Warner Music Group Corp (WMG) 2012 Q2 法說會逐字稿

Welcome to Warner Music Group's second-quarter earnings call for the period ended March 31, 2012.

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 would like to turn today's call over to your host, Mr. Will Tanous, Executive Vice President of Communications and Marketing.

You may begin.

Good morning, everyone.

Welcome to Warner Music Group's fiscal second-quarter 2012 conference call.

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

Today our CEO, Steve Cooper, will update you on our business performance and strategy; our Executive Vice President and CFO, Brian Roberts, will discuss our financial results; and then both of them will take your questions.

Before Steve'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.

All forward-looking statements are made as of today, and we disclaim any duty to update such statements.

Our expectations, beliefs, and projections are expressed in good faith and we believe there is a reasonable basis for them.

However, there can be no assurance that management's expectations, beliefs, and projections will result or be achieved.

Investors should not rely on forward-looking statements because they are subject to a variety of risks, uncertainties, and other factors that could 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 release and Form 10-Q and other SEC filings.

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

Revenue data we 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 Steve Cooper.

Thanks, Will.

Good morning, everyone.

Welcome to our second-quarter earnings conference call.

Thanks for joining us today.

I appreciate you taking the time.

This quarter we achieved a number of positive metrics.

Our cash balance and free cash flow both showed substantial growth, reflecting our continued focus on cash generation through disciplined A&R investment and operating cost control.

We grew OIBDA and improved OIBDA margin also because of operating cost controls, and we continued to grow digital revenue.

We accomplished this even with the second quarter's anticipated light release schedule, which resulted in a decline in total revenue compared to last year's quarter.

In the US, WMG's track equivalent album units were down 5% year-over-year, and track equivalent album share fell 1 percentage point to 18%.

While our release schedule affected our results, we did see some noteworthy industrywide performance trends which could bode well for the future.

In the US, the world's largest music market, track equivalent album units were up 2% for the quarter, continuing the growth trends seen in calendar-year 2011.

Also, catalog album units grew for the fifth consecutive quarter, up 10%; and digital download unit growth remained strong at 11%.

In other geographies where there is publicly available data, the industry picture was more mixed.

In the UK, for example, physical album sales continued to decline sharply, down 25% in the quarter.

However, digital albums and tracks both showed upward momentum, up 20% and 4%, respectively.

In Japan, the physical market held flat in the quarter but faced an easy compare, as last year's quarter reflected the impact of the March 2011 earthquake and tsunami.

And while iTunes continues to grow in Japan, the rest of the digital business has been weaker due to declines in the mobile ring tone business.

There were several exciting developments in the US digital space.

According to the RIAA, US digital subscription revenue for the industry grew 13% in 2011 and the number of subscribers grew 19% to 1.8 million.

Growth in both digital performance royalties from SoundExchange and in subscription service revenue indicates increasing consumer demand for music streaming models.

New digital music services should also receive a boost from an agreement reached by the trade associations for record labels and music publishers and digital music providers regarding US statutory mechanical royalty rates.

This agreement should streamline the licensing process with respect to mechanical royalties.

It creates rates and terms for new digital music service categories including various types of blockers, bundles, and limited interactive services.

This creates the potential for entrepreneurs to continue developing exciting new business models, a win for the consumers, the music community, and new music services alike.

And in another effort to further the growth of legitimate digital music, US Internet service providers are expected to roll out their copyright alert systems later this year.

This follows the July 2011 Memorandum of Understanding among a group of US Internet service providers and content industry trade associations, which outlined a system for alerting subscribers of their copyright infringements and educating them on the importance of avoiding infringement, as well as on the availability of legal digital alternatives.

For WMG, 2012 has already been a period of strong digital innovation.

We were among the first partners for Spotify's new desktop apps.

These enable labels to develop a wide range of music experiences for consumers.

The Warner Sound app features songs, albums, and playlists from our artists and includes genre-specific and artist-curated playlists among other features.

In March, we launched the Warner Sound YouTube channel, featuring original programming.

