Warner Music Group eked out a slight profit in Q1 ending 12/31/08 even though revenue dropped by 11% and operating income fell 34%.

It wasn’t improved cost management that allowed WMG to eke out a slight profit of $23 million on revenue of $878 million. Cost of sales was flat at 51.5% of revenue, and SG&A was basically flat at 33.6% of revenue (versus 33.5% of revenue last year).

Selling its stake in Front Line Management was the difference between last year’s net loss of $16 million on the recent gain of $24 million was non-operational. The $36-million gain from the sale of WMG’s share of Front Line Management (sold to Live Nation) and a $9-million gain on foreign currency transaction (the result of the settlement of a short-term foreign-denominated loan relating to its sale of Front Line equity) were the difference between the red and the black.

Digital revenue was $171 million (19% of total Q1 revenue). That was up 2% sequentially from $167 million in the Q4 2008 and up 20% from $142 million from Q1 2008.

The success of Josh Groban in the 2007 holiday season took much of the blame for WMG’s 18.8% drop in U.S. revenue. International revenue declined 4.9% but improved 5.1% on a constant-currency basis.

Recorded music: Revenue dropped 11.9% (7.4% on a constant-currency basis) to $749 million. Digital music accounted for 20.8% of global recorded music revenue and 31.4% of U.S. recorded music revenue.

Publishing: Revenue dropped 6.9% (increased .8% on a constant-currency basis) to $134 million. Mechanical revenue dropped 16.4%, synchronization revenue increased 10%, performance revenue rose 4.3% and digital revenue jumped 66.7%.

Below are notes I took from the Q&A part of the earnings call.

• On debt covenants: “We can and will meet our covenants.”
• Josh Grobin was responsible for the big Q4 year-over-year drop in operating margin
• Outside consultants reviewed A&R spending, and it was concluded they are “very strong” and “probably the strongest in the industry.” A&R spending has been constant for two or three years and will remain constant in 2009. They found a formula for strong A&R returns.
• Mobile deals in the U.S. Introduction of OTA downloads will show a “significant increase” in consumers accessing downloads in that manner. Apple iPhone OTA agreement will be the first impetus for mobile growth in the U.S>
• Music industry will “unquestionably become a growth industry,” but there are questions about when that will happen and from what base. Multi-rights deals will impact that change, mobile will impact that change.
• Bronfman believes digital business will lead to higher margins — even for mobile and digital subscriptions.
• On physical retail: WMG had limited exposure to Circuit City and other troubled retailers through inventory management.
• Live Nation-Ticketmaster impact: No comment on rumors.
• Are there pieces of the music business that would be required to offer artists a more meaningful package? Bronfman does not believe WMG needs additional infrastructure to do so. WMG will either involve itself in revenue streams or simply share in those streams. Would rather stick with a variable-cost structure than take on additional pieces to a 360-degree service.
• Almost all senior executives had been recently signed, so Bronfman does not expect losses in management team.
• No shift between new releases and catalog due to reductions in shelf space. Drops in floor space has impact WMG’s business “very little” and mainly the slow-moving titles.
• There will be competition for Apple. Apple continues to grow WMG’s business. As long as Apple innovates and allows WMG to innovate, WMG sounds content with iTunes’ market dominance.
• Cash balance is stronger, no great desire to buy back bonds.
• Performance royalties legislation introduced yesterday: Bronfman mentioned the countries that do not pay sound recording owners (China, Iran, Rwanda, etc). Not much of a comment about the income impact.
• WMG comment on a possible no-returns policy at retail: Not much of a comment.
• Market share gains in recorded music in historical context: WMG’s historic market share high is about the same as where it is now. In the past, there were six majors and many stronger indies. Bronfman believes WMG will be able to gain more U.S. market share.
• What role WMG plays in convergence of landscape and multi-rights deals in light of disbursement of Front Line: “We are more in the venture capital business. We are not so much in the business of renewing or partnering with artists when they are at a mature level in their careers.” WMG believes the highest-margin opportunity is to partner with artists early in their career. The infrastructure of other companies are focused more on mature artists.
• Impact of iTunes’ three-tier pricing: Dropping DRM has not changed piracy activity. It’s too early to predict what will happen with variable pricing or predict what songs will end up at what price points and for how long. WMG is hopeful for a better consumer experience and an improved position for the entire industry.

Posted by: Amy Sikkes

Source: http://www.coolfer.com/blog/archives/warner_music_group/