Earnings Call Transcript - SPOT Q2 2023

Operator, Operator

Good morning. My name is Julian, and I will be your conference operator today. I would like to welcome everyone to Spotify's Q2 2023 Earnings Call and Webcast. I now turn the call over to Bryan Goldberg, Head of Investor Relations. Thank you. You may begin your conference.

Bryan Goldberg, Head of Investor Relations

Thank you, operator, and welcome to Spotify's second quarter 2023 earnings conference call. Joining us today will be Daniel Ek, our CEO, and Paul Vogel, our CFO. We'll start with opening comments from Daniel and Paul, and afterwards, we'll be happy to answer your questions. Questions can be submitted by going to slido.com, S-L-I-D-O.com, and using the code #SpotifyEarningsQ223. 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'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 shareholder deck and in filings with the Securities and Exchange Commission. During this call, we'll also refer to certain non-IFRS financial measures. Reconciliations between our IFRS and non-IFRS financial measures can be found in our shareholder deck, in the Financial section of our Investor Relations website and also furnished today on Form 6-K. And with that, I'm going to turn the call over to Daniel.

Daniel Ek, CEO

All right. Hey, everyone, and thank you all for joining us. I hope you all had a chance to review our shareholder deck, and as you can see, it was a very strong quarter. We beat our own expectations again, across both MAU and subscribers. And in addition, it's really gratifying to see the outperformance in growth that continues to come from markets all over the world. So let me share some more context on the growth this quarter before we go into what it ultimately means for the business. So this quarter netted the highest MAU growth in Spotify's history. And as a point of comparison, our growth this quarter was 36 million compared to Q2 of 2022, where we saw MAU growth of 19 million. And this reacceleration is significant and shows that our investments in adding podcasts and improving our platform and user experience are paying off nicely. I've talked before about the fact that the biggest driver of our subscriber growth comes from users who start on our ad-supported service. It is a really powerful funnel where the more our users discover and engage, the more they're willing to pay for an enhanced experience. And with six quarters of MAU outperformance, we are capitalizing on this momentum and it is proving to have a meaningful effect, helping us achieve 10 million net new subscribers this quarter, 3 million more than we originally anticipated. So now let's talk about revenue growth. There are three ways for us to drive revenue growth. We can grow our users, we can create new business with new revenue streams, and we can increase revenue per user. Our preference among them is to focus on growing the overall number of consumers on our platform as this gives us scale advantages and retains optionality for the future. However, we've also been clear that there will come a time when price increases become a more important tool in the toolbox. And to that end, as most of you are now aware, yesterday, we announced broad price increases across more than 50 markets, including most of Europe and North America. And we've carefully weighed this decision, but we felt the timing was right. We have expanded value to price significantly by meaningfully improving our content offering and we continue to enhance the user experience and lower churn. And over the past few years, we have learned a lot as we've conducted over 50 price increases already, and this experience, coupled with our strong offering, puts Spotify in an excellent position to make this move. And while this won't impact revenue per user much up until the end of Q3, we expect it to have a meaningful impact on Q4 and beyond. And finally, we continue to make progress on improving efficiency across the company. As Paul will explain, we have taken several actions to further streamline our operations and reduce costs, which we largely outlined in Q1. These moves position us to become a much stronger business in the future. Despite making these changes in an effort to create more efficiency, we have still managed to increase the overall velocity of experiments and new improvements. And this gives me a lot of confidence. So looking back at Spotify, the lesson we have learned is that daily progress, even if faint, is more important than the occasional clash of brilliance we've had. Therefore, I believe that the speed of iteration is perhaps the ultimate leading indicator of our long-term success. And with that, I'll turn it over to Paul for more detail behind the numbers and then Bryan will open it up for our Q&A.

