Image source: Netflix.
Ahead of Netflix's (NFLX 3.41%) second-quarter report on Monday, it was clear the pressure was on. Q2 marks the first quarter in which the streaming-video giant would measure its actual results against its worse-than-expected first-quarter guidance for international subscriber growth. Unfortunately, Netflix didn't deliver -- and the stock is trading about 14% lower in after-hours trading because of it. Netflix significantly underperformed its own guidance for both international and local subscriber growth.
Here are two areas where Netflix totally missed the mark.
International subscriber additions
There was no doubt Netflix's net international subscriber additions were going to be a key metric investors would be focusing on when the company reported first-quarter results on Monday. First of all, Netflix's international growth has been in the spotlight lately because the company embarked on a massive global expansion in January, extending its service from 60 countries to an additional 130 countries. Second, Netflix's guidance for second-quarter international net adds was one of the key reasons shares fell after the company's first-quarter report; Netflix had said it expected 2 million new international subscribers internationally -- a sharper-than-anticipated decline from the record 4.5 million international subscribers it added in Q1.
The question going into Netflix's second-quarter report, therefore, was whether management's lower-than-expected guidance baked in conservativism. Now, it appears Netflix's guidance for the quarter was actually much too aggressive. Netflix added just 1.52 million new international subscribers, or nearly 25% less than its guidance or 2 million net adds.
U.S. subscriber additions
Netflix also fell significantly short in its important U.S. market. The company added just 0.16 million new members, meaningfully behind its guidance for 0.5 million new members and even further behind its 0.9 million net U.S. adds in the year-ago quarter.
Netflix's second-quarter net subscriber adds brought its total global subscriber count to over 83 million members -- 47 million in the U.S. and 36 million abroad.
Image source: Netflix.
Management commentary
Explaining its worse-than-expected subscriber growth, management had a few things to say about the miss:
- "Churn ticked up slightly and unexpectedly," management said. The company's gross member additions for the new quarter were on target, so its worse-than-expected member additions was primarily because of this higher-than-expected churn, management explained.
- Management believes press coverage during the quarter of the completion of a two-year long grandfathered price increase was probably a key reason for the higher-than-expected churn:
"We think some members perceived the news as an impending new price increase rather than the completion of two years of grandfathering. ... With our large subscriber base, slight variances in retention versus forecast can result in significant swings in net adds, particularly in a seasonally small net quarter like Q2."
- Increased competition wasn't the problem, according to management:
"Our view, however, is that we are all growing primarily against linear TV hours and that competition did not contribute materially to our miss in Q2. First, increased competition would show up mostly in soft gross additions rather than churn. Second, we experienced a similar uptick in churn in early April in Canada, where there has been no recent increase in SVOD competition but where ungrandfathering is also under way."
- Market saturation also isn't the problem, management says:
"Similarly, we don't believe market saturation is a key factor in the U.S., given that we experienced similar performance over the same period in multiple countries with differing levels of Netflix market penetration."
Overall, management's excuse for its underperformance in net member additions was clear: It's likely simply due to significant press coverage of the completion of its grandfathered price increase.
Meanwhile, management remains optimistic about Netflix's long-term opportunity.
"Disrupting a big market can be bumpy, but the opportunity ahead is as big as ever, and we continue to improve every aspect of our business," management said.
Investors, of course, should take management's optimistic view with a grain of salt. In particular, it would be worth investors' time to check back in on the company when it reports its third-quarter results to see if its forecast for 2.3 million new members -- 2 million internationally and 0.3 million in the U.S. -- will hold true. If Netflix lives up to this guidance, it would importantly mark a return to more accurate guidance and faster growth.