Built around exclusive access to artisan celebrities, the site offers a mix of music-based specialty-produced programs.

For example, we launched a program called Stage featuring comedy and drama based on our top artists' lyrics.

As always we are working closely with a variety of new digital services to help broaden consumer access to music.

As consumer tastes evolve, it is important for us to continue to enable and support innovation and experimentation in the digital space.

Turning back to our results, even in a light release quarter both our Recorded Music and Music Publishing businesses delivered some strong metrics indicative of the continued transformation of our businesses.

In Recorded Music, we grew digital revenue by 8%; and digital revenue represented 58% of US Recorded Music revenue and 44% of worldwide Recorded Music revenue, both of which are our highest percentages to date.

In Music Publishing, synchronization revenue grew 3%, OIBDA grew by 8%, and OIBDA margin expanded 6 percentage points to 42%.

In that context, let's look at some of our recent successes.

Breaking new artists remains at the core of our strategy.

Top rock band FUN is a 360 recording artist who is also signed to a publishing deal with Warner/Chappell.

Their second album, Some Nights entered Billboard's Top Current Albums chart at number two.

We Are Young, the first single from the album, was the top-selling track in the US for the March quarter, had the number-one spot on Billboard's Hot 100 for six weeks, and hit number one on the local charts in Canada, Australia, and Ireland.

To date, the track has global sales of over 5 million units.

It also became the first track ever to launch six weeks of 300,000 units or more in US digital sales.

The Black Keys' El Camino, a Q1 release, continued to sell well globally in Q2.

The album was certified gold in the US a month after its release, and has also been certified platinum in Australia and gold in France, Ireland, and the UK.

The album currently has two singles in the top 10 at US alternative rock radio, Lonely Boy and Gold on the Ceiling; and Gold on the Ceiling has received a number of sync placements, including for the NCAA, Discovery Channel's Shark Week, CBS's CSI Miami, and Universal Pictures' upcoming feature film, Battleship.

In Japan a new English language album from Jin Akanishi, along with strong singles from two other local artists, helped drive revenue and OIBDA growth.

Under our new Warner Music Japan CEO, we are working to regain momentum in this important territory, with a number of major releases slated for later in the fiscal year.

I want to congratulate members of the Warner Music Group family who were recently inducted into the Rock 'n Roll Hall of Fame.

These include Warner Bros.

recording artists Red Hot Chili Peppers and The Faces; Atlantic recording artist, the late Freddie King; and Atlantic Records staff engineer and producer, the late Tom Dowd.

In the remainder of this fiscal year we have scheduled some exciting new releases.

Warner Bros.

Records recently announced that Green Day is in the studio finalizing the recording of three new albums, the first of which we are targeting for release in September.

The three albums, Uno, Dos, and Tre, are produced by the band's long-time producer and Warner Bros.

Records Chairman, Rob Cavallo.

Also, Linkin Park has seen strong presales for their new album Living Things, which will be released in June.

Turning to Music Publishing, which continues to have a great year, Warner/Chappell was jointly named the 2012 Publisher of the Year at the ASCAP Pop Music Awards.

Our songwriters collected 19 Most Played Song of the Year awards and the coveted Song of the Year award for Bruno Mars, Just the Way You Are.

In addition to FUN's previously mentioned success, Warner/Chappell's songwriter Katy Perry broke the record for most number-one singles, six, from a female artist's album.

And Wayne Hector co-wrote two songs that hit the top five of the Hot 100 -- The Wanted's Glad You Came and Nikki Minaj's Starships.

Also in the quarter, Warner/Chappell continued to strengthen its catalog by signing extensions or expansions with a number of its top artists including Van Halen, Hayley Williams of Paramore, Michael Buble, and Bruno Mars.

With our renewed focus on licensing tracks in which we have both Recorded Music and Music Publishing rights, we are pleased that Warner Bros.

recording artist and Warner/Chappell songwriter Van Morrison has eight songs features in Judd Apatow's new film, The Five-Year Engagement.

Since we control both the sound recordings and musical compositions on three of these tracks, it is a double benefit to us.

