Warner Music Group Corp (WMG) 2005 Q4 法說會逐字稿

Welcome to Warner Music Group's fourth quarter and fiscal year ending September 30, 2005 earnings conference call.

At the request of Warner Music Group today's call is being recorded for replay purposes.

If you object you may disconnect at any time. [OPERATOR INSTRUCTIONS] Now I would like to turn the call over to your host, Ms. Jill Krutek, Senior Vice President, Investor Relations and Corporate Development, you may begin.

Thank you very much.

Good morning, everyone.

I'm delighted to introduce Warner Music Group Corp's fiscal fourth quarter and full year 2005 earnings call.

We released our earnings for the three months and full year ended September 30, this morning and we'll also be filing our Form 10-K today, a copy of which may be obtained on the SEC's website at www.sec.gov.

I'll read the Safe Harbor language before Edgar Bronfman Jr., our Chairman and CEO, shares with you our strategic update; and Michael Fleisher, EVP and CFO provides an analysis of fiscal fourth quarter and full year 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, expects, plans, intends, believes, 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.

Such statements include but are not limited to estimates of our future performance such as the success of future album sales and projected digital sales increases and gains in physical sales, expected expansion of the online marketplace and market share gains.

All forward-looking statements are made as of today, and we disclaim any duty to update such 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 variety of risks, uncertainties, and other factors that can cause actual results to differ materially from our expectations.

Information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in our earnings press release and Form 10-K and other SEC filings.

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

We have provided schedules reconciling our GAAP results to the adjusted numbers that will be discussed today, which exclude certain nonrecurring 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 are included in a Form 8-K filed today with the SEC which will be available on the SEC's website.

I also want to mention that as we announced, Edgar will be participating at both the UBS and CSFB conferences next week.

He will be doing a slide presentation at UBS on Monday and a Q&A session at CSFB on Tuesday, details are posted on our website.

With that let me turn it over to Edgar.

Thank you.

Thanks Jill, and welcome everyone.

Thank you for joining us.

We're capping off a very successful year for Warner Music Group, a year in which we've become a public company.

Over the course of the year we've made strong progress delivering on our strategic and financial goals.

We've experienced success with a number of new and established artists and have seen several important and favorable music industry developments.

I'm going to start by today describing our fourth quarter to you, then let Michael discuss the financial results, and I'll come back to outline a few of our goals for next year.

For the quarter there were four particularly significant items to note.

First, strong revenue growth in Recorded Music driven by continued digital momentum and impressive gains in the U.S. as well as gains in our U.S. and overseas physical group.

Second an expanding legitimate online business and continued success in antipiracy effort in the wake of the Supreme Courts unanimous Grokster decision in June.

Third, a strong music pipeline as our focus on A&R continues to show results both in mining established acts and developing new artists.

Fourth, Warner'Chappell, our Music Publishing division, has new leadership which is rapidly reenergizing that business.

Let me discuss each of these for a moment.

Warner Music Group achieved 13% worldwide revenue growth in our fourth quarter driven by continued strong digital momentum and an encouraging increase in our physical Recorded Music business globally.

In the U.S. our total Recorded Music business grew 22% over the fourth quarter of last year.

In the quarter we had total digital revenue of $53 million, up 20% sequentially and up over 300% from our fourth quarter of '04.

Digital revenue represented 6% of total Warner Music Group revenue for the fourth quarter.

We've experienced several encouraging achievements.

Our U.S. physical sales were up for the second consecutive quarter year-over-year.

In addition, in the fourth quarter we had physical gains year-over-year overseas as well.

Looking at the full year, our total revenue grew by 2% to $3.5 billion, led by the U.S. where we saw the gains in digital revenue from Recorded Music outpace marginal declines in our physical business.

As the scale of online penetration rises internationally, we believe we'll see similar growth opportunities to those we've begun to see in the U.S.

Warner Music's total digital revenue was $157 million, a more than four-fold increase year-over-year.

This is particularly important because we're taking a unique approach transforming music from a traditional records and songs based company into a music-based content company.

We are today at the very beginning of attempting to define the new consumer experience for digital music.

That experience is no longer just a song or an album but creative in innovative formats which we are at the early stages of exploring.

Digital offerings are likely to morph and develop over time as new business models are tested.

It is our goal to remain a leader in this new world for digital music which we believe will drive profitable growth.

For example we've been leading the industry in the evolution of premium priced digital album bundles.

These bundles contain album only bonus content such as music videos, liner notes, lyrics, bonus tracks, arts, interviews, concert tickets, and behind the scenes footage.

The premium bundles have a retail price anywhere from 20 to 80% higher than the standard 9.99 digital album.

This is one way we are monetizing our extraordinary content library and it's proving to be very effective.

For the bundles we've offered since June almost all have seen a dramatic rise in the number of album purchases versus single track purchases.

On the physical side of the Recorded Music business Warner continues to outperform the industry and grow our margin share which we define as profitable market share.

As we talk about total album sales, we include both front line, or albums released in the last 18 months, and catalog, albums released over 18 months ago.

