UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2010March 31, 2011
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
Netflix, Inc.
(Exact name of Registrant as specified in its charter)
Delaware | 77-0467272 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) |
100 Winchester Circle, Los Gatos, California 95032
(Address and zip code of principal executive offices)
(408) 540-3700
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | x | Accelerated filer | ¨ | |||
Non-accelerated filer | ||||||
| Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of September 30, 2010,March 31, 2011, there were 52,257,49552,519,159 shares of the registrant’s common stock, par value $0.001, outstanding.
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Item 1. | Consolidated Financial Statements | 3 | |||||||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 16 | |||||||
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | ||||||||
Item 4. | Controls and Procedures | ||||||||
Item 1. | Legal Proceedings | ||||||||
Item 1A. | Risk Factors | ||||||||
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | ||||||||
Item 6. | Exhibits | ||||||||
Item 1. | Consolidated Financial Statements |
Index to Consolidated Financial Statements
Page | ||||
4 | ||||
Consolidated Balance Sheets as of | 5 | |||
6 | ||||
7 |
NETFLIX, INC.
Consolidated Statements of Operations
(unaudited)
(in thousands, except per share data)
Three Months Ended | Nine Months Ended | Three Months Ended | ||||||||||||||||||||||
September 30, 2010 | September 30, 2009 | September 30, 2010 | September 30, 2009 | March 31, 2011 | March 31, 2010 | |||||||||||||||||||
Revenues | $ | 553,219 | $ | 423,120 | $ | 1,566,703 | $ | 1,225,727 | $ | 718,553 | $ | 493,665 | ||||||||||||
Cost of revenues: | ||||||||||||||||||||||||
Subscription | 292,406 | 233,091 | 817,353 | 677,863 | 376,992 | 259,560 | ||||||||||||||||||
Fulfillment expenses * | 52,063 | 42,183 | 149,212 | 125,922 | ||||||||||||||||||||
Fulfillment expenses | 61,159 | 47,602 | ||||||||||||||||||||||
Total cost of revenues | 344,469 | 275,274 | 966,565 | 803,785 | 438,151 | 307,162 | ||||||||||||||||||
Gross profit | 208,750 | 147,846 | 600,138 | 421,942 | 280,402 | 186,503 | ||||||||||||||||||
Operating expenses: | ||||||||||||||||||||||||
Technology and development * | 42,108 | 30,014 | 117,370 | 81,333 | ||||||||||||||||||||
Marketing * | 81,238 | 58,556 | 230,990 | 167,029 | ||||||||||||||||||||
General and administrative * | 17,135 | 11,543 | 51,447 | 37,809 | ||||||||||||||||||||
Gain on disposal of DVDs | (1,232 | ) | (1,604 | ) | (4,857 | ) | (2,819 | ) | ||||||||||||||||
Technology and development | 50,905 | 37,399 | ||||||||||||||||||||||
Marketing | 104,259 | 75,219 | ||||||||||||||||||||||
General and administrative | 22,998 | 15,540 | ||||||||||||||||||||||
Total operating expenses | 139,249 | 98,509 | 394,950 | 283,352 | 178,162 | 128,158 | ||||||||||||||||||
Operating income | 69,501 | 49,337 | 205,188 | 138,590 | 102,240 | 58,345 | ||||||||||||||||||
Other income (expense): | ||||||||||||||||||||||||
Interest expense | (4,945 | ) | (674 | ) | (14,797 | ) | (2,018 | ) | (4,865 | ) | (4,959 | ) | ||||||||||||
Interest and other income | 853 | 1,808 | 2,746 | 4,284 | 865 | 972 | ||||||||||||||||||
Income before income taxes | 65,409 | 50,471 | 193,137 | 140,856 | 98,240 | 54,358 | ||||||||||||||||||
Provision for income taxes | 27,442 | 20,330 | 79,379 | 55,909 | 38,007 | 22,086 | ||||||||||||||||||
Net income | $ | 37,967 | $ | 30,141 | $ | 113,758 | $ | 84,947 | $ | 60,233 | $ | 32,272 | ||||||||||||
Net income per share: | ||||||||||||||||||||||||
Basic | $ | 0.73 | $ | 0.54 | $ | 2.17 | $ | 1.48 | $ | 1.14 | $ | 0.61 | ||||||||||||
Diluted | $ | 0.70 | $ | 0.52 | $ | 2.09 | $ | 1.43 | $ | 1.11 | $ | 0.59 | ||||||||||||
Weighted average common shares outstanding: | ||||||||||||||||||||||||
Basic | 52,142 | 56,146 | 52,510 | 57,576 | 52,759 | 52,911 | ||||||||||||||||||
Diluted | 53,931 | 57,938 | 54,341 | 59,427 | 54,246 | 54,775 | ||||||||||||||||||
*Stock-based compensation included in expense line items: | ||||||||||||||||||||||||
Fulfillment expenses | $ | 323 | $ | 99 | $ | 806 | $ | 321 | ||||||||||||||||
Technology and development | 2,694 | 1,169 | 6,939 | 3,430 | ||||||||||||||||||||
Marketing | 777 | 452 | 2,176 | 1,353 | ||||||||||||||||||||
General and administrative | 3,502 | 1,512 | 9,805 | 4,538 |
See accompanying notes to the consolidated financial statements.
Consolidated Balance Sheets
(unaudited)
(in thousands, except share and par value data)
As of | As of | |||||||||||||||
September 30, 2010 | December 31, 2009 | March 31, 2011 | December 31, 2010 | |||||||||||||
Assets | ||||||||||||||||
Current assets: | ||||||||||||||||
Cash and cash equivalents | $ | 113,108 | $ | 134,224 | $ | 150,419 | $ | 194,499 | ||||||||
Short-term investments | 143,705 | 186,018 | 192,302 | 155,888 | ||||||||||||
Current content library, net | 138,389 | 37,329 | 265,933 | 181,006 | ||||||||||||
Prepaid content | 59,322 | 26,741 | 74,597 | 62,217 | ||||||||||||
Other current assets | 37,723 | 26,701 | 38,351 | 47,357 | ||||||||||||
Total current assets | 492,247 | 411,013 | 721,602 | 640,967 | ||||||||||||
Content library, net | 120,047 | 108,810 | 197,554 | 180,973 | ||||||||||||
Property and equipment, net | 125,057 | 131,653 | 134,800 | 128,570 | ||||||||||||
Deferred tax assets | 19,219 | 15,958 | 22,452 | 17,467 | ||||||||||||
Other non-current assets | 13,713 | 12,300 | 13,780 | 14,090 | ||||||||||||
Total assets | $ | 770,283 | $ | 679,734 | $ | 1,090,188 | $ | 982,067 | ||||||||
Liabilities and Stockholders’ Equity | ||||||||||||||||
Current liabilities: | ||||||||||||||||
Accounts payable | $ | 170,120 | $ | 92,542 | $ | 301,009 | $ | 222,824 | ||||||||
Accrued expenses | 36,974 | 33,387 | 44,123 | 36,489 | ||||||||||||
Current portion of lease financing obligations | 2,027 | 1,410 | 2,141 | 2,083 | ||||||||||||
Deferred revenue | 102,986 | 100,097 | 143,045 | 127,183 | ||||||||||||
Total current liabilities | 312,107 | 227,436 | 490,318 | 388,579 | ||||||||||||
Long-term debt | 200,000 | 200,000 | 200,000 | 200,000 | ||||||||||||
Lease financing obligations, excluding current portion | 34,659 | 36,572 | 33,564 | 34,123 | ||||||||||||
Other non-current liabilities | 31,542 | 16,583 | 90,584 | 69,201 | ||||||||||||
Total liabilities | 578,308 | 480,591 | 814,466 | 691,903 | ||||||||||||
Commitments and contingencies | ||||||||||||||||
Commitments and contingencies (Note 9) | ||||||||||||||||
Stockholders’ equity: | ||||||||||||||||
Common stock, $0.001 par value; 160,000,000 shares authorized at September 30, 2010 and December 31, 2009; 52,257,495 and 53,440,073 issued and outstanding at September 30, 2010 and December 31, 2009, respectively | 52 | 53 | ||||||||||||||
Common stock, $0.001 par value; 160,000,000 shares authorized at March 31, 2011 and December 31, 2010; 52,519,159 and 52,781,949 issued and outstanding at March 31, 2011 and December 31, 2010, respectively | 52 | 53 | ||||||||||||||
Additional paid-in capital | — | 51,622 | ||||||||||||||
Accumulated other comprehensive income, net | 1,279 | 273 | 590 | 750 | ||||||||||||
Retained earnings | 190,644 | 198,817 | 275,080 | 237,739 | ||||||||||||
Total stockholders’ equity | 191,975 | 199,143 | 275,722 | 290,164 | ||||||||||||
Total liabilities and stockholders’ equity | $ | 770,283 | $ | 679,734 | $ | 1,090,188 | $ | 982,067 | ||||||||
See accompanying notes to the consolidated financial statements.
NETFLIX, INC.
Consolidated Statements of Cash Flows
(unaudited)
(in thousands)
Three Months Ended | Nine Months Ended | Three Months Ended | ||||||||||||||||||||||
September 30, 2010 | September 30, 2009 | September 30, 2010 | September 30, 2009 | March 31, 2011 | March 31, 2010 | |||||||||||||||||||
Cash flows from operating activities: | ||||||||||||||||||||||||
Net income | $ | 37,967 | $ | 30,141 | $ | 113,758 | $ | 84,947 | $ | 60,233 | $ | 32,272 | ||||||||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||||||||||||||
Acquisition of streaming content library | (115,149 | ) | (9,998 | ) | (231,781 | ) | (41,432 | ) | (192,307 | ) | (50,475 | ) | ||||||||||||
Amortization of content library | 77,146 | 56,690 | 204,581 | 159,229 | 112,927 | 62,292 | ||||||||||||||||||
Depreciation and amortization of property, equipment and intangibles | 8,678 | 9,618 | 28,846 | 27,806 | ||||||||||||||||||||
Amortization of discounts and premiums on investments | 200 | 126 | 670 | 439 | ||||||||||||||||||||
Amortization of debt issuance costs | 140 | — | 375 | — | ||||||||||||||||||||
Depreciation and amortization of property, equipment, and intangibles | 9,826 | 10,859 | ||||||||||||||||||||||
Stock-based compensation expense | 7,296 | 3,232 | 19,726 | 9,642 | 12,264 | 5,502 | ||||||||||||||||||
Excess tax benefits from stock-based compensation | (16,093 | ) | (1,600 | ) | (34,699 | ) | (9,099 | ) | (15,654 | ) | (7,424 | ) | ||||||||||||
Loss on disposal of property and equipment | 254 | — | 254 | 254 | ||||||||||||||||||||
Gain on sale of short-term investments | (206 | ) | (984 | ) | (685 | ) | (1,455 | ) | ||||||||||||||||
Gain on disposal of DVDs | (2,142 | ) | (2,491 | ) | (8,428 | ) | (5,030 | ) | ||||||||||||||||
Other non-cash income | (925 | ) | (3,160 | ) | ||||||||||||||||||||
Deferred taxes | 3,194 | (71 | ) | (2,961 | ) | 4,710 | (4,982 | ) | (2,761 | ) | ||||||||||||||
Changes in operating assets and liabilities: | ||||||||||||||||||||||||
Prepaid content | (25,485 | ) | 107 | (32,581 | ) | 2,592 | (12,380 | ) | (4,963 | ) | ||||||||||||||
Other current assets | (3,374 | ) | 7,518 | (12,037 | ) | (4,203 | ) | 9,084 | 548 | |||||||||||||||
Accounts payable | 41,692 | (13,173 | ) | 78,738 | (11,150 | ) | 77,963 | 17,340 | ||||||||||||||||
Accrued expenses | 18,003 | 2,175 | 39,666 | 6,272 | 22,670 | 13,746 | ||||||||||||||||||
Deferred revenue | 1,567 | (1,372 | ) | 2,889 | (4,004 | ) | 15,862 | 12 | ||||||||||||||||
Other assets and liabilities | 8,539 | (1,607 | ) | 13,353 | (272 | ) | ||||||||||||||||||
Other non-current assets and liabilities | 21,742 | 3,417 | ||||||||||||||||||||||
Net cash provided by operating activities | 42,227 | 78,311 | 179,684 | 219,246 | 116,323 | 77,205 | ||||||||||||||||||
Cash flows from investing activities: | ||||||||||||||||||||||||
Acquisition of DVD content library | (29,900 | ) | (46,273 | ) | (90,993 | ) | (135,996 | ) | (22,119 | ) | (36,902 | ) | ||||||||||||
Purchases of short-term investments | (15,379 | ) | (21,006 | ) | (73,169 | ) | (102,159 | ) | (52,266 | ) | (35,995 | ) | ||||||||||||
Proceeds from sale of short-term investments | 42,238 | 85,904 | 105,063 | 130,669 | 14,961 | 30,770 | ||||||||||||||||||
Proceeds from maturities of short-term investments | 1,995 | 3,480 | 10,318 | 30,985 | 650 | 4,013 | ||||||||||||||||||
Purchases of property and equipment | (7,342 | ) | (9,994 | ) | (19,406 | ) | (23,499 | ) | (16,320 | ) | (6,393 | ) | ||||||||||||
Proceeds from sale of DVDs | 3,109 | 3,345 | 10,908 | 7,230 | ||||||||||||||||||||
Other assets | (327 | ) | 134 | (619 | ) | (57 | ) | 1,419 | 3,682 | |||||||||||||||
Net cash (used in) provided by investing activities | (5,606 | ) | 15,590 | (57,898 | ) | (92,827 | ) | |||||||||||||||||
Net cash used in investing activities | (73,675 | ) | (40,825 | ) | ||||||||||||||||||||
Cash flows from financing activities: | ||||||||||||||||||||||||
Principal payments of lease financing obligations | (470 | ) | (294 | ) | (1,296 | ) | (858 | ) | (501 | ) | (361 | ) | ||||||||||||
Proceeds from issuance of common stock | 10,927 | 2,725 | 33,954 | 26,092 | 6,762 | 9,918 | ||||||||||||||||||
Excess tax benefits from stock-based compensation | 16,093 | 1,600 | 34,699 | 9,099 | 15,654 | 7,424 | ||||||||||||||||||
Repurchases of common stock | (57,390 | ) | (129,686 | ) | (210,259 | ) | (244,916 | ) | (108,643 | ) | (107,724 | ) | ||||||||||||
Net cash used in financing activities | (30,840 | ) | (125,655 | ) | (142,902 | ) | (210,583 | ) | (86,728 | ) | (90,743 | ) | ||||||||||||
Net increase (decrease) in cash and cash equivalents | 5,781 | (31,754 | ) | (21,116 | ) | (84,164 | ) | |||||||||||||||||
Net decrease in cash and cash equivalents | (44,080 | ) | (54,363 | ) | ||||||||||||||||||||
Cash and cash equivalents, beginning of period | 107,327 | 87,471 | 134,224 | 139,881 | 194,499 | 134,224 | ||||||||||||||||||
Cash and cash equivalents, end of period | $ | 113,108 | $ | 55,717 | $ | 113,108 | $ | 55,717 | $ | 150,419 | $ | 79,861 | ||||||||||||
See accompanying notes to the consolidated financial statements.
NETFLIX, INC.
Notes to Consolidated Financial Statements
(unaudited)
1. Basis of Presentation and Summary of Significant Accounting Policies
The accompanying condensed consolidated interim financial statements of Netflix, Inc. and its wholly owned subsidiaries (the “Company”) have been prepared in conformity with accounting principles generally accepted in the United States (“U.S.”) and are consistent in all material respects with those applied in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.2010. The preparation of condensed consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and judgments that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. ExamplesSignificant items subject to such estimates and assumptions include the estimates of useful lives and residual valueamortization methodology of the Company’s content library, the valuation of stock-based compensation and the recognition and measurement of income tax assets and liabilitiesliabilities. The Company bases its estimates on historical experience and royaltieson various other assumptions that maythe Company believes to be due to performing rights organizations.reasonable under the circumstances. The actual results experienced by the Company may differ from management’s estimates.
The interim financial information is unaudited, but reflects all normal recurring adjustments that are, in the opinion of management, necessary to fairly present the information set forth herein. The interim financial statements should be read in conjunction with the audited financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 20092010 filed with the Securities and Exchange Commission (the “SEC”) on February 22, 2010.18, 2011. Interim results are not necessarily indicative of the results for a full year.
The Company is organized into two operating segments: Domestic (which includes the United States) and International. See Note 10 for further information about the Company’s operating segments.
Certain prior period amounts have been reclassified to conform to current period presentation. These reclassifications did not impact any prior amounts of reported total assets or total liabilities, and did not impact stockholders’ equity, results of operations or cash flows.
There have been no material changes in the Company’s significant accounting policies as compared to the significant accounting policies described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.
Recent Accounting Pronouncements
There have been no recent accounting pronouncements or changes in accounting pronouncements during the nine months ended September 30, 2010, as compared to the recent accounting pronouncements described in the Company’s Annual Report on Form 10-K, that are of significance, or potential significance to the Company.2010.
2. Net Income Per Share
Basic net income per share is computed using the weighted-average number of outstanding shares of common stock during the period. Diluted net income per share is computed using the weighted-average number of outstanding shares of common stock and, when dilutive, potential common shares outstanding during the period. Potential common shares consist of incremental shares issuable upon the assumed exercise of stock options and shares currently purchasable pursuant to the Company’s employee stock purchase plan using the treasury stock method. The computation of net income per share is as follows:
Three months ended | Nine months ended | Three months ended | ||||||||||||||||||||||
September 30, 2010 | September 30, 2009 | September 30, 2010 | September 30, 2009 | March 31, 2011 | March 31, 2010 | |||||||||||||||||||
(in thousands, except per share data) | (in thousands, except per share data) | |||||||||||||||||||||||
Basic earnings per share: | ||||||||||||||||||||||||
Net income | $ | 37,967 | $ | 30,141 | $ | 113,758 | $ | 84,947 | $ | 60,233 | $ | 32,272 | ||||||||||||
Shares used in computation: | ||||||||||||||||||||||||
Weighted-average common shares outstanding | 52,142 | 56,146 | 52,510 | 57,576 | 52,759 | 52,911 | ||||||||||||||||||
Basic earnings per share | $ | 0.73 | $ | 0.54 | $ | 2.17 | $ | 1.48 | $ | 1.14 | $ | 0.61 | ||||||||||||
Diluted earnings per share: | ||||||||||||||||||||||||
Net income | $ | 37,967 | $ | 30,141 | $ | 113,758 | $ | 84,947 | $ | 60,233 | $ | 32,272 | ||||||||||||
Shares used in computation: | ||||||||||||||||||||||||
Weighted-average common shares outstanding | 52,142 | 56,146 | 52,510 | 57,576 | 52,759 | 52,911 | ||||||||||||||||||
Employee stock options and employee stock purchase plan shares | 1,789 | 1,792 | 1,831 | 1,851 | 1,487 | 1,864 | ||||||||||||||||||
Weighted-average number of shares | 53,931 | 57,938 | 54,341 | 59,427 | 54,246 | 54,775 | ||||||||||||||||||
Diluted earnings per share | $ | 0.70 | $ | 0.52 | $ | 2.09 | $ | 1.43 | $ | 1.11 | $ | 0.59 | ||||||||||||
Netflix, Inc.
