Warner Music Group Corp (WMG) 2006 Q2 法說會逐字稿

Welcome to Warner Music Group's fiscal second quarter earnings call for the three-month period ended March 31, 2006. [OPERATOR INSTRUCTIONS]

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

Thank you.

You may begin.

Thank you very much.

Good morning, everyone.

Welcome to Warner Music Group Corp.'s fiscal second 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 our Chairman and CEO Edgar Bronfman, Jr. will share with you our strategic update and our EVP and CFO, Michael Fleisher will discuss fiscal second quarter results.

Then we will take your questions.

Before Edgar's comments, let me remind you that this communication involves 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.

As statement -- such statements includes, but are not limited to estimates of our future performance such as the success of the future album sales, 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 a variety of risks, uncertainties and other factors that can cause actual results that 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.

Reconciliation schedules are detailed in our press release posted on our website at www.wmg.com.

With that, thank you and let me turn it over to Edgar.

Edgar?

Thanks, Jill.

Good morning, everyone and thanks for joining us.

First of all, to dispense with the elephant in the room regarding the EMI proposal, we will have nothing further to say this morning, other than to reiterate that the proposal was unanimously rejected by our board as not being in the best interests of our shareholders.

We would appreciate your cooperation in focusing on our quarter, which continues to reflect how we've been able to transform the Warner Music Group and how highly the work of our artists and our employees with regarded by consumers around the world.

Having seen our results, you'll understand how pleased we are about the Company's performance, especially just one year after our initial public offering.

In particular, I'd note that, even in the face of a challenging industry environment, we had several major accomplishments.

First, we continued to out perform the market and gain margin and market share.

Excluding the effect of currency and the sale of our sheet music business last year, our revenue grew by 10% or 4% on an as-reported basis.

Second, we sustained our leadership position in digital, growing digital revenue to 11% of our total revenue, up about 30% sequentially from quarter one.

On a worldwide basis, digital revenue gains exceeded gains in physical revenue on a constant dollar basis in recorded music.

Third, we had a series of successful releases and A&R achievements, including: Stronger performance from a broader base of top sellers, consistent with our strategy for international and domestic growth, innovative efforts with established artists and initiatives to develop new artists; gaining share in the fastest growing genres such as urban; and strengthening our competitive position in the independent space, most obviously through our agreement to acquire Ryko Corporation, a leading independent integrated music and entertainment company.

And fourth, we continue to reap benefits from our focus on profitable growth, as measured by our previously mentioned digital growth, OIBDA improvement.

Our OIBDA margin rose 1.6 percentage points year-over-year to 13.1%, as we continue to manage the business efficiently and operating income improvements, which Michael will address in his remarks.

Now, I'd like to give you some further color on our digital business and our A&R strategy.

We continue to sustain our digital leadership position.

For the March quarter, our digital album share in the U.S. continued to out pace our physical album share.

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

The momentum of digital sales activity remains very encouraging.

The average base of weekly U.S. track sales for the March quarter was 11 million, up 33% sequentially and 89% of above the same period last year.

U.S. digital albums continue to sustain an even steeper unit growth trajectory than digital tracks, rising about 145% over last year and accounting for a larger share of digital sales overall.

Our digital success is evident both domestically and internationally.

For example, this quarter a Warner Music act, Gnarls Barkley, made music history when their debut single, Crazy, topped the UK singles chart from sales of downloads alone.

As we described on our last call, we have been leading the industry in the evolution of premium-priced digital album bundles, with more than double the number of bundled offerings than our closest competitor.

We find that if we include special features within albums, such as music videos, liner notes, digital booklets and preferred status for concert tickets, consumers are much more likely to buy the entire package instead of a track or two.

These offerings have an average suggested retail price 20% to 30% above the traditional 9.99 level, with little or no additional cost to us.

This approach has become the norm for us, representing the lion's share of our album offerings on iTunes.