Looking at our nine-month calendar results for 2005 over the same prior year period, our front line album sales were flat compared to an industry that was down 9%.

For the year-over-year September quarter results our strong performance is much more pronounced, underscoring our successful A&R efforts and continued investments with Warner music front line albums growing 9% and the industry's declining 10%.

Catalog results are a bit weaker but still outpaced the industry on a nine-month calendar basis with WMG down 4% and the industry down 5.

Taken together, Warner Music Group's fourth fiscal quarter SoundScan album share rose 1.9 percentage points to 18.2 compared to 16.3% in last year's comparable quarter.

One of our key strategies we've outlined for you in the past is our goal to energize our urban business with a growing roster of high performing artists.

Jumps in our R&B and rap shares are a clear result or these efforts.

For example, our R&B and rap SoundScan shares rose by 4 and 6 share points to 13 and 16% respectively for the nine calendar months year to date over the same period last year.

In our fourth fiscal quarter our rap share actually surged from 7 to 20% as compared to our fourth quarter of '04 thanks to a handful of urban artist success stories including Mike Jones and Paul wall.

Next there have been several favorable industry developments related to the growth of the legitimate online business in the wake of the Supreme Court unanimous Supreme Court Grokster decision in June.

We believe we're going to see a significant legitimization of the peer to peer industry.

In fact a legitimate online music business has been expanding since the Grokster ruling with an estimated two million tracks now available for download on over 300 legal sites around the world.

Next, in the area of A&R, we continue to make significant investments in order to build a strong pipeline of music across the country and expand our world renowned artists -- of writers and artists and recordings in order to create superstars of tomorrow.

As we've highlighted on previous calls and during our IPO road show our Atlantic revitalization is gaining traction.

After the careful restructuring of our Atlantic label quarterly U.S. revenue at that label rose more than 50% over the comparable quarter last year.

We had more than doubled the artist releases in this year's fourth quarter with one-third of the increase coming from new artists, driving significantly improved chart position.

The progress at Atlantic complements the continued robust performance at our Warner Brothers label which saw U.S. revenue rise more than 25% in the quarter and in the low teens for the full year compared to the comparable prior year results.

We have focused our A&R attention on two key areas.

The traditional A&R of superstar artists on one hand, and promising new artists on the other, as well as innovative ways to develop and execute our A&R strategy to take advantage of changing conditions in the music industry.

Regarding traditional A&R introducing established global acts like Warner Brothers' Green Day and Madonna to new audiences is one of our hallmarks.

For example, we have had an artist relationship with Green Day for more than a decade with seven album releases.

Their top selling "American Idiot" album which was released over one year ago has sold over 10.5 million units to date, is still going strong, with 20% of this year's units sold in our September quarter.

To further extend the Green Day phenomenon on November 15, we released "Bullet in a Bible", a Green Day live CD plus DVD.

Similarly this quarter Warner Brothers engineered a unique trendsetting promotional approach for Madonna's newest album, "Confessions on a Dance Floor".

By staging, or windowing, the albums release in order to build strong demand for this iconic artist.

We kicked off the promotional activity in Europe given Madonna's large fan base overseas with an exclusive prerelease of a mobile ring tone of her first single, "Hung Up", which was followed one month later by the release of the song to radio.

Shortly after that we offered a prerelease album bundle for Madonna on iTunes with a download of "Hung Up" at the time of order along with a video for $12.99.

Music fans could preorder the album on iTunes four weeks prior to the album's street date and immediately get her single with the remaining album trucks plus bonus content available on street date, November 15t.

With this album Madonna has become the first artist to have a simultaneous number one hit across Europe in every music format.

Single, album, digital single, digital album, and mobile phone ring tone, a testament to our new media leadership.

Furthermore, in addition to debuting at the number one spot on Billboard's top 200 chart, "Confessions on a Dance Floor" held three of the top four best selling album slots on iTunes reported last week with her bundled version, her remixed version, and the unbundled version of the same album.

On the new artist side, we are particularly proud of the performance of our Asylum and East West incubator initiatives.

These are designed to identify future superstars earlier in the A&R process and at lower cost by leveraging our strong and industry leading independent distribution network.

Through that system we have upstreamed five urban and three rock artists, four of whom who have debuted in the top 10 on Billboards top 200 chart.

We also recently launched Cordless, a new E-label designed to discover and develop new recording artists by releasing songs using the latest digital strategies and online and mobile technologies.

Beyond these innovative A&R approaches successful beginnings for new artists through more traditional A&R are also taking shape across the Company.

James Blunt, an artist we discussed on our last call, is a young British born rock artist who we nurtured by returning to grass-roots artist development with an eye to long-term career advancement.

This year James won best new act at the MTV Europe music awards held in November and will almost certainly be the top selling U.K. artist of the year.

Now we are beginning his U.S. launch which is also designed to maximize his long-term career potential.

To conclude let me turn to Warner/Chappell, our Music Publishing business.