Notes to Consolidated Financial Statements—(Continued)
Employee stock options with exercise prices greater than the average market price of the common stock during the period were excluded from the diluted calculation as their inclusion would have been anti-dilutive. The potential common sharesnumber of options excluded from the diluted calculation were not material as of the three or nine months ended September 30, 2010 or 2009.is immaterial for all periods presented.
3. Short-Term Investments and Fair Value Measurement
The Company’s investment policy is consistent with the definition of available-for-sale securities. The Company does not buy and hold securities principally for the purpose of selling them in the near future. The Company’s policy is focused on the preservation of capital, liquidity and return. From time to time, the Company may sell certain securities but the objectives are generally not to generate profits on short-term differences in price. Short-term investments are therefore classified as available-for-sale securities and are reported at fair value as follows:
September 30, 2010 | ||||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | |||||||||||||
(in thousands) | ||||||||||||||||
Corporate debt securities | $ | 100,760 | $ | 1,408 | $ | (51 | ) | $ | 102,117 | |||||||
Government and agency securities | 37,842 | 674 | — | 38,516 | ||||||||||||
Asset and mortgage backed securities | 3,028 | 172 | (128 | ) | 3,072 | |||||||||||
$ | 141,630 | $ | 2,254 | $ | (179 | ) | $ | 143,705 | ||||||||
December 31, 2009 | ||||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | |||||||||||||
(in thousands) | ||||||||||||||||
Corporate debt securities | $ | 82,362 | $ | 915 | $ | (106 | ) | $ | 83,171 | |||||||
Government and agency securities | 96,998 | 72 | (416 | ) | 96,654 | |||||||||||
Asset and mortgage backed securities | 6,262 | 143 | (212 | ) | 6,193 | |||||||||||
$ | 185,622 | $ | 1,130 | $ | (734 | ) | $ | 186,018 | ||||||||
Gross unrealized losses are not material as of September 30, 2010 or December 31, 2009 either individually or in the aggregate. Because the Company does not intend to sell the investmentsThe following table summarizes, by major security type, our assets that are in an unrealized loss position and it is not likely that the Company will be required to sell the investments before recovery of their amortized cost basis, the Company does not consider those investments with an unrealized loss to be other-than-temporarily impaired at September 30, 2010. There were no material other-than-temporary impairments or credit losses related to available-for-sale securities in the three or nine months ended September 30, 2010 or 2009. Gross realized gains in the three months ended September 30, 2010 and 2009 were $0.2 million and $1.0 million, respectively. Gross realized gains in the nine months ended September 30, 2010 and 2009 were $0.7 million and $1.7 million, respectively. There were no material gross realized losses from the sale of available-for-sale securities in the three or nine months ended September 30, 2010 or 2009.
The estimated fair value of short-term investments by contractual maturity as of September 30, 2010 is as follows:
(in thousands) | ||||
Due within one year | $ | 21,388 | ||
Due after one year and through 5 years | 119,315 | |||
Due after 5 years and through 10 years | — | |||
Due after 10 years | 3,002 | |||
Total short-term investments | $ | 143,705 | ||
The Company measures certain financial assetsmeasured at fair value on a recurring basis including cash equivalents and available-for-sale securities. are categorized using the fair value hierarchy:
March 31,2011 | ||||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | |||||||||||||
(in thousands) | ||||||||||||||||
Cash | $ | 135,887 | $ | — | $ | — | $ | 135,887 | ||||||||
Level 1 securities (1): | ||||||||||||||||
Money market funds | 4,996 | — | — | 4,996 | ||||||||||||
Level 2 securities (2): | ||||||||||||||||
Corporate debt securities | 113,384 | 825 | (140 | ) | 114,069 | |||||||||||
Government and agency securities | 90,921 | 311 | (117 | ) | 91,115 | |||||||||||
Asset and mortgage-backed securities | 1,158 | 58 | — | 1,216 | ||||||||||||
$ | 346,346 | $ | 1,194 | $ | (257 | ) | $ | 347,283 | ||||||||
Less: Long-term restricted cash (1) | (4,562 | ) | ||||||||||||||
Total cash, cash equivalents and short-term investments | $ | 342,721 | ||||||||||||||
December 31, 2010 | ||||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | |||||||||||||
(in thousands) | ||||||||||||||||
Cash | $ | 194,146 | $ | — | $ | — | $ | 194,146 | ||||||||
Level 1 securities (1): | ||||||||||||||||
Money market funds | 4,914 | — | — | 4,914 | ||||||||||||
Level 2 securities (3): | ||||||||||||||||
Corporate debt securities | 109,745 | 1,043 | (101 | ) | 110,687 | |||||||||||
Government and agency securities | 42,062 | 331 | (101 | ) | 42,292 | |||||||||||
Asset and mortgage-backed securities | 2,881 | 168 | (140 | ) | 2,909 | |||||||||||
$ | 353,748 | $ | 1,542 | $ | (342 | ) | 354,948 | |||||||||
Less: Long-term restricted cash (1) | (4,561 | ) | ||||||||||||||
Total cash, cash equivalents and short-term investments | $ | 350,387 | ||||||||||||||
(1) | Includes $0.4 million that is included in cash and cash equivalents in the Company’s consolidated balance sheets and $4.6 million of long-term restricted cash that is included in other non-current assets in the Company’s consolidated balance sheets as these funds represent restricted cash related to workers compensation deposits. |
(2) | Includes $14.1 million that is included in cash and cash equivalents in the Company’s consolidated balance sheets and $192.3 million included in short-term investments in the Company’s consolidated balance sheets. |
(3) | Included in short-term investments in the Company’s consolidated balance sheets. |
Fair value is a market-based measurement that should be determined based on the assumptions that market participants would use in pricing an asset or liability.
Netflix, Inc.
Notes to Consolidated Financial Statements—(Continued)
Fair Value Measurements at September 30, 2010 | ||||||||||||||||
Total | Quoted Prices in Active Markets for Identical Assets | Significant Other Observable Inputs | Significant Unobservable Inputs | |||||||||||||
(Level 1) | (Level 2) | (Level 3) | ||||||||||||||
(in thousands) | ||||||||||||||||
Current Assets: | ||||||||||||||||
Money market funds (1) | $ | 217 | $ | 217 | $ | — | $ | — | ||||||||
Fixed income securities (2) | 155,904 | — | 155,904 | — | ||||||||||||
Total current assets | 156,121 | 217 | 155,904 | — | ||||||||||||
Non-current Assets: | ||||||||||||||||
Money market funds (3) | 3,729 | 3,729 | — | — | ||||||||||||
Total assets | $ | 159,850 | $ | 3,946 | $ | 155,904 | $ | — | ||||||||
Fair Value Measurements at December 31, 2009 | ||||||||||||||||
Total | Quoted Prices in Active Markets for Identical Assets | Significant Other Observable Inputs | Significant Unobservable Inputs | |||||||||||||
(Level 1) | (Level 2) | (Level 3) | ||||||||||||||
(in thousands) | ||||||||||||||||
Current Assets: | ||||||||||||||||
Money market funds (1) | $ | 690 | $ | 690 | $ | — | $ | — | ||||||||
Fixed income securities (4) | 186,018 | — | 186,018 | — | ||||||||||||
Total current assets | 186,708 | 690 | 186,018 | — | ||||||||||||
Non-current Assets: | ||||||||||||||||
Money market funds (3) | 2,829 | 2,829 | — | — | ||||||||||||
Total assets | $ | 189,537 | $ | 3,519 | $ | 186,018 | $ | — | ||||||||
The hierarchy level assigned to each security in the Company’s available-for-sale portfolio and cash equivalents is based on its assessment of the transparency and reliability of the inputs used in the valuation of such instrument at the measurement date. The fair value of available-for-sale securities included in the Level 1 category is based on quoted prices that are readily and regularly available in an active market. The fair value of available-for-sale securities and cash equivalents included in the Level 2 category is based on observable inputs, such as quoted prices for similar assets at the measurement date; quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly. These values were obtained from an independent pricing service and were evaluated using pricing models that vary by asset class and may incorporate available trade, bid and other market information and price quotes from well established independent pricing vendors and broker-dealers. Our procedures include controls to ensure that appropriate fair values are recorded such as comparing prices obtained from multiple independent sources. See Note 4 for further information regarding the fair value of the Company’s 8.50% senior notes.
Because the Company does not intend to sell the investments that are in an unrealized loss position and it is not likely that the Company will be required to sell any investments before recovery of their amortized cost basis, the Company does not consider those investments with an unrealized loss to be other-than-temporarily impaired at March 31, 2011. There were no material other-than-temporary impairments or credit losses related to available-for-sale securities in the three months ended March 31, 2011 and 2010. In addition, there were no material gross realized gains or losses in the three months ended March 31, 2011 and 2010.
The estimated fair value of short-term investments by contractual maturity as of March 31, 2011 is as follows:
(in thousands) | ||||
Due within one year | $ | 35,219 | ||
Due after one year and through 5 years | 155,866 | |||
Due after 5 years and through 10 years | — | |||
Due after 10 years | 1,217 | |||
Total short-term investments | $ | 192,302 | ||
4. Long-term Debt
As of September 30, 2010,March 31, 2011, the Company had $200.0 million of long-term debt outstanding. The debt consists of $200.0 million aggregate principal amount of 8.50% senior notes due November 15, 2017 (“the Notes”(the “Notes”). Interest on the Notes is payable semi-annually at a rate of 8.50% per annum on May 15 and November 15 of each year, commencing on May 15, 2010.
The 8.50% Notes include, among other terms and conditions, limitations on the Company’s ability to create, incur, assume or be liable for indebtedness (other than specified types of permitted indebtedness); dispose of assets outside the ordinary course (subject to specified exceptions); acquire, merge or consolidate with or into another person or entity (other than specified types of permitted acquisitions); create, incur or allow any lien on any of its property or assign any right to receive income (except for specified permitted liens); make investments (other than specified types of investments); or pay dividends, make distributions, or purchase or redeem our equity interests (each subject to specified exceptions). At September 30, 2010March 31, 2011 and December 31, 2009,2010, the Company was in compliance with these covenants.
Netflix, Inc.
Notes to Consolidated Financial Statements—(Continued)
Based on quoted market prices, the fair value of the 8.50% Notes as of September 30, 2010March 31, 2011 and December 31, 20092010 was approximately $223.0$225.3 million and $207.5$225.0 million, respectively.
5. Balance Sheet Components
Content Library, Net
Content library and accumulated amortization are as follows:
As of | As of | |||||||||||||||
September 30, 2010 | December 31, 2009 | March 31, 2011 | December 31, 2010 | |||||||||||||
(in thousands) | (in thousands) | |||||||||||||||
DVD content library, gross | $ | 615,908 | $ | 627,392 | ||||||||||||
Streaming content library, gross | 605,355 | 441,637 | ||||||||||||||
Content library, gross | $ | 918,720 | $ | 742,802 | 1,221,263 | 1,069,029 | ||||||||||
Less: Accumulated amortization | (660,284 | ) | (596,663 | ) | ||||||||||||
Less: accumulated amortization | (757,776 | ) | (707,050 | ) | ||||||||||||
Total content library, net | 463,487 | 361,979 | ||||||||||||||
Less: Current content library, net | 265,933 | 181,006 | ||||||||||||||
258,436 | 146,139 | |||||||||||||||
Less: Current content library, net | 138,389 | 37,329 | ||||||||||||||
Content library, net | $ | 120,047 | $ | 108,810 | $ | 197,554 | $ | 180,973 | ||||||||
Property and Equipment, Net
Property and equipment and accumulated depreciation are as follows:
As of | As of | |||||||||||||||||||||||
Useful Life | September 30, 2010 | December 31, 2009 | March 31, 2011 | December 31, 2010 | ||||||||||||||||||||
(in thousands) | (in thousands) | |||||||||||||||||||||||
Computer equipment | 3 years | $ | 59,908 | $ | 62,132 | 3 years | $ | 59,984 | $ | 60,289 | ||||||||||||||
Other equipment | 5 years | 63,539 | 65,059 | |||||||||||||||||||||
Computer software, including internal-use software | 3 years | 25,953 | 35,401 | |||||||||||||||||||||
Operations and other equipment | 5 years | 91,527 | 72,368 | |||||||||||||||||||||
Software, including internal-use software | 3 years | 27,911 | 26,961 | |||||||||||||||||||||
Furniture and fixtures | 3 years | 11,342 | 12,421 | 3 years | 12,333 | 11,438 | ||||||||||||||||||
Building | 30 years | 40,681 | 40,681 | 30 years | 40,681 | 40,681 | ||||||||||||||||||
Leasehold improvements | Over life of lease | 35,975 | 35,156 | Over life of lease | 38,354 | 36,530 | ||||||||||||||||||
Capital work-in-progress | 16,726 | 15,097 | 5,720 | 16,882 | ||||||||||||||||||||
Property and equipment, gross | 254,124 | 265,947 | 276,510 | 265,149 | ||||||||||||||||||||
Less: Accumulated depreciation | (129,067 | ) | (134,294 | ) | (141,710 | ) | (136,579 | ) | ||||||||||||||||
Property and equipment, net | $ | 125,057 | $ | 131,653 | $ | 134,800 | $ | 128,570 | ||||||||||||||||
InCapital work-in-progress as of March 31, 2011 consists primarily of approximately $5.5 million of operations equipment not yet placed in service.
Other Non-Current Liabilities
Other non-current liabilities consisted of the third quarter of 2010, the Company wrote off fully depreciated property and equipment of $32.6 million related to assets which were no longer in existence.following:
As of | ||||||||
March 31, 2011 | December 31, 2010 | |||||||
(in thousands) | ||||||||
Accrued content acquisition costs | $ | 67,119 | $ | 48,179 | ||||
Other | 23,465 | 21,022 | ||||||
Other non-current liabilities | $ | 90,584 | $ | 69,201 | ||||
6. Other Comprehensive Income
OtherComprehensive income was $60.1 million and $32.5 million for the three months ended March 31, 2011 and 2010, respectively. The primary difference between net income as reported and comprehensive income consists ofis unrealized gains and losses on available-for-sale securities, net of tax. The components of comprehensive income are as follows:
Three months ended | Nine months ended | |||||||||||||||
September 30, 2010 | September 30, 2009 | September 30, 2010 | September 30, 2009 | |||||||||||||
(in thousands) | ||||||||||||||||
Net income | $ | 37,967 | $ | 30,141 | $ | 113,758 | $ | 84,947 | ||||||||
Other comprehensive income: | ||||||||||||||||
Change in unrealized gain (loss) on available-for-sale securities, net of tax | 477 | (173 | ) | 1,006 | 468 | |||||||||||
Comprehensive income | $ | 38,444 | $ | 29,968 | $ | 114,764 | $ | 85,415 | ||||||||
Netflix, Inc.
Notes to Consolidated Financial Statements—(Continued)
7. Stockholders’ Equity
Stock Repurchases
During the three months ended September 30, 2010, the Company repurchased 530,000 shares of common stock at an average price of approximately $110 per share for an aggregate amount of approximately $59 million. Shares repurchased have been retired. Under the current stock repurchase plan, announced on June 11, 2010, the Company is authorized to repurchase up to $300 million of its common stock through the end of 2012. During the three months ended March 31, 2011, the Company repurchased 501,847 shares at an average price of $216 per share for an aggregate amount of $108.6 million. As of September 30, 2010, $240.6March 31, 2011, $132.0 million of this authorization is remaining. The timing and actual number of shares repurchased will depend on various factors including price, corporate and regulatory requirements, debt covenant requirements, alternative investment opportunities and other market conditions.
Shares repurchased by the Company are accounted for when the transaction is settled. ThereAs of March 31, 2011, there were no36,000 unsettled share repurchases at September 30, 2010.a total cost of $8.5 million. Shares repurchased and retired are deducted from common stock for par value and from additional paid in capital for the excess over par value. If additional paid in capital has been exhausted, the excess over par value is deducted from retained earnings. Direct costs incurred to acquire the shares are included in the total cost of the shares. ForDuring the three and nine monthsquarter ended September 30, 2010, $23.1March 31, 2011, $22.9 million and $121.9 million, respectively, werewas deducted from retained earnings related to share repurchases.
Stock-Based Compensation
A summary of the activity related to the Company’s stock option planplans during the ninethree months ended September 30, 2010March 31, 2011 is as follows:
Options Outstanding | Weighted-Average Remaining Contractual Term (in Years) | Aggregate Intrinsic Value (in Thousands) | ||||||||||||||||||
Shares Available for Grant | Number of Shares | Weighted- Average Exercise Price | ||||||||||||||||||
Balances as of December 31, 2009 | 2,591,267 | 4,241,438 | $ | 22.74 | ||||||||||||||||
Granted | (464,178 | ) | 464,178 | 85.67 | ||||||||||||||||
Exercised | — | (1,391,898 | ) | 23.35 | ||||||||||||||||
Balances as of September 30, 2010 | 2,127,089 | 3,313,718 | 31.31 | 5.96 | $ | 433,615 | ||||||||||||||
Vested and exercisable at September 30, 2010 | 3,313,718 | 31.31 | 5.96 | $ | 433,615 | |||||||||||||||
Options Outstanding | Weighted-Average Remaining Contractual Term (in Years) | Aggregate Intrinsic Value (in Thousands) | ||||||||||||||||||
Shares Available for Grant | Number of Shares | Weighted-Average Exercise Price | ||||||||||||||||||
Balances as of December 31, 2010 | 2,038,502 | 2,892,130 | $ | 36.11 | ||||||||||||||||
Granted | (112,294 | ) | 112,294 | 201.07 | ||||||||||||||||
Exercised | — | (239,057 | ) | 28.28 | ||||||||||||||||
Balances as of March 31, 2011 | 1,926,208 | 2,765,367 | 43.48 | 5.88 | $ | 537,298 | ||||||||||||||
Vested and exercisable at March 31, 2011 | 2,765,367 | 43.48 | 5.88 | $ | 537,298 | |||||||||||||||
The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between the Company’s closing stock price on the last trading day of the thirdfirst quarter of 20102011 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on September 30, 2010.March 31, 2011. This amount changes based on the fair market value of the Company’s common stock. Total intrinsic value of options exercised for the three months ended September 30,March 31, 2011 and 2010 and 2009 was $44.8$44.1 million and $5.0$22.8 million, respectively. Total intrinsic value of options exercised
Cash received from option exercises for the ninethree months ended September 30,March 31, 2011 and 2010 and 2009 was $100.7$6.8 million and $32.6$9.9 million, respectively.
