UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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x |
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended December 31, 2015
OR
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¨ |
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)
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Delaware |
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13-4271875 |
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(State or other jurisdiction of incorporation or organization) |
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(I.R.S. Employer Identification No.) |
1633 Broadway
New York, NY 10019
(Address of principal executive offices)
(212) 275-2000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ¨ No x
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 x 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.
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Large accelerated filer |
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¨ |
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Accelerated filer |
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¨ |
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Non-accelerated filer |
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x |
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(Do not check if a smaller reporting company) |
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Smaller reporting company |
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¨ |
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) Yes ¨ No x
There is no public market for the Registrant’s common stock. As of February 4, 2016 the number of shares of the Registrant’s common stock, par value $0.001 per share, outstanding was 1,055. All of the Registrant’s common stock is owned by affiliates of Access Industries, Inc. The Registrant has filed all Exchange Act reports for the preceding 12 months.
INDEX
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Page |
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Part I. |
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Financial Information |
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Item 1. |
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3 |
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Consolidated Balance Sheets as of December 31, 2015 and September 31, 2015 |
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3 |
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4 |
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5 |
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6 |
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Consolidated Statement of Equity for the Three Months Ended December 31, 2015 |
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7 |
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8 |
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Supplementary Information—Consolidating Financial Statements |
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18 |
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Item 2. |
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Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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27 |
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Item 3. |
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45 |
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Item 4. |
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46 |
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Part II. |
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47 |
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Item 1. |
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47 |
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Item 1A. |
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47 |
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Item 2. |
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47 |
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Item 3. |
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48 |
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Item 4. |
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48 |
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Item 5. |
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48 |
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Item 6. |
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48 |
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49 |
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2
Warner Music Group Corp.
Consolidated Balance Sheets (Unaudited)
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December 31, |
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September 30, |
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2015 |
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2015 |
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(in millions) |
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Assets |
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Current assets: |
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Cash and equivalents |
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$ |
278 |
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$ |
246 |
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Accounts receivable, net of allowances of $74 million and $56 million |
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408 |
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349 |
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Inventories |
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41 |
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42 |
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Royalty advances expected to be recouped within one year |
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135 |
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130 |
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Prepaid and other current assets |
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60 |
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60 |
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Total current assets |
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922 |
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827 |
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Royalty advances expected to be recouped after one year |
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202 |
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195 |
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Property, plant and equipment, net |
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217 |
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220 |
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Goodwill |
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1,625 |
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1,632 |
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Intangible assets subject to amortization, net |
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2,423 |
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2,514 |
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Intangible assets not subject to amortization |
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119 |
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119 |
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Other assets |
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105 |
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114 |
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Total assets |
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$ |
5,613 |
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$ |
5,621 |
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Liabilities and Equity |
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Current liabilities: |
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Accounts payable |
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$ |
161 |
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$ |
173 |
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Accrued royalties |
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1,131 |
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1,087 |
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Accrued liabilities |
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297 |
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296 |
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Accrued interest |
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47 |
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58 |
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Deferred revenue |
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202 |
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206 |
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Current portion of long-term debt |
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13 |
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13 |
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Other current liabilities |
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36 |
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24 |
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Total current liabilities |
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1,887 |
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1,857 |
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Long-term debt |
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2,973 |
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2,981 |
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Deferred tax liabilities, net |
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286 |
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302 |
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Other noncurrent liabilities |
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228 |
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242 |
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Total liabilities |
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$ |
5,374 |
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$ |
5,382 |
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Equity: |
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Common stock ($0.001 par value; 10,000 shares authorized; 1,055 shares issued and outstanding) |
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$ |
— |
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$ |
— |
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Additional paid-in capital |
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1,128 |
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1,128 |
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Accumulated deficit |
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(713 |
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(740 |
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Accumulated other comprehensive loss, net |
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(192 |
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(167 |
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Total Warner Music Group Corp. equity |
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223 |
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221 |
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Noncontrolling interest |
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16 |
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18 |
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Total equity |
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239 |
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239 |
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Total liabilities and equity |
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$ |
5,613 |
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$ |
5,621 |
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See accompanying notes
3
Consolidated Statements of Operations (Unaudited)
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Three Months Ended |
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December 31, |
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2015 |
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2014 |
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(in millions) |
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Revenue |
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$ |
849 |
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$ |
829 |
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Costs and expenses: |
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Cost of revenue |
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(449 |
) |
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(445 |
) |
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Selling, general and administrative expenses (a) |
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(276 |
) |
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(296 |
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Amortization expense |
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(62 |
) |
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(65 |
) |
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Total costs and expenses |
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(787 |
) |
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(806 |
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Operating income |
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62 |
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23 |
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Interest expense, net |
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(45 |
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(46 |
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Other income (expense) |
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8 |
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(9 |
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Income (loss) before income taxes |
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25 |
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(32 |
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Income tax benefit (expense) |
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3 |
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(9 |
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Net income (loss) |
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28 |
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(41 |
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Less: Income attributable to noncontrolling interest |