Publishing is a stable, highly profitable, diversified business that is an essential component of our success and our value.

We have established new leadership at Warner/Chappell with the appointment of Richard Blackstone as Chairman and CEO, mining and building our publishing catalog will be one of our top priorities.

Today I can say with confidence that we are quickly becoming more effective in our publishing A&R efforts.

In addition deriving publishing revenue stream from existing and new Warner Music Group recorded music artist will remain central to our strategy.

Even since Richard arrived in May we have signed the publishing rights to several of Warner Music Group's label artists including TI, Mike Jones, Paul Wall, Nana from Germany, and Paulo from the U.K. , just to mention a few.

We have also expanded or extended deals with some of our hit artists like Dr. Dre, Morrissey, Staind, and The Strokes.

As evidenced by the numbers we reported this morning our artist roster for both writers and recording artists is strengthening just as the digital opportunity is unfolding.

We believe this is a potentially potent combination.

Now I would like to turn this over to Michael to take you through the financials, then I'll return to give you some concluding remarks before Q&A.

Michael.

Thank you, Edgar, and good morning, everyone.

This morning we issued our earnings release for Warner Music Group Corp, the parent entity we recently took public and that trades under the New York Stock Exchange.

We will be filing our Form 10-K today and have included consolidated balance sheet and cash flow information in our press release.

With this quarter now complete we have presented eight quarters of financial information on a comparable basis.

I'm really proud of the progress we have made with our disclosure and timing of our public filings.

As we have been working hard to bring you the most complete and transparent information on a timely basis.

This quarter, we are almost a full month ahead of our SEC deadline.

I'm also really proud that our 10-K doesn't include the same material weakness language of our previous filings, as we have successfully cleared one of our two material weaknesses.

We've built a strong finance team and come a long way in providing timely information with increased disclosure.

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

First as we mentioned last quarter, our restructuring program is complete and we achieved our stated goal of approximately 250 million in annualized cost savings.

In October, we announced a $31 million charge related to the restructuring of Lava and the departure of one of its executives.

Approximately 20 million of this charge was noncash.

In November we reached a $5 million settlement with the New York State Attorney General relating to an industry wide investigation into the promotion relationship between record companies and radio stations.

This has a $4 million one-time impact in this quarter as we had accrued $1 million reserve in the third quarter.

Excluding the impact of the Lava restructuring, the Spitzer settlement charge, and $7 million in quarterly noncash FAS 123 expenses, we generated quarterly adjusted net income of $12 million or $0.08 per diluted share.

For our full year 2005, excluding these and other nonrecurring items in FAS 123 expenses, our adjusted net income was 32 million, or $0.25 per diluted share.

We have provided schedules reconciling our GAAP results to the adjusted numbers that I will be discussing today.

The reconciliation schedules are detailed in our press release, posted on our website, and included in our Form 8-K filed today with the SEC.

Looking at the income statement for the three months ended September 30, 2005, we reported revenue of 905 million which rose 13% from the same period in 2004, and increased 12% on a constant currency base.

We exhibited strength in both the U.S. and international markets.

Revenue rose 17% in the U.S. and 11% internationally on an as-reported basis, and 9% internationally on a constant currency basis.

As Edgar mentioned, this performance is being driven by global strength in both our physical and digital business.

Europe has picked up momentum for us in the Recorded Music business with mid-single-digit revenue gains on a constant currency basis.

While we had double-digit gains in each of our other major regions.

North America, Latin America, and Asia Pacific.

For our full fiscal year 2005 our revenue grew 2% to 3.5 billion with modest gains from both Recorded Music and Music Publishing.

Annual revenue was down 1% on a constant currency basis.

The U.S. was up 4% while international was largely flat but down 5% on a constant currency basis.

Top sellers for the full year were Green Day, Linkin Park/Jay-Z, Michael Bubble, James Blunt. and Simple Plan.

Worldwide we had 17 releases that sold more than 1 million units this fiscal year versus 15 last year, and 30 releases that sold between 500,000 and 1 million units this year, double last year's level.

On a full fiscal year basis in the U.S., we saw gains in our digital business more than offset modest declines in our physical business, driving overall growth.

For the full fiscal year our digital revenue grew more than four-fold to 157 million from 36 million last year.

The domestic/international split for our digital business currently stands at 73% versus 27%.

Highlighting the fact that the U.S. digital business is the most developed in the world.

Quarterly digital revenue of 53 million or 6% of total revenue contributed to our overall revenue increase and was a 20% sequential rise from the third quarter.

Managing the cost and investment balance wisely our total operating income before depreciation and amortization, or OIBDA, adjusted for nonrecurring items and FAS 123 expenses for this quarter was 119 million, up 29% over last year's comparable period, driving a 1.6 percentage point improvement in adjusted OIBDA margin to 13.1%.

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

For the full fiscal year our margin expansion was even more pronounced.

Adjusted OIBDA was up 31% to 491 million, generating a 3.1 percentage point improvement in our margin to 14%.

