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Operator
Welcome to the Warner Music Group fiscal earnings call for the period ended December 31, 2009.
(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.
- SVP-IR & Corporate Communications
Thank you very much.
Good morning, everyone.
Welcome to Warner Music Group's fiscal first quarter 2010 conference call.
Both our earnings press release and the Form 10-Q we filed this morning are available on our website at WMG.com.
Today, Chairman and CEO, Edgar Bronfman Jr., will update you on our business performance and strategy.
Executive Vice President and CFO, Steve Macri, will discuss our quarterly financial results; and then Edgar, Steve and Michael Fleisher, our Vice Chairman-Strategy and Operations, will take your questions.
Before Edgar's comments, let me remind that you this communication includes forward-looking statements that reflect the current views of Warner Music Group about future events and financial performance.
Words such as estimates, expects, plans, intends, believes, should and will, and variations of such words or similar expressions that predict or indicate future events or trends or do not relate to historical matters, identify forward-looking statements.
Such statements include, but are not limited to, estimates of our future performance, such as the success of future albums, 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, the impact general economics conditions may have on us, market share gains and our intentions to deploy our capital, including the level and effectiveness of future A&R investments.
Also forward-looking statements are made as of today, and we disclaim any duty to update such statements.
Our expectations, beliefs an projections are expressed in good faith and we believe there is a reasonable basis for them.
However, there can be no assurance that management's expectations, beliefs, and projections will result or be achieved.
Investors should not rely on forward-looking statements because they are subject to a variety of risks, uncertainties, and other factors that can cause actual results to differ materially from our expectations.
Information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in our earnings press reese lease 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 relose posted on our website.
With that, let me turn it over to Edgar.
Thank you.
- President & CEO
Thanks, Jill.
Welcome, everyone.
Thank you for joining us.
We're proud to have delivered stable revenue and OIBDA in our core reported music and Music Publishing businesses despite ongoing Recorded Music industry pressures and macro economic headwinds.
In this environment, that is no small task.
We remain confident in our capacity to achieve our long-term strategic and financial goals.
That confidence is based on our demonstrated record of accomplishment, which includes developing new business models, maintaining digital leadership, managing costs, diversifying revenue, and delivering strong returns on our A&R investments.
And very importantly, our effective balance sheet strategy continues to provide the necessary financial flexibility to position us for growth.
The Recorded Music industry continues to face pressures which are exacerbated by the current state of the global economy.
Turning to four key areas in this quarter.
First, our disciplined A&R marketing and promotional efforts continued to yield results.
In calendar 2009, for the second year in a row, Atlantic Records won the distinction of being the Number One label in the United States.
This marks the fourth time in the past five years that one of our labels has held the top spot in the US.
Second, we remain an industry leader in the important digital arena.
Our quarterly digital revenue rose 5% to $184 million on a constant currency basis.
And in the US, digital represented 35% of Recorded Music as compared to 31% in the prior year.
We sustained our significant digital share advantage over physical share in the US, both in the quarter and for calendar 2009, and we have the greatest digital share advantage of any of the major music companies.
Third, we continue to transform the Company by entering into expanded rights deals with new recording artists and growing our worldwide artist services business.
And fourth, we continue to strengthen our music publishing business by further developing our artist roster and catalog while delivering enhanced results.
As our stable margins show, we continue to adjust our highly variable cost structure to drive profitability.
Let's look at the quarter's results in further depth.
Recorded Music revenue for the quarter was down only modestly on a constant currency basis.
Growth of 2% in international Recorded Music constant currency revenue largely offset a 10% decline in the US.
Our international performance showcased rising revenue from our artist services business, and continued solid growth in our international digital Recorded Music business.
Our US share contracted by 2.4 percentage points to 19.5 in the December quarter, primarily due to our light release schedule.
Our Recorded Music results were led by current and carry-over releases from artists including Michael Buble, Enya and Muse, as well as soundtrack albums from several motion pictures.
Reflecting our focused approach to A&R and long-term artist development, Warner Brothers' multi-platinum artist, Michael Buble, continues to gain popularity around the world and was a key driver for the quarter.
Strong holiday sales momentum for his latest release, Crazy Love, continued after its initial three-week run at number one on the Billboard US album chart.
The album has taken off on a global basis, selling nearly five million units worldwide so far.
And we are pleased that Warner/Chappell recently extended its worldwide publishing agreement with Michael Buble.
In addition, we recently acquired his global merchandising rights, which should start to generate revenue from his Arena Tour, which begins in March.
Warner Brothers Records' recent chart strength is evident across a broad range of genres, from rock from Muse, to rap with Gucci Mane, and country with Blake Shelton.
In addition, Warner Brothers has strengthened its presence in pop, with singles from developing artists Jason Derulo and Iyaz, which together held the number one spot on the Billboard US Singles chart for eight consecutive weeks and sold over four million digital tracks in the US on a combined basis.
Our Company has built an incredible success story in soundtracks over the past several years, beginning with Rhino Records' groundbreaking Juno soundtrack in January 2008.
Atlantic's creative marketing efforts for the first two soundtrack albums based on the Twilight series, Twilight and New Moon, magnified the success of those soundtracks and raised the visibility of our artists.
Rhino is currently working the soundtrack for the Alvin and the Chipmunks sequel, for which more than 75% of the digital album unit sales to date have been of the Deluxe $11.99 album bundle.
The album achieved gold status just over a month after the film opened.
Our International Recorded Music revenue growth was driven by a handful of solid performances from local and international artists, a strong international digital business, and our growing artist services business.
We achieved this growth despite a challenging retail landscape, which was most pronounced in Japan.
We delivered robust reported music revenue across several major European territories, including the UK, France and Italy.
Warner Music UK had a particularly strong quarter.
