Netflix Q3 Adds 2.4 Million Subscribers, Beats Forecasts, Net Profits

After half a year in misery that forced dramatic changes across the company and the entire streaming industry, Netflix bounced back in its third quarter earnings in a big way, topping forecasts, adding 2.4 million subscribers and even making money.

The company released results and an investor letter after markets closed Tuesday that also marked a return to the company’s traditional swagger, as it tweaked competitors for losing money, bragged about a string of big hits led by Dahmer – Monster: The Jeffrey Dahmer Story, and said viewer engagement far outstrips other major streaming services, “with room for growth.”

“After a challenging first half, we believe we’re on a path to reaccelerate growth,” the investor newsletter says. “The key is pleasing members. It’s why we’ve always focused on winning the competition for viewing every day. When our series and movies excite our members, they tell their friends, and then more people watch, join and stay with us.”

Netflix founder and Co-CEO Reed Hastings put it even more pungently during the subsequent earnings call: “Well, thank God we’re done with shrinking quarters. The guidance is reasonable, and we have to pick up the momentum. Everything lines us up for a good next year. We still have (foreign-exchange headwinds), that’s a huge hit. That’s not going to go away. Other than that, the stars are lining up really well.”

Shares, which had drooped 1.67% during the day, shot up more than 13% in initial after-hours trading, briefly topping $274 a share. That’s still far below the stock’s stratospheric heights of last November, when prices topped $685 a share.

Prices plummeted after a disastrous April earnings call, when the company reported its first drop in subscribers in a decade, followed a quarter later by an even bigger drop of about 1 million subscribers.

The relatively small initial drop, however, sent investors to the exit door, forcing the company to begin cutting spending, laying off hundreds of employees and contract workers, killing some projects, and most notably announcing a new ad-supported tier, which launches in 16 days.

Netflix’s drop also forced a reckoning on the rest of the industry as investors began looking at metrics beyond subscriber adds, and started pushing companies to say when they’d begin making money on streaming. For most, the answer is 2024 or after.

Netflix appeared to answer all those questions for itself on Tuesday:

• It’s beating forecasts, at least its own, as it slightly exceeded expected revenue, operating income and membership;
• It’s growing again, adding 2.4 million subscribers, to 223.09 million worldwide, a rise of 4.5% year over year;
• It’s making hits. Beyond Monster and some other Dahmer-related programming, the company debuted several other big hits, including Season 4 of Stranger Things (the season’s second half debuted at the very start of the quarter), Korean-made Extraordinary Attorney Woo, $200 million spy thriller The Gray Man, and romantic drama Purple Hearts;
• People are sticking around to watch a lot. Engagement – one of those newly valued Wall Street metrics – far exceeded competitors in the United States and United Kingdom, with 8.2 % of video viewing in the UK and 7.6% of U.S.;
• It’s making money, and everyone else isn’t: “Our competitors are investing heavily to drive subscribers and engagement, but building a large, successful streaming business is hard – we estimate they are all losing money, with combined 2022 operating losses well over $10 billion, vs. Netflix’s $5 to $6 billion annual operating profit.”

Co-CEO Ted Sarandos, who runs the programming side, said the company has released seven of its most-watched shows ever over the past few months, and it has paid off for the company’s bottom line: “Big shows that a lot of people talk about drive a lot of growth.”

The company’s fourth quarter is starting well too. Ryan Murphy’s Monster set viewership records, and the just released horror miniseries The Watcher, also co-created by Murphy, is similarly stacking up viewers, Sarandos said.

A string of other big shows are planned for Q4, beginning with the next season of Emmy winner The Crown, new seasons of Emily in Paris, Ginny in Georgia and Manifest, and a spinoff of long-time hit The Witcher. Also coming are shows from two big Hollywood names, Tim Burton’s Addams Family spinoff series Wednesday and Guillermo del Toro’s Cabinet of Curiosities.

The company reported $7.93 billion in revenue, up 5.9% year over year, but down slightly from Q2, which hit $7.97 billion. The company credited the higher revenue to more subscribers, up 5%

Net income hit $1.398 billion, and diluted earnings per share remained high at $3.10. Free cash flow topped $472 million, dramatically up from Q2’s $13 million, and the negative FCF of the second half of 2021.

The company forecasted a much tighter set of results for 2022’s last quarter, however, with another decline in revenue, to $7.78 billion, a big drop in net income to $163 million, and diluted earnings per share to 36 cents.

CFOCFO
Spence Neumann attributed the flattened results almost entirely to foreign-exchange problems that are dogging all U.S.-based international companies thanks to the strong dollar. Neumann said bad exchange rates will cost the company about $1 billion in revenues. The investor letter said the impacts would equate to 9% of year-over-year revenue growth.

Those F/X headwinds will blow despite a projected big bump in subscribers again, up 4.5 million in the quarter to 227.59 million worldwide, the company said.

At the same time, Neumann said the company expects free cash flow next year to increase “materially above (this year’s) $1 billion. We expect it to be significantly larger.”

LightShed Partners’ Rich Greenfield wondered in a note published before the earnings came out if Netflix’s “approach to advertising (is) primitive on purpose,” designed to milk the $65 billion or so spent annually in legacy broadcast and cable, rather than take on the data-informed precision of YouTube and Facebook. Those legacy ad revenues are seeing a significant outflow to connected TV and streaming as advertisers follow the shift in viewing habits.

COO Greg Peters said during the earnings call that initial demand for the company’s ad inventory is “very strong. People are excited about bringing their brands and their ads to consumers around the world.”

Company executives acknowledged the initial ad system will be more like what is done in legacy cable and broadcast, though with lighter ad loads and frequency capping. The less sophisticated approach was dictated in part by the speed with which the complex systems are being rolled out, initially in 12 countries around the globe just six months after announcing plans. Over time, the ad products will include much more of the sophisticated targeting and other features brands have become used to on the digital side.

“We’re very much in the crawl-walk-run model,” Peters said. “We’re building in a lot of capabilities over the next four quarters to make our offering more attractive. We have a lot more work do on that for brands.”

Also unclear, Greenfield wrote, is how Microsoft’s reported $5 billion in revenue guarantees over the next five years will impact Netflix’s Average Revenue Per User, another newly prized metric. Microsoft is Netflix’s technology partner on the ad tier.

Peters said the company doesn’t expect to see a lot of current subscribers switching down to the Basic Plus Ads tier when it rolls out. Rather, the opportunity they expect is more people, particularly among the 100 million or so who are using someone else’s account, will switch over to a lower-cost ad program.

“We believe this can margin accretive over time,” CFO Spence Neumann said. The impact of the new ad tier on revenues is “going to be pretty small out of the gates, as reflected in our guidance. We’re not expecting any material financial impact over this first partial quarter.”

Netflix has long wrung more revenue from its subscribers than most competitors, especially Disney, whose roughly equal global subscriber totals have been plumped by tens of millions of Indian subscribers paying far less per month for Disney+/Hotstar subscriptions.