Warner Music Group F4Q07 (Qtr End 9/30/07) Earnings Call Transcript

Warner Music Group Corp. (WMG)

F4Q07 Earnings Call

November 29, 2007 8:30 am ET

Executives

Edgar Bronfman - Chairman of the Board, Chief Executive Officer

Michael D. Fleisher - Chief Financial Officer, Executive Vice President

Analysts

Bishop Cheen - Wachovia

Doug Mitchelson - Deutsche Bank

Howard Gleicher - Metropolitan West

Jessica Reif-Cohen - Merrill Lynch

Jason Bazinet - Citigroup

Richard Greenfield - Pali Research

Ingrid Chung - Goldman Sachs

Tuna Amobi - Standard & Poor’s

Presentation

Unidentified Participant

-- will update you on our business performance and strategy and our EVP and CFO, Michael Fleisher, will discuss fiscal fourth quarter and full year results. Then Edgar will wrap up before we 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," "believes," "should" and "will" and variations of such words or similar expressions that predict or indicate future events or trends, or do not relate to historical matters, identify forward-looking statements.

Such statements include, but are not limited to, estimates of our future performance, such as the success of future album sales, projected digital sales increases, and declines in physical sales, expected expansion of the online marketplace, the success of strategic actions we are taking to accelerate our transformation as we redefine our role in the music industry, 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 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-K and other SEC filings.

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

With that, let me turn it over to Edgar.

Edgar Bronfman

Thanks, Jill. Welcome, everyone. Thank you all for joining us. This year has proven to be a year of real challenge in the recorded music industry. Physical sales declines have accelerated. Digital growth, and particularly mobile, have been on a slower trajectory than initial expectations. These are real and serious issues and we are focused on managing through them effectively.

This is a time of fundamental recorded music industry transition. An industry transformation of this scale is and will continue to be unpredictable and difficult by its nature. Nonetheless, we believe we have the right strategy in place to effectively navigate through these challenging times.

There are two things that remain abundantly clear, even today: that the changes affecting the recorded music business also offer tremendous opportunity. Even with the problems facing the physical side of the business, more music is being consumed today than ever before in more ways than ever before; and that the transformation of the recorded music business will require not only a creative approach to broadening our business models but also leadership, financial discipline, and resilience.

We have exhibited these characteristics with our aggressive moves in the online and mobile arenas, our responsible and more comprehensive approach to artist negotiations, our continual review of our organization and its ability to compete in the current environment, and our expanding and altering of our business models.

Despite significant recorded music headwinds, it’s important to recognize the meaningful progress we’ve made towards our strategic goals. Comparing our fiscal ’07 to ’06, digital revenue grew 30% to $460 million. We continue to realign our workforce to accelerate our transformation. We generated significant free cash flow, ending the fiscal year with a cash balance of $333 million, and we reached numerous partnerships and made a number of acquisitions that has strengthened our competitive position in our traditional businesses and have given us an initial presence in the broader music business that will be increasingly meaningful to us going forward.

We believe that our ongoing success will require true partnership with artists and a commitment to nurturing and growing all facets of their careers. Among the things important to our ongoing success at Warner Music, we are creating a first-in-class infrastructure that will enable us to develop mutually beneficial broad-ranging partnerships with our artists. Discovering and promoting artists and developing artists’ brands is the foundation upon which Warner Music was built and the driving principle that guides us today.

Our unique and essential role in finding new artists with the greatest long-term potential and then maximizing that potential over the course of a career comes from carefully piecing together an intricate mosaic of business opportunities individually suited to the artist.

We see our value to artists as an endearing one. Despite the record industry’s changing economics and the entrants of new competitors, and we see the role of record companies, or rather music-based content companies such as Warner Music, expanding over time.

As we discussed last quarter, we continue to take decisive steps to broaden Warner Music’s position in the music value chain beyond recorded music and music publishing by working side-by-side with artists to exploit growing areas of the music business, such as sponsorship, fan club, merchandising, touring, and artist management, and participating in those revenue streams.

We are also continuing to expand beyond transactional business models into areas that include increased licensing and other opportunities. All of those revenue streams are derived from the artist brands we helped to create. We believe that strengthening our already significant capabilities in the non-traditional music areas will not only assist us in diversifying our revenue streams to better capitalize on the growth areas of the music industry but will also foster deeper and longer term relationships with artists and more effectively connect artists with their fans.

Turning now to quarterly results, I’ll discuss with you today some key performance metrics, the important strategic actions we’re taking to accelerate our transformation as we redefine our role in the broader music industry, and notable steps we are taking on the A&R side to build brand equity for our artist roster.

As I mentioned, this proved to be another tough quarter for the recorded music industry. Even so, we delivered sequential year-over-year improvement in our quarterly revenue and delivered domestic market share gains. Michael will discuss the detailed financial data, but there are several performance metrics that highlight the progress Warner Music is making towards achieving our strategic objectives.

Warner Music outpaced the U.S. recorded music industry again in the quarter. September quarter Soundscan album share rose nearly two points year over year to 21%, the second consecutive quarter our share remained at a level not seen by Warner in over 10 years.

At the same time, we managed costs effectively and grew OIBDA margins in the quarter, while successfully completing our realignment plan announced earlier this year.

We remain committed to the expansion of digital revenue streams in the face of the shrinking physical recorded music business. Warner Music Group has consistently reported digital album share in the U.S. substantially above its physical share and this September quarter was no different.

Moreover, we had quarterly digital revenue of $130 million, a sequential improvement of 9% and a 25% gain compared to the same quarter last year. On a percentage of total revenue basis, we remain a leader in digital revenue among the majors. This quarter, our digital revenue was 15% of our total revenue and was 20% of our total U.S. recorded music revenue.