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(1 |
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(1 |
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Net income (loss) attributable to Warner Music Group Corp. |
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$ |
27 |
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$ |
(42 |
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(a) Includes depreciation expense of: |
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$ |
(13 |
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$ |
(14 |
) |
See accompanying notes
4
Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
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Three Months Ended |
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December 31, |
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2015 |
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2014 |
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(in millions) |
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Net income (loss) |
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$ |
28 |
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$ |
(41 |
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Other comprehensive loss, net of tax: |
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Foreign currency adjustment |
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(24 |
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(34 |
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Deferred losses on derivative financial instruments |
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(1 |
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— |
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Other comprehensive loss, net of tax |
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(25 |
) |
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(34 |
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Total comprehensive income (loss) |
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3 |
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(75 |
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Less: Income attributable to noncontrolling interest |
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(1 |
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(1 |
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Comprehensive income (loss) attributable to Warner Music Group Corp. |
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$ |
2 |
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$ |
(76 |
) |
See accompanying notes
5
Consolidated Statements of Cash Flows (Unaudited)
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Three Months |
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Three Months |
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Ended |
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Ended |
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December 31, |
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December 31, |
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2015 |
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2014 |
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(in millions) |
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Cash flows from operating activities |
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Net income (loss) |
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$ |
28 |
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$ |
(41 |
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Adjustments to reconcile net loss to net cash provided by operating activities: |
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Depreciation and amortization |
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75 |
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79 |
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Unrealized (gains)/losses and remeasurement of foreign denominated loans |
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(8 |
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14 |
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Deferred income taxes |
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(9 |
) |
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— |
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Non-cash interest expense |
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2 |
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2 |
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Non-cash share-based compensation expense |
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1 |
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— |
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Changes in operating assets and liabilities: |
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Accounts receivable |
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(63 |
) |
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(67 |
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Inventories |
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(1 |
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(1 |
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Royalty advances |
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(16 |
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(7 |
) |
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Accounts payable and accrued liabilities |
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(11 |
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(47 |
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Royalty payables |
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58 |
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46 |
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Accrued interest |
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(11 |
) |
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(12 |
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Deferred revenue |
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1 |
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39 |
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Other balance sheet changes |
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15 |
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30 |
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Net cash provided by operating activities |
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61 |
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35 |
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Cash flows from investing activities |
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Acquisition of music publishing rights, net |
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(7 |
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(5 |
) |
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Capital expenditures |
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(10 |
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(24 |
) |
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Investments and acquisitions of businesses, net |
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(1 |
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(8 |
) |
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Net cash used in investing activities |
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(18 |
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(37 |
) |
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Cash flows from financing activities |
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Proceeds from the Revolving Credit Facility |
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— |
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100 |
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Repayment of the Revolving Credit Facility |
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— |
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(100 |
) |
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Repayment of Acquisition Corp. Senior Term Loan Facility |
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(3 |
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(3 |
) |
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Distribution to noncontrolling interest holder |
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(3 |
) |
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— |
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Net cash used in financing activities |
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(6 |
) |
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(3 |
) |
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Effect of exchange rate changes on cash and equivalents |
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(5 |
) |
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(7 |
) |
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Net increase (decrease) in cash and equivalents |
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32 |
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(12 |
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Cash and equivalents at beginning of period |
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|
246 |
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|
|
157 |
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Cash and equivalents at end of period |
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$ |
278 |
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$ |
145 |
|
See accompanying notes
6
Consolidated Statements of Equity (Unaudited)
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Accumulated |
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Total |
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Additional |
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Other |
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Warner Music |
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Common Stock |
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Paid-in |
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Accumulated |
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Comprehensive |
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Group Corp. |
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Noncontrolling |
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Total |
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Shares |
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Value |
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Capital |
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Deficit |
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Loss |
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Equity |
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Interest |
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Equity |
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(in millions, except share amounts) |
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Balance at September 30, 2015 |
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1,055 |
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$ |
— |
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$ |
1,128 |
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|
$ |
(740 |
) |
|
$ |
(167 |
) |
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$ |
221 |
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$ |
18 |
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$ |
239 |
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Net income |
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|
— |
|
|
|
— |
|
|
|
— |
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|
27 |
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|
|
— |
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|
27 |
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1 |
|
|
|
28 |
|
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Other comprehensive loss, net of tax |
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|
— |
|
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|
— |
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— |
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— |
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(25 |
) |
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(25 |
) |
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— |
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(25 |
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Distribution to noncontrolling interest holders |
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— |
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— |
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— |
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— |
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— |
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— |
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(3 |
) |
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(3 |
) |
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Balance at December 31, 2015 |
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1,055 |
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$ |
— |
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$ |
1,128 |
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|
$ |
(713 |
) |
|
$ |
(192 |
) |
|
$ |
223 |
|
|
$ |
16 |
|
|
$ |
239 |
|
See accompanying notes
7
Notes to Consolidated Interim Financial Statements (Unaudited)
1. Description of Business
Warner Music Group Corp. (the “Company”) was formed on November 21, 2003. The Company is the direct parent of WMG Holdings Corp. (“Holdings”), which is the direct parent of WMG Acquisition Corp. (“Acquisition Corp.”). Acquisition Corp. is one of the world’s major music-based content companies.
Acquisition of Warner Music Group by Access Industries
Pursuant to an Agreement and Plan of Merger, dated as of May 6, 2011 (the “Merger Agreement”), by and among the Company, AI Entertainment Holdings LLC (formerly Airplanes Music LLC), a Delaware limited liability company (“Parent”) and an affiliate of Access Industries, Inc. (“Access”), and Airplanes Merger Sub, Inc., a Delaware corporation and a wholly owned subsidiary of Parent (“Merger Sub”), on July 20, 2011 (the “Merger Closing Date”) Merger Sub merged with and into the Company with the Company surviving as a wholly owned subsidiary of Parent (the “Merger”). In connection with the Merger, the Company delisted its common stock from the NYSE. The Company continues to file with the SEC current and periodic reports that would be required to be filed with the SEC pursuant to Section 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) in accordance with certain covenants contained in the agreements governing its outstanding indebtedness.
