Warner Music Group Corp. (WMG) Q1 2016 Earnings Report, Transcript and Summary

Welcome to Warner Music Group's first quarter earnings call for the period ended December 31, 2015. 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. James Steven, Executive Vice President, Communications and Marketing. You may begin.

Good morning, everyone. Welcome to Warner Music Group's Fiscal First Quarter 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, Eric Levin, 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 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, our Form 10-Q and Form 10-K 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. Also, please note that all revenue figures and comparisons discussed today will be presented in constant currency unless otherwise noted. With that, let me turn it over to Steve Cooper.

Good morning, everyone. Thanks for joining us today. I'm very pleased with our first quarter results, which continue to reflect our strong momentum. Not only did we have a terrific holiday season, but our plan for delivering sustainable growth is paying off. Specifically, in the quarter, we grew total revenue by 11%, digital revenue by 25% and OIBDA by 34%. Our revenue growth came from a healthy variety of sources, with gains in nearly all key revenue segments and territories. Furthermore, that 11% revenue growth is on top of 7% growth in the prior year quarter. There are 2 points I'd like to highlight as we consider these results. First as you know, last June, we settled a lawsuit with SiriusXM regarding their use of pre-'72 recordings. Eric will share more of the specifics, but our portion of the settlement was $33 million, of which $24 million was booked as revenue in the first quarter. Importantly, even excluding this amount, our total revenue grew a robust 8%, digital revenue grew by 17% and OIBDA was up over 20%, further proof of the growing health of our business. Second, the strength of our results, coupled with our positive view on the future of the music industry, has paved the way for us to begin delevering. We recently announced plans to redeem $50 million of our 13 3/4% full-term notes. Eric will discuss the timing and the impact in more detail, but it represents a good first step in reducing our debt. Our strong performance in the quarter stems from our continued focus on 3 key priorities. First, we remain committed to generating a steady stream of great releases from a wide range of genres and regions, as well as from artists at all career stages. Our first quarter top sellers show the diversity we are shooting for, highlighted by Parlophone's Coldplay, Atlantic's Ed Sheeran, Warner Bros.' Enya, France's Johnny Hallyday, the U.K.'s Jess Glynne, the legendary Grateful Dead and the smash Broadway musical, Hamilton. Second, we are concentrating on expanding our international business. We had solid first quarter growth across both emerging and established markets. In China, we grew revenue close to 15%, while Latin America and Russia were each up over 20%. In addition, in Japan, our revenue also grew nicely, rising 11%, aided by music from a number of our local stars. Third, we want to drive commercial innovation, especially finding ways to turbocharge subscription streaming. Once again this quarter, we managed to accelerate the growth of our Recorded Music Streaming revenue, which grew 56%, excluding the SiriusXM settlement. While we report on our progress quarterly, our long-term success is predicated on a healthy ecosystem. So we're encouraged by the following recorded music industry data from calendar 2015 from the world's 4 largest music markets. In the U.S., consumption rose 15%, driven by a near doubling in the volume of streams, which rose 93%. In Japan for the first 9 months of calendar '15, digital revenue rose 6%, while physical declines were modest, down only 2% for the full year. In Germany, revenue rose 4%, thanks to streaming revenue leaping 97%. And in the U.K., consumption grew 4%, led by streaming, which rose 82%. These figures make it clear that streaming is on a trajectory to become our primary source of revenue. As there is an ongoing debate in the media regarding how artists should be paid for use of their music on streaming services, we wanted to take this opportunity to address the issue head-on. While the main form of compensation we receive from streaming services is revenue based on actual streams, there is some services from which we receive additional forms of compensation. First, there is compensation which is commonly referred to as breakage. This is derived from advances, minimum guarantees, non-recoupable payments and audit settlements. We are proud to have been recognized as the first major to implement a breakage policy, sharing this revenue with our artists since October of 2009. Second, there are equity stakes in some streaming services for which we have not paid. Although none of these equity stakes have been monetized since we implemented our breakage policy, today, we are confirming that in the event we do receive cash proceeds from the sale of these equity stakes, we will also share this revenue with our artists on the same basis as we share revenue from actual usage and digital breakage. This policy stems from our desire to continue building deep and lasting partnerships with our artists. We strongly believe that aligning our interests with those of