Welcome to the Netflix Q2 2014 earnings interview. I'm David Wells, CFO. I'm joined today on the company side by Reed Hastings, our CEO, and Ted Sarandos, our Chief Content Officer. Interviewing us today will once again be Doug Anmuth from J.P. Morgan, and joining us today for the first time will be Michael Nathanson from MoffettNathanson, who receives the baton from Rich Greenfield. We will be making forward-looking statements today. Actual results may vary. Our first question comes from Doug. I'll turn it over to Doug.
Great. Thanks, David. Welcome, everybody, and thank you to Netflix for having Michael and me host today's conference call. Our first question, just on international strength, Reed, if you could talk about what drove the international strength in subscribers in 2Q. You called out a couple things in particular in terms of the Virgin deal, in terms of the set-top box integration, and then also smart TV viewing in Latin America. I was hoping you could add a little bit more color on those as well.
You bet, Doug. What we've seen really is just tremendous adoption of on-demand viewing. Consumers around the world, whether it's Argentina, Brazil, Finland, the U.K., it's been really quite consistent. There's some accelerators that we talked about with the smart TV, but there's probably no better symbol of how strong this on-demand phenomenon than to tell you that during the World Cup, we were concerned that we would see a drop-off around the world, particularly in Brazil, that we didn't want to overread it if we saw a drop-off in net adds and growth. What was incredible is just how straight our line of net additions were in Brazil during the World Cup. That's nothing I don't think that we're specifically doing. It's really this growing demand for control and for the consumer to be able to click and watch what they want.
That's why we're stepping up on the international expansion, is because we really see that this is an enormous moment in history as on-demand internet services are coming to the fore around the world.
Thank you.
David, can I ask you one on incremental margins? If you look at your margins in the first half of the year, you're growing your margins incrementally 45%, dropping down from revenues to margin to profits. Why don't you think margins can continue growing at the 400-basis point range that you saw? Why did you identify different levels, the 100, 200, 400 basis point level of improvement? What controls those potential margin levels?
Well, Michael, I don't know if I agree with your premise. I don't think we said that margins will stop growing or will shift to 200. What we said is when we get to 30%, we want to give ourselves a little bit of leeway to reevaluate. There's a number of things that we'll weigh and balance, and that is the competitive set, what we want to spend on content, how we want to grow that, how our average subscription price is growing with the recent price changes. It's still very early on those. There's a number of things that we'll balance out, and we want to give ourselves the leeway to back off a little bit if we think that's the right trade-off to make in terms of spending more on content. It doesn't mean that we will.
It just means that we're trying to create a little bit of room for ourselves, especially with all of those unknowns as we get closer to next year.
Okay, thanks.
Reed, in the letter, you talked about the price changes having sort of a minimal impact on growth overall. Can you just provide a little bit more color? Do you think in terms of the nuances, did it impact churn or help reduce churn in any way during the quarter? What's your view on the way the price change could impact going forward?
I think we've seen really the impact of the price change go through already. It's pretty nominal, both in terms of acquisition, which in principle becomes a little bit harder because of the roughly $1 higher prices, or in retention, which could be a hair better from the grandfathered subs, it's only a dollar difference. I really think it's background noise, which is what we want it to be, is we want to think of what we do as we're steadily improving the content and the growth and the word of mouth, and that when we make a small change in price and handle it appropriately, it really makes no noticeable effect on the business. That's why we're thrilled with that outcome.
Okay. David, I wonder, if you look at your guidance for 3Q, would you have gotten to breakeven internationally in the third quarter if it wasn't for the new market launches? Should we think about the growth rate and costs in the third quarter as sustainable into the fourth quarter internationally?
In terms of our international guide, I think you can see that most of that is our new markets. Yes, we would be pretty close to breakeven, if not at breakeven, for Q3 in our existing markets. The second part of your question was again? Could you repeat that?
If you look at that inflation in Q3 from, let's say, breakeven to where you're guiding to, should we assume that continues to the fourth quarter? It seems like a logical assumption that there won't be a lot of change.
I see what you mean. Just a reminder that our launches that we're saying are in the back half of the third quarter. They're not a full quarter of content spending. You're going to get that full quarter of content spending for the first time in Q4. Our typical pattern has been to grow content spend from the launch quarter. In marketing, it balloons a little bit in that first quarter of growth as we launch a brand-new brand in those markets. It tends to settle down into a run rate. That should give you some trending on our international costs.
