Quarterly Report (10-q)

Date : 10/18/2019 @ 5:25PM
Source : Edgar (US Regulatory)
Stock : Netflix Inc (NFLX)
Quote : 294.18  2.61 (0.90%) @ 10:45PM
After Hours
Last Trade
Last $ 294.18 ◊ 0.00 (0.00%)

Quarterly Report (10-q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
OR

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 of principal executive offices)
(Zip Code)
(408) 540-3700
(Registrant’s telephone number, including area code)
 

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common stock, par value $0.001 per share
NFLX
NASDAQ Global Select Market
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      No  
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      No     
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
 
Accelerated filer
Non-accelerated filer
 
Smaller reporting company
 
 
 
Emerging growth company
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.
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).    Yes      No  
As of September 30, 2019, there were 438,251,289 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,
2019
 
September 30,
2018
 
September 30,
2019
 
September 30,
2018
Revenues
$
5,244,905

 
$
3,999,374

 
$
14,689,013

 
$
11,607,500

Cost of revenues
3,097,919

 
2,531,128

 
8,974,190

 
7,234,138

Marketing
553,797

 
510,330

 
1,773,525

 
1,639,114

Technology and development
379,776

 
308,620

 
1,135,773

 
890,025

General and administrative
233,174

 
168,628

 
659,783

 
454,764

Operating income
980,239

 
480,668

 
2,145,742

 
1,389,459

Other income (expense):
 
 
 
 
 
 
 
Interest expense
(160,660
)
 
(108,862
)
 
(448,222
)
 
(291,686
)
Interest and other income (expense)
192,744

 
7,004

 
215,378

 
9,289

Income before income taxes
1,012,323

 
378,810

 
1,912,898

 
1,107,062

Provision for (benefit from) income taxes
347,079

 
(24,025
)
 
632,952

 
29,754

Net income
$
665,244

 
$
402,835

 
$
1,279,946

 
$
1,077,308

 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
Basic
$
1.52

 
$
0.92

 
$
2.93

 
$
2.48

Diluted
$
1.47

 
$
0.89

 
$
2.83

 
$
2.39

Weighted-average common shares outstanding:
 
 
 
 
 
 
 
Basic
438,090

 
435,809

 
437,547

 
435,033

Diluted
451,552

 
451,919

 
451,896

 
451,283











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,
2019
 
September 30,
2018
 
September 30,
2019
 
September 30,
2018
Net income
$
665,244

 
$
402,835

 
$
1,279,946

 
$
1,077,308

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustments 
(20,894
)
 
(2,081
)
 
(21,664
)
 
6,049

Comprehensive income
$
644,350

 
$
400,754

 
$
1,258,282

 
$
1,083,357

























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,
2019
 
September 30,
2018
 
September 30,
2019
 
September 30,
2018
Cash flows from operating activities:
 
 
 
 
 
 
 
Net income
$
665,244

 
$
402,835

 
$
1,279,946

 
$
1,077,308

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
 
 
 
 
Additions to streaming content assets
(3,648,292
)
 
(3,238,717
)
 
(9,971,141
)
 
(9,259,185
)
Change in streaming content liabilities
(95,548
)
 
65,868

 
(122,660
)
 
733,227

Amortization of streaming content assets
2,279,977

 
1,911,767

 
6,636,578

 
5,478,428

Amortization of DVD content assets
6,654

 
9,959

 
22,819

 
32,247

Depreciation and amortization of property, equipment and intangibles
26,704

 
21,161

 
75,761

 
59,938

Stock-based compensation expense
100,262

 
82,316

 
305,310

 
231,943

Other non-cash items
51,280

 
8,962

 
141,518

 
31,092

Foreign currency remeasurement gain on long-term debt
(171,360
)
 
(7,670
)
 
(167,676
)
 
(52,000
)
Deferred taxes
52,105

 
(39,453
)
 
94,251

 
(71,041
)
Changes in operating assets and liabilities:
 
 
 
 
 
 
 
Other current assets
145

 
(30,364
)
 
(56,162
)
 
(111,833
)
Accounts payable
(7,643
)
 
(4,449
)
 
(134,784
)
 
77,367

Accrued expenses and other liabilities
260,872

 
134,000

 
391,814

 
200,198

Deferred revenue
22,729

 
18,983

 
154,607

 
98,101

Other non-current assets and liabilities
(44,923
)
 
(25,609
)
 
(75,528
)
 
28,803

Net cash used in operating activities
(501,794
)
 
(690,411
)
 
(1,425,347
)
 
(1,445,407
)
Cash flows from investing activities:
 
 
 
 
 
 
 
Acquisition of DVD content assets
(4,634
)
 
(7,731
)
 
(21,602
)
 
(31,079
)
Purchases of property and equipment
(45,333
)
 
(39,333
)
 
(145,298
)
 
(103,826
)
Change in other assets
613

 
(121,630
)
 
(12,593
)
 
(123,857
)
Net cash used in investing activities
(49,354
)
 
(168,694
)
 
(179,493
)
 
(258,762
)
Cash flows from financing activities:
 
 
 
 
 
 
 
Proceeds from issuance of debt

 

