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Spotify Technology (SPOT) Q2 2020 Earnings Call Transcript

SPOT Earnings Call - Final Transcript

Spotify Technology S.A. (NYSE: SPOT) Q2 2020 earnings call dated July 29, 2020

Corporate Participants:

Paul Vogel — Chief Financial Officer

Bryan Goldberg — Head of Investor Relations

Daniel Ek — Founder, Chairman and Chief Executive Officer

Presentation:

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Spotify Q2 2020 Earnings Call. [Operator Instructions].

Thank you. I would now like to hand the conference over to your speaker for today, Paul Vogel, Chief Financial Officer. Please go ahead.

Paul Vogel — Chief Financial Officer

Great. Thank you and welcome to Spotify’s second quarter 2020 earnings conference call. I hope everyone is continuing to stay safe. As is the case with just about everyone, our team again we’ll be hosting this call entirely remotely. Our CEO, Daniel Ek is participating from Stockholm, and I am at my home office in New Jersey. This morning, I’m pleased to introduce our new Head of Investor Relations, Bryan Goldberg, who just recently joined our team. I’m sure many of you recognize his name from his time at Bank of America. Also joining the IR team is Lauren Katzen, who was previously on our licensing finance team within FP&A. We’re excited to have both of them onboard. Mike Urciuoli, who has been both part of our IR team and FP&A teams over the past few years, is transitioning into an expanded role within FP&A, but will be on hand to answer questions post this quarter and for the next few weeks.

And with that, I’ll turn it over to Bryan.

Bryan Goldberg — Head of Investor Relations

Thanks Paul. Turning now to the call. We will start with opening comments from Daniel. After the remarks, Daniel and Paul will be happy to answer your questions. Like last quarter, we will be taking questions exclusively through Slido. Questions can be submitted by going to slido.com, S-L-I-D-O dotcom, and using the code #spotifyearnings. Analysts can ask questions directly into Slido and all participants can then vote on the questions they find the most relevant. If for some reason you don’t have access to Slido, you can email Investor Relations at ir@spotify.com, and we will have in your question.

Before we begin, let me quickly cover the Safe Harbor. During the call, we will be making certain forward-looking statements, including projections or estimates about the future performance of the company. These statements are based upon 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 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 page and also furnished today on Form 6-K.

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

Daniel Ek — Founder, Chairman and Chief Executive Officer

All right. Hey everyone and thank you so much for joining us. Like all of you, Spotify continues to navigate issues related to COVID-19 and racial injustice, both of which are reshaping our industry and society in significant ways. Given the role we play in culture, we believe Spotify has the responsibility to use our platform to help build a more equitable future. For us, that means focusing on what’s core to our business, amplifying the music and perspectives on black creators and taking every opportunity to connect them with current and future fans. We’re also taking a hard look at what we can do to build a more equitable workplace and we have committed to increasing representation of black employees at all levels within Spotify. When we do this right, it’s good for employees, good for creators and good for shareholders.

Now turning to the quarter; we’re pleased with our results, which met or exceeded our guidance by almost every metric. After making adjustments to help us weather the pandemic in Q1, consumption returned to normal levels this quarter. Monthly active users increased to 299 million and subscribers grew 238 million, both exceeding our expectations. Advertising revenue, which took a significant hit in Q1, improved notably throughout the quarter, and we feel good about our momentum as we enter Q3.

We also continue to invest in our Audio-First strategy, signing exclusive deals with some of the world’s most well-known creators and most powerful voices. Earlier today, we launched the first episode of the Michelle Obama podcast, and it features a conversation with a very special guest, President Barack Obama. Our podcast catalog now has over 1.5 million shows, 50% of which launched in 2020. And while it has been gratifying to see so much enthusiasm for these announcements throughout the quarter, it’s important to remember that with many of our newest shows, we’re still early in the progress. In some cases like D.C. Comics we need to produce the content and in others like Joe Rogan, it id yet to launch on our platform. There is still work to do and much more to come.

On the music fronts, we entered a new multi-year global license agreement with Universal Music Group, that reflects our shared commitment in growing the industry and supporting artists at all stages of their careers. Universal Music Group will leverage Spotify’s marketplace tools for both frontline and catalog artists to connect them with fans, grow their audiences and better monetize their fanbase. And we will also work together to develop new products and tools to drive discovery and engagement, at a scale that has never before existed.

Spotify has now surpassed 60 million tracks globally, giving artists even more opportunities to connect with their biggest fans. And just last week, Taylor Swift surprised release of our new album Folklore, broke the Number One First Day record for a female artist album in Spotify’s history. She also became the most streamed artist on Spotify on any day this year, with nearly 98 million streams on July 24th alone.

