Netflix Q4 2005 Results & Webcast Notes

Netflix has announced Q4 2005 financial results (click here to view the release).

In Q4 2005:

$195 million in revenue.

Churn declined to a record low 4.0%, despite the efforts of some commenters on this blog. ;-)

GAAP net income as $38.1 million, including a one-time tax benefit of $30.2 million.

Income before taxes was $9.1 million.

Gross margin was 47.1%.

Subscriber aquisition costs were $40.65 (see the notes from the call for more information).

For 2005:

Netflix ended the year with 4.2 million subscribers, a 60% increase.

Revenue was $688.0 million.

GAAP net income was $41.9 million.

Davis Freeberg at Thomas Hawk's Digital Connection has written an excellent analysis of the news.

The Internet Stock Blog has posted a transcript of the call and the Q & A session.

Follow the link to see my notes from the investor webcast:

Hastings began the call with: “We enter 2006 with great confidence in achieving the major goals we’ve outlined.”

$50-60 million dollars pretax profit this year
50% annual earnings growth for the next 3 – 4 years
20 million subs in 2010 to 2012 timeframe

Subscriber additions by year:

600k in 2003
1.1 in 2004
1.6 million net new subs in 2005 (2.6 to 4.2 million)

2006 Forecast of at least 1.7 million net ads in 2006 total 5.9 million. Note this is the “bottom of range.”

Churn dropped from 4.3% to 4.0% – the lowest ever

$24 m free cash flow in 2005, $13 million pretax profit– onetime tax benefit of $30 million

$42 million GAAP profit

$50 - $60 million pretax net income in 2006

They expect to hit 5 million subs in mid-2006 (original 2002 goal was 5 million in 2007 - 2009) Note: Blockbuster expects to hit 2 million in 2006.

Raised Q4 marketing investment to $47 million – 50% increase yet exceeded earnings target.

Strategy: Grow as fast as possible while delivering on earnings target.

Continued expansion of DVD market grew domestically from $22b in 2004 to $24b (WSJ & Adams media research). Fox is forecasting the DVD market to grow to $30b by 2010. If studios move to full simultaneous release, the DVD market could grow by 50%.

$499 for High-def dvd player at BestBuy – delivered in 8 weeks. No additional cost for HD DVD content. Will also support Blu-ray when it launches.

3 possible situations for HD DVD:

1. Single format emerges
2. Samsung & others create dual players
3. Most studios publish in dual formats

Mass conversion will take 10 years to convert from DVD to HD DVD.

Netflix research shows that local video stores are primary alternative to Netflix, not VOD or Blockbuster Online.

Economic pressure of 2 million Blockbuster Online and 6 million Netflix subscribers will create economic pressure on Movie Gallery, Blockbuster and independent stores. Blockbuster has already closed 10% of stores in Bay Area. Netflix growth accelerated and they are now in 12% of bay area households.

Netflix will remain focused on leading in the download market. Will have 20 million DVD customers and most compelling solution. 2nd delivery option for consumers who desire it.

Two big constraints to movie downloads:

1. Content availability. 55k titles @ Netflix. Movielink has less than 2k titles – less than 15% of Netflix rentals last week. 7x larger selection than best download service. Problem is long-term contracts.
2. Getting internet connection to TV. Netflix customer report that only 4% of dvd watching is done on computer. Cisco announced Wifi-enable DVD player. Netflix hopes that by 2010 as many as 30% of households can display internet video on high-def displays.

2005 Netflix grew from 9% to 12% in Bay Area (the most technically oriented region), and expect to hit 20% in next 3 years -- despite TiVo, Comcast VOD, etc.

Barry McCarthy takes over.

4 upward revisions in forecast last year.
Net income. Large tax benefit from NOL (Net Operating Loss)
Expect 41% tax base in 2006.
Beat high end of earnings forecast despite increased marketing
Q4 gross margin was 47.1%– mostly due to lower cost of content
Lower priced plans popular – and have higher margin customers.
$24.3 million free cash flow in Q4 due to strong holiday sales of gift subscriptions and growth in accounts payable.
Free cash flow will turn negative in Q1 and positive for rest of year. Increase in purchase of content (as in Q1 2005) as high as 20% of revenue. Support for high-def DVD will not increase content cost in 2006.

Downloading is just another way to deliver movies. Players will be companies that get the technology right. The winners will provide best content and consumer experience – something Netflix does right.
Large subscriber base and intuitive Web site are key to success. Netflix merchandises content specific to each customer – 1 billion movie ratings and growing.

Netflix: 8 years from start to $1 billion in revenue.

Reminded us again that guidance is at bottom of range

Testing lower prices and will continue to test prices in 2006. If lower price accelerates growth and lowers marketing costs they will consider it.

No plans to cut earnings guidance for the year.

