Warner Music Group (WMG) CEO Stephen Cooper on Q3 2014 Results - Earnings Call Transcript

Aug. 7.14 | About: Warner Music (WMG)

Warner Music Group Corp. (NYSE:WMG)

Q3 2014 Earnings Conference Call

August 7, 2014 08:30 am ET

Executives

Stephen Cooper – Chief Executive Officer

Brian Roberts – Executive Vice President & Chief Financial Officer

James Stephens – Senior Vice President Communications and Marketing

Analysts

Aaron Watts – Deutsche Bank

Operator

Welcome to Warner Music Group’s Q3 2014 Earnings Call for the period ended June 30, 2014. 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, Mr. James Stephens, Senior Vice President Communications and Marketing. You may begin.

James Stephens

Good morning, everyone. Welcome to Warner Music Group’s F3Q 2014 conference call. Both our earnings press release and the Form 10(q) we filed this morning are available on our website.

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

Before Steve’s comments let me remind you that this communication includes forward-looking statements that reflect the current views of Warner Music Group about future events and financial performance. All forward-looking statements are made as of today and we disclaim any duty to update such statements. Our expectations, beliefs and projections are expressed in good faith and we believe there is a reasonable basis for them. However, there can be no assurance that management’s expectations, beliefs and projections will result or be achieved.

Investors should not rely on forward-looking statements because they are subject to a variety of risks, uncertainties, and other factors that could cause actual results 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 Steve Cooper.

Stephen Cooper

Good morning, everyone. Welcome to our F3Q 2014 earnings conference call. We’re delighted to be speaking to you for the first time from our new global headquarters at 1633 Broadway in New York.

We had a great Q3, achieving double-digit revenue growth. As previously anticipated on these calls we are now seeing the benefits of the stronger release schedule, which is weighted toward the second half of the fiscal year and bolstered by our acquisition of Parlophone Label Group. Parlophone UK was responsible for two of our top-ten selling albums this quarter including Coldplay’s Ghost Stories and Lily Allen’s Sheezus. We released other global chart toppers from the Black Keys, Ed Sheeran, and Lincoln Park.

Overall we are pleased with our performance this quarter, especially that the strategic moves we’ve made to expand and diversify our business are yielding positive metrics. Unless otherwise noted, I’ll be giving our figures in constant currency.

We grew total revenue by 17%. We increased digital revenue by 25%, and we improved adjusted OIBDA by 38% and adjusted OIBDA margin by two percentage points. This accomplishments illustrate how our intensive focus on A&R, executive talent and global infrastructure are combining with first-class execution by our operators to deliver meaningful results.

We remain on track with our PLG integration which is now in its final stages. By this time next year we anticipate realizing the benefits of previously disclosed annual cost savings of around $70 million. With carryover from this quarter’s releases and a solid Q4 release schedule we are well positioned to build on our momentum through the remainder of the fiscal year.

Before going into further detail on our quarterly performance let’s take a brief look at the broader industry landscape to provide some context for our results. At its most basic level the global recorded music industry is now made up of a digital business comprised of downloads and streaming and a physical business. Even as our revenue mix continues to evolve we see consumer choice around many digital alternatives as a real positive and we are energized by the powerful rise of streaming models.

Growth in streaming is sending a clear message to the entire music industry – fans love the convenience, connectivity and depth of experience that streaming offers. In the streaming world, the more that fans enjoy the music the better for everyone. Recording artists, songwriters, music publishers and recording companies are compensated based on repeated listening, thus rewarding quality as well as popularity.

In addition, streaming more fully captures the true demand for music including monetizing the type of sharing behavior that in the mp3 world would be considered piracy. Our own research tells us that through streaming services fans are more likely to engage with entire albums and dive more deeply into a recording artist’s catalog. That said, the overall global outlook remains mixed with varying local conditions determining how markets are evolving.

While in many territories including the US we are not yet seeing the rise in digital revenue driven by the growth of streaming offset a decline of physical sales, there are also a growing number of markets where streaming is leading a return to overall growth much as it did last year in places such as Denmark, Norway, and Sweden.

In Spain for example, local music association COMUSICA recently reported positive revenue growth for the first time in thirteen years. This turnaround was largely due to streaming which surged 14% in the first half of calendar ’14. This benchmark is especially encouraging given that Spain is traditionally a market where piracy is rife and digital models have struggled to take hold.

The long-term prospects in the streaming sector are also highlighted by the surging growth of streaming services like Spotify, now reaching over 10 million paying subscribers with 40 million monthly active users across 56 markets. Clear Channel’s internet radio service, iHeartRadio, has seen its user base swell to 50 million in two and a half years.

At the same time this quarter has seen three of the world’s biggest technology companies expand their streaming offers. Apple acquired Beats Music, Amazon introduced its Prime Music service, and Google agreed to purchase Songza. These deals once again underscore the importance of continued innovation in our industry as well as the value of music in attracting and exciting huge global audiences.

We’re deeply embracing the momentum of streaming with our recorded music streaming revenue growing 102% year-over-year. We remain optimistic that these exciting developments along with increasingly connected consumers will drive even greater global consumption and monetization of music.

Now returning to our results in recorded music in constant currency, total revenue increased 21%; digital revenue grew 25%. Artists services and expanded rights revenue leapt 31% thanks to the timing of major European tours, and adjusted OIBDA increased by 51%. Driving these results is our ability to deliver wide-ranging success in almost every genre, with pop hits as well a career acts and with new recording artists as well as established legends.

In its week of release Coldplay’s Ghost Stories had 2014’s largest first week album sales in both the US and UK. The Black Keys celebrated new heights when their eighth album Turn Blue became the band’s first US #1 and hit the top spot in Canada and Australia. Ed Sheeran’s Multiply which also debuted at #1 in the US and UK made Spotify history as the most streamed album in a single week only to go on and surpass its own record a week later.

Our recording artists have also been burning up the singles charts around the world. For example, Jason Derulo has celebrated three consecutive global hits including his most recent track “Wiggle” which went top ten in the US, UK, Australia, Germany and Sweden. And Nico and Vinz, originally signed by Parlophone Norway, hit #1 on Shazam’s Worldwide Top 100 with their single “Am I Wrong,” proving once again that great music can come from anywhere and translate everywhere.

In addition Led Zeppelin made an impressive return to the charts with deluxe editions of their first three albums, all debuting in the top ten in the US, Canada and Denmark more than four years after they were released. This achievement highlights why we continue to build what is already one of the most extraordinary catalogs in the history of recorded music, including through our acquisition of PLG last year.

We are also aggressively pursuing a strategy in emerging markets as shown by our recent purchase of Gold Typhoon, one of the largest independent collections of modern Mandarin music from China, Hong Kong and Taiwan dating from the early 1990’s through the present day. While growth in Europe, Latin America and the US only partially offsets declines in our Pacific and Asia regions we saw impressive locally-led successes this quarter. In Norway, for example, our album market share grew to 22% in the quarter during which we had six #1 albums including at one time holding the top three spots on the charts.

Our UK company with Max Lousada as its CEO is having a terrific run with some extraordinary recording artists who have emerged as global stars. We scored the UK’s top three biggest selling artists’ albums of the year, with Ed Sheeran’s Multiply, preceded by #1s from Coldplay and Paolo Nutini. As a result, we took second place in Music Week’s quarterly rankings, overtaking Sony Music by earning 23% artist album market share. Ed Sheeran’s album has gone on to become the longest-running UK #1 since Adele’s 21 topped the charts back in January of 2011.

Looking forward to the next quarter we have recently released or are planning to release phenomenal new music from stars such as Trey Songz, Jason Mraz, Robert Plant, Tom Petty and Whiz Kalifa as well as from up and coming talent like Charlie XCX, [Jess Grin, Carey Pagnu-Pagnu], and Fences.

Now, turning to our results in music publishing, in constant currency our revenue grew 1% with declines in mechanical and synchronization revenue more than offset by performance revenue which rose 2% and digital revenue which climbed 29%. Our ongoing investment is creating a sustained creative resurgence at Warner/Chappell. This year has seen a richly deserved historic achievement for the company when for the first time ever it won the highest honor, Publisher of the Year, at three of ASCAP’s prestigious ceremonies – Rhythm & Soul, the Pop, and the Country Music Awards.

