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

Nov.29.07 | About: Warner Music (WMG)

Warner Music Group Corp. (NYSE:WMG)

F4Q07 Earnings Call

November 29, 2007 8:30 am ET

Executives

Edgar Bronfman - Chairman of the Board, Chief ExecutiveOfficer

Michael D. Fleisher - Chief Financial Officer, ExecutiveVice 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

UnidentifiedParticipant

-- will update you on our business performance and strategyand our EVP and CFO, Michael Fleisher, will discuss fiscal fourth quarter andfull year results. Then Edgar will wrap up before we take your questions.

Before Edgar’s comments, let me remind you that thiscommunication includes forward-looking statements that reflect the currentviews 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 indicatefuture events or trends, or do not relate to historical matters, identify forward-lookingstatements.

Such statements include, but are not limited to, estimatesof our future performance, such as the success of future album sales, projecteddigital sales increases, and declines in physical sales, expected expansion ofthe online marketplace, the success of strategic actions we are taking toaccelerate 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 wedisclaim any duty to update such statements. Our expectations, beliefs andprojections are expressed in good faith and we believe there is a reasonablebasis for them. However, there can be no assurance that management'sexpectations, beliefs and projections will result or be achieved. Investorsshould not rely on forward-looking statements because they are subject to avariety of risks, uncertainties, and other factors that could cause actualresults that differ materially from our expectations.

Information concerning factors that could cause actualresults to differ materially from those in the forward-looking statements iscontained in our earnings press release and Form 10-K and other SEC filings.

We plan to present certain non-GAAP results during thisconference call. We have provided schedules reconciling these results to ourGAAP 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 joiningus. This year has proven to be a year of real challenge in the recorded musicindustry. Physical sales declines have accelerated. Digital growth, andparticularly mobile, have been on a slower trajectory than initialexpectations. These are real and serious issues and we are focused on managingthrough them effectively.

This is a time of fundamental recorded music industrytransition. An industry transformation of this scale is and will continue to beunpredictable and difficult by its nature. Nonetheless, we believe we have theright strategy in place to effectively navigate through these challengingtimes.

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

We have exhibited these characteristics with our aggressivemoves in the online and mobile arenas, our responsible and more comprehensiveapproach to artist negotiations, our continual review of our organization andits ability to compete in the current environment, and our expanding andaltering of our business models.

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

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

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

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

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

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

Turning now to quarterly results, I’ll discuss with youtoday some key performance metrics, the important strategic actions we’retaking to accelerate our transformation as we redefine our role in the broadermusic industry, and notable steps we are taking on the A&R side to buildbrand equity for our artist roster.

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

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

At the same time, we managed costs effectively and grewOIBDA margins in the quarter, while successfully completing our realignmentplan announced earlier this year.

We remain committed to the expansion of digital revenuestreams in the face of the shrinking physical recorded music business. WarnerMusic Group has consistently reported digital album share in the U.S.substantially above its physical share and this September quarter was nodifferent.

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

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

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

Two recent developments in Asia that should serve to propelthese efforts further are first, we acquired a 70% stake in Taisuke, a leadingartist services company in Japan. Taisuke is an all-rights music company withactivities spanning artist management, recorded music and music publishing. Thecompany’s roster includes artists signed to Warner Music Japan as well as otherlabels.

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

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

A natural extension of our transformation is to not onlyexpand our presence in the mobile and online channels but also to redefine ourrole by creating a direct link between our artists and their fans. Byestablishing a robust, direct-to-consumer infrastructure our artists and theirfans will be able to communicate frequently, not just every year or so when analbum gets released.

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

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

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

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

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

In addition, Verizon Wireless became the first exclusivemobile 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 LedZeppelin’s historic concert video clips and offer an interactive video fancontest. In fact, last week eight of Led Zeppelin’s albums were in iTune’s top100 albums, including Mothership at number two and the Led Zeppelin completeboxed set, which costs $99, at number 12.

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

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

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

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

FSE will also own and manage Sinatra’s name and likenessrights and will represent the artist’s rights to the Columbia and Capitolcatalogs.

