Sep 30, 2011 - ed by the deb cancellations in weekly gro. We expect str above, and a ..... where we had broadband t for
October 2 24th, 2011 Dear Fello ow Sharehold ders, The Intern net is transforming video e entertainmen nt, stream by stream, conssumer by consumer, nation by nation. Ou ur opportunitty is to be one e of the leade ers of this tra nsformation with the bestt streaming vvideo subscriptiion service on n the planet. The last few w months, how wever, have b been difficult for sharehold ders, employee es, and most u unfortunatelyy, many mem mbers of Netfl ix. While wee dramaticallyy improved our $7.99 unlimited stream ming service b by embracing new platform ms, simplifyin ng our user‐in nterface, and more bling domestiic spending on streaming ccontent over 2010, we greeatly upset many domesticc than doub Netflix me embers with our significan nt DVD‐related pricing cha nges, and to a lesser degree, with the proposed‐and‐now‐cancelled rebranding of our DVD service. In doing so, we’ve hurt o our hard‐earned d our domestiic growth. But our long‐terrm streamingg opportunityy is as compellling reputation, and stalled nd we are mo oving forward as quickly ass we can to reepair our repu utation and reeturn to grow wth. as ever an (in millions exce ept per share data)
Q3 '09
Q4 '09
Q1 ''10
Q2 '10
Q3 '10
Q4 4 '10
Q1 '11
Q2 '11
Q3 '11
Domestic:: Streaming SSubscriptions DVD Subscriiptions Total Unique U.S. Subscriberrs
21.45 2 1 13.93 11.11
12.27
13..97
15.00
16.80
19 9.50
22.80
24.59
2 23.79
Y/Y Change
28%
31%
35%
42%
51%
5 59%
63%
64%
42%
Net Subscriber Additions
0.51
1.16
1..70
1.03
1.80
2 2.70
3.30
1.80
‐ ‐0.81
Y/Y Change
95%
61%
85%
255%
253%
13 33%
94%
75%
‐145%
Revenue
$ 423 $ 445 $ 4 494 $ 520 $ 553 $ 592 $ 706 $ 770 $ 799
Y/Y Change
24%
Contribution Profit Y/Y Change
Y/Y Change
25%
27%
31%
3 33%
43%
48%
44%
$ 89 $ 98 $ 1 111 $ 130 $ 130 $ 152 $ 187 $ 213 $ 219 32%
Operating In ncome
24%
38%
53%
40%
46%
5 55%
68%
64%
68%
$ 49 $ 53 $ 58 $ 77 $ 72 $ 88 $ 113 $ 124 $ 120 45%
39%
61%
45%
47%
66%
95%
61%
67%
Internatio onal: Subscription ns
‐
‐
‐
‐
0.13
0 0.51
0.80
0.97
1.48
Net Subscription Additions
‐
‐
‐
‐
0.13
0 0.38
0.29
0.16
0.51
Revenue
‐
‐
‐
‐ $ ‐ $ 4 $ 12 $ 19 $ 23
Contribution Profit (Loss)
‐
‐
‐
$ $ (9) $ (11) $ (9) $ (23) ‐ $ (3)
Global: Revenue
494 $ 520 $ 553 $ 596 $ 719 $ 789 $ 822 $ 423 $ 445 $ 4
Y/Y Change
24%
Net Income
24%
25%
27%
31%
3 34%
46%
52%
49%
$ 30 $ 31 $ 32 $ 44 $ 38 $ 47 $ 60 $ 68 $ 62
Y/Y Change
48%
EPS
35%
45%
38%
27%
5 52%
88%
55%
63%
$ 0.52 $ 0.56 $ 0..59 $ 0.80 $ 0.70 $ 0 0.87 $ 1.11 $ 1.26 $ 1.16
Y/Y Change
58%
Free Cash Flow Buyback Shares (FD)
47%
59%
48%
35%
5 55%
88%
58%
66%
$ 26 $ 30 $ 38 $ 34 $ 8 $ 51 $ 79 $ 60 $ 14 108 $ 45 $ 57 $ ‐ $ 109 $ 51 $ 40 $ 130 $ 79 $ 1 55.5 54 4.8 54.3 5 54.2 54.2 57.9 53.9 53.9 53.9
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DVD and d Streamingg We think that $7.99 fo or unlimited sttreaming and d $7.99 for unnlimited DVD are both veryy aggressive llow of the servicees, and they aare the right p place for Netfflix to prices, rellative to competition and tto the value o be in the long term. W What we misju udged was ho ow quickly to move there. We compou unded the with our lack of explanatio on about the rising cost of the expansio on of streamin ng content, and problem w steady DV VD costs, so th hat absent th hat explanatio on, many percceived us as ggreedy. Finally, we annou unced and then retracted a se eparate brand for DVD. W While this brannding inciden nt further den nted our d a temporaryy cancellation n surge, comppared to our price change,, its impact w was reputation, and caused primary issue e is many of our long‐term members fellt shocked byy the pricing relatively minor. Our p n we expected d. changes, aand more of tthem have exxpressed thatt by cancellingg Netflix than Because o of this, our revenue and prrofits in Q4 w will be lower thhan we had aanticipated, b but we’ll remaain profitable e on a global b basis. In Q1’1 12 we’ll be lau unching in thee UK and Irelaand, as we haad planned. FFor a few quartters starting in Q1, we expect the costs of our entry into the UK aand Ireland w will push us to be unprofitable on a global basis; that is, domestic profits will noot be large en nough to both h cover onal investme ents and pay ffor global G& &A and Technoology & Deveelopment. Aftter launchingg the internatio UK and Ire eland, we will pause on op pening new in nternational m markets until we return to o global profitabiliity. We plan to do that byy increasing o our global streeaming subsccriber base faster than we increase o our costs. Investors and memberrs will be relie eved to know we are donee with pricing changes, and d that at $7.9 99 each for sstreaming and d DVD we can n move forwaard for a long time. Some inve estors have asked us abou ut the combin nation or “hybbrid” offeringg in the U.S. In our currentt signup flo ow, we offer tthree choices: (a) streamin ng only at $7.999, (b) DVD o only at $7.99, and (c) both,, for $15.98. A About 7% of n new memberss choose the $15.98 hybridd offering. O One could arggue that this percentagge would incrrease if we reduced the price for hybridd, but if we were going to llower prices, we would do it on streamiing. Our futu ure is in rapid dly expandingg streaming, b but we will maake sure thatt current hyybrid subscrib bers continue e to get a greaat and stable experience. As of today, less than hallf of our stream ming subscrib bers also subsscribe to our DVD service, and we expeect that numb ber to continu ue to fall, given that only 7% % of new streaaming subscriibers also currrently sign up p for DVD. We see a huge global o opportunity for our $7.99 unlimited strreaming service, as indicatted by reachin ng 10% of Caanadian house ehold penetration in just o one year sincee launching sservice there. In the U.S., w we’ll build backk our brand th he same way we built it in the first placce: no grand gestures, just amazing serrvice day‐after‐‐day, for an in ncredibly low price.
