Warner Music Group Corp. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended March 31, 2012. Unless otherwise noted, amounts are in millions of dollars. The company operates Recorded Music and Music Publishing businesses.
Important comparability caveat: The 2012 statements are for the “Successor” after Access Industries’ acquisition closed July 20, 2011; 2011 figures are for the “Predecessor.” Acquisition accounting created a new basis of accounting, so year-over-year comparisons are not strictly comparable.
Financial performance and position
| Metric | Three months ended Mar. 31, 2012 | Three months ended Mar. 31, 2011 | Six months ended Mar. 31, 2012 | Six months ended Mar. 31, 2011 |
|---|---|---|---|---|
| Revenue | $628 | $684 | $1,407 | $1,462 |
| Operating income | $22 | $16 | $61 | $43 |
| OIBDA, a non-GAAP measure | $85 | $82 | $184 | $172 |
| OIBDA margin | 14% | 12% | 13% | 12% |
| Net loss attributable to Warner Music Group Corp. | $(36) | $(38) | $(62) | $(56) |
| Net interest expense | $56 | $47 | $113 | $94 |
- Revenue mix and trends: Quarterly revenue fell 8%; six-month revenue fell 4%. Digital revenue after eliminations increased 7% to $235 for the quarter and 12% to $454 for six months, representing 37% and 32% of consolidated revenue, respectively. Physical and other revenue declined 20% in the quarter and 11% for six months.
- Segments: Quarterly Recorded Music revenue was $503, down 9%, while OIBDA was $48, down 11%. Music Publishing revenue was $128, down 7%, but OIBDA increased 8% to $54. For six months, Recorded Music revenue declined 4% to $1,164 while OIBDA rose 4% to $150; Music Publishing revenue declined 2% to $251 while OIBDA rose 6% to $72.
- Cash flow: Six-month operating cash flow was $146, compared with cash use of $7 in the prior period. Investing used $29, primarily for publishing rights, capital expenditures and acquisitions; financing used $2. Cash rose to $272 from $154 at September 30, 2011.
- Liquidity and debt: Total debt was $2,212, down from $2,217 at September 30, 2011; net debt was $1,940. The $60 revolving facility had no borrowings and approximately $1 of letters of credit outstanding. Current assets were $838 versus current liabilities of $1,543. Debt carries a weighted-average interest rate of 10.5%, versus 8.9% in the prior comparable periods. No scheduled long-term debt maturities were reported before 2016, when $1.25 billion is due.
- Leverage covenant: The reported covenant leverage ratio was 4.49x. A maximum of 6.25x applies in fiscal 2012 only if revolver borrowings exceed $5.
Material changes versus the prior comparable period
- Revenue pressure reflected continuing physical-sales declines and a lighter release schedule in the quarter. Six-month results benefited from Michael Bublé’s “Christmas,” while digital downloads and streaming growth partly offset physical declines.
- Operating income and OIBDA improved despite lower revenue, supported by cost savings, lower severance expense, a cost-recovery benefit from an artist contract termination, and lower amortization following purchase accounting. Music Publishing also improved margins.
- Net loss attributable to the parent improved by $2 in the quarter but worsened by $6 for the six-month period. Higher interest costs associated with post-merger debt contributed to the six-month deterioration.
- Interest expense increased as the post-merger debt carried higher rates. The company reported $2.212 billion of debt and cash of $272 at quarter-end.
- Management reported $11 of severance charges for the six months, down from $18 in the prior period, and targeted $50–$65 of additional savings over the nine fiscal quarters following the merger. Management cautioned that savings are not assured.
Outlook, commentary, risks and unusual items
- Management said existing cash sources and operating cash flows should be sufficient to support existing operations over the next fiscal year. It provided no specific revenue or earnings guidance in the supplied filing text.
- Management expects digital and emerging distribution models, streaming, expanded-rights deals and artist services to diversify revenue and potentially support growth. It noted that digital and nontraditional revenues have not yet fully offset physical-sales declines and that results can fluctuate with release and touring schedules.
- Key risks include substantial leverage and debt-service needs; ongoing recorded-music industry declines, piracy and pricing pressure; dependence on successful artists and releases; digital business-model and royalty-rate uncertainty; foreign exchange exposure; and possible impairment of goodwill or intangible assets. The filing reported no current-period indicators requiring an interim goodwill impairment test.
- Supplier concern: Cinram, a primary manufacturing and distribution provider in North America and parts of Europe, disclosed going-concern uncertainty and covenant breaches. Its lenders extended certain waivers to May 30, 2012, subject to possible termination; Warner said switching suppliers could be costly or cause transition delays.
- Litigation: Digital-download pricing claims and five artist royalty-calculation putative class actions remained pending. The company said it intends to defend itself, but cannot predict outcomes; it could not estimate reasonably possible losses beyond accrued amounts. Accruals for currently pending matters were not material.
- Other items: The merger resulted in purchase accounting and new debt. The company incurred Access management fees of $4 for six months. A $15 German tax-audit payment was reimbursed by Time Warner under the 2004 acquisition agreement. Two note exchange offers were completed after quarter-end, on April 25, 2012.
Important facts for investors to verify
- Assess the limitations of comparing Successor 2012 results with Predecessor 2011 results, including acquisition accounting effects on amortization and reported debt expense.
- Review debt terms, interest burden and the 2016 maturity concentration, as well as the conditions that could restrict access to the revolving facility or cash transfers among subsidiaries.
- Evaluate the quality and sustainability of operating cash flow, including the role of working-capital timing, release schedules and touring activity.
- Monitor progress against the $50–$65 cost-savings target and the company’s ability to offset physical-sales declines with digital and expanded-rights revenue.
- Follow Cinram’s financial condition and any effect on Warner’s manufacturing and distribution continuity; monitor the pending litigation and related exposure as cases develop.