Simply put, Netflix (NASDAQ:NFLX) knocked it out of the park last quarter. The addition of nearly 16 million new subscribers more than doubled the seven million it expected to add just three months ago, and operating income similarly doubled on a year-over-year basis. The streaming giant even posted positive operating cash flow, getting over a hump that has been bugging investors since the company's inception. The global coronavirus lockdown plays right into the hand Netflix is holding -- people are stuck at home with little else to do.
Don't get your hopes up thinking big profits and positive cash flow are the new norm, however. For that matter, don't assume last quarter's pace of user growth is sustainable. CEO Reed Hastings even cautioned in his quarterly letter to shareholders that the company expects "viewing to decline and membership growth to decelerate as home confinement ends, which we hope is soon."
Margins could shrink dramatically, too, but for a different reason.
Drilling into the numbers
The final numbers: The addition of 15.8 million new subscribers for the quarter ending in March pushed the top line up to $5.8 billion, which was 27.6% better than the year-ago figure of $4.5 billion. Higher prices helped as well. Thanks to price increases in the meantime, the average monthly revenue per North American user improved from $11.45 to $13.09. With the exception of the Asia-Pacific market, other regions saw slightly higher average revenue per user as well.
Better yet, per-share profits more than doubled year over year from $0.76 to $1.57, and Netflix reported net income grew from $344 million to $709 million. Best of all, last quarter's operating cash flow of $260 million was a swing from negative cash flow of $380 million in the prior-year period.
It is as it should be: Companies like Netflix are supposed to increase profitability and profit margins as they scale up. Last quarter looks like it may have been the tipping point, so to speak, where good top line progress translates into great bottom line progress. But don't get too excited just yet as there's a reason profits exploded last quarter, and it's unlikely that feat will be easily repeated in the future.
The table below tells the tale. Revenue grew almost 28% year over year during the first quarter, and most expenses grew by a similar degree, save one glaring exception. Marketing costs fell more than 18% year over year and were down 43% from fourth-quarter levels -- another way this latest income statement is something of an outlier.
|Q1 2020||Q4 2019|| QoQ
|Cost of revenues||$3,600||$3,466||4%||$2,871||25%|
|Technology and development expenses||$454||$409||11%||$373||22%|
|General and administrative expenses||$252||$255||(1%)||$202||25%|
|Income before income taxes||$796||$149||434%||$400||99%|
|Operating cash flow||$260||($1,462)||N/A||($380)||N/A|
|Diluted earnings per share||$1.57||$1.30||21%||$0.76||107%|
It comes as no major surprise when you stop to think about it. Most consumers are extremely busy these days, and you have to fight -- and spend -- just to get their attention. That's not been the case for the past several weeks thanks to coronavirus-related lockdowns. Consumers here and abroad are proactively looking for things to do at home, and many turned to Netflix for their entertainment.
It's no small matter either. Netflix spent nearly $113 million less on marketing last quarter than it did during the first quarter of 2019. Assuming the more typical 25% increase in expenses (roughly mirroring revenue growth) we saw last quarter, Netflix might have spent something on the order of $770 million on marketing for the three-month stretch ending in March. That's $266 million of savings flowing to the bottom line.
And for the record, that $266 million difference exceeds the company's total positive cash flow for its first quarter.
Keep it in perspective
Before putting too much weight into the developments from the recent quarter, keep in mind this is back-of-the-envelope math, and Netflix still would have made solid progress last quarter even if it had spent normally on marketing. The company continues to grow more profitable as it scales, and it deserves credit in that regard.
The scope of last quarter's leap in profitability and the subsequent swing to positive cash flow is still considerably exaggerated, however, and not likely something that can be sustained for the remainder of 2020, let alone on a long-term basis. The eventual end of the lockdowns will mean that once again, Netflix has to fight for its audience, and it will have to fight in an arena that will soon include HBO Max, Peacock, and ever-growing competition. The new rivals may actually mean Netflix has to ramp up marketing spend even more than we've seen in the past.