Earnings Call Transcript - WMG Q2 2024

Operator, Operator

Welcome to Warner Music Group's Second Quarter Earnings Call for the period ended March 31, 2024. 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 the call over to your host, Mr. Kareem Chin, Head of Investor Relations. Please, you may begin.

Kareem Chin, Head of Investor Relations

Good morning, everyone, and welcome to Warner Music Group's Fiscal Second Quarter Earnings Conference Call. Please note that our earnings press release, earnings snapshot, and Form 10-Q are available on our website. On today's call, we have our CEO, Robert Kyncl; and our CFO, Bryan Castellani, 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 earnings snapshot to remind you that this communication involves 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 earnings 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. Our references to normalized revenue and adjusted OIBDA are adjusted for items that impact comparability. The details of these can be found in our filings. 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 to 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'll turn it over to Robert.

Robert Kyncl, CEO

Thanks, Kareem. Good morning, everyone, and thank you for joining us. I am pleased with everything our global team is doing to deliver for our artists and songwriters and drive our business forward. In Q2, total revenue increased 7% with Recorded Music and Music Publishing increasing 4% and 19%, respectively. On a normalized basis, total revenue grew 9%, with Recorded Music up 7%. The Recorded Music streaming revenue increased 11%, led by subscription streaming growth of 13.5%. This was driven by stronger music performance as well as subscriber growth and subscription price increases. Total adjusted OIBDA increased 9% or 10% on a normalized basis. In Recorded Music, we continue to break new artists, build global careers, and mine our extraordinary catalog. This quarter, we saw massive hits from artists across different genres in all stages of development, exactly the kind of mix we want. Benson Boone and Teddy Swims are standout artist development stories of the year. They are also both signed to Warner Records as recording artists as well as to Warner Chappell as songwriters. During the quarter, Benson Boone reached #1 on the Spotify global chart, while Teddy Swims and Megan Thee Stallion individually hit #1 on the U.S. Hot 100 chart. Benson, Megan, and Teddy all spent weeks in the Hot 100 top 10, alongside carryover hits from Jack Harlow and Zach Bryan. Around the world, we also had #1 hits from Myke Towers, Green Day, Jolie, and Blast. We also continue to attract outstanding global talent with recent signings, including India-based superstar, Nora Fatehi; top Ukrainian rock band, Okean Elzy; and legendary multi-Grammy winning icon, Angélique Kidjo. It's encouraging to see our artists creating bodies of work with real staying power. These new releases are our catalog of the future. Here are some great examples of how our so-called shallow catalog is contributing to revenue growth. Ed Sheeran's Divide, released in 2017, and Dua Lipa's Future Nostalgia, released in 2020, are both among our top-earning albums for the quarter. Deep catalog releases that are more than 10 years old also remain an important growth area with meaningful untapped opportunity. When we market catalog with the same ingenuity as new releases, they often have a significant impact. For example, at this year's Grammys, our recording artists, Tracy Chapman and Joni Mitchell both performed classic songs that saw a big boost in weekly audio streams of over 180%, respectively. Our Music Publishing division, Warner Chappell, continues to perform extremely well. Our songwriters contributed to a range of recent hits from Benson Boone's Beautiful Things, Teddy Swims' Lose Control, and Jack Harlow's Lovin' On Me to Ariana Grande's We Can't Be Friends and Kanye West and Ty Dolla $ign's Carnival. Top-tier songwriters continue to recognize Warner Chappell's momentum. Recent signings include five-time Grammy nominee Coco Jones and Dua Lipa, who joins other superstars such as Cardi B, Zach Bryan, Madonna, and Led Zeppelin, who are represented by our company for both recorded music and music publishing. As reported in music and copyright, we outpaced our peers in 2023, growing our global market share in Music Publishing. Simply put, we've executed well on expanding our songwriting roster, strengthening our services, and finding innovative ways for songs to be heard. Impressively, this growth has largely been achieved organically, not through acquisitions at inflated multiples. Further evidence of our success in identifying world-class songwriters early is the phenomenal success of British singer-songwriter Raye. She signed to Warner Chappell nine years ago. In March, she matched records for the most nominations and wins in a single year at the Brit Awards. In addition to her solo work, she's written hit songs for the likes of Beyoncé, Rihanna, and John Legend. Earlier this year, I laid out three strategic priorities: grow engagement with our music, increase the value of our music, and evolve how we work together. We continue to make important progress on all these fronts. First, growing engagement with our music. This is primarily driven by signing and serving an ever-broadening spectrum of artists and songwriters, identifying and investing in territories where local music is gaining global appeal, and helping our talent break through the noise in a cluttered and fiercely competitive environment. Unusual for a company of our scale, most of our biggest stars are homegrown talent who have been with us since the earliest days of their careers—Bruno Mars, Ed Sheeran, Cardi B, and Dua Lipa, among others. We're building on this legacy by nurturing original artists into the next generation of superstars. A great example is Warner Records, which is the hottest label in the U.S. right now due to its focus on genuine talent and long-term artist development. In an industry where it's harder than ever to cut through, Warner Records has bucked the trend with success stories like Zach Bryan, Benson Boone, and Teddy Swims, and their hot streak shows no sign of slowing down. Last September, we announced a joint venture with 10K Projects, founded by Elliott Grainge. 