Top Investor Questions

Streaming Service

What are your long-term margin targets for domestic streaming?
Your domestic net adds year on year are down, are you reaching saturation in the US market?
Could you add PPV/VOD so you have a more robust content offering and could include new releases?
Why not add additional tiers of content (i.e. premium content for more $ per month)?
What's your FX exposure for International?

International

What impact will upcoming VAT changes have on your international business?
How does content licensing work in international territories? Can you just add on to existing contracts for the U.S. service?
Could margins in the international segment eventually reach domestic levels?
Are there seasonal patterns to international member growth, are they similar to U.S. seasonal patterns?
What lessons have you learned from your Latin America expansion and how does that influence your future choice of markets?
What are the major factors you look for when you pick new international markets?

Content

Why are you moving towards more exclusive content arrangements which must cost more?
How do you evaluate new content deals or renewals?

Streaming Content Accounting

What is the accounting guidance you apply for streaming content?
How do you account for streaming content?
How do you account for original series?
Do you have titles that are not included in Content Library assets even though the titles are available to members?
Do you have any significant amounts that are not included in the Contractual Obligations table even though the contracts are signed?
Where do you report Prepaid Content?
Where is streaming content amortization recorded in the P&L?
Are there other components of streaming content acquisition expenses other than amortization of content library assets?

Originals

How do you measure success of originals?
What percent of your content spend and percent of viewing does originals make up?
Since you've been successful with originals and are increasing your investment in this area, will this increase your overall content spend or does it replace spend on other content deals?

DVD

What will happen to DVD contribution margins?
How long will DVD last?

Miscellaneous

In terms of competition, would people maintain multiple relationships with subscription video providers or just chose one provider?
You've often talked about HBO being a competitor, if they go direct to consumers in the US will this impact your growth or view of your ultimate market size?

What are your long-term margin targets for domestic streaming?

The margin structure we have chosen is to grow content spending plus marketing slightly more slowly than we grow revenue, and in the US to target 400 basis points of contribution margin improvement compared to same quarter of the prior year until we reach 30%, likely in Q1 or Q2 of 2015.  

We will seek to grow margins an average of 200 basis points per year for the following years. Ideally, we will achieve 40% contribution margin five years after achieving 30%. This increase in our domestic contribution margin gives us room to increase content spending as we grow, as well as to provide substantial domestic profitability.

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Your domestic net adds year on year are down, are you reaching saturation in the US market?

As best we can tell, the primary cause is the slightly higher prices we now have compared to a year ago.  Slightly higher prices result in slightly less growth, other things being equal, and this is manifested more clearly in higher adoption markets such as the US. Additionally, we provide our internal forecast for the current quarter.  For the prior three quarters, we under-forecasted membership growth.  This quarter we over-forecasted membership growth.  We’ll continue to give you our internal forecast for the current quarter, and it will be high some of the time and low other times.

There is no change to our view on the long term attractiveness and US market size of Internet television, and no change to our view of the ultimate size of our US membership. 

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Could you add PPV/VOD so you have a more robust content offering and could include new releases?

PPV/VOD isn't  a high margin business as demand is driven by studio new releases with the content owners receiving the lion share of the revenue. It's also a crowded, undifferentiated marketplace with many providers, several of which are valuable partners to us.

Lovefilm in the UK had PPV for years, and they dropped it in mid-2012, so their brand could better be about unlimited viewing for a flat-fee.

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Why not add additional tiers of content (i.e. premium content for more $ per month)?

We have tiers of simultaneous streams (1 stream, 2 streams and 4 streams) but we don't think tiers of content would be wise at this time.

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What's your FX exposure for International?

In general, it’s quite modest.  We engage, generally, in natural hedging, in which our content licenses for international markets are paid in local currency to match the revenue collected from our members.

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What impact will upcoming VAT changes have on your international business?

Starting in January 2015, we have to pay higher VAT in most of Europe due to changes in European law (country of origin to country of destination).  We will absorb these increases rather than pass them on to our members.  This absorption will be reflected in slightly lower international contribution margin/profit starting in Q1 than we would otherwise have.

