Shares of video streaming giant, Netflix, Inc. (NFLX - Analyst Report) surged nearly 20% in the after-hours session following its third-quarter 2016 earnings. Better-than-expected subscriber growth in the quarter primarily boosted investors’ confidence.
Earnings of 12 cents per share in the quarter were well ahead of the Zacks Consensus Estimate of 6 cents. In the prior-year quarter, the company had reported earnings of 7 cents a share.
The company’s total revenues rose 31.7% year over year to $2,290 million driven by higher revenues from both International and Domestic Streaming. Revenues also surpassed the Zacks Consensus Estimate of $2,280 million.
International Streaming revenues (37.3% of revenues) soared 65.1% year over year to $853.5 million driven by an increase in paid members.
Domestic Streaming revenues (57% of revenues) improved 22.6% from the year-ago quarter to about $1,304.3 million.
However, DVD revenues (5.8% of revenues) declined 16% year over year to $132.4 million.
In the quarter, Netflix recorded 3.57 million new members, bringing the total to approximately 86.7 million subscribers across the globe (guided range was 85.5 million). Paid streaming members totaled 83.3 million, up from 66 million in the prior quarter.
In the Domestic Streaming segment, Netflix’s subscriber base totaled 47.5 million, up from 47.1 million in the last quarter. Paid members increased to 46.5 million from 46 million in the last quarter.
In the International Streaming segment, the company recorded 39.2 million members compared with 36.5 million in the prior quarter. Paid members were approximately 36.8 million, up from 33.9 million at the end of the last quarter.
In a letter to shareholders, CEO Reed Hastings stated that “By the end of Q3’16, we had un-grandfathered 75% of the members that are being un-grandfathered this year and the impact has been consistent with our expectations.”
Consolidated contribution profit margin (revenues minus the cost of revenues and marketing cost) from the streaming business was 18.8% compared with 17.5% in the year-ago quarter.
Operating income (for both streaming and DVD business) surged 43.2% year over year to $106 million. Operating margin increased 50 basis points to 4.7%.
Net income was $52 million compared with $29 million in the year-ago quarter.
Netflix had $1.34 billion in cash and cash equivalents (and short-term investments) as of Sep 30, 2016 compared with $2.3 billion as of Dec 31, 2015.
Cash used in operations in the quarter was $462 million compared with $196 million cash used in operations in the prior-year quarter. The company reported free cash outflow of $506 million.
Netflix’s total streaming content obligations increased to $14.4 billion from $10.4 billion in the year-ago quarter.
For the fourth quarter of 2016, management forecasts earnings of 13 cents per share and net income of $56 million.
Domestic and international streaming revenues are expected to be $1.4 billion and $947 million, respectively. Total streaming revenues are expected to be $2.34 billion.
Management expects to add 1.45 million subscribers in the domestic streaming segment and 3.75 million subscribers in the international segment. Domestic streaming contribution profit is expected to be $515 million. International streaming loss is expected to be $75 million due to higher marketing spend. Netflix estimates U.S. contribution margin to be around 36.9% in the quarter.
Netflix forecasts operating income of $125 million for the quarter.
The streaming giant has been driving subscriber growth both domestically and internationally based on its quality original programs. In the third quarter, the results especially benefited from the release of programs like Stranger Things and season two of Narcos. Last month, CFO David Wells announced that the company plans to make 50% of its total content original over the next few years.
Apart from this, the company is also forming strategic partnerships with the likes of CBC, Northwood Entertainment and others to boost its content further. Moreover, Netflix has been strategically placing itself to meet the needs of new-age binge-watchers.
However, investors need to watch out for astronomically high costs that come with rapid international expansion and the addition of relevant content. In addition, the company is getting embroiled in legal battles, which remain an overhang. Last month, Twenty First Century Fox (FOXA - Analyst Report) filed a lawsuit against Netflix saying that the streaming giant has been on a “brazen campaign to unlawfully target, recruit, and poach valuable Fox executives by illegally inducing them to break their employment contracts with Fox to work at Netflix.”
These aside, stiff competition from bellwethers like Amazon.com (AMZN - Analyst Report) , Hulu and Time Warner’s (TWX - Analyst Report) HBO is a concern.
At present, Netflix carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
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