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Executives

Deborah Crawford – VP, IR

Reed Hastings – Co-Founder and CEO

Barry McCarthy – CFO

Analysts

Steve Frankel – Brigantine Advisors

Youssef Squali – Jefferies & Company

Mark Mahaney – Citigroup

Ryan Hunter – Wedge Partners

David Miller – Carris & Company

Doug Anmuth – Barclays Capital

Tony Wible – Janney Montgomery Scott

Mark Harding – Maxim Group

Ben Rose – Battle Road Research

Wayne Change – Canaccord Adams

Melinda Davies – Susquehanna Investment Group

Ralph Scharkar – William Blair

Edward Williams – BMO Capital Markets

Jason Helfstein – Oppenheimer & Company

Scott Devitt - Morgan Stanley

Andy Hargreaves - Pacific Crest

Barton Crockett - Lazard Capital Markets

Michael Olson - Piper Jaffray & Co

Daniel Ernst - Hudson Square Research

Brian Fitzgerald - UBS

Nat Schindler - B of A

Imran Khan - J.P. Morgan

John Blackledge - Credit Suisse

Richard D. Skaggs - Loomis, Sayles

Mario D. Cibelli - Marathon Partners

Netflix, Inc. (NFLX) Q1 2010 Earnings Call April 21, 2010 6:00 PM ET

Operator

Good day everyone and welcome to the Netflix first quarter 2010 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 Deborah Crawford, Vice President of Investor Relations. Please go ahead.

Deborah Crawford

Thank you and good afternoon. Welcome to Netflix’s first quarter 2010 earnings Q & A session. We released earnings for the first quarter at approximately 1:05 p.m. PT today. The earnings press release, management’s commentary on the quarter’s results and the webcast of this Q & A session are all available at the company’s Investor Relations website at IR.netflix.com.

Like last quarter, this call will consist solely of Q & A and we are going to conduct the Q & A via email. Please email your questions to ir@netflix.com. Please note that this is a new email address from previous quarters.

We may make forward-looking 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 SEC on February 22, 2010. A rebroadcast of this Q&A session will be available at the Netflix website after 6:00 p.m. PT today.

Before moving into Q&A, I would like to turn the call over to Reed for opening remarks.

Reed Hastings

Thanks Deborah and welcome everyone to today’s Q & A session. Q1 was another outstanding quarter. We saw record net sub-additions, the lowest SAC and churn in our history and EPS grew 59% year over year. At the same time, the percentage of our subscribers streaming movies and TV episodes in the last 90 days grew to 55%.

This was driven by the progress we’ve made in enhancing our streaming content offering, expanding the breadth of Netflix enabled devices, and improving the user interface. As our guidance for the remainder of 2010 indicates, we expect our momentum to continue. So with that, let’s go over to the questions.

Question and Answer Session

Deborah Crawford

The first question comes from the line of Steve Frankel – Brigantine Advisors.

Steve Frankel – Brigantine Advisors

Can you share any insights into the viewing habits of watch instantly customers? How many times per month does a typical user stream? Have you seen any material impact on disc usage? Is the viewing skewed materially to TV content?

Reed Hastings

Steven, it’s Reed here. Think of the distribution of instant watching users like any normal distribution. There are some people who barely use it; there are some that use it a lot. It is pretty typical, normal distribution. TV and movies; it is more towards TV than DVD, but movies are still the majority. We are continuing to strengthen the TV side.

What was the last part, usage? On the usage part it appears that we’re seeing some substitution of DVD rental for streaming.

Deborah Crawford

He had a second question.

Steve Frankel – Brigantine Advisors

What is the largest competitive threat facing Netflix today; Kiosk vendors, digital VOD, or traditional cable VOD?

Reed Hastings

Well Steven there are a lot of competitive threats and it’s always hard to figure out what the biggest ones are. Certainly cable, satellite, Telco, MSO; just improving their product is the biggest one. The better, more on demand, more HD TV everywhere; they are continuing to improve that. That is a competitor for time at least. Then there’s the potential emergence of direct competitors, who refer to Hulu to see what the do and potentially others over time.

