Warner Music Group Corp. (NASDAQ:WMG) Q1 2023 Earnings Call Transcript

Warner Music Group Corp. (NASDAQ:WMG) Q1 2023 Earnings Call Transcript February 9, 2023

Operator: Welcome to Warner Music Group’s First Quarter Earnings Call for the Period Ended December 31, 2022. At the request of Warner Music Group, today’s call is being recorded for replay purposes and if you object, you may disconnect at any time. Now I would like to turn today’s call over to your host, Mr. Kareem Chin, Head of Investor Relations, you may begin.

Kareem Chin: Good morning, everyone. Welcome to Warner Music Group’s fiscal first quarter earnings conference call. Please note that our earnings press release, earnings snapshot and the Form 10-Q we filed this morning will be available on our website. On today’s call, we have our CEO, Robert Kyncl; and our CFO, Eric Levin, who will take you through our results and then we will answer your questions. Before our prepared remarks, I’d like to refer you to the second slide of the earning snapshot to remind you that this communication includes forward-looking statements that reflect the current views of Warner Music Group about future events and financial performance. We plan to present certain non-GAAP results during this conference call and in our earning snapshot slides and have provided schedules reconciling these results to our GAAP results in our earnings press release.

All of these materials are posted on our website. Also, please note that all revenue figures and comparisons discussed today will be presented in constant-currency unless otherwise noted. All forward-looking statements are made as of today and we disclaim any duty to update such statements. Our expectations, beliefs and projections are expressed in good faith and we believe there is a reasonable basis for them. However, there can be no assurance that management’s expectations, beliefs and projections will result or be achieved. Investors should not rely on forward-looking statements, because they are subject to a variety of risks, uncertainties and other factors that can cause actual results that differ materially from our expectations. Information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in our filings with the SEC.

And with that I will turn it over to Robert.

Robert Kyncl: Thank you, Kareem and good morning, everyone. I’m pleased to be here speaking with all of you for my first earnings call at Warner Music Group. I’ve been on the job for five weeks and I’m grateful to our Board of Directors, and our employees, artists and songwriters for giving me such a warm welcome. I would especially like to thank my predecessor, Steve Cooper for everything he has done to position the company for long-term success. And for all his insights as I’ve been getting up to speed. Thanks also to you, our valued shareholders and everyone who follows the company for your continued support. So let’s get into Q1 results. I am committed to maintaining straightforward and consistent communication with the investor community.

So in that spirit, I want to immediately and clearly acknowledge that this was a tough quarter. Like most companies, WMG has been dealing with macroeconomic headwinds and the impact of currency exchange rates. It’s important to note that last year’s Q1 included an extra week of reporting, as a result, this quarter’s comparisons need to be adjusted to provide an accurate picture and I’ll be discussing our results in that context. Eric will give you more detail, but here are the headlines. Total revenue in Q1 grew 2% and adjusted OIBDA increased 13%, with 210 basis points of margin improvement. Recorded Music revenue was flat as the strength of our global performance was offset by a softer quarter in the U.S. We had a tough comparison with the prior year quarter, which included releases from some of our superstar artists.

We’re expecting a stronger release schedule in the back-half of the fiscal year, which will feature new music from Ed Sheeran, Cardi B, David Guetta, Aya Nakamura and BeBe Rexha. Music Publishing had another strong quarter with revenue growth of 14%. Our operating cash-flow growth was healthy, despite some of our revenue lines coming under pressure. This further underscores our disciplined fiscal management, as we navigate this challenging business environment. I’d like to spend some time on this call, proactively addressing two questions that often been asked. Specifically, why I chose to go into the Music business and why I joined the Warner Music Group after 12 years at YouTube and seven years at Netflix. YouTube drives the intersection of creators and technology, which means that I had many options to choose from in planning my next chapter.

I chose Music first and foremost, because everyone loves music including me. It’s embraced by 100% of global population. In an increasingly digital world, music makes people feel and it brings them joy, hope and comfort, plus in an increasingly divided world, music brings people together. That engagement is very powerful and valuable and we expect the evolution of monetization models to reflect that. On top of that, music’s global appeal is matched by its ubiquity. This industry has achieved something rare. It’s build mutually beneficial, long-term partnerships with many of the world’s biggest companies. Amazon, Apple, Google, Meta, Spotify and Tencent, among them. As successful as music has become, there is still meaningful upside ahead for three reasons.

One, as technology opens up emerging economies, the industry’s addressable market will continue to expand even further. Two, innovation is constantly creating new use cases for music, giving us the opportunity to diversify our revenue sources. Three, music is still undervalued, especially when compared to other forms of entertainment like video. I’d like to expand a bit on that last point. Since 2011, the subscription price of Netflix’s standard service has roughly doubled. Data shows that almost 80% of U.S. households subscribed to at least three streaming video services. This means that the average household is spending more than four times per month on a combination of digital video services that isn’t even a comprehensive offering. In contrast, the price of the music subscription has stayed the same since streaming was introduced over a decade ago.

