Good day, ladies and gentlemen, thank you for standing by. Welcome to the Netflix fourth quarter 2012 earnings Q&A session. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session, and instructions will follow at that time. If anyone should require operator assistance, you may press star then zero on your touch-tone telephone. As a reminder, today's conference may be recorded. It's now my pleasure to turn the call over to Ellie Mertz, Vice President of Finance and Investor Relations. Please go ahead.
Thank you, good afternoon. Welcome to the Netflix fourth quarter 2012 earnings Q&A session. I am joined here by Reed Hastings, CEO, and David Wells, CFO. We announced our financial results for the fourth quarter at approximately 1:00 P.M. Pacific Time today. The shareholder letter and the Q4 financial results and the webcast of this Q&A session are all available at the company's investor relations website at ir.netflix.com. As is our standard practice, we will begin the call with questions received via email. Please email your questions to ir@netflix.com. After email Q&A, we will also open up the phone lines for additional questions not covered by the email Q&A or the investor letter. The dial-in number is within our investor letter, but let me repeat it now. Please call 760-666-3613 if you would like to get in the queue.
We may make forward-looking statements during this call regarding the company's future performance. Actual results may differ materially from these statements due to risks and uncertainties related to the business. A detailed discussion of such risks and uncertainties is contained in our filings with the Securities and Exchange Commission, including our annual report on Form 10-K filed with the Commission on February 10, 2012. A rebroadcast of this Q&A session will be available at the Netflix website after 6:00 P.M. Pacific Time today. Let's move directly to questions. As is our standard practice, we've organized the questions by topics as we've received them this afternoon via email. First topic, questions on domestic streaming. To what extent would you attribute the growth in subscribers to mobile, particularly tablet adoption? How much of usage is over mobile devices? Same question for connected television.
Both the rise of tablets, phones, and the rise of smart TVs are very helpful to us. They're really the beginning of a trend around internet-connected ecosystems with devices. Certainly, the more convenient those devices get, the more people will feel comfortable watching and enjoying content on a wide range of devices, someday including Google Glass, internet-watches, all kinds of scenarios over the next five years, and as well as multi-screen scenarios where you use your tablet or phone to choose content on your TV. What we'll see over the next couple of years, and we saw in this fall also, was more and more consumer adoption of internet-connected screens, which are both tablets and smart TVs.
What is the % likelihood that you increase the price of your streaming plans over the next 12 months or even over the next 24 months?
We're happy at $7.99 and not speculating on the future.
You talked about improvements in both voluntary and involuntary retention. Can you give us some color on where churn levels are relative to historical numbers? Are you back to pre-fall 2011 levels?
That was a really different business when it includes DVDs, I'm not going to focus on that comparative reference. What we are doing is seeing nice improvement, again, relative over this last year when we've been on the straight streaming side, and we'll continue to look at that. The fundamental, though, is not to focus, or we don't focus on churn because we really want to make it easy to quit. I know that sounds strange, but we spend a lot of time so that if you leave, you have a really good experience, and that makes you much more likely to come back in. We think that's the right way to build a long-term growth in paid adds, but it does result in easy exit.
I would say that our rejoin continued to be a very strong channel for acquisition, and that continues to be the case. We've seen that in Q3, Q4, all the way through the quarter, and that's a function of people flowing in and out of the service. Because we make it easy, they don't feel trapped by a contract, and it's very easy for them to come back in the service when their lifestyle warrants signing up again.
How much confidence do you usually have at this point going into Q1 relative to other quarters, given all of the sub adds that come in early January from holiday devices?
It's marginally better than other quarters in terms of % of the quarters numbers that have come in by the 20th, but it's not hugely material.
All right. Moving to questions about content. First, questions on the Disney deal. You made a bold and expensive move with your output deal with Disney. Presumably, the magnitude of the Disney deal will result in your devoting less content dollar resources elsewhere, even accounting for subscriber growth. What types of content are likely to be sacrificed as a result?
Well, the way Pay-1 deals work is you pay per film, the flow in 2016 that would hit in the second half of 2016 are relatively small in total payments, and you don't really get a full load of the payments until 2018. It's a long way off. We've got a lot of content to look at between now and then in terms of what generates the most viewing and satisfaction and a lot of flexibility to build the best service that we can by that point
What changed the attractiveness of the Disney content, which last year only accounted for 2% of your streaming hours? Was it solely the ability to be exclusive? Was it the Lucasfilm acquisition?
It is pretty amazing that the Disney content, when it was on our service from Starz, was only 2%. It just shows you how much incredible great content that we have, that content as good as the Disney content could only be 2%. Going forward, in addition to the straight Disney content, we have the Disney Marvel content and the Lucasfilm. It'll be bigger than it would've otherwise, but the rest of our content is growing. The big thing that we're excited about with the Disney content, once it eventually flows in, is it's fully exclusive to Netflix. As we've been talking about, we're more and more interested in exclusive content. Yeah, I think it hits that point of differentiation that we've articulated before as part of our content strategy. That exclusivity allows us to have that differentiation in the long term.
