Warner Music Group Corp (WMG) 2010 Q4 法說會逐字稿

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  • Operator

  • Welcome to the Warner Music Group's fourth quarter and fiscal year ended September 30, 2010 earnings call.

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

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

  • (Operator Instructions)

  • Now I'd 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 Development

  • Thank you very much.

  • Good morning, everyone.

  • Welcome to Warner Music Group's fiscal fourth quarter 2010 conference call.

  • Both our earnings press release and the Form 10-K we filed this morning are available on our website.

  • 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 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, projected success of future albums, projected digital sales increases and declines in physical sales, expected expansion of the digital music business, the success of strategic actions we are taking to accelerate our transformation as we redefine our role in the music industry, the impact general economic conditions may have on us, market share fluctuations and our intentions to deploy our capital including the level 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 could be no assurance that management's expectations, beliefs and projections will result or be achieved.

  • Investors should not rely on forward-looking statements because they are subject to a variety of risks, uncertainties and other factors that can cause actual results that differ materially from our expectations.

  • Information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in our earnings press release and Form 10-K and other SEC filings.

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

  • All of the revenue data we will provide on today's call will be on a constant currency basis.

  • 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.

  • - Chairman & CEO

  • Thanks, Jill.

  • Welcome everyone.

  • Thanks for joining us.

  • This quarter caps a year of strong progress at Warner Music.

  • As we reflect on fiscal 2010 we're proud of what we've accomplished.

  • We remain focused on our core business of A&R marketing and promotion and have demonstrated exciting progress in our ability to encourage and sustain viable new business models.

  • We also delivered solid digital results which, in conjunction with our efforts to diversify our revenue mix, are helping us further transform our Company.

  • All the while we've remained vigilant in managing costs and maintaining financial flexibility.

  • Of course, we continue to face some significant challenges from the recorded music industry transition, but as a Company we have continued to effectively manage the impact of those challenges.

  • Six years ago when we purchased Warner Music virtually all our recorded music revenue and a large part of our music publishing revenue were based upon the sale of CDs.

  • We knew from the outset that in order to position ourselves for a return to growth, we needed to focus on accelerating and diversifying our revenue mix.

  • When we look at our business today we can see the results of those efforts.

  • In the quarter, our digital and non-traditional revenue grew to a combined nearly 40% of total revenue compared to essentially zero in 2004.

  • This statistic represents a fundamental expansion of our business model that we've implemented and executed since Warner became a standalone company.

  • Our proactive approach to redefining our role in the industry has allowed us to outperform our recorded music competitors.

  • In the five years from 2004 to 2009, Warner Music has gained four points of global revenue share in the sale of both physical and digital recorded music.

  • But even with all we've done to transform our business, our results continue to be negatively impacted by the macro trends in recorded music.

  • This quarter, for example,, our international and domestic recorded music revenue decreased 10% and 15%, respectively.

  • This makes our cost management strategy all the more important.

  • We continue to fine tune our cost structure by simplifying business processes, reducing fixed costs, and converting other fixed costs into variable ones.

  • Even in the face of declining revenue we strive to sustain OIBDA margins and I'm pleased to report we once again accomplished this goal in fiscal year 2010.

  • OIBDA margins remain largely steady year-over-year at 12% despite declining revenue and increased severance charges.

  • In the fiscal year before we acquired the Company, Warner Music's OIBDA margins were approximately 6%.

  • In the September quarter we took additional actions to better balance our cost structure with our revenue profile.

  • Steve will detail those in a moment.

  • Looking at our balance sheet management, as you know for several years we have executed on our strategy to generate cash and maintain a conservative balance sheet.

  • That approach yielded timely benefits and positioned us well during the global economic downturn and deteriorating credit markets of several years ago.

  • Thanks to our focus on our balance sheet, we have a strong cash position and expect to continue generating cash in excess of our operating and investing needs.

  • Now let me give you some highlights for this quarter and for the fiscal year by focusing on the Company's performance in several key areas.

  • First, our focused A&R marketing and promotional efforts continue to yield results.

  • Of note, Warner Music achieved our highest quarterly US track equivalent album share since December 2008, up 1 percentage point to 21.7%.

  • And our total album share of 22.4% represented our highest quarterly US share in 14 years.

  • Second, we sustain our industry leadership in the digital arena.

  • We continue to outpace the other music majors in the US and digital over physical album share and we have maintained this advantage every quarter since June of 2004 when it first became measurable.

  • Third, we continue to transform the Company by entering into expanded rights deals with new recording artists and building our worldwide artist service business.

  • And fourth we continue to invest in our music publishing business by further strengthening our artist roster, our business mix and our catalog.

