NetFlix 2004 Annual Report Download - page 74

Download and view the complete annual report

Please find page 74 of the 2004 NetFlix annual report below. You can navigate through the pages in the report by either clicking on the pages listed below, or by using the keyword search tool below to find specific information within the annual report.

Page out of 95

  • 1
  • 2
  • 3
  • 4
  • 5
  • 6
  • 7
  • 8
  • 9
  • 10
  • 11
  • 12
  • 13
  • 14
  • 15
  • 16
  • 17
  • 18
  • 19
  • 20
  • 21
  • 22
  • 23
  • 24
  • 25
  • 26
  • 27
  • 28
  • 29
  • 30
  • 31
  • 32
  • 33
  • 34
  • 35
  • 36
  • 37
  • 38
  • 39
  • 40
  • 41
  • 42
  • 43
  • 44
  • 45
  • 46
  • 47
  • 48
  • 49
  • 50
  • 51
  • 52
  • 53
  • 54
  • 55
  • 56
  • 57
  • 58
  • 59
  • 60
  • 61
  • 62
  • 63
  • 64
  • 65
  • 66
  • 67
  • 68
  • 69
  • 70
  • 71
  • 72
  • 73
  • 74
  • 75
  • 76
  • 77
  • 78
  • 79
  • 80
  • 81
  • 82
  • 83
  • 84
  • 85
  • 86
  • 87
  • 88
  • 89
  • 90
  • 91
  • 92
  • 93
  • 94
  • 95

NETFLIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except share, per share and percentages)
adopted the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation,in
the second quarter of 2003, and restated prior periods at that time. Accordingly the Company believes SFAS No.
123(R) will not have a material impact on its balance sheet or income statements.
2. DVD Library
The Company acquires DVDs from studios and distributors through either direct purchases or revenue
sharing agreements. The revenue sharing agreements enable the Company to obtain DVDs at a lower upfront cost
than under traditional direct purchase arrangements. Under the revenue sharing agreements, the Company shares
a percentage of the actual net revenues generated by the use of each particular title with the studios over a fixed
period of time, or the Title Term, which is typically twelve months for each DVD title. At the end of the Title
Term, the Company generally has the option of either returning the DVD title to the studio, destroying the title or
purchasing the title.
In addition, the Company remits an upfront payment to acquire titles from the studios and distributors under
revenue sharing agreements. 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. This payment
may also include a contractually specified prepayment of future revenue sharing obligations that is classified as
prepaid revenue sharing expense and is charged to expense as future revenue sharing obligations are incurred.
Prior to July 1, 2004, the Company amortized the cost of its entire DVD library, including the capitalized
portion of the initial fixed license fee, on a “sum-of-the-months” accelerated basis over one year. However, based
on a periodic evaluation of both new release and back-catalogue utilization for amortization purposes, the
Company determined that back-catalogue titles have a significantly longer life than previously estimated. As a
result, the Company revised the estimate of useful life for the back-catalogue DVD library from a “sum of the
months” accelerated method using a one year life to the same accelerated method of amortization using a three-
year life. The purpose of this change was to more accurately reflect the productive life of these assets. In
accordance with Accounting Principles Board Opinion No. 20, Accounting Changes (“APB 20”), the change in
life has been accounted for as a change in accounting estimate on a prospective basis from July 1, 2004. New
releases will continue to be amortized over a one year period. As a result of the change in the estimated life of the
back-catalogue library, total cost of revenues was $10.9 million lower, net income was $10.9 million higher and
net income per diluted share was $0.17 higher for the year ended December 31, 2004.
In addition, the Company has also determined that it is selling fewer previously rented DVDs than estimated
but at an average selling price higher than historically estimated. The Company has therefore revised its estimate
of salvage values, on direct purchase DVDs. For those direct purchase DVDs that the Company estimates it will
sell at the end of their useful lives, a salvage value of $3.00 per DVD has been provided effective July 1, 2004.
For those DVDs that the Company does not expect to sell, no salvage value is provided. Simultaneously with the
change in accounting estimate of expected salvage values the Company recorded a write-off of approximately
$1.9 million related to non-recoverable salvage value. As a result of this write-off, total cost of revenues was $1.9
million higher, net income was $1.9 million lower and net income per diluted share was $0.03 lower for the year
ended December 31, 2004.
DVD library and accumulated amortization consisted of the following:
As of December 31,
2003 2004
DVD library ........................................... $110,360 $ 198,216
Less: accumulated amortization ............................ (88,122) (156,058)
DVD library, net ....................................... $ 22,238 $ 42,158
F-14