10-Q 1 nflx-093018x10qxdoc.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, 2018
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 every Interactive Data File required to be submitted 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 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
 
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, 2018, there were 436,084,995 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,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Revenues
$
3,999,374

 
$
2,984,859

 
$
11,607,500

 
$
8,406,958

Cost of revenues
2,412,346

 
1,992,980

 
6,898,288

 
5,552,312

Marketing
435,269

 
312,490

 
1,441,271

 
858,083

Technology and development
327,026

 
255,236

 
944,969

 
779,427

General and administrative
344,065

 
215,526

 
933,513

 
623,760

Operating income
480,668

 
208,627

 
1,389,459

 
593,376

Other income (expense):
 
 
 
 
 
 
 
Interest expense
(108,862
)
 
(60,688
)
 
(291,686
)
 
(162,912
)
Interest and other income (expense)
7,004

 
(31,702
)
 
9,289

 
(76,473
)
Income before income taxes
378,810

 
116,237

 
1,107,062

 
353,991

Provision for (benefit from) income taxes
(24,025
)
 
(13,353
)
 
29,754

 
(19,421
)
Net income
$
402,835

 
$
129,590

 
$
1,077,308

 
$
373,412

Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.92

 
$
0.30

 
$
2.48

 
$
0.87

Diluted
$
0.89

 
$
0.29

 
$
2.39

 
$
0.84

Weighted-average common shares outstanding:
 
 
 
 
 
 
 
Basic
435,809

 
432,404

 
435,033

 
431,473

Diluted
451,919

 
447,362

 
451,283

 
446,367













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,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Net income
$
402,835

 
$
129,590

 
$
1,077,308

 
$
373,412

Other comprehensive income:
 
 
 
 
 
 
 
Foreign currency translation adjustments 
(2,081
)
 
5,678

 
6,049

 
22,604

Change in unrealized gains on available-for-sale securities, net of tax of $0, $212, $0, and $378, respectively

 
328

 

 
599

Total other comprehensive income (loss)
(2,081
)
 
6,006

 
6,049

 
23,203

Comprehensive income
$
400,754

 
$
135,596

 
$
1,083,357

 
$
396,615

























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,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Cash flows from operating activities:
 
 
 
 
 
 
 
Net income
$
402,835

 
$
129,590

 
$
1,077,308

 
$
373,412

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
 
 
 
 
Additions to streaming content assets
(3,238,717
)
 
(2,315,017
)
 
(9,259,185
)
 
(7,328,104
)
Change in streaming content liabilities
65,868

 
(34,587
)
 
733,227

 
846,560

Amortization of streaming content assets
1,911,767

 
1,627,477

 
5,478,428

 
4,483,954

Amortization of DVD content assets
9,959

 
13,259

 
32,247

 
48,368

Depreciation and amortization of property, equipment and intangibles
21,161

 
19,238

 
59,938

 
52,838

Stock-based compensation expense
82,316

 
44,763

 
231,943

 
133,679

Other non-cash items
8,962

 
9,896

 
31,092

 
43,081

Foreign currency remeasurement loss (gain) on long-term debt
(7,670
)
 
50,830

 
(52,000
)
 
115,050

Deferred taxes
(39,453
)
 
(57,090
)
 
(71,041
)
 
(104,556
)
Changes in operating assets and liabilities:
 
 
 
 
 
 
 
Other current assets
(30,364
)
 
(41,399
)
 
(111,833
)
 
(147,000
)
Accounts payable
(4,449
)
 
34,029

 
77,367

 
10,590

Accrued expenses
134,000

 
74,006

 
200,198

 
119,506

Deferred revenue
18,983

 
32,947

 
98,101

 
94,777

Other non-current assets and liabilities
(25,609
)
 
(7,549
)
 
28,803

 
(40,146
)
Net cash used in operating activities
(690,411
)
 
(419,607
)
 
(1,445,407
)
 
(1,297,991
)
Cash flows from investing activities:
 
 
 
 
 
 
 
Acquisition of DVD content assets
(7,731
)
 
(10,217
)
 
(31,079
)
 
(43,213
)
Purchases of property and equipment
(39,333
)
 
(33,963
)
 
(103,826
)
 
(151,717
)
Change in other assets
(121,630
)
 
(1,107
)
 
(123,857
)
 
(2,940
)
Purchases of short-term investments

 
(2,799
)
 

 
(74,819
)
Proceeds from sale of short-term investments

 
250,278

 

 
320,154

Proceeds from maturities of short-term investments

 

 

 
22,705

Net cash provided by (used in) investing activities
(168,694
)
 
202,192

 
(258,762
)
 
70,170

Cash flows from financing activities:
 
 
 
 
 
 
 
Proceeds from issuance of debt

 

 
1,900,000

 
1,420,510

Debt issuance costs

 
(312
)
 
(16,992
)
 
(15,325
)
Proceeds from issuance of common stock
29,781

 
34,669

 
113,052

 
73,673

Other financing activities
(544
)
 
65

 
(1,397
)
 
189

Net cash provided by financing activities
29,237

 
34,422

 
1,994,663

 
1,479,047

Effect of exchange rate changes on cash, cash equivalents, and restricted cash
(5,562
)
 
10,685

 
(34,725
)
 