Finally, I would like to address our business overall. Investors often ask me what our secret sauce is, expecting that there is some sort of silver bullet to our growth. The reality is that, at a platform of our scale, it’s rarely about one thing. Instead, it’s about setting up a culture of experimentation and being willing to double down on opportunities, if we believe they have the potential to enhance the user experience and change the slope of our growth curve. And I want to share two recent examples that I think exemplifies this point. Over the last two years, we have tripled the number of experiments from a few hundred to thousands of AB tests. Some of these experiments yield nothing more than a few key learnings, while others have shown great promise. In one of our recent podcast experiments, we increased listening among the test group by 33%, and that’s just one example of many, and when we see results like this, you should expect us to invest even more, and we know that no one experiment is going to materially impact us, even in the next year. It’s the thousands of little things that we’re doing, which will gradually add up over time.

The second example I want to point is, is new market launches. Just this month, we launched in Russia and 12 other European countries. And our first week in Russia was huge, even bigger than our first week in India. So if we do this right, we have the opportunity to reach 250 million more listeners in these markets over the long term, and we’re now operating in nearly every country across Europe, but there is still a lot of pent-up demand for Spotify in markets around the world, which is why we have plans for further expansion globally.

Now what these two recent examples underscore, is that staying focused on the long-term growth, whilst managing for speed of iteration near term, is what will drive future growth. And using that lens, and with the examples I gave, it is apparent that we still have many more improvements left to make, and that’s also why we keep investing.

And with that, I’ll turn it back to Bryan.

Questions and Answers:

Bryan Goldberg — Head of Investor Relations

Thanks, Daniel. Again, if you have any questions, please go to slido.com, #spotifyearnings. We will read the questions in the order they come in, with respect to help people vote up their preference for questions. And the first question today is going to come from Eric Sheridan. Can you frame the impacts you expect long term in your business from greater podcast content consumption, lower churn, greater gross ad share, upstreamed audio, increased long-term ad supported gross margins?

Daniel Ek — Founder, Chairman and Chief Executive Officer

Well, it’s really about taking a step back, and I think what we’re seeing here is the beginning of our flywheel. So as we talked about before, Spotify is now going after all of audio, and that’s obviously a significantly larger market than just the music industry in and of itself. And so what we’re seeing is that, by every piece of content that we’re adding on the service that we’re successful in serving to a consumer, we are creating more engagement. That engagement in turn leads to obviously lower churn, but more importantly, now that we have almost 300 million monthly active users on the platform, these users are also, when they find great shows, sharing that on social media and other forms to other consumers as well, driving this virtuous cycle, where more and more people are learning about what’s going on, on Spotify, and more and more creators who want to be on Spotify, creating this virtuous flywheel. So with the expansion of podcast, we’re definitely seeing more of that and it’s happening at a faster clip than what we’ve seen before, and we’re very encouraged by it.

Paul Vogel — Chief Financial Officer

Yeah. And then from a numbers perspective, I would say everything you mentioned is what we’re looking at to value each piece of content. So it is the combination of what is it doing for our user growth, what is it doing to improve retention and lower churn, and then also how can we grow advertising on top of it. And so, when we look at pieces of content and we look at how much we need to add and where we’re spending it’s really about the LTV of the overall spend on content, and how it impacts holistically the entire business from user growth to subscriber growth to advertising growth.

Bryan Goldberg — Head of Investor Relations

Okay, great. Next question from Rich Greenfield, what percentage of ad revenue is now directly tied to podcasting? Trying to understand what ad supported music revenues were down year-over-year relative to 21% overall ad decline in the quarter, as podcasting growth and acquisition first time benefits presumably benefited the 21% decline?

Paul Vogel — Chief Financial Officer

Yes, I would say a couple of things. And one is, podcasting is still reasonably small relative to the overall amount of advertising. That being said, it did outperform in the quarter and we felt it was one of the stronger areas of growth which is great. Hopefully, everyone had seen the deal we struck with Omnicom the last couple of weeks, which is a $20 million deal to invest in podcast advertising moving forward, which we’re really excited about. And the other thing about podcasting is, having a couple of facts; one is overall podcast growth is there and so we finished this quarter at 21% of MAU, which is up from 19%. Your podcast consumption is still up over 100% and we’re seeing advertisers really wanting to invest in podcasting as a media. The other thing that’s benefiting us as we’re starting to sell more media deals across all of our products, and so we’re seeing nice growth from deals that incorporate both music advertising and podcasting advertising in the deals. And so in general, podcast was strong in the quarter. It’s still reasonably small, but growing very nicely.

