Warner Music Group Corp (WMG) 2006 Q1 法說會逐字稿

Welcome to Warner Music Group's fiscal first-quarter earnings call for the three-month period ended December 31, 2005.

At the request of Warner Music Group, today's call is being recorded for replay purposes and if you object you may disconnect at any time.

As a reminder, there will be a question-and-answer session following today's presentation.

Now I would like to turn today's call over to your host, Ms. Jill Krutick, Senior Vice President of Investor Relations and Corporate Development.

You may begin.

Thanks very much.

Good morning, everyone.

Happy Valentine's Day and welcome to Warner Group Corp.'s fiscal first-quarter 2006 conference call.

Hopefully you've seen the press release we issued this morning with our results.

We also filed our Form 10-Q today which you can find on our website at investors.WMG.com.

Today Edgar Bronfman, Jr., our Chairman and CEO, will share with you our strategic update and Michael Fleisher, our EVP and CFO, will provide an analysis of fiscal first-quarter results.

Edgar will come back for a wrap-up and then we will be happy to answer your questions.

Before we begin let me remind you that 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, should and will 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; projected digital sales; increases and gains in physical sales; expected expansion of the online marketplace and marketshare 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 a 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-Q and other SEC filings.

We plan to present certain non-GAAP results during this conference call.

We have provided schedules reconciling these results to our GAAP results.

The reconciliation schedules are detailed in our press release posted on our website at www.WMG.com.

With that let me turn it over to Edgar.

Thank you.

Thanks, Jill, and welcome, everyone.

We're building upon last year's success as we continue to deliver on our strategic and financial goals.

We had a terrific quarter delivering flat revenue on an apples-to-apples basis, which I'll describe in a moment, despite tough comparisons which we highlighted for you on our last call.

Not only did we achieve strong performance of our top sellers, but we did this while continuing to outperform our competitors and gain margin and market share.

Our digital revenue, representing 7% of our total revenue this quarter, was up 30% sequentially to $69 million and nearly tripled over the same period last year.

Moreover, on a constant currency basis, our worldwide recorded music business for the first time achieved revenue gains in digital that exceeded modest physical decline.

We had solid margin expansion, our OIBDA margin rose 2 percentage points year-over-year to 19.3% as we continue to efficiently manage the business.

We had a series of successful releases and A&R achievements that strengthened our competitive position.

For the first time in nearly a decade Warner Brother Records, led by Tom Whalley, was the top-ranked label of the year based on U.S. sales.

I'm also pleased to mention that at last week's Grammy ceremony in Los Angeles, Warner Music Group recording artists and songwriters won 29 Grammys including awards for Faith Hill, Missy Elliot, Linkin Park, Luis Miguel and Green Day who won the prestigious Record of the Year Grammy award for their hit "Boulevard of Broken Dreams".

These achievements were tempered by challenging year-over-year comparisons as well as the negative affect on revenues caused by exchange rates and the sale of our sheet music business in May 2005.

It's important to note that excluding exchange rates and the sheet music business we achieved flat year-over-year revenue performance this quarter and, on a unit basis, continued to outperform the market and gain margin and market share.

Let me highlight four particularly significant accomplishments that are aligned with the key focus items we discussed on the last call.

First we achieved success with a series of global releases as part of our innovative efforts with established artists and initiatives to develop new artists.

Second, we sustained our leadership position in digital and continue to expand our digital content offerings for consumers.

Third, we're actively addressing our music publishing business' performance.

And fourth, we reaped the benefits of our continued focus on profitable growth which Michael will address.

Let me discuss these accomplishments.

First, our successful global releases and A&R initiatives.

As noted earlier, we're particularly proud that Warner Bros. records was the number one selling label in the United States in calendar '05 according to SoundScan.

What is gratifying is that both established artists and new developing artists contributed to the label's success.

Starting with established artists, the hit album of iconic Warner Bros. recording artist Madonna was a worldwide highlight in the quarter.

Our innovative digital approach to Madonna launching our major marketing and promotional campaign with a ringtone clearly resonated with consumers by accelerating sales upon launch.

In fact, highlighting the success of our digital album bundle strategy, three-quarters of Madonna's iTunes track sales were sold in album form.

Enya and Green Day were also major sellers in the quarter.

We successfully continued our hugely productive Green Day campaign with the release of Bullet In A Bible, a live CD plus DVD.

Strong performances from developing artists such as My Chemical Romance and Disturbed also contributed to Warner Bros.' tremendous success and showcased our ongoing A&R investments.