How are the terms and conditions of exclusive Pay-1 deals, such as the recent Disney deal, similar to or different from typical content deals?
We don't typically discuss terms on individual deals. I would say that deals like the Disney deal and other output style deals tend to be more cash intensive upfront, but other than that, are not remarkable in any way. You pay per film based upon the box office performance.
Are there any material holes in your content library still, in terms of studios or categories you feel you need to have?
I would say, there's much more than holes. There's vast amounts of additional content that we want to acquire as we grow. The virtuous cycle for us is to gain more subscribers and get more content. What propels our growth is that continuing content. There's no specific hole. We'd like to get more movies, we'd like to get more prior season television, we'd like to get more originals. In general, as we grow, we'll be able to deliver on that more and more for consumers.
Netflix described its library in terms of three groupings: movies, serialized TV, and proprietary content. The first two buckets are extremely large compared to proprietary content. Should we expect a large slate of proprietary content that launches in the future? Does your hierarchy suggest that despite being small, the proprietary content value is on par with movies and serialized TV?
It's early for us on the proprietary original content. We'll know a lot more maybe on the July call after we've launched "House of Cards" and after it launched "Arrested." We'll be able to comment a little more, at that point, we'll make decisions about how much we want to invest in it, do we want to increase the investment, keep it about the same, do less. We'll have a lot more knowledge. We're going to take our time and for the next six months, just focus on the current originals. I'd say the bar on the we've said this before, but it's worth articulating again. The bar on the originals is that it performs in similar to other third-party licensed content that is exclusive. If the originals are exclusive for us, and they are, we would look to do that better inside.
If we can't, we wouldn't pursue that. There's the brand halo effects and the PR effects that we get from it, those are very, very attractive. That comes from the exclusivity as well.
Give me some more questions on originals. This year you will have four new original series on Netflix, plus "Lilyhammer." What are your plans for 2014? Presumably, you have some idea now, given the long lead times on original programming. What % of content costs do you envision for original programming next year?
Again, we haven't made the decisions for next year in terms of what % of our budget will be original content. We're going to look at the results, look at the viewing, the overall press attention, subscriber acquisition trends, all of the factors before making those decisions.
How do you plan to market "House of Cards?" How does your approach to marketing the show differ from how traditional cable networks market their shows? Do you envision creating a section to highlight original programming within the Netflix service over time?
The huge benefit is that we don't have to advertise, 8:00 P.M. on a Thursday night, tune in. We get to let people know about the show, they can watch it anytime at their leisure. That lets us be much more efficient in our marketing and much less focused on a specific date and time. Mostly, we're going to be able to generate tremendous demand through our service by targeting the specific online ads on the service, the content for the people who it would be relevant for. We'll get tremendous viewing from our 33 million global members. In addition, we're also generating a lot of attention in certain cities, doing a highly concentrated, large-scale promotion to be able to see what the effects of ours to stimulate the creative community awareness and generally build a lot of buzz around those shows.
We're very much looking forward to that launch.
For a few of Netflix's upcoming original programs, please discuss the specific rights Netflix owns and the monetization strategies of the other rights holders. Which monetization channels, if any, does Netflix view as most complementary to its streaming business over time?
Well, I think that's something we'll learn over time. If you look at HBO, they experimented and had great success with DVD as a channel for their content. They did some syndication. Then they pulled back on some of that. I'm sure we'll try some of the same things, trying to see what makes sense. The current originals mostly were our first window licensor. For example, on "House of Cards," Media Rights Capital owns the other rights, and they'll be monetizing those downstream from us. We'll try different structures as we go forward. Primarily, we're focused on monetization on our platform.
You said that "Arrested Development" could bump subscriber growth in Q2. Can you point to any good data that supports this view? Expressions of interest by Netflix subscribers, surveys that point to interest or anything like that? How would you compare interest in "Arrested Development" to interest in other originals queued up this year like "House of Cards" and "Hemlock Grove?
Well, it's a great question. In the case of "Hemlock Grove," it's a new property like "House of Cards," and the same with "Orange Is the New Black." That'll take some time to develop for those shows. "Arrested" is unique because it's already got a big brand. It's going to be more front-loaded in its overall viewing and attention. In terms of hard data, it's very hard to predict what will happen in terms of membership in Q2. I think what we'll do is we'll be cautious. It's not particularly built into our forecast. Then we'll see what happens in Q2. Then from that basis, we'll be able to project going forward.
