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Netflix, Inc. (NASDAQ:NFLX) Q4 2019 Earnings Conference Call January 21, 2020 6:00 PM ET
Company Participants
Spencer Wang - VP of Finance and Investor Relations
Reed Hastings - Founder and Chief Executive Officer
Spencer Neumann - Chief Financial Officer
Greg Peters - Chief Product Officer
Ted Sarandos - Chief Content Officer
Conference Call Participants
Mike Morris - Guggenheim
Operator
Spencer Wang
Good afternoon and welcome to the Netflix Q4, 2019 Earnings interview. I'm Spencer Wang, VP of IR and Corporate Development. Joining me today, our CEO, Reed Hastings; CFO, Spence Neumann; Chief Content Officer, Ted Sarandos; and Chief Product Officer, Greg Peters.
Our interviewer this quarter is Mike Morris, Guggenheim. As a reminder, we'll be making forward-looking statements and actual results may vary.
With that, let me turn it over to Mike now for his first question.
Question-and-Answer Session
Operator
[Operator Instructions]
MikeMorris
Great. Thank you, Spencer and good afternoon. Before we dive into some of the details we provided in this quarters letter. I'd love to have Reed provide some strategic thoughts as we head into the New Year, the new decade. Perhaps we can start with just what were the most important strategic accomplishments in your mind of 2019? And as you look forward what do you hope to accomplish this year?
ReedHastings
We've had the same strategy basically for 20 years which has pleased our members and they helped us grow. Ad we've done that in a variety of ways. Of course, initially just with DVD-by-mail then the combination. And if you look at what we've done in expanding film and making that a really strong aspect of Netflix. We've had a lot of continuous progress. But the same strategy we've always done how do we learn? How to please our members? Whether that's on the product side, marketing side or content side. And the next decade we anticipate the same. How do we use the great resources that we have to do even better?
MikeMorris
Now let's talk a little bit about some of the key specifics from the letter today. The first, of course, is the guidance on your member growth for the coming quarter. You have a very strong fourth quarter compared to your guide. The first quarter is lighter than it was in the prior year. You talked about some of the potential for timing between the first and second quarter. I think the key question on investors' minds is how to think about the full year. 2019 looked very similar to 2018 with the strong fourth quarter. How should we think about the coming year in that regard?
SpencerNeumann
You want me to take this one?
ReedHastings
Sure.
SpencerNeumann
I'll take this one, Mike. So and first, I just say, Mike, our opportunity, we view our opportunity are long-term opportunity, is big and unchanged. So we should be clear about that. We're not providing full-year guidance but when you think about Q1, again it's comping off of the all-time biggest quarter we've ever had in Q1 of last year. We guided to 7 million paid net adds in 2020. So when you look at that Q1, 2020 number of 7 million that's still big growth. That's-- we've only had four quarters in our history where we've grown more than 7 million in paid net adds. And the number specifically it reflects, first, there's primarily a US story there and that we've -- we have seen and we talked about in the letter. Some elevated churn in the US from combination of pricing and competition.
We've -- we can roll that through into Q1 including a full quarter of competition in Q1 versus a partial quarter in Q4. We also anticipate that competition rolling out globally throughout the year. So we're trying to be prudent of thinking about that impact throughout the business. And then we talked about as well as when we think about the seasonality, the arc between Q1 and Q2, the first half of the year, we think it's likely to be more balanced because of the timing of the price it changes. We took that rolled through Q2 of 2019. So we think that our seasonality is going to look more like 2018 and 2019 when you think about the first half of the year.
MikeMorris
Okay. When we talk about competition, you've mentioned churn a couple of times with respect to the potential impact. Can you talk about competition on both gross adds and engagement as well? Especially on engagement. I know it's early but clearly the Disney Plus product is a -- has a very heavy kids and family focus to it. Have you seen any specific engagement change on your content in that genre?
ReedHastings
Sure. Well, I'll jump and others can, we actually alluded to this in the letter, Mike. The great thing is, first off, we're growing in Q4 including in the US even with some of those noise from competitive launches. And ultimately what drives our business is increasing member satisfaction and viewing. And what you also see in the US what we saw across the board is that our viewing, our per membership viewing grew not just globally but in the US through Q4 and continues. So that bodes well for our long-term opportunity as long as we keep getting better.
SpencerNeumann
And, Mike, thinking with the Disney product, Disney Plus has a lot of great catalog product and one big new show Mandalorian. And it primarily is going to take away from linear TV and takes away a little bit from us. But again most of the growth in the future is coming out of linear TV.
ReedHastings
It draws down by a variety people because they were so broadly distributed prior to the launch.
MikeMorris
Okay. And I guess the last thing on this particular topic is the behavior outside the US as compared to the inside. Clearly within the US, a more mature market and that's where the products were primarily focused in the fourth quarter, their launches. We do have some more expanded international rollout particularly Disney talked about or announced a broader European rollout at the end of the first quarter. Any thoughts specific to that? Is that factored in? Is it one of many things? What's your thought there?
