| NETFLIX INC Item 1A Risk Factors If any of the following risks actually occurs, our business, financial condition and results of operations could be harmed |
| In that case, the trading price of our common stock could decline, and you could lose all or part of your investment |
| Risks Related to Our Business If our efforts to attract subscribers are not successful, our revenues will be affected adversely |
| We must continue to attract new subscribers |
| To succeed, we must continue to attract a large number of subscribers who have traditionally used video retailers, video rental outlets, cable channels, such as HBO and Showtime, pay-per-view and VOD for in-home filmed entertainment |
| In addition, we face direct competition to our service, namely from services like Blockbuster Online, that will likely impact our ability to attract subscribers |
| Our ability to attract subscribers will depend in part on our ability to consistently provide our subscribers with a valuable and quality experience for selecting, viewing, receiving and returning titles, including providing accurate recommendations through our recommendation service |
| Furthermore, if our competitors are able to offer similar service levels at lower prices, our ability to attract subscribers will be affected adversely |
| If consumers do not perceive our service offering to be of value, or if we introduce new services that are not favorably received by them, we may not be able to attract subscribers |
| In addition, many of our new subscribers originate from word-of-mouth advertising and referrals from existing subscribers |
| If our efforts to satisfy our existing subscribers are not successful, we may not be able to attract new subscribers, and as a result, our revenues will be affected adversely |
| If we experience excessive rates of churn, our revenues and business will be harmed |
| We must minimize the rate of loss of existing subscribers while adding new subscribers |
| Subscribers cancel their subscription to our service for many reasons, including a perception that they do not use the service sufficiently, delivery takes too long, the service is a poor value, competitive services provide a better value and/or experience, and customer service issues are not satisfactorily resolved |
| We must continually add new subscribers both to replace subscribers who cancel and to grow our business beyond our current subscriber base |
| If too many of our subscribers cancel our service, or if we are unable to attract new subscribers in numbers sufficient to grow our business, our operating results will be adversely affected |
| Further, if excessive numbers of subscribers cancel our service, we may be required to incur significantly higher marketing expenditures than we currently anticipate to replace these subscribers with new subscribers |
| If we are unable to compete effectively, our business will be affected adversely |
| The market for in-home filmed entertainment is intensely competitive and subject to rapid change |
| New technologies for delivery of in-home filmed entertainment, such as VOD and downloading over the Internet, continue to receive considerable media attention |
| Many of our competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial, marketing and other resources than we do |
| The rapid growth of our online entertainment subscription business since our inception may continue to attract direct competition from larger companies with significantly greater financial resources and national brand recognition |
| For example, we have seen the entry of direct competition from Blockbuster, which launched its online service in August 2004, and could face competition from potential new entrants into the online DVD rental market |
| If we are unable to successfully or profitably compete with current and new competitors, our business will be adversely affected, and we may not be able to increase or maintain market share, revenues or profitability |
| In addition, many consumers maintain simultaneous relationships with multiple in-home filmed entertainment providers and can easily shift spending from one provider to another |
| For example, consumers may subscribe to HBO, rent a DVD from Blockbuster, buy a DVD from Wal-Mart and subscribe to Netflix, or some 8 ______________________________________________________________________ [31]Table of Contents combination thereof, all in the same month |
| New competitors may be able to launch new businesses at relatively low cost |
| DVDs represent only one of many existing and potential new technologies for viewing filmed entertainment |
| In addition, the growth in adoption of DVD technology is not mutually exclusive from the growth of other technologies |
| If we are unable to successfully compete with current and new competitors and technologies, we may not be able to achieve adequate market share, increase our revenues or maintain profitability |
| Our principal competitors include, or could include: • video rental outlets, such as Blockbuster and Movie Gallery; • online DVD subscription rental sites, such as Blockbuster Online; • pay-per-view and VOD services and alternative content delivery methods such as Apple’s video iPod and MovieBeam; • movie retail stores, such as Best Buy, Wal-Mart and Amazon |
| com; • subscription entertainment services, such as HBO and Showtime; • Internet movie providers, such as Movielink, CinemaNow |
| com and Vongo; • Internet companies such as Yahoo! |
| and Google; • cable providers, such as AOL Time Warner and Comcast; and • direct broadcast satellite providers, such as DIRECTV and Echostar |
| Some of our competitors have adopted, and may continue to adopt, aggressive pricing policies and devote substantially more resources to marketing and Web site and systems development than we do |
| There can be no assurance that we will be able to compete effectively against current or new competitors at our existing pricing levels or at even lower price points in the future |
| Furthermore, we may need to adjust the level of service provided to our subscribers and/or incur significantly higher marketing expenditures than we currently anticipate |
| As a result of increased competition, we have seen and may continue to see a reduction in operating margins and market share |
| If VOD or other technologies are widely adopted and supported as a method of content delivery by the studios and consumers, our business could be adversely affected |
| Some digital cable providers and Internet content providers have implemented technology referred to as VOD This technology transmits movies and other entertainment content on demand with interactive capabilities such as start, stop and rewind |
