Welcome to the Netflix Q4 2016 Earnings Call. I'm David Wells, the CFO. Joining me today from the company is Reed Hastings, our CEO and Ted Sarandos, our Chief Content Officer. Interviewing us on today's call or interview is Doug Mitchelson from UBS and Scott Debit from Stifel Nicolaus. A cautionary note that we will be making forward looking statements,
actual results may vary. Scott, I think you have the first question. So over to Scott. Yes. Thanks, David.
And first question for Reid. Just outstanding quarter, both domestically and internationally relative to expectations from a subscriber standpoint. And there's so much focus on national given the opportunity there to grow the business as well as the way you've built out the international business with some more mature markets that you've been in quite some time. So newer markets like France and Germany that are starting to kick in and in 130 that were added at the beginning of 2016. So I was wondering if you could frame potentially the over performance in the quarter and where you saw trend regionally?
You describe it as over performance in the quarter. But if you look at it on a longer term basis, like over the last couple of years, it smooths it out. So we are seeing some lumpiness in the quarters depending on when we launch certain content. But the big picture is remarkably steady. And so we have a huge quarter like Q4.
This quarter, it's a little bit less. And so think of it really as this big adoption of Internet TV. It's been somewhat influenced by the content in the short term. And then you asked about the international expansion, which has been remarkably steady. Again, if you don't look at it by the quarter, but you look at it by the year, what we've seen in Latin America is steady growth.
Europe as a whole has been really picking up momentum for us. In Asia, we're just getting started in.
And then secondly, possibly for David, you've got the 1st quarter U. S. Contribution margin above the longer term, I think, target? Understanding that there's lumpiness and now you're going to continue to invest in their business. Is there any update on that longer term target in terms of the contribution margin in the U.
S. Market?
No, Scott, we did, as you correctly asked me. There's 2 pieces. 1 is the U. S. Contribution margin pops up in the Q1 and we're indicating that that's we're going to continue to reinvest.
And then on the international line, we actually broke through into profitability for our consolidated international segment and we will continue to invest and take that back down through the year. So I think that we don't talk about long term targets other than an operating margin target. We had mentioned before that we would produce meaningful operating profit in 2017 and beyond. So we fleshed that out a little bit for you, the investor, now targeting a 7% operating margin for this year and steady growth afterward. And then we don't think anything structurally is at hand in terms of our international businesses.
It really depends on the competitiveness of each market. But we think we can continue to grow the overall profitability. So we'll grow operating profit by continuing to grow U. S. Margin and also reduce international losses with respect to adding on more investment.
So I think long term we'll reduce those losses and grow international margin, but we haven't provided a specific target.
Thank you.
I think on the Q4 results also, I'm curious, in the U. S, what content specifically drove the strong performance relative to budgets?
Well, we had a pretty powerful release in Q4. So you see particularly shows like Luke Cage, Narcos, new seasons of Narcos that really travel really well around the And we know that they're exciting here as consumers of television in America, but it's been fantastic to see how these shows are adopted around the world.
And Doug, I would just add to that, that we're you're now seeing the benefit of Netflix having sort of in its 3rd, 4th year of original slates. So we're now getting, as Ted mentioned, Narcos season 2 comes out, but we've got new seasons as well. So you're getting the benefit of shows that might take hold in their 2nd or 3rd season, but some new shows as well like Stranger Things did for us in the Q3 and continue to be popular through the Q4 as well.
And a nice upside surprise was something like Gilmore Girls where you think would be incredibly domestic in its popularity, but we found it to be incredibly internationally popular as well, particularly performing great in Europe.
And this might seem relatively obvious given the comments so far that content is drive for subscribers. But in terms of your ability to measure how content is driving subscribers, and you talked last quarter about including new content into your subscriber growth guidance and then you see the strong result this quarter. Is it tangible title by title? Are you making just an overall estimate based on spending or number of umbrellas released? Think of it as it's
a cumulative effect. Very few people will join Netflix just because of a single title. But there's a tipping point. You have one more title that has great excitement that you're hearing a lot about and that triggers you to finally sign up for Netflix. So it's a cumulative effect of all of these.
