Warner Music Group Corp (WMG) 2007 Q4 法說會逐字稿

(Audio difficulties) I would like to turn today's call over to your host.

You may begin.

(Audio difficulties) --we'll update you on our business strategy and our EVP and CFO Michael Fleisher will discuss fiscal fourth quarter and full-year results, then Edgar will wrap up before we take your questions.

Before Edgar's comments let me remind you that this communication includes forward-looking statements that reflect the current views of Warner Music from 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 estimate's of our future performance such as the success of future album sales, projected digital sales increases and declines in physical sales, expected expansion of the on-line marketplace, the success of strategic actions we are taking to accelerate our transformation as we redefine our role in the music industry 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's 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-K and other filings.

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

We have provided schedules reconciling these results to our GAAP results in our earnings press release posted on our website.

With that, let me turn it over to Edgar.

Thanks, Jill.

Welcome everyone.

Thank you all for joining us.

This year has proven to be a year of real challenge in the Recorded Music industry.

Physical sales declines has accelerated.

Digital growth and particularly mobile have been on a slower trajectory than initial expectations.

These are real and serious issues and we are focused on managing through them effectively.

This is a time of fundamental Recorded Music industry transition.

And industry transformation of this scale is and will continue to be unpredictable and difficult by its nature.

Nonetheless we believe we have the right strategy in place to effectively navigate through these challenging times.

There are two things that remain abundantly clear even today, that the changes affecting the Recorded Music business also offer tremendous opportunity, even with the problems facing the physical side of the business more music is being consumed today than ever before in more ways than ever before, and that the transformation of the Recorded Music business will require not only a creative approach to broadening our business models but also leadership, financial discipline, and resilience.

We have exhibited these characteristics with our aggressive moves in the online and mobile arenas, our responsible and more comprehensive approach to artist negotiations, our continual review of our organization and its ability to compete in the current environment and our expanding and altering of our business models.

Despite significant Recorded Music industry head winds it's important to recognize the meaningful progress we've made towards our strategic goals comparing our fiscal '07 to '06, digital revenue grew 30% to $460 million.

We continued to realign our workforce to accelerate our transformation.

We generated significant free cash flow ending the fiscal year with a cash balance of $333 million.

We reached numerous partnerships and made a number of acquisitions that have strengthened our competitive position in our traditional businesses and have given us an initial presence in the broader music business that will be increasingly meaningful to us going forward.

We believe that our ongoing success will require true partnerships with artists and a commitment to nurturing and growing all facets of their careers.

Among the things important to our ongoing success at Warner Music we are creating a first in class infrastructure that will enable us to develop mutually beneficial broad ranging partnerships with our artists.

Discovering and promoting artists and developing artist brands is the foundation upon which Warner Music was built and the driving principal that guides us today.

Our unique and essential role in finding new artists with the greatest long-term potential and then maximizing that potential over the course of a career comes from carefully piecing together an intricate mosaic of business opportunities individually suited to the artist.

We see our value to artists as an enduring one despite the record industries changing economics and the entrance of new competitors, and we see the role of record companies, or rather, music based content companies such as Warner Music expanding over time.

As we discussed last quarter we continue to take decisive steps to broaden Warner Music's position in the music value chain beyond Recorded Music and Music Publishing by working side by side with artists to exploit growing areas of the business such as sponsorship, fan club, merchandising, touring, and artist management and participating in those revenue streams.

We are also continuing to expand beyond transactional business models into areas that include increased licensing and other opportunities.

All of those revenue streams are derived from the artist brands we help to create.

We believe that strengthening our already significant capabilities in the nontraditional music areas will not only assist us in diversifying our revenue streams to better capitalize on the growth areas of the music area but will also foster deeper and longer-term relationships with artists and more effectively connect artists with their fans.

Turning now to quarterly results, I'll discuss with you today some key performance metrics, the important strategic actions we're taking to accelerate our transformation as we redefine our role in the broader music industry, and notable steps we are taking on the A&R side to build brand equity for our artist roster.

As I mentioned, this proved to be another tough quarter for the Recorded Music industry.

Even so we delivered sequential year-over-year improvement in our quarterly revenue and delivered domestic market share gains.

Michael will discuss the detailed financial data but there are several performance metrics that highlight the progress Warner Music is making towards achieving our strategic objectives.

Warner Music outpaced the U.S.

recorded industry again in the quarter.

September quarter SoundScan album share rose nearly 2 points year-over-year to 21%, the second consecutive quarter our share remained at a level not seen by Warner in over 10 years.

At the same time, we managed costs effectively and grew OIBDA margins in the quarter while successfully completing our realignment plan announced earlier this year.

We remain committed to the expansion of digital revenue streams in the face of the shrinking physical Recorded Music business.

Warner Music Group has consistently reported digital album share in the U.S.

substantially above its physical share and this September quarter was no different.

Moreover we had quarterly digital revenue of 130 million, a sequential improvement of 9%, and a 25% gain compared to the same quarter last year.

On a percentage of total revenue basis, we remain a leader in digital revenue among the majors.

This quarter our digital revenue was 15% of our total revenue and was 20% of our total U.S.

Recorded Music revenue.

Before highlighting some A&R achievements I'd like to update you on some of the strategic actions we're taking to lay the foundation for future growth including partnering with our artists to exploit additional revenue streams around the world, fostering creative business models to maximize our potential in both the mobile and on-line worlds and establishing a direct relationship between our artist and their fans.

