Other reserves
| | | | | | | | | | | |
| 2022 | | 2021 |
| (in € millions) |
Currency translation | | | |
At January 1 | 17 | | | (54) | |
Currency translation | 208 | | | 52 | |
At September 30 | 225 | | | (2) | |
Short term investments | | | |
At January 1 | (3) | | | 5 | |
Losses on fair value that may be subsequently reclassified to condensed consolidated statement of operations | (28) | | | (4) | |
Losses/(gains) reclassified to condensed consolidated statement of operations | 2 | | | (1) | |
Deferred tax | — | | | 1 | |
At September 30 | (29) | | | 1 | |
Long term investments | | | |
At January 1 | (26) | | | 1,059 | |
Losses on fair value not to be subsequently reclassified to condensed consolidated statement of operations | (299) | | | (1,185) | |
Gain on sale of long term investments, net of tax reclassified to accumulated deficit | (1) | | | — | |
Deferred tax | 15 | | | 231 | |
At September 30 | (311) | | | 105 | |
Exchangeable Notes | | | |
At January 1 | — | | | — | |
Gains on fair value attributable to changes in credit risk | 21 | | | — | |
Deferred tax | (6) | | | — | |
At September 30 | 15 | | | — | |
Cash flow hedges | | | |
At January 1 | (4) | | | (3) | |
Losses on fair value that may be subsequently reclassified to condensed consolidated statement of operations | (1) | | | (8) | |
Losses reclassified to revenue | 38 | | | 39 | |
Gains reclassified to cost of revenue | (26) | | | (30) | |
| | | |
At September 30 | 7 | | | (2) | |
Share-based compensation | | | |
At January 1 | 869 | | | 680 | |
Share-based compensation | 284 | | | 171 | |
Income tax impact associated with share-based compensation | 56 | | | 9 | |
| | | |
Restricted stock units withheld for employee taxes | (31) | | | (40) | |
At September 30 | 1,178 | | | 820 | |
Other reserves at September 30 | 1,085 | | | 922 | |
16. Share-based compensation
The expense recognized in the condensed consolidated statement of operations for share-based compensation is as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three months ended September 30, | | Nine months ended September 30, | | |
| 2022 | | 2021 | | 2022 | | 2021 | | | | |
| (in € millions) |
Cost of revenue | 2 | | | 3 | | | 6 | | | 7 | | | | | |
Research and development | 63 | | | 30 | | | 157 | | | 90 | | | | | |
Sales and marketing | 21 | | | 10 | | | 55 | | | 31 | | | | | |
General and administrative | 22 | | | 14 | | | 63 | | | 45 | | | | | |
Total | 108 | | | 57 | | | 281 | | | 173 | | | | | |
Activity in the Group's RSUs and other contingently issuable shares outstanding and related information is as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| RSUs | | | | Other |
| Number of RSUs | | Weighted average grant date fair value | | | | | | Number of Awards | | Weighted average grant date fair value |
| | | US$ | | | | | | | | US$ |
Outstanding at January 1, 2022 | 1,425,196 | | 211.25 | | | | | | | 108,720 | | 145.19 | |
Granted | 2,314,475 | | 131.30 | | | | | | | 30,824 | | 162.21 | |
Forfeited | (170,522) | | 196.34 | | | | | | | (20,357) | | 145.21 | |
Released | (566,913) | | 181.84 | | | | | | | (47,470) | | 145.20 | |
Outstanding at September 30, 2022 | 3,002,236 | | 156.01 | | | | | | | 71,717 | | 152.50 | |
In connection with the acquisition of Podsights during the three months ended March 31, 2022, the Company granted 30,824 equity instruments to certain employees of Podsights. The instruments vest annually over a four-year period from the acquisition date and the vesting is contingent upon continued employment. The instruments are accounted for as equity-settled share-based payment transactions and are measured based on the fair market value of the underlying ordinary shares on the date of grant. The grant date fair value for each equity instrument granted to employees of Podsights was US$162.21.
In the table above, the number of RSUs and other contingently issuable shares released include ordinary shares that the Group has withheld for settlement of employees' tax obligations due upon the vesting of RSUs and other contingently issuable shares.
Activity in the Group's stock options outstanding and related information is as follows:
| | | | | | | | | | | |
| Options |
| Number of options | | Weighted average exercise price |
| | | US$ |
Outstanding at January 1, 2022 | 8,695,348 | | 190.19 | |
Granted | 7,885,279 | | 151.72 | |
Forfeited | (436,775) | | 228.82 | |
Exercised | (620,143) | | 78.33 | |
Expired | (261,628) | | 189.06 | |
Outstanding at September 30, 2022 | 15,262,081 | | 173.78 | |
Exercisable at January 1, 2022 | 4,453,983 | | 152.64 | |
Exercisable at September 30, 2022 | 5,623,351 | | 173.25 | |
The weighted-average contractual life for the stock options outstanding at September 30, 2022 was 3.3 years. The weighted average share price at exercise for options exercised during the nine months ended September 30, 2022 was US$158.59. The weighted average fair value of options granted during the nine months ended September 30, 2022 was US$45.66 per option.
The following table lists the inputs to the Black-Scholes option-pricing models used for stock options for the three and nine months ended September 30, 2022 and 2021:
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three months ended September 30, | | Nine months ended September 30, | | |
| 2022 | | 2021 | | 2022 | | 2021 | | | | |
Expected volatility (%) | 48.7 - 57.1 | | 35.4 - 42.9 | | 35.9 - 57.1 | | 34.1 - 42.9 | | | | |
Risk-free interest rate (%) | 2.7 - 3.5 | | 0.3 - 0.8 | | 0.9 - 3.5 | | 0.2 - 0.8 | | | | |
Expected life of stock options (years) | 2.6 - 4.8 | | 2.6 - 4.8 | | 2.6 - 4.9 | | 2.6 - 4.8 | | | | |
Weighted average share price (US$) | 106.44 | | | 243.23 | | | 133.84 | | | 287.48 | | | | | |
17. Exchangeable Notes
On March 2, 2021, the Company’s wholly owned subsidiary, Spotify USA Inc. (the “Issuer”), issued US$1,500 million aggregate principal amount of 0% Exchangeable Senior Notes due 2026 (the “Exchangeable Notes”), which included the initial purchasers’ exercise in full of their option to purchase an additional US$200 million principal amount of the Exchangeable Notes. The Exchangeable Notes will mature on March 15, 2026, unless earlier repurchased, redeemed or exchanged. The Exchangeable Notes are fully and unconditionally guaranteed, on a senior, unsecured basis by the Company.
The net proceeds from the issuance of the Exchangeable Notes were €1,223 million after deducting transaction costs of €18 million. The transaction costs were immediately expensed and included in finance costs in the condensed consolidated statement of operations for the three months ended March 31, 2021.
The Exchangeable Notes are the Issuer’s senior unsecured obligations and are equal in right of payment with the Issuer's future senior, unsecured indebtedness, senior in right of payment to the Issuer’s future indebtedness that is expressly subordinated to the Exchangeable Notes and effectively subordinated to the Issuer’s future secured indebtedness, to the extent of the value of the collateral securing that indebtedness. The Exchangeable Notes will be structurally subordinated to all future indebtedness and other liabilities, including trade payables, and (to the extent the Issuer is not a holder thereof) preferred equity, if any, of the Issuer’s subsidiaries.
The noteholders may exchange their Exchangeable Notes at their option into consideration that consists, at the Issuer’s election, of cash, ordinary shares of the Company, or a combination of cash and ordinary shares, but only under certain circumstances as set forth in the indenture governing the Exchangeable Notes (the "Indenture"). The circumstances required to allow the noteholders to exchange their Exchangeable Notes were not met during the nine months ended September 30, 2022.
The Exchangeable Notes will not be redeemable prior to March 20, 2024, except in the event of certain tax law changes as set forth in the Indenture. The Exchangeable Notes will be redeemable, in whole or in part, at the Issuer’s option at any time, and from time to time, on or after March 20, 2024 and on or before the 40th scheduled trading day immediately before the maturity date, at a cash redemption price equal to the principal amount of the Exchangeable Notes to be redeemed, plus accrued and unpaid special and additional interest, if any, but only if the last reported sale price per ordinary share exceeds 130% of the exchange price on:
(1) each of at least 20 trading days, whether or not consecutive, during the 30 consecutive trading days ending on, and including, the trading day immediately before the date the Issuer sends the related redemption notice; and
(2) the trading day immediately before the date the Issuer sends such notice.
In addition, the Issuer will have the right to redeem all, but not less than all, of the Exchangeable Notes if certain changes in tax law as set forth in the Indenture occur. In addition, calling any Exchangeable Note for redemption will constitute a make-whole fundamental change with respect to that Exchangeable Note, in which case the exchange rate applicable to the exchange of that Exchangeable Note will be increased in certain circumstances if it is exchanged after it is called for redemption.
Upon the occurrence of a “fundamental change” as set forth in the Indenture, noteholders may require the Issuer to repurchase their Exchangeable Notes at a cash repurchase price equal to the principal amount of the Exchangeable Notes to be repurchased, plus accrued and unpaid special and additional interest, if any, to, but excluding, the fundamental change repurchase date as set forth in the Indenture.
The Group accounted for the Exchangeable Notes at fair value through profit and loss using the fair value option in accordance with IFRS 9, Financial Instruments. The fair value of the Exchangeable Notes as of September 30, 2022 was €1,197 million. See Note 21 for information regarding the key inputs and assumptions used to estimate the fair value of the Exchangeable Notes.
