Categories Earnings Call Transcripts, Leisure & Entertainment

Spotify Technology S.A. (NYSE: SPOT) Q1 2020 Earnings Call Transcript

SPOT Earnings Call - Final Transcript

Spotify Technology S.A. (SPOT) Q1 2020 earnings call dated Apr. 29, 2020

Corporate Participants:

Paul Vogel — Chief Financial Officer

Daniel Ek — Founder, Chief Executive Officer and Chairman

Analysts:

Mark Mahaney — RBC Capital Markets — Analyst

Ben Swinburne — Morgan Stanley — Analyst

Jessica Reif Ehrlich — Bank of America — Analyst

Doug Anmuth — J.P. Morgan — Analyst

Rich Greenfield — LightShed — Analyst

Michael Klein — — Analyst

Richard Kramer — — Analyst

Ross Sandler — Barclays — Analyst

Shugad Manon — — Analyst

Matt Thornton — SunTrust — Analyst

Heath Terry — Goldman Sachs — Analyst

Michael Morris — Guggenheim — Analyst

Eric — UBS — Analyst

Hamilton Faber — Atlantic Equities — Analyst

Brian Russo — Credit Suisse — Analyst

John Egbert — Stifel — Analyst

Maria Ripps — Canaccord — Analyst

Emilio — — Analyst

Justin Patterson — — Analyst

Daniel Jones — — Analyst

Lloyd Walmsley — Deutsche Bank — Analyst

Presentation:

Operator

Welcome to Spotify’s First Quarter 2020 Financial Results Question-and-Answer session. A copy of the Company’s shareholder letter, issued premarket open today, is available on the Investor Relations website, investors.spotify.com. [Operator Instructions]

I will now turn the call over to Paul Vogel, Chief Financial Officer. You may now begin your conference.

Paul Vogel — Chief Financial Officer

Great. Thank you, and welcome to Spotify’s first quarter 2020 earnings conference call. I hope everyone is staying safe during these unusual times. As is the case with just about everyone, our team will be hosting the call entirely remotely. Our CEO, Daniel Ek, is participating from Stockholm, and I’m at my home office in New Jersey.

Turning now to the call. We will start with opening comments from Daniel. And after the remarks, Daniel and I will be happy to answer your questions. New for the quarter is that we will be taking questions exclusively through Slido. Questions can be submitted by going to slido.com, slido.com, and using the code hashtag, SpotifyEarnings. Analysts can ask questions directly into Slido, and all participants can then vote on the questions they find the most relevant. We hope this keeps the call as efficient as prior quarters but increases the transparency around which questions get asked and in what order. If for some reason you don’t have access to Slido, you can email Investor Relations at ir@spotify.com, and we will add your questions.

Before we begin, let me quickly cover the safe harbor. During this call, we will make 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 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 page and also furnished today on Form 6-K.

And with that, I will turn it over to Daniel.

Daniel Ek — Founder, Chief Executive Officer and Chairman

All right. Hi, everyone, and thanks for joining us. Before jumping into our quarterly results, I want to acknowledge these extraordinary times that have profoundly impacted the world around us. On behalf of the entire Spotify team, I want to express our deepest appreciation to the healthcare workers and first responders around the world who are keeping us safe. I also want to acknowledge all of the creators whose livelihoods have been altered, from the artists whose music continues to inspire us to the podcasters who keep us entertained and informed. We know that many creators with touring and live shows canceled, the pandemic has brought unthinkable levels of uncertainty into their lives.

And like every other company, we’re operating with a new — in a new reality. And it’s, of course, premature to say when things will return to normal or what the normal will look like. But despite this uncertainty, Q1 was a strong quarter for Spotify. We continued to see impressive user growth, up 31% from last year. In fact, we saw faster growth in all four of our regions in the first quarter of 2020 compared to Q1 2019. And we met our guidance by nearly every measure, growing both our subscribers and MAUs.

The one exception was advertising revenue, which is a very small portion of our total revenue. Obviously, a loss in ad revenue is something that every media company is experiencing during this challenging time. So in sum, our overall business is less impacted than many others.

Podcast consumption grew by triple digits during the quarter compared to just a year ago. It was also our biggest quarter ever for organic podcast creation. And while many companies have had to adjust their output during this crisis, almost all of our original and exclusives have either maintained or increased their pace of new releases in response to audience demand. For example, our original podcast Science Vs and Fest & Flauschig have both doubled their weekly releases. And we also launched a new daily news podcast in Germany that has already become the second-largest show in the country and regularly ranks in the top 20 worldwide. And we’ve been encouraged by the wave of creativity in new podcast creation this quarter. More than 70% of new podcasts on Spotify were created with Anchor and within our own ecosystem.

With 286 million monthly active users and 130 million subscribers, it’s clear that audio and Spotify continue to play an important role in our users’ lives. Our solid performance is the result of the audio-first strategy that we put in place just over a year ago. And we’re up 31% in both MAU and subs year-over-year. And while we saw some minor impact from COVID-19 during the back half of the first quarter, MAU and subs remain in line with our forecast and held steady. In hard-hit markets like Italy and Spain, we saw more of a decline in daily active users and consumption. But over the last few weeks, we’ve seen listening start to rebound in a big way.

