Spotify Technology S.A. (NYSE:SPOT) Q1 2023 Earnings Call Transcript

Spotify Technology S.A. (NYSE:SPOT) Q1 2023 Earnings Call Transcript April 25, 2023

Spotify Technology S.A. misses on earnings expectations. Reported EPS is $-1.16 EPS, expectations were $-0.85.

Operator: Good morning. My name is Julian and I will be a conference operator today. At this time, I would like to welcome everyone to Spotify’s First Quarter 2023 Earnings Call. . I would now like to turn the call over to Bryan Goldberg, Head of Investor Relations. You may begin your conference.

Bryan Goldberg: Thank you, and welcome to Spotify’s first quarter 2023 earnings conference call. Joining us today will be Daniel Ek, our CEO; and Paul Vogel, our CFO. We’ll start with opening comments from Daniel and Paul and afterwards, we’ll be happy to answer your questions. Questions can be submitted by going to slido.com, S-L-I-D-O.com and using the code #SpotifyEarningsQ123. Analysts can ask questions directly into Slido, and all participants can then vote on the questions they find the most relevant. . If for some reason you don’t have access to Slido, you can e-mail Investor Relations at ir@spotify.com, and we’ll add in your question. Before we begin, let me quickly cover the safe harbor. During this call, we’ll be making certain forward-looking statements, including projections or estimates about the future performance of the company.

These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed on today’s call, in our letter to shareholders and in filings with the Securities and Exchange Commission. During this call, we’ll also refer to certain non-IFRS financial measures. Reconciliations between our IFRS and non-IFRS financial measures can be found in our letter to shareholders, in the financial section of our Investor Relations website and also furnished today on Form 6-K. And with that, I’ll turn it over to Daniel.

Daniel Ek : All right. Hey, everyone, and thank you so much for joining us. As we open this call, I really can’t help but feel a tremendous amount of excitement about the progress our team made this quarter. In fact, this quarter represents our strongest Q1, since going public. And over the last few months, we’ve celebrated a few significant milestones, including surpassing over 0.5 billion users and reaching more than 200 million subscribers. Further, our user growth exceeded our expectations by 15 million and our subscriber numbers by 3 million. And at our scale, it is pretty remarkable to see this level of reacceleration in our user growth, but it is a trend that’s been consistent now for over the last five quarters. In fact, the last two quarters saw the largest MAU growth in our history.

The outperformance was broad based, meaning growth was pretty evenly spread across every region without a single market dominating. And on top of this, we were able to accomplish this level of growth with lower marketing spend. We look at this as a promising sign. But it’s too early to draw any conclusions yet. And as you heard me say repeatedly over the years, a healthy top line user growth is the leading indicator of our ability to achieve future success on all other financial metrics. And when we successfully attract new users, it’s only a matter of time before the conversion rate that subscriber increases, which then of course, drives our revenue upwards over the long term. And this is a formula that’s been worked for us exceptionally well, and one I fully expect to play out again.

And speaking of long term, I want to spend a moment talking about our approach to investment timelines and the outcomes they can deliver when we stay on the course. So let me give you a recent example. For those who turn in through our March Stream On event, we unveiled numerous creator tools and the debuted in an entirely new and updated Spotify experience, including a first of its kind AI DJ. And these changes marked the biggest updates to our user experience since we introduced mobile more than 10 years ago. But of course, this didn’t happen overnight. These are things that we’ve been building on over the last 12 to even 18 months, and in some cases even longer. And as we shift to rolling out these features, as well as several others across our 184 markets, we’re seeing an acceleration in MAU retention and subs.

And sometimes our investments manifest themselves immediately. But more often than not, their impact is gradual and takes shape over several quarters, or sometimes even years. And while we really can’t anticipate when the benefits will materialize, we do know that our growth is a consequence of our relentless pursuit of learning, iterating and improving. We make strategic investments, and we wait for the results to compound for proving out the benefits for users, creators, and of course, our other stakeholders. And by delivering an exceptional experience that is centered on creating value for the stakeholders, overtime, we’re seeing a correlation with a stronger financial performance. I’ve often talked about the fact that our success is not attributable to just one thing, but literally 100s, if not sometimes even 1000s of improvements that we’re investing in and working on in parallel.

