Netflix, Inc. — Form 10-Q Summary
Business context and reporting period
Quarter ended September 30, 2013; financial statements are unaudited. Netflix operated Domestic Streaming, International Streaming and Domestic DVD segments, with revenue primarily from monthly memberships. Management’s strategy was to grow streaming domestically and internationally, including through greater content investment.
Financial and operating metrics
All dollar amounts below are in millions except per-share data and member counts.
| Metric | Q3 2013 | Q3 2012 | First nine months 2013 | First nine months 2012 |
|---|---|---|---|---|
| Revenue | $1,106.0 | $905.1 | $3,199.3 | $2,664.0 |
| Operating income | $57.1 | $16.1 | $146.1 | $30.4 |
| Net income | $31.8 | $7.7 | $64.0 | $9.3 |
| Diluted EPS | $0.52 | $0.13 | $1.06 | $0.16 |
| Operating cash flow | $34.7 | $(2.9) | $56.4 | $35.6 |
| Free cash flow (company-defined, non-GAAP) | $7.1 | $(20.5) | $(21.5) | $(7.1) |
At September 30, cash and cash equivalents were $439.1 million and short-term investments were $695.9 million. Long-term debt was $500 million, comprising 5.375% senior notes due 2021; the prior $200 million related-party convertible notes had converted to equity in April 2013. Total assets were $4.90 billion and total liabilities were $3.70 billion.
Streaming content library, net, was $3.39 billion. Total streaming content obligations were $6.51 billion, including $3.7 billion not yet recorded on the balance sheet because recognition criteria were not met. Approximately $2.77 billion of these obligations were due within one year.
Material changes versus comparable periods
- Q3 revenue increased 22% year over year; operating income rose to $57.1 million from $16.1 million and net income to $31.8 million from $7.7 million.
- Domestic Streaming revenue rose 26% to $701.1 million; contribution profit increased to $166.5 million from $95.7 million and margin to 24% from 17%. Paid members reached 29.9 million.
- International Streaming revenue grew 135% to $183.1 million. The segment remained loss-making, with a $74.3 million contribution loss, improved from $92.4 million; paid members reached 8.1 million.
- Domestic DVD revenue fell 18% to $221.9 million as paid members declined 17% to 7.0 million. Contribution profit was $106.7 million, down 18%; contribution margin held at 48%.
- For the first nine months, operating cash flow increased to $56.4 million, but free cash flow was $(21.5) million versus $(7.1) million, chiefly reflecting content cash payments exceeding content expense. Cash and short-term investments rose from $748.1 million at year-end 2012 to $1.135 billion.
- Netflix issued $500 million of 5.375% notes and used part of the proceeds to redeem $200 million of 8.50% notes, recognizing a $25.1 million debt-extinguishment loss. The $200 million zero-coupon convertible notes were converted into approximately 2.3 million shares.
Outlook, commentary, risks and unusual items
- Management expected Domestic Streaming membership to continue growing and projected Q4 2013 contribution margin to be roughly flat with Q3, but higher than Q4 2012. It also expected DVD memberships to continue declining.
- Management expected original-content cash outflows to be less than 10% of total streaming-content payments for 2013. It anticipated significant ongoing content investment and stated available funds were expected to meet cash needs for the foreseeable future, while noting that additional financing might be needed, particularly to fund original-content growth.
- A change in estimate accelerated amortization for certain original content based on updated viewing patterns. Management reported reductions in contribution profit/loss of $20.2 million for Domestic Streaming and $6.5 million for International Streaming; the filing also reported effects on operating income, net income and EPS. Verify the period-specific amounts in the filing, as the wording of the effect disclosure is not fully clear.
- Netflix expected a USPS rate increase to add approximately $3 million to $4 million of expense per quarter in 2014.
- Content licensing obligations, including unrecorded and potentially significant variable-title commitments, create substantial future cash requirements. Ongoing negotiations with performing rights organizations could result in litigation or restrictions on music availability.
- Gross unrecognized tax benefits were $59.7 million; the company was under IRS and California tax examinations and said the balance could change significantly within 12 months, although the potential adjustment range could not be estimated.
- A shareholder derivative case was stayed; management considered a possible loss reasonably possible but could not estimate an amount or range. A separate securities class action was dismissed with prejudice, with judgment entered September 27, 2013.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. It reported no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Period-specific financial impact of the accelerated original-content amortization estimate and its effect on reported earnings and EPS.
- Cash timing and total exposure under the $6.51 billion streaming-content obligations, including commitments excluded from the disclosed total.
- Whether Domestic Streaming margin expansion continues and International Streaming losses narrow as the company expands internationally.
- Free cash flow and liquidity needs as content payments and original-content investment grow, including any need for additional financing.
- Outcomes of performing-rights negotiations, tax examinations and the stayed derivative litigation.