Welcome to Warner Music Group's Second Quarter 2015 Earnings Call for the period ended March 31, 2015. At the request of the Warner Music Group, today's call is being recorded for replay purposes. And if you have an objection, you may disconnect 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 afternoon, everyone. Welcome to Warner Music Group's Fiscal Second Quarter 2015 Conference Call. Both our earnings press release and the Form 10-Q we filed this afternoon 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 and Form 10-Q and other SEC filings. We plan to present certain non-GAAP's 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. With that, let me turn it over to Steve Cooper.

Good afternoon, everyone, and thanks for joining us today. I'm very pleased to say that the first half of our fiscal year has been great. Our strong momentum is reflected in our second quarter results where we grew total revenue by 13%, total digital revenue by 10% and adjusted OIBDA by 17%. It's impressive that revenue growth was widespread in key segments of our business. In particular, Recorded Music, both the U.S. and international and across digital and physical. There are 2 items that bear mentioning when looking at our revenue figures this quarter. First, our release schedule is more front-end loaded this year as compared to last year when the majority of our bigger releases came in the last 6 months; and second, the dollar has strengthened, particularly relative to the euro. However, even taking into account this currency trend, we still made great progress, with total revenue up 4% on an as-reported basis. Although we feel it is more indicative to measure our performance on a full year basis, at this halfway point, it is clear that our artist-development strategy is having a very positive impact in fiscal '15. Before we look more closely at our Recorded Music and Music Publishing results, I want to provide an update on the state of the recorded music industry based on IFPI data for calendar '14. The global recorded music business was essentially flat last year, declining 0.4 of a percent. That's modest compared to the 4% decline in '13. A 39% increase in Streaming revenue nearly offset 8% declines in both physical and download revenue. Streaming comprised nearly 1/3 of overall digital revenue, including 41 million paying subscribers, up 46% from 28 million in 2013 and far in excess of the 8 million subscribers we had in 2010. This jump…

Thank you, Steve, and good afternoon, everyone. Our strong second quarter results reflect the success of our artist-development activities, the momentum in our digital transformation and the expansion of our global footprint. We continue to carefully manage our costs so that we can balance investment in the business with growth on the bottom line. Total revenue grew 13%, driven by a slate of new releases and strong carryover sales. As Steve mentioned, foreign exchange was a significant factor. Total revenue rose 4% on an as-reported basis. In our filings, we provided some additional information on the effect that currency had on our revenue this quarter. 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, but let me walk you through them. In the quarter, we had $1 million in PLG-related expenses, which is down significant from the $33 million in the prior year quarter and $3 million in expenses related to other cost savings initiatives. Backing out of these items, we saw double-digit growth in adjusted OIBDA, up 17% to $125 million and adjusted OIBDA margin rose 2.1 percentage points to 18.5%. Our adjusted OIBDA margin benefited from revenue growth as well as prudent cost management. We have recently implemented a series of cost-containment initiatives, targeting back office overhead, from which we expect annualized savings of over $20 million with the majority expected to be realized this fiscal year. We expect the costs associated with the initiatives identified to be -- to-date, to be under $10 million, most of which have already been incurred. The integration of PLG is now complete, and I'm pleased to say we have realized the full projected $70 million in annual savings. In Recorded Music, we delivered 15% revenue growth. Physical…

[Operator Instructions] Our first question coming from the line of Aaron Watts of Deutsche Bank.

A few questions for me. That was encouraging, your comments on Streaming revenue surpassing your download revenue for the first time in the quarter. Can you just talk about -- is that a trend you expect to kind of we'll see play out over the next few quarters? Or was there anything kind of one-off in nature in this quarter you just reported that bumped up the Streaming for some reason in this particular quarter?

No, there were no real unusual elements here. And we think that Streaming will continue to see very meaningful growth quarter-over-quarter, year-over-year. And that while we are hopeful that the contraction of downloads slows, we would expect that as people move from downloading to streaming that you should expect to see this, not only for the balance of this year, but for the foreseeable future. I mean, nothing leads me to conclude that this trend is going to change.

Okay. All right, great. And just remind me, and I'm sorry. I know I've ask you this in the past, but just as we think about kind of your margins on the Streaming revenues versus downloads and Physical, just again, please just remind me what that's going to look like.