And again, you see some front loading pull forward. But the basic demand creation is increasing as people get more comfortable and more aware of the idea of Internet television, where you don't get the commercial interruptions, where you just get to watch when and where you want. So those are the big drivers. And then the things that capture the demand are really these big launches that we're doing of particular title franchises.
Just to feed off of Doug's question, there is a commentary in the letter regarding content being a big driver for subscribers in the second half of twenty seventeen. Is that a being gear driver for subscribers in the second half of twenty seventeen. Is that just looking at the slate in that period as a driver for the business or is there something else to that comment?
You should
look at we have multiple seasons of our shows and we see that the audience continues to build cumulatively and therefore the excitement for the upcoming season builds as well. And so in Q2 of this year, we have new seasons of a lot of our very popular shows like Orange is the New Black and Kimmy Schmidt, Bloodline, Sense8, Master of None, And we think that they should have a pretty nice impact on subscriber growth as well.
Yes. And Doug, if I and Scott, if I can knit these comments together, Reed's comments, Ted's comments and your questions, there's a difference between so the baseline demand, as Reed said, is just the transition to Internet TV and the overwhelming convenience of it. We get talking a lot about the sort of quarter, intra quarter, whether we hit above what we expected or not based on some of how these shows perform. And if they're brand new shows, they don't tend to if they're having punch into the consciousness of the consumer, they don't tend to draw new subscribers in as great of numbers as some of our existing shows. So what we were saying is in the Q1, we have some great new shows like OA that are doing well, but they don't tend to draw numbers like House of Cards did last year in terms of we're lapping House of Cards.
And for us, it was a surprise of Making a Murderer as well. So I think what Ted is saying is we have all these great shows coming in the back half the year and more of them are 2nd season that tend to draw in more subscribers because they're better known shows.
2nd, 3rd, 4th and 5th seasons even.
And sorry to be so myopic around the more near term subs, but one final question on that for me. There was, I think, a comment as well in terms of potential of being a pull forward in subscribers into 4Q from 1Q as part of the explanation for the 1Q sub guidance? And can you flesh that just a bit and what gives you that type of visibility?
Sure, Rita, I could
do that, but I'll take a stab at it. I think what we saw in 2016 around our un grandfathering and our price change was a lot of lumpiness 1st quarter, 2nd and third more modestly and then building into the 4th quarter. And what we found was we found a lot of rejoins coming back. So yes, there was a reaction to the price change, but we got many of those subscribers back. And so I think what we're talking about in the Q1 or the Q4 is we got many of them back that may have come in the Q1.
We may have seen some of those folks in the Q1. So we tend to look less at a specific quarter's performance and we look sort of over a 6 or 9 or 12 month period in terms of what is the real trend here, not focusing too much on any specific quarter because they do seem to have bleeds in terms of some folks joining in a quarter that they would have joined the former quarter.
Got it. Thank you.
Two more questions for me on near term subscribers. First, Reid, you said that Europe is really picking up. And I think when you launch those markets, you indicated it would take some time for them to work to Latin America. Now that's happening. But investors are still wondering something specific that you have done differently or done recently that's been drive improvements, particularly in Germany and France?
No, there's no specific like pricing marketing tactic. It's the cumulative effect of show after show being in market, just the steady work that we've done. And this is what we also saw in Latin America is there was no step function. There was just a steady discipline of staying on our game, of great shows, great movies and the enjoyment continues to increase. There's slightly incremental more partners that we have, but there's no real step function.
Again, it's really the continued buildup of momentum.
Yes. We're seeing as we're adding more and more global shows that it's rising all boats across the world.
And I think we've talked about acquisition a lot near term. When you think about churn management, I think investors are curious both on did X1 integration have any unions in the quarter, did other bundling deals throughout the world, you certainly have done quite a bit for them, have any influence? And as you think about churn trends, is there anything noticeable for investors and how should we think about that on a flow basis going forward?