And that’s not to say that every one of them ends up producing the outcomes we strive for. But over time, the things that do work, they do add up. And together they have a compounding effect. So think of it really as waves of innovation, investment and improvement. There’s an ebb and there’s a flow overtime, but overtime, it really becomes more predictable and produces steadier results. And the key then, it seems is to maintain a long term focus to help us navigate current short term uncertainties. But don’t let all my talk about the importance of long-term investing allow you to believe that we are rethinking our commitment to driving efficiency. So as many know last quarter and building on what we shared at last year’s Investor Day, I talked about shifting towards becoming a more efficient company.

There’s really no question that we’ve become leaner in the last six months, but this progress is still early in its reflection on our financials. The actions we’ve taken coupled with other opportunities to reduce spending in areas like marketing and content production and real estate should lead to a steady progression of key metrics throughout the year, all of which makes me even more bullish about the remainder of 2023 and beyond. And with that, I’ll turn it over to Paul for more detail behind the numbers, and then Bryan will open it up for the Q&A.

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Paul Vogel: Great. Thanks, Daniel, and thanks, everyone, for joining us. Let’s start with Q1. User growth was exceptionally strong in the quarter. Total monthly active users grew to 550 million in Q1. This was 15 million ahead of guidance, up 26 million quarter-over-quarter the largest Q1 net additions in our history and the second largest all-time only surpassed by Q4 of last year. The strength was broad-based, and we had record Q1 net additions across nearly all age demographics in both developed and developing regions. Moving to premium. We finished the quarter with 210 million subscribers, 3 million ahead of guidance, thanks once again to broad-based strength across all regions. Engagement trends were strong in Q1 with healthy uplift to year-over-year growth in content hours per MAU across all platforms.

We also saw positive trends in our DAU to MAU ratio as well as in churn. Our revenue grew 14% year-on-year, topping $3 billion in the quarter. Results in the quarter were just slightly behind forecasts as premium revenue slightly outperformed, offset by a very modest underperformance in advertising. This marks the first Q1 in Spotify’s history where we surpassed €300 million in ad revenue. And turning to gross margin. Gross margin of 25.2% was above guidance by 30 basis points. Moving to operating expenses. Growth was lower than forecast helped by less marketing spend than plan. When combined with our better gross profit, operating loss was ahead of guidance by €38 million. The better than planned results also include €44 million of severance-related charges.

Free cash flow was a positive €57 million in Q1. Now looking ahead, it’s clear we have a lot of momentum coming out of Q1. With respect to second quarter guidance, we continue to see strong momentum in MAU and subscribers, we’re forecasting 530 million MAU, an increase of 50 million from Q1 and 270 million subscribers, an increase of 7 million over Q1. We are forecasting €3.2 billion in total revenue, a gross margin of roughly 25.5% and an operating loss of approximately €129 million. On revenue, the currency translation benefits we’ve been experiencing for the last six quarters are expected to reverse in Q2, led by the weakening U.S. dollar relative to the euro. As a result, we are forecasting a 300 basis point headwind to growth. Excluding this effect, our constant currency revenue will be closer to €3.3 billion, reflecting our expectation for accelerating currency-neutral growth to 14% versus 13% growth we delivered in Q1.

From a profitability standpoint, we continue to expect a steady ramp in gross margins throughout 2023 as well as sequential improvements in our operating loss. And then one final note. As Daniel mentioned in his remarks, we will continue to be diligent regarding operating efficiency improvements and we’ll be looking at areas such as real estate optimization. During Q2, we hope to finalize some of these decisions, and this could lead to material non-cash charge during the quarter. We have not included any potential charges in our Q2 guidance, but should they occur we will break them out during our Q2 earnings report. And with that, I’ll turn it back over to Bryan.

Paul Vogel: Yes. As I said in my opening comments, we’re slightly behind on the ad side, about 15 — about 20 million or so. The quarter was choppy, again, incrementally throughout the quarter, it got a little bit better. We feel like we have momentum heading into Q2, but I think we’ve had similar sort of trends heading into Q1 as well. So it’s a little bit too early to say. Overall, I think we feel really good about our relative position in the ad market and how we performed relative to how the overall market performed in Q1. Again, it was a bit up and down. We missed by a small amount, but nothing really that concerns us in any way.

