10-Q 1 nflx-093017x10qxdoc.htm 10-Q Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
OR

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                  to                 
Commission File Number: 001-35727
 
Netflix, Inc.
(Exact name of Registrant as specified in its charter)
 
Delaware
77-0467272
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
100 Winchester Circle, Los Gatos, California 95032
(Address and zip code of principal executive offices)
(408) 540-3700
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No   o  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
 
Accelerated filer
o
Non-accelerated filer
o
(Do not check if a smaller reporting company)
Smaller reporting company
o
 
 
 
Emerging growth company
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).    Yes  o    No  x
As of September 30, 2017, there were 432,731,130 shares of the registrant’s common stock, par value $0.001, outstanding.



Table of Contents
 


2



NETFLIX, INC.
Consolidated Statements of Operations
(unaudited)
(in thousands, except per share data)

 
Three Months Ended
 
Nine Months Ended
 
September 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
Revenues
$
2,984,859

 
$
2,290,188

 
$
8,406,958

 
$
6,353,128

Cost of revenues
1,992,980

 
1,532,844

 
5,552,312

 
4,375,482

Marketing
312,490

 
282,043

 
858,083

 
706,082

Technology and development
255,236

 
216,099

 
779,427

 
626,907

General and administrative
215,526

 
153,166

 
623,760

 
418,798

Operating income
208,627

 
106,036

 
593,376

 
225,859

Other income (expense):
 
 
 
 
 
 
 
Interest expense
(60,688
)
 
(35,536
)
 
(162,912
)
 
(106,528
)
Interest and other income (expense)
(31,702
)
 
8,627

 
(76,473
)
 
50,907

Income before income taxes
116,237

 
79,127

 
353,991

 
170,238

Provision for (benefit from) income taxes
(13,353
)
 
27,610

 
(19,421
)
 
50,308

Net income
$
129,590

 
$
51,517

 
$
373,412

 
$
119,930

Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.30

 
$
0.12

 
$
0.87

 
$
0.28

Diluted
$
0.29

 
$
0.12

 
$
0.84

 
$
0.27

Weighted-average common shares outstanding:
 
 
 
 
 
 
 
Basic
432,404

 
428,937

 
431,473

 
428,514

Diluted
447,362

 
438,389

 
446,367

 
438,180













See accompanying notes to the consolidated financial statements.

3


NETFLIX, INC.
Consolidated Statements of Comprehensive Income
(unaudited)
(in thousands)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
Net income
$
129,590

 
$
51,517

 
$
373,412

 
$
119,930

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustments 
5,678

 
2,357

 
22,604

 
5,453

Change in unrealized gains (losses) on available-for-sale securities, net of tax of $212, $(412), $378, and $810, respectively
328

 
(676
)
 
599

 
1,325

Total other comprehensive income
6,006

 
1,681

 
23,203

 
6,778

Comprehensive income
$
135,596

 
$
53,198

 
$
396,615

 
$
126,708

























See accompanying notes to the consolidated financial statements.

4


NETFLIX, INC.

Consolidated Statements of Cash Flows
(unaudited)
(in thousands)
   
Three Months Ended
 
Nine Months Ended
   
September 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
Cash flows from operating activities:
 
 
 
 
 
 
 
Net income
$
129,590

 
$
51,517

 
$
373,412

 
$
119,930

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
 
 
 
 
Additions to streaming content assets
(2,315,017
)
 
(2,442,080
)
 
(7,328,104
)
 
(6,550,445
)
Change in streaming content liabilities
(34,587
)
 
529,885

 
846,560

 
1,674,125

Amortization of streaming content assets
1,627,477

 
1,224,108

 
4,483,954

 
3,457,990

Amortization of DVD content assets
13,259

 
19,284

 
48,368

 
59,746

Depreciation and amortization of property, equipment and intangibles
19,238

 
14,410

 
52,838

 
43,339

Stock-based compensation expense
44,763

 
43,495

 
133,679

 
130,029

Excess tax benefits from stock-based compensation

 
(12,762
)
 

 
(37,401
)
Other non-cash items
9,896

 
9,682

 
43,081

 
31,479

Foreign currency remeasurement loss on long-term debt
50,830

 

 
115,050

 

Deferred taxes
(57,090
)
 
14,338

 
(104,556
)
 
(20,141
)
Changes in operating assets and liabilities:
 
 
 
 
 
 
 
Other current assets
(41,399
)
 
10,250

 
(147,000
)
 
48,649

Accounts payable
34,029

 
27,810

 
10,590

 
16,707

Accrued expenses
74,006

 
28,957

 
119,506

 
72,288

Deferred revenue
32,947

 
30,230

 
94,777

 
80,485

Other non-current assets and liabilities
(7,549
)
 
(11,065
)
 
(40,146
)
 
(43,604
)
Net cash used in operating activities
(419,607
)
 
(461,941
)
 
(1,297,991
)
 
(916,824
)
Cash flows from investing activities:
 
 
 
 
 
 
 
Acquisitions of DVD content assets
(10,217
)
 
(17,249
)
 
(43,213
)
 
(58,380
)
Purchases of property and equipment
(33,963
)
 
(27,366
)
 
(151,717
)
 
(46,605
)
Change in other assets
(1,107
)
 
125

 
(2,940
)
 
676

Purchases of short-term investments
(2,799
)
 
(128,136
)
 
(74,819
)
 
(181,590
)
Proceeds from sale of short-term investments
250,278

 
171,747

 
320,154

 
198,687

Proceeds from maturities of short-term investments

 
24,855

 
22,705

 
112,555

Net cash provided by investing activities
202,192

 
23,976

 
70,170

 
25,343

Cash flows from financing activities:
 
 
 
 
 
 
 
Proceeds from issuance of debt

 

 
1,420,510

 

Issuance costs
(312
)
 

 
(15,325
)
 

Proceeds from issuance of common stock
34,669

 
3,819

 
73,673

 
11,587

Excess tax benefits from stock-based compensation

 
12,762

 

 
37,401

Other financing activities
65

 
58

 
189

 
170

Net cash provided by financing activities
34,422

 
16,639

 
1,479,047

 
49,158

Effect of exchange rate changes on cash and cash equivalents
10,685

 
(441
)
 
27,667

 
2,151

Net increase (decrease) in cash and cash equivalents
(172,308
)
 
(421,767
)
 
278,893

 
(840,172
)
Cash and cash equivalents, beginning of period
1,918,777

 
1,390,925

 
1,467,576

 
1,809,330

Cash and cash equivalents, end of period
$
1,746,469

 
$
969,158

 
$
1,746,469

 
$
969,158

Supplemental disclosure:
 
 
 
 
 
 
 
Change in investing activities included in liabilities
$
(6,876
)
 
$
17,243

 
$
(27,041
)
 
$
15,486

See accompanying notes to the consolidated financial statements.

5


NETFLIX, INC.
Consolidated Balance Sheets
(in thousands, except share and par value data)

 
As of
   
September 30,
2017
 
December 31,
2016
 
(unaudited)
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,746,469

 
$
1,467,576

Short-term investments

 
266,206

Current content assets, net
4,223,387

 
3,726,307

Other current assets
415,492

 
260,202

Total current assets
6,385,348

 
5,720,291

Non-current content assets, net
9,739,704

 
7,274,501

Property and equipment, net
322,421

 
250,395

Other non-current assets
504,067

 
341,423

Total assets
$
16,951,540

 
$
13,586,610

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Current content liabilities
$
4,142,086

 
$
3,632,711

Accounts payable
301,443

 
312,842

Accrued expenses
331,723

 
197,632

Deferred revenue
535,425

 
443,472

Total current liabilities
5,310,677

 
4,586,657

Non-current content liabilities
3,296,504

 
2,894,654

Long-term debt
4,888,783

 
3,364,311

Other non-current liabilities
128,215

 
61,188

Total liabilities
13,624,179

 
10,906,810

Commitments and contingencies (Note 6)


 


Stockholders’ equity:
 
 
 
Common stock, $0.001 par value; 4,990,000,000 shares authorized at September 30, 2017 and December 31, 2016; 432,731,130 and 430,054,212 issued and outstanding at September 30, 2017 and December 31, 2016, respectively
1,807,123

 
1,599,762

Accumulated other comprehensive loss
(25,362
)
 
(48,565
)
Retained earnings
1,545,600

 
1,128,603

Total stockholders’ equity
3,327,361

 
2,679,800

Total liabilities and stockholders’ equity
$
16,951,540

 
$
13,586,610





See accompanying notes to the consolidated financial statements.

