NetFlix 2005 Annual Report Download

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WHO’S WATCHING?

Table of contents

  • Page 1
    W H O ' S WATC H I N G ?

  • Page 2

  • Page 3
    ...intensely focused on providing an online movie rental service that engages and delights our subscribers. That's why we're confident we can reach 20 million subscribers in the next five to seven years. Because we're delivering a superior home entertainment experience. NETFLIX 2005 ANNUAL REPORT 1

  • Page 4
    DELIVERING MOVIES OUR 4.2 MILLION SUBSCRIBERS LOVE. Netï¬,ix offers personalized movie recommendations. 

  • Page 5

  • Page 6
    DELIVERING ANOTHER STRONG YEAR.

  • Page 7
    ... offer the broadest selection of movies, an intuitive and personalized Web site, and a distribution system that enables delivery in about one business day to the vast majority of our subscribers. Those attributes are why we were independently ranked number one in online retail customer satisfaction...

  • Page 8

  • Page 9
    DELIVERING EXECUTING, PERSONALIZING, , WINNING. Netï¬,ix was named number one in online retail customer satisfaction in 2005 by ForeSee Results.

  • Page 10
    .... With millions of online subscribers addicted to the Netï¬,ix Web site, we will have both a mass audience and the most compelling consumer experience in the market, which will give us critical advantages as we begin to offer downloading as a second delivery option. 8 NETFLIX 2005 ANNUAL REPORT

  • Page 11
    ...rst choice for movie rental, whether by mail or other forms of delivery. We know that delivering for our subscribers will enable us to achieve our goals and create value for our shareholders. Sincerely, Reed Hastings Chief Executive Officer, President and Co-founder NETFLIX 2005 ANNUAL REPORT 9

  • Page 12

  • Page 13
    DELIVERING OVER 1 MILLION DVDs A DAY. Today, we can provide more than 90% of our subscribers with delivery in about one business day.

  • Page 14
    DELIVERING RESULTS. Subscribers (in thousands) '05 '04 '03 '02 4,179 2,610 1,487 857 Revenue (in millions) '05 '04 '03 '02 $682 $501 $270 $151 Net Income (Loss) (in millions) '05 '04 '03 '02 $42 $22 $7 $(21)

  • Page 15
    ... is a shell company (as defined in Rule 12b-2 of the Act) Yes ' No Í As of June 30, 2005, the aggregate market 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...

  • Page 16
    ... and Related Transactions ...Principal Accountant Fees and Services ...42 42 42 42 42 Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities ...Selected Financial Data ...Management's Discussion and Analysis of Financial Condition and...

  • Page 17
    ... expenses; gross margin; liquidity; subscriber acquisition and retention; churn; developments in downloading and the DVD format; revenue per average paying subscriber; and impacts relating to our pricing strategy, delivery time, volume of movie rentals and growth of the online DVD rental market...

  • Page 18
    ... and pay-per-view services continue to 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
    ...low-cost shipping centers. We employ temporary, hourly and part-time workers to contain labor costs and provide maximum operating flexibility. Convenience, Selection and Fast Delivery. Subscribers can conveniently select titles by building and modifying a personalized queue of titles on our Web site...

  • Page 20
    ... Our Web site-www.netflix.com We have applied 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. We...

  • Page 21
    ... that our paid marketing efforts are significantly enhanced by the benefits of word-of-mouth advertising, our subscriber referrals and our active public relations programs. Content Acquisition We acquire content either through revenue sharing agreements or direct purchases. Under our revenue sharing...

  • Page 22
    ...frequent communication with and feedback from our subscribers in order to continually improve our Web site and our service. Our customer service center is open seven days a week. We utilize e-mail to correspond with subscribers. We also offer phone support for subscribers who prefer to talk directly...

  • Page 23
    ...reporting is contained in Note 1 to the Notes to the Consolidated Financial Statements. Other Information We were incorporated in Delaware in August 1997 and completed our initial public offering in May 2002. Our principal executive offices are located at 100 Winchester Circle, Los Gatos, California...

