Warner Music Group Corp

NASDAQ:WMG

Earnings Call Transcript 2020-Q1

[Operator]

Welcome to Warner Music Group's First Quarter Earnings Call for the period ended December 31, 2019. 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 and Chief Communications Officer. You may begin.

[James Steven, executive]

Good morning. Welcome to Warner Music Group's fiscal first quarter ended December 31, 2019, 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 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, 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.

With that, I'll turn it over to Steve.

[Stephen Cooper, executive]

Thanks, James. Happy New Year, everyone, and thanks for joining us. My comments today will be briefer than usual since we spoke 2 months ago.

Our Q1 results were very strong. We achieved the highest revenue in our 16-year history as a stand-alone company. We're especially pleased with this, considering the tough comparison with our results in the prior year quarter. Specifically, we grew total revenue by 5%, digital revenue by 14% and OIBDA by 10%.

Our results reflect the benefit of both our own execution and industry performance. Recorded Music continues to expand in both established and emerging markets. For calendar '19, consumption in the U.S. rose 15%, with streaming up 29%. In the U.K., album equivalent sales grew 7.5%, with streaming up 26%. All indications are that other major territories, particularly in Europe, will show strong performance figures when released over the coming weeks. But as we've said many times, we're not satisfied with merely keeping pace with the industry. We're determined to take advantage of our unique position. We are the planet's only pure-play global music entertainment company. We have the worldwide scale necessary to flourish in the streaming environment. We also have the agility and nimbleness required to capitalize on new opportunities and business models. The combination of our creative expertise and expanding global footprint, innovation mindset and financial discipline makes us very confident about our long-term growth prospects.

Above all, our results this quarter are further evidence that our investment in a consistent flow of great music is paying off. Our top sellers reflected new talent, including Lizzo and Tones and I; hip-hop stars, such as Cardi B and Young Thug; legends, like Rod Stewart and Prince; and superstars, including Coldplay and Ed Sheeran, who was named Artist of the Decade by the U.K.'s Official Charts Company and whose single, Shape of You, was the most streamed song of the decade on Spotify.

In order to turbocharge our A&R activity, we continue to build out the breadth and depth of our repertoire centers. One of the most recent examples is Elektra Music Group, which we established as a new stand-alone frontline U.S. label in the last fiscal year under Gregg Nadel and Mike Easterlin's leadership. Elektra's many early accomplishments include signing Tones and I, whose single, Dance Monkey, has had a 3-month run at #1 on Spotify's global chart. And in December, Elektra formed a joint venture with DTA Records, the label founded by Blink-182's Travis Barker, whose worked with groundbreakers, like Lil Nas X, Halsey and Pharrell.

Our commitment to extending our global reach by adding to our local expertise clearly shows up in our results this quarter. Local stars like France's Renaud and Japan's WANIMA and TWICE featured high up on our list of top sellers, despite not yet having significant global fan bases.

We're seeing incredible success with the new generation of local European artists who are helping drive streaming growth. These include Aya Nakamura in France, Bausa in Germany; and Fred De Palma, who ,with his 5x platinum single, Una Volta Ancora, celebrated Italy's biggest #1 single of 2019.

We're always looking for imaginative ways to break into new markets and add to our existing presence, whether that's through organic investment, local partnerships or acquisitions. I'll give you 2 recent examples.

At the beginning of the year, we opened new offices in Turkey, following the expansion of our partnership with the country's largest independent music company, Dogan.

And at the end of last year, our Netherlands-based label, Spinnin', launched a nation imprint to capitalize on the popularity of new dance music coming out of the region.

In Publishing, Warner Chappell songwriters are contributing to today's top hits. For example, Julia Michaels, Justin Tranter and Mattman & Robin cowrote Selena Gomez's Lose You to Love Me; Michael Pollack cowrote Maroon 5's Memories and Dre Moon cowrote The Weeknd's Heartless. Under the great leadership of Guy Moot and Carianne Marshall, Warner Chappell continues to build its roster of superstar songwriters. They've added breakthrough artists such as Lizzo, Tones and I and Ava Max to a roster that already includes Twenty One Pilots, Green Day, Wiley, Lin-Manuel Miranda, Katy Perry, George Michael and many, many more.