Paul Vogel, CFO

Great. Thanks, Daniel, and thanks, everyone, for joining us. I'd like to add a bit more color on the quarter and then touch upon the broader performance of the business and our outlook. Overall, our user and subscriber growth was exceptionally strong in the quarter. Users grew by 36 million to 551 million, while we added 10 million new subscribers, finishing at 220 million. Both MAU and subscriber growth accelerated from Q1, driving the highest quarterly user growth in our industry and the best Q2 for subscribers on record. On the revenue front, we grew 11% year-on-year to EUR3.2 billion during the quarter. Our FX neutral growth was 14% and accelerated versus the prior quarter's result. Let me turn now to gross margin. As I previewed during the Q1 call, we expected to incur charges in Q2 related to our ongoing efficiency efforts. In the quarter, we took steps to shrink our real estate footprint and rationalize certain areas of our podcasting business. We also exited our Soundtrap Marketplace business. We expect all of these moves to have a positive impact on our rate of profitability on a go-forward basis. However, they did result in roughly EUR135 million of net charges in the quarter, with EUR44 million flowing through gross margin and EUR91 million flowing through our operating expense. About EUR25 million of these charges were cash related. With that context, adjusted gross margin, which excludes these charges, was 25.5% and in line with expectations. As a reminder, we guided gross margin excluding potential one-time charges. Adjusted operating loss of EUR112 million was better than planned, helped by lower marketing and legal spend, which more than offset higher-than-anticipated social charge accruals. Free cash flow was positive EUR9 million in Q2. Looking ahead to third quarter guidance, we are forecasting 572 million MAU, an increase of 21 million from Q2, and 224 million subscribers, an increase of 4 million over Q2. We're also forecasting EUR3.3 billion in total revenue, a gross margin of 26% and an operating loss of approximately EUR45 million. First, looking at user and subscriber growth, we've had an outstanding start to the year, and we see momentum continuing into the back half of the year. And to address a likely question right up front with respect to price increases and subscriber growth, our data would suggest that historical price increases have had minimal impact on growth, but given the breadth of this change and the significant outperformance in the first half of the year, there is some conservatism baked into our outlook for Q3. We do expect our net adds through Q3 of this year to be higher than at the same point last year, roughly 30% better. And turning to revenue, we are forecasting a 600 basis point headwind to growth given the continued strengthening of the euro relative to the dollar, and those trends appear to be continuing into Q3. Excluding this effect, our constant currency revenue would be closer to EUR3.5 billion, reflecting our expectations for accelerating currency-neutral growth to 16% year-on-year versus the 14% growth that we delivered in Q2. We anticipate further revenue growth acceleration in Q4 relative to Q3 on a currency-neutral basis due to a full quarter benefit from price increases. For clarity, the recently announced price increases will have a small impact on Q3 revenue, given building cycles and timing. Q4 will get a full quarter benefit and therefore the greater impact on accelerating revenue. From a profitability standpoint, we continue to expect a sequential ramp in margins through the balance of 2023 as well as improvements in our operating loss. And with that, I'll turn it back to Bryan for Q&A.

Bryan Goldberg, Head of Investor Relations

All right. Thanks, Paul. Again, if you've gotten any questions, please go to slido.com #spotifyearningsq223. We are going to be reading the questions in the order they appear in the queue with respect to how people vote up their preference for questions. And our first question today is going to come from Justin Patterson on efficiency. Daniel and Paul, efficiency has been a major theme for you in 2023. As you look at actions taken this year and consider your long-term margin targets, where do you see opportunities to be more efficient while still ensuring you have the right level of investment to support revenue growth?

Daniel Ek, CEO

I'll start and maybe Paul can add some thoughts. If you recall my earlier comments this year, there are two main points. First, the criteria for any new investment will be much more stringent moving forward. Our investments in operating expenses are a clear reflection of that. Second, I mentioned earlier that we likely overextended ourselves with those investments, leading to a reduction in staff related to that. I’m now more optimistic about our overall operating expenses and our current standing. Moving forward, you should expect that the percentage of revenue spent on these expenses will decrease, as we won’t be increasing our operating expenses to the same level as in previous years. Additionally, we made investments based on promising leading indicators, and it's important to highlight our strong performance over the last six quarters in monthly active users, which is now positively impacting subscriber growth. I feel confident about those investments, but we may have overshot a bit, and moving forward, we'll maintain the investments we've already made since they are yielding excellent results. Paul, do you want to add anything?

Paul Vogel, CFO

Yeah. I'll just add a few things. One, I mean, if you look at some of the changes we made both this quarter and the beginning of the year, Q2 was the last quarter where we had headcount higher year-over-year. We expect our headcount year-over-year to actually be down in Q3. We'll see where that goes moving forward. But as Daniel said, we're continuing to become more efficient. We're continuing to find ways to innovate and launch new products and experiment at the current level. So we feel really good about where we are. So you will see some of that efficiency have even more of an impact in the back half of the year with respect to the OpEx.

