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Netflix's Profit Surprises as Firm Gains Wider Audience

July 26, 2005|Claire Hoffman | Times Staff Writer

Netflix Inc. showed it could fight off its bigger competitors, reporting Monday that second-quarter profit nearly doubled as it signed up new customers and contained marketing expenses.

The Los Gatos, Calif.-based company also reversed forecasts of a loss for the year and now expects to post a sizable profit. For the quarter, Netflix earned $5.68 million, or 9 cents a share, up from $2.89 million, or 4 cents, a year earlier.

Netflix's results underscore the strength of the burgeoning online rental business, in which customers receive through the mail DVDs they rent via the Internet. Netflix's success has cut into business at video rental giant Blockbuster Inc., which recently started its own online business to counter Netflix.

The Netflix report surprised analysts, who had predicted a second-quarter profit of 1 cent a share, according to a survey by Thomson First Call.

Netflix's stock climbed to $18.75 after hours after gaining 56 cents to $16.96 during regular trading.

Revenue for the quarter rose 37% to $164.5 million from $120.3 million a year earlier. Sales were a shade more than what analysts had predicted.

"I don't think we have ever felt better about the business than we do today," Netflix Chief Financial Officer Barry McCarthy said during a conference call with analysts.

Netflix executives also said they were reversing earlier forecasts that the company could lose as much as $15 million this year. They now expect a profit of $2.4 million to $11.9 million.

That reversal is particularly surprising after Blockbuster entered the online DVD rental market last year with an aggressive marketing campaign. Online powerhouse Inc. has launched a similar service in England, which some analysts believe will lead to the launch of a similar U.S. operation.

Netflix announced in May that it would take over the online rental operation of retailer Wal-Mart Stores Inc. after it was unable to make a significant dent in Netflix's business. Netflix executives said the alliance had little effect on second-quarter earnings and had added only about 100,000 subscribers.

Despite increased competition from Blockbuster, Netflix spent less than expected fending off the competition, which boosted earnings.

The company ended June with 3.2 million subscribers, a 53% increase over a year earlier. Industry estimates have put Blockbuster subscriptions at about 1 million.

"We are clearly winning the fight on all fronts," Netflix Chief Executive Reed Hastings said.

Hastings said Netflix planned to increase advertising spending to keep pace with growth. By the end of the year, he said, Netflix hopes to begin offering downloadable movies.

In an effort to counter Blockbuster's campaign for a larger share of the market, Netflix increased advertising and promotional spending and reduced its subscription price. It also offered a new cut-rate program for $9.99 a month.

"It looks like the threat from Blockbuster is much more diminished than before," said Safa Rashtchy, a senior analyst at Piper Jaffray & Co. "Online retailers in general are more agile and in the long term can generally win against the offline companies."

Other analysts, however, were concerned that Netflix was relying too much on cost cutting, especially in advertising, to boost earnings.

"I think these guys are attempting to save their way to prosperity," said Michael Pachter, an analyst at Wedbush Morgan Securities who covers Netflix.

For Netflix, the looming question is loyalty, with the company losing around 500,000 customers a quarter.

But Netflix executives urged analysts to look instead at the attrition rate for established customers, those who have been signed up with the company for at least a year.

They said that those customers had defected at a rate of less than 2.5% a month and that the low-cost subscribers also were less likely to discontinue the service.

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