Netflix (NFLX.US) FY25Q1 conference call: Profits greatly exceed expectations, content investment in the second half of the year will accelerate relatively.

Recently, Netflix (NFLX.US) held a conference call for FY25Q1 earnings. The company's first-quarter profit significantly exceeded expectations, mainly due to higher-than-expected gross margins. This was related to both the continued popularity of their shows and the price increases in multiple regions in the first quarter, as well as the high-margin advertising push. Management raised their profit margin guidance for the second quarter to 33% (up 1.5 percentage points from the previous quarter), but maintained their full-year profit margin guidance at 29%, possibly due to cautious considerations in the current environment, especially as pressure is gradually being felt in the second half of the year. Although they no longer disclose subscription numbers in the first quarter, based on actual revenue and price increases in different regions, they have roughly estimated the increase in subscription users in different regions for the company. Overall, the growth in subscription revenue in the first quarter was still driven by an increase in users (estimated net increase of 4.5 million users, higher than the latest institutional expectations of 3-4 million). The company's first-quarter free cash flow (Non-GAAP) was nearly 2.7 billion, a 25% year-on-year increase. As cash flow is peaking due to the content cycle, the growth rate of content investment has slowed down. Generally speaking, in the same year, the second half of the year will see a relative acceleration in investment. However, considering the current volatile environment, with a content investment budget of 18 billion, it is possible that they may not spend it all due to cautious control. Competing companies may also face this issue, but generally speaking, this situation may be more advantageous for the current market leader. Q&A Q: How do you view Netflix's plans to increase content spending over the next 5 years, as well as the internal goal reported by The Wall Street Journal that Netflix aims to double revenue and triple operating profit by 2030? A: The company generally does not disclose forward-looking information publicly, but occasionally internal discussions may leak to the media. The long-term vision reported in the news is not our prediction, as the company does not have a 5-year forecast or guidance. The company has long-term plans - that is, every day working towards creating the most beloved and valuable entertainment company for all stakeholders. Currently, the company's business is doing well, with annual revenue exceeding 40 billion US dollars, over 300 million paying households, and over 700 million viewers leading in streaming share. However, in terms of reach, the company's share in the addressable market is still relatively small, accounting for about 6% of consumer spending and advertising revenue in countries and regions where services are provided, and there is still a lot of room for growth in user engagement, revenue, and profit. Q: This is the first time Netflix may enter a period of decline with low-cost ad packages, how do you view consumer behavior in switching packages during this decline compared to previous periods of decline? A: The company closely monitors consumer sentiment and macroeconomic trends. From the current business operations, key indicators such as user retention rate are stable and strong, package combinations and acceptance rates show no significant changes, recent price adjustments are as expected, and user engagement remains strong. The entertainment industry tends to be resilient during economic difficulties, and Netflix is no exception. Launching a low-cost ad package in its largest market has strengthened the company's ability to withstand risks, with the ad packages priced at $7.99 in the US and Canada, offering great entertainment value, and the demand for entertainment is expected to remain strong. In addition, the company is focused on enhancing the value of Netflix by producing original content in 50 countries worldwide, including a commitment of 1 billion dollars in Mexico and 2.5 billion dollars in South Korea, making positive contributions to the local economy and culture, with relatively small exposure to international risks. Q: Will global economic uncertainty change the pace of price increases for Netflix, or will the content advantage and increased user viewing time offset this impact? A: The company adjusts prices mainly based on member feedback, and decides whether to adjust prices for reinvestment after sufficient investment to enhance service value. The company will continue to follow this principle rather than a predetermined plan. Historically, during economic challenges in different countries, the company has been able to maintain a positive cycle, indicating a gap between product value and price that is a cost-effective choice for many people. The company is also expanding price ranges, including launching low-priced ad packages in the advertising market to meet the needs of more consumers, and will continue to strive to increase value and accessibility overall as in the