Netflix - Earnings Call - Q4 2011

Transcript

Speaker 1

Good day, everyone, and welcome to the Netflix Fourth Quarter 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 Ms. Allie Mertz, Vice President of Finance and Investor Relations. Ma'am, you may begin.

Thank you, and good afternoon. Welcome to the Netflix 4th Quarter 2011 Earnings Q&A session. I am joined here by Reed Hastings, CEO, and David Wells, CFO. We announced our financial results for the 4th quarter at approximately 1:00 P.M. Pacific Time today. The shareholder letter and the Q4 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 ir.netflix.com. In the time remaining after email Q&A, we will also open up the lines to take live follow-up questions. 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 in 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 18, 2011. A rebroadcast of this Q&A session will be available at the Netflix website after 6:00 P.M. Pacific Time today. Before moving directly to questions, I'd like to turn it over to Reed Hastings for any opening remarks.

Just jump in with a question, Billy.

All right, let's move directly to questions. Similar to previous quarters, we've organized the questions by topic as we receive them this afternoon. We're going to start with general content questions. First question, can you help us better understand the fixed versus variable components in the content deals you are signing? Or how the industry is maybe moving more towards variable mechanisms as content owners better understand digital?

Speaker 4

This is David. We have been bidding in an industry that was set up before us by the cable, satellite, and paid television world. All of our deals are fixed, and that reflects the nature of the market that we're competing in. It's been like that for 10+ years.

Speaker 1

What is your appetite for bidding against HBO for film studio content in the paid TV window when the paid TV studio deals come up for renewal? Assuming linear and over-the-top rights for those deals are decoupled, would you attempt to acquire both as you did in the case of DreamWorks?

Speaker 3

I don't think it's likely that those rights will be decoupled. We'd be bidding for the, and that's because HBO, as an example, would certainly want both. If we're to win the bidding, we have to really be willing to bid for both, as we did in DreamWorks Relativity. Yes, we will continue to be an active bidder in that market.

Speaker 1

Are you relatively comfortable with your current levels of content? Or is Netflix still on the market for blockbuster-sized content deals? Do you anticipate that a potential slowdown in content acquisitions will have a meaningful impact on new subscriber acquisitions?

Speaker 3

We're rapidly increasing the amount of money that we spend on content domestically and internationally. The only thing that's slightly different is this quarter, we're increasing our spend over a year ago over 100%. It's more than double one year ago. That year-over-year increase is declining, but it's still a substantial increase on a year-over-year basis all through this year. The question is, are we comfortable with the content? We always want to get more content. That's the virtuous cycle, which is, as we get more subscribers, we're able to get more content, which then helps us get more subscribers. We'll continue to invest in improving the service by adding more content for a very long time.

Speaker 4

To add on to that, it's not just about expense, adding new content. As we discussed in the letter, that increase in expense is somewhat a small portion for renewals, but actually is for new content to the service. It's going to be exciting as we add new titles to the service through 2012.

Speaker 1

How should we think about subscription costs as a % of revenue for 2012 and longer term?

Speaker 3

That will vary by market and maturity. What we think about it as is contribution margin and contribution profit. As we've talked about, we did better in Q4 than we expected, and we're taking up our target for 11% for Q1 for contribution margin in the U.S. In our different international markets, we're still contribution margin negative, and that's the losses we'll abate in each market as it grows, breaking into contribution margin positive.

Speaker 4

For longer term, obviously, there's only two buckets. There's content expense and marketing. If we're going to expand our contribution margin on profitability long term, we'd be looking to leverage some of that content long term as well.

Speaker 1

Would Netflix work with a virtual MVPD, adding a premium layer of content the way HBO offers content as a tier on traditional MVPDs?

Speaker 3

You know, I'm not sure what's meant by virtual MVPD. If it means like what was reputed that some of the internet firms are working on, which is sort of a national footprint over-the-top MVPD, I don't think that's going to come into existence. Several large firms have tried to put that package together and backed off. I think what we'll see is a continuation of the current localized over-your-own-pipe model.

Speaker 1

What's driving the change in tone and/or practice in terms of importance around exclusivity of content?

Speaker 3

The more that we bid against other cable networks, there were many bidders for Mad Men, and there's many bidders for the movies. Those other bidders are cable networks that demand full exclusivity against us. We're essentially pushed into bidding exclusive to succeed in this industry. What's driving it is that we're in the first leagues of cable network buying now in syndication, and that's always been done exclusively.

Speaker 1

Even with Netflix growing movie streaming library, one of the biggest appeals seems to be TV series episodes. Do you have any plans to offer current-season episodes of shows after they air on traditional television instead of waiting for their DVD release? Us Breaking Bad fans are dying to find out what happens next.