Switching to Recorded Music, our fourth quarter Recorded Music revenue increased by 17% to 775 million, or 16% on a constant currency basis over last year.

The U.S. was among our strongest territories with more than 20% revenue growth.

Digital revenue grew 20% sequentially from the third quarter to 6% of total Recorded Music revenue.

Major sellers for the fourth quarter were James Blunt, Faith Hill, Green Day, Eric Clapton, Sean Paul, Disturbed, and Staind.

During the quarter WMG had 11 new album release and 11 new digital album releases that debuted in their respective top ten in the U.S.

Quarterly Recorded Music OIBDA, excluding nonrecurring charges and FAS 123 expenses, had double-digit gains reflecting the benefit from the shift to digital and our cost savings initiatives.

Recorded Music adjusted OIBDA improved 72%, to 103 million.

These gains translated into a 4.2 percentage point improvement in Recorded Music adjusted OIBDA margins to 13.3%.

Full fiscal year Recorded Music adjusted OIBDA margins expanded more than 5 percentage points to 15.3% compared to last year.

Highlighting digital gains in our previous restructuring efforts.

In the Music Publishing business, on May 31, during our third quarter, we completed the sale of our sheet music business to Alford Publishing.

The sheet music business contributed 9 million to fourth quarter 2004 Music Publishing revenue which we exclude from our discussion of the continuing operations of our Music Publishing business.

In comparison to the same quarterly period in 2004, and on a continuing operations basis, Music Publishing revenue climbed by 5% to 137 million, or flat on a constant currency basis.

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

The declines in mechanical revenue partially reflect the timing of our Music Publishing A&R investments and prior year Recorded Music industry declines as this revenue is booked on a cash basis.

Music Publishing adjusted OIBDA declined 2 million to 43 million compared to last year's comparable quarter.

Music Publishing adjusted OIBDA margin was relatively flat at 31%.

We ended the quarter with a cash balance of 288 million, total net debt of approximately 1.9 billion, and a $250 million undrawn revolver.

Our weighted average cost of debt was an attractive 6.6% as most of our highest yield debt was redeemed on June 15.

As previously disclosed, we announced our first dividend of $0.13 per share which was paid on November 23, giving us a very attractive yield of 3% based on yesterday's close.

We maintain our intention to pay up to an $80 million annual dividend on a quarterly basis.

For the year, we generated free cash flow of 151 million, calculated by taking cash from operations, less capital expenditures of 30 million, and cash paid for investments of 24 million.

Our unlevered after-tax cash flow, excluding nonrecurring expenses, which we believe to provide a more accurate reflection of the ongoing cash generation capability of our business, was $410 million, resulting in an adjusted OIBDA conversion of 84%.

Unlevered after-tax cash flow excluding nonrecurring expenses is calculated by adding back 151 million in cash interests as well as nonrecurring cash payments of 108 million.

A full reconciliation schedule is provided in our press release.

On the tax front our cash taxes were 15 million for the quarter and 51 million for the year.

Substantially all of our income taxes are being paid outside the U.S. because our U.S. taxable income is being offset by our interest expense deduction and the annual recurring noncash amortization deduction of approximately $100 million.

We're entitled to this deduction because we can amortize and deduct for U.S. tax purposes ratably over the next 15 years a substantial portion of the purchase price we pay to Time Warner.

At September 30, 2005, we have a substantial tax carryover amount in the U.S. resulting from net operating losses and foreign tax credit carryovers.

This tax carryover will be available to reduce our U.S. taxable income and U.S. cash taxes in future years.

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

Quarterly variations are the norm, given the rhythm of our music release schedule and our associated marketing and promotion costs, which is why we believe our annual performance is the best indicator of our success.

We are very pleased with the strength we exhibited in the fiscal fourth quarter.

However, as we mentioned, the Atlantic revitalization was expected to drive a big finish to the year.

The swell of new product launched is a bit of an anomaly given our efforts to get many new artists off the ground as we rebuild the Atlantic roster.

Further, looking at recent exciting releases like Madonna and Enya it's easy to get carried away with expectations.

We caution you not to overestimate the impact of these releases to our overall performance, especially since releases of this sort usually come with heavy promotional expenses in an effort to drive multiplatinum sales for our 2006 fiscal year.

Also, last year's fourth quarter was very strong -- I'm sorry, last year's first quarter was very strong with six platinum releases including Green Day and Linkin Park/Jay-Z at around 3 million units each as well as the Ray Charles phenomenon.

I'm encouraged by our strong finish to the fiscal year and remain very optimistic about our ability to leverage our unique content to seize the business opportunities in both the physical and digital worlds.

Thank you, and now Edgar would like to make some concluding remarks before we take your questions.

Thanks Michael.

So looking back over the last year as I said we've made strong progress and I'm pleased to see much of that progress evidenced by the numbers we've posted today for our quarter and for the full year.

I'm proud of the fact as part of our ongoing commitment to growing shareholder value we set out this year to accomplish four major goals and we delivered on them including rebuilding Atlantic records, reducing our absolute costs and continued vigilance of that improved cost structure, building a world-class management team, and improving our roster of high performing artists.