| High-speed Internet access has greatly increased the speed and quality of viewing VOD content, including feature-length movies, on personal computers over the Internet |
| In addition, other technologies have been developed that allow alternative means for consumers to receive and watch movies or other entertainment, such as on cell phones or other handheld devices such as Apple’s iPod |
| If VOD or other technologies become affordable and viable alternative methods of content delivery widely supported by studios and adopted by consumers, our business could be adversely affected |
| If the popularity of the DVD format decreases, our business could be adversely affected |
| Consumers have rapidly adopted the DVD format for viewing in-home filmed entertainment |
| In addition, DVD sales account for more than 42prca of studio revenues |
| We believe that the DVD format, including any successor formats such as HD-DVD and BluRay, will be valuable long-term consumer propositions and studio profit centers |
| However, if DVD sales were to decrease, whether because of a shift away from movie watching or because new or existing technologies were to become more popular at the expense of DVD enjoyment, studios and retailers may reduce their support of the DVD format |
| Our subscriber growth will be substantially influenced by future popularity of the DVD format, and if such popularity wanes, our subscriber growth may also slow |
| 9 ______________________________________________________________________ [32]Table of Contents We depend on studios to release titles on DVD for an exclusive time period following theatrical release |
| Our ability to attract and retain subscribers is related to our ability to offer new releases of filmed entertainment on DVDs prior to their release to other distribution channels |
| Except for theatrical release, DVDs currently enjoy a significant competitive advantage over other distribution channels, such as pay-per-view and VOD, because of the early distribution window for DVDs |
| The window for DVD rental and retail sales is generally exclusive against other forms of non-theatrical movie distribution, such as pay-per-view, premium television, basic cable and network and syndicated television |
| The length of the exclusive window for movie rental and retail sales varies |
| Our business could suffer increased competition if: • the window for rental were no longer the first following the theatrical release; or • the length of this window was shortened |
| The order, length and exclusivity of each window for each distribution channel is determined solely by the studio releasing the title, and we cannot assure you that the studios will not change their policies in the future in a manner that would be adverse to our business and results of operations |
| Currently, studios distribute their filmed entertainment content approximately three to six months after theatrical release to the home video market, seven to nine months after theatrical release to pay-per-view and VOD, one year after theatrical release to satellite and cable, and two to three years after theatrical release to basic cable and syndicated networks |
| However, in what continues to be an emerging trend, the major studios have shortened the release window on certain titles, in particular the theatrical to home video window |
| In addition, some studios have discussed eliminating the release window on certain titles, in particular releasing movies simultaneously on DVD and VOD If we are unable to offset increased demand for titles with increased subscriber retention or operating margins, our operating results may be affected adversely |
| With our unlimited plans, there is no established limit to the number of movies that subscribers may rent |
| Historically, on a plan-by-plan basis, we have seen the average number of movies rented per subscriber increase on an annual basis |
| We believe that this increase in usage is influenced by improvements to our service as well as consumer usage habits |
| In addition, demand for titles may increase for a variety of reasons beyond our control, including promotion by studios and seasonal variations or shifts in consumer movie watching |
| We are continually adjusting our service in ways that may impact subscriber movie usage |
| Such adjustments include new Web site features and merchandising practices, an expanded distribution network, as well as software and process changes |
| Our subscribers may continue to increase their usage of our service, which would increase our operating costs |
| If our subscriber retention does not increase or our operating margins do not improve to an extent necessary to offset the effect of increased operating costs, our operating results will be adversely affected |
| In addition, our subscriber growth and retention may be affected adversely if we attempt to alter our service or increase our monthly subscription fees to offset any increased costs of acquiring or delivering titles |
| If our subscribers select titles or formats that are more expensive for us to acquire and deliver more frequently, our expenses will increase |
| Certain titles cost us more to acquire or result in greater revenue sharing expenses, depending on the source from whom they are acquired and the terms on which they are acquired |
| If subscribers select these titles more often on a proportional basis compared to all titles selected, our revenue sharing and other DVD acquisition expenses could increase, and our gross margins could be adversely affected |
| In addition, films released on the new high definition DVD formats, HD-DVD and BluRay, may be more expensive to acquire |
| The rate of customer acceptance and adoption of these new formats is uncertain |
| If subscribers select these formats on a 10 ______________________________________________________________________ [33]Table of Contents proportional basis more often than the existing DVD format, our DVD acquisition expenses could increase, and our gross margins could be adversely affected |
| If our efforts to build strong brand identity and improve subscriber satisfaction and loyalty are not successful, we may not be able to attract or retain subscribers, and our operating results will be affected adversely |
| The Netflix brand is still developing, and we must continue to build strong brand identity |
| To succeed, we must continue to attract and retain a large number of owners of DVD players who have traditionally relied on store-based rental outlets and persuade them to subscribe to our service through our Web site |