In Europe we had the number one and number two best-selling albums of 2005, Green Day's American Idiot and James Blunt's Back to Bedlum.

In fact, James Blunt also had the largest selling album of 2005 in the UK.

These achievements are particularly notable as they underscore how we are now successfully sourcing global repertoire, both from the U.S. and the UK.

Our strategy to translate James Blunt's European success into a similar success in the U.S. is clearly gaining traction here.

In addition, we continued to outperform the music industry in the December quarter.

According to SoundScan, while for the industry as a whole total album units sold in the U.S. in physical and digital form fell by 6.5% in the quarter, our total album units sold were down just 0.3%.

As a result, we increased our total U.S. album share 1.1 percentage points year-over-year to 17.7% for the quarter.

As further proof that our focused and consistent A&R investments are paying off, we have gained album unit share in the U.S. year-over-year in four out of the top five musical genres.

For example, highlighting our commitment to increase our presence in the rap genre, our share this quarter rose to 20%, an increase of 9 percentage points over the same period last year.

Warner Music had only an 8% quarterly share in the rap genre just 18 months ago.

Artist that have contributed to this success in the quarter includes Notorious B.I.G., D4L, Trina and Sean Paul and they are part of our expanding roster of rap artists that includes Mike Jones, Paul Wall, T.I. and Missy Elliot.

These gains are at least partly attributable to our innovative A&R approach being executed by our incubator labels, East, West and Asylum.

They seek to identify high potential artists earlier in their career and sign them at lower cost.

Moreover, Warner Music has become a leader in the independent artist sector through the strength of ADA, our independent music distribution system.

ADA's digital album share for this quarter of 6% is more than triple its physical share, illustrating the value of connecting with artists earlier in their careers, particularly artists whose fan basis are active consumers of digital music, which brings me to our second point, digital.

We have made incredible progress in the digital arena.

The holiday season helped to set a new performance benchmark for digital music in general.

A record number of MP3 players were sold during this holiday season and holiday gift cards were much more popular this year than last, helping to drive U.S. weekly digital track sales to a record 19.9 million digital tracks downloaded during the week ended January 1, 2006.

Since then, while U.S. digital track sales have pulled back somewhat as expected based on the developing seasonal buying pattern, the most recent pace of 11 million tracks per week is still over 30% stronger than the calendar fourth-quarter average of 8.3 million and almost double last year's comparable weekly track sales.

A contributor to the U.S. digital track sales climb was the single "Laffy Taffy" by D4L, a rap group signed to our Asylum incubator label.

In the week after Christmas 175,000 digital units of the track were sold, smashing SoundScan's weekly digital tracks record by more than double.

Looking more broadly at digital, we've expanded our digital leadership position.

For the December quarter our digital album share in the U.S. of 23% is 6 percentage points above our physical album share, a greater share differential than any of our competitors.

This performance is a testament to our efforts to weave digital into the fabric of Warner Music and our mission to be a music-based content company.

As we described on our last call, we have been leading the industry in the evolution of premium priced digital album bundles and these initiatives are gaining traction.

The top three U.S. digital album bundles by unit sales for Warner Music in the December quarter were Madonna, James Blunt and Depeche Mode.

These album bundles included special features such as music videos, liner notes, digital booklets and preferred status for Ticketmaster concert tickets at an average suggested retail price 20% to 30% above the traditional $9.99 price with little or no additional cost.

More importantly, the introduction of our digital album bundles has resulted in a significant increase in the number of digital tracks sold to consumers in album form, which serves to drive increases in digital revenue.

In short, consumers are showing significant demand for new creative bundled digital album products.

Our digital product innovation is now expanding into the mobile landscape.

For example, with KDDI we offered the first mobile bundle ever in Japan.

For 500 yen or roughly $4.25 purchasers receive a package of audio, video, graphic and text products in a single downloadable file to their mobile phone, allowing users to personalize their phone with different content from their favorite artist.

We also recently announced a partnership with Skype to become the first recorded music company to offer online personalization through a Voice Over IP ringtone service.

Shifting gears to our third point, music publishing, getting this business back on the growth track remains a top priority.

As we've mentioned, new management is in place and is taking steps to reinvigorate our business.

Because today's music publishing number results from market performance in earlier periods, the impact of these new efforts will be seen over time rather than immediately.

Today we're focused on monetizing our existing music publishing catalog, exploiting the digital opportunity, driving cross-fertilization between recorded music and music publishing, and examining targeted catalog and other A&R investment opportunities.

