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									Maltby Capital Ltd Annual Review Year ended 31 March 2008


Contents Section 1 2 3 4 5 6 7 8 Appendix 1 2 3 Risk Management and Treasury Policies Contacts Directors Report and Consolidated Accounts 49 53 54 Introduction Chairman’s Letter Acquisition Background Market and Company Context Progress Report Financials - Overview EMI Music Publishing EMI Music Page 3 5 10 16 27 32 40 45




About this report This Annual Review is a report by Maltby Capital Limited (‘Maltby’) on its investment in EMI Group Limited (‘EMI’) and covers EMI’s performance for the financial year ended 31 March 2008. This covers the four and a half month period prior to the acquisition and the seven and a half month period post acquisition. The report aims to be open and transparent and to give a fair picture of EMI during the period. Maltby acquired EMI, one of the world’s leading independent music companies, on 17 August 2007. Maltby is owned by funds managed by Terra Firma 1 . EMI was de-listed from the London Stock Exchange on 18 September 2007 and on 4 October 2007 ceased to be a public limited company and became EMI Group Ltd. The statutory financial statements of Maltby cover the period post acquisition, and reflect the capital and financing structure since ownership by Terra Firma. To aid understanding and to provide a more meaningful comparison to the prior year, we have included results on a 12 month pro-forma basis together with a discussion of the 12 month results of the two operating divisions of EMI, EMI Music and EMI Music Publishing. In line with the Walker recommendations for private equity companies and their investments, we will be publishing an interim report later this year. This will cover the six-month period ended 30 September 2008 and will include the half year results with a discussion of strategy and outlook. Overview of EMI structure The Maltby Board oversees the EMI businesses, fulfils a corporate governance role and is consulted on key business decisions. Across the Group, EMI is organised into two core businesses: EMI Music, and EMI Music Publishing. These are operationally separate divisions with separate CEOs reporting in to the Maltby Board. Limited Group functions now reside in EMI Music. Music and Publishing Explained Music and Publishing have different drivers and business models. EMI Music Publishing signs songwriters and earns its income from acquiring and marketing the rights to their songs. After signing a songwriter, it
Terra Firma means Terra Firma Investments (GP) 2 Limited and Terra Firma Investments (GP) 3 Limited. Terra Firma raises funds from external investors, including pension funds, insurance companies, sovereign wealth funds and individuals from around the world


proactively markets their songs for a variety of uses - to be performed live, used in advertising or in a range of other ways. It earns revenue for each commercial use of these, passing a royalty to the songwriter. EMI Music signs recording artists, working with them to produce and then market their music. It earns revenue for each sale or use of a recording, passing a royalty to the artist. Both businesses have to seek out, manage and market musical talent; however, EMI Music carries the additional task of recording music and then selling units of the recording. Singer-songwriters frequently sign with one record label as a performer and with an unrelated music publisher as a songwriter - and EMI Music Publishing and EMI Music therefore often have to operate as independent businesses. The two divisions have delivered very different results. Most of the issues identified in this report relate to EMI Music, which faces a number of challenges. EMI Music Publishing, on the other hand, is an industry-leading business. It is anticipated that EMI Music Publishing’s organisation and strategy will require less change, while Maltby’s priority is to reshape EMI Music for success. Roger Faxon was appointed Chairman and CEO of EMI Music Publishing in March 2007, after previously holding posts as CFO, COO, co-CEO and President and continues in this post under the new shareholder. Since the period covered by this report (in September 2008), Elio Leoni-Sceti joined EMI Music as CEO.




Welcome to the first Maltby Annual Review. I am delighted to have this opportunity to communicate with our stakeholders. Readers turning to the financial section will see that continuing underperformance from EMI Music in the year to 31 March 2008 resulted in adjusted EBITDA of £164 million, down 5% on the previous year. A further £192 million charge arising from the re-valuation of balance sheet assets and liabilities, restructuring costs of £123 million, depreciation of £109 million and £520 million of net financing costs (and other items) resulted in Maltby reporting a substantial pro forma loss of £757 million after tax for the year, compared with a loss of £287 million in the previous year. This report puts this loss in context and explains the factors behind it in detail. By way of introduction, it is worth emphasising a few key points: The main factor behind the very large loss was continued operational poor performance, but more particularly accounting factors, in particular the revaluation of the balance sheet and the requirement to mark assets and liabilities to fair values. While interest charges will recur annually and we anticipate a restructuring charge in the next financial year, we do not expect to see other costs and charges recur at the same level. Operating performance for the full year continued to be poor and this reflected long-term weaknesses in EMI Music which we discuss in this report. EMI’s operational performance has improved significantly during the first seven and a half months of Maltby ownership and we expect the six months results ended 30 September 2008 to show year on year improvement. EMI now has a stronger balance sheet and team with which to start a new era. As Maltby’s Chairman, I would like to say at the outset that this report is not a typical company report. Listed company reports tend to minimise challenges and highlight successes in order to manage their reputations in the market place. Readers of this report, therefore, may well be struck by the forthright presentation of problems and the absence of rosy assurances about the future. I would like to explain why we have taken this approach. Firstly, this report has been designed primarily to look back over the challenging period of acquisition, the financial year 2007/8, so that readers


can clearly understand what happened. Later this year, the Interim report will set out EMI’s new strategy and plans for the future. Secondly, we have been open about the difficulties we have faced and still face, because it is vital that our investors understand the extent and nature of the challenge in EMI. Many turnarounds are primarily about strategic, financial or business change. EMI does indeed face such challenges - but beyond these customary issues, many of EMI’s problems have their origin in a culture and behaviours embedded not just in EMI but in much of the wider music industry. These factors in no way alter the fundamental rationale for investment in EMI but they will alter the time frame of the turnaround and will prompt more radical change. Backed by private equity, Maltby is not subject to the artificial constraints of public company reporting - constraints that we believe had a negative impact on EMI in the past. We are fortunate in having shareholders who take a longterm perspective, understand the market challenges and are prepared to give the business the breathing space to introduce the necessary change. However, there should be no false expectations. EMI cannot be turned around overnight. Thirdly, this report inevitably focuses on EMI Music, the better known of EMI’s two divisions, because this is the division where most of EMI’s problems originate. However, within EMI Music, there is a healthy catalogue business whose good performance has been obscured by problems in the rest of the division. It would be wrong, therefore, to conclude that the poor result in this report applies to the whole of EMI, when EMI Music Publishing is in fact an industry-leading business and the catalogue side of EMI Music is largely working well. Overall, therefore, this report does not signal any lack of confidence in EMI but sets out the problems faced during the year and how these were handled, taking time and investing the necessary resources. It is because we have scrutinised EMI in such great detail that we can have real confidence in EMI succeeding in achieving the task ahead. My own involvement with the company dates back to September 2007 when, after spending several years as an adviser to Terra Firma, leading the restructuring work for specific portfolio companies, I was asked to become Chairman of Maltby and to lead a dedicated team working on detailed research and analysis of EMI and its markets. This analysis was an absolutely vital step in the restructuring of EMI. From outside the company, it was by no means simple to understand what had tipped this outstanding brand, with its remarkable history, into decline. The company has a wonderful heritage with legendary recording artists like the Beatles and the Beach Boys signed to EMI Music and classic songs such as ‘Over The Rainbow’ and ‘Bohemian Rhapsody’ in the EMI Music Publishing Catalogue. More recently, EMI Music has signed talent like Norah Jones, Gorillaz, Robbie Williams, Kylie Minogue, Keith Urban and Katy Perry while


EMI Music Publishing has modern successes like songwriters such as Kanye West, Amy Winehouse and Norah Jones. EMI’s catalogues are rich and extremely valuable and it is home to many very creative, able and committed people. Why, then, was it looking for financial rescue? EMI - and much of the industry and its commentators – saw declining music industry fortunes as primarily a market issue. Falling CD sales and piracy had eroded revenues from its core product so quickly and so severely that the resulting losses could not be offset even by the continuing good performance of EMI Music Publishing. In its public statements, EMI highlighted piracy and a generally adverse market as the reasons for its difficulties, while its strategy was particularly focused on external solutions such as anti-piracy legislation or a merger. Whilst it was right for EMI to address these external market issues and to pursue legal or regulatory solutions, analysis quickly revealed that it had also failed to tackle equally important problems in its own business. It is not easy or palatable for any organisation, particularly a listed company, to critically and openly evaluate itself. The pressure on management teams to unveil strategic solutions at short notice – without really facing up to internal problems that may be the root cause of failing profitability - is intense. For outsiders with access to only published reports & accounts, many of which are opaque, the information necessary to get to the root causes of problems is often simply unavailable. By acquiring EMI and taking it private, we have had the time to understand those root causes; and the insight obtained has enabled us to establish a sound foundation for the Group’s new strategy. The market was, of course, a major factor in EMI’s recent decline. But close involvement with the company over the past year has exposed how internal factors within EMI Music had significantly eroded the Group’s profitability. Firstly, EMI Music had a culture where high expenditure at odds with the challenges it faced was widely accepted. This meant the company accepted as normal costs that should have been substantially cut back. Secondly, EMI Music’s traditional way of working with artists – highly successful in the days of booming CD sales and a significantly simpler and less fragmented market – had become less fit for purpose. As a result, EMI Music’s creative performance, as well as its financial performance, had begun to slide. Thirdly, the company’s internal reporting, while data-rich, focused on traditional measures which could tell the company little about the major changes in its market place as they evolved. It provided insufficient information for fundamental metrics – such as artist profitability.


These are some of the issues that lay behind EMI Music’s poor operating result, which, with the below-the-line charges discussed above, explain the very significant loss presented in this year’s report. We have dwelled on these historical issues to make the extent of the task ahead of us plain to our stakeholders. However, this in no way alters the fact of the substantial potential that can be released from EMI’s considerable assets over time. Indeed, we have already tackled many of the practices that lay behind EMI’s financial difficulties and have made significant progress against the restructuring goals set out at acquisition. In particular: We have got costs under control, and introduced compensation policies in line with general business norms. We are on track to achieve Year 1 target run-rate headcount cuts of 1,500 and headcount and other savings of between £85 million and £100 million. Further cost savings will be achieved, keeping us on track for our target of £200 million savings overall. We have put a new organisational structure in place, addressing the problems of geographical silos and promoting best practices and global cost saving and standardisation. We have introduced business discipline, ensuring that decisions are economically rational and that profitability and return on investment are front of mind. We have appointed a strong and talented new senior team in EMI Music. Individuals with experience in digital and consumer markets that EMI particularly lacked – and strong creative A&R track records – are already reshaping the company’s culture, introducing new dynamism and commercial rigour. The numbers presented here today tell you clearly that this is the first year in the radical turnaround of a company culture, a business model and perhaps even a market. It will not be a quick fix. Nevertheless, we expect to be in line with targets by the half year period. We are on track to address the company fundamentals and to reverse the decline in profitability even before we move ahead with a new strategy to address the music market today. We are in the process of taking EMI back to business basics: understanding customers, sourcing an excellent product, finding the right channels to market, and packaging and marketing music in an appealing way. These basics will take us a long way. Keeping close to today’s demanding customers, while thinking constantly of artist profitability, will concentrate EMI on finding outstanding new music, and fresh, imaginative ways of getting it to listeners. This is the only way we can succeed for our artists and all our stakeholders.


