Warner Music Group F2Q08 (Qtr End 3/31/08) Earnings Call Transcript

May. 8.08 | About: Warner Music (WMG)

Warner Music Group Corp. (NYSE:WMG)

F2Q08 Earnings Call

May 8, 2008 8:30 am ET


Jill S. Krutick - Senior Vice President of Investor Relations and Corporate Development

Edgar Bronfman - Chairman of the Board, Chief Executive Officer

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


Bishop Cheen - Wachovia

Mike Craufield - ClearBridges

Doug Mitchelson - Deutsche Bank

Ingrid Chung - Goldman Sachs

Jessica Reif-Cohen - Merrill Lynch

Jason Bazinet - Citigroup

Rich Greenfield - Pali Capital

Tuna Amobi - Standard & Poor’s


Welcome to the Warner Music Group’s fiscal second quarter earnings call for the period ended March 31, 2008. At the request of Warner Music Group, today’s call is being recorded for replay purposes and if you object, you may disconnect at any time. (Operator Instructions) Now I would like to turn today’s call over to your host, Ms. Jill Krutick, Senior Vice President of Investor Relations and Corporate Development. You may begin.

Jill S. Krutick

Thank you very much. Good morning, everyone. Welcome to Warner Music Group’s fiscal second quarter 2008 conference call. This morning we issued a press release announcing our results. If you haven’t already seen them, both the press release and our Form 10-Q are available on our website at wmg.com.

Today our Chairman and CEO, Edgar Bronfman Junior, will update you on our business performance, strategy and suspension of our regularly quarterly dividend, also announced today; and our EVP and CFO, Michael Fleisher, will discuss our financial results for the quarter. Then, Edgar will wrap up before we take your questions.

Before Edgar’s comments, let me remind you that this communication includes forward-looking statements that reflect the current views of Warner Music Group about future events and financial performance. Words such as estimates, expects, plans, intends, believe, should and will, and variations of such words or similar expressions that predict or indicate future events or trends, or do not relate to historical matters, identify forward-looking statements.

Such statements include, but are not limited to, estimates of our future performance, such as the success of future album sales, projected digital sales increases and declines in physical sales, expected expansion of the online marketplace, the success of strategic actions we are taking to accelerate our transformation as we redefine our role in the music industry, market share gains, our expected income tax expense for fiscal 2008, our intentions to deploy our capital, including the level of and effectiveness of future A&R investments, and our intentions with respect to our dividend policy.

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 can cause actual results that differ materially from our expectations. Information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in our earnings press release and Form 10-Q and other SEC filings.

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

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

Edgar Bronfman

Thanks, Jill. Welcome, everyone. Thanks for joining us. Let me start by saying Warner Music Group had a strong operating quarter and again outperformed our competitors as we continue to execute on our strategy of becoming a broad-based music business with more a diversified revenue stream.

Physical recorded music sales continue to decline industry wide and slowing ringtone growth, as well as the softening broader economy, are also negatively impacting the recorded music industry. However, despite these challenges, Warner Music continues to effectively steer through difficult times and is best positioned to take advantage of the opportunities offered by the music industry’s ongoing transformation. We continue to have a strong track record of outperforming our peers in the tumultuous music market place, due in large part to the excellent returns we have consistently generated on our A&R investments.

As the challenges in the recorded music industry persist, we recognize that the global economy has weakened the credit markets have deteriorated dramatically, making the choice to be even more fiscally prudent and add more financial flexibility to our balance sheet a high priority.

As we’ve previously discussed, our board and management regularly evaluate our balance sheet and use of capital to enhance shareholder value. How best to maintain our financial flexibility while continue to outperform competitively and derive equity appreciation for our shareholders has always been of paramount importance to us. As a result of our analysis, we’ve decided to suspend our dividend. Given the current state of both the economic and music markets, this action will provide us the flexibility we need to remain conservative in the management of our balance sheet while sustaining our level of A&R investment as a key ingredient to our continuing to achieve superior competitive results and investment returns.

Further, in pursuing this path we feel confident that when the economic environment ameliorates and as the recorded music industry transformation advances, we will be best positioned to seize even greater opportunities within the recorded music industry.

Now let me describe to you some of our recent achievements and ongoing initiatives aimed at positioning us for further growth. Highlighting the success of our focused investment in A&R, marketing and promotion, we continue to discover and develop successful artists. In our second quarter in the U.S., Warner Music was the only music major to grow, gaining 2% while the industry declined 5% in track equivalent album unit sales. And Warner Music gained 1.2 percentage points of market share in the quarter, more than any music major, ending the quarter at 20.2%. This is the fifth consecutive quarter for which we have grown SoundScan U.S. track equivalent album share on a year-over-year basis.

Second, in the important digital arena we continue to be a leader in shaping the future of the music industry. Our quarterly digital revenue was 21% of total revenue, up from 14% in the December quarter. For U.S. recorded music, our digital revenue reached an all-time high of 34%, up from 22% in the December quarter. And we sustained our competitive digital lead into the March quarter with the greatest U.S. digital album share advantage over physical album share of any of the music majors.