past. Q: Given the strong growth in paid users in the fourth quarter, how is member retention, have most of the new subscription users been retained, and what is the trend in user churn rate? A: The company's user acquisition and retention trends are strong and stable, with healthy membership growth in the first quarter. The new users attracted by some large live events in the fourth quarter of last year (such as the Paul Tyson boxing match, NFL games on Christmas, and "Squid Game") accounted for a small percentage of net new users in that quarter, and the retention characteristics of the members attracted by these events are similar to those who joined due to other popular content, with no significant change in retention rate at present. Q: Given the strong operating profit margin performance in the first half of the year, can you discuss what key incremental costs are expected to cause a decrease in profit margin in the second half of the year? Which of these costs are expected to have a larger impact in the third quarter or the fourth quarter? A: The company still predicts a full-year operating profit margin of 29%, primarily managing the full-year profit margin. Quarterly profit margins will fluctuate, mainly influenced by content scheduling. Content costs are expected to increase year-on-year in the third and fourth quarters, as there are major series returning in the second half of the year, and the fourth quarter usually has more movie schedules. Sales and marketing expenses are expected to increase in the second half of the year to support content scheduling and ad sales. Besides the higher volume of movie schedules in the fourth quarter, there are no significant differences between the third and fourth quarters. The first quarter operating income exceeded expectations, mainly due to timing differences in revenue and expenses, and overall spending is expected to remain unchanged. Q: Will the current macro environment change the company's strategy for the TV advertising upfront market? What is the overall view of your strategy for the upfront market and scatter market? A: The company closely monitors the market, but direct interaction with buyers has not shown signs of market weakness, and some positive signals have been seen in the lead-up to upfront activities. The company has a relatively small scale in the advertising business, which allows it to some extent to resist market changes. The company is rolling out its own advertising technology suite, launched in Canada and the US, and will be launching it elsewhere.Ten markets will be launched successively, providing advertisers with new features and opportunities. Based on the current situation, the company expects advertising revenue to roughly double by 2025, achieved through a combination of presales, programmatic advertising expansion, and scattered market integration.A: Can you update on the situation of the company's first-party advertising technology platform? How does the launch in Canada compare to expectations? What are the observations in the United States? A: Launching our own advertising suite is an important milestone, and it is still ongoing, with the launch in Canada and the United States meeting expectations. Based on operational feedback, the company is quickly learning and improving, and will gradually launch in the remaining 10 markets in the coming months. The main advantage of using our own ad server is to provide more flexibility to advertisers, reduce activation barriers, improve overall purchasing experience, and drive sales growth. Over time, the first-party advertising technology platform will provide advertisers with more key features, such as more programmatic advertising opportunities, enhanced targeting capabilities, utilization of more data sources, and stronger measurement and reporting capabilities. Additionally, using our own advertising technology stack allows for better control in creating higher quality ad experiences for members, such as improving ad relevance. The company has a clear roadmap for continuously iterating and innovating in the advertising business. Q: Netflix has made some progress in personalized content recommendations. So, what are the key steps in solving ad content recommendation or relevance, and at what stage are we currently? A: Netflix aims to achieve the same level of maturity and capability in advertising as in personalized content recommendations, matching appropriate ads with the right audience, viewers, and titles, which is a win-win for advertisers and members. This process has just begun, with the first step being the launch of our own ad platform in Canada and the United States, expanding to other markets in the coming months. During this period, significant advancements have been made in targeted advertising capabilities, including targeting based on Netflix's unique data, such as life stages, interests, viewing moods, etc. In the U.S., advertisers are allowed to more precisely target their imported audiences, Netflix model audiences, and audiences provided by third-party vendors. Looking ahead, by 2026, there will be more data targeting capabilities added and expanded globally, along with increased measurement capabilities