July 16, 2018
Netflix naysayers and short sellers got their wish July 16 after the market close when the SVOD pioneer disclosed it added just 670,000 net domestic subscribers in the second quarter, ended June 30 – down from more than 1 million net sub additions in the previous-year period.
The SVOD, which had projected 1.2 million domestic sub additions in the quarter, ended the period with 57.4 million domestic subs.
Revenue topped $3.9 billion, which was up from $2.8 billion during the previous-year period, but below Netflix’s projected revenue of $3.93 billion.
Wall Street, which has sent Netflix shares to market-leading highs over the past year, reacted swiftly. Shares are down more than 14% in after-hours trading, with a market cap loss around $1.3 billion.
Internationally, Netflix added 4.5 million net subs, below the 5 million projected. The service ended the period with 72.7 million subs outside the United States. Netflix ended Q2 with more 130 million subs globally, compared to almost 104 million a year ago.
In the shareholder letter, co-founder/CEO Reed Hastings and CFO David Wells tried to downplay the subscriber misses as result of internal forecast “accuracy.”
“Meaning, in some quarters we will be high and other quarters low relative to our guidance,” Hastings and Wells wrote. “This Q2, we over-forecasted global net additions … as acquisition growth was slightly lower than we projected.”
Going forward, Netflix is putting the brakes on sub growth. In the current third quarter, it is projecting global net adds of 5 million compared with 5.3 million in Q3 2017. Netflix is projecting 650,000 domestic net new subs (versus 850,000 last year) and 4.35 million internationally (4.45 million).
In the investor interview, Hastings and Wells shrugged off the sub miss as a “movie” they saw two years ago.
“We never did find an explanation to that, other than there’s some lumpiness in the business, and we continued to perform after that,” Hastings said.
Netflix generated net income of $384 million on revenue of $3.9 billion, up from income of $66 million and revenue of $2.7 billion. It ended the period with third-party content obligations of $18.4 billion — up from $15.7 billion a year ago.
Netflix ended the period with 2.9 million combined disc/streaming subs — down from 3.7 million subs last year. The segment generated $52.9 million operating profit on revenue of $92.9 million — nearly a 57% margin — compared an operating margin of 54% on income of $62 million and revenue of $114.7 million.
Meanwhile, Netflix generated a negative $559 million free cash flow (FCF) in Q2 compared to a negative $608 million FCF in the year-ago quarter. Free cash flow is a measure of a company’s fiscal performance. Technically, FCF is the difference between a businesses’ cash flow and capital expenditures.
Indeed, Netflix said it expects to generate negative FCF from $3 billion to $4 billion for the full year 2018, which implies that its content cash spending will be weighted to the second half of the year. The service completed a $1.9 billion bond deal in Q2, which brought its gross debt level at $8.4 billion, and a cash balance of $3.9 billion. Netflix said its debt level is about 5% of the company’s enterprise level, or total value.
“While interest rates have risen, and the federal tax rate is now lower [reducing the tax shield on interest costs)], we judge that our after-tax cost of debt continues to be lower than our cost of equity, so we anticipate that we’ll continue to finance our capital needs in the high yield market,” Hastings and Wells wrote.