A question on accounting for originals. Over what period of time are you amortizing the upfront cash spend on important originals this year, particularly "Arrested Development" and "House of Cards?
Well, the accounting for originals is similar to or is consistent with the accounting for our full library, which means we amortize it straight line over the license period. I would say the question was asked about amortizing the cash. It's not the cash that gets amortized, it's the expense of that full title. When we have quarters like Q4, and we talked about Q1 being intensive for originals, we'll pay depending on the terms of the deal, heavy upfront payments, even upwards of 50%. That content will come into window later in the year. You'll see the cash come out in terms of the cash flow, but there's no offsetting expense. Some of it flows into prepaid content as you see. You'll see that cash be less as we go through the year and the expense starts to catch up.
How do you look at original Netflix content? What are your expectations for how it will perform in the U.S. and international markets?
Very strong.
How do you decide which original programming to invest in and stream? Do you look to reach certain segments of your sub-base or best available programming or other factors?
Well, again, we're at very early stages. I think Ted Sarandos has done a great job of different types of content. "Hemlock Grove" and "House of Cards" are quite different. I think you'll be very pleased with "Orange Is the New Black." Of course, "Arrested Development" will be a huge winner. I think it's just too early for us to have any great confidence. We're staying flexible, learning, and we'll grow into original program step by step.
A few questions on competition. Do consumers need to choose between Netflix and Amazon? In the past, you've referred to HBO and Netflix along the lines of baseball and football. Do you feel that way about Amazon too? Netflix and Amazon both have exclusive content and original content, will it make sense for consumers to have both rather than choose between them? Do you think the two services will take on different identities and be the two leading digital cable networks of the future?
Well, some of this is already happening in the U.K., where LoveFilm, Sky, Now TV, and Netflix have nearly no overlapping content. The press tone is shifting in ways to be getting both or getting all three as they're different channels basically serving someone's total need. Of course, not everybody has infinite budget. Everybody's budget is tight. There's real competition for choosing us if you need to choose. I do think that many people will choose to get multiple services, like we compete with HBO. Today in the U.S., Amazon Prime content has started to be mostly a subset of ours and is then going to add original content, and Hulu has done the same. I think over time, there's a pretty good likelihood that we'll compete like we compete with HBO.
That is, we'll all have different shows, and all will be competing for dollars and attention, but not have the same content.
Can you help us understand your methodology behind the top 200 title comparative analysis? Do you use ratings, actual viewing, et cetera?
We use actual viewing hours in Q4 on our Netflix service. In the U.S., those would be for each title in there, not just a season, but a title of an entire show, how many hours that was viewed basically during Q4, and that's the methodology behind that.
Moving to questions on international. On previous calls, Reed has stated his intention to continue to reinvest in international expansion once you get back to profitability. Can you update us on your current thinking on this topic?
I can let Reed speak, or I can just reiterate what we said last quarter, which was there's two gating items or gating conditions. One is global profitability, which we're really pleased that we continue to demonstrate even with the Nordics launch in Q4, and the second condition being that we're pleased with the path of our existing investments. Those two conditions still hold.
Two quarters ago, Reed spoke about raising the content spend in the U.K. Do you have a sense whether the expanded offerings in the U.K. have impacted the subscriber growth or churn in any meaningful way?
Yeah, absolutely. We've continued right from inception, frankly, in all of our territories, in Canada, Latin America, and in the different nations in Europe, to expand the content. Expanding the content has definitely increased viewing, decreases churn, makes the service better. We're very eager and ambitious to get more and more content on all of the services, including the U.K.
Has the competitive environment in the U.K. evolved over time? In the U.K., are you seeing different levels of net adds, churn, et cetera, given a potentially more competitive environment?
The only real change in the U.K., and LoveFilm been there from our launch at the same price that they've always been at, has been Sky's Now TV, which launched in the fall. That's increased. There is active marketing going on between us. As far as we can tell, those services are doing well also. It comes back to this, it may not end up as a zero-sum game. We want to get the biggest piece of the pie, it may be that people subscribe to multiple of the services.
Can you tell us if the payment changes made in Latin America had a material impact on sub growth in Q4, or will it help the Q1 numbers?
It helped a little bit in Q4, will help a little bit more in Q1, and we've still got progress to come.
I'd say it was an incremental improvement.
What penetration of sub levels do you need in any given country in, say, Europe or Latin America to reach breakeven? Roughly, what is the time to achieving that now?
It'll depend by market. In some markets, we'll get there relatively quickly. Others will take longer. There's no precise level of penetration. It depends. For example, in Latin America, you'll end up at breakeven at lower overall household penetrations because the internet is at lower penetrations. I would say each market is unique in this way.
In the past you've said you believe Netflix can grow its domestic sub base 2x-3x out of HBO long term. What are your expectations in the various international markets that you have entered?
