Netflix Announces Q2 2006 Financial Results

Netflix Announces Q2 2006 Financial Results

Subscribers - 5.2 million

Revenue - $239.4 million

GAAP Net Income - $16.8 million

LOS GATOS, Calif., July 24 /PRNewswire-FirstCall/ -- Netflix, Inc. (NASDAQ:NFLX) today reported results for the second quarter ended June 30, 2006.

"In the second quarter, Netflix demonstrated solid progress toward our goals of 20 million subscribers by 2010 to 2012 and 50 percent year-over-year earnings growth for the next several years," said Reed Hastings, Netflix co- founder and chief executive officer.

"Our industry-leading customer service and selection attracted new subscribers at an increasing rate and we achieved 62% year-over-year subscriber growth despite a modest seasonal uptick in churn. Our strong performance in the first half of the year demonstrates the power of our business model and positions us to hit our full-year goals for both subscribers and earnings."

Second-Quarter 2006 Financial Highlights

Revenue(1) for the second quarter of 2006 was $239.4 million, representing 46 percent year-over-year growth from $164.0 million for the second quarter of 2005, and 7 percent sequential growth from $224.1 million for the first quarter of 2006.

GAAP net income for the second quarter of 2006 was $16.8 million, or $0.24 per diluted share, compared to GAAP net income of $5.7 million, or $0.09 per share, for the second quarter of 2005 and GAAP net income of $4.4 million, or $0.07 per diluted share, for the first quarter of 2006. GAAP net income for 2006 is a fully taxed number while 2005 was not. On a pretax(2) basis, the second quarter profit was an all-time record.

Non-GAAP net income was $18.7 million, or $0.27 per diluted share, for the second quarter of 2006, compared to non-GAAP net income of $9.1 million, or $0.14 per share, for the second quarter of 2005 and non-GAAP net income of $6.4 million, or $0.10 per diluted share, for the first quarter of 2006.

Non-GAAP net income equals net income on a GAAP basis before stock-based compensation expense, net of taxes.

Gross margin(3) for the second quarter of 2006 was 37.1 percent, compared to 28.2 percent for the second quarter of 2005 and 33.8 percent for the first quarter of 2006.

Stock-based compensation. In accordance with SEC Staff Accounting Bulletin No. 107, stock-based compensation is no longer presented as a separate line item on our income statement. Stock-based compensation is now presented in the same lines as cash compensation paid to the same individuals. Stock-based compensation recognized in prior periods has been reclassified to conform with the presentation in the current period. In the second quarter, the charge related to stock-based compensation was $3.1 million, compared to $3.4 million in the second quarter of 2005 and compared to $3.3 million in the first quarter of 2006.

Free cash flow(4) for the second quarter of 2006 was positive $5.5 million, compared to positive $1.8 million in the second quarter of 2005 and positive $11.7 million for the first quarter of 2006.

Cash provided by operating activities for the second quarter of 2006 was $46.3 million, compared to $36.5 million for the second quarter of 2005 and $57.6 million for the first quarter of 2006.

Subscriber acquisition cost(5) for the second quarter of 2006 was $43.95 per gross subscriber addition, compared to $38.13 for the same period of 2005 and $38.47 for the first quarter of 2006.

Churn(6) for the second quarter of 2006 was 4.3 percent, compared to 4.7 percent for the second quarter of 2005 and 4.1 percent for the first quarter of 2006. Churn includes free subscribers as well as paying subscribers who elect not to renew their monthly subscription service during the quarter.

Subscribers. Netflix ended the second quarter of 2006 with approximately 5,169,000 total subscribers, representing 62 percent year-over-year growth from 3,196,000 total subscribers at the end of the second quarter of 2005 and 6 percent sequential growth from 4,866,000 subscribers at the end of the first quarter of 2006.

Net subscriber additions in the quarter were 303,000, compared to 178,000 for the same period of 2005 and 687,000 for the first quarter of 2006.

