) reported an impressive second-quarter 2014. The streaming
service provider reported earnings of $1.15 per share that
surpassed the Zacks Consensus Estimate by a penny.
Revenues of $1.34 billion were in line with the Zacks
Consensus Estimate in the quarter. Most significantly, the
company added 1.69 million streaming subscribers (domestic +
international), much better than management's guidance of
Quarter Details - Revenues
Revenues jumped 25.3% from the year-ago quarter and 5.5%
from the previous quarter, primarily driven by higher
international revenues (23.0% of revenues), which soared
85.3% year over year and 15.1% quarter over
Domestic revenues (63.0% of revenues) surged 25.0% from
the year-ago quarter and 5.0% from the previous quarter.
However, DVD revenues decreased 16.2% year over year and 4.7%
on a sequential basis.
Robust subscriber additions in Netflix's streaming
business (domestic + international) led to the year-over-year
and sequential improvement in the top line. Notably, the
company added 12.36 million paid streaming subscribers over
the last 12 months. On a sequential basis, Netflix added 1.85
million paid subscribers in the second quarter.
Total streaming subscriber base increased 12.49 million
year over year to 50.05 million. Sequentially, total
subscriber growth was 1.70 million. This strong subscriber
addition was primarily driven by Netflix's expanding content
portfolio that includes original productions such as
House of Cards
Orange is the New Black
In May, Netflix raised its subscription prices for
domestic new subscribers to $8.99, which is a $1.00 hike from
the previous pricing plan of $7.99 per month. International
new subscribers (Europe and United Kingdom) will be paying a
little more than $1.00 due to foreign currency conversions.
However, existing subscribers in both the regions will
continue to enjoy the current $7.99 plan for the next two
The modest price increase reflected Netflix's cautious
approach as it does not want to repeat the 2011 debacle. In
Jul 2011, Netflix raised the prices of its combined streaming
and DVD-rental package by 60% that enraged customers,
resulting in substantial subscriber loss.
We believe that the price hike did not have any material
effect on subscriber growth due to Netflix's superior content
portfolio that improved engagement. The company's growing
investments in original program pipeline will continue to
play a significant role in limiting any churn due to the
Netflix recently won 31 nominations for the 66th annual
Emmy Awards. Per The Wall Street Journal, the number of
nominations won by the company was higher than
), Showtime, Comedy Central and Fox.
Last year, out of 14 nominations, Netflix had won 3
awards. This year, its original show
House of Cards
received nomination for the second consecutive time in the
category of best drama. Netflix's another original series
Orange is the New Black
received 12 nominations and will compete for the best comedy
Netflix's strong show pipeline for the third quarter
includes the final season of the revived series
, adult animated comedy
from the Oscar-winning director of
, Fisher Stevens.
Under its original program initiative, the company has
whose production has started in Kazakhstan and Malaysia. The
other shows that are in production includes
, the first of the four original series from Marvel
Orange is the New Black 3
House of Cards 3
Grace and Frankie
and an unnamed series from the creators of
Netflix recently bought the exclusive U.S. video-on-demand
) drama series Zoo, set to release in summer 2015. The
company recently signed a deal with renowned comedian and
actress, Chelsea Handler, to create a new talk-show slated
for a 2016 release.
Moreover, Netflix will begin offering streaming services
in Germany, Austria, Switzerland, France, Belgium and
Luxembourg by September this year. The entry into these
markets with 60 million broadband households will
significantly expand Netflix's European presence and total
addressable market to over 180 million broadband households.
Consolidated contribution profit margin (revenues minus
the cost of revenues and marketing costs) improved 460 basis
points (bps) from the year-ago quarter and 190 bps on a
sequential basis to 22.7%.
The strong year-over-year growth in contribution profit
was primarily driven by 50.2% surge in domestic contribution
profit, which fully offset a 14.6% decline in DVD
contribution profit and loss in international streaming
The sequential increase was primarily due to 12.9%
increase in the domestic streaming business. Despite
heightened marketing activities, international streaming
segment reported loss, though much lower.
