Okay. David's mic is unmuted.
Welcome to the Netflix Q3 2014 earnings call. I'm David Wells, CFO. Joining me today on the company side is Reed Hastings, our CEO, and Ted Sarandos, our Chief Content Officer. Interviewing us on our results today will be Michael Nathanson from MoffettNathanson, and for his last time, Doug Anmuth from J.P. Morgan. Doug will be handing the baton over to Mark Mahaney from RBC next quarter. I think Michael, you have our first question, I'll turn it over to Michael.
That's right. Thanks, David. The first question will be to Reed. I think the obvious question to ask is, given the miss in subscribers this quarter in the U.S. and the slightly slow growth next quarter in the U.S., what gives you confidence that you're still on the middle part of the growth curve on the S curve, especially given the fact that you have a grandfathered price increase a couple of years down the road? Anything on that?
Sure, Michael. We added 3 million net subscribers in Q3, about 1 million a month, in Q4, we're forecasting 4 million. If you look just at the domestic side, however, that's about 1 million and about 2 million in Q4. We're hoping for big numbers. We're always working hard on that. When you ask what's the confidence that we're on the middle part, we really have to feel our way along quarter by quarter as we improve the content. If you think about the general society all moving to internet TV, like HBO's announcement today, there's a lot of feeling of just everyone is going there. Not exactly sure the rate of transfer, but internet TV is going to be everything in a couple of years.
Reed, just to follow up on that, why is $60 million-$90 million still the right number in the U.S., given what we saw here in 3Q and what you're looking at for the fourth quarter?
Well, everything that we're seeing is completely consistent with the whole society, not only the U.S., but around the world, is moving to internet video and internet television. I think it's completely consistent with what we're seeing. We saw Starz a week ago announce that they're doing an internet video service. We saw HBO. Perhaps there'll be other providers over the coming weeks. Think of all the big networks are moving to internet video, and it's just becoming a very large opportunity.
David, given that revenues came in line, subscribers came in lighter in the U.S., was there a mix shift amongst your pricing tiers in the third quarter?
Not really. Before I jump into the question, I realize that I didn't provide the safe harbor statement. We will be making forward-looking statements during this interview and actual results may vary. There's your proof that this is not a scripted interview. Michael, back to your question. In terms of really the revenue number, we sort of missed on the total subscriber line, and there is a bit of a delay between the folks getting a 30-day free trial and the revenue coming in. That would explain most of it. There's a little bit of a mix shift in terms of ASP being slightly higher than we forecasted, but most of it was just because of the revenue having a little bit of a lag.
Reed, can you talk about the strength of subscribers in the new Western European markets in 3Q, how they performed early on versus your expectations? Also, how much do you know here about conversion rates as they're just coming off of their one-month free trials, and how is that impacting your guidance for 4Q?
Well, we had a very successful launch. We've done numerous launches now, starting in Canada four years ago, so we're getting better and better at it. We've got some of the fastest integration with MVPD set tops that we've ever seen in the world. In the U.S., we still don't really have anything material. In the U.K., it took us a year and a half to get Virgin. We were able to announce Orange and Deutsche Telekom, and these are all going live shortly or just turned live or going live over the next couple of months. Really a great successful launch that portends well for us, and that's built into the guidance.
We're feeling just incredible about international when you think that from starting four years ago in Canada through to the Netherlands, almost 40 countries as a whole are now profitable, just an average of two or three years after starting. It's a great success, that's why we're continuing to invest so rapidly in international.
Okay, I have a two-parter for Reed and Ted on HBO Go. Today, the big news out of Time Warner Investor Day was the announcement of an over-the-top service to be launched next year in the U.S. Two questions would be for Reed: What do you think the impact on competition will be as they start really pushing that product? For Ted, the takeaway was they might start putting Time Warner's content into HBO on kids and maybe on movies and TV shows. Talk about those two things.
