Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Warner Music Group Corp (NYSE:WMG)

F1Q10 (Qtr End 12/31/09) Earnings Call

February 9, 2010 8:30 am ET

Executives

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

Edgar J. Bronfman Jr. - Chairman of the Board, Chief Executive Officer

Michael D. Fleisher – Vice Chairman - Strategy and Operations

Steven James Macri - Chief Financial Officer, Executive Vice President

Analysts

Bishop Sheen - Wells Fargo

Doug Mitchelson - Deutsche Bank

Laura Martin - Needham & Company

Ingrid Chung - Goldman Sachs

Richard Greenfield - Pali Research

Jessica Reif Cohen - Bank of America Merrill Lynch

Jason Bazinet - Citigroup

Tuna Amobi - Standard & Poor’s

Marla Backer - Hudson Square

Presentation

Operator

Welcome to the Warner Music Group’s fiscal first quarter earnings call for the period ended December 31, 2009. 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. (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 S. Krutick

Thank you very much. Good morning, everyone. Welcome to Warner Music Group’s fiscal first quarter 2010 conference call. Both our earnings press release and the Form 10-Q we filed this morning are available on our website at wmg.com.

Today Chairman and CEO Edgar Bronfman Junior will update you on our business performance and strategy. Executive Vice President and CFO, Steven 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, believe, should and will, and variations of such words or similar expressions that predict or indicate future events or trends, or do not relate to historical matters, identify forward-looking statements.

Such statements include but are not limited to estimates of our future performance, such as the success of future albums, projected digital sales increases and declines in physical sales, expected expansion of the online marketplace, the success of strategic actions we are taking to accelerate our transformation as we redefine our role in the music industry, the impact general economic conditions may have on us, market share gains, and our intention 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 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-Q and other SEC filings.

We plan to present certain non-GAAP results during this conference call. We have provided schedules reconciling these results to our GAAP results in our earnings press release posted on our website.

With that, let me turn it over to Edgar. Thank you.

Edgar J. Bronfman Jr.

Thanks, Jill and welcome, everyone. Thank you for joining us. We’re proud to have delivered stable revenue and OIBDA in our quarter reported music and music publishing businesses, despite ongoing recorded music industry pressures and macroeconomic headwinds, in this environment that is no small task. We remain confident in our capacity to achieve long-term strategic and financial goals, that confidence is based on our demonstrative requisite accomplishment, which includes developing new business models, maintaining digital leadership, managing costs, diversifying revenue and delivering strong returns on our A&R investments. And very importantly our effective balance sheet strategy continues to provide the necessary financial flexibility to position us for growth.

The recorded music industry continues to face pressures which are exacerbated by the current state of the global economy. Turning to four key areas in this quarter, fist our disciplined A&R marketing and promotional efforts continue to yield results. In calendar 2009 for the second year in a row Atlantic Records won the distinction of being the number one label in the United States. This marks the fourth time in the past five years that one of our labels has held the top spot in the U.S.

Second, we remain an industry leader in the important digital arena. Our quarterly digital revenue rose 5% to $184 million on a constant currency basis and in the U.S digital represented 35% of recorded music as compared to 31% in the prior year. We sustained our significant digital share advantage over physical share in the U.S., both in the quarter and for calendar 2009 and we have the greatest digital share advantage of any of the major music companies.

Third, we continue to transform the company by entering into expanded right fields with new recording artists and growing our worldwide artist services business. And fourth we continue to strengthen our music publishing business by further developing our artist roster and catalogue, while delivering enhanced results. As our stable margins show we continue to adjust our highly variable cost structure to drive profitability, let’s look at the quarter’s results in further depth. Recorded music revenue for the quarter was down only modestly on a constant currency basis, growth of 2% in international recorded music constant currency revenue largely offset a 10% decline in the U.S.

Our international performance showcased rising revenue from our artist services business and continued solid growth in our international digital recorded music business. Our U.S. share contracted by 2.4 percentage points to 19.5 in the December quarter, primarily due to our light release schedule. Our recorded music results were led by current and carry over releases from artists including Michael Buble, Enya and Muse as well soundtrack albums from several motion pictures, reflecting our focused approach to A&R and long-term artists development.

Warner Brother’s multiplatinum artist Michael Buble, continues to gain popularity around the world and was a key driver for the quarter. Strong holiday sales momentum for his latest release, Crazy Love, continued after its initial three week run at number one on the Billboard U.S. album charts. The album has taken off on a global basis selling nearly 5 million units worldwide so far. We are pleased that Warner Chappell recently extended its worldwide publishing agreement with Michael Buble. In addition, we recently acquired his global merchandising rights, which will start to generate revenue from his arena tour which begins in March.

Warner Brothers records recent chart strength is evident across a broad range of genres from rock with Muse to rap with Gucci Mane and country with Blake Shelton. In addition, Warner Brothers has strengthened its presence in pop with singles from developing artists Jason Derulo and Iyaz, which together held the number one spot on the billboard U.S. singles chart for eight consecutive weeks and sold over four million digital tracks in the U.S. on a combined basis.

Our company has built an incredible success story in soundtracks over the past several years. Beginning with Rhino Records groundbreaking Juno soundtrack in January 2008. Atlantic’s creative marketing efforts for the first two soundtrack albums based on the Twilight book series, Twilight and New Moon, magnify the success of those soundtracks and raise the visibility of our artists. Rhino’s currently working the soundtrack for the Alvin and the Chipmunks sequel, for which more than 75% of the digital album unit sales to date have been of the deluxe $11.99 album bundle. The album achieved gold status just over a month after the film opened.

Our international recorded music revenue growth was driven by a handful of solid performances from local and international artists, a strong international digital business and our growing artist services business. We achieved this growth despite a challenging retail landscape which was most pronounced in Japan. We delivered robust reported music revenue across several major European territories including the UK, France and Italy.