27,667

Net increase (decrease) in cash, cash equivalents, and restricted cash
(835,430
)
 
(172,308
)
 
255,769

 
278,893

Cash, cash equivalents, and restricted cash at beginning of period
3,913,994

 
1,918,777

 
2,822,795

 
1,467,576

Cash, cash equivalents, and restricted cash at end of period
$
3,078,564

 
$
1,746,469

 
$
3,078,564

 
$
1,746,469

Supplemental disclosure:
 
 
 
 
 
 
 
Increase (decrease) in investing activities included in liabilities
$
(2,130
)
 
$
(6,876
)
 
$
2,512

 
$
(27,041
)
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,
2018
 
December 31,
2017
 
(unaudited)
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
3,067,534

 
$
2,822,795

Current content assets, net
4,987,916

 
4,310,934

Other current assets
674,531

 
536,245

Total current assets
8,729,981

 
7,669,974

Non-current content assets, net
13,408,443

 
10,371,055

Property and equipment, net
371,152

 
319,404

Other non-current assets
856,653

 
652,309

Total assets
$
23,366,229

 
$
19,012,742

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Current content liabilities
$
4,613,011

 
$
4,173,041

Accounts payable
441,427

 
359,555

Accrued expenses
527,079

 
315,094

Deferred revenue
716,723

 
618,622

Total current liabilities
6,298,240

 
5,466,312

Non-current content liabilities
3,593,823

 
3,329,796

Long-term debt
8,336,586

 
6,499,432

Other non-current liabilities
127,927

 
135,246

Total liabilities
18,356,576

 
15,430,786

Commitments and contingencies (Note 6)


 


Stockholders’ equity:
 
 
 
Common stock, $0.001 par value; 4,990,000,000 shares authorized at September 30, 2018 and December 31, 2017; 436,084,995 and 433,392,686 issued and outstanding at September 30, 2018 and December 31, 2017, respectively
2,215,736

 
1,871,396

Accumulated other comprehensive loss
(14,508
)
 
(20,557
)
Retained earnings
2,808,425

 
1,731,117

Total stockholders’ equity
5,009,653

 
3,581,956

Total liabilities and stockholders’ equity
$
23,366,229

 
$
19,012,742





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, as amended by Form 10-K/A, for the year ended December 31, 2017 filed with the Securities and Exchange Commission (the “SEC”) on February 5, 2018. 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 and the recognition and measurement of income tax assets and liabilities. 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/A, for the year ended December 31, 2017. 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 pronouncements below, as compared to the significant accounting policies described in the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2017.

Recently adopted accounting pronouncements
In May 2014, the Financial Accounting Standards Board ("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. The Company adopted 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 impact on its consolidated financial statements is not material.
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. The Company adopted ASU 2016-18 in the first quarter of 2018 and the impact on its consolidated financial statements is not material as the Company's restricted cash balances are immaterial.
In January 2018, the FASB released guidance on the accounting for tax on the global intangible low-taxed income (“GILTI”) provisions of the Tax Cuts and Jobs Act (the “Act”). The GILTI provisions impose a tax on foreign income in excess of a deemed return on tangible assets of foreign corporations. In the first quarter of 2018, the Company elected to treat any potential GILTI inclusions as a period cost.

Recently issued accounting pronouncements not yet adopted
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 current 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 and is in the process of implementing changes to its systems and processes in conjunction with its review of lease agreements. 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 change will be related to the recognition of right-of-use assets and lease liabilities on the Company's balance sheet for real estate operating leases.
In August 2018, the SEC adopted the final rule under SEC Release No. 33-10532, Disclosure Update and Simplification, amending certain disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expanded the disclosure requirements on the analysis of stockholders' equity for interim financial statements. Under the amendments, an analysis of changes in each caption of stockholders' equity presented in the balance sheet must be provided in a note or separate statement. The analysis should present a reconciliation of the beginning balance to the ending balance of each period for which a statement of comprehensive income is

7


required to be filed. This final rule is effective on November 5, 2018. The Company is in the process of evaluating the impact of the final rule on its consolidated financial statements.


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,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
 
(in thousands, except per share data)
Basic earnings per share:
 
 
 
 
 
 
 
Net income
$
402,835

 
$
129,590

 
$
1,077,308

 
$
373,412

Shares used in computation:
 
 
 
 
 
 
 
Weighted-average common shares outstanding
435,809

 
432,404

 
435,033

 
431,473

Basic earnings per share
$
0.92

 
$
0.30

 
$
2.48

 
$
0.87

 
 
 
 
 
 
 
 
Diluted earnings per share:
 
 
 
 
 
 
 
Net income
$
402,835

 
$
129,590

 
$
1,077,308

 
$
373,412

Shares used in computation:
 
 
 
 
 
 
 
Weighted-average common shares outstanding
435,809

 
432,404

 
435,033

 
431,473

Employee stock options
16,110

 
14,958

 
16,250

 
14,894

Weighted-average number of shares
451,919

 
447,362

 
451,283

 
446,367

Diluted earnings per share
$
0.89

 
$
0.29

 
$
2.39

 
$
0.84


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. These anti-dilutive stock options were immaterial for each period presented.


