Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  
TRANSCRIPT SPONSOR
Wall Street Horizon Logo

Warner Music Group Corp. (WMG)

F2Q07 Earnings Call

May 8, 2007 8:30 am ET

Executives

Jill Krutick - SVP of IR and Corporate Development

Edgar Bronfman - Chairman and CEO

Michael Fleisher - CFO and EVP

Analysts

Gerd Hansen - Deutsche Bank

Anthony Noto - Goldman Sachs

Bishop Cheen - Wachovia Securities

Jessica Reif Cohen - Merrill Lynch

Howard Gleicher - Metropolitan West

Richard Greenfield - Pali Research

T.J Mills - Pacific Crest

Tuna Amobi - Standard & Poor's Equity Group

Aaron Watts - Deutsche Bank

Presentation

Operator

Welcome to Warner Music Group’s Fiscal Second Quarter Earnings Call for the period ended March 31, 2007. At the request of Warner Music Group, today’s call is being recorded for replay purposes and if you object, you may disconnect at any time. As a reminder, there will be a question-and-answer session following today’s presentation. (Operator Instructions)

Now I would like to turn today's call over to your host Mr. Jill Krutick, Senior Vice President of Investor Relations and Corporate Development. Thank you. You may begin.

Jill Krutick

[Technical difficulty] reflect the current views of Warner Music Group about future events and financial performance. Words such as estimates, expect, 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 album sales, projected digital sales increases, and gains in physical sales, expected expansion of the online marketplace and market share gains. 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 managements' 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 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 at wmg.com.

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

TRANSCRIPT SPONSOR

Wall Street Horizon Logo

Do you get frustrated during earnings season?

Have you had trades go south because of bad earnings dates?

We know what it's like. We’ve been there. We’re Wall Street Horizon and we work with some of the largest firms on Wall Street.

Founded by former Fidelity Investments executives, we understand the power of trading on good information and the pain and suffering of trading otherwise. We obsess about earnings and economic events calendars so you don’t have to. Accurate. On time. Guaranteed.

Let us help.

Get Smart

Get Wall Street Horizon.

View our Free 30-day trial for investment professionals

To sponsor a Seeking Alpha transcript click here.

Edgar Bronfman

Thanks, Jill. Welcome, everyone. Thanks for joining us. Today I'll discuss the quarterly results, some key performance metrics, and also some important strategic actions we're taking to accelerate our transformation including an organizational realignment to more effectively deploy our resources to growth areas. First, as anticipated and discussed on last quarters' call this proved to be a challenging quarter. While the industry faced a difficult Recorded Music environment, we also face tough comparisons against our very strong second quarter last year. Michael will discuss the financial data in greater detail but there are several key performance metrics that may not come through clearly in the framework of our earnings release. This quarter, we outperformed the industry in the U.S. by gaining album market share. We sustained our leadership position in the music industry’s digital revolution and we posted some notable A&R achievements despite an unusually light quarterly release schedule. On market share according to SoundScan, we gained nearly one point of total U.S. album share year-over-year for the first calendar quarter of '07. Our U.S. album share rose 19% for the quarter up 3 percentage points sequentially from the December '06 quarter. In digital, Warner Music remains the only major music company that reported digital album share in the U.S. substantially above its physical album share for the March quarter of ‘07 according to SoundScan. Moreover, we've had $100 million or more in digital revenue for each of the last three-quarters, including a sequential gain of 11% in the current quarter. On a percentage of total revenues basis, we remain the leader in digital revenue among the majors. This quarter our digital revenue was 14% of our total revenue. For our Domestic Recorded Music business, digital revenue was 22%.

Before we detail some of our A&R achievements this quarter, as you know, we've remained focused on managing the business for the full fiscal year rather than for any single quarter. So let me update you on our most recent efforts to deliver our strategic vision of transforming to a music-based content company, maximizing the value of our content, adding new revenue streams across a broader array of music related businesses and reshaping this organization to effectively seize on growth opportunities.

The realignment initiatives we announced today are intended to enhance our effectiveness, flexibility, structure and performance. This is part of our ongoing effort to redeploy resources and fund ongoing investments toward new growth opportunities, while managing our physical is costs.

Not only is it essential to execute on our digital agenda, which we've talked a lot about, but it's also necessary to explore new ways to generate revenues and profits from our powerful artist brand. We look to capitalize on these transformation initiatives to adapt to the continuing changes in the music business, not just for this year or the next, but for years to come. In other words, and I think this is an essential point for everyone to understand, this realignment is not simply about containing costs.

While there will be some cost reduction, more importantly this realignment, (and we choose that word carefully) is an essential component of our ongoing effort to refocus and retool this company to deploy our resources where they can best seize growth opportunities in areas such as digital, mobile, video and many others.

Let me highlight some of our recent work in these new types of growth areas. First in the mobile space, we continue to advance our global music footprint of 1.5 billion subscribers by expanding beyond China, Russia, Japan, South Korea, Europe and the Americas to now include the Middle East and North Africa. Our recent deal with Orascom Telecom and O-Media Holdings announced in February has extended our reach in delivering music-based content into these regions for the first time.

We formed a strategic partnership with Norway-based Telenor to offer full-length songs, ring tones, ringback tones, mobile music videos and wallpapers in several regions throughout Europe and SouthEast Asia where Telenor's subscriber base currently includes 105 million people in 13 countries.

