Netflix, Inc. — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010. Unaudited consolidated results; dollar amounts below are USD millions except per-share data and subscriber metrics.
Business context
Netflix reported more than 15 million subscribers for its combined streaming and DVD-by-mail subscription service. The company said over 61% of subscribers watched more than 15 minutes of streaming content during Q2. It generated all revenue in the United States and planned to launch a streaming subscription service in Canada in the second half of 2010.
Financial and operating performance
| Metric | Q2 2010 | Q2 2009 | Change |
|---|---|---|---|
| Revenue | $519.8 | $408.5 | +27.2% |
| Gross profit / margin | $204.9 / 39.4% | $139.3 / 34.1% | Margin +5.3 percentage points |
| Operating income / margin | $77.3 / 14.9% | $52.8 / 13.0% | — |
| Net income | $43.5 | $32.4 | +34.1% |
| Diluted EPS | $0.80 | $0.54 | +48.1% |
| Operating cash flow | $60.3 | $75.3 | −20.0% |
- For the first half, revenue was $1,013.5 million (+26.3%), net income $75.8 million (+38.3%), diluted EPS $1.39 (+52.7%), and operating cash flow $137.5 million (down from $140.9 million).
- Q2 ended with 15.001 million total subscribers, including 14.577 million paid subscribers; total subscribers were up 41.5% year over year. Q2 churn was 4.0% versus 4.5% a year earlier.
- Average monthly revenue per paying subscriber fell 7.5% year over year to $12.29, primarily as lower-priced plans gained share. Management noted that growth in one- and two-DVD-at-a-time plans more than offset declines in other plans.
- Cash and cash equivalents were $107.3 million and short-term investments $171.8 million at June 30, for combined cash and investments of $279.1 million. Total assets were $694.0 million; current liabilities were $258.2 million.
- Long-term debt was $200.0 million, comprising 8.50% senior notes due 2017; the company reported compliance with debt covenants. Lease financing obligations totaled about $37.2 million, including current and long-term portions.
Changes, outlook, and notable matters
- Year-over-year gross margin increased from 34.1% to 39.4%. Management attributed the improvement mainly to lower DVD content acquisition costs per disc and fewer monthly DVD rentals per average paying subscriber, partly offset by greater streaming-content investment.
- Q2 operating cash flow declined despite higher earnings. The filing cites increased streaming-content additions, delivery and marketing spending, payroll, fulfillment costs, and taxes. Streaming-content acquisitions in operating cash flows were $116.6 million for the first half, compared with $31.4 million a year earlier.
- Marketing expense rose 61.2% year over year in Q2 to $74.5 million; subscriber acquisition cost was $24.37, up 2.1% year over year and 13.1% sequentially. Technology and development expense rose 39.6% to $37.9 million.
- Management expected substantial continued content-library investment, potentially including higher streaming-content spending, and warned that spending growing faster than revenue could reduce gross margin and affect liquidity. It said operating cash flows and available funds were expected to meet cash needs for the foreseeable future, while noting additional financing could be sought or chosen.
- No specific numeric earnings or revenue guidance was provided. The company stated it expected average monthly revenue per paying subscriber to continue declining until new-subscriber pricing converged with that of existing subscribers; future pricing changes and competition could affect results.
- Contractual obligations totaled $923.3 million, including $519.9 million of other purchase obligations, primarily for content. Separately, the company disclosed $228.9 million of streaming-content license commitments not meeting asset-recognition criteria and an additional theatrical-title licensing arrangement with significant but unestimable future fees.
- Legal exposures included patent-infringement matters and consolidated antitrust litigation. Management recorded no loss accrual for the disclosed claims because losses were not considered probable; for several matters, potential losses could not be reasonably estimated. Legal costs were expected to remain high. The company was also negotiating music royalties with performing rights organizations; outcomes were uncertain.
- Netflix repurchased 406,309 shares in Q2 for approximately $44 million. A new $300 million repurchase authorization runs through the end of 2012; $299.2 million remained available at quarter-end. The company had issued $200 million of 8.50% notes in November 2009, contributing to the year-over-year increase in interest expense.
Investor verification priorities
- Track subscriber growth, churn, plan mix, and average revenue per paying subscriber to assess whether subscriber expansion offsets continued price-per-subscriber pressure.
- Monitor streaming-content spending, related commitments, content amortization, gross margin, and operating cash flow; confirm how much of future content obligations is reflected in reported contractual obligations.
- Review liquidity alongside the $200 million notes, lease obligations, repurchases, and any additional financing needs; verify ongoing covenant compliance.
- Follow the Canada launch and its costs, and assess competitive and pricing developments that could affect subscriber acquisition and revenue.
- Check developments in patent and antitrust litigation and music-rights negotiations, including any change in probability, estimability, or potential financial exposure.