Spotify Technology (NYSE:SPOT) held its first-quarter earnings conference call on Tuesday. Below is the complete transcript from the call.
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The full earnings call is available at https://app.webinar.net/jY6LnRmxr0N
Summary
Spotify Technology SA reported a strong start to 2026 with an increase in MAUs to 761 million, supported by healthy user engagement and subscriber growth.
The company achieved its second-highest gross margin ever and paid out over $11 billion to rights holders in 2025, indicating strong financial performance and industry relationships.
Strategic initiatives include a global rollout of an enhanced free tier, a new fitness hub featuring Peloton content, and significant investments in AI to drive personalization and engagement.
Q2 guidance predicts continued momentum with expected MAU growth to 778 million and revenue of approximately 4.8 billion euros, alongside a gross margin of 33.1%.
Management highlighted the transformation of the ad business to programmatic sales, strong progress in AI-driven features, and a disciplined approach to operating expenses and investments.
Full Transcript
OPERATOR
At this time I would like to turn the conference over to Brian Goldberg, Head of Investor Relations. Please go ahead. Thanks Operator and welcome to Spotify's first quarter 2026 earnings conference call. Joining us today will be our co CEOs Alex Norstrom and Gustav Soderstrom and our CFO Christian Luiga. We'll start with opening comments from the team and afterwards we'll be happy to answer your questions. We will be taking questions today via slido. Questions can be submitted by going to Slido and using the code Spotify EarningsQ126. 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 [email protected] 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 differ materially because of factors discussed on today's call in our Shareholder deck and in filings with the securities and Exchange Commission (SEC). 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 for furnished today on Form 6K and with that I'll turn it over to Alex.
Alex Norstrom (Co-CEO)
Thank you Brian hey everyone and thank you for joining us. 2026 is off to a strong start with performance reflecting solid execution, healthy growth and the kind of engagement trends that give Gustav, myself and the team confidence in building Spotify for the future. In Q1 we saw results that were in line or better across the board and we surpassed 760 million MAU delivered on the subscriber growth we aim to achieve. And we saw healthy engagement from existing users, reactivations and new users alike since the global rollout of our more personalized free experience, users in key markets like the US are now listening and watching more days per month. Now for a business as established as ours. By the way, that we're celebrating 20 years this month? This is an exciting development and I'll share more about why in just a moment. We also netted our second highest gross margin ever. All that reinforces this confidence in sustained user and subscriber growth, low churn and then also continued progress on revenue and margin. Now, for over two decades, we have worked hard to forge strong relationships with our industry partners and the artists and the creators that we support. You've watched these relationships evolve in the last 20 years, but we have never been in a better position to innovate and to grow thanks to the progress we're making together. So the trust that we've built is rooted in our collective desire to deliver results and expand the overall opportunity. We will have some new things to share on that front soon, and we just released our annual report on the health and growth of the industry. It's noteworthy that Spotify remains the only platform offering this level of visibility into how the music industry actually works. Loud and Clear show that in 2025 we paid out a record $11 billion plus to rights holders while continuing to outpace the growth of others. And year over year, we expect that outperformance to continue. Now, on top of the streaming success, there's no doubt that artists, songwriters, musicians and fans are just always seeking stronger connections. Song DNA and About the Song were introduced this quarter to pull back the curtain on the remarkable talent behind our favorite tracks and offer more insights into a song. But we didn't stop there. Live experiences are one of the most impactful ways for artists and fans to connect. So this winner we took Spotify's most streamed global artist, Bad Bunny, to Tokyo to perform in Asia for the first time in front of some of his biggest superfans. And then we turned around and broadcast that iconic moment to the world. This went beyond the concert. It was a real opportunity to amplify culture. Now all of this drives retention. So let me take a minute to just explain how we think about retention. Importantly, it acts as a proxy for how users value their time on Spotify. Now we look at many metrics, but the three that drive retention are more days in a month, more devices or contacts, and more content types or verticals. I've already told you, we've been growing the days users spend with us each month. Engagement really is the lifeblood of Spotify and I've been super excited to see this expand over the years. And now too. Engaging with us then on more devices and also across our three content types just compounds this. This is how we grow the lifetime value of a user. Users who engage in this way, they stay longer or perhaps never leave. These three levers are rooted in our personalization efforts and act to reinforce one another and AI just takes this to a whole new level. It essentially we are unlocking your Spotify your way for Three quarters of a billion users around the world. Yesterday's announcement around fitness is a natural extension of this strategy. Spotify is already a trusted resource for wellness and fitness. Nearly 70% of premium users work out monthly and our users have created more than 150 million workout centered playlists with many also turning to prompted playlists for support. So to meet this need more directly, we are launching a fitness Hub on Spotify. And as we just announced, this hub features Peloton's premium subscriber content in an ad free experience. And of course this content will be a very strong complement to what has already been working, including content like Yoga with Cassandra, Jordan Yeoh and Chloe Tingley. I know we continue to talk about our ads business as a work in progress, but the key point is that a year and a half of rebuilding the foundation is now in place. Brands have always valued Spotify for its high user engagement, its beloved brand and its high quality content. But the market shifted with advertisers now favoring biddable buying. We had to evolve to capture that Tamil, so we rebuilt our stack end to end. Now while this creates some short term pressure, it unlocks a much larger opportunity. We are making solid progress. Today Biddable represents more than a third of ad revenue and it's growing quickly. So with biddable expanding and also our active advertisers growing, coupled with improvements in our measurement and performance, we can now innovate in new ways the old stack never allowed. This finally lets us better capture the value of our audience. This is exactly how we wanted to start the year of raising ambition. We're now growing at scale, generating significant cash and reinvesting to capture the opportunities that matter the most. What you are now seeing is the beginning of a much larger next chapter and we're excited to go deeper on that at our upcoming Investor Day with you all. With that I'll hand over to Gustav.