Acquisition of Parlophone Label Group
On July 1, 2013, the Company completed its acquisition of Parlophone Label Group (the “PLG Acquisition”).
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 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.
In the United States, Recorded Music operations are conducted principally through the Company’s major record labels—Warner Bros. Records and Atlantic Records. 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. The Company also conducts its Recorded Music operations through a collection of additional record labels, including, Asylum, Big Beat, Canvasback, Eastwest, Elektra, Erato, FFRR, Fueled by Ramen, Nonesuch, Parlophone, Reprise, Roadrunner, Sire, Warner Classics, Warner Music Nashville and Word.
Outside the United States, Recorded Music activities are conducted in more than 50 countries through various subsidiaries, affiliates and non-affiliated licensees. Internationally, the Company engages in the same activities as in the United States: discovering and signing artists and distributing, marketing and selling their recorded music. In most cases, the Company also markets and distributes the records of those artists for whom the Company’s domestic record labels have international rights. In certain smaller markets, the Company licenses the right to distribute the Company’s records to non-affiliated third-party record labels. The Company’s international artist services operations include a network of concert promoters through which it provides resources to coordinate tours for the Company’s artists and other artists as well as management companies that guide artists with respect to their careers.
The Company’s Recorded Music distribution operations include Warner-Elektra-Atlantic Corporation (“WEA Corp.”), which markets and sells music and video products to retailers and wholesale distributors; Alternative Distribution Alliance (“ADA”), which distributes the products of independent labels to retail and wholesale distributors; various distribution centers and ventures operated internationally; and an 80% interest in Word, which specializes in the distribution of music products in the Christian retail marketplace.
8
In addition to the Company’s Recorded Music products being sold in physical retail outlets, 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 download services such as Apple’s iTunes and Google Play, and are offered by digital streaming services such as Apple Music, Deezer, Rhapsody, Spotify and YouTube, including digital radio services such as iHeart Radio, iTunes Radio, Pandora and Sirius XM.
The Company has integrated the exploitation of digital content into all aspects of its business, including artist and repertoire (“A&R”), marketing, promotion and distribution. The Company’s business development executives work closely with A&R departments to ensure that while a record 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. The Company also works side by side with its online and mobile partners to test new concepts. The Company believes existing and new digital businesses will be a significant source of growth and will provide new opportunities to successfully monetize its assets and create new revenue streams. The proportion of digital revenues attributed to each distribution channel varies by region and proportions may change as the roll out of new technologies continues. As an owner of music 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.
The Company has diversified its revenues beyond its traditional businesses by entering into expanded-rights deals with recording artists in order to partner with artists in other aspects of their careers. Under these agreements, the Company provides services to and participates in artists’ activities outside the traditional recorded music business such as touring, merchandising and sponsorships. The Company has built artist services capabilities and platforms for exploiting this broader set of music-related rights and participating more widely in the monetization of the artist brands it helps create.
The Company believes that entering into expanded-rights deals and enhancing its artist services capabilities in areas such as concert promotion and management have permitted it to diversify revenue streams and capitalize on other revenue opportunities. This provides for improved long-term relationships with artists and allows the Company to more effectively connect artists and fans.
Music Publishing Operations
While recorded music is focused on exploiting a particular recording of a composition, music publishing is an intellectual property business focused on the exploitation of the composition itself. In return for promoting, placing, marketing and administering the creative output of a songwriter, or engaging in those activities for other rightsholders, the Company’s Music Publishing business garners a share of the revenues generated from use of the composition.
The Company’s Music Publishing operations include Warner/Chappell, its global Music Publishing company, headquartered in Los Angeles with operations in over 50 countries through various subsidiaries, affiliates and non-affiliated licensees. The Company owns or controls rights to more than one million musical compositions, including numerous pop hits, American standards, folk songs and motion picture and theatrical compositions. Assembled over decades, its award-winning catalog includes over 65,000 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, gospel and other Christian music. Warner/Chappell also administers the music and soundtracks of several third-party television and film producers and studios, including Lucasfilm, Ltd., Hallmark Entertainment and Disney Music Publishing. The Company has an extensive production music library collectively branded as Warner/Chappell Production Music.
2. Summary of Significant Accounting Policies
Interim Financial Statements
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“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 notes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three month period ended December 31, 2015 are not necessarily indicative of the results that may be expected for the fiscal year ended September 30, 2016.
The consolidated balance sheet at September 30, 2015 has been derived from the audited consolidated financial statements at that date but does not include all of the information and notes required by U.S. GAAP for complete financial statements.
For further information, refer to the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2015 (File No. 001-32502).
9
The accompanying financial statements present the consolidated accounts of all entities in which the Company has a controlling voting interest and/or variable interest required to be consolidated in accordance with U.S. GAAP. All intercompany balances and transactions have been eliminated.
Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 810, Consolidation (“ASC 810”) requires the Company first evaluate its investments to determine if any investments qualify as a variable interest entity (“VIE”). A VIE is consolidated if the Company is deemed to be the primary beneficiary of the VIE, which is the party involved with the VIE that has both (i) the power to control the most significant activities of the VIE and (ii) either the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. If an entity is not deemed to be a VIE, the Company consolidates the entity if the Company has a controlling voting interest.