Let's see, our hopes would be that we should get to similar house internet or broadband household penetration levels as we can in the U.S. Until we actually prove that that's possible, we're a little cautious on forecasting it. In principle, when you look at internet usage or YouTube usage or television, both paid television and free television, it's pretty ubiquitous across all these societies. The notion that over 10 or 20 years Internet TV is as strong around the world as it is in the U.S., is pretty sound.
Can you achieve long-term international contribution margins equivalent to the U.S. without the same amount of scale in any single region?
I think we would need the same. The contribution margin is a factor of the scale. I think we would need to get to that scale.
It's scale and competition. I would just add in competition. Those two things are the primary determinants of long-term margin.
You expect more modest quarter-over-quarter improvements in international losses beyond Q1. Is that because of lower sub-add expectations or an increase in spending relative to sub growth?
A little bit of both.
Now to a question on the DVD business. You appear to be marketing DVD subscriptions to streaming-only subscribers again. We're noticing more email promotions offering a free month trial to the DVD program. Do you really want to push people back to DVDs? Isn't it a bit confusing to consumers given your intense focus on streaming being the future of media consumption?
I would say this is, David here, it was a program that we did around the holidays and into January. I think you'll see us use it sporadically. I wouldn't describe it as a large program. It was incrementally positive to our DVD subscriptions. We faced a lot of criticism 12 to 18 months ago that we weren't doing enough in terms of monetizing some of the failed search opportunities on the DVD, on the website, and so forth. I think we've cleaned a lot of that up. The email program campaign that you were talking about is an evidence of us doing a little bit. We A/B test a lot of this, and usually when we do something, it's going to be an incremental positive.
Now a question on Open Connect. Could Super HD and 3D streaming theoretically be extended to ISPs without Open Connect, without significant engineering investment? Asked another way, is Open Connect a prerequisite for technical reasons or more for strategic reasons?
It's a mix of both. I think what companies do with new features, like Super HD, is they focus on newer platforms, whether that's Siri only available on an iPhone 5, say, or something like that. It both gets people to adopt a new platform and allows you from an engineering side to concentrate on a simpler use case. Being able to support Super HD and 3D is demanding. Open Connect is free to all ISPs. We don't anticipate much of a problem, and I think what we'll find is by doing that, we can be more efficient not going through middlemen.
A question on streaming delivery costs. Did Open Connect drive delivery costs down in Q4? Was it better pricing from suppliers?
Delivery costs, I'm not sure you could read into that as a result. I would say that our Open Connect program has investments that are front-loaded. To the extent that we're rolling out our Open Connect program, there's a little bit of expenses that are loaded into Q4 and into 2013, depending upon the pace of our rollout, and that those should moderate going forward. I think the question is in reference to in the letter, we said that the U.S. contribution margin was better because of just some delayed expenses that'll show up relative to planning in Q1 than Q4.
Thank you for the clarification.
Yeah. Some timing around expenses for Q4. In general, delivery is something that's a relatively small % of our total cost. It works quite well. It's relatively inconsequential.
A question on the social experience. Please discuss Netflix's experience with social media integration in international markets. Could you provide some common examples of how Netflix uses social media in international markets? How do you expect social integration to impact your U.S. business?
It'll be a nice thing for us. I don't think it's going to be huge. It hasn't been huge for us internationally. It's very segmented. There's a section of a group within each country that loves social, they're really into it on Netflix and probably every other site that they use. Then there's a lot of people for whom that's not why they're there at Netflix in terms of a social aspect. Of course, over time, those ratios will shift. For now, all of our social work really caters to a specific, typically younger but very social-centric demographic. It's a good investment. It's making good progress. We're thankful the VPPA passed, the change to it, we'll continue to make progress on this front.
Questions on the financials. How should we be thinking about 2013 in terms of profitability and margins? Similar to 2012 as a heavy investment year, or a year where we start seeing leverage in the model? If so, how much?
We should see leverage in the model. We haven't made decisions in the back half of the year on international expansion, obviously that'll matter as well. We probably have 7 million reasons not to give full-year guidance right here, we'll avoid doing that this year.
We might also make the point that we saw considerable leverage in the model in 2012 in our Domestic Streaming segment, where we saw 700 basis points of margin expansion.
Yeah, we can be confident that it won't be as big as that. We hope.
Profits overall are somewhat exceeding guidance, do you think you might increase investments in marketing content and/or additional country rollouts in the near to medium term?
No, that's not directly affecting us. We outlined in the letter, we're feeling good about those plans.
You talk about the goal of 100 basis points of contribution margin expansion sequentially in domestic streaming, you don't indicate how far out that goal extends. Can you talk about what your thinking is related to long-term, i.e., multiple years out, domestic streaming contribution margin?