Gustav Soderstrom (Co-CEO)
Thanks Alex. Now I'll pick up a little bit on what comes next because that's where much of our focus is right now. So if you zoom out, the way we think about Spotify is pretty straightforward. With AI expanding our opportunities, we're building a system that understands our deeply engaged, passionate three quarters of a billion users. One that adapts to them and improves the more they use it. It's also increasingly a platform that puts control directly in users hands with their ideas, logic and creativity. A platform that's deeply personal, increasingly interactive, and evolving from a solo experience into something inherently multiplayer. As I shared last quarter and more recently at south by Southwest, AI isn't new for us. Machine learning and personalization have long been core to Spotify. From discovery to recommendations what's changing is what the technology is now, allowing us to better understand, develop and deliver, creating differentiation and unlocking a very different experience and a new level of personalization. From our earliest days, Spotify has been a technology company and we've always seen ourselves as the R&D Department for the Music industry, and that mindset has helped us embrace new technologies to accelerate product development and create unique value. Combined with our ads/subscription model, deep expertise and personalization and scale operations, we think this positions us very strongly for the AI era. We're integrating AI across every part of Spotify, accelerating how we build and deliver at a pace we haven't seen before. We're shipping more, faster and with greater efficiency, lowering the cost per feature while increasing the impact. You can see some of the inference costs behind that acceleration in our OpEx, but we have tremendous confidence in what we're building and I will share more about that soon. Our DJ is now used by 94 million subscribers, closing in on 100 million, driving billions of hours of engagement this quarter we've continued to push the boundaries of the user experience with new AI powered features. As always, early adoption and deep usage is coming from our power users. But what's changed is how quickly we can learn from that behavior, refine the experience and scale it to a broader audience, delivering improvements faster, faster and at a fraction of the historical cost. And all of this benefits ltv. We're particularly excited about Taste Profile, now in beta. It gives users a clear view of how Spotify models they're listening across music, podcasts and audiobooks, and puts them in the driver's seat, allowing them to directly edit and refine their profile. So imagine telling Spotify to include more songs by those two artists my kids are obsessed with. Or maybe the opposite, actually exclude those two artists or add a classical playlist to my homepage. This level of nuanced control empowers users like never before. We've also significantly expanded Prompted Playlist, enabling users to act as their own algorithmic curators. You can write prompts to generate playlists for specific moods, activities, or cultural trends across music, but now also podcasts. So. So together these features point to something bigger, a transition from a world where Spotify recommends things to you to a world where you can actively shape, guide and interact with our platform. From passive to interactive, from static to adaptive, and from single player to multiplayer. And we think that's really important, not just for Spotify, but for how people experience media. We're already seeing this more interactive multiplayer Spotify take off with features like jam, where usage has doubled year over year and now exceeds 100 million monthly listening hours. And there's also blend messaging, mixing and of course wrap party. So we're just getting started here. We're well positioned because of our large engaged user base, our deep creator relationships, and years of investment in personalization and infrastructure at scale to arrive at this agentic moment. Together these create a platform that can take advantage of this moment and unlock entirely new growth vectors that will enable us to climb to new mountains previously unimaginable. This connects to the broader opportunity ahead. We see significant room to grow across users formats and engagement and to really expand what Spotify is and can become over time. We're at a pivotal moment building towards something even bigger and on May 21st we'll show you why we're so excited about what comes next. So we'll hope that you'll join us there at our Investor Day. Now I'll turn it over to Christian to take you through the numbers.
