Warner Music Group Corp

NASDAQ:WMG

Earnings Call Transcript 2020-Q2

[Operator]

Welcome to Warner Music Group's Second Quarter Earnings Call for the Period Ended March 31, 2020. 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. James Steven, Executive Vice President and Chief Communications Officer. You may begin.

[James Steven, executive]

Good morning, everyone. Welcome to Warner Music Group's Fiscal Second Quarter Ended March 31, 2020 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 and then our Executive Vice President and CFO, Eric Levin, will discuss our financial condition and results. Usually, we then open the call for questions. However, in February, we filed a registration statement on Form S-1 with the SEC for a proposed IPO. As a result, we remain in a quiet period, and we have decided not to take questions this quarter.

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.

And with that, I'll turn it over to Steve Cooper.

[Stephen Cooper, executive]

Hi, everyone. Thanks so much for joining us in the midst of this difficult time. I hope that you and your families are all keeping safe, sound, sane and out of harm's way. As James noted, we decided not to do a Q&A session today. That being said, I want to address one topic upfront, what's happening with our IPO. As you'll appreciate, we're in a regulatory quiet period, and we're limited in what we can say. The current market conditions are obvious, so our Board and management will continue to monitor the situation.

In Q1, we achieved the highest quarterly revenue in our 16-year history as a stand-alone company. And well before the pandemic turned all of our lives upside down, we knew Q2 this year would be a tough comparison with an especially strong Q2 in 2019. In the prior year quarter, our results included the impact of a onetime digital streaming license and unusually high physical revenue due to several very successful physical-centric releases. So I'm really very pleased to report that due in large part to an 11% increase in streaming revenue in recorded music and a 17% increase in digital revenue in music publishing, we've matched our great performance in the prior year quarter. That's a tremendous achievement, especially given the unusual circumstances that I'll explain shortly.

During this quarter, total revenue was flat, digital revenue was up 7.4% and OIBDA was down 93.7%. It's important to note that this OIBDA result doesn't properly reflect our great operating performance or the strong underlying health of our business. That's because we had an abnormal level of noise in our numbers this quarter, including expenses associated with our long-term incentive plan, which are a direct reflection of the strength of our results and the rising value of our company; expenses relating to restructuring and music publishing and other transformation expenses, including our financial system upgrade; reserves taken by us due to the outbreak of COVID; and expenses relating to the proposed IPO. Without these expenses, our OIBDA would have been $212 million, an increase of 4% over the prior year quarter.

I also want to note that as of this quarter, we will report adjusted EBITDA figures in our quarterly earnings releases. Since we included adjusted EBITDA and our S-1 for the proposed IPO, we want to continue to update you on it going forward. Adjusted EBITDA for the 12 months ending March 31 was $755 million compared to roughly $1.1 billion for the comparable prior year period. The decrease was largely the result of the impact of the net gain on the sale of our Spotify shares in 2019. Taking that out of the equation, adjusted EBITDA would have increased by $47 million, largely driven by the growth in stream. This is another demonstration of the continued strong fundamentals underlying our business. Eric will, of course, provide more detail later.

Like all businesses, ours is facing unique challenges in 2020. During the pandemic, we expected our -- we expect our physical artist services and synchronization revenue streams to be somewhat affected. We won't really know the exact impact of COVID until we see our Q3 results, but there may also be some shifts in our release plans due to changes in recording and songwriting schedules. Having gone through 2 decades of industry transformation, we're now in a position where almost 70% of our revenue is digital, and that percentage continues to grow. This makes us more resilient in a crisis such as this. As a result, digital revenue was not materially impacted by COVID in the quarter. Perfect examples are major new albums from Dua Lipa, Lil Uzi Vert and PARTYNEXTDOOR, all released in March, just as the pandemic was impacting major markets, they're enjoying global success supported by massive streaming and social media awareness.

We're very pleased with the global diversity and chart-topping successes of our A&R activities across both emerging and superstar talent as well as our thriving catalog business. Among the quarter's top recorded music sellers were, Roddy Ricch's debut album, Please Excuse Me for Being Antisocial, featuring the global smash, The Box, which spent 11 weeks at #1 in the U.S.; Dua Lipa's second album, Future Nostalgia, which saw her become the third most listened to artist on Spotify globally; and albums from 2 artists that we're pleased to work with across both recorded music and music publishing, multi-Grammy winner Lizzo and Australian sensation, Tones and I, whose global smash, Dance Monkey, crossed the 1 billion streams mark. On the international front, best sellers included Japan's Kobukuro and Korea's Twice. We also saw #1 chart success stories in multiple markets across the globe, including Ghali in Italy, [ Gondi ] in France and Capital Bra in Germany.

At Warner Chappell, our momentum continues to build. With revenue up 8%, our songwriters contributed to every #1 song on the Billboard Hot 100 singles chart this quarter, including Belly and Oscar Holter on the Weeknd's Blinding Lights and 30 Roc and Dat Boi Squeeze on Roddy Ricch's The Box. As mentioned earlier, our digital revenue was rising at a healthy pace. In light of streaming's continued growth, I'm happy to say that we recently renewed our licensing partnership with Spotify and we're looking forward to collaborating with them on impactful campaigns for our artists and songwriters and working together to grow the global industry.