Before highlighting some A&R achievements, I would like to update you on some of the strategic actions we’re taking to lay the foundation for future growth, including partnering with our artists to exploit additional revenue streams around the world, fostering creative business models to maximize our potential in both the mobile and online worlds, and establishing a direct relationship between our artists and their fans.

As we discussed last quarter, we are working to optimize the value of our investment in recording artists by broadening the number of revenue streams in which we participate. This strategy has existed for some time in Asia where our arrangements with recording artists include touring, merchandise, sponsorship, and artist management. These revenue streams already represent between 5% and 15% of total recorded music revenue in some of our Asian territories.

Two recent developments in Asia that should serve to propel these efforts further are first, we acquired a 70% stake in Taisuke, a leading artist services company in Japan. Taisuke is an all-rights music company with activities spanning artist management, recorded music and music publishing. The company’s roster includes artists signed to Warner Music Japan as well as other labels.

Second, our acquisition of the independent record label, Vitamin Entertainment, will strengthen our revenue opportunities in South Korea, a region where digital represents nearly 60% of total music consumption.

Advancing our digital agenda with creative business solutions also remains a priority. For example, underscoring the potential of mobile subscription models, Vodafone will soon roll out Music Station, giving customers the ability to download more than 1 million tracks, including our repertoire, direct to their handsets. We see this as an important first step in the direction that we expect the mobile business to develop.

A natural extension of our transformation is to not only expand our presence in the mobile and online channels but also to redefine our role by creating a direct link between our artists and their fans. By establishing a robust, direct-to-consumer infrastructure our artists and their fans will be able to communicate frequently, not just every year or so when an album gets released.

Also, by windowing our offerings over an extended timeline; that is, by releasing customized artist content through different formats and channels at different prices and times, we can better maximize an artist’s revenue potential as well as their consumer connection.

Our D-to-C and windowing plans will fundamentally change the way we create and market content.

More broadly, we will look to expand our music-based video products in addition to our audio content, uniquely designed for different platforms. In the mobile world, we already have bundled mobile offerings with Motorola and KDDI in Japan. We are also creating high quality music-based programming for the broadcast, online and mobile platforms, such as music-based video content -- as music video based content becomes a more important product for consumers.

Moving to A&R, building artist brands essential to our A&R strategy and Warner Music has an incredibly rich history of artists, both legendary and new. Warner Music is home to legendary bands including The Grateful Dead, Led Zeppelin, The Doors, Eric Clapton, Neil Young, Fleetwood Mac, and many others. Newer artists that are reaching fresh career highs and developing artists include Josh Groban, Michael Buble, My Chemical Romance, Gym Class Heroes and Paramour, a group we signed to an expanded rights deal.

Perhaps one of the best examples of a band with whom we have built a long and endearing relationship over almost four decades is Led Zeppelin. This month, Led Zeppelin, one of the greatest bands of all time, a band that has sold more than 300 million albums worldwide, officially released their recordings to legitimate digital platforms. Atlantic Records and Rhino Entertainment also released Mothership, a 24-track two CD comprehensive collection that spans Led Zeppelin’s career.

In addition, Verizon Wireless became the first exclusive mobile music service provide for Led Zeppelin’s ringtones, ringback tones, alert tones, and wallpapers, as well as full song, over-the-air downloads.

iMeme, a leading social media network, will promote Led Zeppelin’s historic concert video clips and offer an interactive video fan contest. In fact, last week eight of Led Zeppelin’s albums were in iTune’s top 100 albums, including Mothership at number two and the Led Zeppelin complete boxed set, which costs $99, at number 12.

Led Zeppelin’s popularity is at an all-time high. The band recently announced a one-night reunion concert for charity to be held in London as a tribute to our own Ahmet Ertegun, founder of Atlantic Records. An online lottery for the 14,000 tickets attracted upwards of 20 million fans who registered in an attempt to purchase a ticket.

We derive a dual revenue stream from Led Zeppelin for both recorded music and music publishing.

In another important recent development, we are delighted that Warner Music and the family of Frank Sinatra have established a worldwide partnership to integrate content, rights management, and the preservation of the legendary entertainer’s inspirational personality and prodigious body of work under a single entity. The partnership will operate under the name Frank Sinatra Enterprises, or FSE, and will manage all aspects of Sinatra’s artistic contribution to music, film and stage.

FSE will also administer all licenses for the use of Sinatra’s name and likeness. FSE will own Sinatra recordings from the Reprise era, as well as a treasure trove of films, television specials and unreleased footage, photos and audio recordings, which collectively represent one of the foremost bodies of artistic work of the modern era.

FSE will also own and manage Sinatra’s name and likeness rights and will represent the artist’s rights to the Columbia and Capitol catalogs.

This deal, in addition to the agreement we reached with The Grateful Dead, whereby we manage virtually every facet of the artist branding, is an important step in the diversification of our business models and the expansion of our revenue streams.

Getting back to some of the specifics on the September quarter, for the industry total U.S. album sales, including digital track equivalents, fell 7% on a year-over-year basis. Yet again, Warner Music handily outpaced the industry and actually grew total album equivalent units by 1%. In the U.S., we gained roughly 1.5 percentage points of quarterly album share year over year in both current and catalog albums.

Perhaps best highlighting our successful approach to A&R over the past few years is the fact that Warner Brothers Records and Atlantic Records are the top two labels for U.S. album share in both the September quarter and calendar year to date.