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Q&A Session

Bryan Goldberg: All right. Our next question is going to come from Mike Morris on AI. Use of AI technology to create new music has resulted in concern from artists and rights holders as seen with the recent fake Drake track. What does Spotify’s responsibility in allowing or preventing the distribution of creative music that draws from another artist’s work?

Daniel Ek: Yes. I mean, first off, let’s acknowledge that this is an incredibly fast moving and developing space. I don’t think in my history with technology I’ve ever seen anything moving as fastest, the development of AI currently is at the moment. And obviously, you pointed out in your question that there’s two parts of this. One is, our role as a platform for allowing innovation of creative works and then how we do to protect the creators and the artist ecosystem that we care so deeply about. And so the big part of this is we have that dual focus, and we take that role of guardian, the artist creativity and the support that we are doing for artists and creators very, very seriously. So we’re in constant dialogue with the industry about these things.

And it’s important to state that there’s everything from what you’ve mentioned sort of fake tracks from artists, which falls in one bucket to everything of just augmenting using AI to allow for expression, which probably falls in the more lenient and easier bucket. So these are very, very complex issues that don’t have a single straight answer on how you take the position depending on what would happen. But we’re in constant discussion with our partners and creators and artists and want to strike a balance between allowing innovation and, of course, protecting artists.

Bryan Goldberg: Okay. Next question from Justin Patterson on operating efficiency. On the fourth quarter earnings call, you framed efficiency is a top priority for Spotify as you’ve transitioned to a new org structure, how are you measuring your initial progress on speed and efficiency? And when can we expect these efforts to roll in more meaningfully to gross margin and operating expense?

Daniel Ek: Yes. I’ll start, and maybe Paul can add to it. So we’re early on in our new work structure and the way we’re working. But I’m feeling really good about it so far. And the leading indicators that I look to is really just speed of decision-making. And we’ve really kind of driven more collaboration and more speed of decisions now than we’ve had probably at any other time in the Spotify history. So I feel good about that. But that obviously will still take some time before that then leads into actual products that then leads to actual business results. So I think as it relates to that, we still have some ways to go before investors will see the actual output. But when I talked about efficiency, it’s important to note that, that’s just one part of the equation.

The other part of the equation, obviously, on efficiency is just being diligent on what we invest in and what we spend on. And I don’t know, Paul, if you want to talk a little bit more about what we’re seeing there.

Paul Vogel: Yes. I would add a couple of things. One is, I think we’ve talked about on the gross margin side seeing sequential improvement throughout 2023, and nothing’s changed there. So you saw the Q1 number come in, you saw the Q2 guidance is sequentially better than Q1, and we expect that to persist throughout 2023. And same thing on the operating loss, we expect to see incremental leverage throughout the year with the sequential improvement in operating loss as well. So we’re starting to see it come through on those lines.

Bryan Goldberg: All right. Next question from Matt Thornton on our subscription business. ARPU was a little lower than expected. Can you talk to what’s driving that, i.e., of how did FX plan mix, market mix, promotional activity vary versus your initial expectations and guidance? And how should we think about ARPU looking forward?

Paul Vogel: Yes. It’s kind of a combination of all the things you mentioned. Clearly, we beat on the subscriber side by 3 million. So when we have that upside, some of it came from additional growth in our family and duo plans as well as people coming on promotional. And so all of those have an impact on ARPU. I would say the product mix, meaning more users coming in on family and duo is probably the biggest driver. Again, it’s pretty minor in terms of where it came in on ARPU and it was pretty much in line with our expectations, maybe a hair below from an ARPU standpoint, but not material.

Bryan Goldberg: Okay. Another question from Justin Patterson. This is on our recent product updates. Daniel, could you share any initial learnings on listener and creator reactions to the new user interface. With the new user interface released, how should we think about the pace of product improvements and monetization opportunities going forward?

Daniel Ek: Yes. Perhaps just to start by setting context. It was a very successful event. We’ve had massive amounts of feedback both from users and creators, where, in particular, this was a greater-focused event. So creators have been overwhelmingly positive about all the new tools that they now have to express themselves and to connect with their audience. But it’s also to temper expectation. It’s probably one of the largest single changes in the history of Spotify. So we take that very seriously. So for instance, the new home feed that we announced is still being rolled out. So most consumers in the world don’t yet have access to that. We’re rolling it out slowly just to make sure we have performance dialled up and that we can react to the feedback.