TV shows and movies is a very, very broad competitive set. The upside is it is a very big market.

Deborah Crawford

The next question is from Youssef Squali

Youssef Squali – Jefferies & Company

What do you believe is the likely impact of the postal service going from six-day delivery to five-days on your DVD by mail business?

Reed Hastings

Youssef, here we are not particularly concerned as our streaming grows. We will be less and less sensitive to particular postal variations. The soonest they are talking about it actually taking effect would be the middle of next year. So it is not a good thing for us. We hope they hold off as long as possible, but we are also cognizant of the total health of the USPS is at stake and they need to make changes.

Deborah Crawford

He had a second question.

Youssef Squali – Jefferies & Company

What kind of adoption are you seeing on the Wii platform since its launch? Would the cost be higher or lower than your average?

Reed Hastings

On the Wii we’re real happy with the first two weeks here. The application is working great. We are shipping more discs every day. We couldn’t be happier on it and there is no particular cost difference from any of our other platforms.

Deborah Crawford

The next question comes from the line of Mark Mahaney - Citigroup.

Mark Mahaney – Citigroup

Can you provide anymore color on the HBO mentioned in the transcript, How Broad is This Deal?

Reed Hastings

Mark the HBO deal is in reference to our HD and BluRay purchasing. That is that we figured out a 28-day dial deal with them like we had with Warner Brothers.

Deborah Crawford

He has a second question.

Mark Mahaney – Citigroup

Do you have any indications yet as to whether the 28-day windows are causing any satisfaction problems with your customers?

Reed Hastings

Yes our indication is our record low churn. We continue to improve our service by taking all of the savings from our 28-day and pouring it into more streaming. You see the net benefit in our record low churn.

Deborah Crawford

The next question comes from the line of Ryan Hunter – Wedge Partners.

Ryan Hunter – Wedge Partners

As instant watch viewing increases are you starting to see subscribers change from multi-out to single-out subscription? If so, will lower operating costs from streaming offset the churn and if so, over what time horizon should we think about this leveling out?

Reed Hastings

It’s not so much people who have been with us for a couple of years on a two-out or three-out switch down. There is a little bit of that, but it’s not material. It’s mostly that as we grow, the new people coming in are differentially choosing our one-out, $9 per month plan. That is where you get the majority of the ASB effect from. We are very happy with the margin structure that, that generates for us and on the earning stream. So I hope that that answers your question.

Deborah Crawford

[Inaudible]

Reed Hastings

I think that the backfill on the switching the migration by price point, roughly 1% of subscriptions per month migrates down, while 1% migrates up; 1.1 or 1.2. On balance for the last quarter, we had 4500 more subscriptions migrate up than migrate down.

So in part we said if it happens a little bit on balance more than up, then that remains the current trend in the business. It just isn’t a dominant consumer behavior.

Deborah Crawford

He had a second question.

Ryan Hunter – Wedge Partners

Vitamin Water recently aired an ad that mentioned searching Netflix for a guilty pleasure marathon. Is there a formal relationship or is this an example of Netflix becoming more of a part of social vernacular?

Reed Hastings

The latter, Ryan.

Deborah Crawford

The next question is from David Miller – Caris & Company

David Miller – Caris & Company

Of the $200 million in leverage, which was forced late last year, can you say what portion has gone to source streaming rights, what portion has gone towards stock buy-backs and what portion has gone towards working capital?

Reed Hastings

The question refers to the $200 million debt that we closed in November of last year. As you know from Q4 and Q1 results, cash flow from operations is positive and free cash flow has been positive. So all of the working capital needs of the business are self-funding and cash flow from operations includes all of the expenses and investments in content related to streaming. So that has been self-funding. So by default all of the proceeds have gone for either stock buyback or to replenish cash on the balance sheet and it’s been a combination of both.

Deborah Crawford

The next questions are from Doug Anmuth – Barclays Capital

Doug Anmuth – Barclays Capital

Why shift marketing expense to conference in the second half when you really have the opportunity to grow the subscriber base and can clearly fund the content funds other ways?

