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Netflix, Inc. (NASDAQ:NFLX)

UBS 39th Annual Global Media and Communications Conference

December 06, 2011 3:30 pm ET

Executives

Reed Hastings - Founder, Chairman, Chief Executive Officer, President and Member of Stock Option Committee

Analysts

Barry Stewart - Omega Advisors

Rich Tullo - Albert Fried and Company

Unknown Analyst

Okay, everyone. Welcome, and thank you for being here, and welcome to the afternoon keynote presentation today and we're delighted to have Reed Hastings as our guest today. He's the Founder and CEO of Netflix, the company he founded in 1997. And Reed is, in addition to running Netflix, is also I've mentioned on the boards of both Microsoft and Facebook and several educational nonprofits, so thanks for being here Reed.

Reed Hastings

Pleasure.

Unknown Analyst

Well, and this would be your first time at the UBS Media and Communications Conference and we're honored to have you here and on the hot seat, so to speak. Last year, you were the talk of the conference, frankly, and I think there was a combination of mystique and envy and fear, and undoubtedly, obviously, you've been through -- so you've had a difficult few months obviously, and we'll get into that, but obviously, you continue to be a leader in the video -- online video space and we'll talk about that as well. So just to get right down into it, we'll go into the Netflix recent trends and obviously, some recent choppiness that you've dealt with after we talk a little bit about the industry.

Question-and-Answer Session

Unknown Analyst

So in your opinion why do consumers use Internet video when they already have hundreds of channels on pay TV and some other multi-channel obviously, video program and distribution devices?

Reed Hastings

I would say the heart of it is click-and-watch. It's the same thing that drove the DVR for a little while is that sense of control, and what really drives Internet video is click-and-watch, probably second biggest is the personalization that you can do on the web. So it's high relevance for each person in terms of the content selection, those will be the big factors.

Unknown Analyst

So outside of Netflix what other video applications online are you impressed by?

Reed Hastings

Which of the competitors do I -- well HBO GO, I would say is probably the biggest one. It's really quite impressive on our Roku device on an iPad, Watch ESPN, ABC.com, those would be the big ones.

Unknown Analyst

Well, how about the broadband season, the infrastructure to support Netflix and other devices. I think it's talked about -- Netflix is about 25% to 30% of prime time viewing, is the broadband infrastructure there to support that kind of product as it grows, especially and do you foresee it like a pay-per-bit type of the model, similar to price per gasoline, things like that?

Reed Hastings

Let's see, in fiber optics everybody knows Moore's law about semiconductor density, but what the businesses have been able to do in fiber optics is even more amazing and so basically, more and more bandwidth can go through a single fiber optic than ever in the past and it's just continuing to increase. As an example the peak Netflix's viewing on a Saturday night on a global basis can still fit inside a single fiber optic. And so fiber optic is just unbelievable, and what we're going to see around the globe is like rural electrification, we're going to see fiber to every home and neighborhood in business and school, and over the next 20 years, you're going to see just fiber everywhere. If you look at what Brazil is doing, if you look at what Phillies [ph] is doing, if you look at what Australia is doing in buying the copper-based telco, Telstra, and replacing it with fiber, it's absolutely incredible what's happening around the world, developed economy, emerging economy. Pay-per-bit may emerge. That would be unfortunate because it's not based on the costs. So the costs are high-fixed cost to roll out fiber, and then there’s some peak speed cost to be able to supply the routers all around the peak speed. But essentially, if you download or stream off-peak, there are 0 marginal costs to anyone in the system, and so it's a 100% about peak loading, and so pay-per-bit would be a really bad inefficient cost model to put on top of something that has peak costing as its big driver, and off-peak, the Internet is free.

Unknown Analyst

Well, are you seeing that trend emerge now with the user space pricing or do you think it's further out?

Reed Hastings

And Time Warner tried it a couple of years ago in Texas and backed down. It exists in Canada but the caps are coming, it exists in Australia but the caps are coming up, and so I don't think so. It's possible there'll be some systems that try to get in a pay-per-gigabyte model. Obviously, on cellular bandwidth is highly constrained and there are lots of cell systems are kept at 2 gigs and a charge above that, but in terms of wired bandwidth where you get these incredible fiber optic delivered efficiencies, I doubt it'll happen, but if it does the market becomes a little more like Canada for us and Canada is growing great for Netflix.

Unknown Analyst

Okay, how and about when you think about the television set, it's clearly been similar for the last few years, but now we're on the verge of trying a lot of innovation on the television set. What do you think that will be in the next 5 to 10 years?

