Warner Music's CEO Discusses F1Q2014 Results - Earnings Call Transcript

| About: Warner Music (WMG)
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Warner Music Group Corp. (NYSE:WMG) F1Q2014 Earnings Conference Call February 6, 2014 8:30 AM ET


James Steven – Senior Vice President-Communications and Marketing

Stephen F. Cooper – Chief Executive Officer

Brian Roberts – Executive Vice President and Chief Financial Officer


Aaron L. Watts – Deutsche Bank Securities, Inc.

Davis Hebert – Wells Fargo Securities LLC


Welcome to Warner Music Group’s First Quarter 2014 Earnings Call for the period ended December 31, 2013. At the request of Warner Music Group, today’s call is being recorded for replay purposes and if you object, you may disconnect at any time. As a reminder, there will be a question-and-answer session following today’s presentation. (Operator Instructions)

Now, I would like to turn today’s call over to your host, Mr. James Steven, Senior Vice President of Communications and Marketing. You may begin.

James Steven

Good morning, everyone. Welcome to Warner Music Group’s fiscal first quarter 2014 conference call. Both our earnings press release and the Form 10-Q we filed this morning are available on our website.

Today, our CEO, Steve Cooper, will update you on our business performance and strategy; our Executive Vice President and CFO, Brian Roberts, will discuss our financial condition and results, and then both of them will take your questions.

Before Steve’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.

All forward-looking statements are made as of today and we disclaim any duty to update those 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 contains 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 Steve Cooper.

Stephen F. Cooper

Good morning everyone. Thanks for joining our first quarter earnings conference call for fiscal 2014. We spoke in mid-December, so I will keep my comments brief. As we mentioned then, we knew this would be a slower quarter since our release schedule is second half waited.

In the first quarter, including PLG, constant currency revenue grew by 7%, adjusted OIBDA grew by 7%, and adjusted OIBDA margin was flat at 15%. Excluding PLG, constant currency revenue declined by 3% and adjusted OIBDA declined by 11%.

There were a number of bright spots for the quarter. Music Publishing posted strong results and we continue to see solid growth in streaming revenue for our Recorded Music business. I will discuss those in just a moment but first, let’s step back and look at a few recorded music industry trends from calendar 2013.

According to SoundScan, in 2013 the industries U.S. track equivalent album sales declined by 8%, digital albums finished the year flat, individual tracks fell 6% and physical sales declined by 13%.

However, it’s no longer possible to measure the health of the U.S. recorded music industry based only on unit sales data. Unit sales data misses the bigger picture as it doesn’t take streaming into account, and streaming has become a meaningful piece of our business.

Nielsen reported that industry wide streams from video services such as YouTube, digital radio services such as iHeartRadio and subscription services such as Spotify grew 32% in the U.S. in calendar 2013.

In the U.K., DTI [ph] reported that wholesale music revenue was very stable in 2013 declining less than 1%. Partially driving this growth was subscription-based streaming revenue which grew 34% in 2013 and accounted for more than 10% of total U.K. recorded music revenue. The U.K. also saw a 7% increase in digital album unit sales, along with a 4% drop in digital tracks and a 13% decline in physical albums.

In Germany, the world’s fourth largest music market revenue increased in 2013 for the first time in 15 years growing 1%. While the digital music business including streaming increased 12% there, the physical business remained relatively stable with a decrease of only 2%.

Given the growing importance of streaming revenue to our industry, we are pleased to see a great deal of activity and competition in the subscription space. For example, Beats Music launched in the U.S. on January 21 with a playlist-based subscription music service. The service has been heavily promoted with a marketing plan that includes a major integration deal with AT&T, where AT&T is offering Beats Music's subscriptions with monthly smartphone service in both individual and family plans.

Deezer which already has 5 million subscribers announced in November that it would launch in U.S. in 2014. And Spotify announced in December that it had started offering a free tour of its mobile service and have expanded to an additional 20 markets. We view the expansion of these and other streaming services as an important component of continued growth in the music industry. In fact in certain European territories, streaming is eclipsing downloads as our leading source of digital revenue.

As the music industry remains in transition, we continue to focus on our core competencies to weigh in our marketing and promotion and investment in artists and executive talent.

