Spotify Technology SA (SPOT) CEO Daniel Ek on Q2 2018 Results - Earnings Call Transcript

Jul. 26, 2018 11:26 AM ETSpotify Technology S.A. (SPOT)1 Comment3 Likes
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Spotify Technology SA (NYSE:SPOT) Q2 2018 Results Earnings Conference Call July 26, 2018 8:00 AM ET

Executives

Paul Vogel – Head of Investor Relations and FP&A

Daniel Ek – Chief Executive Officer

Barry McCarthy – Chief Financial Officer

Analysts

Ross Sandler - Barclays

Matt Thornton - SunTrust

Rich Greenfield - BTIG

Anthony DiClemente - Evercore

Eric Sheridan - UBS

Amy Yong - Macquarie

Jess Reif Cohen - Bank of America Merrill Lynch

Michael Morris - Guggenheim

Mark Mahaney - RBC

Nick Delfas - Redburn

Rob Sanderson - MKM Partners

Ben Swinburne - Morgan Stanley

Peter Stabler - Wells Fargo

Heath Terry - Goldman Sachs

John Egbert - Stifel

Richard Elliott - UBS

James Cordwell - Atlantic Equities

Ashwin Kesireddy - JPMorgan

Justin Patterson - Raymond James

Lloyd Walmsley - Deutsche Bank

Lou Citroen - Arete Research

Operator

Welcome to Spotify’s Second Quarter 2018 Financial Results question-and-answer session. A copy of the Company’s shareholder letter issued before the market opened today is available on the investor relations website, investors.spotify.com. This call is being recorded and an archived replay will be available on the IR site after the event concludes.

I will now turn the call over to Paul Vogel, Head of Investor Relations and FP&A. You may now begin your conference.

Paul Vogel

Great. Thank, Josh. Thank you and welcome to Spotify’s second quarter 2018 earnings conference call. With us today are Daniel Ek, Spotify’s CEO and Barry McCarthy, Spotify’s CFO.

The format of today’s call will be similar to last quarter, Dan will give a few brief opening remarks, followed by an online question-and-answer session. Questions can be submitted either through the widget alongside the webcast or by emailing directly to IR@Spotify.com. We’ll get to as many questions as we can. The call will last approximately 30 minutes.

Before we begin, let me quickly cover the Safe Harbor. During this call, we will make forward-looking statements, including projections or estimates about the future performance of the Company. These statements are based on current expectations and assumptions that are subject to risk and uncertainties. Actual results could materially differ because of factors discussed on today’s call and in our letter to shareholders and filings with the Securities and Exchange Commission.

During this call, we will refer to certain non-IFRS financial measures. Reconciliations between our IFRS and non-IFRS financial measures can be found in our letter to shareholders and on the financial section of the Investor Relations page on our website and also furnished today on Form 6-K.

And with that, I’ll it over to Daniel.

Daniel Ek

Thanks, Paul and thanks everyone for joining today’s call. So I think second quarter results showed continued strong growth in all of our core metrics and our goal is to each quarter deliver within our stated guidance. And most of our key metrics finished towards the top end of our forecast ranges. And as I said at the Investor Day, we believe we're still in the very early stages of the global streaming markets with a very large opportunity still in front of us.

Before we begin the question-and-answer session, I did want to address one thing that's been written about a lot over the past few weeks around Spotify signing direct licensing deals with artists.

As we spoke at our Investor Day, we're really building a two-sided marketplace that provides tools and services for labels and artists to focus on promotion and marketing, and as a platform we have always licensed music from rights holders, both large and small and we will continue to license music from whomever owns the rights And we have been doing this for years because our goal is to get as much music onto the Spotify platform as we possibly can.

The long-term success metrics for this platform is growing the number of creators on our platform, growing the number of creators using our promotion marketing and career management tools. And three, the number of artists and labels paying us to use those tools and services.