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

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

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

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

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

Warner Chapell, which boasts one of the most valuable globallibraries in the industry, enjoys a stable, diversified revenue stream from itsmore than 1.3 million copyrights and more than 65,000 songwriters andcomposers. 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 successby signing and resigning key songwriters, moving into the production musicbusiness with our already announced acquisition of Non-stop Music, andenhancing our existing management team with a deep bench of seasoned musicpublishing executives.

Continuing its tradition of industry recognition, WarnerChapell recently received top honors at the seventh annual BMI Urban MusicAwards as pop publisher of the year. In addition, Warner Chapell Musicsongwriters and producers were recognized at the eighth annual Latin Grammiesfor best new artist, best urban music album, best urban song, bestsinger/songwriter album, and producer of the year.

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

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

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

As always, we remain focused on improving Warner Music'sresults while developing a more powerful foundation to enhance shareholdervalue.

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

Michael D. Fleisher

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

First, to get some housekeeping out of the way, you may havenoticed that we changed the presentation of some of our financials in our pressrelease and 10-K. Based on a routine review of our financials by the SEC, wewere 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 companiespresent operating results without adjustments for items they do not perceive tobe one-time in nature. Throughout my discussion of our results, I will pointout 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 endedSeptember 30, 2007, we reported revenue of $869 million, which grew 2% from thesame period last year and fell 2% on a constant currency basis.

An ongoing challenging environment for physical recordedmusic sales is clearly evident in our results not only for the quarter but alsofor 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. Domesticrevenue slipped 2% while international revenue fell 11% on a constant-currencybasis.

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

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

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

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

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

Quarterly digital revenue rose sequentially by 9% as strongglobal online and international mobile performance was partially offset bydomestic mobile declines.

Approximately 65% of our total digital revenue was generatedin the U.S. and 35% in the rest of the world. Our worldwide digital revenuestands at about 65% online and 35% mobile. In the U.S., online remains a largershare of our digital business than mobile. Internationally, online and mobileare similar in size.

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

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

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

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

As Edgar has discussed, we are broadening our approach tothe recorded music business to mitigate our exposure to current industrytrends. We are diversifying into growth areas of the music business thatinclude sponsorship, touring, merchandising, artist management, to driveoverall revenue growth.

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

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

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

For example, we are modernizing our sales force, outsourcingcertain IT processes, and investing in people with expertise in videoproduction, advertising, and mobile and online sales.

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

As we’ve said, we expect our business initiatives, our newbusiness initiatives to largely offset the economic effects of our realignmentplan. The very nature of our realignment is to redirect the benefits of costsavings from the physical side of the business towards transformationalspending initiatives designed to drive faster growth at the company.

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

In addition, we had a $12 million benefit in recorded musicfrom the final allocation of royalty payable balances to artist accounts linkedto the settlement with Bertelsmann regarding Napster. In fiscal year 2006,fourth quarter results included a $13 million benefit in recorded music relatedto 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] bonuscompensation, were partially offset -- were partially offset by a decline in physicalsales, increased product costs, and the costs associated with our realignmentplan.

For the full fiscal year, our OIBDA fell 11% to $461million. This includes $63 million in expenses related to our realignmentinitiative, a $64 million benefit from the settlement with Bertelsmannregarding Napster, and $9 million in expenses related to our previouslydisclosed proposed acquisition of EMI.

In fiscal year 2006, results included a $13 million benefitin 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 negativeoperating leverage from lower sales on a similar fixed cost base that wasparticularly evident early in the fiscal year. This was partially offset by anincrease 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. Quarterlyrecorded 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 byeasier comparisons. Releases from Linkin Park, Matchbox 20, James Blunt,Smashing Pumpkins, and Nickelback from our highly successful Roadrunner jointventure, drove results.

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

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

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

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

Moving on to our music publishing business, in comparison tothe same quarterly period in 2006, music publishing revenue grew 7% to $137million, or up 1% on a constant-currency basis. Music publishing revenue grew16% internationally, or 5% on a constant-currency basis, more than offsetting a6% domestic revenue decline.