Most consumers subscribe to a single-service that carries virtually all the music ever released. Against this backdrop, it is encouraging that we’re seeing first steps in the right direction by Apple, Deezer and Amazon. The other question I often get us, is why WMG? First and foremost, it’s the artists and songwriters and powerful catalogs that are the lifeblood of this company and it’s such a pleasure to bring this creative work depends around the world. The new generations of stars like Lizzo, Dua Lipa and Aya Nakamura. Global superstars such as Ed Sheeran, Bruno Mars, Coldplay and Neil Young. Songwriters and composers like Lin-Manuel Miranda, Gamble & Huff and John Williams and legends such as John Coltrane, Led Zeppelin, Aretha Franklin and Prince.

Second, it’s the people at WMG. This company has a consistent decades long history of finding and developing unique voices that change culture globally and then increasingly complex uncluttered world that originality is an essential ingredient of our success. Third is about size. WMG is big enough to drive meaningful change in the industry, but small enough to have plenty of room for growth. As just one example, the company has been taking thoughtful approach to global expansion. WMG has made world time moves that lead front the competition and dynamic fast-growing markets such as China and the Middle-East. This approach has also delivered record-breaking global first, with audits like Anita from Brazil, Paulo Londra from Argentina, King from India and CK from Nigeria.

I wanted to briefly address what we’re doing to architect the next phase of growth. I’m only five weeks in, but I’ve been very intentional about how we’ve gone about this. I made two significant appointments, both of which tell you something about our priorities going-forward. I hired Tim Matusch my former colleague at YouTube, as our new EVP of Strategy and Operations, which is a new role at WMG. Tim will be critical to facilitating our strategic vision and ensuring operational execution. I also hired Ariel Bardin, as our President of Technology. Ariel’s career includes 16 years at Google, where he built, launched and let some of the company’s most successful products, including YouTube’s creator tools, memberships and content ID. He will drive the development of the systems, infrastructure and products needed to support our growth.

As I’ve said, I’m committed to clear and straightforward communication on our progress. I also want you to know, I’m a big believer that actions speak louder than words and I’m laser-focused on execution. Right now, I’m working with leaders across the company to develop our plans for the future. We’re already exploring some exciting ideas and initiatives and we will provide you with updates as soon as appropriate. That said, many of the fundamentals will remain the same. The foundations of this company are very strong and the music industry is rich with opportunities. We will continue to invest in new artists and songwriters, our catalog and our global expansion. At the same time, we plan to thoughtfully reallocate some resources to accelerate how we use technology and data to empower artists and songwriters, as well as drive greater efficiency in our business.

As subscription revenue continues to grow, as supported recovers and we explore the possibilities of new technologies and business models, it’s essential we structure our deals smartly and strategically. I am approaching this next phase of growth with the unique benefits of having been on both sides of the table. I am proud that over the last five years at YouTube, we developed a very collaborative mutually beneficial relationship with the music industry, after years of rocky ones. I plan on bringing in the same approach to the WMG and the industry, so that our interests are aligned with our partners and that our artists and songwriters gain maximum participation and monetization. Now, I’ll pass it over to Eric, who will take you through our results and then we’ll answer your questions.

Eric Levin: Thank you, Robert and good morning, everyone. As Robert mentioned, our year-over-year comparisons should take into account the impact of the extra week in fiscal Q1, 2022. Adjusting for the extra week, we delivered growth across key metrics, including revenue, adjusted OIBDA and adjusted OIBDA margin. Additionally, we saw strong operating cash-flow growth and strong cash conversion as a percentage of adjusted OIBDA, despite a challenging macro-environment. Total revenue declined 2.7%, but increased 2% when adjusted for the impact of the extra week. Adjusted OIBDA was flat and increased 12.8% when adjusted for the extra week. Adjusted OIBDA margin was 22.5% compared to 21.9% in the prior year quarter. Adjusting for the extra week, margin increased 210 basis-points.

These increases were primarily due to disciplined operating performance and the impact of currency exchange rates. Recorded Music revenue declined 5.6%, that was roughly flat when adjusting for the impact of the extra week. Streaming revenue decreased by 2.6%, after adjusting for the extra week Streaming revenue grew by 5%, as subscription streaming revenue grew by high-single-digits and was partially offset by ad-supported revenue declining in the mid-teens. Physical revenue declined 27%, adjusting for the extra week, Physical declined 22%. Our Streaming and Physical results reflect a lighter release schedule we had this quarter compared with the prior year period, which included releases from Ed Sheeran and Coldplay. Artist services and expanded rights revenue decreased by 4%, due to macro-economic pressures affecting our E&P business and lower advertising revenue.

