Universal Music Grp U/Adr

Good evening and welcome to Universal Music Group's second quarter and first half earnings call for the period ended June 30th, 2023. My name is Maxine and I'll be your conference operator today. Your speakers for today's call will be Sir Lucian Grange, Chairman and CEO of Universal Music Group, and Boyd Muir, Executive Vice President, CFO and President of Operations. They will be joined during Q&A by Michael Nash, UMG's Executive Vice President and Chief Digital Officer. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number 1 on your telephone keypad. If you would like to withdraw your question, please press star followed by 2. Please let me remind you that management's commentary and responses to questions on today's call may include forward-looking statements, which by their nature are uncertain and outside of the company's control. Although these forward-looking statements are based on management's current expectations and beliefs, actual results may vary in a material way. For a discussion of some of the factors that could cause actual results to differ from expected results, please see the Risk Factors section of UNG's 2022 Annual Report, which is available on its website at universalmusic.com. Management's commentary will also refer to non-IFRS measures on today's call. Reconciliations are available in the Interim Financial Review and Unaudited Condensed Consolidated Interim Financial Statements for the six-month period ended June 30, 2023 – on the investor relations page of UMG's website. Thank you. Sir Lucian, you may begin your conference.

Thank you, and good evening from Hilversum. I'm very happy to welcome you as we report another consecutive quarter of strong results for Universal Music Group. Results that are not strong only financially, but strategically and creatively as well. I'll have more to say about the creative steps our teams have been taking to drive our strategy forward, especially in the areas of streaming, artificial intelligence, and high-growth potential markets. But first, a brief look at our financial results. In the second quarter, our revenue grew 9% in constant currency over last year's second quarter, and adjusted EBITDA grew 19%. Boyd will dive into the numbers in greater detail in a few minutes, but I wanted to say how proud I am of these results. Once again, our growth came from all segments of the business, music publishing, merchandising, and recorded music, as well as from all major revenue streams within our recorded music business. We're an artist-centric company, our consistently stellar performance is directly attributable to the deep and sustaining partnerships we've formed with our artists. These partnerships with both established artists and new ones are in place throughout the world, in developed music markets, and ones with high growth potential as well. I'd like to take a moment to share with you just a few of the numerous examples that reflect how our relationships with artists help us achieve immediate chart success, and even more critically, how those relationships can build long-term staying power. Let's start with the US. For the first six months of this year, UMG had seven of the top ten albums, as well as four of the top five albums, with Morgan Wallen filling the number one slot. When it came to songs, UMG had six of the top ten, And recently, Taylor Swift became the very first woman in history to have four albums in the top 10 simultaneously, including this week's number one. In the UK, UMG artists had six of the top 10 albums in the first half of the year. Out of those 26 chart weeks, UMG artists held the number one slot for 15 of those weeks. As further evidence of the depth and breadth of our roster, Those 15 number one slots were held by 13 different UMG artists, from Metallica and U2 to Niall Horan, Lana Del Rey, Shania Twain, Sam Smith to Boy Genius and the Lathams, amongst others. And in Japan for the first half of the year, King & Prince was the top-selling artist, and two of the top three new artists were ours too, including Le Seraphim and Travis Japan. I'll finish up this portion of my remarks by talking about our partnerships with two of today's greatest Latin music artists. We're thrilled that Carol Gee has partnered with Interscope Records for her future recordings, reaffirming her long-term relationship with UMG. Ever since signing with Universal Music Latin Entertainment in 2016, Carol has become an astonishing musical presence. Currently one of the most successful Latin female artists in the world, she's generated nearly 80 billion global music streams so far. And this year, she became the first woman ever to debut at number one on the Billboard 200 with a Spanish language album. And while we're talking about mega Latin superstars, Anita has signed to Republic Records in partnership with Universal Music Latin. Nominated for Best New Artist at the 2023 Grammy Awards, she's a string of other historic making accomplishments, including the first solo Latin artist to reach number one on Spotify globally, and the 2022 winner of the Best Latin Artist at the American Music Awards, MTV Video Music Awards, and MTV European Music Awards. These are just a handful of highlights from a long list of remarkable achievements by our artists. But in the interests of time, I'd like to shift attention to those significant strategic topics I referred to earlier. We're fiercely determined to make sure that the industry grows along with us. Creativity thrives on competition and is propelled forward by an industry in ascent. Back in January, I talked about how it was time for the streaming model to be transformed, and I outlined some of those core principles that we would use to guide our work with platforms to have them become more artist-centric. Over the last few months, we have not been idle. Far from it. Our teams have been working diligently and creatively with our platform partners to turn these principles into reality. I'm pleased to tell you that along the way, we learned that many of the platforms actually share our desire to update the streaming model and thereby improve the music experience they provide to their subscribers. As we all know, in recent months, two significant developments grew in prominence in our industry, adding a sense of urgency to our efforts. These are the rise of generative AI and the proliferation of fraud. I'll have more to say about AI in a minute, but the nature of both of these developments further validated our concerns about streaming's content oversupply, as we call it, and what we saw as the diminished experience for fans. Today, I'm delighted to tell you that the transformation of streaming we have envisioned has begun. Any meaningful change to the streaming model must first and foremost address the fact that today, Music is undervalued. We've long believed that