The Company maintains a 52-53 week fiscal year ending on the last Friday in each reporting period. As such, all references to December 31, 2015 and December 31, 2014 relate to the periods ended December 25, 2015 and December 26, 2014, respectively. For convenience purposes, the Company continues to date its financial statements as of December 31. The fiscal year ended September 30, 2015 ended on September 25, 2015. For convenience purposes, the Company continues to date its balance sheet as of September 30.
The Company has performed a review of all subsequent events through the date the financial statements were issued, and has determined that no additional disclosures are necessary.
Income Taxes
At the end of each interim period, the Company makes its best estimate of the effective tax rate expected to be applicable for the full fiscal year and uses that rate to provide for income taxes on a current year-to-date basis before discrete items. If a reliable estimate of the annual effective tax rate cannot be made, which could be caused by the significant variability in rates when marginal earnings are expected for the year, a discrete tax rate is calculated for the period.
New Accounting Pronouncements
During the first quarter of fiscal 2016, the Company adopted ASU 2015-17, Balance Sheet Classification of Deferred Taxes (“ASU 2015-17”). ASU 2015-17 requires that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The Company has elected to adopt this standard retrospectively, and thus the reclassification of prior period balances has been made. The application of ASU 2015-17 to the Company’s September 30, 2015 Consolidated Balance Sheets resulted in a decrease to current deferred tax assets of $52 million, an increase to non-current deferred tax assets of $2 million, and a decrease to non-current deferred tax liabilities of $50 million.
In May 2014, the FASB issued guidance codified in ASC 606, Revenue Recognition – Revenue from Contracts with Customers (“ASC 606”), which replaces the guidance in former ASC 605, Revenue Recognition and ASC 928, Entertainment – Music. The amendment was the result of a joint effort by the FASB and the International Accounting Standards Board to improve financial reporting by creating common revenue recognition guidance for U.S. GAAP and international financial reporting standards ("IFRS"). The joint project clarifies the principles for recognizing revenue and develops a common revenue standard for U.S. GAAP and IFRS. ASC 606 is effective for annual periods beginning after December 15, 2017, and interim periods within those years. Early application is not permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The update may be applied using one of two methods: retrospective application to each prior reporting period presented, or retrospective application with the cumulative effect of initially applying the update recognized at the date of initial application. The Company is currently evaluating the transition method that will be elected and the impact of the update on its financial statements and disclosures.
In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). This ASU will explicitly require management to assess an entity’s ability to continue as a going concern, and to provide related disclosure when substantial doubt exists. ASU 2014-15 will be effective in the first annual period ending after December 15, 2016, and interim periods thereafter. Earlier adoption is permitted. The adoption of this standard is not expected to have a significant impact on the Company’s financial statements, other than disclosure.
In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”). This ASU will require that debt issuance costs are presented as a direct deduction to the related debt in the liability section of the balance sheet, rather than presented as an asset. ASU 2015-03 will be effective for annual periods beginning after December 15, 2015, and interim periods within those years. Earlier adoption is permitted. The adoption of this standard is not expected to have a significant impact on the Company’s financial statements, other than presentation.
10
In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). This ASU will require that equity investments are measured at fair value with changes in fair value recognized in net income. The Company may elect to measure equity investments that do not have a readily determinable fair value at cost minus impairment, if any, plus or minus changes resulting from observable price. ASU 2016-01 will be effective for annual periods beginning after December 15, 2017, and interim periods within those years. Earlier adoption is permitted. The adoption of this standard is not expected to have a significant impact on the Company’s financial statements, other than disclosure.
3. Comprehensive Loss
Comprehensive loss, which is reported in the accompanying consolidated statements of equity, consists of net income (loss) and other gains and losses affecting equity that, under U.S. GAAP, are excluded from net income (loss). For the Company, the components of other comprehensive loss primarily consist of foreign currency translation losses and minimum pension liabilities. The following summary sets forth the changes in the components of accumulated other comprehensive loss, net of related taxes:
|
|
|
Foreign |
|
|
Minimum |
|
|
(Losses) |
|
|
Accumulated |
|
||||
|
|
|
Currency |
|
|
Pension |
|
|
On Derivative |
|
|
Other |
|
||||
|
|
|
Translation |
|
|
Liability |
|
|
Financial |
|
|
Comprehensive |
|
||||
|
|
|
Loss |
|
|
Adjustment |
|
|
Instruments |
|
|
Loss, net |
|
||||
|
|
|
(in millions) |
|
|||||||||||||
|
Balance at September 30, 2015 |
|
$ |
(157 |
) |
|
$ |
(10 |
) |
|
$ |
— |
|
|
$ |
(167 |
) |
|
Other comprehensive loss (a) |
|
|
(24 |
) |
|
|
— |
|
|
|
(1 |
) |
|
|
(25 |
) |
|
Amounts reclassified from accumulated other comprehensive income |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
Balance at December 31, 2015 |
|
$ |
(181 |
) |
|
$ |
(10 |
) |
|
$ |
(1 |
) |
|
$ |
(192 |
) |
|
|
|
(a) |
Foreign currency translation adjustments include intra-entity foreign currency transactions that are of a long-term investment nature of $23.4 million |
4. Goodwill and Intangible Assets
Goodwill
The following analysis details the changes in goodwill for each reportable segment:
|
|
|
Recorded |
|
|
Music |
|
|
|
|
|
||
|
|
|
Music |
|
|
Publishing |
|
|
Total |
|
|||
|
|
|
(in millions) |
|
|||||||||
|
Balance at September 30, 2015 |
|
$ |
1,168 |
|
|
$ |
464 |
|
|
$ |
1,632 |
|
|
Acquisitions |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
Dispositions |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
Other adjustments |
|
|
(7 |
) |
|
|
— |
|
|
|
(7 |
) |
|
Balance at December 31, 2015 |
|
$ |
1,161 |
|
|
$ |
464 |
|
|
$ |
1,625 |
|
Other adjustments during the three months ended December 31, 2015 represent foreign currency movements.