As we discussed last quarter, we are working to optimize the value of our investment in recording artists by broadening the number of revenue streams in which we participate.

This strategy has existed for sometime in Asia where our arrangements with recording artists include touring, merchandise, sponsorship, and artist management.

These revenue streams already represent between 5 and 15% of total Recorded Music revenue in some of our Asian territories.

Two recent developments in Asia that should serve to propel these overs further, first, we acquired a 70% stake in Taisuke, a leading artist services company in Japan.

Taisuke is an oral rights music company with activities spanning artist management, Recorded Music, and music publishing.

The company's roster includes artists signed to Warner Music Japan as well as other labels.

Second, our acquisition of the independent record label Vitamin Entertainment will strengthen our revenue opportunities in South Korea, a region where digital represents nearly 60% of total music consumption.

Advancing our digital agenda with creative business solutions also remains a priority.

For example, underscoring the potential of mobile subscription models.

Vodafone will soon roll out Music Station giving customers the ability to download more than one million tracks, including our repertoire direct to their handsets.

We see this as an important first step in the direction that we expect the mobile business to develop.

A natural extension of our transformation is to not only expand our presence in the mobile and on-line channels but also to redefine our role by creating a direct link between our artists and their fans.

By establishing a robust direct to consumer infrastructure our artists and their fans will be able to communicate frequently, not just every year or so when an album gets released.

Also, by windowing our offerings over an extended time line, that is, by releasing customized artist content through different formats and channels at different prices and times we can better maximize an artist's revenue potential as well as their consumer connection.

Our D to C and windowing plans will fundamentally change the way we create and market content.

More broadly we will look to expand our music-based video products in addition to our audio content uniquely designed for different platforms.

In the mobile world we already have bundled mobile offerings with Motorola and KDDI in Japan.

We are also creating high-quality music-based programming for the broadcast, on-line, and mobile platforms, such music-based video content -- as music-based video content becomes a more important product for consumers.

Moving to A&R, building artist brands is central to our A&R strategy and Warner Music has an incredibly rich history of artists.

Both legendary and new.

Warner Music is home to legendary bands including the Grateful Dead, Led Zeppelin, The Doors, Eric Clapton, Neal Young, Fleetwood Mac and many others.

Developing artists that are reaching fresh career highs and developing artists include Josh Groban, Michael Buble, My Chemical Romance, Gym Class Heroes, and Paramore, a group we signed to an expanded rights deal.

Perhaps one of the best examples of a band with whom we have built a long and enduring relationship over almost four decades is Led Zeppelin.

This month, Led Zeppelin, one of the greatest bands of all time, a band that has sold more than 300 million albums worldwide officially released their recordings to legitimate digital platforms.

Atlantic Records and Rhino Entertainment also released Mothership, a 24-track, 2-CD comprehensive collection that spans Led Zeppelin's career.

In addition, Verizon Wireless became the first exclusive mobile music service provider for Led Zeppelin's ringtones, ring back tones, alert tones, and wallpapers as well as full song over the air downloads.

Imeem, a leading social media network will promote Led Zeppelin's historic concert video clips and offer an interactive video fan contest.

In fact, last week, eight of Led Zeppelin's albums were in iTunes top 100 albums, including Mothership at number two and the Led Zeppelin complete box set which cost $99 at number 12.

Led Zeppelin's popularity is at an all time high.

The band recently announced a one-night reunion concert for charity to be held in London as a tribute to our own Ahmet Ertegun, founder of Atlantic Records.

An on-line lottery for the 14,000 tickets attracted upwards of 20 million fans who registered in an attempt to purchase a ticket.

We derive a dual revenue stream from Led Zeppelin for both recorded music and music publishing.

In another important recent development, we are delighted that Warner Music and the family of Frank Sinatra have established a worldwide partnership to integrate content, rights management, and the preservation of the legendary entertainer's inspirational personality and prodigious body of work under a single entity.

The partnership will operate under the name Frank Sinatra Enterprises, or FSE, and will manage all aspects of Sinatra's artistic contribution to music, film, and stage.

FSE will also administer all licenses for the use of Sinatra's name and likeness.

FSE will own Sinatra recordings from the reprise era as well as a treasure trove of films, television specials, and unreleased footage, photos, and audio recordings which collectively represent one of the foremost bodies of artistic work of the modern era.

FSE will also own and manage Sinatra's name and likeness rights and will represent the artist rights to the Columbia and Capital catalogs.

This deal, in addition to the agreement we reached with the Grateful Dead whereby we manage virtually every facet of the artist branding is an important step in the diversification of our business models and the expansion of our revenue streams.

Getting back to some of the specifics on the September quarter for the industry total U.S.

album sales including digital track equivalents fell 7% on a year-over-year basis, yet again Warner Music handily outpaced the industry and actually grew total album equivalents units by 1%.

In the U.S.

we gained roughly 1.5 percentage points of quarterly album share year-over-year in both current and catalog albums.

Perhaps best highlighting our successful approach to A&R over the past few years is the fact that Warner Brothers Records and Atlantic Records are the top two labels for U.S.

album share in both the September quarter and calendar year to date.

Our outperformance in the U.S.

only paints part of the picture.

We did see mixed results internationally.

While we had an outstanding year in Japan, overall a light local and international release schedule coupled with a challenged Recorded Music industry backdrop limited our performance particularly in the U.K.

