Netflix Announces Q3 2005 Financial Results

Netflix Announces Q3 2005 Financial Results

- Subscribers - 3.6 million

- Churn - 4.3%

- GAAP Net Income - $6.9 million

- Non-GAAP Net Income Before Net Settlement Expense - $13.4 million

LOS GATOS, Calif., Oct. 19 /PRNewswire-FirstCall/ -- Netflix (NASDAQ:NFLX) today reported results for the third quarter ended September 30, 2005.

For the third quarter:

-- Revenue was $174.3 million.

-- GAAP net income was $6.9 million. Before net settlement expense, net income was $10.1 million.

-- Non-GAAP net income was $10.2 million. Non-GAAP net income before net settlement expense was $13.4 million.

-- Subscribers increased 61 percent year-over-year to 3.592 million. -- Churn declined to a record low of 4.3 percent.

"The third quarter provided a good view of the power and potential of the Netflix model, coupling strong subscriber growth with the cost benefits of our increasing scale," said Reed Hastings, Netflix co-founder and chief executive officer. "Combining the best customer experience with the lowest costs is a powerful formula for success, and we expect that formula to deliver increasingly impressive results in the balance of 2005 and in 2006."

Third-Quarter 2005 Financial Highlights

Revenue for the third quarter of 2005 was a record $174.3 million, representing 23 percent year-over-year growth from $141.6 million for the third quarter of 2004, and 6 percent quarter-over-quarter growth from $164.5 million for the second quarter of 2005.

GAAP net income for the third quarter of 2005 was $6.9 million, or $0.11 per diluted share, compared to GAAP net income of $18.9 million, or $0.29 per diluted share, for the third quarter of 2004 and GAAP net income of $5.7 million, or $0.09 per diluted share, for the second quarter of 2005. Management had guided to GAAP net income of $2.5 million to $5.3 million.

GAAP net income included the impact of a net settlement expense in the quarter related to the previously announced lawsuit settlement of $3.2 million. The settlement remains subject to court approval. Excluding the net settlement expense, net income was $10.1 million, or $0.15 per diluted share. Management had guided to net income excluding the net settlement expense of $6.5 million to $8.3 million.

Non-GAAP net income was $10.2 million, or $0.16 per diluted share, for the third quarter of 2005, compared to non-GAAP net income of $22.6 million, or $0.35 per diluted share, for the third quarter of 2004 and non-GAAP net income of $9.1 million, or $0.14 per diluted share, for the second quarter of 2005. Non-GAAP net income equals net income on a GAAP basis before stock-based compensation expense. Excluding the net settlement expense in the quarter related to the previously announced lawsuit settlement, non-GAAP net income was $13.4 million, or $0.20 per diluted share.

Gross margin for the third quarter of 2005 was 43.2 percent compared to 49.5 percent for the third quarter of 2004 and 39.0 percent for the second quarter of 2005.

Free cash flow(1) for the third quarter of 2005 was $7.5 million, compared to $14.1 million in the third quarter of 2004 and $1.8 million for the second quarter of 2005.

Cash provided by operating activities for the third quarter of 2005 was $33.3 million, compared to $49.3 million for the third quarter of 2004 and $36.5 million for the second quarter of 2005.

Subscriber acquisition cost(2) for the third quarter of 2005 was $35.69 per gross subscriber addition, compared to $36.97(3) for the same period of 2004 and $37.25 for the second quarter of 2005.

Churn(4) for the third quarter of 2005 was 4.3 percent, compared to 5.6 percent for the third quarter of 2004 and 4.7 percent for the second quarter of 2005. 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 third quarter of 2005 with approximately 3,592,000 total subscribers, representing 61 percent year-over-year growth from 2,229,000 total subscribers at the end of the third quarter of 2004 and 12 percent sequential growth from 3,196,000 subscribers at the end of the second quarter of 2005. Net subscriber additions in the quarter were 396,000, compared to 136,000 for the same period of 2004 and 178,000 for the second quarter of 2005.

During the quarter Netflix acquired 921,000 gross subscriber additions, representing 56 percent year-over-year growth from 590,000 gross subscriber additions acquired in the third quarter of 2004 and 30 percent quarter-over-quarter growth from 707,000 gross subscriber additions acquired in the second quarter of 2005.

