Welcome to Warner Music Group's Third Quarter Earnings Call for the period ended June 30, 2018. 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, sir.

Good morning, everyone. Welcome to Warner Music Group's Fiscal Third Quarter ended June 30, 2018, 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'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's 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 can -- 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 the 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. And with that, let me turn it over to Steve.

Good morning, everyone. Thanks for joining us. Our momentum remain strong, fueled by great new music from our artists and songwriters and excellent execution by our global operators. In the third quarter, we grew total revenue by 2% and digital revenue by 14%. OIBDA declined 14%. Eric will give you the details, but this was the result of us investing in A&R and marketing as well as higher variable compensation expense. It's worth bearing in mind that Ed Sheeran's Divide, the industry's biggest album in 2017, was released in the prior year quarter. The strength of that quarter overall, combined with revenue impact from divesting concert promotion and PLG-related assets, makes for a tough year-over-year comparison. So far this fiscal year, our revenue is up 7%, a far better barometer in looking at this quarter alone. In Recorded Music, streaming revenue grew 22% in the quarter and now represents 56% of total revenue. It's now 3x physical revenue and 7x download revenue. During the last quarter, we sold our entire stake in Spotify, realizing $504 million in proceeds. In February 2016, we were the first major to announce a policy to share proceeds from equity in streaming services with artists. I'm pleased to say that in connection with the sale of our Spotify equity, an estimated $126 million will be credited to artist accounts on their June 30 royalty statements, which are issued around the world in August and September. As such, we took a P&L expense in the quarter. The overall Recorded Music industry picture remains encouraging. For the first half of calendar '18, music consumption was up 18% in the U.S. and 6% in the U.K. Streaming revenue recently overtook physical for the first time in Germany, and in Japan, streaming is beginning to gain traction with digital…

Thank you, Steve, and good morning, everyone. The third quarter was solid, especially when you consider the very difficult comparisons with the prior year quarter. Revenue was up 2% in constant currency and 5% on an as-reported basis. Excluding the impact of the divestitures Steve -- mentioned by Steve, our revenue growth would have been about 1 point higher. Our business -- our U.S. business was up 5%. International was essentially flat, with strength in Latin America, up 30%; and Asia, up 13%, offset by an 8% decline in Europe, where the digital transformation is ongoing. From an OIBDA perspective, certain adjustments are necessary to make the year-over-year comparisons more meaningful. The details are in our press release. At the end of the quarter, we had $11 million of onetime expenses, up $6 million in the prior year quarter. The expenses in the quarter relate to restructuring costs, our share -- our national shared service center move and our L.A. office consolidation. Adjusted OIBDA for the quarter declined 9% to $110 million. The decline was largely driven by higher variable compensation expense related to our long-term incentive plan. A&R and marketing investment was also higher. I wanted to note that A&R includes a $16 million recovery related to previously written-off advances. Adjusted OIBDA margin declined 1.7 percentage points to 11.5%, driven largely by higher variable compensation expense, which more than offset the benefits of revenue mix. Our Recorded Music revenue in the quarter was up 2%, with digital revenue up 14% driven by a 22% increase in streaming revenue. Physical revenue declined 23%, a continuation of market trends but also reflects the significant physical-centric releases in the prior year quarter. Licensing was flat. Artist services and expanded rights revenue declined 12% due to lower concert promotion activity and the impact…

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

A few questions. Eric, maybe I could start with you just to be clear on kind of the comparability of EBITDA year-over-year. I know you highlighted the compensation plan. I believe that was $22 million of expense in the quarter. Is that adjusted out of the EBITDA at all or that is hurting the EBITDA number as presented?

That is adjusted out of EBITDA, yes.

Okay. And then the $16 million of advance recovery is benefiting EBITDA then in the quarter, that's not adjusted out? Or...

Just to be -- so the $22 million of LTIP is in OIBDA -- and actually, I'm sorry, I'm going to correct that -- and in EBITDA, okay? Just -- it's in both. Yes, just that. And the recovery is -- say that again. What was the question on the recovery, Aaron?

Is the recovery adjusted out? Or is that impacting EBITDA as well, up or down?

That is impacting EBITDA as well.

Okay. All right. Got it. And then just thinking ahead. The majority, I think, of the Prince catalog is headed to another label. Is that going to have any noticeable impact on results as we move forward? Or is it not large enough for it to really show up when we look at the numbers on the whole?

Aaron, just to be clear, the Warner Music Group has a number of Prince rights in perpetuity, including really the cream of the crop, Purple Rain, and the other movie tracks. That's number one. Number two, we have some rights expiring in, I believe, 2020 or 2021 in North America, but we still have rights to all of the pre-1986 music in Prince's vault -- or I guess, '96, '77 through '96. So rights that have been picked up is for later music, as I understand it, in his vault. That being said, while our Prince business is also very good, at the end of the day, given our current levels of revenue, it is not a needle mover.