We are addressing this issue and expect improved performance from the U.K.

in 2008.

In addition to the steps already taken by Warner Music International to invigorate our competitive positioning outside the U.S.

over the next year.

Getting Music Publishing on a more stable footing was a key priority for us this fiscal year.

I'm happy to report we've made solid strides in establishing more consistent operating performance and this quarter was the third consecutive quarter of improving revenue and OIBDA year-over-year.

Warner Chappell, which boasts one of the most valuable global libraries in the industry enjoys a stable diversified revenue stream from its more than 1.3 million copyrights and more than 65,000 song writers and composers.

Warner Chappell also has strong OIBDA to free cash flow conversion, favorable working capital dynamics, and low capital requirements.

We have invested in this business to drive long-term success by signing and resigning key song writers, moving into the production music business with our already announced acquisition of Nonstop Music and enhancing our existing management team with a deep bench of seasoned Music Publishing executives.

Continuing its tradition of industry recognition Warner Chappell recently received top honors at the seventh annual BMI Urban Music Awards as top publisher of the year.

In addition, Warner Chappell Music song writers and producers were recognized at the eighth annual Latin Grammys for best new artist, best urban music album, best urban song, best singer/song writer album, and producer of the year.

In all Warner Chappell song writers and producers contributed to nearly a dozen Latin Grammy award winning songs and albums.

As we've consistently said our release schedule varies from quarter to quarter resulting in variable performance between periods and the transformation of the industry will heighten this variability.

The pace of technological introductions and our ability to develop new innovative products and business models to diversify our revenue streams remained a key factor in the progress of our business.

We firmly belief these efforts will be successful over time but recognize the transition will be a multiyear process.

As always, we remain focused on improving Warner Music's results while developing a more powerful foundation to enhance shareholder value.

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

Thank you, Edgar, and good morning, everyone.

Let me begin by providing some context on our quarterly financial results.

First to get some housekeeping out of the way you may have noticed that we changed the presentation of some of our financials is in our press release and 10-K.

Based on a routine review of our financials by the SEC we were given some suggestions on how to present our numbers which we adopted, and there are no outstanding SEC comments remaining.

As you may know, the SEC generally prefers that companies present operating results without adjustment for items they do not perceive to be one-time in nature.

Throughout my discussions of our results I will point out material items that are not comparable for informational purposes.

For the quarter, we reported net income of $5 million, or $0.03 per share.

Looking at the income statement for the three months ended September 30, 2007, we reported revenue of $869 million, which grew 2% from the same period last year and fell 2% on a constant currency basis.

An ongoing challenging environment for physical Recorded Music sales is clearly evident in our results not only for the quarter but also for the entire fiscal year.

During the fiscal year period our revenue fell to $3.4 billion, a decline of 4% or 7% on on a constant currency basis.

Domestic revenue slipped 2%, while international revenue fell 11% on a constant currency basis.

Top sellers for the year were Linkin Park, Josh Groban, Michael Buble, James Blunt, and My Chemical Romance.

Worldwide we had 14 releases that sold more than 1 million units this fiscal year and 27 releases that sold between 500,000 and 1 million units.

Total quarterly revenue gains in the U.S.

and flat European results were offset by declines in the Latin America and Asia Pacific regions.

Domestic revenue grew 6% while international revenue fell 8% on a constant currency basis.

Declines in our physical Recorded Music business were the primary reason for the drop in total worldwide revenue but they were partially offset by year-over-year revenue increases in our digital Recorded Music business and to a lesser extent our Music Publishing business.

In Recorded Music, constant currency quarterly revenue declines primarily in the U.K., Spain, France, and Japan were partially offset by revenue increases in the U.S., Germany, Italy, and other European markets.

Overall, total quarterly digital revenue rose 25% to $130 million, or 15% of total revenue versus 12% of total revenue in the prior year quarter.

Quarterly digital revenue rose sequentially by 9% as strong global on-line and international mobile performance was partially offset buy domestic mobile declines.

Approximately 65% of our total digital revenue was generated in the U.S.

and 35% in the rest of the world.

Our worldwide digital revenue stands at about 65% on-line and 35% mobile.

In the U.S., on-line remains a larger share of our digital business than mobile.

Internationally, on-line and mobile are similar in size.

Mobile is weaker than we would like to see as ring tone sales have lost some luster and new products such as ring-back tones, full track downloads, and other more innovative offerings are taking time to develop.

Several gating factors that impact the pace of change in the mobile industry, include interoperability, 3G penetration, mobile consumer interfaces, consumer education, and pricing.

Logically, as the penetration of high-quality music-enabled handsets improves and some of these other issues are dealt with the mobile contribution to digital revenue should grow.

As we indicated last quarter, we are pleased to see the iPhone raising the profile of music on mobile handsets, and this holiday season should have an outpouring of exciting competitive mobile products.

As Edgar has discussed, we are broadening our approach to the Recorded Music business to mitigate our exposure to current industry trends.

We're diversifying into growth areas of the music business that include sponsorship, touring, merchandise, and artist management to drive overall revenue growth.

It will take some time for the rise in these newer revenue streams, combined with the continued growth of digital sales to overtake the effect of the decline of the physical Recorded Music business.

We remain optimistic that the future for Warner Music is bright given that the demand for music is as strong as it's ever been and we are determined to exploit the right business models to capture that demand.

While transforming our business mix, we remain vigilant about managing our costs.

This was evident in our quarterly results.

