Warner Music Group Corp. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following discussion of our results of operations and financial condition with the unaudited interim financial statements included elsewhere in this Quarterly Report on Form 10-Q for the fiscal quarter ended December 31, 2020 (the “Quarterly Report”). “SAFE HARBOR” STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 This Quarterly Report includes forward-looking statements and cautionary statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Some of the forward-looking statements can be identified by the use of forward-looking terms such as “believes,” “expects,” “may,” “will,” “shall,” “should,” “would,” “could,” “seeks,” “aims,” “projects,” “is optimistic,” “intends,” “plans,” “estimates,” “anticipates” or other comparable terms or the negative thereof. Forward-looking statements include, without limitation, all matters that are not historical facts. They appear in a number of places throughout this Quarterly Report and include, without limitation, our ability to compete in the highly competitive markets in which we operate, statements regarding our ability to develop talent and attract future talent, our ability to reduce future capital expenditures, our ability to monetize our music, including through new distribution channels and formats to capitalize on the growth areas of the music entertainment industry, our ability to effectively deploy our capital, the development of digital music and the effect of digital distribution channels on our business, including whether we will be able to achieve higher margins from digital sales, the success of strategic actions we are taking to accelerate our transformation as we redefine our role in the music entertainment industry, the effectiveness of our ongoing efforts to reduce overhead expenditures and manage our variable and fixed cost structure and our ability to generate expected cost savings from such efforts, our success in limiting piracy, the growth of the music entertainment industry and the effect of our and the industry’s efforts to combat piracy on the industry, our intention to pay dividends or repurchase or retire our outstanding debt or notes in open market purchases, privately or otherwise, the impact on us of potential strategic transactions, our ability to fund our future capital needs and the effect of litigation on us. Forward-looking statements are subject to known and unknown risks and uncertainties, many of which may be beyond our control. We caution you that forward-looking statements are not guarantees of future performance or outcomes and that actual performance and outcomes, including, without limitation, our actual results of operations, financial condition and liquidity, and the development of the market in which we operate, may differ materially from those made in or suggested by the forward-looking statements contained in this Quarterly Report. In addition, even if our results of operations, financial condition and cash flows, and the development of the market in which we operate, are consistent with the forward-looking statements contained in this Quarterly Report, those results or developments may not be indicative of results or developments in subsequent periods. New factors emerge from time to time that may cause our business not to develop as we expect, and it is not possible for us to predict all of them. Factors that could cause actual results and outcomes to differ from those reflected in forward-looking statements include, without limitation: • risks related to the effects of natural or man-made disasters, including pandemics such as COVID-19; • our ability to identify, sign and retain recording artists and songwriters and the existence or absence of superstar releases; • our inability to compete successfully in the highly competitive markets in which we operate; • the ability to further develop a successful business model applicable to a digital environment and to enter into artist services and expanded-rights deals with recording artists in order to broaden our revenue streams in growing segments of the music entertainment business; • the popular demand for particular recording artists and/or songwriters and music and the timely delivery to us of music by major recording artists and/or songwriters; • the diversity and quality of our recording artists, songwriters and releases; • slower growth in streaming adoption and revenue; • our dependence on a limited number of digital music services for the online distribution and marketing of our music and their ability to significantly influence the pricing structure for online music stores; • trends, developments or other events in some foreign countries in which we operate; • risks associated with our non-U.S. operations, including limited legal protections of our intellectual property rights and restrictions on the repatriation of capital; • unfavorable currency exchange rate fluctuations; 25 • the impact of heightened and intensive competition in the recorded music and music publishing industries and our inability to execute our business strategy; • significant fluctuations in our operations, cash flows and the trading price of our common stock from period to period; • our failure to attract and retain our executive officers and other key personnel; • a significant portion of our revenues are subject to rate regulation either by government entities or by local third-party collecting societies throughout the world and rates on other income streams may be set by governmental proceedings, which may limit our profitability; • risks associated with obtaining, maintaining, protecting and enforcing our intellectual property rights; • our involvement in intellectual property litigation; • threats to our business associated with digital piracy, including organized industrial piracy; • an impairment in the carrying value of goodwill or other intangible and long-lived assets; • our failure to have full control and ability to direct the operations we conduct through joint ventures; • the impact of, and risks inherent in, acquisitions or other business combinations; • risks inherent to our outsourcing certain finance and accounting functions; • the fact that we have engaged in substantial restructuring activities in the past, and may need to implement further restructurings in the future and our restructuring efforts may not be successful or generate expected cost savings; • our ability to maintain the security of information relating to our customers, employees and vendors and our music; • risks related to evolving laws and regulations concerning data privacy which might result in increased regulation and different industry standards; • legislation limiting the terms by which an individual can be bound under a “personal services” contract; • a potential loss of catalog if it is determined that recording artists have a right to recapture U.S. rights in their recordings under the U.S. Copyright Act; • potential employment and withholding liabilities if our recording artists and songwriters are characterized as employees; • any delays and difficulties in satisfying obligations incident to being a public company; • the impact of our substantial leverage on our ability to raise additional capital to fund our operations, on our ability to react to changes in the economy or our industry and on our ability to meet our obligations under our indebtedness; • the ability to generate sufficient cash to service all of our indebtedness, and the risk that we may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful; • the fact that our debt agreements contain restrictions that limit our flexibility in operating our business; • the significant amount of cash required to service our indebtedness and the ability to generate cash or refinance indebtedness as it becomes due depends on many factors, some of which are beyond our control; • our indebtedness levels, and the fact that we may be able to incur substantially more indebtedness, which may increase the risks created by our substantial indebtedness; • risks of downgrade, suspension or withdrawal of the rating assigned by a rating agency to us could impact our cost of capital; • the dual class structure of our common stock and Access’s existing ownership of our Class B Common Stock have the effect of concentrating control over our management and affairs and over matters requiring stockholder approval with Access; and • risks related to other factors discussed under “Risk Factors” of this Quarterly Report and in our Annual Report on Form 10-K for the fiscal year ended September 30, 2020. You should read this Quarterly Report completely and with the understanding that actual future results may be materially different from expectations. All forward-looking statements made in this Quarterly Report are qualified by these cautionary statements. Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake any obligation, other than as may be required by law, to update or revise any forward-looking or cautionary statements to reflect changes in 26 assumptions, the occurrence of events, unanticipated or otherwise, and changes in future operating results over time or otherwise. Comparisons of results for current and any prior periods are not intended to express any future trends or indications of future performance, unless expressed as such, and should only be viewed as historical data. Other risks, uncertainties and factors, including those discussed in the “Risk Factors” of this Quarterly Report and our Annual Report on Form 10-K, could cause our actual results to differ materially from those projected in any forward-looking statements we make. You should read carefully the factors described in the “Risk Factors” section of this Quarterly Report and our Annual Report on Form 10-K to better understand the risks and uncertainties inherent in our business and underlying any forward-looking statements. INTRODUCTION Warner Music Group Corp. (the “Company”) was formed on November 21, 2003. The Company is the direct parent of WMG Holdings Corp. (“Holdings”), which is the direct parent of WMG Acquisition Corp. (“Acquisition Corp.”). Acquisition Corp. is one of the world’s major music entertainment companies. On June 5, 2020, the Company completed an IPO of 77,000,000 shares of Class A Common Stock at a public offering price of $25 per share. The offering consisted entirely of secondary shares sold by Access and certain related selling stockholders. On July 7, 2020, the Company completed the sale of an additional 11,550,000 shares of Class A Common Stock from the selling stockholders to the underwriters of the Company’s IPO pursuant to the exercise by the underwriters of their option to purchase additional shares of Class A Common Stock. We did not receive any