Of the 3,592,000 total subscribers at quarter end, 95 percent, or 3,423,000, were paid subscribers. The other 5 percent, or 169,000, were free subscribers. Paid subscribers represented 96 percent of total subscribers at the end of the third quarter of 2004 and 97 percent of total subscribers at the end of the second quarter of 2005.

Business Outlook

The Company's performance expectations for the fourth quarter of 2005 and full-year 2006 are as follows:

Revised Fourth-Quarter 2005

-- Ending subscribers of 4.0 million to 4.2 million from 3.85 million to 4.05 million

-- Revenue of $191 million to $196 million from $187 million to $193 million

-- GAAP net income of $4.0 million to $7.5 million from $1.0 million to $6.0 million

Full-Year 2006 -- Ending subscribers of at least 5.65 million -- Revenue of at least $940 million -- Pretax income of $50 million to $60 million(5)

Float and Trading Plans

The Company estimates the public float at approximately 46,874,645 shares as of September 30, 2005, up 1 percent from 46,279,628 shares as of June 30, 2005, based on registered shares held in street name with the Depository Trust and Clearing Corporation. No outstanding shares are subject to a lock-up agreement of any kind. 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 6:00 p.m. Eastern Time / 3:00 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 6:00 p.m. Pacific Time on October 19, 2005 through October 25, 2005. To listen to a replay, call 719-457-0820, access code 4417528.

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 net settlement expense related to the previously announced lawsuit settlement. 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 three million subscribers access to over 50,000 DVD titles. Under the company's most popular program, for $17.99 a month, Netflix subscribers rent as many DVDs as they want and keep them as long as they want, with three movies out at a time. 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 1 billion movie ratings. Netflix also allows members to share and recommend movies to one another through its Friends(TM) 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 fourth quarter of 2005 as well as subscriber growth, revenue and pre-tax 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 of our advertising; fluctuations in consumer usage of our service, customer spending on DVD players, 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 15, 2005. We undertake no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this press release.

(1) 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.

(2) Subscriber acquisition cost is defined as the total marketing expense on the Company's Statement of Operations divided by total gross subscriber additions during the quarter.

(3) SAC in the third quarter of 2004 excludes costs associated with international operations. Consolidated SAC was $38.18 for the third quarter of 2004.

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

(5) 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.

Netflix, Inc. Consolidated Statements of Operations (unaudited) (in thousands, except per share data)

Three Months Ended Nine Months Ended Sept. 30, June 30, Sept. 30, Sept. 30, Sept. 30, 2004 2005 2005 2004 2005 Revenues: Subscription $140,414 $164,027 $172,740 $359,947 $489,213 Sales 1,230 470 1,577 2,388 3,741 Total revenues 141,644 164,497 174,317 362,335 492,954 Cost of revenues: Subscription 71,130 99,957 97,878 197,178 291,821 Sales 471 354 1,189 838 2,542 Total cost of revenues 71,601 100,311 99,067 198,016 294,363 Gross profit 70,043 64,186 75,250 164,319 198,591 Operating expenses: Fulfillment 15,013 17,560 17,544 40,176 51,798 Technology and development 6,325 7,513 8,006 17,016 22,674 Marketing 22,525 26,338 32,867 69,695 95,008 General and administrative 4,122 4,898 8,020 10,538 17,925 Stock-based compensation 3,660 3,423 3,293 12,229 10,995 Total operating expenses 51,645 59,732 69,730 149,654 198,400 Operating income 18,398 4,454 5,520 14,665 191 Other income (expense): Interest and other income 579 1,246 1,491 1,474 3,788 Interest and other expense (52) (3) (13) (113) (54) Income before income taxes 18,925 5,697 6,998 16,026 3,925 Provision for income taxes -- 13 52 -- 109 Net income $18,925 $5,684 $6,946 $16,026 $3,816 Net income per share: Basic $.36 $.11 $.13 $.31 $.07 Diluted $.29 $.09 $.11 $.25 $.06 Weighted average common shares outstanding: Basic 52,211 53,190 53,693 51,798 53,237 Diluted 64,449 64,592 66,012 64,797 64,928