Against this backdrop, we're also pleased to see some recent legal decisions that help protect the value of music. Following the $1 billion verdict against Cox Communications in December, the majors continue to make progress in other ISP cases, including those against Grande, Charter, Bright House and RCN.

Now I'd like to turn to the pandemic. It's certainly no secret that we're in uncharted territory, what one of my colleagues happily called business unusual. Right now, our priorities are to protect the health of our people and our company, sustain our artists' and songwriters' livelihoods and support the wider music ecosystem. Ultimately, we will come out of this awful situation having absorbed some valuable lessons while evolving into a company that's even stronger and more efficient.

So what are we learning in this unprecedented environment? First and foremost, we're seeing how vital and important music is to people's daily lives. In difficult times like these, music can lift people's spirits, transport them and make them feel connected and safe. The global appetite for great music is higher than ever and will continue to expand. It's still early days, but we're seeing daily consumption patterns shifting to reflect people's new working-from-home reality. Initially, at least, we've not seen fundamental changes in the dynamic of the streaming subscription business which remains strong and healthy.

Second, our A&R teams are demonstrating their ability to find new and imaginative ways to help and support our artists' and songwriters' creative processes even in the most challenging circumstances. Great talent always rises to the occasion in good times and bad, and incredible music is being written and recorded right now, not only about the crisis itself but about life, relationships and resiliency.

Just a few examples. Atlantic artist and Warner Chappell songwriter, Alec Benjamin, released Six Feet Apart a moving song about social distancing. He recorded the vocals and guitar on his phone, and the track was written and produced over Face Time. The 2 members of Twenty One Pilots collaborated remotely on a fantastic new song and inventive video, Level of Concern. At Warner Chappell, they've responded by setting up a series of video dates between songwriters who've never met before. And in the midst of the pandemic, Warner Music Italy couldn't film the traditional video for their breakout superstar, Ghali. So they supported the artist's vision by organizing fans to sing the song from their homes and created a video with user-generated content that brought everyone together. We're also not missing a beat when it comes to attracting the next-generation of talent. We're already adept at negotiating and signing deals remotely and we're accelerating the adoption and use of our proprietary A&R tool, Sodatone, to identify emerging artists across the globe.

Third, our ability to cut through all the noise on streaming services is more valuable than ever to our artists and songwriters. We pivoted quickly implementing imaginative solutions to not only compensate for the abrupt halt to live promotional appearances but to actually deepen the connections between artists and fans. Songkick, the world's leading gig discovery tool, which we acquired in 2017, has been at the forefront of this effort. They've staged a series of livestream gigs by artists such as France's Christophe Maé, the U.K.'s Rudimental and Sweden's Paul Rey to name just a few. And we continue to focus on moving into emerging markets to expand our reach for both global superstars and local talent.

At the beginning of April, we unveiled our new office in Vietnam where they marked the opening in grand style by nailing the top 3 spots on the country's Spotify playlist. This follows our recent launch of operations in India and Turkey.

None of us can be sure how long this situation is going to last. So we believe that besides supporting our people, our artists and our songwriters. Through this tough time, we need to help those less fortunate than ourselves. We've set aside a central multimillion-dollar fund to support both local and global COVID-related philanthropic efforts over an extended period of time. We're helping the fight against the virus by donating to groups such as the World Health Organization and Heart to Heart International.

We're helping people across the music community, not only artists and songwriters in need of emergency aid, but also the wider ecosystem of technicians, session musicians, production crews and tour managers with donations to music-focused organizations such as use of MusiCares, the Health Musicians Fund, the Unison Fund, the Jazz Foundation and the Crexendo Trust.

We're also supporting the efforts of our artists and songwriters to make a difference. One highlight was the hugely successful PlayOn Fest, a first-of-its-kind global virtual music festival presented by the Warner Music Group. Held over the last weekend of April, it benefited the World Health Organization's COVID-19 Solidarity Response Fund.

Right now, our global teams, our artists and our songwriters are proving just how flexible, endlessly creative and solution-driven they are. As I've noted in the past, we're the planet's only pure-play global music entertainment company. Both our scale and our nimbleness will serve us very well in the coming months as we keep the music flowing and fans engaged. I'm very optimistic that our distinctive combination of creative innovation and financial discipline will see us whether this storm and emerge stronger, better and more agile than ever.

With that, I'll now turn it over to Eric.

[Eric Levin, executive]

Thank you, and good morning, everyone. As Steve said, total revenue was flat in constant currency. On an as-reported basis, it was down slightly at 1.7%. While our headline performance isn't as impressive as in recent quarters, we're anticipating a very tough comparison with a strong Q2 2019, and our results are in line with what our expectations were for this 1 quarter. I'd also like to add that while COVID presents real and significant challenges to our industry, we remain very confident that we're well positioned for long-term growth.