And licensing content does not make us a label, nor do we have any interest in becoming a label. We don't own any rights, any music and we're not acting like a record label. Our agreements are specific to Spotify and are not exclusive.

We want to grow the number of labels and creators on the platform, as well as the number of creators using our tools and services. So in some cases we license from labels and others artists if they own the rights to their own music.

We believe there is been some confusion regarding our intention and for us it's really about providing the largest opportunity for the widest group of creators and artists to bring their music to Spotify.

Thanks. And now we can begin the question-and-answer session.

Question-and-Answer Session

A - Paul Vogel

Great. Thanks, Daniel. We'll start our first question from Ross Sandler of Barclays.

Ross Sandler

Can you unpack what drivers you see over the next few years to bridge the gross margin increase from today's mid-20s to the 30%, 35% range?

Daniel Ek

Paul, let's kind of up level it and talk strategy for a moment. As I kind of alluded in the opening remarks, the overarching goal for us is to build the marketplace for all creators and labels on how they better interact with Spotify.

So if you think about that, that means that was really trying to grow the number of creators that are on our platform. We're trying to grow the number of creators that are using our tools. And then thirdly, trying to increase the number of those people that then are paying us to use those tools and services.

So that's essentially the strategy through which we're going about - growing our gross margin. It will be less about ongoing licensing discussion and much more about inclusion of the services that our marketplace is providing.

Barry McCarthy

So let me add - I'd like to remind our listeners that at our Investor Day, we included a slide on the long-term margin structure for the business and included gross margins in the 30% to 35% range. That remains our vision and objective for the business. If we're successful in building a two-sided marketplace and developing the tools to own demand creation, then I think we'll land comfortably in that range.

Paul Vogel

And then Barry, just a quick follow up - this one came in. You mentioned in the letter that your long-term gross margin target is 30% plus. You mentioned 30% to 35% at the Investor Day, is there any change?

Barry McCarthy

No, no. No change. Our objective remains 30%, 35% for gross margin.

Paul Vogel

Thanks. Next question is from Matt Thornton at SunTrust.

Matt Thornton

Any update on progress on the artist label side of the two-sided marketplace?

Daniel Ek

Well, I think as being clear in our earnings remarks, we are seeing really, really good remarks. We're seeing overall growth of 5% of more number of artists being heard and Spotify for artists is growing very nicely and has hit a new milestone of over 200,000 artists monthly. Both of those are incredibly positive and are ahead of where we expected.

Paul Vogel

Next question is from Rich Greenfield at BTIG.

Rich Greenfield

Podcast and non-music audio appears to be a relatively minor portion of listening time today. We presume 1% to 2%, is that fair? What are you doing to grow that share over time and what timeframe should we look for progress?

Daniel Ek

It is fair that music is still the vast majority of all listening on our platform. That said, we're very encouraged with the growth of podcasts, this is growing really, really fast. But obviously from a small base today. It's unclear long-term how big that opportunity is, so I think everyone in the entire industry is trying to figure that out.

But we're certainly of the belief that it's going to be a significant portion of what we do going forward and are investing to make both the product experience better and driving the number of creators on board – at our platform.

Paul Vogel

Okay. The next question comes from Anthony DiClemente at Evercore.

Anthony DiClemente

Can you talk about churn in the quarter at least directionally and as it continue to come down as much as expected as the 10 year subscribers ages and that family, student plans grow as a percentage of the subscriber mix?

Daniel Ek

The short answer is yes and yes. Let's see - let's talk about the business overall, the global business, the churn in the quarter was down year-over-year of about 900 basis points. And then I want to - secondly I want to talk specifically about the U.S., since its seen couple of news articles reported, an increase in churn, as a result I think of Apple competition, it in fact is not what happened.

We also have seen improvement in the U.S. and in the most recent quarter in the U.S. saw a 3 handle on churn rate. So very encouraged by the business overall on global basis and in the U.S. in particular.

Paul Vogel

Great. All right. Our next question is from Eric Sheridan at UBS.