Another development that highlights our innovative approach in digital was the selection of Warner Music to be the launch partner for Cingular's video service powered by Music Choice, which will include a diverse selection of our music videos, artist interviews and behind the scenes footage.

Moving to our successful global releases and A&R initiatives, we continue to out-perform the industry in this quarter.

Industry-wide total album units sold in the U.S., both in physical and digital form, fell by 3% this quarter.

However, according to SoundScan, our total album units rose 1%.

As a result, we increased our total U.S. album share nearly one percentage point year-over-year to 18.1% for the quarter, and an even more impressive 2.7 percentage points over the past two years.

At our labels, it is worth noting that we continue to see significant improvements at Atlantic, while Warner Brothers, last year's top-ranked label of the U.S. based -- label of the year based on U.S. sales, is performing well across all genres.

We've been working to build and carefully manage a premier roster of artists, both developing and established.

Following on the success of James Blunt, among our developing artists is Daniel Powter, a Canadian-born singer-songwriter whose Warner Brothers debut album first broke overseas, selling more than one million copies outside the U.S.

He is now gaining traction in the U.S., helped by the hit single, Bad Day, which has been the number one digital track for the last six weeks.

Strong performances from developing artists, such as Death Cab for Cutie and Panic at the Disco, contributed to Atlantic's tremendous success and showcased the continued payoff from our ongoing A&R investments.

Established artists also contribute to our success in the quarter with solid carryover sales from Green Day, James Blunt, Madonna, Sean Paul and Michael Buble'.

Another significant part of our strategy is growing high potential genres of our recorded music business, such as Urban.

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

For example, highlighting our commitment to increase our presence in the Rap genre, our share this quarter rose to 22%, an increase of 11 percentage points over the same period last year.

Artists that have contributed to our recent Rap success include TI, Juvenile, and E-40, and they are part of our roster Rap artists that include Mike Jones, Paul Wall, D4L, and Missy Elliott.

In fact, TI's album, King, debuted in the U.S. at number one and sold over 500,000 albums in its first week, generating Atlantic's biggest first week sales for an artist since the introduction of SoundScan fifteen years ago.

The TI highlight caps an exciting three-year, three-album career development story, only enhanced by the dual revenue stream flowing from the ownership of both TI's recordings and music publishing rights.

To best illustrate our development as a music-based content Company, when we released the TI album we released over 100 SKU's of TI product, including digital albums, digital singles, ringtones, ring-back tones, video ringers and E graphics.

These accomplishments are. in part. attributable to the innovative A&R approach executed by our Incubator labels -- East, West and Asylum -- that seek to identify independent label entrepreneurs and high-potential artists and sign them at lower cost.

In fact, we have reorganized our Incubator labels, together with our digital-only label Cordless Recordings, under one umbrella called the Independent Label Group.

As I mentioned earlier, one important event that strengthened our competitive position in the independent space was our announcement on March 24th that we signed an agreement to acquire Ryko Corporation.

Ryko will bolster our presence in the independent artist community, diversify our catalog, bring a new label to our family and further our leadership position in the distribution of independent music.

Before handing it over to Michael, let me give you a quick update on Music Publishing.

As we have said, getting this business back on growth track -- remains a top priority.

Just to recap, the Music Publishing management team, which has been in place for less than a year, is continuing to take steps to reinvigorate the business.

For example, this quarter Music Publishing extended and expanded agreements with George Michael, Nickelback and the estate of Irving Berlin.

We also formed a publishing venture with TI, which includes co-writers on his recently released album, King.

In addition, we announced the music publishing industry's only Incubator label initiative with the creation of Perfect Game Recording Company, designed to promote and develop emerging artists.

With Perfect Game, Warner/Chappell can now organically develop its performing song writers in a low-risk environment, with an eye towards long-term career growth in the either the independent or the major label community.

You can see why we're very pleased with our results.

We continue to focus on executing our strategy and building shareholder value every day.

