Warner Music Group Corp. — Q3 FY2015 Form 10-Q
Business context and period. Warner Music Group operates Recorded Music and Music Publishing businesses. This unaudited quarterly report covers the three and nine months ended June 30, 2015; due to its fiscal calendar, the periods actually ended June 26, 2015. Dollar amounts are in millions unless noted. The company is privately held by Access Industries affiliates, and its common stock has no public market.
Financial performance and position
- Quarter revenue: $710, down 10% reported year over year but down 1% excluding foreign-exchange effects. Recorded Music revenue was $592, down 10%; Music Publishing was $123, down 10%. Digital revenue was $314, or 44% of consolidated revenue, versus $324, or 41%, a year earlier.
- Quarter profit and margins: OIBDA was $100 (14% of revenue), versus $66 (8%). Operating income was $23 versus an operating loss of $15. Net loss attributable to Warner Music Group was $44 versus $185; the prior-year quarter included a $141 debt-extinguishment loss. Interest expense was $45, and other expense was $17.
- Nine-month results: Revenue was $2,216, down 2% reported but up 6% excluding foreign exchange. OIBDA was $323 (15% of revenue), versus $233 (10%). Operating income was $90 versus a $5 loss. Net loss attributable to Warner Music Group was $68 versus $282; the prior-year period included the $141 debt-extinguishment loss. Interest expense was $136 versus $157.
- Segment trends: For the quarter, Recorded Music OIBDA increased to $100 from $71, while Music Publishing OIBDA declined to $20 from $24. For the nine months, Recorded Music OIBDA rose to $302 from $203; Music Publishing OIBDA declined to $88 from $98.
- Cash flow: Nine-month operating cash flow was $118, compared with $41. Investing cash use was $79, including $51 of capital expenditures; financing cash use was $15. Cash increased by $11 to $168.
- Debt and liquidity: Total debt was $2,996, down from $3,030 at September 30, 2014; net debt was $2,828. The company had $168 cash and no Revolving Credit Facility loans outstanding, with $150 of commitments less approximately $5 of letters of credit. Current assets were $773 and current liabilities $1,824. Management said existing liquidity sources should support operations over the next fiscal year.
- Leverage and equity: The reported covenant leverage ratio was 5.26x versus a 5.75x maximum when revolving borrowings exceed $30. The company reported covenant compliance at June 30. Warner Music Group equity was $254, down from $371, primarily reflecting its $68 attributable net loss and $49 foreign-currency translation loss.
Material changes and management commentary
- Reported quarterly revenue was pressured mainly by unfavorable currency movements. Excluding currency, Recorded Music and Music Publishing revenue each declined approximately 1%. Streaming growth was offset by falling downloads; physical sales and artist-services revenue also declined in the quarter, with tour timing affecting artist services.
- For the nine months, digital revenue increased 1% reported and 7% excluding currency. Streaming growth, including releases by Ed Sheeran, David Guetta and Wiz Khalifa, more than offset download declines in Recorded Music. Physical revenue and artist-services revenue were also affected by release mix and tour timing.
- Lower restructuring and PLG integration costs, ongoing cost controls and lower selling, marketing and product costs supported improved OIBDA. PLG restructuring costs totaled $74 to date against an expected total of approximately $75; management reported approximately $70 of cost savings and synergies and expected the remaining restructuring work to finish by fiscal year-end. Material PLG integration costs were also expected to be substantially completed by fiscal year-end.
- Management views digital distribution and streaming as potential growth drivers, but noted uncertainty over the timing of industry recovery and possible margin effects from changing sales mix, digital costs and publishing royalties. Artist-services revenue is variable with touring schedules and has differing margins by activity.
Outlook, risks and contingencies
- No specific revenue or earnings guidance was provided. Management stated it expects existing cash sources and revolver capacity to fund debt service, working capital and capital expenditures over the next fiscal year; this depends on operating performance and other conditions.
- Key risks include recorded-music industry and physical-sales declines, pricing and margin pressure, dependence on a limited number of digital services, piracy and intellectual-property enforcement, hit-driven releases and artist retention, foreign-exchange movements, and substantial leverage. The company also cited debt-agreement restrictions and its ability to generate cash to service debt.
- A Sirius XM settlement concerning pre-1972 recordings was reached after quarter-end: Sirius XM paid plaintiffs $210 in aggregate on July 29, 2015. Warner Music Group’s allocation had not been determined, and the company said it would recognize its share when reasonably determinable and distribute artists’ share through SoundExchange.
- Digital-download pricing class actions remained in discovery. The company could not estimate a reasonably possible loss range and said it intends to defend the cases. Other pending matters had no material accruals reported; potential excess losses could not be estimated.
- The company reported effective disclosure controls and no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether streaming revenue growth can continue to offset download and physical declines, and how foreign exchange affects reported growth.
- Whether the reported OIBDA improvement persists after restructuring and PLG integration costs subside, and whether anticipated savings are sustained.
- Cash generation, the substantial current-liability position, revolver availability and covenant headroom, including the 5.26x leverage measure and its contractual definitions.
- Timing and amount of Warner Music Group’s Sirius XM settlement allocation and the resulting artist payments.
- Developments in digital-pricing litigation, foreign-exchange exposure, and the company’s ability to service its substantial debt.