Netflix - Earnings Call - Q1 2012

Transcript

Speaker 1

Good day, everyone, and welcome to the Netflix First Quarter 2012 Earnings Q&A session. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Ellie Mertz, Vice President of Finance and Investor Relations. Please go ahead.

Speaker 2

Thank you, and good afternoon. Welcome to the Netflix First Quarter 2012 Earnings Q&A session. I am joined here by Reed Hastings, CEO, and David Wells, CFO. We announce our financial results for the first quarter at approximately 1:00 P.M. Pacific Time today. The shareholder letter and the Q1 financial results and the webcast of this Q&A session are all available at the company's Investor Relations website at ir.netflix.com. As is our standard practice, we will begin the call with questions received via email. Please email your questions to [email protected]. After email Q&A, we will also open up the phone lines in case there are additional questions not covered by the email Q&A or letter. The dial-in number is within our Investor Letter, but let me repeat it now. Please call 760-666-3613 if you would like to get into the queue.

We may make forward-looking statements during this call regarding the company's future performance. Actual results may differ materially from these statements due to risks and uncertainties related to the business. A detailed discussion of such risks and uncertainties is contained in our filings with the Securities and Exchange Commission, including our annual report on Form 10-K filed with the Commission on February 10, 2011. A rebroadcast of this Q&A session will be available at the Netflix website after 6:00 P.M. Pacific Time today. Now, let's move directly to questions. As is our standard practice, we have organized the questions by topic as we receive them via email this afternoon. The first topic we'll take questions on is domestic streaming. First question: Why are you so confident that gross ad trends result from seasonality and not slowing growth? How can you be confident in 7 million net additions for the year?

Speaker 0

We had a fantastic Q1 adding nearly 3 million members to our global subscriber base. We had strong results in all of our territories, including the U.S. Our gross ads are consistent with our historic patterns. Our churn is consistent with our historic patterns, and we're feeling very good about the year. If you look at adding 7 million net ads, which is our target for the year, and you compare that to 2010, where we also added 7 million net ads, in 2010, that was 7 million on top of 12 million starting members. This year, that's 7 million on top of 22 million starting members. It's a mathematical effect, if that's true, with steady churn, that in adding 7 million on top of 12 versus 7 million on top of 22, there will be a significantly increased seasonality of net additions.

The business is performing exactly as we had hoped. We're continuing to execute on all of the key dimensions, but the artifact of having 7 million net ads on 22 increases the seasonality relative to 2010. We've tried to demonstrate that or illustrate that in our appendix showing this phenomenon. I would say everything's consistent with what we've been hoping for, and that's why we feel good about the year continuing like this. I would say probably secondarily, all of the macro vectors are very good, which is broadband's continuing, we're getting better and better content, viewings at record levels, and consumers want click-and-watch on-demand Netflix Internet television.

Speaker 2

A follow-up question to that: What will be the earliest indicators that you can or can't achieve that 7 million net U.S. streaming subs goal for 2012?

Speaker 0

I think the earliest indicators will be our net additions in Q2 going into Q3. In looking at, as we continue to see the same net addition rate, both with the strength of the new members that we're bringing onto the space and the user engagement that we see, both with new members and existing members, if those trends continue forward, we would expect to be continually confident in our ability to add 7 million members.

Speaker 2

Can you discuss the rate within the quarter of subscriber additions? Was there seasonality in net additions within the quarter?

Speaker 0

There's seasonality, if you want. There's variation month to month, week to week, that follows pretty typical patterns, and all of those patterns have stayed consistent, are going consistently. The main consternation that we've picked up is, if gross ads are steady and following the traditional seasonal patterns, why is the net ads different? Why are the net ads diverging? The answer is just a factor, as to slightly repeat myself, of the math of it's on top of 22 million instead of on top of 12 that we've tried to demonstrate in the appendix the way that works.

Speaker 2

Is there another question on that? Churn spikes after the price increase, but remains above historic levels. Will churn come down, or is streaming only structurally higher churn? Please explain your rationale.

Speaker 0

On the prior question, too, I think the prior question asked narrowly the seasonality in Q1. It followed the prior seasonal pattern, so just to make sure we answer that question, and then could you ask that question in the top?

Speaker 2

Sure. Churn spiked after the price increase, but remains above historic levels. Will churn come down, or is streaming only structurally higher churn? Please explain.

Speaker 0

What we've said before is streaming only does have a slightly higher churn rate than our DVD service did in sort of part of our legacy. It's easier to sort of come in and out of that service than the DVD, having the DVDs at home and having to mail them. We would anticipate that that ease continues forward. We do retain subscribers that have been with us longer at higher rates than subscribers that join our service. As the base ages, the retention rate, the overall retention rate improves. Therefore, as the base ages, that retention rate will improve just like it did with our DVD service.