In May we announced a global realignment plan designed to advance our longstanding digital strategy and efforts to build a more progressive organization equipped to take advantage of the changing global music market.

For example, we are modernizing our sales force, outsourcing certain IT processes, and investing in people with expertise in video production, advertising, and mobile and on-line sales.

As expected, we incurred all of the restructuring costs associated with our announced realignment plan by the end of our fiscal year.

During the quarter we took restructuring related charges of $9 million for our realignment efforts bringing our total restructuring related charges to $63 million better than our forecasted range of 65 million to $80 million.

As we've said, we expect our business initiatives, our new business initiatives to largely offset the economic effects of our realignment plan.

The very nature of our realignment is to redirect the benefits of cost savings from the physical side of the business towards transformational spending initiatives designed to drive faster growth at the Company.

As I previously mentioned we have a few items that impact period to period comparisons that we want to point out for informational purposes.

For the fourth quarter of fiscal 2007, our results included $9 million in restructuring and implementation expenses related to our realignment initiative, $5 million of which related to Recorded Music, $1 million to Music Publishing, and the remainder in corporate.

In addition we had a $12 million benefit in Recorded Music from the final allocation of royalty payable balances to artist accounts linked to the settlement with Bertelsmann regarding Napster.

In fiscal year 2006 fourth quarter results included a $13 million benefit in Recorded Music, related to our settlement regarding Kazaa.

Our operating income before depreciation and amortization, or OIBDA for the quarter rose 6.3% to $134 million.

Margins expanded to 15.4% as an increase in higher margin digital sales and a decrease in compensation were partially offset by a decline in physical sales, increased product costs, and the costs associated with our realignment plan.

For the full fiscal year our OIBDA fell 11% to $461 million.

This included $63 million in expenses related to our realignment initiative, a $64 million benefit from the settlement with Bertelsmann regarding Napster, and $9 million in expenses related to our previously disclosed proposed acquisition of EMI.

In fiscal year 2006 results included a $13 million benefit in Recorded Music related to our settlement regarding Kazaa.

Our OIBDA margin contracted 1.1 percentage points to 13.6% because of higher product costs, realignment plan expenses, and negative operating leverage from lower sales on a similar fixed cost base that was particularly evident early in the fiscal year.

This is partially offset by an increase in higher margin digital sales, the benefit of the Napster settlement, and a decrease in annual bonus compensation.

Let's now look at our different business segments.

Quarterly Recorded Music revenue fell 2% to $736 million on a constant currency basis.

Declines in international markets were responsible for the revenue weakness.

Quarterly domestic Recorded Music revenue rose 8% year-over-year, helped by easier comparisons.

Releases from Linkin Park, Matchbox 20, James Blunt, Smashing Pumpkins, and Nickelback from our highly successful Roadrunner joint venture drove results.

International Recorded Music revenue fell 11% on a constant currency basis from the prior year as industry pressures and a lighter slate of both local and major international releases limited results.

Tough comparisons have started to impact results in the Asia Pacific region which enjoyed solid performance over the past year.

Local repertoire from Japanese recording artists Ayaka and Kobukuro were key drivers to Japan's huge success in fiscal 2007.

Nevertheless despite the soft fourth quarter our Japanese Recorded Music Company operating in the world's second largest music market after the U.S.

still delivered a 25% year-over-year revenue gain for the full fiscal year.

Recorded Musics digital revenue grew 28% from the prior year quarter to $124 million or 17% of total Recorded Music revenue, up from 13% in the same period last year.

Domestic Recorded Music digital revenue amounted to $80 million, or 20% of total domestic recorded music revenue up from 19% last year.

Quarterly Recorded Music OIBDA advanced 3% to $104 million which includes the previously mentioned items.

Moving on to our Music Publishing business, in comparison to the same quarterly period in 2006, Music Publishing revenue grew 7% to $137 million, or up 1% on a constant currency basis.

Music Publishing revenue grew 16% internationally, or 5% on a constant currency basis, more than offsetting a 6% domestic revenue decline.

On a constant currency basis the improvement in total Music Publishing revenue was the result of an increase in performance revenue partially offset by declines in mechanical and synchronization revenues.

Music Publishing OIBDA was $55 million, up 4% from the prior year quarter including $1 million in expenses related to our realignment initiatives.

As Edgar said we are pleased to see a more stable performance from this business over the past few quarters.

As for our cash management and our balance sheet, we ended the quarter with a cash balance of $333 million.

Total net debt amounted to approximately $1.9 billion which reflects total debt less cash.

For the quarter, we had a negative free cash flow of $48 million.

Our free cash flow is calculated by taking cash from operations of $105 million, less capital expenditures of $8 million, and net cash paid for investments of $145 million.

Cash balances in the calculation of free cash flow in the fourth quarter of 2007 reflect the previously disclosed investment of 110 million in front line management.

Unlevered after-tax cash flow calculated by adding back $15 million in cash interest to free cash flow was negative $33 million for the quarter.

We booked income tax expense of $49 million for fiscal 2007 compared to $47 million for fiscal 2006.

For the three months ended September 30, 2007, we had net cash refunds of $1 million, and we had a tax provision of $22 million on pretax income of $27 million.

Our tax expense includes income taxes accrued mainly outside the U.S., and withholding taxes paid to non-U.S.

countries where we generate royalty income from sales of repertoire outside of the U.S.

Our taxes will fluctuate based on which jurisdictions income is generated overseas.

