Warner Music Group Corp. (WMG) Q4 2016 Earnings Report, Transcript and Summary

Welcome to Warner Music Group's Fourth Quarter and Fiscal Year-end Earnings Call for the period ended September 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 Fourth Quarter and Year ended September 30, 2016 Conference Call. Both our earnings press release and the Form 10-K 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'll 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-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.

Good morning, everyone. It was great to see some of you in Europe this past October. We really appreciate your ongoing support, which I hope you'll feel is well founded once I've updated you on our performance today. I'm very, very pleased to say that we had an excellent year, during which we've again proven our ability to deliver sustained growth. For the fiscal year, we grew total revenue by 13%, digital revenue by 24% and OIBDA by 16%. In addition, we generated $342 million from operations. Our fourth quarter was also very strong. We grew total revenue by 13%, digital revenue by 25% and OIBDA by 9%. In fiscal '16, we saw a global double-digit revenue jump in both our Recorded Music and publishing businesses. This came on top of our 6% growth in total revenue for fiscal '15. This fiscal year marked our highest total revenue in 8 years and our highest OIBDA in a decade. In addition, every year since Access took ownership in 2011, we've grown the combined digital and physical revenue in our Recorded Music business. While it's clear that we're benefiting from the macro effect of strong subscription revenue growth, we are also consistently outperforming the industry. Following calendar '15, when we scored the largest global recorded music market share gain of any major music company, we've continued to see the ongoing results of our strategic focus in 2016. For the first half of calendar '16, our 2.5 percentage point jump in U.S. recorded music market share was the best of any major. During the same time period, the U.S. recorded music industry grew about 6% at wholesale, while our U.S. recorded music business grew at more than double that rate. We expect our revenue overperformance to be further highlighted by market share gains when full year figures are available both for the U.S. and on a global basis. Given our ability to achieve strong results on a consistent basis, we're now in a position to pay a modest dividend of approximately $50 million. We are taking this step after growing our investment in A&R, paying down debt and improving the financial health of our company. Eric will share more of this and talk about our priorities for cash later in the call. While we're confident the industry will continue on its positive trajectory for the next year and beyond, we are absolutely determined to maintain our own momentum by focusing on our 3 key priorities. First, having consistent flow of great new music. We've harnessed our collective strength in order to reduce our dependence on any single label or division. This past year, we increased our direct investment in our artists and their music to over $1 billion. This spend is paying off, as we're seeing increased output from a wider range and a greater number of artists resulting in a healthier, less top-heavy revenue distribution. For example, in fiscal '13, our top 10 sellers represented over 12% of our Recorded Music revenue. In '16, they represented only 8%. We've also been working to enhance our creative collaboration with our artists and songwriters. Over the past couple of years, we pursued a strategy of building or acquiring recording studios and writing rooms in or near our offices. We believe that over the long term, this will foster experimentation and strengthen relationships with the creative community. In 2014, we installed new studios at Atlantic Records in New York. This year, we launched The Firepit, an innovation center in our London office, and we've created a new studio complex for our APG venture in L.A. We'll be opening our new L.A. offices in early '18, which are being designed to contain multiple state-of-the-art media studios. Our second priority is expanding our global presence. We do this by continuing to invest heavily in our existing operations and entering new markets. In 2016, we grew our footprint with organic investment in areas, such as Latin America, and acquisitions in smaller markets with huge potential, such as ISS in Indonesia. We've also improved our local operating teams by bringing in Mike Smith as our Managing Director of Warner/Chappell UK and Clayton Jin as Managing Director for Warner Music Korea. The strategy is clearly working, with our annual revenue at double digits in all of our regions around the globe across both established and emerging markets. Our third priority is leading in commercial innovation. In fiscal '16, our recorded music streaming revenue grew 