Bryan Goldberg, Head of Investor Relations

Alright. Our next question is going to come from Justin Patterson again. This one on AI. Daniel, we've started to see AI extend beyond discovery into areas like the AI DJ. What additional opportunities do you see for AI across the product portfolio? How should we think about AI potentially influencing podcast or even audiobook growth over time?

Daniel Ek, CEO

Yeah. I think we're in the early innings of even seeing all of its potential. And I assume with the question that you're talking more about generative AI than not, but for the purposes of this, I think there's almost three major applications. We still think there's enormous benefits of just core machine learning or AI improvements in discovery. So that's going to be massive, and you can see some of those improvements already paying off very nicely in higher engagements and higher retention, which then lowers churn. This is a trend that's been going on now for many years. So I still think that there's quite a lot that we can do there that will improve engagement and retention over time. And then the second bucket, of course, comes into generative AI. And AI DJ is a phenomenal product. It's probably one of my personal favorites over the last few years that we have developed, and we've seen really strong consumer interactions with that. And that just talks about the ability for us to contextualize and personalize all the amazing content that we have on the Spotify platform. So I think you're going to see a lot more of that where we can contextualize and personalize content across the entire platform to make it more accessible. So, an easy way to think about it as an investor is if you think about podcasting today, it's really high-quality content, but it requires quite a lot for you to get into new podcasting. So one very easy thing we can do with these new AI developments is, of course, summarize what these podcasts are about. And by doing so, you can imagine it becoming a lot easier to merchandise new podcast for consumers which drives in turn higher engagement and more growth for creators, which is a really positive thing. And then lastly, I would say, just making the company overall more efficient. And I think this is probably the part that most people are investing in in the broader ecosystem, but not enough credit yet of understanding among investors is happening. But I significantly believe that we can become a lot more efficient as a company by leveraging AI. So a great example of that would be, if you think about advertisers today, the cost of generating new advertisements on Spotify is quite a big thing, especially on audio ads. By using generative AI and our tools here, I think you're going to be able to see that we can significantly reduce the cost that it takes for advertisers to develop new ad formats. And that obviously means that you as an advertiser instead of having one ad, you can imagine having thousands and tested across the Spotify networks, things that you could easily do today using text but you haven't been able to do over video or in audio. So there's going to be a lot of those opportunities where we're going to be, not just on the consumer side but really across the entire company, become a lot more efficient, which will drive more value for all stakeholders, consumers, creators, and Spotify itself.

Bryan Goldberg, Head of Investor Relations

Okay. Our next question is going to come from Matthew Thornton on price increases. What does third quarter revenue guidance assume in terms of timing and subscriber guidance, assume in terms of churn and gross intake? And do you think a structure is in place with the content owners to now incentivize regular or recurring price increases?

Paul Vogel, CFO

I'll address the first part of that question, and then I'll let Daniel handle the second part. The guidance takes into account price increases. We announced a price increase recently. Most subscribers have a notice period, meaning the price increase won't take effect until the next billing cycle. Therefore, most subscribers won't see the price increase until September, which is why I mentioned its minimal impact on Q3. Most of the price increase will occur in the last month of the quarter, so you can expect to see the full benefit in Q4. As a result, ARPU and revenue growth will likely accelerate more in Q4 than in Q3. Regarding churn and gross intake, we don’t typically comment on those metrics. As I stated in my prepared remarks, there is some conservatism reflected in the Q3 numbers. Historically, when we have raised prices, we have seen positive outcomes, with minimal impact on gross intake and churn trends. There is no reason to expect that this time will be different, even though this change is more significant and widespread than previous ones. As a result, conservatism is considered in how Q3 unfolds. Daniel, I'll pass it over to you for the second part of the question.

Daniel Ek, CEO

Yeah. So I think the second half was around the structure that allows the regular and recurring price increases. And I commented on that already. I think, again, we have, in the past, done over 50 already, so I don't want to overstate this, price increases. But, obviously, this is the biggest one we've done to date, and I think I addressed it in my opening remarks, but I believe you should all look at it as a tool in our toolbox, but the overall goal is per market basis grow our revenue and we're trying to grow it at 20% as we've outlined already in our targets. And so there's three ways to do that. One is obviously to grow the number of consumers. That's our preferred way of doing that and keep the value of the price super high because that creates optionality. When user growth slows down, take Sweden as a great example where we're already at a massive part of the population there, then price increases becomes an even more important tool in the toolbox. And then thirdly, of course, we have grown revenues through our new verticals or new products, which is also another tool we have in the toolbox, but, of course, more longer term. So, yes, I think you should assume that this is a tool we now have in the toolbox.

