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Warner Music Group Corp. (NYSE:WMG)

F4Q08 (Qtr End 09/30/08) Earnings Call Transcript

November 25, 2008, 8:30 am ET

Executives

Jill Krutick – SVP, IR and Corporate Development

Edgar Bronfman – Chairman and CEO

Steve Macri – EVP and CFO

Michael Fleisher – Vice Chairman, Strategy and Operations

Analysts

Bishop Sheen – Wachovia

Rich Greenfield – Pali Capital

Howard Gleicher – Metropolitan West

Tuna Amobi – Standard & Poors

Doug Mitchelson – Deutsche Bank

Operator

Welcome to the Warner Music Group's fiscal fourth quarter earnings call for the period ended September 30th, 2008. 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, Ms. Jill Krutick, Senior Vice President of Investor Relations and Corporate Development. You may begin.

Jill Krutick

Thank you very much. Good morning everyone. Welcome to Warner Music Groups' fiscal fourth quarter 2008 conference call. This morning we issued the press release announcing our results. If you haven't already seen them, both the press release and our Form 10-K are available on our website at wmg.com. Today our Chairman and CEO, Edgar Bronfman Jr. will update you on our business performance and strategy, and our Executive Vice President and CFO, Steve Macri, will discuss our financial results for the quarter. Then Edgar will wrap up before Edgar, Steve, and Michael Fleisher, our Vice Chairman, Strategy and Operations takes your questions.

Before Edgar's comments, let me remind you that this communication includes forward-looking statements that reflect the current views of Warner Music Group about future events and financial performance. Words such as "estimates," "expects," "plans," "intends," "believes," "should" and "will," and variations of such words or similar expressions that predict or indicate future events or trends or do not relate to historical matters identify forward-looking statements. Such statements include, but are not limited to estimates of our future performance such as the success of future album sales, projected digital sales increases and declines in physical sales, expected expansion of the online marketplace, the success of strategic actions we are taking to accelerate our transformation as we redefine our role in the music industry, market share gains, and our intentions to deploy our capital including the level of and effectiveness of future A&R investments. All forward-looking statements are made as of today and we disclaim any duty to update such statements. Our expectations, beliefs, and projections are expressed in good faith and we believe there is a reasonable basis for them. However, there can be no assurance that Management's expectations, beliefs and 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. 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.

Edgar Bronfman

Thanks, Jill. Welcome, everyone. Thank you for joining us. This quarter capped a year of strong progress at Warner Music. As I look back at fiscal ’08, I am very proud of what we have accomplished. We consistently outperformed our competitors in the marketplace gaining share, diversified our revenue mix and improving our financial flexibility. In addition, despite a worsening global economy and the recorded music industry still in transition we essentially sustained revenue and OIBDA over the fiscal year, no small achievement in this challenging environment.

We moved to a more conservative balance sheet posture early in our fiscal year which has served us well given the recent turmoil in the economy. Our declining net debt, which results from our building cash position gives us the financial flexibility to not only weather the storm but also to prepare us for growth.

We remain confident in our ability to execute on our long-term goals given our track record of developing new business music solutions, maintaining our digital leadership position, managing costs, gaining share by delivering strong returns on our investment. While the economy is experiencing significant turbulence the music industry has been relatively resilient in prior financial downturns as its products are low priced relative to other entertainment goods. Whether this downturn will be different still remains to be seen.

Let me give you some highlights for this quarter and for the fiscal year. First, as a result of our focused investments in A&R, marketing and promotion we continue to discover and develop successful artists. This quarter Warner Music again outpaced the industry, down 4% while the industry declined 7% in US track equivalent album unit sales according to SoundScan. And Warner Music was the only music major to increase share over the 12 months ending September 30th, gaining 2.2 percentage points to end at 21%. For the quarter, we raised our share to 21.5%, up half a point from last year’s quarter.