We have also expanded content offerings in Central America with mobile operators, WAP [one line] and Tigo. Secondly, video remains an area with great momentum and we are moving beyond our current video agreements with players such as Google, YouTube and BrightCo. For example, we recently became the first music company to launch video content over the global Pioneering Internet TV Platform Joost.

The agreement with Joost which incorporates an advertising revenue sharing model will allow us to showcase the depth of our video catalog and exclusive video content to on-demand branded channels. We're also broadening our own video content development efforts with the creation of a new production division designed to develop and produce original programming for network, cable, DVD, broadband and mobile platforms.

The division, named Den of Thieves, is being led by two music and television industry veterans from Universal and MTV. Third, recognizing the size and scope of the video game business in the world of entertainment, we are in the process of establishing an attractive commercial distribution channel for music used in video games. In this area, we announced a deal with Acclaim for the game DANCE! Online, a multiplayer online game that is already wildly popular in Asia.

Supported by advertising and digital merchandise transactions, PC users will be able to dance virtually to the music of top Warner music artists. Warner music is also teaming up with Harmonics, MTV and Electron Arts, the creators of Guitar Hero in the launch of the video game Rock Band. Rock Band will allow gamers to perform music from the world's biggest rock artists with their friends as a virtual band.

Even as we work to transform the company, we continue to have successes in the A&R and distribution areas. In the March quarter, total U.S. album sales, including track equivalence based on the RIA's standard ten tracks per album, fell 10% on a year-over-year basis for the industry according to SoundScan.

Despite a light release schedule, Warner music still outpaced the industry, declining 7% in the same period. We gained about one point of quarterly album unit share in the U.S. year-over-year in both current and catalog albums. Current releases from Red Hot Chili Peppers, Neil Young and My Chemical Romance contributed to these results, while catalogue revenue was invigorated by sales from Nickelback, The Doors, Prince, Green Day, and Tim McGraw.

Several urban artists, including Pretty Ricky, Paul Wall, Musiq Soulchild and Notorious B.I.G. also added to our current album share gains. Bad Boys and Notorious B.I.G.'s greatest hits compilation, honoring the hip-hop legend, made a number one debut on the Billboard 200 chart marking Biggie's third number one album.

We have been successful with our A&R efforts design to enhance our local repertoire in key international markets and drive international superstars globally. In Japan, the world's second largest Recorded Music market, our operating momentum continued into the second fiscal quarter and was best exemplified by the performance of Warner music artists at the Japan Gold Disk Awards with wins in virtually every major category, including Daniel Powter, as International Artist of the Year, Ayaka, as Best New Domestic Artist, and Daniel Powter and James Blunt, as Best New International Artists among many other awards.

Back here in the U.S., Warner music won big at the National Association of Recording Merchandisers Convention. For the second year in a row, WEACorp., our U.S. sales and distribution company was named largest distributor of the year. Alternative distribution alliance, or ADA, our independent distribution company, earned its first ever Medium Distributor of the Year award and Rhino Entertainment was awarded Large Entertainment Software Supplier of the Year for the third year in a row.

Given the challenging environment for the traditional retail music segment, it's especially gratifying to be recognized as an industry leader by music retailers, suppliers, distributors and wholesalers.

Turning to Music Publishing, we are making strategic investments to drive long-term growth and are pleased that our efforts are beginning to show a more stabilized performance. In the March quarter, we signed a worldwide agreement with Microsoft to administer music for Microsoft's video games including the upcoming Halo 3. Furthermore, as part of our strategy to bolster and expand Warner/Chappell’s global synchronization efforts, we made several executive appointments and promotions.

Our redesigned synchronization team will enhance our close relationships with members of the music licensing community including marketers and advertisers, film and television producers and video game creators among others. As expected our release schedule this quarter compared unfavorably to our exceptionally strong schedule from the same quarter last year.

As we noted during our last earnings call, we expect ‘07 to be a back-end-weighted year based on anticipated album release date and we are excited about our lineup. Linkin Park’s third studio album, “Minutes to Midnight” is already out as a top selling pre-order. Their new album, which will be released on May 15 is another example of how we continue to experiment with new and creative ways to promote our artists and create connections between our artists and their fans.

We produced 15 webisodes for Linkin Park TV that chronicled the time between the band's last album and this album. These webisodes are available as individual downloads, bundled with an album, and on an advertising-based YouTube channel.

On our launch date for Linkin Park, we will also debut a new DVD-based physical product called MVI which stands for Music Video Interactive. In addition to a full album of music, the MVI disk contains bonus content, electronic packaging and functionality that brings together the physical and digital worlds in an interactive creative customized consumer experience. We know that most consumers who buy CDs put them first in their computers to listen.

The new MVI disk will significantly enhance and enlarge the consumers experience with the artist while allowing us to capitalize on this opportunity by creating an ongoing connected experience between us, our artists and their fans. This effort underscores how we are committed to innovation not only in the digital world but in the physical world as well.

As we've consistently said, the timing of our release schedule will result in fluctuations between periods and the transformation of the industry will contribute further to variations in performance. As always, we remain focused on improving Warner Music's current performance, building our long-term strength, and creating shareholder value. We have the vitality and drive to adapt and innovate as we develop new business models and broaden our business and revenue streams. In fact, our vision and drive were recently recognized by Fortune Magazine, where Warner Music was named as one of America's Most Admired Companies.