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How does content licensing work in international territories? Can you just add on to existing contracts for the U.S. service?

In general, content is bid for and licensed on a country by country basis (in some instances, licensing occurs on a regional basis as in Latin America).

In launching our service in a new international market, we must license a content portfolio for that country.

For certain categories, like indie films and Original series, we can enter into multi-territory licensing agreements.

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Could margins in the international segment eventually reach domestic levels?

Each market will have different levels of competition, both for consumer time and for access to content.  In some markets we may eventually reach or surpass domestic contribution margin levels. For example, in Q3’14, contribution margin from our first international market, Canada, now approximates the US.

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Are there seasonal patterns to international member growth, are they similar to U.S. seasonal patterns?

It is still early days in many of our markets, so we are still learning the different seasonal patterns in terms of member growth and viewing on a market-by-market basis.

That said, many of our markets are in the Northern hemisphere and so far exhibit seasonal patterns in terms of viewing and member growth like our U.S. business.  For instance, Q2 is generally a slower quarter for viewing consumption and net member additions and Q4 and Q1 are relatively stronger quarters.

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What lessons have you learned from your Latin America expansion and how does that influence your future choice of markets?

The consumer mistrust around entering methods of payment via a website and the less-developed e-commerce payment infrastructure in general has been more challenging than we anticipated.  We are growing members in the region and continue to make progress on enhancing payment options; it is just harder than we anticipated.

We factor the relative ease of e-commerce payment into our decisions around future expansion markets.

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What are the major factors you look for when you pick new international markets?

We evaluate markets across a variety of dimensions, including:

Broadband infrastructure - including speeds, # of households, projected growth

Content availability and cost

Entertainment consumption & consumer interest

Competitive landscape

E-commerce maturity

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Why are you moving towards more exclusive content arrangements which must cost more?

We want to offer a differentiated service.

We are focused on becoming an expert programmer that provides a high-quality, curated offering and therefore have increasingly licensed content on an exclusive basis.

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How do you evaluate new content deals or renewals?

We utilize detailed statistical models to determine expected hours of viewing for each piece of content over its license period.

We compare cost per hour viewed against other "like" content deals (i.e. exclusive versus non-exclusive, TV versus movies, etc.)

We look for high engagement and cost efficiency.

For renewals, we look to renew content that performs well (based on hours generated relative to the cost) and do not renew content where the price doesn't make sense relative to the value generated.

We feel we have good breadth of content so that no specific title or set of titles is must-renew.

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What is the accounting guidance you apply for streaming content?

We follow the guidance of ASC 920, Entertainment - Broadcasters, which provides the accounting framework  for licensees of films and TV shows as applicable to our business.

The accounting guidance of ASC 926, Entertainment - Films, is currently not applicable to our originals because we license the rights, as opposed to owning them.  In the future, we may explore production arrangements which would include ownership of the content.

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How do you account for streaming content?

We generally license content for a fixed fee and a defined time period with payment terms varying by agreement.

The signing of a license agreement to obtain future titles creates a streaming content obligation which we include in our Contractual Obligations footnote disclosure in our 10Q’s and 10K’s.  If the minimum obligations are quantifiable, the amounts are included in the tabular disclosure. For deals with unknown future output, the obligation is added in the table when the title and its cost become known.

Once a title is made available for us to use on our service, a Content Liability (current for the portion due within one year and non-current for the portion beyond one year) and a Content Library asset are recorded (current for the portion to be amortized within one year and non-current for the portion beyond one year) on the Balance Sheet.

We amortize the license fee for most titles on a straight-line basis over the license period. For original titles, see next question.

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How do you account for original series?

When we started with original content we didn’t have specific data about viewing patterns over time for content that premieres on Netflix.  We decided to use straight line amortization based on our experience with TV series from other networks.  Now we have more specific viewing data for original content which shows more viewing in the early months of a show’s debut, so we are accelerating the amortization of such content commensurately.  We’ll continue to monitor the viewing patterns and adjust the amortization schedule as appropriate and we’ll continue to add a year to the amortization if there is a following season.