And we’ve already made lots of iterations with the user feedback we’ve gotten. So it will be very successful when it’s fully rolled out, and I feel really good about that. But I’m using this as a moment to educate all investors and analysts as well that there are some product improvements that we do that you just can’t turn on the button on. And there’s some that you can. And this happened to be one of those things that takes multi quarters for us to roll out because it’s not just a feature or something else. It’s a whole new infrastructure behind it with a whole new instrumentation for our AI tools as well. So it’s an important piece of infrastructure that we’re basically still rolling out, but I feel really good about it and the response.

And I think once that’s fully rolled out, we can iterate massively on top of that as well. But the big focus for the next few months from the teams is just really kind of rolling this out, making sure it’s very performant and that we can start then allowing our machine learning and AI teams to start iterating on top of that. And then we’ll see compounding improvements for many years, just like I outlined in my initial remarks.

Bryan Goldberg: Okay. Next question from Mario Lu. With regards to the 6% workforce reduction announced earlier this year, is that the final or first round of reductions this year? And should we expect any additional severance charges other than the €41 million in your operating expense in Q1?

Paul Vogel: Let me take the second part first, just to get it out of the way. So the €41 million is the charge on the operating expense line. There was actually €44 million overall. There was a small component of a severance that hit gross margin. So there’s been two numbers that have been floating out there, but it’s €44 million in total, €41 million to hit the OpEx and then that €3 million that hit the gross margin side. And in terms of workforce, nothing else at in terms of workforce reductions. I think we’ve talked about, I’ll let kind of Daniel take the efficiency side from here.

Daniel Ek: Yes. I mean the only thing I’d really add is that we have really become a lot leaner over the last six months, but I think that progress is still early in its reflection on our financials. And then what investors should probably expect going forward is for us to keep looking for waste that can help us. And that includes, obviously, everything from our real estate footprint. We will keep reviewing the content deals we’ve made, are they performing, not performing and obviously have a much higher hurdle rates, as I mentioned last quarter as well on any new investments going forward.

Bryan Goldberg: Okay. A question from Rich Greenfield for Daniel. I would love to hear your perspective on the recent Apple versus EPIC ruling being able to message about paying for Spotify off platform is clearly positive, but it appears that the court largely cited with Apple. And then I would also love to hear more about your recent trip to Washington, D.C.

Daniel Ek: Yes, Rich. I would characterize it probably as disappointed but not surprised with the ruling. As you rightly called out, it does still include the anti-steering provision, which I think is very important and a good step in the right direction. And I think it’s also worthwhile pointing out, I just briefly read through the judge’s remarks, I may be getting this, but I’m wrong, but I’ll try to paraphrase it, where the judge, I think, was referring and reacting to the fact that there’s a larger conversation going on in Washington about future regulation and the judge just noted that they were simply making a decision, a ruling based on the existing law and not future regulation. And this is kind of the point why I went to Washington I do believe new laws are needed for this and that the App Store bill or Ooma bill that is also called is a very much needed improvement.

And I had great meetings. I really did from bipartisan, both Republicans and Democrats. I found them to be very supportive of the issue, very understanding of some of these things. And I think a lot of the people I spoke to didn’t realize it was this bad. And for us, just to kind of level set for those that may not be involved in the intricate details. The primary issue for me is that when I started as a 14-year-old entrepreneur, the Internet was this democratic place that anyone anywhere in the world could have an impact. And right now, we’re in a place where billions of consumers are using the Internet primarily through smartphones and primarily through apps. And there’s literally two companies now that control all of that on the internet, and they can unilaterally change the rules.

They, in Apple’s case, can prevent us from talking to our customers and prevent customers from even understanding that there are better deals in the marketplace. So this is super important to me on a principal level, I want better climate for innovation to bring progress. I want consumers and if they’ve opted into communication from a company, I want that company to be able to communicate to that consumer without the interference of these platforms. And those message points really resonated across both the House and the Senate and across the aisle of both Republican and Democrats. So I feel encouraged but it’s still early days here in the U.S. And obviously, we’ve had a lot more progress on this issue lately in Europe.

Bryan Goldberg: Great. Next question from Mario Lu on gross margin. Gross margins beat guidance by 30 basis points, but saw a drag from other cost of revenue. Can you explain what within other cost of revenue was the main drag and if that’s expected to continue going forward?