18.Trade and other payables
| | | | | | | | | | | |
| September 30, 2022 | | December 31, 2021 |
| (in € millions) |
Trade payables | 695 | | | 534 | |
Value added tax and sales taxes payable | 238 | | | 229 | |
Other current liabilities | 14 | | | 30 | |
Total | 947 | | | 793 | |
19.Accrued expenses and other liabilities
| | | | | | | | | | | |
| September 30, 2022 | | December 31, 2021 |
| (in € millions) |
Non-current | | | |
Other accrued liabilities | 31 | | | 37 | |
Total | 31 | | | 37 | |
Current | | | |
Accrued fees to rights holders | 1,578 | | | 1,378 | |
Accrued salaries, vacation, and related taxes | 120 | | | 92 | |
Accrued social costs for options and RSUs | 8 | | | 84 | |
Accrued operating liabilities | 197 | | | 188 | |
Other accrued expenses | 117 | | | 99 | |
Total | 2,020 | | | 1,841 | |
20.Provisions
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Legal contingencies | | Indirect tax | | Onerous Contracts | | Other | | Total |
| (in € millions) |
Carrying amount at January 1, 2022 | 4 | | | 8 | | | 10 | | | 7 | | | 29 | |
Charged/(credited) to the condensed statement of operations: | | | | | | | | | |
Additional provisions | 1 | | | 4 | | | 18 | | | — | | | 23 | |
Reversal of unutilized amounts | — | | | (2) | | | (1) | | | — | | | (3) | |
Exchange differences | 1 | | | 1 | | | 2 | | | — | | | 4 | |
Utilized | — | | | (1) | | | (20) | | | — | | | (21) | |
Carrying amount at September 30, 2022 | 6 | | | 10 | | | 9 | | | 7 | | | 32 | |
As at January 1, 2022 | | | | | | | | | |
Current portion | 4 | | | 8 | | | 6 | | | 4 | | | 22 | |
Non-current portion | — | | | — | | | 4 | | | 3 | | | 7 | |
As at September 30, 2022 | | | | | | | | | |
Current portion | 6 | | | 10 | | | 9 | | | 4 | | | 29 | |
Non-current portion | — | | | — | | | — | | | 3 | | | 3 | |
Various legal actions, proceedings, and claims are pending or may be instituted or asserted against the Group. The results of such legal proceedings are difficult to predict and the extent of the Group's financial exposure is difficult to estimate. The Group records a provision for contingent losses when it is both probable that a liability has been incurred, and the amount of the loss can be reasonably estimated.
As of April 2019, the Group's settlement of the Ferrick et al. v. Spotify USA Inc., No. 1:16-cv-8412-AJN (S.D.N.Y.), putative class action lawsuit, which alleged that the Group unlawfully reproduced and distributed musical compositions without obtaining licenses, was final and effective. Even with the effectiveness of the settlement, we may still be subject to claims of copyright infringement by rights holders who have purported to opt out of the settlement or who may not otherwise be covered by its terms. The Music Modernization Act of 2018 contains a limitation of liability with respect to such lawsuits filed on or after January 1, 2018. Rights holders may, nevertheless, file lawsuits, and may argue that they should not be bound by this limitation of liability. For example, in August 2019, the Eight Mile Style, LLC et al v. Spotify USA Inc., No. 3:19-cv-00736-AAT, lawsuit was filed against us in the U.S. District Court for the Middle District of Tennessee, alleging both that the Group does not qualify for the limitation of liability in the Music Modernization Act and that the limitation of liability is unconstitutional and, thus, not valid law. The Group intends to vigorously defend this lawsuit, including plaintiffs' challenges to the limitation of liability in the Music Modernization Act.
21.Financial instruments
Foreign exchange forward contracts
Cash flow hedges
The Group's currency pairs used for cash flow hedges are Euro / U.S. dollar, Euro / Australian dollar, Euro / British pound, Euro / Swedish krona, Euro / Canadian dollar, and Euro / Norwegian krone. The notional principal of foreign exchange contracts hedging the revenue and cost of revenue line items in the condensed consolidated statement of operations was approximately €1,219 million and €871 million, respectively, as of September 30, 2022, and approximately €1,185 million and €835 million, respectively, as of December 31, 2021.
Fair values
The carrying amounts of certain financial instruments, including cash and cash equivalents, trade and other receivables, restricted cash, trade and other payables, and accrued expenses and other liabilities approximate fair value due to their relatively short maturities. All other financial assets and liabilities are accounted for at fair value.
The following tables summarize, by major security type, the Group's financial assets and liabilities that are measured at fair value on a recurring basis, and the category using the fair value hierarchy:
| | | | | | | | | | | | | | | | | | | | | | | |
| Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | September 30, 2022 |
| (in € millions) |
Financial assets at fair value | | | | | | | |
Cash equivalents: | | | | | | | |
Money market funds | 1,919 | | | — | | | — | | | 1,919 | |
Time Deposits | 51 | | | — | | | — | | | 51 | |
Short term investments: | | | | | | | |
Money market funds | 25 | | | — | | | — | | | 25 | |
Government securities | 257 | | | 6 | | | — | | | 263 | |
Corporate notes | — | | | 346 | | | — | | | 346 | |
Fixed income funds | 181 | | | — | | | — | | | 181 | |
Derivatives (designated for hedging): | | | | | | | |
Foreign exchange forwards | — | | | 28 | | | — | | | 28 | |
| | | | | | | |
| | | | | | | |
Long term investments | 589 | | | — | | | 41 | | | 630 | |
Total financial assets at fair value | 3,022 | | | 380 | | | 41 | | | 3,443 | |
Financial liabilities at fair value | | | | | | | |
Exchangeable Notes | — | | | — | | | 1,197 | | | 1,197 | |
Derivatives (not designated for hedging): | | | | | | | |
Warrants | — | | | — | | | 3 | | | 3 | |
Derivatives (designated for hedging): | | | | | | | |
Foreign exchange forwards | — | | | 21 | | | — | | | 21 | |
Total financial liabilities at fair value | — | | | 21 | | | 1,200 | | | 1,221 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | December 31, 2021 |
| (in € millions) |
Financial assets at fair value | | | | | | | |
Cash equivalents: | | | | | | | |
Money market funds | 1,970 | | | — | | | — | | | 1,970 | |
Short term investments: | | | | | | | |
Money market funds | 25 | | | — | | | — | | | 25 | |
Government securities | 204 | | | 18 | | | — | | | 222 | |
Corporate notes | — | | | 308 | | | — | | | 308 | |
| | | | | | | |
Collateralized reverse purchase agreements | — | | | 67 | | | — | | | 67 | |
Fixed income funds | 134 | | | — | | | — | | | 134 | |
Derivatives (designated for hedging): | | | | | | | |
Foreign exchange forwards | — | | | 11 | | | — | | | 11 | |
Long term investments | 852 | | | — | | | 64 | | | 916 | |
Total financial assets at fair value | 3,185 | | | 404 | | | 64 | | | 3,653 | |
Financial liabilities at fair value | | | | | | | |
Exchangeable Notes | — | | | — | | | 1,202 | | | 1,202 | |
Derivatives (not designated for hedging): | | | | | | | |
Warrants | — | | | — | | | 72 | | | 72 | |
Derivatives (designated for hedging): | | | | | | | |
Foreign exchange forwards | — | | | 17 | | | — | | | 17 | |
Contingent consideration | — | | | — | | | 17 | | | 17 | |
Total financial liabilities at fair value | — | | | 17 | | | 1,291 | | | 1,308 | |
The Group's policy is to recognize transfers into and transfers out of fair value hierarchy levels at the end of each reporting period. During the nine months ended September 30, 2022, there were no transfers between levels in the fair value hierarchy.
Recurring fair value measurements
Long term investment - Tencent Music Entertainment Group
The Group's approximate 8% investment in TME is carried at fair value through other comprehensive loss. The fair value of ordinary shares of TME is based on the ending New York Stock Exchange American depository share price. The fair value of the investment in TME may vary over time and is subject to a variety of risks including company performance, macro-economic, regulatory, industry, USD to Euro exchange rate and systemic risks of the equity markets overall.
The table below presents the changes in the investment in TME:
| | | | | | | | | | | |
| 2022 | | 2021 |
| (in € millions) |
At January 1 | 852 | | | 2,228 | |
Changes in fair value recorded in other comprehensive loss | (266) | | | (1,343) | |
At September 30 | 586 | | | 885 | |
A 10% decrease or increase in TME's share price would have resulted in a fair value of the Group's long term investment in TME ranging from €527 million to €645 million at September 30, 2022.
The following sections describe the valuation methodologies the Group uses to measure its Level 3 financial instruments at fair value on a recurring basis.
Long term investments - other
The Group has interests in certain long term investments, the most significant of which is our equity investment in DistroKid, an independent digital music distribution service. These long term investments primarily represent unlisted equity securities carried at fair value through other comprehensive loss. The fair values of these equity investments are generally determined using business enterprise values based on market transactions or by (i) applying market multiples to the projected financial performance and (ii) discounting the future value to its present value equivalent. The key assumptions used to estimate the fair value of these equity investments include market multiples of revenue or earnings before interest, income taxes, depreciation and amortization for benchmark companies used to estimate business enterprise value and discount rate.
The fair value of the long term investments may vary over time and is subject to a variety of risks including company performance, macroeconomic, regulatory, industry, USD to Euro exchange rate, and systemic risks of the overall equity markets.
The table below presents the changes in the other long term investments:
| | | | | | | | | | | |
| 2022 | | 2021 |
| (in € millions) |
At January 1 | 64 | | | 49 | |
| | | |
Initial purchase of long term investment | 3 | | | — | |
Changes in fair value recorded in other comprehensive loss | (31) | | | 159 | |
Changes in fair value recognized in condensed consolidated statement of operations | — | | | (4) | |
Effect of changes in foreign exchange rates | 5 | | | 1 | |
At September 30 | 41 | | | 205 | |
Warrants
As of September 30, 2022 and December 31, 2021, the number of outstanding warrants was 800,000 and 1,600,000, respectively. 800,000 warrants issued on July 1, 2019 expired unexercised on July 1, 2022.
The outstanding warrants are valued using a Black-Scholes option-pricing model. Assumptions used to estimate the fair value of the warrants in the option pricing model are as follows:
| | | | | | | | | | | |
| September 30, 2022 |
Expected term (years) | 1.9 | |
Risk free rate (%) | 4.2 | |
Volatility (%) | 55.0 | |
Share price (US$) | 86.30 | |
The table below presents the changes in the warrants liability:
| | | | | | | | | | | |
| 2022 | | 2021 |
| (in € millions) |
At January 1 | 72 | | | 89 | |
Issuance of warrants for cash | — | | | 31 | |
| | | |
| | | |
Changes in fair value recognized in condensed consolidated statement of operations | (73) | | | (53) | |
Effect of changes in foreign exchange rates | 4 | | | 5 | |
At September 30 | 3 | | | 72 | |
A 10% decrease or increase in the Company's ordinary share price would have resulted in a fair value of the warrants ranging from €2 million to €4 million at September 30, 2022.
