Warner Music Group Corp
NASDAQ:WMG

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Warner Music Group Corp
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Market Cap: 15.9B USD
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Earnings Call Transcript

Earnings Call Transcript
2018-Q4

from 0
Operator

Welcome to Warner Music Group's Fourth Quarter and Fiscal Year-End Earnings Call for the period ended September 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, Lori Scherwin, Vice President Investor Relations. You may begin.

L
Lori Scherwin
executive

Thanks, and good morning, everyone. Welcome to Warner Music Group's Fiscal Fourth Quarter and Year-End September 30, 2018, 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, our 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.

S
Stephen Cooper
executive

Thanks, Lori. Good morning, everyone, and thanks for joining us.

We've had a great year with revenue exceeding $4 billion for the first time in our 15-year history as a stand-alone company.

From this position of strength, we continue to invest in our company's core business, and at the same time, we're expanding the range of services we offer to artists and songwriters.

In fiscal '18, we grew total revenue by 9%, digital revenue by 19% and OIBDA by 1%, for which Eric will give you more details.

As recently as 3 years ago, streaming represented less than 25% of our Recorded Music revenue. It's remarkable that for fiscal '18, streaming generated over half of our revenue and is now nearly 3x physical. Although from a smaller base, streaming is on a similar growth trajectory in publishing.

Our business is thriving around the world, with Recorded Music revenue up 8.5% for the year and publishing up about 12%.

Every region grew. The U.S. was up 11%; Latin America, 29%; Asia, 21%; and Europe, 1%. The music industry has emerged as one of the fastest-growing businesses in the global entertainment economy.

Just by way of a few examples, Recorded Music trade revenues rose 10% in the U.S. during the first half of the calendar year. In Japan, physical volume was up 10% through September and digital revenue was up 13% through June. And for the first time ever, in Germany and France, which have both been predominantly physical markets, streaming became the largest source of revenue in the first half of calendar '18.

We remain very focused on ways to turbocharge the industry's recent growth period. With over 200 million paying customers globally, subscription streaming now has a firm economic foundation. That being said, the 200 million subscribers represent only around 3% of the worldwide population. Said differently, there is plenty of room for long-term growth across both established and emerging markets.

Last month, we saw Spotify launch in the Middle East, joining other players in the region such as Apple, YouTube and Deezer, which in August, announced an exclusive partnership with Rotana, the regional powerhouse for Arabic music.

For artists, songwriters, labels and publishers, profitable subscriber growth is only one objective. One metric that we'd like to see greater focus on is average revenue per user, or ARPU. The main drivers responsible for the trend of falling ARPU are family plans and meaningfully lower price points in emerging markets. We will be working with our subscription partners to address this concerning trend.

As I said at the beginning of the call, we're investing in our future. We're not just sitting back and enjoying the fruits of our success. Instead, we're taking our gains and reinvesting them to expand the value we provide to artists and songwriters. While it's great that streaming has broken down the barriers for artists and songwriters to be heard, true talent is still very rare and not easy to discover. We're one of the only music companies on a planet that can offer global impact across to all platforms, services and geographies. We have the creative expertise and worldwide scale needed to unlock the biggest opportunities to build long-term careers.

Over the last 12 months, we made a series of strategic moves to broaden the spectrum of our services. That starts with A&R and goes all the way through to igniting global fan basis.

To help give us an edge in spotting unsigned talent, we acquired Sodatone, the proprietary A&R tool that uses data and machine learning to track early signs of success anywhere in the world. To add to our existing in-house music-making capabilities, we opened a new recording studio complex for Warner/Chappell in London, upgraded our recording studios in Nashville and are in the process of building state-of-the-art recording facilities in Los Angeles.

To offer artists a wider choice of label homes, we relaunched 2 iconic U.S. brands, Asylum and Elektra and continued our international expansion, including the launch of Black Hat Cat Records in Malaysia. We also opened a new office in Beirut to cover Middle East markets.

To drive incremental streaming revenue, we've struck deals with Facebook and Instagram as well as fitness brands, Aaptiv and Pelican. To create new commercial opportunities for our artists and to gain greater insight into the spending habits of music fans, we acquired EMP, a leading European music merchandising and e-commerce destination. To expand our video storytelling and direct-to-consumer reach, we bought UPROXX, one of the most influential brands in media platforms for youth culture. And to help explore and support the future of our industry, we're experimenting with next-gen technologies through our new start-up investment fund called WMG Boost. Of course, none of this matters without having a consistent flow of amazing music.