Finally, in April, we launched Warner/Chappell Production Music, which unites all of our production music businesses including 615, Carlin, Non-Stop, and Groove Addicts.

Among the benefits this provides clients is a simple central point of access to our significant collection of compositions and sound recordings.

We believe this platform will help us continue to enhance the performance of the investments we have made in Production Music over the past several years.

In sum, we remain optimistic with our plans and pleased -- but never satisfied -- with our progress.

Given the release schedule,, we knew this would be a softer quarter from a revenue perspective.

Going forward, I am confident that our strategy of sustained artist development, digital innovation, revenue diversification, and careful cost management will continue to benefit us over the long term.

With that, let me turn it over to Brian Roberts to detail our financial results.

Thanks, Steve, and good morning, everyone.

This quarter demonstrates that even in a period with declines in revenue we have the ability to grow OIBDA, improve OIBDA margin, and generate meaningful free cash flow.

Our cash balance grew by $104 million from December to $272 million, and free cash flow improved to $103 million from $46 million in the prior-year quarter.

Our improved free cash flow was largely related to an increase in OIBDA, the timing of our working capital requirements, the timing of our A&R spend, and a decrease in cash paid for severance and acquisitions.

As you know, our cash balance is also impacted by the timing of our interest payments.

For example, in the third quarter we have a semiannual cash interest payment which will make it tougher to build cash in the quarter.

While our total revenue declined 7%, digital revenue continued to grow solidly, up 7%.

We continued to see growth in international digital downloads, particularly from emerging digital markets in Latin America and certain European territories, and we are getting increasingly more revenue from streaming and subscription businesses.

While subscription and streaming businesses account for less than 20% of our Recorded Music digital revenue in the quarter, this revenue is growing at a significantly higher rate than revenue from downloads.

Partially offsetting this growth, ring tone revenue continued its multiyear downward trend.

Additionally, digital revenue from Music Publishing declined, driven partially by a long-time settlement in the prior-year quarter.

The decline in digital revenue from Music Publishing was also due to the timing of collections, since this revenue -- as with most of our Music Publishing revenue -- is largely recognized on a cash basis.

From a geographic perspective, revenue growth in Japan and other parts of Asia, Italy, and Canada were offset by weakness in the US and most of Europe including the UK and France.

Total OIBDA grew 4%, and OIBDA margin expanded by 2 percentage points, given our continued execution on our cost savings plan as well as a reduction in severance expense.

We have recently executed on a number of initiatives including restructuring our international Recorded Music operations and reorganizing certain of our smaller labels.

And we remain on track to achieve our targeted cost savings of between $50 million and $65 million over the nine fiscal quarter period which began July 2011.

Additionally, we continue to identify incremental cost savings opportunities.

In Recorded Music, this quarter's release schedule magnified the effect of the industry's physical declines.

However, this was partially offset by our digital revenue growth of 8%.

Digital revenue represented 58% of US Recorded Music revenue in the quarter and 44% of worldwide Recorded Music revenue, both of which are our highest percentages to date.

Top sellers in the quarter include Skrillex, The Black Keys, Bruno Mars, Ed Sheeran, and FUN.

360 revenue, which includes revenue from concert promotion, touring, and merchandising, grew 8% year-over-year and represented 12% of Recorded Music revenue in the quarter.

This growth was largely driven by merchandising revenue from expanded rights deals in the USA and Japan, as well as from our European concert promotion business.

The Recorded Music OIBDA decline largely reflected the decline in revenue, partially offset by ongoing cost savings initiatives.

In Music Publishing, the increase in synchronization revenue was more than offset by continued decline in mechanical revenue, the timing-related decline in digital revenue, and the decline in performance revenue resulting largely from softness in the US.

This softness related to an overall reduction in distributions made by US performing rights societies to the music publishing industry, principally related to reduced radio license fees.

Music Publishing gross revenue improved as cost of revenue declined due to our focus on acquiring higher-margin assets.

As a result, OIBDA grew 8% and OIBDA margin expanded 6 percentage points.

