Shares of online and DVD content provider Netflix (NFLX) beat expectations when it reported fourth quarter earnings on Wednesday, sending shares higher by 15% in the after hours. It was a good report for Netflix on many levels, but there are still plenty of issues the company is dealing with. Let's crunch some numbers.
Q4 Results:
The following chart sums up Netflix's results in comparison to the guidance they gave with last quarter's earnings report.
| Domestic Streaming | Guidance | Actual |
| Subscriptions | 20.0m to 21.5m | 21.67m |
| Revenue | $462m to $477m | $476m |
| Contribution Profit | $30m to $42m | $52m |
| Domestic DVD | Guidance | Actual |
| Subscriptions | 10.3m to 11.3m | 11.17m |
| Revenue | $354m to $368m | $370m |
| Contribution Profit | $177m to $192m | $194m |
| International | Guidance | Actual |
| Subscriptions | 1.6m to 2.0m | $1.86m |
| Revenue | $25m to $30m | $29m |
| Contribution Loss | ($70m) to ($60m) | ($60m) |
| Global | Guidance | Actual |
| Net Income | $19m to $37m | $41m |
| EPS | $0.36 to $0.70 | $0.73 |
In mostly all of the categories, Netflix was at the upper end of their given ranges or beat the high end of the range. I must give them credit for that. However, I must point out that earlier in 2011, this company was hoping for a billion dollar revenue quarter in the year. They fell well short of that expectation.
Margins:
While the numbers may look good at initial glance and beat expectations, the margin numbers were not as good as you may have thought. Here's how they look.
| Margins | 3Q 2010 | 4Q 2010 | 1Q 2011 | 2Q 2011 | 3Q 2011 | 4Q 2011 |
| Gross | 37.73% | 34.42% | 39.02% | 37.87% | 34.71% | 34.31% |
| Operating | 12.56% | 13.16% | 14.23% | 14.60% | 11.78% | 8.09% |
| Profit | 6.86% | 7.90% | 8.38% | 8.65% | 7.60% | 4.65% |
Why were the numbers so low? Here are things down the income statement came out, quarter over quarter (Q3 to Q4).
- Revenues up 6.5%.
- Cost of Revenues (Subscriptions) - up 8.6%, and these account for nearly 90% of cost of revenues.
- Marketing expenses up 28.3%.
- Technology and development expenses up 16.3%.
- General and administrative expenses up 15.7%.
- Effective tax rate up from 33.3% to 38.1%.
Subscriber Numbers / Subscriber Guidance:
Here's how the subscriber numbers look over the past six quarters.
| Subscribers | 3Q 2010 | 4Q 2010 | 1Q 2011 | 2Q 2011 | 3Q 2011 | 4Q 2011 |
| Domestic | 16.800 | 19.501 | 22.797 | 24.595 | 23.789 | 24.395 |
| International | 0.133 | 0.509 | 0.803 | 0.967 | 1.480 | 1.858 |
| Total | 16.933 | 20.010 | 23.600 | 25.562 | 25.269 | 26.253 |
Netflix was up a million overall on the quarter, but we have to realize that domestic numbers are still down 200k in the past six months, all of the gains have come from international growth. The worst part for Netflix is that most of the losses come in the DVD business, which is the very profitable part of the company.
Now the important numbers the company gives are its subscriber guidance for Q1. Here is what they gave.
| Domestic Streaming | Q4 Actual | Q1 Guidance |
| Total Subscriptions | 21.67m | 22.8m to 23.6m |
| Paid Subscriptions | 20.15m | 21.5m to $22.3m |
| Revenue | $476m | $496m to $511m |
| Contribution Profit | $52m | $50m to $64m |
| International Streaming | Q4 Actual | Q1 Guidance |
| Total Subscriptions | 1.86m | 2.5m to 3.1m |
| Paid Subscriptions | 1.45m | 1.9m to 2.45m |
| Revenue | $29m | $38m to $44m |
| Contribution Profit | ($60m) | ($118m) to ($108m) |
| Domestic DVD | Q4 Actual | Q1 Guidance |
| Total Subscriptions | 11.17m | 9.4m to 10.0m |
| Paid Subscriptions | 11.04m | 9.3m to 9.9m |
| Revenue | $370m | $308m to $322m |
| Contribution Profit | $194m | $139m to $154m |
| Consolidated Global | Q4 Actual | Q1 Guidance |
| Net Income | $41m | ($27m) to ($9m) |
| EPS | $0.73 | ($0.46) to ($0.19) |
A couple of important points to make here:
- Paid domestic streaming subscriptions guidance is for up 8.7%, total domestic streaming subscriptions up 7%, but revenue for the segment only guided up 5.8%.