Some recent music publishing developments that will flow through our financials over time include an administration deal with Lucas Arts for the Indiana Jones catalog which should benefit from the release of the newest Indiana Jones film expected in 2007, and an extended deal with producer/songwriter Bryan-Michael Cox who made significant creative contributions to both Mariah Carey's number one U.S. album and Mary J. Blige's number one U.S. album.

In addition to restoring growth to music publishing, we're on track to meet our agenda that we articulated on our last call -- growing high potential segments of our recorded music business, such as our urban roster, while continuing to build the best overall group of artists across all genres, enlarging our mobile footprint and our catalog of mobile content as we continue to create and expand the new digital experience for consumers, and driving for margin share for profitable share gains that only come with a carefully managed roster and focused artist development.

Now before I turn the call over to Michael, I'm sure you saw the announcement that Patrick Vien has joined the Warner Music Group team to run Warner Music International, our international recorded music division.

We're very excited to have Patrick onboard to contribute his tremendous experience in managing global media operations and to spearhead our burgeoning digital effort overseas.

But I would be remiss if I didn't take the opportunity to thank Paul-René Albertini for his dedication, passion and drive in running Warner Music Int'l and leaving us so well positioned to grow from a very fundamentally strong base.

And we wish him the very best in his future endeavors.

Now I'll turn the call over to Michael.

Thank you, Edgar.

Good morning, everyone.

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

We generated quarterly net income of $69 million or $0.46 per diluted share.

Excluding $6 million of FAS 123 expenses in the current period, quarterly net income was $75 million or $0.50 per diluted share.

Looking at the income statement for the three months ended December 31, 2005, we reported revenue of $1,044,000,000 which was essentially flat from the same period in 2005 excluding the $15 million contribution in the same quarter last year from our sheet music business and a $27 million negative impact from foreign exchange.

As we highlighted on our last call, we did face difficult comparisons and despite that we outperformed the market and managed costs effectively driving solid overall results.

As we have consistently said, evaluating our performance on a trailing 12-month basis is a much better indication of our progress.

In calendar 2005 we had a year-over-year revenue advance of 3% to 3.5 billion in a tough market and all our measures of profitability were up as well.

We exhibited strength overseas.

While reported revenue from both domestic and international markets each slipped 3% in this quarter, year-over-year, excluding the sheet music business, international revenue rose by 1.9% on a constant currency basis.

Driven by our strong international performance revenue gains in our worldwide digital recorded music business outpaced marginal physical declines on a constant dollar basis.

In fact, Europe has picked up momentum for us in the recorded music business with low single digit revenue gains on a constant currency basis while we had double-digit revenue gains in Asia-Pacific, relatively flat U.S. results and modest declines in Latin America.

The UK was a bright spot led by Madonna, James Blunt, Green Day and Enya.

Our quarterly digital revenue more than doubled to $69 million or 7% of total revenue from $25 million last year and rose 30% sequentially.

Many of you have asked for more detail on our digital business.

What we can tell you is that we derive 70% of our digital revenue in the U.S., the most developed digital market in the world, and about 30% internationally.

Our worldwide digital revenue split is about 50-50 between online and mobile.

While today online is larger than mobile in the U.S. and the reverse is true overseas, over time we expect this distinction to blur as we strike deals with mobile operators that include dual content delivery and over the air downloads become more prominent.

As a result of managing our costs and investment balance wisely, our total operating income before depreciation and amortization, or OIBDA, amounted to $202 million for the quarter, up 6% year-over-year driving a 1.8 percentage point improvement in OIBDA margin to 19.3%.

Excluding FAS 123 charges of $6 million, OIBDA was $208 million for the quarter.

Now let's look at our different business segments.

Recorded music first-quarter worldwide revenue decreased by 2% to $920 million and was flat on a constant currency basis over the same period last year.

Recorded music quarterly OIBDA increased 6% to $206 million, reflecting the benefit of a shift to higher margin digital revenue and higher margin top sellers.

The success of our first-quarter releases translated into a 22.4% recorded music OIBDA margin, a 1.8 percentage point improvement over the prior year.

Let's move on to our music publishing business.

I'll exclude the sheet music business from my comments.

In comparison to the same quarterly period in 2005, music publishing revenue fell 6% to $131 million or 4% on a constant currency basis.

Declines in mechanical and performance revenue were partially offset by gains in digital revenue with synchronization revenue being flat for the quarter.