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 a charge of $169 million associated with variable compensation under our long-term incentive plan due to an increase in our valuation. This compares to $5 million of variable compensation expense in the prior year quarter. We also had $31 million of onetime expenses related to restructuring and publishing associated with management changes, the upgrade of our financial system, reserves taken due to COVID and cost of our proposed IPO. Q2 adjusted OIBDA declined 78% to $43 million, and adjusted OIBDA margin declined 16.4 percentage points to 1.1%, primarily driven by higher variable compensation expense. Excluding the impact of this higher expense, Q2 adjusted OIBDA would have increased $8 million or 3.9%. Adjusted OIBDA margin increased 1.1 percentage points to 19.8% due to revenue mix.

Based on our valuation at quarter end, we would expect the payout associated with our long-term incentive plan to be approximately $400 million, which relates to the redemption of equity interests, with the majority expected to be paid out in fiscal '21.

In recorded music, second quarter revenue was down 1.5%. Digital revenue grew 6% driven by an 11% increase in streaming revenue. Adjusting for the onetime impact of the pre-1972 digital streaming license with SiriusXM in Q2 2019, digital revenue grew 9% and driven by a 14% increase in streaming revenue. Licensing revenue increased 3% due to timing of payments. Physical revenue declined 28%, mostly due to timing of strong physical releases in the prior year quarter and also due to ongoing industry trends and the impact of COVID this quarter. Artist services and expanded rights revenue, which includes merchandising, declined 13% driven by timing of tour schedules as well as some COVID-related tour postponements.

Recorded music adjusted OIBDA declined 52% to $89 million due to higher variable compensation expense. Adjusted OIBDA margin declined 10.9 percentage points to 8.4%. Excluding the impact of this higher expense, Q2 adjusted OIBDA would have increased $3 million or 1.6%. Adjusted OIBDA margin increased 0.9 percentage points to 21.1% due to revenue mix.

We are pleased that after only a year of new leadership under Guy Moot and Carianne Marshall, Music Publishing grew its revenue by 8% in Q2. Digital revenue rose 17% as streaming revenue continues to grow. Mechanicals increased 25% due to timing of distributions; synchros, 10%, due to our expanded sync team driving greater revenue from licensing for TV and commercials. These gains were partially offset by a 9% decline in performance revenue due to timing of distributions and the impact of COVID. Music Publishing adjusted OIBDA grew 4% or $2 million to $49 million. Adjusted OIBDA margin declined 0.2 percentage points to 29.5% due to timing of A&R investment.

Our operating cash flow in Q2 was $86 million versus $7 million in the prior year quarter. The chink was largely due to timing of receivables and strong working capital management. CapEx was $13 million compared with $33 million in the prior year quarter. The decrease was due to the completion of spend on our L.A. headquarters in the prior year. For the full year '20, we had expected total CapEx of about $100 million due to spend on the upgrade of our financial system, but the actual spend should be closer to $80 million, with the remainder shifted to fiscal '21.

Adjusted EBITDA for the last 12 months ended March 31, 2020, was $755 million compared to $1.097 billion for the comparable prior year of LTM period. The chink was largely a result of the impact of a net gain of $389 million from the sale of the company's Spotify share in the prior year period. Excluding the impact of the Spotify share sale, adjusted EBITDA would have increased $47 million to $755 million, largely driven by the growth in streaming. While we have previously reported adjusted EBITDA in our SEC filings as a measure of covenant compliance, from this quarter forward, we plan to also update you on it in our filings and our earnings calls as a performance metric.

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

Like many other companies right now, we're managing our finances carefully to help us respond to the COVID-related business disruption of our industry and the economy at large. In the short term, we're taking all the prudent steps you would expect: we're adjusting spend, and we're allocating our resources to where they'll be the most impactful. In the long term, our prospects are as strong as ever. As of March 31, we had a cash balance of $484 million. In addition, on April 3, in the midst of this chaos, we managed to amend our revolving credit agreement expanding the size from $180 million to $300 million, extending the maturity, reducing the interest margin and improving covenants. This transaction is a real show of confidence by the financial community and our company's strength. While we haven't needed to draw on the revolver in the past 5 years, it's helpful to know it's available to us if necessary.

So while we're realistic about the pressures created by COVID, we're staying light on our feet and remaining positive about the future. Our industry becomes more digital every day. And our biggest source of revenue, streaming, is also the most durable and recurrent. Not only that, music subscription services are an incredible value for consumers. And subscriber growth is continuing.

These are extraordinary times, but I'm proud to say this situation is bringing out the best in our teams around the world. Our people are showing great creativity, resilience and empathy as they're supporting our artists and songwriters and keeping an amazing music flowing to fans everywhere. We have some excellent releases in the market and have some hugely exciting music on the way.

As Steve mentioned, because we're in a regulatory quiet period, we won't be doing a Q&A session today. We'd like to thank you all for joining, and hope everyone stays safe and healthy. We look forward to speaking to you again soon. Thank you, and have a great day.