Netflix, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; unaudited consolidated results, compared with Q1 2018 unless noted. Netflix operates domestic and international streaming services and a declining U.S. DVD-by-mail business.
Financial and operating performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Revenue | $4.521 billion | $3.701 billion | +22% |
| Operating income | $459 million | $447 million | +3% |
| Operating margin | 10.2% | 12.1% | Down 1.9 percentage points |
| Net income | $344 million | $290 million | +19% |
| Diluted EPS | $0.76 | $0.64 | +19% |
| Operating cash flow | $(380) million | $(237) million | Greater cash use |
| Free cash flow (non-GAAP) | $(460) million | $(287) million | Greater cash use |
Global paid streaming memberships reached 148.9 million, up 25%; paid net additions were 9.6 million versus 8.3 million. Average monthly revenue per paying streaming membership was $10.27, down 2%, primarily reflecting foreign-exchange movements. International streaming generated 53% of streaming revenue.
- Domestic streaming: Revenue $2.074 billion (+14%); contribution profit $713 million (+13%) and contribution margin 34% versus 35%. Paid memberships were 60.2 million.
- International streaming: Revenue $2.367 billion (+33%); contribution profit $274 million (+57%) and contribution margin 12% versus 10%. Paid memberships were 88.6 million. Management estimated revenue would have been about $228 million higher at prior-year exchange rates.
- Domestic DVD: Revenue $81 million, down 18%; paid memberships fell 18% to 2.6 million. Netflix expects DVD membership declines to continue.
Financial position, liquidity and obligations
- Cash, cash equivalents and restricted cash were $3.370 billion at March 31, 2019, down from $3.812 billion at year-end. Cash and cash equivalents alone were $3.349 billion.
- Long-term debt, net of issuance costs, was $10.305 billion. Contractual principal and interest payments totaled $14.768 billion, including $536 million due within one year. The company had no borrowings under its $750 million revolving credit facility, whose maturity was extended to March 2024; debt covenants were met.
- Streaming content assets were $20.889 billion. Streaming content obligations totaled $18.923 billion, including $10.4 billion not yet recorded on the balance sheet because recognition criteria had not been met. Netflix also said unknown future-title commitments could be significant, estimating approximately $2–$5 billion over the next three years.
- Operating cash use reflected content payments exceeding content amortization: content payments were approximately $3.012 billion, while streaming content amortization was $2.125 billion. Management attributed higher cash use also to operating-cost growth.
Material changes and unusual items
- Revenue growth was led by international membership expansion, but content and personnel costs grew faster than revenue, reducing the consolidated operating margin. Operating expenses included cost of revenues of $2.871 billion, marketing of $617 million, technology and development of $373 million, and general and administrative costs of $202 million.
- Interest expense increased to $136 million from $81 million, primarily due to higher long-term debt. Interest and other income was $76 million, versus expense of $66 million in Q1 2018, mainly reflecting a $62 million foreign-exchange gain compared with a $72 million loss a year earlier.
- The effective tax rate rose to 14% from 3%; management cited reduced benefits from stock-based compensation and R&D credits, and additional foreign taxes. A $41 million discrete tax benefit from stock-based compensation was recognized in Q1 2019.
- Netflix adopted lease accounting (ASC 842) and early adopted ASU 2019-02 for film and license accounting. At March 31, operating lease right-of-use assets were about $812 million and lease liabilities about $888 million. The content presentation change placed streaming content assets in non-current assets; the adoption had no material income-statement impact.
Outlook, risks and contingencies
- Management expects to continue substantially increasing global streaming-content investment, particularly original content, and anticipates negative operating cash flow and free cash flow for many years. It expects cash from operations, available funds and financing access to meet cash needs for at least the next 12 months, and expects to continue using debt markets to finance capital needs. No specific quarterly or full-year financial guidance is provided in the supplied filing text.
- Foreign-exchange volatility may affect reported revenue, international contribution profit and net income; Netflix said it does not hedge foreign-currency exposures. International revenue and cost of revenue were 52% and 59% of consolidated amounts, respectively.
- Content amortization depends on estimated viewing patterns and other management judgments. Content commitments, including significant amounts not yet recognized, create substantial future cash requirements. Actual results may differ from estimates.
- The filing describes ordinary-course litigation and indemnification obligations, with no material legal matter identified in the supplied text. Current tax examinations include U.S. federal, California and U.K. returns; the company could not estimate the possible range of changes to unrecognized tax benefits. Risk factors were reported as having no material change from the 2018 Form 10-K.
- Management stated that disclosure controls were effective and that there were no material changes in internal control over financial reporting during the quarter.
Investor verification points
- Assess whether international paid-member growth and pricing can offset foreign-exchange pressure and declining average revenue per member.
- Track operating margin and content-cost growth against revenue growth, including the cash-to-amortization gap and management’s multi-year negative-free-cash-flow outlook.
- Review the scale and timing of recognized and unrecognized content commitments, including the estimated $2–$5 billion of unknown future-title obligations.
- Evaluate leverage, upcoming debt payments, access to debt financing and the sufficiency of liquidity if cash use remains elevated.
- Monitor tax-audit outcomes, foreign-exchange gains or losses, and the effects of the lease and content-accounting changes on comparability.