In this environment, we’ve had to suspend what we normally believe and think differently about our business. So for example, when we saw consumption starting to decline, we would have assumed that MAUs and paid subscribers would be negatively impacted. But that wasn’t the case. In fact, both new and reactivated MAUs grew substantially even during lockdown periods in major markets. And we believe this is a testament to how engaging our platform and ecosystem are to our users.

And last year, as you all know, we outlined a vision to be the world’s largest audio platform, and we’ve made significant progress. We now have more than 1 million podcasts on the platform, and we’re the number 1 audio service for podcasts in dozens of countries around the world and quickly gaining ground where we’re not.

And I know many are wondering how we will continue to weather the storm. With so many unknowns, there are some questions we simply can’t answer at this point. But I can say that I’m confident that we will continue to be in a position of strength when this is behind us. And that’s because of our model, our scale and our superior user experience and, of course, our content pipeline. These are the fundamentals that have fueled our success and will continue to do so in the future.

When I look ahead both short and long term, I’m always thinking about what’s Spotify’s role within the larger ecosystem. And while most focus is on competition between streaming services, we continue to be focused on the billions of users that are listening to linear radio. The 20-year trend is that everything linear dies and on-demand wins. This is a trend that we suspect will be accelerated by the COVID pandemic. Time at home has moved people out of their cars, requiring them to shift their listening behaviors, and that’s when they discover streaming. And Spotify is best positioned to capitalize on this. And because we offer personalized and on-demand experience, they end up staying.

So in my mind, our competition is actually those learned and long-held user behaviors. For us, it will always be about capturing the share of time listeners spend elsewhere and prove out that their time is far better spent with us. And we see this happening now on our platform as routines like commuting to work and going to the gym were disrupted and consumers started to form new habits. And of course, the ubiquity of our platform was a true advantage for Spotify.

And because we’re available on over 300 devices across 80 hardware brands, we’re accessible to users even after listening behaviors have changed. For example, while listening in the cars declined, listening on gaming consoles is exploding. And we continue to see increased listening on home speakers and through TVs.

And on the music front, we were pleased to reach a long-term licensing deal with Warner Music that covers all of our existing markets and paves the way for us to enter new ones. We also delivered some of the year’s most popular music releases to our fans. The Weeknd album, After Hours, had the biggest debut of the year so far, and Dua Lipa’s album, Future Nostalgia, broke three Spotify records when it was released in late March. Fans are craving new music, and we expect to see more artists and labels move forward with their planned releases.

But it’s not just about delivering relevant content. In the midst of an economic downturn, Spotify’s free tier and freemium model are more valuable now than ever. It’s important to remember that just over 60% of our paid subscribers come from our free tier. So growing the top of the funnel has always been a priority for us.

And with more and more people dealing with the financial stress, our free service provides a bridge to ensure users don’t have to give up access to their favorite podcasts and music. In fact, over the last few weeks, we’ve seen an increase in the number of users coming to the platform for our free service. Many of these listeners are returning to Spotify from lapsed accounts, and some are joining from other streaming providers. As you know, the majority of our competitors do not have a free tier. And that, of course, makes Spotify a more appealing option in this environment. This should allow us to expand the pool of subscribers available to us as the economy recovers.

No one knows how long this will last or what the long-term implications will be, but we’re very optimistic because of the many positive indicators we continue to see in our business and our strong cash position and our strong belief that we will continue to grow and gain share. There have been many unknowns and surprises throughout this crisis, but I’m really proud of our team and pleased by how well our business has responded.

I will now turn it over to Paul to open the call for questions.

Questions and Answers:

Paul Vogel — Chief Financial Officer

Great. Thanks, Daniel. And again, if you have questions, please go to slido.com, hashtag, SpotifyEarnings, and we’ll read the questions in the order they come in with respect to people voting up their preference for questions. The first question comes from Mark Mahaney.

Mark Mahaney — RBC Capital Markets — Analyst

How are you thinking about long-term gross margins for the sub and ad segments given the allocation of all podcast content costs to the ad segment?

Paul Vogel — Chief Financial Officer

So there’s really no change in thinking there. We mentioned in the shareholder letter that we made an adjustment from an accounting perspective in terms of how we allocate costs for the podcasting business. Historically, we had allocated across both free and premium. Now all of the revenue associated with podcasts and all of the costs associated with podcasts will both be in our Ad-Supported business. It doesn’t in any way change our view of podcasts or the importance of podcasts for the Premium business with respect to engagement, with respect to consumption and with respect to users. This is just a decision we made from an accounting perspective. So it has no impact on our consolidated gross margins. We manage the business for our consolidated gross margin and all of our expectations in terms of how that will change and improve over time. This has no impact on that whatsoever.

Also Read:  Palatin Technologies, Inc. (PTN) Q1 2021 Earnings Call Transcript

The next question, also from Mark.

Mark Mahaney — RBC Capital Markets — Analyst

Could you elaborate on the gross margin improvements stemming from — oops. There’s our — yeah. It just got moved — stemming from the core royalty component due to product mix. Does this mean gross margins benefited from the shift towards podcasts?