Bryan Goldberg, Head of Investor Relations

Okay. We've got another question from Matthew Thornton on the ad market. Can you talk about the performance and linearity of the ad market through second quarter and into third quarter? And can you provide any updates on SPAN?

Paul Vogel, CFO

Yeah. So the quarter on the outside was pretty solid relative to our expectations. We did see some improvement throughout the quarter, so definitely the back half the quarter was better than the first half, although not that out of line with our expectations. We expect advertising to be even better in 3Q, which is baked into our guidance. So on an FX neutral basis, a better quarter from a growth perspective than we saw in Q2. And then progress at SPAN. SPAN was a big driver of the outperformance. It definitely helped podcast ad revenue. Podcast ad revenue got better throughout the quarter as well in terms of growth rate. So SPAN was a big contributor to that.

Bryan Goldberg, Head of Investor Relations

All right. Our next question is going to come from Michael Morris. In the past, you've referenced seeking a win-win scenario with labels prior to raising consumer pricing. Can you share detail about the win you achieved in conjunction with yesterday's announced increase? Will you pay royalties on the incremental revenue at the same rate as your current agreements?

Daniel Ek, CEO

Yeah. I'm not going to dive into specifics about anything in our agreements as per usual. But I will say that we're, of course, very pleased with where we are with our partners, and we feel really good about the situation. And that I believe, again, I think I mentioned this in the past, but I feel like, quite often, this is being put in a situation where this is kind of a win-lose relationship between our partners and us. That is not how we see it. We very much see it as, again, not a zero-sum game, but a growing pie, and the goal is for both parties to be win-win. And I feel like we're at a situation where we are at a win-win with all of our rights partners. And I feel really good about the growth of Spotify, but also the growth of the overall music economy. And that's really the kind of main focus for us at Spotify is we're really trying to create a win-win, and I feel like that's the part that's often missing. But we're really pleased with where we are both with this price increase and our overall position with our partners.

Bryan Goldberg, Head of Investor Relations

All right. Our next question is going to come from Mario Lu on ARPU. ARPU declined 3% year-on-year, excluding currency, in the quarter. Can you help break down the contribution from product and market mix and whether the price increases announced last week will be able to offset these two negative impacts by Q4?

Paul Vogel, CFO

Yep. Thanks, Mario. So the biggest impact on the quarter was the product mix. That was the majority of the impact to the 3% decline, FX neutral on ARPU. Looking out, the price increase will moderately help in Q3. We're looking for FX neutral ARPU kind of flat to down 1% in Q3, and then we should expect a meaningful improvement in FX neutral ARPU in Q4 as we get the full benefit of the price increase into Q4. So minus 3% this quarter, call it zero to minus 1% in Q3 and then nicely positive. We don't obviously guide the Q4 at this point, but nicely positive in Q4 of this year.

Bryan Goldberg, Head of Investor Relations

Great. Next question from Rich Greenfield. TikTok recently reached a new supposedly groundbreaking deal with the labels? How should we think about what this means for competition with Spotify?

Daniel Ek, CEO

Well, again, competition is nothing new. It's something that we've been dealing with since the start of the company, and we have had many formidable competitors, and, obviously, TikTok is one. All of that said, I think the results this quarter kind of speaks for themselves, with the outperformance in users and outperformance in subs. I feel really, really good about the investments we've been doing over the past few years in improving our competitive position and improving the consumer value that we're providing to our consumers. And yeah, I mean, again, competition isn't anything new. It is expected especially in such a large category that so many consumers care about, like, music. So yeah, really nothing to add more than that.

Bryan Goldberg, Head of Investor Relations

All right. Our next question is going to come from Mario Lu on podcast economics. The second quarter podcast gross margin improvement, can you give us a rough ballpark of where we are right now versus a timeline of breakeven within the next year?

Paul Vogel, CFO

Yeah. We continue to see improvements. The rate of improvement on the gross margin on the podcasting side, I would say that relative to all the expectations we gave at the Investor Day, we're right on track. We expect to hit all the targets we laid out for podcasts and podcast breakeven and improvement in margins. And at a higher level, I think we feel really good about all the targets we laid out at the Investor Day.

