Warner Music Group F1Q06 (Qtr Ending Dec 31, 2005) Earnings Conference Call Transcript (WMG)

Feb.16.06 | About: Warner Music (WMG)

Warner Music Group (NYSE:WMG)

Q1 2006 Earnings Conference Call

February 14th 2006, 8:30 AM.

Executives:

Jill Krutick, Senior Vice President, Investor Relations and Corporate Development

Edgar Bronfman, Chairman, Chief Executive Officer

Michael Fleisher, Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Analysts:

Doug Mitchelson, Deutsche Bank

Anthony Noto, Goldman Sachs

Michael Savner, Banc of America

Bishop Cheen, Wachovia Securities

Jason Bazinet, Citigroup

Eric Handler, Lehman Brothers

Richard Greenfield, Pali Research

Mark Harrington, ABN AMRO

Karol Winsted (phonetic), Forest Investments

Tuna Amobi, Standard & Poor’s Equity Group

Operator

Welcome to Warner Music Group’s Fiscal First Quarter Earnings Call for the three month period ended December 31, 2005. At the request of Warner Music Group, today’s call is being recorded for replay purposes. And if you object you may disconnect at anytime. As a reminder there will be a question-and-answer session following today’s presentation and at that time you may press “*” “1” if you have a question. You will be prompted to speak your name in order for your question to register.

Now I would like to turn today’s call over to your host Ms. Jill Krutick, Senior Vice President of Investor Relation and Corporate Development. You may begin.

Jill Krutick, Senior Vice President, Investor Relations and Corporate Development

Thanks very much, good morning everyone. Happy Valentine’s Day and welcome to Warner Group’s Fiscal First Quarter 2006 Conference Call. Hopefully you’ve seen the press release we issued this morning with our results. We also filed our Form 10-Q today which you can find on our website at investors.wmg.com. Today Edgar Bronfman Jr., our Chairman and CEO will share with you our strategic update, and Michael Fleisher, our EVP and CFO will provide an analysis of fiscal first quarter results. Edgar will come back for a wrap-up and then we’ll be happy to answer your question.

Before we begin 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, engage in typical sales, expected expansion of the online market trades 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 in Form 10-Q and other SEC filings. Intend to present certain non-GAAP results during this conference call. We have provided schedules reconciled in these results to our GAAP results. The reconciliation schedules are detailed in our press release posted on our website at www.wmg.com. With that let me turn it over to Edgar, thank you.

Edgar Bronfman Jr., Chairman, Chief Executive Officer

Thanks Jill and welcome everyone. We are building upon last year’s success as we continue to deliver on our strategic and financial goals. We had a terrific quarter delivering flat revenue on an apples-to-apples basis, which I will describe in a moment, despite tough comparisons, which we highlighted for you on our last call. Not only did we achieve strong performance of our top sellers but we did this while continuing to outperform our competitors and gain margin and market share.

Our digital revenue representing 7% of our total revenue this quarter was up 30% sequentially to $69 million and nearly tripled over the same period last year. Moreover on a constant currency basis, our worldwide Recorded Music business for the first time achieved revenue gains in digital that exceeded modest physical decline.

We had solid margin expansion, our OIBDA margin rose 2 percentage points year-over-year to 19.3% as we continue to efficiently manage the business. We had a series of successful releases in A&R achievements that strengthened our competitive position. For the first time in nearly a decade, Warner Brothers record lead by Tom Whalley was the top-ranked label of the year based on U.S. sales. And most of these dimension that at last week’s Grammy Ceremony in Los Angeles, Warner Music Group, recording artist and song writers won 29 Grammy, including awards for Fatal (phonetic), Missy Elliot, Linkin Park, Luis Miguel and Green Day, who won the prestigious record of the year Grammy Award for their hit Boulevard of Broken Dreams. These achievements were temperate by challenging year-over-year comparison as well as the negative effect on revenue caused by exchange rates and the sale of our Sheet Music business in May 2005. Its important to note that excluding exchange rate and the Sheet Music business, we achieved flat year-over-year revenue performance this quarter and on a unit basis continue to outperform the market and gain margins and market share.

Let me highlight four particularly significant accomplishments that are aligned with the key focus items we discussed on the last call. First we achieved success with the series of global release as a part of our innovative efforts with established artists and initiatives to develop new artists. Second, we sustained our leadership position in digital and continue to expand our digital content offerings for consumers. Third, we’re actively addressing our Music Publishing businesses performance, and fourth, we reap the benefits of our continued focus on profitable growth, which Michael will address.

Let me discuss these accomplishments. First our successful global releases in A&R initiatives, as noted earlier we are particularly proud that Warner Brothers records was the number one selling label in United States in calendar ’05 according to Soundscan. What is gratifying is that both established artist and new developing artist contributed to the label success. Starting with established artist, the hit album of iconic Warner Brothers recording artist Madonna was a worldwide highlight in the quarter.