Paul Vogel — Chief Financial Officer

No, what that refers to is product mix can impact the gross margin in a couple of ways. One is when Premium is slightly more than Ad as — relative to our forecast. Because Premium has a higher gross margin, it can impact the gross margin positively that way. It also means that sometimes, the mix of products within Premium relative to our forecast with respect to standard and Family and Student, that can also impact the reported gross margin. So that’s what that is in reference to. Next question comes from Ben Swinburne.

Ben Swinburne — Morgan Stanley — Analyst

Can you provide some color on the 500 basis points drag to advertising gross margins called out in the letter as unusual? As advertising revenues slow, can you help us think about the incremental margins and whether minimum guarantees will increase the proportion of revenue decline that fall to gross profit?

Paul Vogel — Chief Financial Officer

Yeah. So the 500 basis point unusual, there’s — oftentimes, the quarters can be lumpier. We had some onetime items in the quarter. They particularly hit the advertising gross margin. They’re not going to recur. So we try and call these things out if possible. So that’s what that is related to. It’s basically some onetime issues around publishing that will not happen again.

And with respect to advertising and a decline on gross margins, so we have modeled this out. We don’t think there’s much of a risk right now to our forecasted advertising gross margin from an even further slowdown in advertising, which we are obviously not forecasting different from what we put in our guidance. But we don’t see much of a risk to gross margins from a further slowdown in advertising with respect to any of the guarantees. Next question comes from Jessica Reif Ehrlich.

Jessica Reif Ehrlich — Bank of America — Analyst

In regard to your new Warner Music agreement, can you discuss key changes, including how podcast revenue will be contemplated and length of the contract, etc?

Daniel Ek — Founder, Chief Executive Officer and Chairman

Yeah. Obviously, we can’t comment on the specifics. What I can say is to up-level the conversation, the focus for these renewals were really around establishing the Marketplace, establishing podcasts and the shift from music to audio. And obviously, we wouldn’t have done the deal if we didn’t — weren’t happy with the terms that we agreed on. And this is a multi-year deal that covers all existing markets and new markets as well. So we’re very pleased with that.

Paul Vogel — Chief Financial Officer

Great. The next question comes from Ben Swinburne.

Ben Swinburne — Morgan Stanley — Analyst

Can you spend a minute on the lowered revenue outlook? You mentioned FX and ad sales are the biggest drivers with FX the largest at almost half. That suggests a lower outlook for advertising is a minority. What are the other factors all Premium ARPU [Phonetic]?

Paul Vogel — Chief Financial Officer

Yeah. So FX is the largest. We mentioned it’s about half. So it’s just under half of the movement. We have some pretty major currencies that have year-over-year down close to 20% relative to the euro. We’ve seen it improve a little bit since the forecast was finalized but not too much. And so that’s still a pretty good number. Yes, ads is less than that. It’s the next biggest component. It’s a pretty sizable amount in terms of expectations for Q2. We expect it to get better throughout the year, but we don’t have a significant ramp-up in ads beyond where we are in Q2.

And then there is a small component on the Premium side. That’s related to a couple of different things. One is a little bit in terms of the timing of the promotional cadence, which can always impact a little bit. FX is impacting Premium as well. And then product mix is having a little bit of an impact. So again, in order, FX is the largest, almost half, advertising is next at a pretty sizable amount, and then the remainder is a little bit on the Premium side. The next question comes from Doug Anmuth.

Doug Anmuth — J.P. Morgan — Analyst

You’re maintaining your outlook for the two-sided Marketplace. Can you talk more about early progress and how it’s impacted in the current environment given fewer new album releases and tours? And what gives you confidence in maintaining your outlook there?

Daniel Ek — Founder, Chief Executive Officer and Chairman

Well, overall, just again, as you could see from the deal with Warner Music, we’re very happy with all the relationships that we have with big and small label partners. And again, I think the notable call-out I’d have in this quarter was The Weeknd, who had a very, very strong release, number 1 versus a lot of the records that used our Marketplace tools. So we continue to be very, very bullish about that. And I would suspect as COVID plays out, music streaming as a category will not be as impacted as many other categories. So that bodes well for labels.

And then two, specifically related to our Marketplace strategy, the direct ROI that we have on our Marketplace products is much better than other mediums that labels can market in. So we suspect that will have a positive impact.

Paul Vogel — Chief Financial Officer

Great. The next question comes from Rich Greenfield.

Rich Greenfield — LightShed — Analyst

With artists sheltered, you will likely be getting fresh, new music in the months ahead. How do you think about that impact? And how has the mix shift in listening frontline versus Catalog shifted in recent weeks?

Daniel Ek — Founder, Chief Executive Officer and Chairman

Yeah. We’ve seen a bit of a shift in terms of consumer behavior. Obviously, we mentioned before car usage is down, in-home usage is up with more than 50% in the quarter. Again, trend has been much more instrumental music, much more classical music. Chill music has been up. That may skew towards Catalog a little bit more than frontline.

We’ve also seen many artists not releasing their releases. I would like to think with Dua Lipa and The Weeknd being such strong releases, that more artists will come back to releasing new songs as well.

