Netflix Pacific Growth Equities Presentation

Netflix CFO Barry McCarthy rushed through a presentation yesterday at the Pacific Growth Equities Top Pick in Tech Conference due to time constraints (you can listen in at: ir.netflix.com). My notes from the call below:

Netflix has been growing at a compound annual rate of 127%

Q4 ending subscribers over 4M, 5.65M subscribers in 2006.

Netflix says video stores are in the business of fulfilling demand created by studios, and Netflix is in the business of creating demand for movies.

The Netflix customer base has changed from mostly male to 54% female, and 40% did not go to college.

96% of the Netflix inventory was rented last quarter.

Expect more advertising like the "Geisha" envelope ad.

90M cable/satellite subscribers, 42M monthly video store customers, and 30M HBO subscribers. A lot of potential for Netflix.

Netflix will offer both Hi-Def DVD formats, but adoption will be gradual.

Netflix is licensing titles TODAY for future ED transactions.

Doesn't belive that movie piracy will be as rampant as music downloading -- different audience and product.

Confirmed forecast of 20 million subs and 50% year-over-year earnings growth.

From the Q&A session:

Netflix operations team has shipped 500 million DVDs since launch. New initiatives in automation will reduce direct labor to ship movies. Software needs to scale to keep up with growth. Operating costs falling about 12% with every doubling of the customer base.

Low-priced customers have similar cash flow profile as higher-priced plans.

Netflix would not respond to another price increase by Blockbuster.

Netflix is not considering other products such as books or games.

Netflix subscriber usage (averaged) is down.

Believes that $9.99 pricing is one of the most innovative things they've done.

Thinks that Blockbuster would need to write a big check to do a deal with Amazon. Doesn't think Blockbuster can do it, and many Amazon partners have found that relationship to "not be entirely what they hoped it would be."

Netflix will probably be profitable in 2006.

Selected slides from the presentation:

Comments

It's interesting to note that studios only make 14% of their revenue from theaters and 51% from home entertainment sales (DVDs and other media). Meanwhile, which do they spend the most marketing and hyping??? They waste time by not getting the DVDs out sooner. It would be ideal to sell DVDs as people leave the theater, when enthusiasm is highest. How many sales do they lose because people don't remember to buy a movie when it comes out on DVD? Or they change their mind and decide to not buy it at all? My guess is they'd make a lot more money if they sold DVDs inside the theaters for movies currently playing.

Another key slide is the rental mix, showing how Blockbuster (Online and stores) put more emphasis on new releases. They deveote more htan double the inventory that Netflix does to new releases (70% vs 30%). I can get new releases from BBO about twice as easily as I can from Netflix. I've never had Netflix get me a movie ON the day of its release, and I rarely get one the day AFTER its release.

It would probably be a good move for Netflix to cut their new release acquisitions more, to say 10% of inventory or even 0%. The new releases are a huge cash sink. After a few months, their usage drops to nil. Meanwhile, NFLX is stuck with thousands of used DVDs. Why not just FORGET ABOUT new releases. Get only titles that are at least 1-2 years old.

They throw a ridiculous amount of money away on New Releases. They should just leave them to video stores and Blockbuster. Perhaps get obscure new releases, but not the typical, mindless, big budget, mainstream, Hollywood new releases. Netflix can kill the sacred cash cow of the studios - new releases. But they don't have the guts to do it. I would applaud them if they took a stand and said, We're not gonna waste our money buying your disposable products.

Studios release crappy DVDs with almost no extras, like "Sin City", then turn around a few months later and sell the new, enhanced special edition version, "Sin City: Re-Cut and Extended", coming December 13th. I wish Netflix would use their clout to send these bastards a message. Enough double-dipping. Do it right the first time and stop jerking us around.

I knew they would double-dip on "Sin City." The original DVD had no commentary, no TV spots, no trailers, no director's cut. The suckers will buy it all over again, though. And so will Netflix, because the customers will demand it. But I'm sick of this happy horse crap. Netflix needs to boycott every new release from Hollywood.

[Rick H]

Don't have the time right now but will have a ton of fun later with the spin in this article

I'd love to see the adoring faces of the zombies as they listened to this tragic comedy.

