Better-than-expected subscriber growth and a historically low churn rate helped Netflix (NASDAQ:NFLX) deliver yet another solid quarter. A legal settlement soured bottom-line results somewhat, but a quick look at the numbers shows some encouraging trends percolating for the DVD rental specialist.

Netflix closed out the period with 3.6 million subscribers -- a 61% improvement over the headcount at this time last year. But revenue grew by only 23% to $174.3 million, a disparity caused by the company's decision to knock down its monthly membership fee and introduce some lower-priced plans as a way to fend off Blockbuster (NYSE:BBI) and Amazon.com (NASDAQ:AMZN).

Cynics who figured that Netflix wouldn't be able to turn a profit in a price war were proved wrong: The company ended up earning $0.11 a share for the quarter. Yes, that's substantially lower than last year's showing, when margins were naturally fatter. Earnings would have come in at $0.15 a share, though, if not for a lawsuit settlement. Netflix also generated $7.5 million in free cash flow during the quarter.

Yes, charging patrons $4 a month less for its most popular rental plan stings, but the company is gaining ground in other ways. Its customer acquisition costs are down. Its subscriber retention rates are at record levels. Netflix now expects to close out 2005 with at least 4 million subscribers. Just a few months ago, it had projected a range between 3.85 million and 4.05 million members. Now it believes that it may close out the current quarter with as many as 4.2 million happy disc swappers.

The company also initiated its guidance for 2006 and things, are looking sharp on that front, too:

Netflix 2006 Guidance
Year end subscribers At least 5.65 million
Revenue At least $940 million
Pretax profits $50 million to $60 million


With 66 million shares outstanding at the moment, the company implies with this guidance that earnings before taxes next year will clock in at between $0.76 and $0.91 a share. It kind of makes you wonder what the market was thinking when it marked down Netflix shares to a mere 10 times that amount earlier this year.

Yes, Netflix has some challenges ahead. Apple Computer (NASDAQ:AAPL) and its new video-enabled iPod may popularize the digital delivery of celluloid. Amazon may decide to enter the DVD rental market for real this time. Wal-Mart (NYSE:WMT) backed out of the market, but a caged Blockbuster will go broke trying to defend its turf before facing extinction.

However, you also have opportunities hanging out in the gray-matter waiting room. The company recently ramped up its advertising department to produce incremental revenue by marketing to its active audience. It also has the distribution center in place that can be used for other light media delivery services, such as video game rentals, CDs, and software. Even if Netflix shares cool off in the near term -- and that's perfectly natural, since the market-thumping Stock Advisor recommendation has more than tripled since bottoming out in the spring -- its prospects look bright. The movie fans keep coming, and they seem to be wild about a happy ending.

Along with Netflix, Amazon.com is a Motley Fool Stock Advisor recommendation.

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Longtime Fool contributor Rick Munarriz has been a Netflix subscriber -- and investor -- since 2002. The Fool has a disclosure policy. He is also part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early.