Bryan Goldberg — Head of Investor Relations

Okay. The next question from Eric Sheridan, can you update investors on your views on acquiring licensing, podcasting content what will drive either approach? Any update on the level of investments in podcasts and how critical is putting podcast content exclusively on your own platform against your long-term goals for the business model?

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Daniel Ek — Founder, Chairman and Chief Executive Officer

Yeah, I mean we are really pursuing sort of all strategies in tandem. It’s really all about creating the best overall user experience, as I talked about before, with this virtuous cycle. Now that said, exclusivity is a key component of that strategy, we want to create more and more original programing that only exists on Spotify. And I think this quarter, you start to see some of those announcements come in, in a big way. And obviously that’s something we are pursuing with creators, but it’s important that we are an open platform and we’re seeing more and more content, as I mentioned in my opening statements, over 1.5 million shows are now available on Spotify and about 50% of them was created in 2020. It’s impossible, even if we wanted to, to have all of that content exclusively on our platform. So it’s going to be a mix of all of those things going forward.

Bryan Goldberg — Head of Investor Relations

Okay. Next question from Richard Kramer. With the UMG deal, has Spot secured any firm commercial commitment to pay for two-sided marketplace services?

Daniel Ek — Founder, Chairman and Chief Executive Officer

So as we talked about before, we’re very-very excited about marketplace and the momentum it’s having. We’re seeing lots and lots of big artists come in. We saw John Legend. We thought the 1975 Lady Gaga among many others, adopt the tools this quarter. So we’re very excited about it. And with the Universal Music Group announcement, they’re really now leaning in, because of that really early excitement in the marketplace I want to adopt more tools and I want to go deeper, because they’re seeing the potential impact that it can have on their business.

Bryan Goldberg — Head of Investor Relations

Next question from Eric Sheridan. Can you give us a sense of how the ad market evolved over the recent quarter in terms of ad budgets, pricing and how you see those dynamics evolving against the current macro backdrop? Can you provide color on any variability by industry verticals, geographies or type of ad budget?

Paul Vogel — Chief Financial Officer

Yes. So the advertising market, it definitely started the quarter started off slow, we mentioned coming out of Q1 that the last three weeks of Q1 were pretty weak and saw some big declines and that continued into April and May. We were actually running behind on the ad business for April and May, probably down about 25% on those two months and then we really had a nice pickup in June. June was only down about 10% on the advertising side.

In terms of geographies, I am not going to get into specifics, but we have a much higher percentage of our revenue on the ad side comes from North America than on the premium side. So how North America goes tends to be how our overall business goes. And then in terms of product, the direct business was weak in the quarter and actually underperformed our expectations and we were very strong. Our Ad Studio, which is our self-service tool, which outperformed and as I mentioned above, podcasting outperformed as well.

Bryan Goldberg — Head of Investor Relations

Okay. Next question from Michael Moore; is the level of podcast engagement similar across both premium and ad supported users? Are you seeing a difference in churn for podcast users? If so, can you quantify the relative impact?

Paul Vogel — Chief Financial Officer

Sort of high level I would say, the good news is that podcast engagement in general overall is increasing. So as I mentioned, 21% of our MAU engaged with podcast, which is up from 19% and consumption was up over 100% in the quarter. So we continue to see it going up in general. Premium does have higher engagement than the ad supported business. But both of them have been moving up nicely and both of them have been improving. And with respect to any impacts on churn, we don’t break that out individually.

Bryan Goldberg — Head of Investor Relations

Okay. Next question from Doug Anmuth. Do you expect podcasts to have a bigger financial impact through advertising dollars or more through incremental premium subscribers to the platform?

Daniel Ek — Founder, Chairman and Chief Executive Officer

I’d really say, it depends on what the time horizon is, that you’re looking at. Obviously, our subscription business is a much larger business. So even if we improve that by a small percentage space that’s likely going to be larger impacted, than even if we improved our advertising business with strong double-digit growth as well. So I think in the short term, any improvement we can make on improving retention is going to be material to the subscription business, and that’s how you should look at it. The long term, when I look at the landscape, what excites me is, that we’re going after all of audio. And all of audio is a multi-billion user opportunity and it’s a marketplace that only in its existing form today, is north of $50 billion in advertising revenue and it’s the combination of subscription and advertising long-term that I think is the future of media businesses, and Spotify has really since its inception, played in both of these businesses. So I am very excited about long-term, both being a principal player in advertising as well in subscription. And so, over the long-term, it will become a bigger part of our business.

Paul Vogel — Chief Financial Officer

And I would just add to what I think I mentioned earlier, when we look at some of the larger content deals we’ve done, we are measuring or forecasting both sides of the equation in terms of how we value that content moving forward.

