NetFlix 2003 Annual Report Download

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Netflix,฀Inc.฀can฀be฀visited฀on฀
the฀Web฀at฀its฀home฀page:
NO฀LATE฀FEES฀
FAST฀AND฀FREE฀
DELIVERY
Netflix, Inc.
042804
01-408-399-3700
Netflix (Nasdaq: NFLX) is the world’s largest online
DVD movie rental service offering nearly 1.5 million
members access to more than 18,000 titles. Our
appeal and success are built on providing the most
expansive selection of DVDs, an easy way to choose
movies and fast, free delivery.
NETFLIX,฀INC.฀฀2003฀ANNUAL฀REPORT
Netflix,฀Inc.
2003฀Annual฀Report

Table of contents

  • Page 1
    Netï¬,ix,฀Inc.฀can฀be฀visited฀on฀ the฀Web฀at฀its฀home฀page: NO฀LATE฀FEES฀ FAST฀AND฀FREE฀ DELIVERY Netï¬,ix,฀Inc. 2003฀Annual฀Report

  • Page 2
    Singular฀Focus Category฀Leadership Personalized฀Experience Deep฀Title฀Selection Customer฀Love Consistent฀Growth

  • Page 3
    ...the฀world's฀฀ largest฀online฀movie฀rental฀service฀-฀฀ and฀we฀now฀provide฀nearly฀1.5฀million฀฀ subscribers฀access฀to฀a฀library฀of฀more฀฀ than฀18,000฀DVD฀titles,฀with฀generally฀฀ next-day฀delivery฀to฀most฀subscribers฀฀ and...

  • Page 4
    ...฀proprietary฀software฀tools฀make฀฀ personal฀movie฀recommendations฀based฀on฀each฀individual฀subscriber's฀likes฀฀ and฀dislikes.฀Our฀logistics฀systems฀make฀sure฀that฀as฀each฀movie฀is฀returned,฀฀ the฀next฀available฀request฀is฀shipped...

  • Page 5
    ...฀as฀long฀as฀they฀want,฀with฀three฀movies฀out฀at฀a฀time.฀There฀are฀no฀ due฀dates,฀no฀late฀fees฀and฀no฀shipping฀fees.฀DVDs฀are฀delivered฀by฀first-class฀mail฀from฀ 3 3 Netï¬,ix฀2003฀Annual฀Report Netï¬,ix฀2003฀Annual฀Report

  • Page 6
    ...฀the฀tune฀of฀an฀all-time฀high฀customer฀satisfaction฀฀ rating฀of฀95%).฀And฀what฀about฀the฀future?฀We฀continue฀to฀invest฀in฀making฀the฀ experience฀even฀better,฀with฀more฀titles,฀faster฀delivery฀and฀unsurpassed฀service. "We've฀been...

  • Page 7
    ... regional฀shipping฀centers฀throughout฀the฀United฀States.฀The฀Netï¬,ix฀website,฀from฀which฀our฀ subscribers฀request฀their฀movies,฀provides฀extensive฀information฀about฀titles,฀as฀well฀as฀critic฀ reviews,฀member฀reviews,฀online฀trailers...

  • Page 8
    ...฀of฀74฀percent฀year฀over฀year.฀And฀our฀efforts฀to฀improve฀ the฀quality฀of฀our฀service฀contributed฀to฀an฀increase฀in฀the฀average฀subscriber฀ life.฀As฀a฀result,฀we฀derive฀more฀value฀from฀every฀customer฀we฀acquire.฀We฀now...

  • Page 9
    ....฀As฀with฀last฀year,฀online฀advertising฀and฀word฀of฀mouth฀฀ will฀continue฀to฀generate฀the฀bulk฀of฀our฀new฀subscribers.฀In฀the฀fourth฀quarter฀of฀2003,฀฀ we฀tested฀TV฀advertising฀in฀several฀markets.฀Those฀test฀results฀looked...

