Netflix Inc (NFLX) 2006 Q3 法說會逐字稿

Good day everyone, and welcome to the Netflix third quarter 2006 earnings conference call.

At this time for opening remarks and introductions, I would like to turn the call over to Deborah Crawford, Director of Investor Relations.

Please go ahead, ma'am.

Thank you and good afternoon.

Welcome to Netflix third quarter 2006 earnings call.

Before turning the call over to Reed Hastings, the Company's Co-founder and CEO I'll dispense with the customary cautionary language and comment about the, webcast for this earnings call.

We released earnings for the third quarter at approximately 1:05 p.m.

Pacific time.

The earnings release which includes a reconciliation of all non-GAAP financial numbers to GAAP and this conference call are available at the Company's investors relations website at www.Netflix.com.

A rebroadcast of this call will be available at the Netflix website after 5:30 p.m.

Pacific time today.

We will be making forward-looking statements during this call regarding the Company's future performance.

Actual results may differ materially from these statements due to risks and uncertainties related to the business.

A detailed discussion of such risks and uncertainties is contained in our filing with the Securities and Exchange Commission, including our annual report on Form 10K filed with the Commission on March 16, 2006, and now over to Reed.

Thank you, Deborah, and welcome, everyone.

In the third quarter, we delivered strong results across our key metrics, subscribers, revenue, and earnings.

Combining the best customer experience with the lowest cost continues to power our cities.

In the third quarter we grew our customer base by nearly 500,000 subscribers and we're on track for achieving our goal of at least 6.3 million subscribers this year.

More precisely, net additions in Q3 were 493,000 subscribers, compared to 396,000 last year in Q3, and 136,000 two years ago in Q3.

This growth in net additions is a sign that we are still on the first half of the S curve of consumer adoption for on-line rental.

On top of our growth in net additions, we were more profitable than we anticipated due to a mix of higher revenue and lower cost, that Barry will discuss shortly.

We delivered about $3 million additional profit beyond the high end of our guidance range.

On our last call 90 days ago, we told you our churn in Q2 was higher than we had expected, because we had failed to recognize and predict some underlying summer seasonality, especially in the more variable northern climates.

Happily, our churn in Q3 was 4.2%, down sequentially and down from a year ago, which is as we expected.

We have gained confidence that we now understand the seasonal churn pattern, and will benefit from it in Q4 as the northern climates get cold and dark.

In marketing, our scale and gross margin allowed to us increase our quarterly marketing investment to $59 million, and still surpass our profit goals for the quarter. $59 million is an all-time record for our quarterly marketing investment for any quarter, and up from $33 million one year ago.

This aggressive spending is what pushes up average SAC, which this quarter was $45.00, an all-time high.

In Q4, we are going to be able to set new records on marketing investment, and still deliver on our increased Q4 profit guidance.

At our scale, we are able to generate growing profits, and to invest heavily in subscriber growth, which positions us for larger profits in the future.

Turning to profits and the future, we had said this year we would generate $30 to $35 million in profit, and that we expected to increase that 50% for several years, which would be $45 to $53 million in 2007.

This year, however, we've been more profitable than we expected, and we've been unable to officially invest all the excess profits into more marketing.

Therefore, we're taking up our profit forecast for this year to $42 to $48 million.

We're also moving up our 2007 guidance to $55 to $60 million, or more precisely $0.76 to $0.83 GAAP EPS.

Let me note that going forward we'll generally guide to EPS rather than absolute profits to bring ourself more in line with how financial markets track earnings.

Purists will note that $55 to $60 million for next year is not 50% above $42 to $48 million for this year.

Our response is $55 to $60 million is more than 50% above the $30 to $35 we expected to generate this year.

Whichever side you agree with, you can probably agree it's a nice argument to be able to have, and we're excited about another year of great subscriber revenue and earnings momentum.

For 2007, we're increasing our investment in marketing, we'll begin much more substantial investments in Internet delivery, and will deliver record earnings.

Barry will give you more color on this in a moment.