Christian Luiga (CFO)
Thank you Gustav and thanks everyone for joining us today. Let me cover the quarter one results and then I'll provide some perspective on our outlook. Unless otherwise noted, all reference growth metrics are presented on a year on year constant currency basis. Additionally, this quarter we have implemented a minor reclassification of non advertising activities from our ad supported segment to premium. This is to better reflect the performance of our core advertising business. Just for reference, in quarter one last year we shifted $12 million in revenue and $7 million in gross profit from our ad supported segment to premium. Any comments on the segment? Growth rates are on a like for like basis, so overall we were very pleased with how the business performed in the quarter. MAU grew by $10 million to $761 million in total, so surpassing our guidance by 2 million. Our growth rate accelerated 12% year over year up from 11% in quarter four. Outperformance was led by rest of the world and North America where we continue to benefit from our enhanced three tier rollout. We added 3 million net subscribers during the quarter finishing at 293 million. In line with our guidance, we saw no surprises with respect to price increase related churn. Following our January US price increase, total revenue was 4.5 billion euro growing 14% year over year which was an acceleration from 13%. We delivered in Q4. Premium revenue rose approximately 15% year over year versus 14% last quarter. This was driven by subscriber growth and arpa expansion of 5.7% year over year. Our ad supported revenue grew approximately 3% year over year. Our new automated sales channel continued to grow fast and now represents over 30 30% of our ad supported revenue in Q1. We also saw some continued choppiness in our legacy direct sales channel. While this dynamic will likely continue in the near term, we still expect improved growth in the second half of 2026 as our billable channels continue to scale. Gross margin came in at 33% surpassing guidance by approximately 20 basis points which year over year with a year over year expansion of approximately 133 basis points. Favorability versus guidance was driven by better other cost of revenue and revenue mix. Other Operating Income the operating income of 750 million was 55 million above our guidance of 660 million Euro delivering an operating margin of 15.8%. Our outperformance was driven primarily by social charges which had a positive impact approximately 49 million relative to our forecast due to share price movements in the quarter. Excluding the non forecasted social charge favorability, we came in approximately 6 million above guidance driven by the gross margin outperformance. Finally, free cash flow was 824 million in the quarter. Performance here was a bit stronger than our typical quarter one due to some timing factors which will likely reverse in quarter two. On capital allocation we repurchased $361 million in shares during Q1, continuing our focus on opportunistically offsetting dilution from employee equity programs. We also settled our $1.5 billion in exchangeable note and that was due in March with cash on hand rather than issuing new shares. As of the close of the quarter we had $8.8 billion in cash and cash equivalents and no debt other than lease liabilities. So then if we look ahead into quarter two we see continued momentum and healthy global funnel that is forecast and are forecasting MAU of 778 million, an increase of 17 million from quarter one. On subscribers we are forecasting 299 million for quarter two or a net addition of 6 million. This is modestly below the significant outperformance we saw in the prior year quarter which benefited from items such as favorable adjustment to our iOS app in the US. We reiterate on our previous statement that we expect another full year of healthy subscriber growth weighted more towards the back half of the year. We are also forecasting total revenue of approximately 4.8 billion Euro in Q2 or or 15% growth. This reflects the ARPU increase of 7 to 7.5% year on year as we see additional benefit from the recently announced pricing action partially offset by the lapping of pricing actions last year in the Benelux region. We anticipate the Q2 gross margin of 33.1%, approximately 160 basis points above the prior year. Our gross margin outlook incorporates continued strengthening in our core business alongside with the reinvestments into new products and initiatives that we believe set us up well for future monetization potential. Moving to the operating income we are guiding to 630 million in quarter two. This reflects the above along with the timing of marketing of our latest features. This also reflects R and D related to strategic AI initiatives that is already driving engagement. We expect operating expenses to remain at these levels for the next quarter or two and we're confident that it will enable healthy LTV returns. Although we do not provide full year guidance for gross margin and operating margin, we continue to expect both to improve in 2026 on a full year basis with quarterly progression being variable and dependent on the timing of our investments. We also continue to expect meaningful year over year growth in free cash flow into 2026 reflecting our improved profitability, a working capital profile, while we also progressing towards a normalized tax rate in 2027. In conclusion, Q1 was a strong start to 2026. Revenue growth accelerated and profitability improved. As we continue to reinvest our future growth potential, we remain really well positioned to continue compounding growth and profitability. With that, I hand it back to you Brian.
Brian Goldberg (Head of Investor Relations)
Great. Thanks Christian. And again, if you've got any questions, please go to slido.com Spotify Earnings Q1 26 we're going to be reading the questions in the order in which they appear in the queue with respect to how people vote up their preferences for the questions. And our first question today is going to come from Ben Black. Oops. I apologize Ben, I just accidentally resolved it. We'll get that question back in the queue. One sec, we're going to go to Rich Greenfield. I apologize. Slight technical issue here. We're going to start with Jessica Rief Ehrlich's question on operating expenses. Q1 had higher marketing cloud and AI spend. Can you discuss the pace of investment for the balance of the year and how you would define a successful outcome for this investment spend?
Gustav Soderstrom (Co-CEO)
Thanks for sneaking an AI question at the beginning. They usually take longer to get to, so I'm going to take the opportunity. So we did spend a little bit more on OPEX and the way to think about it is we have not increased our headcount. Actually, we've slightly decreased our headcount, but we are spending more compute per employee. And that is because we're seeing significant return in terms of productivity. We talked about accelerating our ability to ship products already during the the late fall. That has only accelerated since then. So we're simply doing much more and we're getting very good return on that investment. But as we ship more features, in order to get the true return on that investment, we also need to tell our users about those features, which is why we're seeing some more sales and marketing spend as we market these features to users. But the way to think about it is we see tremendous opportunity here. I usually make the analogy to 2009 when the iPhone came out and the app store came out. And believe it or not, I was actually here back in 2009. So I lived through that. It was a time of tremendous opportunity. Some people sat around and waited. Spotify did not. We took the opportunity and we drastically accelerated first our conversion to premium and then our free user growth. We think this opportunity is as big or possibly bigger, so we're taking that opportunity. But we are very diligent and very disciplined about those investments. So we are seeing these returns. I talked to my prepared remarks about the DJ closing in on 100 million users, also something we released only four weeks ago. Song DNA is now up to 52 million users in just four weeks. So we are seeing the kind of growth and return on these feature investments that we want to see. Obviously, we think that usage is a good proxy for retention, and retention is a. Is a good proxy for revenue long term.
