Warner Music Group Corp. — Q1 FY2020 10-Q Summary
Reporting period: Three months ended December 31, 2019 (the company’s fiscal quarter ended December 27, 2019; dates are presented for convenience). All amounts are in U.S. dollars. The filing is unaudited. Warner Music Group operates Recorded Music and Music Publishing businesses. Its common stock is wholly owned by Access Industries affiliates, and the filing states there is no public market for the shares.
Financial performance
| Metric | Q1 FY2020 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $1,256 million | $1,203 million | +4% |
| Operating income | $165 million | $147 million | +12% |
| OIBDA | $236 million | $215 million | +10% |
| Net income attributable to WMG | $120 million | $86 million | +40% |
| Operating cash flow | $78 million | $92 million | Down $14 million |
OIBDA margin increased to 19% from 18%; operating margin was approximately 13%. Net income attributable to WMG was approximately 10% of revenue. OIBDA is a non-GAAP measure defined by the company and should be considered alongside GAAP results.
- Revenue drivers: Recorded Music revenue rose 4% to $1,084 million; Music Publishing revenue increased 5% to $173 million. Streaming growth drove much of the improvement: recorded-music streaming revenue rose $87 million to $589 million. Digital revenue across the business increased 13% after intersegment eliminations.
- Revenue mix: Digital and physical Recorded Music revenue together increased 3%, as digital growth was partly offset by declining physical sales. Artist services and expanded-rights revenue rose 13%; physical revenue fell 20%. Music Publishing gains in digital and synchronization revenue were partly offset by lower performance revenue.
- Costs and margins: Cost of revenue increased 6% to $665 million. SG&A increased 1% to $379 million, but declined to 30% of revenue from 31%. Recorded Music OIBDA increased 14% to $241 million, while Music Publishing OIBDA fell 15% to $33 million, primarily from higher artist-and-repertoire and general and administrative costs.
- Cash flow and capital allocation: Investing cash outflow was $32 million, compared with $238 million a year earlier, when the company acquired EMP and made other investments. Financing cash outflow was $207 million, including $206 million reported as dividends paid. Cash declined $157 million to $462 million, principally reflecting financing outflows and working-capital timing.
Balance sheet and liquidity
- At December 31, 2019, cash and equivalents were $462 million and reported long-term debt was $2.988 billion, versus $619 million and $2.974 billion at September 30, 2019. The company reported net debt of $2.526 billion, up from $2.355 billion.
- There were no borrowings under the $180 million revolving credit facility; approximately $13 million of letters of credit were outstanding. Management said available cash, operating cash flows, and borrowing availability should fund operations, debt service, working capital, and capital expenditures for the next 12 months.
- The company reported a 3.36x senior secured leverage ratio under its credit agreement and compliance with debt covenants at quarter-end. Its debt agreements restrict dividends and other actions. Debt maturities are scheduled to begin in 2023.
- Current assets were $1.656 billion and current liabilities were $2.799 billion. The company reported a total deficit of $169 million.
Material changes, outlook, and risks
- Reported revenue growth included $12 million of unfavorable foreign-exchange effects. International revenue increased 5% excluding currency effects, compared with 3% reported growth.
- Net income benefited from a $33 million release of a valuation allowance on foreign tax credit carryforwards. The company recorded $5 million of income tax expense, compared with $50 million in the prior-year quarter. The release depended on management’s assessment that the deferred tax assets are more likely than not to be realized.
- Depreciation expense included a one-time $10 million charge related to a building’s expected recoverable value. Management also cited transformation-related costs and increased artist-development marketing spend.
- The company adopted lease accounting standard ASC 842, recognizing operating lease liabilities of $366 million and right-of-use assets of $297 million at adoption. At December 31, lease liabilities totaled $359 million.
- Management announced a two-year finance and IT transformation initiative, with expected capital expenditures of $30–$40 million; approximately two-thirds was expected in FY2020 and the balance in FY2021. The filing gives no specific revenue or earnings guidance.
- Management’s principal business risks include dependence on streaming platforms and their pricing, the transition away from physical formats, piracy, competition, artist and songwriter retention, hit-driven results, foreign exchange, regulated royalty rates, intellectual-property litigation, and substantial leverage. The company also identifies risks from acquisitions, data security, international operations, and potential impairment of goodwill or other intangible assets.
- Ordinary-course claims and legal proceedings are pending. Management did not expect them to have a material adverse effect based on currently available information, while noting litigation uncertainty. The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Reconcile the $206 million of dividends paid in the cash-flow statement with the separately disclosed $37.5 million declared quarterly dividend, accrued at quarter-end and paid in January 2020; clarify the timing and recipient of the larger cash-flow amount.
- Assess how much earnings growth is attributable to recurring operations versus the $33 million tax valuation-allowance release and the $10 million one-time depreciation charge.
- Monitor streaming growth against physical declines, platform concentration and pricing exposure, and the weaker Music Publishing OIBDA.
- Review debt-service capacity, covenant definitions and restrictions, the 3.36x leverage calculation, and planned transformation spending against operating cash generation.
- Track realization of foreign tax credit assets, foreign-exchange exposure, pending legal matters, and any future goodwill or intangible-asset impairment indicators.