In addition to growing our earnings nicely, we continue to make progress towards our $20 million subscriber goal.

A large subscriber base and trusted brand will be key competitive advantages as we add the option for Internet delivery to our service.

Part of our strong reputation is from astoundingly fast shipping of DVDs, but another big part of our brand is from our award winning website that helps customers find the particular movies they are likely to love from the 65,000 available.

That's why our relentless focus is on making our website even more engaging and useful.

You saw that commitment again this past quarter as we added website enhancements, including an improved friends experience, our previews feature, and we launched our million dollar Netflix prize for progress in the accuracy of web recommendation systems

Turning to Internet delivery, Apple and Amazon launched their services in Q3.

Their solutions will improve over time both in technology and selection.

They are primarily targeting the download to own market, where price points are $10.00 to $20.00 per movie, and they primarily compete with DVD sales, which is a $16 billion market domestically.

DVD rental has always competed with DVD sales for its piece of consumer spending, and DVD rental will be minimally affected by these new entrants in the movie ownership market.

Our market is movie rental, an $8 billion market with approximately $3.00 per movie pricing in stores and on-line.

In terms of the download rental market opportunity, we have been patiently learning, through prototyping and consumer research.

While there may be little near-term threat to physical DVD rental, that doesn't change our view on the importance of Netflix leading the download rental market.

In our next earnings call, we'll talk in more detail about our Internet delivery plans.

We think our solution will offer superior ease of use in value, but as with all Internet movie services, we will initially have significant content availability constraints imposed by the TV network windowing system for movies.

Fortunately, physical DVD remains ubiquitous in nearly 100 million U.S. households, which by combining Internet delivery with DVD by mail delivery gives us a huge advantage in competing for consumer's entertainment dollars.

In terms of DVD rental, our fundamental thesis about on-line taking share from store-based rental is playing out.

Blockbuster says it's on target for 2 million on-line subscribers by the end of the year, and we're on target for 6.3 million.

So that is 8.3 million active renters not paying video stores to rent movies.

On-line rental provides a better consumer experience and greater value than store-based rental.

The larger on-line gets, the more difficult store based rental becomes economically, and we think the major chains will close 5% to 10% of their stores next year.

As more stores close, the on-line market is further strengthened.

Our view is the trend of online rental growth and store rental decline will continue for many years.

In the long-term, as our base grows and our strong word of mouth spreads, our marketing as a percentage of revenue and our SAC should decline.

Rental is an $8 billion industry, and we believe much of it will move on-line over the next 10 years.

Within the industry, the only dark cloud we see is high-definition DVD, which has become trapped in the video game boxing ring.

There are two competing formats, HD-DVD backed by Microsoft, and Blu-Ray backed by Sony.

Because of their video game interests, Microsoft wants to make sure Sony's High Def DVD format is not the winner and Sony wants to make sure Microsoft is not the winner.

Neither of these companies can be defeated in the short run.

As long as the press writes about the format war, most consumers will stay away.

The only practical studio is for all studios to announce the war is over because everyone is supporting both formats.

Two formats are not hard, we've had VHS and D DVD the last 10 years with minimal trouble.

Two movie studios are already supporting both High Def movie formats, now we just hope other studios will do the same, the press will declare the war over because both formats are supported by all studios, and the consumer adoption cycle will begin in earnest.

To close, I'll note that 14.9% of the 2 million plus Bay Area households now subscribe to Netflix, up from 14.1% one quarter ago.

The Bay Area is also blanketed with Comcast VOD, Internet Broadband, TiVo and Apple, yet the Netflix movie service continues to grow more popular here every quarter.

In thinking about our national market share, remember that the Bay Area is our oldest market, which we have served with generally next day delivery for 7 years.

The rest of the country, time lagged by the commencement of generally next day delivery continues to follow the Bay Areas growth trajectory.

In fact, Seattle, Washington D.C., and Austin, Texas are now all above 10% of households subscribing to Netflix.

