Warner Music Group Corp. — Q1 FY2019 Form 10-Q
Reporting period: Three months ended December 31, 2018 (the company’s fiscal quarter; periods are presented using December 31 dates for convenience). Comparatives are for the three months ended December 31, 2017. Amounts below are in U.S. dollars and millions unless noted.
Business context
Warner Music Group operates in Recorded Music and Music Publishing. The company is privately held by affiliates of Access Industries; it reports to the SEC but its common stock has no public market. The quarter’s comparison is affected by the acquisition of merchandise retailer EMP and the October 1, 2018 adoption of ASC 606 revenue recognition.
Key financial results
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Revenue | $1,203 | $1,045 | +15% |
| Operating income | $147 | $90 | +63% |
| OIBDA | $215 | $155 | +39% |
| Net income attributable to WMG | $86 | $4 | +$82 |
| Operating cash flow | $92 | $136 | -$44 |
| Capital expenditures | $26 | $16 | +$10 |
| Cash and equivalents at period end | $548 | $776 | Down from prior-year quarter; up from $514 at September 30, 2018 |
Operating margin was approximately 12.2% versus 8.6%; OIBDA margin was approximately 17.9% versus 14.8%; net margin was approximately 7.1% versus 0.5%. OIBDA is a company-defined non-GAAP measure and should be considered alongside GAAP results.
Revenue and segments
- Recorded Music revenue rose 15% to $1,041; segment operating income was $163 and OIBDA $211. Streaming revenue increased $98 to $502, while downloads fell $16 to $56. Artist services and expanded-rights revenue grew 58% to $166, including EMP.
- Music Publishing revenue rose 15% to $165; operating income improved to $22 from a $1 loss, and OIBDA increased to $39 from $17. ASC 606 contributed materially to the reported improvement.
- Digital revenue across the company increased 18% after eliminations to $627, or 52% of consolidated revenue. U.S. revenue grew 16% to $504; international revenue rose 14% to $702, or 19% excluding unfavorable currency effects.
Balance sheet, debt and liquidity
- Long-term debt carrying value was $2,998 at December 31, 2018, compared with $2,819 at September 30, 2018. Debt principal was approximately $3,031; cash was $548 and reported net debt was $2,450.
- Current assets were $1,592 and current liabilities $2,593, indicating negative working capital of approximately $1,001. The balance includes $1,551 of accrued royalties.
- The $180 revolving facility had no borrowings outstanding; approximately $16 of letters of credit left about $164 of commitments available. The company reported covenant compliance at quarter end.
- Operating cash flow declined to $92, partly because of payment timing for payables, royalties and artist and repertoire costs, despite higher OIBDA. Investing cash outflow was $238, including $183 net cash for EMP, $23 for equity investments and $26 of capital expenditures. Financing provided $182, primarily from a notes issuance.
Material changes, outlook and risks
- ASC 606: Adoption increased opening equity by $150, including a $139 reduction in accumulated deficit and an $11 increase in noncontrolling interest. It added $20 to reported quarterly revenue and $11 to net income versus the filing’s presentation without adoption; operating cash flow was unchanged. Prior-year results were not restated, limiting comparability.
- EMP acquisition: Closed October 10, 2018 for approximately €166 million, or $190 million. EMP contributed $76 revenue and $6 operating income during the quarter; preliminary purchase accounting recorded $109 goodwill.
- Debt refinancing and redemptions: The company issued €250 million of 3.625% secured notes due 2026 and used proceeds in part to fund EMP and retire portions of other notes. Quarter-end weighted-average debt interest rate was 4.7%; interest expense was $36.
- Unusual income items: Other income of $28 included a $15 unrealized gain on an equity-method investment and foreign-exchange and hedging gains, partly offset by currency losses. Net income growth therefore included non-operating effects as well as improved operations.
- Dividends and outlook: The company instituted a modest quarterly dividend policy, with a variable fourth-quarter dividend subject to cash generation, other uses of cash and board approval. A $31.25 dividend was accrued at December 31 and paid January 4, 2019. Management said existing liquidity should fund operations and obligations over the next twelve months; no specific earnings or revenue guidance was provided.
- Risks and contingencies: Key stated risks include dependence on digital platforms and streaming growth, piracy, artist and songwriter retention and release performance, currency and interest-rate exposure, leverage and debt restrictions, acquisitions, intellectual-property matters, and regulated royalty rates. The Sirius XM pre-1972 recordings license dispute remained under discussion/arbitration; other litigation accruals were described as not material, with additional exposure not estimable.
- The company used foreign-exchange forwards and interest-rate swaps; a hypothetical 10% U.S. dollar depreciation would reduce the forwards’ fair value by about $13, with underlying exposures expected to largely offset the effect. GILTI contributed to the tax burden; management was also evaluating possible effects of proposed tax regulations on a roughly $133 foreign-tax-credit valuation allowance.
Important facts for investors to verify
- Separate organic revenue and profit growth from EMP contributions, ASC 606 timing effects and foreign-exchange movements; confirm the sustainability of streaming and artist-services trends.
- Review cash conversion and working-capital movements, particularly receivables, accrued royalties and the timing of artist and royalty payments.
- Confirm debt principal, maturity schedule, covenant headroom and actual availability under the revolver; assess cash needs against dividends, acquisitions and debt service.
- Track the final EMP purchase-price allocation and performance, and the resolution and potential financial impact of the Sirius XM arbitration and other legal matters.
- Assess the recurring versus unrealized components of other income and the effect of tax rules, foreign currency and interest rates on future earnings.