Netflix, Inc. (NASDAQ:NFLX) Q1 2023 Earnings Call Transcript April 18, 2023
Netflix, Inc. beats earnings expectations. Reported EPS is $2.88, expectations were $2.86.
Spencer Wang Hello. And welcome to the Netflix Q1 2023 Earnings Interview. I am Spencer Wang, VP of Finance, IR and Corporate Development. Joining me today are Co-CEOs, Ted Sarandos and Greg Peters; and CFO, Spence Neumann. Our interviewer this quarter is Jessica Reif Erlich. And as a reminder, we will be making forward-looking statements and actual results may vary.With that, Jessica, I am going to turn it over to you for your first question.
Question-and-Answer Session
Q – Jessica Reif Erlich Thank you. So let’s start with Ted and Greg. You have worked together for over 15 years, but this is your first quarter as Co-CEOs. Are there any highlights you want to share?Ted Sarandos Well, Jessica, as you pointed out, it’s our first quarter together as Co-CEOs but 15 years working together and in those 15 years, you build a lot of respect and trusting each other to help you get you through some trying times.And not to let you down about – there is no drama, but this was pretty much a business as usual quarter for us having done this together for so long.
And Greg and I enjoy the same kind of trust, respect and shorthand that I enjoyed with Reed for so many years. I know that Greg did as well.So it’s not as eventful as folks might have thought and it’s really been incredibly and wonderfully professionally stimulating to have a Co-CEO to get to tackle big problems together. So I think one of the things that we will look back at Reed’s incredible 25 years at Netflix, one of the great accomplishments is facilitating this very, very smooth transition and succession.Jessica Reif Erlich Great. So you have recently reduced prices in 116 countries. Is this a more local approach similar to what you did in India in 2021 or is the impetus to enable a successful introduction of password sharing and advertising tiers?Spence Neumann I can take this one, if you want.
Jessica, this is really about, we talked for the last few quarters about further refining our pricing strategy and monetization. And if you think back to when we did our global launch in 2016, it was pretty much across the board, a bit of a skim approach and not particularly sophisticated in terms of our pricing.So think of this as kind of that next step in our evolution of a bit of a better market fit, product market fit, pricing fit, with the aim of growing our penetration in these markets and also better medium and long-term revenue. So better for our members, better for our business.But just want to emphasize, this is not a material to our business anytime in the near-term for sure. So it’s a lot of countries, but it represents less than 5% of our revenue and so it’s something that will — over the long-term, hopefully, will benefit us and we can point to an example of success is sort of like what we saw in India.So last year back in December of 2021, we launch — we dropped prices in India between 20% to 60%.
We saw engagement over the past year grow by about 30% high growth in paid net adds. And also revenue, FX neutral revenue growth actually accelerated from 19% in the year prior to 24% last year. So that’s — we are not saying every market is going to play out like that, but that’s what it would look like a success.Jessica Reif Erlich Great. Let’s move on to password sharing. What have you seen in your Q1 new market launches, churn, as well as conversion and can you give us any specific color on what you have seen in Canada, whether it’s in terms of new subs versus add-ons?Greg Peters Yeah. I will take that one. So this is an important transition for us and so we are working hard to make sure that we do it well and as thoughtfully as we can.
This last of the country rollouts have gone well, and maybe most importantly, were directionally consistent with what we saw in Latin America.So just to remind people what that looks like, very much like a price increase, we see an initial cancel reaction and then we build out of that, both in terms of membership and revenue as borrowers sign up for their own Netflix accounts and existing members purchase that extra member facility for folks that they want to share with.So, first of all, it was a strong validation to see consistent results in these new countries, because there are different market characteristics different from each other and also different from the original Latin American rollout countries.So to get to a positive outcome, you mentioned Canada, we are now in a positive member and positive revenue position relative to pre-rollout.
So that’s a really strong confirmation that we have got an approach that we can apply in many different countries with different market characteristics, including our largest revenue countries. In fact, we actually — we could have launched that solution. We actually considered that option.But we also learned from this last set of launches about some improvements we can do, especially in areas that matter a lot to our members, things like having seamless access to Netflix as they have always been using it on the go or while traveling, as well as making sure that we have got good tools for them to manage access to their accounts and their devices.So, all in, we felt based, on those results, it was better to take a little bit of extra time, incorporate those learnings and make this transition as smooth as possible as we can for members and we think that approach also best serves the long-term business goals as well.