6


NETFLIX, INC.
Notes to Consolidated Financial Statements
(unaudited)

1. Basis of Presentation and Summary of Significant Accounting Policies
The accompanying interim consolidated financial statements of Netflix, Inc. and its wholly owned subsidiaries (the “Company”) have been prepared in conformity with accounting principles generally accepted in the United States (“U.S.”) and are consistent in all material respects with those applied in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 filed with the Securities and Exchange Commission (the “SEC”) on January 27, 2017. The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. Significant items subject to such estimates and assumptions include the streaming content asset amortization policy; the recognition and measurement of income tax assets and liabilities; and the valuation of stock-based compensation. The Company bases its estimates on historical experience and on various other assumptions that the Company believes to be reasonable under the circumstances. On a regular basis, the Company evaluates the assumptions, judgments and estimates. Actual results may differ from these estimates.
The interim financial information is unaudited, but reflects all normal recurring adjustments that are, in the opinion of management, necessary to fairly present the information set forth herein. The interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. Interim results are not necessarily indicative of the results for a full year.
The Company has three reportable segments: Domestic streaming, International streaming and Domestic DVD, all of which derive revenue from monthly membership fees. See Note 10 for further detail on the Company's segments.
There have been no material changes in the Company’s significant accounting policies, other than the adoption of Accounting Standards Update ("ASU") 2016-09 described below and in Note 9 and ASU 2017-01 described below, as compared to the significant accounting policies described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

Recently adopted accounting pronouncements
In March 2016, the Financial Accounting Standards Board ("FASB") issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends Accounting Standards Codification ("ASC") Topic 718, Compensation - Stock Compensation. ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Under the new standard, all excess tax benefits and tax deficiencies are recorded as a component of the provision for income taxes in the reporting period in which they occur. Additionally, ASU 2016-09 requires that the Company present excess tax benefits on the Statement of Cash Flows as an operating activity. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016. The Company adopted ASU 2016-09 in the first quarter of 2017 and elected to apply this adoption prospectively. Prior periods have not been adjusted. See Note 9 for information regarding the impact on the Company’s financial statements.
In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. The standard provides guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. If substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single asset or a group of similar assets, the assets acquired (or disposed of) are not considered a business. ASU 2017-01 is effective for fiscal periods beginning after December 15, 2017 (including interim periods within those periods) with early adoption permitted. The Company early adopted the standard in the third quarter of 2017 on a prospective basis and the impact on its consolidated financial statements was not material.

Recently issued accounting pronouncements not yet adopted
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) which amended the existing accounting standards for revenue recognition. ASU 2014-09 establishes principles for recognizing revenue upon the transfer of promised goods or services to customers, in an amount that reflects the expected consideration received in exchange for those goods or services. In July 2015, the FASB deferred the effective date for annual reporting periods beginning after December 15, 2017 (including interim reporting periods within those periods). Early adoption is permitted to the original effective date for annual reporting periods beginning after December 15, 2016 (including interim reporting periods within those periods). The amendments may be applied retrospectively to each prior period (full retrospective) or retrospectively with the cumulative effect recognized as of the date of initial application (modified retrospective). The Company will adopt ASU 2014-09 in the first quarter of 2018 using the modified retrospective approach. Because the Company's primary source of revenues is from monthly membership fees which are recognized ratably over each monthly membership period, the Company does not expect the impact on its consolidated financial statements to be material.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) in order to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet for those leases classified as operating leases under previous

7


GAAP. ASU 2016-02 requires that a lessee should recognize a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term on the balance sheet. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018 (including interim periods within those periods) using a modified retrospective approach and early adoption is permitted. The Company will adopt ASU 2016-02 in the first quarter of 2019. Although the Company is in the process of evaluating the impact of adoption of the ASU on its consolidated financial statements, the Company currently believes the most significant changes will be related to the recognition of new right-of-use assets and lease liabilities on the Company's balance sheet for real estate operating leases.
In November 2016, the FASB issued ASU 2016-18, Restricted Cash, which requires amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the total beginning and ending amounts for the periods shown on the statement of cash flows. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017 (including interim periods within those periods) using a retrospective transition method to each period presented and early adoption is permitted. The Company will adopt ASU 2016-18 in the first quarter of 2018 and does not expect the impact on its consolidated financial statements to be material.


2. Earnings Per Share

Basic earnings per share is computed using the weighted-average number of outstanding shares of common stock during the period. Diluted earnings per share is computed using the weighted-average number of outstanding shares of common stock and, when dilutive, potential common shares outstanding during the period. Potential common shares consist of incremental shares issuable upon the assumed exercise of stock options. The computation of earnings per share is as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
 
(in thousands, except per share data)
Basic earnings per share:
 
 
 
 
 
 
 
Net income
$
129,590

 
$
51,517

 
$
373,412

 
$
119,930

Shares used in computation:
 
 
 
 
 
 
 
Weighted-average common shares outstanding
432,404

 
428,937

 
431,473

 
428,514

Basic earnings per share
$
0.30

 
$
0.12

 
$
0.87

 
$
0.28

 
 
 
 
 
 
 
 
Diluted earnings per share:
 
 
 
 
 
 
 
Net income
$
129,590

 
$
51,517

 
$
373,412

 
$
119,930

Shares used in computation:
 
 
 
 
 
 
 
Weighted-average common shares outstanding
432,404

 
428,937

 
431,473

 
428,514

Employee stock options
14,958

 
9,452

 
14,894

 
9,666

Weighted-average number of shares
447,362

 
438,389

 
446,367

 
438,180

Diluted earnings per share
$
0.29

 
$
0.12

 
$
0.84

 
$
0.27


Employee stock options with exercise prices greater than the average market price of the common stock were excluded from the diluted calculation as their inclusion would have been anti-dilutive. The following table summarizes the potential common shares excluded from the diluted calculation:
 
Three Months Ended
 
Nine months ended
 
September 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
 
(in thousands)
Employee stock options
187

 
2,559

 
213

 
1,942




8


3. Short-term Investments
In July 2017, the Company sold all short-term investments. As of September 30, 2017, $13.9 million and $1.3 million of money market funds, classified as Level 1 securities, were included in Cash and cash equivalents and Non-current assets, respectively, on the Company's Consolidated Balance Sheet. Additionally, $3.6 million of restricted cash is included in Non-current assets on the Company's Consolidated Balance Sheet.
The following table summarizes, by major security type, the Company’s assets at December 31, 2016 that were measured at fair value, the category using the fair value hierarchy and where they are classified on the Consolidated Balance Sheets:
 
As of December 31, 2016
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Cash and cash equivalents
 
Short-term investments
 
Non-current assets (1)
 
(in thousands)
Cash
$
1,267,523

 
$

 
$

 
$
1,267,523

 
$
1,264,126

 
$

 
$
3,397

Level 1 securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
204,967

 

 

