NetFlix 2009 Annual Report Download

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Table of Contents
Letter to Shareholders
Form 10-K
Part I
Item 1. Business.
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
Part II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and issuer purchases of equity securities
Item 6. Selected Financial Data
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
Part III
Item 10. Directors, Executive Officers and Corporate Governance
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions, and Director Independence
Item 14. Principal Accounting Fees and Services
Part IV
Item 15. Exhibits and Financial Statement Schedules
Corporate Directory

Table of contents

  • Page 1
    ... Item 4. Submission of Matters to a Vote of Security Holders Part II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and issuer purchases of equity securities Item 6. Selected Financial Data Item 7. Management's Discussion and Analysis of Financial Condition and Results...

  • Page 2
    2009 ANNUAL REPORT

  • Page 3
    Netï¬,ix 2009 Annual Report Subscribers (in thousands) Revenue (in millions) Net Income (in millions) 12,268 $1,670 $116 9,390 $1,205 7,479 $997 6,316 $1,365 $83 $67 $49 2006 2007 2008 2009 2006 2007 2008 2009 2006 2007 2008 2009

  • Page 4
    ... our distribution centers, which will improve service quality while reducing costs. And we continued to enhance our streaming feature. In 2009, we added new, relevant content and new partnerships with consumer electronics manufacturers, ranging from Blu-ray players and Internet-connected TVs to game...

  • Page 5
    ... year ended December 31, 2009 OR ' TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number: 000-49802 (Exact name of Registrant as specified in its charter) Netflix, Inc. 100 Winchester Circle Los Gatos...

  • Page 6
    ...Certain Relationships and Related Transactions and Director Independence ...Principal Accounting Fees and Services ...45 45 45 45 45 Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities ...Selected Financial Data ...Management's Discussion and...

  • Page 7
    ... These Netflix Ready Devices currently include Blu-ray disc players, Internet-connected TVs, digital video players and game consoles. • Receive DVDs by U.S. mail and return them to us at their convenience using our prepaid mailers. After a DVD has been returned, we mail the next available DVD in...

  • Page 8
    ...to provide fast delivery and return service to our subscribers. We also utilize third party content delivery networks to help us efficiently stream movies and TV episodes in high volume to Netflix subscribers over the Internet. We are focused on growing our subscriber base and revenues and utilizing...

  • Page 9
    ...DVD subscription rental web sites, such as Blockbuster Online; • entertainment video retail stores, such as Best Buy, Wal-Mart and Amazon.com; and • Internet movie and TV content providers, such as Apple's iTunes, Amazon.com, Hulu.com and Google's YouTube. Studio licensing and movie distribution...

  • Page 10
    ... price its service offering at levels difficult for competition to meet. Convenience, selection and fast delivery. Subscribers can conveniently select titles by building and modifying a personalized queue of titles on our Web site or by selecting titles directly from select Netflix Ready Devices...

  • Page 11
    ... direct purchases, revenue sharing agreements and license agreements. We work with the content providers to determine which method of acquiring titles is the most beneficial for each party. Our growing subscriber base provides studios with an additional distribution outlet for popular movies and TV...

  • Page 12
    ...and license agreements. Under our DVD and streaming revenue sharing agreements with studios and distributors, we generally obtain titles for a low initial cost in exchange for a commitment for a defined period of time either to share a percentage of our subscription revenues or to pay a fee based on...

  • Page 13
    ... 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 95032, and our telephone number is (408) 540-3700. We maintain a Web site at www.netflix...

  • Page 14
    ... relative service levels, pricing and related features of competitors to our service may adversely impact our ability to attract subscribers. Competitors include DVD rental outlets and kiosk services, video package providers with pay-per-view and VOD content, online DVD subscription rental web sites...

  • Page 15
    ... competitive and subject to rapid change. New technologies for delivery of in-home entertainment video, such as VOD and Internet delivery of content, continue to receive considerable media and investor attention. Many of our competitors have longer operating histories, larger customer bases, greater...

  • Page 16
    ...-per-view, Internet delivery, premium TV, basic cable and network and syndicated TV. The length of the exclusive window for movie rental and retail sales varies and the order, length and exclusivity of each window for each distribution channel are determined solely by the studio releasing the title...

