Warner Music Group Corp (WMG) 2008 Q3 法說會逐字稿

Welcome to the Warner Music Group's fiscal third quarter earnings call for the period ended June 30th, 2008.

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

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

(OPERATOR INSTRUCTIONS).

Now I would like to turn today's call over to your host, Ms.

Jill Krutick, Senior Vice President of Investor Relations and Corporate Development.

You may begin.

Thank you very much.

Good morning, everyone.

Welcome to Warner Music Group Corps' fiscal third quarter 2008 conference call.

This morning we issued the press release announcing our results.

If you haven't already seen them, both the press release and our Form 10-Q are available on our website at wmg.com.

Today our Chairman and CEO, Edgar Bronfman Jr.

will update you on our business performance and strategy, and our EVP and CFO, Michael Fleisher will discuss our financial results for the quarter.

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 Group about future events and financial performance.

Words such as "estimates," "expects," "plans," "intends," "believes," "should" and "will," and variations of such words or similar expressions that predict or indicate future events or trends or do not relate to historical matters identify forward-looking statements.

Such statements include, but are not limited, to estimates of our future performance such as success of future album sales, projected digital sales increases and declines in physical sales, expected expansion of the online marketplace, the success of strategic actions we are taking to accelerate our transformation as we redefine our role in the music industry, market share gains, our expected income tax expense for fiscal 2008, and our intentions to deploy our capital including the level of and effectiveness of future A&R investments.

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 expectations 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 in our earnings press release posted on our website.

With that, let me turn it over to Edgar.

Thank you.

Thanks, Jill.

Welcome, everyone.

Thanks for joining us.

I'm pleased to say that once again this quarter we outperformed our competitors while making solid progress in becoming a broad-based music business with more diversified revenue stream.

While the recorded music industry and global economic backdrop remain challenging, Warner Music continues to develop new business solutions, deepen relationships with our partners, maximize returns on our A&R investment, and more effectively align our artists with their fans.

Now let me describe some of our resent achievements and ongoing initiatives aimed at positioning us for future growth.

Highlighting the success of our focused investments in A&R, marketing and promotion we continue to discover and develop successful artists.

This quarter Warner Music again outpaced the industry, down 1% while the industry declined 5% in US track equivalent album unit sales according to SoundScan.

And notably, for the first half of 2008 calendar year, Warner Music was the only music major to grow on the same basis, gaining 1% while the industry declined 5%.

In addition, Warner Music gained nearly 1 percentage point in market share in the quarter, ending the quarter at 21.5%, the sixth consecutive quarter in which we have grown our US share on a year-over-year basis.

Second, in the important digital arena, we continue to be a leader in shaping the future of the music industry.

Our quarterly Digital revenue rose 39% to $166 million, and in the US, digital represented 32% of Recorded Music revenue.

We continue to explore new business models to broaden our consumer reach and align our interests with our partners as we monetize our content more efficiently.

We sustained our competitive lead in to the June quarter with the greatest US digital track equivalent album share advantage over physical album share of any of the music majors.

Third, as part of our transformational effort to expand or role in the music business, we continue to expand our rights in recording agreements with new artists around the world giving us a presence in the broader music and artist service businesses that will be increasingly meaningful to us going forward.

And fourth, we continue to bolster our Music Publishing business by strengthening our artist roster and catalog and expanding our digital presence while delivering consistent results.

Now let me provide you with some detail about these achievements.

A&R, marketing and promotion remain the cornerstones of our business activities.

Our improved recorded music -- US music market share was driven by current releases from artists ranging from Madonna, Disturbed, Plies, to Frank Sinatra.

Sinatra's "Nothing But the Best" was the first album released by our Frank Sinatra Enterprises joint venture with the Sinatra family.

Atlantic and Warner Brothers were the number 1 and 2 labels in the June quarter in the US, according to SoundScan.

Furthermore in this quarter, for the first time since the inception of SoundScan, Warner held the top three weekly positions on the Billboard "Top 200" album chart, with Death Cab for Cutie, Frank Sinatra and Jason Mraz.

In terms of revenue, our international Recorded Music grew nicely, while the US Recorded Music turned in softer results.

Despite our relative US outperformance as measured by SoundScan unit sales, our revenue in the US is based on the dollar-value of shipments and primarily reflects the timing of release and to a lesser extent ongoing efforts by US physical retailers to more actively manage their inventory levels.

We continued to see a pickup in our UK business, while most of the other key European markets benefited from comparisons to our weaker prior-year quarter and stronger local repertoire from such artists as Luis Miguel and [Manade].

In July, the European Commission proposed an extension of the copyright term for sound recordings from 50 to 95 years which would harmonize the European copyright term with that of the US.

This proposal underscores the value of intellectual property and should provide a long-term benefit to artists and to our European Recorded Music business when enacted.

We remain committed to growing our Digital Recorded Music revenue, one of the key drivers to future growth in the Recorded Music business.

As expected, sequentially, we saw modest Digital revenue growth in the post-holiday period, consistent with patterns exhibited in prior years.

While Online Digital revenue picked up globally year-over-year, ring-tone revenue is lagging our expectations in the US and Europe.

We believe as new mobile products and business models are rolled out on a global basis, Mobile revenue growth will accelerate in the US and Europe as it continues to do in Japan.