Now I would like the turn the call over to Michael for a run-through of our financials.

Michael?

Thank you, Edgar, and good morning, everyone.

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

Looking at the income statement for the three months ended March 31, 2006, we reported revenue of $796 million, which rose 4% from the same period in 2005.

Excluding the $11 million contribution in the same quarter last year from our sheet music operations, sold in May of 2005, and a $31 million negative impact from foreign exchange, revenue rose an even more impressive 10%.

We generated a quarterly net loss of $7 million or $0.05 per diluted share, including $2 million of FAS 123 expenses versus a $0.28 loss per share last year.

Despite a challenging industry back drop, we out performed the market and managed costs effectively, driving excellent overall results.

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

In the last twelve months we had a year-over-year revenue advance of 4% to $3.5 billion, and all our measures of profitability were up, as well, on a currency adjusted basis.

The U.S. was a major source of our strength, with revenue for the quarter up 18% year-over-year, excluding the results of our sheet music business.

Recorded music was the primary business that fueled our growth, while Music Publishing was relatively flat.

Driven by our strong domestic recorded music results, we achieved worldwide revenue gains in both our physical and digital recorded music business on a constant dollar basis.

We also exhibited revenue growth overseas of 2% currency adjusted.

In fact, 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 strong double-digit revenue gains in Asia-Pacific and flat Latin American performance.

The UK and Italy were two bright spots, led by Madonna, James Blunt and Enya.

Our quarterly digital revenue nearly tripled to $90 million or 11% of total revenue from $35 million last year and rose 30% sequentially.

To spotlight a particularly exciting number, in our recorded music business digital now represents 13% of revenue.

For the six months digital revenue was 8.6% of total revenue and 9.4% of recorded music revenue.

Similar to last quarter, approximately 70% of our digital revenue is generated in the U.S. and 30% outside the U.S.

Our worldwide digital revenue continues to be split about 50/50 between online and mobile.

While today, online is larger than mobile in the U.S. and the reverse is true overseas, overtime 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 we've discussed in the past, we're seeing an emerging seasonal pattern to the digital business, with stronger year-over-year sales growth in the first half of our fiscal year and more flattish second half performance.

This sales pattern is partially a result of the timing of music device sales.

More over, as digital revenue grows, results will also more closely mirror the timing of our album releases, which may cause quarterly fluctuations in our percentage of revenue coming from digital sales.

As a result of managing our costs and investment balance wisely, our total operating income before depreciation and amortization, or OIBDA, amounted to $104 million for the quarter, up 18% year-over-year driving a 1.6 percentage point improvement in OIBDA margin to 13.1%.

OIBDA included the $8.1 million severance charge for previously announced executive departure and $2 million in FAS 123 charges.

Prior year OIBDA included $7 million in FAS 123 charges.

Now let's take a look at our different business segments.

Recorded music's quarterly world-wide revenue rose by 9% to $676 million and was up 13% on a constant currency basis over the same period last year.

Contributing to this growth were new releases in the quarter from TI and Juvenile and significant carryover sales from James Blunt, Madonna and Sean Paul.

Recorded music quarterly OIBDA increased 13% to $81 million, reflecting the benefit of a shift to higher margin digital revenue and higher margin top sellers.

The success of our recorded music business translated into a 12% recorded music OIBDA margin, a 0.4 percentage point improvement over the prior year, and a 1.6 percentage point improvement, excluding the executive severance I mentioned earlier.

Let's move on to our Music Publishing business.

In comparison to the same quarterly period in 2005, excluding the sheet music business in last year's comparable quarter, Music Publishing revenue fell 10% to $129 million or 3% on a constant currency basis.

Declines in mechanical and synchronization revenue were partially offset by gains in performance revenue.

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

Music publishing OIBDA was flat at $47 million compared to last year's comparable quarter.

As for our cash management in our balance sheet, we ended the quarter with a cash balance of $359 million, short-term investments of $61 million, total net debt of approximately $1.8 billion, and a $250 million undrawn revolver.