  • Page 17
    ...Netflix to various devices. We currently offer subscribers the ability to receive streaming content through their PCs, Macs and other devices, including Internet-connected Blu-ray players and TVs, digital video players and game consoles. We intend to broaden our capability to instantly stream movies...

  • Page 18
    ... currently promote our service decide to enter our business or a similar business or decide to exclusively support our competitors, we may no longer be given access to such channels. In addition, if ad rates increase, we may curtail marketing expenses or otherwise experience an increase in our cost...

  • Page 19
    ... to maintain and enhance our technology to manage the processing of DVDs among our shipping centers or the streaming of movies and TV episodes to our subscribers in a timely and efficient manner, our ability to retain existing subscribers and to add new subscribers may be impaired. In addition, if...

  • Page 20
    ... game rental company filed a complaint with the Postal Regulatory Commission alleging that the U.S. Postal Service unreasonably discriminated against it in favor of Netflix and Blockbuster. To the extent this proceeding was to result in operational or regulatory changes impacting our mail processing...

  • Page 21
    ...we are required to directly purchase more titles. If the sales price of DVDs to retail consumers decreases, our ability to attract new subscribers may be adversely affected. The cost of manufacturing DVDs is substantially less than the price for which new DVDs are generally sold in the retail market...

  • Page 22
    ...-party Web hosting provider. We recently have begun utilizing third-party Internet-based or "cloud" computing systems in connection with our business operations. Also, we utilize third-party content delivery networks to help us stream movies and TV episodes in high volume to Netflix subscribers over...

  • Page 23
    .... Our subscribers pay for our subscription services predominately using credit cards and debit cards. Our acceptance of these payment methods requires our payment of certain fees. From time to time, these fees may increase, either as a result of rate changes by the payment processing companies or...

  • Page 24
    ... or trademark infringement or other claims based on the nature and content of materials that we 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...

  • Page 25
    ... and other general corporate purposes; • Limiting our flexibility in planning for, or reacting to, changes in our business and the markets in which we operate; and • Limiting our ability to borrow additional funds or to borrow funds at rates or on other terms we find acceptable. In addition...

  • Page 26
    ... covenants may limit our ability to effectively operate our businesses. Any failure to comply with the restrictions of any agreement governing our other indebtedness may result in an event of default under those agreements. Risks Related to Our Stock Ownership Our officers and directors and their...

  • Page 27
    ... under our employee share purchase program both require the input of highly subjective assumptions, including the price volatility of the underlying stock. If facts and circumstances change and we employ different assumptions for estimating stock-based compensation expense in future periods, or if...

  • Page 28
    ...Expiration Date Location Primary Use Los Gatos, California ...Columbus, Ohio ... 165,000 90,000 March 2013 August 2016 Hillsboro, Oregon ...Beverly Hills, California ... 49,000 20,000 April 2011 August 2015 Corporate office, general and administrative, marketing and technology and development...

  • Page 29
    ...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 of our common stock for the periods indicated, as reported by the NASDAQ Global Select Market. 2009 High Low High 2008 Low First quarter ...Second quarter...

  • Page 30
    ... relating to the price performance of our common stock shall not be deemed "filed" with the Commission or "soliciting material" under the Securities Exchange Act of 1934 and shall not be incorporated by reference into any such filings. The following graph compares, for the five year period ended...

  • Page 31
    Issuer Purchases of Equity Securities Stock repurchases during the three months ended December 31, 2009 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 ...

  • Page 32
    ... Data: Total subscribers at end of period ...Gross subscriber additions during period ...Subscriber acquisition cost (4) ... 12,268 9,332 $ 25.48 9,390 6,859 $29.12 7,479 5,340 $40.86 6,316 5,250 $42.94 4,179 3,729 $38.78 (3) Short-term investments are comprised of corporate debt securities...

  • Page 33
    ... These Netflix Ready Devices currently include Blu-ray disc players, Internet-connected TVs, digital video players and game consoles. • Receive DVDs by U.S. mail and return them to us at their convenience using our prepaid mailers. After a DVD has been returned, we mail the next available DVD in...

  • Page 34
    ... of the license agreement but may also be obtained through a revenue sharing agreement. We acquire DVD content for the purpose of rental to our subscribers and earning subscription rental revenues, and, as such, we consider our direct purchase DVD library to be a productive asset. Accordingly, we...

