discussion reply

January 22, 2018

Fellow shareholders,

We had a beautiful Q4, completing a great year as internet TV expands globally. In 2017, we grew

streaming revenue 36% to over $11 billion, added 24 million new memberships (compared to 19 million

in 2016), achieved for the first time a full-year positive international contribution profit, and more than

doubled global operating income. .

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Q4 Results Average paid streaming memberships rose 25% year over year in Q4. Combined with a 9% increase in

ASP, global streaming revenue growth amounted to 35%. Operating income of $245 million (7.5%

margin) vs. $154 million prior year (6.2% margin) was slightly above our $238 million forecast. Operating

margin for FY17 was 7.2%, on target with our goal at the beginning of this year.

EPS was $0.41 vs. $0.15 last year and met our forecast of $0.41. There were several below the line items

that affected net income, including a pre-tax $26 million non-cash unrealized loss from F/X

remeasurement on our Eurobond. Our tax rate was helped by a $66 million foreign tax benefit, which

partially offset a revaluation of our deferred tax assets and the impact from the mandatory deemed

repatriation of accumulated foreign earnings related to the recent US tax reform.

In Q4, we registered global net adds of 8.3 million, the highest quarter in our history and up 18% vs. last

year’s record 7.05 million net adds. This exceeded our 6.3m forecast due primarily to stronger than

expected acquisition fueled by our original content slate and the ongoing global adoption of internet

entertainment. Geographically, the outperformance vs. guidance was broad-based.

In the US, memberships rose by 2.0 million (vs. forecast of 1.25m) bringing total FY17 net adds to 5.3

million. ASP rose 5% year-over-year. Domestic contribution profit increased 5% year-over-year although

contribution margin of 34.4% declined both on a year-over-year and sequential basis due to the

marketing spend we noted in last quarter’s investor letter.

Internationally, we added 6.36 million memberships (compared with guidance of 5.05m), a new record

for quarterly net adds for this segment. Excluding a F/X impact of +$43 million, international revenue

and ASP grew 59% and 12% year over year, respectively. The increase in ASP reflects price adjustments

in a wide variety of our markets over the course of 2017. With contribution profit of $227 million in 2017

(4.5% contribution margin), the international segment delivered its first full year of positive contribution

profit in our history.

We took a $39m non-cash charge in Q4 for unreleased content we’ve decided not to move forward

with. This charge was recognized in content expense in cost of revenues. Despite this unexpected

expense, we slightly exceeded our contribution profit and operating income forecast due to our stronger

than expected member growth and the timing of international content spend.

Forecast The guidance we provide is our internal forecast at the time we report. For Q1, we project global net

adds of 6.35 million (vs. 5.0m in the year ago quarter), with 1.45m in the US and 4.90m internationally.

As we wrote last quarter, our primary profit metric is operating margin and we are targeting a full year

2018 target of 10%, up about 300 basis points year over year, as in the prior year.

We believe our big investments in content are paying off. In 2017, average streaming hours per

membership grew by 9% year-over-year. With greater than expected member growth (resulting in more

revenue), we now plan to spend $7.5-$8.0 billion on content on a P&L basis in 2018.

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Big hits like ​13 Reasons Why​, ​Stranger Things​ and ​Bright ​result from a combination of great content and great marketing. We’re taking marketing spend up a little faster than revenue for this year (from about

$1.3B to approximately $2B) because our testing results indicate this is wise. We want great content,

and we want the budget to make the hits we have really big, to drive our membership growth. We’ll

grow our technology & development investment to roughly $1.3 billion in 2018.

Content Q4 capped an amazing year for Netflix original content with returning seasons of ​The Crown​ and ​Black Mirror​ as well as ​Stranger Things​, which cemented its place as a global phenomenon​.​ In the quarter, we also successfully launched new titles like the limited series ​Godless​, ​Marvel’s The Punisher​ and Mindhunter​ (from director David Fincher), the latter two of which are renewed for a second season. It’s amazing to think that in only 5 years since launching our first original series, Netflix had ​three of the Top 5​ most searched TV shows globally for the second year in a row.

Our largest investment in original films to date, ​Bright, ​a fantasy action movie starring Will Smith, was a major success and drove a notable lift in acquisition. In its first month, ​Bright​ has become one of our most viewed original titles ever. We’re thrilled with this performance and are planning a sequel as well

as additional investment in original films.