Overall on our service, clearly in Q1, we had a great growth. We expect that trend to keep happening. So it’s not a huge impact that we haven’t seen as many new releases in the first quarter. But I think you’re probably right that we should see a lot more new music come up in Q2 and Q3, which will be great.

Paul Vogel — Chief Financial Officer

The next question comes from Michael Klein [Phonetic].

Michael Klein — — Analyst

Why not be more active in offering live virtual performances as a way to connect artists with their fans? This seems like an opportunity to leverage your data advantage to provide a service that artists would find extremely valuable right now. Any reasons why Spotify isn’t more engaged here?

Daniel Ek — Founder, Chief Executive Officer and Chairman

Well, I think, again, the macro trend here isn’t really live. I think the big macro trend is linear to on demand. And of course, live is a component of that, but it’s still a relatively small component. So the investment that we’re making is moving linear to on demand. And that’s been the big trend for the past 20 years, that just everything linear moves to on demand.

And what we’re spending a lot of time on is making sure that we are reflecting culture and the realities of consumption habits shifting. So as an example, we launched an at-home hub. And we are responding with more wellness content, health content, more news. And you’ve also seen some of our original podcasts increasing their output as pure reactions to this. And I would suspect that’s going to be a bigger story of the overall consumption trend both going forward as well as in this moment.

Paul Vogel — Chief Financial Officer

Next question comes from Richard Kramer.

Richard Kramer — — Analyst

The IFPI Global Music Report shows a decline in the growth rate of streaming revenue in 2019. With multiple offers, often bundled, competing for attention, how can you be sure we are not reaching saturation in key developed markets?

Daniel Ek — Founder, Chief Executive Officer and Chairman

Well, as I outlined in my opening remarks, we’re actually seeing an increased growth rate relative to Q1 2019. So we’ve accelerated our rate of growth in all of our territories, including North America and Europe. So we’re very happy about that. That does not indicate a sign of a slowdown. So we’re very encouraged. And I would like to remind people, again if we just up-level here, the big opportunity for us over time is the billions of people that are currently listening to radio. If you compare it to streaming, we’re in the hundreds of millions of consumers globally on streaming. So we think that there’s plenty of growth left we had both in mature markets and as well developing markets like Asia.

Paul Vogel — Chief Financial Officer

Another question from Richard Kramer.

Richard Kramer — — Analyst

In the 2008/ ’09 global financial crisis, radio advertising was particularly badly hit. And that is a target market for your efforts in ads and podcasts. How does the current situation affect plans to monetize podcast content? Will ads growth permanently lag growth in subscriptions?

Daniel Ek — Founder, Chief Executive Officer and Chairman

I would just like to remind people again that ads is a very, very small portion of our business. It’s about 10% of our overall revenues. So to the extent that we’re impacted by ads, we’re likely a lot less impacted than many other businesses. So long term, we believe this is a great opportunity for us as the trend line of moving from linear to on demand will likely be accelerated by the COVID-19 crisis. And we suspect that advertisers will shift from pure reach to more measurable ad formats, of which our ad formats are obviously a lot better compared to analog ad formats. So our suspicion both on the advertising front as well as the consumption front is that this will play into the tailwinds of what’s already been happening of linear moving to on demand.

Paul Vogel — Chief Financial Officer

And then with respect to the podcast part of the question, we actually feel pretty good about podcasts. Podcasts is actually one of the stronger categories heading out of Q1 and into Q2. So there seems to still be a lot of demand for podcast advertising.

Next question comes from Ross Sandler of Barclays.

Ross Sandler — Barclays — Analyst

The 2Q premium sub guidance doesn’t look like it has much impact from cancellations, you noted in the letter. Can you talk about how the recession is impacting or not Premium cancellations and overall sub cadence?

Paul Vogel — Chief Financial Officer

Yes. So cancellations — active cancellations are actually a pretty small part of overall churn. And so if you take a step back, churn in the quarter was right in line with our expectations, and we didn’t see any impact from COVID in the churn numbers. It ticked up just a teeny bit sequentially. It was down about 70 basis points year-on-year. So the churn number overall in Q1 was really good and was in line with our expectations.

The biggest driver for us of churn is still payment failure. And so that’s something we’re working on to try and improve. But in general, we haven’t really seen much. As I said cancellations, active cancellations are still pretty small, and that’s number one. And number two is, while we did see some pickup towards the end of March, we’ve seen some pretty nice improvement in that in the beginning stages of April. So it’s obviously factored into all of our numbers and guidance, but not much of an impact at this point. Next question comes from Eric [Phonetic] at UBS. Can you provide granularity on how the marketing subscriber acquisition funnel continues to evolve, especially the impacts you are seeing from the current environment? Have you adjusted your approach to either trials, promotional activity or trying to stimulate reactivations?

Also Read:  Sohu.com, Inc. (SOHU) Q3 2020 Earnings Call Transcript

Daniel Ek — Founder, Chief Executive Officer and Chairman

Yes. Overall, just again, growth has been very, very strong, and the growth rate is accelerating compared to Q1 in 2019. We’re very pleased with that. What’s happening is obviously, there’s been a bit of a platform shift mix where more and more consumption is happening in-home rather than in the car. I suspect that changes some of the tactics that we will pursue and just the channels that we’re reaching consumers in on the marketing side. And then mid to long term, that ends up being an opportunity to remind users — as we start easing up on some of the restrictions to promote people to come back to the car and all the amazing content that fits really well, daily commutes, etc, like the daily drive playlist that we have on our service, too.