Warner Chappell is also taking a more global outlook, signing a host of local songwriters from all corners of the world, including Vicente Barco from Columbia, Espina from Spain and Kim Jae-hwan from Korea.

Our artists and songwriters had a great showing at the Grammys this past Sunday, with Lizzo and Gary Clark, Jr. each taking home 3. We congratulate all our winners who include Dan + Shay, Brandi Carlile, Nipsey Hussle, Anderson .Paak and the Hadestown cast recording.

We're looking forward to the Brit Awards on February 18, where our artists and songwriters are up for a wide range of awards.

Warner Chappell's Dave, and Atlantic and Warner Chappell's Stormzy led the pack for us with 4 and 3 nominations, respectively. Other Warner recording artists and songwriters up for a Brit include Burna Boy, Charli XCX, Foals, Lizzo, Mahalia and Rag'N'Bone Man. We wish them all the best of luck.

Fiscal '20 is off to an excellent start, and there's lots of amazing new music on the horizon. Our partnerships with our digital distributors have never been better, we put the India litigation with Spotify behind us, and we're looking forward to working with all the streaming services to grow the industry and create new possibilities for artists and songwriters.

One of our unwavering goals is to preserve and protect the value of music. While we expect an appeal, we are pleased that in December, a jury rendered a $1 billion verdict in the copyright infringement case brought by us, Sony and Universal against Cox Communications. This was the fifth largest U.S. jury award in 2019 and clearly demonstrates the juries understand piracy is not okay. We've brought similar industry cases against 4 other ISPs, Charter, Grande, RCN and Bright House, all of which should proceed to trial within the next 12 to 18 months.

In short, given our critical role in the music ecosystem, we believe we've only just begun to realize the Warner Music Group's true potential as the global music entertainment powerhouse.

I'll now turn the call over to Eric.

[Eric Levin, executive]

Thank you, Steve. Good morning, everyone. Our first quarter results are very healthy, particularly in the context of a very strong prior year quarter.

Revenue rose 5% in constant currency and 4% on an as-reported basis. From an OIBDA perspective, certain adjustments are necessary to make the year-over-year comparisons more meaningful. The details are in our press release. But in the quarter, we had $11 million of onetime expenses related to our financial system upgrade and restructuring and publishing associated with management changes.

Q1 adjusted OIBDA rose 10% to $247 million, and adjusted OIBDA margin rose 1.1 percentage points to 19.7% driven by revenue growth and lower variable compensation expense. Variable compensation associated with our long-term incentive plan was a benefit of $2 million compared with an expense of $17 million in the prior year quarter due to the impact of dividends paid. Based on the valuation at quarter end, we expect the cash payout associated with the plan to be in the range of $250 million to $300 million spread mostly over fiscal '20 and fiscal '21. That said, we are in the process of evaluating what impact the Tencent investment in Universal could have on the current valuation and the resulting impacts to variable comp expense and future cash payouts.

In Recorded Music, first quarter revenue was up 5%. On a segment basis, digital revenue grew 13% driven by a 19% increase in streaming. Physical revenue declined 19% due to industry trends and timing of releases. Licensing declined 1% due to timing of payments. Artist service and expanded rights revenue grew 14% driven by touring and advertising revenue.

Recorded Music adjusted OIBDA rose 12% to $241 million driven by revenue growth and lower variable compensation expense. Adjusted OIBDA margin rose 1.5 percentage points to 22.2%.

Q1 Music Publishing revenue grew 6%. Digital rose 12%. Performance declined 12% due to timing of distributions. Mechanicals, which only relate to physical sales, was flat. Sync rose 29% due to higher revenue from licensing for TV and commercials.

Music Publishing adjusted OIBDA declined 13% or $5 million to $34 million. Adjusted OIBDA margin declined 3.9 percentage points to 19.7% due to timing of A&R investment.

Our operating cash flow in Q1 was $78 million versus $92 million in the prior year quarter. The change was largely due to the timing of working capital.

CapEx was $15 million compared to $26 million in the prior year quarter. The decrease was due to timing of our L.A. headquarter -- spend on our L.A. headquarters in the prior year quarter. For full year '20, we continue to expect our total CapEx of about $100 million due to anticipated spend on the upgrade of our financial systems.

