Adjusting Content Amortization Ratio

• As the company switches from DVDs to streaming, they amortize their content over
longer periods of time (from 1-3 years to 3-5 years on average), and using a different
schedule (sum-of-the-months vs. straight line)

• The ratio of interest is amortization of content divided by total content library.

• The fiscal period we want to adjust is 3Q 2011.

• You get the numerator from the cash flow statement (Exh. 3c, “amortization of content
library”)

• You get the denominator from the balance sheet (Exh. 3b, both “current content library,
net”, and “content library, net” [the second one is the non-current portion]).
 Adjusting Content Amortization Ratio
• You need to make some assumptions. For example, in the denominator, you can use the content library at the
end of 3Q 2011, at the beginning (i.e., at the end of 2Q 2011), or the average thereof. You could also add back
the numerator to approximate gross instead of net content.
• For tractability, let’s just use beginning balances, and compare 3Q 2011(current) to 2Q (historical) 2008.
• Using the “Netflix spreadsheet” on QuestromTools:
• The “current” content amortization is 210,446/(499,434+425,246)=22.8%
• The “historical” content amortization is 57,012/(0+145,361)=39.2% (incidentally, this is also the average ratio from 2Q 2008
to 2Q2011
• If you believe that the historical rate should still apply, then you can adjust your content amortization expense
by adding (historical rate – current rate)*content library, which is (39.2%-22.8%)*(499,434+425,246)=151,648
 Your expenses increase by this amount, therefore your pretax profit decreases by the same amount.
• Then, if you want to estimate the impact on net income, you need to adjust by the tax rate as follows:
• After tax adjustment = Pre tax adjustment * (1- tax rate), where tax rate can be estimated as the ratio of Provision for Income
Taxes divided by Income before Income Taxes (using 3Q 2011 data, that’s about 33.3%)
• Hence, using the assumptions above, net income in 3Q 2011 would have been 62,460 – 151,648*(1-33.3%) = (38,689)