Topping it all off, at the ASCAP Rhythm & Soul Music Awards in June, Warner/Chappell’s songwriter Mike WILL Made it was named Songwriter of the Year while Warner/Chappell’s songwriters received a collective 21 Most-Performed Song of the Year awards, five of which went to Kendrick Lamar and four to Jay-Z. These important recognitions acknowledge what we already knew – our songwriters are shaping the musical landscape and our Warner/Chappell team is helping songwriters at all stages of their careers realize their creative visions and commercial goals.

We are signing exciting new acts such as the previously mentioned Nico and Vinz and country singer/songwriter Lauren Alaina, as well as fostering the development of up and coming recording artists like [Hilja] who co-wrote Ariana Grande’s massive hit “Problem,” and Tom Odell who won Songwriter of the Year at the UK’s Ivor Novello Awards in May.

We are forming deeper publishing partnerships with today’s most influential hit makers. For example we recently extended our deal with Terius Nash AKA The-Dream. Terius is one of music’s most prolific talents and composer of some of modern pop’s biggest hits such as Beyonce’s “Single Ladies” and Jay-Z’s “Holy Grail.” At the same time we continue to nurture the legacy of our legendary talents including the King’s Way Babies and Philadelphia International Founders’ Kenneth Gamble and Leon Huff who were the top honorees at the Songwriters Hall of Fame in June.

This month we announced the publishing agreement with Grammy, Emmy and Tony Award winning composer Charles Strouse whose works include musicals such as “Bye-Bye Birdie” and “Annie.”

This quarter’s many highlights from our recorded music and music publishing businesses demonstrate our strength and diversity across every country, label and genre. We’re bringing superstars to new heights, breaking recording artists out of territories that have not traditionally produced global stars and developing local recording artists and songwriters with renewed energy and focus.

We are laser focused on transforming our company to benefit for new opportunities, technologies and business models, and we remain committed to driving growth through a well-balanced and diversified portfolio. With that let me turn it over to Brian to detail our financial results.

Brian Roberts

Thank you, Steve, and good morning everyone. We had a robust Q3 in terms of our top line results driven by the strong release schedule and the inclusion of PLG, which we acquired on July 1, 2013. In line with the end of our fiscal year next quarter will be the final quarter we report earnings including and excluding PLG. From F1Q 2015 onwards we will report just our combined company earnings.

I’m pleased to say that this quarter including PLG revenue rose 17% in constant currency. Excluding PLG, which contributed $102 million, our revenue rose 2%. This growth was due to a stronger release schedule, solid digital results and an improvement in our artists services and expanded rights revenues.

As we outlined in our past two quarters our release schedule is weighted toward the second half of this fiscal year for both the total company as well as for PLG. We clearly see this in our Q3 results and expect the impact from our strong release schedule will continue into Q4. Year-to-date our total company revenue is up 7%.

As we’ve discussed on prior calls from an OIBDA perspective, certain adjustments are necessary to make the year-over-year comparisons more meaningful. We’ve highlighted these in our press release but let me walk you through them. In the quarter we had $15 million in integration costs associated with the acquisition of PLG including IT and supply chain costs and professional fees; $18 million in restructuring expenses which were mostly employee-related in connection with the PLG integration; and $14 million in one-time costs associated with our move to our new global headquarters. This is compared with $10 million in costs related to the acquisition of PLG in the prior-year quarter.

Adjusted OIBDA rose by 38% to $109 million and adjusted OIBDA margin increased two percentage points to 14% from 12% in the prior-year quarter. Excluding PLG which contributed $27 million, adjusted OIBDA increased 4%.

In recorded music revenue grew 21% in constant currency or 2% excluding PLG. Digital revenue grew 25% and was up 9% excluding PLG. This reflects our strong release schedule and worldwide growth in streaming revenue offset by declines in downloads and physical.