of the proceeds of the IPO or exercise of the underwriters’ option. Following completion of the IPO and the exercise in full of the underwriters’ option to purchase additional shares, Access and its affiliates held an aggregate of 421,450,000 shares of Class B Common Stock, representing approximately 99% of the total combined voting power of the Company’s outstanding common stock and approximately 83% of the economic interest. As a result, the Company is a “controlled company” within the meaning of the corporate governance standards of NASDAQ. The Company and Holdings are holding companies that conduct substantially all of their business operations through their subsidiaries. The terms “we,” “us,” “our,” “ours” and the “Company” refer collectively to Warner Music Group Corp. and its consolidated subsidiaries, except where otherwise indicated. Management’s discussion and analysis of financial condition and results of operations (“MD&A”) is provided as a supplement to the unaudited financial statements and related notes thereto included elsewhere herein to help provide an understanding of our financial condition, changes in financial condition and results of our operations. MD&A is organized as follows: • Business overview. This section provides a general description of our business, as well as a discussion of factors that we believe are important in understanding our results of operations and comparability and in anticipating future trends. • Results of operations. This section provides an analysis of our results of operations for the three months ended December 31, 2020 and December 31, 2019. This analysis is presented on both a consolidated and segment basis. • Financial condition and liquidity. This section provides an analysis of our cash flows for the three months ended December 31, 2020 and December 31, 2019, as well as a discussion of our financial condition and liquidity as of December 31, 2020. The discussion of our financial condition and liquidity includes recent debt financings and a summary of the key debt covenant compliance measures under our debt agreements. Use of OIBDA We evaluate our operating performance based on several factors, including our primary financial measure of operating income (loss) before non-cash depreciation of tangible assets and non-cash amortization of intangible assets (“OIBDA”). We consider OIBDA to be an important indicator of the operational strengths and performance of our businesses. However, a limitation of the use of OIBDA as a performance measure is that it does not reflect the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in our businesses and other non-operating income (loss). Accordingly, OIBDA should be considered in addition to, not as a substitute for, operating income (loss), net income (loss) attributable to Warner Music Group Corp. and other measures of financial performance reported in accordance with United States generally accepted accounting principles (“U.S. GAAP”). In addition, our definition of OIBDA may differ from similarly titled measures used by other companies. A reconciliation of consolidated OIBDA to operating income (loss) and net income (loss) attributable to Warner Music Group Corp. is provided in our “Results of Operations.” 27 Use of Constant Currency As exchange rates are an important factor in understanding period to period comparisons, we believe the presentation of revenue on a constant-currency basis in addition to reported results helps improve the ability to understand our operating results and evaluate our performance in comparison to prior periods. Constant-currency information compares revenue between periods as if exchange rates had remained constant period over period. We use revenue on a constant-currency basis as one measure to evaluate our performance. We calculate constant currency by calculating prior-year revenue using current-year foreign currency exchange rates. We generally refer to such amounts calculated on a constant-currency basis as “excluding the impact of foreign currency exchange rates.” This revenue should be considered in addition to, not as a substitute for, revenue reported in accordance with U.S. GAAP. Revenue on a constant-currency basis, as we present it, may not be comparable to similarly titled measures used by other companies and are not a measure of performance presented in accordance with U.S. GAAP. BUSINESS OVERVIEW We are one of the world’s leading music entertainment companies. Our renowned family of iconic record labels, including Atlantic Records, Warner Records, Elektra Records and Parlophone Records, is home to many of the world’s most popular and influential recording artists. In addition, Warner Chappell Music, our global music publishing business, boasts an extraordinary catalog that includes timeless standards and contemporary hits, representing works by over 80,000 songwriters and composers, with a global collection of more than one million musical compositions. We classify our business interests into two fundamental operations: Recorded Music and Music Publishing. A brief description of each of those operations is presented below. Components of Our Operating Results Recorded Music Operations Our Recorded Music business primarily consists of the discovery and development of recording artists and the related marketing, promotion, distribution, sale and licensing of music created by such recording artists. We play an integral role in virtually all aspects of the recorded music value chain from discovering and developing talent to producing, distributing and selling music to marketing and promoting recording artists and their music. In the United States, our Recorded Music business is conducted principally through our major record labels—Atlantic Records and Warner Records. In October 2018, we launched Elektra Music Group in the United States as a standalone label group, which comprises the Elektra, Fueled by Ramen and Roadrunner labels. Our Recorded Music business also includes Rhino Entertainment, a division that specializes in marketing our recorded music catalog through compilations, reissuances of previously released music and video titles and releasing previously unreleased material from our vault. We also conduct our Recorded Music business through a collection of additional record labels including Asylum, Big Beat, Canvasback, East West, Erato, FFRR, Nonesuch, Parlophone, Reprise, Sire, Spinnin’ Records, Warner Classics and Warner Music Nashville. Outside the United States, our Recorded Music business is conducted in more than 70 countries through various subsidiaries, affiliates and non-affiliated licensees. Internationally, we engage in the same activities as in the United States: discovering and signing artists and distributing, selling, marketing and promoting their music. In most cases, we also market, promote, distribute and sell the music of those recording artists for whom our domestic record labels have international rights. In certain smaller markets, we license the right to distribute and sell our music to non-affiliated third-party record labels. Our Recorded Music business’ distribution operations include Warner-Elektra-Atlantic Corporation (“WEA Corp.”), which markets, distributes and sells music and video products to retailers and wholesale distributors; Alternative Distribution Alliance (“ADA”), which markets, distributes and sells the products of independent labels to retail and wholesale distributors; and various distribution centers and ventures operated internationally. In addition to our music being sold in physical retail outlets, our music is also sold in physical form to online physical retailers, such as amazon.com, barnesandnoble.com and bestbuy.com, and distributed in digital form to an expanded universe of digital partners, including streaming services such as those of Amazon, Apple, Deezer, SoundCloud, Spotify, Tencent Music Entertainment Group and YouTube, radio services such as iHeart Radio and SiriusXM and download services. 28 We have integrated the marketing of digital content into all aspects of our business, including A&R and distribution. Our business development executives work closely with A&R departments to ensure that while music is being produced, digital assets are also created with all distribution channels in mind, including streaming services, social networking sites, online portals and music-centered destinations. We also work side-by-side with our online and mobile partners to test new concepts. We believe existing and new digital businesses will be a significant source of growth and will provide new opportunities to successfully monetize our assets and create new revenue streams. The proportion of digital revenues attributable to each distribution channel varies by region and proportions may change as the introduction of new technologies continues. As one of the world’s largest music entertainment companies, we believe we are well positioned to take advantage of growth in digital distribution and emerging technologies to maximize the value of our assets. We have diversified our revenues beyond our traditional businesses by entering into expanded-rights deals with recording artists in order to partner with such artists in other aspects of their careers. Under these agreements, we provide services to and participate in recording artists’ activities outside the traditional recorded music business such as touring, merchandising and sponsorships. We have built and acquired artist services capabilities and platforms for marketing and distributing this broader set of music-related rights and participating more widely in the monetization of the artist brands we help create. We believe that entering into expanded-rights deals and enhancing our artist services capabilities in areas such as merchandising, VIP ticketing, fan clubs, concert promotion and management has permitted us to diversify revenue streams and capitalize on other revenue opportunities. This provides for improved long-term relationships with our recording artists and allows us to more effectively connect recording artists and fans. Recorded Music revenues are derived from four main sources: • Digital : the rightsholder receives revenues with respect to streaming and download services; • Physical : the rightsholder receives revenues with respect to sales of physical products such as vinyl, CDs and DVDs; • Artist services and expanded-rights : the rightsholder receives revenues with respect to our artist services businesses and our participation in expanded rights associated with our recording artists, including merchandising, touring, concert promotion, ticketing, sponsorship, fan clubs, artist websites and artist and brand management; and • Licensing : the rightsholder receives royalties or fees for the right to use sound recordings