55%, and it was up 47% in the fourth quarter. Our annual recorded music streaming revenue is approaching $1 billion, which is more than double our download revenue, and over $100 million more than our physical revenue. Now that streaming is firmly established as our largest revenue source, we're focusing on finding ways to turbocharge mainstream adoption and improve monetization. First, we're enhancing our playlisting activity by growing our in-house expertise as well as through acquisitions such as X5. Second, we're enabling greater consumer choice by supporting tiered subscription offerings from iHeart music, Pandora and Amazon. Third, we are also very active part of the music community's continuing efforts to close the value gap for user-uploaded services. Now turning to our results, starting with Recorded Music. For the year, revenue rose 13% on top of 7% growth in the prior year. Digital revenue rose 22%, physical declined 2%, artist services and expanded rights grew 25% and licensing was up 1%. For the quarter, revenue rose 11%, with digital revenue up 21%, physical down 5%, artist services and expanded rights up 16%, and licensing was flat. Again this quarter, our top 25 sellers showed a healthy mix of artists across different genres, from rock with the Red Hot Chili Peppers, pop with Charlie Puth, country with Blake Shelton, hiphop with Kevin Gates, dance with GALANTIS and soundtracks with Suicide Squad. This diversity is underscored by our 2 top sellers this quarter: Blurryface from rock band Twenty One Pilots and the Hamilton cast recording. What's more, the songs on both albums are published by Warner/Chappell, which is ongoing evidence of the deep collaboration between our recorded music and publishing businesses. Finally, I would be remiss if I didn't highlight the particularly impressive year that Atlantic Records has had. 12 years into the partnership between Julie Greenwald and Craig Kallman, the label is having fantastic run by any metric, including chart performance, market share, revenue and OIBDA. Atlantic has led the industry by mastering artist development in the streaming age, breaking new artists such as Melanie Martinez and Twenty One Pilots while building the careers of established stars such as Bruno Mars and Panic! at the Disco. I'm thrilled that fiscal '17 is off to an amazing start. Already, we've seen Green Day's 12th studio album, Revolution Radio, reach #1 in the U.S. and U.K. Bruno Mars' third studio album, 24K Magic, debuted in November and immediately went top 5 in the U.S. and across Europe. We also have great new music from Michael Bublé, Clean Bandit, Robin Schulz, soprano Anne-Marie, Dua Lipa and Charli XCX among many more. Turning to Music Publishing, Warner/Chappell continues to build its reputation as the industry's leading home for songwriters and hit makers while posting improved financial performance. For the full year, revenue rose 13%, with digital up 47%, performance up 11%, sync up 10%, these more than compensating for a 16% decline in mechanical. As a reminder, mechanical only includes revenue from the use of songs on CD and vinyl. For the quarter, revenue rose 23%, with digital up 74%, performance up 22%, sync up 4% and mechanical down 22%. Warner/Chappell and its songwriters continue to receive industry accolades. During country music week in November, which includes the ASCAP, SESAC and BMI Country Music Awards, our songwriters picked up 38 awards, setting a new company record. In addition, Warner/Chappell was named ASCAP Country Publisher of the Year for the fourth year running. This past Tuesday, many of our recording artists and songwriters were recognized by The Recording Academy with nominations for the 59th Annual Grammy Awards. We had a tremendous showing across an impressive range of genres and from artists at all stages of career development. To name a few, Twenty One Pilots earned a fantastic 5 nominations, including Record of the Year for Stressed Out; while Lukas Graham nailed 3 nominations for 7 Years, including both Record and Song of the Year. Besides being WMG recording artists, both Twenty One Pilots and Lukas Graham are also Warner/Chappell songwriters. Many other Warner/Chappell songwriters also had strong showings. Of note, Beyoncé was the most nominated artist this year with a remarkable 9 nods, including Record of the Year, Song of the Year and Album of the Year. And right behind her in the tally was Rihanna with 8 nominations. We wish all of our nominees the best of luck at the awards in February. Over the last few years, we stepped up our company-wide communication, coordination and collaboration, and this is clearly benefiting our results. Whatever we've achieved, we do it as a team. So I'm proud of our team for all of our successes this year, and I'm confident we have the right strategies in place to take us, our artists and songwriters to new heights. With that, I'll now turn the call over to Eric.

