Highlights From NFLX's Q2 Conference Call: Adds 1.8 Million Net Subs; Guides Slightly Below

Netflix, Inc. (NASDAQ: NFLX) reported Q2 EPS of $1.26, $0.15 better than the analyst estimate of $1.11. Revenue for the quarter came in at $789 million versus the consensus estimate of $790.5 million.

Highlights From NFLX's Q2 Conference Call (Q&A Only):

• Adds 1.8 million net subs...Sees Q3 EPS of 72c-$1.07, vs. the consensus of $1.09.
  
• (Q&A) Similar to last quarter, we have organized the questions by topic as we've received them by e-mail this afternoon. We'll start with questions about the pricing changes we announced just two weeks ago. How are you feeling about the price increase two weeks since announcing it? Do expect for some of the subscribers turning off with the pricing increase, that they will return later once they try other alternatives? (A) This is Reed. Like any customer-driven organization, we feel bad about having customers upset with us, but we feel great about the amazing new content we're going to be able to license in the fourth quarter and next year, which will further propel our growth and our subscriber satisfaction. And the price change takes effect upon each subscriber's renewal in September, so we don't have a full-range view of it. But so far from what we've seen, we've been very pleased at the effects and we're feeling great about the decision, as tough as it is, and it's going to allow us to have just fantastic streaming content going forward.
  
• Let me follow up on that. While still early, could you help us understand the initial effects of the subscription plan pricing change? So, the net effect on subscriber growth, churn and ARPU? (A) Because of the timing, we it announced at the very beginning of a quarter, we will see the negative effects of it in Q3, that is, the elevated churn and lower revenue growth than we would otherwise have. Then the price increase takes effect, essentially, mid-September on average. So, we get a little bit of benefit at the end of the quarter and then the real benefit comes in the following quarters, Q4 and beyond. But in terms of tracking where we are and our expectations, we're feeling very good.
  
• Can you tell us what percentage of subscribers have canceled the service? Have you seen subscribers migrate more towards the unlimited streaming plans or towards the DVD plans, or are they opting for both? (A) Well, we're making estimates for the end of the quarter, that's what's in our guidance and we'll see over time what the split is. We feel great when you think about it with our DVD service at $7.99. It's an incredible value, it's the lowest-priced offer in the marketplace, it's the best service levels in the marketplace. So, if a customer wants a DVD rental by mail, we're definitely the place to go. And then in terms of streaming, we've gained increasing confidence over the last two years about the viability and strength of a pure streaming plan. We gained some confidence when we launched in Canada, and that blew away our expectations of the response. We gained some confidence when we led on our non-member homepage with streaming-only and as we put in our shareholder letter, in Q2 about 75% of subscribers chose streaming-only. In other words, even though DVD was only $2 more, 75% stuck with streaming-only. And again, with this pricing change, we're going to be able to strengthen that streaming plan with more content. So, that's why we feel good about it. (A) I'd say just to add onto that, our guidance in the letter shows people the strength of the offerings in the sense that we do feel that most people are taking the hybrid offering. A lot of those hybrid subscribers are staying on both plans and that's implied in both the guidance and the diagram that we put in the letter.
  
• Why lower the price on DVD-only? As subs shift to streaming, the economics of the remaining DVD business would appear to be working against you. Is there a lot less infrastructure for less subs? (A) Well, we didn't lower the price on DVD-only. We never had a DVD-only plan, so the perception of lowering might come from the combination plan which was $9.99 and it was the only way to get DVD. And for someone who's very rural and doesn't have broadband, they were essentially paying that extra $2 for streaming not being able to access it and so we felt great about making a low-priced, aggressively low-priced $7.99 DVD plan and that that was the right plan to carry forward on our DVD side.
  
• Could you explain in more detail the thought process and drivers behind separating the DVD-only business, the start of DVD-only marketing again and looking to improve the service after several quarters of effectively putting that part of your service back-of-mind? (A) One of the aspects that we wanted to get is that the DVD can last a long time as a successful service and generate lots of satisfaction and lots of profits if we give it a platform to succeed on. And it is true that we haven't marketed it much in the next couple of years, but by now having it as a division within Netflix, we've got a way to measure the P&L and we think it will be a smart investment in its growth and sustainability, and whether - growth is probably maybe a bit overstated, that would be an aggressive case, but at least that it will shrink slowly as opposed to rapidly with a little bit of investment. And we'll figure that out over the next couple of quarters. (A) And I think we've always talked about the DVD side of our business in a spectrum of emphasis and focus, and rather than being pushed to the extremes, what we've said is that we focused on streaming, we've proved it out, we've had two quarters to three quarters of tremendous growth and now it's the right time to go back and look at how easy is it to find a DVD service, how easy is it for those subscribers to find what interests them and that's what, I think, this is a step in that progression.
  
• Can you please give us a little bit more color on your Q3 guidance? I was hoping to hear your thoughts on U.S. subscribers? Are you expecting significant cancellations with the new price plan? Are we close to the peak number of subscribers Netflix reasonably hopes to obtain in the U.S.? (A) Well, I think we've answered most of that question in the sense that we've provided pretty clear guidance in addition to providing some streaming versus DVD subscribers guidance. I don't think there's any implication that we're nearing the peak in that and I think that we're expecting Q3 to be a quarter where we have subscribers choosing where they want to land and then Q4 we expect return to growth, as the comments in the letter indicate.

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