Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Netflix, Inc. (NASDAQ:NFLX)

Q2 2008 Earnings Call

July 25, 2008 8:30 am ET

Executives

Deborah Crawford - Vice President, Investor Relations

Reed Hastings - Chairman of the Board, President, Chief Executive Officer

Barry McCarthy - Chief Financial Officer

Operator

Good day, everyone and welcome to the Netflix second quarter earnings release conference. 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 morning. Welcome to Netflix's second quarter 2008 earnings call. Before turning the call over to Reed Hastings, the company’s co-founder and CEO, I’ll dispense with the customary cautionary language and comment about the webcast for this earnings call.

We will 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 28, 2008.

We released earnings for the second quarter at approximately 4:00 a.m. Pacific Time. The earnings release, which includes a reconciliation of all non-GAAP financial measures to GAAP, and this conference call are available at the company’s investor relations website at www.netflix.com.

A rebroadcast of this call will be available at the Netflix website after 8:30 a.m. Pacific Time today.

Finally, as we noted in the press release we issued earlier this morning, we are going to conduct the question portion of the Q&A via e-mail. Please e-mail your questions to me at dcrawford@netflix.com. If you’ll recall, last quarter technical difficulties forced us to take questions via e-mail and Reed and Barry responded to them on the call. As it happens, we received a lot of positive feedback last quarter so we are going to try it again this quarter. Please let us know what you think.

And now I would like to turn the call over to Reed.

Reed Hastings

Thanks, Deborah, and welcome everyone. Our goal at Netflix is very simple -- to materially growth subscribers and EPS every year while expanding the unlimited enjoyment we offer with DVD by mail to also include unlimited Internet streaming. Once again, our quarterly results reflect strong progress towards this goal. We delivered our lowest ever SAC as a public company, profits at the top end of our guidance, and ending subscribers above the midpoint of our guidance.

In addition, we made significant progress on our expansion into streaming with the launch of the Netflix play by Roku, the announcement of our Xbox partnership last week, and our continued growth in the number of movies and TV episodes available to our subscribers for unlimited streaming.

We discussed at length our views on the market and how we are approaching it at our investor day about eight weeks ago. In summary, we think that DVD by mail will continue to grow for five to 10 years, despite overall DVD rental flatness, as e-commerce continues to grow generally and as video store economics force more store closures. As we expand more into streaming, we are improving our core consumer proposition of unlimited enjoyment for a low monthly fee by combining unlimited DVDs by mail with unlimited streaming.

We don’t plan to enter the pay-per-view segment where Apple, Amazon, Sony, and others focus, or the ad-support segment, where Hulu, YouTube, and others compete. Both of those segments will likely be substantial but our subscription segment will also be large and will provide Netflix plenty of room for growth over the coming year.

In order to succeed broadly with streaming, we need it to be easy and inexpensive for consumers to watch Internet video on their television screens. Specifically, our goal is to have our streaming software integrated into Blu-Ray players, game consoles, connected DVDs, and standalone Internet devices. Our substantial streaming content, available to consumers on an unlimited viewing basis makes it attractive for consumer electronics companies to integrate our streaming software, because it increases the attractiveness of their devices and we promote their devices to our large subscriber base.

Our results to date with this approach have been excellent, starting with the launch of the Roku box in May. This $99 box allows Netflix subscribers to instantly stream movies and TV episodes to their TV. It’s been a huge hit with strong reviews, strong sales, and great subscriber satisfaction. Roku purchasers are streaming video to their TVs and getting great value for the unlimited streaming portion of their Netflix membership.

In the future, Roku boxes will support other Internet video content and migrate from being a Netflix only player to a general Internet video play, which will increase Roku’s sales and therefore the number of TVs we can stream to.

We also have a technology partnership with LG Electronics, which we’ll be discussing more in more detail soon, one other similar partner not yet announced, and the Xbox partnership, which we announced last week.

