Brazil's tax shock, Netflix's Q3 earnings far below expectations, lowered full-year guidance, and dropped 7% in after-hours trading | Earnings report insights
In the third quarter, Netflix's revenue grew by more than 17% year-on-year, in line with analyst expectations; advertising revenue reached a record high for a single quarter; net profit and EPS earnings were at least 14% lower than expected; operating profit margin fell to 28.2%, with a $619 million expense related to a tax dispute in Brazil causing a 5 percentage point decline in profit margin. Without this expense, the profit margin could have exceeded the company's guidance of 31.5%. Netflix expects that the tax dispute will not have a significant impact on future performance, but due to tax issues, it has lowered this year's operating profit margin guidance from 30% to 29%; it expects advertising revenue to more than double this year and has raised the full-year free cash flow guidance by 9%
American streaming giant Netflix reported a "surprise" performance in the third quarter: although price increases and strong membership growth drove the company's advertising revenue to a record high, unexpected expenses from a tax dispute with the Brazilian tax authorities led to profits falling far short of expectations, prompting a downward revision of the annual profit margin guidance.
Netflix's revenue in the third quarter was roughly in line with expectations, maintaining double-digit growth, but earnings per share (EPS) and net profit were well below Wall Street's expectations. Netflix did not significantly adjust its full-year revenue guidance but slightly lowered its operating profit margin guidance. The company stated that this year's advertising business revenue reached a quarterly high, without disclosing specific business scale.
After the earnings report was released, Netflix's stock, which had risen slightly by over 0.2%, plummeted in after-hours trading, with a decline of up to 7.5%. Netflix's stock had previously reached an all-time high of nearly $1,340 on June 30, but has since fluctuated downward. The second-quarter earnings report released in late July failed to boost the stock price, and by the close of trading this Tuesday, it had fallen more than 7% from its record closing high.
On October 21, Eastern Time, Netflix announced its financial performance for the third quarter ending September 30 and provided financial guidance for the fourth quarter and the full year.
1) Key Financial Data:
Revenue: Third-quarter operating revenue was $11.51 billion, a year-on-year increase of 17.2%, with analysts expecting $11.52 billion, compared to a year-on-year growth of 15.9% in the second quarter.
Operating Profit Margin: The operating profit margin for the third quarter was 28.2%, with Netflix's own guidance at 31.5%, compared to 34.1% in the second quarter and 29.6% in the same period last year.
Net Profit: Third-quarter net profit was $2.547 billion, a year-on-year increase of 7.7%, with analysts expecting about $3 billion, and Netflix's own guidance at $2.979 billion, compared to a year-on-year growth of nearly 45.6% in the second quarter.
EPS: The diluted EPS for the third quarter was $5.87, a year-on-year increase of 8.7%, with analysts expecting $6.94, and Netflix's own guidance at $6.87, compared to a year-on-year growth of 47.3% in the second quarter.
Free Cash Flow: The third-quarter free cash flow was $2.66 billion, a year-on-year increase of 21.2%, compared to a year-on-year growth of 86.9% in the second quarter.
2) Performance Guidance:
Revenue: The expected revenue for the fourth quarter is $11.96 billion, with analysts expecting $11.9 billion, and the expected full-year revenue is $45.1 billion, with analysts expecting $45.02 billion. The company previously expected $44.8 billion to $45.2 billion.
EPS: The expected EPS for the fourth quarter is $5.45, with analysts expecting $5.42
Operating Profit: Expected operating profit of $3.63 billion in the fourth quarter, with an operating profit margin of 23.9% for the quarter, and an expected annual operating profit margin of 29%, down from the previous estimate of 30%.
Free Cash Flow: Expected annual free cash flow of $9 billion, fluctuating by a few hundred million dollars, with the previous estimate being $8 billion to $8.5 billion.
Net Profit and EPS Lower Than Expected by at Least 14% Due to $619 Million Tax Dispute in Brazil
The financial report shows that Netflix's revenue in the third quarter maintained double-digit growth, with the year-on-year growth rate slightly accelerating from nearly 16% in the second quarter to over 17%, which is basically in line with expectations. However, profit growth significantly slowed compared to the second quarter.