  • Now, let's look at each of these points in a little more detail.

  • As expected, while our recorded music results reflect continued industry pressures, we did benefit from our solid fourth quarter release slate.

  • The top sellers in the quarter included Lincoln Park, Phil Collins and Zach Brown, as well as two Japanese artists, Kobukuro and Superfly.

  • In addition, our recorded music results were enhanced by releases from established rock bands, Disturbed and Avenged Sevenfold, from urban artists Trey Songz, and from developing artists, Jason Derulo, DOB, Bruno Mars, and Plan B.

  • Our efforts to build artist careers are at the core of our A&R strategy.

  • We will aim to establish sustained creative success for artists that we believe will yield strong returns.

  • We are proud that Atlantic Records Zach Brown Band was named best new artist at last week's Country Music Association awards.

  • And we're pleased records Warner Music national artist Blake Shelton won awards including male vocalist of the year.

  • In addition expanded rights artist Paramore was named best alternative artist at MTV's European Music Awards.

  • Our international recorded music business saw some solid performances from both local and international artists and strong digital sales.

  • However we saw declines in recorded music revenue across most major European territories as well as the Asia Pacific region.

  • On the other hand, our UK and German companies were standout performers this quarter.

  • Our UK business continues to benefit from our consistent investments in A&R and executive talent over the last few years.

  • Warner Music UK was one of only two majors to gain share year-over-year in the September quarter, up 1.9 percentage points to 14.6%.

  • Contributing to these results was Plan B's recent breakthrough album which has been one of the highest selling new releases in the year in the UK.

  • In the first quarter of fiscal 2011 we're looking forward to releases from My Chemical Romance, Flo Rida, Kid Rock, Josh Grobin, James Blunt and Cee Lo Green.

  • The first quarter is also benefiting from Warner Brothers Records release of an expanded double album version of Michael Buble's multi platinum, Crazy Love.

  • This new version includes both the original album and a second album with new studio recordings and live songs recorded during Michael's recent sold out tour.

  • In September, we announced a new senior Management team for Warner Brothers Records.

  • Rob Cavallo, one of the top record producers in the world and previously our Chief Creative Officer, has been appointed Chairman of Warner Brothers Records.

  • Joining Rob's new leadership team at WBR are veteran Warner executives Todd Moskowitz, who will serve as Co-President and CEO, and Livia Tortello, who will serve as Co-President and Chief Operating Officer.

  • We are very excited about this new executive team which we feel is well positioned to continue to strengthen the reputation of WB R, as an artist friendly haven with a unique approach to discovering and nurturing new talent.

  • I'd like to discuss our growing digital business, an area that holds great promise for us.

  • Our fiscal year digital revenue rose 6% to $759 million and digital revenue represented 40% of our US recorded music revenue, up from 36% for the prior year.

  • As our release schedule improved in the quarter, digital album downloads showed particular strength for Warner with US unit sales increasing by 13% as compared to 10% for the industry.

  • Online digital revenue was a bright spot for us both domestically and internationally.

  • However mobile revenue remained pressured by the declining ring tone business.

  • Total domestic digital revenue grew 2% while international digital revenue increased 19% year-over-year.

  • Achieving healthy digital gains remains a top priority and is one of the key elements of our long term growth strategy.

  • Based on industry developments we continue to believe that we can improve the rate of digital growth.

  • The key to that growth is well crafted business models that cater to consumer demands and fairly compensate content owners.

  • On that note, I'm happy to report that in October, we successfully reached a new agreement with Spotify for Europe.

  • We're pleased with the new agreement because we've long seen great promise in Spotify.

  • We were among the first music companies to license them in Europe in 2008 and today they report more than 10 million users.

  • The question has always been how to ensure that free to consumer models, which are generally supported by advertising and offers to attract consumers are effective at converting consumers to paid subscriptions.

  • We are pleased with the new agreement we've struck with Spotify for Europe because the terms more closely align our economics with Spotify, enabling artists to be properly compensated while also enabling Spotify to continue to offer its compelling service to consumers.

  • In addition to our focus on increasing our digital revenue, we continue to transform our place within the music value chain and diversify our revenue mix.

  • We are broadening our revenue base to include sponsorship, fan clubs, artist websites, merchandising, touring, ticketing and artist management, among others.

  • Some of this non-traditional recorded music revenue comes from our expanded rights agreements with our recording artists and some of it comes from artists services businesses that we have acquired or created.

  • Non-traditional recorded music revenue amounted to 13% of our recorded music revenue in the quarter and 10% for the full fiscal year.

