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.
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:
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Three Months Ended
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|
Six Months Ended
|
|
June 30,
2018
|
|
June 30,
2017
|
|
June 30,
2018
|
|
June 30,
2017
|
|
(in thousands, except per share data)
|
Basic earnings per share:
|
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|
|
|
|
|
Net income
|
$
|
384,349
|
|
|
$
|
65,600
|
|
|
$
|
674,473
|
|
|
$
|
243,822
|
|
Shares used in computation:
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|
|
|
|
|
|
Weighted-average common shares outstanding
|
435,097
|
|
|
431,396
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|
|
434,638
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|
|
431,000
|
|
Basic earnings per share
|
$
|
0.88
|
|
|
$
|
0.15
|
|
|
$
|
1.55
|
|
|
$
|
0.57
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|
Diluted earnings per share:
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Net income
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$
|
384,349
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|
|
$
|
65,600
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|
|
$
|
674,473
|
|
|
$
|
243,822
|
|
Shares used in computation:
|
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|
|
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|
Weighted-average common shares outstanding
|
435,097
|
|
|
431,396
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|
|
434,638
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|
|
431,000
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|
Employee stock options
|
16,455
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|
|
14,866
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|
|
16,320
|
|
|
14,862
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|
Weighted-average number of shares
|
451,552
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|
|
446,262
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|
|
450,958
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|
|
445,862
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|
Diluted earnings per share
|
$
|
0.85
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|
$
|
0.15
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$
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1.50
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$
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0.55
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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.
3. Cash, Cash Equivalents and Restricted Cash
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As of June 30, 2018
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Cash and cash equivalents
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Non-current Assets (1)
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(in thousands)
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Cash
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$
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2,232,132
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|
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$
|
6,351
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Level 1 securities:
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Money market funds
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1,524,225
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|
|
1,286
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Level 2 securities:
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Time Deposits
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150,000
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—
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As of December 31, 2017
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Cash and cash equivalents
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Non-current Assets (1)
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(in thousands)
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Cash
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$
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2,072,296
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|
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$
|
4,367
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Level 1 securities:
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Money market funds
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449,734
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|
|
1,276
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Level 2 securities:
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Time Deposits
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300,765
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—
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(1) Restricted cash related to workers compensation deposits and letter of credit agreements. Balance as of June 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 six months ended June 30, 2018 and 2017, respectively.
4. Balance Sheet Components
Content Assets
Content assets consisted of the following:
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As of
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June 30,
2018
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December 31,
2017
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(in thousands)
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Licensed content, net
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$
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13,032,400
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$
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11,771,778
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Produced content, net
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Released, less amortization
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1,786,221
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|
1,427,256
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In production
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2,085,501
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1,311,137
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In development and pre-production
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179,060
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158,517
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4,050,782
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2,896,910
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DVD, net
|
12,551
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|
|
13,301
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Total
|
$
|
17,095,733
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$
|
14,681,989
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Current content assets, net
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$
|
4,803,663
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|
$
|
4,310,934
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Non-current content assets, net
|
$
|
12,292,070
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|
|
$
|
10,371,055
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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.
As of
June 30, 2018
, over
30%
of the
$17.1 billion
unamortized cost is expected to be amortized within
one
year and
30%
and
81%
of the
$1.8 billion
unamortized cost of the produced content that has been released is expected to be amortized within
one
year and
three
years, respectively.
As of
June 30, 2018
, the amount of accrued participations and residuals was not material.
