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Author: LeKitKat Big gold star, 5000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Feste Award Winner! Old School Fool Global Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 3899  
Subject: Netflix accounting tangle Date: 11/1/2011 4:10 PM
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Help--any accountants out there?

Encapsulated version of some convoluted accounting:

NFLX spent $200 million in 2007--highest ever capex spend on DVDs. Declining since then

Streaming content around since 2008 or so not very expensive and not a capital expense

Streaming content was $1.3 billion in the first 9 months of 2011. It is not a capital expense. It is not a cost of revenue expense. It is in a gray zone on cash flow from operations and labeled additions to streaming content--it is on operational cash flow and not investment cash flow where capex goes. The amount for 9 months was $1.3 billion. Normally this would decrease cash flow from operations by that amount. That would be an unmitigated disaster but for two offsetting accounts. Here's where it gets a bit hairy

To soften the blow of the $1.3 billion, they created an account line that is an increase in content liabilities. You can think of it as payables or as bills due. They also have added back the amortization that is deducted from COGS

What we end up with is a $1.2 billion offset to the $1.3 billion charge for 9 months and that makes CFFO look in line

What we have is $650 million due in 12 months that is not called a payable --it is a change in content liability.

What NFLX has is maybe $350 million in CFFO in 2011--estimated. They average around the $200-$300 million range

My accounting question is the treatment of content as part of CFFO--it's unique as far as I can tell after looking at DirecTV, Comcast and Amazon. Amazon and DirecTv expense this as cost of revenue and comcast calls it a capex expense

The problem is how to bring NFLX accounting into a form where it can be evaluated for adequacy of CFFO to cover the "payables". Any ideas? Looks to me like paying down those due in 12 months at $650 million on CFFO of $300 million may be a problem.
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Author: TMFSandman Big red star, 1000 posts Feste Award Nominee! Old School Fool Coverage Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3834 of 3899
Subject: Re: Netflix accounting tangle Date: 11/2/2011 12:25 AM
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LeKitKat,

Not all of that $650 million is a current liability. As far as I can tell slightly less than half of that is. Check out page 8 of the 10Q:

http://www.sec.gov/Archives/edgar/data/1065280/0001193125112...

The content liability incurred from the acquisition of streaming rights for a property can range anywhere from 6 months to 5 years, so not all of it falls into the current liability bucket:

The Company typically enters into multi-year licenses with studios and other distributors that may result in an increase in content library and a corresponding increase in accounts payable and other non-current liabilities. The payment terms for these license fees may extend over the term of the license agreement, which typically range from six months to five years.



Mike

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Author: zoningfool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3835 of 3899
Subject: Re: Netflix accounting tangle Date: 11/2/2011 8:55 AM
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Mike,

The $650M of streaming content is listed as a current liability.

On the balance sheet, there is $750M listed as 'accounts payable' under 'current liabilities' (page 3)

Of that $750M categorized as accounts payable, $654M is streaming content--so that is considered an obligation falling due within a year. (page 8)

There is another $348M of streaming content that is listed under non-current liabilities. (page 8)

Also, if you look at the off-balance sheet obligations--there is another $740K of estimated streaming content payment due in less than a year--making the $654M higher (page 11)

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Author: TMFSandman Big red star, 1000 posts Feste Award Nominee! Old School Fool Coverage Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3836 of 3899
Subject: Re: Netflix accounting tangle Date: 11/2/2011 10:14 AM
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You're right, zoningfool, thanks for the catch. Sorry about that KitKat.

From page 27 of the 10Q:

For the titles recognized in content library, the license fees due but not paid are classified on the consolidated balance sheets as “Accounts payable” for the amounts due within one year and as “Other non-current liabilities” for the amounts due beyond one year.


I think comparing this number to CFFO might not be the right way to go. NFLX straight-line amortizes the content liabilities over their contract life and then adds or subtracts back the actual cash expense paid for these rights in the cash flow statement. If you subtract the content liability expenses from CFFO again you'd be counting it twice.

Questions similar to this must come up pretty regularly. The accounting treatment for these streaming rights is question number one on Netflix's investor relation FAQ:

http://ir.netflix.com/faqTopQ.cfm#

These seem to be small details though when you look at the size of the combined short term on and off balance sheet liabilities. My first assumption would be that cash acquisition costs would be managed/reduced in order fund content liabilties as they come due.