Q3 Dom mestic Resullts We ended d the quarter with 21.4 miillion streamin ng subscriptioons and 13.9 million DVD subscriptionss. Unique do omestic subsccribers declin ned to 23.8 million subscribbers, driven b both by a high her than expeected level of caancellations aand a reductio on in acquisitions driven b y the PR storm that engulfed our brand d and its impactt on word‐of‐mouth. In spiite of this, we e continued too experience year‐over‐yeear growth in gross
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additions,, acquiring 4.7 7 million new w subscribers, or nearly 20% % year‐over‐yyear growth. Not only waas acquisition up compared to last yeaar, but SAC off $15 was com mparable to Q Q2’11 before the brand hitt, and down 24% % from a yearr ago. New su ubscribers are e coming for our market‐leeading stream ming service. Domestic revenue grew w 44% year‐o over‐year to $ $799 million i n Q3. Despite lower subsccribers than ectations as su ubscriber canncellations weere back‐load ded in the quaarter expected,, revenue wass within expe relative to o our forecastt. Domestic o operating proffit of $120 m illion, represeenting 15% operating margin, exceeded our previouss margin targe et of 14% due e to fewer DV VD shipmentss than expected, in part du ue to DVD usage. fewer DVD subscriberss as well as lower overall D
Q4 Dom mestic Outlo ook In Q4, we are providingg guidance fo or both our do omestic DVD and streamin ng segments, and will be reporting on that basiss going forward so investors have greatter transparency on the reespective businesse es. In the pastt, we have guided to a totaal domestic o perating marrgin target. G Going forward d, we will be guiding to separate contribu ution profit raanges for eachh segment, ass well as provviding guidancce on global nett income and EPS. Similarlyy, we will be ffocused on, aand thereforee guiding to, sstreaming and d DVD subscriptions, as tthey drive revvenue for eacch of our dom mestic segmen nts (rather th han total unique htly domestic subscribers.) Nevertheless, we do anticcipate that tootal unique U.S. subscriberrs will be sligh up in Q4. We think DVD subscrip ptions will deccline sharply this quarter, as reflected iin our guidance, due to ou ur price chan nges. Our we eekly rate of DVD cancellaation is steadiily shrinking, as the price eeffect washess through, aand in future quarters we expect DVD ssubscriptions to shrink mo ore modestly.. We don’t anticipate e any addition nal material in nvestment in equipment oor other PP&EE and a majorrity of our DV VD library is ffully depreciaated; so at $7.99, the segm ment is profitaable. We havve yet to decid de whether o or not to offer viideo game disscs. The decission will have e little financiaal impact eith her way. Wee still expect D DVDs to last a lo ong time, as tthey serve some unique ne eeds for com pleteness, for simplicity, aand for those household ds without acccess to high sspeed broadb band. Our $77.99 pricing iss a full 20% lo ower than our nearest unlimited DVD D‐by‐mail com mpetitor, and our service iss better because we have more distribu ution nd, as such, faaster deliveryy. centers an Looking at our domesttic streaming segment, we started the ccurrent quartter with somee subscribers who D and streamiing and not u using streamin ng enough to were mosstly DVD users, but paying for both DVD justify payying $7.99 forr it. Those su ubscribers are e cancelling sttreaming, which reduces rrevenue and streamingg subscription ns. This cance ellation wave was triggereed by the debit and credit ccard bills arriving with our n new prices. The wave peakked a few weeks ago and ccancellations are now steaadily decliningg. At the sam me time, we ccontinue to se ee year‐over‐‐year growth in weekly gro oss additions,, demonstrating the contin nued strength h of the streaming value proposition. W We expect strreaming net aadditions will be negative iin October du ue to the canccellation wave referred to above, and aas the wave subsides and ggross additions remain stron ng, net additio ons will be ab bout flat in Noovember, and d strongly possitive in December. Overall forr the quarter we expect slightly negativve streaming net additionss. Streaming
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hours are continuing to o climb, as members who use streaminng mostly stayy with Netflixx streaming. O Our es from a yearr ago, and sett new recordss most weekss. streamingg hours year‐tto‐date are up over 3 time The contrribution marggin for domesttic streamingg will be low inn Q4, at around 8% assum ming the mid‐p point of guidance, due to our increased sttreaming con ntent spend. ((Note: contrib bution profit is revenue less d marketing; iit doesn’t incllude our glob bal G&A or Te ch&Dev). W We’ve been agggressively COGS and increasingg our contentt spending, an nd in 2012 will nearly doubble what we’vve spent this year, puttingg us almost at par with whaat HBO, the b biggest of the premium TV networks, sp pends in the U U.S. and makiing e and quality o of content on n Netflix the b best it has eveer been. As w we grow the domestic the range streamingg member basse over comin ng quarters, w we plan to ta ke the stream ming contribu ution margin u up about 100 0 basis pointss every quarte er.