Reed Hastings

Yes, I mean the untold story everybody again knows Moore's law, lots of people know about bandwidth growing, that's what's happening on the endpoint for Smart TV. And Smart TV is an incredible category that's growing rapidly. If you go in a Best Buy it's all Smart TV, Smart TV. If you look at have a row of streaming boxes like Roku and an Apple TV and the headline is, "Turns your existing TV into a Smart TV," and the industry is very motivated behind this concept of the Smart TV. And if you're a TV manufacturer, you don't want to be a dumb monitor on the back of cable or satellite or even broadcast system, you'd much rather have software written for your platform and to have things like CPU -- like sometimes you buy a mobile phone and you know it's got a gigahertz processor, right? But when's the last time you bought a television because it had a gigahertz processor, I mean you don't . And what the industry TV industry would like to do is make the amount of multi-core that's a nasty part of why you buy a TV, because then you're going to buy more and you're going buy them more frequently. They'd like to have the remote control from the TV being the remote control you use most of the time. So in a Smart TV, like LG TV, you've got this Wiimote like Magic Remote that's an amazing pointer and you can choose all kinds of apps and lots of new apps are getting written for that experience. So that's another big reason why Samsung, Sony and others are investing so much in Internet connectivity to the TV because they want you to live in their device, on their remote control with applications built into the television, and so really over the next couple of years most TV sold will be Smart TVs and fits -- creates another cycle of innovation. For example, when the TV manufacturers figured out how to do 3D or 1920 or 4K video they have a real problem, which is none of the cable or satellite broadcasters broadcast 4K video. So they've got this cool new technology, but they can't get any content for it. But to the degree that their systems are Internet-connected and Internet-delivered content then they can deliver 3D, 4D, 4K, all kinds of new video experiences to the TV. So what the TV manufacturers see is an ability to turn their space into its interesting dynamic, creative as the smart phone, and so there's a ton of excitement around the world about the Smart TV category and you're going to see that, I think, really explode over the next 5 years.

Unknown Analyst

How soon do you think we'll see -- do you think we'll start seeing in 2012?

Reed Hastings

Again, if you look in Best Buy today on a run rate basis it's probably at least 1/3 of the TVs sold and then it's just going to increase year-after-year as a component cost down and this whole Smart Internet TV click-and-watch paradigm is changing, I mean it's just going to be a phenomenal revolution over the next 10, 20 years.

Unknown Analyst

So just to continue and set the stage Internet video viewing is right now a very small percentage of total video viewing. When do you think that's going to become more material or where do you think that's going to change -- how do you think that's going to change in the next 5 to 10 years?

Reed Hastings

Well, I think all the big brands like ESPN and ABC and HBO and Netflix will drive Internet video because they can create great experiences. Like it'll be great to watch 3 sports games at once so -- different angles and think of all the creativity you can bring to a user interface around sports content or around movie content in co-viewing of different places and times and all kinds of amazing innovation. No one has yet invented social TV, we haven't figured out as a society and culture, what is social TV, what does that mean exactly. So that's a whole another wave of innovation. So I don't know. 5 or 10 years I guess half of video viewing will be Internet viewing or 2% or 3% today in the developed world and then it will go more year-by-year. And really what's happening is broadcast was the most cost-effective way to deliver. Broadcast over the air, broadcast over satellite, broadcast over cable very efficient because everybody is on the same signal, but as the cost of Internet drops as fiber optic gets everywhere, those costs aren't going to matter. And so think of it like before World War II, most people had party lines. So they would take copper for telephone and they would ring it to 10 homes and come back because it was cheaper. And it's like my grandmother, you grew up with a party line, you never really trusted the phone, right? It was always -- you can listen to your neighbors' conversation and that was the cost of it, and eventually after World War II and it was one copper loop for every household, she still never trusted it, she only knew that the whole paradigm. And to some degree, I think we'll look at broadcast in probably 20 years and think of it like party line, like people will say, "Everybody got the same signal, really? That's so weird." Because even on the big events like the Super Bowl it's going to be a single-cast ad stream. So everyone is going to get the same event, but the ad stream will be individualized over the Internet, and so again, the big brands or the big content -- it was a huge investment of making this happen because they get the -- even on the big-event viewing, single cast ads and then for the content that you click and watch and choose like Netflix that's not time-sensitive, it's not realtime then obviously, there's tremendous advantages. So we're in the beginning of this massive change fiber optic everywhere provides the substrate, brings the cost down smart TVs enable this amazing interaction paradigm, where again, whether again it's a mobile phone revolution or landline, telephony, very big changes to society and incredible user experience is created by the different groups.

Unknown Analyst

So by your vision over the next 20 years, broadcast video whether distributor broadcast via cable, satellite or antenna will be a dinosaur?

