Netflix, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Unaudited consolidated results; amounts below are U.S. dollars. Netflix operates domestic streaming, international streaming and domestic DVD membership businesses.
Business context and operating results
Netflix reported 130.4 million paid streaming memberships worldwide at quarter-end, up 25% year over year; total streaming memberships, including qualifying free trials, were 137.1 million. Growth was led by international streaming. Management’s stated strategy is global streaming membership growth while operating within its margin target, supported by continued investment in content and service improvements.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $4.00bn | $2.98bn | $11.61bn | $8.41bn |
| Operating income | $480.7m | $208.6m | $1.39bn | $593.4m |
| Operating margin | 12.0% | 7.0% | 12.0% | 7.1% |
| Net income | $402.8m | $129.6m | $1.08bn | $373.4m |
| Diluted earnings per share | $0.89 | $0.29 | $2.39 | $0.84 |
| Net cash used in operating activities | $690.4m | $419.6m | $1.45bn | $1.30bn |
| Non-GAAP free cash flow | $(859.1)m | $(464.9)m | $(1.70)bn | $(1.50)bn |
At September 30, cash, cash equivalents and restricted cash totaled $3.08bn; balance-sheet cash and cash equivalents were $3.07bn. Long-term debt, net of issuance costs, was $8.34bn, versus $6.50bn at December 31, 2017. The company issued $1.9bn of notes in April and had no borrowings under its $500m revolving credit facility. The current ratio was approximately 1.4, based on reported current assets and liabilities.
Streaming content assets totaled $18.40bn. Streaming content amortization was $1.92bn in Q3 and $5.51bn year to date. Cash payments for streaming content exceeded amortization by $1.26bn in Q3 and $3.05bn year to date, a principal driver of negative free cash flow.
Material changes versus comparable periods
- Q3 revenue rose 34% year over year; operating income increased 130% and net income increased 211%. For the first nine months, revenue rose 38% and operating income increased to $1.39bn from $593.4m.
- International streaming revenue grew 49% in Q3 and 60% year to date. Q3 international contribution margin improved to 17% from 5%; domestic streaming contribution margin was 39% versus 36%.
- Global paid streaming net additions were 6.1 million in Q3, up from 5.0 million. Global average monthly revenue per paying streaming membership increased 8% to $10.23, reflecting price changes and a shift toward higher-priced plans.
- Domestic DVD memberships continued to decline: paid memberships fell 20% year over year to 2.8 million at quarter-end.
- Debt, interest expense and content commitments increased. Q3 interest expense was $108.9m, up 79%, primarily due to higher debt.
Outlook, risks and unusual items
- Management expects substantial continued investment in global streaming content, particularly original productions, and anticipates negative free cash flow for many years. It stated that operating cash flow, available funds and financing sources were expected to meet cash needs for at least the next 12 months, while noting future financing may not be available on acceptable terms.
- Streaming content obligations totaled $18.65bn, including $10.4bn not yet recognized as balance-sheet liabilities. The filing says unknown future-title commitments are expected to be significant and could be approximately $3bn–$5bn over the next three years; these estimates are judgment-based and excluded from the contractual-obligations table.
- Foreign exchange is a material exposure; Netflix does not hedge currency exposures with foreign-exchange contracts or derivatives. Management estimated Q3 international revenue would have been $89.9m higher at prior-year exchange rates.
- Q3 included a $24.0m income-tax benefit and a $37.6m provisional benefit related to U.S. tax reform; the tax-law measurement period remained open. A favorable IRS settlement for 2014–2015 also produced a $7.4m discrete tax benefit.
- Contractual obligations totaled $32.42bn, including content, debt, leases and other purchases. The company reported compliance with debt covenants. Legal claims arise in the ordinary course; management did not consider the disclosed matters material at the time. No material changes to previously reported risk factors were disclosed.
- Netflix planned to adopt lease accounting in Q1 2019 and expected the principal effect to be recognition of right-of-use assets and lease liabilities for real-estate operating leases.
Important facts for investors to verify
- Whether membership growth and higher average revenue per paying member continue to support revenue and operating-margin expansion.
- How content cash payments, amortization and the $18.65bn disclosed obligations affect future free cash flow and financing needs, including excluded unknown-title commitments.
- Debt maturities, interest costs and the availability and terms of future capital-market financing.
- The sensitivity of international revenue and contribution profit to foreign-exchange movements, given the company’s unhedged exposure.
- Final tax-reform accounting adjustments, tax-audit outcomes and the impact of the planned lease-accounting adoption.