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I have followed Netflix (NASDAQ:NFLX) closely for a long-time. I first became a bear when the stock valuation went astronomical in late 2010, and I placed a sizeable short bet. As the fundamentals continued to deteriorate and the news worsened (Latin America expansion, Amazon (NASDAQ:AMZN) competition, contract renegotiations, etc), the stock continued to surge. We all know what happened in late 2011 - and the stock has been a roller coaster since. This earnings report, it is important to look beyond Wall Street's focus on subscriber numbers and to take a look at Netflix's serious liquidity issues.

The Roller Coaster

Netflix has had a wild ride throughout the past 52 weeks, with a range of $52.81-$133.43. Earnings have always been volatile for NFLX, the past 4 reports have seen movements of -25%, -14%, +22%, and -35% respectively. Dating back a year decreases the volatility (-5.2%, -9%, +15.2%, +6.5%), but even a lesser known NFLX had the potential to shock the market. The chart below (Source: Google Finance) shows the past year of movement with earnings-aftermath highlighted.

Netflix's Trajectory

Back in February, I made a model to plot cash expenditures and relevant liquidity which predicted that NFLX would need massive restructuring in 2013. I was overly pessimistic on my streaming numbers, and NFLX did not renew a few expensive streaming contracts as well. Regardless, its financial position is very flimsy especially in the face of international expansion.

As part of my model, I have calculated all relevant metrics since Q1-09 and have highlighted the best three numbers in green and the worst three numbers in red. Looking at the chart below shows two strengths for NFLX - revenue and quick liquidity/revenue. The important figures to notice are the declining revenue/sub, plummeting profit metrics, and the disastrous size of the Accounts Payable. NFLX currently can only cover its AP by 2.75X on an annual run basis. Another shocking factor is the Quick coverage of 1y AP. This coverage hit an all-time low in Q3-11 at 0.488. The next month NFLX issued $400M in convertible bonds and stock.

With these factors in mind, you will know how to cut through the noise and look for what truly matters in this afternoon's report.

What to Look For

Wall Street will be focusing on subscribers and net profitability. While these numbers are important, the real numbers to dive for are the liquidity ratios. Unfortunately, it will take a few days to get the full picture of NFLX's several billion in off-balance sheet liabilities. The 10Q that shows these will not be posted on the SEC EDGAR for several days; however, 1y accounts payable and other on-balance sheet information will be available in a few hours.

The second most important number to look for is revenue growth. Although this will largely be correlated with subscriber growth, revenue differentiates between the DVD/streaming mix and the several million free trial users. For example in Q1-12, paid subs increased by 11.43%, but revenue declined by -0.66%. In Q2-12, paid subs grew by 4.32%, but revenue only grew by 2.23%. NFLX needs a revenue growth of at least 10% Q/Q to keep pace with rising liabilities.

Gamble on Earnings?

My favorite play on this broken company is 1w OTM puts, but these are truly lottery tickets. I personally have a 1-1-2 score against NFLX (1win-1loss-2breakeven). The nice part is that the win (Q3-11) was an overnight 9-bagger.

The suggested volatility after earnings is massive, but the market is pricing the straddle at a 14% movement breakeven, so I do not recommend that trade. 10% or lower and I would back up the truck.

Patient Approach

My best recommendation for a casual investor (as opposed to a reckless speculator) is to wait and see what the earnings bring. Wall Street is too busy focusing on the subscriber counts to focus on the upcoming liquidity crisis. A "beat" on subs might lift the stock while the fundamentals deteriorate and a short opportunity will still exist. I have not naked shorted NFLX since the $80s- and not long-term since well over $100, I believe that there is much 'safer' long-term plays available like Amazon or LinkedIN (NYSE:LNKD).

Source: Watch Liquidity Problems In Netflix Earnings

Additional disclosure: I am short NFLX through (1w) $60 puts.