Third, as part of our transformational effort to expand our role in the music business, we continue to expand our rights in recording agreements with new artists around the world, giving us a presence in the broader music business that will be increasingly meaningful to us going forward.

And fourth, we continue to bolster our music publishing business by strengthening our artist roster and catalog and expanding our digital presence while delivering consistent results.

Now let me provide you with some detail about these achievements. A&R marketing and promotion remain at the heart of our business activities. Our success in these areas over time is best measured by our ability to grow our margin and market share. In fact, according to SoundScan, we have increased our U.S. album share in 11 of the 12 quarters that the company has been publicly traded and we have grown that share by nearly 5 percentage points since our team acquired Warner Music in March 2004.

This was the first quarter since we’ve been public that we gained U.S. album share year over year in all of the top five musical genres. And while we’ve accomplished all of the above, based on available reported margin data, we continue to manage our business at margins that we believe are equal to or superior to those of our much larger competitors.

In the March quarter, our international recorded music business rebounded solidly while the U.S. recorded music turned in weaker results. Despite our relative U.S. out performance as measured by SoundScan our results, which are based on shipments, reflect the timing of releases and efforts by retailers to more actively manage their inventory levels. Michael will address this more fully in a moment.

We continue to see a pick-up in our U.K. business led by sales from Nickelback, Michael Buble, Muse, and REM. Most of the other key European markets benefited from stronger releases and comparisons to our softer prior year quarter. We also had another excellent quarter in Japan, gaining nearly two points in SoundScan album share year over year in the world’s second-largest recorded music market. Results were driven by strong momentum from local artists, such as multi-platinum seller, Kobukuro.

We remain committed to growing our digital recorded music revenue, first to compensate for and then to overtake the decline of the physical recorded music business. This quarter produced stellar online digital results, helped by the mix of releases and post-holiday gift card activity.

While ringtone sales remain pressured in the U.S. and Europe, we believe the success of Japan’s mobile music business can be looked at as an indicator of where the mobile music business is heading outside of Japan. Japan’s digital music business is almost entirely driven by mobile, given faster networks, advanced handsets, superior user interfaces, flat rate data plans, and more complete catalog offerings.

In 2007, according to the Recording Industry Association of Japan, Japan’s digital music business grew 41%. Full track downloads showed the greatest growth rising 91% over the previous year and accounted for one-half of overall mobile music revenues. While off an extremely small base, we are seeing full track mobile downloads growing rapidly in other markets, including the U.S. As new mobile products and developing mobile business models spread worldwide, we believe mobile growth will accelerate in the U.S. and Europe, as it continues to do in Japan.

Warner Music had quarterly digital revenue of $164 million, a sequential improvement of 16% and a 48% gain compared to the same quarter last year. As I mentioned, this quarter our digital revenue was a record 21% of our total revenue and was 34% of our U.S. recorded music revenue. These are very significant percentages and provide insight into how quickly our business is evolving.

This quarter we again demonstrated both the success of our digital strategy, including our ongoing supremacy in the sale of premium album bundles on iTunes and the strength of our content. Atlantic Records artist Flo Rida broke several chart records. Flo Rida’s single, Low, set the record for most consecutive weeks as the number one ringtone in the U.S. on the Nielsen ringscan chart. Flo Rida is also the first ever debut artist to have two top 10 songs on Billboard’s hot digital songs chart prior to an album release.

While we will see the results in our third quarter, in March Warner Music began implementing a progressive global marketing campaign for Madonna’s 11th Warner Brothers studio album, Hard Candy, released 10 days ago. We entered into a series of carefully crafted digital partnerships with Vodafone, Samsung, Verizon and Microsoft, each of which is individually designed to raise awareness and drive Madonna’s record sales. For example, an exclusive global prelaunch from Vodafone offered its subscribers one new track from Hard Candy each day, counting down the week before the album was first made available, resulting in the single, Four Minutes, becoming Vodafone’s best-selling track ever.

Collectively, tens of millions of dollars in advertising was spent by our digital partners, contributing to Hard Candy debuting at number one in 28 countries around the world. Hard Candy is one of Warner Music's most successful pre-release album bundles on iTunes in the U.S. During the prerelease period, the premium version of Madonna’s Hard Candy, at $13.99, outsold its standard $11.99 version eight to one.

In December, we began offering DRM free audio downloads on the Amazon MP3 digital music store, which allows every track and album purchased to be playable on practically any digital music device, including iPods. NPD’s research has found that digital sales through Amazon are enlarging the digital business rather than cannibalizing sales from iTunes and that Amazon sells a much higher proportion of albums to singles than iTunes both encouraging developments for our industry.

