Updated from 4:57 p.m. EDT

Price cuts enabled Netflix ( NFLX) to regain its footing in the online DVD rental market after a challenge from Blockbuster ( BBI) spooked the company and its investors.

The Los Gatos, Calif., company rebounded from a dismal second-quarter performance to report a third-quarter jump in subscribers and earnings that demolished expectations. Netflix also cranked up its outlook for 2007 and 2008, reflecting a dramatic swing in its public view of its own prospects.

Shares were up $2.89, or 12.6%, to $25.90 in recent after-hours trading.

In July, the company reported its first-ever sequential decline in subscribers, and Netflix CEO Reed Hastings called Wall Street's outlook on the company's prospects "excessively optimistic." Chief Financial Officer Barry McCarthy predicted a decline in annual net income in 2008 -- a forecast that sent the company's shares tumbling.

"Ninety days later, we see a very different picture," said McCarthy on a conference call Monday that followed Netflix's afternoon earnings release.

The improvement comes after Netflix lowered the prices on its subscription service to better compete with Blockbuster's competing offering. But Netflix also reduced its marketing expenses to offset the price cuts, enabling it to rejuvenate its subscriber tallies without sacrificing profits.

The company reported third-quarter net income of $15.7 million, or 23 cents a share, up from $12.8 million, or 18 cents a share, in the same period last year. The results blew past Netflix's guidance for earnings of 11 cents to 19 cents a share.

Analysts expected earnings of 15 cents a share, according to the average estimate reported by Thomson Financial.

Netflix's revenue for the period rose 15% from last year to $294 million, beating Wall Street's expectation of $286.5 million and the company's forecast of $284 million to $289 million.

For the fourth quarter, it now expects to earn anywhere from $6 million, or 9 cents a share, to $11 million, or 16 cents a share. Analysts on Wall Street were forecasting fourth-quarter earnings of 4 cents a share.

Previously, Netflix predicted fourth-quarter results ranging from a loss of $1 million to a profit of $4 million.

It also raised its revenue forecast for the quarter to a range from $297 million to $302 million, up from its previous range of $277 million to $287 million.

McCarthy said his prediction that annual earnings would decline next year now seems too pessimistic. Now, he sees 2008 earnings flat to slightly higher than 2007 levels.

Netflix's third-quarter performance was boosted by a 24% year-over-year increase in subscribers, giving it more than 7 million customers. That marked a 4% improvement over the second quarter, when the company posted its first-ever sequential drop in subscribers.

Netflix's churn rate, which measures customers opting out of its service, was down to 4.2% from last year's 4.6%.

Netflix now expects to end the year with 7.3 million to 7.5 million subscribers, up from its previous projection of 6.8 million to 7.3 million.

Hastings said Netflix is continuing to invest in an online video service that allows subscribers to view some movies and TV shows instantly on the Internet with no DVD. He said it's too early to offer investors guidance on the financial model for a hybrid DVD rental and online viewing service.

"The online video opportunity will emerge slowly," said Hastings.