5 Things Netflix, Inc. Management Wants You to Know

By Markets Fool.com

Streaming video pioneer Netflix reported its first quarter results last week, and once again, it managed to beat lofty Wall Street expectations.

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Earnings per share declined to $0.38 from $0.86 in the prior-year period due to a foreign currency adjustment, but underlying operating income was roughly flat despite massive growth investments. More importantly, Netflix added 4.88 million subscribers last quarter, which was significantly better than its guidance for 4.33 million net adds.

Netflix is continuing to grow its subscriber base at a rapid rate.

Following the earnings release, management hosted its customary earnings interview with two analysts. Here are five key points Netflix leadership emphasized during the interview.

Subscribers sticking around

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But we did see improving churn. So we are saying that we saw improving retention through the quarter, and that contributed to that net add performance and growth that we saw in Q1.-- CFO David Wells

Just a few years ago, Netflix was losing about 4% of its U.S. subscribers every month. A cancellation rate of that magnitude would dramatically constrain growth over time. At its current size, a 4% "churn" rate would mean that nearly 20 million customers were canceling each year!

While Netflix no longer reports its churn rate, it has said several times over the years that churn is falling. A growing library of original content has been a big help in getting subscribers to stick around. This is enabling Netflix to maintain its strong growth rate.

Well on the way to the long-term goal

And so, yes, 60 million to 90 million [U.S. subscribers] feels great to us. We're continuing to grow.-- CEO Reed Hastings

Falling churn and strong interest from new customers helped Netflix add 2.28 million subscribers in the U.S. last quarter, which was slightly more than the 2.25 million it added in the first quarter of 2014. This brought its U.S. subscriber total to 41.4 million, up by 5.73 million year-over-year.

Hastings has long talked about having a long-term market opportunity of reaching 60 million to 90 million subscribers in the U.S. Based on the recent growth rate, the company could enter that long-term target range just three to four years from now.

Sizing up international losses

I don't provide specific guidance four or five quarters out for operating loss. But we've said that we're committed to running the business at global breakeven, and we have ambitious plans to launch international.-- CFO David Wells

Having become so successful in the U.S., Netflix is aggressively expanding internationally in order to replicate its first-mover advantage in other countries. However, opening new markets is incredibly expensive. In fact, while some foreign markets are profitable, Netflix has never earned a quarterly profit for its full international segment.

The international contribution loss was $65 million last quarter. In the second quarter, it is projecting an even larger $101 million contribution loss due to the costs of its recent launch in Australia and New Zealand, as well as increased marketing efforts. That would be one of its biggest quarterly losses yet.

Netflix CFO David Wells warned investors last week to expect even bigger international losses ahead as the company moves to complete its global rollout by the end of 2016. He would not quantify just how large the losses could get, but at least he confirmed that Netflix wants to (at worst) break even on a global basis despite its expansion costs.

Expect more negative free cash flow

But in general, we're building out our content investment, our original content investment. And that is cash intensive [...] I think what you're going to see now is several persistent quarters, and going forward, of negative free cash flow, while we build this out.-- CFO David Wells

While Netflix plans to run its business at break-even or better for the next couple of years, that only refers to its accounting earnings. On a cash basis, it is burning through quite a lot of money these days. Last quarter, the company generated negative free cash flow of $163 million.

Netflix is posting negative free cash flow due to heavy spending on original content

The difference is mostly attributable to original content, which requires significant upfront payments. With Netflix rapidly growing its original content production, its free cash flow situation could get worse before it gets better. But if the resulting content attracts lots of new members, the investment will be well worth the money.

Don't expect sports anytime soon

I think part of our core consumer proposition is on demand. We make viewing certain kinds of content better, because they're on demand. And I don't know that on demand sports is markedly better than live sports. So that's why we haven't been that excited about it.-- Chief Content Officer Ted Sarandos

Netflix is loaded with all kinds of content: feature films, TV shows, documentaries, stand-up comedy specials, etc. One thing that has been conspicuously absent is sports content.

Netflix fans should not expect that to change. Management continues to believe that it should focus on types of content for which users strongly prefer on-demand viewing. Most people want to watch sports events live, so Netflix plans to leave that content category to other providers.

The article 5 Things Netflix, Inc. Management Wants You to Know originally appeared on Fool.com.

Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.