8


3. Cash, Cash Equivalents and Restricted Cash
 
As of September 30, 2018
 
Cash and cash equivalents
 
Non-current Assets (1)
 
Total
 
(in thousands)
 
 
Cash
$
2,501,504

 
$
9,739

 
$
2,511,243

Level 1 securities:
 
 
 
 
 
Money market funds
566,030

 
1,291

 
567,321

 
 
 
 
 
 
 
$
3,067,534

 
$
11,030

 
$
3,078,564


 
As of December 31, 2017
 
Cash and cash equivalents
 
Non-current Assets (1)
 
Total
 
(in thousands)
 
 
Cash
$
2,072,296

 
$
4,367

 
$
2,076,663

Level 1 securities:
 
 
 
 
 
Money market funds
449,734

 
1,276

 
451,010

Level 2 securities:
 
 
 
 
 
Time Deposits
300,765

 

 
300,765

 
 
 
 
 
 
 
$
2,822,795

 
$
5,643

 
$
2,828,438

(1) Restricted cash related to workers compensation deposits and letter of credit agreements. Balance as of September 30, 2018 is included in cash, cash equivalents, and restricted cash on the Consolidated Statements of Cash Flows.
There were no material gross realized gains or losses in the three and nine months ended September 30, 2018 and 2017, respectively.

4. Balance Sheet Components
Content Assets
Content assets consisted of the following:
 
As of
 
September 30,
2018
 
December 31,
2017
 
(in thousands)
Licensed content, net
$
13,458,275

 
$
11,771,778

 
 
 
 
Produced content, net


 


Released, less amortization
1,946,994

 
1,427,256

In production
2,757,434

 
1,311,137

In development and pre-production
222,885

 
158,517

 
4,927,313

 
2,896,910

DVD, net
10,771

 
13,301

Total
$
18,396,359

 
$
14,681,989

 
 
 
 
Current content assets, net
$
4,987,916

 
$
4,310,934

Non-current content assets, net
$
13,408,443

 
$
10,371,055


On average, over 90% of a licensed or produced streaming content asset is expected to be amortized within four years after its month of first availability.

9


As of September 30, 2018, over 30% of the $18.4 billion unamortized cost is expected to be amortized within one year and 32% and 82% of the $1.9 billion unamortized cost of the produced content that has been released is expected to be amortized within one year and three years, respectively.
As of September 30, 2018, the amount of accrued participations and residuals was not material.
Property and Equipment, Net
Property and equipment and accumulated depreciation consisted of the following:
 
 
As of
 
 
 
 
September 30,
2018
 
December 31,
2017
 
Estimated Useful Lives

 
 
(in thousands)
 
 
Leasehold improvements
 
$
273,292

 
$
229,848

 
Over life of lease
Information technology
 
222,966

 
223,850

 
3 years
Furniture and fixtures
 
60,217

 
49,217

 
3-15 years
Buildings
 
40,681

 
40,681

 
30 years
Corporate aircraft
 
58,058

 
30,039

 
8 years
DVD operations equipment
 
58,175

 
59,316

 
5 years
Capital work-in-progress
 
13,726

 
8,267

 

 
 
727,115

 
641,218

 
 
Less: Accumulated depreciation
 
(355,963
)
 
(321,814
)
 
 
Property and equipment, net
 
$
371,152

 
$
319,404

 
 


Deferred Revenue

The Company’s primary source of revenues are from monthly membership fees. Members are billed in advance of the start of their monthly membership and revenues are recognized ratably over each monthly membership period. Revenues are presented net of the taxes that are collected from members and remitted to governmental authorities. The Company is the principal in all its relationships where partners, including consumer electronics (“CE”) manufacturers, multichannel video programming distributors (“MVPDs”), mobile operators and internet service providers (“ISPs”), provide access to the service as the Company retains control over service delivery to its members. Typically, payments made to the partners, such as for marketing, are expensed, but in the case where the price that the member pays is established by the partners and there is no standalone price for the Netflix service (for instance, in a bundle), these payments are recognized as a reduction of revenues.
Deferred revenue consists of membership fees billed that have not been recognized, as well as gift and other prepaid memberships that have not been fully redeemed. As of September 30, 2018, total deferred revenue was $716.7 million, the vast majority of which was related to membership fees billed that are expected to be recognized as revenue within the next month. The remaining deferred revenue balance, which is related to gift cards and other prepaid memberships, will be recognized as revenue over the period of service after redemption, which is expected to occur over the next 12 months. The $98.1 million increase in deferred revenue as compared to the year ended December 31, 2017 is a result of the increase in membership fees billed due to increased members and average monthly revenue per paying member.