New Do omestic Con ntent We have ccontinued to rapidly expan nd new conte ent on the serrvice both do omestically an nd internation nally. Specifically, we have re ecently closed d output deals with Dream mWorks Anim mation, Open Road, and Th he CW, as we ell as an ongo oing deal with h AMC, all of w which will proovide a uniqu ue differentiator from our competito ors in the yeaars to come. A As more moviies come from m “mini‐majo ors” like Open n Road, Relativity and Lionsgate relative to the big Ho ollywood stud dios, Netflix m members will enjoy a stead dy stream of ggreat new filmss in addition to the hundre eds of movies recently addded from parttners includin ng Paramountt, Sony, Miramax, MGM, Universal, an nd Warner Brros. In the nexxt few weekss, the new Joh hnny Depp film “The Rum m Diaries” and d the epic actiion film “The Immortals” w will open in th heaters and b be among thee films available tto Netflix sub bscribers exclusively in the e pay TV winddow. Other reecent films incclude “Drive” and “The Killer Elite.” Curre ent box office e hits like “Paranormal Acttivity 3” and ““Footloose” w will also be co oming Netflix subscrribers. soon for N or Our recen nt agreements with AMC aand the CW w will assure thee flow of exclu usive – and ad ddictive – prio season se erialized televvision in the co oming years. On top of shhows that havve proven exttremely popu ular with Netflix members like “Mad Me en” and “Breaaking Bad,” liccensed from Lionsgate and d Sony Picturres Television n respectivelyy, we’ve added “The Walking Dead” fro m AMC and sseries that ap ppeal to teenss and young adu ults like “Gossip Girl” and “Vampire Diaaries” from Thhe CW. Add this to just ren newed or expanded d deals with A ABC, NBC Univversal, FOX, C CBS, Viacom M Media Netwo orks, Discoverry Communiications, PBS, and Sony Picctures Televission, and we’vve added around 3,800 neew TV episodees to the servicce in recent w weeks. At thiss point, Netflix now offers prior season television content from all 5 U.S. broad dcast networks and 95% o of the U.S. cab ble networks..
Netflix SStreaming C Content Qu uality – 10xx of Starz There are e various wayss to evaluate the content o of a video‐strreaming serviice. One wayy is to focus purely on quantity, but that le eads to the liccensing of tho ousands of raarely watched d titles. At the other extreeme is n quality, as m measured by the number oof Oscar‐nom minated or Em mmy‐nominatted concentraating solely on titles we h have. Instead, we think ab bout the value e of our conteent as a functtion of how m much a given movie or TTV series getss watched rellative to othe er titles, for hoow long and by how manyy members. FFrom
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that persp pective, an Osscar‐nominatted film may b be of less valuue to Netflix ssubscribers than “Pawn Sttars,” because ssubs are watcching the reality show morre than the Osscar‐nominatted movie. We have tthe Starz offe ering within o our service, an nd it is currenntly running aabout 6% of vviewing hourss because w we have adde ed so many otther movies aand TV showss (with no bias one way or the other in our merchand dising). In oth her words, 94 4% of the time e members sttream from N Netflix, they aare watching aa non‐Starzz title. Includiing the Sony ffilms from Staarz, which Staarz removed ffrom Netflix sseveral months ago, the 6 6% figure wou uld rise to abo out 10%. From this perspeective, Netflixx has about teen times the streaming g content seleection of full SStarz, in terms of what connsumers actually choose to o watch. Using a similar techniq que, we have analyzed all tthe video conntent offered through Amaazon Prime, including the TV prograams announcced but not ye et live. We h ave essentiallly all of this ccontent on Neetflix, and that ccontent contrributes a small fraction of Netflix viewinng. Specificallly, the dupliccative Amazon content th hat is available on Netflix rrepresents more than halff of hours view wed for only 2% of our subscribers. Therefore e, when evalu uating Amazo on Prime as a competitive sstand‐alone o offering, this low election explaains why we h have not seen n much usagee of Amazon Prime in our research. content se Hulu Plus is harder to aanalyze becau use we think most Hulu Pl us subs are p paying to get ccurrent seaso on TV which Netflix does not carry, such as this week’s SNLL clips, on theeir TV‐conneccted devices, content, w rather thaan paying for the Plus‐speccific content. In this sensee, Hulu Plus ccurrent seaso on TV is just a complementary conten nt model to u us, like sports or news subsscriptions. O Our prior seasson TV offerin ng is far more ccomplete thaan Hulu Plus, aand our moviie content is vvastly larger tthan Hulu Plu us, but, again,, we think mosst people who o pay for Hulu u Plus are doiing so for lastt‐night’s TV episodes on th heir PS3, iPads, and otherr devices.
Netflix is the Conte ent Leader – but Video o is not Mu usic Radio stattions and tele evision netwo orks develope ed with differ ent content licensing mod dels, and the online evo olution of mu usic and video o streaming se ervices to a laarge extent reeflects that leegacy. With radio o, automatic,, non‐negotiaable, statutoryy music licenssing meant th hat there wou uld be no exclusivityy over the mu usic played byy different rad dio stations. Clear Channeel, for examp ple, doesn’t geet Sony Mussic exclusivelyy. As music m moved online from radio, t he music labeels and majorr music servicces – Pandora, Rhapsody, Sp potify, iTunes, Amazon, an nd others – coontinued this non‐exclusive practice, offering a nearly comp plete selection n of songs. In television, by contraast, the netwo orks (ABC, FX, etc.) have loong relied upo on exclusive ccontent to differentiaate among th hemselves. As video move es online, so ttoo has this practice of excclusive conten nt. HBO has aan exclusive license to rece ent Universall movies that includes its o online HBO GO, for examp ple. Netflix has signed exclu usive licensess for DreamW Works Animat ion, for Relattivity, and oth hers. In episo odic orm. Netflix doesn’t licen se “Deadwoo od” from HBO O because theey see television, exclusives aare also the no strategic vvalue in keeping it exclusivve. Netflix liccenses “Mad M Men” and “House of Cards” exclusivelyy for much the same reason n.