Finally, I wanted to address two items that we have received a number of questions on.

First, where our cash is located.

While the picture will obviously vary quarter-to-quarter, as of March 31 more than half of our cash was on deposit in the United States or readily accessible through our intercompany cash pooling arrangements.

A substantial portion of our organic cash is owed to the US by our foreign affiliates through intercompany debt.

As a result we have the ability to repatriate cash to the US through the paydown of intercompany debt.

Therefore, while we have significant foreign operations, the majority of our global cash is available to fund US obligations.

Second, as a matter of policy, we do not provide financial or release schedule guidance, given that quarterly variations in the timing of our music release schedule and associated marketing and promotional expenses are a normal part of our business.

Overall we are pleased with our cost management and margin expansion this quarter, although there is still a lot of work to be done.

With that, operator, please open the line for questions.

(Operator Instructions) Aaron Watts, Deutsche Bank.

Good morning, guys.

Brian, maybe just a couple quick ones for you.

In the Publishing segment, can you remind me what the amount of that settlement was in the prior year?

It was about $1.6 million.

Got it.

Okay.

And on the costs side of the equation, I know you said I think nine months from the time you guys stepped into the picture; so does that mean, in terms of thinking about the costs going forward, that this was the last quarter where we are going to see as drastic year-over-year declines as we have seen?

Like I think you had 10% decline in cost of operations and something close to that in terms of SG&A.

Yes, you know, as we said, we started that process of the cost savings back in July of 2011.

We have continued to rationalize different costs within the business.

We just in the recent quarter did some label reorganization in the United States and Europe that we announced; and there are continuing changes in the international organization, all of which will have quarterly impact going forward with the goal at the end to have this $50 million to $65 million.

So from an overall percentage drop quarter-to-quarter, you can still see some changes against our prior-year quarter G&A, the magnitude of which will unfold as we execute the plans and the timing of them as we roll things out.

So you are still going to see some severance charges in our results.

We will identify those as those occur.

And then really in fiscal '13 and in the future you will start to see the impact on a permanent basis forward.

Okay, that's helpful.

Steve, maybe for you, with Spotify and other streaming services out there, can you maybe just give us an update on the success you are seeing in converting consumers to actually paying subscribers, and perhaps how that is tracking against your initial expectations?

Well, I can't -- I am not privy to all of the specific numbers, Aaron.

But I believe Spotify has been satisfied with the conversion from premium to paid to date in the United States; and obviously it is expanding nicely in Europe.

They have looked at ways to increase the size of their front-end funnel, for lack of a better term, in order to expose more potential users to the service.

And we continue to support them by way of hours of play and free play, so on and so forth, to make the experience meaningful enough to the free users to convert to paying customers.

So, to date we are very happy with the way Spotify seems to be gaining traction in the United States and with their continued expansion in both Western and Eastern Europe.

Okay.

Then last one for me, I appreciate you taking these questions.

Just this has to do with -- I think next year I under the Copyright Act some artists are going to begin to have the right to take their works back, the rights to their works back.

I was just curious if you'd put that in perspective for us, for what it could mean for Warner Music and Warner/Chappell?

Thanks.

We are comfortable with our legal position regarding the termination provisions in the Copyright Act.

We believe that labels will continue to enjoy the full ownership of these recordings where their contracts so provide.

We are actually talking this through with our artists and their representatives.

Our intent is to work through any issues that are outstanding so that we can resolve these in a fair and amicable fashion.

Obviously, as you know, any sound recording that is a work made for hire, the termination right doesn't apply.

And where termination rights do apply, only US rights would be affected; ex-US rights are not being affected.

So it is something we are aware of, something we are cognizant of, and it is our intent, if and when we do have issues, to work through them in a very proactive, fair way with our artists, Aaron.

Okay.

Thanks, Steve.

Adam Spielman, PPM America.

Thanks.

I was just hoping to get your thoughts on -- how do you guys look at the cash generation goals or potential of the business?

And I ask, understanding there is going to be a lot of movement quarter-to-quarter and you have got some annual interest payments.