10


5. Long-term Debt
As of September 30, 2018, the Company had aggregate outstanding long-term notes of $8,336.6 million, net of $72.7 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 outstanding long-term debt and the fair values based on quoted market prices in less active markets as of September 30, 2018 and December 31, 2017:
 
 
 
 
 
 
 
 
 
 
Level 2 Fair Value as of
 
 
Principal Amount at Par
 
Issuance Date
 
Maturity
 
Interest Payment Dates
 
September 30, 2018
 
December 31, 2017
 
 
(in millions)
 
 
 
 
 
 
 
(in millions)
5.375% Senior Notes
 
$
500

 
February 2013
 
February 2021
 
February 1 and August 1
 
$
515

 
$
530

5.50% Senior Notes
 
700

 
February 2015
 
February 2022
 
April 15 and October 15
 
724

 
739

5.750% Senior Notes
 
400

 
February 2014
 
March 2024
 
March 1 and September 1
 
411

 
427

5.875% Senior Notes
 
800

 
February 2015
 
February 2025
 
April 15 and October 15
 
828

 
856

4.375% Senior Notes
 
1,000

 
October 2016
 
November 2026
 
May 15 and November 15
 
942

 
983

3.625% Senior Notes (1)
 
1,509

 
May 2017
 
May 2027
 
May 15 and November 15
 
1,491

 
1,575

4.875% Senior Notes
 
1,600

 
October 2017
 
April 2028
 
April 15 and October 15
 
1,504

 
1,571

5.875% Senior Notes
 
1,900

 
April 2018
 
November 2028
 
May 15 and November 15
 
1,901

 

 
 
$
8,409

 
 
 
 
 
 
 
 
 
 
(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.
The expected timing of principal and interest payments for these Notes are as follows:
 
As of 
 
September 30,
2018
 
December 31, 2017
 
(in thousands)
Less than one year
$
429,664

 
$
311,339

Due after one year and through three years
1,333,487

 
627,444

Due after three years and through five years
1,448,258

 
1,761,465

Due after five years
8,623,554

 
6,348,580

Total debt obligations
$
11,834,963

 
$
9,048,828


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, 2018 and December 31, 2017, 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, 2018, 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 (i) 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”),

11


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, 2018, the Company was in compliance with all related covenants.

6. Commitments and Contingencies

Streaming Content
As of September 30, 2018, the Company had $18.6 billion of obligations comprised of $4.6 billion included in "Current content liabilities" and $3.6 billion of "Non-current content liabilities" on the Consolidated Balance Sheets and $10.4 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, 2017, the Company had $17.7 billion of obligations comprised of $4.2 billion included in "Current content liabilities" and $3.3 billion of "Non-current content liabilities" on the Consolidated Balance Sheets and $10.2 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,
2018
 
December 31,
2017
 
(in thousands)
Less than one year
$
8,407,156

 
$
7,446,947

Due after one year and through three years
8,557,396

 
8,210,159

Due after three years and through five years
1,590,976

 
1,894,001

Due after five years
90,230

 
143,535

Total streaming content obligations
$
18,645,758

 
$
17,694,642

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 as well as other production related commitments. 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.

12


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.
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, 2018, 9.2 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, 2017
10,739,915

 
21,647,350

 
$
61.13

 
 
 
 
Granted
(1,507,700
)
 
1,507,700

 
306.98

 
 
 
 
Exercised

 
(2,692,309
)
 
41.75

 
 
 
 
Expired

 
(2,051
)
 
4.64

 
 
 
 
Balances as of September 30, 2018
9,232,215

 
20,460,690

 
$
81.80

 
5.76
 
$
5,984,520

Vested and exercisable as of September 30, 2018
 
 
20,460,690

 
$
81.80

 
5.76
 
$
5,984,520


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 2018 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 2018. 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,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
 
(in thousands)
Total intrinsic value of options exercised
$
193,411

 
$
142,664

 
$
718,116

 
$
351,488

Cash received from options exercised
29,781

 
34,669

 
113,052

 
73,673


13


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,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Dividend yield
%
 
%
 
%
 
%
Expected volatility
40
%
 
34
%
 
40% - 42%

 
34% - 37%

Risk-free interest rate
2.90
%
 
2.24
%
 
2.61% - 2.90%

 
2.24%-2.45%

Suboptimal exercise factor
2.97

 
2.58

 
2.80 - 2.97

 
2.48 - 2.58

Weighted-average fair value (per share)
$
182.45

 
$
72.98

 
$
153.84

 
$
67.23

Total stock-based compensation expense (in thousands)
$
82,316

 
$
44,763

 
$
231,943

 
$
133,679

Total income tax impact on provision (in thousands)
$
18,036

 
$
14,428

 
$
49,617

 
$
43,606


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 accumulated balance of other comprehensive loss, net of tax, for the three and nine months ended September 30, 2018 decreased $2.1 million and increased $6.0 million, respectively, due to cumulative translation adjustments for its non-US dollar functional currency subsidiaries.


9. Income Taxes
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
2018
 
September 30,
2017
 
September 30, 2018
 
September 30, 2017
 
 
(in thousands, except percentages)
Provision for (benefit from) income taxes
 
$
(24,025
)
 
$
(13,353
)
 