The following table summarizes the assumptions used to value stock option grants using the lattice-binomial model:
Three Months Ended September 30, | Nine Months Ended September 30, | Three Months Ended | ||||||||||||||
2010 | 2009 | 2010 | 2009 | March 31, 2011 | March 31, 2010 | |||||||||||
Dividend yield | 0% | 0% | 0% | 0% | 0 | % | 0 | % | ||||||||
Expected volatility | 54% | 48% | 46%-54% | 48%-56% | 52 | % | 46 | % | ||||||||
Risk-free interest rate | 2.97% | 3.62% | 2.97-3.67% | 2.60%-3.62% | 3.42 | % | 3.67 | % | ||||||||
Suboptimal exercise factor | 2.00-2.40 | 1.74-1.94 | 1.78-2.40 | 1.73-1.94 | 2.17-3.39 | 1.78-2.15 |
In the ninethree months ended September 30,March 31, 2011, the Company used a suboptimal exercise factor of 3.39 for executives and 2.17, for non-executives, resulting in a calculated expected life of the option grants of eight years for executives and five years for non-executives. In the three months ended March 31, 2010, the Company used a suboptimal exercise factor ranging fromof 2.15 to 2.40, for executives and 1.78 to 2.00, for non-executives, resulting in a calculated expected life of the option grants of five years for executives and four years for non-executives. In the nine months ended September 30, 2009, the Company used a suboptimal exercise factor ranging from 1.87 to 1.94 for executives and 1.73 to 1.74 for non-executives, which resulted in a calculated expected life of the option grants of four years for executives and three years for non-executives.
Netflix, Inc.
Notes to Consolidated Financial Statements—(Continued)
The weighted-average fair value of employee stock options granted during the three months ended September 30,March 31, 2011 and 2010 was $109.21 and 2009 was $56.55 and $18.07$27.59 per share, respectively. The weighted-average fair value of employee stock options granted during the nine months ended September 30, 2010 and 2009 was $40.96 and $16.63 per share, respectively.
The following table summarizes the assumptions used to value employee stock purchase rights under the Company’s Employee Stock Purchase Plan (“ESPP”) for the offering periods commencing in May 2010 and May 2009, respectively, using the Black Scholes option pricing model:
Three Months Ended September 30, | ||||||||
2010 | 2009 | |||||||
Dividend yield | 0 | % | 0 | % | ||||
Expected volatility | 45 | % | 55 | % | ||||
Risk-free interest rate | 0.24 | % | 0.35 | % | ||||
Expected life (in years) | 0.5 | 0.5 |
Cash received from option exercises for the three months ended September 30, 2010 and 2009 was $10.9 million and $2.7 million, respectively. Cash received from option exercises and purchases under the ESPP for the nine months ended September 30, 2010 and 2009 was $34.0 million and $26.1 million, respectively.
The following table summarizes stock-based compensation expense, net of tax, related to stock option plans and employee stock purchases for the three and nine months ended September 30,March 31, 2011 and 2010 and 2009 which was allocated as follows:
Three Months Ended September 30, | Nine Months Ended September 30, | Three Months Ended | ||||||||||||||||||||||
2010 | 2009 | 2010 | 2009 | March 31, 2011 | March 31, 2010 | |||||||||||||||||||
(in thousands) | (in thousands) | |||||||||||||||||||||||
Fulfillment expense | $ | 323 | $ | 99 | $ | 806 | $ | 321 | $ | 560 | $ | 176 | ||||||||||||
Technology and development | 2,694 | 1,169 | 6,939 | 3,430 | 5,292 | 1,869 | ||||||||||||||||||
Marketing | 777 | 452 | 2,176 | 1,353 | 1,249 | 643 | ||||||||||||||||||
General and administrative | 3,502 | 1,512 | 9,805 | 4,538 | 5,163 | 2,814 | ||||||||||||||||||
Stock-based compensation expense before income taxes | 7,296 | 3,232 | 19,726 | 9,642 | 12,264 | 5,502 | ||||||||||||||||||
Income tax benefit | (3,064 | ) | (1,302 | ) | (8,118 | ) | (3,833 | ) | (4,744 | ) | (2,234 | ) | ||||||||||||
Total stock-based compensation after income taxes | $ | 4,232 | $ | 1,930 | $ | 11,608 | $ | 5,809 | $ | 7,520 | $ | 3,268 | ||||||||||||
8. Income Taxes
The effective tax rates for the three months ended September 30,March 31, 2011 and 2010 were 38.7% and 2009 were 42.0% and 40.3%40.6%, respectively. The effective tax rates for the nine months ended September 30, 2010 and 2009 were 41.1% and 39.7%, respectively.
As of December 31, 2009,2010, the Company had $13.2$20.7 million of gross unrecognized tax benefits. During the ninethree months ended September 30, 2010,March 31, 2011, the Company had an increase in gross unrecognized tax benefits of approximately $2.3$1.9 million. The gross uncertain tax positions, if recognized by the Company, will result in a reduction of approximately $12.4$18.5 million to the tax provision for income taxes thereby favorably impacting the Company’s effective tax rate. The Company’s unrecognized tax benefits are classified as other non-current liabilities in the consolidated balance sheet. Income tax benefits attributable to the exercise of employee stock options of $15.1 million and $7.4 million, during the three month period ended March 31, 2011 and 2010, respectively, were recorded directly to additional paid-in-capital.
The Company includes interest and penalties related to unrecognized tax benefits within the provision for income tax expense.taxes. As of March 31, 2011, the total amount of gross interest and penalties accrued was $2.0 million, which is classified as non-current liabilities in the consolidated balance sheet.
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 to U.S. federal income tax examinations for years after 2000 and state income tax examinations by state taxing authorities for years after 1999.returns. The Company is currently under examination by the IRS for the years 2008 and 2009. The years 1997 through 2007 (which represent approximately $3.5 million of the gross unrecognized tax benefit) remain subject to examination by the IRS but the statute of limitations for these years expires in various states including2011. The Company is currently under examination by the state of California for the years 2006 and 2007. ItThe years 1997 through 2005, as well as 2008 and 2009, remain subject to examination by the state of California.
Given the potential outcome of the current examinations as well as the impact of the current examinations on the potential expiration of the statute of limitations, it is reasonably possible that the liability associated with ourbalance of unrecognized tax benefits will increase or decreasecould significantly change within the next twelve months. These changes may be the result of ongoing audits. AtHowever, at this time, an estimate of the range of reasonably possible outcomesadjustments to the balance of unrecognized tax benefits cannot be made.
9. Commitments and Contingencies
Lease Financing Obligation
In June 2004 and June 2006, the Company entered into two separate lease agreements for the Los Gatos, California headquarters site. Because the terms of the original facilities lease required the Company’s involvement in the construction funding of the buildings, the Company is the “deemed owner” (for accounting purposes only) of these buildings in accordance with the Financial Accounting Standard Board’s Accounting Standards Codification Topic (“ASC”) 840.40Leases—Sale-Leaseback Transactions as it applies to situations where an entity is involved with the construction funding of an asset that will be leased when the construction project is completed.
Accordingly, the Company recorded an asset of $40.7 million, representing the total costs of the buildings and improvements, including the costs paid by the lessor (the legal owner of the buildings), with a corresponding liability. Upon completion of construction of each building,
Netflix, Inc.
Notes to Consolidated Financial Statements—(Continued)
the Company did not meet the sale-leaseback criteria for derecognition of the building assets and liabilities. Therefore the leases are accounted for as financing obligations and the buildings are depreciated over a 30 year useful life. The monthly rent payments made to the lessor under the lease agreements are recorded in the Company’s financial statements as land lease expense and principal and interest on the financing liabilities.
In the first quarter of 2010, the Company extended the facility leases for the Los Gatos buildings for an additional five year term after the remaining term of the original lease, thus increasing the future minimum payments under lease financing obligations by approximately $14 million. As of September 30, 2010, the remaining future minimum payments under the lease financing obligation are $24.6 million. The leases continue to be accounted for as financing obligations and no gain or loss was recorded as a result of the lease financing modification. The lease financing obligation balance at the end of the extended lease term will be approximately $25.8 million which approximates the net book value of the buildings to be relinquished to the lessor.
Streaming Content
The Company classifies streaming content as either a current or non-current library asset in the consolidated balance sheets based on the estimated time of usage after certain criteria have been met, including availability of the content for streaming by Netflix subscribers. The Company had $1,180.7$1,634.0 million and $114.8$1,075.2 million of commitments at September 30, 2010March 31, 2011 and December 31, 2009,2010, respectively, related to streaming content license agreements that do not meet assetcontent library recognition criteria.
The Company has entered into an agreement under which it has the obligationexpected timing of payments for these commitments ranges from less than one year to pay license fees in exchange for certain qualifying titles that are released theatrically in the United States from 2010 through 2018. The titles to be received under the agreement are at the discretion of the content provider, subject to certain minimum requirements.more than 5 years. The license fees are based onagreements do not meet content library recognition criteria because either the quantity of titles received and domestic theatrical exhibition receipts of qualifying titles. As these titles havefee is not known or reasonably determinable for a specific title or it is known but the title is not yet been released in theatres, the Company is unableavailable for streaming to estimate the amounts to be paid under this arrangement. However, such amounts are expected to be significant.subscribers.
The Company also has entered into certain license agreements with studios that include an unspecified or a maximum number of titles that the Company may or may not receive in the future. Accessfuture and /or that include pricing contingent upon certain variables, such as domestic theatrical exhibition receipts for the title. As of the reporting date, it is unknown whether the Company will receive access to these titles is based onor what the discretion ofultimate price per title will be. However such amounts, which are not included in the studios and, as such, the Company may not receive these titles. If the Company did receive accesscommitments described above, are expected to the maximum number of titles, the Company would incur up to an additional $21.6 million in commitments.be significant.
The Company has a license with a certain performing rights organization (“PRO”), and is currently involved in negotiations with performing rights organizations (PROs)other PROs, that hold thecertain rights to music used in connection with streaming content. TheFor the latter, the Company accrues for estimated royalties that are due to PROs and adjusts these accruals based on any changes in estimates. During the third quarter of 2010,While the Company reduced this accrual by $3.5 million as a result of lower estimated royalty rates. Theanticipates finalizing these negotiations, the outcome of these negotiations is uncertain. Additionally, pending litigation between certain PROs and other third parties could impact our negotiations. If we arethe Company is unable to reach mutually acceptable terms with the PROs, the Company could become involved in similar litigation. The results of any negotiation or litigation may be materially different from management’s estimates.
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, business practices and patent infringement. Litigation can be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict and the Company’s view of these matters may change in the future as the litigation and events related thereto unfold. The Company expenses legal fees as incurred. The Company makesrecords a provision for contingent losses when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. An unfavorable outcome to any legal matter, if material, could have an adverse effect on the Company’s operations or its financial position, liquidity or results of operations.
On March 29, 2010, Parallel Networks, LLC filed a complaint for patent infringement against the Company and others in the United States District Court for the Eastern District of Texas, captionedParallel Networks, LLC v. Abercrombie & Fitch Co., et. al , Civil Action No 6:10-cv-00111-LED. The complaint alleges that the Company infringed U.S. Patent No. 6,446,111 entitled “Method and Apparatus for Client-Server Communication Using a Limited Capability Client Over a Low-Speed Communication Link,” issued on September 3, 2002. The complaint seeks unspecified compensatory and enhanced damages, interest and fees, and seeks to permanently enjoin the Company from infringing the patent in the future. With respect to this matter, management has determined that a potential loss is not probable and accordingly, no amount has been accrued. Management has determined a potential loss is reasonably possible as it is defined by ASCthe Financial Accounting Standard Board’s Accounting Standards Codification (“ASC”) 450Commitments and Contingencies; however, based on its current knowledge, management does not believe that the amount of such possible loss or a range of potential loss is reasonably estimable.
On September 25, 2009, Alcatel-Lucent USA Inc. filed a complaint for patent infringement against the Company in the United States District Court for the Eastern District of Texas, captionedAlcatel-Lucent USA Inc. v. Amazon.com Inc., et. al, Civil Action No. 6:09-cv-422. The complaint alleges that the Company infringed U.S. Patents Nos. 5,649,131 entitled “Communications Protocol” issued on July 15, 1997,1997; 5,623,656 entitled “Script Based Data Communication System and Method Utilizing State Memory” issued on April 22, 19971997; and 5,404,507 entitled “Apparatus and Method for Finding Records in a Database by Formulating a Query Using Equivalent Terms Which Correspond to Terms in the Input Query,” issued April 4, 1995. The complaint seeks unspecified compensatory and enhanced damages, interest, costs and
Netflix, Inc.
Notes to Consolidated Financial Statements—(Continued)
fees, and seeks to permanently enjoin the Company from infringing the patents in the future. With respect to this matter, management has determined that a potential loss is not probable and accordingly, no amount has been accrued. Management has determined a potential loss is reasonably possible as it is defined by ASC 450; however, based on its current knowledge, management does not believe that the amount of such possible loss or a range of potential loss is reasonably estimable.
In January through April of 2009, a number of purported anti-trust class action suits were filed against the Company.Company in various United States Federal Courts. Wal-Mart Stores, Inc. and Walmart.com USA LLC (collectively, Wal-Mart) were also named as defendants in these suits. Most ofThese cases have been transferred by the suits were filed in the United States District Court forJudicial Panel on Multidistrict Litigation to the Northern District of California to be consolidated or coordinated for pre-trial purposes, and other federal district courts aroundhave been assigned the country.multidistrict litigation number MDL-2029. A number of substantially similar suits were filed in the Superior Court of theCalifornia State of California,Courts, and have been consolidated in Santa Clara County. The plaintiffs, who are current or former Netflix 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. On April 10, 2009, the Judicial Panel on Multidistrict Litigation ordered all cases pending in federal court transferred to the Northern District of California to be consolidated or coordinated for pre-trial purposes. These cases have been assigned the multidistrict litigation number MDL-2029. On March 19, 2010, plaintiffs filed a motion to certify a class consisting of “any person or entity in the United States that paid a subscription fee to Netflix on or after May 19, 2005 up to and including the date of class certification” with certain exceptions. The Court granted the motion for class certification. Thecertification on December 23, 2010. A number of other cases pending in the Superior Court of the State of California, Santa Clara County have been consolidated. In addition,filed in May of 2009, three additional lawsuits were filed—two in the Northern District of CaliforniaFederal and one in the Superior Court of the State of California, San Mateo County—alleging identical conduct and seeking identical relief. In these three cases, the plaintiffs arecourts by current or former subscribers to the online DVD rental service offered by Blockbuster Inc. The two, alleging injury arising from similar facts. These cases filed in federal court on behalf of Blockbuster subscribers have been related to MDL-2029.MDL 2029 or, in the case of the California State cases, coordinated with the cases in Santa Clara County. On December 1, 2009,March 8, 2011, the federalCompany filed a motion for summary judgment in Federal Court entered an order granting defendants’ motionwith respect to dismiss the two federal cases filedsuits brought on behalf of Blockbuster subscribers. Plaintiffs filed an amended complaintThe summary judgment motion was heard on March 1, 2010. Defendants moved to dismiss the Blockbuster subscribers’ amended complaint on March 31, 2010. The Court denied the motion to dismiss on July 6, 2010. The lawsuit filed in Superior Court of the State of California, San Mateo County has been coordinated with the cases pending in Santa Clara County. The complaints, which assert violations of federal and/or state antitrust laws, seek injunctive relief, costs (including attorneys’ fees) and damages in an unspecified amount.April 20, 2011. On August 27, 2010, Wal-Mart stated that it had settled the cases filed in Federal Court with both the Netflix and Blockbuster plaintiffs. Details ofA hearing on the settlement were not disclosed and plaintiffs have not yet filed aplaintiffs’ motion for preliminary approval of the settlement was heard on February 9, 2011. On March 9, 2011, the Court denied plaintiffs’ motion for preliminary approval of the settlement. On April 18, 2011, Wal-Mart settlement.stated that it had entered into a revised settlement agreement in principle with the Netflix plaintiffs only. Netflix is not part of the settlement and continues to litigate these cases. With respect to this matter, management has determined that a potential loss is not probable and accordingly, no amount has been accrued. Management has determined a potential loss is reasonably possible as it is defined by ASC 450; however, based on its current knowledge, management does not believe that the amount of such possible loss or a range of potential loss is reasonably estimable.
On October 24, 2008, Media Queue, LLC filed a complaint for patent infringement against the Company in the United States District Court for the Eastern District of Oklahoma, captionedMedia Queue, LLC v. Netflix, Inc., et. al , Civil Action No. CIV 08-402-KEW. The complaint alleges that the Company infringed U.S. Patent No. 7,389,243 entitled “Notification System and Method for Media Queue” issued on June 17, 2008. The complaint seeks unspecified compensatory and enhanced damages, interest and fees, and seeks to permanently enjoin the Company from infringing the patent in the future. On February 24, 2009, the case was transferred to the Northern District of California. On August 14, 2009, the Company filed a motion for summary judgment of non-infringement. A hearing on the motion was held on November 17, 2009. On December 1, 2009, the Court granted the Company’s motion for summary judgment of non-infringement. On February 10, 2010, plaintiff appealed the summary judgment ruling. With respect to this matter, management has determined that a potential loss is not probable and accordingly, no amount has been accrued. Management has determined a potential loss is reasonably possible as it is defined by ASC 450; however, based on its current knowledge, management does not believe that the amount of such possible loss or a range of potential loss is reasonably estimable.
On December 28, 2007, Parallel Networks, LLC filed a complaint for patent infringement against the Company in the United States District Court for the Eastern District of Texas, captionedParallel Networks, LLC v. Netflix, Inc., et. al , Civil Action No 2:07-cv-562-DF. The complaint alleges that the Company infringed U.S. Patent Nos. 5,894,554 and 6,415,335 B1 entitled “System For Managing Dynamic Web Page Generation Requests 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 and enhanced damages, interest and fees, and seeks to permanently enjoin the Company from infringing the patent in the future. On March 10, 2010, the Company filed a motion for summary judgment of invalidity. On March 26, 2010, the Company filed a motion for summary judgment of non-infringement. The Court had set a July 28, 2010 hearing date for these motions. On August 5, 2010, the parties stipulated to dismiss the litigation. On August 9, 2010, the Court entered an Order dismissing the case pursuant to the stipulation. Netflix paid no amount to plaintiff in relation to the dismissal.
The Company is involved in other litigation matters not listed above but does not consider the matters to be material either individually or in the aggregate at this time. The Company’s view of the matters not listed may change in the future as the litigation and events related thereto unfold.
Netflix, Inc.
Notes to Consolidated Financial Statements—(Continued)
Indemnification
In the ordinary course of business, the Company entershas entered into contractual arrangements under which it has agreed to provide indemnification of varying scope and terms to business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of the Company’s breach of such agreements and out of intellectual property infringement claims made by third parties. In these circumstances, payment may be conditional on the other party making a claim pursuant to the procedures specified in the particular contract. Further, the
The Company’s obligations under these agreements may be limited in terms of time or amount, and in some instances, the Company may have recourse against third partiesthird-parties for certain payments. In addition, the Company has entered into indemnification agreements with its directors and certain of its officers that will require it, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. The terms of such obligations vary.
It is not possible to make a reasonable estimate of the maximum potential amount of future payments under these or similar agreements due to the conditional nature of the Company’s obligations and the unique facts and circumstances involved.involved in each particular agreement. No amount has been accrued in the accompanying consolidated financial statements with respect to these indemnification obligations.guarantees.
10. Segment Information
In September 2010, the Company began international operations by offering an unlimited streaming plan without DVDs in Canada. At that time, the Company began segmenting operating results into two segments: Domestic and International. The Company presents the segment information along the same lines that the Company’s chief operating decision maker reviews the operating results in assessing performance and allocating resources. The Company’s chief operating decision maker reviews revenue and operating income (loss) information for each of the reportable segments.