Our out-performance in the U.S. only paints part of the picture. We did see mixed results internationally. While we had an outstanding year in Japan, overall a light local and international release schedule coupled with a challenged recorded music industry backdrop limited our performance, particularly in the U.K. We are addressing this issue and expect improved performance from the U.K. in 2008 in addition to the steps already taken by Warner Music International to invigorate our competitive positioning outside the U.S. over the next year.

Getting music publishing on a more stable footing was a key priority for us this fiscal year. I am happy to report we’ve made solid strides in establishing more consistent operating performance and this quarter was the third consecutive quarter of improving revenue and OIBDA year over year.

Warner Chapell, which boasts one of the most valuable global libraries in the industry, enjoys a stable, diversified revenue stream from its more than 1.3 million copyrights and more than 65,000 songwriters and composers. Warner Chapell also has strong OIBDA to free cash flow conversion, favorable working capital dynamics, and low capital requirements.

We have invested in this business to drive long-term success by signing and resigning key songwriters, moving into the production music business with our already announced acquisition of Non-stop Music, and enhancing our existing management team with a deep bench of seasoned music publishing executives.

Continuing its tradition of industry recognition, Warner Chapell recently received top honors at the seventh annual BMI Urban Music Awards as pop publisher of the year. In addition, Warner Chapell Music songwriters and producers were recognized at the eighth annual Latin Grammies for best new artist, best urban music album, best urban song, best singer/songwriter album, and producer of the year.

In all, Warner Chapell songwriters and producers contributed to nearly a dozen Latin Grammy award-winning songs and albums.

As we’ve consistently said, our release schedule varies from quarter to quarter, resulting in variable performance between periods and the transformation of the industry will heighten this variability.

The pace of technological introductions and our ability to develop new, innovative products and business models to diversify our revenue streams remains a key factor in the progress of our business. We firmly believe these efforts will be successful over time but recognize the transition will be a multi-year process.

As always, we remain focused on improving Warner Music's results while developing a more powerful foundation to enhance shareholder value.

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

Michael D. Fleisher

Thank you, Edgar and good morning, everyone. Let me begin by providing some context on our quarterly financial results.

First, to get some housekeeping out of the way, you may have noticed that we changed the presentation of some of our financials in our press release and 10-K. Based on a routine review of our financials by the SEC, we were given some suggestions on how to present our numbers, which we adopted, and there are no outstanding SEC comments remaining.

As you may know, the SEC generally prefers that companies present operating results without adjustments for items they do not perceive to be one-time in nature. Throughout my discussion of our results, I will point out material items that are not comparable for informational purposes.

For the quarter, we reported net income of $5 million or $0.03 per share. Looking at the income statement for the three months ended September 30, 2007, we reported revenue of $869 million, which grew 2% from the same period last year and fell 2% on a constant currency basis.

An ongoing challenging environment for physical recorded music sales is clearly evident in our results not only for the quarter but also for the entire fiscal year. During the fiscal year period, our revenue fell to $3.4 billion, a decline of 4% or 7% on a constant-currency basis. Domestic revenue slipped 2% while international revenue fell 11% on a constant-currency basis.

Top sellers for the year were Linkin Park, Josh Groban, Michael Buble, James Blunt, and My Chemical Romance. Worldwide, we had 14 releases that sold more than 1 million units this fiscal year and 27 releases that sold between 500,000 and 1 million units.

Total quarterly revenue gains in the U.S. and flat European results were offset by declines in the Latin America and Asia-Pacific regions. Domestic revenue grew 6% while international revenue fell 8% on a constant-currency basis.

Declines in our physical recorded music business were the primary reason for the drop in total worldwide revenue but they were partially offset by year-over-year revenue increases in our digital recorded music business and to a lesser extent, our music publishing business.

In recorded music, constant currency quarterly revenue declines primarily in the U.K., Spain, France and Japan were partially offset by revenue increases in the U.S., Germany, Italy, and other European markets.

Overall, total quarterly digital revenue rose 25% to $130 million, or 15% of total revenue versus 12% of total revenue in the prior year quarter.

Quarterly digital revenue rose sequentially by 9% as strong global online and international mobile performance was partially offset by domestic mobile declines.

Approximately 65% of our total digital revenue was generated in the U.S. and 35% in the rest of the world. Our worldwide digital revenue stands at about 65% online and 35% mobile. In the U.S., online remains a larger share of our digital business than mobile. Internationally, online and mobile are similar in size.

Mobile is weaker than we’d like to see as ringtone sales have lost some luster and new products, such as ringback tones, full track downloads, and other more innovative offerings are taking time to develop.

Several gaiting factors that impact the pace of change in the mobile industry include interoperability, 3G penetration, mobile consumer interfaces, consumer education and pricing.

Logically, as the penetration of high quality music-enabled handsets improves and some of these other issues are dealt with, the mobile contribution to digital revenue should grow.

As we indicated last quarter, we are pleased to see the iPhone raising the profile of music on mobile handsets and this holiday season should have an outpouring of exciting competitive mobile products.

As Edgar has discussed, we are broadening our approach to the recorded music business to mitigate our exposure to current industry trends. We are diversifying into growth areas of the music business that include sponsorship, touring, merchandising, artist management, to drive overall revenue growth.

It will take some time for the rise in these newer revenue streams, combined with the continued growth of digital sales, to overtake the effect of the decline of the physical recorded music business.

We remain optimistic that the future for Warner Music is bright, given that the demand for music is as strong as it’s ever been and we are determined to exploit the right business models to capture that demand.

While transforming our business mix, we remain vigilant about managing our costs. This was evident in our quarterly results. In May, we announced a global realignment plan designed to advance our long-standing digital strategy and efforts to build a more progressive organization equipped to take advantage of the changing global music market.