For example, we are beginning to see measurable global growth in full-track over-the-air downloads.

This quarter we again demonstrated both the success of our Digital strategy, including our ongoing supremacy in the sale of premium album bundles on iTunes, and the strength of our content.

The innovative US launch of Jason Mraz's recent album is a good example.

Based on a three month windowing effort leading up the album's May 13th release date, Atlantic released four singles and two EPs, which are bundles of four or more tracks being sold together.

All of this content was included in a premium album bundle which has a suggested retail price of $20.

The goal of this campaign was to maximize artist exposure and consumer purchase options, thereby enhancing revenue and margin.

This album went on to become a top "Complete My Album" on iTunes, and in the first week, the higher margin premium album bundle out-sold the standard album by almost three to one.

And important step in the evolution of Digital Music is the launch of access models where the purchase of a device is bundled with access to music.

Nokia's "Comes with Music" is a leading example.

We believe all stakeholders will benefit from the access model.

It presents an attractive value proposition for consumers who want to achieve a richer, deeper music experience.

Artists have the opportunity to significantly broaden their fan base.

Record companies, music publishers and artists monetize consumer behavior across vast networks and platforms.

And device manufacturers can drive device purchases, customer retention and data revenue by associating their devices with leading global, and local artists brands and comprehensive music offerings.

Most critically, the access model creates an opportunity to enhance Mobile revenue growth for the music industry by at last aligning the music industry's economic model with the mobile industry's economic model.

With the advent of the access business, both the mobile industry and the music industry will view the world through the same lens - average revenue per user, commonly known as ARPU.

Nokia's "Comes with Music" is expected to launch in the second half of the '08 calendar year on a range of Nokia devices in selected territories, supported by significant marketing resources.

We have reached other access based deals in France with Orange and with the Danish carrier TVC.

Several additional deals are now working their way through our pipeline.

In December, we began offering DRM- Free audio downloads on the Amazon MP3 Digital Music Store which allows every track and album purchased to be playable on practically any digital music device, including iPods.

Extending the strategy, Warner Music has announced a series of MP3 deals in recent months with partners who have agreed to support our product management strategy and product innovation initiatives including Wal-Mart, Napster, and 7digital.

As we have done in the past, we continue to enter into short-term Digital agreements to maintain the greatest flexibility in a dynamic marketplace.

This approach allows us to explore innovative solutions and support different business models to enhance our performance.

And as we've pushed to increase our Digital revenue, we recognize that we must also transform our business within the music value chain while broadening our revenue mix.

We have reached hundreds of expanded rights deals throughout the world with new and developing recording artists by partnering with them in growing areas of the music business, such as sponsorship, fan club, website, merchandising, touring, ticketing and artist management.

In fact, we estimate that we now have expanded rights deals in place for one-third of our active global Recorded Music roster.

Over the past few years we have largely built the necessary footprint through acquisitions, partnerships or new hires so we can now optimize the exploitation of these expanded rights.

We have no single worldwide approach to expanded rights deals with recording artists.

Rather, we tailor that approach to the custom and practice in each territory.

In Japan, management companies rather than record companies traditionally capture the expanded rights of recording artists.

So in Japan in September '07, we acquired a 70% stake in Taisuke, a leading management and artist services company.

This transaction has significantly exceeded our initial expectations.

Superfly, a female rock band for which Taisuke has expanded rights, has gotten off to an exciting start with the number 1 position on the Oricon charts, reaching local platinum sales levels, concert dates across Japan, and a building fan club and merchandising business.

Our revenue contribution from non-traditional revenue sources such as touring, merchandise, artist management, sponsorship, fan club, et cetera, varies greatly by region.

While Asia in aggregate derives about 5% of it's Record Music revenue from these sources, some territories such as China, where piracy has necessitated new business solutions, can be as high as 35%.

One of our principal strategic goals has been to enhance the results of our distinctly valuable Warner/Chappell Music, which is the world's third largest music publishing company.

Warner/Chappell enjoys a stable, diversified revenue stream from it's extraordinary library of songs and has delivered steady performance over the past year.

We continue to invest in talented song writers to support the development of our Music Publishing catalog.

Warner/Chappell recently signed a worldwide publishing agreement for singer/songwriter Katy Perry.

Perry's current single "I Kissed a Girl" has sold more than 1 million online downloads in the US and was number 1 for six consecutive weeks on Billboards "Hot 100," Hot Digital Song" and "Hot Digital Tracks" charts.

Additionally, Perry's songs have appeared on a number of film soundtracks and television shows.

A another Warner/Chappell artist recently topping the charts is Little Wayne.

His new album, "The Carter 3," debuted at number 1 on the Billboard chart in June.

Little Wayne became the first artist since 2005 to sell more than one million units of an album in a single week.

Warner/Chappell also announced the extension of its Worldwide Publishing Agreement with Warner Brothers Record's multi-platinum hard rock band, Disturbed.

Their highly anticipated fourth studio album, "Indestructible," debuted at number 1 on the Billboard 200, marking their third consecutive number 1 US album debut, something only six other rock bands in history have ever done.

We also just extended our Worldwide Publishing Agreement with highly acclaimed musical theater, film and television composer/lyricist, Stephen Sondheim.

Mr.

Sondheim originally signed to Warner/Chappell in 1992.

