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Netflix Posts 810K Sub Loss in Q3

24 Oct, 2011 By: Erik Gruenwedel

Nextflix shares free-fall after service forecasts global losses throughout much of 2012

As expected, Netflix Oct. 24 said it lost a record 810,000 net subscribers in the United States in the third quarter (ended Sept. 30) — a 145% downturn from the previous-year quarter.

The subscriber loss was partially offset by the net addition of 510,000 subscribers internationally as Netflix expands operations beyond the U.S. into Canada, Latin America and Mexico.

Netflix ended the quarter with 23.79 million subs in the U.S., which included 13.93 million DVD/Blu-ray Disc subs. That tally represented a 42% increase in domestic subs from the same period last year.

The Los Gatos, Calif.-based company also reported an international sub base of 1.48 million, which generated $23 million in revenue and an operating loss of $23 million.

Global net income reached $62 million, up 63% from net income of $38 million last year. Worldwide revenue increased 49% to $822 million from $553 million.

In a letter to shareholders, CEO Reed Hastings and CFO David Wells admitted management missteps “greatly upset”  myriad subscribers with the ill-received price increase and the proposed‐and‐now‐cancelled Qwikster rebranding of the DVD service.

“In doing so, we’ve hurt our hard‐earned reputation, and stalled our domestic growth,” they wrote, adding that Netflix's fourth-quarter (ending Dec. 31) revenue and income would be lower than previously forecast.

The executives then dropped a bombshell of sorts saying that losses from international expansion would likely supplant domestic profits for a few quarters beginning next year.

"After launching the UK and Ireland, we will pause on opening new international markets until we return to global profitability," Hastings and Wells wrote. "We plan to do that by increasing our global streaming subscriber base faster than we increase our costs."

That news sent Netflix shares in a freefall, plunging more than 27% ($32) to $86.90 per share in after-hours trading.

Meanwhile, in its zeal to upgrade quality of content to its streaming portfolio, Netflix accrued more than $539 million in licensing liabilities in the third quarter to bring its content spending through nine months to more than $1.3 billion.

By comparison, Netflix spent just $20.8 million on DVD/Blu-ray Disc content rights, or $62 million through the first nine months of the year.

Hastings and Wells said the flip-flop regarding separating Netflix's disc rental business into a stand-alone "Qwikster" service had a "relatively minor" impact on the company's reputation.

"Our primary issue is many of our long‐term members felt shocked by the pricing changes, and more of them have expressed that by cancelling Netflix than we expected," they wrote.

Indeed, the executives said that just 7% of new Netflix streaming subs in the U.S. also want to rent physical discs. Hastings and Wells think DVD subscriptions will decline sharply in the current quarter, as reflected in the revised guidance, due to the Oct. 1 price increase to the combined streaming/disc rental option.

"Our weekly rate of DVD cancellations is steadily shrinking, as the price effect washes through, and in future quarters we expect DVD subscriptions to shrink more modestly," they wrote.

When asked why Netflix wouldn’t offer a discount for combined streaming/disc rentals, Hastings said it would be counter productive to use “discounting dollars” to entice disc subscribers in the business focused on streaming.

Indeed, the margins for disc rentals are higher than the comparative streaming margins. Yet, Netflix projects a decline in combined streaming/disc subs going forward, unlike the separate streaming and disc-only options.

“Then it will be a slow decline over the next many years,” he said, adding that he believes DVD rentals will eventually emulate AOL dial-up from 2002 to today.

“There will be a long-term residual market,” Hastings said.


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