Monday night, DVD-by-mail pioneer Netflix (NASDAQ:NFLX) will report earnings for the fiscal period Q3 2006. Let's check up on expectations and market conditions together.

What analysts say:

  • Buy, sell, or waffle? Eighteen Wall Street analysts follow Netflix, and 10 of them advocate a buy. Six are stuck at hold, and the last two want to sell. It's a two-star stock in our CAPS service, where a whopping 250 of our all-star stock pickers are bullish on the stock, while 32 side with the bears.
  • Revenues. The average sales forecast calls for $251 million, up 44% from last year's $174 million.
  • Earnings. Wall Street doesn't think the earnings will be so hot, though. After last year's $0.20 of earnings per share, the analyst community calls for just $0.13 this time.

What management says:
CEO Reed Hastings has said that Netflix aims to grow its subscriber base as fast as possible while maintaining a 50% annual earnings growth pace. We'll check up on that target below. He also thinks that someday, a majority of the $8 billion DVD rental market will be transacted online, and that Netflix expects to continue its clear leadership of that very large market. Regarding the threat of movie download services, Hastings is confident that Netflix can stay relevant for several years, if the trajectory of the music business is anything to go by: "This year, eight years after Napster, five years after the iPod, more than 90% of music-industry revenues are plain old CDs. DVD won't be dominant forever, but it will be dominant for a very, very long time."

What management does:
Rolling 12-month earnings have certainly met the stated 50% growth target, except in the third quarter of last year, where the very profitable Q3 2004 fell off the trailing wagon. Yearly subscriber growth hasn't slowed down; in fact, it picked up noticeably over the past year. The margins have followed suit, and with nearly 7% operating margins, Netflix could afford to stomp on the gas with more marketing if it wants to.

Margins %

3/05

6/05

9/05

12/05

3/06

6/06

Gross

32.5

31.8

30.6

31.9

33.4

35.5

Op.

5.9

5.6

3.2

3.6

5.1

6.9

Net

3.4

3.6

1.5

6.2

7.3

8.0


Year over Year Growth %

3/05

6/05

9/05

12/05

3/06

6/06

Revenues

74.4

59.4

41.8

36.3

36.4

39.0

Diluted EPS

493

615

(43.2)

92.2

181

180

Subscribers

56.2

52.9

61.1

60.1

61.2

61.6

* Total subscriber counts at the end of each quarter, in millions.
All data courtesy of Capital IQ, a division of Standard & Poor's, except subscriber counts derived from SEC filings. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
I have this theory about companies like Netflix, Overstock.com (NASDAQ:OSTK), and The Knot (NASDAQ:KNOT) -- these guys are in charge of their own destinies. Operating margins are managed down to almost nothing by investing in marketing and research, and when the time is right to let up on the customer-acquisition throttle, the net earnings resulting from lowered costs will be quite astounding.

In Netflix's case, that investment horizon is supposed to stretch into 2010 or so, when the company hopes to have 20 million subscribers. That should translate into at least $800 million in revenues, and the gross margin on that take is on a long-term upward trajectory. Make your own assumptions, and see what ridiculous earnings figure you arrive at. This is a more-than-plausible reality, and I, for one, welcome our new video-rental overlords.

As for this quarter, Wall Street expects an earnings slowdown from last year. I'm sorry, but with Hastings' stated goals in mind alongside the income management tools at his disposal, I don't see that happening. I think a considerably higher figure is a real possibility.

Competitors:

  • Blockbuster (NYSE:BBI)
  • Movie Gallery (NASDAQ:MOVI)
  • Amazon.com (NASDAQ:AMZN)
  • Apple (NASDAQ:AAPL)

Netflix and Amazon are Motley Fool Stock Advisor recommendations. Find out more about David Gardner's entertainment keiretsu with a free special report from our flagship service. The Knot is a Rule Breakers pick, also under David's capable wing. Overstock is a former Hidden Gems and Rule Breakers selection.

Fool contributor Anders Bylund is a Netflix shareholder, but he holds no other position in any of the companies discussed here. You can check out Anders' holdings if you like. Foolish disclosure stuns Wall Street every time.