Warner Music Group Corp (WMG) 2005 Q3 法說會逐字稿

Welcome to Warner Music Group's Third Quarter Fiscal Endings June 30, 2005 Earnings Conference Call, hosted by Jill Krutick, Senior Vice President of Investor Relations and Corporate Development. [OPERATOR INSTRUCTIONS]

I would now like to turn the call over to your host.

Ms. Krutick, you may begin.

Thank you very much.

Good morning everyone.

I am delighted to introduce Warner Music Group's Fiscal Third Quarter Earnings Call.

We released our earnings for the 3 months ending June 30th this morning.

I'll read the Safe Harbor Language before Edgar Bronfman Jr., our Chairman and CEO shares with you our strategic update, and Michael Fleischer, our EVP and CFO, provides an analysis of fiscal third quarter results, before turning the call over for Q&A.

This communication includes forward-looking statements that reflect the current views of Warner Music Group about future events and financial performance.

Words such as estimates, expect, anticipate, project, plan, intend, believe, forecast and variations of such words or similar expressions that predict or indicate future events or trends or do not relate to historical matters identify forward-looking statements.

Our expectations, beliefs and projections are expressed in good faith, and we believe there is a reasonable basis for them.

However, there can be no assurance that management's expectations, beliefs and projections will result or be achieved.

Investors should not rely on forward-looking statements because they are subject to a variety of risks, uncertainties and other factors that can cause actual results that differ materially from our expectations.

We plan to present certain and adjusted non-GAAP results during this earnings call.

We have provided scheduled reconciling our GAAP results to the adjusted numbers that will be discussed today, which excludes certain non-recurring charges and FAS 123 expenses that will be explained in more detail by Michael.

The reconciliation schedules are detailed in our Press Release posted on our website at www.WMG.com, and included in the form AK filed today with the SEC, which is available on the SEC's web site, at www.sec.gov.

With that, I am delighted to turn the call over to Edgar.

Edgar Bronfman, Jr.: Thank you for joining us.

Since our last earnings call, we have made very strong progress, delivering on our strategic and financial goals.

We have had success on the market place with a number of new and exciting artists, and attained important and favorable music industry developments.

This has been a very significant quarter for Warner Music.

For the first time in the world's most advanced digital market place, the United States, we are now seeing digital games outpacing the physical business.

This performance is highlighted by the fact that we achieved 8 percent overall revenue growth for the U.S. recorded music segment when compared to the same quarter last year.

While the scale of digital penetration is lower internationally, it is coming and will lead to similar opportunities in growth for Warner Music.

In the quarter, our total revenues grew by 2 percent, with the important combination of significant growth in digital and diminishing declines in our physical business.

Our digital revenues were $44 million in the quarter, a 26 percent increase from the second fiscal quarter, and a 76 percent increase from the first quarter.

This impressive performance sparked our overall revenue growth for the quarter, and digital revenues represented 6 percent of all Warner Music Group revenues for our third quarter.

We were gratified in the quarter by the unanimous Supreme Court decision in the MGM vs.

Grokster case, a lawsuit that the music and film industries brought against the widely used file sharing networks brought against Dreamcast.

The court ruled that software or any other product that is distributed with the object of promoting infringement then the distributors are liable for the resulting infringement.

This landmark decision sends the clear message that intellectual property will be protected and sets the framework in which the content and technology communities can work together to meet consumers ever increasing appetite for music and music-based content.

We are also pleased that according to a recent IFPI report, illegal file sharing is being kept in check relative to broadband growth, while the number of legal downloads has tripled to 180 million in the first half of 2005, for the top 4 online territories when compared to last year.

Furthermore, there are over 300 legitimate online music sites worldwide.

That is up four-fold over 2004, and close to 200 in Europe alone, leading to my earlier assertion that the international digital market place will soon be far more robust than it is today.

We have taken a unique approach to transforming ourselves from a traditional record and song-based company into a music content company.

We have firmly integrated digital into our way of life.

Where some of our competitors have set up separate divisions within their organizations for marketing and promotion of online and mobile content, at Warner, we have integrated these new platforms into all aspects of our everyday business, from A&R to Marketing, to Promotion and Distribution.