We will continue to publish his legendary catalog of award-winning work which spans more than 50 years, as well as his future compositions.

Highlighting the overall success of our Music Publishing business, Warner/Chappell was named Publisher of the Year for the sixth year in a row at SESAC's 12th Annual Music Awards.

In June of '06, Warner/Chappell announced its innovative pan-European digital licensing initiative, which was designed to facilitate pan-European licensing of musical compositions for digital music services throughout Europe.

Warner/Chappell has had great success in entering into deals with collection societies to further that initiative.

In July of this year, the European Commission issued a decision which will spur competition among European collection society, thereby fostering pan-European licensing efforts to the benefit of artists, recorded music companies, music publishing companies and digital music services.

We're very pleased with the EC's decision which is well aligned with the goals of our pan-European initiative.

One final note on Warner/Chappell.

We are delighted to announce that we have further strengthened our senior management team with the recent appointment of Scott Frances to the newly created position of President of Warner/Chappell Music and Chairman and CEO of Warner/Chappell Music US.

A seasoned music publishing executive, Scott was formally President of BMG Music Publishing's BMG Songs North America division, which became one of the most successful music publishing operations in the world during his tenure.

Scott is charged with running Warner/Chappell's US operations and will play a key role in Warner/Chappell global strategy.

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 covering some of our key financial highlights for the quarter.

For the three months ended June 30, 2008, we reported revenue of $848 million which declined 1% on a constant currency basis.

All of the revenue data I'm about to discuss is on a constant currency basis.

As we will be comparing this quarter's metrics with those of the prior year's quarter, we wish to note that the prior year's quarter had a $6 million net benefit resulting from $38 million in expenses related to the Company's realignment initiatives, a $52 million benefit related to our settlement with Bertelsmann regarding Napster, and $8 million in expenses incurred in connection with the potential acquisition of EMI, all of which we have adjusted for in any figures I am discussing.

Domestic revenues fell 7% while international revenue grew by 4%, led by gains in Europe and Canada.

Overall total quarterly Digital revenue grew 39% to $166 million, or 20% of total revenue, up from $119 million or 15% of total revenue in the prior-year quarter.

Not unexpectedly, Digital revenue improved 1% sequentially given the seasonal nature of the business and release schedules.

Approximately 65% of our total Digital revenue was generated in the US, and 35% in the rest of the world.

Online continues to be the primary growth driver of our Digital business globally.

While Mobile remains soft in the US with flat ring-tone sales, we did see a more significant pickup in Mobile internationally over the prior-year quarter, helped by easier comparisons and a stronger local release schedule.

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

Our operating income before depreciation and amortization, or OIBDA, from continuing operations rose 14% year-over-year, and our OIBDA margin grew 1 percentage point to 14% as we strictly managed costs through the recorded music industry transition.

Now let's look at our different business segments.

Quarterly Recorded Music revenue fell 1% to $686 million.

We saw growth in our international Physical business, and our global Digital business.

We had revenue gains in the UK, Germany, and France.

Overall, international Recorded Music revenue grew 5% while domestic Recorded Music revenue fell 8% year-over-year.

As expected, the timing of our release schedule and continued inventory management by retailers led to weak domestic recorded music shipments.

Partially offsetting the physical declines, Recorded Music Digital revenue grew 39% from the prior year quarter to $156 million or 23% of total Recorded Music revenue, up from 17% in the same period last year.

Domestic Recorded Music Digital revenue grew 31% to $101 million, or 32% of total domestic Recorded Music revenue, compared to 22% in the same period last year.

Quarterly Recorded Music OIBDA from continuing operations rose 17% year-over-year as ongoing cost management efforts and strong international sales of local repertoire drove results.

Moving on to our Music Publishing business.

In comparison to the same quarterly period in 2007, Music Publishing revenue of $168 million was essentially stable given that revenue was flat domestically and declined 1% internationally.

As expected, Mechanical revenue, which represents less than 38% of Warner/Chappell's fiscal year-to-date revenue mix is beginning to more closely mirror the contraction in the Physical Recorded Music business.

In contrast, growth in Performance, Synchronization and Digital revenue are effectively offsetting the Mechanical revenue declines.

Music Publishing OIBDA was $33 million, up 6% from the prior year quarter due to our sales mix.

Our strategy to build cash on our balance sheet and improve our cash flow is gaining traction.

We ended the quarter with a cash balance of $338 million, an improvement from the March quarter level of $249 million, which was up from the December level of $160 million.

For the quarter, we increased our free cash flow to $93 million from $57 million in our prior-year quarter.

Our free cash flow is calculated by taking cash from operations of $89 million, less capital expenditures of $6 million, and net cash received from investments of $10 million.

Net investment proceeds include the sale of a small equity stake in Front Line to Cablevision's Madison Square Garden which was mandated by the terms of the July 2007 transaction.

As Edgar said on our last quarterly call, we are comfortable with our balance sheet and our capital deployment strategy has only increased our financial flexibility.

We discontinued our dividend last quarter, we have curtailed our M&A investment spending, and we continue to be vigilant about managing our costs throughout the recorded music industry transformation.

Strong returns on our A&R investments, over the past few years, support our plan to maintain a consistent and focused level of A&R investment going forward.