Reed Hastings

Doug, that is a legitimate question and I think probably either one would get us great growth. I just want to point out that when we invest in streaming content, that also attracts more subscribers because it improves the service. So they are both vehicles for growth. We make judgment calls between the two, but on the margin our results are not that sensitive to it. That is if it were $10 million or $15 million one way or the other, we would get really the same growth. Think of it as that we are continuing to invest adequately in marketing and generously in terms of streaming content, which is a strategy decision.

Our approach and objective with respect to the streaming is to improve the overall quality of the service by year-end. That serves the long-term strategic objective of improving the value proposition, which increases life-time value by lower return and improved word-of-mouth, which lowers SAC and the combination if you play in the most recent quarter than in the prior quarter.

Deborah Crawford

The second question from Doug.

Doug Anmuth – Barclays Capital

What is your view of the iPad, more of a new subscriber driver or another device for subscribers that will improve value, proposition, reduce return, etc.?

Reed Hastings

It’s a little of both. I think it’s a great device that will grow over time in both its impact and usage. As we’ve mentioned, we will expand onto the iPhone also. Of course that’s a much bigger install base, but a smaller screen. Both of those will be good. I would say that both are a relatively small part of video viewing. Most of our focus is on television, either directly with Wi-Fi TV or through the BluRay player or through the video game console, but it is easy enough to support mobile so we are doing that also.

Deborah Crawford

The next question is from Tony Wible – Janney Montgomery Scott

Tony Wible – Janney Montgomery Scott

When does the Starz contract come up for renewal?

Reed Hastings

We don’t talk about the details of any of the contracts, but we’re not overly dependent on any single piece of content. We’re continuing to grow our total content and we are confident we will be able to continue to grow that content this year, next year and going forward as we are able to invest more money in it, which we have been.

Deborah Crawford

The next couple of questions are from Mark Harding – Maxim Group.

Mark Harding – Maxim Group

First could you comment on the linearity of subscriber ads during the quarter?

Reed Hastings

Historically what we’ve seen is seasonality effects in counter Q1 and counter Q4 with growth just after the Christmas holiday season. So back end loaded in Q4 and front-end loaded in Q1 and then growth during Q2 was back-end loaded and during Q3 it is pretty linear across the quarter.

Our growth patterns this quarter were less pronounced, with the growth in partners and the appeal of streaming. With the launch of Wii, we’ve seen sort of the non-traditional growth pattern during the 2nd quarter and incremental marketing spending around that growth as well.

Deborah Crawford

The second question.

Mark Harding – Maxim Group

Can you update us on the split between new releases and catalog DVDs? Can you provide any similar matrix for streaming; perhaps newer releases through your Starz relationship versus older titles?

Reed Hastings

Mark, on DVD we haven’t seen any material changes in years. That’s been a pretty consistent story. On streaming, we haven’t provided any color on the breakout between different types of content or images.

Deborah Crawford

The next question is from Ben Rose – Battle Road Research

Ben Rose – Battle Road Research

Can the company share the number of subscribers who are utilizing streaming for virtually all their Netflix consumption? If not may you share that percentage in the future?

Reed Hastings

It is a pretty small number, almost everybody watches DVDs also of our subscriber base. We don’t have any plans to break that out. What we are focused on is driving up the percentage that does some screenings. We see that as our key metrics and that is why we developed it and I appreciate doing an update for everyone on it.

Deborah Crawford

The next question is from Wayne Chang – Canaccord Adams.

Wayne Chang – Canaccord Adams

Could you speak a little bit more extensively concerning the levels of activation you have seen on all of the various connective devices, be it television, set top boxes, and portable devices such as the iPad?

Reed Hastings

Not particularly in terms of the levels of activation that we are going to talk about, but probably underlying the question is trying to get some insight as to how people are using the service. A key insight for you is that there is a significant amount of people who are watching on a PC and are watching with a PC hooked to a TV, which to us looks like a PC.

