Netflix, Inc. — FY2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. The filing also reports fourth-quarter results. Amounts are in U.S. dollars unless noted.
Business context
Netflix operates domestic streaming, international streaming, and U.S. DVD-by-mail businesses. At year-end, it reported 117.6 million global streaming memberships across more than 190 countries. Its strategy is to grow global streaming membership while expanding exclusive and original programming and pursuing profit-margin targets.
Financial and operating performance
| Metric | FY2017 | FY2016 |
|---|---|---|
| Revenue | $11.69 billion | $8.83 billion |
| Operating income / margin | $838.7 million / 7% | $379.8 million / 4% |
| Net income | $558.9 million | $186.7 million |
| Diluted earnings per share | $1.25 | $0.43 |
| Cash used in operating activities | $1.79 billion | $1.47 billion |
| Free cash flow | $(2.02) billion | $(1.66) billion |
| Cash, cash equivalents and short-term investments at year-end | $2.82 billion | $1.73 billion |
| Long-term debt at year-end | $6.50 billion | $3.36 billion |
| Total content liabilities at year-end | $7.50 billion | $6.53 billion |
Revenue grew 32%, driven by global paid membership growth and higher average monthly revenue per paying streaming member, which rose 10% to $9.43. International streaming revenue increased 58% and represented 44% of consolidated revenue, compared with 36% in 2016. The international segment moved from a $308.5 million contribution loss to $226.6 million contribution profit; domestic streaming contribution profit was $2.28 billion, and DVD contribution profit was $248.0 million.
Fourth-quarter revenue was $3.29 billion and net income was $185.5 million, versus $2.48 billion and $66.7 million, respectively, in fourth-quarter 2016.
Working capital was $2.20 billion at year-end. Netflix had a $500 million unsecured revolving credit facility, undrawn at year-end. Streaming content assets, net, totaled $14.68 billion. Contractual streaming content obligations were $17.69 billion, including $10.2 billion not recognized as balance-sheet liabilities; the filing also estimates a further $3–$5 billion of obligations for unknown future titles over the next three years.
Material changes versus prior year
- Revenue rose 32%, operating income rose 121%, and net income rose 199% from FY2016.
- Global streaming memberships increased 25% to 117.6 million. International memberships supplied 18.5 million of the 23.8 million net additions.
- International contribution profit improved by $535.1 million, turning positive; domestic streaming contribution margin rose to 37% from 36%.
- Operating cash use increased by $312.0 million and free cash flow worsened by $359.9 million, principally because cash paid for streaming content exceeded content amortization by $2.71 billion.
- Debt increased by approximately $3.14 billion, reflecting 2017 note issuances. Interest expense increased 59% to $238.2 million.
Outlook, commentary, risks and unusual items
- Management expects marketing spending growth in domestic streaming to outpace revenue growth in 2018. It expects significantly increased investment in global streaming content, particularly original programming, and negative free cash flow for many years.
- Management said available funds, operating cash flows and financing access, including the revolver, should meet cash needs for at least the next 12 months. It anticipates using debt markets for capital needs; financing availability and terms are not assured.
- Key risks include intense competition and member cancellations; long-term, largely fixed content commitments and upfront production cash needs; dependence on content licensing and original-program performance; international regulatory, tax and currency exposure; cybersecurity and privacy incidents; and reliance on Amazon Web Services for most computing. Netflix does not hedge foreign-currency exposures.
- The 2017 tax provision included a net benefit and a negative 15% effective tax rate. The Tax Cuts and Jobs Act generated a provisional $79.1 million tax expense, including $46.9 million from deferred-tax remeasurement and $32.2 million of transition tax; the company also recorded a $66.5 million foreign-tax-credit benefit. Further tax analysis could change provisional amounts.
- Netflix recorded $39.1 million of expense for abandoned, unreleased content and a $127.9 million foreign-exchange loss, primarily from remeasurement of euro-denominated notes.
- The auditor issued an unqualified opinion on the financial statements and internal controls. Netflix reported no material legal proceeding in the supplied filing text; it disclosed ordinary-course litigation and said outcomes are uncertain.
Important facts for investors to verify
- Whether membership growth, retention, pricing and international contribution margins can support the scale of planned content spending.
- How negative free cash flow and future debt issuance evolve against $6.50 billion of long-term debt and $17.69 billion of disclosed content obligations, plus estimated commitments for unknown titles.
- Whether tax accounting estimates under the 2017 tax law are revised, and how foreign exchange movements affect revenue, earnings and euro-denominated debt.
- Whether original programming performs as expected and whether content amortization estimates, impairments or abandoned-content charges change materially.