NetFlix 2007 Annual Report Download - page 61

NETFLIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Cost of Revenues
Subscription. Cost of subscription revenues consists of postage and packaging expenses, amortization of
the content library and revenue sharing expenses. Revenue sharing expenses are recorded when either DVDs are
shipped to subscribers or Internet-based content is viewed by 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 certain
purchase 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 content 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 Internet-based
delivery of content to subscribers, telecommunications systems and infrastructure and other internal-use software
systems. Technology and development expenses also include depreciation of the computer hardware and
capitalized 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 amortization related to free trial periods. Advertising costs are expensed as
incurred except for advertising production costs, which are expensed the first time the advertising is run.
Advertising expense totaled approximately $207.9 million, $215.3 million and $135.9 million in 2007, 2006 and
2005, respectively.
The Company and its vendors participate in a variety of cooperative advertising programs and other
promotional programs in which the vendors provide the Company with cash consideration in exchange for
marketing and advertising of the vendor’s products. If the consideration received represents reimbursement of
specific incremental and identifiable costs incurred to promote the vendor’s product, it is recorded as an offset to
the associated marketing expense incurred. Any reimbursement greater than the specific incremental and
identifiable costs incurred is recognized as a reduction of cost of revenues when recognized in the Company’s
consolidated statements of operations.
Income Taxes
The Company accounts for income taxes using the asset and liability method. Deferred income taxes are
recognized by applying enacted statutory tax rates applicable to future years to differences between the financial
statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and
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