Sure, absolutely. On the consumer side, it's one more channel. Already consumers subscribe to us and Hulu and Amazon, and they do pay-per-view, and they do DVD, and they do cable. There's so many great sources of entertainment, and consumers subscribe to many of these. It's not much of a change in the direct competitive landscape. We and HBO have completely different content. I don't think it'll be a significant impact at the consumer level. As we bid for content, that's more significant, and I'll turn that over to Ted.
Yeah, I'd say similarly that HBO is another buyer in the market if they do choose to start licensing even from their sister companies. Different companies have different views of how they look to vertically integrate. In this case, I think they have an established revenue model for that content With buyers like Netflix and others that they will have to competitively bid in the market for.
Reed, just following up on HBO Go and the competitive dynamic there, do you have a view on how it could be priced and distributed when it ultimately comes out?
In the Nordics, they've competed with us since launch, two years now with HBO Nordic. There they chose to price on top of our pricing. That pricing is higher because of VAT and cost of living, so it's not definitely indicative. They've been quite aggressive in the Nordics, and we've stayed well ahead.
It looks like this quarter, I'll just throw to David, that the guidance provided on free subs in international markets missed our expectations and your expectations. What is going on there? How could free trial subs miss expectations?
Well, there's a number of ways. We just didn't grow as much as we thought we were going to in terms of bringing folks in. Across a number of markets, we were lighter versus our forecast than we expected. You collect all of those markets together and you get to a point where you missed on the total number, but you made it on the paid number.
When David talks about missing, remember that what we're providing is our internal forecast, and we expect to miss pretty frequently. That's the midpoint, essentially. We'll be a little above that, a little below that every quarter.
David, you called out in the letter basically that the increase in pricing may have had some impact in 3Q and perhaps a greater impact than you saw in the second quarter perhaps because "Orange Is the New Black" offset that. Was the said pricing? Is there anything else that you can point to in the U.S. in particular?
Any given quarter, there's a number of swing factors involved. We said that was our leading indicator or leading factor in the quarter. The Home Depot breach certainly put a number of people on payment hold. We felt like if we provided three or four more swing factors, it felt a little bit like an excuse, so we didn't do that. There were certainly other factors at play. We had a strong comp last year with releasing "Orange" in July versus in Q2 of this year. We talked a little bit about that. We certainly saw some effects from The Home Depot breach. Then, there's two or three more of those that we could talk about, but they're minor compared to what we think is the major one.
Reed, we get a lot of questions about France versus Germany as markets. I know it's early days, can you share some information as what you're seeing on initial take-up rates or excitement around in France and Germany for Netflix?
Absolutely. France and Germany are unique markets, so is Brazil a unique market, so is Norway. Now we're over 45 of these unique markets. In every market, we've been able to figure out over time what's the right mix of content. Think of basic consumer behavior is they want control and they want internet video because they get to watch on any screen. They get to watch any time they want. They get to binge-watch. Those are very universal values. So we're gaining increasing confidence that Netflix is highly relevant around the world, that's why we're just looking forward to continue to expand next year.
Following up, Reed, and perhaps Ted here as we talk about the international business, what percentage of content in new international markets is local? How do you know what the right level is here? Do you feel like you have enough currently in France and Germany?
Doug, I'll jump in there. It's similarly placed as the other markets have been, around 15%-20% local, with the 80%, 85% being either Hollywood or other international content. One of our first indicators that we are getting the mix right is how many hours of viewing people are participating in. In France and Germany, the viewing hours are quite healthy relative to all of our other launches. The consumers are finding the things they want. The tricky thing is figuring out is the local content something that people want in the long term? Because when we first get to a new market, I think people are mostly excited about those things that they didn't have access to before. "Orange Is the New Black" was by far the most-watched show in both France and Germany, and in fact, all of the markets that we launched.
It tells you that with all the differences in taste, that they all rallied around that show. I do think too that we're offering those markets unprecedented choice, not just in programming, but also in choice of language, where you can watch the show either in native language with subtitles or dubbed in local language, which is something that's not been available to consumers in those markets before.
David, in the press release today or the letter to shareholders, you mentioned that Canada's now at the same margin as the U.S. after 4 years. How different are the penetration rates between those markets? I know you don't get into the actual rates, but how different are acceptance rates there? Is that the threshold for profitability in terms of U.S. level profitability around the world?