Property and Equipment, Net
Property and equipment and accumulated depreciation consisted of the following:
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As of
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June 30,
2018
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December 31,
2017
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Estimated Useful Lives
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(in thousands)
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Information technology
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$
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215,298
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$
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223,850
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3 years
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Furniture and fixtures
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50,513
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49,217
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3 years
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Buildings
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40,681
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|
40,681
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30 years
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Leasehold improvements
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237,944
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|
|
229,848
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Over life of lease
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DVD operations equipment
|
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58,666
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|
|
59,316
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5 years
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Corporate aircraft
|
|
57,938
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|
|
30,039
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|
|
8 years
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Capital work-in-progress
|
|
28,902
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|
|
8,267
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Property and equipment, gross
|
|
689,942
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|
|
641,218
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Less: Accumulated depreciation
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|
(340,296
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)
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|
(321,814
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)
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Property and equipment, net
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$
|
349,646
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$
|
319,404
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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
June 30, 2018
, total deferred revenue was
$697.7 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
$79.1 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.
5. Long-term Debt
As of
June 30, 2018
, the Company had aggregate outstanding long-term notes of
$8,342.1 million
, net of
$74.9 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
June 30, 2018
and December 31,
2017
:
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Level 2 Fair Value as of
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Principal Amount at Par
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Issuance Date
|
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Maturity
|
|
Interest Payment Dates
|
|
June 30, 2018
|
|
December 31, 2017
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(in millions)
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(in millions)
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5.375% Senior Notes
|
|
$
|
500
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|
|
February 2013
|
|
February 2021
|
|
February 1 and August 1
|
|
$
|
516
|
|
|
$
|
530
|
|
5.750% Senior Notes
|
|
400
|
|
|
February 2014
|
|
March 2024
|
|
March 1 and September 1
|
|
411
|
|
|
427
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|
5.875% Senior Notes
|
|
800
|
|
|
February 2015
|
|
February 2025
|
|
April 15 and October 15
|
|
822
|
|
|
856
|
|
5.50% Senior Notes
|
|
700
|
|
|
February 2015
|
|
February 2022
|
|
April 15 and October 15
|
|
723
|
|
|
739
|
|
4.375% Senior Notes
|
|
1,000
|
|
|
October 2016
|
|
November 2026
|
|
May 15 and November 15
|
|
942
|
|
|
983
|
|
3.625% Senior Notes (1)
|
|
1,517
|
|
|
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
|
|
1,526
|
|
|
1,571
|
|
5.875% Senior Notes
|
|
$
|
1,900
|
|
|
April 2018
|
|
November 2028
|
|
May 15 and November 15
|
|
1,923
|
|
|
—
|
|
|
|
$
|
8,417
|
|
|
|
|
|
|
|
|
|
|
|
(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:
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|
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As of
|
|
June 30,
2018
|
|
December 31, 2017
|
|
(in thousands)
|
Less than one year
|
$
|
429,942
|
|
|
$
|
311,339
|
|
Due after one year and through three years
|
1,347,480
|
|
|
627,444
|
|
Due after three years and through five years
|
1,448,814
|
|
|
1,761,465
|
|
Due after five years
|
8,687,586
|
|
|
6,348,580
|
|
Total debt obligations
|
$
|
11,913,822
|
|
|
$
|
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
June 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
June 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”), 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
June 30, 2018
, the Company was in compliance with all related covenants.
6. Commitments and Contingencies
Streaming Content
As of
June 30, 2018
, the Company had
$18.4 billion
of obligations comprised of
$4.5 billion
included in "Current content liabilities" and
$3.6 billion
of "Non-current content liabilities" on the Consolidated Balance Sheets and
$10.3 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:
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|
|
|
|
|
|
As of
|
|
June 30,
2018
|
|
December 31,
2017
|
|
(in thousands)
|
Less than one year
|
$
|
8,212,614
|
|
|
$
|
7,446,947
|
|
Due after one year and through three years
|
8,374,640
|
|
|
8,210,159
|
|
Due after three years and through five years
|
1,718,511
|
|
|
1,894,001
|
|
Due after five years
|
93,001
|
|
|
143,535
|
|
Total streaming content obligations
|
$
|
18,398,766
|
|
|
$
|
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.