So overall, we feel very, very good about the slate of content that we have and that there’s content for pretty much every moment of a user’s life. And our job from a marketing perspective is to remind them of that and remind them of all the amazing content that’s being created every day on Spotify.

Paul Vogel — Chief Financial Officer

And before we move on, I’ve been told my audio is a little choppy, so I apologize for that. Hopefully, I can improve it. So if there’s any questions that don’t get answered, we will have a replay of the call afterwards if anything isn’t clear. So our next question is from Shugad Manon [Phonetic].

Shugad Manon — — Analyst

Will Spotify Premium change in pricing in any way in the upcoming months or years?

Daniel Ek — Founder, Chief Executive Officer and Chairman

No. Again, our primary strategy is growth, as we said before, rather than maximizing revenue, and that’s due to the fact that we have — we see this amazing opportunity of moving from radio to on-demand audio. And that’s the trend line that we’re trying to capture, and that’s what you’re seeing us go after. We have made small pricing experiments in some of our more mature markets. And obviously, due to inflation, you’ve seen us adjust pricing in some territories, too. The response from those have been very positive, but it’s not something that we’re focusing on in the short term. But it’s definitely encouraging to see that we have that opportunity for when the economy improves, and we feel that’s the right trade-off to make.

Paul Vogel — Chief Financial Officer

The next question comes from Matt Thornton at SunTrust.

Matt Thornton — SunTrust — Analyst

Does 2020 guidance contemplate any meaningful new market launches, i.e., South Korea and/or Russia? Yes. So we’ve talked about both Russia and South Korea as being markets we want to be in, and nothing has changed there. All of the guidance and forecasts we give you always include our expectations of if and when we will launch in new markets. So while we have nothing to announce at this point, you should know those are definitely two markets that we are focused on. And all the guidance that we’ve provided includes the timing of any new market launches, whether it be South Korea, Russia or anything else.

Paul Vogel — Chief Financial Officer

The next question comes from Doug Anmuth.

Doug Anmuth — J.P. Morgan — Analyst

Can you talk more about podcasts? One, how that’s driving higher DAU, MAU, two, your early progress with exclusives, and three, your appetite for more acquisitions in the current environment?

Daniel Ek — Founder, Chief Executive Officer and Chairman

Yeah. I mean, overall, just to up-level, it was about a year ago since we announced our shift from the music to audio-first strategy. At that place, we were about 0.25 million or so in our podcast catalog. We’ve grown that by 3x to over 1 million podcasts now. We were a small player in podcast, but we’re now more than number 1 in more than a dozen markets and growing very fast in the markets where we’re not number 1. So we’re feeling pretty good about that.

In terms of user behaviors, what we are seeing is that podcast users are more engaged overall. They do listen to more music as well. And in terms of some of our Originals & Exclusives, we are seeing some pretty good progress. We’re still learning how to best market those shows, whether it all-out exclusives, whether it’s windowing. So we’re experimenting a bit with that. We’re experimenting with how to market these shows, too. I suspect that will be down to different audiences and consumption behaviors of those audiences. You should expect that to play out in 2020 of more experimentation, but we’re definitely doubling down based on the early signs that we’re seeing.

And I think in — as related to more acquisitions, we keep on doing more deals and podcasts based on what we’re seeing. So if the macro environment means that there will more advantageous deals to be done, we will for sure look into that.

Paul Vogel — Chief Financial Officer

Great. The next question is from Heath Terry at Goldman Sachs.

Heath Terry — Goldman Sachs — Analyst

Do you have any way to quantify what impact an increase in shared listening may have had on reported DAUs or engagement? Do you believe that an increase in shared listening impacted churn positively or negatively?

Daniel Ek — Founder, Chief Executive Officer and Chairman

We don’t have any reliable way of the impact in shared listening. What we can say is obviously, in the home, there’s more shared listening than it is on mobile devices. So it may have played a part in DAU and engagement. That said, the overall churn was obviously in line with earlier expectations. So we haven’t seen a big impact on churn numbers.

Paul Vogel — Chief Financial Officer

Yeah. And I would just add, we mentioned this, that the DAU-to-MAU ratio in Q1 of 2020 was above where it was in Q1 of 2019. So we feel really good about the trends in the DAU-to-MAU ratio. Next question comes from Jessica.

Jessica Reif Ehrlich — Bank of America — Analyst

In large music markets that have remained largely physical, such as Japan and Germany, how has shelter at home impacted penetration? Also, can you provide color on India and some of your other more recent market entries?

Daniel Ek — Founder, Chief Executive Officer and Chairman

Yeah. We don’t break out specific markets. But what I can say is two observations. One is obviously that our user growth rate year-over-year is increasing, and that is true in established markets as well as expanding geographies. And then what I believe we will see is just the trend line of linear and physical will move to on demand, and that trend line will be accelerated due to this pandemic as more and more people are learning new habits and new experiences. And I think they will find that streaming is just a much more beneficial and much better user experience. So we suspect that teaches new audiences about streaming and that we’ll likely have an uptick in long-term retention as well of those users.