In addition to Michael Buble, who was at the top of the UK charts during Christmas week, UK artists Paolo Nutini, Muse, The Soldiers, and Katherine Jenkins contributed to the impressive UK results.
France continued to benefit from strong local and international releases, including Michael Buble.
Taking a closer look at our digital business, we recognized both our challenges and our growth opportunities.
In the December quarter, releases that appealed to CD buyers helped to offset the industry-wide impact of decelerating digital unit sales growth in the US.
Digital download unit sales growth in the US has slowed following iTunes' introduction of a higher-priced tier for single track downloads in April 2009.
Year-over-year US digital track equivalent album unit growth for the industry was 5% in the December quarter, down sequentially from 10% in the September quarter and 11% in the June quarter.
While affecting unit sales, variable pricing for single track downloads on iTunes has been a net positive for our digital revenue.
While the US Recorded Music industry did experience a typical seasonal pickup in digital demand triggered by sales of MP3 players and gift cards, the current post holiday pace of unit sales activity remains similar to the 5% growth of the December quarter.
While our US Recorded Music digital revenue was flat for the quarter, we continued to see strong growth in our international Recorded Music digital revenue.
Implementation of variable pricing of downloads, growing international demand for iTunes and iPhones, and new business development activities all boosted international performance.
On a constant currency basis, our International Recorded Music digital revenue increased 20% year-over-year and 6% sequentially.
Needless to say, achieving robust digital growth remains a top priority, and is central to our long-term growth strategy.
We expect digital revenue growth to accelerate once again as new mobile products and business models are rolled out on a global basis, and as device capabilities and network technologies advance.
The recent Consumer Electronics Show reaffirmed our view that digital innovation will evolve rapidly on many levels.
Access models, which typically bundle the purchase of a mobile device with access to music, continue to gain ground, supporting our view that these models will be one of the long-term drivers of digital revenue.
Vodafone recently announced that since March 2009, nearly 450,000 of its customers have signed up for its music subscription services in Europe.
The growth is being driven both by monthly 10 track bundles, as well as unlimited access of subscription services.
In December alone, over 100,000 customers signed up to one of these services in Vodafone's eight largest markets in Europe.
TDC, a Danish telecom operator, has continued to see strong results for its bundled music subscription service.
TDC believes that this service has significantly reduced churn for cellular customers.
By November, 2009, TDC reported that more than 120 million tracks have been downloaded from the service, the equivalent of 2.5 downloads per second, since the April 2008 service launch.
With mobile providers, ISPs and consumer electronics manufacturers all working with us to refine consumer choices in the access model space, we remain optimistic that access models will meaningfully contribute to our revenue over time.
As we mentioned, we continue to transform our business within the music value chain, while broadening our revenue mix into growing areas of the music business, such as sponsorship, fan clubs, website, merchandising, touring, ticketing and artist management, among others.
We continue to diversify our Recorded Music revenue.
Nontraditional revenue grew to nearly 10% of our revenue in the quarter, driven primarily by concert promotion revenue in France and Italy.
Today, essentially all of the contracts we enter into with new recording artists are expanded rights deals, and artists with expanded rights deals now account for more than half of our active global roster.
Turning to Warner/Chappell Music, this business remains a stable performer with very attractive financial attributes.
Similar to Recorded Music, the Music Publishing business is characterized by strong OIBDA to free cash flow conversion, favorable working capital dynamics and low CapEx requirements.
However, Music Publishing currently enjoys far more diversified revenue streams than Recorded Music.
Our goal is to continue to enhance the results of our distinctly valuable Music Publishing business.
As we've noted in the past, we have a global multi-pronged plan to drive long-term growth at Warner/Chappell.
This plan includes continuing to invest in talented song writers to support the development of our Music Publishing catalog, building new opportunities to exploit the value of our existing catalog, expanding our leadership position in digital music by playing a key role in the industry initiatives, and leveraging our international reach.
Warner/Chappell has had significant A&R and licensing success in calendar 2009, with its song writers contributing to six of the Top 10 US albums.
Warner/Chappell had the largest share of the publishing rights associated with Susan Boyle's multi-platinum holiday release, and it controlled a significant portion of the songs on Michael Jackson's Number Ones, and Eminem's Relapse.
Warner/Chappell also controlled portions of three of the Top 10 US digital songs of 2009.
Another recent highlight is the Grammy recognition of Warner/Chappell's song writer Terius Nash for Best Song with single ladies.
Warner/Chappell continues to strengthen its roster through artist signings and extensions of existing agreements.
In addition to the previously mentioned extension of its Music Publishing arrangements with Michael Buble, Warner/Chappell expanded its world-wide agreement with Grammy award-winning performer and song writer, Don Henley.
Warner/Chappell is proud to be Don Henley's musci publisher since 1993, and to now add US rights to our deal.
Before moving on to our financials, I wanted to speak about the growing recognition of the value of intellectual property.
There is building momentum all over the world to implement graduated response programs, in which ISPs notify and eventually institute sanctions on copyright-infringing customers.
Given the ability of ISPs to deter illegal activity on their networks, it is essential that they play an active role in promoting the legal flow of copyrighted content.
We believe that all of the stake holders -- ISPs, content companies and consumers alike, gain the most when we all work together to support the legitimate distribution of content.
In the US, the most content rich country in the world, efforts have lagged.
Recently, I'm gratified to say, there have been some positive developments.
Most notably in December, I joined other executives from the US Intellectual Property Community and Labor Union, in a meeting hosted by Vice President Biden.
Many high-ranking officials from the Obama administration, including Attorney General Holder, Homeland Security Secretary Napolitano, and Commerce Secretary Locke, among others, also attended the meeting to discuss how the government can help to protect our nation's intellectual property.
The Administration officials cited the significant impact that intellectual property has on the overall US economy, and called for the content industry to continue to work with the Administration to help identify policy and regulatory goals to protect IP-related industries and jobs.
