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Executives

Erin Kasenchak - Senior Manager, IR

Reed Hastings - CEO

Barry McCarthy - CFO

Analysts

Steve Frankel - Brigantine Advisors

Dave Miller - Caris & Company

Youssef Squali - Jeffries & Company

Ryan Hunter - Wedge Partners

Ben Rose - Battle Road Research

Dan Ernst - Hudson Square

Jeff Rath - Canaccord

Nat Schindler - BofA-Merrill

Jason Helfstein - Oppenheimer

Scott Devitt - Morgan Stanley

Doug Anmuth - Barclays

Mark Mahaney - Citigroup

George Askew - Stifel Nicolaus

Ralph Scharkart - William Blair

Tony Wible - Janney Montgomery Scott

Justin Patterson - Morgan Keegan

Wayne Chang - Canaccord

Barton Crockett - Lazard

Mike Olson - Piper Jaffray

Imran Khan - JPMorgan

Brian Fitzgerald - UBS

John Blackledge - Credit Suisse

Ed Williams - BMO

Jim Friedland - Cowen

Andy Hargreaves - Pacific Crest

Heath Terry - FBR

Presentation

Netflix, Inc. (NFLX) Q2 2010 Earnings Call July 21, 2010 6:00 PM ET

Operator

Good day everyone and welcome to Netflix second quarter 2010 earnings Q&A session. Today's call is being recorded. At this time for opening remarks and introductions, I'll turn the call over to Erin Kasenchak, Director of Investor Relation. Please go ahead.

Erin Kasenchak

Thank you and good afternoon. Welcome to the Netflix second quarter 2010, earnings Q&A session. We released earnings for the second quarter at approximately 1.05 PM Pacific Time today. Earnings press release, management's commentary on the quarter's results and the webcast of this Q&A session are available at the company's Investor Relations website at ir.netflix.com.

Like last quarter, this call consists solely of Q&A and we are going to conduct the Q&A via email. Please email your questions to ir@netflix.com. 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 22nd, 2010. A rebroadcast of this Q&A session will be available at the Netflix website after 6.00 PM Pacific Time today. Before moving into Q&A, I would like to turn the call over to Reed for a few opening remarks.

Reed Hastings

Welcome everyone and let's just jump in with question, Erin.

Question-and-Answer Session

Erin Kasenchak

Great, first question is from Steve Frankel at Brigantine Advisors. Will the recent content deal with Relativity Media signal a material increase in the overall content expenditures or a continuation of the trend of shifting investment from physical to digital?

Erin Kasenchak

Steven, it's a little of both, we have been investing more in streaming content, quarter-after-quarter, year-after-year, as we get revenue growth and confirmation that the streaming content investment is a smart one. And Relativity does indicate a material step up in that, most of that doesn't come in until Relativity delivers the films so that would be next year and beyond. So it's a material step up this year for Relativity. But we are out looking for more content and unique to Relativity is that it’s completely exclusive for internet subscription to Netflix, so it's the first essentially a shift in our strategy which is to also be licensing exclusive content in addition to non-exclusive content. We don't see a big radical shift. It's a thing we are doing some of the content on movies and TV shows exclusively now which as you know is open to new parts of content of availability because much of the content in the pay-TV window is sold exclusively.

Erin Kasenchak

And second question is what is the percentage of subscribers on Blu-ray plan?

Reed Hastings

Steve, it's a little over 10%.

Erin Kasenchak

Great, next question from Dave Miller of Caris & Company. Can you confirm whether or not the introduction of the iPad app has resulted in additional subs beyond your expectation or whether the Netflix app has resulted in already existing subs acquiring iPad?

Reed Hastings

Well Dave, every new platform whether that's the Wii, the iPad, all of the platforms, do both. They help us with existing subscribers getting more value from the Netflix service and they help us attract new subscribers and the iPad was big success for us as the Wii was and as really all of our platforms have been.

Erin Kasenchak

Next question from Youssef Squali at Jeffries & Company. How is the rate of activations on the Wii versus what you have seen for the Xbox in the first 90 days?

Reed Hastings

Youssef, we don't break out platforms specifics. But I would say that we were very happy with Xbox when it came out and we've been very happy with the PS3 and now we're very happy with Wii. They all have large install bases and that's a meaningful way for our subscribers to get value from our service, and watch great movies and TV shows.

