Warner Music Group Corp. (NASDAQ:WMG) Q3 2023 Earnings Call Transcript

Warner Music Group Corp. (NASDAQ:WMG) Q3 2023 Earnings Call Transcript August 8, 2023

Warner Music Group Corp. beats earnings expectations. Reported EPS is $0.23, expectations were $0.21.

Operator: Welcome to Warner Music Group’s Third Quarter Earnings Call for the period ended June 30, 2023. 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, and welcome to Warner Music Group’s fiscal third 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 earnings 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 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. 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’s 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: Thanks, Kareem, and good morning, everyone, and thank you for joining. After a challenging first two quarters, we’re pleased to see strong evidence of back half recovery that we told you to expect. This has been a big team effort. I’m grateful to our leadership, all of our operators around the world and all of our incredible artists and songwriters. I was happy that our Q3 results were driven by such a wide diversity of music. Strength came from many different territories, labels and revenue lines. We succeeded with artists and songwriters across the spectrum of genres and generations. And we saw the return of some of our biggest superstars, whose new music fueled fans engagement with all of their albums. In addition to improved performance in our core recorded music revenue, we also saw growth in licensing, artist services and almost all areas of publishing.

I’m particularly pleased to say we’re seeing our momentum accelerate into Q4. I’ll provide more details. But first, let me get into our Q3 results. Total revenue grew 10% and adjusted OIBDA increased 18% with margins growing 140 basis points year-on-year. Recorded Music revenue increased 9% and streaming grew 7%, reflecting double-digit growth in subscription revenue and modest growth in ad-supported revenue. Please note that beginning this quarter when we talk about ad-supported streaming revenue, it includes revenue from emerging streaming platforms such as TikTok, Meta, Peloton and others. Music Publishing turned in yet another impressive quarter, delivering revenue growth of 16% driven by strong streaming growth of 28%. I’d like to dive a little deeper into the different projects that drove these results as they reflect the strength of our commitment to developing extraordinary talent and growing our incredible catalog.

In Recorded Music, artists at all stages of their careers, global superstars and local names, new albums and timeless classics all added to our growing momentum. Ed Sheeran’s sixth studio album, Subtract, hit number 1 in 11 countries and top five in 7 other countries. Melanie Martinez’s third album, Portals, went top 3 in the U.S., U.K., Canada, Ireland, New Zealand and Australia, where she celebrated her first number 1 album. Both Ed and Melanie are great examples of the same phenomenon in the modern music business. New Music combined with Perring is resulting in an uptick of streams across the entire catalog. Given the cultural relevance of life and music right now, I’m pleased to say that our Latin division is on plan. Recent successes include Puerto Rico’s Myke Towers, who sought to #1 on Spotify Global Top 50 with his song Lala, and Mexico’s Yng Lvcas, who’s monster hit, La Bebe, spent nearly 4 months in Spotify’s Global Top 10.

Photo by Denisse Leon on Unsplash

And by the way, we just signed Yng Lvcas for publishing as well. Other amazing artists that are enjoying breakout hits include Korea’s aespa, Italy’s Capo Plaza, Sweden’s Rogefeldt, France’s Nino, the U.K. PinkPantheress, the U.S.’s Bailey’s Zimmerman and Australia’s Budjerah. We also partnered with Chinese superstar, Jam, for her groundbreaking album, marking the first time a Mandarin pop artist has recorded a full-length Spanish release. This partnership truly highlights how languages and genres are cross pollinating. The combination of our global reach and local expertise continues to give us a competitive advantage as we lean into this trend. Equally, it was great to see how music from our incredible catalog continued to contribute meaningfully to our results.

This includes major projects with renowned names such as Linkin Park and the Grateful Dead, as well as impressive carryover sales from newer artists such as Zach Bryan, Ava Max and Don Toliver. I’m also happy to say that our Q3 momentum is carrying over into Q4. Lil Uzi Vert scored his third #1 album on the Billboard 200 with Pink Tape, the first hip hop album to top the chart in 2023. Young Thug’s Business Is Business peaked at #2, and Gunna’s A Gift and a Curse debuted at #3 on the Billboard 200 with his lead single reaching #1 on the Spotify in the U.S. Dua Lipa’s highly anticipated new track, Dance the Night, which is currently #1 on the official European Airplay chart, kicked off the campaign for Barbie The Album released on Atlantic Records.