  • With more than half of our global active artist roster signed to comprehensive expanded rights deals, we expect non-traditional recorded music revenue from these deals to be a continued source of revenue growth.

  • Let's turn to Warner/Chappell.

  • This quarter, growth in digital and synchronization revenue was more than offset by declines in mechanical and performance revenue.

  • Steve will elaborate on this shortly.

  • Specifically in the area of synchronization rights, we're gratified to see that our efforts, along with the rebounding advertising market, are beginning to generate a turnaround in this segment of our music publishing business.

  • A number of Warner/Chappell songs have been used in recent television commercials, films, trailers and TV spots.

  • For example, on the commercial front, Chase Bank is currently featuring both George Michael's "Freedom" and Sugar Ray's "Fly" in its US campaigns while Honda is using Cole Porter's "Night and Day." In films, the trailer for "The Social Network" uses both "Creep" by Radiohead, as well as "Power" by Kanye West.

  • We have also had increased activity in licensing music for film trailers stemming from our investments in the production music area.

  • Additionally, we're now pursuing a joint pan-European sync licensing strategy for Warner Music's recorded music repertoire and Warner/Chappell's music publishing catalog.

  • For example, music from Warner Brothers iconic rock band Muse, who are also Warner/Chappell songwriters, was featured in European ads by Christian Dior, Virgin Atlantic and Volkswagen.

  • We believe this joint licensing strategy will facilitate the licensing of tracks for which Warner Music Group owns both the recorded master and the song.

  • Our A&R efforts are also yielding success, as evidenced by the fact that Warner/Chappell songwriters have featured permanently in a number of recent Top 40 radio hits Warner/Chappell writer Katy Perry has followed her tremendous success on "California Girls" with her additional hit "Teenage Dream" and "fireworks." In addition, Warner/Chappell Cassius co-wrote Bruno Mars' break out single, "Just the way you are," and Eric Holljes co-wrote Mike Posner's hit, "Cooler than me."

  • Before moving on to our financials, I'll describe some recent public policy developments.

  • Regarding the Performance Rights Act in the US, we were initially encouraged by the progress the National Association of Broadcasters and musicFIRST had made in July.

  • Unfortunately, the NAB's membership voted in October to present musicFIRST representatives with a legislative term sheet which differed significantly from the July agreement that had been reached.

  • While we are pleased that US radio broadcasters have finally acknowledged their obligation to pay the recording artists who are the foundation of their business, we are disappointed that they failed to vote on the deal both parties had agreed upon and that this issue remains unresolved.

  • Looking forward we have seen a number of promising developments in the fight against piracy on both the US and European policy fronts.

  • In the US Senator Patrick Lahey recently introduced the Combating Online Infringement and Counterfeiting Act which is currently scheduled to be marked up in the judiciary committee.

  • This bill is a welcome step in severing the financial life line that sustains rogue websites and threatens the livelihoods of the US creative community.

  • We applaud Chairman Lahey, Senator Hatch and other co-sponsors for casting a spotlight on a critically needed reform and for their continued leadership in protecting US ingenuity and creativity.

  • The European parliament recently voted in support of the Gallo Report.

  • That Report calls for the European Commission to propose legislation establishing a framework for European governments to tackle intellectual property infringement, both online and off line.

  • This clears the path for the European Commission to propose legislation on ISP cooperation.

  • Steve will now run through the financials before Michael, Steve and I take your questions.

  • - EVP & CFO

  • Thank you, Edgar, and good morning.

  • For the three months ended September 30, 2010, we reported revenue of $752 million, down 12% year-over-year.

  • For the quarter domestic revenue declined 17% while international fell 7%.

  • Our quarterly digital revenue grew 7% to $197 million, or 26% of total revenue.

  • And it's up from 21% in the prior year quarter.

  • As the release schedule improved in the quarter, we showed strength in both domestic and international downloads.

  • That performance was partially offset by continued declines in mobile revenue primarily related to ring tone demand.

  • Digital revenue was up 9% sequentially and was split about 60% US and 40% international.

  • As Edgar noted, managing our costs remains a top priority and it is now ingrained in our DNA.

  • Even though we benefit from a highly variable cost structure, we have undertaken scores of global initiatives to optimize current operations, provide greater operating flexibility, reduce costs, and drive continued competitive performance.

  • Over the past fiscal year, ongoing efforts to streamline the management of our supply chain have resulted in a 20% reduction in our inventory balance, a 9 percentage point improvement in our US catalog return rates.

  • In addition, we have undertaken an assessment of our global operational structure.

  • This has led to consolidating activities at our labels and distribution units and rationalization of certain international offices.

  • We also continue to reduce global procurement costs as well as overhead related to our physical business.

