NetFlix 2002 Annual Report Download

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Netflix Annual Report 2002

Table of contents

  • Page 1
    N e t f l i x A nnual Report 2 0 0 2

  • Page 2
    ...E S T O N L I N E M O V I E R E N TA L S E R V I C E , P R O VIDING MORE THAN ONE MILLION SUBSCRIBERS W I T H A C C E S S TO A C O M P R E H E N S I V E L I B R A RY OF MOR E THAN 14,500 DVD TITLES, WITH G E NE R A L LY N E X T- D AY D E L I V E R Y T O M O S T S U B S C R I B E R S , A N D N O L AT...

  • Page 3
    ... for key financial metrics, including revenues, expenses, EB ITDA, and free cash flow. In this climate, the strength of our business model has been resoundingly validated by consumers who, in ever increasing numbers, have found significant enjoyment and value in our online movie rental service. In...

  • Page 4
    ... invested in 12 new distribution centers around the U.S., increasing the number of our subscribers who receive their DVDs with next-day service through the U.S. mail. Our marketing initiatives to acquire new subscribers through various channels including banner advertising, direct merchandising, and...

  • Page 5
    ... go to the video store on a Saturday night to rent a movie- or make a return trip to avoid a late fee. Instead, Netflix offers our subscribers direct home delivery of their DVD selections, usually the next day. And, in our most popular subscription package, they can rent as many movies as they want...

  • Page 6
    ...never pay late fees. When it 's time to return a movie, a subscriber puts it back into the postage-paid mailer that came with it and drops it into a mailbox. That 's all there is to it. As soon as we receive that DVD, we automatically mail the next available selection on the subscriber's rental list...

  • Page 7
    The Following 10K Has Been Approved For ALL FINANCIAL AUDIENCES by the Management of Netflix FA RATED FA / FINANCIAL AUDIENCES P R E S E N T E D B Y N E T F L I X

  • Page 8
    P R E S E N T S 2002 Form 10-K Report

  • Page 9
    ... 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2002 OR ¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____ to _____ Commission File Number: 000âˆ'49802 Netflix, Inc. (Exact name...

  • Page 10
    ... 28, 2002, the aggregate market value of voting stock held by nonâˆ'affiliates of the Registrant, based upon the closing sales price for the Registrant's Common Stock, as reported in the NASDAQ National Market System, was $164,240,446. Shares of Common Stock held by each officer and director and by...

  • Page 11
    ... time with no due dates, late fees or shipping charges for $19.95 per month. Subscribers can view as many titles as they want in a month. Subscribers select titles at our Web site (www.netflix.com) aided by our proprietary recommendation service, receive them on DVD by firstâˆ'class mail and return...

  • Page 12
    ... HBO and Showtime, and payâˆ'perâˆ'view services currently offer a narrow selection of titles at specified times due to programming schedule constraints and technological issues relating to channel capacity. Traditional video rental outlets primarily focus on offering new releases and devote limited...

  • Page 13
    ..., late fees or shipping charges for a fixed monthly fee. We merchandize titles in easy to recognize lists including new releases, genres and other targeted categories. Our convenient, easy to use Web site allows subscribers to quickly select current titles, reserve upcoming releases and build an...

  • Page 14
    ... substantial resources to plan, develop and maintain proprietary technology to implement the features of our Web site, such as subscription account signup and management, personalized movie merchandising, inventory optimization and customer support. Our software is written in a variety of languages...

  • Page 15
    ... and our active public relations program. Online Advertising Online advertising is our largest paid source of new subscribers. We advertise our service online through paid search listings, permission based eâˆ'mails, banner ads, and text on popular Web portals and other Web sites. In addition, we...

  • Page 16
    ... also offer phone support for subscribers who prefer to talk directly with a customer service representative. We focus on eliminating the causes of customer support calls and automating certain selfâˆ'service features on our Web site, such as the ability to report and correct most shipping problems...

  • Page 17
    ... Best Buy. In particular, Blockbuster continues to test in a number of its locations a storeâˆ'based subscription model for DVD and game rentals which, if released nationally, would provide many of the benefits of our business model in a storeâˆ'based retail environment. We believe that we compete...

  • Page 18
    ...located in Los Gatos, California, where we lease approximately 25,000 square feet under a lease that expires in October 2005. We also lease approximately 50,000 square feet of space in San Jose, California, where we maintain our customer service center, information technology operations and shipping...