$
29,754

 
$
(19,421
)
Effective tax rate
 
(6
)%
 
(11
)%
 
3
%
 
(5
)%

The effective tax rates for the three and nine months ended September 30, 2018 differed from the Federal statutory rate primarily due to the recognition of excess tax benefits of stock-based compensation, Federal and California research and development credits (“R&D”), and updated provisional amounts related to US tax reform as a result of the US federal tax return filing, partially offset by state taxes, foreign taxes, and non-deductible expenses. The effective tax rate 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 of stock-based compensation and Federal and California R&D credits, partially offset by state taxes, foreign taxes, and non-deductible expenses.
The increase in effective tax rates for the three and nine months ended September 30, 2018 as compared to the same periods in 2017 was due primarily to lower benefit on a percentage basis from the recognition of excess tax benefits of stock-based compensation as well as additional expense related to foreign taxes, and non-deductible expenses. For the three and nine months ended September 30, 2018, the Company recognized a discrete tax benefit related to the excess tax benefits from stock-based compensation of $40.1 million and $157.5 million, respectively, compared to the three and nine months ended September 30, 2017 of $41.7 million and $110.5 million, respectively.
In December 2017, the Tax Cuts and Jobs Act of 2017 (the “Act”) was signed into law making significant changes to the Internal Revenue Code. Changes include, but are not limited to, a corporate tax rate decrease from 35% to 21% effective for tax years beginning after

14


December 31, 2017, the transition of U.S. international taxation from a worldwide tax system to a territorial system, and a one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings as of December 31, 2017.
On December 22, 2017, Staff Accounting Bulletin No. 118 (“SAB 118”) was issued to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Act. During the third quarter of 2018, we recorded a total provisional benefit of $37.6 million. This provisional benefit included $16.5 million related to adjustments to the transition tax and a $21.1 million benefit related to the remeasurement of certain deferred tax assets and liabilities as a result of the US federal tax return filing. While we do not anticipate any remaining adjustments related to the Act, the measurement period under SAB 118 remains open as there is still anticipated guidance clarifying certain aspects of the Act. Any subsequent adjustment to these amounts will be recorded to current tax expense in the fourth quarter of 2018 when the full analysis is complete.
Gross unrecognized tax benefits were $50.7 million and $42.9 million as of September 30, 2018 and December 31, 2017, respectively. The gross unrecognized tax benefits, if recognized by the Company, will result in a reduction of approximately $47.6 million to the provision for income taxes thereby favorably impacting the Company’s effective tax rate. As of September 30, 2018, gross unrecognized tax benefits of $19.0 million was classified as “Other non-current liabilities” and $31.7 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 for (benefit from) 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 for (benefit from) income taxes” were not material in any of the periods presented.
Deferred tax assets of $549.3 million and $478.3 million were classified as “Other non-current assets” on the Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017, 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. The Company has a valuation allowance of $132.4 million and $49.4 million as of September 30, 2018 and December 31, 2017, respectively. The valuation allowance is primarily related to certain foreign tax credit carryovers that are not likely to be recognized.
The Company files U.S. Federal, state and foreign tax returns. In August 2018, the Company reached a favorable settlement with the IRS for tax years 2014 and 2015 and recorded a discrete tax benefit of $7.4 million in the third quarter of 2018. The 2016 and 2017 Federal tax returns currently remain subject to examination by the IRS. The Company is currently under examination by the state of California for 2014 and 2015. The 2009 through 2017 state tax returns are subject to examination by state tax authorities. The Company is also currently under examination in the UK for 2015. The Company has no other significant foreign jurisdiction audits underway. The years 2013 through 2017 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 related to streaming content to members in the United States. The International streaming segment derives revenues from monthly membership fees for services related to streaming content to members outside of 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.
Amortization of streaming content assets makes up the vast majority of cost of revenues. The Company obtains multi-territory or global rights for its streaming content and allocates these rights between Domestic and International streaming segments based on estimated fair market value. Amortization of content assets and other expenses associated with the acquisition, licensing, and production of streaming content for each streaming segment thus includes 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 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 CE manufacturers, MVPDs, mobile operators and ISPs, which are generally included in the segment in which the expenditures are directly incurred.

15


The Company's long-lived tangible assets were located as follows:
 
As of
 
September 30,
2018
 
December 31, 2017
 
(in thousands)
United States
$
331,336

 
$
289,875

International
39,816

 
29,529


The following tables represent segment information for the three and nine months ended September 30, 2018:
 
 
As of/ Three Months Ended September 30, 2018
 
Domestic
Streaming
 
International
Streaming
 
Domestic
DVD
 
Consolidated
 
(in thousands)
Total paid memberships at end of period
56,957

 
73,465

 
2,828

 
 
Total memberships at end of period (1)
58,464

 
78,635

 
2,852

 


Revenues
$
1,937,314

 
$
1,973,283

 
$
88,777

 
$
3,999,374

Cost of revenues
991,823

 
1,383,422

 
37,101

 
2,412,346

Marketing
183,521

 
251,748

 

 
435,269

Contribution profit
$
761,970

 
$
338,113

 
$
51,676

 
$
1,151,759

Other operating expenses
 
 
 
 
 
 
671,091

Operating income
 
 
 
 
 
 
480,668

Other income (expense)
 
 
 
 
 
 
(101,858
)
Benefit for income taxes
 
 
 
 
 
 
(24,025
)
Net income
 
 
 
 
 
 
$
402,835

 
As of/ Nine Months Ended September 30, 2018
 
Domestic
Streaming
 
International
Streaming
 
Domestic
DVD
 
Consolidated
 
(in thousands)
Total paid memberships at end of period
56,957

 
73,465

 
2,828

 
 
Total memberships at end of period (1)
58,464

 
78,635

 
2,852

 
 