We’re finding continued success with international originals and in Q4 we released: season 3 of ​Club de Cuervos ​as well as ​The Day I Met El Chapo,​ both of which are from Mexico; ​Suburra​ from Italy; and an unscripted series from the UK, ​Jack Whitehall: Travels with My Father​. We also debuted ​Dark​, our first German original drama series. High-quality content can travel globally, irrespective of language; for

instance, ​Dark​, in addition to being well-received in its home country, has also been viewed by millions of members in the US and has outsized watching throughout Europe and Latin America. Combined with

attractive economics and a positive impact on our business in local markets, we will expand this

initiative with over 30 international original series this year, including projects from France, Poland,

India, Korea and Japan.

We are increasingly self-producing our original content. As part of this initiative, in Q4 we signed overall

deals with ​Stranger Things​ producer Shawn Levy and ​Orange is the New Black​ and ​GLOW​ creator Jenji Kohan. Our goal is to work directly with the best talent to bring amazing stories to our members all over

the world.

Product and Partnerships We are partnering with a growing number of MVPDs and ISPs across the world to the benefit of our

mutual customers. These partnerships make it easier for consumers to sign up, enjoy and pay for Netflix,

while our service allows our partners to deepen their relationships with these subscribers. Examples of

these types of partnerships that we struck in Q4 include an expanded global partnership with Deutsche

Telekom and with Cox Communications and Verizon Communications in the US. As expected, the FCC

removed the US net neutrality rules. We believe that a strong internet should have enforceable net

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neutrality rules, so we and other internet firms are backing the Internet Association’s challenge to the

FCC’s action.

Competition We have been talking about the transition from linear to streaming for the past 10 years. As this trend

becomes increasingly evident, more companies are entering the market for premium video content. On

the commercial-free tech side, Amazon Studios is likely to bring in a strong new leader given their large

content budgets, and Apple is growing its programming, which we presume will either be bundled with

Apple Music or with iOS.

Facebook and YouTube are expanding and competing in free ad-supported video content. With their

multi-billion global audiences, free ad-supported internet video is a big force in the market for

entertainment time, as well as a great advertising vehicle for Netflix.

Traditional media companies are also expanding into streaming. Disney is in the process of acquiring

most of 21st Century Fox and plans to launch a direct-to-consumer service in 2019 with a beloved brand

and great franchises. The market for entertainment time is vast and can support many successful

services. In addition, entertainment services are often complementary given their unique content

offerings. We believe this is largely why both we and Hulu have been able to succeed and grow.

Free Cash Flow and Capital Structure In Q4, free cash flow amounted to -$524 million, bringing full year 2017 FCF to -$2.0 billion, at the lower

end of the -$2.0 to -$2.5 billion range we had previously indicated. This was largely due to the timing of

content payments, which will now occur in 2018.

Our operating margins and income are rising, and our only material cash-ahead-of-P&L-expense is

content. When we develop a title like ​Bright​, the cash spend is 1-3 years before the viewing, associated membership growth, and P&L expense. Thus, the faster we grow our originals budget (particularly for

self-produced content), the more cash we consume. We are increasing operating margins and expect

that in the future, a combination of rising operating profits and slowing growth in original content spend

will turn our business FCF positive.

In the near term, however, membership, revenue and original content spend are booming. We’re

growing faster than we expected, which allows us to invest more in original content than we had

planned, so our FCF will be around negative $3B-$4B in 2018. Given our track record of content

investments helping to increase growth, we are excited about the growth in future years from the

increased investments we are making in original content this year.

We anticipate continuing to raise capital in the high yield market. The new limitation on deductibility of

interest costs is not expected to affect us. We are striving to make the right choices and investments to

grow the value of the firm, and that is what also ultimately secures our debt. High yield has rarely seen

an equity cushion so thick.

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Board of Directors We are pleased to add ​Rodolphe Belmer​ to our board of directors. Rodolphe is the former CEO of Canal+ Group in France, and is currently CEO of Eutelsat, a global satellite business. A large and growing

percentage of our members are European, and we are fortunate to have a leader like Rodolphe join our

board.

Summary Our goal is to entertain people. We are thrilled to be able to do that at great scale.

For quick reference, our eight most recent investor letters are: ​October 2017​, ​July 2017​, ​April 2017​, January 2017​, ​October 2016​, ​July 2016​, ​April 2016​, ​January, 2016​.