Our innovative digital approach to Madonna launching our major marketing and promotional campaign with a ringtone, clearly resonated with consumers by accelerating sales upon launch. In fact highlighting the success of our digital album bundle strategy, three quarters of Madonna’s iTune track sales were sold in album form. Enya and Green Day were also major sellers in the quarter. We successfully continued our hugely productive Green Day campaign with the release of ‘Bullet In A Bible’ a live CD plus DVD.

Strong performances from developing artist, such as My Chemical Romance and Disturbed also contributed to Warner Brothers tremendous success and show case to our ongoing A&R investments. In Europe, we have the number one and number two best selling albums of 2005, Green Day's American Idiot and James Blunt’s Back to Bedlam. In fact James Blunt also had the largest selling album of 2005 in the UK. These achievements are particularly notable as they underscore how we are now successfully sourcing global repertory both from the U.S. and the U.K. And our strategy to translate James Blunt’s European success into a similar success in the U.S. is clearly gaining traction here.

In addition we continue to outperform the music industry in the December quarter, according to Soundscan while for the industry as a whole, total album music sold in the U.S. in physical and digital form sold by 6.5% in the quarter. Our total album unit sold were down just 0.3%.

As a result we increased our total U.S. album share 1.1 percentage point year-over-year to 17.7% for the quarter. As further proved that our focused consistent A&R investments are paying off, we have gained album unit share in the U.S. year-over-year in 4 out of the top 5 musical jonras. For example highlighting our commitment to increase our presence in the rap jonra our share this quarter rose to 20%, an increase of 9 percentage points over the same period last year. Warner Music had only an 8% quarterly share in the rap jonra just 18 months ago. Artist that have contributed to the success in the quarter include Notorious B.I.G., De Ferrol, Trina and Sean Paul and they are part of our expanding roster of rap artists that excludes Mike Jones, Paul Wall, Teary Eyed and Missy Elliot. These gains are at least partly attributable to our innovative A&R approach being executed by our Incubator Labels, East West and Asylum. They seek to identify a high potential artist earlier in their career and sign them at lower cost. Moreover Warner Music has become a leader in the independent sector to the strength of ADA, our independent music distribution system. ADA’s digital album share for this quarter of 6% is more than triple its physical share, illustrating the value of connecting with artists early in their careers particularly artists whose stand basis are active consumers of digital music which brings me to our second point digital.

We have made incredible progress in the digital arena. The holiday season helped to set a new performance benchmark for digital music in general, a record number of MP3 players were sold during this holiday season and holiday gift cards were much more profitable this year than last, helping to drive U.S. weekly digital track sales to a record 19.9 million digital tracks downloaded during the weekend of January 1, 2006. Since then while U.S. digital track sales have pulled back somewhat as expected based on the developing seasonal buying pattern, the most recent pace of a 11 million tracks per week is still over 30% stronger than the calendar fourth quarter average of 8.3 million and almost double last year’s comparable weekly track sales. A contributor to the U.S. digital track sales client was the single Laffy Taffy by De Ferrol, a rap group signed to our Asylum Incubator Label. In the week after Christmas a 175,000 digital units of the track were sold. Smashing Soundscans weekly digital tracks record by more than double.

Looking more broadly at digital, we’ve expanded our digital leadership position. For the December quarter our digital album share in the U.S. of 23% is 6 percentage points above our physical album share, a greater share differential than any of our competitors. This performance is a testament to our efforts to re-digital into the fabric of Warner Music and our mission to be music based content company.

As we described on our last call, we have been leading the industry in the evolution of premium price digital album bundles and these initiatives are gaining traction.

The top three U.S. digital album bundles by unit sales for Warner Music in the December quarter were Madonna, James Blunt and Depeche Mode. These album bundles included special features such as music video, liner notes, digital booklets and preferred status for ticket maps or concert tickets at an average suggested retail price 20% to 30% above the traditional 999 price with little or no additional cost. More importantly the introduction of our digital album bundles has resulted in a significant increase in the number of digital tracks sold to consumers in the album form, which serves to drive increases in digital revenue. In short, consumers are showing significant demand for new creative bundled digital album products.

Our digital product innovation is now expanding into the mobile landscape. For example, with KDDI, we offered the first mobile bundle ever in Japan. For ¥500 or roughly $4 in the quarter, purchases receive a package of audio, video, graphic and text products in a single downloadable files of their mobile phone, allowing users to personalize their phone with different content from their favorite artist. We also recently announced a partnership with Skype to become the first Recorded Music Company to offer online personalization through a Voice over IP ringtone service.

