Spotify Technology SA (SPOT) Q1 2023 Earnings Call Transcript

Spotify Technology SA (NYSE:SPOT) Q1 2023 Earnings Call dated Apr. 25, 2023.

Corporate Participants:

Bryan Goldberg — Head of Investor Relations

Paul Vogel — Chief Financial Officer

Daniel Ek — Founder, Chief Executive Officer & Chairman of our Board of Directors

Analysts:

Matthew Thornton — Truist Capital — Analyst

Michael Morris — Guggenheim — Analyst

Justin Patterson — KeyBanc — Analyst

Mario Lu — Barclays — Analyst

Doug Anmuth — JP Morgan — Analyst

Benjamin Black — Deutsche Bank — Analyst

Rich Greenfield — BTIG — Analyst

Jed Kelly — Oppenheimer — Analyst

Maria Ripps — Canaccord Genuity — Analyst

Presentation:

Operator

Good morning, my name is Julianne, and I’ll be your conference operator today. At this time, I would like to welcome everyone to Spotify’s First Quarter 2023 earnings call. [Operator Instructions] I would now like to turn the call over to Bryan Goldberg, Head of Investor Relations.

You may begin your conference.

Bryan Goldberg — Head of Investor Relations

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 SLIDO.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. We ask that you try to limit yourself to one to two questions and to the extent you’ve got follow-ups, we’ll be happy to address them, time permitting. If for some reason, you don’t have access to Slido, you can email 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. Alright. 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 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 to 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 turned in to our March Stream-On Month event, we unveiled numerous creator tools and debuted 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, 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 these stakeholders, over time 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 hundreds, if not sometimes even thousands 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 is an ebb and there is a flow over-time but over time, 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 the 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.

Paul Vogel — Chief Financial Officer

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 hit 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 EUR3 billion in the quarter. Results from 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 EUR300 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 and plan. When combined with our better gross profit, operating loss was ahead of guidance by EUR38 million. The better-than-planned results also include EUR44 million of severance-related charges. Free-cash flow was a positive EUR57 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 are 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 EUR3.2 billion in total revenue, a gross margin of roughly 25.5% and an operating loss of approximately EUR129 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 US 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 close to the EUR3.3 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 hoped 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.

Bryan Goldberg — Head of Investor Relations

All right. Thanks Paul. Again, if you’ve got any questions, please go to slido.com #spotifyearningsQ123. We’ll 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 advertising.

Questions and Answers:

Matthew Thornton — Truist Capital — Analyst

Ad revenue actually reaccelerated in first-quarter, which would seem better than feared. Can you talk to what you’re seeing in the ad market, i.e., how it performed relative to your expectations and linearity through and exiting the quarter?

Paul Vogel — Chief Financial Officer

Yeah, as I said in my opening comments, we’re slightly behind on the ad side, about 15 — about EUR20 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 anyway.

Bryan Goldberg — Head of Investor Relations

All right. Our next question is going to come from Mike Morris on AI.

Michael Morris — Guggenheim — Analyst

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 is Spotify’s responsibility in allowing or preventing the distribution of created music that draws from another artists’ work?

Daniel Ek — Founder, Chief Executive Officer & Chairman of our Board of Directors

Yeah. 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 have ever seen anything moving as fast as the development of AI currently is at the moment. And obviously, you’ve pointed out in your question that there is 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 guarding the artists’ creativity and the support that we are doing for artists and creators very, very seriously. So we’re in constant dialog with the industry about these things and it’s important to state that there is 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 into more lenient and easier buckets.

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 — Head of Investor Relations

Okay, next question from Justin Patterson, on operating efficiency.

Justin Patterson — KeyBanc — Analyst

On the fourth quarter earnings call, you framed efficiency as 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 — Founder, Chief Executive Officer & Chairman of our Board of Directors

Yeah, I’ll start and maybe Paul can add to it. So, we’re early on in our new org 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 question. 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 — Chief Financial Officer

Yeah. I had a couple of things, one is I think we’ve talked about, on the gross margin side seeing sequential improvement throughout 2023 and nothing has 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 — Head of Investor Relations

All right, next question from Matt Thornton on our subscription business.

Matthew Thornton — Truist Capital — Analyst

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 — Chief Financial Officer

Yeah, it’s kind of a combination of all the things you mentioned. Clearly, we beat on the subscriber side by 3 million. When we have that upside, some that 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. And again it’s pretty minor in terms of where it came in at ARPU and it was pretty much in-line with our expectations maybe a hair below from an ARPU standpoint but not material.

Bryan Goldberg — Head of Investor Relations

Okay, another question from Justin Patterson, this is on our recent product updates.