in combination with visual images such as in films or television programs, television commercials and video games; the rightsholder also receives royalties if sound recordings are performed publicly through broadcast of music on television, radio and cable, and in public spaces such as shops, workplaces, restaurants, bars and clubs. The principal costs associated with our Recorded Music business are as follows: • A&R costs : the costs associated with (i) paying royalties to recording artists, producers, songwriters, other copyright holders and trade unions; (ii) signing and developing recording artists; and (iii) creating master recordings in the studio; • Product costs : the costs to manufacture, package and distribute products to wholesale and retail distribution outlets, the royalty costs associated with distributing products of independent labels to wholesale and retail distribution outlets, as well as the costs related to our artist services business; • Selling and marketing expenses : the costs associated with the promotion and marketing of recording artists and music, including costs to produce music videos for promotional purposes and artist tour support; and • General and administrative expenses : the costs associated with general overhead and other administrative expenses. Music Publishing Operations While Recorded Music is focused on marketing, promoting, distributing and licensing a particular recording of a musical composition, Music Publishing is an intellectual property business focused on generating revenue from uses of the musical composition itself. In return for promoting, placing, marketing and administering the creative output of a songwriter, or engaging in those activities for other rightsholders, our Music Publishing business garners a share of the revenues generated from use of the musical compositions. The operations of our Music Publishing business are conducted principally through Warner Chappell Music, our global music publishing company headquartered in Los Angeles, with operations in over 70 countries through various subsidiaries, affiliates, and non-affiliated licensees and sub-publishers. We own or control rights to more than one million musical compositions, including numerous pop hits, American standards, folk songs and motion picture and theatrical compositions. Assembled over decades, our award-winning catalog includes over 80,000 songwriters and composers and a diverse range of genres including pop, rock, jazz, classical, country, R&B, hip-hop, rap, reggae, Latin, folk, blues, symphonic, soul, Broadway, techno, alternative and gospel. Warner 29 Chappell Music also administers the music and soundtracks of several third-party television and film producers and studios. We have an extensive production music catalog collectively branded as Warner Chappell Production Music. Music Publishing revenues are derived from five main sources: • Performance : the rightsholder receives revenues if the musical composition is performed publicly through broadcast of music on television, radio and cable and in retail locations (e.g. bars and restaurants), live performance at a concert or other venue ( e.g. , arena concerts and nightclubs), and performance of music in staged theatrical productions; • Digital : the rightsholder receives revenues with respect to musical compositions embodied in recordings distributed in streaming services, download services and digital performance and other digital music services; • Mechanical : the rightsholder receives revenues with respect to musical compositions embodied in recordings sold in any physical format or configuration such as vinyl, CDs and DVDs; • Synchronization : the rightsholder receives revenues for the right to use the musical composition in combination with visual images such as in films or television programs, television commercials and video games as well as from other uses such as in toys or novelty items and merchandise; and • Other : the rightsholder receives revenues for use in sheet music and other uses. The principal costs associated with our Music Publishing business are as follows: • A&R costs : the costs associated with (i) paying royalties to songwriters, co-publishers and other copyright holders in connection with income generated from the uses of their works and (ii) signing and developing songwriters; and • Selling and marketing, general overhead and other administrative expenses : the costs associated with selling and marketing, general overhead and other administrative expenses. Factors Affecting Results of Operations and Comparability COVID-19 Pandemic In January 2020, a new strain of coronavirus, COVID-19, was identified in Wuhan, China. On March 11, 2020, the World Health Organization declared a global pandemic. The global pandemic and governmental responses thereto have disrupted physical and manufacturing supply chains and required the closures of physical retailers, resulting in declines in our physical revenue streams. Additionally, stay at home orders, limited indoor and outdoor gatherings and other restrictions have negatively affected our business in other ways, such as, making it impossible to hold live concert tours, adversely impacting our concert promotion business and the sale of merchandise, delaying the release of new recordings and disrupting the production and release of motion pictures and television programs, which has negatively affected licensing revenue in our Recorded Music business and synchronization revenue in our Music Publishing business. However, the disruption from the COVID-19 pandemic has accelerated growth of other revenue streams such as fitness and interactive gaming (including augmented reality and virtual reality). Our results of operations, cash flows and financial condition at and for the three months ended December 31, 2020 were adversely affected by the global pandemic, but direct costs recorded to OIBDA related to COVID-19 were not material. Initial Public Offering On June 5, 2020, we completed an IPO of 77,000,000 shares of Class A Common Stock, par value $0.001 per share at a public offering price of $25 per share. On July 7, 2020, we completed a sale of an additional 11,550,000 shares of Class A Common Stock from the selling stockholders to the underwriters of the IPO pursuant to the exercise by the underwriters of their option to purchase additional shares of Class A Common Stock. The sale of shares through the offering consisted entirely of secondary shares sold by Access. We did not receive any proceeds resulting from the sale and listing of shares. Going forward, our results of operations will include expenses associated with being a public company, including auditing, accounting and legal fees and expenses, investor relations expenses, increased directors’ fees and director and officer liability insurance costs, registrar and transfer agent fees and listing fees, as well as other expenses. For the three months ended December 31, 2020, costs associated with being a public company were $4 million. 30 Senior Management Free Cash Flow Plan On June 5, 2020, we amended our Senior Management Free Cash Flow Plan (the “Plan”), which pays annual bonuses to certain executives based on our free cash flow and offers participants the opportunity to share in the appreciation of the value of our common stock, to remove the cash-settlement feature of the awards issued previously under the Plan. Subsequent to the amendment, the awards issued under the Plan will no longer be adjusted for changes in the value of our common stock. We will continue to incur non-cash stock-based compensation expense for awards that were unvested as of the modification date of the Plan and awards issued under the Omnibus Incentive Plan. We incurred non-cash stock-based compensation expense of $6 million and non-cash stock-based compensation benefit of $7 million for the three months ended December 31, 2020 and December 31, 2019, respectively. 31 RESULTS OF OPERATIONS Three Months Ended December 31, 2020 Compared with Three Months Ended December 31, 2019 Consolidated Results Revenues Our revenues were composed of the following amounts (in millions): For the Three Months Ended December 31, 2020 vs. 2019 2020 2019 $ Change % Change Revenue by Type Digital $ 727 $ 633 $ 94 15 % Physical 174 184 (10) -5 % Total Digital and Physical 901 817 84 10 % Artist services and expanded-rights 180 188 (8) -4 % Licensing 80 79 1 1 % Total Recorded Music 1,161 1,084 77 7 % Performance 30 46 (16) -35 % Digital 99 73 26 36 % Mechanical 11 15 (4) -27 % Synchronization 33 36 (3) -8 % Other 2 3 (1) -33 % Total Music Publishing 175 173 2 1 % Intersegment eliminations (1) (1) — — % Total Revenues $ 1,335 $ 1,256 $ 79 6 % Revenue by Geographical Location U.S. Recorded Music $ 481 $ 453 $ 28 6 % U.S. Music Publishing 91 81 10 12 % Total U.S. 572 534 38 7 % International Recorded Music 680 631 49 8 % International Music Publishing 84 92 (8) -9 % Total International 764 723 41 6 % Intersegment eliminations (1) (1) — — % Total Revenues $ 1,335 $ 1,256 $ 79 6 % Total Revenues Total revenues increased by $79 million, or 6%, to $1,335 million for the three months ended December 31, 2020 from $1,256 million for the three months ended December 31, 2019. The increase includes $30 million of favorable currency exchange fluctuations. Prior to intersegment eliminations, Recorded Music and Music Publishing revenues represented 87% and 13% of total revenue for the three months ended December 31, 2020, respectively, and 86% and 14% of total revenue for the three months ended December 31, 2019. Prior to intersegment eliminations, U.S. and international revenues represented 43% and 57% of total revenues for the three months ended December 31, 2020, respectively, and 43% and 58% of total revenues for the three months ended December 31, 2019, respectively. Total digital revenues after intersegment eliminations increased by $119 million, or 17%, to $825 million for the three months ended December 31, 2020 from $706 million for the three months ended December 31, 2019. Total digital revenues represented 62% and 56% of consolidated revenues for the three months ended December 31, 2020 and December 31, 2019, respectively. Prior to intersegment eliminations, total digital revenues for the three months ended December 31, 2020 were comprised of U.S. revenues of $418 million and international revenues of $408 million, or 51% and 49% of total digital revenues, respectively. Prior to intersegment eliminations, total digital revenues for the three months ended December 31, 2019 were comprised of U.S. revenues of $380 million and international revenues of $326 million, or 54% and 46% of total digital revenues, respectively. 