10K operates as a standalone U.S. label, opening up a whole new channel through which we can bring quality talent to market. From the get-go, this has been successful for Warner Music Group both commercially and creatively. 10K continues to deliver incredible hits with Artemas' latest single, I Like The Way You Kiss Me, going #1 on the Spotify global chart. As I've mentioned before, we continue to fuel our growth organically and via partnerships and acquisitions. As part of our mission to be a destination for artists and songwriters at every stage of development, we're expanding our lower-touch services that many independent artists, labels, and songwriters rely on. One recent example is our partnership with BandLab, the social music creation platform. We'll work together to identify and sign emerging songwriters, providing them with access to our comprehensive suite of offerings. We have a clear plan to develop this area of our ecosystem across the company, and we're building solutions in-house while staying vigilant about our M&A opportunities, which could accelerate our capabilities. At the same time, we're expanding our presence in dynamic recorded music markets. We've seen impressive results this past year. In Argentina, the fastest-growing market in 2023, we doubled our year-over-year revenue organically. In Sub-Saharan Africa, the fastest-growing region in 2022 and 2023, we were the only major music company to grow share last year. In India, already the 14th largest market and climbing, we were again the only major to grow share in 2023. We continue to find ways to turbocharge our growth and strengthen our global platform for local talent. Last month, we launched Warner Music South Asia to address a region with 400 million people across Bangladesh, Nepal, Pakistan, and Sri Lanka. Turning to our next strategic priority, growing the value of our music. There are two aspects to achieving this: growing the pie and growing our participation in the pie. Over the past year, there have been some initial steps in the right direction, including the first price increases at all major DSPs. We will continue to advocate for further increases as well as more sophisticated price optimization, especially as DSPs improve their offerings to bring in more subscribers. We've also seen encouraging early signs in the evolution of royalty models, aligning economics with premium content, thus growing our participation in the pie. It's important to note that these shifts to more artist-centric models take time to fully implement, and we don't expect an immediate impact on our results. We're making every effort to build alignment with our partners, and that's the best way to ensure that the value that music provides to these platforms is properly recognized. Another area where we see great potential to grow the value of music is AI. Like I said before, there are three constituents that play critical roles in the evolution of AI: platforms, models, and governments. The concepts of control, monetization, attribution, and prominence are the core of our discussions with all parties in order to protect artists, songwriters, and rights holders. Last Tuesday, I testified on the promise and perils of generative AI before the U.S. Senate Judiciary Subcommittee on Intellectual Property, voicing the shared concerns of the creative community. I urge Congress to act this year and pass a federal law that addresses deep fakes. My central message was that the use of people's likeness and voice requires consent and must be subject to free market negotiations. We should not abide by the appropriation of people's identities and the theft of artist livelihoods. I'll briefly highlight one amazing example of the power of AI when done right. Since 2013, Randy Travis has had aphasia, a condition that limits his ability to speak and sing. Last week, the legendary Grammy award-winning country music Hall of Famer was able to release new music for the first time in over a decade, thanks to AI. We played his new song, Where That Came From, on our pre-call hold music, and you should add it to your playlist right now. Moving on to my third priority, evolving how we work. On our last earnings call, we announced a restructuring plan that will enable us to increase our investment in music, technology, and new skill sets. We are on track, although the full savings will not be realized until the end of fiscal '25. The majority of the changes have already been implemented, including centralizing certain functions and exiting our owned and operated media businesses. Since we last spoke, we have sold the entertainment websites, UPROXX and HipHopDX. We're laying a strong foundation to accelerate our progress and yield greater value over time. As part of this, we continue to develop our tech capabilities. I'll give you a few examples of some of our projects. We've made improvements to our royalty systems and the tools used to identify unclaimed revenue. We've overhauled our global supply chain, unlocking our ability to scale our third-party distribution business, and we've transformed our proprietary tools that identify fan trends while building new ways to engage with superfans. Our second half includes eagerly anticipated music from Dua Lipa, who dropped her new album Radical Optimism last Friday. We're excited about new releases from Twenty One Pilots, Sia, Gaana, Megan Thee Stallion, David Guetta, Fred Again, Charlie Puth, and Maria Bechara. This is an exciting and transformative period for our company and for the music industry. We're looking forward to building incredible careers and creating dynamic new opportunities in the months and years ahead. And with that, I'll turn it over to Bryan.