 
2,243,196

 
1,900,000

Debt issuance costs

 

 
(18,192
)
 
(16,992
)
Proceeds from issuance of common stock
11,989

 
29,781

 
56,857

 
113,052

Other financing activities

 
(544
)
 

 
(1,397
)
Net cash provided by financing activities
11,989

 
29,237

 
2,281,861

 
1,994,663

Effect of exchange rate changes on cash, cash equivalents, and restricted cash
(29,325
)
 
(5,562
)
 
(29,341
)
 
(34,725
)
Net increase (decrease) in cash, cash equivalents, and restricted cash
(568,484
)
 
(835,430
)
 
647,680

 
255,769

Cash, cash equivalents and restricted cash at beginning of period
5,028,205

 
3,913,994

 
3,812,041

 
2,822,795

Cash, cash equivalents and restricted cash at end of period
$
4,459,721

 
$
3,078,564

 
$
4,459,721

 
$
3,078,564

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,
2019
 
December 31,
2018
 
(unaudited)
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
4,435,018

 
$
3,794,483

Current content assets, net

 
5,151,186

Other current assets
892,740

 
748,466

Total current assets
5,327,758

 
9,694,135

Non-current content assets, net
23,234,994

 
14,960,954

Property and equipment, net
481,992

 
418,281

Other non-current assets
1,896,967

 
901,030

Total assets
$
30,941,711

 
$
25,974,400

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Current content liabilities
$
4,860,542

 
$
4,686,019

Accounts payable
444,129

 
562,985

Accrued expenses and other liabilities
1,037,723

 
477,417

Deferred revenue
915,506

 
760,899

Total current liabilities
7,257,900

 
6,487,320

Non-current content liabilities
3,419,552

 
3,759,026

Long-term debt
12,425,746

 
10,360,058

Other non-current liabilities
977,008

 
129,231

Total liabilities
24,080,206

 
20,735,635

Commitments and contingencies (Note 6)


 


Stockholders’ equity:
 
 
 
Common stock, $0.001 par value; 4,990,000,000 shares authorized at September 30, 2019 and December 31, 2018; 438,251,289 and 436,598,597 issued and outstanding at September 30, 2019 and December 31, 2018, respectively
2,677,972

 
2,315,988

Accumulated other comprehensive loss
(41,246
)
 
(19,582
)
Retained earnings
4,224,779

 
2,942,359

Total stockholders’ equity
6,861,505

 
5,238,765

Total liabilities and stockholders’ equity
$
30,941,711

 
$
25,974,400





See accompanying notes to the consolidated financial statements.

6


NETFLIX, INC.
Consolidated Statements of Stockholders’ Equity
(unaudited)
(in thousands)
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
2019
 
September 30,
2018
 
September 30,
2019
 
September 30,
2018
Total stockholders' equity, beginning balances
 
$
6,105,548

 
$
4,496,600

 
$
5,238,765

 
$
3,581,956

 
 
 
 
 
 
 
 
 
Common stock and additional paid-in capital:
 
 
 
 
 
 
 
 
Beginning balances
 
$
2,566,365

 
$
2,103,437

 
$
2,315,988

 
$
1,871,396

Issuance of common stock upon exercise of options
 
11,345

 
29,983

 
56,674

 
112,397

Stock-based compensation expense
 
100,262

 
82,316

 
305,310

 
231,943

Ending balance
 
$
2,677,972

 
$
2,215,736

 
$
2,677,972

 
$
2,215,736

 
 


 


 
 
 
 
Accumulated other comprehensive income (loss):
 
 
 
 
 
 
 
 
Beginning balances
 
$
(20,352
)
 
$
(12,427
)
 
$
(19,582
)
 
$
(20,557
)
Other comprehensive income (loss)
 
(20,894
)
 
(2,081
)
 
(21,664
)
 
6,049

Ending balance
 
$
(41,246
)
 
$
(14,508
)
 
$
(41,246
)
 
$
(14,508
)
 
 
 
 
 
 
 
 
 
Retained earnings:
 
 
 
 
 
 
 
 
Beginning balances
 
$
3,559,535

 
$
2,405,590

 
$
2,942,359

 
$
1,731,117

Net income
 
665,244

 
402,835

 
1,279,946

 
1,077,308

Adoption of ASU 2016-02, Leases (Topic 842)
 

 

 
2,474

 

Ending balances
 
$
4,224,779

 
$
2,808,425

 
$
4,224,779

 
$
2,808,425

 
 
 
 
 
 
 
 
 
Total stockholders' equity, ending balances
 
$
6,861,505

 
$
5,009,653

 
$
6,861,505

 
$
5,009,653
























See accompanying notes to the consolidated financial statements.


7


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, 2018 filed with the Securities and Exchange Commission (the “SEC”) on January 29, 2019 and February 8, 2019, respectively. 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, as amended by Form 10-K/A, for the year ended December 31, 2018. Interim results are not necessarily indicative of the results for a full year.
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, as amended by Form 10-K/A, for the year ended December 31, 2018.