for all markets; by 2027, targeted investments will be made in advanced data capabilities, such as machine learning-based optimization and advanced targeting. Additionally, having our own ad platform allows for faster innovation and development of new ad formats. Netflix believes it can progress in this process faster than other streaming services, utilizing existing technology, data, data science expertise, and rapid product innovation experience. Q: How does Netflix's strategy align with the UFC, WWE pay-per-view events, F1, and Major League Baseball resources in the sports content category? A: Netflix's live offerings are not limited to sporting events, so we currently do not comment on specific opportunities in this area. Our live event strategy remains focused on major breakthrough events, with all participation events being economically reasonable. Live events account for a relatively small proportion of content expenditure and viewer hours, approximately 2,000 billion hours, but they have a significant positive impact on topic discussions, user acquisition, and retention. For example, in July, the Taylor Sorrento return match was the most-watched women's sports event in U.S. history; on December 25, 2025, NFL games will be broadcasted all day again. Currently, live events are mainly held in the U.S., with plans to expand related capabilities globally in the coming years. Q: Will the video podcast category perform well on Netflix? A: Netflix has always been focused on various content and content creators, and the boundaries between podcasts and talk shows are becoming increasingly blurred, seeking to collaborate with various media creators that consumers love. With podcasts increasingly focusing on video formats, Netflix has also produced many podcasts for promotion and marketing purposes, targeting specific shows, types, or stars. With the popularity of video podcasts, it is expected that some video podcasts will appear on Netflix. Q: What is needed to create iconic animated series and build animation IP with cultural relevance? Is it through building different teams, making acquisitions, or other means? A: Building animation IP is a new and entirely creative process, with both successes and failures at Netflix, and much work still to be done. However, there have been some good results, such as "Puss in Boots 2," "Seabeast Hunter," and "Pinocchio" (LEO, Seabeast, Gamma DeToro Pinocchio), with "Pinocchio" winning the Oscar for Best Animated Feature. In 2024, 9 out of the top 10 most popular streaming movies were animated movies, indicating a high demand for animated films. In terms of animation strategy, Netflix wants to both produce and license animation content, currently obtaining more licensing opportunities through output agreements with Universal, Illumination Entertainment, and Sony. Animation team Hanna and Dan are working hard on a series of promising exclusive original animations planned for release in 2027, including "Inner Dreams," set to launch in the fourth quarter. Q: In the next 5 years, can investors expect Netflix to enter the short video or creator-led content field, competing directly with YouTube? A: From a macro perspective, Netflix has always faced strong competitors, including YouTube, all vying for users' entertainment time. Netflix believes the biggest opportunity right now is to capture about 80% of TV viewing time not currently occupied by Netflix or YouTube. In direct competition with YouTube or similar platforms, Netflix believes it can provide more competitively services for specific types of creators and storytellers, leading in the monetization of this content, offering better opportunities for creators and stories than YouTube. At the same time, Netflix is always open to exploring new opportunities and challenges in the evolving entertainment landscape.Currently seeking the next generation of outstanding creators, believing in having the best global monetization model for quality storytelling, able to help creators reach audiences, and support creators in more ambitious creations while reducing risks. Like Ms. Rachel consistently ranking in the top ten on Netflix every week, Kill Tony being welcomed by stand-up comedy fans, and Netflix collaborating with Side man to release Pop the Balloon.Q: How does Netflix use artificial intelligence technology for its creative partners? What significance does this have? Can you share some examples? A: Currently, creators are very excited about the changes that artificial intelligence can bring to content creation. Netflix's creators are using AI tools for scene references, pre-visualization, preparation of visual effects sequences, and shoot planning, making the creative process better. In the past, only big-budget projects could use advanced visual effects, such as VFX. Now, with the help of AI tools, even small-budget projects can achieve big-budget visual effects on screen. For example, 5 years ago, "The Irishman" used very cutting-edge and expensive de-aging technology, but it still had many limitations and troubles for actors on set. This year, Rodrigo Pieto, who was the director of photography for "The Irishman," used AI tools for de-aging visual effects in Netflix's first