Second, we remain an industry leader in the important digital arena. Our quarterly Digital revenue rose 28% to $157 million, and in the US Digital represented 27% of Recorded Music revenue. Our fiscal year Digital revenue rose 39% to $639 million, 18% of our total revenue. We sustained our significant digital track equivalent album share advantage over physical album share in the US. We believe the new business models we have been implementing to broaden our customer reach and align our interest with our partners will enable us to monetize our content more efficiently.

Third, as part of our transformational effort to broaden our role in the music business, we continue to expand our rights in recording agreements with new artists around the world giving us a presence in the greater music and artist services businesses that will be increasingly meaningful over time. And fourth, we continue to develop our Music Publishing business by strengthening artist roster and catalog and expanding our digital presence while delivering improved results.

I would like to provide you with some detail about these achievements. A&R marketing and promotion remain at the heart of our business activities. Our improved US Recorded Music share was driven by current releases from artists ranging from Metallica and Kid Rock to T.I. T.I.’s most recent album Paper Trail was another successful premium digital album bundle in the US with an innovative three-month windowing effort leading up to its launch. The album’s first weeks sales of $568,000 were a personal best for T.I.

Softer revenue performance in the September quarter from our US recorded music businesses is tied to ongoing recorded music industry transition pressures as physical declines are not yet being offset by digital growth and to a lesser extent our proactive efforts in managing retailer inventory.

Internationally, strength in Japan and modest gains in France and Italy were more than offset by weakness in Spain, Germany, and the rest of Europe.

As part of our effort to optimize performance in dynamic regions around the world, we recently announced the strategic partnership with EMI in Southeast Asia. This multiyear agreement builds upon existing relationships between Warner and EMI in India, the Middle East, and North Africa. Under the new agreement Warner will distribute EMI’s worldwide repertoire in Hong Kong, Indonesia, Malaysia, Singapore, Korea, and Thailand. We’re delighted to be able to work together with EMI to focus our efforts in these territories.

Now let us turn to Digital Recorded Music revenue, one of the key drivers to future growth in the Recorded Music business and an area in which we continue to grow. As expected, sequentially, we saw modest Digital revenue growth this quarter consistent with seasonal patterns exhibited in prior years. While Online Digital revenue picked up globally year-over-year, ring-tone revenue continues to lag expectations in the US and Europe. As new mobile products and business models are rolled out on a global basis and as device capability and network technology advances, we believe Mobile revenue growth will accelerate. We are already seeing this acceleration in Japan where the Mobile Music space has a compound annual growth rate of about 34% over the past 3 years. In addition, Mobile accounts for 91% of Japan’s digital music revenue and over the year download revenue there is more than 3 times greater than it is in Europe.

We have now arrived at a very significant point in the evolution of digital music, the launch of access models that bundle the purchase of a device with access to music. Several of these models are just now being launched including Nokia's "Comes with Music" and Sony Ericsson's PlayNow plug [ph]. We believe that major global handset makers and other device manufacturers are in a strong position to introduce new digital music offers. We continue to transform our business within the music value chain while broadening our revenue mix in the growing areas of the music business including sponsorship, fan club, website, merchandising, touring, ticketing, and artist management.

As we have mentioned we have expanded rights deals in place with about one-third of our active global recorded music roster.

We recently announced the sale of our minority stake in Front Line to Ticketmaster for $123 million in cash. In total, including the $18 million we received from a small sale of Front Line sales to Madison Square Garden in June of 2008, we will have realized $141 million for our original $119 million investment generating a return well in excess of our cost of capital.

The strategic rationale for purchasing our stake in Front Line fit in with our larger revenue diversification plan. However, as we gain experience and focus on these 360 investments, it is important that we can control and consolidate these businesses for the full benefit of our artist partnerships. Front Line did not ultimately fit this profile and the proceeds from the sale will bolster our already strong cash position.

While there maybe occasional targeted opportunities which can enhance our global 360 footprint, we have largely built the necessary resources through acquisitions, partnerships, and new hires so we can effectively engage in the artist services business on behalf of our own artists and artists signed to other record companies.