Having already assembled what we believe to be the largest mobile footprint of any media company, we are best positioned to capitalized on the growth of ringtones and ringback tones today, and shortly fulltrack music and full music video downloads among other new businesses from these emerging distribution platforms.

While the physical signs of recorded music business is still down year-to-date, Warner continues to outperform and grow our share.

Soundscan numbers for the first half of the calendar year report sales of album and singles in the U.S. declined 7 percent, excluding digital.

However, Warner Music Group is down only 3 percent, clearly outperforming the industry, even at a time when we deliberately reduced our artist roster and release scheduling.

At the mid-year mark, Warner Music Groups' Soundscan share in each of the all-genre album category, total album, current albums and catalog albums was up by half a percentage point or more compared to the first half of 2004.

During the June quarter, Warner Music Group increased our Soundscan current album share by more than 1 full percentage point, as compared to the same period last year, underscoring our successful A&R efforts.

And we continue to place significant investment in A&R in order to build a strong pipeline of music across the company.

Progress is already evident at the restructured Atlantic, where our quarterly revenues rose in double digits compared to the comparable quarter last year, reversing previous decline, while reflecting early stages of a rebuild artist roster and release schedules.

We have focused our attention on both traditional A&R as well as new business models like our asylum in East/West incubator initiatives, which are designed to identify future superstars earlier in the A&R process, and at lower costs, while leveraging our strong and industry-leading independent distribution network.

At its essence, our incubator system is innovative A&R, and it has already produces some breakout recording artists and top-selling albums for Warner Music Group, including Mike Jones, the first of the 3 incubator artists we have upstreamed so far.

His first Warner Brothers album debuted at #3 on the Billboard Top 200 chart in April, and we are pleased to report that he has become the first Platinum Hip Hop artist in our Warner Brothers label in history.

Let me give you another A&R success story, and one that you are going to be hearing about for quite some time.

James Blunt is a young British foreign rock artist who we nurtured by returning to grassroots art development with an eye to a long-term career advancement.

Today, James' album and single are #1 on the charts in the UK, and his album is #2 in France and #3 on the European Consolidated Chart.

His debut album, called Back to Bedlam will be among the largest selling UK albums this year.

At a 150,000 unit weekly album sales rate, Blunt is outselling the next-best selling artist in the UK by a ratio of 3 to 1, and has sold more than 1.5 million units in Europe to date.

In fact, Blunt is the first Warner Music artist in nearly 10 years to simultaneously top the Singles and Album charts in the UK, and his album has been #1 in the UK for 4 consecutive weeks.

James has been the highlight of our international performance during the quarter, and we are currently setting up the album for release in the U.S.

Our efforts of growing Warner Music's urban business are also bearing fruit.

In the first 6 months of 2005, compared to the same period last year, our R&B and Rap Soundscan share has rose by 2 and 3 percentage points to 12.2 and 13.7 respectively.

In our third fiscal quarter, our Rap share actually surged about 10 share points to 18 percent, reflecting the impact of strong releases from Mike Jones and Fat Joe, who debuted at #2 on the Billboard Top 200 chart on June 10, and our Bad Boy joint venture has already contributed Top 5 debut on that chart from Boyz in Da Hood.

Our increased presence in Urban is also being born out in the digital world, where Urban products is exceedingly popular.

For example, of the nearly 10 million ringtones we sold in the quarter, Urban artists represented about two-thirds of that activity.

We are also increasing our share in other genres.

For example, in the U.S., we have grown our Jazz share to 20 percent and Country to 18 percent, thanks to strong fellows like Michael Blueblaze, Tim McGraw and Big and Rich.

Our refocus national operations are in the midst of a major marketing and promotion efforts of the release this week of Faith Hill's newest album called Firefly.

We continue to spend requisite A&R dollars to build a strong pipeline of music content across the company, which will be evident especially for Atlantic where its momentum to continue in our fourth fiscal quarter and beyond.

As we turn to our music publishing business, we have made significant strides in having our recorded music and music publishing units work more closely to reap the benefits from multiple revenue streams.

Warner Chappell, lead by its new Chairman and CEO, Richard Flagstone, who joined the company May 28, has quickly become much more competitive and aggressive in its A&R.

