An In Depth Look at Netflix's Blowout Earnings

Earlier today, Netflix (NASDAQ: NFLX  ) , a provider of video streaming services, released its earnings report for the company's third fiscal quarter of 2013. According to analyst's expectations, the company was expected to report earnings of $0.49 per share, an increase of 276.9% from the $0.13 per share that the company reported the same quarter a year ago. In addition to this, analysts at Needham & Co. expected that the company should show its customer base increasing to approximately 30 million subscribers domestically, effectively allowing the company to surpass the 28.7 million subscribers of Time Warner's (NYSE: TWX  ) wholly owned subsidiary, HBO.

Immediately preceding the company's earnings release at 1:05 pm Pacific Time, Mr. Market was optimistic that the company would announce earnings at least in line with expectations. This was made evident by Netflix's share price being up more than 6% in the hours leading up to the release.

Earnings Headline News
Despite the company's all-time high share price and expensive valuation, Netflix ended up blowing away analyst's expectations with earnings of $0.52 per share. In addition to beating out expectations in regards to net income, the company also outperformed on revenue as it reached $1.1 billion in sales for the quarter. This was $0.1 billion higher than what analysts had expected and higher than the $905.1 million reported in the same quarter a year ago.

To make matters even sweeter for the company, it blew away analyst's expectation in regards to its subscriber base, which rose to around 40 million. This is, according to the company's earnings release, due to a combination of greater marketing (such as their "All You Can Watch" campaign in the Netherlands and their TV Too initiative that they launched last month), and the launch of a program that allows users to make and customize their own profiles for simpler viewing.

In terms of additions to their customer base, the company saw 1.3 million new customers domestically (for a rise of around 11%) but their greatest growth took place in their international operations, which rose by 18.6% from 7.75 million to 9.19 million. However, before you get excited, you should be aware that the company is expecting its international additions to remain flat as it works through it's "low quality" free trials.

In addition to blowing away analyst's estimates in every respect, Netflix also saw its costs level out. As opposed to eating away all of the company's profits like in the recent past, costs as a percentage of sales have declined considerably. According to the company's earnings release, this is attributable primarily to the company's costs of revenues declining from 73.2% of sales to 71.5% of sales. The result of this decline is an operating margin for the quarter of 5.2% vs. 1.8% for the same quarter a year ago. Likewise, the company's net profit margin also improved, rising to 2.9% from 0.8% a year ago.

Moving Forward
Despite Netflix's earnings surprise (and its after-market rise of nearly 10%), the company does face some headwinds moving forward. Even though it was capable of surpassing Time Warner's HBO subsidiary this quarter, it does still have the threat of competition coming from companies like Hulu, which also operates an online streaming service. As a member of a joint venture between Comcast Corporation (NASDAQ: CMCSA  ) , Twenty-First Century Fox (NASDAQ: FOX  ) and The Walt Disney Company (NYSE: DIS  ) , Hulu has seen rapid growth. As an example, the company announced earlier this year that, from April of 2012 through April of 2013, its paid subscriber base had doubled from 2 million to around 4 million.

This is far smaller than Netflix's subscriber base, but its size and, especially, its growth are impressive to say the least. On top of this, the company's revenue had grown 65.5% from $420 million in 2011 to $695 million in 2012. This could eventually spell trouble for Netflix, which has seen its revenue rise by only 12.6% from $3.2 billion to nearly $3.61 billion over the same time horizon, an indication that perhaps the gap between these two companies is beginning to narrow.

Foolish Takeaway
It's no secret that Netflix is a fast-growing company. It has a significant subscriber base that has become more dominant over the past few years and it poses a real threat to incumbent companies like Time Warner, as well as to new entrants like Hulu (though the reverse is also true!). This is especially true after the company completely destroyed analyst's expectations today and may continue as management implements growth initiatives while trying to keep costs in check. I don't know what the future holds for Netflix, but I can say that the company will have many ups and downs and that today was, for the company's sake, as well as the sake of its shareholders, a major up day.


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