For example, we are modernizing our sales force, outsourcing certain IT processes, and investing in people with expertise in video production, advertising, and mobile and online sales.

As expected, we incurred all of the restructuring costs associated with our announced realignment plan by the end of our fiscal year. During the quarter, we took restructuring related charges of $9 million for our realignment efforts, bringing our total restructuring related charges to $63 million, better than our forecasted range of $65 million to $80 million.

As we’ve said, we expect our business initiatives, our new business initiatives to largely offset the economic effects of our realignment plan. The very nature of our realignment is to redirect the benefits of cost savings from the physical side of the business towards transformational spending initiatives designed to drive faster growth at the company.

As I previously mentioned, we have a few items that impact period-to-period comparisons that we want to point out for informational purposes. For the fourth quarter of fiscal 2007, our results included $9 million in restructuring and implementation expenses related to our realignment initiative, $5 million of which related to recorded music, $1 million in music publishing and the remainder in corporate.

In addition, we had a $12 million benefit in recorded music from the final allocation of royalty payable balances to artist accounts linked to the settlement with Bertelsmann regarding Napster. In fiscal year 2006, fourth quarter results included a $13 million benefit in recorded music related to our settlement regarding Kazaa.

Our operating income before depreciation and amortization, or OIBDA, for the quarter rose 6.3% to $134 million. Margins expanded to 15.4% as an increase in higher margin digital sales and a decrease [inaudible] bonus compensation, were partially offset -- were partially offset by a decline in physical sales, increased product costs, and the costs associated with our realignment plan.

For the full fiscal year, our OIBDA fell 11% to $461 million. This includes $63 million in expenses related to our realignment initiative, a $64 million benefit from the settlement with Bertelsmann regarding Napster, and $9 million in expenses related to our previously disclosed proposed acquisition of EMI.

In fiscal year 2006, results included a $13 million benefit in recorded music related to our settlement regarding Kazaa.

Our OIBDA margin contracted 1.1 percentage points to 13.6% because of higher product costs, realignment plan expenses, and negative operating leverage from lower sales on a similar fixed cost base that was particularly evident early in the fiscal year. This was partially offset by an increase in higher margin digital sales, the benefit of the Napster settlement, and a decrease in annual bonus compensation.

Let’s now look at our different business segments. Quarterly recorded music revenue fell 2% to $736 million on a constant currency basis. Declines in international markets were responsible for the revenue weakness. Quarterly domestic recorded music revenue rose 8% year over year, helped by easier comparisons. Releases from Linkin Park, Matchbox 20, James Blunt, Smashing Pumpkins, and Nickelback from our highly successful Roadrunner joint venture, drove results.

International recorded music revenue fell 11% on a constant-currency basis from the prior year as industry pressures and a lighter slate of both local and major international releases limited results.

Tough comparisons have started to impact results in the Asia-Pacific region, which enjoyed solid performance over the past year. Local repertoire from Japanese recording artists Ayaka and Kobukuro were key driver’s to Japan’s huge success in fiscal 2007. Nevertheless, despite the soft fourth quarter, our Japanese recorded music company, operating in the world’s second-largest music market after the U.S., still delivered a 25% year-over-year revenue gain for the full fiscal year.

Recorded music digital revenue grew 28% from the prior year quarter to $124 million, or 17% of total recorded music revenue, up from 13% in the same period last year. Domestic recorded music digital revenue amounted to $80 million, or 20% of total domestic recorded music revenue, up from 19% last year.

Quarterly recorded music OIBDA advanced 3% to $104 million, which includes the previously mentioned items.

Moving on to our music publishing business, in comparison to the same quarterly period in 2006, music publishing revenue grew 7% to $137 million, or up 1% on a constant-currency basis. Music publishing revenue grew 16% internationally, or 5% on a constant-currency basis, more than offsetting a 6% domestic revenue decline.

On a constant-currency basis, the improvement in total music publishing revenue was the result of an increase in performance revenue, partially offset by declines in mechanical and synchronization revenues.

Music publishing OIBDA was $55 million, up 4% from the prior year quarter, including $1 million in expenses related to our realignment initiatives. As Edgar said, we are pleased to see a more stable performance from this business over the past few quarters.

As for our cash management and our balance sheet, we ended the quarter with a cash balance of $333 million. Total net debt amounted to approximately $1.9 billion, which reflects total debt less cash.

For the quarter, we had a negative free cash flow of $48 million. Our free cash flow is calculated by taking cash from operations of $105 million less capital expenditures of $8 million and net cash paid for investments of $145 million.

Cash balances and the calculation of free cash flow in the fourth quarter of 2007 reflect the previously disclosed investment of $110 million in frontline management. Unlevered after-tax cash flow, calculated by adding back $15 million in cash interest to free cash flow, was negative $33 million for the quarter.

We booked income tax expense of $49 million for fiscal 2007, compared to $47 million for fiscal 2006. For the three months ended September 30, 2007, we had net cash refunds of $1 million and we had a tax provision of $22 million on pretax income of $27 million.

Our tax expense includes income taxes accrued mainly outside the U.S. and withholding taxes paid to non-U.S. countries where we generate royalty income from sales of repertoire outside of the U.S. Our taxes will fluctuate based on which jurisdictions income is generated overseas.

For the year ended September 30, 2007, we paid net cash income taxes of $44 million. Substantially all of our income taxes are being paid outside the U.S. because our U.S. taxable income is being offset by our interest expense deduction and the annual recurring non-cash deduction related to the amortization of the purchase price paid to Time Warner for Warner Music Group.

