Even at a market capitalization of over $79 billion, Netflix (NFLX -3.92%) can still shock Wall Street. The streaming video giant this week announced second-quarter numbers that were right in line with revenue and profit expectations. However, subscriber growth was way ahead of management's plan.
Executives tried to stay subdued while describing the results in a letter to shareholders. "It was a good quarter," CEO Reed Hastings said in his summary.
Other words sprinkled through the letter hinted at their growing optimism, though. Management talked about Netflix's "amazing content" portfolio and the "incredible" demand for streaming video. As for the power of the internet to boost the industry, Hastings said, "wow."
"Wow" was the response of many investors, too.
Image source: Netflix.
1. The growth slowdown never happened
Netflix has a habit of predicting a growth slowdown that doesn't actually happen. A huge fourth-quarter surprise led the company to a 19 million-member gain in 2016 to keep its streak of accelerating annual gains alive. The same story played out this week.
Three months ago, executives predicted that user growth would slow to an 8.2 million-member pace over the first six months of the year from 8.4 million over the comparable period in 2016. Instead, subscriber gains spiked to over 10 million, with net additions up 21%.
Netflix said it underestimated the popularity of its content catalog, and that mistake led to the surprise bump in users. Management isn't aiming to repeat the scenario next quarter. The company is predicting 4.4 million new members for a solid boost over last year's gain of 3.6 million.
It's an international business now
The international expansion is going better than expected. Surprisingly strong growth this quarter pushed membership in the segment to 56 million, which put the U.S. market in the minority for the first time.
This business is racing toward profitability, too. Netflix forecast a positive profit contribution for the division next quarter (for just the second time in its history) and announced that it now believes the segment will produce a profit for the full year. That success is speeding up the transformation of what's been a major weight on earnings into a long-term profit driver.
International contribution in millions. Q3 2017 is projected. Chart by author. Data source: Netflix.
Cash flow is getting worse
Netflix burned through $600 million of cash in the quarter compared to a $250 million outlay a year ago. The spike came from a surge in original content, which requires more cash to launch than licensed shows and movies. Netflix released 14 new seasons of original series, 9 exclusive movies, 8 documentaries, and 13 comedy specials during the quarter.
Management credits these launches with driving improving operating results. "With our content strategy paying off in strong member, revenue, and profit growth," they explained in the shareholder letter, "we think it's wise to continue to invest."
To that end, the company said that it now expects free cash outflow to be as high as $2.5 billion this year, up from its prior forecast of a $2 billion. Investors can also expect this metric to stay in negative territory for years, and that means Netflix will keep dipping into credit markets and taking on extra debt.
Considering the impressive return it's already producing in terms of sales growth and expanding profit margins, shareholders shouldn't be surprised that management is directing additional funds toward the strategy as it will ideally put it in position to generate significant positive cash flow in a few years.