  • Page 35
    .... Under the revenue sharing agreements for our DVD library, at the end of the Title Term, we generally have the option of returning the DVD to the studio, destroying the DVD or purchasing the DVD. Stock-Based Compensation Stock-based compensation expense is estimated at the grant date based on the...

  • Page 36
    ... loss and tax credit carryforwards. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance for any tax benefits for...

  • Page 37
    ...their computer or Netflix Ready Device. The vast majority of our subscriber base has chosen a 1, 2 or 3-out Unlimited plan. Customers electing access to the high definition Blu-ray discs in addition to standard definition DVDs pay a surcharge ranging from $1 to $4 for our most popular plans. Pricing...

  • Page 38
    ... proposition of streaming and DVDs by mail for one low price and other benefits of our service. This increase was offset in part by a 3.3% decline in average monthly revenue per paying subscriber, resulting from the continued growth in our lower priced subscription plans. The total number of average...

  • Page 39
    ... Internet. Content acquisition expenses consist of costs incurred in obtaining content such as amortization of content and revenue sharing expense. We obtain content from studios, distributors and other suppliers through direct purchases, revenue sharing agreements and license agreements. Year ended...

  • Page 40
    ... • Shipping and customer service centers expenses increased $10.5 million primarily due to a 14.0% increase in headcount to support the higher volume of content delivery and growth in subscribers. • Credit card fees increased $10.2 million as a result of the 22.4% growth in revenues. Change Year...

  • Page 41
    ...consumer electronics partners. Advertising expenses include marketing program expenditures and other promotional activities, including allocated costs of revenues relating to free trial periods. Also included in marketing expense are payroll related expenses. Year ended December 31, Change 2009 2008...

  • Page 42
    ... in marketing program spending, principally in TV and radio advertising and direct mail to promote our hybrid service of streaming content and DVDs by mail. Subscriber acquisition cost decreased primarily due to momentum associated with the launch of new consumer electronics partner devices and...

  • Page 43
    ... proceeds from sales of DVDs and associated cost of DVD sales. Cost of DVD sales includes the net book value of the DVDs sold, shipping charges and, where applicable, a contractually specified fee for the DVDs that are subject to revenue sharing agreements. Year ended December 31, Change 2009 2008...

  • Page 44
    ... recorded assets on our balance sheet for the costs paid by our lessor to construct our headquarters facilities, along with corresponding financing liabilities for amounts equal to these lessor-paid construction costs. The monthly rent payments we make to our lessor under our lease agreements are...

  • Page 45
    ... by Federal and California research and development ("R&D") tax credits of $2 million. The increase in our effective tax rate was primarily attributable to a cumulative benefit recorded as a discrete item in the second quarter of 2008 for prior period R&D tax credits. Change Year ended December 31...

  • Page 46
    ...by $6.3 million over the prior period as we continue to purchase additional titles in order to support our larger subscriber base. The decrease in net changes in operating assets and liabilities was mainly driven by acquisitions of content library related to our streaming content, as we continued to...

  • Page 47
    ... uncertainties in the timing of tax audit outcomes; therefore, such amounts are not included in the above contractual obligation table. License Agreements In addition to the above contractual obligations, we have certain license agreements with studios that include a maximum number of titles that we...

  • Page 48
    ... in may be subject to market risk due to changes in prevailing interest rates which may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises...

  • Page 49
    ... amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as...

  • Page 50
    ...Financial Reporting There was no change in our internal control over financial reporting that occurred during the quarter ended December 31, 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Item 9B. Other Information None...

  • Page 51
    ... 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 and Director Independence Information required by this item...

  • Page 52
    ... Netflix, Inc., the guarantors from time to time party thereto and Wells Fargo Bank, National Association, relating to the 8.50% Senior Notes due 2017. Form of Indemnification Agreement entered into by the registrant with each of its executive officers and directors 2002 Employee Stock Purchase Plan...

  • Page 53
    ... Number Exhibit Description Form Incorporated by Reference File No. Exhibit Filing Date Filed Herewith 10.9†10.10†23.1 24 31.1 Description of Director Equity Compensation Plan Amended and Restated Executive Severance and Retention Incentive Plan Consent of Independent Registered Public...