Thank you, Steve, and good morning, everyone. 2016 was a great year for us. Our formula for financial success is yielding fantastic results. We're driving revenue growth, controlling costs, growing OIBDA, generating stronger cash flow and optimizing our capital structure. Our global team is building our reputation as the most forward-thinking, commercially savvy and artist-friendly music company in the world. While the industry backdrop has been improving, it's unrealistic to expect the recovery to be linear, as the business continues that shift towards streaming. In addition, we know we just enjoyed a year with very strong releases around the world. For us, comparisons in fiscal '17 will be impacted by the 2016 sale of one of our European concert promotion businesses as well as by ongoing PLG-related divestitures. Turning to our fiscal '16 results. Total revenue grew 13% in both the quarter and the fiscal year. Even with a modest currency impact, on an as-reported basis, we grew a very strong 12% for the quarter and 9% for the year. From an OIBDA perspective, certain adjustments are necessary to make the year-over-year comparisons more meaningful. The details are in the press release, but in the quarter, we had a $1 million loss related to asset sales versus $8 million of nonrecurring expenses in the prior year quarter. For the quarter, adjusted OIBDA rose 2.5% to $124 million. The increase was driven by revenue growth. Adjusted OIBDA margin declined 1.4 percentage points to 14.7%. The decline was largely due to higher variable compensation expense and the impact of revenue mix. For the year, adjusted OIBDA grew 7.7% to $501 million, driven by revenue growth, and margin declined 0.3 percentage points to 15.4% due to the same factors that impacted the quarter. In Recorded Music, fourth quarter revenue was up 11%, with digital revenue up 21% driven by streaming. Our largest source of revenue is now our fastest-growing, which is great news after over a decade when our largest source of revenue, physical, was in decline. Physical revenue declined 5%, licensing was essentially flat and artist services and expanded rights revenue rose 16%, driven by the timing of concert promotion activity. Recorded Music OIBDA was up 12.9% to $96 million, benefiting from revenue growth; and Recorded Music adjusted OIBDA margin rose 0.3 percentage points to 13.8%, which was related to revenue mix. For the year, Recorded Music adjusted OIBDA margin was up 0.7 percentage points to 16.6% related to revenue mix shifting towards streaming. For the quarter, music publishing revenue rose 23%, while mechanical revenue declined 22%, reflecting industry trends. Digital was a standout, increasing 74%. Performance revenue was also strong, up 22%, benefiting from increased U.S. airplay market share. Sync revenue rose 4%. Music publishing OIBDA declined 3% or $2 million to $56 million, driven by a litigation settlement and revenue mix. OIBDA margin declined 9.1 percentage points to 38.1%, driven by the same factors that impacted OIBDA. I am pleased to say our cash flow is currently very strong. We are generating operating cash flow of $135 million, up from $104 million in the prior year quarter. For the year, operating cash flow was $342 million versus $222 million last year. This was driven by increased OIBDA and ongoing work in capital management. For the year, CapEx came in at $42 million. We expect our underlying run rate for CapEx to be about $50 million a year. That said, given our decision to consolidate our L.A. offices into one location, as we've previously announced, we expect to see an incremental onetime spend of $40 million to $50 million taken over the next 2 years. This office move is similar to what we did in New York a few years ago and will create a wide range of operating efficiencies and strategic benefits. We also recently announced a new Center of Excellence for financial shared services based in Nashville. For the first time, our U.S. accounting operations, cash management and Recorded Music rights administration will all be under one roof, helping us to develop expertise and best processes and practices in a centralized location. We expect this move to realize annual cost savings in real estate and other expenses by fiscal '19. This will result in a charge of approximately $30 million, which we expect to take over the next 2 years. We took steps to further optimize our capital structure this year, and we will remain opportunistic. In 2016, we extended maturities of certain tranches of our debt and paid down $175 million, including all of our 13.75% holdco notes. And as you know, we've already begun efforts in fiscal '17 with our bond offering and related refi in October and term loan extension in November. All of this activity will save us about $30 million of interest expense on a go-forward annualized basis, as we've lowered our blended interest rate to 4.9% compared with 5.6% only a year ago. We have also been making select asset sales, which garnered $45 million in cash in '16. This includes the first few PLG-related divestitures as well as some other noncore sales. During the year, we also received $42 million from real estate sales, including the sale-leasebacks of our Sydney office and an office in the U.K. We ended the year with $359 million of cash on the balance sheet, noting we had no revolver draw during the entire year. This is up significantly from the $246 million in 2015. Our net debt is nearly $300 million lower than last year. Subsequent to year-end, in November, we received our portion of the Pandora pre-'72 settlement, which was about $18 million in cash. We will book this on the P&L in the first quarter of '17. We are using our cash in a balanced way, to reinvest in business and to delever, yet ample cash remains on balance sheet. Given this, and based on the continued confidence of our growth, our board has decided to issue a dividend in the amount of $54 million, which will be paid on January 3. Importantly, our philosophy with respect to dividends requires that operating cash flow is more than sufficient to serve our continued investment in our artists, our songwriters and our company. We are also committed to continued debt pay-down. To be clear, we only plan to consider future dividends after first achieving these priorities. 2016 marks the first year that we are issuing a dividend since Access acquired us in 2011, and we will evaluate the potential for future dividends in the context of our ongoing annual performance. In conclusion, our company is performing extremely well as part of a healthy industry, and I'm confident that we are well positioned for long-term growth. With that, operator, please open the line for questions.