It will take t¡me to build a new EMI fully equipped to meet the radical cha¡lenges of a wholly new and different modern media and entertainment environment. However, we expect our first half results to demonstrate that EMI Music has begun its journey to recovery. The task of restoring this business's creative vibrancy and commercial vitality - while making even more of the Publishing business - is underway.

Lord Birt Chairman Maltby Capital Ltd.


Acquisition Background

This section covers the challenges that made EMI ripe for acquisition, the value underpinning the deal, and the further restructuring challenges uncovered once the deal was completed. The EMI Challenge The Terra Firma strategy is to invest in businesses that need transformation and its stock-in-trade is asset-rich companies whose management teams are failing to deliver value from those assets. In August 2007, EMI was, in many ways, a classic Terra Firma investment: cost-heavy, with value locked up in its assets; it was also operating in a market in transition. In other ways, however, EMI Music turned out to be uniquely challenging. Management information It took time to be able to see what was actually going on in the business. EMI’s monthly management report was the main internal tool for analysing the business. While data-rich, the report presented significant challenges in terms of understanding the true drivers of the business performance and drawing strategic conclusions for the future. Here and elsewhere, EMI used historic financial reporting metrics but had insufficient operating and management information to identify trends as they evolved. While divisional results for EMI Music and EMI Music Publishing were split out, detail was largely by country or region, discouraging the aggregation of data across the piece in a way that would enable strategic conclusions to be drawn. In particular, results from the New Music business which signs and records new artists were blended with the results from Catalogue, which markets work from artists who are no longer recording and older recordings of artists who continue to record either with EMI or other record companies. In fact, New Music was making substantial losses, but this was not apparent in the Management Report. In addition, while EMI did employ critical performance measures, such as artist profitability or return on investment, it did not do so globally and lacked important data it needed to conduct a proper analysis, such as comprehensive digital sales figures. In recent years and particularly in 2007, significant over-shipping of CDs distorted sales figures as insufficient provision was made for subsequent returns. This made it hard to see how EMI Music’s New Music market share was declining. Post-acquisition, consultants, including the accountants, KPMG, diligently returned to source data, separating out income streams to measure


profitability below the divisional level and to build an accurate picture of EMI’s business. EMI Music did gather and analyse substantial amounts of data and it did identify clearly the need to cut costs in the business. However, the new management’s analysis quickly led well beyond this to the conclusion that a large and critical part of the Music business was losing substantial amounts of money because its business model was fundamentally flawed. We extend sincere thanks to all of the teams involved in this work whose dedication has helped to establish EMI’s true position and enable the Group to move forward. Culture and Organisation EMI Music operated in a close-knit industry with strong shared traditions and values and ways of doing business. EMI itself had a strongly-rooted, traditional music industry culture and judged itself largely against the rest of the industry as well as accepting certain long-established practices that were no longer acceptable in a modern business outside of the music industry. In recent years, EMI Music found itself operating in a much harsher business environment than in the past, but its culture and behaviour had not changed substantially. EMI Music had, of course, made serious efforts to introduce change and improve the business, for instance by successfully implementing a series of cost-cutting initiatives. However, there remained a business culture with insufficient supervision and control where responsibility was delegated quite far down the organisation and it was not normal to benchmark rigorously against best practices and standards beyond the music industry. Similarly, new roles and policies did not achieve the level of radical change needed. The new management strongly believed that it was time for EMI to achieve that change and start to assess itself against wider best practices and standards. Introducing a different and more critical culture has been a significant challenge given the deep-rooted practices which prevailed in the business. In addition, EMI is a large and complex business, working in over 40 countries worldwide, with a strongly regional structure which made it harder to implement accepted global best practices of sharing and standardisation. Changing debt and equity markets The company was purchased on the cusp of a dramatic financial and global credit market change. Maltby Acquisitions Limited (‘Maltby Acquisitions’) agreed to acquire EMI at the very peak of a buoyant and bullish debt market. Almost immediately afterwards, the climate changed dramatically. As the first signs of the credit crunch began to manifest themselves, the market for leveraged buy-out debt dried up. It became impossible in these new market conditions for Maltby’s shareholders to syndicate part of their investment in


order to reduce their exposure to the target level of between 10% and 15%. As a result, acquisitions and investments which had been part of the plan for EMI were for a time made much more difficult. Value in EMI These challenges should not obscure the value in EMI. It is a remarkable company whose history is deeply interwoven with the history of the music industry. The EMI brand is recognised around the world. One of the world’s largest music companies, EMI was established in 1897 in London as The Gramophone Company. Within a few years its roster of artists included the sopranos Adelina Patti, Nellie Melba, Emma Calve and, most significantly, the Italian tenor Enrico Caruso, who is widely considered to have been one of the greatest tenors of the twentieth century. Before long, the company was operating across Europe, Russia and the Middle East as well as in Australia, India, China and parts of Africa. By 1906, less than 10 years after starting up, over 60% of the company’s revenues came from outside the UK. By 1914 The Gramophone Company was selling nearly four million records a year. In 1931 it merged with another major record company of the day, US-based Columbia Gramophone Company. The two became Electric and Musical Industries, or EMI as it quickly became known. Continuing to expand, by the 1950s EMI was releasing hits by the new star Elvis Presley, and in 1955 bought Capitol Records on the US west coast, acquiring an impressive roster of artists including Frank Sinatra, Nat King Cole, Peggy Lee, Dean Martin, Les Paul and Gene Vincent. EMI went from strength to strength, signing stars like Adam Faith, Shirley Bassey, Frankie Vaughan, Max Bygraves, Alma Cogan and Cliff Richard in the 1950s and the Beatles, Gerry and the Pacemakers, Cilla Black and the Beach Boys in the 1960s, when it also signed a deal with Tamla Motown, allowing it to distribute artists like Marvin Gaye, Stevie Wonder, Diana Ross and the Supremes and Smokey Robinson. By the 1970s EMI could rely on two out of every three Motown releases being a hit, an unheard of success ratio in the music business. In the late 1960s EMI established the Harvest label, dedicated to emerging progressive rock. By the early 1970s the Harvest roster included Deep Purple, Roy Harper, the Edgar Broughton Band, the Electric Light Orchestra, and the most influential and popular of all, Pink Floyd. In 1973 EMI released Pink Floyd’s all-time chart-topper album, ‘Dark Side of the Moon’. In 1975 Queen was signed to EMI and in 1977, the Rolling Stones. In 1979 EMI bought US record label Liberty/United Artists which owned Blue Note Records, the most famous and influential label name ever in jazz music and brought EMI legendary musicians like Miles Davis. As the 1980s opened, the music industry began to feel the winds of change that persist today. Heavy metal emerged and EMI signed, among others, Iron Maiden. CDs were born, and EMI acquired a 50% stake in Chrysalis Records.


Through the 1990s a series of deals, including the acquisition of Virgin Group, transformed EMI, which continued to sign highly successful artists like the Spice Girls and Blur. At the start of the 21st century, EMI was still a powerful force in the music industry, with a roster of artists and songs that few could parallel. Recent Events EMI today still retains two world-class assets. Its stable and profitable Music Publishing division regularly tops the awards list with its roster of talented songwriters. EMI Music, meanwhile, is a storehouse of musical value with one of the strongest recorded music catalogues of any music company. Music Publishing and the Music Catalogue division today represent the majority of the value of EMI. Despite these great assets, by 2007 EMI was in poor financial shape, with a history of declining profitability over the previous five years. EMI
£ million Revenue Operating profits before exceptional items Operating profit / (loss) 2003 2,175 212 401 2004 2,121 198 43 2005 2,001 177 161 2006 2,080 201 206 2007 1,752 98 (157) 2008 1,458 (135) (258)

Source: 2003-7 figures taken from 2007 Annual EMI Group PLC Exceptional item in 2008 represents the cost of restructuring

EMI’s adjusted revenue shows a small overall decline of 4% over the four years ended March 2006, with a more pronounced decline of 16% occurring in the year ended March 2007. EMI Music’s revenues over the same period showed the same trends, with a 19% decline in the year ended March 2007. EMI operating profit before exceptional items was also relatively steady over the same earlier period, with a significant decline of 51% in the year ended March 2007. However, reported operating profit after exceptional items was volatile over the period, reflecting not only the natural volatility of EMI New Music but also changes including exiting from joint ventures, the move from owning to leasing property and the outsourcing of non-core businesses. In addition, EMI had introduced a number of restructuring programmes over the five-year period in an attempt to reduce the cost base as sales fell. A charge of £242 million was taken in the year ended March 2002; a further £138 million charge in the year ended 2004, and a major restructuring programme was announced in January 2007, resulting in a charge of £306 million in the year ended March 2007. In February 2007, EMI revised its expectations for the year downwards and bid speculation began to surround the company. In April, it cut its dividend, pending completion of its restructuring programme, and in May, preliminary


results for the year showed operating profit or EBITDA falling by nearly 40%, while in EMI Music this figure fell 68.2%. In summary, the last five years have seen EMI incur substantial restructuring costs in an attempt to mitigate the impact of falling revenues. Despite these efforts, performance did not improve. In recent years, the company also pursued a merger with Warner. From the outside, EMI was a great brand with world-class assets whose strategy had failed. This report will detail the reasons for that failure, but particular factors are worth noting here. EMI Music had a history of signing great artists but had not adapted sufficiently to the changing consumer market for music. Additionally, it had grown through acquisition and deals into a sprawling organisation with a culture that in many ways had not been brought into line with current business practice. It was unsurprising, therefore, that prospective buyers could see the significant potential for transforming the business into a professionally-run, modern music services organisation. Given the asset underpinning of the strong Music Publishing business, the world-class catalogue, the potential recovery in Music and an excellent debt package, EMI represented a superb opportunity. Turnaround situation in EMI Music At the time of purchase it was clear that EMI Music needed to be turned around. As the initial teams assembled and analysed the necessary numbers and got to grips with the organisation and the culture, the scale of the challenge became clear. Like the whole recorded music industry, EMI Music was in a declining market, where physical CD sales were falling fast and digital music sales were growing considerably more slowly. At acquisition, Terra Firma forecast a 15.1% decline in physical sales and a 51.0% growth in digital for the financial year 2008 giving an overall decline of 7.4%. In reality, the physical decline for the calendar year 2008 was 13.4% and digital growth was 29.0% giving an overall decline of 7.9%, very close to original estimates. Addressing this changing environment would be a critical task for the new team. In fact, EMI Music was also losing market share against this falling market, but during 2007 over-shipping (over-selling CDs and taking back returns later) meant that this was not immediately apparent. Despite its challenges, we saw - and still see - substantial potential in EMI Music and are well into the turnaround of the company. It is a remarkable brand and the home not only of great music but of considerable talent, energy