Bryan Castellani, CFO

Thank you, Robert, and good morning, everyone. Before I get into the details of our Q2 results, I want to remind everyone that growth rate comparisons will be in constant currency. The items affecting recorded music streaming revenue comparability include the BMG digital revenue roll-off, which was $22 million unfavorable in the quarter. Additionally, the renewal with one of our international digital partners that resulted in upfront incremental revenue recognition of $27 million last quarter resulted in an unfavorable impact of $4 million this quarter and will have a similar impact in Q3 and Q4. Details relating to these items can be found in our earnings press release. In Q2, total revenue grew 7% and adjusted OIBDA increased 9% with a margin of 20.9% and an increase of 40 basis points over the prior year quarter. On a normalized basis, total revenue grew 9%, and adjusted OIBDA increased 10%. Recorded Music revenue grew 4% and 7% on a normalized basis. Streaming revenue grew 11% on a comparable basis with subscription streaming growth accelerating to 13.5%, while ad-supported revenue increased 5%. The improvement in subscription growth was driven by stronger DSP sub performance, along with price increases, partially offset by a deceleration in ad-supported revenue driven by platform mix. Physical revenue decreased 7% driven by the timing of releases. Artist services and expanded rights revenue decreased 3% due to lower merchandising revenue, partially offset by higher concert promotion revenue in France and Japan. Licensing revenue grew 5% primarily due to the timing of legal settlements. Recorded music adjusted OIBDA increased 9% with a margin of 22.9%, an increase of 110 basis points. On a normalized basis, adjusted OIBDA increased 10%. Music Publishing continues to deliver impressive results with revenue growth of 19%, driven by streaming and performance revenue. Digital and streaming revenue increased by 27% and 29%, respectively, reflecting the continued growth in streaming and the impact of digital deal renewals. We also benefited from the continued investment in and expansion of our publishing catalog. Performance revenue increased by 18% due to strong artist touring activity in Europe, while sync revenue increased 2%, driven by the timing of legal settlements. Mechanical revenue decreased 6% due to lower physical sales. Music Publishing adjusted OIBDA grew 8% with a margin of 26.8%, a decrease of 270 basis points due to revenue mix. Turning to CapEx, we saw a $9 million decrease from the prior year quarter to $26 million due to the timing of tech investment. Operating cash flow decreased to a use of $31 million from a use of $6 million in the prior year quarter due to increased ANR investment and the timing of working capital items. Free cash flow decreased to a use of $57 million from a use of $41 million in the prior year quarter. Our goal continues to be to deliver operating cash flow conversion of 50% to 60% over a multiyear period, which we expect to achieve for the full year 2024. As of March 31, we had a cash balance of $587 million, total debt of $4 billion, and net debt of $3.4 billion. Our weighted average cost of debt was 4.5% and our nearest maturity date remains in 2028. In February, we announced a plan to deliver $200 million of annualized run-rate cost savings by the end of fiscal 2025. The plan is proceeding according to schedule. We achieved modest cost savings in the quarter, the majority of which were reinvested into tech. Regarding BMG, we estimate the revenue impact to be in the range of $25 million to $30 million in both Q3 and Q4, eventually rolling off completely in fiscal 2025. As a reminder, BMG's physical distribution will roll off in fiscal 2025. As we look ahead, Q3 is off to a solid start. As Robert mentioned, we are excited about our upcoming releases. The momentum in music in the business is strong, and we continue to position ourselves for long-term success, including to deliver on our goals of healthy top-line growth, margin expansion, and strong cash flow conversion on a consistent basis. Thank you to everyone for joining us today. We'll now open the call for questions.

