Yesterday Netflix (NASDAQ: NFLX) reported its second quarter financials for the year with less than stellar results. The company grew its subscriber base by 1.7 million new members, which was below the 2.5 million net new members expected and about half of net additions of 3.3 million members for the same period last year.

Investors expressed their displeasure on NASDAQ, with stock prices dropping 13 percent to $86.28 in (July 19) morning trading, said USA Today. At the end of business yesterday, July 19, Netflix’s stock was valued at $85.84 per share. By comparison, Netflix stock opened at $98.81 on Monday, July 18.

In a letter to shareholders, CEO Reed Hastings explained the quarterly results.

“We are growing, but not as fast as we would like or have been. Disrupting a big market can be bumpy, but the opportunity ahead is as big as ever and we continue to improve every aspect of the business,” Hastings said. “Gross additions were on target, but churn ticked up slightly and unexpectedly, coincident with the press coverage in early April of our plan to un-grandfather longer tenured members and remained elevated through the quarter.

“We think some members perceived the news as an impending new price increase rather than the completion of two years of grandfathering. Churn of members who were actually un-grandfathered is modest and conforms to our expectations. With our large subscriber base, slight variances in retention versus forecast can result in significant swings in net adds, particularly in a seasonally small net add quarter like Q2,” said Hastings.

Over the remainder of the year, Netflix will transition – un-grandfather – subscribers and move them to their updated three-tier pricing which also applies to new subscribers. In the U.S., those monthly price levels are $7.99, $9.99 for HD and $11.99 for UHD).

Shareholders first expressed their doubts about this price increase after Netflix posted its first quarter financials. Along with shareholder doubts, some subscribers have been quite vocal about their displeasure over the price increase. In fact, one Florida subscriber has gone so far as to file a class action lawsuit against Netflix for violating their agreement with him.

Despite the subscriber churn, Netflix posted positive results in other categories for Q2:

• Operating income was $70 million, compared to a forecast of $47 million
• Net income was $41 million, compared to a forecast of $9 million
• U.S. revenue rose 18 percent, year-over-year
• International revenue rose 67 percent, year-over-year

From a content perspective, Netflix has had lower costs than anticipated, boosting its bottom line. Its original programming received 54 Primetime Emmy nominations from 17 of its shows. Netflix has extended its licensing agreement with The CW Network and it will be the exclusive home of the highly anticipated new Star Trek series outside the U.S. and Canada.

“While we did not grow as fast as forecast in Q2, we are optimistic about the future owing to our singular focus, global scale and the growth of Internet TV viewing. We are in the very early days of the shift from linear television to on-demand viewing and there are nearly 1 billion pay TV subscribers worldwide who will migrate to Internet TV over the coming decades,” Hastings said in summary.

Insider Take:

While Netflix continues to do well in terms of income, revenue and subscriber growth, financial experts and investors expect a lot from this early pioneer of streaming video on demand, and they’re holding Netflix’s feet to the fire. Netflix must stay on pace, or their stock will keep dropping.

While Netflix has a solid growth plan in place and it remains the most popular of the SVOD services, the publicity it is receiving on the price increase could cause a big problem, not to mention the legal mess and expense that could come from a class action suit.

To some, a price increase of $2 a month is negligible. To others, it is a broken promise that is not easily forgivable. In a time where other alternatives exist, Netflix may be ignoring a blind spot here. The bad press alone has been damaging. Netflix needs to correct how it is handling the communication of the price increase to reduce the churn, and to offer incentives or run a  promotion to win back subscribers who have already left.