  • Page 24
    ...a large number of subscribers who have traditionally used video retailers, video rental outlets, cable channels, such as HBO and Showtime, pay-per-view and VOD for in-home filmed entertainment. In addition, we face direct competition to our service, namely from services like Blockbuster Online, that...

  • Page 25
    ... share, increase our revenues or maintain profitability. Our principal competitors include, or could include video rental outlets, such as Blockbuster and Movie Gallery; online DVD subscription rental sites, such as Blockbuster Online; pay-per-view and VOD services and alternative content delivery...

  • Page 26
    ... terms on which they are acquired. If subscribers select these titles more often 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. In addition, films released on the new...

  • Page 27
    ... and radio advertising, direct mail and print campaigns, consumer package and mailing insertions. We also acquire a number of subscribers who rejoin our service having previously cancelled their membership. We maintain an active public relations program to increase awareness of our service and...

  • Page 28
    ... results. We rely exclusively on the U.S. Postal Service to deliver DVDs from our shipping centers and to return DVDs to us from our subscribers. We are subject to risks associated with using the public mail system to meet our shipping needs, including delays or disruptions caused by inclement...

  • Page 29
    ...are made only if our subscribers rent the DVD. Under a purchase arrangement, we must pay the full wholesale price, regardless of whether the DVD is rented. In addition, revenue sharing agreements generally provide for studio promotional support of the associated DVD and our service as well as permit...

  • Page 30
    ... 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 may be...

  • Page 31
    ... general public loss of confidence in the use of the Internet for commerce transactions, which could adversely affect our business. In addition, because we obtain subscribers' billing information on our Web site, we do not obtain signatures from subscribers in connection with the use of credit cards...

  • Page 32
    ... 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 33
    ...that we publish or distribute. We also may face potential liability for content uploaded from our users in connection with our community-related content or movie reviews. If we become liable, then our business may suffer. Litigation to defend these claims could be costly and the expenses and damages...

  • Page 34
    ... 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 35
    ... the expectations of securities analysts, investors and the financial community; announcements of developments affecting our business, systems or expansion plans by us or others; competition, including the introduction of new competitors, their pricing strategies and services; market volatility in...

  • Page 36
    ...Los Gatos, California ...Beverly Hills, California ...Sunnyvale, California ... 80,000 18,000 115,000 December 2012 August 2009 April 2009 Corporate Office, general and administrative, marketing, and technology and development Content acquisition, general and administrative Customer service center...

  • Page 37
    ... Purchases of Equity Securities Our common stock has traded on the NASDAQ National Market under the symbol "NFLX" since our initial public offering on May 23, 2002. The following table sets forth the high and low sales prices per share of our common stock for the periods indicated, as reported...

  • Page 38
    ...data) 2005 (2) Statement of Operations Data: Revenues ...Cost of revenues: Subscription ...Fulfillment expenses ...Total cost of revenues ...Gross profit ...Operating expenses: Technology and development ...Marketing ...General and administrative ...Restructuring charges ...Stock-based compensation...

  • Page 39
    ... charges for $17.99 per month. In addition, we offer a number of other subscription plans to accommodate a variety of movie watching preferences. Subscribers select titles at our Web site aided by our proprietary recommendation service, receive them on DVD by U.S. mail and return them to us at their...

  • Page 40
    ... revenue sharing agreements. We acquire DVDs for the purpose of renting them to our subscribers and earning subscription rental revenues and as such, we consider our DVD library to be a productive asset, and classify our DVD Library as a non-current asset. Additionally, in accordance with Statement...

  • Page 41
    ...sharing agreements, we share 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 12 months for each DVD title. At the end of the Title Term, we generally have the option of returning...

  • Page 42
    ... generating a $34.9 million tax benefit. Deferred tax assets do not include the tax benefits attributable to approximately $65 million of excess tax deductions related to stock options. These benefits will only be recorded when realized on tax returns and will be credited to equity at that time...

  • Page 43
    ... per month, we offer other service plans with different price points that allow subscribers to keep either fewer or more titles at the same time. Cost of Revenues: Subscription: We acquire titles for our library through traditional direct purchase and through revenue sharing agreements with content...

