Interest Expense
Interest expense consists primarily of the interest associated with our outstanding long-term debt obligations, including the amortization of debt issuance costs, as well as interest on our lease financing obligations.
Three months ended June 30, 2017
as compared to the
three months ended June 30, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Change
|
|
|
June 30,
2017
|
|
June 30,
2016
|
|
Q2'17 vs. Q2'16
|
|
|
(in thousands, except percentages)
|
Interest expense
|
|
$
|
(55,482
|
)
|
|
$
|
(35,455
|
)
|
|
$
|
(20,027
|
)
|
|
(56
|
)%
|
As a percentage of revenues
|
|
(2
|
)%
|
|
(2
|
)%
|
|
|
|
|
Six months ended June 30, 2017
as compared to the
six months ended June 30, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
Change
|
|
|
June 30,
2017
|
|
June 30,
2016
|
|
YTD'17 vs. YTD'16
|
|
|
(in thousands, except percentages)
|
Interest expense
|
|
$
|
(102,224
|
)
|
|
$
|
(70,992
|
)
|
|
$
|
(31,232
|
)
|
|
(44
|
)%
|
As a percentage of revenues
|
|
(2
|
)%
|
|
(2
|
)%
|
|
|
|
|
Interest expense primarily consisted of interest on our Notes of $53.3 million and $98.1 million for the three and six months ended
June 30, 2017
. The increase in interest expense for the three and six months ended
June 30, 2017
as compared to the three and six months ended
June 30, 2016
was primarily due to the higher average aggregate principal of interest bearing notes outstanding.
Interest and Other Income (Expense)
Interest and other income (expense) consists primarily of foreign exchange gains and losses on foreign currency denominated balances and interest earned on cash, cash equivalents and short-term investments.
Three months ended June 30, 2017
as compared to the
three months ended June 30, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Change
|
|
|
June 30,
2017
|
|
June 30,
2016
|
|
Q2'17 vs. Q2'16
|
|
|
(in thousands, except percentages)
|
Interest and other income (expense)
|
|
$
|
(58,363
|
)
|
|
$
|
16,317
|
|
|
$
|
(74,680
|
)
|
|
(458
|
)%
|
As a percentage of revenues
|
|
(2
|
)%
|
|
1
|
%
|
|
|
|
|
Six months ended June 30, 2017
as compared to the
six months ended June 30, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
Change
|
|
|
June 30,
2017
|
|
June 30,
2016
|
|
YTD'17 vs. YTD'16
|
|
|
(in thousands, except percentages)
|
Interest and other income (expense)
|
|
$
|
(44,771
|
)
|
|
$
|
42,280
|
|
|
$
|
(87,051
|
)
|
|
(206
|
)%
|
As a percentage of revenues
|
|
(1
|
)%
|
|
1
|
%
|
|
|
|
|
Interest and other income (expense) increased for the three and
six
months ended
June 30, 2017
, due to foreign exchange losses of $60.7 million and $49.4 million, respectively, compared to gains of $14.0 million and $38.2 million, respectively, for the corresponding periods in
2016
. In both the three and
six
months ended
June 30, 2017
, the foreign exchange losses were primarily driven by the $64.2 million loss from the remeasurement of our
€1,300.0
million Senior Notes partially offset by the remeasurement of cash and content liability positions in currencies other than the functional currencies of our European and U.S. entities.
Provision for Income Taxes
The effective tax rates for the three months ended
June 30, 2017
and
2016
were
(370)%
and 20%, respectively. The effective tax rate for the three months ended
June 30, 2017
differed from the Federal statutory rate primarily due to the recognition of excess tax benefits attributable to the adoption of ASU 2016-09, foreign income taxed at rates lower than the U.S. statutory rate and Federal and California research and development ("R&D") credits partially offset by state taxes and non-deductible expenses. The effective tax rate for the three months ended
June 30, 2016
, differed from the Federal statutory rate primarily due to the Federal and California R&D credits partially offset by state taxes, foreign taxes and non-deductible expenses. The decrease in our effective tax rate for the three months ended
June 30, 2017
, as compared to the same period in
2016
was due primarily to the recognition of the excess tax benefits attributable to the adoption of ASU 2016-09 and an increase in foreign income taxed at rates lower than the U.S. statutory rate.