The Company performs its annual goodwill impairment test in accordance with FASB ASC Topic 350, Intangibles—Goodwill and other (“ASC 350”) during the fourth quarter of each fiscal year as of July 1. The Company may conduct an earlier review if events or circumstances occur that would suggest the carrying value of the Company’s goodwill may not be recoverable. No indicators of impairment were identified during the current period that required the Company to perform an interim assessment or recoverability test.
11
Intangible assets consist of the following:
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
|
Average |
|
December 31, |
|
|
September 30, |
|
||
|
|
|
Useful Life |
|
2015 |
|
|
2015 |
|
||
|
|
|
|
|
(in millions) |
|
|||||
|
Intangible assets subject to amortization: |
|
|
|
|
|
|
|
|
|
|
|
Recorded music catalog |
|
10 years |
|
$ |
979 |
|
|
$ |
992 |
|
|
Music publishing copyrights |
|
27 years |
|
|
1,484 |
|
|
|
1,497 |
|
|
Artist and songwriter contracts |
|
13 years |
|
|
914 |
|
|
|
926 |
|
|
Trademarks |
|
7 years |
|
|
7 |
|
|
|
7 |
|
|
Total gross intangible asset subject to amortization |
|
|
|
|
3,384 |
|
|
|
3,422 |
|
|
Accumulated amortization |
|
|
|
|
(961 |
) |
|
|
(908 |
) |
|
Total net intangible assets subject to amortization |
|
|
|
|
2,423 |
|
|
|
2,514 |
|
|
Intangible assets not subject to amortization: |
|
|
|
|
|
|
|
|
|
|
|
Trademarks and tradenames |
|
Indefinite |
|
|
119 |
|
|
|
119 |
|
|
Total net intangible assets |
|
|
|
$ |
2,542 |
|
|
$ |
2,633 |
|
5. Debt
Debt Capitalization
Long-term debt, including the current portion, consists of the following:
|
|
December 31, |
|
|
September 30, |
|
||
|
|
2015 |
|
|
2015 |
|
||
|
|
(in millions) |
|
|||||
|
Revolving Credit Facility—Acquisition Corp. (a) |
$ |
— |
|
|
$ |
— |
|
|
Senior Term Loan Facility due 2020—Acquisition Corp. (b) |
|
1,279 |
|
|
|
1,282 |
|
|
5.625% Senior Secured Notes due 2022—Acquisition Corp. |
|
275 |
|
|
|
275 |
|
|
6.00% Senior Secured Notes due 2021—Acquisition Corp. |
|
450 |
|
|
|
450 |
|
|
6.25% Senior Secured Notes due 2021—Acquisition Corp. (c) |
|
172 |
|
|
|
177 |
|
|
6.75% Senior Notes due 2022—Acquisition Corp. |
|
660 |
|
|
|
660 |
|
|
13.75% Senior Notes due 2019—Holdings |
|
150 |
|
|
|
150 |
|
|
Total debt |
|
2,986 |
|
|
|
2,994 |
|
|
Less: current portion |
|
13 |
|
|
|
13 |
|
|
Total long-term debt |
$ |
2,973 |
|
|
$ |
2,981 |
|
|
(a) |
Reflects $150 million of commitments under the Revolving Credit Facility, less letters of credit outstanding of approximately $5 million and $5 million at December 31, 2015 and September 30, 2015, respectively. There were no loans outstanding under the Revolving Credit Facility at December 31, 2015 or September 30, 2015. |
|
(b) |
Principal amount of $1.284 billion and $1.287 billion less unamortized discount of $5 million and $5 million at December 31, 2015 and September 30, 2015, respectively. Of this amount, $13 million, representing the scheduled amortization of the Senior Term Loan Facility, was included in the current portion of long-term debt at December 31, 2015 and September 30, 2015. |
|
(c) |
Face amount of €158 million. Above amounts represent the dollar equivalent of such notes at December 31, 2015 and September 30, 2015. |
Interest Rates
The loans under the Revolving Credit Facility bear interest at Acquisition Corp.’s election at a rate equal to (i) the rate for deposits in the borrowing currency in the London interbank market (adjusted for maximum reserves) for the applicable interest period (“Revolving LIBOR”), plus 2.00% 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) 0.50% in excess of the overnight federal funds rate and (z) the one-month Revolving LIBOR plus 1.0% per annum, plus, in each case, 1.00% per annum. If there is a payment default at any time, then the interest rate applicable to overdue principal will be the rate otherwise applicable to such loan plus 2.0% per annum. Default interest will also be payable on other overdue amounts at a rate of 2.0% per annum above the amount that would apply to an alternative base rate loan.