Net debt reflects total debt less both cash and short-term investments.

As previously disclosed, we declared our third quarterly dividend of $0.13 per share on March 14th, giving us a yield of 1.8% based on yesterday's close.

The dividend was paid on May 3rd.

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 $162 million, calculated by taking cash from operations of $176 million less capital expenditures of $7 million and cash paid for investments of $7 million.

Our unlevered after-tax cash flow, which we believe provides the most accurate reflection of the ongoing cash generation capability of our business, was $186 million, resulting in an OIBDA conversion rate of 179% due in part to the collection of cash related to holiday sales during this quarter.

Unlevered after tax cash flow is calculated by added back $24 million in cash interest to free cash flow.

OIBDA conversion is calculated by dividing unlevered after tax cash flow by OIBDA.

For the six-month period ended March 31, our conversion rate amounts to 80%, a rate that is more representative of our typical annual performance.

On the tax front, our cash taxes were $12 million for the quarter.

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 non-cash amortization deduction.

As we previously mentioned, we're entitled to this deduction because we can amortize and deduct for U.S. tax purposes, ratably over a fifteen-year period, a substantial portion of the purchase price we paid to Time Warner.

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

We expect our effective tax rate to rise over the year.

Before we wrap up, I would like to mention one item regarding our corporate governance.

We are delighted that Michelle Hooper has joined our Board of Directors.

Michelle will serve as an independent director and will sit on the audit committee.

She currently serves on the board of directors and chairs the audit committee for PPG Industries and previously served as a director and audit chair on the board of Target Corporation.

Michelle was the President and Chief Executive Officer of Voyager Expanded Learning and today is co-founder and managing partner of the Director's Council.

We will be adding another independent director as soon as possible to bring our total to three, giving us an entirely independent audit committee as required by the New York Stock Exchange rules.

As you know, as a matter of policy, we have chosen not 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 promotion expenses, quarterly variations of results are normal.

We're very pleased with our financial growth, digital leadership and cost management efforts, and remain very optimistic about our ability to capitalize on opportunities in the rapidly changing music industry.

Thank you and now we'll open up the call for Q&A.

Operator?

[OPERATOR INSTRUCTIONS] Our first question is going to come from Doug Mitchelson and please state your company name.

Thank you very much, just terrific results, guys.

Edgar, sorry but I can't help but ask, You and EMI are similar size.

Given the fantastic execution we've seen from you in the past four quarters and your experience putting Universal and Polygram together, wouldn't be make more sense for Warner to be the acquirer in any deal with EMI rather than the other way around?

Doug, we're just not going to comment on the EMI proposal or any speculation around the combination of the companies.

I appreciate the kind comments you made about our results and that's where we'd would like to focus the call.

Alright, then maybe just one quick follow-up question.

Is your new release digital market share also higher than your physical market share?

I mean, the implication, of course, is that your strong library could be driving your digital sales and once consumers have rebuilt their library in digital, your share would slip.

Are you seeing the same results on a new release side?

We are.

Our strength is across the board.

We do have strength in catalog, but very much our growth is a factor due to new releases, as well.

Interesting.

Thank you very much.

Thanks, Doug.

Our next question comes from Michael Savner.

Please state your company name.

Good morning.

Banc of America Securities.

Two questions.

First, if you could maybe, Michael, give us a little bit more color on what was going on in domestic recorded music, because when we strip out the growth in digital, it still looks like growth was significantly higher than, I think, most people would have expected so maybe a little bit more color on what was going on on physical.

I think you said 1% growth, but that was probably a worldwide number, so that would be helpful.

And then, secondly for Edgar, on the Apple announcement from last week that the label agreed to extend the deal at $0.99.

Presuming that's a one or two-year deal, can you give us your thoughts on your desire and you think the need to get to tiered pricing, and if this new deal precludes you from going back to them prior to the expiration of the deal?

