Warner Music Group Corp. — FY2011 Form 10-K
Reporting period: Fiscal year ended September 30, 2011. The July 20, 2011 acquisition by Access created a new accounting basis: GAAP results are split between the Predecessor period (October 1, 2010–July 19, 2011) and Successor period (July 20–September 30, 2011), so those periods are not directly comparable. Annual 2011 figures below combine both periods where indicated; management states this presentation is non-GAAP and is not pro forma. All dollar amounts are U.S. dollars.
Business context
WMG operates Recorded Music and Music Publishing businesses, with more than half of revenue generated outside the U.S. On July 20, 2011, Access affiliate AI Entertainment Holdings acquired the company; eligible shares were converted into $8.25 cash per share, and WMG was delisted. Access owned all outstanding common stock at year-end. The company continued SEC reporting under its debt-document covenants.
Financial performance and position
| Metric | FY2011 combined / September 30, 2011 | Comparable period |
|---|---|---|
| Revenue | $2.869 billion | $2.988 billion in FY2010, down 4% reported (down 6% excluding favorable currency) |
| Net loss attributable to WMG | $205 million | $143 million loss in FY2010 |
| OIBDA | $290 million; 10% margin | $348 million; 12% margin in FY2010 |
| Operating income | $32 million; about 1% margin | $90 million; 3% margin in FY2010 |
| Interest expense, net | $213 million | $190 million in FY2010 |
| Cash from operations | $(52) million | $150 million provided in FY2010 |
| Capital expenditures | $48 million | $51 million in FY2010 |
| Cash and equivalents | $154 million | $439 million at September 30, 2010 |
| Total debt / net debt | $2.217 billion / $2.063 billion | $1.945 billion / $1.506 billion at September 30, 2010 |
| Total assets / WMG equity | $5.469 billion / $1.096 billion | $3.811 billion / $(265) million at September 30, 2010 |
FY2011 combined investing cash outflow was $1.447 billion, largely reflecting $1.278 billion to purchase the Predecessor in the Merger. Financing provided $1.204 billion, including a $1.099 billion Parent contribution and new debt proceeds, offset by repayment of prior notes and financing costs. Free cash flow, calculated as operating cash flow less capital expenditures, was approximately negative $100 million.
At September 30, current assets were $849 million and current liabilities $1.565 billion (current ratio approximately 0.54). The $60 million revolving facility was undrawn. Management said existing liquidity sources should support existing operations over the next fiscal year. Debt included $1.162 billion of 9.5% secured notes due 2016, $157 million of 9.5% secured notes due 2016, $748 million of 11.5% unsecured notes due 2018, and $150 million of 13.75% Holdings notes due 2019. Net debt rose $557 million year over year; the refinancing also raised borrowing costs.
Recorded Music revenue was $2.344 billion, down 5%; Music Publishing revenue was $544 million, down 2%. Consolidated digital revenue after intersegment eliminations rose 8% to $820 million, or 29% of revenue. Recorded Music digital revenue grew 8%, but physical and other revenue declined 12%. Recorded Music OIBDA was $282 million, while Music Publishing OIBDA fell 6% to $147 million.
Material changes versus prior period
- Revenue continued to decline, mainly from physical music sales and a stronger prior-year release schedule. Digital and licensing gains did not offset physical declines.
- OIBDA fell 17% and operating income fell 64%; net loss attributable to WMG increased by $62 million.
- Operating cash flow shifted from positive $150 million in FY2010 to negative $52 million in combined FY2011, reflecting lower OIBDA, merger-related costs, severance, higher cash interest and working-capital timing.
- The Merger reset the balance sheet to fair value, substantially increasing reported definite-lived intangible assets and goodwill. Consequently, successor and predecessor financial statements are not comparable.
Outlook, commentary, risks and unusual items
- Management targeted $50–$65 million of cost savings over the next nine fiscal quarters, including savings from becoming private and restructuring; realization is not assured. No specific revenue or earnings guidance is provided.
- Management expects digital distribution and expanded-rights/artist-services arrangements to grow, but acknowledged these streams had not yet offset physical declines. Digital revenue was about 33% of Recorded Music revenue; non-traditional Recorded Music revenue was about 13% of total revenue.
- Principal risks include continued industry decline and piracy, dependence on a small number of digital outlets (particularly Apple’s iTunes), talent and release volatility, foreign exchange exposure, royalty rate regulation, and reliance on Cinram for physical manufacturing and distribution in major territories.
- WMG is highly leveraged, with substantial fixed interest obligations and restrictive debt covenants. Management cautioned that cash flows may be insufficient to service debt and that refinancing or additional capital may not be available on favorable terms.
- Access controls the company; the filing identifies possible conflicts with debt holders and related-party arrangements, including an annual management fee initially equal to the greater of $6 million or 1.5% of EBITDA, plus expenses and certain transaction fees.
- A digital-download pricing class action was proceeding to discovery after a motion to dismiss was granted in part and denied in part. WMG said it would defend the case but could not predict the outcome. Other ordinary-course litigation was not expected by management to be material.
- FY2011 included $53 million of Merger transaction costs, $38 million of severance expense, and $24 million of share-based compensation expense. The Limewire settlement generated a $12 million benefit. Adjusted OIBDA was $357 million and adjusted net loss attributable to WMG was $138 million, excluding specified acquisition expenses and share-based compensation.
- The announced proposed acquisitions of EMI’s recorded-music and publishing businesses remained subject to regulatory approval and could alter competition. The filing reports no goodwill impairment indicators at year-end.
Most important facts for investors to verify
- Use the audited statements and distinguish GAAP Predecessor and Successor results from management’s combined, non-GAAP FY2011 presentation.
- Review the debt instruments, interest burden, maturity schedule, covenant restrictions and cash available at the operating subsidiaries; the $60 million revolver was undrawn.
- Assess whether the $50–$65 million savings target is achieved and whether digital, licensing and expanded-rights growth can offset continued physical-sales declines.
- Track operating cash flow, working capital and royalty-advance recoverability; advances totaled $314 million at year-end.
- Monitor the digital-pricing litigation, piracy developments, major-platform bargaining power, Cinram service continuity and the regulatory outcome of the proposed EMI transactions.
- Consider purchase accounting and governance changes: Access ownership, related-party fees and the new fair-value basis materially affect comparability. The auditor gave an unqualified opinion on the financial statements; management concluded internal control over financial reporting was effective.