Artists services and expanded rights revenue was up 31% to $92 million from $70 million in constant currency. Excluding PLG, artists services and expanded rights revenue was up by 30%. The increase was a result of tours operated by our European concert promotion businesses in Italy and France. Artists services and expanded rights revenue represented 14% of recorded music revenue as compared to 13% in the prior-year quarter.

Recorded music adjusted OIBDA jumped 51% to $104 million and recorded music adjusted OIBDA margin was up three percentage points to 16%. The margin improvement reflects the strong release schedule as well as continued costs management. Excluding PLG adjusted OIBDA increased 12% to $77 million. With regard to PLG we recently completed the lengthy process of combining our businesses in France, one of the final steps in our integration. As Steve mentioned we remain on track to realize our $70 million in planned cost savings.

Turning to music publishing, in constant currency revenue was also up this quarter by 1%. Performance revenue rose 2% or $1 million and digital revenue rose 29% or $6 million, driven by streaming growth. At the same time mechanical revenue declined 9% as a result of the continued industry shift from physical to digital; and synchronization revenue declined 4% primarily related to changes in the licensing marketplace.

OIBDA declined to $24 million while OIBDA margin declined three percentage points to 18% from 21% primarily due to the flow through of certain high-margin deals in the prior-year quarter. While OIBDA was down in the quarter and can fluctuate from quarter to quarter due to revenue mix and timing of collections, for the nine months ended June OIBDA was flat and OIBDA margin was steady at 25% compared to 26% in the prior year.

We remain keenly focused on task management and are committed to delivering solid free cash flow. Operating cash flow was negative $38 million versus positive $22 million in the prior-year quarter. This quarter was burdened by approximately $31 million in cash expenses related to the PLG integration and restructuring as well as our office moves. Free cash flow was affected by the same one-time costs coming in at negative $55 million versus negative $25 million in the prior-year quarter.

CAPEX was $16 million for the quarter versus $10 million in the prior-year quarter. As we’ve discussed previously, we expect a meaningful increase in 2014 CAPEX as we continue to invest in long-term upgrades to our IT infrastructure, relocate our corporate headquarters and consolidate our offices across Europe in connection with the PLG integration; and take some additional CAPEX related to PLG’s supply chain and IT.

As you can see on our cash flow statement, the refinancing of the largest portion of our unsecured indebtedness closed in early April. I reviewed the details of this refinancing last quarter and will not go through them again today, other than to say that as a result of the refinancing we will realize annual cash interest savings of approximately $30 million.

As Steve noted, we continue to make progress throughout our business, focusing on artist development and digital innovation, diversifying revenue and managing costs carefully, while continuing to invest in growth opportunities. With that, Operator, please open the line for questions.

Question-and-Answer Session

Operator

Thank you. Our first question today is from Aaron Watts with Deutsche Bank.

Aaron Watts – Deutsche Bank

Good morning, guys. I appreciate all the detail you’ve put in the release by the way, it’s extremely helpful.

Brian Roberts

Thanks, Aaron.

Aaron Watts – Deutsche Bank

Brian, one quick one on the cost saves, $70 million target – where are you at relative to that bogey?

Brian Roberts

So to date we’ve realized about $30 million and we have a $40 million realization to go, Aaron.

Aaron Watts – Deutsche Bank

Okay.

Brian Roberts

And we’re in line with what we had said when we first talked about the acquisition and the cost savings and the plans. We had a 24-month window to execute against and to get them out of the business, and we feel very comfortable with that.

Aaron Watts – Deutsche Bank

Okay, so figure by this time next year the rest of those savings should kind of be flowing through and benefiting you?

Brian Roberts

Yes.

Aaron Watts – Deutsche Bank

Okay, and any kind of material additional costs tied to those last bit of savings or have most of the costs already been kind of upfront-weighted?

Brian Roberts

Yeah, so we do have some costs yet to go but I think we’ve from a restructuring perspective, I think when you get a chance to take a look at the (q) you’ll see we’ve probably incurred about $64 million of what I think we have in there, sort of $84 million, $86 million. So most of it’s been incurred and we still have some to incur on the integration side as well, so the restructuring bucket and the integration bucket. Restructuring is primarily in place stuff, Aaron, and the integration is primarily IT and supply chain.

