Netflix's 3rd-quarter earnings blow through Wall Street's expectations

Ernesto S. Ruscio/Getty Images for NetflixReed Hastings is the CEO of Netflix.

Netflix’s third-quarter earnings crushed Wall Street’s expectations thanks to a surge in subscribers, but the streaming-media giant warned investors that the costs of developing original content will take a bite out of its profit at the end of the year.

Netflix added 6.96 million new subscribers in Q3, well above the 5.3 million new subscribers it reeled in at this time last year and the roughly 5 million expected by analysts.

The better-than-expected subscriber additions, combined with some one-time accounting-related benefits, helped Netflix handily beat Wall Street profit targets. The company posted a profit of 89 cents a share in its most recent period, a full 21 cents a share better than analysts polled by Bloomberg had forecast.

Netflix’s stock was up $US41.72, or 12%, to $US388.12 a share in after-hours trading on Tuesday. Earlier in after-hours exchanges, the stock had been up as much as 15%.

Even as investors cheered the good news, Netflix warned that its per-share earnings in the fourth quarter would be just 23 cents a share – less than half of what Wall Street had predicted. Netflix said its bottom line would be weighed down by having to recognise on its income statement the money it’s invested in licensing and developing movies and shows, particularly its “Originals.”

Netflix said it would continue to invest heavily in content, and stressed the increasing competition it faces from giants like Apple and Amazon in its quarterly letter to shareholders.

“Content companies such as WarnerMedia and Disney/Fox are moving to self-distribute their own content; tech firms like Apple, Amazon and others are investing in premium content to enhance their distribution platforms. Amid these massive competitors on both sides, plus traditional media firms, our job is to make Netflix stand out so that when consumers have free time, they choose to spend it with our service,” Netflix said.

Here’s what Netflix reported, compared with analysts’ forecasts:

  • Q3 revenue: $US4 billion. Analysts were expecting $US4 billion also. In the same quarter last year, Netflix pulled in $US2.98 billion in sales.
  • Q3 earnings per share (GAAP): 89 cents. Wall Street was looking for 68 cents a share. In last year’s third quarter, it earned 29 cents a share.
  • Q3 subscriber additions: 6.96 million. In the same period last year, Netflix added 5.3 million subscribers
  • Revenue, Q4 forecast: Netflix’s projects it will post $US4.2 billion. Before the report, analysts had predicted it would pull in $US4.23 billion. In the fourth quarter last year, Netflix saw sales of $US3.29 billion.
  • Earnings per share, Q4 forecast: The company expects 23 cents. Wall Street had projected it would earn 50.4 cents a share. In the same quarter last year, it posted a profit of 41 cents a share.
  • Subscriber additions, Q4 forecast: Netflix said it will add 9.4 million. In the holiday period last year, it added 8.33 million.

Netflix’s stock closed regular trading Tuesday up $US13.27 a share, or 4%, to $US346.40.

Netflix’s investments in shows, movies catching up

The company expects its profit to plunge in the fourth quarter because of its content costs.

Netflix has been investing billions of dollars a year to licence and develop shows and movies for its streaming services. It recognises those costs on its income statement over time, usually in sync with when the movies and shows become available to viewers.

Big MouthNetflixBig Mouth is among Netflix’s popular catalogue of original programs

Because of those costs, the company expects its operating margin – which is its profit before interest expenses, interest and other income, and taxes – to plunge, from 12% of revenue in the just-completed quarter to 4.9% in the holiday period. The company still expects to post a full-year operating margin of between 10% and 11% of sales.

“We would have preferred our operating margin to have been a little steadier over the course of the year, and we will target a little less quarterly variance next year in our progress to our full year target of 13%,” the company said in a letter to shareholders.

Meanwhile, the company’s third-quarter results were boosted in part by several one-time accounting items.

It got an $US8 million gain from remeasuring its euro-denominated bonds. It also saw a $US38 million tax benefit that was a result of last year’s tax law. Together, those two windfalls accounted for about 10 cents of its 21-cent-per-share earnings beat.

But the company also benefited from signing up lots more new subscribers than it expected. Its tally for the quarter was 2 million higher than it had forecast.

Despite the blowout quarter and the better-than-expected reported earnings, Netflix is still burning through cash fast.

In the quarter, the company’s free cash flow – which represents the amount of cash generated by or used up in its operations less the amount it spends on in things like equipment and new content and capital investments – ran in the red, to the tune of $US859 million. That was up from a deficit of $US465 million in the same period a year earlier.

The company expects its negative free cash flow for the year to be between $US3 billion and $US4 billion, though more likely closer to the former.

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