Eric Sheridan

Data analytics, should investors think of this as a standalone business or one that makes the music industry smarter and could play a constructive role in the commercial dialogue with the music industry?

Daniel Ek

Data and insights is definitely part of the platform and a key fundament for how we view the marketplace. As mentioned Spotify for artists today if we just kind of up level for a second and look at what it is. It's amazing insights for artists and labels today about how they're doing and who their audience is.

And we've never before been at a place in time where you could make as many informed decisions and understand your audience, as well as you can do now as an artist. And we're seeing a lot of these artists making much smarter decisions on the basis of it.

As an example, here I have an artist like Metallica who changes their set list on a city by city basis just by looking at Spotify data to see which of the most popular songs happen to be in that city. And there are many, many other examples.

Our view is if artists and labels have better data and can make better insights, they’re going to also take action on those insights. And that's kind of key fundament that's also been prevalent on the rest of the Internet.

Paul Vogel

Our next question here is from Amy Yong at Macquarie.

Amy Yong

As free cash flow piles up, how should we think about priorities of cash? What types of organic, inorganic opportunities do you see? Any update view, any updated views on balance sheet optimization?

Barry McCarthy

No updates on balance sheet optimization. It's steady as things go. I want to remind everyone that our overarching objective for the business in addition to our strategic goals is to continue to generate positive free cash flow, x of CapEx investments and new office space in New York, Boston L.A., et cetera.

Our goal with respect to cash is to manage it smartly like we do all of the other asset allocation decisions we make in the business. If in the fullness of time we decide or it becomes clear that the business is overcapitalized then you should expect us to use that cash productively to buy back shares in the marketplace.

We are nowhere near of deciding that we can't constructively deploy the cash we've raised. The biggest single investment opportunity in front of us is to acquire technology that helps us achieve faster the strategic objectives for the business.

You've seen us make several acquisitions over time, which have contributed to the success of the business and we are continuing down that path.

Paul Vogel

Our next question is from Jess Reif Cohen at Bank of America Merrill Lynch.

Jess Reif Cohen

UMG was reported in the press to be considering a move to monthly accounting for royalties over to artists versus the current quarterly or semi-annual basis. Should this shift happen, how would this impact your working capital profile and free cash flow prospects?

Barry McCarthy

It shouldn't affect the free cash flow of the business at all, we remit levels monthly.

Paul Vogel

Next question is from Michael Morris at Guggenheim.

Michael Morris

Why is your direct artist relationship business not an incremental threat to your relationship with the labels? A recent FT article described labels as withholding rights in India due to your licensing music directly from artists, is this accurate? How can you grow your direct business without creating risk of poor relationships with the major labels?

Daniel Ek

So you know, again, I think the goal of the marketplace is to create tools for all size of artists and labels. And if you just look at a label today and you look at how labels are investing, one of the largest costs for them is to figure out how to effectively market and promote an artist.

As we talked about in our marketplace strategy the key objectives that we're pursuing is taking the data and insights that we're generating on our platform and creating tools that allow artists and labels to better market themselves in the marketplace.

And so as I look at that, I think that this is a huge opportunity for all labels to become more effective and if they become more effective that will allow them to sign even more talent and invest even more in and then further growing our mission as a company of course which is to allow 1 million creators to be able to live off with their art. So this is kind of a key component to make the labels more effective than they are today.

Then to address specifically your question in regards to India, I think the truth of the matter is when you deal with licensing and in our case not just one company, but you deal with local publishers, local record companies, global record companies, global publishers, it is you know, always a complicated maneuver and as much as I would like to see that we can accurately and timely estimate on the day when we're going to launch a market.

There is always local considerations that gets added. This has been true not just in India, but it has been true I think pretty much every market that we've ever entered into as well.

So delays unfortunately when it comes to licensing for various reasons is just you know commonplace in this industry and nothing related to our overall strategy.

