Netflix, Inc. — Q1 2017 Form 10-Q
Business context and period: Unaudited results for the three months ended March 31, 2017, compared with Q1 2016; balance-sheet amounts are compared with December 31, 2016. Netflix operates Domestic Streaming, International Streaming and Domestic DVD segments, primarily funded by monthly membership fees.
Financial performance
| Metric | Q1 2017 | Q1 2016 / comparison |
|---|---|---|
| Revenue | $2.637 billion | $1.958 billion; up 35% |
| Operating income / margin | $256.9 million / 9.7% | $49.5 million / 2.5% |
| Net income | $178.2 million | $27.7 million |
| Diluted earnings per share | $0.40 | $0.06 |
| Cash from operating activities | $(343.9) million | $(228.6) million |
| Free cash flow (non-GAAP) | $(422.5) million | $(260.6) million |
| Cash and cash equivalents | $1.078 billion | $1.468 billion at Dec. 31, 2016 |
| Cash, cash equivalents and short-term investments | $1.341 billion | $1.734 billion at Dec. 31, 2016 |
| Long-term debt, net of issuance costs | $3.365 billion | $3.364 billion at Dec. 31, 2016 |
Global streaming memberships were 98.748 million at quarter-end, up 21% year over year. Average monthly revenue per paying global streaming membership rose 12% to $9.14.
- Domestic Streaming: Revenue rose 27% to $1.470 billion; contribution profit was $605.5 million and margin 41%, versus 36% a year earlier. Ending memberships rose 8% to 50.854 million.
- International Streaming: Revenue rose 61% to $1.046 billion; contribution profit was $42.7 million, versus a $104.2 million loss, and margin improved to 4% from negative 16%. Ending memberships rose 39% to 47.894 million.
- Domestic DVD: Revenue declined 17% to $120.4 million; contribution profit declined 16% to $60.2 million, with margin holding at 50%. Ending memberships fell 17% to 3.944 million.
Cash used in operations increased as content cash payments outpaced content amortization; management reported a 1.5 ratio of content payments to content expense. Streaming content additions were $2.349 billion, while streaming content amortization was $1.306 billion. Total assets were $14.359 billion and total liabilities $11.385 billion at quarter-end.
Material changes and management commentary
- Revenue growth reflected more paid streaming memberships globally, particularly internationally, and higher average monthly revenue per paying membership from price changes and plan mix.
- Operating income growth reflected higher revenue, partly offset by increased content spending and personnel costs. Technology and development expenses rose 26% and general and administrative expenses rose 53% year over year.
- International streaming moved from a contribution loss to a profit as growth in more mature markets offset investment in newer markets. Management projected a small International Streaming contribution loss in Q2 2017.
- Management expects significantly higher investment in global streaming content, especially originals, and negative free cash flow for many years. It anticipated available cash, operating cash flows and financing access would cover needs for at least the next 12 months, and said it might raise additional long-term debt, including in Q2 2017.
Risks, commitments and unusual items
- Streaming content obligations totaled $15.3 billion, up from $14.5 billion at year-end; $8.4 billion was not yet recognized on the balance sheet. Management said additional obligations for unknown future titles were expected to be significant and could be approximately $3–$5 billion over the next three years, mostly payable after the next 12 months.
- Foreign currency movements are a risk, and Netflix does not hedge foreign-currency exposure with derivatives. Management estimated Q1 international revenue would have been about $11.8 million higher at prior-year exchange rates.
- The 20% effective tax rate included a $36.0 million discrete benefit from excess stock-based compensation tax benefits following adoption of ASU 2016-09. Adoption also increased retained earnings by $43.6 million; management warned that the new accounting could increase effective-tax-rate volatility.
- Gross unrecognized tax benefits were $30.7 million. The IRS was examining 2014 and 2015 federal returns; the company said the balance could change significantly within 12 months, but could not estimate a range.
- Debt notes are senior unsecured obligations; Netflix reported compliance with their covenants. Routine litigation and indemnification exposures were disclosed, with no material litigation provision described. Management reported no material change to previously disclosed risk factors and no material change in internal control over financial reporting.
Investor verification priorities
- Track whether membership growth and pricing sustain revenue gains, particularly as Domestic membership additions slowed and DVD memberships continued to decline.
- Compare content cash payments with amortization and monitor free cash flow, content obligations—including unrecognized and unknown-title commitments—and financing needs.
- Assess whether International Streaming contribution margins improve while the company continues investing in newer markets and original content.
- Review foreign-exchange effects and tax developments, including the IRS examination and the potential volatility from stock-compensation tax benefits.
- Verify debt and liquidity capacity against scheduled obligations, including the company’s stated reliance on access to financing.