Do you hear it? It’s everywhere. 2005 ANNUAL REPORT Do you hear it? Pictured on the cover: Yi Ping Ho, Senior Manager, Strategic Planning and Business Development 4 Listening to Hung Up by Madonna dear shareholder This year Warner Music Group has emerged as a leader in the MORPHING WMG FROM A RECORDS- AND SONGS-BASED digital music realm, and became the only publicly-traded COMPANY TO A MUSIC-BASED CONTENT COMPANY independent music company in the United States. One of the reasons my partners and I invested in Warner Music Group is that we believed we could drive innovation Warner Music Group today is a high-performing, innovative within the industry by making the transition from a records- and streamlined global company, with an industry-leading man- and songs-based company to a music-based content company. agement team and some of the world’s greatest musical artists. For us a “music-based content company” is a multifaceted And this is just the beginning. Our ongoing transformation company designed to maximize the potential of our artist- as a company is geared to seizing the opportunities in the branded content. rapidly changing music industry for the mutual benefit of our shareholders, artists and customers. We have taken an industry-leading approach to monetize our existing content through the development of new and multiple As we bring you our first annual report, we are proud to share revenue streams. We are highly focused on extracting the with you some of this year’s accomplishments that demon- greatest value from all of our content, including music strate how Warner Music Group is evolving. videos, artwork and lyrics. We see this content being exploited across many new product categories—ringtones, mastertones, LEADING THE RENAISSANCE OF THE MUSIC INDUSTRY ringback tones, full track, video and music downloads—and The music industry is undergoing a renaissance driven by new distribution channels and delivery devices, like MP3- converging forces in technology and entertainment. The shift players, mobile phones, online download stores, subscription from “physical” sales (of CDs and DVDs) to “digital” sales services, podcasts and satellite radio. (of downloads and ringtones) offers great potential to power ever greater consumption of music. To more fully grasp this market opportunity, we’ve woven the creation of digital products into all aspects of our business— We are highly focused on fully exploiting this growth poten- from “Artists and Repertoire” (A&R) to marketing, promotion tial, and we are already beginning to see some of the and packaging. We are also increasingly “bundling” content, results. For the twelve months ended September 30, 2005, our such as bonus tracks, “making-of” videos, and digital book- growth in key genres and our digital business contributed lets with an album, to create premium packages that are significantly enough to our domestic recorded music business attractive to the consumer and derive superior margins and that we outperformed the industry by 4.0 percentage points, potentially higher sales for us and our artists. These bundling based on year-over-year U.S. SoundScan total album unit initiatives will remain a key priority as we work towards more sales performance. variable pricing of music in the digital world. We believe that these changes are fundamental and provide a To best capitalize on the mobile music market opportunity, significant source of future growth in the industry. we believe we have developed one of the largest mobile foot- prints of any media company today—one that reaches more Why? Because this trend is buttressed by two market- than half a billion subscribers worldwide. Smart mobile changing developments: solutions for music will also open up economically viable • the rapid growth in portable entertainment devices driven solutions in emerging markets where piracy remains rampant. by companies like Apple, Motorola and large consumer In order to take a more active and influential role in shaping electronics companies that provide consumers choice on new business models and strategic marketing plans in this how and where to connect to the music they love; and area, we have established “Chief Experiment Partner” status • the increased competition among distributors such as tele- with many mobile companies. phone companies, mobile providers, online retailers, broad- casters and cable companies which are all trying to deliver As part of our ongoing efforts to lead innovation in the digital musical content to consumers. space, we have trail-blazed a series of “firsts.” This explosive device growth, supported by a virtually infi- To date, we are the first major music company to: nite inventory of digital music available in a myriad of combi- • sell music videos for digital download through a wireless nations, creates a win-win situation for Warner Music Group. carrier; • make its music video catalogue available