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Netflix Financials Hit by Blockbuster Total Access

18 Apr, 2007 By: Jessica Wolf

Blockbuster's Total Access online subscription program and its free in-store rental element hit competitor Netflix hard in the first quarter of the year, the online DVD rental pioneer's executives said.

Netflix, which launched the online DVD rental phenomenon, reported $9.9 million in net income from $305.3 million in revenue for the quarter and about 500,000 net subscriber additions to bring the company's total subscriber base to 6.8 million.

First quarter results were all within stated expectations for the period, but for the first time, at the low end of those expectations, company executives said.

Things won't really look up with regard to growth until Blockbuster raises the price of its Total Access program, which Netflix CEO Reed Hastings said is inevitable, but which may not happen this year.

Blockbuster's offering, as it stands now, is “unsustainable,” Hastings said. Netflix estimates Big Blue could loose as much as $200 million on the scheme this year.

“Obviously, when you literally give away the store, you're going to see market share growth,” Hastings said of Blockbuster. “[But] Blockbuster is materially less efficient that we are. To us it's not a question of if Blockbuster will raise online prices, but when and how much.”

Netflix did mark record revenue numbers in the first quarter and 120% year-over-year growth, as well as 10% subscriber growth in gross additions, said Barry McCarthy, company CFO.

“But given our track record of performance versus guidance, Q1 was disappointing,” he said.

Executives said they may have to revise the company's 2012 goals of 50 million subscribers and 50% year-over-year revenue growth depending on how long Blockbuster hangs on to rock-bottom Total Access pricing.

Subscriber acquisition cost was $47 in the first quarter, a high figure based on a smaller undisclosed marketing spend in the time frame, affected by fewer word-of-mouth new subscriptions, McCarthy said. Churn was 4.4% in the quarter, compared to 4.1% in 2006.

On the electronic delivery front, Netflix was able to get its new Watch Now streaming-video service up and running for all 6.8 million subscribers in half the time it had expected — three months rather than six. By the end of the first quarter, all Netflix subscribers were enabled with the service.

Netflix grew the content offering for Watch Now from 1,000 titles to 2,000 and expects to have 5,000 movies and TV shows available for instant Internet streaming by the end of this year. The company declined to discuss any usage trends or specifics for the fledgling service, however.

Hastings also said Netflix hopes to have an Internet-video-to-TV option in place by next year, but also declined to discuss specifics on that program.

“We've previously said we wanted to get [online video] to every Internet-connected screen, from computers to cell phones to plasma screens in the living room,” he said. “There are a number of partnerships we are looking at.”

Content costs for the new digital offering are coming in at lower-than-expected levels, adding to a $500 million cash flow the company expects to have by the end of the year. Netflix will “redirect” $100 million of that into the company with its first share buyback offering.

Hastings said the overall growth of the online DVD rental market combined from 6 million subscribers last year to 10 million total this year is a positive indication of the potential of the market.

Hastings said he sees the future for the next decade as a hybrid model of physical DVD rental and online streaming for several reasons, including longstanding release-window issues that are keeping DVD vibrant. Also, it will take some time for titles available for digital viewing to match Netflix's 75,000 available DVD titles.

For the second quarter, Netflix expects revenue of $303 million to $309 million, net income of $13 million to $17 million and an ending subscriber base of 6.7 million to 6.9 million.

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