During the quarter Netflix acquired 1,070,000 gross subscriber additions, representing 51 percent year-over-year growth from 707,000 gross subscriber additions in the second quarter of 2005 and 22 percent quarter-over-quarter decline from 1,377,000 gross subscriber additions in the first quarter of 2006.

Of the 5,169,000 total subscribers at quarter end, 97 percent, or 5,017,000, were paid subscribers. The other 3 percent, or 152,000, were free subscribers. Paid subscribers represented 97 percent of total subscribers at the end of the second quarter of 2005 and the first quarter of 2006.

Business Outlook

The Company's performance expectations for the third and fourth quarters of 2006 and full-year 2006 are as follows:

Third-Quarter 2006
-- Ending subscribers of 5.5 million to 5.7 million
-- Revenue of $249 million to $254 million
-- GAAP net income of $5 million to $10 million

Fourth-Quarter 2006
-- Ending subscribers of at least 6.3 million
-- Revenue of $267 million to $272 million
-- GAAP net income of $3.8 million to $8.8 million

Full-Year 2006
-- Ending subscribers of at least 6.3 million
-- Revenue of at least $980 million
-- GAAP net income of $30 million to $35 million

Float and Trading Plans

The Company estimates the public float at approximately 54,880,404 shares as of June 30, 2006, up 11 percent from 49,500,883 shares as of March 31, 2006, based on registered shares held in street name with the Depository Trust and Clearing Corporation. From time to time executive officers of Netflix may elect to buy or sell stock in Netflix. All open market sales are made pursuant to the terms of 10b5-1 Trading Plans approved by the Company and generally adopted no less than three months prior to the first date of sale under such plan.

Earnings Call

The Netflix earnings call will be webcast today at 5:00 p.m. Eastern Time / 2:00 p.m. Pacific Time, and may be accessed at http://ir.netflix.com/ . Following the conclusion of the webcast, a replay of the call will be available via Netflix's website at http://ir.netflix.com/. For those without access to the Internet, a replay of the call will be available from approximately 5:00 p.m. Pacific Time on July 24, 2006 through July 30, 2006. To listen to a replay, call (719) 457-0820, access code 4975362.

Use of Non-GAAP Measures

Management believes that non-GAAP net income is a useful measure of operating performance because it excludes the non-cash impact of stock option accounting, and, where specified, excludes the benefit of the realized tax assets. In addition, management believes that free cash flow is a useful measure of liquidity because it excludes the non-operational cash flows from purchases and sales of short-term investments and cash flows from financing activities. However, these non-GAAP measures should be considered in addition to, not as a substitute for or superior to, net income and net cash provided by operating activities, or other financial measures prepared in accordance with GAAP. A reconciliation to the GAAP equivalents of these non-GAAP measures is contained in tabular form on the attached unaudited financial statements.

About Netflix

Netflix is the world's largest online movie rental service, providing more than five million subscribers access to over 60,000 DVD titles. The company offers a variety of subscription plans, starting at $5.99 a month. There are no due dates, no late fees and no shipping fees. DVDs are delivered for free by the USPS from regional shipping centers located throughout the United States. Netflix can reach more than 90 percent of its subscribers with generally one business-day delivery. Netflix offers personalized movie recommendations to its members and has more than one billion movie ratings. Netflix also allows members to share and recommend movies to one another through its Friends(SM) feature. For more information, visit www.netflix.com.

Forward-Looking Statements

This press release contains certain forward-looking statements within the meaning of the federal securities laws, including statements regarding our subscriber growth, revenue and GAAP net income for the third and fourth quarters of 2006 as well as subscriber growth, revenue, and GAAP net income for the full-year 2006. The forward-looking statements in this release are subject to risks and uncertainties that could cause actual results and events to differ, including, without limitation: impacts arising out of competition, our ability to manage our growth, in particular, managing our subscriber acquisition cost as well as the mix between revenue sharing titles and titles not subject to revenue sharing that are delivered to our subscribers; our ability to attract new subscribers and retain existing subscribers; changes in pricing, availability and effectiveness related to our advertising; fluctuations in consumer usage of our service, customer spending on DVDs and related products; disruption in service on our website or with our computer systems; deterioration of the U.S. economy or conditions specific to online commerce or the filmed entertainment industry; conditions that effect our delivery through the U.S. Postal Service, including regulatory changes and increases in first class postage; increases in the costs of acquiring DVDs; and, widespread consumer adoption of different modes of viewing in-home filmed entertainment. A detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in our filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 16, 2006. We undertake no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this press release.