Licensing increased 17% due to an increase in broadcast fees, synchronization and other third-party licensing. Recorded music adjusted OIBDA decreased by 6% with margin of 24.1%, which was roughly flat compared to the prior year quarter. Excluding the impact of the extra week, adjusted OIBDA grew 7% and the margin improvement was approximately 150 basis-points. This was driven by disciplined operating performance and the favorable impact of currency exchange rates. Music Publishing continues to deliver strong results, posting 14% growth, driven by strength across digital, performance and mechanical. Digital revenue grew 16%, reflecting growth in streaming, which increased 17% driven by continued growth in streaming services and timing of new digital deals.

Performance revenue increased by 29%, due to continued growth from bars, restaurants, concerts and live events. Mechanical revenue increased by 17%, due to growth in France and Sync revenue decreased by 5%, due to lower commercial licensing activity in the U.S. and the timing of legal settlements. Music Publishing adjusted OIBDA increased 36% to $72 million with margin increasing 460 basis points, driven by strong operating performance and the favorable impact of currency exchange rates. Q1 CapEx decreased to $21 million as compared to $34 million in the prior year quarter, mainly due to lower facilities investments. We anticipate some acceleration in the coming quarters, driven by IT infrastructure facilities and financial transformation investments.

Our financial transformation program remains on-track to meaningfully rollout in fiscal 2024 and expand globally in the following years. The program is expected to deliver annualized run rate savings of $35 million to $40 million once fully implemented. Operating and free-cash flow growth and conversion were robust in Q1. Operating cash-flow increased 62% to $209 million from $129 million in the prior year quarter. Free-cash flow increased 98% to a $188 million from $95 million in the prior year quarter. Operating cash-flow conversion was 62% in Q1, the strong performance was driven by the timing of working capital items. While working capital will fluctuate from quarter-to-quarter, our goal remains to deliver a conversion rate of 50% to 60% over a multi-year period.

As of December 31, we had a cash balance of $720 million, total debt of $3.9 billion and net-debt of $3.2 billion. Our weighted-average cost of debt is 3.7% and our nearest maturity date is in 2028. As we look ahead to the rest of the year, our goal is to release amazing new music from our talented roster of artists and songwriters. While some of the macro and release schedule driven pressures we saw in Q1 will impact Q2, our slate in the back-half of fiscal 2023 is strong. Featuring releases from some of our biggest stars, as well as our next-generation of talent from across the globe. There’s no question that our industry is feeling the impacts of the macro-economic environment. From currency fluctuations and a dislocated ad market to the short-term choppiness inherent in our business, there are a number of variables that can obscure our underlying health.

However, our resilience through challenging times has been proven and we remain confident in our future growth. Against that backdrop, we are resolved to capitalize on the powerful tailwinds that will drive our company forward. Thank you to everyone for joining us today and we’ll now open the call for questions.

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Q&A Session

Operator: And our first question will come from Benjamin Black from Deutsche Bank. Your line is open.

Benjamin Black: Good morning, and thanks for taking my question. Robert, I know you’ve only been in the seat for about a month now. But can you touch on where you potentially see opportunity for improvement within the organization and where you see potential for faster growth?

Robert Kyncl: Thank you for the question, Benjamin. So yes, as you said yourself, I’ve been on the job for five weeks and have been digging in very quickly. Strategy at this point is, in development as I mentioned. I do have the benefit of understanding the industry from both sides, but to be honest, I’m still calibrating the site due to my short tenure on this one. So I’d like to have a little bit more time on that and in order to be thoughtful. But here’s what I know, which is will very thoughtfully relocate resources to accelerate our technology investments and then to empower not only artists and songwriters, but also to drive efficiencies in the company. So that is something that I can tell you now and I think my actions speak louder than words.

I’ve already made two appointments in that direction in the first month with the hiring of Tim and Ariel and I think we’ll — my goal is to accomplish all of that with continued focus on financial discipline and cost-containment.

Benjamin Black: And so, just a follow-up, if I may. Does that mean that you’re planning to potentially cut costs, we’ve seen cost getting cut impacting music industry more broadly to our recent action from Spotify, for example, so any view on cost-containment more specific and if so, which areas would it be cutting from?

Robert Kyncl: So one, the company has actually then much more measured and it’s headcount growth for instance over the last few years than others in the industry, who are now undergoing significant layoffs. Two, we are all aware that cost transformation initiatives already underway for the last two to three years, before any of this macroeconomic issues have emerged. So there’s been a lot of momentum on this, that is probably putting us in a slightly different position than others. And but again, I’d like to reiterate that I’ll be focusing on driving, reallocating resources, our internal resources in order to invest in technology and drive not only more tools for each monetization for creators, but also greater efficiencies for us.