Well, it'll be a function of competition and how much of the market, the total addressable market that we can collect. For right now, we're focused on the target of expanding that routinely by growing faster, basically, than our content, than expanding our content expense.
What is the size of the off-balance sheet content liability?
I think the question usually I get on this is related to the contractual obligations table. The streaming obligations were $5 billion as of 9/30, as of the end of Q3. That corresponds to a $5.6 billion number as of the end of 12/31. $2.5 billion of that is on the balance sheet, $3.1 billion is not on the balance sheet.
Do you expect to be free cash flow positive for the full year?
We don't provide full-year guidance on that.
Can you give a sense of how much money you plan to raise in the debt offering? Did you consider using stock? Would the potential new debt financing be straight debt, or could it be convertible debt? When would it occur?
No on stock, no on convert. I think the plans that we put in there are still sort of an opportunity and exploration base. It's really based on the 20-plus year lows that we see in the debt market. It's a good time to lock in very low-cost, long-term capital. We'd be remiss in not looking at that opportunity.
Will additional financing be needed if you decide to open new international markets in late 2013 or early 2014?
No.
Your marketing costs in domestic streaming have fallen 24% year-over-year, yet you've been able to grow your top line significantly. How sustainable is your Q4 marketing spend, and how do you think you're gaining efficiencies in marketing?
Very sustainable on the Q4 marketing spend. The second part of that, what efficiencies? The main efficiency comes because most marketing is on members telling their friends about Netflix. It's not the ads that we pay for. As we have more and more members, and as they're happier and happier with the service, then that benefits the growth, and then you don't need as much paid marketing. Let me say also, we put in the letter about we're expanding our content expense, and that has benefits in terms of getting people excited about the site, retaining better. All of that is a quasi-marketing expense. Is Arrested Development a marketing expense or a content expense?
Will the company break out cost of subscription versus fulfillment expense for the quarter?
Not likely. Fulfillment has grown to be a pretty relatively small portion of our cost of revenues as our DVD business continues to scale down. It's a small portion of cost of revenue.
Great. That's the end of our email questions. Let's turn it back over to the operator to take live calling questions.
Yes, ma'am. Ladies and gentlemen on the phone lines, to queue up for a question, please press star then one on your touch-tone phone. If your question has been answered or wish to remove yourself from the phone queue, you may press the pound key. Again, if you would like to queue up for a question, please press star then one on your touch-tone phone. One moment for questioners to queue. Our first question comes from the line of Mark Mahaney with RBC. Please go ahead. Your line is now open.
Hey, great. Thanks. Congrats on the quarter. I don't think I've said that on an earnings call in five years. Reed, I know you don't run the business near term, but congrats on the quarter anyway. In terms of rebuilding the brand, Reed, you talked a year ago, year and a half ago, and said it would be a multi-year process in terms of rebuilding the brand. As you think about and survey your customer base now, do you think you've recovered that brand hit that you took in the wake of the controversies?
No, not entirely, Mark. There's still an echo and a bruise. We still are extremely thoughtful and careful about what we're trying to do because it wouldn't take much to have the issue flare up again or for us to lose trust. You might say we're on probation at this point. We're out of jail, but we still got, as we had initially talked about, a three-year timeframe. We've still got a year and a half of probation.
One follow-up question. In terms of the content requirements for likes, the wants of your subscriber base, have you seen a noticeable change in the satisfaction level of your subscribers with current content? Or do you still see there's always going to be gap, but do you think that that gap's kind of narrowed a little bit over the course of the last three to six months?
That would be mostly what drives the improvement in voluntary retention, is that satisfaction with the content. In addition, it's satisfaction with the user experience, how quick and easy it is to choose, how well the personalization works, how well the streaming works. That all comes together in the feeling of satisfaction.
Mark, I would say that the other contributors of that is people when, two to three years ago, when they first experienced a streaming offering, had expectations of a DVD full content library. I would say those people are starting to be a little bit more aware of what's available in an internet channel and an internet network offering like we have. The expectations gap might be narrowing as well.
Thank you, David.
Thank you. Our next question comes from the line of Doug Anmuth with JPMorgan. Please go ahead. Your line is now open.
Great. Thanks for taking the questions. Just wanted to ask about content costs, sort of the outlook for 2013, if you could give us some sense of how you're thinking about the increase here and perhaps in relation to what you did from 2011 to 2012. Just secondly, can you give us more detail on how you improved that involuntary retention? You mentioned processing payments and recovering members better, so if you could give us more color there. Thanks.
Sure, Doug. In terms of content costs, we continue to expand our content library, we expect that to continue to increase. It's going to increase slower than revenue. From that, you can infer that the year-over-year increase for 2013 will be less than the increase that we saw in 2012. The second piece of that question was around how we improved the involuntary retention numbers, that was through looking at a number of optimizations in terms of how we handle folks that go on payment hold.