Erin Kasenchak

The second question, is there a subscriber segment? Is there a sub-segment of subscribers who only stream the service and stop ordering DVDs? If so, can you quantify?

Reed Hastings

The majority of subscribers do both stream and take DVDs.

Erin Kasenchak

Next question from Ryan Hunter at Wedge Partners. Are marketing expenses associated with the Canadian expansion already factored into your operating margin guidance for 2010?

Reed Hastings

Yes, it is.

Erin Kasenchak

And what percentage of your CDM partners will support Canadian subscribers?

Reed Hastings

Assuming that you meant CDN, in which case there is no real issue of the internet, our providers such as Akamai and Limelight and others that's out in Canada.

Erin Kasenchak

Great next question's from Ben Rose at Battle Road Research. As Netflix gears up to enter the Canadian market and for similarly other foreign markets, what is the most significant content delivery challenge facing the company? Do you expect higher content delivery unit costs than you have in the US?

Reed Hastings

If by delivery one means the cost of streaming, that's a fairly small part of the total picture. So, I would say in Canada, the challenges are licensing the right content, the right cost, and then taking advantage of the right marketing channels at the right cost. Those are the two primary drivers, the content and the marketing.

Erin Kasenchak

Next question from Dan Ernst at Hudson Square. Questions on accessing rights for digital content for instant watch. Is the size of your subscriber base relative to large cable and satellite carriers factored at all into your ability to gain such rights? And if you looked at your top 500 titles across the year, what percentages of those are now available for instant watch?

Reed Hastings

Our relative size is into direct impact, Dan. It's more the absolute size of our checks. So, if the biggest check we can write for a piece of content is $10,000, you know it's a long shot to get it. If the biggest is $20 million for some piece of content, we're pretty likely to be out there with anybody else. So, it's as you would expect in that way. So there is an indirect influence around our revenue or our content spending budget, larger that it is, the more effective we can be.

And then you ask about the top 500, I'm not sure how to answer that exactly. But I would say that the power of Netflix is to take a lot of content, it may not be the hottest content and make it feel like it's an incredible service to subscribers. That's where we add value as a service and that when one is nearly carrying the hottest content on the planet, there is not as much of a profit opportunity in that, because you got to pay the content owner. Well the content owner has earned most of the value generated as you extract that. So our key is not around top 500, our key is direct. And what percent of our subscribers are streaming, can we keep them actively streaming because if they are actively streaming and taking DVDs, then they will be paying better and you can see that in the year-over-year improvements in retention that we have generated.

Erin Kasenchak

The second question is related to churn. Churn, my second are of interest is on churn. What are the top two areas a customer goes to instead of Netflix when they leave also are the customers you have added over the last year, what percentage of those have been Netflix customers previously?

Reed Hastings

It's usually around the third, and plus you're paying five points. And on the first part of the question, what's that Erin?

Erin Kasenchak

What are the top two places that people go when they churn?

Reed Hastings

You know when we ask them, it's a little bit of choppy exactly because you ask about movies, where did you get movies from? This is going to be different answer than where you get TV shows from. But when you ask where we get movies from, consumers say that kiosk, the $1 rental. That's the big one and is still rising. Almost everything else is in the noise.

Erin Kasenchak

Great. Next question from Jeff Rath at Canaccord. Free subscribers as a percentage of paying subscribers have reached the highest level ever for Netflix, what's causing this and how should we expect just the trend for the remainder of 2010?

Reed Hastings

There is kind a huge difference. In general, that's a reflection of our growth rates. So our growth rates astoundingly have been moving up all year long and we expect them to continue to grow and a higher growth rate will be associated with a higher rate or free trials at any point in time.

That's pretty much, it. Seasonality contributes end results slightly to the number of revenue months generated in a quarter which bears on the likes of free and paid. And Q2 tends to be slightly backend loaded. Q3 is pretty much flat along through the quarter. Q4 is backend loaded. But we described the predominant influence, which is sub-growth.

Erin Kasenchak

Great. Next question from Nat Schindler. BofA-Merrill. Dramatic increase in subscriber guidance, up 1.2 million on top and bottom end of guidance for year end, coupled with limited increase in revenue guidance which absolutely in our view are coming down much faster than it did before, what has changed?