Warner Music U.K. had a particularly strong quarter, in addition to Michael Buble, who was at the top of the U.K. charts during Christmas week, U.K. artists Paolo Nutini, Muse, The Soldiers and Katherine Jenkins contributed to the impressive U.K. results. France continued to benefit from strong local and international releases including Michael Buble.

Taking a closer look at our digital business, we recognize both our challenges and our growth opportunities. In the December quarter releases that appealed to CD buyers, helped to offset the industry wide impact of decelerating digital unit sales growth in the U.S. Digital download unit sales growth in the U.S. has slowed following iTunes introduction of a higher priced tier for single track downloads in April 2009.

Year-over-year U.S digital track equivalent album unit growth for the industry was 5% in the December quarter down sequentially from 10% in the September quarter and 11% in the June quarter. While affecting unit sales variable pricing for single track downloads on iTunes has been a net positive for our digital revenue. While the U.S. recorded music industry did experience a typical seasonal pick-up in digital demands, triggered by sales of MP3 players and gift cards, the current gross holiday pace of unit sales activity remains similar to the 5% growth for the December quarter.

While our U.S. recorded music digital revenue was flat for the quarter, we continue to see strong growth in our international reported music digital revenue. Implementation of variable pricing of downloads growing international demand for iTunes and iPhones and new business development activities all boosted international performance. On a constant currency basis our international recorded music digital revenue increased 20% year-over-year and 6% sequentially. Needless to say achieving robust digital growth remains a top priority and essential to our long-term growth strategy.

We expect digital revenue growth to accelerate once again as new mobile products and business models are rolled out on a global basis as device capabilities and network technologies advance. The recent Consumer Electronics show reaffirmed our view that digital innovation will evolve rapidly on many levels, access models which typically bundle the purchase of a mobile device with access to music continue to gain ground, supporting our view that these models will be one of the long-term drivers of digital revenue.

Vodafone recently announced that since March 2009 nearly 450,000 of its customers have signed up for its music subscription services in Europe. The growth is being driven both by monthly ten try 9bundles, as well as unlimited access to subscription services. In December alone over 100,000 customers signed up to one of these services in Vodafone’s eight largest markets in Europe.

TDC a Danish telecom operator has continued to see strong results for its bundled music subscription service. TDC believes that this service is significantly reduced churn for cellular customers by November 2009 TDC reported that more than 120 million tracks have been downloaded from the service the equivalent of two and a half downloads per second, since the April 2008 service launch.

With mobile providers ISPs and consumer electronics manufacturers all working with us to refine consumer choices in the access model space. We remain optimistic that access models will meaningfully contribute to our revenue over time.

As we mentioned we continue to transform our business within the music value chain, while broadening our revenue mix into growing areas of the music business, such as sponsorship, fan clubs, websites, merchandising, touring, ticketing and artist management among others. We continue to diversify our recorded music revenue non-traditional revenue included nearly 10% of our revenue in the quarter, driven primarily by concert promotion revenue in France and Italy. Today, essentially all of the contracts we enter into with new recording artists are expanded rights deals and artists with expanded rights deals now account for more than half of our active global roster.

Turning to Warner Chappell Music this business remains a stable performer with very attractive financial attributes. Similar to recorded music the music publishing business is characterized by strong OIBDA to free cash flow conversion, favorable working capital dynamics and low CAPEX requirements. However music publishing currently enjoys far more diversified revenue streams than recorded music, our goal is to continue to enhance the results of our distinctly valuable music publishing business.

As we’ve noted in the past we have a global multi-pronged plan to drive long-term growth at Warner Chappell. This plan includes continuing to invest in talented song-writers to support the development of our music publishing catalogue, building new opportunities to exploit the value of our existing catalogue, expanding our leadership position in digital music by playing a key role in industry initiatives and leveraging our international reach. Warner Chappell has had significant A&R and licensing success in calendar 2009 with its songwriters contributing to six of the top ten U.S. albums.

Warner Chappell had the largest share of the publishing rights associated with Suzanne Boyle’s multiplatinum holiday release and it controlled a significant portion of the songs on Michael Jackson’s Number Ones and Eminem’s Relapse. Warner Chappell also controlled portions of three of the top ten U.S digital songs of 2009. Another recent highlight is the Grammy recognition of Warner Chappell songwriter, Terius Nash, for best song with Single Ladies. Warner Chappell continues to strengthen its roster through artist findings and extensions of existing agreements.

In addition to the previously mentioned extension of its music publishing arrangements with Michael Buble, Warner Chappell expanded its worldwide agreement with Grammy award winning performer and songwriter Don Henley. Warner Chappell is proud to be Don Henley’s music publisher since 1993 and to now add U.S. rights to our deal.

Before moving on to our financials I want to speak to about the growing recognition of the value of intellectual property. There is building momentum all over the world to implement graduated response programs in which ISPs notify and eventually institute sanctions on copyright infringing customers. Given the ability of ISPs to deter illegal activity on their network it’s essential that they plan an active role in promoting the illegal flow of copyrighted content. We believe that all the stakeholders, ISPs, content companies and consumers alike gain the most when we all work together to support the legitimate distribution of content.

In the U.S. the most content rich country in the world efforts have lagged. Recently, I am gratified to say, there have been some positive developments, most notably in December I joined other executives from the U.S. intellectual property community and labor unions in a meeting hosted by vice-president

Biden. Many high ranking officials from the Obama administration including attorney general, Holder, homeland security secretary, Napolitano, and commerce secretary, Locke, among others also attended the meeting to discuss how the government can help to protect our nation’s intellectual property.

