3

Net increase (decrease) in cash and equivalents		71			(108	)
Cash and equivalents at beginning of period		288			555

Cash and equivalents at end of period	$	359		$	447

See accompanying notes.

Warner Music Group Corp.

Consolidated Statement of Shareholders’ Equity (Unaudited)

Six Months Ended March 31, 2006


	Common Stock			Additional Paid-in Capital		Retained Earnings (Deficit)			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity
	Shares	Value		Additional Paid-in Capital		Retained Earnings (Deficit)			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity
	(in millions, except number of common shares)
Balance at September 30, 2005	148,455,313	$	—	$	548	$	(480	)	$	21		$	89
Comprehensive income:
Net income	—		—		—		62			—			62
Foreign currency translation adjustment	—		—		—		—			(2	)		(2	)
Deferred gains on derivative financial instruments	—		—		—		—			9			9

Total comprehensive income	—		—		—		62			7			69
Dividends	—		—		—		(57	)		—			(57	)
Issuance of stock options and restricted shares of common stock, net	41,225		—		8		—			—			8

Balance at March 31, 2006	148,496,538	$	—	$	556	$	(475	)	$	28		$	109

See accompanying notes.

Warner Music Group Corp.

Notes to Consolidated Interim Financial Statements (Unaudited)

1. Description of Business

Warner Music Group Corp. (the “Company” or “Parent”) was formed by a private equity consortium of Investors (the “Investor Group”) 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 companies and the successor to the interests of the recorded music and music publishing businesses of Time Warner Inc. (“Time Warner”). Effective March 1, 2004, Acquisition Corp. acquired such interests from Time Warner for approximately $2.6 billion (the “Acquisition”). On May 10, 2005, the Company sold 32,600,000 shares of its common stock in an initial public offering (the “Initial Common Stock Offering”) and became a public company.

The Company classifies its business interests into two fundamental areas: recorded music and music publishing. A brief description of those operations is presented below.

The Company’s business is seasonal. Therefore, operating results for the three and six month periods ended March 31, 2006 are not necessarily indicative of the results that may be expected for fiscal 2006.

Recorded Music Operations

The Company’s recorded music operations consist of the discovery and development of artists and the related marketing and distribution of recorded music produced by such artists. In addition to the more traditional methods of discovering and developing artists, the Company has implemented new initiatives to identify and nurture artists earlier in the development process and reduce development costs by leveraging its independent distribution network. The Company refers to these new business models as incubator initiatives. Asylum and East West are the current recorded music incubator labels. In addition, the Company launched Cordless Recordings an “e-label” that gives artists the ability to come to market with one or several songs in digital formats without the need to create an entire album. Asylum, East West and Cordless Recordings make up the Company’s Independent Label Group (“ILG”). The Company has also entered into strategic ventures with other record labels.

The Company’s recorded music operations also include a catalog division called Rhino Entertainment (“Rhino”). Rhino specializes in marketing the Company’s music catalog through compilations and reissuances of previously released music and video titles, as well as in the licensing of tracks to/from third parties for various uses, including film and television soundtracks.

The Company’s principal recorded music distribution operations include Warner-Elektra-Atlantic Corporation (“WEA Corp.”), which primarily distributes the Company’s music products to retailers and wholesale distributors in the United States; a 90% interest in Alternative Distribution Alliance (“ADA”), a distribution company which primarily distributes the products of independent record labels to retailers and wholesale distributors; various distribution centers and ventures operated internationally; and an 80% interest in Word Entertainment, whose distribution operations specialize in the distribution of music products in the Christian retail marketplace.

The Company has signed a definitive agreement to acquire Ryko Corporation, a leading independent, integrated music and entertainment company. The acquisition is expected to close during the third quarter of fiscal 2006. See Note 3.

The Company plays an integral role in virtually all aspects of the music value chain from discovering and developing talent, to producing albums and promoting artists and their product. After an artist has entered into a contract with one of the Company’s record labels, a master recording of the artist’s music is created. The recording is then replicated for sale to consumers primarily in CD and digital formats. In the U.S., WEA Corp.

Warner Music Group Corp.

Notes to Consolidated Interim Financial Statements (Unaudited)—(Continued)

and ADA market, sell and deliver products, either directly or through sub-distributors and wholesalers, to thousands of record stores, mass merchants and other retailers throughout the country. Recorded music products are also sold in physical form to Internet physical retailers. In addition, the Internet and wireless networks have become increasingly important sales channels for records in non-physical forms.

In the U.S., the Company’s recorded music operations are conducted principally through its major record labels—Warner Bros. Records and The Atlantic Records Group. In markets outside the U.S., recorded music activities are conducted through the Warner Music International (“WMI”) division and its various subsidiaries, affiliates and non-affiliated licensees.

Music Publishing Operations

The Company’s music publishing business is focused on the exploitation of songs as intellectual property. In return for promoting, placing, marketing and administering the creative output of a songwriter, or engaging in those activities for other rightsholders, the Company’s music publishing business garners a share of the revenues generated. In addition to the more traditional methods, the Company has implemented new initiatives to promote and develop emerging songwriters. For example, the Company’s music publishing business has its own incubator label, Perfect Game Recording Co.

Warner/Chappell is the Company’s global music publishing company, headquartered in Los Angeles, with operations in over 50 countries through various subsidiaries, affiliates and non-affiliated licensees. The Company owns or controls rights to more than one million musical compositions, including numerous pop hits, American standards, folk songs and motion picture and theatrical compositions. The music publishing library includes many standard titles that span multiple music genres. Warner/Chappell also administers the music and soundtracks of several third-party television and film producers and studios, including Lucasfilm, Ltd. and Hallmark Entertainment.

The Company also previously owned Warner Bros. Publications (“WBP”), which printed and distributed a broad selection of sheet music, books and educational materials, orchestrations, folios, personality books, and arrangements from the catalogs of Warner/Chappell and other music publishers. On May 31, 2005, the Company sold WBP to Alfred Publishing. See Note 3.

Music publishing revenues are derived from four main sources:

•

Mechanical: the licensor receives royalties with respect to compositions embodied in recordings sold in any format or configuration, including singles, albums, CDs, digital downloads and mobile phone ringtones.

•

Performance: the licensor receives royalties when the composition is performed publicly (e.g., broadcast radio and television, movie theater, concert, nightclub or Internet and wireless streaming).

•

Synchronization: the licensor receives royalties or fees for the right to use the composition in combination with visual images (e.g., in films, television commercials and programs and videogames).

•

Other: the licensor receives royalties from other uses such as stage productions.

2. Basis of Presentation

Interim Financial Statements

The accompanying consolidated financial statements are unaudited but, in the opinion of management, contain all the adjustments (consisting of those of a normal recurring nature) considered necessary to present fairly the financial position and the results of operations and cash flows for the periods presented in conformity

Warner Music Group Corp.

Notes to Consolidated Interim Financial Statements (Unaudited)—(Continued)

with accounting principles generally accepted in the U.S. (“U.S. GAAP”) applicable to interim periods. The accompanying consolidated financial statements should be read in conjunction with the audited consolidated financial statements of the Company included in its Annual Report on Form 10-K (Registration No. 001-32502).

Recapitalization

As discussed above, on May 10, 2005, the Company sold 32,600,000 shares of its common stock in the Initial Common Stock Offering. In connection with the Initial Common Stock Offering, the Company (i) converted all its formerly outstanding shares of Class L Common Stock into shares of Class A Common Stock, (ii) renamed all of its formerly outstanding shares of Class A Common Stock as “common stock”, which had the effect of eliminating from the Company’s authorized capital stock the Class L Common Stock and Class A Common Stock and (iii) authorized an approximately 1,139 to 1 split of the Company’s common stock, (collectively, the “Recapitalization”).

Accordingly, historical financial statements have been restated to reflect the Recapitalization for all periods occurring after the Acquisition that was effective as of March 1, 2004. Such restatement primarily related to common stock and equivalent shares information, net income per common share computations and stock-based compensation disclosures.

Reclassifications

Certain reclassifications have been made to the prior period’s financial information in order to conform to the current period’s presentation.

Basis of Consolidation

The consolidated accounts include 100% of the assets, liabilities, revenues, expenses, income, losses and cash flows of the Company and all entities in which the Company has a controlling voting interest and/or variable interest entities required to be consolidated in accordance with U.S. GAAP. Significant intercompany balances and transactions have been eliminated in consolidation.

Short-term Investments

The Company considers all investments with maturities greater than three months, but less than one year, when purchased to be short-term investments. Short-term investments include high-quality, investment grade securities such as taxable auction rate securities as well as commercial paper and corporate bonds. Auction rate securities are classified as available for sale and are carried at fair value. Unrealized gains and losses on such securities are included in accumulated other comprehensive income (loss). Commercial paper and corporate bonds that the Company has both the positive intent and ability to hold to maturity are carried at cost and classified as held to maturity.

Stock-Based Compensation

In December 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123(R), “Share-Based Payment,” (“FAS 123(R)”) which revises FASB Statement No. 123, “Accounting for Stock-Based Compensation” (“FAS 123”). FAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized as compensation expense based on their fair value. Effective March 1, 2004, in connection with the Acquisition, the Company adopted the fair value recognition provisions of FAS 123 to account for all stock-based compensation plans adopted subsequent to the Acquisition. Under the fair value recognition provisions of FAS 123, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the vesting period. The Company expenses deferred stock- based compensation on an accelerated basis over the vesting period of the stock award. Effective October 1, 2005, the Company adopted FAS 123(R) using the modified prospective method. There was no impact to the Company’s results of operations or financial position as a result of the adoption of FAS 123(R).

Warner Music Group Corp.

Notes to Consolidated Interim Financial Statements (Unaudited)—(Continued)

Comprehensive (Loss) Income

Comprehensive (loss) income consists of net (loss) 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 and deferred gains and losses on financial instruments designated as hedges under FASB Statement No. 133, “Accounting for Derivative and Hedging Activities”, which include interest-rate swaps and foreign exchange contracts. The following summary sets forth the components of comprehensive (loss) income, net of related taxes, for the three and six months ended March 31, 2006 and 2005 (in millions):


	Three Months Ended March 31, 2006			Three Months Ended March 31, 2005		Six Months Ended March 31, 2006			Six Months Ended March 31, 2005
Net (loss) income	$	(7	)	$	4	$	62		$	40
Foreign currency translation gains (losses)		—			13		(2	)		(12	)
Derivative financial instruments gains		2			7		9			10

Comprehensive (loss) income	$	(5	)	$	24	$	69		$	38

Net Income (Loss) Per Common Share

The Company computes net income (loss) per common share in accordance with FASB Statement No. 128, “Earnings per Share” (“FAS 128”). Under the provisions of FAS 128, basic net income (loss) per common share is computed by dividing the net income (loss) applicable to common shares after preferred dividend requirements, if any, by the weighted average of common shares outstanding during the period. Diluted net income (loss) per common share adjusts basic net income (loss) per common share for the effects of stock options, warrants and other potentially dilutive financial instruments, only in the periods in which such effect is dilutive.

The following table sets forth the computation of basic and diluted net income (loss) per common share (in millions, except per share amounts):


	Three Months Ended March 31, 2006			Three Months Ended March 31, 2005			Six Months Ended March 31, 2006		Six Months Ended March 31, 2005
Basic and diluted net income (loss) per common share:
Numerator:
Net income (loss) for basic calculation	$	(7	)	$	4		$	62	$	40
Less: Unrealized gain on warrants		—			(39	)		—		(17	)

Net income (loss) for diluted calculation	$	(7	)	$	(35	)	$	62	$	23

Denominator:
Weighted average common shares outstanding for basic calculation (a)		141.9			107.7			141.7		107.6

Weighted average common outstanding shares for diluted calculation		141.9			123.5			150.6		119.6

Net income (loss) per common share—basic	$	(0.05	)	$	0.04		$	0.44	$	0.37

Net income (loss) per common share—diluted	$	(0.05	)	$	(0.28	)	$	0.41	$	0.19

(a)	The denominator excludes the effect of unvested common shares subject to repurchase or cancellation.

Warner Music Group Corp.