for use in original Bolstered by technological, legal and educational advances content developed for wireless platforms; and to combat piracy, the growth of legitimate digital music • launch a wireless streaming music subscription service in services is rising. With economic incentive further fueled by the U.S. the unanimous Supreme Court ruling in MGM vs. Grokster, there are already more than 300 legal online music sites And we’re one of the first to make ringback tones available globally providing alternatives to illegal file-sharing. in the U.S. Our early investments in building a digital music presence becoming the number one UK selling artist in 2005. This is a have met with great success. Digital has grown to 6% of our good example of our carefully honed marketing and promo- revenues for the quarter ended September 30, 2005—a tional strategies designed to drive long-term success. tremendous increase from March 2004 when we bought the company from Time Warner and digital revenues were negli- We also pioneered the incubator model, which is designed to gible. What’s more, this performance is partially incremental to identify future superstars earlier in the A&R process, and at our physical sales. In fact, we have seen the absolute growth lower cost, by leveraging our strong and industry-leading in digital exceed the marginal decline in our physical business independent distribution network. To date, we have upstreamed for the year ended September 30, 2005 for our U.S. recorded five urban and three rock artists to our major labels, four of music business. And as the international digital markets whom have debuted in the top 10 on Billboard’s Top 200 become more developed, we expect this digital advantage to chart (Paul Wall, Mike Jones, Webbie and Bun-B). Our U.S. spread overseas as well. SoundScan album share in Rap and R&B music—two of the most significant sales sectors in our industry—surged DRIVING SHARE GAINS THROUGH A&R STRATEGY 11.5 percentage points and 6.0 percentage points respectively Through our focused and innovative A&R efforts, we are year-over-year for the six months ended September 30, 2005. breaking new acts, building on the potential of our storied, diversified recorded music catalog and publishing businesses, As part of our digital A&R efforts, we also launched Cordless and maximizing our A&R spending efforts. We are carefully Recordings, a new “e-label” where artists can develop in a investing more A&R dollars in our most promising and supportive, lower-risk environment. More specifically, an profitable artists and applying a rigorous IRR analysis to all e-label artist is not required to have enough material for an major artist signings. album, only enough to excite our ears. Rather than releasing an album every couple of years, every few months the label We carefully mine the potential of the artists in our roster. will release “clusters”—three or more songs—by an artist. For example, we nurtured James Blunt, a young singer and This approach helps maximize our return while giving artists songwriter, by returning to grass roots artist development more visibility to consumers. with an eye to long-term career advancement. Since his launch in October 2004, he has sold more than 3.5 million albums, It can transport us to another place and time and give us the pleasure of solitude in a chaotic world. Richard Jennings, Creative Director, WEA Creative Services Listening to ASAP by T.I. It brings joy to our lives and inspires us to conquer life’s challenges. Ruby Marchand, Head of A&R, Cordless Recordings Listening to You’re Beautiful by James Blunt ENSURING PROFITABLE GROWTH THROUGH GIVING BACK TO THE COMMUNITY FINANCIAL DISCIPLINE Our company culture is bound by shared values and a strong As a result of these efforts, our total fiscal year 2005 revenues sense of collaboration. We are committed to philanthropy and and operating income amounted to $3.5 billion and $84 mil- working with our communities. In the wake of Hurricane lion respectively. Katrina, hundreds of us joined Habitat for Humanity to build 65 homes for families affected by the hurricane and to raise To achieve our goal of profitable growth, we’ve instilled a millions of dollars for hurricane victims. sense of financial discipline. We restructured and streamlined the company to achieve approximately $250 million in annual THIS IS ONLY THE BEGINNING cost savings. Going forward, our flexible cost structure—with Thanks to the hard work of our employees and artists, our about 25% fixed and 75% discretionary or variable costs— vision to transform Warner Music Group into the leading enables us to be nimble, and the migration to digital further music content provider for today’s rapidly evolving digital advantages this operating structure. We derive an operating world is quickly becoming a reality. margin advantage in digital given the lack of inventory, distri- bution and returns expenses.