  • Page 10
    ...฀about฀personal฀choice.฀Our฀subscribers฀enjoy฀powerful฀online฀browsing฀ and฀search฀features฀to฀help฀them฀choose฀from฀virtually฀every฀DVD฀published฀-฀more฀ than฀18,000฀titles.฀We฀carry฀both฀acclaimed฀and฀smaller,฀low-profile฀movies...

  • Page 11
    ...฀year฀for฀the฀Company.฀I฀look฀forward฀to฀reporting฀again฀on฀our฀progress฀฀ 12฀months฀from฀now. Sincerely, Reed฀Hastings Chief฀Executive฀Officer,฀President฀and฀Co-Founder 9 Netï¬,ix฀2003฀Annual฀Report Netï¬,ix฀2003฀Annual฀Report...

  • Page 12
    ... Netï¬,ix฀2003฀Annual฀Report Million฀active฀subscribers Customer฀satisfaction฀and฀loyalty Million฀DVDs฀shipped฀each฀month -day฀delivery฀service฀for฀80%฀of฀all฀subscribers Unique฀movie฀titles฀available฀(and฀growing) Shipping฀centers฀throughout...

  • Page 13
    ... Subscribers (in฀thousands) 00 $300 01 02 03 00 $10 01 02 03 $7 00 01 02 03 $272 1,500 1,487 250 0 (10) (20) $(21) 1,200 200 $153 150 900 857 (30) 100 $76 600 (40) (50) (60) $(58) 456 $(39) 50 $36 300 292 0 0 11 Netï¬,ix฀2003฀Annual฀Report Netï¬,ix฀2003...

  • Page 14
    Financial฀Performance฀and฀Form฀10-K 12 12 Netï¬,ix฀ 2003฀Annual฀Report Netï¬,ix฀ 2003฀Annual฀Report

  • Page 15
    ... value of voting stock held by non-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 $255,835,855. Shares of common stock held by each officer and director and by each person who owns five percent...

  • Page 16
    ... on Form 8-K ...Directors and Executive Officers of the Registrant ...Executive Compensation ...Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters ...Certain Relationships and Related Transactions ...Principal Accountant Fees and Services ... 40 40 40 40...

  • Page 17
    ... levels of customer satisfaction, rapid consumer adoption of DVD players and our effective marketing programs. In the San Francisco Bay Area, where we have had generally one-day delivery service since launch, approximately 5.9 percent of all households subscribed to Netflix at the end of 2003. Our...

  • Page 18
    ..., and pay-per-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 offer new releases and devote limited space to display and stock back...

  • Page 19
    ..., easy-to-use Web site allows subscribers to quickly select current titles, reserve upcoming releases and build an individual queue for future viewing using our proprietary personalization technology. Our recommendation service provides subscribers with recommendations of titles from our library. We...

  • Page 20
    ... 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 and runs on industry...

  • Page 21
    ...personal rating, average rating and other similar titles the subscriber may enjoy. Marketing We have multiple marketing channels through which we attract subscribers to our service. Online advertising is our largest paid source of new subscribers. We advertise our service online through paid search...

  • Page 22
    ... to revenue sharing agreements, we also purchase titles from various studios, distributors and other suppliers on a purchase order basis. Fulfillment Operations We currently stock more than 18,000 titles on more than 12 million DVDs. During December 2003, we shipped to and received from subscribers...

  • Page 23
    ... principal executive offices are located at 970 University Avenue, Los Gatos, California 95032, and our telephone number is (408) 317-3700. We maintain a Web site at www.netflix.com. The contents of our Web site are not incorporated in, or otherwise to be regarded as part of, this annual report on...

  • Page 24
    ...Location Primary Use Los Gatos, California ...Beverly Hills, California ...San Jose, California ... 38,000 4,000 58,000 October, 2005 December, 2006 December, 2004 Corporate offices, general and administrative, marketing, and technology and development General and administrative Central customer...