(1) The Company had previously recorded proceeds from sales of previously viewed DVDs and the related cost of DVDs sales as Sales revenue and Cost of sales revenue, respectively. The Company now records the net gain on sales of DVDs as a separate line item on the income statement. In the second quarter of 2006, sales from previously viewed DVDs was $2.8 million, compared to $0.5 million in the second quarter of 2005 and compared to $2.5 million in the first quarter of 2006. The cost of sales revenues for the second quarter of 2006 was $1.8 million, compared to $0.4 million in the second quarter of 2005 and compared to $1.1 million in the first quarter of 2006.

(2) Pretax income is defined as income before income taxes as shown on the Company's Statement of Operations, which line item includes stock-based compensation expense.

(3) Gross margin is defined as revenue less cost of subscription and fulfillment expense. The Company had previously recorded fulfillment expense as an operating expense.

(4) Free cash flow is defined as cash provided by operating activities less cash used in investing activities excluding purchases and sales of short- term investments.

(5) Subscriber acquisition cost is defined as the total marketing expense, which includes stock-based compensation for marketing personnel, on the Company's Statement of Operations divided by total gross subscriber additions during the quarter.

(6) Churn is defined as customer cancellations in the quarter divided by the sum of beginning subscribers and gross subscriber additions, divided by three months.

Netflix, Inc.
Consolidated Statements of Operations
(unaudited)
(in thousands, except per share data)
Three Months Ended Six Months Ended
June 30, March 31, June 30, June 30, June 30,
2005 2006 2006 2005 2006

Revenues $164,027 $224,126 $239,351 $316,473 $463,477
Cost of revenues:
Subscription 99,957 126,220 128,605 193,943 254,825
Fulfillment expenses* 17,892 22,045 21,974 35,027 44,019
Total cost of
revenues 117,849 148,265 150,579 228,970 298,844
Gross profit 46,178 75,861 88,772 87,503 164,633
Operating expenses:
Technology and
development * 8,648 11,206 12,043 17,214 23,249
Marketing * 26,959 52,968 47,031 63,508 99,999
General and
administrative * 6,233 8,292 7,174 12,921 15,466
Gain on disposal of
DVDs (116) (1,387) (964) (811) (2,351)
Total operating
expenses 41,724 71,079 65,284 92,832 136,363
Operating income (loss) 4,454 4,782 23,488 (5,329) 28,270
Other income (expense):
Interest and other
income 1,246 2,452 3,698 2,297 6,150
Interest and other
expense (3) -- -- (41) --
Income (loss) before
income taxes 5,697 7,234 27,186 (3,073) 34,420
Provision for income
taxes 13 2,830 10,387 57 13,217
Net income (loss) $5,684 $4,404 $16,799 $(3,130) $21,203
Net income (loss) per
share:
Basic $.11 $.08 $.29 $(.06) $.37
Diluted $.09 $.07 $.24 $(.06) $.31
Weighted average common
shares outstanding:
Basic 53,190 55,213 58,383 53,005 56,808
Diluted 64,592 66,456 69,175 53,005 67,813

Amortization of stock-
based compensation
included in
expense line items:
Fulfillment $332 $260 $223 $773 $483
Technology and
development 1,135 965 867 2,546 1,832
Marketing 621 554 529 1,367 1,083
General and
administrative 1,335 1,531 1,468 3,016 2,999
$3,423 $3,310 $3,087 $7,702 $6,397
Reconciliation of Non-
GAAP Financial
Measures
(Unaudited)
Non-GAAP net income
reconciliation:
Net income (loss) $5,684 $4,404 $16,799 $(3,130) $21,203
Add back:
Stock-based
compensation 3,423 3,310 3,087 7,702 6,397
Income tax effect of
stock-based
compensation -- (1,294) (1,179) -- (2,473)
Non-GAAP net income $9,107 $6,420 $18,707 $4,572 $25,127
Non-GAAP net income per
share:
Basic $.17 $.12 $.32 $.09 $.44
Diluted $.14 $.10 $.27 $.07 $.37
Weighted average common
shares outstanding:
Basic 53,190 55,213 58,383 53,005 56,808
Diluted 64,592 66,456 69,175 64,122 67,813