On a constant-currency basis, the improvement in total musicpublishing 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 prioryear quarter, including $1 million in expenses related to our realignmentinitiatives. As Edgar said, we are pleased to see a more stable performancefrom this business over the past few quarters.

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

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

Cash balances and the calculation of free cash flow in thefourth quarter of 2007 reflect the previously disclosed investment of $110million in frontline management. Unlevered after-tax cash flow, calculated byadding back $15 million in cash interest to free cash flow, was negative $33million 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 September30, 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 outsidethe U.S. and withholding taxes paid to non-U.S. countries where we generateroyalty income from sales of repertoire outside of the U.S. Our taxes willfluctuate based on which jurisdictions income is generated overseas.

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

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

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

As a matter of policy, we do not provide financial guidanceto the investment community given that quarterly fluctuations in the rhythm ofour music release schedule and associated marketing and promotional expensesare normal.

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

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

Edgar Bronfman

Thanks, Michael. Before we go to your questions, I just wantto summarize by saying that while this has been a challenging year, it’s alsonot fully unexpected in a time of such fundamental transition but it’s clearthat this time of transformation also offers great opportunity for thosecompanies who understand where the music business is going and have aprogressive strategy in place and a passion to get them there.

Looking ahead, our agenda over the next fiscal year will befocused on several areas. We plan to remain vigilant in managing costs whiletransitioning the business back to a growth trajectory. We will broaden ourpartnership with artists and consumers to add new revenue streams from growingsegments of the music business. We will maintain our digital leadership throughcontinued innovation. We will expand our business models to take advantage ofnew opportunities as a result of technological transformation, and we willincrease our market share while maximizing our margin potential.

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

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

Question-and-AnswerSession

Operator

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

Bishop Cheen -Wachovia

Thank you for taking the question. Edgar, if I heard youright, I think you gave some very useful color on let’s call it ancillaryeconomics or revenue streams or 360. You said in Asia, it’s alreadyrepresenting 5% to 15% of your total revenue, if I have that right. Can yougive us some color on what you think overall you can grow the ancillary part ofyour 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 andmusic publishing.

While I can’t give guidance in a sense, I think what I wouldsay is we no longer regard these revenue streams as ancillary. These are goingto be core revenue streams and therefore they will grow both organically as wesign artists to 360 deals. They will grow as a result of infrastructure that wemay acquire in order to service those deals, and they will grow as a result ofacquisitions 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 morequickly or not, as I said, depending on the pace of investment.

But we are really changing our focus from being a recordedmusic company with a couple of extra revenue streams to being a broad-basedmusic content company and I think you’ll see a significant increasing mix ofrevenues 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. Iguess first for Michael, not an easy one but are you prepared from a coststructure 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 aboutnegative operating leverage. What does your cost structure look like today inthe recorded music side and how do you continue to adapt to that kind ofenvironment?

And then separately for Edgar, I think you talked a bitabout a wireless subscription effort. Could you talk a little bit about thepotential for Nokia to have a big impact on the marketplace? Where do you thinkthat’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 lastthree years is tightly manage the cost structure of the company. And reallythat strategy has two prongs to it. One is a constant day-to-day managing ofwhere our expenses are going. So literally, every time somebody leaves thecompany or we cut an expense, we’re trying to be very thoughtful aboutstrategically how do we put those dollars back in the place that will be mostproductive as part of our future and growth strategy.

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

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

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

Edgar Bronfman

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

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

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

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

So there’s no question that the mobile industry is going tobe in a very transformative mode over the next couple of years and I thinkmusic will be one of the foremost content upon the mobile platform, which Ithink 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’sa little bit early to predict whether subscription, whether it’s OEM or carrierbased, will at some point be the dominant way to distribute music versuspurchase to own. It’s just a bit early to know which business model is going tobe the most valuable over time.

Edgar Bronfman

I think it’s early to know -- first of all, I think I wouldsay it’s early to know whether the OEMs or the carriers will carry the day, andit’s really not my place to make that call. I think it’s also early to saywhether purchase-to-own or subscription will also be the predominant businessmodel, but I would not limit potential business models on mobile topurchase-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 MetropolitanWest.

