Welcome to Warner Music Group's Second Quarter Earnings Call for the period ended March 31, 2022. 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. Now I would like to turn today's call over to your host, Mr. Kareem Chin, Head of Investor Relations. You may begin.

Good morning, everyone. Welcome to Warner Music Group's fiscal second quarter earnings conference call. Please note that our earnings press release, earnings snapshot and the Form 10-Q we filed this morning will be available on our website. On today's call, we have our CEO, Steve Cooper; and our Executive Vice President and CFO, Eric Levin, who will take you through our results, and then we will answer your questions. Before our prepared remarks, I'd like to refer you to the second slide of the earnings snapshot to remind you that this communication includes forward-looking statements that reflect the current views of Warner Music Group about future events and financial performance. We plan to present certain non-GAAP results during this conference call in our earnings snapshot slides and have provided schedules reconciling these results to our GAAP results in our earnings press release. All of these materials are posted on our website. Also, please note that all revenue figures and comparisons discussed today will be presented in constant currency, unless otherwise noted. 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 to 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 filings with the SEC. And with that, I'll turn it over to Steve.

Thanks, Kareem. Good morning, everyone, and thanks for joining us. As we approach the two-year anniversary of our IPO, I'd like to reflect for a moment on the key pillars of our success. These are the fundamentals of our strategy, the principles we bear in mind when charting our course into the future. First, of course, is the music. It's at the heart of everything we do. While taste, trends and tech are ever-changing, our artists and songwriters will always be our driving force. Second is our global growth. About a decade ago, we set a goal to become a global music entertainment company through the expansion of our local expertise. Today, I'll share the progress we're making in growing our presence around the world. Third, we're a company that thrives at the intersection of art and technology. Innovation and data-driven insights are helping us actively create our future. And fourth, our people and our commitment to making our company a place where the best individual talents can be long and build a career. But first, let's get into our Q2 results. I'm pleased to say that they reflect the strong health of our streaming revenue, continued growth in publishing and recovery from COVID in artist services and performance. Total revenue in the quarter was almost $1.4 billion. This represents year-over-year growth of 10% and 13% on an as-reported and constant currency basis. Adjusted EBITDA was $282 million with a margin of 20.5%, compared to 21.4% in the prior year quarter. This decline was driven by our revenue mix. As our lower-margin revenue streams recovered from COVID, they became bigger contributors to overall revenue. We continue to expect that we'll achieve our long-term margin targets in the next several years as mix and growth rates normalize. In recorded music, our…

Thank you, Steve, and good morning, everyone. There is a lot to unpack within our Q2 results, but I will start with some high-level takeaways. Core streaming remains healthy -- remains incredibly healthy underpinned by strength in subscription streaming. All of our non-digital revenue lines continue to grow as well. While publishing is firing on all cylinders posting impressive results yet again. . Over the last several quarters, we've seen elevated levels of investments in A&R and M&A, which have obvious impacts on our cash flow. As expected, this has drawn attention from analysts, and shareholders who want to better understand how we view these investments, what the return thresholds are and how these investments will drive future growth. I will get into that in more detail shortly. Moving on to our results. Total revenue increased by over 13% on a constant currency basis reflecting double-digit growth in both recorded music and music publishing. On an as-reported basis, total revenue grew 10%. Total streaming revenue increased 12%, driven by growth across both businesses, including revenue from emerging streaming platforms. This strong operating performance translated to adjusted OIBDA growth of 7%, with margins of 19.9% compared to 20.4% in the prior year quarter. The decline in margin reflects the continued recovery in lower-margin artist services revenue, as well as the reduction in high-margin streaming revenue resulting from the impact of the new deal with one of our digital partners we discussed on our last earnings call. Adjusted EBITDA grew 5% with margins declining from 21.4% to 20.5% due to the same factors that impacted adjusted OIBDA. As a reminder, adjusted EBITDA includes the pro forma impact of future cost savings and certain specified transactions. You can find the calculations and reconciliations related to adjusted OIBDA and adjusted EBITDA in our press…

[Operator Instructions] Our first question comes from Benjamin Black with Deutsche. Your line is open.