For the year ended September 30, 2007, we paid net cash income taxes of $44 million.

Substantially all of our income taxes are being paid outside the U.S.

because our U.S.

taxable income is being offset by our interest expense deduction and the annual recurring noncash deduction related to the amortization of the purchase price paid to Time Warner for Warner Music Group.

At September 30, 2007, we had a U.S.

tax loss carry-over of $200 million and foreign tax credit carry-overs of $56 million.

These carry-overs will be available to reduce our U.S.

income taxes in future years.

As we have consistently said, we do not manage our business for any single quarter.

We strive to release the right content at the right time in an effort to maximize fiscal year profit potential and artist career development.

As a matter of policy we do not provide financial guidance to the investment community given the quarterly fluctuations in the rhythm of our music release schedule and associated marketing and promotional expenses are normal.

While recognizing the challenges ahead we are confident in our future.

In addition, we remain focused on sustaining our financial discipline and digital leadership.

Now I would like to turn the call back to Edgar for some closing remarks.

Thanks, Michael.

Before we go to your questions I just want to summarize by saying that while this has been a challenging year it's also not fully unexpected in the time of such fundamental transition but it's clear that this time of transformation also offers great opportunity for those companies who understand where the music business is going and have a progressive strategy in place and the passion to get them there.

Looking ahead, our agenda over the next fiscal year will be focused on several years.

We plan to remain vigilant in managing costs while transitioning the business back to its growth trajectory, we'll broaden our partnership with artists and consumers to add new revenue streams from growing segments of the music business.

We will maintain our digital leadership through continued innovation.

We will expand our business models to take advantage of new opportunities as a result of technological transformation, and we will increase our market share while maximizing our margin potential.

While recognizing we still have much work to do our goal is to drive shareholder value and improve our competitive positioning over the next fiscal year and beyond.

We look forward to answering your questions about our business.

Thank you, and operator would you please open it up Q&A.

(OPERATOR INSTRUCTIONS) The first question is from Bishop Cheen of Wachovia ?

Thank you for taking the question.

Edgar, if I heard you right I think you gave some very useful color on, let's call it ancillary economics or revenue streams or 360.

You said in Asia it's already representing 5 to 15% of your total revenue, if I have that right.

Can you give us some color on what you think overall you can grow the ancillary part of your business to as a percentage of revenue?

Bishop, just to clarify, the 5 to 15% in Asia is correct.

It's 5 to 15% of Recorded Music as opposed to Recorded Music and Music Publishing.

And while I can't give guidance, in a sense, I think what I would say is we no longer regard these revenue streams as ancillary.

These are going to be core revenue streams, and therefore, they will grow both organically, as we sign artists to 360 deals.

They will grow as a result of infrastructure that we may acquire in order to service those deals, and they will grow as a result of acquisitions in businesses or joint ventures such as the Frank Sinatra deal to expand those streams.

So depending on the pace of acquisition and investment, obviously these revenue streams as a percentage of our total will grow more quickly or not as I said depending on the pace of investment.

But we are really changing our focus from being a Recorded Music company with a couple of extra revenue streams to being a broad based music content company and I think you will see a significant increasing mix of revenues coming from Warner Music.

Very good.

Thank you, Edgar.

The next question is from Doug Mitchelson of Deutsche Bank.

Mr.

Mitchelson, your line is open.

You may ask your question.

Sorry, I had the mute on.

Thanks.

A couple questions.

First for Michael, not an easy one, but are you prepared, from a cost structure standpoint, for a worst case scenario for domestic CD sales next year?

Say CD sales continue to decline at this pace or worse.

You talked about negative operating leverage.

What does your cost structure look like today in the Recorded Music side?

And how do you continue to adapt to that type of environment?

And then secondly, for Edgar, I think you talked a bit about a wireless subscription effort.

Can you talk a little bit about the potential for Nokia to have a big impact on the marketplace?

Where do you think that's going to go?

Thanks.

Thanks, Doug.

Let me start with the cost structure question.

I think the thing you've seen us do, I believe really successfully over the last three years is tightly manage the cost structure of the Company.

And really that strategy has sort of two prongs to it.

One is, a constant day to day managing of where our expenses are going.

So literally every time somebody leaves the Company or we cut an expense, we're trying to be very thoughtful about strategically how do we put those dollars back in the place that we most productive as part of our sort of future and growth strategy.

There's this sort of constant day to day monitoring, and I think we've been very successful at that.

At the same time, we will occasionally, we did it when we first took over the Company, we did it again this past May, we will regularly look at our cost structure as a whole, understand whether we need to take a more aggressive stance in terms of taking out a bigger chunk of costs to redeploy them against the future growth opportunities.

I don't have plans in place do that right now, but at the same time, I tell you this is something that we monitor on a day-to-day basis.

And then lastly, I think one of the things you've seen us do is, as we watch the marketplace and how the market performs, you've watched us execute on our plan A, our plan B, and our plan C.

Right?

We are constantly prepared for the market getting worse or the market getting better and being really ready to know exactly what we're going to execute on if those scenarios play out.

Doug, it's Edgar.

On the wireless subscription I specifically mentioned Vodafone.

But I do think, and your question was around Nokia.

I think that Nokia has the potential to be a very important player.

They're obviously the leading OEM in the world.

I should note that we do not yet have a deal with Nokia to license our content.