Q&A

Customer usage on decline and revenue per disc on rise.
Cost of content is up 10% but growth of subscribers is up 60%. No change in rev share.

Will take incremental profits and reinvest them to grow the business.
Marketing costs on low-end are $50-60 million, expectations are higher.
Ad sales and previewed movies approx. $8-16 million.

International expansion looked at from time to time, but has to fit with financial goals.

Interesting explanation about the difference between music and video downloads – the difference is quality (music down, DVD up) and portability.

SAC $40.55 is so far below the lifetime value of a customer that it’s not a worry. Netflix focuses on marketing costs vs. earnings target. SAC based on marketing costs (if they can spend more, it’ll go up).

Netflix was an early company to adopt expensing options, so it won’t be a problem.

Don’t anticipate any problems with HD DVD because the process is similar to standard DVD. They should know more about Blu-Ray in the next few months.

HD DVD will have no impact on content costs this year.

Q1 churn is higher than Q4 because of the high influx of new subscribers in Q4.

VOD is a $500 million market (excluding adult titles), and Netflix is bigger than the entire market.

In regards to Google, Amazon, Yahoo! etc., the barrier is not technology but lack of content available for download and the fact that only 4% of Netflix subscribers watch movies on a computer.

Comments

Can't keep a good company down.*

4.2 million. That's above expectations, isn't it?

[* I know that'll probably garner some cat calls from the peanut gallery, but hey, I think NetFlix *is* a good company. And no, I'm not an investor - it's kind of sad I feel I even have to make that disclaimer here.]

"Churn declined to a record low 4.0%, despite the efforts of some commenters on this blog. ;-)"

Take THAT manuel!

[Rusty Ramrod]

I like both NF and Blockbuster, but these numbers must have been massaged like a greenhorn grunt on his first leave.

"Churn declined to a record low 4.0%, despite the efforts of some commenters on this blog. ;-)"

I personally know about a dozen people who tried NetFlix. All 12 dropped it within a year for varying reasons, so for that group the churn was 100%.
My guess is the real numbers are more in the 20-30% range. Maybe they just left off a 0?

[Mike]

More customers NF gets, the worse the service becomes :(

You have to hand it to Hastings and his management team. If you listen to the Earnings call, the Netflix boys are focused, no obsessed, with hitting their quarterly earnings numbers. And they have the formula down for making the numbers. If expenses go up in one area, cut something else by the same amount. The unsaid something is DVD shipments to the customers. None of the analysts on these calls must be Netflix customers, because there is never a question about throttling or the lawsuit.

Chilling comment by one of the Netflix suits on the call. Their strategic goal is drive all the brick and mortar video stores out of business. They call this the "tipping" point. Thats when Netflix prices will rise substantially, and customers will have no other viable choices for DVD rental.

[CJ]

Once Netflix has buried the brick and mortar stores, they will follow good monopolistic pricing theory - that is change their pricing structure to both a monthly subcription fee (varying by number out at time) and a per rental fee. You'll pay based both on belonging, and how much you use the service. This pricing scheme is certainly more fair than the current "throttling" (to control costs). Additionally it allows revenue stability, thus profit maximization.

You're all paranoid. Sad, really.

You're all paranoid. Sad, really.

[netflixfan]

I love it. Rahrahrah.

Hey Netflix suits. No need to wait. I'd sign up for a flat fee per movie option right now. Get with it.

Back in 1999, NetFlix was a pay-per-rental model. I believe the price was $3.95 (or maybe $4.95), and I believe you had to mail the disk back within 7 days.

If that appeals to you, hey, you're welcome to it. Personally I really, really like a service with no due dates.

[anonymouse]

These numbers won't last if they continue to piss of their customer base. See the comments in the "New Release Hack" from the guy who came up with the hack in the first place.

Perhaps. Depends on how many customers are pissed off. I personally don't agree with the reasoning. IMO NetFlix provides a good service at an affordable price, but not to a fault. You shouldn't expect to get 15 disks a month AND every new movie on the day of release.

I guess if we see a significant slow down in subscriber growth or a spike in churn, that'll be a sign that customers are bailing. So far the trend indicates otherwise.

A flat fee option doesn't have to have a due date. A plan that charges a monthly subscriber fee of $9.99 and then adds $1.29 per rental is the equivalent of the 8-out plan profit-wise and would meet the needs of many heavy users, while at the same time preserving the all-important Netflix gross margin.

The flat fee plus rental fee idea above is brilliant. Netflix needs to test it somewhere ASAP.

You don't get it. The $1.29 per movie rental fee would have to be per movie per month, otherwise someone could keep out 30 movies beyond the first month for only $9.99. Still most people wouldn't keep their movies beyond a week. Netflix would have to keep track of how long you held each movie, and charge an extra fee when you went over 30 days.