| In addition, we will have to compete for subscribers against other brands which have greater recognition than ours, such as Blockbuster |
| We believe that the importance of brand loyalty will only increase in light of competition both for online subscription services and other means of distributing titles, such as VOD From time-to-time, our subscribers express dissatisfaction with our service, including among other things, our inventory allocation and delivery processing |
| To the extent such dissatisfaction is widespread or not adequately addressed, our brand may be adversely impacted |
| If our efforts to promote and maintain our brand are not successful, our operating results and our ability to attract and retain subscribers will be affected adversely |
| If we are unable to manage the mix of subscriber acquisition sources, our subscriber levels may be affected adversely and our marketing expenses may increase |
| We utilize a broad mix of marketing programs to promote our service to potential new subscribers |
| We obtain a large portion of our new subscribers through our online marketing efforts, including third party banner ads, pop-under placements, direct links and permission-based e-mails as well as our active affiliate program |
| In addition, we have engaged in various offline marketing programs, including television and radio advertising, direct mail and print campaigns, consumer package and mailing insertions |
| We also acquire a number of subscribers who rejoin our service having previously cancelled their membership |
| We maintain an active public relations program to increase awareness of our service and drive subscriber acquisition |
| We opportunistically adjust our mix of marketing programs to acquire new subscribers at a reasonable cost with the intention of achieving overall financial goals |
| If we are unable to maintain or replace our sources of subscribers with similarly effective sources, or if the cost of our existing sources increases, our subscriber levels may be affected adversely and our marketing expenses may increase |
| If we are unable to continue using our current marketing channels, our ability to attract new subscribers may be affected adversely |
| We may not be able to continue to support the marketing of our service by current means if such activities are no longer available to us, become cost prohibitive or are adverse to our business |
| If companies that currently promote our service decide to enter our business or a similar business or decide to exclusively support our competitors, we may no longer be given access to such channels |
| In addition, if ad rates increase, we may curtail marketing expenses or otherwise be required to increase our cost per subscriber |
| Laws and regulations impose restrictions on the use of certain channels, including commercial e-mail and direct mail |
| We may limit or discontinue use or support of e-mail and other activities if we become concerned that subscribers or potential subscribers deem such activities intrusive, which could affect our goodwill or brand |
| If the available marketing channels are curtailed, our ability to attract new subscribers may be affected adversely |
| If we are not able to manage our growth, our business could be affected adversely |
| We have expanded rapidly since we launched our Web site in April 1998 |
| We anticipate further expanding our operations to help grow our subscriber base and to take advantage of favorable market opportunities |
| Any future expansion will likely place significant demands on our managerial, operational, administrative and financial resources |
| If we are not able to respond effectively to new or increased demands that arise because of 11 ______________________________________________________________________ [34]Table of Contents our growth, or, if in responding, our management is materially distracted from our current operations, our business may be affected adversely |
| In addition, if we do not have sufficient breadth and depth of the titles necessary to satisfy increased demand arising from growth in our subscriber base, our subscriber satisfaction may be affected adversely |
| We rely heavily on our proprietary technology to process deliveries and returns of our DVDs and to manage other aspects of our operations, and the failure of this technology to operate effectively could adversely affect our business |
| We use complex proprietary software to process deliveries and returns of our DVDs and to manage other aspects of our operations |
| Our proprietary technology is intended to allow our nationwide network of shipping centers to be operated on an integrated basis |
| We continually enhance or modify the software used for our distribution operations |
| We cannot be sure that any enhancements or other modifications we make to our distribution operations will achieve the intended results or otherwise be of value to our subscribers |
| Future enhancements and modifications to our proprietary technology could consume considerable resources |
| If we are unable to maintain and enhance our technology to manage the processing of DVDs among our shipping centers in a timely and efficient manner, our ability to retain existing subscribers and to add new subscribers may be impaired |
| If we experience delivery problems or if our subscribers or potential subscribers lose confidence in the US mail system, we could lose subscribers, which could adversely affect our operating results |
| We rely exclusively on the US Postal Service to deliver DVDs from our shipping centers and to return DVDs to us from our subscribers |
| We are subject to risks associated with using the public mail system to meet our shipping needs, including delays or disruptions caused by inclement weather, natural disasters, labor activism, health epidemics or bioterrorism |
| Our DVDs are also subject to risks of breakage during delivery and handling by the US Postal Service |
| The risk of breakage is also impacted by the materials and methods used to replicate our DVDs |
| If the entities replicating our DVDs use materials and methods more likely to break during delivery and handling or we fail to timely deliver DVDs to our subscribers, our subscribers could become dissatisfied and cancel our service, which could adversely affect our operating results |
| In addition, increased breakage rates for our DVDs will increase our cost of acquiring titles |
| Increases in the cost of delivering DVDs could adversely affect our gross profit and marketing expenses |
