Warner Music Group Corp. quarterly report, Q2 FY2014

Warner Music Group Corp. — Form 10-Q Summary

Reporting period: Fiscal second quarter and six months ended March 31, 2014 (the company’s fiscal periods ended March 28, 2014). Comparisons are with the corresponding 2013 periods. Amounts are in U.S. dollars; financial statements are unaudited. The company operates Recorded Music and Music Publishing businesses and is privately owned by Access Industries affiliates.

Financial results

Metric	Three months 2014	Three months 2013	Six months 2014	Six months 2013
Revenue	$653m	$675m	$1,468m	$1,444m
OIBDA	$74m	$116m	$167m	$228m
Operating income (loss)	$(5)m	$57m	$10m	$108m
Net income (loss) attributable to WMG	$(60)m	$2m	$(97)m	$(78)m
Operating cash flow	Not provided separately	Not provided separately	$79m	$125m

Quarterly revenue: Down 3% reported and 3% at constant currency. Recorded Music revenue declined 3% to $535m; Music Publishing declined 4% to $122m. Digital revenue, after eliminations, rose 5% to $295m and represented 45% of consolidated revenue. Physical revenue fell 24% to $145m.
Six-month revenue: Up 2% reported and 2% at constant currency. Recorded Music rose 1% to $1,226m and Music Publishing rose 3% to $250m. Digital revenue, after eliminations, increased 7% to $571m; physical revenue fell 15% to $418m.
Profitability and margins: Quarterly OIBDA margin fell to 11% from 17%; six-month margin fell to 11% from 16%. Quarterly operating margin was approximately -1%, versus 8% a year earlier; six-month operating margin was below 1%, versus 7%. The filing reports no earnings-per-share figure.
Cash flow and investment: Six-month operating cash flow was $79m; investing cash outflow was $75m, including $30m capital expenditures, $26m of business acquisitions and $19m for music publishing rights. Financing cash outflow was $5m. Cash declined by $6m to $149m.
Balance sheet and liquidity: At March 31, cash was $149m, current assets $808m and current liabilities $1,983m. Total debt was $2,869m, including $13m current debt; net debt was $2,720m. The $150m revolving facility had no borrowings outstanding, with approximately $11m of letters of credit; availability was therefore subject to those letters and facility terms.

Material changes and drivers

The July 2013 Parlophone Label Group (PLG) acquisition contributed $72m of quarterly revenue and $146m for the six-month period. Excluding PLG, revenue declined 14% for the quarter and 8% year to date, primarily reflecting a light Recorded Music release schedule.
Recorded Music’s physical and digital results were pressured by a light release slate and the continuing shift away from physical sales. Streaming growth partly offset falling downloads: six-month streaming revenue grew $78m overall, while digital download revenue fell $41m. Excluding PLG, streaming grew $54m and downloads fell $67m.
Artist services and expanded-rights revenue benefited from concert-promotion activity and tour timing. Music Publishing’s six-month improvement reflected performance, synchronization and digital growth, partly offset by lower mechanical revenue.
Quarterly SG&A rose 12% to $273m; six-month SG&A rose 12% to $566m. PLG restructuring, integration and overhead costs contributed, alongside higher amortization from acquired intangible assets. Six-month amortization increased to $132m from $95m.
Interest expense was $54m for the quarter and $109m for six months, up from $49m and $102m, respectively, mainly due to acquisition-related debt. The reported weighted-average debt interest rate was 6.9% at March 31, versus 8.3% a year earlier.

Outlook, risks and unusual items

PLG integration: Management estimated total restructuring charges of approximately $86m and separate integration/nonrecurring costs of approximately $77m. Through March 31, restructuring charges totaled $46m, with $31m cash paid; the remaining plan was expected to finish by the end of fiscal 2015. Management anticipated approximately $70m of cost savings and synergies, had realized $17m, and expected the remaining benefits over 18 months; achievement is not assured.
Outlook: Management said existing liquidity sources were expected to support operations, debt service, working capital and capital expenditures over the next fiscal year/foreseeable future. The release schedule was expected to be more heavily weighted to the third and fourth quarters of fiscal 2014. Certain PLG releases were delayed to late fiscal 2014 or fiscal 2015, with adverse effects expected on fiscal 2014 revenue and results. No numerical full-year revenue or earnings guidance was provided.
Post-quarter refinancing: On April 9, 2014, the company issued $275m of 5.625% secured notes and $660m of 6.75% unsecured notes, both due 2022, and used $869m to redeem or repurchase the $765m 11.5% notes due 2018 and pay premiums and fees. Pro forma debt at March 31 would have been $3,052m. A $141m extinguishment loss was recorded in the third fiscal quarter, after the period covered by these statements. The revolving facility maturity was extended to April 1, 2019.
Leverage and refinancing risk: The filing’s covenant calculation showed a 5.04x leverage ratio using pro forma debt and defined EBITDA adjustments; the reported maximum was 5.75x when revolving borrowings exceeded the applicable threshold. The company said it was compliant with debt covenants at March 31. It cautioned that its substantial leverage, variable-rate exposure, restrictive debt covenants and dependence on cash generation could constrain financial flexibility.
Contingencies: Digital-download pricing litigation remained in discovery; the company could not estimate a reasonably possible loss. A separate artist royalty class action had preliminary settlement approval involving $11.5m made available to compensate class members, less specified fees and costs; final approval was scheduled for October 2014. The related reserve was described as not material.
Other risks and controls: Key risks include industry decline and piracy, release and artist-performance volatility, digital-platform concentration, foreign exchange, acquisition integration, possible impairment of goodwill and intangibles, and competition. Management identified no interim goodwill impairment indicators and concluded disclosure controls were effective; no material change in internal control over financial reporting was reported.

Important facts for investors to verify

Whether PLG integration costs and the planned $70m of savings are tracking management’s estimates, and how much of the savings are realized versus assumed in covenant calculations.
Post-refinancing debt, interest burden, facility availability, covenant headroom and the timing of debt maturities; distinguish reported March 31 debt from the subsequent pro forma refinancing.
Whether streaming growth can offset continued physical and download declines, especially given the light release schedule and the timing of delayed PLG releases.
The sustainability of operating cash flow, including the effects of deferred digital-service advances, ticket-sale timing, royalty payments and working-capital movements.
Final status and potential financial exposure from the digital-download pricing litigation and artist royalty settlement.