 
204,967

 
203,450

 

 
1,517

Level 2 securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate debt securities
199,843

 
110

 
(731
)
 
199,222

 

 
199,222

 

Government securities
35,944

 

 
(128
)
 
35,816

 

 
35,816

 

Certificates of deposit
9,833

 

 

 
9,833

 

 
9,833

 

Agency securities
21,563

 

 
(228
)
 
21,335

 

 
21,335

 

Total
$
1,739,673

 
$
110

 
$
(1,087
)
 
$
1,738,696

 
$
1,467,576

 
$
266,206

 
$
4,914


(1) Primarily restricted cash that is related to workers compensation deposits and letter of credit agreements.
Fair value is a market-based measurement that is determined based on the assumptions that market participants would use in pricing an asset or liability. The hierarchy level assigned to each security in the Company’s available-for-sale portfolio and cash equivalents is based on its assessment of the transparency and reliability of the inputs used in the valuation of such instrument at the measurement date. The fair value of available-for-sale securities and cash equivalents included in the Level 1 category is based on quoted prices that are readily and regularly available in an active market. The fair value of available-for-sale securities included in the Level 2 category is based on observable inputs, such as quoted prices for similar assets at the measurement date; quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly. These values were obtained from an independent pricing service and were evaluated using pricing models that vary by asset class and may incorporate available trade, bid and other market information and price quotes from well-established independent pricing vendors and broker-dealers. The Company's procedures include controls to ensure that appropriate fair values are recorded, such as comparing prices obtained from multiple independent sources. See Note 5 to the consolidated financial statements for further information regarding the fair value of the Company’s senior notes.
There were no material gross realized gains or losses in the three and nine months ended September 30, 2017 and 2016, respectively.


9


4. Balance Sheet Components
Content Assets
Content assets consisted of the following:
 
As of
 
September 30,
2017
 
December 31,
2016
 
(in thousands)
Licensed content, net
$
11,462,217

 
$
9,595,315

 
 
 
 
Produced content, net


 


Released, less amortization
984,945

 
335,400

In production
1,338,208

 
1,010,463

In development and pre-production
163,393

 
34,215

 
2,486,546

 
1,380,078

DVD, net
14,328

 
25,415

Total
$
13,963,091

 
$
11,000,808

 
 
 
 
Current content assets, net
$
4,223,387

 
$
3,726,307

Non-current content assets, net
$
9,739,704

 
$
7,274,501

Produced content is included in "Non-current content assets, net" on the Consolidated Balance Sheets. Certain original content is licensed and therefore not included in produced content. Of the produced content that has been released, approximately 29%, 79% and over 80% of the unamortized cost is expected to be amortized over the next twelve, thirty-six and forty-eight months, respectively. The amount of accrued participations and residuals is not material.
Property and Equipment, Net
Property and equipment and accumulated depreciation consisted of the following:
 
 
As of
 
 
 
 
September 30,
2017
 
December 31,
2016
 
Estimated Useful Lives

 
 
(in thousands)
 
 
Information technology assets
 
$
225,988

 
$
185,345

 
3 years
Furniture and fixtures
 
47,312

 
32,185

 
3 years
Buildings
 
40,681

 
40,681

 
30 years
Leasehold improvements
 
218,242

 
107,945

 
Over life of lease
DVD operations equipment
 
68,196

 
70,152

 
5 years
Corporate aircraft
 
29,391

 

 
8 years
Capital work-in-progress
 
14,412

 
108,296

 

Property and equipment, gross
 
644,222

 
544,604

 
 
Less: Accumulated depreciation
 
(321,801
)
 
(294,209
)
 
 
Property and equipment, net
 
$
322,421

 
$
250,395

 
 

The decrease in capital work-in-progress from December 31, 2016 is primarily due to leasehold improvements for the Company's expanded Los Gatos, California headquarters and the Company's new Los Angeles, California facility, both of which were placed into operation in the first quarter of 2017.



10


5. Long-term Debt

As of September 30, 2017, the Company had aggregate outstanding long-term debt of $4,888.8 million, net of $46.8 million of issuance costs, with varying maturities (the "Notes"). Each of the Notes were issued at par and are senior unsecured obligations of the Company. Interest is payable semi-annually at fixed rates.
The following table provides a summary of the Company's Notes and the fair values based on quoted market prices in less active markets as of September 30, 2017 and December 31, 2016:
 
 
 
 
 
 
 
 
 
Level 2 Fair Value as of
 
Principal Amount at Par
 
Issuance Date
 
Maturity
 
Interest Payment Dates
 
September 30, 2017
 
December 31, 2016
 
(in millions)
 
 
 
 
 
 
 
(in millions)
3.625% Senior Notes (1)
$
1,535.6

 
May 2017
 
2027
 
May 15 and November 15
 
$
1,563

 
$

4.375% Senior Notes
1,000.0

 
October 2016
 
2026
 
May 15 and November 15
 
1,006

 
975

5.50% Senior Notes
700.0

 
February 2015
 
2022
 
April 15 and October 15
 
765

 
758

5.875% Senior Notes
800.0

 
February 2015
 
2025
 
April 15 and October 15
 
879

 
868

5.750% Senior Notes
400.0

 
February 2014
 
2024
 
March 1 and September 1
 
436

 
431

5.375% Senior Notes
500.0

 
February 2013
 
2021
 
February 1 and August 1
 
539

 
539

 
$
4,935.6

 
 
 
 
 
 
 
 
 
 
(1) Debt is denominated in euro with a €1,300 million aggregate principal amount and is remeasured into U.S. dollars at each balance sheet date. Total proceeds were $1,420.5 million and remeasurement loss on long-term debt was $50.8 million and $115.1 million for the three and nine months ending September 30, 2017, respectively.

Each of the Notes are repayable in whole or in part upon the occurrence of a change of control, at the option of the holders, at a purchase price in cash equal to 101% of the principal plus accrued interest. The Company may redeem the Notes prior to maturity in whole or in part at an amount equal to the principal amount thereof plus accrued and unpaid interest and an applicable premium. The Notes include, among other terms and conditions, limitations on the Company's ability to create, incur or allow certain liens; enter into sale and lease-back transactions; create, assume, incur or guarantee additional indebtedness of certain of the Company's subsidiaries; and consolidate or merge with, or convey, transfer or lease all or substantially all of the Company's and its subsidiaries assets, to another person. As of September 30, 2017 and December 31, 2016, the Company was in compliance with all related covenants.
Revolving Credit Facility

In July 2017, the Company entered into a $500.0 million unsecured revolving credit facility (“Revolving Credit Agreement”), with an uncommitted incremental facility to increase the amount of the revolving credit facility by up to an additional $250.0 million, subject to certain terms and conditions. Revolving loans may be borrowed, repaid and reborrowed until July 27, 2022, at which time all amounts borrowed must be repaid. The Company may use the proceeds of future borrowings under the Revolving Credit Agreement for working capital and general corporate purposes. As of September 30, 2017, no amounts have been borrowed under the Revolving Credit Agreement.

The borrowings under the Revolving Credit Agreement bear interest, at the Company’s option, of either a floating rate equal to a base rate (the “Alternate Base Rate”) or (ii) a rate equal to an adjusted London interbank offered rate (the “Adjusted LIBO Rate”), plus a margin of 0.75%. The Alternate Base Rate is defined as the greatest of (A) the rate of interest published by the Wall Street Journal, from time to time, as the prime rate, (B) the federal funds rate, plus 0.500% and (C) the Adjusted LIBO Rate for a one-month interest period, plus 1.00%. The Adjusted LIBO Rate is defined as the London interbank offered rate for deposits in U.S. dollars, for the relevant interest period, adjusted for statutory reserve requirements, but in no event shall the Adjusted LIBO Rate be less than 0.00% per annum.