Reed Hastings

I would say not so much. The only thing that's changed in the business and it's quite a significant change is the accelerated growth and we attribute that to streaming, and streaming implies for 1-out unlimited price point. So I said on Q3 call a year ago that if prices decline rapidly towards that 1-out unlimited plan, we'll be very excited. That's great news for the business because it means that streaming is resonating with consumers and likely we will see accelerating growth. And in fact we are seeing accelerated growth. So if you're doing year-over-year comp, it helps to remember that we initiated in part of Blu-ray price increase in Q2 a year ago for two months of the quarter and then three months of the quarter in Q3, and so that dampens the fact of the shift towards 1-out plan. But tax in that effect we're tracking year-over-year say Q3, Q4, I think will be on par, one to another.

Barry McCarthy

And now we do expect streaming continues to be successful. It has been for us, that our $8.99 one-year plan will be a larger and larger percentage both the sign ups and therefore the installed base. We're not seeing any material migration of the installed base. That has stayed pretty constant. When people come in on a certain plan they stay with it. I have said that new subscribers are predominately coming in on the unlimited streaming one DVD at a time plan.

Reed Hastings

I want to remind everyone that I think the pure indicator of the growth potential of the business is subscriber growth. We've had lots of discussion about ASP overtime and it's declined, and because of that discussion we added a metric which was gross profit per paying sub. So on a year-over-year basis, we actually saw an increase of about $0.30 in that metric. So even though ASP is going down and revenues are growing slower than subscribers are growing in terms of gross profit dollar, we are adding more prudent sub in Q2 of this year than we did a year ago.

Erin Kasenchak

The second question. I think visibility into Q4 subscriber growth or in other words how do you get comfortable without quarter guidance?

Reed Hastings

We have lots of confidence about next week's outcome, declining less ability to be accurate next month and as we point out declining less ability the following quarter. It's really a continuum. The trend lines that are propelling Netflix' acceleration have been a very steady, strong acceleration since the beginning of the year at least and that's what gives us confidence that it's not one short term aspect. And while we're not able to, we are choosing not to predict continued acceleration of growth in Q4, that is our model, our expectation and guidance is that growth will remain at a very strong 48%, 49% subscriber growth in Q4. Its because of the continuity and steadiness of our acceleration to date as opposed to say we are banking on CPM rates or some specific aspect of Q4.

Erin Kasenchak

The next question is from Jason Helfstein at Oppenheimer. Can you update us on our three to five year outlook for operating margins?

Barry McCarthy

Jason my update that implies that we said something about that in the past, except I don't believe we have. In general we would hold the domestic business. We would want that to steadily improve, probably at a fairly modest rate, because the top line is expanding so dramatically. The global operating margin would depend upon international and at what rate it was prudent to invest.

Erin Kasenchak

Great, next question from Scott Devitt at Morgan Stanley. Given that the three largest devices' install bases, Xbox, PS3 and Wii have already launched, how should we think about the subscriber contribution from the initial launches versus follow-on contribution from the existing installed base versus incremental growth in the console install base?

Reed Hastings

Scott we've been very happy that the Xbox which is our longest standing device relationship, we continue to see substantial growth in the number of Xbox users and Xbox activations for Netflix and that's partially because they're continuing to sell more, new devices in to the market at a considerable rate. And it's partially because we are marketing our service to people who include current Xbox owners. So, both install bases, Netflix and Xbox are growing. And from that we're seeing continued growth. So, we look at it and we think that we will continue to generate substantial growth from all three of the gate platforms, because all three are growing.

Erin Kasenchak

While Netflix may have the skill to aggressively acquire streaming content, availability of content appears limited due to the exclusivity agreement between premium TV networks and most major studios. Are there other buckets of content similar to Relativity Media that are not tied up in exclusive agreements or is Netflix made to pursue another stars like distribution deal the likes of Epics or Showtime in order to dramatically expand the content library.

Reed Hastings

Again want to separate that out between TV shows and movies. So in movies there are a small number of makers and as you've said and mentioned a number of exclusive deals and so we are definitely interested in licensing from HBO, from Epics, from Showtime. In addition, there are pockets of content like Relativity, therefore on the movie sides.

On the TV network side, there is a vast array of content and providers and exclusives are of the type that movies are much less common and there is a lot of incremental ability for us to generate new profits for those networks. Because we focus on the prior season, we try to be particularly careful about not conflicting with cable networks which focus on the newest episode. And we focus on the prior season in generating incremental view better than anyone from that prior season viewing and you will see us continue to expand on that in the coming years.

