Netflix Inc (NFLX) 2008 Q4 法說會逐字稿

Good day, everyone, and welcome to the Netflix fourth quarter 2008 earnings conference.

As a reminder, today's call is being recorded.

For opening remarks and introductions, I would like to turn the conference over to Ms.

Deborah Crawford, Vice President of Investor Relations.

Please go ahead, Ma'am.

Thank you and good afternoon.

Welcome to Netflix fourth quarter 2008 earnings call.

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

We will make 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 filings with the Securities and Exchange Commission including our annual report on Form 10-K, filed with the Commission on February 28, 2008.

We released earnings for the fourth quarter at approximately 1:05 PM Pacific time.

The earnings release, which includes a reconciliation of all non-GAAP financial measures to GAAP, and this conference call are available at the Company's Investor Relations Website at www.netflix.com.

A rebroadcast of this call will be available at the Netflix Website after 5 PM Pacific time today.

Finally, as we noted in the press release we issued earlier today, we are going to conduct the question portion of the Q&A via e-mail.

Please e-mail your questions to me at dcrawford@netflix.com.

And now, I'd like to the call over to Reed.

Thanks, Deborah, and welcome everyone to the call.

Our goal is to grow subscribers and earnings every year, while expanding into Internet-delivered video.

We made great progress against this goal in 2008.

Despite the recession, we grew our subscriber base from 8.7 million to 9.4 million subscribers in Q4.

As you can see from our Q1 guidance, we expect this strong growth to continue in the first quarter.

Paralleling our strong subscriber growth was strong earnings growth, with EPS at $0.38 for the quarter, up 65% from a year ago; at $1.32 for the full year, up 36% from 2007.

The strength of our business allowed us to increase EPS at these rates while, at the same time, substantially increasing our investment levels in Internet-delivered video.

In hindsight, in Q4, we under-forecast our subscriber growth, primarily because we underestimated the positive impact of the introduction of the multifunction CE devices from LG Electronics, Samsung, Microsoft and TiVo that promote Netflix streaming.

The second smaller factor in our outperformance was better-than-expected responses to our marketing.

The precise impact of the recession is unclear, but it's very clear that streaming is energizing our growth.

While our streaming excess is exciting and we will spend some time on that later on this call, we continue to invest in improving our DVD by mail experience.

There is a lot of top and bottom line growth left in online DVD rental.

We expect our DVD and Blu-ray shipments to continue to grow in 2009 as they did in 2008, as we improve our service levels and this general e-commerce acceptance helps us growth despite flatness in the overall DVD and Blu-ray rental.

We think our annual disk shipments will continue to grow every year for many years.

And even in the highly penetrated San Francisco Bay area, our shipments are continuing to grow.

In terms of Blu-ray specifically, about 700,000 of our subscribers were renting Blu-ray from Netflix at the end of Q4 and adoption is growing nicely.

If Blu-ray player prices continue to fall as expected, driven by next generation chip designs, then wide adoption becomes increasingly likely and with it extended life of disk-based viewing.

Our growing scale gives us many operational advantages.

We are now up to nearly 60 distribution centers across America and can provide delivery to over 97% of our subscribers in about one business day.

This quarter, we will be attempting weekend shipping in parts of the country which will provide even faster service, both for those new subscribers who sign up over the weekend and for those subscribers returning movies at the end of the week.

The payoff of this relentless, operational focus is the competitive advantage of continuing high levels of customer satisfaction.

We once again came in on top of [4C] results ranking of customer satisfaction for e-commerce, tied this time at number one with Amazon.

Our success in DVD by mail is driving our earnings growth as well as fueling our Internet delivery.

We are working hard to ensure that our success in DVD by mail continues.

Turning to streaming, in Q4, we substantially increased our investment in streaming content.

And we plan to substantially increase our spending on streaming content in 2009.

We have a basic plan at $4.99 per month that offers some streaming of some content and we have premium unlimited plans starting at $8.99.

One of our content investments is to include Stars Play in all of our premium plans.