Okay. Thanks.
Great. Ted, just perhaps one more question just related to 2Q and then we'll move on. Can you comment on "Orange Is the New Black"? You guys talked about in the letter how it became the most-watched show in every country during 2Q. Are there any other updates that you can provide around usage metrics? Then maybe talk about what you saw in Orange in 2Q perhaps versus the second season of "House of Cards" a quarter earlier.
Well, I think it continued the positive trajectory that we saw from "House of Cards," meaning that the excitement from a second season is amplified from something like a show that people don't really know a lot about yet, or in the case of "House of Cards," before we launched that, no one even know what a Netflix original series was going to be like. Here you've had a large pool of people around the world anxious for that second season to hit. You saw it in the social media buzz. That was really phenomenal for that launch. It gives us a lot of confidence for the outlying seasons for "Orange Is the New Black" and our other original series as well.
Okay. I have one for Ted and for Reed together. Last week, Fox announced interest in acquiring Time Warner, two companies you know a lot about. If a merger were to occur, how do you think that would affect your negotiating leverage to get acquired and original programming? Is this a deal that you would block, Reed, given the scale of the TV and film output from both companies?
Well, Michael, I'd say that Fox and Warner are both pretty powerful companies today, particularly in the area of original production for television and film. I don't know how that changes much in terms of them coming together. Wouldn't want to make a lot of speculation about what's driving it. Probably has a lot more to do with cable negotiations in sports than consolidating power in production. It's very difficult to corner the market on creativity or ideas. I don't see how it would affect things too dramatically in these early days.
Michael, I don't have any speculation for you on what we would do. There's not even a deal between those companies. We'll take it as it comes. As Ted said, the more that we're working directly with producers, the less vulnerable we are to aggregation in the big content suppliers.
Okay, thanks. Just following up there in terms of content and on studio-related, do you feel like you have the need to own your own studio production capabilities to protect yourself from some of the risks potentially associated with fewer production houses to buy from? Would you create your own studio from scratch, perhaps? Would it make sense to be acquisitive in this area?
Derek, I think a lot of it is tactical in terms of how you go about the production cost. Do you want to own the infrastructure versus hire it or rent it? You'd make those decisions as you go. There are probably some advantages to either model, we'll keep exploring them as we own more and more of our production as we go forward. Think about it as the difference between renting soundstage time or owning the stage itself. It would really depend on the volume of production you're planning to ramp up.
Okay, Reed, can I shift you to the net neutrality debate, which I know you've shared a lot with already. In your opinion, what is the right regulatory approach for the U.S.? Should the FCC regulate the broadband industry as a Title II service? I want to know if you could effect change of regulatory view, how would you do it?
I think the most practical thing would be for the FCC to make it a merger condition policy of strong net neutrality, including no-fee interconnect. That's our main focus, is around the merger acquisitions. In terms of the broad policy framework, it's tough in the U.S. because there doesn't seem to be much chance that the Congress will pass a new law, then you've got some imperfect instruments in Title II and Section 706. The fundamental, though, is really for the FCC has the power in merger conditions, and there are clearly going to be a lot of mergers to be able to institute strong net neutrality. We think that's the most pragmatic approach.
Okay, thanks. Just following up there, Reed, last week in your comment letter to the FCC, you said that the internet is at a crossroads and there's a risk of going down the path toward cable TV. Can you talk about what you meant there in a little bit more detail, why you think the other road is better for the industry?
Sure. In the cable industry, there's been constant conflict between the networks and the cable distributors, leading to blackouts and brownouts, trying to figure out pricing. We would hate to see ISPs brown out or blackout certain internet sites while they tried to extract payments. That just ruins the consumer experience, this idea that when you sign up for the internet, you can get everywhere. It's finding an industry structure that works for everybody, that allows there to be great investment in super high-speed broadband. Also a stable, understood interconnect structure that then makes it able so that consumers can get all the services they want, and those doing content services like ourselves and Hulu and others can innovate without the fear of being taxed. That's why we're so big on the no-fee interconnect.
Reed, it's Michael. Following up on that as a media analyst here, I would say, if you look at the power of retrans is the content owner that has the power over the dumb pipe. When I look at where you're going as a company, you're making more investments in original content, exclusive content. You are the content owner. Why don't you think you don't have the power to force the pipes into putting you on whenever you want? Because you are the content to what I'm subscribing to.