  • Page 19
    ... Operations Data (in thousands, except per share data) Year Ended December 31, 1998 1999 2000 2001 2002 Revenues: Subscription Sales Total revenues Cost of revenues: Subscription Sales Total cost of revenues Gross profit Operating expenses: Fulfillment Technology and development Marketing General...

  • Page 20
    ... time with no due dates, late fees or shipping charges for $19.95 per month. Subscribers can view as many titles as they want in a month. Subscribers select titles at our Web site (www.netflix.com) aided by our proprietary recommendation service, receive them on DVD by firstâˆ'class mail and return...

  • Page 21
    ... monthly fee, with a maximum of three titles out at the same time. There is no minimum subscription period and subscribers can cancel our service at any time. We had no DVD sales in 2000 and insignificant amounts in 2001 and 2002. Beginning in late 2000, as part of the change in our business model...

  • Page 22
    ... amortized our cost of DVDs using an accelerated method over an estimated life of three years and assumed no salvage value. Amortization of intangible assets related to equity issued to studios . In 2000, in connection with signing revenue sharing agreements with Columbia TriStar Home Entertainment...

  • Page 23
    ... delivery times and increase library utilization. Technology and Development Technology and development expense consists of payroll and related expenses we incur related to testing, maintaining and modifying our Web site, our recommendation service, telecommunications systems and infrastructure...

  • Page 24
    ... change in our stock price will directly impact the amount we record as stockâˆ'based compensation in an amount equal to the number of shares underlying the variable awards outstanding multiplied by the change in the fair value of our common stock. For example, assuming all 635,000 exchanged options...

  • Page 25
    ... in this Annual Report on Form 10âˆ'K. Year Ended December 31, 2000 2001 2002 Revenues: Subscription Sales Total revenues Cost of revenues: Subscription Sales Total cost of revenues Gross profit Operating expenses: Fulfillment Technology and development Marketing General and administrative...

  • Page 26
    ...101% increase in the number of new trial subscribers in 2002 compared to 2001, partially offset by decreases in the marketing cost per acquired subscriber from $37.16 to $31.39. The decrease in the cost per acquired subscriber was due primarily to costs related to free trials and marketing staff and...

  • Page 27
    ... in 2002, prior to our initial public offering, with exercise prices below the fair value of our common stock. Since our initial public offering, there is no longer any difference between fair market value and the exercise price for new option grants and as a result no new deferred stockâˆ'based...

  • Page 28
    ... our software related to our Web site, our recommendation service and our internalâˆ'software infrastructure. As a percentage of revenues, technology and development expenses decreased from 47% in 2000 to 23% in 2001 primarily due to an increase in subscription revenues. Marketing . Our marketing...

  • Page 29
    ... revenue sharing agreements. Net cash used in investing activities in 2002 was attributable primarily to a $43.0 million purchase of shortâˆ'term investments with a portion of our initial public offering proceeds and $24.1 million related to the acquisition of titles for our DVD library. While DVD...

  • Page 30
    ..., services, and/or rights to use assets. Revenue arrangements with multiple deliverables are divided into separate units of accounting if the deliverables in the arrangement meet the following criteria: (1) the delivered item has value to the customer on a standalone basis; (2) there is objective...

  • Page 31
    ... effectively could adversely affect our business. We use complex proprietary software to process deliveries and returns of our DVDs and to manage other aspects of our operations. Our proprietary technology is intended to allow our shipping centers throughout the United States to be operated on an...

  • Page 32
    ...in the delivery and return time for DVDs to those subscribers serviced by the shipping centers. In addition, we have experienced an increase in the exchange of titles by subscribers in those areas. The more frequent exchange of titles has increased our shipping and delivery costs and revenue sharing...

  • Page 33
    ...• price competition; • our ability to maintain an adequate breadth and depth of titles; • our ability to manage our inventory levels; • changes in promotional support offered by studios; • our ability to maintain, upgrade and develop our Web site, our internal computer systems and...

  • Page 34
    ...players who have traditionally relied on storeâˆ'based rental outlets and persuade them to subscribe to our service through our Web site. We may be required to incur significantly higher advertising and promotional expenditures than we currently anticipate to attract large numbers of new subscribers...