The administration officials cited the significant impact that intellectual property has on the overall U.S economy and calls for the content industry to continue to work with the administration to help identify policy and regulatory goals to protect IP related industries and jobs. We are delighted to see the U.S. government focusing on this very important issue and pleased to be included in its efforts to help in this critical area.

I also want to take a moment to congratulate some of our artists on their Grammy success last week, among the recipients were WMG recording artist, Michael Buble, Green Day Jason Mraz, Neil Young and Zac Brown Band, as well as Warner Chappell songwriters, Calle 13, Lady Antebellum and Stephen Sondheim, among many others.

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

Steven James Macri

Thank you and good morning. All the revenue data we’ll provide is on a constant currency basis. For the three months ended December 31, 2009, we reported revenue of $918 million, down 2% year-over-year. Domestic revenue declined 9%, while international grew 2%. As expected domestic revenue continues to be more effected by the recorded music industry pressures and the general economic and retail environment, our quarterly digital revenue grew 5% to $184 million or 20% of total revenue. Due to strong international download growth, digital revenue was up 4% sequentially. About 60% of our digital revenue was generated in the U.S., while 40% was generated internationally. Our operating income before depreciation and amortization or OIBDA grew 5% and our OIBDA margins remain flat at 12% as we continue to carefully manage costs and adjust our business.

Looking at our different business segments for the quarter. Recorded music revenue fell just 2% to $783 million, as we continue to diversify our revenue we grew our worldwide non-traditional revenue and also saw a strong international digital download grow. These gains were offset by expected declines of physical revenue.

Recorded music digital revenue grew 8% for the prior quarter to $172 million or 22% of total recorded music revenue that is up from 21% in the same period last year. As iTunes continues to gain traction outside the U.S. international recorded music digital revenue grew 20%. Domestic recorded music digital revenue was unchanged at $99 million, as compared to 31% in the same period last year. This represents 35% of domestic recorded music revenue this quarter. Recorded music OIBDA grew 6% year-over-year, this is a result of ongoing pruning cost management efforts as well as changes in our product mix.

Moving on to our music publishing business, music publishing revenue of $141 million was flat versus the prior year quarter. International growth offset domestic declines. Due to a pickup in film and TV production license and activity Warner Chappell grew synchronization by 9%, that result was more than offset by a 2% decline in performance revenue and a 4% mechanical revenue decrease. Digital revenue was unchanged year-over-year, delayed by the time of cash collections. Music publishing OBIDA was $22 million consistent with the prior year quarter and OBIDA margin was also steady at about 16%.

Turning to our balance sheet and cash position, we continue to execute on our effective balancing strategy. We ended the quarter with a cash balance of $339 million, as anticipated this is down sequentially from $384 million at September 30, 2009, due to two primary factors.

First is the time limit of our interest payments. As a result of our May 2009 refinancing our cash interest payments are now made semi-annually in the fiscal first and third quarters. Therefore our December quarter included $81 million in cash interest compared with $45 million in the prior year. We previously made quarterly interest payments under our credit agreement, which has now been retired. In addition, our net interest expense increased to $51 million versus $44 million in the prior year quarter, this is due to the previous (inaudible)’s change in interest rate related to our refinancing.

Second is the variable timing of our working capital requirements, which included an decrease in cash associated with the European concert promotion business. As it relates to our concert promotion business we experience a cash buildup in advance for tour as ticket sales occur increasing deferred revenue. Deferred revenue is then worked down as the tour occurs and the cash due to the venue and the artist is paid out. This business can be seasonal and is subject to the timing of touring cycles.

Free cash flow declined to a negative $44 million from a positive $160 million in the prior year quarter. This is related to the two factors I just described as well as the fact that last year’s quarter included $123 million from the sale of our investment in Frontline Management. Our free cash flow is calculated by taking cash dues from operating activities of $42 million less capital expenditures of $7 million and adding back net cash received from investments of $5 million. Despite the timely related cash flow items of this quarter, we remain confident in our ability to generate significant free cash flow this fiscal year as we have in the past.

Turning now to taxes, we had tax provision of $13 million and net cash taxes of $9 million on a pretax loss of $3 million. We generated net loss of $17 million or $0.11 per diluted share. The prior year quarter’s net income was $23 million or $0.15 per diluted share. including a gain of $36 million or $0.24 per diluted share from the sale of our investment in frontline management.

As a matter of policy we do not provide financial guidance, as you know this business traditionally includes fluctuations based on our recorded music release schedule and associated marketing promotional expenses. We remain confident in our overall release schedule for the fiscal year and anticipate the (inaudible) of our releases to be back-end weighted similar to last year. As always in order to minimize the impact of a challenging industry transition and a difficult economy, we will continue to actively manage our expenses.

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

Edgar J. Bronfman Jr.

Thanks, Steve. I’m pleased with our ability to stay at the core and optimize and transform our business despite serious challenges, our focus and determination are unwavering. We continue to leave the industry transitioned to new digital formats and platforms, all along diversifying our revenue streams into new growth areas and delivering solid performance in our quarter-over-quarter music and music publishing businesses. I’d like to reiterate five critical strategies on which we will continue to focus over this fiscal year.

One, manage our balance sheet by generating significant pr-cash flow while controlling our overhead costs and other expenses. Two, strengthen our digital leadership through a combination of consistent execution on our current business models and development of new business models. Three, enhance the value and growth of Warner Chapel. Four, monetize businesses and growing segments for the music industry by expanding partnerships with artists and building relationships with consumers, and five, continue to invest in A&R marketing and promotions which remain the core elements of our recorded music and music publishing businesses.

Michael, Steve and I look forward to answering your questions. Thank you, Operator and please open it up for Q and A.

Question and Answer Session

Operator

(Operator's Instructions) The first question is from Bishop Sheen from Wells Fargo.