Our ability to continue to increase penetration in our oldest market demonstrates the strength and potential of the on-line rental market, and reinforces our confidence that we can deliver on our growth objectives for both profits and subscribers.

Thank you, and now over to you, Barry.

Thank you, Reed.

Most of our listeners know that Netflix came public in May of 2002.

In the four and a half years that followed, we've grown our quarterly revenues from $36 million to $256 million, and subscribers from 670,000 to 5.7 million.

Against this frame work of historical performance, covering the 18 quarters that Reed and I have reported on quarterly earnings, our business scale model has scaled profitably, and this quarters results are a great example of how well the model can perform.

My remarks today will focus on the key drivers of our earnings performance this quarter.

Then I'll talk about how we managed the trade offs in Q3 between marketing spending, subscriber growth and earnings, and lastly, before opening the call to questions, I'll discuss our guidance for Q4 and for the full year 2007.

Sometimes the numbers tell a clear story, and this is one of those quarters, so my remarks today will be brief.

Before I discuss the P&L performance, I would like to say a word about free cash flow.

In Q3 we produced $22.3 million, the second largest quarter of free cash flow in our history.

To put this in historical context, we produced nearly as much free cash flow last quarter as we produced for all of 2005, and for the 12 months ended September 30, we produced $64 million of free cash flow.

I think this shows that our model is working well, even as we grow rapidly, and even at current levels of subscriber acquisition cost, and we expect that success to continue.

Let's turn now to our P & L. There were three drivers of strong performance last quarter.

The largest of these drivers was content cost, which was approximately $3 million lower than we expected in the quarter.

These cost savings resulted from a favorable mix of owned versus rev shared content.

We expect these content costs to increase in Q4, and I'll say more about that in a moment.

The second largest source of our performance was technology and development spending, primarily due to lower headcount and lower data center spending than forecast.

And the final source of earnings upside resulted from a favorable variance in ASP, which contributed $1.5 million more in net income than we expected last quarter.

Because we out performed our earnings guidance in Q3, I want to spend a few moments discussing how we managed the balance between growth and earnings.

As many of you know we have a long-term goal of reaching 20 million subscribers.

That goal is founded on the belief that the key competitive advantage in the emerging downloading market will be strong relationships with a large customer base that, as Reed mentioned, is accustomed to getting their video entertainment from Netflix.

Against the framework of this over arching objective, we articulated three important goals for 2006.

One, finish the year with at least 6.3 million subscribers, two, generate $30 to $35 million in net income, which we've already accomplished and, three, position the Company to grow earnings at 50% per year for several years.

Along the way, we said we would invest excess earnings in faster subscriber growth if we could acquire subscribers cost effectively relative to their lifetime value as Netflix subscribers.

Given these objectives, why did we outperform our earnings guidance for the third consecutive quarter without redeploying all of our excess profit into faster subscriber growth?

For those of you who follow the Company closely, this might sound like a replay of last quarter's earnings call when I posed a similar question, and I answered that question by saying that for Q3 and Q4, we had greater visibility into the outperformance, which better positioned our marketing team to deploy the money productively and cost effectively, and on balance, we largely accomplished that objective in Q3.

We plan to increase marketing spending in the quarter by about $7 million.

That increase was factored into our subscriber guidance, and we put 100% of that money to work in the quarter.

During the quarter, we identified another $1.5 million of profit, which we weren't able to redeploy cost effectively, and so it fell to the bottom line.

The rest of the upside was pure outperformance, which we just failed to forecast accurately.

So at this point, let's ask ourselves how our performance for Q3 and year to date positions us for Q4 and 2007 guidance.

As many of you know from reading today's earnings release, we raised our Q4 guidance.

I want to comment on two aspects of that increase.

First let's talk about gross margin.

Earlier in my remarks, I said we expect to see content costs increase in Q4.

This means increased margin pressure, but we also expect to see a seasonal decrease in dish shipments, which will fully offset the increased cost we forecast for content, which means steady as she goes in terms of gross margin.