Extending this strategy, Warner Music has announced a series of MP3 deals in recent months with partners who have agreed to support our product management strategy, promote pricing flexibility, and meet our technology initiatives. We remain focused on monetizing the broad reach of our digital offerings. One of our key priorities has been to unlock the value of music in the context of social media and online communities. For example, we continue to develop new partnerships and business models in the online community space, potentially one of the industry’s greatest growth opportunities. We’ve approached the social networking landscape through investments and partnerships with selective companies. You’ve heard us speak in the past about our deal with iMeme, the fastest growing social network today, to which we’ve recently licensed the rights to our music publishing catalog in addition to our recorded music catalog. However, nothing we have done in the past has been anything like the scale of the deal we recently announced with MySpace.

The new joint venture, which will be called MySpace Music, will offer DRM free digital downloads, ad-supported audio and video streaming, ringtones and the mobile products, as well as merchandise, concert tickets, information, and all kinds of ongoing interaction between artists and fans on the world’s largest social network.

We will be participating in a fully integrated music offering, making use of our large library of recorded music and music publishing content. We see this as a powerful way to monetize our content on a platform that has the broadest possible reach. This consumer offer is strengthened in its breadth of repertoire by the participation of Sony BMG and Universal Music Group.

Creating and developing new digital business models to accelerate our business transformation remains a top strategic imperative. We’ve recently entered into a content agreement with TVC, a leading telco in Denmark, which established some key parameters for future business development initiatives.

TVC launched a new groundbreaking service that offers its mobile and broadband customers unlimited access to tethered music downloads without additional charge. We believe that packaging unlimited into mobile services presents an attractive value proposition for subscribers, as well as a significant opportunity for us to monetize consumer behavior across cast networks. We will continue to explore and develop these types of models around the world.

As we push to increase our digital revenues, we recognize that we must also transform our business within the music value chain. As we have mentioned, we are continuing to enter into expanded rights deals with recording artists that provide us participation in growing areas of the music business, such as sponsorship, fan club, merchandising, touring, ticketing, and artist management. Through a broadened partnership between artists and their label, both parties’ interests are aligned to nurture and grow all aspects of an artist’s career. We are entering into these deals at a rapid pace all around the world.

We are moving aggressively to establish a best-in-class skillset beyond our core recorded music and music publishing expertise so that we can optimize our offerings to artists and broaden our revenue mix. This process should largely be accomplished by organically growing the businesses we acquired in the last few years and through small, incremental moves strategically designed to enhance our overall results.

In February, we acquired a controlling stake in an Italian touring company founded by executives from Friends and Partners, Italy’s leading touring company. This transaction will provide Warner Music Italy with a strong entry into the concerts and booking business with local Italian artists, facilitating our efforts to broaden our artist relationships and adding proven touring management to our team.

One of our strategic goals has been to drive the performance of the uniquely valuable Warner Chappell music publishing business, which is the world’s third-largest music publisher. Warner Chappell enjoys a stable, diversified revenue stream from its extraordinary library and has delivered improved performance over the past year. As we’ve noted in the past, we have a global multi-front plan to drive long-term growth at Warner Chappell. We intend to make the necessary content investments to support our growing production music business, new songwriter discovery, and catalog development, develop new exploitation opportunities to expand the value of our existing catalog, expand our leadership position in digital music by playing a key role in industry initiatives, platform development, and standards setting, such as our recent pan-European digital licensing effort, and broaden our international reach and deepen our global content offerings. We continue to make progress against these initiatives.

The recent U.S. federal court decision on music publishing performance rates for Internet streaming by AOL, RealNetworks, and Yahoo! was an important victory for the music publishing industry, ASCAP, and Warner Chappell. The new rates was set at 2.5% of revenue until 2010 and will be retroactive to the launch of these streaming services in 2002. While the decision is still subject to appeal, it establishes a clear, well-reasoned framework for properly valuing musical compositions in the digital world.

Furthermore on the digital front, in addition to agreements with MySpace and iMeme, Warner Chappell has also now concluded licensing agreements with online radio player, Slacker, and with the web-based ad-supported music service, Spiral Frog. The Warner Chappell team will continue to be aggressive in developing a winning digital music strategy and we continue to see great potential here.

Warner Chappell’s A&R efforts identify some of the brightest talent in the business. In February, Warner Chappell announced a worldwide publishing agreement with singer/songwriter duo Glenn Hansard and Marketa Irglova, winners of the Best Original Song Academy Award for “Falling Slowly”, from the critically acclaimed independent Irish musical film, Once.

Highlighting the success of our Warner Chappell artists, songwriter/producer Timbaland earned the ASCAP songwriter of the year title for his contributions to nine award-winning songs. Prior to receiving this award, Timbaland was twice recognized by ASCAP as rhythm and soul songwriter of the year. In addition, Warner Chappell music writers Burt Bacharach and Robbie Robertson were awarded lifetime achievement awards for their artistic contributions to the recording medium at the recent Grammy Awards.

We look forward to updating you on Warner Chappell’s continued progress.

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

Michael D. Fleisher

Thank you, Edgar and good morning, everyone. Let me begin by covering some of the key financial highlights for the quarter. Looking at the income statement for the three months ended March 31, 2008, we reported revenue of $800 million, which declined 4% on a constant-currency basis. All the revenue data that I am about to discuss is on a constant-currency basis. All the margin data, for purposes of comparisons between periods, will account for the prior year’s quarter $16 million restructuring related charges in connection with the company’s fiscal 2007 realignment initiatives.