  • Page 44
    ...Marketing expenses consist of payroll and related expenses and advertising expenses. Advertising expenses include marketing program expenditures and other promotional activities, including revenue sharing expenses, postage and packaging expenses and library amortization related to free trial periods...

  • Page 45
    ... Annual Report on Form 10-K. Year Ended December 31, 2003 2004 2005 Revenues ...Cost of revenues: Subscription ...Fulfillment expenses ...Total cost of revenues ...Gross profit ...Operating expenses: Technology and development ...Marketing ...General and administrative ...Stock-based compensation...

  • Page 46
    ... the selection of titles as we expanded our DVD library and enhancing our Web site and recommendation service. We believe these improvements to our service increased subscriber satisfaction, which resulted in lower churn. • • If we are unable to compete effectively against Blockbuster and...

  • Page 47
    ... paying subscribers and the number of DVDs mailed to paying subscribers, partially offset by a decrease in the percentage of DVDs subject to revenue sharing agreements mailed to paying subscribers. • • • Fulfillment expenses The increase in fulfillment expenses in absolute dollars in 2005...

  • Page 48
    ... popular subscription plan of $17.99 per month. In addition, the gross margin for 2004 was favorably impacted by certain credits received from studios resulting from amendments to revenue sharing agreements. If movie rentals per average paying subscriber increases or if we see more shipments of DVDs...

  • Page 49
    ...in marketing expenses in absolute dollars in 2005 as compared to 2004 was primarily attributable to an increase in marketing program costs, primarily direct mail, radio, television and online advertising, to attract new subscribers. As a percentage of revenues, the increase in marketing expenses was...

  • Page 50
    ... and administrative expenses in absolute dollars in 2004 as compared to 2003 was primarily attributable to an increase in personnel-related costs, as well as an increase in professional fees to support our growing operations and compliance requirements. As a percentage of revenues, the decrease in...

  • Page 51
    ... expenses. Accordingly, Sales revenues and Cost of sales revenues in the Consolidated Statements of Income for 2003 and 2004 were reclassified to conform to the 2005 presentation (see Note 1 of Notes to Consolidated Financial Statements). The decrease in gain on disposal of DVDs in absolute dollars...

  • Page 52
    ...the valuation allowance in all years. We currently anticipate that our effective tax rate will be approximately 41% in 2006. The effective rate will be impacted, favorably or unfavorably, by the effect of book and tax stock option expenses in 2006. Liquidity and Capital Resources Since inception, we...

  • Page 53
    ... the sale of our short-term investments, cash used in investing activities increased by $25.3 million, primarily due to increased purchases of titles for our DVD library to support our larger subscriber base and increased purchases of property and equipment to support our growing operations in 2005...

  • Page 54
    ...our statement of cash flows include the cash retained as a result of the tax deductibility of increases in the value of equity instruments issued under share-based payment arrangements in excess of any related stock-based compensation recognizable for financial reporting purposes. These tax benefits...

  • Page 55
    ... amortizing a long-lived nonfinancial asset be accounted for prospectively as a change in estimate, and correction of errors in previously issued financial statements should be termed a restatement. SFAS 154 is effective for accounting changes and correction of errors made in fiscal years beginning...

  • Page 56
    ... misstatement of the annual or interim financial statements will not be prevented or detected. Management identified a material weakness in our internal control over financial reporting as of December 31, 2005 related to our accounting for income taxes. Specifically, our policies and procedures do...

  • Page 57
    (d) Inherent Limitations on Effectiveness of Controls Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well ...

  • Page 58
    ... contained under the sections "Security Ownership of Certain Beneficial Owners and Management" and "Equity Compensation Plan Information" in our Proxy Statement for the Annual Meeting of Stockholders. Item 13. Certain Relationships and Related Transactions Information required by this item is...

  • Page 59
    ... registrant with each of its executive 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...