We are still in discussions with Nokia, because we think there are things that Nokia has yet to do that it needs to do in order to license our content.

Having said all of that, what I would say is I see a real opportunity in the mobile space going forward.

I think the introduction of the iPhone has been a very positive development and the iPhone has shown the mobile industry, quite frankly, how to create a device that is both enormously attractive and enormously easy to use and to access the content and information that a consumer wants in a really easy and intuitive way.

That has been lacking in the mobile industry.

Whether that's because of the carriers or the OEMs, I really don't know, but now that the competitive environment has been reset bay the iPhone, I think you will see all of the OEMs and all of the carriers engaging in trying to bring much more consumer friendly devices to the market.

And in that context, I can tell you that the mobile industry believes that music is among the top five, in fact, the number two priority that they have in place to increase data revenue.

The number one priority being micro payments, which is okay with me because if the number one priority helps them pay for the number two priority that works out just fine, according to my math.

There's no question that the mobile industry is going to be in a very transformative mode over the next couple of years, and I think music will be one of the foremost content on the mobile platform which I think will only serve to benefit Warner and the rest of the music industry.

So I guess if I paraphrase that, what you're saying is it's a little early to predict whether subscription, whether it's OEM or carrier based, will at some point be kind of the dominant way to distribute music versus purchase to own, it's just a bit early to know which business model is going to be the most valuable over time?

I think it's early to know -- first of all, I think I would say it's early to know whether the OEMs or the carriers will carry the day.

And it's really not my place to make that call.

I think it's also early to say whether purchase to own or subscription will also be the predominant business model, but I would not limit potential business models on mobile to purchase to own or subscription as I see it going forward.

Thank you.

The next question is from Howard Gleicher of Metropolitan West.

Thank you for taking the question.

Edgar, a quick question.

I understand that benefits to a rising or new artist of forming a broader relationship with you.

What are the benefits to an existing artist, though, and you've told me over the years that they are the majority of your revenues, of forming this broader or deeper partnership, as they're already known, and they already have the following, and they can take advantage of other sources of getting distributed digitally and Internet sites?

Why would they allow you to share in a greater portion of their revenues as the physical sales decline?

Sure.

I think first of all, I think the most important comment to make is that within five years newer artists will be established and existing artists, so that as the years unfold, a significantly increasing number of our artists roster will be artists with whom we have a much broader relationship.

With existing artists I think it's clearly -- it's a mix.

Our view is we can do more for the artist and allow the artist to connect more effectively with their fan base if we're involved as partners in all aspects of their career.

I think you will see us coming to agreements with a number of existing artists.

I think you'll see us not coming to agreements with a number of existing artists.

And there will be some agreements that existing artists will sign with others as has been the case with Madonna, where it simply was, in our view, economically imprudent for us to do that deal.

I think you will see a mix.

We think the most important benefit that we derive, is not one of creating a pressure on an artist to do something they would otherwise not want to do.

I think the critical issue here is that we are providing an opportunity for artists to give their consumers, their fans, more, in a more effective, comprehensive way that can build and sustain a better and longer career.

We believe that a number of the newer artists who have already experimented with us have become believers in a very short period of time.

I think we'll be able to continue to demonstrate that to existing artists and to new artists over the next few years.

That was helpful.

Thank you.

The next question is from Jessica Reif Cohen of Merrill Lynch.

Three sets of questions.

The first is on front line.

The $121 million investment, could you just discuss what percent you own?

What are you actually getting?

Do you have any management involvement at all and do you have any options to buy?

Second question is, do you plan on following EMI in decreasing spending to the trade organization?

And then third, could you discuss your outlook for 2008 for pricing, both digital and physical?

Do you expect to see any more pressure, and shelf space here and abroad?

Thanks.

Sure.

On front line, Jessica, we sort of disclosed what we're going to disclose.

$110 million investment, and we haven't disclosed any more than that, in terms of our percentage ownership or future rights or anything else.

We think that the management space is a very important space to us going forward front line is one of, if not the leading management company in the U.S., and in a business we're excited to be a partial owner of and involved in as an owner of that business.

On the other two, Jessica, it's Edgar, we constantly evaluate our contributions to the trade organizations.

We think that both (inaudible) and RIAA do a largely very effective job in promoting our interests in a number of areas both legislatively and in enforcement areas and other.

I think that there will be discussion in the future around (inaudible) and RIAA and their respective roles and responsibilities and how that's organized, but we continue to sort evaluate that situation.

We don't have a position and we're not going to comment obviously on EMI's position.

In terms of 2008 pricing, all I can say is that throughout this period, since we've owned Warner Music, we have fundamentally held our pricing on a wholesale basis, both to the physical and to the digital areas.

I see no reason for that to change in 2008.

With regard to shelf space, I think that you should -- that we anticipate that there will be some continued reduction in shelf space, probably consistent with the decline.

So we think we'll probably see, again, if physical declines are in the mid teens, I would expect to see shelf space overall decline in that area.

But I think also there are a number of physical chains who are more committed to music than others, so it will be a mix between chains, I think netting out to sort of that on average.

And I think that there are opportunities as yet unexplored between music and retail to improve or ameliorate the rate of decline on the physical side of the business while the digital side of the business grows.

Thank you for answering those questions.

Just to go back to Front Line.

I'm curious what actually you get out of this investment?

Well, as I said, well, as Michael said, Front Line is far and away the most important, largest industry business.

It gives us a real insight into how managers think about building their artist careers.