Stars Play includes the major films of Sony and Disney.

Most of our streaming spend -- most of our streaming content spending however is directly with TV networks and studios.

We now have over 12,000 movie and TV choices up from [2000, two] years ago and we plan to spend as much money as we can with the studios licensing as much content as we can.

And we are already one of the studio's largest Internet revenue sources.

Our spending is limited away by what content is available at reasonable prices.

And what we can afford in total, given our earnings goals.

Our existing subscribers are watching instantly in ever greater numbers.

And in just the last month, millions of our subscribers got more value from their Netflix subscription by streaming.

The more subscribers watch online from Netflix, the more likely we think they are to remain subscribers and to watch slightly fewer DVDs in a month.

Since we don't have a control group of random subscribers who are not enable for [instant] watching, we can tell you exactly how large these positive effects on churn and disk usage are, but we believe they exist.

Increased streaming content not only helps us with our current subs, but also helps us with CE partnerships.

One of the main reasons LG Electronics, Samsung, Microsoft, TIVO, and others want to offer Netflix streaming to their customers is instant access to compelling content with a promise of even more content to come.

This helps them differentiate their products against non-Netflix-ready devices and adds value to the customer.

The LG Electronics and Samsung Blu-ray players in particular had a very high connect rate during the fourth quarter.

That is, a high percentage of purchasers are subscribing to Netflix.

Xbox and TIVO had a lower percentage, but larger total numbers, due to their software update to their substantial install basis.

While we don't pay or charge anything to have our software included in devices, we do pay our partners to generate new Netflix subscribers.

In other words, some of our marketing dollars are going to our CE partners to help create demand for new Netflix subscribers.

And that is included in our subscriber acquisition cost.

Nearly all the CE-generated subscribers also rent DVDs from Netflix, which really reinforces the importance of the DVD streaming combination subscription.

For the long period, the DVD is relevant to consumers.

If our CE partners can make more money from promoting us than promoting other services because of our broader relevance then we will be able to maintain a preferred placement over time.

We continue to gain new and deeper partnerships with CE manufacturers.

At CES a few weeks ago, Samsung and LG announced the expansion of Netflix into a wider range of their Blu-ray models in 2009.

And to have the Netflix application included directly in some of the LG broadband-connected televisions.

Similarly, we announced our first partnership with Visio to have the Netflix application included in their televisions.

We are in discussions with nearly every major CE company and, one by one, we hope to be able to broadly cover the Blu-ray category and the Internet TV category over the next few years.

In terms of having our Netflix application included in additional video game consoles, we currently have an exclusive deal with Microsoft Xbox.

We have been very busy expanding our CE device partnerships, but we also added support for Apple Computers and improved our PC-based player.

We see the laptop as a significant long-term viewing platform, not as an intermediate step towards something else, and are investing accordingly and continuing to improve our laptop-based player.

Our first CE partner, Roku, recently announced that their devices -- including the installed base of Netflix players -- would be updated to include the Amazon pay-per-view service.

We are fully in support of this and let me explain why.

There are three primary economic models for streaming.

Add supported such as Hulu and You Tube, pay-per-view such as Amazon and Apple, and subscription such as Netflix.

The downside of our CE partners adding the Amazon pay-per-view service is more competition for Netflix, but the competition is pretty indirect because most of the pay-per-view business is in big new releases that we don't offer on streaming subscription.

The upside is that Amazon will also be promoting the streaming CE devices, which provides us more households to stream our service to.

Similarly, CE companies are adding the add supported services to their devices.

The combination of all of these models will accelerate adoption of video streaming.

At some point, the ad supported companies or the pay-per-view company may decide to also provide subscription like Netflix.

The Netflix competitive advantages are that we combine streaming with DVD rental, and that our large subscriber base helps us support more content, and that we are significantly subsidized streaming content for the next few years.

Our intent is to focus exclusively on our subscription model as it is large -- as it is a large enough opportunity for us and we are more likely to prevail by focusing on subscription.