Sure. There's a lot of ways to think about it. We do get asked in the cable business. For example, HBO is our peer in the cable business. They actually charge the distributor rather than pay the distributor. The question comes up, should we over time be charging ISPs for the privilege of carrying our data to their customers and charging for that? Again, I don't think so. I think the Internet really has this different, much more open architecture than classic cable, where we meet in the middle, we bring the bits to where they want. We don't charge them, they don't charge us. Both sides innovate, very open structure. I think you get more competitors for Netflix, frankly. What you get is this open, vibrant system that the Internet has been so famous for.
That's really the tradition that we grew up in and that we're trying to see carry forward. I'm optimistic about it, frankly.
Okay, thanks.
Reed, or actually for David, let me switch gears a little bit, but sticking with net neutrality. If the condition and case arises where we don't have strong net neutrality going forward, how do investors get assurances that the business is protected, in terms of cost, perhaps Internet or interconnection costs over time? Really thinking about it both on a short-term basis and then over the long term.
On a short-term basis, I think there's great assurances in the sense that we've been able to sign these immediate interconnect deals and still able to achieve our margin targets and our guidance implies those costs are embedded. I do think it's about a long-term cost, and we'll see where we go from here in terms of the years. I think for Netflix, content is our largest cost. It dwarfs all the other costs. I think it's really about profit margin at that point, in terms of how much margin goes to a delivery cost versus other costs in our business. We would rather spend it on content.
Reed, this will be our last one I have for net neutrality. You referenced the Virgin relationship in the U.K. as being helpful. Can you give us any more specifics on the rates of growth you get when you become closer to the distributor, the MSO? Anything you can talk about, maybe growth rates in the U.K. pre- and post-the Virgin relationship?
We've only been live on Virgin for about six months, what we can say is the initial reaction's been positive. It's not transformative to ballpark it, I don't think for either of us. It's great for consumers on input number one, that's their default input, to be able to use Netflix on the device, the Virgin set-top that they use most of the time. I would say it's an incremental positive. When you look, there's so many new smart TVs coming that have Netflix built in. There's going to be lots of ways to access Netflix, Chromecast, Apple TV, Smart TV, MVPD set-top. It's a nice positive, but it's not transformative.
Okay, thanks.
David, a question just around free cash flow. As you're ramping up originals here fairly aggressively, and you obviously mentioned a number of titles that are in production, and as that ramps up into 2015, can you just help us understand how we should think about the impact in terms of working capital around originals and how we should think about the future trajectory of free cash flow versus EPS going forward? Thanks.
Sure. It's no different than we've said before, which is the two main things that are pressuring cash use are content expansion, predominantly our produced content, as well as our international expansion. Doug, I don't think anything has changed. I will say that we've been able to bump along sort of at flat to slightly up in terms of free cash flow. If we expand more aggressively internationally, obviously that'll pressure a little bit, and as we continue to expand original content and produced content, that will expand. Investors should expect to see a little bit of a dip in Q4 and Q1, and it'll be tied to that expansion of content. In the future, it really depends on how fast we expand internationally.
Ted, following on that answer, how does the content offerings differ domestically and internationally? How does the local language factor play in? Do you have to source more locally than we probably would expect in France and Germany versus Canada and the U.K.? Any update on your strategies on sourcing content internationally?
Michael, what's been really great is how much the content travels. In all of the international territories, France and Germany don't appear to be that much different. It's somewhere between 10%-20% local, mostly the rest would be international product, mostly Hollywood product that people want to see around the world. We do have a heavy focus on accessing the local content that matters and establishing local relationships with the local producers in every market. We imagine when we get out to some more exotic parts of the world that that may skew a little more local. To date, it's been well within that 20% local range.
Okay, thanks.
A question on international expansion, perhaps for Reed. If we think about the six markets that are coming here over the next few months, it feels like there are some specific nuances to some of them. Perhaps Germany, which is more of a debit card than a credit card market, for example. France, which has some protections around its own local content. Can you talk about some of those nuances and how they're likely to impact your business?
I think, Doug, in every market around the world, there are nuances. Just to give you an example, in Brazil, there's a tremendous payment complexity plus the leadership of TV Globo. In Canada, there's the CRTC. In the U.K., the BBC is quite unique in its role in society. Think of us as adapting to the local conditions in each case. As you point out, in Germany, there's a number of aspects that are unique, as well as in France. We're going to see this as we continue to expand beyond France and Germany and other countries, that there's unique conditions in every market. Our challenge and excitement around the company is becoming a great global company, where we really understand the nuance of each of these markets and do a great job for consumers around the world.