The Domestic segment derives revenue from monthly subscription services consisting of streaming content and DVD-by-mail. The International segment derives revenue from monthly subscription services consisting solely of streaming content.
Segment operating income (loss) includes allocations of “Cost of Revenues” which includes allocations of streaming content, streaming delivery and fulfillment costs, as well as allocations of “Marketing”, “Technology and Development” and “General and Administrative” operating expenses. The vast majority of the Company’s costs for “Technology and Development” and “General and Administrative” are incurred in the United States and are allocated to our Domestic segment. There are no internal revenue transactions between our reporting segments. In addition, the Company does not identify or allocate our assets by reportable segment and all of our long lived assets are held in the United States.
Information on reportable segments and reconciliation to consolidated net income is as follows:
Three Months Ended | ||||||||
March 31, 2011 | March 31, 2010 | |||||||
(in thousands) | ||||||||
Domestic | ||||||||
Total subscribers at end of period | 22,797 | 13,967 | ||||||
Revenues | $ | 706,274 | $ | 493,665 | ||||
Cost of revenues and operating expenses | 593,292 | 435,320 | ||||||
Segment operating income | $ | 112,982 | $ | 58,345 | ||||
International | ||||||||
Total subscribers at end of period | 803 | |||||||
Revenues | $ | 12,279 | $ | — | ||||
Cost of revenues and operating expenses | 23,021 | — | ||||||
Segment operating income (loss) | $ | (10,742 | ) | $ | — | |||
Consolidated | ||||||||
Total subscribers at end of period | 23,600 | 13,967 | ||||||
Revenues | $ | 718,553 | $ | 493,665 | ||||
Cost of revenues and operating expenses | 616,313 | 435,320 | ||||||
Operating income | $ | 102,240 | $ | 58,345 | ||||
Other income (expense) | (4,000 | ) | (3,987 | ) | ||||
Provision for income taxes | 38,007 | 22,086 | ||||||
Net income | $ | 60,233 | $ | 32,272 |
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of the federal securities laws. These forward-looking statements include, but are not limited to:to statements regarding international expansion, trends in average revenue per paying subscriber, investments in our content library and increased spending for streaming content, our competitive advantage,regarding: our core strategy, expectations with respect tostrategy; the growth of Internet delivery of content, growth incontent; the market opportunity for streaming content; our average numberfocus within the subscription segment of paying subscribers, future investments inthe entertainment video market; operating margins; liquidity; subscriber revenue; our pricing strategy; DVD usage and shipments; the fading differentiation of DVD; our content library and its effects on our gross margin and liquidity, continuing legal costs, deferred tax assetsinvestments; future contractual obligations; international expansion; and our liquidity. stock-based compensation expense for 2011.These forward-looking statements are subject to risks and uncertainties that could cause actual results and events to differ.differ materially from those included in forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in theour Annual Report on Form 10-K for the year ended December 31, 20092010 filed with the Securities and Exchange Commission (“SEC”) on February 22, 2010.18, 2011, in particular the risk factors discussed under the heading “Risk Factors” in Part I, Item IA.
We assume no obligation to revise or publicly release any revision to any forward-looking statements contained in this Quarterly Report on Form 10-Q.10-Q, unless required by law.
Overview
Our Business
With more than 1623 million subscribers as of March 31, 2011, we are the world’s leading Internet subscription service for enjoying moviesTV shows and TV shows.movies. Our subscribers can instantly watch unlimited movies and TV shows and movies streamed over the Internet to their TVs, computers and computersmobile devices and, in the United States, subscribers can also receive standard definition DVDs, and their high definition successor, Blu-ray discs (collectively referred to as “DVD”), delivered quickly to their homes. We offer a variety of subscription plans, with no due dates, no late fees, no shipping fees and no pay-per-view fees. Aided by our proprietary recommendation and merchandising technology, subscribers can select from a growing library of titles that can be watched instantly and a vast array of titles on standard definition DVD, along with its high definition successor, Blu-ray (collectively referred to in this Quarterly Report as “DVD”).
Subscribers can:
Watch streaming content without commercial interruption on their computers and TVs. The viewing experience is enabled by Netflix controlled software that runs on a variety of consumer electronics devices (“Netflix Ready Devices”). These Netflix Ready Devices currently include platforms such as Blu-ray disc players, Internet-connected TVs, digital video players and game consoles.
In the United States, receive DVDs by 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 a subscriber’s queue.
Our core strategy is to grow a largeour streaming subscription business consistingdomestically and globally. We are continuously improving the customer experience, with a focus on expanding our streaming content, enhancing our user interface and extending our streaming service to even more Internet-connected devices, while staying within the parameters of streaming and DVD-by-mail content. our operating margin targets.
By combining streaming and DVD as part ofcontinuously improving the Netflix subscription,customer experience, we are able to offer subscribers a uniquely compelling selection of movies and TV shows for one low monthly price. We have seen tremendousbelieve we drive additional subscriber growth in the popularity of the streaming portionfollowing ways:
Additional subscriber growth enables us to obtain more content, which in turn drives more subscriber growth.
Additional subscriber growth leads to greater word-of-mouth promotion of our service, and we are rapidly increasingwhich in turn leads to more subscriber growth at an increasingly cost-effective marketing spend.
Additional subscriber growth enables us to invest in further improvements to our investmentservice offering, which in streaming content in orderturn leads to fuel thismore subscriber growth.
Performance Highlights
The following represents our consolidated performance highlights for the three months ended September 30, 2010, June 30,March 31, 2011, December 31, 2010 and March 31, 2010:
Three Months Ended | Change | |||||||||||||||||||
March 31, 2011 | December 31, 2010 | March 31, 2010 | Q1’11 vs. Q1’10 | Q1’11 vs. Q4’10 | ||||||||||||||||
(in thousands except per share data and percentages) | ||||||||||||||||||||
Revenues | $ | 718,553 | $ | 595,922 | $ | 493,665 | 45.6 | % | 20.6 | % | ||||||||||
Operating income | 102,240 | 78,453 | 58,345 | 75.2 | % | 30.3 | % | |||||||||||||
Net income | 60,233 | 47,095 | 32,272 | 86.6 | % | 27.9 | % | |||||||||||||
Net income per share - diluted | $ | 1.11 | $ | 0.87 | $ | 0.59 | 88.1 | % | 27.6 | % | ||||||||||
Total subscribers at end of period | 23,600 | 20,010 | 13,967 | 69.0 | % | 17.9 | % | |||||||||||||
Net subscriber additions | 3,590 | 3,077 | 1,699 | 111.3 | % | 16.7 | % |
In September 30, 20092010, we began international operations by offering an unlimited streaming plan without DVDs in Canada. As of March 31, 2011, our international segment had over 0.8 million subscribers and had revenues of $12.3 million and an operating loss of $10.7 million for the ninethree months ended September 30, 2010March 31, 2011. Substantially all of our revenues, operating income and September 30, 2009:
Three Months Ended | Change | |||||||||||||||||||
September 30, 2010 | June 30, 2010 | September 30, 2009 | Q3’10 vs. Q2’10 | Q3’10 vs. Q3’09 | ||||||||||||||||
(in thousands except per share data, percentages and subscriber acquisition cost) | ||||||||||||||||||||
Revenues | $ | 553,219 | $ | 519,819 | $ | 423,120 | 6.4 | % | 30.7 | % | ||||||||||
Net income | 37,967 | 43,519 | 30,141 | (12.8 | )% | 26.0 | % | |||||||||||||
Net income per share - diluted | $ | 0.70 | $ | 0.80 | $ | 0.52 | (12.5 | )% | 34.6 | % | ||||||||||
Total subscribers at end of period | 16,933 | 15,001 | 11,109 | 12.9 | % | 52.4 | % | |||||||||||||
Churn* | 3.8 | % | 4.0 | % | 4.4 | % | (5.0 | )% | (13.6 | )% | ||||||||||
Subscriber acquisition cost** | $ | 19.81 | $ | 24.37 | $ | 26.86 | (18.7 | )% | (26.2 | )% | ||||||||||
Gross margin | 37.7 | % | 39.4 | % | 34.9 | % | (4.3 | )% | 8.0 | % |
Nine Months Ended | Change | |||||||||||
September 30, 2010 | September 30, 2009 | YTD ‘10 vs. YTD ‘09 | ||||||||||
(in thousands, except per share data, percentages and subscriber acquisition cost) | ||||||||||||
Revenues | $ | 1,566,703 | $ | 1,225,727 | 27.8 | % | ||||||
Net income | 113,758 | 84,947 | 33.9 | % | ||||||||
Net income per share—diluted | $ | 2.09 | $ | 1.43 | 46.2 | % | ||||||
Total subscribers at end of period | 16,933 | 11,109 | 52.4 | % | ||||||||
Churn * | 3.8 | % | 4.4 | % | (13.6 | )% | ||||||
Subscriber acquisition cost | $ | 21.69 | $ | 25.58 | (15.2 | )% | ||||||
Gross margin | 38.3 | % | 34.4 | % | 11.3 | % |
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally acceptednet income are still generated in the United States requires managementStates. We anticipate further international expansion into an additional market in the second half of 2011 and will manage our business going forward with two distinct operating segments: Domestic (which includes the United States) and International.
We believe that DVD will be a fading differentiator given the explosive growth of streaming, and that in order to prosper in streaming we must concentrate on having the best possible streaming service. As a result, we are beginning to treat them separately in many ways. For example, our signup page for non-members is focused on streaming. While DVD rentals are still a great business for us, and we are working on solutions to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported periods. The Securities and Exchange Commission (“SEC”) has defined a company’s critical accounting policies as the ones that are most important to the portrayal of a company’s financial condition and results of operations, and which require a company to make its most difficult and subjective judgments. Based on this definition, we have identified the critical accounting policies and judgments addressed below. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates.
Content Accounting
We obtain content throughsure DVD direct purchases, streaming content license agreements and DVD and streaming revenue sharing agreements with studios, distributors, and other suppliers.
We acquire DVD content for the purpose of renting such content to our subscribers and earning subscription rental revenues, and, as such, we consider our direct purchase DVD librarycontinues to be a productive asset. Accordingly, we classify our DVD library as a non-current asset onprofitable business for us in the consolidated balance sheets. We amortize our direct purchase 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 our DVDs, we consider historical utilization patterns primarily including the number of times a DVD title is shipped to subscribers in a given period as well as an estimate for lost or damaged DVDs. Historically, the utilization patterns of our DVDs have not changed significantly andahead, we do not expect thembelieve it is core to change significantly in the future. However, if we were to amortize our DVDs over a period that is greater or shorter than our estimated useful life of one to three years, our amortization expense and results of operations could be materially impacted.
We provide a salvage value for those direct purchase DVDs that we estimate we will sell at the end of their useful lives. Use of a different salvage value would not materially impact our financial statements. Further, historically, the actual number of DVDs sold and the actual salvage value of those DVDs have not differed significantly from our estimates and, in the future, we do not expect the differences to be material to our financial position or results of operations. For those DVDs that we do not expect to sell, no salvage value is provided. We periodically evaluate the useful lives and salvage valuessuccess of our DVDs.
The terms of certain DVD direct purchase agreements with studios and distributors provide for discounts based on type of purchases or based on volume of purchases. The discounts based on type of purchases are recorded as a reduction of DVD content library when the eligible titles are purchased. The discounts based on volume of purchases are also recorded as a reduction of DVD content library when the eligible titles are purchased and are recorded at a discount rate based on historical and estimated purchases over the title term. Historically, actual discounts have not differed significantly from estimated discounts and we do not expect the differences to be material to our financial position or results of operations.
We obtain content distribution rights in order to stream movies and TV shows without commercial interruption to subscribers’ computers and TVs via Netflix Ready Devices. We account for streaming content in accordance with the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) topic 920Entertainment – Broadcasters . Streaming content is generally licensed for a fixed fee for the term of the license agreement. We classify our streaming content obtained through a license agreement as either a current or non-current library 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. Any licensed streaming content payments not meeting the criteria for classification in the library are classified as prepaid content. We amortize licensed streaming content on a straight-line basis generally over the term of the related license agreements or the title’s window of availability.
We also obtain DVD and streaming content through revenue sharing agreements with studios and distributors. The terms of some revenue sharing agreements obligate us to make a generally low initial payment for certain titles, representing a minimum contractual obligation under the agreement. The low initial payment is in exchange for a commitment to share a percentage of our subscription revenues or to pay a fee, based on utilization, for a defined period of time, or the title term, which typically ranges from six to twelve months for each title. The initial payment may be in the form of an upfront non-recoupable payment. This payment is capitalized in the content library in accordance with our DVD and streaming content policies as applicable. The initial payment may also be in the form of a prepayment of future revenue sharing obligations which is classified as prepaid content. This prepayment is amortized as revenue sharing obligations are incurred. If during the title term, we determine that the full prepayment will not be amortized based on utilization, a provision for the estimated difference is recorded in the period that such shortfall is deemed probable. Under the revenue sharing agreements for its 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. In most cases, we purchase the disc where we have the ability to do so. This end of term buy-out cost is also included in DVD library.
Cash flows associated with obtaining content are classified as either operating activities or investing activities based on the underlying type of content obtained and type of arrangement. Other companies in the in-home entertainment video industry classify all cash flows associated with obtaining content as operating activities. We classify cash flows related to our content as follows:
Revenue sharing obligations incurred based on utilization as well as amortization of licensed streaming content that do not meet asset recognition criteria are classified as cash used in operating activities in the line item “net income”.
Changes in prepaid content are classified as operating activities.
The amortization of the streaming and DVD content libraries is classified as a reconciling item between net income and cash flow from operating activities in the line item “Amortization of content library”.
The acquisition of streaming content library is classified as cash used in operating activities in the line item “Acquisition of streaming content library”.
The acquisition of DVD content library, net of changes in related accounts payable, is classified as cash used in investing activities in the line item “Acquisition of DVD content library” because the DVD content library is considered a productive asset.
Stock-Based Compensation
Stock-based compensation cost at the grant date is based on the total number of option shares granted and an estimate of the fair value of the awards expected to vest and is recognized as expense ratably over the requisite service period, which is the vesting period.
We calculate the fair value of new stock-based compensation awards under our stock option plans using a lattice-binomial model. We use a Black-Scholes model to determine the fair value of employee stock purchase plan shares. These models require the input of highly subjective assumptions, including price volatility of the underlying stock. Changes in the subjective input assumptions can affect the estimate of fair value of options granted and our results of operations could be impacted.
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Income Taxes
We record a tax provision for the anticipated tax consequences of our reported results of operations using the asset and liability method. Deferred income taxes are recognized by applying the enacted 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 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 which future realization is uncertain.
Although we believe our assumptions, judgments and estimates are reasonable, changes in tax laws or our interpretation of tax laws and the resolution of any tax audits could significantly impact the amounts provided for income taxes in our consolidated financial statements.
In evaluating our ability to recover our deferred tax assets, in full or in part, we consider all available positive and negative evidence, including our past operating results, and our forecast of future market growth, forecasted earnings, future taxable income and prudent and feasible tax planning strategies. The assumptions utilized in determining future taxable income require significant judgment and are consistent with the plans and estimates we are using to manage the underlying businesses. Actual operating results in future years could differ from our current assumptions, judgments and estimates. However, we believe that the deferred tax assets recorded on our balance sheet will ultimately be realized. In the event we were to determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to earnings in the period in which we make such determination.
We did not recognize certain tax benefits from uncertain tax positions within the provision for income taxes. We may recognize a tax benefit only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefit recognized in the financial statements from such position is then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. At September 30, 2010, our estimated gross unrecognized tax benefits were $15.5 million of which $12.4 million, if recognized, could favorably impact our future earnings. Due to uncertainties in any tax audit outcome, our estimates of the ultimate settlement of our unrecognized tax positions may change and the actual tax benefits may differ significantly from the estimates. See Note 8 to the consolidated financial statements for further information regarding income taxes.business.
Results of Operations
The following table sets forth, for the periods presented, the line items in our consolidated statements of operations as a percentage of total revenues. The information contained in the table below should be read in conjunction with the consolidated financial statements, notes to the consolidated financial statements and the entirety of this Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Quarterly Report on Form 10-Q.Operations.
Three Months Ended | Nine Months Ended | |||||||||||||||||||
September 30, 2010 | June 30, 2010 | September 30, 2009 | September 30, 2010 | September 30, 2009 | ||||||||||||||||
Revenues | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||||
Cost of revenues: | ||||||||||||||||||||
Subscription | 52.9 | % | 51.1 | % | 55.1 | % | 52.2 | % | 55.3 | % | ||||||||||
Fulfillment expenses | 9.4 | % | 9.5 | % | 10.0 | % | 9.5 | % | 10.3 | % | ||||||||||
Total cost of revenues | 62.3 | % | 60.6 | % | 65.1 | % | 61.7 | % | 65.6 | % | ||||||||||
Gross margin | 37.7 | % | 39.4 | % | 34.9 | % | 38.3 | % | 34.4 | % | ||||||||||
Operating expenses: | ||||||||||||||||||||
Technology and development | 7.6 | % | 7.3 | % | 7.1 | % | 7.5 | % | 6.6 | % | ||||||||||
Marketing | 14.7 | % | 14.3 | % | 13.8 | % | 14.7 | % | 13.6 | % | ||||||||||
General and administrative | 3.1 | % | 3.3 | % | 2.7 | % | 3.3 | % | 3.1 | % | ||||||||||
Gain on disposal of DVDs | (0.3 | )% | (0.4 | )% | (0.3 | )% | (0.3 | )% | (0.2 | )% | ||||||||||
Total operating expenses | 25.1 | % | 24.5 | % | 23.3 | % | 25.2 | % | 23.1 | % | ||||||||||
Operating income | 12.6 | % | 14.9 | % | 11.6 | % | 13.1 | % | 11.3 | % | ||||||||||
Other income (expense): | ||||||||||||||||||||
Interest expense | (0.9 | )% | (0.9 | )% | (0.2 | )% | (0.9 | )% | (0.2 | )% | ||||||||||
Interest and other income | 0.2 | % | 0.1 | % | 0.5 | % | 0.1 | % | 0.4 | % | ||||||||||
Income before income taxes | 11.9 | % | 14.1 | % | 11.9 | % | 12.3 | % | 11.5 | % | ||||||||||
Provision for income taxes | 5.0 | % | 5.7 | % | 4.8 | % | 5.0 | % | 4.6 | % | ||||||||||
Net income | 6.9 | % | 8.4 | % | 7.1 | % | 7.3 | % | 6.9 | % | ||||||||||
Three Months Ended | ||||||||||||
March 31, 2010 | December 31, 2010 | March 31, 2010 | ||||||||||
Revenues | 100.0 | % | 100.0 | % | 100.0 | % | ||||||
Cost of revenues: | ||||||||||||
Subscription | 52.5 | % | 56.5 | % | 52.6 | % | ||||||
Fulfillment expenses | 8.5 | % | 9.1 | % | 9.6 | % | ||||||
Total cost of revenues | 61.0 | % | 65.6 | % | 62.2 | % | ||||||
Operating expenses: | ||||||||||||
Technology and development | 7.1 | % | 7.7 | % | 7.6 | % | ||||||
Marketing | 14.5 | % | 10.6 | % | 15.2 | % | ||||||
General and administrative | 3.2 | % | 3.0 | % | 3.2 | % | ||||||
Total operating expenses | 24.8 | % | 21.3 | % | 26.0 | % | ||||||
Operating income | 14.2 | % | 13.1 | % | 11.8 | % | ||||||
Other income (expense): | ||||||||||||
Interest expense | (0.7 | )% | (0.8 | )% | (1.0 | )% | ||||||
Interest and other income | 0.2 | % | 0.2 | % | 0.2 | % | ||||||
Income before income taxes | 13.7 | % | 12.5 | % | 11.0 | % | ||||||
Provision for income taxes | 5.3 | % | 4.6 | % | 4.5 | % | ||||||
Net income | 8.4 | % | 7.9 | % | 6.5 | % | ||||||
Revenues
We derive substantially all of our revenues from monthly subscription fees and recognize subscription revenues ratably over each subscriber’s monthly subscription period. We record refunds to subscribers as a reduction of revenues. We currently generate substantially all of our revenues in the United States. In September 2010, we began international operations by offering an unlimited streaming plan without DVDs in Canada. We launched a streaming only subscription service in Canadaanticipate further international expansion in the third quartersecond half of 20102011.