Consumers who subscribe to Netflix also go to movie theaters, buy DVDs, subscribe to cable, use pay-per-view services, watch YouTube and Hulu, and even read DVDs from local stores.

No firm or model owns an entertainment customer and we think there is room for us to create a large subscriber base while other firms also succeed with their model.

All in all, we are making solid progress in our online video efforts.

We are still in investment mode for Internet delivery, but we can see how between the CE partner promotion and the possibly reduced disk usage, we should be able to keep increasing our content investment while, at the same time, growing earnings in accordance with our desires.

In terms of competition, the market for entertainment video remains intense.

DVR-based television continues to grow.

Free ad-supported Internet video services are growing.

Kiosk-based $1.00 DVD rentals continue to grow.

VOD from both cable and the Internet companies is growing, and video stores are only shrinking slowly.

Despite this intense marketplace activity, our consumer proposition is working well.

And we continue to significantly expand our subscriber base.

I will close where I started.

We had a strong fourth quarter capping off a solid year.

We had good growth in our core DVD offering and growing momentum in our instant watching.

We currently expect to hit 10 million subscribers this quarter, which is a wonderful, hugely symbolic milestone of which we are proud.

And now, I'll turn it over to Barry.

Good afternoon and thank you for joining today's call.

Q4 performance will be the focus of my remarks.

I'll also comment on our Q1 and full year 2009 guidance and update you on our stock buyback authorization and repurchase activity.

Sub growth, revenue, SAC, churn, gross margin, net income, EPS, free cash flow.

All these metrics were better than we expected in Q4 especially free cash flow of $51 million, which was more free cash flow than we had produced in all of 2007 -- a new record.

I will provide more detail on the quarter in a moment, but first I want to acknowledge that our October forecast of slowing growth turned out to be wrong.

As Reed indicated our CE partnerships and our expanding library of licensed content has a positive impact on our growth in Q4.

We have been heavily investing in Internet delivery for several years.

And Q4 was the first time we saw the benefits in terms of significantly faster sub growth, lower SAC, more profit, and greater enterprise value.

So let's look at the drivers of Q4 performance in more detail.

Subscriber growth accelerated during the quarter.

And we finished 2008 up 26% on a year-over-year basis.

It was our fourth consecutive quarter of 20 plus percent net sub growth -- remarkable, considering we cut marketing spending on a year-over-year basis by 8%.

The acceleration in sub growth was accompanied by near-record low SAC of $26.67.

In addition to the multi platform growth I just talked about, near-record low SAC was driven by stronger growth across paid acquisition channels and word-of-mouth combined.

As the quarter unfolded, it became clear from the underlying performance of the business that we could drive faster growth with increased marketing spending of $8 million and still meet street expectations for Q4 earnings.

This increased spending helped drive the performance on netting subscribers and we continue to see strong momentum in our business quarter to date.

Gross margin improved 140 basis points year-over-year to 35.2%, despite the 2008 postal rate increase and the growing expense of licensing Internet-delivered content.

With great engineering talent, we continue to improve our Website's ability to merchandise longtail content, which was an important contributor to margin expansion.

The sequential improvement in margins of 100 basis points resulted from the expected seasonal decline in DVD usage in Q4.

Two additional observations about gross margin.

One, we are seeing early signs of less DVD usage with some subscribers, who are also watching instantly as compared to subscribers who only receive DVDs.

Time will tell whether the substitution effect is an attribute of early adopters were a mainstream behavior.

Over the long term, if this substitution effect becomes a mainstream behavior and other things being equal, Netflix profit margins would expand as postage and packaging expense is replaced by streaming expense.

This margin expense would be offset somewhat by higher content cost, which would accelerate revenue growth for our studio partners, a win-win proposition for us and for them.

My second observation is that one of the primary determinants of gross margin for the foreseeable future will be the overall level of investment spending in online content.

The level of spending will be paced by our success with streaming and our determination to continue to deliver strong earnings growth.

As I mentioned in my opening remarks, free cash flow of $51 million was remarkably strong and established a new high watermark for the business.