Notes to Consolidated Interim Financial Statements (Unaudited)—(Continued)

The calculation of diluted net income (loss) per share for each of the periods includes the effects of the assumed exercise of any outstanding stock options or warrants, and the assumed vesting of shares of restricted stock where dilutive. The assumed exercise of outstanding stock options and the assumed vesting of restricted stock represent the following dilutive effect (in millions of shares):


	Three Months Ended March 31, 2006	Three Months Ended March 31, 2005	Six Months Ended March 31, 2006	Six Months Ended March 31, 2005
Stock options	2.7	3.2	2.6	2.7
Restricted stock	6.2	6.9	6.3	6.8
Warrants	—	5.7	—	2.5

	8.9	15.8	8.9	12.0

The Company recognized a net loss for the three months ended March 31, 2006. Therefore, the effects from the assumed exercise of any outstanding stock options or warrants, or the assumed vesting of shares of restricted stock, during such period would be antidilutive. Accordingly, they have not been included in the presentation of diluted net income (loss) per share for the three months ended March 31, 2006.

See Note 19 in the Company’s audited consolidated financial statements for the year ended September 30, 2005 for a summary of the terms of the warrants that were issued to Time Warner in connection with the Acquisition. The Company repurchased the warrants from Time Warner in May 2005 for approximately $138 million.

3. Significant Acquisitions and Dispositions

Acquisition of Ryko Corporation

In March 2006, the Company entered into a definitive agreement to acquire Ryko Corporation (“Ryko”), a leading independent, integrated music and entertainment company, for approximately $67.5 million, subject to post-closing purchase price adjustments. Ryko consists of a recorded music label, Rykodisc, which focuses on a range of contemporary music and comedy releases and numerous film and television soundtracks and Ryko Distribution, which distributes music and DVD releases from Rykodisc as well as from independent third-party record and video labels. Additionally, Ryko owns a catalog of more than 1,000 titles of rock, folk, jazz, world, blues and alternative albums including Restless Records’ catalog of punk, new wave and soundtrack recordings. The catalog and roster includes artists such as Frank Zappa, Joe Jackson, Soul Asylum, The Flaming Lips and They Might Be Giants. Completion of the transaction is subject to customary closing conditions including regulatory clearances, and is expected to close in the third quarter of fiscal 2006. Under the purchase method of accounting the acquisition cost will be allocated to the underlying net assets based on their fair values, including identifiable intangible assets such as music catalog and artist contracts. The excess of the purchase price over the estimated fair value of the net assets acquired, if any, will be recorded primarily as goodwill.

Bad Boy Records LLC Joint Venture

On April 8, 2005, the Company entered into an agreement with an affiliate of Sean “Diddy” Combs to form Bad Boy Records LLC (“Bad Boy”), a joint venture, owned 50% by the Company and 50% by the affiliate. The Company purchased its 50% membership interest in Bad Boy Records LLC for approximately $30 million in cash. Mr. Combs is the CEO of the joint venture and supervises its staff and day-to-day operations. The Company provides funding, marketing, promotion and certain back-office services for the joint venture. The

Warner Music Group Corp.

Notes to Consolidated Interim Financial Statements (Unaudited)—(Continued)

transaction was accounted for under the purchase method of accounting, and the results of operations of Bad Boy are included in the Company’s results of operations from its acquisition date.

Sale of Warner Bros. Publications

In May 2005 the Company sold WBP, which conducted the Company’s sheet music operations, to Alfred Publishing. As part of the transaction, the Company agreed to license the right to use its music publishing copyrights in the exploitation of printed sheet music and songbooks for a twenty-year period of time. No gain or loss was recognized on the transaction as the historical book basis of the net assets being sold was adjusted to fair value in connection with the accounting for the Acquisition. Due to the Company’s continuing involvement with Warner Bros. Publications, it was not reported as discontinued operations.

The sale is not expected to have a material effect on the future operating results and financial condition of the Company. For the three months ended March 31, 2005, the operations sold generated revenues of approximately $11 million; an operating loss of $1 million; an operating loss before depreciation and amortization expense of $1 million; and a net loss of approximately $1 million. For the six months ended March 31, 2005, the operations sold generated revenues of approximately $26 million and had no operating income, operating income before depreciation and amortization expense, or net income.

Maverick

In November 2004, the Company acquired an additional 30% interest in Maverick Recording Company (“Maverick”) from its existing partner for approximately $17 million and certain amounts previously owed by such partner to the Company. The transaction was accounted for under the purchase method of accounting and the purchase price was allocated to the underlying net assets of Maverick in proportion to the estimated fair value, principally artist contracts and recorded music catalog. As part of the transaction, the Company and the remaining partner in Maverick entered into an agreement pursuant to which either party can elect to have the Company purchase the remaining 20% interest in Maverick that it does not own by December 2007.

4. Inventories

Inventories consist of the following (in millions):


	March 31, 2006			September 30, 2005
	(unaudited)			(audited)
Compact discs, cassettes and other music-related products	$	80		$	84
Published sheet music and song books		2			2

		82			86
Less reserve for obsolescence		(38	)		(34	)

	$	44		$	52

Warner Music Group Corp.

Notes to Consolidated Interim Financial Statements (Unaudited)—(Continued)

5. Intangible Assets

Intangible assets consist of the following (in millions):


	September 30, 2005			Acquisitions		Other (a)			March 31, 2006
	(audited)								(unaudited)
Intangible assets subject to amortization:
Record music catalog	$	1,242		$	4	$	(2	)	$	1,244
Music publishing copyrights		817			9		2			828
Artist contracts		31			4		—			35
Trademarks		10			—		—			10
Other intangible assets		4			—		—			4

		2,104			17		—			2,121
Accumulated amortization		(289	)							(384	)

Total net intangible assets subject to amortization		1,815								1,737
Intangible assets not subject to amortization:
Trademarks and brands		100								100

Total net other intangible assets	$	1,915							$	1,837

(a)	Other represents foreign currency translation adjustments.

6. Restructuring Costs

Acquisition-Related Restructuring Costs

As of March 31, 2006, the Company had approximately $36 million of liabilities for Acquisition-related restructuring costs that were recognized as part of the cost of the Acquisition. These liabilities represent estimates of future cash obligations for all restructuring activities that have been implemented, as well as for all restructuring activities that have been committed to by management but have yet to occur. The outstanding balance of these liabilities primarily relates to extended payment terms for severance obligations and long-term lease obligations for vacated facilities. These remaining lease obligations are expected to be settled by 2019. The Company expects to pay the majority of the remaining employee termination costs in fiscal 2006.


	Employee Terminations			Other Exit Costs			Total
	(in millions)
Liability as of September 30, 2005	$	14		$	35		$	49
Cash paid during the six months ended March 31, 2006		(7	)		(1	)		(8	)
Non-cash reductions during the six months ended March 31, 2006 (a)		—			(2	)		(2	)
Reversal of excess liabilities(b)		(1	)		(2	)		(3	)

Liability as of March 31, 2006	$	6		$	30		$	36

(a)	Principally relates to changes in foreign currency exchange rates and the non-cash write-off of the carrying value of advances relating to terminating certain artist, songwriter and co-publisher contracts.

(b)	Excess liabilities were reversed through the statement of operations.

Warner Music Group Corp.

Notes to Consolidated Interim Financial Statements (Unaudited)—(Continued)

7. Debt

The Company’s long-term debt consists of (in millions):


	March 31, 2006			September 30, 2005
	(unaudited)			(audited)
Senior secured credit facility:
Revolving credit facility	$	—		$	—
Term loan		1,422			1,430

		1,422			1,430
7.375% U.S. dollar-denominated Senior Subordinated Notes due 2014—Acquisition Corp		465			465
8.125% Sterling-denominated Senior Subordinated Notes due 2014—Acquisition Corp		174			177
9.5% Senior Discount Notes due 2014—Holdings		182			174

Total debt		2,243			2,246
Less current portion		(17	)		(17	)

Total long term debt	$	2,226		$	2,229

The Holdings Refinancing

In December 2004, Holdings issued $847 million principal amount at maturity of debt consisting of (i) $250 million principal amount of Floating Rate Senior Notes due 2011 (the “Holdings Floating Rate Notes”), (ii) $397 million principal amount at maturity of 9.5% Senior Discount Notes due 2014, which had an initial issuance discount of $147 million (the “Holdings Discount Notes”), and (iii) $200 million principal amount of Floating Rate Senior PIK Notes due 2014 (the “Holdings PIK Notes”, and collectively, the “Holdings Notes”), which had an initial discount of $4 million. The gross proceeds of $696 million received from the issuance of the Holdings Notes were used to (i) redeem the remaining shares of cumulative preferred stock of Holdings at a redemption price of $209 million, including $9 million of accrued and unpaid dividends, (ii) pay a return of capital to the Company’s shareholders in the aggregate amount of $472 million, and (iii) pay debt-related issuance costs of approximately $15 million.

The Holdings Redemption

In June 2005, using proceeds from the Company’s Initial Common Stock Offering and approximately $57 million of cash on hand, Holdings redeemed all of the Holdings Floating Rate Notes, all of the Holdings PIK Notes, and 35% of the aggregate outstanding principal at maturity of Holdings Discount Notes.

The Holdings Discount Notes were issued at a discount and have an initial accreted value of $630.02 per $1,000 principal amount at maturity. Prior to December 15, 2009, no cash interest payments are required. However, interest accrues on the Holdings Discount Notes in the form of an increase in the accreted value of such notes such that the accreted value of the Holdings Discount Notes will equal the principal amount at maturity on December 15, 2009. Thereafter, cash interest on the Holdings Discount Notes is payable semiannually at a fixed rate of 9.5% per annum. The Holdings Discount Notes mature on December 15, 2014. The Company redeemed 35% of the Holdings Discount Notes on June 15, 2005.

Parent has fully and unconditionally guaranteed the remaining Holdings Discount Notes. The Holdings Discount Notes are unsecured and subordinated to all of Holdings’ existing and future secured debt, including

Warner Music Group Corp.

Notes to Consolidated Interim Financial Statements (Unaudited)—(Continued)

Holdings’ guarantee of borrowings by Acquisition Corp. under the Company’s senior secured credit facility. In addition, the Holdings Discount Notes are structurally subordinated to the Senior Subordinated Notes of Acquisition Corp.

The indentures limit Holdings’ ability and the ability of its restricted subsidiaries to (i) incur additional indebtedness or issue certain preferred shares; (ii) pay dividends on or make other distributions in respect of its capital stock or make other restricted payments; (iii) make certain investments; (iv) sell certain assets; (v) create liens on certain debt without securing the notes; (vi) consolidate, merge, sell or otherwise dispose of all or substantially all of its assets; (vii) enter into certain transactions with affiliates; and (viii) designate its subsidiaries as unrestricted subsidiaries.

Restricted Net Assets

The Company is a holding company with no independent operations or assets other than through its interests in its subsidiaries, such as Holdings and Acquisition Corp. Accordingly, the ability of the Company to obtain funds from its subsidiaries is restricted by the senior secured facility of Acquisition Corp., the indenture for the Acquisition Corp. Senior Subordinated Notes and the indenture for the Holdings Notes.

8. Shareholders’ Equity

Return of Capital and Dividends Paid

In September 2004, the Company declared a $342 million dividend to its Class L common shareholders in the form of a note payable. The note payable was paid in October 2004 using proceeds received from a return of capital previously invested in Acquisition Corp.

In connection with the Holdings Refinancing, the Company paid a $465 million return of capital to its Class L common shareholders, of which $422 million was paid in December 2004 and $43 million was paid in March 2005. The remaining $7 million from the Holdings Refinancing was declared and paid as a dividend to the Company’s shareholders in May 2005.

On October 3, 2005, December 29, 2005 and March 14, 2006 the Company declared dividends on its outstanding common stock at a rate of $0.13 per share. The dividends were paid on November 23, 2005, February 17, 2006 and May 3, 2006, respectively, except for the portion of the dividends with respect to unvested restricted stock, which will be paid at such time as such shares become vested.

During the six months ended March 31, 2006, 1,244,822 shares of restricted stock purchased by or awarded to certain employees vested.

The following table represents the expense recorded by the Company with respect to its stock-based awards for the three and six month periods ended March 31, 2006 and 2005 by segment and on a consolidated basis (in millions):


	Three Months Ended March 31, 2006		Three Months Ended March 31, 2005		Six Months Ended March 31, 2006		Six Months Ended March 31, 2005
Recorded Music	$	1	$	4	$	4	$	6
Music Publishing		—		1		1		1
Corporate expenses		1		2		3		2

Total	$	2	$	7	$	8	$	9

9. Commitments and Contingencies

Radio Promotion Activities

In 2004 and 2005, the Attorney General of the State of New York served the Company with requests for information in connection with an industry-wide investigation of the relationship between music companies and

Warner Music Group Corp.

