Netflix, Inc. — 2018 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2018. The filing also reports unaudited quarterly results; Q4 2018 revenue was $4.187 billion and net income was $133.9 million. Unless noted, amounts below are U.S. dollars.
Business context and financial performance
Netflix operates domestic and international streaming services and a declining U.S. DVD-by-mail business. Its strategy is to grow global streaming memberships while progressing toward its operating-margin target. At year-end, it had 139.3 million paid streaming memberships in more than 190 countries.
| Metric | FY 2018 | FY 2017 | Change |
|---|---|---|---|
| Revenue | $15.794B | $11.693B | +35% |
| Operating income | $1.605B | $838.7M | +91% |
| Operating margin | 10% | 7% | Up 3 percentage points |
| Net income | $1.211B | $558.9M | +117% |
| Diluted EPS | $2.68 | $1.25 | — |
| Operating cash flow | $(2.680)B | $(1.786)B | Greater cash use |
| Free cash flow | $(3.020)B | $(2.020)B | Greater cash use |
| Cash and cash equivalents at year-end | $3.794B | $2.823B | +$971.7M |
| Long-term debt, net | $10.360B | $6.499B | +$3.861B |
Global streaming paid memberships increased 26% to 139.3 million, with 28.6 million net additions. Average monthly revenue per paying streaming membership rose 9% to $10.31, reflecting price changes and a shift toward higher-priced plans. Annual gross margin, calculated from reported revenue and cost of revenue, was approximately 36.9%.
Segments and changes versus prior year
- Domestic streaming: Revenue rose 24% to $7.647B; paid memberships ended at 58.5 million. Contribution profit increased 24% to $2.583B, with contribution margin flat at 34%.
- International streaming: Revenue rose 53% to $7.782B; paid memberships ended at 80.8 million. Contribution profit improved to $661.9M from a $103.0M loss, and contribution margin reached 9% from negative 2%. Foreign exchange movements reduced reported results; management estimated revenue would have been $94M higher at prior-year exchange rates.
- Domestic DVD: Revenue declined 19% to $365.6M, and year-end paid memberships fell 19% to 2.7 million. Netflix expects the membership decline to continue.
- Content amortization rose to $7.532B from $6.198B. Content-asset cash payments increased to $12.044B from $8.906B, contributing to the larger operating cash outflow.
- Interest expense increased 77% to $420.5M, primarily because of higher debt. The effective tax rate was 1%, versus negative 15% in 2017; 2018 included a $72M tax benefit related to finalizing accounting for U.S. tax reform.
Liquidity, obligations, outlook and risks
- Cash and cash equivalents were $3.794B; the company also had a $500M undrawn revolving credit facility. Management said available funds, operating cash flows and financing access were expected to cover cash needs for at least the next 12 months.
- Management expects significant investment in global streaming content, particularly original productions, and negative free cash flow for many years. Netflix anticipates continuing to finance future capital needs through debt markets, subject to business performance and market conditions.
- Contractual obligations totaled $36.564B, including $19.286B of streaming content obligations, $14.873B of scheduled debt principal and interest, and $1.708B of lease obligations. Of the content obligations, $10.8B was not yet recorded as a balance-sheet liability. Separate commitments for unknown future titles were estimated at approximately $2B–$5B over the next three years and were not included in that contractual-obligations total.
- Key risks include intense competition and member churn; large, largely fixed, multi-year content commitments and upfront production cash needs; dependence on successful original programming; rising debt and recurring negative operating cash flow; foreign-exchange exposure without hedging; changing regulation and tax rules; cybersecurity and privacy threats; and reliance on Amazon Web Services for most computing.
- Q4 net income was $133.9M, down from $402.8M in Q3 2018 and $185.5M in Q4 2017. The filing provides quarterly figures but does not identify a single cause for the sequential decline.
- The company reclassified certain personnel expenses among cost of revenue, marketing, and technology and development to better reflect their functions. Prior periods were recast; consolidated operating income, net income and cash flows were unchanged.
- The auditor issued an unqualified opinion on the financial statements and internal controls. Management reported effective disclosure controls and internal control over financial reporting.
Investor verification priorities
- Assess whether membership growth and pricing can sustain revenue and margin improvement amid competition, churn and potential content-rights changes.
- Reconcile reported earnings with cash generation, especially the gap between content cash payments and amortization, and evaluate the funding needs implied by management’s negative-free-cash-flow outlook.
- Review the scale, timing and accounting treatment of recorded and unrecorded content obligations, including unknown-title commitments.
- Evaluate debt-service capacity, future borrowing requirements, maturity schedule and access to capital markets.
- Monitor international contribution margins, currency effects, tax examinations and any changes in content or data regulation.