Edgar Filing: Warner Music Group Corp.

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

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, 2011

¨	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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

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

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

As of May 4, 2011, the number of shares of the Registrant’s common stock, par value $0.001 per share, outstanding was 155,754,133.

WARNER MUSIC GROUP CORP.

INDEX


		Page
Part I.	Financial Information
Item 1.	Financial Statements (Unaudited)		3
	Consolidated Balance Sheets as of March 31, 2011 and September 30, 2010		3
	Consolidated Statements of Operations for the Three and Six Months Ended March 31, 2011 and 2010		4
	Consolidated Statements of Cash Flows for the Six Months Ended March 31, 2011 and 2010		5
	Consolidated Statement of Deficit for the Six Months Ended March 31, 2011		6
	Notes to Consolidated Interim Financial Statements		7
	Supplementary Information—Consolidating Financial Statements		16
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		23
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		49
Item 4.	Controls and Procedures		50
Part II.	Other Information
Item 1.	Legal Proceedings		51
Item 1A.	Risk Factors		51
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		61
Item 3.	Defaults Upon Senior Securities		61
Item 4.	(Removed and Reserved)		62
Item 5.	Other Information		62
Item 6.	Exhibits		62
Signatures			64

ITEM 1.

FINANCIAL STATEMENTS

Warner Music Group Corp.

Consolidated Balance Sheets (Unaudited)


	March 31, 2011			September 30, 2010
	(in millions)
Assets
Current assets:
Cash and equivalents	$	319		$	439
Accounts receivable, less allowances of $88 and $111 million		337			434
Inventories		31			37
Royalty advances expected to be recouped within one year		168			143
Deferred tax assets		30			30
Other current assets		54			46

Total current assets		939			1,129
Royalty advances expected to be recouped after one year		207			189
Property, plant and equipment, net		123			121
Goodwill		1,084			1,057
Intangible assets subject to amortization, net		1,103			1,119
Intangible assets not subject to amortization		100			100
Other assets		61			64

Total assets	$	3,617		$	3,779

Liabilities and Deficit
Current liabilities:
Accounts payable	$	151		$	206
Accrued royalties		1,041			1,034
Accrued liabilities		221			314
Accrued interest		60			59
Deferred revenue		116			100
Other current liabilities		—			8

Total current liabilities		1,589			1,721
Long-term debt		1,951			1,945
Deferred tax liabilities		166			169
Other noncurrent liabilities		165			155

Total liabilities		3,871			3,990

Commitments and Contingencies (See Note 9)
Deficit:
Common stock ($0.001 par value; 500,000,000 shares authorized; 155,164,390 and 154,950,776 shares issued and outstanding)		—			—
Additional paid-in capital		618			611
Accumulated deficit		(985	)		(929	)
Accumulated other comprehensive income, net		63			53

Total Warner Music Group Corp. shareholders’ deficit		(304	)		(265	)
Noncontrolling interest		50			54

Total deficit		(254	)		(211	)

Total liabilities and deficit	$	3,617		$	3,779

See accompanying notes.

Warner Music Group Corp.

Consolidated Statements of Operations (Unaudited)


	Three Months Ended March 31,						Six Months Ended March 31,
	2011			2010			2011			2010
	(in millions, except per share data)
Revenues	$	682		$	666		$	1,471		$	1,586
Costs and expenses:
Cost of revenues		(357	)		(329	)		(799	)		(846	)
Selling, general and administrative expenses (a)		(254	)		(259	)		(520	)		(559	)
Amortization of intangible assets		(55	)		(54	)		(109	)		(110	)

Total costs and expenses		(666	)		(642	)		(1,428	)		(1,515	)

Operating income		16			24			43			71
Interest expense, net		(47	)		(46	)		(94	)		(97	)
Other expense, net		(1	)		(4	)		(1	)		(3	)

Loss before income taxes		(32	)		(26	)		(52	)		(29	)
Income tax expense		(7	)		(2	)		(5	)		(15	)

Net loss		(39	)		(28	)		(57	)		(44	)
Less: loss attributable to noncontrolling interest		1			3			1			2

Net loss attributable to Warner Music Group Corp.	$	(38	)	$	(25	)	$	(56	)	$	(42	)

Net loss per common share attributable to Warner Music Group Corp.:

Basic	$	(0.25	)	$	(0.17	)	$	(0.37	)	$	(0.28	)

Diluted	$	(0.25	)	$	(0.17	)	$	(0.37	)	$	(0.28	)

Weighted average common shares:
Basic		150.5			149.6			150.2			149.6
Diluted		150.5			149.6			150.2			149.6
(a) Includes depreciation expense of:	$	(11	)	$	(9	)	$	(20	)	$	(18	)

See accompanying notes.

Warner Music Group Corp.

Consolidated Statements of Cash Flows (Unaudited)


	Six Months Ended March 31, 2011			Six Months Ended March 31, 2010
	(in millions)
Cash flows from operating activities
Net loss	$	(57	)	$	(44	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization		129			128
Deferred income taxes		(8	)		(6	)
Impairment of cost-method investment		—			1
Non-cash interest expense		6			14
Non-cash stock-based compensation expense		7			5
Other non-cash items		(1	)		1
Changes in operating assets and liabilities:
Accounts receivable		105			136
Inventories		7			6
Royalty advances		(35	)		4
Accounts payable and accrued liabilities		(170	)		(191	)
Accrued interest		1			2
Other balance sheet changes		9			(5	)

Net cash (used in) provided by operating activities		(7	)		51

Cash flows from investing activities
Investments and acquisitions of businesses		(57	)		(6	)
Acquisition of publishing rights		(47	)		(29	)
Proceeds from the sale of investments		—			9
Capital expenditures		(22	)		(15	)

Net cash used in investing activities		(126	)		(41	)

Cash flows from financing activities
Distribution to noncontrolling interest holder		(1	)		(2	)

Net cash used in financing activities		(1	)		(2	)

Effect of exchange rate changes on cash and equivalents		14			(9	)

Net decrease in cash and equivalents		(120	)		(1	)
Cash and equivalents at beginning of period		439			384

Cash and equivalents at end of period	$	319		$	383

See accompanying notes.

Warner Music Group Corp.

Consolidated Statement of Deficit (Unaudited)


	Common Stock				Additional Paid-in		Accumulated			Accumulated Other Comprehensive		Total Warner Music Group Corp. Shareholders’			Noncontrolling			Total Equity
	Shares		Value		Capital		Deficit			Income		Deficit			Interests			(Deficit)
	(in millions, except number of common shares)
Balance at September 30, 2010		154,950,776	$	0.001	$	611	$	(929	)	$	53	$	(265	)	$	54		$	(211	)
Comprehensive loss:
Net loss		—		—		—		(56	)		—		(56	)		(1	)		(57	)
Foreign currency translation adjustment		—		—		—		—			9		9			—			9
Deferred gains on derivative financial instruments		—		—		—		—			1		1			—			1

Total comprehensive loss													(46	)		(1	)		(47	)
Noncontrolling interests of acquired businesses		—		—		—		—			—		—			(3	)		(3	)
Stock based compensation		44,963		—		7		—			—		7			—			7
Exercises of stock options		168,651		—		—		—			—		—			—			—

Balance at March 31, 2011		155,164,390	$	0.001	$	618	$	(985	)	$	63	$	(304	)	$	50		$	(254	)

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-based content companies and 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”). The original Investor Group included affiliates of Thomas H. Lee Partners (“THL”), affiliates of Bain Capital Investors, LLC (“Bain”), affiliates of Providence Equity Partners, Inc. (“Providence”) and Music Capital Partners, L.P. (“Music Capital”). Music Capital’s partnership agreement required that the Music Capital partnership dissolve and commence winding up by the second anniversary of the Company’s May 2005 initial public offering. As a result, on May 7, 2007, Music Capital made a pro rata distribution of all shares of common stock of the Company held by it to its partners. The shares held by Music Capital had been subject to a stockholders agreement among Music Capital, THL, Bain and Providence and certain other parties. As a result of the distribution, the shares distributed by Music Capital ceased to be subject to the voting and other provisions of the stockholders agreement and Music Capital was no longer part of the Investor Group subject to the stockholders agreement.

The Company classifies its business interests into two fundamental operations: Recorded Music and Music Publishing. A brief description of these operations is presented below.

Recorded Music Operations

The Company’s Recorded Music business primarily consists of the discovery and development of artists and the related marketing, distribution and licensing of recorded music produced by such artists.

The Company is also diversifying its revenues beyond its traditional businesses by entering into expanded-rights deals with recording artists in order to partner with artists in other areas of their careers. Under these agreements, the Company provides services to and participates in artists’ activities outside the traditional recorded music business. The Company has built artist services capabilities and platforms for exploiting this broader set of music-related rights and participating more broadly in the monetization of the artist brands it helps create. In developing the Company’s artist services business, the Company has both built and expanded in-house capabilities and expertise and has acquired a number of existing artist services companies involved in artist management, merchandising, strategic marketing and brand management, ticketing, concert promotion, fan clubs, original programming and video entertainment. The Company believes that entering into expanded-rights deals and enhancing its artist services capabilities associated with the Company’s artists and other artists will permit it to diversify revenue streams to better capitalize on the growth areas of the music industry and permit it to build stronger, long-term relationships with artists and more effectively connect artists and fans.

In the U.S., Recorded Music operations are conducted principally through the Company’s major record labels—Warner Bros. Records and The Atlantic Records Group. The Company’s Recorded Music operations also include Rhino, a division that specializes in marketing the Company’s music catalog through compilations and reissuances of previously released music and video titles, as well as in the licensing of recordings to and from third parties for various uses, including film and television soundtracks. Rhino has also become the Company’s primary licensing division focused on acquiring broader licensing rights from certain catalog artists. For example, the Company has an exclusive license with The Grateful Dead to manage the band’s intellectual property and a 50% interest in Frank Sinatra Enterprises, an entity that administers licenses for use of Frank Sinatra’s name and likeness and manages all aspects of his music, film and stage content. The Company also conducts its Recorded Music operations through a collection of additional record labels, including, among others, Asylum, Cordless, East West, Elektra, Nonesuch, Reprise, Roadrunner, Rykodisc, Sire and Word.