But how do you guys target?

Do you look through those restructuring charges or do you -- how do you think about CapEx over the longer term, should the business generate cash flow?

Well, let me see if I can take each of those points.

Obviously, both in the short, intermediate, and long term, Adam, the objective of the business is to generate substantial free cash flow which we can utilize to either reduce debt, provide returns to our owners, or to continue to make investments in the business.

The fact of the matter is that as we generate more and more cash flow, obviously given our cost of capital, debt reduction is one of our priorities over time.

That being said, we have in both the Recorded Music side of the business and Music Publishing side long-term views about what our expenditures should be, whether it is for A&R investment, both proven and unproven artists on both sides of the business, or the acquisition of complementary or supplementary businesses both to Recorded Music and to Music Publishing.

Now, obviously the rate at which we are able to reduce debt and the rate at which we are able to find good investments will indicate how at the end of the day we utilize that cash flow.

But our goal is as much as possible, within the realm of reason.

All right.

Just any comments on plans for the refinancing the 9.5% notes due 2016?

No, we have no comments on that today.

Obviously we keep an eye on our capital structure, which is a relatively high cost capital structure; and we continue to keep a very close eye on our cash flow so that we balance the needs to service the capital structure with our needs to manage and invest in the business.

Great.

Thanks.

Andrew Finkelstein, Barclays Capital.

Hey, guys.

Thanks.

First on Recorded Music in the US, I thought at the beginning -- did you guys say that -- was it that units were down for you guys 5%?

Because I am just looking at the revenue line in the back, and it looks like the US Recorded Music line was down a lot more.

So I was hoping maybe you could bridge the two numbers or give us some more color.

Compared to the industry, Andrew, for our second fiscal quarter, in the US our total equivalent album unit sales were down 4.83% compared to the industry, which was up a couple points.

The unit sales though, keep in mind, don't factor in any pricing considerations.

Okay.

Then the $254 million last year to $211 million this year, I mean is it just price, or should there be something else I am thinking about?

It just was a bigger drop I guess than expected given the units.

I didn't think there was that material change in pricing across the industry.

Andrew, the units are based on SoundScan, which is a measurement taken at the retail cash registers or self-service scanners, whatever it happens to be.

Whereas year-to-year, year-over-year revenue is based on shipments.

And there is always a variation as to what has been shipped versus what has been sold.

Okay.

If that's helpful.

Okay.

So there could be some timing in that is what it sounds like as well?

Yes, typically there is.

Okay.

Obviously, it sounds like you expect the gaps to the industry sales, whatever, to close as your release slate picks up for the second half of your year.

Well, I think it the end of the first quarter we had mentioned that as we went into the second quarter we were going to have a relatively light release schedule.

And any comparisons of the Warner Music Group to the industry are obviously -- it is very sensitive based upon the release schedule.

We think we have a pretty good back end of the year coming.

I mentioned Green Day, I mentioned Linkin Park.

While we don't publicly announce our release schedule, those have already hit various information mediums.

But I'm hopeful that as we progress through the third and fourth quarter that our showing both year-over-year and against the industry will be stronger.

Okay.

Then just one more on the expense side.

It has been pretty impressive.

I mean, I guess do you think the A&R is where it needs to be, I guess, really to maintain share?

Or is there some maybe share that you don't want, if there was unprofitable business?

It has obviously been impressive, the further cost reductions that we have seen.

Yet obviously revenue continues to drop.

So are the spending cuts I guess hurting the top line, or is it top line that you are willing to give up at this point?

Well, I think that, certainly on Music Publishing I think the operating philosophy on the Music Publishing side is to give up very, very, very low-margin revenue where the cost to service that revenue doesn't warrant extension of that business.

And that's pretty straightforward on the Publishing side.

On the Recorded Music side -- and incidentally on the Music Publishing side, the A&R budget really has two components, one proven artists and the other unproven.

The constraint is more our infrastructure and what we have by way of required artist support in any 12-month period for their releases, for the marketing and promotion and what that requires with respect to the A&R budget, Andrew, and then what we can devote to new artists.

