Netflix, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; unaudited. Netflix operates a global subscription streaming service and a U.S. DVD-by-mail business. Comparisons below are with Q1 2019 unless otherwise noted.
Financial and operating performance
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Revenue | $5.768 billion | $4.521 billion | +28% |
| Operating income | $958 million | $459 million | +109% |
| Operating margin | 16.6% | 10.2% | +6.4 percentage points |
| Net income | $709 million | $344 million | +106% |
| Diluted EPS | $1.57 | $0.76 | +107% |
| Operating cash flow | $260 million | $(380) million | Improved $640 million |
| Free cash flow (company-defined, non-GAAP) | $162 million | $(460) million | Improved $622 million |
- Streaming revenue was $5.703 billion, up 28%; DVD revenue was $64 million, down 20%. Revenue growth reflected 21% higher average paying memberships and 6% higher average monthly revenue per paying membership.
- Paid net streaming additions were 15.8 million, versus 9.6 million; paid memberships at quarter-end reached 182.9 million, up 23%. Average monthly revenue per paying membership was $10.87, up 6%.
- Cost of revenue rose 25% to $3.600 billion, slower than revenue growth. The filing reports operating margin; it does not provide a labeled gross-margin measure.
- Cash, cash equivalents and restricted cash were $5.178 billion at quarter-end. Balance-sheet debt, net of issuance costs, was $14.670 billion, including $499 million short-term; debt principal and interest obligations totaled $20.588 billion. The company had no borrowings under its $750 million revolving facility.
- Content assets, net, were $25.267 billion. Total content obligations were $19.174 billion, including $11.2 billion not yet recognized on the balance sheet because recognition criteria had not been met.
Material changes and drivers
- Revenue and operating income increased substantially, while operating margin expanded. Management attributed margin improvement mainly to revenue growth, partly offset by increased headcount and content costs.
- Marketing expense fell 18% to $504 million, primarily because advertising expense declined. Technology and development expense rose 22% and general and administrative expense rose 25%, largely due to personnel costs.
- Content amortization increased 17% to $2.483 billion. Netflix also recorded $218 million of incremental Q1 content costs related to paused productions and a hardship fund for affected workers.
- Foreign currency movements reduced Q1 revenue by an estimated $115 million versus constant exchange rates. The company reported a $93 million gain from remeasuring euro-denominated debt, while total interest and other income declined year over year.
- Effective tax rate was 11%, compared with 14%; the 2020 rate included a $65 million discrete tax benefit from stock-based compensation.
Outlook, risks and contingencies
- COVID-19 restrictions contributed significantly to unusually high Q1 membership additions. Management said this may represent growth pulled forward from later periods and warned membership growth could slow or reverse as restrictions ease. It did not provide a clear quantified full-year forecast.
- Most Netflix and third-party productions were paused, potentially reducing new content availability in subsequent quarters, affecting retention and acquisition, and shifting production cash payments to future periods. Management also cited service and customer-support disruption, reduced availability of some product features, and possible vendor constraints, delays or higher costs.
- Management expects continued investment in global, particularly original, content and anticipates future periods of negative free cash flow. It stated that operating cash flows, available funds and financing sources are expected to meet cash needs for at least the next 12 months, while noting that pandemic-related market disruption could make financing harder or more expensive.
- Content obligations totaled $19.2 billion; additional unknown future-title commitments are excluded from the obligation table and management estimated they could be approximately $1 billion to $4 billion over the next three years, mostly payable after the next 12 months.
- Other key exposures include foreign exchange fluctuations (53% of Q1 revenue was denominated in currencies other than the U.S. dollar; the company does not hedge those exposures), legal claims, and tax examinations. The company reported $71 million of gross unrecognized tax benefits and said the possible range of changes could not be estimated.
- The company reported compliance with debt covenants and effective disclosure controls. No material change in internal control over financial reporting was reported.
Investor verification points
- Whether Q1’s pandemic-related membership surge was pulled forward from later quarters, and the resulting effects on cancellations, retention and revenue.
- Production restart timing, future content slate and the potential effects on content costs, cash-payment timing and member demand.
- Cash generation relative to content investment, including whether free cash flow remains positive and how financing needs evolve.
- The scale and timing of recognized and unrecognized content commitments, including unknown future-title obligations.
- Foreign-currency effects on revenue and earnings, and any material changes in tax examinations or unrecognized tax benefits.