The effective tax rates for the six months ended June 30, 2017 and 2016 were (3%) and 25%, respectively. The effective tax rates for the six months ended June 30, 2017, differed from the Federal statutory rate primarily due to the recognition of excess tax benefits attributable to the adoption of ASU 2016-09, 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 effective tax rate for the six months ended June 30, 2016, differed from the Federal statutory rate primarily due to the Federal and California research and development credits partially offset by state taxes, foreign taxes and non-deductible expenses. The decrease in our effective tax rate for the three and six months ended June 30, 2017 as compared to the same periods in 2016 was attributable primarily due to the recognition of the excess tax benefits attributable to the adoption of ASU 2016-09 and an increase in foreign income taxed at rates lower than the U.S. statutory rate.
Liquidity and Capital Resources
Cash, cash equivalents and short-term investments increased $431.1 million from $1,733.8 million as of
December 31, 2016
to $2,164.9 million as of
June 30, 2017
. The increase in cash, cash equivalents and short-term investments in the
six
months ended
June 30, 2017
was primarily due to the proceeds from the issuance of debt partially offset by cash used in operations.
Our primary uses of cash include the acquisition, licensing and production of content, streaming delivery, marketing programs and personnel-related costs. Investments in original content, and in particular content that we produce and own, require more cash upfront relative to licensed content. We expect to significantly increase our investments in global streaming content, particularly in original content, which will impact our liquidity and result in future negative free cash flows for many years. We currently anticipate that cash flows from operations, together with available funds and access to financing sources, will continue to be sufficient to meet our cash needs for at least the next twelve months.
In May 2017, we issued
€1,300.0
million of long-term debt. Long-term debt, net of debt issuance costs, was
$4,836.5 million
and
$3,364.3 million
as of
June 30, 2017
, and
December 31, 2016
, respectively. See Note 5 to the consolidated financial statements for additional information. Our ability to obtain any additional financing that we may choose to, or need to, obtain will depend on, among other things, our development efforts, business plans, operating performance and the condition of the capital markets at the time we seek financing. We may not be able to obtain such financing on terms acceptable to us or at all. If we raise additional funds through the issuance of equity or debt securities, those securities may have rights, preferences or privileges senior to the rights of our common stock, and our stockholders may experience dilution.
As of
June 30, 2017
, cash and cash equivalents held by our foreign subsidiaries amounted to
$396.8 million
. If these funds are needed for our operations in the U.S., we would be required to accrue and pay U.S. income taxes and foreign withholding taxes on the portion associated with undistributed earnings for certain foreign subsidiaries.
Free Cash Flow
We define free cash flow as cash provided by (used in) operating and investing activities excluding the non-operational cash flows from purchases, maturities and sales of short-term investments. We believe free cash flow is an important liquidity metric because it measures, during a given period, the amount of cash generated that is available to repay debt obligations, make investments in content and for certain other activities or the amount of cash used in operations, including investments in global streaming content. Free cash flow is considered a non-GAAP financial measure and should not be considered in isolation of, or as a substitute for, net income, operating income, cash flow (used in) provided by operating activities, or any other measure of financial performance or liquidity presented in accordance with GAAP.
In assessing liquidity in relation to our results of operations, we compare free cash flow to net income, noting that the three major recurring differences are excess content payments over expense, non-cash stock-based compensation expense and other working capital differences. The excess content payments over expense is variable based on the payment terms of our content agreements and is expected to increase as we enter into more agreements with upfront cash payments, such as licensing and production of original content. In the first half of 2017, the ratio of content payments over content expense was 1.4. Working capital differences include deferred revenue, taxes and semi-annual interest payments on our outstanding debt. Our receivables from members generally settle quickly and deferred revenue is a source of cash flow.
Three months ended June 30, 2017
as compared to the
three months ended June 30, 2016
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
June 30,
2017
|
|
June 30,
2016
|
|
(in thousands)
|
Net cash used in operating activities
|
$
|
(534,528
|
)
|
|
$
|
(226,293
|
)
|
Net cash used in investing activities
|
(56,432
|
)
|
|
(2,896
|
)
|
Net cash provided by financing activities
|
1,420,386
|
|
|
17,612
|
|
|
|
|
|
Non-GAAP free cash flow reconciliation:
|
|
|
|
Net cash used in operating activities
|
(534,528
|
)
|
|
(226,293
|
)
|
Acquisition of DVD content assets
|
(7,624
|
)
|
|
(17,924
|
)
|
Purchases of property and equipment
|
(65,231
|
)
|
|
(10,814
|
)
|
Change in other assets
|
(1,064
|
)
|
|
907
|
|
Non-GAAP free cash flow
|
$
|
(608,447
|
)
|
|
$
|
(254,124
|
)
|
Cash used in operating activities increased $308.2 million to $534.5 million for the three months ended
June 30, 2017
, compared to the same period of
2016
. The significant net cash used in operations is due primarily to the increase in investments in streaming content that requires more upfront payments. The payments for streaming content assets increased $596.3 million or 38%. In addition, we had increased payments associated with higher operating expenses. The increased use of cash was partially offset by a $680.3 million or 32% increase in revenues.