Revenues
$
5,650,555

 
$
5,676,513

 
$
280,432

 
$
11,607,500

Cost of revenues
2,812,399

 
3,966,471

 
119,418

 
6,898,288

Marketing
639,504

 
801,767

 

 
1,441,271

Contribution profit
$
2,198,652

 
$
908,275

 
$
161,014

 
$
3,267,941

Other operating expenses
 
 
 
 
 
 
1,878,482

Operating income
 
 
 
 
 
 
1,389,459

Other income (expense)
 
 
 
 
 
 
(282,397
)
Provision for income taxes
 
 
 
 
 
 
29,754

Net income
 
 
 
 
 
 
$
1,077,308


16




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 paid memberships at end of period
51,345

 
52,678

 
3,520

 
 
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 (loss)
$
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 paid memberships at end of period
51,345

 
52,678

 
3,520

 
 
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


The following table represents the amortization of content assets:
 
Domestic
Streaming
 
International
Streaming
 
Domestic
DVD
 
Consolidated
 
(in thousands)
Three months ended September 30,
 
 
 
 
 
 
 
2018
$
800,884

 
$
1,110,883

 
$
9,959

 
$
1,921,726

2017
727,832

 
899,645

 
13,259

 
1,640,736

Nine months ended September 30,
 
 
 
 
 
 
 
2018
2,283,102

 
3,195,326

 
32,247

 
5,510,675

2017
2,033,268

 
2,450,686

 
48,368

 
4,532,322



17


(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.


18




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; DVD memberships; dividends; impact of foreign currency and exchange rate fluctuations, including on net income, revenues and average revenues per paying member; membership metrics; deferred revenue; investments in global streaming content, including original content; impact of content on membership growth; liquidity and free cash flow; unrecognized tax benefits; deferred tax assets; effective tax rate; adjustments relating to the Tax Cuts and Jobs Act of 2017; 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, as amended by Form 10-K/A, for the year ended December 31, 2017 filed with the Securities and Exchange Commission (“SEC”) on February 5, 2018, 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 entertainment service with over 130 million paid streaming memberships in over 190 countries enjoying TV series, documentaries and feature films across a wide variety of genres and languages. Members can watch as much as they want, anytime, anywhere, on 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. Increasingly, our membership growth is 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 operating margin target. 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 continuously enhancing our user interface and extending our streaming service to more internet-connected screens. Our members can download a selection of titles for offline viewing.


19


Results of Operations

The following represents our consolidated performance highlights:
 
As of/ Three Months Ended
 
Change
 
September 30,
2018
 
September 30,
2017
 
Q3'18 vs. Q3'17
 
(in thousands, except revenue per membership and percentages)

Global paid streaming net membership additions
6,068

 
4,987

 
1,081

 
22
%
Global paid streaming memberships at end of period
130,422

 
104,023

 
26,399

 
25
%
Global streaming average monthly revenue per paying membership
$
10.23

 
$
9.44

 
$
0.79

 
8
%
Global total streaming net membership additions
6,958

 
5,296

 
1,662

 
31
%
Global streaming memberships at end of period
137,099

 
109,248

 
27,851

 
25
%
 
 
 
 
 
 
 
 
Revenues
$
3,999,374

 
$
2,984,859

 
$
1,014,515

 
34
%
Global operating income
480,668

 
208,627

 
272,041

 
130
%
Global operating margin
12.0
%
 
7.0
%
 
5.0
%
 
71
%
Net income
402,835

 
129,590

 
273,245

 
211
%

Consolidated revenues for the three months ended September 30, 2018 increased 34%, including an increase of 25% and 49% in revenues in the Domestic streaming and International streaming segments, respectively, as compared to the three months ended September 30, 2017. International revenues accounted for 50% of total streaming revenue for the three months ended September 30, 2018 as compared to 46% of total streaming revenue for the three months ended September 30, 2017. The increase in consolidated revenues was primarily driven by the growth in the average number of paid streaming memberships globally, the majority of which was growth in our international memberships. Average paid international streaming memberships accounted for 56% of total average paid streaming memberships as of September 30, 2018, as compared to 50% of total average paid streaming memberships for the same period in 2017. In addition, the average monthly revenue per paying streaming membership increased primarily due to price changes and a shift in the plan mix towards higher priced plans. The growth in paid net membership additions has been less volatile when compared to growth in total net membership additions as a result of free trial variability. We therefore believe paid memberships is a more reliable indicator of revenue growth.
The increase in operating margin is 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 marketing expenses and headcount costs to support continued improvements in our streaming service, our international expansion, and our growing content production activities.
We offer three types of streaming membership plans. Our “basic” plan includes access to standard definition quality streaming on a single screen at a time. Our “standard” plan is our most popular streaming plan and includes access to high definition quality streaming on two screens concurrently. Our “premium” plan includes access to high definition and ultra-high definition quality content on four screens concurrently. As of September 30, 2018, pricing on our plans ranged in the U.S. from $7.99 to $13.99 per month and internationally from the U.S. dollar equivalent of approximately $3 to $20 per month. We expect that from time to time the prices of our membership plans in each country may increase.
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. It represents each segment's performance before global corporate costs. As markets within our International streaming segment become profitable, we increasingly focus on our global operating profit margin target as a measure of profitability.
For the Domestic and International streaming segments, amortization of the streaming content assets makes up the vast majority of cost of revenues. Increasingly, we obtain multi-territory or global rights for our streaming content and allocate these rights between Domestic and International streaming segments based on estimated fair market value. Expenses associated with the acquisition, licensing and production of streaming content, streaming delivery costs and other operations costs make up the remainder of 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. Other operations costs include customer service and payment processing fees, including those we pay to our integrated payment partners, as well as other costs incurred in making our content available to members.
For the Domestic and International streaming segments, marketing expenses consist primarily of advertising expenses and certain payments made to our marketing partners, including consumer electronics manufacturers, MVPDs, mobile operators and ISPs. Advertising expenses include promotional activities such as digital and television advertising. Marketing expenses are incurred by our