32 Recorded Music revenues increased by $77 million, or 7%, to $1,161 million for the three months ended December 31, 2020 from $1,084 million for the three months ended December 31, 2019. The increase includes $27 million of favorable currency exchange fluctuations. U.S. Recorded Music revenues were $481 million and $453 million, or 41% and 42%, of consolidated Recorded Music revenues for the three months ended December 31, 2020 and December 31, 2019, respectively. International Recorded Music revenues were $680 million and $631 million, or 59% and 58%, of consolidated Recorded Music revenues for the three months ended December 31, 2020 and December 31, 2019, respectively. The overall increase in Recorded Music revenue was driven by increases in digital and licensing revenue, partially offset by decreases in physical and artist services and expanded-rights revenues. Digital revenue increased by $94 million as a result of the continued growth in streaming services and strength of releases, which included carryover success from Dua Lipa, Ava Max, Hamilton, Cardi B, Ed Sheeran, and Roddy Ricch. Revenue from streaming services grew by $103 million or 17% to $692 million for the three months ended December 31, 2020 from $589 million for the three months ended December 31, 2019. Digital revenue growth was partially offset by decreases in digital download and other digital declines of $9 million to $35 million for the three months ended December 31, 2020 from $44 million for the three months ended December 31, 2019 due to the continued shift to streaming services. Digital revenue was not materially impacted by COVID-19 in the quarter. Licensing revenue increased by $1 million due to favorable foreign currency exchange rates. Physical revenue decreased by $10 million primarily due to the impact of the COVID-19 business disruption resulting in lower physical sales and continued shift from physical revenue to digital revenue, partially offset by the success of new releases including Johnny Hallyday, Mariya Takeuchi, and Kim Hojoong, and favorable impact of foreign currency exchange rates of $7 million. Artist services and expanded-rights revenue decreased by $8 million primarily due to a decrease in touring activity resulting from COVID-19 business interruption related tour postponements and cancellations, partially offset by higher direct-to-consumer merchandising revenue at EMP and the favorable impact of foreign currency exchange rates of $10 million. Music Publishing revenues increased by $2 million, or 1%, to $175 million for the three months ended December 31, 2020 from $173 million for the three months ended December 31, 2019. U.S. Music Publishing revenues were $91 million and $81 million, or 52% and 47%, of consolidated Music Publishing revenues for the three months ended December 31, 2020 and December 31, 2019, respectively. International Music Publishing revenues were $84 million and $92 million or 48% and 53%, of consolidated Music Publishing revenues for the three months ended December 31, 2020 and December 31, 2019, respectively. The overall increase in Music Publishing revenue was mainly driven by increases in digital revenue of $26 million, partially offset by decreases in performance revenue of $16 million, synchronization revenue of $3 million, and mechanical revenue of $4 million. The increase in digital revenue is primarily due to increases in streaming revenue driven by the continued growth in streaming services and timing of new digital deals. The decline in performance revenue and synchronization revenue is primarily driven by the impact from COVID-19. The decline in mechanical revenue is driven by the continued market decline in physical revenue and the impact from COVID-19. Revenue by Geographical Location U.S. revenue increased by $38 million, or 7%, to $572 million for the three months ended December 31, 2020 from $534 million for the three months ended December 31, 2019. U.S. Recorded Music revenue increased by $28 million, or 6%. The primary driver was the increase of U.S. Recorded Music digital revenue of $24 million driven by the continued growth in streaming services and an increase in U.S. Recorded Music physical revenue of $6 million due to the success of new releases, partially offset by market decline due to the shift from physical to digital formats and the impact of COVID-19. These increases were also partially offset by a decrease of U.S. Recorded Music artist services and expanded-rights revenue of $2 million primarily driven by the impact of COVID-19 business interruptions, which resulted in tour postponements and cancellations and decreased physical retail and tour-related merchandising revenues. U.S. Music Publishing revenue increased by $10 million, or 12%, to $91 million for the three months ended December 31, 2020 from $81 million for the three months ended December 31, 2019. This was primarily driven by the increase in U.S. Music Publishing of $14 million in digital revenue due to the continued growth in streaming services and timing of new digital deals, partially offset by decreases in synchronization revenue and performance revenue of $2 million and $1 million, respectively, primarily due to the impact of COVID-19 as well as a decline in mechanical revenue of $1 million driven by the continued market decline in physical revenue. 33 International revenue increased by $41 million, or 6%, to $764 million for the three months ended December 31, 2020 from $723 million for the three months ended December 31, 2019. Excluding the favorable impact of foreign currency exchange rates, International revenue increased by $11 million, or 2%. International Recorded Music revenue increased by $49 million primarily due to increases in digital revenue of $70 million and licensing revenue of $1 million, partially offset by decreases in physical revenue of $16 million and artist services and expanded-rights revenue of $6 million. The increase in International Recorded Music digital revenue was due to continued growth in streaming services internationally. International Recorded Music licensing revenue increased by $1 million due to favorable foreign currency exchange rates. International Recorded Music physical revenue decreased by $16 million due to the continued shift from physical revenue to digital revenue and the impact of COVID-19, partially offset by the success of new releases, including Johnny Hallyday, Mariya Takeuchi, and Kim Hojoong, and favorable impact of foreign currency exchange rates. International Recorded Music artist services and expanded-rights revenue decreased by $6 million primarily due to the impact of COVID-19 business interruptions, which resulted in tour postponements and cancellations, in contrast to strong touring in the prior year. This was offset by growth in EMP direct-to-consumer merchandise revenue and the favorable impact of foreign currency exchange rates of $10 million. International Music Publishing revenue decreased from the prior-year quarter by $8 million, or 9%, to $84 million for the three months ended December 31, 2020. This was primarily driven by decreases in performance revenue of $15 million, mechanical revenue of $3 million, and synchronization revenue of $1 million, partially offset by an increase in digital revenue of $12 million. The decline in performance revenue and synchronization revenue is primarily driven by the impact from COVID-19. The decline in mechanical revenue is driven by the continued market decline in physical revenue and the impact from COVID-19. The increase in digital revenue is primarily due to increases in streaming revenue driven by the continued growth in streaming services and timing of new deals. Cost of revenues Our cost of revenues was composed of the following amounts (in millions): For the Three Months Ended December 31, 2020 vs. 2019 2020 2019 $ Change % Change Artist and repertoire costs $ 425 $ 411 $ 14 3 % Product costs 261 254 7 3 % Total cost of revenues $ 686 $ 665 $ 21 3 % Artist and repertoire costs increased by $14 million, to $425 million for the three months ended December 31, 2020 from $411 million for the three months ended December 31, 2019. Artist and repertoire costs as a percentage of revenue decreased to 32% for the three months ended December 31, 2020 from 33% for the three months ended December 31, 2019. The overall decrease as a percentage of revenue is due to revenue mix and timing of artist and repertoire investments within the Music Publishing segment. Product costs increased by $7 million, to $261 million for the three months ended December 31, 2020 from $254 million for the three months ended December 31, 2019. Product costs as a percentage of revenue remained constant at 20% for both the three months ended December 31, 2020 and the three months ended December 31, 2019. Selling, general and administrative expenses Our selling, general and administrative expenses were composed of the following amounts (in millions): For the Three Months Ended December 31, 2020 vs. 2019 2020 2019 $ Change % Change General and administrative expense (1) $ 189 $ 172 $ 17 10 % Selling and marketing expense 178 173 5 3 % Distribution expense 34 34 — — % Total selling, general and administrative expense $ 401 $ 379 $ 22 6 % ______________________________________ (1) Includes depreciation expense of $19 million and $24 million for the three months ended December 31, 2020 and December 31, 2019, respectively. Total selling, general and administrative expense increased by $22 million, or 6%, to $401 million for the three months ended December 31, 2020 from $379 million for the three months ended December 31, 2019. Expressed as a percentage of revenue, selling, general and administrative expense remained flat at 30% for both the three months ended December 31, 2020 and the three months ended December 31, 2019. 