November 24, 2009

By By Glenn Peoples, Nashville

Warner Music Group's Q4 and fiscal 2009 earnings show the company is shrinking, yet staying afloat through a digital transition that is not replacing lost CD revenues. A more diversified music company like WMG still has not arrived at that place where revenues bottom out. Digital revenue continued to trend upward and grew at a much faster pace in Q4 than in the previous three quarters. But the bottom is not yet clearly in sight. Read the earnings release here.

In Q4, the company benefited a one-time boost of $25 million in publishing revenues as a result of the mechanical royalties settlement October. And the company's position at the end of the year benefited from the sale of its share in Front Line Management in fiscal Q1.

Digital was a frequent topic in the earnings call. In his opening comments, CEO and Chairman Edgar Bronfman, Jr. highlighted a few examples of a "confluence of pioneering new services" Bronfman pointed to BSkyB's Sky Songs, an ISP-created service that launched in the U.K. in October. Sky Songs gives users a fixed number of downloads and unlimited streaming for a flat monthly fee. It is available as a standalone product to customers of competing ISPs and is bundled with BSkyB's broadband service. (Other ISPs will soon launch similar services. On paper they are a great idea - bundling music services with data services makes sense. But their success will ultimately depend on the quality of the products, not just who creates them and how customers are billed.) Bronfman also mentioned Dell's partnership with Best Buy and Napster. "We're optimistic about its potential during the holiday season," he said.

iTunes' multi-tiered pricing has been "a net positive," said Bronfman. Billboard analysis and comments from multiple industry sources point to improved label revenues since the implementation of a three-tiered pricing system for individual tracks in early May. Google's inclusion of audio streams at the top of search results should "increase music discovery and downloading purchasing," he said. And Bronfman cited Lala's partnership with Facebook that will allow users to buy streaming music gifts for friends.

The achievements of Atlantic Records were also highlighted during the earning call. Atlantic was able to grow both revenue and margin, said Bronfman, and its digital share of total revenue was over 50%. The last three years have been the best in the label's history, he said. When asked by an analyst about the viability of subscription services, Bronfman noted there have been some failures but explained digital services comprise a young market that will better develop over time. "I think that will be a significant area of the music industry going forward."

Fiscal 2009: Revenue dropped 9% (3% on constant currency basis) to $3.176 billion. International revenue was down 6.6% while domestic down 11.8%. %. Net loss was $100 million compared to a loss of $56 million in 2008. Free cash flow (cash from operations minus capital expenditures and cash paid for investments) was $316 million. That was a big jump from free cash flow of $137 million in 2008. (Remember that in Q1 WMG sold its stake in Front Line Management for $123 million.) Recorded music revenue dropped 9.4% -- domestic was down 14.6% and international was down 4.6%.

Q4: Q4 revenue rose 1% (5% on constant currency basis) to $861 million, which the company said reflects backend-weighted release schedule. Net loss was $18 million. Free cash flow was $20 million, a big drop from $100 million in 2008. Recorded music revenue was flat (up 3.7% at constant currency) at $709 million. The gain in the international division (16%) was canceled out by the fall in domestic revenues (-14.6%).

Publishing: Annual revenue was down 7.2% (up almost 1% at constant currency). Fueled by declines in CD sales, annual mechanical revenue dropped 14.7%. Revenues got a $25 million boost in Q4 from the agreement reached last month between publishers and labels that provided a means to disburse $264 million in pending and unmatched mechanical royalties. With that $25 million amount, Q4 publishing revenues rose 3.8% (11.7% at constant currency). The global economy's impact on advertising budgets was probably a big factor in the 25% drop in synchronization revenue in Q4.

Digital: Annual revenue rose 10% (14% at constant currency) to $703 million. Domestic digital revenue was up 8%. Revenue in the quarter was $184 million, a 5% increase sequentially. That is the largest sequential gain in quite a few quarters. During the earnings call Bronfman said the company expects digital music revenue growth to "accelerate" despite falling ringtone revenues in the U.S. and Europe. WMG's sequential digital revenue growth was only 1.2% in both Q3 and Q2 and 2% in Q1. "We remain optimistic about access models as a driver of revenue," said Bronfman, "though they may take some time to gain meaningful traction."

Follow Billboard senior analyst Glenn Peoples on Twitter at twitter.com/billboardglenn.

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