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Netflix Inc.’s (NFLX - Analyst Report) first quarter 2012 loss per share of 8 cents not only bettered the Zacks Consensus Estimate of a loss of 28 cents, but was also significantly above management’s guided range of a loss of 49 cents to a loss of 16 cents per share. However, when compared on a year-over-year basis, Netflix’s loss per share had plummeted from earnings per share (EPS) of $1.11.

Quarter Details

Total revenue increased 21.0% year over year to $869.8 million, ahead of the Zacks Consensus Estimate of $867.0 million.

Domestic revenue increased 17.0% from the year-ago quarter to $826.4 million, which was within management’s guided range of $804.0 to $833.0 million. International operations generated revenues of $43.4 million, up 252.8% year over year and were at the higher end of management’s guided range of $38.0 million to $44.0 million.

The year-on-year revenue growth was primarily boosted by newer additions in the total subscriber base. At the end of first quarter 2012, total number of subscribers (Domestic and International) was 29.1 million, an increase of 23.3% from the prior-year quarter.

Gross profit decreased 12.3% from the year-ago quarter to $245.9 million. Gross margin decreased from 39.0% in the year-ago quarter to 28.3% due to higher subscriber acquisition costs.

Operating expenses shot up 39.1% year over year to $247.8 million, due to higher marketing expenses (up 30.3% year over year), technology and development expense (up 62.7% year over year) and general and administrative expense (up 26.5% year over year) in the quarter.

Operating loss for the quarter was $1.93 million, down from an operating profit of $102.2 million in the previous-year quarter. The loss was primarily due to increase in spending for streaming content and higher licensing fees.

Net loss was $4.58 million from a profit of $60.2 million earned in the previous-year quarter.

Balance Sheet and Cash Flow

Exiting first quarter 2012, Netflix had $804.5 million in cash and cash equivalents (including short-term investments) compared with $797.8 million in the previous quarter. Long-term debt was $200.0 million at the end of first quarter 2012.

Cash flow from operating activities was $19.1 million in the first quarter of 2012, compared with $65.5 million in the fourth quarter of 2011. Free cash flow was $2.1 million, down from $33.9 million in the previous quarter.

Quarter Ahead

For the forthcoming quarter, the loss/earnings per share is projected between a loss of 10 cents to profit of 14 cents per share. The Zacks Consensus EPS Estimate is pegged at a loss of 18 cents per share. Net income is expected to be in the range of ($6.0 million) to $8.0 million.

Domestic and International revenue is expected to be in the range of $526.0 million to $534.0 million and $60.0 million to $67.0 million, respectively. Domestic DVD revenue is expected to be in the range of $287.0 million to $294.0 million for the second quarter of 2012.

Management expects subscribers in the consolidated domestic market and in the international market to range from 23.6 million to 24.2 million and 3.45 million to 4.0 million, respectively. The U.S. DVD subscriber base is expected to be in the range of 8.95 million to 9.35 million.

Management expects the subscriber decline in the DVD business to continue in the forthcoming quarters. However, strong growth in streaming customer base in both US and International market will limit customer base erosion in 2012.

Moreover, Netflix hinted on European expansion in the fourth quarter of 2012 and expects to be profitable globally in the second quarter.

Our Recommendation

Although Netflix reported better-than-expected first quarter results, we believe that earnings growth will take some time to rebound. Despite the higher costs, we believe Netflix will probably see sales strengthening, as subscribers take note of the improving portfolio. This would ultimately enable the company to build a position for itself over the long term.

Netflix’s offering of new and exclusive content to its subscribers are its biggest USP compared to some of its closest peers. Apart from recent movies and documentaries, Netflix is also boosting its original content portfolio to entice new subscribers in the US and International markets.

However, higher capital expenditure due to international expansion will hurt earnings growth in the near term, in our view. Moreover, when compared to some of its cable and communications peers that have diversified revenue and cash flow streams, Netflix relies solely on streaming for future growth, as its DVD rental business continues to lose subscribers. Moreover, increasing competition from Amazon.com Inc. (AMZN - Analyst Report) will remain an overhang on the stock going forward.

We have a Neutral recommendation on Netflix shares over the long term. Currently, Netflix has a Zacks #3 Rank, which implies a Hold rating over the short term.

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