Netflix shares plunge on lower Q2 earnings, mixed subscriber results

Netflix (Nasdaq: NFLX) announced second-quarter earnings that included a return to profitability that still included 91 percent drop in net income. On top of that, the service provider announced mediocre subscriber gains and cautioned that things could be muddled in the third quarter because viewers might drift away to watch the London Summer Olympics.

As a result Tuesday, shares in the video rental business dropped about 17 percent, The Associated Press reported. Shares of Netflix dropped $13.39, to $67, in after-hours trading on the Nasdaq.

Statistically, things were not horrible for Netflix. The income results reflected an ongoing need by Netflix to pay the piper--or in this case TV- and movie studios--for the content it sells to streaming customers for $8 a month. Increased content charges--also being shouldered by MVPDs and other streaming services--caused the service provider to increase customer prices which, in its own turn, caused a drop in the number of new subscribers coming aboard.

Netflix added about 1.1 million subscribers in the quarter--about 50 percent fewer than its comparable period in 2010, the company said in a letter to shareholders, noting that "2011 is an anomaly due to our mid-year price changes." These additions are part of a trend that will be "more seasonal," the letter continued.

This is also the season of the Summer Olympics and, while more traditional pay-TV services expect to see a viewership jump based on live content the Games, Netflix, which streams TV shows (increasingly) and movies, sees a drop-off.

"The Olympics are likely to have a negative impact on Netflix viewing and sign-ups," the shareholder letter said, predicting 1 to 1.8 million domestic adds in the third quarter.

During a Q&A with analysts, Netflix Chairman-CEO Reed Hastings said the caution comes because "people are viewing the Olympics impartially instead of viewing Netflix."

Net income results were positive for the quarter ($6.164 million, compared to a loss of $4.584 million in the first quarter) but well below the $68.214 million the company reported in the second quarter of 2011. First-half to first-half, too, was a downer. For the first six months of this year, Netflix reported earnings of $1.580 million compared to $128,447 million for the same period in 2011.

International expansion is at least partially responsible for these figures, the company said in its shareholder letter because "our highly profitable U.S. business, both streaming and DVD, is funding our international expansion," the letter said. "In Q3 we expect to be profitable, while with the launch of a fourth international market in Q4, we will move to a consolidated loss."

The company also addressed its ongoing move towards streaming and away from DVD subscriptions where DVD subscriptions declined to 9.2 million in the quarter. About 6.7 million of those 9.2 million also subscribe to streaming, the shareholder letter said, noting that the company expects "DVD member declines will continue to moderate."

The biggest worries going forward are competition, but, Hastings said, that will come from MVPDs who are expanding their streaming offers via TV Everywhere, not other services like Google (Nasdaq: GOOG), Amazon.com (Nasdaq: AMZN) and Hulu.

"Google doesn't really have a subscription premium TV service at this point," Hastings said, pointing out that Netflix actually advertises on Google's YouTube service "which is very successful for us and for Google."

He pointed to Sandvine streaming data to support a claim that "we've got a huge lead and that lead is only growing" over Amazon and Hulu Plus.

The shareholder letter also dismissed the yet-to-be-launched Redbox Instant by Verizon (NYSE: VZ) streaming competition which, the letter said, "will face a big challenge to break into the top 3 of subscription streaming services."

The big competition comes from an old source of content provisioning, "MVPDs and cable networks, both directly and through their TV Everywhere offerings," the shareholder letter said. "MVPDs continue to improve their offerings and Comcast's (Nasdaq: CMCSA) X1 interface, shown off at the recent cable show, is an impressive and leading example of this work."

The best way to defeat these competitors is to move at what the shareholder letter called an "Internet pace, so that by the time Comcast broadly rolls out X1 over the coming years, we'll be another generation ahead in member-pleasing experiences."

For more:
 - see the earnings letter (.pdf)
 - read the earnings-call transcript
 - see the AP story

Special Report: IPTV earnings in the second quarter of 2012

Related articles:
Verizon, Redbox collaboration called 'Redbox Instant by Verizon'
Amazon strikes video licensing deal with Warner Bros.
Netflix streams record 1 billion hours of video in June
Netflix 'struggling' to remain profitable, analysts say

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