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| NFLX > SEC Filings for NFLX > Form 10-Q on 3-Nov-2008 | All Recent SEC Filings |
3-Nov-2008
Quarterly Report
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of the federal securities laws. These forward-looking statements include, but are not limited to, statements regarding: our strategy for delivering streaming content; subscriber growth; operating expenses; interest and other income (expense); liquidity; churn; developments in DVD formats; that the DVD format will continue to be the main vehicle for watching content in the home; the broadening of our distribution capabilities over other platforms; and average revenue per average paying subscriber. These forward-looking statements can be identified by words such as: "will", "anticipate", "intend", "may", "expect" and derivations thereof. These forward-looking statements are subject to risks and uncertainties that could cause actual results and events to differ. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in the Annual Report on Form 10-K for the year ended December 31, 2007 filed with the Securities and Exchange Commission ("SEC") on February 28, 2008, in the Quarterly Reports on Form 10-Q filed with the SEC on May 6, 2008 and August 11, 2008.
We assume no obligation to revise or publicly release any revision to any forward-looking statements contained in this Quarterly Report on Form 10-Q.
Overview
Our Business
We are an online movie rental subscription service in the United States ("U.S."), providing approximately 8.7 million subscribers access to over 100,000 DVD titles plus a growing library of over 12,000 choices that subscribers can watch on their PCs and TVs via Netflix ready devices ("streaming content"). We offer a variety of subscription plans with no due dates, no late fees and no shipping fees. Subscribers select titles at our Web site aided by our proprietary recommendation service, receive them on DVD by U.S. mail and return them to us at their convenience using our prepaid mailers. After a DVD has been returned, we mail the next available DVD in a subscriber's queue. We also offer certain movies and TV episodes that can be watched on subscribers' PCs and TVs via Netflix ready devices. The terms and conditions by which subscribers utilize our service and a more detailed description of how our service works can be found at www.netflix.com/TermsOfUse.
Our core strategy is to grow a large DVD subscription business and expand into streaming content as that market develops. We believe that the DVD format, along with its high definition successor format, Blu-ray Disc, will continue to be the main vehicle for watching content in the home for the foreseeable future, and, by growing a large DVD subscription business, we will be well positioned to transition our subscribers and our business to stream movies and TV episodes if that becomes the preferred consumer medium for accessing content.
Key Business Metrics
Management periodically reviews certain key business metrics within the context of our articulated performance goals in order to evaluate the effectiveness of our operational strategies, allocate resources and maximize the financial performance of our business. The key business metrics include the following:
• Churn: Churn is a monthly measure defined as customer cancellations in the quarter divided by the sum of beginning subscribers and gross subscriber additions, then divided by three months. Management reviews this metric to evaluate whether we are retaining our existing subscribers in accordance with our business plans.
• Subscriber Acquisition Cost: Subscriber acquisition cost is defined as total marketing expense divided by total gross subscriber additions. Management reviews this metric to evaluate how effective our marketing programs are in acquiring new subscribers on an economical basis in the context of estimated subscriber lifetime value.
• Gross Margin: Management reviews gross margin to monitor variable costs and operating efficiency.
Management believes it is useful to monitor these metrics together and not individually as management does not make business decisions based upon any single metric. Please see "Results of Operations" below for further discussion on these key business metrics.
Performance Highlights
The following represents our performance highlights for the three months ended
September 30, 2008, June 30, 2008 and September 30, 2007 and the nine months
ended September 30, 2008 and September 30, 2007:
Three Months Ended Change Nine Months Ended Change
September 30, June 30, September 30, Q3'08 vs. Q3'08 vs September 30, September 30, Q3'08 vs.
2008 2008 2007 Q3'07 Q2'08 2008 2007 Q3'07
(in thousands except per share data, percentages and subscriber acquisition cost)
Revenues $ 341,269 $ 337,614 $ 293,972 16.1 % 1.1 % $ 1,005,066 $ 902,985 11.3 %
Net income 20,371 26,579 15,647 30.2 % (23.4 %) 60,294 50,917 18.4 %
Net income per share - diluted $ 0.33 $ 0.42 $ 0.23 43.5 % (21.4 %) $ 0.95 $ 0.73 30.1 %
Total subscribers at end of period 8,672 8,411 7,028 23.4 % 3.1 % 8,672 7,028 23.4 %
Churn 4.2 % 4.2 % 4.2 % - - - - -
Subscriber acquisition cost $ 32.21 $ 28.89 $ 37.89 (15.0 %) 11.5 % $ 30.18 $ 43.31 (30.3 %)
Gross margin 34.2 % 31.8 % 33.9 % 0.9 % 7.5 % 32.6 % 35.1 % (7.1 %)
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Recent Developments and Initiatives
We continue to make progress in the area of streaming content. We have announced several partnerships with technology and consumer electronics companies that will enable our subscribers to stream content directly to their television sets. These partners include Roku, LG, Microsoft, Samsung, and TiVo. The Netflix Player by Roku as well as LG's BD300 Blu-ray player are currently
available for retail purchase. We continue to increase our streaming content offering as well, including recent additions of content from CBS, Disney and Starz Play.