Now I'd like to turn the call over to Michael for a run-through of our financials.

Michael Fleisher

Thank you Edgar and good morning everyone. Let me begin by covering some of our key financial highlights for the quarter. We reported a net loss of $27 million, or $0.19 per diluted share. Excluding non-recurring items related to our realignment our net loss was $15 million or $0.10 per diluted share. Looking at the income statement for three months ended March 31, 2007, we reported revenue of 784 million, which declined 2% from the same period last year or 5% on a constant currency basis.

As expected a tough comparison to the success of our prior year quarter in a challenging industry environment were clearly evident in our results. Domestic revenue was relatively flat while international revenue fell 11% on a constant currency basis. Declines in our physical Recorded Music business were the primary reason for the revenue declines, partially offset by year-over-year increases in our Digital Recorded Music business and Music Publishing.

In Recorded Music, constant currency quarterly revenue declines in the U.K., France, Canada, and Latin America were partially offset by increases in Japan, Italy, and Spain. As Edgar mentioned, Japan was a standout again this quarter with revenue rising 19% year-over-year as strength in both local and international repertoire propelled sales.

The Music Publishing's quarterly revenue which declined in the U.K., Canada, and the Asia Pacific region were offset by growth in the U.S. and the rest of Europe. Our quarterly digital revenue rose 23% to $111 million or 14% of total revenue up from $90 million or 11% of total revenue in the prior year quarter. Quarterly digital revenue rose sequentially by 11%, driven mainly by strong U.S. online performance.

The year-over-year digital growth was limited by our release schedule, which had strong urban digital sales in the prior year quarter from T I., Sean Paul, and Juvenile. Approximately 70% of our digital revenue is generated in the U.S. and 30% in the rest of the world.

Our Worldwide digital revenue was about 60% online and 40% mobile. However, we see this ratio reversing over time. While it still holds true that online is larger than mobile in the U.S. and the reverse is true internationally, we expect the mobile contribution to become more prominent in the U.S. as music-enabled handsets gain greater penetration.

We continue to believe that we are still in the very early stages of a digital music revolution. As Edgar mentioned, and we have consistently said, we are constantly evaluating and proactively shifting costs from the physical to the digital side of our business.

As we work through this process, we recognize that to push our transformation agenda to the next level we needed to take a bigger step now. We announced a global realignment plan that will be implemented between now and the end of fiscal 2007. This plan will advance our longstanding digital strategy and efforts to build a more progressive organization equipped to take advantage of the changing global music market.

For example we will modernize our sales force, outsource certain IT processes and invest in people with expertise in video production, advertising, and mobile and online sales. As we assess our organization today, we are reducing our workforce by approximately 400 people. At the same time, we will be hiring new people with complimentary skills and continue to opportunistically invest in new business areas to facilitate our transformation.

While Edgar touched on some of our most recent strategic initiatives including interactive video games and video production, we see an abundance of opportunities as the industry evolves. As a result, we expect our spending initiatives to largely offset the economic effects of our restructuring. The very nature of our realignment is not to trim costs but to redirect the benefit s of these actions coupled with transformational spending initiatives to drive faster growth at the company.

Total restructuring-related charges are expected to be in the range of $65 million to $80 million, including $10 million to $15 million in implementation costs. We expect to incur substantially all of the restructuring costs associated with the realignment plan by the end of our current fiscal year.

In the second quarter, we booked 16 million in restructuring relayed charges, mostly related to management changes at Warner Music International and redirecting resources to the growth areas of the European Recorded Music business.

In our results released today, we provided tables calculating our results adjusted to exclude the restructuring related expenses. We will update you on our plans as each quarter unfolds. Since we are in the early stages of this process, it's premature to go into much more detail now.

Moving on, our operating income before depreciation and amortization or OIBDA, adjusted for restructuring declined to $96 million, compared to $104 million in the prior year quarter. We experienced the decline in our margins this quarter, which is the result of lower revenue and substantially similar fixed costs.

Without as many blockbuster releases in the current quarter, our OIBDA margin adjusted for restructuring expenses fell to 12.2%, compared to 13.1% last year. Now let's look at each segment. Quarterly worldwide recorded music revenue fell 4% to $648 million on a constant currency basis.

Contributing to this decline was a tough comparison against significant carry-over sales from Madonna and James Blunt in last year's quarter, as well as strong releases last year from T I, Sean Paul, and Juvenile. The third fiscal quarter of 2006 benefited from the multi-platinum Red Hot Chili Pepper double album release, Stadium Arcadeium, and a platinum selling album from Gnarls Barkley.

Considering this and looking at the timing of our releases for the balance of fiscal 2007, we expect our year-over-year comparisons to improve progressively over the next two quarters. Domestic Recorded Music revenue slipped 1% this quarter and international recorded revenue fell 14% on a constant currency basis, as the large releases and successful carry-over album in the prior year had significant international sales.