Second, with respect to marketing spending, we don't currently foresee opportunities to increase our already large planned expenditures to drive faster subscriber growth in Q4.

If opportunities present themselves during the quarter, you may see us end Q4 in the low end of our upwardly revised earnings guidance.

If they don't materialize, and the business out performs our forecast expectations again this quarter, you should expect to see us land at or above the high end of our earnings guidance for Q4.

For 2007, we expect to produce $55 to $60 million in net income, or $0.76 to $0.83 per share in net income.

We'll continue to guide to ending subscribers and revenue as well as EPS, and will give you our full 2007 guidance on the Q4 earnings call in January.

As Reed mentioned earlier, we also plan to discuss our digital downloading strategy on the January call.

As you think about your Netflix model for 2007, bear in mind that we plan to significantly accelerate our spending on digital downloading in 2007, from less than $10 million this year to more than $40 million next year.

So in summary, Q3 was the beat and raise quarter for Netflix with rapid subscriber growth of 58% year-over-year, better than expected net income of $12.8 million.

Net income growth of 84% year-over-year, and exceptionally strong free cash flow of $22.3 million.

We expect another strong quarter in Q4, and today we upwardly revised our guidance to reflect that optimism.

That concludes my prepared remarks, and now we'll open the call to questions.

[OPERATOR INSTRUCTIONS]

We'll take our first question from Gordon Hodge with Thomas Weisel Partners.

Good afternoon, thanks.

Just two questions.

Barry, I know--I think you've mentioned in the past that advertising sellout has been really high on the mailers, and I'm wondering if that is starting to now kick in as a major source of profit for you, or a meaningful source, anyway, and then also if you could comment on usage trends during the third quarter.

I think you indicated in the fourth quarter, you expect it to tick down, but any commentary just in terms of how it behaved in the third quarter would be great.

Thank you.

Thank you, Gordon, with respect to ad sales on the mailer, we are sold out, substantially sold out in Q3 and Q4, so that business is progressing well.

I don't think it will emerge as a line item for a year or two, so early indications are that we're on the right path, also trying to build out the on-line piece of that, and we'll probably have more to say about it next year, built it looks promising.

The targeting is being well-received by the studios, and I think we're perceived to be a value added player with a valuable target market.

With respect to usage, no real news, actually, during the quarter.

Subscribers behaved very much as we expected, as we finished on plan.

The seasonal pattern that we're expecting in Q4 is the seasonal pattern that we've seen in each of the prior years.

And to break out ad sales, at what level would that have to be to become a line item that you break out?

Well, under SEC rules, 10%.

Not till 10.

Okay great.

Thanks.

And we'll take our next question from Heath Terry with Credit Suisse.

Great.

Was wondering if you could just talk a little bit about your studio relationships, and how the revenue share agreements are changing, or if they are, as you move into the HD DVD Blu-ray world, and are the current relationships that you've got on the DVD front changing as you start to negotiate this next round?

Sure, Heath, it's Reed here.

Not much change over the past two or three years, some studios get more favorable on it, other studios get less favorable on it, but, the overall mix for us is approximately the same.

And HD DVD and Blu-ray it's too early to tell.

We're talking microscopic volumes of players.

Probably 10,000, 20,000, 30,000 total units sold of hardware players, so the market is so small right now that you just can't tell anything.

We think as it grows, it becomes pretty much parity with DVD, but could be three, four, or five years until it gets to 10 or 20 million units--10 or 20 million households, depending on how you want to count PlayStation 3.

Got you, and then on that revenue share front, as you evaluate the buy versus share decision, as those relationships change, and you say they haven't changed that much, but can you talk to us about the thought process that goes through there, just from an accounting perspective on how you evaluate which disks you're going to buy versus the ones you're actually going to go into a revenue share agreement on?

Sure.

We don't really get to choose on a title by title basis.

It's really studio by studio, and a rev share agreement would generally cover all of the new releases from the studio.