Outside the U.S., Recorded Music activities are conducted in more than 50 countries primarily through Warner Music International (“WMI”) and its various subsidiaries, affiliates and non-affiliated licensees. WMI engages in the same activities as the Company’s U.S. labels: discovering and signing artists and distributing, marketing and selling their recorded music. In most cases, WMI also markets and distributes the records of those artists for whom the Company’s U.S. record labels have international rights. In certain smaller markets, WMI licenses to unaffiliated third-party record labels the right to distribute its records. The Company’s international artist services operations also include a network of concert promoters through which WMI provides resources to coordinate tours for the Company’s artists and other artists.

Recorded Music distribution operations include WEA Corp., which markets and sells music and DVD products to retailers and wholesale distributors in the U.S.; ADA, which distributes the products of independent labels to retail and wholesale distributors in the U.S.; various distribution centers and ventures operated internationally; an 80% interest in Word Entertainment, which specializes in the distribution of music products in the Christian retail marketplace and ADA Global, which provides distribution services outside of the U.S. through a network of affiliated and non-affiliated distributors.

The Company plays an integral role in virtually all aspects of the recorded music value chain from discovering and developing talent to producing albums and promoting artists and their products. 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 the CD and digital formats. In the U.S., WEA Corp., ADA and Word market, sell and deliver product, either directly or through sub-distributors and wholesalers, to record stores, mass merchants and other retailers. The Company’s recorded music products are also sold in physical form to online physical retailers such as Amazon.com, barnesandnoble.com and bestbuy.com and in digital form to online digital retailers like Apple’s iTunes and mobile full-track download stores such as those operated by Verizon or Sprint. In the case of expanded-rights deals where the Company acquires broader rights in a recording artist’s career, the Company may provide more comprehensive career support and actively develop new opportunities for an artist through touring, fan clubs, merchandising and sponsorships, among other areas. The Company believes expanded-rights deals create better partnerships with its artists, which allow the Company and its artists to work together more closely to create and sustain artistic and commercial success.

The Company has integrated the sale of digital content into all aspects of its Recorded Music and Music Publishing businesses including A&R, marketing, promotion and distribution. The Company’s new media executives work closely with A&R departments to make sure that while a record is being made, digital assets are also created with all of its distribution channels in mind, including subscription services, social networking sites, online portals and music-centered destinations. The Company works side by side with its mobile and online partners to test new concepts. The Company believes existing and new digital businesses will be a significant source of growth for the next several years and will provide new opportunities to monetize its assets and create new revenue streams. As a music-based content company, the Company has assets that go beyond its recorded music and music publishing catalogs, such as its music video library, which it has begun to monetize through digital channels. The proportion of digital revenues attributed to each distribution channel varies by region and since digital music is in the relatively early stages of growth, proportions may change as the roll out of new technologies continues. As an owner of musical content, the Company believes it is well positioned to take advantage of growth in digital distribution and emerging technologies to maximize the value of its assets.

Music Publishing Operations

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

The Company’s Music Publishing operations include Warner/Chappell, its global Music Publishing company, headquartered in New York with operations in over 50 countries through various subsidiaries, affiliates and non-affiliated licensees. The Company owns or controls rights to more than one million musical compositions, including numerous pop hits, American standards, folk songs and motion picture and theatrical compositions. Assembled over decades, its award-winning catalog includes over 65,000 songwriters and composers and a diverse range of genres including pop, rock, jazz, country, R&B, hip-hop, rap, reggae, Latin, folk, blues, symphonic, soul, Broadway, techno, alternative, gospel and other Christian music. In January 2011, the Company acquired Southside Independent Music Publishing, a leading independent music publishing company, further adding to its catalog. Warner/Chappell also administers the music and soundtracks of several third-party television and film producers and studios, including Lucasfilm, Ltd., Hallmark Entertainment, Disney Music Publishing and Turner Music Publishing. In 2007, the Company entered the production music library business with the acquisition of Non-Stop Music. The Company has subsequently continued to expand its production music operations with the acquisitions of V The Production Library in 2009 and Groove Addicts Production Music Library, Carlin Recorded Music Library and 615 Music in 2010.

2. Basis of Presentation

Interim Financial Statements

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended March 31, 2011 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2011.

The consolidated balance sheet at September 30, 2010 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

For further information, refer to the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2010 (File No. 001-32502).

Basis of Consolidation

The accompanying financial statements present the consolidated accounts of all entities in which the Company has a controlling voting interest and/or variable interest entities required to be consolidated in accordance with U.S. GAAP. Significant inter-company balances and transactions have been eliminated. Certain reclassifications have been made to the prior fiscal years’ consolidated financial statements to conform with the current fiscal-year presentation.

The Company maintains a 52-53 week fiscal year ending on the Friday nearest to each reporting date. As such, all references to March 31, 2011 and 2010 relate to the three-month periods March 25, 2011 and March 26, 2010, respectively. For convenience purposes, the Company continues to date its financial statements as of March 31.

The Company has performed a review of all subsequent events through the date the financial statements were issued, and has deemed that other than as described in footnote 14, no additional disclosures are necessary.

New Accounting Pronouncements

In June 2009, the FASB issued FASB Statement No. 167, “Amendments to FASB Interpretation No. 46(R)” (“FAS 167”) (codified under ASC Topic 810, Consolidation), which amends the consolidation guidance for variable interest entities. The amendments include: (1) the elimination of the exemption from consolidation for qualifying special purpose entities, (2) a new approach for determining the primary beneficiary of a VIE, which requires that the primary beneficiary have both (i) the power to control the most significant activities of the VIE and (ii) either the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE and (3) the requirement to continually reassess who should consolidate a variable-interest entity. FAS 167 is effective for the beginning of an entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. The Company has adopted the new standard, effective October 1, 2010, on a prospective basis, which did not have a material impact on its financial statements.

3. Comprehensive (Loss) Income

Comprehensive (loss) income consists of net loss and other gains and losses affecting equity that, under U.S. GAAP, are excluded from net (loss) income. For the Company, the components of other comprehensive (loss) income primarily consist of foreign currency translation gains and losses and deferred gains and losses on financial instruments designated as hedges under FASB ASC Topic 815, Derivatives and Hedging (“ASC 815”), which include foreign exchange contracts. The following summary sets forth the components of accumulated other comprehensive income, net of related taxes (in millions):


	Foreign Currency Translation Gain (Losses)		Minimum Pension Liability Adjustment			Derivative Financial Instruments Gain (Losses)			Accumulated Other Comprehensive Income
	(in millions)
Balance at September 30, 2010	$	58	$	(3	)	$	(2	)	$	53

Activity through March 31, 2011		9		—			1			10

Balance at March 31, 2011	$	67	$	(3	)	$	(1	)	$	63

4. Net (Loss) Income Per Common Share

The Company computes net (loss) income per common share in accordance with FASB ASC Topic 260, Earnings per Share (“ASC 260”). Under the provisions of ASC 260, basic net (loss) income per common share is computed by dividing the net (loss) income applicable to common shares after preferred dividend requirements, if any, by the weighted average of common shares outstanding during the period. Diluted net (loss) income per common share adjusts basic net (loss) income 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 (loss) income per common share (in millions, except per share amounts):


	Three Months Ended March 31, 2011			Three Months Ended March 31, 2010			Six Months Ended March 31, 2011			Six Months Ended March 31, 2010
Numerator:
Basic and diluted net loss per common share:
Net loss attributable to Warner Music Group Corp.	$	(38	)	$	(25	)	$	(56	)	$	(42	)

Denominator:
Weighted average common shares outstanding for basic calculation (a)		150.5			149.6			150.2			149.6

Dilutive effect of options and restricted stock		—			—			—			—

Weighted average common outstanding shares for diluted calculation		150.5			149.6			150.2			149.6

Net loss per common share attributable to Warner Music Group Corp.—basic	$	(0.25	)	$	(0.17	)	$	(0.37	)	$	(0.28	)

Net loss per common share attributable to Warner Music Group Corp.—diluted	$	(0.25	)	$	(0.17	)	$	(0.37	)	$	(0.28	)

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

The calculation of diluted net loss per share excludes the following weighted average number of stock options and restricted stock because to include them in the calculation would be anti-dilutive:


	Three Months Ended March 31, 2011		Three Months Ended March 31, 2010		Six Months Ended March 31, 2011		Six Months Ended March 31, 2010
Stock options		12.3		13.6		11.6		13.6
Restricted stock		0.6		—		0.3		—

5. Goodwill and Intangible Assets

Goodwill

The following analysis details the changes in goodwill for each reportable segment during the three months ended March 31, 2011 (in millions):


	Recorded Music		Music Publishing		Total
Balance at September 30, 2010	$	463	$	594	$	1,057
Acquisitions		14		7		21
Dispositions		—		—		—
Other (b)		6		—		6

Balance at March 31, 2011	$	483	$	601	$	1,084

Intangible Assets

Intangible assets consist of the following (in millions):


	September 30, 2010			Acquisitions (a)		Other (b)		March 31, 2011
Intangible assets subject to amortization:
Recorded music catalog	$	1,376			—		5	$	1,381
Music publishing copyrights		976			68		19		1,063
Artist contracts		79			—		1		80
Trademarks		31			—		—		31
Other intangible assets		9			—		—		9

		2,471			68		25		2,564
Accumulated amortization		(1,352	)						(1,461	)

Total net intangible assets subject to amortization		1,119							1,103
Intangible assets not subject to amortization:
Trademarks and brands		100							100

Total net other intangible assets	$	1,219						$	1,203

(a)	The acquisition of music publishing copyrights for the six months ended March 31, 2011 primarily includes Southside Independent Music Publishing and 615 Music.

(b)	Other represents foreign currency translation adjustments.

