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Netflix (NFLX) Wilmot Reed Hastings on Q1 2016 Results - Earnings Call Transcript

Netflix, Inc. (NASDAQ:NFLX)

Executives

David B. Wells - Chief Financial Officer

Wilmot Reed Hastings - Founder and CEO

Theodore A. Sarandos - Chief Content Officer

Analysts

Benjamin Daniel Swinburne - Morgan Stanley & Co. LLC

Peter Kafka - Re/code

David B. Wells - Chief Financial Officer

Welcome to the Netflix Q1 2016 Earnings Call. I'm David Wells, CFO. I'm joined today by Reed Hastings, CEO, and Ted Sarandos, Chief Content Officer. Interviewing us today will once again be Ben Swinburne with Morgan Stanley and Peter Kafka with Re/code.

Just a warning before we begin that we will be making forward-looking statements, actual results may vary. I think Ben you have the first question, so over to you.

Question-and-Answer Session

Benjamin Daniel Swinburne - Morgan Stanley & Co. LLC

Sure, thank you. Maybe you can start out by just reflecting on the quarterly results you guys just delivered relative to your expectations. And maybe you could start out in the new markets you launched at the beginning of the year and how those performed relative to your expectations.

Wilmot Reed Hastings - Founder and CEO

Sure. We were incredibly excited to grow to over 81 million subscribers. It's an enormous quarter for us that way. Some of it was from our expansion around the world. It's 130 countries. So there's quite a bit of variety. And remember that most of those countries we haven't yet seen the full potential of, because we're only in English and only with international credit cards. So over the next couple of years, as we further localize, we'll be able to see more opportunity. But by going so broad, we've increased our rate of learning, and so, we're really excited about the approach and looking forward to the rest of the year.

Benjamin Daniel Swinburne - Morgan Stanley & Co. LLC

And how did you feel the U.S. markets behave this quarter versus your expectations? You had noted in the letter a lot of strength from the originals that came in ahead of expectations. I'm guessing that's on gross connects, but how do the originals perform even relative to what I'm sure where your fairly bullish expectation is in the U.S. market.

Wilmot Reed Hastings - Founder and CEO

Well, in the U.S. market, we did about 2.25 million net adds, which is nearly identical, not only to last year, but to the year before. So what you see is this continued growth and we're thrilled to keep that growth steady, between 5 million and 6 million net additions. And the content just keeps improving and that keeps the word of mouth growing. So we're very excited about that formula and what we saw in Q1.

Peter Kafka - Re/code

Reed, you guys have been watching Amazon for a long time. You compete with them at least on content for quite some time. Four years ago, you predicted they'd come out with a standalone servers priced under yours. They announced that yesterday. What's your view of them now, and in particular, with the announcement they made yesterday, do you think they're trying to compete head-to-head with you for subscriber dollars, or are they trying to underscore the value of Prime overall.

Wilmot Reed Hastings - Founder and CEO

Hulu is doing some great work. Amazon is, HBO, Showtime. There are so many competitors, and everyone is working hard to build the best content. And so, we're seeing growth in the overall Internet TV market. Of course, that's displacing linear TV, and it's natural that everybody is coming in as they realize that the future is Internet TV. And in terms of our shows, we're very excited about what we're doing. Not only are we expanding the number of original series we're doing, but we're also expanding into original movies.

So again, this is all part of the natural evolution from linear TV to Internet TV.

Peter Kafka - Re/code

Amazon has been talking with programmers for a while about adding linear channels. So you're looking at a scenario where they might have an offering that's similar to yours for the on-demand stuff, with a mix of originals and older movies and TV shows, plus current content live. What does that look like to you in terms of the prospects of competing against that head-to-head?

Wilmot Reed Hastings - Founder and CEO

We're very focused on global competition. Obviously, around the world, it's very fast growing for us. We're coming towards 50/50 International, Domestic revenue. And so, we're focused on content that we can have around the world, which is why we're investing in original movies, original series so that we can have that content and also producing around the world like our French series Marseille or Spanish in Narcos.

And that's very different from carrying other people's single nation networks. So that's just a very different business. It's not one we focus on a lot. We know what we want to be, which is a great global producer and distributor of content, and other people will do other things and that's fine. They may be very successful.

Benjamin Daniel Swinburne - Morgan Stanley & Co. LLC

Let me throw a question out for David and/or Ted about – thinking about the second quarter guidance internationally, there's a lot to chew on there. The number you laid out is probably below where most people were expecting. I'm wondering if you could talk, David, about how you thought through putting the second quarter guide together around the seasonality, some of the comp issues you talked about in the letter and whether we're seeing a more earlier than expected level of seasonality in some of these markets that are still one year or two years old.