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We have d dramatically more content than any other subscripttion service or network, bu ut given the existing licensing struccture of the caable network industry, thee total conten nt available w will likely remaain carved up p between Ne etflix, Showtim me, HBO, Hulu and others.. Two services can licensee jointly, or frrom one anoth her, like Netfllix and Epix, w where it is in ttheir mutual interest, but to date that has been the exception n rather than the rule. While we and our com mpetitors face the constrain nts imposed bby the traditional licensingg structure off cable, we have many aadvantages ovver linear pre emium pay neetworks. We are unbundleed, and chargge a very low p price of $7.99 9 a month. We are pure on n‐demand so we can creatte more comp pelling user experiencces than a primarily linear channel. We e are personaalized, so each user interfaace is tailored d specificallly to the indivvidual taste of a given conssumer, helpinng them to eaasily find movvies and TV sh hows they’ll enjjoy. Finally, w we can innovaate at Interne et pace ratherr than cable‐sset‐top‐firmw ware‐update p pace. We don’t have to “beaat” Starz or otther networkss to succeed. In fact, we o offer significant value to th he television licensing eco osystem by crreating additional revenuee in the prior season windo ow for netwo orks, which allo ows them to iinvest in additional first ru un content. W We won’t havve every movie or TV seriess; but we do pro ovide enough value that co onsumers also o want to subbscribe to Netflix. Any givven consumer will have onlyy one of DirecTV or Comcast, say, for their video servvice. That is cclassic either‐‐or competition. But with p premium tele evision netwo orks like Netflix, the more ggood experiences there arre, the more consumerrs are willing to spend to h have multiple channels froom which to gget enjoyment.
Internattional We’re ple eased to report that we have over 1 million Canadiann members, aand we madee a small contributiion profit in Q Q3 in Canada.. We’re excited enough byy the opportu unity in Canad da that, over the next year,, we are doub bling our quarterly content spending, sttarting by add ding in Q4 hitt feature films in their first pay window,, such as “Tru ue Grit”, “Blacck Swan” and “The Chroniccles of Narniaa: Voyage of tthe Dawn Treader”, along with considerable high pro ofile feature ffilms just com ming out of th heir first pay window, aand premium m catalog film titles, as well as many TV series. By th he time we’vee added all th his great ente ertainment, w we will have ccomparable content qualitty to what wee have in the U.S., and be spending the populatio on‐adjusted e equivalent. Th his investmennt will push co ontribution m margin back under in Canadaa for a few quarters, and our plan is to aachieve consiistent positivee contribution profit startiing in Q3 of nexxt year, two ye ears after ourr initial launch. In early Se eptember, we e launched Netflix in 43 co ountries in Lattin America. Early resultss indicate that member ccount at the e end of the year will be a litttle above Ca nada at the eend of 2010, w where we had d far higher braand awarenesss from the sttart. Given tthat Latin Am erica has abo out 4x more b broadband household ds than Canad da, there is lo ots of room fo or growth. W We recently ad dded supportt for Android in the region n, with suppo ort for Xbox and iOS to follow in comingg weeks, and are constantly adding new w content. Now that we are serving h hundreds of thousands of Latin Americaans, we can m measure what is njoyed a lot, aand what isn’t, and adjust our mix of coontent accord dingly. We are just beginn ning getting en in this maarket with a lo ot to learn, an nd a lot we caan improve ovver time, so itt’s too early tto tell whetheer we will reach run‐rate break‐even within two years as we would like.
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We annou unced this mo orning that w we are launchiing in the UK and Ireland in Q1. The UK K is a large media market with about 26 million house eholds. Abou ut 20 million hhouseholds h have broadband Internet aand video gam me console pe enetration is vvery high. About 60% of hhouseholds subscribe to aan MVPD offeering from eithe er Sky or Virggin, compared d to the rough hly 90% of U. S. and Canadian househollds that subsccribe to an MVP PD. The UK m market is simiilar to Canadaa in that onlinne piracy use is reasonablyy small and neearly everyone has a debit o or credit card,, unlike Latin America. In ggeneral, UK ISSP’s do not haave Canadian‐style dband usage ccaps. Over‐th he‐top video is more deveeloped in the UK, with greaater familiaritty low broad and usage e for catch‐up p‐TV than in C Canada or the e U.S., with suuch offerings as the BBC iP Player and 4oD. In terms o of premium TTV networks, SSky Movies has exclusives for first pay w window featu ure films with h all six major American stu udios, and offfers service sttarting at £166 per month o over Virgin an nd Sky, attractting ddition, consu umers pay thee mandatory BBC license ffee of about £ £12 about 4.5 million subsccribers. In ad per month. Finally, Lovvefilm has a liittle over 1 million subscribbers in the UK paying about £10 per month by‐mail, as we ell as a small b but growing sstreaming librrary with thatt offering. Wee believe our for DVD‐b service, att an aggressivve price, will b be compellingg. As in the U U.S., it is not aa winner takees all market; UK members will subscribe to Netflix and to other e entertainmen t offerings. W We have to atttract and rettain e able to gene erate a profit . While we normally targeet two years tto subscribers efficiently enough to be profitabiliity, with the increased com mpetition in the UK relativve to Canada, we anticipate it may take longer. W We’ll know more after ourr first few quaarters.