Bryan Goldberg, Head of Investor Relations

All right. And then we got another question from Rich Greenfield. Everyone was expecting you to raise the base single user price which has never gone up, but you also pushed through a $1 increase on the Family Plan in April of 2021. How do you think about your Family Plan pricing power versus the base tier?

Daniel Ek, CEO

Yeah. I mean, again, it's phenomenal value, really, for consumers, both the standard tier, but obviously the family pricing as well. So we feel it's a great offering. And as we said before, we've been, in the past, waiting and kind of reviewing and building up more value, and that's really how you should think about it. We are trying to build more value towards our consumers. That's where we start. And then when we feel like that gap, the value to price ratio is getting out of whack, you should now assume that we have a new tool in our toolbox, which is we have the ability to raise prices and we feel good about doing that, and the Family Plan, of course, is an even better value proposition relative to the standard plan. So that's another tier that we have the opportunity to raise prices on.

Bryan Goldberg, Head of Investor Relations

Okay. We've got a question from Matt Thornton on streaming economics. Do you think the music streaming market will get to a structure where higher value is ascribed to premium music streams versus perhaps other content that may be perceived as less premium?

Daniel Ek, CEO

I think what you're discussing is probably a variant around artists centric rather than the sort of difference between ad supported and premium parts. And obviously, this is kind of a big contention. How do we make the economic model fair for as many participants on the platform, and we're always making tweaks to that model. We're always reviewing how we can make the model fairer, and we're in constant dialogue with our partners around how we can do that. I think the expectation from an investor point of view is, however, is that it doesn't actually meaningfully impact Spotify's economics one way or the other. This is more around how we divide the pie from the right holders and to what artists or what groups of artists we should do it. But most studies we've done in this is that even if you change it on a user centric or an artist centric approach, it seldom leads to gigantic differences that most people perceive it to do. So again, we're in constant discussion with our partners, and we're always sharing data about what we see and they're sharing data back, of course, but we're always open to hear how we can make the system more fair to more artists.

Bryan Goldberg, Head of Investor Relations

Alright. next question from Maria Ripps. Could you comment on the June Bloomberg report that indicated you were planning on launching a Hi-Fi tier later this year. What are your expectations for engagement and plan switching across different pricing tiers if and when you release this offering?

Daniel Ek, CEO

Yeah. We don't really have any announcements to make on this call around any new sort of features or things. We tend to do that directly towards consumers when we have them. What I will say, of course, is that Hi-Fi remains something that we think has value, but it's something that has value to probably and more aficionados in the streaming market and we're interested in, obviously, how we could use that as one tool to, in the future, increase our value even further, but we don't have anything to announce at this point.

Bryan Goldberg, Head of Investor Relations

All right. Next question from Matt Thornton on the user interface. What impacts have you seen, engagement, retention, conversion, or anything else from the new user interface, and how far along are we in the rollout of that new UI?

Daniel Ek, CEO

Yeah. So again, the user interface for those that may not be aware that I believe Matt is referencing is the one we announced at Stream On. And as we outlined back then, it was the single largest shift that we've ever made to the user experience, both on a look and feel, but more importantly, on the back end because we had to rearchitect all the signals that our machine learning systems were using as well. And what we're seeing is pretty good results. We have made lots and lots of tweaks based on user feedback, which is normal. And we are making those tweaks. We're also making lots of tweaks on our recommendation based on these new signals. So I feel really good about where we are, but it's an entirely new system. So we're being very, very careful about how we're rolling it out. And you should expect most of it to be rolled out over the remainder of this year with this new UI. We feel good about it. And you should expect long-term that engagement will increase. And, of course, if engagement increases, that tends to lead to better retention, which in turn tends to lead to better conversion over time as well.

Bryan Goldberg, Head of Investor Relations

Okay. We've got a question from Maria Ripps on podcasting. Last quarter, you talked about canceling or not renewing underperforming podcast content. Could you provide some further detail regarding how your original content strategy is evolving under more streamlined operations? And are there any audience demographics or genre types that you're more focused on now?