20


Domestic and International streaming segments given our focus on building consumer awareness of the streaming offerings, and in particular our original content.




Domestic Streaming Segment
Three months ended September 30, 2018 as compared to the three months ended September 30, 2017
 
 
As of/ Three Months Ended
 
Change
 
 
September 30,
2018
 
September 30,
2017
 
Q3'18 vs. Q3'17
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
Paid net membership additions
 
998

 
1,022

 
(24
)
 
(2
)%
Paid memberships at end of period
 
56,957

 
51,345

 
5,612

 
11
 %
Average monthly revenue per paying membership
 
$
11.44

 
$
10.15

 
$
1.29

 
13
 %
Net additions
 
1,085

 
851

 
234

 
27
 %
Memberships at end of period
 
58,464

 
52,772

 
5,692

 
11
 %
 
 
 
 
 
 
 
 
 
Contribution profit:
 
 
 
 
 
 
 
 
Revenues
 
$
1,937,314

 
$
1,547,210

 
$
390,104

 
25
 %
Cost of revenues
 
991,823

 
864,408

 
127,415

 
15
 %
Marketing
 
183,521

 
128,901

 
54,620

 
42
 %
Contribution profit
 
761,970

 
553,901

 
208,069

 
38
 %
Contribution margin
 
39
%
 
36
%
 
 
 
 

In the Domestic streaming segment, we derive revenues from monthly membership fees for services related to streaming content to our members in the United States. The 25% increase in our domestic streaming revenues was primarily due to the 11% growth in the average number of paid memberships, as well as a 13% increase in the average monthly revenue per paying membership, resulting from our price changes and a shift in the plan mix towards higher priced plans. 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 $73.1 million increase in content amortization relating to our existing and new streaming content, including more exclusive and original programming. Other costs increased $54.3 million primarily due to an increase in other content-related costs, and an increase in payment processing fees which grew due to our growing member base.
Domestic marketing expenses increased primarily due to increased advertising and public relations, as well as increased payments to our partners.



21


Nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017
 
 
As of/ Nine Months Ended
 
Change
 
 
September 30,
2018
 
September 30,
2017
 
YTD'18 vs. YTD'17
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
Paid net membership additions
 
4,147

 
3,440

 
707

 
21
%
Paid memberships at end of period
 
56,957

 
51,345

 
5,612

 
11
%
Average monthly revenue per paying membership
 
$
11.35

 
$
10.10

 
$
1.25

 
12
%
Net additions
 
3,714

 
3,341

 
373

 
11
%
Memberships at end of period
 
58,464

 
52,772

 
5,692

 
11
%
 
 
 
 
 
 
 
 
 
Contribution profit:
 
 
 
 
 
 
 
 
Revenues
 
$
5,650,555

 
$
4,522,751

 
$
1,127,804

 
25
%
Cost of revenues
 
2,812,399

 
2,445,858

 
366,541

 
15
%
Marketing
 
639,504

 
357,547

 
281,957

 
79
%
Contribution profit
 
2,198,652

 
1,719,346

 
479,306

 
28
%
Contribution margin
 
39
%
 
38
%
 
 
 
 
The 25% increase in our domestic streaming revenues was primarily due to the 11% growth in the average number of paid memberships, as well as a 12% increase in average monthly revenue per paying membership, resulting from our price changes and a shift in the plan mix towards higher priced plans.
The increase in domestic streaming cost of revenues was primarily due to a $249.8 million increase in content amortization relating to our existing and new streaming content, including more exclusive and original programming. Other costs increased $116.7 million primarily due to an increase in other content-related costs, and an increase in payment processing fees which grew due to our growing member base.
Domestic marketing expenses increased primarily due to increased advertising and public relations, as well as increased payments to our partners.