  • Page 25
    ... has traded on the NASDAQ National Market under the symbol "NFLX" since our initial public offering on May 29, 2002. The following table sets forth the high and low per-share closing prices of our common stock for the periods indicated, as reported by the NASDAQ National Market: 2002 High Low 2003...

  • Page 26
    ... ...Sales ...Total revenues ...Cost of revenues: Subscription ...Sales ...Total cost of revenues ...Gross profit ...Operating expenses: Fulfillment ...Technology and development ...Marketing ...General and administrative ...Restructuring charges ...Stock-based compensation ...Total operating...

  • Page 27
    ..." of this annual report on Form 10-K. Overview Our Business We are the largest online movie rental subscription service in the United States, providing more than 1,487,000 subscribers access to a comprehensive library of more than 18,000 movie, television and other filmed entertainment titles. Our...

  • Page 28
    ... cost is defined as total marketing expense divided by total gross subscriber additions. Management reviews this metric closely to evaluate how effective our marketing programs are in acquiring new subscribers on an economical basis. Disc Usage Per Paying Subscriber: Disc usage per paying subscriber...

  • Page 29
    ... offer other service plans with different price points that allow subscribers to keep either fewer or more titles at the same time. As of December 31, 2003, more than 92 percent of our paying subscribers paid $19.95 or more per month. Cost of Subscription Revenues: We acquire titles for our library...

  • Page 30
    .... Technology and Development. Technology and development expenses consist of payroll and related expenses we incur related to testing, maintaining and modifying our Web site, our recommendation service, telecommunications systems and infrastructure and other internal-use software systems. Technology...

  • Page 31
    ... revenue sharing agreements enable us to acquire DVDs at a lower upfront cost than traditional direct purchase arrangements. We share a percentage of the net revenues generated by the use of each particular title with these studios over a fixed period of time, generally twelve months for each title...

  • Page 32
    ... of this annual report on Form 10-K. Year Ended December 31, 2001 2002 2003 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 33
    ... rate and selection of titles as we expanded our DVD library; (2) enhancing the Web site and recommendation service; and (3) expanding our nationwide network of shipping centers in order to reduce delivery time. We believe these improvements to our service increased subscriber satisfaction, which...

  • Page 34
    ... number of average paying subscribers and the number of DVDs mailed to paying subscribers, partially offset by a decrease in the percentage of titles subject to revenue sharing agreements mailed to paying subscribers. • • • The increase in cost of subscription revenues in absolute dollars...

  • Page 35
    ... disc usage per average paying subscriber. The decrease in gross margin was partially offset by a lower percentage of revenue sharing expenses as a result of our rental mix shifting proportionately in favor of purchased titles and away from titles subject to revenue sharing agreements. Gross margin...

  • Page 36
    ...internal hardware and software systems in an effort to improve our productivity and enhance our subscribers' experience. As a result, we expect our technology and development expenses will continue to increase in absolute dollars in 2004. Marketing Year Ended December 31, Percent Percent Change 2002...

  • Page 37
    ...of stock options with three to four-year vesting periods, coupled with compensation expenses associated with shares of common stock issued under our employee stock purchase plan, which was adopted during 2002. The calculation of our stock-based compensation expenses is highly sensitive to the market...

  • Page 38
    ... to meet our cash needs for the foreseeable future, we may require or choose to obtain additional financing. Our ability to obtain financing will depend, among other things, on our development efforts, business plans, operating performance and condition of the capital markets at the time we...

  • Page 39
    ... the amortization of our DVD library as a result of increased purchases of titles during 2003, an increase in accounts payable as a result of our growing operations, an increase in deferred revenue due to a larger subscriber base and an increase in stock-based compensation expenses. The increase in...

  • Page 40
    ... obligations under non-cancelable operating leases and capital leases with various expiration dates through 2006. Future minimum lease payments under these leases are as follows: Year Ending December 31, Capital Operating Leases Leases (in thousands) 2004 ...2005 ...2006 ...Total ... $462 55 - $517...