* Stock-based compensation recognized in the three and six months ended
June 30, 2005 has been reclassed to this expense line to conform with the
current period presentation.

Netflix, Inc.
Consolidated Balance Sheets
(unaudited)
(in thousands, except share and par value data)
As of
December 31, June 30,
2005 2006
Assets
Current assets:
Cash and cash equivalents $212,256 $341,702
Prepaid expenses 7,848 5,956
Prepaid revenue sharing expenses 5,252 6,055
Deferred tax assets 13,666 6,943
Other current assets 4,669 9,545
Total current assets 243,691 370,201
DVD library, net 57,032 79,030
Intangible assets, net 457 1,019
Property and equipment, net 40,213 41,607
Deposits 1,249 1,136
Deferred tax assets 21,239 18,788
Other assets 800 1,130
Total assets $364,681 $512,911
Liabilities and Stockholders'
Equity
Current liabilities:
Accounts payable $63,491 $70,785
Accrued expenses 25,563 25,992
Deferred revenue 48,533 49,029
Total current liabilities 137,587 145,806
Deferred rent 842 1,031
Total liabilities 138,429 146,837
Stockholders' equity:
Common stock, $0.001 par value;
160,000,000 shares authorized
at December 31, 2005 and June 30,
2006; 54,755,731and 67,936,774
issued and outstanding at
December 31, 2005 and June 30,
2006, respectively 55 68
Additional paid-in capital 315,868 434,474
Accumulated deficit (89,671) (68,468)
Total stockholders' equity 226,252 366,074
Total liabilities and
stockholders' equity $364,681 $512,911

Netflix, Inc.
Consolidated Statements of Cash Flows
(unaudited)
(in thousands)
Three Months Ended Six Months Ended
June 30, March 31, June 30, June 30, June 30,
2005 2006 2006 2005 2006
Cash flows from
operating
activities:
Net income (loss) $5,684 $4,404 $16,799 $(3,130) $21,203
Adjustments to
reconcile net
income to net cash
provided by
operating
activities:
Depreciation of
property and
equipment 2,156 3,609 3,854 4,094 7,463
Amortization of
DVD library 25,552 27,281 31,910 47,558 59,191
Amortization of
intangible assets 380 12 11 834 23
Stock-based
compensation
expense 3,423 3,310 3,087 7,702 6,397
Excess tax
benefits from
stock-based
compensation -- (690) (2,910) -- (3,600)
Loss on disposal
of property and
equipment -- (23) -- -- (23)
Gain on disposal
of DVDs (208) (2,049) (2,029) (1,337) (4,078)
Noncash interest
expense -- -- -- 11 --
Deferred taxes -- 2,058 7,116 -- 9,174
Changes in
operating assets
and liabilities:
Prepaid expenses
and other
current assets (3,219) 2,304 (6,091) 1,452 (3,787)
Accounts payable 3,579 14,505 (7,211) 6,436 7,294
Accrued expenses (1,979) 3,439 590 571 4,029
Deferred revenue 1,034 (608) 1,104 1,561 496
Deferred rent 92 70 119 185 189
Net cash
provided by
operating
activities 36,494 57,622 46,349 65,937 103,971
Cash flows from
investing
activities:
Purchases of
property and
equipment (5,931) (3,484) (5,373) (12,776) (8,857)
Acquisition of
intangible asset -- -- (585) -- (585)
Acquisitions of DVD
library (29,218) (44,676) (37,669) (62,258) (82,345)
Proceeds from sale
of DVDs 470 2,481 2,753 2,164 5,234
Proceeds from
disposal of
property and
equipment -- 23 -- -- 23
Deposits and other
assets 22 (291) 74 (155) (217)
Net cash used
in investing
activities (34,657) (45,947) (40,800) (73,025) (86,747)
Cash flows from
financing
activities:
Proceeds from
issuance of common
stock 3,313 3,144 105,478 3,678 108,622
Excess tax benefits
from stock-based
compensation -- 690 2,910 (79) 3,600
Net cash
provided by
financing
activities 3,313 3,834 108,388 3,599 112,222
Net increase
(decrease) in cash
and cash
equivalents 5,150 15,509 113,937 (3,489) 129,446
Cash and cash
equivalents,
beginning of period 165,822 212,256 227,765 174,461 212,256
Cash and cash
equivalents, end of
period $170,972 $227,765 $341,702 $170,972 $341,702