These steps allow us to build our cash balance, reduce our net debt, preserve our financial flexibility, and satisfy our balance sheet requirements.

We often get the question about our organic revenue growth.

In fact, our year-over-year organic revenue in the quarter, year-to-date, and for the last 12 months, declined 4% compared to our stated constant currency revenue decline of 1% for each of these periods, just a 3 percentage point differential.

Some of our investments are unconsolidated and therefore are not captured in these results.

At this point, we have already anniversaried our largest acquisitions, including Roadrunner, an investment that has far exceeded our expectations.

Recent investments that are reflected in our current results include Camus, a touring company in France, and Frank Sinatra Enterprises.

For the three months ended June 30, 2008, we had a net cash taxes of $16 million, and a tax provision of $13 million, on pre-tax income from continuing operations of $4 million.

As we have discussed, we expect our tax expense for fiscal 2008 to be the same or slightly higher than the prior-year level of $49 million, depending on our geographic mix of profitability.

For the quarter, we generated a net loss from continuing operations of $9 million or $0.06 per diluted share, an improvement from the prior-year loss of $16 million or $0.11 per diluted share.

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

For example, in our fourth fiscal quarter, we will compare against a strong music quarter last year that included James Blunt, Linkin Park, and Match Box 20 releases.

While recognizing the hurdles ahead, we remain confident in our future.

And now I would like to turn the call back to Edgar for closing remarks.

Thanks, Michael.

Over the course of this upcoming year, we plan to work towards optimizing, evolving and transforming our business.

In doing that we'll stay vigilant in managing costs and investments while generating significant free cash flow and reducing our net debt.

We will augment our digital leadership through innovative business models, continue to enhance the value and prospects of Warner/Chappell, broaden our partnerships with artists and build relationships with consumers to add new revenue streams from growing segments of the music business, and increase market share while maximizing our margin potential in our core Recorded Music and Music Publishing businesses.

Recognizing that we have a lot to accomplish and the challenges remain substantial, our consistent competitive outperformance, transformational strategy and management resource give us the confidence that we are well positioned to take advantage of the opportunities that lie again.

We remain focused on driving shareholder value over the fiscal year and beyond.

We look forward to answering your questions.

Thank you.

And Operator, would you please open it up for Q&A?

(OPERATOR INSTRUCTIONS).

Please stand by for the first question.

The first question is from Bishop Sheen from Wachovia.

Thank you for taking the question.

Hi Edgar, Jill, Michael.

Appreciate the overview.

Let me go right to the balance sheet, Michael, I'm going to pick on you.

If you could give us debt for dummies, covenants for dummies.

You are sitting there are a credit facility covenant at 4.25 times EBITDA now, which steps down to 4 times at calendar year-end, and through most of fiscal '09 it's at 3.75 times.

You have said repeatedly in the call you want to reduce your net debt.

Can you give us a quick primer on the math on how you clear covenant?

In other words what carve-outs come in to play when we figure out how you're doing?

Happy to try, Bishop, and as I know you know, all of the documents for all of our debt agreements and all of the covenant calculations are available and are a matter of public record.

I think the covenant calculation is actually fairly straight forward.

It really is.

And the reason that I focus on the net debt is obviously reducing the denominator in that calculation as much as increasing the numerator, and so to the extent our net debt, our debt less our cash balance, reduces that it makes the covenant calculation that much better.

And I guess the only piece I would point out as a nuance is that the cash that gets calculated in the net debt calculation for covenant purposes is a trailing 12 month average cash balance.

Okay.

So it is the average balance?

Correct.

And -- all right.

That's what I was looking for.

And then -- now that you have eliminated, roughly $90 million -- carve out was for $90 million.

You have eliminated the dividends, would they being eliminated in the technical calculation -- does that have any impact?

No, more cash on the balance sheet, it doesn't have a different impact.

Okay.

So it's strictly, as you say it's pretty simple, it's the average cash on the balance sheet for the net debt for the key numerator in there?

Correct.

Okay.

So going forward, we should expect to see a large cash buildup because you really don't have anything drawn on that revolver, do you?

Correct.

And our cash balance -- if you look it from December to today, so over a two quarter period, we have doubled your cash balance from 160 to 338.

Great.

And if you could just give us your view on any update or progress in the never-ending music royalty battle, and the herky-jerky way that is moving through Congress?

Bishop it's Edgar.

I don't think we can give you much update other than to say that we have seen some strong enforcement legislation introduced through the House through the IP Subcommittee and through the Senate Judiciary Committee under Chairman Leahy.

And then in addition, there is movement on the royalty with regard to radio-broadcasters where we have seen legislation introduced there as well.

I think it's not likely to be an issue that this current session of Congress engages in, but I hope that we'll see significant progress under the next Congress.

That's helpful.

Thank you, Edgar.

Thank you, Michael.

Thanks, Bishop.

The next question is from [Andrew Whittenberg] from Jennison Associates.

Hi, guys, thank for taking the question.

I actually had two questions.

Just in terms of the Recorded Music business, you guys haven't talked for a while about trends and the overall size of your Catalog business, just in terms of revenues and cash flow and, over the last couple of years.

Can you just kind of update us on what the status of that line of business is?

And then my second question was - just as it pertains to the music video games opportunity with Guitar Hero, et cetera, how is that effecting the business today?

