Warner Music Group Corp. — FY2017 Form 10-K
Reporting period: Fiscal year ended September 30, 2017; comparisons are with fiscal 2016 unless stated otherwise. The filing is an annual report, not a standalone fourth-quarter report. WMG operates Recorded Music and Music Publishing and is privately held, with all common stock owned by Access Industries affiliates; there is no public market for its common stock.
Business context and financial results
WMG is a global music company with operations in more than 50 countries. Recorded Music includes labels, distribution, licensing and artist services; Music Publishing owns or administers composition rights. More than half of revenue came from outside the U.S.
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Revenue | $3.576 billion | $3.246 billion | Up 10% reported; up 12% excluding foreign-exchange effects |
| Operating income | $222 million | $214 million | Up $8 million |
| OIBDA (non-GAAP) | $473 million | $507 million | Down 7%; margin declined to 13% from 16% |
| Net income attributable to WMG | $143 million | $25 million | Up $118 million |
| Cash from operating activities | $535 million | $342 million | Up $193 million |
| Cash and equivalents at year-end | $647 million | $359 million | Up $288 million |
| Total debt, net of financing costs | $2.811 billion | $2.778 billion | Up $33 million |
Revenue less cost of revenue was $1.645 billion, or approximately 46% of revenue, versus approximately 47% in FY2016. Total current assets were $1.275 billion and current liabilities were $2.100 billion. Net debt, as defined by WMG, was $2.164 billion, down from $2.419 billion. Capital expenditures were $44 million.
Revenue mix and material changes
- Digital: Consolidated digital revenue rose 25% to $1.870 billion and represented 52% of revenue, versus 46% a year earlier. Streaming revenue grew strongly; Recorded Music streaming increased $434 million to $1.342 billion, while digital downloads declined $106 million to $328 million.
- Recorded Music: Revenue increased 10% to $3.020 billion. Digital and artist-services/expanded-rights growth more than offset an $59 million decline in physical revenue. Recorded Music OIBDA fell 2% to $451 million, with margin down to 15% from 17%, primarily due to higher artist and repertoire costs and general and administrative expense.
- Music Publishing: Revenue increased 9% to $572 million, led by digital streaming and performance income. OIBDA increased 10% to $152 million; margin improved to 27% from 26%.
- Expenses: Cost of revenue increased 13% to $1.931 billion, faster than revenue. Selling, general and administrative expense increased 13% to $1.222 billion, including higher compensation and restructuring/relocation costs.
- Income and taxes: The $143 million attributable net income included a substantial income-tax benefit. WMG reported a $2 million pretax loss and a $151 million income-tax benefit, including a $125 million reversal of U.S. valuation allowance and a $59 million benefit related to foreign-currency losses on intra-entity loans. Earnings therefore do not solely reflect operating performance.
Cash flow, debt and liquidity
Operating cash flow rose to $535 million, with working-capital movements—including royalty payables and timing of advances—among the main drivers; timing of collections partly offset the increase. Investing activities used $126 million, including $139 million for acquisitions and business investments, $16 million for publishing rights and $44 million of capital expenditures, partly offset by $73 million of divestiture proceeds. WMG acquired Spinnin’ Records in September 2017.
Financing activities used $128 million, including $84 million of special dividends and repayments/redemptions of debt, partly offset by proceeds from new secured notes and a term-loan amendment. The company refinanced 2021 notes with 2024 secured notes and reduced the term-loan pricing in May 2017. Interest expense, net, declined to $149 million from $173 million; weighted-average debt interest was 4.9% at year-end. Debt included $1.006 billion of variable-rate term loans and $1.840 billion of fixed-rate debt. The revolving facility had no borrowings; $138 million was available after letters of credit.
Management stated that existing cash and operating sources should be sufficient for operations, debt service, working capital and capital expenditures over the next 12 months. WMG reported covenant compliance at September 30, 2017. Its springing revolving-credit leverage limit is 4.625:1.00 when borrowings exceed the specified threshold; the reported secured leverage ratio was 3.41x under the agreement’s defined calculation. These covenant measures use adjusted definitions and are not GAAP earnings or cash flow measures.
Outlook, risks, contingencies and unusual items
- No quantified revenue, profit or cash-flow guidance is provided. Management expects digital distribution and streaming to remain important growth drivers, while continuing cost controls, artist development, catalog monetization and investment in new technologies. It cautions that streaming growth may not fully offset declines in physical sales and downloads.
- Key business risks include dependence on successful artists and release schedules; competition and pricing leverage of major digital services; piracy, including stream-ripping; foreign-exchange movements; regulated publishing and recording royalty rates; and potential loss or impairment of catalog rights and intangible assets.
- Debt is substantial and subject to restrictive covenants. Variable-rate borrowings, refinancing access, subsidiary cash transfers and debt-service needs could constrain investment or distributions. Goodwill was $1.685 billion; the annual impairment review found no impairment, but future cash-flow shortfalls could trigger charges.
- WMG’s digital-download pricing class-action litigation remained unresolved. The court denied class certification in July 2017; plaintiffs sought permission to appeal. The company could not estimate a reasonably possible loss range. Accruals for other pending proceedings were described as not material, though outcomes and potential losses were uncertain.
- Unusual items include the $125 million U.S. valuation-allowance reversal, $35 million debt-extinguishment loss, $70 million non-cash share-based compensation expense and $30 million free-cash-flow compensation expense. WMG paid $84 million in special dividends and reported a $6 million net gain on divestitures.
- After year-end, WMG disclosed a November 2017 term-loan amendment, scheduled to close in December, that would reduce pricing and change certain covenant-related terms.
Important facts for investors to verify
- How much of the operating-cash-flow increase is repeatable versus attributable to working-capital timing, especially royalty payables and collections.
- Whether streaming growth and its margins can continue to offset physical and download declines, and how much digital revenue depends on a small number of platforms.
- The recurring earnings impact of the tax benefit, variable compensation, debt-refinancing charges and relocation/transformation costs.
- Debt maturities, refinancing terms, available revolver capacity and compliance with covenant definitions; reconcile reported debt net of financing costs with principal obligations.
- The appeal and potential exposure in the digital-download litigation, and the final purchase accounting and performance of the Spinnin’ Records acquisition.
- Cash available at the operating subsidiaries versus the parent holding company, and the impact of future dividends, acquisitions and Access-related fees or transactions.