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
June 30, 2018
,
9.7 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
|
(1,056,538
|
)
|
|
1,056,538
|
|
|
282.22
|
|
|
|
|
|
Exercised
|
—
|
|
|
(2,064,819
|
)
|
|
39.92
|
|
|
|
|
|
Expired
|
—
|
|
|
(1,820
|
)
|
|
4.72
|
|
|
|
|
|
Balances as of June 30, 2018
|
9,683,377
|
|
|
20,637,249
|
|
|
$
|
74.58
|
|
|
5.85
|
|
$
|
6,538,997
|
|
Vested and exercisable as of June 30, 2018
|
|
|
20,637,249
|
|
|
$
|
74.58
|
|
|
5.85
|
|
$
|
6,538,997
|
|
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
second
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
second
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
|
|
Six Months Ended
|
|
June 30,
2018
|
|
June 30,
2017
|
|
June 30,
2018
|
|
June 30,
2017
|
|
(in thousands)
|
Total intrinsic value of options exercised
|
$
|
246,795
|
|
|
$
|
101,727
|
|
|
$
|
524,705
|
|
|
$
|
208,824
|
|
Cash received from options exercised
|
26,936
|
|
|
14,826
|
|
|
83,271
|
|
|
39,004
|
|
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
|
|
Six Months Ended
|
|
June 30,
2018
|
|
June 30,
2017
|
|
June 30,
2018
|
|
June 30,
2017
|
Dividend yield
|
—
|
%
|
|
—
|
%
|
|
—
|
%
|
|
—
|
%
|
Expected volatility
|
42
|
%
|
|
34
|
%
|
|
40% - 42%
|
|
|
34% - 37%
|
|
Risk-free interest rate
|
2.90
|
%
|
|
2.37
|
%
|
|
2.61 % - 2.90%
|
|
|
2.37%-2.45%
|
|
Suboptimal exercise factor
|
2.93
|
|
|
2.51
|
|
|
2.80 - 2.93
|
|
|
2.48 - 2.51
|
|
Weighted-average fair value (per share)
|
$
|
161.39
|
|
|
$
|
67.21
|
|
|
$
|
141.62
|
|
|
$
|
64.67
|
|
Total stock-based compensation expense (in thousands)
|
$
|
81,232
|
|
|
$
|
44,028
|
|
|
$
|
149,627
|
|
|
$
|
88,916
|
|
Total income tax impact on provision (in thousands)
|
$
|
16,889
|
|
|
$
|
14,477
|
|
|
$
|
31,580
|
|
|
$
|
29,178
|
|
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 six months ended June 30, 2018
decreased
$16.7 million
and increased
$8.1 million
, respectively, due to cumulative translation adjustments for its non-US dollar functional currency subsidiaries.
9. Income Taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Six Months Ended
|
|
|
June 30,
2018
|
|
June 30,
2017
|
|
June 30, 2018
|
|
June 30, 2017
|
|
|
(in thousands, except percentages)
|
Provision for (benefit from) income taxes
|
|
$
|
44,287
|
|
|
$
|
(51,638
|
)
|
|
$
|
53,779
|
|
|
$
|
(6,068
|
)
|
Effective tax rate
|
|
10
|
%
|
|
(370
|
)%
|
|
7
|
%
|
|
(3
|
)%
|
The effective tax rates for the three and
six months ended June 30, 2018
differed from the Federal statutory rate primarily due to the recognition of excess tax benefits of stock-based compensation and Federal and California research and development credits (“R&D”), partially offset by state taxes, foreign taxes, non-deductible expenses, and the international provisions from the U.S. tax reform enacted in December 2017. The effective tax rate for the three and
six months ended June 30, 2017
differed from the Federal statutory rate primarily due to the recognition of excess tax benefits of stock-based compensation, foreign income taxed at rates lower than the U.S. statutory rate and Federal and California R&D credits, partially offset by state taxes and non-deductible expenses.