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Do you have titles that are not included in Content Library assets even though the titles are available to members?

Yes. Certain titles do not qualify for inclusion in the Content Library under ASC 920 because the associated license fee is not known or reasonably determinable for a specific title.  This typically occurs when the license agreement does not specify the number of titles, the license fee per title or the windows of availability per title.

Our current Epix agreement is an example of this type of arrangement.  A Content Library asset is not recorded, and as such, the expense is not classified as Library Amortization. The content expense is recorded in Cost of Revenues on a straight-line basis over the license period.

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Do you have any significant amounts that are not included in the Contractual Obligations table even though the contracts are signed?

Yes. As discussed above, we have entered into certain license agreements that include an unspecified or a maximum number of titles that we may or may not receive in the future and/or that include pricing contingent upon certain variables, such as  theatrical box office performance.

As of each reporting date, it may be unknown whether we will receive access to these titles or what the ultimate price per title will be. Accordingly such amounts are not reflected in the Contractual Obligations table but they are expected to be significant and the expected timing of payments could range from less than one year to more than five years.  Traditional film output deals like the future output deal with Disney are an example of this type of license agreement. Once we know the title that we will receive and the license fees, we include the amount in the Contractual Obligations table.

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Where do you report Prepaid Content?

It is included in “Other current assets”.

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Where is streaming content amortization recorded in the P&L?

Streaming content amortization is included in content acquisition expenses which comprises the vast majority of our Cost of Revenues.

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Are there other components of streaming content acquisition expenses other than amortization of content library assets?

Yes, but smaller in comparison.  Other components of streaming content acquisition expenses include expenses related to agreements that do not meet library asset classification as well as estimated music right royalties.

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How do you measure success of originals?

We seek reasonable economics relative to other exclusive content on a cost per hour viewed.

We also take into account the impact original series may have on enhancing our brand and attractiveness of our service which helps with member growth.

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What percent of your content spend and percent of viewing does originals make up?

Given the success we've had with our original series, we are increasing our investment in this area.  We expect the % of our content spend on original series to increase over time, however this increased investment replaces spend on other content deals rather than elevating our overall content spend.

Note that cash payments for originals are weighted more up front (relative to P&L) so the percentage of overall global content cash payments spent on originals will be higher than the percentage of P&L expense attributable to originals.

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Since you've been successful with originals and are increasing your investment in this area, will this increase your overall content spend or does it replace spend on other content deals?

Replaces other content spend. However since we are growing content spend, there is room to grow both prior-season and original content.

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What will happen to DVD contribution margins?

The largest costs (postage and content) for the DVD business segment vary with the level of shipments which is determined by the number of subscribers.

So as the segment declines, DVD contribution margins tends to scale with the level of subscribers, outside of the effect of annual increases in postal rates.

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How long will DVD last?

The overall market for DVDs is declining, but there will likely be some persistent level of demand for DVD's, particularly in rural areas where broadband is not easily available or affordable

Additionally, there will be some level of demand from members interested in the tremendous reference library available on DVD.

Our goal is to continue to provide great service levels for our DVD members.

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In terms of competition, would people maintain multiple relationships with subscription video providers or just chose one provider?

Given our increased focus on exclusive content, our service will continue to become even more differentiated.

We compete broadly for time with reading magazines, channel surfing MVPD, playing a video game, browsing the web, doing pay-per-view, and many other activities.

Many people will subscribe to multiple networks, such as HBO and Netflix.

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You've often talked about HBO being a competitor, if they go direct to consumers in the US will this impact your growth or view of your ultimate market size?

Starting back in 2011 we started saying that HBO would be our primary long-term competitor, particularly for content. The competition will drive us both to be better.  It was inevitable and sensible that they would eventually offer their service as a standalone application.  Many people will subscribe to both Netflix and HBO since we have different shows, so we think it is likely we both prosper as consumers move to Internet TV.   

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