The Company is also obligated to pay a commitment fee on the undrawn amounts of the Revolving Credit Agreement at a rate of 0.10%. The Revolving Credit Agreement requires the Company to comply with certain covenants, including covenants that limit or restrict the ability of the Company’s subsidiaries to incur debt and limit or restrict the ability of the Company and its subsidiaries to grant liens and enter into sale and leaseback transactions; and, in the case of the Company or a guarantor, merge, consolidate, liquidate, dissolve or sell, transfer, lease or otherwise dispose of all or substantially all of the assets of the Company and its subsidiaries, taken as a whole. As of September 30, 2017, the Company was in compliance with all related covenants.

11



6. Commitments and Contingencies

Streaming Content
As of September 30, 2017, the Company had $17.0 billion of obligations comprised of $4.1 billion included in "Current content liabilities" and $3.3 billion of "Non-current content liabilities" on the Consolidated Balance Sheets and $9.6 billion of obligations that are not reflected on the Consolidated Balance Sheets as they did not yet meet the criteria for asset recognition.
As of December 31, 2016, the Company had $14.5 billion of obligations comprised of $3.6 billion included in "Current content liabilities" and $2.9 billion of "Non-current content liabilities" on the Consolidated Balance Sheets and $8.0 billion of obligations that are not reflected on the Consolidated Balance Sheets as they did not yet meet the criteria for asset recognition.
The expected timing of payments for these streaming content obligations is as follows:
 
As of 
 
September 30,
2017
 
December 31,
2016
 
(in thousands)
Less than one year
$
6,984,360

 
$
6,200,611

Due after one year and through three years
7,918,009

 
6,731,336

Due after three years and through five years
1,918,123

 
1,386,934

Due after five years
171,438

 
160,606

Total streaming content obligations
$
16,991,930

 
$
14,479,487

Content obligations include amounts related to the acquisition, licensing and production of streaming content. Obligations that are in non-U.S. dollar currencies are translated to the U.S. dollar at period end rates. An obligation for the production of content includes non-cancelable commitments under creative talent and employment agreements. An obligation for the acquisition and licensing of content is incurred at the time the Company enters into an agreement to obtain future titles. Once a title becomes available, a content liability is recorded on the Consolidated Balance Sheets. Certain agreements include the obligation to license rights for unknown future titles, the ultimate quantity and/or fees for which are not yet determinable as of the reporting date. Traditional film output deals, or certain TV series license agreements where the number of seasons to be aired is unknown, are examples of such license agreements. The Company does not include any estimated obligation for these future titles beyond the known minimum amount. However, the unknown obligations are expected to be significant.
Legal Proceedings
From time to time, in the normal course of its operations, the Company is subject to litigation matters and claims, including claims relating to employee relations, business practices and patent infringement. Litigation can be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict and the Company's view of these matters may change in the future as the litigation and events related thereto unfold. The Company expenses legal fees as incurred. The Company records a provision for contingent losses when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. An unfavorable outcome to any legal matter, if material, could have an adverse effect on the Company's operations or its financial position, liquidity or results of operations.
The Company is involved in litigation matters not listed herein but does not consider the matters to be material either individually or in the aggregate at this time. The Company's view of the matters not listed may change in the future as the litigation and events related thereto unfold.
Indemnification
In the ordinary course of business, the Company has entered into contractual arrangements under which it has agreed to provide indemnification of varying scope and terms to business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of the Company’s breach of such agreements and out of intellectual property infringement claims made by third parties. In these circumstances, payment may be conditional on the other party making a claim pursuant to the procedures specified in the particular contract.
The Company's obligations under these agreements may be limited in terms of time or amount, and in some instances, the Company may have recourse against third parties for certain payments. In addition, the Company has entered into indemnification agreements with its directors and certain of its officers that will require it, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. The terms of such obligations vary.

12


It is not possible to make a reasonable estimate of the maximum potential amount of future payments under these or similar agreements due to the conditional nature of the Company’s obligations and the unique facts and circumstances involved in each particular agreement. No amount has been accrued in the accompanying consolidated financial statements with respect to these indemnification obligations.


7. Stockholders’ Equity
Stock Option Plan
In June 2011, the Company adopted the 2011 Stock Plan. The 2011 Stock Plan provides for the grant of incentive stock options to employees and for the grant of non-statutory stock options, stock appreciation rights, restricted stock and restricted stock units to employees, directors and consultants. As of September 30, 2017, 11.3 million shares were reserved for future grants under the 2011 Stock Plan.
A summary of the activities related to the Company’s stock option plans is as follows:
 
 
 
Options Outstanding
 
 
 
 
 
Shares
Available
for Grant
 
Number of
Shares
 
Weighted-
Average
Exercise Price
(per share)
 
Weighted-Average Remaining
Contractual Term
(in years)
 
Aggregate
Intrinsic Value
(in thousands)
Balances as of December 31, 2016
13,289,953

 
22,437,347

 
$
44.83

 
 
 
 
Granted
(1,988,266
)
 
1,988,266

 
151.82

 
 
 
 
Exercised

 
(2,676,918
)
 
27.53

 
 
 
 
Expired

 
(1,561
)
 
3.25

 
 
 
 
Balances as of September 30, 2017
11,301,687

 
21,747,134

 
$
56.74

 
6.04
 
$
2,709,943

Vested and exercisable as of September 30, 2017
 
 
21,747,134

 
$
56.74

 
6.04
 
$
2,709,943


The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between the Company’s closing stock price on the last trading day of the third quarter of 2017 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on the last trading day of the third quarter of 2017. This amount changes based on the fair market value of the Company’s common stock.
A summary of the amounts related to option exercises, is as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
 
(in thousands)
Total intrinsic value of options exercised
$
142,664

 
$
35,443

 
$
351,488

 
$
104,168

Cash received from options exercised
34,669

 
3,819

 
73,673

 
11,587

Stock-based Compensation
Stock options granted are exercisable for the full ten year contractual term regardless of employment status. The following table summarizes the assumptions used to value option grants using the lattice-binomial model and the valuation data:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
Dividend yield
%
 
%
 
%
 
%
Expected volatility
34
%
 
41
%
 
34% - 37%

 
41% - 50%

Risk-free interest rate
2.24
%
 
1.57
%
 
2.24% - 2.45%

 
1.57% - 2.04%

Suboptimal exercise factor
2.58

 
2.48

 
2.48 - 2.58

 
2.48

Weighted-average fair value (per share)
$
72.98

 
$
44.68

 
$
67.23

 
$
47.79

Total stock-based compensation expense (in thousands)
$
44,763

 
$
43,495

 
$
133,679

 
$
130,029

Total income tax impact on provision (in thousands)
$
14,428

 
$
16,294

 
$
43,606

 
$
48,828



13


The Company considers several factors in determining the suboptimal exercise factor, including the historical and estimated option exercise behavior.
The Company calculates expected volatility based solely on implied volatility. The Company believes that implied volatility of publicly traded options in its common stock is more reflective of market conditions, and given consistently high trade volumes of the options, can reasonably be expected to be a better indicator of expected volatility than historical volatility of its common stock.
In valuing shares issued under the Company’s employee stock option plans, the Company bases the risk-free interest rate on U.S. Treasury zero-coupon issues with terms similar to the contractual term of the options. The Company does not anticipate paying any cash dividends in the foreseeable future and therefore uses an expected dividend yield of zero in the option valuation model. The Company does not use a post-vesting termination rate as options are fully vested upon grant date.