One recent opportunity, which required a relatively small investment was our acquisition of a majority stake in Get In, a leading artist services company in Spain that specializes in artist management, live production, tour promotion, and brand partnerships. Not only does Get In have an impressive list of established artists that it manages but it is has also staged concerts for major local and international acts including Metallica, El Divo [ph], and Lenny Kravitz.

One of our principal strategic goals is to enhance the results of our distinctly valuable Warner/Chappell Music. Warner/Chappell, which is the world's third largest music publishing company and enjoys a stable, diversified revenue stream from its extraordinary library of songs has delivered steady performance over the past year.

We continue to invest in talented song writers to support the development of our Music Publishing catalog. We recently extended deals with both Timberland, it is one of the most important writers and producers in the urban hip-hop arena, and The-Dream, a writer producer who is experienced tremendous success with several singles including Umbrella by Rihanna.

Adding to Warner/Chappell’s legacy is the well established home for award winning song writers, Dido, the multi-platinum English singer songwriter was recently named Songwriter of the Year at the ASCAP awards in London.

Warner/Chappell’s also has great success this year concluding agreements with collection societies to further its innovative Pan-European Digital Licensing Initiative known as PEDL. PEDL is designed to facilitate Pan-European licensing and musical compositions for digital music services throughout Europe. Recently the Spanish Collecting Society, SGAE, joined PEDL.

Another important development for music publishers and recorded music companies alike was the US Copyright Royalty Board’s decision to maintain physical and digital mechanical rates at $0.091 per song till the end of 2012 and to establish a compulsory rate for ring-tones at $0.24. The Board also set a first of its kind mechanical royalty for interactive streaming of 10.5% of revenue, which applies to audio subscription services with interactive features. This decision brings critical clarity and rates for the next 4 years and represents a win-win outcome for all stakeholders including consumers, digital service providers, record companies, music publishers, and artists.

In addition to the continuing progress in several European countries, I want to mention two US legislative developments that are helpful to the music industry. First is the passage of the ProIP Act of 2008, a law that protects copyrights both domestically and internationally. Echoing similar efforts across Europe and Australia, the ProIP Act toughens US criminal laws against piracy and counterfeiting and has important accountability in the law’s implementation.

Second is the enactment of The Higher Education Act, which sets up provisions designed to annihilate [ph] the piracy problem on college campuses. The act requires colleges to consistently disseminate information to better educate students about the policies of disciplinary actions, risks, and penalties of piracy. Furthermore, for educational institutions to have continuing eligibility for federally funded assistance programs they must develop plans to effectively combat unauthorized content distribution on campus.

Finally, I would like to discuss our recently announced senior management moves, which will be instrumental in accelerating our progress to exploit growth opportunities in the evolving music business. As we had announced in September Michael Fleisher and Lyor Cohen have joined in the newly created office for the Chairman which is responsible for strategy, transformation, and operations of the company.

Lyor was named Vice Chairman Warner Music Group and Chairman and CEO Recorded Music of the Americas and the UK. In this role, he will expand its responsibilities across a larger geographic footprint enabling us to more effectively coordinate our worldwide Recorded Music strategy.

Michael has been named Vice Chairman Strategy and Operations. He will oversee corporate strategy and operations and will lead to transformation of Warner Music’s business models in operational processes on a global basis.

I am pleased (inaudible) controller stepped up as new CFO. Steve has been with our company since 2004. He has assembled our strong corporate finance team (inaudible) to ensure the Sarbanes-Oxley compliance. And so without further ado, Steve will now run through (inaudible) Michael and I with your questions.

Steve Macri

Thank you Edgar and good morning everyone. Let me begin by saying how thrilled I am to be CFO.

I would like to start by covering some of our key financial highlights for the quarter and for the fiscal year. All the revenue data I am about to discuss is on a constant currency basis. As we will be comparing this quarter's metrics with those of the prior year's quarter, we wish to note that the prior year's quarter included a pre-tax net benefit of $7 million. The prior full year included a pre-tax net expense of $3 million. (inaudible) are detailed in our press release in which we have adjusted for in the figures I am discussing.