6. Restructuring Costs

Acquisition-Related Restructuring Costs

In connection with the Acquisition that was effective as of March 1, 2004, the Company reviewed its operations and implemented several plans to restructure its operations. As part of these restructuring plans, the Company recorded a restructuring liability during 2004, which included costs to exit and consolidate certain activities of the Company, costs to exit certain leased facilities and operations such as international distribution operations, costs to terminate employees and costs to terminate certain artist, songwriter, co-publisher and other contracts. Such liabilities were recognized as part of the cost of the Acquisition. As of March 31, 2011, the Company had approximately $17 million of liabilities outstanding primarily related to long-term lease obligations for vacated facilities, which are expected to be settled by 2019 and $42 million of liabilities outstanding primarily related to revaluations of artist and other contracts.

7. Debt

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


	March 31, 2011		September 30, 2010
9.5% Senior Secured Notes due 2016—Acquisition Corp (a)	$	1,067	$	1,065
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. (b)		161		157
9.5% Senior Discount Notes due 2014—Holdings		258		258

Total long term debt	$	1,951	$	1,945

(a)	9.5% Senior Secured Notes due 2016; face amount of $1.1 billion less unamortized discount of $33 million at March 31, 2011 and $35 million at September 30, 2010.

(b)	Change represents the impact of foreign currency exchange rates on the carrying value of the £100 million Sterling-denominated notes.

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 indenture for the Acquisition Corp. Senior Secured Notes, the indenture for the Acquisition Corp. Senior Subordinated Notes, and the indenture for the Holdings Senior Discount Notes.

8. Stock-based Compensation

The following table represents the expense recorded by the Company with respect to its stock-based awards for the three and six months ended March 31, 2011 and 2010 (in millions):


	Three Months Ended March 31, 2011		Three Months Ended March 31, 2010		Six Months Ended March 31, 2011		Six Months Ended March 31, 2010
Recorded Music	$	3	$	1	$	4	$	3
Music Publishing		—		—		—		—
Corporate expenses		2		1		3		2

Total	$	5	$	2	$	7	$	5

During the six months ended March 31, 2011, the Company awarded 44,963 shares of restricted stock and 1,910,000 stock options to its employees. During the six months ended March 31, 2010 the Company awarded 35,309 shares of restricted stock and 185,000 stock options to its employees.

9. Commitments and Contingencies

Pricing of Digital Music Downloads

On December 20, 2005 and February 3, 2006, the Attorney General of the State of New York served the Company with requests for information in connection with an industry-wide investigation as to 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 Antitrust Division of 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. Both investigations have now been closed. Subsequent to the announcements of the above governmental investigations, more than thirty putative class action lawsuits concerning the pricing of digital music downloads were filed and were later consolidated for pre-trial proceedings in the Southern District of New York. The consolidated amended complaint, filed on April 13, 2007, alleges conspiracy among record companies to delay the release of their content for digital distribution, inflate their pricing of CDs and fix prices for digital downloads. The complaint seeks unspecified compensatory, statutory and treble damages. All defendants, including the Company, filed a motion to dismiss the consolidated amended complaint on July 30, 2007. On October 9, 2008, the District Court issued an order dismissing the case as to all defendants, including the Company. On November 20, 2008, plaintiffs filed a Notice of Appeal from the order of the District Court to the Circuit Court for the Second Circuit. Oral argument took place before the Second Circuit Court of Appeals on September 21, 2009.

On January 12, 2010, the Second Circuit vacated the judgment of the District Court and remanded the case for further proceedings. On January 27, 2010, all defendants, including the Company, filed a petition for rehearing en banc with the Second Circuit. On March 26, 2010, the Second Circuit denied the petition for rehearing en banc. On August 20, 2010 all defendants including the Company, filed a petition for Certiorari before the Supreme Court. The petition was rejected on January 10, 2011. The case is now with the trial court. 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.

In addition to the matter discussed above, the Company is involved in other litigation arising in the normal course of 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

The Company uses derivative financial instruments primarily foreign currency forward exchange contracts (“FX Contracts”) for the purpose of managing foreign currency exchange risk by reducing the effects of fluctuations in foreign currency exchange rates.

The Company enters into FX Contracts primarily to hedge its royalty payments and balance sheet items denominated in foreign currency. The Company applies hedge accounting to FX Contracts for cash flows related to royalty payments. The Company records these FX Contracts in the consolidated balance sheet at fair value and changes in fair value are recognized in Other Comprehensive Income (“OCI”) for unrealized items and recognized in earnings for realized items. The Company elects to not apply hedge accounting to foreign currency exposures related to balance sheet items. The Company records these FX Contracts in the consolidated balance sheet at fair value and changes in fair value are immediately recognized in earnings. Fair value is determined by using observable market transactions of spot and forward rates (i.e., Level 2 inputs). Refer to Note 13.

Netting provisions are provided for in existing International Swap and Derivative Association Inc. (“ISDA”) agreements in situations where the Company executes multiple contracts with the same counterparty. As a result, net assets or liabilities resulting from foreign exchange derivatives subject to these netting agreements are classified within other current assets or other current liabilities in the Company’s balance sheet. The Company monitors its positions with, and the credit quality of, the financial institutions that are party to any of its financial transactions.

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 operations: 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, non-cash amortization of intangible assets and non-cash impairment charges to reduce the carrying value of goodwill and intangible assets (“OIBDA”). The Company has supplemented its analysis of OIBDA results by segment with an analysis of operating income (loss) by segment.

The accounting policies of the Company’s business segments are the same as those described in the summary of significant accounting policies included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2010. The Company accounts for intersegment sales at fair value as if the sales were to third parties. While inter-company 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, therefore, do not themselves impact the consolidated results. Segment information consists of the following (in millions):


Three Months Ended	Recorded music			Music publishing			Corporate expenses and eliminations			Total
March 31, 2011
Revenues	$	550		$	137		$	(5	)	$	682
OIBDA		54			50			(22	)		82
Depreciation of property, plant and equipment		(7	)		(1	)		(3	)		(11	)
Amortization of intangible assets		(37	)		(18	)		—			(55	)

Operating income (loss)	$	10		$	31		$	(25	)	$	16

March 31, 2010
Revenues	$	538		$	134		$	(6	)	$	666
OIBDA		49			61			(23	)		87
Depreciation of property, plant and equipment		(6	)		(1	)		(2	)		(9	)
Amortization of intangible assets		(37	)		(17	)		—			(54	)


Three Months Ended	Recorded music			Music publishing			Corporate expenses and eliminations			Total

Operating income (loss)	$	6		$	43		$	(25	)	$	24


Six Months Ended		Recorded music			Music publishing			Corporate expenses and eliminations			Total
March 31, 2011
Revenues	$	1,223		$	257		$	(9	)	$	1,471
OIBDA		144			68			(40	)		172
Depreciation of property, plant and equipment		(13	)		(2	)		(5	)		(20	)
Amortization of intangible assets		(74	)		(35	)		—			(109	)

Operating income (loss)	$	57		$	31		$	(45	)	$	43

March 31, 2010
Revenues	$	1,323		$	275		$	(12	)	$	1,586
OIBDA		162			83			(46	)		199
Depreciation of property, plant and equipment		(12	)		(2	)		(4	)		(18	)
Amortization of intangible assets		(76	)		(34	)		—			(110	)

Operating income (loss)	$	74		$	47		$	(50	)	$	71

12. Additional Financial Information

Cash Interest and Taxes

The Company made interest payments of approximately $88 million and $81 million during the six months ended March 31, 2011 and 2010, respectively. The Company paid approximately $18 million and $21 million of income and withholding taxes during the six months ended March 31, 2011 and 2010, respectively. The Company received $8 million and $6 million of income tax refunds during the six months ended March 31, 2011 and 2010, respectively.

13. Fair Value Measurements

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

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

•

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

•

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

•

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

In accordance with the fair value hierarchy, described above, the following table shows the fair value of the Company’s financial instruments that are required to be measured at fair value as of March 31, 2011. Derivatives not designated as hedging instruments primarily represent the balances below and the gains and losses on these financial instruments are included as other income of approximately $1 million in the statement of operations. Derivatives designated as hedging instruments as of March 31, 2011 are not material to the Company’s financial statements.


	Fair Value Measurements as of March 31, 2011
	(Level 1)		(Level 2)			(Level 3)			Total
	(in millions)
Other Current Assets:
Foreign Currency Forward Exchange Contracts (a)	$	—	$	1		$	—		$	1
Other Current Liabilities:
Foreign Currency Forward Exchange Contracts (a)	$	—	$	(2	)	$	—		$	(2	)
Other Non-Current Liabilities:
Contractual Obligations (b)	$	—	$	—		$	(12	)	$	(12	)

(a)	The fair value of foreign currency forward exchange contracts is based on dealer quotes of market forward rates and reflects the amount that the Company would receive or pay at their maturity dates for contracts involving the same currencies and maturity dates.

(b)	This represents purchase obligations and contingent consideration related to our various acquisitions. This is based on a discounted cash flow (“DCF”) approach and it is adjusted to fair value on a recurring basis.

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

Fair Value of Debt

Based on the level of interest rates prevailing at March 31, 2011, the fair value of the Company’s fixed-rate debt exceeded the carrying value by approximately $108 million. Unrealized gains or losses on debt do not result in the realization or expenditure of cash and generally are not recognized for financial reporting purposes unless the debt is retired prior to its maturity.

14. Subsequent Events

Entry into Agreement to Sell the Company

On May 6, 2011 the Company entered into an Agreement and Plan of Merger, dated as of May 6, 2011 (the “Merger Agreement”), with Airplanes Music LLC, a Delaware limited liability company (“Airplanes”), and Airplanes Merger Sub, Inc., a Delaware corporation and a wholly-owned subsidiary of Airplanes (“Merger Sub” and, together with Airplanes, the “Acquiring Parties”). The Acquiring Parties are affiliated with Access Industries, Inc.

The Merger Agreement provides for, upon the terms and subject to the conditions in the Merger Agreement, the merger of Merger Sub with and into the Company with the Company surviving as a wholly-owned subsidiary of Airplanes (the “Merger”).