We believe that recent deterioration in the economy has slowed our growth. We would anticipate that a continued deterioration in the economy or a prolonged recession would slow the rate of subscriber growth or otherwise impact our business, including churn and subscriber acquisition costs.
Critical Accounting Policies and Estimates
There have been no significant changes during the nine months ended September 30, 2008 to the items that we disclosed as our critical accounting policies and estimates in Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2007.
Results of Operations
The following table sets forth, for the periods presented, the line items in our condensed consolidated statements of operations as a percentage of total revenues. The information contained in the table below should be read in conjunction with the condensed consolidated financial statements, notes to the condensed consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations included in this Quarterly Report on Form 10-Q.
Three Months Ended Nine Months Ended
September 30, June 30, September 30, September 30, September 30,
2008 2008 2007 2008 2007
Revenues 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
Cost of revenues:
Subscription 54.7 % 57.4 % 55.6 % 56.5 % 54.9 %
Fulfillment expenses 11.1 % 10.8 % 10.5 % 10.9 % 10.0 %
Total cost of revenues 65.8 % 68.2 % 66.1 % 67.4 % 64.9 %
Gross margin 34.2 % 31.8 % 33.9 % 32.6 % 35.1 %
Operating expenses:
Technology and development 6.8 % 6.6 % 6.2 % 6.5 % 5.9 %
Marketing 14.4 % 11.8 % 16.7 % 14.3 % 18.4 %
General and administrative 3.4 % 4.0 % 4.4 % 3.9 % 4.3 %
Gain on disposal of DVDs (0.4 %) (0.7 %) (0.8 %) (0.4 %) (0.6 %)
Gain on legal settlement - - - - (0.8 %)
Total operating expenses 24.2 % 21.7 % 26.5 % 24.3 % 27.2 %
Operating income 10.0 % 10.1 % 7.4 % 8.3 % 7.9 %
Other income (expense):
Interest expense on lease
financing obligations (0.2 %) (0.2 %) (0.1 %) (0.2 %) (0.1 %)
Interest and other income
(expense) 0.4 % 0.7 % 1.7 % 1.2 % 1.7 %
Income before income taxes 10.2 % 10.6 % 9.0 % 9.3 % 9.5 %
Provision for income taxes 4.2 % 2.7 % 3.7 % 3.3 % 3.9 %
Net income 6.0 % 7.9 % 5.3 % 6.0 % 5.6 %
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Revenues
We currently generate all of our revenues in the United States. We derive
substantially all of our revenues from monthly subscription fees and recognize
subscription revenues ratably over each subscriber's monthly subscription
period.
Three Months Ended Change Nine Months Ended Change
September 30, June 30, September 30, Q3'08 vs. Q3'08 vs September 30, September 30, Q3'08 vs.
2008 2008 2007 Q3'07 Q2'08 2008 2007 Q3'07
(in thousands except percentages and average monthly revenue per paying subscriber)
Revenues $ 341,269 $ 337,614 $ 293,972 16.1 % 1.1 % $ 1,005,066 $ 902,985 11.3 %
Average number of paying
subscribers 8,363 8,169 6,727 24.3 % 2.4 % 8,082 6,595 22.5 %
Average monthly revenue per
paying subscriber $ 13.60 $ 13.78 $ 14.57 (6.7 %) (1.3 %) $ 13.82 $ 15.21 (9.1 %)
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Three and nine months ended September 30, 2008 as compared to the three and nine months ended September 30, 2007
The increase in our revenues during the three and nine months ended September 30, 2008 as compared to the same prior-year periods was primarily a result of the substantial growth in the average number of paying subscribers. This was partly offset by a price reduction for our most popular subscription plans during the second half of 2007 and a decline in the average monthly revenue per paying subscriber resulting from the continued growth of our lower cost subscription plans.