  • Page 54
    ... STATEMENTS Page Report of Independent Registered Public Accounting Firm ...Consolidated Balance Sheets as of December 31, 2009 and 2008 ...Consolidated Statements of Operations for the Years Ended December 31, 2009, 2008 and 2007 ...Consolidated Statements of Stockholders' Equity and Comprehensive...

  • Page 55
    ..., and cash flows for each of the years in the three-year period ended December 31, 2009. We also have audited Netflix, Inc's internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring...

  • Page 56
    ...Short-term investments ...Prepaid expenses ...Prepaid revenue sharing expenses ...Current content library, net ...Other current assets ...Total current assets ...Content library, net ...Property and equipment, net ...Deferred tax assets ...Other non-current assets ...Total assets ...Liabilities and...

  • Page 57
    ... per share data) 2009 Year ended December 31, 2008 2007 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 58
    ...share data) Accumulated Additional Other Retained Earnings Total Common Stock Paid-in Treasury Comprehensive (Accumulated Stockholders' Shares Amount Capital Stock Income Deficit) Equity Balances as of December 31, 2006 ...68,612,463 Net Income ...- Unrealized gains on available-for-sale securities...

  • Page 59
    ......Gain on disposal of DVDs ...Gain on sale of investment in business ...Deferred taxes ...Changes in operating assets and liabilities: Prepaid expenses and other current assets ...Content library ...Accounts payable ...Accrued expenses ...Deferred revenue ...Other assets and liabilities ...Net cash...

  • Page 60
    ... devices ("Netflix Ready Devices"). These Netflix Ready Devices currently include Blu-ray disc players, Internet-connected TVs, digital video players and game consoles. • Receive DVDs by U.S. mail and return them to the Company at their convenience using the Company's prepaid mailers. After a DVD...

  • Page 61
    ... cost basis. Content Library The Company obtains content through direct purchases, revenue sharing agreements and license agreements with studios, distributors and other suppliers. DVD content is obtained through direct purchases or revenue sharing agreements. Streaming content is generally licensed...

  • Page 62
    ... 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 to pay a fee, based on utilization, for a defined period of time...

  • Page 63
    ... allocated costs of revenues relating to free trial periods. Also included in marketing expenses are payroll related expenses. Advertising costs are expensed as incurred except for advertising production costs, which are expensed the first time the advertising is run. Advertising expense totaled...

  • Page 64
    ...used in computation: Weighted-average common shares outstanding ...Basic earnings per share ...Diluted earnings per share: Net income ...Shares used in computation: Weighted-average common shares outstanding ...Employee stock options and employee stock purchase plan shares ...Weighted-average number...

  • Page 65
    ..., stock-based compensation expense is fully recognized on the grant date, and no estimate is required for post-vesting option forfeitures. 2. Short-term Investments The Company's investment policy is consistent with the definition of available-for-sale securities. The Company does not buy and hold...

  • Page 66
    .... There were no material other-than-temporary impairments or credit losses related to available-for-sale securities in 2009, 2008 or 2007. The gross realized gains on the sales of available-for-sale securities for the three years ended December 31, 2009, 2008 and 2007 were $1.9 million, $4.9 million...

  • Page 67
    ...Prices in Significant Active Markets Other Significant for Identical Observable Unobservable Assets Inputs Inputs Total (Level 1) (Level 2) (Level 3) (in thousands) Current Assets: Money market funds (1) ...Fixed income available-for-sale securities (2) ...Total current assets ...Non-current Assets...

  • Page 68
    ... 31, 2009 2008 (in thousands) Computer equipment ...3 years Operations and other equipment ...5 years Software, including internal-use software ...1-3 years Furniture and fixtures ...3 years Building ...30 years Leasehold improvements ...Over life of lease Capital work-in-progress ...Property and...

  • Page 69
    ... state sales and use tax ...Accrued payroll and employee benefits ...Accrued settlement costs ...Accrued interest on debt ...Accrued content acquisition costs ...Other ...Total accrued expenses ... $11,625 6,427 - 2,597 5,810 6,928 $33,387 $ 9,127 5,956 2,409 - 6,237 7,665 $31,394 4. Long-term...