  • Page 41
    ...on the service plan, may have out between two and eight titles at a time. With our use of multiple shipping centers and the associated software and procedural upgrades, we have reduced the transit time of DVDs. As a result, our subscribers have been able to exchange more titles each month, which has...

  • Page 42
    ... on a proportional basis compared to all titles selected, our revenue sharing and other DVD acquisition expenses could increase, and our gross margins could be adversely affected. If our efforts to build strong brand identity and improve subscriber satisfaction and loyalty are not successful, we may...

  • Page 43
    ... pricing policies and devote substantially more resources to marketing and Web site and systems development than we do. The rapid growth of our online entertainment subscription business since our inception may attract direct competition from larger companies with significantly greater financial...

  • Page 44
    ... us from period to period and may affect our long-term performance changes by our competitors to their product and service offerings; our ability to improve or maintain gross margins in our business; our ability to effectively manage the development of new business segments and markets; our ability...

  • Page 45
    ... in DVD player sales and in the use of the Internet. During our limited operating history, we have experienced greater additions of new subscribers during late fall and the winter months, and these seasonal fluctuations may continue in future periods. We face many risks associated with our plans to...

  • Page 46
    ... and recommend titles that our subscribers will enjoy or if we are unable to implement meaningful improvements, our personal movie recommendation service will be less useful, in which event: • our subscriber satisfaction may decrease, subscribers may perceive our service to be of lower value and...

  • Page 47
    ... by future consumer adoption of DVD players, and if such adoption slows, our subscriber growth may also slow. We depend on studios to release titles on DVD for an exclusive time period following theatrical release. Our ability to attract and retain subscribers is related to our ability to offer new...

  • Page 48
    ... acquire under a revenue sharing agreement are purchased on a wholesale basis from studios or other distributors. If the price of purchased titles 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 49
    ...-made disaster, our operations would be affected adversely. Our executive offices and our San Jose-based shipping center, which also houses our customer service operations and our excess DVD inventory, are located in the San Francisco Bay Area. Our business and operations could be adversely affected...

  • Page 50
    ... will be affected adversely. Increases in credit card processing fees would increase our operating expenses and adversely affect our results of operations. Our subscribers pay for our subscription services predominately using credit cards. From time to time, Visa, MasterCard, American Express and...

  • Page 51
    ... our Web site, our recommendation service, title selection processes and marketing activities. Trademark, copyright, patent and other intellectual property rights are important to us and other companies. Our intellectual property rights extend to our technology, business processes and the content on...

  • Page 52
    ... attitudes toward use of the Internet change, consumers may become unwilling to select their entertainment online or otherwise provide us with information necessary for them to become subscribers. Further, we may not be able to effectively market our services online to users of the Internet. If we...

  • Page 53
    ... significant control over Netflix. As of December 31, 2003, our executive officers and directors, their immediate family members and affiliated venture capital funds beneficially owned, in the aggregate, approximately 38 percent of our outstanding common stock, warrants and stock options that are...

  • Page 54
    ... of our growth and our limited operating history, it is difficult to accurately forecast our revenues, gross margin, operating expenses, number of paying subscribers, number of DVDs shipped per day and other financial and operating data. Our inability or the inability of the financial community to...

  • Page 55
    ...of the period covered by this report were effective in ensuring that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules...

  • Page 56
    ...reference from information contained under the section "Compensation of Executive Officers and Other Matters" in our Proxy Statement for the Annual Meeting of Stockholders. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information required by...

  • Page 57
    ... officers and directors 2002 Employee Stock Purchase Plan Amended and Restated 1997 Stock Plan 2002 Stock Plan Amended and Restated Stockholders' Rights Agreement Office Lease between the registrant and BR3 Partners Lease Agreement with Lincoln-Recp Oakland Opco, LLC, as amended Employment Offer...