Domestic revenue fell 14% while international revenue grew by 7%. We saw revenue gains in Europe, Asia-Pacific, Canada, and Latin America.

Overall, total quarterly digital revenue growth outpaced the market, growing 48% to $164 million, or 21% of total revenue, up from $111 million, or 14% of total revenue in the prior year quarter. This spike upwards of seven percentage points sequentially came as a result of the release schedule, post holiday gift card activity, and the general consumption shift from physical to digital. We expect to continue to see fluctuations quarter to quarter in the digital revenue percentages, driven by our release schedule and seasonality in format mix.

Approximately 65% of our total digital revenue was generated in the U.S. and 35% in the rest of the world. Our worldwide digital revenue stands at about 70% online and 30% mobile. In both the U.S. and internationally, online is a larger share of our digital business than mobile. Mobile remains soft as ringtone sales fell year over year in the U.S. and remained flat sequentially internationally in the quarter. Newer mobile products, such as ringback tones, full track downloads, and other more innovative offerings remain too small as yet to meaningfully impact mobile results.

Though the overall recorded music may take some time before it returns to growth, we continue to develop our digital business and broaden our approach to the recorded music business in order to mitigate our exposure to current industry trends while delivering profitability through our focus on financial discipline.

While transforming our business mix, we remain vigilant about managing our costs, even as we make the investments necessary to lay the foundation for future growth. Our operating income before depreciation and amortization, or OIBDA, from continuing operations was flat year over year and our OIBDA margins were also relatively stable.

Now let’s look at our different business segments. Quarterly recorded music revenue fell 4% to $652 million. Major sellers in the quarter included REM, Simple Plan, Kobukuro, Nickelback, and the Juno soundtrack. We saw growth in our international physical recorded music business and our global digital business. We had revenue gains in the U.K., Germany, France, Canada, Latin America, and Japan. Overall international recorded music revenue rebounded 10% while domestic recorded music revenue fell 17% year over year.

The timing of our release schedule and continued contracting demand for physical product led to weak domestic recorded music results. In the U.S., retailers are more actively managing their inventory levels in response to the tougher economy and credit markets, as well as the changing underlying demand for physical product. We expect this realignment process to continue.

Importantly, as evidenced by SoundScan, which measures over the counter unit sales, consumer demand for physical product, including catalog, hasn’t changed substantially over the past several quarters. As a result, the variance between our U.S. shipments and the SoundScan reports are primarily due to timing differences and retailer inventory levels.

We are unwilling to cut our prices just to ship product into retailer inventory. Ultimately, this retailer process will lead to a healthier physical marketplace, with retailers better managing their physical music business.

Partially offsetting the physical declines, recorded music digital revenue grew 48% from the prior year quarter to $155 million, or 24% of total recorded music revenue, up from 16% in the same period last year. Domestic recorded music digital revenue grew 31% to $101 million, or 34% of total domestic recorded music revenue, compared to 22% in the same period last year.

Quarterly recorded music OIBDA from continuing operations was flat year over year.

Moving now to our music publishing business, in comparison to the same quarterly period in 2007, music publishing revenue of $155 million was flat. Music publishing revenue grew 5% domestically, offset by a 3% decline internationally. Total music publishing revenue benefited from gains in digital and performance revenue, offset by declines in both mechanical revenue and to a lesser extent, synchronization revenue. Sync revenues continue to feel the impact from the recent writer’s guild of America strike.

Music publishing OIBDA was $54 million. OIBDA and OIBDA margins for music publishing were flat year over year, excluding a $1 million favorable impact of foreign currency exchange rates.

As for our cash management and our balance sheet, we ended the quarter with a cash balance of $249 million. Total net debt amount to approximately $2 billion, which reflects total debt less cash.

As we indicated last quarter, our cash and net debt balances reflect a reversal of the timing related increase in net accounts receivable from the holiday period. For the quarter, we had positive free cash flow of $99 million, primarily due to working capital improvements from the timing of sales. Our free cash flow is calculated by taking cash from operations of $132 million less capital expenditures of $13 million, and net cash paid for investments of $20 million.

For the three months ended March 31, 2008, we had net cash taxes of $9 million and a tax provision of $13 million on a pretax loss from continuing operations of $21 million.

As we have discussed before, our income tax expense is primarily based on income earned by our foreign affiliates. In addition, our income tax expense includes withholding taxes paid to non-U.S. countries where we generate royalty income from sales of repertoire outside the U.S.

Our income tax expense fluctuates based on the mix of income or loss and the different applicable tax rates within each foreign jurisdiction. We expect our tax expense for fiscal 2008 to be about the same as the prior year level of $49 million, depending on our geographic profit mix.

For the quarter, we generated a net loss from continuing operations of $34 million, or $0.23 per diluted share, including a $0.09 per share tax impact on results.

