Good afternoon, and welcome to the Netflix Q2 2020 Earnings Interview. I'm Spencer Wang, VP of IR and Corporate Development. Joining me today are Co-CEOs, Reed Hastings and Ted Sarandos; COO, Greg Peters; and CFO, Spence Neumann. Our interviewer this quarter is Kannan Venkateshwar from Barclays Capital. As a reminder, we'll be making forward-looking statements and actual results may vary. Now let me turn it over to Kannan for his first question.

Thank you, Spencer, and you nailed my last name. So congratulations for that. So thanks for having me here. And I guess the best place to start here is Ted and Greg, congratulations on your new role; and Reed, you too, I guess you can relax a little bit more. So maybe we could just start off with your priorities, Ted, and maybe followed by Greg, just in terms of how you see the world evolving, what your priorities are. And of course, we are in the middle of a lot of change, so how you see the world. So maybe you could just start there.

We should begin by noting that it's unlikely Reed will take it easy anytime soon. I want everyone to know that Reed and I have collaborated for over 20 years. He has been an incredible role model and a source of inspiration for me. Together, we have faced some of the most challenging decisions the company has encountered, from mailing DVDs across the U.S. to streaming worldwide. My focus is on maintaining the successful trajectory we've been on as we work toward acquiring the next 200 million subscribers globally. I'm excited to hand it over to you, Greg.

Thank you, Ted. From my perspective, when I think about what our future is and I think it's just a tremendous next stage of growth that we will see mostly coming from outside the United States. So think of more and more employees outside the United States, more productions, more operations happening outside the U.S. and hopefully, many, many more members outside the U.S. This is an opportunity to lean in just a little bit more, be proactive and drive a little bit more alignment across those activities where we think alignment will benefit the business and push the optimization of those activities a little bit more. And Kannan, you might not know, but many years ago now it feels, I was able to spend a couple of years in Japan, launching the service there. And I got a chance to work with the local teams that we were hiring and growing there as well as our global teams to really look at every aspect of the service and try and improve it for our Japanese members and grow our membership base there. So I think of that as sort of like a mini version or trial or a test out for what I anticipate I'll be doing more in this role.

And just as a small little fun fact for our listeners and shareholders who may not know, but Greg actually speaks 5 languages. So I think as we become more global service, that skill set will really benefit the company.

Are you talking Java, C++? So you mean like programming languages? How do you find time, Greg, to do all that? It's pretty amazing. We are so excited about the next decade of Netflix growth. We've definitely got a good start, but the opportunity across the next decade is just amazing for us. It's a lot international, as Greg was referring, but I couldn't be more excited about it, and it will be great to have some help as we span the globe, and I'm looking forward to that. And to be totally clear, I'm in for a decade. So let me be really clear on that. I'm in for a decade, okay. And as Co-CEO, it's two of us full time. It's not like a part-time deal. So it's definitely broadening the management team and helping us grow even faster over the next 10 years.

That's great. Reed, from your perspective, now that you have a relatively new setup, are there any unusual growth plans you're considering? Will Netflix in the next 10 years look the same as it did in the last decade? Could you help us understand what your priorities might be now that you're sharing a job with Ted?

The three of us have been collaborating for a long time. There will be essentially no changes in the upcoming quarter. Ted's profile has grown externally, allowing him to arrange larger deals for us, which is exciting. Additionally, Greg will begin to spend more time globally for us. However, view this as being much more in line with our previous approach rather than a shift. Over the next decade, we have a solid model that we aim to improve continually. Each day, we focus on enhancing our service, ensuring that the content presented on the front of the user interface is easy to access and reliable, while also providing a wide range of content that we have been expanding. A few years ago, we only featured premium TV, but now we excel in movies, unscripted content, animation, and local language shows and series. The growth that Ted has achieved over the past five years is remarkable. So, think of this as us doing more of the same at a larger scale and appealing to more people, with no change in our focus or execution as we prepare for increased scale.

I feel like we have to make the shows and the films that people love and the stars that they want to spend more time with and being able to launch those brands, whatever your taste is all around the world, is such a monumental job, and I'm just thrilled that we have such a strong team to do it together.