Daniel Ek, CEO

Yeah. I think, Maria, you're rightly pointing it out. I think the biggest shift in our strategy is really around the more streamlined operations and that we're being more careful about, now that we have a lot more data around, doubling down and renewing the things that did work and stop doing the things that didn't work. And I think that's the primary consideration that we're going through. And then in terms of any new genres or demographics, I think the most interesting thing from my vantage point is how the number of podcasters is growing. So you're seeing more and more new podcasters come in and do that. And unlike before where perhaps we saw people in the very early innings that were native to podcasting and didn't do any other form of media, then when we made the announcement, we brought new talent to the platform. Now we're seeing a lot of Internet native creators who are creating new podcasts for it. And I think our video podcasting is a great example of that where we're seeing podcasters now realizing that they have one video feed on Instagram and YouTube and all these other platforms and now uploading more long-form content on Spotify with great success. So we are very much tailoring on the content type to these new creators and broadening the base of podcasters. Feel really good about that. And then on the consumer side, that tends to lead to much younger consumers getting in and starting to realize that podcasting is not just something for older consumers, but it's something that has a lot of appeal. It could be funny. It could be not just facts, but you're seeing, Call Her Daddy, a great example of younger women taking up to podcasting and loving the format. And we're seeing, obviously, something like Call Her Daddy also then cross-referenced when Alex Cooper brings musical artists onto the show, you're seeing great results in music streams as well. So nice sort of a brand halo that shines onto the music side as well. So that's the expectations. We're going for more creators, which probably will lead to more younger consumers all around the world as well. And more importantly, of course, the big shift being that it has to be efficient.

Bryan Goldberg, Head of Investor Relations

All right. Next question from Doug Anmuth on sales and marketing. Do you expect sales and marketing to decelerate or decline year-on-year in the back half of 2023 given the heavy spending from 2022? And how does that influence your MAU and premium subscriber outlook?

Paul Vogel, CFO

Yes, as you mentioned, Doug, there was definitely an acceleration in the latter half of last year. When considering the year-over-year comparisons, those figures are what they are. Additionally, in the last few quarters, we have spent less on marketing yet still experienced impressive user and subscriber growth. We've observed that after a period during which our LTV/CAC dipped slightly, it has improved significantly and is now rising nicely. We have seen considerable progress in our LTV/CAC metrics and in our cost per gross ad relative to LTV. This improvement is becoming evident. Marketing will always be crucial to our growth, but it hasn’t influenced our guidance on user and subscriber numbers, nor have there been any significant changes to our marketing strategy from last year. We are confident about the efficiencies we have achieved and pleased with the marketing expenditure that is now yielding results. When entering new markets, initial awareness is necessary, and once we establish that momentum, growth tends to accelerate on its own, which we are starting to see in several of our markets.

Bryan Goldberg, Head of Investor Relations

Okay. Another one from Doug Anmuth. This one on podcast content deals. As some meaningful podcast content potentially comes up for renewal later this year and through 2024, how is your positioning discipline and thought process different from where you were when you were building out the podcast a few years ago?

Daniel Ek, CEO

I would say the most significant change is not only the different environment we are in, which is quite obvious and something I've addressed previously, but also the expectations we set four years ago when we had minimal data to guide our decisions. It's crucial to put this in context for investors. We believed that podcasts were under-monetized and underutilized by consumers, and we saw a real opportunity to enter the marketplace, even though we were starting from scratch. Today, we are the leading player in most markets globally, and this media category is proving to be a growing one, which makes us feel very positive about our position. Overall, it was the right decision, and it has paid off well, positively impacting our engagement, retention, and reducing churn. I feel quite confident about that aspect. That being said, we now have a wealth of data from the millions of podcasts we’ve developed that informs us about new user acquisition, retention, conversion, and subscriber metrics. Unsurprisingly, we've discovered that while some shows resonate strongly with our audience, others do not, and some may have been overcompensated relative to their value. As a result, we're in the process of adjusting certain deals—enhancing investments in successful shows while stepping back from those that haven't performed as expected. This is a normal part of our strategy as we aimed to dominate the space and quickly amass data. The insights we have now are far richer and enable us to make far better decisions than we could have made four years ago.

Bryan Goldberg, Head of Investor Relations

All right. We've got a question from Richard Kramer relating to gross margin. What led to the favorability of other cost of revenues in the quarter? And how might that develop given the introduction of more video on the platform?

