Netflix stock slammed after earnings, as subscriber growth and revenue fall short

Netflix stock slammed after earnings, as subscriber growth and revenue fall short

Company’s guidance for new subscribers and revenue also below consensus

Netflix Inc. posted weaker-than-expected second-quarter subscriber numbers and revenue Monday afternoon, sending its stock into a sharp dive during after-hours trading.

Netflix shares NFLX, -4.79% traded 12% lower in premarket action Tuesday after the Los Gatos, Calif.-based company announced it added 5.15 million streaming users in the second quarter, a substantial drop from the 6.2 million estimate the company provided in April. The company added 4.47 million international subscribers and 670,000 domestic subscribers, missing its April estimates of 5.9 million and 1.2 million.

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The company reported a profit of $384 million, or 85 cents a share, topping the FactSet consensus of 79 cents a share and up from $66 million, or 15 cents a share, in the same quarter a year ago. Revenue rose to $3.91 billion from $2.79 billion the year before, just below the FactSet consensus of $3.94 billion.

In a letter to shareholders, Netflix said the company had a "strong but not stellar" quarter, acknowledging the company had “over-forecasted” both domestic and global net subscriber additions and “acquisition growth was lower than we projected.”

“We’ve seen this movie of Q2 shortfall before, about two years ago in 2016, and we never did find the explanation to that, other than there is some bumpiness in the business, and continued to perform after that,” Chief Executive Reed Hastings said during Netflix’s version of an earnings conference call, a prerecorded interview with a single analyst who asks questions. The analyst on Monday’s earnings call was Sanford C. Bernstein & Co.’s Todd Juenger.

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The question for investors, said GBH Insights analyst Daniel Ives, was whether this was a one-quarter blip or signs of something more worrisome.

“I think it’s more of a one-quarter issue that shouldn’t bleed into the next few quarters, despite the company’s conservative guidance for September,” he said.

“In uber growth stories, especially in technology, from Apple to Amazon to Netflix, you’re going to run into these one- or two-quarter issues when they’re white-knuckle periods in the very near-term.”

Netflix stock slammed after earnings, as subscriber growth and revenue fall short

Company’s guidance for new subscribers and revenue also below consensus

In its letter to shareholders, Netflix blamed the strengthening of the U.S. dollar for its weaker-than-expected international revenue. In April, the company predicted a $65 million-plus impact on international revenue year over year, but the impact turned out to be smaller due to the strengthening of the dollar against many international currencies, the company said. Netflix does not hedge its revenue with derivatives.

“We slowly adjust pricing over time to mitigate forex moves over the longer term, but when currency movements are rapid, they will affect our near term operating margin,” Netflix wrote. “We’ll tend to outperform our near term operating margin targets on dollar weakness and underperform on dollar strength.”

In its letter, Netflix acknowledged rising competition from other entertainment companies. “HBO and Disney DIS, +0.04%  are evolving to focus on internet entertainment services. Amazon AMZN, +1.27%  and Apple AAPL, +0.24%  are investing in content as part of larger ecosystem subscriptions,” Netflix wrote. “We anticipate more competition from the combined AT&T/Warner Media, from the combined Fox/Disney or Fox/Comcast as well as from international players like Germany’s ProSieben and Salto in France.”

The company reiterated its commitment to a broad slate of content “to serve a wide variety of tastes,” citing its second-quarter debut of sci-fi action series “Lost in Space,” which was renewed for another season, and the release of the second season of “13 Reasons Why.” Other second-quarter offerings included follow-up seasons of “Santa Clarita Diet,” “A Series of Unfortunate Events,” “Marvel’s Jessica Jones, “La Casa de Papel,” “GLOW,” and “Marvel’s Luke Cage.” Netflix also debuted several romantic comedies like “Set It Up” and “The Kissing Booth,” both of which were “watched and loved by tens of millions of Netflix members,” according to the company.

In the earnings interview, Hastings said Netflix does not have any plans to move into new genres like sports, news, gaming or audio content. Movies and TV are “consuming every bit of energy and excitement we have,” he said.

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The streaming giant also doubled down on international content in the second quarter, releasing the second season of “3%,” a sci-fi thriller from Brazil, as well as the Indian original film “Lust Stories” and Danish thriller “The Rain," which the company said became one of its “biggest non-English original productions yet, with viewing all over the world.”

Some viewers and analysts have wondered if Netflix’s rate of content output will mean a decrease in quality of its shows and movies. But for now, critics seem to approve of the company’s offerings, as Netflix last week nabbed the most Emmy nominations of any network, breaking HBO’s 17-year streak of leading TV networks in nominations.

The company is focusing heavily on marketing amid the content push, spending $576.7 million this past quarter and just more than $1 billion in the past six months.

As for how that’s allocated, “only a fraction of our spend is oriented around direct acquisition,” said Netflix chief financial officer David Wells during the company’s earnings interview. “The majority of the marketing spend — call it 80% to 85% — is oriented around building title brands.”

Netflix also ramped up its spending on technology and development, spending $317.2 million in the second quarter. Last week, the company unveiled “Smart Downloads,” a feature aimed at users who download episodes to watch on phones or tablets while on the go. The feature deletes an episode after a user watches it, and then automatically downloads the next episode while the device is connected to Wi-Fi.

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Analysts have voiced concern about Netflix’s continuing negative free cash flow. During the second quarter, the company burned $559 million more than it brought in, 8.8% less than the same quarter last year, when it burned $608 million. Netflix said it continues to anticipate negative free cash flows of $3 billion to $4 billion for 2018, implying its content cash spending will be weighted to the second half of 2018. Netflix completed its latest bond deal, raising $1.9 billion, in the second quarter, and its gross debt balance now stands at $8.4 billion.

“We continue to see debt as the most optimal choice, the most cost-effective source of capital for the company,” said Wells. “Obviously we’d love to get to that point where we’re organically and self-funding content, and we do see a point where we can get there. But until we do, we see as debt as the right choice in terms of cost of capital,” he said.

Netflix shares have seen a meteoric rise of 109% so far this year, while the S&P 500 SPX, +0.44% has risen 4.7%.