Reed Hastings

Yes, there will be a residual market where dinosaur is sort of an emotional word. I mean there'll be some fraction of viewing as a baseline, but by far, most of the economics -- I know think of it like landline telephony, okay, it will be declining like landline telephony is declining in the U.S. today and like mobile phone is growing that'll be Internet video. It will be something like that. It'll be a very long changeover. It's pretty cheap to run broadcast video, so that's not the hard part. And then anywhere where the Internet happens some very different deeper rural place where no one has fiber optic yet, there'll be little residual markets. But for the most part, once you've got a gigabit to every home in America and you might say, "A gigabit, what's he talking about?" Well, it's 2011. 10 years ago, it was 2001 and that's when dial-up, AOL was king -- just 10 years ago, dial-up was the dominant way people interact with the Internet. Look where we are today. Like, no one ever listens to a modem anymore. [indiscernible] all that stubborn part. In another 10 years if you look at what Google is doing, this amazing work with fiber-to-the-home and Google access and they're providing gigabit access today in Kansas or next year in Kansas. So if you can do it in Kansas, you can do it anywhere and we really are going to have the gigabit to most homes and a gigabit is a tiny fraction of what's possible over fiber optic. You almost cannot underestimate how powerful and dense optics are and what incredible low-cost are plausible and how that's going to change the planet, as like rural electrification, you get fiber optic everywhere in the planet.

Unknown Analyst

So if you were running one of the broadcast networks today, what else should you be doing differently?

Reed Hastings

Well, I think they're doing a lot of things like the ABC.com application and things like that, probably authentication. I mean it's crazy that they're not doing more authentication to me. I mean Fox is doing it, starting to, but really the economic paradigm, I think, should be authentication for them and then that drives re-trends and lots of other things so -- and I think they get that and you see that in Fox's recent moves. So I'll bet that most of that content moves to authentication, really driving stability of the MVPD industry and driving re-trends.

Unknown Analyst

So MVPD is a multi-channel video program and distribution? And now in this country, 100 million homes versus subscribers, so to speak, and where do think that will go in 5 years because they've been relatively mature today.

Reed Hastings

Yes. Well, broadcast video viewing will go down over 20 years. I think MVPD connections, you'll pay for your service through your MVPD and then you'll use it on the Internet with authentication like HBO GO. So video viewing will be less broadcast, more Internet. But total MVPD descriptions will decline very small, I mean I don't know $95 million or something in 5 or 10 years. No cataclysm because that's going to be the economic engine behind authentication.

Unknown Analyst

Okay. So for Netflix now when you look at this landscape, who do you view as your biggest competitor? Is it -- Amazon obviously rolled out Prime in February, I think 2011 this year. And how do you think about your competitive landscape?

Reed Hastings

It depends on time frame, but the competitor we fear the most, I would say, is HBO GO. Their -- I think they've got a lot of content, they've got a pretty global brand they've got -- today, they are kind of in a gilded cage on top of an MVPD system and it works very well for them. They're not competing directly with us, but they can and then it will be a more direct competition. And the funny thing is HBO is becoming more Netflix-like, i.e., going over the Internet and interactive streaming and that kind of thing, and we're becoming more HBO-like doing -- winning the bidding for House of Cards and doing originals. And I think the 2 of us will compete for a very long time, hopefully we'll make ourselves both better to that competition and it could easily be that we both end up with substantial growth multi-tens of millions of subscribers and then many people will subscribe to both services because we have distinct content, but as the 2 of us are pushing the envelope on what can be done on original, on a studio output deals, on TV syndication, on the Internet, and we'll always be a little better at the Internet. They may try to stay better on originals, we'll start to catch up with them on that, that'll be a really interesting -- it's not -- I don't think a winner-take-all, there'll be the 2 channels of us in HBO and again, we'll have distinct content and in a good scenario, we'll push each other like 2 runners push each other to do more innovation and more ambition and have us both succeed.

Unknown Analyst

Well, just to be fair around that competition, you obviously, have a lot connected devices and some content now. HBO has a lot of content and a lot of scale and really is not charging for the incremental HBO GO product. So how do you think about the pricing model between the 2 services in the last game?

Reed Hastings

Well, HBO GO will become HBO. In other words, a separate brand. It will go away over time because that will be how most -- when you use HBO GO on a Roku or on your TV, it's so much better than the on-demand MVPD system for accessing that, and that's just the beginning of HBO. It's not just HBO, HBO will invest ABC will invest, ESPN has done amazing work on an iPad. So all of the big brands, Discovery, and the works are creating incredible user interfaces that then will be through authentication. We'll be relatively unique in being direct-to-consumer in our billing relationship, and so we're an add-on channel. That gives us some advantages, some disadvantages, but it's who we are in that play.

Unknown Analyst

I'm little surprised you didn't think -- you have mentioned Amazon obviously because of their Prime service, talk about how you see Prime as a competitor, more near-term?

Reed Hastings

I don't think Prime will be a -- Prime is -- I use Prime a lot as probably everybody in this audience does for the free shipping and gets me to purchase more, but if someone -- Verizon made an announcement today, Amazon, Hulu Plus, I mean there'll be a lot of competitors out there, but HBO and Netflix both spend between $1 billion and $2 billion a year on content. And if you want to compete with HBO or Netflix, you better commit to multi-year spending of between $1 billion and $2 billion and then your competitor with us. And at this point, none of those guys have chosen to do that.

Unknown Analyst

That's interesting. Now that you have scale and the reach obviously which will continue to grow, content is the differentiator, that's why you've in yourself and HBO GO in different leagues and even Verizon which seems a pretty well-capitalized competitor maybe rolling out a service like this, not having the content is a differentiator?