Well, you're right, we don't get into specifics, but the penetration, the rate of growth in any given market can be different. The rate of growth between Canada, between Europe, and between Latin America can be very different. Just reiterating, in terms of the financial performance and the return on investment, in 2012, we spent nearly $400 million in terms of contribution loss on international. What we were telling you today is that is now a positive number. In little less than 2 years, we've made great progress, and we think the international is a very good investment. Some markets are going to take longer than others. The content may be priced lower in those markets, so the economics are very different market to market.
David, you mentioned in the letter a little bit about the changes in the VAT in Europe that go into effect in 2015. Can you talk here about how those new rules will impact Netflix in Europe and how much profit is at risk here? Can you just perhaps quantify things beyond just talking qualitatively about it?
Sure. Luxembourg had an arrangement with the EU where if you were headquartered there, you could charge a 15% Luxembourg VAT rate. VAT rates, they vary from Switzerland at 8% on the low end to the Nordic countries at 25% on the high end. For us, we're talking about an internal cost change to Netflix, because we're not going to pass that along to the consumer, of about 5% on average of European revenue. Some of those rates are going from 15 to 25, some of them are going from 15 to 19 and so forth. A weighted average that you can sort of ballpark is about 5% of European revenue.
David or Reed, can you give us an update on 2015 international expansion plans? You've called out that you're going to keep opening up new markets. How should investors think about the speed of those openings and investments in 2015?
We're still sorting that out, Michael. Trying to figure out which markets are most attractive. We'll have some announcements to make over the next year. If you look at our long-term strategy, we've been extremely consistent over the past three years, saying that we're going to take all of our profits and put them into international expansion because we see it as such a big opportunity. Think of that as the base case. If we can move quickly enough, then we can deploy all of those profits in highly productive ways.
I would say to give you some sense of the magnitude. We peaked out of international loss at $105 million. We've guided in Q4 to a number that's slightly lower than that. In terms of the potential down the road, we certainly could see that level of investment.
Okay. Thank you.
Following up on that, Reed, and perhaps David as well. Reed, you were quoted about a month ago as saying that it would take three to five years for a single country to get to break even, then also that it could take Europe five to 10 years overall to be break even. Then also that you want to be fully global, including China. Can you help us sort these out, and in particular, do you still believe that international contribution margins can be comparable to U.S. margins in a more mature state?
We're making great progress on international. We gave you the proof point on Canada having gotten there. We're continuing to make progress in all those markets towards having a similar contribution profit to the U.S. in contribution margin. Feeling great about that. The three to five years is what we've seen in our experience. We'll see if future markets are slower or faster. There's some variation. Then the overall Europe picture is because we keep adding new markets. That's why that's a longer timeframe, because it's a cascade from the very beginning.
Just to clarify on that, you still think that that's the right kind of timeframe for Europe overall cascading from the beginning?
Yeah. There's nothing that's changed.
Okay.
Ted, as you start buying rights like "Gotham" worldwide, you start seeing some markets like Australia acknowledge that you have the rights to "Gotham" in those markets. How do you balance the need to basically buy global rights with a desire to be more measured as you expand internationally?
Well, the one thing that's been really encouraging, Michael, is that a lot of our content choices have proven to be extremely global, starting with all of our original series that "Orange Is the New Black" and "House of Cards" have been huge successes in not just in Australia, but in China. I mean, all over the world. These buys bode well, I think for future expansion in all territories. Right now, I believe we've hit kind of a financial tipping point where we can move forward on buying up more territories than we're currently operating in versus playing catch-up, which we had been doing licensing the territory or creating original series and then several years later, having to go back and either renegotiate for that series or not have it, like we don't have "House of Cards" in some of our current expansion territories.
David, just on international expansion, what do you think the best way is for The Street to think about and model your future international markets? Meaning, if we don't know the exact markets in any given year, what is a reasonable expectation for the number of new broadband households that you'd like to address over the next few years? Obviously, there's big implications here for both subs and of course for the bottom line. Do you expect these international launches to continue to be more heavy in Q3 and Q4 or more evenly spread out through the year?