Contingent consideration
On April 1, 2019, the Group acquired Cutler Media, LLC ("Parcast"), a premier storytelling podcast studio. Included in the purchase price was €13 million related to the estimated fair value of contingent consideration. The contingent consideration was valued by the Group using a simulation of user engagement outcomes. The change in the fair value of the contingent consideration was recognized within general and administrative expenses in the condensed consolidated statement of operations.
The table below presents the changes in the contingent consideration liability:
| | | | | | | | | | | |
| 2022 | | 2021 |
| (in € millions) |
At January 1 | 17 | | | 30 | |
| | | |
Contingent consideration payments | (17) | | | (17) | |
Changes in fair value recognized in condensed consolidated statement of operations | — | | | 2 | |
Effect of changes in foreign exchange rates | — | | | 2 | |
At September 30 | — | | | 17 | |
As of June 30, 2022, the contingent consideration was fully paid.
Exchangeable Notes
The table below presents the changes in the Exchangeable Notes:
| | | | | | | | | | | | | |
| 2022 | | 2021 | | |
| (in € millions) |
At January 1 | 1,202 | | | — | | | |
Initial recognition | — | | | 1,232 | | | |
Changes in fair value recognized in condensed consolidated statement of operations | (159) | | | (117) | | | |
Changes in fair value recorded in other comprehensive loss | (21) | | | — | | | |
Effect of changes in foreign exchange rates | 175 | | | 60 | | | |
At September 30 | 1,197 | | | 1,175 | | | |
The change in estimated fair value is recognized within finance income/(costs) in the condensed consolidated statement of operations, excluding changes in fair value due to changes in the Group’s own credit risk, which are recognized in other comprehensive loss and will not be reclassified to the condensed consolidated statement of operations.
The fair value of the Exchangeable Notes was estimated using a combination of a binomial option pricing model and prices observed for the Exchangeable Notes in an over-the-counter market on the last trading day of the reporting period. A weight of 75% was applied to the binomial option pricing model and a weight of 25% was applied to the price of the Exchangeable Notes in the over-the-counter market on the last trading day of the reporting period. The key assumptions used in the binomial option pricing model for the Exchangeable Notes were as follows:
| | | | | | | |
| September 30, 2022 | | |
Risk free rate (%) | 4.2 | | | |
Discount rate (%) | 7.5 | | | |
Volatility (%) | 45.0 | | | |
Share price (US$) | 86.30 | | |
A decrease or increase of 10 percentage points in volatility would have resulted in a fair value of the Exchangeable Notes ranging from €1,194 million to €1,204 million at September 30, 2022. A 10% decrease or increase in the Company's ordinary share price would have resulted in a fair value of the Exchangeable Notes ranging from €1,196 million to €1,199 million at September 30, 2022. A decrease or increase of 100 basis points in credit spread would have resulted in a fair value of the Exchangeable Notes ranging from €1,227 million to €1,168 million at September 30, 2022.
22. Commitments and contingencies
Commitments
The Group is subject to the following minimum guarantees relating to the content on its Service, the majority of which relate to minimum royalty payments associated with its license agreements for the use of licensed content:
| | | | | | | | | | | |
| September 30, 2022 | | December 31, 2021 |
| (in € millions) |
Not later than one year | 1,629 | | | 788 | |
Later than one year but not more than five years | 414 | | | 2,491 | |
| | | |
| 2,043 | | | 3,279 | |
In addition, the Group is subject to various non-cancelable purchase obligations and service agreements with minimum spend commitments, including a service agreement with Google for the use of Google Cloud Platform and certain podcast and marketing commitments:
| | | | | | | | | | | |
| September 30, 2022 | | December 31, 2021 |
| (in € millions) |
Not later than one year | 691 | | | 362 | |
Later than one year but not more than five years | 312 | | | 435 | |
More than five years | 98 | | | — | |
| 1,101 | | | 797 | |
Contingencies
Various legal actions, proceedings, and claims are pending or may be instituted or asserted against the Group. These may include, but are not limited to, matters arising from alleged infringement of intellectual property; alleged violations of consumer regulations; employment-related matters; and disputes arising from supplier and other contractual relationships. As a general matter, the music and other content made available on the Group's Service are licensed to the Group by various third parties. Many of these licenses allow rights holders to audit the Group's royalty payments, and any such audit could result in disputes over whether the Group has paid the proper royalties. If such a dispute were to occur, the Group could be required to pay additional royalties, and the amounts involved could be material. The Group expenses legal fees as incurred. The Group records a provision for contingent losses when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. An unfavorable outcome to any legal matter, if material, could have an adverse effect on the Group's operations or its financial position, liquidity, or results of operations.
On August 11, 2020, the United States Court of Appeals for the D.C. Circuit issued an opinion which, as of the issuance of the formal “mandate” on October 26, 2020, vacated the Copyright Royalty Board’s determination of the royalty rates for applicable mechanical rights in the United States for calendar years 2018 to 2022. These rates apply both to compositions that we license under compulsory license pursuant to Section 115 of the Copyright Act of 1976 and to a number of direct licenses that we have had with music publishers. On July 1, 2022, the Copyright Royalty Board issued its initial ruling to set those rates in light of the D.C. Circuit’s opinion. That ruling will need to be adapted into regulations, which, when issued by the U.S. Copyright Office, will become law. In August 2022, we and other services reached an agreement in principle with publisher organizations for rates and terms for U.S. mechanical royalties beginning in 2023 and asked the Copyright Royalty Board to adopt those rates and terms on an industry-wide basis. That request is pending. Until the final rates are determined, our recorded royalty costs both retrospectively and prospectively will be based on management estimates of the rates that will apply. Changes to these estimates could either benefit or adversely affect our results of operations and financial condition.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Special Note Regarding Forward-Looking Statements
This discussion and analysis reflects our historical results of operations and financial position and contains estimates and forward-looking statements. All statements other than statements of historical fact are forward-looking statements. The words "may," "might," "will," "could," "would," "should," "expect," "plan," "anticipate," "intend," "seek," "believe," "estimate," "predict," "potential," "continue," "contemplate," "possible," and similar words are intended to identify estimates and forward-looking statements.
Our estimates and forward-looking statements are mainly based on our current expectations and estimates of future events and trends, which affect or may affect our businesses and operations. Although we believe that these estimates and forward-looking statements are based upon reasonable assumptions, they are subject to numerous risks and uncertainties and are made in light of information currently available to us. Many important factors may adversely affect our results as indicated in forward-looking statements. These factors include, but are not limited to:
•our ability to attract prospective users, retain existing users, and monetize our products and services;
•competition for users, user listening time, and advertisers;
•risks associated with our international operations and our ability to manage our growth;
•our emphasis on innovation and long-term user engagement over short-term results;
•our ability to predict, recommend, and play content that our users enjoy;
•our ability to be profitable or generate positive cash flow on a sustained basis;
•our ability to convince advertisers of the benefits of our advertising offerings;
•our ability to forecast or optimize advertising inventory amid emerging industry trends in digital advertising;
•our ability to generate revenues from podcasts and other non-music content;
•potential disputes or liabilities associated with content made available on our Service (as defined above);
•risks relating to acquisitions, investments, and strategic alliances;
•our dependence upon third-party licenses for most of the content we stream;
•our lack of control over third-party content providers who are concentrated and can unilaterally affect our access to content;
•our ability to comply with complex license agreements;
•our ability to accurately estimate royalty payments under our license agreements and relevant statutes;
•the limitations on our operating flexibility due to financial commitments required under certain of our license agreements;
•our ability to identify the compositions and ownership thereof embodied in sound recordings in order to obtain licenses or comply with existing license agreements;
•assertions by third parties of infringement or other violations by us of their intellectual property rights;
•our ability to protect our intellectual property;
•the dependence of streaming on operating systems, online platforms, hardware, networks, regulations, and standards that we do not control;
•our ability to maintain user data security;
•undetected errors, bugs, or vulnerabilities in our products;
•interruptions, delays, or discontinuations in service arising from our systems or systems of third parties;
•changes in laws or regulations affecting us;
•risks relating to privacy and data security;
•our ability to maintain, protect, and enhance our brand;
•our ability to achieve our net zero emissions target or make progress in other environmental, social, and governance initiatives;
•payment-related risks;
•our dependence on key personnel and ability to attract, retain, and motivate highly skilled employees;
•our ability to access capital to support growth;
•risks relating to currency exchange rate fluctuations and foreign exchange controls;
•the impact of economic, social, or political conditions, including the continued effects of the COVID-19 pandemic, rising inflation and interest rates, the continued conflict between Russia and Ukraine, and supply chain disruptions;
•our ability to accurately estimate user metrics and other estimates;
•our ability to manage and remediate attempts to manipulate streams and attempts to gain or provide unauthorized access to certain features of our Service;
•risks related to our Exchangeable Notes (as defined above);
•tax-related risks;
•the concentration of voting power among our founders, which limits shareholders' ability to influence our governance and business; and
•risks related to our status as a foreign private issuer and a Luxembourg company.
We operate in an evolving environment. New risk factors and uncertainties emerge from time to time, and it is not possible for our management to predict all risk factors and uncertainties, nor are we able to assess the impact of all of these risk factors on our business or the extent to which any risk factor, or combination of risk factors, may cause actual results to differ materially from those contained in any forward-looking statements.
We qualify all of our forward-looking statements by these cautionary statements. For additional information, refer to the risk factors discussed under Part I, Item 3.D. "Risk Factors" in our Annual Report on Form 20-F for the year ended December 31, 2021 ("Annual Report on Form 20-F"), Part II, Item 1A. "Risk Factors" in our quarterly report for the three months ended March 31, 2022, and in our other filings with the U.S. Securities and Exchange Commission ("SEC").
You should read this discussion and analysis completely and with the understanding that our actual future results may be materially different from our expectations.
Investors and others should note that we announce material financial information to our investors using our Investors website (investors.spotify.com), SEC filings, press releases, public conference calls, and webcasts. We use these channels, as well as social media, to communicate with our users and the public about our company, our Service, and other issues. It is possible that the information we post on these channels could be deemed to be material information. Therefore, we encourage investors, the media, and others interested in our Company to review the information we post on the channels listed on our Investors website.
Overview
Our mission is to unlock the potential of human creativity by giving a million creative artists the opportunity to live off their art and billions of fans the opportunity to enjoy and be inspired by these creators.