Looking at the income statement for the 3 months ended September 30, 2008, we reported revenue of $854 million which declined 5%. During the fiscal year period our revenue was $3.5 billion a decline of 2%.

For the quarter, domestic revenues fell by 5% while international decreased by 4%. For the fiscal year of 2008, domestic revenue dropped by 4% while international revenue slipped less than 1%.

Looking at our Digital revenue growth overall it grew 28% to $167 million, or 20% of total revenue, up from $131 million or 15% of total revenue in the prior-year quarter. Digital revenue improved 1% sequentially given the seasonal nature of the business and time to release schedules. Approximately 65% of our total Digital revenue was generated in the US, and 35% was generated in the rest of the world. Online continues to be the primary growth driver of our Digital business. While Mobile was weak in the US, we did see a pickup in Mobile internationally over the prior-year quarter.

Managing our costs remains our top priority while transforming our business mix. For the quarter, our operating income before depreciation and amortization, or OIBDA, from continuing operations declined 4% and our OIBDA margin was relatively flat at 16% as we continue to manage costs through the Recorded Music industry transition.

For the full fiscal year, our OIBDA was $475 million essentially flat with last year. Our OIBDA margin held fairly stable at 14%, even given the prior year benefit we realized from lower annual bonus compensation.

Let's us now look at our different business segments. Quarterly Recorded Music revenue decreased 7% to $707 million. We saw growth in both our global Digital and licensing businesses more than offset by global Physical declines. International Recorded Music revenue fell 6% while domestic Recorded Music revenue declined 8% year-over-year.

As expected, continued contracting demand for physical products in our retailers lead to soft recording Music results. Partially offsetting the physical declines, Recorded Music Digital revenue grew 26% from the prior year quarter to $156 million or 22% of total Recorded Music revenue, up from 17% in the same period last year. Domestic Recorded Music Digital revenue grew 24% to $99 million, or 27% of domestic Recorded Music revenue, compared to 20% in the same period last year. Quarterly Recorded Music OIBDA from continuing operations fell 8% year-over-year, which reflected higher third party distribution costs partially offset by an improved digital sales mix.

Moving on to our Music Publishing business. In comparison to the same quarterly period in fiscal 2007, Music Publishing revenue of $156 million grew by 6% as revenue was strong both domestically and internationally. Mechanical revenue fell 6%, better than the mid-teens year-over-year decline we reported in our third fiscal quarter. Timing of releases and the ongoing support from our catalog were the primary factors that lead to this better than expected results. Growth in Performance, Synchronization and Digital revenue more than offset the Mechanical revenue decline. Music Publishing OIBDA was $54 million, up 2% from the prior year quarter, and OIBDA margin for Music Publishing contracted to 34.6% partially due to minor severance costs.

Let us look at our year-over-year organic constant currency revenue growth in the quarter and fiscal year. We registered just about a 3 percentage point benefit investments made over the past quarter and 12 months. At this point, we have already anniversaried our largest acquisitions, including Roadrunner. Recent investments that are reflected in our current results include Camus, which is a touring company in France, and Frank Sinatra Enterprises.

Turning now to our balance sheet and cash position, our strategy to build cash on our balance sheet and improve our cash flow has continued to yield results. We increased our free cash flow to $100 million from negative $48 million in our prior year quarter, reflecting our conservative financing strategy and reduced M&A spending.

Our free cash flow is calculated by taking cash from operations of $119 million, less capital expenditures of $6 million, and net cash paid for investments of $13 million. We ended the quarter with a cash balance of $411 million, another sizeable step up sequentially from $338 million at June. This $411 million cash balance is more than double our December 31, 2007, level of $160 million.

As Edgar mentioned, our cash balance with benefit from an additional $123 million collected in the first quarter of fiscal 2009 as we received the proceeds from the sale of our Front Line equity stake to Ticketmaster. We remain comfortable with our balance sheet and our capital deployment strategy has only increased our financial flexibility.