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So we are going to launch this new improved version broadly, including in the United States in Q2.Jessica Reif Erlich So as a follow-up, so the cadence, you just said the U.S. in Q2. How about the rest of the world and is there — can you give us your thoughts on pricing and whether you have a preference for a current borrower to become a subscriber or an add-on?Greg Peters Yeah. So that launch we are doing in Q2 is a very broad launch, it includes the United States, includes many, many other countries. I mean, we reserve the right for some countries where we think there’s a different approach. But I would say the bulk of our countries, and certainly, when you think about it from a revenue perspective, the vast majority will be rolling out in Q2.You mentioned in terms of pricing.
We will look at that on a market-by-market basis. But obviously, we tested different pricing in these last rollouts that will be tested in Latin America and that gives you a sense about how we are thinking about what is optimal pricing, especially in more affluent countries, so I will leave it at that.And then in terms of preference, what we are trying to do is create a structure that really supports choice. So that gives an opportunity for folks to spin-off to borrower accounts where they think that’s the right solution for them or for use cases, which are legitimate use cases where somebody wants to basically buy Netflix for a family member or something like that, we want that extra member to be in place, too.So we don’t really have, I’d say, a strong preference.
We are not trying to steer in one perspective other than using pricing to both satisfy those customer choice goals, as well as thinking about long-term revenue optimization.Jessica Reif Erlich One more on password sharing. Are there any incremental cost and it seems like content distribution, marketing are already in your expenses? So is the incremental margin 100% or are there plans to reinvest some of this revenue so it doesn’t all flow through?Greg Peters Well, I will leave this — go ahead, Spencer.Spence Neumann No. Go. Go for it.Greg Peters No. You got it. You got it. You got it.Spence Neumann I was going to say there’s really not, other than just kind of just the general kind of allocation of resources. I wouldn’t say there’s real incremental costs, but of course, we always want to reinvest.
So as you kind of see with our kind of guidance and our objectives generally, Jessica, we are looking to reaccelerate the revenue growth. That’s the path that we are on right now, and as we do that, we want to kind of balance gradually increasing margins.You see that in our guide where we are looking to tick up margins a bit to the 18% to 20% range full year relative to just under 18% last year, but balance that with that big prize ahead of us. So reinvesting to more and more great entertainment for our members and drive that flywheel of more entertainment, more value for members, and ultimately, more and more members over time and then build a really, really big and profitable business.Jessica Reif Erlich So let’s move on to advertising.
Netflix appears to have a huge advantage in, let’s call it, television advertising. I mean, you pretty much have nothing to lose from a legacy perspective and everything to gain on an AVOD platform. Given the limited ad load, premium video content, your humongous reach and engagement with some pretty hard to reach demographics, as well as the ongoing mass transition from linear to streaming, your position is enviable. Having said that, you seem to be very careful in your advertising rollout. Can you give us your key learnings to-date and what the growing pains have been so far?Greg Peters Yeah. As you state, we are significantly optimistic about the long-term opportunity for the reasons that you mentioned. But we have always expected and we continue to expect, frankly, this to be a gradual build.It follows a very similar process that we have used in so many other areas where we get in, we learn as we go, we iterate and we found that having that approach yields basically great long-term outcomes as we sort of grow and learn.So I would say where we are at today, we have got a lot of work to do to develop — continue to develop features that support advertisers.
We are rolling out things like measurement and verification, but we have got a bigger, longer roadmap that we have to go do there.We are improving our go-to-market and sales capabilities in partnership with Microsoft. There’s a lot of good work that we have to go do and some of this is hard work which vary country-by-country.You have seen us add programmatic private marketplace that gives advertisers more ways to buy as we grow inventory. And then we are also trying to improve things on the consumer-facing side. So we are adding more features to the ad plan. We are making that experience better for members.And through that sort of process, we expect those iterations, which we are trying to go as fast as we can on them while being judicious and thoughtful about the business, to really add up over a period of time into a significant, highly material and highly lucrative, high margin business.
But there’s plenty to go do and we are trying to maintain a fast pace but also a thoughtful pace.Jessica Reif Erlich There have been a lot of press reports regarding your buildup of ad tech capabilities. Can you provide an overview of plans, time frame and cost?Greg Peters Yeah. I would say we have ambition to be innovative in this space and a lot of that innovation is thinking about not a one size fits all in terms of the member experience and thinking about what’s the right time to flight an ad, things like that.But I would also say that we are very much in the mode right now where we are doing a lot of work that is following a well-trodden path to build a big business back to when you think about verification, measurement, et cetera, what we are doing on programmatic.Those are sort of, I’d say, relatively straightforward thing.