We will continue to press ahead with our transformational initiatives, but as previously mentioned the M&A investments over the remainder of this fiscal year should be nominal as we build cash and effectively reduce our net debt, preserving financial flexibility.

We will continue to exercise financial discipline around all of our A&R investments. We also expect that we will continue to invest in A&R at the same level as the last few years.

As we have consistently said, we do not manage our business for any single quarter. We strive to release the right content at the right time in an effort to maximize fiscal year profit potential and artist career development. As a matter of policy, we do not provide financial guidance to the investment community, given the quarterly fluctuations from our music release schedule and associated marketing and promotional expense are normal.

While recognizing the challenges ahead, we are confident in our future. And now I’d like to turn the call back to Edgar for some closing remarks.

Edgar Bronfman

Thanks, Michael. Over the course of this year, we plan to work towards optimizing, evolving, and transforming our business. In doing that, we will stay vigilant in managing costs and investments while generating significant free cash flow as we adopt a more prudent approach to our balance sheet in this uncertain economic environment. We will enhance our digital leadership through an innovative business model while transitioning the recorded music industry back to a growth trajectory. We will continue to enhance the value and progress of Warner Chappell. We will broaden partnerships with artists and build relationships with consumers to add new revenue streams from growing segments of the music business, and we will increase market share while maximizing our margin potential.

Recognizing that we have an aggressive agenda, we are confident that we have the right strategy and team in place. Our goal is to drive shareholder value over the fiscal year and beyond as we evolve our business models and take advantage of opportunities in the rapidly transforming music industry. We look forward to answering your questions. Thank you and Operator, if you’d open it up to Q&A.

Question-and-Answer Session


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

Bishop Cheen - Wachovia

Thank you. Let me focus on the balance, Michael. You have a covenant step-down I think to 4.25 times in your credit facility, and then it goes down I think to four times at October 1st. So with these step-downs and with your new approach, cutting the dividend, et cetera, it still looks to be a little tight. Is the definition of that ratio net of cash? And if so, can you then continue to build up cash to meet those covenants?

Edgar Bronfman

First of all, the definition does include cash on our balance sheet and I don’t think it’s tight, and I don’t intend to let it get tight and I want to be very clear -- we feel totally comfortable that we have complete financial flexibility that we need to meet our covenants going forward.

In addition, we feel great about our competitive performance and our ability to continue to generate excellent returns on our A&R investments and those constants we don’t expect to change.

What has changed, of course, is the economy has weakened, the credit markets have deteriorated incredibly, and we are grappling with a recorded music industry that is in the middle of a transformation. As a result, we decided to suspend the dividend in order to take a more conservative approach to cash management. This allows us to reduce the net debt while maintaining our level of A&R investment and we think that’s the best combination of policies to create equity appreciation for shareholders.

Bishop Cheen - Wachovia

Understood, and you have been very articulate about that -- just a quick follow-up; as you look forward in these investments in A&R, do you expect that you will see the lift from your A&R investments continue throughout ’08 and into ’09, or is it something that is just going to ratchet up a year from now? In other words, how long does it take to cook this up-tick?

Edgar Bronfman

First of all, as Michael indicated, we intend to continue to invest in A&R at approximately the same levels that we have in the past and you can see what’s happened to, as we’ve explained, our market share, which continues to grow both internationally and particularly in the U.S. over the past four or five years and the fact that, as I mentioned, we manage our business at margins which we believe are greater to or better than our much larger competitors.

So you’ve got a real -- you’ve got to sort of take the view that our A&R investments have resulted and continue to result in good returns for -- or outstanding returns, actually, for investors and we see no reason why that should change.

Bishop Cheen - Wachovia

All right. Thank you for the color.


The next question is from Mike [Craufield] from ClearBridges Advisors.

Mike Craufield - ClearBridges

Just following up on the first question, could you talk a little bit more about your policy on -- you know, you’re cutting the dividend and are you doing that because you are concerned about your ability to meet your debt covenants going forward?

Edgar Bronfman

I think, as I said, we are not concerned about our ability to meet our debt covenants and I can’t underline that strongly enough. But I think given the uncertain economic environment, as we look at what levers do we want to pull to make sure that as we sail our ship, no matter what currents run under the water, no matter what winds blow above the water, we are going to be nowhere near the shoals or the rocks that we don’t anticipate.

There are a lot of different levers that we can pull. We felt that cutting or simply suspending our dividend for the time being was the best of those levers, but I do feel quite confident that even if we had not done so, we would not have a debt covenant issue.

Mike Craufield - ClearBridges

Okay. Thank you.


The next question is from Doug Mitchelson from Deutsche Bank.

Doug Mitchelson - Deutsche Bank

Thanks. Edgar, you went through an awful long list of things that you are doing on digital either to grow revenue or reinvent the business model, both different business models, domestically and internationally. I guess what would be helpful is which of those do you think will have the greatest impact on your business this year, which will have the greatest impact on your business next year? What would you point us to in terms of where we’ll actually hit the financials over the next year or two? Thanks.