8. Accumulated Other Comprehensive Loss

The following table summarizes the changes in the accumulated balance of other comprehensive income (loss), net of tax, for the three and nine months ended September 30, 2017:

 
Foreign currency
 
Change in unrealized gains on available-for-sale securities
 
Total
 
(in thousands)
Balance as of June 30, 2017
$
(31,040
)
 
$
(328
)
 
$
(31,368
)
Other comprehensive income before reclassifications
5,678

 
328

 
6,006

Net decrease in other comprehensive loss
5,678

 
328

 
6,006

Balances as of September 30, 2017
$
(25,362
)
 
$

 
$
(25,362
)


 
Foreign currency
 
Change in unrealized gains on available-for-sale securities
 
Total
 
(in thousands)
Balances as of December 31, 2016
$
(47,966
)
 
$
(599
)
 
$
(48,565
)
Other comprehensive income before reclassifications
22,604

 
599

 
23,203

Net decrease in other comprehensive loss
22,604

 
599

 
23,203

Balances as of September 30, 2017
$
(25,362
)
 
$

 
$
(25,362
)
The amounts reclassified from accumulated other comprehensive loss were immaterial for the three and nine months ended September 30, 2017.



14


9. Income Taxes
The effective tax rates for the three months ended September 30, 2017 and 2016 were (11)% and 35%, respectively. The effective tax rates for the nine months ended September 30, 2017 and 2016 were (5)% and 30%, respectively. The effective tax rates for the three and nine months ended September 30, 2017 differed from the Federal statutory rate primarily due to the recognition of excess tax benefits as a component of the provision for income taxes attributable to the adoption of ASU 2016-09 and Federal and California research and development ("R&D") credits, partially offset by state taxes, foreign taxes, and non-deductible expenses. The effective tax rates for the three and nine months ended September 30, 2016 differed from the Federal statutory rate primarily due to Federal and California R&D credits partially offset by state taxes, foreign taxes and non-deductible expenses. The decrease in effective tax rate for the three and nine months ended September 30, 2017 as compared to the same period in 2016 was due primarily to the recognition of excess tax benefits attributable to the adoption of ASU 2016-09 and an increase in foreign income taxed at rates lower than the US statutory rate.
Gross unrecognized tax benefits were $37.2 million and $19.7 million as of September 30, 2017 and December 31, 2016, respectively. The gross unrecognized tax benefits, if recognized by the Company, will result in a reduction of approximately $33.3 million to the provision for income taxes thereby favorably impacting the Company’s effective tax rate. As of September 30, 2017, gross unrecognized tax benefits of $15.8 million was classified as “Other non-current liabilities” and $21.4 million as a reduction to deferred tax assets which was classified as "Other non-current assets" in the Consolidated Balance Sheets. The Company includes interest and penalties related to unrecognized tax benefits within the "Provision (benefit) for income taxes" on the Consolidated Statements of Operations and “Other non-current liabilities” in the Consolidated Balance Sheets. Interest and penalties included in the Company’s “Provision (benefit) for income taxes” were not material in any of the periods presented.
Deferred tax assets of $374.0 million and $227.2 million were classified as “Other non-current assets” on the Consolidated Balance Sheets as of September 30, 2017 and December 31, 2016, respectively. In evaluating its ability to realize the net deferred tax assets, the Company considered all available positive and negative evidence, including its past operating results and the forecast of future market growth, forecasted earnings, future taxable income, and prudent and feasible tax planning strategies. As of September 30, 2017, the Company has a valuation allowance of $33.1 million primarily due to foreign tax credit carryovers. As of December 31, 2016, it was considered more likely than not that substantially all deferred tax assets would be realized.
As a result of the adoption of ASU 2016-09 in the first quarter of 2017, the Company recorded a cumulative effect adjustment to increase retained earnings by $43.6 million with a corresponding increase to deferred tax assets for the Federal and state net operating losses attributable to excess tax benefits from stock-based compensation which had not been previously recognized. All excess tax benefits and deficiencies in the current and future periods will be recognized as income tax expense in the Company’s Consolidated Statement of Operations in the reporting period in which they occur. This will result in increased volatility in the Company’s effective tax rate. For the three and nine months ended September 30, 2017, the Company recognized a discrete tax benefit related to the excess tax benefits from stock-based compensation of $41.7 million and $110.5 million, respectively.
The Company files U.S. Federal, state and foreign tax returns. The Company is currently under examination by the IRS for 2014 and 2015. The 2008 through 2015 state tax returns are subject to examination by state tax authorities. The Company has no significant foreign jurisdiction audits underway. The years 2011 through 2016 remain subject to examination by foreign tax authorities. Given the potential outcome of the current examinations as well as the impact of the current examinations on the potential expiration of the statute of limitations, it is reasonably possible that the balance of unrecognized tax benefits could significantly change within the next twelve months. At this time, an estimate of the range of reasonably possible adjustments to the balance of unrecognized tax benefits cannot be made.

10. Segment Information
The Company has three reportable segments: Domestic streaming, International streaming and Domestic DVD. Segment information is presented in the same manner that the Company’s chief operating decision maker ("CODM") reviews the operating results in assessing performance and allocating resources. The Company’s CODM reviews revenues and contribution profit (loss) for each of the reportable segments. Contribution profit (loss) is defined as revenues less cost of revenues and marketing expenses incurred by the segment. The Company has aggregated the results of the International operating segments into one reportable segment because these operating segments share similar long-term economic and other qualitative characteristics.
The Domestic streaming segment derives revenues from monthly membership fees for services consisting solely of streaming content to members in the United States. The International streaming segment derives revenues from monthly membership fees for services consisting solely of streaming content to members outside the United States. The Domestic DVD segment derives revenues from monthly membership fees for services consisting solely of DVD-by-mail. Revenues and the related payment card fees are attributed to the operating segment based on the nature of the underlying membership (streaming or DVD) and the geographic region from which the membership originates. There are no internal revenue transactions between the Company’s segments.
The vast majority of the cost of revenues relate to content expenses, which include the amortization of streaming content assets and other costs associated with the licensing and acquisition of streaming content. In connection with the Company's global expansion, content acquired, licensed, and produced increasingly includes global rights. The Company allocates this content between the International and Domestic streaming segments based on estimated fair market value. Content expenses for each streaming segment thus include both expenses directly incurred by the segment as well as an allocation of expenses incurred for global or multi-territory rights. Other costs of revenues such as

15


delivery costs are primarily attributed to the operating segment based on amounts directly incurred by the segment. Marketing expenses consist primarily of advertising expenses and certain payments made to marketing partners, including consumer electronics ("CE") manufacturers, multichannel video programming distributors ("MVPDs"), mobile operators and internet service providers ("ISPs"), which are generally included in the segment in which the expenditures are directly incurred.
The Company's long-lived tangible assets were located as follows:
 
As of
 
September 30,
2017
 
December 31, 2016
 
(in thousands)
United States
$
293,733

 
$
236,977

International
28,688

 
13,418

The following tables represent segment information for the three and nine months ended September 30, 2017:
 
 
As of/ Three Months Ended September 30, 2017
 
Domestic
Streaming
 
International
Streaming
 
Domestic
DVD
 
Consolidated
 
(in thousands)
Total memberships at end of period (1)
52,772

 
56,476

 
3,569

 


Revenues
$
1,547,210

 
$
1,327,435

 
$
110,214

 
$
2,984,859

Cost of revenues
864,408

 
1,081,485

 
47,087

 
1,992,980

Marketing
128,901

 
183,589

 

 
312,490

Contribution profit
$
553,901

 
$
62,361

 
$
63,127

 
$
679,389

Other operating expenses
 
 
 
 
 
 
470,762

Operating income
 
 
 
 
 
 
208,627

Other income (expense)
 
 
 
 
 
 
(92,390
)
Benefit from income taxes
 
 
 