We are the world's most popular audio streaming subscription service. With a presence in 183 countries and territories, our platform includes 456 million monthly active users ("MAUs"), including 195 million Premium Subscribers (as defined below) as of September 30, 2022.
We currently monetize our Service through both subscriptions and advertising. Our Premium Subscribers have grown 13% year-over-year, as of September 30, 2022, to 195 million. Our 456 million MAUs have grown 20% year-over-year, as of September 30, 2022.
Our results reflect the effects of our trial programs, both discounted and free trials, in addition to seasonal trends in user behavior and, with respect to our Ad-Supported segment, advertising behavior. Historically, Premium Subscriber growth accelerates when we run such trial programs.
For our Ad-Supported segment, typically we experience higher advertising revenue in the fourth quarter of each calendar year due to greater advertising demand during the holiday season. In the first quarter of each calendar year, we typically experience a seasonal decline in advertising revenue due to reduced advertiser demand.
Acquisitions
On July 11, 2022, the Group acquired 100% of Sonantic Limited ("Sonantic"), an artificial intelligence voice platform, for a total purchase consideration of €93 million. This acquisition allows the Group to expand text-to-speech capabilities across the Group's platform.
On June 15, 2022, the Group acquired 100% of Findaway World, LLC (“Findaway”), a digital audiobook distribution platform, for a total purchase consideration of €117 million. The acquisition allows the Group to accelerate its audiobook content offering.
During February 2022, the Group acquired Podsights and Chartable to provide improved podcast ad measurement and analytics services for a total purchase consideration of €83 million. These acquisitions allow the Group to expand and scale its podcast monetization and product offering for advertisers and publishers.
Global marketing partnerships
On March 15, 2022, we announced a long-term partnership with Football Club Barcelona ("FC Barcelona") whereby Spotify will become the Main Partner of FC Barcelona and its Official Audio Streaming Partner. This partnership went into effect on July 1, 2022 and allows Spotify to amplify artist voices, connect artists to new and existing fans, and help grow our global user base across key growth markets and audience segments.
Launch of audiobooks
In September 2022, we launched a first iteration catalog of audiobooks in the United States that our users may purchase and listen to on our platform alongside our catalog of music and podcasts. This new format will help expand our user base into a new category of potential listeners and will connect diverse creators to new and existing fans.
Long term investment - Tencent Music Entertainment Group
During the nine months ended September 30, 2022, the fair value of our holdings in TME decreased by €266 million from €852 million as of December 31, 2021 to €586 million as of September 30, 2022 due to the decline in TME’s share price during this period. The market value of our investment in TME fluctuates due to volatility in the share price used to measure the investment. Furthermore, the value of our investment is subject to the risks associated with TME’s business, as well as any changes by the Chinese government in foreign investment laws or elevated scrutiny or regulation of foreign investments in Chinese companies.
Current macroeconomic environment
The global macroeconomic environment continues to be challenging, reflecting the impacts of the continued effects of the COVID-19 pandemic, rising inflation and interest rates, the continued conflict between Russia and Ukraine, and supply chain disruptions.
The continued impact of the macroeconomic environment on our business, financial condition, and results of operations is uncertain and will vary by region or market. In response to the uncertain macroeconomic environment, we have reduced our forecasted hiring for the remainder of 2022 and plan to grow headcount more slowly in 2023. We will continue to actively monitor and respond accordingly to the macroeconomic environment.
For additional information, see "Key Performance Indicators" section below. Also, refer to Part II, Item 1A. "Risk Factors" in our quarterly report for the three months ended March 31, 2022.
Key Performance Indicators
We use certain key performance indicators to monitor and manage our business. We use these indicators to evaluate our business, measure our performance, identify trends affecting our business, formulate business plans, and make strategic decisions. We believe these indicators provide useful information to investors in understanding and evaluating our operating results in the same manner we do.
MAUs
We track MAUs as an indicator of the size of the audience engaged with our Service. We define MAUs as the total count of Ad-Supported Users and Premium Subscribers that have consumed content for greater than zero milliseconds in the last thirty days from the period-end indicated. Reported MAUs may overstate the number of unique individuals who actively use our Service within a thirty-day period as one individual may register for, and use, multiple accounts. Additionally, though we strive to detect and minimize non-bona fide accounts that may typically be created in an attempt to artificially stream content, they may contribute, from time to time, to an overstatement in our reported MAUs. Our MAUs in the tables below are inclusive of Ad-Supported Users who may have employed methods to limit or otherwise avoid being served advertisements.
For additional information, refer to the risk factors discussed under Part I, Item 3.D. "Risk Factors" in our Annual Report on Form 20-F, and in our other filings with the SEC.
The table below sets forth our MAUs as of September 30, 2022 and 2021.
| | | | | | | | | | | | | | | | | | | | | | | |
| As of September 30 | | | | |
| 2022 | | 2021 | | Change |
| (in millions, except percentages) |
MAUs | 456 | | | 381 | | | 75 | | | 20 | % |
MAUs were 456 million as of September 30, 2022 and 381 million as of September 30, 2021, which represented an increase of 20%. MAUs increased due to our continued investment in driving the growth of our Service through successful consumer marketing campaigns, enhanced content offerings and product enhancements, resulting in increased user engagement and customer satisfaction.
Premium Subscribers
We define Premium Subscribers as users that have completed registration with Spotify and have activated a payment method for Premium Service. Our Premium Subscribers include all registered accounts in our Family Plan and Duo Plan. Our Family Plan consists of one primary subscriber and up to five additional sub-accounts, allowing up to six Premium Subscribers per Family Plan Subscription. Our Duo Plan consists of one primary subscriber and up to one additional sub-account, allowing up to two Premium Subscribers per Duo Plan Subscription. Premium Subscribers includes subscribers in a grace period of up to 30 days after failing to pay their subscription fee.
The table below sets forth our Premium Subscribers as of September 30, 2022 and 2021.
| | | | | | | | | | | | | | | | | | | | | | | |
| As of September 30 | | | | |
| 2022 | | 2021 | | Change |
| (in millions, except percentages) |
Premium Subscribers | 195 | | | 172 | | | 23 | | | 13 | % |
Premium Subscribers were 195 million as of September 30, 2022 and 172 million as of September 30, 2021, which represented an increase of 13%. The increase was driven primarily by our standard plan, including related free trial offers and global promotional campaigns. Our Family Plan also accounted for a significant portion of gross added Premium Subscribers.
Ad-Supported MAUs
We define Ad-Supported MAUs as the total count of Ad-Supported Users that have consumed content for greater than zero milliseconds in the last thirty days from the period-end indicated.
The table below sets forth our Ad-Supported MAUs as of September 30, 2022 and 2021.
| | | | | | | | | | | | | | | | | | | | | | | |
| As of September 30 | | | | |
| 2022 | | 2021 | | Change |
| (in millions, except percentages) |
Ad-Supported MAUs | 273 | | | 220 | | | 53 | | | 24 | % |
Ad-Supported MAUs were 273 million as of September 30, 2022 and 220 million as of September 30, 2021, which represented an increase of 24%. Ad-Supported MAUs increased due to our continued investment in driving the growth of our Service through successful consumer marketing campaigns, enhanced content offerings and product enhancements, resulting in increased user engagement and customer satisfaction.
Premium ARPU
Premium average revenue per user ("ARPU") is a monthly measure defined as Premium subscription revenue recognized in the quarter indicated divided by the average daily Premium Subscribers in such quarter, which is then divided by three months. Fiscal year-to-date figures are calculated by averaging Premium ARPU for the quarters in such period.
The table below sets forth our average Premium ARPU for the three and nine months ended September 30, 2022 and 2021.
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| Three months ended September 30, | | | | | | Nine months ended September 30, | | | | | | | | | | | |
| 2022 | | 2021 | | Change | | 2022 | | 2021 | | Change | | | | | | | |
Premium ARPU | € | 4.63 | | | € | 4.34 | | | € | 0.29 | | | 7 | % | | € | 4.52 | | | € | 4.25 | | | € | 0.27 | | | 6 | % | | | | | | | | | |
For the three months ended September 30, 2022 and 2021, Premium ARPU was €4.63 and €4.34, respectively, which represented an increase of 7%. This increase of €0.29 is primarily attributable to movements in foreign exchange rates, increasing Premium ARPU by €0.32.
For the nine months ended September 30, 2022 and 2021, Premium ARPU was €4.52 and €4.25, respectively, which represented an increase of 6%. The increase of €0.27 is primarily attributable to movements in foreign exchange rates, increasing Premium ARPU by €0.25.
How We Generate Revenue
We operate and manage our business in two reportable segments - Premium and Ad-Supported. We identify our reportable segments based on the organizational units used by the chief operating decision maker to monitor performance and make operating decisions. See Note 5 to our interim condensed consolidated financial statements for additional information regarding our reportable segments.
Premium
We generate revenue for our Premium segment through the sale of the Premium Service. The Premium Service is sold directly to end users and through partners who are generally telecommunications companies that bundle the subscription with their own services or collect payment for the stand-alone subscriptions from their end customers. Premium partner subscription revenue is based on a per-subscriber rate in a negotiated partner agreement. We also bundle the Premium Service with other services and products.
Ad-Supported
We generate revenue for our Ad-Supported segment primarily from the sale of display, audio, and video advertising delivered through advertising impressions across our music and podcast content. We generally enter into arrangements with advertising agencies that purchase advertising on behalf of their clients and we also enter into arrangements directly with some large advertisers. These advertising arrangements are typically sold on a cost-per-thousand basis and are evidenced by an insertion order that specifies the terms of the arrangement such as the type of advertising product, pricing, insertion dates, and number of impressions or downloads in a stated period. Additionally, we generate revenue through arrangements with certain advertising automated exchanges, internal self-serve, and advertising marketplace platforms to distribute advertising inventory for purchase on a cost-per-thousand basis. These advertising arrangements typically specify the type of advertising product, pricing, insertion dates, and number of impressions in a stated period.