and dedication. The right leadership team, with the right strategy, can harness that talent and unlock the potential in EMI Music’s assets, releasing real value. Meanwhile, EMI Music Publishing was a steady and growing business, which had produced reliable results, signing top songwriters and working with them to achieve creative and commercial success. Almost all its artists were profitable, as well as hugely talented. EMI Music Publishing had also adapted well to its changing market place, migrating away from traditional income streams such as CD sales to build new and important sources of revenue, for instance from licensing music to TV, for advertising or for computer games. At the same time, it continued to top the industry award lists. At acquisition, this business needed to work its assets harder but was already on the right road, with a fit-for-purpose strategy. EMI will not be transformed overnight. EMI Music – which is responsible for the company’s recent ills, is in recovery, but this will take time. However, we expect the progress already achieved to continue. In private ownership, EMI Music’s new management will have the time to make the major changes it needs to make, without the pressure of delivering short–term results. We are confident that the whole of EMI can deliver value for its customers, for its artists, for its shareholders and for its many wider stakeholders over time.



Market and Company Context

This section looks at the key factors driving the performance of the Group. It looks in detail at the EMI Music business model, briefly covers EMI Music Publishing and then covers general governance and control issues. EMI Music New Music and Catalogue EMI Music’s poor performance was not only due to external factors like the declining market for physical CDs and the growing problem of piracy. Once the teams working post-acquisition separated out the results from different parts of EMI Music, it became clear that many of the problems originated with the business model in the New Music area of the business. EMI Music can be considered to comprise two distinct activities. The New Music business finds and develops new artists, working with them to market and sell their music. (Manufacturing was fully outsourced by the end of 2005 and distribution is increasingly being carried out by third parties.) This is a highly volatile business which depends for its success on the challenging task of picking artists who have commercial potential and then investing appropriately in them to achieve that potential in a way that profits both EMI and the artist. The Catalogue business markets work from past artists and the past work of current artists, packaging and marketing music already in EMI Music’s stable. Like EMI Music Publishing, Catalogue is a relatively steady business, marketing music whose appeal has been established and little further investment is required. For instance, it can package existing music in compilations. New Music is more like a venture capital business, often investing large sums of money in the risky process of picking artists, producing and marketing their work in the hope of eventually recouping the investment through sales, while Catalogue is an income business with relatively low risks. Because EMI Music blended the results of these activities together, the real performance of each was not visible. As light was shed on the separate results of these two activities, it became clear that Catalogue was masking substantial losses in the New Music side of the business. In the year ended March 2008, our analysis indicates that New Music revenue fell 40% and estimated losses rose to around £125 million. In fact, New Music had been underperforming for some time. The reasons for its deteriorating performance are set out below.


Changing Market Conditions Market conditions were undeniably challenging during this period. The music industry was facing dramatic falls in CD sales, due to the following factors in particular. Firstly, piracy had a substantial impact on sales. Industry sources such as the International Federation of the Phonographic Industry (IFPI) have argued that illegal downloads outnumber legal sales online by a factor of 20 to 1 and that billions of dollars have been lost to piracy. However, the impact of piracy is complex and some have argued that pirated tracks consumed cannot be proven to equate directly to lost sales (people who cannot afford to buy CDs may pirate them) and that pirating may sometimes promote consumption by helping to create a reputation for music. There is also evidence that people who pirate music buy more music than some other consumer groups. What is clear, however, is that the early impact of illegal downloading on CD sales was significant and that piracy has made retailers significantly more price sensitive, contributing to the general transformation of the industry. Secondly, the shift to digital resulted not only in lower physical CD sales and in piracy but also in a significant change in general consumer attitudes to music. Market research conducted in the US in 2006 showed that more than 73% of people believed music downloads should be free. The wider availability of free music through digital channels made sampling and downloading free a common practice and consumers in general began buying less and expecting to pay less when they did buy. The possibility of buying individual album tracks rather than having to purchase a whole album also decreased overall spend. At the same time, consumers began to be more discriminating about price and less prepared to pay for average products. Today, only outstanding product can command a premium price. Thirdly, there were important changes to the retail market. Previously, CD sales were often through specialist music retailers, but this has changed as these retailers have faced competition from general retailers like supermarkets. These retailers either typically have less dedicated shelf space or have music competing with other entertainment products for shelf space. Our recent research shows that good products still sell (even to customers who were prepared to pirate more average music) but the average CD could no longer command the same price. Finally, as the market fragmented and traditional channels to market were eroded, it became harder for most consumers to discover the music they wanted. In the past, there were only a few well-known ways of discovering music, such as the mainstream radio or TV programmes that promoted new releases, but the emergence of many and diverse ways to listen to and buy music left traditional consumers confused and deterred them from purchasing. All these factors have had a significant impact on music industry sales.


Our research shows that the number of physical music tracks sold in the major music markets fell from 12 billion in 2004 to 8.7 billion in 2007. During the same period, digital sales grew from 259 million to 1.9 billion, not enough to offset the physical decline. Unpaid file sharing increased from 3.5 billion to 10.8 billion in the period, while the number of tracks ripped from CDs by friends and family increased from 1.3 billion to just over 5 billion. In 2007, global music sales dropped 8% to $19.4 billion, their lowest level in the last 10 years, according to a report from the IFPI published in June 2008. Revenue dropped to the levels of 1997, the first year for which the body issued figures. Physical sales of CDs and DVDs fell 13% to $15.9 billion. An increase in digital content sales failed to make up for the decline in CD sales and the effects of piracy. Overall, while there has been a significant increase in the unpaid consumption of music, paid consumption of music through the traditional channels has declined sharply. EMI Music Relative to Market However, EMI Music’s poor performance was not just due to what was happening in the market. The division - and essentially New Music – began to under-perform the market a few years ago. During the years 2005-7, EMI Music’s revenue from New Music fell by 36% when the market fell by an average of 23%. In 2006, its market share dropped down to 12.8% from 13.6% in 2005 and Warner overtook EMI Music with global market share of 13.8% as the third largest music company behind Universal and Sony BMG. By March 2007, EMI Music’s market share of physical recorded music sales had dropped to 11.9% and at the time of the acquisition, the Group reported a 19.8% fall in CD-based sales for the three months to June 2007 alone. Again, EMI Music was underperforming the market: its sales of physical CDs between 2005 and 2007 fell 45% versus a 19% average market decline. However, over-shipping of CDs meant that this relative decline was not initially apparent. Our analysis over the first six months of ownership has shown that this decline relative to the market was due to a number of factors, which we set out below. Considerable work was needed to get this level of information, which was only validated as a result of our detailed investigation into the business. Digital Strategy EMI Music reported only limited focus on the growing digital market before 2004, when its annual report noted that 2003 was the year that legitimate digital music took off, with the launch of the iTunes music store. During the year, the Group generated only around £15 million of digital sales, against a total turnover for the year of over £2 billion. By 2007, Group digital revenue


was reported to have grown to reach £164 million, 9.4% of total revenue. Research conducted post-acquisition, however, showed that despite this improvement EMI Music’s digital sales had grown more slowly than the digital market: only 115% between 2005 and 2007 against market growth in the same period of 148%. At the time of acquisition its digital organisation was limited: a strategic group disconnected from the main technology workforce across the company. While EMI Music concluded an important deal with iTunes and Google in 2007, it still lacked any relationship with the social networking sites that were becoming an important route to market. EMI Music has not yet fully digitised more than a moderate percentage of its catalogue. Indeed, even today, only around 3035% of the part of the catalogue in CD format is available for downloading – and much is not even in CD form. Physical Sales and Consumers At the same time, EMI Music was not maintaining its share of physical sales. Unable consistently to develop an excellent product and package and market it effectively to emerging customer segments, it lost traction and was unable to command the prices and margins it had enjoyed in the past. One of the reasons EMI Music was losing customers was that it had limited information on the changing tastes and buying behaviour of customers, particularly those buying through new digital channels. The division did gather data on individual releases but research was unsystematic and was not used to inform future repertoire or marketing decisions. EMI Music consequently lost touch with a customer base that had undergone significant change as the digital revolution gathered pace and the market fragmented. Research conducted since the acquisition of EMI shows that a number of clear customer segments have emerged in recent years, each of which has a distinctive buying behaviour. This research indicates that persuading these groups of customers, many of whom are at least partly disaffected, requires marketing individually to each segment, something EMI Music was not set up to do. Meanwhile, recent years have seen the emergence of new wholesale music customers, such as Tesco, and global customers like Nokia or Apple, who are best served by global marketing. However, EMI Music had a primarily regional structure. This could lead to duplication of research and marketing efforts across regions and did not provide motivation to individual geographies to put global EMI marketing priorities ahead of local objectives. Artist and Repertoire (A&R) – Discovery A&R is the “engine room” of New Music, finding and developing new artists. However, at acquisition, it had for some time been failing to drive EMI Music


forward. An important measure of success for A&R is the number of hit releases it achieves. Between 2004 and 2007, EMI Music’s share of new releases within the top 200 albums by volume fell 40% in the US and 32% in the UK. The origins of this decline go back further, as the pipeline of new music is long and takes time to feed through from signing to release. This suggests worsening A&R performance over a five-year period. Postacquisition research has linked this to a lack of commercial focus, the failure of cross-business collaboration in EMI Music and generally poor selection decisions and A&R processes. An underlying factor is likely to have been the process used to assess business decisions such as signing a new artist. Creative concerns were frequently given more weight than the underlying economic rationale. While a formal business case was officially required, in practice decisions were made more informally and this led to mistakes being made about artists’ commercial potential. While creativity can and should be profitable – as the success of the recent Coldplay album shows - by the time of the acquisition EMI Music had signed and was supporting many artists who showed no sign of delivering a return to EMI. Artist Profitability Unsurprisingly therefore, the overall profitability of signed EMI Music artists was poor and compared unfavourably to the far more consistently successful Publishing division. Recent analysis revealed that a small number of EMI Music artists were producing half of the division’s (positive) profit and of all the currently performing artists on its roster, 88% made a loss for EMI Music. This poor profitability was at least partly due to its high production and marketing costs, set at a generous estimate of likely sales. A typical marketing and promotion spend on a developing artist in the UK was £98,000 which represented, on average, 81% of sales. In addition, much of the marketing and promotional spend associated with a release was focused on traditional mainstream or mass-market channels, which yielded diminishing returns in a fragmenting market. And, at the same time, the business was spending excessively on top-end production that in many cases had no measurable impact on customer perception of quality. One reason for the widespread underperformance of artists was that EMI Music generally measured success in terms of physical units sold rather than profits and when it did look at profitability by artist, did not have sufficiently good quality or comprehensive data to do this effectively. For this reason, the division was slow to recognise the substantial business risk that its roster of artists had come to represent.