In Recorded Music, we’re encouraged by some of our international successes in calendar 2013. Globally according to [indiscernible] we owned or distributed the music for three of the Top 10 selling artists of the year including at number four, Bruno Mars; at seven, Macklemore and Ryan Lewis; and at nine, Michael Bublé.

In the UK, we finished the year on a high note. Incredibly, Michael Bublé had the year’s biggest selling album from an international male artist for the fifth consecutive year. In addition, Michael also had two albums in the Christmas Top 10, a historic achievement. Also in the UK, Rudimental was one of the year's biggest breakthrough outs, thanks to their number one platinum selling debut album, Home.

James Blunt had his highest charting single in seven years helping to propel his latest album, Moon Landing to platinum status in a number of international markets. Somewhere Only We Know, a single from Parlophone artist Lily Allen, topped the chart for three weeks over the holidays. As a result of these and other successes our artist album share in the UK improved nearly 3 percentage points to 16.1% in calendar 2013.

In Australia, we finished 2013 with seven of the top 15 albums for the year. Michael Bublé garnered two of the top in there as well. In Brazil, we had seven of the top 15 albums leading to a nearly 4 percentage point year-over-year album share increase. In Finland, we had seven of the Top 10 and 13 of the Top 20 albums for the year. And in Italy, we had three albums in the Top 10 including Mondovisione from Ligabue which was certified four times platinum in just five weeks.

So we remain excited about our release schedule for the fiscal year as a whole which as we previously noted will be far more heavily weighted to our second half when we are expecting releases from a number of our biggest artists.

Retracting and retaining executive talent is key to our business. It strengthens our ability to retract and retain the finest new and established artists and to effectively market and promote their music. So we’re very pleased to welcome Dan McCarroll as President of Warner Bros. Records and Peter Thea as its EVP of Creative Operations. They will be joining Dion Singer, EVP of Creative Marketing and Brian Frank, EVP of Marketing and Strategy as part of the Senior Warner Bros. Records team reporting to Cameron Strang.

Now Warner/Chappell, Clark Miller has joined as EVP of our North American operations reporting to Cameron Strang and working closely with Jon Platt, Warner/Chappell’s North American President.

We are also encouraged by the results of our PLG integration plans, so far and they remain on schedule. In fact in certain key areas of strength for PLG such as classics, we began to reinvest some of our cost savings into growth opportunities.

Now turning to Music Publishing. As I mentioned earlier, Warner/Chappell had a solid quarter. We grew all components of our music publishing revenue. We increased OIBDA and we expanded OIBDA margin. We grew sync revenue reflecting growth in many segments in U.S. including commercials, movies and video games and we increased performance revenue as a result of the timing of collections.

Mechanical revenue benefited from higher distributions in several countries in Europe, while digital revenue increased due to the growth in streaming.

Warner/Chappell also had significant A&R and chart success in calendar 2013. Its song writers contributed to nine of SoundScan’s Top 10 U.S. albums including notes from Justin Timberlake, Eminem, Luke Bryan, Bruno Mars and Beyoncé. We also controlled portions of eight of the Top 20 U.S. digital songs of 2013 including PINK’s, “Just Give A Reason” and Katy Perry’s, “Roar”.

With respect to artists and writers, we’ve had a number of important music publishing assignments over the last few months. We recently extended our partnership with international superstar, George Michael, and will continue to administer the worldwide rights to his entire catalog. George is one of the finest catalogs in contemporary music and has received countless industry accolades over the course of his career.

With its joint venture publishing partner, Combustion Music, Warner/Chappell also recently expanded its worldwide co-publishing agreement with country song writer Ashley Gorley. Named the number one country song writer of 2013 by Billboard, Ashely has penned 13 number one singles including recently, Luke Bryan's “That's My Kind Of Night” and Randy Houser's, “Runnin' Outta Moonlight.”

We also signed a worldwide publishing agreement with top charting song writer Chris Stapleton. Chris has written four number one country hits including “Love's Gonna Make It Alright” by George Strait. “Come Back Song” by Darius Rucker, “Your Man” by Josh Turner and “Never Wanted Nothing More” by Kenny Chesney.