Shifting gears to our third point Music Publishing, again this business back on a growth track remains a top priority. As we’ve mentioned, new management is in place and is taking steps to reintegrate our business. Because today’s Music Publishing numbers result from market performance in earlier periods, the impact of these new efforts will be seen overtime rather than immediately. Today we are focused on monetizing our existing Music Publishing catalog, exploiting the digital opportunity, driving cost for utilization between Recorded Music and Music Publishing and examining targeted catalog in other A&R investment opportunities. Some recent Music Publishing developments that will flow through our financials overtime included an administration deal with LucasArts for the Indiana Jones catalog, which would benefit from the release of the newest Indian Jones film expected in 2007. And an extended deal with producer/songwriter Brian Michael Cox who made significant and creative contribution to both Mariah Carey’s number 1 U.S. album and Mary J. Blige’s number 1 U.S. album.

In addition to restoring growth to Music Publishing we are on track to meet our agenda that we articulated on our last call. Growing high potential segments of our Recorded Music business such as our Urban Roster are continuing to build the best overall group of artist across all genres; enlarging our mobile footprint and our catalog of mobile content as we continue to create and expand the new digital experience for consumers and driving from margin share or profitable share gains that only come with a carefully managed roster and focused artist development.

And before I turn the call over to Michael, I am sure you saw the announcement that Patrick Vien has joined the Warner Music Group team to run Warner Music International, our international Recorded Music division. We are very excited to have Patrick on board to contribute his tremendous experience in managing global media operations as a spearhead our bridging digital efforts overseas. But I will be remissive, I didn’t take the opportunity to thank Paul-Rene Albertini for his dedication, passion and drive in running Warner Music International and leaving us so well positioned to grow from a very fundamentally strong base. And we wish him the very best in his future endeavors. Now I will turn the call over to Michael.

Michael Fleisher, Chief Financial Officer

Thank you Edgar and good morning everyone. Let me begin by covering some of our key financial highlights for the quarter. We generated quarterly net income of $69 million or $0.46 per diluted share. Excluding $6 million of FAS 123 expenses in the current period, quarterly net income was 75 million or $0.50 per diluted share.

Looking at the income statement for the three months ended December 31, 2005. We reported revenue of $1.44 billion which was essentially flat from the same period in 2005 excluding the 15 million contribution in the same quarter last year from our Sheet Music business and a 27 million negative impact from foreign exchange. As we highlighted on our last call we did face difficult comparisons and despite that we outperformed the market and managed cost effectively driving solid overall results. As we have consistently said evaluating our performance on a trialing 12 month basis is a much better indications of our progress.

In calendar 2005, we had a year-over-year revenue advance of 3% to 3.5 billion in a tough market. And all our measures of profitability were up as well. We exhibited strengths overseas, while reported revenue from both domestic and international markets each slipped 3% in this quarter. Year-over-year excluding the Sheet Music business, international revenue rose by 1.9% on a constant currency basis. Driven by our strong international performance, revenue gains in our worldwide digital Recorded Music business outpaced marginal fiscal declines on a constant dollar basis. In fact, Europe has picked up momentum for us in the Recorded Music business with low single-digit revenue gains on a constant currency basis. While we have double-digit revenue gains in Asia-Pacific, relatively flat U.S. results and modest declines in Latin America. The U.K. was a bright spot lead by Madonna, James Blunt, Green Day and Enya.

Our quarterly digital revenue more than doubled to 69 million or 7% of total revenue from 25 million last year and rose 30% sequentially. Many of you have asked for more detail on our digital business, what we can tell you is that we derived 70% of our digital revenue in the U.S. the most developed digital market in the world, and about 30% internationally. Our worldwide digital revenue split is about 50-50 between online and mobile. Well today online is larger than mobile in the U.S and the reverse is true overseas. Overtime we expect this distinction to blur as we strike deals with mobile operators that include dual content delivery and over the air downloads become more prominent.

As a result of managing our costs and investment balance wisely, our total operating income before depreciation and amortization or OIBDA amounted to 202 million for the quarter, up 6% year-over-year driving a 1.8 percentage point improvement in OIBDA margin to 19.3%. Excluding FAS 123 charges of 6 million, OIBDA was 208 million for the quarter.

Now let’s look at our different business segments. Recorded Music’s first quarter worldwide revenue decreased by 2% to 920 million and was flat on a constant currency basis over the same period last year. Recorded Music quarterly OIBDA increased 6% to 206 million, reflecting the benefit of a shift to higher margin digital revenue and higher margin top sellers. The success of our first quarter releases translated into a 22.4% Recorded Music OIBDA margin, a 1.8 percentage point improvement over the prior year.

Let’s move to our Music Publishing business. I’ll exclude the Sheet Music business from my comments. In comparison to the same quarterly period in 2005, Music Publishing revenue fell 6% to 131 million or 4% on a constant currency basis. Declines in mechanical and performance revenue were partially offset by gains in digital revenue with synchronization revenue being flat for the quarter. The decline in mechanical and performance revenue partially reflects prior year industry declines in physical sales as this revenue is recognized on a cash basis and is typically received on at least a one year lag. Music Publishing OIBDA declined 2 million to 21 million compared to last year’s comparable quarter.