It is, by the way, a very fast growing and profitable business, though just on the basis of an investment it has already been a very good investment for the Company and we expect that that will continue.

And obviously, it positions us in the future, and I will go further than that, to get more into the artist management business as things play out.

So we like our position.

We think Front Line is an outstanding company.

We think Irving Azoff is proving that he is the most visionary of the artist managers in building a large management company, and we thought it made a lot of sense to be in business with him.

Thank you.

The next question is from Jason Bazinet of Citi.

If I look over the last three years, and just look at cash from operations less CapEx, you've done about $650 million.

Around a third of that has gone for the recurring dividend, about 240, which means the balance has really gone for various investments, but two-thirds of your free cash flow.

My question is twofold.

How much have those acquisitions benefited the top line that you're reporting?

And then second, how far along in the evolution of this transition are we?

In other words, are we sort of in the second or third inning of using the firm's free cash for acquisitions, or are we in the eighth or ninth inning?

Thank you.

It is Edgar.

I think if you look at the preponderance of our acquisitions, they have, in terms of the money spent, they have been in the traditional areas of Recorded Music.

However, our single largest investment has been Front Line, which is a minority interest so we don't report its revenue or consolidate its revenue or income into our results, so there has been a mix, Jason, with regard to investment.

I think as we think about going forward, I'm not sure I know how to answer your question whether we're in the second or third inning or the eighth or ninth inning, in terms of investment, but I would say that this is a business in significant transition.

I think we have a very clear idea of the value that we currently create.

I think this are significant opportunities yet to monetize with regard to the value of our current assets, and there are clearly areas we are interested in, excuse me, investing in and participating in within the broader music chain as I've already explained.

And so I think you can -- you'll see us continue to use the free cash flow that we generate to grow the business, and I think that -- we continue to believe that that is the highest and best use of cash and the highest and best return to shareholders.

If you saw a need to invest further than the magnitude of free cash that you generate, would you consider reducing the dividend to make those investments?

I would say that this is a Company with a lot of resources.

It's Company with resources that are well beyond its free cash flow.

I think we've got a good balance sheet.

We've got our free cash flow resources, we've got deep pockets in support of investors, and so I think there are a number of ways that we could contemplate growing our acquisition strategy without contemplating a reduction in the dividend, and beyond that, I assume we're not going to comment, but I would not -- I don't think there's a quid pro quo between the dividend and our acquisition appetite.

Next question is from Richard Greenfield of Pali Research.

Hi, I was just hoping to follow-up on Jason's question.

He had asked regarding how much the acquisitions have actually impacted your Recorded Music revenues.

I think you were down on a constant currency basis about 8% worldwide.

I'm just wondering if you backed out the acquisitions this year what would that down 8% have been?

And then too, Michael you mentioned that bonuses were down, or accrual for bonuses were down year-over-year.

Just wondering if you would give us a sense how significant that reduction in bonuses was year-over-year?

Then just lastly, about how much lag is there in your Music Publishing business right now?

You had about a 1% growth in Music Publishing for the full year on constant currency.

Just wanting to think about as we move into next year, given the acceleration we've seen in the declines of physical, how that might impact 2008's Music Publishing business?

Thanks.

Richard, it's Edgar.

Let me try and tackle the first question, which is around acquisitions in the year.

I think that particularly with regard to this year, I would make the following comment, which is I don't think it's a good way to look at the business, because the principal acquisition that affected revenues this year was Roadrunner, which is a joint venture, but we own the majority of Roadrunner.

That, frankly, is an A&R expenditure.

There were a number of A&R decisions that we made throughout the year where we didn't spend money to either release or acquire artists from other companies.

If that so much is not in my view an acquisition as it is simply one way to make an A&R investment versus a different way to make an A&R investment.

Clearly, and I would say acquisitions in other areas other than what I would call sort of a different way of doing A&R, were frankly immaterial in our revenue results for the year.

Rich, on your other two questions, on the bonus compensation, think if you look at last year's performance, was clearly a really good year, and people were appropriately rewarded for that.

This is a much tougher year, both from an industry and our own performance, and therefore bonuses are down year-over-year.

I don't think that should be shocking or surprising.

We're not going to disclose the specific details of the dollar amounts.

In terms of the lag on music publishing there's a lag on music publishing.

It ranges anywhere, depending on when you make an investment in an artist and where they're at in their career anywhere from 12 to 24 months.

We started making more investments in that business probably about a year ago, so we're starting to see some of the benefits of that.

At the same time, we're continuing to make investments in that business.

I don't think we're saying that the challenges are solved there or that that business is on track the way we want it to be over time.

So you'll continue to see us invest both not only in A&R line but also as we continue to build out our sync capabilities, which is an area we think has great promise for the future but hasn't performed as well, and that's a place where really having the right people in place and the resources in place you can actually actively generate revenues and profits in that business.

Michael, just to follow-up on what Edgar said in terms of Roadrunner, your not owning all of it, it's a joint venture, when you look across you EBITDA for the full year, how much of your EBITDA comes from joint ventures where you don't all of the EBITDA, things like Bad Boy or Roadrunner?

Is there any way to think about that?

It's a very small percentage.

Thank you.

The next question is from Anthony Noto of Goldman Sachs.

This is actually [Ingrid Chung] for Anthony.

The first question I have is, in terms of signing 360 deals with artists what kind of competition have you seen in getting these deals besides Live Nation?