And where are we going to see that in the income statement in the future?

Maybe if you can just talk about the opportunity there for the industry as a whole.

Thank you.

Andy, on the Catalog side, our Catalog business has continued to perform well.

I think there's quarter-to-quarter fluctuations, but there has not been a dramatic change in the mix between Frontline and Catalog, either in the Physical business or the Digital business, so even throughout all of this transformation, the catalog titles continue to sell well in both formats.

Okay.

And, as you know, are an extraordinarily profitable piece of our business.

And I think even as we have seen physical retailers work to better manage their inventory, I actually think we're seeing greater thoughtfulness around how to manage the catalog titles.

So I think there's some misperception out there that somehow having physical retailers do a better job there will undermine our ability to sell catalog titles.

I actually think it will be the opposite, which is the ones that actually sell will get much better placement and visibility and therefore -- and have higher velocity through physical stores, and that's actually better for them, and better for us.

Andy, it's Edgar.

I think on the video game business.

I think this is an area of enormous opportunity, and I think the success of these games evidenced the popularity of opportunity for music and music-based content businesses to grow and expand well beyond the traditional means that we have been experiencing up until now.

But I think what we need to be very careful of is that the recorded music industry and the music publishing industry do not allow an ecosystem to occur where we are not properly compensated.

You know, if I use the analogy of MTV 25 years ago, or even Apple five years ago, those are two ecosystems that from whom -- people other than the recorded music industry have derived the majority of the value created in that ecosystem.

That I think is the state we're currently in with Activision and Harmonic, where the amount being paid to the music industry, even though their games are entirely dependent on the content we own and control, is far too small.

And I think the industry as a whole needs to take a very different look at this business and participate more fully and in a much more partnership way with both our artists and with the games manufacturers than is currently the case.

And if that does not become the case, as far as Warner Music is concerned, we will not license to those games.

Could you just remind us how the licensing deals work, without giving the specifics?

You know, each game is somewhat different, but essentially there is what I would call a very paltry licensing fee per song, and then depending on whether or not there is artists involved specifically - as in the Guitar Hero Aerosmith game, as an example - there are different economics based the specificity of an artist.

But the actual royalty derived for the use of the song or the royalty derived from the download of the song remain in my estimation far below what their true value is.

Got it.

Thank you for the questions.

Thanks, Andy.

Thanks, Andy.

The next question is from Howard Gleicher from Metropolitan West.

Thanks a lot.

Michael, in your prepared remarks when you were talking about your success at the reduction of debt, you used one of the examples as reduced A&R, but later on when you sort of summarized what you were saying, you talked about how your current success is due to your successful A&R in the past.

Can you reconcile for me, how you go about making sure, or what you are doing differently now, to make sure that we don't result in -- just using an example of maybe EMI, where you cut the bone and you cut the meat, and you find yourself a couple of years from now lacking in the new artists that you have been so successful today?

Thanks.

Thanks, Howard.

And thanks for clarifying, because I may have misspoke in my remarks.

I -- in no way shape or form meant to say we reduced our A&R spend.

Our A&R spend has been very consistent.

I did say we reduced our M&A spend, and that certainly added to our cash flow this quarter.

From an A&R perspective, we are extraordinarily bullish about the process we have in place, the team of people we have around the globe.

In particular, when you think about our US organization and Lyor Cohen and his team and what they have been able to do in terms of being so thoughtful in terms of the process that we're using to invest our A&R dollars and the efficiency and yield that we're getting off of those investments.

We're quite bullish, and therefore, one of the reasons we're so focused on managing our cash and expenses across all of the other segments of the business is so that we can make sure that we can continue to invest at the levels we have been investing in A&R.

So it was simply a misspoke -- or probably a mis-hearing in my ear, a reduction in M&A, not A&R?

Howard, exactly.

That's correct.

There's no reduction in A&R.

Thank you very much.

The next question is from Doug Mitchelson from Deutsche Bank.

Great.

Thanks.

A couple of questions on then digital transition.

One is, Edgar, you made a comment about the Nokia deal, and how it would be added to the value -- I wonder if there was some way you can walk us through the economics of why you think that deal will be good news?

Not that I disagree at all, I'm just curious as how you view the economics as being additive.

And then, secondly, we talked a long time about that cross-over point where Digital is 50% of the business, and slowly but surely in the US you are approaching that level.

And I'm curious as you think about Digital becoming the majority of your Recorded Music revenue, when is there a significant change in the physical cost structure?

When do you look at this business and say I should just head toward an all Digital cost structure?

And what would that mean for your margins?

Thanks.

Let me try to answer the Nokia first.

The -- while the specific economics, of course, are not disclosed, and can't be disclosed, the economics, I think are extremely favorable to us, and to the industry generally.

Though I'm obviously not specifically aware of the deals of our competitors.

But I would say that we look at what we think the average revenue per music consumer is.

We try to solve for that as we make our music available on a per device basis.

The potential for this business is obviously quite large since last year Nokia sold 437 million handsets, and expects to sell close to 500 million handsets in the 2008 calendar year.

Now, of course, not all of the music will be on all of the handsets day one.

In fact, not all the music may be on all the handsets for some time to come.

But the potential of that platform is extraordinarily large.

There are already hundreds of millions of music enabled handsets around the world.

