This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

Netflix's House of Cards Cash Flow Hole Poised to Grow

NEW YORK ( TheStreet) -- Investors need to pay attention to the hidden costs of the original content spending strategy Netflix's (NFLX - Get Report) House of Cards in the company's second-quarter earnings results expected after the close of trading today.

House of Cards, Arrested Development and Orange Is the New Black are helping to boost expectations on Netflix's (NFLX - Get Report) subscriber growth and earnings, however, those critically acclaimed original series may also prove to be a problem for the near 30 million-member strong network.

Netflix is expected to report its highest quarterly profit in 18 months, as nearly 1 million new members join the streaming video service and the company sees a declining percentage of subscribers switching to other media such as Hulu, Amazon (AMZN - Get Report) Prime and traditional cable. The only problem is that Netflix is also expected to report a fourth consecutive quarter of negative free cash flow (FCF), as a result of heavy capital investment on its original programming.

"The investments that will continue to weigh on our cash flow relative to net income are Originals and non-Originals content (ongoing) and our Open Connect conversion (primarily in 2013)," the company said in April.

Over the long-term, the company's cash flow and profits will have to converge as money spent on programming weighs against Netflix's earnings. If investors are caught off guard, the original content driving optimism on Netflix's shares could turn to a drag.

The divergence in Netflix's cash flow and its profitability stems from how the company accounts for its spending on original shows.

While Netflix spends heavily up front to make its original series -- about $50 million a season -- very little of that money is expensed to the company's bottom line. Instead, Netflix treats its original programming as a capitalized asset that will be depreciated over multiple quarters.

Because of the accounting, Netflix's recent earnings reflect very little of the cost of its spending, however its cash flow statement shows the full amount of the money going out the door for original shows.

Investors should, at the very least, factor Netflix's streak of negative quarterly cash flow into expectations of the company's long-term profitability, and scrutinize such numbers in second quarter earnings results.

Netflix is forecast to report adjusted earnings of roughly $25 million, or 40 cents a share, according to Bloomberg data. The company, however, said it expects to see a mismatch between cash flow and net income for 2013 and analysts project about -$10 million in free cash flow for the quarter.

For the first quarter , Netflix reported operating profits of $31.8 million and adjusted earnings per share of 31 cents. Those figures, however, excluded $45 million in quarterly cash costs related to original content that pushed overall free cash flow to negative $42 million.

Netflix's cash flow statement also showed $591 million in cash spent on its streaming content library, but just $485 million in streaming content expense amortized in the first quarter.

The divergence indicates its original content expense is yet to be fully amortized.

Put another way, Netflix hasn't had to recover every dollar it spends on shows like House of Cards in the quarter they are released. Netflix's expectation, as per its accounting, is that the company will see long-term revenue from current content spending among subscriptions paid by a rising number of users.

If Netflix is correct on its assumptions, it should earn revenue equal or beyond the amortization of spending in coming quarters.
1 of 2

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free
AMZN $675.34 0.62%
NFLX $124.16 0.69%
AAPL $118.03 -0.71%
FB $105.41 -0.31%
GOOG $748.15 -0.02%


Chart of I:DJI
DOW 17,813.39 +1.20 0.01%
S&P 500 2,088.87 -0.27 -0.01%
NASDAQ 5,116.1430 +13.3350 0.26%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs