NetFlix 2007 Annual Report Download

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2 0 0 7 A N N U A L R E P O R T

Table of contents

  • Page 1
    2 0 0 7 A N N U A L R E P O R T

  • Page 2
    ...Annual Report Subscribers (in thousands) Revenue (in millions) Net Income (in millions) 7,479 $997 6,316 $1,205 $67 $49 $42 $682 4,179 $501 2,610 $22 2004 2005 2006 2007 2004 2005 2006 2007 2004 2005* 2006 2007 * 2005 Net Income includes the benefit of realized deferred tax asset...

  • Page 3
    ... Netï¬,ix subscription at no additional cost; strengthening customer support with 800 number availability seven days a week, 24 hours a day; enhancing our web site's ability to help our subscribers find movies they'll love; and adding shipping points for more one-business-day delivery. As a result...

  • Page 4
    ... 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 Global Select Market System, was $813,946,440. Shares of common stock beneficially owned by each executive officer and...

  • Page 5
    ... Item 15. Exhibits and Financial Statement Schedules ...45 Directors, Executive Officers and Corporate Governance ...Executive Compensation ...Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters ...Certain Relationships and Related Transactions and Director...

  • Page 6
    ... of our business; growth in online DVD rentals; operating expenses; gross margin; liquidity; developments in Internet delivery of content, our instant-watching feature and DVD formats; revenue per average paying subscriber; impacts relating to our pricing strategy, our content library investments...

  • Page 7
    ... of the free trial period, subscribers are automatically enrolled as paying subscribers, unless they cancel their subscription. All paying subscribers are billed monthly in advance. We stock approximately 90,000 DVD titles. We have established revenue sharing relationships with several studios and...

  • Page 8
    ...new releases, by genre and other targeted categories. We also offer more than 6,000 choices through our instant-watching feature. Our convenient, easy-to-use Web site allows subscribers to quickly select current titles, reserve upcoming releases and build an individual queue for future viewing using...

  • Page 9
    ... store software optimizes subscriber satisfaction and management of our library by integrating the predictions from our recommendation service, each subscriber's current queue and viewing history, inventory levels and other factors to determine which movies to promote to each subscriber. Our account...

  • Page 10
    ... by the benefits of word-of-mouth advertising, our subscriber referrals and our active public relations programs. Content Acquisition We acquire content through direct purchases, revenue sharing agreements and license agreements. Under our revenue sharing agreements with studios and distributors...

  • Page 11
    ... compete against other online and store-based DVD subscription services, such as Blockbuster's Total Access, subscription entertainment services, such as HBO, Showtime and Starz, pay-per-view and VOD providers and cable and satellite providers. VOD and delivery of movies over the Internet may also...

  • Page 12
    ... of Internet delivered content, the download-to-own segment and the advertisingsupported online delivery segment, and we believe we will lead the rental segment with our instant-watching feature as it develops. In late 2006, Blockbuster launched its integrated store-based and online program, Total...

  • Page 13
    ... 1997 and completed our initial public offering in May 2002. Our principal executive offices are located at 100 Winchester Circle, Los Gatos, California 95032, and our telephone number is (408) 540-3700. We maintain a Web site at www.netflix.com. The contents of our Web site are not incorporated...

  • Page 14
    ... cable channels, pay-per-view and VOD for their in-home filmed entertainment. While the market segment for online DVD rental has grown significantly, we saw our growth slow in 2007. Our slowing growth appears primarily to be the result of the rapid growth of our direct competitor, Blockbuster Online...

  • Page 15
    ... market share, increase our revenues or maintain profitability. Our principal competitors include: • video rental outlets and kiosk services, such as Blockbuster, Movie Gallery and Redbox; • online DVD subscription rental sites, such as Blockbuster Online; • pay-per-view and VOD services...

  • Page 16
    ... such as Blu-ray, will be valuable long-term consumer propositions and studio profit centers. However, if DVD sales were to decrease, because of a shift away from movie watching or because new or existing technologies were to become more popular at the expense of DVD enjoyment, studios and retailers...

  • Page 17
    ... our service in ways that may impact subscriber movie usage. Such adjustments include new Web site features and merchandising practices, computer-based instant watching of select titles through our instant-watching feature, an expanded DVD distribution network and software and process changes. In...

  • Page 18
    ... marketing programs, including television 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...

  • Page 19
    ...DVDs among our shipping centers in a timely and efficient manner, our ability to retain existing subscribers and to add new subscribers may be impaired. In addition, through our instant-watching feature, our subscribers will access titles on our Web site through our proprietary movie player software...

  • Page 20
    ... process is designed to accommodate the delivery of one DVD to fulfill a selection. Because of the lightweight nature of a DVD, we generally mail one DVD per envelope using standard first class U.S. postage rates. Studios occasionally provide additional content on a second DVD or may package a title...

  • Page 21
    ... our instant-watching feature, our subscribers access titles on our Web site through our proprietary movie player software and must maintain their connection to our Web site for an uninterrupted viewing experience. Service interruptions, errors in our software or the unavailability of our Web site...

  • Page 22
    ... or with the systems by which it allocates capacity among its customers, including us, could adversely impact the experience of our subscribers. Our executive offices and our Sunnyvale-based shipping center are located in the San Francisco Bay Area. In the event of an earthquake or other natural...

  • Page 23
    ... processing fees or changes to operating rules would increase our operating expenses and adversely affect our business and results of operations. Our subscribers pay for our subscription services predominately using credit cards and debit cards. Our acceptance of these payment methods requires...

  • Page 24
    ... 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 25
    ..., if consumer 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...

  • Page 26
    ...our service or reduce their service levels. Also, our efforts to attract new subscribers may be adversely impacted. Risks Related to Our Stock Ownership Our officers and directors and their affiliates will exercise significant control over Netflix. As of December 31, 2007, our executive officers and...

  • Page 27
    ..., forecasts of our revenues, gross margin, operating expenses, number of paying subscribers, number of DVDs shipped per day and other financial and operating data may differ materially from actual results. Such discrepancies could cause a decline in the trading price of our common stock. Item 1B...

  • Page 28
    ... Lease Expiration Date Location Primary Use Sunnyvale, California ...Los Gatos, California ...Hillsboro, Oregon ...Beverly Hills, California ... 115,000 81,000 49,000 18,000 Receiving and storage center, processing and shipping center for the San Francisco Bay Area December 2012 Corporate office...

  • Page 29
    ... Purchases of Equity Securities Our common stock has traded on the NASDAQ Global Select Market and its predecessor, the NASDAQ National Market, under the symbol "NFLX" since our initial public offering on May 23, 2002. The following table sets forth the intraday high and low sales prices per share...

  • Page 30
    ...Securities Stock repurchases during the three months ended December 31, 2007 were as follows: Total Number of Shares Purchased as Part of Publicly Maximum Dollar Value Total Number of Average Price Announced that May Yet Be Purchased Shares Purchased Paid per Share Programs Under the Program Period...

  • Page 31
    .... Under this program, the Company repurchased 3,847,062 shares of common stock at an average price of $25.96 per share for an aggregate amount of $99.9 million, net of expenses. For further information regarding stock repurchase activity, see Note 7 of Notes to consolidated financial statements. 26

  • Page 32
    ... 37.02 $ 1,487 1,571 32.80 (3) Short-term investments are comprised of corporate debt securities, government and agency securities and asset and mortgage-backed securities. (4) Subscriber acquisition cost is defined as total marketing expenses divided by total gross subscriber additions during the...

  • Page 33
    ... can be watched instantly on their PCs. We offer nine subscription plans, starting at $4.99 a month. There are no due dates, no late fees and no shipping fees. Subscribers select titles at our Web site aided by our proprietary recommendation service, receive them on DVD by U.S. mail and return them...

  • Page 34
    ... new-release DVDs and back-catalog DVDs is estimated to be 1 year and 3 years, respectively. In estimating the useful life of our DVDs, we take into account library utilization as well as an estimate for lost or damaged DVDs. Volume purchase discounts received from studios on the purchase of titles...

  • Page 35
    ... changed our method of calculating the fair value of new stock-based compensation awards under our stock plans from a Black-Scholes model to a lattice-binomial model on January 1, 2007. We continue to use a Black-Scholes option model to determine the fair value of employee stock purchase plan shares...

  • Page 36
    ...or license agreements. Direct purchases of DVDs normally result in higher upfront costs than titles obtained through revenue sharing agreements. Cost of subscription revenues consists of postage and packaging costs related to shipping titles to paying subscribers, amortization of our content library...

  • Page 37
    ... include credit card fees. Operating Expenses Technology and Development. Technology and development expenses consist of payroll and related costs incurred in testing, maintaining and modifying our Web site, our recommendation service, developing solutions for the Internet-based delivery of content...

  • Page 38
    ... Annual Report on Form 10-K. Year Ended December 31, 2007 2006 2005 Revenues ...Cost of revenues: Subscription ...Fulfillment expenses ...Total cost of revenues ...Gross profit ...Operating expenses: Technology and development ...Marketing ...General and administrative ...Gain on disposal of DVDs...

  • Page 39
    ...monthly subscription revenue per paying subscriber. We believe the increase in the number of paying subscribers was driven primarily by increased consumer awareness of the benefits of online DVD rentals and continuing improvements in our service. The decline in the average monthly revenue per paying...

  • Page 40
    ... attributable to an increase in personnel-related costs resulting from the higher volume of activities in our customer service and shipping centers, coupled with higher credit card fees as a result of 32% growth in the average number of paying subscribers. In addition, the increase in fulfillment...

  • Page 41
    ... sharing agreements mailed to paying subscribers, as well as an increase in revenue per paid shipment as a result of a decline in overall usage and the continued popularity of our lower priced plans. The increase in postage rates by 2 cents effective January 8, 2006 negatively impacted gross margin...

  • Page 42
    ... in cost of providing free trials associated with our lower priced plans coupled with a slight decline in personnel-related costs. We anticipate that our marketing expense will decrease in absolute dollars in 2008 due to more efficient use of our marketing dollars. General and Administrative Year...

  • Page 43
    ... our operations including, but not limited to, the number of subscribers who sign up for our service, the growth or reduction in our subscriber base and our ability to develop new revenue sources. In addition, we may have to or otherwise choose to lower our prices and increase our marketing expenses...

  • Page 44
    ...and net changes in assets and liabilities of $2.5 million. Investing Activities Our investing activities consisted primarily of purchases and sales of available-for-sale securities, acquisitions of content library, including Internet-delivered content in 2007, and purchases of property and equipment...

  • Page 45
    ... our content library. Our purchase orders are based on our current needs and are generally fulfilled by our vendors within short time horizons. License Agreements In addition to the above contractual obligations, we have certain license agreements with studios that include a maximum number of titles...

  • Page 46
    ... 2007, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141-R, Business Combinations (SFAS No. 141-R), to replace SFAS No. 141, Business Combinations. SFAS No. 141-R requires the use of the acquisition method of accounting, defines the acquirer, establishes the acquisition date and...

  • Page 47
    ... this Annual Report on Form 10-K were effective in providing reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified...

  • Page 48
    ... any, within Netflix have been detected. (b) Management's Annual Report on Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934...

  • Page 49
    ... 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 this item is incorporated...

  • Page 50
    ... with each of its executive officers and directors 2002 Employee Stock Purchase Plan Amended and Restated 1997 Stock Plan Amended and Restated 2002 Stock Plan Amended and Restated Stockholders' Rights Agreement Lease between Sobrato Land Holdings and Netflix, Inc. Lease between Sobrato Interests II...