Warner Chappell has recently signed platinum selling artists T.I. and Mew, and the songwriters for Honda Replay, which is performed by Rhianna and is this week the #1 song on [inaudible].

We also resigned Hip Hop superstar artist, producer and songwriter Dr. Dre.

As evidence by those numbers we reported this morning, our artist roster is strengthening, just as the digital opportunity is unfolding, a potent combination.

We are committed to being at the forefront of this wave. iPod sales have topped 20 million units so far this year.

ITune actually hit its 500 millionth paid download with one of our tracks, Faith Hill's Mississippi Girl, and a dozen new devices and service alternatives are being launched later this year and next.

More than ever, I am comfortable saying that we are moving forward quickly and beginning to achieve our goals.

There is little doubt that we are effectively transitioning to a multi-faceted music base content company.

We are poised for a more dynamic future in an industry that is evolving rapidly and doing so increasingly in a positive direction.

Now I would like to turn this over to Michael to take you through the financials and we will open up the call to Q&A.

Thank you, Edgar, and good morning everyone.

This morning, we issued our earnings release for Warner Music's Group, the parent entity we recently took public in the trades on the New York Stock Exchange.

We will be issuing our Form 10-Q within the next couple of weeks.

Let me begin this morning by covering some of our key financial highlights.

First, as we mentioned last quarter, the savings from our restructuring program have largely been captured through our second fiscal quarter, making our third fiscal quarter more of an apples to apples comparison.

We have achieved our stated goal of $250 million in annualized cost savings.

During our third fiscal quarter, we also completed the sale of our print business to Alfred Publishing.

While print had a negligible impact on this quarter, last year's fourth quarter had a $9 million revenue contribution from print, which will affect our fourth quarter 2005 revenue comparison.

As expected, and previously disclosed, our fiscal third quarter had some unusual cost items we can aggregate, amounted to $135 million adjustment to our June 30, 2005 results, as well as $9 million in FAS 123 expenses.

Adjusting for these items, we generated an adjusted net loss of $35 million, or $0.27 per share.

Including all of the one time charges and FAS 123 expenses, our net loss for the fiscal quarter was $179 million, or $1.41 per share.

We have provided schedules reconciling our GAAP results for the adjusted numbers that I will be discussing today, which exclude the non-recurring charges and FAS 123 expenses.

The reconciliation schedules are detailed in our Press Release posted on our website and included in a form 8K filed today with the SEC.

The primary factors that contributed to the IPO related non-recurring charges were $73 million for the termination of a management agreement in connection with our IPO.

Certain cash payments to employees totaling $29 million, related to the issuents of stock awards, the low fair market value and payment of an IPO bonus to our employees, and $35 million resulting from the payment of redemption premiums and other charges in connection with the previously announced redemption of debt issued by our subsidiary WMG Holdings Corp.

We exclude these items in the discussion of our operating results, as these charges relate to specific one-time events, tied to the IPO, and do not reflect ongoing operations of the business.

There were also $9 million in FAS 123 expenses in the quarter, which we have excluded from the results we are discussing today.

Looking at the income statement for the 3 months ended June 30, 2005, we reported total revenue of $742 million, which rose 2 percent from the same period in [2005], and a 0.5 percent decline on a currency adjusted basis.

This quarter, U.S. revenues represent 49 percent and International was 51 percent of total revenue.

Generally, the European markets remain soft, and our digital growth is not yet outpacing physical decline internationally.

Though, as Edgar mentioned earlier, James Blunt was a powerful revenue generator for us internationally this quarter.

In contrast, our combined U.S. recorded music and publishing revenue was much more robust, up 10 percent for the 3 months ended June 30, compared to last year's comparable quarter, with $1.00 gain in digital, outstripping the physical business.

Digital revenues of $44 million, or 6 percent of total revenues contributed to our overall revenue increase.

Digital revenues rose 26 percent sequentially.

Managing the cost and investment balance wisely, our total adjusted operating income before depreciation and amortization, or EBIDTA, was $79 million, up 5 percent over last year's comparable period, driving a 30 basis point improvement in adjusted EBIDTA margin to 10.6 percent.

Our expenses were in line with our expectations for the quarter.