Atlantic Records continues its hot streak. They have led the industry in U.S. streaming share over the last 9 consecutive quarters. Contributing to this success are Cardi B, the biggest female rap star in the generation, superstars Ed Sheeran and Bruno Mars and the soundtrack for The Greatest Showman.

At Warner Bros, Dua Lipa, Bebe Rexha and Lil Pump are reaching new heights and at Warner Music Nashville, we've seen extraordinary success with Dan + Shay.

Our international artists are thriving including Pablo Alboran in Spain, Amir in France, Korean Group Sensation Twice and Japanese punk rock band WANIMA to name a few.

We've got a great slate of music out for the holiday season in the start of our fiscal '19.

Johnny Holiday's posthumous album, My Country is love, went straight to #1 in France, breaking multiple records despite being a predominantly physical release.

We also have great music out from Twenty One Pilots, Michael Bublé, Muse, David Guetta, Cher, Disturbed, Kodak Black, Clean Bandit and The Greatest Showman Reimagined among many others.

In publishing, our songwriters are contributing to the top hits of today such as Ilya of Wolf Cousins, who co-wrote for Ariana Grande's God is a Woman; Justin Tranter and Jussi for Bebe Rexha's I'm a Mess; Tay Keith for Travis Scott's Sicko Mode; Taylor Parks for Panic! At The Disco's High Hopes and Arianna Grande's Thank U, Next.

Internationally, a stand-out success is German songwriter Bones MC who has been dominating the singles charts in his home country.

Warner/Chappell is also having a lot of success with music from artists who are Warner Music Group recording artists. I'd like to especially highlight Twenty One Pilots who recently released Trench, their third Atlantic Studio album and Warner Music Nashville's Dan + Shay, whose latest hit Tequila went to #1 on the country airplay charts and has since crossed over to become a pop sensation.

Commercially, our artists and songwriters are winning big with this slew of recent accolades.

During Country Music Week in November, Warner/Chappell won ASCAP Publisher of the Year for the sixth time in a row and was also named BMI Publisher of the Year for the first time in nearly 2 decades. To take home both titles in 1 year is an incredible achievement.

Many of our recording artists and songwriters were also recently recognized by The Recording Academy with nominations for the 61st Annual Grammy awards. We had a tremendous showing across an impressive range of genres and from all of our major labels.

To name a few, Elektra's Brandi Carlile and Atlantic's Cardi B are the 2 most nominated female artists of the year with 6 and 5 nods respectively.

We have 3 nominations in the Album of the Year category, which includes Cardi, Brandy and also Janelle Monáe.

Warner Bros.' Dua Lipa and Bebe Rexha are both nominated for best new artist.

At Warner/Chappell, we are nominations in every songwriting field with recognition in Song of the Year for R&B, rap, rock, country and contemporary Christian.

Kendrick Lamar is the overall most nominated artist with 8 nods and country star Kacey Musgraves picked up 4.

We wish all of our artists and songwriters the best of luck at the awards ceremony, which will take place February 10.

I'm very, very proud of what our team, in support of our amazingly talented family of artists and songwriters, has accomplished in fiscal '18.

We have the right strategies and the industry's best operators in place to continue our growth trajectory in '19 and beyond.

As Eric will explain in more detail, we continue to invest in our business and expect to make some noteworthy cash outlays in support of our long-term growth.

Finally, I want to pay tribute to 2 great artists who passed away earlier this year at different stages of their careers. They both made enormous contributions to our company and thrilled music fans around the world. Aretha Franklin was the Queen of Soul. She was a global icon with an unparalleled voice and a spirit that has forever changed music. Mac Miller was a half century younger than Aretha and acclaimed inspiring artist who had achieved much but who still had decades of success ahead of him.

All of us at Warner are deeply saddened by their passing. They will be greatly missed.

I'll now turn the call over to Eric.

E
Eric Levin
executive

Thank you, Steve, and good morning, everyone.

Our 2018 results were strong. The fact that we ended the year with over $500 million in cash despite significant spend on A&R, marketing, CapEx and paying $925 million in dividends is evidence of the underlying health of our business. Steve talked mostly about the fiscal year, so I will focus my remarks on the fourth quarter.

Revenue grew 15% in constant currency and 13% on an as-reported basis. For the quarter, our U.S. business grew 17% and International was up 12%.

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 $23 million of onetime expenses compared with a $1 million net benefit in the prior year quarter.

The expenses in the quarter relate to restructuring costs, our Nashville shared service center move and our LA office consolidation.

Adjusting for these factors, OIBDA increased 61% to $95 million. There are several additional items to note in understanding the quarter.