Recently adopted accounting pronouncements
In February 2016, the Financial Accounting Standards Board ("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 prior 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. The Company adopted ASU 2016-02 in the first quarter of 2019 utilizing the modified retrospective transition method through a cumulative-effect adjustment at the beginning of the first quarter of 2019. The Company has elected the package of practical expedients, which allows the Company not to reassess (1) whether any expired or existing contracts as of the adoption date are or contain a lease, (2) lease classification for any expired or existing leases as of the adoption date and (3) initial direct costs for any existing leases as of the adoption date. The Company did not elect to apply the hindsight practical expedient when determining lease term and assessing impairment of right-of-use assets. The adoption of ASU 2016-02 on January 1, 2019 resulted in the recognition of right-of-use assets of approximately $743 million, lease liabilities for operating leases of approximately $813 million and a cumulative-effect adjustment on retained earnings of $2 million on its Consolidated Balance Sheets, with no material impact to its Consolidated Statements of Operations. See Note 4 for further information regarding the impact of the adoption of ASU 2016-02 on the Company's financial statements.
In March 2019, the FASB issued ASU 2019-02, Improvements to Accounting for Costs of Films and License Agreements for Program Materials, in order to align the accounting for production costs of an episodic television series with the accounting for production costs of films by removing the content distinction for capitalization. ASU 2019-02 also requires that an entity reassess estimates of the use of a film in a film group and account for any changes prospectively. In addition, ASU 2019-02 requires that an entity test films and license agreements for program material for impairment at a film group level when the film or license agreements are predominantly monetized with other films and license agreements. ASU 2019-02 is effective for fiscal years beginning after December 15, 2019 and early adoption is permitted. The Company early adopted ASU 2019-02 in the first quarter of 2019 and as such has included all content assets (licensed and produced) as "Non-current content assets, net" on its Consolidated Balance Sheets, beginning with the period of adoption. There was no material impact to its Consolidated Statements of Operations. See the Company's updated Streaming Content policy below for further details.
Streaming Content (Effective January 1, 2019)
The Company acquires, licenses and produces content, including original programming, in order to offer members unlimited viewing of TV series 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.
The Company recognizes content assets (licensed and produced) as “Non-current content assets, net” on the Consolidated Balance Sheets. For licenses, the Company capitalizes the fee per title and records 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. For productions, the Company capitalizes

8


costs associated with the production, including development costs, direct costs and production overhead. Participations and residuals are expensed in line with the amortization of production costs.
Based on factors including historical and estimated viewing patterns, the Company amortizes 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 or ten years, beginning with the month of first availability. The amortization is on an accelerated basis, as the Company typically expects more upfront viewing, for instance due to additional merchandising and marketing efforts and film amortization is more accelerated than TV series amortization. The Company reviews factors impacting the amortization of the content assets on an ongoing basis. The Company's estimates related to these factors require considerable management judgment.
The Company's business model is subscription based as opposed to a model generating revenues at a specific title level. Content assets (licensed and produced) are predominantly monetized as a group and therefore are reviewed in aggregate at a group level when an event or change in circumstances indicates a change in the expected usefulness of the content or that the fair value may be less than unamortized cost. To date, the Company has 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 or fair value. In addition, unamortized costs for assets that have been, or are expected to be, abandoned are written off.


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,
2019
 
September 30,
2018
 
September 30,
2019
 
September 30,
2018
 
(in thousands, except per share data)
Basic earnings per share:
 
 
 
 
 
 
 
Net income
$
665,244

 
$
402,835

 
$
1,279,946

 
$
1,077,308

Shares used in computation:
 
 
 
 
 
 
 
Weighted-average common shares outstanding
438,090

 
435,809

 
437,547

 
435,033

Basic earnings per share
$
1.52

 
$
0.92

 
$
2.93

 
$
2.48

 
 
 
 
 
 
 
 
Diluted earnings per share:
 
 
 
 
 
 
 
Net income
$
665,244

 
$
402,835

 
$
1,279,946

 
$
1,077,308

Shares used in computation:
 
 
 
 
 
 
 
Weighted-average common shares outstanding
438,090

 
435,809

 
437,547

 
435,033

Employee stock options
13,462

 
16,110

 
14,349

 
16,250

Weighted-average number of shares
451,552

 
451,919

 
451,896

 
451,283

Diluted earnings per share
$
1.47

 
$
0.89

 
$
2.83

 
$
2.39



Employee stock options with exercise prices greater than the average market price of the common stock were excluded from the diluted calculation as their inclusion would have been anti-dilutive. The following table summarizes the potential common shares excluded from the diluted calculation:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2019
 
September 30,
2018
 
September 30,
2019
 
September 30,
2018
 
(in thousands)
Employee stock options
2,402

 
176

 
1,268

 
96


 


9


3. Cash, Cash Equivalents, and Restricted Cash

The following tables summarize the Company's cash, cash equivalents, and restricted cash as of September 30, 2019 and December 31, 2018:

 
As of September 30, 2019
 
Cash and cash equivalents
 
Non-current Assets
 
Total
 
(in thousands)
Cash
$
3,013,907

 
$
23,383

 
$
3,037,290

Level 1 securities:
 
 
 
 
 
Money market funds
1,421,111

 
1,320

 
1,422,431

 
 
 
 
 
 
 
$
4,435,018

 
$
24,703

 
$
4,459,721


 
As of December 31, 2018
 
Cash and cash equivalents
 
Non-current Assets
 
Total
 
(in thousands)
Cash
$
2,572,685

 
$
16,260

 
$
2,588,945

Level 1 securities:
 
 
 
 
 
Money market funds
1,221,798

 
1,298

 
1,223,096

 
 
 
 
 
 
 
$
3,794,483

 
$
17,558

 
$
3,812,041


Non-current assets include restricted cash related to letter of credit agreements and workers compensation deposits.
There were no material gross realized gains or losses in the three and nine months ended September 30, 2019 and 2018, respectively.

