Spotify Technology S.A.

Good morning and welcome to Spotify's third quarter 2023 earnings call and webcast. All participants are in a listen only mode. If you require operator assistance at any time, please press star zero. As a reminder, this conference call is being recorded. I would now like to turn the call over to Brian Goldberg, head of investor relations. Thank you. Please go ahead.

Thanks, Operator, and welcome to Spotify's third 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 hashtag SpotifyEarningsQ323. 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 email investorrelations at ir at 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 can materially differ because of factors discussed on today's call, in our shareholder deck, 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 shareholder deck, in the financial section of our investor relations website, and also furnished today on Form 6K. And with that, I'll turn it over to Daniel.

All right. Hey, everyone, and thank you so much for joining us. I hope you've had the opportunity to review our shareholder deck. Bottom line, it's a really exciting time at Spotify, and I'm super pleased at how the business is performing. It was a truly stellar quarter and one that clearly illustrates that we're making great progress against the goals that we laid out for you at our 2022 Investor Day. Q3 was our second largest quarter ever for MAU Net Edition. And as we look ahead to the end of the year, you'll also see that we're forecasting to hit another big milestone, reaching more than 600 million monthly active users at the end of the year. This puts us well on our way to reaching more than 1 billion global users by 2030. And to put that number into context, 15 years ago this month, Spotify went live in France, Finland, Norway, Spain, Sweden, and the UK. It's been a wild ride. Next, let's turn to the strength of our subscriber growth. We walked into 2023 thinking we would do just over 20 million in net subscriber ads for the full year, but we're actually on track to deliver 30 million, which is a significant beat from where we thought we would be. In fact, this will be the second biggest full year gain in net subs additions since going public. This momentum is especially significant when you put it in the context of the price increases that went into effect in Q3. And as we previously shared, because of our confidence in our product and our ever-expanding content offering, we felt the timing was right to raise prices across more than 50 markets. I know some of you wondered how we'd weather these increases, so I'm really pleased to report that this went as well as we'd hoped, even modestly exceeding our expectations. All of this sustained growth is a testament to the exceptional value Spotify continues to deliver globally. And with our new focus on operational efficiencies, we managed to achieve this with reduced marketing costs. The essence of our business model is to deliver unparalleled value to our user base through an ever-improving consumer and creator experience. This is coupled with every now and then expanding our ecosystem through new verticals to deliver even more value. And this, of course, nicely segues into the groundbreaking audiobooks offering for premium subscribers that we announced a few weeks ago. So not only will our expansion into this category supercharge the growth of the audiobooks format, but it also will drive engagement and reduced churn, which further enhances our value proposition. And this, of course, gives us more flexibility for our business. And while it's still too early to see the impact in our numbers, initial signs from subscribers in the UK and Australia are incredibly positive as we bring them more content to discover. In the first two weeks since launch, premium subs in these two markets are loving the breadth of titles and have already listened to over 28% of the catalog. They're flocking to fiction, memoirs, sci-fi, and fantasy, and I can't wait to see what US subscribers gravitate towards when we launch there soon. In terms of how all of this flows down to the underlying fundamentals of the business, including, of course, revenue and gross margin, I'll turn it over to Paul to provide more detail, and then Brian will open it up for Q&A.