Mike

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Author: LeKitKat Big gold star, 5000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Feste Award Winner! Old School Fool Global Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3838 of 3899
Subject: Re: Netflix accounting tangle Date: 11/2/2011 6:12 PM
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thanks guys--appreciate the responses.

I also posed this over at DMC and HR answered with a lengthy and detailed explanation I have not had time to go through. I hope you all will go over to the link and read through it too and then let me know if you have any additions or other points to think about

I may have some internet access trouble that keeps me from getting in to the details this week unfortunately. Hope to get it straightened out. I think this could be a great tool[HRs response] to use to try to understand NFLX now and for the future

http://boards.fool.com/netflix-accounting-questions-29642318...

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Author: zoningfool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3839 of 3899
Subject: Re: Netflix accounting tangle Date: 11/3/2011 10:51 AM
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KitKat--I have zero familiarity with Netflix and haven't had a chance to wade through either their filings or HR's response on the other board--but this statement from one of your posts caught my attention and I may be able to offer a potential explantion for it:

The streaming content is not officially capex it is cash flow from operations.

Capital investments are those meant to yield benefits beyond a year (that's why many of us capitalize--and then amortize-- R&D instead of expensing it in DCF analyses). So my assumption is that Netflix feels that the streaming content's benefits will be limited to a year or less--not that off-beat an assumption given the short duration of demand for movies, imo.

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Author: zoningfool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3840 of 3899
Subject: Re: Netflix accounting tangle Date: 11/3/2011 4:06 PM
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Also, if you look at the off-balance sheet obligations--there is another $740K of estimated streaming content payment due in less than a year--making the $654M higher (page 11)

I stand corrected--Howard Rourke on the Monkey board just pointed out that there is an error in the filing. The amount of off-balance sheet obligations for streaming content due in less than a year is $740M--quite a difference. Btw, although the correct number appears on page 26 of the filing, I contacted Netflix's IR dept to ask for an amended filing (10-Q/A) to be made given the discrepancy.

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Author: LeKitKat Big gold star, 5000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Feste Award Winner! Old School Fool Global Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3841 of 3899
Subject: Re: Netflix accounting tangle Date: 11/4/2011 12:44 PM
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hi zf

Thanks for your posts. I had been using millions and that threw me for a loop when I saw the footnote reported the results in thousands. Thankfully it was their error :)

About the streaming content. It is not exactly defined by time but more by if the costs are known and by the first availability of the title. So it can show up as a current asset and as content library under non-current assets.

At AMC, it is included in the section where we normally see changes in working capital. So I am inclined to start thinking of it more as inventory and the acquisition of content is a change in inventory and a use of cash. It is offset by the change in streaming content liability that can be thought of as a payable and an addition to cash flow. They both occur above the little piece of the cash flow from operations that traditionally is set aside at the tail end of the cash flow from operations at the bottom . I am not exactly sure why it goes where it does but it makes no difference really. Just need to start thinking of it the way I would inventory and other working capital management

HR was totally right about the double counting. Costs of streaming are not being paid by CFFO, but changes in the accounts will affect it. So if inventory continues to increase dramatically and if payables come due and are paid down significantly and contract on the CFFO then we would see smaller cash flow. There are a lot payables/obligations coming due in the next 12 months--both those on the CFFO and in the footnotes that said thousands but were actually millions--big difference!

maybe you can help me find the illusive $239 million in content expense paid

From HR

-A better estimate of what they actually paid for total streaming content for the first nine months starts with the $1.34b of new liabilities accrued less the $817m actual increase in liabilities = ~$523m.

But this isn't the whole story because as mentioned above Netflix also makes cash payments on deals that never hit the balance sheet. This isn't always as easy to find but thanks to Netflix's unusually investor-friendly disclosure (yes), you can use their 10-Q to figure out that total cash paid for streaming content in the first 9 months was ~$762m, meaning that another ~$239m was actually paid for streaming content that never hit the balance sheet.

But note this additional $239m cash payment (or something very close to it) is already recognized as a cost of subscription on the P&L over and above the amortization identified in the cash flow statement. As you can see from this (plus the library amortization YTD of $418m), its streaming cash costs appear to only outstrip its P&L costs by about $100m YTD.