4. Balance Sheet Components

Content Assets
Content assets consisted of the following:
 
As of
 
September 30,
2019
 
December 31,
2018
 
(in thousands)
Licensed content, net
$
14,581,407

 
$
14,081,463

 
 
 
 
Produced content, net


 


Released, less amortization
3,646,870

 
2,403,896

In production
4,411,581

 
3,305,126

In development and pre-production
587,914

 
311,842

 
8,646,365

 
6,020,864

DVD, net
7,222

 
9,813

Total
$
23,234,994

 
$
20,112,140

 
 
 
 


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.

10


As of September 30, 2019, approximately $5,666 million, $3,713 million, and $2,546 million of the $14,581 million unamortized cost of the licensed content is expected to be amortized in each of the next three years.  
As of September 30, 2019, approximately $1,264 million, $997 million, and $737 million of the $3,647 million unamortized cost of the produced content that has been released is expected to be amortized in each of the next three years.
As of September 30, 2019, the amount of accrued participations and residuals was not material.

The following table represents the amortization of streaming content assets:
 
Three Months Ended
 
September 30,
2019
 
September 30,
2018
 
(in thousands)
Licensed content
$
1,810,757

 
$
1,671,516

Produced content
469,220

 
240,251

Total streaming content
$
2,279,977

 
$
1,911,767



 
Nine Months Ended
 
September 30,
2019
 
September 30,
2018
 
(in thousands)
Licensed content
$
5,382,225

 
$
4,810,476

Produced content
1,254,353

 
667,952

Total streaming content
$
6,636,578

 
$
5,478,428



Property and Equipment, Net
Property and equipment and accumulated depreciation consisted of the following:
 
 
As of
 
 
 
 
September 30,
2019
 
December 31,
2018
 
Estimated Useful Lives
 
 
(in thousands)
 
 
Leasehold improvements
 
$
323,630

 
$
282,028

 
Over life of lease
Information technology
 
239,472

 
224,296

 
3 years
Furniture and fixtures
 
84,322

 
63,667

 
3-15 years
Buildings
 
32,950

 
73,468

 
30 years
Corporate aircraft
 
104,985

 
62,560

 
8 years
DVD operations equipment
 
45,163

 
53,416

 
5 years
Machinery and equipment
 
4,512

 
1,692

 
3 years
Land
 
6,125

 
6,125

 
 
Capital work-in-progress
 
43,437

 
19,548

 

Property and equipment, gross
 
884,596

 
786,800

 
 
Less: Accumulated depreciation
 
(402,604
)
 
(368,519
)
 
 
Property and equipment, net
 
$
481,992

 
$
418,281

 
 



Leases
The Company has entered into operating leases primarily for real estate. These leases generally have terms which range from 1 year to 15 years, and often include one or more options to renew. These renewal terms can extend the lease term from 1 to 15 years, and are included in the

11


lease term when it is reasonably certain that the Company will exercise the option. These operating leases are included in "Other non-current assets" on the Company's September 30, 2019 Consolidated Balance Sheet, and represent the Company’s right to use the underlying asset for the lease term. The Company’s obligation to make lease payments are included in "Accrued expenses and other liabilities" and "Other non-current liabilities" on the Company's September 30, 2019 Consolidated Balance Sheet.  Based on the present value of the lease payments for the remaining lease term of the Company's existing leases, the Company recognized right-of-use assets of approximately $743 million and lease liabilities for operating leases of approximately $813 million on January 1, 2019. Operating lease right-of-use assets and liabilities commencing after January 1, 2019 are recognized at commencement date based on the present value of lease payments over the lease term. As of September 30, 2019, total right-of-use assets and operating lease liabilities were approximately $1,031 million and $1,114 million, respectively. The Company has entered into various short-term operating leases, primarily for marketing billboards, with an initial term of twelve months or less. These leases are not recorded on the Company's balance sheet. All operating lease expense is recognized on a straight-line basis over the lease term. In the three months ended September 30, 2019, the Company recognized approximately $105 million in total lease costs, which was comprised of $57 million in operating lease costs for right-of-use assets and $48 million in short-term lease costs related to short-term operating leases. In the nine months ended September 30, 2019, the Company recognized approximately $307 million in total lease costs, which was comprised of $148 million in operating lease costs for right-of-use assets and $159 million in short-term lease costs related to short-term operating leases.
Because the rate implicit in each lease is not readily determinable, the Company uses its incremental borrowing rate to determine the present value of the lease payments. The Company has certain contracts for real estate and marketing which may contain lease and non-lease components which it has elected to treat as a single lease component.
Information related to the Company's right-of-use assets and related lease liabilities were as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2019
 
September 30, 2019
 
(in thousands)
Cash paid for operating lease liabilities
$
51,767

 
$
130,740

Right-of-use assets obtained in exchange for new operating lease obligations (1)
77,549

 
1,150,443

(1) Nine-month ended balance includes $743 million for operating leases existing on January 1, 2019.
 