Erin Kasenchak

Great, our next question is from Doug Anmuth at Barclays. They are changing until now from three months ago in terms of shifting sense from marketing content spending. Seems like you're more definitive about the second half contents spend increase after Q1 than now.

Barry McCarthy

There was intended shift in tone Doug. We expect to significantly increase the spending streaming in the second half of the year as compared to the first half of the year and the first half was a big increase over the second half of the prior year. So as the business scales in terms of subscribers we have, it generates more and more capacity to reallocate spending and so that's our plan.

You probably are referring to the language in my commentary which said that if we're not successful in licensing additional contents then we will spend that money in marketing and grow this sub-growth and I was kind of inoculate us against creating expectations on the part of investors that in the absence of increased content spending, it would all fall at bottom-line. They didn't want earnings expectations to run away from us. It was another way of reminding folks that earnings is a managed outcome and we consciously every quarter make a choice between how much earnings to deliver on the bottom-line and how much to invest quarterly and glorify them in the form of marketing or making the service better to drive additional (inaudible).

Reed Hastings

And Doug I would say that after the same which is about a consistent strategy which is content gets first-ins on the budget and marketing spends, what's left over and content thrives only by efficiently. What they don't want to do is spend inefficiently and so that combination works well for us in Q2 and works well for us for the rest of the year.

Erin Kasenchak

Great and second question. In deals like Relativity and others, how does the timing of content payments work in terms of cash payment and financial statement recognition? How lumpy are payments here and when was would you start to actively begin talking to Starz without renewing?

Barry McCarthy

Let me take the accounting and cash flow part of the question. Of course, we don't make disclosures on a deal-by-deal basis but in general and by way of reminder, if we negotiate a multi-year deal for streamed content and if we are not able to allocate value for the deal's individual titles then when we amortize the cost of the license agreement on a straight line basis over the term. And the cash flow aspects of the deals are unique and individual deals and can vary quite a bit. Nothing about any of the deals that we've negotiated, and the rate changes in any significant way our cash flow attributes of the business. And what's the second part?

Erin Kasenchak

When might you start discussions about our Starz renewal?

Barry McCarthy

On these Hollywood type deals, they are always in discussions that never end, so no particular time does this begin or end.

Erin Kasenchak

Great, next question from Mark Mahaney at Citigroup. Is the slowdown in growth of DVD shipments are at an inflection point where we could start to see DVD shipments growth flat lined or even start to decline and it really starts to take off or is this more of a function of limited content acquired during the quarter as DVD shipments continue to grow and/or even accelerate?

Reed Hastings

Well Mark DVD shipments are growing. We don't expect them to flatten this year. Yes, as we said, that growth was less than we thought. So, that would imply the peak would be here earlier than we had thought.

We’ll know more each quarter on do those trends continue and yes there is great news in this which is if churn stays low and DVD shipments grow slower than revenue, then that frees up a lot of money for marketing, for content, both growth oriented investments or for earnings. So, good outcomes in all cases as essentially streaming and substituting for DVD as it seems to be happening for us.

Erin Kasenchak

The next question. You said over the next two quarters you will spend on content and marketing especially streaming content in order to drive subscriber growth, what metrics will you be looking at in order to determine where you focused your spend? Could we expect other forms of marketing spend like more TV, print, mobile advertising?

Reed Hastings

We are very happy with the mix of marketing that we are doing. And if we spend more you would see us be doing more online and more TV, but no radical changes. It's simply getting more impressions of the great advertising that we've got.

Erin Kasenchak

Great. Next question from George Askew at Stifel Nicolaus. You stated in your commentary that you see TV shows that's equally important to the franchise as movies, within the Watch Instantly library, could you share with us the mix of content between TV shows and movies?

Reed Hastings

George, we don't break it out, the mix of content, because TV shows are a smaller unit. You get unit viewables, hours of viewing, hours of viewables, all different kinds of measures. But what I can tell you is they are both very big for us and both very substantial and we continue to expand both on the movie side and on the TV show side.

Erin Kasenchak

The next question is based on what you know about the movie plus subscription offering, do you view it as a substitute or a complement to the Netflix streaming program?