ReedHastings
It's one of many. I mean, Disney is going to be a global service quite quickly. And there are many other global services. Remember that we compete a lot for time with YouTube. And it's not dollars because that's ad supported. But we compete very broadly for viewing and as Spence mentioned our viewing on a per member basis is up. And that's because our content is getting better. Our service is getting better. And that's all coming out of linear TV.
SpencerNeumann
And I would say that they're --their brands are definitely global brands. But they're no --with the exception of China, they're not more popular than they are in the US anywhere else in the world.
MikeMorris
Okay. And so, Greg, a question on pricing. When we spoke last quarter, you felt that these competitive launches would not have an impact on your prices.
So I guess the first question is now that you have this quarter under your belt. Any update on that point in particular?
GregPeters
Yes. I think it's useful to start with just noticing that our revenue in the United States is up 23% year-over-year in Q4. So we're still seeing a pretty significant growth there. And we're not seeing anything that fundamentally contradicts our core model or suggests that it's changed in a material way. And that model is if we do a good job of judiciously investing, the money that our members give us every month and great stories and better product experiences creating more value for them then we occasionally earn the ability to come back to them and ask them for a little bit more money to keep that virtuous cycle of improvements going. And everything we're seeing continues to support that core models intact. So that's our job.
MikeMorris
Okay, great. And you go down that path a little bit further historically you have done some sizable price increases at least on a percentage basis on a somewhat spread out timeframe. How do you think about possibly doing perhaps a single annual price increase in a more mature market at a more modest rate? I hate to say this but maybe somewhat more similar what people have experienced with their cable bill or something to that effect.
GregPeters
We don't have a fixed model that our PR, we're coming in and saying this is the right approach. So I think our job is to actually listen to our members. Give it -- if the signals that they're giving us in terms of the engagement that we're seeing that we gain from growth that you heard we're going after. And we'll really use that as a mechanism to guide us towards when if we earned that opportunity to come back and ask for more. So we're not really coming in with just a fixed model that we're going to shift to or anything like that.
SpencerNeumann
And if we're -- we're putting hits on the board. And we can see that in the terms of watching an engagement and subscriber growth and growth and the zeitgeist to run our projects then the more --the more you can do that the more frequently you can go back. So we have to --we're in this great model of where we have to prove ourselves to our members literally every month. So it's really -- it does hold us to a very high bar and keeps us coming back and doing more and topping ourselves if we need to.
MikeMorris
One last question on this is around premium plan subscribers versus your standard plan subscribers which largest, you've mentioned in the past clearly the largest group. On what has been the trend with respect to your subscribers moving to the premium plan? And is there a way to further incentivize them to almost have a self opted price increase but also clearly getting an improved product as well?
GregPeters
I think we're --again constantly evaluating the right balance of what's -- what features, what prices at those various different tiers. But we haven't seen a significant shift in that. And we see a healthy take rate across all of our plan options which are a really good sign. I think that we're providing a range of options at a range of price points that allow consumers in the markets that we serve to sort of selecting into the right model. Again, we want to be innovative about that. And we'll look for ways to create more value across all of our tiers. But right now that blend is pretty healthy, we think.
SpencerNeumann
And, Mike, I would just add that in terms of plan mix, you have over the years seen a slight migration towards the higher price point plans. That is something that we have seen but it's quite gradual. So there's no sort of big jump in any sort of given quarter, but quite a gradual increase in that which I think maps to the growth in smart TVs and high-definition TVs.
MikeMorris
Okay. I'd like to switch to a few questions on content and content strategy. So, Ted, the ramp in feature-film product in particular both development release big step forward for you in 2019. As you looks into 2020 what are you most excited about either from a content perspective or an overall thematic perspective. There's a healthy amount of information on some key titles [Indiscernible] but would appreciate you highlighting the things that are most important to you.
TedSarandos
Well, looking forward to next year, we get the opportunity to do some things that we know have worked and come back with some sequels. And they are super popular. YA genres, we've got these rom-coms; To all the Boys I've Loved Before and Kissing Booth coming back with sequels in Q1 and Q2. We have a big ticket action films with Mark Wahlberg and Charlize Theron and Chris Hemsworth more like the things you've seen in Q4 and trying to program our movies like we do our series for every taste, every mood, every region of the world.
So it's not trying to make one-size-fits-all program. That's what we have so much of it, just what we all -- we want to hold it all to a very high entertainment bar. So you're going to see us working across all genres like we did in Q4 and still continuing to kind of press up the production quality and the production investment in these films.
ReedHastings
And those are all coming out in Q1 and Q2 of this year and some in Q3, Q4.
TedSarandos
Yes.
ReedHastings
Just got a tremendous slate this year.
TedSarandos
Yes and I think the one thing we have been putting out in the letter, it's exciting that we end up with being the most nominated studio at the Oscars this year with our films. But the most exciting thing is those films are all incredibly popular with our members as well.
MikeMorris
So that leads into another question which is as you have sort of shifted and increased this focus on film, Ted, and particularly you've highlighted a couple of reasons for that and benefits to the members. Those have included some comparison with respect to the value proposition, right and compare to a film.
TedSarandos
You know what a movie ticket costs so sure.
