Highlights From NFLX's Q4 Q&A Conference Call: Fixed vs. Variable, Competition & International Expansion

Last night, Netflix (NASDAQ: NFLX) reported Q4 EPS of $0.73, $0.18 better than the analyst estimate of $0.55. Q4 sales of $875.6 million vs. the Street estimate of $857 million. Shares are trading at $115.15, up $20.11 (+21.16%) heading into the close.

Sees Q1 sales of $842-$877 million, vs. the consensus of $845.6 million. Sees Q1 2012 loss between -0.16 to -0.49 vs. the Street consensus of -0.29.

Highlights From NFLX's Q4 Q&A Conference Call:

• Can you help us better understand the fixed versus variable components in the content deals you are signing or how the industry is maybe moving more towards variable mechanisms as content owners better understand digital? (A) We have been bidding in an industry that was set up before us by the cable, satellite, and pay television world. So all of our deals are fixed, and that reflects the nature of the market that we're competing in, and it's been like that for 10-plus years.
  
• What is your appetite for bidding against HBO for film studio content in the pay-TV window, when the pay-TV studio deals come up for renewal? Assuming linear and over-the-top rights for those deals are decoupled, would you attempt to acquire both, as you did in the case of DreamWorks? (A) I don't think it's likely that those rights will be decoupled. So we'd be bidding for the - and that's because HBO, as an example, would certainly want both. So if we are to win the bidding, we have to really be willing to bid for both, as we did in DreamWorks, Relativity; and yes, we will continue to be an active bidder in that market.
  
• Are you relatively comfortable with your current levels of content, or is Netflix still on the market for blockbuster-size content deals? Do you anticipate that a potential slowdown in content acquisitions will have a meaningful impact on new subscriber acquisitions? (A) We're rapidly increasing the amount of money that we spend on content domestically and internationally. The only thing that's slightly different is this quarter we are increasing our spend over a year ago over 100%, so it's more than double one year ago. And that year-over-year increase is declining, but it's still a substantial increase on a year-over-year basis all through this year. And the question is are we comfortable with the content. We always want to get more content. That's the virtuous cycle, which is, as we get more subscribers, we're able to get more content, which then helps us get more subscribers. So we'll continue to invest in improving the service by adding more content for a very long time. (A) And just to add on to that, it's not just about expense in adding new content. As we discussed in the letter, that increase in the expense is a somewhat small portion for renewals, but actually is for new content to the service. So it's going to be exciting as we add new titles to the service through 2012.
  
• How should we think about subscription costs as a percent of revenue for 2012 and longer-term (A) Well, that will vary by market and maturity. What we think about it as is contribution margin and contribution profit. And as we talked about, we did better in Q4 than we expected, and so we're taking up our target for 11% for Q1 for contribution margin. In the U.S. In our different international markets, we're still contribution-margin-negative, and the losses will abate in each market as it grows, breaking into contribution-margin-positive. (A) And I think for longer-term, we'll obviously - there's only two buckets. There's content expense and marketing. And so if we're going to expand our contribution margin on profitability long-term, we'd be looking to leverage some of that content long-term as well.
  
• Given that your content purchase deals are based on assumptions of subscribers, did you experience with the price increase and subsequent slowdown in net adds that you have spent more on content than you would have, given all the information you have now? In other words, do you feel like you're in an over-bought position now? (A) We feel great about the content we've got. We don't feel great about the profit stream we have for this quarter. And the impact of the relatively lower subscribers than we thought we would be at is not showing up in the quality of our service, which has continued to be excellent, and for the content to grow, it shows up in our profit stream. We hope to mitigate that, obviously, as we grow the subscriber base over this year and return back to breakeven and continued rapid international expansion.
  
  Looking at Latin America, there are some key differences in terms of income levels and broadband penetration rates. Is there anything about Latin America that indicates the region may achieve profitability faster or slower than a region like Canada? How should we think about the cost of content deals in Latin America compared to the U.S. and Canada? (A) So Latin America, you can infer from our discussion in the earnings letter, both from our net additions in this Q4 for international versus last year is growing slower than Canada did in its first quarter launch. I'd say that we're building a new brand in Latin America, where we had much more of a U.S. halo-brand effect in Canada, and device penetration in Canada was higher than it is in Latin America. Those two things are turning out to be important. So I think Latin America is a good and prospectively a great market for us going forward, but it does look like it's going to be on a path slower to profitability than Canada.And then the second part of your question dealt with - can you ask that one more time?
  
  How do you think about content deals and the cost in Latin America relative to Canada and the U.S.? (A) Sure. So content pricing is related to the value that the owner of that content and the producer of that content can monetize in each different market. It's more specific than even Latin America; it's within a country market. And so relative to Canada, it's hard to answer that question in terms of the content. It would be less if that content owner had fewer monetization options in, say, a Brazil or Mexico than they do in Canada.

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