Aaron Watts – Deutsche Bank

Okay, got it. And then obviously big new releases can move the numbers, and that helped in a good way this quarter. But maybe just some thoughts you have on the weight that catalog can have in today’s world where streaming is becoming a bigger presence versus maybe in the past – I guess thinking about catalog versus the new releases and the singles, and just some thoughts around that and how it impacts the business.

Stephen Cooper

Aaron, it’s Steve. Catalog is a tremendous asset in the streaming world. When you think about you know, filling the streaming pipeline if you will with content, almost by definition the bulk of it has to come from catalog versus…. [coughs] Excuse me, my allergies are killing me – has to come from catalog versus current releases. And we’ve seen on a regular basis where streaming dollars have been more catalog-oriented than current release-oriented.

So we continue to look at catalog as a critical, critical asset in the development and the successful monetization of streaming over time which is why we continue to invest heavily in it. In large part the PLG and EMI acquisition that we made was catalog-oriented. We just announced, I don’t know, several weeks ago the acquisition of one of the largest modern Mandarin catalogs in China, Hong Kong and Taiwan. We continue to evaluate catalog acquisition opportunities on a regular basis.

And as you know, current releases after 18 months, which is somewhat of an arbitrary standard, flow into catalog and catalog continues to grow and be revitalized by the current release cycle. So while connected catalog is an integral part of the streaming world and an integral part of our strategy.

Aaron Watts – Deutsche Bank

That’s helpful. Are the economics different on catalog versus new release for you in a streaming world?

Stephen Cooper

With respect to the economics of revenue, no. I mean a stream is a stream.

Aaron Watts – Deutsche Bank

Okay. And then last question from me: you mentioned some market share details from around the world. I’m curious in the US how you think about your market share position on the recorded music side. Is it something that you see as being stable, do you need to grow it? And then kind of also on the publishing side, is there more of a focus to grow that share via acquisitions and such? So I guess the overall theme on market share here in the US.

Stephen Cooper

Well, we do want to grow market share but we want to grow market share intelligently. So whether it’s on the recorded music side, you know, typically we grow market share there by being thoughtful about the artists that we, new artists that we want to go to contract with as well as working with our established and global artists who continue to enhance and elongate their career – all of which contribute to market share. But it’s done within the context of thoughtful and rigorous financial discipline.

We are not in the market so to speak of building market share with lack of solid economical thought and consideration, Aaron. So we just don’t buy market share to have market share, particularly if acquiring that market share is not profitable. We take the same approach on the music publishing side where both through a very thoughtful A&R policy and hopefully this earnings call provided you with a little flavor of the successes we’ve been having with our songwriters; and/or with the acquisition of catalogs, again, within the context of really rigorous financial boundaries, we continue to build market share.

But again, I want to emphasize that while market share is important to us it’s not important to us at any cost. Again, it’s got to be from our perspective an intelligent investment. It’s got to meet or exceed baseline financial metrics and most importantly it’s pursued in the support of acquiring really great new talent and continuing to bolster our existing roster of very, very talented and legendary artists.

Aaron Watts – Deutsche Bank

Okay, that makes sense. And one more if I could, let me see, just one last one – I think we’re at a little over three years since your current owners stepped into the picture here and bought the company. Any kind of thoughts you can give us on sort of what the strategic destiny is for Warner Music in the kind of intermediary team? Do you envision Warner as a public company again, remaining private, just any kind of broad thoughts on that?

Stephen Cooper

Len has said publicly that he intends on holding this forever. I assume that means very, very, very, very long term and to the best of my knowledge that statement has and continues to be accurate.

Aaron Watts – Deutsche Bank

Okay, I appreciate you taking all the questions.

Stephen Cooper

Sure, thanks Aaron.

Operator

Thank you. (Operator instructions.)

Stephen Cooper

Great, it looks like everything’s been answered. So listen, everybody, have a wonderful August and Labor Day holiday and keep safe. Talk to you in a few months, bye-bye.

Operator

Thank you. This does conclude today’s conference. Thank you for joining. You may disconnect at this time.

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