Non-GAAP free cash
flow reconciliation:
Net cash provided by
operating
activities $36,494 $57,622 $46,349 $65,937 $103,971
Purchases of
property and
equipment (5,931) (3,484) (5,373) (12,776) (8,857)
Acquisition of
intangible asset -- -- (585) -- (585)
Acquisitions of DVD
library (29,218) (44,676) (37,669) (62,258) (82,345)
Proceeds from sale
of DVDs 470 2,481 2,753 2,164 5,234
Proceeds from
disposal of
property and
equipment -- 23 -- -- 23
Deposits and other
assets 22 (291) 74 (155) (217)
Non-GAAP free cash
flow $1,837 $11,675 $5,549 $(7,088) $17,224

Netflix, Inc.
Consolidated Other data
(unaudited)
(in thousands, except percentages and subscriber acquisition cost)
As of / Three Months Ended
June 30, March 31, June 30,
2005 2006 2006
Subscriber information:
Subscribers: beginning of period 3,018 4,179 4,866
Gross subscribers additions:
during period 707 1,377 1,070
Gross subscriber additions year-
to-year change 21.3% 45.7% 51.3%
Gross subscriber additions
quarter-to-quarter sequential
change (25.2%) 19.1% (22.3%)
Less subscriber cancellations :
during period (529) (690) (767)
Subscribers: end of period 3,196 4,866 5,169
Subscribers year-to-year change 52.7% 61.2% 61.7%
Subscribers quarter-to-quarter
sequential change 5.9% 16.4% 6.2%
Free subscribers: end of period 87 132 152
Free subscribers as percentage of
ending subscribers 2.7% 2.7% 2.9%
Paid subscribers: end of period 3,109 4,734 5,017
Paid subscribers year-to-year
change 53.6% 64.0% 61.4%
Paid subscribers quarter-to-
quarter sequential change 7.7% 17.6% 6.0%
Churn 4.7% 4.1% 4.3%
Subscriber acquisition cost -
Consolidated $38.13 $38.47 $43.95
Margins:
Gross margin 28.2% 33.8% 37.1%
Operating margin 2.8% 2.1% 9.8%
Net margin 3.5% 2.0% 7.0%
Expenses as percentage of revenues:
Technology and development 5.3% 5.0% 5.0%
Marketing 16.4% 23.6% 19.6%
General and administrative 3.8% 3.7% 3.0%
Gain on disposal of DVDs (0.1%) (0.6%) (0.3%)
Total operating expenses 25.4% 31.7% 27.3%
Year-to-year change:
Total revenues 37.0% 47.0% 45.9%
Fulfillment 20.6% 28.7% 22.8%
Technology and development 15.0% 30.8% 39.3%
Marketing 28.0% 44.9% 74.5%
General and administrative 38.5% 24.0% 15.1%
Gain on disposal of DVDs (72.8%) 99.6% 731.0%
Total operating expenses 27.8% 39.1% 56.5%

Source: Netflix, Inc.

CONTACT: IR Contact, Deborah Crawford, Director, Investor Relations,
+1-408-540-3712, OR PR Contact, Ken Ross, VP, Corporate Communications,
+1-408-540-3931, both of Netflix

Web site: http://www.netflix.com/

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