We offer subscription plans in the United States and expectCanada that international revenues will grow.
Weallow our subscribers to instantly watch unlimited TV shows and movies streamed over the Internet to their TVs, computers and mobile devices. In the United States, we offer a variety of subscription plans combiningthat, in addition to streaming, movies and TV shows over the Internet and in the United States, sendingoffer subscribers DVDs by mail. The price per plan varies based on the number of DVDs that a subscriber hasmay have out at any given point and based on whether the service has limited or unlimited usage. All of our unlimited plans allow the subscriber unlimited streaming to their computer or Netflix Ready Device. More than 90% of our subscriber base has chosen a 1, 2, or 3-out Unlimited plan which range in price from $8.99 to $16.99 per month.point. Customers electing access to the high definition Blu-ray discs in addition to standard definition DVDs pay a surcharge ranging from $1 to $4 per month for our most popular plans. In Canada, our subscription service consists of only streaming movies and TV shows over the Internet and is priced at $7.99 CAD. We anticipate that any future international markets will likewise only offer a streaming subscription.
The following table presents our ending subscriber information:
As of | As of | |||||||||||||||||||||||
September 30, 2010 | June 30, 2010 | September 30, 2009 | March 31, 2011 | December 31, 2010 | March 31, 2010 | |||||||||||||||||||
(in thousands, except percentages) | (in thousands, except percentages) | |||||||||||||||||||||||
Free subscribers | 1,070 | 424 | 274 | 1,522 | 1,742 | 345 | ||||||||||||||||||
As a percentage of total subscribers | 6.3 | % | 2.8 | % | 2.5 | % | ||||||||||||||||||
As a percentage of total subscribers (1) | 6.4 | % | 8.7 | % | 2.5 | % | ||||||||||||||||||
Paid subscribers | 15,863 | 14,577 | 10,835 | 22,078 | 18,268 | 13,622 | ||||||||||||||||||
As a percentage of total subscribers | 93.7 | % | 97.2 | % | 97.5 | % | 93.6 | % | 91.3 | % | 97.5 | % | ||||||||||||
Total subscribers | 16,933 | 15,001 | 11,109 | 23,600 | 20,010 | 13,967 |
(1) | The 3.9 percentage point increase in free subscribers as a percentage of total subscribers as of March 31, 2011 as compared to March 31, 2010 is due to the expanded use of our one month free trial subscriptions over the previously used two week free trials. |
Three months ended September 30, 2010March 31, 2011 as compared to the three months ended September 30, 2009March 31, 2010
Three Months Ended | Change | Three Months Ended | Change | |||||||||||||||||||||
September 30, 2010 | September 30, 2009 | Q3’10 vs. Q3’09 | March 31, 2011 | March 31, 2010 | Q1’11 vs. Q1’10 | |||||||||||||||||||
(in thousands except percentages and average monthly revenue per paying subscriber) | (in thousands, except percentages and average monthly revenue per paying subscriber) | |||||||||||||||||||||||
Revenues | $ | 553,219 | $ | 423,120 | 30.7 | % | $ | 718,553 | $ | 493,665 | 45.6 | % | ||||||||||||
Other data: | ||||||||||||||||||||||||
Domestic | 706,274 | 493,665 | 43.1 | % | ||||||||||||||||||||
International | 12,279 | — | — | |||||||||||||||||||||
Other domestic data: | ||||||||||||||||||||||||
Average number of paying subscribers | 15,220 | 10,605 | 43.5 | % | 19,670 | 12,757 | 54.2 | % | ||||||||||||||||
Average monthly revenue per paying subscriber | $ | 12.12 | $ | 13.30 | (8.9 | )% | $ | 11.97 | $ | 12.90 | (7.2 | )% |
The $130.1$224.9 million increase in our consolidated revenues was primarily a result of the 43.5%54.2% growth in the domestic average number of paying subscribers arising from increasedthe continuous improvement to our customer experience which in turn, drives consumer awareness of the compelling value proposition of streaming and DVDs by mail for one low price and other benefits of our service.service benefits. This increase was partially offset by an 8.9%a 7.2% decline in the domestic average monthly revenue per paying subscriber to $12.12, resulting from the continued growth of our lower priced subscription plans. The total number of average paying subscribers in our 1 and 2-out plans grew by 71.6% year over year as compared to a 14.7% decline in all other plans.
Nine months ended September 30, 2010 as compared to the nine months ended September 30, 2009
Nine Months Ended | Change | |||||||||||
September 30, 2010 | September 30, 2009 | YTD ‘10 vs. YTD ‘09 | ||||||||||
(in thousands except percentages and average monthly revenue per paying subscriber) | ||||||||||||
Revenues | $ | 1,566,703 | $ | 1,225,727 | 27.8 | % | ||||||
Other data: | ||||||||||||
Average number of paying subscribers | 14,026 | 10,164 | 38.0 | % | ||||||||
Average monthly revenue per paying subscriber | $ | 12.41 | $ | 13.40 | (7.4 | )% |
The $341.0 million increase in our revenues was primarily a result of the 38.0% growth in the average number of paying subscribers arising from increased consumer awareness of the compelling value proposition of streaming and DVDs by mail for one low price and other benefits of our service. This increase was partially offset by a 7.4% decline in the average monthly revenue per paying subscriber to $12.41,$11.97, resulting from the continued growth of our lower priced subscription plans. As compared toof March 31, 2011, approximately 90% of our domestic subscriber base has chosen either the same prior year period,unlimited streaming plan without DVDs at $7.99 per month or a 1 or 2 DVD-out unlimited plan, which are priced at $9.99 and $14.99 per month, respectively. As of March 31, 2010 approximately 72% of our domestic subscriber base had chosen either the total number of average paying subscribers in our 1 and 2-out plans grew by 66.0% duringor 2 DVD-out unlimited plan, as the nine months endedunlimited streaming plan was not introduced until September 30, 2010 as compared to a 13.5% decline in all other plans.
2010.
Three months ended September 30, 2010March 31, 2011 as compared to the three months ended June 30,December 31, 2010
Three Months Ended | Change | Three Months Ended | Change | |||||||||||||||||||||
September 30, 2010 | June 30, 2010 | Q3’10 vs. Q2’10 | March 31, 2011 | December 31, 2010 | Q1’11 vs. Q4’10 | |||||||||||||||||||
(in thousands except percentages and average monthly revenue per paying subscriber) | (in thousands, except percentages and average monthly revenue per paying subscriber) | |||||||||||||||||||||||
Revenues | $ | 553,219 | $ | 519,819 | 6.4 | % | $ | 718,553 | $ | 595,922 | 20.6 | % | ||||||||||||
Other data: | ||||||||||||||||||||||||
Domestic | 706,274 | 592,305 | 19.2 | % | ||||||||||||||||||||
International | 12,279 | 3,617 | 239.5 | % | ||||||||||||||||||||
Other domestic data: | ||||||||||||||||||||||||
Average number of paying subscribers | 15,220 | 14,100 | 7.9 | % | 19,670 | 16,899 | 16.4 | % | ||||||||||||||||
Average monthly revenue per paying subscriber | $ | 12.12 | $ | 12.29 | (1.4 | )% | $ | 11.97 | $ | 11.68 | 2.5 | % |
The $33.4$122.6 million increase in our consolidated revenues was primarily a result of the 7.9%16.4% growth in the domestic average number of paying subscribers arising from increasedsubscribers. We believe this is due to the continuous improvement to our customer experience which in turn, drives consumer awareness of the compelling value proposition of streaming and DVDs by mail for one low price and otherour service benefits of our service.available to paying subscribers. This increase was partially offset by a 1.4% declinealso attributed to an increase in the domestic average monthly revenue per paying subscriber to $12.12, resulting from the continued growth of our lower priced subscription plans. The total number of average paying subscribers in our 1 and 2-out plans grew by 11.7% quarter over quarter as compareddue to a 5.3%price increase that went into effect in January 2011. Going forward, we believe the domestic average monthly revenue per paying subscriber will revert back to a slight decline in all other plans.as streaming only becomes a larger part of the overall subscriber mix.
Until the average price paid by our new subscriber additions is equal to the average price paid by existing subscribers, we expect our average monthly revenue per paying subscriber will continue to decline, asdecline. We expect the lower priced plans to continue to grow as a percentage of our subscriber base. We are currently testing a streaming only subscription plan in the United States and may offer such a plan later in 2010. If such a plan is offered, our pricing structure will change, thus impacting our revenues and average monthly revenue per paying subscriber.
Cost of Revenues
Cost of Subscription
Cost of subscription revenues consists of content delivery costs related to shipping DVDs and providing streaming content to subscribers as well as expenses related to the acquisition and licensing of content.content, as well as content delivery costs related to providing streaming content and shipping DVDs to subscribers. Costs related to free-trial periods are allocated to marketing expenses.
Content acquisition and licensing expenses consist primarily of amortization of streaming content licenses, which may or may not be recognized in streaming content library, amortization of DVD content library and revenue sharing expenses. We obtain content through streaming content license agreements, DVD direct purchases and DVD and streaming revenue sharing agreements with studios, distributors and other suppliers.
Content delivery expenses consist of the postage costs to mail DVDs to and from our paying subscribers, the packaging and label costs for the mailers and all costs associated with streaming content over the Internet. We utilize third partythird-party content delivery networks to help us efficiently stream content in high volume to our subscribers over the Internet.
Content acquisition and licensing 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.
Three months ended September 30, 2010March 31, 2011 as compared to the three months ended September 30, 2009March 31, 2010
Three Months Ended | Change | Three Months Ended | Change | |||||||||||||||||||||
September 30, 2010 | September 30, 2009 | Q3’10 vs. Q3’09 | March 31, 2011 | March 31, 2010 | Q1’11 vs. Q1’10 | |||||||||||||||||||
(in thousands except percentages) | (in thousands, except percentages) | |||||||||||||||||||||||
Cost of Subscription | $ | 292,406 | $ | 233,091 | 25.4 | % | $ | 376,992 | $ | 259,560 | 45.2 | % | ||||||||||||
As a percentage of revenues | 52.9 | % | 55.1 | % | 52.5 | % | 52.6 | % |
The $59.3$117.4 million increase in cost of subscription revenues was due to the following factors:
Content acquisition and licensing expenses increased by $110.5 million primarily attributable to licensing of streaming content, partially offset by decreases in DVD content acquisition costs; and
Content delivery expenses increased $18.4$6.9 million primarily due to an increase in costs associated with streaming content over the Internet resulting from an increase in the total number of hours of streaming content viewed by our subscribers.
Three months ended March 31, 2011 as compared to the three months ended December 31, 2010
Three Months Ended | Change | |||||||||||
March 31, 2011 | December 31, 2010 | Q1’11 vs. Q4’10 | ||||||||||
(in thousands, except percentages) | ||||||||||||
Cost of Subscription | $ | 376,992 | $ | 336,756 | 11.9 | % | ||||||
As a percentage of revenues | 52.5 | % | 56.5 | % |
The $40.2 million increase in cost of subscription revenues was due to the following factors:
Content acquisition and licensing expenses increased by $29.8 million. This increase was primarily attributable to licensing of streaming content, partially offset by decreases in DVD content acquisition costs; and
Content delivery expenses increased $10.4 million primarily due to a 9.2%5.6% increase in the number of DVDs mailed to paying subscribers. The increase in the number of DVDs mailed was driven by a 43.5%16.4% increase in the domestic average number of paying subscribers, partially offset by a 24.0%9.3% decline in monthly DVD rentals per domestic average paying subscriber primarily attributed to the growing popularity of our lower priced plans and growth in streaming. In addition, content delivery expenses increased due to higher costs associated with our use of third party delivery networksstreaming content over the Internet resulting from an increase in the total number of hours of streaming content viewed by our subscribers.
Content acquisition Streaming hours are currently growing faster than DVD hours and licensing expenses increased by $40.9 million primarily due to an increase resulting from investments in streaming content, partially offset by decreases in DVD content acquisition costs.
Nine months ended September 30, 2010 as compared to the nine months ended September 30, 2009
Nine Months Ended | Change | |||||||||||
September 30, 2010 | September 30, 2009 | YTD’10 vs. YTD’09 | ||||||||||
(in thousands except percentages) | ||||||||||||
Cost of Subscription | $ | 817,353 | $ | 677,863 | 20.6 | % | ||||||
As a percentage of revenues | 52.2 | % | 55.3 | % |
The $139.5 million increase in cost of subscription revenues was due to the following factors:
Content delivery expenses increased $66.9 million primarily due to an 11.1% increase in the number of DVD’s mailed to paying subscribers. The increase in the number of DVD’s mailed was driven by a 38.0% increase in the number of average paying subscribers, partially offset by a 19.7% decline in monthly DVD rentals per average paying subscriber attributed to the growing popularity of our lower priced plans and growth in streaming. In addition, content delivery expenses increased due to higher costs associated with our use of third party delivery networks resulting from an increase in the total number of hours of streaming content viewed by our subscribers.
Content acquisition and licensing expenses increased by $72.6 million primarily due to an increase resulting from investments in streaming content, partially offset by decreases in DVD content acquisition.
Three months ended September 30, 2010 as compared to the three months ended June 30, 2010
Three Months Ended | Change | |||||||||||
September 30, 2010 | June 30, 2010 | Q3’10 vs. Q2’10 | ||||||||||
(in thousands except percentages) | ||||||||||||
Cost of Subscription | $ | 292,406 | $ | 265,387 | 10.2 | % | ||||||
As a percentage of revenues | 52.9 | % | 51.1 | % |
The $27.0 million increase in cost of subscription revenues was due to the following factors:
Content delivery expenses increased $3.6 million due to higher costs associated with our use of third party delivery networks resulting from an increase in the total number of hours of streaming content viewed by our subscribers. In addition, the number of DVD’s mailed to paying subscribers increased 4.4% primarily due to the 7.9% increase in the average number of paying subscribers.
Content acquisition and licensing expenses increased by $23.4 million primarily due to an increase resulting from investments in streaming content, offset partially by decreases in DVD content acquisition costs. The increase in expense was also offset by a $3.5 million reduction in the estimated accrual for royalties that we expect DVD shipments will be flat to pay to certain performing rights organizations.declining in future periods.
Fulfillment Expenses
Fulfillment expenses represent those expenses incurred in content processing including operating and staffing our shipping centers as well as receiving, encoding, inspecting and warehousing our content library. Fulfillment expenses also include operating and staffing our customer service centers and credit card fees.
Three months ended September 30, 2010March 31, 2011 as compared to the three months ended September 30, 2009March 31, 2010
Three Months Ended | Change | Three Months Ended | Change | |||||||||||||||||||||
September 30, 2010 | September 30, 2009 | Q3’10 vs. Q3’09 | March 31, 2011 | March 31, 2010 | Q1’11 vs. Q1’10 | |||||||||||||||||||
(in thousands except percentages) | (in thousands, except percentages) | |||||||||||||||||||||||
Fulfillment expenses | $ | 52,063 | $ | 42,183 | 23.4 | % | $ | 61,159 | $ | 47,602 | 28.5 | % | ||||||||||||
As a percentage of revenues | 9.4 | % | 10.0 | % | 8.5 | % | 9.6 | % |
The $9.9$13.6 million increase in fulfillment expenses was due to the following:
Credit card fees increased $8.7 million as a result of the 45.6% growth in revenues; and
Content processing and customer service expenses increased $4.5$4.9 million primarily due to a $3.8$4.0 million increase in personnel relatedpersonnel-related costs resulting from a 9.0% increase in headcount to support the higher volume of content delivery.
Credit card fees increased $5.4 million as a result of the 30.7% growth in revenues.salary increases.
NineThree months ended September 30, 2010March 31, 2011 as compared to the ninethree months ended September 30, 2009December 31, 2010
Nine Months Ended | Change | |||||||||||
September 30, 2010 | September 30, 2009 | YTD’10 vs. YTD’09 | ||||||||||
(in thousands except percentages) | ||||||||||||
Fulfillment expenses | $ | 149,212 | $ | 125,922 | 18.5 | % | ||||||
As a percentage of revenues | 9.5 | % | 10.3 | % |
Three Months Ended | Change | |||||||||||
March 31, 2011 | December 31, 2010 | Q1’11 vs. Q4’10 | ||||||||||
(in thousands, except percentages) | ||||||||||||
Fulfillment expenses | $ | 61,159 | $ | 54,034 | 13.2 | % | ||||||
As a percentage of revenues | 8.5 | % | 9.1 | % |
The $23.3$7.1 million increase in fulfillment expenses was due to the following:
Content processing and customer service related costs increased $9.6 million primarily due to an $8.8 million increase in personnel related costs resulting from an 11.3% increase in headcount to support the higher volume of content delivery.
Credit card fees increased $13.7$3.7 million as a result of the 27.8%20.6% growth in revenues.revenues; and
Three months ended September 30, 2010 as compared
Content processing and customer service expenses increased $3.4 million primarily due to the three months ended June 30, 2010
Three Months Ended | Change | |||||||||||
September 30, 2010 | June 30, 2010 | Q3’10 vs. Q2’10 | ||||||||||
(in thousands except percentages) | ||||||||||||
Fulfillment expenses | $ | 52,063 | $ | 49,547 | 5.1 | % | ||||||
As a percentage of revenues | 9.4 | % | 9.5 | % |
The $2.5a $3.1 million increase in fulfillment expenses was primarily due to an increase in credit card fees of $2.0 millionpersonnel-related costs resulting from the 6.4% growth in revenues.salary increases.