There are some challenges there's no question. I'm sure we'll stub our toes on some things and learn and pick up the pieces, like with payments in the beginning of LATAM three years ago. We got a lot of confidence about being able to figure out the issues once we get started. That's why our view is we should get in the market, we should figure things out, and then we'll figure out those issues, again, around payments or other things in Germany and in France.
Following on the answer to France for Reed Hastings. There's a government policy in France called l'exception culturelle, and you're familiar with it, where you have to fund a certain number of local productions and also pay taxes to an authority. How do you get around that issue where in France I know is very protectionist about the content that can be shown there?
Well, we're not really trying to get around anything. We want to invest in French society and in French content, and we want to give an avenue for French content to get out around the world. There's some amazing French storytellers. There's a great French movie business. TV shows are growing. We're looking to do some investments in France with production that we can do. We could joke about it being "House of Cards" being House of Versailles. That's not literally the kind of thing it would be, something like that, where it's a big French production, but it's not just for France, it's for the whole world. We're actively licensing, again, French content. Think of what we're trying to do as connecting the world, as some of the world's best content brought to the world's citizens.
That's really motivating for Ted, for me, for all the people at Netflix. We definitely got to work with French society and with the assumptions and beliefs that they have, and we want to be loved in France by French consumers because we understand French content, because we give it a bigger home, and because we bring them some variety, like U.S. television shows, things that historically have been under-distributed.
Okay.
Ted, do you want to add to that?
I would just say for all of that protectionism and all of the cultural favors, that "The Mentalist" is the most popular television show in France. The tastes don't run that far off when you get down to the consumer. We're really excited to have France look at us as somebody who brings opportunity to the market, not there to harm the market in any way, and that we will employ French production employees and create great content in France, but as Reed said, for around the world. We currently even have Gaumont is a French company that produces "Hemlock Grove" for us now and is about to go into production with "Narcos." A lot of our animation projects are co-productions with French production companies, so this is not new ground for us. We're really excited about it.
Ted, just following up there, can you give us an update on certain content that you have as originals in the U.S. and other parts of the world, but that you don't currently own on a first-run basis in Germany and France, I believe, such as "House of Cards," and your thoughts just on how material that is to the service?
Well, Doug, because we're expanding our originals so rapidly, I don't think it's necessarily detrimental. We would love to have had "House of Cards" in the first window in France and Germany, but it's been very successful for others there. "Orange Is the New Black" we will be launching for the first time in those territories, and all of our going-forward series will also be there. We're backfilling by having some other first-run content, like "From Dusk till Dawn" and other series that will premiere in France and Germany for the first time on Netflix as well.
Hey, Ted, do you have to change the way you source content? Would it be more efficient for the company to buy all rights from all media going forward? How do you think about that, and what does that impact to the business model by doing that?
The more we expand, the more that you reach those tipping points where the economics make sense to buy out the rest of the world for different projects. When we first got in, remember, we were taking a pretty big bet on "House of Cards" right off the bat, so we were kind of hedging it a bit by leaving some of those other territories on the table. As we've gotten more and more international and more and more original, we're picking up those territories today.
Sure. Thanks. David, a question just about the overall addressable market internationally. I think you go into a little bit of detail in the letter, you mentioned 700 million broadband households, I believe, globally. We know sort of the 90 million or so in the U.S. and expanding international here to 180 million. How are you thinking basically about the rest of the TAM and the ability for that to grow here over time?
Well, yeah, those numbers, the 730 is Kagan's number. There's another number that's 800, that's PricewaterhouseCoopers's. Around that range of 700 million-800 million are today's broadband households. All of those territories, mainly outside the U.S. and most of the developed markets in Europe, are growing at a much faster pace. Those numbers are going to grow and grow. For us, we look at China's about a quarter of that 730. We're addressing a large swath of Europe, we would look to further that in Europe later if we're successful. We like what we see. As Reed said earlier, we really do see widespread adoption and enjoyment of Netflix as a product. The on-demand aspects, the great content that's produced in any market
The exciting aspects of us as a global distribution platform and being able to bring great content to markets in the U.S., to markets in Europe and Asia, we like the prospects of our opportunities there.