Bryan Goldberg — Head of Investor Relations

Okay. Another question here from Doug, can you talk about how the recent Universal deal may treat the two-sided marketplace differently than other recently signed label deals? Or are they essentially the same?

Daniel Ek — Founder, Chairman and Chief Executive Officer

Well, I think the big difference here is really Universal’s willingness to experiment and go all-in on marketplace and that’s what I think should be the bigger takeaway here for all investors as well. So what that means in essence is, Universal has seen the early success, and it’s very excited by it and they want to make sure that it can get behind and experiment a lot more with the paid tools of marketplace, but also the organic tools that allows artists to create more fans, engage with those fans and monetize those fans better. And so, overall, we want to work with all labels, but we are very-very encouraged to see Universal go all-in on the tools and services that we are building.

Bryan Goldberg — Head of Investor Relations

Okay. Next question from Mark Mahaney. Where can ad supported gross margins go near-term? And long-term, can these gross margins match those of premium?

Paul Vogel — Chief Financial Officer

Yes. So in the very long-term, we definitely think ad gross margins could reach the Premium gross margins. We haven’t given a timeframe on that. But we believe that’s where we are headed. In the near-term, there is a couple of factors at play here. One, obviously is the weaker overall ad environment, which is impacting gross margins and particularly, on the ad side, there are some minimum that we pay in certain markets where the advertising hasn’t quite reached critical mass and so as we get to a tipping point in some of those markets on the music side, the gross margin will improve. And then additionally, just a reminder, we now account for all of the costs of podcasting in our ad-supported business, so the entire brunt of the investment we are making on the content side is hitting the ad-supported line and so, as we continue to invest in content, the ad business will fill more. We do expect ad gross margins to improve in Q3 and then be even better in Q4.

Bryan Goldberg — Head of Investor Relations

Our next question is from Steven Cahall. What do you expect will be the impact to MAUs, premium subs and gross profit when The Joe Rogan Experience comes exclusive to Spotify in September?

Daniel Ek — Founder, Chairman and Chief Executive Officer

I think it’s too early to talk about what the impact will be yet. We obviously know it’s a big show and we are encouraged by the reception we’ve seen in the marketplace. So, I do think a lot of his fans are very excited about the announcements. But it’s going to take time, and we have to learn how to market and merchandise The Joe Rogan Show, both to his existing fans, as well as to all of the other 300 million or so of listeners on Spotify as well, because this, as we have talked about before, even with the announcement of Joe Rogan, this was the number one searched for show on Spotify that we are now including. So, I think it’s going to be a very-very positive one. But again, I think the best way to think about this is that, Spotify is not about one single show, it is really about the drumbeat now of new exclusive content, original programming and the 1.5 million podcasts that exist on the platform, that’s growing at a very, very rapid pace. So there is something for everyone. That’s the message I want you to take away.

Bryan Goldberg — Head of Investor Relations

Next question is from Rich Greenfield. Howard Stern’s multiyear agreement with Sirius expires at the end of this calendar year. If you were Howard Stern, why would you want to be on Spotify versus Sirius?

Daniel Ek — Founder, Chairman and Chief Executive Officer

I can’t really speak to Howard Stern, specifically. What I can say though, as you’ve seen in the quarter, there are more and more great creators around the world that are turning to Spotify. And I think, part of that reason is, because this is an interactive medium. This allows them to better connect with their audience, seeing the data, seeing how they are engaging with the content, seeing the feedback directly. It is an international platform too, not just a domestic. So while we are very large in North America, we are equally large in Europe and LatAm and Asia, as well. So this is a global audio platform unlike anything else. And now thirdly, the size of this platform is just huge, compared to many of these platforms that may operate in just one market. So I think the combination of that interactivity, the flexibility that it allows you and the global nature and scale of this platform is what excites a lot of creators to be on our platform.

Bryan Goldberg — Head of Investor Relations

Next question is from Richard Kramer. How will you get the local data to target podcast ads you intend to insert? Will each host have to record a large number of ads, which will be inserted depending on local interests, customer segment, etc?

Daniel Ek — Founder, Chairman and Chief Executive Officer

I’ll take this and maybe Paul, you can chime in, as well. So just to level set with everyone, there is a number of different tools that we have in our podcasting advertising set and the host read ads is one of them, and what we call SAI is something very different. So, specifically, to address the question, on our host read ads, the host itself decides among a number of different brands that it wants to work with, and then reads those ads in and then Spotify serves that base to the audience that best suits the advertisers intent. And then with SAI it’s more dynamically created ads that are set in. Some of them are recorded by the advertisers themselves and some of them are host-read ads as well, that are baked into the mix. But this is a very, very nascent marketplace that exists today. So generally speaking, when it comes to podcast, a lot of this data that we are now talking about, that has become standard on the Internet, has not existed. So what I think the general trend has been, is that when you have — Internet level data and accessibility of those tools, the performance of those ads goes up and when the performance of those ads goes up, the value goes up as well, both to the creator and to the platform as well. So we are very-very excited about bringing Internet level advertising technology to the podcast medium and this is something that I am very-very encouraged by and that I think you should look out for, for the next coming quarters and years.