The Xbox partnership means that with Microsoft’s late fall software update to over 10 million domestic Xbox 360s, Netflix members can stream movies and TV episodes to their TVs as long as they are also Xbox Live Gold members. As with our streaming to the Roku box and to the PC, there is no extra Netflix charge for the unlimited streaming.

While our strategy is to achieve ubiquity, we were willing to do an inclusive partnership in the game console segment because of the very large installed base of 10 million households that Xbox has developed. We believe this will be our only exclusive deal in any segment.

Since the Xbox software update is schedule for late fall, its impact during this calendar year is unclear. While this functionality will certainly increase streaming amongst our current subscribers, we and Microsoft have yet to really understand how much it will drive additional Live gold subscriptions, new console sales, and how much it will drive additional Netflix subscription. As we both learn more about the attractiveness of this joint functionality with consumers, we will use that information to determine the extent of our promotional activities over the next year.

In the best case, substantial cross promotion in 2009 will make economic sense for both parties in terms of increased efficient growth.

Between the large and growing Xbox installed base, the strong sales of Roku boxes, and the anticipated sales of the Netflix ready LG device, we are off to a very solid start. As I mentioned earlier, as we increase the number of connected TVs, we are also increasing the content we are making available. In fact, over the last 18 months, we’ve grown our number of choices from 2,000 to over 12,000 and we plan to continue to increase the amount of content available. This planned investment is already factored into our earnings guidance.

Shifting to the competitive climate, Blockbuster remained active in DVD by mail over the quarter. Our guidance for the year assumes that they continue to stay active at similar levels for the rest of the year. The rise of DVD rental kiosks in supermarkets, while new competition for us in the short-term, is a bigger competitor for new release focused video stores and should accelerate store closures over the coming years.

In addition, the rise of DVD rental kiosks shows that the DVD franchise is still very strong with mainstream consumers. In the long-term, we think it is likely that DVD by mail and DVD rental kiosks will continue to increase their share of the DVD rental market at the expense of stores.

To close, our goal is to materially increase subscribers and EPS every year as we expand into streaming, and this quarter we continued to make excellent progress towards that goal.

Thank you and now I would like to turn the call over to Barry for a more detailed discussion of our Q2 results.

Barry McCarthy

Thank you, Reed and good morning, everyone. My remarks will cover three areas -- our Q2 performance, our guidance for the remainder of the year, and an update on the share repurchase program we announced in March.

Like last quarter, our Q2 financial performance was strong, with revenue above the midpoint of guidance in net income and EPS at the high-end of the range of our guidance. This year’s second quarter followed a well-established seasonal pattern of slower subscriber growth and increased profitability, which we spoke about on last quarter’s earnings call. Seasonally slower subscriber growth was accompanied by record high operating profit of $33.5 million, when you exclude one-time items from prior year comparisons, and strong free cash flow of $12.5 million. Free cash flow nearly tripled sequentially, and I’ll say more about that in a moment, in spite of our growing investment in content rights to distribute Internet delivered movies and TV content.

Gross margin was 10 basis points higher than it was in Q1, as expected. Looking at the components of cost as a percent of revenue, we see a small increase in content spending was offset by an equally small decline in both fulfillment and shipping and packaging expense, despite the postal rate increase in May. We expect gross margin to be up slightly in Q3 and Q3, despite our ongoing investments in Internet delivered movies and TV content.

With the seasonal decline in subscriber acquisition in Q2, our marketing expense declined by $15 million, or 27% sequentially to just under 10% of revenue. As a percent of revenue, this represents the lowest quarterly marketing spend in our history as a public company. In Q2, we expensed $40.1 million on marketing. That’s $5.2 million less than we expensed in Q2 of last year or about an 11% decrease in marketing expense. What’s remarkable about the lower spending is that gross subscriber additions continued to grow anyway on a year-over-year basis.

SAC declined again this quarter to just under $29, the lowest SAC has ever been since taking the company public in 2002. This seasonal decline in marketing spending was the primary contributor to the increase in operating income in the quarter.