Reconciliation of Non-GAAP Financial Measures (Unaudited) Non-GAAP net income reconciliation: Net income $18,925 $5,684 $6,946 $16,026 $3,816 Add back: Stock-based compensation 3,660 3,423 3,293 12,229 10,995 Non-GAAP net income $22,585 $9,107 $10,239 $28,255 $14,811 Non-GAAP net income per share: Basic $.43 $.17 $.19 $.55 $.28 Diluted $.35 $.14 $.16 $.44 $.23 Weighted average common shares outstanding: Basic 52,211 53,190 53,693 51,798 53,237 Diluted 64,449 64,592 66,012 64,797 64,928

Netflix, Inc. Consolidated Balance Sheets (unaudited) (in thousands, except share and par value data)

As of December 31, September 30, 2004 2005 Assets Current assets: Cash and cash equivalents $174,461 $181,886 Prepaid expenses 2,741 2,918 Prepaid revenue sharing expenses 4,695 3,710 Other current assets 5,449 3,404 Total current assets 187,346 191,918 DVD library, net 42,158 52,735 Intangible assets, net 961 469 Property and equipment, net 18,728 30,415 Deposits 1,600 1,568 Other assets 1,000 1,197 Total assets $251,793 $278,302

Liabilities and Stockholders' Equity Current liabilities: Accounts payable $49,775 $43,951 Accrued expenses 13,131 20,404 Deferred revenue 31,936 34,400 Current portion of capital lease obligations 68 -- Total current liabilities 94,910 98,755 Deferred rent 600 875 Total liabilities 95,510 99,630 Stockholders' equity: Common stock, $0.001 par value; 160,000,000 shares authorized at December 31, 2004 and September 30, 2005; 52,732,025 and 53,961,946 issued and outstanding at December 31, 2004 and September 30, 2005, respectively 53 54 Additional paid-in capital 292,843 308,123 Deferred stock-based compensation (4,693) (1,401) Accumulated other comprehensive loss (222) (222) Accumulated deficit (131,698) (127,882) Total stockholders' equity 156,283 178,672 Total liabilities and stockholders' equity $251,793 $278,302

Netflix, Inc. Consolidated Statements of Cash Flows (unaudited) (in thousands)

Three Months Ended Nine Months Ended Sept. 30, June 30, Sept. 30, Sept. 30, Sept. 30, 2004 2005 2005 2004 2005 Cash flows from operating activities: Net income $18,925 $5,684 $6,946 $16,026 $3,816 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation of property and equipment 1,569 2,156 2,424 4,144 6,518 Amortization of DVD library 20,450 25,552 24,477 59,718 72,035 Amortization of intangible assets 453 380 139 1,533 973 Stock-based compensation expense 3,660 3,423 3,293 12,229 10,995 Stock option income tax benefits -- -- 12 -- 12 Loss on disposal of short-term investments -- -- -- 274 -- Gain on disposal of DVDs (941) (208) (819) (1,732) (2,156) Non-cash interest expense 11 -- 33 11 Changes in operating assets and liabilities: -- Prepaid expenses and other current assets (3,478) (3,219) 1,401 (5,000) 2,853 Accounts payable 5,116 3,579 (12,260) 15,014 (5,824) Accrued expenses 1,988 (1,979) 6,702 4,215 7,273 Deferred revenue 1,407 1,034 903 8,334 2,464 Deferred rent 108 92 90 246 275 Net cash provided by operating activities 49,268 36,494 33,308 115,034 99,245 Cash flows from investing activities: Purchases of short-term investments -- -- -- (586) -- Proceeds from sale of short-term investments -- -- -- 45,013 -- Purchases of property and equipment (4,165) (5,931) (5,429) (8,021) (18,205) Acquisition of intangible asset -- -- (481) -- (481) Acquisitions of DVD library (31,986) (29,218) (21,939) (79,639) (84,197) Proceeds from sale of DVDs 1,230 470 1,577 2,388 3,741 Deposits and other assets (206) 22 (10) (393) (165) Net cash used in investing activities (35,127) (34,657) (26,282) (41,238) (99,307) Cash flows from financing activities: Proceeds from issuance of common stock 373 3,313 3,888 4,497 7,566 Principal payments on notes payable and capital lease obligations (100) -- -- (329) (79) Net cash provided by financing activities 273 3,313 3,888 4,168 7,487 Effect of exchange rate changes on cash and cash equivalents (44) -- -- (44) -- Net increase in cash and cash equivalents 14,370 5,150 10,914 77,920 7,425 Cash and cash equivalents, beginning of period 153,444 165,822 170,972 89,894 174,461 Cash and cash equivalents, end of period $167,814 $170,972 $181,886 $167,814 $181,886

