NetFlix 2008 Annual Report Download - page 58

NETFLIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Content Library
The Company obtains content from studios and distributors through direct purchases, revenue sharing
agreements or license agreements. The Company acquires DVD content for the purpose of rental to its
subscribers and earns subscription rental revenues, and, as such, the Company considers its DVD library to be a
productive asset. Accordingly, the Company classifies its DVD library as a non-current asset on its consolidated
balance sheets. Additionally, in accordance with SFAS No. 95, Statement of Cash Flows, cash outflows for the
acquisition of the DVD library, net of changes in related accounts payable, are classified as cash flows from
investing activities in the Company’s consolidated statements of cash flows. This is inclusive of any upfront
non-refundable payments required under revenue sharing agreements.
The Company amortizes its DVDs, less estimated salvage value, on a “sum-of-the-months” accelerated
basis over their estimated useful lives. The useful life of the new release DVDs and back catalog DVDs is
estimated to be one year and three 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.
The Company provides a salvage value of $3.00 per DVD for those direct purchase DVDs that the Company
estimates it will sell at the end of their useful lives. For those DVDs that the Company does not expect to sell, no
salvage value is provided.
The Company obtains content distribution rights in order to stream movies and TV episodes without
commercial interruption to subscribers’ PCs, Macs and TVs enabled by Netflix controlled software that can run
on a variety of devices. The Company accounts for streaming content in accordance with SFAS 63,which
requires classification of streaming content as either a current or non-current asset in the consolidated balance
sheets based on the estimated time of usage after certain criteria have been met including availability of the
streaming content for its first showing. Streaming content is amortized on a straight-line basis generally over the
terms of the license agreements or the title’s window of availability. Liabilities related to streaming content
acquisitions are reported at the gross amount. Cash outflows associated with streaming content are classified as
cash flows from operating activities in the consolidated statements of cash flow.
The Company also obtains DVD and streaming content through revenue sharing agreements with studios
and distributors. The Company generally obtains titles for low initial cost in exchange for a commitment to share
a percentage of its subscription revenues or a fee, based on utilization, over a fixed period, or the Title Term,
which typically ranges from six to twelve months for each title. The initial cost may be in the form of an upfront
non-refundable payment. This payment is capitalized in the content library in accordance with the Company’s
DVD and streaming content policies as applicable. The initial cost may also be in the form of a prepayment of
future revenue sharing obligations which is classified as prepaid revenue sharing expense. 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. Under the revenue sharing agreements for its DVD library, at the end
of the Title Term, the Company generally has the option of returning the DVD title to the studio, destroying the
title or purchasing the title.
Additionally, the terms of certain DVD purchase agreements with studios provide for volume purchase
discounts or rebates based on achieving specified performance levels. Volume purchase discounts are recorded as
a reduction of DVD library when earned. The Company accrues for 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.
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