Yes, all the partnership deals, we really believe in. That's why we're doing more of them. But you can see we had big outperformance in international and in domestic. So it wasn't just a Comcast story, in which case it would have been domestic only. It's fundamentally a story of the broad acceptance of Internet TV in the content.
And then on the margin, those partnership deals are good for the customers, good for us and good for the partner.
The cable set top box deals, I think John Malone was quoted recently at Lionsgate Analyst Day as saying that you had approached some operators in terms of being bundled into service where carriers would cover the bill. And just interested in terms of the accuracy of that statement, is that something you're interested in, what you think the benefit of that would be if so?
We wouldn't want to speculate on future deals. In general, around the world, we've done extremely well focusing on our service as a discrete service, dollars 7.99 a month and incredible content. And so we're just going to keep pounding that drum as we expand around the world and also here in the U. S.
And the X1 interface, which is standing by the way, we have it at our house, are there I assume that there's interest in doing more integrations like that. Is there any reason other than simply being able to cut those deals, technology restriction standpoint with other providers that would limit the ability to do deals with
others? Yes, the X1 is a very advanced set top. So not all MSOs in the U. S. Have such advanced, so they basically can't do Internet apps or can't do Netflix.
So the X1 is very strong in that way. So is the DISH, the receiver. So we're able to operate on ones that are relatively modern and have other IP apps also.
Reid, I think you've had an advantage just because of the technology investments you've made over time, the scale that you've deployed. Any concerns longer term that to the extent more and more of your competitors are bundled in on the same aggregating platforms like X1 that you could lose a bit of a technology as consumers access your content all through the same interface that they're accessing users?
Well, when the consumer finds in the Comcast UI some Netflix show, they click on that and it opens the Netflix app. And then the consumers in the Netflix app, they enjoy the show. And then we control after the show, the post play experience, which guides them into another show, another show. So we look at it as an entry ramp onto our application. And we feel that our application really is the best way to enjoy Netflix content.
That doesn't mean there shouldn't be easy entry ramps from interfaces like the Comcast user interface, because that's very effective for customers.
And sort of circling back to some of the subscribers, I'm curious, any learnings now that the global rollout is a full year behind you? When you look back, anything that surprised you, anything different than expected? And when can we expect the next round of taking some of those skin markets like Poland and Turkey and turning them into market launches.
We'll continue with more Poland and Turkey like launches this year with several countries. So that'll just be a steady process we're going through. We've really liked what we saw once we localized in Poland and Turkey in terms of increased viewing, increased membership growth. So we'll just keep on that pattern. So think of it, but from a near term subscriber standpoint, it's a background influence compared to the big established markets in Europe, LATAM and North America.
And then of course, over time, they should be quite substantial. But they're long term plays.
And Doug, from a financial standpoint, just keep in mind that when we talk about the investments in international, content is the big piece of that. Localization is relatively modest compared to the content.
Ted, I think the last time you spoke publicly on the topic, you were doing local language content in 10 different countries. And I was wondering if you could talk about success or challenges of that and that was tied to original content. And then also more broadly, local language in newer markets as well as marketing campaigns, which was identified in 2016 and some of the stuff that needed to be put in place to get some of the newer markets to begin to progress that S curve?
Yes. Well, so far we've been really happy with the success of our local language productions in France and Mexico and Brazil. And as I mentioned last time, we've rolled it out to Germany, to Spain, to Italy. We're deep in production. We're entering into a couple of new productions in Asia.
What we find is it creates a lot of great excitement for Netflix in the market, because it's a really elevated form of television relative to what else is available in the market. And we love that we're working with local storytellers, local producers to make that content. And even more importantly, making it available around the world has been a huge differentiator for us. So when I mentioned earlier about the Gilmore Girls being so popular globally, So if it was a little softer anywhere, it might have been in Brazil. At about the same time, we were launching a really great little science fiction show called The 3%, a local Portuguese language show that we shot in Brazil that was enormously popular in Brazil and played to millions of subscribers around the world, including in the U.
S. So it's been a great way to find great new global storytellers and then make Netflix feel a lot more local in those countries.