  • Page 51
    ... File No. Exhibit Filing Date Filed Herewith 23.1 24 31.1 Consent of Independent Registered Public Accounting Firm Power of Attorney (see signature page) Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Certification of Chief Financial Officer...

  • Page 52
    NETFLIX, INC. INDEX TO FINANCIAL STATEMENTS Page Report of Independent Registered Public Accounting Firm ...Consolidated Balance Sheets as of December 31, 2007 and 2006 ...Consolidated Statements of Operations for the Years Ended December 31, 2007, 2006 and 2005 ...Consolidated Statements of ...

  • Page 53
    ... 2007 and 2006, and the related consolidated statements of operations, stockholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2007. We also have audited Netflix, Inc's internal control over financial reporting as of December 31...

  • Page 54
    ... ...Prepaid revenue sharing expenses ...Deferred tax assets ...Other current assets ...Total current assets ...Content library, net ...Property and equipment, net ...Deferred tax assets ...Other assets ...Total assets ...Liabilities and Stockholders' Equity Current liabilities: Accounts payable...

  • Page 55
    ... per share data) Year ended December 31, 2007 2006 2005 Revenues ...Cost of revenues: Subscription ...Fulfillment expenses* ...Total cost of revenues ...Gross profit ...Operating expenses: Technology and development* ...Marketing* ...General and administrative* ...Gain on disposal of DVDs ...Gain...

  • Page 56
    ... on available-for-sale securities, net of tax ...- Comprehensive income ... Exercise of options ...828,824 Issuance of common stock under employee stock purchase plan ...205,416 Repurchases of common stock ...(4,733,788) Stock-based compensation expense ...- Excess tax benefits from stock options...

  • Page 57
    ... of common stock ...9,611 Excess tax benefits from stock-based compensation ...26,248 Repurchases of common stock ...(99,860) Principal payments on notes payable and capital lease obligations ...- Net cash (used in) provided by financing activities ...(64,001) Effect of exchange rate changes on cash...

  • Page 58
    ... be watched instantly on their PCs. The Company offers nine subscription plans, starting at $4.99 a month. There are no due dates, no late fees and no shipping fees. Subscribers select titles at the Company's Web site aided by its proprietary recommendation service, receive them on DVD by U.S. mail...

  • Page 59
    ... useful lives. The useful life of the new release DVDs and back catalog DVDs is estimated to be 1 year and 3 years, respectively. In estimating the useful life of its DVDs, the Company takes into account library utilization as well as an estimate for lost or damaged DVDs. Volume purchase discounts...

  • Page 60
    ... 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...

  • Page 61
    ... software used to run its Web site and store its data. Marketing Marketing expenses consist primarily of advertising expenses. Advertising expenses include marketing program expenditures and other promotional activities, including revenue sharing expenses, postage and packaging expenses and content...

  • Page 62
    ... shares outstanding during the period. Potential common shares consist primarily of incremental shares issuable upon the assumed exercise of stock options, warrants to purchase common stock and shares currently purchasable pursuant to our employee stock purchase plan using the treasury stock method...

  • Page 63
    ... 2007, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141-R, Business Combinations (SFAS No. 141-R), to replace SFAS No. 141, Business Combinations. SFAS No. 141-R requires the use of the acquisition method of accounting, defines the acquirer, establishes the acquisition date and...

  • Page 64
    ... investments were classified as available-for-sale securities and are reported at fair value as follows: Gross Amortized Cost Gross Gross Unrealized Unrealized Gains Losses (in thousands) Estimated Fair Value Corporate debt securities ...Government and agency securities ...Asset and mortgage backed...

  • Page 65
    ... equipment ...3-5 years 41,140 25,000 Computer software, including internal-use software ...1-3 years 22,058 16,883 Furniture and fixtures ...3 years 7,882 4,855 Leasehold improvements ...Over life of lease 18,440 14,389 Capital work-in-progress ...18,452 11,482 Property and equipment, gross ...143...