As for our cash management in our balance sheet, we ended the quarter with a cash balance of 278 million, total net debt of approximately 2 billion and a $259 million undrawn revolver. We are very pleased with our two-notch Moody’s upgrade in the quarter, which recognizes our improved financial performance.

As previously disclosed we declared our second quarterly dividend of $0.13 per share on December 29th payable later this week on February 17th, giving us a very attractive yield of 2.6% based on yesterday’s close. We maintain our intention to pay up to an 18 million annual dividends to shareholders on a quarterly basis. For the quarter we generated free cash flow of 13 million calculated by taking cash from operations of 29 million, less CapEx of 5 million and cash paid for investments of 11 million.

The comparison with the first quarter of 2005 free cash flow results is impacted by the shift of employee annual bonus payments from the March quarter to the December quarter, given the previous change in our fiscal year-end from November 30th to September 30th. Our unlevered after-tax cash flow which we believe provides the most accurate reflection of the on going cash generation capability of our business with 60 million, resulting in an OIBDA conversion of 29%, which highlights the seasonal low point in our working capital cycle. Unlevered after-tax cash flow is calculated by adding back 47 million in cash interest. At the timing of the bonus payments not changed we would have handily beaten last year’s cash flow numbers.

On the tax front our cash taxes were 14 million for the quarter, substantially all of our incomes 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 amortization deduction. As we previously discussed, we are entitled to this deduction because we can amortize and deduct for U.S. tax purposes ratably over a 15 year period, a substantial portion of the purchase price we paid to Time Warner. We have a substantial tax carryover amount in the U.S. resulting from net operating losses and foreign tax credit carryovers.

We expect our effective tax rate to rise during the year as we increase the international contribution to earnings. Before we wrap-up, I would like to mention one item regarding our corporate governance. As it was widely reported, our Director Richard Bressler has joined TH Lee, a firm in our investor group. As a result Mr. Bressler is no longer considered an independent Director under the NYSE rules. We are now in the process of recruiting two additional independent candidates to join our Board. After we add these new Directors we will have a total of 3 independent Directors on our Board and an entirely independent audit committee as required by New York Stock Exchange rules. We intend to add these Directors as soon as possible. As you know as a matter of policy we have chosen not to provide financial guidance to the investment community. We believe that especially given the rhythm of the music release schedule and associated marketing and promotional expenses, quarterly variations of results are normal.

That is why we believe our trailing 12 month performance is the best indicator of our success. We are very pleased with the progress we exhibited in the fiscal first quarter, and remain very optimistic about our ability to leverage our unique content to seize the business opportunities in both the physical and digital worlds. Thank you and now I will turn it back over to Edgar for a brief wrap-up.

Edgar Bronfman, Chairman, Chief Executive Officer and Member of Executive, Governance & Nominating Committee

Thanks Michael. So in just a few quarters Warner Music Group has become a nimble, integrated and forward-looking music based content company. We’ve been able to create a cutting-edge business model predicated on new thinking and new initiatives. Our innovative approach to A&R has driven consistent and profitable share gains, our focus to approach the digital has helped us to expand the lead that our digital share goners over our physical share and our efficient approach to cost management has contributed to our expanding margin despite the challenging music industry back up. The music industry is changing and WMG is on the fore front of that transformation. We’ve sought to run our business differently to capture the opportunity of an evolving marketplace and drive shareholder value and that is precisely what we are doing. So let me stop there and let me say we would be delighted to take any questions, thanks. Operator?

Questions-and-Answer Session

Operator

Thank you. Operator Instruction. Our first question is coming from Doug Mitchelson and please state your company name.

Q - Douglas Mitchelson

Hi, Deutsche Bank. Two questions, just on pricing, one question on pricing, two parts. Any update on pricing flexibility negotiations with iTunes any comments if you could make on, this puts your investigation of price fixing and as a satellite radio sector begun to engage music companies in furious negotiations or should we just assume that this will add towards arbitration later this year if I remember correctly?

A - Edgar Bronfman

Doug, its Edgar, I don’t think really we can bring you a lot of light on any of those subjects, you know the negotiations with Apple, will perceive but obviously we are not going to discuss those negotiations as they are ongoing, we obviously cannot comment on the Attorney General’s investigation as you know, we have reached a settlement with the Attorney General on the previous investigation and I believe this current one is, is in its very earliest days, so it would be inappropriate for us to comment there. And I think really again in terms of negotiations with the satellite industry it doesn’t -- but to speculate it for the outcome of those negotiations, there are ongoing negotiations with the industry and I think that’s, really all we can do is to suggest that those are ongoing but without commenting on them.

Q - Douglas Mitchelson

And may be just a quick follow-up, the bundling that you are doing with albums adding additional content at a higher price, is that delivering for you the additional margin that you are hoping for out of iTunes anyways?

A - Edgar Bronfman

Well there are number of things that we are doing that drive additional margin, I mean iTunes and other DSPs but yes the album bundles are more profitable and have a greater margin share than the regular priced digital album.