Speaker 2

How should we think about Q2 seasonality this year relative to last year when you added 1.8 million subscribers on a similar overall pace?

Speaker 0

In last year, 2011, we were on track for 11 or 12, arguably, net ads on a starting base of 19. That roughly parallels the 7 million net ads on 12 million from 2010. It's the ratio of net ads to the starting base that's different this year, and that's what creates the variation in net additions. This year, we're at 7 million targeting 7 million net additions on 22, and that's what's different from last year. It comes back to essentially these unintuitive math effects. If you've got consistent churn across the year, the net ad seasonality increases. The easiest way to see that is in the three tables at the very end of the letter where we've abstracted some examples to try to get comfortable with that phenomenon. We feel very much that we're on track for the 7 million net additions for the year.

Speaker 2

What drove the upside in contribution margins for the U.S. streaming business? Was there a timing issue associated with content costs?

Speaker 0

We talked about in the letter, streaming content costs were lower, some customer service costs were lower, and some delivery costs were lower. On the content side, we actually were pretty close to what we expected in terms of expense, but because it's such a large number, if you're slightly under that, it can be meaningful in terms of contribution margin. Most of what I saw was several small deals got pushed into Q2 or didn't close other than the end of the quarter.

Speaker 2

Is the domestic streaming outlook tied at all to HR 2471? Meaning, do you assume passage of this amendment at some point?

Speaker 0

HR 2471 is our bill to amend and improve and modernize the DPDA, and no, there's no assumption built into the numbers of that passing.

Speaker 2

At current churn levels, over 20 million people will turn off the U.S. streaming service at some point. Are you concerned that the large number of people that are trying Netflix and unsubscribing will ultimately prevent you from reaching your target of 60 to 90 million U.S. subscribers? Said alternatively, how much of churn is people turning the service off and on repeatedly?

Speaker 0

Lots of churn is people turning the service on and off. In other words, you join for three months, then you're not using it or you run out of money, then it's off for three months, then it's back on. Because we only offer a free trial to new members, subscribers particularly who are economically sensitive or price sensitive have an incentive to then start Netflix again under a different email address than they've had before. There's no real clean counting of that dimension. What we feel great about is the very strong gross ads, the churn that's in line with our historic trends, so we're feeling quite good about the numbers.

Speaker 2

Question on domestic costs. You've hiked your Q4 2012 domestic streaming contribution profit assumption to 17%. What's the biggest driver of that? Is it streaming content costs coming in lower than anticipated? Do you expect continued contribution margin expansion in 2013?

Speaker 0

The biggest driver are deals that we thought would close slightly earlier than they did, and that has a carry-forward effect from Q1 to Q2. I would say that's the largest driver of that contribution margin outperformance. In terms of 2013, we haven't given any guidance. We would like to see the 100 basis points per quarter go on for as long as we can, but we're going to have to feel our way through that year by year.

Speaker 2

January 2012, Netflix indicated that over 2 billion hours of content had been streamed globally in Q4. You alluded to continued growth in Q1 2012. Can you provide any more color as to the increase in streaming hours per sub per quarter sequentially?

Speaker 0

There's a reasonable amount of seasonality in viewing timed in northern climates to the long nights, so we really compare this on a year-over-year basis as opposed to sequentially. I can tell you that Q1 was an all-time record for us in total viewing and in viewing per members. In Q2, because of the seasonal, again, we'll compare that on a year-over-year basis.

Speaker 2

Moving to a question on profit outlook. Do you still anticipate net income losses for all of 2012? I.e., will losses in the fourth quarter international eat up the surprisingly high profit delivery in Q2 2012 and presumably through Q2 2012? Do you expect to lurk around breakeven in 2013 as you reinvest domestic profits into international expansion?

Speaker 0

I think we addressed this in the letter, but in terms of Q2 profit expectation, if you take the midpoint of guidance, there's a modest net income profit. What we said is we would continue to launch international markets and stay about roughly breakeven. With a Q4 launch, we would probably be facing the small loss rather than breakeven and then work our way back to breakeven.

Speaker 2

I'll shift to questions on content. Do you expect to slow the growth in U.S. streaming content spend, and do you believe there's a certain terminal amount of content that is needed to sustain any number of subscribers, whether it be 25 million or 40 million subscribers? Said another way, do you think Netflix has to spend considerably more on content to grow from 25 million to 40 million subscribers?