Paul Vogel: Yes. So there’s a little bit of nuance in this. So let me kind of go through it. So when you look throughout 2022 and into 2023, we’ve seen a sort of steady increase on the other cost of revenue line. A lot of that has come from streaming delivery and other compute costs that had slowly risen throughout the year and it’s been impacting us. And so when you look at it Q1 versus Q1, that trend had still continued to put a little bit of pressure on the gross margin as a negative. That being said, some of the outperformance we saw in Q1 actually related to that being less of a drag than we thought and starting to see some of the efficiency improvements and initiatives that we put in place starting to pay off. And so while the increase that we’ve seen for the last kind of three, four quarters persisted, the incremental increase was less given some of the efficiencies.

And so we feel really good about that. We’ve got more plans in place to continue to improve that line item, which is sort of the non-royalty-bearing side of gross margin. So I think we’re in a good place going forward with how that should trend.

Bryan Goldberg: Okay. Next question from Doug Anmuth on podcasting. With a decent amount of hit podcast content deals seemingly up for renewal in 2023 and ’24, what gives you confidence you can retain exclusive talent while not overpaying and overinvesting?

Daniel Ek: Yes. I think you’re right in calling out the overpaying and overinvesting. And what I can start out by saying is we’re not going to do that. And we’re going to be very diligent in how we invest in future content deals. And the ones that aren’t performing, obviously, we won’t renew. And the ones that are performing, we will obviously look at those on a case-by-case basis on the relative value. And I would say two things here. One, we have very sophisticated tools for measuring impact on the platform where we talked about this at the Investor Day, where we do understand the relative impact on lifetime value in our subscribers and so on and so forth. I think that helps us paying a fair price or understanding what a fair price would be.

But then the second part also, because we are now the largest podcasting platform that means we have a great opportunity to amortize across a larger base. So relative to someone that’s smaller, we should be in a better position should we want to renew a deal because we obviously can amortize that against a larger base of users.

Bryan Goldberg: Okay. Question from Benjamin Black on subscription pricing. Since you haven’t raised pricing, are you seeing any benefit from being the lower-cost distributor?

Daniel Ek: One would think so, given the outperformance in the quarter. But again, it is important to note that it’s been fairly broad-based the outperformance. And just by way of context, we did raise prices in 46 different occasions and markets last year. So it’s not like we haven’t raised prices. And even in those markets, we were still outperforming. So I’ve said this before and I’ll say it again, I feel really good about our ability to raise prices over time that we have that ability, and we have lots of data now that backs that up. We may have been marginally helped by being a lower cost provider, but it isn’t a primary part of our strategy, and it’s not something that we’re thinking about. Instead, we’re working with our label partners to really work with them to figure out what’s the best opportunity for us to do that.

And that’s obviously a more complex trade with many other variables. And I’ve talked about that before. But when the timing is right, we will raise it. And I think that price increase will go down well because we’re delivering a lot of value for our customers.

Bryan Goldberg: Okay. Another question from Rich Greenfield on advertising. You’ve talked about advertising revenue scaling to be 20% of your overall revenue. While it’s growing faster than subscription revenue, the mix hasn’t moved a lot. How should we think about the timing of getting to 20%, let alone 30% of your revenues?

Paul Vogel: Yes, Rich, I think we still feel really good about the ability for advertising to grow and be a larger part of Spotify’s revenue mix. Right now, there’s one part of what we can control and one part we can’t control. So the part we can control is to continue to build out the tools, the services, the measurement, the attribution, all of the things that we think we’re doing to bring an even better advertising product to Spotify and that continues on, and we feel really good about the advancements we’ve made there. Obviously, in the last quarter or two, we’ve been somewhat impacted by macro. Again, we feel like we’re growing nicely and outperforming the market and our peer group overall, but the macro has probably slowed us down.

So I don’t really think that a couple of quarters of macro uncertainty is going to change our long-term view of how we get to 20% or even beyond that. And for us, it’s really just heads down, making sure that the product and innovation is there. So that when the macro does come back, where you can benefit as much as we possibly can.

Bryan Goldberg: Okay. A question from Doug Anmuth on AI DJ. Could you give us your thoughts on how AI DJ plays out given your launch of the beta version at Stream On and subsequent copyright pushback from some of the major labels?