Operator, Operator

Our first question comes from Benjamin Black of Deutsche Bank.

Benjamin Black, Analyst

I have two. So Robert, last quarter, you're obviously contemplating a bid, a formal bid for Believe. You've since withdrawn your interest. So I'd be curious to hear sort of why that deal fell apart. And also it would be good to hear sort of where strategic M&A fits into your capital allocation hierarchy right now? And then secondly, there appear to be quite a few developments on the pricing front. Spotify is currently in the early innings of introducing a tiered structure, with what at least appears to us to be a potential surcharge for audio books. So I guess the question is, will Warner potentially benefit from that incremental surcharge, or is it more of a carve-out? And relatedly, in their bundled offering, does it at least qualify for lower mechanical rates as dictated by the CRB in the U.S.?

Robert Kyncl, CEO

All right. Thank you. So on Believe. As I've mentioned on, I think, several earnings calls, we have a clear strategy in expanding our offerings to serve more artists across a wider array of their careers. We have our team working really hard, building all the right features that we need. But as any other steward of our business, we always look at ways to accelerate because all of this work takes time. Anytime there's an option in the market that allows us to accelerate our road maps, we will look at it. We pursued that with Believe. This was a very unique situation because the timing was out of our control, as well as the public nature of it and the extremely short timeframe for diligence. So obviously, this all played out publicly. We decided not to pursue it for a variety of reasons that I really can't go into. However, our strategy is to continue to look for opportunities that can augment our built strategy, and we continue to do that. On pricing and evolution of pricing, especially as it relates to bundling, I would say that bundling is generally good for subscription business because it achieves two things: one, it tends to lower subscriber acquisition costs, and two, it tends to lower churn rates. For platforms, this becomes a strong growth driver. We've had 50 years of very healthy television markets through bundling, and you can see that across various sectors. The job of wholesalers like music companies, like ourselves, is to ensure that the sanctity of our pricing across the different services, whether individual or bundled offerings are in line with each other. So you can expect us to pursue that strategy. As it relates to what you were referring to, the CRB is a U.S. specific issue. I don't see it persisting in the long term, as I believe in global solutions. We are in a global business, and individual carve-outs in any market are not conducive to our long-term partnerships.

Bryan Castellani, CFO

And Ben, it's Bryan. And just to echo what Robert said on the capital allocation hierarchy, there's really no change there as we've articulated before, and we've walked you through our cascade. We continue to see plenty of runway on organic investment, which you continue to see in our artist signings and ANR investment, as well as we continue to expand our publishing and catalog rights. Last year, we acquired 10K, which was a smaller inorganic acquisition. Of course, we also continue to return capital via dividends to shareholders. It's our job to survey the market. If any inorganic opportunities can accelerate our initiatives, we will consider those. However, we've always demonstrated to be good stewards financially, and we will continue to do that. Our interest in Believe was well-founded in looking through our capital allocation hierarchy, if it could accelerate it. However, again, the unique nature of that opportunity led to the outcome we observed, with no change to our capital allocation.

