Netflix, Inc. — Q3 2009 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2009. Unaudited consolidated results. Unless stated otherwise, amounts are in U.S. dollars.
Business context
Netflix operated a U.S. subscription service combining DVDs by mail with streaming movies and TV episodes. At quarter-end it reported 11.109 million total subscribers, including 10.835 million paid subscribers. More than 40% of subscribers watched over 15 minutes of streaming content during Q3.
Key financial metrics
| Metric | Q3 2009 | Q3 2008 | Nine months 2009 | Nine months 2008 |
|---|---|---|---|---|
| Revenue | $423.1 million | $341.3 million | $1,225.7 million | $1,005.1 million |
| Gross profit / margin | $147.8 million / 34.9% | $116.8 million / 34.2% | $421.9 million / 34.4% | $327.7 million / 32.6% |
| Operating income / margin | $49.3 million / 11.6% | $34.1 million / 10.0% | $138.6 million / 11.3% | $83.6 million / 8.3% |
| Net income | $30.1 million | $20.4 million | $84.9 million | $60.3 million |
| Diluted EPS | $0.52 | $0.33 | $1.43 | $0.95 |
| Operating cash flow | $78.3 million | $60.5 million | $219.2 million | $191.9 million |
- Revenue grew 24% year over year in Q3 and 22% for the nine-month period. Growth was driven by average paying-subscriber increases of 26.8% and 25.8%, respectively. Average monthly revenue per paying subscriber declined 2.2% in Q3 to $13.30 and 3.0% year to date to $13.40, reflecting greater adoption of lower-priced plans.
- Q3 total subscribers increased 28.1% year over year to 11.109 million. Churn was 4.4%, versus 4.2% a year earlier; subscriber acquisition cost fell 16.6% to $26.86. For the nine months, churn averaged 4.4% versus 4.1%, and acquisition cost declined 15.2% to $25.58.
- Gross margin improved year over year. Management attributed the Q3 comparison in part to a $6.5 million shipping-disruption credit to subscribers in Q3 2008; catalog-title utilization also supported margins. The nine-month margin benefited from lower subscription cost per subscriber, partly offset by investment in streaming content.
- Cash and cash equivalents were $55.7 million and short-term investments were $99.7 million at September 30, versus $139.9 million and $157.4 million, respectively, at December 31, 2008. Current assets were $235.0 million and current liabilities $203.5 million. Total liabilities were $259.9 million, including $38.3 million of lease financing obligations.
- Year-to-date investing cash outflow was $92.8 million, including $136.0 million in content-library acquisitions and $23.5 million in property and equipment purchases. Financing cash outflow was $210.6 million, primarily reflecting $244.9 million of share repurchases.
Changes, outlook and management commentary
- Operating income rose 44.7% in Q3 and 65.8% year to date; net income rose 48.0% and 40.9%, respectively. The nine-month effective tax rate increased to 39.7% from 35.4%, mainly because the prior-year period included a cumulative benefit for earlier R&D credits.
- Marketing expense increased 19% year over year in Q3, while technology and development expense increased 28.4%, including $1 million for the Netflix Prize and higher streaming-related personnel costs. Q3 general and administrative expense included a $2 million release of accruals related to a previously settled class action.
- Management expected device availability to support subscriber growth, while noting average monthly revenue per subscriber could continue to decline as lower-priced plans gain share. It expected substantial continued content investment, particularly in streaming, which could reduce gross margin if spending grows faster than subscribers. No specific numerical earnings or revenue guidance was provided.
- Netflix stated cash from operations and available funds were expected to meet cash needs for the foreseeable future, while noting financing needs could change. It entered into a $100 million, three-year revolving credit facility; no amounts were drawn at September 30, and $20 million was borrowed in October 2009. The facility includes financial covenants, with which Netflix was compliant at quarter-end.
- The company authorized a $300 million repurchase program through the end of 2010. It repurchased approximately $70 million under that program through September 30 and a further $52 million afterward. Buybacks were a major use of cash and contributed to lower cash balances and investment income.
Risks, contingencies and unusual items
- Streaming-content license commitments of $102 million had been signed but were not yet eligible for balance-sheet recognition. These are commitments, not recorded content assets at quarter-end.
- Disclosed litigation included patent-infringement cases, a consumer-marketing class action, and consolidated antitrust claims alleging an agreement with Walmart concerning DVD sales and rentals. Outcomes and potential damages were uncertain; the filing did not provide a clear estimate of exposure.
- Netflix identified risks involving consumer-electronics partners’ willingness to renew or maintain agreements on acceptable terms; a Postal Regulatory Commission complaint that could lead to changes affecting mail processing; and studios’ potential delays or restrictions on new-release DVD rentals.
- Short-term investments had $471,000 of gross unrealized losses at quarter-end, including $394,000 on securities in a loss position for at least 12 months. Management did not consider these investments other-than-temporarily impaired and reported no material 2009 or 2008 other-than-temporary impairments or credit losses.
- The filing reported no material change in previously disclosed risk factors other than the items described above, and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether subscriber growth and streaming engagement continue to offset declining average revenue per paying subscriber.
- Whether increased streaming-content spending can be supported without eroding gross margin or operating cash generation.
- Cash and investment balances, post-quarter borrowing, facility covenants, and the scale and pace of share repurchases.
- Developments in the disclosed litigation, content-license commitments, partner agreements, postal issues, and studio release practices.
- The filing’s stated outlook is qualitative; verify subsequent guidance and actual results against management’s expectations.