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Netflix (NFLX +1%) is trading slightly higher today following its Q2 earnings report. The stock initially traded sharply lower following the report but recovered during the call. NFLX reported a nice double-digit EPS beat with modest revenue upside. The Q3 guidance was mixed with upside EPS but revenue was a bit light. Netflix did tweak its FY24 revenue guidance slightly higher to +14-15% from +13-15%.

• Let's dig into it. Global streaming paid net adds in Q2 were a healthy +8.05 mln, which was above street estimates. A dip was expected from Q1's +9.33 mln. Netflix no longer provides specific net add guidance, but did say 3Q24 will be lower than 3Q23's +8.76 mln, which benefitted from being the first full quarter with paid sharing. In simple terms, Netflix started cracking down on password sharing last summer and that boosted net adds.
• Netflix had a wide variety of hit series in Q2, including Bridgerton S3, Baby Reindeer, Queen of Tears along with popular films like Under Paris, Atlas and Hit Man and The Roast of Tom Brady, which attracted its largest live audience yet. Of note, Netflix began testing a new, simpler and more intuitive TV homepage in June, which it believes will significantly improve the discovery experience on Netflix.
• Advertising was a bright spot in Q2. Netflix says it's making steady progress scaling its ads business. Ads tier membership grew 34% sequentially. Also, NFLX is building an in-house ad tech platform that it will test in Canada in 2024 and launch more broadly in 2025. NFLX says this will give advertisers new ways to buy, insights to leverage and ways to measure impact.
• NFLX says its ad revenue is becoming a more meaningful contributor to its business. However, building a business from scratch takes time. The company conceded that a near term challenge is that it's scaling faster than its ability to monetize its growing ad inventory. It is adding more sales and operations people to help.
• Another metric that stands out is operating margin, which we think will become a more important measuring stick as NFLX phases out reporting its net add metric in 1Q25. In Q2, it came in at 27.2% vs 26.6% prior guidance. It also raised its FY24 forecast to 26% from 25% and guided for Q3 at 28.1%. However, NFLX cautioned that margins could bounce around in any given year with FX and content spend, and other investment opportunities.

Overall, Netflix's Q2 report had some cross currents. It posted nice EPS and operating margin upside. Also, net adds were quite good. We had been bracing for some headwinds given that Q2 marked the third full quarter of cracking down on password sharing. The positive effect wears off over time. On the negative side, Q3 revenue guidance was a bit light and NFLX's comments about monetizing the ads business were a bit worrisome. Hence, the stock is trading roughly flat.