our artists is not only good for our artists but also good for us and the health of the music industry. I'd now like to turn to our Recorded Music and Music Publishing results for the quarter. I'll start with Recorded Music, where we had a fantastic showing. Specifically, we grew total revenue by 12%, digital revenue by 26% and OIBDA by 37%. During the quarter, some of our biggest names had strong chart success. Coldplay's seventh studio album, A Head Full of Dreams, went top 5 in over 20 markets around the world, including all top 5 music markets. In recognition of their global powerhouse status, Coldplay will be headlining the halftime show at this weekend's Super Bowl. And Enya's Dark Sky Island, her eighth studio album, went top 10 in 14 countries worldwide, including the U.S., U.K., Japan and Germany. In addition, we saw a number of key releases from the -- 2015 have strong carryover sales during the important holiday season. Ed Sheeran's album, Multiply, was further fueled by the release of a special edition. Jess Glynne, who was the best-selling debut artist in the U.K. last year, saw her #1 album remain in the U.K. top 10 for every week of the quarter. And David Guetta's Listen continued to have multiple singles that top dance charts around the world. These achievements demonstrate our long commitment to artist development, which is now being reflected in the breakout global success of twenty one pilots. The band is a great example of what can happen when all the right elements are in place. The band's label is the Atlantic imprint, Fueled by Ramen, and their publisher is Warner/Chappell. Twenty one pilots' second album for Atlantic, Blurryface, debuted last May at #1 in the U.S. and is currently back in the top 10. During the quarter, the single, Stressed Out, reached #1 on the rock and alternative airplay charts. As evidenced in the band's rapidly expanding appeal, in December, the single crossed over to the main pop chart and recently reached the top 5 on the Hot 100. Meanwhile, twenty one pilots began a global arena tour last month and have already sold out 2 Madison Square Garden shows scheduled for August of '16. In the Broadway arena, we have also had groundbreaking success with the musical Hamilton, whose original cast recording's on Atlantic. In addition, Warner/Chappell is an investor in the show, and Lin-Manuel Miranda, the show's creator, composer and star, is a Warner/Chappell songwriter. The album was the first cast recording to reach #1 on the Billboard rap chart and achieved the highest debut for a cast recording on the Billboard top 200 since 1963. Our second quarter is off to a great start, with some tremendous new music already in the marketplace. This includes Panic! at the Disco's Death of a Bachelor, the band's first-ever #1 album in the U.S.; and Charlie Puth's debut album, Nine Track Mind. More high profile releases are planned later this year. Turning to results in Music Publishing. In the quarter, total revenue increased 6%, digital revenue grew 17% and OIBDA declined 71%, driven in large part by expenses related to the Happy Birthday settlement. While we are not satisfied with the drop off in OIBDA, there is a confluence of factors in addition to the Happy Birthday settlement that impacted our performance. Eric will provide more details, but I am confident that we will get back on course as the year progresses. We are committed to increasing the monetization of publishing rights and ensuring that Warner/Chappell and our strong writers receive their compensation for the value music creates. As such, one significant development this quarter is Warner/Chappell's direct license with Pandora, which will enhance revenue flow by improving performance royalties. Warner/Chappell is exploring a wide range of opportunities to grow our revenue with all of our digital partners. At the same time, Warner/Chappell continues to expand its talent base with recent signings, including: Grammy-nominated songwriter and producer, Dave Cobb, whose Atlantic Elektra label imprint, Low Country Sound, will soon release a new album featuring Zac Brown; Miranda Lambert; and Multi-Grammy nominee, Chris Stapleton; and songwriter and former American idol judge, Kara DioGuardi, whose credits include songs performed by artists including: Katy Perry, Britney Spears, Carrie Underwood and Santana. Following Jon Platt's appointment this fall as CEO of Warner/Chappell, he's been making a series of key appointments that are positioning the company for continued creative resurgence as well as long-term commercial health. This includes naming new co-heads of A&R in the U.S., the hiring of a new CFO and recruiting a new head of catalog promotions. Finally, I want to wish all of our many nominated recording artists and songwriters the best of luck at the upcoming Grammy awards. As our quarterly results prove, we are charting our own course to grow our business in an industry that remains in transition. I'm impressed every day with the creativity and devotion of our artists, songwriters and colleagues across the globe. Before Eric discusses the numbers, I want to acknowledge the loss of several musical icons in recent weeks: David Bowie, Glenn Frey of the Eagles, and Natalie Cole. All members of our family left us way too young, but we are blessed that their music will be with us forever. With that, I'd like to turn the call over to Eric.