A second large contributor to the increased profitability in Q2 was the expected decline in our effective tax rate from 41% to 26% in Q2. This was something we discussed with you on last quarter’s earnings call. The tax rate decline relates to a one-time R&D tax credit and we expect a return to 41% in Q3 and Q4.

Free cash flow of $12.5 million in Q2 nearly doubles from a nearly ago and nearly tripled sequentially. Higher net income was the primary contributor to the sequential growth in free cash flow, coupled with a $10 million sequential decline in content spending.

The sources of cash were offset by a decline in AP and accrued expenses of $11 million. On a year-over-year basis, there were three primary contributors to the growth in free cash flow. First, the increase in depreciation on PP&E and the amortization of content; second, the growth in AP plus accrued expenses net of excess tax benefits on stock comp; and lastly, the growth in long-term income taxes payable related to the R&D tax credit.

Although this is the second consecutive quarter of exceptionally strong free cash flow growth, I don’t expect these hyper growth rates of 100%-plus to continue through Q3 and Q4. When the dust settles and we look back on the year’s result, year-over-year growth in free cash flow for the full year of 35% to 45% seems possible.

Today’s earnings release includes subscriber revenue net income and the EPS guidance for the third and fourth quarters. Today we reaffirmed our year-end subscriber and net income guidance, tightened our full-year revenue guidance, and raised our guidance for EPS, reflecting our expectations for a lower weighted average share count by year-end.

It’s worth mentioning that we expect year-over-year revenue growth to accelerate in Q3 and again in Q4, as the effects of last year’s Q3 price decrease slip away for comparison purposes. And by the way, we saw year-over-year revenue growth begin to accelerate this past quarter from 7% in Q1 to 11% in Q2, the first acceleration in the last seven quarters.

With regard to our share count, I’d like to talk briefly about the status of our share repurchase program. In March, we announced an additional share repurchase program of $150 million. All $150 million is currently available to buy back shares. No shares were repurchased last quarter because we closed the trading window pending the Microsoft announcement on July 14th. If the trading program had been open during the quarter, we would have been buyers of Netflix stock at these prices.

That concludes my prepared remarks. Now it’s time to answer your questions and as Deborah mentioned at the beginning of our call, we’d like you to e-mail your questions to dcrawford@netflix.com, as we did last quarter. Deborah will read the questions out loud and Reed and I will do our best to answer them. As Deborah mentioned, we received lots of positive feedback on this approach last quarter and we are able to answer more questions from more investors than we typically get to, so we thought we would try this format again.

Deborah, over to you for the first question.

Question-and-Answer Session

Deborah Crawford

The first question is from Barton Crockett at J.P. Morgan; first question, what drove down SAC? Lower pricing of media, i.e. lower Yahoo! CPMs or was advertising simply more effective? Could that be a function of better word of mouth, impact of service trends, or greater consumer interest, perhaps due to higher gas prices?

Reed Hastings

I don’t think it’s the outside advertising climate, which hasn’t shifted materially for us. It’s mostly that we are spending less marketing as a percentage of revenue, so we are trying to push the market less hard than we have in the past. Second, better competitive climate than last year, and then third we made a big investment with lower prices last year. Last Q3 we lowered our prices and you can think of lower prices as a marketing investment, although it’s not reflected in SAC. So those three factors have helped us to achieve this very efficient sub-$30 SAC.

Deborah Crawford

Also, talk about the expected subscriber and economic impact of the Xbox deal. Is there one other major announcement still to come with another partner this year?

Reed Hastings

Barton, my guess is that question you had sent in just before I read the script, because I think I’ve covered that, that this year, hard to tell because it’s a late fall update. Next year we’re optimistic that the cross promotions will be economically efficient for both parties.

Deborah Crawford

Shutting down red envelope -- talk about why.

Reed Hastings

On red envelope, we did some experiments, tried to figure out an economic model that was scaleable and sensible. Unable to do that. We decided to close it down and all the closure costs are baked into our current guidance.

Deborah Crawford

Are DVD usage trends being impacted by gas prices or the economy?

Reed Hastings

We don’t comment on usage.

