Netflix's (NASDAQ:NFLX) first quarter was anything but ordinary. It added nearly 16 million subscribers, more than twice the amount it forecast back in January.

And while subscriber additions got all the headlines, something else is going on below the surface: Netflix produced positive free cash flow. The $162 million in free cash flow for the first quarter is the first time Netflix produced cash instead of burning it since 2014.

"We would have been positive free cash flow without the recent COVID events," CFO Spence Neumann said on Netflix's first-quarter earnings call. He's referring mostly to production shutdowns that will push certain cash content expenditures into next year, as well as the spike in subscribers. 

Neumann still expects Netflix to burn through about $1 billion in cash this year (versus a previous estimate of about $2.5 billion). He also anticipates some "lumpiness" in the path to positive free cash flow. But Netflix's first-quarter results show how close it is to funding its own programming and generating tons of cash.

A family watching TV in a living room.

Image source: Netflix

Sustainable revenue growth

Netflix's revenue grew 27.6% in the first quarter. That's largely a result of its price increase from last year, not the heightened subscriber growth. Most subscribers that signed up in March won't actually start paying until April thanks to free trials.

Netflix lapped its price increase last quarter, and it should see a slowdown in revenue growth. Still, management expects growth over 20% in Q2, and it could easily meet that number in the second half of the year on the strength of its subscriber count.

Going forward, Netflix's biggest opportunity lies in international markets. While it's nearing saturation in the United States and other early streaming markets, it still has a long way to go before its market penetration in most international markets is even close to the level seen in the U.S. There may also be room to increase average pricing more internationally, as the price for Netflix is generally lower outside of the United States. That should sustain strong revenue growth for several years.

Planned operating margin expansion

Along with strong revenue growth, Netflix has consistently expanded its operating margin. The company manages its spending for a target operating margin, and it hasn't missed the mark once since adopting that strategy. This year's target margin is 16%, a 3-percentage-point expansion from last year.

In the first quarter, operating margin was actually 16.6%. Again, that's not because of any outsize impact from COVID-19. It was actually lower than management expected due to costs of shutting down productions and its hardship fund commitments. Netflix's first-quarter results show what's possible when the company has a relatively high operating margin and strong revenue growth.

If its pattern holds, Netflix will target 19% operating margin in 2021, which combined with another 20% increase in revenue will translate into a 42% rise in operating income, and about $1.7 billion in absolute dollars next year. If Netflix can expand operating margin again in 2022, it could be producing nearly $4 billion more in operating income than it does this year.

Continuing to expand operating margin and growing international subscriptions should enable the FAANG stock to get to break-even cash flow in just a few years -- perhaps by 2023 or 2024. And it will grow free cash flow rapidly from there. Jefferies analyst Alex Giaimo thinks Netflix could produce $10 billion in free cash flow by 2026. That's the power of massive scale, and Netflix is nearly there.

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