Like the movie itself, the album has been a massive global cultural event, hitting #1 in 7 countries, including the U.K., Canada, Australia, New Zealand, Netherlands, Ireland and Portugal. It is the first soundtrack ever to land 3 top 5 singles in the U.K. All in all, I’m pleased with our improvement in Q3, but we still have lots of work to do. Kudos to the whole Recorded Music team for how they partnered with our artists and worked hard to drive these results. In Publishing, we continue to see impressive results from our strategy to diversify our revenue streams, strengthen our services and mine our deep catalog. At the same time, our songwriters are contributing to massive hits, including Morgan Wallen’s Last Night, Miley Cyrus’ Flowers and SZA’s Kill Bill, all of which reached #1 on Billboard Hot 100.

And we’re also seeing huge successes from Germany’s Apache 207, Spain’s Cavazos, the U.K.’s Dave and Mega Heart [ph] producer, Matt, to name a few. We’re always expanding our publishing roster and have recently signed deals with Grammy-winning pop rockers Imagine Dragons, Ice Spice producer RiotUSA and Spanish star Ana Mena. I’d like to emphasize one other key theme today, our efforts to grow the value of music, which includes our approach to AI. We’re focused on creating a virtuous cycle, where innovation, fan engagement and greater monetization thrive together, providing even bigger opportunities for artists and songwriters and music fans around the world. When I arrived at WMG, one of the first priorities I identified was the push for increases in music subscription prices.

I am pleased with the traction that we’re getting. Last month, Tidal, YouTube and Spotify all followed Apple, Amazon and Deezer by upping their prices. This is the fiscally responsible thing to do for themselves and for the creative community. I’d like to thank them all for taking this important step. Back in March, I said that if we adjusted for inflation since 2011, the year that music streaming was introduced in the U.S., the price of a monthly music subscription in the U.S. should be $13.25 today. I’d like to point out that in 2011, the price of a standard Netflix plan was $7.99. It has since increased to $15.49 today. If the monthly price of a music subscription had gone up by the same proportion, it would have increased from $9.99, where it was in 2011, to $19.37 today.

Let’s remember that music subscription services give you access to all the music ever released and a continuously growing library for roughly the price of a single CD. You need to subscribe to 3 or 4 movie and TV services for roughly $45 a month to get anywhere near a comprehensive offer. So we see these initial price increases as an encouraging start. There is no evidence that the services are experiencing elevated levels of churn. We believe the market will bear further price increases in the future, and we’re expecting that they’ll arrive on a more regular cadence than in the past. Again, when I joined WMG, one of the questions I repeated got was about TikTok. 7 months in, I’m pleased to say we also made great progress there. Last month, we announced an expanded and significantly improved deal with them.

The agreement covers the main TikTok app; the rollout of the subscription service, TikTok Music; the video editing app, Capcut; and TikTok’s commercial music library. Our deal gives our artists and songwriters access to new levels of monetization, marketing and fan development features. This is the first of its kind partnership that will also mean the joint development of additional and alternative economic models as we grow the ecosystem together. I know there is interest in the specifics of our expanded relationship, but due to confidentiality provisions, we aren’t at the liberty to disclose them. What I can say is this: the deal features improved monetization per MAU that is comparable to other ad-supported DSPs, fully recognizing the value of our music and how critical it is to engagement on the platform.

I was glad to have as the benefit of my experience at YouTube aligning with the music industry on solutions that worked for everyone. We look forward to working with the team at TikTok along with our other partners to continue to innovate and grow the value of music. The market’s adoption of subscription price increases, combined with the ongoing evolution of our key partnerships, gives us tremendous optimism for the future of streaming growth. As we turn to AI, I’d like to point out we have a long history of working together with distribution platforms to establish licensing models that drive growth and innovation. For the past 15 years, music companies and distribution platforms have partnered to grow user-generated content as a multibillion dollar revenue stream for artists and songwriters.

