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Neflix Makes the Grade

24 Jan, 2007 By: Jessica Wolf

Netflix hit or exceeded all its revenue, income and subscription projections for the fourth quarter and full-year 2006, even as the company launched into digital delivery and dropped pricing to $4.99 on its bottom-level subscription plan.

Netflix ended 2006 with its target of 6.3 million subscribers, the company reported. The company added 654,000 subscribers in the fourth quarter, not as many as competitor Blockbuster Inc. in the same period, but enough to hit the company goal and please analysts.

Net income for the fourth quarter was $14.9 million, down 61% from the previous year. The company benefited in fourth-quarter 2005 from $34.9 million in deferred tax assets. Netflix had previously projected net income to be $7.5 million to $13.5 million in the quarter.

For full-year 2006, net income stood at $49.1 million, up about 16% from 2005. Netflix surpassed its goal to end the year with $41.7 to $47.7 million in net income.

The online rentailer also hit its revenue target for the year with $996.7 million, up from $682.2 million in 2005. Quarterly revenue also landed well within company projections at $277.2 million, a 44% year-over-year increase.

Churn was at an all time low of 3.9% in the quarter.

By the end of this year, Netflix will be operating 50 distribution centers across the country and be able to serve 95% of its subscribers with overnight delivery, said company CEO Reed Hastings in an earnings call with investors.

Exceptional customer service like overnight delivery as well as the new Watch Now online streaming option will help set Netflix apart as it faces a first-quarter "headwind" thanks to massive Blockbuster advertising around the Netflix competitor's Total Access online/instore rental hybrid, Hastings said.

But, Netflix has been there before, he pointed out. When Blockbuster dropped subscription prices in late 2004, Netflix saw a turnover of about 6 subscribers per thousand in the first quarter of 2005. That drop-off rebounded in the second quarter of the year and Netflix expects to do the same this year, once the dust settles on Blockbuster's Total Access marketing blitz, he said.

What's most important is the rapid uptick both companies saw in subscribers in the fourth quarter of 2006, he said.

"America is fast becoming a nation of online renters," he said. "There are over 8.5 million in the total space and that's likely to grow to 12 million by the end of this year. Together we are growing online rental faster than either company could on its own."

As Blockbuster tries to reach its stated goal of 4 million subs by the end of 2007, the chain has a lot of costs to absorb with regard to the Total Access program, from the marketing to the free store rentals the chain offers with the plan, said Netflix CFO Barry McCarthy.

Netflix's goal is to hit 8 million subscribers by the end of 2007. And the company is bullish about its long-term projection of 20 million subscribers by 2010-2012, Hastings and McCarthy said.

Meanwhile, Netflix's recent launch into digital video with streaming service Watch Now is a selling point for current and future subscribers, Hastings said.

Subscribers on the $18 model plan at Netflix will get 18 hours per month of access to streaming video at no extra monthly charge, he said. Several thousand Netflix users are already live on the service and Netflix will bring all of its subscribers on board hopefully by the end of June, executives said.

The company has dug in to a digital rental delivery model, leaving the ad-supported model to such players as Yahoo, Youtube and TV broadcast sites, and electronic sellthrough to such leaders in the space as iTunes and Amazon.com.

Netflix will spend more than $40 million maintaining and upgrading Watch Now this year, according to the company. That figure includes technology issues as well as licensing titles from content holders for the service.

Netflix executives declined to give too many details on its content agreements, but Hastings said some deals are multi-year and the company is not looking for "exclusives" in the digital space. There are 1,000 titles now available for Netflix streaming and there will be 5,000 by year-end, Hastings said.

Maggie Gyllenhaal starrer Sherrybaby streeted January 23 on DVD from Universal Studios Home Entertainment was available simultaneously on Watch Now, Hastings said, when pressed for content examples for the streaming service.

The two biggest challenges for Netflix's new digital offering are "selection and TV screen access," Hastings admitted. "We're working on them, and over the coming years you will see advances."

Netflix executives shrugged off potential competition from studios testing Comcast video-on-demand downloads day and date with DVD releases in select cities.

"Studios are testing things all the time," McCarthy said. “Just because they're running a test doesn't really indicate much except a desire to learn."

Netflix is phasing out banner advertising on its Web site, instead planning to use the virtual space for customer-centric online merchandising and recommendations as it battles with Blockbuster to keep subscribers and gain new ones.

Netflix's pricing drop last week on its lowest-tier subscription — from $5.99 to $4.99 — won't have a negative impact on profitability, executives said.

"In terms of total revenue the $4.99 subs are completely inconsequential to the business model," McCarthy said.

Every time Netflix drops subscription prices, it has resulted in faster growth and more profits, Hastings said.

Meanwhile, Blockbuster Inc. rejected dropping its bargain sub in reaction to Neflix.

A company spokesperson said the entry-level Total Access plan at $5.99 provides up to 5 free DVD rentals per month — more than double the monthly rentals Netflix offers through its $4.99 plan. That's because the $5.99 two-out-a-month plan allows consumers the ability to return each DVD at a participating store for a free in-store rental, and they also receive a monthly coupon good for one free movie or game rental.

“We think Blockbuster Total Access is a better offer and that value conscious consumers understand that,” said spokesperson Randy Hargrove.

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