Tech

Netflix shares fall after earnings miss, weak subscriber guidance for third quarter

Key Points
  • Netflix missed analyst expectations on earnings per share but beat revenue expectations.
  • The company provided weak subscriber growth guidance for the third quarter, saying, "growth is slowing as consumers get through the initial shock of Covid and social restrictions."
  • The company announced that Netflix Chief Content Officer Ted Sarandos will become co-CEO alongside current CEO Reed Hastings.
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Netflix reported a massive surge in users as people stayed home due to the coronavirus, but the company's stock dropped almost 9% after hours on guidance for new subscribers that was less than half what analysts expected.

Simultaneously, the company announced that Ted Sarandos was being promoted to co-CEO, elevating him from chief content officer.

Netflix's results for the second quarter reflect for the first time how business looked during three full months of a pandemic. Netflix missed analyst expectations on earnings per share largely due to a one-time charge in California related to research and development tax credits. But the company beat expectations for revenue and global paid net subscribers. 

Here are the key numbers:

  • Earnings per share (EPS): $1.59 vs. $1.81 expected, according to Refinitiv survey of analysts
  • Revenue: $6.15 billion vs. $6.08 billion, according to Refinitiv
  • Global paid net subscriber additions: 10.09 million vs. 8.26 million expected, according to FactSet

Hastings confirmed in the company's earnings video that he plans to stick around for a while.

"I'm in for a decade," he said.

Along with becoming co-CEO, Sarandos will retain his current role and join the board. Chief Product Officer Greg Peters will take on the added position of chief operating officer, Netflix said.

Netflix provided third-quarter revenue guidance of $6.33 billion, below analyst estimates of $6.40 billion, according to Refinitiv. It expects third quarter earnings of $2.09 per share, above analyst estimates of $2.01.

Netflix expects 2.5 million net subscriber additions for the third quarter, while analysts were expecting 5.27 million.

Executives said in the shareholder letter that "growth is slowing as consumers get through the initial shock of Covid and social restrictions. Our paid net additions for the month of June also included the subscriptions we cancelled for the small percentage of members who had not used the service recently."

Netflix, which in the past has named everything from Snapchat to sleep a competitor, now counts social media app TikTok among its rivals.

"TikTok's growth is astounding, showing the fluidity of internet entertainment," the company wrote to shareholders. "Instead of worrying about all these competitors, we continue to stick to our strategy of trying to improve our service and content every quarter faster than our peers. Our continued strong growth is a testament to this approach and the size of the entertainment market."

Netflix said it does not expect its 2020 slate of content to be significantly impacted by production shutdowns created by the pandemic. It expects that current production setbacks will push more of its big titles to the end of 2021, but that the "total number of originals for the full year will still be higher than 2020." Netflix plans to supplement its original content with other films and shows it's acquired.

Netflix said it's made the most progress resuming production in Asia Pacific and never fully shut down in Korea. It's resumed some production in Europe as well as two stop-motion animation projects in Oregon and two films in California. But the company warned that "current infection trends create more uncertainty for our productions in the US. Parts of the world like India and some of Latin America are also more challenging and we are hoping to restart later in the year in these regions."

The company said its net cash in operating activities was +$1 billion compared to -$544 million in the same period last year. Netflix was free cash flow positive for the second consecutive quarter, coming in at +$899 million versus -$594 million in the second quarter last year. The company said its growing operating margin has helped its free cash flow profile, along with content spending being pushed into the second half of 2020 and into next year. Netflix expects free cash flow for the year to be breakeven or positive, though it expects to dip into the negative again next year.

The company expects to see a 16% operating margin for the year and 19% for 2021. Hastings described that as "tamping down the expectations."

"This is a great growth opportunity for us, so any revenue upside we would tend to put into more content for our members, which tends to generate more growth over time," Hastings said.

Netflix revealed some viewership numbers in its earnings report. "Never Have I Ever," the coming of age series by Mindy Kaling, saw 40 million households choosing to watch the show in its first four weeks on the service, according to Netflix. And Spike Lee's film "Da 5 Bloods" was viewed by 27 million households, Netflix said. However, Netflix changed the way it counts views last year, and now counts a view as a household watching at least two minutes of a show or movie. In the third quarter Netflix expects shows and films with big stars to drive engagement, such as "The Old Guard" with Charlize Theron and "Project Power" with Jamie Foxx.

Disclosure: NBCUniversal is the parent company of CNBC.

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