  • Page 60
    ... Sobrato Interests II and Netflix, Inc Description of Director Equity Compensation Plan Executive Severance and Retention Incentive Plan Consent of Independent Registered Public Accounting Firm Power of Attorney (see signature page) Certification of Chief Executive Officer Pursuant to Section 302...

  • Page 61
    ... TO FINANCIAL STATEMENTS Page Reports of Independent Registered Public Accounting Firm ...Consolidated Balance Sheets as of December 31, 2004 and 2005 ...Consolidated Statements of Income for the Years Ended December 31, 2003, 2004 and 2005 ...Consolidated Statements of Stockholders' Equity and...

  • Page 62
    ... the management of Netflix, Inc. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan...

  • Page 63
    ...on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan...

  • Page 64
    ...extent of audit tests applied in our audit of the 2005 consolidated financial statements, and this report does not affect our report dated March 14, 2006, which expressed an unqualified opinion on those consolidated financial statements. In our opinion, management's assessment that Netflix, Inc. did...

  • Page 65
    ... revenue sharing expenses ...Deferred tax assets ...Other current assets ...Total current assets ...DVD library, net ...Intangible assets, net ...Property and equipment, net ...Deposits ...Deferred tax assets ...Other assets ...Total assets...Liabilities and Stockholders' Equity Current liabilities...

  • Page 66
    ... per share data) Year ended December 31, 2003 2004 2005 Revenues ...Cost of revenues: Subscription ...Fulfillment expenses* ...Total cost of revenues...Gross profit ...Operating expenses: Technology and development* ...Marketing* ...General and administrative* ...Stock-based compensation ...Gain...

  • Page 67
    ... 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 ...Stock option income tax benefits ... Balances as of December...

  • Page 68
    ... of DVD library ...43,125 80,346 96,883 Amortization of intangible assets ...3,146 1,987 985 Stock-based compensation expense ...10,719 16,587 14,327 Stock option income tax benefits ...- 176 - Loss on disposal of property and equipment ...- 135 - Loss on disposal of short-term investments...

  • Page 69
    ... $17.99 per month. In addition, the Company offers a number of other subscription plans to accommodate a variety of movie watching preferences. Subscribers select titles at the Company's Web site aided by its proprietary recommendation service, receive them on DVD by U.S. mail and return them to the...

  • Page 70
    ... Statements of Income Revenues: Subscription ...Sales ...Total revenues ...Cost of revenues: Subscription ...Sales ...Fulfillment expenses ...Total cost of revenues ...Gross profit ...Operating expenses: Fulfillment ...Technology and development . . Marketing ...General and administrative ...Stock...

  • Page 71
    ...asset management accounts at two large financial institutions. Restricted Cash As of December 31, 2005, other assets included restricted cash of $500 related to a workers' compensation insurance deposit. Short-Term Investments The Company's short-term investments are classified as available-for-sale...

  • Page 72
    ... ("SOP 00-2") Accounting by Producers or Distributors of Films. Net capitalized film costs are recorded within DVD Library as such amounts are currently not material to the consolidated financial statements. Capitalized film costs include costs to develop and produce movies, which primarily consist...

  • Page 73
    ...DVD library, amortization of intangible assets related to equity instruments issued to studios, and postage and packaging expenses related to DVDs provided to paying subscribers. Revenue sharing expenses are recorded as DVDs subject to revenue sharing agreements are shipped to subscribers. The terms...

  • Page 74
    ...currently purchasable pursuant to our employee stock purchase plan using the treasury stock method. The shares used in the computation of net income per share are as follows (rounded to the nearest thousand): Year Ended December 31, 2003 2004 2005 Weighted-average shares outstanding-basic ...Effect...

  • Page 75
    ...FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 123(R), Share-Based Payment, which establishes standards for transactions in which an entity exchanges its equity instruments for goods or services. This standard replaces SFAS No. 123, Accounting for Stock-Based Compensation and...

  • Page 76
    ...'s statement of cash flows include the cash retained as a result of the tax deductibility of increases in the value of equity instruments issued under share-based payment arrangements in excess of any related stock-based compensation recognizable for financial reporting purposes. These tax benefits...