Deborah Crawford

The next set of questions is from Doug Anmuth at Lehman Brothers -- with SAC at its lowest ever for Netflix as a public company, why not push the marketing a little further for more subs ahead of the back half?

Reed Hastings

Well, that’s an interesting question. It’s something we debate, which is the balance, really, of earnings versus growth and certainly there are good arguments that we could have taken, generated less earnings and pushed more into growth. But at the end of the day, we think it’s better to stick to our earnings targets, despite these great opportunities. And it does give us substantial room for growth, so I don’t feel like we’re making bad choices. But it is a very attractive opportunity when SAC is as low as it is.

Deborah Crawford

Is it becoming more competitive to partner with CE manufacturers now that Amazon has turned to streaming, i.e., and signed a deal with Sony and possibly others?

Reed Hastings

Amazon’s pay-per-view streams is very nicely implemented and I think what we are going to see is them also emerging to various devices. But again, that’s really the pay-per-view new release focused content. And in many ways, you need that, you need our subscription service and you need ad-supported content from say Hulu and NBC.com and ABC.com and others to really form a total Internet video solution on these devices.

So I don’t think it’s competing against each other. We’re not trying to block them. I don’t know of them trying to block us. These are really different segments -- the ad support, the pay-per-view segment, and the subscription segment.

Deborah Crawford

Finally, can you provide more color on digital usage? What percentage of subscriber base are streams? Are digital users churning less and using fewer discs? What percentage of total usage is digital?

Reed Hastings

You know, like eight weeks ago, we haven’t given any color on the specific trends around watching. It’s just too early to tell and we don’t have a control group that doesn’t get instant watching. So there’s really no easy way for us to say anything conclusively. We’re very encouraged by the usage. People are watching, are instant-watching in significant and growing numbers and that’s very exciting. But at this point, we don’t have any specific numbers to provide.

Deborah Crawford

From Tony Wible of Citigroup -- can you speak to if you have seen higher DVD consumption trends in your core DVD subscriber base over the past quarter versus last year to adjust for seasonality?

Reed Hastings

Tony, thanks for the question. Again, we’re not commenting on usage specifically.

Deborah Crawford

This is from Michael Olson at Piper Jaffray -- anymore details you can provide on potential pricing changes for Blu-Ray or watch instantly? Is there a threshold of Blu-Ray or watch instantly subscribers that you are looking to reach before raising prices, or what is the trigger for those potential changes?

Reed Hastings

We’ll be commencing the testing of Blu-Ray price increases very shortly, depending on the test results of those, then we’ll move forward with implementing.

Deborah Crawford

Next question, also from Michael Olson -- what should we expect for gross margin going forward? Is there any potential to get back to the 33% to 34% of ’07, or should we expect it to be kept at 32% in the near-term? What is keeping the ceiling on gross margins?

Barry McCarthy

As I said in my remarks, we expect gross margin will increase next quarter, which is a change from our expectations in Q1. And I expect it to be up in Q4 as compared with the current quarter, although not quite as strong as it was in Q3.

As relates to the question around how high can gross margin go, let me answer it this way; if gross margin rose to 35% or 36%, it would not necessarily mean that the business is more profitable. But there is a relationship that we’ve continued to explore during our history as a public company between a customer SAT and gross margin, and in some respects they are inversely related. And since customer SAT drives, at least indirectly, SAC, and retention, which drives lifetime value, sometimes the business is more profitable with lower SAC, higher retention, lower churn, higher lifetime value, and a lower gross margin. And we learned that experience when we launched hubs, and we are exploring those inter-relationships again with the launch of the Watch Now service. So it remains to be seen what will happen with gross margins over time.

So at least through year-end, we expect some improvement. What the implications are for ’09 and ’010 depends on the inter-relationship between lifetime value, SAC, and gross margin as we expand the number of titles available for Internet downloading and as the number of devices available for people to view that content on their TV sets increases.

