Warner Music Group Corp. — Form 10-Q Summary
Reporting period: Fiscal third quarter ended June 30, 2017; comparisons are with the quarter ended June 30, 2016. Year-to-date figures cover the nine months ended June 30. Amounts are in millions of dollars unless stated otherwise. WMG operates Recorded Music and Music Publishing businesses. It is privately owned by Access Industries affiliates, and its common stock has no public market.
Financial performance
| Metric | Three months ended June 30, 2017 | Three months ended June 30, 2016 | Nine months ended June 30, 2017 | Nine months ended June 30, 2016 |
|---|---|---|---|---|
| Revenue | $917 | $811 | $2,659 | $2,405 |
| Operating income | $51 | $45 | $223 | $159 |
| OIBDA (non-GAAP) | $115 | $120 | $413 | $384 |
| Net income (loss) attributable to WMG | $141 | $(9) | $182 | $29 |
| Operating cash flow | Not separately presented | Not separately presented | $309 | $207 |
- Revenue and mix: Quarterly revenue rose 13% (16% excluding unfavorable foreign exchange); nine-month revenue rose 11% (13% excluding foreign exchange). Digital revenue after eliminations increased 30% in the quarter and 27% year to date; it represented 54% and 52% of consolidated revenue, respectively. Streaming growth and releases including Ed Sheeran and Bruno Mars were major drivers. Physical revenue declined 8% in both periods.
- Segments: Quarterly Recorded Music revenue was $770, up 13%; Music Publishing revenue was $150, up 12%. For nine months, Recorded Music revenue was $2,253, up 11%, and Publishing revenue was $419, up 11%. Nine-month segment OIBDA was $397 for Recorded Music and $97 for Publishing.
- Margins: Quarterly OIBDA margin fell to 13% from 15%, despite higher revenue, due to increased artist and repertoire costs and general and administrative expenses. Nine-month OIBDA margin was 16%, unchanged. Quarterly operating income increased partly because amortization declined as certain intangible assets became fully amortized.
- Cash and liquidity: Cash and equivalents were $567 at June 30, versus $359 at September 30, 2016. Current assets were $1,178 and current liabilities $1,938. Operating cash flow was $309; investing activities used $6 and financing activities used $97. Management said existing cash and operating flows should fund operations and requirements over the next 12 months.
- Debt: Long-term debt was $2,797 net of discount and financing costs; principal debt was approximately $2,834. WMG reported net debt of $2,230 using its stated measure. The $150 revolving facility was undrawn, with approximately $12 of letters of credit outstanding. Weighted-average debt interest rate was 4.9%; 65% of principal debt was fixed-rate. The company reported covenant compliance and a 3.35x senior-secured leverage ratio under its credit agreement calculation.
Changes, outlook and notable items
- Profit comparison is tax-driven: Quarterly net income included a $152 income tax benefit, including a $128 release of U.S. deferred-tax valuation allowance and a $51 benefit related to foreign-currency losses on intercompany loans. Nine-month tax benefit was $132. WMG retained a $105 valuation allowance, mainly against foreign tax credit carryforwards. These benefits substantially explain the sharp increase in reported net income and should not be treated as recurring operating improvement.
- Debt refinancing: WMG issued 4.125% and 4.875% secured notes due 2024 and used proceeds to refinance 2021 secured notes. A May 2017 term-loan amendment reduced borrowing margins to LIBOR plus 2.50% (from 2.75%) or base rate plus 1.50% (from 1.75%). Nine-month debt-extinguishment losses totaled $35, including $32 related to refinancing and redemptions.
- Dividends: A $54 special dividend was paid in January 2017. A further $30 special dividend, approved in June, was paid July 31, 2017 and accrued at quarter-end.
- Guidance and management commentary: The filing provides no specific numerical earnings or revenue guidance. Management identified digital distribution and streaming as growth opportunities, while noting continued physical-to-digital transition, variable artist-services results, and potential cost savings from transformation initiatives are uncertain.
- Risks and contingencies: Risks include streaming and digital-market development, dependence on a limited number of digital services, piracy, artist and release performance, foreign exchange, competition, substantial leverage and debt restrictions. In long-running digital-download pricing litigation, the court denied plaintiffs’ class-certification motion on July 12, 2017; plaintiffs sought permission to appeal on August 1. WMG cannot estimate a reasonably possible loss. Other pending litigation accruals were described as immaterial, but outcomes and potential excess losses were not estimable.
- Controls: Management concluded disclosure controls were effective; no material change in internal control over financial reporting was reported for the quarter.
Important facts for investors to verify
- How much of reported earnings growth reflects the $128 deferred-tax valuation-allowance release and other discrete tax benefits, rather than recurring operations?
- Whether streaming growth can offset physical and download declines, and how artist/repertoire costs affect margins as revenue mix changes.
- Cash-flow quality and working-capital effects, particularly royalty payables and timing of collections; nine-month operating cash flow benefited from working-capital movements.
- Debt maturity, refinancing and covenant terms, including the springing-maturity provisions and restrictions on cash transfers from operating subsidiaries.
- Developments in the digital-download pricing litigation and any other legal or regulatory matters that could create material costs.
- The realized cost savings from shared-services relocation and transformation initiatives, and the sustainability of dividends and other capital returns.