 
 
 
(13,353
)
Net income
 
 
 
 
 
 
$
129,590

 
As of/ Nine Months Ended September 30, 2017
 
Domestic
Streaming
 
International
Streaming
 
Domestic
DVD
 
Consolidated
 
(in thousands)
Total memberships at end of period (1)
52,772

 
56,476

 
3,569

 


Revenues
$
4,522,751

 
$
3,538,862

 
$
345,345

 
$
8,406,958

Cost of revenues
2,445,858

 
2,946,414

 
160,040

 
5,552,312

Marketing
357,547

 
500,536

 

 
858,083

Contribution profit
$
1,719,346

 
$
91,912

 
$
185,305

 
$
1,996,563

Other operating expenses
 
 
 
 
 
 
1,403,187

Operating income
 
 
 
 
 
 
593,376

Other income (expense)
 
 
 
 
 
 
(239,385
)
Benefit from income taxes
 
 
 
 
 
 
(19,421
)
Net income
 
 
 
 
 
 
$
373,412



16


The following tables represent segment information for the three and nine months ended September 30, 2016:
 
As of/ Three Months Ended September 30, 2016
 
Domestic
Streaming
 
International
Streaming
 
Domestic
DVD
 
Consolidated
 
(in thousands)
Total memberships at end of period (1)
47,497

 
39,246

 
4,273

 


Revenues
$
1,304,333

 
$
853,480

 
$
132,375

 
$
2,290,188

Cost of revenues
720,658

 
748,515

 
63,671

 
1,532,844

Marketing
108,495

 
173,548

 

 
282,043

Contribution profit (loss)
$
475,180

 
$
(68,583
)
 
$
68,704

 
$
475,301

Other operating expenses
 
 
 
 
 
 
369,265

Operating income
 
 
 
 
 
 
106,036

Other income (expense)
 
 
 
 
 
 
(26,909
)
Provision for income taxes
 
 
 
 
 
 
27,610

Net income
 
 
 
 
 
 
$
51,517

 
As of/ Nine Months Ended September 30, 2016
 
Domestic
Streaming
 
International
Streaming
 
Domestic
DVD
 
Consolidated
 
(in thousands)
Total memberships at end of period (1)
47,497

 
39,246

 
4,273

 


Revenues
$
3,673,845

 
$
2,263,429

 
$
415,854

 
$
6,353,128

Cost of revenues
2,094,310

 
2,076,576

 
204,596

 
4,375,482

Marketing
277,243

 
428,839

 

 
706,082

Contribution profit (loss)
$
1,302,292

 
$
(241,986
)
 
$
211,258

 
$
1,271,564

Other operating expenses
 
 
 
 
 
 
1,045,705

Operating income
 
 
 
 
 
 
225,859

Other income (expense)
 
 
 
 
 
 
(55,621
)
Provision for income taxes
 
 
 
 
 
 
50,308

Net income
 
 
 
 
 
 
$
119,930

The following table represents the amortization of content assets:
 
Domestic
Streaming
 
International
Streaming
 
Domestic
DVD
 
Consolidated
 
(in thousands)
Three months ended September 30,
 
 
 
 
 
 
 
2017
$
727,832

 
$
899,645

 
$
13,259

 
$
1,640,736

2016
597,039

 
627,069

 
19,284

 
1,243,392

Nine months ended September 30,
 
 
 
 
 
 
 
2017
2,033,268

 
2,450,686

 
48,368

 
4,532,322

2016
1,709,168

 
1,748,822

 
59,746

 
3,517,736


(1)
A membership (also referred to as a subscription) is defined as the right to receive Netflix service following sign-up and a method of payment being provided. Memberships are assigned to territories based on the geographic location used at time of sign-up as determined by the Company's internal systems, which utilize industry standard geo-location technology. The Company offers free-trial memberships to certain new and rejoining members. Total members include those who are on a free-trial as long as a method of payment has been provided. A membership is canceled and ceases to be reflected in the above metrics as of the effective cancellation date. Voluntary cancellations become effective at the end of the prepaid membership period, while involuntary cancellation of the service, as a result of a failed method of payment, becomes effective immediately.


17




Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws. These forward-looking statements include, but are not limited to statements regarding: our core strategy; the impact of, and the Company’s response to, new accounting standards; content amortization; pricing changes; dividends; impact of foreign currency and exchange rate fluctuations, including on net income, revenues and average revenues per paying member; investments in global streaming, including original content; impact of content on membership growth; cash use in connection with the acquisition, licensing and production of content; liquidity and free cash flow; unrecognized tax benefits; deferred tax assets; effective tax rate; accessing and obtaining additional capital, including future debt financing; accounting treatment for changes related to content assets; and future contractual obligations, including unknown streaming content obligations and timing of payments. These forward-looking statements are subject to risks and uncertainties that could cause actual results and events to differ materially from those included in forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in our Annual Report on Form 10-K for the year ended December 31, 2016 filed with the Securities and Exchange Commission (“SEC”) on January 27, 2017, in particular the risk factors discussed under the heading “Risk Factors” in Part I, Item IA. 
We assume no obligation to revise or publicly release any revision to any forward-looking statements contained in this Quarterly Report on Form 10-Q, unless required by law.
Investors and others should note that we announce material financial information to our investors using our investor relations Web site (http://ir.netflix.com), SEC filings, press releases, public conference calls and webcasts. We use these channels, as well as social media, to communicate with our members and the public about our company, our services and other issues. It is possible that the information we post on social media could be deemed to be material information. Therefore, we encourage investors, the media, and others interested in our company to review the information we post on the United States ("U.S.") social media channels listed on our investor relations Web site.

Overview
We are the world’s leading internet television network with over 109 million streaming members in over 190 countries enjoying more than 125 million hours of TV shows and movies per day, including original series, documentaries and feature films. Members can watch as much as they want, anytime, anywhere, on nearly any internet-connected screen. Members can play, pause and resume watching, all without commercials or commitments. Additionally, in the U.S., our members can receive DVDs delivered quickly to their homes.
We are a pioneer in the internet delivery of TV shows and movies, launching our streaming service in 2007. Since this launch, we have developed an ecosystem for internet-connected screens and have added increasing amounts of content that enable consumers to enjoy TV shows and movies directly on their internet-connected screens. As a result of these efforts, we have experienced growing consumer acceptance of, and interest in, the delivery of TV shows and movies directly over the internet. Historically, the first and fourth quarters (October through March) represent our greatest membership growth across our Domestic and International streaming segments. Our membership growth may be impacted by the release of certain high-profile original content, which may affect historical seasonal patterns. Internationally, we expect each market to demonstrate more predictable seasonal patterns as our service offering in each market becomes more established and we have a longer history to assess such patterns.
Our core strategy is to grow our streaming membership business globally within the parameters of our profit margin targets. We are continuously improving our members' experience by expanding our streaming content with a focus on a programming mix of content that delights our members. In addition, we are perpetually enhancing our user interface and extending our streaming service to more internet-connected screens. Our members can also download a selection of titles for offline viewing.