TV Everyywhere Dueling Mode els in the U.S. We’ve wrritten before tthat authentication models for Internett access of caable network content would be our eventtual primary ccompetitor. The first of th he two mode ls for authenttication is thaat subscriberss use their MVP PD application n, such as DisshOnline, or C Comcast Xfinitty, to access content onlin ne from lapto ops, tablets, phones, game consoles, Sm mart TVs, and Internet set‐ttops. The seccond of the tw wo models fo or he cable TV ne etwork appliccations, such as HBO GO or WatchESPN N on authentication is subsccribers use th or Roku or Sam msung TV. W Whichever mo odel wins view wing share ovver time will cconfer a lot off the iPad o profit pow wer on its owner, and the competition iis stimulatingg a lot of investment by bo oth MVPDs an nd networks in TV Everyw where. In the long term, Sm mart TVs and tablets will b be similar, offfering a wide uding Netflix.. It’s slightly better for us if those other range of vvideo applicattions via the IInternet, inclu applicatio ons are also “cchannels” like e ESPN and HBO, because they are on eequal footingg with us. It’s slightly worse for us if the other primary applicattions are EPG Gs like DishOn nline, and Xfin nity, because we main focused o on making ouur service onee of the best, in terms of wouldn’t be in those EPGs. We rem develops. consumerr value and eaase of use, ass the market d
Faceboo ok / VPPA U Update We were thrilled to announce at Faacebook’s f8 cconference inn September o our new Faceebook integraation ws Netflix subscribers in Caanada and Lattin America too connect theeir Netflix sub bscriptions with that allow their Face ebook accoun nts. The Netfllix/Facebook integration eempowers Neetflix subscribers to share w what they watcch on Netflix w with their frie ends on Faceb book and com mmunicate ab bout that con ntent. We’ve seen strong connect rates in n Latin American and Canaada, but we a re in the early phase of integration in tthese
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countries and we have e yet to see ju ust how powe erful an impacct this will havve on the con nsumer dustry. experiencce and our ind
We have d decided not tto launch Facebook integraation in the U U.S., due to th he Video Privaacy Protectio on Act (VPPA), a 1980’s law th hat creates so ome confusion over our abbility to let U..S. members cchoose to automaticcally share their viewing history with friends on Faceebook. A bipaartisan group of lawmakerrs has introduce ed legislation, H.R. 2471, a bill to moderrnize the VPPPA to allow su ubscribers to m make this cho oice. We are pleased that th his bipartisan group of law wmakers recoggnizes the neeed to modern nize this law tthat has not ke ept pace with h technology, and that con nsumers, the eeconomy and d innovative ttechnologies will benefit if it passes.
Just for Kids nt is a very important part of the Netflixx streaming o offering, drivin ng significant Kids and ffamily conten hours view wed. We know that kids te end to have d different view wing behavior r from adults; namely, kidss love to watch tthe same thin ng over and o over again. More importanntly, kids iden ntify with show ws more by the characters than by the e title. With th his in mind, w we launched aa new “Just fo or Kids” feature in July whiich watch all of th he great age‐aappropriate TTV provides aa more intuitive and enjoyyable way for children to w shows and d movies available to watcch instantly frrom Netflix. ovies and TV By clickingg on the “Justt For Kids” tab on the Netfflix website, kkids can find aa world of mo shows suiitable for children 12 and u under, with kkid‐friendly geenres and sorrting by charaacters such ass “Dora the e Explorer”, “P Phineas & Ferrb”, “iCarly”, “Caillou” andd “Thomas the Tank Enginee." This new feature is just one morre way we are e improving o our UI and co nsumer expeerience to bettter connect es and TV sho ows they’ll lovve. “Just for KKids” is available on the PC C and Mac to subscribers with movie embers with similar functionality to com me on the Wiii, iPad and m many other deevices in coming Netflix me months.
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Free Cassh Flow Our streaming contentt offering and d the associated expense hhas risen dram matically overr the past few w d $1.34 billion n of streamingg content asssets to our baalance sheet ssince the start of quarters. We’ve added have been succcessful in maatching paym ment terms with the expense so cash use for 2011. In ggeneral, we h streamingg content has been a bit ah head of expen nse but offsett by other sources of cash such as stock comp. Ass a result, free e cash flow haas roughly folllowed net in come. In Q3, FCFF of $13.8 milllion increased sharply yeaar‐over‐year ((77%), but siggnificantly trailed net incom me of $62 millio on. Our Septe ember Latin A America launcch, with a full quarter of caash paymentss but only one month of amortization n, was a material contributtor to this gapp. In addition n, we had approximately $ $22 ments go out at the end off the quarter for content sstarting on the site in earlyy million in content paym October, increasing the e prepaid con ntent on our b balance shee t. We expecct our FCF to ccontinue to laag net income e for the nextt few quarterrs as our spen nding on content continuess to increase b both domestiically and inte ernationally. As a reminder, when a content licen nse meets the e criteria for library asset recognition, w we recognize the es as an assett in our conte ent library whhile unpaid po ortions are reccognized as value of the license fee liabilities. Since many o of our agreem ments are mu ulti‐year, the aadditions willl be amortized and the on‐current liabilities (long‐term liabilities paid, in mostt cases, over sseveral years.. In sum, A/P and other no w deals becom me available oon our servicee. A/P) will increase as tittles from new $39.6 million in Q3 to repu urchase 182,0 000 shares att an average ccost basis of $ $218. Since We used $ inception of our share repurchasingg programs in n 2007, the avverage cost peer share repu urchased is $4 45. with $366 mil lion in cash and equivalen nts. After the repurchases, we finished tthe quarter w Historically, we have always run a vvery lean capital structure,, returning alll “excess” cassh to shareho olders in the form m of buybackks. We expectt to report a gglobal consoliidated net losss in Q1’12 ass well as to
9
consume cash as we laaunch the UK.. By pausing on further intternational expansion and d halting buyb backs, he our current cash on haand is adequate to supportt the growth oof the busineess. As we haave done in th past, we w will continue to evaluate the appropriate cash level for the busin ness.