Justin Patterson — KeyBanc — Analyst

Daniel, can 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 — Founder, Chief Executive Officer & Chairman of our Board of Directors

Yeah, 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 creator-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 [Phonetic] 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. 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 dialed up and that we can react to the feedbacks and we have 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 are some that you can, and this happened to be one of those things that takes multi-quarters for us to rollout, 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 — Head of Investor Relations

Okay, next question from Mario Lu.

Mario Lu — Barclays — Analyst

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 EUR41 million in your operating expense in Q1?

Paul Vogel — Chief Financial Officer

Yeah, 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, it was actually EUR44 million overall. There was a small component of severance that hit gross margin, so there’s been two numbers that have been floating out there, but it’s EUR44 million in total EUR41 million that hit the opex and then that EUR3 million that hit the gross margin side. And in terms of workforce, nothing else to add in terms of workforce reductions and I think we’ve talked about, I’ll let kind of Daniel take the efficiency side from here.

Daniel Ek — Founder, Chief Executive Officer & Chairman of our Board of Directors

Yeah. 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 ways 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 — Head of Investor Relations

Okay, question from Rich Greenfield for Daniel.

Mario Lu — Barclays — Analyst

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 sided with Apple and then would also love to hear more about your recent trip to Washington DC?

Daniel Ek — Founder, Chief Executive Officer & Chairman of our Board of Directors

Yeah 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 maybe getting this wrong, but I’ll try to paraphrase it where the judge I think was referring and reacting to the fact that there is 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 OAMA Bill that is also called is 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. So — and those message point really resonated across both the House and the Senate and across the aisle of both Republicans and Democrats, so I feel encouraged, but it’s still early days here in the US and obviously we’ve had a lot more progress on this issue lately in Europe.

Bryan Goldberg — Head of Investor Relations

Great. Next question from Mario Lu on gross margin.

Mario Lu — Barclays — Analyst

Gross margins beat guidance by 30 basis-points, but saw a drag from other cost of revenue. Can you explain what’s within other cost to revenue was the main drag and if that’s expected to continue going-forward?

Paul Vogel — Chief Financial Officer

Yes, so there’s a little bit of nuance in there, so — let me kind of go through it, so when you look throughout 2022 and in 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 has slowly risen throughout the year and have been impacting us. And so, when you look at it Q1 versus Q1 that trend had still continued, so 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’ve 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 moving forward with how that should trend.

Bryan Goldberg — Head of Investor Relations

Okay, next question from Doug Anmuth on podcasting.

Doug Anmuth — JP Morgan — Analyst

With a decent amount of hit podcast content deals seemingly up for renewal in 2023 and 2024, what gives you confidence you can retain exclusive talent, while not overpaying and over-investing?

Daniel Ek — Founder, Chief Executive Officer & Chairman of our Board of Directors

Yeah. I think you’re right in calling out the overpaying and over-investing in and what I can start-off 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 and 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 smaller, we should be in a better position should we want to renew a deal because we obviously can amortize that against the larger base of users.

Bryan Goldberg — Head of Investor Relations

Okay, question from Benjamin Black on subscription pricing.

Benjamin Black — Deutsche Bank — Analyst

Since you haven’t raised pricing, are you seeing any benefit from being the lower-cost distributor?

Daniel Ek — Founder, Chief Executive Officer & Chairman of our Board of Directors

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 primary part of our strategy and it’s not something that we’re thinking about. Instead, we are 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 and I think that price increase will go down well because we’re delivering a lot of value for our customers.

Bryan Goldberg — Head of Investor Relations

Okay, another question from Rich Greenfield on advertising.

Rich Greenfield — BTIG — Analyst

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 — Chief Financial Officer

Yeah, 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 that 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 and even better advertising products to Spotify 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, we can benefit as much as we possibly can.

Bryan Goldberg — Head of Investor Relations

Okay, a question from Doug Anmuth on AI DJ.

Doug Anmuth — JP Morgan — Analyst

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 — Founder, Chief Executive Officer & Chairman of our Board of Directors

Yeah. 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 rights to something where you upload something and claim it to be Drake and 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 — Head of Investor Relations

Okay. Next question from Michael Morris on subscription pricing.

Michael Morris — Guggenheim — Analyst

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 — Founder, Chief Executive Officer & Chairman of our Board of Directors

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 really a negotiation thing. But, I think maybe it’s up level, it’s 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 topline 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 dialog that we’re in but yeah, we would like to raise prices in 2023, but it’s really a discussion with our partners.

Bryan Goldberg — Head of Investor Relations

Okay, another question from Doug Anmuth on Marketplace.

Doug Anmuth — JP Morgan — Analyst

How should we think about the outlook for Marketplace growth this year following approximately 40% growth in 2022?