The increase in effective tax rates for the three and
six months ended June 30, 2018
as compared to the same periods in
2017
were 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, non-deductible expenses, and the international provisions from the U.S. tax reform enacted in December 2017. For the three and six months ended
June 30, 2018
, the Company recognized a discrete tax benefit related to the excess tax benefits from stock-based compensation of
$56.7 million
and
$117.4 million
, respectively, compared to the three and six months ended
June 30, 2017
of
$32.8 million
and
$68.8 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
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. Additional work is still necessary for a more detailed analysis of the Company's deferred tax assets and liabilities and its historical foreign earnings as well as potential correlative adjustments. Any subsequent adjustment to these amounts will be recorded to current tax expense in the quarter of 2018 when the analysis is complete.
Gross unrecognized tax benefits were
$56.1 million
and
$42.9 million
as of
June 30, 2018
and
December 31, 2017
, respectively. The gross unrecognized tax benefits, if recognized by the Company, will result in a reduction of approximately
$52.3 million
to the provision for income taxes thereby favorably impacting the Company’s effective tax rate. As of
June 30, 2018
, gross unrecognized tax benefits of
$28.5 million
was classified as “Other non-current liabilities” and
$27.6 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
$509.9 million
and
$478.3 million
were classified as “Other non-current assets” on the Consolidated Balance Sheets as of
June 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
$103.4 million
and
$49.4 million
as of
June 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. The Company is currently under examination by the IRS and the state of California for
2014
and
2015
. The
2016
Federal tax return remains subject to examination by the IRS. The
2009
through
2016
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
2012
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 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 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.
The Company's long-lived tangible assets were located as follows:
|
|
|
|
|
|
|
|
|
|
As of
|
|
June 30,
2018
|
|
December 31, 2017
|
|
(in thousands)
|
United States
|
$
|
312,872
|
|
|
$
|
289,875
|
|
International
|
36,774
|
|
|
29,529
|
|
The following tables represent segment information for the
three and six months ended June 30, 2018
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of/ Three Months Ended June 30, 2018
|
|
Domestic
Streaming
|
|
International
Streaming
|
|
Domestic
DVD
|
|
Consolidated
|
|
(in thousands)
|
Total memberships at end of period (1)
|
57,379
|
|
|
72,762
|
|
|
2,999
|
|
|
—
|
|
Revenues
|
$
|
1,893,222
|
|
|
$
|
1,921,144
|
|
|
$
|
92,904
|
|
|
$
|
3,907,270
|
|
Cost of revenues
|
925,703
|
|
|
1,324,240
|
|
|
39,924
|
|
|
2,289,867
|
|
Marketing
|
227,961
|
|
|
298,819
|
|
|
—
|
|
|
526,780
|
|
Contribution profit
|
$
|
739,558
|
|
|
$
|
298,085
|
|
|
$
|
52,980
|
|
|
$
|
1,090,623
|
|
Other operating expenses
|
|
|
|
|
|
|
628,410
|
|
Operating income
|
|
|
|
|
|
|
462,213
|
|
Other income (expense)
|
|
|
|
|
|
|
(33,577
|