  • We have recently upgraded our financial reporting systems and retain an outside vendor to manage certain IT and financial functions.

  • This will help reduce costs and simplify our business processes.

  • We expect these actions to generate approximately $30 million of run rate savings in fiscal year 2011.

  • This should help us sustain our fiscal year OIBDA margins on a go forward basis.

  • Severance charges for the quarter were $34 million compared to $14 million in the prior year quarter.

  • As a result, our operating income before depreciation and amortization, or OIBDA, fell 29% to $85 million, and our quarterly OIBDA margins contracted to 11% from 14%.

  • We continue to see opportunities for cost savings as our business model continues to evolve.

  • Given our track record, we remain confident in our ability to drive this corporate priority.

  • Looking at our different business segments for the quarter, recording music revenue fell 12% to $619 million.

  • Recording music digital revenue grew 7% to $183 million or 30% of total recorded music revenue.

  • That is up from 24% in the same period last year.

  • Non-traditional revenue was 13% of our recording music revenue and was boosted by our European concert promotion business, particularly in Italy.

  • International recording music digital revenue grew 20% given strong iTunes momentum outside the US.

  • Domestic recording music digital revenue was flat at $104 million as a result of continued declines in the ring tone business.

  • Digital now represents 40% of domestic recorded music revenue as compared to 34% in the same period last year.

  • The increases in recorded music digital and non-traditional revenue were more than offset by contract in demand for physical products.

  • Recorded music OIBDA fell 45% year-over-year due primarily to the severance costs I just mentioned.

  • Of those costs, $31 million were in our recorded music business versus $13 million in last year's quarter.

  • In music publishing, revenue of $142 million was down 10% versus the prior year quarter.

  • Synchronization revenue jumped 38% as we began to see the benefit of an improving advertising business.

  • Performance revenue fell by 9% due to the timing of cash collections and our decision not to renew certain low margin administration deals.

  • Mechanical revenue declined 33% due to continued pressures on physical recorded music sales.

  • In addition, in last year's quarter, Warner/Chappell realized $25 million in mechanical revenue and a $7 million OIBDA benefit from an agreement reached by the US recorded music and music publishing industries.

  • The current quarter added $5 million of mechanical revenue and $2 million in OIBDA stemming from this agreement.

  • Digital revenue increased 13% to $18 million and represented 13% of music publishing revenue.

  • This reflects the growth of the digital business and the timing of cash collections.

  • Music publishing OIBDA was down 7% to $56 million, largely due to the industry agreement I just mentioned.

  • OIBDA margin grew more than two percentage points to 39%, primarily due to revenue mix.

  • Turning to our balance sheet and cash position.

  • We ended the quarter with a cash balance of $439 million, up sequentially from $400 million at June 30, 2010.

  • We reported net debt of $1.51 billion, down from net debt of $1.56 billion in the prior year period.

  • Free cash flow of $25 million rose from $20 million in the prior year quarter.

  • Our free cash flow is calculated by taking cash provided by operating activities of $50 million less capital expenditures of $21 million and cash used for investments of $4 million.

  • The elevated capital expenditure levels in the quarter are mainly tied to the IT activities previously described.

  • We anticipate lower capital expenditures in fiscal year 2011.

  • Our cash taxes continued to benefit from our tax planning strategies.

  • We had a tax provision of $17 million and net cash taxes of $9 million on a pre-tax loss of $29 million.

  • In the prior year period, we had a tax provision of $20 million and net cash taxes of $18 million on pre-tax income of $4 million.

  • We generated a net loss of $46 million or $0.31 per diluted share compared to a net loss of $18 million or $0.12 per diluted share in the prior year quarter.

  • Severance charges had a $0.23 per diluted share impact in the current quarter and a $0.09 per diluted share impact in the prior year quarter.

  • Turning now to our fiscal year results.

  • In fiscal year 2010, revenue of nearly $3 billion declined 9%.

  • International revenue fell 6% while domestic revenue declined 11%.

  • Full year digital revenue grew 6% to $759 million or 25% of total revenue.

  • That is up from 22% in the prior year.

  • OIBDA of $348 million declined 12% while OIBDA margin was largely flat year-over-year at 12%, even with higher severance costs in the current year.

  • Free cash flow of $65 million for the current year compares to $316 million in the prior year.

  • The prior year included $123 million of cash received from the October 2008 sales of a minority stake in Front Line Management.

  • Digital factors that had a negative impact in our free cash flow in fiscal year 2010 included $60 million in incremental cash interest expense due to the timing of payments.