| Increases in postage delivery rates will adversely affect our gross profit if we elect not to raise our subscription fees to offset the increase |
| The US Postal Service recently increased the rate for first class postage on January 8, 2006 by 2 cents, from 37 cents to 39 cents |
| In addition, the US Congress has been considering postal reform legislation which would provide the US Postal Service with more flexibility in establishing postal rates |
| The US Postal Service continues to focus on plans to reduce its costs and make its service more efficient |
| If the US Postal Service were to change any policies relative to the requirements of first-class mail, including changes in size, weight or machinability qualifications of our DVD envelopes, such changes could result in increased shipping costs or higher breakage for our DVDs and our gross margin could be affected adversely |
| Also, if the US Postal Service curtails its services, such as by closing facilities or discontinuing or reducing Saturday delivery service, our ability to timely deliver DVDs could diminish, and our subscriber satisfaction could be affected adversely |
| Currently, most filmed entertainment is packaged on a single lightweight DVD Our delivery process is designed to accommodate the delivery of one DVD to fulfill a selection |
| Because of the lightweight nature of a DVD, we generally mail one envelope containing a title using standard US postage |
| Studios occasionally provide additional content on a second DVD or may package a title on two DVDs |
| In addition, the studios have recently announced plans to release certain films in high definition format on HD-DVDs and BluRay DVDs |
| These new DVDs have characteristics that are different than those currently in circulation |
| These high-definition format DVDs may be heavier and/or more fragile than current DVDs |
| If packaging of filmed entertainment on 12 ______________________________________________________________________ [35]Table of Contents multiple DVDs were to become more prevalent, if the weight of DVDs were to increase, or the durability of DVDs deteriorate, our costs of delivery and fulfillment processing would increase and our costs of replacing damaged DVDs may rise materially which would depress gross margins and profitability and adversely affect free cash flow |
| If we are unable to effectively utilize our recommendation service, our business may suffer |
| Based on proprietary algorithms, our recommendation service enables us to predict and recommend titles and effectively merchandize our library to our subscribers |
| We believe that in order for our recommendation service to function most effectively, it must access a large database of user ratings |
| We cannot assure you that the proprietary algorithms in our recommendation service will continue to function effectively to predict and recommend titles that our subscribers will enjoy, or that we will continue to be successful in enticing subscribers to rate enough titles for our database to effectively predict and recommend new or existing titles |
| We are continually refining our recommendation service in an effort to improve its predictive accuracy and usefulness to our subscribers |
| We may experience difficulties in implementing such refinements |
| In addition, we cannot assure you that we will be able to continue to make and implement meaningful refinements to our recommendation service |
| If our recommendation service does not enable us to predict and recommend titles that our subscribers will enjoy or if we are unable to implement meaningful improvements, our personal movie recommendation service will be less useful, in which event: • our subscriber satisfaction may decrease, subscribers may perceive our service to be of lower value and our ability to attract and retain subscribers may be affected adversely; • our ability to effectively merchandise and utilize our library will be affected adversely; and • our subscribers may default to choosing titles from among new releases or other titles that cost us more to provide, and our margins may be affected adversely |
| If we do not correctly anticipate our short and long-term needs for titles, our subscriber satisfaction and results of operations may be affected adversely |
| If we do not acquire sufficient copies of titles, we may not satisfy subscriber demand, and our subscriber satisfaction and results of operations could be affected adversely |
| Conversely, if we attempt to mitigate this risk and acquire more copies than needed to satisfy our subscriber demand, our inventory utilization would become less effective and our gross margins would be affected adversely |
| If we are unable to renew or renegotiate our revenue sharing agreements when they expire on terms favorable to us, or if the cost of purchasing titles on a wholesale basis increases, our gross margins may be affected adversely |
| Since 2000, we have entered into numerous revenue sharing arrangements with studios and distributors |
| These revenue sharing agreements generally have terms of up to five years |
| Revenue share agreements typically enable us to increase our copy depth of DVDs on an economical basis because of the low initial payment |
| Additional payments are made only if our subscribers rent the DVD Under a purchase arrangement, we must pay the full wholesale price, regardless of whether the DVD is rented |
| In addition, revenue sharing agreements generally provide for studio promotional support of the associated DVD and our service as well as permit us to own the DVD following expiration of the revenue sharing period, typically no more than 12 months following street date |
| During the course of our revenue sharing relationship with studios and distributors, various contract administration issues arise |
| To the extent that we are unable to resolve any of these issues in an amicable manner, our relationship with the studios and distributors may be adversely impacted |
| 13 ______________________________________________________________________ [36]Table of Contents As our revenue sharing agreements expire, we may be required to negotiate new terms that could be disadvantageous to us or if we cannot renew the agreements we would be required to purchase titles |
| In such event, the cost of acquiring content could increase and our gross margins may be affected adversely |
| In addition, if we were required to purchase titles the risk associated with accurately predicting title demand could increase |
| Titles that we do not acquire under a revenue sharing agreement are purchased on a wholesale basis from studios or other distributors |
| If the price of purchased titles increases, our gross margin will be affected adversely |