So in terms of the overall evaluation, it tends to be, I think, heavily influenced by what the studio prefers, if the studio prefers revenue sharing, they're generally revenue share with a number of companies including us.

If the studio prefers not to, then it will be typically wholesale with all of the rental companies, so it follows those broad patterns.

Great.

Thank you.

And we'll go next to Safa Rashtchy with Piper Jaffray.

Good afternoon, Barry and Reed and congratulations on a great quarter.

A couple of questions here.

First I just want to begin just to, Reed, to understand where you might be spending the money.

You mentioned that if one is a purist, it would look like you are lowering your 50% growth, but either way you look at it, you have achieved with or without performance or otherwise, you have achieved a base now, and you are going from this higher base, so I'm trying to see if you're being conservative in the guidance for next year, if there are some spending plans, or if you are trying to maybe grow the EPS a little slower, and I have a quick follow-up?

That's our most accurate--remember, we've got the guidance for next year, it's our view of the expected case, and next year, relative to this year, we have this much larger downloading investment going on, so that's one of the factors involved in that.

I think that's a perfect summary.

If we weren't spending upwards of $40 million or more on downloading, let's see, on an after tax basis, that's another $20 million, so instead of looking at $60 million in profits, you're looking at $80 million in profit, and that is maybe more consistent with upper bounds of your expectations predownloading expenditure.

Okay.

Well, that's actually a perfect segue for my follow-up, which is can you give us some at least some qualitative sense of what you need to do, what are you going to spend the $40 million on when you had done some preliminary work on downloading already, and obviously content, as you said, is the key, and that doesn't require a lot of infrastructure build up, so could you give us some sense of what you need to do to get going?

Yes, we'll be--we're able and willing to talk about it in detail, Safe, next quarter on our conference call, so I'll defer your question until then.

Okay.

And we'll go next to Barten Crockett with JP Morgan.

Okay, great, thank you very much.

Wanted to ask a couple of things about a couple of the numbers, and then a larger question about another issue.

The Q4 churn you said should benefit seasonally.

So are you suggesting then, as I understand, the churn rate should be a little bit better than the 4.2% which we saw in the third quarter, that would be kind of the first number question, and then secondly related on the SAC, you're going to be spending more in total on marketing, but does the SAC per gross additionals will go up in the fourth quarter?

So those are two types of number questions.

And then more broadly when we look at the download services that have been launched, in particular Amazon.

They have a number of titles available for download for purchase, a few hundred available for rental.

Is there anything at the they've done that has changed your view of the licensing restrictions that you thought were going to be kind of a content bottle neck?

I was surprised they have so many date and titles available for download, day and date, but of course they are purchase and maybe that's factored into the contracts.

Would you guys expect to have sort of a comparable number of titles available for rental, or maybe comparable to what they have for download available for rental?

Some idea of whether your size would be like what they've come out with.

Thanks.

Sure, on churn and SAC for the past couple of years, we haven't guided to them.

So that doesn't mean we won't give some color on it, but if you look at last year's churn pattern that gives you a sense of the degree of seasonality in the business, Q3 to Q4, and then on SAC, it really depends on how much we're able to grow the marketing investment and still make our profit goals.

So the bigger the more we spend, the marginal 10 million is always spent less efficient than the rest of it.

By definition we go on to spend our most efficient first, so that would tend to drive up average SAC.

So it depends on how much we're able to deploy within the context of our profit goals.

Then you asked on licensing.

There's no surprise in the licensing and what Apple and Amazon have.

It is approximately the same as Movie Link has had for four years now which is a pretty broad set of what the Comcast VOD, or any cable VOD system has.

That's been a pretty stable window.

That's what's there.

You referred to the day and date with DVD which is there for purchase titles.

Again, from my perspective, that's the only focus for Apple, and the main focus for Amazon in terms of title breadth, and that is available at essentially DVD prices at the same time as DVD, so no surprise.

It's consistent with Movie Link licensing over the last couple of years.

Okay.

Great.

So would that be consistent with the selection that you guys would be able to have, you think at the offset?