Reed Hastings

Correct. If you're not -- if you don't have -- if you're not willing to invest at those levels, it's pretty hard to compete with us or HBO. And both of us, it'll be bit of arms race between us and hopefully we'll end up both creating amazing consumer experiences and really push the bar in a positive way for each other. Okay?

Unknown Analyst

What you do about online video piracy?

Reed Hastings

That's a big problem. It's a very big problem in some countries. It's not that big in the United States. On a global basis, it's a significant concern. There's bills right now that are very controversial in the Senate and Congress and House and hopefully, what they'll do is they'll tune those bills down and alleviate the concerns about free speech and the very important political rights that we all cherish, and that there really will be a uniform approach to making piracy more and more edge case, and not be something in the mainstream.

Unknown Analyst

Okay. So let's talk a little bit more about the fundamentals of your business this quarter. How is it trending in the fourth quarter? I want you to give us a business update, if you could.

Reed Hastings

Well, streaming has been a rocket ship for us. It just keeps growing 3, 4 years ago we started -- it grew huge, it grew huge. We'll do well over 1 billion hours of streaming just this quarter. The amount of streaming is just going through the roof because people love the on-demand click-and-watch because we're built in to every Blu-ray player, every Smart TV, every game console. So that's incredibly satisfying and exciting for us. Streaming payers was higher in our hybrid plan and then we had our pricing missteps, and so streaming payers came down a little bit, but streaming usage has always continued to climb. And we did a capital raise about 2 weeks ago so we had a mid-quarter S3, and we updated that we're comfortable with our guidance that we were on target.

Unknown Analyst

And I assume you still are comfortable?

Reed Hastings

We're not going to comment on the current quarter.

Unknown Analyst

Okay. Well, just to put you on the couch now for a little bit, you've been doing so well for 10 years, what happened this year?

Reed Hastings

I think a range of things in hindsight. We definitely -- we had done so many difficult things that we got overconfident and we're so focused on streaming. So many companies rise and fall with one round of technology. Our big obsession for the years was let's not live and die with DVD, let's make sure we get into streaming and we all became very heavy streamers, not using DVD much and that's why this summer, we said, "Okay, it's mature enough. Streaming is growing. What's the plan? Let DVD be a comfortable drift at whatever it's going to do and keep those customers happy and let's charge in the streaming as fast as we possibly can." And it turned out to be a little bit too fast for those customers who had it and owned $10. They were very upset and we became a sort of Bank of America symbol. I think carefully, which is super unfortunate. I mean we berate ourselves tremendously for that lack of insight because it didn't need to be that way, but in 3 or 5 years, we're not going to remember it, it's going to be -- did we succeed in streaming? That is all the people are going to care about in 3 or 5 years, and so we're not losing too much sleep over it. We're charging ahead growing or streaming, getting more content. It's just been very satisfying.

Unknown Analyst

And so you're back on tract?

Reed Hastings

?

Yes.

Unknown Analyst

Now, what does it tell you and the company that you run about your -- being in touch with the consumer and what they want?

Reed Hastings

Well, consumers want streaming. I think we underestimate a reaction to the price change and for the next couple of years, we'll do great at $7.99, essentially, on a global basis. We'll be launching in the U.K. in Q1. We're very excited about that. In Ireland, we launched LatAm a couple of months ago, we launched Canada about 1.5 years ago and at Canada, as a proof point, has been $7.99 streaming for 1.5 years and it's just continue to grow and grow and grow and grow, and people love that click-and-watch, on-demand product and right now, we're essentially the only ones with a great click-and-watch on-demand product. So we've got to get as big as we can before the rest of the world catches up.

Unknown Analyst

So when do you expect the come into return to global profitability, which is I think a core milestone that investors are tracking right now?

Reed Hastings

Well, it's core milestone for us because we said we're not going to continue with our global rollout until we get back to global profitability, but we're not sure. At this point, it depends on how quickly the U.S. recovers. It's not in the next few quarters so we've got a little bit more than that, but we're working really hard to get it there quickly, partially for investors and partially because we see the potential to create a really global company, and so our focus is can we get successful in say, 2/3 of the world's entertainment GDP? And by entertainment GDP, China has a huge GDP, but it's not much of the entertainment GDP. But if we can get successful in 2/3 of the world's GDP, then we can take the lead to global buying and go to the anime studios and get a global license to the telenovela studios, to the Hollywood studios, to the BBC, to all the content producers around the world and get global content and really create a service of the world's best content for the world's citizens. And that's our 10-year ambition is to pull that off and so we are working really hard towards that country-by-country, market by market and so we're patient. It's going to take a long time, but the Internet is the first time there's been a global distribution medium. Before that, broadcast, cable, it's all regulated country-by-country in the Internet. So you'll see in YouTube a really global brand. You see in Facebook, a really global brand. That's what's natural on the Internet, and so that's what our ambition is for Netflix, is to make that happen. If you get there, we've got to get the U.S. recovered, we've got to get growth back, we've got to get back to breakeven first in the U.S.