Notes to Consolidated Interim Financial Statements (Unaudited)—(Continued)

radio stations, including the use of independent promoters and accounting for any such payments. The investigation was pursuant to New York Executive Law §63(12) and New York General Business Law §349, both of which are consumer fraud statutes. On November 22, 2005, the Company reached a settlement with the Attorney General in connection with this investigation. As part of such settlement, the Company agreed to make $5 million in charitable payments and to abide by a list of permissible and impermissible promotional activities. On July 25, 2005, Sony BMG reached a settlement with the Attorney General in connection with the same industry-wide investigation. Subsequent to the Company’s settlement, two independent labels have filed related antitrust suits against the Company alleging that its radio promotion activities are anticompetitive. Radikal Records, Inc. v. Warner Music Group, et al. was filed on March 21, 2006 in U.S. District Court in the Central District of California, Western Division. TSR Records, Inc. v. Warner Music Group, et al. was filed on March 28, 2006 in U.S. District Court in the Central District of California, Western Division. The Company intends to defend against these lawsuits vigorously, but is unable to predict the outcome of these suits. Any litigation the Company may become involved in as a result of the settlement with the Attorney General, regardless of the merits of the claim, could be costly and divert the time and resources of management.

Pricing of Digital Music Downloads

On December 20, 2005 and February 3, 2006, the Attorney General of the State of New York served the Company with requests for information in the form of a subpoena duces tecum and subpoena ad testificandum in connection with an industry-wide investigation as to whether the practices of industry participants concerning the pricing of digital music downloads violate Section 1 of the Sherman Act, New York State General Business Law §§ 340 et seq., New York Executive Law §63(12), and related statutes. On February 28, 2006, the U.S. Department of Justice served the Company with a request for information in the form of a Civil Investigative Demand as to whether its activities relating to the pricing of digitally downloaded music violate Section 1 of the Sherman Act (15 U.S.C. Section 1). The Company intends to fully cooperate with the Attorney General’s and Department of Justice’s industry-wide inquiries. Subsequent to the announcements of the above governmental investigations, the Company has been named in a total of fourteen class action lawsuits (five in New York, eight in California and one in Washington D.C.) related to the pricing of digital music downloads, which are expected to be consolidated into one case. The lawsuits are all based on the same general subject matter as the Attorney General’s request for information alleging conspiracy among record companies to fix prices for downloads. The complaints generally seek unspecified compensatory, statutory and treble damages. The Company intends to defend against these lawsuits vigorously, but is unable to predict the outcome of these suits. Any litigation the Company may become involved in as a result of the inquiries of the Attorney General and Department of Justice, regardless of the merits of the claim, could be costly and divert the time and resources of management.

Other Matters

In addition to the matters discussed above, the Company is involved in other litigation arising in the normal course of our business. Management does not believe that any legal proceedings pending against the Company will have, individually, or in the aggregate, a material adverse effect on its business. However, the Company cannot predict with certainty the outcome of any litigation or the potential for future litigation. Regardless of the outcome, litigation can have an adverse impact on the Company, including its brand value, because of defense costs, diversion of management resources and other factors.

10. Derivative Financial Instruments

During the six months ended March 31, 2006, the Company did not enter into additional interest rate swap agreements to hedge the variability of its expected future cash interest payments or any new foreign currency hedge programs. As of March 31, 2006, the Company had interest rate swap agreements to hedge a total notional

Warner Music Group Corp.

Notes to Consolidated Interim Financial Statements (Unaudited)—(Continued)

debt amount of $897 million and recorded deferred gains in comprehensive income of $16 million. Additionally, as of March 31, 2006 the Company had approximately $1 million of deferred net gains in comprehensive income related to foreign currency hedging.

The Company recorded unrealized gains of $39 million and $17 million on the stock warrants issued to Historic Time Warner in connection with the Acquisition for the three-months and six-months ended March 31, 2005. On May 16, 2005, the Company repurchased the three-year warrants from Time Warner at a cost of approximately $138 million, which approximated fair value at that date.

11. Segment Information

As discussed more fully in Note 1, based on the nature of its products and services, the Company classifies its business interests into two fundamental areas: recorded music and music publishing. Information as to each of these operations is set forth below.

The Company evaluates performance based on several factors, of which the primary financial measure is operating income (loss) before non-cash depreciation of tangible assets and non-cash amortization of intangible assets (“OIBDA”). The Company has supplemented its analysis of OIBDA results by segment with an analysis of operating income (loss) by segment.

The Company accounts for inter-segment sales at fair value as if the sales were to third parties. While intercompany transactions are treated like third-party transactions to determine segment performance, the revenues (and corresponding expenses recognized by the segment that is counterparty to the transaction) are eliminated in consolidation and, therefore, do not themselves impact consolidated results.


	Three Months Ended March 31, 2006			Three Months Ended March 31, 2005			Six Months Ended March 31, 2006			Six Months Ended March 31, 2005
	(in millions)
Revenues
Recorded music	$	676		$	621		$	1,596		$	1,561
Music publishing		129			154			260			309
Corporate expenses and eliminations		(9	)		(8	)		(16	)		(15	)

Total revenues	$	796		$	767		$	1,840		$	1,855


	Three Months Ended March 31, 2006			Three Months Ended March 31, 2005			Six Months Ended March 31, 2006			Six Months Ended March 31, 2005
	(in millions)
OIBDA
Recorded music	$	81		$	72		$	287		$	266
Music publishing		47			47			68			71
Corporate expenses and eliminations		(24	)		(31	)		(49	)		(59	)

Total OIBDA	$	104		$	88		$	306		$	278


	Three Months Ended March 31, 2006		Three Months Ended March 31, 2005		Six Months Ended March 31, 2006		Six Months Ended March 31, 2005
	(in millions)
Depreciation of Property, Plant and Equipment
Recorded music	$	7	$	9	$	14	$	18
Music publishing		1		1		2		2
Corporate expenses and eliminations		3		4		6		8

Total depreciation	$	11	$	14	$	22	$	28

Warner Music Group Corp.

Notes to Consolidated Interim Financial Statements (Unaudited)—(Continued)


	Three Months Ended March 31, 2006			Three Months Ended March 31, 2005			Six Months Ended March 31, 2006			Six Months Ended March 31, 2005
	(in millions)
Amortization of Intangibles Assets
Recorded music	$	34		$	33		$	67		$	66
Music publishing		14			14			28			27
Corporate expenses and eliminations		—			—			—			—

Total amortization	$	48		$	47		$	95		$	93


	Three Months Ended March 31, 2006			Three Months Ended March 31, 2005			Six Months Ended March 31, 2006			Six Months Ended March 31, 2005
	(in millions)
Operating Income (Loss)
Recorded music	$	40		$	30		$	206		$	182
Music publishing		32			32			38			42
Corporate expenses and eliminations		(27	)		(35	)		(55	)		(67	)

Total operating income	$	45		$	27		$	189		$	157


	Three Months Ended March 31, 2006			Three Months Ended March 31, 2005			Six Months Ended March 31, 2006			Six Months Ended March 31, 2005
	(in millions)
Reconciliation of OIBDA to Operating Income
OIBDA	$	104		$	88		$	306		$	278
Depreciation expense		(11	)		(14	)		(22	)		(28	)
Amortization expense		(48	)		(47	)		(95	)		(93	)

Operating income	$	45		$	27		$	189		$	157

12. Additional Financial Information

Cash Interest and Taxes

The Company made interest payments of approximately $71 million during the six months ended March 31, 2006 and $66 million during the six months ended March 31, 2005. The Company paid approximately $26 million and $23 million of income and withholding taxes in the six months ended March 31, 2006 and 2005, respectively. The Company received $4 million and $9 million of income tax refunds in the six months ended March 31, 2006 and 2005, respectively.

Non-cash Transactions

There were no significant non-cash investing and financing activities during the six months ended March 31, 2006 and 2005.

13. Subsequent Event

Certain of the stock options and restricted shares of common stock awarded by the Company vest upon the occurrence of a 3x liquidity event, which is defined with respect to the awards as the occurrence of an event that implies an aggregate value for the equity held by the Investor Group of 3x its initial value, as adjusted for prior dividends or other returns of capital received. In April 2006, the 3x liquidity event, as defined, occurred, which resulted in the vesting of 1,169,932 shares of restricted common stock awarded to or purchased by employees of the Company and 516,719 stock options awarded to employees of the Company. In addition, the Company paid out accrued dividends owed to restricted stockholders of $1.3 million upon the occurrence of the 3x liquidity event and the subsequent vesting of their restricted shares. In accordance with the requirements of FAS 123(R), the Company recognizes the compensation for these awards over the employee’s requisite service period. Accordingly, there is no impact of this event to the Company’s statement of operations.

WARNER MUSIC GROUP CORP.

Supplementary Information

Condensed Consolidating Financial Statements of Registrant

The Company is the direct parent of Holdings, which is the direct parent of Acquisition Corp.

Holdings has issued and outstanding the Holdings Discount Notes. The Holdings Discount Notes are guaranteed by the Company. These guarantees are full, unconditional, joint and several. The following condensed consolidating financial statements are presented for the information of the holders of the Holdings Discount Notes and present the results of operations, financial position and cash flows of (i) the Company, which is the guarantor of the Holdings Discount Notes, (ii) Holdings, which is the issuer of the Holdings Discount Notes, (iii) the subsidiaries of Holdings and (iv) the eliminations necessary to arrive at the information for the Company on a consolidated basis. Investments in consolidated subsidiaries are presented under the equity method of accounting.

The Company and Holdings are holding companies that conduct substantially all their business operations through Acquisition Corp. Accordingly, the ability of the Company to obtain funds from its subsidiaries is restricted by the senior secured credit facility of Acquisition Corp., the indenture for the Senior Subordinated Notes issued by Acquisition Corp., and the indenture for the Holdings Notes.

WARNER MUSIC GROUP CORP.

Supplementary Information

Condensed Consolidating Balance Sheet (unaudited)

March 31, 2006


	Warner Music Group Corp.			WMG Holdings Corp. (issuer)		WMG Acquisition Corp.		Eliminations			Warner Music Group Corp. Consolidated
	(in millions)
Assets:
Current assets:
Cash and equivalents	$	48		$	—	$	311	$	—		$	359
Short-term investments		34			—		27		—			61
Accounts receivable, net		—			—		530		—			530
Due from (to) affiliates		(1	)		—		1		—			—
Inventories		—			—		44		—			44
Royalty advances expected to be recouped within one year		—			—		196		—			196
Deferred tax assets		—			—		32		—			32
Other current assets		—			—		56		—			56

Total current assets		81			—		1,197		—			1,278
Royalty advances expected to be recouped after one year		—			—		196		—			196
Investments in and advances to (from) consolidated subsidiaries		56			234		24		(290	)		24
Property, plant and equipment		—			—		147		—			147
Goodwill		—			—		876		—			876
Intangible assets subject to amortization		—			—		1,737		—			1,737
Intangible assets not subject to amortization		—			—		100		—			100
Other assets		—			4		102		—			106

Total assets	$	137		$	238	$	4,379	$	(290	)	$	4,464

Liabilities and Shareholders’ Equity:
Current liabilities:
Accounts payable	$	—		$	—	$	211	$	—		$	211
Accrued royalties		—			—		1,088		—			1,088
Taxes and other withholdings		—			—		43		—			43
Current portion of long-term debt		—			—		17		—			17
Dividends payable		20			—		—		—			20
Other current liabilities		—			—		327		—			327

Total current liabilities		20			—		1,686		—			1,706
Long-term debt		—			182		2,044		—			2,226
Dividends payable		6			—		—		—			6
Deferred tax liabilities, net		—			—		192		—			192
Other noncurrent liabilities		2			—		223		—			225

Total liabilities		28			182		4,145		—			4,355
Total shareholders’ equity		109			56		234		(290	)		109

Total liabilities and shareholders’ equity	$	137		$	238	$	4,379	$	(290	)	$	4,464

WARNER MUSIC GROUP CORP.