So don’t think about it as the only thing that matters is the Xbox or the PS3. It is really a very broad usage pattern across a whole lot of devices, even in a given household. You will have people accessing Netflix from multiple devices and that’s part of the strength of our service in really being an internet video service is to be on all of the devices that the internet is on and have consumers think of them as internet service across all of those devices.

Deborah Crawford

The next question is from Melinda Davies – Susquehanna Investment Group

Melinda Davies – Susquehanna Investment Group

A question about the new distribution deal with Warner Brothers. Now that you have, Blind Side for example, do you have enough to fill the demand for DVDs? Are demands for Blind Side, 28 days after the DVD release, similar to what you have been seeing for new releases of this type in the past. We are trying to understand “pent-up demand” from Netflix subscribers or are Netflix subscribers shifting to Pay-Per-View and/or buying DVDs for the new releases and using Netflix for other content like older movies, TV shows, etc.?

Reed Hastings

Melinda there is a little bit of both as you would expect. There are people who, in terms of the 28-day, are turning to buying the DVD, especially because it is a widely promoted at Wal-Mart and other places. There are some that take Pay-Per-View because Warner Brothers is aggressive on the Pay-Per-View licensing. That’s really the intent of the deal.

In terms of the backlog, once it comes to the 28-day, we try to target to have enough DVDs to quickly clear that back wall pretty quickly. There is a little bit of guesswork based on that. We are still learning together with Warner Brothers and how to predict that, but that’s the goal and intent.

Deborah Crawford

The next question is from Ralph Scharkar – William Blair

Ralph Scharkar – William Blair

Why is Netflix committed to staying out of the 40 billion plus, transaction-based Pay-Per-View market if we include DVD rentals and sales? Why wouldn’t content owners want me to sell new releases with the Netflix strong brand and digital distribution channel, but there will be multiple different storefronts going forward?

Reed Hastings

That is an interesting question. I would say at times that content owners have wanted us to do that. I would say that we don’t see that we don’t see much added value in that. That is when we buy DVDs, we buy them from Wal-Mart, as consumers; from Wal-Mart or Amazon because they do a great job and that is what their main focus is. Our focus is on subscription and it is hard and it takes us a lot of work. That is probably the main reason that we don’t do the selling of DVDs.

In terms of Pay-Per-View, then there is a very specific thing, which is, for example Xbox has for years had a big Pay-Per-View business. If we had also had Pay-Per-View as part of our service, it would have been a lot harder to get distribution on the Xbox. Similarly with PS3, then of course you see now with Wal-Mart entering the Pay-Per-View market online with Voodoo that many of those firms want to go after that business. So it is really much smarter for us, we think, to be out of that and not in a position of conflict and just to be focused on our subscription business.

Deborah Crawford

The next question is from Edward Williams – BMO Capital Markets

Edward Williams – BMO Capital Markets

In terms of the iPad app, how does it affect your view of the mobile market for watching instantly?

Reed Hastings

I think that it doesn’t change it, Edward. As I said a few minutes ago, we look at mobile for video viewing as a nice extra because it is pretty easy as opposed to fundamental and the TV based and laptop based screens; like a primary screen is the focus.

Deborah Crawford

The second question.

Edward Williams – BMO Capital Markets

How much of your shared buy-back program is left? On top of that, another modeling question. What should we assume for a tax rate in 2010?

Reed Hastings

The second part of the answer, probably 41% for the tax rate. The up-levels, at least in response to the question on the buy-back program, you should imagine that if we exhaust the current buy-back authorizations and that there will be additional buy-back authorizations. You should expect that to continue to be active in repurchasing stock.

Deborah Crawford

The next question is from Jason Helfstein – Oppenheimer & Company

Jason Helfstein – Oppenheimer & Company

As you begin to acquire content for international streaming, would you expect the subscriber economics to be different from the U.S. business and how could this impact margins?

Reed Hastings

Jason, we will be able to talk more about international at the end of the year. In our guidance, it is built in the modest expenditures that we have planned for this year.

