Netflix, Inc. — Q3 2016 Form 10-Q
Business context and period. Unaudited results for the quarter and nine months ended September 30, 2016, compared with the corresponding 2015 periods. Netflix operates Domestic Streaming, International Streaming, and Domestic DVD segments. At quarter-end it reported 86.7 million global streaming memberships, up 25% year over year, across more than 190 countries.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $2.290 billion | $1.738 billion | $6.353 billion | $4.956 billion |
| Operating income | $106.0 million | $73.6 million | $225.9 million | $245.9 million |
| Net income | $51.5 million | $29.4 million | $119.9 million | $79.5 million |
| Diluted EPS | $0.12 | $0.07 | $0.27 | $0.18 |
| Cash from operating activities | $(461.9) million | $(196.0) million | $(916.8) million | $(504.7) million |
| Non-GAAP free cash flow | $(506.4) million | $(252.0) million | $(1.021) billion | $(644.4) million |
Q3 revenue increased 32%, operating income 44%, and net income 75% year over year. Nine-month revenue rose 28% and net income rose 51%, while operating income declined about 8%. Q3 operating margin was approximately 4.6% versus 4.2% a year earlier. Content costs, marketing, technology and development, and general and administrative expenses all increased.
Q3 segment results: Domestic Streaming revenue was $1.304 billion and contribution profit was $475.2 million (36% margin); International Streaming revenue was $853.5 million and contribution loss was $68.6 million (8% negative margin); Domestic DVD revenue was $132.4 million and contribution profit was $68.7 million (52% margin). Domestic streaming memberships grew 10% year over year to 47.5 million; international memberships grew 51% to 39.2 million. DVD memberships fell 16% to 4.3 million.
Cash, debt and liquidity
At September 30, cash and cash equivalents were $969.2 million and short-term investments were $374.1 million, totaling $1.343 billion, down $967.4 million from year-end 2015. Long-term debt, net of issuance costs, was $2.374 billion. Total assets were $12.347 billion and total liabilities were $9.818 billion. Management expected operating cash flows, available funds, and capital-market access to meet cash needs for at least 12 months, and planned to obtain additional long-term debt in Q4 2016.
Negative operating cash flow primarily reflected content investment: nine-month streaming content cash payments exceeded streaming content amortization by $1.418 billion. The company said it expects to significantly increase global content investment, particularly original productions, and that negative free cash flow may continue even after achieving material global profitability.
Changes, outlook and risks
- Growth was driven mainly by international membership expansion and higher average monthly revenue per paying streaming membership, supported by pricing changes and plan mix. Q3 global average monthly revenue per paying streaming membership was $8.82, up 8% year over year.
- The U.S. phase-out of grandfathered standard-plan pricing was underway and expected to finish in Q4 2016. Management said cancellations among members whose grandfathered prices expired had not been material, but higher cancellations or movement to lower-priced plans could weaken membership and revenue outcomes.
- Domestic streaming contribution margin was 36% in Q3; the company retained a 40% domestic streaming contribution-margin target for 2020. International streaming remained loss-making as content and marketing investment supported expansion.
- Foreign exchange reduced international revenue: management estimated Q3 revenue would have been $34.9 million higher at prior-year exchange rates, and nine-month revenue $153.6 million higher. The company does not hedge foreign-currency exposure; currency movements also affected earnings through remeasurement gains and losses.
- Streaming content obligations totaled $14.353 billion, including $7.9 billion not recognized on the balance sheet because recognition criteria were not yet met. The company also estimated significant unknown future-title obligations of approximately $3–$5 billion over the next three years, mostly payable after the next 12 months; these are excluded from the stated obligation total.
- Other contractual obligations totaled $18.675 billion, including streaming content, debt principal and interest, leases, and other purchases. Content obligations rose $3.5 billion from December 2015, primarily due to multi-year exclusive and original-programming commitments.
- In Q3, Netflix changed the amortization method for certain content based on revised viewing-pattern estimates; the reported effect was not material. The company identified content amortization estimates as a critical accounting judgment.
- The company was under IRS examination for 2014–2015 and reported $16.5 million of gross unrecognized tax benefits. The possible range of near-term adjustments was not estimable. The described securities class action had been dismissed with prejudice; a related derivative action was dismissed by stipulation in August 2016.
Most important facts for investors to verify
- Whether membership growth and pricing changes can sustain revenue growth without materially increasing cancellations or lowering plan mix.
- Whether content spending and cash payment timing continue to widen negative free cash flow, and how the company finances that investment.
- The scale, timing, and balance-sheet treatment of recorded, unrecorded, and unknown streaming content commitments.
- Progress toward the 2020 domestic streaming contribution-margin target and the path to reducing international streaming losses.
- Exposure to foreign exchange movements and the terms and amount of any additional debt issuance planned for Q4 2016.