Pursuant to the Merger Agreement, at the effective time of the Merger, each outstanding share of common stock of the Company (other than any shares owned by the Company or its wholly-owned subsidiaries or the Acquiring Parties or their respective affiliates or by any stockholders who are entitled to and who properly exercise appraisal rights under Delaware law), will be cancelled and will be converted automatically into the right to receive $8.25 in cash, without interest. The closing of the Merger is subject to customary conditions, including the approval by the holders of a majority of the outstanding shares of the Company’s common stock entitled to vote on the Merger and certain regulatory approvals. It is anticipated that the transaction will be completed in the third calendar quarter of this year. For additional details regarding the Merger Agreement, please see our Current Report on Form 8-K, dated May 9, 2011, filed with the SEC.

WARNER MUSIC GROUP CORP.

Supplementary Information

Consolidating Financial Statements

The Company is the direct parent of Holdings, which is the direct parent of Acquisition Corp. Holdings has issued and outstanding the Holdings Senior Discount Notes due 2014. The Holdings Senior Discount Notes are guaranteed by the Company. These guarantees are full, unconditional, joint and several. The following consolidating financial statements are presented for the information of the holders of the Holdings Senior Discount Notes and present the results of operations, financial position and cash flows of (i) the Company, which is the guarantor of the Holdings Senior Discount Notes, (ii) Holdings, which is the issuer of the Holdings Senior Discount Notes, (iii) the subsidiaries of Holdings (Acquisition Corp. is the only direct subsidiary 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 and Holdings to obtain funds from its subsidiaries is restricted by the indentures for the Acquisition Corp. Senior Secured Notes due 2016 and the Acquisition Corp. Senior Subordinated Notes due 2014, and, with respect to the Company, the indenture for the Holdings Senior Discount Notes.

WARNER MUSIC GROUP CORP.

Supplementary Information

Consolidating Balance Sheet (Unaudited)

March 31, 2011


	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	$	164		$	—		$	155		$	—	$	319
Accounts receivable, net		—			—			337			—		337
Inventories		—			—			31			—		31
Royalty advances expected to be recouped within one year		—			—			168			—		168
Deferred tax assets		—			—			30			—		30
Other current assets		—			—			54			—		54

Total current assets		164			—			775			—		939
Royalty advances expected to be recouped after one year		—			—			207			—		207
Investments in and advances to (from) consolidated subsidiaries		(491	)		(200	)		—			691		—
Property, plant and equipment, net		—			—			123			—		123
Goodwill		—			—			1,084			—		1,084
Intangible assets subject to amortization, net		—			—			1,103			—		1,103
Intangible assets not subject to amortization		—			—			100			—		100
Other assets		23			(26	)		64			—		61

Total assets	$	(304	)	$	(226	)	$	3,456		$	691	$	3,617

Liabilities and Deficit:
Current liabilities:
Accounts payable	$	—		$	—		$	151		$	—	$	151
Accrued royalties		—			—			1,041			—		1,041
Accrued liabilities		—			—			221			—		221
Accrued interest		—			7			53			—		60
Deferred revenue		—			—			116			—		116
Other current liabilities		—			—			—			—		—

Total current liabilities		—			7			1,582			—		1,589
Long-term debt		—			258			1,693			—		1,951
Deferred tax liabilities, net		—			—			166			—		166
Other noncurrent liabilities		—			—			165			—		165

Total liabilities		—			265			3,606			—		3,871

Total Warner Music Group Corp. shareholders’ deficit		(304	)		(491	)		(200	)		691		(304	)

Noncontrolling interest		—			—			50			—		50
Total deficit		(304	)		(491	)		(150	)		691		(254	)

Total liabilities and deficit	$	(304	)	$	(226	)	$	3,456		$	691	$	3,617

WARNER MUSIC GROUP CORP.

Supplementary Information

Consolidating Balance Sheet (Unaudited)

September 30, 2010


	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	$	176		$	—		$	263		$	—	$	439
Accounts receivable, net		—			—			434			—		434
Inventories		—			—			37			—		37
Royalty advances expected to be recouped within one year		—			—			143			—		143
Deferred tax assets		—			—			30			—		30
Other current assets		—			—			46			—		46

Total current assets		176			—			953			—		1,129
Royalty advances expected to be recouped after one year		—			—			189			—		189
Investments in and advances to (from) consolidated subsidiaries		(454	)		(174	)		—			628		—
Property, plant and equipment, net		—			—			121			—		121
Goodwill		—			—			1,057			—		1,057
Intangible assets subject to amortization, net		—			—			1,119			—		1,119
Intangible assets not subject to amortization		—			—			100			—		100
Other assets		14			(15	)		65			—		64

Total assets	$	(264	)	$	(189	)	$	3,604		$	628	$	3,779

Liabilities and Deficit:
Current liabilities:
Accounts payable	$	—		$	—		$	206		$	—	$	206
Accrued royalties		—			—			1,034			—		1,034
Accrued liabilities		—			—			314			—		314
Accrued interest		—			7			52			—		59
Deferred revenue		—			—			100			—		100
Other current liabilities		—			—			8			—		8

Total current liabilities		—			7			1,714			—		1,721
Long-term debt		—			258			1,687			—		1,945
Deferred tax liabilities, net		—			—			169			—		169
Other noncurrent liabilities		1			—			154			—		155

Total liabilities		1			265			3,724			—		3,990

Total Warner Music Group Corp. shareholders’ deficit		(265	)		(454	)		(174	)		628		(265	)

Noncontrolling interest		—			—			54			—		54
Total deficit		(265	)		(454	)		(120	)		628		(211	)

Total liabilities and deficit	$	(264	)	$	(189	)	$	3,604		$	628	$	3,779

WARNER MUSIC GROUP CORP.

Supplementary Information

Consolidating Statements of Operations (Unaudited)

For The Three Months Ended March 31, 2011 and 2010


	Three months ended March 31, 2011
	Warner Music Group Corp.			WMG Holdings Corp. (issuer)			WMG Acquisition Corp.			Eliminations		Warner Music Group Corp. Consolidated
	(in millions)
Revenues	$	—		$	—		$	682		$	—	$	682
Costs and expenses:
Cost of revenues		—			—			(357	)		—		(357	)
Selling, general and administrative expenses		—			—			(254	)		—		(254	)
Amortization of intangible assets		—			—			(55	)		—		(55	)

Total costs and expenses		—			—			(666	)		—		(666	)

Operating income		—			—			16			—		16
Interest expense, net		—			(6	)		(41	)		—		(47	)
Equity (losses) gains from consolidated subsidiaries		(38	)		(32	)		—			70		—
Other expense, net		—			—			(1	)		—		(1	)

Loss before income taxes		(38	)		(38	)		(26	)		70		(32	)
Income tax expense		—			—			(7	)		—		(7	)

Net loss		(38	)		(38	)		(33	)		70		(39	)
Less: loss attributable to noncontrolling interest		—			—			1			—		1

Net loss attributable to Warner Music Group Corp.	$	(38	)	$	(38	)	$	(32	)	$	70	$	(38	)


	Three months ended March 31, 2010
	Warner Music Group Corp.			WMG Holdings Corp. (issuer)			WMG Acquisition Corp.			Eliminations		Warner Music Group Corp. Consolidated
	(in millions)
Revenues	$	—		$	—		$	666		$	—	$	666
Costs and expenses:
Cost of revenues		—			—			(329	)		—		(329	)
Selling, general and administrative expenses		—			—			(259	)		—		(259	)
Amortization of intangible assets		—			—			(54	)		—		(54	)

Total costs and expenses		—			—			(642	)		—		(642	)

Operating income		—			—			24			—		24
Interest expense, net		—			(6	)		(40	)		—		(46	)
Equity (losses) gains from consolidated subsidiaries		(25	)		(19	)		—			44		—
Other expense, net		—			—			(4	)		—		(4	)

Loss before income taxes		(25	)		(25	)		(20	)		44		(26	)
Income tax expense		—			—			(2	)		—		(2	)

Net loss		(25	)		(25	)		(22	)		44		(28	)
Less: loss attributable to noncontrolling interest		—			—			3			—		3

Net loss attributable to Warner Music Group Corp.	$	(25	)	$	(25	)	$	(19	)	$	44	$	(25	)

WARNER MUSIC GROUP CORP.

Supplementary Information

Consolidating Statements of Operations (Unaudited)

For The Six Months Ended March 31, 2011 and 2010


	Six months ended March 31, 2011
	Warner Music Group Corp.			WMG Holdings Corp. (issuer)			WMG Acquisition Corp.			Eliminations		Warner Music Group Corp. Consolidated
	(in millions)
Revenues	$	—		$	—		$	1,471		$	—	$	1,471
Costs and expenses:
Cost of revenues		—			—			(799	)		—		(799	)
Selling, general and administrative expenses		—			—			(520	)		—		(520	)
Amortization of intangible assets		—			—			(109	)		—		(109	)

Total costs and expenses		—			—			(1,428	)		—		(1,428	)

Operating income		—			—			43			—		43
Interest expense, net		—			(12	)		(82	)		—		(94	)
Equity (losses) gains from consolidated subsidiaries		(55	)		(43	)		—			98		—
Other expense, net		—			—			(1	)		—		(1	)

Loss before income taxes		(55	)		(55	)		(40	)		98		(52	)
Income tax expense		(1	)		—			(4	)		—		(5	)

Net loss		(56	)		(55	)		(44	)		98		(57	)
Less: loss attributable to noncontrolling interest		—			—			1			—		1

Net loss attributable to Warner Music Group Corp.	$	(56	)	$	(55	)	$	(43	)	$	98	$	(56	)


	Six months ended March 31, 2010
	Warner Music Group Corp.			WMG Holdings Corp. (issuer)			WMG Acquisition Corp.			Eliminations		Warner Music Group Corp. Consolidated
	(in millions)
Revenues	$	—		$	—		$	1,586		$	—	$	1,586
Costs and expenses:
Cost of revenues		—			—			(846	)		—		(846	)
Selling, general and administrative expenses		—			—			(559	)		—		(559	)
Amortization of intangible assets		—			—			(110	)		—		(110	)

Total costs and expenses		—			—			(1,515	)		—		(1,515	)

Operating income		—			—			71			—		71
Interest expense, net		—			(12	)		(85	)		—		(97	)
Equity (losses) gains from consolidated subsidiaries		(42	)		(30	)		—			72		—
Other expense, net		—			—			(3	)		—		(3	)

Loss before income taxes		(42	)		(42	)		(17	)		72		(29	)
Income tax expense		—			—			(15	)		—		(15	)

Net loss		(42	)		(42	)		(32	)		72		(44	)
Less: loss attributable to noncontrolling interest		—			—			2			—		2

Net loss attributable to Warner Music Group Corp.	$	(42	)	$	(42	)	$	(30	)	$	72	$	(42	)

WARNER MUSIC GROUP CORP.

