Netflix (NFLX)

Descriptions of Consolidated Statements of Operations Components

Revenues

We derive substantially all of our revenues from monthly subscription fees and recognize subscription revenues ratably over each subscriber’s monthly subscription period. We record refunds to subscribers as a reduction of revenues. We generate all our revenues in the United States.

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Cost of Revenues

Subscription

Cost of subscription revenues consists of postage and packaging costs related to shipping DVDs to subscribers as well as content related expenses. Costs related to free-trial periods are allocated to marketing expenses.

Postage and Packaging.    Postage and packaging expenses consist of the postage costs to mail DVDs to and from our paying subscribers and the packaging and label costs for the mailers. Between January 8, 2006 and May 13, 2007, the rate for first-class postage was $0.39. The U.S. Postal Service increased the rate of first class postage by 2 cents to $0.41 effective May 14, 2007 and by one cent to $0.42 effective May 12, 2008. We receive discounts on outbound postage costs related to our mail preparation practices.

Content Expenses.    We obtain titles from studios and distributors through direct purchases, revenue sharing agreements or license agreements. Direct purchases of DVDs normally result in higher upfront costs than titles obtained through revenue sharing agreements. Content related expenses consist of costs incurred in obtaining titles such as amortization of content and revenue sharing expense.

Fulfillment expenses

Fulfillment expenses represent those expenses incurred in operating and staffing our shipping and customer service centers, including costs attributable to receiving, inspecting and warehousing our content library. Fulfillment expenses also include credit card fees.

Operating Expenses

Technology and Development.    Technology and development expenses consist of payroll and related costs incurred in testing, maintaining and modifying our Web site, our recommendation service, developing solutions for streaming content to subscribers, telecommunications systems and infrastructure and other internal-use software systems. Technology and development expenses also include depreciation of the computer hardware and capitalized software we use to run our Web site and store our data.

Marketing.    Marketing expenses consist primarily of advertising expenses. Advertising expenses include marketing program expenditures and other promotional activities, including allocated costs of revenues relating to free trial periods Also included in marketing expense are payments made to our consumer electronics partners to generate new subscribers for our service as well as payroll related expenses.

General and Administrative.    General and administrative expenses consist of payroll and related expenses for executive, finance, content acquisition and administrative personnel, as well as recruiting, professional fees and other general corporate expenses.

Stock-Based Compensation.    Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123(R) using the modified prospective method.

We grant stock options to our employees on a monthly basis. We have elected to grant all options as non-qualified stock options which vest immediately. As a result of immediate vesting, stock-based compensation expense determined under SFAS No. 123(R) is fully recognized on the grant date, and no estimate is required for post-vesting option forfeitures.

Gain on disposal of DVDs.    Gain on disposal of DVDs represents the difference between proceeds from sales of DVDs and associated cost of DVD sales. Cost of DVD sales includes the net book value of the DVDs sold, shipping charges and, where applicable, a contractually specified fee for the DVDs that are subject to revenue sharing agreements.

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Descriptions of Consolidated Statements of Operations Components

Revenues

We derive substantially all of our revenues from monthly subscription fees and recognize subscription revenues ratably over each subscriber’s monthly subscription period. We record refunds to subscribers as a reduction of revenues. We generate all our revenues in the United States.

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Table of Contents

Cost of Revenues

Subscription

Cost of subscription revenues consists of postage and packaging costs related to shipping DVDs to subscribers as well as content related expenses. Costs related to free-trial periods are allocated to marketing expenses.

Postage and Packaging.    Postage and packaging expenses consist of the postage costs to mail DVDs to and from our paying subscribers and the packaging and label costs for the mailers. Between January 8, 2006 and May 13, 2007, the rate for first-class postage was $0.39. The U.S. Postal Service increased the rate of first class postage by 2 cents to $0.41 effective May 14, 2007 and by one cent to $0.42 effective May 12, 2008. We receive discounts on outbound postage costs related to our mail preparation practices.

Content Expenses.    We obtain titles from studios and distributors through direct purchases, revenue sharing agreements or license agreements. Direct purchases of DVDs normally result in higher upfront costs than titles obtained through revenue sharing agreements. Content related expenses consist of costs incurred in obtaining titles such as amortization of content and revenue sharing expense.

Fulfillment expenses

Fulfillment expenses represent those expenses incurred in operating and staffing our shipping and customer service centers, including costs attributable to receiving, inspecting and warehousing our content library. Fulfillment expenses also include credit card fees.

Operating Expenses

Technology and Development.    Technology and development expenses consist of payroll and related costs incurred in testing, maintaining and modifying our Web site, our recommendation service, developing solutions for streaming content to subscribers, telecommunications systems and infrastructure and other internal-use software systems. Technology and development expenses also include depreciation of the computer hardware and capitalized software we use to run our Web site and store our data.

Marketing.    Marketing expenses consist primarily of advertising expenses. Advertising expenses include marketing program expenditures and other promotional activities, including allocated costs of revenues relating to free trial periods Also included in marketing expense are payments made to our consumer electronics partners to generate new subscribers for our service as well as payroll related expenses.

General and Administrative.    General and administrative expenses consist of payroll and related expenses for executive, finance, content acquisition and administrative personnel, as well as recruiting, professional fees and other general corporate expenses.

Stock-Based Compensation.    Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123(R) using the modified prospective method.