Artist Contract and Advances The artist contract has acted as another bar to progress for EMI Music. Particularly in the UK and US, in line with the industry, the business traditionally offered advances well above the level it was able to recoup from sales – advances in the UK could represent several hundred percent of actual sales. For a majority of artists this large advance relative to sales means that artists earn most of their money upfront and little from the subsequent royalties. This structure, while generally accepted, does not motivate them to help drive sales through promotional activity, for instance, and so to help their recording company recover its investment. Furthermore, the music industry norm is that artists receive royalties based on revenue and not profit and so do not share the responsibility for controlling marketing and promotional costs. Catalogue Assets The catalogue business has a better track record, representing over 100% of EMI Music earnings before interest, tax and depreciation (EBITDA) in the financial year to March 2007. As the music and artists have already been established, the costs of repertoire creation, marketing and promotion are relatively low and yield significantly higher margins. However, EMI Music could do more to exploit the full potential of catalogue. For audio assets, the top 250 artists today represent more than 75% of sales, leaving a long tail that is under-utilised. More importantly, EMI Music has not made the most of its top 250 artists. Catalogue sales of these artists varies widely: while EMI Music has successfully worked with some artists so that their new releases also trigger sales of their catalogue work, with other artists it has much weaker working relationships and has only driven limited sales. In summary, the business model in the New Music part of EMI Music was fundamentally flawed and Catalogue had not reached its full potential. This explains the underperformance reported in Section 8 below, but also indicates the substantial opportunity for turning around the business. EMI Music Publishing As the music market changed over the last decade, EMI Music Publishing faced some of the same market issues as EMI Music. Traditionally, most of its income arose from the sale of CDs on which its songwriters featured, but the declining CD market has sharply reduced available revenues from this source. Across the music publishing industry, these revenues have fallen; in EMI Music Publishing’s case from nearly 60% of its total income in the year to March 1998 to under 40% in the year to March 2008. This trend is set to continue. However, Music Publishing has succeeded in growing its overall revenue levels, despite this shift. Stable, underlying growth in revenue from


Performance (royalties paid each time a song is performed live) and Licensing and Synch (royalties paid when a song is used in a visual medium like TV or film) have more than compensated for the decline in income from CD or other unit sales. Music Publishing has actively pursued a strategy of diversifying away from traditional sources of income. At the same time, the business has substantially cut costs and has a cost base in line with its revenues. At the same time, the business has continued to sign top songwriters, and to lead award tables, indicating a healthy creative function. Music Publishing can and must continue to work its assets harder and even more creatively, releasing more and more diverse income from the rights to songs. However, management has been vigorous in pursuing a more proactive approach, and as a result this is a sound business that needs only modest recalibration to be even more successful.


Governance and Control This section looks at the ways in which the Group’s (primarily EMI Music’s) management systems and processes, business practices and culture affected its performance. The acquisition in August 2007 revealed that despite having dedicated people and pockets of real excellence throughout the division, EMI Music lacked business discipline and effective leadership. We identify below some areas that particularly needed to be addressed. Decision making EMI Music’s Capital and Special Expenditures (CSE) Committee made many of the company’s important contractual decisions – such as decisions to sign artists or digital, distribution or licensing deals. The CSE process was sound but was not consistently applied. Proposal quality was variable and proposals often reached the CSE Committee when a verbal commitment had already been given to an artist or other counterparty, which influenced the impartiality of the decision. The proposal review process itself did require assessment against metrics such as internal rate of return, but its application lacked rigour and documentation supporting decisions was not adequate. Management Information and Analysis We noted earlier that the EMI Management Report, while data rich, did not cut its data in a way that supported strategic analysis. This point can be reinforced in a governance context. While EMI had the usual financial reporting systems by division and territory, and plenty of data on the regions and on physical product, it had very little information on the areas of future growth such as digital, licensing and synch and B2B opportunities. Its analysis therefore focused on the historical business and not on the future, where it lacked the operational and management information that would have allowed global management to identify and respond to risks. There was also insufficient information to be able to get an accurate picture of how unprofitable to EMI many individual artists were. Salaries Much of the £200 million of cost cuts identified at acquisition and to be achieved over the initial period of restructuring relate to the salary bill. EMI Music showed a gross profit for the year to March 2008 of £355 million (a margin of 34%), eroded by £297 million of overheads (primarily salaries) to give an EBITDA of £58 million (just under 6% of sales).


Music industry senior executive salaries have traditionally exceeded norms in the wider media, telecommunications and entertainment industry and EMI Music was no exception. EMI Music executive salaries were historically very high, with some individual executives being paid at the very top of their peer group in UK companies. At the same time, contracts at EMI Music were often fixed over unusually long periods and guaranteed its executives generous benefits. Notwithstanding this fact, EMI did not disclose to Maltby Acquisitions a number of the contracts of the most highly paid executives during the due diligence process. This was despite the fact that the amounts payable under the contracts would have a material impact on the cost of any future changes to the organisation and that, in some instances, changes to these contracts were negotiated and executed following the launch of the Terra Firma offer. EMI Music paid some functional roles salaries at double market rates or more, while paying more junior staff closer to average salaries. At the same time, EMI Music was overstaffed at these junior levels and lacked suitably qualified middle management. Employment Policies Many policies in EMI Music varied by region and by business. Employment policies were not standardised and many did not support business goals. The division had at least 40 different incentive schemes, meaning there was no clarity about business priorities. Incentives were not tied to the overall business performance as a minimum requirement but were disaggregated to local targets, usually set for a year only. As a result, people became territorial, focused on short term objectives rather than long term value. The absence of any consistent performance management system meant that there was also no accepted way of measuring achievements against objectives. Duplication, Lack of Standardisation EMI Music’s complex global structure resulted in considerable duplication, lack of standardization and failure to share best practice. In particular, organisation around various different labels led to considerable replication of marketing and other costs across the Group. Elsewhere, the company had taken the decision to abolish its global procurement function, resulting in the use of multiple suppliers – as many as 10,000 were in use in the UK. EMI Music also lacked central or standard systems for holding data. Staff data, for instance, was not centralised and in the absence of formal global policies for recruiting or determining salaries, these were agreed on a local or ad hoc basis. One of the challenges of restructuring was the absence of any overview of EMI Music people; the company had no consolidated global headcount or payroll database.


Delegated Responsibilities While much less significant in P&L terms, other elements of corporate overhead vitally had to be addressed if EMI Music was to be taken forward. In particular, the company had delegated responsibility for signing expenses and invoices down further than the new management considered appropriate for retaining control. This downward delegation reflected an exceptionally liberal approach to cost control, which pervaded the company. While there were appropriate policies, they were not consistently applied. In particular, EMI operated in an industry in which generous spending on hospitality, travel and similar expenses were considered normal. In EMI Music, this type of cost was not closely monitored and employees were not encouraged to feel accountable. The approach to travel and expense policies was more than generous. Recent investigation showed EMI Music to be the fourth largest spender on a wellknown taxi firm in London, with a bill of over £700,000 in the last year. This was only slightly less than the bills of 3 investment banks, with 8-10 times more staff than EMI Music. Reporting Practices There were two areas where EMI Music’s policy made it particularly hard to view the underlying trends in the business: accounting for returns and the accounting for artist advances. Returns Forecasting sales from a new release is difficult. To ensure supply meets demand, the music industry has an agreement with retailers to ship product at the top end of the forecast sales range and then take back any unsold product. A provision is normally made for returns to try to true up revenues. Returns in EMI Music over the last few years fluctuated considerably – averaging around 20% in the financial years ending March 2007 and 2008. However, sales noticeably trended higher in the period leading up to each half year and full year results, causing sales in the subsequent periods to be depressed by returns. When the market for physical CDs worsened in Q1 2007/08, the gap between sales and actual sales net of returns widened significantly. In April and May 2007, returns of close to 50% of gross sales in the month were recorded. However, EMI did not change the shipping policy. In EMI, the provision for returns was based on a weighted average historical return rate. However, at times when returns were above average, this rate proved inadequate. Whilst EMI Music raised its provision for returns to


acknowledge the trend to higher returns there was still a considerable gap between reported and actual sales. Had EMI taken a one-off hit to end this rolling practice and take over-reported sales off the P&L, it would have had a negative impact on EBITDA of at least £14 million, the amount of the provision for returns made by EMI in August 2007 and relating to sales up to March 2007. Advances When paying substantial advances to established artists such as superstars, EMI Music anticipated recouping these and held them as receivables on the balance sheet. Periodically, if these advances were not in fact recouped through sales, EMI Music wrote them down and applied a related charge to the P&L. Over the last few years, such large write-downs of artist’s advances were included as part of the reported exceptional items, even though the fact that most artists were unprofitable meant that such charges occurred regularly. Because these provisions did not affect reported underlying earnings, there was little to discourage the practice of overpaying established artists. Once the new management separated out the figures for New Music and was able to see how unprofitable artists were, it became clear that writing down artists’ advances was by no means an exceptional occurrence but was in fact normal in this naturally volatile business in a declining market. Indeed, the concept of ‘underlying earnings’ makes little sense in this context. Summary The factors behind EMI’s operational performance during the financial year to March 2008 arose primarily in EMI Music. This division faced the immediate and evident problem of declining sales, but beyond that the new management identified a range of more complex and relatively intractable long term problems: a cost structure that was not aligned to revenue levels, a business model that needed updating and an organisational culture that was insufficiently focused on shareholder value. EMI Music Publishing, meanwhile, delivered solid results and has pursued a policy of aggressive and creative exploitation of its assets. By continuing with this policy and working its assets harder, the division can achieve still more.



