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Netflix (NFLX) Q2 Earnings Beat, User Addition Disappoints

Zacks Equity Research

Netflix NFLX reported second-quarter 2019 earnings of 60 cents per share that beat the Zacks Consensus Estimate by 4 cents and was better than management’s guidance of 55 cents. However, earnings declined 29.4% year over year.

Revenues of $4.92 billion lagged the consensus mark and management’s guidance of $4.93 billion. However, the top line increased 26% year over year, driven by a solid 27.1% jump in streaming revenues.

Nonetheless, shares were down almost 11.7% in pre-market trading, as Netflix missed its subscriber addition target of 5 million. The streaming giant only added 2.70 million of paid subscribers, down 50.5% year over year.

At the end of the quarter, Netflix had 151.56 million paid subscribers globally, up 21.9% from the year-ago quarter. The company had expected to add 153.86 million paid subscribers, globally.

Netflix, Inc. Price, Consensus and EPS Surprise

 

Netflix, Inc. Price, Consensus and EPS Surprise

Netflix, Inc. price-consensus-eps-surprise-chart | Netflix, Inc. Quote

International Subscriber Addition Declines Y/Y

In the International Streaming segment, Netflix recorded 91.46 million paid members that increased 33.7% from the year-ago quarter. The company added 2.83 million paid members, lagging management’s expectation of 4.7 million and declining 38.3% on a year-over-year basis.

In the U.S. Streaming segment, Netflix’s paid subscriber base totaled 60.10 million, up 7.4% from the year-ago quarter. The company lost roughly 130,000 paid subscribers against management’s expectation of growth of 0.3 million.

The subscriber addition target miss was primarily attributed to the price hike that the company announced in January. Netflix also blamed weak content slate for lower subscriber growth.

ARPU increased 3% year over year primarily due to the price hike. Excluding unfavorable foreign exchange impact, global streaming ARPU improved 9% year over year. ARPU in the U.S. and International segments improved 12% and 7%, respectively.

Content & Viewership Details

Netflix’s Dead to Me, When They See Us, Our Planet, Murder Mystery, The Perfect Date and Always Be My Maybe were the most viewed shows and movies in the reported quarter.

Christina Applegate starrer Dead to Me was watched by 30 million households in the first four weeks of release. Netflix has renewed this half-hour comedy for a second season.

When They See Us, based on the Central Park Five case, was watched by 25 million households in the first four weeks of release. The show has received 16 Emmy nominations, including Outstanding Limited Series.

Docu-series Our Planet was watched by 33 million households in the first four weeks of release. The show has been nominated for 10 Emmy Awards.

Notably, Netflix’s 40 original series, films and specials have been nominated for 117 Emmy Awards.

Further, Adam Sandler and Jennifer Aniston starrer Murder Mystery was watched by 73 million households in the first four weeks of release.

While The Perfect Date, starring Noah Centineo, was watched by 48 million households in the first four weeks of release, 32 million households viewed Always Be My Maybe.

Netflix’s focus on regional language content has been a major driver behind its expanding international footprint. The Rain season 2 returned to the platform in the reported quarter. Swedish series Quicksand, the first two installments of the Historia de un Crimen franchise in Latin America and Family Business in France were major hits.

The content slate for the third quarter includes Stranger Things season 3, new seasons of La Casa de Papel (Money Heist), The Crown and the final season of Orange is the New Black. Movies include The Irishman from Martin Scorsese and action movie 6 Underground, directed by Michael Bay and starring Ryan Reynolds.

Marketing, Brand Partnerships & Games

In terms of marketing, Netflix makes efforts to build excitement about its shows among existing subscribers as well as non-users of the streaming platform.

Moreover, brand partnerships with the likes of Coke, Nike, Burger King and Baskin Robbins in Stranger Things 3 are a step toward improving user engagement.

Further, to create buzz about its upcoming new show Dark Crystal: Age of Resistance, Netflix announced Stranger Things mobile game. The company has also inked a partnership with Epic Games, the developers of Fortnite.

Netflix also stated that it has no intention to sell advertisement and will instead focus on boosting user engagement.

Further, the company stated that it will launch a low-priced mobile plan in India.

Quarter Details

International Streaming revenues (51.8% of revenues) rose 32.6% year over year to $2.55 billion. The figure missed management’s guidance of $2.58 billion.