Cash used in investing activities increased $53.5 million, primarily due to an increase in the purchases of property and equipment of $54.4 million, primarily due to the expansion of our Los Gatos, California headquarters and our new Los Angeles, California facility.
Cash provided by financing activities increased $1,402.8 million in the quarter ended
June 30, 2017
, due to the proceeds from the issuance of debt of $1,405.5 million, net of $15.0 million of issuance costs.
Free cash flow was $674.0 million lower than net income for the three months ended
June 30, 2017
primarily due to $598.7 million of cash payments for streaming content assets over streaming amortization expense coupled with $119.3 million of non-favorable other working capital differences partially offset by $44.0 million of non-cash stock-based compensation expense.
Free cash flow was $294.9 million lower than net income for the three months ended
June 30, 2016
, primarily due to $377.9 million of cash payments for streaming content assets over streaming amortization expense partially offset by $44.1 million of non-cash stock-based compensation expense and $38.9 million favorable other working capital differences.
Six months ended June 30, 2017
as compared to the
six months ended June 30, 2016
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
June 30,
2017
|
|
June 30,
2016
|
|
(in thousands)
|
Net cash used in operating activities
|
$
|
(878,384
|
)
|
|
$
|
(454,883
|
)
|
Net cash (used in) provided by investing activities
|
(132,022
|
)
|
|
1,367
|
|
Net cash provided by financing activities
|
1,444,625
|
|
|
32,519
|
|
|
|
|
|
Non-GAAP free cash flow reconciliation:
|
|
|
|
Net cash used in operating activities
|
(878,384
|
)
|
|
(454,883
|
)
|
Acquisition of DVD content assets
|
(32,996
|
)
|
|
(41,131
|
)
|
Purchases of property and equipment
|
(117,754
|
)
|
|
(19,239
|
)
|
Change in other assets
|
(1,833
|
)
|
|
551
|
|
Non-GAAP free cash flow
|
$
|
(1,030,967
|
)
|
|
$
|
(514,702
|
)
|
Cash used in operating activities increased $423.5 million to $878.4 million for the
six
months ended
June 30, 2017
, compared to the same period of
2016
. The significant net cash used in operations is due primarily to the increase in investments in streaming content that requires more upfront payments. The payments for streaming content assets increased $1,167.8 million or 39%. In addition, we had increased payments associated with higher operating expenses. The increased use of cash was partially offset by a $1,359.2 million or 33% increase in revenues.
Cash provided by investing activities decreased $133.4 million, primarily due to a decrease in the proceeds from the sale and maturities of short-term investments of $40.6 million, net of purchases, coupled with an increase in the purchases of property and equipment of $98.5 million, primarily related to the expansion of our Los Gatos, California headquarters and our new Los Angeles, California facility.
Cash provided by financing activities increased $1,412.1 million in the
six
months ended
June 30, 2017
, due to the proceeds from the issuance of debt of $1,405.5 million, net of $15.0 million of issuance costs.
Free cash flow was $1,274.8 million lower than net income for the
six
months ended
June 30, 2017
primarily due to $1,275.5 million of cash payments for streaming content assets over streaming amortization expense coupled with $88.2 million non-favorable other working capital differences, partially offset by $88.9 million of non-cash stock-based compensation expenses.
Free cash flow was $583.1 million lower than net income for the
six
months ended
June 30, 2016
, primarily due to $730.2 million of cash payments for streaming content assets over streaming amortization expense partially offset by $86.5 million of non-cash stock-based compensation expense and $60.6 million favorable other working capital differences.