On January 17, we paid a dividend of $37.5 million as compared to our Q1 dividend of '19 of $31.25 million. We expect to pay the same $37.5 million dividend in each of Q2 and Q3. And consistent with our policy, we'll determine any potential variable dividend for Q4 at fiscal year-end.

I am pleased with Q1 results and remain confident in our growth prospects for the full year.

With that, operator, please open the line for questions.

[Operator]

[Operator Instructions] We do have a question from the line of David Farber from Crédit Suisse.

[David Farber, analyst]

I have a couple of questions. The way -- the business is obviously performing as you've talked about for a couple of quarters. But I wanted to touch base on just 2 items. The first on what you mentioned in the prepared remarks around Cox and some of the other cable operators. Can you kind of just give us a high-level sense for what the back and forth is around the $1 billion? Sort of just walk us through what's happening there because I think that would be helpful. And then I have a follow-up.

[Eric Levin, executive]

I can...

[Stephen Cooper, executive]

Yes, go ahead.

[Eric Levin, executive]

Yes. So well, I would say that that's a jury ruling or judgment, which we're very pleased with. We do fully expect the likelihood of an appeal, and that process will move forward. We'll continue to pursue that case and the other ISP cases rigorously. But it could take time to go through the appeals process and the discussions that, that could bring up. So although we're pleased, we do expect a favorable outcome. We'll pursue rigorously. We realize we have to be patient given the judicial process.

[David Farber, analyst]

Right. But what's the crux of the back and forth? Yes.

[Stephen Cooper, executive]

Just to elaborate for a minute on Eric's response. The case was really the basis of a disregard for the DMCA and disregarding takedown and policing of their network for people that were pirating our intellectual property as well as Sony's and Universal. And there really is no back and forth. There were repeated requests to police and takedown, which were ignored. And it's similar in the other cases where, as I mentioned, we are determined to preserve the value of music, and we don't believe piracy is okay. I mean, that's really the back and the forth.

[David Farber, analyst]

Right. I just didn't know if there were particular way that users you felt like were pirating via Cox or some of the other providers.

[Eric Levin, executive]

Using things like BitTorrent, David.

[David Farber, analyst]

Right. Okay. And then the other one that we get asked from time to time is just the fitness industry and sort of how that's evolving over time in terms of people using music and obviously your content. Do you have any thoughts there? And then I did want to touch upon some of the dot-coms that you mentioned as well. And that's it.

[Eric Levin, executive]

Well, David, what I would say on fitness is fitness is one of a series of emerging opportunities that we think there's, what we'll call, traditional streaming, the services that people use to access the full library of music, which is wonderful. But there's also these emerging digital opportunities. Fitness is one. Various short-form social media forms are another and so on. As digital proliferates with new types of consumer services and products, these represent new growing areas where music will be consumed and areas of potential solid and incremental growth for us to license music. The various fitness services are services we do license our music to. We do monetize the platforms. We're thrilled they utilize our music. We look forward to more types of experimentation in new companies in addition to the big ones that we know of now emerging. And we'll continue to speak with them and license our music.

David, did you have a follow-up?

[David Farber, analyst]

Yes. My follow-up is just you touched upon it briefly, but I want to make sure I understand. On the valuation, so we're understanding, to the extent you think there's going to be, it sounded like somewhere between $250 million and $300 million of outflows over the next 2 years related to the valuation of the business, but just maybe help us with that.

[Eric Levin, executive]

No, that's right. So the long-term incentive plan we have in place has a payout mechanism over the next -- this and the next fiscal year. Our current valuation is in the range that we described in that you just $250 million to $300 million. We also noted that with the Tencent Universal transaction, we will evaluate what impact that has going forward. And that is -- I think that's the summary.

[Operator]

I'll now turn the call back to Steve Cooper for closing remarks.

[Eric Levin, executive]

Okay. Well, this is Eric. Steve may be having a challenge with technology, but we thank everyone for joining the call. We look forward to speaking to everyone next quarter. And we hope everyone has a good rest of the winter, and we will speak to everyone soon. Thank you so much.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.