That's great. Let's start by discussing the current environment. It seemed to be opening up, but now it appears things might regress a bit. Considering the changes around us, including how we work and the workflows in different organizations, how have your plans for Netflix been affected by COVID? Which of these planned changes do you see as permanent? Additionally, can you identify any cost or workflow advantages that may persist for a longer time?

Do you want to start, Spence?

Sure. Generally, it doesn’t change much. What we’ve learned is that the Internet is a more important part of our lives and it’s here to stay, and people really enjoy film and television shows. Our strategy is to continuously improve our content and product. You can see this in the business, and we can discuss it at some point. We’ve noticed some acceleration in our member growth, but our strategy hasn’t fundamentally changed. There are minor adjustments regarding our real estate strategy and content acquisition in specific regions, but overall, our strategy remains consistent and the growth opportunities are substantial.

I can comment on the production side. It's been impressive how flexible the teams have been, transitioning from full production to complete shutdown and then back to ramping up globally within a few months. Some of the safety protocols we're implementing worldwide will likely become a permanent aspect of our production, which is beneficial. The time spent between the shutdown and the ramp-up on scripts, development, and preparedness will enhance shooting efficiency, and I believe that will last. When it comes to releasing programming and content to the public and collaborating with the press, we've successfully conducted virtual press junkets that have allowed talent to connect with top writers from their homes instead of hotel rooms. The speed and efficiency of that approach might have lasting effects. We're learning to adapt our marketing strategies to compensate for not being able to host screenings, and I believe some of these adaptations will be relevant for certain content going forward. Overall, I think we'll emerge from this situation more capable and informed, just as we have from past challenges.

And just to pile on to that, I think it's been an opportunity to accelerate things that we were already excited about. One, I think, great example is creating a sort of technical infrastructure that allows distributed content creators, artists, think about visual effects artists, animating artists to be effective when they're at home and collaborate collectively on assets. We think that was in the plans before this all happened. But it's the opportunity to accelerate that and make sure that we're incrementally more effective during this period has been great and we'll learn a bunch from it that I think will serve us quite well as we go back to a more normal working pattern.

That's great. And when we look at the first half in terms of the subscriber numbers, obviously, you guys did close to the numbers that all of 2019 did. And so when you think about your guidance in that context, it does seem to embed an expectation of a lot of pull forward of growth. But over this period, we've also seen cord-cutting reach record levels, and that doesn't seem to be slowing down. And some parts of the world, again, seem to be shutting down right now. So if you could just help us think through the framework for growth for the next quarter and the guidance, that would be great.

Sure, I'll address that. Kannan, you really hit the mark. When we consider the guidance for Q3, we're not looking at it in isolation; we have to consider the context of what occurred in Q2. We added 10 million members, which represents our largest growth in a second quarter ever. When we evaluate the entire period of Q2 and Q3, historically, our best performance in that timeframe was two years ago in 2018, when we grew by 11.5 million members. If we achieve our Q3 guidance this year, that would mean we’re growing by 12.5 million members in that same period, which is 1 million more than our previous record. This signifies significant growth on top of an already strong Q1. Notably, those new members are highly engaged and are staying with us at rates comparable to or even exceeding pre-COVID levels. Our service continues to improve. Netflix in 2021 will offer a much better experience than in 2020, providing even more motivation for new and existing members to remain engaged and attract future subscribers. We believe there is a substantial growth opportunity available, even though we’re observing some near-term acceleration in growth.

Okay. When considering other aspects of guidance, what really stands out is the margin, and the marketing spend as a percentage of revenues is 7%, which is an impressive new low. Therefore, when looking ahead, particularly with content being more back-loaded next year compared to this year, it suggests that as we move into the second half of this year and the first half of next year, your marketing spend should remain lower than usual. Is that a correct interpretation? Also, does this indicate that the amount you need to invest in marketing due to the growth in engagement will be reduced moving forward?

Well, one of the things that's unique about our services is that our members spend a lot of time on Netflix every day. So it turns out the best place to talk to them about Netflix is on Netflix. And our investment in time, energy and dollars goes into kind of building the conversation, the zeitgeist, the buzz around our shows and our stars and how do we make sure we amplify that even when you're not on Netflix. But in terms of the march towards less traditional media, we've been on that for some time, meaning that it's just a more efficient, more impactful and more global way to talk to our members is not through always through the most traditional channels. So yes, you're spending less but doing more to attract buzz and attention to our shows, trying to cut through a world where there's a lot of choices.