The first one is for Steve. As you mentioned, a lot has happened into your IPO between COVID, inflation, interest rates and obviously the war. So has your long-term outlook changed at all? I know the entire market has come under pressure, but your stock has actually been hit a lot harder. So what do you think the market is missing? And then perhaps one for Eric on margins. How should we be thinking about the cadence of your margin expansion over the next couple of years? I understood that some of the lower-margin revenue streams are coming back this year, and you have the drag from a new DSP deal. So should we anticipate sort of more modest margin trends this year before we see a more meaningful step-up in '23?

All right. Thanks for your questions, Ben. I'll take the first one, which is really about the changes in the world since our IPO. I think everybody is seeing -- and is concerned about some of these situations that involve in the world today: War, inflation, rising interest rates. That being said, music has, and I believe will continue to prove its resilience because it is fundamental to human nature, whether it be in good times or bad times. I would remind everyone that at the height of the pandemic, music consumption continued to increase and new use cases emerged virtually every day. So our long-term outlook remains unchanged. And if anything, we're even more optimistic. As Eric mentioned, streaming continues to be strong, both in established and emerging markets and new opportunities are coming online all the time. Many of the emerging business models that we had talked about at the time of our IPO are now generating meaningful revenue and are growing faster than traditional revenue streams. I also believe that we're better positioned to capitalize on these opportunities because of our size and our innovative mindset. We remain committed to long-term artist development. We were early to see opportunities in emerging markets, and we continue to seek out, find and seize those opportunities. We are clearly the market leader by way of innovation. We saw it with streaming. And now as we see the Web3 space, we've moved faster and in more agile ways than our competitors. We've been the first to set precedent setting deals and we'll continue to do so. So I'm very confident despite all of the craziness and chaos in the world that music will continue to be a driving force in our lives and in business until the end of time. Hopefully, that answers your question number one, Ben.

Ben, let me tackle your second question. I'll hit a few key points, and thank you for the question on margins. So first, what we're seeing is something that we fully expected. Two is our recorded music margins actually increased once you adjust for the DSP renewal. So on a fundamental operating basis we’re still seeing margin growth, but yes, your question in these results, as artist services recovers it is a lower margin business. It will cause a slowing or a flattening in margin in the short term. Once artist services recovers, we fully expect to resume our margin expansion trajectory consistent with our plans at the time of the IPO and heading towards mid-20s margin. So everything we're seeing is what we expected and, operating basis, we're still very comfortable with our commitment towards margin expansion.

Our next question comes from Ben Swinburne with Morgan Stanley. Your line is open.

I guess I was hoping, Steve or Eric or both, could give us some more color on the emerging streaming business that you mentioned grew on a run rate basis this quarter. What's happening at a high level with those deals in terms of fixed versus variable? And is there -- are there one or two areas, Steve, you would really highlight that you're particularly excited about as you look out over the next 12, 24 months? And then maybe for Eric, obviously, there's a lot of concern in the market about the economy than just sort of macro headwinds. Could you just remind us, again, at a high level, how you think about your revenue base in terms of what might be exposed to the economic cycle versus just sort of underlying growth tied to subscriptions, et cetera?

So I'll start on the emerging streaming fix versus variable question. So it is absolutely something that we've been working with our emerging streaming partners. Note that we literally have hundreds of licenses with many different categories of products and services. So it's not a onetime thing, but we are -- and one thing just to set the table, emerging streaming platforms are generally services or products that are multimedia. Music is incorporated into the product, critically essential to their products, but it can be music paired with video, music paired with a game, music paired with graphics or some other social or fitness multimedia product. We have been encouraging and working with these partners for them to develop the systems and capabilities to report on music on a stream-by-stream, consumption-detailed basis that allows us to have truly variable deals. As they develop those capabilities, it is our intent to negotiate variable deals tied to revenue or consumption, whatever the right variable is, and we're moving towards that. In this quarter, there were no major renewals, smaller renewals, but not major renewals. So we continue to work towards that end. What I will say is it will take some time. Different companies are making different degrees of progress on developing the systems capabilities to track music on a stream-by-stream, consumption basis. So it's not going to be a moment but a process that we're working with over time. Hopefully, that answers your first question. What I will say is that we are incredibly excited about what we're seeing, and you see this focus of our partnerships on Web3-type capabilities, whether it's NFTs, avatars, games that can be installed within metaverses. We think there's an extraordinary amount of opportunity to be developed there. We want to develop long-term business models, not…

Our next question comes from Kutgun Maral with RBC Capital Markets. Your line is open.

