Netflix, Inc. — Q2 2019 Form 10-Q
Business context and reporting period. This unaudited quarterly filing covers the three and six months ended June 30, 2019. Netflix operates Domestic Streaming, International Streaming and Domestic DVD segments. It reported 151.6 million paid streaming memberships in more than 190 countries at quarter-end; paid DVD memberships were 2.4 million.
Financial and operating performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $4.923 billion | $3.907 billion | $9.444 billion | $7.608 billion |
| Operating income / margin | $706 million / 14.3% | $462 million / 11.8% | $1.166 billion / 12.3% | $909 million / 11.9% |
| Net income | $271 million | $384 million | $615 million | $674 million |
| Diluted EPS | $0.60 | $0.85 | $1.36 | $1.50 |
| Net cash used in operating activities | $544 million | $518 million | $924 million | $755 million |
| Free cash flow, company-defined non-GAAP | -$594 million | -$559 million | -$1.054 billion | -$845 million |
- Revenue grew 26% year over year in Q2 and 24% in the first half. Growth reflected more paid streaming members and, overall, higher average monthly revenue per paying member. International streaming generated 53% of Q2 streaming revenue.
- Q2 paid net streaming additions were 2.699 million, down from 5.452 million a year earlier. Domestic streaming lost 126,000 paid memberships, versus a gain of 872,000; International added 2.825 million, versus 4.580 million. Management cites paid memberships as a more reliable revenue indicator than total membership additions because free-trial results vary.
- Q2 operating income increased 53%, but net income fell 30%. The effective tax rate rose to 46% from 10%; higher tax expense and foreign-exchange losses contributed to the lower net income. Six-month effective tax rates were 32% and 7%, respectively.
- Q2 segment contribution margins were 37% Domestic Streaming, 16% International Streaming and 60% Domestic DVD. International’s Q2 average monthly revenue per paying member declined 3%, partly due to currency movements; management estimated Q2 international revenue would have been about $265 million higher at prior-year exchange rates.
Balance sheet, liquidity and obligations
- At June 30, cash and cash equivalents were $5.004 billion; cash, cash equivalents and restricted cash totaled $5.028 billion. Current assets were $5.877 billion and current liabilities $6.934 billion.
- Long-term debt, net of issuance costs, was $12.594 billion, up from $10.360 billion at December 31, 2018. Netflix issued debt in April; no borrowings were outstanding under its $750 million revolving credit facility. The company reported compliance with debt covenants. $645 million of principal and interest was due within 12 months.
- Streaming content assets were $21.946 billion. Streaming content obligations totaled $18.503 billion, including $10.1 billion not yet recognized on the balance sheet because recognition criteria had not been met. The contractual obligations table excludes unknown future title commitments, which management estimated could be approximately $2 billion to $5 billion over the next three years.
- Operating cash use and negative free cash flow primarily reflect content payments made ahead of amortization. In the first half, streaming-content cash payments exceeded streaming-content amortization by approximately $1.993 billion.
Outlook, commentary and risks
- Management expects to continue significantly increasing global streaming-content investment, particularly original content, and anticipates negative operating cash flow and free cash flow for many years. It said cash from operations, available funds and financing access should be sufficient for at least the next 12 months, while noting financing may not be available on acceptable terms or at all.
- The company’s core strategy is global streaming growth within its operating-margin target. Management noted that first and fourth quarters historically produce the greatest membership growth, and that growth can be affected by the release of high-profile originals.
- Foreign exchange is a material exposure: management estimated first-half international revenue would have been about $493 million higher at prior-year rates. Netflix said it does not hedge foreign-currency exposures with derivatives.
- Content amortization depends on estimated viewing patterns and requires management judgment; changes in expected usefulness could affect expense or asset values. Certain future content commitments are unknown and expected to be significant.
- Netflix adopted lease accounting and early-adopted new film-cost guidance in Q1 2019. The filing reports no material impact to the income statement from either adoption. Disclosure controls were considered effective, and the company reported no material changes to previously disclosed risk factors.
Most important facts for investors to verify
- Whether paid membership additions recover after Q2’s year-over-year slowdown, particularly the domestic decline.
- Whether revenue growth and operating margins can continue as content costs, staffing and international expansion increase.
- How ongoing negative free cash flow and content investment affect borrowing needs, debt levels and access to capital.
- The timing and amount of recognized and unrecognized content commitments, including unknown future-title obligations.
- The effects of foreign exchange and the higher effective tax rate on reported revenue, earnings and cash generation.