At September 30, 2007, we had a U.S. tax loss carryover of $200 million and foreign tax credit carryovers of $56 million. These carryovers will be available to reduce our U.S. income taxes in future years.

As we have consistently said, we do not manage our business for any single quarter. We strive to release the right content at the right time in an effort to maximize fiscal year profit potential and artist career development.

As a matter of policy, we do not provide financial guidance to the investment community given that quarterly fluctuations in the rhythm of our music release schedule and associated marketing and promotional expenses are normal.

While recognizing the challenges ahead, we are confident in our future. In addition, we remain focused on sustaining our financial discipline and digital leadership.

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

Edgar Bronfman

Thanks, Michael. Before we go to your questions, I just want to summarize by saying that while this has been a challenging year, it’s also not fully unexpected in a time of such fundamental transition but it’s clear that this time of transformation also offers great opportunity for those companies who understand where the music business is going and have a progressive strategy in place and a passion to get them there.

Looking ahead, our agenda over the next fiscal year will be focused on several areas. We plan to remain vigilant in managing costs while transitioning the business back to a growth trajectory. We will broaden our partnership with artists and consumers to add new revenue streams from growing segments of the music business. We will maintain our digital leadership through continued innovation. We will expand our business models to take advantage of new opportunities as a result of technological transformation, and we will increase our market share while maximizing our margin potential.

While recognizing we still have much work to do, our goal is to drive shareholder value and improve our competitive positioning over the next fiscal year and beyond. We look forward to answering your questions about our business.

Thank you and Operator, would you please open it up for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) The first question is from Bishop Cheen of Wachovia.

Bishop Cheen - Wachovia

Thank you for taking the question. Edgar, if I heard you right, I think you gave some very useful color on let’s call it ancillary economics or revenue streams or 360. You said in Asia, it’s already representing 5% to 15% of your total revenue, if I have that right. Can you give us some color on what you think overall you can grow the ancillary part of your business to as a percentage of revenue?

Edgar Bronfman

Bishop, just to clarify, the 5% to 15% in Asia is correct. It’s 5% to 15% just to say of recorded music as opposed to recorded music and music publishing.

While I can’t give guidance in a sense, I think what I would say is we no longer regard these revenue streams as ancillary. These are going to be core revenue streams and therefore they will grow both organically as we sign artists to 360 deals. They will grow as a result of infrastructure that we may acquire in order to service those deals, and they will grow as a result of acquisitions in businesses or joint ventures, such as the Frank Sinatra deal, to expand those streams.

So depending on the pace of acquisition and investment, obviously these revenue streams as a percentage of our total will grow more quickly or not, as I said, depending on the pace of investment.

But we are really changing our focus from being a recorded music company with a couple of extra revenue streams to being a broad-based music content company and I think you’ll see a significant increasing mix of revenues coming from Warner Music.

Bishop Cheen - Wachovia

Very good. Thank you, Edgar.

Operator

The next question is from Doug Mitchelson of Deutsche Bank. Mr. Mitchelson, your line is open. You may ask your question.

Doug Mitchelson - Deutsche Bank

Sorry, I had the mute on. Thanks. A couple of questions. I guess first for Michael, not an easy one but are you prepared from a cost structure standpoint for a worst-case scenario for domestic CD sales next year? Say CD sales continue to decline at this pace or worse, and you talked about negative operating leverage. What does your cost structure look like today in the recorded music side and how do you continue to adapt to that kind of environment?

And then separately for Edgar, I think you talked a bit about a wireless subscription effort. Could you talk a little bit about the potential for Nokia to have a big impact on the marketplace? Where do you think that’s going to go? Thanks.

Michael D. Fleisher

Thanks, Doug. Let me start with the cost structure question. I think the thing you’ve seen us do I believe really successfully over the last three years is tightly manage the cost structure of the company. And really that strategy has two prongs to it. One is a constant day-to-day managing of where our expenses are going. So literally, every time somebody leaves the company or we cut an expense, we’re trying to be very thoughtful about strategically how do we put those dollars back in the place that will be most productive as part of our future and growth strategy.

So there’s this constant day-to-day monitoring and I think we’ve been very successful at that. At the same time, we will occasionally, we did it when we first took over the company, we did it again this past May, we will regularly look at our cost structure as a whole and understand whether we need to take a more aggressive stance in terms of taking out a bigger chunk of cost to redeploy them against the future growth opportunities.

We don’t have plans in place to do that right now but at the same time, I would tell you this is something that we monitor on a day-to-day basis.

And then lastly, I think one of the things you’ve seen us do is as we watch the marketplace and how the market performs, you’ve watched us execute on our plan A, our plan B, and our plan C. We are constantly prepared for the market getting worse or the market getting better and being really ready to know exactly what we’re going to execute on if those scenarios play out.

Edgar Bronfman

On the wireless subscription, I specifically mentioned Vodafone but I do think, and your question was around Nokia, I think that Nokia has some potential to be a very important player. They are obviously the leading OEM in the world. I should note that we do not yet have a deal with Nokia to license our content. We are still in discussions with Nokia because we think there are things that Nokia has yet to do that it needs to do in order to license our content.

Having said all of that, what I would say is I see a real opportunity in the mobile space going forward. I think the introduction of the iPhone has been a very positive development and the iPhone has shown the mobile industry, quite frankly, how to create a device that is both enormously attractive and enormously easy to use, and to access the content and information that a consumer wants in a really easy and intuitive way.

That has been lacking in the mobile industry. Whether that’s because of the carriers or the OEMs, I really don’t know. But now that the competitive environment has been reset by the iPhone, I think you’ll see all of the OEMs and all of the carriers engaging in trying to bring much more consumer friendly devices to the market.