  • Page 66
    ... require the Company to pay property taxes, insurance and maintenance costs. Further, several lease agreements contain rent escalation clauses or rent holidays. For purposes of recognizing minimum rental expenses on a straight-line basis over the terms of the leases, the Company uses the date...

  • Page 67
    ..., filed a class action lawsuit against the Company in California Superior Court, City and County of San Francisco. The complaint asserts claims of, among other things, false advertising, unfair and deceptive trade practices, breach of contract as well as claims relating to the Company's statements...

  • Page 68
    ... by Intercepting Request at Web Server and Routing to Page Server Thereby Releasing Web Server to Process Other Requests" and "System and Method for Managing Dynamic Web Page Generation Requests", issued on April 13, 1999 and July 2, 2002, respectively. The complaint seeks unspecified compensatory...

  • Page 69
    ... reserved a total of 1,166,666 shares of common stock for issuance. The 2002 Employee Stock Purchase Plan also provides for annual increases in the number of shares available for issuance on the first day of each year, beginning with 2003, equal to the lesser of: • 2% of the outstanding shares of...

  • Page 70
    ...for determining the purchase price is six months. Employees may invest up to 15% of their gross compensation through payroll deductions. In no event shall an employee be permitted to purchase more than 8,334 shares of common stock during any six-month purchase period. During the years ended December...

  • Page 71
    NETFLIX, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) A summary of the activities related to the Company's options is as follows: Weighted-Average Options Outstanding Remaining Aggregate Shares Available Number of Weighted-Average Contractual Term Intrinsic Value for Grant Shares ...

  • Page 72
    ... 2007, employee stock options will remain exercisable for the full ten year contractual term regardless of employment status. In conjunction with this change, the Company changed its method of calculating the fair value of new stock-based compensation awards granted under its stock option plans from...

  • Page 73
    ... of tax, related to stock option plans and employee stock purchases under SFAS No. 123(R) which was allocated as follows: Year Ended December 31, 2007 2006 2005 (in thousands) Fulfillment expenses ...Technology and development ...Marketing ...General and administrative ...Stock-based compensation...

  • Page 74
    ... related to stock options. In 2007 all of the unrecognized net operating loss was used to reduce the taxable income and the benefit was credited to equity. The Company files income tax returns in the U.S. federal jurisdiction and all of the states where income tax is imposed. The Company is subject...

  • Page 75
    ... with Netflix. 11. Selected Quarterly Financial Data (Unaudited) December 31 Quarter Ended September 30 June 30 March 31 2007 Total revenues ...Gross profit ...Net income ...Net income per share: Basic ...Diluted ...Subscribers at end of period ...2006 Total revenues ...Gross profit ...Net...

  • Page 76
    ... to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Netflix, Inc. Dated: February 27, 2008 By: /s/ REED HASTINGS Reed Hastings Chief Executive Officer...

  • Page 77
    ... with each of its executive officers and directors 2002 Employee Stock Purchase Plan Amended and Restated 1997 Stock Plan Amended and Restated 2002 Stock Plan Amended and Restated Stockholders' Rights Agreement Lease between Sobrato Land Holdings and Netflix, Inc. Lease between Sobrato Interests II...

  • Page 78
    ... 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 79
    ... 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 80
    ... 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, 2008 By: /s/ REED HASTINGS Reed Hastings Chief Executive Officer I, Barry McCarthy...

  • Page 81
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  • Page 82
    ... STOCK LISTING Netï¬,ix, Inc. common stock trades on the Nasdaq Stock Market under the symbol NFLX. For additional copies of this report or other financial information: http://ir.netï¬,ix.com Email: ir@netï¬,ix.com INVESTOR RELATIONS Netï¬,ix, Inc. 100 Winchester Circle Los Gatos, CA 95032 Phone...

  • Page 83
    Netflix, Inc. | 100 Winchester Circle, Los Gatos, CA 95032 | www.netflix.com