Netflix earnings call: Pursuing higher margins, ads still growing

Netflix stock (NASDAQ:NFLX) had pared its heaviest immediate declines and was down 1.7% after hours as the company started an executive interview to handle analyst questions about its second-quarter earnings beat — and then the stock turned marginally positive afterward, as execs gave lengthy answers about the quarter and their outlook.

There was plenty to be pleased with, Chief Financial Officer Spence Neumann said as he addressed revenue growth drivers: “In terms of member growth and churn … I’d say the outsized paid net adds in the quarter was primarily driven by stronger acquisition, a little stronger than we expected, but also very healthy retention in the quarter, and that’s across all regions.”

Three factors likely drove the member growth, he said: “strong performance” of the content slate delivering across genres and regions; some positive impact from paid sharing that is “tougher and tougher” to tease out; and “at least on the paid member front, we’re also probably benefiting from that attractive entry point (price point and feature set) for our ads plan.”

The executives restated their commitment to growing margins, and noted they’re now targeting 26% operating margin, up from a prior 25%. That “could bounce around” from year to year because of foreign exchange or other considerations. “But we’re committed to grow margins each year, and we see a lot of room to continue to grow profit margin, absolute profit dollars, and do that over an extended period of time, for years to come,” Neumann said.

In an otherwise strong report, free cash flow was the one figure that might have showed a dent: it declined to $1.213B from a year-ago $1.339B (and last quarter’s $2.137B), falling well short of an expected $1.6B.

And while Netflix bumped up some of its full-year guidance on other figures, it stuck with its full-year forecast for $6B in free cash flow. (At the halfway point, free cash flow has hit $3.35B.)

“There’s always some uncertainty in terms of timing of things like content spend, sometimes timing of taxes. So that kind of keeps us right now, holding at approximately $6B, but no other read-through beyond that,” Neumann said in response.

Netflix said in its earnings report that advertising wasn’t a “primary” driver of revenue growth — and pressed on what that means for the future, Neumann said “We’ve been primarily focused on scaling reach. But if you think about even just the revenue portion of ads, it is growing nicely … it just happens to be growing off of a relatively small base, because we’re starting from only 18 months into ads.”

“So to have the kind of primary revenue impact across a business that has been primarily subscription for a long time, that just takes some time,” Neumann added.

As for the company’s competition, the execs signaled that big streaming has largely become a two-horse race — pointing to June Nielsen data showing Netflix (NFLX) and YouTube (GOOG) (GOOGL) as leaders in streaming share, with 8.4% and 9.9% share of TV time respectively.

Netflix and YouTube “represent about 50% of all streaming to the TV in the U.S. … So really, what we’re focused on here is … that other 80% of total TV time that isn’t going to either us or YouTube. So that’s a ton,” co-CEO Ted Sarandos said.