Warner Music Group Corp. (WMG) Q3 2016 Earnings Report, Transcript and Summary

Welcome to Warner Music Group's Third Quarter Earnings Call for the period ended June 30, 2016. 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 third 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 we 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, all revenue figures and comparisons discussed today will be presented in constant currency, unless otherwise noted. With that, I'll turn it over to Steve Cooper.

Thank you, James. Good morning, everyone. Thanks for joining us, and I hope you're all having a great summer. I'd like to start by marking the recent fifth anniversary of the acquisition of the Warner Music Group by Len Blavatnik's Access Industries. It's a happy anniversary, as today we are reporting our largest third quarter revenue since Access's ownership began. Over the last 5 years, we've signed and developed fantastic artists and songwriters, we've expanded and transformed our operations around the world and we've significantly improved our financial health. Since Q3 2011, we've grown our Recorded Music revenue at a CAGR of 5% and our OIBDA at a CAGR of 9%. Meanwhile, for calendar year 2011 through '15, the recorded music industry stayed relatively flat at a CAGR of 0.1%, a very positive indication that we've been outpacing the industry. In 2011, physical formats were our largest source of Recorded Music revenue, and those formats were declining steadily. In stark contrast, over the last 5 years, given our early embrace of streaming, it has grown from an insignificant portion of digital sales to our largest single source of revenue for the second quarter running. Today's results are further evidence of our strong momentum. Specifically, this quarter, we grew total revenue by 15%, digital revenue by 23% and OIBDA by 20%. We're having a great year and are well positioned for long-term growth. Once again, I'd like to update you on our key priorities, which are driving our business forward. First, our commitment to delivering a consistent flow of great new music, driven by our operators all over the world. We're achieving this goal by ensuring that we are never dependent on any single label, country or division for sustaining our success. Instead, we're drawing on our collective strength. It's encouraging that this quarter, our top-25 albums were drawn from 11 different repertoire centers. Further, our top-25 sellers included artists at all stages of their careers, from Charlie Puth, who released his debut album this year; to Udo Lindenberg, who released his debut album in 1971. The diversity of our A&R activity is reflected in the fact that our global top seller was the 16th studio album from French singer-songwriter, Renaud. Renaud is relatively unknown in the U.S. and the U.K., but he's a huge star in Continental Europe, his latest album having hit #1 in France, Belgium and Switzerland. Our emphasis on a consistent flow of music is helping boost our Recorded Music market share around the world. In the first half of calendar '16, we gained almost 3 points in U.S. market share for physical and digital albums. That's more than any other major. Other countries showed a similar story, including the U.K. where we've moved up to the #2 spot in artist album share; and Germany, where our year-to-date album market share is at an all-time high. Our second priority is the expansion of our global presence. As you know, over the past few years, we've invested in developing markets where we see real growth potential. During the quarter, we acquired the ISS recorded music catalog in Indonesia, the fourth most populous country in the world, where mobile technology is opening up a viable music business. And in Music Publishing, Warner/Chappell signed an expanded sub-publishing deal with Times Music, where we will generate new commercial possibilities for our songwriters in emerging markets, such as India, Pakistan and Sri Lanka. Our third quarter results were strong across the globe in both established and emerging markets. But we saw especially bright spots in emerging territories, such as Russia and Latin America, where our operators drove revenue growth of 40% and 25%, respectively. Our third quarter priority is our -- sorry our third priority, also during the third quarter, is our focus on streaming and commercial innovation. Today, we can report that our recorded music streaming revenue grew more than 45% over the prior year quarter. Streaming revenue for the quarter was about double the size of download revenue and was meaningfully larger than physical revenue. We continue to look for ways to turbocharge streaming growth. To this end, we acquired the X5 Music Group in June. Based in Sweden, X5 will bring us additional expertise in streaming, playlisting and download products. At the same time, we're exploring new business models beyond traditional streaming services. This is because we aren't satisfied with simply growing existing revenue streams. We want to create additional opportunities that anticipate new types of fan engagement. For example, we continue to experiment with video content. We became the first music major to license the hugely popular lip-sync app musically, and we added our videos to Vevo-owned and operated properties. We believe that bringing high-resolution sound to mainstream consumers could be a huge opportunity for our industry. As a result, we were the first major to partner with MQA, a groundbreaking technology developed by Meridian. We're also exploring new digital experience, such as virtual and augmented reality, having recently signed a deal with Digital Domain to create concert packages for fans in Greater China. Turning to our third quarter results, let's start with Recorded Music. We grew total revenue by 15%, digital revenue by 20% and OIBDA by 19%. Once again, a broad array of artists contributed to this success. We've continued to break new global superstars, such as Warner Bros.' Lukas Graham and Fueled by Ramen's twenty one pilots, whose album hit #1 in the U.S. over a year ago and was our third-biggest seller worldwide this quarter. This demonstrates the success created by our emphasis on long-term artist development. We furthered the careers of our established artists such as Warner Music Nashville's Blake Shelton, who recently had his fourth U.S. country #1 album; and Warner Bros.' Red Hot Chili Peppers, who celebrated their seventh consecutive top-5 album in the U.S. This album also went top 5 in Germany, Canada, U.K. and Australia, among other places. I'm also pleased that 3 of our top-25 sellers this quarter were from Japan, Kobukuro, Kyosuke Himuro and Kyary Pamyu Pamyu. Japan remains the second-biggest music market in the world, and we've worked hard to improve our performance there, so it's great to see our team making such a positive impact. Importantly, our momentum continues with the first quarter off to a good start. We've also been welcoming some spectacular talent to the company, including multiplatinum selling artist Kelly Clarkson and Rita Ora. Now let's turn to Music Publishing, where we also had terrific results. Specifically, we grew total revenue by 11%, digital revenue by 48% and OIBDA by 15%. Jon Platt and his team continue to make great strides at Warner/Chappell. For instance, last quarter, the company had its largest share of U.S. airplay in a decade. This success is being driven by an impressive range of songwriters and music from Beyonce's Lemonade and Rihanna's Anti, to Chris Stapleton's, the Traveler and Lin-Manuel Miranda's Tony-winning Hamilton. We continue to invest in our songwriters and are consistently attracting well-known names into the Warner/Chappell fold, including Marv Green, Jesse Frasure and a new partnership with Roc Nation Nashville. Not surprisingly, Warner/Chappell continues to receive industry accolades, including being named 2016 Music Publisher of the Year at the ASCAP Rhythm & Soul Music Awards. Our artists and songwriters are delivering exceptional music, we're expanding our presence around the globe and we're leading the field in A&R and digital innovations. All of this is underpinned by the great execution of our worldwide teams, which continue to show themselves to be the best in the business. With that, I'll now turn the call over to Eric.