Additionally we signed a worldwide publishing agreement with acclaimed vocalists and song writer Aloe Blacc. Aloe is the vocalist and co-writer on one of 2013’s biggest global success stories, Swedish DJ Avicii's massive hit, “Wake Me Up,” which has risen to number one in over a 100 countries.

I wanted to take a moment to congratulate all of the Warner Music Group recording artists and song writers who received Grammy Awards in January. Among our winners were Bruno Mars, Gary Clark Jr., Michael Bublé, JT, Emmylou Harris and Rodney Crowell and Kacey Musgraves.

Macklemore and Ryan Lewis took home four awards making them one of the night’s biggest winners. Served by AGA and Warner Brothers, this duo was undoubtedly the breakthrough act of the year.

Finally, I would like to make special mention to the legendary Led Zeppelin's, who won Best Rock Album for “Celebration Day”. While they were given a life-time achievement award in 2005, amazingly this was the first time Led Zeppelin received a Grammy for one of their Albums.

Finally given our continuing efforts to boost the performance of our Sync and Licensing business, we are pleased to replace songs in ten Super Bowl commercials including ads for Pepsi, Coca Cola, Chevy and Budweiser. I hope many of you got to see two of our key artists, Bruno Mars and the Red Hot Chili Peppers perform at the Super Bowl half time show this past weekend.

I am pleased with the progress we’re making throughout our business. We continue to focus on long-term artist development, digital innovation, revenue diversification and cost savings, while continuing to invest in growth opportunities.

So with that let me turn it over to Brian, who will walk you through our financial results in more detail.

Brian Roberts

Thank you, Stephen. Good morning everyone. As Steve mentioned and we anticipated our revenue results for the quarter reflect a late release schedule. On a constant currency basis including PLG revenue grew 7%. Excluding PLG which contributed $74 million of revenue in this quarter, our constant currency revenue declined 3%.

From an OIBDA perspective certain adjustments are necessary to make the year-over-year comparisons more meaningful. We have highlighted these in our press release, so let me walk you through them.

In the quarter we had $20 million in professional fees and integration costs associated with the acquisition of PLG including IT, supply chain and royalty’s integration costs, legal and order fees, retention bonuses and transitional employee costs and $7 million in restructuring expenses which were employee related in connection with the PLG integration.

Backing out these items adjusted OIBDA for the quarter grew by 7% to $120 million and adjusted OIBDA margin was largely flat at 15%. Excluding PLG which contributed $20 million in adjusted OIBDA this quarter, adjusted OIBDA declined 11%.

And looking at PLG’s OIBDA results, there are a few factors worth noting. First, like the rest of our release schedule, PLG's releases are backend weighted this year. Second, upon closing the acquisition, we were required to make certain changes for accounting policy differences between WMG and PLG. These changes primarily related to the booking of broadcast fees and the resulting timing differences with related PLG revenue being recognized by WMG, later than under PLG's previous accounting policies.

Third, as Steve mentioned, we're excited to reinvest a portion of the cost savings we derived from the integration with promising growth areas such as classics. As Steve mentioned we are moving forward as expected with our integration plans and remain on track to deliver projected cost savings and operating strategies.

In Recorded Music we delivered 6% revenue growth in the quarter on a constant currency basis. Excluding PLG, constant currency revenue declined 5%.

Digital revenue grew 9% in constant currency and was largely flat excluding PLG. This result reflects strong worldwide growth in streaming revenue and growth in international download revenue offset by revenue declines for downloads in the United States. These declines are result of release schedule compounded by U.S. unit declines for downloads across the industry.

Recorded music licensing revenue grew by $18 million in the quarter of which $10 million was from PLG. The remainder of the licensing growth largely reflected new deals and increased broadcast fees. Artist services and expanded rights revenue was up $24 million, $2 million of which was from PLG. The increase was the result of tours operated by our European concert promotion businesses, primarily in Italy, France and Germany including tours for Bruno Mars, Christophe Maé, Rapper Z-Ro and Laura Pausini.