Speaker 3

Catch-up TV is really a good model for authentication. To the degree that we try to be a substitute for cable networks by, for example, having current day-and-date content, then we get into a cord-cutting kind of battle that's not really in our interest. Our view is to be complementary by having complete prior season. We think authentication TV everywhere interfaces, like Fox is doing, is the way to go for the broadcast networks and cable networks to maximize their opportunity. We're comfortable with that partitioning because we feel like our segment is very broad and big at a low price point of $7.99. That's why we're partitioning ourselves to be prior season. No, we're not bidding on any current season, and we don't have any current season.

Speaker 1

How will you measure whether your original programming has a positive ROI and a success? If you believe original programming can start to drive incremental subs, will you commit significantly more capital to this?

Speaker 3

HBO spends about a third or 40% of their budget on original and the rest on already produced movie content. That would be the high watermark, and they do a great job on those originals. We're starting much more modestly with our originals. Some of it will judge by how much it gets viewed and how much it costs. Is it an efficient source of programming? Some others in terms of, does it attract new subscribers and build the reputation for Netflix? Today, it's a modest part of our budget, and we'll keep it as a modest part of our budget until we learn more as we go year by year.

Speaker 1

Can you talk about, can you talk through the rationale of making all the episodes of an original series available at the same time, like you're doing with Lonely Hammer, instead of spreading them out a bit more?

Speaker 3

Yeah, Netflix's brand for TV shows is really about binge viewing. It's the ability to just get hooked and watch episode after episode. It's addictive. It's exciting. It's different. Our release strategy for original content emphasizes that brand strength, which is to be able to get hooked and pour through those episodes rather than get strung out. We're not particularly focused on a single show for driving retention. It's the expectation of more and more shows that really drives retention.

Speaker 1

Final question on originals. Can you please talk about how accounting for these series will work, and under what scenarios a write-down is possible?

Speaker 4

The accounting for them will be straight line. We always monitor the content in terms of the engagement or hours viewed. Unless proven differently in the usage and watch patterns, it'll be straight line. I'll point out, as Reed discussed, that for 2012, it's a very modest portion of our budget. I really think this is more of an issue for 2013 and going forward, unless you see us announce some other large original that's going to come out this year.

Speaker 1

Do exclusive contracts only differentiate you from other web-only players or also the TV everywhere players? For example, could Xfinity show some of the TV catalog that is exclusive to you either via the set-top box or Xfinity app? Are the contracts like Epix where authenticated paid TV subscribers can watch the movies online?

Speaker 3

It varies. We have different types of exclusivity in different contracts. In the strongest form, it's like DreamWorks or Relativity, and then it's in all forms other than DVD. In some, it's just exclusive in the internet SVOD, some in all SVOD with different carve-outs. There's quite a mix there.

Speaker 1

Given that your content purchase deals are based on assumptions of subscribers, did you experience with the price increase and subsequent slowdown in net ads that you have spent more on content than you would have given all the information you have now? In other words, do you feel like you're in an overbought position now?

Speaker 3

We feel great about the content we've got. We don't feel great about the profit stream we have for this quarter. The impact of the relatively lower subscribers than we thought we would be at is not showing up in the quality of our service, which has continued to be excellent. For the content to grow, it shows up in our profit stream. We hope to mitigate that, obviously, as we grow the subscriber base over this year and return back to break-even and continued rapid international expansion.

Speaker 4

As Reed said, we've been really pleased with the engagement of the content that we added through Q4. I don't think that we've bought a group of content or a block of titles that we're unhappy with.

Speaker 1

What is the balance in content purchase commitments for content as of 12/31/2011?

Speaker 4

I think this is referring to the contractual obligations footnote. They're probably asking before we file the K. It was $3.5 billion at the end of Q3. That goes up to $3.9 billion at the end of this quarter at Q4 that we're reporting on.

Speaker 1

What percentage of streaming is occurring on TVs versus mobile or smartphones versus tablets versus PC Macs?

Speaker 3

We don't break it out publicly. All of those platforms are very successful for us and an important part of the mix.

Speaker 1

If the goal of Netflix is to provide consumers with a convenient place to watch TV shows and movies, but subscription can only allow for a partial library of what a consumer wants to view, why doesn't it make sense to add the ability to rent a la carte new release films? In other words, what's wrong with being everything to everyone and providing a one-stop shop for digital movies through Netflix?

Speaker 3

I don't think there's a lot of brand strength in being, to use the quote, "everything for everyone." You gain profit and brand strength from being something important and precise. We believe that unlimited for a low fee in the U.S., $7.99 a month, is the core of our brand proposition. If we were to add pay-per-view, it would be a negative. It would confuse the brand. There are a number of providers: Walmart's Vudu, Apple's iTunes, Amazon Unbox, Best Buy CinemaNow, Blockbuster. The list just goes on and on of providers who already offer pay-per-view. We have no way to do it better that we know of. What we're focused on is instead working with all of those partners and keeping the clarity of our brand. Our strategy is to essentially, you can think of it like Dolby Digital as being every platform and get along with everyone.

