Netflix, Inc. — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; unaudited. Comparisons are primarily with Q1 2012. Netflix operated Domestic streaming, International streaming and Domestic DVD segments, deriving revenue from monthly memberships.
Financial and operating results
| Metric | Q1 2013 | Q1 2012 |
|---|---|---|
| Revenue | $1,024.0 million | $869.8 million |
| Operating income (loss) | $31.8 million | $(1.9) million |
| Net income (loss) | $2.7 million | $(4.6) million |
| Diluted EPS | $0.05 | $(0.08) |
| Operating cash flow | $(12.2) million | $19.1 million |
| Free cash flow (non-GAAP) | $(41.5) million | $2.1 million |
Revenue rose 18% year over year, driven by streaming membership growth. Operating income improved, but net income remained modest partly because Netflix recorded a $25.1 million loss on extinguishment of debt. Cost of revenue was $726.9 million; marketing was $129.2 million; technology and development was $92.0 million; and general and administrative expense was $44.1 million. Cash payments for content exceeded content expense by approximately $98 million, a principal factor behind negative free cash flow.
At March 31, cash and cash equivalents were $418.1 million and short-term investments were $607.8 million, totaling approximately $1.026 billion. Total assets were $4.363 billion and total liabilities were $3.550 billion. Current assets were $2.557 billion versus current liabilities of $1.689 billion. Long-term debt included $500 million of 5.375% senior notes due 2021 and $200 million of zero-coupon convertible notes due 2018, held by a related party. Cash increased from $290.3 million at year-end, with financing proceeds from the new notes contributing significantly.
Segments and changes versus prior period
- Domestic streaming: Revenue increased 26% to $638.6 million; period-end members rose 25% to 29.2 million. Contribution profit was $131.4 million and margin expanded to 21% from 14%, as revenue grew faster than content spending.
- International streaming: Revenue rose 227% to $142.0 million; members increased to 7.1 million from 3.1 million. Contribution loss narrowed to $76.9 million from $102.7 million, but the segment remained loss-making as Netflix invested in content and markets.
- Domestic DVD: Revenue declined 24% to $243.3 million and period-end members fell 21% to 8.0 million. Contribution profit decreased 22% to $113.5 million; margin was 47% versus 46%.
- Consolidated contribution profit increased 45% to $167.9 million. Streaming growth more than offset the continuing DVD decline.
Versus Q4 2012, revenue increased 8% and contribution profit increased 23%; operating income rose to $31.8 million from $19.6 million. Free cash flow improved from negative $51.0 million to negative $41.5 million, but remained negative.
Outlook, risks and unusual items
- Management’s stated strategy is to grow streaming domestically and internationally through investment in content, marketing, product experience and device availability. It expects Domestic streaming contribution margins to expand as content and marketing investment grows more slowly than revenue.
- Management expected International streaming losses to remain significant; it did not expect substantial improvement in Q2 2013 contribution losses, anticipating content spending to increase with revenue. DVD memberships were expected to continue declining.
- Netflix expected significant ongoing content investment, including Original programming, and said negative operating cash flows and/or cash use may continue. Management considered available funds and remaining note proceeds sufficient for foreseeable needs, while noting additional financing might be required and could be unavailable on acceptable terms.
- Streaming content obligations totaled $5.672 billion, including $3.3 billion not recorded on the balance sheet because the related titles or fees did not yet qualify for asset recognition. The filing says additional contingent or unspecified-title commitments are expected to be significant and are not included in that total.
- In February 2013, Netflix issued $500 million of 5.375% notes and used proceeds in part to redeem $200 million of 8.50% notes, paying a make-whole premium. After quarter-end, Netflix elected to convert the $200 million related-party convertible notes into approximately 2.3 million common shares.
- Shareholder securities and derivative lawsuits remained pending; management considered potential losses reasonably possible but said amounts could not be reasonably estimated. The SEC notified Netflix and its CEO on April 2, 2013 that it had concluded its investigation and did not intend to recommend enforcement action.
- Tax authorities were examining specified federal and California years. Gross unrecognized tax benefits were $51.9 million at quarter-end; the filing said the possible range of adjustments and timing of payments could not be reliably estimated.
Important facts for investors to verify
- Whether streaming membership and revenue growth can translate into sustained profitability and positive free cash flow, given content payment timing.
- The scale, timing and accounting treatment of the $5.672 billion disclosed streaming content obligations and excluded contingent commitments.
- International contribution losses and the pace of investment required for expansion.
- The effect of the post-quarter convertible-note conversion on share count, ownership dilution and future interest costs.
- Developments in shareholder litigation, music-rights negotiations and tax examinations, for which potential financial exposure was not clearly quantifiable.