And in that context, I can tell you that the mobile industry believes that music is among the top five -- in fact, the number two priority that they have in place to increase data revenue; the number one priority being micropayments, which is okay with me because it’s the number one priority that helps them pay for the number two priority. That works out just fine, according to my math.

So there’s no question that the mobile industry is going to be in a very transformative mode over the next couple of years and I think music will be one of the foremost content upon the mobile platform, which I think will only serve to benefit Warner and the rest of the music industry.

Doug Mitchelson - Deutsche Bank

So I guess if I paraphrase that, what you are saying is it’s a little bit early to predict whether subscription, whether it’s OEM or carrier based, will at some point be the dominant way to distribute music versus purchase to own. It’s just a bit early to know which business model is going to be the most valuable over time.

Edgar Bronfman

I think it’s early to know -- first of all, I think I would say it’s early to know whether the OEMs or the carriers will carry the day, and it’s really not my place to make that call. I think it’s also early to say whether purchase-to-own or subscription will also be the predominant business model, but I would not limit potential business models on mobile to purchase-to-own or subscription as I see it going forward.

Doug Mitchelson - Deutsche Bank

Great. Okay, thank you.

Operator

The next question is from Howard Gleicher of Metropolitan West.

Howard Gleicher - Metropolitan West

Thank you for taking the question. Edgar, a quick question; I understand the benefits to a rising or new artist of forming a broader relationship with you. What are the benefits to an existing artist though, and you’ve told me over the years that they are the majority of your revenues, of forming this broader or deeper partnership, as they are already known and they already have the following and they can take advantage of other sources of getting distributed digitally and Internet sites? Why would they allow you to share in a greater portion of their revenues as the physical sales decline? Thanks.

Edgar Bronfman

Sure. I think first of all, I think the most important comment to make is that within five years, newer artists will be established and existing artists, so that as the years unfold a significantly increasing number of our artist roster will be artists with whom we have a much broader relationship.

With existing artists, I think it’s clearly -- it’s a mix. Our view is we can do more for the artist and allow the artist to connect more effectively with their fan base if we are involved as partners in all aspects of their career. I think you’ll see us coming to agreements with a number of existing artists. I think you’ll see us not coming to agreements with a number of existing artists. And there will be some agreements that existing artists will sign with others, as has been the case with Madonna, where it simply was in our view economically imprudent for us to do that deal. So I think you will see a mix.

I think the most important benefit that we derive is not one of creating a pressure on an artist to do something they would otherwise not want to do. I think the critical issue here is that we are providing an opportunity for artists to give their consumers, their fans more in a more effective, comprehensive way that can build and sustain a better and longer career.

We believe that I think a number of the newer artists who already experimented with us have become believers in a very short period of time and I think we’ll be able to continue to demonstrate that to existing artists and to new artists over the next few years.

Howard Gleicher - Metropolitan West

That was helpful. Thank you.

Operator

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

Jessica Reif-Cohen - Merrill Lynch

Thanks. I have three sets of questions. The first is on Frontline. The $121 million investment, could you just discuss what percent you own, what you are actually getting? Do you have any management involvement at all and do you have any option to buy?

The second question is do you plan on following EMI in decreasing spending to the trade organizations?

And then third, could you discuss your outlook for 2008 for pricing, both digital and physical? Do you expect to see anymore pressure? And shelf space, here and abroad. Thanks.

Michael D. Fleisher

Sure. On Frontline, Jessica, we’ve sort of disclosed what we are going to disclose. It was a $110 million investment and we haven’t disclosed anymore than that in terms of our percentage of ownership or future rights or anything else.

We think that the management space is a very important space to us going forward. Frontline is one of if not the leading management companies in the U.S. and a business we’re excited to be a partial owner of and involved in as an owner of that business.

Edgar Bronfman

On the other two, we constantly evaluate our contributions to the trade organizations. We think that both IFPI and RIAA do largely very effective jobs in promoting our interests in a number of areas, both legislatively and in enforcement areas and other.

I think that there will be discussion in the future around IFPI and RIAA and their respective roles and responsibilities and how that’s organized, but we continue to evaluate that situation. We don’t have a position and we’re not going to comment obviously on EMI’s position.

In terms of 2008 pricing, all I can say is that throughout this period since we’ve owned Warner Music, we have fundamentally held our pricing on a wholesale basis both to the physical and to the digital areas. I see no reason for that to change in 2008.

With regard to shelf space, I think that you should -- that we anticipate that there will be some continued reduction in shelf space, probably consistent with the decline. So we think we’ll probably see again, if physical declines are in the mid-teens, I would expect to see shelf space overall decline in that area. But I think also there are a number of physical chains who are more committed to music than others, so it will be a mix between chains I think netting out to that on average.

And I think that there are opportunities as yet unexplored between music and retail to improve or ameliorate the rate of decline on the physical side of the business while the digital side of the business grows.

Jessica Reif-Cohen - Merrill Lynch

Thank you for answering those questions. I just go back to Frontline; I’m just curious on what actually you get out of this investment.

Edgar Bronfman

Well, as I said, or as Michael said, Frontline is far and away the most important and largest management business. It gives us a real insight into how managers think about building their artists’ careers. It is, by the way, a very fast-growing and profitable business, so just on the basis of an investment, it has already been a very good investment for the company and we expect that that will continue.

And obviously it positions us in the future and I won’t go further than that to get more into the artist management business as things play out. So we like our position. We think Frontline is an outstanding company. We think Irving Azoff has proven that he is the most visionary of the artist managers in building a large management company and we thought it made a lot of sense to be in business with him.