Okay. I appreciate the clarifier. And as I think about, Eric, your comment on potentially funding deals in the future with financing, can you give us your latest thoughts around leverage comfort zones, whether you still like to see that trend down at all or how high you'd be willing to take it to complete any acquisition?

So we continue to focus on operating growth day in and day out, Aaron. Our job day to day is continue to grow, which will have the effect of reducing leverage, and that is our priority. If we see M&A and we will consider financing options, if one -- and we're talking kind of hypothetically, not of something that we're looking at that would -- that is imminent. If one comes up, we could see debt as an option if it is cash flow generative. If the business funds the cost of debt, that could cause our debt to tick up by 1 point or 2 potentially, and then we'll go right back to focus on operating growth and getting our leverage right back down. So for us, we have financial strength that we could consider leverage on debt, but we continue to focus on growing our business and overall, continuing to work down debt over time.

Okay, got it. And last one for me. Appreciate overtime again. Just -- there was a flurry of stories around Spotify offering some artists and managers advances to license music directly. I guess to put this in the form of an ESPN question, is this a big deal, a little deal, no deal as you think about that as a competitive threat?

Well, we assess opportunities and threats on an ongoing basis. In this particular case, Warner is, as we mentioned before, Aaron, one of the few companies on the planet that can actually help artists maximize their opportunities from a musical career and breadth and depth of our ability to move that music literally on any place around the globe. My perspective, and it's only my perspective, is that as the digital landscape becomes more and more crowded, that our services are needed more than ever. And while the move to license artists directly will be applauded by many people, I think, at the end of the day, it will just be another situation that we'll have to deal with over time. But I'm confident that it's not going to have a negative impact on our business when artists and their managers see what it is that the Warner Music Group has to offer.

[Operator Instructions] Your next question comes from the line of David Farber with Crédit Suisse.

I had a couple of questions. I wanted to tackle first just the EBITDA for the quarter a little bit differently. So it looked to us you're reporting, I think, $110 million for the quarter versus what would otherwise be last year's $121 million. So it sounds like $22 million was in the $110 million but the $16 million helped you. So I guess what I'm trying to figure out is just, if I was to clean it up a little bit, you have effectively $6 million impact negatively in the quarter because of the incremental expense related to the stock fair valuation. Is that the right way to look at it?

So talking about OIBDA. So at OIBDA, the $16 million recovery is a positive in OIBDA. The deferred compensation expense is an increase. Therefore, it's a negative. And as we said before, we also had increased investment in A&R and marketing. So those are the 4, I think, pieces that moved around. Is that -- were you trying to isolate those pieces, David?

Yes. Well, you talked about the $22 million and the $16 million advance, so I was just trying to get you guys to zero in on it being sort of a $6 million drag away from the A&R...

Correct. The net of those 2 is a $6 million drag. That's correct, David.

Got it, okay. The other thing I wanted to just talk a little bit about was the releases for the back half of the year, understanding Ed Sheeran. And so how do you guys feel about the release schedule that you have? And then I had a couple of follow-ups just on the balance sheet.

Well, we think we've got a great release schedule both with respect to the -- this last quarter of our fiscal year and heading into the first quarter of next year. We've got some of our best-selling artists returning. As I mentioned, twenty one pilots has already dropped a couple of singles. We will have some great releases coming out early to mid first quarter. So I think our operators have done a tremendous job of working with our artists to have a very nice fall and winter lineup, David.

Okay. And then -- so the $500 million special dividend was announced just now. I guess I'd see it in the Q. You also mentioned acquisitions, which is something you've talked about a little bit from time to time. But I wanted to sort of hear a little bit more. Is there anything that's driving the focus perhaps on M&A? Would it be in Recorded Music? Would it be publishing? Kind of help us think about how you guys would view the M&A landscape as it pertains today.

So I think consistent in the M&A market, David, as we've said before, we continue to be opportunistic. We have done -- last year, we did Spinnin', which had both a label and publishing component to it. It was dominantly a label but did have a component to it. We look for deals that are strategic fits for us, fit the areas that we think are necessary to help turbocharge growth. And we look for businesses that have strong financial returns. So if it fits that profile, we'll continue to look for them, whether it's on the recorded or the publishing side of the business.

Okay. And then you mentioned a regular dividend. Can you, just maybe high level, talk to us about how we could think about sizing that? Are there any bookends or covenants or anything that would help us sort of think about going to a regular-way dividend versus the special that you guys have been using in the past? And that's it for me.

I don't think we've -- David, I don't think we've finalized the policy there, so we're not announcing anything. But we do recognize that as our business is consistently cash flow generative, that coming up with a policy that is more clear and consistent is something that is appropriate for us to consider at this time.

And we have no further questions at this time. We'll turn the call over to Steve Cooper for closing remarks.

Thanks again for your time, everyone. I hope you have a wonderful end of summer over the next 5 or 6 or 7 weeks, and we'll talk to you in a couple of months. Bye now.

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