As of
 
September 30, 2019
 
 
Weighted-average remaining lease term
8.2 years

Weighted-average discount rate
5.3
%


Maturities of lease liabilities as of September 30, 2019 were as follows (in thousands):
Due in 12 month period ended September 30,
2020
$
210,160

2021
193,616

2022
167,166

2023
145,677

2024
135,489

Thereafter
560,518

 
1,412,626

Less imputed interest
(299,007
)
Total lease liabilities
1,113,619

 
 
Current operating lease liabilities
160,941

Non-current operating lease liabilities
952,678

Total lease liabilities
$
1,113,619




12


The Company has additional operating leases for real estate of $1,146 million which have not commenced as of September 30, 2019, and as such, have not been recognized on the Company's Consolidated Balance Sheet. These operating leases are expected to commence between 2019 and 2020 with lease terms between 1 year and 15 years.

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, 2019, total deferred revenue was $916 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 $155 million increase in deferred revenue as compared to the year ended December 31, 2018 is a result of the increase in membership fees billed due to increased members and average monthly revenue per paying member.

Other Current Assets
Other current assets consisted of the following:
 
 
As of
 
 
September 30,
2019
 
December 31,
2018
 
 
(in thousands)
Trade receivables
 
$
466,168

 
$
362,712

Prepaid expenses
 
187,865

 
178,833

Other
 
238,707

 
206,921

Total other current assets
 
$
892,740

 
$
748,466






13


5. Long-term Debt
As of September 30, 2019, the Company had aggregate outstanding long-term notes of $12,426 million, net of $99 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. A portion of the outstanding long-term notes is denominated in foreign currency (comprised of €3,600 million) and is remeasured into U.S. dollars at each balance sheet date.
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, 2019 and December 31, 2018:
 
 
 
 
 
 
 
 
 
 
Level 2 Fair Value as of
 
 
Principal Amount at Par
 
Issuance Date
 
Maturity
 
Interest Payment Dates
 
September 30, 2019
 
December 31, 2018
 
 
(in millions)
 
 
 
 
 
 
 
(in millions)
5.375% Senior Notes
 
$
500

 
February 2013
 
February 2021
 
February and August
 
$
516

 
$
509

5.500% Senior Notes
 
700

 
February 2015
 
February 2022
 
April and October
 
744

 
706

5.750% Senior Notes
 
400

 
February 2014
 
March 2024
 
March and September
 
438

 
407

5.875% Senior Notes
 
800

 
February 2015
 
February 2025
 
April and October
 
881

 
812

4.375% Senior Notes
 
1,000

 
October 2016
 
November 2026
 
May and November
 
1,016

 
915

3.625% Senior Notes (1)
 
1,418

 
May 2017
 
May 2027
 
May and November
 
1,507

 
1,446

4.875% Senior Notes
 
1,600

 
October 2017
 
April 2028
 
April and October
 
1,629

 
1,464

5.875% Senior Notes
 
1,900

 
April 2018
 
November 2028
 
May and November
 
2,069

 
1,851

4.625% Senior Notes (2)
 
1,199

 
October 2018
 
May 2029
 
May and November
 
1,336

 
1,241

6.375% Senior Notes
 
800

 
October 2018
 
May 2029
 
May and November
 
888

 
797

3.875% Senior Notes (3)
 
1,308

 
April 2019
 
November 2029
 
June and December
 
1,392

 

5.375% Senior Notes
 
900

 
April 2019
 
November 2029
 
June and December
 
940

 

 
 
$
12,525

 
 
 
 
 
 
 
 
 
 

(1) Debt is denominated in euro with a €1,300 million principal amount. Total proceeds were $1,421 million.
(2) Debt is denominated in euro with a €1,100 million principal amount. Total proceeds were $1,262 million.
(3) Debt is denominated in euro with a €1,200 million principal amount. Total proceeds were $1,343 million.
The expected timing of principal and interest payments for these Notes are as follows:
 
As of 
 
September 30,
2019
 
December 31, 2018
 
(in thousands)
Less than one year
$
638,318

 
$
538,384

Due after one year and through three years
2,404,589

 
1,550,581

Due after three years and through five years
1,509,068

 
1,646,101

Due after five years
13,095,347

 
11,138,129

Total debt obligations
$
17,647,322

 
$
14,873,195



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, 2019 and December 31, 2018, the Company was in compliance with all related covenants.


14


Revolving Credit Facility
In July 2017, the Company entered into a $500 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 million, subject to certain terms and conditions. On March 29, 2019, the agreement was amended to extend the maturity date from July 27, 2022 to March 29, 2024 and to increase the size of the credit facility to $750 million, without impacting the existing uncommitted incremental facility. Revolving loans may be borrowed, repaid and reborrowed until March 29, 2024, 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, 2019, 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 an annual 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, 2019 and December 31, 2018, the Company was in compliance with all related covenants.

