Last Monday, Netflix (NFLX 1.74%) reported strong second-quarter results. The streaming video leader added 2 million more subscribers than management had projected in Q2. Revenue and earnings were right in line with management's forecast.
However, despite its rapid growth and rising profitability, Netflix is burning more cash than ever. During the company's standard post-earnings interview, Netflix executives spent a lot of time talking about their investment priorities and long-term growth philosophy. Here are five central points they discussed.
Netflix reported stellar subscriber growth numbers last week. Image source: Netflix.
Netflix will reinvest all of its profits
So we had a 9% margin in the first quarter, and we had a lot of content come on in this quarter, so we guided down to 5%. So on the first six months, we're running right on our [margin] target of 7%, and our guide is right on 7%. So you can take from that, that we're going to reinvest and plow back in the business sort of any over-forecasted growth that we have on the top line.
-- Netflix CFO David Wells
After years of running around breakeven, Netflix is finally solidly profitable -- in accounting terms. However, producing original content requires spending a lot of money up front that may not pay off for years. As a result, the company expects to burn up to $2.5 billion of cash this year.
Furthermore, periods of strong subscriber growth encourage Netflix to invest even more heavily, leading to worse short-term cash flow performance. This is something Netflix investors just have to accept. The rewards for the heavy investments of today will come years down the road.
Producing content in-house is paying off
Look, when we produce an amazing show like Stranger Things, that's a lot of capital up front, and then you get a payout over many years. And seeing the positive returns on that for the business as a whole is what makes us comfortable that we should continue to invest and integrate to basically self-develop many more properties as [Chief Content Officer] Ted [Sarandos] can find the appropriate ones.
-- Netflix CEO Reed Hastings
For its early original series like House of Cards and Orange Is the New Black, Netflix licensed the shows from various TV studios. More recently, it has started to produce a growing proportion of its original content through its own in-house studio. Self-producing content requires even more upfront spending than licensing first-run shows. However, it cuts out the middleman, potentially reducing costs, and gives Netflix more control over the content.
Having the best content is still Netflix's No. 1 priority. The company won't pass up top-notch shows just because they're controlled by another studio. But when possible, Netflix would prefer to produce shows in-house -- even if it drags down free cash flow in the short run.
Content bets won't always pay off
[T]he more shows we add, the more likely in absolute numbers that you'll see cancellations, of course. But that's only novel on Netflix.
-- Netflix Chief Content Officer Ted Sarandos
Netflix has canceled a few of its original series, but most have been renewed every year for a new season. By contrast, cancellations are extremely typical in the TV business, where roughly a third of shows get cut after a single season.
The low cancellation rate speaks to Netflix's success at finding great shows -- it was nominated for 91 Emmy Awards this year -- and using viewing data to understand what its members want to watch. That said, the Netflix content team doesn't want to stick to "safe" choices. It's important to take big risks sometimes, even if that means canceling shows more frequently.
Netflix hasn't had to cancel many of its original shows so far. Image source: Netflix.
In other words, failure is just a part of doing business in the entertainment industry. As Netflix expands its original content slate, investors should expect some shows to be complete busts.
Asia is the toughest nut to crack
Yes, as Reed mentioned, matching the programming into local taste is really the key. ... And as we look to Asia, we have to get better and better at matching those tastes. And those tastes are not as easily aligned with Western tastes. So we'll invest more time and energy in Asia, putting some people on the ground in Asia that we haven't historically.
-- Ted Sarandos
Over the past five years or so, Netflix has caught on in a big way in places such as Canada, Latin America, Europe, and Australia. Growing in Asia has been tougher, though. Netflix has found that consumer tastes are a lot different there.
To improve its performance in Asia, Netflix plans to deploy more staff in its top markets there, rather than managing most content acquisitions centrally. Winning in Asia will be tough, but with the right focus on content localization, it's an achievable goal.
Mobile is one of the keys to Netflix's growth
I mean, we've had great success on mobile in the developed markets like the U.S. and Europe and then throughout Latin America, now in Asia. And all of the Netflix service works extremely well on mobile. We're continuing to get better and better at encoding efficiently our films and TV series so that it takes less and less network bandwidth.
-- Reed Hastings
Offering a great mobile experience is critical to Netflix's success in developing countries, like much of Latin America and Asia. Wired broadband is less common in these countries, so a cell-phone data connection may be the only way a potential customer can use Netflix.
Netflix has positioned itself to thrive in a mobile-first environment by investing in its mobile interface. The company also continues to work on encoding technology, so that streaming uses less bandwidth. These efforts raise costs in the short run, but they are critical in paving the way for Netflix's long-term growth.
