Netflix, Inc. Earnings: Material Profits Begin

On Monday afternoon, Netflix (NFLX 0.50%) reported that it began the year with another strong quarter.

Subscriber growth did come in slightly below Netflix's forecast during Q1, unlike Q4, when it sailed far above management's expectations. However, the company's profitability soared. Most importantly, management continues to see a long runway ahead for revenue and earnings growth.

Growth moderates but profit soars

During the first quarter, Netflix fell shy of its subscriber growth guidance by about 5% in both the domestic and international markets. Nevertheless, Netflix hit its revenue forecast, as average revenue per user continued to rise. Meanwhile, lower-than-expected spending allowed Netflix to comfortably beat its earnings guidance.

Data source: Netflix Q4 2016 and Q1 2017 subscriber letters.

For more than two years, Netflix has said it would produce "material global profits" beginning in 2017. In Q1, it gave investors a peek at what this might look like, posting record earnings per share of $0.40, up from just $0.06 a year earlier.

One major highlight of the quarter was that Netflix's international operations posted their first-ever profit. Of course, some countries, such as Canada, have been profitable for years for Netflix. Yet up until now, those profits had been more than offset by losses in newer markets.

Netflix plans to continue investing heavily to drive growth in its international markets, so profitability will remain inconsistent from quarter to quarter. That said, the days of racking up big international contribution losses have clearly ended.

Don't fear the volatility

Netflix added 4.95 million streaming subscribers last quarter, compared with 6.74 million net adds in the first quarter of 2016. However, this doesn't necessarily mark the beginning of a big slowdown in growth.

Instead, the year-over-year decrease can be attributed to two factors. The first is the timing of original-content releases. Most notably, the fifth season of House of Cards will be released on May 30, whereas the first four seasons came out in February or March.

The timing of new original content releases can impact Netflix's quarterly results. Image source: Netflix.

The second factor affecting Netflix's Q1 subscriber growth was a tough comparison in the international market. Netflix expanded to 130 new markets in early 2016, driving a brief surge in subscriber growth there.

Netflix CEO Reed Hastings has been urging investors to take the long view with respect to this sort of volatility. The timing of various revenue-driving events and costs will vary from year to year, but Netflix is clearly moving in the right direction no matter which business metric investors look at.

The growth plan is still on track

For the second quarter, Netflix expects to add nearly twice as many subscribers as it did in the year-earlier period, helped by a strong slate of new original content. This guidance implies that subscriber growth for the first half of 2017 will be roughly in line with what Netflix achieved in the first half of last year.

On the flip side, Netflix expects to post a 4.4% operating margin this quarter: far below its 9.7% Q1 operating margin, because of higher costs associated with its original content launches. Still, that would be well ahead of the 3.3% operating margin Netflix posted in Q2 2016 -- and Netflix is still on pace to reach its 7% full-year operating margin target.

Some investors may be concerned about Netflix's muted Q1 subscriber growth. But there's really no reason to worry. Netflix continues to expand its subscriber base at a steady pace year after year. Moreover, the company's strong revenue growth is finally starting to filter through to the bottom line, launching what could be a long-term trend of margin expansion.