International Streaming Segment
Three months ended September 30, 2018 as compared to the three months ended September 30, 2017
 
 
As of/ Three Months Ended
 
Change
 
 
September 30,
2018
 
September 30,
2017
 
Q3'18 vs. Q3'17
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
Paid net membership additions
 
5,070

 
3,965

 
1,105

 
28
%
Paid memberships at end of period
 
73,465

 
52,678

 
20,787

 
39
%
Average monthly revenue per paying membership
 
$
9.27

 
$
8.73

 
$
0.54

 
6
%
Net additions
 
5,873

 
4,445

 
1,428

 
32
%
Memberships at end of period
 
78,635

 
56,476

 
22,159

 
39
%
 
 
 
 
 
 
 
 
 
Contribution profit:
 
 
 
 
 
 
 
 
Revenues
 
$
1,973,283

 
$
1,327,435

 
$
645,848

 
49
%
Cost of revenues
 
1,383,422

 
1,081,485

 
301,937

 
28
%
Marketing
 
251,748

 
183,589

 
68,159

 
37
%
Contribution profit
 
338,113

 
62,361

 
275,752

 
442
%
Contribution margin
 
17
%
 
5
%
 
 
 




22


In the International streaming segment, we derive revenues from monthly membership fees for services related to streaming content to our members outside the United States. The 49% increase in our international revenues was due to the 40% growth in the average number of paid international memberships, in addition to a 6% 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 a shift in the plan mix towards higher priced plans partially offset by unfavorable fluctuations in foreign exchange rates. We estimate that international revenues in the third quarter of 2018 would have been approximately $89.9 million higher if foreign exchange rates had remained consistent with the foreign exchange rates from the third quarter of 2017. If foreign currency exchange rates fluctuate more than expected, revenues and average revenue per paying membership may differ from our expectations.
The increase in international cost of revenues was primarily due to a $211.2 million increase in content amortization relating to our existing and new streaming content, including more exclusive and original programming. Other costs increased $90.7 million primarily due to increases in other content-related costs, payment processing fees, and an increase in our streaming delivery expenses.
International marketing expenses increased mainly due to increased advertising and payments to our partners.

Nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017
 
 
As of/ Nine Months Ended
 
Change
 
 
September 30,
2018
 
September 30,
2017
 
YTD'18 vs. YTD'17
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
Paid net membership additions
 
15,631

 
11,493

 
4,138

 
36
%
Paid memberships at end of period
 
73,465

 
52,678

 
20,787

 
39
%
Average monthly revenue per paying membership
 
$
9.56

 
$
8.39

 
$
1.17

 
14
%
Net additions
 
15,803

 
12,111

 
3,692

 
30
%
Memberships at end of period
 
78,635

 
56,476

 
22,159

 
39
%
 
 
 
 
 
 
 
 
 
Contribution profit:
 
 
 
 
 
 
 
 
Revenues
 
$
5,676,513

 
$
3,538,862

 
$
2,137,651

 
60
%
Cost of revenues
 
3,966,471

 
2,946,414

 
1,020,057

 
35
%
Marketing
 
801,767

 
500,536

 
301,231

 
60
%
Contribution profit
 
908,275

 
91,912

 
816,363

 
888
%
Contribution margin
 
16
%
 
3
%
 
 
 
 
The 60% increase in our international revenues was due to the 41% growth in our average number of paid international memberships, in addition to a 14% 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 a shift in the plan mix towards higher priced plans coupled with favorable fluctuations in foreign exchange rates. We estimate that international revenues in the nine months ended September 30, 2018 would have been approximately $89.4 million lower if foreign exchange rates had remained consistent with the foreign exchange rates for the nine months ended September 30, 2017.
The increase in international cost of revenues was primarily due to a $744.6 million increase in content amortization relating to our existing and new streaming content, including more exclusive and original programming. Other costs increased $275.5 million primarily due to increases in other content-related costs, as well as 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 for the nine months ended September 30, 2018 increased mainly due to increased advertising and payments to our partners.


23


Domestic DVD Segment
Three months ended September 30, 2018 as compared to the three months ended September 30, 2017
 
 
As of/ Three Months Ended
 
Change
 
 
September 30,
2018
 
September 30,
2017
 
Q3'18 vs. Q3'17
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
Net losses
 
(147
)
 
(189
)
 
42

 
22
 %
Memberships at end of period
 
2,852

 
3,569

 
(717
)
 
(20
)%
Paid memberships at end of period
 
2,828

 
3,520

 
(692
)
 
(20
)%
Average monthly revenue per paying membership
 
$
10.20

 
$
10.19

 
$
0.01

 
 %
 
 
 
 
 
 
 
 
 
Contribution profit:
 
 
 
 
 
 
 
 
Revenues
 
$
88,777

 
$
110,214

 
$
(21,437
)
 
(19
)%
Cost of revenues
 
37,101

 
47,087

 
(9,986
)
 
(21
)%
Contribution profit
 
51,676

 
63,127

 
(11,451
)
 
(18
)%
Contribution margin
 
58
%
 
57
%
 
 
 
 

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 $7.99 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. Cost of revenues in the Domestic DVD segment consist primarily of delivery expenses such as packaging and postage costs, content expenses, and other expenses associated with our DVD processing and customer service centers. The number of memberships to our DVD-by-mail offering is declining, and we anticipate that this decline will continue.

Nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017
 
 
As of/ Nine Months Ended
 
Change
 
 
September 30,
2018
 
September 30,
2017
 
YTD'18 vs. YTD'17
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
Net losses
 
(531
)
 
(545
)
 
14

 
3
 %
Memberships at end of period
 
2,852

 
3,569

 
(717
)
 
(20
)%
Paid memberships at end of period
 
2,828

 
3,520

 
(692
)
 
(20
)%
Average monthly revenue per paying membership
 
$
10.17

 
$
10.16

 
$
0.01

 
 %
 
 
 
 
 
 
 
 
 
Contribution profit: