Netflix (NFLX) is trading lower today after it reported Q1 results. EPS came in at $0.40, which was better than prior guidance of approx $0.37 while revenue rose 34.7% year/year to $2.64 bln, which was in-line with market expectations. In terms of Q2 guidance, NFLX expects EPS of $0.15, which was quite a bit below market expectations.
Net subscriber additions (streaming) in Q1 came in at +4.95 mln (+1.42 in US and +3.53 international), which was below prior guidance of +5.2 mln and below its prior year performance of +6.74 mln. In terms of guidance for net adds, the company expects Q2 to come in around +3.2 mln (+0.60 in US and +2.60 international). As you can see, most of NFLX's subscriber growth is coming from outside the US. With that said, international net additions in Q1 decreased 22% YoY as the company lapped its January 2016 launch of over 130 countries, and the accompanying early surge demand.
Due to content (primarily House of Cards season 5) moving from Q1 to Q2, NFLX had higher operating margins in Q1 at 9.7% than its plan for the year (about 7%). NFLX forecasts operating margin at 4.4% in Q2, placing the company on track to reach its 7% target for the full year. The other effect of the content moves is lower net adds in Q1 compared to prior year and heavier net adds in Q2 compared to prior year (about double).
Key releases in Q1 include A Series of Unfortunate Events, a dark comedy for the entire family, Santa Clarita Diet, a "zom-com" starring Drew Barrymore and Ultimate Beastmaster, Netflix's first competition show which pits athletes from around the globe against a fearsome 600-foot obstacle course. In addition to these titles, on March 17, NFLX debuted Marvel's Iron Fist, which has quickly become another highly viewed Marvel series. Netflix has also stepped up its investment in stand up comedy. Early results are promising; the triumphant return of a comedy legend in Dave Chappelle: Collection 1 was NFLX's most viewed comedy special ever.
As always, NFLX's product team has dozens of tests running in the endless quest for even higher member satisfaction. One test that won conclusively last year and has now been rolled out to all members is its new "thumbs-up thumbs-down" feedback model, replacing the 5-star model from its DVD days. The amount of usage with this new approach is over twice as many ratings.
On the competitive front, Netflix says its investors often ask about ecosystem changes, such as the advent in the US of virtual MVPDs (like Sling, PlayStation Vue, DirecTV Now, YouTube TV and Hulu's forthcoming service). NFLX believes VMVPDs will likely be more directly competitive to existing MVPD services since they offer a subset of the same channels at $30-$60 per month, and may appeal to a segment of the population that doesn't subscribe to a pay TV bundle.
But Netflix does not think it will have much of an impact as Netflix is largely complementary to pay TV packages. Also, Netflix's focus is on on-demand, commercial free viewing rather than live, ad-supported programming. Additionally, investors ask about Amazon's move into NFL football. NFLX says that's not a strategy that is smart for NFLX since it can earn more viewing and satisfaction from spending that money on movies and TV shows.
In sum, this was a decent quarter for NFLX but not great. The downside Q2 EPS guidance coupled with Q1 net subscriber adds not living up to guidance is weighing on the stock this morning. With that said, it's down only about 2-3% in early trading, so not a huge move at this point. It seems investors are giving NFLX a pass on sub adds as House of Cards was pushed back into Q2 from Q1. And some big releases in Q2 are expected to weigh on margins which explains much of the Q2 EPS shortfall.
All in all, the stock has been making a nice run in recent months, so expectations may have gotten ahead of themselves. The longer term trend seems to remain in place. NFLX says it has come to see these quarterly variances as mostly noise in the long-term growth trend and adoption of internet TV. For example, in 1H17, NFLX expects to have 8.15 mln net adds, compared to 8.42 mln net adds in 1H16.