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Bryan Goldberg — Head of Investor Relations

Next question is from Michael Kleen [Phonetic]. Can you elaborate on how you expect the addition of video will impact the growth of Spotify’s advertising business? Is it realistic for investors to expect a positive impact in the next 12 months?

Daniel Ek — Founder, Chairman and Chief Executive Officer

Yes. So, I think the way you should look at video overall is, it’s yet another capability that we are adding for creators to connect to fans as well. And it’s just in this quarter as well, with discovery of podcasts, where the podcast charts are coming in, more and more tools and data that we are adding to podcasters as well. This is another innovation, as well, to allow podcasters to creatively express themselves in a different way. So you should expect this to iterate on that.

Now, that said, we are an Audio-First platform and so, we expect for the foreseeable future, the majority of consumption to be audio. Meaning that consumers that watch video will go in and out of the video experience and then be able to put that experience in their pocket and continue, and then, when they hear something interesting, pull it back up and then watch the show again. So this is — you should not look at this as some of the other platforms like YouTube and Snap, where it’s predominantly a lean-in experience. Video is an added capability. It is priced very attractively for advertisers, but the share of video on Spotify is low right now, and it will be growing, but I don’t think you should expect it to be another YouTube.

Bryan Goldberg — Head of Investor Relations

Next question from Matt Thorton. On podcast, can you give some color on, one, what percent of hours are currently monetizable and how is that trending? Two, how current ad loads and CPM stack up versus industry average? And three, the third party ad network opportunity.

Paul Vogel — Chief Financial Officer

Yes. So we don’t really disclose ad loads particularly, but I’d say, they are pretty close to industry averages. I would say in general, what’s really interesting and I think Daniel touched on this is, as you get better at targeting when you have tools like SAI, you are able to actually increase your monetization, increase the relevancy of the ads and increase overall monetization without actually having to increase the overall ad load. So we feel really optimistic that our technology and innovation we bring to technology will allow for greater monetization, over time and doing it in a way we don’t necessarily have to increase ad loads. In some cases, you might have to deal with the lower ad loads, if you were able to target the ads more specifically to users with a higher ROI.

And in terms of the third party ad network opportunity, it’s definitely something potentially longer term we could look into. We know that when we launched SAI which is only on our owned and operated properties, the number of inbound calls that we got from folks who had interest in using that technology as well was pretty high. So nothing to announce at this point in time, but obviously something we would potentially consider.

Daniel Ek — Founder, Chairman and Chief Executive Officer

One thing I would add also, I think part of this question was how — where we are in just the rollout of this. So we are very-very early days. So the expectation I want everyone to have, is the vast majority of advertising you hear on Spotify today is the burnt-in ads that the podcasters themselves have served. Spotify does not participate in that. But by building out tools like SAI and host-read ads, which are a lot more efficient and better for the advertisers, better for the creator as well, we expect that to mean a lot more adoption in the coming quarter, as well. So, just want to make everyone aware of that.

Bryan Goldberg — Head of Investor Relations

Next question is from Rich Greenfield. You mentioned a change in the cadence in promotional offers impacting churn. How should we think about the timing length of major promos going forward?

Paul Vogel — Chief Financial Officer

Yes. So, I think if you take a step back, historically we’ve run promotional offerings seasonally. So one in the summer and one at the holiday period of time every year, which we’ve done for the last couple of years. Last year, we did even more experimentation with offers at different times and different types of offers. And so for instance, in 4Q of last year, we had an always on promotion, it started earlier in 4Q than normal. And in Q1 this year, we actually extended the normal holiday campaign into Q1, which persisted for — through the early parts of February.

The seasonal cadence there is that we had more folks in Q2 this year coming off of seasonal campaigns than we normally do. So, as a result, you normally expect some uptick in churn, when you have people rolling off of those promotional offerings. I would say the — well, the quarter-on-quarter — year-on-year churn was down, but quarter-on-quarter was up modestly. But that was totally expected and in line with our expectations, and moving forward, you can expect us to continue to experiment, I would say the seasonal campaigns are likely to continue to happen with the same regularity, and then, we’ll experiment with other offerings and promotions, other regional plans over time.