We believe that there's a large enough market at an $8 unlimited subscription to have us grow very large. To some degree, it's a niche strategy, but it's a very large niche that we think we can lead. That's why our focus is exclusively on unlimited. We're not at all, nor have we ever been interested in pay-per-view.

Speaker 1

What does content underspending mean as it relates to the margin impact on streaming in the fourth quarter of 2011?

Speaker 4

It was a small understand, and it's related to the contract date shifting out by a month or so. It's a pretty small number. We always have contracts that are moving around up backward in terms of when the window of availability starts. That's what it was related to.

Speaker 1

All right, let's move to questions about international. I know it's early, but what you've seen so far from international, is there a case to be made one way or the other about the relative profitability long term of a U.S. versus a non-U.S. subscriber?

Speaker 3

I'm sorry, repeat that one more time. I'll take it. The profitability of a subscriber is based upon the barriers, competitive barriers of a relative scale. In any market in which we have very strong scale advantage, we'll have higher profitability. In any market where, for example, there's three roughly equal-sized firms, we would have less profitability. It's not so much U.S. versus non-U.S. It's relative scale in each of the markets. That's part of why we're investing so aggressively to be early and to lead this market in as many markets as we can.

Speaker 4

The only thing I'd add to that is it's also about relative consumer offerings in that market or competition. Between the scale and the available consumer offerings, see those two things.

Speaker 1

How do you determine that your initial launch offering has the right ingredients for a successful launch and positive word of mouth?

Speaker 3

We focus upfront on the research in terms of consumer preferences, look at Nielsen-type data in terms of what people are viewing. We do in-market research, and all of that informs our intuition. We launch, and we start to really learn what people are viewing, what they like in terms of, say, subtitles, what they like in terms of how much of it is high-depth, how important is that, what platforms. There is considerable variation between markets. Think of it as we do a bunch of effort upfront, but it does not matter much. It just gets us started, and we rapidly iterate and learn as to what are the important preferences in each market.

Speaker 1

Looking at Latin America, there are some key differences in terms of income levels and broadband penetration rates. Is there anything about Latin America that indicates the region may achieve profitability faster or slower than a region like Canada? How should we think about the cost of content deals in Latin America compared to the U.S. and Canada?

Speaker 4

The Latin America, you can infer from our discussion in the earnings letter, both from our net additions in this Q4 for international versus last year, is growing slower than Canada did in its first quarter launch. I'd say that we're building a new brand in Latin America where we had much more of a U.S. halo brand effect in Canada. Device penetration in Canada was higher than it is in Latin America. Those two things are turning out to be important. I think Latin America is a good and perspectively a great market for us going forward. It does look like it's going to be on a path slower to profitability than Canada. The second part of your question dealt with, can you ask that one more time?

Speaker 1

How do you think about content deals and the cost in Latin America relative to Canada and the U.S.?

Speaker 4

Content pricing is related to the value that the owner of that content and the producer of that content can monetize in each different market. It's more specific than even Latin America. It's within a country market. Relative to Canada, it's hard to answer that question in terms of the content. It would be less if that content owner has fewer monetization options in, say, Brazil or Mexico than they do in Canada.

Speaker 1

Given the situation you're describing in Latin America, is it going to take you longer than you've anticipated to reach profitability in that market?

Speaker 3

It's early to say. On balance, I'd guess yes, that it'll take us longer than two years. We're working hard on all of our payment issues and subtitling issues, rapidly improving that. Then we'll be able to see what's the underlying growth trajectory. It's not out of the question, but I would say the odds are it'll take longer than two years. I'll point out that the two years is a bit of an aspirational arbitrary benchmark. If you look at DirecTV, it took them a number of years to gain their market position. Now they have an extremely valuable franchise. Mostly, the two-year goal is a great internal goal because we want to turn around that money and invest in the next market.

The fundamental where we get a return on it is we feel very strongly about, with the growing economies in Latin America and our strong relative competitive position, that we can build a very valuable franchise in Latin America.

Speaker 1

In examining your Latin American product, would you say that most of the streaming activity is in the Televisa Novelas or Hollywood programming out of the studio system? Also, what are your feelings about how the Latin American streaming product is priced versus the competition? Do you think any pricing tweaks are necessary?

Speaker 3

Pricing is not an issue. We're very aggressively priced, for example, $99 pesos in Mexico. Most of the content viewing is Hollywood content. That's how we've programmed, and then we complement that with the telenovelas.