Results of Operations

The following represents our consolidated performance highlights:

18


 
As of/ Three Months Ended
 
Change
 
September 30,
2017
 
September 30,
2016
 
Q3'17 vs. Q3'16
 
(in thousands, except revenue per membership and percentages)

Global streaming memberships at end of period
109,248

 
86,743

 
22,505

 
26
%
Global streaming average monthly revenue per paying membership
$
9.44

 
$
8.82

 
$
0.62

 
7
%
Revenues
2,984,859

 
2,290,188

 
694,671

 
30
%
Global operating income
208,627

 
106,036

 
102,591

 
97
%
Global operating margin
7.0
%
 
4.6
%
 
2.4
%
 
52
%
Net income
129,590

 
51,517

 
78,073

 
152
%

Consolidated revenues for the three months ended September 30, 2017 increased $694.7 million as compared to the three months ended September 30, 2016 due to growth in the average number of paid streaming memberships globally, the majority of which was growth in our international memberships. In addition, the average monthly revenue per paying streaming membership increased primarily due to price changes and plan mix. The increase in operating income for the three months ended September 30, 2017 as compared to the same period in 2016 was due primarily to increased revenues partially offset by increased content expenses as we continue to acquire, license and produce content, including more Netflix originals, as well as increased headcount costs to support continued improvements in our streaming service, our international expansion, and increased content production activities. The increase in net income was comprised of an increase in operating income and an increase in the tax benefit primarily due to the adoption of ASU 2016-09 in the first quarter of 2017, partially offset by an increase in interest expense primarily due to the higher principal of notes outstanding and an increase in foreign exchange losses primarily due to the remeasurement of our euro denominated senior notes.
We offer three types of streaming membership plans. In the U.S. our "basic" plan is priced at $7.99 per month and includes access to standard definition quality streaming on a single screen at a time. Our "standard" plan is our most popular streaming plan and is priced at $10.99 per month and includes access to high definition quality streaming on two screens concurrently. Our "premium" plan is priced at $13.99 per month and includes access to high definition and ultra-high definition quality content on four screens concurrently. Internationally, the membership plans are structured similarly to the U.S. and range in price from the U.S. dollar equivalent of approximately $5.00 per month to $21.00 per month.
We expect that from time to time the prices of our membership plans in each country may change. For instance, in May 2014, in the U.S., we increased the price of our standard plan from $7.99 per month to $8.99 per month with existing memberships grandfathered for a two year period. In October 2015, in the U.S., we increased the price of this same standard plan from $8.99 per month to $9.99 per month with existing memberships grandfathered for a one year period. In 2016, we phased out grandfathered pricing, giving members the option of electing the basic streaming plan at $7.99 per month, continuing on the standard streaming plan at the higher price of $9.99 per month, or electing the premium plan at $11.99 per month. In October 2017, in the U.S., we increased the price of our standard streaming plan from $9.99 to $10.99 per month and our premium plan from $11.99 to $13.99 per month.
The following represents the key elements to our segment results of operations:
We define contribution profit (loss) as revenues less cost of revenues and marketing expenses incurred by the segment. We believe this is an important measure of our operating segment performance as it represents each segment's performance before global corporate costs.
For the Domestic and International streaming segments, content expenses, which include the amortization of the streaming content assets and other expenses associated with the licensing and acquisition of streaming content, represent the vast majority of cost of revenues. Streaming content rights were generally obtained for our current geographic regions. As we expanded internationally, we obtained additional rights for new geographies. With our global expansion, we now aspire to obtain global rights for our content. We allocate this content between the Domestic and International streaming segments based on estimated fair market value. Other cost of revenues such as streaming delivery expenses, customer service and payment processing fees, including those we pay to our integrated payment partners, tend to be lower as a percentage of total cost of revenues. We have built our own global content delivery network ("Open Connect") to help us efficiently stream a high volume of content to our members over the internet. Streaming delivery expenses, therefore, include equipment costs related to Open Connect and all third-party costs, such as cloud computing costs, associated with delivering streaming content over the internet. Cost of revenues in the Domestic DVD segment consist primarily of delivery expenses, content expenses, including amortization of DVD content assets and revenue sharing expenses, and other expenses associated with our DVD processing and customer service centers. Delivery expenses for the Domestic DVD segment consist of the postage costs to mail DVDs to and from our members and the packaging and label costs for the mailers.
For the Domestic and International streaming segments, marketing expenses consist primarily of advertising expenses and certain payments made to our marketing partners, including CE manufacturers, MVPDs, mobile operators and ISPs. Advertising expenses include promotional activities such as digital and television advertising. Marketing expenses are incurred by our Domestic and

19


International streaming segments given our focus on building consumer awareness of the streaming offerings, and in particular our original content. Marketing expenses incurred by our International streaming segment have been significant and fluctuate dependent upon the number of international territories in which our streaming service is offered, the timing of the launch of new territories and the timing of content releases.
We have demonstrated our ability to grow domestic streaming contribution margin as evidenced by the increase in contribution margin from 17% in 2012 to 36% in the third quarter of 2017. As a result of our focus on growing the streaming segments, contribution margins for the Domestic and International streaming segments are lower than for our Domestic DVD segment.


Domestic Streaming Segment
Three months ended September 30, 2017 as compared to the three months ended September 30, 2016
 
 
As of/ Three Months Ended
 
Change
 
 
September 30,
2017
 
September 30,
2016
 
Q3'17 vs. Q3'16
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
Net additions
 
851

 
368

 
483

 
131
%
Memberships at end of period
 
52,772

 
47,497

 
5,275

 
11
%
Paid memberships at end of period
 
51,345

 
46,479

 
4,866

 
10
%
Average monthly revenue per paying membership
 
$
10.15

 
$
9.40

 
$
0.75

 
8
%
 
 
 
 
 
 
 
 
 
Contribution profit:
 
 
 
 
 
 
 
 
Revenues
 
$
1,547,210

 
$
1,304,333

 
$
242,877

 
19
%
Cost of revenues
 
864,408

 
720,658

 
143,750

 
20
%
Marketing
 
128,901

 
108,495

 
20,406

 
19
%
Contribution profit
 
553,901

 
475,180

 
78,721

 
17
%
Contribution margin
 
36
%
 
36
%
 
 
 
 

In the Domestic streaming segment, we derive revenues from monthly membership fees for services consisting solely of streaming content to our members in the United States. The increase in our domestic streaming revenues was primarily due to the 10% growth in the average number of paid memberships, as well as an 8% increase in the average monthly revenue per paying membership, resulting from our price changes and plan mix. In the second half of 2016, we phased out grandfathered pricing and cancellations by members whose grandfathered pricing expired were not material. Our standard plan continues to be the most popular plan choice for new memberships.
The increase in domestic streaming cost of revenues was primarily due to a $136.5 million increase in content expenses relating to our existing and new streaming content, including more exclusive and original programming.
Domestic marketing expenses increased primarily due to increased advertising and public relations.
Our Domestic streaming segment had a contribution margin of 36% for the three months ended September 30, 2017, which is flat compared to the contribution margin of 36% for the three months ended September 30, 2016.

Nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016

20


 
 
As of/ Nine Months Ended
 
Change
 
 
September 30,
2017
 
September 30,
2016
 
YTD'17 vs. YTD'16
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
Net additions
 
3,341

 
2,759

 
582

 
21
%
Memberships at end of period
 
52,772

 
47,497

 
5,275

 
11
%
Paid memberships at end of period
 
51,345

 
46,479

 
4,866

 
10
%
Average monthly revenue per paying membership
 
$
10.10

 
$
8.96

 
$
1.14

 
13
%
 
 
 
 
 
 
 
 
 
Contribution profit:
 
 
 
 
 
 
 
 
Revenues
 
$
4,522,751

 
$
3,673,845

 
$
848,906

 
23
%
Cost of revenues
 
2,445,858

 
2,094,310

 
351,548

 
17
%
Marketing
 
357,547

 
277,243

 
80,304

 
29
%
Contribution profit
 
1,719,346

 
1,302,292

 
417,054

 
32
%
Contribution margin
 
38
%
 
35
%
 
 
 
 
The increase in our domestic streaming revenues was primarily due to the 9% growth in the average number of paid memberships, as well as a 13% increase in average monthly revenue per paying membership, resulting from our price changes and plan mix.
The increase in domestic streaming cost of revenues was primarily due to a $331.5 million increase in content expenses relating to our existing and new streaming content, including more exclusive and original programming.
Domestic marketing expenses increased primarily due to increased advertising and public relations.
Our Domestic streaming segment had a contribution margin of 38% for the nine months ended September 30, 2017, which increased as compared to the contribution margin of 35% for the nine months ended September 30, 2016 due to growth in paid memberships and revenue which continued to outpace content spending.