6. Commitments and Contingencies

Streaming Content
As of September 30, 2019, the Company had $19.1 billion of obligations comprised of $4.9 billion included in "Current content liabilities" and $3.4 billion of "Non-current content liabilities" on the Consolidated Balance Sheets and $10.8 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, 2018, the Company had $19.3 billion of obligations comprised of $4.7 billion included in "Current content liabilities" and $3.8 billion of "Non-current content liabilities" on the Consolidated Balance Sheets and $10.8 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,
2019
 
December 31,
2018
 
(in thousands)
Less than one year
$
8,993,612

 
$
8,611,398

Due after one year and through three years
8,082,440

 
8,841,561

Due after three years and through five years
1,586,731

 
1,684,582

Due after five years
478,760

 
148,334

Total streaming content obligations
$
19,141,543

 
$
19,285,875


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.


15


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 September 30, 2019, approximately 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, 2018
8,699,941

 
20,479,278

 
$
89.61

 
 
 
 
Granted
(1,850,795
)
 
1,850,795

 
333.73

 
 
 
 
Exercised

 
(1,652,692
)
 
34.29

 
 
 
 
Expired

 
(175
)
 
6.17

 
 
 
 
Balances as of September 30, 2019
6,849,146

 
20,677,206

 
$
115.88

 
5.57
 
$
3,361,640

Vested and exercisable as of September 30, 2019
 
 
20,677,206

 
$
115.88

 
5.57
 
$
3,361,640



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 2019 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 2019. This amount changes based on the fair market value of the Company’s common stock.

16


A summary of the amounts related to option exercises, is as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2019
 
September 30,
2018
 
September 30,
2019
 
September 30,
2018
 
(in thousands)
Total intrinsic value of options exercised
$
119,439

 
$
193,411

 
$
513,213

 
$
718,116

Cash received from options exercised
11,989

 
29,781

 
56,857

 
113,052


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,
2019
 
September 30,
2018
 
September 30,
2019
 
September 30,
2018
Dividend yield
%
 
%
 
%
 
%
Expected volatility
38
%
 
40
%
 
38% - 41%

 
40% - 42%

Risk-free interest rate
1.92
%
 
2.90
%
 
1.92% - 2.74%

 
2.61% - 2.90%

Suboptimal exercise factor
3.19

 
2.97

 
3.07 - 3.19

 
2.80 - 2.97

Weighted-average fair value (per share)
$
154

 
$
182

 
$
165

 
$
154

Total stock-based compensation expense (in thousands)
$
100,262

 
$
82,316

 
$
305,310

 
$
231,943

Total income tax impact on provision (in thousands)
$
22,679

 
$
18,036

 
$
69,152

 
$
49,617



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. Income Taxes
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
2019
 
September 30,
2018
 
September 30, 2019
 
September 30, 2018
 
 
(in thousands, except percentages)
Provision for (benefit from) income taxes
 
$
347,079

 
$
(24,025
)
 
$
632,952

 
$
29,754

Effective tax rate
 
34
%
 
(6
)%
 
33
%
 
3
%


In connection with the Tax Cuts and Job Act of 2017 the Company simplified its global corporate structure, effective April 1, 2019. The tax impacts of such simplifications were not material to the financial statements taken as a whole.
The effective tax rates for the three and nine months ended September 30, 2019 differed from the Federal statutory rate primarily due to changes from the global corporate structure simplification, state taxes, foreign taxes, non-deductible expenses, and the international provisions of U.S. tax reform that became effective in 2018, partially offset by the recognition of excess tax benefits of stock-based compensation, and Federal and California research and development (“R&D”) credits. 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 R&D credits, and updated provisional amounts related to U.S. tax reform as a result of the U.S. federal tax return filing, partially offset by state taxes, foreign taxes, non-deductible expenses.
The increase in effective tax rates for the three and nine months ended September 30, 2019, as compared to the same period in 2018 was primarily due to changes from the global corporate structure simplification, a lower benefit from the recognition of excess tax benefits of

17


stock-based compensation, lower benefit on a percentage basis from Federal and California R&D credits, and additional expenses related to the international provisions of U.S. tax reform that became effective in 2018. For the three and nine months ended September 30, 2019, the Company recognized a discrete tax benefit related to the excess tax benefits from stock-based compensation of $27 million and $114 million, respectively, compared to the three months and nine months ended September 30, 2018 of $40 million and $158 million, respectively.
Gross unrecognized tax benefits were $68 million and $48 million as of September 30, 2019 and December 31, 2018, respectively. The gross unrecognized tax benefits, if recognized by the Company, will result in a reduction of approximately $63 million to the provision for income taxes thereby favorably impacting the Company’s effective tax rate. As of September 30, 2019, gross unrecognized tax benefits of $18 million were classified as “Other non-current liabilities” and $50 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 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 income taxes” were not material in any of the periods presented.
Deferred tax assets of $470 million and $564 million were classified as “Other non-current assets” on the Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018, 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 $133 million and $125 million as of September 30, 2019 and December 31, 2018, respectively. The valuation allowance is primarily related to certain foreign tax credits that are not likely to be realized.
The Company files U.S. Federal, state and foreign tax returns. The Company is currently under examination by the IRS for 2016 and 2017 and 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 through 2018. The Company has no other significant foreign jurisdiction audits underway. The years 2014 through 2018 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.