Supplementary Information

Consolidating Statement of Cash Flows (Unaudited)

For The Six Months Ended March 31, 2011


	Warner Music Group Corp.			WMG Holdings Corp. (issuer)			WMG Acquisition Corp.			Eliminations			Warner Music Group Corp. Consolidated
	(in millions)
Cash flows from operating activities
Net (loss) income	$	(56	)	$	(55	)	$	(44	)	$	98		$	(57	)
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Depreciation and amortization		—			—			129			—			129
Deferred income taxes		—			—			(8	)		—			(8	)
Non-cash interest expense		—			—			6			—			6
Non-cash, stock-based compensation expense		—			—			7			—			7
Equity losses (gains) from consolidated subsidiaries		55			43			—			(98	)		—
Other non-cash items		—			—			(1	)		—			(1	)
Changes in operating assets and liabilities:
Accounts receivable		—			—			105			—			105
Inventories		—			—			7			—			7
Royalty advances		—			—			(35	)		—			(35	)
Accounts payable and accrued liabilities		—			—			(170	)		—			(170	)
Accrued interest		—			—			1			—			1
Other balance sheet changes		(11	)		12			8			—			9

Net cash (used in) provided by operating activities		(12	)		—			5			—			(7	)

Cash flows from investing activities
Investments and acquisitions of businesses		—			—			(57	)		—			(57	)
Acquisition of publishing rights		—			—			(47	)		—			(47	)
Capital expenditures		—			—			(22	)		—			(22	)

Net cash used in investing activities		—			—			(126	)		—			(126	)

Cash flows from financing activities
Distribution to noncontrolling interest holder		—			—			(1	)		—			(1	)

Net cash used in financing activities		—			—			(1	)		—			(1	)

Effect of exchange rate changes on cash and equivalents		—			—			14			—			14

Net decrease in cash and equivalents		(12	)		—			(108	)		—			(120	)
Cash and equivalents at beginning of period		176			—			263			—			439

Cash and equivalents at end of period	$	164		$	—		$	155		$	—		$	319

WARNER MUSIC GROUP CORP.

Supplementary Information

Consolidating Statement of Cash Flows (Unaudited)

For The Six Months Ended March 31, 2010


	Warner Music Group Corp.			WMG Holdings Corp. (issuer)			WMG Acquisition Corp.			Eliminations			Consolidated
	(in millions)
Cash flows from operating activities
Net (loss) income	$	(44	)	$	(44	)	$	(32	)	$	76		$	(44	)
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Depreciation and amortization		—			—			128			—			128
Deferred income taxes		—			—			(6	)		—			(6	)
Impairment of cost-method investment		—			—			1			—			1
Non-cash interest expense		—			5			9			—			14
Non-cash stock-based compensation expense		—			—			5			—			5
Equity losses (gains) from consolidated subsidiaries		44			32						(76	)		—
Other non-cash items		—			—			1			—			1
Changes in operating assets and liabilities:
Accounts receivable		—			—			136			—			136
Inventories		—			—			6			—			6
Royalty advances		—			—			4			—			4
Accounts payable and accrued liabilities		—			—			(191	)		—			(191	)
Accrued interest		—			7			(5	)		—			2
Other balance sheet changes		—			—			(5	)		—			(5	)

Net cash provided by operating activities		—			—			51			—			51

Cash flows from investing activities
Investments and acquisitions of businesses		—			—			(6	)		—			(6	)
Acquisition of publishing rights		—			—			(29	)		—			(29	)
Proceeds from the sale of investments		—			—			9			—			9
Capital expenditures		—			—			(15	)		—			(15	)

Net cash used in investing activities		—			—			(41	)		—			(41	)

Cash flows from financing activities
Distribution to noncontrolling interest holder		—			—			(2	)		—			(2	)

Net cash used in financing activities		—			—			(2	)		—			(2	)

Effect of foreign currency exchange rate changes on cash		—			—			(9	)		—			(9	)

Net decrease in cash and equivalents		—			—			(1	)		—			(1	)
Cash and equivalents at beginning of period		188			—			196			—			384

Cash and equivalents at end of period	$	188		$	—		$	195		$	—		$	383

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, 2011 (the “Quarterly Report”).

We maintain an Internet site at www.wmg.com. We use our website as a channel of distribution for material company information. Financial and other material information regarding the Company is routinely posted on and accessible at http://investors.wmg.com. In addition, you may automatically receive email alerts and other information about the Company by enrolling your email by visiting the “email alerts” section at http://investors.wmg.com. We make available on our 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 Securities and Exchange Commission (the “SEC”). Our website and the information posted on it or connected to it shall not be deemed to be incorporated by reference into 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 the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. 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, cost savings, industry trends 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, our ability to reduce future capital expenditures, our ability to monetize our music content, including through new distribution channels and formats to capitalize on the growth areas of the music industry, our ability to effectively deploy our capital, the development of digital music and the effect of digital distribution channels on our business, including whether we will be able to achieve higher margins from digital sales, the success of strategic actions we are taking to accelerate our transformation as we redefine our role in the music industry, the effectiveness of our ongoing efforts to reduce overhead expenditures and manage our variable and fixed cost structure and our ability to generate expected cost savings from such efforts, our success in limiting piracy, 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 dividends or repurchase our outstanding notes or common stock in open market purchases, privately or otherwise, our ability to fund our future capital needs and the effect of litigation 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 continued decline in the global 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, Internet peer-to-peer file-sharing and sideloading of unauthorized content;

•

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;

•

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 and to enter into expanded-rights deals with recording artists in order to broaden our revenue streams in growing segments of the music business;

•

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 reliance on a limited number of online music stores and their ability to significantly influence the pricing structure for online music stores;

•

the impact of rate regulations on our Recorded Music and Music Publishing businesses;

•

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

•

the impact an impairment in the carrying value of goodwill or other intangible and long-lived assets could have on our operating results and shareholders’ deficit;

•

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;

•

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;

•

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 including our ability to successfully manage new businesses that we may acquire as we diversify revenue streams within the music industry;

•

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

•

the fact that we are outsourcing certain back-office functions, such as IT infrastructure and development and certain finance and accounting functions, which will make us more dependent upon third parties;

•

that changes to our information technology infrastructure to harmonize our systems and processes may fail to operate as designed and intended;

•

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

•

failure to attract and retain key personnel; and

•

risks and uncertainties, including the satisfaction of specified conditions, associated with the consummation of the proposed merger with Airplanes Music LLC and Airplanes Merger Sub, Inc.

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. was formed by the Investor Group on November 21, 2003. The Company is the direct parent of Holdings, which is the direct parent of Acquisition Corp. Acquisition Corp. is one of the world’s major music-based content companies and the successor to substantially all of the interests of the recorded music and music publishing businesses of Time Warner. Effective March 1, 2004, Acquisition Corp acquired such interests from Time Warner for approximately $2.6 billion. The original Investor Group included THL, Bain, Providence and Music Capital. Music Capital’s partnership agreement required that the Music Capital partnership dissolve and commence winding up by the second anniversary of the Company’s May 2005 initial public offering. As a result, on May 7, 2007, Music Capital made a pro rata distribution of all shares of common stock of the Company held by it to its partners. The shares held by Music Capital had been subject to a stockholders agreement among Music Capital, THL, Bain and Providence and certain other parties. As a result of the distribution, the shares distributed by Music Capital ceased to be subject to

the voting and other provisions of the stockholders agreement and Music Capital was no longer part of the Investor Group subject to the stockholders agreement.

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

Management’s discussion and analysis of results of operations and financial condition (“MD&A”) is provided as a supplement to the 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, 2011 and 2010. 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, 2011 and 2010, as well as a discussion of our financial condition and liquidity as of March 31, 2011. The discussion of our financial condition and liquidity includes (i) a summary of our debt agreements 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, non-cash amortization of intangible assets and non-cash impairment charges to reduce the carrying value of goodwill and 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, net income (loss) attributable to Warner Music Group Corp. and other measures of financial performance reported in accordance with U.S. GAAP. In addition, our definition of OIBDA may differ from similarly titled measures used by other companies. A reconciliation of consolidated historical OIBDA to operating income and net income (loss) attributable to Warner Music Group Corp. is provided in our “Results of Operations.”

Use of Constant Currency

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

OVERVIEW

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

Recorded Music Operations

Our Recorded Music business primarily consists of the discovery and development of artists and the related marketing, distribution and licensing of recorded music produced by such artists.

We are also diversifying our revenues beyond our traditional businesses by entering into expanded-rights deals with recording artists in order to partner with artists in other areas of their careers. Under these agreements, we provide services to and participate in artists’ activities outside the traditional recorded music business. We have built artist services capabilities and platforms for exploiting this broader set of music-related rights and participating more broadly in the monetization of the artist brands we help create. In developing our artist services business, we have both built and expanded in-house capabilities and expertise and have acquired a number of existing artist services companies involved in artist management, merchandising, strategic marketing and brand management, ticketing, concert promotion, fan club, original programming and video entertainment. We believe that entering into

expanded-rights deals and enhancing our artist services capabilities with respect to our artists and other artists will permit us to diversify revenue streams to better capitalize on the growth areas of the music industry and permit us to build stronger, long-term relationships with artists and more effectively connect artists and fans.

