Spotify’s Q1 Earnings: Subscribers Reach 75 Million, Revenue Hit $1.36 Billion

Associated Press
– Spotify

Spotify’s first earnings release as a public company on Wednesday checked all the boxes: listeners were up, subscribers were up, revenue was up, gross margin had improved, and net loss was reasonable. The stock price fell, however, eliminating an 11-percent appreciation since April 25. 

The world’s largest music streaming company finished the first quarter of 2018 with 75 million paying customers, up four million from the end of 2017. Revenue clocked in at 1.14 billion euros ($1.36 billion), up 26 percent from a year ago. Operating loss was 41 million euros and net loss was 169 million euros. 
The key metrics were in line with expectations. Analysts’ forecasts averaged 74.43 million subscribers and revenue of 1.143 billion euros, according to Thomsom Reuters. But the market wanted better news about the current quarter. Spotify said its subscriber count will finish the second quarter between 79 and 83 million; analysts’ average forecast is 81.79 million—790,000 higher than the midpoint of Spotify’s guidance. Almost any time a company’s guidance falls under expectations, analysts update their models accordingly and the share price falls to reflect the drop in valuation. And that’s what happened Wednesday.  
Shares of the Swedish company were down about eight percent in after-hours trading, giving back more than twice the three percent gain during normal trading hours. Investors had little reason to be disappointed as Spotify delivered results in line with guidance provided in March. Nevertheless, the market has spoken. A better test of market sentiment comes Thursday morning. If the share price drops eight percent when trading begins, Spotify’s market capitalization will have lost $2.4 billion. 
One questionable spot on Spotify’s income statement is a 100 million euro revenue decline from the fourth quarter of 2017. So, Spotify lost money even though it added four million subscribers. An additional four million subscribers paying the 2017 average (5.15 euros per month) is worth about 31 million euros. The revenue drop could mean Spotify replaced high revenue subscribers for lower-value subscribers of its family and student plans. Part of the decline could be seasonality; a first quarter is typically a slower advertising period than its preceding fourth quarter. Advertising is a small piece of the pie, however, consistently accounting for about 10 percent of Spotify’s annual revenues from 2015 to 2017. 
Given the subscription model is constantly on trial, it’s worth nothing Spotify is taking home more of what it takes in revenue. The gross margin was 24.9 percent, up slightly from 24.5 percent in the previous quarter and far better than the 11.7 percent margin Spotify achieved in the first quarter of 2017. Gross margin is simply the money left over after paying for the cost of goods. For example, a shoe that sells wholesale at $50 and costs $10 to make has a gross margin of $40. Just as the show manufacturer incurs costs to make its products, Spotify incurs costs to provide its product. Gross margin reflects the royalties Spotify pays to rights holders. At a 24.9-percent margin, Spotify paid 75.1 percent of revenues for content costs. 
Standard metrics like operating income and net income are less important when a company is engaged in battle for market share. Spotify wants to acquire and retain free listeners and subscribers before they become loyal listeners to Apple Music, Amazon’s paid services, Pandora, Deezer, Napster or Tidal. The money spent on developing the service—from new features to integration with hardware like Sonos and auto in-dash entertainment systems—reflects the constant struggle to draw and retain customers. Research and development accounts for almost half the company’s headcount and 35 percent of expenses in the quarter. 
The math can work over time. Spotify’s challenge is two-fold: pay a smaller percentage of revenue to rights holders, and grow revenue so the gross margin becomes a livable wage. At some level of critical mass, assuming costs don’t run out of control, Spotify’s 30 percent will be large enough to operate profitably. Some analysts predict the company can expand its subscriber base by roughly 200 percent over five years. Spotify can easily wait it out for a few years: 733 million euros of cash and cash equivalents sat on the company’s books at the end of March.