And to sort of have music be available on the device as they're purchased, creates an opportunity for us to reach consumers that we have never reached, deal in markets that we have never been able to deal in before - such as India, China, other markets that are not part of our real revenue stream today - and to do so at very significant margins for the industry.

So it -- the model has yet to be introduced.

It has yet to be proven out, but to have the world's number 1 handset manufacturer solidly behind trying to make this work, is obviously potentially very good news for the industry.

But we'll have to wait to see how progress occurs.

On the Digital side of things, we are fast approaching a 50% revenue.

I mean, as you saw 32% of our revenue in the US Recorded Music this quarter was Digital.

We have been, I think, very, very focused on reducing the amount of assets devoted to our physical infrastructure, while increasing the number of assets devoted to our Digital distribution.

That's an ongoing transformation.

Sometimes it's done incrementally within the Company.

Sometimes it's done in a step-change process.

But since we have been here, there have been dramatic changes - perhaps not evident to the outside world - but dramatic changes to our distribution and services infrastructure, where we now have significant assets redeployed from our Physical business to our Digital distribution business.

That's an ongoing evolution and we'll continue to, I think, stay ahead of the game as we move in to a digital future.

And then can I ask another question on the Sony BMG deal?

Two parter.

One, how do you feel about the valuation relative to the value of your company?

And then secondly, it seems like it's just a financial transaction, but is there any disruption there that you might be able to take advantage of?

As to taking advantages, the only thing I would say about that which is not specific to Sony BMG, is that when we bought the company over four years ago, everyone was skeptical that we would be able to increase market share.

And you can look our performance, since we bought the company, and I see no reason why our momentum cannot continue.

With specific regard to Sony BMG, what I'd say is, I think first of all, it was a private transaction.

I don't think anyone other than Sony and Bertelsmann know exactly the values that were either paid or received.

The actual OIBDA of the joint venture is also not disclosed.

But from our knowledge of the transaction, what I can say is I think the analysis that has been done, and the resulting multiples that have been proffered as the multiple, are in fact well below the actual multiples paid.

And last thing I would say in terms of our own valuation, is that even if the multiples were as low as have been proffered in the analysts community - which as I say, I think are below the true multiple - that would still, we think, argue for an improved valuation of our own business.

Are you in a position to offer us what the adjustments might be to what you think the real multiple are, or is something you don't think you can discuss?

I don't think I can discuss that.

Thank you very much, Edgar.

Thanks, Doug.

The next question is from Ingrid Chung from Goldman Sachs.

Good morning, thanks.

Just three quick questions.

Firstly, on the revenue line, you have benefited from FX.

I was just wondering if you could quantify for us how FX has impacted your costs?

Secondly, in terms of Frank Sinatra, obviously you did really well with "Nothing But the Best." I was just wondering if you generated significant ancillary revenue around the release of "Nothing But the Best" and the 10th anniversary of his death?

And then, thirdly, on Digital sales at Amazon, I was wondering if it is a significant sales channel for you yet?

Ingrid, I'll start with the FX question.

Our costs are pretty well matched to our revenues around the globe, and so FX doesn't tend to have a meaningful impact on the profit line.

So -- I mean, I think that's what you were driving for.

So that's why we report the FX impact on revenue, but we're pretty well buffered in that our cost structures mirrors the revenues around the globe.

Okay.

Ingrid on Frank Sinatra and Amazon, we did a lot of work around the introduction of "Nothing But the Best," there was a stamp issued by the US government in Frank Sinatra's honor.

And we did derive a fair amount of ancillary revenue, but I think, frankly, the licensing and ancillary revenue for the Frank Sinatra brand is still ahead of us.

And we're working very, very diligently on that, and seeing a great deal of progress.

One of the tremendous opportunities that we saw when we made this investment was that you have a business like Elvis Presley with probably something close to 450 separate licenses, whereas Frank Sinatra, when we made the investment, had 7 licenses.

So this is -- this is a business that we think we can grow, we can grow dramatically.

We're in discussions for significant licensing opportunities across a number of industries.

And I think both that opportunity, the opportunity with Grateful Dead, and other such businesses will be an increasing part of our revenues going forward.

As far as Amazon is concerned, Amazon -- it's early, but it's encouraging.

And what appears to be the case is that Amazon is attacking a different customer base than iTunes, and so, at least as far as we can tell so far, the sales on Amazon are incremental to the sales on iTunes and are far more skewed towards the entire album than single purchases versus iTunes.

Okay.

Great.

Thank you.

The next question is from Jason Bazinet from Citi.

Thanks, I have a quick question on the Recorded Music side.

If I was just -- maybe these numbers are wrong.

I was just looking at the quarter.

The US Digital as a percent of total was 32% and international was closer to 15%.

And I was just wondering if you could comment on the two or three underlying drivers of that disparity, and if any of those drivers are structural in nature like piracy or, alternatively, if you imagine or anticipate that the percentages will converge over time?

Thanks.

Jason, I don't think there's anything structural other than timing, as a large part.

I guess I would say a couple of things.

One, wireless is a more -- is a much broader model in Europe for internet access rather than online.

iTunes, which has lead the Digital business in the US was first introduced here several years before it was introduced in Europe, number one; and number two, is much more of an online business than a wireless business.