Operator, Operator

Our next question comes from the line of Ben Swinburne of Morgan Stanley.

Unknown Analyst, Analyst

This is Cameron on for Ben. You guys have previously described this year as a second half weighted year from a release slate perspective. Is that still your expectation as we look through the remainder of the year? And does that translate into accelerating organic streaming growth over the next couple of quarters? And then another one, if I can. What, to the extent you can share with us, drove the sale and add an emerging platform organic growth from last quarter to this quarter? I know you called out platform mix, but anything in addition to that that you could provide would be helpful.

Robert Kyncl, CEO

I'll take the first, and Bryan will take the second. Thank you, Ben. So we remain excited about our new music. We have lots of great content coming from the likes of Dua Lipa. She just released her album, and Twenty One Pilots, Sia, Gaana, and so on and on. At the same time, we're also having great real-time success, which is amazing to see with Teddy Swim, Benson Boone, and Artemas. We've been doing well on new music. One thing to keep in mind is that we've now seen the full impact of the Spotify price increases in our results. In the second half, we'll be lapping last year's price increases with the other DSPs like Apple and YouTube. However, we are continually encouraged by the subscriber growth as well.

Bryan Castellani, CFO

Cameron, it's Bryan. Just to break down the quarter a bit, the overall recorded music streaming grew 11% on a normalized basis. Within that, I would say two or three pieces accelerated. You saw subscription grow at 13.5% versus 12% in the prior quarter. While ad-supported and emerging combined decelerated, we did see growth and an accelerating trend in the traditional ad-supported. Emerging can have some lumpiness based on deal timing, content delivery, as well as a mix of platforms. However, the underlying strength remains in core subscription streaming and traditional ad-supported models. Overall, while there may be some lumpiness, we still believe it's a growing category, and over the long term, we expect it to continue to grow.

Operator, Operator

Our next question comes from the line of Batya Levi of UBS.

Batya Levi, Analyst

Can you talk a little bit more about the initiatives to monetize super fans? I think you had plans to launch an app. How are you approaching the partnership with DSPs versus going direct in that initiative?

Bryan Castellani, CFO

Sure. Thank you. Yes, we've been working on developing our plans, and it's well progressed but nothing new to announce on that. On partnerships with DSPs, the way we think about these partnerships versus doing it ourselves is interesting. The unique insight with music is that, unlike other forms of creation, it's incredibly ubiquitous. If you're an artist, you want your content to be distributed as widely as possible across many touch points. Therefore, it's hard to optimize for any single platform and try to anchor a superfan relationship in one place because your superfans are spread across many different platforms. This means we are naturally set up to be the right place to do this across platforms. We can always partner with the DSPs, but through our offerings, it has to be a controlled solution.

Operator, Operator

Our next question comes from the line of Kutgun Maral of Evercore ISI.

Unknown Analyst, Analyst

Our next question comes from the line of Michael Morris of Guggenheim Securities.

Michael Morris, Analyst

I had two topics, if I can. The first, I wanted to follow up on the question about pricing changes at Spotify, in particular. As you see the pricing changes that they have announced right now and the structure of those price changes, do you expect to participate in the incremental revenue that's being generated from the new pricing plans? Or do you see it as all earmarked for their audio book product, which is part of a pool that you don't participate in? And do you think that this change by Spotify is representative of another leg of the cycle of pricing, Robert, that you've spoken about in the past, helping to close that gap between the intrinsic value of music and the current price point? And then second, I wanted to ask about the lower-touch services that you referenced developing. How do you ensure that this creates a pipeline to deeper artist relationships that you can progress on, rather than just offering a service that meets artist needs in a less revenue-generating manner?