Reed Hastings

It's a potential significant competitor and it is a direct competitor, movies and TV shows streaming; so subscription, and we take it seriously as a direct competitor.

Erin Kasenchak

Great. Next question from Ralph Scharkart at William Blair. Does the Digital Entertainment Content Ecosystem's recent branding campaign and stated goal of rolling out a standard digital platform for new released movies change Netflix' stand on offering new digital movies/VoD? If not, what is the rationale given Netflix' membership in the DECE?

Reed Hastings

Well, we've often addressed this topic which is sort of what's our relationship to pay-per-view and sometimes called download-to-own, which are two variants, a $4 variant and a $20 variant. And that is that there are many companies in that business; Amazon, Apple, Sony, Microsoft, CinemaNow and others. It's well addressed. We don't know how to add any particular value to that space. And we are really focused on subscription and we've got such a big opportunity in subscription that this year our growth is accelerating dramatically, and so we don't see any need or desire to expand our available market. We're just very focused on subscription.

Erin Kasenchak

Next question from Tony Wible of Janney Montgomery Scott. Will Netflix have exclusive access to all of their Relativity films or only the single production films, would the joint production films still go to HBO and Starz.

Reed Hastings

Tony, Relativity does as you know a broad range of production and then we did at a deal for some of the content but we are not the sole distribution partner or sole PayTV partner for Relativity produced films.

Erin Kasenchak

Next question from Justin Patterson at Morgan Keegan. You mentioned then the Playstation user interface coming this fall, will that require access to the premium Playstation Plus subscription service, should we think about a new user interface probably in the coming months too?

Reed Hastings

On the PS3, we'll have more to say about that when we roll it out and that will be before or expected to be before the next call. In terms of re-user interface like all of our user interfaces, we're working on improvements but we have nothing to announce today.

Erin Kasenchak

Next question is from Wayne Chang at Canaccord. Could you speak both qualitatively and quantitatively on the success you are seeing with regards to activations on web-enabled televisions from manufacturers you mentioned i.e., Samsung, Sony VIZIO et cetera.

Reed Hastings

Wayne, we focus on three broad categories, the videogame consoles that have large installed bases and upgradeability over the internet, so like gives them a big advantage. Second category is Blu-ray. And that advantage is they are all internet connected because it was part of the Blu-ray security spec and they are relatively low in price. So they are easy to upgrade if you got a big TV already in place.

The third category is the one you asked about, Internet TV which is just emerging now. We've been very happy with some of the early progress from Sony and VIZIO and others, but that category in the very long term is likely to be the leading category. But at this point, it's still nascent. And that works for us fine. We're doing significant investments in all three of those broad areas.

Erin Kasenchak

The next question is from Barton Crockett at Lazard. Can you offer a prediction of when Netflix will be recognizing more expensive income statements from an online content when it occurs from the direct content cost of DVDs excluding of this?

Reed Hastings

I don't think we're going to comment on it at this time.

Erin Kasenchak

And next question regarding core cutting, do you see any evidence on Netflix subscribers are inclined to either cancel multi-channel video subscriptions or to (inaudible) back use of premium services such as Starz, Encore, HBO?

Reed Hastings

No, we haven't seen any evidence of that and there's no evidence in the total numbers of those firms in the last quarter's financials and total subscribers. Total multi-channel video subscribers is continuing to grow in the US, premium subscribers is not showing any decline, so I don't think there is any material core cutting. And I think what's happening is you know the multi-channel video is such a broad package with an incredible array of products that were a tiny little fraction of that and our subscribers view it as a supplemental service and because it's a modest cost, at nine bucks a month. It works for them and their budget.

Erin Kasenchak

Next question from Mike Olson at Piper Jaffray. Have you ever considered raising the price of the subscription to fund content acquisition and to accrue [ph] introducing a 999 a month plan that is also ad-supported change of thinking on your monthly fees?

Reed Hastings

Well who knows that we change our thinking at all? You it is early stage, too small to matter. But generally, we ask ourselves every quarter, should we cut price, should we raise price, should we add more content, shrink the content? We think through every quarter, in what way should we be evolving the business model? So, nothing particularly at this point but it is always the ongoing question we ask ourselves.