Deborah Crawford

A question from Steve Frankel – Brigantine Advisors

Steve Frankel – Brigantine Advisors

Is the increase in stock-based compensation like we saw in Q1 a level that will be sustained throughout the year?

Reed Hastings

Probably so. Yes the margin low on new employee hiring during the year. The thing that should give you comfort that is likely to be true is that it was relevantly flat, plus or minus a couple hundred, thousand dollars last year and the year before that. The big drivers of incremental expense would be entries volatility both implied and actual and employee growth.

We are on a calendar year of review cycle. Generally it will be stable during the year and then shift over the calendar year boundary.

Deborah Crawford

The next set of questions is from Scott Devitt – Morgan Stanley

Scott Devitt – Morgan Stanley

With regards to growth margin, the recent week coupons you sent out offering 10% off the next monthly bill to users who install “Watch Instantly” on their Wii leads us to believe that streaming users are materially higher margin than non-streaming users given they watch less DVDs. Can you give us any idea of the margin difference between streaming and non-streaming users?

Reed Hastings

Scott, we are not commenting on gross margin for streamers versus non-streamers. You are right that if there is a shift, at a high level you are right that all things being equal, if there is a shift away from DVD towards streaming it could be an accelerated gross margin, but you should also remember that we have explicitly said that all things will not be equal. To the extent that there is more profit in the business, our objective is to re-invest the profit and improving the user experience so in that way margins are a managed outcome. Our objective is to take what would have been at higher margins reinvested in the business in order to drive faster subscriber growth and move over churn and lower SAC and increase competitive motes.

Scott Devitt – Morgan Stanley

Then specifically on the Wii test, that was just ever aggressive product and marketing that’s testing various [inaudible] the program you had referred to is just at this point?

Deborah Crawford

Second question from Scott Devitt. With Redbox considering a streaming service at a lower pr ice point than your $8.99 per month subscription, are you revisiting the idea of offering a streaming only subscription plan at a lower price point?

Barry McCarthy

No, Scott, Redbox does many things incredibly well but we’re not worried about them particularly as a streaming competitor. So anything they do in streaming doesn’t affect how we think about that space.

Deborah Crawford

Finally, given the ever-expanding number of Netflix enabled devices, have you seen or do you expect to see consumers trading up to higher priced subscription plans in order to watch multiple videos simultaneously. Either multiple people in different rooms in the house, mobile users watching while others at home are as well, or to have Netflix enabled on greater than 6 devices.

Reed Hastings

In the next year or two we don’t anticipate much of that. It’s pretty much one account per family model I the near term.

Deborah Crawford

Next questions are from Andy Hargreaves - Pacific Crest.

Andy Hargreaves - Pacific Crest

To your knowledge, are cable satellite subscribers who cancel citing your service in increasing numbers, if so, could that impact your ability to gain access to TV content?

Reed Hastings

There’s been a bunch of stories about so called cord cutting but we haven’t seen a lot of it. Netflix has a subset of the content available on [inaudible] in particular no sports so it’s not much of a substitute for the packages that MSOs offer.

Deborah Crawford

He had a second question with regards to G&A.

Andy Hargreaves - Pacific Crest

What drove the increase in the quarter and should G&A stay around the Q1 level through 2010?

Reed Hastings

Two contributing factors primarily on the comp side. [CEO] swapped a very large percentage of its comp this year versus last year in the options and has a higher rate of expense so at least doubling down is [inaudible] the business that way. I find that encouraging and secondly the brand has grown. The [plaintiff’s bar] has become more active and legal expenses as a consequence are up on a year-over-year and quarter over quarter basis.

Deborah Crawford

Your next question comes from Barton Crockett - Lazard Capital Markets

Barton Crockett - Lazard Capital Markets

First, there’s a long term content question. As Netflix subscriber base grows and seemingly gets closer and closer to total subscribers for premium and paid TV networks such as HBO, Showtime, and Starz, does the company ever need to think about borrowing a page from their strategy and investing in unique, original content? Over the long term, it seems that for a video network to remain relevant to consumers, and ward off competition, it needs unique content. Otherwise, the check book becomes the main barrier to [entry] which is not sustainable. Do you agree or disagree with that thought?