The decline in mechanical and performance revenue partially reflects prior year industry declines in physical sales as this revenue is recognized on a cash basis and is typically received on at least a one-year lag.

Music publishing OIBDA declined $2 million to $21 million compared to last year's comparable quarter.

As for our cash management and our balance sheet, we ended the quarter with a cash balance of $278 million, total net debt of approximately $2 billion and a $250 million undrawn revolver.

We are very pleased with our two notch Moody’s upgrade in the quarter which recognizes our improved financial performance.

As previously disclosed, we declared our second quarterly dividend of $0.13 per share on December 29th payable later this week on February 17th, giving us a very attractive yield of 2.6% based on yesterday's close.

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

For the quarter we generated free cash flow of $13 million calculated by taking cash from operations of $29 million less CapEx of $5 million and cash paid for investments of $11 million.

The comparison with the first-quarter 2005 free cash flow results is impacted by the shift of employee annual bonus payments from the March quarter to the December quarter given the previous change in our fiscal year-end from November 30th to September 30th.

Our unlevered after-tax cash flow, which we believe provides the most accurate reflection of the ongoing cash generation capability of our business, was $60 million, resulting in an OIBDA conversion of 29% which highlights the seasonal low point in our working capital cycle.

Unlevered after-tax cash flow is calculated by adding back $47 million in cash interest.

Had the timing of the bonus payments not changed, we would have handily beaten last year's cash flow numbers.

On the tax front our cash taxes were $14 million for the quarter.

Substantially all 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 non-cash amortization deduction.

As we previously discussed, we're entitled to this deduction because we can 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.

We have a substantial tax carryover amount in the U.S. resulting from net operating losses and foreign tax credit carryovers.

We expect our effective tax rate to rise during the year as we increase the international contribution to earnings.

Before we wrap up I'd like to mention one item regarding our corporate governance.

As was widely reported, our director Richard Bressler has joined T.H.

Lee, a firm in our investor group.

As a result Mr. Bressler is no longer considered an independent director under the NYSE rules.

We are now in the process of recruiting two additional independent candidates to join our Board.

After we add these new directors we will have a total of three independent directors on our Board and an entirely independent audit committee as required by New York Stock Exchange rules.

We intend to add these directors as soon as possible.

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

We believe that, especially given the rhythm of the music release schedule and associated marketing and promotional expenses, quarterly variations of results are normal.

That is why we believe our trailing 12-month performance is the best indicator of our success.

We're very pleased with the progress we exhibited in the fiscal first quarter 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 I'll turn it back over to Edgar for a brief wrap up.

Thanks, Michael.

In just a few quarters Warner Music Group has become a nimble, integrated and forward-looking music-based content company.

We've been able to create a cutting-edge business model predicated on new thinking and new initiatives.

Our innovative approach to A&R has driven consistent and profitable share gains, focused approach to digital has helped us to expand the leads that our digital share garners over our physical share.

And our efficient approach to cost management has contributed to our expanding margins despite the challenging music industry backdrop.

The music industry is changing and WMG is on the forefront of that transformation.

We have sought to run our business differently to capture the opportunity of an evolving marketplace and drive shareholder value and that is precisely what we're doing.

So let me stop there and let me say we'd be delighted to take any questions.

Thanks.

Operator?

(OPERATOR INSTRUCTIONS).

Doug Mitchelson.

Deutsche Bank.

Two questions just on pricing -- or one question on pricing, two parts.

Any update on pricing flexibility negotiations with iTunes?

Any comments you can make on the Spitzer investigation of price-fixing?

And has the satellite radio sector begun to engage music companies in serious negotiations or should we just assume that this will head towards arbitration later this year if I remember correctly?

Doug, it's Edgar.

I don't think really we can bring you a lot of light on any of those subjects.

The negotiations with Apple will proceed, but obviously we're not going to discuss those negotiations as they're ongoing.

We obviously cannot comment on the Attorney General's investigation.

As you know, we reached a settlement with the Attorney General on the previous investigation and I believe this current one is in its very earliest days.

So it would be inappropriate for us to comment there.

And I think really, again, in terms of negotiations with the satellite industry, it doesn't behoove us to speculate as to the outcome of those negotiations.

There are ongoing negotiations with the industry and I think that's really all we can do is to suggest that those are ongoing but without commenting on them.

So maybe just a quick follow-up.

The bundling that you're doing with albums, adding additional content at a higher price, is that delivering to you the additional margin that you were hoping for out of iTunes anyways?