  • Page 35
    ...expense shipping costs of free trial programs to new subscribers as marketing expense. Therefore, if the cost of delivering titles were to increase, our marketing expense would be adversely affected. If we are unable to effectively utilize our recommendation service, our business may suffer. Based...

  • Page 36
    ... by studios and seasonal variations in movie watching. Our subscriber growth and retention may be affected adversely if we attempt to increase our monthly subscription fees to offset any increased costs of acquiring or delivering titles. If we are unable to compete effectively, our business will...

  • Page 37
    ... in 2003. Likewise, Blockbuster recently acquired an online DVD subscription service, FilmCaddy.com. Blockbuster is also testing inâˆ'store DVD rental subscription programs. Increased competition may result in reduced operating margins, loss of market share and reduced revenues. In addition, our...

  • Page 38
    ...revenue sharing agreement are purchased on a wholesale basis from studios or other distributors. If the price of titles that we purchase wholesale increases, our gross margin will be affected adversely. If the sales price of DVDs to retail consumers decreases, our ability to attract new subscribers...

  • Page 39
    ... to attract new subscribers may be affected adversely. We may not be able to continue to support the marketing of our service by eâˆ'mail or other online means if such activities are adverse to our business. Laws or regulations may be enacted which prohibit use of eâˆ'mails or similar marketing...

  • Page 40
    ..., our operations would be affected adversely. Our executive offices and San Joseâˆ'based distribution center, which houses our customer service operations and our excess DVD inventory, are located in the San Francisco Bay area. Our business and operations could be materially adversely affected in...

  • Page 41
    ...accessed by unauthorized persons. To secure transmission of confidential information obtained by us for billing purposes, including subscribers' credit card data, we rely on licensed encryption and authentication technology. In conjunction with the credit card companies, we take measures to protect...

  • Page 42
    ... to attract subscribers may be adversely affected. Intellectual property claims against us could be costly and result in the loss of significant rights related to, among other things, our Web site, our recommendation service, title selection processes and marketing activities. Trademark, copyright...

  • Page 43
    ... affect the popularity or growth in use of the Internet could decrease the demand for our subscription service and increase our cost of doing business. In addition, if consumer attitudes toward use of the Internet change, consumers may become unwilling to select their entertainment online or...

  • Page 44
    ... original purchase price. In the past, securities class action litigation often has been instituted against companies following periods of volatility in the market price of their securities. This type of litigation, if directed at us, could result in substantial costs and a diversion of management...

  • Page 45
    34

  • Page 46
    ... the fair market value of our common stock for financial reporting purposes and the exercise price of these options at the date of grant. This deferred compensation is amortized over the vesting period of the applicable options, generally three to four years, using the graded vesting method. At...

  • Page 47
    ...within 90 days of the filing date of this Annual Report on Form 10âˆ'K, the Company's principal executive officer and principal financial officer have concluded that the Company's disclosure controls and procedures (as defined in Rules 13aâˆ'14(c) and 15dâˆ'14(c) under the Securities Exchange Act of...

  • Page 48
    (2) Financial Statement Schedules: See Index to Financial Statements on page Fâˆ'1. 36

  • Page 49
    ... Executive Officers and Directors. (4) 2002 Employee Stock Purchase Plan. (5) Amended and Restated 1997 Stock Plan. (6) 2002 Stock Plan. (7) Amended and Restated Stockholders' Rights Agreement dated July 10, 2001. (8) Office Lease dated October 27, 2000 with BR3 Partners. (9) Letter Agreement dated...

  • Page 50
    ... to our quarterly report on Form 10âˆ'Q filed with the Securities and Exchange Commission on November 14, 2002. The registrant has been granted confidential treatment on portions of this exhibit. (b) We did not file any current reports on Form 8âˆ'K for the quarter ended December 31, 2002. 38

  • Page 51
    NETFLIX, INC. INDEX TO FINANCIAL STATEMENTS Page Independent Auditors' Report Balance Sheets as of December 31, 2001 and 2002 Statements of Operations for the years ended December 31, 2000, 2001 and 2002 Statements of Stockholders' (Deficit) Equity and Comprehensive Loss for the years ended ...

  • Page 52
    ..., 2001 and 2002, and the related statements of operations, stockholders' (deficit) equity and comprehensive loss, and cash flows for each of the years in the threeâˆ'year period ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility...