Unknown Analyst

So this not starting the expansion until you're back to profitability is the right one, but I mean it happen next few quarters, but clearly given the market potential, you get underway. So when would it be uncomfortable or to late for the company to get back to profitability, is it 2013?

Reed Hastings

The sooner, the better. I mean, it really depends on the subscriber growth. So we know roughly what our costs will be, so it's how much can we spread the word? How do we make the service better? We've got these amazing new versions of our user interface. A version came out today on Xbox that's really integrated with Kinect and you can speak to it and you can wave at it, and then it chooses your Netflix movies. It's very cool. There's a new stuff coming out on iPad, there's new stuff coming out on all the different platforms, and so what we measure by is, is it actually improving viewing? And the more that consumers view from Netflix, the more they have positive word-of-mouth and the more they retain. And so if you only watch 1 hour or 2 a month, you're not that likely to retain with us nor to tell your friends about Netflix. And if you watch 50 hours a month, then you're very likely to retain and very likely to tell your friends about us. So we're constantly in trying to make the user experience better, we're adding more content. In Q1 and Q2 next year we'll have a huge amount -- I mean close to double as much content as we did the prior year, Q1 and Q2. So it's a phenomenal increase in content that we've been adding over the last couple of quarters, getting us up into this HBO parody spend that we're at.

Unknown Analyst

Okay, so you want to be $1 billion to $2 billion a year in content, so where are you now?

Reed Hastings

That's where we are now.

Unknown Analyst

Okay, that's where you're now. Okay. So...

Reed Hastings

For next year.

Unknown Analyst

Correct. Okay, we'll get to the content strategy in a minute. But do you think consumers will really pay ultimately for both the cable or DBS subscription and Netflix? I mean do you think that the cable DBS operators are you competitors or is it -- or you could do both?

Reed Hastings

They are competitors in a way, but they're a $70 or $80 product and we don't have sports at all, we don't have news, we don't have reality. So we are not really a substitute, we more like one additional channel. So if you're tight on money you might cut HBO and use Netflix, if you got plenty of money, you might do HBO and Netflix. So we compete with HBO for dollars, for time in viewing, sometimes for content like in House of Cards, but it's not a direct competitor because many people will do both.

Unknown Analyst

So Jeff was with us here earlier and obviously last year I think you talked about you guys in a different light than he spoke at you today, not to go through the comments again, but now he's speaking much nicer around his view of you and the company. Why do you think that is? What's changed in the last year in Time Warner's mind?

Reed Hastings

Jeff is great provocative guy. He would be a great competitor for us for years and I would just say your only worry should be if Jeff stops talking about us, the more he talks about us, you can tell we're doing some stuff right.

Unknown Analyst

Okay. So now let's talk about the content strategy in more depth. Is that a strategy that obviously is going to be potentially a costly strategy, but one that you obviously circle as a cost, can you really go out there and compete against the installer or Time Warner for House of Cards, Arrested Development and those, are you potentially overpaying for content as a result?

Reed Hastings

Are we overpaying, I'm sure that's what our competitors would say because we paid more than them, that's the nature of competition. We'll see when those properties come to Netflix, how big a boost it is. We think House of Cards is coming together great. I mean we are very, very excited about that and Arrested Development, it'll be off the charts. And the only problem, that's not until 2013. So the House of Cards is 2012. We have a very interesting little series, Lily Hammer that's coming out in Q1 that's I think going to be very interesting. It's not quite as mainstream as the others, but very interesting artistically. So we'll start to build up muscle, and there's a lot of artistic talents in the world, and so it's not a corner of a resource. So if we're willing to invest. And if we're thoughtful about what we invest in, we're not going to squeeze them out, they're still going to do amazing, great originals and all kinds of things. So there's plenty of creative talent. What we need is more money in the ecosystem that flows to content producers. And so they're all welcoming us as another bidder, driving up the pricing and it's not just in originals. If you look at it in movies from when Showtime dropped to Paramount, at the time, it was like, "Oh my God, the pricing for output is going to plummet," because there's like one too many studios out there and now that we're an active bidder, it's really driven the pricing expectations around movie output deals up, which is great for the content owners. You see the same thing in the U.K. So Sky has the big 6 and they were not paying any money for the mini majors, and so there was no distribution for many people in the U.K. for a pay deal. And now with us coming in, we're bidding those prices up and we're making a business out of it. So I think it's a really healthy thing and again, what we bring to the table is the Internet sensibilities around click-and-watch, social, recommendations, personalization, really pioneering a whole new paradigm that's very much Smart TV-based rather than cable and satellite set-top box based.

Unknown Analyst

But as you bid those prices up, in your words, how do you become comfortable you're getting a return on the investment. Obviously, the traditional model of buying content has been improved now over an economic model for decades or a long time. How do you get that comfortable in this nascent stage?