  • Page 58
    ....12** Revenue Sharing Output License Terms between the registrant and Warner Home Video Form of Subordinated Promissory Note Strategic Marketing Agreement between the registrant and Best Buy Co., as amended Consent of Independent Auditors, KPMG LLP Certification of Chief Executive Officer Pursuant...

  • Page 59
    NETFLIX, INC. INDEX TO FINANCIAL STATEMENTS Page Independent Auditors' Report ...Balance Sheets as of December 31, 2002 and 2003 ...Statements of Operations for the Years Ended December 31, 2001, 2002 and 2003 ...Statements of Stockholders' (Deficit) Equity and Comprehensive Income (Loss) for the ...

  • Page 60
    ... each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. As discussed in note 8, the Company changed its method of accounting for stock based compensation by adopting the fair value method with...

  • Page 61
    ... ...Deferred rent ...Capital lease obligations, less current portion ...Total liabilities ...Stockholders' equity: Common stock, $0.001 par value; 150,000,000 and 80,000,000 shares authorized at December 31, 2002 and 2003, respectively; 44,891,590 and 50,849,370 issued and outstanding at December 31...

  • Page 62
    ... ...Sales ...Total revenues ...Cost of revenues: Subscription ...Sales ...Total cost of revenues ...Gross profit ...Operating expenses: Fulfillment* ...Technology and development* ...Marketing* ...General and administrative* ...Restructuring charges ...Stock-based compensation ...Total operating...

  • Page 63
    ... losses on available-for-sale securities ...- Comprehensive income ...Exercise of options ...- Issuance of common stock under employee stock purchase plan ...- Issuance of common stock upon exercise of warrants ...- Deferred stock-based compensation, net ...- Stock-based compensation expense...

  • Page 64
    ... revenue ...Deferred rent ...Net cash provided by operating activities ...Cash flows from investing activities: Purchases of short-term investments ...Purchases of property and equipment ...Acquisitions of DVD library ...Proceeds from sale of DVDs ...Deposits and other assets ...Net cash used...

  • Page 65
    ... mail from shipping centers throughout the United States. The Company also provides extensive information on DVD movies, including critic reviews, member reviews, online trailers, ratings and personalized movie recommendations. Initial Public Offering On May 29, 2002, the Company closed the sale...

  • Page 66
    ... 31, 2003, the cost, unrealized gain and market value of the Company's short-term investments were $44,701, $596 and $45,297, respectively. Amortization of DVD Library The Company amortizes its DVD library, less estimated salvage value, on a "sum-of-the-months" accelerated basis over one year. See...

  • Page 67
    ..., advertising, public relations, payments to marketing affiliates who drive subscriber traffic to the Company's Web site and other costs related to promotional activities including revenue-sharing expenses, postage and packaging expenses and DVD library amortization related to free-trial periods...

  • Page 68
    ... 31, 2001 2002 2003 Warrants ...Employee stock options ...Redeemable convertible preferred stock ...Convertible preferred stock ...Segment Reporting 14,036,000 5,999,000 19,320,000 6,246,000 12,556,000 8,201,000 - - - 113,000 - - The Company is an online movie rental subscription service and...

  • Page 69
    ... 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 a "sum-of-the-month" accelerated method using...

  • Page 70
    ... payment to acquire titles from the studios. This payment includes a contractually specified initial fixed license fee that is capitalized and amortized in accordance with the Company's DVD library amortization policy. Some payments also include a contractually specified prepayment of future revenue...

  • Page 71
    ... 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 intangible assets with a corresponding credit to additional paid...

  • Page 72
    NETFLIX, INC. NOTES TO FINANCIAL STATEMENTS-(Continued) (in thousands, except share, per share and per DVD data) Accrued Expenses Accrued expenses consisted of the following: As of December 31, 2002 2003 Accrued state sales and use tax ...Employee benefits ...Other ...Total accrued expenses ... $2,...