The operating profit margin in the third quarter fell below 30% to about 28%, returning to a low for the year. The net profit growth rate slowed from nearly 46% in the second quarter to less than 8%, and EPS growth slowed from over 47% in the second quarter to less than 9%, both about 15% lower than analyst expectations and at least 14% lower than Netflix's own guidance.
Netflix attributed the disappointing profit to a dispute with the Brazilian tax authorities. To settle this dispute, which dates back to 2022, Netflix paid approximately $619 million in the third quarter. Although the company had previously disclosed potential risks in documents submitted to regulators, it did not include the related potential expenses in its performance guidance.
In its shareholder letter, Netflix stated that the expenses related to the Brazilian tax dispute caused the company's operating profit margin to decline by more than 5 percentage points in the third quarter. Without this expense, the operating profit margin could have exceeded the company's guidance of 31.5%.
Netflix indicated that it expects the Brazilian tax issue "will not have a significant impact on future performance." However, considering this tax impact, Netflix has slightly lowered its annual operating profit margin guidance from 30% to 29%.
Netflix expects the operating profit margin in the fourth quarter to further decline to a one-year low. Its revenue and EPS guidance for the fourth quarter are both slightly above analyst expectations. The annual revenue guidance of $45.1 billion is slightly higher than the previous midpoint guidance of $45 billion and also slightly above analyst expectations.
Advertising Sales Reach Record High in a Single Quarter
Netflix reported that third-quarter advertising sales set a record for a single quarter, with this year's advertising revenue expected to more than double compared to last year. Revenue growth is driven by membership growth, price increases, and increased advertising revenue. The company raised subscription prices in January this year, including fees for ad-supported plans.
EMarketer senior analyst Ross Benes noted: "Netflix has had its best advertising sales quarter to date, but has yet to disclose the specific scale of its advertising business. This gives the impression that the sustained revenue growth achieved this quarter and the projected growth for the next quarter will primarily still come from subscription fees."
Analysts are questioning whether Netflix's pricing power is nearing a short-term peak.
Content Lineup Sets Viewership Records
Despite facing tax issues, Netflix attracted record user engagement in the third quarter with a strong content lineup. The animated film "Kpop Demon Hunters" became the most-watched film in the platform's history, with over 325 million views. The popular series "Wednesday" Season 2 and the comedy sequel "Happy Gilmore" also performed well In addition, Netflix also live-streamed the popular boxing match between Canelo Alvarez and Terence Crawford.
The company emphasized in its letter to shareholders that user engagement in the third quarter reached an all-time high, addressing investor concerns about the slowdown in user watch time growth and fears regarding the potential threat of AI-generated videos. Currently, the vast majority of streaming growth is directed towards free services like YouTube, Roku, and Tubi.
The content lineup for the fourth quarter is even stronger, including the final season of "Stranger Things," the sequel to the mystery film "Knives Out," Guillermo del Toro's "Frankenstein," Rian Johnson's "Wake Up Dead Man: A Knives Out Mystery," and a new work by American director Kathryn Bigelow.
Netflix will also live-stream two NFL games on Christmas Day.
Strong Cash Flow Supports Expansion Plans
Despite having a large content lineup, Netflix generated $2.66 billion in free cash flow in the third quarter, exceeding Wall Street expectations, and raised its full-year forecast to about $9 billion, nearly a 9.1% increase from the company's previous annual guidance median.
The company will use some of the funds for stock buybacks and content investment while revealing potential acquisition possibilities. According to previous reports, Netflix has expressed interest in acquiring certain assets from Warner Bros. Discovery.
Netflix is seeking growth in new areas such as advertising and video games, and currently, the company has over 300 million users worldwide. It faces competition from platforms like YouTube, Amazon Prime Video, and Disney+.
Netflix also announced a collaboration with toy giants Hasbro and Mattel to launch toy merchandise around "Kpop Hunter Girl Group," with related products set to hit the market in spring 2026