First, variable compensation. As you may remember in the prior year's fourth quarter, we had an unusually high expense related to our deferred compensation plan. While we still had expense in this year's Q4, it was much lower, specifically, our variable comp expense was $33 million in the fourth quarter of '18 versus $57 million in the fourth quarter of '17, a difference of $24 million.

During the second quarter, we accrued our estimated share of the sound exchange Sirius XM Radio under payment settlement, which benefited OIBDA by $11 million.

Offsetting these 2 benefits were 2 additional items. First, we expensed the $7 million higher management fee to access as a result of higher covenant EBITDA; and second, A&R included a $4 million adjustment to the advanced recovery estimate we booked last quarter.

Excluding these factors, our fourth quarter OIBDA and OIBDA margin were still up nicely, benefiting from revenue growth and revenue mix.

As Steve mentioned, our fiscal year OIBDA grew 1%. I'd like to highlight that it was up 14% adjusting for onetime costs related to restructuring Nashville and LA, all of which better position us for the future.

Turning back to the fourth quarter. Our Recorded Music revenue grew 14% with digital up 21%, driven by a 28% increase in streaming.

Physical revenue declined 4%, a continuation of market trends, partially offset by the benefit of strong local releases and more physical markets.

Licensing revenue grew 18% due to a combination of higher sync activity, the impact of the Spinnin' acquisition and a timing-related increase in broadcast fees.

Artist services and expanded-rights revenue increased 5% due to higher touring and merchandising revenue, which more than offset the impact of concert promotion divestitures.

Recorded Music adjusted OIBDA increased 68% to $84 million, driven mainly by revenue growth and lower variable compensation expense.

For the quarter, Music Publishing revenue rose 18%. Led by digital, up 36%, performance rose 4% due to the timing of distributions. Mechanical was up 21%, which was also timing related, and sync rose 12% due to higher licensing revenue.

Music Publishing OIBDA rose 6% or $3 million to $58 million due to revenue growth.

OIBDA margin declined 3.1 percentage points to 32.8%, driven by revenue mix and higher A&R expense.

Our operating cash flow in the quarter was $160 million versus $226 million in the prior year quarter. This change was due to timing of deferred revenue and royalty payable.

CapEx was $34 million, up from $15 million in the prior year quarter as spend related to our LA office consolidation accelerated.

Full year CapEx was $74 million, and we now expect full year '19 CapEx to be in the range of $100 million net of landlord contributions, as we continue to build out the LA office.

During the quarter, we paid the previously announced $500 million special dividend to our shareholders. Even after these investments and the dividend, our cash balance was $514 million at the end of the quarter.

Post quarter-end, in early October, we acquired EMP for EUR 155 million plus assumption of cash on hand, working capital and revolver pay down.

The EMP business will add about EUR 200 million in revenue and mid-teens euro OIBDA to our results on an annualized basis going forward.

The net impact of M&A and divestitures in fiscal '19 could add 4 to 5 percentage points to revenue growth.

We funded the EMP acquisition with euro bonds to balance out our increased exposure in Europe given EMP's revenue mix.

We issued EUR 215 million of 3.625% senior secured notes and used the incremental proceeds from the new debt issuance not needed to fund EMP to refinance higher cost tranches of our capital structure, including redemption of $26.55 million of our 5.625% notes, an open market purchase of $30 million principal amount of our 4.875% notes, which we retired and redemption of EUR 34.5 million of our 4.125% notes.

Our weighted average interest is now 4.6%, down from nearly 6% just 3 years ago.

Due to our additional borrowing, interest expense in '19 should be in the range of $150 million compared with about $140 million in '18.

Before taking your questions, I wanted to make a few additional notes with respect to fiscal '19.

First, we are adopting the new revenue recognition standard ASC 606. The main impact will be timing and publishing and licensing in Recorded Music, as we switch from a cash basis to an accrual basis. While there should be no material impact over the full fiscal year, there will be lumpiness in the quarterly comparisons within '19. When we record each quarter, we will provide pro forma revenue to enable like-for-like analysis.

Second, in fiscal '18, the expense associated with our variable comp plan was $108 million compared with $102 million in fiscal '17. The expense in '19 will depend on our business performance. From a cash perspective, we paid $75 million in fiscal '18 related to this program. We will begin paying out the deferred compensation portion of this plan beginning in fiscal '19.

We currently expect the payout for fiscal '19 through '21 to be around $200 million spread over the 3 years.

Third, as part of our ongoing cost control efforts, we have started to make a more expansive look at ways to optimize our operations, including finance and IT.

