Netflix (NASDAQ:NFLX) just closed the books on an incredibly successful 2018. Not only did subscriber growth accelerate, but Netflix's operating margin crossed into double-digit territory: up from 7% in the prior year and 4% in 2016.
CEO Reed Hastings and his team issued a shareholder letter in conjunction with the company's recent earnings report to add context to those top- and bottom-line numbers. And this quarter's note has some juicy details for investors -- including specifics on viewing data and competition -- that prior letters haven't contained. Let's take a look at the highlights.
1. "We added a record 8.8 [million] paid memberships ... higher than our beginning-of-quarter expectation for 7.6 [million] paid net adds and up 33% year over year."
Netflix trounced its fourth-quarter membership forecast by over 1 million users, which essentially negated the big miss it posted in the second quarter. Those short-term predictions are interesting to follow, but the bigger picture reflects a business with a massive runway for growth. For the full year, membership gains accelerated to 29 million from 22 million in 2017. It was the streaming giant's fifth straight year of accelerating global membership growth.
2. "We grew annual revenue 35% to $16 billion in 2018, and nearly doubled operating profits to $1.6 billion."
Strong subscriber growth paired with favorable financial trends like higher monthly prices caused revenue to grow faster than expenses last year, allowing Netflix to deliver much stronger earnings. Operating profit hit $1.6 billion, compared to $839 million in 2017 and $380 million in 2016.
Netflix's plan is to use recent price hikes to keep profits rising at a faster pace than revenue. The company is targeting an operating margin of around 13% in 2019, which would continue its recent pace of expanding its operating margin by about 3 percentage points per year.
3. "In its first 4 weeks on Netflix, we estimate that Bird Box ... will be enjoyed by over 80 million member households, and we are seeing high repeat viewing."
Profitability fell slightly for the fourth quarter due to a spike in original movie releases, which carry higher initial expenses when they are launched. As expected, executives provided some detail around why these film investments make sense for the business even though members aren't paying anything close to the $10 per viewer that a movie theater would charge. Releases like Bird Box and Roma lifted user engagement and attracted viewership that confirms the platform's power to launch global entertainment hits on par with theatrical launches.
4. "In the [U.S.], we earn around 10% of television screen time ..."
Netflix estimates that its programming accounts for 10% of all TV time in the domestic market. That translates to 100 million hours of Netflix content streaming into U.S. homes on a typical day.
Executives say that Netflix operates in a "highly-fragmented market" where it competes not just with other streaming services like Hulu, but also with video games like Fortnite. They believe the company's success rests on its ability to raise the bar on content quality and the viewing experience, rather than on any strategic moves from new or existing competitors.
5. "This [free cash flow] improvement will be driven by growing operating margin, which will allow us to fund more of our investment needs internally."
Investors should be happy to hear that Netflix is predicting that its cash outflows will peak either in 2018 or 2019. (Cash burn will be roughly $3 billion in each period.) From there, executives say, rising membership prices, coupled with what they expect to be robust subscriber gains, will allow cash flow to start marching back toward positive territory.
Netflix will then be in a better position, the argument goes, to self-fund its original content spending rather than relying on debt, which surpassed $10 billion in 2018 -- up from $6.5 billion at the end of 2017 and $3.4 billion at the end of 2016.