Speaker 0

We're growing content spend and content offering very aggressively going forward, and revenue is growing faster than that, so that's where we get the widening margin. We have a fraction, you know, a smallish fraction of the total amount of content that we would like to eventually have. We will continue to grow the investment in content quite aggressively, slightly less than the rate of revenue growth.

Speaker 2

You secured the DreamWorks Animation output deal well before the 2013 start date. Are there other studio output contracts that are coming up for renewal, such as Fox, Universal, Disney, and Sony? Are these all beginning 2014 or 2015? Will they similarly be bid out well before the start date? Do existing paying cable channels have right-of-first refusal?

Speaker 0

It's highly variable by deal. 2014 to 2015 are when most of them come up. As far as I know, no one else has a right-of-first refusal.

Speaker 2

What is the current status of Epix content as it relates to exclusivity, and what you intend to do going forward?

Speaker 0

Epix is on cable, and it's on Epix HD, which is a TV everywhere extension of Epix, and it's on Netflix. That's all that it's on right now. As we go forth with Epix, we're in a broad range of discussions about how to operate most effectively for both of us.

Speaker 2

Here's a handful of questions about originals. How significant overall views are exclusive or original content?

Speaker 0

Both the exclusive and original are two different things. Breaking Bad's exclusive but not original, as an example. Originals are just beginning, so all we've got up is Lillehammer. It's not yet, you know, hugely significant, but as we add in the next couple of originals coming later this year, that'll build to a nice % of our total viewing. I would say we look at the performance of those pieces of content like any other piece of content in terms of cost per hour viewed and its efficiency. Across that class of content, we would expect to compare it against other like content. If we think we can produce content at no greater cost than that per hour of viewing, essentially, then it would cost to get licensed. We have the advantages of the brand halo, as well as the defensive hedge if we need it over time.

Speaker 2

Can you discuss how successful Lillehammer was, maybe helping to place it in perspective with its views versus other shows?

Speaker 0

It was quite successful for the amount that we invested in it, the amount of the cost. It parallels some of the other premium exclusive content that we've got, like a Breaking Bad, in terms of its ratio of cost to viewing. We feel really good about that of our first shot out. As House of Cards and the other originals that we have come forth next year, we'll be very excited about those also.

Speaker 2

You said the cost associated with originals will ramp in 2013. Any way we can quantify the impact of that?

Speaker 0

It's really just part of content cost. That is, we'll spend in the neighborhood of, you know, single-digit % of our total spending, content spending for next year on a P&L basis will be original. For us, it's just another source of content. I think what we said in the letter was that the free cash flow, the cash will actually ramp as originals ramp into 2013. The costs are already baked into our assumptions around content expenses. It's the cash that will ramp noticeably in the back half of the year.

Speaker 2

This is a somewhat similar question. Netflix appears increasingly focused on exclusivity, especially compared to 12 to 18 months ago. Should we expect the vast majority of your content to be exclusive by year-end 2013? In turn, is it reasonable that content spending will continue to move notably higher next year, as well as due to healthy sub growth?

Speaker 0

As we move up the content buying economic strata, you start off with kind of the low-end non-exclusive content. Then as you want to get shows like Mad Men, you have to outcompete with other cable networks to get those shows in syndication, and those are exclusive licenses. We started doing more and more of those. As we want to do direct deals with movie studios like DreamWorks Animation, the other bidders will not take that content if we also have it. Those are de facto exclusives. This exclusive trend has been going on towards more and more exclusives and will continue as we climb the economic strata and have better and better content. It's a natural outcome of us being a network like other cable networks, all of which are exclusive against each other.

I don't think we'll have all of our content exclusive, you know, really at any point in time, because we'll continue to also have a broad range of non-exclusive content. Certainly, there'll be more and more that is exclusive.

Speaker 2

Can Netflix survive as a middleman? I define middleman as an intermediary between content owner and end user. If the company's largely middleman status, the reasons for its apparent evolution to, at least in part, original programmer. How long do you think it will take to become a credible peer to HBO, which has had smash hit originals such as Sopranos and Sex and the City?

Speaker 0

There are lots of middlemen that are hugely successful in many different industries, and sometimes they verticalize the production and they have store brands for various items. It doesn't mean that their middleman or retail status is weakened; they do that to strengthen themselves. If you think about HBO, initially it was on almost all licensed content, and then they grew in as they gained scale to also doing produced content. Still, a majority of HBO's budget is on content produced by others, by the major studios. We feel very comfortable about being an aggregator that packages together an incredible set of content, provide a great value for consumers, and that's a great position to be in.

