Netflix, Inc. — 2015 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2015; filed January 28, 2016. This is an annual report, not a standalone Q4 filing. Amounts below are in U.S. dollars unless noted.
Business context
Netflix operates domestic streaming, international streaming, and U.S. DVD-by-mail services. Its strategy is to grow streaming memberships globally while pursuing consolidated net income and segment contribution-profit targets, with increased investment in exclusive and original programming. At year-end, it reported 74.8 million global streaming memberships and 4.9 million DVD memberships; it said members streamed more than 125 million hours per day. In January 2016, the company announced service availability virtually worldwide, excluding China and territories where U.S. companies could not operate.
Financial and operating metrics
| Metric | FY 2015 | FY 2014 |
|---|---|---|
| Revenue | $6.780 billion | $5.505 billion |
| Operating income | $305.8 million | $402.6 million |
| Operating margin | 4.5% (approx.) | 7.3% (approx.) |
| Net income | $122.6 million | $266.8 million |
| Diluted EPS | $0.28 | $0.62 |
| Net cash from operating activities | $(749.4) million | $16.5 million |
| Free cash flow (non-GAAP) | $(920.6) million | $(126.7) million |
| Cash, cash equivalents and short-term investments | $2.311 billion | $1.608 billion |
| Long-term debt, net of issuance costs | $2.371 billion | $885.8 million |
Revenue rose 23%, while operating income fell 24% and net income fell 54%. Operating cash flow and free cash flow turned substantially more negative as content cash payments grew faster than content expense; management attributed the cash use principally to increased investment in streaming content with upfront payment requirements. The company issued $1.5 billion of notes in February 2015.
- Streaming growth: Global streaming memberships increased 30% to 74.8 million, including 17.4 million net additions. Domestic streaming revenue rose 22% to $4.180 billion; contribution profit increased 47% to $1.376 billion and margin improved to 33% from 27%.
- International streaming: Revenue rose 49% to $1.953 billion, but contribution loss widened to $333.4 million from $159.8 million. Average monthly revenue per paying membership fell 10% to $7.48, mainly due to currency movements and higher VAT, partly offset by pricing and plan mix.
- DVD: Revenue declined 16% to $645.7 million as average paid memberships fell 16%. Contribution profit declined 13% to $321.8 million, although margin rose to 50% from 48%.
- Q4 context: Unaudited fourth-quarter 2015 revenue was $1.823 billion and net income was $43.2 million, compared with $1.485 billion and $83.4 million, respectively, in Q4 2014.
- Liquidity and obligations: Streaming content obligations totaled $10.9 billion, including $6.1 billion not yet recognized on the balance sheet. The filing also estimated $3 billion to $5 billion of additional obligations for unknown future titles over the next three years, with most payments expected after the next 12 months. Working capital was $1.902 billion.
Changes, outlook and notable items
- Management attributed lower operating income to higher international expansion costs, headcount, marketing, and content spending. Interest expense increased to $132.7 million from $50.2 million, primarily reflecting increased debt; foreign-exchange losses were $37.3 million.
- Management maintained a 40% domestic streaming contribution-margin target for 2020. It expected to significantly increase global streaming content investment, particularly in originals, and anticipated that free cash flow could remain negative. It said available funds and operating cash flows were expected to cover cash needs for at least 12 months, but it was likely to raise additional capital in future periods.
- The company increased the U.S. two-screen HD plan price to $9.99 per month in October 2015; a substantial number of existing U.S. memberships were due to reach the end of grandfathered pricing in 2016, after which members could choose the $7.99 basic plan or continue at the higher price.
- A change in estimated viewing patterns led to a revised amortization method for certain content, increasing 2015 cost of revenue by $25.5 million and reducing net income by $15.8 million, or $0.04 per share. No material content-asset write-downs were reported.
- The effective tax rate was 14%, versus 24% in 2014, reflecting research-and-development credits and a $13.4 million release of tax reserves following audit settlements. The 2015 result also included the retroactive benefit of the federal R&D credit.
- Risks highlighted include member acquisition and retention, intense competition and piracy, large fixed and multi-year content commitments, original-programming performance, international execution and foreign-exchange exposure, dependence on Amazon Web Services, cybersecurity and privacy, and network-operator practices. The company did not hedge foreign-currency exposure.
- Shareholder securities and derivative litigation remained pending; management considered a potential loss reasonably possible but said it could not reasonably estimate a loss or range. The company reported effective disclosure controls and internal control over financial reporting; the auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Whether membership growth and pricing can sustain domestic contribution-margin improvement while international streaming moves toward profitability.
- How content cash payments, the $10.9 billion of disclosed commitments, and estimated unknown-title obligations affect future free cash flow and financing needs.
- The sensitivity of international revenue, contribution losses, and content liabilities to exchange rates and local taxes.
- Member response to the U.S. price increase and the 2016 expiration of grandfathered pricing.
- Potential outcomes of pending litigation and content/music-rights negotiations, whose costs or timing may be uncertain.