streaming monetization in both developed and emerging markets has significant upside. Therefore, we obviously welcome Spotify's announcement that they will increase prices in more than 50 territories, as well as YouTube's announcement that they have raised the price of their subscription music service in the U.S. But addressing average revenue per user, or ARPU, is just one component of the artist-centric approach. First, we must ensure that real artists with real fan bases are fairly rewarded for the platform engagement they drive. Second, that platforms need to apply stricter fraud detection and enforcement systems, removing incentives for bad actors and protecting streaming royalties for legitimate artists. This includes ensuring real artists don't have their royalties diluted by noise and other content that has no meaningful engagement whatsoever from music fans. And third, better aligning the relationship between artists and fans by promoting greater discovery and promotion of real artists. And on these three critical points, Spotify shares these concerns, and as part of our newly expanded agreement, they've committed to continue to work to address them. In addition, they will be collaborating with us on deep data analysis, formally taking part in this foundational piece of our expanding artist-centric initiative. To summarize, who are the winners under this new model? Simply real artists, by which I mean artists at all stages of their careers who are DIY, independent or major, who are real, actual human beings who have real, actual fans, who are the losers, those devoted to gaming the system, to committing fraud, and to flooding the platform with content that music fans do not want. There are many others in the music industry who share our firmly held principles about the value of artistry and the artist-fan relationship. I'm confident that the unique structures we've put in place and those we are working with on a number of other partners will bring those principles to life across the streaming world. Again, I want to stress our goal is a simple one. To promote an environment in which great music does not drown in a sea of noise, an environment in which fans can enjoy a more satisfying experience and creators of music content are more fairly compensated. Now let me turn to AI. On our last call, we talked at length about generative AI. Since then, speculation about the changes AI will bring to almost every aspect of our lives keeps growing. As a supporter of the human artistry campaign since its inception, UMG is working with the other 140 organizations in the creative industries to educate and support policymakers around the world about how to ensure AI is used at the service of creators. I also talked about the opportunities AI presents. We already employ AI in a variety of ways, identifying new audiences for our artists, optimizing the production, mixing, and mastering of recordings. and enhancing the quality of music experience, such as immersive sound. One example of how the responsible use of AI can support and enhance the creativity of our artists, labels, and songwriters is our first of its kind strategic relationship with Endel, an AI sound wellness company. As we recently announced under the agreement, a UMG artist using Endel's proprietary AI technology can create soundscapes from the artist's existing recordings to promote listeners' wellness, opening new commercial opportunities for our existing and growing catalog. And in April, we released a new track with our partners at HYBE from their artist, Midna. Using HYBE's proprietary technology and with the artist's collaboration and consent, the track was simultaneously released in six languages, Korean, English, Japanese, Chinese, Spanish, and Vietnamese, with the goal of offering music fans the opportunity to hear the K-pop track in their own local language. It was a fascinating example of how AI can be used to help music reach global audiences and use in exciting ways. And our legal and public policy teams are actively working to bring legal clarity to responsible AI. We want to drive smart, future-proof public policy solutions that protect artists' rights and enhance AI innovation. In fact, two weeks ago, our general counsel, Jeff Arleston, testified before the U.S. subcommittee on intellectual property. He told the senators that AI, and this is a quote, AI in the service of artists and creativity is a wonderful thing. That AI that uses, or worse yet, appropriates their work, or their name, image, likeness, or voice without authorization is not. We'll have announcements in the very near future about how AI can unlock other commercial and creative opportunities in our business. In short, we're optimistic about AI and see it as a powerful tool in the service of artists when deployed responsibly. Now let me turn to the third important strategic focus I want to say a few words about, and that is expanding our presence and accelerating our growth in those music markets around the world that we see as having great potential. We're approaching this goal in three different ways. Firstly, by signing and developing local artists just as we do in more developed music markets. Second, by partnering with local labels to produce them with global promotion, distribution, and a full suite of artist services. And thirdly, through M&A, that is the acquisition of local labels, catalog, and artist services businesses. Our most recent such transaction, announced at the end of last month, is in Thailand, where we've agreed to form a strategic partnership of which we'll own 70%. The transaction will instantly make UMG the second largest player in one of the world's fastest-growing music markets. and provide UMG with the scale to make an even greater impact in Thailand and outside of it as well. We're constantly on the lookout for similarly attractive M&A opportunities in high growth potential markets. And whenever and wherever such an opportunity makes financial and strategic sense, we will pursue it. Let me close by saying that we're obviously thrilled with our results this quarter. that our excitement doesn't end there. It extends to the great music we've got on the horizon, coming from every corner of the globe and to the long-term vision we have for both UMG and the industry. We're confident that the groundwork we are putting in place to drive strong subscription growth, to introduce new artists and genres to generations of new fans, to use artificial intelligence wisely, responsibly, and profitably, and grow our e-commerce and DTC business, and to expand our presence in high-growth markets, all our efforts will enable us to turn our long-term vision into reality for years to come. And with that, I'd like to turn over to Boyd to walk you through the financial results that we talked about just earlier in greater detail. Thank you. Over to you, Boyd.