Speaker 2

What is the balance of streaming content as of 3/31/2012 that are not currently reflected on the balance sheet?

Speaker 0

I think that's referring to the content contractual obligations. At the end of Q1, that was $3.7 billion, which compares to $3.9 billion as of the end of 2011 and $1.8 billion a year ago. It's down slightly from the end of the year. As we moved content from that table onto the balance sheet, it became in window, essentially, in that asset recognition criteria.

Speaker 2

I would say just as a follow-up to that, if you include what's in that note to the financials, if you ask about the accounts table, you'd see that our total minimum commitments for streaming content is flat quarter over quarter. The biggest complaint I hear is that Netflix has a weak library of streaming content. While keeping prices low is a strategy that seems to be working well, it prohibits this very common complaint from being addressed. Has Netflix proposed the idea of a tiered subscription plan for online access, a silver, gold, and platinum plan, which would open up an increasingly larger and more popular library? Could both address this issue and increase profitability? Has this ever been considered?

Speaker 0

No, we're very focused on keeping our proposition extremely simple. We think that that is the right strategy when we're in this rapid phase of growth of the market to have a single $8 unlimited product in the marketplace. Eventually, in an S-curve model, in the tail phase when a market matures, you look to segment in various ways. Knock on wood, we're a long way from that, and we'll continue to focus for the foreseeable future on a clean, simple proposition.

Speaker 2

Cable ratings for many networks have declined this year. Do you believe networks are attributing this to Internet TV, and could it impact pricing on renegotiated TV content deals?

Speaker 0

I'm not sure why cable network ratings are some are up and some are down. I think it's mostly to do with the individual programming. If you've got incredible programming, there are several examples where the ratings are up. In terms of how it affects us, we've got the ability to pay because we've got a larger subscriber base than anybody else. To the degree that the prices are higher, we're still able to deliver on the consumer proposition.

Speaker 2

I'll shift to questions about competition. Are you still thinking Amazon will do its standalone streaming product outside of Prime?

Speaker 0

Our understanding is that that will still happen, yes. In terms of a particular time frame, we're not sure what that might be.

Speaker 2

You've talked a lot about net neutrality. What do you see as the most realistic and/or likely path towards enforcement of net neutrality?

Speaker 0

I'm not sure at this point. I think we're broadly socializing the idea of what's neutral and what's not. We documented one clear example where we think this is not at all neutral, and we're engaged in a public discussion, essentially, of the issues. We'll see how that plays out.

Speaker 2

A related question. Why are you so concerned about Comcast and bandwidth caps? If one hour of streaming time takes up a mere gigabit of bandwidth and the Comcast monthly bandwidth cap is 250, implying 8.3 hours per day of viewing time, why the concern, especially if you believe that the Netflix streaming product is vastly superior to Xfinity?

Speaker 0

I think the concern we have is with the principles of net neutrality. Obviously, with a high enough cap, it kind of doesn't matter. If something is accepted with one cap, we may find the next year that the cap is much lower. I think we have to really try to think about the principles and advocate for those upon which we're operating. I would agree it's not a near-term issue with the 250-gigabyte cap, but the core principle is important anyway, which is the cap should be applied equally or not at all.

Speaker 2

I was wondering what Netflix will do to increase and hold existing subscriber base in the U.S. and elsewhere, with so many other companies entering the streaming video business.

Speaker 0

I think what's happening is everyone's realizing that consumers want click-and-watch on demand. There are a lot of announcements of everything from startups to large companies. We've been focused on this market for a very long time and have some substantial advantages because of that, in terms of the breadth of our integration into various devices, in terms of our on-the-remote control buttons that we have on smart TVs, in terms of our integration into all of the game consoles. We have big advantages in terms of the development of our website and the core service, the algorithms, and the personalization. We have incredible content. It's not as broad as we'll eventually have, but it's much broader than any competitor. Often what happens is when there's a lot of attention on the market, there are new competitors, but the leader gets the majority of the benefit of that.

It's our job to continue to deliver for consumers so that we're chosen more often than anybody else.

Speaker 2

Let's turn to questions about international. What have you learned from existing market launches that you apply to the thought process of selecting your next international market that you indicated will launch in Q4 of this year?

Speaker 0

We have been really happy with the UK and Ireland, just great results there. We have got great results in Canada. In Latin America, we will get there eventually, but it is going to be longer and harder than we initially thought. We will tend to be more towards developed markets that are more like Canada, UK, and Ireland than strong emerging markets like Latin America.

Speaker 2

Your international expense guidance on January's Q4 call forecasts $5 million for subtitling. Yet your release today, only months later, says you instead have capitalized such expenses. Why change from past immediate expensing to a more aggressive income presentation?