Supplementary Information

Condensed Consolidating Balance Sheet (audited)

September 30, 2005


	Warner Music Group Corp.		WMG Holdings Corp. (issuer)			WMG Acquisition Corp.		Eliminations			Warner Music Group Corp. Consolidated
	(in millions)
Assets:
Current assets:
Cash and equivalents	$	40	$	1		$	247	$	—		$	288
Accounts receivable, net		—		—			637		—			637
Due (to) from affiliates		15		(23	)		8		—			—
Inventories		—		—			52		—			52
Royalty advances expected to be recouped within one year		—		—			190		—			190
Deferred tax assets		—		—			36		—			36
Other current assets		—		—			39		—			39

Total current assets		55		(22	)		1,209		—			1,242
Royalty advances expected to be recouped after one year		—		—			190		—			190
Investments in and advances to (from) consolidated subsidiaries		43		235			—		(278	)		—
Investments		—		—			21		—			21
Property, plant and equipment		—		—			157		—			157
Goodwill		—		—			869		—			869
Intangible assets subject to amortization		—		—			1,815		—			1,815
Intangible assets not subject to amortization		—		—			100		—			100
Other assets		—		4			100		—			104

Total assets	$	98	$	217		$	4,461	$	(278	)	$	4,498

Liabilities and Shareholders’ Equity:
Current liabilities:
Accounts payable	$	1	$	—		$	246	$	—		$	247
Accrued royalties		—		—			1,057		—			1,057
Taxes and other withholdings		—		—			23		—			23
Current portion of long-term debt		—		—			17		—			17
Other current liabilities		1		—			403		—			404

Total current liabilities		2		—			1,746		—			1,748
Long-term debt		—		174			2,055		—			2,229
Dividends payable		5		—			—		—			5
Deferred tax liabilities, net		—		—			201		—			201
Other noncurrent liabilities		2		—			224		—			226

Total liabilities		9		174			4,226		—			4,409
Total shareholders’ equity		89		43			235		(278	)		89

Total liabilities and shareholders’ equity	$	98	$	217		$	4,461	$	(278	)	$	4,498

WARNER MUSIC GROUP CORP.

Supplementary Information

Condensed Consolidating Statements of Operations (unaudited)

For The Three Months Ended March 31, 2006 and March 31, 2005


	Three months ended March 31, 2006
	Warner Music Group Corp.			WMG Holdings Corp. (issuer)			WMG Acquisition Corp.			Eliminations		Warner Music Group Corp. Consolidated
	(in millions)
Revenues	$	—		$	—		$	796		$	—	$	796
Costs and expenses:
Cost of revenues		—			—			(409	)		—		(409	)
Selling, general and administrative expenses		—			—			(294	)		—		(294	)
Amortization of intangible assets		—			—			(48	)		—		(48	)

Total costs and expenses		—			—			(751	)		—		(751	)

Operating income		—			—			45			—		45
Interest expense, net		—			(4	)		(41	)		—		(45	)
Equity in the gains (losses) of equity method investees		—			—			1			—		1
Equity in the gains (losses) of consolidated subsidiaries		(7	)		(3	)		—			10		—
Other income, net					—			2					2

Income before income taxes		(7	)		(7	)		7			10		3
Income tax expense		—			—			(10	)		—		(10	)

Net (loss) income	$	(7	)	$	(7	)	$	(3	)	$	10	$	(7	)


	Three months ended March 31, 2005
	Warner Music Group Corp.		WMG Holdings Corp. (issuer)			WMG Acquisition Corp.			Eliminations			Warner Music Group Corp. Consolidated
	(in millions)
Revenues	$	—	$	—		$	767		$	—		$	767
Costs and expenses:
Cost of revenues		—		—			(400	)		—			(400	)
Selling, general and administrative expenses		—		—			(293	)		—			(293	)
Amortization of intangible assets		—		—			(47	)		—			(47	)

Total costs and expenses		—		—			(740	)		—			(740	)

Operating income		—		—			27			—			27
Interest expense, net		—		(17	)		(35	)		—			(52	)
Equity in the gains (losses) of consolidated subsidiaries		35		18			—			(53	)		—
Unrealized losses on warrants		39		—			—			—			39
Minority interest		—		—			—			—			—
Other income, net		—		—			—			—			—

Income before income taxes		74		1			(8	)		(53	)		14
Income tax expense		—		—			(10	)		—			(10	)

Net income (loss)	$	74	$	1		$	(18	)	$	(53	)	$	4

WARNER MUSIC GROUP CORP.

Supplementary Information

Condensed Consolidating Statements of Operations (unaudited)

For The Six Months Ended March 31, 2006 and March 31, 2005


	Six months ended March 31, 2006
	Warner Music Group Corp.		WMG Holdings Corp. (issuer)			WMG Acquisition Corp.			Eliminations			Warner Music Group Corp. Consolidated
	(in millions)
Revenues	$	—	$	—		$	1,840		$	—		$	1,840
Costs and expenses:
Cost of revenues		—		—			(939	)		—			(939	)
Selling, general and administrative expenses		—		—			(617	)		—			(617	)
Amortization of intangible assets		—		—			(95	)		—			(95	)

Total costs and expenses		—		—			(1,651	)		—			(1,651	)

Operating income		—		—			189			—			189
Interest expense, net		—		(8	)		(82	)		—			(90	)
Equity in the gains (losses) of equity method investees		—		—			1			—			1
Equity in the gains (losses) of consolidated subsidiaries		62		70			—			(132	)		—
Other income, net		—		—			2			—			2

Income before income taxes		62		62			110			(132	)		102
Income tax expense		—		—			(40	)		—			(40	)

Net income (loss)	$	62	$	62		$	70		$	(132	)	$	62


	Six months ended March 31, 2005
	Warner Music Group Corp.			WMG Holdings Corp. (issuer)			WMG Acquisition Corp.			Eliminations			Warner Music Group Corp. Consolidated
	(in millions)
Revenues	$	—		$	—		$	1,855		$	—		$	1,855
Costs and expenses:
Cost of revenues		—			—			(981	)		—			(981	)
Selling, general and administrative expenses		—			—			(624	)		—			(624	)
Amortization of intangible assets		—			—			(93	)		—			(93	)

Total costs and expenses		—			—			(1,698	)		—			(1,698	)

Operating income		—			—			157			—			157
Interest expense, net		(1	)		(18	)		(71	)		—			(90	)
Equity in the gains (losses) of equity method investees, net		—			—			(1	)		—			(1	)
Equity in the gains (losses) of consolidated subsidiaries		24			47			—			(71	)		—
Unrealized losses on warrants		17						—			—			17
Minority interest		(5	)		—			—			—			(5	)
Other income, net		—			—			4			—			4

Income before income taxes		35			29			89			(71	)		82
Income tax expense		—			—			(42	)		—			(42	)

Net income (loss)	$	35		$	29		$	47		$	(71	)	$	40

WARNER MUSIC GROUP CORP.

Supplementary Information

Condensed Consolidating Statement of Cash Flows (unaudited)

For The Six Months Ended March 31, 2006


	Warner Music Group Corp.			WMG Holdings Corp. (issuer)			WMG Acquisition Corp.			Eliminations			Consolidated
	(in millions)
Cash flows from operating activities:
Net income	$	62		$	62		$	70		$	(132	)	$	62
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		—			—			117			—			117
Non-cash interest expense		—			8			18			—			26
Non-cash stock compensation expense		—			—			8			—			8
Deferred taxes		—			—			(2	)		—			(2	)
Equity in the losses of equity-method investees, including distributions		—			—			(1	)		—			(1	)
Equity in the losses of consolidated subsidiaries		(62	)		(70	)		—			132			—
Changes in operating assets and liabilities:
Accounts receivable		—			—			108			—			108
Inventories		—			—			8			—			8
Royalty advances		—			—			(29	)		—			(29	)
Accounts payable and accrued liabilities		—			—			(66	)		—			(66	)
Other balance sheet changes		—			—			(26	)		—			(26	)

Net cash provided by operating activities		—			—			205			—			205

Cash flows from investing activities:
Investments and acquisitions		—			—			(18	)		—			(18	)
Investments in short term investments		(34	)		—			(27	)		—			(61	)
Capital expenditures		—			—			(12	)		—			(12	)

Net cash used in investing activities		(34	)		—			(57	)		—			(91	)

Cash flows from financing activities:
Quarterly debt repayments		—			—			(8	)		—			(8	)
Capital contributions received/paid		(3	)		3			—			—			—
Increase in intercompany		—			(8	)		8			—			—
Returns of capital and dividends paid		45			4			(86	)		—			(37	)

Net cash used in financing activities		42			(1	)		(86	)		—			(45	)

Effect of foreign currency exchange rate changes on cash		—			—			2			—			2

Net increase (decrease) in cash and equivalents		8			(1	)		64			—			71
Cash and equivalents at beginning of period		40			1			247			—			288

Cash and equivalents at end of period	$	48		$	—		$	311		$	—		$	359

WARNER MUSIC GROUP CORP.

Supplementary Information

Condensed Consolidating Statement of Cash Flows (unaudited)

For The Six Months Ended March 31, 2005


	Warner Music Group Corp.			WMG Holdings Corp. (issuer)			WMG Acquisition Corp.			Eliminations			Consolidated
	(in millions)
Cash flows from operating activities:
Net income	$	35		$	29		$	47		$	(71	)	$	40
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		—			—			121			—			121
Non-cash interest expense		—			13			17			—			30
Non-cash stock compensation expense		—			—			9			—			9
Deferred taxes		—			—			2			—			2
Equity in the (income) losses of equity-method investees, including distributions		—			—			1			—			1
Equity in the (gains) losses of consolidated subsidiaries		(24	)		(47	)		—			71			—
Unrealized gain on warrants		(17	)		—			—			—			(17	)
Minority interest expense		5			—			—			—			5
Changes in operating assets and liabilities:
Accounts receivable		—			—			103			—			103
Inventories		—			—			1			—			1
Royalty advances		—			—			9			—			9
Accounts payable and accrued liabilities		—			1			(23	)		—			(22	)
Other balance sheet changes		—			—			10			—			10

Net cash provided by operating activities		(1	)		(4	)		297			—			292

Cash flows from investing activities:
Investments and acquisitions		—			—			(48	)		—			(48	)
Investment proceeds		—			—			1			—			1
Capital expenditures		—			—			(14	)		—			(14	)

Net cash used in investing activities		—			—			(61	)		—			(61	)

Cash flows from financing activities:
Borrowings		—			696			—			—			696
Financing costs of borrowings		—			(17	)		—			—			(17	)
Debt repayments		—			—			(6	)		—			(6	)
Proceeds from the issuance of restricted shares		1			—			—			—			1
Repurchase of subsidiary preferred stock					(209	)		—			—			(209	)
Return of capital and dividends paid		(807	)		(816	)		(344	)		1,160			(807	)
Return of capital received		816			344			—			(1,160	)		—
Change in intercompany		(2	)		6			(4	)		—			—

Net cash used in financing activities		8			4			(354	)		—			(342	)

Effect of foreign currency exchange rate changes on cash		—			—			3			—			3
Net increase (decrease) in cash and equivalents		7			—			(115	)		—			(108	)

Cash and equivalents at beginning of period		—			—			555			—			555
Cash and equivalents at end of period	$	7		$	—		$	440		$	—		$	447

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion of our results of operations and financial condition with the unaudited interim financial statements included elsewhere in this Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2006 (the “Quarterly Report”). This discussion contains forward-looking statements and involves numerous risks and uncertainties. Actual results may differ materially from those contained in any forward-looking statements.

We make available on our Internet website free of charge our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K as soon as practicable after we electronically file such reports with the SEC. Our website address is www.wmg.com. The information contained in our website is not incorporated by reference in this Quarterly Report.

“SAFE HARBOR” STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

This Quarterly Report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical facts included in this Quarterly Report, including, without limitation, statements regarding our future financial position, business strategy, budgets, projected costs, savings and plans and objectives of management for future operations, are forward-looking statements. In addition, forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe” or “continue” or the negative thereof or variations thereon or similar terminology. Such statements include, among others, statements regarding our ability to develop talent and attract future talent, to reduce future capital expenditures, to monetize our music content, including through new distribution channels and formats, to effectively deploy our capital, the development of digital music and the effect of digital distribution channels on our business, including whether or not the Internet will become an important sales channel and whether we will be able to achieve higher margins from digital sales, our success in limiting piracy, our ability to compete in the highly competitive markets in which we operate, the growth of the music industry and the effect of our and the music industry’s efforts to combat piracy on the industry, our intention to pay regular quarterly dividends, the adequacy of our existing sources of cash to support our existing operations the next twelve months and the effect of litigation and other investigations on us. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct.