Rich Greenfield
Okay, our next question is going to come from Rich Greenfield on the state of the ads. Business growth is still slowing after the meaningful investments in ad tech in 2025 and absorbing the impact from changes to podcast advertising for premium subs. Why is increased engagement not translating to accelerating ad revenue growth?
Alex Norstrom (Co-CEO)
Rich, my friend, this is Alex. I hope you're doing well. I just want to. Before I expand on the question, I do want to just mention to Jessica, you should check out Prompted Playlist. A global campaign just came online yesterday. It's just a terrific campaign that explains how basically we give you back more control over your Spotify with us, you know, using AI. And this is, this is, you know, good, good point to sort of back up what Gustav just said. It's out there in the wild right now and it's performing. So let's get back to the Ad business, you know, the ad business, Rich has, has, you know, been seeing very sturdy progress more recently. But if you take it back, you know, a year and a half or two years almost, you know, we, we observed that there was a gap. What was the gap? Well, essentially we saw us missing out on a TAM where people were putting a lot of money and this time was programmatic, it was automated sales and it was biddable exchanges. And the decision we made back then was a pretty tough one because we had to essentially rebuild the entire stack. And we did that knowing that we would face a bunch of short term pressure, but that it would unlock meaningfully much bigger market for us in the long term. Now that transition is done. So now it's about execution, it's about patience. And really what you have to believe for this to work out for us are a couple of different things, but mainly it's whenever we have seen increased time spent on Spotify and quality time to boot, and then there's a gap to monetization, typically that gap will close. It's a question of time and whether it's like you're thinking about it as like advertising as a category, whether it's inside a company, the gap will close. It's just a matter of time. The other things you need to believe in is that really this rebuilt new stack that we have, it actually gives us more opportunity to do new things that we couldn't do before. And obviously that our measurement and performance shows that Spotify delivers as a brand. What hasn't changed, I'll end with that, is that advertisers, they come to Spotify marketers, they come to Spotify for three different reasons. Our beloved brand that they want to associate themselves with, our high user engagement and also of course, our high quality content.
Benjamin Black
Okay, our next question is going to come from Benjamin Black on gross margin. First quarter premium gross margin was very strong despite only one month of US pricing. Can you highlight some of the key drivers of the outperformance and also dig a bit deeper into the 2Q gross margin guide? Could you talk about the investments you're making that may be weighing on gross margin upside?
Alex Norstrom (Co-CEO)
Hey, Benjamin, Alex here. I was looking forward to answering this question, but I don't know what Brian did there when he sort of hit it, but it's now back up again. I was happy to see that it's cool that you call it out because both Gustavana and Christian are very pleased with the gross margin progression, not just for this quarter, but also consistently in the last three years. And really the underlying reason for this is a very healthy core that actually spans both music and podcasts and audiobooks. Now Christian will give you the technicalities of that as far as going forward. I think the important thing is to understand how we think about gross margin. And like Gustav said, this is a time of tremendous opportunity for us. And you know, the muscle that we've built during the past three years, actually even four years, is that we think about reinvestments using cost of revenue, using gross margin in a very disciplined way. We do that. We try to strike a balance between that and margin progression. And again, like, you know, I think we have pretty good track record striking a good balance between these two things.
Christian Luiga (CFO)
Should I just give you a little bit more flavor on the second quarter gross margin guide, as you ask about that? I mean, we do have a very strong gross margin expansion. 133 basis points in quarter one and 160 basis points in quarter two. I got a comment earlier today on it's not growing quarter over quarter. It didn't do that last year either. And we have talked about the variability and then we want to invest more. We can and see the opportunity and we will expand over time and we do that. But. But it may not just look like that in each quarter, but it actually looks like that we are growing year on year both quarter one, quarter two, we have reinforced the statement that we will do it for the full year and, and we do invest in the same time on the base on the top of, of our, our core that is going really well and that we do in Q2 in smaller investment in different things. And some of them you will see today and some of them you will see when we get to investor day, and some of them you maybe will see later. But it's a good flow we have right now and we're very disciplined and working very hard in our weekly bets board, to actually update ourselves to see what we want to do.
Doug Anmoth
Okay, our next question is going to come from Doug Anmoth on AI products. Can you update us on your progress towards new AI products that would empower users to create new content and enable derivatives of existing music? What are the hurdles to launching these products and do you expect that they would impact your cost structure or margin trajectory in any meaningful way?