Recorded Music digital revenue grew 22% from the prior year quarter to $105 million or 16% of total Recorded Music revenue, up from 13% in the same period last year. Domestic Recorded Music digital revenue amounted to $77 million or 22% of total domestic Recorded Music revenue up from 18% last year. Major sellers for the quarter included Madonna, Pretty Ricky, Red Hot Chilli Peppers, Gerald Levert, and Musiq Soulchild. Quarterly Recorded Music OIBDA, adjusted for restructuring related costs, was $70 million, down from $81 million in the prior year period, which reflected the tough comparisons, lower revenue on a similar fixed cost base and a difficult industry backdrop.

Let's move on to our Music Publishing business. In comparison to the same quarterly period in 2006, Music Publishing revenue grew 11% to $143 million and was up 4% on a constant currency basis. The revenue improvement was primarily the result of an increasing performance in digital revenue. On a global basis, performance revenue grew 15%, synchronization 5%, and digital 50%. Mechanical revenue fell 7% as Recorded Music industry pressures limited results. Strong domestic results offset the slight international decline. Music Publishing OIBDA was 13% over the prior year quarter to $53 million due largely to an increase in revenue and a sales mix benefit from the shift to higher-margin revenue sources.

As for our cash management and our balance sheet, we ended the quarter with a cash balance of $362 million. Total net debt amounted to approximately 1.9 billion which reflects total debt less cash. We declared our quarterly dividend of $0.13 per share on March 8 giving at the yield of 3% based on yesterday's close. The dividend was paid on April 27. We maintain our intention to pay up to an $80 million annual dividend to shareholders on a quarterly basis.

For the quarter, we generated free cash flow of $49 million. Our free cash flow is calculated by taking cash from operations of $70 million, less capital expenditures, and net cash paid for investment of $13 million. Unlevered after-tax cash flow, we believe provides the most accurate reflection of the on going cash capability. Unlevered after tax cash flow calculated by adding back $24 million in cash interest to free cash flow which amounted to $73 million during the quarter. This unlevered after tax cash flow includes $2 million in non-recurring restructuring charges.

For the quarter, our cash conversion, calculated by taking unlevered after tax cash flow and dividing it by OIBDA adjusted for restructuring expenses was a strong 76%. We were also pleased that on April 24, we announced we reached a $110 million settlement of a contingent Recorded Music and Music Publishing claims held by Warner Music relating to Bertelsmann's relationship with Napster in 2000 and 2001. We will be sharing these proceeds with recording artists and song writers. Our net cash taxes were $16 million for the quarter substantially all of our income taxes are being paid outside the U.S. because our U.S. taxable income is offset by interest expense deduction and the annual recurring non-cash amortization deduction. For the three months ended March 31, 2007 we had a tax provision of $1 million on a pretax loss of $26 million.

Before closing out my remarks, I wanted to update you on one of our original private equity investors. Music Capital Partners is a partnership that following our IPO held 14.2 million shares, or approximately 9.5% of the Warner music stock. Music Capital's partnership agreement required that the partnership dissolve and commence winding up by the second anniversary of Warner music's initial public offering. Therefore, we announced in an 8-K today, as dictated by its partnership agreement, Music Capital Partners has made a liquidating distribution of all of the Warner Music shares it held to its partners.

Edgar's beneficial ownership of Warner Music now stands at 5.4% including both the shares he received as part of the distribution by the Music Capital partnership plus shares he previously held directly. None of our other original private equity investors have distributed shares to date. T.H. Lee being capital in providence continue to beneficially own over 60% of our outstanding shares. As we have consistently said, we do not manage our business for any single quarter.

We strive to release the right content at that time right time in an effort to maximize fiscal year profit potential and artist's career development. As a matter of policy, we do not give financial guidance to the investment community. Given the quarterly fluctuations and the timing of our music release schedule and associated marketing and promotional expenses are normal. We're confident in our future and remain pleased with our financial strengths, digital leadership, transformation initiatives, and realignment effort.

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

Edgar Bronfman

Thanks, Michael. Our agenda over the next six months will be focused on a couple of areas. We plan to broaden our music business mix to add new revenue streams; we're going drive profitable growth through innovation and financial discipline. We intend to maintain our digital leadership and increase our margin and market shares. Our goal is to drive shareholder value over the fiscal year and beyond and our transformation continues. We now look forward to answering your questions about our business. So Thank you and operator, would you please open it up for Q&A.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question is coming from Doug Mitchelson, and please state your company name.

Gerd Hansen - Deutsche Bank

It's Deutsche Bank, however it's [Gerd Hansen] in for Doug Mitchelson. Just a couple of questions. I just wanted to know if there’s been any sort of update on the satellite negotiations. Number two, obviously you guys have a more robust pipeline for the next six months or so. Can you guys surpass EBITDA margin on a year-over-year basis not including restructuring charges? Thanks.

Edgar Bronfman

Hi [Gerald], it's Edgar. I'll take first part. There is no new update on the satellite negotiations. I just would point out of course that the Copyright Royalty Board, which adjudicated the case between the Recorded Music industry and the Webcasters, that same board is adjudicating the dispute between the Recorded Music industry, the potential dispute between the Recorded industry and satellite. So I think it is useful to note that there is no progress or anything else that we can comment on with regard to satellite.

Michael Fleisher

On the release schedule, we do have a more robust release schedule in the back half of the year and are looking forward to putting out that content and selling it to consumers. We don't give guidance. What I can say, as I said in my talk track, we do expect our year-over-year comparisons to get progressively better over the next couple of quarters.

Gerd Hansen - Deutsche Bank

Okay. Thank you.