Looking to next year we have established a new set of objectives that will continue our drive to deliver value to our shareholders by transforming Warner Music Group into a different face content company.

For '06 our important goals include growing our urban and country rosters while continuing to build the best overall stable of artists across all genres, enlarging our global footprint and related content as we continue to create and expand the new digital experience for consumers.

Driving from margin share more profitable market share gains that only come with carefully managed rosters and artist development and restoring growth to our publishing business.

Before opening the call for Q&A I just want to mention that we're thrilled that Shelby Bonnie, Chairman and CEO of CNET Networks, has joined our Warner Music Group's Board and audit committee as our second Independent Director.

Shelby's addition will help ensure that the Board continues to have the appropriate mix of skills, professional experience, and diversity of backgrounds to lead our company and provide strong oversight.

Thanks for taking the time to listen to us, and we look forward to taking your questions.

Operator, we can start the Q&A now.

Thank you. [OPERATOR INSTRUCTIONS] Our first question is coming from Anthony Noto.

Please state your company name.

Goldman Sachs.

Good morning Edgar and Michael.

When you all went public we started out with a thesis that the growth in digital and the new formats and distribution channels could offset the declines in physical, and in the last two quarters you've been able to grow both of those revenue streams, I was wondering do you think that is something that can continue and it's a direct result of your specific strategy, or do you think that could actually also happen for the industry?

Then the second question is, how far do you think we are from variable pricing on digital downloads, and do you think you would actually gain share of dollars in digital if that were to occur, based on what you're currently doing in units and based on the roster that you have?

Thank you.

Anthony, it's Edgar.

I think we should talk about Warner Music and not the industry.

It's difficult to know, and clearly our performance this year has been stronger than some and weaker than others but it's been a very strong performance for Warner Music and we're very pleased to be able to deliver it.

Clearly in the U.S. our digital revenue growth has offset the marginal declines in our physical business for two quarters, and we do see increased penetration in international.

Also, we see some anecdotal evidence of that strength continuing, or continuing to grow, for instance, in Scandinavia, which admittedly is a very small overall market, sales of Madonna's "Hung Up" full-track downloads on the mobile platforms outsold its physical sales.

This is the first time we've seen that phenomenon.

Of course, Scandinavia is a very forward mobile market.

So as we look out over the future, and that's not an indication of the next quarter or the next two or three or four quarters, but certainly as we look to the future we remain optimistic about the ability of the digital platform to penetrate and to allow us to grow our overall revenue.

I think in terms of variable pricing potential, we are -- we're -- we believe that it makes sense for the music industry to have the opportunity to price its artists and its content at different levels.

We obviously need to discuss this in detail with our digital service provider partners.

We think it makes sense for both, but beyond that, until we have those discussions we can't predict the outcome.

Michael, one quick follow-up for you.

Thank you, Edgar.

I know that you mentioned that your expenses were in line with expectations with where your revenue came in, but I was wondering, did the amount of money you spend increase proportionally with the amount of revenue upside that you had, and therefore you spent more because you had the upside in revenue, or was your absolute level in line with what you thought?

Our absolute level was pretty much in line with what we thought.

Thank you.

And our next question comes from Eric Handler.

Please state your company name.

Lehman Brothers.

Two questions.

When you look at your physical 2006 slate how do you figure that compares right now versus what you put out in 2005, and based on that, do you think, at this point would you expect to see top-line revenue growth on a year-over-year basis, and then also, could you just comment, as far as digital music, where is the majority of that growth coming from right now relative to digital downloading and mobile?

Thanks, Eric.

It's Michael.

We're working very hard not to give guidance.

We think that we've got a great slate of artists and releases for '06, like we had in '05, and as I said in my comments, I caution people because we don't try and line up the quarters for year on year comparisons.

So we release whatever artists are sort of ready and appropriate to be released based on the creative side and when that music is ready to go, and also when the market is ready to accept it based on what we see happening at radio.

But obviously feel real good about the new artists that we've built in '05 and the artists we released in '05 and the roster for '06 as well.

Just to give you a couple of breakdowns, digital versus mobile, or track downloads versus mobile--.

most of the growth we've seen is coming in the U.S. and is coming more from the download side, though we actually saw very strong ring tone and digital generated in the U.S. as well.

So I think most people think about those markets as being sort of Europe being mobile centric and the U.S. being download centric.

That hasn't changed, but I will say that we saw in particular in the urban side of our business very strong ring tone sales in the U.S. in the fourth quarter.

And just to give you an international breakdown, digital revenues are approximately, I think, 72% U.S., 27 or 8% international.

So roundly, three-quarters/one quarter domestic to international, and we do expect the international business to grow.

Thank you.

Thanks, Eric.

Our next question comes from Doug Mitchelson.

Deutsche Bank.

Two questions, but actually, based on what you just said does that imply that perhaps urban is going to be a more profitable line of business for you?

