Netflix, Inc. Earnings: What Subscriber Growth Slowdown?

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For the past few months, Netflix (NASDAQ: NFLX) has been a battleground stock. Bulls have highlighted the huge year-over-year earnings growth that Netflix posted in Q1. Meanwhile, bears have noted that subscriber growth slowed significantly in the first quarter relative to the prior-year period -- and that Netflix stock trades for more than 100 times earnings.

In the second quarter, Netflix chipped away at the bear thesis by posting stellar subscriber growth in what is usually a seasonally weak quarter. Furthermore, operating income continued to rise on a year-over-year basis. Netflix's growth engine is still turning quickly.

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Netflix's second quarter by the numbers

Last quarter, revenue and operating income came in slightly ahead of the guidance that Netflix had provided in April. Contribution profits for the domestic and international segments were also modestly better than expectations -- but up significantly from Q2 2016. However, subscriber growth is where Netflix really excelled last quarter.

In April, Netflix projected that it would add 3.2 million subscribers in Q2. Instead, the company soared past that estimate, with 5.2 million net streaming subscriber additions during the quarter.

Most of the upside came from the international market, where Netflix beat its subscriber growth guidance by more than 1.5 million. However, even in the relatively mature domestic market, Netflix exceeded its subscriber growth forecast by nearly 500,000.

Growth is accelerating

Based on Netflix's guidance entering the second quarter, it appeared that membership growth would plunge by double digits in the first half of 2017. But when all was said and done, Netflix added 21% more subscribers in the first six months of 2017 than it did during the same period of 2016.

This accelerating subscriber growth is remarkable, because Netflix completed its global rollout in January 2016, boosting subscriber growth in the first few months of last year. By contrast, last quarter's wave of subscriber growth was driven primarily by excitement for Netflix's original series.

On the Q1 earnings call, Netflix CFO David Wells had noted that the company had a strong slate of original content scheduled for release during the second quarter. But even Netflix's top brass underestimated how consumers would respond to this content. The timing of original series releases is starting to outweigh seasonality in terms of driving subscriber growth.

Looking ahead

Netflix continues to invest huge amounts of money to expand its original content library. As a result, free cash flow has moved deeper into the red this year, even as Netflix has posted strong profit growth.

However, these investments will prove to be worthwhile if Netflix's original content continues to drive strong subscriber growth. Netflix is building up a huge base of relatively "sticky" recurring revenue. In the long run, rising subscriber revenue will drive strong free cash flow at Netflix.

Not surprisingly, bulls were delighted with Netflix's second quarter results. Netflix stock soared more than 10% in after-hours trading. Despite the stock's lofty valuation, Netflix shares could continue to march higher if the company's subscriber growth persists.

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Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Netflix. The Motley Fool has a disclosure policy.