The largest sequential growth drivers were a $19 million increase in deferred revenue from the sale of gift subscriptions, followed by a working capital increase of $11 million, and higher net income excluding non-cash items such as depreciation and amortization expense of $6 million, offset by a $15 million increase in content spending.

Some of these seasonal factors and timing differences, like the growth in deferred revenues in AP, will reverse themselves in Q1 which brings me to the subject of guidance.

Our Q1 guidance reflects the strong momentum we see in the business today.

The full year guidance assumes a continuing difficult economic climate.

From our perspective, subscriber growth in the back half of the year is subject to greater uncertainty than in prior years, both because of the economic climate and because the increased complexity around Internet streaming.

You have only to look at our forecasting miss in Q4 to see an example of this.

So while our full-year forecast of decelerating net sub growth represents our best and possibly somewhat conservative thinking, we acknowledge that the full year could be much better than we forecast like it was in Q4 or it could be somewhat worse.

Given the rapid growth in the popularity of our stream content as more and more Netflix subscribers are able to consume that content on their TVs, we expect the popularity of our $8.99 subscription plan to continue to grow and SAC to continue to remain below $30.

Our guidance assumes a $0.02 postal rate increase in May of this year.

In the event postal rate increase by less than we forecast, we would likely reinvest some of the savings in growing the business faster.

With or without this added investment, we will grow on a percentage basis our investment in the Internet delivery of movies and TV content significantly faster than the year-over-year percentage growth in revenue.

Over time, we expect this incremental investment to generate faster subscriber growth and potentially lower churn and lower disk usage, as well as more profit and more enterprise value.

As is customary in Q1, we expect to see a sequential decline in gross margin related to seasonal patterns of disk usage.

By way of rebut a reminder, disk usage tends to pick up in Q1, down in Q2 and Q3, and Q4 is lower still.

Gross margins tend to move inversely with disk usage.

At a high level, I would say our core financial objective for 2009 is to grow net income by at least 12%, even as we significantly increase our investment in Internet streaming.

And if we began to outperform our net income forecast, our secondary objective is to reinvest some of the additional profit in even more spending on Internet streaming and/or subscriber acquisition expense to derive future profit growth.

And, finally, I would like to provide an update on our stock buyback program.

During Q4, we repurchased $10 million or 499,000 shares at an average cost of $20.

The balance of the unused authorization, about $50 million, expired on December 31st of last year.

For the full year 2008, we purchased a total of 7.3 million shares, offset by stock option grants and ESP issuance of 1.1 million shares, for a net decrease in outstanding shares of 6.2 million.

Under previous authorizations, we have repurchased a total of 12.1 million shares at a total cost of $300 million, and an average cost of $24.85, reducing our year-end fully diluted share count by 17%.

Today I am pleased to announce the Netflix Board has authorized a new share repurchase program for 2009.

Based on the Board's authorization, we anticipate a repurchase program of up to $175 million.

Future repurchases would be made in accordance with this authorization.

In closing and in summary, Q4 results were better than we expected -- actually much better -- and we continue to see strong momentum in the business today.

We are excited by the early indications that our investment in the Internet delivery of movie and TV content is beginning to bear fruit; and we look forward to talking with you about the performance of the business again next quarter.

So now it is time to answer your questions and as a reminder we would like you to email your questions to Deb Crawford at dcrawford -- with a C -- @netflix.com as you did last quarter.

Deb will read the questions out loud.

Reed and I will do our best to answer them.

So, Deborah, over to you.

Once again if you would like to ask a question please email to dcrawford@netflix.com.

Ms.

Crawford, I will turn the conference back over to you with the first question.

Thank you.

The first question is from Michael Olson at Piper.

What can we expect for the trajectory of Watch Instantly content acquisition?

First part of that question.

As Barry said, we are going to increase the spending faster than revenue growth.

If you are looking for title count, we are trying not to get measured by that because sometimes a single set of big titles makes a bigger difference than 1,000 small titles.

