Discussions of the Prospects for Advertising and Shared Account Payments in the Netflix 1Q23 Earnings Call Summary

The following is a transcript of the Netflix Q1 23 conference call. For a review of the financials, please refer to "Netflix Can't Keep Up with Mooching, Stale Growth" (https://longportapp.com/en/topics/5233184?app_id=longbridge)

Q1: Regarding the recent widespread price changes, is this a local strategy similar to India in 2021, or is it to promote the successful implementation of the pay-sharing and ad support plans?

A1: We have been refining our pricing and earnings strategies over the past few quarters. When we launched globally in 2016, our pricing strategy was essentially a rough and uncomplicated approach. Therefore, we see this price change as the next step in our evolution, which is better product fit, market fit, and price fit, with the goal of increasing our penetration and long-term revenue in these markets.

But we want to emphasize that the impact of this change is not immediately visible - while the price change affects many countries, the impact accounts for less than 5% of revenue. Therefore, we hope that it will benefit us in the long run. We can give an example, as we saw in India last year - our prices dropped 20-60%, and user stickiness grew by 30%. Net revenue for paid games grew very rapidly. Regarding revenue, our neutral forex revenue growth accelerated from 19% two years ago to 24% last year. We're not saying that every market will develop like this, but this is indeed a successful performance.

Q2: Regarding the new password-sharing measures launched, can you provide the churn rate, retention rate, and conversion rate for the first users in the Canadian region to adopt this measure?

A2: This new measure is an important change for us. So we are working hard to make sure we do it well, and thinking about it as fully as possible. The launch in this last group of countries has gone well - perhaps most importantly, in the development direction consistent with what we saw in Latin America.

This is similar to a price increase - we saw the initial unsubscribe reaction, and then we worked hard on members and revenue, allowing account-sharing borrowers to register their own online accounts, with existing members purchasing additional member services for the people they want to share with.

Therefore, seeing consistent results in these new countries is a strong validation, as they have different market characteristics from each other and the countries initially launched in Latin America.

You mentioned Canada (the region where this new measure was first launched). Compared to before the launch, we have now returned to positive user and revenue growth. Therefore, this is strong evidence that we have found a way that can be applied to many countries with different market characteristics, including our highest-income countries.

We have also learned some improvements from a recent series of releases, such as being able to access Netflix anytime, anywhere, even on the go, and ensuring that we have good tools for them to manage their accounts and devices. In summary, based on these results, we feel it's best to take a little more time and incorporate these learnings to make the transition for our members as smooth as possible. We believe this approach is also most advantageous for our long-term business goals. Therefore, we will be rolling out this new improved version extensively, including in the US in Q2.

Q3: What is the outlook for the other regions of the world in Q2? What are your thoughts on pricing, are you leaning towards converting current account sharers to subscribers?

A3: Our update in Q2 will be very broad, including the US as well as many other countries. We've reserved the right to take different strategies in countries we believe should have a different approach. However, I can say that the vast majority of our countries will launch in Q2, keeping in mind the revenue recognition aspect.

In terms of pricing, we will be deciding based on the market fundamentals, but it's clear we've tested different pricing. We will then accept testing in Latin America, giving you insight into how we're thinking about the best pricing, especially in wealthier countries and states.

Then when it comes to preferences, what we want to do is really support diverse choices, there is no preference or deliberate guidance. This gives users a chance to choose different packages, borrowing accounts they feel are the right solution, for example someone might want to purchase Netflix for family members - we want that extra member to be there too. We're not trying to think about long-term pricing from a single angle to meet the choice goals of these customers and also consider long-term revenue optimization.

Q4: Regarding measures to share passwords that may bring incremental cost margins, it seems that content distribution and marketing expenditures are already in the current operating expenses. Are there other incremental costs? How do you see incremental profit margins? Will there be further investment?

A4: There's nothing else other than general resource allocation. I wouldn't say there are true incremental costs here, but of course, we always want to reinvest. As you can see, we're looking to accelerate revenue growth again, and that's the path we're on now. We want to balance gradually increasing profits while doing so. You can see in our guidance, we're looking to increase the full year profit margin to 18% to 20% but that's with our massive bonuses before. So, we're reinvesting more and more in entertainment activities for our members, driving more entertainment, more value, ultimately gaining more members and building a truly massive and profitable business.