And then I think you're also quoted as saying that 1,000 hours of content in 2017 seemed to be pretty conservative. Can you speak to that in terms of I suppose local language as a contributor to that, also genres and geographies and what actually is going to be the makeup of those 1000 hours?
I would like to focus you a little less on the 1000 hours and more on the quality of those 1000 hours. About half of the most searched for shows on television around the world this year were Netflix original shows. And that's the kind of thing we're really proud of, a little bit more, even more so than the volume of it all. It's interesting and it's an artifact of of past growth and commitment that it's so many hours. But the rest of this quarter, we still have 42 original launches to launch the rest of this quarter, including shows like Santa Clarita Diet with Drew Barrymore and Timothy Olyphant, a second season of Love, Iron Fist, our latest Marvel series, we'll be launching this quarter.
So I really want to focus you on, yes, it's a lot of volume, but it's also a tonne of quality that consumers are falling in love with.
Shifting over to the strategies, I'm just curious, reflecting back on the last year where you had your price increases flowing through from the young grandfathering. Reed, David, did you learn anything about the pricing power of Netflix? And can you give it about what investors should expect for your pricing strategies into 2017 beyond, please?
Well, you should expect us to continue to invest in the consumer experience, making the content incredible. And we don't have any plans for any near term changes. So I would just continue to look at us and model us as expanding the membership base
at these terrific rates. I also think, Doug, in terms of nothing's changed in terms of our long term view of our belief and ability to continue to add great value and slowly, steadily assume that value over time. So I don't think anything has changed in that respect.
I think along the lines of some of the things you've been saying, Reed, one of the questions that we get from investors is, why focus on earnings at all at Netflix? I mean, shareholders have clearly rewarded the company for subscriber growth and revenue growth, a leadership position in the marketplace. While Ted is ramping content pretty aggressively, I'm sure he's always asking for more money. Why the philosophy around trial and strength growth with delivering earnings?
Yeah, we don't really believe in hockey stick kind of businesses, like suddenly we'll turn significantly profitable at 200,000,000 members. We think it's much smarter to grow into that bit by bit. So expect us to modestly move continue a slow and growing into that as we grow larger. We'll keep an eye on the investment levels that are necessary to protect the advantages that we have. So don't worry about that.
But I would say, in general, you grow into the profitability as opposed to postpone it forever and then hope that you can change the business model to deliver on the profitability front later.
And the only thing I'd add to that, and Ted probably has his own answer, is a little bit of scarcity goes a long way in terms of efficiency and just making sure that we continue to focus on quality. Well said.
Ted, how did the Crown do? And did it it seems like it would perform well in the UK. How did it travel throughout Europe? How did it perform in the U. S.
And in other regions?
We're incredibly proud of it for the both for the reasons you just mentioned, which is that it's been incredibly popular globally. There's an enormous interest in the Royal family around the world. So in the UK, it was really celebrated as something that only the BBC could do just a couple of years ago and really beloved in the UK, in the US, but also even in countries throughout Asia, throughout Europe, obviously, where people just love that story. And more importantly, they loved how it was told. And we were thrilled that it won the Golden Globes for Best Drama.
It was our 1st Best Drama Award there. And we're excited. We're deep into Season 2 now and excited to tell the rest of the story.
Great. Thank you. And Reed, in the S. Market, you're 1 quarter away. I think you're going to be approaching 50,000,000 in U.
S. Paying subscribers at the end of the Q1. There's over 100,000,000 households in the U. S. That subscribe to cable and satellite.
The price point and the value proposition, it really doesn't seem like there's any reason why over time with broadband speeds that you should be able to address households. When you look at the next $50,000,000 in the U. S, where do you incur the friction points that are limiting you right now to getting to those 3rd numbers faster?
I think it's really just this diffusion to the society as more and more people use Netflix. We have better and better shows and more of them. You just get the word-of-mouth, which is how you grow from the nearly $50,000,000 to $60,000,000 And hopefully, we keep going. In terms of getting to a full one to 1 tie ratio with today's cable, that includes a lot of sports, which we don't have and don't have plans for. So you want to weight that a little bit.