Operator

Thank you. Our next question comes from Anthony Noto, and please state your company name.

Anthony Noto - Goldman Sachs

Edgar and Michael, three questions. The first one is, could you give us a sense of organic growth on the Recorded Music side? Second question, what percentage of the digital revenue was catalogued and how did that compare to the December quarter? And then the last question, the initiatives within video - my guess is you didn't start this initiative planning yesterday when you made the announcement, but you've probably looked at some sense of the type of product, the new management team will focus on so I was wondering when the first potential time is that we could see revenue contribution from these initiatives? Is it '08? Is it sometime in '07? How far out would that be? Thanks.

Edgar Bronfman

Let me just quickly answer some of your questions and maybe, Michael you can do organic growth on Recorded Music. Catalog represented about 60% of our digital revenue this quarter. And in terms of video, you're right to point out that we've actually been planning this transformation really since, I would say, in earnest since February of ''06 as a management team. So, the initiatives that we're undertaking have been variously implemented and accelerated through that period.

I would say that there are a number of things that we haven't even talked about in terms of building our own advertising capabilities and other kinds of things, obviously much of the video - much of our video content may well be advertising related revenue rather than transactional related revenue. So I think, really realistically, as YouTube becomes more robust at actually delivering revenue, as opposed to merely eyeballed, and as I think initiatives like Joost and others get traction, I think we'll begin to see advertising related video revenue but I think that's going to be an '08 phenomenon, and I don't expect to see a great deal of it in ''07.

Michael Fleisher

Anthony, on the organic revenue side, we don't split out details from our acquisitions. As you know, we've done two acquisitions that are contributing to our business in the last year, Ryco and Roadrunner. Both had some contributions to this quarter, particularly Roadrunner continued the Nickelback sales. But I wouldn't say that those were substantive, the business as a whole on an organic basis performed well as well.

Anthony Noto - Goldman Sachs

If I could just follow up on that, when we look at the SoundScan data, it appears that the U.S. Recorded Music industry, including digital was down about 20% and it appears, from what we can tell, you gained market share of about 100 basis points. So, I'm trying to reconcile whether those numbers are just inaccurate or what leverage you were able to drive to get to a sort of down of 1% in U.S. Recorded Music. That's what I was trying to reconcile really.

Michael Fleisher

I think if -- you've got to dig into the SoundScan numbers, both on sort of frontline and catalog and then also look at sort of licensing revenue and all the other sources of revenue we have that aren't captured in the SoundScan numbers including importantly the mobile component and subscriptions.

Anthony Noto - Goldman Sachs

Great. Thank you.

Operator

Thank you. Our next question comes from Bishop Cheen. And please state your company name.

Bishop Cheen - Wachovia Securities

It is Wachovia. Thank you for taking the question. Good morning Edgar and good morning Michael. Going to the restructuring, 400 plus I think headcount reduction is the goal. And then you're hiring new people with skill sets in digital and all the growth areas. How many new people do you expect to be hiring, and secondly, is the restructuring charges total gross charges for the headcount reduction, or is there a net number offset by the amount you will be spending to hire new people?

Michael Fleisher

The charges are sort of -- are the growth number, Bishop, if I understand your question correctly. So it's the cost of determinations of the 400 plus employees who will be leaving the business.

Bishop Cheen - Wachovia Securities

Okay. And then, how many people, roughly, do you expect to be hiring, adding?

Edgar Bronfman

I think we're going to add back some number of the people; it will be less than that because these are especially in the digital area and the new skill sets that we're hiring tend to be higher cost people. So, I don't think the number of employees will match identically, and we will be continuing to make some investments. Some of that spending will be not just in people, investments in some of the new areas like we talked about with Den of Thieves, etc., which is not only people but also expenses to go out and build content to sell.

Bishop Cheen - Wachovia Securities

Okay. And as the sequential quarterly year-over-year comparisons get better, that's going to be better on the adjusted basis as well after the add-backs, or are you just talking about top line better?

Michael Fleisher

No, I am sorry, that’s better. That will be better on an adjusted basis, both on the revenue and the top line.

Bishop Cheen - Wachovia Securities

Okay. Great, thank you.

Operator

Thank you. Our next question comes from Jessica Reif Cohen. And please state your company name.

Jessica Reif Cohen - Merrill Lynch

Merrill Lynch. A couple of questions. First on Rock Band, is Warner music the exclusive music company for the game or will others come in?

Edgar Bronfman

I think, Jessica, we are not exclusive. We are leading the introduction, but not exclusive.

Jessica Reif Cohen - Merrill Lynch

Can you talk about the economics at all of that?

Edgar Bronfman

I think we've got a confidentiality agreement, so we can't really talk about the economics. But obviously to the extent that the game is successful it will [inure] well to us. It is an example of the kinds of broadening initiatives that we need to undertake.

Jessica Reif Cohen - Merrill Lynch

And then, just a couple of other things. What is the timing of the Napster payment and will you treat it as an extraordinary gain?

Edgar Bronfman

We've already received the monies, and, Michael you wanted to say --

Michael Fleisher

It will be broken out separately. It will be treated as an extraordinary item. So, you will see it in the detail of the Q3 results.

Jessica Reif Cohen - Merrill Lynch

Okay, and then, just on the restructuring. What kind of (inaudible) do you expect to see the benefits of the restructuring? Is this like -- by fiscal '08 we should start to see some improvement -- bottom line improvement?