Q5: Regarding advertising business, Netflix seems to have a huge advantage in TV advertising (because there are not many incremental costs, and revenue can basically be counted as profit), and given limited advertising load, premium video content, your tremendous influence, and audience that's difficult to reach, and the massive shift from linear to streaming, your position is enviable.

Having said that, you seem to be very cautious when launching ads. What are the main experiences and lessons learned so far, and what are the possible growth impediments? A5: As you mentioned, we are very optimistic about the long-term opportunities due to the reasons you mentioned. But to be honest, it is a gradual process that follows a very similar process that we have used in many other areas - we learn, iterate, and discover that this method will basically produce great long-term results.

So what I want to say is that we have a lot of work to do today - continuing to develop features that support advertisers. We are launching measurements and validations, but we have a bigger, longer roadmap that we have to go through. We are working with Microsoft to improve our market entry and sales capabilities.

You have seen us increase our programmatic private bidding market, which provides advertisers with more purchasing options as inventory increases. Then we are also working hard to improve the consumer-oriented aspect - we are adding more functionality in advertising campaigns, and we are bringing a better experience for members.

Through this process, we expect these iterations, we try to be a fast-paced and wise and thoughtful business, and truly become an important, high-material, high-profitable business for a period of time. But there is still a lot to do, and we are working hard to maintain a fast pace but also a thoughtful pace.

Q6: About the media reports on establishing advertising technology capabilities, can you provide an overview of the plan, timeline, and cost?

A6: What I want to say is that we have the ambition to innovate in this field, and many innovations consider an experience suitable for members, considering things like the right time to play ads and similar. But I also want to say that we are now building a business model and doing a lot of work to build a big business on a good path, considering verification, measurement, programming, etc. These are relatively easy things. So a lot of the work we are doing is in this area.

Regarding costs and how they affect our overall financial position, our revenue and incremental profit contributions, we can do this in a very healthy way. This is our direction of development. So yes, there is some cost, whether it is based on the cost of working with Microsoft or the cost of building our capabilities, personnel, and technical capabilities - but these are all easy to manage. We also talked about some content costs, because we continued to increase the content parity level of the plan in the last quarter, which is good. So this achieved more than 95% of viewing price parity, which is also a huge progress.

So we continue to move forward, but to some extent, we believe that it is not only to provide better options for members at a lower price, but also better for our business. We think we can do it, and I want to believe it's like 50% or more incremental profit contribution business.

Q7: About the mention of advertising next month, have standard services been introduced at this stage, and are there plans to introduce premium services in the future? How much scale will you have when you promise to arrive in the fall? A7: Regarding your first question, we have been considering and working to improve our pricing structure. We have two goals in mind:

First, we want to have a broad-based consumer audience, ideally increasingly broad-based, who can access our great content at the right price and corresponding features.

The second goal is to consider optimizing long-term revenue. A good example is the optimization of our economic model based on our advertising program, which has been beneficial due to the switch between our standard and premium services that we have already seen.

We have upgraded the features of our advertising program, including video resolution or quality and number of concurrent streams, because we believe it supports these two goals. This is a good example. I want to say that we have been - and will continue to evaluate, as you have seen us act in this area before, but we do not have any additional updates today.

As far as scale is concerned, we are clearly growing every day and will seek to continue to grow, but we will not announce or set targets, or make any forecasts of our expected forecast.

Q8: Can you provide details on the current advertising ARPU you're seeing?

A8: Overall, we're pleased with the advertising performance of each of our members.

It's higher than our overall basic plan, and in the US, it's actually higher than our standard plan. So we really love our trajectory right now.

As I said, it's a win because it's a lower-priced choice for our members. It's incremental revenue, it's incremental margin to the company. So it makes the business stronger, and, of course, we can invest more and more into entertainment. So we like this path.

But it's still early days. We've only been at it for a few quarters, so we'll get better returns in the future. Better targeting and measurement, better tools and purchase options. We think all of these will build on the foundation. This will strengthen our high-quality cpm advertising network that we're building.

Q9: Regarding capital return and free cash flow, you did raise your free cash flow guidance, but you've kept your margin steady this year. What's your long-term margin growth or expectation right now? Can you provide any updates?

A9: We've never provided long-term guidance on margins. But what I will say is that we're in a great place with the existing business that we're happy with. It's a great business model. Over $30 billion in revenue, healthy margins, margin expansion, and expanding free cash flow. It's a starting point, and as I mentioned earlier, when we accelerate revenue, then invest back into the business, back into the member base, we feel like we're just small today.

