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Netflix CFO: Blockbuster is 'Treading Water'

27 Feb, 2008 By: Erik Gruenwedel

Citing reduced online competition from Blockbuster Inc., Netflix Inc. Feb. 27 said it expects to end 2008 with 8.9 million to 9.5 million subscribers, compared to a previous projection of 8.4 million to 8.9 million.

The Los Gatos, Calif.-based online DVD rental pioneer said first quarter (ending March 31) subs would increase from 8.16 million to 8.26 million, compared to previous estimates of 7.85 million to 8.05 million.

The company expects quarterly net income to increase $1 million in the range from $10 million to $14 million, with annual profit ranging from $75 million to $83 million.

Speaking at an investor conference in New York, Netflix CFO Barry McCarthy said the company's PC-based instant movie streaming service and lower subscriber acquisition costs, or SAC, helped grow record sub growth in the quarter.

“There aren't many times in the company's history when we are firing on all cylinders, and Q1 is one of those times,” McCarthy said. “I think it is going to shock some people.”

He said online sources of subscriber acquisitions are less expensive than they used to be because of curtailed demand among financial service advertisers for online content.

“So, we are getting a slightly bigger bang for our [advertising] buck,” McCarthy said.

The CFO said ongoing efforts to market Netflix's movie streaming service as a value proposition to subscribers, in addition to last year's price cuts, contributed to increased subs.

“There's no question the lower price is contributing to faster-than-expected subscriber growth,” McCarthy said.

He said he envisioned increased consumer adoption of HD packaged media, now that Blu-ray has been declared the winner. McCarthy said HD rentals remain a single digit percentage item among Netflix subscriber shipments.

He expects to see about 1,300 to 1,500 Blu-ray releases by the end of the year, including 300 new titles, and the remaining, catalog.

The CFO said stocking Blu-ray titles is more expensive than standard DVD, but the HD format represents an extension of the DVD lifecycle.

“It remains to be seen how much price erosion takes place over the next couple of years, but it seems apparent the content will cost us more,” McCarthy said. “And it will.”

The CFO offered a blunt assessment of competitor Blockbuster, whose online rental service McCarthy said has been hemorrhaging subscribers.

“If they are not going to invest to grow it to profitability, and it is not profitable today, then they are going to [have to] do something with it,” he said. “The business is treading water. We as managers and companies in general are not in the business of treading water.”

McCarthy doubted Blockbuster has the resources to grow both in-store and online rental growth. He said new CEO Jim Keyes has a retail background and could succeed at the store level.

“If they don't fix the store-based problem, they're toast,” he said. “I don't think they have the resources to do both.”

McCarthy said Netflix had no conclusive evidence bankrupt Movie Gallery's recent announcement to shutter 1,000 Gallery and Hollywood Video stores would have an impact on online rentals.

“[But] it is hard to image that the closures [have] slowed our growth,” he said.

McCarthy said he remained impressed with the growth of the kiosk DVD rental market spearheaded by Redbox. He said the business has caught traditional store rental services by surprise.

“By focusing on the online competitor, they missed the boat,” he said.

McCarthy said kiosks could present opportunities for incremental growth because they are primarily focused on new releases and Netflix generates 70% of revenues from catalog titles.

“Subscription always wins in competition with a-la-carte [rentals] … because unlimited rental proves to be a tremendous call to action for consumers,” he said.

Finally, McCarthy said he had no comment on rumors Netflix was partnering with Microsoft Corp. to offer content for Xbox Live. Netflix last month announced a deal with LG Electronics to begin streaming movies via a proprietary set-top box manufactured by the South Korean CE company.

“It won't be sufficient for us to have a couple [of deals],” he said. “We'll need many. So expect more announcements.”

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