Paul Vogel

Next question comes from Mark Mahaney at RBC.

Mark Mahaney

Any more color on Hulu bundle and whether we could see other bundled deals?

Daniel Ek

As we outlined in the remarks as well, we're very encouraged by the early results on both launches, both the Hulu student plan and now the Hulu standalone plan. We are you know, this is a huge part of what we're doing, which is trying to find more ways to bring more value to our members, the subscriber base. We don't have anything to announce, but you should look at it as part of our strategy just like we've said before to look at more ways to add more value for our members.

Paul Vogel

Next question is from Nick Delfas at Redburn.

Nick Delfas

My Amazon Echo keeps trying to sell me Amazon Music Unlimited, even though I have selected Spotify. What are your plans on speakers in home or in car?

Daniel Ek

Well, as we outlined in our Investor Day, one of our key strategic objectives is to be ubiquitous on all platforms. Music is one of those things that are used not just in your home, like video, but really on mobile, in your car and in home. So our strategy is to look at all the major platform, try to make sure that we have a best in class experience and all of those platforms work with the platform providers of those to enable that experience.

And we're seeing great results in the home and particularly in the connected speaker segments. Its still pretty early market, I would say, and then just specifically to address the car to that's a longer term investment from our perspective, we are both working with manufacturers enabling, so that you can connect your phone via Bluetooth and of course we are a huge part of Android Auto which is Google's car initiative and CarPlay which is Apple's car initiative. So this is part of our overall strategy of being in all places where people might want to have music.

Paul Vogel

Next question is from Rob Sanderson from MKM Partners.

Rob Sanderson

The adjusted MAU metric, it looks to be - well looks to been at the low end of guidance. The GDPR have an impact is the revamp of the ad supported product performing to expectation. Also can you offer early observations from the new product?

Daniel Ek

Let’s see, at a high level, particularly from a revenue and margin perspective, the business is performing towards the high end of our expectations. I think it's clear that that top of funnel MAU growth in the quarter, given street consensus expectations was a couple million light, million and a half light.

And the question is what are the implications of that for the future growth of the business? And the answer is not much different than what we told you to expect last quarter. And the question is why? And the answer is because we're seeing great conversion in paid business, we're seeing faster growth in the paid business than we were expecting and we're seeing super strong retention in the paid business.

GDP was an issue for a couple of weeks and we were past that speed bump, if it had an impact on revenue in the quarter, it was less than a €1million. So quite small in the grand scheme of things.

Now if the premium business grows faster than our expectations, we're going to have fewer free MAU’s than we were expecting, which creates a headwind for the free business. Question, is the overall business better off or worse off? And the answer is the business is better off. It means, if the paid business is growing faster than we expected we will have more revenue than we expected and we will have higher margins than we expected, because the paid business has higher gross margins than the free business does.

So that - it has meant good things for the business, as compared with our expectations and you know from our guidance we're expecting that trend to continue.

Paul Vogel

Great. From Ben Swinburne from Morgan Stanley.

Ben Swinburne

Barry, if Family Plan mix pressure moderating, how should we think about organic ARPU declines in the second half?

Barry McCarthy

Yeah, I comment on ARPU last quarter, we've seen sort of a seasonal pattern of fluctuation in ARPU last year and expecting a similar pattern this year to decline in Q1 up Q2, down in Q3 up in Q4, I expect that that pattern to continue, point one.

Point two, when we launched the Family Plan we sold it across the entire base. During that launch there was more downward pressure on ARPU generally because of growth and Family Plan, then you will see this year and going forward, because the installed base has already been sold to. So the only incremental pressure is at the margin.

So be mindful of the seasonal pattern and then be mindful of this dynamic change 2017 versus 2018 because there's no installed base to sell across.

Paul Vogel

Next question is from Peter Stabler from Wells Fargo.

Peter Stabler

Does your recent hiring of Dawn Ostroff signal an intention to aggressively pursue original video production?