Contractual Obligations
For the purpose of this table, contractual obligations for purchases of goods or services are defined as agreements that are enforceable and legally binding and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. The expected timing of the payment of the obligations discussed below is estimated based on information available to us as of
June 30, 2017
. Timing of payments and actual amounts paid may be different depending on the time of receipt of goods or services or changes to agreed-upon amounts for some obligations. The following table summarizes our contractual obligations as of
June 30, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments due by Period
|
Contractual obligations (in thousands):
|
Total
|
|
Less than
1 year
|
|
1-3 years
|
|
3-5 years
|
|
More than
5 years
|
Streaming content obligations (1)
|
$
|
15,699,387
|
|
|
$
|
6,592,517
|
|
|
$
|
7,461,470
|
|
|
$
|
1,488,760
|
|
|
$
|
156,640
|
|
Debt (2)
|
6,663,805
|
|
|
235,189
|
|
|
465,893
|
|
|
1,632,601
|
|
|
4,330,122
|
|
Lease obligations (3)
|
695,877
|
|
|
85,859
|
|
|
167,447
|
|
|
148,051
|
|
|
294,520
|
|
Other purchase obligations (4)
|
699,110
|
|
|
428,448
|
|
|
190,878
|
|
|
40,371
|
|
|
39,413
|
|
Total
|
$
|
23,758,179
|
|
|
$
|
7,342,013
|
|
|
$
|
8,285,688
|
|
|
$
|
3,309,783
|
|
|
$
|
4,820,695
|
|
|
|
(1)
|
As of
June 30, 2017
, streaming content obligations were comprised of
$4.1 billion
included in "Current content liabilities" and
$3.4 billion
of "Non-current content liabilities" on the Consolidated Balance Sheets and
$8.2 billion
of obligations that are not reflected on the Consolidated Balance Sheets as they did not then meet the criteria for recognition.
|
Streaming content obligations increased $1.2 billion from $14.5 billion as of
December 31, 2016
to $15.7 billion as of
June 30, 2017
, primarily due to multi-year commitments associated with the continued expansion of our exclusive and original programming.
Streaming content obligations include amounts related to the acquisition, licensing and production of streaming content. An obligation for the production of content includes non-cancelable commitments under creative talent and employment agreements. An obligation for the acquisition and licensing of content is incurred at the time we enter 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, like the U.S. output deal with Disney, or certain TV series license agreements where the number of seasons to be aired is unknown, are examples of these types of agreements. The contractual obligations table above does not include any estimated obligation for the unknown future titles, payment for which could range from less than one year to more than five years. However, these unknown obligations are expected to be significant and we believe could include approximately $3 billion to $5 billion over the next three years, with the payments for the vast majority of such amounts expected to occur after the next twelve months. The foregoing range is based on considerable management judgments and the actual amounts may differ. Once we know the title that we will receive and the license fees, we include the amount in the contractual obligations table above.
|
|
(2)
|
Long-term debt obligations include our Notes consisting of principal and interest payments. See Note 5 to the consolidated financial statements for further details.
|
|
|
(3)
|
Lease obligations include lease financing obligations of
$17.1 million
related to a portion of our current Los Gatos, California headquarters for which we are the deemed owner for accounting purposes, commitments of
$529.7 million
for our expanded headquarters in Los Gatos, California, and our new office space in Los Angeles, California and other commitments of
$149.1 million
for facilities under non-cancelable operating leases. These leases have expiration dates varying through approximately 2028.
|
|
|
(4)
|
Other purchase obligations include all other non-cancelable contractual obligations. These contracts are primarily related to streaming delivery, DVD content acquisition, and miscellaneous open purchase orders for which we have not received the related services or goods.
|
As of
June 30, 2017
, we had gross unrecognized tax benefits of
$29.3 million
which was classified in “Other non-current liabilities” and a reduction to deferred tax assets which was classified as "Other non-current assets" in the consolidated balance sheets. At this time, an estimate of the range of reasonably possible adjustments to the balance of unrecognized tax benefits cannot be made.
Off-Balance Sheet Arrangements
We do not have transactions with unconsolidated entities, such as entities often referred to as structured finance or special purpose entities, whereby we have financial guarantees, subordinated retained interests, derivative instruments, or other contingent arrangements that expose us to material continuing risks, contingent liabilities, or any other obligation under a variable interest in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to us.
Indemnification
The information set forth under Note 6 to the consolidated financial statements under the caption “Indemnification” is incorporated herein by reference.
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reported periods. The Securities and Exchange Commission ("SEC") has defined a company’s critical accounting policies as the ones that are most important to the portrayal of a company’s financial condition and results of operations, and which require a company to make its most difficult and subjective judgments. Based on this definition, we have identified the critical accounting policies and judgments addressed below. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates.
Streaming Content
We acquire, license and produce content, including original programing, in order to offer our members unlimited viewing of TV shows and films. The content licenses are for a fixed fee and specific windows of availability. Payment terms for certain content licenses and the production of content require more upfront cash payments relative to the amortization expense. Payments for content, including additions to streaming assets and the changes in related liabilities, are classified within "Net cash used in operating activities" on the Consolidated Statements of Cash Flows.