We are delighted to see the US government focusing on this very important issue and pleased to be included in its efforts to help in this critical area.
I also wanted to take a moment to congratulate some of our artists on their Grammy success last week.
Among the recipients were WMG recording artist Michael Buble, Green Day, Jason Mraz, Neil Young and Zac Brown Band, as well as Warner/Chappell song writers, Calle 13, Lady Antebellum and Stephen Sondheim, among others.
Steve Macri will now run through the financials before Michael, Steve and I will take your questions.
- EVP & CFO
Thank you, and good morning.
All of the revenue data I will provide is on a constant currency basis.
For the three months ended December 31, 2009, we reported revenue of $918 million, down 2% year-over-year.
Domestic revenue declined 9%, while international grew 2%.
As expected, domestic revenue continues to be more affected by the recording music industry pressures and the general economic and retail environment.
Our quarterly digital revenue grew 5% to $184 million, or 20% of total revenue.
Due to strong international download growth, digital revenue was up 4% sequentially.
About 60% of our digital revenue was generated in the US, while 40% was generated internationally.
Our operating income before depreciation and amortization, or OIBDA, grew 5%, and our OIBDA margins remained flat at 12% as we continued to carefully manage costs and adjust our business.
Looking at our different business segments for the quarter, Recorded Music revenue fell just 2% to $783 million.
As we continued to diversify our revenue, we grew our worldwide nontraditional revenue and also saw strong international digital download growth.
These gains were offset by expected declines of physical revenue.
Recorded Music digital revenue grew 8% from the prior year quarter to $172 million, or 22% of total Recorded Music revenue.
That is up from 21% in the same period last year.
As iTunes continues to gain traction outside the US, International Recorded Music digital revenue grew 20%.
Domestic Recorded Music digital revenue was unchanged at $99 million, as compared to 31% in the same period last year.
This represents 35% of domestic Recorded Music revenue this quarter.
Recording music OIBDA grew 6% year-over-year.
This is a result of ongoing prudent cost management efforts, as well as changes in our product mix.
Moving on to our Music Publishing business.
Music Publishing revenue of $141 million was flat versus the prior year quarter.
International growth offset domestic declines.
Due to a pickup in film and TV production licensing activity, Warner/Chappell grew synchronization revenue by 9%.
That result was more than offset by a 2% decline in performance revenue and a 4% mechanical revenue decrease.
Digital revenue was unchanged year-over-year, delayed by the timing of cash collections.
Music publishing OIBDA was $22 million, consistent with the prior year quarter, and OIBDA margin was also steady at about 16%.
Turning to our balance sheet and cash position, we continue to execute on our effective balance sheet strategy.
We ended the quarter with a cash balance of $339 million.
As anticipated, this is down sequentially from $384 million at September 30, 2009, due to two primary factors.
First is the timing of our interest payments.
As a result of our May 2009 refinancing, our cash interest payments are now made semi-annually, in the fiscal first and third quarters.
Therefore, our December quarter included $81 million in cash interest, compared with $45 million in the prior year.
We previously made quarterly interest payments under our credit agreement, which has now been retired.
In addition, our net interest expense increased to $51 million versus $44 million in the prior year quarter.
This is due to the previously announced change in interest rates related to our refinancing.
Second is the variable timing of our working capital requirements, which included a decrease in cash associated with our European concert promotion business.
As it relates to our concert promotion business, we experience a cash buildup in advance of a tour as ticket sales occur, increasing the deferred revenue.
Deferred revenue is then worked down at the tour curves, and the cash due to the venue and the artist is paid out.
This business can be seasonal and is subject to the timing of touring cycles.
Free cash flow declined to a negative $44 million from a positive $160 million in the prior year quarter.
This is related to the two factors I just described, and as well as the fact that last year's quarter included $123 million from the sale of our investment in Front Line Management.
Our free cash flow is calculated by taking cash used in operating activities of $42 million, less capital expenditures of $7 million, and adding back net cash received from investments of $5 million.
Despite the timing-related cash flow items in this quarter, we remain confident in our ability to generate significant free cash flow this fiscal year, as we have in the past.
Turning now to taxes, we had a tax revision of $13 million, and net cash taxes of $9 million on a pre-tax loss of $3 million.
We generated net loss of $17 million, or $0.11 per diluted share.
The prior year quarter's net income was $23 million or $0.15 per diluted share, including a gain of $36 million or $0.24 per diluted share from the sale of our investment in Front Line Management.
As a matter of policy, we do not provide financial guidance.
As you know, this business traditionally includes fluctuations based on our Recorded Music release schedule and associated marketing and promotional expenses.
We remain confident in our overall schedule for the fiscal year and anticipate the timing of our releases to be back-end weighted, similar to last year.
As always, in order to minimize the impact of a challenging industry transition and the difficult economy, we will continue to actively manage our expenses.
Now I would like to turn the call back to Edgar for closing remarks.
- President & CEO
Thanks, Steve.
I'm pleased with our ability to stay the course and optimize and transform our business despite serious challenges.
Our focus and determination are unwaivering.
We continue to lead the industry's transition to new digital formats and platforms, all while diversifying our revenue streams into new growth areas and delivering solid performance in our core Recorded Music and Music Publishing businesses.
I would like to reiterate five critical strategies on which we will continue to focus over this fiscal year.
One, manage our balance sheet by generating significant free cash flow while controlling our overhead costs and other expenses.
Two, strengthen our digital leadership through a combination of consistent execution on our current business models, and development of new business models.
Three, enhance the value and growth of Warner/Chappell.
Four, monetize businesses in growing segments of the music industry by expanding partnerships with artists and building relationships with consumers.