12
The loans under the Senior Term Loan Facility bear interest at Acquisition Corp.’s election at a rate equal to (i) the rate for deposits in U.S. dollars in the London interbank market (adjusted for maximum reserves) for the applicable interest period (“Term Loan LIBOR”), plus 2.75% per annum, or (ii) the base rate, which is the highest of (x) the corporate base rate established by the administrative agent as its prime rate in effect at its principal office in New York City from time to time, (y) 0.50% in excess of the overnight federal funds rate and (z) one-month Term Loan LIBOR, plus 1.00% per annum, plus, in each case, 1.75% per annum. The loans under the Senior Term Loan Facility are subject to a Term Loan LIBOR “floor” of 1.00%. If there is a payment default at any time, then the interest rate applicable to overdue principal and interest will be the rate otherwise applicable to such loan plus 2.0% per annum. Default interest will also be payable on other overdue amounts at a rate of 2.0% per annum above the amount that would apply to an alternative base rate loan.
Amortization and Maturity of Senior Term Loan Facility
The loans under the Senior Term Loan Facility amortize in equal quarterly installments due December, March, June and September in aggregate annual amounts equal to 1.00% of the original principal amount of the amended Senior Term Loan Facility, or $13 million per year, with the balance payable on maturity date of the Term Loans. The loans outstanding under the Senior Term Loan Facility mature on July 1, 2020.
Maturity of Revolving Credit Facility
The maturity date of the Revolving Credit Facility is April 1, 2019.
Maturities of Senior Notes and Senior Secured Notes
As of December 31, 2015, there are no scheduled maturities of notes until 2019, when $150 million is scheduled to mature. Thereafter, $1.557 billion is scheduled to mature.
Interest Expense, net
Total interest expense, net, was $45 million and $46 million for the three months ended December 31, 2015 and December 31, 2014, respectively. The weighted-average interest rate of the Company’s total debt was 5.6% at each of December 31, 2015, September 30, 2015 and December 31, 2014.
6. 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 the pricing of digital music downloads. On February 28, 2006, the Antitrust Division of the U.S. Department of Justice served us with a Civil Investigative Demand, also seeking information relating to the pricing of digitally downloaded music. Both investigations were ultimately closed, but subsequent to the announcements of the investigations, more than thirty putative class action lawsuits were filed concerning the pricing of digital music downloads. The lawsuits were consolidated 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. On October 9, 2008, the District Court issued an order dismissing the case as to all defendants, including us. However, on January 12, 2010, the Second Circuit vacated the judgment of the District Court and remanded the case for further proceedings and on January 10, 2011, the U.S. Supreme Court denied the defendants’ petition for Certiorari.
13
Upon remand to the District Court, all defendants, including the Company, filed a renewed motion to dismiss challenging, among other things, plaintiffs’ state law claims and standing to bring certain claims. The renewed motion was based mainly on arguments made in defendants’ original motion to dismiss, but not addressed by the District Court. On July 18, 2011, the District Court granted defendants’ motion in part, and denied it in part. Notably, all claims on behalf of the CD-purchaser class were dismissed with prejudice. However, a wide variety of state and federal claims remain for the class of Internet download purchasers. Plaintiffs filed an operative consolidated amended complaint on August 31, 2011. The Company filed its answer to the fourth amended complaint on October 9, 2015. Plaintiffs filed an amended Class Certification brief on October 12, 2015. The Company’s opposition to the amended brief is due February 12, 2016, and Plaintiffs’ reply in support of the brief is due June 10, 2016. The Company filed amended answers to the fourth amended complaint on November 3, 2015. A mediation has been scheduled for February 22, 2016. The Company intends to defend against these lawsuits vigorously, but is unable to predict the outcome of these suits. Regardless of the merits of the claims, this and any related litigation could continue to be costly, and divert the time and resources of management. The potential outcomes of these claims that are reasonably possible cannot be determined at this time and an estimate of the reasonably possible loss or range of loss cannot presently be made.
Other Matters
In addition to the matter discussed above, the Company is involved in various litigation and regulatory proceedings arising in the normal course of business. Where it is determined, in consultation with counsel based on litigation and settlement risks, that a loss is probable and estimable in a given matter, the Company establishes an accrual. In the currently pending proceedings, the amount of accrual is not material. An estimate of the reasonably possible loss or range of loss in excess of the amounts already accrued cannot be made at this time due to various factors typical in contested proceedings, including (1) the results of ongoing discovery; (2) uncertain damage theories and demands; (3) a less than complete factual record; (4) uncertainty concerning legal theories and their resolution by courts or regulators; and (5) the unpredictable nature of the opposing party and its demands. However, the Company cannot predict with certainty the outcome of any litigation or the potential for future litigation. As such, the Company continuously monitors these proceedings as they develop and adjusts any accrual or disclosure as needed. Regardless of the outcome, litigation could have an adverse impact on the Company, including the Company’s brand value, because of defense costs, diversion of management resources and other factors and it could have a material effect on the Company’s results of operations for a given reporting period.
7. Derivative Financial Instruments
The Company uses derivative financial instruments, primarily foreign currency forward exchange 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 foreign currency forward exchange contracts primarily to hedge the risk that unremitted or future royalties and license fees owed to its domestic companies for the sale, or anticipated sale, of U.S.-copyrighted products abroad may be adversely affected by changes in foreign currency exchange rates. The Company focuses on managing the level of exposure to the risk of foreign currency exchange rate fluctuations on its major currencies, which include the Euro, British pound sterling, Japanese yen, Canadian dollar, Swedish krona and Australian dollar. The foreign currency forward exchange contracts related to royalties are designated and qualify as cash flow hedges under the criteria prescribed in ASC 815. The Company records these contracts at fair value on its balance sheet and gains or losses on these contracts are deferred in equity (as a component of comprehensive loss). These deferred gains and losses are recognized in income in the period in which the related royalties and license fees being hedged are received and recognized in income. However, to the extent that any of these contracts are not considered to be perfectly effective in offsetting the change in the value of the royalties and license fees being hedged, any changes in fair value relating to the ineffective portion of these contracts are immediately recognized in the statement of operations.