So there's some correlation with title count and it will continue to rise, but what we want to do is have more and more relative content for our subscribers.

And we have made good progress on that to date.

Second question also from Michael Olson -- the revenue and subscriber guidance in Q1 in 2009 is higher than we anticipated.

But EPS guidance is essentially in line.

Can you talk about what expectations are offsetting higher revenue?

Is it Watch Instantly or marketing spend?

Well, difficult for us to respond to changes in our forecast as compared with your expectations since, obviously, we are on slightly different pages.

I'd remind you that as the business grows faster, we also incur marketing expenses associated with the growth in those subscribers and then over the life of those subscribers, we capture value in terms of lifetime profit and enterprise value.

So it may simply be a timing difference.

From Jim Friedland at Cowen.

Are the cuts in G&A from the shutdown of Red Envelope and the recent downsizing of Watch Instantly customer service now behind the Company?

Red Envelope.

Yes.

We're not sure what the other --.

He said downsizing of Watch Instantly customer service.

I think that might be a reference to, we've had in our customer support group, people who had to debug low-level PC issues because our software had low-level PC bugs.

We did a new release of our PC watching client which is substantially free of those errors.

And so we were able to release a number of those technical specialists to customer support.

So I think that is what that's in reference to.

Which is, there wasn't work for them to do that was technical in nature.

The next question is from Rich Ingrassia at Roth.

Do you think you are still pulling the majority of your new subscribers from the pool of current or former Blockbuster members?

If not, from where then?

I don't know that we've ever pulled the majority of our subscribers from current or past Blockbuster subscribers.

I don't perceive a material change in our -- where subscribers come from.

A lot of them, they are multiuse customers.

They do pay-per-view, they buy, they rent, they are involved in media.

So there's no big shift there that we've perceived about where subscribers come from.

Doug Anmuth at Barclays Capital.

Can you talk about the reclassification in the cash flows statement, etc., for streaming content?

Sure.

I've gotten several questions about this.

With the evolution of our acquisition of streaming content, we determined in consultation with our orders that the streaming content should be classified in accordance with FAS 63, which is new; and the portion of the streaming content that is expected to be amortized on a straight line basis over the next 12 months is classified in the current content library.

The acquisition of streaming content is classified as operating activities in the cash flow, different from DVD.

But there's no impact on the income statement or free cash flow.

Srinivas Anantha at Oppenheimer & Co.

I know that the streaming service is currently complementary to the normal suspension service.

But in the future do you plan to launch a dedicated streaming service?

There's definitely a possibility.

There is nothing that prevents us from offering dedicated.

Our view on it is, the bulk of the market is interested in the big new releases and in the subscription and we're able through the DVD combination to provide that.

So it is definitely a possibility for the future.

But we don't think there's a big market there for dedicated streaming -- or streaming only, given the content availability situation, which is roughly 100,000 titles on DVD and about 12,000 on streaming.

The next question is from Colin Sebastian at Lazard.

Do you have any plans to expand Internet delivery from streaming videos into the rental or purchase of digital download?

That's not an area as I went through my comments about pay-per-view and when whether pay-per-view or streaming or download, it's essentially the same thing.

That is really about our brand.

Our brand is really about a monthly entertainment subscription and that's what we're focused on.

So we don't have any plans to be involved in those markets where Amazon, Apple, Blockbuster, a few others play.

Matthew Hart at VanKampen.

Would you ever look to acquire Blockbuster's mail business?

Never say never, but I think those days were big two, three years ago and most people were focused on now is expanding in the streaming direction.

Second question also from Matthew Hart.

What are some of the key technological hurdles preventing broader adoption of streaming?

I don't know if they are really broad technological hurdles but the broad hurdles are just having people get used to it.

First stage is having people watch Internet video on their PC -- their laptop, from You Tube, from Hulu, from CNN, from Netflix.

Second stage is through Internet-baked devices -- game consoles, Blu-ray, TV.

And then what you'll see is more and more content providers follow ABC, CBS, etc., and provide the streaming on the Web.