Today, there are obvious similarities with AI. Working with our artists and songwriters, we’re leaning in, moving fast and working with a network of partners, including both generative AI engines and distribution platforms. Many Warner artists are already exploring impactful ways to use generative AI to create, augment and remix their music. We have some great examples from big names on the way later this quarter. Other artists are using generative AI for visuals with the artist like metal band Disturbed and dance producer [indiscernible] and the superstar Rob of Linkin Park all creating highly impactful music videos. In addition, AI-enabled stem separation technology is giving new life to recordings by artists who are no longer with us. For example, AI has been used to isolate the vocal performance from sound recordings of legendary entertainment Sammy Davis Jr. and renowned opera singer Maria Callas as part of groundbreaking singles.

We’re deeply inspired by our artists’ abilities to embrace and push the boundaries of the latest technology. I’d like to highlight one of the first official and professionally AI-generated song featuring a deceased artist, which came through our ADA Latin division. Costa Rican musician Pedro Capmany has released a new duet with his dad, the legendary father of Costa Rican Rock, Jose Capmany. This is Jose’s first song since 2001, the year of his tragic death. After analyzing hundreds of hours of interviews, a cappellas recorded songs and live performances from Jose’s career, every nuance and the pattern of his voice was modeled using AI and machine learning. The resulting song movingly announces the arrival of Pedro’s son, Jose’s grandson.

It also coincides with Jose’s catalog being available on all streaming services for the first time. With the right framework in place, AI will enable fans to pay their heroes the ultimate compliment through a new level of user-driven content, including new cover versions and mash-ups. AI is unquestionably one of the most transformative forces in human history. Nonetheless, this technology shift is more familiar terrain than first meets the eye. Like many technologies before it, it presents massive opportunities for human creativity and innovation. Q4 is off to a strong start with amazing releases, including Barbie The Album, Burna Boy, Nino, PinkPantheress, Tiago PZK, Cali, Tiesto and Anne-Marie. And we have new music coming from Zach Bryan, Sia, Dan and Shay, David Guetta, Charlie Puth, Omar Apollo and Robin Schulz.

We have a fantastic roster of artists and songwriters and a great team. We continue to invest in our expertise and infrastructure, both creative and technological, in order to create long-term success. As I said in my first earnings call, I’m a big believer in action speaking louder than words. So today, more than anything else I’ve said, it’s our results that show we’re gaining real traction. And there is a lot to be excited about in Q4 and beyond. Eric, over to you.

Eric Levin: Thank you, Robert, and good morning, everyone. Our Q3 results are reflective of a robust release slate, strong carryover from a variety of artists across different genres and geographies, easing ad comps and outstanding performance in our publishing business. As a result, we delivered solid growth across key metrics, including revenue, adjusted OIBDA and adjusted OIBDA margin. Total revenue increased 10%, reflecting growth in both Recorded Music and Music Publishing. Adjusted OIBDA increased 18% with a margin of 19% compared to 17.6% in the prior year quarter. These increases were primarily due to strong operating performance and disciplined cost management. Our margin performance in the quarter was not materially impacted by savings from our March headcount reduction as we reinvested most of the savings into technology.

Although, we anticipate that we will similarly reinvest most of those savings for the balance of this fiscal year, we are raising our guidance to deliver full year margin expansion at the high end of our 50 to 100 basis point range. Recorded Music revenue grew 9%. Streaming revenue increased 7%. Subscription streaming revenue grew in the low double-digits and ad-supported increased in the low single-digits. As Robert mentioned earlier, starting Q3 and going forward, when we talk about ad-supported streaming revenue, it will be inclusive of revenue from emerging streaming platforms. Our streaming results improved in each month of the quarter as we released new music. Additionally, the market-related ad-supported headwind moderated as we lapped the pressure we began to see in the prior year quarter.

Physical revenue increased 2%, driven by solid performance in the U.S. Artist services and expanded rights revenue increased by 14% due to higher content promotion and merchandising revenue. Licensing revenue increased 24% driven by growth in sync and broadcast fees. Recorded Music adjusted OIBDA increased by 16% with a margin of 20.6%. This is an increase of 130 basis points compared to the prior year quarter. Music Publishing continues to deliver strong results, posting 16% revenue growth, driven by strength in digital and mechanical. Digital revenue grew 27% and streaming revenue increased 28%, reflecting the continued growth in streaming, digital deal renewals and a revenue true-up of $9 million. We had a $17 million benefit from the CRB rate increase in the prior year quarter, and we had a $7 million benefit in the current quarter.