We talked about it on our recent earnings call. When we look at it, about 5% of consumers directly consume in entertainment today, and we're mostly in the TV, movie, and gaming areas. When we just look at the available member audience, the more than one billion broadband households today, about 450 to 500 million of them are connected TV households, and we have about 230 million or so paid members today, right? This is why we are so focused on paid sharing, so that we can better serve our business and bring more value to our members. This is our goal.

In the long run, the current profit margin is not the short-term limit. There are many intermediary platforms in the entertainment and network services industry that have already exceeded our operating profit margin of about 20% in terms of scale.

So we believe we still have a long way to go, but we have some inherent advantages. We are a truly global entertainment network, perhaps the first, with a truly healthy leading participation and truly scalable content model. So we believe we still have a long way to go, but there are no specific guidelines at the moment.

Just as I can add an example - the magnitude of our global business, each of our important contents begins with local victories. Then they succeed, they gain regionalization, and then they gain enormous global success. When we are right, all additional audiences have no marginal cost. The potential for growth and profit margins is very, very high even beyond what we have today.

Q10: Can you give us an update on your capital return plan? Can you tell us your thoughts on long-term capital returns?

A10: We are pleased to have achieved full investment grade in the first quarter, which is a good milestone for the company. You are right that our capital allocation philosophy has not changed. Therefore, our goal is still to maintain the minimum cash equivalent to approximately two months of revenue.

According to the data from the first quarter, the minimum amount of cash is about $5.4 billion. At the end of this quarter, our balance sheet had approximately $7.8 billion in cash, so we do have approximately $2.4 billion in excess cash. That's why we said in the letter that our stock repurchase will accelerate in this year.

Q11: How are you preparing for a potential strike by potential creators?

A11: First of all, we respect the writers and the WGA. We can't be here without them. We don't want a strike. The last strike was devastating for creators. It's really hard in this industry. It's painful for the local economy that supports production, and it's really, really bad for the fans.

So if there is a strike, we want to try to make sure that we can find a fair and fair deal so that we can avoid it. But if there is one, we have a lot of programs and movies from all over the world, and we may be better able to serve our members than most.

We really don't want this to happen, but we have to make worst-case plans, so we do have a fairly strong release version to carry us for a long time. But to clarify, we are already at the negotiating table and we will try to find a fair solution to avoid a strike.

Q12: How do you expect content spending to change in the next few years? You already have a pace of $17 billion. Is it relying on revenue growth? Can you give us some of your thoughts?

====== A12: Yes, that depends on the growth of income. It's also important to keep in mind the way income or content spending is formulated and delivered initially. We're still working on whether to keep or shut down those floodgates that opened after the coronavirus outbreak, so it definitely will cause the cost of content to be a bit rough. We expect to return to the level of around $17 billion by 2024, and the growth rate certainly depends on the growth rate of income.

As we said, we expect to average around $17 billion from 2022 to 2024, but there's also a huge entertainment market to pursue. So, as we accelerate our income, we see many opportunities to become commercial opportunities for watching and participating. So we hope to be there and we just need to build it.

Q13: Do you have any thoughts on re-examining your movie strategy? You have had great success with dramas and distributions at the Oscars. So does this change anything for you? You have recently restructured this department, is there anything that can be interpreted?

A13: The movie sector is doing well. They're really making some great movies. As you pointed out, the success of the Oscars is huge. But even better than that, those award-winning movies are also very, very popular with fans. So this is a good reputation for winning awards, very popular with fans, and even, as I said, like Pinocchio in "All Quiet on the Western Front," we're really proud of the mixed movies because they're loved by movie fans.

So we're really satisfied with investing in movies. Of course, we're working to improve it, just like we handle all of our movies. But our distribution strategy, remember, there are many ways to create and collect demand for movies.

Driving people to the theater is not our job. We create the demand for this. We collect the demand for our subscription service from our members. I think having a lot of ideal and new content, including feature films in the first window, can bring value to our members and create value for the business. So, other than continuing to work hard to improve movies for our members and make a splash in the beloved and watched movies, there are no major changes in the game.

We believe this is really an advantage to favoring value for our members. But due to our size, our size is an average revenue of more than 230 million paying members, it provides the opportunity to invest in these big movies and bring them to our members. It's just another or area, a variety of content that must be watched and entertained. So it's really an advantage.