Progress Report

This section covers the key changes made since the change of ownership, both the reshaping of the organisation and the teams, the introduction of more rigorous processes and structures, and cost cutting measures. Top Team A vital first step in the transformation process was addressing the management and culture of EMI Music, and we have taken important steps towards this goal. The old management has now been replaced with a new team, which includes some excellent new hires as well as the best talent and experience from the past. Only by doing this was it possible to tackle cultural habits and behaviours being driven from the top. Since the period covered by this report, we have recruited the new CEO, Elio Leoni-Sceti (who joined in September 2008), Douglas Merrill from Google, Nick Gatfield from Universal and Billy Mann, founder of independent music development company, Stealth Entertainment. We have also promoted longstanding and valued EMI Music executives such as Ronn Werre, Chris Kennedy, Colin Finkelstein and Adrian Cheesley to work alongside us on the turnaround. Their experience has been vital in maintaining continuity in key areas. Headcount, Remuneration and Organisational Change Cutting headcount and reshaping EMI Music’s approach to recruitment and pay have been priorities for the new team. The replacement of some senior executives has cut the salary bill but also enabled change by bringing in fresh perspectives from outside the music industry and providing scope for a change in strategy. EMI Music has also been implementing central systems such as a global HR database which it previously lacked and standardising employment contracts across the company. New policies and standards are being drawn up, based on best practices from a range of relevant consumer and entertainment businesses. An overall remuneration review is currently taking place and includes external benchmarking of packages to ensure EMI Music pay is in line with the wider Media and FMCG sectors. A target of approximately 1,500 job losses was identified during the postacquisition period. This has been achieved through natural wastage, redundancies and outsourcing, where this is suitable. In addition, salaries are being brought into line with market norms.


Over the last year, a matrix organisation has been put in place, so that key functions like marketing work globally and professionally. This global rather than regional focus is already bringing benefits, for instance by making it possible to market albums globally. More widely it will help to cut duplication and promote knowledge-sharing and best practice. Already, individual country teams are making decisions that make commercial sense for the whole of EMI Music, not just for their region. The matrix organisation still needs to be implemented at lower levels in the organisation. However, with the top layers in place we are effectively recruiting people to functional as well as geographic reporting lines. Music has been streamlined in other ways. The considerable duplication of resources around labels has been addressed by taking out and centralising the functional support previously replicated in each label. In addition, over the last 6 months EMI Music has invested in digital staff, right-sized IT, reestablished central procurement (appointing a Global Head of Procurement) and is outsourcing much of the Finance function. Worldwide, EMI Music has been looking at its organisation and resources, and reviewing the number and location of its offices. While it is early days, some moves have already been made to replace physical operations in a territory with licensing agreements, whereby EMI Music distributes through a third party. This has been put in place notably in some South East Asian markets and the company’s joint venture in China has also been sold. Reporting As EMI has shifted from a geographical to a matrix organisation, so it too has begun to migrate from its historical reporting approach, which was also largely geographical. We have begun to put in place approaches and processes which are refocusing EMI to gather and interpret functional and strategic information, rather than just market data. This is a laborious process as all the existing systems for data collection and reporting need to be reviewed and new systems put into place. For instance, going forward, EMI needs to collect comprehensive information on digital sales, something it did not do before. It also needs regular information on artist profitability and on the pipeline of artists being signed. By doing this, we will ensure EMI is monitoring key trends in its business and the market. Employment Policies All EMI Music employment policies are under review, with benchmarking underway. Training and development will be an important component of the new approach, with compulsory management development and leadership programs. As part of the restructuring process, skills and knowledge gaps in the business have been identified and are being addressed. During the restructuring, it undertook a rigorous assessment of talent, involving


interviewing and assessing around 1,000 staff. This will enable the company to retain key people and identify areas where it needs to recruit more. HR is now working with the Board to ensure more rigorous long term processes are in place for assessing employees and acquiring key business skills that match EMI’s needs. The recent restructuring has streamlined processes and management layers, making it possible to promote talented people from lower down the organisation. EMI Music now plans to build on this by putting in place an effective system for managing performance and remunerating its people. Cultural and Business Practice Change EMI Music has also begun the slower and more difficult process of changing its culture. With a largely new management team, including Elio Leoni-Sceti, the new CEO who started in September, this business is starting to feel and behave differently. In particular, treating Catalogue and Music as stand-alone segments within Recorded Music will encourage more transparent and accountable behaviour, and will give staff more motivation to take responsibility for their business. Business practices that focused EMI Music on short term financial reporting goals are being actively discouraged. In particular, the company has now radically cut over-shipping of CDs, a practice which was distorting sales figures at quarter ends and resulting in substantial returns of CDs later down the line. CD return rates as a percentage of sales have been substantially reduced. Costs EMI Music’s cost base is being brought into line with its revenues. At acquisition, we set a target cost reduction of £200 million, of which £120 million was fixed and £80 million variable costs. This target was against an addressable spend of around £700 million. We are on track to achieve these planned cuts. As noted above, the first year since acquisition (August 2007-8) is expected to yield a run rate saving of £85-100 million. This has been achieved through job cuts, property savings and improved cost control processes. Some of the headcount savings will take time to flow through and will be fully realised by June 2009. As we go forward, we intend to achieve further savings of up to £100 million through streamlining the organisation and its processes, better procurement and tight control of EMI Music M&P and repertoire creation costs. These improvements alone will make EMI Music significantly more profitable.


Decision-Making New systems and processes will ensure that investment decisions are supported by robust analysis and that the profitability of individual artists can be measured in full. In future, EMI Music will have a culture which more closely monitors the renegotiation of contracts, where accounting policies will be clear and helpful and where decisions are rigorously evaluated on the basis of underlying data. EMI Music has now undertaken a thorough reform of the CSE, introducing financial rigour to the decision-making process and ensuring compliance with the agreed process. A new emphasis on return on equity has led to the recruitment of a Chief Investment Officer supported by a team of finance professionals who evaluate expenditure and review any major deals. There has been significant tightening of delegated authorities: the process for signing off expenses and invoices has been brought under management control. Corporate Governance framework We have made a number of major changes to address the governance issues identified above, and a fuller review is still ongoing. The arrival of a new CEO of Music and confirmation of the CEO of Music Publishing means Maltby will increasingly be able to step back from its deep involvement in the business and establish the necessary governance structures. Already, Maltby has established a governance structure for EMI, setting the strategy for the two operating divisions. It also reviews and authorises key strategic and material decisions. This is formalised through three Committees of the Board with delegated authority – the Audit Committee, the Finance Committee and the Remuneration Committee - which elicit regular reports from the CEOs of EMI Music and EMI Music Publishing and in turn report regularly to the Maltby Board. The Audit Committee defines accounting policies, assures compliance with accounting and regulatory frameworks and sets the overall control framework for the organisation. The Remuneration Committee sets the compensation framework for the organisation overall and particularly the packages and employment terms of senior executives. It determines targets for any performance-related incentives, ensures the administration of any other remuneration arrangements for employees and reviews major changes in Group employee benefit structures. It also approves the participation of individuals in the longterm incentive plan (LTIP).


The Finance Committee makes key business decisions regarding the commitment of the company’s resources, including the renewal of certain contracts. The new management recognises that this structure itself, like all governance structures, is not sufficient to prevent abuses and that the key to future good practice is transparency, excellent communication and a vigilant and principled management. The Board of Maltby will therefore undertake to ensure a culture of integrity is driven through the organisation. Accounting Policies In addition, there has been a thorough review of EMI’s accounting policies, undertaken by the Group’s new external auditors, KPMG. The internal report has been reviewed and actions taken to address all issues identified. The business will continue to implement recommendations from the review but have already made substantial changes over the last year. Summary In summary, while it is early days in terms of the restructuring of this major business, we have made progress towards our agreed targets for EMI Music, as results for the first quarter begin to show. Meanwhile, EMI Music Publishing remains on track to deliver performance as expected. We now move on to an overview of Maltby’s results, after which we look in more detail at EMI’s two divisions and their performance during the year.



Financial Overview

In this section, we give an overview of Maltby’s numbers presented in full in the appendix. Basis of Accounts Maltby Limited was incorporated on 11 July 2007, and did not trade until it acquired the EMI Group, via its wholly owned subsidiary, Maltby Acquisitions Limited, on 17 August 2007. As a result, the statutory financial statements of Maltby reflect only the results of the post acquisition period, the seven and a half months ended 31 March 2008. As such, these results do not tell the reader much about year on year trends or the outlook. To address this and allow readers to relate EMI’s performance to its performance in the previous year, this section also presents a pro-forma income statement for the full year ended 31 March 2008, together with year ended March 2007 results. This will allow the reader to relate these results to the more detailed divisional discussion presented in the Music and Music Publishing sections 7 and 8 below. Overview of results The table on the next page gives an overview of Maltby’s result for the financial year. This was a year in which large non-recurring events relating to the acquisition affected the result more materially than any operational factors. Therefore, before we explain the like-for-like operating performance of the two divisions, we set out the impact of changes relating to the acquisition. These include accounting changes, the impact of restructuring and the changes to the capital and financing structure of the business. In addition, the impact of recent turbulence in the financial markets on exchange rates and interest rates has also affected these numbers. The Maltby Group reported an EBITDA loss of £151 million for the year ended 31 March 2008, compared with a loss of £88 million in the previous year (a fall of 72%). However, this is a result of the £192 million charge to the P&L arising as a result of the fair valuation of balance sheet assets and liabilities at acquisition, and the restructuring charge of £123 million taken as a consequence of the acquisition. Adding back these significant non-recurring items, the adjusted EBITDA for the year ended 31 March 2008 of £164 million declined 5% from £173 million in the previous year.