Marketing expense as a percentage of revenues declined 170
bps from the year-ago quarter and 180 bps from the previous
quarter. Technology & development expense as a percentage
of revenues decreased 10 bps on both year-over-year and
General & administrative expense as a percentage of
revenues increased 40 bps from the year-ago quarter and 10
bps from the previous quarter.
As a result of improving cost structure and higher revenue
base, operating income jumped to $129.6 million from $57.1
million in the year-ago quarter. Operating income also
increased 32.8% from the previous quarter.
Net income was $71.0 million or $1.15 (better than
management's guidance of $69.0 million/$1.12) compared with
$29.5 million or 49 cents in the year-ago quarter and $53.1
million or 86 cents in the previous quarter.
Netflix, Inc - Earnings Surprise |
At the end of the second quarter, Netflix had $1.71
billion in cash and cash equivalents (including short-term
investments) compared with $1.67 billion in the previous
quarter. Long-term debt stood at $900.0 million at the end of
Netflix generated $56.0 million in cash flow from
operations compared with $36.4 million at the end of the
previous quarter. The company reported free cash flow of
$16.3 million in the quarter.
For the third quarter, management forecasts earnings of 89
cents and net income of $55.0 million. The earnings guidance
is lower than the current Zacks Consensus Estimate ($1.02)
and is much higher than 32 cents per share reported in the
year-ago second quarter.
Domestic and international streaming revenues are expected
to be $877.0 million and $347.0 million, respectively. Total
streaming revenues are expected to be $1.22 billion.
Management expects to add 1.33 million subscribers in the
domestic streaming segment and 2.36 million in the
international segment in the third quarter of 2014. Netflix
expects total subscribers of 53.74 million at the end of the
Domestic streaming contribution profit is expected to be
$245.0 million. International streaming loss is expected to
increase $42.0 million sequentially, due to increased
marketing spend. Netflix forecasts operating income of $103.0
million for the third quarter.
We believe that Netflix's impressive second-quarter
results, streaming subscriber growth and growth opportunities
from international expansion will drive the share price in
the near term. However, rising content costs, net neutrality
related concerns and intensifying competition are the major
headwinds. Netflix has $7.7 billion due for content streaming
Although the company is lobbying for "strong net
neutrality" rules, we believe that it will have no
significant effect on major Internet service providers (ISPs)
), at least in the near term.
Reportedly, the Federal Communications Commission (FCC)
plans to investigate the slowdown in Internet traffic. The
investigation aims to find the probable cause of bandwidth
congestion at the interconnection point of content networks
FCC's move has received support from all concerned parties
as it is expected to enhance transparency over key issues
like net neutrality and peering. However, such
investigations take a long time to complete and many a times
fail to bear any conclusive result. Further, FCC's new
proposed net neutrality rules that will allow ISPs to charge
fees for faster connections remains a headwind for
Netflix believes that its large customer base will attract
government attention to form new net neutrality regulations
in favor of content distributors and intermediaries. However,
large ISPs will not give up easily, as government
intervention is likely to hurt their business model.
Instead, they might try to follow the Comcast and Verizon
model, forcing Netflix to enter into similar fee paying
arrangements to ensure better streaming quality. Moreover, if
the Comcast-Time Warner deal gets approval, Netflix may face
significant pressure from the combined entity to increase its
annual fees, which will further dent cash balances.
Although Netflix's measured approach regarding price
increase is appreciative, we believe that the cautious step
may not be enough to offset the rising operating costs.
However, too much aggressiveness may hurt subscriber growth,
particularly in international markets amid intensifying
competition from the likes of
) Prime and HBO.
Nevertheless, we believe that Netflix's expanding content
portfolio, innovative show pipeline for the second half and
robust on-demand viewing from international consumers are the
major positives that will continue to boost its top line. The
partnerships with Virgin Media and TiVo will help Netflix to
easily penetrate the European markets, which will be a key
growth catalyst, in our view.
Currently, Netflix has a Zacks Rank #3 (Hold).
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