U.S. Streaming revenues (46.7% of revenues) improved 21.4% from the year-ago quarter to about $2.30 billion. The figure was better than management’s guidance of $2.28 billion.

The DVD business revenues (1.5% of revenues) declined 18% year over year to $76.2 million.

Marketing expenses increased 1.9% year over year to $603.2 million. However, as percentage of revenues, marketing expenses decreased 290 basis points (bps) to 12.3%.

Consolidated contribution margin (revenues minus the cost of revenues and marketing cost) expanded 330 bps on a year-over-year basis to 26.7%. International and the U.S. streaming segments’ contribution margin expanded 650 bps and 160 bps, respectively.

Moreover, consolidated operating income jumped 52.8% year over year to $706.4 million. Consolidated operating margin expanded 250 bps on a year-over-year basis to 14.3%, better than management’s guidance of 12.5%.

Balance Sheet & Free Cash Flow

Netflix had $5 billion of cash and cash equivalents as of Jun 30, 2019, compared with $3.35 billion as of Mar 31, 2019.

Long-term debt was $12.59 billion, up from $10.31 billion at the end of the previous quarter. Streaming content obligations were $18.5 billion compared with $18.9 billion at the end of the previous quarter.

Netflix reported free cash outflow of $594 million compared with $460 million in the previous quarter.

Guidance

For the third quarter of 2019, Netflix forecasts earnings of $1.04 per share, implying year-over-year growth of 16.9%. The Zacks Consensus Estimate is pegged at 97 cents.

Netflix expects to add 7 million paid subscribers, up 15.3% year over year. In the U.S. Streaming segment, the company anticipates to add 0.8 million subscribers, down 20% from the year-ago quarter. However, in the International Streaming segment, Netflix expects paid subscriber addition of 6.2 million, up 22.3% year over year.

The company expects to have 158.56 million paid subscribers globally, up 21.6% from the year-ago quarter.

Total revenues, including the DVD business, are anticipated to be $5.25 billion, up 31.3% year over year. The Zacks Consensus Estimate stands at $5.22 billion, indicating growth of $30.4% from the figure reported in the year-ago quarter.

The U.S. and International Streaming revenues are expected to be $2.40 billion and $2.78 billion, respectively. While the U.S. Streaming revenues are anticipated to grow 23.9% year over year, International Streaming revenues are projected to surge 40.8%.

Contribution profits for the U.S. and International Streaming segments are expected to be $923 million and $503 million, respectively. On a year-over-year basis, the U.S. Streaming contribution profit is expected to increase 34.2% and the same for International Streaming is anticipated to jump 130.7%.

Moreover, contribution margin for the U.S. Streaming segment is expected to expand 290 bps year over year. The same for the International Streaming segment is projected to expand 710 bps.

Operating margin is projected at 15.9%, up from 12% in the year-ago quarter.

For 2019, Netflix reiterated operating margin guidance at 13%, up 300 bps on a year-over-year basis.

Moreover, management still expects 2019 free cash outflow to be $3.5 billion. The company expects free cash flow to improve in 2020 and each year after that, driven by growing member base, revenues and operating margins.

Conclusion

Netflix’s second-quarter subscriber addition rate faltered primarily due to the price hike in a number of regions and weak content slate. The company also blamed the record addition (9 million) of subscribers in the first quarter that resulted in a pull-forward effect for the decline.

Although Netflix provided optimistic third-quarter view, we expect the streaming giant to face hard times due to increasing competition in the video streaming space.

Apart from established platforms like Disney’s DIS Hulu, AT&T’s T HBO, Amazon’s AMZN Prime Video, YouTube, BBC and Hotstar, upcoming streaming services from Disney, Apple, Comcast CMCSA and AT&T pose significant threat to Netflix’s dominance over the next 12 months.  

Disney, Comcast and AT&T are now looking to remove their popular movies and shows from Netflix. Disney is set to pull its movies and shows from the platform ahead of the launch of Disney+ in November. Netflix is also set to lose hit shows, Friends and The Office, to AT&T’s HBO Max and Comcast’s NBC, respectively.

However, Netflix believes that the lost shows will free-up budget that it can spend on original content. Moreover, partnerships with telcos like Telefonica in Spain, KDDI in Japan, AT&T, Comcast, DISH, Verizon, Charter, Altice and T-Mobile in the United States, and Sky in the U.K. and Germany bode well for the streaming platform.

Currently, Netflix has 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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