Gustav Soderstrom (Co-CEO)
Hey Doug, this is Gustav. I'll take this. I've talked about this a little bit before, so for now I'll mostly reiterate how we actually think about this opportunity. The way to think about it is that the generative Market, for example, for music is really two things. It's new original music, which is happening at scale and quickly expanding the catalog. And that we think is good for a company that aggregates content because it makes the recommendation problem even more important. I think it's worth thinking about. I just mentioned reveal my age here, saying that I joined Spotify back in 2008. When I joined, I think the music catalog was about 2 million tracks, and now it's something like 250 million tracks. So the growth of the catalog is not new. We think it's going to keep increasing, and that means that the recommendation problem gets more important for consumers. But where we think there is a unique opportunity is that right now existing creators are largely left out of the AI opportunity altogether. Many creators are using AI to make new music, but existing creators cannot join. That's because the copyright problem is much more complicated to solve. Well, and the attribution problem of who should get paid what is is much harder. But we love hard problems, so that's the problem we want to go after. We want to take this opportunity to existing creators as well, with derivatives of existing ip. So as I've said before, we have the capabilities and technologies we need. We are the right company to solve this problem, and we think that existing creators should participate in AI just as well as new creators.
Justin Patterson
Okay. Our next question comes from Justin Patterson on productivity. We're seeing many companies wrestle with headcount investment versus rising AI costs. How is Spotify approaching this problem and gauging employee productivity?
Gustav Soderstrom (Co-CEO)
So this is Gustav again. Thank you, Justin. So I kind of mentioned this. I snuck this point in before, but I'll reiterate that we are seeing tremendous productivity growth. You can translate that into different things. You could translate it straight into cost savings and cut headcount, which some companies out there are doing. The other thing you could do is to say we're going to be roughly the same amount of people, we're just going to do more. The third thing you could do, which also see many companies doing, is saying we should invest like crazy because there's so much opportunity. Right now, we're going for the middle approach. We're keeping our headcount roughly flat and just doing much more shipping more value to consumers. And then on the question on how we measure this, you have many proxies on the way. So one proxy for this would be something very technical like pull request, what amount of code is getting written, and maybe better proxy is how much we actually ship. We have something called DODs, definitions of done for any feature that we build. So how many DODs are getting done? How many bets do we have on this bet board that I think Christian mentioned, I talked about before? And all of these keep increasing and they're increasing several times. They're not increasing 10%, they're doubling that kind of increase. So we're seeing all of these metrics now. We are starting to see these things ship. And as I mentioned, with things like Song, DNA, dj, we're starting to see them translate into usage. And usage, as Alex mentioned, is a really good predictor of retention. And retention is a predictor of revenue. And as Alex mentioned as well, we have three different modes of monetizing features. There is the free tier, where you can maximize the reach. There is one of the world's largest subscription where you can bundle things. And then as of recently, we've also shown that we can do top ups like within audiobooks, which we are very excited about the progress on and the numbers that we are seeing. So we feel very good. What I'm trying to convey is that we are diligent and disciplined, but we are not sitting around waiting for this opportunity to go past us. We are taking the opportunity. So that's where we are right now.
Christian Luiga (CFO)
And just to give a little bit of historical flavor on that, I just want to add and remind us that some years ago we did a resizing of the organization. And since then, as you've seen, we. We haven't increased our employees and we have been very diligent in keeping the overall platform stable. And as last. As the last quarter, we decreased with 65 people. So it's not like we are growing people and doing that. And we haven't done that. We haven't done that for three years. It's been a very disciplined approach to this.
Gustav Soderstrom (Co-CEO)
I think Alex here is probably too humble to say it himself, so I'll say it for him. Alex is actually the one who set this plan about three years ago to get Spotify to be profitable. And we've been executing on this plan. So we are very diligent with our costs.
OPERATOR
Thank you. That wasn't planned. Give me that much praise. It's both of us. It was actually spur of the moment for both of us. Okay.
Deepak Madhavanan
All right. Our next question is going to come from Deepak Madhavanan on our ubiquity strategy. You have integrated Spotify in leading AI applications already. ChatGPT last year and Claude, more recently. Can you talk about what type of traffic you're seeing and how consumers are using Spotify in AI applications at this time. And how are AI applications helping KPIs such as MAUs and time spent?
Gustav Soderstrom (Co-CEO)
It's really all about AI today. It's great. So we are. There are a few ways to think about this. As you know, Spotify has had a few core pillars, one being freemium, another being personalization, and the third being ubiquity. So one way to think about this is just ubiquity. Spotify was always going to be everywhere, right? This has been a strategy to some of our competitors who favor their own ecosystems. So this goes for ChatGPT, Cloud, etc. As well. We just want to be wherever users are. And so that's a simple way to think about it. And I also mentioned that we track usage and engagement and costs very diligently and we are seeing what we want to see in terms of type of traffic. It depends on the feature. But what Alex mentioned up front is we have for the first time in Spotify history, this ability for users to actually tell us in plain English or actually whatever language they want, what they want. We were always guessing old school machine learning was a statistical activity based on clicks and and streams. Now people are telling us in English that they're going for a run and they want this BPM and that cadence and so forth. So we're getting this treasure trove of data that we are capturing, training on and this builds a unique advantage for us. I talked last time about the large personalization model, which is a model that we're training based on open source models, but it's trained on our proprietary data. This is not something that we rent from someone, this is something we're building in house. And the casual name for the large personalization model is a taste model. Why is that important? It is because it turns out that taste is actually not a fact. It is an opinion. And it differs between people, between markets, between use cases and activities. So that is the kind of usage that we were hoping to see in Prompted Playlist in AI dj. And that's exactly what we are seeing. Very advanced usage that is giving us a type of data we never had before. And now we're just heads down serving those use cases better than anyone else.
