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| NFLX > SEC Filings for NFLX > Form 10-Q on 31-Jul-2009 | All Recent SEC Filings |
31-Jul-2009
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 the breadth of content choices available to us, our competitive advantage, increasing content choices for streaming, the availability of electronic equipment that will enable streamed content, the continued popularity of the DVD format, expectations on the growth of Internet delivery of content, and our liquidity. 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, 2008 filed with the Securities and Exchange Commission on February 25, 2009, in the Quarterly Report on Form 10-Q filed with the SEC on May 8, 2009, and in the other Quarterly Reports on Form 10-Q to be filed by us in 2009.
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
With more than 10 million subscribers, we are the largest online movie rental subscription service in the United States. We offer a variety of subscription plans, with no due dates, no late fees, no shipping fees and no pay-per-view fees. We provide subscribers access to over 100,000 DVD and Blu-ray titles and more than 12,000 streaming content choices. Subscribers select titles at our Web site aided by our proprietary recommendation service and merchandising tools. Subscribers can:
• Receive DVD's 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.
• Watch streaming content without commercial interruption on personal computers ("PCs"), Intel-based Macintosh computers ("Macs") and televisions ("TVs"). The viewing experience is enabled by Netflix controlled software that can run on a variety of devices. These devices include PCs, Macs, Internet connected Blu-ray players, such as those manufactured by LG Electronics and Samsung, set-top boxes, such as TiVo and the Roku Player, game consoles, such as Microsoft's Xbox 360, and TVs from Sony and LG Electronics.
Our core strategy is to grow a large subscription business consisting of DVD by mail and streaming content. We offer over 100,000 titles on DVD. In comparison, the 12,000 content choices available for streaming are relatively limited. We expect to substantially broaden the content choices as more content becomes available to us. Until such time, by bundling DVD and streaming as part of the Netflix subscription, we are able to offer subscribers a uniquely comprehensive selection of movies for one low monthly price. We believe this creates a competitive advantage as compared to a streaming only subscription service. This advantage will diminish over time as more content becomes available over the Internet from competing services, by which time we expect to have further developed our other advantages such as brand, distribution, and our proprietary merchandising platform. Despite the growing popularity of Internet delivered content, we expect that standard definition DVD, along with its high definition successor, Blu-ray (collectively referred to in this Quarterly Report as "DVD"), will continue to be the primary means by which most Netflix subscribers view content for the foreseeable future. However, at some point in the future, we expect that Internet delivery of content directly to the home will surpass DVD.
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
June 30, 2009, March 31, 2009 and June 30, 2008 and the six months ended
June 30, 2009 and June 30, 2008:
Three Months Ended Change
June 30, March 31, June 30, Q2'09 vs. Q2'09 vs.
2009 2009 2008 Q2'08 Q1'09
(in thousands, except per share data,
percentages and subscriber acquisition cost)
Revenues $ 408,509 $ 394,098 $ 337,614 21.0 % 3.7 %
Net income 32,443 22,363 26,579 22.1 % 45.1 %
Net income per share - diluted $ 0.54 $ 0.37 $ 0.42 28.6 % 45.9 %
Total subscribers at end of period 10,599 10,310 8,411 26.0 % 2.8 %
Churn 4.5 % 4.2 % 4.2 % 7.1 % 7.1 %
Subscriber acquisition cost $ 23.88 $ 25.79 $ 28.89 (17.3 )% (7.4 )%
Gross margin 34.1 % 34.2 % 31.8 % 7.2 % (0.3 )%
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Six Months Ended Change
June 30, June 30, YTD'09 vs
2009 2008 YTD'08
(in thousands, except per share data,
percentages and subscriber acquisition cost)
Revenues $ 802,607 $ 663,797 20.9 %
Net income 54,806 39,923 37.3 %
Net income per share - diluted $ 0.91 $ 0.62 46.8 %
Total subscribers at end of period 10,599 8,411 26.0 %
Churn* 4.3 % 4.1 % 4.9 %
Subscriber acquisition cost $ 24.94 $ 29.23 (14.7 )%
Gross margin 34.2 % 31.8 % 7.5 %
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* Churn for the six months ended June 30, 2009 and 2008 is the average of Churn for the two quarters of the respective period.