There are a number of risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements contained in this Quarterly Report. Additionally important factors could cause our actual results to differ materially from the forward-looking statements we make in this Quarterly Report. As stated elsewhere in this Quarterly Report, such risks, uncertainties and other important factors include, among others:

•

the impact of our substantial leverage on our ability to raise additional capital to fund our operations, on our ability to react to changes in the economy or our industry and on our ability to meet our obligations under our indebtedness;

•

the decline over the past five years in the global physical recorded music industry and the rate of overall decline in the music industry;

•

our ability to continue to identify, sign and retain desirable talent at manageable costs;

•

the threat posed to our business by piracy of music by means of home CD-R activity and Internet peer-to-peer file-sharing;

•

the significant threat posed to our business and the music industry by organized industrial piracy;

•

the popular demand for particular recording artists and/or songwriters and albums and the timely completion of albums by major recording artists and/or songwriters;

•

the diversity and quality of our portfolio of songwriters;

•

the diversity and quality of our album releases;

•

significant fluctuations in our results of operations and cash flows due to the nature of our business;

•

our involvement in intellectual property litigation;

•

the possible downward pressure on our pricing and profit margins;

•

the seasonal and cyclical nature of recorded music sales;

•

our ability to continue to enforce our intellectual property rights in digital environments;

•

the ability to develop a successful business model applicable to a digital environment;

•

the ability to maintain product pricing in a competitive environment;

•

the impact of heightened and intensive competition in the recorded music and music publishing businesses and our inability to execute our business strategy;

•

risks associated with our non-U.S. operations, including limited legal protections of our intellectual property rights and restrictions on the repatriation of capital;

•

the impact of legitimate music distribution on the Internet or the introduction of other new music distribution formats;

•

the impact of rate regulations on our music publishing business;

•

the impact of rates on other income streams that may be set by arbitration proceedings on our business;

•

risks associated with the fluctuations in foreign currency exchange rates;

•

our ability and the ability of our joint venture partners to operate our existing joint ventures satisfactorily;

•

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

•

potential loss of catalog if it is determined that recording artists have a right to recapture recordings under the U.S. Copyright Act;

•

changes in law and government regulations;

•

legal or other developments related to pending litigation or investigations by the Attorney General of the State of New York and the Department of Justice;

•

trends that affect the end uses of our musical compositions (which include uses in broadcast radio and television, film and advertising businesses);

•

the growth of other products that compete for the disposable income of consumers;

•

risks inherent in relying on one supplier for manufacturing, packaging and distribution services in North America and Europe;

•

risks inherent in our acquiring or investing in other businesses;

•

the possibility that our owners’ interests will conflict with ours or yours;

•

our ability to act as a stand-alone company;

•

increased costs and diversion of resources associated with complying with the internal control reporting or other requirements of Sarbanes-Oxley;

•

weaknesses in our internal controls related to U.S. royalties that could affect our ability to ensure reliable financial reports;

•

the effects associated with the formation of Sony BMG Music Entertainment; and

•

failure to attract and retain key personnel.

There may be other factors not presently known to us or which we currently consider to be immaterial that may cause our actual results to differ materially from the forward-looking statements.

All forward-looking statements attributable to us or persons acting on our behalf apply only as of the date of this Quarterly Report and are expressly qualified in their entirety by the cautionary statements included in this Quarterly Report. We disclaim any duty to publicly update or revise forward-looking statements to reflect events or circumstances after the date made or to reflect the occurrence of unanticipated events.

INTRODUCTION

Warner Music Group Corp. (the “Company” or “Parent”) was formed by a private equity consortium of Investors (the “Investor Group”) 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 the successor to substantially all of the interests of the recorded music and music publishing businesses of Time Warner Inc. (“Time Warner”). Effective March 1, 2004, Acquisition Corp. acquired such interests from Time Warner for approximately $2.6 billion (the “Acquisition”).

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

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

•

Overview. This section provides a general description of our business, as well as recent developments that we believe are important in understanding our results of operations and financial condition and in anticipating future trends.

•

Results of operations. This section provides an analysis of our results of operations for the three and six months ended March 31, 2006 and 2005. This analysis is presented on both a consolidated and segment basis.

•

Financial condition and liquidity. This section provides an analysis of our cash flows for the six months ended March 31, 2006 and 2005, as well as a discussion of our financial condition and liquidity as of March 31, 2006. The discussion of our financial condition and liquidity includes (i) our available financial capacity under the revolving credit portion of our senior secured credit facility and (ii) a summary of our key debt compliance measures under our debt agreements.

Use of OIBDA

We evaluate our operating performance based on several factors, including our primary financial measure of operating income (loss) before non-cash depreciation of tangible assets and non-cash amortization of intangible assets (which we refer to as “OIBDA”). We consider OIBDA to be an important indicator of the operational strengths and performance of our businesses, including the ability to provide cash flows to service debt. However, a limitation of the use of OIBDA as a performance measure is that it does not reflect the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in our businesses. Accordingly, OIBDA should be considered in addition to, not as a substitute for, operating income (loss), net income (loss) and other measures of financial performance reported in accordance with U.S. GAAP.

OVERVIEW

Description of Business

We are one of the world’s major music content companies. Effective as of March 1, 2004, substantially all of Time Warner’s music division was acquired from Time Warner by us for approximately $2.6 billion.

We classify our business interests into two fundamental areas: Recorded Music and Music Publishing. A brief description of each of those operations is presented below.

Our business is seasonal. Therefore, operating results for the three and six month periods ended March 31, 2006 are not necessarily indicative of the results that may be expected for fiscal 2006.

Recorded Music Operations

Our Recorded Music business consists of the discovery and development of artists and the related marketing, distribution and licensing of recorded music produced by such artists. In the U.S., our operations are conducted principally through our major record labels—Warner Bros. Records Inc. and The Atlantic Records Group. Internationally, our Recorded Music operations are conducted through our Warner Music International division (“WMI”), which includes various subsidiaries, affiliates and non-affiliated licensees in more than 50 countries outside the United States. In addition to the more traditional methods of discovering and developing artists, we have implemented new initiatives to identify and nurture artists earlier in the development process and reduce development costs by leveraging our independent distribution network. We refer to these new business models as incubator initiatives. Asylum and East West are the current recorded music incubator labels. In addition, we have recently launched Cordless Recordings, an “e-label” that gives its artists the ability to come to market with one or several songs in the digital formats without the need to create an entire album. Asylum, East West and Cordless Recordings make up our Independent Label Group (“ILG”). We have also entered into strategic ventures with other record labels.

Our Recorded Music operations also include a catalog division named Rhino Entertainment (“Rhino”). Rhino specializes in marketing our music catalog through compilations and reissuances of previously released music and video titles, as well as in the licensing of recordings to/from third parties for various uses, including film and television soundtracks.

Our principal Recorded Music distribution operations include Warner-Elektra-Atlantic Corporation (“WEA Corp.”), which primarily markets and sells music products to retailers and wholesale distributors in the U.S.; a 90% interest in Alternative Distribution Alliance, an distribution company that primarily distributes the products of independent labels to retail and wholesale distributors in the United States; various distribution centers and ventures operated internationally; and an 80% interest in Word Entertainment, whose distribution operations specialize in the distribution of music products in the Christian retail marketplace.

We have signed a definitive agreement to acquire Ryko Corporation, a leading independent, integrated music and entertainment company. The acquisition is expected to close during the third quarter of fiscal 2006.

Our principal recorded music revenue sources are sales of CDs, digital downloads and other recorded music products and license fees received for the ancillary uses of our recorded music catalog. The principal costs associated with our Recorded Music operations are as follows:

•

artist and repertoire costs—the costs associated with (i) signing and developing artists, (ii) creating master recordings in the studio, (iii) creating artwork for album covers and liner notes and (iv) paying royalties to artists, producers, songwriters, other copyright holders and trade unions;

•

manufacturing, packaging and distribution costs—the costs to manufacture and distribute product to wholesale and retail distribution outlets;

•

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

•

administration costs—the costs associated with general overhead and other administrative costs, as well as costs associated with anti-piracy initiatives.

Music Publishing Operations

Our Music Publishing operations include Warner/Chappell Music, Inc. and its wholly owned subsidiaries, and certain other music publishing affiliates. We own or control the rights to more than one million musical compositions, including numerous pop music hits, American standards, folk songs and motion picture and theatrical compositions. Our Music Publishing operations also formerly included Warner Bros. Publications (“WBP”), which marketed printed versions of our music throughout the world. On May 31, 2005, we sold WBP to Alfred Publishing. The sale is not expected to have a material effect on our future operating results and financial condition. In addition to the more traditional methods, we have implemented new initiatives to promote and develop emerging songwriters. For example, our music publishing business has its own incubator label, Perfect Game Recording Co.

Publishing revenues are derived from four main sources:

•

Performance: the licensor receives royalties if the composition is performed publicly (e.g., broadcast radio and television, movie theater, concert, nightclub or Internet and wireless streaming).

•

Synchronization: the licensor receives royalties or fees for the right to use the composition in combination with visual images (e.g., in films, television commercials and programs and videogames).

•

Other: the licensor receives royalties from other uses such as stage productions.

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

•

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

•

administration costs—the costs associated with general overhead and other administrative costs.

Factors Affecting Results of Operations and Financial Condition

Market Factors

Over the past five years, the recorded music industry has been unstable, which has adversely affected our operating results. The industry-wide decline can be attributed primarily to digital piracy. Other drivers of this decline are the bankruptcies of record retailers and wholesalers, growing competition for consumer discretionary spending and retail shelf space, and the maturation of the CD format, which has slowed the historical growth pattern of recorded music sales. However, new avenues for selling recorded music product have been created, including the legal downloading of digital music using the Internet and DVD-Audio formats and the distribution of music on mobile devices, and revenue streams from these new sources are beginning to emerge. As reported by the International Federation of the Phonographic Industry (IFPI), sales of music via the Internet and mobile phones generated sales of $1.1 billion for record companies in 2005, up from $380 million in the prior year. As of April 30, 2006, year-to-date U.S. recorded music sales (excluding sales of digital tracks) are down approximately 2.03% year-over-year. However, sales of music through new avenues are beginning to offset the declines seen in prior years. It is too soon to determine if the industry has stabilized or the impact of sales of

music through new channels might have on the industry and the recorded music industry performance may continue to negatively impact our operating results. In addition, a declining recorded music industry could continue to have an adverse impact on the music publishing business. This is because our music publishing business generates a significant portion of its revenues from mechanical royalties received from the sale of music in CD and other recorded music formats.

Restructuring

Due in part to the development of the new channels mentioned above and ongoing anti-piracy initiatives, we believe that the recorded music industry is positioned to improve over the coming years. However, the industry may relapse into a period of decline. In addition, there can be no assurances as to the timing or the extent of any improvement in the industry. Accordingly, in connection with the Acquisition, we executed a number of cost-saving initiatives in an attempt to realign our cost structure with the changing economics of the industry. These initiatives, primarily implemented in fiscal 2004 and the first half of fiscal 2005, included significant headcount reductions from the consolidation of operations and the streamlining of corporate and label overhead, exiting certain leased facilities in an effort to consolidate locations and the sale of our manufacturing, packaging and physical distribution operations. We completed substantially all of our restructuring efforts in fiscal 2005.

Initial Common Stock Offering

In May 2005, we completed the initial public offering of our common stock (the “Initial Common Stock Offering”). Prior to the consummation of the Initial Common Stock Offering, we, among other things, renamed all of our outstanding shares of Class A Common Stock as common stock and authorized an approximately 1,139 for 1 split of our common stock. We contributed the net proceeds from the Initial Common Stock Offering of $517 million to Holdings as an equity capital contribution. Holdings used all of such funds and approximately $57 million of cash received through dividends from Acquisition Corp. to redeem its outstanding notes as discussed below.

In addition, in connection with the Initial Common Stock Offering, we, among other things, repurchased the warrants issued as part of the initial purchase price consideration for the Acquisition from Time Warner for $138 million, we declared and paid a dividend to our stockholders prior to the Initial Common Stock Offering of $100.5 million, terminated a management agreement with the Investor Group as discussed below and borrowed an additional $250 million under the term loan portion of our senior secured credit facility.