Non-GAAP free cash flow reconciliation: Net cash provided by operating activities $49,268 $36,494 $33,308 $115,034 $99,245 Purchases of property and equipment (4,165) (5,931) (5,429) (8,021) (18,205) Acquisitions of DVD library (31,986) (29,218) (21,939) (79,639) (84,197) Proceeds from sale of DVDs 1,230 470 1,577 2,388 3,741 Deposits and other assets (206) 22 (10) (393) (165) Non-GAAP free cash flow $14,141 $1,837 $7,507 $29,369 $419

Netflix, Inc. Consolidated Other data (unaudited) (in thousands, except percentages and subscriber acquisition cost)

As of / Three Months As of / Nine Ended Months Ended Sept June Sept Sept Sept 30, 30, 30, 30, 30, 2004 2005 2005 2004 2005 Subscriber information: Subscribers: beginning of period 2,093 3,018 3,196 1,487 2,610 Gross subscribers additions: during period 590 707 921 1,933 2,573 Gross subscriber additions year- to-year change 54.0% 21.3% 56.1% 71.5% 33.1% Gross subscriber additions quarter-to-quarter sequential change 1.2% (25.2%) 30.3% -- -- Less subscriber cancellations : during period (454) (529) (525) (1,191) (1,591) Subscribers: end of period 2,229 3,196 3,592 2,229 3,592 Subscribers year-to-year change 72.7% 52.7% 61.1% 72.7% 61.1% Subscribers quarter-to-quarter sequential change 6.5% 5.9% 12.4% -- -- Free subscribers: end of period 94 87 169 94 169 Free subscribers as percentage of ending subscribers 4.2% 2.7% 4.7% 4.2% 4.7% Paid subscribers: end of period 2,135 3,109 3,423 2,135 3,423 Paid subscribers year-to-year change 71.9% 53.6% 60.3% 71.9% 60.3% Paid subscribers quarter-to- quarter sequential change 5.5% 7.7% 10.1% -- -- Churn 5.6% 4.7% 4.3% -- -- Subscriber acquisition cost - Consolidated $38.18 $37.25 $35.69 $36.06 $36.92 Subscriber acquisition cost - U.S. $36.97 $37.25 $35.69 $35.69 $36.92 Margins: Gross margin 49.5% 39.0% 43.2% 45.4% 40.3% Operating margin 13.0% 2.7% 3.2% 4.0% 0.1% Net margin 13.4% 3.5% 4.0% 4.4% 0.8% Expenses as percentage of revenues: Fulfillment 10.6% 10.7% 10.1% 11.1% 10.5% Technology and development 4.5% 4.6% 4.6% 4.7% 4.6% Marketing 15.9% 16.0% 18.9% 19.2% 19.3% General and administrative 2.9% 3.0% 4.6% 2.9% 3.6% Operating expenses before stock- based compensation 33.9% 34.3% 38.2% 37.9% 38.0% Stock-based compensation 2.6% 2.0% 1.8% 3.4% 2.2% Total operating expenses 36.5% 36.3% 40.0% 41.3% 40.2% Year-to-year change: Total revenues 96.2% 36.7% 23.1% 89.6% 36.0% Fulfillment 80.4% 22.2% 16.9% 83.2% 28.9% Technology and development 33.5% 32.9% 26.6% 30.5% 33.3% Marketing 84.9% 28.6% 45.9% 97.2% 36.3% General and administrative 53.9% 49.3% 94.6% 50.1% 70.1% Operating expenses before stock- based compensation 71.9% 28.6% 38.5% 77.7% 36.4% Stock-based compensation 31.8% (17.2%) (10.0%) 77.6% (10.1%) Total operating expenses 68.2% 24.7% 35.0% 77.7% 32.6%

Source: Netflix, Inc.

CONTACT: investors, Deborah Crawford, Director of Investor Relations, +1-408-317-3712, or media, Ken Ross, VP, Corporate Communications, +1-408-317-3931, both of Netflix, Inc.

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

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