But in terms of the next couple of years, again, I think, if you look back 4 or 5 years, it's been really pretty steady growth overall. And it's following this formula of just improving the value, improving the content, improving the service, like adding our offline viewing. It's really creating a big wave of customer joy, the video merchandising that you'll see, where you get to choose content by looking at content. So we're continuing to innovate on multiple fronts to just make it a better experience.
Two questions from me for David, just on some of the financial commentary in the letter. I think you gave 7% visibility guidance for full year 2017. I think it would be helpful to help investors just to understand on the cost category, by category, what the outlook might be for 20 17. So when you look at G and A and Tech and Dev and Marketing, if you could give us a sense of what the dynamics for
each of those are this year, that'd be helpful. Sure, Doug. And we updated our long term letter a little bit in this respect as well. So think about $6,000,000,000 in content, dollars 1,000,000,000 in tech and dev, somewhere around $1,000,000,000 in G and A to sort of round out the operating profit expense lines and that should get you there. That will work.
And then also notable free cash flow burn $2,000,000,000 for this year. That was a bit higher than I believe you suggested a few months ago. So what's changed?
Well, I think what we put in the October letter was that free cash flow might be similar to Q3. It was more than that. We do think it's going to come down this quarter in Q1. But we wanted to give an indication that it's pretty lumpy right now. Even my team has we don't really focus on trying to optimize a single quarter.
We're looking at sort of across 4 8 quarters. And we think the run rate is around $500,000,000 right now in terms of the quarter as we continue to expand content. It's not too different from 2016. I mean, we moved up to $1,700,000,000 in 2016. And so we're indicating it might be around 2,000,000,000 this year.
And we'll go from there. I mean, I think what you'll find is, we will organically fund more and more of our own content expansion with the growth of our operating profit. And so more and more as we transition over the next few years, our debt will be about content expansion, but it will also transition to being about optimization of cost of capital.
And I think you've said at one point in time or possibly it was Reed that if content is available, you would be willing to take on more leverage or take the attention on versus otherwise letting it go because it does fit into the P and L currently. So with and I'm paraphrasing there, but with where you are now in terms of the $2,000,000,000 drag, but where content spend seems to be beginning to normalize in terms of the outlay versus the P and L spend, Is there visibility to when the business becomes self funding based on the current trajectory?
We haven't provided that guidance, Scott. It really depends on how much we want to continue to expand content and the growth of the business itself. So we're a little bit guarded in terms of providing specific because there's interdependencies there. What I think, and this is back to Doug's question prior is, part of the reason that our working capital needs have gone up a little bit is because we're owning more and more of our content. And I think that's a good thing for the investor and the shareholder.
We control more of the rights, more of the sort of global advantages from being a platform that is increasingly having 90,000,000 and beyond global subscribers will be advantageous for us to own that content. So I think the step up, the slight step up from years past, a couple of years to the 2,000,000,000 that we're talking about this year is inclusive of more owned content and increasingly more content categories. I think you get both of those in there.
And then secondly, as investors begin to look at the U. S. Market as a template for rest of world as happens with businesses in the Internet when they grow globally. Can you just talk about the puts and takes in terms of what could lead to similar margin profile of markets outside the U. S.
Versus higher or lower as the churn? Sure.
I think I'll pitch it to Reed. I'll say something and then Reed can follow on. But I would say it's competitiveness in those markets. Generally, overall, I would say there's nothing fundamental that we can't get to margins equal or better in some places of the U. S.
So then you think about an average across the globe and it really is about determined somewhat by competitiveness, it's determined by the cost of that content. But the more that we can grow and provide sort of spread the cost of popular content that is engaging to a large portion of the world, the more advantage and scale advantage we see there in terms of being able to do that. So I would provide those comments and then see if Reid has anything that you might want to add to that.
No, I think that's perfect, David. Our North Star is providing an incredible value to consumers because upon that you can build a very large and very profitable franchise. But it starts with an amazing value for consumers, which is a great service and amazing content behind that. Thanks.