Who out there is brainful enough to at least produce a starter set of holes in the presentation? Step back and do some serious tinking. Let go of the love for 10 minutes.

"...but will have a ton of fun later with the spin in this article..."

Just want to point out that it wasn't really an article. It was a presentation which, by it's nature, is going to be nothing but spin.

I am interested in theories both serious and half-baked that'll come from your challenge though.

[No New Releases]

If netflix stopped carrying New Releases, I'd drop them in a heart beat.

[RAYMOND KNIGHT]

They should have also presented in there presentation how much money they have saved through "smoothing". They could include a pie chart as well as some graphs.

[CashForFlow]

Very good job on getting the data posted so quickly.

[SykoBoy]

"Netflix customer base has changed from mostly male to 54% female, and 40% did not go to college."

40% did not go to college? To what societal bottom feeders is Netflix catering? Great... I'm envisioning welfare checks being squandered on the 8-out plan so that a crack momma and her seven ankle-biters can huddle in front of their 60-inch plasmas watching Chappelle seasons DVDs keeping an eye out on the repo-man who has come to repossess their TV since they've missed the past year in payments.

[Becky]

There is data which shows that a disproportionate number of poor families have large-screen TVs.

However, I prefer to look at it this way: 60% of Netflix subscribers went to college.

Good post, Mike! Thanks.

[Morgan]

Clearly, people who didn't go to college must be welfare mothers. It's the only possibility. There's no way these people might be making good money working a trade.

[PlungeBob]

"If netflix stopped carrying New Releases, I'd drop them in a heart beat"

I understand your feelings, but if one is being throttled, then
getting new releases from NetFlix is nigh unto impossible.

(at least not in until they are not "new" anymore ;0)

Seriously, I no longer even *try* to get new releases from NF.

[SykoBoy]

Morgan:
I wasn't generalizing oh sarastic one. I would just like to think that my fellow college educated renters exude intelligence and sophistication. Now, however, I am going to rightfully generalize. I'm going to assume that those Netflix renters who have college degrees would have a greater sense of responsibilty than those who do not. So I'll generalize that the majority of Shaniquas or Tammy Trailer Trashes are not going to carefully handle the DVD and store them in their sleeves when they're not in the DVD player. And now I know why discs that haven't been out for more than a month are completely scratched up.

"If netflix stopped carrying New Releases, I'd drop them in a heart beat."

Then you're probably NOT the type of person they want to have as a customer. They lose a huge amount of money providing you all your disposable new releases. Their main value to me is obscure / old movies that stores don't carry. If you want new release crap, get the Blockbuster Movie pass. Enjoy the rotting of your brain on mindless garbage like "Dodge Ball", "Stuck on You", "Starsky & Hutch", "Charlie's Angels: Full Throttle", etc.

In my opinion, 90% of new releases (or more) are not worth seeing. Netflix should wake up and realize New Releases are a loss leader. MOST people would be happy just getting the obscure/older movies from Netflix. Culture would improve if Netflix and other rental companies refused to carry these brain-dead new releases. Studios may start making some movies with LASTING VALUE, for a change.

I would not shed a tear if Netflix stopped carrying new releases. They're a racket for the studios to sucker people out of billions of dollars. People who "can't live without" new releases are truly sad, pathetic losers.

"Seriously, I no longer even *try* to get new releases from NF."

Same here. I just load up at Blockbuster for the few new releases I actually want to see. Had to get "Star Wars: Episode III", eventho the first 2 sucked. I Wasn't expecting much, but it turned out to be the best of the lame series. No Jar-Jar Binks and no Qui-Gon Jin. Sounds better already. BTW, who noticed that Liam just recycled Qui-Gon for Batman Begins?

"And now I know why discs that haven't been out for more than a month are completely scratched up."

Your theory is full of holes. I have plenty of college-educated friends who I would not loan a CD/DVD, because they return them with scratches, dings, and abrasions. The fact is most people are clumsy fools. I take care of my CDs/DVDs and they are in MINT condition. I always handle by center or edge. Most are not this careful. They hold DVDs by top and bottom, drop it in the player, cram it back in the case, etc. If everybody was careful, DVDs would last forever and look as good as new on the 1,000th rental. Only post office incompetence would result in broken/damaged discs. Sadly, the world is full of cretins. It has nothing to do with college education. There are lots of educated fools too.