Q14: How has your live strategy evolved? Chris Brock is very successful, but live broadcast has some technical issues. Is live broadcasting a huge advertising driver? Do you need to invest more funds to enhance your technical capabilities?

A14: First of all, I would like to say that we are really sorry to disappoint so many people. We did not meet the standard of serving our members as we expected. From a technical perspective, we have the infrastructure, we just have one loophole, and we made some changes in March to try to improve live performance. We only did not see this error during internal testing, as it only became apparent when we stress-tested multiple systems under the load of millions of users.

So we hate when these things happen, but we will learn from it, we will get better and we do have the foundational infrastructure we need. The good news is, ultimately 6.5 million people watched and enjoyed the show.

We said we wanted a creative live event where it could help the content itself be a news-making and buzz-generating reunion show. And it really played better when people could enjoy it together. Of course, Chris Rock's stand-up was so great because people were really looking forward to what he had to say in that episode. So when we have the opportunity to do projects like this, we love that we can choose to do them. As previously mentioned, we were very disappointed to not see all the live products we wanted first, because love is blind reunion. But we were very excited that people liked the show. It does demonstrate both people's love for the brand and the growing love for the scriptless brands on Netflix. Some of which will be alive. I do think sometimes these results-driven programs work better in live broadcasts, they do generate a lot of conversation. But just like I'm Chris Rock, about 90% of the views happen after the fact. But that doesn't change the fact that it was a big event when it happened live.

We are not advertising live at this time.

Q15: What is the conversion rate for potential members regarding password sharing?

A15: Those who borrow accounts represent people with a certain level of technical literacy who use Netflix, who need to know how to use smart TV, broadband access. And they have clearly enjoyed our service.

Some of these people watch as much of our shows as a regular paying account, so the stickier people are highly likely to convert. But we will also see a situation where in high audience penetration markets (like the US), some people won't convert, but they will become part of our members as we improve our products, launch more amazing movies, and TV shows, and games.

Q16: What is the advertising feature that excites you the most?

A16: In this advertising model, I'm very excited about how we really need to work and how we can become bigger. There are some taxes, many of which are about measurement, validation, targeting, and expanding the way advertisers buy. So I'm excited about the financial return on these works.

But when you look at it from a technical product experience point of view, what excites me? This is where I think we have the opportunity to bring the specific characteristics of a completely addressable, completely locatable, and completely deterministic high-end advertising streaming system to this world. This means we can do a lot of things, like how we associate brands related to certain programs. It's about customizing the user experience to meet their current needs, rather than fitting all the rules for flying ads. So we can continue to pursue a stunning innovation roadmap, to be honest, we will continue to pursue it for many years. We don't even know what all these things are, because we mainly work with advertisers and members to try things out, and then let them tell us what is effective and what is not.

Q17: What do you think of the steady growth phase?

A17: I think we have entered the steady growth phase after the initial stage. This may be a combination of various factors.

Obviously, scale is relevant. We have achieved a certain scale to change advertisers' perception of us. Partially due to the technical features of ads facing ads. This is largely in line with measurement, validation, targeting, programmatic buying capabilities, which are part of it. So I think these really constitute that we have basically entered the middle stage of growth. To be honest, we have a lot of work to do in entering the running phase. This is a construction that takes years and a gradually building and crawling to walking and running. And we, we have only done a few quarters. I hope we can enter the walking phase by the end of this year and next year- I think it's a year from crawling to walking.

Q18: I want to confirm some costs, you mentioned that the profit margin is 50%. I mean, typically, the profit margin for advertising may be as high as 80% or 85%. Or do you think this is just a business with a profit margin of 50%+.

A18: I added a plus sign, so I said at least 50%, it’s just to emphasize that we are still in the entrepreneurial model of this industry. This is also a bit conservative. But over time, our expectation is that it will indeed exceed 50%, but I don’t want to give a specific number yet.

Q19: Can you give us some data on game engagement and retention rate that you see?

A19: I won't give you those specific data, but let me review our current situation. We already have 55 games. There are 40 very exciting games this year.

Our first new game from an internal studio will be launched later this year. You can see that it combines licensed and internally developed games. We have seen its trajectory afterwards. I want to say that in these other new content categories, if you think of movies, you hear people talking about movie progress or non-fiction or international, our building in a period of several years has given our members a new way of entertainment and more ways to enjoy the incredible universe, and deepen their fan base.