I've given you some indication of sort of at least the financial magnitude. I don't think we have an addressable broadband household target in mind when we think about the next wave of international expansion. There's a number of just execution elements that come into play, how many we think we can do successfully well at the same time or consecutively. Certainly, we're getting closer and closer, as Ted talked about, to a global right. In terms of the incremental cost associated with an international launch, we certainly are reflective in some of our produced content today of having a global right or close to a global right. I would say it's our intent to continue to roll out international. You've got some indication of magnitude on the financial side, and we intend to continue to pursue it because it's been a great investment so far.
David, based on some of our analysis, I think other people feel the same way. It looks like you can add new markets between 300 to 500 basis points of penetration in the first couple of years. Is that consistent with your own data which you have and we've not been able to dig into?
We don't provide that level of detail and specificity.
The one thing, David, that we've said as we do in the launch markets, is that it took, in the U.S., seven years to get to about one-third of broadband households, and that in the developed markets, not as much LatAm, but for Western Europe, that we're targeting those kind of numbers, getting to a third of households over seven years. That would be consistent with the trajectory that you just outlined, Michael.
Sure.
Okay, thanks.
All right. Let's shift over a little bit more toward content. Ted, a couple of big announcements recently, certainly "Crouching Tiger, Hidden Dragon," and then also the Adam Sandler deal. I'll just hit on the latter. Can you talk more about how data influenced the decision to do the four-movie deal with Adam Sandler? Can you talk about his global appeal as well? Do you think there are other actors or actresses that could have similar appeal for Netflix going forward?
Sure, Doug. The Adam Sandler decision was driven by following market after market, seeing Adam's films from his deepest catalog to his newest releases outperforming, not only outperforming their box office, but performing wonderfully in every territory, defying conventional wisdom that American comedy doesn't travel. More importantly, he really performs well in the box office in our key markets like Brazil, like Germany, like the U.K. His last movie was 60% international. Adam is not only a proven 20-year star, meaning he has a movie that performs well in the box office every summer for 20 years, he is a real global superstar. We see that in the data, and the more international we get, the more access we have to those data points versus relying on conventional wisdom of generic thinking like that American comedians don't travel so well.
We're really proud of the deal, and we think that our subscribers are going to love having access to those movies immediately through this new deal.
Ted, you mentioned, or the letter mentioned today that it's more efficient for you to buy movies this way than buying it in your pay one window. Can you talk more about that? It seems to me that if you are a successful film producer, you want to use the windows to monetize all your consumer touch points. Why is it more efficient to do it this way versus pay one?
Well, there's a couple of ways to think about it, Michael. The main one is access to content that people want to watch. I think this long, protracted window model was fine before on-demand was possible. Consumers now expect to see content sooner and have access to content in earlier windows in the formats that they want to watch. In this case, we're talking about Netflix, and the current pay model doesn't deliver movies to us till about 10 months to a year after theatrical, and in some cases, nine years after theatrical if it's sitting behind someone else's deal. If you look at a successful film and you roll up all the licensing fees in each territory, it is possible there's an economic trade-off that you are paying less to produce the film than you are to license it.
This model, to your point about you want to exploit those other windows, for us, this is programming cost, not an individual P&L on each film.
The broad point here is, especially with the Adam Sandler multi-movie deal, it's establishing a sense in the subscribers of, "I'm thrilled with Netflix because I'm into Adam Sandler. I watch this, and now the next movie and the next movie comes." Think of it, with us playing with this idea of episodic and serialized, but now in the movie form and seeing what kind of great brand allegiances we can create for Adam's fans. That's not everybody, but they're very identifiable. I think it's a very creative approach that Ted's pioneered here.
On that note with the Adam Sandler deals, Ted, can you just talk to us about how you'd actually measure the success of these kind of partnerships given that you don't have the traditional barometer of the box office to track here?