Holdings Refinancing and Redemption

In December 2004, Holdings issued $847 million principal amount of debt. The $847 million principal amount of Holdings’ debt consisted of (i) $250 million principal amount of Floating Rate Senior Notes due 2011 (the “Holdings Floating Rate Notes”), (ii) $397 million principal amount at maturity of 9.5% Senior Discount Notes due 2014, which had an initial issuance discount of $147 million (the “Holdings Discount Notes”) and (iii) $200 million principal amount of Floating Rate Senior PIK Notes due 2014 (the “Holdings PIK Notes”, and collectively, the “Holdings Notes”).

In connection with the Initial Common Stock Offering, we used $517 million of proceeds from the offering along with $57 million of available cash to redeem certain of the Holdings Notes outstanding. As of March 31, 2006, Holdings had $182 million of debt on its balance sheet relating to such securities, net of issuance discounts.

The Holdings Floating Rate Notes were redeemed in full on June 15, 2005. From the issuance date through the redemption date, the notes bore interest at a quarterly floating rate based on three-month LIBOR rates plus a margin equal to 4.375%. Interest was payable quarterly in cash beginning on March 15, 2005.

The Holdings Discount Notes were issued at a discount and had an initial accreted value of $630.02 per $1,000 principal amount at maturity. Prior to December 15, 2009, no cash interest payments are required. However, interest accrues on the Holdings Discount Notes in the form of an increase in the accreted value of such notes such that the accreted value of the Holdings Discount Notes will equal the principal amount at maturity on December 15, 2009. Thereafter, cash interest on the Holdings Discount Notes is payable semiannually at a fixed rate of 9.5% per annum. The Holdings Discount Notes mature on December 15, 2014. The Company redeemed 35% of the Holdings Discount Notes on June 15, 2005.

The Holdings PIK Notes were redeemed in full on June 15, 2005. From the date of issuance through the date of redemption, the notes bore interest at a semi-annual floating rate based on six-month LIBOR rates plus a margin equal to 7%. Interest was accrued in the form of additional PIK notes at the election of the Company. Such amounts were also repaid in connection with the redemption.

Termination of Management/Monitoring Agreement

As described in Note 20 to our audited consolidated financial statements for the year ended September 30, 2005, we entered into a management monitoring agreement (the “Management Agreement”) with the Investor Group in connection with the Acquisition.

Under the Management Agreement, we were required to pay the Investor Group an aggregate annual fee of $10 million per year (the “Periodic Fees”) in consideration for ongoing consulting and management advisory services.

The Management Agreement provided that it would continue in full force and effect until December 30, 2014, provided, however, that the Investor Group could cause the agreement to terminate at any time. In the event of the termination of the Management Agreement, the Company, Holdings and Acquisition Corp. were required by the terms of the agreement to pay each of the Investor Group any unpaid portion of the Periodic Fees, any Subsequent Fees and any expenses due with respect to periods prior to the date of termination plus the net present value (using a discount rate equal to the then yield on U.S. Treasury Securities of like maturity) of the Periodic Fees that would have been payable with respect to the period from the date of termination until December 30, 2014.

The Investor Group terminated the Management Agreement and on May 16, 2005, we paid the Investor Group a $73 million termination fee, which was reflected in our statement of operations for the fiscal year ended September 30, 2005. As a result, certain fees paid in prior periods do not appear in subsequent periods. We paid $2.5 million and $5 million of Periodic Fees under the Management Agreement during the three and six months ended March 31, 2005, respectively. We no longer pay any Periodic Fees following the termination of the agreement.

Sale of Warner Bros. Publications

In May 2005, we sold Warner Bros. Publications, which conducted our sheet music operations, to Alfred Publishing. No gain or loss was recognized on the transaction, as the historical book basis of the net assets being sold was adjusted to fair value in connection with the accounting for the Acquisition. Due to our continuing involvement with Warner Bros. Publications, it was not reported as discontinued operations. The sale is not expected to have a material effect on our future operating results and financial condition. For the three months ended March 31, 2005, the operations sold generated revenues of approximately $11 million; an operating loss of $1 million; an operating loss before depreciation and amortization expense of $1 million; and a net loss of approximately $1 million. For the six months ended March 31, 2005, the operations sold generated revenues of approximately $26 million and had no operating income, operating income before depreciation and amortization expense, or net income.

RESULTS OF OPERATIONS

Three Months Ended March 31, 2006 Compared to Three Months Ended March 31, 2005

The following table summarizes our historical results of operations:


	Three Months Ended March 31, 2006			Three Months Ended March 31, 2005
	(unaudited)			(unaudited)
	(in millions)
Revenues	$	796		$	767
Costs and expenses:
Cost of revenues (1)		(409	)		(400	)
Selling, general and administrative expenses (1)		(294	)		(293	)
Amortization of intangible assets		(48	)		(47	)

Total costs and expenses		(751	)		(740	)

Operating income		45			27
Interest expense, net		(45	)		(52	)
Equity in gains of equity-method investees, net		1			—
Unrealized gain on warrants		—			39
Other income, net		2			—

Income before income taxes		3			14
Income tax expense		(10	)		(10	)

Net (loss) income	$	(7	)	$	4

(1)	Includes depreciation expense of: $11 million and $14 million for the three months ended March 31, 2006 and 2005, respectively.

Consolidated Historical Results

Revenues

Our revenues increased $29 million, or 4%, to $796 million for the three months ended March 31, 2006 as compared to $767 million for the three months ended March 31, 2005. Excluding a $31 million unfavorable impact of foreign currency exchange rates and prior year revenue of $11 million related to our sheet music business, which was sold in May 2005, total revenue increased by $71 million or 10%. Recorded Music revenues increased by $55 million, to $676 million for the three months ended March 31, 2006. Excluding a $21 million unfavorable impact of foreign currency exchange rates, Recorded Music revenues rose $76 million, or 13%, comprised of a $21 million increase in physical sales and a $55 million increase in digital sales. Music Publishing revenues declined by $25 million to $129 million for the three months ended March 31, 2006. Excluding a $10 million unfavorable impact of foreign currency exchange rates and the prior year revenue related to our sold sheet music business, Music Publishing revenue declined $4 million or 3%. International operations represented $379 million of consolidated revenues for the three months ended March 31, 2006 as compared to $404 million for the three months ended March 31, 2005, comprising 48% and 53% of total revenues, respectively.

Overall digital revenues grew to $90 million for the three months ended March 31, 2006, as compared to $69 million for the three months ended December 31, 2005 and $35 million for the three months ended March 31, 2005. Digital revenues represented 11% of consolidated revenues for the three months ended March 31, 2006, up from 7% in the most recent reported quarter and 5% in the prior year same quarter. Total digital revenues for the three months ended March 31, 2006 was comprised of U.S. revenues of $64 million, or 71% of total digital revenues, and international revenues of $26 million, or 29% of total digital revenues. The increase in digital revenues resulted from continued efforts to develop our digital business including efforts to further monetize existing content through new formats and new distribution channels and the increased usage of legal, online and mobile distribution channels for the music industry.

See “Business Segment Results” presented hereinafter for a discussion of revenue by business segment.

Cost of revenues

Our cost of revenues increased $9 million, or 2%, to $409 million for the three months ended March 31, 2006 as compared to $400 million for the three months ended March 31, 2005. Expressed as a percent of revenues, cost of revenues was 51% and 52% for the three months ended March 31, 2006 and 2005, respectively or 51% for each of the three months ended March 31, 2006 and 2005, excluding the impact of changes in foreign currency exchange rates and the sale of our sheet music business. Excluding a $21 million benefit of foreign currency exchange rates and $8 million of costs related to our sheet music business, which was sold in May 2005, our cost of revenues increased by $38 million. The increase was primarily due to increases in product costs of $27 million, which were a result of higher physical sales as well as the increased costs related to a number of special edition physical products sold in the quarter, such as CD/DVD box sets. As a percentage of revenues, artist and repertoire costs declined for the three months ended March 31, 2006 as compared to the three months ended March 31, 2005, excluding the impact of foreign currency exchange rates. The decrease relates to changes in product mix in the current quarter as compared to the prior-year quarter.

Selling, general and administrative expenses

Our selling, general and administrative expenses increased by $1 million, to $294 million for the three months ended March 31, 2006 as compared to $293 million for the three months ended March 31, 2005. Expressed as a percent of revenues, selling, general and administrative expenses were 37% and 38% for the three months ended March 31, 2006 and 2005, respectively. Excluding an $9 million benefit of foreign currency exchange rates and $4 million of expenses related to our print operations which were sold in May 2005, selling, general and administrative expenses increased by $14 million, or 5%, primarily related to a $13 million increase in selling and marketing expense which was the result of the timing of marketing costs incurred in relation to our product release schedule in the current quarter. General and administrative costs increased by $4 million, primarily due to a severance payment of $8 million related to the departure of the chairman of WMI, offset by the management fees incurred in the prior year of $2.5 million, due to the previously discussed termination of the Management Agreement. Additionally, depreciation expense decreased by $3 million as discussed below. Stock compensation expense amounted to $2 million for the three months ended March 31, 2006 and $7 million for the three months ended March 31, 2005.

Reconciliation of Consolidated Historical OIBDA to Operating Income and Net Income

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


	Three Months Ended March 31, 2006			Three Months Ended March 31, 2005
	(unaudited)			(unaudited)
	(in millions)
OIBDA	$	104		$	88
Depreciation expense		(11	)		(14	)
Amortization expense		(48	)		(47	)

Operating income		45			27
Interest expense, net		(45	)		(52	)
Equity in gains of equity-method investees		1			—
Unrealized gain on warrants		—			39
Other income, net		2			—

Income before income taxes		3			14
Income tax expense		(10	)		(10	)

Net (loss) income	$	(7	)	$	4

OIBDA

Our OIBDA increased $16 million, or 18%, to $104 million for the three months ended March 31, 2006 as compared to $88 million for the three months ended March 31, 2005. Expressed as a percentage of revenues, total OIBDA margin was 13% for the three months ended March 31, 2006 as compared 11% for the three months ended March 31, 2005. Excluding an approximate $1 million unfavorable impact of foreign currency exchange rates, OIBDA increased by $17 million, which was primarily a result of the increases in revenues, offset by the increases in costs of revenues and selling, general and administrative expenses, which are more fully discussed above. See “Business Segment Results” presented hereinafter for a discussion of OIBDA by business segment.

Depreciation expense

Our depreciation expense decreased by $3 million to $11 million for the three months ended March 31, 2006 as compared to $14 million for the three months ended March 31, 2005. The decrease primarily relates to lower capital spending since the date of the Acquisition.

Amortization expense

Our amortization expense increased by $1 million, or 2%, to $48 million for the three months ended March 31, 2006 as compared to $47 million for the three months ended March 31, 2005. The increase is due to various acquisitions of recorded music catalog and music publishing copyrights since the prior year.

Operating income

Our operating income increased $18 million, to $45 million for the three months ended March 31, 2006 as compared to $27 million for the three months ended March 31, 2005. The increase in operating income was primarily a result of the increases in revenues, offset by increases in costs of revenues and selling, general and administrative expenses, which are more fully discussed above. See “Business Segment Results” presented hereinafter for a discussion of operating income by business segment.

Interest expense, net

Our interest expense decreased to $45 million for the three months ended March 31, 2006 compared to $52 million for the three months ended March 31, 2005. The decrease in interest expense is due to a higher average debt balance in the prior year, as the three months ended March 31, 2005 included interest expense related the outstanding Holdings Floating Rate Notes and Holdings PIK Notes, which were fully redeemed in June 2005, as well as the Holdings Discount Notes, which were partially redeemed in June 2005. See “-Financial Condition and Liquidity” for more information.

Equity in the gains of equity-method investees, net

The three months ended March 31, 2006 includes $1 million of equity in the gains of equity-method investees. There was no comparable income for the three months ended March 31, 2005.

Unrealized gain on warrants

We recognized a $39 million unrealized gain to mark-to-market the value of the warrants issued to Time Warner in connection with the Acquisition for the three months ended March 31, 2005. In connection with the Company’s Initial Common Stock Offering, we repurchased the warrants at a cost of approximately $138 million, which approximated fair value at that date.

Other Income, net

We recognized other income, net, of $2 million for the three months ended March 31, 2006. Other income relates to favorable foreign currency exchange rate movements associated with intercompany receivables and payables that are short-term in nature, and therefore required to be recognized in the statement of operations under U.S. GAAP. There was no comparable income for the three months ended March 31, 2005.