Daniel Ek: Yes. I do think it’s important to kind of separate AI DJ from the sort of AI conversation. So AI DJ, in and on itself, I think we’ve had nothing but positive reactions from across the industry. I think the AI pushback from the copyright industry or labels and media companies. And it’s really around really important topics and issues like name and likeness, what is an actual copyright, who owns the right to something where you upload something in claim it to be drain, it’s really not and so on. And those are legitimate concerns. And obviously, those are things that we’re working with our partners on in trying to establish a position where we both allow innovation, but at the same time, protect all of the creators that we have on our platform.

Bryan Goldberg: Okay. Next question from Michael Morris on subscription pricing. Do you plan to raise price on any of your current plans during 2023? And what are the current considerations to changing pricing?

Daniel Ek: I can start and then maybe Paul can chime in. So I think it’s important perhaps to just add as a context here. As I mentioned in my prior response, we raised prices in 46 places last year. I would like and hope for us to do that in 2023 as well, but we’re in discussion with our partners around that. So that’s a really negotiation thing. But I think maybe to up-level it. What we’re trying to do is we’re just really trying to focus on how can we optimize for growth. And there are many ways to achieve growth. You can grow top line users that then subsequently will turn into conversion to premium subscribers that then subsequently would turn into revenue, or you can increase ARPU on a lower set of base and you can still achieve that top line growth.

So we have many tools at our disposal as we’re thinking about how to increase growth. And the industry realizes that and our label partners realizes that as well. So that’s the constant dialogue that we’re in. But yes, we would like to raise prices in 2023, but it’s really a discussion with our partners.

Bryan Goldberg: Okay. Another question from Doug Anmuth on Marketplace. How should we think about the outlook for marketplace growth this year following approximately 40% growth in 2022?

Paul Vogel: Yes. I think we’re still very optimistic about marketplace. It had a really strong Q1. It continues to be a driving force for engagement with the creator community. They’re loving the tools and services. So we haven’t given a target out for 2023. But Q1 was very strong, and we’re optimistic that we’ll continue to sort of be able to advance all the offerings we have in marketplace.

Bryan Goldberg: Okay. Next question from Deepak on podcasting. Can you provide some recent — some color on recent engagement trends on the podcast side? Revenue growth is healthy, even as you optimize the content portfolio, we’re curious on the recent engagement trends within podcasts.

Daniel Ek: Yes. So overall, Q1 has been a phenomenal quarter when it comes to engagement. So engagement is up more than predicted on pretty much every front. So retention is higher, the DAU over MAU is higher than before, and the actual engagement is higher. And that’s across music, but it’s certainly true on podcasting as well. And we’ve seen a healthy trend sort of up to the right on podcasting for now many, many, many quarters. And we’re seeing how both podcast and music is acting in great symbiosis together to drive an overall healthier user funnel on Spotify. So I feel really good about the mix. And obviously, that’s a testament to the great catalogue and content portfolio we have on both music and podcasts.

Paul Vogel: Yes. I would just add, the one other metric, listening hours for MAU was really strong in the quarter, both across music and podcasting. So to Daniel’s point, on the engagement side, we’re seeing a number of our engagement metrics, really uptick in Q1.

Bryan Goldberg: Okay. Another question from Doug Anmuth on users. Given the first quarter upside and the first half outlook, how do you think about overall net adds and growth for MAUs and Premium subscribers in 2023 relative to the 83 million and 25 million added, respectively, in 2022?

Paul Vogel: Yes. We don’t obviously give full year guidance anymore, but implied in the question is sort of where we already are. So if you think about between Q1 and our outlook for Q2, we’re just over 40 million net additions on the MAU side. So we’d be halfway to last year through half of this year, and the same thing on the sub side. So about — if we hit our guidance for Q2, that’s about 12 million sub additions. So again, about halfway to next year. So nothing really to add other than we feel really good about the trends and the trajectory we’ve seen on both the user side and then subside for the — for Q1 and our expectations for Q2.

Bryan Goldberg: Okay. Next question is from Deepak on AI. Daniel, can you discuss your thoughts on what opportunities and risks there are from generative AI, specifically on music creation? Do you think these developments have potential to materially shift economics towards distribution platforms like Spotify over time?