Critical Accounting Policies and Estimates
There have been no significant changes during the six months ended June 30, 2009 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, 2008.
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 Six Months Ended
June 30, March 31, June 30, June 30, June 30,
2009 2009 2008 2009 2008
Revenues 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
Cost of revenues:
Subscription 55.0 % 54.6 % 57.4 % 54.8 % 57.4 %
Fulfillment expenses 10.9 % 11.2 % 10.8 % 11.0 % 10.8 %
Total cost of revenues 65.9 % 65.8 % 68.2 % 65.8 % 68.2 %
Gross profit 34.1 % 34.2 % 31.8 % 34.2 % 31.8 %
Operating expenses:
Technology and development 6.6 % 6.1 % 6.6 % 6.4 % 6.4 %
Marketing 11.3 % 15.8 % 11.8 % 13.5 % 14.3 %
General and administrative 3.2 % 3.3 % 4.0 % 3.3 % 4.1 %
Gain on disposal of DVDs - (0.2 )% (0.7 )% (0.2 )% (0.5 )%
Total operating expenses 21.1 % 25.0 % 21.7 % 23.0 % 24.3 %
Operating income 13.0 % 9.2 % 10.1 % 11.2 % 7.5 %
Other income (expense):
Interest expense on lease financing
obligations (0.2 )% (0.2 )% (0.2 )% (0.2 )% (0.2 )%
Interest and other income (expense) 0.2 % 0.5 % 0.7 % 0.3 % 1.5 %
Income before income taxes 13.0 % 9.5 % 10.6 % 11.3 % 8.8 %
Provision for income taxes 5.0 % 3.8 % 2.8 % 4.4 % 2.8 %
Net income 8.0 % 5.7 % 7.8 % 6.9 % 6.0 %
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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. We record refunds to subscribers as a reduction of revenues.
We offer a variety of subscription plans for DVD rental and streaming service. The price per plan varies based on the number of DVD's that a subscriber has out at any given point and based on whether the service has limited or unlimited usage. All of our unlimited plans allow the subscriber unlimited streaming to their computer or Netflix ready device. The vast majority of our subscriber base has chosen a 1, 2 or 3-out Unlimited plan. Customers electing access to the high definition Blu-ray discs in addition to standard definition DVD's pay a surcharge of $1 to $4 for our most popular plans. Pricing of our plans is as follows:
Price per
month
1-out Limited $ 4.99
1-out Unlimited 8.99
2-out Unlimited 13.99
3-out Unlimited 16.99
All other Unlimited Plans 23.99 to 47.99
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The following table presents our ending subscriber information:
As of
June 30, March 31, June 30,
2009 2009 2008
(in thousands, except percentages)
Free subscribers 224 194 176
As a percentage of total subscribers 2.1 % 1.9 % 2.1 %
Paid subscribers 10,375 10,116 8,235
As a percentage of total subscribers 97.9 % 98.1 % 97.9 %
Total subscribers 10,599 10,310 8,411
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Three months ended June 30, 2009 as compared to the three months ended June 30, 2008
Three Months Ended Change
June 30, June 30, Q2'09 vs.
2009 2008 Q2'08
(in thousands except percentages and
average monthly revenue per paying subscriber)
Revenues $ 408,509 $ 337,614 21.0 %
Other data:
Average number of paying subscribers 10,246 8,169 25.4 %
Average monthly revenue per paying
subscriber $ 13.29 $ 13.78 (3.6 )%
|
The $70.9 million increase in our revenues was primarily a result of the 25.4% growth in the average number of paying subscribers. This increase was partially offset by a 3.6% decline in the average monthly revenue per paying subscriber to $13.29, resulting from the growing popularity of our lower priced subscription plans. The total number of average paying subscribers in our 1 and 2-out plans grew by 41.5% year over year as compared to a 3.5% growth in all other plans.
