Netflix woes deepen with plunging stock

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SAN FRANCISCO -- Netflix Inc.'s stock price plunged to its lowest point in more than two years Tuesday after the online DVD rental leader reported the first quarterly customer losses in its history and dimmed its earnings outlook for the rest of the year.

To make matters worse, Netflix's Web site -- the hub of its rental system -- went down Monday evening and remained inaccessible as of Tuesday afternoon (EDT). Spokesman Steve Swasey attributed the outage to an unanticipated problem that he declined to describe. Engineers hoped to fix the trouble by 2 p.m. EDT.

Netflix had been in the process of updating its computers to reflect price reductions that took effect Tuesday.

The timing of the breakdown was especially awkward because it occurred shortly after Netflix management had briefed industry analysts on plans to improve its customer service in an increasingly bitter battle with rival Blockbuster Inc.

Lowering prices will erode Netflix's profit -- a sacrifice that the Los Gatos-based company is making in an attempt to regain market share from Blockbuster. The decision led to a further drubbing of Netflix's already battered stock, which has plunged by nearly 40% so far this year.

The shares dropped as low as $15.62 early Tuesday, its lowest point since June 2005. The stock later rebounded to $16.39, down 88 cents, or 5.1%.

Hoping to retain more of its current customers while enticing new subscribers, Netflix is decreasing monthly fees by $1 on its two most popular plans to match Blockbuster's prices for comparable Internet-only services.

Netflix has been having trouble signing up subscribers since late last year, when Blockbuster began giving its online customers the option of swapping DVDs at one of its stores instead of relying on the mail and waiting at least two days for another movie.

"We are in a very competitive, large battle," Reed Hastings, Netflix's chief executive officer, said in an interview Monday after the company released its second-quarter earnings. "But we feel like we are still in a great position."

Wedbush Morgan Securities analyst Michael Pachter believes Blockbuster may have exposed Netflix's Achilles' heel by aggressively promoting the convenience of Blockbuster stores to build its online service.

"Netflix has a broken model," Pachter said. "They aren't used to competition and now someone is competing against them very effectively."

Netflix ended June with 6.74 million subscribers, a decrease of 55,000 customers from April. It marked the first time Netflix's total subscribers have declined from one quarter to the next since the service began renting DVDs through its Web site in 1999.

Blockbuster is expected to update its online subscriber count Thursday when it is scheduled to release its second-quarter results. The Dallas-based company ended March with 3 million subscribers after outstripping Netflix's customer growth for two consecutive quarters.

The gains haven't helped Blockbuster financially. The company lost $49 million in the first quarter. Blockbuster last month indicated it might try to reverse that trend by raising the prices of its online service. If that happens, Netflix's earnings during the second half of this year might not shrink as much as management currently expects.

Assuming Blockbuster holds steady, Netflix expects its performance during the second-half of the year to lag 2006's pace. Management expects Netflix's full-year profit to range from $42.4 million to $52.4 million, down from an April forecast of $55 million to $60 million. Netflix earned $35.4 million through the first half of this year.

Netflix's earnings may fall even further next year as the company continues to compete for subscribers and invests in new technology to deliver movies over high-speed Internet connections so they can be watched on television sets, Chief Financial Officer Barry McCarthy told analysts Monday.

Netflix fared well financially in the second quarter, earning $26.6 million, or 37 cents per share. That represented a 50% increase from net income of $17 million, or 25 cents per share at the same time last year.

Revenue totaled $303.7 million, a 27% improvement from $239.4 million last year.

If not for a $4.1 million payment from Blockbuster to settle a patent infringement lawsuit, Netflix said it would have earned 31 cents per share. That was still well above the average earnings estimate of 23 cents per share among analysts surveyed by Thomson Financial.
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