But the two questions I had was, you obviously had fantastic margin expansion this past year.

Where do you think the ultimate margins will settle out for your recorded and publishing businesses?

And then also, now that you've proven you can build a healthy release slate and control costs, the question is what do you do with the cash, if my math is right you'll have over 100 million of available free cash flow in 2006 after paying your dividends so if you give us some sense on your cash strategy, that would be helpful as well, thanks.

Sure.

I think on the urban side, I think urban is a profitable business today.

It's a different business, and we are seeing huge success on the digital side in urban on the ring tone side of digital.

Probably a little less so on the download side, but I think more work to be done there and I think the consumer segmentation and consumer demographics are really just beginning to be understood in this new digital world.

On your question about margins, I think with what we have said and continue to say is that we think this is a mid-teens OIBDA margin business in the near term.

Obviously we're delivering at or close to that at this point, and we'll continue to work to improve that.

But I think that's probably the most guidance we want to give on the margin side of the business.

In terms of our cash, job number one is to pay our $80 million a year dividend.

Job number two is to continue to invest our cash in our business to generate a return for our shareholders.

Obviously that investment is in primarily artists and to the extent opportunities for acquisitions of either businesses or catalogs that are accretive to our business, we look at those as well.

And then, lastly, to the extent that we can't put that capital to work in a way that makes good sense, we will find the right ways to deploy it back to our shareholders, whether that be dividend, stock buybacks, or whatever is the most efficient way to return capital to our shareholders.

Great.

Thank you.

Thanks, Eric, I mean Doug.

Our next question comes from Michael Sayner, please state your company name.

Banc of America.

Couple quick questions.

If you can go into a little bit more detail on your digital album strategy, Madonna being a good example but we noticed some instances where the scaled down basic version of the album wasn't available at a couple different times.

I'm wondering if your strategy going forward could be to shy away from the basic album and only sell the premium product, or you continue to kind of give consumers a choice offer to either one, and then digital as a percentage of total sales.

Obviously this quarter we didn't see a big upside to the contribution to total sales but that was probably partly related, or mostly related to the upside in physical, so looking out now in your physical market seems to be stabilizing somewhat, have you changed your expectations about where digital goes as a percentage of revenue, or do you still assume that within a matter of three to five years this can be a 20% of your top line?

Thanks very much.

Sure.

Let me try and tackle the second question first.

I think the overall percentage of revenues remained constant, much more due to the fact that, I mean, essentially due to the fact that we had very strong physical growth in the quarter.

We also had very strong digital growth in the quarter.

So we expect the overall percentage of revenue derived from digital to continue to expand and more or less at the rates that we've discussed in the past.

In terms of the album bundles, we've taken both approaches to having the sort of normal album and the enhanced or premium version of the album available.

In some cases, we've had one only, in other cases we've had both, and it's really a very artist by artist specific decision in terms of what we think those artists want to do, what their fans want to have, and so we'll be making sort of artist by artist decisions.

It is interesting to all of us that in the case of Madonna, the premium version of her album outsold the normal version of her album.

So in terms of the 12.99 download was more popular to the early Madonna fans than the $9.99 version.

We don't know that that's predictive as a general rule, but it was encouraging for us in the case of Madonna.

Edgar, just to follow up on the first part of the question was there any change to the wholesale pricing in physical units during the quarter or anything this holiday season that might have helped spur growth?

No, no changes from what we've seen over the last year.

Great, thank you very much.

Our next question comes from Bishop Cheen.

My company name is Wachovia.

Thanks for taking the call.

Edgar, Michael, and Jill, let me just go to balance sheet management, since you've done such a great job on the operations for the color.

You stated that whatever money is from free cash flow is left over that you don't invest in catalogs or strategic businesses, you would look for equity enhancements.

Does that mean, should we infer that you think you can do better for your stock with buybacks and dividends than for reducing your debt load and your leverage?

Bishop, I think it's an iterative question that you always have to look at the point in time.

Right now, with a 6.6% average cost of debt we feel like that's a pretty good rate and creates good leverage, is a good return for our debt holders and creates good leverage for our equity shareholders.

So any time we have excess capital we have got to look at both pieces of the balance sheet, and then figure out where we think is the sort of greatest return for all of our constituents, but obviously at a 6.6% cost of debt, that's a good place to be right now, and we're not the least bit uncomfortable with our leverage of -- with our level of leverage based on the performance of our business.

Fair answer.

Just one follow-up.

When you've -- did the IPO, one of your initial goals was to cut down on excess releases, focus on the quality of releases.

Could you just give us kind of range on what you think a more normalized '06 release -- number of releases should be?

Bishop, I don't think we had an untoward number of releases in '05.

I think we had an untoward number of releases in the fourth quarter of '05.

And remember what Michael said.

We are not managing to quarters.

We're managing to artists and market.

So I think if you look over the entire '05 year, we had a reasonable number of releases.

I expect we will have a similar number of releases over the '06 year.

There may or may not be bulges in any of our quarters, simply depending on when artists are ready and when markets are ready to receive.