Bishop Sheen - Wells Fargo

Hi, Edgar, Steve, Michael and Jill. Thank you for taking the question. Edgar, when you talk about how challenging domestic has been, as you look forward to a stronger release schedule in the back half and maybe some of these investments and initiatives that you're doing – how do you see the domestic scene changing?

Edgar J. Bronfman Jr.

Well, I think that the challenge obviously has been with the – yearend sales growth on the digital side with iTunes, where we're seeing tremendous interest in Apple, in Apple products, tremendous growth with the iPhone and in the sale of gift cards, but of course there's more competition in the Apple ecosystem now with apps and video content and other things on which those gift card monies can be spent.

I think what we'll see – as we've talked about, is the very significant growth over the next little while of access models and other models like that, whether that's streaming services that are subscription based, cloud services which are not that dissimilar from streaming services, but other kinds of things where new ecosystems frankly will be developed, and I think content will play a stronger role in the development of those ecosystems than perhaps it did at least in terms of the value of those content derived from the – it's role in the helping to build as an example Apple's ecosystem over the past seven or eight years. And to that extent I think the comment that Rupert Murdoch has made in the past month about the value of content, the role of content and the necessity for content to be fairly recompense as new business models emerge, are well thought out and reasonable looking forward.

Bishop Sheen - Wells Fargo

And then one last question. On the never-ending debate about performance royalties. If not in this lifetime then maybe in the next. Do you see any significant progress in the current congress?

Edgar J. Bronfman Jr.

Well I think that – it's hard to say that there's progress at the moment as congress grapples with other significant areas of – within the administration including healthcare deficits, financial regulatory reform, energy and other kinds of things. But I have to say that the Democratic Leadership in congress has been very vocal about their determination to set this right, and to pass a performance rights (inaudible) of legislation.

As you know it's been passed both out of the house committees and the senate committees. So I am hopeful that – if there's an opportune moment for the democratic leadership to turn to this issue then we will see progress.

Bishop Sheen - Wells Fargo

All right, thank you.

Operator

The next is Doug Mitchelson from Deutsche Bank

Doug Mitchelson - Deutsche Bank

Thanks, good morning. A few questions. So I guess the first – I'm just interested – you mentioned over half the global rosters now, 360-degree rights deals. Is that sort of similar also on a percentage of revenue contributions from their artists? Or you have a lot of - half of your large artists also on those types of deals now?

Edgar J. Bronfman Jr.

So Doug, it would not be the same on revenue because we have taken a specific approach to sign new recording artists to 360-degree rights, which means it's going to take them some time to develop before we see the real strength of that strategy coming to the fore. So our bigger releases which tend to be artists that have been developing for several years in most cases don't have 360 rights associated with them. And we have not, by and large negotiated with those artists to buy or to invest in their 360 rights simply because by the time they are at the stage of their career where they are, their value is well established and buying those rights is sort of – I would say paying retail. There's not much margin in making those investments – I mean there's better uses of our capital so there's no question that we will see I think significant acceleration of non-traditional recorded music revenue over the next two, three, four years, but it will be as these younger artists develop.

Doug Mitchelson - Deutsche Bank

Right. I just wanted to make sure relative to the context that 10% of revenue on non-traditional. But I know you're making a lot of progress there. I think, you know, the second area I wanted to talk about is just trends at retail. I'm not sure – you know we always try to get you to guess when the lines cross or digital revenue growth outstrips physical declines, and you always demure, so I'm just hoping you can give us some context of what you're seeing at retail now and do you think the DVD physical declines will sort of continue at the pace that they have over the last few years.

Steven James Macri

Thanks, good morning Doug, this is Steve. Right now it's kind of a little early to tell with regards to our physical retail market. I can tell you since post holiday there's been no significant changes to year over year returns or reductions of floor space. We continue to be proactively involved with our retail partners in managing SKU count and inventory levels. I think one important note is the 80/20 rule in particular with our physicals SKU's, the vast majority of revenue comes from a very small amount of SKU's so we'll continue to work and proactively partner with the retailers to manage those SKU counts and inventory levels.

Doug Mitchelson - Deutsche Bank

And then the last question was – Edgar you've been bullish on Wallace for a long time and you've been a leader here. I'm just sort of curious – when I heard the 120 million tracks downloaded on the TDC, in a way if almost made me a little bit nervous – I mean do you think the sort of equivalent value of $120 million through iTunes for 120 million tracks, do you think that the music industry is getting the right value from something like TDC with that amount of tracks being downloaded?

Edgar J. Bronfman Jr.

I would say that yes, - in a sense the subscription model that we are promoting or the access models or however one wants to refer to them I think will create much more value for us over time than the per-play or per-purchase models. The difference is of course that the access to a subscription model will rely on scale, so if you do the absolute trade of tracks downloaded on subscriptions versus the tracks paid for on iTunes, that's not a good trade and you're right to point it out. However the number of people accessing iTunes versus the number of potential subscribers – you know the number of potential subscribers dwarfs the number of people who are actually purchasing on iTunes. So for me the opportunity really is in monetizing consumers who are either – in a large part today not major purchasers on iTunes – and frankly so far we've seen very little accountablization (sic.) one to the other. So I think in a large part these models are incremental.

Doug Mitchelson - Deutsche Bank

So the fear that the heavy music user would go after these plans and then not be a heavy purchaser anymore, and that the light user would look at them and say “well geez, why do I need to spend extra money on this” that hasn't played out with what you've seen so far?

Edgar J. Bronfman Jr.

That has not played out with what we've seen so far, and I think no one – certainly not I – would suggest that Steve Jobs is not going to be able to keep the customers that he has at Apple, or even increase those customers, and at the same time I think the service model that increasingly network operators and device manufacturers and others are coming up with will allow us to monetize hundreds of millions if not billions of people, most of whom are not today either buyers or certainly heavy buyers of music.