Reed Hastings

It’s a deep analysis but I would disagree. Your premises that video services such as HBO and Starz need original content to differentiate, and I’m not in disagreement with that part, but what Netflix has to differentiate is the user interface, personalization on demand aspect of the internet, and [lab].

Our view is that we can remain a packager and be significantly differentiated from other services because our value add is not just the content, it’s all of the recommendations, how people interact with them, helping them match with content they’re going to end up loving.

So our view is that we won’t ever need to go into original series. I would certainly say that if we ever did, we would probably have the wrong CEO and we shouldn’t be based in [Silicon] Valley and there’s a number of other things that make that an unpromising avenue.

So instead what we’re focused on is can we license the content as we have with Starz? We have some content from Showtime. Not yet anything from FX or HBO, and as those firms look at us, they can look at us two ways. One is geez, we’re another packager of movies and another potential competitor, or they can look at it as we’re a natural distributor for their original series.

When you see the enormous success that Starz is having with Spartacus, that Showtime has had with Weeds, Californication and others, and of course HBO has for many years. You can see that those services are differentially good at the original series and so we’ll be hopeful these lines of partnership will be us as a great distributor writing them big checks for their original content. We focus on packaging and they focus on the original series.

Deborah Crawford

The next question is related to gross margin and the 28 day window.

Barton Crockett - Lazard Capital Markets

Did the new 28 day window deal with Warner Brothers have a meaningful impact on Q1 gross margin? Can you discuss whether it helped or hurt gross margins and the materiality of the impact? How do you see the 28 day window deals with Warner Brothers and other studios affecting gross margin for the balance of the year?

Reed Hastings

I’ll let Barry talk about the gross margins as a whole, but you remember that what we’re doing is saving money on DVD and then plugging it into streaming. So if you ask a question are we saving money on DVD, the answer is yes. If we’re saving money on content, the answer is no because we’re making a choice to put the additional money into more streaming content which is a perfect preamble to remind everyone that gross margin in that way is a managed outcome.

Deborah Crawford

The last question from Barton.

Barton Crockett - Lazard Capital Markets

You say you intend to remain active this year in share repurchases. Your repurchase volume doesn’t seem to have been affected much by the meteoric rise in Netflix stock. Are we anywhere near the price of Netflix shares that was what prompted you to scale back your share repurchase volumes?

Barry McCarthy

No. To expand on the answer, I would say that if you look at it in the rear view mirror, the stock looks expensive. I can remember when we were [inaudible] and the Wall Street Journal back in January and in the middle of last year for repurchasing at record high prices which now in retrospect look pretty [inaudible] so whether you think the stock is expensive or cheap depends entirely on your view [inaudible] the business and [inaudible] Netflix is a winner in a very large market than probably the target price at which you’re willing to acquire the stock is relatively high and if in the alternative you think we get trampled or our margins get trampled in this space then perhaps it’s a low price that you’re willing to buy and we have been and continue to be an optimistic view about our likely success in this space and as a result we have pretty aggressive targets at which we’re willing to buy stock and so far so good.

Deborah Crawford

Your next question comes from Michael Olson - Piper Jaffray & Co.

Michael Olson - Piper Jaffray & Co

What do you think attach rates are on the tens of millions of devices Netflix is now integrated with, and are mobile device partnerships incremental for new sub additions or are mobile devices just churn reducers for subs using watch instantly through other devices?

Reed Hastings

The generous tens of millions that you refer to in devices, maybe two in the fall, as more devices sell and come to market with Netflix included in them. That’s a little aggressive for the current situation. In mobile I would say not sure if it’s a sign up vehicle or just one of the many platforms that someone watches. My intuition would be that it’s one of the many platforms that someone accesses Netflix with and that it helps, but either way it’s not that much work to put a client together for a mobile device so it makes sense for us.

Deborah Crawford

Your next question comes from Daniel Ernst - Hudson Square Research.

