Netflix, Inc. — Q2 2009 Form 10-Q
Reporting period: Three and six months ended June 30, 2009. Unaudited results; amounts below are in millions of dollars unless otherwise noted. Netflix reported more than 10 million subscribers and operated a U.S. subscription service combining DVD-by-mail with streaming.
Financial and operating performance
| Metric | Q2 2009 | Q2 2008 | Six months 2009 | Six months 2008 |
|---|---|---|---|---|
| Revenue | $408.5 | $337.6 | $802.6 | $663.8 |
| Gross profit / margin | $139.3 / 34.1% | $107.5 / 31.8% | $274.1 / 34.2% | $210.9 / 31.8% |
| Operating income / margin | $52.8 / 13.0% | $34.2 / 10.1% | $89.3 / 11.2% | $49.5 / 7.5% |
| Net income | $32.4 | $26.6 | $54.8 | $39.9 |
| Diluted EPS | $0.54 | $0.42 | $0.91 | $0.62 |
| Operating cash flow | $75.3 | $67.4 | $140.9 | $131.4 |
- Q2 revenue grew 21.0% year over year; net income grew 22.1%. For the first half, revenue rose 20.9% and net income 37.3%.
- At June 30, paid subscribers were 10.375 million, up 26% year over year. Average monthly revenue per paying subscriber declined 3.6% to $13.29 in Q2, while churn rose to 4.5% from 4.2% a year earlier.
- Cash and cash equivalents were $87.5 million and short-term investments were $167.5 million, totaling $255.0 million, versus $297.3 million at year-end 2008. Current assets were $342.6 million and current liabilities $211.2 million.
- Total liabilities were $267.6 million. Lease financing obligations totaled $38.6 million; the filing does not report conventional borrowings. Six-month investing cash outflow was $108.4 million and financing cash outflow was $84.9 million.
Material changes and management commentary
- Subscriber growth drove revenue gains, partly offset by lower average monthly revenue as lower-priced plans grew in popularity. Management expected average monthly revenue per paying subscriber to continue declining until new subscribers’ average plan price matched that of existing subscribers.
- Gross margin improved year over year, which management attributed to lower DVD rentals per subscriber relative to revenue, catalog-title utilization and merchandising improvements; increased streaming-content investment partly offset these benefits.
- Management cited increased postage and packaging costs, including a first-class postage rate increase in May, and higher streaming-content spending. Technology and development costs also rose as the company developed streaming solutions and improved its service.
- Management said operating cash flow and available funds were expected to meet cash needs for the foreseeable future, while noting that financing might be required or chosen. The company continued to invest in content, technology and operations and repurchased approximately $115.2 million of stock during the first half.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Netflix described streaming choices as more limited than its DVD library and expected to broaden streaming content over time. Management expected DVD to remain the primary viewing format for most subscribers for the foreseeable future, while anticipating that Internet delivery would eventually surpass DVD.
- Risks include competition and possible pricing changes; dependence on content availability and consumer-electronics partners; and litigation. The filing disclosed a consumer-marketing class action, consolidated antitrust claims involving Netflix and Walmart, and several patent suits. Netflix obtained summary judgment in its favor in the Lycos matter.
- The filing reports $88.5 million in executed streaming-content license commitments that did not yet meet the criteria for asset recognition. It also describes operating lease commitments and contingent indemnification obligations, for which no maximum potential payment could be reasonably estimated.
- The effective tax rate increased to 38.8% in Q2 from 26.0%, primarily because the prior-year period included a cumulative benefit from earlier R&D tax credits. Short-term investments had $0.855 million of gross unrealized losses; the company did not consider them other-than-temporarily impaired.
- A consumer-electronics partner exercised an option to extend an agreement covering a significant number of streaming devices; Netflix warned that its business could be harmed if partners do not extend agreements on acceptable terms. Management reported effective disclosure controls and no material changes in internal control over financial reporting.
Important facts for investors to verify
- Whether subscriber growth, churn and declining average revenue per paying subscriber continue to support revenue and margin growth.
- The scale, timing and economics of streaming-content commitments, including the $88.5 million not yet recognized as an asset.
- The cash and investment position after buybacks, ongoing content spending and any future repurchases; reconcile the filing’s repurchase-program authorization wording with its reported first-half purchases and remaining authorization.
- Developments and potential financial exposure from the disclosed marketing, antitrust and patent litigation.
- Renewal terms for consumer-electronics distribution agreements and the effect of competition or pricing changes on the subscriber base.