Netflix Inc. (NFLX) reported strong fourth quarter 2010 earnings of 87 cents per share that handily surpassed the Zacks Consensus Estimate of 71 cents. Netflix posted strong revenue growth based on robust net subscriber additions. Shares were up $19.07 (10.42%) in after hours trading.
Operating Performance
Earnings per share were 87 cents in the fourth quarter, up 55.4% year over year and 24.3% sequentially.
In fiscal 2010, earnings increased 49.5% year over year to $2.96 per share, beating the Zacks Consensus Estimate of $2.81.
Net income grew a sharp 52.3% year over year and 24.0% sequentially to $47.1 million, with net margins increasing 90 basis points (bps) year over year and 100 bps sequentially to 7.9% in the fourth quarter.
In fiscal 2010, net income increased 38.8% year over year to $160.9 million. Net margin upped 50 bps on a year-over-year basis to 7.4%.
Gross profit increased 21.3% year over year but declined 1.7% sequentially to $205.1 million in the quarter. Gross margin plunged 360 bps on a year-over-year basis and 330 bps sequentially to 34.4%, primarily due to higher cost of revenues.
In fiscal 2010, gross profit increased 36.3% year over year to $805.3 million, with gross margin increasing 180 bps.
The gross margin drop witnessed during the quarter was, however, fully offset by lower operating expenses, which, as a percentage of revenue, decreased 470 bps year over year and 390 bps sequentially to 21.3% in the quarter.
Operating expenses increased 20 bps year over year to 24.1% in fiscal 2010.
Operating income increased 47.1% year over year and 12.9% sequentially to $78.5 million. Operating margin accordingly spurred 120 bps year over year and 60 bps sequentially to 13.2% in the quarter.
In fiscal 2010, operating income increased 47.8% year over year to $283.6 million, with operating margin increasing 160 bps to 13.1%.
Pre-tax income increased 45.2% year over year and 14.0% sequentially to $74.6 million. Pre-tax margin rose 100 bps year over year and 70 bps sequentially.
In fiscal 2010, pre-tax income increased 39.3% year over year to $267.7 million. Pre-tax margin increased 90 bps to 12.4% in the fiscal year.
Revenue
Revenues in the reported quarter increased 34.1% year over year and 7.7% sequentially to $595.9 million. Revenues narrowly missed the Zacks Consensus Estimate of $598.0 million. In fiscal 2010, revenues increased 29.5% year over year to $2.16 billion.
At the end of fourth quarter 2010, the number of subscribers increased 63.1% year over year and 18.2% sequentially to 20.0 million. In 2010, net subscriber additions were 7.7 million, compared with 2.9 million in 2009, way ahead of management’s target of 3.6 million for the year.
Free subscribers, as a percentage of ending subscribers, increased to 8.7% from 6.3% at the end of the sequentially preceding quarter and 3.1% in the prior-year quarter.
Average monthly revenue per paying subscriber was $11.64 in the quarter, compared with $12.12 in the preceding quarter and $13.04 in the prior-year quarter.
Churn was 3.8% at the end of the quarter, flat sequentially and down 10 bps year over year.
Balance Sheet and Cash Flow
As of December 31, 2010, cash and cash equivalents (including short-term investments) were $350.4 million compared with $256.8 million at the end of September 30, 2010.
Long-term debt was $200.0 million at the end of December 31, 2010, flat sequentially.
Cash flow from operating activities was $96.7 million in the fourth quarter, compared with $42.2 million in the third quarter and $105.8 million in the prior-year quarter. In fiscal 2010, net cash provided by operating activities was $276.4 million compared with $325.1 million in fiscal 2009.
Guidance
Netflix expects U.S. subscribers to grow to a range of 21.9 million to 22.8 million in the first quarter of 2011. Revenue is expected to come in a band of $684.0 million to $704.0 million for the first quarter. Operating income is expected in a $98.0 million to $116.0 million range.
In the overseas markets, Netflix expects subscribers to increase to a range of 0.75 million to 0.9 million for the first quarter. Revenue is expected in the range of $10.0 million to $13.0 million, with operating loss in the range of $10.0 million to $14.0 million.
Disc shipments are expected to decline in the coming quarters, as Netflix continues to focus on streaming.
For the first quarter of 2011, Netflix expects net income in the range of $49.0 million to $62.0 million. Earnings per share are expected in the range of 90 cents to $1.13 for the first quarter. The Zacks Consensus Estimate is currently pegged at 87 cents for the quarter, lower than the guided range.
Netflix expects the effective tax rate to increase in the first quarter 2011 to 39% and range between 39% and 41% going forward.
For fiscal 2011, Netflix expects to achieve U.S. operating margin of 14.0%. US subscriber net additions are expected to grow in 2011. Netflix expects Canadian operations to have a positive operating margin by third quarter 2011. International expansion beyond Canada is however expected to incur an operating loss of $50.0 million in fiscal 2011.
Our Take
Netflix achieved strong growth in fiscal 2010 on the strength of robust subscriber net additions. We believe Netflix’s unique business model, strong subscriber base and continuous focus on streaming services are the key catalysts for growth in the forthcoming quarters.
On the flip side, increasing competition from Amazon.com (AMZN), threats of better offerings from Multichannel Video Programming Distributors (MVPD) and operating margin lumpiness owing to international expansion are some of the headwinds. Hence, we maintain a Neutral rating on Netflix on a long-term basis (6 to 12 months).
Currently, Netflix has a Zacks #2 Rank, which implies a Buy rating over the short term.
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