I know it's hard for us to throw this out about we're spending the money on downloading, but now we're not going to tell you what we're spending it on, but we're going to give you a full briefing next quarter, so I'll have to hold you off like I did Safa and say 90 days we'll give you a full briefing and give you all of the context.

Okay, great, thank you very much.

This is Barry.

Let me just jump in and explain why we mentioned downloading at all, and the expected increase in spending for 2007.

In the context of giving you guidance on earnings so that you wouldn't run away from our own expectations, we anticipated that it would be nearly impossible for you to reconcile to our net income guidance given your projections for subscriber growth and revenue unless you had some perspective on how much money we anticipated spending on digital downloading.

So that's the reason that we mentioned the dollar amount, and we appreciate your patience in waiting until next quart before we put some meat on the bones.

We'll go next to Doug Anmuth with Lehman Brothers.

Thank you.

A few questions.

First one is regarding churn, Reed, you mentioned that you benefited in terms of seasonality during this quarter especially in some of the colder climates.

Can you talk about anything that you were able to do specifically on your own in terms of pulling that lever a little bit, whether maybe it was managing or marketing rather, to existing subscribers a little bit better, anything there?

And then also the second question in terms of your free cash flow, Barry, which you mentioned, looks like you had a $20 million working capital benefit.

Can you talk about the details there, and if there is anything specific in driving that number higher?

Thank you.

On the seasonality, what I said is we anticipated benefiting in Q4 as the northern climates get dark and people stay basically stay at home and watch movies more and cancel at proportionally--slightly smaller rates, so that's what we were focused on.

In terms of separating from what we were able to do, it's pretty hard to separate with any confidence.

That is we improved the service, we added a couple of new distribution centers, we made these improvements on the site, but there's no really scientific way for us to separate the improvements due to that.

So we continue to believe there are good things.

We continue to drive churn down, that we work for it on that basis.

I'll turn it over to Barry on the free cash flow.

With respect to free cash flow, there was nothing out of the ordinary that happened in the quarter.

We happened to benefit from an increase in AP, and you'll notice that was reversal of the prior quarter, which was a reversal of the quarter before that.

So it's following a normal pattern, there's nothing unusual in the business, and next quarter we'll see a big swing in free cash flow again unrelated to AP, but this time related to strong inflow of cash from the sale of gift certificates, which we've lifted the free cash flow boat dramatically in the fourth quarter of last year.

Okay.

Great.

Thank you.

And we'll go next to Jim Friedland with Cowan and Company.

Thanks, a couple of questions.

First on some of the social networking features like friends, can you tell us about what percent of the users use it on a regular basis, or maybe at least users that have been with the service for six months, a year, and then the second question is on the last call, you talked about how even though you have a range of price offerings and the average selling price is going down, that I think you said the majority of gross ads is still going for the three DVD product, is that a correct statement?

Can you talk about how that played out in the third quarter?

Sure.

The three out programs remained our most popular program in Q3.

And then in terms of friends we're really excited about what we've been doing in the improvements on it.

We haven't given for competitive reasons any precise breakdowns on it.

It's growing very nicely, and, one of the great aspects of friends is the viral network nature to it.

So the more people that get in it, the more there is benefits to the other members.

So we're continuing to push on that very aggressively.

And would you say on that, Reed, that the people that use friends regularly churn at a lower rate or--well, I'll just throw that out.

Well, yes, that's definitely true, that those who are active in friends are great customers for us.

The only question is, how much of that is an indicator of fact, and how much of that is causal from friends?

Do you follow what I me by that?

Sure, sure.

So, yes, if it were pure causal, we would be celebrating all day long, because we know some of it is an indicator of those--are people live their lives on the Internet, we continue to work on it but we don't say it's why the churn is lower for them.

We'll take our next question from Tony Wible with Citigroup.

I was curious in your '07 guidance what your assumptions are on postage that are implicit in that?

We're expecting a postage increase, Tony, in the first quarter of next year.