Speaker 0

The costs were immaterial in the past. They rose in Q1, as we talked about in the letter, getting more towards 100% of our offering in Latin America subtitled. We faced increased costs in Q1. The prospect, as we launch additional non-English markets, is that these costs will be material. From an accounting standpoint, when they're low, they don't matter, you don't have a policy. When they become material and in bulk they are material and they stay material, there's more argument that they could be capitalized. We looked at this and we needed to create a policy in Q1, and we didn't have that accounted in our forecast.

Speaker 2

Question on Latin America. In Latin America, we fully understand the limitations of infrastructure, credit cards, and broadband hindering uptake. What I would like to know is what about the progress there gives you confidence that it will succeed, albeit at a slower pace than you had initially expected, as opposed to not work at all?

Speaker 0

In Latin America, we're seeing very nice revenue growth. It's just not as fast as we anticipated in terms of catching up to the content. If there were a situation where we didn't have revenue growth, you know, that would worry us. That's not the situation that we have. We're seeing very nice revenue growth, and we're continuing to improve, whether it's payment, whether it's the streaming delivery, all the other systems. Second, there's no competitor that's ahead of us. If we were resoundingly beaten in some nation by some other competitor, that would have us maybe rethink how long it would take us to get to profitability. That hasn't happened. For now, we've got a rapidly growing business. It's still running at a loss, and it's going to take longer, we think, than the two years to get there. The vectors are all in the right direction.

Speaker 2

Could the iTunes integration be extended beyond Apple TV to iPhones and iPads too, in order to ameliorate the e-commerce payment problems in Latin America and elsewhere?

Speaker 0

are a number of integrations we could do. One would be in the iTunes aspect, others would be with ISPs, others would be with cable companies. We are looking at those broadly, and each one will have a small positive effect. There will be no one breakthrough or silver bullet.

Speaker 2

I would just add, as we say in the letter, we're obviously open to other people billing on our behalf, but also in Latin America, we're looking to improve the payment options that we offer to the consumer to solve the problem ourselves. The letter said you were looking to expand into additional European markets beginning in Q4 of this year. If you can't be more specific, can you talk about the characteristics of that market?

Speaker 0

I think that's probably just a duplicate question, so let's just go to the next thing.

Speaker 2

What is the incremental impact of your decision to enter another international market on the expected full-year results for 2012 on a consolidated basis? Should we see an investment along the lines of Latin America and the UK or smaller?

Speaker 0

We haven't provided guidance on that. What I said earlier was that we would be looking to fight back to a global consolidated breakeven after the market launch in Q4.

Speaker 2

How are you funding the entry and expansion into each country, and how many additional countries plan for this year and next?

Speaker 0

Fundamentally, we're funding it with the domestic profit stream. Our domestic business is showing great growth in both rent and contribution margin, and we're using those profits to fund the international expansion. It's needed by that, by our view of staying approximately breakeven on a global basis.

Speaker 2

Has your view of international competition changed in recent months?

Speaker 0

No, not particularly. We anticipated that in markets that we don't get to for a few years, there will be stronger local competition than in markets we get to soon. I think that's probably pretty obvious. That's really the only aspect of it.

Speaker 2

Do you expect to see any different seasonal patterns in international markets? I know it would not show today because of the high growth phase you're in, but would still like to know if there are any quarters with tailwinds or headwinds.

Speaker 0

From a diversification standpoint, if we were as big in the Southern Hemisphere as Northern, they would balance each other. It is definitely linked to length of the winter, length of the night. It would be in reverse seasonality from the Northern Hemisphere and the Southern. On a practical basis, with the U.S., just under 90% of the business, it's the dominant aspect of the U.S. seasonality. I would say that the pronounced weather pattern is one aspect of it, but as we contemplate other markets, we look at the seasonal TV viewing behavior, the seasonal rental behavior on video on demand, things like that. Some of these countries are tropical. They don't have a pronounced, you know, winter, summer, and they may follow the same pattern in terms of the Northern Hemisphere, but it's early to tell.

Speaker 2

While the subs trajectory in the UK appears far better than Latin America initially, can you give us a sense of what usage looks like? How much time are UK subscribers spending with the service?

Speaker 0

Usage has been very strong. I don't want to give, for competitive reasons, specific numbers, but we've been very pleased with that active usage and growing usage as we add more and more content and continue to flush out the devices, in particular to getting on the smart TVs.

Speaker 2

Let me take some questions on DVD. Why are you so confident that the DVD will not fall off as fast going forward as it did in the past couple of quarters? Even if churn is going down, is it not getting hard to find new growth additions for DVD plans?