  • Page 53
    NETFLIX, INC. BALANCE SHEETS (in thousands, except share and per share data) As of December 31, 2001 2002 Assets Current assets: Cash and cash equivalents Shortâˆ'term investments Prepaid expenses Prepaid revenue sharing expenses Other current assets Total current assets DVD library, net ...

  • Page 54
    NETFLIX, INC. STATEMENTS OF OPERATIONS (in thousands, except per share data) Year Ended December 31, 2000 2001 2002 Revenues: Subscription Sales Total revenues Cost of revenues: Subscription Sales Total cost of revenues Gross profit Operating expenses: Fulfillment * Technology and development * ...

  • Page 55
    ... Warrants issued in connection with services rendered Warrants issued in connection with debt financing Subscribed Series F nonâˆ'voting preferred stock Deferred stockâˆ'based compensation, net Stockâˆ'based compensation expense Net loss Appreciation (depreciation) in value of availableâˆ'forâˆ'sale...

  • Page 56
    ...employees Stockâˆ'based compensation expense Loss on disposal of property and equipment Gain on disposal of DVDs Noncash interest and other expense Changes in operating assets and liabilities: Prepaid expenses and other current assets Accounts payable Accrued expenses Deferred revenue Deferred rent...

  • Page 57
    ...âˆ'day service. The Company also provides background information on DVD releases, including reviews, member reviews and ratings and personalized movie recommendations. For more information on the company, visit www.netflix.com. Initial public offering On May 29, 2002, the Company closed the sale...

  • Page 58
    ... of newly released titles and satisfy subscriber demand for such titles over a shorter period of time. In connection with the change in business model, on January 1, 2001, the Company revised the amortization policy for the cost of its DVD library from an accelerated method using a three year life...

  • Page 59
    ... Web site and the Company's Web site over a period of 24 months. In addition, the Company is allowed to use the partner's trademark and logo in marketing the Company's subscription services. The Company recognized the fair value of these instruments as an intangible asset with a corresponding credit...

  • Page 60
    ...DVD library. Fulfillment costs also include credit card fees. Technology and development Technology and development costs consist of payroll and related costs incurred related to testing, maintaining and modifying the Company's Web Site, Cinematch software and other internalâˆ'use software systems...

  • Page 61
    ... including revenueâˆ'sharing payments, postage, packaging and DVD library amortization related to free trial periods. The Company expenses these costs as incurred. Stockâˆ'based compensation The Company accounts for its stockâˆ'based employee compensation plans using the intrinsicâˆ'value method...

  • Page 62
    NETFLIX, INC. NOTES TO FINANCIAL STATEMENTS-(Continued) Years Ended December 31, 2000, 2001 and 2002 (in thousands, except share, per share and per DVD data) SFAS No. 123 requires the disclosure of net loss as if the Company had adopted the fair value method for its stockâˆ'based compensation ...

  • Page 63
    NETFLIX, INC. NOTES TO FINANCIAL STATEMENTS-(Continued) Years Ended December 31, 2000, 2001 and 2002 (in thousands, except share, per share and per DVD data) Net loss per share Basic net loss per share is computed using the weightedâˆ'average number of outstanding shares of common stock, ...

  • Page 64
    Fâˆ'13

  • Page 65
    ..., services, and/or rights to use assets. Revenue arrangements with multiple deliverables are divided into separate units of accounting if the deliverables in the arrangement meet the following criteria: (1) the delivered item has value to the customer on a standalone basis; (2) there is objective...

  • Page 66
    ...-(Continued) Years Ended December 31, 2000, 2001 and 2002 (in thousands, except share, per share and per DVD data) obligations under guarantees issued. The Interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the...

  • Page 67
    ... July 2001, the Company issued subordinated promissory notes and warrants to purchase 6,818,947 shares of its common stock at an exercise price of $3.00 per share for net proceeds of $12,831. The subordinated notes had an aggregate face value of $13,000 and stated interest rate of 10%. Approximately...

  • Page 68
    ...) Years Ended December 31, 2000, 2001 and 2002 (in thousands, except share, per share and per DVD data) Warrants and common stock issued with debt instruments In May 2000, in connection with a capital lease, the Company issued a warrant that provided the lender the right to purchase 7,669 shares...

