Warner Music Group Corp. — Q3 FY2016 Form 10-Q
Reporting period: Quarter and nine months ended June 30, 2016; the company notes these dates correspond to fiscal periods ended June 24, 2016. Amounts are in U.S. dollars, millions, unless stated otherwise. The company operates Recorded Music and Music Publishing businesses and is wholly owned by Access Industries affiliates; there is no public market for its common stock.
Financial performance and condition
| Metric | Three months ended June 30 | Nine months ended June 30 |
|---|---|---|
| Revenue | $811; up 14% year over year | $2,405; up 9% reported, 13% excluding currency effects |
| OIBDA | $120 vs. $100; margin 15% vs. 14% | $384 vs. $323; margin 16% vs. 15% |
| Operating income | $45 vs. $23 | $159 vs. $90 |
| Net income (loss) attributable to WMG | $(9) vs. $(44) | $29 vs. $(68) |
| Net interest expense | $43 vs. $45 | $131 vs. $136 |
Q3 revenue growth reflected Recorded Music revenue of $680 million, up 15%, and Music Publishing revenue of $134 million, up 9%. For the nine-month period, Recorded Music revenue rose 9% to $2.038 billion and Music Publishing revenue rose 5% to $377 million. Digital revenue was a key driver: consolidated digital revenue increased 21% in Q3 and 20% for nine months. Streaming growth outweighed declining downloads and, over nine months, declining physical sales.
Q3 operating margin was approximately 5.5%; nine-month operating margin was approximately 6.6%. Cost of revenue increased to 55% of revenue in Q3 from 53% and to 53% for nine months from 51%. Concert promotion and other artist-services activity contributed revenue growth but carried higher costs and generally lower margins than traditional streams. Nine-month Music Publishing OIBDA declined 7% to $82 million, despite higher segment revenue, amid higher proportional costs and settlement and restructuring expenses.
Cash flow and liquidity: Nine-month operating cash flow was $207 million, compared with $118 million. Investing cash flow was positive $1 million, including $42 million of real-estate sale proceeds and $27 million from divestitures; financing cash flow was negative $105 million, principally reflecting debt repayments. Cash increased to $345 million from $246 million at September 30, 2015. Current assets were $942 million and current liabilities $1.950 billion. Management said existing liquidity sources were expected to support operations for the next 12 months.
Debt: At June 30, total debt was $2.908 billion and net debt was $2.563 billion; weighted-average debt interest rate was 5.4%. No revolving loans were outstanding; the facility had $150 million of commitments, less approximately $5 million of letters of credit. Subsequent to quarter-end, the company redeemed the remaining $100 million of 13.75% notes and issued $300 million of 5.00% secured notes due 2023, using proceeds to prepay $295.5 million of term loans. It expected a roughly $10 million extinguishment loss on the redemption and an immaterial loss on the prepayment in Q4. The company reported compliance with debt covenants at June 30.
Material changes and notable items
- Revenue growth was led by digital and streaming. Nine-month streaming revenue increased $223 million, partly offset by a $66 million decline in digital downloads. Physical revenue fell $34 million for the period.
- Q3 Recorded Music growth also benefited from artist services and expanded-rights revenue, up $19 million, particularly European concert promotion. Such revenue represented approximately 11% of total revenue for the nine months and can fluctuate with touring schedules and business mix.
- Nine-month results included $27 million of revenue recognized from the Sirius XM pre-1972 recordings settlement. The company received a $33 million cash distribution; the remaining allocation was to be recognized over the next six quarters. Allocation of proceeds from a separate $90 million Pandora settlement had not yet been determined, so WMG had not recorded its share.
- The nine-month period included a $24 million gain on real-estate sale, an $8 million net gain on divestitures, and a $4 million loss on extinguishment of debt. Music Publishing SG&A also included Happy Birthday settlement and restructuring costs; the filing does not provide a clear amount for these costs individually.
- Foreign exchange remained a factor: nine-month revenue growth was 9% reported versus 13% excluding currency effects. The company used foreign-exchange hedges; at June 30, contracts covered sales of $94 million and purchases of $50 million of foreign currencies.
Outlook, risks and contingencies
The filing provides no specific revenue or earnings guidance. Management expressed confidence that operations and available borrowing capacity would fund debt service, working capital and capital expenditures for the foreseeable future, while noting results and liquidity depend on industry and economic conditions. Management highlighted digital monetization, streaming growth, artist and songwriter performance, piracy, competition, foreign currency, substantial leverage and debt-service capacity among important risks.
A long-running class action concerning alleged digital music download pricing remains pending. The company intends to defend the claims; it cannot estimate a reasonably possible loss or range, and litigation may entail costs and divert management resources. Other pending litigation accruals were described as not material, but excess possible losses could not be estimated. The company also said its uncertain-tax-position reserve could decrease by approximately $9 million to $23 million, primarily due to foreign audits and settlement discussions.
Investor verification priorities
- Check whether streaming growth continues to offset download and physical declines, and how revenue mix affects margins.
- Review post-quarter debt transactions, the resulting debt balance and interest burden, and compliance with facility covenants.
- Assess cash-flow quality, including working-capital timing, settlement receipts, divestiture proceeds and the real-estate gain.
- Monitor the unresolved digital-download class action, Pandora settlement allocation and uncertain tax positions.
- Confirm subsequent-period performance against management’s liquidity expectations; the filing provides no formal earnings guidance.