Edgar Bronfman

I think I’d frame it in the following way, Doug, without trying to be too specific as to what timing will be, but I will try and give some color to that as well. I think over time you are going to see four income streams largely emerge from the digital arena. Those are going to -- the continued purchase of music, advertising based revenue, subscription based revenue, and what I’ll call access-based revenue. I think those four buckets are likely to be the largest buckets in digital revenues as our business models evolve.

Clearly for some time, the purchase bucket is going to be the largest of those. There is increased traction around subscription and I think access and advertising will follow. I think when you look at -- and then, of course, beyond that we think that we will have revenue streams from businesses that are affiliated with but are not specifically recorded music, such as merchandise, ticketing, fan club, subscriptions, et cetera as we expand our partnerships with our artists going forward.

Doug Mitchelson - Deutsche Bank

Okay, and can I just follow-up with Michael -- on the A&R investment, I understand that you are probably not going to give us a return that you think you’ve earned so far or what your return hurdle on A&R might be, but can you give us a sense of how returns have been changing? Have they been improving, deteriorating? Obviously there’s some competition for some of the bigger artists out there that’s relatively new. On a blended basis, how are returns trending on A&R? Thanks.

Michael D. Fleisher

We actually just completed some work really looking at our A&R returns over the last three or four years since we took over the company in 2004 and comparing those to the A&R returns in the past. And or A&R returns have held quite steady; actually, we’ve had even better returns in the last couple of years on our A&R investments as our management teams have been sort of stable and had good longevity and been able to sort of build artists over time.

And so when we look at sort of the vintages of our releases, going through ’05, ’06, ’07, we continue to see really fabulous returns on our A&R and that’s the reason we’re going to continue to invest against it.

Edgar Bronfman

If I could give a little color to that, we did just finish that study but I don’t think Michael made enough of the point that our returns on A&R have dramatically improved since 2004 when we acquired the company versus the A&R investments made prior to 2004. Much of that, of course, has to do with we are making those A&R investments over a much smaller overhead base.

Within the four year period that we’ve owned the business, the investment returns on A&R have actually improved in the last two years versus the first two years, much of that because of the Atlantic/Elektra restructuring and the resuscitation of the artists rosters on the east coast.

And I think the last point I would make is, as I said many times before, the over-investment in chapter two or chapter three of a major artist’s career has historically been a poor return for the recorded music industry and the industry is replete with examples and I won’t go into them.

We continue to exercise a very high degree of financial discipline so that our investments do return superior results for our investors. And when we fail to make an investment, whether it’s in a new artist or in an established artist, it is almost always because we simply make an investment decision not to proceed with a project or a deal that we feel will not return according to the standards that we insist upon.

Doug Mitchelson - Deutsche Bank

Great, thanks.


The next question is from Ingrid Chung from Goldman Sachs.

Ingrid Chung - Goldman Sachs

Good morning. Thank you. So two questions -- to start off, to use a baseball analogy, which inning do you think you are in terms of the investment cycle for A&R and also to become a 360 music company? Or is it more of an ongoing investment?

And then number two, could you talk a little bit more about the tighter retail management of inventory? It seems like it had almost a -- it looks to me like a 1,500 basis point impact on your domestic growth. When do you see that returning back to normalized levels?

Edgar Bronfman

I’ll let Michael do the second part of your question and it was interesting to see your note earlier this morning, so let me try and answer some of the questions that you just asked and you posited in your note as well.

A&R investment is a continuing investment and I think as we’ve tried to indicate both in our prepared remarks and previous answers, we don’t expect our A&R investment to increase or decrease. We think we’ve got the right level of A&R across the right level of overhead and based on the extensive studies that we’ve done, those investments return very, very well for shareholders. So I don’t see that cycle increasing or decreasing. It’s more of a constant.

In terms of the 360, we’ve made a series of investments and as we indicated I think in prepared remarks, we expect going forward that our business will benefit from really monetizing those investments rather than making incremental investments. And I guess lastly I’d say that we’ve had enormous success both in the U.S. and globally in signing new recording artists with significantly broadened rights without significantly increased investment to obtain those rights. So we think that will continue and so I guess I would say we don’t expect significant M&A activity to broaden our 360 platform. We think we will continue to do that organically and with the M&A activity that preceded us. And as I said, A&R remains sort of a constant rather than a cycle.

Michael D. Fleisher

On the question of retailers and how they are managing inventory, I think our view is that especially coming off of the holiday season when inventory levels are extraordinarily high at retailers, they are intentionally growing their inventories through the holidays, up to and including through the holidays. And so as we went into the first calendar quarter, I think our physical retailers, smartly for their businesses, by the way, chose to work down those inventory levels. And one of the practices in our industry historically has been in those kinds of quarters, to discount dramatically particularly around catalog product in order to push inventory from our loading dock into the inventory of our physical retailers.

And we’ve been I think quite clear that we are not going to bow to that kind of pricing pressure, particularly in catalog where we know that catalog will sell through, because when a consumer is actually looking for a piece of particular catalog product, they are happy to pay full retail price for it.