Three months ended September 30, 2008 as compared to the three months ended June 30, 2008
The increase in our revenues during the three months ended September 30, 2008 as compared to the three months ended June 30, 2008 was primarily a result of the growth in the average number of paying subscribers. This was partly offset by a one-time credit of $6.5 million given to subscribers related to a shipping disruption during the quarter.
Churn was flat at 4.2% in the third quarter of 2008, as compared with the second quarter of 2008 and the third quarter of 2007.
We anticipate that the average revenue per paying subscriber will continue to decline until the mix of new subscribers and existing subscribers is approximately equivalent by subscription plan price point.
The following table presents our ending subscriber information:
As of
September 30, June 30, September 30,
2008 2008 2007
(in thousands, except percentages)
Free subscribers 182 176 183
As a percentage of total subscribers 2.1 % 2.1 % 2.6 %
Paid subscribers 8,490 8,235 6,845
As a percentage of total subscribers 97.9 % 97.9 % 97.4 %
Total subscribers 8,672 8,411 7,028
Cost of Revenues
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Subscription
Three Months Ended Change Nine Months Ended Change
September 30, June 30, September 30, Q3'08 vs. Q3'08 vs September 30, September 30, Q3'08 vs.
2008 2008 2007 Q3'07 Q2'08 2008 2007 Q3'07
(in thousands, except percentages)
Subscription $ 186,573 $ 193,769 $ 163,707 14.0 % (3.7 %) $ 567,498 $ 495,734 14.5 %
As a percentage of revenues 54.7 % 57.4 % 55.6 % 56.5 % 54.9 %
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Three and nine months ended September 30, 2008 as compared to the three and nine months ended September 30, 2007
The increase in cost of subscription revenues for the three and nine months ended September 30, 2008 as compared to the same prior-year periods was primarily attributable to the following factors:
• The number of DVDs mailed to paying subscribers increased 23% and 19%, respectively, in the three and nine months ended September 30, 2008, which was driven by an increase in the number of average paying subscribers of 24% and 23%, respectively. This increase was partially offset by a decline in monthly DVD rentals per average paying subscriber attributed to the continued popularity of our lower priced plans.
• Revenue sharing expenses increased by 25% and 10%, respectively, in the three and nine months ended September 30, 2008. This increase was primarily attributable to an increase in the number of DVDs subject to revenue sharing agreements mailed to paying subscribers coupled with the increases in the number of average paying subscribers.
• Content library amortization increased by 9% for the nine months ended September 30, 2008. This increase was primarily due to acquisitions in the content library. The content library amortization for the three months ended September 30, 2008 was relatively flat as compared to the same prior-period.
Three months ended September 30, 2008 as compared to the three months ended June 30, 2008
The decrease in cost of subscription revenues for the three months ended September 30, 2008 as compared to the three months ended June 30, 2008 was primarily attributable to the following factors:
• Content library amortization decreased by 17%. This was primarily attributable to decreased content library acquisitions resulting from a decline in the purchase of new release DVDs.
• Revenue sharing expenses decreased by 5%. This was primarily attributable to a decrease in the number of DVDs subject to revenue sharing agreements mailed to paying subscribers.
• The number of DVDs mailed to paying subscribers increased by 2%. This increase was primarily attributed to the increase in the number of average paying subscribers.
• Postage and packaging expenses increased by 3%. This increase was primarily attributable to the increase in the number of DVDs mailed to paying subscribers, as well as the increase in the rates of first class postage effective May 2008.
Fulfillment Expenses
Three Months Ended Change Nine Months Ended Change
September 30, June 30, September 30, Q3'08 vs. Q3'08 vs September 30, September 30, Q3'08 vs.
2008 2008 2007 Q3'07 Q2'08 2008 2007 Q3'07
(in thousands, except percentages)
Fulfillment expenses $ 37,923 $ 36,318 $ 30,746 23.3 % 4.4 % $ 109,890 $ 90,384 21.6 %
As a percentage of revenues 11.1 % 10.8 % 10.5 % 10.9 % 10.0 %
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Three and nine months ended September 30, 2008 as compared to the three and nine months ended September 30, 2007
The increase in fulfillment expenses for the three and nine months ended September 30, 2008 as compared to the same prior-year periods was primarily attributable to an increase in personnel-related costs resulting from the higher volume of activities in our shipping centers and customer service location, coupled with higher credit card fees as a result of the increase in revenues from subscriptions. In addition, the increase in fulfillment expenses was attributable to additional facility-related costs resulting from the addition of new shipping centers.