Paul Vogel, CFO

There are two main points to consider. First, our streaming delivery and compute costs, with streaming delivery being the more significant factor. This is largely due to the maturation of our business and our improved ability to estimate and predict these costs, which has beneficially impacted us. Last year, after experiencing some declines, we faced a couple of quarters where costs went up, but now they are decreasing again as a percentage of revenue. We believe we have a better grasp on forecasting and managing these costs moving forward. While there can always be variations and fluctuations, especially if video becomes a larger part of our offerings, we now have the necessary models to accurately predict these expenses. Overall, we feel we are in a good position to maintain our current revenue cost levels.

Bryan Goldberg, Head of Investor Relations

Okay. Another one from Doug about pricing power. How do you think about pricing power over the long term and Spotify's ability to innovate on product to continuously make it more valuable to users?

Daniel Ek, CEO

Yeah, Doug. The way we think about it is, we're constantly thinking about how we can increase the value that we give our consumers on the platform, no matter if they're on their ad-supported tier or our paid subscription tier and really kind of increasing that sort of value to price ratio that we have. So I think, so long as we're able to bring more value to our consumers, then we should have the ability to raise pricing over time as well to sort of narrow that gap. But we're always going to be focused on over-delivering on value towards our consumers on this platform. And then when you think about the innovation, I feel really good about that. As I mentioned in my opening remarks, despite the efficiencies that we've now made across the business, we are at an all-time high on the number of experiments that we're doing and improvements. I mean, just in the last quarter, as you could see in our shareholder deck, we've introduced an entirely new redesign of our desktop clients. Last quarter, we did one on the mobile client. We have updated Tesla this quarter. We've updated many of our partner experiences. We've introduced AI DJ to a wide number of consumers and the list goes on and on and on of all of these improvements. And again, podcasting is still growing very nicely, still relatively early. Audiobooks is even more nascent in this business, and I believe long-term, going to be very, very big for Spotify, similarly to how investors may not have necessarily understood podcasting early on. I think audiobooks will be the next one where we will look back in a few years and say, wow, that became quite meaningful quite fast for Spotify. So I feel really good about us being able to add lots of value to consumers over time. And if we're doing that, I believe that we have the ability to then raise prices to keep the value to price ratio at an appropriate level.

Bryan Goldberg, Head of Investor Relations

Okay. Our next question is going to come from Zach Morrissey on advertising. Music ad revenues decelerated to mid-single digits in terms of year-on-year growth in the second quarter. How did this perform relative to your expectations? And can you discuss the trends you saw through the quarter and into July?

Paul Vogel, CFO

Yeah. So at a very high level, revenue was right in line with our expectations. We're obviously dealing with some heavier currency than we expected. But if you look at both the advertising side and the premium side, we are almost spot on, on both of those with respect to our own internal forecast. So revenue was right in line with expectations. We don't really guide to music or podcasting and advertising specifically. But I would say music was pretty much in line. The podcast was in line to slightly better. And so we saw good trends in advertising overall. So I would say, again, to recap, revenue right in line, not much of a difference either on the ad side or premium side with our expectations.

Bryan Goldberg, Head of Investor Relations

All right. We've got a question from Mike Morris. What are the factors driving third quarter premium subscriber growth, the outlook, that is below the prior year's level of net adds? Are there promotions or other activities that are driving increased quarterly variability? And how much is the announced price increase expected to impact net adds?

Paul Vogel, CFO

Yeah. So I'd probably take a step back first and just look at sort of subscriber growth in general. We outperformed in Q1 of this year. We outperformed in Q2 of this year. If you look at subscriber growth over the last 12 months, we've added over 30 million net subscribers, which is sort of phenomenal and accelerating trajectory over any 12-month period of time. So subscriber growth has been really, really strong. Obviously, user growth has been even better. I think we've added something like 118 million users over the last 12 months as well. So both of them have really been strong. And when you look at over a nine-month period, incorporating our guidance, we expect net additions in the first nine months of this year to be up 30% relative to the net additions we had in the first nine months of last year. So that's just sort of the level set. And with respect to the absolute guide in Q3, well, one, we did significantly outperform in Q2. So there's always a question of how much, if any, we pull forward from Q3 into Q2, given it was our strongest Q2 ever from a subscriber perspective. The second thing is, as I mentioned in my comments, there's definitely some conservatism baked in. We've done price increases in the past. We've never done them this extensive and in some of our very key markets, and so there's some conservatism baked in there. So in general, I think we feel great about the overall subscriber trends over the last 12 months, over the last nine months, throughout this year and into Q3. And again, when you look at some of the comments I made into the start of the year with respect to both user growth and subscriber growth, we're on pace to exceed kind of the comments I made in terms of similar growth to the prior year. So we feel really good about the trends on both sides.