And five, continue to invest in A&R, marketing, and promotion, which remain the core elements of our Recorded Music and Music Publishing businesses.
Michael, Steve and I will look forward to answering your questions.
Thank you, operator, and please open it up for the Q&A.
Operator
(Operator Instructions).
The first question is from Bishop Cheen from Wells Fargo.
- Analyst
Hi, Edgar, Steven, Michael, Jill.
Thank you for taking the question.
Edgar, when you talk about how challenging domestic has been, as you look forward to a stronger release schedule in the back half and maybe some of these investments and initiatives that you're doing, how do you see is the domestic scene changing?
- President & CEO
Well, I think that the challenge obviously has been with the unit sales growth on the digital side, with iTunes, where we're seeing tremendous interest in Apple and Apple products, tremendous growth of the iPhone, and in the sale of gift cards.
And of course there is more competition in the apple eco-system now with apps and video content and other things on which those gift card monies can be spent.
I think what we will see, as we've talked about, is the very significant growth over the next little while of access models and other models like that, whether that is streaming services that are subscription-based, cloud services which are not that dissimilar from streaming services; but other kinds of things where new ecosystems, frankly, will be developed, and I think content will play a stronger role in the development of those ecosystems than perhaps it did in terms at least of the value the content derived from its role in helping to build, as an example, Apple's ecosystem over the past seven or eight years.
And to that extent, I think the comments that Rupert Murdoch has made in the past month around the value of content, the role of content and the necessity of content to be fairly recompensed, as new business models emerge, are well thought out and reasonable looking forward.
- Analyst
And then one last question.
On the never-ending debate about performance royalties -- if not in this lifetime, then maybe in the next -- do you see any significant progress in the current Congress?
- President & CEO
Well, I think the -- it is hard to say that there is progress at the moment as Congress grapples with other significant areas of the Administration, including health care, deficits, and financial regulatory reform, energy, and other kinds of things; but I have to say that the Democratic leadership in Congress has been very vocal about their determination to set this right and to pass a performance rights piece of legislation.
As you know, it has been passed both out of the House committees and out of the Senate committees.
So I am hopeful that when -- if there is an opportune moment for the Democratic leadership to turn to this issue, that we will see progress.
- Analyst
All right.
Thank you.
Operator
The next is Doug Mitchelson from Deutsche Bank.
- Analyst
Thanks.
Good morning.
A few questions.
So I guess the first, I'm just interested, you mentioned over half of the global roster is now 360-degree rights deals.
Is that sort of similar also on a percentage of revenue contribution from their artists?
Or you have a lot of your -- half of your large artists also on those types of deals now?
- President & CEO
So Doug, it would not be the same on revenue, because we have taken a specific approach to sign new recording artists to 360-degree rights, which means that it is going to take them some time to develop before we see the real strength of that strategy coming to the fore.
So our bigger releases, which tend to be artists that have been developing for several years, in most cases don't have 360 rights associated with them.
And we have not by and large negotiated with those artists to buy or to invest in their 360 rights, simply because by the time they are at the stage of their career where they are -- their value is well established, and buying those rights is sort of -- as I would say, paying retail, there is not much margin in making those investments.
I think there are better uses of our capital.
So there is no question that we will see, I think, significant acceleration of nontraditional Recorded Music revenue over the next two, three, four years, but it will be as these younger artists develop.
- Analyst
Right.
But I just wanted to make sure relative to the context of the 10% of revenue in nontraditional, but I know you're making a lot of progress there.
I think the second area I wanted talk about is just trends at retail.
I'm not sure -- we always try to get you to guess when the lines cross, where digital revenue outstrips physical decline and you always demure; and so I was just hoping you could give us some context of what you're seeing at retail now, and do you think the DVD physical declines will sort of continue at the past that they have in the last few years?
- EVP & CFO
Good morning, Doug.
This is Steve.
- Analyst
Hi, Steve.
- EVP & CFO
Right now, it's kind of a little too early to tell with regards to our physical retail market.
I can tell you since the post-holiday, there has been no significant changes to year-over-year returns or reductions of floor space, And we continue to be proactively involved with our retail partners in managing SKU count and inventory levels.
I think one important note is the 80/20 rule, and particularly with our physical SKUs, the vast majority of revenue comes from a very small amount of SKUs.
So we will continue the work and actually partner with the retailers to manage those SKU counts and inventory levels.
- Analyst
And then the last question was -- Edgar, have you been bullish on this for a long time and you've been a leader here, and I was just sort of curious, when I heard the 120 million tracks downloaded on the GDC, in a way it almost made me a little bit nervous.
I mean, do you think that sort of the equivalent value of $120 million through iTunes for 10 million tracks, do you that the music industry is getting the right value from something like TDC with that amount of tracks being downloaded?
- President & CEO
Yes, I would say that yes, the -- in a sense, the subscription models that we are promoting, or that access models or however one wants to refer to them, I think will create much more value for us over time than the per play, or the per purchase models.
The difference is, of course, that the access to subscription models rely on scale.
So if you do the absolute trade of tracks downloaded on subscription versus tracks paid for on iTunes, that is not a good trade, and you're right to point it out.
However, a number of people accessing iTunes versus the number of potential subscribers -- the number of potential subscribers -- dwarfs the number of people who are actually purchasing music on iTunes.
So for me, the opportunity is really in monetizing consumers who are either -- who are in large part today not major purchasers on iTunes.
And frankly so far, we've seen very little cannibalization one to the other.
So I think in large part, these models are incremental.
- Analyst
So the fear that the heavy music user would go after these plans, and then not be a heavy purchaser anymore and that the light use would look at them and say, "Well, geez, why do I need to spend extra money on this?", that hasn't played out with what you've seen so far?
- President & CEO
That has not played out with what we've seen so far.