  • As a result of our May 2009 refinancing, the prior year reflects only nine months of cash interest expense compared to 12 months in the current year.

  • Other factors include $24 million in capital expenditures, $20 million in incremental investments including publishing acquisitions, and $16 million in incremental cash severance payments.

  • These items are partially offset by a $26 million decline in net cash taxes.

  • Looking forward, we remain confident in our ability to generate significant free cash flow this fiscal year as we have in the past.

  • Our tax expense for fiscal 2010 was $41 million compared with $50 million last year and cash taxes amounted to $29 million versus $55 million last year.

  • Now I'll turn the call back to Edgar for closing remarks.

  • - Chairman & CEO

  • Thanks, Steve.

  • I'm pleased with the progress we've made over the past fiscal year despite the prolonged challenges we faced.

  • We're embarking on this new fiscal year with confidence and the assurance that we will remain focused on the following key strategies.

  • Managing our balance sheet by generating significant free cash flow while controlling our overhead costs and other expenses.

  • Accelerating the growth of our digital business and other new business models.

  • Diversifying our recorded music revenue stream by growing our number of expanded rights deals and our artist services business.

  • Enhancing the value of our Warner/Chappell business.

  • And investing of A&R marketing and promotion which remain the core strengths of our recorded music and music publishing operations.

  • The challenges are great but so are the opportunities.

  • By remaining focused on driving our core business while diversifying revenue and supporting innovative new digital business models, we are establishing the framework for sustainable long term growth.

  • Michael, Steve and I look forward to answering your questions.

  • So thank you, and Operator, please open it up for Q&A.

  • Operator

  • (Operator Instructions) The first question is from Bishop Cheen from Wells Fargo.

  • - Analyst

  • Hi, everyone.

  • Thank you for taking the question and the update.

  • So Edgar, headwinds, tough quarter, tough environment.

  • What can you tell us to encourage us about -- I know your plans, you talked about the balance sheets and costs, et cetera, but as we're in this very important fiscal Q1 for you, the holiday December quarter, what can you tell us that will make us think that the results for this quarter are going to be a lot stronger than they have been the last two or three quarters?

  • - Chairman & CEO

  • Bishop, thanks.

  • I think, first of all, we look at the business beyond just quarters.

  • And as you know, we don't give financial guidance but I did point you to what we think is a relatively strong release schedule for Q1.

  • Beyond that, we've also said that we believe we can accelerate the rate of digital growth and we see a number of opportunities in place to do that, not the least of which, as I said, is our new agreement with Spotify in Europe and agreements with other major companies that we hope will come on line in at least calendar 2011, though it may not come on line for Q1 this quarter.

  • But I think as we focus on maintaining our margins, our reduced cost base is such that the moment we start to see lower headwinds or a little bit of breeze at our back, our margins and our business should expand very very quickly.

  • And whether that change in the wind comes this quarter, next quarter, three or four quarters from now, I see increasing signs that it's coming.

  • And as I said, when it does, given all the work that we've done to both diversify our revenue mix, increase our opportunities for revenue and reduce our fixed costs, the turnaround of our business will be significant and rapid.

  • - Analyst

  • All right, let me pass it on.

  • Thank you.

  • Operator

  • The next question is from Marla Backer from Hudson Square.

  • - Analyst

  • Thank you.

  • I was wondering if we could get a little bit more color about the first quarter release slate.

  • So obviously you have some strong releases expected.

  • If I recall correctly, last year, last calendar year, Sony was a big player because it benefited from Michael Jackson and I think it had Susan Boyle, and Sony seems to have already released its Susan Boyle album.

  • What does the competitive environment look like for this holiday release slate?

  • I'm assuming that there are a lot of other big releases coming during the period as well, which will compete with some of yours.

  • Thank you.

  • - Chairman & CEO

  • Sure.

  • Marla, the December quarter is always a highly competitive quarter and nothing new this year versus years before.

  • We've got strong release schedule, our competitors have a strong release schedule.

  • The Michael Jackson phenomenon was as much a Q3 calendar phenomenon last year as it was a Q4 calendar phenomenon.

  • And obviously Susan Boyle was an outstanding success last year and she's released a new album and we'll see whether or not that is as successful as it was last year.

  • But we're always facing strong competition from our competitors in the December quarter but we're very comfortable that our relative competitive position this year is no different than it has been in years past.

  • - Analyst

  • Okay, thank you.

  • Operator

  • The next question is from Richard Greenfield from BTIG.

  • - Analyst

  • Hi.

  • A few questions.

  • One, just looking at the substantial rise in severance for the full fiscal year, just can you give us a sense of how many bodies were actually eliminated year-over-year, and was there a significant uptick?