Robert Kyncl, CEO

Okay. So on the first one, first, I want to emphasize that we had 15 years of no price action by anyone, including myself when I was on YouTube. It’s amazing to see that we have price increases now. We can now say on an earnings call that we're lapping a one-year anniversary of a price increase. So it's significant that it's finally happening. As services grow and think through their pricing strategies, this indicates that they're thinking very carefully about it. They are presenting all kinds of different solutions, and bundled solutions are part of that suite. I believe that music companies must ensure that the integrity of our pricing is upheld appropriately. There may be higher-priced bundled offerings allocated for additional content providers, which also benefits us due to the bundled offerings. If we price correctly ourselves, we will benefit. This is moving in the right direction despite the bumps in the road we may face. As for the second question regarding lower-touch services, it's important to recognize that at various stages of their careers, artists may have no following or a large one. It's important for us to widen the net in which we work with artists and find great talent. This is essentially about deal flow. We are focused on ensuring that we don’t simply set up more shops with the same success rate, but instead run our business profitably across these offerings while fostering mutually beneficial relationships with all artists involved.

Operator, Operator

Our next question comes from the line of David Karnovsky of JPMorgan.

David Karnovsky, Analyst

Robert, you noted in the quarter the contribution from shallow and deep catalog results. Maybe a follow-up on this. Absent an artist putting out a new album, what tools do you have to kind of drive increased engagement with your older content? And separately, looking at Universal and TikTok's announcement, there's a lot of lip service paid to potential protections around AI as well as co-development of tools to enable creativity. I just wanted to follow up here. Does this agreement mean anything incremental for WMG and your ability to make the imports front?

Robert Kyncl, CEO

Sure, I can repeat that. We've focused on optimizing the performance of our catalog for quite some time. The best way to think about this is that catalog is a tremendous asset for us, and it continues to grow and provide dividends, simply because it's an incredible resource. The majority of our revenue is now driven by digital distribution. Therefore, if we want to increase the performance of our catalog, we have to make sure that we optimize all our titles across all major DSPs. It sounds simple, but given the size and scale of our catalog, this task is very complex, and it cannot only be managed by human effort due to the sheer number of SKUs. So, we have a project involving our technology team and business team to ensure our entire catalog is adequately optimized for streaming across every large DSP. This is a methodical approach. All this enhances our marketing campaigns against the catalog, making it a two-pronged strategy: one that is large-scale and another that is focused on selected promotional efforts. Regarding UMG and TikTok’s agreement, I cannot discuss specifics about their business. However, I am pleased that they reached an agreement. We must stay alert to ensure that this category drives growth for our companies overtime.

Operator, Operator

Our next question comes from the line of Stephen Laszczyk of Goldman Sachs.

Stephen Laszczyk, Analyst

Bryan, on margins, I was curious if there's any help you could give us on the expected pace of margin expansion this year, just as we see some of the cost efficiencies flowing through the income statement and how that compares versus the rate at which you can reinvest. Any help there would be great. And then maybe just on the market for music rights. Would be curious if you could give us an update on what you're seeing in that market. It feels like there was hope that the bid-ask spread will get closer as rates came down, but that appears that might not be the case at this point. Just curious what you're hearing on that front.

Bryan Castellani, CFO

Thanks, Bryan. On margin, as we always say, we remain focused on our three goals of healthy revenue growth, margin expansion, and cash flow conversion. We highlighted the cash flow conversion this quarter, recognizing that Q2 is seasonally a quarter where we have low cash conversion due to timing of receivables and payments. On margin, we don’t guide quarter-to-quarter, but rather over the course of the year. There will be lumpiness in margin based on timing slate deals and internal efficiencies. We're focused on managing it effectively, but look at it in terms of a year-long perspective rather than quarterly. Regarding content rights, we are evaluating numerous opportunities out there, and we find pricing and offerings to be advantageous currently. Given the recent fluctuations in interest and pricing, we still see multiple opportunities—there's a lot we can consider and pursue in the current market environment.

Robert Kyncl, CEO

Yes, I'll add to that. The current market offers a range of opportunities, and we're maintaining a robust pipeline of deals. The contours of the market provide us with multiple avenues to explore. It’s more than we can even pursue today, and we are very diligent about our approach to ensure we achieve solid returns and sustenance across our international divisions. Okay. That's it from my end. I really appreciate your questions and engagement today. And please do not forget to go to your favorite DSP and listen to Randy Travis' song, Where That Came From, which was generated with AI, with Randy's permission. This collaboration showcases the incredible possibilities that AI can offer.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.