Netflix, Inc. — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. The filing also reports unaudited fourth-quarter results. Netflix operates Domestic Streaming, International Streaming, and Domestic DVD businesses, with streaming its central growth focus.
Financial and operating performance
| Metric | FY 2016 | FY 2015 | Change |
|---|---|---|---|
| Revenue | $8.831 billion | $6.780 billion | +30% |
| Operating income | $379.8 million | $305.8 million | +24% |
| Net income | $186.7 million | $122.6 million | +52% |
| Diluted EPS | $0.43 | $0.28 | +$0.15 |
| Cash from operations | $(1.474) billion | $(749.4) million | Cash use increased |
| Free cash flow | $(1.660) billion | $(920.6) million | Cash use increased |
| Cash, cash equivalents and short-term investments | $1.734 billion | $2.311 billion | Down $576.9 million |
| Long-term debt | $3.364 billion | $2.371 billion | Up $992.9 million |
- Consolidated gross margin was approximately 31.7%, versus 32.3% in 2015; operating margin was approximately 4.3%, versus 4.5%. Domestic streaming contribution margin improved to 36% from 33%; International streaming contribution loss narrowed to $308.5 million from $333.4 million, and its margin improved to (10)% from (17)%. These segment contribution margins are not consolidated operating margins.
- Global streaming memberships reached 93.8 million, up 25%, with 19.0 million net additions. International streaming added 14.3 million memberships and generated $3.211 billion in revenue, up 64%; Domestic streaming revenue rose 21% to $5.077 billion. Domestic DVD revenue fell 16% to $542.3 million as memberships declined 16% to 4.1 million.
- Fourth-quarter 2016 revenue was $2.478 billion and net income was $66.7 million; diluted EPS was $0.15. Compared with fourth-quarter 2015, revenue rose from $1.823 billion and net income from $43.2 million.
Material changes and liquidity
- Revenue growth reflected higher average paid streaming memberships and higher average monthly revenue per paying membership, including pricing changes and plan mix. Global average monthly revenue per paying membership increased 6% to $8.61.
- Operating income and net income increased, but content, marketing, technology, and administrative costs also rose as Netflix expanded internationally and invested in original programming. Interest expense increased to $150.1 million from $132.7 million. The effective tax rate rose to 28% from 14%, partly because 2015 benefited from a tax-reserve release.
- Operating cash use increased primarily because cash payments for streaming content rose 49% to $6.881 billion. Free cash flow was substantially below net income, chiefly due to content cash payments exceeding content amortization.
- Streaming content assets were $11.001 billion at year-end, while recognized content liabilities were $6.527 billion. Total disclosed streaming content obligations were $14.479 billion, including $8.0 billion not yet recognized on the balance sheet. The filing estimates a further $3–5 billion of significant obligations for unknown future titles over the next three years; these are excluded from the contractual-obligations total.
- Netflix issued $1.0 billion of 4.375% senior notes in October 2016. Management said cash flows from operations, available funds, and financing access were expected to cover cash needs for at least the next 12 months, while noting financing may not be available on acceptable terms.
Outlook, risks, and unusual items
- Management said it would focus on growing global operating margin in 2017. It expects to significantly increase global streaming content investment, particularly in originals, and cautioned that negative free cash flow may continue even after achieving material global profitability.
- Key risks include retaining and adding members amid intense competition; the scale, fixed-cost, and upfront-cash nature of content commitments; original-programming performance; foreign-exchange exposure; international regulatory and operating challenges; and reliance on third-party technology and Amazon Web Services. Netflix does not hedge foreign-currency exposures with derivatives.
- Foreign-exchange movements reduced 2016 international revenue: management estimated revenue would have been approximately $174 million higher at 2015 exchange rates. The company recorded a $22.8 million foreign-exchange gain, mainly from remeasurement of content liabilities.
- A third-quarter change in estimated viewing patterns and content amortization reduced 2016 operating income by $19.8 million, net income by $12.3 million, and basic and diluted EPS by $0.03.
- The company disclosed ongoing litigation and uncertain music-rights licensing negotiations; it said the outcome of those negotiations could differ materially from management estimates. No material content-asset write-down was recorded. Management and the auditor reported effective internal control over financial reporting, and the auditor issued an unqualified opinion on the financial statements.
Important facts for investors to verify
- Whether membership growth, pricing, and retention can support improving global operating margins without materially worsening cash use.
- The timing and cash requirements of the $14.5 billion disclosed content obligations, the additional estimated $3–5 billion for unknown titles, and future content commitments.
- Whether content amortization assumptions remain appropriate, given management judgment and the 2016 estimate change.
- Debt-service capacity and access to financing, particularly if operating cash flows remain negative or content payments accelerate.
- The effects of foreign-exchange movements, international regulation, and unresolved legal or music-licensing matters.