Doug Mitchelson - Deutsche Bank

I'm sorry, I'm going to throw one more in on this wireless angle. When do you think we'll see sort of more substantial presence of bundled music offerings in the U.S.?

Edgar J. Bronfman Jr.

I think it's coming soon. I think that if you – I think it was a Business Week cover recently with sort of a faceoff between Apple and Google. I think that's and important space to watch, I think that there are going to be a lot of people – there are a lot of people who look at the extraordinary ecosystem that Apple has built and say “wow, look at all the value they've traded. Are they really going to be the only ones to create that value?” and I think you're going to see a number of companies try to – if not emulate specifically the Apple ecosystem but create ecosystems of their own that allow them to hold onto customers – give customers more of what it is that customers want. And I think if you watch the space you're going to see accelerated competition for the hearts and minds of U.S. consumers but also European, Asian, Latin American consumers and that's going to be – there are going be quite a lot of players engaged in trying to win those hearts and minds and one of the things, one of the tools, one of the weapons that they're going to be using is content, overwhelmingly content, and music will be a very important part of that content play.

Doug Mitchelson - Deutsche Bank

Okay, great, thank you very much.

Operator

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

Laura Martin - Needham & Company

Hi there, can you hear me okay?

Edgar J. Bronfman Jr.

Yes, we can hear you Laura, good morning.

Laura Martin - Needham & Company

Thanks. So I guess I'm interested in what we learned from carrying the pricing on Apple's digital downloads, because I know we fought for that for a long time. But actually these U.S. numbers have turned out to be a little disappointing so do you think that the consumer was more price sensitive than we thought when we threw the pricing – did they just steal the hit stuff and only take advantage of the cheaper stuff on the low end?

And then my second questions kind of builds on one of the questions Doug asked which was – if we talk about these streaming models which it sounds like you're optimistic about. I understand the breadth argument, but how do we model or how do we think through in a new world where things are moving in a cloud and music is moving into streaming services – how do we think about modeling that in kind of our longer term models from the point of view of Warner Music's economics? Thanks.

Edgar J. Bronfman Jr.

I'm going to ask Steve for some help here, but first of all, on the iTunes pricing front, the industry has been fighting for variable pricing for some time. Let me just give you a little bit of background. You'll remember that we introduced premium album bundling probably four years ago now, maybe even a little longer. That's been very successful and it continues to be successful and I noted even on something like Alvin and the Chipmunks, 75% of the digital albums sold are at the $11.99 price, not the $9.99.

I think what the digital album bundle shows is that consumers will pay for the kind of content in music that they want. I think frankly on the single track downloads, in April 2009 price increase probably couldn't have come at a worse time. It was a price increase that frankly agreed with Apple, I think back in the summer of 2008 before the financial crisis even hit – the timing was set as far back as then. The industry went through with that or Apple went through with that price increase in April but clearly in the teeth of the worst recession since the depression.

So it's difficult to know even today some sort of eight, nine months later how much of that is just consumer resistance to a higher price point or how much of it is just taking a price increase of 30% at such a fragile economic time. I don't think there's any other consumer product that's taken such a price increase in the 2009 period and so we don't have a lot to relate it – so I think we need a little more time to really get underneath the cause and effect of the price increase. But as I said nonetheless to date it's been positive for our revenue.

Steve, do you want to talk about how we sort of think about streaming and modeling?

Steven James Macri

There's one other point with regards to secured pricing. As digital becomes more meaningful over time it becomes more highly coordinated with the release schedule. And so the timing of your releases – new releases in the marketplace will dictate digital revenue growth as well.

Edgar J. Bronfman Jr.

And Laura, I'm sorry I just wanted to add one other thing. I think the other thing that recently happened – it's kind of an interesting dichotomy – as you saw Amazon had the $9.99 sort of across the board eBook price. That broke, frankly, with the introduction of the iPad where Apple essentially is allowing publishers to price their books at a wholesale level wherever they'd like, and Apple taking a 30% mark-up for a retail price to consumers. It's interesting frankly that the book publishing business on the iPad has much more pricing flexibility than the music industry had on any of the Apple devices. But I think – and again going back to some things Rupert said – I think what this signals is that content is going to have more pricing flexibility over time rather than less, because frankly the only thing that drives iPhones, iPads, Kindles, Zunes (ph) and other kinds of devices is content. And I think the power content in that little fracas with Amazon was clearly evident. So I suspect over time you'll see sort of an increase in pricing flexibility for content companies rather than the opposite.

Steven James Macri

And then Laura, with regards to modeling. You know it's difficult to predict the rate of growth in the digital business from the streaming models. But what I can tell you is that the margin is higher on digital so you just compare a digital album to a physical album. The gross margin on a digital album is roughly six to eight points higher than a physical record.

Laura Martin - Needham & Company

Even if they are streaming the cloud (inaudible) or they are taking down 100 million free songs for every one they would have bought?

Edgar J. Bronfman Jr.

Well, first of all we don't know what consumer behavior is going to be in the cloud and whether we can correlate purchase to sort of subscription or other kinds of models. But we do a lot of sort of modeling work here to talk about what – to think about what kind of scale is necessary at what pricing and we do see that the opportunity to expand music consumption and music purchase, whether that's by track, by album or simply by service across a vastly greater number of consumers is net extremely positive for the industry. That having been said, free streaming services are clearly not net positive for the industry. And as far as Warner Music's concerned will not be licensed. So this sort of get all the music you want for free and then we maybe we can – with a few bells and whistles move you to a premium price strategy is not the kind of approach to business that we will be supporting in the future.

Laura Martin - Needham & Company

Thank you.

Operator

The next question is from Ingrid Chung with Goldman Sachs.

