What a difference a day and an earnings report make. At the time of writing, shares in video-delivery giant Netflix
First, the good news
Here are the first-quarter highlights:
- Gross revenue grew 21% year over year.
- The company added 1.7 million U.S. subscribers.
- The company launched new streaming services in the U.K. and Ireland.
Netflix now has more than 26 million global-streaming customers, an impressive number that clearly backs up the company's own claim that it's the "world's leading Internet TV network." Netflix also hit its earnings estimates. This is usually the deciding factor in whether the stock pops or dives, but this quarter Wall Street and investors were focused on something else.
And now for something completely different
- While gross revenue is up, gross profit is down, for a YOY change in gross margin from 39% to 28%.
- Net income has gone from $60,233 million to -$4,584 million YOY.
- Earnings per share have likewise plummeted, from $1.11 this quarter last year to -$0.08 this year.
Gross margin is an indicator or brand strength, pricing power, and production efficiencies. An 11% drop means something significant has changed in the top lines of the income statement, and unless the company can make up the difference farther down, that 11% comes directly off the bottom line. Whatever else contributed to the net-income nosedive, the change in gross margin certainly contributed.
Gross margin aside, this quarter the market and Wall Street focused on the rate at which the subscriber base is growing. Yes, Netflix added 1.7 million subscribers this quarter, a hefty number, but the company is projecting gross total subscriber additions of around 7 million for 2012. And for the second quarter of the year, which has just begun, the company is projecting that just an additional 600,000 subscribers will come on board.
Through the looking glass
I'm sure you see where the math is going here. If all goes as planned, Netflix will have 2.3 million new subscribers at the year's halfway point, so it will need to add 4.7 million subscribers in the last half of the year to make its goal. That's 2.35 million per quarter -- well above the current rate.
The company is basing this subscriber growth model on 2010, when the company also added 7 million new subscribers. On the investor conference call, CEO Reed Hastings said, "We feel very good about the year," but all he seems to be able to offer in defense of the slow start and projected weak second quarter is that this year there would be more "quarterly seasonality ... because the company was starting with a larger number of subscribers."
He finally added: "Our gross additions are consistent with historic patterns." His rationale is, frankly, weak, and that's not just your columnist's opinion. The market obviously didn't like what it saw, either.
Competitors at the gates
Competition for Netflix, as we all know, is growing and is only going to get more fierce. Amazon.com
And, of course, last year Netflix was its own worst enemy, with its botched attempt at rebranding its DVD-by-mail service and the abrupt 60% price increase. The brand took a big hit on both actions. Hastings came off as squirrely, arrogant, and out of touch on the rebranding effort in particular, and the company lost customers and credibility overall.
Foolish bottom line and a top stock pick
Of course, you can't really blame Hastings for going easy on the details regarding subscriber growth. It's all he really has to go with at the moment, and he needs to go with something. The company is running in the red, and Hastings is predicting Netflix's return to profitability this year. That can only happen with more subscribers -- a lot of them. The stock price took a big hit last year with the company's ill-conceived actions. This one is much more of a mild reaction, but investors should see it as a warning shot.
This is going to be an axial year for Netflix. If subscriber growth doesn't come through as promised, expect further investor revolt. While you're waiting to see what happens, pass the time by checking out the stock The Motley Fool is calling its top pick for 2012. Learn all about it in this special free report: "The Motley Fool's Top Stock for 2012." Get it while it's still available and the stock is still hot.