Netflix, Inc. — Q1 2015 Form 10-Q
Business context and reporting period. Unaudited results for the three months ended March 31, 2015, compared with Q1 2014. Netflix reported Domestic Streaming, International Streaming, and Domestic DVD segments. Its strategy was to grow streaming globally while managing consolidated net income and segment contribution targets. It reported 62.3 million global streaming memberships at quarter-end, up 29% year over year.
Financial performance
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Revenue | $1.573 billion | $1.270 billion | +24% |
| Operating income | $97.5 million | $97.6 million | Approximately flat |
| Operating margin | 6.2% | 7.7% | Down 1.5 percentage points |
| Net income | $23.7 million | $53.1 million | −55% |
| Diluted EPS | $0.38 | $0.86 | Lower |
| Operating cash flow | $(127.4) million | $36.4 million | Declined |
| Non-GAAP free cash flow | $(163.1) million | $8.4 million | Declined |
Margins and segment results. Consolidated operating income was flat despite revenue growth as costs increased. Domestic Streaming revenue rose 23% to $984.5 million; contribution profit increased 55% to $312.5 million and contribution margin improved to 32% from 25%. International Streaming revenue rose 56% to $415.4 million, but its contribution loss widened to $65.0 million from $35.0 million; contribution margin fell to −16% from −13%. Domestic DVD revenue declined 15% to $173.2 million; contribution profit fell 13% to $84.6 million, with contribution margin of 49% versus 48%.
Balance sheet and liquidity. At March 31, cash and cash equivalents were $2.455 billion and short-term investments were $502.9 million, totaling $2.958 billion. Long-term debt was $2.4 billion, up from $900 million at year-end 2014 after issuing $1.5 billion of notes in February. Total assets were $9.241 billion and total liabilities were $7.331 billion. The company reported compliance with debt covenants. Q1 operating cash use reflected content payments exceeding content expense, among other factors; financing cash inflow was $1.522 billion, primarily from debt issuance.
Material changes and management commentary
- Revenue growth reflected more streaming memberships and higher average monthly revenue per paying Domestic Streaming member, partly offset by foreign-exchange effects. Domestic Streaming memberships reached 41.4 million; International Streaming reached 20.9 million. DVD memberships declined 16% to 5.6 million.
- International Streaming added Australia and New Zealand in Q1; management expected to launch in additional markets, including Japan, later in 2015. It expected to significantly increase international and streaming-content investment, particularly in original content.
- International average monthly revenue per paying member declined 7%, to $7.68, reflecting currency movements and higher European VAT, partly offset by plan pricing changes. Management estimated that, at prior-year exchange rates, Q1 international revenue would have been about $48 million higher and the international contribution loss about $15 million lower.
- Interest expense rose to $26.7 million, primarily reflecting higher debt. Interest and other expense included a $33.7 million foreign-exchange loss, principally from remeasurement of content liabilities amid U.S. dollar strength. The company did not hedge foreign-currency exposures.
- Cash and short-term investments increased from $1.609 billion at year-end, substantially due to debt proceeds. Management noted that certain content agreements require cash payments ahead of expense recognition and that further financing, if needed, may not be available on acceptable terms or at all.
Outlook, risks and unusual items
- Content commitments: Streaming content obligations totaled $9.8 billion, including $4.0 billion due within one year; $5.5 billion was not yet recognized on the balance sheet. The filing also estimated significant, unquantified future-title commitments of approximately $3 billion to $5 billion over the next three years, with most payments expected after the next 12 months. Actual amounts and timing may differ.
- Other contractual obligations: The filing reported total contractual obligations of $14.0 billion, including streaming content, debt payments, leases, and other purchases. Unknown future-title obligations were excluded from that table.
- Currency and expansion risks: International growth increases exposure to exchange-rate movements; management warned that currency fluctuations could significantly affect future results. International contribution losses were attributed to expansion-related content and marketing investment, as well as currency effects.
- Content and accounting estimates: Content amortization depends on estimated viewing patterns and useful periods; changes in estimates could materially affect results. Negotiations with performing-rights organizations were uncertain, and resulting license fees could differ materially from estimates.
- Tax and legal matters: The company had $38.2 million in gross unrecognized tax benefits and was under IRS and California examinations; possible changes to those balances within 12 months could not be reliably estimated. Shareholder securities and derivative litigation remained disclosed as reasonably possible losses, but management could not estimate a loss amount or range.
- Unusual comprehensive loss: Comprehensive loss was $15.0 million, despite net income of $23.7 million, primarily due to $39.5 million of foreign-currency translation losses. A change in functional currency for certain European entities contributed a $21.8 million cumulative translation adjustment.
- The filing provided no clear numerical consolidated earnings or cash-flow guidance. Management’s stated outlook emphasized continued global streaming growth, international expansion, and increased content investment. The company said there were no material changes to its previously disclosed risk factors.
Important facts for investors to verify
- Whether membership growth and plan pricing can sustain revenue growth while preserving or improving consolidated profitability.
- The pace and return on International Streaming investment, including the effect of launches, marketing, content costs, VAT, and foreign exchange.
- Cash requirements from content commitments, especially the estimated $3–$5 billion of future-title obligations not included in the contractual-obligations table.
- Debt service and financing needs relative to negative free cash flow and ongoing content and expansion investment.
- Potential financial effects of tax audits, litigation, music-rights negotiations, and changes in content amortization estimates.