Two questions for Ted. Ted, any view in terms of ROIs on your investment in content? You look at acquired versus originals, are the lines starting to cross in any way? And as part of that, are you willing to give us an update in hours consumed globally? We haven't had that number from you in a while.
Well, stay tuned for those numbers. We don't have anything to report today. But I'll tell you, I think the as David had mentioned, while it is a bit more cash consumptive, owning our own content, including our original productions has a lot of big scale advantages to the business. And probably the most meaningful one is removing the studio markup and overhead on those productions and being able to put more of that on the screen, owning the IP as we expand into multiple seasons, having control over the windows. And so I lean into both original programming and owned original programming, but we're still a very active buyer of 2nd window content for our studio partners.
We are increasingly co producing some of that programming with networks and studios around the world, where they'll take one country and we'll premiere the show globally at the same time, which takes off some of that risk and also enhances our partnerships with those networks and studios. But I do think there's a lot of value in owning the IP and a lot of value in creating their own content. But we need to have great programming for our members and sometimes we don't have that. So we'll have to go out and we're buying it elsewhere to enhance what we're doing.
I think along those lines, any suggestions as to where the emphasis will be going forward? I think there's still a feeling that this could use more movie content. You've made huge investments on the comedy side, if you want to talk about that. But particular genres that we should expect you to focus on going forward?
Well, you can look at those comedy investments as a good example of taking a category that we primarily bought 2nd window from other people just a few years ago and now are producing original programming that takes it from being just something people watch to something people really value Netflix for differentially. The rest of this quarter, you're going to see stand up shows from Amy Schumer, Dave Chappelle, Trevor Noah, Jim Norton, like some of the top names in comedy. And as you're going out, we've already talked about Chris Rock and Jerry Seinfeld's recent deals. But that's a category we took it from being kind of cheap second window programming to something that really becomes an event and a subscriber acquisition driver for Netflix. Same thing with unscripted programming, which shows that we'll be launching in even this quarter like Ultimate Beastmaster and Abstract, which is a variant on Chef's Table, but about design.
And it's all that programming that we used to license in 2nd window that we're finding to be much more valuable to go ahead and produce originally for Netflix.
Scott and Doug, I think we've got time for maybe one final question from either one of you or one each.
I'll go first. The question that I had is squeeze in net neutrality, and it's commented on the letter. But Reed, could just make assumption under the new administration, the Title II net neutrality is rolled back. What are the implications for Netflix?
I think we addressed that in the letter. I don't have really anything to add to that. Okay.
I think from my end, last question, for just curious the ultimate vision at this point, we're churning the new calendar year. I think we've had a conversation in the past where you talked about to satisfy consumers, you have to give them all the television shows they want for $25 I'm just curious, as you talked about in the letter, your decade and the next decade is going to be pretty exciting. What's your ultimate vision at this point for the services?
You never want to characterize something as an ultimate vision, because when you get there, there's always more that you want to do. And so we're taking it year by year. We're growing around the world. We're thrilled with our global expansion. Ex China.
We're really focused on all the different markets. Asia is still doing work in Europe. We're building up our content production muscle. We're able to produce shows now in many countries around the world. So think of us as just continuing to iterate on the basic cycle of more content, a better product that combines as a great service at a great price.
And hopefully with that, we can attract many more people to join Netflix and then that fuels the whole cycle. So we're just going to lather, rinse, repeat again and again for the next couple of years and just expand out. We have a long way to go when you think about how many movies and TV shows we don't have. We want to be able just think about the great range of content that we have. And we're very ambitious about what we can do, especially around the world.
So there's a lot for us to work on. And then just the next 6 weeks, I'm in Brazil, Europe, Asia. We are having a blast just spreading and evangelizing this vision of Internet TV, where you get to control what you watch and you get incredible quality content. And we hope to land this quarter in a 99,000,000 subscribers, which would be quite an achievement. And thank you very much all for your support and look forward to talking to you again in the quarter.