Speaker 1

When negotiating with the studios, how does the prevalence of piracy in Latin America impact the deals in terms of pricing and/or release schedules?

Speaker 4

I think it's back to my earlier comment about the available monetization channels that the content owner has. If piracy depresses those, then the cost of that content is lower because their ability to monetize the content in market is lower.

Speaker 1

Why do you dismiss LoveFilm so quickly as DVD only? Let me take this one. Historically, LoveFilm has been predominantly focused on DVD. Streaming is really something that they're only in the early stage of, whereas we've been focused on streaming for five years now. If you look at the services, we're better, faster, and easier to use in the UK. We expect they'll likely continue to be successful in the DVD by mail and the hybrid segment of the market, which for us domestically is about 40%. If you just look at how they're offering the service today, they came out with a strong streaming-only offering around the time of our launch, yet it's still very difficult to find on their website. We'll continue to monitor them. I think we have a leg up in terms of our streaming experience.

Now that you are operating in four distinct regions: U.S., Canada, Latin America, and UK, Ireland, is there a need to favor one specific region over another in terms of allocating the content spend?

Speaker 3

No, there's no such need.

Speaker 1

Why did international free subs decline quarter over quarter? Is this normal seasonality?

Speaker 4

I think the reference in terms of international frees, if you take the total that.

Speaker 3

That would be Latin America. We launched Latin America mid-September, so there was a big burst of trial subs. There was no market that we launched in December.

Speaker 4

Right, so seasonal with the launch.

Speaker 1

Do you expect international quarterly losses to begin to decline in the second quarter of 2012?

Speaker 4

What we said in the letter was that losses would moderate. Yes, I think that implies that they would go down in moderation from Q1 to Q2.

Speaker 1

I think it's safe to say that our losses will obviously be dependent on subscriber growth and the revenue that we generate from that growth. Let's move to questions about DVDs. If the DVD business continues to decline, would you look to consolidate warehouses? How do you expect closing of post offices to impact shipment times?

Speaker 3

The closing of post offices has been put off probably post the election. I don't see a big threat in that this year. In terms of closing our distribution centers, there's no practical savings to closing those. Most of the costs are the discs and the postage. Very little of it is our own processing center. It's just not material.

Speaker 1

How do you think consumers will react to a 56-day new release window? Do you expect that to drive more consumers away from DVD subscription?

Speaker 4

Our DVD consumers, including hybrid and DVD only, continue to be weighted towards catalog. It's less than 30% in terms of the shipment mix that are new release oriented. When we went to 28-day, we didn't see a big shift because, again, that mix was about the same then. It's actually gone slightly down. It hasn't gone slightly up, as you might surmise from more concentration to DVD subscribers.

Speaker 1

Will you be adding video games or 3D movies to your product offering, especially if subscribers are willing to pay a premium like they do for Blu-ray discs?

Speaker 3

3D movies, we already have. We have a lot of Blu-rays that's on 3D. On streaming, that's definitely something we can do and we'll be looking at. In terms of video games, we have no plans to enter video games.

Speaker 1

Looking at your Q1 guidance and utilizing the midpoints, it seems that your guidance is suggesting that a DVD subscriber is contributing about six times more to profits than a streaming subscriber, or around $15 for a DVD customer, but only $2.50 for a streaming customer. Do you still feel it is a wise strategy to push customers towards a streaming service? If so, what effects do you anticipate on long-term margins?

Speaker 3

The analysis is well-intentioned, I'm sure. It's not looking at the marginal cost and the marginal increment, which is the important one. A marginal streaming subscriber is almost pure contribution margin. There's a little bit for credit card, CS, and CDN fees, but it's pretty modest. A marginal DVD subscriber has a number of variable costs, the postage and the DVD fees in particular. Actually, it's the opposite, which is the profitability of a new streaming subscriber, the contribution margin is almost twice what it is for a DVD subscriber. That's the way we think about it. We'd like to have someone use both services because obviously, that's both more revenue and more profit. If they were only going to use one, we'd much prefer them use the Netflix streaming service.

Speaker 1

Why the reduced expectations for Q1 DVD contribution profit margin? Are content costs going up, or do you expect to market the service more?

Speaker 4

The reduced margin is related to the reduced revenue that we discussed in the letter. I don't think it's not going down too much other than the fact that there's a seasonal increase in usage in the DVD business. Q4 to Q1, we usually see a margin reduction in the DVD business.

Speaker 1

What types of retention initiatives are being done in the DVD segment? Will Netflix be marketing the DVD service in 2012?

Speaker 3

There are no specific retention efforts, and we don't plan on marketing the DVD service. Our primary goal is to keep it stable, very high functioning, to keep our operational metrics in terms of top-of-queue fulfillment, in terms of one-day turnaround very, very high, and not to otherwise disturb it, keep it running very well.