Maltby Capital Ltd Result
Year ended Year ended 31 March 2008 31 March 2007 £ million Net Revenue Costs excluding fair value adjustments, restructuring, depreciation & amortisation 1,458 (1,294) 1,808 (1,635) (19)% 21% %

Adjusted EBITDA [1] Fair value adjustments Restructuring costs Reported exceptional items EBITDA Depreciation and amortisation Share of profit from associates Profit/loss from operations Finance Charges Tax Loss for the period Adjusted EBITDA %

164 (192) (123)



(156) (105) (88) (71) 2 (157) (107) (23) (287) 10%


(151) (109) 2 (258) (520) 21 (757) 11%

(72)% (54)% 0% (64)%

[1] Adjusted EBITDA means that the fair value adjustments, restructuring, depreciation and amortisation have been excluded

Amortisation and depreciation for the year ended 31 March 2008 of £109 million compared with £71 million in the prior year reflects the higher amortisation charge as a result of the recognition of the significant intangible assets on the balance sheet on acquisition. As a consequence of the above factors, the loss from operations for the year ended 31 March 2008 of £258 million compares with a loss of £157 million in the previous year. After finance charges and taxation charge for the year, the proforma loss for the financial year ended 31 March 2008 was £757 million, compared with a loss of £287 million in the prior year. Impact of Fair Value Provisions on P&L On acquisition, all assets and liabilities acquired must be fair valued in accordance with International Financial Reporting Standards (IFRS). The


acquisition of EMI therefore led to some substantial changes to the valuation of assets and liabilities on the balance sheet as items held at book value were re-valued to fair values (discussed under Balance Sheet below). The fair value exercise resulted in a £192m downward revaluation of a number of balance sheet assets relating to the anticipated recoupment of artists’ advances and other artist-related assets. With the benefit of hindsight, plus an in-depth analysis of artist profitability and a much greater understanding of the relative profitability of Catalogue and New Music, we have been able to make a more realistic assessment of these assets. We have made an equivalent charge of £192 million in the income statement. Restructuring Costs Maltby reported restructuring costs of £123 million for the year, of which £79 million was incurred in the post-acquisition period. This related to the strategic and organisational review of the company. Amortisation and Depreciation The £109 million depreciation and amortisation charge for the year comprises £86 million amortisation and £23 million depreciation. The high amortisation charge arises as a result of the recognition on acquisition of the EMI Music and Publishing catalogues, contractual arrangements with artists and writers, and other previously unrecognised intangible assets. As a result, the amortisation charge will be at these higher levels in future. Financing Charges Financing charges in the post acquisition period of £436 million reflect major changes to the capital and financing structure of EMI, and the turbulence in world financial markets over the last 12 months which affected EMI’s borrowings and other derivative instruments. The £436 million charge comprises in particular three items: £161 million losses on foreign currency borrowings Maltby reported an accounting loss of £161 million on foreign exchange movements as exchange rates adversely affected the level of its borrowings. Maltby holds its borrowings in US Dollars, Euros and Sterling and reports these in Sterling at the exchange rates prevailing at the period end. This loss has arisen as a result of the strengthening of the Euro and the US Dollar against Sterling; the Euro rate has moved from 1:1.48 on acquisition to 1:1.25 at the period end, whilst the US Dollar has moved from 1:2.02 to 1:1.99. The impact of these moves in exchange rates was to increase the reported level of borrowings at year-end compared with the level on acquisition. Any


movement in the rate will alter reported debt levels in this way and the trend could be reversed in subsequent periods. This is an accounting effect which has little commercial impact as EMI’s debt largely matches its foreign currency revenue streams. £89 million fair valuation of interest rate swaps and caps At acquisition, as part of the financing structure, Maltby entered into interest rate swaps, and interest rate caps which hedge its variable interest rate borrowings against rate changes. Under IFRS, these derivatives need to be marked to market at each period end. Owing to adverse market conditions, the fair values of these derivatives have reduced, with the movement in their value reported as a net loss of £89 million. This is however a non-cash item which has no real commercial impact unless the derivatives are broken before their maturity. £165 million ongoing interest on borrowings Interest payable on the Group’s new bank loans and overdrafts in the postacquisition period totalled £165 million which reflects the finance cost of the borrowings put in place on acquisition for seven and half months. The acquisition of the EMI Group was financed by bank loans of £2.6 billion and £1.5 billion of shareholder debt and equity (constituting the consideration of approximately £4 billion). Balance Sheet The balance sheet changed substantially during the year, with net liabilities of £1,151 million as at 31 March 2007 increasing to net assets of £545 million as at 31 March 2008. This was principally owing to the recognition on acquisition of intangible assets, notably the catalogues of Music and Music Publishing, which were previously unrecognised on the balance sheet. Fair value adjustments to Balance Sheet As noted above, as a result of the acquisition, the assets and liabilities of EMI were required to be stated at their fair value in the financial statements of Maltby. This resulted in the recognition on acquisition of £3,411 million of intangible assets, relating to the catalogues, contractual arrangements with artists and writers, software, brands and other intangible assets. At the period end, after amortisation of £69 million and exchange gains of over £200 million, the carrying value of these intangible assets was £3,553 million. As a result of the first time recognition of these intangible assets, a deferred tax liability of £855 million was also recognised. Together with the downward adjustment of £192 million previously discussed, and other smaller adjustments, the fair value adjustments recognised on acquisition totalled £2,085 million.


Maltby Capital Ltd Balance Sheet
£ million Assets Music copyrights and intangibles Goodwill Pension assets Other non-current assets Total non-current assets Current assets Total assets Liabilities Shareholders' loan Other financial liabilities Pension liabilities Deferred taxation Other non-current liabilities Current liabilities Total liabilities Net assets/liabilities Total equity As at 31 March 2008 As at 31 March 2007

3,553 1,507 114 231 5,404 1,026 6,430

306 29 176 511 988 1,499

(1,056) (2,720) (41) (930) (7) (1,131) (5,885) 545 545

(1,317) (42) (4) (7) (1,280) (2,650) (1,151) (1,151)

Goodwill In addition, goodwill of £1,429 million relating to the acquisition of EMI is recognised on the acquisition balance sheet. This reflects intangibles assets which cannot be separately recognised on the balance sheet under IFRS rules, such as customer loyalty, artist relations and the assembled workforce, and the opportunity as a result of taking EMI into private ownership. This goodwill is allocated roughly equally between the Music and Music Publishing divisions. However, excluding the effect of recognising the deferred tax liabilities discussed above, the split would show that the goodwill relating to music to be ten times as large as that relating to Music Publishing. This reflects the greater perceived opportunity in the Music business. Exchange movements during the period increased the carrying value of goodwill to £1,507 million as at 31 March 2008. Goodwill is tested annually to ensure it is not impaired, or in other words, to test whether it has held its value. The reviews as at 31 March 2008 concluded that this was the case. 36

Long term liabilities Long-term financial liabilities on the balance sheet totalled £3,776 million at 31 March 2008, which included £2,618 million of bank loans (net of £66 million of fees) and £1,056 million of shareholders’ loans. EMI’s bank facilities provided by Citigroup are as follows: A £1,410 million securitisation bridge facility for Music Publishing A £1,175 million senior facility for Music and Music Publishing A £155 million mezzanine facility for Music The drawings against these facilities translated as at 31 March 2008 can be summarised as follows:
Drawn in GBP 251 92 155 498 Drawn in USD 875 345 1,220 Drawn in EUR 346 620 966 Total

£ million Music Publishing Facility Senior Facility Mezzanine Facility Drawings as at 31 March 2008

1,472 1,057 155 2,684

As can be seen, the debt has been drawn in three major currencies: Sterling, US Dollars and Euros. These borrowings are matched against the underlying earnings of EMI which provides an economic hedge against exchange rate fluctuations. Further, EMI has entered into a series of interest rate swaps for the Music Publishing loan that has fixed a significant proportion of the cost of borrowing for the publishing business. For EMI Music, EMI has entered into a number of interest rate caps in order to mitigate its exposure to significant adverse interest rate movements. The Citigroup debt facilities contain only one financial covenant which tests the ratio of Net Debt (or Debt in relation to Music Publishing) to Maintenance EBITDA as well as allowing the business a degree of operational flexibility. To the extent that EMI ever were to fail a financial covenant test then there is the opportunity to cure such a breach by the injection of further equity which will count towards Maintenance EBITDA for the purposes of the test. The amounts outstanding under the term facilities are repayable in 2015 (or in 2017 in the case of the mezzanine facility). In addition, EMI is funded by a £1,056 million shareholders’ loan and £545 million of equity from funds managed by Terra Firma. 37

Pension schemes The Group operate a number of defined benefit pension schemes. The scheme in the UK is the largest, with gross scheme assets of £958 million. As at 31 March 2008 in accordance with IFRS, the UK scheme was in actuarial surplus of £111 million. The Group’s other large scheme is in Germany which is reflected on the balance sheet at a liability of £32 million. Operational Performance Revenue fell by nearly 17%, compared with a 16% decline in the previous year. This reflected the continuing decline in the traditional music market and also a year in which EMI Music had a poor schedule of new releases. Revenue by Segment Music revenues fell by 23% reflecting the continuing sharp decline in the market for physical CDs and insufficient growth in digital to compensate. In addition, Music had a poor release schedule during the year. Publishing revenues increased modestly in the year as revenue from newer sources offset the decline in traditional revenues from CD sales.
£ million Revenue - Music Revenue – Music Publishing Revenue Exceptional revenue Total revenue Year ended 31 March 2008 1,047 411 1,458 1,458 Year ended 31 March 2007 1,350 401 1,751 57 1,808 %

(23)% 2% (17)%


EBITDA by segment (Excluding Associates)
£ million EBITDA – Music EBITDA – Music Publishing Corporate EBITDA Year ended 31 March 2008 59 116 (11) 164 Year ended 31 March 2007 76 114 (17) 173 %

(22)% 3% 35% (5)%


While costs overall have been on a downward trend owing to a series of cost reduction programs, in Music this was insufficient to offset the sharp decline in sales. Music reported a 22% decrease in EBITDA year on year, whilst the Publishing result showed a 3.1% increase on the prior year. EBITDA was £164 million, comprising £59 million for EMI Music, £116 million from EMI Music Publishing, and corporate costs of £11 million. We now look in more detail at the performances of the two divisions and the factors underlying these.