Thank you, Steve, and good morning. We had a great quarter owing to excellent music and first class execution from our worldwide operators. I am very pleased that our robust results and stronger cash flow provide us with an opportunity to improve our balance sheet, with $50 million in deleveraging already planned. Turning to our first quarter results in more detail. Total revenue growth of 11% was impressive, coming on top of 7% growth in the prior year quarter. Although currency was a significant factor, we were able to grow about 2% on an as-reported basis. As Steve mentioned, our results this quarter included the majority of our share of the SiriusXM settlement. In total, we received $33 million in cash. In the quarter, we booked $24 million in digital revenue. In addition, there will be an ongoing revenue contribution from the settlement through December 2017 in the range of about $1 million in each of the next 8 quarters. As we mentioned last quarter, we, Sony, Universal and ABKCO, also reached a $90 million settlement with Pandora for the use of pre-'72 recordings, although the allocation of that settlement among the plaintiffs has not yet been determined. As a reminder, we will be treating our allocations of these settlements like any other payments from SiriusXM and Pandora, with the artist share being distributed through SoundExchange. From an OIBDA perspective, certain adjustments are necessary to make the year-over-year comparisons more meaningful. The details are in our press release. But in the quarter, we had no nonrecurring expenses versus the prior year quarter, when we had $14 million. Adjusted OIBDA, which excludes nonrecurring expenses rose 18% to $137 million. Adjusted OIBDA margin rose 2.1 percentage points to 16.1%, due largely to revenue growth and revenue mix. Recorded music revenue was up a meaningful 12%, or 8% excluding the SiriusXM settlement. Digital revenue increased 26%, driven by growth in streaming. Excluding SiriusXM, digital revenue was up 16%. Physical revenue was down 8%, reflecting industry trends and a number of strong physically centric releases in the prior year quarter. Licensing revenue rose 25%, benefiting from healthy sync activity in the U.S. and the timing of neighboring rights distributions. You may recall that in Q2 2015 was the first time we received PLG neighboring rights distributions from certain European countries, which could make for a challenging comparison in next quarter. Artist Services and Expanded Rights revenue rose 22%, driven by the timing of touring activity. Recorded Music adjusted OIBDA was up 30% to $152 million and reported music adjusted OIBDA margin rose by 4.2 percentage points to 20.6%. The margin improvement was primarily driven by revenue growth and revenue mix. Music Publishing revenue rose 6%. While mechanical revenue declined 5%, digital revenue was a standout, increasing 17%. Sync rose 9% and performance rose 8%. Music Publishing OIBDA declined 71%, with margin down 10 percentage points to 4.3%. Cost related to the Happy Birthday settlement represented over half of the decline. While the settlement, net of insurance proceeds, is immaterial to our overall business, this effect was larger in this quarter where OIBDA is traditionally smaller. Music Publishing OIBDA was also impacted by the as reported revenue decline, revenue mix, severance costs and timing of distributions. As Steve indicated, we are not satisfied with this OIBDA performance and are working towards OIBDA growth over the balance of the year. I'm pleased that our cash situation continues to improve. We generated operating cash flow of $61 million, up from $35 million in the prior year quarter. This was driven by OIBDA improvement, collection of the SiriusXM settlement and thoughtful working capital management. CapEx came in at $10 million. As expected, this represented a decrease versus the prior year quarter when we had significant costs related to our headquarters move. For fiscal 2016, we continue to expect CapEx -- lower CapEx relative to 2015 due largely to the absence of the costs related to the move. As we are continuing to invest in IT, the go-forward run rate should be modestly higher than in this quarter. Our cash balance was $278 million as of December, with no revolver drawn during the quarter. This compares favorably versus a balance of $246 million at the end of fiscal '15 and $145 million at the end of the prior year quarter. Last month, we received $33 million from a sale-leaseback arrangement to one of our U.K. buildings, which will benefit cash in Q2. Given our strong operational and cash performance, we recently gave notice that we will be redeeming $50 million of our 13.75% senior notes on February 16, and this will be done with cash. The total payment for the redemption will be approximately $56 million, including redemption premiums and accrued interest. On an annualized basis, repaying these notes will yield nearly $7 million in cash interest savings [indiscernible]. Importantly, we retain the flexibility to continue reinvesting in our business and to accelerate growth. We have not yet made any final decisions with respect to future deleveraging opportunities, and we'll continue to thoughtfully consider all potential uses of cash. 2016 is off to a great start for us. I'm very optimistic about our performance for the remainder of the year and beyond. With that, operator, please open the line for questions.