Yeah, I would think about it the same way we look at the successes around original series or any of our licensed series. Relative to what you're paying, do you get this kind of three legs of success, with the viewing, the brand halo, and the net subscriber additions based on access to the content? I think that particularly in this one is we try to be as consumer-friendly as we can, and I think the model here is telling us is that consumers want access to those films sooner and that we could build a model that's economically feasible to do it. You should think about measuring success the same way we do series, and do people get excited about Netflix because of it?
I think as Reed pointed out, I'm as excited about this as I have been since we talked about "House of Cards" a couple of years ago about the potential impact on the brand and the subscriber enthusiasm around it.
Ted, in the U.K., we found some data that suggests that younger households are consuming a lot more Netflix than older households. Penetration rates are higher. You mentioned in the letter that you had a concerning five series, kids series with over 2 million views. Can you talk a little bit about what does that mean? Is that over a week? What duration is that, and is that globally?
Those are active titles that are currently being watched, that's a domestic number. We wanted to point that out because, relative to other outlets for kids programming, that's a pretty big number, and particularly in that kind of volume. Those are domestic, and you could think about the international and domestic split roughly similar to our subscriber base.
Within what time frame? Is it on a monthly basis? Is it cumed over time?
They're currently active titles and they're cumed for active titles.
Okay. All right, thanks.
Ted, on Crouching Tiger, Hidden Dragon, some of the major theater chains here have responded pretty negatively early on in terms of the day and date IMAX release and Netflix streaming plans. What happens to the economics of your film strategy if some of those major chains prevent IMAX from exhibiting the film?
Very little economically. I think the key to it is we would like to give the consumers the choice to see a big film on a big screen. Crouching Tiger, Hidden Dragon is not a direct-to-video, low-budget sequel. It's a big film. It'd be fantastic to have the opportunity to see it on the IMAX screens at the same time, and IMAX has made arrangements with us for that to happen. I think it's as expected, the theater chains reacted negatively publicly. I think the real story will unfold on August 28th when the film opens, and we see if it's on those screens or not.
Reed, in the past quarter, it looks like in Canada, a local tribunal, the CRTC, was asking for some data regarding Netflix that you guys were not willing, because of privacy, to share. Are you worried that governments and regulators will start asking for even more disclosure and try to enforce more traditional regulatory pressures upon your business?
It's super important that Netflix maintain a reputation with consumers for protecting privacy against a wide range of players. You'll see us be a really staunch ally of the consumer. Will there be conflict with certain government agencies? There may over time. We're not seeking to have a fight. We're going to try to work well with everyone, and certainly as an example, in France, I think we really turned around what could have been a difficult situation into one that was quite positive. We're getting better and better at those government relations skills where we don't have to have a battle.
It's probably worth mentioning, Michael, in Canada producing Netflix content, particularly in the animated space, we're one of the largest employers in Canada for animation executives. There's, I think, something on the magnitude of $140 million a year being poured into the Canadian economy, producing animation for Netflix. It's pretty impressive.
David, can you talk about just how the amortization of these newer movie deals are going to be recognized on the financial statements? Then just in particular, can you go into some more detail? I know you talk about it in the letter some, but just the dynamics around free cash flow and EPS as both a function of some of the heavier content investments and then also the international expansion as well.
Sure. I'll take the amortization question. In terms of how the movies will be amortized, they will be accelerated, like our large original series are. Until we have more data to challenge that, whether it should be faster or slower, we'll take that assumption that they'll be accelerated. Then your second question was on free cash flow relative to net income. We put the graph in there to illustrate the separation that happened in Q3. We've been saying this for quite some time in terms of the pressures on cash being the expansion of content, including produced content, as well as the international expansion, because it forces the loss lower. I would say, it's still consistent when we talked about a 1.2 to 1.3 ratio of cash outlaid to content P&L expense is still consistent.
If we spend $3 billion globally on content and growing, even taking the 1.2 or the 20% ratio, that's $600 million of cash laid out for content over and above the P&L expense. We expect these trends to be persistent. I think that we have $1.7 billion in cash. I think we're okay for the next few quarters, but we continually look at this and if we continue to expand both content and international as we expect to do, then you should continue to see some pressure on the free cash flow.