Fourth, our cash taxes in '18 were $49 million, up from $40 million in 2017 due to a combination of better operational results and the sale of equity investments.

We currently expect our cash taxes to be in the range of $50 million to $60 million until our U.S. NOLs and foreign tax credits are fully utilized, which could happen by the end of 2020. Beyond that, cash taxes could materially increase.

And finally, we've shown over the past few years, we have more than ample funds to grow our business while still being able to issue dividends. Given our comfort with the outlook, we are planning to start paying a regular quarterly dividend. We intend the dividends in the first 3 fiscal quarters to be modest with a variable dividend after the fourth fiscal quarter in amount commensurate with cash generated from operations taking into consideration potential organic investment and M&A.

We expect to pay the first quarterly dividend in January 2019. We're on a great run and remain committed to investing in our future.

I look forward to many more years of success. With that, operator, please open the line for questions.

Operator

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

A
Aaron Watts
analyst

One quick clarifier question for you, Eric. On the dividend that you're going to roll out in the near future, did I hear it correctly that you have some flexibility around the size of that dividend each quarter, and you can base it on opportunities to use that cash up elsewhere or the ups and downs in the business?

E
Eric Levin
executive

That's right, Aaron, I mean we expect to pay a predictable but modest amount the first 3 fiscal quarters of the year and the variability we'd adjust into the fourth quarter based on projected cash needs for M&A, organic or otherwise. So that's a correct interpretation there.

A
Aaron Watts
analyst

Okay. Got it. And then, Steve, maybe one for you. And you touched on this a little bit at the beginning of your comments, but how should we think about the growth of streaming or the trajectory of streaming growth going forward. I suppose at some point, we start to hit the law of large numbers, so the growth rate has to slow, but at the same time, you noted that you're only hitting around 3% of the worldwide pop in terms of who's paying for music these days. So is there still enough runway that we can think about streaming growth being in the double digits? Or do we need to temper that expectation?

S
Stephen Cooper
executive

I think you have to look at it in 2 different ways, Aaron, so let's start with subscribers or monthly active users. I think that, that will continue to grow in a very robust way. And if frankly -- if I could predict that more precisely, I would be not sitting here, I'd be sitting in front of my other crystal ball just watching the money come out of the ATM. In the developed countries, the Western markets, streaming and subscription has a very nice foothold, and we continue to believe there is growth there, but it will -- I believe, because of the adoption just mathematically by way of a rate slow down over time, and I would expect that over the next 5 to 10 years, we see something akin to saturation. In the emerging markets, they're just now being tapped, and I would expect to see very strong subscriber and/or monthly active user growth. That being said, as we move to those markets, the emerging markets, we would expect to see reduced economics just because of the economic status of those countries and the ability of their population to pay. So while we would expect a continued strong trajectory for the metrics around subscription and monthly active users, I think we can expect over time, a more modest trajectory by way of revenue growth and by way of what we referred to as ARPU, Aaron.

A
Aaron Watts
analyst

Yes. Okay. That's helpful. And then I guess the last question I had. Can you remind us how to think about the tenure of your -- some of your larger streaming distribution deals? And whether those deals are negotiated for specific geographies or globally? How much influence you have on some of the pricing because as you touched on ARPU been a concern? And if you think the next time these deals come up for renewal, should we think about that as an opportunity for Warner to improve the economics for Warner? Or might there be a little bit of pressure on the margin towards Warner when you, again, renegotiate those deals?

S
Stephen Cooper
executive

Well, I think that all of our deals are different. They -- as I sit here today, our deals include for some X set of geographies and for others, Y. I think that every time we enter into a renegotiation, it's an opportunity to create better, stronger partnerships on both sides of the coin, Aaron, with the understanding that we feel very strongly that music is valuable, and that it's always in the best interest of our artists and songwriters to negotiate deals that recognize that value. At the same time, we know that we have to support, in a thoughtful, well-balanced way, the growth of our streaming partners. That obviously leads to a give-and-take, a push-and-pull on both sides of the table, but through at least current history, we've been able to reach an amicable, thoughtful middle ground. And I expect that to continue.

Operator

[Operator Instructions] And we have no further questions at this time. I'll turn the call over to Steve Cooper for closing remarks.

S
Stephen Cooper
executive

Again, we want to thank everybody for their time and their ongoing interest in the Warner Music Group, and we wish all of you and your families a very healthy, happy, wonderful holiday season.

And we'll talk to you in -- it's hard to believe I'm saying this, 2019. The year has gone very, very quickly. So merry, merry holidays, everybody.

Operator

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