Turning now to taxes, for the three months ended September 30, 2008, we had net cash taxes of $1 million, and a tax provision of $13 million, on pre-tax income from continuing operations of $19 million. Our tax expense for fiscal 2008 was $49 million, which is the same as the prior year level at September 30, 2008, with a US tax loss carryover of $203 million and foreign tax credit carryovers of $70 million. These carryovers will be available to reduce our US income taxes in future years.

For the quarter, we generated income from continuing operations of $6 million or $0.04 per diluted share, compared to the prior year income from continuing operations of $11 million or $0.07 per diluted share.

As you know, as a matter of policy, we do not provide financial guidance primarily because fluctuations from our recording music release schedule and associated marketing and promotional expenses are normal part of the recording music business. But since we are two months into our December quarter and this year’s holiday’s season weighs heavily on investor’s minds, I probably should update you on our current expectations. We had previously said that fiscal year 2009 will be more back-end weighted due to the timing of our releases. We continue to believe that this is a correct assessment.

You may recall that in our first quarter of fiscal 2008 we sold a staggering 5 million units of Josh Groban's Noel, the number one selling album in the US last year. This release will set up the first quarter of 2009 for a tough comparison but we have confidence in our overall release schedule for the ‘09 fiscal year.

Beyond the timing of releases it is too early to fully assess the impact of the cautious retail marketplace on music sales. Let me assure you, we will continue to monitor current events closely and take advantage of our flexible cost structure to minimize any impact.

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

Edgar Bronfman

Thanks Steve. We expect challenges at a time when the Recorded Music business is in such a fundamental state of transition. No doubt that’ll be compounded by the macroeconomic and environment. But it is clear that there is great opportunity for those companies that understand where the music business is going, have a progressive strategy in place to get them there and know how to operate in difficult times.

Over the course of the new fiscal year are priorities continue to evolve but remain centered on optimizing and transforming our business. In doing that I would like to reiterate that we will manage our balance sheet by generating significant free cash flow while balancing our costs and investments, fortify our digital leadership through the development of original business models, focus on enhancing the value and growth of Warner/Chappell, expand partnerships with artists and nurture relationships with consumers to monetize businesses that represent growing segments of the music business and increase market share while maximizing our margin potential in our core Recorded Music and Music Publishing businesses. Recognizing that we have made substantial progress but still have a significant way to go we’re confident that we’re building the most progressive company in the music industry today. Michael, Steve, and I look forward to answering your questions. Thank you operator. Please open it up for Q&A.

Question-and-Answer Session

Operator

(Operator instructions) The first question is from Bishop Sheen from Wachovia.

Bishop Sheen – Wachovia

Hi, Edgar, Michael, Jill, thank you for taking the questions. Edgar I’m looking at your balance sheet and your leverage and you’re managing debt by building up cash. Have you considered the arbitrage of buying in your bonds, which are at significant discounts and is there anything in your credit facility right now that would specifically restrict you from doing that other than the normal RP test [ph]?

Edgar Bronfman

I would say to the second part of the question, no we don’t believe that there is anything in our credit agreement that would restrict our ability and we’re always looking at ways to create yield for all our stakeholders, bondholders, shareholders, alike. And so we continue to monitor the situation and we’re very pleased with the amount of financial flexibility that we have in order to take advantage of market opportunities.

Bishop Sheen – Wachovia

One quick follow up. $123 million from Front Line, I think that deal closed end of October, have you already received those proceeds?

Edgar Bronfman

We have.

Bishop Sheen – Wachovia

Okay, all right. That is it. Thank you very much.

Edgar Bronfman

Thank you Bishop.

Operator

Oh, my gosh that was a (inaudible).

Edgar Bronfman

Hello.

Operator

The next question is from Rich Greenfield from Pali Capital.