Reed, David just mentioned that China is a large source of potential broadband households. How do you get into China, and what's your thinking about potential timing of a China expansion?
Well, I'll let David address that. I think it's early. It's fair to tennis match that right back at me, Michael, but I think it's pretty early. I think my reason that I would say it's a quarter is it's conspicuously large and it's conspicuously a growing very strong economy. Look for the future in terms of an answer from us in China.
Okay, thanks.
Great. Just shifting gears into the U.S. streaming business. As you approach 40 million streaming subs in the U.S. toward the end of this year, and you're looking toward that lower end of 60 million-90 million that you talk about, how do you think the mix of net adds changes between gross adds and churn going forward? Does lower churn really become an even stronger driver of the business?
Doug, if that's addressed to me, I think that obviously, we do think that we've got growth in both. It would be growth in reducing churn or improving our retention and in bringing more and more people into the market. Our originals have the potential, as we produce more and more content, to sort of bring more people into Netflix and bring new types of subscribers into Netflix. I think over time, that mix will shift more and more to people who are coming back and people who are staying longer, just as we penetrate deeper into the U.S., but we still think we've got some room to grow on both sides.
Ted, when you think about your U.S. programming mix, what do you think the optimal mix of expenses would be between originals, acquired TV, acquired film, and what's the right balance of spending across those three buckets?
Over time, Michael, I'd love that you could think about it much more fluidly than that because we have a lot of programming like "Breaking Bad" that in the U.K., it's a Netflix original show, and in other territories, it's a license. We move pretty fluidly in and out of that, so baked into our margin guidance is our content spend. We want to move a lot of it to originals, mostly because we have found that it's given us new brand strength as those shows have been successful. If they continue to prove to be successful, we're going to move down that path further. There's a lot of times where we will premiere the sequel to "Breaking Bad," "Better Call Saul." We're going to premiere that everywhere outside of North America on Netflix.
That's kind of an original show and kind of not for us in terms of how we treat it. Really, if you want to sort of think about it as total content expense, and we want to get the content that consumers love. Right now, we're having success in that area, and we want to keep pushing down that path. There's no optimal mix in that way.
Okay.
Ted, can you walk us through what the release schedule looks like for originals just through the rest of 2014 and then into 2015? I realize it's tough maybe to choose between your kids here, what new shows are you particularly excited about?
Well, we've listed out all the premiere dates that are coming up. The ones coming up in August, we have "BoJack Horseman," which is our first foray into adult animated comedy. It has Will Arnett and Aaron Paul voicing it. It's very funny. It's, again, a new broadening of what we're doing on originals that's pretty exciting. We have the fourth season of "The Killing" also coming out in a couple of weeks that we're also really excited about in August. The one that's very ambitious and on a large scale, and we've been really thrilled with how it's been coming in, is "Marco Polo" that we're filming in Malaysia right now. It's a very large-scale show. We filmed it in Venice, in Malaysia, in Kazakhstan. Like we're trying to do things that'd be very difficult to do on conventional television.
Marco Polo" is a very ambitious project that's coming together really beautifully, we're really excited about that for Q4.
Reed and Ted, I wonder, from when you first started, you basically built a service on library-acquired content. You've evolved to exclusives and originals. I wonder, when you look at usage trends today, how important are the library archive shows that you've maybe bought in the first rounds of negotiations with studios versus the things you're buying now? If you could talk a bit about behavior usage trends among your consumers as you've gotten longer into the process.
Well, the great thing about this time that we're in right now, Michael, is that content is so great and there's so much of it being produced, you could barely watch it all in your lifetime. The library becomes important because most people have never seen it, so it's new to them. We're producing and bringing out original programming at about as fast a pace as we can and maintaining the kind of quality that we've been able to. We're going to continue pushing down that path, and originals is going to be an important component of that all the time. We'll also, I think, will always be a very valuable off-net buyer for networks because so much of that content has never been seen by the public. We're excited to continue to play in that space where we're pretty popular at LA screenings.
We come in when they're showing those projects for us to potentially be a first-window partner for those shows outside of the U.S. Because we're not wed to we're only going to put on the shows that we produce, that gives us the opportunity to put a lot of content in front of consumers that they love, regardless of the business model.
Okay.