So you have the sort of structural issue, which is much less online access in Europe versus the US, and therefore less iTunes buying because of the nature of the internet access model in Europe, A; and B, iTunes' introduction in Europe is several years behind the introduction in the US.

But you see our international Digital revenue as a percentage revenue growing more quickly than our US, so I do think those lines will converge.

I do think it will be some time.

And I think it will depend -- the acceleration of those lines crossing will depend on things like Nokia and other wireless models, which is where most of the consumers are in most of the rest of the world.

Thank you very much.

The next question is from Rich Greenfield from Pali Capital.

Couple of questions.

One.

First a financial one for Michael - Last year in your press release you talked about - for Recorded Music for instance - $110 million of EBITDA, and $93 million on a continuing operations basis excluding all of the charges.

This year you have $109 and it doesn't seem as clear that you are breaking out what the growth was.

It would seem like your growth was $110 million versus $93 last year.

And I'm just wanting to understand what drove that margin expansion if in fact that $93 million is still an accurate number for last year, and why the presentation change?

And two, if you could just talk through how to think about the return on investment in terms of the size of your investment in both Sinatra as well as with Roadrunner, you mentioned that was very successful from your standpoint.

Just wondering what the loss of Nickelback couple albums out -- How that changes what the ROI was on that acquisition?

Yeah, I'll start with your first question about the Recorded Music margin.

I don't think the format has changed all that much.

Last year we had a bunch of one-time items, so there was a slightly different format than this year when sit was a clean set of numbers.

I think the numbers you're stating are right, there was good growth in profitability in the Recorded Music business.

I guess I think about that as coming from three areas.

One is international had much better performance this year over last year, largely driven by local releases, and so it sort of generated and contributed to greater profit performance.

Piece number one.

Piece number two is, as the Digital business continues to grow as a percentage of that business -- as we all know Digital is more profitable on a dollar basis.

And then lastly, we continue to have extraordinarily tight cost management.

We've -- for four years now we wake up every morning and try to figure out where we can save costs and put our costs in the right places, and the Recorded Music business across the globe, particularly here in the US, has done a fantastic job on that front and we expect them to continue.

So I think that's what driving the good margin performance in the Recorded Music business.

Rich, it's Edgar.

On the acquisitions, I guess I would just sort of say as background - some two-thirds or so of our Company still remains in the hands of private equity investors who demand, quite rightly, a significant return for the use of capital.

So we have very high internal hurdle rates, and if we don't feel we can meet those hurdle rates, we don't make the investment.

Now, obviously, some investments do as we thought, some do better, some don't.

But we go in with a pretty high bar.

I would say both on Frank Sinatra and on Roadrunner, we're on track to meet those internal hurdle rates as we go forward.

And the loss of Nickelback, to be clear, has no effect whatsoever on our Roadrunner investment.

We made the investment based only on the current contract.

We have the band's catalog.

We the next two studio albums, and a greatest hits under the current agreements.

And we've got a multi-year publishing rights to the band's catalog and futures, and to Chad Kroeger, the lead writer and singer of Nickelback, to his non-Nickelback songs under separate agreements with Warner/Chappell.

So the band's music, the band's brand, the band's writers will remain with Warner for quite sometime to come.

And as I said, our investment was based only on the current contract, did not contemplate any renewals which would have been a separate investment had we made it.

And just a quick follow-up.

Just because it relates to some of the joint ventures that you are doing, like with Sinatra.

How much of your market share growth in the quarter came from artists that essentially you fully own versus your deals with independent labels or with JVs like something like Sinatra.

Just trying to understand how the revenue growth filters down into profitability.

You can see how it filters down into profitability because our margins expanded nicely in the quarter.

And I would say that -- as far as JVs are concerned, Rich, it is de minimus.

We're not in the joint venture business in the Recorded Music business with very, very rare exception - Bad Boy being one of them.

But very, very rare exception, because generally, the profitability of joint venture is not good enough for us to make those kinds of deals.

When we're in the name and likeness business, or merchandising business, or other kinds of businesses, we might look at that differently as we did in the case of Frank Sinatra.

But the amount of JV in our income statement is de minimus.

Thank you.

Rich, just to your first question to clarify.

The change in format from last year's press release to this year's was because we're now following the SEC's preferred presentation that doesn't have any of the detail of sort of adjusted numbers.

Okay.

So there was just -- there was never a 110 in the press release last year.

Yeah, so we're just using -- we're using what the SEC has said as the way we're supposed to be presenting the numbers.

Gotcha.

Thank you.

The next question is from Aaron Watts from Deutsche Bank.

Good morning, just a couple of quick ones from me.

One to follow-up on the balance sheet.

Keeping the cash on the balance sheet, obviously important for you to stay in compliance with your covenants for the net test, but, ultimately, how do you prioritize what that cash might be used for?

Whether it's actual debt pay-down or M&A, or at some point reinstating a dividend?

How do you think about that?

I think the way we think about that -- I think the way we think about it is we have got, we think, a very good capital structure, and for us, with ever dollar that we put up on our balance sheet, that accrues to our equity holders.

It obviously makes our bond holders and other stake holders more comfortable, but, in fact, as we put cash up on the balance sheet, every dollar there goes directly towards an increase in equity value.