Bryan Goldberg — Head of Investor Relations

Next question from Lloyd Walmsley. Can you tell us how much premium gross margins benefited in 2Q relative to a year ago from the extended use of the free trial this year versus last year’s $0.99 for three months? What about the total impact to first half premium gross margins?

Paul Vogel — Chief Financial Officer

Yes. So, in Q2, that impact was small. It was probably about 15, 20 basis points and it had a bigger impact in Q1 around 80 basis points. So, together, it’s probably about 40 basis points or so for the first half of the year.

Bryan Goldberg — Head of Investor Relations

Next question from Rich Greenfield. The core Apple Podcast experience hasn’t evolved in years, but there are a wide array of dedicated podcast apps such as Pocket Casts, Overcast, Castro, etc. How would you rank the experience of Spotify as a podcast player versus the dedicated apps? Can you become the best place for podcasts?

Daniel Ek — Founder, Chairman and Chief Executive Officer

Well, that’s certainly our ambition. Again, what I’ve said prior is, that we want to be the de facto audio platform of the world, and there is a lot more innovation that we have started doing about two years ago and that we keep shipping quarter-by-quarter. I think my personal favorite at the moment, which I am super excited about, is the ability to do group listening remotely. So just as an example, this is something we announced yesterday, where our consumers can now share what they are currently listening to and people can tune in to that experience. So whether that be podcast or whether that be music. But because we have this large music platform and because we have this audio platform, all of the benefits that we are developing for the music ecosystem are coming to the podcast ecosystem, as well and that’s true of advertising, as well as the discovery tools and other usability benefits too. And I think, over time, that’s going to compound into an amazing user experience that we believe will be attractive to most, if not all consumers around the world who are interested in listening to audio content.

Bryan Goldberg — Head of Investor Relations

Next question comes from Ben Swinburne. Why do you believe COVID-19 pressures seem to be persists and be more substantial in Latin America and rest of world relative to North America? And separately, do you think there has been a reduction in artist releases due to COVID and if that’s impacted engagement?

Daniel Ek — Founder, Chairman and Chief Executive Officer

It’s a very good question and generally I would say, we see some of this seasonality on a market-by-market basis as well, not related to COVID, but just due to seasonality, due to holidays that kind of thing. My best thesis at the moment, we have talked about this last quarter that there has been a pull forward effect of smart devices and smart home devices. So, smart speakers, smart TV screens, etc, exploding in consumption. This has been a very-very nice tailwind overall. My best thesis at the moment is, we don’t have the same extent of smart devices in LatAm, as we do in, say, more mature markets like North America and Europe, and that can have some of the impact that we are seeing as well, on that. But that’s my own thesis and not something that I can sort of just confirm on a broader basis.

Bryan Goldberg — Head of Investor Relations

Next question from Sumant Wahi. Can you talk about the margin profile of the podcast business in the shape of the ROI? What are your expectations there?

Paul Vogel — Chief Financial Officer

Yes. So, I think as we’ve talked about in the short-term, short to intermediate term, we are still in investment mode and we are going to continue to invest in the business and you will see that the content drag on gross margins continue for some period of time as advertising grows. Over the long-term, we think it should be margin accretive. How long that takes, we’ll have to see and I think we said on a couple of occasions that if you continue to see the goodness in the business from podcasting, whether it’s on user growth or subscriber growth, if we see it impacting the retention numbers and churn numbers in a positive way, we are going to continue to invest in that business and so, I think you’ll see it holistically in our LTV and our LTV to SAC and how we think about that. But it could be a drag for a period of time before it starts to give benefit which we think will be significant over time.

Daniel Ek — Founder, Chairman and Chief Executive Officer

The one added thing I would probably add to what Paul said, just a little for all is, that the best measure that we use internally for judging the business success is the LTV to SAC metric and baked into the LTV metric of course, is the retention of our basis. It is about getting exclusive content and that exclusive content may mean that we are the only place that have that show which enables pricing power, as well. So, long-term, that’s the flywheel, that’s the metric that we are focusing on. So, we are investing in that business to build a differentiated business, compared to all other businesses that exist here and we think this will be the audio platform on the Internet and that’s a large opportunity and a very valuable opportunity both with subscription and advertising.

Bryan Goldberg — Head of Investor Relations

Okay. Next question from Brian Russo. On your recent renewal with UMG, can you confirm this partner has agreed to treat podcasting on your premium tier in the same manner that the other majors have with regard to a carve out of listening time?

Daniel Ek — Founder, Chairman and Chief Executive Officer

I think what we have said is that, from a podcasting perspective, the advertising related to podcasting will be a 100% Spotify’s and not shared. Beyond that, I am not sure we have commented much on any other terms of the deal.