Great. Thanks, Daniel, and thanks, everyone, for joining us. I'd like to add a bit more color on the quarter and then touch upon the broader performance of the business and our outlook. Q3 was a very strong quarter. MAU grew by 23 million to 574 million, and we added 6 million net subscribers, finishing at 226 million. Both MAU and subscriber growth continue to be well above our historical trend and outperformed forecast. On the revenue front, we grew 11% year-on-year to $3.4 billion during the quarter. Importantly, our FX neutral growth was 17% and accelerated 300 basis points versus the prior quarter's result, reflecting the early effects of the new pricing and accelerated advertising results. Turning to gross margin, gross margin of 26.4% was above guidance by 40 basis points due primarily to favorability in our music business. Moving to operating expenses, growth in the quarter was lower than forecast due mainly to lower than expected personnel and related costs as well as marketing spend. When combined with our better gross profit, we achieved an operating profit of $32 million in the quarter. We believe this is an important inflection point for the business as we start to see the benefits of our focus on speed and efficiency and progress towards delivering on the profitability targets we laid out to you at our investor day last summer. Finally, free cash flow was positive $216 million in Q3. Looking ahead to fourth quarter, we are forecasting 601 million MAU, an increase of 27 million from Q3, and 235 million subscribers, an increase of 9 million over Q3. This has us adding about 112 million MAU for all of 2023, which is nearly 60% above our four-year historical trend, and adding 30 million subscribers for the year, which is 12% above the historical trend. 2023 should finish with the highest net additions for MAUs and the second largest for subscribers in company history, but actually the largest if you exclude the impact of Russia. We are also forecasting $3.7 billion in total revenue, a gross margin of 26.6%, and an operating profit of approximately $37 million. Turning to revenue, we are forecasting a 300 basis point headwind to growth, given the strengthening of the euro relative to the dollar. Excluding this effect, our constant currency revenue would be closer to 3.8 billion, reflecting our expectation for accelerating currency neutral growth to 20% year-on-year versus the 17% growth we delivered in Q3. This acceleration is aided by a full quarter benefit of the price increases we announced in Q3. In sum, we are very pleased with how we're tracking into year end. While it's too early to give guidance on 2024, I do want to point out that we are confident in our path and expect another year of meaningful progress towards delivering on our profitability goals for the business. And with that, I'll hand things over to Brian for Q&A.

Thanks, Paul. Again, if you've got questions, please go to slido.com, hashtag SpotifyEarningsQ323. We're going to be reading the questions in the order they appear in the queue with respect to how people vote up their preference for questions. And our first question today is going to come from Matt Thornton on efficiency. Daniel and Paul, you've been successful in wringing out cost efficiencies across marketing personnel and podcasts. Do you feel the business is at steady state now on the cost side, or do you see more opportunity?

Yeah, I'll start and maybe Paul can fill in. Yeah, we feel, you know, as we walked into the year, just to level set and remind everyone, we talked about having a great product, but also needing to become a great business and to prove that out to investors. So that's been very much the focus for Paul and myself and the rest of the management team throughout this year. And I think you're really starting to see this nicely being proved out with the delivery of this quarter's results. But it really is two parts here. One is the thing that I said in my opening remarks, which is we're focused, as always, on providing great consumer experience and creator experience. And that is what allows that top-line growth to then translate into that business side. But a new part of the Spotify modus operandi is our focus on efficiencies. and we're starting to see some leverage here coming into play, but this is the state going forward. Paul, myself, and the rest of the management team is constantly looking at how we can make improvements, and we're constantly finding new ways to bring more efficiencies out of the business. So I'm pleased with the progress so far. We've seen some improvements, but you should expect us to continue to look for more improvements going forward because that's just our modus operandi.

Yeah, and I would just add, we're obviously very pleased to see some of the initial success with an operating profit in Q3 and guidance for operating profit in Q4 as well. And our expectations are now that we will consistently be in the black moving forward. Obviously, you never know what can happen in any one quarter, but we feel good that we're on a different trajectory and we've hit an inflection point with respect to profitability of the business.

Great. Next question is going to come from Justin Patterson, a related question on efficiency. Daniel, you began the year restructuring business units with the goal of greater efficiency and product velocity. As we head towards 2024, where do you see the next areas to be more efficient while driving innovation? And Paul, how should we think about expense puts and takes of audiobook scaling?