Q - Douglas Mitchelson

Okay, thank you.

Operator

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

Q - Anthony Noto

Thank you very much, its Goldman Sachs. Edgar and Michael two questions. Edgar, I was wondering if you could elaborate a little bit on the types of innovation that you see in the digital music world in 2006 and beyond, clearly the formats that we’ve seen from ringtones and downloadable music are probably not the end of innovation in terms of types of formats, especially that may relate to portability and other types of innovations. And then Michael, in terms of the EBITDA margin expansion in the year-over-year basis, I think you said a 170 basis points and I think that includes FAS 123, without FAS 123 I think it’s 210 basis points. Could you break out for us in big buckets that expansion what came from mix shift versus cost savings versus a year ago? Thank you.

A - Edgar Bronfman

Well, Anthony it’s Edgar. You know one thing I would like to, well two things I mentioned. One, we just started with the mobile bundle that we described in Japan which is a single downloadable file to consumers that contains all kinds of different material from a single artist but that request will probably change to a variety of thematic single bundles as well. So currently you can have on KDDI a single file from an artist that will have a ringtone, some wallpaper, some text, a ringtone et cetera. So that – that’s the unique product and I suspect we will move to thematic products as well, so its not just the single artist but it’s a long different kinds of themes. We are also starting with a product in Germany that we will announce with Vodafone and T-Mobile which is what we called SMS tones. The SMS market or the text messaging market in Europe is huge and we are going to introduce a product that has a tone probably something more in the order of sort of somewhere in the two to five second range rather than a much longer ringtone or ring-back tone that would accompany SMS messages, but again we are the very, very early stage of experimentation and innovation that you think we continue to lead the market and these are just examples of where something’s may go, whether these will be enormous consumer winners or others will be, the variety of content that we can create and distribute across these platforms is unlimited.

A - Michael Fleisher

Anthony, to answer the margin question, and just to clarify it, OIBDA margin including FAS charges was up 160 basis points, excluding FAS was up 200 basis points. I think it really comes, there is two broad buckets and its about 50-50. Broad bucket number one is as we get a larger percentage of our business from digital revenues as we’ve discussed many times before, the digital business is more profitable, this quarter we were up to 7% of our revenues from digital, higher in the U.S. and higher in particular in our U.S. Recorded Music business. And so that’s driving part of the profit improvement. And in the second place is just the mix of the products we have in the marketplace, as we’ve talked about before we are very focused on driving margin share, the notion of finding products that will generate not just revenue but good profitability for us and putting those out in the market, we are not interested in putting products in the market that generate lots of revenue without lots of profitability, and so you will continue to see as much more focused on the products that can generate both topline and bottomline, and I think this quarter some of our big releases in the marketplace that was true.

Q - Anthony Noto

Great, thank you.

Operator

Our next question comes from Michael Savner, and please state your company name.

Q - Michael Savner

Good morning thanks, Banc of America. Two questions also, first on pricing, this time on the physical side you’ve done a, obviously a good job of beating industry trends in terms of unit decline, but are you considering other avenues to kind of spur growth whether its reducing your pricing or other things or, at some point you kind of throw in the towel and say look it is, what it is and we’re going to focus all of our energy on the much stronger growth in digital? So, I guess that’s one broad question. And then second one also a general question just your, most recent thoughts on the industry consolidation where you see yourselves in it, how beneficial if at all you see it or whether you go very content to kind of keep the ship sailing when its going down? Thank you.

A – Edgar Bronfman

Michael, let me comment on both. First of all lets remember that the physical business remains 93% of our business and rather than discussed during in the tow, I’ll tell you we have a very different perspective, we actually think that as we’ve continue to innovate in the digital world we can begin to do, to bring much more innovation to the physical world as well, obviously the breadth of things that we can do in physical is not as broad as the best of things that we can do in digital, but we see many opportunities in physical and we continue to do anything and everything we can to expand our distribution base, our product and the quality of our content, so that we can either arrest – both arrest the decline of the physical business and potentially even increase physical sales overtime. And I guess the same thing is I think they remain far too much discussion which as far as I know is not generated either by Warner Music or any other potential partner in the consolidation of the music industry. I don’t think its – it will be helpful for me to comment other than to say that if you look at the progress of Warner Music, I think its clear that without consolidation Warner Music can continue to make real progress, and I think I should just leave it at that.

Q - Michael Savner

Thanks, and just a quick follow-up I mean, I guess, I certainly didn’t mean throwing the tow on physical sales, what maybe better said, devoting your energy to coming up with new physical sales marketing campaign versus what you’ve done before?

A – Edgar Bronfman

Well, I think, you know, we remain very focused on both, I mean we’re very proud of the fact that as Lyndon Johnson once said we can walk and chew gum at the same time, which is to say we gained share in the physical business, which means we’re driving tremendous focus in that area as well as being the innovator and the leader in the digital space. So we’re going to remain focused on both and as long as we feel that we can do both as well as each can be done we’re going to continue to do that.