Speaker 4

When we've tested DVD plans and put more emphasis on DVD plans, there hasn't been a great take rate. I think we get that question a lot. We have looked at it through A/B testing, and there's not a large consumer adoption of those plans.

Speaker 1

Moving to questions about our consolidated results and outlook. With the stated goal of returning to profitability before launching new markets, is it fair to expect that you'll basically be matching the rollout of new markets to profitability for the foreseeable future, meaning that once margins go above break-even, new markets will be launched that bring them back down until that profitability is reached again, and the cycle repeated until you reach a global or near-global offering?

Speaker 3

Yes, that's a very articulate description.

Speaker 1

Let's move to questions about competition. Looking at competition for streaming rights domestically, we agree the breadth of content on Hulu and Amazon does not appear to match Netflix today. Do you see that changing? Are you seeing them or potentially other players bid more aggressively for broader rights analogous to yours? In other words, is the bidding activity for streaming rights picking up?

Speaker 3

There's very little market just for streaming rights. It's mostly generalized exploitation rights. Actually, Hulu Plus and Amazon are quite small bidders compared to the cable networks that we bid against. No material change from them.

Speaker 1

You talk about Amazon getting into the standalone subscription market at a lower price. Would you expect them to do that with their current offering, or would they need to acquire more content and more aggressive movies?

Speaker 3

Not sure on their content strategy. It depends on how much they want to spend.

Speaker 4

To date, they've taken a measured approach. We'll see.

Speaker 1

What do you think the implications of the future Apple TV that is reported in the works might mean for your business and strategy?

Speaker 3

I don't have any insight on an Apple TV, but there is a small 3-inch by 3-inch box called Apple TV that Apple invited us on about two years ago and has been very successful for us. We've just updated that application, making it even better, adding a great Netflix for Kids interface on it. It's now throughout Latin America, and we expanded the agreement with Apple for the UK and Ireland. We are working really well with the current and existing Apple TV.

Speaker 1

Moving to questions on the financials and other metrics, in early January, Netflix announced that it streamed 2 billion hours of content in Q4. Can you explain why hours streamed is a relevant metric? If subscribers stream more hours, what impact does this have on Netflix's subscription cost? Will you be reporting hours streamed on a regular basis?

Speaker 4

I would liken that to in 2007 when we announced the milestone 1 billionth DVD shipment. It's a measure of engagement and scale in terms of the widespread adoption of our service and the use of our service. I wouldn't expect us to regularly update that on a quarterly basis, but on a milestone basis. It's a great milestone for us to have hit, and like I said, shows widespread adoption and usage of our service.

Speaker 3

There is very little margin impact for more usage. It's only in the CDN fees that that exists.

Speaker 1

Could you update us on the percentage of subscribers who have both DVD and streaming? I can think that at the end of the year, we had about 8.4 million subscribers who were on both of the services, so about 40% of our total streaming subscribers domestically.

Speaker 3

It is continuing to fall.

Speaker 1

Any impact to costs from the Durbin Amendment? I can take this as well. The Durbin Amendment, as related to our business, basically caps the interchange fee charged to merchants when transacting with debit cards. As can be expected, we have a high percentage of our transactions that are indeed conducted through debit cards. We will see a decrease in the % of revenue paid towards credit card fees this year. It's incorporated into our guidance.

Speaker 4

It's buried in the cost of revenue. Streaming content expenses obviously are much bigger than our transaction fees on debit and credit cards.

Speaker 1

Going forward with international mix, what are assumptions on blended tax rate for Q1 and all of 2012?

Speaker 4

Q1 will be 39%. We continue to be pretty close to a full tax rate there. It's unknown whether the R&D tax credit will be renewed this year. My guess will be punted through until the end of the election. If it behaves similarly to 2010, if it is adopted, they'll probably make it retroactive, and we might have a similar tax pattern to 2010, which means that we'll have 38%, 39%, and then there'll be a low rate catch-up in Q4.

Speaker 1

Great. Let's move to questions on Facebook. How has the Facebook integration impacted subscriber growth in Canada and Latin America?

Speaker 3

There's no direct measurement that we're able to do on our success in all of our international markets, how much of that is due to Facebook and social integration. Instead, what we look at is engagement. How do we get people to enjoy it more, use it more, click on more of the stories, watch movies from the social rows? Our driving focus in each of our updates is just increasing engagement. That's been going very well. We're excited about the possibilities of social TV as we continue to figure out how to evolve it and improve it.

Speaker 1

Is there an update on when you expect the app to be available to U.S. members?

Speaker 3

I think we covered that in the investor letter under the BPPA section.

Speaker 1

Did the international test to date provide meaningful data in terms of the average boost of new subs, increased fees, viewing from existing subs, etc.?