Daniel Ek

The easy answer on that one is no. Our primary focus as we've said many, many times over is audio and music in particular and that remains our focus today.

Paul Vogel

Next question is from Heath Terry at Goldman Sachs.

Heath Terry

What kind of progress are you seeing in monetizing your ad supported business? How much of that is ad loaded and how much is achieving higher eCPMs in your ad units? What's the appropriate long-term level of monetization to assume for ad supported?

Daniel Ek

It's mostly about increased sell-through, ad business is a - is a tale of two growth rates, relatively slow growth on desktop and very fast growth on mobile, increasingly it's a mobile first business.

We have relatively high margins in our five largest markets, think of them as the developed world U.S., Western Europe, Australia, New Zealand, and Canada [indiscernible] an example. And then significantly lower margins in emerging markets where we're quite small. So if you're an advertiser, a limited opportunity for you to buy reach. But the dynamics of those markets are changing pretty quickly as we continue to grow quite rapidly. The challenge in those markets is sell-through rate, as they get larger s the challenge diminishes.

Paul Vogel

The next question is from John Egbert at Stifel.

John Egbert

It looks like your subscriber growth remains quite healthy. Could you give us any color on specific countries or geographies where you're seeing strong momentum and perhaps any emerging markets where you're seeing growth traction that could meaningfully influence subscriber growth down the road?

Daniel Ek

I wouldn't single out any particular country or territory with respect to growth in the premium business. We're growing strongly across the board, Family Plan is a big driver of growth.

Paul Vogel

Next question is from Richard Elliott at UBS.

Richard Elliott

How is the price increase in Norway been received? Are you planning to launch HD products? If so how big is the market opportunity?

Daniel Ek

Well, let me up a level and then say you should not expect to see price increases from us across markets. We're playing a market share game, we're not playing margin game. There may be opportunities for us in individual markets to test price elasticity like we're doing in Norway, but don't expect a shift in strategy.

Now specifically with respect to Norway, we saw a brief slowdown in growth and a few weeks later, growth reverted back to its historic level with no adverse change in churn. So it appears to have been well received in the marketplace.

Paul Vogel

Our next question is from James Cordwell at Atlantic Equities.

James Cordwell

Can you provide more detail on the data policy change you called out in the letter and what impact it had on ad revenue for Q2? When you expect that revenue growth to have fully recovered to the trend you were seeing prior to the change?

Barry McCarthy

Let me just jump in and say it's fully recovered, which is what really matters.

Paul Vogel

Our next question is from Ashwin Kesireddy at JPMorgan.

Ashwin Kesireddy

Can you comment on GDPR disruptions during the quarter? Any color and whether this is driven by advertisers taking a wait and see approach or whether this was a compliant process disruption which would not repeat going forward?

Daniel Ek

Well, not everybody was equally prepared in the marketplace. So that caused some fallout. And then there were some examples of some advertisers who sought to use GDPR as an opportunity to leverage the renegotiation of data sharing in the marketplace and that friction cleared the market in a couple of weeks, so relatively quickly. So I would say the overall impact from GDPR is ignoring the confusion in the moment when it went live, it was relatively short lived.

Paul Vogel

Another question from Justin Patterson of Raymond James.

Justin Patterson

How should we think about the impact of the new self-serve ads to your platform on the pace - and the pace of the rollout? What are your early - early learning from ad studio?

Daniel Ek

Well, we're – yeah, I'm not sure how to answer this. I'm not sure what the question is. I'm not sure if its a question about Australia, New Zealand, or if it's a question generally about the launch of ad studio. So let me take up sequentially.

In Australia, New Zealand we have - we are trying to discover whether or not we can have a more successful business for us and for advertisers, by testing pay per listen, pay per view as an alternative to pay per CPM and we're in the very early stages.

Let’s talk about growth in automation. So this is an automated platform. If it's successful it will have a large following in the SMB marketplace, which would significantly expand monetization opportunities for our business. And if executed well will result in an important shift in the overall cost structure of the business dramatically expanding margins.