34 General and administrative expense increased by $17 million to $189 million for the three months ended December 31, 2020 from $172 million for the three months ended December 31, 2019. The increase in general and administrative expense was mainly due to higher non-cash stock-based compensation expense of $13 million, public company related expenses totaling $4 million, and increased employee related costs, partially offset by a one-time charge in the prior year within depreciation expense of $10 million and lower overhead due to active cost management efforts. Expressed as a percentage of revenue, general and administrative expense remained constant at 14% for both the three months ended December 31, 2020 and the three months ended December 31, 2019 due to the factors described above. Selling and marketing expense increased by $5 million, or 3%, to $178 million for the three months ended December 31, 2020 from $173 million for the three months ended December 31, 2019. Expressed as a percentage of revenue, selling and marketing expense decreased to 13% for the three months ended December 31, 2020 from 14% for the three months ended December 31, 2019 due to a decrease in spend as a percentage of revenue resulting from COVID-19 business disruption. Distribution expense was $34 million for both the three months ended December 31, 2020 and the three months ended December 31, 2019. Expressed as a percentage of revenue, distribution expense remained constant at 3% for both the three months ended December 31, 2020 and the three months ended December 31, 2019. Reconciliation of Net Income Attributable to Warner Music Group Corp. and Operating Income to Consolidated OIBDA As previously described, we use OIBDA as our primary measure of financial performance. The following table reconciles operating income to OIBDA, and further provides the components from net income attributable to Warner Music Group Corp. to operating income for purposes of the discussion that follows (in millions): For the Three Months Ended December 31, 2020 vs. 2019 2020 2019 $ Change % Change Net income attributable to Warner Music Group Corp. $ 98 $ 120 $ (22) -18 % Income attributable to noncontrolling interest 1 2 (1) -50 % Net income 99 122 (23) -19 % Income tax expense 35 5 30 — % Income before income taxes 134 127 7 6 % Other expense 31 5 26 — % Interest expense, net 31 33 (2) -6 % Operating income 196 165 31 19 % Amortization expense 52 47 5 11 % Depreciation expense 19 24 (5) -21 % OIBDA $ 267 $ 236 $ 31 13 % OIBDA OIBDA increased by $31 million to $267 million for the three months ended December 31, 2020 as compared to $236 million for the three months ended December 31, 2019 as a result of higher revenues, partially offset by higher cost of revenues and selling, general, and administrative expenses. Expressed as a percentage of total revenue, OIBDA margin increased to 20% for the three months ended December 31, 2020 from 19% for the three months ended December 31, 2019. Depreciation expense Our depreciation expense decreased by $5 million, or 21%, to $19 million for the three months ended December 31, 2020 from $24 million for the three months ended December 31, 2019. The decrease is primarily due to a one-time charge of $10 million representing the difference between the net book value of a building and its recoverable value. The building was exited was part of our Los Angeles, California headquarters relocation. This was partially offset by new assets placed into service. Amortization expense Our amortization expense increased by $5 million, or 11%, to $52 million for the three months ended December 31, 2020 from $47 million for the three months ended December 31, 2019. The increase is primarily due to an increase in amortizable intangible assets related to the acquisition of music-related assets. 35 Operating income Our operating income increased by $31 million to $196 million for the three months ended December 31, 2020 from $165 million for the three months ended December 31, 2019. The increase in operating income was due to the factors that led to the increase in OIBDA. Interest expense, net Our interest expense, net, decreased to $31 million for the three months ended December 31, 2020 from $33 million for the three months ended December 31, 2019 due to lower interest rates resulting from debt refinancing, partially offset by the issuance of the new senior secured notes. Other expense Other expense for the three months ended December 31, 2020 primarily includes foreign currency loss on our Euro-denominated debt of $41 million, aggregate realized and unrealized losses on hedging activity of $5 million, and currency exchange losses on our intercompany loans of $2 million, partially offset by an unrealized gain of $14 million on the mark-to-market of an equity method investment. This compares to foreign currency loss on our Euro-denominated debt of $12 million and aggregate realized and unrealized losses on hedging activity of $4 million, partially offset by currency exchange gains on our intercompany loans of $11 million for the three months ended December 31, 2019. Income tax expense Our income tax expense increased by $30 million to $35 million for the three months ended December 31, 2020 from $5 million for the three months ended December 31, 2019. The change of $30 million in income tax expense primarily relates to the release of a valuation allowance on foreign tax credits of $33 million during the three months ended December 31, 2019. For the three months ended December 31, 2020, income tax expense is partially offset by a $4 million benefit related to the impact of excess tax benefits on our long term incentive plan. Net income Net income decreased by $23 million to $99 million for the three months ended December 31, 2020 from $122 million for the three months ended December 31, 2019 as a result of the factors described above. Noncontrolling interest There was $1 million of income attributable to noncontrolling interest for the three months ended December 31, 2020 and $2 million for the three months ended December 31, 2019. 36 Business Segment Results Revenues, operating income (loss) and OIBDA by business segment were as follows (in millions): For the Three Months Ended December 31, 2020 vs. 2019 2020 2019 $ Change % Change Recorded Music Revenues $ 1,161 $ 1,084 $ 77 7 % Operating income 223 191 32 17 % OIBDA 269 241 28 12 % Music Publishing Revenues 175 173 2 1 % Operating income 18 14 4 29 % OIBDA 39 33 6 18 % Corporate expenses and eliminations Revenue eliminations (1) (1) — — % Operating loss (45) (40) (5) 13 % OIBDA loss (41) (38) (3) 8 % Total Revenues 1,335 1,256 79 6 % Operating income 196 165 31 19 % OIBDA 267 236 31 13 % Recorded Music Revenues Recorded Music revenue increased by $77 million, or 7%, to $1,161 million for the three months ended December 31, 2020 from $1,084 million for the three months ended December 31, 2019. U.S. Recorded Music revenues were $481 million and $453 million, or 41% and 42%, of consolidated Recorded Music revenues for the three months ended December 31, 2020 and December 31, 2019, respectively. International Recorded Music revenues were $680 million and $631 million, or 59% and 58%, of consolidated Recorded Music revenues for the three months ended December 31, 2020 and December 31, 2019, respectively. The overall increase in Recorded Music revenue was mainly driven by increases in digital and licensing revenues, partially offset by decreases in physical and artist services and expanded-rights revenues, as described in the “Total Revenues” and “Revenue by Geographical Location” sections above. Cost of revenues Recorded Music cost of revenues was composed of the following amounts (in millions): For the Three Months Ended December 31, 2020 vs. 2019 2020 2019 $ Change % Change Artist and repertoire costs $ 313 $ 294 $ 19 6 % Product costs 261 254 7 3 % Total cost of revenues $ 574 $ 548 $ 26 5 % Recorded Music cost of revenues increased by $26 million, or 5%, to $574 million for the three months ended December 31, 2020 from $548 million for the three months ended December 31, 2019. Expressed as a percentage of Recorded Music revenue, Recorded Music artist and repertoire costs remained constant at 27% for both the three months ended December 31, 2020 and December 31, 2019. Expressed as a percentage of Recorded Music revenue, Recorded Music product costs decreased to 22% for the three months ended December 31, 2020 from 23% for the three months ended December 31, 2019. The decrease in product costs relates to revenue mix due to lower physical and artist services and expanded-rights revenues. 37 Selling, general and administrative expense Recorded Music selling, general and administrative expenses were composed of the following amounts (in millions): For the Three Months Ended December 31, 2020 vs. 2019 2020 2019 $ Change % Change General and administrative expense (1) $ 122 $ 113 $ 9 8 % Selling and marketing expense 175 169 6 4 % Distribution expense 34 34 — — % Total selling, general and administrative expense $ 331 $ 316 $ 15 5 % ______________________________________ (1) Includes depreciation expense of $13 million and $21 million for the three months ended December 31, 2020 and for the three months ended December 31, 2019, respectively. Recorded Music selling, general and administrative expense increased by $15 million, or 5%, to $331 million for the three months ended December 31, 2020 from $316 million for the three months ended December 31, 2019. The increase in general and administrative expense was primarily due to higher non-cash stock-based compensation expense of $8 million and increase in employee related costs, partially offset by a one-time charge in the prior year within depreciation expense of $10 million representing the difference between the net book value of a building and its recoverable value, and lower overhead due to active cost management efforts. The increase in selling and marketing expense was primarily due to increased variable marketing spend primarily at EMP, which drove higher direct-to-consumer merchandising revenue. Distribution expense remained flat. Expressed as a percentage of Recorded Music revenue, Recorded Music selling, general and administrative expense remained flat at 29% for both the three months ended December 31, 2020 and the three months ended December 31, 2019. Excluding non-cash stock-based compensation expense, selling, general and administrative expense as a percentage of Recorded Music revenue decreased to 28% for the three months ended December 31, 2020 from 29% for the three months ended December 31, 2019 due to the factors described above. Operating income and OIBDA Recorded Music OIBDA included the following amounts (in millions): For the Three Months Ended December 31, 2020 vs. 2019 2020 2019 $ Change % Change Operating income $ 223 $ 191 $ 32 17 % Depreciation and amortization 46 50 (4) -8 % OIBDA $ 269 $ 241 $ 28 12 % Recorded Music OIBDA increased by $28 million, or 12%, to $269 million for the three months ended December 31, 2020 from $241 million for the three months ended December 31, 2019 as a result of higher revenues and lower costs. Expressed as a percentage of Recorded Music revenue, Recorded Music OIBDA margin increased to 23% for the three months ended December 31, 2020 from 22% for the three months ended December 31, 2019. Recorded Music operating income increased by $32 million to $223 million for the three months ended December 31, 2020 from $191 million for the three months ended December 31, 2019 due to the factors that led to the increase in Recorded Music OIBDA noted above. Music Publishing Revenues Music Publishing revenues increased by $2 million, or 1%, to $175 million for the three months ended December 31, 2020 from $173 million for the three months ended December 31, 2019. U.S. Music Publishing revenues were $91 million and $81 million, or 52% and 47%, of consolidated Music Publishing revenues for the three months ended December 31, 2020 and December 31, 2019, respectively. International Music Publishing revenues were $84 million and $92 million, or 48% and 53%, of consolidated Music Publishing revenues for the three months ended December 31, 2020 and December 31, 2019, respectively. The overall increase in Music Publishing revenue was mainly driven by digital revenue growth, partially offset by lower performance, synchronization, and mechanical revenues as described in the “Total Revenues” and “Revenue by Geographical Location” sections above. 