And I think no one, certainly not I, would suggest that [Steve Jobs] is not going to be able to keep the customers that he has at Apple, or even increase those customers.
And at the same time, I think these service models that increasingly network operators, device manufacturers, and others are coming up with, will allow us to monetize hundreds of millions if not billions of people, most of whom are not today either buyers or certainly heavy buyers of music.
- Analyst
And I'm sorry.
I'm going to throw one more in on this wireless angle.
When do you think we will see sort of more substantial presence of bundled music offerings in the US?
- President & CEO
I think it is coming soon.
I think that if you -- I think it was a Business Week cover recently, was sort of the face-off between Apple and Google.
I think that is an important space to watch.
I think that there are going to be a lot of people who -- there are a lot of people -- who look at the extraordinary eco-system that Apple has built, and say, "Wow, look at all of the value they've created.
Are they really going to be the only ones to create that value?" And I think you're going to see a number of companies try to, if not emulate specifically the Apple eco-system, but create ecosystems of their own that allow them to hold on to customers, give customers more of what it is that customers want.
Now I think if you watch the space, you are going to see really accelerated competition for the hearts and minds of US consumers, but also European, Asian, Latin American consumers, and that's going to be -- there are going to quite a lot of players engaged in trying to win those hearts and minds.
And I think one of the things -- one of the tools, one of the weapons they will be using -- is content -- overwhelmingly content -- and music will be a very important part of that content play.
- Analyst
All right.
Great.
Thank you very much.
Operator
The next question is from Laura Martin from Needham and Company.
- Analyst
Hi there.
Can you hear me okay?
- President & CEO
Yes, we can hear you, Laura.
Good morning.
- Analyst
Great.
Thanks.
So I guess I'm interested in what we learned from tiering the pricing on Apple's digital downloads, because I know we fought for that for a long time.
But actually these US numbers have turned out to be a little disappointing, so do you think that the consumer was more price sensitive than we thought when we tiered the pricing?
Did they just steal the hit stuff and only take advantage of the cheaper stuff on the low end?
And then my second question kind of builds on one of the questions Doug asked, which was if we think about these streaming models -- which it sounds like you're optimistic about -- I understand the breath argument, but how do we model or how do we think through in a new world where things are moving to the Cloud and music is moving to streaming services.
How do we think of modeling that in kind of our longer term models from the point of view of Warner Music's economics?
Thanks.
- President & CEO
I am going to ask Steve for some help here, but first of all, on the iTunes pricing front, the industry had been fighting for variable pricing for some time.
And let me just give you a little bit of background.
You will remember that we introduced premium album bundling probably four years ago now, maybe a little bit longer.
That has been very successful, and it continues to be successful.
And I noted even on something like Alvin and the Chipmunks, 75% of the digital albums sold are at the $11.99 price, not the 9.99.
But I think with the digital album bundles showed is that consumers will pay for the kinds of content in music that they want.
I think, frankly, on the single track downloads, in April, 2009, price increase, probably couldn't have come at a worst time.
It was a price increase that, frankly, agreed with Apple, I think back in the summer of 2008, before the financial crisis even hit.
The timing was that as far back as then.
The industry went through with that, or Apple went through with that price increase in April, but clearly, in the teeth of the worst recession since the Depression.
So it is difficult to know even today as to some sort of eight, nine months later, how much of that is just consumer resistance to the higher price point, or how much of it is just taking a price increase of 30% in such a fragile economic time.
I don't think there is any other consumer product that has taken such a price increase in the 2009 period, and so we don't have a lot to relate it to.
So I think we need a little bit more time to really sort of get underneath the cause and effect of the price increase.
But as I say, nonetheless to date, it has been positive for our revenue.
Steve, do you want to talk about how we sort of think about streaming and modeling?
- EVP & CFO
Just one other point with regards to the tier pricing.
As digital becomes more meaningful over time, it becomes more highly correlated with the release schedule, and so the timing of your releases -- of new releases -- in the marketplace will dictate digital revenue growth as well.
- President & CEO
And Laura, I'm sorry, I just want to add one other thing.
I think that the other thing that recently happened,$ and it is kind of an interesting dichotomy, as you saw Amazon had a 9.99 sort of across the board eBook price.
That broke, frankly, with the introduction of the iPad, where Apple essentially is allowing publishers to price their book at a wholesale level wherever they would like, Apple taking a 30% markup for a retail price to consumers.
It is interesting, frankly, that the book publishing business on the iPad has much more pricing flexibility than the music industry has on any of the Apple devices.
But I think -- and again, going back to some things that Rupert said -- I think this what this signals is that content is going to have more pricing flexibility over time rather than less, because frankly, the only thing that drives iPhones, iPads, Kindles, Zunes, and other kinds of devices, is content.
And I think the power of content in that little fracus with Amazon was clearly evident.
So I suspect over time you will see sort of an increase in pricing flexibility for content companies rather than the opposite.
- EVP & CFO
And then Laura with regard to modeling, it is difficult to predict the rate of growth in the digital business and from the streaming models.
But what I can tell you is that the margin is higher on digital, so if you just compare a digital album to a physical album, the gross margin on a digital album is roughly 6 to 8 points higher than a physical record.
- Analyst
And even in (inaudible), where they're taking down 100 million -- or three songs for every one they would have bought?
- President & CEO
Well, first of all, we don't know what consumer behavior is going to be sort of in the cloud, and whether we can correlate purchase to sort of subscription or other kinds of models.
But we do a lot of sort of modeling work here, to talk about what -- to think about what kind of scale is necessary at what pricing, and et cetera, and we do see that the opportunity to expand music consumption and music purchase -- whether that is by track, or by album or simply by service -- across a vastly greater number of consumers is net extremely positive for the industry.
That having been said, free streaming services are clearly not net positive for the industry, and as far as Warner Music is concerned, will not be license the.