  • Page 69
    ...-(Continued) Years Ended December 31, 2000, 2001 and 2002 (in thousands, except share, per share and per DVD data) In July 2001, the Company issued a warrant to purchase 100,000 shares of Series F nonâˆ'voting preferred stock at $9.38 per share to a Web portal company in connection with an...

  • Page 70
    ... upon the closing of the Company's initial public offering. 7. Stockholders' (Deficit) Equity The convertible preferred stock at December 31, 2001 consisted of the following: Number of Shares Number of Shares Authorized Issued and Outstanding Dividends Per Share Liquidation Value Per Share Total...

  • Page 71
    ... to be voted upon by the Company's stockholders. Employee Stock Purchase Plan In February 2002, the Company adopted the 2002 Employee Stock Purchase Plan. The Company reserved a total of 583,333 shares of common stock for issuance under the 2002 Employee Stock Purchase Plan. Under the Fâˆ'19

  • Page 72
    ...provides for annual increases in the number of shares available for issuance under the 2002 Employee Stock Purchase Plan on the first day of each fiscal year, beginning with fiscal year 2003, equal to the lesser of: • 2% of the outstanding shares of the Company's common stock on the first day of...

  • Page 73
    ... or four years. Generally, the Company's Board of Directors grants options at an exercise price of not less than the fair value of the Company's common stock at the date of grant. In 2001, the Company offered its employees the right to exchange certain employee stock options. The exchange resulted...

  • Page 74
    NETFLIX, INC. NOTES TO FINANCIAL STATEMENTS-(Continued) Years Ended December 31, 2000, 2001 and 2002 (in thousands, except share, per share and per DVD data) As of December 31, 2002, the range of exercise prices and weightedâˆ'average remaining contractual life of outstanding options were as ...

  • Page 75
    ...deferred tax assets for which realization is uncertain. The total valuation allowance for the years ended December 31, 2001 and 2002 increased $12,713 and decreased $1,301, respectively. As of December 31, 2002, the Company had net operating loss carry forwards for federal and California income tax...

  • Page 76
    ... July 2001, the Company issued subordinated promissory notes and warrants to purchase 6,818,947 shares of its common stock at an exercise price of $3.00 per share for net proceeds of $12,831. The subordinated notes had an aggregate face value of $13,000 and stated interest rate of 10%. Approximately...

  • Page 77
    NETFLIX, INC. NOTES TO FINANCIAL STATEMENTS-(Continued) Years Ended December 31, 2000, 2001 and 2002 (in thousands, except share, per share and per DVD data) offering. The Company consummated a qualified initial public offering during May 2002 and repaid the face value and all accrued interest on ...

  • Page 78
    ... of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signature Title Date /s/ R EED H ASTINGS President, Chief Executive Officer and Director (principal executive...

  • Page 79
    /s/ M ICHAEL N. S CHUH Director March 27, 2003 Michael N. Schuh /s/ M ICHAEL R AMSAY Director March 26, 2003 Michael Ramsay

  • Page 80
    ... made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows...

  • Page 81
    ... made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows...

  • Page 82
    ... Executive Officers and Directors. (4) 2002 Employee Stock Purchase Plan. (5) Amended and Restated 1997 Stock Plan. (6) 2002 Stock Plan. (7) Amended and Restated Stockholders' Rights Agreement dated July 10, 2001. (8) Office Lease dated October 27, 2000 with BR3 Partners. (9) Letter Agreement dated...

  • Page 83
    ... Sarbanesâˆ'Oxley Act of 2002, that the Annual Report of Netflix, Inc. on Form 10âˆ'K for the year ended December 31, 2002 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Annual Report fairly presents in all...

  • Page 84
    ...(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Annual Report fairly presents in all material respects the financial condition and results of operations of Netflix, Inc. By: Name: Title: /s/ B ARRY M C C ARTHY Barry McCarthy Chief Financial Officer

  • Page 85
    ... Stock Listing Netflix, Inc. common stock trades on the Nasdaq Stock Market under the symbol NFLX. Investor Relations For additional copies of this report or other financial information: URL: http:/ / ir.netflix.com Email: [email protected] Investor Relations Netflix, Inc. 970 University Avenue Los...

  • Page 86
    N E T F L I X, I N C. 970 University Avenue Los Gatos, Calif ornia 9 5 0 3 2 Phone: 4 0 8 .3 9 9 .3 70 0 netflix.com