Daniel Ernst - Hudson Square Research

With regards to Netflix’s iPad app, can you talk about any trends in terms of subscribers or viewing that you have seen with the iPad?

Reed Hastings

I can say the wonderful thing about the Apple eco system is that it gets so much press and attention and so it brings a lot of press and attention to the company, obviously to this call in excess of its short term contribution to viewing or subscribers. In the long term the iPad is a very exciting device that has great potential but in the short term in comparison to the nearly 30 million households that have a Wii, it’s not a major contributor.

Deborah Crawford

Your next question comes from Brian Fitzgerald – UBS.

Brian Fitzgerald - UBS

What are the most popular content categories on the streaming service?

Barry McCarthy

The beautiful thing about Netflix is that it’s adaptive to the individual pace. So if a subscriber really likes comedy, it will start featuring lots of comedy. If a subscriber likes drama, TV shows, horror, it adapts to their tastes. That’s our fundamental focus, which is learning the taste of each of our members and presenting them an experience that makes them feel how Netflix has all the stuff that I really want to watch so we really don’t focus on programming for categories or types. It’s really a broad set of content and then the real focus is on learning and adapting in the user interface for the particular case.

Brian Fitzgerald - UBS

Regarding Netflix’s relationship with TiVo and their new premier set top box, this box will be deployed as the set top box for RCM end users. Will Netflix have to remove Starz content for those users so as not to conflict with RCM’s offering?

Reed Hastings

To tell you the truth I didn’t know about this TiVo RCM deal so I’m not sure. I haven’t heard anything to that and I think I probably would have if there was such a conflict. So I imagine there isn’t one.

Deborah Crawford

Your next question comes from Nat Schindler - B of A.

Nat Schindler - B of A

Your spend on the DVD library of just $37 million down 21% year-over-year and 35% year-over-year (both say year-over-year, one of them must be quarter-over-quarter) despite the steep rise in subscribers. Is this decline driven by the recent better library management and back catalog marketing, Time Warner contract, users substituting streaming content for DVDs, or simply a lack of big Hollywood hits in Q1 to buy?

Reed Hastings

We’d say none of the above. It reflects the shift in purchasing to rev share and the rev share gets expensed in the P&L and you don’t see it. It flows through the statement of cash flows like Cap Ex for content purchasing on DVD stuff.

Deborah Crawford

Your next question comes from Imran Khan - J.P. Morgan.

Imran Khan - J.P. Morgan

Could you please give us some color on your churn rate for customers who are using streaming predominantly?

Reed Hastings

We don’t break out the individual churn rates for different sectors. I would say overall we’re very happy with where churn is trending and you seeing churn coming down and streaming rising so that’s a good thing.

Barry McCarthy

Just to amplify comments I made on last quarter’s call and in my commentary on the website, I attributed record low churn to the growth in streaming and made similar comments last quarter and so you should infer that subscribers who are engaged in streaming are incremental and happy and spend longer.

Deborah Crawford

Your next question comes from John Blackledge - Credit Suisse.

John Blackledge - Credit Suisse

Would you expect to raise additional debt in 2010?

Reed Hastings

Not likely. We clearly could. I think we’ve got something like 0.74 turns of debt on the business but we have no immediate plans.

Deborah Crawford

Your next question comes from Richard D. Skaggs - Loomis, Sayles.

Richard D. Skaggs - Loomis, Sayles

Share repurchase was substantial in the quarter, increasing balance sheet leverage on the surface. What do you see as an optimum of debt to capital ratio given the predictability of cash flows and other investment opportunities?

Reed Hastings

Still teasing that out and not prepared to talk about it publicly. We could very comfortably support 1.5 turns of debt. There is [inaudible] currently less than 0.8 to 1 but I would want the capital structure to be conservative enough so that the company, if we were ever challenged competitively, would never be constrained on the operating decisions we made to confront competition and I wouldn’t want that leverage to get in the way of any decisions we might want to make in the future.

On the other hand, the business is growing rapidly. The competitive motes seem well established. We’re very optimistic about their future, so why don’t we put some calls in the context of our interests in using proceeds from [inaudible] financing to repurchase shares.