Paul Vogel — Chief Financial Officer

Yeah. 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 — Head of Investor Relations

Okay, next question from Deepak on podcasting, can you provide 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 — Founder, Chief Executive Officer & Chairman of our Board of Directors

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, the 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 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 catalog and content portfolio we have on both music and podcast.

Paul Vogel — Chief Financial Officer

Yes, I would just add, the one other metric listening hours per 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 — Head of Investor Relations

Okay, another question from Doug Anmuth on users.

Doug Anmuth — JP Morgan — Analyst

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 — Chief Financial Officer

Yeah, 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, or just over 40 million net additions on MAU sides, we’d be halfway to last year through half of this year and the same thing on the sub side, so if we hit our guidance for Q2, that’s about 12 million sub additions so again about halfway to two 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 the sub side for Q1 and our expectations for Q2.

Bryan Goldberg — Head of Investor Relations

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 — Founder, Chief Executive Officer & Chairman of our Board of Directors

Yeah 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 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 etc.

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 our 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 music production software tools that 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 congas into the mix, when you’re creating a drum pattern or something like it and that has the chance like I think to meaningfully augment that creative journey that many artists do and you could even imagine someone just humming something and then the AI, helping it out by creating a backdrop that you could then can edit and alter into your existing [Indecipherable] which is the music sort of software environment that many producers, the music creators are doing.

And that should lead to more music and that more music obviously, we think is 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 could have users, creating their own music and perhaps Spotify can 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 — Head of Investor Relations

Okay, another question from Rich Greenfield.

Rich Greenfield — BTIG — Analyst

At the Investor Day, last year you talked about introducing three new verticals. Looking beyond music, podcasts and audiobooks when should we expect to hear more?

Daniel Ek — Founder, Chief Executive Officer & Chairman of our Board of Directors

Yeah, 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 is just me 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 been — being worked at, at Spotify teams for sometimes two, three even four years before we are ready to announce them for the world.

So, we have a very good sense what those are, those three and two of them are right now progressing very nicely. We’re not ready yet to announce them so we’ll see when they’re ready for prime-time.

Bryan Goldberg — Head of Investor Relations

Okay, question coming from Benjamin Black on advertising.

Benjamin Black — Deutsche Bank — Analyst

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 — Chief Financial Officer

So, in 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 were some momentum in Q1 and it ended-up being pretty choppy as well. So, I think we’re optimistic but also cautious or maybe cautiously optimistic would be the right word, so I think we feel like there is some momentum there, I think we feel-good about where we’re positioned from an advertising standpoint. But just given the macro uncertainty I think, we’re — caveat is cautiously optimistic.

Bryan Goldberg — Head of Investor Relations

Okay, another question from Doug Anmuth on podcasting.

Doug Anmuth — JP Morgan — Analyst

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 — Chief Financial Officer

Yes, so no change to what we said, look, we think we’ve continued 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 profitability have not changed. So, we still feel good about that and then the ad-supported gross margins. I mean, there’s really two factors that are impacting that which we’ve talked about; podcasting is a big part of that so as the podcasting loss turns to break even and then profitability that will obviously help the ad-supported gross margins a lot. And then we do have some markets and 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 ad-parity with our more developed ad markets. So, it’s a combination of the two, but obviously the transition from the podcasting business from being a drag to a break even in profitability will be a big help.

Bryan Goldberg — Head of Investor Relations

All right. We’ve got time for a couple of more questions and it looks like Doug Anmuth has a follow-up on operating expenses.

Doug Anmuth — JP Morgan — Analyst

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 — Chief Financial Officer

Yeah, it’s a great question. And so — 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 head count is in guidance, I’m just using this as sort of an illustrative example, assuming no changes in head count, those comps just get easier throughout the year as we start to lap the reduction we had a few months ago.

And again Q1, the 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 — Head of Investor Relations

Okay, and we’ve got a question from Jed Kelly.

Jed Kelly — Oppenheimer — Analyst

We’re seeing the stock price benefit from strong MAU growth and improving gross margins, if this continues, does this play Spotify in a favorable position to negotiate a “win-win” outcome with the labels on any incremental price increases?

Daniel Ek — Founder, Chief Executive Officer & Chairman of our Board of Directors

Yeah. 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 are 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 — Head of Investor Relations

All right. And our last question today is going to come from Maria Ripps on advertising.

Maria Ripps — Canaccord Genuity — Analyst

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 — Chief Financial Officer

Yeah. I think there’s a lot in that question. Look, I think there’s a lot to our advertising growth and so it’s kind of unpack it and so some of it has been — 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’ll be some benefits from that as well and then as you said, the macro is the big wildcard 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 — Head of Investor Relations

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 — Founder, Chief Executive Officer & Chairman of our Board of Directors

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 — Head of Investor Relations

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.