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Netflix (NFLX) Q2 Earnings Beat, Subscriber Addition Lags

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Netflix (NFLX - Free Report) reported second-quarter 2018 earnings of 85 cents per share that beat the Zacks Consensus Estimate by a nickel. The figure was much better than 15 cents reported in the year-ago quarter.

The results included $85 million of non-cash unrealized gain from foreign exchange remeasurement on the company’s Eurobond.

Revenues of $3.91 billion lagged the consensus estimate of $3.94 billion. However, the top line surged 40.1% year over year, driven by solid streaming revenues that jumped 42.8% from the year-ago quarter.

Nevertheless, the solid top-line growth was marred by lower subscriber addition that missed management’s expectations, after four consecutive quarters of outperformance.

Shares were down almost 12% in pre-market trading. Notably, shares of Netflix have skyrocketed 108.6% on a year-to-date basis, significantly outperforming the industry’s 37.5% rally.

 



Subscriber Base Hits 130 Million

Netflix added 5.2 million subscribers, much less than the expected 6.2 million in the quarter. Paid net additions were 5.5 million better than 4.7 million in the year-ago quarter but less than management’s expectation of 6.1 million.

The company now has more than 130 million subscribers globally. At the end of the quarter, Netflix's paid streaming members across the globe were 124.35 million, up 25.5% from the year-ago quarter.  The figure is impressive, considering 14% increase in its average selling price (ASP).

In the Domestic Streaming segment, Netflix’s subscriber base was 57.38 million, up from 51.92 million in the year-ago quarter. The company added 0.67 million of subscribers (lower than 1.2 million expectation) in the quarter. Paid members increased 11.2% from the year-ago period to 55.96 million.
 

Netflix, Inc. Price, Consensus and EPS Surprise

Netflix, Inc. Price, Consensus and EPS Surprise | Netflix, Inc. Quote

 

In the International Streaming segment, the company recorded 72.76 million members compared with 52.03 million in the year-ago quarter. The company added 4.47 million of subscribers in the quarter. Paid members were 68.39 million, up 40.4% from the year-ago quarter.

Original Content Expansion Continues

Netflix’s expanding original content portfolio is the major growth driver.

The second quarter had a strong programming slate, with popular shows like Marvel’s Jessica Jones, 13 Reasons Why, Santa Clarita Diet, A Series of Unfortunate Events, La Casa de Papel, GLOW and Marvel’s Luke Cage. Boss Baby: Back in Business became one of the biggest kids’ series ever.

Netflix’s effort to strengthen regional programming is a key growth driver. The company streamed second season of Brazilian show named 3%. The company also launched Danish thriller, The Rain and Lust Stories, a new Indian original film.

The company’s growing roster of original films included romantic comedies like Set It Up and The Kissing Booth in the quarter.

Quarter Details

International Streaming revenues (49.1% of revenues) soared 63.2% year over year to $1.92 billion. Favorable foreign exchange impacted revenues by more than $65 million as ASP grew over 13%.

Domestic Streaming revenues (48.3% of revenues) improved 25.2% from the year-ago quarter to about $1.89 billion.

The DVD business (2.6% of revenues) declined 19% year over year to $92.9 million.

Consolidated contributions margin (revenues minus the cost of revenues and marketing cost) was 27.9% compared with 21.9% in the year-ago quarter.

Consolidated operating income soared 261.6% year over year to $462.2 million. Consolidated operating margin was 11.8% as compared with 4.6% in the year-ago quarter.

Balance Sheet

Netflix had $3.91 billion of cash and cash equivalents as of Jun 30, 2018 compared with $2.59 billion as of Mar 31, 2018.

Long term debt was $8.34 billion at the end of the quarter. Streaming content obligations were $18.4 billion compared with $17.9 billion at the end of the previous quarter.

The company reported free cash outflow of $559 million compared with $287 million in the previous quarter.

Guidance

For the third quarter of 2018, Netflix forecasts earnings of 68 cents per share. The Zacks Consensus Estimate is currently pegged at 71 cents.

Domestic and international streaming revenues are expected to be $1.93 billion and $1.97 billion, respectively. Total streaming revenues are expected to be $3.90 billion, while total revenues, including the DVD business, are anticipated to be almost $3.99 billion.

Management expects to add 0.65 million subscribers in the domestic streaming segment and 4.35 million subscribers in the international segment for the current quarter.

The company forecasts operating margin to be near the lower end of its guided range of 10-11% for fiscal 2018. Netflix continues to expect free cash outflow in the range of $3-$4 billion for 2018.

Conclusion

Netflix’s second-quarter subscriber addition rate was disappointing, considering the solid outperformance in the previous quarters. Although management cited over-optimistic guidance, we believe subscriber addition pace has hit a rough patch due to increasing competition from Alphabet’s YouTube and HBO.

Post Time Warner’s acquisition, AT&T (T - Free Report) has shown interest in escalating spending on HBO for content acquisition. Moreover, aggressive spending on building original content by the likes of Apple (AAPL - Free Report) and Amazon (AMZN - Free Report) is expected to intensify competition in the streaming market.

Further, Disney is also gearing up to enter the streaming market and the pending acquisition of 21st Century Fox’s assets will expand its content portfolio significantly.

Nevertheless, Netflix’s focus on providing quality content, expanding original movie slate, strong regional content portfolio and aggressive spending on content acquiring is expected to help it steer away competition.

Moreover, partnerships with telcos like Telefonica in Spain and Latin America as well as KDDI in Japan are expected to boost subscriber addition. Further, availability of new features like “Smart Downloads” on Android phones that uses offline mode is likely to boost company’s penetration in the emerging countries like India.

Currently, Netflix has a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks Rank #1 (Strong Buy) stocks here.

 

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