Yeah. As I mentioned in my last response, it's very much a focus, I think, across the base. And maybe just to highlight one example. So as the product and technology teams are working on this focus of efficiency, everyone at the company is tasked at it. Everyone has their own deliverables. So we constantly end up finding ways where, for instance, we are on the compute side, on our infrastructure side, finding from engineers that there are better utilization patterns doing that. And they're able to save expenses as we're doing that. And that's then improving on the streaming delivery cost side. that we're ending up having. And this is just one example where it's not that we're looking for top-down initiatives as much as we're seeing a lot of bottom-up initiatives that are adding up to the numbers. You saw it also very clearly in our marketing spend. We were able to deliver better top-line numbers but with less spend because we're now focused on this efficiency goal. And I think that's the power of the Spotify team and the work that everyone's doing. But that also gives Paul and myself great comfort in that there's great opportunities out there as long as we get the teams focused on it.

Yeah. And then with respect to kind of the audiobook side of the question, let me take a step back for a second. If you look at 2023, we said from the start of the year that we expected to see gross margins sequentially improve every quarter of 2023. You know, obviously, we have the benefit of knowing what we're planning to do throughout the year. And so we knew all the initiatives were going to come in play, both the price increases and the launch of audiobooks. And so all of that played into the commentary we had that we would see that sequential growth. And we're glad that that's what we actually were able to realize and expected to realize in 2023. As you look into 2024, we expect to see a continued improvement in our gross margin trends and a continued improvement in our operating income trends as well. Obviously, there's some investment when it comes to the audiobooks business, but there's nothing about the launch that will derail our progress on the gross margin side or our progress on the operating income side, or probably just as important, our progress on the free cash flow side. So hopefully everyone noticed we did $200 million of positive free cash flow in Q3. We feel good about the free cash flow trajectory as well in the business. And so We're very encouraged with kind of how 2023 is forecast to end. And we're very optimistic with respect to, you know, the early indications of where we think 2024 will be.

All right. Next question from Rich Greenfield on our subscribers. Is this your first ever North American subscriber loss? And is that due to churn from the price hike? And how does this inform future price hikes? And did premium churn subs shift to the free ad supported tier?

Yeah, so the first part of the question, we actually did not lose subs in North America. So I think what's going on here is the math is you're coming up with a number that's based on three rounded numbers, right? So you've got a prior quarter number, a current quarter number that are both rounded. as well as a percentage number that's rounded. So we actually grew subscribers in North America in line with expectations. Actually, all of our regions performed well from a subscriber perspective and relative to expectations. It was pretty broad-based across the board. So we did not lose any subscribers in North America. It was actually a good quarter there. And so I think it's just rounding. And if that's unclear for anyone, please reach out to the IR team after, and we can kind of walk through how that works. And then with respect to the price increase, as Daniel mentioned in his opening, we feel really good about how that went down. We have, you know, when you think about a price increase, there's really the two components you're always going to be focused on. One is anything that elevates churn and then to anything that impacts the gross intake in any way. And so what was great was, you know, the churn was right in line with expectations. And we talked about in the past when we've raised prices that, you know, churn had never been that material. And it was similar this this go around. And then I guess even just as importantly, we outperformed on the gross intake side, which is one of the reasons why we outperformed on overall subs. So churn from price increases right in line with expectations and then gross intake even better than expected, which led to the outperformance.

All right, another question from Justin Patterson on AI. Daniel, Spotify has made a lot of progress with AI through DJ and the AI voice translation pilot. Could you talk about how you view these products affecting listener engagement and creating opportunities for creators? In turn, what type of monetization opportunities does this create for Spotify?