What -- can you share with us the number, the '05 number of total releases the way you keep score?

We haven't done that.

Thank you.

Thanks, Bishop.

Our next question comes from Marc Sugarman, and please state your company name.

It's Citigroup.

I've got two questions.

The first is over the next 18 months or so most every regulated contract that the music industry has with webcast comes up for renewal and I think the first one is webcasting.

Can you give us a sense of what you would expect broadly from those contracts?

Should we be looking I think for webcasting the industry gets paid something like [0.07 cents] per song that's listened to on Internet radio.

Can you give us a sense of what sort of percentage uplift you would hope to see as some of those mediums gain traction with their own audiences?

Then the second question, I couldn't quite hear exactly what you said the number of operating cash flow was for '05.

I think it was about 410 million.

Can you give us a sense of what the working capital year on year change was within that number?

Thanks.

Sure, I'll ask Michael to answer your second question, Marc, but the -- the answer to the first question is that there are a number of different contracts coming up over the next 18 months, as you point out.

Some of those are industry based contracts, such as webcasting and satellite radio.

Others are individually negotiated such as some of the digital service provider contracts.

And I think it would be unwise for us to predict how those negotiations will unfold.

So I think I just, unfortunately, can't -- I can't answer your question both because we don't know the answer, and secondly, because any prospective would be really merely speculation at this point.

Can I follow-up on that then?

Is your sense on discussions that you've had with some of the outreach raters, are they going to look at the commercial success of some of the platforms or are they sort of considering the models, or relative to historic arbitrators here in the U.S.?

At this point we have not had discussions with arbitrators.

We are really at the early stages of industry discussions with some of the people to whom you refer, like webcasters and satellite radio.

But we have not had direct discussions with arbitrators.

And again, I don't know what they'll take into account should negotiations break down and should they become involved in the procedure.

Marc, to your question on working capital this quarter working capital was a small use of cash.

As we've talked in the past, as our business grows, our accounts receivable and our payables grow relatively in lock-step.

And so generally this business isn't a big user of cash on the working capital line.

There is some seasonality to that obviously as we build towards the holiday period, and we're putting more product out to our customers, our working capital becomes a use of cash, then it reverses, or tends to reverse early in the calendar year.

And for the full year can you give us a sense of what the working capital should be?

I think for the full year, you know, we're -- again, there was a sort of a slight positive impact to the working capital.

But again, not a huge use or source of cash either way.

Thanks very much.

Our next question comes from P.J.

McNealy, and please state your company name.

American Technology Research.

Good morning.

Just a clarification on digital on the question.

When you look at digital, is there an element of seasonality in the digital mix?

For example, slowness in the services over the summer and perhaps stronger holiday mix with digital because of the new devices in the market, and then just one question on share gain.

It seems like it's a bit of an unusual quarter.

Do you think you can continue to take share, and what's a reasonable target for share gain going forward?

Thanks.

On the second question, it is our expectation to continue to grow our margin share, and we want to make that distinct from market share because we are very focused on profitable share, and we don't want to chase share just by throwing out releases that either are returned to us in a subsequent quarter or which are unprofitable by he nature of their contract and details.

So we are focused, but we do believe that the progress we've made will result in year-over-year margin share expansion.

P.J., on the question of seasonality and digital, the short answer it's too early in this marketplace to tell.

There are -- we're starting to see some patterns.

I'm actually very interested to see the calendar fourth quarter holiday pattern, because I think you're going to see a lot of gift card buying on digital, and maybe less digital purchasing.

You also have a huge number of digital devices that will all go on line in the last few days of the calendar fourth quarter.

So I think we're going to see some seasonality, and there's going to be a pattern to it, and my best guess is it'll be different than the physical product pattern, and I think we'll learn a lot more about that over the coming 12 months.

Great, thank you.

Our next question comes from Richard Greenfield.

Please state your company name.

Hi, Rich Greenfield, Fulcrum Global Partners.

First question is, when you look at digital, you spoke to a full year number of 157 million.

If you were to leave off downloads and ring tones and the small bit of subscription how much would really fall into that content category of revenues you get from things like webcasting and satellite radio, et cetera, and so once you get that number how do you think about where that number could grow over the next couple of years?

Is that a number that you see as kind of doubling in'06 and '07, or just what is even the base level of that number starting with?

Second, a question specifically for Michael, you mentioned that the 103 million of OIBDA in the quarter was versus 60 million last year.

You said cost savings and digital were really the two drivers of that.

How much of that actual 43 million increase was cost savings driven?

Thanks.

I think, Rich to your first question--.

Rich, I think, first of all, we haven't broken it out in that way, but I can tell you that the two that you specifically mentioned, webcasters and satellite, remain a relatively modest part of our overall digital revenue pie, but as Marc pointed out, those contracts will be renegotiated, so I think over time, we will expect those businesses to be a more important part of our businesses as well.

But to try and speculate how fast they'll grow, at what rate they'll grow, or how dramatic those increases will be, I think at this point would be purely speculation.