Daniel Ek: Yes. Well, so again, to caution everyone, this is very early days, and it’s an incredibly fast developing space. As I mentioned before, I don’t think I’ve ever seen anything like it in technology, how fast innovation and progress is happening in all the really both cool and scary things that people are doing with AI at the moment. But I think it’s important. I guess on the risk side would be not just for Spotify, but I think for our — the entire creative ecosystem is obviously the question around copyrights and who owns what copyrights and what the fairway would be to attribute value when you’re doing things in name and likeness situations or inspired by a certain artist, et cetera. I think the whole industry is trying to figure that out and trying to figure out training and I would definitely put that on the risk account because there’s a lot of uncertainty, I think, for the entire ecosystem.

But on the positive side, to flip on that for a moment because I don’t think that’s been as highlighted as part of the story. One, I think this could be potentially huge for creativity on the positive side. I go in and talk a little bit more in detail about this on for the record podcasts. So that’s a little bit of a plug for you guys to listen to that if you’re interested in understanding more. But the short of it would be, if you really think about it, with that now these conversational interfaces, it will allow people that perhaps don’t know anything about how to play a music or even know these complex software’s music production software tools to now create just using their voice, instruct the AI to make something to sound a little bit more upbeat, make something sound a little bit more like add some conges into the mix when you’re creating a drum pattern or something like it.

And that has the chance, I think, to meaningfully augment that creative journey that many artists to do. And you could even imagine someone just humming something and then the AI helping you out by creating a backdrop that you then can add it and alter into your existing DAW , which is the music sort of software environment that many producers and music creators are doing. And that should lead to more music. And that more music, obviously, we think it’s great culturally, but it also benefits Spotify because the more creators we have on our service the better it is and the more opportunity we have to growing the engagement and growing the revenue. So that would be on the upside, which a lot of people aren’t talking about. And then, of course, there’s entirely new potential products that perhaps can happen where you can have users creating their own music and perhaps Spotify could be a conduit of that, but I think it’s way too early to speculate on those types of things at present moment.

Bryan Goldberg: Okay. Another question from Rich Greenfield. At the Investor Day last year, you talked about introducing three new verticals looking beyond music, podcast and audio books. When should we expect to hear more?

Daniel Ek: Yes. So obviously, I don’t have anything to announce at this moment. But in the pipeline, there’s two that’s progressing very nicely out of the three. And then there’s a few candidates of the third that’s in a little bit of an earlier stage than that. So again, this just be kind of more hinting at that — we have things in the work. I mentioned this prior in my opening remarks, many of these things that we are working on is not the product of something that we started three months ago or six months ago, but we have projects that’s being worked at Spotify by teams for sometimes 2, 3, even 4 years before we are ready to announce them for the world. So we have a very good sense of what those are, those three, two of them are right now progressing very nicely, not ready yet to announce them. So we’ll see when they’re ready for prime time.

Bryan Goldberg: Okay. Question coming from Benjamin Black on advertising. Could you give us an update on the advertising backdrop? How have ad sales trended so far in April? Shouldn’t you benefit from easing year-on-year comparisons as the year progresses?

Paul Vogel: So on the second part of the question, yes, the comps do get easier throughout the year, which will definitely benefit us. And in terms of April, we feel like we had some momentum coming out of March and April, so that’s positive. That being said, I think we felt that there was some momentum in Q1 and ended up being pretty choppy as well. So I think we’re optimistic but also cautious — maybe cautiously optimist would be the right word because I think we feel like there’s some momentum there. I think we feel good about where we’re positioned on an advertising standpoint. But just given the macro uncertainty, I think we’ll — caveat is cautiously optimistic.

Bryan Goldberg: Okay. Another question from Doug Anmuth on podcasting. Can we get an updated view on timing for podcasting profitability? And when should we expect to see a meaningful inflection in ad-supported gross margins?

Paul Vogel: Yes. So no change to what we said. Look, we think we continue to see the loss — the podcasting loss continue to get better throughout the year and the targets we gave at the Investor Day with respect to podcasting breakeven and then profitability have not changed. So we still feel good about that. And then the ad-supported gross margins, I mean, there’s really 2 factors that are impacting that, which we’ve talked about. Podcasting is a big part of that. So as the podcasting loss turns to breakeven and then profitability that will obviously help the ad-supported gross margins a lot. And then we do have some markets in regions where our ads gross margins are quite where they are in some of our more established and developed advertising markets.