  • Page 77
    ...acquires DVDs from studios and distributors through either direct purchases or revenue sharing agreements. The Company acquires DVDs for the purpose of renting them to its subscribers and earning subscription rental revenues and as such, the Company considers its DVD library to be a productive asset...

  • Page 78
    ... Assets During 2000, in connection with revenue sharing agreements with three studios, the Company agreed to issue each studio an equity interest equal to 1.204 percent of the Company's fully diluted equity securities outstanding in the form of Series F Non-Voting Convertible Preferred Stock...

  • Page 79
    ... 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 80
    ... ...Employee benefits ...Accrued settlement costs ...Other ...Total accrued expenses ... $ 4,736 2,709 - 5,686 $ 6,656 3,513 8,589 6,805 $ 13,131 $ 25,563 5. Warrants In April 2000, in connection with the sale of Series E preferred stock, the Company sold warrants to purchase 533,003 shares...

  • Page 81
    ... 31, 2005, no warrants were outstanding in connection with the integration and distribution agreement. The Company calculated the fair value of the warrants using the Black-Scholes valuation model with the following assumptions: the terms of the warrants ranging from 4 to 10 years; risk-free rates...

  • Page 82
    ...a free one-month upgrade in service level and Netflix subscribers who were enrolled in a paid membership before January 15, 2005 and were not a member on October 19, 2005 are eligible to receive a free one-month Netflix membership of either the 1, 2 or 3 DVDs at-a-time unlimited program. The Company...

  • Page 83
    ...' Equity Preferred Stock The Company has authorized 10 million shares of undesignated preferred stock with par value of $0.001 per share. None of the preferred shares were issued and outstanding at December 31, 2004 and 2005. Stock Split On January 16, 2004, the Company's Board of Directors...

  • Page 84
    ...'s Board of Directors may determine. Under the 2002 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...

  • Page 85
    ... to four years. During the third quarter of 2003, the Company began granting fully vested options on a monthly basis. 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...

  • Page 86
    ... related to the stock options over their remaining vesting periods using the accelerated multiple-option approach. The fair value of employee stock options granted as well as the fair value of shares issued under the employee stock purchase plan was estimated using the Black-Scholes option pricing...

  • Page 87
    ...-average fair value of shares granted under the employee stock purchase plan during 2003, 2004 and 2005 was $4.43, $10.00 and $6.68 per share, respectively. 9. Income Taxes The components of provision for (benefit from) income taxes for all periods presented were as follows: Year Ended December...

  • Page 88
    ...2004, the Company's deferred tax assets were offset in full by a valuation allowance because of its history of losses, limited profitable quarters to date and the competitive landscape of online DVD rentals. As a result of the Company's analysis of expected future income at December 31, 2005, it was...

  • Page 89
    ... limits set by the Internal Revenue Service. The Company matches employee contributions at the discretion of the Board of Directors. During 2003, 2004 and 2005, the Company's matching contributions totaled $0, $379 and $905, respectively. 11. Selected Quarterly Financial Data (Unaudited) March 31...

  • Page 90
    ... or their or his substitute or substituted, may lawfully do or cause to be done by virtue thereof. 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...

  • Page 91
    ... financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer...

  • Page 92
    ... financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer...

  • Page 93
    ... the Annual Report on Form 10-K of Netflix, Inc. for the year ended December 31, 2005 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 report fairly presents, in all material respects, the financial condition...

  • Page 94
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  • Page 95
    ... of this report or other financial information: http://ir.netflix.com Email: [email protected] Investor Relations Netflix, Inc. 100 Winchester Circle Los Gatos, CA 95032 Phone: (408) 540-3639 SENIOR MANAGEMENT Reed Hastings Chief Executive Officer, President, Chairman of the Board and Co-founder Bill...

  • Page 96
    Diane Court: Nobody thinks it will work, do they? Lloyd Dobler: No. You just described every great success story. Say Anything (1989) Netflix, Inc. • 100 Winchester Circle • Los Gatos, CA 95032 • www.netflix.com