Alex Norstrom (Co-CEO)
Hey, let me jump in on the action here a little bit, Gustav. So I think it's important that you're hearing Gustav say this, and I say it sometimes about how we think. I think as a general approach it's good for us to explain to you how we think about things so that you can understand how it applies to other things as well. I think when Gustav said earlier in the response to another question that when the music catalog grows and when our content platform grows in volume, it's always been good. It's good for users, it's good for the industries that we're in, and so on. But then the second thing that happens is something we've also said for a long time, and Daniel mentioned this many times in these calls that we optimize for the long term and we talk about optimizing for lifetime value. So how do you bridge these two things with an ever increasing catalog of content and lifetime value? Well, it turns out that the number one reason for why people actually engage more with Spotify is personalization. And how we track that is if AI increases engagement for us, it generally means that it increases personalization for us. And increased personalization and engagement to Gustav's points are going to lead to. Well, they are going to be the best proxies for the increase in retention that we're going to see over time with these investments. And if that happens, then we know that that will eventually translate to a longer lifetime value, which in turn translates to more enterprise value. So that's how we think about the investments.
Eric Sheridan
Okay, our next question is going to come from Eric Sheridan on operating expenses. Can you frame the key platform and product initiatives that are driving incremental operating expense trends? How should investors think about the trajectory of operating margins going forward?
Gustav Soderstrom (Co-CEO)
I'll start with them and then Christian can talk about the trajectory. So I've kind of mentioned it already in terms of the OPEX band, that it's a mix of increased computer, not increase headcount and sales and marketing to make sure that we capture the value of the features that we're now launching. To give you a bit more detail in what do we mean with compute? It's a few different things actually. One is just using things like cloud code, codecs, etc. To accelerate our development pace and building some proprietary systems around that. I talked a little bit about Honk last time. I have many more exciting things to talk about if you guys want to go there. That we are doing. But that's just one type. Accelerating our productivity or writing code. But then as I also mentioned briefly, we are training rather large models in house because we have lots and lots of unique data that no one else has. For example, the Large Personalization Model, which is not something that you can rent or buy off the Internet. You literally need 700 million plus people every day using the platform to be able to say what is, what is trending in a certain region in India right now. So a lot of it is training or some of it's training cost, and that's upfront and we'll capture that value when those products roll out. And some of it is this direct productivity in terms of development costs. So think of part of it strategic investment, part of it as a productivity investment.
Christian Luiga (CFO)
Yeah. And when we see product market fit with the features that we launch, it just leads to an opportunity for us to talk more about it. Meaning we can start telling compelling marketing stories around it to scale it even further. On top of this healthy core that we have. It's all about awareness and use once you find product market fit. And what we highlighted, and I did in my script, was that the next two quarters will be a little bit elevated from this. And we do have a different pattern on our, our launches this year of products. And that's what Alex talked about. And the R and D, of course, is extremely important for building the tech stack that we are delivering to our customers. So I just want to say with that also that what we did say, and we reiterate, is that the operating margin will improve year over year.
Justin Patterson
All right, our next question comes from Justin Patterson on the new free tier for Alex and Christian. How are you judging the higher cost of the free tier versus subscriber conversion and your LTV framework? How does this compare to your expectations when rolling this out last September?
Alex Norstrom (Co-CEO)
All right, Justin, good question. I'll start and then Christian will fill in. So you heard me in the remarks saying that we in particular pay a lot of attention to the number of days in a month that that users spend on Spotify. So I'd much rather someone spend many days in a month rather than many hours per day. Of course you would want both, but if you have to prioritize, it's the many days in a month. And really internally we talk about it as the lifeblood of our system. And if you look back on the development of the free tier, the new, more enhanced free tier that we launched, I can't remember, is it a little bit more than a year ago now? We have seen consistently that the free tier users have increased in the active days in a month now. What does that mean? Well, we've had this consistent increase for many years, basically from 21, 22, 23 and so on. But when we launched new improved free tier globally, we saw this step change, which essentially means that people are liking the free tier much more. It's satisfaction and more usage and more days in a month. So that is always going to downstream lead to more subscriber conversion and eventually lifetime value. I mean, it's just blown up my expectations fully since we launched this last September.
Christian Luiga (CFO)
So just chiming in, I guess you also have then read the numbers and maybe a little bit surprised that in the quarter was one of the few times we had a negative development on the year over year gross margin in the ads business. But that is really coming back to the great engagement we have and where the engagement is driving more content costs right now than the income on top line. But the beauty in that and the healthy thing with that is that of course that means that we will be able to monetize that as we move into future quarters and that will be then a positive push going forward. So that is really a short term issue.
Rich Greenfield
Okay, our next question is from Rich Greenfield on fitness. Fitness will undoubtedly drive increased video engagement on Spotify, particularly on TV screens. How does this impact your video ad business? And how should we think about the cost impact you will bear within the premium business from adding this content?