38 Cost of revenues Music Publishing cost of revenues were composed of the following amounts (in millions): For the Three Months Ended December 31, 2020 vs. 2019 2020 2019 $ Change % Change Artist and repertoire costs $ 113 $ 118 $ (5) -4 % Total cost of revenues $ 113 $ 118 $ (5) -4 % Music Publishing cost of revenues decreased by $5 million, or 4%, to $113 million for the three months ended December 31, 2020 from $118 million for the three months ended December 31, 2019. Expressed as a percentage of Music Publishing revenue, Music Publishing cost of revenues decreased to 65% for the three months ended December 31, 2020 from 68% for the three months ended December 31, 2019. This decrease is primarily attributable to revenue mix and timing of artist and repertoire investments. Selling, general and administrative expense Music Publishing selling, general and administrative expenses were comprised of the following amounts (in millions): For the Three Months Ended December 31, 2020 vs. 2019 2020 2019 $ Change % Change General and administrative expense (1) $ 24 $ 22 $ 2 9 % Selling and marketing expense 1 1 — — % Total selling, general and administrative expense $ 25 $ 23 $ 2 9 % ______________________________________ (1) Includes depreciation expense of $2 million and $1 million for the three months ended December 31, 2020 and the three months ended December 31, 2019, respectively. Music Publishing selling, general and administrative expense increased to $25 million for the three months ended December 31, 2020 from $23 million for the three months ended December 31, 2019. Expressed as a percentage of Music Publishing revenue, Music Publishing selling, general and administrative expense increased to 14% for the three months ended December 31, 2020 from 13% for the three months ended December 31, 2019 mainly due to higher employee-related costs and higher depreciation expense. Operating income and OIBDA Music Publishing OIBDA included the following amounts (in millions): For the Three Months Ended December 31, 2020 vs. 2019 2020 2019 $ Change % Change Operating income $ 18 $ 14 $ 4 29 % Depreciation and amortization 21 19 2 11 % OIBDA $ 39 $ 33 $ 6 18 % Music Publishing OIBDA increased by $6 million, or 18%, to $39 million for the three months ended December 31, 2020 from $33 million for the three months ended December 31, 2019. Expressed as a percentage of Music Publishing revenue, Music Publishing OIBDA margin increased to 22% for the three months ended December 31, 2020 from 19% for the three months ended December 31, 2019. The increase was primarily due to the increase in revenue and the timing of artist and repertoire investments. Music Publishing operating income increased by $4 million to $18 million for the three months ended December 31, 2020 from $14 million for the three months ended December 31, 2019 due to the factors that led to the increase in Music Publishing OIBDA noted above. Corporate Expenses and Eliminations Our operating loss from corporate expenses and eliminations increased by $5 million for the three months ended December 31, 2020 to $45 million from $40 million for the three months ended December 31, 2019, which primarily includes an increase in non-cash stock-based compensation expense of $5 million, public company related expenses totaling $4 million, and 39 higher employee related costs, partially offset by a decline in management fees of $3 million and lower overhead due to active cost management efforts. Our OIBDA loss from corporate expenses and eliminations increased by $3 million for the three months ended December 31, 2020 to $41 million from $38 million for the three months ended December 31, 2019 due to the operating loss factors noted above. 40 FINANCIAL CONDITION AND LIQUIDITY Financial Condition at December 31, 2020 At December 31, 2020, we had $3.387 billion of debt (which is net of $31 million of deferred financing costs), $566 million of cash and equivalents (net debt of $2.821 billion, defined as total debt, less cash and equivalents and deferred financing costs) and $16 million of Warner Music Group Corp. equity. This compares to $3.104 billion of debt (which is net of $29 million of deferred financing costs), $553 million of cash and equivalents (net debt of $2.551 billion) and $63 million of Warner Music Group Corp. deficit at September 30, 2020. Cash Flows The following table summarizes our historical cash flows (in millions). The financial data for the three months ended December 31, 2020 and December 31, 2019 are unaudited and have been derived from our consolidated interim financial statements included elsewhere herein. Three Months Ended December 31, 2020 2019 Cash provided by (used in): Operating activities $ 169 $ 78 Investing activities (343) (32) Financing activities 178 (207) Operating Activities Cash provided by operating activities was $169 million for the three months ended December 31, 2020 as compared with cash provided by operating activities of $78 million for the three months ended December 31, 2019. The $91 million increase in cash provided by operating activities was primarily due to an increase in OIBDA, a decrease in cash interest payments, and timing of working capital. Investing Activities Cash used in investing activities was $343 million for the three months ended December 31, 2020 as compared with cash used in investing activities of $32 million for the three months ended December 31, 2019. The $343 million of cash used in investing activities in the three months ended December 31, 2020 consisted of $1 million relating to investments, $18 million relating to capital expenditures and $324 million to acquire music publishing rights and recorded music catalogs, a portion of which was debt-financed. The $32 million of cash used in investing activities in the three months ended December 31, 2019 consisted of $6 million relating to investments, $15 million relating to capital expenditures and $11 million to acquire music publishing rights. Financing Activities Cash provided by financing activities was $178 million for the three months ended December 31, 2020 as compared with cash used in financing activities of $207 million for the three months ended December 31, 2019. The $178 million of cash provided by financing activities for the three months ended December 31, 2020 consisted of proceeds from debt issuance of $244 million which was used to fund investments, partially offset by dividends paid of $62 million, distributions to noncontrolling interest holders of $1 million and deferred financing costs of $3 million. The $207 million of cash used in financing activities for the three months ended December 31, 2019 consisted of dividends paid of $206 million and distributions to noncontrolling interest holders of $1 million. Liquidity Our primary sources of liquidity are the cash flows generated from our subsidiaries’ operations, available cash and equivalents and funds available for drawing under our Revolving Credit Facility. These sources of liquidity are needed to fund our debt service requirements, working capital requirements, capital expenditure requirements, strategic acquisitions and investments, and dividends, prepayments of debt, repurchases or retirement of our outstanding debt or notes or repurchases of our outstanding equity securities in open market purchases, privately negotiated purchases or otherwise, we may elect to pay or make in the future. We believe that our primary sources of liquidity will be sufficient to support our existing operations over the next twelve months. 41 In August 2019, we announced that we were beginning a financial transformation initiative to upgrade our information technology and finance infrastructure over the next two years, including related systems and processes, for which we currently expect upfront costs to be approximately $120 million, which includes capital expenditures of approximately $40 million to $50 million (approximately half of which was incurred in the 2020 fiscal year and the remainder of which is largely expected to be incurred in the 2021 fiscal year). There has been a slight delay in the timing of the transformation initiative as a result of COVID-19 business interruption but it is still expected to be completed in the next fiscal year. Annualized run-rate savings from the financial transformation initiative are expected to be between approximately $35 million and $40 million once fully implemented. We expect that our primary sources of liquidity will be sufficient to fund these expenditures. Debt Capital Structure Since Access acquired us in 2011, we have sought to extend the maturity dates on our outstanding indebtedness, reduce interest expense and improve our debt ratings. For example, our S&P corporate credit rating has improved from B in 2017 to BB in 2020 with a stable outlook, and our Moody’s corporate family rating has improved from B1 in 2016 to Ba3 in 2020. In addition, our weighted-average interest rate on our outstanding indebtedness has decreased from 10.5% in 2011 to 3.7% as of December 31, 2020. Our nearest-term maturity date is in 2026 following effectiveness of the Senior Term Loan Credit Agreement Amendment in January 2021. Subject to market conditions, we expect to continue to take opportunistic steps to extend our maturity dates and reduce related interest expense. From time to time, we may incur additional indebtedness for, among other things, working capital, repurchasing, redeeming or tendering for existing indebtedness and acquisitions or other strategic transactions. Additional 3.000% Senior Secured Notes On November 2, 2020, Acquisition Corp. issued and sold $250 million of additional 3.000% Senior Secured Notes (the “Additional Notes”). Interest on the Additional Notes will accrue at the rate of 3.000% per annum and will be payable semi-annually in arrears on February 15 and August 15, commencing on February 15, 2021. Acquisition Corp. had the option to repurchase all or a portion of the Additional Notes at any time on one or more occasions on or prior to the fifth business day after December 18, 2020 (the “Special Optional Redemption Election Date”), but did not exercise its option to repurchase. The Additional