Barry McCarthy

The bigger driver than how much leverage is just that we’re clearly not in a mode of trying to build our cash out. If we had not done any buyback over the last three years, we’d have a $1 billion on the balance sheet. That sounds good, it’s a nice dress up line, but we are really happy with the decisions that we’ve made to keep cash pretty steady and to return that money to shareholders. That part we are happy to talk about.

Deborah Crawford

Your next question comes from Youssef Squali - Jeffries & Company.

Youssef Squali - Jeffries & Company

Can you explain the reasons for moving to Amazon’s AWS? Can you quantify potential savings?

Reed Hastings

I’m not sure on the savings. Architecturally we’re big believers in the public cloud for any company that doesn’t have Google or Facebook’s scale. As you know, you get the big advantage of their vast resources. So we think it will help us with cost and it will help with reliability. It’s obviously early in the public [cloud] movement. We’ll see a lot of new companies enter that space and the vigorous competition will help draw the prices down which will benefit for us if we’re architected for the public cloud.

Barry McCarthy

[inaudible] ability to incur the library for new platform launches in short periods of time.

Reed Hastings

Barry’s got a good anecdote in that one. We moved our encoding facility out of our internal data center in Amazon about six months ago and when we got the sudden ability to do the Apple iPad and we had to do a very large encoding job, we would never have been able – it would have taken six months in our prior internal data center. Because of the elasticity of the public cloud, we were able to spin up thousands and thousands of encoding [inaudible] and do it in parallel. So you’re right Barry that we’ve already seen good progress from that.

Deborah Crawford

Your next question comes from Mario D. Cibelli - Marathon Partners.

Mario D. Cibelli - Marathon Partners

Will Netflix still deliver its last DVD in 2030?

Reed Hastings

Mario, I will personally deliver that last DVD in 2030 and yes, that’s still our best guess on when we look at the DVD market. Our DVD shipments are continuing to climb throughout the country, even in the Bay area where you see this astounding, up to 24% of bay area households subscribing to Netflix, and our DVD shipments, DVD and Bluray combined are continuing to grow. So DVD’s got a lot of legs there and 2030 is still the target.

Deborah Crawford

Last couple of questions and they are from Scott Devitt - Morgan Stanley.

Scott Devitt - Morgan Stanley

Now that Netflix is available on the iPad and is expected on the iPhone, what is the likelihood that the Netflix app lands on Apple TV someday?

Reed Hastings

Apple declared themselves two months ago to be a mobile company that ‘s focused on mobile, mobile, mobile, so I’m not sure how much going forward they’re going to spend on Apple TV. If we decide to invest in it, that it’s something that would make sense for us. But at this point that’s not their focus. Their focus is on mobile and will work with them on all those mobile platforms as we have been.

Scott Devitt - Morgan Stanley

Given the increased focus on mobile devices and the incremental engineering costs associated with developing products for these platforms, do you see any opportunity to monetize this customer base differently? For example, offering a higher priced plan that includes mobile access similar to Bluray?

Reed Hastings

On the web, the basic model is that you’re a web based or internet based service available on devices that have web browsers and speak internet. So that’s the basic paradigm. As opposed to well, it’s one price on this type of PC, it’s another on a different machine, and we’re very much a webcentric internet video firm in that way and because of that we tend not to think about things like extra charges for certain modalities of access. We do think about charges for HD or more content, but that’s across all of the devices that are simply to us internet access devices.

Deborah Crawford

Great. Operator, that’s the last question I have. Before we conclude the call, I would like to turn the call back over to Reed Hastings for some closing remarks.

Reed Hastings

Thanks Deborah and thanks all of you for joining us on the call. Q1 was another great quarter and as you can see from our guidance, we’re well positioned for continued growth and I look forward to reporting to you on our progress on next quarter’s call.

Operator

This does conclude your program. Thank you for your participation and have a wonderful day. You may disconnect your lines at this time.

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Source: Netflix, Inc. Q1 2010 Earnings Call Transcript
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