Q4 Busin ness Outloo ok Q4 2011 G Guidance Domesttic Streamin ng: Subscriptiions Revenue Contributtion Profit
20.0 m m to 21.5 m $462 m to $477 m $30 m m to $42 m
Domesttic DVD: Subscriptiions Revenue Contributtion Profit
10.3 m m to 11.3 m $354 m to $368 m $177 m to $192 m
Internaational: 1.6 m m to 2.0 m $25 m m to $30 m ($70 m) to ($60m)
Subscriptiions Revenue Contributtion Profit / (Lo oss)
Consolidated Globaal: $19 m m to $37 m $0.3 36 to $0.70
Net Incom me EPS
Summa ary We contin nue to be welll positioned tto succeed in n the large gloobal market fo or streaming video. Consu umer demand ffor unlimited, on‐demand movies and TTV shows streeamed over th he Internet keeeps growingg, driven by increased broadband pen netration, the adoption of Smart TVs, an nd increased video consumpttion from lapttops, tablets, and phones. Moving forw ward, we are ffocused on co ontinually improvingg our service, by expandingg our streamiing content liibrary and enhancing our u user experien nce, to both bu uild consume er trust and to o stay ahead o of the compeetition. Sincerely,
Reed Hasttings, CEO
David W Wells, CFO
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Conferen nce Call Q&A A Session Netflix maanagement w will host a web bcast Q&A session at 3:00 p.m. Pacific TTime today to o answer questionss about the Co ompany’s finaancial results and businesss outlook. Pleease email yo our questionss to
[email protected]. The co ompany will rread the quesstions aloud oon the call and respond to as many questionss as possible. For those witthout access tto the Interneet the dial‐in for the live earnings Q&A session is: (760) 666‐36 613. The live w webcast, and tthe replay, off the earningss Q&A sessionn can be acceessed at ir.nettflix.com. IR Contacct: Ellie Merttz VP, Financce & Investorr Relations 408 540‐3 3977
PPR Contact: SSteve Swaseyy V VP, Corporatee Communicaations 4408 540‐39477
Use of Non‐GAAP Measures This share eholder letterr and its attacchments inclu ude referencee to the non‐G GAAP financiaal measures o of free cash flow and con ntribution pro ofit. Managem ment believess that free cash flow is an important liquidity m metric becausse it measures, during a givven period, thhe amount off cash generaated that is available tto repay debtt obligations, make investm ments, repurrchase stock aand for certain other activities. Managemen nt believes th hat contribution profit is usseful in assesssing the relattive contributtion to operating income off each segme ent by eliminaating any alloccation of Technology & Deevelopment aand enses that apply across the ese segmentss. However, tthis non‐GAAP measure sh hould be G&A expe considere ed in addition to, not as a ssubstitute forr or superior tto, net incom me, operating income and n net cash provvided by operaating activitie es, or other financial meassures prepareed in accordan nce with GAAP. Re econciliation tto the GAAP e equivalent off this non‐GAA AP measure is contained in tabular form m on the attach hed unaudited financial staatements.
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Forward‐‐Looking Stattements This share eholder letterr contains cerrtain forward‐‐looking stateements within the meanin ng of the fedeeral securities laws, including statementts regarding o our long‐term m opportunitiees and buildin ng back our b brand, subscriber additions, in nternational e expansion, co ontribution prrofit and marrgin; internatiional segmen nt performance, includingg Canadian co ontribution profit; free cassh flow and u usage of cash;; our subscrib ber evenue, and ccontribution profit (loss) for both domeestic and inteernational opeerations as w well as growth, re net incom me and earnin ngs per share for the fourth h quarter of 22011. The forrward‐lookingg statements in this letterr are subject tto risks and uncertainties tthat could ca use actual ressults and eveents to differ, including,, without limitation: our ab bility to attracct new subscrribers and rettain existing ssubscribers; o our ability to ccompete effe ectively; our aability to build d back our br and; the conttinued availab bility of conteent on terms and condition ns acceptable e to us; mainttenance and eexpansion of device platfo orms for instaant streamingg; fluctuationss in consumer usage of ou ur service; dis ruption in serrvice on our w website or wiith third‐partty computer ssystems that help us operaate our servicce; competitio on and widesspread consum mer adoption of different m modes of view wing in‐home e filmed enterrtainment. A d detailed discu ussion of thesse and otherr risks and uncertainties th hat could causse actual resuults and events to differ m materially from m such forw ward‐looking sstatements is included in o our filings witth the Securitties and Exchaange Commisssion, including our Annual R Report on Form 10‐K filed w with the Secuurities and Exchange Comm mission on February 18, 2011. We e undertake n no obligation to update forrward‐lookingg statements to reflect eveents or circumstances occurring after the e date of thiss press releasee.
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Netflix, Incc. Consolidatted Statements of Operations (unaudited) (in thousand ds, except per shaare data) Three Montths Ended Nine Months Ended d Septemb ber 30, June 3 30, Septemb ber 30, Septemb ber 30, Septem ber 30, 201 11 2011 201 0 201 11 201 10 Revenues Cost of revenues: Subscri ption ment expenses Fulfillm Tottal cost of revenues Gross profitt Operating exxpenses: Technol ogy and developm ment Marketi ng General and administrattive * Tottal operating expeenses Operating in ncome Other incom me (expense): Interestt expense Interestt and other incom me Income befo ore income taxes Provision fo or income taxes Net income Net income per share: Basic Diluted ng: Weighted avverage common s hares outstandin Basic Diluted *
Includess gain on disposaal of DVDs.