There are number of things that we're doing that drive additional margin in iTunes and other DSPs.

But yes, the album bundles are more profitable and have a greater margin share than the regular priced digital album.

Okay, thank you.

Anthony Noto.

Goldman Sachs.

Edgar and Michael, two questions.

Edgar, I was wondering if you could elaborate a little bit on the types of innovation that you see in the digital music world in 2006 and beyond.

Clearly the formats that we've seen from ringtones downloadable music are probably not the end of the innovation in terms of types of formats, especially as it may relate to portability and other types of innovations.

And then Michael, in terms of the EBITDA margin expansion on a year-over-year basis, I think you said 170 basis points and I think that includes FAS 123.

Without FAS 123 I think it's 210 basis points.

Could you break out for us in big buckets that expansion, what came from mix shift versus cost savings versus a year ago?

Thank you.

Anthony, it's Edgar.

One thing I'd like to -- well, two things I'll mention.

One, we just started with this mobile bundle that I described in Japan which is a single downloadable file to consumers that contains all kinds of different material from a single artist, but that request will probably change to a variety of fanatic single bundles as well.

So currently you can have on KDDI a single file from an artist that will have a ringtone, some wallpaper, some text, a ringtone, etc.

So that's a unique product.

And I suspect we will move to thematic products as well.

So it's not just a single artist but it's along different kinds of themes.

We're also starting with a product in Germany that we'll announce with Vodafone and T-Mobile which is what we call SMS tones.

The SMS market or the text messaging market in Europe is huge and we're going to introduce a product that has a tone, probably something more on the order of somewhere in the 2 to 5 second range rather than a much longer ringtone -- or ringback tone that would accompany SMS messages.

But again, we are at the very, very earliest stage of experimentation and innovation.

But I do think we can continue to lead the market any these are just examples of where some things may go.

Whether these will be enormous consumer winners or others will be, the variety of content that we can create and distribute across these platforms is unlimited.

Anthony, to answer the margin question, and just to clarify -- OIBDA margin including FAS charges was up 160 basis points excluding FAS was up 200 basis points.

I think it really comes -- there are two broad buckets and it's about 50-50.

Broad bucket number one is that as we get a larger percentage of our business from digital revenues, as we've discussed many times before, the digital business is more profitable.

This quarter we were up to 7% of our revenues from digital, higher in the U.S. and higher in particular in our U.S. recorded music business.

And so that's driving part of the profit improvement.

And then the second place is just the mix of the products we have in the marketplace.

As we've talked about before, we're very focused on driving margin share, the notion of finding products that will generate not just revenue but good profitability for us in putting those out in the market.

We're not interested in putting products in the market that generate lots of revenue without lots of profitability.

And so you'll continue to see us much more focused on the products that can generate both top-line and bottom-line.

And I think this quarter some of our big releases in the marketplace, that was true.

Great, thank you.

Michael Savner.

Banc of America.

Two questions also.

First, on pricing, this time on the physical side.

You've done obviously a good job of beating industry trends in terms of unit declines.

But are you considering other avenues to spur growth whether it's reducing your pricing or other things?

At some point you throw in the towel and say, look, it is what it is and we're going to focus all of our energy on the much stronger growth in digital?

So I guess that's one broad question.

And the second, also a general question -- just your most recent thoughts on industry consolidation, where you see yourselves in it, how beneficial if it all you see it or whether you're very content to kind of keep the ship sailing the way it's going now?

Thank you.

Michael, let me comment on both.

First of all, let's remember that physical business remains 93% of our business.

And rather than discuss throwing in the towel, I would tell you, we have a very different perspective.

We actually think that as we continue to innovate in the digital world we can begin to bring much more innovation to the physical world as well.

Obviously the breadth of things that we can do in physical is not as broad as the breadth of things that we can do in digital, but we see many opportunities in physical and we continue to do anything and everything we can to expand our distribution base, our products and the quality of our content so that we can either arrest -- both arrest the decline of the physical business and potentially even increase physical sales over time.

And I guess the second thing is I think there remains far too much discussion, which as far as I know is not generated either by Warner Music or any other potential partner in the consolidation of the music industry.

I don't think it's -- would be helpful for me to comment other than to say that if you look at the progress of Warner Music, I think it's clear that without consolidation Warner Music can continue to make real progress and I think I should just leave it at that.

Thanks.

And just to follow up, I certainly didn't mean throwing the towel in on physical sales.

It may be better to devote your energy to coming up with new physical sales, marketing campaigns versus what you've done before.

