Netflix, Inc. — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011; balance sheet compared with December 31, 2010. Financial statements are unaudited. Unless noted, amounts are U.S. dollars.
Business context
Netflix reported 23.6 million total subscribers, up 69% year over year, and described its core strategy as growing streaming subscriptions domestically and internationally. The U.S. service combined streaming and DVD-by-mail plans; Canada, launched in September 2010, offered streaming-only service. Management viewed DVD as a fading differentiator while continuing to seek a profitable DVD business.
Financial and operating performance
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Revenue | $718.6 million | $493.7 million | +45.6% |
| Gross profit / margin | $280.4 million / 39.0% | $186.5 million / 37.8% | Margin +1.2 points |
| Operating income / margin | $102.2 million / 14.2% | $58.3 million / 11.8% | Income +75.2% |
| Net income | $60.2 million | $32.3 million | +86.6% |
| Diluted EPS | $1.11 | $0.59 | +88.1% |
| Operating cash flow | $116.3 million | $77.2 million | +50.7% |
| Company-defined free cash flow | $79.3 million | $37.6 million | +111% approximately |
Revenue growth reflected a 54.2% increase in average domestic paying subscribers, partly offset by a 7.2% decline in domestic average monthly revenue per paying subscriber, to $11.97, as lower-priced plans gained share. Domestic subscribers were 22.8 million; international subscribers were 803,000. International revenue was $12.3 million and segment operating loss was $10.7 million.
Cost of subscription revenue rose 45.2%, largely from streaming-content licensing. Marketing expense rose 38.6%, while domestic subscriber acquisition cost fell 33.2% year over year to $14.38; reported domestic churn was 3.9%. Approximately 90% of domestic subscribers were on streaming-only or one- or two-DVD plans by quarter-end.
At March 31, cash and cash equivalents were $150.4 million and short-term investments were $192.3 million. Current assets were $721.6 million and current liabilities $490.3 million. Total assets were $1.09 billion; total liabilities were $814.5 million. Long-term debt was $200 million, consisting of 8.50% senior notes due November 2017; the company reported compliance with debt covenants. Operating, investing and financing cash flows were respectively $116.3 million, $(73.7) million and $(86.7) million; cash declined $44.1 million during the quarter. The company repurchased $108.6 million of stock.
Changes versus prior periods
- Year-over-year subscriber growth and higher streaming activity supported strong revenue and earnings growth; gross and operating margins also improved.
- Domestic average monthly revenue per paying subscriber declined year over year, driven by the expanding mix of lower-priced plans. Compared with Q4 2010, it increased 2.5% to $11.97, partly reflecting a January 2011 price increase; management expected it to resume a slight decline as streaming-only plans grew.
- Streaming-content investment increased materially: streaming content library acquisition in operating cash-flow reconciliation was $192.3 million versus $50.5 million a year earlier. Management cited content licensing as the principal driver of higher subscription costs.
- Compared with Q1 2010, free cash flow improved, but content payments exceeded content expense by $20.1 million. The company’s non-GAAP free cash flow measure excludes cash flows from purchases and sales of short-term investments.
Outlook, risks and unusual items
- Management anticipated entering another international market in the second half of 2011, expected DVD shipments to be flat to declining, and expected lower-priced plans to continue gaining share. No specific numerical earnings or revenue guidance was provided.
- Management expected substantial continuing content investment, particularly for streaming, which could affect liquidity and operating cash flows. It said cash from operations and available funds were expected to meet cash needs for the foreseeable future, while noting additional financing could be required or chosen.
- Contractual obligations totaled $2.39 billion, including $1.84 billion of content obligations; $754.5 million was scheduled within one year. Separately, streaming license commitments not meeting content-library recognition criteria were $1.634 billion. Further title commitments with unspecified quantities or contingent pricing were not quantified and were expected to be significant.
- Pending risks included patent litigation and customer antitrust litigation. Management considered potential losses reasonably possible but not probable and said loss amounts or ranges were not reasonably estimable; no accruals were recorded for the described cases. Netflix was not part of Walmart’s revised settlement agreement in principle with Netflix plaintiffs and continued litigating.
- The company was under IRS examination for 2008–2009 and California examination for 2006–2007. Gross unrecognized tax benefits were $22.6 million, with $18.5 million potentially favorable to earnings if recognized; management could not estimate the range of possible adjustments over the next 12 months.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. The filing stated there were no material changes to previously disclosed risk factors.
Key facts for investors to verify
- Whether streaming subscriber growth and content licensing costs sustain improved margins and cash generation.
- How subscriber plan mix, average revenue per paying subscriber, churn and acquisition cost evolve, including the effects of pricing and free trials.
- The timing and ultimate cash cost of content commitments, including unquantified or variable-title agreements.
- International expansion costs, subscriber growth and progress toward segment profitability.
- Developments in the antitrust, patent and tax matters, and any resulting changes to contingent-loss or tax estimates.
- Future capital allocation: the company had $132.0 million remaining under its $300 million repurchase authorization at quarter-end, alongside substantial content obligations.