| If the sales price of DVDs to retail consumers decreases, our ability to attract new subscribers may be affected adversely |
| The cost of manufacturing DVDs is substantially less than the price for which new DVDs are generally sold in the retail market |
| Thus, we believe that studios and other resellers of DVDs have significant flexibility in pricing DVDs for retail sale |
| If the retail price of DVDs decreases significantly, consumers may choose to purchase DVDs instead of subscribing to our service |
| We may need additional capital, and we cannot be sure that additional financing will be available |
| Historically, we have funded our operations and capital expenditures through proceeds from private equity and debt financings, equipment leases and cash flow from operations |
| Although we currently anticipate that the proceeds from our May 2002 initial public offering, together with our available funds and cash flow from operations, will be sufficient to meet our cash needs for the foreseeable future, we may require additional financing |
| Our ability to obtain financing will depend, among other things, on our development efforts, business plans, operating performance and condition of the capital markets at the time we seek financing |
| We cannot assure you that additional financing will be available to us on favorable terms when required, or at all |
| If we raise additional funds through the issuance of equity, equity-linked or debt securities, those securities may have rights, preferences or privileges senior to the rights of our common stock, and our stockholders may experience dilution |
| Any significant disruption in service on our Web site or in our computer systems could result in a loss of subscribers |
| Subscribers and potential subscribers access our service through our Web site, where the title selection process is integrated with our delivery processing systems and software |
| Our reputation and ability to attract, retain and serve our subscribers is dependent upon the reliable performance of our Web site, network infrastructure and fulfillment processes |
| Interruptions in these systems could make our Web site unavailable and hinder our ability to fulfill selections |
| Much of our software is proprietary, and we rely on the expertise of our engineering and software development teams for the continued performance of our software and computer systems |
| Service interruptions or the unavailability of our Web site could diminish the overall attractiveness of our subscription service to existing and potential subscribers |
| Our servers are vulnerable to computer viruses, physical or electronic break-ins and similar disruptions, which could lead to interruptions and delays in our service and operations as well as loss, misuse or theft of data |
| Our Web site periodically experiences directed attacks intended to cause a disruption in service |
| Any attempts by hackers to disrupt our Web site service or our internal systems, if successful, could harm our business, be expensive to remedy and damage our reputation |
| Our insurance does not cover expenses related to direct attacks on our Web site or internal systems |
| Efforts to prevent hackers from entering our computer systems are expensive to implement and may limit the functionality of our services |
| Any significant disruption to our Web site or internal computer systems could result in a loss of subscribers and adversely affect our business and results of operations |
| Our communications hardware and the computer hardware used to operate our Web site are hosted at the facilities of a third party provider |
| Hardware for our delivery systems is maintained in our shipping centers |
| Fires, floods, earthquakes, power losses, telecommunications failures, break-ins and similar events could damage these 14 ______________________________________________________________________ [37]Table of Contents systems and hardware or cause them to fail completely |
| As we do not maintain entirely redundant systems, a disrupting event could result in prolonged downtime of our operations and could adversely affect our business |
| Problems faced by our third party Web hosting provider, with the telecommunications network providers with whom it contracts or with the systems by which it allocates capacity among its customers, including us, could impact adversely the experience of our subscribers |
| Our executive offices and our Sunnyvale-based shipping center are located in the San Francisco Bay Area |
| In the event of an earthquake or other natural or man-made disaster, our operations would be affected adversely |
| Our executive offices and our Sunnyvale-based shipping center, which also houses our customer service operations, are located in the San Francisco Bay Area |
| Our business and operations could be adversely affected in the event of electrical blackouts, fires, floods, earthquakes, power losses, telecommunications failures, break-ins or similar events |
| We may not be able to effectively shift our fulfillment and delivery operations due to disruptions in service in the San Francisco Bay Area or any other facility |
| Because the San Francisco Bay Area is located in an earthquake-sensitive area, we are particularly susceptible to the risk of damage to, or total destruction of, our Sunnyvale-based operations center and the surrounding transportation infrastructure |
| We are not insured against any losses or expenses that arise from a disruption to our business due to earthquakes |
| The loss of our Chief Executive Officer, Chief Financial Officer or Chief Marketing Officer, or our failure to attract, assimilate and retain other highly qualified personnel in the future, could harm our business and new service developments |
| We depend on the continued services and performance of our key personnel, including Reed Hastings, our Chief Executive Officer, President and Chairman of the Board, W Barry McCarthy Jr, our Chief Financial Officer and Leslie J Kilgore, our Chief Marketing Officer |
| In addition, much of our key technology and systems are custom-made for our business by our personnel |
| The loss of key personnel could disrupt our operations and have an adverse effect on our ability to grow our business |
| Privacy concerns could limit our ability to leverage our subscriber data |
| In the ordinary course of business, and in particular in connection with providing our personal movie recommendation service, we collect and utilize data supplied by our subscribers |
| We currently face certain legal obligations regarding the manner in which we treat such information |