  • Page 73
    ... the term of the lease agreement, which is 45 months. As of December 31, 2003, no warrants were outstanding in connection with the capital lease agreement. In July 2001, the Company issued a warrant to purchase 100,000 shares of Series F preferred stock at $9.38 per share to a Web portal company in...

  • Page 74
    ... expiration dates through 2005. Future minimum lease payments under non-cancelable capital and operating leases as of December 31, 2003 are as follows: Year Ending December 31, Capital Leases Operating Leases 2004 ...2005 ...2006 ...Total minimum payments ...Less: amount representing interest...

  • Page 75
    ... Employee Stock Purchase Plan, shares of the Company's common stock may be purchased over an offering period with a maximum duration of two years at 85 percent of the lower of the fair market value on the first day of the applicable offering period or on the last day of the six-month purchase period...

  • Page 76
    ... years. During the third quarter of 2003, the Company began granting fully vested options on a monthly basis. In 2001, the Company offered its employees the right to exchange certain employee stock options. The exchange resulted in the cancellation of employee stock options to purchase 1.8 million...

  • Page 77
    NETFLIX, INC. NOTES TO FINANCIAL STATEMENTS-(Continued) (in thousands, except share, per share and per DVD data) A summary of the activities related to the Company's options is as follows: Options Outstanding WeightedAverage Number of Exercise Shares Price Shares Available for Grant Balances as of...

  • Page 78
    ...minimum-value method prior to the Company's initial public offering in May 2002. The fair value of employee stock options granted after the initial public offering, as well as the fair value of shares issued under the employee stock purchase plan, was estimated using the Black-Scholes option pricing...

  • Page 79
    ...except share, per share and per DVD data) The weighted-average fair value of employee stock options granted during 2001, 2002 and 2003 was $0.16, $5.19 and $5.98 per share, respectively. The weighted-average fair value of shares granted under the employee stock purchase plan during 2002 and 2003 was...

  • Page 80
    ...the Company's operations and reduce expenses. All liabilities related to this restructuring charge have been paid. 12. Subsequent Event On January 16, 2004, the Company's Board of Directors approved a two-for-one split in the form of a stock dividend on all outstanding shares of its common stock. As...

  • Page 81
    ...share and per DVD data) 13. Selected Quarterly Financial Data (Unaudited) March 31 Quarter Ended June 30 September 30 December 31 2003 Total revenues ...Gross profit ...Net income (loss) ...Net income (loss) per share: Basic ...Diluted ...Subscribers at end of period ...2002 Total revenues ...Gross...

  • Page 82
    ... hereof. Pursuant to the requirements of the Securities and Exchange Act of 1934, this annual report on Form 10-K 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/ REED HASTINGS Reed Hastings BARRY...

  • Page 83
    ... OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Reed Hastings, certify that: 1. I have reviewed this annual report on Form 10-K of Netflix, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state...

  • Page 84
    ...in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who...

  • Page 85
    ... of the Securities Exchange Act of 1934 and that information contained in such report fairly presents, in all material respects, the financial condition and results of operations of Netflix, Inc. Dated: February 27, 2004 By: /s/ REED HASTINGS Reed Hastings Chief Executive Officer I, Barry McCarthy...

  • Page 86
    ...฀report or฀other฀financial฀information: URL:฀http://ir.netï¬,ix.com Email:฀ir@netï¬,ix.com Investor฀Relations฀ Netï¬,ix,฀Inc. 970฀University฀Avenue Los฀Gatos,฀CA฀95032 Phone:฀1-408-317-3700 Neil฀Hunt฀ Chief฀Product฀Officer฀ Designed฀by฀Casper฀Design...

  • Page 87
    ...408-399-3700 Netflix (Nasdaq: NFLX) is the world's largest online DVD movie rental service offering nearly 1.5 million members access to more than 18,000 titles. Our appeal and success are built on providing the most expansive selection of DVDs, an easy way to choose movies and fast, free delivery.