And Ted, there's a narrative out of Europe, in particular, that the incumbents are sort of teaming up against you from a content perspective, and you've got a lot of stuff coming down the pike on originals. So if you could talk about your relationship with suppliers overseas since that's probably an area people have spent less time thinking through.

Theodore A. Sarandos - Chief Content Officer

Sure, I let David kick it off there to go first.

David B. Wells - Chief Financial Officer

So Ben, in terms of thinking about the guide, just a reminder that we put in the letter that absent the strong performance that we saw last year from a very recently launched Australia/New Zealand market, our guide would have been up. So I think you haven't yet seen sort of a normalized pattern of growth from us, in terms of a year-on-year growth expectation across our international markets, because we've been layering on new markets as we go.

So I think, from our perspective, we were super happy with the results of Q1. And we wanted, in Q2, that to continue and it is, but we're mindful of the fact that we've got these large blooms of launches last year, and then, in Q1 this year with the rest of world markets, the Netflix global launch that are going to continue forward, because they're addressing pent-up demand.

So for us, we're focused on continued growth in those markets and that's what we're seeing. And we're focused on continued improvement from an economic sense of reducing those losses and this year, you're seeing us continue to invest, but the U.S. is growing. So overall, operating profit is improving as we go and into next year.

Theodore A. Sarandos - Chief Content Officer

I just say the reaction from the broadcasters across Europe is not different than it's been anywhere else. There's always uncertainty when we come to the new market, what role we're going to play, how complementary we're going to be versus competitive, and I think everyone just likes to weigh (06:40) other options in terms of their competitive strength.

We're buying a lot of Pan-European rights as part of our global acquisitions, which I think probably makes them a bit nervous too while they're trying to figure out what the next moves will be. But again, I don't think it's that unusual. I mean even here in the U.S., where three of our largest suppliers teamed up to create Hulu with probably much of the same motivation.

Benjamin Daniel Swinburne - Morgan Stanley & Co. LLC

And just as a follow-up, there's I don't think any mention of VPN changes in the letter, but that obviously has happened. Is that impacting at all the second quarter guidance at all?

Wilmot Reed Hastings - Founder and CEO

No, that change was in the first quarter. It's a very small but quite local minority. So it's really inconsequential to us as you could see in the Q1 results.

David B. Wells - Chief Financial Officer

And the only thing I'd add to that, Ben, is we were able to grow. In the first quarter, we had a very strong U.S. growth, at the same time, we had a very robust Netflix global launch. So I think it validates sort of the fact that we're seeing new demand for Netflix in those markets.

Benjamin Daniel Swinburne - Morgan Stanley & Co. LLC

Sure.

Peter Kafka - Re/code

This is for Reed. You keep getting asked this, but I want to keep asking, because the question keeps coming up. Any interest in live sports in any capacity?

Wilmot Reed Hastings - Founder and CEO

Any interest in what?

Peter Kafka - Re/code

Live sports.

Wilmot Reed Hastings - Founder and CEO

Live sports. Ted, I'll let you handle that question. It worked so well for us last time I knew it (07:59).

Theodore A. Sarandos - Chief Content Officer

Exactly. There's no interest in live sports currently.

Peter Kafka - Re/code

Currently. What about live in general? There's a lot of interest, Twitter, YouTube, Facebook, in particular, and the idea of broadcasting live video over the Internet. You guys have tweaked your model a little bit and we'll be tweaking a bit with Chelsea Handler where you're going to sort of move away from the dumping out all the stuff in one go and sort of staggering it. So if you're not doing live – if you don't plan to do live now, why not consider it down the pike?

Wilmot Reed Hastings - Founder and CEO

So just to correct you, we have never dumped anything. We have given it a proper platform with all of the great content that it deserves.

Peter Kafka - Re/code

Full release (08:36).

Theodore A. Sarandos - Chief Content Officer

So Chelsea is near live, in that we're going to be putting it up to our subscribers just a couple hours after it's recorded live in front of an audience. There's not a technological reason we wouldn't want to go to live. But you should think about our brand proposition is very much about on-demand. So to the extent that watching on-demand is better than watching live, would bring a ton of value to it. And other people doing live, I think it's great. It's about further expansion of Internet television to include live. We don't have to do everything to be part of that expansion.