I was hoping to dig into streaming revenue trends and your expectations for the back half of the year. Underlying growth at recorded music of 15% in Q2 was fairly healthy. I guess looking ahead, do you view the mid-teens growth rate as being sustainable? And is there a scope for a potential acceleration off of the 15%? Just for my end, looking at the different components it seems like subscription streaming revenue growth will presumably stay in the high teens range and that you just reported in Q2. Ad-supported streaming growth should maybe normalize closer to that high teens increase at subscription as well as you shift away from that true-up payment comp from last year. And perhaps there are new deals with emerging streaming platforms as well after a relatively quiet few quarters, and maybe that could help bolster overall streaming growth. So I know that you don't provide guidance, but is this the right way to think about the trajectory for the back half of the year? Or are there any other puts and takes that -- puts and takes that we should be mindful of?

Thanks, Kutgun. I think that was a quite thoughtful kind of statement. Certainly, we don't give guidance. So what I would say is, this quarter, our fiscal Q2 subscription streaming continue to grow high teens, the fundamentals of that business, we see are incredibly healthy. We see penetration growth opportunities in both developed and emerging markets around the world. Spotify has had success with their price increases. Their constant currency ARPU went up 3%, I believe, in this quarter. We continue to be encouraging of others to look at pricing as an opportunity to improve economic performance of streaming. So we see streaming as being very strong, the emerging forms of streaming and what we're starting to see in Web 3.0 gives us a lot of enthusiasm as well going forward. On the ad-supported side, you're right, there was that true-up in the accounting of that this quarter that have caused it to have lower growth for this individual quarter, but the fundamentals of ad-supported streaming growth remain very healthy and we have seen and fully expect to continue to see ad-supported streaming growing in line with subscription streaming on a fundamental basis. So we feel very good about the streaming platforms, their growth and the opportunities going forward, absolutely.

Our next question comes from Andrew Uerkwitz with Jefferies. Your line is open.

Just -- could you talk a little bit more about the catalog environment and the impact interest rates could have there? Are there a lot of catalogs out there? Are there a lot of sellers, are there a lot of buyers? Can you just talk about the competition there and the impact of interest rates -- rising interest rates could have on sale and price to those catalogs?

So Andrew, I appreciate the question. So look, there have been, and I think COVID's impact on artists' ability to tour certainly -- and low interest rates create an environment where a lot of artists were interested in exploring the sale of their catalogs. As artists are able to tour again and additional revenue streams come back to artists, and as interest rates rise, which could cause potential buyers to just analyze the math with different discount rates and come up with lower values could cause things to change over time. Obviously, interest rates are projected to go up over time. So we don't think there's a moment where either catalog values will change dramatically or artists' interest in selling will change dramatically. But over time, those changing dynamics could have changed the equation both for buyers and sellers. In the short term, we do expect more catalogs to come up for sale. We will do what we have always done, which is we analyze them on an opportunistic basis. If it's a strategic fit and well priced, we will consider doing deals, but we don't feel any pressure to do deals. We have many ways to invest capital to drive growth, both organically through M&A, launching in new markets, acquiring labels and acquiring catalogs. There's many different tools that we have, and we will continue to evaluate the market and do deals where appropriate, and work to make sure we're investing our capital with financial discipline to find the best returns for our investment and to drive the best growth profile going forward.

Our next question comes from Michael Morris with Guggenheim. Your line is open.

A couple of questions. One, Eric, you just touched on this, but I'm curious if you could expand on thoughts on the return of touring and the impact, or impacts that could have on the business. We know about the margin dynamic, but I'm thinking more like top line impact. First of all, do you think it's just kind of a return to sort of the prior environment? Or are there any reasons to think that sort of touring and in-person interactivity could be something bigger in sort of a post-COVID world? I'm also curious whether you think that the ability to have live performances can impact streaming and just kind of appetite for music, enthusiasm, et cetera. So that's the first question. And then the second question along the line of the acquisitions. As you think about the geographic expansion that you've also been embarking on and supplementing with acquisitions, what are your thoughts on expanding the footprint further from here versus where you currently stand?