So the ecosystem is building very nicely; Internet video is on a significant rise and that's bringing in advertisers, subscription, pay-per-view and all the content providers.

So I think we'll see very significant growth in online video over the next five years, and we intend to participate in that.

From Daniel Ernst at Hudson Square.

While I realize it is a small base today, if you look at the base of streaming customers using one of the hardware solutions -- Roku, LG, Samsung, Xbox, TIVO -- what percentage of those subscribers are new to Netflix?

In other words, can you give a sense of the subscriber contribution from those devices?

I'm going to hold off on providing any detail on that for competitive reasons.

Second question from Daniel Ernst.

Despite an increase in subscribers and some new releases like Wall-E and Dark Knight, as well as a larger base of Blu-ray available films, your DVD library acquisition spend was down both sequentially and year over year.

Can you discuss content acquisition spend trends?

Yes, the thing that's confusing there is the difference between rev share and purchase.

So you are looking at the purchase (inaudible) the balance sheet.

And that only tells a percentage of the picture and then, some years depending on what rev share deals we have and how hot the studios are that we have the rev share deals with, you'll see that acquisition line move around.

So it's not a very useful indicator for you.

We are continuing to invest and provide complete DVD availability and we have every Blu-ray that's out, too, from the major studios.

We are very committed to that business and it's on par, I would say, with the last couple of years in terms of where the trends have been.

Tony Wible.

Janney Montgomery Scott.

Are you seeing or do you expect to see any benefit from reduced ad rates for online and/or television?

(Technical Difficulties)

Helps the rest of our marketing work and similarly the more that we spend on marketing, it reinforces all those things with our CE partners and gets people who want Netflix service then, to buy those devices.

So they both reinforce each other in very positive ways.

Michael Olson, Piper Jaffray.

I have a hard time thinking of a reason why a CE partner would not want you incorporate Watch instantly.

Can you talk about any reasons why any potential CE partners have pushed back on Watch Instantly integration?

Also how many additional CE partners can we expect in the next couple of quarters?

That's a good insight that there is really no reason not to include the Netflix offering.

So it has purely been technology which has, some chip platforms are more able to handle the streaming of DRM and some take a little longer in the porting activity.

Some companies perceive it as a high priority to get Netflix in and they will allocate the team early.

Other companies haven't yet seen it as a high priority.

But in all cases, it is not a negative.

It is purely around the amount of work that it takes to get in; and the good news is we are getting better and better as we do more and more of these platforms of making it easier to put in.

So I think you can expect a broader range of partners over the year.

But again, you don't quite want to think about it as -- or strictly not think about it as a number of partners.

You want to think of it as kind of a percentage of devices that are sold.

That is, a few big partners make a bigger difference than a whole lot of smaller ones.

So I think our efforts are focused in the right way.

Heath Terry at Friedman Billings Ramsey.

Does the success of your streaming service renew your interest in expanding internationally?

Is there an important first mover advantage that you would consider in evaluating that decision?

Only slightly does it renew the interest.

You know we would be on the international doing streaming only there and I don't know if there is enough content and a large enough ecosystem to do that.

In terms of first mover damage, I'm sure there are.

We would love to be the first mover in those categories.

I'm not 100% sure we will be.

But for now, we are focused on growing in this very large opportunity in the US and adding, spending more on content and continuing to grow earnings and subscribers in the US.

Derek Brown at Cantor Fitzgerald.

You have mentioned in the past that we should measure, at least in part, your success in the digital realm by the number of Netflix-enabled devices in the market by year-end 2009.

Could you provide us with the aggregate number of Netflix-enabled devices at year-end 2008 and a target for 2009?

We haven't released specific numbers on how many devices.

I think what you've seen in our investments is that we -- our strategy is working.

That is, we are getting in devices and it is manifesting itself positively in the P&L and the more that it manifests itself positively in the P&L, we will be able to ask you to judge us purely by the P&L which is easier for everyone than the indirect of how many partners.

Operator, that's about it.

We would now like to open the call for a few final questions.