Excluding 1 time charges and FAS 123 expenses, our net income amounted to a loss of $35 million, a sizable year-over-year improvement from last year's loss of $82 million, adjusted on the same basis.

On the tax front, substantially all our cash income taxes are paid outside the U.S., because our U.S. taxable income is being offset by our interest expense and the annual recurring non-cash amortization deduction of approximately $100 million.

We are entitled to this deduction because we amortize and deduct for U.S. tax purposes ratably over a 15-year period, a substantial portion of the purchase price we paid to Time Warner.

In recorded music, same quarter revenue increased by 2 percent to $588 million, a 1 percent decline on a currency adjusted basis.

Favorite sellers in the U.S. were Rob Thomas, Mike Jones and Missy Elliott, while James Blunt, Green Day and Michael Buble were the top International sellers.

During the quarter, WMG had 5 new album releases and five new digital album releases that they viewed in the Top 10 in the U.S.

Recorded music, EBIDTA and operating income, excluding the non-recurring charges and FAS 123 expenses both had double digit gains, reflecting the benefit from the shift to digital and continued good cost management.

Recorded music, adjusted EBIDTA improved 11 percent to 73 million, while adjusted operating income rose more swiftly by 33 percent to 32 million.

These gains translated into a 1 percentage point improvement in recorded music's adjusted EBIDTA margin to 12.4 percent.

In comparison to the same period in 2004, music publishing revenue climbed by 5 percent to 161 million, or 3 percent when adjusted for currency.

Increases in synchronization and mechanical revenues were somewhat offset by declines in performance and other revenues.

Music publishing adjusted EBIDTA rose 7 percent to $30 million, compared to last year’s comparable quarter.

Music publishing adjusted EBIDTA margin improved to 18.6 compared to 18.3 last year.

We ended the quarter with a cash balance of $265 million, total net debt of approximately $2 billion, and a $250 million undrawn revolver.

As expected, we used our IPO net proceeds of $517 million, along with approximately $57 million of cash-on-hand to pay down 100 percent of our WMG Holdings Corp. floating rated notes and pick notes, and 35 percent of our WMG Holdings Corp. discount notes.

Our weighted average cost of debt dropped to an attractive 6.5 percent, as most of our highest yield debt was redeemed on June 15.

As previously disclosed, we intend to pay an annual $80 million dividend to shareholders on a quarterly basis.

As you know, we have chosen not to provide financial guidance to the investment community as a matter of policy.

Quarterly variations of the norm, given the rhythm of our music release schedule and our associated marketing and promotion cost.

Having said that, looking at the balance of our fiscal year, our expectations for the year remain unchanged.

We believe our operating momentum in the current fiscal fourth quarter should continue to be solid for many of the reasons we have described today.

I remain very optimistic about how Warner Music Group is positioned to leverage our unique content to seize the business opportunities in both the physical and digital worlds.

Thank you for your interest, and now, operator, we would like to open up the call for Q&A.

Thank you.

Our first question comes from Anthony Noto.

You may ask your question, and please state your firm’s name.

Goldman Sachs is our firm.

Edgar, I was wondering if you could comment, or Michael, on the digital sales growth, there was an increase of 26 percent.

I know you are not going to report that on a segmented basis, but I was wondering if you could give us a sense of the growth by type of digital music, whether it is ringtones, or full song downloads from Apple or other providers.

And as you are looking through the back half of the year, I know there are a fair number of new releases.

We have calculated that in the first half of the year there was an increase in the number of releases versus a year ago.

Will the same be true for the second half of the year, and then my third question is as it relates to catalog wholesale pricing, are you seeing any pressure there at retail?

Thanks.

Okay, Anthony, we'll try to take them in the order you gave to us.

On digital, we continue to see strong growth across all of the categories, both the ringtone side, the mobile side as well as full track download, on the online side, so I would not highlight one over the other.

As Edgar mentioned earlier, we have seen great strengths in the U.S. digital business, which is more focused on the full track download side, though international, there is a lot of new sites that have come online, so we are starting to see some pick up and continued investment there.

In terms of the number of releases, I think you'll see our number of releases this year being approximately flat with our number of releases last year on an overall basis.

