Netflix, Inc. — Q2 2017 Form 10-Q
Business context and period: Unaudited results for the quarter and six months ended June 30, 2017, compared with the same 2016 periods. Netflix operates Domestic Streaming, International Streaming and Domestic DVD segments. At quarter-end, it reported 103.952 million streaming memberships across more than 190 countries.
Key financial metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $2.785 billion | $2.105 billion | $5.422 billion | $4.063 billion |
| Operating income | $127.8 million | $70.4 million | $384.7 million | $119.8 million |
| Operating margin | 4.6% | 3.3% | 7.1% | 2.9% |
| Net income | $65.6 million | $40.8 million | $243.8 million | $68.4 million |
| Diluted EPS | $0.15 | $0.09 | $0.55 | $0.16 |
| Operating cash flow | $(534.5) million | $(226.3) million | $(878.4) million | $(454.9) million |
| Non-GAAP free cash flow | $(608.4) million | $(254.1) million | $(1.031) billion | $(514.7) million |
At June 30, cash and cash equivalents were $1.919 billion and short-term investments were $246.1 million. Long-term debt, net of issuance costs, was $4.837 billion, up from $3.364 billion at December 31, 2016. The company issued €1.3 billion of senior notes in May. Current assets were $6.701 billion and current liabilities were $5.123 billion; these include substantial content assets and obligations.
Changes and operating performance
- Q2 revenue increased 32% year over year, reflecting growth in paid streaming memberships and higher average monthly revenue per paying membership. Global streaming average monthly revenue per paying membership rose 11% to $9.21.
- Streaming memberships increased 25% year over year to 103.952 million. International streaming memberships grew 44% to 52.031 million; Domestic Streaming memberships grew 10% to 51.921 million. Domestic DVD memberships declined 17% to 3.758 million.
- Domestic Streaming Q2 contribution margin improved to 37% from 34%. International Streaming narrowed its contribution loss to $13.1 million from $69.2 million; Domestic DVD contribution profit declined to $62.0 million from $70.9 million.
- Content amortization rose to $1.567 billion in Q2 from $1.195 billion. Total streaming content assets were $13.228 billion at quarter-end, up from $11.001 billion at year-end 2016.
- Q2 net income included a $51.6 million income tax benefit. The reported effective tax rate was negative 370%, principally reflecting excess stock-compensation tax benefits and other tax factors. Separately, foreign-exchange losses and remeasurement of euro debt weighed on other income and expense.
Outlook, risks and contingencies
- Management’s stated strategy is to expand global streaming while pursuing profit-margin targets and investing in content, particularly original programming. It expects significantly higher global content investment and negative free cash flow for many years; cash from operations, available funds and financing access are expected to meet needs for at least the next 12 months.
- Streaming content obligations totaled $15.7 billion, including $8.2 billion not yet recorded as balance-sheet liabilities. The filing also estimates approximately $3 billion to $5 billion of additional obligations for unknown future titles over the next three years; actual amounts may differ.
- Management cited upfront cash requirements for content as the primary reason operating cash use increased. First-half cash payments for streaming content assets exceeded streaming amortization expense by about $1.276 billion.
- Foreign-currency exposure is significant and unhedged with foreign-exchange contracts or derivatives. Q2 international revenue would have been about $22.6 million higher at prior-year exchange rates; first-half revenue would have been about $34.4 million higher.
- Tax benefits from stock-based compensation may increase effective-tax-rate volatility. The IRS was examining 2014 and 2015 returns, and the company said possible changes to unrecognized tax benefits over the next 12 months could not be estimated.
- The company disclosed ordinary-course litigation and indemnification exposures but did not identify them as material at the time. It reported no material changes to previously disclosed risk factors and stated that disclosure controls were effective.
Important facts for investors to verify
- Whether membership growth and pricing gains continue, especially in international markets, while international contribution profitability improves.
- How content spending, amortization and the $15.7 billion of reported obligations—plus significant unquantified future-title commitments—affect cash needs and margins.
- Financing requirements and debt-service capacity if negative free cash flow persists; the filing notes that future financing may not be available on acceptable terms.
- The sensitivity of revenue, earnings and euro-denominated debt to exchange-rate movements, given the lack of currency hedges.
- The durability of reported earnings given the unusually large tax benefit and foreign-exchange losses in the quarter.