Income tax expense

We provided income tax expense of $10 million for each of the three months ended March 31, 2006 and 2005. In connection with the Acquisition we made a joint election with Time Warner under Section 338(h)(10) of the U.S. Internal Revenue Code to treat the Acquisition as an asset purchase. There was no offsetting income tax benefit on U.S. domestic tax losses recognized due to the uncertain nature of these deferred tax assets. Our income tax expense for each of the three months ended March 31, 2006 and 2005 primarily relates to the tax provisions on foreign income.

Net (loss) income

Our net income decreased to a loss of $7 million for the three months ended March 31, 2006 as compared to net income of $4 million for the three months ended March 31, 2005. The decrease is primarily the result of the unrealized gain on warrants in the prior year offset by the increase in operating income in the current year, as described more fully above.

Business Segment Results

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


	Three Months Ended March 31, 2006			Three Months Ended March 31, 2005
	(unaudited)			(unaudited)
	(in millions)
Recorded Music
Revenue	$	676		$	621
OIBDA	$	81		$	72
Operating income	$	40		$	30

Music Publishing
Revenue	$	129		$	154
OIBDA	$	47		$	47
Operating income	$	32		$	32

Corporate and Revenue Eliminations
Revenue eliminations	$	(9	)	$	(8	)
OIBDA	$	(24	)	$	(31	)
Operating loss	$	(27	)	$	(35	)

Total
Revenue	$	796		$	767
OIBDA	$	104		$	88
Operating income	$	45		$	27

Recorded Music

Recorded Music revenues increased by $55 million, or 9%, to $676 million for the three months ended March 31, 2006 from $621 million for the three months ended March 31, 2005. Excluding a $21 million unfavorable impact of foreign currency exchange rates, Recorded Music revenues increased by $76 million, or 13%, which was driven by an increase in digital sales of approximately $55 million and an increase in physical sales of $21 million. Digital sales totaled $86 million, or 13% of Recorded Music revenues for the three months ended March 31, 2006 compared to $31 million, or 5%, for the three months ended March 31, 2005. Digital sales totaled $64 million, or 7% for the immediately preceding three months

ended December 31, 2005. U.S. physical sales increased by approximately $26 million as a result of several key releases in the three months ended March 31, 2006, as well as significant sales of several carryover releases. International physical sales declined slightly, excluding the impact of foreign currency exchange rates. The decrease in international physical sales was more than offset by the increase in international digital sales.

Recorded Music revenues represented 85% and 81% of consolidated revenues, prior to corporate and revenue eliminations, for the three months ended March 31, 2006 and 2005, respectively. U.S. Recorded Music revenues were $361 million and $296 million, or 53% and 48% of consolidated Recorded Music revenues for the three months ended March 31, 2006 and 2005, respectively. International Recorded Music revenues were $315 million and $325 million, or 47% and 52% of consolidated Recorded Music revenues for the three months ended March 31, 2006 and 2005, respectively.

Recorded Music OIBDA increased by $9 million, or 13%, to $81 million for the three months ended March 31, 2006 compared to $72 million for the three months ended March 31, 2005. Expressed as a percentage of Recorded Music revenues, Recorded Music OIBDA was 12% for each of the three months ended March 31, 2006 and 2005. Excluding a $2 million unfavorable impact of foreign currency exchange rates, OIBDA increased $11 million primarily as a result of the $76 million increase in revenues more fully described above, offset by (i) a $27 million increase in product costs due to the increase in physical sales and changes to product mix previously described, (ii) a $13 million increase in selling and marketing expenses related to the timing of marketing costs incurred in relation to our product release schedule in the current quarter, (iii) an $11 million increase in general and administrative expenses due primarily to the $8 million severance payment made related to the departure of the chairman of WMI and (iv) an $11 million increase in artist and repertoire costs due to the increases in physical and digital sales previously described. As a percentage of Recorded Music revenues, artist and repertoire costs declined, excluding the impact of foreign currency exchange rates, as compared to the prior-year quarter.

Recorded Music operating income was $40 million for the three months ended March 31, 2006 as compared to $30 million for the three months ended March 31, 2005. Recorded Music operating income included the following components:


	Three Months Ended March 31, 2006			Three Months Ended March 31, 2005
	(unaudited)			(unaudited)
	(in millions)
OIBDA	$	81		$	72
Depreciation and amortization		(41	)		(42	)

Operating income	$	40		$	30

The $10 million increase in Recorded Music operating income related to the $9 million increase in Recorded Music OIBDA more fully discussed above, and a decrease in Recorded Music depreciation and amortization of $1 million.

Music Publishing

Music Publishing revenues decreased to $129 million for the three months ended March 31, 2006 as compared to $154 million for the three months ended March 31, 2005. Excluding a $10 million unfavorable impact of foreign currency exchange rates, and prior year revenue of $11 million from our sheet music business, which was sold in May 2005, Music Publishing revenues declined $4 million, or 3%, and such decline was comprised of a $8 million decrease in mechanical revenue and a $2 million decline in synchronization revenue, offset by increases in performance revenue of $3 million and other revenues of $3 million. Mechanical revenue declines reflect prior-year industry declines in physical record sales. Music Publishing revenues consisted of $58 million of mechanical revenues, $42 million of performance revenues, $20 million of synchronization revenues, $4 million of revenues from digital sales and $5 million of other revenues. Digital sales represented 3% of Music

Publishing revenues for the three months ended March 31, 2006 and 2005. Music Publishing revenues represented 16% and 20% of consolidated revenues, prior to corporate and revenue eliminations, for the three months ended March 31, 2006 and 2005, respectively.

Music Publishing OIBDA was a flat $47 million for the three months ended March 31, 2006 and 2005. Excluding a $3 million unfavorable impact of changes in foreign currency exchange rates and a $1 million prior year OIBDA loss from our sheet music business, OIBDA increased by $2 million primarily as a result of a decrease in artist and repertoire costs, offset by the $4 million decrease in revenue discussed above. Expressed as a percentage of Music Publishing revenues, Music Publishing OIBDA was 36% and 31% for the three months ended March 31, 2006 and 2005, respectively.

Music Publishing operating income was a flat $32 million for the three months ended March 31, 2006 and 2005. Music Publishing operating income includes the following components:


	Three Months Ended March 31, 2006			Three Months Ended March 31, 2005
	(unaudited)			(unaudited)
	(in millions)
OIBDA	$	47		$	47
Depreciation and amortization		(15	)		(15	)

Operating income	$	32		$	32

Corporate Expenses and Eliminations

Corporate expenses before depreciation and amortization expense decreased $7 million, to $24 million for the three months ended March 31, 2006 as compared to $31 million for the three months ended March 31, 2005. The decrease primarily related to the absence of the management fees incurred in the prior year of $2.5 million, due to the previously discussed termination of the Management Agreement, along with a decrease in depreciation.

Six Months Ended March 31, 2006 Compared to Six Months Ended March 31, 2005

The following table summarizes our historical results of operations:


	Six Months Ended March 31, 2006			Six Months Ended March 31, 2005
	(unaudited)			(unaudited)
	(in millions)
Revenues	$	1,840		$	1,855
Costs and expenses:
Cost of revenues (1)		(939	)		(981	)
Selling, general and administrative expenses (1)		(617	)		(624	)
Amortization of intangible assets		(95	)		(93	)

Total costs and expenses		(1,651	)		(1,698	)

Operating income		189			157
Interest expense, net		(90	)		(90	)
Equity in the gains (losses) of equity-method investees, net		1			(1	)
Unrealized gain on warrants		—			17
Other income, net		2			4
Minority interest expense		—			(5	)

Income before income taxes		102			82
Income tax expense		(40	)		(42	)

Net income	$	62		$	40

(1)	Includes depreciation expense of: $22 million and $28 million for the six months ended March 31, 2006 and 2005, respectively.

Consolidated Historical Results

Revenues

Our revenues decreased $15 million, or 1%, to $1.840 billion for the six months ended March 31, 2006 as compared to $1.855 billion for the six months ended March 31, 2005. Excluding a $58 million unfavorable impact of foreign currency exchange rates and prior year revenue of $26 million related to our sheet music business, which was sold in May 2005, total revenue increased by $69 million, or 4%, primarily due to significant increases in digital sales. Recorded Music revenues increased by $35 million, to $1.596 billion for the six months ended March 31, 2006. Excluding the impact of foreign currency exchange rates, Recorded Music revenues increased by $79 million or 5%, primarily driven by a decline of $19 million in worldwide Recorded Music physical sales, which was more than offset by an increase in worldwide Recorded Music digital sales of $98 million. Music Publishing revenues declined by $49 million, to $260 million for the six months ended March 31, 2006. Excluding the impact of foreign currency exchange rates and the prior year revenue related to our sold sheet music business, Music Publishing revenue declined $9 million, or 3%. International operations represented $964 million of consolidated revenues for the six months ended March 31, 2006 as compared to $1.005 billion for the six months ended March 31, 2005, comprising 52% and 54% of total revenues, respectively.

Overall digital revenues grew $99 million to $159 million for the six months ended March 31, 2006 as compared to $60 million for the six months ended March 31, 2005. Digital revenues represented 9% and 3% of consolidated revenues for the six months ended March 31, 2006 and 2005, respectively. Total digital revenues for the six months ended March 31, 2006 were comprised of U.S revenues of $113 million, or 71% of total digital revenues, and international revenues of $46 million, or 29% of total digital revenues. The increase in digital revenues resulted from continued efforts to develop our digital business including efforts to further monetize existing content through new formats and new distribution channels and the increased usage of legal, online and mobile distribution channels for the music industry.

See “Business Segment Results” presented hereinafter for a discussion of revenue by business segment.

Cost of revenues

Our cost of revenues decreased by $42 million, or 4%, to $939 million for the six months ended March 31, 2006 as compared to $981 million for the six months ended March 31, 2005. Expressed as a percent of revenues, cost of revenues was 51% and 53% for the six months ended March 31, 2006 and 2005, respectively. Excluding a $36 million favorable impact of foreign currency exchange rates and $17 million of expenses related to our sheet music business, which was sold in May 2005, our cost of revenues increased $11 million, or 1%. The increase was primarily due to increases in product costs of $24 million, which is related to the sale of special edition physical products, such as CD/DVD box sets in the current quarter, and was offset by a $17 million decrease in artist and repertoire costs related to the change in mix of products sold as well as fewer unrecoverable artist advances.

Selling, general and administrative expenses

Our selling, general and administrative expenses decreased by $7 million, or 1%, to $617 million for the six months ended March 31, 2006 as compared to $624 million for the six months ended March 31, 2005. Expressed as a percent of revenues, selling, general and administrative expenses were 34% for the six months ended March 31, 2006 and 2005. Excluding a $16 million benefit of foreign currency exchange rates and $9 million of expenses related to our sold sheet music business, selling, general and administrative expenses increased by $18 million, or 3%, primarily due to a $29 million increase in selling and marketing expense which was the result of the timing of marketing costs incurred in relation to our product release schedule in the current period, and a severance payment of $8 million related to the departure of the chairman of WMI. These increases were offset by a $4 million decrease in general and administrative costs, which was primarily the result of the absence of $5 million of management fees incurred in the prior year related to the terminated Management Agreement

described above, and the decrease in depreciation expense of $6 million as discussed further below. Stock compensation expense amounted to $8 million for the six months ended March 31, 2006 and $9 million for the six months ended March 31, 2005.

Reconciliation of Consolidated Historical OIBDA to Operating Income and Net Income


	Six Months Ended March 31, 2006			Six Months Ended March 31, 2005
	(unaudited)			(unaudited)
	(in millions)
OIBDA	$	306		$	278
Depreciation expense		(22	)		(28	)
Amortization expense		(95	)		(93	)

Operating income		189			157
Interest expense, net		(90	)		(90	)
Equity in the gains (losses) of equity-method investees, net		1			(1	)
Unrealized gain on warrants		—			17
Minority interest expense		—			(5	)
Other income, net		2			4

Income before income taxes		102			82
Income tax expense		(40	)		(42	)

Net income	$	62		$	40

OIBDA

Our OIBDA increased $28 million, or 10%, to $306 million for the six months ended March 31, 2006 as compared to $278 million for the six months ended March 31, 2005. Expressed as a percentage of revenues, total OIBDA margin was 17% for the six months ended March 31, 2006 as compared 15% for the six months ended March 31, 2005. Excluding an approximate $6 million unfavorable impact of foreign currency exchange rates, OIBDA increased by $34 million, or 13%, which was primarily a result of the increase in revenues offset by the increases in costs of revenues and selling, general and administrative expenses, which are more fully discussed above.