We grant stock options to our employees on a monthly basis. We have elected to grant all options as non-qualified stock options which vest immediately. As a result of immediate vesting, stock-based compensation expense determined under SFAS No. 123(R) is fully recognized on the grant date, and no estimate is required for post-vesting option forfeitures.

Gain on disposal of DVDs.    Gain on disposal of DVDs represents the difference between proceeds from sales of DVDs and associated cost of DVD sales. Cost of DVD sales includes the net book value of the DVDs sold, shipping charges and, where applicable, a contractually specified fee for the DVDs that are subject to revenue sharing agreements.

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Descriptions of Consolidated Statements of Operations Components

Descriptions of Consolidated Statements of Operations Components

Descriptions of Consolidated Statements of Operations Components

Descriptions of Consolidated Statements of Operations Components

Revenues

We generate all our revenues in the United States. We derive substantially all of our revenues from monthly subscription fees and recognize subscription revenues ratably over each subscriber’s monthly subscription period. We record refunds to subscribers as a reduction of revenues.

Cost of Revenues

Subscription

We acquire titles from studios and distributors through direct purchases, revenue sharing agreements or license agreements. Direct purchases of DVDs normally result in higher upfront costs than titles obtained through revenue sharing agreements. Cost of subscription revenues consists of postage and packaging costs related to shipping titles to paying subscribers, amortization of our content library and revenue sharing expenses. Costs related to free-trial subscribers are allocated to marketing expenses.

Postage and Packaging.    Postage and packaging expenses consist of the postage costs to mail DVDs to and from our paying subscribers and the packaging and label costs for the mailers. The rate for first-class postage was $0.37 between June 29, 2002 and January 7, 2006. Between January 8, 2006 and May 13, 2007, the rate for first-class postage was $0.39. The U.S. Postal Service increased the rate of first class postage by 2 cents to $0.41 effective May 14, 2007 and by one cent to $0.42 effective May 12, 2008. We receive discounts on outbound postage costs related to our mail preparation practices.

Amortization of Content Library.    The useful life of the new release DVDs and back catalog DVDs is estimated to be 1 year and 3 years, respectively. We provide a salvage value of $3.00 per DVD for those direct purchase DVDs that we estimate will sell at the end of their useful lives. For those DVDs that we do not expect to sell, no salvage value is provided. We amortize license fees on Internet-based content on a straight-line basis consistent with the terms of the license agreements.

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Revenue Sharing Expenses.    Our revenue sharing agreements generally commit us to pay an initial upfront fee for content acquired and either a percentage of revenue earned from such rentals for a defined period of time or to pay a fee based on utilization. A portion of the initial upfront fees are non-recoupable for revenue sharing purposes and are capitalized and amortized in accordance with our content library amortization policy. The remaining portion of the initial upfront fee represents prepaid revenue sharing, and this amount is expensed as revenue sharing expense as content subject to revenue sharing agreements is shipped to or watched by subscribers. The terms of some revenue sharing agreements with studios obligate us to make minimum revenue sharing payments for certain titles. We amortize minimum revenue sharing prepayments (or accrete an amount payable to studios if the payment is due in arrears) as revenue sharing obligations are incurred. A provision for estimated shortfall, if any, on minimum revenue sharing payments is made in the period in which the shortfall becomes probable and can be reasonably estimated. Additionally, the terms of some revenue sharing agreements with studios provide for rebates based on achieving specified performance levels. Volume purchase discounts received from studios on the purchase of titles are accrued when earned based on historical title performance and estimates of demand for the titles over the remainder of the title term.

Fulfillment expenses

Fulfillment expenses represent those expenses incurred in operating and staffing our shipping and customer service centers, including costs attributable to receiving, inspecting and warehousing our content library. Fulfillment expenses also include credit card fees.

Operating Expenses

Technology and Development.    Technology and development expenses consist of payroll and related costs incurred in testing, maintaining and modifying our Web site, our recommendation service, developing solutions for the Internet-based delivery of content to subscribers, telecommunications systems and infrastructure and other internal-use software systems. Technology and development expenses also include depreciation of the computer hardware and capitalized software we use to run our Web site and store our data.

Marketing.    Marketing expenses consist primarily of advertising expenses. Advertising expenses include marketing program expenditures and other promotional activities, including revenue sharing expenses, postage and packaging expenses and content amortization related to free trial periods. Marketing expenses also include payroll and related expenses for marketing personnel.

General and Administrative.    General and administrative expenses consist of payroll and related expenses for executive, finance, content acquisition and administrative personnel, as well as recruiting, professional fees and other general corporate expenses.

Stock-Based Compensation.    Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123(R) using the modified prospective method. We had previously adopted the fair value recognition provisions of SFAS No. 123 as amended by SFAS No. 148 and restated prior periods at that time.

We grant stock options to our employees on a monthly basis. We have elected to grant all options as non-qualified stock options which vest immediately. As a result of immediate vesting, stock-based compensation expense determined under SFAS No. 123(R) is fully recognized on the grant date, and no estimate is required for post-vesting option forfeitures.

Gain on disposal of DVDs.    Gain on disposal of DVDs represents the difference between proceeds from sales of DVDs and associated cost of DVD sales. Cost of DVD sales includes the net book value of the DVDs sold, shipping charges and, where applicable, a contractually specified fee for the DVDs that are subject to revenue sharing agreements.

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