Warner Music Group Corp. — Q2 FY2018 Form 10-Q
Period: Fiscal quarter and six months ended March 31, 2018; amounts in U.S. dollars, millions unless stated otherwise. The company operates Recorded Music and Music Publishing businesses. It is privately held, with all common stock owned by Access Industries affiliates.
Financial performance and liquidity
| Metric | Three months ended March 31, 2018 | Prior-year quarter | Six months ended March 31, 2018 | Prior-year six months |
|---|---|---|---|---|
| Revenue | $963 | $825 | $2,008 | $1,742 |
| Operating income | $83 | $78 | $173 | $172 |
| OIBDA (non-GAAP) | $152 | $141 | $307 | $298 |
| Net income (loss) attributable to WMG | $(3) | $19 | $1 | $41 |
| Operating cash flow | Not separately reported | Not separately reported | $136 | $226 |
Quarterly revenue grew 17%; operating income rose 6% and OIBDA rose 8%. OIBDA margin was approximately 16%, versus 17% a year earlier. For the six-month period, revenue rose 15%, but operating income was nearly flat and OIBDA margin declined to approximately 15% from 17%. Quarterly net loss reflected higher tax expense and a $23 million debt-extinguishment loss; six-month net income was sharply lower, principally due to tax expense.
- Revenue drivers: Digital revenue after intersegment eliminations increased 25% in the quarter to $547 million and 22% year to date to $1.08 billion. Recorded Music streaming revenue increased to $415 million for the quarter and $819 million year to date. Publishing revenue grew 20% for the quarter and 18% year to date. Strong releases and streaming growth, including Ed Sheeran and The Greatest Showman soundtrack, contributed to growth.
- Margins and costs: Quarterly cost of revenue rose to 51% of revenue from 50%; SG&A rose to 35% from 34%. Severance and restructuring costs, higher compensation, office lease overlap and marketing contributed to expense growth. Music Publishing OIBDA margin fell to 35% from 40% for the quarter and to 24% from 28% year to date.
- Cash and liquidity: Cash and equivalents were $612 million at March 31, down from $647 million at September 30, 2017. Current assets were $1.407 billion and current liabilities $2.273 billion. Operating cash flow was $136 million; investing activities used $28 million and financing activities used $149 million. Management said available cash, operating cash flow and revolver capacity should support obligations and operations over the next 12 months.
- Debt: Debt was $2.947 billion, including $111 million current, compared with $2.811 billion at September 30; reported net debt was $2.335 billion. The company had no revolver borrowings and reported $180 million of commitments, less about $12 million of letters of credit. The 12-month secured leverage ratio under the credit agreement was 3.53x; the company reported covenant compliance at quarter end. Weighted-average debt interest rate was 4.7%.
Material changes and unusual items
- In March, the company issued $325 million of 5.50% Senior Notes due 2026 and borrowed $320 million of supplemental term loans, using proceeds principally to tender and redeem 6.75% Senior Notes. It recorded a $23 million extinguishment loss in the quarter. The remaining $112 million principal was redeemed April 15, 2018; an additional approximately $5 million extinguishment loss was expected.
- The Tax Cuts and Jobs Act prompted a provisional $26 million tax expense for remeasurement of U.S. deferred tax assets. The six-month tax provision was $71 million; management noted foreign taxes, withholding taxes, foreign losses without tax benefits and uncertain tax positions also affected the provision.
- Subsequent to quarter end, WMG sold Spotify shares for approximately $400 million cash proceeds and expected a pretax gain of approximately $300 million, a portion of proceeds to be shared with artists. On May 7, the board declared a $300 million special cash dividend, payable May 11.
- Cash dividends paid during the six months totaled $125 million. Capital expenditures were $29 million, including IT investment and the Los Angeles office build-out.
Outlook, commentary and risks
The filing provides no specific revenue, earnings or margin guidance. Management emphasized continued opportunities in digital distribution and streaming, but results depend on consumer demand, releases and artist popularity, the evolution of digital channels, and execution of transformation and cost-saving initiatives. Management cautioned that interim results are not necessarily indicative of full-year results.
- Principal business risks include competition and pricing pressure, dependence on a limited number of digital music services, piracy and intellectual-property protection, artist and songwriter retention, foreign exchange exposure, and the shift from physical to digital formats.
- Substantial leverage creates debt-service and refinancing risks and debt agreements restrict financial and operating flexibility. Ability to borrow under the revolver may depend on a springing leverage covenant if specified borrowing levels are exceeded.
- Foreign currency movements affect results; the company used foreign-exchange forwards and had $320 million of pay-fixed interest-rate swaps at quarter end. A hypothetical 10% U.S. dollar depreciation would reduce the fair value of outstanding foreign-exchange contracts by $8 million, with underlying exposures expected largely to offset losses.
- Pending matters include a digital-download pricing case for which the parties reached a nominal-payment settlement, and a Sirius XM arbitration dispute over licensing rates for pre-1972 recordings. Other litigation accruals were not material; potential excess losses could not be estimated.
Investor verification priorities
- Confirm the realized gain and artist-sharing impact from the Spotify share sale, and how proceeds were used.
- Verify payment of the special dividend and resulting effects on cash, debt and liquidity.
- Track the post-quarter redemption of the remaining 6.75% notes and related extinguishment expense.
- Assess whether streaming-led growth can sustain revenue while cost growth, restructuring expenses and segment margin pressure moderate.
- Review the Tax Act provision as provisional amounts are finalized, and monitor the Sirius XM arbitration and other legal exposures.