Paul Vogel

Next question is from Lloyd Walmsley from Deutsche Bank.

Lloyd Walmsley

Can you give us an update on the competitive - competitive environment in the U.S. and otherwise. Is there a phenomenon you have observed where new entrants in the market can actually stimulate broader demand in a way that helps you?

Daniel Ek

Yeah. Well, our global subscriber growth continues to be really strong and we continue of course to meet our growth goals for the business, which you've seen over the last two quarters. In the U.S. in particular, we're also performing well and growing rapidly and the U.S. churn continues to decline year-over-year and is now below 4%.

We continue to see a large opportunity for future growth and our growth is really coming both from the increased paid and ad supported users in the U.S.. So I think a good metric is to look at the total amount of Spotify users we have and we are now at 2x the size of our nearest competitor in regards to that.

So just to level set again, the streaming market really is still very much in the early stages and we're the largest global streaming music platform and we expect our leadership to continue going forward.

Paul Vogel

Next question is from Irland Lewen.

Unidentified Analyst

Finance costs in Q2 increased to $343 million from $154 million in Q1 and $148 million in Q1 of ‘17. What is the reason for this increase and do you expect higher finance costs to continue?

Barry McCarthy

It relates to the two things, one is revaluation of the convert which is now gone. And then secondly the accounting for the cost of [indiscernible]

Paul Vogel

We’ll try and get more - some more questions here. From Heath Terry at Goldman Sachs.

Heath Terry

What's your strategy for exclusive contact such as your podcast deal with Amy Schumer? How do expect the economics of exclusive content to compare to deals with the labels and publishers?

Daniel Ek

Well, so first off let's level set for everyone. In music, we don't believe in exclusivity and haven't participated in that. In podcasts, we do see that that marketplace works differently and that there is room for exclusivity and there's room for original content production to cede [ph] the marketplace.

This is probably something that you should expect us to test and experiment with. Marketplaces are more well-developed than others. You know, I think interestingly as we kind of look at the market we have a very young audience, typically there aren't that much podcasts available for them. Certainly when you look at a global space. Hence, we're very encouraged about ceding that and helping and develop that.

As a cost basis, we kind of think, again, this fits really well into our dual monetization strategy of both ad supported and subscription.

Paul Vogel

We’ll take two more questions. One from Ben Swinburne from Morgan Stanley.

Ben Swinburne

Can you give us a sense for engagement trends, are content hours per user still growing at levels disclosed in the prospectus?

Daniel Ek

We’re not going to break it out, but we continue to feel quite good about the levels of engagement in the service. As we get better at developing the two sided marketplace and driving discovery and as we add new forms of content to the platform, like podcasts offering consumers a better service, we expect to continue to be able to drive increases in hours consumed.

Paul Vogel

We’ll take one last question Lou Citroen at Arete Research.

Lou Citroen

You said last quarter that the launch into new markets was built into your 2018 guidance, can you give us an update on those, especially in India, Russia and Africa and how important those geographies were for your 2018guidance. Any comments around ongoing discussions with the labels which I think we already addressed.

Daniel Ek

Yeah, I think we addressed the conversations with the label. We're still looking at opportunistically launching in more markets across the world. Obviously it's the big markets like Russia, India that probably will contribute the most. I don't have any further comment on any specific launch dates on those things. I will say however that any impact on our forecasts will be minor or immaterial.

Paul Vogel

Great. With that, I’ll turn it over to Daniel for just some final closing comments.

Daniel Ek

Yeah, I would just say thanks again everyone for participating in our second earnings call. As a public company, I really hope that you've found the earnings call and the answer session helpful and we will continue to be as open, as transparent as possible in providing insights into our business. And of course, as always we welcome any feedback you have in making the earnings call better. And I look forward to speaking with everyone again next quarter. Thank you, everyone.

Paul Vogel

Okay. Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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