| Other businesses have been criticized by privacy groups and governmental bodies for attempts to link personal identities and other information to data collected on the Internet regarding users’ browsing and other habits |
| Increased regulation of data utilization practices, including self-regulation, as well as increased enforcement of existing laws, could have an adverse effect on our business |
| Our reputation and relationships with subscribers would be harmed if our billing data were to be accessed by unauthorized persons |
| To secure transmission of confidential information obtained by us for billing purposes, including subscribers’ credit card or checking account data, we rely on licensed encryption and authentication technology |
| In conjunction with the payment processing companies, we take measures to protect against unauthorized intrusion into our subscribers’ data |
| If, despite these measures, we experience any unauthorized intrusion into our subscribers’ data, current and potential subscribers may become unwilling to provide the information to us necessary for them to become subscribers, and our business could be affected adversely |
| Similarly, if a well-publicized breach of the consumer data security of any other major consumer Web site were to occur, there could be a general public loss of confidence in the use of the Internet for commerce transactions, which could adversely affect our business |
| In addition, because we obtain subscribers’ billing information on our Web site, we do not obtain signatures from subscribers in connection with the use of credit cards by them |
| Under current credit card practices, to the 15 ______________________________________________________________________ [38]Table of Contents extent we do not obtain cardholders’ signatures, we are liable for fraudulent credit card transactions, even when the associated financial institution approves payment of the orders |
| From time to time, fraudulent credit cards are used on our Web site to obtain service and access our DVD inventory |
| Typically, these credit cards have not been registered as stolen and are therefore not rejected by our automatic authorization safeguards |
| While we do have a number of other safeguards in place, we nonetheless experience some loss from these fraudulent transactions |
| We do not currently carry insurance against the risk of fraudulent credit card transactions |
| A failure to adequately control fraudulent credit card transactions would harm our business and results of operations |
| Increases in payment processing fees would increase our operating expenses and adversely affect our results of operations |
| Our subscribers pay for our subscription services predominately using credit cards and debit cards and, to a lesser extent, electronic checks |
| Our acceptance of these payment methods requires our payment of certain fees |
| From time to time, these fees may increase, either as a result of rate changes by the payment processing companies or as a result in a change in our business practices which increase the fees on a cost-per-transaction basis |
| These fees may increase in 2006 |
| Such increase may adversely affect our results of operations |
| If our trademarks and other proprietary rights are not adequately protected to prevent use or appropriation by our competitors, the value of our brand and other intangible assets may be diminished, and our business may be adversely affected |
| We rely and expect to continue to rely on a combination of confidentiality and license agreements with our employees, consultants and third parties with whom we have relationships, as well as trademark, copyright, patent and trade secret protection laws, to protect our proprietary rights |
| Netflix is a registered trademark of Netflix, Inc |
| We have also filed trademark applications in the United States for the Friends and Profiles service marks and for the Netflix design logo, and have filed US patent applications for certain aspects of our technology |
| We have also filed a trademark application in the European Union for the Netflix name |
| From time to time we expect to file additional trademark and patent applications |
| Nevertheless, these applications may not be approved, third parties may challenge any patents issued to or held by us, third parties may knowingly or unknowingly infringe our patents, trademarks and other proprietary rights, and we may not be able to prevent infringement without substantial expense to us |
| If the protection of our proprietary rights is inadequate to prevent use or appropriation by third parties, the value of our brand and other intangible assets may be diminished, competitors may be able to more effectively mimic our service and methods of operations, the perception of our business and service to subscribers and potential subscribers may become confused in the marketplace and our ability to attract subscribers may be adversely affected Intellectual property claims against us could be costly and result in the loss of significant rights related to, among other things, our Web site, our recommendation service, title selection processes and marketing activities |
| Trademark, copyright, patent and other intellectual property rights are important to us and other companies |
| Our intellectual property rights extend to our technology, business processes and the content on our Web site |
| We use the intellectual property of third parties in merchandising our products and marketing our service through contractual and other rights |
| From time to time, third parties allege that we have violated their intellectual property rights |
| If we are unable to obtain sufficient rights or develop non-infringing intellectual property or otherwise alter our business practices on a timely basis in response to claims against us for infringement, misappropriation, misuse or other violation of third party intellectual property rights, our business and competitive position may be affected adversely |
| Many companies are devoting significant resources to developing patents that could potentially affect many aspects of our business |
| There are numerous patents that broadly claim means and methods of conducting business on the Internet |
| We have not exhaustively searched patents relative to our technology |
| Defending ourselves against intellectual property claims, whether they are with or without merit or are determined in our favor, results in costly litigation and diversion of technical and 16 ______________________________________________________________________ [39]Table of Contents management personnel |