I'm not sure about your calculations for the first half, but I think we are going to see a very similar number of releases in '05 versus '04.

And in terms of pricing, what we've seen as continued pressure for pricing, but we continue to see the same pattern of whatever price ammunition exists, exists at the retail level out of retailer margin, not out of our margins, and again, as has been true for other quarters, we see a slight firming of our own prices at the wholesale level.

Vijay Jayant you may ask your question, and please state your firm name.

Lehman Brothers is the firm.

I am just trying to reconcile some of the recorded music revenues.

You said ex-currency, recorded music was down 1 percent for the quarter.

Based on the Soundscan numbers, we estimate that recorded music, included digital was down about 4 and a half percent.

You said you gained about 1 percentage point of market share, but I am just hoping you can walk me through how you can get to minus 1 percent.

Did you take any reserve reversals?

Was there something extra from ADA or maybe some type of non-organic type of growth as an acquisition or something?

Edgar Bronfman, Jr: First of all, just to qualify the numbers, 1 percent is a global number ex-currency.

Soundscan that you are referring to, of course, is U.S.

In the U.S., the dichotomy was more dramatic, because while Soundscan was down on a physical basis, 7 percent, we were down only 3 percent, but our overall U.S. recorded music revenues showed growth.

I think there are a couple of important features here, Eric.

First of all, Soundscan is really good at tracking the physical business, but not yet really robust in tracking the digital business in terms of revenues, and I think there is still a lot of work to be done there in terms of having good market data.

But as we said, earlier, we saw tremendous growth in the U.S. in digital sales.

The other piece that is important to recognize, is that the Soundscan figures track actual product sold to the consumers.

Our revenues are obviously based on our shipment to the retailers.

And then lastly, there are some components of our business, as an example, DVD product, that is not captured in Soundscan.

As an example, the new Eagles DVD set, is not picked up anywhere in Soundscan, but is a substance of revenue generator for us.

Edgar Bronfman, Jr: And Eric, I think the only other thing I would add, just to clarify, there are no extraordinary items or reversals or other whatever you might come up with that adjusted our revenue.

The revenue is pure straight forward revenue.

We have seen no dramatic change in returns and have no dramatic changes in our reserves.

Doug Mitchelson, you may ask your question, and please state your Firm name.

Deutsche Bank.

When you look industry wide [inaudible..static on line]

We will move to the next question.

Michael Savner, you may ask your question, and please state your firm name.

Bank of America.

Michael, can you give us, just for housekeeping, can you give us a little bit more detail on the domestic versus international breakdown.

I think you gave it in aggregate, but if it is possible to get those metrics on a recorded versus publishing basis and also on an EBIDTA basis.

Secondly, can you talk a little bit about your agreements with the satellite radio companies and when they are coming up and your outlook for any economic changes there, and then lastly, will you comment potentially a Clapton and/or a Red Hot Chili Peppers album in the back half of this calendar year?

On the international domestic split, we are not providing that information at the recorded music or publishing level.

We are only providing the 49/51 split at the gross revenue levels.

What I will tell you is that as we head into our year-ending quarter, this quarter and think about our year-end call, we are going to look at some of the statistics that people have asked for, particularly domestic and international splits and digital splits, and try and provide a little greater breakdown at the end of the year numbers.

Edgar Bronfman, Jr: Michael, with regard to satellite radio, the agreement, which is an industry-wide agreement ends at the end of December of '06.

The agreement provides for a whole series of mechanisms that would potentially maintain the license fee of '06 in '07, while we renegotiate the prices, and then of course it would be retroactive, so I only make that mention as to when you are writing down when things might change, but we do expect to have a significant negotiation with the satellite radio industry in '06, and obviously we believe that that will lead to increased revenues for the music industry, but those negotiations have yet to begin, so it is difficult to predict how they will come out.

And I think the last question was having to do with our release schedule.

We have some great artists.

You named two of them, but we are not going to get into the specifics of when they will be released.

Could you refresh us on the thought process behind that, whether it is competitive, or if they can move?

Just a little background on why you are not you are disclosing certain artists, you know, your major artists when their albums are coming out?

Edgar Bronfman, Jr: Because I think it creates an unhealthy pressure on both the company and the artist when one does that.