Notes were not initially fungible with the 3.000% Senior Secured Notes issued on August 12, 2020 (the “Original Notes”). Following the Special Optional Redemption Election Date, Acquisition Corp. caused the Additional Notes to bear the same CUSIP and ISIN numbers as the Original Notes (the “CUSIP Merger Event”). Following the CUSIP Merger Event, the Additional Notes have identical terms as (other than the issue date and the issue price), and are fungible with, and treated as a single series of senior secured debt securities with, the Original Notes. The proceeds of the issuance and sale of the aforementioned Additional Notes, in conjunction with cash on hand, were used to fund the acquisition of music-related assets for aggregate cash consideration of $338 million. Revolving Credit Facility On January 31, 2018, Acquisition Corp. entered into the revolving credit agreement (as amended by the amendment dated October 9, 2019 and as further amended, amended and restated or otherwise modified from time to time, the “Revolving Credit Agreement”) for a senior secured revolving credit facility with Credit Suisse AG, as administrative agent, and the other financial institutions and lenders from time to time party thereto (the “Revolving Credit Facility”). On April 3, 2020, Acquisition Corp. entered into an amendment to the Revolving Credit Agreement (the “Second Amendment”) which, among other things, extended the final maturity of the Revolving Credit Facility from January 31, 2023 to April 3, 2025. Acquisition Corp. is the borrower under the Revolving Credit Agreement which provides for a revolving credit facility in the amount of up to $300 million and includes a $90 million letter of credit sub-facility. Amounts are available under the Revolving Credit Facility in U.S. dollars, euros or pounds sterling. The Revolving Credit Agreement permits loans for general corporate purposes and may also be utilized to issue letters of credit. Borrowings under the Revolving Credit Agreement bear interest at Acquisition Corp.’s election at a rate equal to (i) the rate for deposits in the borrowing currency in the London interbank market (adjusted for maximum reserves) for the applicable interest period (“Revolving LIBOR”) plus 1.875% per annum, or (ii) the base rate, which is the highest of (x) the corporate base rate established by the administrative agent from time to time, (y) the overnight federal funds rate plus 0.5% and (z) the one-month Revolving LIBOR plus 1.00% per annum, plus, in each case, 0.875% per annum; provided that, for each of clauses (i) and (ii), the applicable margin with respect to such loans is subject to adjustment upon achievement of certain leverage ratios as set forth in a leverage-based pricing grid in the Revolving Credit Agreement. Based on the Senior Secured Indebtedness to EBITDA Ratio of 3.15x at December 31, 2020, the applicable margin for Eurodollar loans would be 1.625% instead of 1.875% and the applicable margin for ABR loans would be 0.625% instead of 0.875% in the case of 2020 Revolving Loans (as defined in the Revolving Credit Agreement). 42 Existing Debt as of December 31, 2020 As of December 31, 2020, our long-term debt, all of which was issued by Acquisition Corp., was as follows (in millions): Revolving Credit Facility (a) $ — Senior Term Loan Facility due 2023 (b) 815 3.625% Senior Secured Notes due 2026 (c) 545 2.750% Senior Secured Notes due 2028 (d) 392 3.875% Senior Secured Notes due 2030 (e) 529 3.000% Senior Secured Notes due 2031 (f) 784 5.500% Senior Notes due 2026 (g) 322 Total long-term debt, including the current portion (h) $ 3,387 ______________________________________ (a) Reflects $300 million of commitments under the Revolving Credit Facility available at December 31, 2020, less letters of credit outstanding of approximately $10 million at December 31, 2020. There were no loans outstanding under the Revolving Credit Facility at December 31, 2020. (b) Principal amount of $820 million less unamortized discount of $1 million and unamortized deferred financing costs of $4 million at December 31, 2020. On January 20, 2021, Acquisition Corp. entered into an amendment of the credit agreement governing the Senior Term Loan Facility which, among other things, extends the maturity date of its outstanding term loans from November 1, 2023 to January 20, 2028 and removes a number of negative covenants limiting the ability of Acquisition Corp. to take various actions. See Note 15 to our unaudited interim consolidated financial statements included in Part I to this Quarterly Report. (c) Face amount of €445 million at December 31, 2020. Above amount represents the dollar equivalent of such note at December 31, 2020. Principal amount of $543 million and an additional issuance premium of $7 million, less unamortized deferred financing costs of $5 million at December 31, 2020. (d) Face amount of €325 million at December 31, 2020. Above amount represents the dollar equivalent of such note at December 31, 2020. Principal amount of $396 million less unamortized deferred financing costs of $4 million at December 31, 2020. (e) Principal amount of $535 million less unamortized deferred financing costs of $6 million at December 31, 2020. (f) Principal amount of $800 million at December 31, 2020 less unamortized discount of $7 million and unamortized deferred financing costs of $9 million at December 31, 2020. On November 2, 2020, Acquisition Corp. issued an additional $250 million in aggregate principal amount of its 3.000% Senior Secured Notes due 2031. (g) Principal amount of $325 million less unamortized deferred financing costs of $3 million at December 31, 2020. (h) Principal amount of debt of $3.419 billion and an additional issuance premium of $7 million, less unamortized discount of $8 million and unamortized deferred financing costs of $31 million at December 31, 2020. For further discussion of our debt agreements, see “Liquidity” in the “Financial Condition and Liquidity” section of our Annual Report on Form 10-K for the fiscal year ended September 30, 2020. Dividends The Company’s ability to pay dividends may be restricted by covenants in certain of the indentures governing its notes and in the credit agreements for the Senior Term Loan Facility and the Revolving Credit Facility. The Company intends to pay quarterly cash dividends to holders of its Class A Common Stock and Class B Common Stock. The Company paid the first dividend under this policy in September 2020. The declaration of each dividend will continue to be at the discretion of the Company’s board of directors and will depend on the Company’s financial condition, earnings, liquidity and capital requirements, level of indebtedness, contractual restrictions with respect to payment of dividends, restrictions imposed by Delaware law, general business conditions and any other factors that the Company’s board of directors deems relevant in making such a determination. Therefore, there can be no assurance that the Company will pay any dividends to holders of the Company’s common stock, or as to the amount of any such dividends. On November 13, 2020, the Company’s board of directors declared a cash dividend of $0.12 per share on the Company’s Class A Common Stock and Class B Common Stock, as well as related payments under certain stock-based compensation plans, which was paid to stockholders on December 1, 2020. The Company paid an aggregate of approximately $62 million in cash dividends to stockholders and participating security holders for the three months ended December 31, 2020. 43 Covenant Compliance The Company was in compliance with its covenants under its outstanding notes, the Revolving Credit Facility and the Senior Term Loan Facility as of December 31, 2020. On January 18, 2019, we delivered a notice to the trustee under the 2012 Secured Indenture and 2014 Unsecured Indenture changing the Fixed GAAP Date, as defined under the indentures, to October 1, 2018. Under the Senior Term Loan Facility, the Revolving Credit Facility and the 2020 Secured Indenture, the Fixed GAAP Date is set for April 3, 2020, other than in respect of capital leases, which are frozen at November 1, 2012. The Revolving Credit Facility contains a springing leverage ratio that is tied to a ratio based on EBITDA, which is defined under the Revolving Credit Agreement. Our ability to borrow funds under the Revolving Credit Facility may depend upon our ability to meet the leverage ratio test at the end of a fiscal quarter to the extent we have drawn a certain amount of revolving loans. EBITDA as defined in the Revolving Credit Facility is based on Consolidated Net Income (as defined in the Revolving Credit Facility), both of which terms differ from the terms “EBITDA” and “net income” as they are commonly used. For example, the calculation of EBITDA under the Revolving Credit Facility, in addition to adjusting net income to exclude interest expense, income taxes and depreciation and amortization, also adjusts net income by excluding items or expenses such as, among other items, (1) the amount of any restructuring charges or reserves; (2) any non-cash charges (including any impairment charges); (3) any net loss resulting from hedging currency exchange risks; (4) the amount of management, monitoring, consulting and advisory fees paid to Access; (5) business optimization expenses (including consolidation initiatives, severance costs and other costs relating to initiatives aimed at profitability improvement); (6) transaction expenses; (7) equity-based compensation expense; and (8) certain extraordinary, unusual or non-recurring items. The definition of EBITDA under the Revolving Credit Facility also includes adjustments for the pro forma impact of certain projected cost savings, operating expense reductions and synergies and any quality of earnings analysis prepared by independent certified public accountants in connection with an acquisition, merger, consolidation or other investment. The Senior Term Loan Facility and the 2020 Secured Indenture use financial measures called “Consolidated EBITDA” or “EBITDA” and “Consolidated Net Income” that have substantially the same definitions to EBITDA and Consolidated Net Income, each as defined under the Revolving Credit Agreement. The 2012 Secured Indenture and the 2014 Unsecured Indenture use financial measures called “Consolidated EBITDA” or “EBITDA” and “Consolidated Net Income” that have similar (but not the same) definitions to EBITDA and Consolidated Net Income, each as defined under the Revolving Credit Agreement. EBITDA as defined in the Revolving Credit Facility (referred to in this section as “Adjusted EBITDA”) is presented herein because it is a material component of the leverage ratio contained in the Revolving Credit Agreement. Non-compliance with the leverage ratio could