Warner Music Group Corp. (WMG) Q1 2013 Earnings Report, Transcript and Summary

Welcome to Warner Music Group's First Quarter 2013 Earnings Call for the period ended December 31, 2012. 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, Mr. Will Tanous, Executive Vice President, Communications and Marketing. You may begin.

Good morning, everyone. Welcome to Warner Music Group's fiscal first quarter 2013 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 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 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 the 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.

Good morning, everyone. Happy Valentine's Day and thanks for joining us. While the primary purpose of this call is to discuss our first quarter results for fiscal '13, I'd like to take a moment to comment on our recently announced acquisition of Parlophone Label Group from Universal Music. This transaction underscores our commitment and the commitment of our owners to making us the world's premier music company by actively and thoughtfully investing in artists, catalogs, executive talent and state-of-the-art systems. The Parlophone Label Group, which had been a part of EMI Music, is comprised of the historic Parlophone Label, the Chrysalis and Ensign labels, as well as EMI Classics and Virgin Classics. We're also acquiring EMI's recording music operations in Belgium, the Czech Republic, Denmark, France, Norway, Poland, Portugal, Slovakia, Spain and Sweden. Its artist roster and catalog of recordings include, among many others, Coldplay, David Guetta, Duran Duran, Iron Maiden, Jethro Tull, Kylie Minogue, Pet Shop Boys, Pink Floyd, Radiohead, Tina Turner and Tinie Tempah, as well as many developing and up and coming artists. This is a unique opportunity for us to combine forces with legendary record labels and artists that are highly complementary to our existing organization from a creative, geographic and strategic perspective. We have attained commitments to finance this transaction to renew term loan facility and we expect the transaction to be neutral to our leverage ratio on a pro forma basis, maintaining our commitment to financial discipline. Turning now into our quarterly results. We are pleased with the start we've had to our fiscal year. In the first quarter, we achieved 17% growth in total constant currency digital revenue, which, along with an increase in Recorded Music licensing revenue, offset the decline in Recorded Music physical revenue for the quarter. We increased OIBDA by…

Thank you, Steve, and good morning, everyone. As Steve mentioned, we are all very excited about the Parlophone Label Group investment. A couple of additional points on that before turning to our quarterly results. First, we have obtained commitments to finance the transaction through a new term loan facility provided by Credit Suisse, Barclays, UBS, Macquarie and Nomura. Given our continued commitment to financial discipline in our investments, it is important to reiterate that we expect the transaction to be leverage ratio and neutral on a pro forma basis. Second, the transaction is expected to close midyear 2013, pending certain regulatory approvals and a consultation procedure with employee representatives in France. Therefore, based on confidentiality obligations associated with the transaction, we are constrained on what we can say about our acquisition of Parlophone Label Group. Turning back to our results. It's another strong quarter for the company. From a revenue perspective, digital revenue showed a significant increase, up 17%, with growth in both Recorded Music and Music Publishing. This was driven by growth in streaming and subscription revenue, as well as continued growth in download revenue. This total digital revenue growth, plus a 13% increase in Recorded Music licensing revenue, helped to offset revenue declines in non-digital Music Publishing and our physical Recorded Music business, keeping total revenue flat for the quarter. This quarter, our Artist Services and Expanded Rights revenue was flat as domestic growth from strong merchandising sales was offset by international declines in our European concert promotion businesses. We remain confident that this revenue will continue to grow over time, although fluctuating quarter-to-quarter based on the timing of tours. As in Recorded Music, Music Publishing digital revenue benefited from growth in download revenue and streaming and subscription revenue. Our solid performance in each of total OIBDA, Recorded…

[Operator Instructions] The first question is from Aaron Watts from Deutsche Bank.

A couple of questions all over the map here a little bit. But one of the digital revenues -- as you're signing up deals, are those digital revenue, the growth on a year-over-year basis, is that going to be kind of lumpy from quarter-to-quarter? Is it -- are most of your deals kind of in place now, so this kind of 16% growth is not kind of a spike up or down, quarter-to-quarter?

Aaron, no, we don't think that we're going to have a significant amount of lumpiness here. We've seen growth in this area quarter-over-quarter for a while. We've actually seen, as we've said in prior quarters, while we're seeing continued growth in downloads, that growth rate is slowing a little bit as compared to the growth rate that we're seeing now with the maturation of the streaming services around the world.

Okay, perfect. And then on the publishing side of the house, just thinking about the mechanical revenues there as it relates to, I think you had around an 11% decline on recorded -- physical recorded music. When does the publishing kind of come in line with the declines you're seeing on the physical recorded side? And maybe you can just talk to kind of the lag that's there, or how those 2 kind of relate from a timing perspective.

Yes, so there is a significant lag between how the declines appear in the Recorded Music business. They come sort of much more quickly on Recorded Music than they do in Music Publishing. Music Publishing delays, from a mechanical decline standpoint, can be as much as 18 months just by virtue of the fact that collections in the U.S. are delayed, just given the way record companies pay. There's just a quarterly delay, they can be collectible 6 months later. And then in foreign collections from the societies, they could be anywhere from 6 to 9 months from a collection standpoint, and then getting processed through our systems. It's another few months to a quarter around getting those mechanical revenues through the entire system. So there is just natural delay in the process.

Okay. And then one more for Brian. Just thinking about your expenses in the quarter and maybe thinking broadly about them going forward. If you were to kind of back out some of the noise, like with the comparisons with EMI and restructuring, how do you think about your expense growth in the quarter and kind of going forward?