Thank you.
Thank you. Our next question comes from Youssef Squali with Cantor Fitzgerald. Please go ahead. Your line is open.
Thank you very much. Hi, Reed and David. Just a couple of questions to follow up. Reed, you spoke about offering more personalization on the site, and if my memory serves me right, I think last time we talked about it was several quarters ago, and I think you talked about maybe offering personalization at least of queues by year-end. One, wanted to see what the holdup there was. Second, what other ways can you improve personalization on the site? I have follow-up.
Youssef, we're still in testing on the feature that's sometimes called profiles, where you set up an explicit view of, say, you, your kids, your spouse, and then each person gets their own area. We're trying to find models that give great benefits to consumers but are also very simple. That's where we're involved in a lot of testing. When we get that to a great state, then we'll roll it out to everyone.
Is that still an imminent kind of launch, or has the date on that been put back on hold?
It's not imminent. We're still in testing mode. We think we've got in something like that, you don't want to roll it out and then change it a lot, so you want to do all the tuning in test mode. Sometime over the year, I'm sure we'll launch it, assuming we find a model that works really well with our testing. It's not imminent.
Okay, great. Just lastly, as you integrate with Facebook for more sharing or social personalization, I was wondering if you'd have any interest in participating in Facebook Gifts program, which is something I'm sure you're aware of that they launched not too long ago. They have other retailers like iTunes, et cetera. Is there anything that would preclude you from wanting to participate or being on that program?
No, there's nothing that would preclude us.
Is there interest on your end?
I should know more about it as a Facebook board member, but it's very new. I'll take your hint that it's a good thing, and I'll go spend some time on it.
Great. Thanks a lot. Congrats.
Thank you. Our next question comes from Scott Devitt with Morgan Stanley. Please go ahead. Your line is open.
Hi. Thanks. Reed, now that the U.S. business has gotten back to this level of strong growth, I was just wondering if you could revisit that U.S. market opportunity, how you're thinking about it, that 60 to 90 million figure, and the points of friction that you're facing from here to grow that U.S. sub base to a much larger level. Secondly, for David, in the 1Q guide, I think you noted that 2Q, you're not specifically attributing any subs to "Arrested Development," but is that also the same thing for "House of Cards?" Is there no specific attribution for "House of Cards" in 1Q? Are you planning any specific TV spend for either of those two shows? Thanks.
Scott, think about it in terms of the content layers. We're at 27 million domestic now. The question is, do we have good enough content to, say, get to 40 million? With that incremental content budget, can we improve the content such that with that incrementally better service, we can get to 50 million? Similarly, we've got more money we can spend on more content. That's one big growth vector. Second is the overall change to internet TV. It's not just us that's benefiting from this. If you look at Hulu's numbers over last year, they doubled from 1.5 million to 3 million subscribers. People around the world are interested in internet television because you can click, watch, pause, control, choose. It's just a better paradigm. As that tailwind continues to develop, that's very helpful.
Finally, it's what happens in the consumer electronics space. It was only six or seven years ago that the iPhone came out. We're now on iPhone 5. If you think about six or eight years from now, by extension, we'll be at the iPhone 10. How incredible will that be for not only viewing video, but maybe controlling video around all of your house and choosing and how immersive. All of that helps internet video services like our own. Those are the three big vectors, the content growth as we grow, the general trend towards internet TV, and the consumer electronics ecosystem.
Scott, on your second set of questions on "House of Cards," we think it is going to be a pretty small benefit for Q1. We talked about how overall it's a generally small share of ours. Really happy about the quality and the fanfare that we're getting with the show, and there'll be some publicity, but overall, pretty small benefit, we think, to subscriber addition. TV spend for "House of Cards," there'll be some media spend, likely very little TV that focus again on sort of influencers in big markets.
Would it be fair to say, David, that it's a very small impact of House of Cards that's modeled into our guidance forecast?
Yes.
Since we have no data to base it on, that's the conservative and correct approach. Some of us are optimistic that it may in fact be substantial, but we really don't know, and we don't want to count on it until it happens.
I would say that's fair. Fair rendering.
Great. Thank you.
Thank you. Our next question comes from Tuna Amobi with S&P Capital IQ. Please go ahead. Your line is open.
Hi. Thank you so much. I think this question is for David. As I think about how you manage your working capital and swings that are resulting from the content licensing payments for originals. I'm just kind of wondering if there's perhaps a better parameter that can aid kind of reduce the swings in free cash flow, not necessarily quarter-to-quarter. As you think about some of the leverage that you might have, for example, perhaps deferred revenues and some other items. I'm wondering if this is the best way to think about that, just kind of managing it to the P&L expense as opposed to something that kind of gives you a little bit more control, granted that the originals are the highest swing factors. Any thoughts on that would be helpful.