$ 82 1,839
$ 788 8,610
$ 553 3,219
$ 2,32 29,002
$ 1,56 66,703
471,823 64 4,794 536 6,617 285 5,222
428 8,203 61 1,775 489 9,978 298 8,632
292 2,406 52 2,063 344 4,469 208 8,750
1,277,018 187,728 1,464,746 864,256
81 17,353 14 49,212 96 66,565 60 00,138
69 9,480 89 9,108 29 9,792 188 8,380 96 6,842
57 7,865 94 4,983 30 0,670 183 3,518 115 5,114
42 2,108 81 1,238 15 5,903 139 9,249 69 9,501
178,250 288,350 83,460 550,060 314,196
11 17,370 23 30,990 46,590 4 39 94,950 20 05,188
(4 4,915) 1,696 93 3,623 31,163 $ 6 2,460
(5 5,303) 1,013 1 110 0,824 42 2,610 $ 68 8,214
(4 4,945) 853 65 5,409 27 7,442 $ 37 7,967
(15,083) 3,574 302,687 111,780 $ 19 90,907
(1 14,797) 2,746 19 93,137 79,379 7 $ 11 13,758
$ 1.19 $ 1.16
$ 1.30 $ 1.26
$ 0.73 $ 0.70
$ 3.63 $ 3.53
$ 2.17 $ 2.09
52,569 5 5 53,870
5 2,470 5 3,909
52,142 5 5 53,931
52,599 5 5 54,008
52,510 54,341
13
Netflix, In nc. Consolidaated Balance SSheets (unaudited d) (in thousan nds, except sha re and par valu ue data) As of September 30, December 31, D 2010 2011 Assets Current asssets: Cash a nd cash equiva lents Short‐teerm investmentts Currentt content librar y, net Prepaid d content Other ccurrent assets To otal current asssets Content lib brary, net Property a nd equipment, n net Deferred taax assets Other non‐‐current assets To otal assets Liabilities aand Stockholderrs' Equity Current lia bilities: Accoun nts payable Accrued d expenses Currentt portion of leasse financing obligations Deferreed revenue To otal current liab bilities Long‐term d debt Lease finan ncing obligation ns, excluding cu urrent portion Other non‐‐current liabilities To otal liabilities Stockholdeers' equity: Common stock, $0.001 p par value; 160,0 000,000 shares authorizeed at Septemberr 30, 2011 and D December 31, 2 010; 52,504,091 and 52,781,949 issued and d outstanding att Septembeer 30, 2011 and d December 31, 2010, respectivvely Additionaal paid‐in capittal Accumulaated other comp prehensive inco ome, net Retained earnings To otal stockholdeers' equity To otal liabilities aand stockholders' equity
$ 159,199 206,573 705,398 77,146 41,797 1,190,113 570,210 143,993 28,743 28,499 $ 1,961,558
$ 194,499 $ 155,888 181,006 62,217 43,621 637,231 180,973 128,570 17,467 17,826 982,067 $ $
$ 750,107 54,671 2,259 160,929 967,966 200,000 32,400 372,840 1,573,206
$ 222,824 $ 36,489 2,083 127,183 388,579 200,000 34,123 69,201 691,903
53 ‐ 588 387,711 388,352 $ 1,961,558
53 51,622 750 237,739 290,164 982,067 $ $
14
Netflix, Inc. d Statements of Caash Flows Consolidated (unaudited) (in thousandss)
Cash flows fro om operating activities: Net income Adjustments to reconcile net inc ome to net cash by operating activitiees: provided b Additionss to streaming conteent library Change i n streaming content liabilities ontent library Amortiza tion of streaming co Amortiza tion of DVD content library on of property, equip pment and intangibl es Deprecia tion and amortizatio Stock‐bassed compensation exxpense Excess taax benefits from stocck‐based compensatiion Other non‐cash items Deferred taxes Changes in operating assets and liabilities: d content Prepaid Other ccurrent assets Other aaccounts payable Accrued expenses Deferreed revenue Other n non‐current assets a nd liabilities Net cash provided by op perating activities om investing activitie es: Cash flows fro Acquisitions of DVD content libr ary ments Purchases off short‐term investm Proceeds fro om sale of short‐term m investments Proceeds fro om maturities of short‐term investments Purchases off property and equip pment Other assets Net cash used in investiing activities om financing activitie es: Cash flows fro Principal pa yments of lease fina ncing obligations om issuance of comm mon stock Proceeds fro Excess tax beenefits from stock‐baased compensation Repurchasess of common stock Net cash used in financ ing activities nd cash equivalents Net increase ((decrease) in cash an Cash and cas h equivalents, beginning of period h equivalents, end off period Cash and cash
Non‐GAAP free e cash flow reconciliaation: Net cash pro ovided by operating aactivities Acquisitions of DVD content libr ary pment Purchases off property and equip Other assets Non‐GAAP frree cash flow
Thrree Months Ended September 30, June 30, Sep ptember 30, 2011 2010 2011
ed Nine Months Ende Septe ember 30, Septem mber 30, 2011 20 010
$ 62,460
$ 68,214
$ 37,967
$ 190,907
$ 113,758 1
(539,285) 314,720 187,446 23,000 11,913 15,705 (11,761) (1,745) (5,281)
(612,595) 419,832 144,466 24,000 10,182 15,536 (17,868) (802) (3,927)
(115,149) 58,638 44,568 32,578 8,678 7,296 (16,093) (1,754) 3,194
(1 1,344,187) 816,620 417,849 73,990 31,921 43,505 (45,283) (3,472) (14,190)
(2 231,781) 88,197 93,091 111,490 1 28,846 19,726 (34,699) (7,814) (2,961)
(17,335) (8,578) (5,422) 20,920 13,992 (11,218) 49,531
14,787 4,015 (4,465) 17,941 3,892 3,184 86,392
(25,485) (3,374) (10,914) 18,003 1,567 2,507 42,227
(14,928) 4,935 4,948 61,531 33,746 (5,646) 252,246
(32,581) (12,037) 1,246 39,666 2,889 2,648 179,684 1
(20,826) (7,673) 37 1,805 (14,080) (844) (41,581)
(19,065) (40,597) 16,510 15,985 (8,626) 844 (34,949)
(29,900) (15,379) 42,238 1,995 (7,342) 2,782 (5,606)
(62,010) (100,536) 31,508 18,440 (39,026) 1,419 (150,205)
(90,993) (73,169) 105,063 1 10,318 (19,406) 10,289 (57,898)