Where is the $239 million hiding? I have started looking but nothing is jumping out at me.

I also arrived at an extra use of $100 million for content expense and the corresponding decrease of CFFO by $100 million. That was:

-$1334 billion increase in SC inventory ie additions to SC library
+ 817 million payables ie change in SC liability
+ 418 amortization
==============================================================
-$99 million


not sure if this represents that same $100 million in extra cash use off the balance sheet HR is referencing because I have not been able to follow the trail to finding the $239 million.

Any ideas?

Thanks much

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Author: zoningfool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3842 of 3899
Subject: Re: Netflix accounting tangle Date: 11/4/2011 4:13 PM
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IN HR's post, the $239 refers to this:

$1344M increase in SC library asset
less $817M increase in SC library liability
-----------------
= $527M net decrease in SC-related OCF (HR used $524)

So:

$762M (from HR's post*--I can't find where he's getting this yet)
less net decrease in cash of $524 (using HR's number)
----------------------
=$239M

*HR writes: you can use their 10-Q to figure out that total cash paid for streaming content in the first 9 months was ~$762m

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Author: LeKitKat Big gold star, 5000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Feste Award Winner! Old School Fool Global Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3843 of 3899
Subject: Re: Netflix accounting tangle Date: 11/6/2011 12:02 AM
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hi zf

Still looking for the $239 million that is expensed on the profit loss bringing total P&L expense of acquisitions to $762. Not finding it.

So far all I can find is for 9 months

costs of subscription $1277 includes content and mailing and cost of distribution of streaming content

amortization was $492 for DVDs+ streaming content

The remainder is $785 million in cost of subscription.

Part of the $785 is mailing DVDs and paying Amazon for access to streaming infrastructure. The rest is the cost of content that does not get amortized. If I knew the amount of each, I would know how much unamortized cost of content was. NFLX doesn't say

NFLX does say that costs of subscription increased $459.7 million.
We know that the entire $459.7 million went to buy content---NFLX says so.

That increase presumably has to include the cost of increased amortized content as well as the elusive amount we are looking for--streaming content paid in the P&L that was not amortized.

There was a $287 million increase in amortized content cost. I included DVDs just to keep it from getting more confusing

That leaves $173 million in increased streaming content cost for 9 months that was not amortized. This is not the total cost--just the increase

Suppose you were tempted just to take the amortized amount of $492 and add the increase $173 to see if that gets you to $762--it does not --it is $665. So there is some content cost in there I can't find. Don't know where to look or even if this where I should be looking. The costs according to HRs work for content in the P&L are $762 and $239 in excess of the amortized amount.

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Author: zoningfool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3844 of 3899
Subject: Re: Netflix accounting tangle Date: 11/7/2011 7:35 AM
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Howard Rourke on the Monkey board just pointed out that there is an error in the filing. The amount of off-balance sheet obligations for streaming content due in less than a year is $740M--quite a difference. Btw, although the correct number appears on page 26 of the filing, I contacted Netflix's IR dept to ask for an amended filing (10-Q/A) to be made given the discrepancy.

Wow--that was quick--the 10-Q/A correcting the error has just been filed:

EXPLANATORY NOTE

Netflix, Inc. is filing this Amendment No. 1 to its Quarterly Report on Form 10-Q for the three months ended September 30, 2011, as filed with the Securities and Exchange Commission on October 27, 2011, to correct a typographical error in the heading to the table contained in the Streaming Content section within footnote 9 “Commitments and Contingencies.” The heading to the table has been changed to “(In millions)” from “(In thousands).” Other than the change to this header, all information included in the initial filing is unchanged.



http://sec.gov/Archives/edgar/data/1065280/00011931251129799...

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Author: zoningfool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3845 of 3899
Subject: Re: Netflix accounting tangle Date: 11/7/2011 11:09 AM
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I don't understand the $762 from Howard's numbers either, so I'll let him explain how he derived it. As far as cash above that which is expensed in the p/l for streaming content--I arrive at $124M:

$1344M in additions to streaming content library
less the $817M increase in liabilities related to streaming content
plus $15M in 'prepaid content'
= -$542M cash changes related to streaming content

The amortization expense for streaming content (which would be recorded on the p/l) is $418M. So that leaves $124M in cash paid above the related expense (in the 9 months ended Sept 30, 2011)

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