Look, we remain very focused on both.

We're very proud of the fact that, as Lyndon Johnson once said, we can walk and chew gum at the same time.

Which is to say we've gained share in the physical business which means we're driving tremendous focus in that area as well as being the innovator and the leader in the digital space.

So we're going to remain focused on both.

And as long as we feel that we can do both as well as each can be done we're going to continue to do that.

Great, thank you.

Bishop Cheen.

The company is Wachovia Securities.

Good morning, Edgar, Michael, Jill.

Thanks for taking the question.

It is a good day for a chemical romance I guess -- or any romance.

A question on gift cards.

We saw a lot of sales in the calendar Q4.

When do you think you'll start to see the blessing, the benefit of those gift cards?

In this current quarter that we're in or will it be -- do you think it's kind of metered and measured out over two or three quarters?

Bishop, it's Michael.

It's too early to tell.

This is, as we know, a developing marketplace.

I think what we are anticipating is that the vast majority of those gift cards will be used pretty quickly.

And we've seen a developing pattern as someone gets a new device, especially one attached with some gift cards, they tend to go out, buy some tracks -- we saw a huge spike, as we mentioned, in downloads the week after Christmas -- and then start to take their own catalog and library of music, put it on that device and then come back into the market and be purchasers again.

But it's still early days to understand exactly how the consumers are using these devices.

We definitely feel like the pattern, the seasonal pattern of the spike in digital downloads and then the drop-off and then what we expect will be some growth again is similar to last year, but obviously it was impacted by a greater sale of gift cards this year and therefore may have sort of a heightened beta to it in the early periods because of the gift cards.

One follow-up.

CapEx was less than expected -- than I expected in this fiscal Q1.

Do you think the CapEx is going to be closer to 20 or closer to 30 or some other number in this fiscal year?

As you know, we don't give any guidance.

I think CapEx has been a pretty consistent spend rate for us and so I think that looking at history is probably a pretty good proxy.

So all these new digital initiatives are not going to break your CapEx budget?

We certainly have some capital expenditures as we build out our digital business, but nothing that's so dramatic that it's going to change our CapEx spend rate in any meaningful way.

Thank you.

Jason Bazinet.

Citigroup.

Two quick questions.

I was wondering if you could comment on at least among digital sales how digital a la carte is fairing versus digital subscription?

And then second, I just had a question on the allowance for doubtful accounts.

It was up I think about 27% sequentially and I was just wondering if you could comment on the source of that?

It's Edgar.

Let me just comment on the a la carte versus subscription and I'll let Michael comment on the reserve.

It's difficult to say.

We see more and more subscription services coming into the market.

Obviously the lead that Apple enjoys in the device market drives a very important growth for a la carte sales and I think we're going to continue to see growth of both.

What we're seeing is real consumer satisfaction both with subscription services and with a la carte services; though I would say that subscription services have been -- their growth and popularity has been impacted by the lack of an outstanding device that consumers have adopted.

I think we're going to see an increasing variety of first-class devices for subscription services.

As that happens I think we're going to see continued and perhaps accelerated growth in the subscription area, but I don't know that that will come at the expense of continued growth of a la carte services.

Understood, thank you.

Jason, on the question about the allowance for doubtful accounts, most of this is related to just the buildup that happens in the December quarter.

Our allowance is somewhat formulaic, it's tied to inventory that we've shipped out to our key physical vendors.

Obviously with the Musicland bankruptcy we remain conservative in making sure that we're sort of fully reserved in a changing world.

As I've pointed out before -- let me take the moment to point out now -- we don't expect the Musicland bankruptcy to have any material impact on our financial statements largely because we are conservatively reserved against the physical retailers and manage that quite carefully.

Okay.

Thank you very much.

Eric Handler.

Lehman Brothers.

Edgar, are you seeing any additional discounting of catalog product this past holiday season relative to last year?

And if so, do you think there are any implications on the market for that?

And then secondly, you talked about international growth, but can you talk a little bit or shed some light on the market share that you have achieved globally?

Thank you.

Eric, I'm going to ask you to repeat the second question, but as to the first, we did see some increased discounting on catalog from the industry.

Warner really didn't participate in that additional discounting.

We have worked very hard to maintain margin and prices in the physical world, and we have a very clear sense on where and when discounting actually results in increased margin and profit.

And if we can't achieve that, then we don't grant the additional discount.

So we have been very disciplined there.

I know your second question was around international, but I just missed it.