As a result, artist services and expanded rights revenue represented 12% of Recorded Music revenue as compared to 9% in the prior year quarter. Recorded Music adjusted OIBDA grew 5% to $120 million in the quarter and Recorded Music adjusted OIBDA margin was flat at 17%. Excluding PLG Recorded Music adjusted OIBDA declined 12% related to our late release schedule.

Music Publishing revenue was the highlight this quarter with growth of 10%. Steve mentioned all revenue segments in the publishing business grew.

OIBDA was also up nicely with 19% growth and OIBDA margin improved by one percentage point to 15%. Operating cash flow in the quarter was negative $52 million. Keep in mind that our fiscal first quarter is historically a negative working capital quarter due to a number of factors including seasonality of physical holiday collections, timing of certain A&R investments and the timing of annual employee bonus pays.

This quarter was further burdened by cash expenses related to the PLG integration as well as costs associated with the set up of releases scheduled for later in the fiscal year. We remain keenly focused on cash management and are committed to delivering solid free cash flow for the whole of fiscal 2014. As of December 31, our cash balance was a $129 million, you will note in our 10-Q that we finished the quarter with $55 million drawn on our revolver.

We’ve long said we would use the revolver to help fund the short-term liquidity needs and that it was necessarily this quarter due to cost associated with the PLG integration. We will continue to use the revolver in this manner.

CapEx came in at $12 million in the quarter and as we said last quarter, we expect meaningful increases in 2014 CapEx as we continue to invest in long-term upgrades to our IT infrastructure, relocate our corporate headquarters, consolidate our offices across Europe in connection with the PLG integration, and take on some additional CapEx related to PLG’s supply chain and IT.

As Steve, noted we continue to make progress throughout our business focusing on artist development and digital innovation, diversifying revenues and managing costs carefully, while continuing to invest in growth opportunities.

With that, operator please open the line for questions.

Question-and-Answer Session


(Operator Instructions) The first question is from Aaron Watts from Deutsche Bank.

Aaron L. Watts – Deutsche Bank Securities, Inc.

Good morning guys.

Stephen F. Cooper

Good morning Aaron.

Brian Roberts

Hey, Aaron.

Aaron L. Watts – Deutsche Bank Securities, Inc.

Two questions from me. I guess, Steve just to clarify your remarks on your release lane expectations, so am I right in saying that this coming March quarter is again going to be a little bit light for you, but that the June and September quarters, is where you think you release like just a little heavier.

Stephen F. Cooper

The answer overall is just albeit I believe in the beginning – early in the third quarter we’ll begin to release some singles, and then as we go more heavily into the third and fourth quarter Aaron, we’ll be coming out with knock on wood a number of very substantial releases from some of our biggest artists.

Aaron L. Watts – Deutsche Bank Securities, Inc.

And you're talking about your fiscal quarter or the calendar year?

Stephen F. Cooper


Aaron L. Watts – Deutsche Bank Securities, Inc.

Okay. Got it. Okay. And then just on the artist services expanded rights line item as well as the licensing you mentioned why you saw a little bit of a bump there? Was there any benefit from the Clear Channel arrangement that you had reached with them or is that not impacting that at all?

Stephen F. Cooper

It's not meaningful in that line, Aaron. There is a real impact in that line for us in the quarter was what I just ran over the impact of the tours around our concert promotion businesses [indiscernible].

Aaron L. Watts – Deutsche Bank Securities, Inc.

Okay. On the publishing side, with the mechanical category, I know you saw growth there and you said it was more timing related, was there any sense of that stabilizing going forward or really was it just a timing issue in the quarter?

Stephen F. Cooper

It is really a timing issue in the quarter, Aaron I think you’ll see results for the publishing company around mechanical the performances like that, vary quarter to quarter, so this really was just a timing issue.

Aaron L. Watts – Deutsche Bank Securities, Inc.

Okay. And I think you touched on this, but industry digital track and album sales had a fairly noticeable fall off in the back half of 2013. And you sensed that in your thoughts, a few more of your thoughts on whether the factors that drove that decline will continue in 2014.