So sort of get all of the music you want for free and maybe we can, with a few bells and whistles, move to you a premium price strategy, is not the kind of approach to business that we will be supporting in the future.
- Analyst
Thank you.
Operator
The next question is from Ingrid Chung from Goldman Sachs.
- Analyst
Thanks.
Good morning.
So a couple of relatively quick ones, if I may.
First, Edgar, you said that you signed on Michael Buble's global merchandising rights, but you also said that you didn't want to pay retail for the rights of the established artists.
Can you give us some color on how this agreement came about and how we should think about how the economics of the deal impact you?
And then I guess the second one is for Steve.
You've roughly 340 million in cash on the balance sheet and you generate a pretty consistent level of free cash flow.
I think we would expect at least 500 million in cash a year from now.
What are your plans for that cash that you're building on the balance sheet?
- President & CEO
So Ingrid, on the Michael Buble deal, I think what I would say is -- obviously we're not going to give the details of the agreement, but it has been our goal to increase, where possible, our relationship with a number of our key leading artists -- Michael chief among them, who is not only one of the most talented, but I have to tell you one of the hardest working artists in the music industry, certainly on the Warner artist roster but I think across the industry.
His tour is now moving from smaller venues -- even though still quite large -- to arena-type venues and so this kind of merchandise business is new to him as well.
And as someone with whom we have had a long and I think successful partnership, we were able to construct a deal where Michael can trust that the merchandise that we make and market will be very consistent with the image that he is trying to project.
And so all in all, it represents an increase in our relationship with the artist.
But I would say that merchandise in general among the 360-degree rights that we signed is among the smallest, and both in terms of revenue opportunity and in absolute margin.
So it is important in terms of indicating the quality of the relationship that exists between the Company and an important artist like Michael Buble, but I don't think terribly relevant in terms of watching our bottom line.
- Analyst
I got it.
And on the cash?
- EVP & CFO
And with regards to cash, I noted in my remarks we remain confident in our ability to generate significant cash and despite those timing related items in Q1.
The primary issues of cash will continue to be funding our A&R investments that we've sustained since we bought the Company in 2004, and also investing in continuing to market and promote those releases.
With regards to M&A, it is really continue with a selective posture toward M&A with a keen eye on value.
I could see us making some small tuck-in acquisitions here and there.
And that's basically -- it's to continue with the balance sheet strategy that we've had in the past.
- President & CEO
But Ingrid, let me add that I think as we continue to build cash -- and your estimate of our ability to continue to do so is certainly correct -- it is certainly directionally correct, at least.
We are constantly looking for ways to increase the value of our Company to our equity holders, and we've done a pretty good job, I would think, so far, to our bond holders, because our bonds are trading very well and we continue to hope that they will trade well, and be very respectful of the investments they've made and the return that we've been able to get to them.
Our equity holders have not done as well, and we are building up significant cash.
And we need to think about how to advantage our equity holders as importantly as our -- or more importantly -- than our bond holders have been rewarded for their investment in the Company.
And our building up the free cash flow gives us a number of alternatives which we continue to study with -- in earnest.
- Analyst
Okay.
Great.
Thank you.
Operator
The next question is from Richard Greenfield from Pali.
- Analyst
Hi, a couple of questions.
With constant currency revenues down 2% and your comments about a back half weighted release question, is it fair to say that all else being equal, that you could actually see flat to up constant currency revenues in the second half?
Essentially asking, is there anything usual or one-time in the second half that makes the comparison difficult versus what you saw in the first fiscal quarter?
And then kind of related to that, assuming that 10% of your currency benefit in the first quarter on a revenue basis flowed to EBITDA, it appears that EBITDA was essentially flat despite a 2% constant currency revenue decline worldwide.
Is that degree of margin expansion sustainable throughout the rest of the year?
Thanks.
- EVP & CFO
Sure, so with regard to the first question, Rich, there is nothing unusual in the back half of the year last year that will distort results.
And then with regard to sustaining margins, I mean what we do for a living is really just continue to manage costs on a regular basis, which has actually enabled us to sustain margins over time.
Refinancing our balance sheet back in May gives us a lot more financial flexibility, and we will continue to look at ways to adjust our business and ways to take costs out, which will enable us to sustain those margins.
- Analyst
How much benefit are you seeing now from some of the changes that you made last year?
I mean, is there any way to quantify how much your restructuring has helped improve margins?
Because obviously you're seeing a benefit year-over-year from what you did throughout 2009.
- EVP & CFO
Yes, I mean, it is difficult to quantify, because it is a constant evolution.
We're always taking costs out of the business, and those results are being reflected.
So as the physical business declines and we selectively take costs out of physical and invest in the growing parts of our business, that's reflected in our margins, and that's one of the reasons why we're flat 12% year-over-year.
- Analyst
But is there any way to look at how much of what happened in this quarter was driven by cost-cutting, versus how much was higher margin digital -- related to Edgar's comments before that there are parts of your business that are higher margin than what you've had previously?
- Vice Chairman - Strategy & Operations
Rich, it's Michael.
I don't think you can parse it out.
The reality is over the last three or four years we've been constantly turning the spigot on costs.
So are there tens of millions of dollars every year of increases in margin because we're managing that cost structure?
Yes?
Is there also the gains that we are getting as more of the business becomes digital?
Absolutely.
But in a way, they're inter-related, right?
We're taking out those higher costs, physical parts of our business, as more of it becomes digital.
So one yields the other.
I don't think you can really parse them that way.
- Analyst
Thanks.
Operator
The next question is from Jessica Reif Cohen from Bank of America Merrill Lynch.
- Analyst
Thank you.
I have a couple of questions.
The first one is EMI related.
In the increasingly likely event that EMI is forced to restructure or be taken over by its lender, would you expect it to be sold in whole or in pieces?