Gross Margin
Three months ended September 30, 2010 as compared to
Three Months Ended | Change | |||||||||||
March 31, 2011 | March 31, 2010 | Q1’11 vs. Q1’10 | ||||||||||
(in thousands, except percentages and average monthly gross profit per paying subscriber) | ||||||||||||
Gross profit | $ | 280,402 | $ | 186,503 | 50.3 | % | ||||||
Gross margin | 39.0 | % | 37.8 | % |
Three Months Ended | Change | |||||||||||
March 31, 2011 | December 31, 2010 | Q1’11 vs. Q4’10 | ||||||||||
(in thousands, except percentages and average monthly gross profit per paying subscriber) | ||||||||||||
Gross profit | $ | 280,402 | $ | 205,132 | 36.7 | % | ||||||
Gross margin | 39.0 | % | 34.4 | % |
Gross margin increased from the three months ended September 30, 2009
Three Months Ended | Change | |||||||||||
September 30, 2010 | September 30, 2009 | Q3’10 vs. Q3’09 | ||||||||||
(in thousands except percentages and average monthly gross profit per paying subscriber) | ||||||||||||
Gross profit | $ | 208,750 | $ | 147,846 | 41.2 | % | ||||||
Gross margin | 37.7 | % | 34.9 | % | ||||||||
Average monthly gross profit per paying subscriber | $ | 4.57 | $ | 4.65 | (1.7 | )% |
The increase inprior periods. We believe that income from operations is a more meaningful measure than gross profit and gross margin was primarily due to lower DVD content acquisition expenses per DVD mailed and a 24.0% decline in monthly DVD shipments per average paying subscriber driven byfor managing the growing popularity of our lower priced plans and the growth in streaming. This decline was higher than the decline in average revenue per paying subscriber of 8.9%. This was offset partially by increased investments in streaming content.
Nine months ended September 30, 2010 as compared to the nine months ended September 30, 2009
Nine Months Ended | Change | |||||||||||
September 30, 2010 | September 30, 2009 | YTD’10 vs. YTD’09 | ||||||||||
(in thousands except percentages and average monthly gross profit per paying subscriber) | ||||||||||||
Gross profit | $ | 600,138 | $ | 421,942 | 42.2 | % | ||||||
Gross margin | 38.3 | % | 34.4 | % | ||||||||
Average monthly gross profit per paying subscriber | $ | 4.75 | $ | 4.61 | 3.0 | % |
The increase in gross margin was primarily due to lower DVD content acquisition expenses per DVD mailed and a 19.7% decline in monthly DVD shipments per average paying subscriber driven by the growing popularity of our lower priced plans and the growth in streaming. This decline was higher than the decline in average revenue per paying subscriber of 7.4%. This was offset partially by increased investments in streaming content.
Three months ended September 30, 2010 as compared to the three months ended June 30, 2010
Three Months Ended | Change | |||||||||||
September 30, 2010 | June 30, 2010 | Q3’10 vs. Q2’10 | ||||||||||
(in thousands except percentages and average monthly gross profit per paying subscriber) | ||||||||||||
Gross profit | $ | 208,750 | $ | 204,885 | 1.9 | % | ||||||
Gross margin | 37.7 | % | 39.4 | % | ||||||||
Average monthly gross profit per paying subscriber | $ | 4.57 | $ | 4.84 | (5.6 | )% |
The decrease in gross margin was primarily attributable to increased investments in streaming content, partially offset by lower DVD content acquisition expenses per DVD mailed and a 3.5% decline in monthly DVD shipments per average paying subscriber.
We have increased and expect to continue to increase investments in our content library, and in particular may increase spending associated with streaming content. These investments would reduce our gross margin to the extent that increases in content spending, net of fulfillment costs, outpace growth in our revenues.business.
Technology and Development
Technology and development expenses consist of payroll and related costs incurred in making improvements to our service offering, including testing, maintaining and modifying our Web site,user interface, our recommendation and merchandising technology, improvements in streaming content to subscribers,as well as, telecommunications systems and infrastructure and other internal-use software systems. Technology and development expenses also include costs associated with computer hardware and software, as well asand in 2010, included certain costs paid for third partythird-party Internet-based or “cloud” computing systemsservices used in connection with our business.
Three months ended September 30, 2010March 31, 2011 as compared to the three months ended September 30, 2009March 31, 2010
Three Months Ended | Change | Three Months Ended | Change | |||||||||||||||||||||
September 30, 2010 | September 30, 2009 | Q3’10 vs. Q3’09 | March 31, 2011 | March 31, 2010 | Q1’11 vs. Q1’10 | |||||||||||||||||||
(in thousands except percentages) | (in thousands, except percentages) | |||||||||||||||||||||||
Technology and development | $ | 42,108 | $ | 30,014 | 40.3 | % | $ | 50,905 | $ | 37,399 | 36.1 | % | ||||||||||||
As a percentage of revenues | 7.6 | % | 7.1 | % | 7.1 | % | 7.6 | % |
The $12.1$13.5 million increase in technology and development expenses was primarily the result of a $5.8 millionan increase in personnel-related costs. This increase in personnel-related costs and a $3.1 million increase in facilities and equipment related expenses. These increases areis due to a 20.8%32% growth in headcount supporting continued improvements in our service and growthcoupled with a $3.4 million increase in streaming content delivered to our growing subscriber base. In addition, costs paid for cloud computing systems increased $2.7 million.stock-based compensation expense.
NineThree months ended September 30, 2010March 31, 2011 as compared to the ninethree months ended September 30, 2009December 31, 2010
Nine Months Ended | Change | Three Months Ended | Change | |||||||||||||||||||||
September 30, 2010 | September 30, 2009 | YTD’10 vs. YTD’09 | March 31, 2011 | December 31, 2010 | Q1’11 vs. Q4’10 | |||||||||||||||||||
(in thousands, except percentages) | (in thousands, except percentages) | |||||||||||||||||||||||
Technology and development | $ | 117,370 | $ | 81,333 | 44.3 | % | $ | 50,905 | $ | 45,959 | 10.8 | % | ||||||||||||
As a percentage of revenues | 7.5 | % | 6.6 | % | 7.1 | % | 7.7 | % |
The $36.0$4.9 million increase in technology and development expenses was primarily attributable to a $16.1 millionthe result of an increase in personnel-related costs. This increase in personnel-related costs and a $12.6 million increase in facilities and equipment related expenses. These increases areis primarily due to 21.3%a 10% growth in headcount supporting the continued improvements into our service and growth in streaming content delivered to our growing subscriber base. In addition, costs paid for cloud computing systems increased $5.1 million.
Three months ended September 30, 2010 as compared to the three months ended June 30, 2010
Three Months Ended | Change | |||||||||||
September 30, 2010 | June 30, 2010 | Q3’10 vs. Q2’10 | ||||||||||
(in thousands except percentages) | ||||||||||||
Technology and development | $ | 42,108 | $ | 37,863 | 11.2 | % | ||||||
As a percentage of revenues | 7.6 | % | 7.3 | % |
The $4.2coupled with a $2.0 million increase in technology and development expenses was primarily attributable to a $1.9 million increase in personnel-related costs. These increases are due to a 6.8% growth in headcount supporting the continued improvements in our service as well as to the increase in streaming content delivered to our growing subscriber base. In addition, costs paid for cloud computing systems increased $1.9 million.stock-based compensation expense.
Marketing
Marketing expenses consist primarily of advertising expenses and also include payments made to our affiliates includingand consumer electronics partners.partners and payroll related expenses. Advertising expenses include marketing program expenditures and other promotional activities includingsuch as television and online advertising as well as allocated costs of revenues relating to free trial periods. Payments to our affiliates includingand consumer electronics partners may be in the form of a fixed feefixed-fee or may be a revenue sharing payment. Also included in marketing expense are payroll related expenses.
Three months ended September 30, 2010March 31, 2011 as compared to the three months ended September 30, 2009March 31, 2010
Three Months Ended | Change | Three Months Ended | Change | |||||||||||||||||||||
September 30, 2010 | September 30, 2009 | Q3’10 vs. Q3’09 | March 31, 2011 | March 31, 2010 | Q1’11 vs. Q1’10 | |||||||||||||||||||
(in thousands except percentages and subscriber acquisition cost) | (in thousands, except percentages and subscriber acquisition cost) | |||||||||||||||||||||||
Marketing | $ | 81,238 | $ | 58,556 | 38.7 | % | $ | 104,259 | $ | 75,219 | 38.6 | % | ||||||||||||
As a percentage of revenues | 14.7 | % | 13.8 | % | 14.5 | % | 15.2 | % | ||||||||||||||||
Other data: | ||||||||||||||||||||||||
Other domestic data: | ||||||||||||||||||||||||
Gross subscriber additions | 4,101 | 2,180 | 88.1 | % | 6,299 | 3,492 | 80.4 | % | ||||||||||||||||
Subscriber acquisition cost | $ | 19.81 | $ | 26.86 | (26.2 | )% | $ | 14.38 | $ | 21.54 | (33.2 | )% | ||||||||||||
Churn | 3.9 | % | 3.8 | % | 2.6 | % |
The $22.7$29.0 million increase in marketing expenses was primarily attributable to a $13.8$25.1 million increase in marketing program spending, primarily from increased spending in television and onlineradio advertising, coupled with growthan increase in our consumer electroniconline advertising and payments to our affiliates. These increases were offset by a decrease in partner programs. In addition, costs of free trials increased $8.4 million primarily due to the 88.1% increase in grossprograms and inserts. Domestic subscriber additions, coupled with shipments of instant streaming discs which enable subscribers to stream content.
Subscriber acquisition cost decreased primarily due to continued strong organic subscriber growth coupled with more efficient marketing spending.growth.
NineThree months ended September 30, 2010March 31, 2011 as compared to the ninethree months ended September 30, 2009December 31, 2010
Nine Months Ended | Change | Three Months Ended | Change | |||||||||||||||||||||
September 30, 2010 | September 30, 2009 | YTD’10 vs. YTD’09 | March 31, 2011 | December 31, 2010 | Q1’11 vs. Q4’10 | |||||||||||||||||||
(in thousands, except percentages and subscriber acquisition cost) | (in thousands, except percentages and subscriber acquisition cost) | |||||||||||||||||||||||
Marketing | $ | 230,990 | $ | 167,029 | 38.3 | % | $ | 104,259 | $ | 62,849 | 65.9 | % | ||||||||||||
As a percentage of revenues | 14.7 | % | 13.6 | % | 14.5 | % | 10.6 | % | ||||||||||||||||
Other data: | ||||||||||||||||||||||||
Other domestic data: | ||||||||||||||||||||||||
Gross subscriber additions | 10,652 | 6,529 | 63.1 | % | 6,299 | 5,132 | 22.7 | % | ||||||||||||||||
Subscriber acquisition cost | $ | 21.69 | $ | 25.58 | (15.2 | )% | $ | 14.38 | $ | 10.87 | 32.3 | % | ||||||||||||
Churn | 3.9 | % | 3.7 | % | 5.4 | % |
The $64.0$41.4 million increase in marketing expenses was primarily attributable to a $46.1$39.8 million increase in marketing program spending, primarily from increased spending in television and online advertising and payments to our affiliates, coupled with growth in our consumer electronic partner programs. In addition, costs of free trials increased $16.9 million primarily due to the 63.1% increase in gross subscriber additions, coupled with the shipment of instant streaming discs which enable subscribers to stream content.
Subscriber acquisition cost decreased primarily due to continued strong organic subscriber growth coupled with more efficient marketing spending.
Three months ended September 30, 2010 as compared to the three months ended June 30, 2010
Three Months Ended | Change | |||||||||||
September 30, 2010 | June 30, 2010 | Q3’10 vs. Q2’10 | ||||||||||
(in thousands except percentages and subscriber acquisition cost) | ||||||||||||
Marketing | $ | 81,238 | $ | 74,533 | 9.0 | % | ||||||
As a percentage of revenues | 14.7 | % | 14.3 | % | ||||||||
Other data: | ||||||||||||
Gross subscriber additions | 4,101 | 3,059 | 34.1 | % | ||||||||
Subscriber acquisition cost | $ | 19.81 | $ | 24.37 | (18.7 | )% |
The $6.7 million increase in marketing expenses was primarily attributable to a $4.5 million increase in marketing program spending, primarily from increased spending in direct mail and television advertising, coupled withadvertising. Domestic subscriber acquisition cost increased due to an increase in cost of free trials of $2.1 million due to the 34.1% increase in gross subscriber additions.
Subscriber acquisition cost decreased due to continued strong organic subscriber growth coupled with more efficient marketing program spending.
General and Administrative
General and administrative expenses consist of payroll and related expenses for executive finance, content acquisition and administrative personnel, as well as recruiting, professional fees and other general corporate expenses. General and administrative expenses also include the gain on disposal of DVDs.
Three months ended September 30, 2010March 31, 2011 as compared to the three months ended September 30, 2009March 31, 2010
Three Months Ended | Change | Three Months Ended | Change | |||||||||||||||||||||
September 30, 2010 | September 30, 2009 | Q3’10 vs. Q3’09 | March 31, 2011 | March 31, 2010 | Q1’11 vs. Q1’10 | |||||||||||||||||||
(in thousands except percentages) | (in thousands, except percentages) | |||||||||||||||||||||||
General and administrative | $ | 17,135 | $ | 11,543 | 48.4 | % | $ | 22,998 | $ | 15,540 | 48.0 | % | ||||||||||||
As a percentage of revenues | 3.1 | % | 2.7 | % | 3.2 | % | 3.2 | % |
The $5.6$7.5 million increase in general and administrative expenses was primarily attributable to an increase of $4.4 million in personnel-related, attributed to a $2.0$2.4 million releaseincrease in stock-based compensation expense and a 19% increase in headcount. Legal costs increased $1.1 million primarily resulting from ongoing litigation of accruals inclaims against us.
Three months ended March 31, 2011 as compared to the three months ended September 30, 2009 that was associated with a former class action lawsuit that settled in 2008. In addition, stock-based compensation expenses increased $2.0 million primarily due to increased employee compensation allocated from total compensation to the stock option program.
Nine months ended September 30,December 31, 2010 as compared to the nine months ended September 30, 2009
Nine Months Ended | Change | Three Months Ended | Change | |||||||||||||||||||||
September 30, 2010 | September 30, 2009 | YTD’10 vs. YTD’09 | March 31, 2011 | December 31, 2010 | Q1’11 vs. Q4’10 | |||||||||||||||||||
(in thousands, except percentages) | (in thousands, except percentages) | |||||||||||||||||||||||
General and administrative | $ | 51,447 | $ | 37,809 | 36.1 | % | $ | 22,998 | $ | 17,871 | 28.7 | % | ||||||||||||
As a percentage of revenues | 3.3 | % | 3.1 | % | 3.2 | % | 3.0 | % |
The $13.6$5.1 million increase in general and administrative expenses was primarily attributable to an increase in personnel-related costs of $2.0 million, attributed to a $6.4$1.4 million increase in legalstock-based compensation expense and a 4% increase in headcount. Legal costs increased $1.5 million primarily resulting from ongoing litigation of claims against the Company as well as a $2.0 million release of accruals in the nine months ended September 30, 2009 that was associated with a former class action lawsuit that settled in 2008. In addition, stock-based compensation expenses increased $5.3 million primarily due to increased employee compensation allocated from total compensation to the stock option program.
Three months ended September 30, 2010 as compared to the three months ended June 30, 2010
Three Months Ended | Change | |||||||||||
September 30, 2010 | June 30, 2010 | Q3’10 vs. Q2’10 | ||||||||||
(in thousands except percentages) | ||||||||||||
General and administrative | $ | 17,135 | $ | 17,119 | 0.1 | % | ||||||
As a percentage of revenues | 3.1 | % | 3.3 | % |
General and administrative expenses for the three months ended September 30, 2010 were relatively flat as compared to the three months ended June 30, 2010.us.
Interest Expense
Interest expense consists primarily of the interest on our 8.50% senior notes, including the amortization of debt issuance costs, as well as the interest on our lease financing obligations.
Three months ended September 30, 2010March 31, 2011 as compared to the three months ended September 30, 2009March 31, 2010
Three Months Ended | Change | Three Months Ended | Change | |||||||||||||||||||||
September 30, 2010 | September 30, 2009 | Q3’10 vs. Q3’09 | March 31, 2011 | March 31, 2010 | Q1’11 vs. Q1’10 | |||||||||||||||||||
(in thousands except percentages) | (in thousands, except percentages) | |||||||||||||||||||||||
Interest expense | $ | 4,945 | $ | 674 | 633.7 | % | $ | 4,865 | $ | 4,959 | (1.9 | )% | ||||||||||||
As a percentage of revenues | 0.9 | % | 0.2 | % | 0.7 | % | 1.0 | % |
The $4.3 million increase in interestInterest expense was entirely attributable to the interest expense associated with our 8.50% senior notes.
Nine months ended September 30, 2010relatively flat as compared to the nine months ended September 30, 2009
Nine Months Ended | Change | |||||||||||
September 30, 2010 | September 30, 2009 | YTD ‘10 vs. YTD ‘09 | ||||||||||
(in thousands except percentages) | ||||||||||||
Interest expense | $ | 14,797 | $ | 2,018 | 633.3 | % | ||||||
As a percentage of revenues | 0.9 | % | 0.2 | % |
The $12.8 million increase in interest expense was entirely attributable to the interest expense associated with our 8.50% senior notes.prior period.
Three months ended September 30, 2010March 31, 2011 as compared to the three months ended June 30,December 31, 2010
Three Months Ended | Change | Three Months Ended | Change | |||||||||||||||||||||
September 30, 2010 | June 30, 2010 | Q3’10 vs. Q2’10 | March 31, 2011 | December 31, 2010 | Q1’11 vs. Q4’10 | |||||||||||||||||||
(in thousands except percentages) | (in thousands, except percentages) | |||||||||||||||||||||||
Interest expense | $ | 4,945 | $ | 4,893 | 1.1 | % | $ | 4,865 | $ | 4,832 | 0.7 | % | ||||||||||||
As a percentage of revenues | 0.9 | % | 0.9 | % | 0.7 | % | 0.8 | % |
Interest expense for the three months ended September 30, 2010 was relatively flat as compared to the three months ended June 30, 2010.prior period.
Income Taxes
Three months ended September 30, 2010March 31, 2011 as compared to the three months ended September 30, 2009March 31, 2010
Three Months Ended | Change | Three Months Ended | Change | |||||||||||||||||||||
September 30, 2010 | September 30, 2009 | Q3’10 vs. Q3’09 | March 31, 2011 | March 31, 2010 | Q1’11 vs. Q1’10 | |||||||||||||||||||
(in thousands, except percentages) | (in thousands, except percentages) | |||||||||||||||||||||||
Provision for income taxes | $ | 27,442 | $ | 20,330 | 35.0 | % | $ | 38,007 | $ | 22,086 | 72.1 | % | ||||||||||||
Effective tax rate | 42.0 | % | 40.3 | % | 38.7 | % | 40.6 | % |
Our effective tax rate for the thirdfirst quarter of 20102011 was 42.0%38.7% and differed from the federal statutory rate due primarily to state taxes. taxes which were partially offset by the Federal and California R&D tax credits. The decrease in our effective tax rate was primarily attributable to the reinstatement of the Federal R&D credit in December 2010 not reflected in the three months ended March 31, 2010 and a lower effective tax rate for California.
Three months ended March 31, 2011 as compared to the three months ended December 31, 2010
Three Months Ended | Change | |||||||||||
March 31, 2011 | December 31, 2010 | Q1’11 vs. Q4’10 | ||||||||||
(in thousands, except percentages) | ||||||||||||
Provision for income taxes | $ | 38,007 | $ | 27,464 | 38.4 | % | ||||||
Effective tax rate | 38.7 | % | 36.8 | % |
The increase in our effective tax rate was primarily attributable to a discrete detriment consistingthe retroactive reinstatement of a write-downthe Federal R&D credit resulting in all of certain deferred tax assets.
