Netflix Cuts Fees; Shares Hammered

The mail-order DVD company posts a strong profit, as it had promised, but has some stiff competition.
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Updated from 8 p.m. EDT

Netflix

(NFLX) - Get Report

got hammered in after-hours trading Thursday on the heels of a price cut and lowered estimates.

Shares in the mail-order DVD rental house dropped 36% in late trading, down $6.30 from the official closing price of $17.43. The 52-week high is $39.77.

Confirming skeptics' views that competition for Netflix will be greater than the company has let on, CEO Reed Hastings said on a Thursday evening conference call that, according to several sources,

Amazon.com

(AMZN) - Get Report

was planning to enter the online video-rental market.

Hastings said Netflix was taking three measures in response: cutting its subscription fee to $17.99 a month, effective Nov. 1; operating the business at a "break-even" basis in 2005; and delaying a planned U.K. rollout for at least a year.

Netflix raised its monthly fee from $19.95 to $21.95 only a few months ago, and analysts had previously expected 2005 earnings to hit $1.21, up 84% from 2004 estimates.

"For all of you, a year of minimal profits in 2005 is, I'm sure, quite a shock," said Hastings, who termed the moves painful but said they would ensure "long-term, sustained leadership."

Both

Blockbuster

(BBI) - Get Report

and

Wal-Mart

(WMT) - Get Report

have launched their own mail-order video-rental services this year.

Calling the moves conservative, Hastings said that leading the mail-order DVD market was necessary for Netflix's eventual success in making the transition from sending DVDs by mail to delivering entertainment electronically.

Citing increased competition in the mail-order rental market, Netflix said it was cutting its monthly subscription fee from $21.95 a month to $17.99 a month, effective Nov. 1.

"We expect to spend the next year rapidly acquiring subscribers and delivering the best consumer experience to continue dominating the online DVD rental market Netflix pioneered," CEO Reed Hastings said in a statement.

The announcement of Netflix's revised strategy came as the company released better-than-expected results for the third quarter ended Sept. 30.

In the third quarter, Netflix reported net income, excluding stock-based compensation expense, of 35 cents per share, ahead of the Thomson First Call consensus of 32 cents per share.

Revenue grew 96% to $141.6 million, besting the analysts' consensus of $141 million.

As Netflix indicated 10 days ago, its bottom line was aided not only by light usage but also by a change in the amortization policy covering older DVD titles.

On the basis of generally accepted accounting principles, Netflix reported income of $18.9 million, or 29 cents per diluted share. Had the company kept its prior accounting for amortization and salvage value, it said it would have reported a profit of $14.9 million, or 23 cents per share.

Subscriber-acquisition costs continue to rise for Netflix, which has been targeted by short-sellers skeptical about the company's ability to retain subscribers economically and to keep competition at bay. Average U.S. SAC for new trial subscribers was $36.97 in the third quarter, up from $31.81 a year ago and $35.12 in the second quarter.

Churn, or the rate at which Netflix calculates subscribers drop the service, amounted to 5.6% per month, up from 5.2% a year ago and unchanged from the second-quarter figure.