And given the current -- I would almost call it benign regulatory environment -- how does that factor into the way you would evaluate it potentially in (inaudible)?
- President & CEO
Jessica, it is Edgar.
Without commending on what will or or won't happen with EMI, I think the EU was pretty clear in the Sony BMG decision that at least as things stood then -- and I don't think things have gotten any better now -- that increased -- that another step of consolidation in the recorded music industry, at least at that time, seemed to be nonthreatening to the EU competition authority.
So I think from a regulatory standpoint, further consolidation in the recorded music industry is possible.
I'm not going to guess whether or not it is likely, but I think it is certainly possible.
And I think should it come to the lender having the opportunity to try and recover value, it is going to try to recover the highest possible value it can, whether that is selling the EMI pieces or selling it in whole.
But the last thing I would say is, as we all try to grow this recorded music industry, a strong universal, strong EMI, strong Warner and frankly a strong EMI is better for us than any of those companies being weak.
And so we will just have to see how the future plays.
But I hope that EMI is able to resolve its difficulties in a way that benefits the industry over time.
- Analyst
Okay.
My second question is about the recent Live Nation/Ticketmaster deal.
Could you just elaborate on what areas you think will most affect your Company -- Warner Music -- either positively or negatively?
- President & CEO
Yes, I mean, I think -- look, I think we think of Live Nation/Ticketmaster largely as a compliment to the business that we're in.
I think it is -- Live Nation/Ticketmaster is a business of scale.
It is a business of consumer relationships and venue relationships, and it deals almost entirely with artists that have proven that they have a significant ticket purchasing capability.
Our business, on the other hand, is essentially a venture capital business, where we're betting on a bunch of unknown artists who have yet to develop that opportunity.
And when we sign those artists, we sign, as I said, all of them -- essentially all of them -- to expanded rights deals, which means whether they go through Ticketmaster/Live Nation when they're eventually touring, or through some other forum, we are going to partner with the artist in the revenues derived from their tours.
So our sense is that these are largely complimentary businesses, not really competitive businesses.
I think Live Nation/Ticketmaster has the opportunity to be a very strong and powerful company, but in an area of the business where we do not currently compete -- although we do expect to derive significantly increased revenue over time.
- Analyst
And the last question is actually on that point.
On the 360 deals that you guys have been doing, how long are the contracts on average?
And when somebody actually does become established, how difficult is it in renegotiating a similar kind of deal?
Or do the deal terms change a lot?
- President & CEO
So the 360 deals essentially are, if you think about them, no different than our Recorded Music deals, which tend to be very long-term deals; and in many cases, in fact, extend well beyond the period of the first -- when the original recording agreement might end.
So in many cases, the 360 deals are actually longer than our recording agreement.
So I think they're quite -- they're very long-term.
In terms of renegotiation, I don't think anything is different than the kinds of things we deal with today.
If we have a new recording artist, and that new recording artist has tremendous success very early in their career, they inevitably come back and attempt to renegotiate.
And at some level, we do try to accommodate them; but of course, it is within an environment and a framework where we control the rights to their recordings for a very long time, and therefore, we're certainly not subject to sort of public auction kinds of payment.
So we always try to maintain good and strong relationships with our artists, but we have very long-term rights, as I said, perhaps even longer than we used to in terms of the 360 rights, and this sort of renegotiation dynamic is something that we've dealt with as an industry for decades, and it is no different in this world.
- Analyst
Okay.
Thank you.
- President & CEO
Thanks, Jessica.
Operator
The next question is from Jason Bazinet from Citi.
- Analyst
Thanks so much.
I just have a question on the recorded physical side of the business.
I was just looking at some data, at least in the US, where the physical units were sort of in the 300 million a year range back in the late '70s, and sort of went all the way up to north of a billion units a year sort of at the tail end of the '90s.
And now we're sort of back at the mid 300s or so.
And my question is, do you ultimately believe the physical business goes to zero, or do you think there will always be some residual amount of physical recorded units that are sold per year?
- President & CEO
Well, I guess I would quote my friend Barry Diller and say "Nothing ever replaces anything, meaning that there is sort of always vestiges.
You can still go to Central Park and see horses and buggies, but they're hardly the main means of transportation.
So look, will there always be physical?
I think there always will be some level of physical.
Vinyl is growing very strongly, and I think among audio files is going to be very hard to replace vinyl for people who are absolutely passionate about the sound quality that they have in their home.
And I think there is some convenience for a lot of consumers for a very long time to have a CD or a CD-like package.
But will physical be the predominant means of music listening five or 10 years from now?
I think almost certainly not.
- Analyst
Okay, thank you.
Operator
The last question comes from Tuna Amobi from Standard and Poor's.
- Analyst
Great.
I have several questions as well.
So in terms, first, of the geographic composition of your digital revenues, it seems like the trend is going from more -- it is kind of shifting from more domestic to more international, and just seems like international actually overtake domestic in the not too distant future, if my observation is correct.
So would you attribute this trend to more of a substantial penetration of mobile access models, or more to kind of a slowdown in the online downloads, just to get a better handle on what is driving that trend?
- President & CEO
So Tuna, I think -- it is Edgar.
I think it is a couple of things driving the trend.
First of all, there are more people outside the US than there are inside the US.
iTunes launched in the US probably 18 months to two years before it really got any traction outside the US.
So you're seeing sort of still significant growth on the Apple platform in Europe.
Apple is now growing in Japan, where it got off to a relatively slow start.
So you're seeing more platform development, more people, and more experimentation and traction on access models in Europe -- and certainly obviously in Japan -- than you have in the US.
So I think it is true that in (inaudible) that international will be greater than US digital revenue.
Quite how quickly that happens, not quite sure; but I think you're right that the trend is clear.