I would like to add a point related to what Ted mentioned earlier regarding our marketing budget, which we expect to remain roughly the same this year at about $2 billion. This is still a significant amount for our marketing efforts. However, it appears that spending may decrease due to changes in our strategies, such as an increase in virtual events and a reduction in award marketing. Some of these changes are temporary, while others could provide valuable insights for being more effective in the future. Overall, this aligns with our strategic shift, but some adjustments reflect the current environment.

Okay. And so when we think about...

We're seeing, Kannan, that the service has just been able to generate amazing viewing. And so as the service gets better and better, we're able to take advantage of that.

Right. And when we think about your margin guidance for next year in that context, you have been improving margins about 300 basis points every year, but it looks like there is incremental opportunity now, but the guidance for next year is consistent more or less with the broader framework. So is that just conservativeness? Or is there something else guiding that as we go into next year?

Let's call it tamping down the expectations. This is a great growth opportunity for us. So any revenue upside, we would tend to put into more content for our members, which generates more growth over time. So we've been pretty good about that, which is taking that upside and then converting it into more and more growth through service quality. So that would be the plan.

Yes. I would like to emphasize that we are always looking to invest strategically in the service. We mentioned that there may be some margin improvement this year, but we are focused on managing for the long term and continuously increasing our margins. Therefore, I wanted to inform everyone that we are still aiming for another 300 basis points increase next year, which would bring us to a 19% margin.

And worth reiterating in an environment where Netflix 2021 is better than Netflix '20.

That's great. And so Ted, just to follow up on that comment, when you say it's better in '21 versus '20, are we talking about subscribers? Are we talking about the amount of content? So how should we frame that?

I'm discussing the upcoming content that's on its way. Right now, while much of the world is in a pause, this month you can expect a new series from Netflix featuring Katherine Langford from 13 Reasons Why called Cursed, which is a large-scale movie that reimagines the King Arthur legend. We also have a sequel to one of our biggest films, Kissing Booth 2, along with a new season of Umbrella Academy, one of our most globally successful series that performed well when it launched in its first season in 2019. Additionally, we're introducing a high-octane action thriller titled Project Power featuring Jamie Foxx and Joseph Gordon-Levitt. This ongoing stream of content and programming is noteworthy. Last year, we were only beginning to explore competition and reality programming, and in this quarter alone, with shows like Floor is Lava and Too Hot to Handle, we've achieved two of our biggest hits overall. Too Hot to Handle, in terms of viewership, was equally popular in Japan as it was in the U.S., which is quite remarkable. All of these insights keep building and growing across different content genres, which ultimately provides great value for consumers.

That's great. So I guess sticking on that theme for a bit. When we think about the content mix, obviously, that's changed quite a bit over the last few years with reality shows and now animation and so on. So when you think about this particular mix, reality shows do seem to be a better return on investment in some ways because a lot of them have shown up, like Too Hot to Handle is in the top 10 list, was there for some time. So when you think about this mix, is it fair to think about reality shows or maybe documentary programming as being slightly better return and, therefore, the mix is shifting slightly more in favor of that? And is this even a framework that you consider, which is when you invest in something, what the returns are versus the engagement?

The primary reason for investing in reality and unscripted programming is not the cost savings in production, but the strong affection people have for this type of content and its significance in their lives. If we aim to become the preferred destination for entertainment, it would be unwise to overlook a genre that heavily influences broadcast. Therefore, we have been exploring unscripted reality and have gained considerable expertise in the documentary field, which has now transitioned into a broader focus on unscripted content. Our foray into the competition space is still in its early stages, but the driving force remains the audience's passion for this programming rather than any minor cost reductions.

Okay. Got it. And Greg, just to think about the world from a distribution perspective, there's a lot going on right now in terms of disputes, the Peacock and HBO not getting carried on Roku. And of course, they're having problems with Amazon as well. And notably, when you think about this, I mean it almost feels like the legacy cable network MVPD disputes of the past where the aggregators are essentially becoming gatekeepers. How do you see this playing out? And is this a risk in the future for Netflix?