And so we’re still working on getting some of those markets kind of at parity with our more developed ad market. So it’s a combination of the two, but obviously, the transition from the podcasting business from being a drag to a breakeven and profitability will be a big help.

Bryan Goldberg: All right. We’ve got time for a couple more questions. And it looks like Doug Anmuth has a follow-up on operating expenses. You had 36% growth year-on-year in OpEx in the first quarter with roughly half of that driven by social charge movements and severance. How should we expect that to improve throughout 2023? And what are the key areas of leverage?

Paul Vogel: Yes, it’s a great question. And so — and thanks for bringing it up. Of the 36% growth, about a third of that was social charges and then another 600 basis points or so from severance. So to your point, yes, it was about a big chunk of the OpEx expense growth came from that. I think you’ll see a couple of things. One, if you look at our head count from a year-over-year basis, we’re still up as we go throughout the year, assuming no changes to headcount is in guidance. I’m just using this as sort of an illustrative example, assuming no changes in headcount, those comps just get easier throughout the year as we start to lap the reduction we had a few months ago. And again, Q1 year-over-year is pretty tough, and it gets easier.

So that will help on the leverage side. And then you saw in Q1, we definitely had some leverage on the marketing side where we spent a little bit less than expected, and we’re still able to grow users and subs pretty phenomenally. And as Daniel said, we’re not reading into that too much after one quarter. But it’s obviously something we’re monitoring to see how that goes for the rest of the year.

Bryan Goldberg: Okay. We’ve got a question from Jed Kelly. We’re seeing the stock price benefit from strong MAU growth and improving gross margins. If this continues, does this place Spotify in a favourable position to negotiate a “win-win” outcome with the labels on any incremental price increases?

Daniel Ek: Yes. I don’t know that I think the stock price impacts our negotiations with our content partners. So I don’t think that has any real impact. As I tried to describe before, usually, when we’re negotiating outcomes, it’s very rare that it’s a single issue. We are negotiating with them. It’s usually — it’s a package of different things that we tend to agree on. So one can almost think of them as bilateral treaties, so you kind of have to negotiate them for a while, and there’s a lot of puts and calls into those things. So it’s a whole sort of set of discussions, and there’s a number of different variables that go into them. And again, I think we’re ready to raise prices. I think we have the ability to do that, but it really comes down to those negotiations.

Bryan Goldberg: All right. And our last question today is going to come from Maria Ripps on advertising. Could you discuss and/or rank order what you consider to be the biggest drivers of advertising in 2023? How much of the growth will be a function of an improving macro backdrop, increased advertiser engagement with the emerging formats, greater inventory availability, given recent investments or anything else?

Paul Vogel: Yes, I think there’s a lot in that question. Look, I think there’s a lot to our advertising growth, and so let’s kind of unpack it. So some of it has been — as we talked about, we’ve invested in regionally and growing some of our sales capabilities in Europe and Rest of World. We saw some of the benefit of that in Q1 and there’s sort of an expense ahead of the benefit there. And I think we talked about that throughout 2022. So that’s one, getting some more leverage on some of the investments we made last year just on the people side. Two would be, as we keep talking about, we’re really going to lead with technology innovation here, better measurement, better attribution, better targeting. And those are improvements that we expect to see throughout 2023 and beyond.

So there will be some benefits from that as well. And then as you said, the macro is the big wild card. And so it’s hard to predict it. We think that we continue to build out a platform that will be really strong and will benefit when the macro gets better and something that can still outperform even when the macro remains uncertain.

Bryan Goldberg: All right. Thanks, Maria. And that concludes our Q&A session for today. And now I’m going to turn it back over to Daniel for some closing remarks.

Daniel Ek: All right. Well, thanks, Bryan. In closing, this was a phenomenal quarter with significant outperformance, and I continue to feel really good about what we’re accomplishing. We closed out 2022 on a high note, and this quarter continued that momentum. But more importantly, we are consistently seeing that our long-term approach to innovation is working. And as we move forward with an increased focus on efficiency, we are even better positioned to translate these efforts into a better business performance. So thank you again for joining us. And as usual, feel free to check out our, for the record podcast dropping later today.

Bryan Goldberg: Okay. And that concludes today’s call. A replay will be available on our website and also on the Spotify app under Spotify earnings call replays. Thanks, everyone, for joining.