For licenses we capitalize the fee per title and record a corresponding liability at the gross amount of the liability when the license period begins, the cost of the title is known and the title is accepted and available for streaming. The portion available for streaming within one year is recognized as “Current content assets, net” and the remaining portion as “Non-current content assets, net” on the Consolidated Balance Sheets.
For productions, we capitalize costs associated with the production, including development cost, direct costs and production overhead. We include these amounts in "Non-current content assets, net" on the Consolidated Balance Sheets. Participations and residuals are expensed in line with the amortization of production costs.
Based on factors including historical and estimated viewing patterns, we amortize the content assets (licensed and produced) in “Cost of revenues” on the Consolidated Statements of Operations, over the shorter of each title's contractual window of availability or estimated period of use, beginning with the month of first availability. The amortization period typically ranges from six months to five years. For content where we expect more upfront viewing, due to the additional merchandising and marketing efforts, we amortize on an accelerated basis. We review factors that impact the amortization of the content assets on a regular basis. Our estimates related to these factors require considerable management judgment.
Our business model is subscription based as opposed to a model generating revenues at a specific title level. Therefore, content assets, both licensed and produced are reviewed in aggregate at the operating segment level when an event or change in circumstances indicates a change in the expected usefulness or that the fair value may be less than amortized cost. To date, we have not identified any such event or changes in circumstances. If such changes are identified in the future, these aggregated content assets will be stated at the lower of unamortized cost, net realizable value or fair value. In addition, unamortized costs for assets that have been, or are expected to be, abandoned are written off. No material write-down from unamortized cost was recorded in any of the periods presented.
Income Taxes
We record a provision for income taxes for the anticipated tax consequences of our reported results of operations using the asset and liability method. Deferred income taxes are recognized by applying enacted statutory tax rates applicable to future years to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases as well as net operating loss and tax credit carryforwards. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance for any tax benefits for which future realization is uncertain. As of
June 30, 2017
, there was a valuation allowance of
$21.9 million
primarily related to foreign tax credit carryovers. There was no valuation allowance as of
June 30, 2016
.
Although we believe our assumptions, judgments and estimates are reasonable, changes in tax laws or our interpretation of tax laws and the resolution of any tax audits could significantly impact the amounts provided for income taxes in our consolidated financial statements.
In evaluating our ability to recover our deferred tax assets, in full or in part, we consider all available positive and negative evidence, including our past operating results, and our forecast of future earnings, future taxable income and prudent and feasible tax planning strategies. The assumptions utilized in determining future taxable income require significant judgment and are consistent with the plans and estimates we are using to manage the underlying businesses. Actual operating results in future years could differ from our current assumptions, judgments and estimates. In the event we were to determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to earnings in the period in which we make such determination.
We did not recognize certain tax benefits from uncertain tax positions within the provision for income taxes. We may recognize a tax benefit only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the consolidated financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. At
June 30, 2017
, our estimated gross unrecognized tax benefits were
$29.3 million
of which
$25.8 million
, if recognized, would favorably impact our future earnings. Due to uncertainties in any tax audit outcome, our estimates of the ultimate settlement of our unrecognized tax positions may change and the actual tax benefits may differ significantly from the estimates. See Note 9 to the consolidated financial statements for further information regarding income taxes.
Stock-Based Compensation
We grant fully vested non-qualified stock options to our employees on a monthly basis. As a result of immediate vesting, stock-based compensation expense is fully recognized on the grant date, and no estimate is required for post-vesting option forfeitures. Stock-based compensation expense at the grant date is based on the total number of options granted and an estimate of the fair value of the awards.
We calculate the fair value of our stock option grants using a lattice-binomial model. This model requires the input of highly subjective assumptions. Changes in the subjective input assumptions can materially affect the estimate of fair value of options granted and our results of operations could be impacted.
|
|
•
|
Expected Volatility:
The Company calculates expected volatility based solely on implied volatility. We believe that implied volatility of publicly traded options in our 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 our common stock. An increase/decrease of 10% in our computation of expected volatility would increase/decrease the total stock-based compensation expense by approximately $5.4 million for the three months ended
June 30, 2017
.
|
|
|
•
|
Suboptimal Exercise Factor:
Our computation of the suboptimal exercise factor is based on historical and estimated option exercise behavior. An increase/decrease in the suboptimal exercise factor of 10% would increase/decrease the total stock-based compensation expense by approximately $1.1 million for the three months ended
June 30, 2017
.
|
Recent Accounting Pronouncements
The information set forth under Note 1 to the consolidated financial statements under the caption “Basis of Presentation and Summary of Significant Accounting Policies” is incorporated herein by reference.