Performance revenue decreased by 9% due to the timing of payments from collection societies. Mechanical revenue increased by 45%, primarily due to a higher share of physical sales and timing of distributions. Sync was flat due to lower commercial licensing activity, offset by copyright infringement settlements. Music Publishing adjusted OIBDA increased 32% to $74 million with margin increasing 310 basis points to 26.1%, driven by strong operating performance. In April, we successfully launched certain components of our financial transformation program in select territories. The program remains on track to meaningfully roll out in a wave-based approach and with expanded functionalities during fiscal 2023, 2024 and into 2025. Once fully implemented, we expect the program to yield annualized run rate savings of $35 million to $40 million.

Q3 CapEx decreased to $33 million as compared to $35 million in the prior year quarter. Operating cash flow decreased 10% to $146 million from $163 million in the prior year quarter due to higher cash taxes and cash interest. Free cash flow decreased 12% to $113 million from $128 million in the prior year quarter. Adjusted OIBDA to operating cash flow conversion was 49% in Q3. Our goal remains to deliver an operating cash conversion of 50% to 60% over a multiyear period, and we expect to achieve this target for 2023. As of June 30, we had a cash balance of $600 million, total debt of approximately $4 billion and net debt of $3.4 billion. Our weighted average cost of debt is 4.1% and our nearest maturity date is in 2028. As we look ahead, we expect continued improvement in our results.

We are working hard to execute against our plan and look forward to sharing more about fiscal 2024 on our next earnings call. Thank you to everyone for joining us today. We’ll now open the call for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Benjamin Swinburne with Morgan Stanley.

Benjamin Swinburne: Robert, you mentioned the price increases. I think you thanked the DSPs for what you described as a good start. But at least from our perspective, there’s a bigger prize longer term, which is really continued movement of prices higher and really maybe a structural change to sort of the incentives that are driving the market. So I’m wondering if you could talk a little bit about your confidence in your ability or the industry’s ability to really drive significant change in the incentive structure and whether or not you have a new agreement with Spotify, because there was some disclosure in their quarterly filings suggesting they’ve got a number of new commitments with partners. Universal announced a new agreement.

So I would love to hear your thoughts on sort of the long-term changes you’d like to see the industry adopt beyond just 1 year of price increases? And also whether you can talk a little bit about your relationship with Spotify, whether anything has changed there?

Robert Kyncl: Let me take it from the backwards. So no, we do not have a new deal with Spotify. So let me just clarify that upfront. We’re not in relationship with the consumers. Our DSP partners are. So they are free to raise prices at any time without any contractual change. So it’s not required in order to do so. I think as I look forward into the future — obviously, you’ve heard me in my opening remarks talk about the value of music. And this being a first step in what I believe is a more regular cadence of increases. But let me give an example of what I think should happen more often and why. If you look at the history of Netflix and their innovation around price, it was really both on the way down and on the way up. Netflix started at $20 a month more than 20 years ago, then it went up to $22, and then it, over the course of many years, has innovated down to $19, $18, $17, $16, all the way down to $7.99.

And then it started to grow it back up. And today, the standard plan is $15. I forget the name of the next plan. I hope with more family members on it, is $19, so close to $20. The level of innovation around price is incredible. And I think that the DSPs in the music space will begin on the same path, because the video services are showing us a price elasticity that consumer has that it is not resulting in elevated levels of churn. Now let me be clear. I am not suggesting that we go to $19 today. That is not what I’m saying. But what I’m pointing out is the innovation that is happening in the entertainment space, around it, the value that we all provide to users and the elasticity that is there. And we are — we obviously want to make sure that we’re working collaboratively together with our DSP partners to innovate over the next decade around this point.

Benjamin Swinburne: And then if I could ask you a follow-up, you and/or Eric, just around margins. I mean this quarter, we really saw the business deliver the kind of growth I think we all kind of expect over time, particularly both revenue, but also operating leverage. I think there’s still some question out there, Robert, about whether your appetite to sort of reinvent the organization from a technology point of view is going to cause some kind of pause in the margin story that we’re seeing again this quarter. Just wondering if you could talk a little bit about the technology investments you’re making and whether you think you can continue to drive operating leverage in the business over time, assuming the top line performs?