January 22, 2018 Earnings Interview, 3pm PST Our video interview with Todd Juenger of Bernstein will be on ​youtube/netflixir​ at 3pm PST today. Questions that investors would like Todd to ask should be sent to ​[email protected]​. ​Reed Hastings, CEO, David Wells, CFO, Ted Sarandos, Chief Content Officer, Greg Peters, Chief Product Officer

and Spencer Wang, VP of IR/Corporate Development will be answering Todd’s questions.

IR Contact:

Spencer Wang

Vice President, Finance/IR & Corporate Development

408 809-5360

PR Contact:

Jonathan Friedland

Chief Communications Officer

310 734-2958

Use of Non-GAAP Measures 

This shareholder letter and its attachments include reference to the non-GAAP financial measure of free

cash flow and EBITDA. Management believes that free cash flow and EBITDA are important liquidity

metrics because they measure, during a given period, the amount of cash generated that is available to

repay debt obligations, make investments and for certain other activities or the amount of cash used in

operations, including investments in global streaming content. However, these non-GAAP measures

should be considered in addition to, not as a substitute for or superior to, net income, operating income,

diluted earnings per share and net cash provided by operating activities, or other financial measures

prepared in accordance with GAAP. Reconciliation to the GAAP equivalent of these non-GAAP measures

are contained in tabular form on the attached unaudited financial statements.

Forward-Looking Statements 

This shareholder letter contains certain forward-looking statements within the meaning of the federal

securities laws, including statements regarding our investments in marketing, technology and

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development, and content, including original content; content and product partnerships; impact of U.S.

net neutrality rules; growth of internet video and competitive landscape; future capital raises;

expectations of positive free cash flow, impact of the new limitation on the deductibility of interest;

domestic and international net, total and paid subscribers; revenue; contribution profit (loss) and

contribution margin for both domestic and international operations, as well as consolidated operating

income, operating margin; net income, earnings per share and free cash flow. The forward-looking

statements in this letter are subject to risks and uncertainties that could cause actual results and events

to differ, including, without limitation: our ability to attract new members and retain existing members;

our ability to compete effectively; maintenance and expansion of device platforms for streaming;

fluctuations in consumer usage of our service; service disruptions; production risks; actions of Internet

Service Providers; and, competition, including consumer adoption of different modes of viewing

in-home filmed entertainment. A detailed discussion of these and other risks and uncertainties that

could cause actual results and events to differ materially from such forward-looking statements is

included in our filings with the Securities and Exchange Commission, including our Annual Report on

Form 10-K filed with the Securities and Exchange Commission on January 27, 2017. The Company

provides internal forecast numbers. Investors should anticipate that actual performance will vary from

these forecast numbers based on risks and uncertainties discussed above and in our Annual Report on

Form 10-K. We undertake no obligation to update forward-looking statements to reflect events or

circumstances occurring after the date of this shareholder letter.

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Netflix, Inc.

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

Three Months Ended Twelve Months Ended

December 31, 2017

September 30, 2017

December 31, 2016

December 31, 2017

December 31, 2016

Revenues $ 3,285,755 $ 2,984,859 $ 2,477,541 $ 11,692,713 $ 8,830,669

Cost of revenues 2,107,354 1,992,980 1,654,419 7,659,666 6,029,901

Marketing 419,939 312,490 284,996 1,278,022 991,078

Technology and development 273,351 255,236 225,191 1,052,778 852,098

General and administrative 239,808 215,526 159,001 863,568 577,799

Operating income 245,303 208,627 153,934 838,679 379,793

Other income (expense):

Interest expense (75,292) (60,688) (43,586) (238,204) (150,114)

Interest and other income (expense) (38,681) (31,702) (20,079) (115,154) 30,828

Income before income taxes 131,330 116,237 90,269 485,321 260,507

Provision for (benefit from) income taxes (54,187) (13,353) 23,521 (73,608) 73,829

Net income $ 185,517 $ 129,590 $ 66,748 $ 558,929 $ 186,678

Earnings per share:

Basic $ 0.43 $ 0.30 $ 0.16 $ 1.29 $ 0.44

Diluted $ 0.41 $ 0.29 $ 0.15 $ 1.25 $ 0.43

Weighted-average common shares outstanding:

Basic 433,108 432,404 429,738 431,885 428,822

Diluted 448,142 447,362 440,063 446,814 438,652

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Netflix, Inc.

