Streaming-video veteran Netflix (NASDAQ:NFLX) reported third-quarter results right after the closing bell on Tuesday. In a sharp reversal, Netflix exceeded its own guidance targets across the board.

Netflix's third-quarter results: The raw numbers

Metric

Q3 2018

Q3 2017

Year-Over-Year Change

Revenue

$4.00 billion

$2.99 billion

34%

Net income

$403 million

$130 million

210%

GAAP earnings per share (diluted)

$0.89

$0.29

207%

Free cash flow

($859 million)

($465 million)

N/A

Total streaming subscriber additions

6.96 million

5.30 million

31%

Data source: Netflix.

A wide-eyed young couple shoveling popcorn into their faces in front of the TV.

Image source: Getty Images.

What happened with Netflix this quarter?

  • Netflix provided guidance targets on 27 different business metrics for this quarter. The company exceeded these estimates in all 27 cases, from subscriber growth and revenue to domestic operating profit and international profit margin.
  • Bottom-line earnings had been projected to land near $0.65 per share but came in at $0.89. This figure included a $0.10-per-share benefit from unexpected tax and currency effects. The rest of the surprise rested on rapid subscriber growth.
  • Netflix now serves 58.5 million domestic subscribers and 78.6 million customers overseas, for a grand total of 137.1 million. That's up from 52.8 million, 56.5 million, and 109.3 million, respectively, in the year-ago period.
  • The average Netflix subscriber paid an even $10.00 per month for the service in the third quarter, an 8% year-over-year boost.

What management had to say

Subscriber additions will remain essential to the Netflix story for many years to come, but the company is changing its reporting of these figures. Arguing that the number of paid subscribers offers a more predictable view of the business than the total figure -- which also includes users still enjoying a free trial promotion -- Netflix will shift its reporting focus toward that metric.

Two charts showing year-to-date subscriber growth for Netflix over several years. The graph for paid subscribers, on the right, presents smoother trend lines than the total subscriber chart on the right.

Image source: Netflix.

"Because growth in paid memberships is more steady, our forecast for paid net adds has been historically more accurate than our total net adds forecast," the management team wrote in the letter to shareholders. "For example in Q2 '18, our paid net adds forecast was off by 11% compared to a 17% variance for total net adds forecast. ... As a result, starting with our earnings report in January 2019, we'll only guide to paid memberships; a year after that, in 2020, we'll cease reporting on end-of-quarter free trial count."

At that point, the charts and reported numbers will focus solely on the paid subscriber figures. It's not a huge difference, but the paid-up trends are drawn with a noticeably steadier hand.

Looking ahead

  • In the fourth quarter, Netflix expects revenue to grow 28% year over year and land near $4.2 billion.
  • Operating margin will be compressed to roughly 5%, down from 12% in the third quarter and 7.5% in last year's fourth quarter, because of a larger volume of original content productions.
  • On the bottom line, that translates to earnings in the neighborhood of $0.23 per share. Hitting that target would work out to a 44% drop from the year-ago period's earnings of $0.41 per share.
  • The company doesn't offer firm guidance for free cash flows, but management did update its cash flow aims in broad strokes. Netflix previously expected to burn between $3 billion and $4 billion of free cash in 2018 but now says the final tally should land closer to the $3 billion end of that range. Given that free cash flows have added up to negative-$1.7 billion so far this year, that leaves at least $1.3 billion of red ink on that line for the fourth quarter. For comparative purposes, Netflix presented $524 million in negative free cash flow for the fourth quarter of 2017.

Anders Bylund owns shares of Netflix. The Motley Fool owns shares of and recommends Netflix. The Motley Fool has a disclosure policy.