narrative feature film "Pedro Paramor." The cost of implementing the de-aging visual effects using AI tools was only a small fraction of what "The Irishman" cost, and the budget for the entire film was equivalent to the visual effects cost of "The Irishman." Netflix's focus is on finding ways for AI to improve the experience for both members and creators. Q: What measures can Netflix take to improve user engagement on the platform in terms of content discovery? Can further structural improvements be made to the recommendation engine? Or is more marketing needed? A: Even the most popular and talked-about content on the platform accounts for less than 1% of views, so content discovery and recommendation capabilities are crucial for unlocking the value of global content investments. Netflix believes there is still room to improve content discovery and recommendation experiences to provide more value to members and reach a wider audience with content. Last year, Netflix began testing a new, simpler, and more intuitive TV homepage, marking the first major structural change in over a decade. It is expected to be rolled out later this year and will significantly improve content discovery experience on Netflix, representing a major structural shift. Furthermore, Netflix is also developing new features such as interactive search using AI-generated technology, which is expected to enhance members' content discovery experience. There are many specific improvement measures in this area for the future, with almost limitless room for improvement. Q: What are the adoption trends of additional member accounts since their launch? What contribution does this service make to revenue growth so far? Do you believe it will be beneficial for future growth? A: Additional member accounts are part of Netflix's package and pricing model, providing members with flexibility and choice to share Netflix services with family or friends at a lower cost. The package has good user retention and engagement rates and is a healthy part of the business composition. However, from a business perspective, additional member accounts are not the main driver for Netflix's business, and its scale is expected to remain relatively small in the foreseeable future, with moderate growth currently. Q: What types of games on Netflix are currently receiving good feedback, and in what areas can user experience be improved to enhance game engagement? A: Currently, the types of games receiving good feedback are as follows: 1. Immersive narrative games based on Netflix IP, such as "Squid Game: Let's Play," which will receive updates with the new season of "Squid Game." There are also dark electronic pet-style games based on "Black Mirror." 2. Mainstream mature games, such as "Grand Theft Auto," have been very successful and more games of this type will be released in the future. 3. Children's games offer a safe gaming experience without ads or in-app purchases for kids, such as the recently announced "Peppa Pig" game. 4. Social interactive party games, although there is limited data currently, are highly anticipated and can be seen as an interactive evolution of family board games or TV game shows. There are many aspects to improve user experience, from game discovery to gameplay starting, and releasing more attractive games are key. In terms of investment and growth, Netflix will gradually increase investment, with the current investment scale relatively small compared to the overall content budget. When there is more evidence of growth, investments will be moderately increased. The global gaming market (excluding China, Russia, and ad revenue) has consumer spending of about $140 billion, showing great long-term opportunities. Q: What are the key driving factors for the expected revenue growth acceleration in North America in the second quarter? Is it mainly due to pricing factors, or are there other aspects such as advertising or subscription user growth? A: In the first quarter, North American revenue increased by 9% year-over-year, a slowdown from the 15% growth in the fourth quarter, mainly due to the timing of price increases and the advertising revenue from National Football League (NFL) games in the fourth quarter. Revenue growth is expected to accelerate again in the second quarter, mainly due to the full quarter revenue from annual pricing (price increase effect), while the advertising business, although smaller than the subscription business, continues to grow throughout the year. Q: Netflix aims to achieve $80 billion in free cash flow by 2025, with the goal of increasing free cash flow growth. Historically, there hasn't been much spending on acquisitions. Can it be assumed that most of the increased free cash flow will be used for stock buybacks? A: Netflix's capital allocation policy has remained consistent over the years, prioritizing profit growth through reinvesting in the business, maintaining sufficient liquidity as the top two priorities, and then returning excess cash to shareholders. Apart from retaining a few billion in minimum cash and using it for selective acquisitions, if there are no major acquisitions, it is expected that the increased free cash flow will be used for stock buybacks.