Sure. Just writing down, there's a lot of question, Michael. So the return of touring, certainly it will be interesting. There'll certainly be some dynamics that change around the tour. So I would expect social to be a great promoter of tours around the world, artists and labels and partners using social applications to build buzz and momentum. I would expect labels and artists to be working together to create surrounding opportunities around tours, where in the past, it be tours with merch, now it will be tours with merch, and there may be Web3 applications to create micro communities that are giving NFTs and special opportunities. And those kinds of things, I think, are going to become one experimented with in the short term, what works, what the fans really love, what do they respond to, obviously, at some level, what monetizes. So I think we'll start to see experimentation in those areas, both around the release of new music but also around tours. So I think there'll be new kind of dynamics that are explored and new norms that develop over time. For the Warner Music Group, obviously, our artist services business has a significant portion that's tied to touring. We have several concert promotion businesses in Europe, in France and Spain, for example. We have a tour merch business in the U.S. And as touring comes back as we're seeing this quarter, those revenue streams start to come back, and that's a very healthy thing. Again, they are lower margin businesses, but they are positive to overall margin. Meaning not the margin percentage, but it's incremental dollars on revenue and OIBDA. So we're thrilled they're coming back. It's an important part of the music equation, and it's healthy that artist services is recovering and show signs that…

Our next question comes from Matthew Thornton with Truist. Your line is open.

Steve and Eric, maybe two quick ones, if I could. You touched on touring, but I was wondering maybe if you could touch a little bit on the E&P business. Obviously, I would assume that it had some benefits during the lockdowns and pandemic. I'm curious how that's performing as we kind of have opened up and continue to open up any color there would be helpful. . And then just secondly, Eric, you talked about cash conversion effectively a little bit early. I'm just kind of wondering if there's a number we should think about as you think about conversion from adjusted OIBDA to free cash flow, again, barring any deals. Is there a way to think about what a normalized number looks like there? Any color would be great.

Sure. So E&P, you're absolutely right. So E&P was a major -- I hate to say beneficiary during COVID, but that doesn't sound like a phrase that should come out of someone's mouth easily. But E&P's business grew, maybe I'll say it that way, on an accelerated basis during COVID. There were quarters we were discussing 30%-plus growth. It just had a significant pull forward as e-commerce businesses benefited from people's desire to stay home and not go in public spaces to shop or other activities. . This year, we're seeing E&P much more of level off, if you will, and that's not because we don't think this is a long-term growth business. We do. We believe very strongly in E&P. But some of the dynamics: One the pull forward of the prior year; but two, some of the supply chain disruptions in the world have created a challenge for E&P getting the products they've ordered on time, that they need, and that has caused a challenge. They have been incredible leaders in working through those challenges and getting those resolved. But that has been a challenge with many companies around the world. E&P is not divorced from that. And quite frankly, the war in Ukraine has been a challenge as well. I think the climate in parts of Europe have been much more cautious, and there's just less of an environment for people to be shopping for, kind of, lifestyle goods. So E&P continues to do fine, but its growth trajectory has definitely in the short term leveled off. But we're very excited about E&P in the longer term. We just have to get past this moment, which we will. And then on the cash side, what I would say is it's kind of two pieces. First and foremost,…

Our next question is from Jason Bazinet with Citi. Your line is open.

I guess over the last couple of months, the market seems to have moved from rev multiples and gross profit multiples and EBITDA multiples down to earnings and free cash. And through that lens, I just wanted to ask a quick question about cash from operations. It seemed like it was your cash generation is pretty muted, I guess, through the first half of the year. But it seems that working capital is almost always a drag in the first half and tends to reverse in the second half, not always. But can you just -- maybe it's related to the topic you just talked about in advances, but can you just elaborate on that a bit? And is there anything different that you anticipate in this fiscal year versus the last few fiscal years where we've seen a reversal in the second half?

No, there's no -- again, the deployment of capital for advances is really opportunistic. It doesn't necessarily have -- it's the timing of deals. There's not really a seasonality to that. There are parts of working capital that are seasonal. Bonuses are paid in the first half of the year, for example. So you see that as a drag in the first half of each year, and then the benefit or recovery in the second half of the year. The timing of when DSP deals are renewed is not seasonal. It is just based on the timing of deals and when they're renewed. So a lot of it is just based on the timing of deals, which is hard to predict, but there are a few things like bonuses that are more of a drag in the first half of the year than the second half, Jason.

This concludes the question-and-answer session. I would now like to turn the call back over to Steve Cooper for closing remarks.

Thanks again, everyone, for joining us today. We appreciate all of you taking the time. We hope you have a wonderful spring and summer, and we will talk again in a few months. Everybody stay well and stay safe. Thank you again. .

This concludes today's conference call. Thank you for participating. You may now disconnect.