[Operator Instructions] Your first question comes from the line of Aaron Watts with Deutsche Bank.

A few housekeeping ones for Eric up front. Just to make sure I'm clear. The SiriusXM settlement, I think you said $24 million in this quarter, the balance spread out over the next kind of through 2017. How much of that $24 million should we assume drops into the bottom line or the EBITDA number?

So we pay our artists through SoundExchange and we keep somewhere in the neighborhood of half.

Okay, got it. So in terms of benefit to EBITDA in the quarter, that's kind of the context we should think of it as? Or...

Yes.

Okay, got it. And then, I guess, secondly on the Happy Birthday settlement, I just want to make sure I heard you right. Should we assume that around $6 million of EBITDA in the quarter kind of hit from that?

That's -- it's more than half of the decline, so it would put it in that ballpark.

Okay, all right. And then, Eric, in the spirit of give an inch, take a mile, the 13 3/4% partial call, how did you decide on $50 million? Why not a little more? And I know you said you're still kind of open to thinking about how to address the remaining bonds, but maybe just some context around the timing and the dollar amount.

Well,, thanks for that, Aaron. So I think the broader picture answer is that we continue to focus on strengthening our cash position by growth in the business, managing working capital as we also mentioned by the sale-leaseback of our U.K. building, also taking a close look at noncore assets. We also want to make sure we use that opportunistically. So as we've said in the past and are now realizing, debt repayment is a significant consideration, and we're getting started there. But we also retained the flexibility to continue to fund operations, which include evaluating potential tuck-in M&A opportunities, other opportunities that can help drive growth. So we want to retain that flexibility yet at the same time as we go forward, we continue to opportunistically determine how and when to utilize the cash.

Got it. Okay, that's helpful. And then just 2 last ones for me. I guess first, if I think about the March quarter that we're currently in, you had a pretty good March quarter last year, so a tough comp. Can you give us any color as to kind of some of the releases that you think are going to drive this quarter this year? I think you mentioned Coldplay at the Super Bowl. I think I read somewhere Bruno Mars might join them. Does he have something dropping soon? And maybe give us some color on the ebbs and flows of the release slate.

Well, so I certainly can, and we've released 2 albums recently of young and up-and-coming, we think, future stars in Panic! at the Disco and Charlie Puth that we think are extraordinary. And those were for this quarter. The continued flow and strength of Coldplay will flow through this quarter. So we think we have some nice music flowing through. Bruno and some of the others don't have declared release dates there. We know there are some rumors. It's not something that we're releasing on this call today, but we're really comfortable and confident with the kind of flow of music. I know, as Steve always talks about, that the continuous flow of music is strategic for us, and we think we're living up to that promise more and more, including this year. You're right, Aaron, there's a relatively tough comp from last year. I mentioned the neighboring rights distributions for PLG started to get released last year, but we still feel very good about the year, and very good about our music flow and monetization opportunities for each quarter this year.

Okay. And last one for me, I appreciate you taking all these. Even after the partial call, I think you're sitting on north of $200 million of cash. Could you just remind us how much of that cash is kind of overseas and difficult for you to bring back? But then also kind of as you think about M&A opportunities and growth opportunities for the company, what areas do you see as most ripe for kind of attack on that front? Publishing? Recording? More technology angles? Or maybe some color around that, Steve.

I'll deal with the latter part of your question, Aaron, and then Eric will circle back on our cash around the globe. We look for opportunities in all of those areas. I think as we've mentioned before, it has to be not only very good to great opportunities, but it has to be coupled with rational values and appropriate structures. I think as we've said consistently, to buy market share at a loss is not one of our strategies or tactics. So both from a corporate perspective and from our operators around the globe, we look at and assess opportunities in Recorded Music, Music Publishing on a regular basis. And from a technology, a digital and innovation perspective, we drive that through corporate. Our goal is to consistently strengthen our business to be the best operators globally and locally and to be always on the leading edge of how we use and how we can utilize technology as music people, not as techs.