MikeMorris
Exactly. I think we've also talked about the ability for film content to travel. There's sort of a perhaps a broader global base of interest. Anything else that you would highlight or remind us up for why this shift in investment or maybe not shift but expansion is important? And also now we have another year under our belt with a pretty robust slate, so have things been progressing as you would have expected given those objectives?
TedSarandos
Yes. I would say, look, when I look back at Q4 I look back say, I'm glad we decided to do this about a year and a half ago. That's about the time it takes to secure the deals that obviously do the production and go get through post and get everything delivered at the level of quality that we were able to. And so now we have all of that kind of ramp up behind us. And while the steady flow of projects like you see in Q4. Similarly with the feature animation. When I see where we're at today with access to programming and all those other issues, we've been ramping up our feature innovation for almost three years. And it really hit the ground their first project with Klaus in Q4. There was a complete audience pleaser and an Oscar nominee for Best Animated Feature. And that will keep a steady drumbeat going there as well.
In Q2, we have an animated feature called the Willoughby's and in Q4 we have Over The Moon, which is from Glen Keane, we did Little Mermaid and Beauty and the Beast. So these are big theatrical scale animated features and big scale feature films that would be competitive with anything you would see in the box office. And I think people really do value them. And to your point they do travel much more predictably than TV series do.
MikeMorris
One of the things you just mentioned and clearly has been very widely reported and seen is the critical acclaim that you've achieved and you've had growth in Golden Globes, now at this point, Oscar nominations. My question is around the business benefit of that and the cost of achieving it as well. Maybe it's a somewhat open-ended question but how much is it costing you at this point to have those films in a place that they can be considered for that? And what does the timeframe for the benefit to, the business look like for that?
TedSarandos
What you've seen the expansion this last year within the confines of our existing content budget. So we're growing, it's how we're choosing to bring the incremental spending to the table in terms of the bigger breadth and scale of films, but not taking it away from our growth in series which is also growing and in particular in our local language series which we've reported before where we're growing by a 130 seasons of local language series around the world as well.
So to me, I look at it as the growth --the benefit to the business is the growth that you're saying.
ReedHastings
And I would just add to that. Sorry - you'll see that if we further our reputation for doing well for content, sorry for talent by being one of the best in the world at winning awards for our talent then the business benefit is that we will win deals that we wouldn't have otherwise won for incredibly entertaining content. So think of all of our awards work as a really smart way to make us the best home for talent in the world.
TedSarandos
I think it's also worth noting that there's a consumer component this too. I mean some of our members around the world use the awards piece as a sign of what they want watch so that when we present those, that information to them we actually see them respond to that. So there is an immediate benefit there as well.
SpencerNeumann
And just one point one more time there is typically there seems to be a big gap between critical acclaim and award winning and popular. And we are really trying to do and we have in the past quarter achieved both of. Meaning we are bringing popular film to the market at such a quality that's also being recognized by the critics and by the awards groups.
ReedHastings
Sorry, Mike. I just want chime in just to that point, it is working already, and the model is working in terms of seeing the return to our business. I mean that programming at that level of diversity and quality across such a broad member base ultimately is driving member satisfaction. It's growing our member base, it's growing our revenues if you seen roughly 30% growth this year. We are growing our profits. Both our profit and margin and up to $2.6 billion of operating profit this year. We are delivering on our cash flow objectives including on a path to improve our cash flow profile next year as you saw in the letter, material improvement from negative $3.3 billion this year to roughly negative $2.5 billion next year on that path to cash flow positive over the coming years. So you are seeing it play out in the business model already.
MikeMorris
To that point, Spencer, my next question for you is really around your cash investment. On content in a coming year, can you share a specific in terms of the growth that you are anticipating there? And also can you just help us with the modeling side which is the amortization of that content relationship between that amortization and the cash investment?
SpencerNeumann
Yes, sure. So we'll continue to increase our content investment across the board next year. Because as I just said, we are seeing a great return on that in terms of our business model. Our content amort is just a little under $10 billion this past year in 2019. I think you should expect to see with our specific guidance, a similar level of growth and that kind of grew I say roughly in that 20% range this past year. And you should assume we will continue to invest at those types of levels this year. The conversion or the relationship between our cash spent and our amortization, that ratio was about 1.6 meaning 1.6x the cash investment relative to our amortization of about $15 billion of cash investment this past year in 2019. And you should see that ratio continue to come down a little bit.
Again, without a specific number but we are scaling into the business. So we've moved the long way in this business model transition from what was once an all licensed content business to now the well over 50% of our cash spent is on originals, the future of our business is mostly originals. And we've very much transition there. So that puts less sort of pressure on our working capital, so that's playing out in the numbers as well. So similar growth rate and amortization, but it's getting closer in terms of our cash versus amort and you're seeing that in terms of the improvement in the cash flow trajectory next year.
ReedHastings
And, Mike, I am sure you realized it but it is a huge milestone in our growth of last year being peak negative free cash flow. And so we're on the glide path slowly towards positive free cash flow. We're excited about that but that's not coming from shrinking back our content spending. That's coming from the increase in revenue and operating income.