EMI Music Publishing

In this section we look at the performance of EMI Music Publishing during the financial year to March 2008 and the underlying trends and drivers affecting this. Business Description and Environment EMI Music Publishing is among the world’s largest publishers, with £411 million revenue. It is the leading music publisher in popular music, representing remarkable catalogue of some of the best-known songs written, such as ‘New York, New York’, ‘Over The Rainbow’ and ‘I Heard It Through The Grapevine’. In recent years it has signed highly successful writers and producers such as Alicia Keys, Kanye West and Amy Winehouse. Publishing earns its income from acquiring and marketing the rights to songs. After signing a songwriter, it will earn revenue for each commercial use of a song, passing a royalty to the songwriter. EMI’s role as publisher is therefore to discover and nurture the best songwriters in the world, and then maximise the revenue from the catalogue of songs which it represents. As well as working with advertising agencies, film and TV production companies, game developers, merchandising businesses and many other third parties, EMI Music Publishing has a significant music production library business which markets pre-recorded music specifically composed for use in films, TV, radio and other media. In Europe, KPM is among the best known production library businesses in the world, while its operations in the US are through Associated Production Music (APM). APM is the world’s largest production library, and is a joint-venture with Universal Music Publishing. Revenue Streams Music Publishing earns income when songs are used in a variety of ways. Mechanical, or traditional income, is received when units, such as physical CDs or DVDs and downloads, are sold. Performance income is earned when a song is performed, for instance on the radio, TV, or at a live venue. Synchronisation income is earned from the use of songs in visual works such as TV programmes, films, commercials, games or karaoke. Other income streams arise when music is used for ringtones and other mobile products, stage productions, sheet music, merchandise and production library music. Market Share EMI Music Publishing’s share of the music publishing market has been about 20% for some years. Universal Music Publishing Group, boosted by its


acquisition of BMG Music Publishing in 2007, has a slightly higher estimated 22.2% share, while Warner Chappell (14.8%) and Sony/ATV (7.4%) are in third and fourth place respectively. The rest of the market is highly fragmented as the rights to individual songs are often owned by small family businesses or individuals. Data for the first quarter of 2008 saw EMI Music Publishing taking a leading market share in both the US and UK. Changing marketplace Structural changes in the world music industry have seen the market fragment, traditional revenue streams decline and new ways of earning income become more important. Revenue from CD sales fell from nearly 60% of EMI Music Publishing’s revenues in 1999 to under 40% in 2008 – and this trend is continuing. At the same time, other revenue streams have grown, and EMI Music Publishing has successfully tapped into this. Synchronisation revenues were only 10.7% in FY 1999, whereas by 2008 they were 19.9% and are forecast to rise substantially. Compound annual growth since 1999 was 11.5%. Performance revenues rose from 22.5% to 29.7% over the same period and are expected to rise further. Over recent years EMI Music Publishing has consciously developed itself as a music services business, building relationships with brands so that it can help its songwriters reach their market, providing them with knowledge and connections. For example, it has a close relationship with a major advertising agency. When the agency pitches for a new client, it will then approach EMI Music Publishing as the music expert who will help find the right music for the campaign. Identifying talent and trends Success in publishing depends on a quick response to changing trends in music, and to the similarly developing needs of artists. EMI Music Publishing’s success in industry awards across all genres and territories testifies to its investment of time and resources in its creative operations. Its strength in urban music across the world is one example of this, with success in the US and around the world contributing to the company’s continued growth. EMI Music Publishing has also identified individual talent early, signing James Blunt and, for example, bringing Amy Winehouse and Mark Ronson together. The division monitors the rate of return on individual artists and has a good track record, more than recouping its advance on 95% of its artists.


Performance in 2007/08 Despite the sharp decline in its core market, EMI Music Publishing turned in a solid result for the financial year. Revenues increased 2.4% against a double digit decline in the core “mechanical” market, with the shift to higher-value new income streams holding the margin steady and giving a slightly better result at the operating profit level. A good reduction in corporate overhead (primarily due to reduced people and office costs) meant that underlying earnings before interest, tax and depreciation (EBITDA) excluding one-off items, grew by over 11%. EMI Music Publishing Results FY ending March 2008
£ million Revenue Gross Operating Profit Overheads Miscellaneous and one off items [1] Underlying EBITDA ex associates Year ended 31 March 2008 411 179 (61) (2) 116 Year ended 31 March 2007 401 175 (67) 6 113 %

2% 3% 10%


[1] 2007 credit relating to copyright sales

Revenues from synchronization grew particularly strongly during the year, despite a 100 day writers’ strike in the US which brought TV production to a standstill. Digital revenues for the year grew to £27.5 million, compared with £25.2 million in the previous year. This reflected strong results in the US and UK, due to higher digital download income, and a rise in mobile phone master tone sales. Music Publishing actively protects the rights it has to songs and as a result will often achieve legal gains when it settles with organisations that have been using its music illegally. In recent years, there have been more significant settlements as Music Publishing has more actively pursued online services using music content and asked them to legitimize their use. In addition, as online services mature and become established, they themselves will often take action to ensure their music content is legal and this too can result in settlements that benefit Music Publishing. Royalty costs increased 3% during the year, while overhead costs were down by 10% due to cost reduction programs. The majority of overheads are personnel costs.


Operating profit at the EBITDA level including associates grew by 3% to £117.4 million, with margin increasing slightly from 28.1% to 28.3%. Digital net profit was £8.1 million compared with £7.6 million in the year before. Highlights of 2007/08 The last twelve months have seen EMI Music Publishing win a remarkable range of awards, while signing some important deals for the future. The success of EMI Music Publishing’s songwriters helped the company win Music Week’s Publisher of the Year title in the UK for the 13th consecutive year, as well as both ASCAP and BMI’s Pop Music Publisher of the Year and Urban Publisher of the Year awards. A range of other EMI songwriters also achieved notable success during the period included James Blunt, Duffy, and Mark Ronson. May 07 Dominated the year’s Ivor Novello Awards, winning 6 out of 15 awards, including Songwriters of the Year, Album of the Year, Best Contemporary Song and the Outstanding Song Collection Announced key executive appointments and the formation of a North American leadership group Teamed up with independent games company Drumond Park to launch a brand-new board game featuring the lyrics of some of the greatest songs of all time. Led nominations for the 50th annual GRAMMY Awards. Kanye West nominations. and Amy Winehouse led the overall

October 07 November 07

December 07

Tor-Erik Hermansen, one half of the StarGate team, has songwriting credits in four categories. January 08 February 08 Extended its relationship with Norah Jones, one of the most successful songwriters and recording artists of the decade. Signed hit singer, songwriter and producer Amanda Ghost. Won a host of awards at Grammy’s for songwriters Amy Winehouse and Kanye West as well as an array of others. Completed agreements to feature its music on high profile ads during the Super Bowl. Signed Sam Sparro and his songwriting partner Jesse Rogg in one of the most sought-after publishing deals of the year.


March 08

Signed an extension to its digital distribution licensing agreement with QTRAX, the free, legal ad-supported peerto-peer music network.

Outlook for 2008-9 Music Publishing had a solid start to this financial year, with EBITDA up around 12% in the first quarter, due largely to a major cost savings initiative implemented during 2007. Revenue declined, but this was primarily due to the positive impact of legal settlements received in Q1 in the previous year. During this first quarter, Music Publishing enjoyed further industry awards success, being named Publisher of the Year at ASCAP’s Rhythm & Soul Awards. It also regained its market leadership in the terms of US radio airplay for the first quarter of the FY to March 2009. Its songwriters were well represented on major releases across the world. Death Cab For Cutie topped the Billboard album charts in the US with their latest release ‘Narrow Stairs’, while Panic At The Disco’s ‘Pretty Odd’ debuted at number two. Other current US successes include songs on hit albums by artists including Mary J Blige, Madonna and Janet Jackson. In the UK, Duffy, Amy Winehouse and Take That continue to sell well, as do many others. Music Publishing recently completed deals with performer-songwriters including Ben Harper, Leona Lewis and Mark Ronson, as well as hit songwriters such as Mike Elizondo, Mikkel Eriksen, Amanda Ghost and Brian Howes. The division also signed a number of important administration deals, notably with Televisa, the largest media company in the Spanish speaking world. Music Publishing manages and administers music assets for Televisa, marketing these to third parties. In July this year, the division completed the acquisition of Music Contact, Spain’s leading production library business, previously a joint venture between Music Contact and EMI Music Publishing. This reflects a strategy of focusing on this high margin business which makes it possible to extend the catalogue at low cost. Overall, the result was encouraging and promises well for the full year.



EMI Music

In this section we look at the performance of EMI Music during the financial year to March 2008 and the underlying trends and drivers affecting this. Business Description and Environment EMI Music is one of the largest music businesses in the world, active in more than 40 countries worldwide though focused on the traditionally dominant markets of the UK and the US. Through its record labels including Capitol, Astralwerks, Blue Note, EMI Classics, and Virgin, EMI Music works with a diverse roster of artists across many genres of music. Headquartered in London, EMI Music owns two famous recording studios, Abbey Road in London and Capitol Tower in Los Angelas. EMI Music signs performers, earning its revenue from the commercial use of a recording and then passing a royalty to the performer. It has two distinct business activities: The New Music business finds and develops new and developing artists, working with them to produce, market and sell their music The Catalogue business markets work from past artists and the past work of current artists, packaging and marketing existing music owned by EMI, particularly in compilations or greatest hit albums. The EMI Catalogue is one of the most extensive in the world, with over 3 million individual tracks, and is a valuable asset for EMI. Much of this is not yet digitised for downloading and represents considerable untapped potential. The support activities which service the two activities such as manufacturing and distribution are, or are in the process of being outsourced. EMI Music faces a rapidly-changing market. As a result of the shift away from the physical CD and a fragmenting entertainment market, music industry sales are back down at the levels that they reached in 1975 and are still declining. Consumers are using many more different channels to find and consume music, making it harder for EMI Music to track their behaviour and needs. On a more positive note, consumption of music is increasing overall. Performance in 2007/2008 The year to March 2008 was a difficult year for EMI Music and the results overall were significantly down on the previous year.


£ million Physical sales Digital sales Other Total revenue Total Gross Profit Overheads EBITDA ex associates

Year ended 31 March 2008 860 166 15 1,041 355 (297) 58

Year ended 31 March 2007 1,195 139 18 1,352 473 (397) 76


(28)% 19% (17)% (23)% (25)% 25% (24)%

Total revenue was down 23% on the prior year, with physical sales falling by 28% to £860 million for the year, partially offset by a digital sales increase of 19% to £166 million. The overall music market in the year ended 31 March 2008 was estimated to show a decline of approximately 13% for physical, and a growth of approximately 28% for the digital market, giving an overall decline of 7%. This resulted in EMI’s market share of the physical market decreasing from over 12% in the prior year to 9% in the year ended March 2008, offset by a slight increase in EMI’s digital market share to 10%. The significant year on year decrease in total revenue was principally as a result of the weakness of the release schedule for the year. During the year ended 31 March 2008, only three EMI albums sold more than one million physical units, with an additional two ‘Now’ albums, of which EMI has a 50% share, also selling more than one million physical units. In the prior year, EMI Music had 18 releases selling more than one million physical units, with four of those selling over two million. However, it should be noted that the release schedule in EMI Music, as in any record company, is highly volatile and the timing of successful releases will not necessarily flatter a particular financial period. In addition, the significant changes with the Maltby acquisition, and the previous 18 months of uncertainty also delayed the timing of new signings and new releases. Overall, EMI Music lost market share during the period. Its global market share for combined digital and physical market for the year ended 31 March 2008 was 9%, compared to 12% in the prior year, principally as a result of its weak release schedule and the uncertainty caused by the acquisition. The gross profit for the year ended 31 March 2008 was £355 million against £473 million for the prior year, with the gross margin decreasing by a little less than one percentage point from 35% to 34%. Overheads decreased from £397 million in the year ended 31 March 2007 to £297 million in 2008, with overheads as a percentage of sales also decreasing from 29% to 28%. 46