Yeah, I think the primary way we look at AI is that, and certainly through the tools that you're mentioning, it is about increasing engagement with the service by creating even more compelling value. And the primary way we think about that is, of course, leveraging AI to create or augment already amazing content. So a great example would be through AI DJ, which mimics some of the behavior on radio that's that companion that provides context around the music you're hearing. And X is doing an amazing job in providing context, cultural context, all of the things that you love radio for but now coming through a personalized DJ for you. I think that nicely scales what AI can do. It can personalize things. It can contextualize things. It can provide this thing at a scale that would be impossible to do by humans. And then on the AI voice translation part, it is a meaningful one because if you fundamentally think about Spotify, the more content we have on the servers – the generally better engagement we start seeing because the more likely it is that we're able to serve up something that consumers love. And so the AI voice translation thing is amazing both for creators and consumers. For consumers, especially in non-English language content, they generally have a lot less content to consume. And for many other creators, this is an ability for them to be able to go with their content through many more geographies that they currently aren't able to penetrate at all. And so this is one of those things where you've heard me say this before, but the win-win thing is what we look for at Spotify, something that's great for creators and great for consumers. It's usually great for Spotify, and this is exactly that. And then the primary way you should think about these initiatives, it does create greater engagement. And that greater engagement means we reduce churn. And that, of course, greater engagement also means we produce more value for consumers. And that value-to-price ratio is what then allows us to raise prices like we did this past quarter with great success. And we're constantly focused on improving that ratio all the time by just adding more and more and more value for consumers. And I think that's what you can see with our top line growth coming into the year with MEUs growing very nicely. And then, you know, eventually, you know, segwaying itself into better subscriber growth, which then, of course, leads to better revenue growth there. And so it's kind of this trifecta of things, but it really starts with improving the consumer and creator value proposition, which we're focused on, and AI can be a real enabler there.

All right, another question from Matt Thornton on growth drivers. What are the key incremental drivers of growth as we look into 2024? For example, can marketplace grow faster than the core business? Do you expect audiobooks to move the needle in 2024? Is ticketing and merch at all material yet? What about a full global rollout of a new UI, AI, DJ, or anything else?

Maybe I'll start and then Paul can chime in. So I think for 2024, just to set the expectation, it is about delivering on the core. And I think hopefully investors should be able to see now that the core has plenty left to offer when it comes to growth. And we feel really good about the growth we've had in 2023. And we can nicely see that segwaying back into 2024. And that's, of course, delivering against all of the things we already have. So our advertising business on one hand, seeing more scale there, which will drive more efficiencies. You mentioned marketplace. We're heading very nicely there, too, on the business side. And we're offering more and more products to people on the marketplace side, which is seeing better and better results relative to all the other marketing spend that labels and artist teams are encountering, which, of course, is a great testament for meaning more and more artists will keep on investing with us there. And then on the product side, you're right in pointing out the new UI. It is being fully rolled out. So we're seeing great results with that. AI DJ has been rolled out to many more countries already, but that's the English language one. So you should definitely expect to see local versions of the AI DJ to allow for even more engagement. But that engagement, as I mentioned in my previous response, allows for more flexibility for the business. That allows for either more top line growth through a better proposition at a low price, which will mean we'll grow even faster. Or we have the ability, of course, if we produce a great value to raise prices again to keep that value and price ratio high. at a good clip. So there'll be plenty of opportunities in 2024 for the core business to produce. And that's what you should expect. We are making great progress on ticketing and merch and all of these other fronts too, but they are not yet material drivers. So I don't want any investor to have that expectation, but long-term they will be, and we're excited about them. But for 2024, it's about delivering on the core, which has plenty more to give.

Yeah. And I would just add real quickly to Daniel's point. Obviously, we'll have almost three full quarters of the price increase from a growth perspective on the revenue side impacting 2024. And then, as Daniel mentioned, advertising business has improved throughout 2023. So we're hoping that advertising can continue to be a driver in 2024 as well.

I forgot to mention, by the way, on the audiobooks side, which you asked about as well. So, yes, we do think audiobooks will be helpful to the 2024 results as well. But it will be early days, of course. It's still an early product development, early launch. And the primary focus is to bring it out in more markets.

Great. Another question from Justin Patterson. This one's on subscription pricing. Spotify is now delivering a lot more value through product innovation and the inclusion of audiobooks. It also seems like churn was minimal from recent price increases. So given these dynamics, how's your approach towards pricing as a lever changing versus what we've observed in the past?