Unless we see an opportunity to increase equity value even more than reducing debt might achieve, that will be our focus, and I expect that reducing net debt, as I mentioned earlier, will continue to be our very strong focus for the foreseeable future.

Okay.

And in looking at the down 4% organic growth you talked about down 1% constant currency.

Given -- on the top line -- given the industry and economic challenges we have right now, it seems relatively reasonable here -- Edgar, as you are now in August, what is sort of the tone you are hearing from consumers and the retail channel, and how does that make you think about being able to continue to produce revenues in the same sort of context, keeping this stabilized?

I -- I'm hesitant to say any business is recession proof, because I don't think any business is recession proof.

I'm not suggesting we are in a recession.

But in a tougher economic climate everything gets a little bit more difficult.

But I would have to say, historically as you look the music industry, the music industry has not been nearly as reactive to changes in economic environments as other industries.

And I think particularly as the business becomes more Digital, that will actually -- that will probably support that trend.

So while I can't suggest that we can ignore a more difficult economic environment, I don't think it would -- I don't expect it to have a material impact on our ability to operate and continue to achieve the results that we have.

Okay.

And the last win for me -- We have seen this recent sort of mini-trend of late of big name well-established artists leaving traditional music houses and striking deals with non-traditional outlets.

Do you view this as a short-term phenomenon?

And I guess either way, does not having some of these marquee names impact your ability to invest and support up-and-coming artists that aren't profitable out of the gates?

Or are those deals -- have they gotten to a point for the big artists where it's just not economical for you to be signing them?

I think it's a the latter.

I think the basis on which artists have been signed are deals simply that we wouldn't do and therefore didn't do.

You know, I think the beauty of our business, even in -- even given all of its challenges, is that we don't pay retail, and -- and I see no reason for us to change that model, and so we won't.

We make partnerships almost like a venture capital business with young and up-and-coming artists, and as a result we are associated with those artists for many, many years.

When it comes time to renew, if the price is too high, and the economic burden too great, we will simply pass.

Okay.

Thanks.

The next question is from Edward Antorino from Benchmark.

Hi, good morning.

You mentioned the inventory situation in the press release.

Has there been much of an impact from the credit crunch on inventories, orders, returns, store closings that is either effecting the business now or might dampen the second half?

No I don't think so.

You know, the weak music-only players were sort of pushed out of the business long ago, and at this point, the sort of credit worthiness, generally, of our physical retailers is quite stellar.

You are talking about the biggest retailers around the globe.

We're not seeing credit issues, we're not seeing collection issues, and we're not seeing anything that's limiting the retailer's ability to buy.

Thanks, much.

Let's take one last question, please, operator.

The next question is from Tuna Amobi from Standard & Poors.

Okay.

Thank you very much.

I guess I'll keep it to one.

So with regard to the timing of the upcoming releases, can you please update us on what you expect for the second half of the year, particularly the holiday period, in terms of new releases and catalog?

And if you can remind us of what the comparisons for that period would be - more difficult, less difficult, or about the same?

And also, related to that, how do you adjust your -- do you make any adjustments to your retail strategy for the holiday period given the issues that have come up lately that you have mentioned with regard to the inventory management by retailers?

Let me talk to you about the release schedule.

You know we don't -- although, as you know, we don't give out our release schedule.

We had very good results last year in our fourth fiscal quarter, the September 30 quarter, as we mentioned with releases from James Blunt, Linkin Park, and others.

And we obviously, if you'll remember, had the phenomenon of Josh Groban's "Wonderful Christmas" album last year in our December 31, or our Q1.

So we did very well in those two quarters.

As we look ahead, you know, we think our release schedule overall for 2009 is a very strong release schedule, and we're very confident that we can continue to make progress.

We're still in the process of budgeting, so for us to break down exactly which releases are coming in which quarters, and how those might compare, I don't think we can give you any guidance or make any comments beyond what we already said.

But as we look ahead to the '09 year, I think we feel good about what is coming.

And Tuna, I don't think the changing inventory management profits is dramatically impacting how we're going to market through the holiday season.

And I think the retailers recognize that we're really good at the distribution side of the business, and so if there's product that they need in the stores, we're going to get that product to them in the stores.

So we feel good about our ability even in an environment where they are carrying lower inventory for us to get full sell through to the consumer demand.

And you still feel as good about wholesale pricing?

That's a world of constant pressure.

Hasn't changed in the four years I have been here.

And we continue to hold the line, and hold the line on wholesale prices.

We have been, from the very beginning, very focused at keeping ourselves at higher-end wholesale price.

We do not believe that lower price drives increased consumer demand.

And I would actually say we have made good progress with some of the biggest physical retailers in looking at our research, looking at our analytics and understanding that there's actually opportunities in their business for them and for us.

It's Edgar and the only other thing I would note on wholesale pricing is that you should see as Digital becomes a larger percentage of our business, a largely lower wholesale price.

So therefore, on a Digital basis, our price per unit is marginally lower than it is on a physical unit, but our profitability is higher.

So you should see as Digital continues to become a larger percentage of our business, some pressure on the revenue line because the per unit numbers are slightly smaller, and as we have mentioned before, increasing margin and profitability on the OIBDA and other income line.

Thank you.

Okay.

Everyone thank you for your time and attention, and we look forward to speaking with you in the interim, and we'll be back again in a few month's time.

Thank you very much.