Warner Music Group Corp. (WMG) Q1 2014 Earnings Report, Transcript and Summary

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.

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.

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…

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…

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

Good morning guys.

Good morning Aaron.

Hey, Aaron.

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.

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.

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

Fiscal.

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?

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].

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?

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.

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.

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.

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?

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.

Okay, great. Thank you for taking the questions.

Sure. Incidentally Aaron.

Yes.

It has more to do incidentally.

I know I apologize.

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

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?

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.

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?

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.

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.

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

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

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.