Speaker 0

We're confident because the retention of those subscribers is improving from Q4 to Q1, and we may see some seasonality around Q2. In general, the number of subscribers we're losing on the hybrid side are not the step change that we experienced from Q4 to Q1, largely because people were deciding whether or not they wanted to pay $16 for a hybrid service when we made the changes in July, and they sort of rationalized those decisions over Q3 and Q4. Increasingly, fewer and fewer people are having to make that decision or have already made that decision about whether it's of value to them to pay $16 for the service, and that's what drives largely the sort of decreasing rate of decline.

Speaker 2

With the Quickster episode fresh in mind, but also considering the high overhead cost of DVD shipping, would you consider spinning off or selling the DVD division? The cash could be put towards faster overseas expansion. Maybe the DVD and streaming services could still be tightly coupled with the right contracts in place.

Speaker 0

No, we're not thinking of that.

Speaker 2

Moving to some miscellaneous questions. Are the terms of your Apple TV deal for new members signed up similar to the 30% revenue Apple has with other content providers?

Speaker 0

Those types of contracts, we're prevented from commenting by confidentiality, so we can't say.

Speaker 2

In late November, you announced the closing of $200 million worth of convertible notes. The notes could be converted after six months, assuming certain conditions were met. The six-month anniversary will end during the second quarter. Given that the shares appear to be above the conversion price, do you expect these shares to be converted? If so, when? Yes, the convert is first convertible six months after issuance, which was November, which places us in May. The company has the option of converting those shares at 30% over the conversion price, which is about $11. The earliest we could do that.

Speaker 0

$111.

Speaker 2

$111, thank you. The earliest we could do that would be July if the stock had stayed above that price for 50 of the prior 65 trading days. What should we assume for forward tax assumption?

Speaker 0

About 38%.

Speaker 2

Higher in Q2?

Speaker 0

Correct. That's right. It'll play a little bit as we should be so lucky to be paying taxes. I was just about to say that rate moves around a little bit as we come from a loss into a profit perspective, but around 38% for the next year.

Speaker 2

Great. That's all we have right now for email questions. At this time, I'd like to turn it back over to the operator, and we will begin taking live call-in questions.

Speaker 1

Thank you, ma'am. Ladies and gentlemen on the phone lines, to queue up at this time, you may press star, then one on your touch-tone phone. If your question has been answered or wish to remove yourself from the queue, you may press the pound key. Again, to queue up for a question at this time, please press star, then one. One moment. Our first question in queue is Chase Elstein with Oppenheimer. Your line is open. Please go ahead.

Speaker 0

Thanks. I only have two questions, and I'm not sure what was hit. With respect to what you talked about with Apple TV now taking sign-ups on the TV, should we assume that you're paying a similar 30% revenue share with Apple and that's kind of taken into account when you think about adding customers that way? My second question, you kind of had a positive take on the social integration in the UK and Ireland, but didn't give any specific metric. I'm wondering if there's any other type of metrics you can give out as far as maybe what % of users are uptaking the social functions. Thanks. Jason and Threed, we did just answer the Apple question, which was no comment. On the UK Facebook success we've had, we haven't characterized any specific metrics, and for competitive reasons, we're not further elaborating. Go to the next one.

Maybe one other follow-up. That functionality you're offering in the UK, is that more of a passive functionality, such as we're seeing like a Spotify, or is it an active sharing functionality where the user is prompted each time to decide whether or not they want to share their viewing habits? It's passive in the way that you use that word, like Spotify U.S. if you're using that, where your viewing history is optionally shared with your friends. Okay, thank you. Thank you, sir. Next question in the queue is Mark Faheny with Citi. Please go ahead. Your line is now open. Thanks. Two questions. I think Reed, last fall in reaction to some of the controversy, I think you made statements to the effect it might take a while for the brand and the relations and the trust with consumers to build back up.

When you think about your DVD streaming NetAd's goal of 7 million for the year and what you've done year to date, do you think you've already overcome some of those concerns, that backlash from the fall of last year, or do you think that that's still a subdued growth number that you could do better once you've regained the full trust of consumers? Could you just quickly talk about usage on tablet devices and that kind of material impact on those overall viewing minutes? Thank you. Good day, Mike. The brand recovery's partway complete. We had said it'd probably take three years with the bulk of the recovery in the first year. That still seems to us to be the correct model. We're feeling good about the progress we've made.

We are conscious that it's tender and that we have to be extremely diligent and thoughtful in the way that we act as we build back our brand reputation. In terms of tablet, it's a great and growing viewing source for us, but we haven't characterized with any specifics any of the particular devices, again, for competitive reasons. We are on both Android and iPad. Okay, thank you.