Depreciation expense

Our depreciation expense decreased by $6 million to $22 million for the six months ended March 31, 2006 as compared to $28 million for the six months ended March 31, 2005. The decrease primarily relates to lower capital spending since the date of the Acquisition.

Amortization expense

Our amortization expense increased by $2 million, or 2%, to $95 million for the six months ended March 31, 2006 as compared to $93 million for the six months ended March 31, 2005. The increase is due to various acquisitions of recorded music catalog and music publishing copyrights since the prior year.

Operating income

Our operating income increased $32 million, or 20%, to $189 million for the six months ended March 31, 2006 as compared to $157 million for the six months ended March 31, 2005. The increase in operating income was primarily a result of the increase in revenues offset by the increases in costs of revenues and selling, general and administrative expenses, which are more fully discussed above. See “Business Segment Results” presented hereinafter for a discussion of operating income by business segment.

Interest expense, net

Our interest expense was a flat $90 million for the six months ended March 31, 2006 and 2005. The six months ended March 31, 2006 includes interest expense related to an additional outstanding term loan of $250 million borrowed in May 2005, which is not reflected in the six months ended March 31, 2005. The six months ended March 31, 2005 included interest expense related the outstanding Holdings Floating Rate Notes and Holdings PIK Notes, which were fully redeemed in June 2005, as well as the Holdings Discount Notes, which partially redeemed in June 2005, in connection with the Holdings Redemption that is not included in the six months ended March 31, 2006. The net effect of these two transactions resulted in flat interest expense in the comparable periods. See “—Financial Condition and Liquidity” for more information.

Equity in the gains (losses) of equity-method investees, net

The six months ended March 31, 2006 includes $1 million of equity in the gains of equity-method investees, as compared to $1 million of equity in the losses of equity-method investees during the six months ended March 31, 2005.

Unrealized gain on warrants

We recognized a $17 million unrealized gain to mark-to-market the value of the warrants issued to Time Warner in connection with the Acquisition for the six months ended March 31, 2005. In connection with the Company’s Initial Common Stock Offering, we repurchased the warrants at a cost of approximately $138 million, which approximated fair value at that date.

Other Income, net

We recognized other income, net of $2 million for the six months ended March 31, 2006 as compared to $4 million for the six months ended March 31, 2005. Other income relates to favorable foreign currency exchange rates movements associated with intercompany receivables and payables that are short-term in nature, and therefore required to be recognized in the statement of operations under U.S. GAAP.

Minority interest expense

We recognized minority interest expense of $5 million for the six months ended March 31, 2005. This expense related to dividends on preferred stock of Holdings that was held directly by the Investor Group and was issued in connection with the initial funding of the purchase price for the Acquisition effective March 1, 2004. The preferred stock was fully repaid in December 2004 from the proceeds of the Holdings Notes. As such, there is no comparable charge recognized during the six months ended March 31, 2006.

Income tax expense

We provided income tax expense of $40 million for the six months ended March 31, 2006 as compared to $42 million for the six months ended March 31, 2005. In connection with the Acquisition we made a joint election with Time Warner under Section 338(h)(10) of the U.S. Internal Revenue Code to treat the Acquisition as an asset purchase. There was no offsetting income tax benefit on U.S. domestic tax losses recognized due to the uncertain nature of these deferred tax assets. Our income tax expense for the six months ended March 31, 2006 and 2005 primarily relates to the tax provisions on foreign income.

Net income

Our net income increased $22 million to $62 million for the six months ended March 31, 2006 as compared to $40 million for the six months ended March 31, 2005. The increase is the primarily a result of increases in operating income and the decrease in minority interest expense, described above. These were offset by the absence of the unrealized gain on warrants in the current period, and the decline in other income as described more fully above.

Business Segment Results

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


	Six Months Ended March 31, 2006			Six Months Ended March 31, 2005
	(unaudited)			(unaudited)
	(in millions)
Recorded Music
Revenue	$	1,596		$	1,561
OIBDA	$	287		$	266
Operating income	$	206		$	182

Music Publishing
Revenue	$	260		$	309
OIBDA	$	68		$	71
Operating income	$	38		$	42

Corporate and Revenue Eliminations
Revenue eliminations	$	(16	)	$	(15	)
OIBDA	$	(49	)	$	(59	)
Operating loss	$	(55	)	$	(67	)

Total
Revenue	$	1,840		$	1,855
OIBDA	$	306		$	278
Operating income	$	189		$	157

Recorded Music

Recorded Music revenues increased by $35 million, or 2%, to $1.596 billion for the six months ended March 31, 2006 from $1.561 billion for the six months ended March 31, 2005. Excluding a $44 million unfavorable impact of foreign currency exchange rates, Recorded Music revenues increased by $79 million, or 5%, which was primarily driven by an increase in digital sales of $98 million offset by a decline in licensing revenue and physical sales of $19 million. Digital sales totaled $150 million, or 9% of Recorded Music revenues for the six months ended March 31, 2006 and $52 million, or 3%, for the six months ended March 31, 2005. Worldwide digital gains more than offset declines in licensing revenue and physical sales, which was comprised of declines in international physical sales of $5 million, international licensing revenue declines of $5 million and U.S physical sales declines of $9 million.

Recorded Music revenues represented 87% and 84% of consolidated revenues, prior to corporate and revenue eliminations, for the six months ended March 31, 2006 and 2005, respectively. U.S. Recorded Music revenues were $768 million and $709 million, or 48% and 45% of consolidated Recorded Music Revenues for the six months ended March 31, 2006 and 2005, respectively. International Recorded Music revenues were $828 million and $852 million, or 52% and 55% of consolidated Recorded Music Revenues for the six months ended March 31, 2006 and 2005, respectively.

Recorded Music OIBDA increased by $21 million, or 8%, to $287 million for the six months ended March 31, 2006 compared to $266 million for the six months ended March 31, 2005. Expressed as a percentage of Recorded Music revenues, Recorded Music OIBDA was 18% and 17% for the six months ended March 31, 2006 and 2005, respectively. Excluding a $6 million unfavorable impact of foreign currency exchange rates, OIBDA increased $27 million, or 10%, primarily as a result of the $79 million increase in revenues more fully described above and a $10 million decrease in artist and repertoire costs related to the change in product mix and a decrease in unrecoverable artist royalty advances, which were offset by (i) a $28 million increase in selling and marketing expense related to the timing of marketing costs incurred related to our product release schedule in the current period, (ii) a $24 million increase in product costs, due to changes in product mix as compared to the

same period in the prior year and (iii) a $9 million increase in general and administrative expenses primarily due to the $8 million severance payment made related to the departure of the chairman of WMI.

Recorded Music operating income was $206 million for the six months ended March 31, 2006 as compared to $182 million for the six months ended March 31, 2005. Recorded Music operating income included the following components:


	Six Months Ended March 31, 2006			Six Months Ended March 31, 2005
	(unaudited)			(unaudited)
	(in millions)
OIBDA	$	287		$	266
Depreciation and amortization		(81	)		(84	)

Operating income	$	206		$	182

The $24 million increase in Recorded Music operating income related to the $21 million increase in Recorded Music OIBDA, more fully discussed above, and a decrease in Recorded Music depreciation and amortization of $3 million.

Music Publishing

Music Publishing revenues decreased to $260 million for the six months ended March 31, 2006 as compared to $309 million for the six months ended March 31, 2005. Excluding a $14 million unfavorable impact of foreign currency exchange rates, and prior year revenue of $26 million of revenue from our sheet music business, which was sold in May 2005, Music Publishing revenues declined $9 million, or 3%, which was comprised of a $12 million decrease in mechanical revenue and a $2 million decline in synchronization revenue, offset by an increase in other revenues of $5 million. Performance revenue was flat. Mechanical revenue declines reflect prior-year industry declines in physical record sales. Music Publishing revenues consisted of $117 million of mechanical revenues, $87 million of performance revenues, $38 million of synchronization revenues, $9 million of revenues from digital sales and $9 million of other revenues. Digital sales represented 3% of Music Publishing revenues for the six months ended March 31, 2006 and 2005. Music Publishing revenues represented 14% and 17% of consolidated revenues, prior to corporate and revenue eliminations, for the six months ended March 31, 2006 and 2005, respectively.

Music Publishing OIBDA decreased $3 million to $68 million for the six months ended March 31, 2006 as compared to $71 million for the six months ended March 31, 2005. Expressed as a percent of Music Publishing revenues, Music Publishing OIBDA was 26% and 23% for the six months ended March 31, 2006 and 2005, respectively. OIBDA decreased primarily as a result of the decrease in revenue more fully discussed above, which was offset by (i) a decrease in product costs of $12 million, (ii) a decrease in royalty expenses of $22 million and (iii) a decrease in general and administrative expenses of $8 million. These decreases in expenses were primarily due to the sale of our sheet music business.

Music Publishing operating income decreased to $38 million for the six months ended March 31, 2006 as compared to $42 million for the six months ended March 31, 2005. Music Publishing operating income includes the following components:


	Six Months Ended March 31, 2006			Six Months Ended March 31, 2005
	(unaudited)			(unaudited)
	(in millions)
OIBDA	$	68		$	71
Depreciation and amortization		(30	)		(29	)

Operating income	$	38		$	42

The $4 million decrease in Music Publishing operating income related to the $3 million decrease in Music Publishing OIBDA described above and a $1 million increase in depreciation and amortization.

Corporate Expenses and Eliminations

Corporate expenses before depreciation and amortization expense decreased $10 million, to $49 million for the six months ended March 31, 2006 as compared to $59 million for the six months ended March 31, 2005. The decrease primarily relates to the absence of management fees in the current period of $5 million, due to the previously discussed termination of the Management Agreement, along with a decrease in consulting fees.

FINANCIAL CONDITION AND LIQUIDITY

Financial Condition

At March 31, 2006, we had $2.243 billion of debt, $359 million of cash and equivalents, $61 million of short-term investments (net debt of $1.823 billion, defined as total debt less cash and equivalents and short-term investments) and $109 million of shareholders’ equity. This compares to $2.246 billion of debt, $288 million of cash and equivalents (net debt of $1.958 billion) and $89 million of shareholders’ equity at September 30, 2005. Net debt decreased by $135 million as a result of (i) a $71 million increase in cash and equivalents, (ii) a $61 million increase in short-term investments, (iii) an $8 million reduction related to our quarterly repayments of our term loans under the senior secured credit facility and (iv) a $3 million impact of foreign currency exchange rates on our Sterling-denominated notes. The accretion of our Holdings Discount Notes of $8 million offset the decline in net debt.

Short-term investments include high-quality, investment grade securities such as taxable auction rate securities as well as commercial paper and corporate bonds with maturities greater than 90 days but less than one year. We have expanded our investment portfolio in order to increase yield while maintaining safety of principal consistent with an investment policy approved by the Board of Directors.

The $20 million increase in shareholders’ equity that occurred during the six months ended March 31, 2006 primarily related to $62 million of net income for the six months ended March 31, 2006, deferred gains on derivative financial instruments of $9 million and stock compensation of $8 million for the six months ended March 31, 2006. These increases were offset by $57.9 million of dividends, which was comprised of our $19.3 million dividend declared on October 3, 2005 and paid on November 23, 2005, our $19.3 million dividend declared on December 29, 2005 and paid on February 17, 2006, and our $19.3 million dividend declared on March 14, 2006 and paid on May 3, 2006.

Cash Flows

The following table summarizes our historical cash flows. The financial data for the six months ended March 31, 2006 and 2005 are unaudited and are derived from our interim financial statements included elsewhere herein.


	Six Months Ended March 31, 2006			Six Months Ended March 31, 2005
	(unaudited)			(unaudited)
	(in millions)
Cash provided by (used in):
Operating activities	$	205		$	292
Investing activities		(91	)		(61	)
Financing activities		(45	)		(342	)

Operating Activities

Cash provided by operations was $205 million for the six months ended March 31, 2006 compared to $292 million for the six months ended March 31, 2005. The $87 million decrease in cash provided by operations was primarily due to higher royalty advance payments in connection with contractual obligations and the timing of releases, and additional royalty payments related to the timing of releases.

Investing Activities

Cash used in investing activities was $91 million for the six months ended March 31, 2006 compared to $61 million for the six months ended March 31, 2005. The $91 million of cash used in investing activities in the six months ended March 31, 2006 primarily reflects $61 million of cash invested in auction-rate securities and other short-term investments, $12 million of capital expenditures and the acquisition of a small independent rec