Warner Music Group Corp. — Q2 FY2013 Form 10-Q
Reporting period: Quarter ended March 31, 2013; comparisons are with the three and six months ended March 31, 2012. Financial amounts are in U.S. dollars and millions unless noted. Warner Music is privately held by Access Industries affiliates; there is no public market for its common stock.
Business context and financial performance
The company operates recorded music and music publishing businesses. Management uses OIBDA, a non-GAAP measure, as its primary segment performance indicator.
| Metric | Three months ended March 31 | Six months ended March 31 |
|---|---|---|
| Revenue | $675, up 8% from $623 | $1,444, up 3% from $1,398 |
| Operating income | $57, versus $22 | $108, versus $61 |
| OIBDA | $116, versus $85; margin 17% versus 14% | $228, versus $184; margin 16% versus 13% |
| Net income (loss) attributable to Warner Music Group Corp. | $2, versus $(36) | $(78), versus $(62) |
| Operating cash flow | Not presented for the quarter alone | $125, versus $146 |
Quarterly growth was led by recorded music: revenue rose 11% to $554, with OIBDA increasing to $87 from $49. Music publishing revenue was flat at $127 and OIBDA was $53. For the six-month period, recorded music revenue rose 5% to $1,211, while publishing revenue declined 2% to $243; OIBDA was $201 and $69, respectively.
Digital revenue after intersegment eliminations increased 20% to $281 in the quarter and 18% to $536 for the six months, representing 42% and 37% of consolidated revenue, respectively. Quarterly recorded music digital growth, physical sales growth, and a strong release schedule supported results. For the six months, digital and licensing growth more than offset lower physical sales. Publishing faced continuing mechanical and synchronization declines, partly offset by digital growth.
Liquidity, debt and balance sheet
- At March 31, cash and equivalents were $294, total debt was $2,211, and net debt was $1,917. At September 30, 2012, these were $302, $2,206 and $1,904, respectively.
- Current assets were $883 and current liabilities were $1,588. The company had $993 of accrued royalties among current liabilities. The $150 revolving credit facility had no borrowings outstanding; approximately $1 of letters of credit was outstanding.
- Debt included $587 of term loans, $500 of 6.00% secured notes due 2021, $224 of 6.25% euro-denominated secured notes due 2021, $750 of 11.5% notes due 2018 and $150 of Holdings notes bearing 13.75% due 2019. The company reported a weighted-average debt interest rate of 8.3% for the quarter, compared with 10.5% in the prior-year quarter.
- Six-month investing cash outflow was $29, including $11 for publishing rights, $13 in capital expenditures and $5 for business investments and acquisitions. Financing cash outflow was $97, reflecting the refinancing, fees and scheduled term-loan amortization. Cash decreased $8 over the period.
Material changes, outlook and notable items
- Refinancing: In November 2012, the company refinanced its 9.5% secured notes due 2016 with new 2021 secured notes and a term loan. The transaction generated an $83 loss on extinguishment of debt in the six-month results. Six-month net loss therefore worsened despite higher operating income and lower net interest expense.
- Parlophone transaction: In February 2013, the company agreed to acquire Parlophone Label Group from Universal Music Group for £487 million, approximately $745 million at the exchange rate cited in the filing. Completion remained subject to regulatory approvals and customary conditions. By May 14, 2013, U.S., Brazilian and Austrian approvals had been obtained; other approvals and the EMI France workers’ council process remained relevant conditions. Management identified potential cost synergies of approximately $70 million, but cautioned these may not be fully realized.
- Subsequent financing and repayment actions: On May 9, 2013, the company prepaid $102.5 of term loans and gave notice to redeem $50 of dollar-denominated secured notes and €17.5 of euro-denominated secured notes. An amendment provided an $820 delayed-draw term facility intended to help finance the Parlophone transaction, lowered margins and the LIBOR floor, and extended maturity of existing term loans. The revolving facility margin was also reduced.
- Management stated that existing liquidity sources were expected to support existing operations over the next fiscal year and that operating cash and revolver availability should fund debt service, working capital and capital expenditures for the foreseeable future. No quantified revenue or earnings guidance was provided. Management also noted that results fluctuate with release timing, artist advances and touring schedules.
- Key risks include continuing recorded-music industry pressure, piracy, dependence on a limited number of digital outlets, artist and release-schedule uncertainty, foreign exchange exposure, high leverage and restrictive debt covenants. The company reported covenant compliance at March 31, 2013; its revolving facility includes a springing leverage test when borrowings exceed specified levels.
- Two notable putative class-action matters remain unresolved: digital-download pricing litigation and artist claims alleging improper calculation of digital royalties. The company said outcomes and reasonably possible losses could not be estimated. Separately, a subsidiary settled FTC allegations concerning children’s online privacy in October 2012 for a $1 civil penalty.
- On May 9, 2013, former director Edgar Bronfman, Jr. received a $1.3 cash payment in recognition of his board service. The filing also reports $4 of share-based compensation expense for the quarter and approximately $22 of unrecognized compensation cost at March 31.
Investor verification priorities
- Track completion, financing and integration of the Parlophone acquisition, including regulatory and workers’ council conditions and realization of the stated synergies.
- Review refinancing terms, subsequent debt repayments and redemptions, total debt service requirements, and available revolver capacity.
- Assess whether digital revenue growth can continue to offset physical-sales declines, including the durability of release-driven results and touring-related revenue.
- Monitor liquidity and operating cash flow against high current liabilities, accrued royalties and debt obligations.
- Follow the digital-pricing and artist royalty lawsuits, for which the filing provides no estimable loss range, and other material legal or regulatory developments.