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Netflix (NFLX) Tops Q2 Earnings, Falls on Subscriber Woes

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Shares of video streaming giant, Netflix, Inc. (NFLX - Free Report)  plunged over 13% in the after-hours session following its second quarter 2016 earnings. Investors were not satisfied with the muted subscriber growth despite the earnings beat.

In a letter to shareholders, CEO Reed Hastings stated that “Netflix membership grew by 1.7 million members in Q2, finishing with over 83 million members. However, this was below the forecast of 2.5 million net new members and prior Q2 net additions of 3.3 million. We are growing, but not as fast as we would like or have been.”

The ongoing ‘un-grandfathering’ or increasing subscription rates for Netflix’s older customers resulted in higher-than-anticipated fall in subscriptions.

Quarter Details

Earnings of 9 cents per share in the quarter were well ahead of the Zacks Consensus Estimate of 2 cents.

The company’s revenues rose 28% year over year to $2,105.2 million driven by higher revenues from both International and Domestic Streaming. However, revenues missed the Zacks Consensus Estimate of $2,109.9 million.

International revenues (38.6% of revenues) soared 66.7% year over year to $758.2 million driven by the growth in paid members.

Domestic revenues (61.4% of revenues) improved 17.8% from the year-ago quarter to about $1.21 billion.

However, DVD revenues (7.1% of revenues) declined 15.41 year over year to $138.7 million.

Subscriber Base

In the quarter, Netflix recorded 1.68 million new members, bringing the total to approximately 83.2 million subscribers across the globe. Paid members totaled 79.9 million, up from 77.7 million in the prior-quarter.

In the Domestic Streaming segment, Netflix’s subscriber base totaled 47.13 million, up from 46.97 million in the last quarter. Paid members increased to 46 million from 45.71 million in the last quarter.

In the International Streaming segment, the company recorded 36.5 million members compared with 34.5 million in the prior quarter. Paid members were approximately 33.9 million, up from 32 million at the end of the last quarter.

Margins

Consolidated contribution profit margin (revenues minus the cost of revenues and marketing cost) from the streaming business was 17.6% compared with 16.7% in the year-ago quarter.

Operating income (for both streaming and DVD business) fell over 7% year over year to $70 million. Operating margin declined 130 basis points to 3.3%.

Net income was $41 million compared with $26 million in the year-ago quarter.

Balance Sheet

Netflix had $1.8 billion in cash and cash equivalents (and short-term investments) as of Jun 30, 2016 compared with $2.3 billion as of Dec 31, 2015.

Cash used in operations in the quarter was $226.3 million compared with $181.3 million cash used in operations in the prior-year quarter. The company reported non-GAAP free cash outflow of $254 million.

Netflix’s total streaming content obligations increased to $13.2 billion from $10.1 billion in the year-ago quarter.

Outlook

For the third quarter of 2016, management forecasts earnings of 5 cents per share and net income of $22 million. The Zacks Consensus Estimate for earnings per share is pegged higher at 7 cents.

Domestic and international streaming revenues are expected to be $1.3 billion and $846 million, respectively. Total streaming revenues are expected to be $2.16 billion.

Management expects to add 0.3 million subscribers in the domestic streaming segment and 2 million subscribers in the international segment. Domestic streaming contribution profit is expected to be $460 million. International streaming loss is expected to be $95 million due to higher marketing spend. Netflix forecasts operating income of $64 million for the quarter.

Netflix estimates U.S. contribution margin to be around 35.1% in the quarter.

NETFLIX INC Price, Consensus and EPS Surprise

NETFLIX INC Price, Consensus and EPS Surprise | NETFLIX INC Quote

Our Take

Though Netflix has been strengthening its position in terms of original content and strategic partnerships with the likes of Disney DIS, the slowdown in subscriber growth remains a major overhang.

In addition, rapid international expansion and content additions have resulted in astronomical cost escalations in the form of technology investments and marketing expenses. Therefore, margins and profitability will be under pressure over the near term.

Furthermore, the company also faces stiff competition from bellwethers like Amazon.com (AMZN - Free Report) , Hulu andTime Warner’s  HBO.

At present, Netflix carries a Zacks Rank #3 (Hold).

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