Nine months ended September 30,the R&D credit for 2010 as compared tobeing recorded in the nine months ended September 30, 2009
Nine Months Ended | Change | |||||||||||
September 30, 2010 | September 30, 2009 | YTD’10 vs. YTD’09 | ||||||||||
(in thousands, except percentages) | ||||||||||||
Provision for income taxes | $ | 79,379 | $ | 55,909 | 42.0 | % | ||||||
Effective tax rate | 41.1 | % | 39.7 | % |
Our effective tax rate for the nine months ended September 30, 2010 was 41.1% and differed from the federal statutory rate due primarily to state taxes. The increase in our effective tax rate was primarily attributable to a discrete detriment consistingfourth quarter of a write-down of certain deferred tax assets.
Three months ended September 30, 2010 as compared to the three months ended June 30, 2010
Three Months Ended | Change | |||||||||||
September 30, 2010 | June 30, 2010 | Q3’10 vs. Q2’10 | ||||||||||
(in thousands, except percentages) | ||||||||||||
Provision for income taxes | $ | 27,442 | $ | 29,851 | (8.1 | )% | ||||||
Effective tax rate | 42.0 | % | 40.7 | % |
The increase in our effective tax rate for the three months ended September 30, 2010 as compared to the three months ended June 30, 2010 was primarily attributable to a discrete detriment consisting of a write-down of certain deferred tax assets.2010.
Liquidity and Capital Resources
Our primary source of liquidity has been cash generated from operations. Additionally, in November 2009, we issued $200 million of our 8.50% senior notes due in 2017. Our primary uses of cash include payroll related expenses, shipping and packaging expenses, and marketing, our stock repurchase programs, the acquisition and licensing of content, and capital expenditures related to information technology and automation equipment. We expect to continue to make substantial investments to obtain content, and in particular expect to increase spending associated with streaming content. These investments could impact our liquidity and in particular our operating cash flows.
Although we currently anticipate that cash flows from operations, together with our available funds, will continue to be sufficient to meet our cash needs for the foreseeable future, we may require or choose to obtain additional financing. Our ability to obtain additional financing will depend on, among other things, our development efforts, business plans, operating performance and the condition of the capital markets at the time we seek financing.
On June 11, 2010, we announced that our Board of Directors authorized a stock repurchase program allowing us to repurchase $300 million of our common stock through the end of 2012. As of September 30, 2010, we have purchased approximately $59.4March 31, 2011, $132.0 million of our
common stock under this program.authorization was remaining. The timing and actual number of shares repurchased will depend on various factors, including price, corporate and regulatory requirements, debt covenant requirements, alternative investment opportunities and other market conditions.
The following table highlights selected measures of our liquidity and capital resources (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, 2010 | September 30, 2009 | September 30, 2010 | September 30, 2009 | |||||||||||||
Net cash provided by operating activities | $ | 42,227 | $ | 78,311 | $ | 179,684 | $ | 219,246 | ||||||||
Net cash (used in) provided by investing activities | (5,606 | ) | 15,590 | (57,898 | ) | (92,827 | ) | |||||||||
Net cash used in financing activities | (30,840 | ) | (125,655 | ) | (142,902 | ) | (210,583 | ) |
Three Months Ended | ||||||||||||
March 31, 2011 | December 31, 2010 | March 31, 2010 | ||||||||||
Net cash provided by operating activities | $ | 116,323 | $ | 96,717 | $ | 77,205 | ||||||
Net cash used in investing activities | (73,675 | ) | (58,183 | ) | (40,825 | ) | ||||||
Net cash (used in) provided by financing activities | (86,728 | ) | 42,857 | (90,743 | ) |
Operating Activities
Cash provided by operating activities decreased $36.1increased $39.1 million or 46.1%50.7% during the three months ended September 30, 2010March 31, 2011 as compared to the three months ended September 30, 2009,March 31, 2010, primarily due to an increase in cash received from subscribers for subscription fees of $240.7 million, resulting from a 54.2% increase in the domestic average number of paying subscribers. This increase was partially offset by increased spendingpayments for content acquisition and licensing other than DVD content library of $95.8 million. This increase was$145.4 million, coupled with increased content delivery expenses of $18.4$6.9 million primarily resulting from higher costs associated with our use of third party delivery networks to deliverdelivering streaming content, and a 9.2% increase in the number of DVDs mailed to subscribers, increased payments for advertising and payments to our affiliates of $13.8$9.5 million, increased payroll expenses of $10.1$15.1 million, due to a 11% increase in employees, increased fulfillment expenses of $9.9$13.6 million, and increased currentincome tax provisionpayments of $7.1$5.5 million. The increase in these expenses was partially offset by an increase in subscription revenues of $130.1 million resulting from a 43.5% increase in the average number of paying subscribers.
Cash provided by operating activities decreased by $39.6increased $19.6 million or 18.0%20.3% during the ninethree months ended September 30, 2010March 31, 2011 as compared to the ninethree months ended September 30, 2009December 31, 2010, primarily due to an increase in cash received from subscribers for subscription fees of $114.3 million, resulting from a 16.4% increase in the domestic average number of paying subscribers. This increase was partially offset by increased spendingpayments for content acquisition and licensing other than DVD content library of $153.3 million. This increase was$42.1 million, coupled with increased content delivery expenses of $66.9$10.5 million primarily resulting from higher costs associated with our use of third party delivery networks to deliverdelivering streaming, content and an 11.1% increase in the number of DVDs mailed to subscribers, increased payments for advertising and payments to our affiliates of $46.1$22.1 million, increased payroll expenses of $26.1$10.0 million due to a 13% increase in employees,and increased fulfillment expenses of $23.3 million, and increased current tax provision of $23.5$7.1 million. The increase in these expenses was partially offset by an increase in subscription revenues of $341.0 million resulting from a 38.0% increase in the average number of paying subscribers.
Investing Activities
During the three months ended September 30, 2010March 31, 2011 as compared to the three months ended September 30, 2009,March 31, 2010, cash used in investing activities increased $21.2$32.9 million primarily due to a $45.2$19.2 million decrease in the proceeds from the sales and maturities of available-for-sale securities coupled with a $16.3 million increase in the purchases of available-for-sale securities. This decrease wasIn addition, purchases of property and equipment increased $9.9 million due to purchases of automation equipment for our various shipping centers. These increases in cash outflows were partially offset by a $16.4 million decrease in acquisitions of DVD content library, as more DVDs were obtained through revenue sharing agreements in the third quarter of 2010 as compared to the same prior year period, and a $5.6 million decrease in purchases of available-for-sale securities.
During the nine months ended September 30, 2010 as compared to the nine months ended September 30, 2009, cash used in investing activities decreased $34.9 million primarily due to a $45.0$14.8 million decrease in acquisitions of DVD content library, as more DVDs were obtained through revenue sharing agreements as compared to the same prior year period, coupled with a $29.0period.
During the three months ended March 31, 2011 as compared to the three months ended December 31, 2010, cash used in investing activities increased $15.5 million decreaseprimarily due to an $18.1 million increase in the purchases of available-for-sale securities. This decrease was partially offset bysecurities coupled with a $46.3$5.7 million decrease in the proceeds from the sales and maturities of available-for-sale securities. These increases in cash outflows were partially offset by a $10.8 million decrease in acquisitions of DVD content library, as more DVDs were obtained through revenue sharing agreements as compared to the same prior year period.
Financing Activities
During the three months ended September 30, 2010March 31, 2011 as compared to the three months ended September 30, 2009,March 31, 2010, cash used in financing activities decreased $94.8$4.0 million primarily due to a decrease in repurchases of our common stock of $72.3 million coupled with a $14.5an $8.2 million increase in the excess tax benefits from stock-based compensation and an $8.2partially offset by a $3.2 million increasedecrease in proceeds from the issuance of common stock.
During the ninethree months ended September 30, 2010March 31, 2011 as compared to the ninethree months ended September 30, 2009,December 31, 2010, cash used in financing activities decreased $67.7increased $129.6 million primarily due to a decrease$108.6 million increase in repurchases of our common stock of $34.7 millionrepurchases, coupled with a $25.6an $11.9 million increasedecrease in the excess tax benefits from stock-based compensation and a $7.9$9.1 million increasedecrease in proceeds from the issuance of common stock.
Effect of Exchange Rates
Revenues in our International segment, as well as some of the related expenses incurred in the International segment, are denominated in the local currency. During the three months ended March 31, 2011, the gains or losses on foreign exchange transactions and the effect of exchange rate changes on cash and cash equivalents were immaterial.
Free Cash Flow
We define free cash flow as cash provided by operating and investing activities excluding the non-operational cash flows from purchases and sales of short-term investments and cash flows from investment in business.investments. We believe free cash flow is an important liquidity
metric because it measures, during a given period, the amount of cash generated that is available to repay debt obligations, make investments, repurchase our stock, and for certain other activities. Free cash flow is considered a non-GAAP financial measure and should not be considered in isolation of, or as a substitute for, net income, operating income, cash flow from operating activities, or any other measure of financial performance or liquidity presented in accordance with GAAP. The following table reconciles net cash provided by operating activities, a GAAP financial measure, to free cash flow, a non-GAAP financial measure (in thousands):measure:
Three Months Ended | ||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | March 31, 2011 | December 31, 2010 | March 31, 2010 | ||||||||||||||||||||||||
September 30, 2010 | September 30, 2009 | September 30, 2010 | September 30, 2009 | (in thousands) | ||||||||||||||||||||||||
Non-GAAP free cash flow reconciliation: | ||||||||||||||||||||||||||||
Net cash provided by operating activities | $ | 42,227 | $ | 78,311 | $ | 179,684 | $ | 219,246 | $ | 116,323 | $ | 96,717 | $ | $77,205 | ||||||||||||||
Acquisition of DVD content library | (29,900 | ) | (46,273 | ) | (90,993 | ) | (135,996 | ) | (22,119 | ) | (32,908 | ) | (36,902 | ) | ||||||||||||||
Purchases of property and equipment | (7,342 | ) | (9,994 | ) | (19,406 | ) | (23,499 | ) | (16,320 | ) | (14,431 | ) | (6,393 | ) | ||||||||||||||
Acquisition of intangible assets | (375 | ) | — | (505 | ) | (200 | ) | |||||||||||||||||||||
Proceeds from sale of DVDs | 3,109 | 3,345 | 10,908 | 7,230 | ||||||||||||||||||||||||
Other assets | 48 | 134 | (114 | ) | 143 | 1,419 | 2,055 | 3,682 | ||||||||||||||||||||
Non-GAAP free cash flow | $ | 7,767 | $ | 25,523 | $ | 79,574 | $ | 66,924 | $ | 79,303 | $ | 51,433 | $ | 37,592 | ||||||||||||||
In comparing free cash flow to net income, the major recurring differences are stock-based compensation expense, deferred revenue, taxes, semi-annual interest payments on the Notes and content acquisition and licensing. Because consumers use credit cards to buy from us, our receivables from customers settle quickly and deferred revenue is a source of cash flow. For streaming content, we typically enter into multi-year licenses with studios and other distributors that may result in an increase in content library and a corresponding increase in liabilities in the consolidated balance sheet.
Free cash flow for the three months ended September 30, 2010 decreased by $17.8 millionMarch 31, 2011 as compared the same period in prior year. The decrease isto March 31, 2010 increased $41.7 million primarily due to changesincreased net income of $28.0 million, increased stock-based compensation expense of $6.8 million, increased deferred revenue of $15.9 million and decreased tax prepayments of $10.6 million. This was partially offset by an increase in cash flow from operations.excess streaming and DVD content payments over expenses of $20.1 million. Payments for content increased $130.6 million while content expenses increased $110.5 million.
Free cash flow for the ninethree months ended September 30,March 31, 2011 as compared to December 31, 2010 increased by $12.7$27.9 million as compared the same period in prior year. The increase is primarily due to lower additions to our DVD content libraryincreased net income of $13.1 million, increased stock-based compensation expense of $4.0 million, decreased tax prepayments of $9.7 million and lower capital expendituresdecreased interest payments of $8.5 million. This was partially offset by decreased deferred revenue of $8.3 million, coupled with an increase in the proceeds received from the saleexcess streaming and DVD content payments over expenses of previously viewed DVDs. These increases in net cash flow were offset by changes in cash flow from operations.$1.5 million. Payments for content increased $31.3 million while content expenses increased $29.8 million.
Contractual Obligations
For the purposes of this table, contractual obligations for purchases of goods or services are defined as agreements that are enforceable and legally binding and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. The expected timing of payment of the obligations discussed above is estimated based on information available to us as of September 30, 2010.March 31, 2011. Timing of payments and actual amounts paid may be different depending on the time of receipt of goods or services or changes to agreed-upon amounts for some obligations. The following table summarizes our contractual obligations at September 30, 2010 (in thousands):March 31, 2011:
Payments due by Period | Payments due by Period | |||||||||||||||||||||||||||||||||||||||
Contractual obligations (in thousands): | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | Total | Less than 1 year(3) | 1-3 years | 3-5 years | More than 5 years | ||||||||||||||||||||||||||||||
8.50% senior notes | $ | 327,500 | $ | 17,000 | $ | 34,000 | $ | 34,000 | $ | 242,500 | $ | 319,000 | $ | 17,000 | $ | 34,000 | $ | 34,000 | $ | 234,000 | ||||||||||||||||||||
Operating lease obligations | 46,674 | 12,639 | 19,147 | 10,467 | 4,421 | 52,414 | 14,132 | 22,574 | 11,566 | 4,142 | ||||||||||||||||||||||||||||||
Lease financing obligations (1) | 24,596 | 4,160 | 7,684 | 5,886 | 6,866 | 22,312 | 4,129 | 6,902 | 5,886 | 5,395 | ||||||||||||||||||||||||||||||
Content obligations | 1,409,248 | 547,575 | 586,068 | 275,605 | — | 1,843,943 | 642,898 | 800,619 | 392,583 | 7,843 | ||||||||||||||||||||||||||||||
Other purchase obligations | 109,222 | 93,737 | 10,860 | 4,625 | — | 155,270 | 76,352 | 74,543 | 4,375 | — | ||||||||||||||||||||||||||||||
Total | $ | 1,917,240 | $ | 675,111 | $ | 657,759 | $ | 330,583 | $ | 253,787 | $ | 2,392,939 | $ | 754,511 | $ | 938,638 | $ | 448,410 | $ | 251,380 | ||||||||||||||||||||
(1) |
(2) | Content obligations include agreements to acquire and license content that represent long-term liabilities or that are not reflected on the consolidated balance sheets. For those agreements with variable terms, we do not estimate what the total obligation may be beyond any minimum quantities and/ or pricing as of the reporting date. For those agreements that include renewal provisions that are solely at the option of the content provider, we include the commitments associated with the renewal period to the |
As of September 30, 2010, we had gross unrecognized tax benefits of $15.5 million. We are currently under examination in California for years 2006 and 2007. It is reasonably possible that the liability associated with our unrecognized tax benefits will increase or decrease within
the next twelve months. These changes may be the result of ongoing audits. At this time, an estimate of the range of reasonably possible outcomes, including the timing of such payments cannot be made. Therefore, potential payments are not included in the above contractual obligations table.
We also have entered into certain license agreements with studios that include an unspecified or a maximum number of titles that we may or may not receive in the future. Access to these titles is based on the discretion of the studios and,future and/or that include pricing contingent upon certain variables, such as such, we may not receive these titles. If we did receive access to the maximum number of titles, we would incur up to an additional $21.6 million in commitments.
We have entered into an agreement under which we have the obligation to pay license fees in exchange for certain qualifying titles that are released theatrically in the United States from 2010 through 2018, subject to certain minimum and maximum requirements. The license fees are based on the number of titles received and domestic theatrical exhibition receipts for the title. As of titles. Asthe reporting date, it is unknown whether we will receive access to these titles have not yet been released in theatres, we are unable to estimateor what the amounts to be paid under this arrangement and accordinglyultimate price per title will be. Accordingly such amounts are not reflected in the above contractual obligations table. However, such amounts are expected to be significant.significant and the expected timing of payments for these commitments could range from one year to more than five years.
We anticipate entering into other agreements
(3) | For purposes of this table, less than one year does not include liabilities which are reflected on the consolidated balance sheets. |
As of March 31, 2011, we had gross unrecognized tax benefits of $22.6 million and an additional $2.0 million for gross interest and penalties classified as non-current liabilities in the consolidated balance sheet. At this time, we are not able to license streaming content, which if consummated, would resultmake a reasonably reliable estimate of the timing of payments in significant additional commitments.individual years due to uncertainties in the timing of tax audit outcomes; therefore, such amounts are not included in the above contractual obligation table.
Off-Balance Sheet Arrangements
As part of our ongoing business, we do not engage in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities. Accordingly, our operating results, financial condition and cash flows are not subject to off-balance sheet risks.
Indemnification
The information set forth under Note 9 in the notes to the consolidated financial statements under the caption “Indemnification” is incorporated herein by referencereference.
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported periods. The SEC has defined a company’s critical accounting policies as the ones that are most important to the portrayal of a company’s financial condition and results of operations, and which require a company to make its most difficult and subjective judgments. Based on this definition, we have identified the critical accounting policies and judgments addressed below. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates.
RecentContent Accounting Pronouncements
ThereWe obtain content through streaming content license agreements, DVD direct purchases and DVD and streaming revenue sharing agreements with studios, distributors and other suppliers.
We obtain content distribution rights in order to stream TV shows and movies to subscribers’ TVs, computers and mobile devices. Streaming content is generally licensed for a fixed-fee for the term of the license agreement which may have been no recent accounting pronouncementsmultiple windows of availability. The license agreement may or may not be recognized in content library.
When the streaming license fee is known or reasonably determinable for a specific title and the specific title is first available for streaming to subscribers, the title is recognized on the consolidated balance sheets as current content library for the portion available for streaming within one year and as non-current content library for the remaining portion. New titles recognized in the content library are classified in the line item “Acquisition of streaming content library” within net cash provided by operating activities in the consolidated statements of cash flows. We amortize the content library on a straight-line basis over each title’s window of availability. The amortization is classified in “Cost of revenues - Subscription” in the consolidated statements of operations and in the line item “Amortization of content library” within net cash provided by operating activities in the consolidated statements of cash flows. For the titles recognized in content library, the license fees due but not paid are classified on the consolidated balance sheets as “Accounts payable” for the amounts due within one year and as “Other non-current liabilities” for the amounts due beyond one year. Changes in these liabilities are classified in the line items “Accounts payable” and “Other assets and liabilities” within net cash provided by operating activities in the consolidated statement of cash flows. We record the streaming content library assets and their related liability on our consolidated balance sheet at the gross amount of the liability. Commitments for the titles not yet available for streaming are not yet recognized in the content library and are included in Note 9 to the consolidated financial statements.
When the streaming license fee is not known or reasonably determinable for a specific title, the title does not meet the criteria for recognition in the content library. The license fee is not known or reasonably determinable for a specific title in fixed fee license agreements that do not specify the number of titles, the license fee per title and the windows of availability per title. Over the term of these agreements, we typically make periodic fixed prepayments that are classified in prepaid content on the consolidated balance sheets. We amortize the license fees on a straight-line basis over the term of each license agreement. The amortization is classified in cost of subscription in the consolidated statements of operations and in the line item “Net income” within net cash provided by operating activities in the consolidated statements of cash flows. Changes in prepaid content are classified within net cash provided by operating activities in the line item “Prepaid content” in the consolidated statements of cash flows. Commitments for licenses that do not meet the criteria for recognition in the content library are included in Note 9 to the consolidated financial statements.
