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Netflix, Inc. Misjudged Subscriber Additions in the Second Quarter

By Anders Bylund - Updated Jul 16, 2018 at 6:17PM

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The streaming video veteran's projections are rarely exactly on target. This time, they turned out to be a bit too optimistic.

Streaming video giant Netflix (NFLX -0.60%) reported second-quarter results after the closing bell on Monday. The company fell short of some of its key guidance targets, exceeded other estimates, and highlighted the progress of some high-profile competitors. Investors balked at the mixed report, sending Netflix share prices more than 14% lower in the after-hours trading session.

Netflix's second-quarter results: The raw numbers

Metric

Q2 2018

Q2 2017

Year-Over-Year Change

Total domestic total memberships

57.4 million

51.9 million

11%

Total international memberships

72.8 million

52.0 million

40%

Revenue

$3.91 billion

$2.79 billion

40%

Net income

$384 million

$66 million

482%

GAAP earnings per share (diluted)

$0.85

$0.15

467%

Data source: Netflix.

What happened with Netflix this quarter?

Management expected to land 1.2 million net new U.S. subscribers in the second quarter and 5.0 million new members overseas. The actual additions came in at 0.67 million and 4.47 million, respectively. To explain the discrepancy, management reminded investors that its guidance targets represent the most accurate internal forecast available at each reporting date, and that these projections sometimes go awry. Over the previous four reports, Netflix exceeded its global subscriber additions targets by 5.9 million. This time, the final tally came up a bit short instead.

Global streaming revenues rose 43% over the year-ago period, driven by 26% more subscribers and a 14% higher average selling price per member. Netflix is both raising subscription prices on a market-by-market basis and encouraging users to spring for higher-end plans with better support for 4K video and more concurrent streams per account.

Currency exchange trends made a small impact on Netflix's top-line revenue. An unexpectedly strong U.S. dollar resulted in softer international revenues and lower operating margins, but it also reduced the current value of the company's euro-denominated long-term financing. All told, the present currency exchange trends point toward full-year operating margins near the bottom end of management's earlier target range of 10% to 11%.

A young couple cuddling on the couch with a bucket of popcorn. The woman peeks at the screen between her fingers.

Image source: Getty Images.

What management had to say

In a prepared statement, Netflix's management presented Alphabet subsidiary YouTube as a head-to-head rival on a global basis. Walt Disney and HBO were held up as prominent content studios with ambitions to run their own online delivery platforms on a Netflix-like scale. Amazon.com and Apple are starting from the platform side and hoping to drum up content production operations to rival Netflix's Emmy-winning studios.

That might sound like a management team trying to remind investors that it's a tough market, but the suggested takeaway was actually quite the opposite:

Each of these firms has unique content and is striving to find the best creators from around the world to entertain its viewers. There has never been a better time to be a creator or consumer of content.

In other words, Netflix would argue that the streaming video market is still finding its sea legs, and that broader and deeper competition only points to a larger and more successful final market.

Looking ahead

In the third quarter, Netflix is aiming for 5 million net new subscribers worldwide. That total should be divided into 650,000 new U.S. accounts and 4.35 million international additions. Total streaming subscribers should land near 135.1 million, 24% above the same period of 2017. At the same time, total revenues are seen rising 34% higher, which points to another round of year-over-year average service pricing increases.

The company still expects free cash flows to land between $3 billion and $4 billion below breakeven for the full year, including a $287 million cash burn in the first quarter and $559 million in this report. The cash spending pattern is naturally weighted toward the back half of the year, based on Netflix's production schedule and the intended premiere dates for the resulting shows and movies.

Management is still open to financing the production slate via additional debt, even though interest rates have been increasing in recent months, and the tax benefits of interest payments are shrinking. The after-tax cost of debt remains lower than management's best estimate of the cost of selling more shares.

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