Components of our Operating Results
Cost of revenue. Cost of revenue consists predominantly of royalty and distribution costs related to content streaming. We incur royalty costs, which we pay to certain record labels, music publishers, and other rights holders, for the right to stream music to our users. Royalties are typically calculated monthly based on the combination of a number of different elements. Generally, Premium Service royalties are based on the greater of a percentage of revenue and a per user amount. Royalties for the Ad-Supported Service are typically a percentage of relevant revenue, although certain agreements are based on the greater of a percentage of relevant revenue and an amount for each time a sound recording and musical composition are streamed. We have negotiated lower per user amounts for our lower priced subscription plans such as Family Plan, Duo Plan, and Student Plan users. In our agreements with certain record labels, the percentage of revenue used in the calculation of royalties is generally dependent upon certain targets being met. The targets can include such measures as the number of Premium Subscribers, the ratio of Ad-Supported Users to Premium Subscribers, and/or the rates of Premium Subscriber churn. In addition, royalty rates vary by country. Some of our royalty agreements require that royalty costs be paid in advance or are subject to minimum guaranteed amounts. For the majority of royalty agreements, incremental costs incurred due to un-recouped advances and minimum guarantees have not been significant to date. We also have certain so-called most favored nation royalty agreements, which require us to record additional costs if certain material contract terms are not as favorable as the terms we
have agreed to with similar licensors. Cost of revenue also reflects discounts provided by certain rights holders in return for promotional activities in connection with marketplace programs. Additionally, it includes the costs of discounted trials.
Cost of revenue also includes the amortization of podcast content assets (both produced and licensed). Amortization of podcast content assets is recorded over the shorter of the estimated useful economic life or the license period (if relevant) and begins at the release of each episode. We make payments to podcast publishers, whose content we monetize through advertising sales, which are also included in cost of revenue.
Cost of revenue also includes credit card and payment processing fees for subscription revenue, customer service, certain employee compensation and benefits, cloud computing, streaming, facility, and equipment costs.
Research and development. We invest heavily in research and development in order to drive user engagement and customer satisfaction on our platform, which we believe helps drive organic growth in MAUs, which, in turn, drives additional growth in, and better retention of, Premium Subscribers, as well as increased advertising opportunities to our users. We aim to design products and features that create and enhance user experiences, and new technologies are at the core of many of these opportunities. Expenses primarily comprise costs incurred for the development of products related to our platform and Service, as well as new advertising products and improvements to our mobile application and desktop application and streaming services. The costs incurred include related facility costs, consulting costs, and employee compensation and benefits costs. We expect engineers to represent a significant portion of our employees over the foreseeable future.
Many of our new products and improvements to our platform require large investments and involve substantial time and risks to develop and launch. Some of these products may not be well received or may take a long time for users to adopt. As a result, the benefits of our research and development investments are difficult to forecast.
Sales and marketing. Sales and marketing expenses primarily comprise employee compensation and benefits, public relations, branding, consulting expenses, customer acquisition costs, advertising, marketing events and trade shows, amortization of trade name intangible assets, the cost of working with music record labels, publishers, songwriters, and artists to promote the availability of new releases on our platform, and the costs of providing free trials of our Premium Service. Expenses included in the cost of providing free trials are derived primarily from per user royalty fees determined in accordance with the rights holder agreements.
General and administrative. General and administrative expenses primarily comprise employee compensation and benefits for functions such as finance, accounting, analytics, legal, human resources, consulting fees, and other costs including facility and equipment costs, directors' and officers' liability insurance, director fees, and fair value adjustments on contingent consideration.
Results of Operations
Revenue
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| Three months ended September 30, | | | | | | Nine months ended September 30, | | | | | | | | | | |
| 2022 | | 2021 | | Change | | 2022 | | 2021 | | Change | | | | | | |
| (in € millions, except percentages) |
Premium | 2,651 | | | 2,178 | | | 473 | | | 22 | % | | 7,534 | | | 6,165 | | | 1,369 | | | 22 | % | | | | | | | | |
Ad-Supported | 385 | | | 323 | | | 62 | | | 19 | % | | 1,027 | | | 814 | | | 213 | | | 26 | % | | | | | | | | |
Total | 3,036 | | | 2,501 | | | 535 | | | 21 | % | | 8,561 | | | 6,979 | | | 1,582 | | | 23 | % | | | | | | | | |
Premium revenue
For both the three months ended September 30, 2022 and 2021, Premium revenue comprised 87% of our total revenue. For the three months ended September 30, 2022 as compared to the three months ended September 30, 2021, Premium revenue increased €473 million, or 22%. The increase was attributable primarily to an increase in the number of Premium Subscribers and an increase in Premium ARPU, as noted above.
For both the nine months ended September 30, 2022 and 2021, Premium revenue comprised 88% of our total revenue. For the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021, Premium revenue increased €1,369 million, or 22%. The increase was attributable primarily to an increase in the number of Premium Subscribers and an increase in Premium ARPU, as noted above.
Ad-Supported revenue
For both the three months ended September 30, 2022 and 2021, Ad-Supported revenue comprised 13% of our total revenue. For the three months ended September 30, 2022 as compared to the three months ended September 30, 2021, Ad-Supported revenue increased €62 million, or 19%. Sales of music impressions grew as did CPM (cost per 1,000 impressions), which increased revenue in our direct and programmatic channels by €28 million. Podcast ad sales, partially offset by a decrease in ad sales from our self-serve platform, also increased revenue by €33 million during the three months ended September 30, 2022.
For both the nine months ended September 30, 2022 and 2021, Ad-Supported revenue comprised 12% of our total revenue. For the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021, Ad-Supported revenue increased €213 million, or 26%. Sales of music impressions grew as did CPM (cost per 1,000 impressions), which increased revenue in our direct and programmatic channels by €99 million. Ad sales from our self-serve platform and podcast ad sales also increased revenue by €107 million during the nine months ended September 30, 2022.
Foreign exchange impact on total revenue
The general movement of the Euro relative to certain foreign currencies, primarily the U.S. Dollar, for the three and nine months ended September 30, 2022, as compared to the same period in 2021, had a favorable net impact on our revenue. We estimate that total revenue for the three and nine months ended September 30, 2022 would have been approximately €236 million and €520 million lower, respectively, if foreign exchange rates had remained consistent with foreign exchange rates for the comparable period in 2021.
Cost of revenue
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| Three months ended September 30, | | | | | | Nine months ended September 30, | | | | | | | | | | |
| 2022 | | 2021 | | Change | | 2022 | | 2021 | | Change | | | | | | |
| (in € millions, except percentages) |
Premium | 1,908 | | | 1,545 | | | 363 | | | 23 | % | | 5,416 | | | 4,361 | | | 1,055 | | | 24 | % | | | | | | | | |
Ad-Supported | 378 | | | 288 | | | 90 | | | 31 | % | | 1,020 | | | 739 | | | 281 | | | 38 | % | | | | | | | | |
Total | 2,286 | | | 1,833 | | | 453 | | | 25 | % | | 6,436 | | | 5,100 | | | 1,336 | | | 26 | % | | | | | | | | |
Premium cost of revenue
For the three months ended September 30, 2022 as compared to the three months ended September 30, 2021, Premium cost of revenue increased €363 million, or 23%, and Premium cost of revenue as a percentage of Premium revenue increased from 71% to 72%. The increase in Premium cost of revenue was driven primarily by increases in new Premium Subscribers, publishing licensing rates and costs incurred to deliver enhanced product features, partially offset by benefits from certain marketplace programs. These collectively resulted in higher royalty costs of €310 million. Additionally, there was an increase in streaming delivery costs and payment fees of €19 million and €13 million, respectively, for the three months ended September 30, 2022. The three months ended September 30, 2022 also included a net €11 million increase in costs related to changes in prior period estimates for rights holder liabilities.
For the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021, Premium cost of revenue increased €1,055 million, or 24%, and Premium cost of revenue as a percentage of Premium revenue increased from 71% to 72%. The increase in Premium cost of revenue was driven primarily by increases in new Premium Subscribers, publishing licensing rates and costs incurred to deliver enhanced product features, partially offset by benefits from certain marketplace programs. These collectively resulted in higher royalty costs of €886 million. Additionally, there was an increase in streaming delivery costs and payment fees of €39 million and €36 million, respectively, for the nine months ended September 30, 2022. The nine months ended September 30, 2022 included a charge of €24 million related to excess and obsolete inventory and adverse purchase commitments. The nine months ended September 30, 2021 also included a net €45 million benefit relating to changes in prior period estimates for rights holder liabilities.
Ad-Supported cost of revenue
For the three months ended September 30, 2022 as compared to the three months ended September 30, 2021, Ad-Supported cost of revenue increased €90 million, or 31%, and Ad-Supported cost of revenue as a percentage of Ad-Supported revenue increased from 89% to 98%. The increase in Ad-Supported cost of revenue was driven primarily by higher royalty costs of €26 million due to growth in both advertising revenue and streams as well as publishing licensing rate increases and additional costs incurred to deliver enhanced product features, partially offset by benefits from certain marketplace programs. Additionally, there was an increase in content costs, streaming delivery costs and advertising measurement costs of €58 million, for the three months ended September 30, 2022.
For the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021, Ad-Supported cost of revenue increased €281 million, or 38%, and Ad-Supported cost of revenue as a percentage of Ad-Supported revenue increased from 91% to 99%. The increase in Ad-Supported cost of revenue was driven primarily by higher royalty costs of €110 million due to growth in both advertising revenue and streams as well as publishing licensing rate increases and additional costs incurred to deliver enhanced product features, partially offset by benefits from certain marketplace programs. Additionally, there was an increase in content costs, streaming delivery costs and advertising measurement costs of €162 million for the nine months ended September 30, 2022.
Foreign exchange impact on total cost of revenue
The general movement of the Euro relative to certain foreign currencies, primarily the U.S. Dollar, for the three and nine months ended September 30, 2022, as compared to the same periods in 2021, had an unfavorable net impact on our cost of revenue. We estimate that total cost of revenue for the three and nine months ended September 30, 2022 would have been approximately €185 million and €406 million lower, respectively, if foreign exchange rates had remained consistent with foreign exchange rates for the comparable periods in 2021.
