WMG defends digital after Q1 dip

Analysts question sector strength after sales slowdown

Shares of Warner Music Group Corp. slumped Thursday after the music company reported fiscal first-quarter figures that declined more than Wall Street expected, and analysts wondered whether digital music growth is starting to slow because of mixed holiday season trends at the company.

WMG closed down 5.8% on Thursday at $20.27 after going as low as $20.01, near its 52-week low of $19.71. It led Thursday's decliners on The Hollywood Reporter's Showbiz 50 stock index.

WMG chairman and CEO Edgar Bronfman Jr. vowed Thursday to continue using anti-piracy protections for digital songs a few days after Apple Inc. CEO Steve Jobs challenged music firms to drop digital rights management efforts to boost digital sales.

Suggestions to end the use of DRM software is "without logic and merit," Bronfman said. "We will not abandon DRM." Asked about the balance of power between Apple and the music labels, he said he doesn't like such discussions and believes cooperation between the two sides will be most beneficial to all.

WMG on Thursday reported that its overall digital revenue rose 45% year-over-year to $100 million in the fiscal first quarter, or 11% of total revenue. This marked the second consecutive quarter in which digital sales exceeded $100 million. However, analysts pointed out that digital revenue in the previous quarter reached $104 million and 12.2% of total revenue, wondering whether that was a sign of slowing momentum. After all, the 4% sequential decline compared with a 30% increase a year ago.

Goldman Sachs analyst Anthony Noto estimated $116 million in digital revenue for the latest quarter, saying the performance "was disappointing for the first time and down sequentially for the holiday quarter, which we would not expect given the early growth phase of the product."

He concluded that "our original thesis we have held since May 2005, that digital growth can offset physical declines … is now in question."

Bronfman argued that his team expected that digital — like all music product — would ebb and flow depending on release strength. He also suggested that digital sales would look healthier if all wireless and online subscription music was included.

Bronfman also said that WMG sees "the next phase of our digital strategy" in deals with mobile phone makers and carriers, pointing to a recent deal with Motorola.

WMG posted a profit of $18 million for its fiscal first quarter, ending Dec. 31, down 74% compared with a $69 million profit a year ago.

Operating income before depreciation and amortization decreased 31% to $140 million.

Revenue fell 11% year-over-year, or 14% on a constant-currency basis, to $928 million because of what the company called "tough recorded music comparisons and a difficult recorded music business environment." Major sellers in the quarter included releases from Josh Groban, My Chemical Romance, Eric Clapton and P. Diddy, but they couldn't reach the year-ago might of titles from Madonna, Enya, Green Day and James Blunt.

Indeed, management had warned of the difficult year-over-year comparisons going into its new fiscal year.

U.S. revenue was off 12%, while international revenue declined 11%, or 16% on a constant-currency basis.

"As expected, we faced unusually difficult year-over-year comparisons this quarter, which do not reflect our prospects for the fiscal year," Bronfman said.

It is WMG's principle not to give financial guidance, but Bronfman said Thursday that the financial performance in the current fiscal year will be backend-loaded. He and CFO Michael Fleisher also emphasized that they are running the company with an eye on full-year rather than quarterly performance.

Worldwide revenue at WMG's recorded music unit decreased 13%, or 16% assuming constant currencies, to $800 million. The company cited softer U.S. and European sales.

Meanwhile, quarterly revenue at WMG's music publishing unit increased 2% to $133 million. However, on a constant currency basis, that amounted to a 3% decline.
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