UPDATE 3-Netflix may offer U.S. Web service in 2010, shares up
* May launch streaming-only in US in Q4
* Canada experience prompts service on home turf
* Ends Q3 with almost 17 million subscribers
* Shares rise 9 pct (Recasts, adds analysts, CEO's quotes)
By Sue Zeidler
LOS ANGELES, Oct 20 (Reuters) - Netflix Inc (NFLX.O), which rose to success with its by-mail DVD rental service, may add a streaming-only service in the United States this year, as it expands its reach in the digital market.
The company also reported on Wednesday another quarter of strong subscriber growth, and its shares rose in after-hours trading.
Its Canadian streaming-only service -- where users pay to watch video instantly off the Internet -- is a hit and on track to become profitable in late 2011, encouraging Netflix to test this model in its home market.
Shares in Netflix -- known for its signature red envelopes and mail-in DVD rentals -- jumped more than 9 percent after it posted better-than-expected third-quarter subscriber growth.
"Three years ago we were a DVD-by-mail company that offered some streaming," Chief Executive Officer Reed Hastings said, adding Netflix will spend more in the fourth quarter on streaming content than on DVDs. "We are now a streaming company, which also offers DVD-by-mail."
"Pure streaming could become Netflix's core offering in the U.S., with discs being offered as a supplement for an additional charge," Hastings said.
Netflix has undergone phenomenal growth since its 1999 debut. Its shares have gained many-fold since a 2002 IPO.
But concerns persist now about the rising cost of paying studios to stream more movies and TV shows, amid intensifying competition and lofty-looking share valuations.
Netflix has paid a big price to provide content through partnerships with EPIX pay TV channel, estimated at $1 billion, and NBC Universal, a unit of General Electric Co (GE.N).
It has a deal with Starz due to expire in 2011 or 2012 and analysts believe the pricing on that deal, estimated at $50 million to $60 million per year, may double or triple.
Epix is owned by Viacom Inc's VIAb.N Paramount Pictures, Metro-Goldwyn-Mayer Studios and Lions Gate Entertainment Corp (LGF.N).
Netflix competes against companies like Hulu Plus, Coinstar Inc's (CSTR.O) Redbox, which is soon launching a streaming service, and Google (GOOG.O). Amazon.com Inc(AMZN.O) has also considered an online video subscription service.
Netflix's Gross margins fell sequentially to 37.7 percent in the third quarter from 39.4 percent in the second quarter.
Hastings told analysts on a conference call he was upbeat about a Starz deal.
"I am optimistic in the long-term. That is, we have money to pay and they are in the business of collecting money," he said. Hastings said he would like to keep long-term gross margins to between 30 percent and 35 percent.
"It's a downtick, but it shows they can hold margins pretty close to where they are despite having to pay up for digital content," said Lloyd Walmsley with Primary Global Research.
The Los Gatos, California-based company started in the United States as a mail-in DVD service but Netflix now says the vast majority of its U.S. subscribers stream content on many devices through a multitude consumer electronic partnerships.
Last month, Apple Inc (AAPL.O) said it would add Netflix's streaming service to a new version of Apple TV.
Netflix's clout was underscored on Wednesday by a Sandvine (SVC.TO) report that found Netflix represents more than 20 percent of the downstream traffic in the U.S. in peak times and is heaviest between 8 p.m. and 10 p.m.
"Right now is the best of all possible worlds for Netflix, being on so many devices and with video stores liquidating and consumer interest in video streaming escalating," said Barton Crockett, analyst with Lazard Capital Markets.
"They stand alone as the only meaningful video service, but the real question as you look ahead to next year is how do you top that when you consider all the big Internet companies who are stepping in competitively," said Crockett.
It raised its fourth quarter forecasts for subscribers and revenues, but left earnings guidance unchanged. It expects to end the quarter with 19 million to 19.7 million subscribers, up from its previous forecast of 17.7 million to 18.5 million.
It expects to generate between $586 million and $598 million in revenue, versus $580 million to $596 million, and left unchanged its earnings forecast of $32 million to $40 million, or 59 cents to 74 cents per diluted share.
Third quarter net income rose to $38 million, or 70 cents per share, from $30.1 million, or 52 cents per share a year ago. Revenue rose 31 percent to $553.2 million -- results roughly in line with earnings forecasts. Analysts on average had forecast earnings of 71 cents on revenue of $550.9 million, according to Thomson Reuters I/B/E/S.
Netflix ended the quarter with 16.9 million subscribers. Its shares rose 9.3 percent to $167.33 in extended trade after closing the regular session at $153.15, up 2.6 percent. (Reporting by Susan Zeidler; Editing by Kenneth Li, Bernard Orr, Edwin Chan and Carol Bishopric)
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