And then my only remarks on India specifically is obviously, we’ve finalized Warner deal, and we have added some notable other licensing deals. So we’ve improved Catalog greatly in India. And I can certainly see from social sentiment at least that that’s having a very positive impact on users’ love for Spotify in India.

Paul Vogel — Chief Financial Officer

Next question comes from Michael Morris at Guggenheim.

Michael Morris — Guggenheim — Analyst

Can you expand on gross margin outperformance comments? What specific customer product mix behavior drove the difference? Also, what drove lower streaming delivery costs? And is that sustainable?

Yes. As I mentioned before, there’s a number of things that can impact gross margin in any one quarter, geographic mix, product mix. And so when you have some quarters where, as I said, Premium is more than advertising, Premium has higher gross margins, so that can help. And then the mix of products within Premium can also impact the gross margin in terms of relative to our expectations. So that would be one.

And then on the lower streaming delivery, we’ve sort of been on this path for the last couple of quarters where we’ve gotten some efficiencies in streaming delivery. I think the long-term trend is we’ll continue to see streaming delivery improve. But I think in the near term, we’ve seen a lot of those benefits over the last couple of quarters. So it’s really been just getting efficiencies on the delivery in general, but I think that sort of improvement will moderate over the next couple of quarters.

Paul Vogel — Chief Financial Officer

The next question comes from Mark Mahaney.

Mark Mahaney — RBC Capital Markets — Analyst

What is happening with Premium sub churn trends in the June quarter so far?

Paul Vogel — Chief Financial Officer

Yes. We’re not going to give any really updates on Q2 other than to say what I already said, which was churn was in line with expectations in Q1, and we feel really good about how we ended Q1 in terms of the impact of COVID on cancellations or anything related to that. So if you look at our guidance and our expectations for subscribers, both for Q2 and for the full year, we haven’t really changed any of those expectations. So hopefully, that should be indicative of how we are seeing the current environment. The next question comes from Eric at UBS.

Eric — UBS — Analyst

Has your view changed in terms of video content as an element of your broader engagement strategy and to support artists looking to reach fans and promote their content in the current environment?

Daniel Ek — Founder, Chief Executive Officer and Chairman

Not really. We continue to see video be important in terms of a complement. But I really do want to focus on just up-leveling the conversation. We believe video is something that a lot of players around in the marketplace is focused on. Again, audio has about the same amount of engagement that video has, yet there’s no one on a global scale that’s focused on audio. We are. We think that’s a massive opportunity to go after, and that’s what we’re focusing on. So to the extent the video will play a complementary role to audio, then we’ll probably pursue it over time. But we really, really focus on audio because that’s the big, big tailwind that we see happening over the next 20 years, is going from linear to on demand.

Paul Vogel — Chief Financial Officer

Next question is from Rich Greenfield at LightShed.

Rich Greenfield — LightShed — Analyst

When you say you reached a long-term agreement with Warner Music, should we take that to mean these are not the typical two-year deals and that this is now in place for at least five years?

Daniel Ek — Founder, Chief Executive Officer and Chairman

Again, can’t comment on any specific terms in the deals. But typically, these are multiyears. They’re not always two years. Some of them are three, etc, as well.

Paul Vogel — Chief Financial Officer

Next question comes from Hamilton Faber at Atlantic Equities.

Hamilton Faber — Atlantic Equities — Analyst

Apple Music now has six-month free trials in new markets. What’s the risk that SPOT needs to see another extension to free trial periods?

Daniel Ek — Founder, Chief Executive Officer and Chairman

Again, we’ll obviously monitor that and see. I think a key difference between us and competitive services is our freemium model, though. So we’ve always had free and paid as the option. And I’ve said this before, but one of our key success elements is we typically bring people in on the free service. They stay, get engaged, learn user behaviors and then over time feel like there’s enormous value here and then turn into paying customers. That’s the macro strategy that we’re investing behind.

Also Read:  Agilent Technologies Inc. (A) Q4 2020 Earnings Call Transcript

One should also note that many of the new markets that our competitors are launching in are emerging markets. And there, obviously, you’re seeing other impactors for growth like credit card penetration, payment methods, etc. So you may see longer trial periods being needed in those markets for those reasons. That’s not to say that, that will happen globally.

Paul Vogel — Chief Financial Officer

Our next question comes from Brian Russo at Credit Suisse.

Brian Russo — Credit Suisse — Analyst

Can you discuss how — or what you have seen so far this year gives you confidence in your full year MAU and subscriber outlook, particularly in light of the pandemic and related recession?

Daniel Ek — Founder, Chief Executive Officer and Chairman

Maybe you want to start, Paul, and I can fill in.

Paul Vogel — Chief Financial Officer

Yeah. I mean, I would say, look, for us, we fully acknowledge there’s a tremendous amount more — I’m trying in English. There’s a lot more uncertainty in the current market than there was in the past. That being said, when we look at all of the metrics in terms of how we exited the quarter, when we look at churn rates, when we look at retention rates, all those things have continued to trend in the right direction. We actually saw some acceleration towards the end of Q1 with respect to users, people coming to our free product, people who had lapsed and had come back to Spotify. So we feel good about the current trends.