Erin Kasenchak

The next question is, while the various metrics were down from quarter-to-quarter and due to seasonality, is it fair to say that as long as the subscriber base continues to migrate through increased usage of streaming in favor of DVD. At gross margin churn and fact should all continue to improve on a year-over-year basis in the foreseeable future? What could cause this not to happen?

Barry McCarthy

As we make the service better Michael, I have every reason to believe that, if we're successful in increasing subscriber engagement with the surplus then we'll see improvements in churn and we'll stand to see improvements in SAC.

I don't expect to see continuing improvements in gross margin and I think we would probably do ourselves a disservice and slow our growth if we were to stop the content spend and in order to manage the gross margin in the business to a higher level. So in lieu of gross margin I encourage you to think about operating margins as we're clearly making trade-offs between.

And we have through our entire history on SAC churn in gross margins offer the purpose of managing our sales to an operating margin that strikes the right balance between growth and profit. So a right example, we saw last quarter, I told you'd expect us to manage the business at 1% operating margin for the year.

Now we're going faster and having more success doing it than we imagined and to the mid-point of guidance our net income implies an operating margin of about 12.5%. So clearly business is running, at least year-to-date more profitably than we expected and at least in the current quarter on gross margin both because of plan mix shift and because of substitution behavior is more profitable than we had expected. Now in a perfect world that we can time content spending and marketing spending and align it with perfect four side in our forecast, that wouldn't have happened and we would have reinvested that money and had factors of growth still.

Reed Hastings

Mike to repeat what Barry said, we do look at operating margins with important discipline, but not gross margin, so if we found the right content deals, we would easily take half of the marketing budget and slip it into contents. If we thought that that's going to help us grow even more than that marketing budget but you know you could see big swings that way, if we think it's in our interest of terms of growth and consistent with our operating margin goals.

Erin Kasenchak

Great, the next question is from Imran Khan at JPMorgan. Can you talk about how much of the increasing churn was driven by seasonality versus other factors?

Barry McCarthy

Well I think we saw 30 basis points of seasonal increase a year ago and we saw a 20 basis points roughly of seasonal increase this year, I am talking about Q-over-Q. So on a net basis, I think we are better by about 10 basis points and all the trend lines for the individual plan types and usage types hybrid versus just going (inaudible) and suggest to me as my commentary indicates there will be continuously improvement in churns through the remainder of the year.

Erin Kasenchak

Next question is from Brian Fitzgerald at UBS. There will be a year term launch April before a user interface upgrade to the Wii and is the driver there exclusivity plus yield terms are related to R&D priorities?

Reed Hastings

Brian there is no limit in our ability to innovate on the Wii. Once the new PS3 launches, that will convert from a disk based user interface to a downloadable user interface, which makes the cost of upgrading very small for PS3. At this point the Wii's forecast will still remain a disk based model. And that is some practical constraints to the timing and frequency of upgrades. So, that's the only material difference going forward.

Erin Kasenchak

Next question is from John Blackledge from Credit Suisse. What is driving streaming content purchase decisions? Is it about acquiring as much quality content, netbooks can get at fair value or the initial viewing trends from subscribers taking purchasing decisions?

Reed Hastings

The two factors are how much budget we have for streaming content. And then can we get it. You referred to fair market value, but really can we just get an agreement of a price that works for us both. And if it's so, then we do that deal.

Erin Kasenchak

Next question is from Ed Williams at BMO. How quickly do you think you might be able to extend outside of Canada into other international markets?

Reed Hastings

Ed we're going to take a look and see how we do in Canada with a New York streaming model. See if we've got the right amount of content, the right marketing approach. And we'll take a look at those results, and then try to figure out what that means for our opportunity in other countries. So until we get a couple months after the launch we're going to be sitting still.

Erin Kasenchak

The second question, can you provide some color on the usage patterns of launch instruments, specifically, our new subscribers using this service differently than those that have been subscribers for a longer period of time? Is there a measurable base of subscribers who are exclusively using launch instantly?

Reed Hastings

And to the last part, almost everyone takes both DVDs and streaming and partially that's because the DVDs have all the new releases, so there is a pretty sector of content there that's DVD only. But in terms of viewing patterns, newer subs as a class are more streaming centric partially is because when they came and that's why some established their habits, we upgrade streaming, whereas if you joined us five years ago, you'll use to it as a DVD business so of a thousand people that are with us to join five years, you get a viewer that are extremely centric as you do in the new subs, pretty much as you would expect. The migration is happening in all classes and its increasing amongst all classes.