Speaker 3

I think we covered that, which is we don't have a clean A/B. We can't tell if the success is because of our brilliant advertising or because of our Facebook integration.

Speaker 1

Let's move to questions on devices. Apple sold 15 million iPads last quarter. In the past, you have said you don't believe that tablets are a subscriber acquisition channel for the Netflix streaming service. Do you think that the faster out-of-home bandwidth speeds would possibly convert tablets into a bigger subscription acquisition channel?

Speaker 3

Not particularly. Tablets are very successful, and people are watching Netflix on lots of tablets. That doesn't make it an acquisition vehicle. It's a great consumption vehicle. Tablets, as opposed to phones, tend to be Wi-Fi and tend to be used then without data caps, whereas phones tend to be used on mobile plans, cellular plans that have data caps, at least in the U.S. generally. We are very bullish on tablets. We're investing heavily in it. We updated our iPad interface and made it much better, and we're continuing to invest in that. It's a key part of our strategy.

Speaker 4

We said earlier that we don't comment on the relative usage across devices. One of the reasons that we're investing in tablets is because we do see people enjoying a lot more of their viewing on tablets relative to the PC.

Speaker 1

Have you seen any impact on smart TV sales during the quarter?

Speaker 3

Yeah, absolutely. Smart TV is one of our fastest growing device categories. It's just beginning, obviously. As consumers set up and buy or buy and set up internet TVs, they certainly want to be able to use Netflix. In many of them, we've got a great red Netflix button right on the remote control, which makes it very easy. The long-term trend for us on smart TV is very exciting and positive.

Speaker 1

One question on the Q4 financing. In hindsight, do you wish you waited on the secondary, given the quarter and guide for Q1 was better than original guidance? Why did you not just wait until Q1 to do the raise?

Speaker 3

You know, it's always fun to pick stock prices in hindsight. You can have great returns when you do that.

Speaker 4

Yeah, I would say that hindsight's easy. Given the same facts, I'd make the same decision. The relative dilution is unfortunate. We'll work a little harder. Otherwise, we're in a much stronger position.

Speaker 1

Great. That's the end of the submitted email questions. At this time, I'll turn it over to our operator, and we'll begin taking live follow-up call-in questions.

Thank you. Ladies and gentlemen on the phone line, if you have a question at this time, please press star then one on your touch-tone telephone. If your questions have been answered and you wish to remove yourself from the queue, please press the pound key. Again, if you have a question, please press star then one. Our first question comes from Richard Greenfield from BTIG.

Speaker 0

Hi. A couple of follow-ups. One, when you initially were going to separate the two plans with Quickster, you had talked about investing in the DVD business. That's part of the reason you were doing it, was to invest in that business because you thought it had a long life. It seemed like the comment you made earlier made it seem like the DVD business is something you're not going to put a whole lot more emphasis on from an investment standpoint. Does this all relate back to the fact that the DVD business is actually now declining? Do you expect standalone DVD subs to be down each of the quarters throughout 2012?

Speaker 3

Yes, Rich. We expect DVD subscribers to decline steadily every quarter forever.

Speaker 0

Even the standalone subscribers, I think, actually were up in Q4. Now you actually think that now that this shift from hybrid to standalone DVD has subsided, the net effect will be standalone DVD-only subscribers going down quarter after quarter?

Speaker 3

No, we don't think about it as standalone versus hybrid. There are just DVD subscriptions, and DVD subscriptions, which are 11 million at the end of last year, are going to decline steadily, essentially forever.

Speaker 0

If I could just ask one last question on viewership. The 2 billion hours, I think, was a real surprise to most people in the industry. I think one of the things that is talked about a lot by investors is that people say the content's not that great. There isn't that much to watch. Yet, when you see 2 billion hours or people watching an hour a day, there seems to be a real disconnect between what people are doing with Netflix or even what some of the other media executives in the industry think people are doing on Netflix and what they're actually doing. What do you think the biggest reason for that disconnect is?

Speaker 3

You know, the average American household watches eight hours of TV a day. The average investor does not watch eight hours of TV a day. When one looks at one's own personal behavior, there's a big disconnect, I would say, relative to median or typical Americans, which is at over 20 million subscribers is most of our market. If there is a disconnect, that might be the reason why.

Speaker 0

Thank you.

Speaker 1

Thank you. Our next question comes from Jason Helfstein from Oppenheimer.

Speaker 2

Thanks. Two questions. First, not sure if you want to comment. In the last filing, you guys talked about expecting an EPS loss for the year that was around your offering. Wondering how the near-term results in your outlook for the first quarter affect that outlook and if that's still a current number. Secondly, can you just update us what share count was at the end of the quarter?

Speaker 3

On the first part, I'll refer you to the investor letter, which addresses that precisely. The share count, 55.4 million, was the diluted share count at the end of the quarter. That's in the investor letter.