| It also may result in our inability to use our current Web site or our recommendation service or inability to market our service or merchandise our products |
| As a result of a dispute, we may have to develop non-infringing technology, enter into royalty or licensing agreements, adjust our merchandizing or marketing activities or take other actions to resolve the claims |
| If we are unable to protect our domain names, our reputation and brand could be affected adversely |
| We currently hold various domain names relating to our brand, including Netflix |
| Failure to protect our domain names could affect adversely our reputation and brand, and make it more difficult for users to find our Web site and our service |
| The acquisition and maintenance of domain names generally are regulated by governmental agencies and their designees |
| The regulation of domain names in the United States may change in the near future |
| Governing bodies may establish additional top-level domains, appoint additional domain name registrars or modify the requirements for holding domain names |
| Furthermore, the relationship between regulations governing domain names and laws protecting trademarks and similar proprietary rights is unclear |
| We may be unable, without significant cost or at all, to prevent third parties from acquiring domain names that are similar to, infringe upon or otherwise decrease the value of our trademarks and other proprietary rights |
| Forecasting film revenue and associated gross profits from our films prior to release is extremely difficult and may result in significant write-offs |
| We are required to amortize capitalized film production costs over the expected revenue streams as we recognize revenue from the associated films |
| The amount of film production costs that will be amortized each period depends on how much future revenue we expect to receive from each film |
| Unamortized film production costs are evaluated for impairment each reporting period on a film-by-film basis |
| If estimated remaining revenue is not sufficient to recover the unamortized film production costs, the unamortized film production costs will be written down to fair value |
| In any given period, if we lower our previous forecast with respect to total anticipated revenue from any individual film, we would be required to accelerate amortization of related film costs |
| Such accelerated amortization would adversely impact our business, operating results and financial condition |
| In addition, we base our estimates of revenue on performance of comparable titles and our knowledge of the industry |
| If the information is incorrect, the amount of revenue and related expenses that we recognize from our films could be wrong, which could result in fluctuations in our earnings |
| If we become subject to liability for content that we publish or that we distribute on DVD through our service, our results of operations would be affected adversely |
| As a publisher of content, a host of third party content and a distributor of content on DVD, we face potential liability for negligence, copyright, patent or trademark infringement or other claims based on the nature and content of materials that we publish or distribute |
| We also may face potential liability for content uploaded from our users in connection with our community-related content or movie reviews |
| If we become liable, then our business may suffer |
| Litigation to defend these claims could be costly and the expenses and damages arising from any liability could harm our results of operations |
| We cannot assure you that we are adequately insured to cover claims of these types or to indemnify us for all liability that may be imposed on us |
| If government regulation of the Internet or other areas of our business changes or if consumer attitudes toward use of the Internet change, we may need to change the manner in which we conduct our business, or incur greater operating expenses |
| The adoption or modification of laws or regulations relating to the Internet or other areas of our business could limit or otherwise adversely affect the manner in which we currently conduct our business |
| In addition, the 17 ______________________________________________________________________ [40]Table of Contents growth and development of the market for online commerce may lead to more stringent consumer protection laws, which may impose additional burdens on us |
| If we are required to comply with new regulations or legislation or new interpretations of existing regulations or legislation, this compliance could cause us to incur additional expenses or alter our business model |
| The manner in which Internet and other legislation may be interpreted and enforced cannot be precisely determined and may subject either us or our customers to potential liability, which in turn could have an adverse effect on our business, results of operations and financial condition |
| The adoption of any laws or regulations that adversely affect the popularity or growth in use of the Internet, including laws limiting Internet neutrality, could decrease the demand for our subscription service and increase our cost of doing business |
| In addition, if consumer attitudes toward use of the Internet change, consumers may become unwilling to select their entertainment online or otherwise provide us with information necessary for them to become subscribers |
| Further, we may not be able to effectively market our services online to users of the Internet |
| If we are unable to interact with consumers because of changes in their attitude toward use of the Internet, our subscriber acquisition and retention may be affected adversely |
| We may be engaged in legal proceedings that could cause us to incur unforeseen expenses and could occupy a significant amount of our management’s time and attention |
| From time to time, we are subject to litigation or claims that could negatively affect our business operations and financial position |
| Such disputes could cause us to incur unforeseen expenses, could occupy a significant amount of our management’s time and attention, and could negatively affect our business operations and financial position |
| Recently enacted changes in securities laws and regulations have increased and may continue to increase our costs |
| Changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and recently-enacted rules promulgated by the Securities and Exchange Commission, have increased and may continue to increase our expenses as we evaluate the implications of these rules and devote resources to respond to their requirements |
