The 3 Things to Look for in Netflix Earnings

Updated from July 18th to include comments from BTIG analyst Richard Greenfield. 

NEW YORK (TheStreet) -- Since we last checked in on Netflix  (NFLX) financials, the online streaming company has been fortunate enough to welcome a lot of good news.

TheStreet's Keris Lahiff previews Netflix's results:

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On the content production side, the Los Gatos, Calif.-based company has gone up against heavy-hitter HBO and proven itself equal to the premium cable channel in terms of quality of output. Any doubts as to whether its original series Orange is the New Black would be a one-hit wonder were put to rest when the second season premiered in June (all at once, binge-style) to positive critical reviews and fan reception.

Netflix's conviction in its original programming strategy was affirmed in early July when Emmy nominations for the 66th Primetime Emmy Awards were announced. Orange received 12, the most for any comedy, three for political drama House of Cards, already winner to three previous Emmys, and one for Ricky Gervais' Derek.

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Netflix is shopping its expansive library to new international markets as it commits to becoming a global force in online video. The company announced in May plans to significantly expand in Europe by the end of the year, notably in Germany, Austria, Switzerland, France, Belgium and Luxembourg.

In the same month, Netflix notified domestic users of a price hike for new members to $8.99 from $7.99, with existing members being grandfathered into the new pricing scheme over two years. While possibly only an incremental increase to revenue over the second quarter (based on the uptick in new subscribers), the extra cash generated from the raise has been bookmarked for investing in more content, which in turn will incent new subscribers into the fold.

The Fundamentals

This has encouraged high expectations among analysts when the Internet TV network reports second-quarter earnings after the bell Monday, July 21. "While investor expectations have increased recently, we believe they remain achievable," wrote Pacific Crest Securities analyst Andy Hargreaves in a note.

Analysts polled by Thomson Reuters anticipate earnings to have more than doubled to $1.15 a share from 49 cents a year earlier, even as the company invests more in production and international expansion.

Revenue is expected to grow nearly 25% to $1.33 billion from just over $1 billion in the year-ago quarter. Analysts also expect sales to climb 5% sequentially, despite the company warning that its second quarter is typically seasonally weak, a byproduct of summer months in the U.S., its largest revenue-generating market.

The May price hike should give a slight bump to top- and bottom-line growth, though it remains to be seen whether the increase deterred new customers from signing up past the one-month free trial period.

Subscriber Growth

Subscriber growth is the significant metric analysts look at to determine the company's recurring revenue stream potential. Strong growth in international net additions, in particular, will be in focus to offset an expected slowdown in domestic growth. Netflix guides for domestic net additions of 520,000, nearly 18% lower than growth a year earlier, while international subscription estimates of 940,000 adds represents a 54% growth rate. At that rate, Netflix will have ended its second quarter with 36.2 million domestic subscribers and 13.6 million international subscribers, for a total 49.8 million worldwide.

Wedbush Securities' Michael Pachter expects a second-quarter beat in adds with the popularity of original programming compensating for seasonal weakness. The firm expects domestic net subscriber additions in line with Netflix's estimate, and international subscriber additions of 1 million.

Likewise, JPMorgan analyst Doug Anmuth (who hosts the investor call along with BTIG analyst Rich Greenfield) expects international strength to offset slight weakness domestically. "We continue to believe the company will add more subscribers in the U.S. in 2014 than in 2013," he wrote in a research note, "however, there is likely greater near-term upside in international streaming, where we project 938,000 net adds in Q2 and 6.5 million for the full year."

Netflix's international markets (servicing more than 40 countries) generate about a quarter of total revenue, so ramping up growth will ensure Netflix holds the title of leading Internet television network. Of course, dominance at home is also crucial, though it isn't at risk of losing its leader status yet. Over the first half of 2014, Netflix accounted for 34.2% of downstream traffic over the peak period, according to networking company Sandvine. YouTube came in second, owning more than half that at 13.2% share of downstream traffic.

Investors will also be asking, "Where next?" Greenfield, in a BTIG note earlier, questions whether management will give any indication of a move into China. Continental Europe will be the major focus in 2015, but Asia would be "the next major untapped, but far more challenging region."

Expansion costs

Investors will be watching for how Netflix is tracking in its international expansion efforts, particularly whether the company will give a timeline for when the service will launch in major markets Germany and France. Though expansion could prove costly, Pacific Crest analyst Andy Hargreaves believes expenses will come in lower than expected, driving second-half profitability above estimates.

"Our estimates assume Netflix's recently announced new European markets will cost approximately $3 per broadband household to enter. If Netflix enters some or all of the new markets in Q3, the initial costs should be included in guidance and could indicate costs that are meaningfully below our current estimates, which would likely drive upside to our Q4 and 2015 profit estimates," Hargreaves wrote in a note.

Continued expansion will be crucial to market penetration. Goldman Sachs analyst Heath P. Terry penned in a note, "We believe Netflix could reach 62mn subs by 2017 while driving 20% margins in that business, even as the company continues to invest. This would represent 30% penetration internationally vs. HBO currently at 33%. We look for incremental color around its plans in new markets such as France and Germany."

Bottom line though, with so many other companies stepping into and ramping up online video, the key theme will be whether Netflix can continue to expand and hold its undisputed lead or see growth plateau, making it that little bit easier for competitors to catch up.

--Written by Keris Alison Lahiff in New York.

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