Thank you, Lucien. As you heard Lucien touch upon, the second quarter has been another strong one for UMG. Revenue grew by 9% and adjusted EBITDA grew by 19% in constant currency. These results drove nearly two points of expansion in adjusted EBITDA margin to 21.9%. Even with the solid second quarter results and margin, we continue to encourage you to view the business over a longer term horizon, as there will always be variability quarter to quarter. We do not expect to add this much margin in every quarter, but we remain on plan to hit our margin guidance of over a point of adjusted EBITDA margin expansion in 2023. In terms of the difference between EBITDA and adjusted EBITDA, we had 85 million euros in non-cash share-based compensation expense for the quarter. Our EBITDA and adjusted EBITDA results also reflect 24 million euros of cash compensation savings in the quarter as we work towards our run rate of 100 million euros per year beginning in 2024. For the half year, revenue was up 9%, and adjusted EBITDA grew 16%, driving margin expansion of 1.3 percentage points to 21.6%. The first half had a total of €345 million in non-cash share-based compensation expense, compared with our guidance of €630 million for the year. And the first half saw €33 million of cash compensation savings in line with our 2023 guidance of between $60 million and $80 million in savings. Recorded music revenue grew 11% for the quarter and 10% for the half year. This revenue growth drove adjusted EBITDA up 16% for the first half and adjusted EBITDA margin expanded 1.1 percentage points to 24.2% in the half. The margin expansion is a result of operating leverage as well as the cash compensation saving associated with the equity plan. Looking further at recorded music, subscription revenue saw an accelerated level of growth, up 13% for the quarter. The uplift in the second quarter was a result of broad-based growth in subscribers across all major global platform partners, as well as price increases from certain platforms. This brings subscription growth to 11.6% for the half year. Ad-supported streaming revenue grew 5% in the second quarter. While we saw an improvement in trends at several partners and in certain countries, the results were not uniform and we believe it is too early to call a positive turnaround in the market. Ad-supported streaming was up 2% in the half and we are encouraged by the fact that our comps are easier in the back half of the year. Physical revenue grew 11% in the second quarter. again helped by strong CD sales in Japan from King and Prince, as well as growth in vinyl sales. Physical revenue was up 21% for the half. However, please note, physical revenue can fluctuate significantly with our release schedule. Licensing and other revenue grew 16% in the quarter, driven by neighboring rights, brand partnerships, and income from live events, and grew 13% for the first half of the year. Also important is that the growth was well distributed globally with the strongest growth in Asia and double digit growth in Latin America as well. As you can see here, major sellers were also well distributed geographically and included a mix of both newer and more established artists. Turning to music publishing, revenue declined slightly for the quarter. This was solely the result of a previously disclosed one-time item in the prior year quarter. As we've previously discussed, as part of our 2022 change in society accounting, we booked a catch-up of 98 million euros in Q2 2022 related to prior years. Excluding this impact, music publishing revenue grew 26% in the second quarter of 2023, thanks to a stronger than expected post-COVID recovery in performance revenue, as well as strong digital growth fueled by streaming and subscription. For the half year, music publishing revenue grew 5%, or 19%, excluding the impact of the one-time catch-up. Music publishing adjusted EBITDA grew 8% from the half, or 18%, excluding last year's €17 million benefit from the one-time accrual. Also excluding the accrual, music publishing adjusted EBITDA margin was flat at 24.3%. Turning now to merchandising. Merchandising revenue grew 12% in the quarter, with growth in direct-to-consumer revenue fueled by a strong performance from Taylor Swift, more than offsetting a decline in touring revenue. As a reminder, the prior year reflected outsized growth from the recovery of touring merch sales following the COVID shutdown. Merchandising revenue grew 6% for the half year, and adjusted EBITDA grew 43%. while margin expanded two percentage points to 7.6% due to the shift towards higher margin direct to consumer sales. Net profit for the first half of 2023 amounted to 625 million euros compared to 241 million euros in the first half of 2022. resulting in earnings per share of 34 euro cents compared to 13 euro cents in the first half of 2022. The increase in net profit in the first half of 2023 included an increase of 313 million euros in the valuation of investments in listed companies, compared to a decrease of 567 million euros in the first half of 2022. Net profit also