In the U.S., our Recorded Music operations are conducted principally through our major record labels—Warner Bros. Records and The Atlantic Records Group. Our Recorded Music operations also include Rhino, a division that 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 and from third parties for various uses, including film and television soundtracks. Rhino has also become our primary licensing division focused on acquiring broader licensing rights from certain recording artists. For example, we have an exclusive license with The Grateful Dead to manage the band’s intellectual property and a 50% interest in Frank Sinatra Enterprises, an entity that administers licenses for use of Frank Sinatra’s name and likeness and manages all aspects of his music, film and stage content. We also conduct our Recorded Music operations through a collection of additional record labels, including, among others, Asylum, Cordless, East West, Elektra, Nonesuch, Reprise, Roadrunner, Rykodisc, Sire and Word.

Outside the U.S., our Recorded Music activities are conducted in more than 50 countries primarily through WMI and its various subsidiaries, affiliates and non-affiliated licensees. WMI engages in the same activities as our U.S. labels: discovering and signing artists and distributing, marketing and selling their recorded music. In most cases, WMI also markets and distributes the records of those artists for whom our U.S. record labels have international rights. In certain smaller markets, WMI licenses to unaffiliated third-party record labels the right to distribute its records. Our international artist services operations also include a network of concert promoters through which WMI provides resources to coordinate tours for our artists and other artists.

Our Recorded Music distribution operations include WEA Corp., which markets and sells music and DVD products to retailers and wholesale distributors in the U.S.; ADA, which distributes the products of independent labels to retail and wholesale distributors in the U.S.; various distribution centers and ventures operated internationally; an 80% interest in Word Entertainment, which specializes in the distribution of music products in the Christian retail marketplace; and ADA Global, which provides distribution services outside of the U.S. through a network of affiliated and non-affiliated distributors.

We play an integral role in virtually all aspects of the recorded music value chain from discovering and developing talent to producing albums and promoting artists and their products. After an artist has entered into a contract with one of our record labels, a master recording of the artist’s music is created. The recording is then replicated for sale to consumers primarily in the CD and digital formats. In the U.S., WEA Corp., ADA and Word market, sell and deliver product, either directly or through sub-distributors and wholesalers, to record stores, mass merchants and other retailers. Our recorded music products are also sold in physical form to online physical retailers such as Amazon.com, barnesandnoble.com and bestbuy.com and in digital form to online digital retailers like Apple’s iTunes and mobile full-track download stores such as those operated by Verizon or Sprint. In the case of expanded-rights deals where we acquire broader rights in a recording artist’s career, we may provide more comprehensive career support and actively develop new opportunities for an artist through touring, fan clubs, merchandising and sponsorships, among other areas. We believe expanded-rights deals create better partnerships with our artists, which allow us and our artists to work together more closely to create and sustain artistic and commercial success.

We have integrated the sale of digital content into all aspects of our Recorded Music and Music Publishing businesses including A&R, marketing, promotion and distribution. Our new media executives work closely with A&R departments to make sure that while a record is being made, digital assets are also created with all of our distribution channels in mind, including subscription services, social networking sites, online portals and music-centered destinations. We work side by side with our mobile and online partners to test new concepts. We believe existing and new digital businesses will be a significant source of growth for the next several years and will provide new opportunities to monetize our assets and create new revenue streams. As a music-based content company, we have assets that go beyond our recorded music and music publishing catalogs, such as our music video library, which we have begun to monetize through digital channels. The proportion of digital revenues attributed to each distribution channel varies by region and since digital music is still in the relatively early stages of growth, proportions may change as the roll out of new technologies continues. As an owner of musical content, we believe we are well positioned to take advantage of growth in digital distribution and emerging technologies to maximize the value of our assets.

Recorded Music revenues are derived from three main sources:

•

Physical and other: the rightsholder receives revenues with respect to sales of physical products such as CDs and DVDs. We are also diversifying our revenues beyond sales of physical products and receive other revenues from our artist services business and our participation in expanded rights associated with our artists and other artists, including sponsorship, fan club, artist websites, merchandising, touring, ticketing and artist and brand management;

•

Digital: the rightsholder receives revenues with respect to online and mobile downloads, mobile ringtones or ringback tones and online and mobile streaming; and

•

Licensing: the rightsholder receives royalties or fees for the right to use the sound recording in combination with visual images such as in films or television programs, television commercials and videogames.

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

•

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

•

Product costs—the costs to manufacture, package and distribute product to wholesale and retail distribution outlets as well as those principal costs related to expanded rights;

•

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

•

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

Music Publishing Operations

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

Our Music Publishing operations include Warner/Chappell, our global Music Publishing company headquartered in New York with operations in over 50 countries through various subsidiaries, affiliates and non-affiliated licensees. We own or control rights to more than one million musical compositions, including numerous pop hits, American standards, folk songs and motion picture and theatrical compositions. Assembled over decades, our award-winning catalog includes over 65,000 songwriters and composers and a diverse range of genres including pop, rock, jazz, country, R&B, hip-hop, rap, reggae, Latin, folk, blues, symphonic, soul, Broadway, techno, alternative, gospel and other Christian music. In January 2011, the Company acquired Southside Independent Music Publishing, a leading independent music publishing company, further adding to its catalog. Warner/Chappell also administers the music and soundtracks of several third-party television and film producers and studios, including Lucasfilm, Ltd., Hallmark Entertainment, Disney Music Publishing and Turner Music Publishing. In 2007, we entered the production music library business with the acquisition of Non-Stop Music. We have subsequently continued to expand our production music operations with the acquisitions of V The Production Library in 2009 and Groove Addicts Production Music Library, Carlin Recorded Music Library and 615 Music in 2010.

Publishing revenues are derived from five main sources:

•

Mechanical: the licensor receives royalties with respect to compositions embodied in recordings sold in any physical format or configuration (e.g., CDs and DVDs);

•

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

•

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

•

Digital: the licensor receives royalties or fees with respect to online and mobile downloads, mobile ringtones and online and mobile streaming; and

•

Other: the licensor receives royalties for use in sheet music.

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

•

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

Factors Affecting Results of Operations and Financial Condition

Market Factors

Since 1999, the recorded music industry has been unstable and the worldwide market has contracted considerably, 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. While CD sales still generate most of the recorded music revenues, CD sales continue to decline industry-wide and we expect that trend to continue. While new formats for selling recorded music product have been created, including the legal downloading of digital music using the Internet and the distribution of music on mobile devices, revenue streams from these new formats have not yet reached a

level where they fully offset the declines in CD sales. 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 portions of the music publishing business. This is because the music publishing business generates a significant portion of its revenues from mechanical royalties from the sale of music in CD and other physical recorded music formats.

Severance Charges

During the six months ended March 31, 2011 we took additional actions to further align our cost structure with industry trends. This resulted in severance charges of $18 million for the six months ended March 31, 2011, compared to $11 million for the six months ended March 31, 2010.

Expanding Business Models to Offset Declines in Physical Sales

Digital Sales

A key part of our strategy to offset declines in physical sales is to expand digital sales. New digital models have enabled us to find additional ways to generate revenues from our music content. In the early stages of the transition from physical to digital sales, overall sales have decreased as the increases in digital sales have not yet met or exceeded the decrease in physical sales. Part of the reason for this gap is the shift in consumer purchasing patterns made possible from new digital models. In the digital space, consumers are now presented with the opportunity to not only purchase entire albums, but to “unbundle” albums and purchase only favorite tracks as single-track downloads. While to date, sales of online and mobile downloads have constituted the majority of our digital Recorded Music and Music Publishing revenue, that may change over time as new digital models, such as access models (models that typically bundle the purchase of a mobile device with access to music) and streaming subscription services, continue to develop. In the aggregate, we believe that growth in revenue from new digital models has the potential to offset physical declines and drive overall future revenue growth. In the digital space, certain costs associated with physical products, such as manufacturing, distribution, inventory and return costs, do not apply. Partially eroding that benefit are increases in mechanical copyright royalties payable to music publishers which apply in the digital space. While there are some digital-specific variable costs and infrastructure investments necessary to produce, market and sell music in digital formats, we believe it is reasonable to expect that digital margins will generally be higher than physical margins as a result of the elimination of certain costs associated with physical products. As consumer purchasing patterns change over time and new digital models are launched, we may see fluctuations in contribution margin depending on the overall sales mix.

Expanded-Rights Deals

We have also been seeking to expand our relationships with recording artists as another means to offset declines in physical revenues in Recorded Music. For example, we have been signing recording artists to expanded-rights deals for the last several years. Under these expanded-rights deals, we participate in the recording artist’s revenue streams, other than from recorded music sales, such as live performances, merchandising and sponsorships. We believe that additional revenue from these revenue streams will help to offset declines in physical revenue over time. As we have generally signed newer artists to these deals, increased non-traditional revenue from these deals is expected to come several years after these deals have been signed as the artists become more successful and are able to generate revenue other than from recorded music sales. While non-traditional Recorded Music revenue, which includes revenue from expanded-rights deals as well as revenue from our artist services business, was less than 10% of our total revenue in fiscal 2010, we believe this revenue should continue to grow and represent a larger proportion of our revenue over time. We also believe that the strategy of entering into expanded-rights deals and continuing to develop our artist services business will contribute to Recorded Music growth over time. Margins for the various non-traditional Recorded Music revenue streams can vary significantly. The overall impact on margins will, therefore, depend on the composition of the various revenue streams in any particular period. For instance, revenue from touring under our expanded-rights deals typically flows straight through to net income with little incremental cost. Revenue from our management business and revenue from sponsorship and touring under expanded-rights deals are all high margin, while merchandise revenue under expanded-rights deals and concert promotion revenue from our concert promotion businesses tend to be lower margin than our traditional revenue streams from recorded music and music publishing.