I expect that we’ll continue to see retailers, physical retailers try to manage their inventory better and smarter. We are actually proactively working with a number of our retailers to do that in concert with each other. We have a pretty good handle on it. They have an okay handle on it and together we can actually create a better inventory pattern for both of us. I would expect that to continue. It has happened. It has been happening over the last year. It will continue over the next year. I do think there was a bigger impact this quarter largely because of the holiday inventory build-up.

Ingrid Chung - Goldman Sachs

Okay, great. Thanks.


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

Jessica Reif-Cohen - Merrill Lynch

Thank you. I have one clarification and two questions. On the clarification, with respect to the balance sheet, could you tell us what your current net debt to EBITDA position is under the covenant definition?

And then the two questions are what is your digital margin now that 34% of U.S. sales and 21% overall of your sales come from digital?

And secondly, more on timing, when do you expect to see some meaningful benefit from MySpace Music?

Edgar Bronfman

Let me start with MySpace and I’ll ask Michael to answer, to clarify the balance sheet issue and the digital margin question. MySpace Music I think is going to launch probably around the September time, and so I would expect if it launches in September, I hope it will have a strong December quarter and then we think it can and will gain momentum beyond that.

So I wouldn’t see anything meaningful from MySpace until our ’09 year, and then obviously we would hope that given the breadth of the offering that we believe MySpace Music will have for consumers we hope that that will become an important contributor as the years go on. But nothing I don’t think of size at all in ’08.

Michael D. Fleisher

On the question on the ratios, we don’t disclose the ratio. The calculation is relatively straightforward. There are some add-backs for things like non-cash charges, FAS-123, et cetera. What I can say is that certainly the ratio at March 31st, where we had to be under 4.5, we were very comfortably under that number.

On the digital margins, I’m not sure I fully understood your question. We clearly get a margin benefit from digital sales versus physical sales.

Jessica Reif-Cohen - Merrill Lynch

Sorry, I was just wondering if you could elaborate on that a little. I mean, you’ve said that -- now that it’s becoming a meaningful contributor to revenue, can you size that at all?

Michael D. Fleisher

It’s a meaningful contributor to revenue and a meaningful contributor to our profitability and I would expect that to continue but we are not going to give any greater detail. We have said in the past that there is a substantial margin benefit from digital and we will continue to see that benefit as the digital business grows.

Jessica Reif-Cohen - Merrill Lynch

Thank you.


The next question is from Jason Bazinet of Citigroup.

Jason Bazinet - Citigroup

I think the amount of money you paid for acquisitions stepped down in the quarter but when I go back over the last four quarters, if I’m doing the math right, you spent about $317 million on acquisitions I guess what’s interesting, when I look at the numbers that you are reporting on year-ago revenue, I think you are reporting those numbers pre any of that M&A. And so I was just wondering, is that right and will we ever get a sense of a sort of pro forma clean numbers after the acquisitions? Thanks.

Michael D. Fleisher

I’m not sure of the question. I’m not sure I understand. On the reporting, as we acquire businesses, we add them into our revenue and our profit mix. That is true of all the businesses we acquire where we are consolidating them. Some of our more substantial investments, as an example, Frontline, are not being consolidated. So we are only picking their profitability up below the line, our share of their profitability. And so I think when you certainly look at the dollar value of investments, you do need to sort of reverse out of that some of those that aren’t contributing to the revenue line at this point in time.

Jason Bazinet - Citigroup

But for the -- when I look at the March ’07 number that you put out in the release, those numbers are not pro forma, correct? Are those revenues that you do consolidate?

Michael D. Fleisher


Jason Bazinet - Citigroup

And will you ever disclose those?

Michael D. Fleisher

I don’t think we have any intention to.

Jason Bazinet - Citigroup

Okay. Thank you.


The next question is from Rich Greenfield from Pali Capital.

Rich Greenfield - Pali Capital

A couple of questions; one, just to kind of follow-up on Jason’s question, you’ve commented in the past about the relative impact of acquisitions. If your revenues were down about 4% on a constant-currency basis, can we assume similar to last quarter that you were down several more points, possibly in the area of 7% to 10%, if you remove the impact of acquisitions year over year?

And then two, you’ve got a couple of big artists currently in the process of contract negotiations in terms of Nickelback and Metallica and I’m wondering what you could tell us in terms of where that stands. I know Nickelback relates to RoadRunner, which you bought last year. That contract I assume expires before they have to deliver their next album. Any clarity would be great on that.

And then just lastly, given that you are cutting the dividend, why did you actually make the acquisition of Frontline as a non-consolidated acquisition? That would have saved you over $100 million and allowed you to pay the dividend for a good while longer. I’m just trying to understand what the rationale for that acquisition was. Thanks.

Edgar Bronfman

You know, the old thing, you grant a premise, you can win any argument. You’ve got so many premises there that are wrong. I’ll try and take them one by one. Michael can do and I’ll ask him to do a better job on the acquisitions but your premise there is in terms of what our revenue would have been is wrong.