We do this to drive the key metrics we face consumers, which are engagement services, retention, and incredible stories. People talk about games, they must play games, create services, and motivate people to register.

Q20: Is there a plan to directly profit from games, such as through advertising or licensing game developers?

A20: There is no such plan currently. We believe that we are very consistent with what we have done in other areas. For us, the best thing is to really focus on the core plan, which is how we bring IP-based games and console games directly to our members and IP fans. And, we believe that part of the game experience and part of the game is about giving game creators the ability to think about building games purely from the player's perspective, without worrying about other forms of monetization, whether it's advertising or in-game payments.

Q21: Localized content in India grew by 28% YoY last year. Can you talk about your long-term strategy in India? Are you currently profitable?

A21: I think we've talked about this before. When our pricing is better and more market-fit, you can see that we can increase revenue, which increases engagement. We have to get the content that people really want. We saw steady progress in that quarter, our original series were great shows that everyone in the country loved. This brought great excitement to the service.

Now that we have a target, we must get the right pricing and payment methods. India is a huge market because it has a lot of entertainment-loving people, and you have to have products they like, which is any product they can do business with. So we have it, we're doing the creative part, and our pricing is getting better. And in India, there are always a lot of growth prospects. It's a very specific market because they like local content, but you also see that their local content is now more than ever before. I think it's been an incredible year, with the constant expansion of content opportunities, our ability to enter the market and allow these viewers to continue to grow, and we can do well in India. We still have a long way to go before that step. We are still investing, and I think this will eventually make India great.

Q22: Regarding ancillary income and products, when you see something, can you give us an outlook or update on your expectations for consumer goods? Are there incremental opportunities?

A22: Yes. We're still developing it. Our consumer goods business is primarily driven by building and deepening fandom. It does drive some revenue. However, overall, we are really looking for those opportunities to help fans connect with their favorite shows, their favorite movies, their favorite talents, wearing shirts or carrying notebooks, and other ways that people really like to express their fandom.

Through these very successful life experiences, we're very excited, and you see us stepping into even a new Stranger Things stage performance, with all kinds of magical things in that world. But please remember that this is primarily about building fandom in a way that can drive revenue, and it primarily strengthens the core business.

Q23: Follow-up work on password sharing. Have you seen any changes between different tiers in the market where you launched password sharing? For example, a household originally subscribed to the premium version, will they later switch to subscribe to two standard versions instead?

A23: We have seen some of the impact, and we know it's a very different situation in different markets, especially in markets where price is particularly sensitive. In some price-sensitive markets, consumers basically subscribe to premium versions and then let others pay for a small part of it because they share accounts. Therefore, after implementing the paid sharing policy, we have seen some people peeling off from these plans and signing up for individual plans, while we are implementing changes to prevent password sharing and enabling them to use things like extra member or use advertising plans as new entry-level prices in applicable countries/regions. I think you will see some changes like this.

In addition, we believe this is better for the business. Ultimately, adjusting the structure allows us to establish one-on-one relationships with more members, enabling all systems to run more correctly and making pricing relationships between different members of different plans more transparent. So, we are excited about this. But I think this is a very country/region-specific approach and some countries/regions will react to it while others won't and this is more about casual sharing.

Conclusion

We are really pleased with this quarter. 2023 is a good start. In terms of engagement, revenue and profit, Netflix is the leading streaming service and streaming is the future of domestic entertainment.

So, just yesterday, Nielsen released data showing that in the first quarter of 2023, Netflix is the highest-rated broadcaster in the US. We have - and we have a lot of room to grow, even with so much viewership, in the most mature markets like the US and the UK, we only account for 10% of total TV time.

We are growing in revenue and profit, not as fast as we believe, not as fast as we want, but we are growing, we are profitable, we have a clear path to reaccelerate revenue and profit growth, and we are executing on it. You will see more widespread launch of paid sharing in the second quarter, and we will also continue to develop this advertising business.

Our goal is also to continue to grow free cash flow. As we said this year, we will generate about $3.5 billion in free cash flow and improve our profit margin. So, please remember, this account sharing plan helps us have a larger potential paying member base and we can continue to serve and develop Netflix for the long term, which is why we are so focused on execution.

So we have to look at the diversity and quality of movies we have to look at TV shows, we have to play games, we will continue to work on improving discovery, with more trendy and creative marketing, because as we deliver as a business when we serve our members. We have been doing better and faster than our competitors on a monthly, quarterly, and yearly basis.

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