Consolidated Balance Sheets (unaudited) (in thousands, except share and par value data)

As of

December 31, 2017

December 31, 2016

Assets

Current assets:

Cash and cash equivalents $ 2,822,795 $ 1,467,576

Short-term investments — 266,206

Current content assets, net 4,310,934 3,726,307

Other current assets 536,245 260,202

Total current assets 7,669,974 5,720,291

Non-current content assets, net 10,371,055 7,274,501

Property and equipment, net 319,404 250,395

Other non-current assets 652,309 341,423

Total assets $ 19,012,742 $ 13,586,610

Liabilities and Stockholders' Equity

Current liabilities:

Current content liabilities $ 4,173,041 $ 3,632,711

Accounts payable 359,555 312,842

Accrued expenses 315,094 197,632

Deferred revenue 618,622 443,472

Total current liabilities 5,466,312 4,586,657

Non-current content liabilities 3,329,796 2,894,654

Long-term debt 6,499,432 3,364,311

Other non-current liabilities 135,246 61,188

Total liabilities 15,430,786 10,906,810

Stockholders' equity:

Common stock 1,871,396 1,599,762

Accumulated other comprehensive loss (20,557) (48,565)

Retained earnings 1,731,117 1,128,603

Total stockholders' equity 3,581,956 2,679,800

Total liabilities and stockholders' equity $ 19,012,742 $ 13,586,610

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Netflix, Inc.

Consolidated Statements of Cash Flows (unaudited) (in thousands)

Three Months Ended Twelve Months Ended December 31,

2017 September 30,

2017 December 31,

2016 December 31,

2017 December 31,

2016

Cash flows from operating activities:

Net income $ 185,517 $ 129,590 $ 66,748 $ 558,929 $ 186,678

Adjustments to reconcile net income to net cash used in operating activities:

Additions to streaming content assets (2,477,659) (2,315,017) (2,102,841) (9,805,763) (8,653,286)

Change in streaming content liabilities 53,446 (34,587) 98,525 900,006 1,772,650

Amortization of streaming content assets 1,713,863 1,627,477 1,330,508 6,197,817 4,788,498

Amortization of DVD content assets 12,289 13,259 19,206 60,657 78,952

Depreciation and amortization of property, equipment and intangibles 19,073 19,238 14,189 71,911 57,528

Stock-based compensation expense 48,530 44,763 43,646 182,209 173,675

Excess tax benefits from stock-based compensation — — (27,720) — (65,121)

Other non-cash items 14,126 9,896 9,430 57,207 40,909

Foreign currency remeasurement loss on long-term debt 25,740 50,830 — 140,790 —

Deferred taxes (104,132) (57,090) (26,706) (208,688) (46,847)

Changes in operating assets and liabilities:

Other current assets (87,090) (41,399) (1,679) (234,090) 46,970

Accounts payable 63,969 34,029 15,540 74,559 32,247

Accrued expenses (5,169) 74,006 (3,582) 114,337 68,706

Deferred revenue 83,197 32,947 16,266 177,974 96,751

Other non-current assets and liabilities (33,657) (7,549) (8,690) (73,803) (52,294)

Net cash used in operating activities (487,957) (419,607) (557,160) (1,785,948) (1,473,984)

Cash flows from investing activities:

Acquisitions of DVD content assets (10,507) (10,217) (18,797) (53,720) (77,177)

Purchases of property and equipment (21,585) (33,963) (61,048) (173,302) (107,653)

Change in other assets (3,749) (1,107) (1,617) (6,689) (941)

Purchases of short-term investments — (2,799) (5,603) (74,819) (187,193)

Proceeds from sale of short-term investments — 250,278 83,797 320,154 282,484

Proceeds from maturities of short-term investments — — 27,690 22,705 140,245

Net cash provided by (used in) investing activities (35,841) 202,192 24,422 34,329 49,765

Cash flows from financing activities:

Proceeds from issuance of debt 1,600,000 — 1,000,000 3,020,510 1,000,000

Issuance costs (16,828) (312) (10,700) (32,153) (10,700)

Proceeds from issuance of common stock 14,705 34,669 25,392 88,378 36,979

Excess tax benefits from stock-based compensation — — 27,720 — 65,121

Other financing activities 66 65 60 255 230

Net cash provided by financing activities 1,597,943 34,422 1,042,472 3,076,990 1,091,630

Effect of exchange rate changes on cash and cash equivalents 2,181 10,685 (11,316) 29,848 (9,165)