Rich Greenfield – Pali Capital

Hi, good morning, a couple of questions. One just a housekeeping question for Steve. You reported last year about $146 million – sorry $134 million of EBITDA, which included I think about $7 sorry about $3 million of nonrecurring benefits via (inaudible) versus restructuring charges, now you are talking about $146 million with a $7 million gain and I am just trying to put the numbers year-over-year what is being included excluded, what should we be thinking about within those numbers. And then two just to Edgar’s comments on the overall economy, sizing the overall economy it looks like we’re seeing a pretty significant decline in CD sales in the calendar fourth quarter due to either floor space cutbacks or potentially weak demand, but just wondering it seems like the fourth quarter started out dramatically weaker than the prior three quarters of the year and any sense on what is driving that, is it retail, is it just consumers not spending at retail et cetera? Thanks.

Edgar Bronfman

Nice question Rich. Steve will put some clarity on that. In addition to the prior year net benefit of $7 million that I spoke to earlier the prior year results also included $12 million dollar impact from our Bulldog Investment to discontinue operations. That is essentially what the difference is between the year-over-year numbers you are looking at.

Steve Macri

Rich to your question on the fourth quarter. We think that the weakness that we have seen so far is really due to a reduction in floor space but just I think lower traffic in the stores. However, we’re happy with the product that they have in the marketplace we’re actually happy with the results we are seeing off of our products in the marketplace and every piece of product that we have planned for the December quarter to be in the market is in the market.

Rich Greenfield – Pali Capital

To the extent that the trends that you are seeing in terms of foot traffic continues though for the next several quarters how much can you reduce your car structure by year-over-year given that i.e. quality of your releases, it may just be the environment at large weakening?

Steve Macri

What I would say Rich is that the market has been skeptical since the day we got here that they could reduce our cost structure and improve our profitability and maintain our investments in A&R. I expect that the skepticism will continue though in my mind it should not. The reason I made the reference to this management knowing how to operate in difficult times is we spent the last five years since we have been here operating in a difficult environment. We know how to do that. We have an extraordinarily managed team And we do believe that that is the opportunity for further cost reductions if we should see weakening sales.

Jill Krutick

Next question please.

Operator

The next question is from Howard Gleicher from Metropolitan West.

Howard Gleicher – Metropolitan West

Thanks for taking my question. The music publishing business this quarter was particularly good I believe and I congratulate you for it. In the past, I was concerned that had in been doing as well as maybe you had expected it would be doing by now and while I have really listened to your few comments about why in the quarter it was good, can you comment in general is there something just about releases that made the quarter good in terms of music publishing or is there something more sustainable that we can expect this results going forward? Thank you.

Edgar Bronfman

Well, Howard it is Edgar. I’m reluctant to sort of give financial forward-looking guidance. What I would tell you is that obviously we had a good quarter. The music publishing business is obviously a mix of growing businesses such as performance, sync, digital and other and the declining business of the mechanical royalties which relate the decline of physical as well as the growth of digital but the mix is still declining. Mechanicals represent 40% or little bit less of our music publishing business, so we have got more growing businesses than declining. One thing I would like to point to with regard to Warner/Chappell is now I think we have got a very fine leadership team in place. Not only with Dave Johnson as a chairman and CEO but Scott Franz is now running under the newly created position of Chairman and CEO of the U.S. business as well as President of our Worldwide Company, and so had digital Brian Roberts as the CFO. Finally, I think we have got a really strong cohesive management team along with a number of very, very strong executives in international. So I thing you should be able to see that management team build on the growing strength of the revenue streams other than mechanical while we try our best to innumerate the declines in the mechanical business.

Howard Gleicher – Metropolitan West

But if you add what you consider to be a release schedule on par with the prior several quarters would we have still seen the improvement in Music Publishing?

Edgar Bronfman

But you have to remember that the Warner/Chappell release schedule is a release schedule made up of releases from all of the record companies not just Warner Music. In fact, Warner Music probably represents only about 15% or so of the Warner/Chappell revenue. So it is a little bit more difficult for Warner/Chappell to predict release schedule fluctuations given that there are so many companies involved and so much fluctuation in company release schedules, but I don’t think that this quarter was better because of an unusually good release schedule.

