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Netflix Turning Back on Rental Discs

25 Apr, 2011 By: Erik Gruenwedel

Online disc rental pioneer subs top 23 million

The home entertainment juggernaut that is Netflix continued its phenomenal fiscal run, topping analyst projections with first-quarter (ended March 31) income of $60 million, up 88% from net income of $32.2 million during the previous-year period. Meanwhile, domestic revenue increased 43% to $706 million, compared with $494 million last year.

The company said it would continue to put its focus and resources on streaming, with similar focus on disc rentals decreasing accordingly. Indeed, in a call with analysts, CEO Reed Hastings declined to talk about disc milestones, reiterating the company's emphasis toward streaming instead of packaged media.

Los Gatos, Calif.-based Netflix added 3.6 million monthly subscribers, including 3.3 million in the United States and 290,000 in Canada. The company now has 23.6 million total subscribers (22.8 million domestically and 800,000 in Canada), up 69% from 13.97 million subs a year ago.

Canadian operations, launched last September, generated an operating loss of $11 million on revenue of $12 million. In an accompanying letter to investors, Hastings and CFO David Wells said the Canadian service generated “lower-than-anticipated” subscriber revenue. Wells said Netflix generated 8% household broadband penetration in Canada in seven months, compared with six years in the United States.

“We are still learning the seasonality curve and nuances specific to Canada, however, and we slightly over-forecast the quarter,” they wrote.

The executives also said they could envision launching streaming-only services in as many as two foreign markets annually going forward to stay ahead of third-party competition.

Hastings and Wells said they expect disc rental shipments to slightly decline in the second quarter and beyond compared with last year. Meanwhile, streaming content costs will increase accordingly.

“As streaming grows, TV shows and feature films are being enjoyed in nearly equivalent volume by our subscribers and our content acquisition team is focusing their attention accordingly,” Hastings and Wells wrote.

They said disc rentals, including Blu-ray Disc, continue to be less of a competitive “differentiator” due to the “explosive” growth of streaming.

“In order to prosper in streaming we must concentrate on having the best possible streaming service,” Hastings and Wells wrote. “As a result, we are beginning to treat them separately in many ways.”

The executives said the decision to acquire content rights to serial remake “House of Cards” was made to test a new licensing model predicated on building an audience (and new subs) through original programming.

“This represents slightly greater creative risk than we’ve taken in the past, but we think it’s reasonable given the popularity of the original BBC show on Netflix and the modest percentage of our content budget it represents,” they wrote. “If ‘House of Cards’ is popular enough on Netflix so that the fee we’ve paid is in line with that of other equally popular content on Netflix at the time, we’ll consider it a success.”

The series, starring Kevin Spacey and directed by Oscar nominee David Fincher, is slated to bow in late 2012.

Hastings and Wells reiterated that Netflix is a supplemental channel — not a replacement — to multichannel video programming and distribution, or MVPD, operators. The media has reported that Netflix represents a direct threat to MPVD, which parties deny. Netflix believes streaming repurposed episodes of prior-season TV shows builds the audience for the current season on broadcast TV.

Hastings and Wells said the “evidence” is mounting that content owners who license to Netflix make more money than those that don’t.

“We hope over time that HBO and Showtime will let us prove this proposition for them,” the executives wrote. “We think more and more evidence that prior season on Netflix helps current season on MVPD will become apparent from our deals with Disney, Viacom, CBS, NBCU and others.”

The executives believe Dish Network likely will bow a streaming service in the near-term under its newly acquired Blockbuster brand.

Netflix’s shares briefly hit an all-time high before release of the fiscal results, topping $254 per share, before dropping 5% on mixed forward outlook.

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