Ted, I just wanted to follow up on a point that you said earlier just around contracts. I guess I'm curious how the initial kind of contracts around House of Cards and Orange may differ from what you're signing for a new original series now. Is it fair to think that you are getting all of the international or global rights, basically, for these new originals that are coming out?
The key for us, Doug, is that we're trying to make sure we can control the exploitation in those territories, particularly the ones that we're heading to. You can either get to that by owning the show outright or by negotiating the control of those rights upfront with the content owners and have them as partners. I'm open to either one of those to give us those kind of controls so that when we open in new markets, we can launch those titles with us if they're coming up at a time that makes sense, given that we put so much branding power behind those shows leading up to their launch.
Reed, can I ask you about international competition? You guys really enjoyed a first-mover advantage in your first markets you went into, but now you see a lot of European markets where there's two or three services outside the U.K., let's say, in Germany and France, trying to do what you're doing. How do you think you'll be able to differentiate yourself and competition levels in some of those markets where someone like a Sky, a Sky Deutschland, is already trying to achieve the same type of service?
Well, that's a bit revisionist history, Michael, because to say that we were first mover, because if you think about the U.K.
Right
LoveFilm had been there for seven years, developed a 2 million subscriber base, bought by Amazon, infused with streaming content, was a tremendous significant competitor to us two and a half years ago when we launched. What we did is we focused on television content. They focused on movies. We focused on incredible streaming performance, so you never got buffering, working with all the integrators. Fundamentally, it's a focus thing, which is, it's everything for us, whereas this was a project for someone within a larger company. Then now, two and a half years later, of course, LoveFilm has folded up as a brand. We're tremendously excited about the opportunity to continue to move forward. We've also had Sky from the beginning in the U.K. be a very aggressive competitor. Lots of different aspects of their service.
What it's turned out is that we can grow very substantially in the U.K., and Sky is untouched, similar to here in the U.S., how we're growing rapidly, but MVPD as a total is untouched. I think the big MVPDs are recognizing that Netflix is one more network. It's like YouTube. It doesn't change our outcomes in any material way. We have, again, great focus, global R&D. Those are the things that we look forward to. In the end of the day, there may well be room for several of these services in a market with different types of content. They each have exclusive content. If you think historically in the U.S., like HBO and Showtime.
they're not really competing against each other except for content. They're competing to get a part of someone's entertainment budget. In the same way, we're like that in a new market. We don't need to beat some new competitor. We just need to create an incredible service that all of the citizens in each country that we serve want to be part of Netflix.
Okay.
Great. Ted, can you talk more about your plans for Chelsea Handler's new show coming up? Does this signal more of a move into kind of live streaming? Now that you're moving more into late-night talk, is there more of a strategy potentially around sports content over the long term?
Look, I think Chelsea is going to be a great representative of the kind of programming on Netflix because her show is a lot about the entertainment world, movies and television and pop culture. We think that it'll be a great addition to Netflix in 2016. We just filmed her first comedy special in Chicago, and she's going to do four more in 2015. The show itself, you should think about it as the way that people are not watching scripted programming the way they used to. They're also not watching these late-night talk shows the way they used to, meaning they're not watching them at 11:30 P.M. They're watching them days, weeks, sometimes months later, online or on stacked episodes on DVR.
What we're hoping to do with Chelsea and her team is create a show that's built closer to the way people are going to watch it. The way we had done with serialized dramas, where we took out the commercial breaks and the cliffhangers and really produce it for the way people watch. We've got a lot of time between now and then to work through all the format details, and Chelsea is incredibly exciting. We're really excited about her brand, and we think it's going to be great for us. In terms of your other question, I think about it as more of a continuum, that this is not that instantly perishable content by any stretch. To your point, it's more perishable than a movie. The economics kind of level that out for us.
David and Reed, I have this question on international margins. Do you think that international margins in their end state will look like US margins? Or is there anything structurally different about your international businesses or the scale versus the US activities?
This is David. I'll take that one. No, there isn't. We've gotten this question before. There's nothing really different about our international businesses that we can't achieve US-like margins or better in some of our markets. It really is about the competition in those markets in terms of what consumer alternatives are there and how much we're able to charge and the value that we deliver to those consumers. There's nothing structurally challenging about those markets that we can't achieve equal or better.
David, just a question on the balance sheet. Can you help us understand how you think about the right amount of cash to have on the balance sheet, just given international expansion and then current free cash flow generation? As part of that, we see the streaming content obligations move from $7.1 billion to $7.7 billion, which I think is one of the more significant moves that we've seen in recent quarters, and just how we should interpret that.