International market share, you talked about international year-over-year growth, but can you talk about maybe some markets, what your global share is?

We don't have that information in as timely a manner as we do with SoundScan, etc. in the U.S.

So I can't give you precise numbers.

But what I can say is -- and I meant it when I said that Paul-René leaves us with a very solid foundation -- we have done extremely well in Europe.

Warner has traditionally been seen as weak in international markets, so for Warner to have the number one and number two albums of 2005 in Europe is really quite exceptional and extraordinary, and I think a testament to our focus both of developing artists in the case of James Blunt and the marketing and promotion of international artists such as Green Day across the globe.

We are also gaining share.

I can tell you that in specific markets, we have done extremely well in France where Warner Music was traditionally an industry laggard and is now a very, very much stronger company and a real competitor in that market.

We are also seeing share gains in Japan in our first quarter, and we hope that will continue through 2006 as well.

Thank you.

Richard Greenfield.

Richard Greenfield, Pali Research.

A question for you, when you think about what you did with Madonna and My Space, allowing consumers to essentially cut and paste her video onto their blogs, I guess the question is how should we think about the opportunity presented by social networking sites like a My Space or a FaceBook?

And do you plan to sign a deal like Sony BMG did about a week and a half ago?

Thanks.

Well, I think we have deals with -- we have deals in place with My Space.

And we've worked with FaceBook for some time.

But I think what I would say, Richard, is rather than close the opportunity for social networks, what I would say is that we do believe that there's a tremendous opportunity for what we would call user generated content.

And that is using the content that is created by Warner Music Group artists and adjusting, amending, improving, subtracting, however consumers might perceive that content with their own contributions.

That I would think is potentially a huge business.

We've got to approach it carefully and thoughtfully and obviously in concert with our artists because each artist may have a different perception as to how much or in what way they want their content amended.

But we do think the general category of user generated content is potentially a very, very large business.

And how do you plan or how are you currently getting paid in those relationships and is advertising over time a possibility?

I think advertising over time is a possibility, but what I'd say is this is an extremely nascent business.

The entire digital arena is 18 months old and obviously in has begun with the more traditional forms which is to take current content and translate it to digital distribution so you have single track or album downloads.

That's the most basic of the digital products.

As the opportunity expands and the content offerings will expand there will be many new models, but I think it's way too early to say exactly how we'll be compensated.

Okay, thanks.

Mark Harrington.

ABN Amro.

A couple industry-related questions.

First, again back to pricing -- I don't know if this is something that you can comment on as a generalization, but looking at your recent trends in wholesale pricing, I know the past five years or so pre 2005 we've seen consistent pricing pressure on the down side.

Have you seen that stabilize?

Second, looking at recent consumption trends in digital, perhaps you could comment on, for example, spending -- percentage of albums downloaded versus singles and any evidence if at all possible on the cannibalization of physical or in fact are you seeing digital download serving to be incremental to physical sales?

Thanks.

On the wholesale pricing question, as we talked about before, though we constantly feel pressure, our wholesale prices on the physical side have remained extraordinarily stable over the last year to two years.

And it's important to remember that our product isn't as substitutional as some other consumer products and the big physical retailers are using our product to generate foot traffic in the stores.

So their worst-case scenario is to not have that Madonna or Green Day or James Blunt CD on their shelves.

So we actually have a reasonable amount of power in that pricing discussion.

So far we've been able to hold our physical wholesale prices pretty consistent.

On the digital side, I would say that it's early days and it's hard to tell.

There's clearly going to be some cannibalization.

What we are seeing though is that if you give consumers a unique digital product, as we have in the digital album bundles, they will spend more in order to get that unique product.

And in particular with the digital album bundles, in the places we've done that we've seen a marked rise in the number of tracks purchased in album form versus single form.

So the consumer has voted with their dollars to say if I can buy Madonna in a bundled form that has some extra bonus things as part of the package, I'll do that rather than picking up a track here and a track there.

Thank you.

Carol [Lindtz].

Carol Lindtz at Forest Investments.

In the quarter, could you please break out for me on the revenue line how much was price and how much was units?

And also, going back to your point of distribution, on the physical side of the business what's the trend in the actual count, shall we say, of points of distribution?

And finally, in the most recent quarter could you tell me what percent of music sales are represented by releases or artists that are, shall we say, new to the mix?

Sure.

Let me try and take your questions in order.

In terms of what makes up the revenue change, if you think about us basically having flat revenues currency adjusted and adjusted for the sale of the print business, that's pretty much -- that flat revenue is pretty much on flat units.