So a lot of the work that we are doing is really heavily in that space. And then in terms of incremental costs, Spence, do you want to chime in here?Spence Neumann Sure. I’d say just generally, Jessica, we try to, in all of this, first, we have always — we have talked about this crawl, walk and run, which Greg mentioned, being very thoughtful and methodical how we are building the business.And with that also, how it impacts our overall financials, our revenue and our incremental profit contribution we believe, we can do that in a very healthy way. So that’s what we are building towards. So, yes, there is some cost to this, both in terms of the cost of the Microsoft partnership and the cost to kind of some building out of our capabilities, people, as well as tech capabilities.But all very manageable.
We also talked about a little bit of content costs as we continue to kind of we increased our level of content parity on the plan this past quarter, which is great. So it’s about 95%-plus of viewing parity, which is again a great progress.So we are — we keep moving forward, but this is all at a level that we believe is not just better for our members with a lower priced option but better for our business and we think we could do it with and are doing it in a way that’s, I would say, without being overly specific, think of it as like 50% or more incremental profit contribution to the business.Jessica Reif Erlich When you come to the May advertising upfront, which is in a couple of weeks, it sounds like you are coming with the standards here now.
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Do you have any plans to introduce it to your premium tier and how much scale, meaning how many subs you expect on the platform when you rollout — when the upfront commitments come in the fall, how much scale will you have?Greg Peters Yeah. So on your first question, we are always thinking about and working to improve that plan structure, the pricing. We have got two goals in mind when we do that. One is, we want to have a wide range of consumers and — ideally increasingly wide range of consumer’s access to our great stories at a range of prices with appropriate corresponding features.The second goal is think about optimizing long-term revenue. A good example of this is based on the economics of our ads plan, based on the limited switching behavior that we have seen off of standard and premium.We have upgraded the ads plan features, both in terms of video resolution or video quality and number of concurrent streams, because we think it supports both of those goals.
So that’s a good example of that. I would say beyond that we have got — we will continue to evaluate as we always do, you have seen us make moves in the space before, but we have got nothing more to add on that today.And then in terms of scale, obviously, we are growing, every day we grow and we are seeking to continue to grow, but we are not going to sort of announce or a target or what we expect forecast, let’s say, for upfronts at this point.Jessica Reif Erlich One more advertising question and then I will move on. But can you provide ARPU specifics on what you have seen so far, because you mentioned in the release that the revenue is actually higher than even standard. So it seems like so far, so good?Spence Neumann Yeah. I can jump in.
I mean, yes, overall, we are pleased with our kind of per member ad plan economics. It’s higher than our basic plan overall, and as you say, in the U.S., it’s actually even higher than our standard plan.So we really like the path we are on, the trajectory we have, and as I said, it’s kind of a win-win, because it’s a lower priced option for our members and it’s both kind of incremental revenue, incremental profit to — as a business — for the business. So it makes the business stronger, which of course, we can then reinvest into more and more great entertainment.So we like the path, but again, it’s early. We are only a couple of quarters into this, Jessica, so we are going to get better, as Greg said, better targeting and measurement, better kind of tools and buying options for advertisers.
So we think all of that will actually kind of build on this so that we will reinforce and strengthen that kind of premium CPM ad network that we are building.Jessica Reif Erlich So maybe switching gears a little bit to the capital returns and free cash flow. You did raise your free cash flow guidance, but you kept your margins the same for this year. What are your longer term margin growth or expectations at this point, pre COVID you had indicated 300 basis points of improvement per year over a few year period? Can you provide any update to that?Spence Neumann We are not — we have never provided a long-term guide to our margins. But, I’d say, we are already in a place where we feel great about the business that we have. It’s a very — it’s a great business model.
The business at scale with over $30 billion of revenue, healthy profit margins, growing margins, growing free cash flow.So that’s sort of a starting point, and as I mentioned before, we are trying to balance, as we reaccelerate revenue, ticking up those margins with also reinvesting back into the business, back into that member base, back into that big prize, where we feel like we are so small today.We have talked on recent earnings calls where we represent we believe roughly 5% of that direct consumer spend in the areas of entertainment that we are participating in today primarily in film, TV and games.And when we think about even just the member population that’s available, those 1 billion-plus broadband households and even today, roughly 450 million, 500 million of those being connected TV households and we only have 230 million-ish paying members today roughly, right?So that’s why we are so focused on addressing with paid sharing and then just making our business and the value that we bring to the service better each day to bring in more members.