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Netflix Subs Top 25 Million

25 Jul, 2011 By: Erik Gruenwedel

Stock tumbles after market close on earnings headwinds going forward

Netflix July 25 reported second-quarter (ended June 30) net income of $68 million, up 54.5% from net income of $44 million during the previous-year period.

The Los Gatos, Calif.-based online disc rental pioneer again produced strong results in all categories, including revenue of $789 million, up 52% from $520 million a year ago.

Domestically, Netflix ended the quarter with 24.6 million subs, up 64% from a domestic subscriber base of 15 million a year ago. Netflix Canada added 16,000 subs to an overall sub base of 970,000 members.

Netflix Canada reported an operating loss of $10 million on revenue of $19 million.

In a letter to shareholders from co-founder/CEO Reed Hastings and CFO David Wells, Netflix said it understands criticism by some subscribers over plans to increase by 60% monthly fees for renting both discs and streaming.

“We hate making our subscribers upset with us, but we feel like we provide a fantastic service and we’re working hard to further improve the quality and range of our streaming content in Q4 and beyond,” Hastings wrote in the letter.

Indeed, Netflix said it expects to end the third quarter (Sept. 30) with 10 million exclusive streaming subs, 12 million joint disc/streaming, and 3 million disc-only.

“We expect domestic net additions in Q3 to be lower than the previous year Q3, and because of the timing of the price change, revenues will only grow slightly on a sequential basis,” Hastings wrote.

Netflix, which expects growth in Q4 in return to normal, for the first time will separate costs associated with its disc rental and streaming businesses.

In fact, the company in January will outline a “straight forward” picture of its domestic disc rental business, including outlining technological, developmental, and general and administrative costs associated with packaged media.

“We’ll be reporting contribution profit (gross profit less marketing costs) for each segment as well as shared global streaming technology, development and G&A costs,” Hastings wrote.

In a Q&A session with analysts, Hastings and Wells backed the recent decision to raise hike the monthly fee for combined streaming and disc rentals, saying the additional revenue would help grow Netflix’s streaming content.

“We feel great about the amazing new content we will be able to license in the fourth quarter and next year,” Hastings said.

CFO Wells said thus far since the announcement, most current subs are sticking with the hybrid plan, while new subs target mostly streaming.

Hastings said confidence in the price increase was underscored by the strength of Netflix’s streaming business and the reality the company could survive only on streaming if it had to.

Hastings said the social media “noise” following the announcement was lower than they expected, while admitting that the flurry of calls from angry subscribers exceeded its customer support line for a short period of time.

The executives refused to address speculation on when Sony movies would return to Netflix’s streaming portfolio, or about a report that Netflix is in talks to secure an exclusive streaming deal with DreamWorks Animation.

“We are always in talks with all the different providers in terms of licensing more content. But we're not going to comment on them in advance,” Hastings said.

With $2.44 billion in content fees committed through the third quarter compared with 1.8 billion in last quarter, Hastings said he remained excited about the pending exclusive offering of past seasons of “Mad Men,” which he expects would produce a “burst” of subscriber growth activity.

Hastings said the planned Latin America rollout would include a lot of telenovelas, in addition to movies. He said the decision to launch a service in 43 countries instead of just a handful of larger ones was due in part to the fact that license agreements included the entire region.

“It is inefficient to arbitrarily not allow the service to be in certain countries when we've essentially paid for the content for those countries anyway,” he said.

Overall, analysts expressed caution regarding Netflix earnings in the third quarter and beyond. Specifically, Wall Street questions whether expansion costs into foreign markets, the Sept. 1 price increase and projected sluggish subscriber growth this quarter will extend earnings pressure into 2012.

"We remain concerned we have entered a prolonged period of difficult earnings headwinds," wrote Eric Wold, research director with Merriman Capital in San Francisco, in a July 26 note. 

Wold said Netflix's increase of projected income loss from international launches to $80 million from $50 million to $70 million, and the fact ramp up in these markets could take two years, underscored downward pressure on the company's stock in after-hour trading.

"We are taking a more conservative stance with our estimates for both [second half of 2011] and first half 2012] due to the international launch costs and potential slowing domestically, Wold wrote.

Netflix shares dropped more than 10% ($28.65) to $252.88 per share in post-market trading.

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