| The NASDAQ National Market, on which our common stock is listed, has also adopted comprehensive rules and regulations relating to corporate governance |
| These laws, rules and regulations have increased and will continue to increase the scope, complexity and cost of our corporate governance, reporting and disclosure practices |
| We also expect these developments to make it more difficult and more expensive for us to obtain director and officer liability insurance in the future, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage |
| Further, our board members, Chief Executive Officer and Chief Financial Officer could face an increased risk of personal liability in connection with the performance of their duties |
| As a result, we may have difficulty attracting and retaining qualified board members and executive officers, which would adversely affect our business |
| Risks Related to Our Stock Ownership Our officers and directors and their affiliates will exercise significant control over Netflix |
| As of December 31, 2005, our executive officers and directors, their immediate family members and affiliated venture capital funds beneficially owned, in the aggregate, approximately 31 percent of our outstanding common stock, warrants and stock options that are exercisable within 60 days |
| In particular, Jay Hoag, one of our directors, beneficially owned approximately 21 percent and Reed Hastings, our Chief Executive Officer, President and Chairman of the Board, beneficially owned approximately 10 percent |
| These stockholders may have individual interests that are different from yours and will be able to exercise significant control over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, which could delay or prevent someone from acquiring or merging with us |
| 18 ______________________________________________________________________ [41]Table of Contents Provisions in our charter documents and under Delaware law could discourage a takeover that stockholders may consider favorable |
| Our charter documents may discourage, delay or prevent a merger or acquisition that a stockholder may consider favorable because they: • authorize our board of directors, without stockholder approval, to issue up to 10cmam000cmam000 shares of undesignated preferred stock; • provide for a classified board of directors; • prohibit our stockholders from acting by written consent; • establish advance notice requirements for proposing matters to be approved by stockholders at stockholder meetings; and • prohibit stockholders from calling a special meeting of stockholders |
| In addition, a merger or acquisition may trigger retention payments to certain executive employees under the terms of our Executive Severance and Retention Incentive Plan, thereby increasing the cost of such a transaction |
| As a Delaware corporation, we are also subject to certain Delaware anti-takeover provisions |
| Under Delaware law, a corporation may not engage in a business combination with any holder of 15 percent or more of its capital stock unless the holder has held the stock for three years or, among other things, the board of directors has approved the transaction |
| Our board of directors could rely on Delaware law to prevent or delay an acquisition of us |
| The price at which our common stock has traded since our May 2002 initial public offering has fluctuated significantly |
| The price may continue to be volatile due to a number of factors including the following, some of which are beyond our control: • variations in our operating results; • variations between our actual operating results and the expectations of securities analysts, investors and the financial community; • announcements of developments affecting our business, systems or expansion plans by us or others; • competition, including the introduction of new competitors, their pricing strategies and services; • market volatility in general; • the level of short interest in our stock; and • the operating results of our competitors |
| As a result of these and other factors, investors in our common stock may not be able to resell their shares at or above their original purchase price |
| Following certain periods of volatility in the market price of our securities, we became the subject of securities litigation |
| We may experience more such litigation following future periods of volatility |
| This type of litigation may result in substantial costs and a diversion of management’s attention and resources |
| We record substantial expenses related to our issuance of stock options that may have a material negative impact on our operating results for the foreseeable future |
| During the second quarter of 2003, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards Nodtta 123 “Accounting for Stock-Based Compensation” (“SFAS 123”) for stock- based employee compensation |
| In addition, during the third quarter of 2003, we began granting stock options to 19 ______________________________________________________________________ [42]Table of Contents our employees on a monthly basis |
| The vesting periods provide for options to vest immediately, in comparison with the three to four-year vesting periods for stock options granted prior to the third quarter of 2003 |
| As a result of immediate vesting, stock-based compensation expenses determined under SFAS Nodtta 123 are fully recognized in the same periods as the monthly stock option grants |
| In addition, we continue to amortize the deferred compensation of stock options with three to four-year vesting periods granted prior to the third quarter of 2003 over the remaining vesting periods |
| We expect our stock-based compensation expenses will continue to be significant in future periods, which will have an adverse impact on our operating results |
| The Black-Scholes option-pricing model, used by us, requires the input of highly subjective assumptions, including the option’s expected life and the price volatility of the underlying stock |
| Changes in the subjective input assumptions can materially affect the fair value estimate |
| Financial forecasting by us and financial analysts who may publish estimates of our performance may differ materially from actual results |
| Given the dynamic nature of our business and the inherent limitations in predicting the future, forecasts of our revenues, gross margin, operating expenses, number of paying subscribers, number of DVDs shipped per day and other financial and operating data may differ materially from actual results |
| Such discrepancies could cause a decline in the trading price of our common stock |