Jessica Reif-Cohen - Merrill Lynch

Thank you.

Operator

The next question is from Jason Bazinet of Citigroup.

Jason Bazinet - Citigroup

Thanks so much. If I look over the last three years and just look at cash from operations less CapEx, you’ve done about $650 million. Around a third of that has gone for the recurring dividend, about 240, which means the balance has really gone for various investments, about two-thirds of your free cash flow. My question I guess is two-fold; how much have those acquisitions benefited the top line that you are reporting? And then second, how far along in evolution of this transition are we? In other words, are we in the second or third inning of using the firm’s free cash for acquisitions or are we in the eighth or ninth inning? Thank you.

Edgar Bronfman

I think if you look at the preponderance of our acquisitions, they have -- in terms of the money spent, they have been in the traditional areas of recorded music. However, our single largest investment has been Frontline, which is a minority interest so we therefore don’t report its revenue or consolidate its revenue or income into our results. So there’s been a mix, Jason, with regard to investment.

I think as we think about going forward, I’m not sure I know how to answer your question whether we are in the second or third inning or the eighth or ninth inning in terms of investment. But I would say that this is a business in significant transition. I think we have a very clear idea of the value that we currently create. I think there are significant opportunities yet to monetize with regard to the value of our current assets, and there are clearly areas we are interested in investing in and participating in within the broader music chain, as I’ve already explained.

And so I think you’ll see us continue to use the free cash flow that we generate to grow the business and I think that we continue to believe that that is the highest and best use of cash and the highest and best return to shareholders.

Jason Bazinet - Citigroup

If you saw a need to invest further than the magnitude of free cash that you generate, would you consider reducing the dividend to make those investments?

Edgar Bronfman

I would say that this is a company with a lot of resources. It’s a company with resources that are well beyond its free cash flow. I think we’ve got a good balance sheet. We’ve got our free cash flow resources. We’ve got deep pockets and support of investors and so I think there are a number of ways that we could contemplate growing our acquisition strategy without contemplating a reduction in the dividend. And beyond that, I’m simply not going to comment but I would not -- I don’t think there’s a quid pro quo between the dividend and our acquisition appetite.

Jason Bazinet - Citigroup

Understood. Thank you.

Operator

The next question is from Richard Greenfield of Pali Research.

Richard Greenfield - Pali Research

I was just hoping to follow-up on Jason’s question; he had asked regarding how much the acquisitions have actually impacted your recorded music revenues. I think you were down on a constant-currency basis about 8% worldwide. I’m just wondering if you backed out the acquisitions this year, what would that have down 8% have been?

And then too, Michael, you mentioned that bonuses were down, or accruals for bonuses were down year over year. I’m just wondering if you can give us a sense of how significant that reduction in bonuses was year over year.

And then just lastly, about how much lag is there in your music publishing business right now? You had about a 1% growth in music publishing for the full year on constant currency, and just wanting to think about as we move into next year, given the acceleration we’ve seen in the declines of physical, how that might impact 2008’s music publishing business. Thanks.

Edgar Bronfman

Let me try and tackle the first question, which is around acquisitions in the year. I think that particularly with regard to this year, I would make the following comment, which is I don’t think it’s a good way to look at the business because the principal acquisition that affected revenues this year was Roadrunner, which is a joint venture but we own the majority of Roadrunner. That frankly is an A&R expenditure. There were a number of A&R decisions that we made throughout the year where we didn’t spend money to either release or acquire artists from other companies.

That so much is not in my view an acquisition as it is simply one way to make an A&R investment versus a different way to make an A&R investment. Clearly -- and I would say acquisitions in other areas other than what I would call just a different way of doing A&R, were frankly immaterial in our revenue results for the year.

Michael D. Fleisher

On your other two questions, on the bonus compensation, I think if you look at last year’s performance was clearly a really good year and people were appropriately awarded for that. This is a much tougher year, both from an industry and our own performance, and therefore bonuses are down year over year. I don’t think that that should be shocking or surprising. We’re not going to disclose the specific details of the dollar amounts.

And in terms of the lag on music publishing, there’s a lag on music publishing. It ranges anywhere depending on when you make an investment in an artist and where they are at in their career, anywhere from 12 to 24 months. We started making more investments in that business probably about a year ago, so we are starting to see some of the benefits of that. At the same time, we’re continuing to make investments in that business. I don’t think we’re saying that the challenges are solved there or that that business is on track the way we want it to be over time.

And so you’ll continue to see us invest both not only in the A&R line but also as we continue to build out our sync capabilities, which is an area we think has great promise for the future but hasn’t performed as well. And that’s a place where really having the right people in place and the resources in place, you can actually actively generate revenue and profits in that business.

Richard Greenfield - Pali Research

Michael, just a follow-up on what Edgar said in terms of Roadrunner, you’re not owning all of it, it’s a joint venture. When you look across your EBITDA for the full year, how much of your EBITDA comes from joint ventures where you don’t own all of the EBITDA, things like Bad Boy or Roadrunner? Is there any way to think about that?

Michael D. Fleisher

It’s a very small percentage.

Richard Greenfield - Pali Research

Okay. Thank you.

Operator

The next question is from Anthony Noto of Goldman Sachs.

Ingrid Chung - Goldman Sachs

Good morning. This is actually Ingrid Chung for Anthony. The first question I have is in terms of signing 360 deals with artists, what kind of competition have you seen in getting these deals besides Live Nation? How competitive are the other labels?

And then secondly, could you talk about the financial impact from the recent proposed settlements with cable and satellite TV, satellite TV music? How has this impacted your discussions with satellite radio?