RESULTS OF OPERATIONS

Three Months Ended March 31, 2011 Compared with Three Months Ended March 31, 2010

Consolidated Historical Results

Revenues

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


	For the Three Months Ended March 31,						*2011 vs. 2010*
	2011			2010			$ Change			% Change
Revenue by Type
Physical and other	$	286		$	294		$	(8	)		-3	%
Digital		205			192			13			7	%
Licensing		59			52			7			13	%

Total Recorded Music		550			538			12			2	%
Mechanical		34			40			(6	)		-15	%
Performance		50			55			(5	)		-9	%
Synchronization		31			24			7			29	%
Digital		17			13			4			31	%
Other		5			2			3			—

Total Music Publishing		137			134			3			2	%
Intersegment elimination		(5	)		(6	)		1			-17	%

Total Revenue	$	682		$	666		$	16			2	%

Revenue by Geographical Location
U.S. Recorded Music	$	254		$	253		$	1			—
U.S. Publishing		61			54			7			13	%

Total U.S.		315			307			8			3	%
International Recorded Music		296			285			11			4	%
International Publishing		76			80			(4	)		-5	%

Total International		372			365			7			2	%
Intersegment eliminations		(5	)		(6	)		1			-17	%

Total Revenue	$	682		$	666		$	16			2	%

Total Revenue

Total revenues increased by $16 million, or 2%, to $682 million for the three months ended March 31, 2011 from $666 million for the three months ended March 31, 2010. Prior to intersegment eliminations, Recorded Music and Music Publishing revenues represented 80% and 20% of total revenues for the three months ended March 31, 2011 and 2010, respectively. Prior to intersegment eliminations, U.S. and international revenues represented 46% and 54% of total revenues for the three months ended March 31, 2011 and 2010. Excluding the favorable impact of foreign currency exchange rates, total revenues increased $11 million, or 2%.

Total digital revenues after intersegment eliminations increased by $18 million, or 9%, to $220 million for the three months ended March 31, 2011 from $202 million for the three months ended March 31, 2010. Total digital revenues represented 32% and 30% of consolidated revenues for the three months ended March 31, 2011 and 2010, respectively. Prior to intersegment eliminations, total digital revenues for the three months ended March 31, 2011 were comprised of U.S. revenues of $134 million and international revenues of $88 million, or 60% and 40% of total digital revenues, respectively. Prior to intersegment eliminations, total digital revenues for the three months ended March 31, 2010 were comprised of U.S. revenues of $130 million and international revenues of $75 million, or 63% and 37% of total digital revenues, respectively.

streams such as Spotify and YouTube, partially offset by the continued decline in global mobile revenue primarily related to lower ringtone demand. Licensing revenue growth was driven primarily by increases in the licensing of our recorded music assets in film, television and compilations. The increases in our European concert promotion business reflected a stronger touring schedule, mostly in France and Italy, as compared with the prior year quarter. Excluding the favorable impact of foreign currency exchange rates, total Recorded Music revenues increased by $6 million, or 1%.

Music Publishing revenues increased by $3 million, or 2%, to $137 million for the three months ended March 31, 2011 from $134 million for the three months ended March 31, 2010. Prior to intersegment eliminations, Music Publishing revenues represented 20% of consolidated revenues, for the three months ended March 31, 2011 and 2010. U.S. Music Publishing revenues were $61 million and $54 million, or 45% and 40% of Music Publishing revenues for the three months ended March 31, 2011 and 2010, respectively. International Music Publishing revenues were $76 million and $80 million, or 55% and 60% of Music Publishing revenues for the three months ended March 31, 2011 and 2010, respectively.

The growth in Music Publishing revenue was driven primarily by increases in synchronization revenue, digital revenue and other revenue, partially offset by expected decreases in mechanical revenue and performance revenue. Synchronization revenue results reflected the improvement of the U.S. advertising market. The increase in digital revenue reflected growth in global digital downloads and certain streaming services. Other music publishing revenue increased primarily as a result of higher print revenue in the U.S. The decrease in mechanical revenue reflected the ongoing impact of the transition from physical to digital sales in the recorded music industry and the timing of cash collections. Performance revenue declined primarily as a result of our decision not to renew a low margin administrative deal in the prior year.

Revenue by Geographical Location

U.S. revenues increased by $8 million, or 3%, to $315 million for the three months ended March 31, 2011 from $307 million for the three months ended March 31, 2010. The overall increase in the U.S. Recorded Music business reflected growth in digital downloads and increases in licensing our recorded music assets in film, television and compilations. The increase was partially offset by the continued decline in mobile revenue primarily related to lower ringtone demand and declines in physical sales in the recorded music industry. The overall increase in the U.S. Music Publishing business was driven primarily by increases in synchronization revenue, digital revenue and other revenue, partially offset by the expected decreases in mechanical revenue and performance revenue.

International revenues increased by $7 million, or 2%, to $372 million for the three months ended March 31, 2011 from $365 million for the three months ended March 31, 2010. Excluding the favorable impact of foreign currency exchange rates, total international revenues increased $1 million. The overall increase in the international Recorded Music business reflected growth in global digital downloads and emerging digital streaming services such as Spotify and YouTube and success from our European concert promotion business which reflected a stronger touring schedule, mostly in France and Italy, as compared with the prior year quarter. Revenue growth in France, Canada, Italy and certain Asia-Pacific countries was partially offset by declines in Japan, the U.K. and other parts of Europe. The overall decrease in the international Music Publishing business was driven by the expected decreases in mechanical revenue and performance revenue, partially offset by the increase in digital download revenue and revenue from certain streaming services.

Cost of revenues

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


	For the Three Months Ended March 31,				*2011 vs. 2010*
	2011		2010		$ Change		% Change
Artist and repertoire costs	$	223	$	205	$	18		9	%
Product costs		115		106		9		8	%
Licensing costs		19		18		1		6	%

Total cost of revenues	$	357	$	329	$	28		9	%

Our cost of revenues increased by $28 million, or 9%, to $357 million for the three months ended March 31, 2011 from $329 million for the three months ended March 31, 2010. Expressed as a percentage of revenues, cost of revenues were 52% for the three months ended March 31, 2011 and 49% for the three months ended March 31, 2010.

Artist and repertoire costs increased by $18 million, or 9%, to $223 million for the three months ended March 31, 2011 from $205 million for the three months ended March 31, 2010. Expressed as a percentage of revenues, artist and repertoire costs increased from 31% for the three months ended March 31, 2010 to 33% in the three months ended March 31, 2011. The increase in artist and repertoire costs was primarily driven by the increase in revenue in the current-year quarter as well as the prior-year quarter impact of a cost-recovery benefit related to the termination of certain artist contracts in our Recorded Music business and an adjustment in royalty reserves in our Music Publishing business.

Product costs increased by $9 million, or 8%, to $115 million for the three months ended March 31, 2011 from $106 million for the three months ended March 31, 2010. The increase in product costs was driven by higher non-traditional recorded music business costs related to the increase in revenue from our European concert promotion businesses, partially offset by effective supply chain management and the continuing change in mix from physical to digital sales. Expressed as a percentage of revenues, product costs increased from 16% for the three months ended March 31, 2010 to 17% in the three months ended March 31, 2011.

Licensing costs increased $1 million, or 6%, to $19 million for the three months ended March 31, 2011 from $18 million for the three months ended March 31, 2010. Licensing costs as a percentage of licensing revenues decreased from 35% for the three months ended March 31, 2010 to 32% for the three months ended March 31, 2011, primarily as a result of changes in revenue mix.

Selling, general and administrative expenses

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


	For the Three Months Ended March 31,				*2011 vs. 2010*
	2011		2010		$ Change			% Change
General and administrative expense (1)	$	144	$	138	$	6			4	%
Selling and marketing expense		96		105		(9	)		-9	%
Distribution expense		14		16		(2	)		-13	%

Total selling, general and administrative expense	$	254	$	259	$	(5	)		-2	%

(1)	Includes depreciation expense of $11 million and $9 million for the three months ended March 31, 2011 and 2010, respectively.

Total selling, general and administrative expense decreased by $5 million, or 2%, to $254 million for the three months ended March 31, 2011 from $259 million for the three months ended March 31, 2010. Expressed as a percentage of revenues, selling, general and administrative expenses decreased from 39% for the three months ended March 31, 2010 to 37% for the three months ended March 31, 2011.

General and administrative expenses increased by $6 million, or 4%, to $144 million for the three months ended March 31, 2011 from $138 million for the three months ended March 31, 2010. Expressed as a percentage of revenues, general and administrative expenses remained flat at 21% for the three months ended March 31, 2011 and 2010. The increase was primarily driven by an increase in stock compensation expense of $3 million related to the modifications of existing restricted stock award agreements and professional fees.

Selling and marketing expense decreased by $9 million, or 9%, to $96 million for the three months ended March 31, 2011 from $105 million for the three months ended March 31, 2010, primarily related to lower variable marketing expense as a result of our efforts to better align spending on selling and marketing expense with revenues earned. Expressed as a percentage of revenues, selling and marketing expense decreased from 16% for the three months ended March 31, 2010 to 14% for the three months ended March 31, 2011.

Distribution expense decreased by $2 million, or 13%, to $14 million for the three months ended March 31, 2011 from $16 million for the three months ended March 31, 2010. The decrease in distribution expense was driven by the ongoing transition from physical to digital sales. Expressed as a percentage of revenues, distribution expense remained flat at 2% for the three months ended March 31, 2011 and 2010.