Speaker 1

Thank you, sir. Next questionary cue is Richard Greenfield with BTIG. Your line is open. Please go ahead. With consumers using Netflix so much, I think you've, you know, the numbers you broke out essentially equate to over an hour per day, actually, now. Shouldn't churn be going down meaningfully? You know, when you made that comment about in 2012, if you added 7 million subs, assuming, you know, flat as churn, why shouldn't we see churn go significantly down as the amount of usage per customer per month or even per day just continues to scale upwards? If you, just as a follow-up to that, could you just give us some sense on, for subscribers canceling now, what is the main reason people are canceling the streaming-only service? Thanks.

Speaker 0

Rich, you know, the average consumer is watching, as you said, nearly an hour a day, and then they're not canceling. The cancellations are amongst the people who aren't watching much. Our job is to get those light users that are not very active to be watching more. The other phenomena is, as the service gets better known and more popular, that expands the circle of people who join it, who maybe aren't as much in entertainment as the initial 20 or 25 million. It's natural that as the service expands its reach, there is continued churn as people try it, figure out if it's for them right now, and if not, they get off. That's where that phenomenon is from.

Speaker 1

Does that imply that the median is dramatically above the mean in terms of usage?

Speaker 0

No, it's just that it's not exactly a bell curve, because it's got the skew on the big end. The median's not wildly different. It's just that there'll be 20% of people that don't watch much, and most of the churn will come from them. You asked the question, when people quit, what do they cite? The two big ones are not watching enough and don't have any money, which we see also.

Speaker 1

When you say not watching enough, is that just because the programming, they can't find something they like, or there just isn't enough content in total?

Speaker 0

It's a mix of those. If you think about the moments of truth for a member, at any point in time, they can watch Netflix, or they can watch cable, or they can watch their DVR, or they can watch a DVD, or they can watch Hulu. We have to win enough of those moments of truth to keep the subscriber active. One of the ways we win is to have a really broad selection, personalization, ease of use, and other ways of just the habit, like being able to see the red Netflix button on the remote control.

Speaker 1

Thanks. Thank you, sir. Next question in the queue is Anthony DeClemont with Barclays. Please go ahead. Your line is now open.

Speaker 0

Thank you. Reed, you just mentioned that one of the big reasons for churn is people not having any money. I wonder if you would consider, you've considered that if StreamPix, for example, is at $4.99 and let's say Amazon comes out with a carve-out Prime streaming service at something lower than $7.99, would you, have you thought about or would you consider adjusting your price point? A second question would be, I think Mark asked about usage on tablets, and I would just ask, has the subscriber acquisition channel changed with the explosion in mobile? Is that something that you can comment on in terms of where you're getting gross ad connects from? That'd be great as well. Thanks a lot. We're feeling great about our $8 price because we can then get lots and lots of content for our subscribers. No anticipated changes there.

In terms of subscriber acquisition, mobile is a good source for us. Video disproportionately is watched on television. Things that are TV-based sign-up, like on the game consoles, like Apple TV, are really the brand center and the biggest drivers of potential opportunity. Here, Anthony, this is David. That hasn't changed, right? That's consistent with what we've said in prior quarters. It's not a big acquisition driver. It's a big value driver for our subscribers. Yep. Okay, thanks.

Speaker 1

Thank you. Next question, our queue is Heath Terry with Goldman Sachs. Your line is open. Please go ahead.

Speaker 0

Great, thanks. I was just wondering if you could give us a sense of what, just purely on a relative basis, if you see any difference in the levels of churn between your users that are engaging you through multiple devices, like connected television sets, tablets, handsets versus your more PC or kind of game console customers? Yeah, it's exactly as your intuition's probably leading you, which is if you use Netflix on lots of devices and if you use it for lots of time, you're more engaged with the service and you're less likely to churn. That's definitely an indicator. This is David. Teasing out people who don't use it a lot but have a lot of connected devices, that's probably not a common case. People who use a lot of devices tend to watch a lot of hours. Great. Thank you.

Speaker 1

Thank you, sir. Next question in the queue is Doug Adams with JP Morgan. Your line is open. Please go ahead.

Speaker 0

Thanks for taking the question. I just wanted to ask about the deleverage in the DVD business. Is that just purely about the declining sub numbers, or is there anything else we should be thinking about here? How are you thinking about distribution centers going forward and any other costs you may be able to take out of the business along the way? Thanks. Hi, this is David. I'll take that one. I would say that in general, in the DVD business, the big driver is the rate of subscriber decline. There are some other smaller things out there, like postage rates and the fact that we would expect an annual postal increase going forward, which we have in the past.