  • Page 70
    ... original facilities lease agreements required the Company's involvement in the construction funding of the buildings at its Los Gatos, California headquarters site, the Company is the "deemed owner" (for accounting purposes only) of these buildings. Accordingly, the Company recorded an asset of $40...

  • Page 71
    ...which the streaming content does not meet asset recognition criteria. Litigation From time to time, in the normal course of its operations, the Company is a party to litigation matters and claims, including claims relating to employee relations and business practices. Litigation can be expensive and...

  • Page 72
    ... customers, generally allege that Netflix and Wal-Mart entered into an agreement to divide the markets for sales and online rentals of DVDs in the United States, which resulted in higher Netflix subscription prices. The complaints, which assert violation of federal and/or state antitrust laws, seek...

  • Page 73
    ... its Board of Directors authorized a stock repurchase plan that enables the Company to repurchase up to $300 million of its common stock through the end of 2010. The timing and actual number of shares repurchased will depend on various factors including price, corporate and regulatory requirements...

  • Page 74
    ... 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 75
    ...non-statutory stock options and stock purchase rights to employees, directors and consultants. As of December 31, 2009, 2,591,267 shares were reserved for future grant under the 2002 Stock Plan. A summary of the activities related to the Company's options is as follows: Options Outstanding Number of...

  • Page 76
    ...granted in 2007. The following table summarizes the assumptions used to value option grants using a lattice-binomial model: 2009 Year Ended December 31, 2008 2007 Dividend yield ...Expected volatility ...Risk-free interest rate ...Suboptimal exercise factor ... 0% 0% 0% 46% - 56% 50% - 60% 43% - 52...

  • Page 77
    ... of shares issued under the ESPP is estimated using the Black-Scholes option pricing model. The following table summarizes the assumptions used to value shares issued under the ESPP: 2009 Year Ended December 31, 2008 2007 Dividend yield ...Expected volatility ...Risk-free interest rate ...Expected...

  • Page 78
    ... employee stock purchases which was allocated as follows: Year Ended December 31, 2009 2008 2007 (in thousands) Fulfillment expenses ...Technology and development ...Marketing ...General and administrative ...Stock-based compensation expense before income taxes ...Income tax benefit ...Total stock...

  • Page 79
    ...in the Consolidated Balance Sheet. The aggregate changes in the Company's total gross amount of unrecognized tax benefits are summarized as follows (in thousands): Balance as of December 31, 2007 ...Increases related to tax positions taken during the current period ...Balance as of December 31, 2008...

  • Page 80
    ... a license agreement with a company in which an employee had a significant ownership interest at that time. Pursuant to this agreement, Netflix recorded a charge of $2.5 million in technology and development expense. In January 2008, in conjunction with various arrangements Netflix paid a total of...

  • Page 81
    ... 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 19, 2010 By: /s/ REED HASTINGS Reed Hastings Chief Executive Officer...

  • Page 82
    ... Netflix, Inc., the guarantors from time to time party thereto and Wells Fargo Bank, National Association, relating to the 8.50% Senior Notes due 2017. Form of Indemnification Agreement entered into by the registrant with each of its executive officers and directors 2002 Employee Stock Purchase Plan...

  • Page 83
    ... Reference File No. Exhibit Filing Date Filed Herewith 32.1* 101 Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 The following financial information from Netflix, Inc.'s Annual Report on Form 10-K for the year ended...

  • Page 84
    ..., process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Dated: February 19, 2010 By: /s/ REED HASTINGS Reed Hastings Chief...

  • Page 85
    ... process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Dated: February 19, 2010 By: /s/ BARRY MCCARTHY Barry McCarthy Chief...

  • Page 86
    ...for the year ended December 31, 2009 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 and results of operations of Netflix, Inc. Dated...

  • Page 87
    ... Circle Los Gatos, CA 95032 STOCK LISTING Netï¬,ix, Inc. common stock trades on the Nasdaq Stock Market under the symbol NFLX. INVESTOR RELATIONS Netï¬,ix, Inc. 100 Winchester Circle Los Gatos, CA 95032 Phone: (408) 540-3639 For additional copies of this report or other financial information: http...

  • Page 88
    Netflix, Inc. | 100 Winchester Circle, Los Gatos, CA 95032 | www.netflix.com