Ingrid Chung - Goldman Sachs

Thanks, good morning. So a couple of relatively quick ones, if I may. First, Edgar, you said that you signed on Michael Buble's global merchandising rights but you also said that you didn't want to pay retail for the rights of established artists. Can you give us some color on how this agreement came about and how we should think about how the economics of the deal impact you? And then I guess the second one's for Steve. You've roughly $340 million cash on the balance sheet, and you generate a pretty consistent level of free cash flow – I think we'd expect at least $500 million in cash at least a year from now. What are your plans for that cash that you're building on the balance sheet?

Edgar J. Bronfman Jr.

So Ingrid, on the Michael Buble deal I think that what I would say is – obviously we're not going to give the details of the agreement, but it's been our goal to increase where possible our relationship with a number of our key leading artists, Michael chief among them, who is not only one of the most talented but I have to tell you one of the hardest working artists in the music industry, certainly on the Warner Arts roster but I think across the industry. His tour is now moving from smaller venues – even though still quite large, to arena type venues.

So this kind of merchandising is new to him as well. And as someone with whom we've had a long and I think successful partnership with we were able to construct a deal where Michael can trust that the merchandise we make and market will be very consistent with the image that he is trying to project. And so all in all it represents an increase in our relationship with the artist but I would say that merchandise in general among the 360-degree rights that we've signed is among the smallest both in terms of revenue opportunity and in absent (ph) margin. So it's important in terms of indicating the quality of the relationship that exists between the company and an important artist like Michael Buble but I don't think terribly relevant in terms of watching our bottom line.

Ingrid Chung - Goldman Sachs

I got it. And as far as cash?

Steven James Macri

As far as the cash. Yeah, I noted in my remarks. We remain confident in our ability to generate significant cash in this fiscal year despite those time related items in Q1. The primary uses of cash will continue to be funding our A&R investments that we've sustained since we've bought the company in 2004, and also investing in continued market growth – those releases. With regards to M&A it's really continue with a selective posture towards M&A with a keen eye on value – I could see us making some small tuck and acquisitions here and there, and that's basically – if we continue with the balancing strategy we've had in the past -

Edgar J. Bronfman Jr.

But Ingrid, let me add that I think as we continue to build cash and your estimate of our ability to continue to do so is certainly correct – it's certainly directionally correct at least – we are constantly looking for ways to increase the value of our company to our equity holders, and we've done a pretty good job I'd say so far to our bond holders. Because our bonds are trading very well and we continue to hope that they will trade well and be very respectful of the investment that they've made and the return that we've been able to get for them. Our equity holders have not done as well and we are building up significant cash, and we need to think about how to advantage our equity holders as importantly – more importantly than our bond holders have been rewarded for their investment in the company. And our building up of free cash flow gives us a number of alternatives which we continue to study in earnest.

Ingrid Chung - Goldman Sachs

Okay, great. Thank you.

Operator

The next question is from Richard Greenfield from Pali.

Richard Greenfield - Pali Research

Hi, a couple of questions. With constant currency revenues down 2% and your comments about a back half with release schedule, is it fair to assume that – all else being equal – you know that you could actually see flaked up constant currency revenues in second half – essentially asking you is there anything unusual or one-time in the second half that makes the comparison difficult versus what you saw in the first fiscal quarter, and then kind of related to that. Assuming that 10% of your currency benefit in the first quarter on a revenue basis flowed to EBITDA, it appears that EBITDA was essentially flat despite a 2% constant currency revenue decline worldwide. Is that degree of margin expansion sustainable throughout the rest of the year? Thanks.

Steven James Macri

Sure. So with regards to the first question, Rich, there's nothing unusual in the back half of the year last year that will distort results. And then with regards to sustaining margins means. What we do for a living is really just to continue to manage costs on a regular basis, which has actually allowed us to sustain margins over time. Refinancing our balance sheet back in May gives us a lot more financial flexibility, and we'll continue to look at ways to adjust our business and ways to take costs out. Which will enable us to sustain those margins.

Richard Greenfield - Pali Research

How much benefit are you seeing now from some of the changes you made last year – I mean is there any way to quantify how much your restructuring has helped improve margins? Because obviously you're seeing a benefit year over year from what you did throughout 2009.

Steven James Macri

Yeah, I mean it's difficult to quantify, because it's a constant evolution. We're always taking costs out of the business and those results are being reflected. So as the physical business declines and we selectively take costs our of physical and invest into growing parts of our business that's reflected in our margins. And that's one of the reasons why we're flat 12% year over year.

Richard Greenfield - Pali Research

Is there any way to look at how much of what happened in this quarter was driven by cost cutting versus by how much was higher margin digital, you know related to Edgar's comments before that there are parts of your business that are higher margin than what you've had previously.

Michael D. Fleisher

Rich, it's Michael. I don't think you can parse it out. The reality is over the last three or four years we've been constantly turning the spigot on costs so are there tens of millions of dollars every year of increases in margins because we're managing that cost structure, yes. They're also – the gains that we're getting as more of the business becomes digital, absolutely. But in a way they're interrelated, right? We're taking out those higher cost physical parts of our business as more of it becomes digital. So one yields the other, I don't think you can really parse them out that way.

Richard Greenfield - Pali Research

Thanks.

Operator

The next question is from Jessica Reif Cohen from Bank of America Merrill Lynch.

Jessica Reif Cohen - Bank of America Merrill Lynch

Thanks, yeah, I have a couple of questions. The first one is EMI related. Now, in the increasingly likely event that EMI is forced to restructure or be taken over by its lender, would you expect it to be sold in whole or in pieces? And given the current, I would almost call it benign regulatory environment, how does that factor into the way you would evaluate a potential EMI deal?

Edgar J. Bronfman Jr.