What we've tried to suggest is that we release 500-1000 albums a year.

No one artist represents more than 2 percent of our revenues in any given year to sometimes 2.5.

It creates an undue pressure in a quarter, and we think it is just a bad habit to get into.

If we tell you that X artist is going to release in Q4 and that artist decides or we decide for whatever reason that we want that in Q1, we then have to reset expectations, we just think it is not a healthy way to run a music business, particularly as these major releases tend not to skew results over the period of a year, which is as you recall, how we ask you to look at our business.

Any given quarter can have an eschewed result, because of any given release and while it is accurate it may not be accurate as to our whole year.

This is a business, as I said, with so many releases, it is not like its own business, or some other kind of entertainment business which is so driven by a particular release, and we think it is a bad precedent.

Thank you for revisiting the issue.

Rich Greenfield, you may ask your question, and please state your firm name.

Rich Greenfield from Fulcrum Global Partners.

A few questions.

One, if you back out the percentage of joint ventures like Bad Boy or Maverick that you do not own 100 percent of, could you give us a sense of what your attributed revenues EBITDA and free cash flow were in the quarter?

And then, Michael, I think you mentioned that your cost savings have now accomplished all $250 million of them.

Did that mean that the remaining $48 million that was specified in last quarters Q, what achieved this quarter that you had in incremental pickup of $48 million in EBIDA?

And then lastly, you mentioned the foreign exchange benefit to revenues.

Could you give us some sense of that was for EBITDA?

Edgar Bronfman, Jr: Rich, let me do the first one, and then Michael can do the last two.

We do not break out our JV versus business we do not own.

I would not call Maverick a JV.

We own 80 percent of Maverick.

So I would say we basically own that business.

Bad Boy is a JV.

But I can say that both companies, while they are making progress, were negligible in terms of our results in either respect.

Rich, on the cost savings, as I said on the last quarter call, effectively all the cost savings initiatives were put into place at the beginning of Q3 last year.

As of the end of Q2, most of our cost savings had already run through the P&L.

As you do know, we have some cash payments still to make over the next couple of years on those cost savings initiatives.

But effectively, they are in the run rate at this point in time.

So, you can really look at Q3 when you compare it to Q3 of last year, as sort of an apples to apples comparison in terms of what the costs were last year and how they have changed this year.

The last question was on FX.

FX had a, we talked about the revenue pieces, it was a negligible impact at the earnings line.

Jessica Reif Cohen.

You may ask your question, and please state your Firm name.

Merryll Lynch.

A couple of questions.

Could you give the cash flow year-over-year for the quarter, also current share accounts, and finally, could you discuss the status of the [solicitor] investigation thing?

Edgar Bronfman, Jr: Why don’t I answer your solicitor question, and then Michael can give you the share terms and cash flow.

We obviously cannot comment on the solicitor investigation.

Obviously you read what Sony BMG did in their settlement.

We have complied with the 3 of the subpoenas that we have received from the Attorney General's office, and would also note that there have been no Warner Music group employees that have been interviewed or otherwise requested for individual information so far.

So we continue to cooperate fully with the AG's office, but cannot really comment any further.

Jessica, on the free cash flow, obviously everyone calculates it a little differently, but if you take the $79 million of adjusted EBIDTA and then think about cash taxes of $13 million, $6 million in CapEx that gives you $60 million of free cash flow, which is a 76 percent conversion rate on EBIDTA.

And then on the share count question, our weighted average share [indiscernible] 127 million and diluted are 131.4 million.

Can you give the end of the quarter share count and also free cash flow from last year?

I will probably have to get back to you on free cash flow from last year, and the share count number from last quarter as of July 26 was 148 million.

I am sorry.

Last year, adjusted EBIDTA was $95 million, $15 million in cash taxes, $8 million in Cap Ex, and therefore $72 million of free cash flow and 76 percent conversion rate.

Our next question comes from Bishop Cheen.

You may ask your question and please state your firm’s name.

The company is Wachovia Securities.

Just a couple of more questions.

Two billion and what on the debt at June 30?

Bishop, it was a total of $2.2 billion in debt and $265 million in cash, so you can use the same net debt calculations.