Edgar Bronfman

On the 360, the competitive nature of 360, I think there’s two very different sets of competitive areas. One is Live Nation at the end of the spectrum of very established artists with a major touring career. In competition with other labels, I think competition occurs around the normal way of signing artists and frankly, to the extent that other labels do not choose a 360 path, it potentially makes them more competitive in terms of signing artists than not. But that’s their business.

We’ve made a decision about our business and what we intend to do and the way we are going to build our business and we’re having, I have to say, very satisfying results in talking to artists and in signing artists to true, broad deep partnerships and we’re going to continue to do that and we’re not going to continue to sign artists for recorded music revenue only.

With regard to satellite radio, and I’m not sure I understand the reference to the cable industry, but as we said before, the satellite radio arbitration I think will come to -- will be decided we believe this year before the end of the year and as we said, we remain hopeful and reasonably confident that whatever the increase in our license revenues will be, there will be an increase in those revenues.

Ingrid Chung - Goldman Sachs

Okay. I guess the question about cable and satellite TV music was just do you get much revenue from cable or satellite TV music? There seems to have been recent proposed settlements for these two distribution streams.

Michael D. Fleisher

Those are fairly small streams today, Ingrid.

Ingrid Chung - Goldman Sachs

All right. Thank you.

Operator

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

Tuna Amobi - Standard & Poor’s

Thanks very much for taking the question. Edgar, as you think about your digital revenues, in the last couple of years it seems like you’ve added approximately north of 4% to 5% of incremental percentage contributions from digital revenues as a percent of the total revenues of the company. So looking ahead, how confident are you that you can stay on that trajectory to get to 20% of digital revenue?

I guess my point is that it’s looking like the next 5% or so is going to be a lot harder to add than the previous trajectory that you have been on, so I’m just trying to reconcile your earlier comments on the mobile market and the impact that might have on your digital outlook.

And separately, I had a question on the international recorded music. It just seems like there’s a lot more heavy lifting to be done in that business and I recognize that you’re invested in some A&R initiatives there. So the question is can you provide some color of how you think that business might turn in fiscal 2008, and any steps that you are currently taking in there, excluding Japan, of course, which has been about the only bright spot. So can you provide some color on what’s going on there -- the margins compared to the U.S. and what steps that you are taking to improve the results there? Thank you very much.

Edgar Bronfman

Let me try and answer both questions. In terms of the digital growth, I actually -- as we look to our overall revenue growth, we think the pace of digital growth is an even more important determinant to returning the industry to overall growth than the decline of physical.

And we are -- I think we see the possibility of continuing digital growth and even potentially, though timeframes are difficult to predict, even potentially increasing digital growth.

First of all, you have to look at iTunes. iTunes has had another very successful year, growing its revenue significantly above overall digital growth. I see no reason why that cannot continue and should not continue.

I think the mobile industry has been slower than we would have liked in both developing devices and interfaces, as well as business models and product to entice consumers to engage in music on wireless devices. I think that will change. I think both because the iPhone introduction, it’s obviously spurring tremendous competition but also there’s further penetration of 3G networks with further deterioration of voice revenues and the greater need for both OEMs and carriers to find other areas of income, and music being one of the most important applications in that pursuit.

So I think as I said, digital growth is critical to the industry returning to overall growth and I think as a result of an increasingly useful and hopefully effective platform, wireless will contribute to increasing revenue growth for the industry.

Tuna Amobi - Standard & Poor’s

So when do you see that 20% magical number happening? Is that something you see as imminent or a couple more years?

Edgar Bronfman

With respect, I think 20% may be your magical number. I’m not sure 20% is a magical number one way or the other, because to me, 30% or 40% would be more magical than 20%.

But what we don’t do is give guidance and we’re not going to make predictions as to how quickly we get there, but I’ve tried to give you some color as to how --

Tuna Amobi - Standard & Poor’s

Okay, that’s helpful.

Edgar Bronfman

-- I view the opportunity. I think with regard to international, it’s a mix of tougher markets in ’07 than we had in ’06 on a general basis, particularly in Europe, and a particularly poor release schedule in the U.K. Warner Music as an overall company has traditionally been dependent on three major markets -- sorry, two major markets, for the majority of its recorded music income, and that is the U.S. and the U.K.

With the tremendous performance and improvement we’ve seen in Japan over the last couple of years, there are now three very large significant markets for Warner Music. In ’07, the U.K. had, in addition to a weaker market, overall a very weak Warner release schedule, a release schedule we expect to be -- our release schedule we expect to be much stronger in ’08. We see continued strength from a market share standpoint in many countries in continental Europe, including Germany, France, Italy, and Spain. Some of those markets are suffering as markets more than others, but I would say our overall continental Europe performance, while less than what we had hoped, was actually on a comparable industry basis reasonably good.

So I think the biggest issue for us internationally was the U.K. in ’07 and I think while that market may well remain soft, there’s a lot of simply inter-Warner issues that we can handle and principally around our release schedule to see a significant improvement year over year in the U.K.

Tuna Amobi - Standard & Poor’s

What’s the margin upside internationally? Any comment on that?

Michael D. Fleisher

I’m sorry, Tuna, what was the question?

Tuna Amobi - Standard & Poor’s

The margins, any color on international recorded music margins compared to domestic?

Michael D. Fleisher

No, nothing other than what we’ve disclosed in all of our statements.

Tuna Amobi - Standard & Poor’s

Thank you.

Edgar Bronfman

Thank you, everyone, for joining us on this call. Let me take this occasion to wish you and your families a happy holiday -- happy and healthy holiday season and we look forward to talking to you again in a couple of months. Thanks.

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