Netflix, Inc. — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015; financial statements are unaudited. Netflix reported three segments: Domestic Streaming, International Streaming and Domestic DVD. The company described more than 65 million memberships in over 50 countries. All share and per-share figures reflect the seven-for-one stock split paid July 14, 2015.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Revenue | $1.645 billion | $1.340 billion | $3.218 billion | $2.610 billion |
| Operating income | $74.8 million | $129.6 million | $172.3 million | $227.2 million |
| Net income | $26.3 million | $71.0 million | $50.0 million | $124.1 million |
| Diluted EPS | $0.06 | $0.16 | $0.12 | $0.29 |
| Operating cash flow | $(181.3) million | $56.0 million | $(308.7) million | $92.4 million |
| Non-GAAP free cash flow | $(229.3) million | $16.3 million | $(392.4) million | $24.7 million |
Q2 revenue increased 23% year over year, while operating income fell 42% and net income fell 63%. Operating margin was approximately 4.6%, versus 9.7% in Q2 2014; net margin was approximately 1.6%, versus 5.3%. Higher content and operating costs, international expansion spending and increased interest expense contributed to lower earnings.
- Streaming: Domestic Streaming Q2 revenue was $1.026 billion and contribution profit was $339.8 million (33% margin), compared with $838.2 million and $227.3 million (27%) a year earlier. International Streaming revenue rose 48% to $454.8 million, but its contribution loss widened to $91.9 million from $15.3 million.
- DVD: Domestic DVD revenue fell 16% to $164.0 million; contribution profit declined 16% to $77.9 million, with the contribution margin steady at 48%.
- Memberships: At quarter-end, Domestic Streaming had 42.3 million memberships, International Streaming 23.3 million and DVD 5.3 million. International memberships grew 68% year over year; Domestic DVD memberships declined 15%.
Liquidity, debt and cash commitments
At June 30, cash and cash equivalents were $2.294 billion and short-term investments were $502.9 million, totaling $2.797 billion. Long-term debt was $2.4 billion, up from $900 million at year-end 2014 after $1.5 billion of notes were issued in February. The notes are senior unsecured obligations; Netflix reported compliance with their covenants.
Operating cash use and negative free cash flow reflected content cash payments exceeding content expense, among other items. Netflix attributed the first-half increase in operating cash use primarily to a $642.3 million rise in content payments, partly offset by higher revenue. Streaming content obligations totaled $10.1 billion, including $5.7 billion not yet recorded as balance-sheet liabilities. The company said unknown future-title commitments were expected to be significant and estimated approximately $3–$5 billion over the next three years, mostly payable after the next 12 months; actual amounts may differ.
Changes, outlook and risks
- Management’s stated strategy is global streaming growth while operating within consolidated net-income and segment contribution targets. It expected to launch in Japan, Spain, Portugal and Italy later in 2015; no specific financial guidance was provided in the supplied filing text.
- Management expected significantly higher investment in international expansion and streaming content, particularly original content. It warned that content payment terms can require cash well before related expense and that additional financing may not be available on acceptable terms, or at all.
- International revenue and contribution were pressured by currency movements and higher European VAT absorbed by the company. Management estimated first-half revenue would have been about $129 million higher and international contribution losses about $42 million lower at prior-year exchange rates. Netflix said it did not hedge foreign-currency exposures.
- International contribution losses expanded as content and marketing spending supported new markets. Domestic DVD continued to contract, while Domestic Streaming margins improved as revenue growth outpaced content and marketing spending.
- Streaming content amortization relies on estimates of viewing patterns and useful lives; changes in estimates could materially affect future results. The filing reported no material content-library write-downs in the periods presented.
- Management disclosed shareholder securities and derivative litigation with potential losses considered reasonably possible but not reasonably estimable. Tax examinations were ongoing, including IRS examinations for 2010–2013 and a California proposed assessment concerning research credits; the possible adjustment to unrecognized tax benefits could not be estimated.
- A change in functional currency for certain European entities contributed a $21.8 million cumulative translation adjustment in first-half other comprehensive loss. A separate $34.4 million foreign-exchange loss affected first-half earnings. The filing reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- How content commitments—including the estimated $3–$5 billion of unknown future-title obligations—could affect cash flow, liquidity and financing needs.
- Whether international membership growth can improve segment economics despite currency exposure, high launch spending and weaker revenue per paying membership.
- Whether Domestic Streaming margin gains can continue as content investment and marketing needs evolve.
- Current debt terms, future interest costs and the company’s capacity to fund expansion without additional borrowing or equity issuance.
- Developments in tax examinations, the California proposed assessment and the disclosed shareholder litigation, whose potential losses were not estimable.