I'll address the first part of the question, Aaron. So you're right. I mean, after the partial call, we still have $200 million of cash as of the end of the quarter on the balance sheet. One of the things I will say is that we've worked very hard to minimize the cash and continued to improve kind of the circulation of cash around the world and how much we need to fund operations. An example of that is the China cash book that we now have in operations, that have us the ability to have money flow through China in a much smoother and consistent basis, which is new for many multinationals. And we're certainly exploiting that. So I would say well over half of the cash that we have is available for investing in our business and fueling our growth or opportunistically debt repayment. And thank you, Aaron.

And your next question comes from the line of David Farber of Crédit Suisse.

A lot of my questions have been asked and answered, but I wanted to just touch on a couple of things. First is just your thoughts on the CRB, the streaming rates and how you guys think about that, impacts, puts and takes there. And then I had a couple of follow-ups.

Sure. Thank you, David. So look, we agree with SoundExchange position. We're disappointed in the CRB findings. We are supportive of a motion for reconsideration. That said, I think it's important to say that the ruling has no negative financial impact on us going forward.

Understood. And the company has obviously done a nice job on generating cash recently in the quarter. We've seen you obviously attack the Holdcos, which makes sense. I guess my question is, given the settlement and the proceeds from that, any update you could give us on sort of the restricted payments baskets? Is that where we stand on that number? If the settlement had anything to do with the call ops, and then over to a tangential question, would just be simply be would you consider bond buybacks just given where the other parts of the structure trade?

Well, on the last part, I'll just -- we consider all options, and we certainly retain our options going forward. We'll be opportunistic in our strategies and tactics of considering future delevering and strengthening of our balance sheet. As far as the settlement and as that cash being used as proceeds towards the debt buyback, we work very hard to manage our cash across a broad array of strategies, managing operations for growth, working capital management, looking at our balance sheet for noncore assets we can monetize. Obviously, settlement is a nice contributor to cash. So we look -- focus first on driving cash flow in aggregate using a broad array of tools. And then as we aggregate cash, we look opportunistically at the best ways to use the cash to drive our business forward, both considering driving growth and strengthening our balance sheet by repaying debt. So we do look at it in aggregate, but certainly, the settlement is a nice cash flow -- nice inflow for us.

Helpful. And then just 2 others. Can you give us an update on restricted payments of the company?

I'm sorry David, we couldn't hear you.

What the restricted payments basket is?

Yes, we certainly can. Oh. Well, we won't disclose -- we don't disclose specifically the baskets, but we have [indiscernible].

Okay. And then finally, just on the digital. Obviously, the numbers are quite good. And I guess I'm just curious -- they continue to be heading in that direction. Do you see any of the -- now that the size is bigger, do you see any behavior among the digital business that surprises you one way or the other now that it's reached such a large piece of the company and you've been at this a little bit longer than, let's say, a couple of years ago? Just a broad question, and that's it for me.

On digital, I think we've seen a few things that -- first of all, I think Apple entering the market is a very healthy thing. The competition between players: Apple, Spotify and others, only help stimulate consumer awareness, consumer demand. And I think as we're seeing, seems to be, at least what we've seen so far, supporting strong consumer and subscriber growth. So that's very healthy for the music industry. I think the rate of growth of both Apple, which reported 10 million users, which I think is a healthy number at these early stages; and Spotify, at this point reporting, or at least reported in the press, well over 25 million subscribers, which is growing substantially from the teens that they had a year ago. Those healthy rates of growth are really helping drive the streaming numbers forward. And we're really pleased. And we work in close partnership with them and the other streaming and digital distributors to make sure they have an excellent product. And that growth is something that we expect going forward.

And there are no further questions in the queue, so I turn the call back over to the presenters for the closing remarks.

Thanks for your time, everyone. I hope everybody can weather the rest of the winter, and we'll talk to you in a couple of months. Have a great day. Bye-bye.

And this concludes today's conference call. You may now disconnect.