I agree that one can get new releases from BB,
or at least I can.

I use a BB in-store pass (enjoying the rotting! ;0) but some
new releases are not carried there.

Example: Star Trek Enterprise Season four
I first put this on my NF queue, where it got a
"Long Wait" status. Then I removed it and added it to my
BB queue. The results is that they are already arriving.

YMMV!

[wheelie]

I was getting new releases from netflix on 3 out at a time on the exact day they came out. They were shipping them on a Monday before they were coming out. Now that I upped it to 5 out. I really screwed myself. Now I barely get movies, and new released are all now very long wait. Also I think going in and just giving 700 movies a rating hurt me. Even though it's only been two months subscription. I'm more into the new releases, and rock concerts. I may have to go back to blockbuster. This stinks I didn't know netflix doesn't care about new releases. I love their website though almost worth staying with them just for that. Their getting my movies very quickly their just takin their damn good time shipping the new ones out to me. On three out I want three a week that is all I ask for. If i up it to 5 I want 5 a week, and so on not 1 a week. I get less movies now than when I was giving them less money. Doesn't make much sense so I just switched back to 3 out. I will see if I get my new releases again.

[Rick H]

RICK H: HERE'S THE DEAL (FORGET ALL THE OTHER NOISE, THIS EXCERPT BELOW FROM MOTLEY FOOL SAYS IT SO WELL)

From Motley Fool

Vanishing Values
By Chuck Saletta
November 17, 2005

"...Unfortunately, at this point, the opportunity to profit from the market's discount on Netflix is long gone. Like so many values before it, that chance went to those who were prepared to make their move during a short window...
...Do you honestly believe that Netflix is more than a merely "OK" business? Go ahead and send me your criticisms. The fact is that Netflix, while a far more nimble company than its nemesis Blockbuster, faces pressure from all sides. On one hand, video-on-demand services allow cable operators like Time Warner (NYSE: TWX) and Comcast (Nasdaq: CMCSA) to give customers a way to rent what they want when they want, without waiting for a disc to arrive. And with discount retailers like Wal-Mart (NYSE: WMT) constantly driving down the price of purchasing new DVDs, the savings that come from renting are rapidly evaporating. Things are tough, and they only look to get tougher as competitors start to take advantage of their economies of scale..."

RICK H PREDICTION:
NFLX stock price within 6 months: $5. When the stock goes down the next time it will be fast and furious. The last move below $10 will look like a long, leisurely walk compared to the next time down. The institutional whores and the sell-sider whores will know the gig is up when it starts going down this next time and they will bail and move on to some other stock to play with.

"I may have to go back to blockbuster."

They are going down the crapper as others have reported. They now ship all of my movies out of order, like 13-21-29-24-27... Never send me my highest choice, even if it's available. I have never seen a "Long Wait" movie even after being with them almost a year with the same movies sitting at the top of my queue. If they don't get me those movies by the one year mark and start sending my DVDs in order, i'm gone.

[ToddTheFrog]

"They lose a huge amount of money providing you all your disposable new releases. Their main value to me is obscure / old movies that stores don't carry. If you want new release crap, get the Blockbuster Movie pass. Enjoy the rotting of your brain on mindless garbage like "Dodge Ball", "Stuck on You", "Starsky & Hutch", "Charlie's Angels: Full Throttle", etc."

You're an idiot. Every movie ever released was at some point a new release.

"Culture would improve if Netflix and other rental companies refused to carry these brain-dead new releases."

And who is going to separate the Dodge Balls from the Murder Balls? If you don't like certain movies, vote with your dollars but please please don't open your mouth anymore. I would rather conversate with a "truly sad, pathetic loser" than you bud.

Kthx

"Every movie ever released was at some point a new release."

So they can wait 1-2 years to buy copies of those new releases and you will have lots of great older movies to enjoy. Meanwhile, they will improve their bottom line. And you can just go down to Blockbuster or Hollywood for new releases.

"And who is going to separate the Dodge Balls from the Murder Balls?"