  • And how do you think about the number of bodies that need to be basically cut back into fiscal 2011.

  • Two, on CapEx, you mentioned, Steve, that it's going to be down year-over-year.

  • Just wondering if you could give us more color.

  • It was a bigger number than I think probably most people were expecting.

  • Just wondering what was in there and what was one-time that drives it down in 2011?

  • And then just the last question, Edgar, you seem to be more excited about Spotify overseas.

  • With US digital downloads relatively stagnant, when might we actually see a service like that hit US shores?

  • Thanks.

  • - EVP & CFO

  • Sure, good morning, Rich, this is Steve.

  • So I'll start with the first question regarding severance.

  • In the current year, we reduced our headcount by roughly 10%.

  • But it's important to realize that it's not just about headcount reductions to reduce our costs, It's also about transforming the way we do our business and enhancing our processes such as our supply chain.

  • So to get cost savings and generate incremental OIBDA in fiscal 2011, we simply just don't have to reduce heads.

  • It's also about enhancing our operating activities.

  • How many people does that work out to roughly, just ballpark?

  • A little north of 300.

  • From a CapEx standpoint, so the two things we've worked on in the current fiscal year, one is our financial systems in the US and two is enhancing our royalty systems.

  • So we would expect CapEx next year to be somewhere in the $40 million range compared to the $50 million plus in the current year.

  • - Analyst

  • So still a higher run rate than a couple years ago?

  • - EVP & CFO

  • Yes, a little higher, yes.

  • - Chairman & CEO

  • And Rich, it's Edgar.

  • On Spotify specifically, as I said we're very comfortable that we finally reached an agreement that aligned our economic interests with those of Spotify, which was a long time coming and not easy for us and not easy for them.

  • As we turn our attention, we're talking to them in the US, but recognize that in the introduction of Spotify here probably requires, again, the agreement of other recorded music companies and publishing companies, not just Warner Music and Warner/Chappell.

  • But again, we are talking to them, we are hopeful that we'll reach an agreement and again that agreement, however, has to reflect an alignment of economic interests, as it did in Europe.

  • - Analyst

  • Did their business in Europe have to change based on your new agreement, or are they still operating under the same business model from a consumer perspective that they had before?

  • - Chairman & CEO

  • I think that's a question better addressed to them.

  • We have an agreement with them and the effect on Spotify or lack of it is really something you should take up with them directly.

  • - Analyst

  • Okay, thanks.

  • Operator

  • The next question is from Laura Martin from Needham & Company.

  • - Analyst

  • Hi, a couple questions.

  • Edgar, can you talk about EMI?

  • They lost their suit, looks like their hands is up against the ropes.

  • Is there a future there between -- can you help them out over at Citibank?

  • I'm interested in your thoughts on how EMI plays out.

  • And then maybe one for Michael, could you talk about the cloud?

  • We're reading in the blogs that Google might actually release a new service for music in the cloud which looks like it might be a new cool subscription based revenue stream which would put a higher multiple on all these music companies.

  • Could you talk about rolling out the consumer facing cloud and what that could mean to the future of Warner Music?

  • Thanks guys.

  • - Chairman & CEO

  • Laura, I might take both questions.

  • So on EMI, we've all been reading what happened with the lawsuit and the result of the lawsuit, et cetera.

  • But I think it makes no sense for us to speculate on what happens next.

  • There's been plenty of speculation in the press and I think we should probably refrain from that, focus on Warner Music and when we've got something to announce, if we have something to announce, then you guys will be the first to hear about it.

  • On the cloud, we really do think that the cloud represents a significant opportunity for Warner Music and for the industry.

  • And we are very hopeful that significant companies, Google among them, will introduce services that we think have, as I said, very significant -- would create very significant opportunity both for consumers and for the music industry.

  • We're not there yet and so it's premature for us to discuss it further.

  • But when I mentioned before some of the things I see that could happen in the near future that would fundamentally accelerate our digital revenue growth, that certainly is among the things I was referring to.

  • - Analyst

  • Okay.

  • And an update on performance rights.

  • I, like you, am disappointed about what's going on.

  • Any update on timing, what's your best guess about when we get a final agreement?

  • - Chairman & CEO

  • I think that obviously depends on, we've got, I won't say an entirely new but essentially a new Congress with a Republican House and a diminished Democratic majority in the Senate.

  • While we have quite a lot of Republican support and quite a lot of Democratic support, it remains to be seen whether or not a legislative solution or a negotiated solution is possible in either case.

  • We continue to be hopeful as part of the musicFIRST coalition that the NAB will formally acknowledge what it's already acknowledged informally in terms of its obligation to pay recorded music artists and we'll continue to press them.

