The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.

Q1 EPS exceeded expectations. Non-GAAP EPS was $0.31 (excluding a $0.26/share debt extinguishment loss), compared with our estimate of $0.22, consensus of $0.19, and guidance of $0.00-0.23. The EPS beat was driven primarily by the aforementioned debt extinguishment loss, as well as better-than-expected gross margin, which more than offset higher-than-expected operating expenses. In addition, the company had a tax benefit from the retroactive reinstatement of the 2012 R&D tax credit that is not expected to occur again in Q2.

Domestic subs were at the high-end of bullish guidance, likely due to the debut of Netflix (NASDAQ:NFLX) exclusive House of Cards. It ended the quarter with 29.17 million total domestic streaming subs, compared with our estimate of 29.20 million, guidance of 28.5-29.2 million, and 27.15 million last quarter.

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We adjusted our FY estimates to reflect Q1 results, Q2 guidance, and the launch of another international market in 2H. We are lowering our 2013 revenue estimate slightly to $4.36 billion from $4.38 billion, but raising our EPS estimate to $1.07 from $0.94. We are decreasing our 2014 estimates for revenue to $4.98 billion from $5.00 billion and for EPS to $0.90 from $0.94.

It appears that Netflix’s Originals (exclusive streaming VOD rights) drove subscriptions in Q1, and will again drive subscriptions in Q2. Domestic streaming subscriptions were at the high end of guidance for Q1, and we believe they are likely to hit the high end of guidance for Q2…

In our view, much of the recent subscriber growth is an acceleration of subscriptions that would have been sold later in the year; accordingly, we expect Netflix to face a headwind in Q3 and Q4. We expect the benefit of originals House of Cards and Arrested Development to reverse when original content dries up in the third quarter.

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Cash flow remains negative. This suggests to us that content costs continue to rise, but are not amortized until later, meaning that net income will drop in future periods.

Maintaining our UNDERPERFORM rating, but raising our 12-month price target to $65 from $55, reflecting a sum-of-the-parts that values domestic streaming ($32.50/share), domestic DVD ($19.60/share) and international streaming ($7/share), plus net cash of $5.42/share.

Michael Pachter is an analyst at Wedbush Securities.



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