Well, the content obligations are a little bit lumpy, depending upon what we do on produced content. I would look at it sort of over a year-on-year basis rather than a sequential basis. You're right, they've gone up some. They'll continue to go up as we expand and grow our produced content line and to some extent, our international expansions as well. As we sign up for multi-year deals, those obligations roll onto the table as well. The right amount of cash. Cash is not an inoculator in terms of a prolonged competitive battle. It does help in terms of short term. It does help the business in terms of making producers and others feel good about our balance sheet position.
I would say, in general, I was a bit worried earlier on, say, two, three years ago, when we were going through 2011, that we were a little thin, and I thought we would be burning it faster than we actually did. For a while there, I was a bit of a Chicken Little in terms of telling investors, "We're going to start burning. We're going to start burning," and we really didn't. We grew it a little bit. We stayed flat for a while. I think I'm pretty solid on telling folks, "Look, in Q4 and in Q1, we're going to start using cash a little bit more as we expand internationally and as we grow our content spend." In the future, it will really depend on the pace of our international expansion.
I think I feel good about the level we're at now, it'll really depend on our future plans.
Ted, just recently this week, and I think you announced a pay one deal in Canada for Disney, and I know you've done a couple of pay one deals elsewhere. Where do you think the potential is to really break the pay one window outside the U.S.? Is that something that we could see more deals like that going forward?
I've made a distinction before around the Disney relative to the other studios, in that for us, that Disney output deal represents a pretty big chunk of kids viewing in general. I think of it more like a kids programming move that also has a lot of movie components. It's some really great movie components with the Marvel films and certainly the upcoming "Star Wars" movies. What's really interesting about the Canadian deal is that Disney's now moved that deal in the U.S. and Canada to one supplier, which has not been the historic norm. We're also going to line up the windows so our Canadian subscribers can be seeing the movies at the exact same time as the U.S. subscribers. We do have other pay one deals around the world, including Warner Bros. in the Nordics, as an example, and a few others.
For us, it's getting access to films, trying to continue to narrow that window so we can get them to consumers sooner and sooner to kind of deliver on the expectation that the internet has set up for what I want, when I want, where I want.
Hey, Doug and Michael, why don't we do one question each for you guys, and then we'll wrap it up.
Okay, great. I wanted to go back to something we touched on earlier, and I guess it's primarily for David. Just trying to understand better and hoping you can drill down more on the 30%, why that's the right level to kind of go to and then reassess the domestic streaming margins. Help us understand better how you think about these trade-offs that you mentioned in the letter, the 400, 200, and then 100 basis points of margin improvement on an annual basis.
Well, Doug, there's nothing magical about the 30% number. It's a convenient level for us to reassess, and we think we'll get there next year. There's nothing magical about that one 30% number. In terms of how we think about the next target, whether we leave it at 400 basis point year-on-year growth, or whether it goes to 200 or 100, it's really about do we think that we can continue to expand our market and solidify our competitive position with investments in content, or do we think that we can continue to grow content at a slightly less aggressive pace and put more to margin? As we grow, what we've explained in terms of that margin number getting bigger and bigger, it just gets harder to deliver 400 basis points of growth on a higher and higher margin. It's just the math behind it.
It may not be the right thing to do to continue to press forward as aggressively on content or on profit growth versus other things that we could spend the money on, with content being the largest one.
I would say just following on that, is there anything that you know today on the content cost side, like the Disney deal coming June 2017, that makes you say that? Is there something that you're looking forward to and saying, "Hey, that is a hurdle that could change it?
No, Michael, this is more about perspective opportunity spend on the content line. We forward plan our business. We forward plan our content spending, knowing fully well that that Disney deal has been done over a year. That we have projections. Disney could have 20 releases at $400 million-plus box office, but that's not likely to happen. I think what we've done is taken a bunch of different median scenarios and say, "Look, we've got that planned out." It's really about what else can we do with it. Can we do more experiments in Ted's world in the produced content? Can we license more content? Is that the right decision versus profit growth? Making a very smart decision as business owners long term about the competitiveness and setting ourselves up competitively for the long term.
Thank you.
Thank you to everyone for joining us for the call. We look forward in October to be able to report to you on our initial success with our French and German launches. Thank you very much.
Thanks.