Gross margin and overheads were on a downward trend as a result of the reorganisation and cost cutting programs implemented over the last five years. Overall, however, the fall in costs was insufficient to offset revenue decline and Music reported underlying EBITDA (excluding associates) of £58 million in the year ended 31 March 2008 compared with £76 million in the prior year. Highlights of 2007/2008 FY 2007/8 was a year of substantial change for EMI Music, as the A&R function in particular was fundamentally restructured to address longstanding cultural and commercial problems. Awards The year’s more modest release schedule meant that EMI Music artists did not dominate awards ceremonies as they have in some years. However, EMI Music artists won a total of 14 Grammys including two awards for the Beatles’ ‘Love’ album. And in May 2007 EMI Music artists including Sir Simon Rattle and the Berliner Philharmoniker and Leif Ove Andsnes took five out of nine Classical Brits. A notable success for EMI was Japanese superstar Utada Hikaru, an example of EMI’s ability to find and develop stars outside the UK and US. EMI sold almost 12 million digital units, including over seven million digital copies of her single ‘Flavor Of Life’ across all digital products and formats. Digital Initiatives In 2007, EMI Music become the first major music company to release higher quality downloads without digital rights management software (DRM). This allows consumers to play tracks they buy on almost any device, whereas previously they were restricted. DRM free music was initially offered through Apple, and then Amazon. EMI Music DRM-free music is now available to all retailers that request it. This move is expected to support EMI Music’s digital sales but is primarily significant in signalling commitment to meeting consumer needs through available and flexible digital downloads. In little over a year DRM-free downloads have become established all over the world, in many countries led by EMI Music. EMI Music has been proactively involved in negotiating partnerships with digital distributors, leading to a series of high profile distribution deals. In May 2007 EMI Music struck a milestone partnership with Google and YouTube which enabled EMI Music to acquire revenues from videos played on YouTube. In addition, deals with Nokia and MySpace (eventually finalised and


announced in summer 2008) will enable EMI Music and its artists to make content commercially available in a legal and user-friendly manner to users of mobile phones and social networking sites. This is a very significant development in terms of the positioning of EMI Music and its content in the digital space. EMI Music also continued to explore new and imaginative ways to market through digital initiatives. As an example, the marketing strategy developed in collaboration with Coldplay for the release of "Viva la Vida or Death and All His Friends" (released shortly after the close of this financial year) included making "Violet Hill", the first single, exclusively available for free download from the band's website for one week. This achieved 2 million downloads, paving the way for a hugely successful commercial release shortly thereafter. Other Partnerships Partnering is vital for EMI Music’s future and its strong brand enables it to continue to attract partners that broaden its reach to consumers. In July 2007, EMI Music signed a distribution agreement with S Curve, the label set up by Steve Greenberg who discovered and broke artists such as Joss Stone and Fountains of Wayne. This allows EMI Music to release S Curve records, providing an important new source of A&R which is already providing hits such as the highly anticipated Little Jackie release and a new Tom Jones album. Outlook for 2008/2009 The first half of the financial year ending March 2009 will show a significant improvement in EMI Music’s performance and will be in line with management’s original expectations. While interim figures reflect timing issues and are not always a good guide to the future, we believe these numbers are a genuine indicator that the new organisational structure and clearer financial accountability have begun to have an impact.


Appendix 1: Risk Management and Treasury Policies EMI takes an active approach to the identification and management of business risks. The principal risks and uncertainties facing EMI and addressed by the risk management process are: Decline of traditional market: EMI operates in a shrinking market for traditional recorded music in particular. Global music sales dropped 8% to $19.4 billion in 2007, their lowest level in at least 10 years, according to a report from the International Federation of the Phonographic Industry published in June 2008. Against this backcloth, EMI Music’s traditional product, the CD, is under threat, both in terms of volume and price and its ability to sell through traditional retail channels has been seriously diminished. Now that the main retail channels are major non-specialists such as supermarkets, EMI faces the real risk of the complete loss of this route to the consumer, should such retailers cease stocking music. EMI has the opportunity to build new business relationships and digital sales, but the failure to do this in a timely way represents one of the major continuing risks to its business. While sales are growing, these are not at present offsetting the decline in physical sales, according to the International Federation of the Phonographic Industry (IFPI). Digital sales "are growing healthily but, crucially, not fast enough to arrest the overall decline of the market", John Kennedy, IFPI chairman and chief executive said in June. If the overall decline in sales continues, it is likely to result in reduced traditional revenues for EMI Music and may also negatively impact Publishing, which generates a significant portion of its traditional revenues from royalties on the sale of music in CD and other recorded music formats. A key plank of EMI’s strategy will be the replacement of traditional sources of revenue with new income streams, to capitalise on the opportunities of the digital market. However, the music market is in transition and its future shape including the dominant digital retailers and access to these cannot at present be clearly predicted. Also, the transition to a new business model requires considerable time and investment in new systems, processes and relationships. Retail environment: In many countries, mass merchandisers have been taking increased retail market share in physical sales. This has given them significantly greater negotiating leverage and hence resulted in downward pressure on our revenues and profits. Specialist music retailers have been losing market share which has, in certain circumstances, resulted in a significant weakening of their businesses. This could have an adverse impact on our ability to get our product to market via this channel, or could result in retailers being unable to pay us for product.


Piracy: Piracy represents a major risk to EMI Music and to the music industry. Tens of billions of illegal files were swapped in 2007. The ratio of unlicensed tracks downloaded to legal tracks sold is estimated to be about 20 to 1. Physical and digital piracy cost the U.S. music industry alone an estimated $5.3 billion in 2007 and there were 30 billion illegal downloads in the year, according to a 2008 IFPI report. Industry structure and competitive environment: Intense competition in the music industry could result in higher artist and writer acquisition costs or failure to attract and retain key talent. Competition amongst record companies for shelf space and retailer promotion could result in lower prices and/or higher marketing expenses. Declining prices for competing entertainment products such as DVDs and video games, as well as the emergence of totally new products, could result in reduced demand for music content. Legal and copyright: EMI regularly faces the known risk of losing exclusive copyright with the passage of time. Whilst the period of copyright protection has increased for sound recordings in the US and for musical works in the US and in the European Union, the period of protection for sound recordings in the European Union and many other countries outside the US remains at 50 years. This means that a portion of EMI’s catalogue within Europe will move out of copyright. This will become increasingly significant over time as some of the most well-known recordings in our catalogue were recorded in the 1960s. We are actively lobbying governments and legislators to increase the period of copyright protection beyond current levels. However it remains a risk that we may lose these rights. Also, future legislation could affect EMI’s relationships with certain artists or enable some artists to recapture rights in certain recordings. In the US, there have been attempts in recent years to change the law to cut the length of contractual relationships between record companies and their artists or to allow artists to take back the rights to their works. Whilst these have not been successful, it is possible that future legislation of this kind could have a negative impact on EMI’s business. External bodies: Music industry royalties are either collected or controlled by 3rd parties, such as industry collection bodies and in some cases the company requires a licence to collect its royalties. This diminishes control and might result in lower revenues, if rates were negotiated downwards, or licensing or collection terms changed. Supply chain: In areas where EMI depends heavily on one supplier, it could face a temporary interruption of manufacturing, supply, digital supply or distribution should such a supplier fail. In the same way, outsourced activities could be affected by a failure of the service provider. Pension fund valuations: EMI has defined benefit plans around the world, the largest of which is its UK pension plan. The asset values of our pension funds may rise or fall over time depending on changing share prices and


interest rates. Should pension funding requirements increase, the company would have to provide additional cash. Treasury Policies From its use of financial instruments, EMI has exposure to credit risk, liquidity risk and market risk, including interest rate and currency risk. Credit / counterparty risk arises principally from the Group’s receivables from customers and investments. The Group limits its exposure by only depositing surplus funds on a short term basis and by only investing in liquid securities and with counterparties that have been given a strong credit rating by both Standard & Poor’s and Moody’s. Surplus cash investments are made only with relationship banks. Occasionally, deposits are made with banking counterparties that provide financing arrangements, reducing the credit exposure of the Group. Trade receivables are assessed for risk of default by customers and terms of trade adjusted accordingly. Receivables are insured on risk and cost grounds. Liquidity risk: The Group’s approach to managing liquidity is to ensure, as far as possible, that it will always have sufficient liquidity to meet its liabilities when due, under normal and stressed conditions, without incurring unacceptable losses or risking damage. The Group relies on committed funding from a variety of sources. It forecasts expected cash flows regularly. As well, it reports weekly on actual cash balances to calculate short and medium term funding needs. On a monthly basis, it reports current headroom on existing facilities and projects this forward until the end of the financial period. The Group currently has a senior facility of £1,175 million, a securitisation bridge facility of £1,410 million and a mezzanine facility of £155 million. All facilities can be drawn in different currencies. The senior facility includes a revolving credit facility that can be drawn at short notice. Market risk covers foreign exchange rate and interest rate risk. The Group aims to maximise the hedging benefit of working in diverse markets, while avoiding any unnecessary exposure. A global netting system has been implemented to minimise transaction costs associated with the settlement of intercompany. Within the Group loans are made between the UK central entity and global subsidiaries. To minimise the exposure of holding currency balances, the UK central entity repatriates cash held in regional locations. The Group ensures that its net exposure is kept to an operationally acceptable level by buying and selling foreign currencies at spot rates when necessary. Interest on borrowings is denominated in currencies that match the cash flows generated by the underlying operations of the Group, primarily Sterling, Euros


and US Dollars. This provides an economic hedge that requires a limited use of foreign exchange derivatives. Interest rate risk: the Group aims to manage the fixed /floating interest rate mix to avoid the impact of any rate change. The financial facility agreements listed below require the Group to hedge the amounts listed below to minimise interest rate risk. Bridge to Securitisation - The interest liability relating to at least 82% of the principal amount outstanding Senior Facility & Mezzanine Facility - The interest liability relating to at least 50% of the principal amount outstanding


Appendix 2: Contacts Press Enquiries Andrew Dowler Financial Dynamics Ltd Holborn Gate, 26 Southampton Buildings London WC2A 1PB United Kingdom +44 20 7831 3113 EMI Corporate Communications Corporate Communications Department EMI Group Limited 27 Wrights Lane London W8 5SW United Kingdom +44 (0)20 7795 7000 Corporate Communications Department EMI Music North America 150 5th Avenue New York NY 10011 USA + 1 212-786 8000


Appendix 3: Directors’ Report and Consolidated Accounts See following pages.


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