Q - Michael Savner

Great, thank you.

Operator

And our next question comes from Bishop Cheen. And please state your company name.

Q - Bishop Cheen

The Company is Wachovia Securities. Good morning Edgar, Michael, Jill, thanks for taking the question. It is a good day for a chemical room (phonetic) so any room, question on gift cards, we saw a modest sales in the calendar Q4. When do you think you’ll start to see the blessing benefit of those gift cards in this current quarter that we’re in or will it be - do you think its kind of meager or, measured out over a 2 or 3 quarters?

A - Michael Fleisher

Hi Bishop, it’s Michael. Its too early to tell this is a – as we know a developing marketplace, I think what we’re anticipating is that the vast majority of those gift cards will be used pretty quickly and we’ve seen developing pattern if someone gets a new MP3 device especially one attached with some gift cards, they tend to go out by some tracks, we saw a huge spike as we mentioned in download the week after Christmas, and then start to take their own catalog in vibrated music, put in on that device and then come back into the market and we purchase those again. But it’s still early days to understand exactly how the consumers are using these devices, we definitely feel like the pattern, the seasonal pattern of the spike in digital downloads and then the drop-off and then what we expect will be some growth again, is similar to last year but obviously it was also impacted by the greater sale of gift cards this year, and therefore may have sort of a heightened data to it in the early periods because of the gift cards.

Q - Bishop Cheen

Okay, one follow-up on CapEx was less was than expected, than I expected in this fiscal Q1. Do you think the CapEx is going to be closer to 20 or closer to 30 or some other number in this fiscal year?

A - Michael Fleisher

As you know, we don’t give any guidance. I think CapEx is going to pretty consistent spend rate for us. And so I think looking at history is probably a pretty good proxy.

Q - Bishop Cheen

Okay, so all these new digital initiatives are not going to run break your CapEx budget it’s…

A - Michael Fleisher

You know we certainly have some capital expenditures as we build out our digital business but nothing that’s so dramatic, that it’s going to change our CapEx spend rate in meaningful way.

Q - Bishop Cheen

Okay, thank you.

A - Michael Fleisher

Thanks Bishop.

Operator

Okay. And our next question comes from Jason Bazinet. Please state your company name.

Q – Jason Bazinet

Hi, it’s Citigroup. Two quick questions, I was wondering if you could comment on at least among digital sales, how digital A La Carte is varying versus digital subscription? And then second, I just had a question on the allowance for doubtful accounts it was up, I think about 27% sequential, and I was just wondering if you could comment on the source of that?

A - Edgar Bronfman

Jason, just comment on the A La Carte subscription, I’ll let Michael to comment on the reserve. It’s difficult to say, we see more and more subscription services coming into the market obviously the lead that Apple enjoys in the device market drives a very important growth for A La Carte sales and I think we’re going to continue to see growth of both, what we’re seeing is real consumer satisfaction both with subscription services and with A La Carte services though I would say that the subscription services have been, their growth and popularity has been impacted by the lack of an outstanding device that consumers have adopted, I think we’re going to see increasing variety of first class devices for subscription services, as that happens I think we’re going to see continued and perhaps accelerated growth in the subscription area, but I don’t know that will come with the expense of continued growth with the A La Carte services.

Q – Jason Bazinet

Understood. Thank you.

A - Michael Fleisher

Jason, on the question about the allowance for doubtful accounts, most of this is related to just the build up that happens in the December quarter. Our allowance is somewhat formulaic, its tied to inventory that we’ve shipped out to our key physical vendors, obviously with the music ran bankruptcy, where we remain conservative in making sure that we’re sort of fully reserved in a changing world. As I’ve pointed out before I only take the moment to point out now, we don’t expect sounds and music ran bankruptcy to have any material impact on our financial statements largely because we are conservatively reserved against the physical retailers and manage that quite carefully.

Q – Jason Bazinet

Okay. Thank you very much.

Operator

And our next question comes from Eric Handler. Please state your company name.

Q - Eric Handler

Thank you, Lehman Brothers. Edgar, are you seeing any additional discount in your catalog product this past holiday seasonal relative to last year and if so, do you think there are any implications on the market for that? And then secondly, you talked about international growth but can you talk a little bit somewhat on the market share that you have achieved globally? Thank you.

A - Edgar Bronfman

Eric, I am going to ask you to repeat the second question, but as for the first we did see some industry, some increased discounting on catalog from the industry. Warner really didn’t participate in that additional discounting, we’ve worked very hard to maintain margin and prices in the physical world and we have a very clear sense on where and when discounting actually results in increased margin and profit, and if we can’t achieve that then we don’t grant the additional discount. So we’ve been very disciplined there. And I know your second question was around international but I just missed it.

Q - Eric Handler

I am sorry, international market share, you talked about international year-over-year growth, but can you talk about maybe some markets what your global share is?