Three months ended September 30, 2008 as compared to the three months ended June 30, 2008
The increase in fulfillment expenses for the three months ended September 30, 2008 as compared to the three months ended June 30, 2008 was primarily attributable to an increase in costs for customer service, as well as an increase in depreciation related to equipment used in our shipping centers. In addition, credit card fees increased resulting from the increase in revenues from subscriptions.
Gross Margin
Three Months Ended Nine Months Ended
September 30, June 30, September 30, September 30, September 30,
2008 2008 2007 2008 2007
(in thousands, except percentages)
Gross profit $ 116,773 $ 107,527 $ 99,519 $ 327,678 $ 316,867
Gross margin 34.2 % 31.8 % 33.9 % 32.6 % 35.1 %
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Three and nine months ended September 30, 2008 as compared to the three and nine months ended September 30, 2007
The increase in gross margin for the three months ended September 30, 2008 as compared to the same prior-year period was primarily attributable to a decrease in content spending as a percentage of revenue, partly offset by an increase in postage and packaging expenses as a result of the increase in postage rates effective in May 2008.
The decrease in gross margin for the nine months ended September 30, 2008 as compared to the same prior-year period was primarily attributable to a reduction in the prices of our most popular subscription plans during the second half of 2007 and increases in postage rates effective May 2007 and May 2008.
Three months ended September 30, 2008 as compared to the three months ended June 30, 2008
The increase in gross margin for the three months ended September 30, 2008 as compared to the three months ended June 30, 2008 was primarily attributable to a decrease in content spending as a percentage of revenue, driven by a weak new release calendar. This was partly offset by an increase in postage and packaging expenses resulting from the increase in postage rates effective in May 2008.
Technology and Development
Three Months Ended Change Nine Months Ended Change
September 30, June 30, September 30, Q3'08 vs. Q3'08 vs September 30, September 30, Q3'08 vs.
2008 2008 2007 Q3'07 Q2'08 2008 2007 Q3'07
(in thousands, except percentages)
Technology and development $ 23,368 $ 22,186 $ 18,112 29.0 % 5.3 % $ 65,821 $ 52,526 25.3 %
As a percentage of revenues 6.8 % 6.6 % 6.2 % 6.5 % 5.9 %
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Three and nine months ended September 30, 2008 as compared to the three and nine months ended September 30, 2007
The increase in technology and development expenses for the three and nine months ended September 30, 2008 as compared to the same prior-year periods was primarily attributable to an increase in personnel-related costs due to growth in headcount.
Three months ended September 30, 2008 as compared to the three months ended June 30, 2008
The increase in technology and development expenses during the three months ended September 30, 2008 as compared to the three months ended June 30, 2008 was primarily attributable to an increase in personnel-related costs.
We regularly research and test a variety of potential improvements to our internal hardware and software systems in an effort to improve our productivity and enhance our subscribers' experiences. As a result, we anticipate that our technology and development expenses will increase on a year-over-year basis for the remainder of 2008.
Marketing
Three Months Ended Change Nine Months Ended Change
September 30, June 30, September 30, Q3'08 vs. Q3'08 vs September 30, September 30, Q3'08 vs.
2008 2008 2007 Q3'07 Q2'08 2008 2007 Q3'07
(in thousands, except percentages and subscriber acquisition cost)
Marketing $ 49,217 $ 39,984 $ 49,149 0.1 % 23.1 % $ 144,096 $ 166,508 (13.5 %)
As a percentage of revenues 14.4 % 11.8 % 16.7 % 14.3 % 18.4 %
Other data:
Gross subscriber additions 1,528 1,384 1,297 17.8 % 10.4 % 4,774 3,845 24.2 %
Subscriber acquisition cost $ 32.21 $ 28.89 $ 37.89 (15.0 %) 11.5 % $ 30.18 $ 43.31 (30.3 %)
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Three and nine months ended September 30, 2008 as compared to the three and nine months ended September 30, 2007
Marketing expenses for the three months ended September 30, 2008 as compared to the same prior-year period was relatively flat. The decrease in marketing expenses for the nine months ended September 30, 2008 as compared to the same prior-year period was primarily attributable to a decrease in marketing program spending, primarily in direct mail advertising.
Subscriber acquisition cost decreased for the three and nine months ended September 30, 2008 as compared to the same prior-year periods primarily due to changes in the competitive environment coupled with a decrease in marketing spending to offset, in part, the costs of the price decrease we implemented in the second half of 2007.
Three months ended September 30, 2008 as compared to the three months ended June 30, 2008
The increase in marketing expenses during the three months ended September 30, . . .
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