Ted, can you talk a bit about off-network syndication? In the past quarter, you were able to license both "Gotham" and "Blacklist" a year after they aired on network television. Can you talk a bit about what's changed in the model, and what's the cost of those types of purchases versus maybe library content?
There's other variants on the model. Like in January, you'll see "Better Call Saul," the "Breaking Bad" prequel, that we will be licensing in all of our other territory, and a year after in the U.S. and Canada, and then in the first run in every other territory operate in. We're super excited about that one, too. I look at it about as all these models are changing pretty rapidly, there's multiple buyers in the market. I think at any one piece of content, the bidding can get pretty intense, but overall, the content costs are pretty consistent on all these new models. I think operating in 50 different countries and being willing to operate in multiple windows gives us a real advantage in the market. We're excited about that.
Ted, there have been some comments in the press recently, and I think coming from agencies essentially, that really the foundation for the agencies in selling to a streaming service, back ends, of course, are typically their foundation, but selling to a streaming service with a perpetual deal, they wouldn't necessarily know where that back end would come from if there may not be a second sale. Does that create a problem for you in buying content rights across all markets, and do you see any pushback there?
No, Doug. Just like every time you press into a new market and a new window and a new paradigm, you got to figure out how to make it work in the old world, too. I think these problems were contemplated back when HBO started doing original series before they had a DVD business, before they knew if they were going to syndicate. I think those are all navigatable and have been navigated in the past, and we're navigating them as well.
Reed, a question on internet net neutrality. One of the things we struggle with looking at broadband investment is if the interconnect fee is capped or protected or capped zero, how do investors in broadband plant recoup their investment if they can't charge interconnection? How does the Comcast investor or the pipe investor think about returns on their investment if they can't charge for interconnection?
Well, the simple version is, they collect revenue on the internet from their customers, that pays for the network, we don't ask them to pay for our content, and we don't think they should ask us to pay for their network. That's the basis of the no-fee interconnect.
David, I think U.S. marketing spend was down about 5% year-over-year, more than 200 basis points as a percentage of revenue. Why spend fewer dollars in Q3 if the growth was slowing down and you were coming in below forecast? Could this have hindered sub growth? How should we think about that marketing dollar trend going forward?
I think back six, eight years ago, there was a much more direct connection between our marketing spend and our net additions in terms of bidding on bounties for people to sign up via a click-through on an online ad. I don't think that's true anymore. I don't think that whether our marketing spend is up 10% or down 10%, there's an immediate direct connection felt on our net addition growth. When we look at our marketing spend, we look at a number of factors. We look at what content and what opportunities we have to spend against that in a quarter. We look at what our margin targets are. There's a number of things that go into that. I wouldn't say that that was a large influence on the year-on-year decline in growth that we saw in the U.S.
Reed, over the past weekend, our home, which uses FiOS, had trouble getting onto Netflix, which is a good problem to have. I wonder, what does your research tell you about satisfaction levels when there's a buffering or connectivity issue, and how does that get solved?
I'm surprised that you got an issue. Verizon's done a lot of investment over the past three months to get the average speeds up, and what's remarkable is how quickly they've been able to expand the interconnect, so that the average speeds for Verizon are now some of the highest in the United States. Still not as high as many of the speeds in Europe, but some of the highest in the U.S. It should be very rare, and I'll have to follow up with you and we can take a look at the logs for your home if you're comfortable with that, and we'll see what was going on. Maybe one of the kids was doing some illegal downloading.
It's my problem.
Reed, just in thinking about the U.S. versus international markets, can you compare and contrast some of the challenges with peering, with interconnection and net neutrality, especially in markets internationally where we may be seeing some consolidation? Do you see any elevated challenges in some of those new markets you might wish to go into in 2015 and beyond?
Outside the U.S., there's much more of a common regimen of settlement-free interconnect. The whole charging for interconnect is really an artifact of size. Comcast is the biggest, so they get to charge the most, and then it goes down from there. It's straight power dynamics, as opposed to costs or anything like that. It's a much friendlier climate outside the U.S. for settlement-free interconnect.