Well, Aaron, this is Eric. And it's a fair assumption that digital has higher margins than Physical given the lower production and distribution costs. We see comparable margins on average between the downloads and Streaming. That said, the margins on Streaming vary depending on the release schedule, mix of revenue in period and individual contracts. For some streaming models, our margins are superior to those on downloads. And then for others, they're slightly less, so it differs. But Streaming is at least comparable for download.

Okay, that's helpful. And then one quick one. Just to clarify, on your Recorded business with the licensing revenues, the broadcast fee you're getting in Europe, is that a one-time bump in the quarter? Or is that something that going forward you will get those fees in the door?

It will be ongoing. We should note of that for Parlophone, there was a change in accounting from accrual to cash. So now we see that rolling on, but it will continue to be an ongoing revenue stream into the future.

Okay, just a couple more for me. On the release slate, I know you don't like to give any specifics, you did say that this year you're a little more front-end loaded. How should we think about the back half of the year relative to last year's back half of the year? I mean, is there -- is it significantly lighter? Relatively in line? Just -- how should we think about that?

Well, I'm hopeful that our second half will remain strong. We had some of our more significant artists releasing in the second half of last year. That being said, we've got some -- they've either begun their rollout or they've come out -- some great artists the second half of this year. We've got Josh Groban. And last week, he was #1 in the U.K. where we dropped the album. Flo Rida is coming out with more singles through the balance of the year. twenty one pilots will be releasing an album, as will Adam Lambert and other new artists that both Atlantic the U.K. and Warner Bros. have signed, Aaron. So while the names may not be as recognizable as the latter half of last year, we've got some absolutely fantastic music being driven by some young, but very, very exciting artists.

Got it. Okay, that's helpful. One question related to when you made your acquisition of PLG, I think as part of that, you were required to sell some assets to appease kind of the regulators. Can you give us an update on where you're at with that process, and if there's kind of material proceeds you expect out of that?

Well, we are working through the process. We have been in discussions with representatives of IMPALA/Merlin. The agreement is confidential, so I can't give you any specifics. But we do expect to be adequately compensated for the assets that we dispose of, and we believe that, that will be a meaningful number. I can't really go beyond that because of the confidentiality agreements, Aaron.

Sure. As you think about any proceeds that do come in, any sense for what you might use of them for at this point?

Well, we have obviously alternatives including: one, reinvesting in the business, which we always look at; two, how we expand our footprint, both by investing internally or through acquisition; and c, pay down of the debt. As you know, we've always had a philosophy of marching towards a conservative balance sheet, but at the same time wanting to ensure that we have a strong growth trajectory with smart investing. So we'll look at the alternatives that we have at that time and determine the best way to put that money to work.

All right, great. Last one for me, I promise, and I will go away. I couldn't help but think of you guys as a saw the valuations being put on Spotify. I believe you and the other majors own a stake in Spotify as part of your arrangements with them. Have you ever kind of clarified exactly what your percentage ownership is at Spotify?

No, and that is confidential as well.

Our next question coming from David Farber of Crédit Suisse.

A couple of questions that you guys haven't touched on yet I wanted to ask about. First, just on the flow-through in the quarter was pretty solid, better than we had thought. And it seemed like some of it had come from the SG&A line, which came down. So just curious to hear what you guys are seeing, and how should we think about SG&A maybe going forward? You were running, I don't know, 275, 300. And this quarter was close to 250. So a pretty big decline. So just your thoughts there, and I have a couple of follow-ups.

So thanks, David. So on SG&A, I think there's a few pieces there. Some of that is PLG-related expenses coming down from prior years. Some of that is related to foreign expenses, some of our expenses are overseas. But we also balance that with strong cost management and making sure that we are evaluating our costs and making sure that we put it through stringent tests. And that any of our general administrative expenses are kept as lean as possible, and we've gone through that exercise.

And do you think that this is a good run rate going forward? Were you guys -- were able to put on through this recent quarter?

Yes, we do. I think this is programmable [ph].

Great. How much of the quarter in your mind you think was release-driven, if you could? And then I just want to make sure I understood you guys in your prepared remarks, but it sounds like you guys are -- will be comp-ing into difficult back half of the year last year. Is that what you were saying?