Reed Hastings

At any one piece of content when we look and say, "How much is it getting viewed?" And sometimes we do owe per pay. We pay x and it doesn't get viewed very much and we're like, "I wonder what happened," and we go back and tune our models. So we have a whole team of statisticians that work on this, the comp title analysis in trying to figure out how much something is getting viewed. So we're very much the money ball content buyers.

Unknown Analyst

Is there a better way to do it than buying a one-off show or the one-off series? Are there ways to marry partnerships with the production companies or to sort of get a much bigger deal together in terms of the film studio partnership or by the way, are you looking to approach on acquisition strategy?

Reed Hastings

I would say we're very flexible. We work on a one-off for a movie sometimes, for TV shows. We work on a package basis many times. So we're agnostic on that part. And what we found is particularly good nations for us our past season, highly serialized content, like Mad Men that doesn't syndicate very well for much money, and so we bid the price up in that category and everywhere we win something, we've had to outbid someone else and generally cable networks buy exclusively, so now we're mostly buying exclusively as we've gotten into that tier.

Unknown Analyst

Now one of the levers that the industry plays is obviously is controversial distribution over the years and there's the content for a volume discounts, the bigger your distribution, the cheaper the content becomes in terms of your buying power. So how do you think about pulling those levers for Netflix as you get more distribution? Will the price of content come down? Or how do you envision that?

Reed Hastings

Well, our basic concept is if we can help content owners increase their profitability and get more shows then it's a huge win. And if you think about the Stars content, we've had all of Stars on our service for 4 years and yet Stars subscribers have not gone down. And if you had said 4 years ago, "Wow, what if we put that content in a $20 million due to sub business like Netflix, isn't that going to trash our current business?" I mean most people would say it's going to trash the currents [indiscernible], but in fact, it hasn't at all, and so also what content owners are realizing is they can put it through us and the other channels had stayed very stable and strong. And if we contribute enough additional revenue, then it's a huge win.

Unknown Analyst

So how do you think about your competitors that are actually purchasing content that are deep-pocketed. You have the Time Warner, on the media side also have technology companies, Google, Amazon have plenty of capital, how do you compete in buying content versus those players?

Reed Hastings

Very well, I mean we compete with HBO for lots of properties. Over time, we'll be a bidder on various movie every movie output deal that we do we compete against other people including many of those names. So they have deep pockets because they're thoughtful spenders, not reckless. So the fact that they have a lot of money doesn't tell you that much because they're actually sensible and we tried, we win the bidding when we can monetize content property better than anybody else and outside of that, it's just an accident of who pays too high or too low, but fundamentally, it's about what we can monetize and how well.

Unknown Analyst

Okay, just a couple of more questions for me. I mean do you view Netflix as a complementary service to the cable industry? Obviously, you have a lot of access devices but not necessarily on the cable modem right now or the cable box. How do you think that's going to change over time?

Reed Hastings

Yes. I mean, we're very complementary to the classic MVPD service. We're arguably competitive with HBO the way Showtime is competitive with HBO, which is they compete for Emmy's, they compete for status, they compete for subscribers, but many people subscribe to both. So we're firmly a pay-TV network, but we're an Internet pay-TV network with this huge advantage of Internet DNA. So we update our UI constantly, we're direct-to-consumer, we're always on the cutting edge of figuring out recommendations, social, incredibly fast streaming all of the new amazing technology.

Unknown Analyst

And when you think about your international expansion when you obviously have these a lot on it, how is it different from the way you build out domestically, both as a content and distribution perspective?

Reed Hastings

Well, domestically, we started on DVD. So it's very similar to how we did in Canada, which is we launched in a wide range of devices with good advertising and good content and then it's letting word-of-mouth really propagate. So we support that with advertising, but most of our growth around the world is word-of-mouth because people are using and loving the service because they use our interphase, the click-and-watch, the personalization, the content and the low prices.

Unknown Analyst

And then just to end on capital, you raised $400 million a few weeks ago as you mentioned, why did you do it as well as the need? Where does that leave you with your capitalization?

Reed Hastings

Well, we were probably adequately capitalized, but it was a touch in and the danger there is, when you're on the touch-in side is that suppliers get nervous. A conversation gets started, "How they going to pay their bills? What's going to happen," and then the suppliers get nervous and then they start wanting to cash upfront and that creates its own cycle, when you actually do have a cash flow problem that you didn't have before. So it's unfortunate on the 10% dilution, but it's worth it to sort of head that off, have plenty of cash and not have those set of issues come up.

Unknown Analyst

Is -- are you done now? You have enough capital so that problem is no longer there?

Reed Hastings

Yes, I think we probably had enough capital before to avoid that kind of crisis of confidence, but it's -- you cannot be too sure. And once you get a hole there, then it's a lot harder.

Unknown Analyst

But do you think capital shore up the confidence level?

Reed Hastings

Yes.