Thanks very much.

I'll start, Michael.

On the physical side, if you look at the SoundScan numbers, the most readily available public numbers, you can see that for the first quarter we out performed the industry quite well.

We did that in both physical and digital.

We had strong new releases and continued strong performance across our carryover records, as well as our catalog.

So, we saw good performance in both the physical and digital markets.

You don't want to quantify the physical gain specifically?

I don't think we've broken that out.

Fair enough.

Michael, it's Edgar.

On Apple a couple things.

First thing I have to say is that the agreement with Apple is confidential and so we can't really comment on the specifics of the agreement or the terms.

I think the second thing I would say is that we don't set retail pricings, so Apple's pricing is Apple's pricing.

So the $0.99 announcement that Apple made is a reference to their retail price, not to our wholesale agreement.

But, nonetheless, that remains confidential.

I think, though, our focus has very much been and will continue to expand in the whole range of digital bundled product.

We, together with Apple as such a large retailer, are constantly redefining what the consumer's experience with digital music is and how that will transform over time.

And I think digitally bundled albums are just the beginning of that.

Of course, we do always price those or almost always -- in fact, always price those at a premium to the unbundled product.

And I think you're just going to see our efforts in that area continue to expand across singles, albums and all other kinds of products giving us, at least from our perspective, the opportunity to differentiate our content.

Thanks and congratulations.

Our next question is from Anthony Noto, and please state your company name.

Thank you very much.

Goldman Sachs.

A couple of questions.

Michael, as we think about the fact that digital music accounts for 11% of revenue, could you give us a perspective what it may account for as a percent of EBITDA ?

And do you think its relationship and margins will stay constant, because I know the margin of the digital music today is greater than physical but will the digital music margins come down overtime as royalties change?

Edgar, second question.

Could you comment a little bit on what drove the significant step-up in the digital music business?

Do you think it was a benefit of new distribution channels, i.e. if you think about every point of distribution on a comparable versus new store opening basis, was it that or was it just from comparable sales growth?

Thank you.

Thanks, Anthony.

On the digital business and looking at it as a percent of revenue, obviously we don't break it out as a percent of our EBITDA or OIBDA, but what I can say is as we've said before, it's more profitable business.

We continue to see that as it grows as a percent of our total revenue.

We are flowing through that incremental profitability to our OIBDA margin rate, and you can see that in our continued pick up in OIBDA margin rate year-over-year.

I don't think -- you know, the one thing you sort of mentioned is as royalties increase, we don't see a reason that royalties are going to increase as the percentage of the digital business increases.

There is a fairly constant relationship.

What we're paying now on digital from a royalty rate perspective we should continue to pay.

Obviously, digital will grow -- continue to grow as a percentage of our total business.

Anthony in terms of the step-up in digital in the quarter, I think it was less from new channel development than it was just from comparable growth.

And I think part of that is due to our release schedule and the strength of our release schedule, and particularly in digital the strength of some of our releases and their relationship to digital, such as Daniel Powter and others.

But I would also say that there is this timing that Michael referred to where we're seeing a slightly dissent pattern than we do in the physical world, where we're seeing significant growth in the December and March quarters somewhat less growth in the June and September quarters as gift Cards and new devices, et cetera, enter the market around the fourth quarter and then play out into the first few months of the next year.

So I don't know whether that pattern is going to continue, whether it will remain, whether it will change, but for '05 and '06, it seems to be a pattern that, at least, is developed for those couple of years.

I had one follow-up, if I could, as well on that topic.

A year ago when we initiated coverage, we had done a study that showed that when consumers start buying digital products, their physical purchases do not decline, i.e. their total purchases remain relatively constant.

We just redid the study and I was looking at the results on the plane last night and it looks like that same cohort of shoppers, after they've been buying digital for a year, are actually increasing their purchases.

Do you have any sense of whether that's what you're seeing in the business, as well?