A - Edgar Bronfman

Yeah, we don’t have that information in this timely manner as we do with Soundscan etc. in the U.S. So I can’t give you precise numbers, but what I can say is – and I mean it when I said before when I leave this was a very solid foundation, we have done extremely well in Europe. Warner has traditionally been seen as weak in the international market. So, for Warner to have the number one and number two albums of 2005 in Europe it’s really quite exceptional and extraordinary, and I think a testament to our focus both of developing artist in the case of James Blunt and the marketing and promotion of international artist such as Green Day across the globe. We are also gaining share, I mean I can tell you that in specific markets we’ve done extremely well in France, where Warner Music was traditionally an industry of migrant and is now a very, very much stronger company and a real competitor in that market and I hope you also seeing share gains in Japan in our first quarter and that we hope that will continue through 2006 as well.

Q - Eric Handler

Thank you.

Operator

Our next question comes from Richard Greenfield. And please state your company name.

Q – Richard Greenfield

Richard Greenfield, Pali Research. The question for you, when you think about what you did with Madonna and MySpace allowing consumers to essentially cut and paste their video on to their VODs. I guess the question is, how should we think about the opportunity presented by social network in sites like MySpace or face booking. Do you plan to sign a deal like Sony BMG did about a week and half ago? Thanks.

A – Edgar Bronfman

Well, I think we have deals with, we have deals in place with MySpace and we’ve worked with Facebook for some time. But I think what – what I would say which is rather than sort of close the opportunity for social networks what I would say is that we do believe that there is a tremendous opportunity for what we call user generated content. And that is using the content that it’s created by Warner Music Group artists and adjusting, amending, improving, subtracting however consumers might receive that content with their own contributions. That I would think is potentially a huge business, if we got to approach it carefully and thoughtfully and obviously in concert with our artist because each artist may have a different perception as to how much or in what way they want their content amended. But we do think the general category of user generated content is potentially a very, very large business.

Q - Eric Handler

And how do you plan or how do you – how are you currently getting paid in those relationship and is advertising overtime a possibility?

A – Edgar Bronfman

I think advertising overtime is a possibility but what I say is, this is an extremely mason business. The entire digital arena is sort of 18 months old and obviously it has began with the more traditional forms which is to take current content and translate it to digital distribution so you have single track or album downloads that’s the most sort of basic of the digital product, as the opportunity expands, the content offerings will expand, there will be many new models, but I think its very too early to say exactly how it will be compensated.

Q - Eric Handler

Okay, thanks.

Operator

And our next question comes from Mark Harrington. Please state your company name.

Q - Mark Harrington

Hi, ABN AMRO. Couple industry related questions. First, again back to pricing, I don’t know if this is something that you can kind of comment on as a generalization, but looking at the recent trends in wholesale pricing, I know the past 5 years or so, pre 2005 we’ve seen kind of consistent pricing pressure on the downside, have you seen that stabilize? Second, looking at kind of recent consumption trends in digital, perhaps if you could comment on for example spending percentage of albums downloaded versus singles and any evidence if at all possible on kind of cannibalization of physical or in fact are you seeing kind of digital download serving to be incremental to physical sales? Thanks.

A – Edgar Bronfman

Hi Mark. On the wholesale pricing question, as we talked about before, we though we constantly feel pressure, our wholesale prices on the physical side have remained extraordinarily stable over the last year to two years, and its important to remember that our product isn’t sort of as substitutional as some other consumer products and the big physical retailers are using our product to generate for traffic in the store. So, their worst case scenario is to not have that Madonna or Green Day or James Blunt CD on their shelves. So, we actually have a reasonable amount of power in that pricing discussion, so far we’ve been able to hold our physical wholesale prices pretty consistent. On the digital side, I would say that its early days and it’s hard to tell, there is clearly going to be some cannibalization, what we are seeing though is that, if you give consumers a unique digital product as we have in the digital album bundles, they will spend more in order to get that unique product and in particular with the digital album bundles in the places we’ve done that, we’ve seen a marked rise in the number of tracks purchased in album form versus single form. So, the consumer has sort of voted with their dollars to say, if I can buy a Madonna in a bundled form that has some extra bonus things as part of the package, I’ll do that rather than picking up a track here and a track there.

Q - Mark Harrington

Thank you.

Operator

Thank you. Our next question comes from Karol Winsted. Please say your company name.

Q – Karol Winsted

Yes, Karol Winsted, Forest Investments. In the quarter, could you please breakout for me the, on the revenue line, how much was price and how much was units and also going back to the – your point of distribution. On the physical side of the business, what’s the trend in the actual count, you know shall we say, a point of distribution? And finally in the most recent quarter, could you tell me what percent of music sales are represented by releases or artist that are, shall we say new to the mix?