Bryan Goldberg — Head of Investor Relations

Okay. Next question from Richard Kramer. What ROI do you think you can provide advertisers or labels for their promoted songs? How do you balance that with the legal limitations on payola and consumer expectations around recommendations?

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Daniel Ek — Founder, Chairman and Chief Executive Officer

Yes. So, we have been investing in marketplace for quite some time and particularly we have had marquee being out there and we are always of course, monitoring to consumer satisfaction and making sure that that is high. That’s the gauging factor that we are looking into everything. But I do want to talk a little bit about the onuses behind this. I talked about the economics of a label before, but the single largest cost of a label today, unlike before used to be that distribution was the single largest cost of a label. Today, the single largest cost of a label is promotion and marketing. And what’s so exciting to me is that Spotify is the platform where most people are consuming and discovering content. So, if labels instead reinvest some of the portion of the marketing spend that they use to promote a market artist on this platform natively, the result should be a lot better. You should see better results for consumers, because they are getting more of what they actually like. You should see better results for artists and labels, as well, because they are able to grow their fans a lot better, at more efficiently prices than say, other advertising marketplaces or billboards that they’ve traditionally spent them on. And of course, for Spotify, it means a higher gross margin business, as well. So I really do look at this as a win-win-win, where it’s better for the consumer, better for artists and labels and better for Spotify.

Bryan Goldberg — Head of Investor Relations

Okay. Next question comes from Steven Cahall. When users combine into a premium dual account or a family plan, how is this factored into gross adds, net adds in churn?

Daniel Ek — Founder, Chairman and Chief Executive Officer

Well, if you are already a subscriber and you just move within plans, you continue to be a subscriber. So there is no change there. And for gross adds, it’s just every new users to the platform. So with respect to churn, if you’re moving from one plan to the other but you are staying a subscriber, it shouldn’t impact churn either. So, that’s pretty much it.

Bryan Goldberg — Head of Investor Relations

Okay. We’ve got time for about two or three more questions. We’ll go to Mark Mahaney. Can you talk through the P&L impact so far from the two-sided marketplace and comment on its potential future financial impacts?

Paul Vogel — Chief Financial Officer

Yes. So, I think we mentioned last year that it was about $30 million benefit to gross profit and then to start the year, we said that we expect the marketplace to be up about 50% in the contribution to gross profit in 2020. And so, there is no change at all to our expectations for the year in terms of how marketplace is rolling out.

Just to add, I know there is some questions on — a good majority of that is counter cost, so it’s a benefit to gross margin without revenue. There is some revenue attached to the benefit to marketplace, but it’s reasonably small. The majority of the benefit we get is directly related to benefits we see directly in the gross margin.

Bryan Goldberg — Head of Investor Relations

And the next question comes from Deepak at Barclays. With Joe Rogan coming on the platform exclusively in September and other podcasts potentially launching, how are you thinking about the potential benefit to premium subs and MAUs in your third and fourth quarter guidance?

Paul Vogel — Chief Financial Officer

Yes. So, it’s a great question and to piggyback on what Daniel said earlier, we’ve been reasonably conservative with the expectations for how much it benefits our platform. And so, when you look at the guidance range, again if you go back to the start of the year, we had mentioned a certain level of conservatism within our guidance, particularly for MAU with respect to how much potential benefit we are going to see this year from podcasts and podcast launches and new content launches.

And so, we definitely have seen continued growth in MAU. As I mentioned earlier, it was up this year more than it was up at the same time first half of 2019 and we’ve seen really nice growth there. But I would say the exact impact modeled in for the benefits of any of the content is still fairly minor and so there is some conservatism baked into the MAU side with respect to the benefit of podcast and new content.

Daniel Ek — Founder, Chairman and Chief Executive Officer

One addition I would just make thereto is that, the interesting factor isn’t just about one show. It is when you are adding more and more things that only exist on Spotify, as we talked about before. So, to the extent that we are looking at this, I’d say, big events that’s fantastic and that’s great and I am sure it will have a big impact, but both existing fans and new fans alike.

But for me, this is really about adding more and more and more and more reasons for you to come to Spotify and be on the Spotify ecosystem, as well and with that, I am very excited about both the launches we’ve already had, but also the coming announcements in the coming quarters about all the other shows that we are making that there should be something for every single person on the Spotify platform and more and more of those shows will only exist on Spotify.

Bryan Goldberg — Head of Investor Relations

Okay and then I have a question from Richard Kramer, what precisely are you hoping to gain from the Apple Antitrust case? What’s your ideal outcome? And given that 70% plus that the U.S. subs are on iOS, how it did affect earnings?