International Streaming Segment
Three months ended September 30, 2017 as compared to the three months ended September 30, 2016
 
 
As of/ Three Months Ended
 
Change
 
 
September 30,
2017
 
September 30,
2016
 
Q3'17 vs. Q3'16
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
Net additions
 
4,445

 
3,198

 
1,247

 
39
%
Memberships at end of period
 
56,476

 
39,246

 
17,230

 
44
%
Paid memberships at end of period
 
52,678

 
36,799

 
15,879

 
43
%
Average monthly revenue per paying membership
 
$
8.73

 
$
8.05

 
$
0.68

 
8
%
 
 
 
 
 
 
 
 
 
Contribution profit (loss):
 
 
 
 
 
 
 
 
Revenues
 
$
1,327,435

 
$
853,480

 
$
473,955

 
56
%
Cost of revenues
 
1,081,485

 
748,515

 
332,970

 
44
%
Marketing
 
183,589

 
173,548

 
10,041

 
6
%
Contribution profit (loss)
 
62,361

 
(68,583
)
 
130,944

 
191
%
Contribution margin
 
5
%
 
(8
)%
 
 
 



In the International streaming segment, we derive revenues from monthly membership fees for services consisting solely of streaming content to our members outside the United States. We launched our streaming service in Canada in September 2010 and have expanded our services internationally as shown below.


21


internationaltimelinea02.jpg
The increase in our international revenues was due to the 43% growth in the average number of paid international memberships, in addition to an 8% increase in the average monthly revenue per paying membership. The increase in the average monthly revenue per paying membership was due to price changes and plan mix coupled with favorable fluctuations in foreign exchange rates. We estimate that international revenues in the third quarter of 2017 would have been approximately $13.3 million lower if foreign exchange rates had remained consistent with the foreign exchange rates from the third quarter of 2016. If foreign currency exchange rates fluctuate more than expected, revenues and average revenue per paying membership may differ from our expectations. Average paid international streaming memberships accounted for 50% of global average paid streaming memberships for the three months ended September 30, 2017, as compared to 43% of global average paid streaming memberships for the same period in 2016.
The increase in international cost of revenues was primarily due to a $298.3 million increase in content expenses relating to our existing and new streaming content, including more exclusive and original programming. Other costs increased $34.7 million primarily due to increases in our streaming delivery expenses, costs associated with our customer service call centers and payment processing fees, all driven by our growing member base.
International marketing expenses increased mainly due to increased advertising and public relations as well as increased payments to our partners.
International contribution profit for the three months ended September 30, 2017 was $62.4 million as compared to a contribution loss of $68.6 million for the three months ended September 30, 2016 as profit growth in our more mature markets offset investments in newer markets.

Nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016
 
 
As of/ Nine Months Ended
 
Change
 
 
September 30,
2017
 
September 30,
2016
 
YTD'17 vs. YTD'16
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
Net additions
 
12,111

 
9,222

 
2,889

 
31
%
Memberships at end of period
 
56,476

 
39,246

 
17,230

 
44
%
Paid memberships at end of period
 
52,678

 
36,799

 
15,879

 
43
%
Average monthly revenue per paying membership
 
$
8.39

 
$
7.70

 
$
0.69

 
9
%
 
 
 
 
 
 
 
 
 
Contribution profit (loss):
 
 
 
 
 
 
 
 
Revenues
 
$
3,538,862

 
$
2,263,429

 
$
1,275,433

 
56
%
Cost of revenues
 
2,946,414

 
2,076,576

 
869,838

 
42
%
Marketing
 
500,536

 
428,839

 
71,697

 
17
%
Contribution profit (loss)
 
91,912

 
(241,986
)
 
333,898

 
138
%
Contribution margin
 
3
%
 
(11
)%
 
 
 
 
The increase in our international revenues was due to the 44% growth in our average number of paid international memberships, in addition to a 9% increase in the average monthly revenue per paying membership. The increase in the average monthly revenue per paying membership was due to price changes and plan mix, partially offset by unfavorable fluctuations in foreign exchange rates. We estimate that international revenues in the nine months ended September 30, 2017 would have been approximately $21.0 million higher if foreign exchange rates had remained consistent with the foreign exchange rates for the nine months ended September 30, 2016.
The increase in international cost of revenues was primarily due to a $769.7 million increase in content expenses relating to our existing and new streaming content, including more exclusive and original programming. Other costs increased $100.2 million primarily due to

22


increases in our streaming delivery expenses, costs associated with our customer service call centers and payment processing fees, all driven by our growing member base, partially offset by decreases resulting from exchange rate fluctuations.
International marketing expenses for the nine months ended September 30, 2017 increased mainly due to increased advertising and public relations, as well as increased payments to our partners.
International contribution profit grew to $91.9 million as opposed to a $242.0 million loss for the nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016 as profit growth in our more mature markets offset investments in newer markets.


23




Domestic DVD Segment
Three months ended September 30, 2017 as compared to the three months ended September 30, 2016
 
 
As of/ Three Months Ended
 
Change
 
 
September 30,
2017
 
September 30,
2016
 
Q3'17 vs. Q3'16
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
Net losses
 
(189
)
 
(257
)
 
68

 
26
 %
Memberships at end of period
 
3,569

 
4,273

 
(704
)
 
(16
)%
Paid memberships at end of period
 
3,520

 
4,194

 
(674
)
 
(16
)%
Average monthly revenue per paying membership
 
$
10.19

 
$
10.23

 
$
(0.04
)
 
 %
 
 
 
 
 
 
 
 
 
Contribution profit:
 
 
 
 
 
 
 
 
Revenues
 
$
110,214

 
$
132,375

 
$
(22,161
)
 
(17
)%
Cost of revenues
 
47,087

 
63,671

 
(16,584
)
 
(26
)%
Contribution profit
 
63,127

 
68,704

 
(5,577
)
 
(8
)%
Contribution margin
 
57
%
 
52
%
 
 
 
 

In the Domestic DVD segment, we derive revenues from our DVD-by-mail membership services. The price per plan for DVD-by-mail varies from $4.99 to $14.99 per month according to the plan chosen by the member. DVD-by-mail plans differ by the number of DVDs that a member may have out at any given point. Members electing access to high definition Blu-ray discs, in addition to standard definition DVDs, pay a surcharge ranging from $2 to $3 per month for our most popular plans.
Our Domestic DVD segment contribution margin was 57% for the three months ended September 30, 2017, as compared to 52% for the three months ended September 30, 2016, due to the decreased DVD usage by paying members and decreased DVD content expenses.

Nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016
 
 
As of/ Nine Months Ended
 
Change
 
 
September 30,
2017
 
September 30,
2016
 
YTD'17 vs. YTD'16
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
Net losses
 
(545
)
 
(631
)
 
86

 
14
 %
Memberships at end of period
 
3,569

 
4,273

 
(704
)
 
(16
)%
Paid memberships at end of period
 
3,520

 
4,194

 
(674
)
 
(16
)%
Average monthly revenue per paying membership
 
$
10.16

 
$
10.21

 
$
(0.05
)
 
 %
 
 
 
 
 
 
 
 
 
Contribution profit:
 
 
 
 
 
 
 
 
Revenues
 
$
345,345

 
$
415,854

 
$
(70,509
)
 
(17
)%
Cost of revenues