• What to Look for in Netflix's Q1 '10 Results Later Today

    Later today Netflix will report its Q1 '10 results which will be closely scrutinized to see if the company's strong momentum has continued following its blowout Q4 '09.  Netflix is easily the most important "over the top" (OTT) contender and recently it announced further moves that will strengthen its position (e.g. launch of Wii streaming, Warner Bros., Universal and Fox 28-day DVD window deals, iPad app, more CE partners and additional indie content).

    In January the company forecasted Q1 ending subscribers would be in a range of 13.5 to 13.8 million, which would represent net sub growth of 1.232 million to 1.532 subs over its Q4 '09 ending 12.268 million subs. The forecasts are a sign of how bullish Netflix management itself is; even the low end would represent the strongest quarterly net sub growth ever. Netflix's best Q1 was in '09 when it added 920K net subs meaning even the low end of the Q1 '10 forecast is 34% higher than the Q1 '09 actual. And a strong Q1 would also bode very well for full 2010 results; historically Q1 represents between 32-41% of Netflix's full year net sub adds.

    As I explained in my Feb post, "It's Official: Netflix has Entered a Virtuous Cycle" there are several other key numbers to zero in on today. First is subscriber acquisition cost (SAC), which is what the company spends to add each new sub. SAC in Q4 '09 was $25.23, the second lowest ever (only Q2 '09 SAC of $23.88 was better). SAC has been falling dramatically (it was $47.46 in Q1 '07). I think this is a direct reflection of the company's unlimited streaming feature becoming better understood and valued as online video viewing has soared and convergence devices have proliferated. A continued decline of SAC in Q1 '10 would be very good news.

    Churn is another number to focus on. In Q4 '09 it was 3.9%, matching the company's all time low. Churn is tightly related to sub growth. If new subs are low quality (e.g. responding to promotional offers, not understanding up-front what to expect, high delinquencies, etc.), churn will increase. If Netflix can sustain sub 4% churn in the face of unusually high sub growth that means sub quality is strong.

    The percentage of subs using its streaming feature for at least 15 minutes/month is yet another number to focus on. In Q4 '09 it was 48%, up from 41% in Q3 '09 and 26% in Q4 '08. I'm sure we'll see an increase in this percentage in Q1 '10, the only question is to what. Last but not least, it will be interesting to see where gross margin comes in. Gross margin ticked up to 38% in Q4 '09, a level not seen since 2006, but it's not clear whether this will be sustained. Benefits of the 28-day DVD deals, which in part reduce the company's cost of acquiring DVDs from these studios will likely not be visible yet in Q1.

    Netflix has a huge amount of momentum in its fundamentals, which the stock market seems to have woken up to recently. The company's stock price closed at $87.07 yesterday, up 58% from its 12/31/09 price of $55.09 and up 71% from $50.97, the level that it was at just prior to when it reported its blowout Q4 results. Investors will no doubt be looking at Q1 results to help justify the stock's big recent move. In particular, if sub growth beats the high end of the forecasted range, it could well trigger another strong move higher for the stock (and no that's not a recommendation to buy). Netflix has a wide open playing field, later today we'll find out how well it continues to capitalize on it.

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