Well, I think that the only I'm not quite clear on your question, if we looked into alternate methods in terms of joint ventures and other vehicles to reduce that cash consumption upfront might be the only available method to us. That we prefer the simplicity and we may get there sometime down the road. In terms of the present course, overall, the content spent on originals is a relatively small part. It's outsized in terms of our cash because it's so lumpy up in the first couple of quarters.
Just to follow up on that, on how you think about managing the risk of your original content in terms of shows that you actually collaborate with third-party producers versus shows that you actually own outright. How does that factor into your calculations of cost per viewing hours in terms of your commitment to either kinds of shows? Thank you.
It's Reed here. The good news is any one show isn't an ongoing commitment, it's a relatively fixed bound. It might be that at some point we produce a show that's not very good. What that really means is we only get a little bit of viewing on it as opposed to a lot of viewing. When you think about the size of any single original and the size of our total multibillion dollar per year content budget, it's not a huge risk.
Thank you.
Thank you. Our next question comes from the line of John Blackledge with Cowen and Company. Please go ahead. Your line is open.
Thanks. Two questions. The first on streaming content spend. Given the current level of streaming content spend after several years of large step-ups, is there a normalized longer-term rate of growth or a range of growth that we should be considering? Will we potentially see lumpiness on a year-in, year-out basis dependent on available content? Then for David, as we think about a potential debt raise, is there a certain level of cash on the balance sheet that you're comfortable with? Thank you.
In terms of the lumpiness, I presume there will be some quarters where it's a little bit lumpy, where we sign a big deal. Generally, any big deal we would know about several quarters in advance. We would have that visibility to build in and to let everybody know and then return to the kind of margin expansion that we're targeting. We're feeling our way along as we grow in the market in creating this service. That's why we're focused on the 100 basis points a quarter versus some specific operating model, because we want to get the operating model to be better and better and better. To do that, we have to really feel our way along and to make sure that it's consistent with increasing viewing and with really good and declining or improving voluntary retention.
I'll turn it over to David on the cash.
John, on the cash, as long as the costs are low, more cash is better. I would say this is again about the opportunity presented by the debt market and the ability to get really low-cost long-term capital. For us to preserve the flexibility of if we see massive success with originals, to preserve the flexibility to expand that program and to develop more down the road. I don't think there's a magic number. This is about sort of long-term planning for the business.
That's great. Thanks so much.
Thank you, sir. Our next question comes from the line of Carlos Kirjner with Sanford Bernstein. Please go ahead.
Thank you. I have two questions, one on content, one on the market potential. First on content. When you lost Starz, you said that it accounted for a small portion of viewership time, and hence its loss had little impact on customer acquisition churn, et cetera, suggesting that no specific content deal has a material impact on the customer metrics. If you can lose any specific content deal with limited impact on the metrics, how do we think about the positive impact of content deals such as Disney's or Time Warner's, where presumably you are paying a premium, for example, for exclusivity, or even how do you think about investment in original content?
On the market potential, if you grow your content offer, as you described a few minutes ago, and succeed in getting 50 million or 60 million households in the U.S., how do you think the cable companies would change their broadband pricing levels or structure? Thank you.
Sure, Carlos. That's a good question, which is why do we talk so much about the increases in content about propelling our growth, but when we lose content, we say it doesn't really matter. I think the insight is your part about any specific piece of content. I think if we lost enough content that would definitely decrease viewing. Similarly, when we increase content, we have to increase it by a lot to make a difference. Adding just one movie or something like that or one show isn't going to make a huge difference. The general view we have is sometimes the content additions are so small, 1% of viewing, that we're not going to see a big difference, but that'll accrete. If we do a lot of that will help.
Second on terms of if we get to 50 or 60 million, how does the relations with cable networks change? I think as long as we're building great audiences for them, if you look at what we've done for "Breaking Bad" in terms of building a bigger audience for it debuting on AMC and if you look at "Mad Men," that's a great win-win where we're incredibly good at the prior season. They've got the current season, and they get bigger and bigger audiences. Second, if it's off-air, like ABC's "Lost," then I think it's pure incremental money for them, the fact that we're able to monetize it well. We don't see a huge conflict there in that licensing dynamic.
Reed, do you think there's a conflict potentially with the cable companies like Comcast or Time Warner Cable and Cox if you increase your subscriber levels and using their pipes to transmit the bits for video? I mean, could they change the pricing of cable broadband access?
The cable broadband is very profitable for them, the more that people want to do high-definition Skype and high-definition Netflix. It's inevitable that there's going to be new high-speed packages that are more successful for those ISPs. They've got an incredibly profitable, great business doing data. That's great for them. It doesn't conflict with us. In fact, we, like high-definition Skype, are a critical application to help them drive more adoption of the higher-end packages. In that way, we work really well with them.