)
|
Provision for income taxes
|
|
|
|
|
|
|
44,287
|
|
Net income
|
|
|
|
|
|
|
$
|
384,349
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of/ Six Months Ended June 30, 2018
|
|
Domestic
Streaming
|
|
International
Streaming
|
|
Domestic
DVD
|
|
Consolidated
|
|
(in thousands)
|
Total memberships at end of period (1)
|
57,379
|
|
|
72,762
|
|
|
2,999
|
|
|
—
|
|
Revenues
|
$
|
3,713,241
|
|
|
$
|
3,703,230
|
|
|
$
|
191,655
|
|
|
$
|
7,608,126
|
|
Cost of revenues
|
1,820,576
|
|
|
2,583,049
|
|
|
82,317
|
|
|
4,485,942
|
|
Marketing
|
455,983
|
|
|
550,019
|
|
|
—
|
|
|
1,006,002
|
|
Contribution profit
|
$
|
1,436,682
|
|
|
$
|
570,162
|
|
|
$
|
109,338
|
|
|
$
|
2,116,182
|
|
Other operating expenses
|
|
|
|
|
|
|
1,207,391
|
|
Operating income
|
|
|
|
|
|
|
908,791
|
|
Other income (expense)
|
|
|
|
|
|
|
(180,539
|
)
|
Provision for income taxes
|
|
|
|
|
|
|
53,779
|
|
Net income
|
|
|
|
|
|
|
$
|
674,473
|
|
The following tables represent segment information for the
three and six months ended June 30, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of/ Three Months Ended June 30, 2017
|
|
Domestic
Streaming
|
|
International
Streaming
|
|
Domestic
DVD
|
|
Consolidated
|
|
(in thousands)
|
Total memberships at end of period (1)
|
51,921
|
|
|
52,031
|
|
|
3,758
|
|
|
—
|
|
Revenues
|
$
|
1,505,499
|
|
|
$
|
1,165,228
|
|
|
$
|
114,737
|
|
|
$
|
2,785,464
|
|
Cost of revenues
|
831,962
|
|
|
1,017,612
|
|
|
52,734
|
|
|
1,902,308
|
|
Marketing
|
113,608
|
|
|
160,715
|
|
|
—
|
|
|
274,323
|
|
Contribution profit (loss)
|
$
|
559,929
|
|
|
$
|
(13,099
|
)
|
|
$
|
62,003
|
|
|
$
|
608,833
|
|
Other operating expenses
|
|
|
|
|
|
|
481,026
|
|
Operating income
|
|
|
|
|
|
|
127,807
|
|
Other income (expense)
|
|
|
|
|
|
|
(113,845
|
)
|
Benefit from income taxes
|
|
|
|
|
|
|
(51,638
|
)
|
Net income
|
|
|
|
|
|
|
$
|
65,600
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of/Six Months Ended June 30, 2017
|
|
Domestic
Streaming
|
|
International
Streaming
|
|
Domestic
DVD
|
|
Consolidated
|
|
(in thousands)
|
Total memberships at end of period (1)
|
51,921
|
|
|
52,031
|
|
|
3,758
|
|
|
—
|
|
Revenues
|
$
|
2,975,541
|
|
|
$
|
2,211,427
|
|
|
$
|
235,131
|
|
|
$
|
5,422,099
|
|
Cost of revenues
|
1,581,450
|
|
|
1,864,929
|
|
|
112,953
|
|
|
3,559,332
|
|
Marketing
|
228,646
|
|
|
316,947
|
|
|
—
|
|
|
545,593
|
|
Contribution profit
|
$
|
1,165,445
|
|
|
$
|
29,551
|
|
|
$
|
122,178
|
|
|
$
|
1,317,174
|
|
Other operating expenses
|
|
|
|
|
|
|
932,425
|
|
Operating income
|
|
|
|
|
|
|
384,749
|
|
Other income (expense)
|
|
|
|
|
|
|
(146,995
|
)
|
Benefit from income taxes
|
|
|
|
|
|
|
(6,068
|
)
|
Net income
|
|
|
|
|
|
|
$
|
243,822
|
|
The following table represents the amortization of content assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Domestic
Streaming
|
|
International
Streaming
|
|
Domestic
DVD
|
|
Consolidated
|
|
(in thousands)
|
Three months ended June 30,
|
|
|
|
|
|
|
|
2018
|
$
|
751,947
|
|
|
$
|
1,065,870
|
|
|
$
|
11,154
|
|
|
$
|
1,828,971
|
|
2017
|
696,688
|
|
|
854,106
|
|
|
16,511
|
|
|
1,567,305
|
|
Six months ended June 30,
|
|
|
|
|
|
|
|
2018
|
1,482,219
|
|
|
2,084,442
|
|
|
22,288
|
|
|
3,588,949
|
|
2017
|
1,305,436
|
|
|
1,551,041
|
|
|
35,109
|
|
|
2,891,586
|
|
|
|
(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.
|