Six months ended June 30, 2009 as compared to the six months ended June 30, 2008
Six Months Ended Change
June 30, June 30, YTD'09 vs.
2009 2008 YTD'08
(in thousands except percentages and
average monthly revenue per paying subscriber)
Revenues $ 802,607 $ 663,797 20.9 %
Other data:
Average number of paying subscribers 9,943 7,942 25.2 %
Average monthly revenue per paying
subscriber $ 13.45 $ 13.93 (3.4 )%
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The $138.8 million increase in our revenues was primarily a result of the 25.2% growth in the average number of paying subscribers. This increase was partially offset by a 3.4% decline in the average monthly revenue per paying subscriber, resulting from the growing popularity of our lower priced subscription plans. The total number of average paying subscribers in our 1 and 2-out plans grew by 40.0% year over year as compared to a 5.5% growth in all other plans.
Three months ended June 30, 2009 as compared to the three months ended March 31, 2009
Three Months Ended Change
June 30, March 31, Q2'09 vs.
2009 2009 Q1'09
(in thousands except percentages and
average monthly revenue per paying subscriber)
Revenues $ 408,509 $ 394,098 3.7 %
Other data:
Average number of paying subscribers 10,246 9,640 6.3 %
Average monthly revenue per paying
subscriber $ 13.29 $ 13.63 (2.5 )%
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The $14.4 million increase in our revenues was primarily a result of the 6.3% growth in the average number of paying subscribers. This increase was partially offset by a 2.5% decline in the average monthly revenue per paying subscriber, resulting from the growing popularity of our lower priced subscription plans. The total number of average paying subscribers in our 1 and 2-out plans grew by 10.5% quarter over quarter as compared to a 0.7% decline in all other plans.
Until the average price of gross new additions is equal to the average price of existing subscribers, we expect our average monthly revenue per paying subscriber will continue to decline, as the lower priced plans grow as a percentage of our subscriber base. Our revenues and average monthly revenue per paying subscriber could be impacted by future changes to our pricing structure which may result from competitive effects that we are unable to predict.
Cost of Revenues
Subscription
Three months ended June 30, 2009 as compared to the three months ended June 30,
2008
Three Months Ended Change
June 30, June 30, Q2'09 vs
2009 2008 Q2'08
(in thousands except percentages)
Subscription $ 224,858 $ 193,769 16.0 %
As a percentage of revenues 55.0 % 57.4 %
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The $31.1 million increase in cost of subscription revenues was due to the following factors:
• Postage and packaging expenses increased $21.0 million due to an 18.3% increase in the number of DVD's mailed to paying subscribers and to a two cent (4.8%) increase in the rates of first class postage in May 2009. The increase in the number of DVD's mailed was driven by a 25.4% increase in the number of average paying subscribers, partially offset by a 5.7% decline in monthly DVD rentals per average paying subscriber attributed to the growing popularity of our lower priced plans.
• Content expenses increased by $10.1 million due to increased investments in our content library, particularly related to additions to our streaming content.
Six months ended June 30, 2009 as compared to the six months ended June 30, 2008
Six Months Ended Change
June 30, June 30, YTD'09 vs
2009 2008 YTD'08
(in thousands except percentages)
Subscription $ 440,157 $ 380,925 15.5 %
As a percentage of revenues 54.8 % 57.4 %
|
The $59.2 million increase in cost of subscription revenues was due to the following factors:
• Postage and packaging expenses increased $40.1 million due to a 17.6% increase in the number of DVD's mailed to paying subscribers. The increase in the number of DVD's mailed was driven by a 25.2% increase in the number of average paying subscribers, partially offset by a 6.1% decline in monthly DVD rentals per average paying subscriber attributed to the growing popularity of our lower priced plans
• Content expenses increased by $19.1 million due to increased investments in our content library, particularly related to additions to our streaming content.