We acknowledge, like everybody else, we’re in uncertain times. We are monitoring the situation as closely as anybody to see if we see any change in the data or any of the metrics. But what we always try and do is give you guys guidance based on the actual forecasts that we have internally, and the current forecasts we have internally has been pretty consistent with where we started the year. Next question comes from John Egbert at Stifel.

John Egbert — Stifel — Analyst

Are you observing any changes in listening behavior during this period that you think could persist beyond the COVID-19 lockdown? Has the mix of new versus Catalog music consumption shifted at all recently? Are you seeing greater consumption of personalized algorithmically generated playlists than before?

Daniel Ek — Founder, Chief Executive Officer and Chairman

I think it’s hard to say what behaviors that will stick post the COVID-19 lockdown. Obviously, if I’d have to guess, I would say that many people are discovering new devices to consume content on like smart TV, smart speakers, Xbox, PlayStation. As we mentioned, those have been growing at more than 50% just this quarter. So enormous change.

I would expect, as you learn that behavior, you’re going to listen. And then as you’re coming back to the car, you will obviously listen to the car, too. So we may see a greater engagement than in the past, which would be great if that was the case, but it’s too early to say.

And then new versus Catalog music, we definitely see more consumption on Catalog music and other types of content. Part of that, though, has been due to the fact that we haven’t seen the same amount of music releases in this quarter. So I would suspect that, that will shift as more new releases will come into play Q2 and onwards.

And then in terms of personalized, that’s just been the trend line overall. As we’re getting better and better at personalization, we’re serving better and better content, and more and more of our users are choosing that. There’s nothing specific to this quarter. It’s just been an overall trend line, and we’re seeing more and more people engaging with our recommendations.

Paul Vogel — Chief Financial Officer

Next question comes from Maria Ripps at Canaccord.

Maria Ripps — Canaccord — Analyst

Can you talk about the adoption of the two-sided marketplace in the current environment? Did the pace change? Do you see adoption of sponsor recommendations accelerating as artists are competing for share of recorded music in the absence of live events?

Daniel Ek — Founder, Chief Executive Officer and Chairman

Not really seen a big change in trend line. As I mentioned, if anything, there’s been fewer new releases overall. But we’re early on in our Marketplace strategy. So we saw very, very strong release with The Weeknd. That’s the sort of highlight of the quarter. But I feel pretty good about the Marketplace team and what they’re doing and the trend line for the coming year as well, certainly when you think about just how much better the ROI is of the Marketplace products compared to some of the tools that labels and artists have available to them today to market their releases.

Paul Vogel — Chief Financial Officer

And I would just add on the Marketplace side. I wouldn’t expect us to update the performance of the Marketplace every quarter. But we did in this quarter reiterate that the guidance we gave at the start of the year has been reiterated for the Marketplace. We expect that we might get some questions based on the current environment, so we have reiterated the guidance we started with at the beginning of the year for Marketplace. Next question is from Emilio [Phonetic].

Emilio — — Analyst

Given the crisis, do you expect some Premium users to change to the Spotify ad version? When services like Apple Music don’t offer free ad version, do you expect to capture new users who unsubscribe from the paid service?

Daniel Ek — Founder, Chief Executive Officer and Chairman

Well, so far, we haven’t seen any meaningful increase in churn, but we have seen an increase in lapsed users coming back to the service. One can speculate and guess that those may have been with competing services but, in light of the economic crisis, are now coming back due to our freemium offering. But we don’t have any concrete evidence that that’s the case. So that’s more me speculating on that. But we’re pretty encouraged, as mentioned, just in increasing overall growth rate and over 130 million in subs, and we are reiterating guidance for Q2 and onwards.

Paul Vogel — Chief Financial Officer

We’re going to answer a couple more questions. Next question comes from Richard Kramer. Oops, let’s move there.

Richard Kramer — — Analyst

At what point do you need to look at the value of podcast investments’ potential impairment given reduced ad spend outlook. Are Premium subs going to be impacted? I’m lost. And so are your subs going to be hearing ads in SPOT podcast?

Paul Vogel — Chief Financial Officer

So I’ll start with that one. At this point, we don’t see any reason. We obviously look at these things every quarter. As I mentioned, coming out of Q1, one of the strong areas of growth for advertising is podcasting, and we see a lot of demand continuing on the podcasting ad front, so we feel really good about that. And yes, currently, Premium users do hear ads in Spotify podcasts.

Next question comes from Justin Patterson.

Justin Patterson — — Analyst

Given artists are increasingly reaching users on social channels, Instagram, YouTube, TikTok, how is Spotify thinking of providing artists off-platform marketing capabilities? It seems like the current iteration of the two-sided marketplace is primarily marketing on Spotify.