They should delay the purchase of all new releases, not just crappy ones. That way, there is no charge of discrimination, BUD. They just wait until demand calms down. It is silly to waste millions of dollars on getting a thousand copies of every brain dead new release. Go in Blockbuster if you want 100 copies of "Shrek 2", "Charlie and the Chocolate Factory", or "Star Wars III."

"If you don't like certain movies, vote with your dollars but please please don't open your mouth anymore."

FCUK YOU. DON'T TRY AND TELL ME WHAT TO DO. I'll say what I please. You don't even get what I'm saying, so you're a moron. PAL.

[wheelie]

Their all out to screw us one way or another out of our money. The above who responded if your thinking about ditching blockbuster. You might want to rethink it, because netflix is SUPER lame after two months. I can't imagine a year of it. I hope something else comes out. I may look into the dvd avenue. I like new releases I can watch reruns all day long on regular tv. If that's what I wanted. Of course it's cool to find that rare movie you loved as a child only to find out it totally sucks as an adult. Still cool though. :)

[Ghost Dog]

"They are going down the crapper as others have reported. They now ship all of my movies out of order, like 13-21-29-24-27..."

I haven't experienced this with Blockbuster. Sure, sometimes they ship #4, but that's OK.
I was tired of having "Jean de Florette" as Long Wait, so I check Netflix and they don't even stock this movie. Netflix is VERY lame after a couple months.

[Rick H]

I sent a re-do of the chart, 'Product Leadership Means Lower Churn' to the email address given for this site so maybe the owner will post it (I could not copy / paste it). I did the chart over quickly in Excel after noticing that the chart from Netflix was very creative in dramatizing / enhancing the slope of the drop in churning, at points where it is dropping. For example, the bar for Mar' 05 is 5.0% and the bar for Sep' 05 is 4.3%, yet the bar for March is 4.5 times the size of the bar for September. These guys are real low-lifes.

Even at 4% churn, if we can trust any of this company's numbers, that's a lot of burn each month, and a very big number on an annual basis. The presentation is meant to distract from that simple fact.

Often people come along who are amazingly convincing in the face of evidence that is persuasive going the other way (e.g. plenty of impending competition with more resourses, connections, and technical know-how). Reed Hastings sounds like a really great guy. But we have seen this time and again. He is a bit full of it. And is getting ever richer. Proceeds from stock sales for Hastings since June' 2004: $3,650,000 [not counting "Disposition (Non Open Market) at $0 per share" - I do not know what this may mean financially for Hastings]. When the stock is at 30, Hastings gets 300,000 from each of his sales of 10,000 shares. I'm sure he appreciates our business but more so a stock price that is at least triple where reality will eventually take it.

[Rick H]

Following are comments on the bulleted items from the call and from the Q&A session. I grouped all the comments into 3 categories and, as usual, I have nothing nice to say. And if Netflix doesn't get honest, it will get much worse.

Growth at Netflix

“Netflix says video stores are in the business of fulfilling demand created by studios, and Netflix is in the business of creating demand for movies.”
• Sounds noble. Unlike saying that rentals are ‘unlimited.’
• The other side of the truth:
o Too expensive to get and manage new releases,
o One less revenue source and attraction to subscribers,
o Do they state anywhere that they limit new releases or is that a bit too forthright?

“Netflix is not considering other products such as books or games.”
• No diversity in revenue stream, compounded by not going international,
• Doesn’t Wal-Mart sell old movies at low prices? This will expand if they start downloading films and burning copies. The majority of people will not be dying to do this for themselves

“Doesn't believe that movie piracy will be as rampant as music downloading -- different audience and product.”
• Some of their own customers are taking copies of movies (when the discs are not too damaged) that they like, meaning they are less likely to stay as customers,
• Made worse by the generous types handing out additional copies to friends.

“Thinks that Blockbuster would need to write a big check to do a deal with Amazon. Doesn't think Blockbuster can do it, and many Amazon partners have found that relationship to "not be entirely what they hoped it would be."”
• Sounds like Reid would reject a partnership with Amazon. Actually, he knows they are not looking at Netflix.
• Leaves Netflix kind of pinned down and all alone.

“Q4 ending subscribers over 4M, 5.65M subscribers in 2006.”
• Maybe, if they give away the product so that they can drive the stock price by touting the subscriber numbers.