Three months ended June 30, 2009 as compared to the three months ended March 31, 2009
Three Months Ended Change
June 30, March 31, Q2'09 vs
2009 2009 Q1'09
(in thousands except percentages)
Subscription $ 224,858 $ 215,299 4.4 %
As a percentage of revenues 55.0 % 54.6 %
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The $9.6 million increase in cost of subscription revenues was due to the following factors:
• Postage and packaging expenses slightly increased by $3.0 million. The number of DVD's mailed to paying subscribers remained flat despite a 6.3% increase in the number of average paying subscribers, consistent with similar historical sequential patterns of lower DVD shipments per average paying subscriber.
• Content expenses increased by $6.6 million due to increased investments in our content library.
Fulfillment Expenses
Three months ended June 30, 2009 as compared to the three months ended June 30,
2008
Three Months Ended Change
June 30, June 30, Q2'09 vs
2009 2008 Q2'08
(in thousands except percentages)
Fulfillment expenses $ 44,385 $ 36,318 22.2 %
As a percentage of revenues 10.9 % 10.8 %
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The $8.1 million increase in fulfillment expenses was due to the following:
• Delivery centers and customer service related costs increased $6.0 million primarily due to a 15.9% increase in headcount to support the higher volume of content delivery.
• Credit card fees increased $2.1 million as a result of the 21.0% growth in revenues.
Six months ended June 30, 2009 as compared to the six months ended June 30, 2008
Six Months Ended Change
June 30, June 30, YTD'09 vs
2009 2008 YTD'08
(in thousands except percentages)
Fulfillment expenses $ 88,354 $ 71,967 22.8 %
As a percentage of revenues 11.0 % 10.8 %
|
The $16.4 million increase in fulfillment expenses was due to the following:
• Delivery centers and customer service related costs increased $12.2 million primarily due to a 14.6% increase in headcount to support the higher volume of content delivery.
• Credit card fees increased $4.2 million as a result of the 20.9% growth in revenues.
Three months ended June 30, 2009 as compared to the three months ended March 31, 2009
Three Months Ended Change
June 30, March 31, Q2'09 vs
2009 2009 Q1'09
(in thousands except percentages)
Fulfillment expenses $ 44,385 $ 43,969 0.9 %
As a percentage of revenues 10.9 % 11.2 %
|
Fulfillment expenses for the three months ended June 30, 2009 as compared to the three months ended March 31, 2009 were relatively flat as costs related to delivery centers and customer service decreased slightly as the number of DVD's shipped to paying subscribers remained flat quarter over quarter. This decrease was offset by a 3.8% increase in the credit card fees consistent with the increase in revenues.
Gross Margin
Three months ended June 30, 2009 as compared to the three months ended June 30,
2008
Three Months Ended Change
June 30, June 30, Q2'09 vs.
2009 2008 Q2'08
(in thousands except percentages and
average monthly gross profit per paying subscriber)
Gross profit $ 139,266 $ 107,527 29.5 %
Gross margin 34.1 % 31.8 %
Average monthly gross profit per
paying subscriber $ 4.53 $ 4.39 3.2 %
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The 2.3% increase in gross margin was due to a decline in the average revenue per paying subscriber of 3.6% offset by a larger decrease in the cost of subscription per average paying subscriber of 7.5%. This is primarily attributable to the growing popularity of our lower priced plans evidenced by the increase in average gross profit per paying subscriber. This increase is due to the fact that the decrease in revenue per average paying subscriber is proportionally lower than the decrease in the DVD rentals per average paying subscriber, offset slightly by higher content expense associated with our investment in streaming. In addition, our gross margins continue to benefit from increased utilization of catalog titles resulting from ongoing improvements in our merchandising and recommendation systems.
Six months ended June 30, 2009 as compared to the six months ended June 30, 2008
. . .
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