Howard Gleicher – Metropolitan West

Great. Thank you very much.

Operator

The last question comes from Tuna Amobi of Standard & Poors.

Tuna Amobi – Standard & Poors

All right, great. Thank you very much. So Edgar as you talk about this innovative windowing effort, I’m just trying to understand this strategy a little bit better because you know, if you look across the industry it seems like it does work for some artists much more so than others. So I’m just trying to get a handle on this is something that you intend to do a little bit more and how can you demonstrate the numbers – numbers the incremental impacts that you may have on a results. I know you cited T.I. for example?

Edgar Bronfman

Sure. So let me answer that but also let me – let the listeners know that we do have another call. So, yes, we will continue the call. You know, we’re had a I think fairly innovative digital bundling strategy for several years now. We have led the industry we continue to lead the industry and we continue to see success really quite across the board with artists, from Madonna where we had a very innovative product to T.I. So, from Pop to Urban we even see it in other genres. So, I don’t think it is restricted to certain artists. I think we have yet to see I think the rest of the industry follow us as aggressive or be as aggressive as we have in the number of premium priced products that we have placed at retail but the reason that we have been successful quite honestly is because consumers like what we offer and they buy what we offer, and we certainly intend to continue to do that and as a result we think our profitability in the digital space is ahead of our competition.

Tuna Amobi – Standard & Poors

Okay, and separately on impairment, I just want kind of an update if you have conducted any impairment tests of late and if so what the results of that has been, I suspect this maybe for either Steve or Michael.

Steve Macri

Yes sure Tuna, this is Steve. We conduct an annual impairment test that is as required and there is absolutely no impairment issues at all.

Tuna Amobi – Standard & Poors

Okay, and lastly, you know I guess Michael, this is a question following your comment in last call about the state of the retail market. I think you specifically said the stellar creditworthiness of the retailers and I think we have seen what has happened in the past month or two which (inaudible) and some other retailers. So, just kind of an update on that comment Michael, do you still believe that there is no issue in that channel and if not then what are you – what is being done to kind of mitigating that?

Michael Fleisher

Thanks Tuna. I think my comments on last quarter were really focused on the biggest physical retailers, certainly the sort of the Wall-Marts of the world and I think we continue to feel confident about their credit worthiness even in this sort of difficult economic and market environment. We have always dealt with over the last 4 years that I have been here sort of challenges in credit worthiness of the smaller and physical retailers and continue to do so. We have managed that through credit insurance risk but also just good day-to-day management of how much product and inventory we are letting those folks take versus how much they are paying us. And so far we have managed that extraordinarily well. We haven’t taken any big losses. Because of it I don’t anticipate that we will going forward. We continue to manage it very, very carefully.

Tuna Amobi – Standard & Poors

Great, thank you very much.

Operator

The next question comes from Doug Mitchelson from Deutsche Bank.

Doug Mitchelson – Deutsche Bank

Thanks everyone. Good morning. So, I guess a few questions. One not to hurt the retailers, but have you guys thought about sort of the possibility of excessive returns post sort of the holiday season as inventory and retailers try to manage their inventory given working capitals will be a big deal for them this year?

Edgar Bronfman

Doug this is Edgar. I will take that to add to what both Michael and Steve has said in the various comments. We’re managing inventories very, very carefully. We are not overshipping as a matter of fact as I mentioned on the call even our September results were impacted by the fact that we shipped less than we can. So that we are managing retailer inventory proactively. So I’m confident we’re on top of this as hard as we can be. I don’t think any of us know what the Christmas shopping season will be but we were monitoring it not only on a week by week basis but on a day by day basis to make sure that our inventories do not get out of hand and that we do not Steve Macri an excessive level of returns come Q2.

Doug Mitchelson – Deutsche Bank

Okay, great. Than any update you can give us sort of on you talked about the premium product pricings with iTunes and how that was sort of helpful for your pricing strategy. Is there still sort of a hope that you could move at some point to a variable pricing strategy with iTunes?