Deborah Crawford

The next question is from Lloyd Walmsley at Thomas Weisel Partners -- as new subscribers come in, do you have any intelligence on where they are coming from? Do you think a weak economy may be driving subscribers off pay TV to Netflix? Do new subscribers tend to use the service more and are your most profitable subscribers those who use the service very little, leaving the service as they cut costs?

Reed Hastings

Lloyd, that’s ultimately related to the depressing economic picture that we face, which attempting to put a lot of -- to read the tea leaves about how it’s affecting Netflix, but we’re not really able to tell is that why we’re growing so strongly or would we have been growing even more strongly if the economy had been strong?

In terms of where subs are coming from, no real changes. New subscribers do use more than older subscribers but that’s been true for 10 years for us, so no material change there.

Overall, the wonderful thing about the Netflix business is we appear to be substantially unaffected by this significant economic negative climate, so we’re very happy about that.

Deborah Crawford

Second question -- what percentage of the subscriber base is using Blu-Ray?

Reed Hastings

Blu-Ray usage has continued to be very low, low-single-digits. It’s something that has promise over the next couple of years, particularly through this Christmas season and beyond, if player prices fall significantly. This will be the first Christmas coming up where there’s dedicated players that are at more aggressive prices.

Deborah Crawford

Two questions from Jim Friedland at Cowen & Company -- as digital demand ramps, what will the impact be on your infrastructure needs? How should we think about CapEx growth over the next couple of years?

Reed Hastings

In terms of CapEx for digital delivery, very little impact. Most of that delivery infrastructure is through third-party CDMs, so no particular connection there.

Deborah Crawford

Second question -- how long does the exclusivity on the Xbox deal last?

Reed Hastings

We haven’t commented on the particulars of the duration.

Deborah Crawford

Another question from Michael Olson at Piper -- why was other income so low in this quarter and what should we expect it to be the rest of this year?

Barry McCarthy

Michael, send a follow-up if I don’t address your question specifically. It was a combination of other interest but it was mostly interest rates are down, long story short.

Deborah Crawford

Questions from Andy Hargreaves at Pacific Crest Securities -- why was the content library on the balance sheet down so much Q over Q? Sorry, why was the content library on the balance sheet down so much Q over Q?

Barry McCarthy

Well, we spent less on new content and it was a relatively weak new release box office. And two -- there are two components that, two content acquisitions. We buy some content outright that affects CapEx. We also rev-share content with the studios, so sometimes there’s switching of -- from the CapEx versus the P&L perspective, depending on which particular studio is in rev-share and which is not, and which particular studio is hot from a new box office perspective and who’s not.

So to be explicit, if a particular studio has a rev-share gain with Netflix and that studio has a number of new release titles which are hot, and that new content is being acquired in the form of rev-share and those expenses will show up in the P&L, in the cost of revenues, and conversely, if there are a number of new titles from a studio which are popular and we’re buying them outright, then that will show up in the cash flows, in the content acquisition.

Deborah Crawford

Next question, direction of disc usage.

Reed Hastings

Probably all these questions piled up, so [it’s basically the same] perspective of us not commenting specifically on usage.

Deborah Crawford

Will there be meaningful cost savings from the end of Red Envelope?

Reed Hastings

No.

Deborah Crawford

Next question is from Derek Brown at Cantor -- a recent article indicated the number of Roku units falls at about 100,000. Can you confirm that figure or say whether it’s close? Can you provide any type of color on the behavior changes, i.e. more digital, less DVD, or Roku owning subscribers?

Reed Hastings

No, we’re not giving any comment on the number of Rokus sold. What was the second part of the question, Deborah?

It’s something we’re starting to look at but we have to be careful about over-reading it because the first people to buy Roku boxes, of course, are not typical people, so they are not necessarily representative of what we are going to see as that market expands. So while we’re looking at it, we don’t think it’s particularly significant.