Just in case anyone has an additional question, clarification or I missed your question.

Thank you.

(Operator Instructions).

Jim Friedland.

Cowen and Company.

Just a few housekeeping questions.

One, San Francisco Bay Area, penetration in Q4; two is buyback -- is the buyback included in the guidance?

And three, which would you be using for an effective tax rate in '09?

Thanks.

Inverse order, 41%; no comment; and 19.4%, Bay Area penetration, 8.1% penetration; rest of country versus 18.8% in Q3 and 7.4, [respectably].

Okay, great.

Thanks.

Youssef Squali.

Jefferies & Company.

Thank you very much.

Barry, just a quick clarification.

I think you said to -- your answer to a question that was those before that you have not seen any benefit from a lower ad rate in Q4.

I'm just trying to reconcile that.

Anything or everything that we're hearing from ad players out there, online ad players is that at least on the CP inside and, particularly, on nonpremium inventory, where you guys seem to spend a lot of money, we've seen double-digit declines year on year.

And, given the fact that you are one of the top 20 online advertisers out there, how can you not see a benefit?

You know, I put the question to our Chief Marketing Officer in almost exactly the same tone.

And she reminded me that we already buy at low rates in mostly in the remnant market.

So what must be happening is that the trickle down effect hasn't yet hit the remnant space which is already incredibly discounted.

Okay to.

Thanks.

Mark Mahaney with Citi.

Just a quick question on the free trial subs.

I know it is a small number, it did seem to tick up a little bit outside of historical norms.

Any read into that?

Do you view that as significant at all?

That would be the strong momentum through the end of the quarter.

The seasonal growth is very back-end loaded in Q4 and tends to be very front-end loaded at least historically in Q1.

So if you are carrying faster growth into the end of the quarter than you have historically, you'd see a higher proportion of free trials.

Thank you Barry.

Doug Anmuth.

Barclays.

Couple of questions.

First one is just given the overall decline in DVD sales which we saw last year, is there any change to your overall, long-term view that your DVD by mail business peaks between 2013 and 2018?

And then, secondly, you commented on the digital spend as being greater than the revenue growth, most likely in 2009.

How would you characterize the increase in digital spend '09 over '08 versus '08 over '07?

Thanks.

We've done a good job of not commenting actually on how much we've been spending and people tell me you've done a pretty good job of estimating how much we spent.

So we grew it a lot last year and we are going to grow it very fast in the upcoming year.

As we said in -- during our prepared remarks, as much as the P&L will afford us the opportunity to grow it constrained by our target growth in EPS in at least 12% and paced by the success we are seeing in the marketplace.

And then, you asked about DVD length.

Nothing has changed our view that our shipments and rentals will continue to grow and peak some time in 2013 to 2018 as best we can tell.

If I could just follow up with one more.

Barry, do you think that you are being equally conservative in your outlook for '09 as you have been in January of other years?

Or is there it reasonable to think you are being even a little bit more conservative just given the overall macro environment?

I think we clearly are uncertain about what the second half of the year will bring.

I would say.

And on balance I think it would perhaps have tipped the scale slightly more towards conservatism than optimism because the cost of missing is enormous as compared with the upside of [beating].

And as the year progresses, we will have greater visibility into how it unfolds.

I would like to remind everyone that most of the sub growth historically has come in Q2 and Q4, and with very little sub growth in Q2 and a slight acceleration in Q3.

So we may not have a whole lot of visibility until late in about the second half of the year until late in the third quarter.

Of course, Barry meant they are Q1 and Q4 are the top growth.

You said Q2 (multiple speakers).

Excuse me.

Yes.

Q1 and Q4 with not much in Q2 and a slight acceleration in Q3.

Heath Terry, FBR Capital Market.

You mentioned that as you start to see a substitution effect there should be a net impact from the decline in packaging and shipping costs.

Can you give us an idea if there is any impact one way or the other on the content front?

I guess, put more simply, is the revenue share agreement that you have for online different in any meaningful way from the cost of serving disks or the revenue share agreements that you have for your DVD business?