In terms of the artist contracts, just to be clear, the Nickelback contract does not expire when we purchase RoadRunner. We have two additional Nickelback studio albums and a greatest hits to come under the contract when we purchase RoadRunner, so there is no pressure on us to negotiate to get additional Nickelback albums, unless of course we did so on an improved financial basis. But there is no urgency for a Nickelback renegotiation other than to improve our financial position, if we chose to do that.

Metallica is at the end of their contract. That’s been a long and great association. We have an album due from Metallica to go before the end of that contract and we don’t comment specifically on artist negotiations beyond that. But again, your -- I just want to be clear about your notion there.

Michael, do you want to give any color on the acquisitions?

Michael D. Fleisher

I guess what I would say on the acquisitions is most of the acquisitions that are sort of generating incremental revenues, we’ve sort of passed their anniversary or we are three quarters through their anniversary, so I don’t think at this point there is any of the consolidating acquisitions that we are doing. I don’t think there is sort of a meaningful year-over-year revenue impact, if you look at this quarter versus the previous quarters.

Edgar Bronfman

And on Frontline, first of all, Frontline was a large, unconsolidated investment. Smaller but still meaningful ones that would also be included would be iMeme and Lala. So that a fair amount of the money that Jason described is going to unconsolidated investments.

We think all of those will bear significant fruit, which is why we made them. Frontline continues to be an expanding and very profitable business and give us a tremendous insight into the management business and the artist perspective on the revenue streams that they are able to generate and significantly enhances I believe our ability to both sign and properly exploit the revenue streams we are bargaining for in new contracts, as well as giving us an insight and background into how to respond to changes in the industry, while being an accreting asset for our shareholders.

With regard to iMeme and Lala, we have a lot of faith in those businesses. If we look at what is happening with iMeme right now, based on its funds raised, I would suggest that our investment is worth a great deal more than we paid for our original investment.

So we make accretive acquisitions where they can benefit the company, where they can further a business model that we think is helpful and trading a dividend for a Frontline investment in my view is a good trade.

Michael D. Fleisher

I think we have time for one more question.


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

Tuna Amobi - Standard & Poor’s

All right. Thanks a lot. I guess my first question is on the MP3 deals that you guys have made in the past couple of -- over the past year, I think you’ve gotten a lot more aggressive in these deals, I think. This year it seems like it’s been an inflection point for the industry in terms of the newer services that we have seen. So I guess the question there is do you think that this market, this digital market for MP3 can co-exist side-by-side with DRM? And if so, how do you think they play off each other? Is there any potential that we are going to see overall growth of the digital music market, the pie is going to grow or is there any potential for cannibalization there?

Edgar Bronfman

I think you are going to continue to see a mix of DRM and DRM-free product in the marketplace. Certain business models like subscription require some levels of DRM. Other kinds of business models, such as purchase, don’t absolutely require it. And I think as business models evolve, you’ll see a mix of DRM and DRM-free. But clearly the digital music market continues to grow. It continues to grow at a strong pace and I think my hope is that that growth will accelerate as the business model significantly expand.

Remember that today our digital revenues really are a function of iTunes, principally, and ringtones. That is still a very, very narrow base for a very, very broad opportunity and those opportunities will come online. We will see additional business models. We will see additional retailers. We will see social networks begin to play an important role. We will see advertising begin to play an important role. We will see ISPs begin to play an important role.

And so the source of funds in digital will continue to grow and as they do, it is my hope that the business’ growth itself will accelerate over the next few years.

Tuna Amobi - Standard & Poor’s

And just to follow on on that digital growth that you just alluded to, of those four buckets that you had earlier identified, where do you see the greatest growth coming from and also on digital, when you do these expanded 360 deals, I presume that digital licensing is a core part of those deals. Am I correct or not?

Edgar Bronfman

Well, let me answer the second question first -- digital rights for recorded music is something that we have in all of our contracts and have had in all of our contracts, so there is nothing new there. Clearly as we have expanded rights with artists in terms of fan clubs or merchandise or ticketing or touring or those kinds of things, some of those apply to the digital world as well, some of those, like touring, apply less to the digital world.

In terms of the -- but clearly where we have rights, we have them in both the physical and the digital world.

In terms of where those four buckets are going to come from, if you think of them as a purchase model, an advertising model, a subscription model, and an access model, and you say which is going to be the largest, assuming that they call come on and they are all robust, I would suggest over time the access model has the best opportunity to be as large or larger than the purchase model, just given the base of mobile subscribers at about 3 billion. But that’s not to say that that model will come on-stream early or will end up being robust. But I think as you look at the general buckets and the opportunity, there’s purchase, there’s access, there’s subscription, and there’s advertising.

But unlocking the value of mobile networks and mobile consumers remains the industry’s largest opportunity, just given the vast numbers of consumers who now have access to a product they never had before.

Tuna Amobi - Standard & Poor’s

Okay. Thank you very much.

Edgar Bronfman

Thanks, everyone.


That concludes today’s conference. You may disconnect at this time.

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