Speaker 2

Yeah, it's on the first page of the letter.

Speaker 0

Thank you.

Speaker 1

Thank you. Our next question comes from Anthony DeClemente from Barclays Capital.

Speaker 2

Thanks a lot. On the Warner Home Entertainment moving its window to 56 days from 28, you mentioned in the letter that it improves your relationship with Warner. I know that it was relevant to the DVD side, but I guess there's some investors out there wondering if there's a possibility that you license more of the Warner Brothers TV Studios content going forward. I just wonder, is your relationship with Time Warner and Warner Brothers improved such that it's any more likely incrementally that you can secure Warner Brothers TV content from here? Does the expanded window relate to that in any way?

Speaker 3

Just to correct you, I don't believe that we said it improved the relationship.

Speaker 2

It's a maintained direct relationship with Warner.

Speaker 3

Yes, as opposed to going in Walmart and buying the DVD sideways.

Speaker 2

Okay.

Speaker 3

That's what that's a reference to. It's a perfectly healthy, respectful relationship. When we're the top bidder and we make them more money than anybody else, we get the content. When we're not the top bidder, we don't get the content. We don't do them favors, they don't do us favors. There's trust and respect, and when there's an overlap, we're able to do good business.

Speaker 2

Okay, thanks, Reed.

Speaker 1

Thank you. Our next question comes from Mark Mahaney from Citi.

Speaker 2

Thanks. The comment about understanding and marketing in Q4, could you just provide a little more color around that with their newfound efficiencies, or was that just a timing issue?

Speaker 4

That wasn't timing, Mark, David. It was related to the fact that we had to make some estimates on Netflix button payments for CE manufacturers, and our estimates were too high.

Speaker 2

Thank you.

Speaker 1

Thank you. Our next question comes from Mike Alston from Piper Jaffray.

Speaker 2

Hey, you said in the letter that you won't add new geographies until you return to profitability. Is that global profitability on a quarterly basis or full year? In other words, if you achieve profitability.

Speaker 3

Quarterly.

Speaker 2

Okay, that answers the question. Thank you.

Speaker 3

Great. Thanks.

Speaker 1

Thank you. Our next question comes from David Wells from Morgan Stanley.

Speaker 2

Sure. Thanks. The first read on the DVD business has this inherent upsell capability given the multi-disc and the Blu-ray premium as well. For streaming, it's less clear. You've talked historically about the possibility of things like family plans. I'm just wondering if you can speak to those opportunities. Do you think that they do exist? Whether you think the $7.99 is the right long-term price for the U.S. streaming product?

Speaker 3

I think $7.99 is the right price for streaming. We feel great about that price. We're succeeding at that price. We've got growing contribution margin, growing market share at that price. We don't have any plans to change that. We will be adding various kinds of multi-account options over the year that our Chief Product Officer, Neil Hunt, has talked about. Those are aimed at providing a better experience so that, for example, not all of your kids' content shows up for you and not all of your content shows up on your kids' accounts. We'll continue to improve the experience in that way.

Speaker 2

Separately, you've also mentioned that the streaming business has a higher incremental contribution margin for profits. I understand it's early in subscribers or key ingredient, I suppose, to the margin profile of the streaming business over time. How do you think about the margin profile of that business, given that on one hand, your retail price is lower than premium TV providers? On the other hand, if you take the premium TV providers such as HBO, and even if you gross their business up for the MSO reps, sure they have operating margins in the mid-20%.

Speaker 3

I agree with your facts, Scott, but I'm not sure what the question was.

Speaker 2

The question is, as you position the streaming business, when you're thinking about understanding that it's very early, what do you think the margin profile of the domestic streaming business is?

Speaker 3

HBO gets round numbers, you know, around $7 or $8 per sub from the MSOs. We hope that we can have a much larger subscriber base than them. That'll allow us to spend even more on content and to have an even better service. You've got the, obviously, the on-demand aspect of Netflix and all the work that we do to make it personalized and even more useful. We should be able to, in the long term, have an even better margin position than HBO. It really depends on our relative scale. If we're twice as large as the nearest competitor, it would tend to lead to large margins. If it's neck and neck of us and HBO in terms of subscriber size, then there would be tighter margins for both of us.

Speaker 2

Thank you. If there's more substitution between those two rather than complement.

Speaker 1

Thank you. Our next question comes from Schindler from Bank of America Merrill Lynch.

Speaker 2

Yes, hi. In the past, you have said that you have seen, at least initially, that there was a kind of a shorter duration or lighter connection with streaming subscribers leading to a free for streaming subscribers on a same cohort basis. Are you content? Where do you think streaming churn will end up relative to your historical near 4%?