Well, first of all, virtually all of our revenue is release-driven, either releases during the quarter, carryovers or catalogs. So the revenue was driven by our music. We had some very, very nice releases. The first half of the year, we've had good carryover. But as I just mentioned, we've got some very, very exciting new artists and some incredible, incredible music that we're going to be releasing in the second half. And while the names may not be as recognizable as some of our releases in the comparable period last year, I'm still hopeful that the music that we are presenting will be very, very well received. So I am not prepared to concede that our second half isn't going to continue to show very nice momentum.

Okay, very good. And then I didn't get a chance to look at the whole Q, but I did notice that the LTM pro forma covenant EBITDA was up a touch, but the reported EBITDA was obviously up considerably. So just curious, what's driving that? Is that because the cost savings are getting realized and they don't get added back anymore? Just walk through us that, and then I have one big-picture question.

So generally that's right. I mean, a lot of the PLG-related LTM pro forma EBITDA results are getting realized. So those get built into EBITDA, that's correct. And obviously, our underlying EBITDA is -- our underlying OIBDA and EBITDA are getting stronger.

Then just lastly, on some of the noise in royalty rates, I was curious to hear how you guys think about it. Anything you can sort of share with us on the Fair Play, Fair Act (sic) [Fair Play, Fair Pay Act]? Or maybe just any thoughts around the royalty rates going into December's discussion? Then that's it for me.

Well, let me start with the CRB process. The proceeding, as you know, just started in late April. I believe, April 27 to be precise, David. And that proceeding will last until June. I believe early June, at which time the judges will do what judges do and render a decision in December, because as you know, the next 5-year period starts January 1, I believe, 2016. We are very happy with the case that Soundscan has developed and -- SoundExchange, sorry, has developed and is presenting. And having rates that adequately compensate the content owners, our artists and our writers, is very important to us particularly in a world that's moving to streaming. So I'm hopeful that the judges will recognize that and that we will get that the rates that we, on the content side of the industry, are hoping for. So that's on the CRB. On the Fair Play, Fair Pay, as you know for terrestrial radio, that's really "a willing buyer and a willing seller" standard. And I think it's premature to comment on it, other than the fact that we are very pleased that the Congressman Nadler is looking to address long-standing inequities in the current U.S. music-licensing system. And so hopefully, his proposed legislation will move forward, and we are obviously supportive of that position.

Our next question coming from the line of Davis Hebert of Wells Fargo Securities.

There's been a lot of debate about the freemium versus a premium model, especially with Apple's, I guess, pending launch of a premium product. Do you feel like the industry is in a position to more proactively move away from the ad-supported model? And second question to that is, Spotify and others have said if that's the case, that there would be a resurgence of piracy. And I'm just curious if you believe that.

Well, let me start with the -- let me start with just our particular point of view as opposed to an industry point of view. You'd have to cast a much wider net to get the industry point of view, Davis. First of all, there are any number of models out there. And all of those models, ad-based, subscription-based or with both, are better than piracy. To be crystal clear, piracy is 0 revenue. It's the theft of intellectual property, and it's not good for anybody. So all of these models are better than piracy. That's number one. Number two, the freemium models, if they encourage the adoption of subscribers, if they encourage the movement of subscribers from ad-based models to subscription-based models over time, we, at Warner, believe that's good news. We are working with a number of our digital partners to see, in fact, if there are ways in which that adoption, that is the movement from the ad-based model to a subscription, if you're an individual user on the ad-based model, moving that person to subscription, if than can be turbocharged through modifications of service offerings or more sophisticated approaches to the consumer market. So we don't believe that there is a just a one size that fits all. With respect to going to a strictly subscription world, I think that you can find evidence that when music is not generally available, that people will seek out sites on the Internet that, in fact, will offer up that music for no charges, and in many instances, with no economic model where income flows to the content owners, the artists or the writers. So I think that before -- and this is not our point of view, but before people conclude that freemium should be burnt at the stake, we should think very carefully about the consequences.

Understood, very, very good commentary. And you mentioned interest in potential acquisitions. Just curious, Liberty Media mentioned on its earnings call last week its interest in audio investments as well. Just curious what the M&A environment looks like for you. Is it more record labels outside of your footprint? Is it publishing? Where do you see the best opportunities for growth there?