A – Edgar Bronfman

Sure, let me try and take your questions in order. In terms of what makes up this sort of revenue change, if you think about us basically having flat revenues, currency adjusted and adjusted for the sale of print business, that’s pretty much, that flat revenues is pretty much on flat units if you look at the Soundscan numbers where we sort of down year-over-year less than 1%, so you are really looking at flat pricing and flat units year-over-year particularly in the physical side. In terms of the number of distribution outlets, I think the first change we are going to see in that, in the sort of current period is what we see the outcome of the Music ran bankruptcy. I don’t think there has been a big change in the number of outlets in the traditional retailers over the last year or so. We are seeing some new physical distribution points, Starbox is an example of a place where before there was no music sales and now is becoming increasingly important, physical distribution outlet for our product. And I forgot your last question.

Q – Karol Winsted

I wanted to know, in consumer products what companies and the analyze is, what percent of their business comes from our new product?

A - Edgar Bronfman

Yeah Karol, it’s Edgar. In the consumer products business, people often do that, but frankly almost everything we sell as a new product other than our catalog, every new album on Madonna is a new piece of work, so that probably 60% of our revenue is derived from new products. But what we have consistently said is that when you take our revenue of those in any given year about less than 10% actually comes from what we would call untested material, which would be new releases from unproven artist. So, we have about 35% to 40% of our revenue from catalog, about 15% of our revenue from publishing that’s about 50%, 55% of our revenue another sort of 35% or so of our revenue comes from new work but by established artist. And then the remainder something slightly under 10% comes from new artist releasing new material.

Q – Karol Winsted

Okay. Thank you.

Operator

And our next question comes from Michael Savner. Please state your company name.

Q - Michael Savner

Hi thanks, just a quick follow-up, and I think couple of people gone up with the same question, you talk about the great growth in digital albums being sold, can you start may be today if not give us some thought going forward to actually providing the same number of digital album sold, so we can kind of quantify the year-over-year growth numbers?

A – Edgar Bronfman

Yeah, I think it’s a great point Mike, I don’t have it front of me right now, but we’ll certainly look at it as sort of part of those statistics we give going forward.

Q - Michael Savner

Fair enough, thanks.

Operator

Okay, our next question is coming from Tuna Amobi, your line is open and please state your company name.

Q - Tuna Amobi

Standard & Poor’s Equity Group, thanks for taking the question. Just a couple of issues, first one on the I was wondering if Edgar perhaps you can share with what’s your vision of Google and Amazon as a potential partners down the road? The other issue is on Skype, what can you share with us about the economics of that deal and do you see that as a prototype for possible deals that you will stride down the road? And finally a question for Michael, will you please quantify where you stand with the NOLs, net operating loss carryovers in the U.S. as well as the foreign tax credits carryovers? Thank you very much.

A - Edgar Bronfman

Sure, let me start with the, with your first series of questions, really Amazon and Google can and should speak for themselves, but you know, we certainly have been working closely with Amazon as they work to launch their service, they have a very powerful a base of CD purchasers, and we think that their digital launch when it comes in the second half of the year we hope will be a successful one and we’re certainly working with them. As we work with every potential distribution partner to get our content to more people and more places with more opportunity. Google as well of course is a massive distribution opportunity, it remains to be seen how committed Google is to the music space or how they want to enter the music space, but we’ve had good conversations with Google, we precede them as very strong potential partners and we hope that will be, we will be able to participate in the tremendous platform that Google presents. Skype is again just an additional distribution deal, it’s just innovative because we believe that the Voice over IP networks are going to continue to grow very dramatically and we should be selling ringtones on those networks as well on the traditional mobile operator. So, again content wants to be ubiquitous, wants to be everywhere, it can be at all times in all places we don’t reveal the actual arrangements of our economic arrangements with any particular distribution partner but we are pleased to be leading the industry and finding new ways to distribute our content.

Q - Tuna Amobi

And then just one quick follow-up Edgar, are you thinking of Google and Amazon as potential on the same similar models to iTunes or you thinking of something little bit dramatically - may be dramatically different model with those providers?

A – Edgar Bronfman

Well remember, both Amazon and Google already have massive businesses themselves, so the music industries needs to work with those partners to provide a service that conforms to the vision that either Google or Amazon has for their customer. So, it really you can us driving a vision, it’s really us trying to support a vision that both can enhance our artist opportunity and the consumer’s opportunity whereas part of either the Amazon or the Google networks, and we will in constant dialogue with those companies and others to try and achieve those goals.

Q - Tuna Amobi

Thanks and Michael?

A - Michael Fleisher

To your question on NOLs, our NOLs and tax carry forwards are about 100 million at year-end.

Q - Tuna Amobi

Thank you very much.

Operator

Thank you. And I would like to turn the call back over for closing comments to Edgar Bronfman and your line is open.

Edgar Bronfman, Chairman, Chief Executive Officer

Thank you very much, we just would like to thank everyone again for joining the call for continued interest in Warner Music Group, we are proud of the quarter and now we are going to go back to work, so we can hopefully deliver good results going forward. Thanks a lot.

Operator

That does conclude today’s conference, you may disconnect at this time.

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