How competitive are the other labels?

And then secondly could you talk about the financial impact from the recent proposed settlements with cable and satellite TV, satellite TV music?

How has this impacted your discussions with satellite radio?

Well, it's Edgar.

On the 360, the competitive nature of 360, we -- I think there's two very different sort of sets of competitive areas.

One is Live Nation, at the end -- at the sort of spectrum of a very established artist with a major touring career.

In competition with other labels I think competition occurs around the normal way of signing artists.

Frankly, to the extent that other labels do not choose a 360 path, it potentially makes them more competitive in terms of signing artists than not.

But that's their business.

We've made a decision about our business and what we intend to do.

And the way we're going to build our business and we're having, I have to say, very satisfying results in talking to artists and in signing artists to true broad, deep partnerships, and we're going to continue to do that and we are not going to continue to sign artists for Recorded Music revenue only.

With regard to satellite radio, and I'm not sure I understand the reference to the cable industry, but as we've said before, the satellite radio arbitration I think will come to -- will be decided, we believe this year before the end of the year.

And as we said, we remain hopeful and reasonably confident that whatever the increase in our license revenues will be, there will be an increase in those revenues.

Okay.

I guess the question about cable and satellite TV music was just do you get much revenue from cable or satellite TV music.

There seems to have been recent proposed settlements for these two distribution streams.

Those are fairly small streams today, Ingrid.

All right, thank you.

The last question comes from Tuna Amobi of Standard & Poor's.

Thanks very much for taking the question.

Edgar, as you think about your digital revenues, in last couple of years it seems like you've added approximately north of 4 to 5% of incremental percentage contributions from digital revenues as a percent of the total revenues of the Company, so looking ahead, how confident are you that you can stay on that trajectory to get to 20% of digital revenue?

I guess my point is that it's looking like the next 5% or so is going to be a lot harder to add than the previous trajectory that you have been on.

So I'm just trying to reconcile your earlier comments on the mobile market and the impact that might have on your digital outlook.

And separately, I had a question on the International Recorded Music.

It just seems like there's a lot more heavy lifting to be done in that business.

I recognize that you're invested in some A&R initiatives there.

So the question is, can you provide some color of how you think that business might turn in fiscal 2008 and any steps that you're currently taking in there, excluding Japan, of course, which has been the only bright spot, so can you provide some color what's going on there, the margins compared to the U.S.

and what steps that you're taking to improve the results there?

Thank you very much.

Let me try and answer both questions.

In terms of the digital growth, I actually -- as we look to our overall revenue growth we think the pace of digital growth is an even more important determinant to returning the industry to overall growth than the decline of physical.

And we are -- I think we've seen the possibility of continuing digital growth and even potentially, though time frames are difficult to predict, even potentially increasing digital growth.

First of all, you have to look at iTunes.

iTunes had another very successful year growing its revenue significantly above overall digital growth.

I see no reason why that cannot continue and should not continue.

I think the mobile industry has been slower than we would have liked in both developing devices and interfaces as well as business models and product to entice consumers to engage in music on the wireless devices.

I think that will change.

I think both because the iPhone introduction is obviously spurring tremendous competition, but also there's further penetration of 3G networks, the further deterioration of voice revenues and the greater need for both OEMs and carriers to find other areas of income and music being one of the most important applications in that pursuit.

So I think, as I said, digital growth is critical to the industry returning to overall growth, and I think as a result of an increasingly useful and hopefully effective platform, wireless will contribute to increasing revenue growth for the industry.

So where do you see that 20% magical number happening?

Is that something you see as imminent, or a couple more years?

With respect to -- I think 20% may be your magical number.

Well, I'm not sure 20% is a magical number one way or the other.

Because to me, 30 or 40% would be more magical than 20%.

But what we don't do is give guidance, and we're not going to make predictions as to how quickly we get there, but I've tried to give you some color.

Okay, that's helpful.

As to the opportunity.

I think with regard to international, it's a mix of tougher markets in '07 than we had in'06, on a general basis, particularly in Europe, and a particularly poor release schedule in the U.K.

Warner Music, as an overall company, has traditionally been dependent on three major markets -- sorry two, major markets for its -- for the majority of its Recorded Music income, and that is the U.S.

and the U.K.

With the tremendous performance and improvement we've seen in Japan over the last couple of years there are now three very large significant markets for Warner Music.

In'07, U.K.

had, in addition to a weaker market, overall a very weak Warner release schedule.

A release schedule we expect to be much -- our release schedule we expect to be much stronger in '08.

We see continued strength from a market share standpoint in many countries in Continental Europe, including Germany, France, Italy, and Spain.

Some of those markets are suffering as markets more than others, but I would say our overall Continental Europe performance, while less than what we had hoped, was actually on a comparable industry basis, reasonably good.

So I think the biggest issue for us internationally was the U.K.

in '07, and I think while that market may well remain soft, there's a lot of simply inter-Warner issues that we can handle, and principally around a release schedule to see a significant improvement year-over-year in the U.K.

What's the margin upside internationally?

Any comment on that?

I'm sorry, Tuna, what was the question?

The margins.

Any color on international Recorded Music margins compared to domestic.

No, nothing other than what we've disclosed in all of our statements.

Thank you.

Thank you, everyone, for joining us on this call.

Let me take this occasion to wish you and your families a happy holiday, happy and healthy holiday season, and we look forward to talking to you again in a couple of months.

Thanks.