Operator

Next question from Jim Friedland from Cowen.

Erin Kasenchak

Did you ever offer new release titles on the pay-per-view basis on the digital video service?

Reed Hastings

Jim you've probably put that question in before I answered it a few minutes ago, so I'll go to the next one.

Erin Kasenchak

Next question from Andy Hargreaves from Pacific Crest.

Erin Kasenchak

Does your increased focus on TV content change conversations of content providers and this is potentially more competitive with their broadcast or affiliate fee businesses?

Reed Hastings

Andy what has that potential, if we weren't focused on prior season instead of current season? On current season you do get potential competition with essentially the DDR model, the advertising model, all of those things but on prior season, we are able to create value that wasn't there before and generate incremental profits for the content owner and so there is not a conflict there.

Erin Kasenchak

Next question from Heath Terry of FBR. Can you breakdown the components of the increase in SAC, rising ad cost, mix of higher bounty deals or lower response rates, to non-bounty deals TV, radio.

Barry McCarthy

I could but I'd get skewered back (inaudible) also. I'm going to take a pass on that. Your walk away should be that there is nothing that's happening in the marketplace particularly that's increasing our cost of doing business. So the increase in SAC is strictly a managed outcome but we would say she starts with the lowest cost of subscriber acquisition and then layer-on-layer she builds out her acquisition channels and as the budget permits. There are quarters like Q4 when consumers are very active and the cost of acquisitions is relatively low and there are an abundance of marketing opportunities available to her, so happens and Q2 is the slowest quarter by far. And so, an aggressive spend in Q2 is a little bit my question on (inaudible).

Reed Hastings

And so Heath if we ever drop the marketing budget on a year-over-year basis and have SAC to increase then you can worry about that case, kind of what's happening. It's harder to get subs. But when you increase marketing dramatically on a year-over-year basis as Barry said, knowing how much you increase it, that's what's driving the SAC up on the margin.

Erin Kasenchak

Next question from Nat Schindler at BofA-Merrill. With churns looking up for the first time sequentially in four quarters as that related to seasonality, do you think we are at or near the low for churn on a seasonally adjusted basis or over the long term will it continue streaming if this drives this churn even lower?

Barry McCarthy

Somewhere its seasonality and somewhere its growth, right. If we had slower growth and new subs churn at a much higher rate than the short subs like a 10% rate versus 1.5% rate, sort of and what it seems lower churn. Now, the question was have we seen an all-time low in seasonality, Erin?

Erin Kasenchak

Could it continue to decline?

Barry McCarthy

Yes, I think so. Could churn continue to decline on a seasonal basis? Yes. Let's see, if we continue to improve the overall quality in the service in a way that increases subscriber engagement with the service then the answer is yes. Certainly in the current competitive environment, it's a competitive environment systematically, or if we make bad decisions about how invest in the quality of service and we are not successful in briefing engagement, the trend could reverse, no question.

Reed Hastings

And Barry if our sub-growth keeps on accelerating, you know it's already 49%; that could also have an effect on the new public churn.

Barry McCarthy

Yes, but we are forecasting faster growth and lower churn.

Erin Kasenchak

Great. Our last question comes from Andy Hargreaves, Pacific Crest. Last quarter you said the goal is to hold second half marketing expense below second half 2009 marketing expense on an affluent basis, is it still the case?

Reed Hastings

Barry and I are looking at each other like did he say that? I don't think we said that anyway. Yes and going forward what we are looking at is if we can spend it on content efficiently, we'll spent it on content, and that would have reduced marketing. If we don't find the right deals then we'll end up spending it on marketing. So if you add up to some of those marketing plus cause, now that's where, that will stay, I think lets say its not a consistent one to P&L but its a trade-off between on the margin marketing expense and streaming content.

Erin Kasenchak

Great. So before we conclude the call, I'd like to just turn it back over to Reed for a few closing remarks.

Reed Hastings

Thank you all for attending the call and continue to give us feedback on the format if you like. In general, we've heard that it's more efficient for all of you and its quick for us and I hope that it gets a higher quality, total information out. So thank you for attending and we'll talk to you again next quarter.

Operator

Thank you. Ladies and gentlemen this does conclude today's program. Thank you for your participation and have a wonderful day. Attendees, you may now disconnect.

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