Netflix, Inc. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions unless noted.
Business context
Netflix reported more than 25.5 million total subscribers, including 24.1 million paid subscribers. Its strategy centered on expanding streaming domestically and internationally while investing in content and improving its service. International streaming began in Canada in September 2010.
Financial and operating performance
| Metric | Q2 2011 | Q2 2010 | Change |
|---|---|---|---|
| Revenue | $788.6 million | $519.8 million | +51.7% |
| Gross profit | $298.6 million | $204.9 million | +45.8% |
| Operating income | $115.1 million | $77.3 million | +48.8% |
| Net income | $68.2 million | $43.5 million | +56.7% |
| Diluted EPS | $1.26 | $0.80 | +57.5% |
| Operating cash flow | $86.4 million | $60.3 million | +43.4% |
| Free cash flow (company-defined, non-GAAP) | $59.5 million | $34.2 million | +74.0% |
- Q2 gross margin was approximately 37.9%, versus 39.4% a year earlier; operating margin was 14.6%, versus 14.9%, and net margin was 8.6%, versus 8.4%.
- For the first six months, revenue was $1.507 billion (+48.7%), operating income $217.4 million (+60.2%), net income $128.4 million (+69.5%), diluted EPS $2.37, operating cash flow $202.7 million, and free cash flow $138.8 million (+93.4%).
- Domestic revenue rose 48.1% to $769.7 million. Average domestic paying subscribers increased 58.4%, while monthly revenue per domestic paying subscriber fell 6.5% to $11.49, primarily as lower-priced plans grew.
- Q2 net subscriber additions were 1.961 million, down 45.4% from Q1’s 3.590 million but up 89.7% year over year. Total subscribers grew 70.4% year over year.
- International revenue was $18.9 million in Q2; the segment reported a $10.0 million operating loss. Management expected significant international operating losses for fiscal 2011.
Liquidity, debt, and content obligations
- At June 30, cash and cash equivalents were $175.2 million and short-term investments were $201.2 million. Current assets were $969.4 million versus current liabilities of $726.7 million.
- Long-term debt was $200 million of 8.50% senior notes due in 2017. Netflix reported compliance with the notes’ covenants.
- Six-month investing cash outflow was $108.6 million; financing cash outflow was $113.4 million. Cash declined $19.3 million from year-end to $175.2 million.
- Streaming content obligations totaled $2.437 billion, including $624.5 million due within one year. The filing says additional commitments for titles with unspecified access or variable pricing were not included and were expected to be significant.
- Netflix repurchased 216,000 shares for $51.4 million in Q2; $80.6 million remained under its $300 million authorization.
Material changes, outlook, and risks
- In July 2011, after quarter-end, Netflix separated unlimited streaming and DVD-by-mail into distinct plans. Customers wishing to use both would pay for both, increasing the price versus the prior combined offering. Management warned results could suffer if subscribers did not continue with both services or adopt new plans in sufficient numbers.
- Management planned Latin American expansion in the second half of 2011 and anticipated further international expansion in 2012. It expected revenue to increase year over year, citing subscriber growth and incremental revenue from the pricing changes, while continuing investment in streaming content.
- Streaming content additions were $804.9 million in the first half. The company noted that content investment and payment timing could affect liquidity and operating cash flow.
- Patent infringement and antitrust matters were disclosed as reasonably possible losses, but management said potential loss amounts could not be reasonably estimated; no provisions were recorded. Negotiations with music performing-rights organizations remained uncertain and could lead to litigation.
- Unrecognized tax benefits were $25.4 million at June 30; tax examinations were ongoing, and the company said the balance could change significantly within 12 months, though it could not estimate a range.
Important facts for investors to verify
- Subscriber retention, cancellations, and plan choices following the July separation and pricing changes.
- Whether domestic average revenue per paying subscriber stabilizes or continues to decline as lower-priced streaming plans gain share.
- Growth in streaming content costs, committed obligations, and their cash-payment schedule, including material variable or unspecified title commitments.
- International subscriber growth and losses relative to management’s expansion plans.
- Developments in disclosed litigation, music-rights negotiations, and tax examinations.