Edgar Bronfman

Because what we're doing in many cases is taking costs out of business and then redeploying them back. You'll start to see as we take those costs out and redeploy them back over the next several quarters. We'll start to see benefits of that over the couple quarters after that. So certainly in early fiscal '08.

Jessica Reif Cohen - Merrill Lynch

My last question, but just to understand the margins, what you're saying is about the margins? I think Michael you said that you're targeting margins will be at least as high as last year an since they were down in the first half, is it right to assume -- it must be that second half margins are going to improve pretty dramatically?

Michael Fleisher

What I'm saying is that the quarterly comparisons on a year-over-year basis will get progressively better over the next couple of quarters. I'm not giving full year guidance on that, I'm not giving any specific quarterly guidance on that, I'm just saying that, if you look at the year-over-year compares for the last quarters, over the next couple the year-over-year quarter comparisons will get progressively better.

Jessica Reif Cohen - Merrill Lynch

Alright, thanks.

Operator

Thank you. Our next question comes from Howard Gleicher. And please state your company name.

Howard Gleicher - Metropolitan West

Metropolitan West. Edgar, you've had now a fair bit of experience with a music company being owned by another media conglomerate, by a music company being standalone, yet private, and now with a music company being standalone public. Which of those three do you think is the most appropriate ownership form for Warner music over a long period of time?

Edgar Bronfman

Well, Howard, I guess what I would say is that I don't think that Warner music derived any untoward or special benefit from being part of a media conglomerate. And while there were some positive relationships that [inured] to Warner music as a result of being part of Time Warner, there were also elements of being part of it conglomerate that slowed down its opportunity. I think in all three, or certainly in the two that I'm familiar with having run the business as an independent company privately and publicly, we try very hard to run the business the same way. And to try and make decisions, frankly as a public company as if we were private, meaning that we try to take the right economic decisions even if on a short-term basis with public market may not agree with that approach.

I would say without regard to, I guess the last thing I'd say is, without regard to this specifically being a music company, but any company that's in an industry that's transforming as quickly as our business is, is going to have a great deal of fluctuation and energy around it quarter-to-quarter which is obviously easier to deal within a private context than in a public context. That’s not really I think specific to music, it would be true with any industry in an industry that's transforming this quickly. And we're trying to react aggressively, proactively, and I'm actually very optimistic about getting through this period and having a real return to growth. As a public company, we're simply going manage the business as if we were private, so that we make the best economic decisions for our shareholders.

Howard Gleicher - Metropolitan West

That’s very helpful. Thank you very much.

Operator

Thank you. Our next question comes from Richard Greenfield. Please state your company name.

Richard Greenfield - Pali Research

It's Rich Greenfield, Pali Research. Just a couple of questions. One, could you maybe talk about what you see as the root cause of significant drop-off from calendar Q4 to calendar Q1 in the industry, obviously you are able to outperform. But what do you think is actually going on in the underlying industry that's causing the change?

Two, Edgar, just given what happened at EMI recently, could you give us an update on your thoughts surrounding DRM? And then just a housekeeping point for Michael. Was the $16 million of restructuring or cost that you said were non-recurring in the quarter; is that part of the total $65 million to $80 million or on top of what you're going to see over the rest of the year? Just trying to understand whether that was included in the number or not.

Michael Fleisher

It is included in the 65 to 80. So it will be part of that amount.

Edgar Bronfman

Rich, I think on the CD declines and the acceleration from Q4 to Q1 calendar, I think there are a number of factors. In the work that we've done, there is some that relates to release schedule. The '07 industry release schedule mirrors more closely the '05 industry release schedule than does the industry '06 release schedule. There was a much more robust industry release schedule in the first quarter of calendar '06 and a much weaker one in the first calendar quarter of '05, and '07 was similar to the one of '05. Some of that is released.

I think some of it is continuing increased competition for consumer dollars. You had the release of the Nintendo Wii, you had PlayStation 3, and you had upgrades on Xbox Live. You had a lot coming into the market, and that ate up sort of Christmas dollars and ongoing spending as a result of the software associated with those platforms and others for Q1 '07.

I think on top of that you have some retail realignment, the closure of places like Tower, which I think that the demand is made up over time but it's not immediately made up, so we're seeing a shift of a lot of Tower's customers, for instance, to Amazon. And Amazon’s become our number one catalog customer.

But those dislocations are probably not ever made up entirely. And even to the extent that they're made up, to the extent that they are, they're not made up immediately. And I think probably the fourth thing I'd say is; we all have to recognize as an industry that the CD is a tired format. It's been around for nearly 30 years.

And as I've said to others within the company, if we were a television manufacturer and we were still making cathode-ray type television sets, our business would probably be declining too, which is one of the reasons why we've decided on our own to innovate and create this MVI disc. Whether that or some other format is the one that prevails.

We hope we've made a contribution in the industry by creating this, but we need to innovate on the physical platform, because increasingly, as I mentioned, consumers are taking a CD, putting it in to the computer.

The computer is capable of so much more than a CD is capable of contributing. The CD is sort of an audio-only experience, meant for a CD player. We need to give the consumer a much richer, much broader experience. So I would say all of those factors have contributed to the declines that we're seeing.