I find it quite unfortunate when negotiations between a device manufacturer and an entertainment service provider reach a point where it negatively affects consumers, preventing them from enjoying the shows they love on their devices. We have been fortunate to collaborate, invest in, and work alongside a diverse array of device manufacturing partners globally, striving to enhance the Netflix experience on their devices. This approach has proven beneficial for all parties involved. It allows us to better serve our members, while making those devices more appealing and valuable for manufacturers. Most importantly, consumers gain from these improved experiences. We will continue to invest in this model, supported by dedicated teams focused on refining the process, aiding our manufacturing partners in utilizing the technology we develop for enhanced experiences, and leveraging the unique features of their devices. We are optimistic that this positive model will persist.

Okay. And then I guess the other model for distribution is just your deals with MVPDs as well as wireless companies, and you have a number of these deals globally. So when you think about mature markets like the U.S. versus the rest of the world, your guidance for next quarter as well as the broader growth framework would suggest that marginally, these become a bit more important than the organic growth channels. So how are you thinking about these wholesale distribution deals? What kind of role do they have going forward? And what's the objective you're trying to solve for when you get into a deal with these guys?

Yes, I believe you are correct in your assessment. We see these partnerships becoming increasingly important, although they still represent a relatively small portion of our total acquisitions compared to our organic channel, which remains the primary method. We're evaluating these partnerships on two main aspects: the potential for growth acceleration and membership increase from adding such channels, as well as understanding their revenue implications, including any cannibalization or differing economics. It's crucial for us to ensure these partnerships contribute positively to our revenue. Additionally, we carefully consider the consumer and member experience, aiming to ensure that the member journey is as seamless and positive as possible. We support this analysis with metrics, focusing on engagement, usage frequency, and churn characteristics to ensure we provide a high-quality experience for our members through these channels. We remain optimistic on both fronts and plan to pursue more such deals, working with various partners in both well-established markets and regions where we have not yet fully penetrated. We see value in expanding these types of partnerships in both scenarios.

That's great. And then I guess looking at pricing, which is also slightly linked to the distribution discussion to some extent, but when you think about the pricing algorithm we've come to expect, it's been in that mid-single-digit growth range over time for Netflix. But more recently, I think when you strip out the effect of the price increases, it's trending a little bit lower than that because of some of the newer plans. So when you think about the pricing algorithm, how are you thinking about that going forward? Is it still the same mid-single-digit kind of a growth profile that you're thinking about? Or has that equation changed?

Yes. I want to start by reiterating what we discussed last time. For the past several months, our main focus has been on ensuring that our service is available to our members as a source of escape and entertainment. We are excited to fulfill that role and have actively invested in enhancing the service's value during this time by adding more content and features. As we look ahead, it's clear that each country is in a different situation. We will continue to evaluate various factors over time, including macroeconomic conditions on a country-by-country basis, as well as closely monitoring our specific metrics, such as engagement and churn. These metrics guide us in understanding when we have successfully increased value for our members. We're not following a strict priority plan but rather responding to these indicators that show we have done well in enhancing value for our members. When we see these signs, it may indicate that it’s time to approach them for a bit more so that we can invest further into delivering excellent stories, great content, improved product experiences, and ultimately create even more value for them.

And Kannan, just to remind you, we don't narrowly manage towards an ARPU number or an ARPU growth number. Our orientation is really on optimizing for revenue.

Great. When considering how to manage yield, which focuses on maximizing revenue, it's clear that units and pricing play a role, but churn is also a significant factor. Given your current scale, even slight changes in churn can greatly affect the overall income statement. Reflecting on the COVID period and the rise in engagement, can you discuss whether this is leading to improved churn performance in newer cohorts compared to earlier ones? It would be helpful to understand consumer behavior during this period of increased engagement.

Yes. Spence, do you want to take that one?

Sure, I can start. The situation is that the newer members resemble the existing members of the business quite closely. It's widespread, with members joining from various parts of the world, contributing a few million each from APAC, EMEA, and the U.K., along with a couple of million from Latin America. They're very engaged, and the retention rates across all cohorts are as good or better than those before COVID. It's not surprising that this membership base, both new and existing, has a strong affinity for film and TV content, and they exhibit similar characteristics. Greg, Ted, or anyone else, feel free to add to that.