9. Segment Information
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 currently 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. Because the Company increasingly obtains multi-territory or global rights for streaming content, contribution profit (loss) on a regional basis is becoming a less meaningful metric and as such, the CODM increasingly focuses on the Company's global operating margin as the primary measure of profitability. As of the third quarter of 2019, the Company has three reportable segments: Domestic streaming, International streaming and Domestic DVD. 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 processing 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 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 either attributed to the operating segment based on amounts directly incurred by the segment or are allocated across segments by management. 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.

18


The Company's long-lived tangible assets, as well as the Company's operating lease right-of-use assets recognized on the Consolidated Balance Sheets as of September 30, 2019, were located as follows:
 
As of
 
September 30,
2019
 
December 31, 2018
 
(in thousands)
United States
$
1,307,086

 
$
381,947

International
206,228

 
36,334



The following tables represent segment information for the three and nine months ended September 30, 2019:
 
 
As of/ Three Months Ended September 30, 2019
 
Domestic
Streaming
 
International
Streaming
 
Domestic
DVD
 
Consolidated
 
(in thousands)
Total paid memberships at end of period (1)
60,620

 
97,714

 
2,276

 
 
Total paid net membership additions (losses) (1)
517

 
6,255

 
(135
)
 
 
Total free trials at end of period
1,375

 
4,215

 
16

 
 
Revenues
$
2,412,598

 
$
2,760,430

 
$
71,877

 
$
5,244,905

Cost of revenues
1,210,105

 
1,860,021

 
27,793

 
3,097,919

Marketing
211,793

 
342,004

 

 
553,797

Contribution profit
$
990,700

 
$
558,405

 
$
44,084

 
$
1,593,189

Other operating expenses
 
 
 
 
 
 
612,950

Operating income
 
 
 
 
 
 
980,239

Other income (expense)
 
 
 
 
 
 
32,084

Provision for income taxes
 
 
 
 
 
 
347,079

Net income
 
 
 
 
 
 
$
665,244


 
As of/ Nine Months Ended September 30, 2019
 
Domestic
Streaming
 
International
Streaming
 
Domestic
DVD
 
Consolidated
 
(in thousands)
Total paid memberships at end of period (1)
60,620

 
97,714

 
2,276

 
 
Total paid net membership additions (losses) (1)
2,134

 
16,941

 
(430
)
 
 
Total free trials at end of period
1,375

 
4,215

 
16

 
 
Revenues
$
6,785,342

 
$
7,674,906

 
$
228,765

 
$
14,689,013

Cost of revenues
3,546,060

 
5,336,032

 
92,098

 
8,974,190

Marketing
683,445

 
1,090,080

 

 
1,773,525

Contribution profit
$
2,555,837

 
$
1,248,794

 
$
136,667

 
$
3,941,298

Other operating expenses
 
 
 
 
 
 
1,795,556

Operating income
 
 
 
 
 
 
2,145,742

Other income (expense)
 
 
 
 
 
 
(232,844
)
Provision for income taxes
 
 
 
 
 
 
632,952

Net income
 
 
 
 
 
 
$
1,279,946




19


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 (1)
56,957

 
73,465

 
2,828

 
 
Total paid net membership additions (losses) (1)
998

 
5,070

 
(143
)
 
 
Total free trials at end of period
1,507

 
5,170

 
24

 
 
Revenues
$
1,937,314

 
$
1,973,283

 
$
88,777

 
$
3,999,374

Cost of revenues
1,038,473

 
1,455,554

 
37,101

 
2,531,128

Marketing
210,595

 
299,735

 

 
510,330

Contribution profit
$
688,246

 
$
217,994

 
$
51,676

 
$
957,916

Other operating expenses
 
 
 
 
 
 
477,248

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 (1)
56,957

 
73,465

 
2,828

 
 
Total paid net membership additions (losses) (1)
4,147

 
15,631

 
(502
)
 
 
Total free trials at end of period
1,507

 
5,170

 
24

 
 
Revenues
$
5,650,555

 
$
5,676,513

 
$
280,432

 
$
11,607,500

Cost of revenues
2,944,948

 
4,169,772

 
119,418

 
7,234,138

Marketing
712,612

 
926,502

 

 
1,639,114

Contribution profit
$
1,992,995

 
$
580,239

 
$
161,014

 
$
2,734,248

Other operating expenses
 
 
 
 
 
 
1,344,789

Operating income
 
 
 
 
 
 
1,389,459

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

Net income
 
 
 
 
 
 
$
1,077,308




(1)
A paid membership (also referred to as a paid subscription) is defined as a membership that has the right to receive Netflix service following sign-up and a method of payment being provided, and that is not part of a free trial or other promotional offering by the Company to certain new and rejoining members. A membership is canceled and ceases to be reflected in the above metrics as of the effective cancellation date. Voluntary cancellations generally become effective at the end of the prepaid membership period. Involuntary cancellation of the service, as a result of a failed method of payment, becomes effective immediately. 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.