- Analyst
Okay, moving on to VIVO, it seems like you guys are still the only major that's kind of holding out.
I know you made a deal with Hulu and YouTube, so can you kind of reconcile, is the reason you're not on VIVO, is that because perhaps that you think perhaps because that you think that Hulu and YouTube might -- are they mutually exclusive in some sort or is this just a question of reaching the right terms on that platform?
- President & CEO
I think it is a little bit of both.
I mean, I think certainly we're very much open to joining VIVO.
We just have a strategy that we think there is a great deal of value to be built, artist by artist, rather than to a single destination.
So VIVO's approach is to try and aggregate all music consumers and music lovers at VIVO and try to give them everything that they'd like.
I think that is probably a very good strategy, if it is successful.
On the other hand, we think that there is also -- there are also a lot of music consumers out there who want their relationship with the artist to be deeper and stronger than you can achieve through a single website.
And so in building our 360 deals and in managing our artist websites, we think there is a great deal of commerce to be done and value to create for consumers on a website by website, artist by artist approach, which VIVO frankly doesn't allow us to do to the extent that we think we would like to do that.
But we continue to evaluate VIVO.
We're very glad for, frankly, the success that they're already achieving.
We think anything that the music industry does that is positive and creates growth is great for all of us.
And we continue to evaluate whether it makes sense for us to be -- in addition to driving our own strategy -- to be part of the VIVO community as well.
- Analyst
And if I can circle back to the Live Nation/Ticketmaster topic, so you -- Comcast and AG obviously were able to strike some valuable concessions there, and I would have thought that you guys are just as well-positioned, if not better positioned, to get some valuable regulatory concessions, particularly as you look at Europe, where you're kind of ramping up on the concert promotion.
Did you look at perhaps any areas where Warner Music could have seized the moment and got some opportunity to maybe diversify your domestic strategy, given the importance of that deal for you guys, and everyone else in the industry?
- President & CEO
Yes, look, I think we certainly watched with interest, and to some degree were asked by various regulatory authorities for our views, but we are not directly competitive with either Live Nation or Ticketmaster in almost any major market where there were regulatory concerns.
And so concessions are usually sought by regulators where, in order to increase competition or at least to keep competition from diminishing, and that really is not applicable to anyone in the Recorded Music or Music Publishing industry.
So I don't think we were in a position to seek concessions or to gain concessions from regulators, and as I said, ultimately we see these businesses as complimentary.
I don't think it is likely that Warner Music will ratchet up our venue ownership or ticketing software to a degree where we become major competitors with the Live Nation or Ticketmaster in that end of the business.
- Analyst
And just lastly -- that's very helpful, by the way -- just lastly on your prepared remarks comments regarding meeting in Washington, Edgar, so as were you talking to the administration officials, is this something along the lines of perhaps reshaping the digital Millennium Act, or some other kind of incremental framework to kind of advance this piracy subject?
- President & CEO
Well, I think it is less about revisiting legislation than it is applying a regulatory framework that seeks enforcement of current copyright law in a more thoughtful way.
It is important to all of us that consumers continue to get the content that they want in as many varied ways as possible.
But I think it is also important to recognize that as consumers increasingly turn to the digital world, that that world cannot be -- cannot have the distinction of being lawless, while the physical world is essentially -- or the United States is -- we always like to say -- a nation of laws.
So the question is, how can you take the accumulated wisdom of centuries of civilized law that have allowed this country and others to get to the place that they have and apply it in a thoughtful way in an entirely new world, without trying to either trample on consumer rights, or restrict consumer access.
And I think there are plenty of ways to do that, and I think, frankly, and finally, the US government is engaged in trying to figure out ways to do that.
- Analyst
Okay.
Thank you very much.
- President & CEO
Thank you.
And thanks, everybody.
We have one last question?
All right.
One last question.
Operator
The next question is from Marla Backer from Hudson Square.
- Analyst
Thank you.
I have two questions.
One is housekeeping.
You made some remarks earlier about the graduated response measures.
But I thought I had read that there had been some push-back.
I think it was specifically in France.
Is that -- that's incorrect?
- President & CEO
Well, it is probably not incorrect that there had been some push-back, because there is push-back with every legislation that gets passed in every country.
But the truth of the matter is, France has passed the legislation, the legislation is in effect, the actual implementation of that legislation probably begins in earnest in sort of the April/May time frame.
- Analyst
Okay, thank you.
And then I had another follow-up on the 360-degree deals.
Are all of the majors -- all of the majors are engaged in 360-degree deals, I would guess, so is that potentially a source of driving up competition for new artists such that it would make you pull back at some point from artists that you would otherwise sign if the 360-degree right weren't attached?
- President & CEO
Well, I think all of the majors are engaged in signing 360-degree deals to some degree or another, because we obviously compete for artists that we sign from time to time with other labels.
And quite honestly, there have been a number of artists -- I won't name them -- that we have not signed, because they would not give 360 rights to us, and were signed by our competitors, without those rights.
In some cases, we were right to do that, in some cases maybe we should have made an exception.
But we are very, very religious here about signing 360 rights because, quite frankly, given the size of the Recorded Music opportunity alone, the amount of incremental investment capital that is required for us to break an artist simply doesn't give us the opportunity for the appropriate returns without ancillary revenues, and so we're going to continue to be quite religious about 360-degree rights.
And I think, honestly, our competitors look at the same set of economics that we do, and though they may make more exceptions from time to time than we do, ultimately, I think this is the only way forward for the industry, and therefore, the levels of competition will be no different in this world than they were in the Recorded Music rights world only.
- Analyst
Okay.
Thank you.
- President & CEO
Thank you.
Thank you, Marla.
Thanks, everyone, for your time and attention, and we will see you in a few months.
Thanks.
Bye-bye.
Operator
That concludes today's conference.
You may disconnect at this time.