Stephen F. Cooper

Well, I think it is a concern Aaron. If you look at the download world, it is dominated by iTunes, hence we all know. But Apple is becoming a smaller and smaller percentage of the smartphone universe. So, if you look at it today, without an iOS acceptable application where Android phones can access iTunes, 85% or 87% or 90% of the smartphone population is blocked out of the Apple Ecosphere. And while we see a little more traction on the part of Amazon and Google Play, that traction or that growth in those two services hasn't been able to date offset the downward pressure on Apple.

So I would expect that because of the declining percentage of the smartphone universe and because of the gaming traction of streaming, that we should expect to see ongoing choppy waters relative to these à la carte downloading services, Aaron.

Aaron L. Watts – Deutsche Bank Securities, Inc.

Okay. That makes sense. And yes, maybe if kind of connected to that, you mentioned the nice growth on the streaming side. As we think about the transition that occurred when we saw it growing from physical to digital downloads and the impact that had on kind of the revenue and cash flow of the industry and Warner Music. How should we think about maybe a transition that’s going to happen from digital downloads to streaming? Is that more of a seamless transition for the business where the revenue and cash flow from streaming can more equitably [ph] offset the decline in digital downloads if that happens?

Brian Roberts

Well, I think that ultimately that's what we believe. And you have to keep in mind when you say streaming that you really have to look at a very important subcomponent which is subscription. And subscription continues to grow, a subscriber with a regular monthly payment and predictable cash flow is very valuable to the industry. And as the services grow and they end up whether it’s on the free side, as they grow we expect that they will get more and more traction with advertisers and that over time both sides of those businesses should prove to have viable long-term sustainable economic models which is our current view.

Aaron L. Watts – Deutsche Bank Securities, Inc.

Okay, great. Thank you for taking the questions.

Stephen F. Cooper,

Sure. Incidentally Aaron.

Aaron L. Watts – Deutsche Bank Securities, Inc.


Stephen F. Cooper,

It has more to do incidentally.

Aaron L. Watts – Deutsche Bank Securities, Inc.

I know I apologize.


(Operator Instructions) The next question is from Davis Hebert from Wells Fargo Securities.

Davis Hebert – Wells Fargo Securities LLC

Good morning everyone. Thanks for taking the question. I wonder if you had any thoughts around the Copyright Royalty Board, I think they started the proceeding to look at webcasting royalty rates. And it kind of considered moving to a percentage of revenue royalty rather than a per play. Just curious if you had any thoughts around that and how that might effect, you know that the streaming business longer-term?

Stephen F. Cooper

So I think on that one it’s really very early days where they are in that process [indiscernible] and the discussions are just starting. It’s really not going to kick off until the back half of this year. So I think for us to get into sort of our view about it right now will just be way too early.

Davis Hebert – Wells Fargo Securities LLC

Okay. Fair enough. And if you could talk about the international side, perhaps on the streaming side, are there differences in growth characteristics between domestic and international and what's the difference in sort of the subscriber penetration if you will – paying subscriber penetration now on the international versus domestic?

Stephen F. Cooper

Well, Davis, it actually depends on – it's really a territory by territory sort of issue. So by way of example, the U.S. is now just digital whether it be download or streaming, more than 50% of our revenues on the digital side and as you know we continue to have fairly rapid decline in physical. If you look at the Nordics, the Nordics are very little physical and are highly, highly digital, mostly streaming. If you look at Japan, Japan remains a heavily physical – Japan is the second or third largest market in the world, second I think actually. And they remain a heavily physical marketplace where smartphones and digital whether it would be downloading or streaming is making some but not meaningful as you had inroads.

Germany ends up being a highly physical market and again while digital including streaming is beginning to make inroads, it’s been slower than in other parts of Europe. So it just actually depends on the kind of the not only the specific market but what has been people’s historical leanings to either physical or digital and in some markets it’s changing more rapidly and others candidly it’s dragging.

Brian Roberts

Davis, I know Steve said in his comments to that, we now are seeing in certain European markets that streaming is becoming sort of a lead over download. So it is a market-to-market thing.

Davis Hebert – Wells Fargo Securities LLC

Okay, great. That’s really helpful guys, I appreciate it.


There are no further questions from the phone at this time.

Stephen F. Cooper

Thanks everybody. Have a wonderful day and it’s sunny in New York with no snow, so God bless.


That concludes today’s conference, please disconnect at this time.

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