“Confirmed forecast of 20 million subs and 50% year-over-year earnings growth.”
• Not going to happen - it’s a ridiculous statement meant for the zombies.
• Who makes projections like this? Google won’t say what they are doing next week. Some companies go private to not deal with this. Maybe Hastings sees a short life for Netflix and knows that he needs to squeeze the juice right now.

“Netflix will probably be profitable in 2006.”
• With all of the claims made above, it’s hard to believe this is not going to be one of the most important, profitable companies in America, starting in 2006.

Inventory at Netflix

“Netflix will offer both Hi-Def DVD formats, but adoption will be gradual.”
• Lot of expense on one hand,
• But people will be seeing Hi-Def elsewhere, including competitors of Netflix, so they have to do it, maybe faster than they would like?

“Netflix operations team has shipped 500 million DVDs since launch. New initiatives in automation will reduce direct labor to ship movies. Software needs to scale to keep up with growth. Operating costs falling about 12% with every doubling of the customer base.”
• The statistics at this point in the game may not have huge predictive value. Also, I suppose they mean 12% in relation to revenue.
• How many of the DVD’s are now in bad shape?
• How bad is the automation now?
• At most the customer base will double one time from here and that will be a miracle.

“96% of the Netflix inventory was rented last quarter.”
• So if they double the customer base, they need to double their DVD inventory. Plus replace damaged goods.

Miscellaneous at Netflix

“90M cable/satellite subscribers, 42M monthly video store customers, and 30M HBO subscribers. A lot of potential for Netflix.”
• A lot of heavy competition, with big money and tough, aggressive managements.

“Netflix subscriber usage (averaged) is down.”
• Is this a good thing?
• How far down is too far? If subscribers get to zero usage they will probably send zero money. That’s bad.

“The Netflix customer base has changed from mostly male to 54% female, and 40% did not go to college.”
• Males tried it first and got tired of it.
• Tendency for non-college subscribers to cancel more quickly, especially in an economic downturn. You know, when they are losing their credit card.

“Low-priced customers have similar cash flow profile as higher-priced plans.”
• What?

“Believes that $9.99 pricing is one of the most innovative things they've done.”
• These guys will say anything.

"Doesn’t Wal-Mart sell old movies at low prices? This will expand if they start downloading films and burning copies. The majority of people will not be dying to do this for themselves."

Rick, there's nothing hard about ripping and burning a DVD. Dual layer media is now below $2 for Verbatim, the best there is. Those in the know realize that Wal-Mart over-charges for everything. They charge $10 a piece for dual layer discs that's $2-3 a piece online. Only a fool would buy technology or DVDs at Wal-Mart. Their prices are usually 2-3 times what Best Buy or New Egg charges. Only fools would go in Wal-Mart and pay more money for a poor selection of crappy old movies nobody cares about.

“Doesn't believe that movie piracy will be as rampant as music downloading -- different audience and product.”

Downloading is a waste of time. Selection is worthless, quality sucks, only serious cheap skates would find that an appealing option. I use Hollywood MVP or Netflix or BB Online or library or BB Rewards or indie store with obscure movies. The average price per rental can be as low as 17 cents with MVP, if you go every day and trade 3 movies.

"Some of their own customers are taking copies of movies (when the discs are not too damaged) that they like, meaning they are less likely to stay as customers."

They will never run out of movies they want. Collecting is additive in the warez scene. I don't think your view (or Netflix's) is very realistic. If you use a BenQ drive, you will have no trouble ripping the contents of the most damaged discs. As long as they are not broken or cracked, you can rip them.

"Made worse by the generous types handing out additional copies to friends."

The smart people would charge their friends for media and case. Which would be maybe 50 cents (at most). This will not make much of a dent in sales/rentals, because we don't all like the same things.

“Low-priced customers have similar cash flow profile as higher-priced plans.”
• What?

That is an admission that they throttles the high-priced plans worse. They have more to lose if an 8-out customer gets 2 shipments a week than if a 3-out customer does. So the 8-out customer should expect to be throttled until their cash flow profile is similar to the lower priced plans. In short, it's just a waste of money to upgrade. Why pay more to have Netflix throttle more discs?