Unknown Analyst

Okay. So to wrap up, what do you think investors should own Netflix stock now?

Reed Hastings

Well, I think if you fundamentally believe in Internet video is going to change the world over 20 years, then you may or may not have considerations but you basically believe in the growth of the segment and where the leading play on that pieces, that you believe Internet video is going to become the dominant global paradigm, then there's a huge addressable market for Netflix. And as long as we don't shoot ourselves in the foot anymore, it should be a fantastic opportunity.

Unknown Analyst

Okay, I think we have time for just a couple of quick questions and then we'll…

Reed Hastings

And I should add to that when our stock was rising rapidly this year, I cut my own sales in half because I was so convinced it was going to 1,000 quickly, so I may not be the best judge.

Unknown Analyst

Well you're certainly the judge of the trends you're talking about, right?

Unknown Analyst

What percent is the $1 million, $2 billion [indiscernible]?

Unknown Analyst

Please, repeat the question.

Reed Hastings

What percent are we spending on original content? On an annual basis, next year, may be 5% or 10% or 15%, depending on how successful it is. We'll start, I should say, in 2013. On a P&L basis, it's pretty small next year because House of Cards and the others coming late in the year. So we'll do a little bit in that and see how it goes, if it's successful, we'll grow it and it could be over 5 or 10 years could become a very significant fraction or it might stay as a relatively small fraction.

Unknown Analyst

So tough a question. Love the brand. I've personally love the brand. I went from DVD to streaming, so I love the brand, best algorithms, predictive algorithms, great UI, but the content is not there on streaming. So my question, since you are humble and a visionary, why not spend the time really getting more streaming rights because if you asked, forgive me for being tough here, but if you ask 100 people, what would you prefer, Arrested Development -- some would people say, "I love Arrested Development," or more content, more streaming, the libraries could be more fleshed out? I would say people want more fleshed out libraries, more current libraries.

Reed Hastings

How many people would say Arrested Development, how many would say more old movies?

Unknown Analyst

How about movies that are unsold?

Reed Hastings

Okay. The key thing to answer your question on the Internet is you can -- we have Bollywood movies, you're probably not a Bollywood, we have Japanese anime, you're probably anime, it's okay. As long as what we do is read buy efficiently that is the cost per hour and the viewing on these titles, it helps everyone. So the fundamental problem we have is a brand perception around content because consumers want the full picture and when they go to a music service, iTunes or Pandora, they get all the music. When they go to a book service like Amazon, they get all the books. When they go to a travel site like Expedia, they get all the flights. So most consumers, reasonably, on the Internet means you get to choose amongst everything, okay? That's a basic presumption and that's true for us in Canada as it is in the U.S., so it's not because of our DVD heritage. The problem is in streaming, we're a cable network, okay, from a rights standpoint and we compete with many other cable networks and there's whole bunch of exclusives in that space. So it's not a matter of time to get the deals because HBO is a bunch of content exclusive, the Warner Bros. movies exclusive against us, and so we can't get it at this point, okay, and the content on video, well, at least for the next or 10 or 20 years be carved up in several different networks, some for sports, some for other movies, some for TV shows, some for balance. Now there will be meta search engines. So if you look at the Samsung TVs, Smart TVs has done a nice job on meta search so then you search across the range of services that are on there just like every website has a unique paradigm, a unique value add, and then there's Google to get you to that website, that index is the whole thing. So that's what you'll see. You'll see meta search within these Smart TV context or on the web, if you're on the web and then you'll see that you'll get index then you'll see your options, either on Netflix, iTunes, all of these different -- so unfortunately no one service can be the complete video solution and it really comes out of the cable network evolution where things always exclusive against each other as opposed radio stations, which were never exclusive against each other or book retailers which were never exclusive against each other. So we're dealing with a completely different paradigm. Now I can tell you that, but most consumers don't want to listen they just want what the Internet it is, it's everything. So that's going to be a long term issue for us, which is the consumer wants everything we've got by far the best selection on the Internet or off much more content than HBO GO, okay, and if HBO GO were part of Netflix, it would probably only be like 1/4 of viewing. And so you can think of it as we're at least 3x more content on a viewing-weighted basis, so -- and we've got this great paradigm, but it's different and on DVD, we have everything. So now online, we're a network and the more people consumers come to view us says, "We like HBO, but we're on demand and we're really inexpensive," and it's Netflix and HBO competing, the more they'll judge us by that standard, but it's going to take 5 or 10 years.

Unknown Analyst

Good answer. Over here

Barry Stewart

Barry Stewart with Omega Advisors. Earlier, you said you had a pretty good feel for what your content cost would be looking forward. For next year, or I guess even for run rate, what are you spending? I know amortization and cash cost can be different, but what's the cash cost your content on a run rate and how does that change in 2012?

Reed Hastings

Cash in P&L follow -- and P&L expense follow each other quite well, it's not a perfect 1:1 match, but it's pretty close to that.

Barry Stewart

And how much dollars?