Alex Norstrom (Co-CEO)
I know you love your TV and Apple tv, Rich, so hopefully we'll see you using Spotify, pumping iron in front of the TV or maybe doing some stretching. You should think about this launch as a launch in fitness. That basically is something that's happening organically already on Spotify. This is something we're doubling down on. And you know, much like, you know, we did when we launched podcasts at first and also audiobooks, we saw the behavior organically happening on the platform. And if you think about the TAM here, the demand here, in our research we have this staggering number that says that 70% of our premium users actually train or, or workout or go to the gym or do yoga every month. And you can also see it in the numbers. Hundreds of millions of playlists are being created to do yoga, to go to the gym, and so on and so forth. So this is us doubling down on that trend. And little did we know, about a year and a half ago, when we launched spp, the ad Free Video Experience for Spotify Premium users, we saw a lot of fitness instructors and fitness creators just unprompted, upload a lot of videos to Spotify. And if you think about it, this is really what we do. We use our platform to bridge the demand between creatives like a fitness instructor and users. We connect them using our three tri modal economic engines like ads, subscriptions and top ups. And we do that between creators and platforms. And this is what we're seeing with fitness right now for us. So we do look forward to this expanding even more. And I'll just give you the highlight of how I'm using it. We're seeing some tennis content come online. I play tennis. Not that I'm very good at all, but I still play a lot. So when I'm gearing up for a bit of a tournament, then it's an amateur tournament, then I'll see recommendations in the future coming up with podcast videos telling me how to stretch and relax before I go into that week. Maybe there's some instructional videos that tell me how to improve my sucky backend. Maybe I'll get an audiobook recommendation on how to think about tennis playing. So this is really something that we're happy to invest in. This is a demand trend that's happening right now on Spotify.
Jess Grief Ehrlich
All right, our next question comes from Jess Grief Ehrlich on arpu. Have you seen anything unusual in subscriber reaction to your recent price increase? And could you talk about tools for further ARPU expansion from here?
Gustav Soderstrom (Co-CEO)
You saw us increase price around the world in the last quarter of last year and then you saw us increase in the US in this most recent quarter. No surprises at all for us ARPA expansion tools. I mean, how do we feel about increasing ARPA over time? I mean, I think one of the things we have talked about is when you bring engagement and more verticals, you can actually monetize on that. But on top of that, I think we've proven with the the model with audiobooks and top ups that that is a way to bring more monetization on our platform from our subscribers and we continue to look at those kind of elements. I'll just jump in here. Alex talked a little bit about us explaining how we think and I think one useful model to think about, not just Spotify, actually all consumer products, is that people talk about averages, your average usage and so forth. But almost nothing is an average. It's almost always a power law. You have a long tail of users who use something a little and then you have a head of people who use it a lot. And so Spotify always had the business model to capture the long tail, which requires a free tier and to capture a bunch of the averagely engaged users in premium. But until we launched audiobooks add on, we didn't really have a tool to capture the head. The people who wanted to read for hundreds of hours a month. We had a clear theory that we could capture the entire power law, but we hadn't proven it to ourselves until recently. Now we have those three tools, so we feel very good about just getting more usage on the platform and use these three tools to monetize it.
Stephen Cajal
Okay, next question from Stephen Cajal on AI music. Does Spotify believe in an AI music creation tier? And if so, what are the sticking points with content partners and how might it be priced to premium users?
Gustav Soderstrom (Co-CEO)
Yeah, so this is. Gustav, I've touched on this a little bit. What we do believe in is that there is a lot of opportunity out there for creators who want to use AI tools, but there is an opportunity that no one is addressing right now for existing artists and we really want to address that part. We don't think existing artists should be left out of AI. We think that may actually be the most interesting part of music. If you look at other industries, existing IP is actually the most valuable ip, not the least valuable. But because of how AI music works right now, that is not addressable. That's the problem we want to solve. We think there's a big opportunity for creators and for Spotify and for investors there. And so we think that there's a big opportunity to expand the music catalog and that is obviously good for us, but we think there is also a big opportunity for existing artists that hasn't been addressed yet.
Benjamin Black
Okay, back to Benjamin Black with another question on fitness. Yesterday you announced a partnership with Peloton. Could you highlight the strategic rationale? And also could you talk about the cost structure or this deal and how does this compare to audiobooks or the Spotify partner program spending? And is it reasonable to think that monetization will follow a similar strategy to audiobooks back in 2024, 2025?
Alex Norstrom (Co-CEO)
Hey Benjamin, good question. I like our partnership with Peloton. Although we don't talk about the specific of deals, you know that I can let you know that this is content that's ad free. It's high quality content that normally resides within subscriptions that retail at much higher price. So we're putting that on premium inside the fitness category. And so your question is like, how does this compare to Audiobooks? Well, in that sense it actually is similar to Audiobooks and spp.
Maria Rips
Okay, question from Maria Rips on advertising. Higher engagement among ad supported users is clearly a positive. What needs to happen for that engagement to start translating into gross margin tailwinds?