  • But at this moment I can't predict there will be a resolution, though I certainly hope there will.

  • - Analyst

  • All right, great.

  • Thanks.

  • Operator

  • The next question is from Jason Bazinet from Citi.

  • - Analyst

  • Thanks.

  • I just had a question regarding the disparity in the top line in the US versus the international markets.

  • I think the US is down low double digit over the last couple of years where international is low to mid single.

  • How should we think about that?

  • Is that a function of the US being further along the ultimate evolution and international eventually will follow?

  • Or there are structural things that caused the US just to have a steeper decline and we shouldn't really infer that international will follow US?

  • Thanks.

  • - Chairman & CEO

  • Sure.

  • First of all, international is a big place.

  • International is made up of a lot of different countries and a lot of different trends.

  • But what I would say is that generally speaking, and you can see this with artist careers and touring schedules, et cetera, is that international is much steadier in terms of its appreciation of artists over many years than the US, which tends to be more fickle in terms of its willingness to support artists over time.

  • So when you see major artists going out on tour who have been around for 20 or 30 years, the bulk of their touring revenue occurs outside of the US.

  • The bulk of their record sales occurs outside the US.

  • So international as a whole, though obviously there are differences place to place, is a steadier audience, frankly, than the US So I don't think that the US is a precursor of trends to come to international, if past is prologue, because the European markets really do operate fairly differently.

  • I also would say that I think to the extent that digital growth might slow, a la the US, A, we haven't seen that trend begin yet, and it's my hope that as the services Spotify and others expand over the next couple of years, both in Europe and in the US, that the actual rate of growth of digital both internationally and domestically will actually accelerate.

  • - Analyst

  • Perfect.

  • Thank you very much.

  • Operator

  • The next question is from Tuna Amobi from Standard & Poor's.

  • - Analyst

  • Thank you very much.

  • So first question for Edgar.

  • I thought it was very interesting when you let out your stepped up licensing strategy, but one of the things that you didn't mention was the opportunity that you see in the video game segment.

  • I don't know what your thoughts are.

  • I know about a year ago you had alluded to some frustrations with how that segment was evolving.

  • So just wanted to get a sense of whether your take on that is perhaps affected by Viacom's decision to give up on Rock Band, how you view the overall category for the music industry.

  • That's the first question.

  • And separately for Steve, I picked up on your commentary in the press release that your free cash flow, your cash needs are now way in excess of your operating and investment needs, which begs the question, or leaves out the financing possibility as the only other possible use of free cash.

  • It seems clear that your free cash is set to accelerate, from your commentary, next year thanks, in part, to the restructuring run rate savings you alluded to.

  • So the question is, within that context of your growing cash balance and free cash flow generation, how do you think about the financing possibilities, specifically use of this growing cash capacity for dividends resumption or perhaps some kind of distribution to shareholders.

  • That would be helpful.

  • - Chairman & CEO

  • So Tuna, it's Edgar.

  • Let me just quickly talk about video games.

  • The video game industry, particularly with regard to music, has fallen significantly since its peak of a couple of years ago.

  • And unfortunately, as I've mentioned, even at its peak, it returned little or no money to the music industry due to the licensing arrangement that much of the music industry made with that particular industry.

  • As you know, we only came very late to the party with an improved deal than the ones that were offered to us earlier.

  • But the industry, the video game industry, has not been able to sustain the growth that it had in the '05, '06, '07 time frame.

  • But the point I'm making is it was never meaningful to us.

  • It wasn't meaningful to us in success, unfortunately, but I guess the fortunate flip side to that is that it's not meaningful to us on the downside.

  • I think what is interesting, and I think we are the first company to be doing it, is when we combined our recorded music and music publishing sync operations in Europe, so that we can both more quickly and more effectively be good partners to the advertising industry and others who are looking for not only high quality music but quick answers in this fast moving environment, I think we found that combining those two operations has been enormously effective for us.

  • And we hope it will continue to show growth in our European sync business.

  • - Analyst

  • Any thoughts on Viacom's pulling the plug on Rock Band and what that means for the overall category from your perspective?

  • - Chairman & CEO

  • Again, we're partners with Viacom, as you know, through MTV Networks, in the online advertising space, as well as, obviously, our long association with MTV.

  • We have a lot of admiration for Viacom as a company.

  • As I said, neither Rock Band nor Guitar Hero nor any of the other music based video games caused much revenue to accrue at Warner Music Group so whether Viacom is in that business or out of that business, frankly, is not going to move the needle at Warner Music.

  • - Analyst

  • Okay, that's helpful.