20


The following table represents the amortization of content assets:
 
Domestic
Streaming
 
International
Streaming
 
Domestic
DVD
 
Consolidated
 
(in thousands)
Three months ended September 30,
 
 
 
 
 
 
 
2019
$
912,793

 
$
1,367,184

 
$
6,654

 
$
2,286,631

2018
800,884

 
1,110,883

 
9,959

 
1,921,726

Nine months ended September 30,
 
 
 
 
 
 
 
2019
2,693,598

 
3,942,980

 
22,819

 
6,659,397

2018
2,283,102

 
3,195,326

 
32,247

 
5,510,675




21




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; content amortization; seasonality; paid memberships as indicator of growth; pricing changes; DVD memberships; dividends; impact of foreign currency and exchange rate fluctuations, including on net income, revenues and average revenues per paying member; deferred revenue; investments in global streaming content, including original content; impact of content on membership growth; liquidity, including cash flows from operations, available funds and access to financing sources; net cash provided by (used in) operating activities and free cash flow; unrecognized tax benefits; deferred tax assets; commencement of operating leases; accessing and obtaining additional capital, including use of the debt market; accounting treatment for changes related to content assets; net income; 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, 2018 filed with the Securities and Exchange Commission (“SEC”) on January 29, 2019 and February 8, 2019, respectively, 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 158 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, over two million members in the U.S. subscribe to our legacy DVD-by-mail service.
We are a pioneer in the internet delivery of TV series and films, 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 series and films 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 series and films directly over the internet. Historically, the first and fourth quarters (October through March) represent our greatest membership growth across our Domestic and International streaming segments. Our membership growth can sometimes be impacted by the release of certain high-profile original content. Within our International streaming segment, 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 and attracts new 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.


22


Results of Operations

The following represents our consolidated performance highlights:
 
As of/ Three Months Ended
 
Change
 
September 30,
2019
 
September 30,
2018
 
Q3'19 vs. Q3'18
 
(in thousands, except revenue per membership and percentages)

Global Streaming Memberships:
 
 
 
 
 
 
 
Paid memberships at end of period
158,334

 
130,422

 
27,912

 
21
 %
Paid net membership additions
6,772

 
6,068

 
704

 
12
 %
Average monthly revenue per paying membership
$
11.13

 
$
10.23

 
$
0.90

 
9
 %
Free trials at end of period
5,590

 
6,677

 
(1,087
)
 
(16
)%
 
 
 
 
 
 
 
 
Financial Results:
 
 
 
 
 
 
 
Revenues
$
5,244,905

 
$
3,999,374

 
$
1,245,531

 
31
 %
Operating income
980,239

 
480,668

 
499,571

 
104
 %
Operating margin
18.7
%
 
12.0
%
 
6.7
%
 
56
 %
Net income
665,244

 
402,835

 
262,409

 
65
 %

Consolidated revenues for the three months ended September 30, 2019 increased 31%, including an increase of 25% and 40% in revenues in the Domestic streaming and International streaming segments, respectively, as compared to the three months ended September 30, 2018. International revenues accounted for 53% of total streaming revenue for the three months ended September 30, 2019 as compared to 50% of total streaming revenue for the three months ended September 30, 2018. 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 61% of total average paid streaming memberships as of September 30, 2019, as compared to 56% of total average paid streaming memberships for the same period in 2018. In addition, the average monthly revenue per paying streaming membership increased by 9% 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 than total memberships.
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 headcount costs to support continued improvements in our streaming service, our international expansion, and our growing content production activities.
We offer three main 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, 2019, pricing on our plans ranged in the U.S. from $8.99 to $15.99 per month and internationally from the U.S. dollar equivalent of approximately $3 to $22 per month. We expect that from time to time the prices of our membership plans in each country may change and we may occasionally test other plan and price variations.
Because we increasingly obtain multi-territory or global rights for streaming content, contribution profit (loss) on a regional basis is becoming a less meaningful metric and as such, we increasingly focus on our global operating margin as the primary measure of profitability. As of the third quarter of 2019, we had three segments. The following represents the key elements to our segment results of operations:
We define contribution profit as revenues less cost of revenues and marketing expenses incurred by the segment. This represents each segment's performance before global corporate costs.
For the Domestic and International streaming segments, amortization of the streaming content assets makes up the 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 (such as payroll and related personnel expenses, costs associated with obtaining rights to music included in our content, overall deals with talent, miscellaneous production related costs and participations and residuals), 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, payroll and related personnel expenses 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.

23


For the Domestic and International streaming segments, marketing expenses consist primarily of advertising expenses and certain payments made to our marketing partners, including CE manufacturers, MVPDs, mobile operators and ISPs. Advertising expenses include promotional activities such as digital and television advertising. Marketing expenses also include payroll and related expenses for personnel that support the Company's marketing activities. Marketing expenses are incurred by our Domestic and International streaming segments in order to build consumer awareness of the streaming offerings, and in particular our original content.


Domestic Streaming Segment
Three months ended September 30, 2019 as compared to the three months ended September 30, 2018