Gross profit and gross margin
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| Three months ended September 30, | | | | | | Nine months ended September 30, | | | | | | | | | | |
| 2022 | | 2021 | | Change | | 2022 | | 2021 | | Change | | | | | | |
| (in € millions, except percentages) |
Gross profit | | | | | | | | | | | | | | | | | | | | | | | |
Premium | 743 | | | 633 | | | 110 | | | 17 | % | | 2,118 | | | 1,804 | | | 314 | | | 17 | % | | | | | | | | |
Ad-Supported | 7 | | | 35 | | | (28) | | | (80) | % | | 7 | | | 75 | | | (68) | | | (91) | % | | | | | | | | |
Consolidated | 750 | | | 668 | | | 82 | | | 12 | % | | 2,125 | | | 1,879 | | | 246 | | | 13 | % | | | | | | | | |
Gross margin | | | | | | | | | | | | | | | | | | | | | | | |
Premium | 28 | % | | 29 | % | | | | | | 28 | % | | 29 | % | | | | | | | | | | | | |
Ad-Supported | 2 | % | | 11 | % | | | | | | 1 | % | | 9 | % | | | | | | | | | | | | |
Consolidated | 25 | % | | 27 | % | | | | | | 25 | % | | 27 | % | | | | | | | | | | | | |
Premium gross profit and gross margin
For the three months ended September 30, 2022 as compared to the three months ended September 30, 2021, Premium gross profit increased by €110 million, and Premium gross margin decreased from 29% to 28%. Premium gross margin decreased due primarily to increases in publishing licensing rates and costs incurred to deliver enhanced product features, partially offset by benefits from certain marketplace programs. Also contributing to the decrease in margin were changes in prior period estimates for rights holder liabilities during the three months ended September 30, 2022 compared to September 30, 2021.
For the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021, Premium gross profit increased by €314 million, and Premium gross margin decreased from 29% to 28%. Premium gross margin decreased due primarily to increases in publishing licensing rates and costs incurred to deliver enhanced product features, partially offset by benefits from certain marketplace programs. There was also a €24 million charge related to excess and obsolete inventory and adverse purchase commitment during the nine months ended September 30, 2022. Also contributing to the decrease in margin were changes in prior period estimates for rights holder liabilities during the nine months ended September 30, 2022 compared to September 30, 2021.
Ad-Supported gross profit and gross margin
For the three months ended September 30, 2022 as compared to the three months ended September 30, 2021, Ad-Supported gross profit decreased by €28 million, and gross margin decreased from 11% to 2%. The decrease in Ad-Supported gross margin was due primarily to an increase in royalty costs due to growth in both advertising revenue and streams as well as publishing licensing rate increases and additional costs incurred to deliver enhanced product features. An increase in content costs, streaming delivery costs, and advertising measurement costs also contributed to the decrease in Ad-Supported gross margin during the three months ended September 30, 2022.
For the nine months ended September 30, 2022, as compared to the nine months ended September 30, 2021, Ad-Supported gross profit decreased by €68 million, and gross margin decreased from 9% to 1%. The decrease in Ad-Supported gross margin was due primarily to an increase in royalty costs due to growth in both advertising revenue and streams as well as publishing licensing rate increases and additional costs incurred to deliver enhanced product features. An increase in streaming delivery costs and advertising measurement costs also contributed to the decrease in Ad-Supported gross margin during the nine months ended September 30, 2022.
Consolidated Operating Expenses
Research and development
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| Three months ended September 30, | | | | | | Nine months ended September 30, | | | | | | | | | | |
| 2022 | | 2021 | | Change | | 2022 | | 2021 | | Change | | | | | | |
| (in € millions, except percentages) |
Research and development | 386 | | | 208 | | | 178 | | | 86 | % | | 972 | | | 659 | | | 313 | | | 47 | % | | | | | | | | |
As a percentage of revenue | 13 | % | | 8 | % | | | | | | 11 | % | | 9 | % | | | | | | | | | | | | |
For the three months ended September 30, 2022 as compared to the three months ended September 30, 2021, research and development costs increased by €178 million, or 86%, as we continually enhance our platform to retain and grow our user base. The increase was due primarily to an increase in personnel-related costs of €135 million that included increased salaries, share-based compensation, and other employee benefits, as a result of increased headcount to support our growth, and increased social costs, as a result of share price movements. There was also an increase in information technology costs of €16 million due to an increase in our usage of cloud computing services and additional software license fees. Additionally, there was an increase in travel and employee trainings of €10 million due primarily to the resumption of global travel and in-person trainings as a result of easing COVID-19 restrictions.
For the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021, research and development costs increased €313 million, or 47%, as we continually enhance our platform to retain and grow our user base. The increase was due primarily to an increase in personnel-related costs of €208 million that included increased salaries, share-based compensation, and other employee benefits, as a result of increased headcount to support our growth, and increased social costs, as a result of share price movements. There was also an increase in information technology costs of €42 million due to an increase in our usage of cloud computing services and additional software license fees. Additionally, there was an increase in travel and employee trainings of €17 million due primarily to the resumption of global travel and in-person trainings as a result of easing COVID-19 restrictions and an increase in facilities costs of €17 million as a result of office re-openings.
The increases in research and development costs described above include the impact of foreign exchange rate movements during the respective periods. A significant portion of our operating expenses are denominated in the U.S. dollar which has strengthened 7% and 16% against the Euro during the three and nine months ended September 30, 2022, respectively, contributing to the overall increase in operating expenses.
Sales and marketing
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| Three months ended September 30, | | | | | | Nine months ended September 30, | | | | | | | | | | |
| 2022 | | 2021 | | Change | | 2022 | | 2021 | | Change | | | | | | |
| (in € millions, except percentages) |
Sales and marketing | 432 | | | 280 | | | 152 | | | 54 | % | | 1,119 | | | 795 | | | 324 | | | 41 | % | | | | | | | | |
As a percentage of revenue | 14 | % | | 11 | % | | | | | | 13 | % | | 11 | % | | | | | | | | | | | | |
For the three months ended September 30, 2022 as compared to the three months ended September 30, 2021, sales and marketing expense increased by €152 million, or 54%. The increase was due primarily to an increase in advertising costs of €72 million for marketing campaigns and sponsorships. There was also an increase in personnel-related costs of €57 million that included increased salaries, share-based compensation, and other employee benefits, as a result of increased headcount to support our growth, and increased social costs, as a result of share price movements. Additionally, there was an increase in travel and employee trainings of €12 million due primarily to the resumption of global travel and in-person trainings as a result of easing COVID-19 restrictions.
For the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021, sales and marketing expense increased by €324 million, or 41%. The increase was due primarily to an increase in advertising costs of €156 million for marketing campaigns and sponsorships. There was also an increase in personnel-related costs of €102 million that included increased salaries, share-based compensation, and other employee benefits, as a result of increased headcount to support our growth, and increased social costs, as a result of share price movements. Additionally, there was an increase in travel and employee trainings of €22 million due primarily to the resumption of global travel and in-person trainings as a result of easing COVID-19 restrictions and an increase in facilities costs of €13 million as a result of office re-openings.
The increases in sales and marketing expenses described above include the impact of foreign exchange rate movements during the respective periods. A significant portion of our operating expenses are denominated in the U.S. dollar which has strengthened 7% and 16% against the Euro during the three and nine months ended September 30, 2022, respectively, contributing to the overall increase in operating expenses.
General and administrative
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| Three months ended September 30, | | | | | | Nine months ended September 30, | | | | | | | | | | |
| 2022 | | 2021 | | Change | | 2022 | | 2021 | | Change | | | | | | |
| (in € millions, except percentages) |
General and administrative | 160 | | | 105 | | | 55 | | | 52 | % | | 462 | | | 324 | | | 138 | | | 43 | % | | | | | | | | |
As a percentage of revenue | 5 | % | | 4 | % | | | | | | 5 | % | | 5 | % | | | | | | | | | | | | |
For the three months ended September 30, 2022 as compared to the three months ended September 30, 2021, general and administrative expense increased by €55 million, or 52%. The increase was due primarily to an increase in personnel-related costs of €37 million that included increased salaries, share-based compensation, and other employee benefits, as a result of increased headcount to support our growth, and increased social costs as a result of share price movements. Additionally, there was an increase in travel and employee trainings of €9 million due primarily to the resumption of global travel and in-person trainings as a result of easing COVID-19 restrictions.
For the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021, general and administrative expense increased €138 million, or 43%. The increase was due primarily to an increase in personnel-related costs of €72 million that included increased salaries, share-based compensation, and other employee benefits, as a result of increased headcount to support our growth, and increased social costs, as a result of share price movements. Additionally, there was an increase in legal and consulting fees of €24 million and an increase in travel and employee trainings of €15 million due primarily to the resumption of global travel and in-person trainings as a result of easing COVID-19 restrictions.
The increases in general and administrative expenses described above include the impact of foreign exchange rate movements during the respective periods. A significant portion of our operating expenses are denominated in the U.S. dollar which has strengthened 7% and 16% against the Euro during the three and nine months ended September 30, 2022, respectively, contributing to the overall increase in operating expenses.
Foreign exchange impact on total operating expenses
The general movement of the Euro relative to certain foreign currencies, primarily the U.S. Dollar, for the three and nine months ended September 30, 2022, as compared to the same periods in 2021, had an unfavorable net impact on our operating expenses. We estimate that total operating expenses for the three and nine months ended September 30, 2022 would have been approximately €85 million and €174 million lower, respectively, if foreign exchange rates had remained consistent with foreign exchange rates for the comparable periods in 2021.
Finance income
Finance income consists of fair value adjustment gains on certain financial instruments, interest income earned on our cash and cash equivalents and short term investments, and foreign currency gains.
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| Three months ended September 30, | | | | | | Nine months ended September 30, | | | | | | | | | | |
| 2022 | | 2021 | | Change | | 2022 | | 2021 | | Change | | | | | | |
| (in € millions, except percentages) |
Finance income | 102 | | | 101 | | | 1 | | | 1 | % | | 395 | | | 226 | | | 169 | | | 75 | % | | | | | | | | |
As a percentage of revenue | 3 | % | | 4 | % | | | | | | 5 | % | | 3 | % | | | | | | | | | | | | |
For the three months ended September 30, 2022 as compared to the three months ended September 30, 2021, finance income increased €1 million due primarily to an increase of €41 million in foreign exchange gains on the remeasurement of monetary assets and liabilities in a transaction currency other than the functional currency. There was also an increase in interest income of €12 million. These increases were partially offset by a decrease in the fair value gain recorded for warrants of €28 million and the Exchangeable Notes of €23 million.
For the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021, finance income increased €169 million. The increase was due primarily to an increase of €86 million in foreign exchange gains on the remeasurement of monetary assets and liabilities in a transaction currency other than the functional currency. Additionally, there was an increase in fair value gains recorded for the Exchangeable Notes of €42 million and warrants of €18 million, respectively. There was also an increase in interest income of €17 million.