David, can you update us on foreign exchange? I know it's still early days and you guys are growing internationally, but is your cost base denominated for the most part in U.S. dollars, and is the revenue base dominated internationally? How does currency affect you guys next year?
It's a mix, but it's actually very quite small. It's under $1 million of P&L effect. On sort of valuing the balance sheet items, there's a little bit more of an effect, especially against the British pound. I would say there's a mixture across it, so there's some natural hedging that occurs, but right now it's actually quite small in terms of an overall influence on our EPS and on our P&L.
Reed, or perhaps David, can you review the economics just around how the through the middle kind of set-top box relationships work, and perhaps talk a little bit about how some of these newer dynamics or relationships in Western Europe may be relative to earlier deals and some of the smaller stuff, for example, that you've had in the U.S.?
I think we'll both tell you the same thing, that we can't tell you much about those deals, that we're comfortable with the economics. We've done lots of deals in the U.S., first with Xbox, then with PlayStation, Apple TV, et cetera. We've been doing these kinds of deals for a long time.
Reed, as HBO starts building out in the U.S., you've had experience in the Nordic region where they've competed with you. Can you share a bit what you've learned within the Nordics, and what does it mean for overall television consumption in that market?
Yeah, each market's unique. I think they've had some teething problems initially two years ago that they probably would not have in the U.S. I think they've been licensing broadly. They've just licensed a number of Starz titles, so they're willing to license beyond their core platform. They've done pretty well, and we've done very well. What we've talked to when we talk to subscribers there is if they're into content, they subscribe to both services. I really think we're going to see this just really fun couple of years where the two of us compete for the best content, the most Emmys, the subscriber growth, and many, many people will subscribe to both services. We're looking forward to that. We're just excited that HBO's really in the game with the internet. They're the leader in their field. They're well ahead of their peer group.
They're ahead of the broadcast networks in this dimension. It's exciting to see.
David, you updated the U.S. margin outlook to the 200 basis points of expansion per year and getting up to 40% over five years, of course, after you hit 30% early next year. How do you get comfortable that you can still invest what you need to in content in the U.S. and also do that 40% longer-term margin?
Well, I think Ted would tell you that he'd take everything that we can give him. I think that even with the shift to the 200, it still allows for some pretty significant expansions of both licensed and produced content. We feel pretty comfortable about the room for continued growth of the quality of the content. I think it provides a little bit of discipline in terms of making sure that we spend that marginal dollar well. I'd say that we're pretty comfortable on both senses.
Any chance you want to share more on what sub-number that 40% implies five years down the line?
It implies continued growth.
Michael and Doug, we should do one more question each, and then we should wrap it up.
Okay. Thanks, Reed. I have one for Ted. I believe one of your content deals early on had a put option for a company to actually put shows to you. I wondered, what do you think will happen to that agreement longer term, and should we expect some more of a big bundle of shows put to you in the next one or two years?
All those deals, especially the early deals, are very organic, and they've all been in various stages of renegotiation and extension and redefining. There's nothing looming that's troubling in that way. Because remember, they were mostly designed at the beginning to gain access to the content, not to try to avoid getting the content. There's nothing out there that we're nervous about or concerned about in our existing deals about a put that could be just looming out there.
Reed, a question that we frequently get still is on pricing. We obviously saw what we thought was a small pricing change in 2Q, but perhaps had a bigger impact in the third quarter. Does that mean really as we look out over the next couple of years, that you may not do anything in terms of pricing, or do you still think that you'd look to experiment and potentially do things around tiering?
We'll definitely be listening closely to our members. As we add more and more great original content, then I think we're more valuable to consumers. We're seeing an adjustment period. That's this quarter. We're learning how to do that. Over the long time, consumers pay for value, and it's up to us to front-load that value. Boy, the slated content that Ted has for next year, it's really exciting, and it kicks off with "Marco Polo" in early December. With that, let me thank everybody for joining us on this call, and I look forward to catching up with all of you over the quarter. Special thanks to Doug for his year of service. We'll continue.
Thank you.
Thank you.