The Company may at times choose to hedge foreign currency risk associated with financing transactions such as third-party and intercompany debt and other balance sheet items. The foreign currency forward exchange contracts related to balance sheet items denominated in foreign currency are reviewed on a contract-by-contract basis and are designated accordingly. If these foreign currency forward exchange contracts do not qualify for hedge accounting, then the Company records these contracts at fair value on its balance sheet and the related gains and losses are immediately recognized in the statement of operations where there is an equal and offsetting entry related to the underlying exposure.
The fair value of foreign currency forward exchange contracts is determined by using observable market transactions of spot and forward rates (i.e., Level 2 inputs) which is discussed further in Note 10. Additionally, netting provisions are provided for in existing International Swap and Derivative Association Inc. agreements in situations where the Company executes multiple contracts with the same counterparty. As a result, net assets or liabilities resulting from foreign exchange derivatives subject to these netting agreements are classified within other current assets or other current liabilities in the Company’s consolidated balance sheets.
14
The Company monitors its positions with, and the credit quality of, the financial institutions that are party to any of its financial transactions.
As of December 31, 2015, the Company had outstanding hedge contracts for the sale of $234 million and the purchase of $138 million of foreign currencies at fixed rates that will be settled by September 2016. As of December 31, 2015, the Company had $1 million of deferred losses in comprehensive loss related to foreign exchange hedging. As of September 30, 2015, the Company had no outstanding hedge contracts and no deferred gains or losses in comprehensive loss related to foreign exchange hedging.
The following is a summary of amounts recorded in the Consolidated Balance Sheet pertaining to the Company’s use of foreign currency derivatives at December 31, 2015 and September 30, 2015:
|
|
|
December 31, |
|
|
September 30, |
|
||
|
|
|
2015 (a) |
|
|
2015 (b) |
|
||
|
|
|
(in millions) |
|
|||||
|
Other current assets |
|
$ |
2 |
|
|
$ |
— |
|
|
Other current liabilities |
|
|
— |
|
|
|
— |
|
|
(a) |
Includes $5 million and $3 million of foreign exchange derivative contracts in asset and liability positions, respectively. |
|
(b) |
Includes no foreign exchange derivative contracts in asset and liability positions. |
8. 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, which also represent reportable segments of the Company. Information as to each of these operations is set forth below. The Company evaluates performance based on several factors, of which the primary financial measure is operating income (loss) before non-cash depreciation of tangible assets and non-cash amortization of intangible assets (“OIBDA”). The Company has supplemented its analysis of OIBDA results by segment with an analysis of operating income (loss) by segment.
The accounting policies of the Company’s business segments are the same as those described in the summary of significant accounting policies included elsewhere herein. The Company accounts for intersegment sales at fair value as if the sales were to third parties. While intercompany transactions are treated like third-party transactions to determine segment performance, the revenues (and corresponding expenses recognized by the segment that is counterparty to the transaction) are eliminated in consolidation, and therefore, do not themselves impact consolidated results.
|
|
|
|
|
|
|
|
|
|
|
Corporate |
|
|
|
|
|
|
|
|
|
Recorded |
|
|
Music |
|
|
expenses and |
|
|
|
|
|
|||
|
|
|
Music |
|
|
Publishing |
|
|
eliminations |
|
|
Total |
|
||||
|
Three Months Ended |
|
(in millions) |
|
|||||||||||||
|
December 31, 2015 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
$ |
737 |
|
|
$ |
116 |
|
|
$ |
(4 |
) |
|
$ |
849 |
|
|
OIBDA |
|
|
152 |
|
|
|
5 |
|
|
|
(20 |
) |
|
|
137 |
|
|
Depreciation of property, plant and equipment |
|
|
(8 |
) |
|
|
(2 |
) |
|
|
(3 |
) |
|
|
(13 |
) |
|
Amortization of intangible assets |
|
|
(46 |
) |
|
|
(16 |
) |
|
|
— |
|
|
|
(62 |
) |
|
Operating income (loss) |
|
|
98 |
|
|
|
(13 |
) |
|
|
(23 |
) |
|
|
62 |
|
|
December 31, 2014 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
$ |
714 |
|
|
$ |
119 |
|
|
$ |
(4 |
) |
|
$ |
829 |
|
|
OIBDA |
|
|
111 |
|
|
|
17 |
|
|
|
(26 |
) |
|
|
102 |
|
|
Depreciation of property, plant and equipment |
|
|
(10 |
) |
|
|
(1 |
) |
|
|
(3 |
) |
|
|
(14 |
) |
|
Amortization of intangible assets |
|
|
(49 |
) |
|
|
(16 |
) |
|
|
— |
|
|
|
(65 |
) |
|
Operating income (loss) |
|
|
52 |
|
|
|
— |
|
|
|
(29 |
) |
|
|
23 |
|
15
9. Additional Financial Information
Cash Interest and Taxes
The Company made interest payments of approximately $54 million and $56 million during the three months ended December 31, 2015 and December 31, 2014, respectively. The Company paid approximately $6 million of income and withholding taxes with no offsetting refunds during the three months ended December 31, 2015 and paid cash taxes of $8 million offset by a refund of $9 million in Germany for the three months ended December 31, 2014.