Benjamin Black: Thank you.

Operator: Thank you. Our next question comes from Sebastiano Petti from JPMorgan. Your line is open.

Sebastiano Petti: Hi, thank you. Robert, I just wanted to ask Robert, one for Eric. Robert, are you concerned about the dilution of music from AI generated content? Maybe given your unique perspective, given some of your prior roles, any impact. I love to hear your thoughts. And then for Eric, you touched on margin expansion was driven just by a strong operating results. Well ahead of expectations, wanted to see if maybe you could provide us a little bit of detail there, maybe unpack some of the underlying drivers in each segment that drove the robust margin expansion? Thank you.

Robert Kyncl: Thank you, Sebastiano. So one, I’d like to say that AI is probably one of the most transformative things that humanity as ever seen, it has so many different implications. So because of that, yes, something very close attention to it than we across the company are. Two, there are many different ways to sort for the music industry, as well as for other industries, who own copyrighted material. And it really falls into four buckets, one, which is the use of existing copyrights to train generate of AI. The second one is a sampling of existing copyrights, as the basis for new and remixed AI content, AI generating Content. The use of AI to help and support creativity. So an assisted way to do that. And then most importantly, find ways to protect the graft of artists and songwriters from being diluted or replaced by generating AI generated content, which is what you mentioned.

But it’s not just that question, it’s all of these together that we as an industry and I don’t mean just the music industry. But overall, sort of copyright owners need to work together with the AI platforms-on. And I want to make sure that everybody understands that, you don’t have to be forward-looking in order to address this, which of course we are. But you can also look into today’s world, would can benefit our position in the future, where there is a lot of AI generating content and what I mean by that is, tracking of content, identifying and tracking of content on consumption platforms that can appropriately identify copyright and remunerate copyright holders, underpins all of this. And different platforms have different capabilities in this regard.

Obviously, YouTube is most advanced with Content ID, something that all the others over seen. But there are others who lacked in this department and need to work on that because, in the AI future, this would be a serious deficiency. So you can — you will see us focusing on this quite a lot. Eric?

Eric Levin: Thank you, Sebastiano. So margin expansion. So, obviously this quarter, when you look at adjusted for the extra week, 210 basis-points increase in margin is substantive and we’re proud of that. We focus on disciplined management, disciplined cost oversight and management. We can look at this quarter and see for example, Warner Chappell had a 36% OIBDA increase. Pretty extraordinary kind of growth from that line of business. We are not targeting 200 basis-points of increase on a consistent basis, we are targeting margin expansion. Generally on an annual basis, not every year will be exactly the same, but 0.5 point to 1 percentage point increase in margin. It’s about what we look towards, again not every year is the same. So this is an exceptional quarter from margin enhancement, but margin enhancement as part of our strategy, for sure.

Sebastiano Petti: Thank you.

Eric Levin: Thank you, Sebastiano.

Operator: Thank you. Our next question will come from Benjamin Swinburne from Morgan Stanley. Your line is open.

Benjamin Swinburne: Good morning, Robert. Nice meeting over the phone and welcome. I wanted to ask you a bit more about your comments around music being undervalued, obviously that have been a long going debate in the industry between the labels and distributors and you give your seat on the other side of the negotiating table, I’d love to hear your thoughts on, how do you affect that change in the industry from the CEO position at Warner Music Groups. Obviously, you don’t get to dictate per se the pricing of the DSPs and sort of what you can extract from players like TikTok, but what do you think you can do given your experience at YouTube to accelerate the value capture at music. And then I just wanted to ask Eric, if I could have follow-up.

And you said high single digit subscription streaming revenue organically I believe. Can that accelerate this year, is that a new normal in your mind that’s obviously quite a bit lower than what we saw from Spotify, for example on an organic basis in premium revenue and I think the market is a bit concerned that the major labels may be losing share. So I’d love to get your thoughts on that. Thank you both.

Robert Kyncl: Thank you. So one, I made my comments, so if I think everyone has been sort of stuck in the conversation, sort of one-on-one relationship between content providers and the DSPs. I look at it more from a more macro-level that the space is generally undervalued. And if you look at all the other indicators, how people pay for subscriptions and the price increases in various subscription, not just entertainment. It has been much more significant than it has been in music. And I think that is something that we have to all being be very mindful of. The — I can’t really get into the tactics of how we would achieve that, but what I can tell you is that, at YouTube we’ve had the history of executing and delivering on our plans.

And that is precisely what I plan to bring here. And we’ve done so at least in the last five to seven years in an extremely collaborative manner. So that is also something that I plan to bring here. So I know, I’m not giving you much of the specifics other than — other history of getting things done. And other history of being collaborative and I won the industry to go for everyone and I believe this is the right path.