Well, I think that there's two paths to mention. One was before this prior quarter, and one is going forward. And we talked about this when we did raise prices that we were adding a leg to the stool. So, again, to kind of bring everyone back and put context – we had plenty of growth drivers we can grow in a market by keeping the price relatively low and grow top line that grows the market and grows our revenue we can of course again increase the engagement even further and have more advertising that's another way to grow our business And then we have the third level lever, of course, which is to grow through price increases. We hadn't up until that point used the lever of price increases to a great extent. We did. I feel really good about what we learned there. So it's definitely part now of the arsenal of tools we can deploy to keep growing the business. And I think you should expect us to use that. when we see the appropriate dynamics. But the primary thing, again, just to level set with investors, why you're seeing the top line growth the way you are is because we're providing an amazing value to consumers. That is the primary thing we are focused on to keep on delivering amazing value. And then when we get to that amazing value, then of course we have more flexibility and we can choose to increase prices more. to get that value to price ratio in the right balance. So we definitely have a lot more opportunities going forward, and we feel really confident given what we've learned in this price increase.

All right, next question is going to come from Benjamin Black on gross margin. You've guided to sequentially improving gross margins for all of 2023. When we look forward to 2024, given the price increases and improving profitability of podcasts, should a similar gross margin progression hold true?

Yeah. So I'd say a couple of things here. One is for first on the podcasting side. Yeah, we've seen the improvements in the podcasting business. And we talked about how that's been a drag on our gross margins. And we expect it to to soon reach break even and then become something that's actually additive to gross profit. So we're on track on the podcasting side there. And that should continue to be helpful into 2024. Same with the music side in terms of incremental gross margins there as well. When you think about the audiobooks side of it, there's obviously some investment anytime you launch a new business. But again, as I said earlier, we feel really good about continuing to have a nice progression in gross margins into 2024. We'll give more specific guidance on the next earnings call. The only thing is, you know, when you think about sequentials, we do tend to have some seasonality in Q1 versus Q4. Some years it's more material than others. Obviously, advertising, it tends to be one of the slower quarters from an advertising perspective. But we are expecting gross margins to be to be improved in 2024. And we feel really good about hitting all the targets we talked about the investor day and the significant progress we've already made to date.

All right. Next question is from Doug Emmeth on audiobooks. Can you talk about the cost structure and the economics of audiobooks? How should we think about the impact of gross margin in fourth quarter and into 2024? And what gives you confidence in adoption by subscribers?

Yeah, so I guess I'll just kind of read what I said, which is obviously there's always going to be there's some cost whenever you launch a new product. But you'll see that the gross margins are up Q3 to Q4. And as I've said a couple of times now, we do expect gross margins to be up again in 2024. And we expect to continue to see that nice progress we've made on the gross margin side and the operating profit side into 2024. and their confidence on adoption of subscribers. I'll start and maybe Daniel has some thoughts here. But I think as Daniel mentioned, it's early days, but we feel really good about the first couple of weeks to month in the markets we've launched in. And we just believe it's gonna be a great product. It's gonna open up more authors to more consumers. And what we've seen in the past is when we enter a business, the business becomes bigger. The podcasting business is a much bigger global business because Spotify is a part of that business now. And we think we're going to have the same benefit on the audiobook side, which will be great for authors and great for consumers.

Yeah, and we feel know great again um as i mentioned in my opening remarks uh with the adoption in in uk and australia and and just as a reminder to investors we are planning to launch in the us this coming winter as well so you're definitely going to see us expand audiobooks and already with this initial launch it is positive it's early days But we're encouraged with what we're seeing. And the most important thing is when you think about the consumers that are trying out the experience, they're loving it and they're finding it a really natural part of the Spotify experience and a great value add. And that speaks to this earlier point we made about sort of consistently improving the experience by adding more things for creators and consumers.