I think maybe the one thing other than this sort of big structural engagement change which was sort of really a result of people being in lockdown and quarantine and turning to us for some escape, I would say, to Spence's point, backing up the high-level churn pieces, when we look at other sort of metrics that inform how they're engaging with the service, we see it being very, very similar to members we added pre-COVID.

And I was going to say, Kannan, it's a little oversimplified, but I think of it as when someone churns, it's always temporary. They're going to come back. It's just a matter of timing as our service gets better, as maybe their income increases, as the Internet gets faster. So we'd love people to get a taste of Netflix. We hope they stay for 50 years. But if they drop out, we think of it as always temporary and we're going to work hard to improve the service enough that they want to spend money with us.

It's been interesting to see the evolution of our relationship with that member, where they used to think of us as the place to watch the reruns of the shows that they missed on other networks all the way to now to where they come to us to be their favorite show and now for Friday night at the movies, where you have Netflix premiering the biggest movies in the world on Netflix. So it's an evolving relationship constantly but nothing unique in this subset of folks in terms of their watching and their churn behavior. So it's exciting.

That's great. And then I guess when you think about the product itself, one of the big discussion points has been content discovery because there's an enormous amount of content and there are an enormous number of streaming services now. And so we've got to sort through all of that in order to figure out what to watch. So when you think about content discovery, I mean, Greg, I know you run a lot of A/B tests all through the year, you run hundreds of them. So what are the kind of things you're thinking about in terms of improving the experience? You have the top 10 list. How has that done? If you could just give us some sense of how you're sort of looking at that issue.

I'll discuss the top 10 list and then address the broader macro question, which is always a favorite of mine. The top 10 serves as a small positive boost in overall engagement. While it's not a groundbreaking change, it highlights a genuine need among some members to easily find popular shows and join in the social discussions about them. This reflects the kind of work we need to undertake. We've assembled the most incredible array of entertainment options available to consumers at the click of a button. Ted's team is continuously producing exceptional content at a faster pace, which is fantastic for our members. This presents both challenges and opportunities for us as a product team to enhance the experience of discovering and selecting a great story, making it as enjoyable and straightforward as possible. The somewhat vague answer is that many changes are necessary, but when combined, they become transformative. If you look back at the Netflix experience from five years ago and compare it to today, the progress is remarkable. We are dedicated to making even more strides in the next five years to ensure our members worldwide enjoy this vast array of content.

Reed, one of the questions that arises is regarding the amount of content. You mentioned in 2017 that Ted was not feeling confident about the success rate of shows. Are you now at a point where you have a balanced portfolio of content, or do you believe Netflix needs to take more risks with its offerings? How do you see the current mix of content?

I feel great about the number of significant projects that Ted has planned. I'm aware of some things we're working on now that will be released in two or three years, and it's truly impressive. Some of these will turn out to be outstanding, and I will take great pride in them. I'm thrilled that we're willing to take those risks. Our goal is to have so many successful offerings that when you visit Netflix, you can seamlessly move from one hit to another without considering any other services. We aim to be your primary source, your best companion for entertainment. Of course, there may be times when you seek out another service for something exceptional like Hamilton, but generally, we want to be the option that consistently satisfies you with an easy and convenient choice.

I believe that franchises are an effective way to build worlds. Video games, books, graphic novels, comic books, and original intellectual property all share this aspect of world-building. Ultimately, the success of these projects depends on their execution. We were incredibly encouraged by our initial attempt with The Old Guard, which offers a fresh take on storytelling, and I see potential for many more stories in that world. Another example is La Casa de Papel, which became the most watched new season of television on Netflix this quarter, regardless of language, even in its fourth season. It has developed into a remarkable universe that we intend to expand. Intellectual property is an excellent starting point, but, like everything else, it relies heavily on execution. If done well, audiences will come back for more, and we aim to meet their expectations. We are very excited about this approach and the diversity of sources we are exploring.

That's great. Thank you all. Thank you.

Thanks, Kannan.

Thank you.