Your question presumes that content is purchased mostly like the -- rights are acquired mostly on a rev share basis in [ED], and there is a combination of fixed and variable just like there is in DVD.

And I would say that the license rights, the variable portion of the license rights, simply because of the nature of the rights that we are acquiring are uniquely different than they are in DVD.

Okay.

Thanks.

Charles Wolf.

Needham & Company.

Do you think your business has actually been helped by the recession in the sense that people are not going to theatres as much and instead substituting Netflix for that experience?

There is no way for us to tell.

We are very thankful that would done so well, but whether that is because of the recession or despite it, there's no strong evidence to either side.

Okay.

Thank you.

I think your answer ran to grow subscriber additions which is the context in which Reed answered it.

I think we probably share the view that in terms of the turn rate that we have seen it, we are seeing an uptick, a slight headwind related to the recession.

So holding all other things constant, in the absence of a recession we would expect to see a lower churn rate and faster net sub growth.

Okay.

Thanks Barry.

Tony Wible.

Janney Montgomery.

Barry, a while ago you talked about this vintage churn concept and I was hoping you could just updates and let us know how that base pool of customers is churning, relatively speaking.

And should we still anticipate that they grow to be a larger portion of the sub base for the overall churn to kind of trend down?

I think you are referring to the base of subscribers we spoke about at the analyst day that has been with us for at least 12 months.

And I think they were at the time of the analyst day roughly 56% of the pay.

And a larger percentage (inaudible) -- I don't know what it is.

And I confess I haven't looked at the turn rate for the subscribers who have been with us 12 plus months, but I don't have any reason to think that it has changed in a significant way then.

It's been very stable for many years.

And I imagine it is now as well.

Okay.

Any update on the number of turns that you are seeing on each individual disk or any change in the breakage rates that you've seen in the most recent quarter or quarters?

No.

I mentioned that seasonally we saw disk usage decline.

I've seen some sellside speculation that with cocooning, usage rates would go up.

I don't think there is any evidence that that is happening.

So the quarter came in about as we expected.

Did that answer your question?

And on the breakage side, are you seeing -- I guess that's what I was more looking at.

Are you seeing any envelopes missing or just how long the disks are lasting?

No real change.

I mean, we make a tiny bit of progress most quarters for the prior quarter.

A lot of hard work, but there's no material -- nothing going on.

And Blu-ray versus standard -- I know a way back you were a little bit -- we didn't know how well Blu-ray's durability would hold up.

It's been comparable to DVD?

It is much stronger than DVD when -- relative to its format introduction.

So when DVD came out, we had a tough situation.

And it took us a couple of years to get ahead of.

We are much smarter now so we are farther down that curve than we were in DVD at this point in the life.

Great.

Thank you.

Andy Hargreaves, Pacific Crest Securities.

Does the expectation for online content acquisition costs to go up quite a bit and (inaudible) any expectations for loosening rights on premium content?

No.

We are not expecting any change in studio windowing or anything dramatic in that way.

So it's a volume issue, not price?

Yes.

I mean, there is a lot of content out there from TV networks and some content from studios and it's just out.

You know we are -- so there's plenty to buy as we give our buying group money.

So it is really just how much can we afford to invest, given our desire to continue to grow total subscriber base, i.e., invest in marketing and grow our earnings.

And am I hearing you right?

That, basically, the margin compression that's embedded into guidance is almost exclusively more content acquisition?

Well, there's a little bit of postal rate, but, yes, that would be other one.

Thank you.

That does conclude today's question and answer session.

At this time I would like to turn the conference over to Mr.

Reed Hastings for any additional or closing comments.

Thank you, everyone, for joining us this afternoon.

To recap and close, the business performed very strongly in Q4 and it looks great quarter to date.

We are really beginning to see the payoff from our investment in Internet-delivered video.

And I look forward to updating you on our continued progress 90 days from now.

Thank you very much.

Again, that does conclude today's conference.

We thank you all for joining us.