Spotify (NYSE:SPOT) has invested heavily in podcast content and technology over the last few years. From content acquisitions and productions to building and acquiring the technology behind the creation, distribution, and monetization of podcasts, Spotify has its hands in nearly every aspect of the industry now.

And the investments are finally starting to have a positive impact on its financial results. Management shared some highlights in its second-quarter letter to shareholders and earnings call.

A reception desk in an office building with Spotify logos on the walls.

Image source: Spotify.

Advertisers are all-in on podcasts

Podcast revenue increased more than sevenfold year over year in the second quarter, CEO Daniel Ek shared in his prepared remarks at the top of the earnings call. Even adjusting for its big acquisitions like Megaphone, revenue grew 200%.

Those comparisons come against a depressed second quarter of 2020, when the coronavirus crisis kept ad spending low. But importantly, Spotify should be able to keep growing podcast revenue substantially for many quarters to come. That's because, as management noted, demand is outstripping supply. Ek says adding inventory is "something we are actively solving for."

Spotify can add inventory through driving more listenership to its owned and exclusive podcasts with more episodes or more engagement (or both). Spotify says total podcast listening increased 95% year over year and the average podcast listener spent 30% more time listening to podcasts last quarter versus the year before.

It can also add inventory by bringing more podcast creators onto its production and monetization tools. With the strong demand it's seeing from advertisers, Spotify should be able to attract more podcasters looking to improve their monetization to its streaming ad insertion product.

Most importantly, management called out a mix shift toward podcast revenue as a reason for its outperformance on gross margin. Gross margin came in at 26.5%, excluding a one-time adjustment. That's well above management's prior guidance of between 23.6% and 25.6%.

What it means going forward

Ek now sees advertising as a meaningful growth driver for the company going forward. "It's clear to me that the days of our ad business accounting for less than 10% of our total revenue are behind us," he told analysts.

Previously, management viewed the free ad-supported tier of Spotify as a conduit for premium subscribers. But with the addition of podcasting over the last few years, the advertising business has reached a level of scale and it's growing fast enough that it will actually show up in the company's top line.

What's more, the leverage in podcasts is showing up in gross margin as well. Ad-supported gross margin climbed to 11.3% in the second quarter, higher than Spotify's ever reported since it started including the costs of podcasts in the calculation at the beginning of 2020.

CFO Paul Vogel said the strength and leverage on the podcasting side means more investments in the business going forward. And with the recent results, strong marketer demand, and positive outlook for the advertising business in general, investors in the growth stock should be happy about that.

Spotify's spent over $1 billion on podcast-related acquisitions and millions more on developing its own content and technology. The ad business now has a run rate of more than 1 billion euros in revenue and expanding gross margin as a result. It's still early, but those results are nothing to sneeze at.

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