Speaker 3

Matt, you're on a mobile phone, and it was cutting out while you spoke. The question I got was kind of long-term churn. It's not something that we really focus on. We make it easy for subscribers to get in and get out. One of the aspects of the membership change that we refer to, definitional change, for example, is that if we go to your credit card and the charge doesn't go through, you're essentially instantly canceled for membership purposes. You no longer count as a paid member. When that credit card clears, you become a member again. You could imagine that if you treat it that way, that wreaks havoc with, you know, or makes churn numbers not really that sensible. That's some of the reasons that we've really been focusing on net additions and total subscriber growth and not churn.

Speaker 4

Actually, the other thing I'd add to that is just like the DVD business, our subscribers get higher in retention the longer they are with us. I think you're referring to the relative statements we made about streaming retention, early subscribers versus streaming retention, hybrid, or DVD subscribers. That retention does get better the longer the sub remains with us, just like it has before. The more the subscriber base ages, the better our retention overall.

Speaker 2

David, just a quick follow-up. Does that equal out to very similar on DVD versus streaming on a same cohort basis in time?

Speaker 4

If the retention pattern starts a little bit lower of a retention pattern, it's not going to equal. I see what you're asking. You're asking if someone who's been with us for a year streaming subscriber is equivalent to someone who's been with us with a year on the hybrid or DVD, and it's roughly in line.

Speaker 2

Okay, thank you.

Speaker 1

Thank you. Our next question comes from Doug Anmuth from JPMorgan.

Speaker 2

Great. A couple of things. First, just on the 1Q streaming guidance, can you clarify? You mentioned that 200,000 fewer domestic streaming subs potentially in 1Q based on the change on payment hold. You're suggesting there that guidance would be 200,000 higher if it weren't for that change. Also, any commentary on what you'd expect for streaming sub growth in 2012?

Speaker 3

Correct on your first one, and nothing more than the latter on the second.

Speaker 2

Okay. If I could just follow up with one more, can you just clarify why there's no deleverage in the DVD business if you have to continue to operate the warehouses around the country?

Speaker 3

Because the warehouses are, I shouldn't say no deleverage. The warehouses are such a tiny % of the total cost, and most of the equipment, or a lot of it, is depreciated, that there's only very modest deleveraging.

Speaker 2

If you think about the DVD cost, postage and the cost of the content are more variable, and those are the bigger pieces than the cost of the fulfillment. That's one of the reasons you see that our fulfillment as a % of revenue is going down. Right. Okay. Thank you.

Speaker 1

Thank you. Our next question comes from Andy Hargrave from Pacific Crest.

Speaker 2

Can you make a sense for how you think about the mix of marketing versus content spend as you're entering new markets?

Speaker 3

Andy, I can't really help you on that for competitive reasons. You know, we enter big on both to create both a lot of brand awareness and to have it be a good experience. Each country, we're learning more and more, or each market, we're learning more and more. We started in Canada. We've adjusted that mix a little bit for Latin America. We adjusted it again for UK and Ireland, and we're continuing to improve in terms of that mix. We view it as a good proprietary advantage.

Speaker 2

Is there early conversion on the TCV convert so that you would have to count those shares in the diluted share count at the crown price?

Speaker 4

The forced conversion price is $111.54, and it has to be at a sustained level for a number of days. It's possible, but the conditions are somewhat public in terms of that.

Speaker 2

When does it become eligible for that payment?

Speaker 4

When it's in six months.

Speaker 3

Six months from this year, it's mid-November.

Speaker 2

Right. Okay, thank you.

Speaker 1

Thank you. Our next question comes from John Blackledge from Credit Suisse.

Speaker 2

Thanks. A couple of questions. The 4Q11 subs, in particular the Net Unique sub adds, are a little better than what you guided to. Just wondering what drove that. Was December better? If you can give us a sense of what the Net Unique sub losses and/or additions by month were in the fourth quarter, that would be helpful. Thank you.

Speaker 3

John, it was better, as we said in the letter that October and November matched what we had expected. In December, it was stronger. That was a combination of more gross ads around the holiday period, integration into all the devices, and fewer cancels than we had expected.

Speaker 2

Great. Thank you.

Speaker 1

Okay. That is going to be the last question for today. We'd like to thank everyone for your time and look forward to speaking with you next quarter.

Speaker 3

I feel obliged, since I just got back from Sundance, to give you two movie recommendations to end the call on a light note. Both The Surrogate and Beasts of the Southern Wild hopefully will get picked up and distributed, and everyone will be able to see them; they're fantastic movies. I'll try to make sure they're on Netflix for all of you too. Thank you, everyone.

Speaker 1

Thank you, ladies and gentlemen. Thank you for participating in today's conference. This concludes our program for today. You may disconnect and have a wonderful day.