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

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 attributable to Warner Music Group Corp. for purposes of the discussion that follows (in millions):


	For the Three Months Ended March 31,						*2011 vs. 2010*
	2011			2010			$ Change			% Change
OIBDA	$	82		$	87		$	(5	)		-6	%
Depreciation expense		(11	)		(9	)		(2	)		22	%
Amortization expense		(55	)		(54	)		(1	)		2	%

Operating income		16			24			(8	)		-33	%
Interest expense, net		(47	)		(46	)		(1	)		2	%
Other expense, net		(1	)		(4	)		3			-75	%

Loss before income taxes		(32	)		(26	)		(6	)		23	%


	For the Three Months Ended March 31,						*2011 vs. 2010*
	2011			2010			$ Change			% Change
Income tax expense		(7	)		(2	)		(5	)		—

Net loss		(39	)		(28	)		(11	)		39	%
Less: loss attributable to noncontrolling interest		1			3			(2	)		-67	%

Net loss attributable to Warner Music Group Corp.	$	(38	)	$	(25	)	$	(13	)		52	%

OIBDA

Our OIBDA decreased by $5 million to $82 million for the three months ended March 31, 2011 as compared to $87 million for the three months ended March 31, 2010. Expressed as a percentage of revenues, total OIBDA margin decreased from 13%, for the three months ended March 31, 2010, to 12% for the three months ended March 31, 2011. Our OIBDA decrease was primarily driven by the increase in stock compensation expense related to the modifications of existing restricted stock award agreements and the prior-year quarter impact of a cost-recovery benefit related to the termination of certain artist contracts in our Recorded Music business and an adjustment in royalty reserves in our Music Publishing business, partially offset by the decrease in selling and marketing expense noted above.

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

Depreciation expense

Our depreciation expense increased from $9 million, for the three months ended March 31, 2010, to $11 million for the three months ended March 31, 2011, primarily related to recently completed capital projects.

Amortization expense

Amortization expense increased from $54 million, for the three months ended March 31, 2010, to $55 million for the three months ended March 31, 2011. The increase primarily related to additional amortization associated with recent acquisitions of certain recorded music catalog assets.

Operating income

Our operating income decreased $8 million to $16 million, for the three months ended March 31, 2011 as compared to operating income of $24 million for the three months ended March 31, 2010. The decrease in operating income was primarily a result of the decrease in OIBDA, as well as the increase in amortization and depreciation expense noted above.

Interest expense, net

Our interest expense, net, increased $1 million, or 2%, to $47 million for the three months ended March 31, 2011 as compared to $46 million for the three months ended March 31, 2010. The increase was primarily driven by changes in foreign currency exchange rates related to our sterling denominated notes.

See “—Financial Condition and Liquidity” for more information.

Other expense, net

Other expense for the three months ended March 31, 2011 and 2010 included net hedging gains on foreign exchange contracts, which represent currency exchange movements associated with inter-company receivables and payables that are short term in nature, offset by equity in earnings on our share of net income on investments recorded in accordance with the equity method of accounting for an unconsolidated investee.

Income tax expense

We provided income tax expense of $7 million for the three months ended March 31, 2011 as compared to an expense of $2 million for the three months ended March 31, 2010. The increase in income tax expense was primarily due to an increase in foreign earnings subject to tax in certain jurisdictions during the three months ended March 31, 2011.

Net loss

Our net loss increased by $11 million, to a net loss of $39 million for the three months ended March 31, 2011 as compared to net loss of $28 million for the three months ended March 31, 2010. The increase was a result of decreased OIBDA and the increase in income tax expense.

Noncontrolling interests

The loss attributable to noncontrolling interests was $1 million and $3 million for the three months ended March 31, 2011 and 2010, respectively.

Business Segment Results

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


	For the Three Months Ended March 31,						*2011 vs. 2010*
	2011			2010			$ Change			% Change
Recorded Music
Revenue	$	550		$	538		$	12			2	%
OIBDA		54			49			5			10	%
Operating income	$	10		$	6			4			67	%
Music Publishing
Revenue	$	137		$	134		$	3			2	%
OIBDA		50			61			(11	)		-18	%
Operating income	$	31		$	43		$	(12	)		-28	%
Corporate expenses and eliminations
Revenue	$	(5	)	$	(6	)	$	1			17	%
OIBDA		(22	)		(23	)		1			4	%
Operating loss	$	(25	)	$	(25	)	$	—			—
Total
Revenue	$	682		$	666		$	16			2	%
OIBDA		82			87			(5	)		-6	%
Operating income	$	16		$	24		$	(8	)		-33	%

Recorded Music

Revenues

Recorded Music revenues increased by $12 million, or 2%, to $550 million for the three months ended March 31, 2011 from $538 million for the three months ended March 31, 2010. Prior to intersegment eliminations, Recorded Music revenues represented 80% of consolidated revenues, for the three months ended March 31, 2011 and 2010. U.S. Recorded Music revenues were $254 million and $253 million, or 46% and 47% of Recorded Music revenues for the three months ended March 31, 2011 and 2010, respectively. International Recorded Music revenues were $296 million and $285 million, or 54% and 53% of consolidated Recorded Music revenues for the three months ended March 31, 2011 and 2010, respectively. The growth reflected increases in digital revenue, licensing revenue and revenue from our European concert promotion businesses, partially offset by the declines in physical sales. The increase in digital revenue was driven by the growth in digital downloads in the U.S. and International and emerging digital revenue streams such as Spotify and YouTube, partially offset by the continued decline in global mobile revenue primarily related to lower ringtone demand. Licensing revenue growth was driven primarily by increases in the licensing of our recorded music assets in film, television and compilations. The increases in our European concert promotion business reflected a stronger touring schedule, mostly in France and Italy, as compared with the prior year quarter. Excluding the favorable impact of foreign currency exchange rates, total Recorded Music revenues increased by $6 million, or 1%.

Cost of revenues

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


	For the Three Months Ended March 31,				*2011 vs. 2010*
	2011		2010		$ Change		% Change
Artist and repertoire costs	$	161	$	154	$	7		5	%
Product costs		115		106		9		8	%
Licensing costs		19		18		1		6	%

Total cost of revenues	$	295	$	278	$	17		6	%

Recorded Music cost of revenues increased $17 million, or 6%, for the three months ended March 31, 2011. The increase in artist and repertoire costs was primarily driven by the increase in revenue in the current-year quarter as well as the prior-year quarter impact of a cost-recovery benefit related to the termination of certain artist contracts. The increase in product costs was driven by higher non-traditional recorded music business costs related to the increase in revenue from our European concert promotion businesses, partially offset by effective supply chain management and the continuing change in mix from physical to digital sales. The increase in licensing costs was driven primarily by the increase in licensing revenue and changes in revenue mix. Expressed as a percentage of Recorded Music revenues, cost of revenues increased from 52% for the three months ended March 31, 2010, to 54% for the three months ended March 31, 2010.

Selling, general and administrative expense

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


	For the Three Months Ended March 31,				*2011 vs. 2010*
	2011		2010		$ Change			% Change
General and administrative expense (1)	$	100	$	98	$	2			2	%
Selling and marketing expense		94		103		(9	)		-9	%
Distribution expense		14		16		(2	)		-13	%

Total selling, general and administrative expense	$	208	$	217	$	(9	)		-4	%

(1)	Includes depreciation expense of $7 million and $6 million for the three months ended March 31, 2011 and 2010, respectively.

Recorded Music selling, general and administrative expense decreased $9 million, for the three months ended March 31, 2011. The decrease in selling and marketing expense was primarily the result of our efforts to better align selling and marketing expenses with revenues earned, the timing of our releases and the effect of continued cost-management efforts. The increase in general and administrative expenses was primarily driven by an increase in stock compensation expense of $3 million related to the modification of existing restricted stock award agreements. Expressed as a percentage of Recorded Music revenues, selling, general and administrative expense decreased from 40% for the three months ended March 31, 2010 to 38% for the three months ended March 31, 2011.

OIBDA and Operating Income

Recorded Music operating income included the following (in millions):


	For the Three Months Ended March 31,						*2011 vs. 2010*
	2011			2010			$ Change			% Change
OIBDA	$	54		$	49		$	5			10	%
Depreciation and amortization		(44	)		(43	)		(1	)		2	%

Operating income	$	10		$	6		$	4			67	%

Recorded Music OIBDA increased by $5 million, or 10%, to $54 million for the three months ended March 31, 2011 compared to $49 million for the three months ended March 31, 2010. Expressed as a percentage of Recorded Music revenues, Recorded Music OIBDA margin increased to 10% for the three months ended March 31, 2011 from 9% for the three months ended March 31, 2010. Our Recorded Music OIBDA increase was primarily driven by the increase in revenues, the realization of cost savings from management initiatives taken in prior periods and the decrease in artist and repertoire costs, product costs and selling and marketing expense noted above, partially offset by the prior-year quarter impact of a cost-recovery benefit related to the termination of certain artist contracts.

Recorded Music operating income increased by $4 million, due primarily to the increase in OIBDA noted above.

Music Publishing

Revenues

Music Publishing revenues increased by $3 million, or 2%, to $137 million for the three months ended March 31, 2011 from $134 million for the three months ended March 31, 2010. Prior to intersegment eliminations, Music Publishing revenues represented 20% of consolidated revenues for the three months ended March 31, 2011 and 2010. U.S. Music Publishing revenues were $61 million and $54 million, or 45% and 40% of Music Publishing revenues for the three months ended March 31, 2011 and 2010, respectively. International Music Publishing revenues were $76 million and $80 million, or 55% and 60% of Music Publishing revenues for the three months ended March 31, 2011 and 2010, respectively.

Cost of revenues

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


	For the Three Months Ended March 31,				*2011 vs. 2010*
	2011		2010		$ Change		% Change
Artist and repertoire costs	$	67	$	58	$	9		16	%

Total cost of revenues	$	67	$	58	$	9		16	%

Music Publishing cost of revenues increased $9 million, or 16%, to $67 million for the three months ended March 31, 2011, from $58 million for the three months ended March 31, 2010. Expressed as a percentage of Music Publishing revenues, Music Publishing cost of revenues increased to 49% for the three months ended March 31, 2011 from 43% for the three months ended March 31, 2010. The increase was driven by a combination of higher revenue and the timing of artist and repertoire spend in the current-year quarter as well as an adjustment to royalty reserves in the prior-year quarter.

Selling, general and administrative expense

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


	For the Three Months Ended March 31,				*2011 vs. 2010*
	2011		2010		$ Change		% Change
General and administrative expense (1)	$	21	$	16	$	5		31	%

Total selling, general and administrative expense	$	21

Large accelerated filer

Accelerated filer

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company