We acquire DVD content for the purpose of renting such content 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 classify our DVD library as a non-current asset on the consolidated balance sheets. The acquisition of DVD content library, net of changes in accounting pronouncements duringrelated liabilities, is classified in the nineline item “Acquisition of DVD content library” within cash used in investing activities in the consolidated statements of cash flows because the DVD content library is considered a productive asset. Other companies in the in-home entertainment video industry classify these cash flows as operating activities. We amortize our direct purchase 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 our DVDs, we consider historical utilization patterns, primarily the number of times a DVD title is shipped to subscribers in a given period, as well as an estimate for lost or damaged DVDs. The amortization of the DVD content library is classified in cost of subscription in the consolidated statement of operations and in the line item “Amortization of content library” within net cash provided by operating activities in the consolidated statements of cash flows.
We also obtain DVD and streaming content through revenue sharing agreements with studios and distributors. Revenue sharing obligations incurred based on utilization are classified in cost of subscription in the consolidated statements of operations and in the line item “Net income” within net cash provided by operating activities in the consolidated statements of cash flows. The terms of some revenue sharing agreements obligate us to make a low initial payment for certain titles, representing a minimum contractual obligation under the agreement. The low initial payment is in exchange for a commitment to share a percentage of our subscription revenues or to pay a fee, based on utilization, for a defined period of time, or the title term, which typically ranges from six to twelve months ended September 30, 2010,for each title. The initial payment may be in the form of an upfront non-refundable payment. This payment is capitalized in the content library in accordance with our DVD and streaming content policies as comparedapplicable. The initial payment may also be in the form of a prepayment of future revenue sharing obligations which is classified as prepaid content. This payment is amortized as revenue sharing obligations are incurred. Under the revenue sharing agreements for our DVD library, at the end of the title term, we generally have the option of returning the DVDs to the recent accounting pronouncements describedstudio, destroying the DVDs or purchasing the DVDs. In most cases, we purchase the DVDs when we have the ability to do so. This end of term buy-out is also included in DVD library at the time of purchase.
Stock-Based Compensation
Stock-based compensation cost at the grant date is based on the total number of options granted and an estimate of the fair value of the awards expected to vest and is recognized as expense ratably over the requisite service period, which is the vesting period.
We calculate the fair value of new stock-based compensation awards under our stock option plans using a lattice-binomial model. We use a Black-Scholes model to determine the fair value of employee stock purchase plan shares. These models require the input of highly subjective assumptions, including price volatility of the underlying stock. Changes in the subjective input assumptions can materially affect the estimate of fair value of options granted and our results of operations could be impacted.
• | Expected Volatility: Our computation of expected volatility is based on a blend of historical volatility of our common stock and implied volatility of tradable forward call options to purchase shares of our common stock. Our decision to incorporate implied volatility was based on our assessment that implied volatility of publicly traded options in our common stock is more reflective of market conditions and, therefore, can reasonably be expected to be a better indicator of expected volatility than historical volatility of our common stock. We include the historical volatility in our computation due to low trade volume of our tradable forward call options in certain periods thereby precluding sole reliance on implied volatility. An increase of 10% in our computation of expected volatility would increase the total stock-based compensation expense by approximately $0.7 million. |
• | Suboptimal Exercise Factor: Our computation of the suboptimal exercise factor is based on historical option exercise behavior and the terms and vesting periods of the options granted and is determined for both executives and non-executives. An increase in the suboptimal exercise factor of 10% would increase the total stock-based compensation expense by approximately $0.5 million. |
Income Taxes
We record a provision for income taxes for the anticipated tax consequences of our reported results of operations using the asset and liability method. Deferred income taxes are recognized by applying enacted statutory tax rates to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as net operating 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 which future realization is uncertain.
Although we believe our assumptions, judgments and estimates are reasonable, changes in tax laws or our interpretation of tax laws and the resolution of any tax audits could significantly impact the amounts provided for income taxes in our Annual Report on Form 10-K for the year ended December 31, 2009, that are of significance, or potential significance, to us.consolidated financial statements.
In evaluating our ability to recover our deferred tax assets, in full or in part, we consider all available positive and negative evidence, including our past operating results, and our forecast of future earnings, future taxable income and prudent and feasible tax planning strategies. The assumptions utilized in determining future taxable income require significant judgment and are consistent with the plans and estimates we are using to manage the underlying businesses. Actual operating results in future years could differ from our current assumptions, judgments and estimates. However, we believe that it is more likely than not that substantially all deferred tax assets recorded on our balance sheet will ultimately be realized. In the event we were to determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to earnings in the period in which we make such determination.
We did not recognize certain tax benefits from uncertain tax positions within the provision for income taxes. We may recognize a tax benefit only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. At March 31, 2011, our estimated gross unrecognized tax benefits were $22.6 million of which $18.5 million, if recognized, would favorably impact our future earnings. Due to uncertainties in any tax audit outcome, our estimates of the ultimate settlement of our unrecognized tax positions may change and the actual tax benefits may differ significantly from the estimates. See Note 8 to the consolidated financial statements for further information regarding income taxes.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
For financial market risks related to changes in interest rates, reference is made to Item 7A “Quantitative and Qualitative Disclosures About Market Risk” contained in Part II of our Annual Report on Form 10-K for the year ended December 31, 2009.2010. Our exposure to market risk has not changed significantly since December 31, 2009.2010.
Item 4. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q 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 (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Netflix have been detected.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2010March 31, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 1. | Legal Proceedings |
The information set forth under Note 9 in the notes to the consolidated financial statements under the caption “Litigation” is incorporated herein by reference.
Item 1A. | Risk Factors |
There have been no material changes from risk factors as previously disclosed under the heading “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 except for the following additional Risk Factor:
We could be subject to economic, political, regulatory and other risks arising from our international operations.
We recently launched a streaming only subscription service in Canada and anticipate further international expansion. Operating in international markets requires significant resources and management attention and will subject us to regulatory, economic and political risks that are different from and incremental to from those in the United States. In addition to the risks that we face in the United States our international operations involve risks that could adversely affect our business, including:2010.
the need to adapt our content and user interfaces for specific cultural and language differences;
difficulties and costs associated with staffing and managing foreign operations;
management distraction;
political or social unrest and economic instability;
compliance with U.S. laws such as the Foreign Corrupt Practices Act, and local laws prohibiting corrupt payments to government officials;
difficulties in understanding and complying with local laws, regulations and customs in foreign jurisdictions;
unexpected changes in regulatory requirements;
less favorable foreign intellectual property laws;
adverse tax consequences;
fluctuations in currency exchange rates, which could impact revenues and expenses of our international operations and expose us to foreign currency exchange rate risk;
profit repatriation and other restrictions on the transfer of funds;
new and different sources of competition;
different and more stringent user protection, data protection, privacy and other laws; and
availability of reliable broadband connectivity and wide area networks in targeted areas for expansion.
Our failure to manage any of these risks successfully could harm our future international operations and our overall business, and results of our operations.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
Stock repurchases during the three months ended September 30, 2010March 31, 2011 were as follows:
Period | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Programs | Maximum Dollar Value that May Yet Be Purchased Under the Program (1) | ||||||||||||
July 1, 2010 – July 31, 2010 | 505,000 | $ | 110.96 | 505,000 | $ | 243,156,820 | ||||||||||
August 1, 2010 – August 31, 2010 | 25,000 | 100.85 | 25,000 | 240,635,672 | ||||||||||||
September 1, 2010 – September 30, 2010 | — | — | — | 240,635,672 | ||||||||||||
Total | 530,000 | $ | 110.48 | 530,000 | 240,635,672 | |||||||||||
Period January 1, 2011 – January 31, 2011 February 1, 2011 – February 28, 2011 March 1, 2011 – March 31, 2011 Total Total Number of
Shares Purchased Average Price
Paid per Share Total Number of Shares
Purchased as Part of
Publicly Announced
Programs Maximum Dollar Value
that May Yet Be Purchased
Under the Program (1) — $ — — $ 240,635,672 211,600 223.91 211,600 193,257,307 290,247 211.06 290,247 131,996,717 501,847 $ 216.48 501,847 131,996,717
(1) | On June 11, 2010, the Company announced that 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 2012. The timing and actual number of shares repurchased will depend on various factors including price, corporate and regulatory requirements, debt covenant requirements, alternative investment opportunities and other market conditions. |
Item 6. | Exhibits |
(a) Exhibits:
Exhibit | Exhibit Description | Incorporated by Reference | Filed Herewith | |||||||||||||
Form | File No. | Exhibit | Filing Date | |||||||||||||
3.1 | Amended and Restated Certificate of Incorporation | 10-Q | 000-49802 | 3.1 | August 2, 2004 | |||||||||||
3.2 | Amended and Restated Bylaws | 8-K | 000-49802 | 3.1 | March 20, 2009 | |||||||||||
3.3 | Certificate of Amendment to the Amended and Restated Certificate of Incorporation | 10-Q | 000-49802 | 3.3 | August 2, 2004 | |||||||||||
4.1 | Form of Common Stock Certificate | S-1/A | 333-83878 | 4.1 | April 16, 2002 | |||||||||||
4.2 | Indenture, dated November 6, 2009, among Netflix, Inc., the guarantors from time to time party thereto and Wells Fargo Bank, Nation Association, relating to the 8.50% Senior Notes due 2017. | 8-K | 000-49802 | 4.1 | November 9, 2009 | |||||||||||
10.1† | Form of Indemnification Agreement entered into by the registrant with each of its executive officers and directors | S-1/A | 333-83878 | 10.1 | March 20, 2002 | |||||||||||
10.2† | 2002 Employee Stock Purchase Plan | Def 14A | 000-49802 | A | April 8, 2010 | |||||||||||
10.3† | Amended and Restated 1997 Stock Plan | S-1/A | 333-83878 | 10.3 | May 16, 2002 | |||||||||||
10.4† | Amended and Restated 2002 Stock Plan | Def 14A | 000-49802 | A | March 31, 2006 | |||||||||||
10.5 | Amended and Restated Stockholders’ Rights Agreement | S-1 | 333-83878 | 10.5 | March 6, 2002 | |||||||||||
10.8† | Description of Director Equity Compensation Plan | 8-K | 000-49802 | 99.1 | June 16, 2010 | |||||||||||
10.9† | Description of Director Equity Compensation Plan | 8-K | 000-49802 | 10.1 | December 28, 2009 | |||||||||||
10.10† | Amended and Restated Executive Severance and Retention Incentive Plan | 10-Q | 000-49802 | 10.10 | May 5, 2009 | |||||||||||
31.1 | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | X | ||||||||||||||
31.2 | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | X | ||||||||||||||
32.1* | Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | X | ||||||||||||||
101 | The following financial information from Netflix, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 filed with the SEC on July 27, 2010, formatted in XBRL includes: (i) Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2010 and 2009, (ii) Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009, (iii) Consolidated Statements of Cash Flows for the Three and Nine Months Ended September 30, 2010 and 2009 and (iv) the Notes to Consolidated Financial Statements, tagged as blocks of text. | X |
Exhibit Exhibit Description Incorporated by Reference Filed Herewith Form File No. Exhibit Filing Date
Number 3.1 Amended and Restated Certificate of Incorporation 10-Q 000-49802 3.1 August 2, 2004 3.2 Amended and Restated Bylaws 8-K 000-49802 3.1 March 20, 2009 3.3 Certificate of Amendment to the Amended and Restated Certificate of Incorporation 10-Q 000-49802 3.3 August 2, 2004 4.1 Form of Common Stock Certificate S-1/A 333-83878 4.1 April 16, 2002 4.2 Indenture, dated November 6, 2009, among Netflix, Inc., the guarantors from time to time party thereto and Wells Fargo Bank, Nation Association, relating to the 8.50% Senior Notes due 2017. 8-K 000-49802 4.1 November 9, 2009 10.1† Form of Indemnification Agreement entered into by the registrant with each of its executive officers and directors S-1/A 333-83878 10.1 March 20, 2002 10.2† 2002 Employee Stock Purchase Plan Def 14A 000-49802 A April 8, 2010 10.3† Amended and Restated 1997 Stock Plan S-1/A 333-83878 10.3 May 16, 2002 10.4† Amended and Restated 2002 Stock Plan Def 14A 000-49802 A March 31, 2006 10.5 Amended and Restated Stockholders’ Rights Agreement S-1 333-83878 10.5 March 6, 2002 10.8† Description of Director Equity Compensation Plan 8-K 000-49802 99.1 June 16, 2010 10.9† Description of Director Equity Compensation Plan 8-K 000-49802 10.1 December 28, 2009 10.10† Amended and Restated Executive Severance and Retention Incentive Plan 10-Q 000-49802 10.10 May 5, 2009 31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 X 31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 X 32.1* Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes - Oxley Act of 2002 X 101 The following financial information from Netflix, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2011 filed with the SEC on April 27, 2011, formatted in XBRL includes: (i) Consolidated Statements of Operations for the Three Months Ended March 31, 2011 and 2010, (ii) Consolidated Balance Sheets as of March 31, 2011 and December 31, 2010, (iii) Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2011 and 2010 and (iv) the Notes to Consolidated Financial Statements, tagged as blocks of text. X
* | These certifications are not deemed filed by the SEC and are not to be incorporated by reference in any filing we make under the Securities Act of 1933 or the Securities Exchange Act of 1934, irrespective of any general incorporation language in any filings. |
† | Indicates a management contract or compensatory plan. |
Pursuant to the requirements 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: | April 27, 2011 | By: | / | |||
Reed Hastings | ||||||
Chief Executive Officer (Principal executive officer) | ||||||
Dated: | April 27, 2011 | By: |
| |||
Chief Financial Officer (Principal financial and accounting officer) |
Exhibit | Exhibit Description | Incorporated by Reference | Filed Herewith | |||||||||
Form | File No. | Exhibit | Filing Date | |||||||||
3.1 | Amended and Restated Certificate of Incorporation | 10-Q | 000-49802 | 3.1 | August 2, 2004 | |||||||
3.2 | Amended and Restated Bylaws | 8-K | 000-49802 | 3.1 | March 20, 2009 | |||||||
3.3 | Certificate of Amendment to the Amended and Restated Certificate of Incorporation | 10-Q | 000-49802 | 3.3 | August 2, 2004 | |||||||
4.1 | Form of Common Stock Certificate | S-1/A | 333-83878 | 4.1 | April 16, 2002 | |||||||
4.2 | Indenture, dated November 6, 2009, among Netflix, Inc., the guarantors from time to time party thereto and Wells Fargo Bank, Nation Association, relating to the 8.50% Senior Notes due 2017. | 8-K | 000-49802 | 4.1 | November 9, 2009 | |||||||
10.1† | Form of Indemnification Agreement entered into by the registrant with each of its executive officers and directors | S-1/A | 333-83878 | 10.1 | March 20, 2002 | |||||||
10.2† | 2002 Employee Stock Purchase Plan | Def 14A | 000-49802 | A | April 8, 2010 | |||||||
10.3† | Amended and Restated 1997 Stock Plan | S-1/A | 333-83878 | 10.3 | May 16, 2002 | |||||||
10.4† | Amended and Restated 2002 Stock Plan | Def 14A | 000-49802 | A | March 31, 2006 | |||||||
10.5 | Amended and Restated Stockholders’ Rights Agreement | S-1 | 333-83878 | 10.5 | March 6, 2002 | |||||||
10.8† | Description of Director Equity Compensation Plan | 8-K | 000-49802 | 99.1 | June 16, 2010 | |||||||
10.9† | Description of Director Equity Compensation Plan | 8-K | 000-49802 | 10.1 | December 28, 2009 | |||||||
10.10† | Amended and Restated Executive Severance and Retention Incentive Plan | 10-Q | 000-49802 | 10.10 | May 5, 2009 | |||||||
31.1 | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | X | ||||||||||
31.2 | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | X | ||||||||||
32.1* | Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | X | ||||||||||
101 | The following financial information from Netflix, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 filed with the SEC on July 27, 2010, formatted in XBRL includes: (i) Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2010 and 2009, (ii) Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009, (iii) Consolidated Statements of Cash Flows for the Three and Nine Months Ended September 30, 2010 and 2009 and (iv) the Notes to Consolidated Financial Statements, tagged as blocks of text. | X |
Exhibit Number | Exhibit Description | Incorporated by Reference | Filed | |||||||||
Form | File No. | Exhibit | Filing Date | |||||||||
3.1 | Amended and Restated Certificate of Incorporation | 10-Q | 000-49802 | 3.1 | August 2, 2004 | |||||||
3.2 | Amended and Restated Bylaws | 8-K | 000-49802 | 3.1 | March 20, 2009 | |||||||
3.3 | Certificate of Amendment to the Amended and Restated Certificate of Incorporation | 10-Q | 000-49802 | 3.3 | August 2, 2004 | |||||||
4.1 | Form of Common Stock Certificate | S-1/A | 333-83878 | 4.1 | April 16, 2002 | |||||||
4.2 | Indenture, dated November 6, 2009, among Netflix, Inc., the guarantors from time to time party thereto and Wells Fargo Bank, Nation Association, relating to the 8.50% Senior Notes due 2017. | 8-K | 000-49802 | 4.1 | November 9, 2009 | |||||||
10.1† | Form of Indemnification Agreement entered into by the registrant with each of its executive officers and directors | S-1/A | 333-83878 | 10.1 | March 20, 2002 | |||||||
10.2† | 2002 Employee Stock Purchase Plan | Def 14A | 000-49802 | A | April 8, 2010 | |||||||
10.3† | Amended and Restated 1997 Stock Plan | S-1/A | 333-83878 | 10.3 | May 16, 2002 | |||||||
10.4† | Amended and Restated 2002 Stock Plan | Def 14A | 000-49802 | A | March 31, 2006 | |||||||
10.5 | �� | Amended and Restated Stockholders’ Rights Agreement | S-1 | 333-83878 | 10.5 | March 6, 2002 | ||||||
10.8† | Description of Director Equity Compensation Plan | 8-K | 000-49802 | 99.1 | June 16, 2010 | |||||||
10.9† | Description of Director Equity Compensation Plan | 8-K | 000-49802 | 10.1 | December 28, 2009 | |||||||
10.10† | Amended and Restated Executive Severance and Retention Incentive Plan | 10-Q | 000-49802 | 10.10 | May 5, 2009 | |||||||
31.1 | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | X | ||||||||||
31.2 | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | X | ||||||||||
32.1* | Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | X | ||||||||||
101 | The following financial information from Netflix, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2011 filed with the SEC on April 27, 2011, formatted in XBRL includes: (i) Consolidated Statements of Operations for the Three Months Ended March 31, 2011 and 2010, (ii) Consolidated Balance Sheets as of March 31, 2011 and December 31, 2010, (iii) Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2011 and 2010 and (iv) the Notes to the Consolidated Financial Statements, tagged as blocks of text. | X |
* | These certifications are not deemed filed by the SEC and are not to be incorporated by reference in any filing we make under the Securities Act of 1933 or the Securities Exchange Act of 1934, irrespective of any general incorporation language in any filings. |
† | Indicates a management contract or compensatory plan. |
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