10-Q/APeriod: Q3 FY2011

NETFLIX INC Quarterly Report (Amendment) for Q3 Ended Sep 30, 2011

Filed November 7, 2011For Securities:NFLX

Summary

Netflix, Inc.'s (NFLX) Q3 2011 filing, though an amendment to correct a minor detail, reveals significant operational shifts and investor concerns. The company experienced a notable decline in domestic subscriber growth and an increase in churn rates following controversial changes to its service plans and pricing structure, including the separation of DVD and streaming services. Despite this, overall revenues saw an increase driven by international expansion and a prior year comparison. However, the company anticipates consolidated net losses and negative operating cash flows in the coming periods due to continued international investment and the impact of subscriber attrition. Financially, revenues increased year-over-year driven by subscriber growth, but operating expenses, particularly in technology and development, rose significantly. The company's balance sheet shows a substantial increase in its content library, reflecting ongoing investments in streaming content. While the company has substantial contractual obligations, particularly for streaming content, it maintains a significant cash position. Investors should monitor subscriber trends, international expansion costs, and the company's ability to regain positive consumer sentiment.

Financial Highlights

46 data points
Beta

Revenue

$821.84M

34.7% Gross Margin

Net Income

$62.46M

7.6% Net Margin

EPS (Diluted)

$0.02

Total Assets

$1.96B

Cash & Equivalents

$159.20M

Free Cash Flow

$35.45M

Financial Statements
Beta
Revenue$821.84M
Cost of Revenue$536.62M
Gross Profit$285.22M
R&D Expenses$69.48M
Operating Expenses$188.38M
Operating Income$96.84M
Interest Expense$4.92M
Net Income$62.46M
EPS (Basic)$0.02
EPS (Diluted)$0.02
Shares Outstanding (Basic)3.68B
Shares Outstanding (Diluted)3.77B

Key Highlights

  • 1Revenue increased by 48.6% year-over-year to $821.8 million for the third quarter of 2011, driven by a 51.5% growth in domestic average paying subscribers.
  • 2Despite revenue growth, domestic subscribers experienced a net loss of 0.8 million in Q3 2011 due to increased churn (6.3%) and declining gross additions following controversial pricing and service separation announcements.
  • 3Technology and development expenses increased by 65.0% year-over-year, largely due to a 63% increase in personnel costs to support service improvements and international expansion.
  • 4The content library, particularly streaming content, saw a substantial increase, with gross streaming content library at $1.63 billion as of September 30, 2011, up from $441.6 million at the end of 2010.
  • 5The company anticipates consolidated net losses and negative operating cash flows in future periods due to international expansion costs and subscriber attrition.
  • 6Stock repurchases slowed significantly, with only $39.6 million repurchased in Q3 2011, and the company indicated it does not expect further repurchases in the near future due to anticipated negative cash flows.

Frequently Asked Questions

The significant increase in subscriber churn (to 6.3%) and the net loss of domestic subscribers were primarily attributed to the company's controversial announcement in July 2011 to separate its unlimited DVD-by-mail and unlimited streaming services, leading to a price increase for customers using both. This, along with a subsequent rebranding announcement that was later retracted, resulted in negative consumer sentiment and higher-than-expected customer cancellations.

Netflix is making substantial investments in its streaming content library. Additions to the streaming content library were $1.34 billion for the first nine months of 2011, and the total streaming content library gross asset was $1.63 billion as of September 30, 2011. This significant investment is reflected in higher 'Cost of subscription' expenses, which increased by 61.4% year-over-year for Q3 2011, and also contributes to increased 'Other non-current liabilities' related to content obligations.

Netflix anticipates consolidated net losses and negative operating cash flows in future periods. This outlook is driven by the ongoing investments in international expansion, particularly in the UK and Ireland, and the impact of increased subscriber cancellations and migration to lower-priced plans. The company stated it expects flat consolidated revenue until positive net subscriber additions are achieved.

Netflix is involved in several litigation matters, including patent infringement claims and anti-trust class action suits. However, for the matters disclosed, management has determined that a probable loss is not incurred, and while losses are considered reasonably possible, the amount is not reasonably estimable at this time. The company does not believe these proceedings will have a material adverse effect on its financial position, liquidity, or results of operations, though this view could change as litigation unfolds.