We continue to do consumer work, as well, but I guess I would just point you to our results and just say, yes, we're seeing strength in the recorded music business as a result of more people buying more music.

Then on top of that, frankly, more people are buying more of our music because we've had specific A&R success.

We're certainly seeing support for your research results in our financial results.

Thank you.

Our next question comes from [Eric Hamler] and please state your company name.

Thank you.

Lehman Brothers.

Can you give a little perspective on the publishing business, specifically with the growth in digital, when that begins to offset some of the declines that you're seeing in synchronization and some of the other areas within publishing?

As you know the publishing business, even in digital, lags by about 12 months the recorded music business and reflects so that our '06 income in publishing would reflect our, essentially, '06 market results, and so on.

Also, publishing has not yet -- is accounted for on a cash basis, so we don't account for publishing or any other kind of revenue unless it is actually received.

And there remains a fair amount of royalties that the publishers-- this is not just Warner/Chappell -- but the publishing industry which have been accrued by the recording music industries but not yet paid to the publishing industry, which we expect will increase our overall percentage of digital revenue in publishing once those cash flows start to flow through our income statement.

I think on top of that, what we've said is given the fact the new management came in a little less than a year ago, and has been working hard to turn the business around but that results are delayed for a year, that you're going to start seeing both digital growth and other growth coming from publishing, but more likely in our '07 results than our '06 results.

Thank you.

Our next question comes from Richard Greenfield and please state your company name.

Good morning. ,Rich Greenfield Pali Research.

Two questions.

One, first in terms of the free cash flow given the strength of your EBITDA -- revenues in EBITDA in the quarter, could you just walk us through what was the pressure on free cash flow?

Was this just a timing issue related to working capital or is there something else going on within that number and how should we think about it going forward, if it was a timing issue?

And then two, you made a change in your disclosure related to the breakout of international and domestic revenue, something you'd done at the end of the year, but not on a quarterly basis.

It, obviously, is very helpful in comparing your results to other company in the sector.

But just wondering why you decided to make the change now?

Thanks.

On the working capital, Rich, it really is just a working capital timing issue, and, in particular, it's somewhat tied to our release schedule.

This quarter we had more of our releases and a lot more of our revenue come from releases in the March quarter -- in the March month and, therefore, later in the quarter, and, therefore, we didn't have collections on those releases.

You can see that in the receivables balance.

The big driver in terms of the change in our cash flow and cash conversion is really just a working capital movement that should work itself out over the next quarter or two much.

What was negative working capital?

I don't have the number right in front of me, but I can get back to you on it.

In terms of the disclosure, I don't think there was anything special to the timing.

We continue to try and -- we continue to try and add more disclosure and make our results more transparent for focus.

Thanks.

Our next question is from Bishop Sheen and please state your company name.

Wachovia Securities.

Thanks for taking the call.

Hi, Edgar, Michael, Jill..

Two questions I guess related more to the digital.

One, Edgar, are you seeing any improvement or change in the way the international digital accounting is developing?

And, two, can you give us a breakdown of what you're seeing and any change in downloading track phone line versus ringtone and ringbacks?

Bishop, I think -- let me answer that in order.

Our international growth in digital, I think, is out pacing our domestic growth because that market's beginning to develop and we are getting much more aggressive about our initiatives internationally.

As an example, as I mentioned when I was speaking earlier, we had really quite a landmark, I think, for the industry which was to have a single become the number one single in the UK from downloads, only.

First time that's ever happened.

So the digital marketplace is beginning to gain traction internationally, just at the same time that our A&R traction is really taking hold, so we think that all goes well for continued international growth.

What about the accounting standards and settlement and that kind of thing?

Is that developing on par with U.S. settlement in backroom accounting?

Bishop, I am not sure I understand the question.

In international I thought that the actual recognition of digital revenues and what the --what I call the settlement, the backroom, wasn't quite as developed as what you were seeing in the U.S.

