Nothing But Netflix

Can anything stop Netflix (Nasdaq: NFLX  ) and its heady growth? If a price hike and polished competition from Wal-Mart (NYSE: WMT  ) and Blockbuster (NYSE: BBI  ) aren't scaring away its users, we have to begin wondering exactly how powerful the company behind those red rectangular envelopes has become.

Netflix started the month with just more than 2.2 million subscribers to its monthly service -- a 73% surge from last year's membership tally. That's impressive, because there were reasons to be fretful when it announced that it had hit the two million mark three months ago.

After the company hiked its monthly dues by roughly 10% over the summer and Blockbuster rolled out a surprisingly worthy online alternative, investors had every right to wonder whether the company's growth was about to become a piece of celluloid on the cutting room floor.

If you think that growing its base of flick-renting loyalists while charging them $2 more a month will mean that the larger subscriber count is just the tip of the good news iceberg, you're right.

The company is revealing that gross margins may come in as high as 51% -- smartly above the 43% to 45% range that it had initially projected. If you want to know what kind of exponential impact that can have as we trickle down the income statement, consider that Netflix had guided investors to expect net earnings to come in between $6.7 million and $10.2 million. It now believes that its net profits can come in as high as $17.5 million.

But nothing is perfect. Part of the reason for the healthier showing is that subscribers weren't going through as many movies as they used to. That's a sobering optimist-deflating notion when you think about it. Between the Olympics, late summer outings, and folks fixated on political coverage, it's easy to see why subscribers weren't zipping through their discs -- that's just a temporary margin boost. If it's something greater than that, and members just aren't interested in renting as many DVDs as they once used to, then it may create a more cumbersome value proposition.

Another profit-padding move is that the company will be writing off the value of its new DVDs over three years instead of just one. Netflix claims that it is achieving a longer useful life on its discs, but if you walk into your local Blockbuster or Hollywood Entertainment's (Nasdaq: HLYW  ) Hollywood Video store and see how quickly new releases are marked down as pre-played closeouts, one has to wonder whether Netflix is only achieving this titular longevity because its speedy subscriber growth can absorb a wider base of older catalog titles.

Ultimately Netflix is doing so well right now that longer disc amortization periods and slower rental traffic is accounting for just a chunk of the company's bottom-line boom. Our new Rule Breakers newsletter is geared toward finding rebels without a clause like Netflix early in their growth cycle. If Netflix keeps penetrating the market at such a nifty rate, perhaps we are earlier in its growth cycle than many think.

Which movies have you seen in the theater lately that you would recommend to someone trying to load up a Netflix rental queue? Which classics have passed the test of time? Since it's October, are there any scary films that have tingled your spin? All this and more in the Great Movies discussion board. Only on Fool.com.

Longtime Fool contributor Rick Munarriz singled out the stock in the October 2002 edition of TMF Select -- which later evolved intoTom Gardner's Motley Fool Hidden Gems. It was a memorable call given the fact that the stock was bottoming out at a split-adjusted $5.45 a share at the time. He is now a member of theRule Breakersanalytical team. Rick has been a Netflix customer -- and shareholder -- since 2002.


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