Great, thanks, and on the gift certificates that you guys sell in the fourth quarter, should we expect any kind of holiday promotion, or any special push on the marketing side to try and increase those types of sales?

Sorry I'm just just getting passed a note on my last answer.

I said Q1, and the increase is Q2.

Okay, so like March, April?

May I think we're expecting it.

And on the promotional front for the gift cards, are you guys planning to do anything abnormal there that would increase the sale of those gift products?

Nothing that we haven't done in particularly--in prior years.

Okay, and there's been a couple of I guess technologies proposed for triple layer for HD to handle the duality issue, are you seeing any of the studios pushing any closer to HD now that there's some solution to have one disk that can carry both formats?

No, we haven't seen any move towards those technologies.

The market is reasonably frozen pending PlayStation's arrival.

So if I had to guess, it will be Q1 before we start seeing some movement.

Great.

Last question is just the use of cash.

Any update?

No updates.

Okay.

Thanks a lot, guys.

And we'll go next to Youssef Squali with Jefferies.

Thank you very much.

Congrats, guys.

A couple of questions.

First, Barry, the sequential decline in your RPU or average rate per user is the lowest we've seen in about seven quarters, while you've obviously been pushing lower and lower price plans.

At the same time we've been--we've gotten word today that Blockbuster had cancelled their 599 service, or at least planning on doing that.

Are we seeing a price stabilization across the industry yet?

Well, I can't comment on Blockbuster's plans.

In terms of our subgrowth in the most recent quarter, it was, as we expected, it has been true in prior years, and was true this year that there is, on a sequential basis, a relatively large decrease in RPU--has been relatively large decrease in RPU in the second quarter as compared with the first, and as compared with the third, and that has everything to do with the number of days in the second quarter, and not much to do with structural changes in the business.

I think some investors were concerned that the large decrease last quarter signalled some structural change in the business, but it was a calendar issue, and I think the change this third quarter reaffirms the historical trend that we've previously seen.

Okay, so it's just seasonal.

I guess on a different point, and I don't know if you'll answer this, but on your '07 guidance, $0.76 to $0.83, can you just, yes or no, you've added about--or you're planning--you're on track to add about 2.1 million new users this year.

To get to your 20 million in the 2010-2012 period, at some point you're going to have to see some acceleration in that net ads.

Is it fair to assume that your '07 number subads should be higher than your '06 number?

Well, you do the math correctly, which is the net ads have to continue rising for us to stay on track for 20 million by 2012, so that's a correct assumption.

Okay.

That's helpful.

Thanks.

And we'll go next to Daniel Ernst with Hudson Square Research.

Yes, good evening, thanks for taking the call.

Two questions if I might.

First on the DVD acquisition line, up to 50 million plus in the quarter, almost up a little more than 2X year on year, versus net subgrowth of 22% year on year.

Is there a trend here, or did something happen in the quarter to decouple a trend that you're preparing for a bunch of new releases, or a big subgrowth coming up in the winter months?

Neither, particularly.

We have been working on the inventory state, and improving operating metrics of the business, so we've increased slightly our investment in content, in particular on a year-over-year basis, we've increased in absolute terms the number of DVDs that we acquire directly from studios or are engaged in at least proportionally last quarter less rev share.

So should we assume that this trend continues, or was it more of a catch up here?

The funny thing, Daniel, about watching our content cost is an arbitrary part of it flows through the balance sheet, in terms of DVD purchase, and then a second arbitrary part goes through revenue sharing, goes directly to the P&L.

And they end up from a P&L standpoint if you count the depreciation to be about the same, and we move back and forth between them again depending on studio preference.

So some of what you are seeing was a shift in one or more studios away from rep share between a year ago and now, so therefore we have more purchasing going on, but the total content cost has been very favorable for us over that year.

So, we continue to seek deals that make economic sense for us and you'll see, if you only look at one half of this, i.e. rev share or purchase, you can get thrown off, you really want to sum those two.

Understood.

That helps.

