Warner Music Group Corp. — Form 10-Q Summary
Business context and reporting period
Quarter ended December 31, 2011. Warner Music operates Recorded Music and Music Publishing businesses. On July 20, 2011, Access Industries affiliate AI Entertainment Holdings acquired the company; the quarter is reported on a “Successor” basis using acquisition accounting, while the December 2010 comparison is “Predecessor” historical accounting. The company cautions that the periods are not comparable because the merger established a new accounting basis. Warner Music is privately owned, with no public market for its common stock.
Financial performance and position
| Metric | Quarter ended Dec. 31, 2011 | Prior-year quarter |
|---|---|---|
| Revenue | $779 million | $778 million |
| OIBDA | $99 million; 13% margin | $90 million; 12% margin |
| Operating income | $39 million | $27 million |
| Interest expense, net | $57 million | $47 million |
| Net loss | $26 million | $18 million |
| Operating cash flow | $25 million | $(113) million |
| Investing cash flow | $(11) million | $(66) million |
All amounts are in U.S. dollars. OIBDA is a non-GAAP measure defined by the company and should be considered alongside GAAP results. Recorded Music revenue was $661 million, approximately flat; Music Publishing revenue rose 3% to $123 million. Total digital revenue, after intersegment eliminations, increased 17% to $219 million and represented 28% of consolidated revenue, versus 24% a year earlier. Physical and other Recorded Music revenue fell 5% to $399 million; licensing revenue declined 8% to $57 million.
At December 31, cash and equivalents were $168 million, up from $154 million at September 30. Total debt was $2.214 billion, down slightly from $2.217 billion; net debt was $2.046 billion. The company reported $857 million of current assets and $1.578 billion of current liabilities. The $60 million revolving facility was undrawn. Debt carried a weighted-average interest rate of 10.5% for the quarter. The company’s reported trailing-four-quarter Consolidated EBITDA was $461 million and its Credit Agreement leverage ratio was 4.44x.
Material changes versus the prior comparable period
- Revenue was effectively flat, while OIBDA rose $9 million and operating income rose $12 million. Higher OIBDA reflected cost savings, lower concert-promotion product costs and severance, and a strong holiday release schedule, including Michael Bublé’s “Christmas.”
- Digital growth helped offset declining physical sales. Recorded Music digital revenue rose 15%; growth in downloads and streaming was partly offset by lower mobile ringtone demand. Music Publishing performance and digital revenue improved, while mechanical revenue declined.
- Net loss widened by $8 million to $26 million, principally because net interest expense increased by $10 million and income tax expense replaced the prior-year tax benefit. The higher interest burden reflects the post-merger debt structure.
- Operating cash flow improved by $138 million to $25 million. Management cited working-capital timing, artist and repertoire spending, lower severance and bonus payments, and lower cash interest paid as factors.
Outlook, commentary, risks and contingencies
- Management said existing liquidity sources should support operations over the next fiscal year. It also described cost savings of $50 million to $65 million targeted over the nine fiscal quarters following the merger; some initiatives were implemented, but achievement of the full amount is not assured. No specific revenue or earnings guidance was provided.
- Key business risks include continued industry-wide physical-sales declines and piracy; uncertain ability of digital and artist-services revenue to offset those declines; dependence on a small number of digital retailers; volatile release schedules and artist demand; foreign-currency exposure; and competition, pricing pressure and regulated publishing rates.
- Leverage is substantial. Debt agreements contain restrictions on additional borrowing, distributions, asset sales and other actions. The revolving facility has a springing leverage test if borrowings exceed $5 million; the maximum ratio stated for fiscal 2012 is 6.25x. A breach could limit access to the facility or trigger other debt consequences.
- A digital-music pricing class action remains pending: claims for CD purchasers were dismissed with prejudice, but claims for internet-music purchasers remain and were proceeding to discovery. The company could not predict the outcome; litigation may be costly and divert management resources. Management did not believe other ordinary-course litigation would have a material adverse effect.
- Other notable items: the quarter included $7 million of severance costs and $3 million of expenses related to the bid for EMI. The company recorded a $6 million tax expense; $6 million of a $13 million uncertain-tax-position accrual was expected to be paid within 12 months. On January 31, 2012, Edgar Bronfman Jr. stepped down as chairman but remained a director.
Important facts for investors to verify
- Review merger-related purchase accounting and the successor/predecessor basis before interpreting year-over-year trends.
- Assess the sustainability of digital growth and cost savings against continued physical-sales declines and variable artist, release and touring schedules.
- Confirm debt-service capacity, covenant headroom, refinancing needs and the terms and structural priority of the secured and unsecured notes.
- Track cash conversion and working-capital movements; this quarter’s operating cash improvement included timing-related factors.
- Monitor the digital-music pricing litigation, uncertain tax positions, and any material developments regarding the company’s targeted savings or EMI-related activity.