Thank you.
Thank you. Our next question comes from Tony Wible with Janney. Please go ahead. Your line is open.
Hi. Do you guys believe that Amazon was in there bidding for the Disney content? What's your appetite for chasing down Sony Pay-1?
Tony, we don't know on Disney, Amazon, and Sony Pay-1. Our appetite's just like it was for Disney. It's strong, and we're interested, and we'll see how it works out. There's no specific piece of content that we must have and it'll just be a bidding negotiation.
Perfect. Thank you.
Thank you. Our next question comes from Nat Schindler with Bank of America. Please go ahead. Your line is open.
Yes. Thank you. If you look at your net sub-adds and then estimate some gross sub-add that you had coming in for the quarter. In domestic streaming, you've said in the past that 30% of those or a third roughly that you touched within the last year and are returned. Has that number changed? Could you think longer than a year, how much of the total market have you touched at this point, do you believe, over the course of your business?
It all depends, Nat, on how you count an entity. Do you count a household where two roommates are, and they try both on their separate email? Lots of people have multiple email addresses, and several of them are willing to enter multiple credit cards to get multiple free trials. There's no clean notion of that. We could tell you how many email addresses we have touched. Mapping that into people and households is pretty tricky.
Makes sense. Thank you.
Yes. Nat, on your first question, it's stayed roughly about the same in terms of %.
Okay.
Thank you, sir. Our next question comes from Daniel Ernst with Hudson Square Research. Please go ahead. Your line is open.
Yes. Good evening. Thanks for taking my call. Three questions, if I might. First, big picture on how you're looking at the business and growth. Profitability has been reasonably above expectations the last couple of quarters and guidance for the coming quarter. Historically, you guys have attempted to manage perhaps not making too much profits and always are willing to invest in growth and how you're thinking about that in terms of new market roll-outs or acquiring new content to really continue to separate yourselves from the competition, sort of color on the investing, profit expectations versus growth investment. Secondly, in a related comment, back in the day, eight, nine years ago, we used to get market-by-market updates. You're at X% penetration in San Francisco, and we got to profitability in X number of months.
Can you give us some sort of directional color like that on some of your international markets in Europe and maybe an update on Latin America there? Third, sort of a viewership question. I know people ask us this before, and you haven't really given us a lot of color, but what is the mix of viewing between connected devices to the TV, the Xboxes and Apple TVs and DVD players and TVs that have Netflix built-in versus tablets and many computers? How does that look domestic versus international, where perhaps some of those devices are less connected to TVs in Europe or in Latin America and sort of color on how that mix in usage is. Thanks.
Daniel, you started it off very nicely about talking about our growth above expectations last year, but I think you have us confused with a different company since last year was difficult on that front. In general, we're pioneering this new service, internet TV, as are other firms. From a macro level, there's a lot of great growth vectors because the internet makes certain user experiences much more enjoyable at lower cost. That's what's propelling our growth, and we are very excited about the growth. In terms of penetration, in the DVD days, we were operating in the San Francisco Bay Area for several years with local delivery before we were doing the rest of the country. That's why we use that as the comp. We don't really have an equivalent. The U.S. is reasonably uniform in terms of DVD viewing.
Each nation is quite different, and you wouldn't want to say every nation's going to be like Canada. There's no useful proxying in that way. Finally, the question was on viewership, and some nations are more smart TV centric, and some are more PS3 centric and Xbox centric. Overall, you see a lot of similar trends, which are tablets are growing somewhat in the absolute and somewhat as a replacement of laptops. Smart TVs are selling. People want to use them. Netflix is the most important application on a smart TV. All of the individual devices like an Apple TV and a Roku are doing well. The whole internet getting to every screen is just a big secular story that's happening and benefiting us.
Great. Thanks. Just to clarify, we were talking about the last couple of quarters being profits above expectations and your guidance there for next quarter.
Yeah, Daniel, let me take a stab at that in your part A. In the past, Netflix has been very good about thinking about that next incremental $1 million or $5 million investment. Is it better in content? Is it better in marketing? Is it better in improving our interface and our product? We continue to do that. You're never perfect in sort of finding out that optimal frontier point. We still continue to think like that in terms of that additional investment, whether it's better placed in an existing market, in a new market, in our product or in our content offering in domestic or international.
Great. Thank you. That's all the questions we have time for. Reed, would you like to offer some closing remarks?
Youssef, if you're still on, we are on Facebook Gifts, I'm sure it's a huge opportunity. Thank you all for visiting with us in the conference, we look forward to seeing you.
Thank you again, ladies and gentlemen. This does conclude today's program. Thank you for your participation.