Yes, I guess what I would say is it's equally undeveloped every where.

I think one of the challenges that we're all seeing across the recorded music and publishing business is that the digital business has a large volume of transactions at very small rates and every company and the publishing agencies, everyone, are struggling to understand how we're going to communicate that amongst ourselves and make sure that we can report appropriately.

Okay.

The second is sort of a break out between ringtone, ringbacks and more traditional downloading tracks online.

As I said before, our mobile and download business splits about 50/50.

It varies a little bit geographically, so U.S. has been heavier downloads.

Overseas has been heavier mobile and ringtones.

That distinction is blurring, as the mobile carriers start to carry over the air downloads.

Not exactly sure how you make a distinction between that and a download to a computer directly.

More to follow on how we'll report that, but nothing unusual this quarter in our digital performance in one category or the other.

We had strong performance across the mobile market, the ringtone and ringback market, as well as the download market.

Very good.

Thanks for the color.

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

Good morning.

Citigroup.

Three quick questions.

The first is just on the U.S. market, if you Xed out your growth and your market share, I guess the rest of the market was flat.

Are you very optimistic. still. about the health of the overall market, not just your market share [inaudible] very well, kind of as you look to the rest of 2006?

Then secondly, you talked about your growth in Europe, you talked about a couple bright spots in Italy and the UK, could you give us a sense of what the overall market growth is for some of the major markets, like Japan and the UK.?

The final question is on the various arbitrations which are coming up.

Is there any more kind of clarity on the timing of, particularly, satellite radio and are you any more positive or negative, as a result of conversations you've had across the -- with the different industries over the last six months or so?

Thanks.

Mark, it is Edgar.

Let me go to the last question first.

I don't think we have an update for you on any kind of arbitration with satellite radio or any other industries., so I don't think there is any new news there to add one-way or the other.

Okay.

I think in terms of the overall market -- in terms of the overall market here in the U.S., the market is, I would say, okay.

It's not robust and it's not showing significant weakness.

I think the SoundScan results are sort of modest declines for the physical business.

And so, I think that we're -- you know, it's hard to project, and we don't like to project, but I think that's what we're seeing now.

I think the only thing I would add in terms of the UK market looks like it is doing reasonably well, and we don't see any significant changes in terms of the international arena that should -- you know, there is a mix of strong and weak markets.

UK has been doing well.

France had some weakness as an overall music market.

The Japan music market is a little bit -- showing some signs of strength.

I think it is a mix of markets, but I think our Q2 results are sort of reflective of that mix.

Thank you very much.

Our next question is from Steve Lidberg and please state your company name.

Good morning.

Pacific Crest Securities.

First of all with regard to the digital business, as you look at the online component, are you seeing any shift with regards to single downloads versus full albums, and maybe a contribution of each would be helpful?

Secondly, with regard to kind of the A&R activity and specifically some of the new labels Asylum and East West, why the structural change in terms of -- I guess, that you made during the quarter?

And lastly, as you look at the success of those initiatives, what are you seeing in terms of kind of the impact on the model?

Steve, let me -- it's Michael.

Let me start with the question on downloads, single tracks versus albums.

I think what we continue to see is when we offer the consumer a unique digital product like the digital album bundles, there is no question, as we look at our results, we are driving people from purchasing single tracks one or a few at a time to those bundles.

And we've definitely seen a pick-up in bundled album purchases versus track purchases on those.

It is obviously a little hard to do apples-to-apples comparison because it is hard to set a control, but that's really been the primary focus of our creative energy is getting the digital album bundles up and running at higher price points and higher margin points, as well.

I think on the independent label group we've seen really significant success for our Incubator initiative at East West and, particularly, at Asylum.

We've begun this new initiative at Cordless, which is the digital-only label, and we see significant relationships amongst all of those businesses.

And we want to make sure there's enough information flow and communication as between all of those businesses, which is why we took the President of Asylum, Todd Moskowitz, and made him head of an integrated independent label group.