Net increase (decrease) in cash and cash equivalents 1,076,326 (172,308) 498,418 1,355,219 (341,754)

Cash and cash equivalents, beginning of period 1,746,469 1,918,777 969,158 1,467,576 1,809,330

Cash and cash equivalents, end of period $ 2,822,795 $ 1,746,469 $ 1,467,576 $ 2,822,795 $ 1,467,576

Three Months Ended Twelve Months Ended December 31,

2017 September 30,

2017 December 31,

2016 December 31,

2017 December 31,

2016

Non-GAAP free cash flow reconciliation: Net cash used in operating activities $ (487,957) $ (419,607) $ (557,160) $ (1,785,948) $ (1,473,984)

Acquisitions of DVD content assets (10,507) (10,217) (18,797) (53,720) (77,177)

Purchases of property and equipment (21,585) (33,963) (61,048) (173,302) (107,653)

Change in other assets (3,749) (1,107) (1,617) (6,689) (941)

Non-GAAP free cash flow $ (523,798) $ (464,894) $ (638,622) $ (2,019,659) $ (1,659,755)

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Netflix, Inc.

Segment Information (unaudited) (in thousands)

As of / Three Months Ended As of/ Twelve Months Ended

December 31, 2017

September 30, 2017

December 31, 2016

December 31, 2017

December 31, 2016

Domestic Streaming

Total memberships at end of period 54,750 52,772 49,431 54,750 49,431

Paid memberships at end of period 52,810 51,345 47,905 52,810 47,905

Revenues $ 1,630,274 $ 1,547,210 $ 1,403,462 $ 6,153,025 $ 5,077,307

Cost of revenues 873,372 864,408 761,479 3,319,230 2,855,789

Marketing 195,784 128,901 105,589 553,331 382,832

Contribution profit 561,118 553,901 536,394 2,280,464 1,838,686

International Streaming

Total memberships at end of period 62,832 56,476 44,365 62,832 44,365

Paid memberships at end of period 57,834 52,678 41,185 57,834 41,185

Revenues $ 1,550,329 $ 1,327,435 $ 947,666 $ 5,089,191 $ 3,211,095

Cost of revenues 1,191,497 1,081,485 834,794 4,137,911 2,911,370

Marketing 224,155 183,589 179,407 724,691 608,246

Contribution profit (loss) 134,677 62,361 (66,535) 226,589 (308,521)

Domestic DVD

Total memberships at end of period 3,383 3,569 4,114 3,383 4,114

Paid memberships at end of period 3,330 3,520 4,029 3,330 4,029

Revenues $ 105,152 $ 110,214 $ 126,413 $ 450,497 $ 542,267

Cost of revenues 42,485 47,087 58,146 202,525 262,742

Contribution profit 62,667 63,127 68,267 247,972 279,525

Consolidated

Revenues $ 3,285,755 $ 2,984,859 $ 2,477,541 $ 11,692,713 $ 8,830,669

Cost of revenues 2,107,354 1,992,980 1,654,419 7,659,666 6,029,901

Marketing 419,939 312,490 284,996 1,278,022 991,078

Contribution profit 758,462 679,389 538,126 2,755,025 1,809,690

Other operating expenses 513,159 470,762 384,192 1,916,346 1,429,897

Operating income 245,303 208,627 153,934 838,679 379,793

Other expense (113,973) (92,390) (63,665) (353,358) (119,286)

Provision for (benefit from) income taxes (54,187) (13,353) 23,521 (73,608) 73,829

Net income $ 185,517 $ 129,590 $ 66,748 $ 558,929 $ 186,678

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Netflix, Inc.

Non-GAAP Information (unaudited) (in thousands)

December 31, 2016

March 31, 2017

June 30, 2017

September 30, 2017

December 31, 2017

Non-GAAP Adjusted EBITDA reconciliation:

GAAP net income $ 66,748 $ 178,222 $ 65,600 $ 129,590 $ 185,517

Add:

Interest and other (income) expense 63,665 33,150 113,845 92,390 113,973

Provision for (benefit from) income taxes 23,521 45,570 (51,638) (13,353) (54,187)

Depreciation and amortization of property, equipment and intangibles 14,189 15,049 18,551 19,238 19,073

Stock-based compensation expense 43,646 44,888 44,028 44,763 48,530

Adjusted EBITDA $ 211,769 $ 316,879 $ 190,386 $ 272,628 $ 312,906