Well, I think it's all of the above. We are constantly looking at opportunities on the recorded music side, on the publishing side, on expanding our relationships with our digital partners, any and all of the above. And I think the watchword for the Warner Music Group is that it has to be thoughtful, well-structured investments that make economic and financial sense from our perspective, Davis. We just don't -- we're not in the game of acquiring market share on uneconomic and on unthoughtful financial bases. We -- that's not a game that we choose to play.

Okay, understood. And with regard to acquisitions, where do you -- Eric, where would you like to see leverage sort of trend over the next 12 months and how that dovetails with potential M&A?

Well, obviously, although we're comfortable with where we are, we continue to work diligently, organically to grow our revenue and OIBDA and pro forma EBITDA to continue to manage the leverage ratio down. When it comes to acquisitions, as Steve said, we look very focused at them on an economic-return basis, but also their ability to deliver earnings and be accretive. And so from that basis, we're very focused on driving growth and making sure all the key metrics are moving in the right direction.

Okay, very helpful. And last one for me. You have some very high coupon bonds, 13%-plus handles at the whole co level that are callable this year. I'm just curious of your intention to potentially refinance those, and what is your interest level to do that at the WMG Acquisition Corp level?

Well, on that -- so we are extremely -- we continue to carefully assess and evaluate our options with regard to potential refinancing and activity related to our high-interest debt -- higher-interest debt. So we are extremely aware of that, and we continue to manage our cash flow. And we will determine what to do as we go forward. And it is something we consider on an ongoing basis.

Our next question is coming from the line of Michael McCaffery of Shenkman Capital.

Just a follow-up on Davis' last question, would you consider -- is one of the options you're considering retiring those bonds as cash as opposed to a refi at all?

Well, we consider all of our options and, obviously, that would be one possible. So we wouldn't want to talk specifically about what we will or won't do, but we're certainly investigating all possible options.

Great. And then I guess a couple of the other questions that had come up earlier regarding how the back half looks as far as release schedule. Can you help me understand, with the acceleration you're seeing in Streaming right now, how much of the Streaming revenue is really driven by new releases as opposed to older catalog hits? I guess, what I'm trying to understand is the extent that Streaming continues to accelerate it can serve as somewhat of a hedge against lumpiness in terms of when key new releases are issued.

The statistics that I've seen, Michael, indicates that, I don't know, something greater than 50%. I think that something in the 60% area is typically what we see by way of the breakdown between new releases and older releases/catalog when it comes to Streaming revenue. That being said, I can tell you that when you look at some of the records that we mentioned, with respect to these last few weeks, when you look at the Furious 7 soundtrack and the music from Wiz and Charlie, it's burning up Streaming. When you look at Ed's Multiply, that has been just an enormous driver of streams. So I think that with current music, they tend to run very hot and then begin to level off. But catalog, I think, for the foreseeable future will also continue to play a major role in the Streaming revenue pie, Michael.

So if I'm understanding that, then should I think about the strong releases you've had over the last, say, 2 quarters continue to have good legs in the Streaming revenue line probably to the back half of this year?

I would think so. I mean, it's the number -- a number of our artists and their music are just white-hot at the moment. And I have an expectation that while it may drop off a bit, it's going to continue at a fairly good rate.

Okay. And then you had mentioned -- you had made reference to the Vessel partnership in your prepared remarks. And during the last conference call, you had indicated 3 other major partnerships, Tencent, Interlude, Snapchat. Can you just comment, as we think about the back half of this year, if any of those 4 are going to have any material contribution to revenue and maybe Warner in the year ago period?

Well, Tencent will have -- relative to China, that will have an impact that's relatively meaningful when you look at our China revenue year-over-year. I don't believe -- if you look at Interlude and if you look at Snapchat, Snapchat in particular, music is not central to their business. And while we have a very nice relationship with Snapchat and we are working with them with respect to their discovery channels, I don't expect that to be a needle mover with respect to revenue, and the same is true of Interlude. Both in all of them, Vessel, Interlude, Snapchat, bring unique things to the Warner Music Group and vice versa, and those unique attributes with these proprietary relationships go beyond just revenue.

At this time, we don't have questions on queue. Now I will turn back the call over to Steve Cooper. Sir, you may proceed.

Thanks, everybody, for your time this afternoon. Everybody, have a wonderful summer, and we'll talk to you in a few months. Bye-bye.

Thank you. And that concludes the conference. Thank you, all, for joining. You may now disconnect.