reflects the €345 million equity plan expense in the first half of 2023. Adjusted net profit, which adjusts for the revaluation of these investments as well as for the equity expense, amongst other items, grew 14% to 754 million euros in the first half of 2023, resulting in adjusted earnings per share of 41 euro cents in the first half compared to 37 euro cents in the first half of last year. You'll notice that the adjusted net profit of €664 million and adjusted earnings per share of €0.37 for the first half of 2022 in today's press release differs from what we reported for these items last year. In compiling our year-end 2022 financials, we excluded from adjusted net profit the €89 million benefit from the two tax litigations settled and disclosed in the first half of 2022, which were one time in nature. At the full year, we determined it more appropriate to exclude these tax settlements from adjusted net profit, and today we are aligning our half-year reporting to how we reported the full year 2022. To be clear, there is no change in adjusted net profit or adjusted EPS for the full year 2022. In line with our commitment to pay a dividend of at least 50% of our net profits, the interim dividend for 2023 will be 437 million euros or 24 euro cents per share in line with 2022's interim dividend. I'd like to turn now to cash flow. Net cash provided by operating activities, forgive me, our net cash provided by operating activities before income taxes paid for the first half of 2023 was 703 million euros, up 16% year over year. This included net royalty advance payments of 95 million euros down 57% from 223 million euros in the first half of 2022 due to less major artist renewals and an increase in recruitment. Net cash provided by operating activities also included the 325 million euros we announced last quarter that we would pay in cash to settle employee tax liabilities arising from equity plan grants. Rather than issue more shares, we funded the taxes to lessen the dilutive impact of the grants. Please note that we also intend to settle the taxes on the equity grants that will rest in March of 2024. We now expect total dilution over five years to be less than 4%, as opposed to the 5% we have shareholder approval for. The strong net cash provided by operating activities before income tax paid allowed the company to continue to strategically invest in the long-term growth of the business. In the first half of 2023, strategic investments included the acquisition of a brand services company and a niche classical music label, among other items. These acquisitions were made at a blended trailing EBITDA multiple of 8.4 times. We also acquired a 50% stake in the entity that owns the iconic Capitol Records building in Hollywood, the home of our Capitol Records label and the world renowned Capitol Studios. We spent 89 million euros on catalog acquisitions, down from 264 million euros in the first half of 2022. Separately, we put 75 million euros cash into escrow for a catalogue acquisition, which will likely transfer out of other investment activities and into catalogue investment in 2024. While our name may get associated in the media with the acquisition of catalogues, we will continue to be incredibly selective when allocating our capital. and very large catalogue acquisitions are not a priority nor a necessity for us. Income taxes paid and net interest paid both grew year over year as the first half of 2022 benefited from previously disclosed tax settlements. Putting this all together, we had a net outflow for free cash flow of €13 million for the first half of 2023 compared to an inflow of 104 million euros in 2022. Remember that the second half of the year is consistently a stronger cash generating period for our business than the first half. We encourage you to look at free cash flow generation on a full year basis rather than for the half year, as working capital movements and the timing of investment can vary considerably during a shorter timeframe. Just before we go to Q&A, I wanted to remind you of a couple of items to remember in the back half of the year. First, a reminder that in the third quarter of 2022, we booked a settlement of a copyright infringement lawsuit with an internet service provider amounting to 71 million euros in revenue and 52 million in EBITDA in our recorded music business. In addition, recorded music EBITDA in the third quarter of 2022 was impacted by the timing of certain ANR expenses. While these expenses were not unusual for 2022 as a whole, in last year's third quarter, these ANR expenses were up nearly 40 million euros over the prior year due to timing. The last item I'd like to mention is that in the third quarter of 2023, we expect to book a catch-up adjustment of approximately 30 million euros in revenue related to the finalization of the Phono Records III determination from the Copyright Royalty Board, the CRB, which will be done as a one-time benefit to our music publishing business. And with that, Lucien, Michael Nash, and I will take your questions. Operator, please open the line for Q&A.