(526) (520) 4,409 7,418 11,761 17,868 (39,602) (51,421) (23,958) (26,655) (16,008) 24,788 175,207 150,419 $ 159,199 $ 175,207
(470) 10,927 16,093 (57,390) (30,840) 5,781 107,327 $ 113,108
(1,547) 18,589 45,283 (199,666) (137,341) (35,300) 194,499 $ 159,199
(1,296) 33,954 34,699 (2 210,259) (1 142,902) (21,116) 134,224 1 $ 113,108 1
Thrree Months Ended ptember 30, September 30, June 30, Sep 2011 2010 2011
Nine Months Ende ed Septe ember 30, Septem mber 30, 2011 20 010
$ 49,531 $ 86,392 (20,826) (19,065) (14,080) (8,626) (844) 844 $ 13,781 $ 59,545
$ 252,246 (62,010) (39,026) 1,419 $ 152,629
$ 42,227 (29,900) (7,342) 2,782 $ 7,767
$ 179,684 1 (90,993) (19,406) 10,289 $ 79,574
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Netflix, Incc. Other Dataa (unaudited) (in thousands, except percen ntages, average m monthly revenue per paying subscriber aand subscriber aacquisition cost) As o of / Three Month hs Ended SSeptember 30, June 30, Septemb ber 30, 2010 0 2011 2011 Domestic su ubscriber informaation: Subscribeers: beginning of period Gross sub bscriber addition ns: during period Gross su ubscriber additio ons year‐to‐year change Gross su ubscriber additio ons quarter‐to‐qu uarter sequentia l change Less subsccriber cancellati ons: during perio od Net subsc riber additions: d during period d Subscribeers: end of period Subscri bers year‐to‐yea r change Subscri bers quarter‐to‐q quarter sequentiaal change Free subscr ibers: end of per iod Free subsccribers as percen ntage of ending s ubscribers Paid subscrribers: end of perriod Paid subs cribers year‐to‐yyear change Paid subs cribers quarter‐tto‐quarter sequential change Average monthly revenue peer paying subscri ber Domestic ch hurn Domestic su ubscriber acquisittion cost
24,594 4,714 18.9% (11.3%) (5,519) (805) 23,789 41.6% (3.3%) 946 4.0% 22,843 44.0% (1.8%) 11.56 $ $ 6.3% 15.25 $ $
SSeptember 30, 2011 Consolidate d margins: Gross marrgin Operatingg margin Net margi n Consolidate d expenses as pe ercentage of reve enues: Technologgy and developmeent Marketingg General a nd administrativve perating expensess Total op Consolidate d year‐to‐year ch hange: Total reveenues Cost of subscription Fulfillmen nt expenses Technologgy and developmeent Marketingg General a nd administrativve Total op perating expensess
22,797 5,315 73 3.7% (15 5.6%) (3,518) 1,797 24,594 63 3.9% 7 7.9% 1,331 5 5.4% 23,263 59 9.6% 8 8.7% $ 11 1.49 4 4.2% $ 15 5.09
15,001 1 3,965 81.9% 29.6% (2,166) ( 1,799 16,800 1 51.2% 12.0% 937 5.6% 15,863 1 46.4% 8.8% $ 12.12 3.8% $ 20.03
Three Months Ended June 30, Septemb ber 30, 2011 2010 0
34.7% 11.8% 7.6%
37 7.9% 14 4.6% 8 8.6%
37.7% 12.6% 6.9%
8.5% 10.8% 3.6% 22.9%
7 7.3% 12 2.0% 4 4.0% 23 3.3%
7.6% 14.7% 2.8% 25.1%
48.6% 61.4% 24.5% 65.0% 9.7% 87.3% 35.3%
5 1.7% 6 1.4% 24 4.7% 52 2.8% 27 7.4% 102 2.5% 43 3.9%
30.7% 25.4% 23.4% 40.3% 38.7% 60.0% 41.4%
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Netflix, Incc. Segment In nformation (unaudited) (in thousand ds) As of / Three Month hs Ended September 30 0, June 30, September 3 0, 2011 2011 2010 Domestic bscribers at end o of period Free sub Paid subscribers at end of period Total subsscribers at end off period Revenue Cost of revvenues and markketing expenses Contributiion profit* Other operating expenses Segment o operating income Internationaal** Free sub bscribers at end o of period Paid subscribers at end of period Total subsscribers at end off period Revenue Cost of revvenues and markketing expenses Contributiion profit (loss)* Consolidate d Free sub bscribers at end o of period Paid subscribers at end of period Total subsscribers at end off period Revenue Cost of revvenues and markketing expenses Contributiion profit* Other operating expenses Operatingg income Other inco ome (expense) Provision for income taxess Net Incom me
As of / N Nine Months End ded Septemberr 30, Septemb ber 30, 2011 201 0
946 6 22,843 3 23,789 9
1,331 23,263 24,594
93 37 15,86 63 16,80 00
946 22,,843 23,,789
937 15,863 1 16,800 1
$ 799,152 2 579,720 0 219,432 2 99,272 2 $ 120,160 0
$ 769,714 556,719 212,995 88,535 $ 124,460
$ 553,21 19 423,01 13 130,20 06 58,01 11 $ 72,19 95
$ 2,275,,140 1,655,,828 619,,312 261,,710 $ 357,,602
$ 1,56 66,703 1,19 94,861 37 71,842 16 63,960 $ 20 07,882
491 1 989 9 1,480 0
110 857 967
13 33 ‐ 13 33
491 989 1,,480
133 ‐ 133
$ 22,687 7 46,005 5 (23,318 8)
$ 18,896 28,242 (9,346 )
$ ‐ 2,69 94 (2,69 94)
$ 53,,862 97,,268 (43,,406)
$ ‐ 2,694 (2,694) (
1,437 7 23,832 2 25,269 9
1,441 24,120 25,561
1,07 70 15,86 63 16,93 33
1,,437 23,,832 25,,269
1,070 15,863 1 16,933 1
$ 821,839 9 625,725 5 $ 196,114 4 99,272 2 96,842 2 (3,219 9) 31,163 3 $ 62,460 0
$ 788,610 584,961 203,649 88,535 $ 115,114 (4,290 ) 42,610 $ 68,214
$ 553,21 19 425,70 07 127,51 12 58,01 11 $ 69,50 01 (4,09 92) 27,44 42 $ 37,96 67
$ 2,329,,002 1,753,,096 575,,906 261,,710 $ 314,,196 (11,,509) 111,,780 $ 190,,907
$ 1,56 66,703 1,19 97,555 36 69,148 16 63,960 $ 20 05,188 (1 12,051) 79,379 7 $ 11 13,758
* Contributi on profit (loss) i s defined as reveenues less cost off revenues and marketing expensees. ** “Technolo ogy and Developm ment” and “General and Administtrative” amounts reported in the In nternational segm ment in prior perriods have been reeclassified to con nform to the currrent period presentation.
17
