Netflix, Inc. — FY 2010 Form 10-K
Reporting period: Fiscal year ended December 31, 2010; filed February 18, 2011. This is an annual report, not a standalone fourth-quarter filing. Unless stated otherwise, financial amounts below are in U.S. dollars.
Business context
Netflix operated a U.S. subscription service offering streaming and DVDs by mail, and launched streaming-only service in Canada in September 2010. At year-end it reported 20.010 million total subscribers, including 18.268 million paid subscribers. Management said that subscribers watched more content by streaming than by DVD in 2010, and that streaming hours were growing faster than DVD hours.
Key financial and operating metrics
| Metric | FY 2010 | FY 2009 | Change |
|---|---|---|---|
| Revenue | $2,162.6 million | $1,670.3 million | +29.5% |
| Gross profit / gross margin | $805.3 million / 37.2% | $591.0 million / 35.4% | Margin +1.8 percentage points |
| Operating income / margin | $283.6 million / 13.1% | $191.9 million / 11.5% | Income +47.8% |
| Net income | $160.9 million | $115.9 million | +38.8% |
| Diluted EPS | $2.96 | $1.98 | +49.5% |
| Net cash from operations | $276.4 million | $325.1 million | −15.0% |
| Free cash flow (company-defined, non-GAAP) | $131.0 million | $97.1 million | +$33.9 million |
- Revenue growth reflected a 41.3% increase in average paying subscribers, partly offset by an 8.3% decline in average monthly revenue per paying subscriber, to $12.19 from $13.30. Lower-priced plans grew; more than one-third of new subscribers in Q4 chose streaming-only service.
- Year-end subscribers rose 63.1% to 20.010 million from 12.268 million. Net additions were 7.742 million versus 2.878 million in 2009. Subscriber acquisition cost fell to $18.03 from $25.48.
- Gross-margin improvement was attributed mainly to lower DVD content costs per DVD and reduced DVD rentals per average subscriber; higher streaming-content investment partly offset the benefit.
- Cash and short-term investments totaled $350.4 million at year-end, versus $320.2 million a year earlier; working capital was $252.4 million. Cash from operations declined amid increased content, delivery, marketing, payroll, fulfillment and tax spending.
- Debt included $200 million of 8.50% senior notes due 2017. Interest expense rose to $19.6 million from $6.5 million. The company reported compliance with debt covenants.
Material changes and unusual items
- Streaming content commitments expanded substantially. Total contractual obligations were $1.853 billion, including $1.299 billion of content obligations; $651.3 million of all listed obligations was due within one year. Some content agreements and future title costs are not included, and management said excluded amounts could be significant.
- Streaming content library acquisition cash outflow reported in operating activities increased to $406.2 million from $64.2 million. DVD library acquisition cash outflow, classified as investing, decreased to $123.9 million from $193.0 million.
- Stock repurchases were $210.3 million in 2010. Of a $300 million authorization through 2012, $240.6 million remained at year-end. Netflix did not pay cash dividends and reported no present intention to do so in the foreseeable future.
- Quarterly Q4 2010 revenue was $595.9 million and net income was $47.1 million, compared with $444.5 million and $30.9 million, respectively, in Q4 2009. Q4 2010 diluted EPS was $0.87 versus $0.56.
- The 2010 tax provision included an approximately $1.8 million federal R&D credit recorded as a discrete item after the credit was reinstated retroactively. Effective tax rate was 39.9%, compared with 39.7% in 2009.
Outlook, management commentary and risks
Management expected U.S. operating margins to increase in 2011, while international operating margins were expected to be negative as the company invested in expansion. Further international launches were anticipated in the second half of 2011. Netflix expected DVD shipments to be flat to declining in future periods and planned continued investment in streaming content, devices and customer experience. Management said cash from operations and available funds were expected to meet cash needs for the foreseeable future, while noting that financing might still be sought or chosen. The filing does not provide a clear numerical 2011 revenue or earnings forecast.
- Content economics: Multi-year, largely fixed-fee licenses create payment commitments and could pressure liquidity or margins if subscriber and revenue growth fall short. Content providers may withhold, withdraw or reprice streaming rights.
- Competition and subscriber trends: Intense competition, changing viewing habits, cancellations, lower-priced plan mix and possible market saturation could affect subscriber growth, retention and average revenue.
- International execution: Expansion brings regulatory, currency, content-localization, connectivity and operational risks; the Canadian launch was early-stage.
- Technology and distribution: Netflix relied on Amazon Web Services for most computing and said it could not easily switch providers. Outages, cyberattacks, delivery-network issues or changes in network-operator pricing or access could impair service or raise costs.
- Legal and contingent matters: Netflix faced patent claims and a certified antitrust class action involving allegations about its arrangements with Walmart. Management considered potential losses reasonably possible but said amounts or ranges were not reasonably estimable; no accrual was recorded for these matters. Separate negotiations with performing rights organizations over music royalties remained uncertain and could lead to litigation.
- Other exposures: The filing identifies privacy and data-security, intellectual-property, postal-service, tax-audit, and natural-disaster risks. Gross unrecognized tax benefits were $20.7 million, with $1.7 million of accrued interest and penalties; examination outcomes could change the balance.
Important facts for investors to verify
- Whether subscriber additions and retention sustain growth as average revenue per paying subscriber declines and the mix shifts toward streaming-only and lower-priced plans.
- How streaming-content costs, the $1.299 billion of disclosed content obligations, and excluded variable or unspecified title commitments affect cash flow and margins.
- Whether the expected U.S. margin improvement and international expansion proceed as described, including the planned 2011 launches and international losses.
- How much operating cash flow is available after content investment, capital expenditures, debt service and repurchases; note the decline in operating cash flow despite higher reported free cash flow.
- Developments in the antitrust and patent matters, music-royalty negotiations, and tax examinations, for which the filing provides no reliably estimable loss amount or outcome.