Edgar Bronfman

I think as I have declined a comment in the past on our negotiations with Apple or our relationship with Apple other than to say that they have continued to be as strong innovative partner particularly regarding our digital bundling strategy and we look forward to growing our relationship with Apple.

Doug Mitchelson – Deutsche Bank

Well, I understand and it is not necessarily specific to any current conversation. This was more just sort of a long-term goal basis. You think about your digital distribution attitude relative to what you are seeing in the marketplace is variable pricing something over a long time of you would like to achieve regardless of current leverage or negotiations?

Edgar Bronfman

Well I have said repeatedly probably three or four years now that I think variable pricing is appropriate for all kinds of content including music content. I don’t believe that every song is worth exactly the same thing and it’s worth the same thing to different consumers. Or perhaps not even worth that money at one particular time versus a later time. And I think artists and record companies should have the right to experiment with pricing and consumers will tell us we’re underpricing more pricing, whether we get it right or we get it wrong. The consumers should have that right. So long term I do hope that that will be an opportunity to have variable pricing in the industry and no question about it.

Doug Mitchelson – Deutsche Bank

Okay, so on top of the premium pricing that’ll be of incremental value. And then I guess the last one just sort of big picture, I know the environment right now is interesting to say to least but sort of thinking structurally you have been a big believer in wireless and the impact that could have on music. Is the growth that you are seeing in smart phones here in the US notably impacting music revenue yet or can you talk a little bit more about sort of how you see wirelessly evolving. And certainly we have been talking about for the last few years?

Edgar Bronfman

Well, as I mentioned in my prepared comments I think the growth of improved handset devices and networks are definitely going to alter and increase content consumption. Whether it is in sales on a per download basis or through other models like Nokia, "Comes with Music." I do think it is clearly going to increase. If you look at the amount of content consumption and frankly sales on the iPhone versus other handsets, it is multiples greater, I mean in some cases 10 or 20 times greater than it is on a regular phone. So I think that augurs well and as phones get smarter and networks get better and as business models get more diverse and I think the business model of owning essentially for nothing the content with the price of the device is a very attractive consumer offer which should also be attractive I think device manufacturers. So, I do think that we will an acceleration in mobile over time. It is difficult to predict the timing. It is difficult to know how quickly smart phone distribution network enhancements will roll out but as they do that is no question that content will be positively affected.

Doug Mitchelson – Deutsche Bank

And I guess of, I just wanted to one more add one more, Now that you have gathered this brain trust around US as Lyor, as sort of Michael have – having their entire day free to sort of think strategically anything that has been new that has sort of come out having the change in their relationship with you?

Edgar Bronfman

I think what – if anything we are applying Lyor’s extraordinary and our talents across a broader geographic region and I think that is very helpful because if you think about our global portfolio – our global repertoire is basically English speaking and to a lesser degree Spanish speaking. Those are the two languages that travel globally. Lyor is now in charge of both. And I think for Michael clearly as we generate new business models, the entire way that we are structured needs to change over time. We – 5 years ago we are entirely a physical business, 5 years from now I don’t say we will be entirely a digital business but we will be within a decade of fundamentally different company than we were and that there’s all kinds of implications on how we structure ourselves, who we hire, what they do, what products we create what are the systems necessary to those products, our customers, and our artists et cetera. And that is why we needed Michael fulltime to be able to think through and implement the kind of structural and process changes necessary to support what is already a very different and what will be an increasingly different business than we have ever managed before.

Doug Mitchelson – Deutsche Bank

So, Michael is not bored yet. That is good.

Edgar Bronfman

I hope not. He’s too well paid to be bored.

Doug Mitchelson – Deutsche Bank

All right. Thank you.

Edgar Bronfman

All right. Thank you very much and thank you everyone for joining us on the call.

Operator

That concludes today’s conference. You may disconnect at this time.

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Source: Warner Music Group Corp. F4Q08 (Qtr End 09/30/08) Earnings Call Transcript

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