  • Steve?

  • - EVP & CFO

  • Sure.

  • So, as you know, our business model continues to generate significant free cash flow, in particular our music publishing business.

  • With regard to the use of that cash, our number one objective and priority is to sustain our levels of A&R investment which we've done since we bought the Company back in 2004.

  • I think beyond that, we continue to look at smaller acquisitions in the publishing space.

  • And then our goal is to enhance shareholder value which one way may or may not be a dividend in the future.

  • - Analyst

  • I believe, Steve, the current indenture restrictions allow for up to $90 million in annual dividends.

  • Has there been any material change to those criteria of late?

  • - EVP & CFO

  • No.

  • No significant changes and all those indentures are filed with the SEC and they are available online.

  • - Analyst

  • Thank you.

  • Operator

  • The next question is from Edward Atorino from Benchmark.

  • - Analyst

  • Most of my questions have been answered.

  • This may be a throw away question and if it is I apologize.

  • The Beatles thing on iTunes, would that be a disrupter in the market of any consequence or is that just noise?

  • - Chairman & CEO

  • It's Edgar.

  • I think it's too early to say.

  • Its been online for a day or two.

  • I would say that the Beatles are the most iconic band of essentially all-time.

  • They are, obviously, and were an extraordinary talent and created an unbelievable library of songs.

  • I don't know how impactful after 10 or 12 years of digital business they are coming online to iTunes will be, but I think it will be helpful in driving more and more people to iTunes.

  • And I think that's a positive outcome for the industry.

  • - Analyst

  • Thank you very much.

  • Operator

  • The last question is from Ian Whittaker from Liberum.

  • - Analyst

  • Hi, yes.

  • Again most have been answered.

  • But I guess just one thing was we had Universal Music talking the other day about they are also gaining share, as well, and obviously in terms of the rate of decline was somewhat less than yours in the quarter.

  • If that's the case, you're gaining share, Universal is gaining share, is all the loss in share really coming from EMI or is it a mixture of EMI, Sony and the independent producers?

  • - Chairman & CEO

  • It's Edgar.

  • I think, first of all, while we talk about quarterly share, I think it's fair to look at trailing 12 months as a better indicator.

  • And we continue to gain share in the industry and we basically have done so pretty consistently since we bought the Company.

  • And that share has come to us variously from Sony, from Universal, from EMI, and from independents.

  • But having said that, where our share gains come from can vary year to year.

  • And it's true that we haven't gained share in every single quarter since 2004 but we fundamentally gained share in the vast majority of those quarters, and obviously essentially every year on a trailing 12 month basis.

  • But where it comes from does vary.

  • Obviously Sony had a very strong year last year with Susan Boyle and Michael Jackson.

  • At the beginning of the Sony/BMG merger they suffered for a couple of years.

  • EMI seems to be doing a little better recently but has suffered really since the Terra Firma acquisition.

  • And Universal has been a very, very strong company throughout, but given the size of their business, their share has moved a little bit up, a little bit down.

  • So there's no real one place where it comes from but I think if you look at our trend over the last six years versus the trends of any of our competitors, ours is a steadier growth in share than any of those with whom we compete.

  • - Analyst

  • And to just ask you one follow-up.

  • You mentioned about transforming fixed costs into variable costs, and the various bits were dotted around the call, but can you just give us an idea of what sort of fixed costs you think can be transformed into variable cost?

  • Is it a case of just outsourcing or are there any other things you think you can do?

  • - EVP & CFO

  • Ian, this is Steve.

  • Outsourcing would be a definite way to do that, so we've done some of that here at Warner with various IT functions, finance and accounting functions around the globe.

  • So that's an obvious way to move the variable costs.

  • - Analyst

  • Would there be any other areas you can see transformation or would it primarily be outsourcing deals?

  • - Chairman & CEO

  • It's Edgar.

  • I think primarily, it's primarily going to be outsourcing deals but there will be distribution arrangements that we can also adjust where we move our own sales functions to outside sales companies potentially in various markets around the world.

  • So there's really quite a mix of things that remain for us to do, both to eliminate further fixed costs and to take fixed costs which we can't eliminate but make them variable and take them off of our balance sheet.

  • So we said we think we can maintain margins and go forward even in the current and I hope not long lived headwinds, and we feel confident that we can do that.

  • - Analyst

  • That's great.

  • Thank you very much.

  • - Chairman & CEO

  • Okay.

  • Listen I want to thank everyone for your time and attention.

  • We look forward to talking to you all again in three months and have a good holiday season.

  • Thanks, everyone.

  • Operator

  • That concludes today's conference.

  • You may disconnect at this time.