Deborah Crawford

Okay, the next question is from Brian Fitzgerald of Banc of America Securities -- with the previous announcements of the streaming service, Roku, and LG, the service is naturally governed as there is a delay as this hardware gets deployed. With the Xbox you will be lighting up 12 million Xbox Live subscriptions potentially at once. We have seen you doing polls gauging the acceptance traction on the Xbox. Can you give us a sense for the traction or speed of adoption you expect on the Xbox and any potential expenses around a big inflection in usage?

Reed Hastings

Yes, you’re right that there’s a real step function there as Microsoft releases their update to the Xbox in the late fall. We think we are well-prepared for that, both in terms of the loads on our various servers and in terms of our financials, and that’s all built into our guidance.

Deborah Crawford

You used to provide us with the number of streams to date and we were hoping you could give us some kind of update on this.

Reed Hastings

Very early on we were disclosing number of streams, but we haven’t -- what we’ve tried to give investors some awareness of is that the content investment is really to drive the number of partnerships and the number of seats of Internet connected TVs and that’s really the point of this aggressive early investment in content. So that’s why we are talking about the various deals that are signed and in process, and that’s really the payback on this big content investment.

Deborah Crawford

Last question from B-of-A -- Amazon streaming VOD has a library of 40,000 versus Netflix 12,000 in the Watch Now library. Can you explain to us what the major difference is between online pay-per-use 40,000 versus an online subscription model, 10,000, that would allow for one library to be so large relative to the other?

Reed Hastings

I don’t have a good answer for you on that yet. It’s something we’ll look at as we get to [use the Amazon], 40,000 more. Obviously YouTube has 400 million titles but you have to think about the weight of the titles in some context. So a straight title count isn’t probably a very interesting way to look at these things.

The way we look at it for the Netflix service is providing enough content that subscribers are very excited about staying as a Netflix subscriber, so that’s the basic subscription calculus.

Again, we see the Amazon, Apple pay-per-view model, the Hulu ABC advertising supported model, and the Netflix subscription model as three different segments of the overall Internet video market.

Having said that, I think the 40,000 for Amazon is an aspirational number that’s been understood to be the current title count. I think actually the current title count is in the 5,000 range.

Deborah Crawford

From Michael Olson at Piper, is there any share repurchase factored into the guidance for the second half of ’08 EPS?

Barry McCarthy

Yes, I mentioned -- probably Michael sent that in before my comments but we expect the weighted average share count to decline through the end of the year, related to share repurchase.

Deborah Crawford

From Larry Wood at Morningstar -- with Blockbuster on the sidelines for now, why not hold down the accelerator on marketing to gain more share?

Reed Hastings

I think I covered that just a moment ago, which is it’s tempting but instead of doing that, we are preserving our earnings guidance and it’s one of those many balances of earnings and growth.

Barry McCarthy

The second point Reed previously made was that there are two ways to invest in growth -- one is direct marketing spending, the other is the subsidy of lower prices, and so in the third quarter last year, we made a significant investment in incremental growth by lowering the pricing and only partially paying for it with reductions in marketing spending. So while we are all very enthusiastic about the reductions in marketing spending, we continue to cross subsidize in business, if you will, with the price reductions from a year ago.

Deborah Crawford

From Ken Smith at [Mundar] -- what was the Bay area household penetration and rest of country penetration?

Barry McCarthy

The Bay area penetration was up 20 basis points to 18.8% from 18.6, and rest of country was up 20 basis points from 7% to 7.2% at the end of Q2.

Deborah Crawford

From Michael Pachter at Wedbush -- Microsoft told us that in surveying its Xbox Live membership, it felt that just under 1 million of its customers were Netflix customers. Have you conducted a similar survey?

Reed Hastings

No, we don’t have access to the Microsoft user base, so we’re unable to do that survey, Michael. And whatever the current numbers are, it’s more interesting thinking about the potential, both as Microsoft markets Netflix service to get Live gold upgrades, and also to sell consoles against their competitors, and as we advertise the Xbox console as a way to get instant streaming.

So we’re mostly excited not about the current install base but about the future overlap that we can both generate.