If you look at the SoundScan numbers, we were sort of down year-over-year less than 1%.

So you're really looking at flat pricing and flat units year-over-year, particularly on the physical side.

In terms of the number of distribution outlets, I think the first change we're going to see in that in the current period is when we see the outcome of the Musicland bankruptcy.

I don't think there's been a big change in the number of outlets in the traditional retailers over the last year or so.

We are seeing some new physical distribution points, Starbucks is an example of a place where before there was no music sales and now has become an increasingly important physical distribution outlet for our product.

And I forgot your last question.

I wanted to know -- in consumer products what companies often analyze is what percent of their business comes from a new product.

Carol, it's Edgar.

In the consumer products business people often do that, but frankly almost everything we sell is a new product other than our catalog.

Every new album by Madonna is a new piece of work so that probably 60% of our revenue is derived from new products.

But what we have consistently said is that when you take our revenue, about -- in any given year about less than 10% actually comes from what we would call untested material which would be new releases from unproven artists.

So while we have about 35 to 40% of our revenue from catalog, about 15% of our revenue from publishing, that 50 to 55% of our revenue, another 35 or so percent of our revenue comes from new work but by established artists.

And then the remainder, something slightly under 10%, comes from new artists releasing new material.

Okay, thank you.

Michael Savner.

Just a quick follow-up.

I think a couple of people have thought of the same question.

You talk about the great growth in digital albums being sold, can you start maybe today giving some thoughts for going forward, to actually providing us that number of digital albums sold so we can kind of quantify the year-over-year growth numbers?

I think it's a great point, Michael.

I don't have it in front of me right now, but we'll certainly look at it as part of the statistics we give going forward.

Fair enough.

Thanks.

Tuna Amobi.

Standard & Poor's Equity Group.

Thanks for taking the question.

Just a couple of issues.

The first one on the -- I was wondering if, Edgar, perhaps you can share with us your vision of Google and Amazon as potential partners down the road?

The other issue is on Skype, what can you share with us about the economics of that deal and do you see that as a prototype for possible deals that you will strike down the road?

And finally a question for Michael.

Will you please quantify where you stand with the NOLs, net operating loss carryovers in the U.S. as well as the foreign tax credit carryovers?

Thank you very much.

Sure, let me start with your first series of questions.

Really Amazon and Google can and should speak for themselves, but we certainly have been working closely with Amazon as they work to launch their service.

They have a very powerful base of CD purchasers and we think that their digital launch, when it comes sort of second half of the year, we hope will be a successful one and we're certainly working with them as we work with every potential distribution partner to get our content to more people and more places with more opportunity.

Google as well of course is a massive distribution opportunity.

It remains to be seen how committed Google is to the music space or how they want to enter the music space.

But we've had good conversations with Google.

We perceive them as very strong potential partners and we hope that we'll be able to participate in the tremendous platform that Google presents.

Skype is, again, just an additional distribution deal.

It's just innovative because we believe that the Voice Over IP networks are going to continue to grow very dramatically and we should be selling ringtones on those networks as well as on the traditional mobile operators.

So again, content wants to be ubiquitous, wants to be everywhere it can be at all times in all places.

We don't reveal the actual arrangements of our -- our economic arrangements with any particular distribution partner, but we are pleased to be leading the industry in finding new ways to distribute our content.

And just one quick follow-up, Edgar.

Are you thinking of Google and Amazon as potentially on the same similar model to iTunes or are you thinking of something a little bit dramatically -- maybe a dramatically different model with those providers?

Well remember, both Amazon and Google already have massive businesses themselves.

So the music industry needs to work with those partners to provide a service that conforms to the vision that either Google or Amazon has for their customers.

So it really isn't us driving a vision, it's really us trying to support a vision that both can enhance our artist's opportunity and the consumer's opportunity that are part of either the Amazon or the Google networks.

And we're in constant dialogue with those companies and others to try and achieve those goals.

Thanks.

Michael?

To your question on NOLs, our NOLs and tax carry forwards are about 100 million at year-end.

Thank you very much.

I'd now like to turn the call back over for closing comments to Edgar Bronfman and your line is open.

Thank you very much.

We just would like to thank everyone again for joining the call, for your continued interest in Warner Music.

We're proud of the quarter and now we're going to go back to work so that we can hopefully deliver good results going forward.

Thanks a lot.

That does conclude today's conference.

You may disconnect at this time.