result in the inability to use the Revolving Credit Facility, which could have a material adverse effect on our results of operations, financial position and cash flow. Adjusted EBITDA does not represent net income or cash from operating activities as those terms are defined by U.S. GAAP and does not necessarily indicate whether cash flows will be sufficient to fund cash needs. While Adjusted EBITDA and similar measures are frequently used as measures of operations and the ability to meet debt service requirements, these terms are not necessarily comparable to other similarly titled captions of other companies due to the potential inconsistencies in the method of calculation. Adjusted EBITDA does not reflect the impact of earnings or charges resulting from matters that we may consider not to be indicative of our ongoing operations. In particular, the definition of Adjusted EBITDA in the Revolving Credit Agreement allows us to add back certain non-cash, extraordinary, unusual or non-recurring charges that are deducted in calculating net income. However, these are expenses that may recur, vary greatly and are difficult to predict. Adjusted EBITDA as presented below should not be used by investors as an indicator of performance for any future period. Further, our debt instruments require that it be calculated for the most recent four fiscal quarters. As a result, the measure can be disproportionately affected by a particularly strong or weak quarter. Further, it may not be comparable to the measure for any subsequent four quarter period or any complete fiscal year. In addition, our debt instruments require that the leverage ratio be calculated on a pro forma basis for certain transactions including acquisitions as if such transactions had occurred on the first date of the measurement period and may include expected cost savings and synergies resulting from or related to any such transaction. There can be no assurances that any such cost savings or synergies will be achieved in full. 44 In addition, Adjusted EBITDA is a key measure used by our management to understand and evaluate our operating performance, generate future operating plans and make strategic decisions regarding the allocation of capital. Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under U.S. GAAP. Some of those limitations include: (1) it does not reflect the periodic costs of certain capitalized tangible and intangible assets used in generating revenue for our business; (2) it does not reflect the significant interest expense or cash requirements necessary to service interest or principal payments on our indebtedness; and (3) it does not reflect every cash expenditure, future requirements for capital expenditures or contractual commitments. In particular, this measure adds back certain non-cash, extraordinary, unusual or non-recurring charges that are deducted in calculating net income; however, these are expenses that may recur, vary greatly and are difficult to predict. In addition, Adjusted EBITDA is not the same as net income or cash flow provided by operating activities as those terms are defined by U.S. GAAP and does not necessarily indicate whether cash flows will be sufficient to fund cash needs. Accordingly, Adjusted EBITDA should be considered in addition to, not as a substitute for, net income (loss) and other measures of financial performance reported in accordance with U.S. GAAP. The following is a reconciliation of net (loss) income, which is a U.S. GAAP measure of our operating results, to Adjusted EBITDA as defined, for the most recently ended four fiscal quarters, or the twelve months ended December 31, 2020, for the twelve months ended December 31, 2019 and for the three months ended December 31, 2020 and December 31, 2019. In addition, the reconciliation includes the calculation of the Senior Secured Indebtedness to Adjusted EBITDA ratio, which we refer to as the Leverage Ratio, under the Revolving Credit Agreement for the most recently ended four fiscal quarters, or the twelve months ended December 31, 2020. The terms and related calculations are defined in the Revolving Credit Agreement. All amounts in the reconciliation below reflect Acquisition Corp. (in millions, except ratios): Twelve Months Ended December 31, Three Months Ended December 31, 2020 2019 2020 2019 Net (Loss) Income $ (493) $ 294 $ 99 $ 122 Income tax (benefit) expense 53 (36) 35 5 Interest expense, net 125 140 31 33 Depreciation and amortization 261 271 71 71 Loss on extinguishment of debt (a) 34 4 — — Net gain on divestitures and sale of securities (b) (1) (4) — — Restructuring costs (c) 20 26 3 5 Net hedging and foreign exchange losses (gains) (d) 104 (23) 48 5 Management fees (e) 17 11 — 3 Transaction costs (f) 76 — — — Business optimization expenses (g) 37 28 8 10 Non-cash stock-based compensation expense (h) 621 30 6 (7) Other non-cash charges (i) (5) (3) (14) 1 Pro forma impact of cost savings initiatives and specified transactions (j) 55 2 10 1 Adjusted EBITDA $ 904 $ 740 $ 297 $ 249 Senior Secured Indebtedness (k) $ 2,844 Leverage Ratio (l) 3.15x ______________________________________ (a) For the twelve months ended December 31, 2020, reflects a net loss incurred on the early extinguishment of our debt incurred as part of the June 2020 redemption of our 4.125% Senior Secured Notes and 4.875% Senior Secured Notes, the June 2020 tender for and the August 2020 redemption of the 5.000% Senior Secured Notes and the August 2020 partial repayment of the Senior Term Loan Facility. For the twelve months ended December 31, 2019, reflects a net loss incurred on the early extinguishment of our debt incurred as part of the May 2019 redemption of the remaining 5.625% Secured Notes. (b) Reflects net gain on sale of securities and divestitures. (c) Reflects severance costs and other restructuring related expenses. (d) Reflects losses from hedging activities and unrealized losses (gains) due to foreign exchange on our Euro-denominated debt and intercompany transactions. (e) Reflects management fees and related expenses paid to Access. For the twelve months ended December 31, 2020, amounts include a one-time fee of $13 million related to termination of the management agreement with Access. Prior to termination of the management agreement, the annual fee was equal to the greater of a base amount, equal to approximately $4 million for the twelve months ended December 31, 2020, and 1.5% of EBITDA (as defined in the indenture governing the redeemed Holdings 13.75% Senior Notes due 2019) of the Company for the applicable fiscal year, plus expenses. 45 (f) Reflects transaction costs, including qualifying IPO costs of $76 million for the twelve months ended December 31, 2020. (g) Reflects costs associated with our transformation initiatives and IT system updates, which includes costs of $6 million and $27 million related to our finance transformation for the three and twelve months ended December 31, 2020, respectively, as well as $10 million and $24 million for the three and twelve months ended December 31, 2019, respectively. (h) Reflects non-cash stock-based compensation expense related to the Warner Music Group Corp. Senior Management Free Cash Flow Plan and the Omnibus Incentive Plan. (i) Reflects non-cash activity, including the unrealized losses (gains) on the mark-to-market of an equity method investment, investment losses (gains) and other non-cash impairments. (j) Reflects expected savings resulting from transformation initiatives and pro forma impact of specified transactions for the three and twelve months ended December 31, 2020. Certain of these costs savings initiatives and transactions were identified in the current quarter and as a result the proforma impact was not included in the three and twelve months ended September 30, 2020, the impact of which would have been approximately a $29 million increase in the previously reported quarters included in the twelve months ended December 31, 2020 Adjusted EBITDA. (k) Reflects the principal balance of senior secured debt at Acquisition Corp. of approximately $3.094 billion less cash of $250 million. (l) Reflects the ratio of Senior Secured Indebtedness, including Revolving Credit Agreement Indebtedness, to Adjusted EBITDA. This is calculated net of cash and equivalents of the Company as of December 31, 2020 not exceeding $250 million. If the outstanding aggregate principal amount of borrowings and drawings under letters of credit which have not been reimbursed under our Revolving Credit Facility is greater than $105 million at the end of a fiscal quarter, the maximum leverage ratio permitted under the Revolving Credit Facility is 5.00:1.00. The Company’s Revolving Credit Facility does not impose any “leverage ratio” maintenance requirement on the Company when the aggregate principal amount of borrowings and drawings under letters of credit, which have not been reimbursed under the Revolving Credit Facility, is less than or equal to $105 million at the end of a fiscal quarter. Summary Management believes that funds generated from our operations and borrowings under the Revolving Credit Facility and available cash and equivalents will be sufficient to fund our debt service requirements, working capital requirements and capital expenditure requirements for the foreseeable future. We also have additional borrowing capacity under our indentures and the Senior Term Loan Facility. However, our ability to continue to fund these items and to reduce debt may be affected by general economic, financial, competitive, legislative and regulatory factors, as well as other industry-specific factors such as the ability to control music piracy and the continued transition from physical to digital formats in the recorded music and music publishing industries. It could also be affected by the severity and duration of natural or man-made disasters, including pandemics such as COVID-19. We and our affiliates continue to evaluate opportunities to, from time to time, depending on market conditions and prices, contractual restrictions, our financial liquidity and other factors, seek to pay dividends or prepay outstanding debt or repurchase or retire Acquisition Corp.’s outstanding debt or debt securities or repurchase our outstanding equity securities in open market purchases, privately negotiated purchases or otherwise. The amounts involved in any such transactions, individually or in the aggregate, may be material and may be funded from available cash or from additional borrowings. In addition, from time to time, depending on market conditions and prices, contractual restrictions, our financial liquidity and other factors, we may seek to refinance the Senior Credit Facilities or our outstanding debt or debt securities with existing cash and/or with funds provided from additional borrowings. 46