Deborah Crawford

From Larry Witt at Morningstar -- what are your expectations for future capital expenditures on technology regarding the Watch Now service? And do you plan on providing better quality streaming in the future? And what are the implications of additional spending on this?

Reed Hastings

Yes, we are continuing to improve the quality of the streaming, but not using our own capital. Mostly that’s through better use of the CDM market, better integration with the CDMs, better monitoring. So that’s how we are achieving that, so it’s a straight P&L model as opposed to anything capitalized or on the balance sheet.

Deborah Crawford

From Derek Brown at Cantor Fitzgerald -- can you help us understand the framework of the digital content deals you were striking? Are they pure revenue share? Are there substantial up-front costs you are incurring for first-time access to the content?

Barry McCarthy

We are trying to be purposefully vague in responding to that question, which I know continues to be frustrating for you. The content deals in some respect at a high level are similar to DVD, meaning there’s some revenue sharing and there’s some fixed fee payment.

Now, if you -- so let’s say from a P&L perspective, if the service were to grow at say twice the rate of adoption that we are projecting, the obvious concern on the part of investors and the management team would be that P&L expenses would run away from us and we would badly miss our guidance. And we’ve been mindful of that in our negotiations of [those two areas] for content deals, and I don’t anticipate that happening.

Deborah Crawford

From Lloyd Walmsley at Thomas Weisel Partners -- your competitors have been paying about 50% rev share splits in physical rentals. Are you seeing -- what are you seeing from studios in terms of increasing splits in rev share? How often are rev share terms negotiated with studios? If you have been seeing increasing rev share costs, how has this impacted gross margin? If not, how might this going forward if pricing were to increase for you in rev share?

Reed Hastings

We haven’t seen any material change in the rev share climate for our purchasing, so we’re continuing to build our DVD library and our relationships with studios, so no material change there.

Barry McCarthy

And as compared with the bricks-and-mortar world, we have a much higher percentage of content that’s purchased outright than rev share because we have the luxury from a free cash flow perspective of being able to acquire the content outright, so we’re -- if that phenomena were to emerge in our world, then probably it would have less of an impact on the P&L than it would be if we had a very high percentage of content acquired on rev share.

Deborah Crawford

I believe this is our final question. If anybody has additional questions, please e-mail them to dcrawford@netflix.com. The question I have is from Daniel Leonard -- can you speak further on share buy-back program and when you can initiate purchases again?

Barry McCarthy

Well, we can initiate purchases when the window opens. The window will open on Monday, absent a particular transaction that would require the company for legal reasons to, because it possesses material non-public information, to not participate in the market. If we were to possess that information, of course, I wouldn’t comment on it, but I expect the window will open Monday.

Deborah Crawford

Another question from Barton Crockett at J.P. Morgan - Blockbuster is showing a beta version of new download service, Movielink. Can you talk about how that compares to your service?

Reed Hastings

Barton, I haven’t used the new Blockbuster service, so I’m just going by the press reports and from being a customer of Movielink, and Movielink is a pay-per-view model, so it competes with Amazon or Apple in that segment. So I imagine they’ve done a good job. Movielink has been well implemented before, so we look at it and we say it’s another pay-per-view service and that’s fine. It’s just not in our segment.

Deborah Crawford

A final question from Ryan Hunter -- you mentioned DVD kiosks having a competitive impact on DVD stores. How do you see this model impacting Netflix?

Reed Hastings

Ryan, it’s something that we’ve looked at extensively using the areas of the country that have high kiosk penetration to see where and how it affects Netflix and we haven’t yet been able to detect any change in those areas. So we are relatively comfortable that as kiosks grow, it doesn’t present a direct threat to our business. We’ll continue to watch that. It’s still early in the DVD rental kiosk market but obviously the secondary benefit will come later, which is with accelerated store closures, which will help us.

Deborah Crawford

I believe that’s the last question. Thank you, everybody.

Reed Hastings

With that, let me thank everyone for joining us for this early morning call and we look forward to talking to you all next quarter.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Netflix Q2 2008 Earnings Call Transcript
This Transcript
All Transcripts