Daniel Ek — Founder, Chief Executive Officer and Chairman

Yeah. We’re experimenting with various tools based on what our customers are telling us, i.e., labels and artist teams. And you may see off-platform tools, too. That said, obviously, on-platform is where we have a chance of doing a really, really highly effective advertising. So you can think about it in a way where people are in line doing their actual listening. That’s probably one of the most effective methods that we can have in reaching users and connecting fans to new — new fans to new artists. And that’s a meaningful trend for us to invest in, and that’s unique to us and something that we think will both strengthen user experience and artist experience on the platform, too.

Paul Vogel — Chief Financial Officer

Great. We have time for about two or three more questions. Next one is from Ben Swinburne.

Ben Swinburne — Morgan Stanley — Analyst

Ex FX ARPU decline accelerated from 4Q ’19. Was this decline greater than you had expected? The letter calls out Trial & Campaigns, but presumably, that was in your expectations. What is the outlook for ex FX ARPU for 2Q ’20?

Paul Vogel — Chief Financial Officer

The ARPU decline was pretty much in line with expectations. It might have been a touch worse, but in general pretty much in line. As we said, the Premium business was slightly ahead on the revenue side. So we feel pretty good about that in terms of where the expectations were. And I would say the ex FX ARPU for 2Q ’20 should be pretty much in line with Q1 trends. The next question is from Daniel Jones [Phonetic].

Daniel Jones — — Analyst

After the launch of direct artist payments, are there long-term plans to develop that channel as an ongoing revenue stream?

Daniel Ek — Founder, Chief Executive Officer and Chairman

I think that’s reserving to the artist pick tool that we released in light of the music relief fund, — next to the music relief fund announcement that we did, too. And what that essentially does is it enables users to tip artists or for artists to promote causes that are near and dear to them, either themselves or a charitable organization like MusiCares in the US and other local organizations around the world.

Look, it’s too early to judge. We were pretty much just reacting based on the new realities. But we’ve been overwhelmed with the results. So put it in perspective, just in the last few days, we’ve seen over 50,000 artists sign up to promote a cause. So we’re very encouraged with that. And so the team is responding to that and responding to the feedback we’re getting from artists and consumers alike.

Paul Vogel — Chief Financial Officer

Next question comes from Heath Terry at Goldman Sachs.

Heath Terry — Goldman Sachs — Analyst

Can you elaborate on the line in the release, stem from the core royalty component due to product mix?

Paul Vogel — Chief Financial Officer

I think we’ve talked about this a couple of times, but I think this refers to the gross margin, and this is about just how gross margin can be impacted by the mix of Premium and ads, and then the product mix within Premium. So I think that was answered earlier. And then we’ll take one last question from Lloyd Walmsley.

Lloyd Walmsley — Deutsche Bank — Analyst

How much of the two-sided marketplace advertising revenue is through arm’s-length cash payments versus labels using credits given to them as part of the broader content deals? Are you seeing a majority of the revenue on the cash side?

Paul Vogel — Chief Financial Officer

Yes. This is separate from that. We don’t really get into specifics. As we said, a lot of these end up being accounted for as a benefit to gross profit and not an actual boost to revenue. But these are separate from the credits. And with that, I will turn it back over to Daniel for some closing comments.

Daniel Ek — Founder, Chief Executive Officer and Chairman

Thank you, Paul. Well, in closing, we’re really pleased with our quarter. And despite all the uncertainty in the world, we feel very good that we will continue to execute and respond quickly to the environment around us. We also believe that we will likely see new opportunities due to the economic environment and that Spotify will ultimately come out of this as an even stronger company. Thank you again for joining us today.

Paul Vogel — Chief Financial Officer

Great. Thanks, everybody. As we said, the replay will be on the website shortly. And please give us any feedback on if you prefer Slido. We think it went pretty well. But if you have any feedback, we definitely appreciate it. So thanks again, everyone, and stay safe.

Operator

[Operator Closing Remarks]

Disclaimer

This transcript is produced by AlphaStreet, Inc. While we strive to produce the best transcripts, it may contain misspellings and other inaccuracies. This transcript is provided as is without express or implied warranties of any kind. As with all our articles, AlphaStreet, Inc. does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company’s SEC filings. Neither the information nor any opinion expressed in this transcript constitutes a solicitation of the purchase or sale of securities or commodities. Any opinion expressed in the transcript does not necessarily reflect the views of AlphaStreet, Inc.

© COPYRIGHT 2020, AlphaStreet, Inc. All rights reserved. Any reproduction, redistribution or retransmission is expressly prohibited.

Most Popular

Walt Disney (DIS): After a tough FY20, the pandemic is likely to take a toll on operations next year too

The Walt Disney Company (NYSE: DIS) had a tough time in fiscal year 2020 with the COVID-19 pandemic bringing its operations to a standstill like never before. The company incurred

Earnings reports to watch for the week of Nov. 30

The recent optimism about economic recovery waned slightly this week after jobless claims increased more-than-expected to about 778,000 amid concerns over a resurgence in coronavirus cases. With the healthcare system

Yunji Inc. (YJ) Q3 2020 Earnings Call Transcript

Yunji Inc. (NASDAQ: YJ) Q3 2020 earnings call dated Nov. 26, 2020 Corporate Participants: Kaye Liu -- Investor Relations Director Shanglue Xiao -- Chairman of the Board of Directors and Chief Executive Officer Chen

Top