Netflix, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; interim financial statements are unaudited. Comparisons are with Q1 2017 unless otherwise noted. Netflix reported 124.995 million global streaming memberships at quarter-end, up 27% year over year, across more than 190 countries.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $3.701 billion | $2.637 billion | +40% |
| Operating income | $446.6 million | $256.9 million | +74% |
| Operating margin | 12.1% | 9.7% | +2.4 percentage points |
| Net income | $290.1 million | $178.2 million | +63% |
| Diluted EPS | $0.64 | $0.40 | +60% |
| Cash from operating activities | $(236.8) million | $(343.9) million | Less cash used |
| Non-GAAP free cash flow | $(286.5) million | $(422.5) million | Less cash used |
Revenue growth reflected more paid streaming memberships and higher average monthly revenue per paying member, driven by pricing and plan mix; foreign exchange also boosted international revenue. International streaming revenue rose 70%, representing 48% of consolidated revenue, while domestic streaming revenue rose 24%. Domestic DVD revenue fell 18% as memberships declined 20%.
Domestic streaming contribution margin decreased to 38% from 41%, as marketing expense increased faster than revenue. International streaming contribution margin improved to 15% from 4%; management attributed the improvement to stronger contribution from more mature markets. DVD contribution margin was 57%, up from 50%, amid lower usage and content expense.
Liquidity, debt and content commitments
- Cash, cash equivalents and restricted cash were $2.599 billion at March 31, down $223.3 million from year-end. Cash and cash equivalents on the balance sheet were $2.594 billion.
- Long-term debt, net of issuance costs, was $6.542 billion, up $42.9 million from December 31, primarily due to remeasurement of euro-denominated notes. No borrowings were outstanding under the $500 million revolving credit facility; the company reported covenant compliance.
- Streaming content assets totaled $15.941 billion. Streaming content obligations were $17.938 billion, including $7.950 billion payable within one year; $10.0 billion of the obligations were not yet recognized on the balance sheet.
- Total contractual obligations were $28.429 billion, including debt payments, leases and other purchase commitments. The content-obligation estimate excludes unknown future-title commitments; management said these could be approximately $3 billion to $5 billion over the next three years, with most payments expected after the next 12 months.
Management commentary, outlook and risks
- Management’s strategy is to grow global streaming memberships while pursuing profit-margin targets and investing in content, particularly original programming. It expects to significantly increase global streaming-content investment and anticipates negative free cash flow for many years.
- Management expects operating cash flows, available funds and financing access, including the revolving facility, to meet cash needs for at least the next 12 months. It anticipates financing capital needs in debt markets but cautions that financing may not be available on acceptable terms or at all.
- Content cash payments exceeded streaming amortization by $859.0 million in Q1. Management noted that owned productions generally require cash earlier than licensed content. Content spending, upfront production payments and future financing needs are important liquidity considerations.
- Foreign exchange loss was $71.6 million, including a $41.1 million loss from remeasurement of euro-denominated notes. Management estimated Q1 international revenue would have been $114.2 million lower at prior-year exchange rates. Netflix does not hedge foreign-currency exposures with derivatives.
- Effective tax rate was 3%, versus 20%, primarily reflecting the U.S. corporate tax-rate reduction and excess stock-compensation tax benefits. Accounting for certain tax-reform effects remained under review; adjustments could affect 2018 tax expense. Tax examinations were ongoing, and the company could not estimate the range of possible changes to unrecognized tax benefits.
- The filing reports ordinary-course litigation and indemnification exposures but identifies no material legal proceedings at this time. Management said previously disclosed risk factors had not materially changed.
- Netflix adopted the new revenue-recognition standard in Q1; management said the impact was not material. It planned to adopt the lease-accounting standard in Q1 2019 and expected the main change to be recognition of operating-lease assets and liabilities.
Investor verification priorities
- Track free cash flow, content cash payments versus amortization, and whether the expected years of negative free cash flow alter funding needs.
- Review the size, timing and balance-sheet recognition of content obligations, including the estimated $3 billion–$5 billion of unknown future-title commitments.
- Monitor debt levels, refinancing access, the effect of euro-denominated debt remeasurement, and compliance with debt covenants.
- Assess membership additions, average revenue per paying member, international contribution margins and the continuing decline of DVD memberships.
- Verify the sustainability of the low effective tax rate and the outcome of tax examinations and remaining tax-reform accounting.