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UPDATE: Netflix Details Expansion Plans in Analysts Call

21 Jan, 2004 By: Holly J. Wagner

Online rentailer Netflix will expand into the United Kingdom and Canada, and is preparing to offer movie downloads alongside its DVD rental-by-mail offering by 2005, all in an effort to hit $1 billion in revenue by 2006 or 2007 — a year earlier than the company's initial business plan anticipated, executives said in an analysts call Jan. 21.

In announcing vastly improved revenue in 2003 over prior years, CEO Reed Hastings told analysts that rapid adoption of the DVD format, combined with lackluster competition from online rental challengers, falling churn rates and growth projections based on the company's performance in its first market, the San Francisco Bay Area, will carry Netflix to its goals.

“Very large companies have tried to get a foothold in our market, and after 15 months they have not done so,” he said. “We have great momentum. Our growth in our initial market has been very steady over the last four years. To reach the $1 billion revenue mark, we need to reach 5 percent of viewing households,” which the company has done in the Bay Area.

The company also kept customer churn rates under 5 percent for the fourth quarter of 2003 for the first time in its history.

“We may or may not have quarters in the future that have churn above 5 percent,” but churn should remain below 5 percent per year, CFO Barry McCarthy said.

Canada and the United Kingdom are also mature DVD markets that offer growth potential for Netflix. The company plans to launch in those countries this year and expects the cost structure to remain about the same as in the United States.

In support of its new efforts, Netflix will begin some TV advertising to increase subscribers, increasing its subscriber acquisition costs from $32.89 per each subscriber last quarter to an estimated $34 to $36.

“Our overall strategy is to acquire as many subscribers as we can for $35 [each],” McCarthy said.

The executives would give few details of the plan for video-on-demand (VOD), but said it could launch in one market as early as the end of this year.

“2005 will be early for downloading because there is only moderate consumer interest,” Hastings said, but increasing broadband penetration will fuel growth. “It will be like the DVD market in 1997. It will take five or six years to reach as many homes.”

Even though brick-and-mortar chains, including Blockbuster and Hollywood, plan to mimic Netflix's subscription model in their stores this year and other download services, like CinemaNow and Movielink have already launched, McCarthy said Netflix will still be the first mover with a combined online model.

“Very few services, if any, will offer a DVD or downloading as a choice,” he said. “It's the intermixing of the two that gives us a very important edge.”

Although the video chains have promised a blended commerce experience that lets customers move between in-store and online rentals, Netflix executives expect that to be delayed.

“It turns out that e-business is considerably more software run” than other businesses, McCarthy said. “The primary difference [at Netflix] is one of our top three competencies in this company is software. I think you will see Blockbuster postponing its plans in terms of online.”

The company considered offering its online service through an existing brick-and-mortar chain, but test results discouraged retailers in the physical world.

“It's too cannibalistic for the stores,” he said. “Once the store customers find out about Netflix, they really don't want to do much with the stores.”

With profits growing fast, the company also announced a two-for-one stock split that will benefit shareholders of record as of Feb. 2 and the departure of CFO McCarthy at the end of 2004. He will seek a CEO or COO position elsewhere, Hastings said.

The Los Gatos, Calif.-based online movie rental service said fourth-quarter revenue rose 80 percent, to $81.2 million.

Netflix reported fourth quarter net income of $2.3 million, or 7 cents a share, compared to a net loss of $2.3 million, or 10 cents a share, a year earlier.

Netflix ended the fourth quarter of 2003 with approximately 1,487,000 total subscribers. During the quarter, the company acquired 444,000 new trial subscribers — a 41 percent year-over-year increase from the 315,000 new trial subscribers acquired in the fourth quarter of 2002.

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