Finance costs
Finance costs consist of fair value adjustment losses on certain financial instruments, interest expense, transaction costs from the issuance of Exchangeable Notes, and foreign currency losses.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three months ended September 30, | | | | | | Nine months ended September 30, | | | | | | | | | | |
| 2022 | | 2021 | | Change | | 2022 | | 2021 | | Change | | | | | | |
| (in € millions, except percentages) |
Finance costs | (18) | | | (14) | | | (4) | | | 29 | % | | (46) | | | (70) | | | 24 | | | (34) | % | | | | | | | | |
As a percentage of revenue | (1) | % | | (1) | % | | | | | | (1) | % | | (1) | % | | | | | | | | | | | | |
For the three months ended September 30, 2022 as compared to the three months ended September 30, 2021, finance costs increased €4 million. The increase was due primarily to an increase in fair value movements on cash equivalents of €6 million, partially offset by a decrease in fair value movements on derivative liabilities of €3 million.
For the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021, finance costs decreased €24 million. The decrease was due primarily to €18 million of transaction costs recorded during the nine months ended September 30, 2021 in connection with the issuance of the Exchangeable Notes. There was also a decrease of €12 million in foreign exchange losses on the remeasurement of monetary assets and liabilities in a transaction currency other than the functional currency. These decreases were partially offset by an increase of €8 million driven by fair value movements on financial instruments.
Income tax expense
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| Three months ended September 30, | | | | | | Nine months ended September 30, | | | | | | | | | | |
| 2022 | | 2021 | | Change | | 2022 | | 2021 | | Change | | | | | | |
| (in € millions, except percentages) |
Income tax expense | 22 | | | 160 | | | (138) | | | (86) | % | | 81 | | | 252 | | | (171) | | | (68) | % | | | | | | | | |
As a percentage of revenue | 1 | % | | 6 | % | | | | | | 1 | % | | 4 | % | | | | | | | | | | | | |
For the three months ended September 30, 2022, income tax expense was €22 million, compared to an income tax expense of €160 million for the three months ended September 30, 2021. The expense for the three months ended September 30, 2022 was due primarily to derecognition of deferred taxes as a result of decreases in unrealized gains on investments of €8 million and tax expense of €7 million related to subsidiaries that generate taxable income. The expense for
the three months ended September 30, 2021 was due primarily to derecognition of deferred taxes of €193 million as a result of the unrealized decrease in the fair value of the Group's long term investment in Tencent Music Entertainment Group (“TME”), partially offset by the recognition of deferred taxes of €40 million as a result of the unrealized increase in fair value of our long term investment in DistroKid.
For the nine months ended September 30, 2022, income tax expense was €81 million, compared to an income tax expense of €252 million for the nine months ended September 30, 2021. The expense for the nine months ended September 30, 2022 was due primarily to utilization of historical share-based compensation deductions recognized in equity of €49 million and tax expense of €21 million related to subsidiaries that generate taxable income. The expense for the nine months ended September 30, 2021 was due primarily to the derecognition of deferred taxes of €251 million as a result of the unrealized decrease in the fair value of the TME investment, partially offset by the recognition of deferred taxes of €42 million as a result of the unrealized increase in fair value of the DistroKid investment. In addition, current share-based compensation deductions recognized in equity resulted in additional tax expense of €37 million.
Non-IFRS financial measure
We have reported our financial results in accordance with IFRS as issued by IASB. In addition, we have discussed our results using the non-IFRS measure of Free Cash Flow as discussed below.
We define "Free Cash Flow" as net cash flows from operating activities less capital expenditures and change in restricted cash. We believe Free Cash Flow is a useful supplemental financial measure for us and investors in assessing our ability to pursue business opportunities and investments. Free Cash Flow is not a measure of our liquidity under IFRS and should not be considered as an alternative to net cash flows from operating activities.
Free Cash Flow is a non-IFRS measure and is not a substitute for IFRS measures in assessing our overall financial performance. Because Free Cash Flow is not a measurement determined in accordance with IFRS, and is susceptible to varying calculations, it may not be comparable to other similarly titled measures presented by other companies. You should not consider Free Cash Flow in isolation, or as a substitute for an analysis of our results as reported on our interim condensed consolidated financial statements appearing elsewhere in this document.
Set forth below is a reconciliation of Free Cash Flow to net cash flows from operating activities for the periods presented.
| | | | | | | | | | | |
| Nine months ended September 30, |
| 2022 | | 2021 |
| (in € millions) |
Net cash flows from operating activities | 116 | | | 242 | |
Capital expenditures | (20) | | | (69) | |
Change in restricted cash | (2) | | | 1 | |
Free Cash Flow | 94 | | | 174 | |
Liquidity and Capital Resources
Our principal sources of liquidity are our cash and cash equivalents, short term investments, and cash generated from operating activities. Cash and cash equivalents and short term investments consist mostly of cash on deposit with banks, investments in money market funds, and investments in government securities, corporate debt securities, and collateralized reverse purchase agreements. Cash and cash equivalents and short term investments increased by €166 million from €3,500 million as of December 31, 2021 to €3,666 million as of September 30, 2022.
We believe our existing cash and cash equivalents, short term investments, and the cash flow we generate from our operations will be sufficient to meet our working capital and capital expenditure needs and other liquidity requirements for at least the next 12 months. However, our future capital requirements may be materially different than those currently planned in our budgeting and forecasting activities and depend on many factors, including our rate of revenue growth, the timing and extent of spending on content and research and development, the expansion of our sales and marketing activities, the timing of new product introductions, market acceptance of our products, our continued international expansion, the acquisition of other companies, competitive factors, the COVID-19 pandemic, and global economic conditions. To the extent that current and anticipated future sources of liquidity are insufficient to fund our future business activities and requirements, we may be required to seek additional equity or debt financing. The sale of additional equity would result in additional dilution to our
shareholders, while the incurrence of debt financing would result in debt service obligations. Such debt instruments also could introduce covenants that might restrict our operations. We cannot assure you that we could obtain additional financing on favorable terms, or at all. For additional information, refer to Part I, Item 3.D. "Risk Factors" in our Annual Report on Form 20-F and Part II, Item 1A. "Risk Factors" in our quarterly report for the three months ended March 31, 2022.
Share repurchase program
On August 20, 2021, the Company announced that the board of directors had approved a program to repurchase up to $1.0 billion of the Company’s ordinary shares. Repurchases of up to 10,000,000 of the Company’s ordinary shares were authorized at the Company’s general meeting of shareholders on April 21, 2021. The repurchase program will expire on April 21, 2026. Since the commencement of this repurchase program and through September 30, 2022, 469,274 shares were repurchased for €91 million under this program.
The timing and actual number of shares repurchased depends on a variety of factors, including price, general business and market conditions, and alternative investment opportunities. The repurchase program is executed consistent with the Company’s capital allocation strategy of prioritizing investment to grow the business over the long term. The repurchase program does not obligate the Company to acquire any particular amount of ordinary shares, and the repurchase program may be suspended or discontinued at any time at the Company’s discretion. The Company uses current cash and cash equivalents and the cash flow it generates from operations to fund the share repurchase program.
Exchangeable Notes
On March 2, 2021, Spotify USA Inc. issued US$1,500 million in aggregate principal amount of the Exchangeable Notes. Net proceeds from the issuance of the Exchangeable Notes were €1,223 million after deducting the transaction costs. See Note 17 to our interim condensed consolidated financial statements for further information regarding our Exchangeable Notes.
Cash flow
| | | | | | | | | | | | | | | | | |
| Nine months ended September 30, | | |
| 2022 | | 2021 | | Change |
| (in € millions) |
Net cash flows from operating activities | 116 | | | 242 | | | (126) | |
Net cash flows used in investing activities | (322) | | | (274) | | | (48) | |
Net cash flows (used in)/from financing activities | (19) | | | 1,275 | | | (1,294) | |
Free Cash Flow(1) | 94 | | | 174 | | | (80) | |
(1)For a discussion of the limitations associated with using Free Cash Flow rather than IFRS measures, and a reconciliation of Free Cash Flow to net cash flows from operating activities, see "Non-IFRS Financial Measure" above.
Operating activities
Net cash flows from operating activities decreased by €126 million to €116 million for the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021. The decrease was due primarily to an increase in operating loss adjusted for non-cash items including depreciation, amortization, excess and obsolete reserve, and share-based compensation expense, resulting in a decrease in cash flows from operating activities of €380 million in aggregate. This change was partially offset by favorable changes in working capital movements of €262 million, principally due to favorable movements in trade receivables and other assets and trade and other liabilities, partially offset by unfavorable movements in deferred revenue.
Investing activities
Net cash flows used in investing activities increased by €48 million for the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021. The increase was due primarily to an increase in cash consideration used in business combinations, net of cash acquired, of €205 million, partially offset by an increase in net cash inflows from sales and purchases of short term investments of €106 as well as a decrease in purchases of property and equipment of €49 million.
Financing activities
Net cash flows used in financing activities changed by €1,294 million for the nine months ended September 30, 2022 as compared to net cash flows from financing activities for the nine months ended September 30, 2021. The change was due primarily to net proceeds of €1,223 million from the issuance of Exchangeable Notes during the nine months ended September 30, 2021 whereas no such activity occurred during the nine months ended September 30, 2022. In addition, there was a decrease in proceeds from exercise of stock options of €60 million. Further, there were proceeds of €31 million as a result of proceeds from the issuance of warrants during the nine months ended September 30, 2021 whereas no such activity occurred during the nine months ended September 30, 2022. These changes were partially offset by a decrease in the net cash used for repurchase of ordinary shares of €22 million.
Free Cash Flow
Free Cash Flow decreased by €80 million to €94 million for the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021, due primarily to a decrease in net cash flows from operating activities of €126 million, as described above, partially offset by a decrease in capital expenditures of €49 million.