Bryan Goldberg, Head of Investor Relations

All right. We've got time for a few more questions. We're going to go now to Benjamin Black on Marketplace. How has Marketplace growth trended and could new products like AI DJ support incremental growth here?

Paul Vogel, CFO

Marketplace has experienced impressive growth. We haven't provided updated figures recently, but the last update in 2021 indicated a gross profit contribution of about EUR160 million. We mentioned it grew over 30% last year, and we've seen significant growth again this year. Marketplace remains a key growth driver. We consistently launch new products and different initiatives aimed at benefiting our partners, the artists, and consumers. We will keep innovating, and we believe Marketplace will continue to add value, both financially and significantly to the artist community by enhancing their participation.

Bryan Goldberg, Head of Investor Relations

Okay. We've got a question from Jed Kelly on monthly active users. Can you quantify how much MAUs benefited from the decision to delay price increases versus competitors? And will that benefit dissipate now?

Daniel Ek, CEO

I believe you're asking about subscriber growth rather than monthly active users. On the free side, I don't think the price increases have had any impact there. When we consider subscriber growth, it's uncertain whether it has been affected. However, if we analyze the data from the approximately 50 price increases we've implemented so far, it appears that these changes have had minimal effect on future growth, churn, or conversion rates. This contributes to our confidence in our current position and leads us to believe that now is the right time for this decision. While we can't predict outcomes with certainty, we don't think it has significantly affected our performance.

Bryan Goldberg, Head of Investor Relations

Okay. Next question from Rich Greenfield on advertising. Ad supported MAUs are growing at over twice the growth rate in your advertising revenues. The ad market is clearly soft. But is there anything else in terms of ad product or advertiser willingness to embrace audio that's dampening your advertising revenue growth?

Daniel Ek, CEO

I think, Rich, part of the explanation is really around the two factors, where we are seeing that growth and then, I would say, a little bit about just the delay in timing. So some of the growth we're seeing in markets that generally don't have the same strength of advertising as, say, the United States has. So when you think about the rest of the world, obviously, the ARPUs on the ad side are going to be much lower there than they are in the US. So that's some of the explanation when you think about ad MAUs growing. But then the other part is, and I think you can see this as you're looking at all platforms, pretty much all social media platforms follow this similar trend, which is, when you have reacceleration of growth or very fast, rapid growth, it usually takes a few quarters before the ad market catches up. So it is not sort of one-to-one when you see a user, you can instantly start monetizing that user. It usually takes a few quarters before you can do that. And I think over time, it will start catching up here, too, but it's more of a lag than anything else. And then, of course, the developing markets part.

Bryan Goldberg, Head of Investor Relations

All right. We're going to take our last question today from Benjamin Black on podcasting. Podcast advertising reaccelerated nicely this quarter. What was the source of the turnaround? And more broadly, how would you characterize the advertising environment?

Paul Vogel, CFO

There are a few key points to highlight. First, SPAN had a strong performance this quarter, which positively impacted our podcasting segment. Much of the improvement came from better overall delivery capabilities and higher sellout rates in podcasting. As I mentioned earlier, podcast advertising improved consistently throughout the quarter, with the last month being our strongest in terms of year-over-year growth in that area.

Bryan Goldberg, Head of Investor Relations

All right. Thanks, Ben. And that's going to wrap up our Q&A session today. Let's turn the call back over to Daniel for some closing remarks.

Daniel Ek, CEO

All right. Thanks, Bryan. It was really a great and historic quarter for Spotify, and I'm energized by our growth and continued outperformance. The price increases we announced yesterday demonstrate the value we provide to our customers and the strength of our offering. As a team, we're also moving faster than ever and we're better positioned to deliver on our potential and the ambitions we laid out for you at the last year's Investor Day. We are making tremendous progress towards those goals, and I feel confident about our momentum heading into the second half of 2023. So thank you all for joining us. And as usual, feel free to check out our For The Record podcast, which will be released later today.

Bryan Goldberg, Head of Investor Relations

All right. 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.

Operator, Operator

This concludes today's call. Thank you for your participation. You may now disconnect.