Jessica, it's Edgar. Without commenting on what will or won't happen to EMI, I think the EU was pretty clear in the Sony BMG decision that at least as things stood then, and I don't think things have gotten any better now, that another step of consolidation in the recorded music industry, at least at that time, seemed to be nonthreatening to the EU competition authority. So I think from a regulatory standpoint, further consolidation in the recorded music industry is possible. I'm not going to guess whether or not it's likely, but I think it's certainly possible. And I think should it come to the lender having the opportunity to try and recover value, it's going to try and recover the highest possible value it can; whether that's selling EMI in pieces or selling it in whole.

But I think the last thing I'd say is as we all try to grow this recorded music industry, strong Universal, strong EMI, and strong Warner, and frankly a strong EMI is better for us than any of those companies being weak. And so we'll just have to see how the future plays, but I hope that EMI is able to resolve its difficulties in a way that benefits the industry over time.

Jessica Reif Cohen - Bank of America Merrill Lynch

Okay. My second question is about the recent Live Nation-Ticketmaster deal. Could you just elaborate on what areas you think will most affect your company, Warner Music, either positively or negatively?

Edgar J. Bronfman Jr.

Yeah. Look, I think we think of Live Nation-Ticketmaster largely as a complimentary business to the business that we're in. I think Live Nation-Ticketmaster is a business of scale, it's a business of consumer relationships and venue relationships, and it deals almost entirely with artists that have proven that they have a significant ticket purchasing capability.

Our business, on the other hand, is essentially a venture capital business where we're betting on a bunch of unknown artists who have yet to develop that opportunity. And when we sign those artists we sign, as I said, essentially all of them to expanded rights deals which means whether they go through Ticketmaster-Live Nation when they're eventually touring or through some other form, we're going to partner with the artists in the revenues derived from their tours. So our sense is that these are largely complimentary businesses, not really competitive businesses. I think Live Nation-Ticketmaster has the opportunity to be a very strong and powerful company, but in an area of the business where we do not currently compete, although we do expect to derive significantly increased revenue over time.

Jessica Reif Cohen - Bank of America Merrill Lynch

And the last question is actually on that point. On the 360 deals that you guys have been doing, how long are the contracts on average and when somebody actually does become established, how difficult is it in renegotiating a similar kind of deal or do the deal terms change a lot?

Edgar J. Bronfman Jr.

So the 360 deals essentially are, if you think about them, no different than our recorded music deals which tend to be very long-term deals, and in many cases in fact extend well beyond the period of the first — when the original recording agreement might end. So in many cases the 360 deals are actually longer than a recording agreement. So I think they're very long term.

In terms of renegotiation, I don't think anything's different than the kinds of things we deal with today. If we have a new recording artist and that new recording artist has tremendous success very early in their career, they inevitably come back and attempt to renegotiate, and at some level we do try to accommodate them, but of course it's within an environment and a framework where we control the rights to their recordings for a very long time and therefore we're certainly not subject to sort of public auction kinds of payments.

So we always try to maintain good and strong relationships with our artists, but we have very long-term rights, as I said, perhaps even longer than we used to in terms of the 360 rights, and the sort of renegotiation dynamic is something that we've dealt with as an industry for decades and it's no different in this world.

Jessica Reif Cohen - Bank of America Merrill Lynch

Okay, thank you.

Operator

The next question is from Jason Bazinet from Citigroup.

Jason Bazinet - Citigroup

Thanks so much. I just have a question on the recorded physical side of the business. I was just looking at some industry data, at least in the US, where the physical units were sort of in the $300 million a year range back in the late '70s and sort of went all the way up to north of a billion units a year sort of at the tail end of the '90s. And now we're sort of back at the mid-300s or so. And my question is do you ultimately believe the physical business goes to zero, or do you think there will always be some residual amount of physical recorded units that are sold per year?

Edgar J. Bronfman Jr.

Well, I guess I would quote my friend Barry Giller (ph) and say "Nothing ever replaces anything," meaning that there's sort of always vestiges. You can still go to Central Park and see horses and buggies, but they're hardly the main means of transportation. So look, will there always be physical? I think there always will be some level of physical. Vinyl is growing very strongly and I think among audiophiles it's going to be very hard to replace vinyl for people who are absolutely passionate about the sound quality that they have in their home, and I think there's some convenience for a lot of consumers for a very long time to a CD or a CD-like package. But will physical be the predominant means of music listening five or 10 years from now? I think certainly almost certainly not.

Jason Bazinet - Citigroup

Okay, thank you.

Operator

The last question comes from Tuna Amobi from Standard & Poor’s.

Tuna Amobi - Standard & Poor’s

Great, I have several questions as well. So in terms of the geographic composition of your digital revenues it seems like the trend is kind of shifted from more domestic towards the international and it just seems like international actually overtakes domestic in the not too distant future if my observation is correct. So would you attribute this trend to more of a substantial penetration of mobile access models of more to kind of a slowdown in online downloads just to get a better handle on what's driving that trend?

Edgar J. Bronfman Jr.

So, I think it's a couple of things driving the trend. First of all, there are more people outside the US than there are inside the US. iTunes launched in the US probably 18 months to two years before it really got any traction outside the US. So you're seeing sort of still significant growth on the Apple platforms in Europe. Apple's now growing in Japan where it got off to a relatively slow start. So you're seeing more platform development, more people, and more experimentation and traction on access models in Europe and certainly obviously in Japan then you have in US.

So I think it's true that inexorably, international digital revenues will be greater than US digital revenues. Quite how quickly that happens I'm not quite sure, but I think you're right that the trend is clear.

