Warner Music Group Corp. — Form 10-Q Summary
Business context and reporting period
Warner Music Group operates recorded-music and music-publishing businesses. This unaudited filing covers the fiscal quarter ended December 31, 2017; the company states the underlying quarter ended December 29, 2017. Comparatives are for the three months ended December 31, 2016. WMG is controlled by Access Industries, and its common stock has no public market.
Financial performance and condition
| Metric | Quarter ended Dec. 31, 2017 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $1.045 billion | $917 million | +14% |
| Operating income | $90 million | $94 million | -4% |
| OIBDA | $155 million | $157 million | -1%; margin 15% vs. 17% |
| Net income attributable to WMG | $4 million | $22 million | Down $18 million |
| Operating cash flow | $136 million | $156 million | Down $20 million |
- Recorded Music revenue rose 13% to $904 million; Music Publishing revenue rose 15% to $143 million. Digital revenue across the company increased 20% to $533 million, or 51% of consolidated revenue. Recorded Music streaming revenue grew $93 million to $404 million. Physical revenue declined 2% to $223 million.
- Cost of revenue was 54% of revenue in both periods, implying a gross margin of approximately 46%. Higher general and administrative costs and artist-related costs weighed on profit; SG&A rose 21% to $333 million.
- Interest expense, net, was $36 million, compared with $40 million. Income tax expense rose to $52 million from $17 million, including a provisional $27 million charge related to the U.S. tax-rate reduction.
- Cash and equivalents were $776 million at quarter-end, versus $647 million at September 30, 2017. Long-term debt was $2.818 billion as reported; management reported net debt of $2.042 billion. Working capital was negative $732 million, with current assets of $1.502 billion and current liabilities of $2.234 billion.
- Operating cash flow was supported in part by a $141 million increase in royalty payables; the company cited collection and royalty-payment timing as drivers of the year-over-year decline in operating cash flow. Investing cash outflow was $6 million and financing cash outflow was $3 million.
Material changes, outlook, risks and unusual items
- Revenue growth reflected streaming expansion and the continued success of Ed Sheeran, alongside higher licensing, artist-services and publishing revenue. International revenue increased 17% reported, or 10% excluding favorable foreign-exchange effects. The Spinnin’ Records acquisition, completed in September 2017, is part of the business context.
- Despite higher revenue, OIBDA declined as corporate and general and administrative costs and artist and repertoire costs increased. G&A included higher variable compensation under the Senior Management Free Cash Flow Plan, other compensation, severance and restructuring costs, and overlapping Los Angeles office lease costs.
- The Tax Cuts and Jobs Act prompted a provisional $27 million deferred-tax expense from remeasuring U.S. deferred tax assets. WMG said its tax accounting remained provisional in certain respects; the quarter’s $52 million tax expense materially reduced net income.
- A December 2017 term-loan amendment reduced loan pricing and changed certain debt-incurrence and excess-cash-flow-sweep provisions; WMG recorded a $1 million extinguishment loss. The company reported covenant compliance at December 31. A new revolving credit agreement was entered into January 31, 2018, with lower margins, an extended maturity and revised covenant terms.
- After quarter-end, the board approved and paid a $125 million special cash dividend on January 12, 2018. Management said existing liquidity sources should support operations and requirements over the next 12 months, while noting that cash generation and debt reduction depend on industry, economic and other factors. No specific financial guidance was provided.
- Risks highlighted include competition, reliance on digital music services, piracy, artist and songwriter retention and release performance, foreign-exchange exposure, substantial leverage and debt restrictions, intellectual-property disputes, and the ability to sustain digital growth. A long-running digital-download pricing case remained pending, although the court denied class certification and the parties expected to seek dismissal. Sirius XM initiated arbitration over licensing rates for pre-1972 recordings for 2018–2022. Management said accruals for other pending proceedings were not material; possible losses beyond accruals could not be estimated.
- Management reported disclosure controls were effective and no material changes to internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether streaming and publishing growth can continue to offset physical and download declines, and whether higher revenue converts into stronger OIBDA and margins.
- The final effects of the Tax Act on tax expense, deferred taxes and cash taxes; current tax estimates include provisional amounts.
- Liquidity after the $125 million post-quarter dividend, including the terms and availability of the replacement revolving facility and restrictions under debt agreements.
- Debt-service capacity and the maturity schedule: the filing says $883 million of notes are scheduled to mature in 2022, with further maturities thereafter.
- Outcomes of the Sirius XM rate arbitration and the remaining digital-download litigation, as well as any material changes in litigation exposure.