Daniel Ek — Founder, Chairman and Chief Executive Officer

Paul, maybe you can talk about the specific impact for us. But just overall, the most important thing for us is to create platform principles where it’s a more fair and equitable marketplace for us and other startups to engage and compete for consumers’ attention time and wallets. We ultimately think this is important not just for Spotify, but actually for the broader ecosystem, as well. The best service is the one that should be win not the one who had an existing platform that we are able to lock in consumers with, as well. So, that’s certainly what we are hoping for as outcome and maybe, Paul have something more specific on the impact for us.

Paul Vogel — Chief Financial Officer

Yes. Nothing other than I think what we’ve said in the past, which is we’ve grown really, really nicely and really well in the phase of some, let’s say competitive dynamics that aren’t ideal for us in terms of how we can market and talk to our consumers within the IoS ecosystem. So, we feel really good about the growth we’ve had in spite of the fact there are limitations that Apple puts on us and our ability to market, promote and convert our users into subscribers.

Bryan Goldberg — Head of Investor Relations

All right. And our last question will come from Ben Swinburne. Product mix shift largely due to discounted and family plans continues to benefit users but weigh on ARPU and your year-over-year premium revenue growth which is slowing. Why should shareholders view this trend positively for the long-term earnings power of the business and not a sign of a maturing market?

Paul Vogel — Chief Financial Officer

I guess, I’ll start off and if Daniel has any comments on this one. But, I think for us, we really been in a mode of growing market share and it’s all been about growing users and growing subscribers and as we’ve talked about on a number of calls, we really focus on LTV to check and making sure that we are adding subscribers that we believe will be profitable and profitable over the long-term. And so, we continue to add, we’ve had a lot of success with our family plan, institution plans, and the affinity plans have helped us grow our overall subscribers and gain share. But we have seen ARPU decline and that was down 9% in the quarter as I mentioned, 7% excluding FX and there was another 1% impact of the revenue reversal.

So, down about 6%. I think over long-term, our expectation is that ARPU will moderate in terms of declines and start to move higher. But, for now, it’s really been about market share gains over near-term profitability.

Daniel Ek — Founder, Chairman and Chief Executive Officer

And I think the only thing I would add to that is, we keep looking at all of those changes in product mix from the lens of just the overall LTV. So there are many variables that go into LTV. One of them of course is retention and overall acquisition, as well. When we monitor for that, and as Paul said, we have been mostly focused for growth and I think lightly.

So, because with the scale of the platform that enables more and more and more of the benefits that we’ve been talking about, as well. It’s easier for us to market to existing consumers when we are doing something like podcast. Those consumers are in turn marketing to other new consumers, because they are all in the platform too.

So we are seeing this virtual cycle of more and more people joining the platform on the basis of that. Long-term though, just to elevate this discussion, we are very, very bullish still and we are still in the early days on this journey of going after the audio platform of the world and that is still measured in billions of consumers, as we are still relatively early in that cycle and just from a TAM perspective, even today, the radio industry is north of $50 billion.

Most of that is advertising, advertising today a small portion of the Spotify’s business, but it will be a much bigger one overall. So that’s an added potential benefit. Then on the subscriber side, as Japan and the U.S. have shown before, there are existing audio products that are monetizing much higher ARPUs than Spotify in those marketplaces. And I think, the Spotify product and content mix is getting better by the day and over time that gives us confidence that we should have ability to be a significant player in subscription and have pricing power, as well going forward.

So, I think the combination of those two — growth will still be the priority given that we are talking about in the billions, but I am very, very bullish on our ability, both on advertising and subscription long-term.

Bryan Goldberg — Head of Investor Relations

Okay. That concludes our question and answer session. Daniel, do you have any final closing remarks?

Daniel Ek — Founder, Chairman and Chief Executive Officer

Yes sure. So, in closing, we had a very strong quarter and as I mentioned just before, I’ve really never been more bullish about where we are today and our future opportunity and there are still billions of people who have yet to discover our on-demand music streaming or listen to a podcast, and of course, many more we have yet to reach in markets around the world where Spotify doesn’t yet exists.

And speaking of podcasts, the last thing I wanted to do is, just to encourage you to check out Spotify’s new For the Record podcast that’s coming out this Friday. Paul and I will be sharing additional thoughts about the quarter and we will be discussing my philosophy on growth, innovation and the importance of risk taking. So, feel free to check that out, shameless plug. But thanks again for joining us this morning. This is an exciting time to be focused on audio, and we are only just getting started.

Bryan Goldberg — Head of Investor Relations

Thanks again everyone for joining. The replay of the call will be available on our website and new for the first time also on the Spotify App under Spotify Earnings Call Replays. Thanks again.

Operator

[Operator Closing Remarks]

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