Just to answer your question on EMI DRM issue. I don't think I have a lot to add to what I said in the call last quarter. We continue to believe that digital rights management is an important element of our ongoing business. We think that it is important for subscription businesses, we think it's important for mobile businesses, we think it's important for video-related business, and frankly we think it's important for paying our artists and for being able to track and understand what consumers are using and being able to collect royalties on behalf of not only the company but artists who create the material in the first place.

So I think our view remains unchanged. EMI is conducting an experience with Apple. We'll obviously watch that. But as of today our view on DRM remains the same as it has been in the past.

Richard Greenfield - Pali Research

Thank you.

Operator

Thank you. Our next question does come from Evan Wilson. Please state your company name.

T.J Mills - Pacific Crest

Hi. Pacific Crest. This is [T.J. Mills] listing for Evan. Thanks for taking the questions. I have a couple. First, in looking at that time double-digit total album equivalent decline in Q1, could you give us details on how you would expect the U.S. industry to trend for the remainder of the year? And second, you signed a deal with the Chinese portal [cnet.com] to generate advertising share, download your music to PC and wireless devices. What's the strategy behind this deal and what do you think is the size of the potential opportunity? Thanks.

Michael Fleisher

T.J., could you just repeat the name of the Chinese partner you were mentioning? We didn't catch it on the call.

T.J Mills - Pacific Crest

[Cnet.com].

Michael Fleisher

On the trends in the U.S. market place we are very careful not to give our perspective as part of not giving guidance. So I think that you can look to any of the market analysts who would talk to sort of how they think the U.S. market will trend.

We had talked to the point that we have a stronger release schedule ourselves in the back half of the year and expect to take advantage of that in the marketplace.

T.J Mills - Pacific Crest

Okay.

Michael Fleisher

And T.J., I have to say, I don't think I can comment effectively or specifically on the deal that you referred to in China. But I would just say this, which is the industry, it's important to note it remains almost entirely a business that derives revenue in North America, Western Europe and Japan, with a little bit of revenue in Australia and Mexico.

But essentially without being unkind to those other countries, those countries that I've just mentioned and the areas that I've just mentioned represent more than 90% of all industry revenue. That represents a rather small probably less than one-third of the world's population accounts for, as I said, 95 plus percent of our revenue.

So we are constantly evaluating our strategies for a large market like China, like India, like Russia, where we believe there are in the future significant opportunities. We've detailed that in the past in these conversations, saying that we think that the likely path to those revenues is through the mobile channel.

But there are lots of opportunities, and frankly, lots of challenges in each of those markets, and they need to be navigated carefully and thoughtfully. But we are focused on trying to broaden not only our product portfolio, but our geographic base in order to grow our revenue.

T.J Mills - Pacific Crest

Okay, thanks.

Operator

Thank you. Our next question comes from Tuna Amobi.

Tuna Amobi - Standard & Poor's Equity Group

Hi it’s Standard & Poor's Equity Group. Thanks for taking the question. On the production division, I am sorry, I didn't get the name that you were going to call it.

Edgar Bronfman

I think we're talking about Den of Thieves.

Tuna Amobi - Standard & Poor's Equity Group

Okay. On that entity, I was just trying to understand it a little bit more if there are any incremental investments that are non-restructuring based you're going to make to set up that entity. With the comment that you made, that most of the revenues from your video activity would be advertising as opposed to transaction base. I just wanted to clarify that that was with respect to the online as opposed to this linear distribution venture that you're setting up here.

Edgar Bronfman

Let me try and clarify further. We're undertaking a number of different initiatives to broaden our revenue stream and to create a better, more robust experience for the consumer in the digital world. Where we don't think we're going to create a lot of additional value for consumers is to simply replicate their analog experience by distributing that analog experience digitally.

We have the opportunity to create a much more robust experience with the consumers in the digital world. Den of Thieves is a new production division which is designed to develop and produce original programming for network, for cable, for DVDs, for broadband and for mobile platforms.

Generally the revenue model for those kinds of business is an advertising model as distinct from the music or the record business which is a transaction kind of model. So I think going forward you will see more of a mix, although obviously it will take some time to build up our advertising revenue stream as opposed to our transaction stream.

But in addition to creating a production capability for all kinds of programming that is music related some of which will end up on each MVI disc that's released, some of which will be original programming for networks or other kinds of distributors. We are also building our own sales force. Excuse me, our own advertising sales force. So there are a number of investments that we're making to broaden our revenue stream outside of the restructuring costs. Is that help helpful?

Tuna Amobi - Standard & Poor's Equity Group

Yeah that's very helpful. So it sounds like most of the revenue would be supported with some likelihood of subscriptions and perhaps even licensing over the long-term as you ramp up that division, right?

Edgar Bronfman

For that division, I think that would be correct, yes.

Tuna Amobi - Standard & Poor's Equity Group

Okay, that's helpful. And correct me, a separate question, Michael, if I'm not mistaken, I think in the past you've talked about long-term EBITDA margins, perhaps in the mid-teen’s. So I'm trying to understand if this restructuring initiative is mainly to keep you within that long-term target or do you see that some total of these efforts would actually create some up side to that mid-teen’s margins that you've talked about in general in the past?