- Paid international streaming subscriptions guidance is for up 50%, total subscriptions up 50.5%, but revenue for the segment only guided up 41.4%.
- Paid domestic DVD subscription guidance is for down 13%, total subscriptions is for down 13.2%, but revenue for the segment guided down 14.9%. Contribution margin for the segment guided down 24.5%.
Overall for the first quarter, here's how the numbers look:
- Revenue range of $842 million to $877, with midpoint of $859.5 million. Current analyst estimates were for $847.8 million.
- EPS range of 19 cent loss to 46 cent loss, with midpoint loss of 32.5 cents. Current analyst estimates were for 30 cent loss.
Financial Data:
Netflix made some moves to shore up its balance sheet, but that doesn't mean things are all clear now. The company raised money, through equity, at $70 a share. This is the same company that was buying back shares at $200 plus in the prior quarter, and a stock that was trading at over $300 just six or so months ago.
Here are some selected financial numbers:
| Selected Financials | 1Q 2011 | 2Q 2011 | 3Q 2011 | 4Q 2011 |
| Operating Cash Flow | $116.32m | $86.39m | $49.53m | $65.47m |
| Content Acquisitions | $22.12m | $19.07m | $20.83m | $23.14m |
| Stock repurchased | $108.64m | $51.40m | $39.60m | None |
While operating cash flow was up quarter over quarter, it was still well below the first half of 2011. Also, the company is not buying back shares, so the number of outstanding shares will continue to rise going forward, instead of declining.
| Ratios | 4Q 2010 | 1Q 2011 | 2Q 2011 | 3Q 2011 | 4Q 2011 |
| Current Ratio | 1.65 | 1.47 | 1.33 | 1.23 | 1.50 |
| Debt Ratio | 70.45% | 74.71% | 78.73% | 80.20% | 78.85% |
| Working Capital | $252,388 | $231,284 | $239,230 | $222,147 | $611,315 |
The company's numbers look a lot better thanks to that $400 million raised, but without it, they would be a lot worse. Without the $400 million raise, the current ratio would have been approximately 1.40, and the debt ratio would have been 83.2%. So their financial situation is getting mostly worse, unless they raise new capital each quarter.
Netflix is still facing a lot of content costs going forward, and still had plenty of off-balance sheet liabilities recently. The company still has 8.4 more cents of liabilities per dollar of assets than it did a year ago, and I think that number will get worse going forward as they lose money in 2012.
Transparency / Insider Sales:
Netflix announced going forward that it will no longer provide information for gross additions, churn, and SAC. However, they will be providing information for paid subscribers. The company also announced that CEO Reed Hastings will be selling some shares as part of a 10b5-1 plan, through which he has some 10-year options expiring in Q1.
Price Action:
At latest update, the stock was trading at $108, well off the $62.37 low it touched at the end of November. While the company did report a good quarter, I don't see it being worth buying after a 73% plus gain. If you do hold shares, taking profits might be a wise idea.
Conclusion - The Good:
I must give Netflix credit for reporting good numbers. Their subscription numbers, revenue numbers, and earnings per share numbers all beat. The company also gave decent growth guidance in terms of streaming subscription numbers going forward. They also improved their balance sheet numbers in some respects.
Conclusion - The Bad:
They are still losing DVD customers, and that is the most profitable part of their business. While subscription guidance was up, the revenue guidance wasn't up as much on a percentage basis. They are going to be losing money starting in Q1 of 2012, and content costs are still rising. Gross margins are at a six quarter low. Content costs are increasing, and the company also increased marketing and administrative costs in Q4. Their tax rate was also nearly five percentage points higher. Their balance sheet looked good, but that was only after a one-time capital infusion of $400 million.
My Opinion:
Netflix did beat its own expectations, but the bar was so low. This stock has had a huge rally lately, and has been extremely volatile over the past few months. Remember, at $108, the stock is only down $9 since the last quarter's report, and since then the DVD guidance has gotten worse, the company has raised money, half of which through equity, the company announced it would start losing money in Q1 of 2012 and for the entire year, and buybacks have stopped.
At the moment, I would just stay away for the short term, and I originally said that in my stocks to be careful with through earnings article. I'll come back in a few weeks with an opinion on a position once I see how it trades post-earnings. Remember, this is a company whose DVD margins are above 50%, and streaming margins are around 10%, as one of my colleagues points out. Just remember which of those segments is growing, and which one is declining.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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