10. 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. |
|
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● |
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 December 31, 2015 and September 30, 2015.
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|
|
Fair Value Measurements as of December 31, 2015 |
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|||||||||||||
|
|
|
(Level 1) |
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|
(Level 2) |
|
|
(Level 3) |
|
|
Total |
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||||
|
|
|
(in millions) |
|
|||||||||||||
|
Other Current Assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign Currency Forward Exchange Contracts (a) |
|
$ |
— |
|
|
$ |
2 |
|
|
$ |
— |
|
|
$ |
2 |
|
|
Other Current Liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign Currency Forward Exchange Contracts (a) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
Other Current Liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contractual Obligations (b) |
|
|
— |
|
|
|
— |
|
|
|
(1 |
) |
|
|
(1 |
) |
|
Other Non-Current Liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contractual Obligations (b) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
Total |
|
$ |
— |
|
|
$ |
2 |
|
|
$ |
(1 |
) |
|
$ |
1 |
|
16
|
|
|
Fair Value Measurements as of September 30, 2015 |
|
|||||||||||||
|
|
|
(Level 1) |
|
|
(Level 2) |
|
|
(Level 3) |
|
|
Total |
|
||||
|
|
|
(in millions) |
|
|||||||||||||
|
Other Current Liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contractual Obligations (b) |
|
|
— |
|
|
|
— |
|
|
|
(1 |
) |
|
|
(1 |
) |
|
Other Non-Current Liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contractual Obligations (b) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
Total |
|
$ |
— |
|
|
$ |
— |
|
|
$ |
(1 |
) |
|
$ |
(1 |
) |
|
|
|
(a) |
The fair value of the 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 the Company’s various acquisitions. This is based on a discounted cash flow approach and it is adjusted to fair value on a recurring basis and any adjustments are included as a component of operating income in the statement of operations. These amounts were mainly calculated using unobservable inputs such as future earnings performance of the Company’s various acquisitions and the expected timing of the payment. |
The following table reconciles the beginning and ending balances of net assets and liabilities classified as Level 3:
|
|
|
Total |
|
|
|
|
|
(in millions) |
|
|
|
Balance at September 30, 2015 |
|
$ |
(1 |
) |
|
Additions |
|
|
— |
|
|
Reductions |
|
|
— |
|
|
Payments |
|
|
— |
|
|
Balance at December 31, 2015 |
|
$ |
(1 |
) |
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 re-measured to fair value on a recurring basis. These assets are evaluated for impairment if certain triggering events occur. If such evaluation indicates that 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 December 31, 2015, the fair value of the Company’s debt was $2.847 billion. Based on the level of interest rates prevailing at September 30, 2015, the fair value of the Company’s debt was $2.976 billion. The fair value of the Company’s debt instruments are determined using quoted market prices from less active markets or by using quoted market prices for instruments with identical terms and maturities; both approaches are considered a Level 2 measurement.
11. Subsequent Events
Notice of Debt Redemption
On January 15, 2016, Holdings elected to call for the partial redemption of $50 million of its $150 million outstanding 13.75% Senior Notes due 2019 (the “Holdings Notes”) and a notice of redemption has been sent by Wells Fargo Bank, National Association, the trustee for the Holdings Notes, to all registered holders of the Holdings Notes. The redemption price for the Holdings Notes is equal to 106.875% of the principal amount of the Holdings Notes, plus accrued and unpaid interest to, but not including, the redemption date, which will be on February 16, 2016. Upon the partial redemption by Holdings of the Holdings Notes, $100 million of the Holdings Notes will remain outstanding.
17
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 13.75% Senior Notes due 2019 (the “Holdings Notes”). In addition, Acquisition Corp. has issued and outstanding the 5.625% Senior Secured Notes due 2022, the 6.00% Senior Secured Notes due 2021, the 6.25% Senior Secured Notes due 2021, and the 6.75% Senior Notes due 2022 (together, the “Acquisition Corp. Notes”).
The Holdings Notes are guaranteed by the Company. These guarantees are full, unconditional, joint and several. The following condensed consolidating financial statements are presented for the information of the holders of the Holdings Notes and present the results of operations, financial position and cash flows of (i) the Company, which is the guarantor of the Holdings Notes, (ii) Holdings, which is the issuer of the Holdings 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 or combined subsidiaries are presented under the equity method of accounting.
The Acquisition Corp. Notes are also guaranteed by the Company and, in addition, are guaranteed by all of Acquisition Corp.’s domestic wholly-owned subsidiaries. The secured notes are guaranteed on a senior secured basis and the unsecured notes are guaranteed on an unsecured senior basis. The Company’s guarantee of the Acquisition Corp. Notes is full and unconditional. The guarantee of the Acquisition Corp. Notes by Acquisition Corp.’s domestic, wholly-owned subsidiaries are full, unconditional, joint and several. The following condensed consolidating financial statements are also presented for the information of the holders of the Acquisition Corp. Notes and present the results of operations, financial position and cash flows of (i) Acquisition Corp., which is the issuer of the Acquisition Corp. Notes, (ii) the guarantor subsidiaries of Acquisition Corp., (iii) the non-guarantor subsidiaries of Acquisition Corp. and (iv) the eliminations n