And I think that that whole model has had -- that whole model has had an impact on our earnings, and if you look at the percentage of our revenue from the independent sector, both through ADA and the growth of Incubators themselves and the artists that have been upstreamed to our major labels.

Across the board it has resulted in increased market share and increased profitability because, of course, we're signing labels and artists earlier in their careers, therefore, at lower cost, and that's a very positive development for the Company.

Thank you.

Our next question does come from P. J. McNealy and please state your company name.

Good morning.

American Technology Research.

Two questions this morning.

The first is you talked about 100 SKUs for one artist.

Is this going to be the typical approach for the entire catalog moving forward, and just to put that SKU count in perspective, how many SKUs are we talking about for artists say, for example, three years ago?

I think you will -- well, to answer your second question first, we're pretty much talking about three.

An album, a single and a music video.

I think being, unfortunately, now with an old pro at the consumer products business, one of the things that you generally don't like to see is this kind of SKU proliferation, but the great thing for our business is these are digital SKUs.

We have really no increased cost of inventory as a result of having so many SKUs.

We have no real increase in cost of developing the SKUs because almost all of the SKUs are simply slicing and dicing the original three SKUs that we've been promoting and developing for 20 odd years.

So with very little incremental -- some no or incremental costs to either inventory or the develop of the SKUs, it gives us the opportunity to market to so many different consumers and so many different kinds of product and, therefore, increase both our revenue and our margin, as a result.

I think you will definitely will see us continue to do that, both significantly increase our SKU development for new releases but also look for opportunities to do the same in catalog.

And this is what we've been talking about in terms of becoming a music-based content company rather than a songs and records company, which is what we and the industry have been for so long.

The digital opportunity for us allows us not only to grow our revenue through increased distribution, but through increased product portfolio well beyond our horizons that existed three or five years ago.

And then just one follow-up, when -- about digital.

What are your expectations or what kind of color can you give us around your expectations for the launches of the music services from M TV and Amazon and how should we think about those launches in relation to what they can do to your digital revenue?

I don't think we should project.

I think first of all we can't predict the success of MTV or Amazon, although we wish every launch well and we're working with all of them to try to make sure they can serve their consumers to the best and best way possible.

I think until new services gain traction, I don't think you should really think about our adding or subtracting from our digital growth.

Thank you.

Our next question is from Tuna Amobi and please state your company name.

Hi, this is Standard and Poor's Equity Group.

Most of my questions have been asked. but I wanted to focus on the Ryko acquisition, which I realize is a very small deal.

I wanted to get a sense of how deal would fit into your current label structure and if you can provide any incremental and EBITDA you expect this from that transaction, that would be helpful.

Thanks, Tuna.

In terms of how it is going to fit, we -- Ryko is primarily a distribution business that distributes a large number of independent labels and is really a complement to our WEA business, which is our U.S. distributor, our ADA business, which is our independent label group and as well as our Rhino business, which does compilations, primarily and markets special packages.

Ryko has pieces in all of those business.

The different pieces will be put into the different pieces of our business integrated in.

That one thing that's important to note is that we do think the Ryko distribution business, for its set of independent labels, is a great asset unto itself, so it will continue as a distribution business, separate from but part of WEA and ADA, and we'll work closely to leverage all of the infrastructure and assets we have in place throughout the U.S.

Any incremental numbers that you can provide in terms of impact?

We haven't other than saying it won't have a substantial impact to our results for the balance of this year.

And is that all cash deal or was any cash and stock transaction?

No, it's an all-cash deal.

Thank you very much.

Our last question is from Jason Bazinet and please state your company name.

Citigroup.

My questions have been answered.

Thank you.

I just want to thank everyone for your time and attention to the call.

Again, we are very proud of our results, very pleased to be able to share them with you and look forward to being back with you on the call again in three months with Q3 results.

Thanks very much.

That does conclude today's conference.

You may disconnect at this time.