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 broaderrelationship with you. What are the benefits to an existing artist though, andyou’ve told me over the years that they are the majority of your revenues, offorming this broader or deeper partnership, as they are already known and theyalready have the following and they can take advantage of other sources ofgetting distributed digitally and Internet sites? Why would they allow you toshare 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 importantcomment to make is that within five years, newer artists will be establishedand existing artists, so that as the years unfold a significantly increasingnumber of our artist roster will be artists with whom we have a much broaderrelationship.

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 moreeffectively with their fan base if we are involved as partners in all aspectsof their career. I think you’ll see us coming to agreements with a number ofexisting artists. I think you’ll see us not coming to agreements with a numberof existing artists. And there will be some agreements that existing artists willsign with others, as has been the case with Madonna, where it simply was in ourview economically imprudent for us to do that deal. So I think you will see amix.

I think the most important benefit that we derive is not oneof creating a pressure on an artist to do something they would otherwise notwant to do. I think the critical issue here is that we are providing anopportunity for artists to give their consumers, their fans more in a moreeffective, comprehensive way that can build and sustain a better and longercareer.

We believe that I think a number of the newer artists whoalready experimented with us have become believers in a very short period oftime and I think we’ll be able to continue to demonstrate that to existingartists 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 MerrillLynch.

Jessica Reif-Cohen -Merrill Lynch

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

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

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

Michael D. Fleisher

Sure. On Frontline, Jessica, we’ve sort of disclosed what weare going to disclose. It was a $110 million investment and we haven’tdisclosed anymore than that in terms of our percentage of ownership or futurerights or anything else.

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

Edgar Bronfman

On the other two, we constantly evaluate our contributionsto the trade organizations. We think that both IFPI and RIAA do largely veryeffective jobs in promoting our interests in a number of areas, bothlegislatively and in enforcement areas and other.

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

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

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

And I think that there are opportunities as yet unexploredbetween music and retail to improve or ameliorate the rate of decline on thephysical 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 toFrontline; 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 andaway the most important and largest management business. It gives us a realinsight 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 basisof an investment, it has already been a very good investment for the companyand we expect that that will continue.

And obviously it positions us in the future and I won’t gofurther than that to get more into the artist management business as thingsplay out. So we like our position. We think Frontline is an outstandingcompany. We think Irving Azoff has proven that he is the most visionary of theartist managers in building a large management company and we thought it made alot 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 justlook at cash from operations less CapEx, you’ve done about $650 million. Arounda third of that has gone for the recurring dividend, about 240, which means thebalance has really gone for various investments, about two-thirds of your freecash flow. My question I guess is two-fold; how much have those acquisitionsbenefited the top line that you are reporting? And then second, how far alongin evolution of this transition are we? In other words, are we in the second orthird inning of using the firm’s free cash for acquisitions or are we in theeighth or ninth inning? Thank you.

Edgar Bronfman

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

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

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

Jason Bazinet -Citigroup

If you saw a need to invest further than the magnitude offree cash that you generate, would you consider reducing the dividend to makethose 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 thinkwe’ve got a good balance sheet. We’ve got our free cash flow resources. We’vegot deep pockets and support of investors and so I think there are a number ofways that we could contemplate growing our acquisition strategy withoutcontemplating a reduction in the dividend. And beyond that, I’m simply notgoing to comment but I would not -- I don’t think there’s a quid pro quobetween the dividend and our acquisition appetite.

Jason Bazinet -Citigroup

Understood. Thank you.

Operator

The next question is from Richard Greenfield of PaliResearch.

Richard Greenfield -Pali Research

I was just hoping to follow-up on Jason’s question; he hadasked regarding how much the acquisitions have actually impacted your recordedmusic 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 cangive us a sense of how significant that reduction in bonuses was year overyear.

