Warner Music Group Corp. annual report, FY2016

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Warner Music Group Corp. — FY2016 Form 10-K

Reporting period: Fiscal year ended September 30, 2016. The filing also reports the quarter ended September 30, 2016. Unless noted, amounts are in U.S. dollars.

Business context

Warner Music Group operates Recorded Music and Music Publishing businesses, with operations in more than 50 countries. Recorded Music includes labels, distribution and artist services; Music Publishing owns or administers rights to more than one million compositions. Affiliates of Access Industries own all common stock; there is no public trading market for the shares.

Financial performance and liquidity

  • Revenue: $3.246 billion for FY2016, up 9% from $2.966 billion. Excluding unfavorable foreign-exchange effects, revenue increased 13%. Recorded Music revenue was $2.736 billion (+9%) and Music Publishing revenue was $524 million (+9%), before eliminations.
  • Digital: Consolidated digital revenue was $1.499 billion, up 21%, and represented 46% of revenue, compared with 42% in FY2015. Recorded Music streaming revenue rose to $908 million from $603 million; downloads declined to $434 million from $521 million.
  • Profit and margins: GAAP operating income was $214 million, versus $127 million; net income was $30 million, versus a net loss of $88 million; net income attributable to Warner Music Group Corp. was $25 million, versus a loss of $91 million. OIBDA, a non-GAAP measure, was $507 million (16% of revenue), compared with $436 million (15%). Recorded Music OIBDA was $459 million (17% margin); Music Publishing OIBDA was $138 million (26% margin), down from $146 million (30%).
  • Cash flow: Operating cash flow was $342 million, up from $222 million. Capital expenditures were $42 million. Investing activities used $8 million and financing activities used $216 million.
  • Debt and liquidity: At September 30, total debt was $2.812 billion and cash was $359 million, for net debt of $2.453 billion. The $150 million revolving facility had no borrowings and approximately $145 million available after letters of credit. Current assets were $908 million and current liabilities were $1.842 billion. The company reported covenant compliance; its stated leverage ratio was 3.66x, against a 4.625x springing limit when revolver borrowings exceed $30 million.
  • Q4: Revenue was $841 million, compared with $750 million in the prior-year quarter. Operating income was $55 million, versus $37 million; net loss attributable to the company was $4 million, versus $23 million. Q4 included $14 million of debt-extinguishment loss.

Changes, unusual items and outlook

  • FY2016 revenue growth was led by streaming, strong releases and artist services/expanded-rights activity; physical revenue fell 5% and licensing revenue fell 4%. Music Publishing digital revenue increased, while mechanical revenue declined amid the shift to digital formats.
  • Cost of revenue rose to 53% of revenue from 51%, reflecting mix and higher artist and repertoire costs. SG&A was $1.082 billion, approximately flat in dollars and lower as a share of revenue.
  • Nonrecurring or notable items included an $18 million debt-extinguishment loss, a $24 million gain on real-estate sales, $9 million net gain on divestitures, and $28 million of Sirius XM settlement revenue recognized in FY2016. The company expected a further approximately $31 million debt-extinguishment loss from the October 2016 refinancing in FY2017.
  • After year-end, the company issued $595 million equivalent of secured notes due 2024 to refinance 2021 secured notes; in November it extended the term-loan maturity to 2023 and partially redeemed $27.5 million of 5.625% notes. These transactions are not reflected in the September 30 debt balance. The board also approved a $54 million special dividend for payment in January 2017.
  • Management said existing cash and operating cash generation should fund operations, debt service, working capital and capital expenditures over the next 12 months. No numerical revenue or earnings guidance is provided. Key risks include piracy (including rising stream-ripping), reliance on a small number of digital platforms, artist and release performance, foreign-exchange exposure, high leverage and debt covenants. A digital-download pricing class action remained unresolved; potential loss could not be estimated. The Music Publishing reporting unit’s estimated fair value was only 11% above carrying value, and the filing notes sensitivity to valuation assumptions.

Important facts for investors to verify

  • Whether streaming growth and new releases can sustain revenue and offset declining downloads and physical sales, and how digital mix affects margins.
  • Post-year-end refinancing terms, resulting debt balances, interest costs, maturities and covenant headroom; the September 30 debt figure excludes later transactions.
  • Cash-flow quality, including working-capital effects and the contribution of settlement proceeds and asset-sale gains; also assess the planned $54 million dividend against leverage and liquidity.
  • Potential exposure from the unresolved digital-download litigation, other contingencies and the sensitivity of Music Publishing goodwill to forecast and discount-rate assumptions.
  • The company’s private ownership and absence of a public equity market, as well as the distinction between GAAP results and management’s non-GAAP OIBDA and covenant EBITDA measures.