I would say the other aspects are there are some minor things on just as you reduce shipments, you lose some sale advantages, but those are small relative to the subscriber decline. That is why we put in the letter that we would expect that the margin would stay relatively flat through 2012. Okay, thank you.

Speaker 1

Thank you, sir. Next question in the queue is John Blackledge with Citi. Please go ahead. Your line is open.

Speaker 0

Thanks. Thank you. Two questions. The first one is, do you feel like the 7 million net domestic streaming add guide is a comfortable target? Did you guys consider maybe giving a range for the year, similar to the range that you give on a quarterly basis? That's one. The second one is, what's the demand for personalized accounts domestically, and is that something we may see introduced at some point? Thanks. John, yeah, we're feeling comfortable on 7 million, and you could put a range on it if you want, but it doesn't really change the goal. We thought we would just be straightforward about what our goal is. In terms of the personalized accounts, that's something that we're developing a number of versions of. We'll be doing some consumer testing with different versions of that going forward. There's unlikely to be any revenue associated with that.

That is, we're mostly focused on how do we improve the experience, and we'll see that in retention and acquisition at this point. Great, thank you.

Speaker 1

Thank you. Next question in the queue is Scott Devitt with Morgan Stanley. Your line is open. Please go ahead.

Speaker 0

Hi, thanks. Reed, I just wanted to ask the 7 million sub question a different way. When you go back to 2010, when you added the 7 million subs, you had two things: the bundled product at $9.99 and pretty significant distribution tailwind because of mostly the game consoles that were coming online and just starting to benefit the business. When you look at that 7 million number for 2012, what do you think are the comparable catalysts that give you the comfort to get to that type of sub number for the year? Thanks. Good. I would say it's mostly based on how we did in Q1, which helped us feel good about being on track for that 7 million. Secondarily, in terms of the macro climate, it's the increased integration with smart TVs.

If you go into Best Buy today, we've got a stronger presence than we've ever had in the integration with both smart TVs and Blu-ray.

Speaker 1

Thank you. Thank you, sir. Next question in the queue is Arden Crockett with Lazard Capital Markets. Please go ahead. Your line is now open.

Speaker 0

Okay, great. One quick one and then one broader. To understand the net income view for the balance of the year, when you talked about global breakeven with the fourth quarter loss of an international market, is that breakeven for the fourth quarter or breakeven for the year? You could think about it as breakeven on some rolling basis or approximately breakeven on some rolling basis, or it will go under and then come up and go under and then come up. Ordinarily, when I made that comment, it was on the quarter. Okay, so you're not saying breakeven for the year. You're not really saying anything about the year, I guess, at this point. That's correct. Okay. I was also wondering, the surge in streaming usage, you know, you guys have had a very significant share of primetime hours, streamed content.

Are you seeing any noticeable deterioration in the quality of service to consumers? The cable companies have warned about brownout scenarios as you see video surge. There are other streaming services coming up. Do you see any negative performance of the quality of your service, or do you anticipate anything as your usage ramps as others ramp? The technology underlying the internet and fiber optics is absolutely mind-blowing. You can take our peak viewing on a Saturday night, 100% of our global viewing, and it can still fit into a single fiber optic. I don't anticipate any brownouts. I anticipate continued growth of the broadband power being released as more and more we become a fiber optic nation and a fiber optic world. I would add to that, Barton, that you're starting to see the ISPs compete on speed. It's prominently featured in their advertising.

It would feel a little inconsistent to be trying to advertise and compete on speed at the same time warning your consumers that you're going to face shortages of the product. Okay, great. Thank you.

Speaker 1

Great. That is all the time we have for questions today. I am going to turn it back over to Reed Hastings for some closing remarks.

Speaker 0

Thank you, everyone. As I said in the beginning, we had a great Q1. We were thrilled by it in terms of our UK launch, in terms of our growth around the world, in terms of getting to great viewing records in Q1. We are on track for breaking those records in Q2 on a year-over-year basis, so we're excited about that. The odd thing about our numbers, I realize, is that with stable seasonality in gross ads, we see increased seasonality in net ads. That is this mathematical artifact that we tried to document. I know it's got some people concerned, but we feel great about our progress and being on track for our 7 million net ads for the year. With that, I want to thank everyone for being on the call and look forward to catching up with you.

Speaker 1

Thank you. Again, ladies and gentlemen, this does conclude today's program. Thank you for your participation and have a wonderful day. Attendees, you may disconnect at this time.