Thank you, Steve, and good morning, everyone. I'm very pleased with our results. We have a proven strategy for financial success, which is allowing us to further optimize our capital structure. We're driving revenue growth with great new music, international expansion and commercial innovation. We're growing OIBDA through a combination of revenue growth and our focus on cost control. We're converting OIBDA into cash by thoughtful working capital management, and we're generating additional cash through select noncore asset sales. To review our third quarter performance, total revenue growth of 15% was strong. And even on an as-reported basis, we grew a very healthy 14%. 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 this quarter, we had $9 million gain related to asset sales versus $3 million of nonrecurring expenses in the prior year quarter. Adjusted OIBDA, which excludes the gain in nonrecurring expenses, rose 8% to $111 million. Adjusted OIBDA margin declined 0.8 percentage points to 13.7%. The decline was driven by revenue mix as we had strong growth in concert promotion and physical revenue, which tend to be lower margin. That said, for the first 9 months of the year, our adjusted OIBDA margin is up 0.2 percentage points to 15.7%. In Recorded Music, total revenue was up 15%, with digital revenue up 20%, driven by streaming. Physical revenue grew 10%, benefiting from local releases and catalog. Licensing was essentially flat, down $1 million, which was largely timing related. Artist services and expanded rights revenue rose 24%, driven by timing of concert promotion activity. Recorded Music adjusted OIBDA was up 8% to $110 million, benefiting from revenue growth. And Recorded Music adjusted margin declined 1 percentage point to 16.2%, which was related to revenue mix. For the first 9 months of the year, our adjusted OIBDA margin was up 0.8 percentage points to 17.5%. Music Publishing revenue rose 11%, while mechanical revenue declined 24%, reflecting industry trends. Digital revenue was again a standout, increasing 48%. Also strong were sync, up 7% and performance, up 6%. Music Publishing OIBDA rose 15%, driven by revenue growth and a gain on asset sales. OIBDA margin rose 0.9 percentage points to 17.2%. Cash flow continues to improve. We generated operating cash flow of $35 million, up from a use of $24 million in the prior year quarter. This was driven by increased OIBDA and ongoing working capital management. CapEx came in at $8 million, slightly below our expected ongoing run rate. As a result of strong free cash flow during the quarter, we announced our intention to redeem the remaining $100 million of our 13.75% holdco notes, which was completed on July 1. This brings our total debt paydown for the year to $175 million, and we will remain opportunistic on debt repayment going forward. Subsequent to quarter end, we refinanced a proportion of our term loan, as we further optimize our capital structure by balancing our proportion of fixed and floating rates as well as by managing maturities. Our cash balance was $345 million at the end of June, with no drawn balance on the revolver during the quarter. This cash level compares favorably with a balance of $316 million at the end of March and $168 million at the end of the prior year quarter. We're working hard to ensure a strong Q4, and I'm excited about the future of Warner Music Group into next 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.

This is Angeline Matthew for Aaron Watts. I wanted to ask you guys a follow-up on the Vevo announcement that was out a couple of days ago. I was wondering if I could get some context around how this could impact your revenue and cash flow. And when you would see this benefit flow through to your P&L?

I'm sorry, I didn't catch your first name again.

Angeline Matthew.

This is Steve Cooper. We don't expect to have a needle-moving revenue boost from the Vevo relationship. It is -- the utilization of our videos on the Vevo-owned properties, which is primarily vevo.com, where their views, relative to their views on YouTube, are not particularly substantial. What we are doing, however, is working on creating a culture relationship with Vevo so that our videos get more exposure off of YouTube, and we will continue to work to grow that relationship.

[Operator Instructions] There are no further in the question-and-answer queue. I now turn the call back -- the presentation to you.

Great. Well, listen, everybody, thanks for your time. I hope you enjoy the balance of the summer, and we will talk to you in the fall. Have a great day. Bye-bye.

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