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

I wanted to start with the publishing unit. Can you talk a little bit more about what's driving the top line growth there? And then, I guess also connected to that, how we think about the margin movement in the quarter. Maybe you can quantify the impact of that litigation settlement, how much that was.

Sure. So Aaron, well, first of all, thank you for your question and call. So the top line movements, similar to Recorded Music, is really driven by digital and streaming growth. You see the strong -- as we discussed streaming numbers, we talked about 74% growth this quarter in publishing. So that's really helping drive that. In addition, our market share growth in publishing has been tremendous. And since we put our new management team in, led by Jon Platt, slightly more than a year ago, they've really focused on their kind of high-touch, high-service model, connecting artists that are recording to writers. And so we've really helped drive our market share. So the combination of that plus streaming growth has led to a very strong revenue year. On margin, litigation that we mentioned here really is the conclusion of the Happy Birthday litigation that we've mentioned earlier in the year. And if you extract the Happy Birthday litigation impact this year, overall OIBDA for publishing was up for the year, and actually, they had a strong solid year, both in revenue and in OIBDA. So we think publishing is on a healthy upswing, and we're very confident in that business.

Okay. And on a related note, as you think about margins for the overall business going forward, do you see opportunities for margin expansion? Or is -- some of the mix shift to digital or streaming, is that going to impact your ability to expand the margins going forward?

No, good question. The mix shift in, really, Recorded Music, because Recorded Music, the shift from physical to streaming. So the more our mix moves away from physical, which has the hard good cost, the shipping cost, towards streaming, the more we would expect to see moderate margin improvement over time as we move from a physical cost business to a digital business.

Okay. And last one for me, I figured I would try to ask if there's any upcoming releases you wanted to highlight, any kind of marquee names that could be material as we think about the numbers over the next quarter or 2?

No, Aaron, it's Steve. As is our practice, we don't give advanced notice of music we'll be dropping throughout the year, given the potential for music to show up early or late. It's just not, for -- from our perspective, a wise practice. So that one, you'll just have to keep your fingers crossed and wait.

[Operator Instructions] Your next question comes from the line of Mary Pulitz [ph], Credit Plus [ph].

I hear you on the debt reduction, which, clearly, you're delivering on, but you're also growing EBITDA. I was wondering if you would feel comfortable setting out a target leverage, where you would seek to maintain an average debt level as opposed to keep decreasing debt or you're just happy for it to come down and down?

So thank you, Mary, and we appreciate the question. We don't set a target leverage number, but we do talk about our approach and our philosophy. And so this really is the first year, certainly since Access has owned us, that we've made significant debt repayment and really made a focus of delevering. And we expect, philosophically, to continue the approach, where our approach is to really focus on operational performance, driving OIBDA, driving cash flow, using that opportunistically between reinvesting in the business and continuing to pay down debt, both of which serve to delever by growing our earnings and reducing our net debt. Those remain our top priorities.

And there's not -- I mean, but you wouldn't pay like at 3x, or at some point that'll become [indiscernible].

I would say, although we're comfortable where our leverage is today, we continue to focus on taking steps to delever going forward. So at this point, our strategy is to continue to work it down for the time being.

And there are no further questions in the queue at this time. I'll turn the call back to the presentation team.

Great. Well, listen, everyone. We appreciate your ongoing support. And I hope that all of you have a safe, warm, happy, wonderful holiday season, and we'll talk to you in calendar 2017. So take care. Have a great holiday, and we'll talk to you soon. Bye-bye.

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