Reed Hastings

We haven't given any guidance on that. What we said is that our operating -- our contribution margin in the domestic market, we want to improve steadily quarter-by-quarter, which means more subscriber growth than content growth.

Barry Stewart

So you're saying, you won’t tell me what the content cost is but you figured that your EBITDA or EBIT margin after amortizing that content will go up in the U.S. as subscribers grow?

Reed Hastings

I think correct. The contribution margin, which also takes out marketing. So no, it's marketing takes out R&D. So it's not quite EBIT, it's all the variable costs.

Unknown Analyst

Okay. We'll go to the next question now?

Unknown Analyst

Just a quick question on the pricing stuff. So I understand you've always tried to have a very clean pricing structure, $8 a month clear in the consumer's mind, given that challenges that you went through summer, I'm surprised that you still don't do anything with the pre-pay annual 5% percent off, something slightly like that, just anything that turn over time. I mean cable companies serious like put on a clinic of how to raise pricing very slowly over time without consumers feeling like they're getting the tough end of things, so I'm just curious, what do you think now, going forward, you can do?

Reed Hastings

I don't think it's different, it's a belief that you can succeed both ways, Wal-Mart has everyday low prices, not a lot of sales, not a lot of special discounts. Other successful retailers have discount of the week and they play the merchandising game of getting you in and getting you another things and you can go by both philosophies. By orientation, our focus is very simple clean. That's what we think works best. That's a reflection of how we built the great brand strength that we had until recently is by not doing a lot of extra little do-dad discount 5%, this kind of thing. So I don't see that doing that. I see us continuing the same things that got us to our great brand strength, and it's unfortunate that we did this to the DVD subscribers, both increased their price to $8 per DVD, the Qwikster had fake, but fundamentally we're focused on this $8 streaming plan and that plan, which we've had for over a year, 1.5 years has just continued to rocket, I mean total streaming will be well over $1 million hours this quarter, it's just continuing to grow and grow and grow.

Unknown Analyst

Okay, and just over here? And we'll then take the last question from Brian.

Rich Tullo - Albert Fried and Company

Time Warner's yield to free cash flow somewhere in the low teens, AMC somewhere around 8%, 9%, what you're telling us that you may be spending $1 billion on content competing against these guys that are cash flow positive, you just came to market for debt. Where does total subscribers or revenue per subscriber ARPU need to be in order to avoid coming to market again, because it just feels like based on what you're saying that sometime in the middle of next year, you need to come to market again for more capital.

Reed Hastings

We recently don't expect that. We expect we substantial a subscriber growth if you look next year if you look at the Internet the kind of secular rates of growth, what you think YouTube viewing is growing out, what you think Hulu viewing is growing at, people are in love with broadband and click-and-watch and there's no effective competitor for Netflix in terms of exactly what we do, and so we're very optimistic that we can put out substantial growth next year. In the first half of this year before the pricing changed on DVD, we grew over $5 million net adds in the 6 months. So I don't think it'll be that big in the first 6 months, we're not going to comp the year ago, but there's no reason it shouldn't be in that kind of aggressive growth, ballpark, over time as the brand loon from the pricing aspect keels. So our view is that we'll have substantial growth next year and we're definitely focused on making that happen.

Unknown Analyst

Last question from Brian

Unknown Analyst

I'm a little surprised that your biggest competitor is HBO only it seems like well, if you look at Xbox right, there's 55 million Xbox within in the channel, 35 million of which are online enabled and a large percent of those which are being paid for. If Xbox is one of your biggest channels for distribution of streaming video, that should be correct based upon the data that we have, why as they ramp up their platform with substantial quantities of content, are they not the biggest challenger to you. I agree with you in terms of Amazon if would take on a bit longer because their mobile devices, but for the big screen, sit-back-in-your-chair experience, Microsoft is the guy and we're trying to be the set-top box player in the living room right now.

Reed Hastings

Yes, well, as you know, I'm on the Microsoft board, so I should be very careful how I answer that, let's say they haven't kicked me off the board and that kind of issue hasn't come up and we're very careful to avoid concentration risks, we're huge on the PS3, we're huge on the Wii, we're huge on Blu-ray players, our Smart TVs are growing rapidly. Once you've got a Smart TV for viewing Netflix and you got a red Netflix button on the remote and it's just one click away, that's a pretty compelling experience. So I don't feel too exposed around any one supplier vertically integrating in that aspect anyone CE company.

Unknown Analyst

So, Reed, I know that you don't do conferences, so we appreciate you being here and obviously you're coming out hopefully from a turbulent period. Any closing messages that you want to focus on as I leave here since you don't plan to do this very often?

Reed Hastings

Streaming is the future. We're focused on it. DVD will do whatever it's going to do. We're not -- we're going to try to not hurt it, but we're not putting a lot of time and energy into doing anything particular around it and then we're focused on, how do we take advantage of this incredible global streaming opportunity? So thank you, everyone.

Unknown Analyst

Reed, thank you for being here.

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