Wilmot Reed Hastings - Founder and CEO

And rather than invest in things like live sports, we're investing in things like The Crown, which is just an epic production and maybe you could talk a little bit about that, Ted.

Theodore A. Sarandos - Chief Content Officer

Yeah. It's being shot right now in the UK. We've previewed some footage of it to the European press last week. They just loved it. It's a massive cast, a massive production that will tell the life of Queen Elizabeth, starring Claire Foy as the Queen and will follow her life through her relationships with the Prime Ministers all the way through to current times. So it's a very – it's those kind of things that we think are massively global that we can produce on a larger scale than anybody else, that we really think we can win the day on.

Peter Kafka - Re/code

Thanks.

Benjamin Daniel Swinburne - Morgan Stanley & Co. LLC

David, coming back to the second quarter guidance again, but on the U.S. market, why did you decide to delay or spread the un-grandfathering through the remainder of the year? You mentioned you don't expect much of an impact, but you decided to sort of spread it out and if you could just walk us through what you've learned in your testing so far and the thought process around that.

David B. Wells - Chief Financial Officer

Well, I think we've always been a testing company. So perhaps there should have been an expectation that this would be a gradual thing in terms of layering that out. We've got a number of markets that are coming off un-grandfathering, not just the U.S. And some of those are timed three months to four months as we go.

So I think it's just about messaging it. It was important to us to make sure that subscribers sort of knew that this was happening, and to put it in front of them. And that's what we're going to do. And we want to do that, do right by the consumer and do right by Netflix as we go. So I think we're just taking our time to do that.

Benjamin Daniel Swinburne - Morgan Stanley & Co. LLC

And Ted, what are you seeing in terms of the efficiency of your spend, as you continue to build on originals. And I'm curious you've had more data points around film results, you'll have more coming up. How are the films performing relative to your expectations, and relatively, maybe, to the spending on TV series?

Theodore A. Sarandos - Chief Content Officer

Well, the efficiencies are a little hard to match, because you've got a couple of hours of viewing versus 10 hours to 13 hours of viewing on a series. But relative to how we license other movies, we've been pretty happy with the direction that it's going. And we have a few films under our belt. Where I'm really looking at is how broadly people engage with them, how do they play around the world, all those data points have been really positive. And as we keep going, I think that content can be as efficient as the series relative to other films. So we're still learning as we go though.

Benjamin Daniel Swinburne - Morgan Stanley & Co. LLC

Thank you.

Peter Kafka - Re/code

Can you guys talk about your M&A strategy? Are you looking at Paramount, which may be partly for sale? What about Starz, which is sort of unofficially for sale? And if you don't want to comment on those in particular, what do you think you might as you consider large acquisitions?

Wilmot Reed Hastings - Founder and CEO

It's been 15 years we've been public, and 20 years existing, and we've done no M&A. So I think that probably speaks for itself.

Peter Kafka - Re/code

And as you guys push into the studio film business, making your own movie, does it make sense to sort of at least do a smaller acquisition that would help you sort of get some of those competencies in-house?

Theodore A. Sarandos - Chief Content Officer

Well, Peter, what you're seeing not just on the films, but also on several of our series where Netflix is increasing the studio and the network on those shows. So we are building that efficiency in-house. The Ranch that just premiered a few weeks ago is a Netflix-produced show, and we'll be doing a lot more of those coming up.

Peter Kafka - Re/code

So you can build that without buying it.

Theodore A. Sarandos - Chief Content Officer

We're building it versus buying it.

Wilmot Reed Hastings - Founder and CEO

Yeah, we'll just hire the people that we want and build it and that could in principle be a constraint on our rate of growth, but Ted's been able to attract an incredible team in LA. And so, when you look at the growth in our originals, you can see that we can deliver on that on this organic hiring basis, which of course is much stronger for the long term than if you tried to juice it with M&A.

Peter Kafka - Re/code

Thanks.

Benjamin Daniel Swinburne - Morgan Stanley & Co. LLC

Reed, can you talk a little bit about how investors and shareholders should look at various opportunities internationally? For example, Brazil is a market that maybe at first blush wouldn't appear to be ripe for Netflix, given sort of low paid TV penetration, lower household income, lower broadband speeds and yet you've described that as a rocketship, you've done really well there. And yet maybe other more sort of developed markets in Europe have been slower.

What are the characteristics and things that are outside of Netflix's control that drive success? And what are the things you're doing that you maybe didn't do a year ago to make sure you capture the opportunity?

Wilmot Reed Hastings - Founder and CEO

One of the...


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