So the constraint is really the organization, what's on their plate at any given time, and the rate at which we can essentially make those capital investments.

During the budgeting process we lay that out as effectively as possible, or as effectively as we can given our knowledge of what is happening at that moment.

But as I am sure you can appreciate in this business, things change during the year; and in some instances we invest more capital against the budget and in other instances less capital.

Again, based upon the infrastructure's ability to handle the investments and what we see on the near, short-term horizon, Andrew, by way of artist support.

And on the Recorded side, do you have any thoughts?

Say that again?

On the Recorded side?

That was very helping on Publishing.

On the Recorded side, do you have any thoughts on A&R and the --?

Yes, the Recorded side is almost the same, with the exception that typically more of their capital expenditures will go into unproven artists, new artists, than on the Music Publishing side.

So, the process is exactly the same; and it is in large part constrained by the ability of our organization, the infrastructure, to invest that money given all of their current expenditures and the commitment to support the artist with those current expenditures.

Okay.

Then just last one for me along those lines, investing is down a lot, which you guys had said I think it would be down this year.

The six-month level, is that a good thought for the rest of the year?

I know things could change if something comes along.

But short of something different happening, is the level of CapEx and investing similar to what you would expect?

You know, Andrew, you're right.

It can vary based on where we are in the process with releases.

And given the Q2 light release schedule, that is going to drive some of that investment.

We have releases in the back end of the year in Q3 and Q4, so I don't want to give you the thought that what we have in the first six months is really indicative to the back end of the year.

You'll probably actually see some uptick there from the pure CapEx standpoint just in PP&E and things like that.

I think we have said before we laid that number out at around $25 million a year and that is the number that we will be at for the year.

But on the investment line you're probably going to see some change there going out as the releases start to come.

Okay, thanks.

Bishop Cheen, Wells Fargo.

Hi.

Thanks for the detailed update.

Let me go back to two things.

On the expense goals of $50 million to $65 million that began in the July quarter 2011, can you remind us again -- ballpark -- where you are on that?

In other words, how much the way you count it have you achieved so far?

We are roughly around $40 million through the process of that targeted $50 million to 65 million.

All right.

Then on 360 revenue, which I think in this Q2 was about 12% of Recorded Music all-in, US and domestic and international.

Can you give us a sense on where you think you would like to take that, how far that can go as a percentage of Recorded Music?

Bishop, we don't have a goal in terms of where we think that number is going to hit as it relates to our total Recorded Music business.

As we have said, there is some variation to that number quarter-to-quarter, largely driven by our European touring and concert promotion business, which are driven by the underlying tours that we are promoting.

So you are going to see some volatility in that on a quarter-to-quarter basis, as well as volatility around where certain things -- like this quarter we had a good quarter in merchandising and some of the expanded rights deals that we have, simply because there were tours to support that.

So you are going to see quarter-to-quarter volatility.

We don't have a targeted percentage of that as it relates to our total Recorded Music business.

Okay.

Fair enough.

Then last one for me; I will make this quick.

Moving to your subscription business and streaming, can we think of this more as a cash business?

Or the way that you GAAP and recognize the revenue on this, is this different than your fiscal business or any other parts of your business?

That line of our business is principally on a cash basis.

So as we receive the royalties and the reportings from those services we are recognizing the revenue associated with it.

There is a piece of it that is based on an accrual, only because we have real visibility around what the collections are and what is going to be paid to us based on the relationship we have with that collection society.

But the lion's share of it is on a cash basis.

Okay, great.

Then the Q, will you be filing that today?

Yes.

It was filed this morning.

Terrific.

You can pick it up off our website, Bishop.

It is right there.

Okay, great.

Thank you.

All right, everybody.

Thanks again for joining us this morning.

I appreciate you taking the time and we look forward to speaking with you again after the third quarter closes.

Have a wonderful day and have a wonderful Memorial Day weekend and safe and happy summer.

Bye.

That concludes today's conference.

You may disconnect at this time.