Restrictions on subsidiaries to transfer funds
The payment of dividends and the making, or repayment, of loans and advances to the Company by the Company's direct subsidiaries and by its indirect subsidiaries to their respective parent entities are subject to various restrictions. Future indebtedness of these subsidiaries may prohibit the payment of dividends or the making, or repayment, of loans or advances to the Company. In addition, the ability of any of the Company's direct or indirect subsidiaries to make certain distributions may be limited by the laws of the relevant jurisdiction in which the subsidiaries are organized or located, including financial assistance rules, corporate benefit laws, liquidity requirements, requirements that dividends must be paid out of reserves available for distribution, and other legal restrictions which, if violated, might require the recipient to refund unlawful payments. Spotify AB, which, directly or indirectly through its subsidiaries, conducts much of the Group's business, may only make dividends to the Company if there would continue to be full coverage of its restricted equity following such dividend, and only if doing so would be considered prudent under Swedish law given the needs of Spotify AB and its subsidiaries. Loans and other advances from Spotify AB to the Company may be subject to essentially the same restrictions as dividends. Since the Company is expected to rely primarily on dividends from its direct and indirect subsidiaries to fund its financial and other obligations, restrictions on its ability to receive such funds may adversely impact the Company's ability to fund its financial and other obligations.
Indebtedness
As of September 30, 2022, our outstanding indebtedness, other than lease liabilities, consisted primarily of the Exchangeable Notes that mature on March 15, 2026 and bear no interest. See Note 17 to our interim condensed consolidated financial statements for further information regarding our Exchangeable Notes. We may from time to time seek to incur additional indebtedness. Such indebtedness, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions, and other factors.
Off-Balance Sheet Arrangements
As of September 30, 2022, we do not have transactions with unconsolidated entities, such as entities often referred to as structured finance or special purpose entities, whereby we have financial guarantees, subordinated retained interests, derivative instruments, or other contingent arrangements that expose us to material continuing risks, contingent liabilities, or any other obligation under a variable interest in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to us.
Tabular disclosure of contractual obligations
The following table sets forth our contractual obligations and commercial commitments as of September 30, 2022:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Payments due by period |
Contractual obligations: | Total | | Less than 1 year | | 1-3 years | | 3-5 years | | More than 5 years |
| (in € millions) |
Minimum guarantees (1) | 2,043 | | | 1,629 | | | 414 | | | — | | | — | |
Exchangeable Notes (2) | 1,531 | | | — | | | — | | | 1,531 | | | — | |
Lease obligations (3) | 977 | | | 108 | | | 205 | | | 201 | | | 463 | |
Purchase obligations (4) | 1,101 | | | 691 | | | 258 | | | 54 | | | 98 | |
Deferred consideration (5) | 43 | | | 13 | | | 30 | | | — | | | — | |
Total | 5,695 | | | 2,441 | | | 907 | | | 1,786 | | | 561 | |
(1)We are subject to minimum royalty payments associated with our license agreements for the use of licensed content. See Part I, Item 3.D. "Risk Factors" in our Annual Report on Form 20-F.
(2)Consists of principal on our 0.00% Exchangeable Notes due March 15, 2026.
(3)Included in the lease obligations are short term leases and certain lease agreements that the Group has entered into, but had not yet commenced as of September 30, 2022. Lease obligations primarily relate to our office space. The lease terms are up to twelve years. See Note 9 to the interim condensed consolidated financial statements for further details regarding leases.
(4)We are subject to various non-cancelable purchase obligations and service agreements with minimum spend commitments, including a service agreement with Google for the use of Google Cloud Platform and certain podcast and marketing commitments.
(5)Included in deferred consideration are obligations to transfer €43 million of cash consideration over the next four years to former owners of certain entities we have acquired.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our activities expose us to a variety of market risks. Our primary market risk exposures relate to currency, interest rate, share price, and investment risks. To manage these risks and our exposure to the unpredictability of financial markets, we seek to minimize potential adverse effects on our financial performance and capital.
Volatile market conditions caused by significant events with macroeconomic impacts, including, but not limited to, volatility in the credit, equity and foreign exchange markets, inflation, rising interest rates, the effects of COVID-19, and the continued conflict between Russian and Ukraine, may result in significant changes in foreign exchange rates, interest rates, and share prices, both our own and those of third parties we use to value certain of our long-term investments. Refer to Part I, Item 3.D. "Risk Factors" in our Annual Report on Form 20-F and Part II, Item 1A. "Risk Factors" in our quarterly report for the three months ended March 31, 2022 for further discussion.
Currency risk
Currency risk manifests itself in transaction exposure, which relates to business transactions denominated in foreign currency required by operations (purchasing and selling) and/or financing (interest and amortization). The volatility in foreign exchange rates, in particular a weakening of foreign currencies relative to the Euro, may negatively affect our revenue. Our general policy is to hedge transaction exposure on a case-by-case basis. Translation exposure relates to net investments in foreign operations. We do not conduct translation risk hedging.
Transaction exposure sensitivity
In most cases, our customers are billed in their respective local currency. Major payments, such as salaries, consultancy fees, and rental fees are settled in local currencies. Royalty payments are primarily settled in Euros and U.S. dollars. Hence, the operational need to net purchase foreign currency is due primarily to a deficit from such settlements.
The table below shows the immediate impact on (loss)/income before tax of a 10% strengthening of foreign currencies relative to the Euro in the closing exchange rate of significant currencies to which we have transaction exposure, at September 30, 2022. The sensitivity associated with a 10% weakening of a particular currency would be equal and opposite. This assumes that each currency moves in isolation.
| | | | | | | | | | | | | | |
| | USD | | SEK |
| | (in € millions) |
Decrease/(increase) in loss before tax | | 98 | | | (13) | |
Translation exposure sensitivity
The impact on our equity would be approximately €133 million if the Euro weakened by 10% against all translation exposure currencies, based on the exposure at September 30, 2022.
Interest rate risk
Interest rate risk is the risk that changes in interest rates will have a negative impact on earnings and cash flow. Our exposure to interest rate risk is related to our interest-bearing assets, primarily our short term debt securities. Fluctuations in interest rates impact the yield of the investment. The sensitivity analysis considered the historical volatility of short term interest rates and we determined that it was reasonably possible that a change of 100 basis points could be experienced in the near term. A hypothetical 100 basis point increase in interest rates would have impacted interest income by €2 million and €6 million for the three and nine months ended September 30, 2022, respectively.
Share price risk
Share price risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate due to changes in the fair value of the Company's ordinary share price. Our exposure to this risk relates primarily to the Exchangeable Notes, outstanding warrants, and accrual for social costs on outstanding share-based compensation awards.
A 10% decrease or increase in the Company's ordinary share price would have resulted in a fair value of the Exchangeable Notes ranging from €1,196 million to €1,199 million at September 30, 2022.
A 10% decrease or increase in the Company's ordinary share price would have resulted in a fair value of the warrants ranging from €2 million to €4 million at September 30, 2022.
A 10% decrease or increase in the Company's ordinary share price would have resulted in a change in the accrual for social costs on outstanding share-based compensation awards of €1 million at September 30, 2022.
Investment risk
We are exposed to investment risk as it relates to changes in the market value of our long term investments, due primarily to volatility in the share price used to measure the investment and exchange rates. The majority of our long term investments relate to TME. A 10% decrease or increase in TME's share price would have resulted in a fair value of the Group's long term investment in TME ranging from €527 million to €645 million at September 30, 2022.
Critical accounting policies and estimates
We prepare our interim condensed consolidated financial statements in accordance with IFRS as issued by the IASB. Preparing these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, equity, revenue, expenses, and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results may differ from these estimates.
We believe that the assumptions and estimates associated with revenue, share-based compensation, content, warrants, Exchangeable Notes, business combinations, the incremental borrowing rate, and income taxes have the greatest potential impact on our interim condensed consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates.
There have been no material changes or additions to our critical accounting policies and estimates as compared to the critical accounting policies and estimates described in our Annual Report on Form 20-F.
Recent accounting pronouncements
There are no new International Financial Reporting Standards (“IFRS") or IFRS Interpretation Committee ("IFRIC") interpretations effective for the nine months ended September 30, 2022 that have a material impact on the interim condensed consolidated financial statements. See Note 2 to our interim condensed consolidated financial statements included in this document.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
We are from time to time subject to various claims, lawsuits and other legal proceedings. Some of these claims, lawsuits and other legal proceedings involve highly complex issues, and often these issues are subject to substantial uncertainties. Accordingly, our potential liability with respect to a large portion of such claims, lawsuits and other legal proceedings cannot be estimated with certainty. Management, with the assistance of legal counsel, periodically reviews the status of each significant matter and assesses potential financial exposure. We recognize provisions for claims or pending litigation when it determines that an unfavorable outcome is probable and the amount of loss can be reasonably estimated. Due to the inherent uncertain nature of litigation, the ultimate outcome or actual cost of settlement may materially vary from estimates. If management's estimates prove incorrect, current reserves could be inadequate and we could incur a charge to earnings which could have a material adverse effect on our results of operations, financial condition, and cash flows.
For a discussion of legal proceedings in which we are involved, see Note 20 and Note 22 to our interim condensed consolidated financial statements included in this report.
Item 1A. Risk Factors
There have been no material changes from the risk factors and information disclosed in Part I, Item 3.D. "Risk Factors" in our Annual Report on Form 20-F and Part II, Item 1A. "Risk Factors" in our quarterly report for the three months ended March 31, 2022.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity
Share repurchase activity during the three months ended September 30, 2022 was as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Period | | Total Number of Shares Purchased | | Average Price Paid per Share | | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1) | | Maximum Value of Shares that May Yet Be Purchased Under the Plans or Programs | |
July 1, 2022 - July 31, 2022 | | — | | | $ | — | | | — | | | $ | 895,551,413 | | |
August 1, 2022 - August 31, 2022 | | — | | | $ | — | | | — | | | $ | 895,551,413 | | |
September 1, 2022 - September 30, 2022 | | — | | | $ | — | | | — | | | $ | 895,551,413 | | |
Total | | — | | | $ | — | | | — | | | $ | 895,551,413 | | |
(1) This column includes all the shares repurchased as a part of the repurchase program announced on August 20, 2021. No ordinary shares were repurchased during the three months ended September 30, 2022. See Note 15 to our interim condensed consolidated financial statements included in this report for additional details. As of September 30, 2022, we had repurchased a total of approximately $104 million under the share repurchase program.
Item 3. Defaults Upon Senior Securities
None.
Item 5. Other Information
None.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | | | | | | | |
| Spotify Technology S.A. |
| | |
Date: October 26, 2022 | By: | /s/ Paul Vogel |
| Name: | Paul Vogel |
| Title: | Chief Financial Officer |
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