Tuna Amobi - Standard & Poor’s

Okay. Moving onto Vivo, it seems like you guys are still the only major that is kind of holding out. I know you made a deal with Hulu and YouTube, so can you kind of reconcile is the reason you're not on Vivo because perhaps that you think Hulu and YouTube — are they mutually exclusive in some sort or is it just a question of reaching the right terms on that platform?

Edgar J. Bronfman Jr.

I think it's a little bit of both. I mean, I think certainly we're very much open to joining Vivo. We just have a strategy that we think there's a great deal of value to be built artist by artist rather than to a single destination. So Vivo's approach is to try and aggravate all music consumers and music lovers at Vivo and try to give them everything that they'd like. I think that's probably a very good strategy if it's successful. On the other hand, we think that there are also a lot of music consumers out there who want their relationship with the artist to be deeper and stronger than you can achieve through a single website. And so in building our 360 deals and in managing our artists' websites we think there's a great deal of commerce to be done and value to create for consumers on a website by website artist by artist approach which Vivo frankly doesn't allow us to do to the extent that we think we'd like to do that.

But we continue to evaluate at Vivo. We're very glad for frankly, the success that they're already achieving. We think anything that the music industry does that is positive and creates growth is great for all of us and we continue to evaluate whether it makes sense for it to be, in addition to driving our own strategy, to be part of the Vivo community as well.

Tuna Amobi - Standard & Poor’s

And if I can circle back to the Live Nation-Ticketmaster topic, so Comcast and AEG obviously were able to strike some valuable concessions there and I would've thought that you guys are just as well positioned if not better positioned to get some valuable regulatory concessions, particularly as you look at Europe where you're kind of ramping up on the (inaudible) promotion. Did you look at perhaps any areas where Warner Music could've seized the moment and got some opportunity to maybe diversify your domestic strategy given the importance of that deal for you guys and everyone else in the industry?

Edgar J. Bronfman Jr.

Yeah look, I think we certainly watched with interest and to some degree were asked by various regulatory authorities for our views. But we are not directly competitive with either Live Nation or Ticketmaster in almost any major market where there were regulatory concerns, and so concessions are usually sought by regulators where in order to increase competition or at least to keep competition from diminishing, and that really is not applicable to anyone in the recorded music or music publishing industry. So I don't think we're in a position to seek concessions or to gain concessions from regulators, and as I said, ultimately we see these businesses as complimentary. I don't think it's likely that Warner Music will ratchet up our venue ownership or ticketing software to a degree where we become major competitors with the Live Nation or Ticketmaster in that end of the business.

Tuna Amobi - Standard & Poor’s

That's very helpful, by the way. Just lastly on your prepared remarks comments, regarding your meeting in Washington, Edgar, so as you were talking to the administration officials, is this something along the lines of perhaps reshaping the Digital Millennium Act or some other kind of incremental framework to kind of advance this piracy subject?

Edgar J. Bronfman Jr.

Well, I think it's less about revisiting legislation then it is applying a regulatory framework that seeks enforcement of current copyright law in a more thoughtful way. It's important to all of us that consumers continue to get the content that they want in as many varied ways as possible. But I think it's also important to recognize that as consumers increasingly turn to the digital world that that world cannot have the distinction of being lawless while the physical world is essentially — or as the United States always likes to say, a nation of laws.

And so the question is how can you take the accumulated wisdom of centuries of civilized law that has allowed this country and others to get to the place that they have and apply it in a thoughtful way in an entirely new world without trying to either trample on consumer rights or restrict consumer access. And I think there are plenty of ways to do that and I think frankly and finally, the US government is engaged in trying to figure out ways to do that.

Tuna Amobi - Standard & Poor’s

Okay, thank you very much.

Edgar J. Bronfman Jr.

Thank you and thanks — oh, we have one last question. All right, one last question.

Operator

The next question is from Marla Backer with Hudson Square.

Marla Backer - Hudson Square

Thank you. I have two questions, one is housekeeping. You made some remarks earlier about the graduated response measures, but I thought I had read that there had been some pushback. I think it was specifically in France. Is that incorrect?

Edgar J. Bronfman Jr.

Well, it's probably not incorrect that there had been some pushback because there's pushback with every piece of legislation that gets passed in every country, but the truth of the matter is France has passed the legislation, the legislation is in effect. The actual implementation of that legislation probably begins in earnest in sort of the April-May timeframe.

Marla Backer - Hudson Square

Okay, thank you. And then I had another followup on the 360 degree deals. Are all of the majors engaged in 360 to redeal? I would guess that's so, so is that potentially a source of driving up competition for new artists such that it would make you pull back at some point from artists that you would otherwise sign if the 360 degree rights weren't attached?

Edgar J. Bronfman Jr.

Well, I think all of the majors are engaged in signing 360 degree deals to some degree or another because we have to compete for artists that we sign from time to time with other labels, and quite honestly, there have been a number of artists, I won't name them, that we have not signed because they would not give 360 rights to us and were signed by our competitors without those rights. In some cases we were right to do that and some cases maybe we should've made an exception, but we are very, very religious here about signing 360 rights because quite frankly, given the size of the recorded music opportunity alone, the amount of incremental investment capital that is required for us to break an artist simply doesn't give us the opportunity for appropriate return without ancillary revenues.

And so we're going to continue to be quite religious about 360 degree rights, and I think honestly, our competitors look at the same set of economics that we do, and although they may make more exceptions from time to time than we do, ultimately I think this is the only way forward for the industry and therefore the levels of competition will be no different in this world than they were in the recorded music rights world only.

Marla Backer - Hudson Square

Okay, thank you.

Edgar J. Bronfman Jr.

Thank you. Thank you, Marla, and thanks, everyone, for your time and attention and we'll see you in a few months. Thanks, bye-bye.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Warner Music Group F1Q10 (Qtr End 12/31/09) Earnings Call Transcript
This Transcript
All Transcripts