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[video] Netflix Soars on Q4 Beat (Update 2)

Updated from 4:25 p.m. to include information from the shareholder letter in the sixth through eighth paragraphs.

NEW YORK (TheStreet) -- Netflix (NFLX - Get Report) shares rose 16.2% to $388.00 after the online entertainment company posted better than expected fourth-quarter earnings.

The Los Gatos Calif.-based firm earned 79 cents a share on $1.175 billion in revenue, as it surpassed 33 million domestic streaming subscribers, ending the quarter with 33.42 million streaming subscribers, of whom 31.71 million were paying members. Streaming margins hit 23% in the fourth quarter.

Analysts surveyed by Thomson Reuters were expecting Netflix to earn 66 cents a share on $1.17 billion in revenue for the fourth quarter.

In the letter to shareholders, CEO Reed Hastings noted that the improvement came from service improvements, effective marketing and Internet connected devices, and expects these trends to continue. "We expect this momentum to continue in Q1 with net additions of 2.25 million to exceed the prior year by about 11%," Hastings wrote in the letter. "Running equal to, or slightly above, prior year net additions is a great outcome because it implies that at 33 million domestic members we're still in the middle section of the S curve of consumer adoption, with years of member growth ahead of us."

With regards to margins, Netflix said it expects to reach 30% contribution margin in 2015, but noted that once that level is reached it would get harder to keep growing at 400 basis points per year.

Aside from new seasons of House of Cards, Orange is the New Black and other Netflix originals, there are more new shows coming. 2015 will see the first season of Sense8, from the Wachowski brothers, and the exclusive new series developed in conjunction with Marvel. Netflix will also be the exclusive provider of Better Call Saul, the spin-off of Breaking Bad in the U.K. Ireland, Latin America, the Nordics and the Netherlands. It will appear in North America on Netflix following its release on AMC Networks (AMCX).

Netflix said it expects to have over 35 million streaming subscribers (35.67 million) by the end of the first quarter of 2014, with 34.26 million of them paying subscribers.

Touching on net neutrality, Hastings said that Netflix would "vigorously protest and encourage our members to demand the open Internet" if Internet Service Providers (ISPs) started to degrade the experience. The letter noted that ISPs are likely to "avoid this consumer-unfriendly path of discrimination."

Though the company is adding streaming subscribers at a record pace, content library costs and international expansion are eating up most of the company's free cash flow. The company generated only $5 million in free cash flow during the quarter. As such, Netflix said it will raise an additional $400 million in long-term debt on "terms similar to our $500 million raise last year." The company ended the quarter with $1.2 billion in cash and equivalents.

Netflix also talked about updates to pricing plans, after introducing an $11.99 streaming option last April. Eventually, Netflix would like to offer three simple options to appeal to everyone, and if there are pricing changes for new members, existing members would be grandfathered in at the old rates.

The company continues to make great strides internationally, adding 1.74 million subscribers from around the world during the quarter, taking it to 10.93 million users. In the first quarter, Netflix said it expects international users to jump almost 60% year-over-year to 1.6 million users. "Our success this year in international net additions and shrinking contribution losses confirms our belief that there is a big international opportunity for Netflix."

For the first quarter, Netflix said it expects to earn 78 cents a share, above the above the consensus estimate of 76 cents a share.

--Written by Chris Ciaccia in New York

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