It is just shy of $2 billion.

Okay.

So it was really $2.2 even, was not 2.27 or any of that.

Yes, and we will obviously the ultimate decimal places in the Q.

And your Q is going to be filed you say in the next 10 days?

In the next couple of weeks, yes.

And margins have been very important because you can certainly do what you said you would do on cost-containment.

I know it is a lumpy business.

But are these margins pretty much the floor you would expect give or take, or do you expect to see margin expansion further on down the line, and if so, where?

Bishop, I think what we have said is that the business should run in the mid-[indiscernible] EBIDTA margins at a run-rate basis, obviously there are seasonal fluctuations to that.

We are running a little bit below that.

We expect to get there over the next year or so.

The margin expansion opportunity comes from the change in mix from physical to digital, because obviously digital without a physical product inventory and returns has higher margin characteristics.

Edgar Bronfman, Jr: In addition to just general growth, because as the business grows, either digitally or physically, we do not need to increase our fixed costs.

So to the extent that we see revenue growth, we will see margin expansion.

And last, on the emerging Euro and international downloading sites, you are talking right now in terms of monitoring and auditing these sites.

Do you feel the systems that are adapting are to be on par with the top U.S. sites?

Are they doing anything significantly different, and have you stipulated how you want the economics audited?

We certainly have stipulated how we want the economics audited.

I would say there really isn't enough data to understand the sort of differences between the U.S. and European sites.

It is still the early days.

Just to clarify to Jessica's earlier question, the numbers I gave, I was mistaken, were not Q3 last year, it was just Q2 of this year free cash flow.

We'll have to get back to people with the Q3 last year compare.

So the 95 you gave for last year?

And the 76 percent conversion, those are Q2 '05 figures.

Okay.

But we do have the right Q3, because you started with 79.

Correct.

So if we contact Jill, or if you could send out an email, that would be very helpful.

[OPERATOR INSTRUCTIONS] Our next question comes from [Erin Watts].

You may ask your question and please state your Firm name.

I am calling from Deutsch Bank.

I was just curious.

You signed on a lot of "superstar" music industry people.

You also had a lot of talent working for your prior to the IPO process and the buyout.

I was curious, how are those people working together, because often when you get a lot of big industry people together, there can be some friction, and how is that influencing as you spend more on A&R, how is that influencing artists in terms of wanting to sign up with Warner Music or helping you out in that way?

Edgar Bronfman, Jr: I am bias in that regard, but I have seen outstanding management work at Universal for a number of years, and I can tell you that the way in which people are working together at Warner Music is every bit, if not more so in terms of seamlessly, in a cooperative manner, as I have ever witnessed.

Warner Music had a great run in the 60's, 70's and 80's, with great divergent management groups at Warner, Atlantic, and Electra.

That's not the model we are following and I have to say the way the people have come together and the degree of cooperation both within recorded music and recorded music international and publishing and recorded music everywhere, is very exciting for us.

So we feel it is a very strong opportunity to continue this momentum.

And in terms of the artist and the management community, I think rather than telling you that Warner is an exciting destination, I believe it is, the proof is in the pudding, and we will just continue to deliver results, and you will see are market share continue to increase as we said it would, and it has begun, and it will continue to do so.

And that will be as a result of our ability to sign the artists that we should sign and be able to promote them in an appropriate manner.

So we are excited by this progress.

We believe it is real and sustainable

Operator, I believe we have time for one more question.

Your final question comes from [Tony Seed].

You may ask your question and please state your Firm name.

I'm from Imperial Investments.

Are there any sizable acquisitions on the horizon?

We do not discuss potential M&A activity or comment on rumors, so I think we will pass on the opportunity to discuss that, and why don't I again reiterate to everyone that this was, in my view, a really solid quarter, that really highlighted the potential for digital.

Cost base, we continue to manage while driving increased EBIDTA margins and we have very successful artists breaking both in the U.S. and internationally which will affect the strength of our A&R and our results going forward, and in short, we are, I think where we said we would be and where we want to be, and we believe the industry is evolving in a way that will be very positive for Warner Music as we go forward.

Thank you for your interest, thank you for participating, and we will be back next quarter.

Thank you.

This concludes today's conference call.

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