So I think what we've said in the past about where we were in terms of achieving targeted cost savings, at $50 million to $65 million, we've actually been able to deliver on that. I think you've seen some of that come through just in the results. You've also taken a look at the projections that we have with -- common in EBITDA and you can see that those projected savings are actually coming down because they're being realized. So I think, overall, our expense growth now is going to be relatively modest around our existing operations, just in terms of signing up new employees, normal merit increases that we would have, operating lease cost increases, those kinds of things. You're not going to see major spikes, in my view, in our operating costs.

Okay, great. Last one for me, I appreciate you taking all these. Maybe for Steve, just -- I'll try a question on the Parlophone buy -- and it's really kind of broad-based, but have you reached out to the artists there at all and gotten any reaction from them, and kind of how the switch -- how they're thinking about coming over from EMI and how that transition happens for them? Just kind of their reaction.

Well, I think that there has been, in general, Aaron, amongst the artists, managers, the independents and others that have observed this are generally positive reactions. There's obviously, in the next few months, given the regulatory process, there's always some uncertainty. And the 2 businesses, through this process, remain separate and remain as competitors. Obviously, that puts some -- as appropriate restraints on what we can and can't do, but I have not gotten any indication that there's been anything other than good news about; this hopefully to-be-consummated transaction.

[Operator Instructions] The next question is from Andrew Finkelstein from Barclays.

Few questions. One, just coming back to physical. Just wondering what -- some pretty good releases in the quarter and some good international releases in France, it seems -- I might have thought that physical could do a little bit better even with -- and Bublé was still selling, I guess, this quarter, too, so this year -- but I was wondering if you could just say a little bit more about the physical and then maybe what you see, going forward, just generally on the physical side, taking into consideration the international as well as the U.S.

Right. So I think, Andrew, from a physical perspective, what you said is accurate. Bublé did continue to sell in the quarter. I think we said he sold roughly 2 million albums or something like that. But if you remember, last year, that number was 6 million albums. Predominantly, he's a physical artist. So from that standpoint, it is a very difficult comp year-over-year. But as we said, even with that decline, it was offset by growth in the aggregate in digital as streaming services become much more significant in their contribution to us. So we were able to maintain flat revenue overall. So I do think our expectations around physical is where we have thought they would be, both in the U.S. and in Europe. And I think, from a U.S. perspective, as we said, there has been some sort of positive digital trends around things, the decline in the aggregate last year. From a PEA perspective, total equivalent albums was not that significant. And with some of the things that are happening in Europe as we've anticipated, we'll see some physical declines that are deeper than in the United States. But they were all been sort of baked into how we look at our plan.

Yes, I mean, in particular, I guess, strong markets where there's a higher physical percentage, Germany, Japan, do you see any changes in either of those?

No, we actually don't. Those markets are still very strong from a physical perspective. As you know, Japan is in 80% -- north of 80% physical market, it's still a protective physical market. So we haven't seen any trends there that are different to what we've expected and what we've seen in the past.

Okay. And then on the digital side, could you give us the breakdown of downloads versus other, and maybe talk about how they performed?

Andrew, why don't I circle back with you on that one offline and I can give you that information.

Okay. And then I guess I've read a few press releases out there with some of the big labels or publishers going around some of the collection agencies on some of the royalties and rights out there. Can you talk about that's happening with regards to that?

Great. I'm assuming you're referring to what's going on with the U.S. with some of the publishers pulling their digital rights?

Yes.

Yes, so what happened was a couple of years ago, EMI Music Publishing was the first one to do that with ASCAP. And now, Warner/Chappell actually followed suit. And also Sony, ETV and EMI have done that from a BMI perspective. And I think what they're looking at is their ability to enter into more direct licensing relationships with these digital services, not to quite frankly, weaken the societies because I think the publishers still very much believe in the strength of collecting societies and their ability to license on their behalf, but to bring some flexibility from a licensing perspective around digital rights, as these services emerge.

Okay. And then last one for me, just M&A. Obviously, you guys are going to be, I'm assuming, busy digesting Parlophone. But can you talk about the environment sort of post the EMI sales? Is there -- did you see a wave of consolidation or continued consolidation among maybe independents that are left in the market?

I think it's likely that we'll see some level of activity into but frankly, Andrew, but frankly, many of them have -- many of them are capital constrained. So I think that it is more probable that the majors end up requiring hearing their independence as opposed to the lateral consolidation among independents. But that's just a point of view.

And I assume Warner would be active if that was the way the industry goes?

Well, I think to the extent that like -- all of our acquisition activities, they have to have the appropriate assets. And by that, I mean very high quality with good longevity. We have to be able to have the right value assigned to those assets and it has to fit within our strategic and tactical plans for the future, whether it be directly in the core music space or in complementary spaces around our business. But we are not at the mind to acquire solely to get bigger and acquire market share if in fact those businesses don't have the right aggregation of intellectual property, intellectual capital at the right valuation because we're going to continue as we had to maintain very good financial discipline around all of our activities including M&A.

Okay. And maybe I think I'll sneak one more, Brian. Do you have a budget? Could you give us some help on CapEx and investments for this coming fiscal year?

Yes, sure, Andy. We do -- from a capital perspective against our existing business, we're roughly at 35 this year, which I think we've always said historically, it's been sort of sub-30, but we've had an uptick in that and just around some of the investments that we're making in our IT systems.

There are no further questions from the phone.

Thank you, everyone. Again, happy Valentine's Day. Have a wonderful day and we'll talk to you next quarter. Bye-bye.

That concludes today's conference. Please disconnect at this time.