Even the satellite radio broadcasters have said they expect to pay more in the future for their music content than they're currently paying, but obviously they'll be in negotiation as to what that increase is.

So I think we understand there will be some increase.

We don't know what the size, the pace, or the scope of those increases will be.

What if you threw music videos into the number, does that alter that very minimal number of on-line music videos?

Rich, I don't think we should get into sort of trying to piecemeal every single revenue stream out on this call.

This is a very nascent business, and video with the introduction of the video iPod, the strength that Yahoo! is getting, the increased 3G platforms across the world, video is going to be an increasingly important part of our digital revenue stream.

But again, the entire digital business, in my view, is extremely nascent today, and video is even younger than most of the other forms of that that revenue takes.

Rich on our continued good performance on the OIBDA side, it is coming from both those sources.

We're not detailing out a split.

As I've said before, most of the cost savings from our big initiative over a year ago are now in the year-over-year compare, so they're sort of apples to apples comparisons, though we obviously continue to manage and scrutinize our costs very closely every day.

At the same time, with digital at 6% of revenues, and it being a more profitable stream, it is starting to contribute to our profitability, and as it grows it will hopefully continue to do so.

Thank you.

Our next question comes from Jessica Reif Cohen.

Please state your company name.

Thank you.

Merrill Lynch.

Couple of questions.

Were there any reserves that were reversed in the quarter?

And I wanted to get back to the expense question.

It looks like your revenue beat the Street by at least 100 million.

You beat ours by like 130 something.

And the cash flow was slightly above Street estimate, 6 million above ours.

Just wondering what was in the expenses in this quarter?

Were there a lot of JVs?

And then finally, on urban music, could you tell us how catalog sales would differ from other genres?

Jessica, why don't I do the urban first, which is just to say that urban has historically differed from, if I get your question correctly, differed from other genres in that it has been made up largely of joint ventures, so that the margin on the urban business has generally been historically a lower margin business.

We are, for the most part, for the overwhelming part, not managing our urban business in that manner.

So that our urban revenues -- we expect will be more profitable than the general industry urban revenue.

That's not to say we'll never do a joint venture or have never done a joint venture, but as a general rule we expect our urban revenues to carry a higher margin than the general genre does throughout the industry.

Jessica, on your question about the -- we haven't reversed any reserves.

The only thing that happened in the quarter is that we reserved $1 million in the third quarter for the Spitzer settlement, which is why there's only a $4 million nonrecurring charge for it this quarter even though the settlement was for 5 million.

On the cash flow question, we did have strong revenue performance, the cash flow, though, is subject to a set of timing that is often not tied to the revenue performance, because one of the big places where our cash is going in and out the door is related to advances to artists.

So as you think about a big release schedule in the fourth quarter and then a handful of major releases, you can see some advances going out to artists over the last quarter or so, that would be, in effect, cash going out the door in advance of those releases, and in advance of the revenue being generated.

So nothing from our perspective that's sort of odd or unusual in the pattern of our cash flow related to the pattern of our revenue.

Why was the advances to artists the same for current as well as long term?

It's exactly the same number.

That's -- as we've described in the past, the way we do that and the accounting treatment for that is that we take the total amount, we split it in two, and so that's why the number's always the say.

It's always been the same if you look at all of the historical balance sheets as well.

Operator is there any more questions?

Yes, our next question comes from Mike Clairefield.

Please state your company name.

Hi.

High Grove Partners.

Just a quick question, I know it's early in the business model for the subscription model online, or digital subscription model.

I was wondering what you guys are seeing there, what your expectations are?

Thanks.

Well, it's Edgar, we're quite hopeful about the subscription business.

As I said, we thought the download business would take off faster first, which it has, because people need to understand for a subscription business some sense of how much they consume and why a subscription is a better outcome for them than simply an a la carte approach, but we think people are fast becoming interested in the subscription model.

We see subscription numbers growing at a number of the digital service providers.

We, of course, as we've said, are indifferent from a margin sense to the download model or the subscription model, and we see the subscription model gaining traction and we think it will continue to gain traction over time.

Are there any handicaps that you see that have been -- or impediments that have been holding you back, and what are sort of the technological or just -- yes, I guess the technological hurdles that have to be overcome in your mind before that really takes off?

What are you guys watching for?

I think the only thing that would be retarding the progress of subscription other than the items I mentioned from a consumer credit perspective in terms of expenditure, et cetera, is just our devices.

The iPod itself is overwhelmingly popular at the moment.

It is not -- it does not have a subscription model.

And the subscription services, like Yahoo!, like Napster, like Rhapsody and others are not compatible with the iPod.

I think we'll see increased device penetration from other manufacturers, and as that happens, I think we'll see continued subscription growth at rates perhaps even greater than the rates that they've been able to achieve so far with increased popularity from new devices too.

Great.

Thanks.

Thank you very much.

I think that was the last question.

So thank you very much, everyone, and we appreciate your time and interest.

And that does conclude today's conference.

You may disconnect at this time.