And the second question on RPU, down about 7% year on year, which is relatively modest, in light of the--most of the teaser ads we see run or reports the 599 plan, so obviously there's not a big uptake of those.

Can you give us some sense of what the current distribution is on your plans?

We don't actually disclose it for competitive reasons.

But can you give us a little bit of flavor?

You could do any, approximate split that generated the ASP, and you would not be far off, it's not very sensitive, so take some normal distribution around the ASP and you'll be pretty close.

Okay.

Thanks.

And we'll take our next question from Charles Wolf with Needham.

Yes, hi.

I wanted to ask about your experience in the Bay Area, and what it might say about the--your prospects going nationally.

I was wondering if you could, directionally, is your subscriber acquisition costs in the Bay Area less than they are nationally, and second is the churn rate in the Bay Area less than nationally, or more?

Could you give us a direction on that?

Sure.

We've said in the past, and reaffirmed today, that they're both substantially lower, favorable, both SAC and churn in the Bay Area.

Let me ask a different type of question about the long tale.

In terms of the movies that are being rented, what percentage are new releases, and what percentage are library?

It varies somewhat quarter to quarter depending on what the studios are releasing, generally it's about a third of the shipments are new releases and about two thirds are long tale content.

Thanks a lot.

And we'll go next to Mario Cibelli with Marathon Partners.

Hi, I'm wondering if you guys had any comments about the store in the box concepts that are coming out now like red box and other things like that where you could reserve a copy.

Do you think this a viable business model longer term?

Kiosk businesses, sort of ATM style may well be a viable business.

They certainly seem to be proliferating.

They're very new release focussed so they tend to hold 20 or 30 titles of the big new releases, so in that way fairly complementary to our market, and another squeeze on video stores.

But, again, they seem to be spreading, from all the press reports.

Thanks.

And we'll go next to Chad Bartley with Pacific Crest Investors.

Hi, thank you.

I had one follow-up on the digital side.

I think you've committed before, so can you talk about the pricing model for digital delivery?

Do you expect to offer that under the subscription plan, or will it be something different?

Thanks.

I have to hold you off again until next quarter.

Again, I know it's frustrating for us to dangle this out and not really complete the sentence, but we will complete it next quarter on this call for you.

Okay.

All right.

Thanks.

And we'll go next to Eric Fisher with Broad Mark Asset Management.

Gentlemen, great quarter.

Just had a few questions.

On average postage costs, round trip in the third quarter, could you give us an idea what that is?

Is it $0.74, $0.76?

We don't actually break it down.

We play first class postage each way, and then we have the benefit of some zip code sorting that we do, which gives us some discounts, but we don't get any special breaks with the post office that aren't available to any other company in the United States.

You have a system put in where you get some kind of a break with the sorting system, right?

Yes, we do.

That's what, about $0.015, $0.02, maybe?

You can look up on the USPS website and the variation depends on finely you presort for any presort mailer, but, no, the discounts can go as much as $0.07 if you have enough volume to--and you're willing to spend the time and effort to sort it.

So it can be bigger than that, but of course there's the labor to do that, and then you have to have enough density in any one geography to be able to take advantage of those discounts.

Got you, perfect.

In the rev share cost in the quarterer, I know you don't really break that out, but would you say it was less than the cost component of the DVD amortization in the gross margin?

No comment.

No comment.

SAC for the quarter was that about 4530?

Correct.

And usage about 5.6?

No comment.

How about RPU.

Did you say what that was?

I think we disclosed it.

Okay.

In the release.

Okay.

And then G&A was up about $3 million versus second quarter.

I was just wondering what that was, exactly.

Continuing bill out of the infrastructure.

Thank you.

That is all the time we have for questions today.

At this time, I'll turn the call back over to Mr. Reed Hastings for any closing remarks.

Thank you, everyone.

We look forward to talking to you in the quarter, and again we'll have more details for you on the beginnings of the Internet delivery option for Netflix.

Thank you very much.

That does conclude today's conference.

Thank you for your participation.

You may disconnect at this time.