Alex Norstrom (Co-CEO)
I think just continue the work on the sturdy progress that we've had so far with the new ad stack getting not just more programmatic ad sales on top, which is growing very, very fast right now, but also sort of looking holistically at the whole system, including direct sales.
Christian Luiga (CFO)
I just want to reiterate that the quarter one gross margin that we had was a very small one in ads was a short term issue. And we reiterate, which we have said now for six months, that, that we see that the second half of 2026 is where we see the growth picking up. And I think I just want to say that again and again as it was some kind of a lot of questions around it today that we have said that quite for a long time now that it's the second half where you see the progress coming through.
Doug Amethyst
Okay, we've got another question from Doug Amethyst on tiering. You've recently shifted tiers to feature and product sets in a handful of markets, essentially enabling good, better and best versions of Spotify. What have been the early learnings with this move and how could they apply to more mature or established markets?
Alex Norstrom (Co-CEO)
I love that you paid attention to this, Doug. This is one of my personal favorites. Like you said, it's very, very early and I can't say much about it, but the early indications is that when we deploy these types of value proposition frameworks, we see a structural increase in arpu. But it may be too early to sort of talk about specifics just now. Are we positive about it?
Sean Difley
Okay, our next question comes from Sean Difley on conversion. How should we think about the conversion of free to paid subs in 2026 relative to prior years given the enhancements to the mobile free tier? And how much of the increase in marketing spend is related to this versus other features that are on the app now or coming later. This.
Alex Norstrom (Co-CEO)
Maybe Gustav can comment on other features on the app and so on. But I'll start by responding to your first question there. I've said it many times before, engagement and really the free tier is the best leading indicator to how our system spins. And by that I mean if you have more engagement and if you have a free tier that's thriving, that's growing fast, then that will eventually translate to more retention to someone converting over to subscriptions and thereby also generating lifetime value for the company
Gustav Soderstrom (Co-CEO)
in terms of the spend it's spread among many features. We are trying to market the features that are differentiated and a lot of them are focused on the premium tier, maybe more so than on the free tier. The free tier is sort of selling itself because it's free.
William Packer
All right, and our last question today is going to come from William Packer on AI investor concerns. Over AI disruption have increased. Could you outline the key moats for Spotify that limit the risk from 1 standalone low cost free AI music alternatives, 2 large platform peers that offer free AI music services, and 3 competition from AI first alternatives which integrate label content.
Gustav Soderstrom (Co-CEO)
Yeah, this is good stuff. Thanks, William. So there's a bunch of questions in here. I don't really like the word moats. I think there are fair advantages possibly that you've earned because you worked really hard. So some of our fair advantages are that we have about almost 20 years of listening history. And so I touched on this before. Some of the things in the world are facts that can be easily commoditized by LLMs, such as the capital of Texas or something. Other things are not so easily commoditized. And it turns out, luckily for us, taste is not easily commoditized because it's not a fact, it's an opinion. It differs between people, it differs between regions, it differs between people in those regions and use cases. And on top of that it changes weekly what is cool right now and what is culture? So, so for this reason we do invest quite a lot in something like our large personalization model, basically our own taste model. We use a bunch of third party services, but not with our core data. We're training proprietary models for that. So I think that will give us a lot of well earned advantage in terms of serving our users better. And I think it's a very durable one because if you theoretically said that someone even could somehow snapshot all our user data, all 700 million plus users, they could train a model on that and then that model is pretty useless after about maybe two, three weeks as culture moved on. So we actually think it's very sustainable and you need to be at scale to keep these models valuable. So I feel pretty good about that. Then to get to your second and maybe third question, standalone, low cost free AI music alternatives. I think you may be thinking about what's happening in China with services like Soda. And I think it's important to remember that it's a different market in a fundamental sense. The Chinese market basically gated on content between free and paid. And what happened was because of AI, that pay gate got challenged. Spotify has never gated on content and in most of the western markets the services are not gated on content. So we just don't have that same risk. That doesn't mean that we don't think we could actually benefit from AI as I've set during this call, both in terms of size of the catalog, but also in terms of serving existing creators.
Brian Goldberg (Head of Investor Relations)
All right, great. Thanks everyone for the questions. I'd like to turn the call back over to Gustav for some closing remarks.
Gustav Soderstrom (Co-CEO)
All right, thanks, Brian. So this month marked our 20th anniversary, actually. 20 years of building what once seemed impossible, innovating for the greatest artists, creators and authors, and shipping the best and most valuable experience for the world's most passionate, engaged fans. And there is still a lot more to come from us. So we hope that you'll join us for upcoming Investor Day on May 21st in New York. We can't wait to show you what it all means for the next chapter of Spotify's growth, so we hope to see you there. Thank you, everyone, for joining. Thank you.
OPERATOR
Okay, and that concludes today's call. A replay will be available on our website and also on the Spotify app under Spotify Earnings Call Replays. Thanks everyone, for joining.
Disclaimer: This transcript is provided for informational purposes only. While we strive for accuracy, there may be errors or omissions in this automated transcription. For official company statements and financial information, please refer to the company's SEC filings and official press releases. Corporate participants' and analysts' statements reflect their views as of the date of this call and are subject to change without notice.
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