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

Edgar Bronfman

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

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

Michael D. Fleisher

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

And in terms of the lag on music publishing, there’s a lagon music publishing. It ranges anywhere depending on when you make aninvestment in an artist and where they are at in their career, anywhere from 12to 24 months. We started making more investments in that business probablyabout a year ago, so we are starting to see some of the benefits of that. Atthe same time, we’re continuing to make investments in that business. I don’tthink we’re saying that the challenges are solved there or that that businessis on track the way we want it to be over time.

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

Richard Greenfield -Pali Research

Michael, just a follow-up on what Edgar said in terms ofRoadrunner, you’re not owning all of it, it’s a joint venture. When you lookacross your EBITDA for the full year, how much of your EBITDA comes from jointventures where you don’t own all of the EBITDA, things like Bad Boy orRoadrunner? 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. Thefirst question I have is in terms of signing 360 deals with artists, what kindof competition have you seen in getting these deals besides Live Nation? Howcompetitive are the other labels?

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

Edgar Bronfman

On the 360, the competitive nature of 360, I think there’stwo very different sets of competitive areas. One is Live Nation at the end ofthe spectrum of very established artists with a major touring career. Incompetition with other labels, I think competition occurs around the normal wayof signing artists and frankly, to the extent that other labels do not choose a360 path, it potentially makes them more competitive in terms of signingartists than not. But that’s their business.

We’ve made a decision about our business and what we intendto do and the way we are going to build our business and we’re having, I haveto say, very satisfying results in talking to artists and in signing artists totrue, broad deep partnerships and we’re going to continue to do that and we’renot going to continue to sign artists for recorded music revenue only.

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

Ingrid Chung -Goldman Sachs

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

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 youthink about your digital revenues, in the last couple of years it seems likeyou’ve added approximately north of 4% to 5% of incremental percentagecontributions from digital revenues as a percent of the total revenues of thecompany. So looking ahead, how confident are you that you can stay on thattrajectory to get to 20% of digital revenue?

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

And separately, I had a question on the internationalrecorded music. It just seems like there’s a lot more heavy lifting to be donein that business and I recognize that you’re invested in some A&Rinitiatives there. So the question is can you provide some color of how youthink that business might turn in fiscal 2008, and any steps that you arecurrently taking in there, excluding Japan, of course, which has been about theonly bright spot. So can you provide some color on what’s going on there -- themargins compared to the U.S. and what steps that you are taking to improve theresults there? Thank you very much.

Edgar Bronfman

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

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

First of all, you have to look at iTunes. iTunes has hadanother very successful year, growing its revenue significantly above overalldigital growth. I see no reason why that cannot continue and should notcontinue.

I think the mobile industry has been slower than we wouldhave liked in both developing devices and interfaces, as well as businessmodels 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’sobviously spurring tremendous competition but also there’s further penetrationof 3G networks with further deterioration of voice revenues and the greaterneed for both OEMs and carriers to find other areas of income, and music beingone of the most important applications in that pursuit.

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

Tuna Amobi - Standard& Poor’s

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

Edgar Bronfman

With respect, I think 20% may be your magical number. I’mnot sure 20% is a magical number one way or the other, because to me, 30% or40% would be more magical than 20%.

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

Tuna Amobi - Standard& Poor’s

Okay, that’s helpful.

Edgar Bronfman

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

With the tremendous performance and improvement we’ve seenin Japan over the last couple of years, there are now three very large significantmarkets 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 continuedstrength from a market share standpoint in many countries in continentalEurope, including Germany, France, Italy, and Spain. Some of those markets aresuffering as markets more than others, but I would say our overall continentalEurope performance, while less than what we had hoped, was actually on acomparable industry basis reasonably good.

So I think the biggest issue for us internationally was theU.K. in ’07 and I think while that market may well remain soft, there’s a lotof simply inter-Warner issues that we can handle and principally around ourrelease 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 onthat?

Michael D. Fleisher

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

Tuna Amobi - Standard& Poor’s

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

Michael D. Fleisher

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

Tuna Amobi - Standard& Poor’s

Thank you.

Edgar Bronfman

Thank you, everyone, for joining us on this call. Let metake this occasion to wish you and your families a happy holiday -- happy andhealthy holiday season and we look forward to talking to you again in a coupleof months. Thanks.

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