Netflix, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019; unaudited. Netflix operates global streaming and a declining U.S. DVD-by-mail service. Its strategy is to grow streaming memberships globally while pursuing an operating-margin target.
Financial and operating performance
| Metric | Q3 2019 | Q3 2018 | Change |
|---|---|---|---|
| Revenue | $5.245 billion | $3.999 billion | +31% |
| Operating income | $980 million | $481 million | +104% |
| Operating margin | 18.7% | 12.0% | +6.7 percentage points |
| Net income | $665 million | $403 million | +65% |
| Diluted EPS | $1.47 | $0.89 | — |
- For the first nine months, revenue was $14.689 billion (+27% year over year), operating income $2.146 billion (+54%), and net income $1.280 billion (+19%). Diluted EPS was $2.83 versus $2.39.
- Paid streaming memberships reached 158.334 million, up 21% year over year; Q3 net additions were 6.772 million. Average monthly revenue per paying streaming membership rose 9% to $11.13.
- Q3 streaming revenue growth reflected membership expansion and higher average pricing/plan mix. International streaming revenue rose 40%; domestic streaming rose 25%. International streaming contribution margin increased to 20% from 11%, while domestic streaming contribution margin rose to 41% from 36%. These are segment contribution margins, not consolidated operating margins.
- Operating expenses increased, including content amortization and spending on content, personnel, marketing, technology, and administration. Q3 streaming content amortization was $2.280 billion versus $1.912 billion.
- Cash flow: Q3 operating cash flow was negative $502 million and free cash flow (company-defined non-GAAP) negative $551 million. For nine months, operating cash flow was negative $1.425 billion and free cash flow negative $1.605 billion. Content cash payments exceeded content amortization by $3.457 billion over the nine-month period.
- Liquidity and debt: September 30 cash and cash equivalents were $4.435 billion (cash, cash equivalents and restricted cash totaled $4.460 billion). Long-term debt, net of issuance costs, was $12.426 billion, up $2.066 billion from year-end 2018. Netflix had no borrowings on its $750 million revolving facility; $638 million of principal and interest was due within 12 months. Current assets were $5.328 billion and current liabilities $7.258 billion.
- Streaming content assets totaled $23.235 billion. Streaming content obligations totaled $19.142 billion, including $10.8 billion not yet recognized on the balance sheet. Total contractual obligations were $39.937 billion, including debt payments, leases, content, and other purchases.
Material changes versus comparable periods
- Revenue growth was led by international streaming, which represented 53% of streaming revenue in Q3 versus 50% a year earlier. Paid international memberships were up 33%; domestic paid memberships were up 6%.
- Domestic DVD memberships fell 20% year over year to 2.276 million; management expects the decline to continue.
- Nine-month content cash payments increased 18%, while streaming content amortization increased 21%, continuing to weigh on free cash flow.
- Debt increased following $2.243 billion of debt issuance during the first nine months. Interest expense rose to $448 million from $292 million.
- Netflix adopted lease accounting in Q1 2019, recognizing operating lease right-of-use assets and liabilities. It also early-adopted updated film and license accounting guidance, reclassifying content assets as non-current; neither adoption materially affected the income statement.
Outlook, commentary, and risks
- The filing provides no specific quantified earnings or revenue guidance in the supplied text. Management expects significant continued investment in global streaming content, especially originals, and anticipates negative free cash flow for many years. It said cash from operations, available funds, and financing sources should cover needs for at least the next 12 months.
- Management cited seasonality, with historically stronger membership growth in the first and fourth quarters. Paid memberships are viewed as a more reliable revenue-growth indicator than total net additions because free-trial activity varies.
- Foreign exchange is a material exposure and is not hedged with foreign-exchange contracts or derivatives. Management estimated Q3 international revenue would have been about $137 million higher at prior-year exchange rates; the nine-month estimate was about $630 million. A $161 million nine-month foreign-exchange gain, primarily from remeasurement of euro-denominated notes, also affected reported results.
- The Q3 effective tax rate was 34%, compared with a 6% tax benefit in Q3 2018; management attributed the increase primarily to tax-structure changes, lower stock-compensation and R&D credit benefits, and international tax provisions.
- Content obligations include significant estimated commitments for unknown future titles. The filing estimates these could represent $2 billion to $5 billion over the next three years, mostly payable after the next 12 months; actual amounts may differ. Additional unknown obligations are not included in the contractual-obligations table.
- Netflix cited ordinary-course litigation and indemnification exposure but said unlisted litigation was not material at the time. It was under tax examinations in the U.S. and U.K.; potential changes in unrecognized tax benefits could not be estimated. Debt covenants were reported in compliance. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether membership growth, pricing, and international contribution margins can be sustained, especially amid foreign-exchange movements and competition.
- How content spending and payment timing affect cash flow, and whether the company can reduce negative free cash flow as planned without impairing growth.
- The scale and timing of recognized and unrecognized content commitments, including unknown-title obligations estimated at $2 billion to $5 billion over three years.
- Debt-service capacity and access to debt markets as borrowing and interest costs rise; reported debt covenants were in compliance as of September 30, 2019.
- The effect of foreign exchange and tax examinations on future reported earnings, cash flows, and tax rates.