Michael Fleisher

No I don't think our long-term targets have changed. I think the realignment efforts are specifically not targeted at trying to sort of manage to those profit metrics but rather to redirect resources within our company at the most exciting growth areas to drive to top-line growth over the coming years. As opposed to sort of a normal restructuring that you might think us to meet our profit target.

Edgar Bronfman

Yeah. If I can just make -- it's Edgar--, an editorial comment here, which is we built this business so far I think with a fair amount of financial discipline, and so nothing that I’m going to say now should take away from the fact that we will continue to be extremely disciplined from the financial standpoint. But the truth of the matter is we're not going to be able to save our way to growth.

So the answer to the industry is not to keep cutting, and cutting, and cutting, and cutting while the business goes down, and down, and down, and down. So the reason we're talking about this as the realignment rather than a restructuring is to say, we see the growth areas, we know what we have to do. We've got to invest in them both in terms of the front end that we've talked about, [like tendencies] or the advertising sales force or many other initiatives. And indeed on the back end, where we've got a redesign and our IT infrastructures, so that we can deliver businesses, and collect revenue, and royalties seamlessly for ourselves and for our artists.

So this is a significant transformation of the business. And in order to invest in those growth areas, we recognize and we still need to deliver financial performance to the street and to our shareholders. And so we're going to have to reduce costs in some areas to invest in others. But this is very much a realignment as opposed to a restructuring. So it's not meant to achieve a particular financial target in this quarter or next quarter but rather to position the company to be able to be the growth vehicle that every investor should expect it to be.

Tuna Amobi - Standard & Poor's Equity Group

Understood. Just one last question, if I may. Can you talk a little bit about what genres, where you saw the sharpest declines? I think there's been some speculation that the urban genre and a lot of others may actually be in some kind of secular decline. Can you talk about any issues there?

Edgar Bronfman

Yeah, I mean, I think that we definitely, the industry saw urban markets decline in the U.S. so far this year. On the other hand, as I mentioned, we've had some standout releases particularly Notorious B.I.G.'s greatest hits. I've seen in my career genres come and go, and come and go, and come and go. So I wouldn't write off the urban genre. These things can be cyclical. Certainly that’s been true of pop, it's been true of country, it's been true of rock, and urban has had pretty much 15 years of uninterrupted growth. If it's going to take a breather, it may take a breather, but I certainly wouldn't write it off as a genre for the future.

Tuna Amobi - Standard & Poor's Equity Group

Thank you.

Operator

Thank you. Our last question comes from Aaron Watts.

Aaron Watts - Deutsche Bank

I'm with Deutsche. Two questions for you. One, as a means of encouraging the consumption of full albums or at least EPS bundles of songs from artists, do you envision the 99-cent digital single download going away at the cassette and CD single, or is there another way you are looking to promote the purchasing of more than one song from an artist?

Edgar Bronfman

I think that Apple has begun an initiative which we support and encourage and applaud, which is what they call complete your album, or complete this album, which is if you buy a song or two from a particular artist, Apple will give you the opportunity to buy the rest of that full album at a discounted price. We think that's a very good initiative. It's just one of many that we think we can undertake to encourage the sale of more music whether that be entire albums or larger pieces of albums. So, I think we're at a very, very, very early stage in terms of merchandising on the digital platform. The sophistication that a Wal-Mart has built up over decades or a best buy or a target or some of our best independent physical retailers has not yet been matched by the very new businesses that we see digitally. And as those merchandising capabilities improve and increase, I think we're going to see increased revenues per user on those platforms.

Aaron Watts - Deutsche Bank

Okay. And then, my last question is how have platforms like MySpace, PureVolume transformed you’re A&R effort or at least how you find new talent and promote that new talent?

Edgar Bronfman

Well, I think, frankly, those platforms have had so far more to do with how we promote new artists than how we find new artists. There are a couple of exceptions, there always are a couple of exceptions where artists have become extremely popular on MySpace then have become potentially commercially popular or at least potentially commercially popular, we have one small artist right now that we are building that we found on MySpace has been extraordinarily popular on MySpace, but that artist has not yet -- we are working very hard to build that artist popularity in the commercial arena. But certainly platforms like PureVolume, MySpace, others are very important to us as we promote our artists, make people aware of their music. But it is yet to be true that there's been a significant shift of A&R to the internet on really any platform where we have found large scale commercially viable artists as a result of their independent distribution on these kinds of sites.

Aaron Watts - Deutsche Bank

Okay, thank you.

Edgar Bronfman

Thanks everyone for your time and attention. Appreciate it, and we'll talk to you again in a few months. Bye-bye.

Operator

Thank you. That does conclude today's conference and you may disconnect at this time.

TRANSCRIPT SPONSOR

Wall Street Horizon Logo

Do you get frustrated during earnings season?

Have you had trades go south because of bad earnings dates?

We know what it's like. We’ve been there. We’re Wall Street Horizon and we work with some of the largest firms on Wall Street.

Founded by former Fidelity Investments executives, we understand the power of trading on good information and the pain and suffering of trading otherwise. We obsess about earnings and economic events calendars so you don’t have to. Accurate. On time. Guaranteed.

Let us help.

Get Smart

Get Wall Street Horizon.

View our Free 30-day trial for investment professionals

To sponsor a Seeking Alpha transcript click here.

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 F2Q07 (Qtr End 3/31/07) Earnings Call Transcript
This Transcript
All Transcripts