NetFlix 2006 Annual Report Download - page 64

NETFLIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except share and per share data and percentages)
Capitalized Software Costs
The Company capitalizes costs related to developing or obtaining internal-use software. Capitalization of
costs begins after the conceptual formulation stage has been completed. Capitalized software costs are included
in property and equipment, net and are amortized over the estimated useful life of the software, which is
generally one year.
Revenue Recognition
Subscription revenues are recognized ratably over each subscriber’s monthly subscription period. Refunds
to subscribers are recorded as a reduction of revenues. Revenues from sales of advertising are recognized upon
completion of the campaign. Revenues are presented net of the taxes that are collected from customers and
remitted to governmental authorities. Deferred revenue consists of subscriptions revenues billed to subscribers
that have not been recognized.
Cost of Revenues
Subscription. Cost of subscription consists of revenue sharing expenses, amortization of the 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 of some revenue sharing agreements with studios obligate the Company to make minimum
revenue sharing payments for certain titles. The Company amortizes minimum revenue sharing prepayments (or
accretes an amount payable to studios if the payment is due in arrears) as revenue sharing obligations are
incurred. A provision for estimated shortfall, if any, on minimum revenue sharing payments is made in the period
in which the shortfall becomes probable and can be reasonably estimated. Additionally, the terms of some
revenue-sharing agreements with studios provide for rebates based on achieving specified performance levels.
The Company accrues for these rebates as earned based on historical title performance and estimates of demand
for the titles over the remainder of the title term. Actual rebates may vary which could result in an increase or
reduction in the estimated amounts previously accrued.
Fulfillment Expenses. Fulfillment expenses represent those costs incurred in operating and staffing the
Company’s fulfillment and customer service centers, including costs attributable to receiving, inspecting and
warehousing the Company’s DVD library. Fulfillment expenses also include credit card fees.
Technology and Development
Technology and development expenses consist of payroll and related costs incurred in testing, maintaining
and modifying the Company’s Web Site, its recommendation service, developing solutions for the online
delivery of content to subscribers, telecommunications systems and infrastructure and other internal-use software
systems. Technology and development expenses also include depreciation on computer hardware and capitalized
software.
Marketing
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. Advertising costs are
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