NFLX-09.30.12-10Q-DOC
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
| |
ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2012
OR
| |
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 000-49802
Netflix, Inc.
(Exact name of Registrant as specified in its charter)
|
| |
Delaware | 77-0467272 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) |
100 Winchester Circle, Los Gatos, California 95032
(Address and zip code of principal executive offices)
(408) 540-3700
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
|
| | | | |
Large accelerated filer | ý | | Accelerated filer | o |
Non-accelerated filer | o | (Do not check if a smaller reporting company) | Smaller reporting company | o |
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes o No ý
As of September 30, 2012, there were 55,545,531 shares of the registrant’s common stock, par value $0.001, outstanding.
Table of Contents
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| | |
| | Page |
| Part I. Financial Information | |
Item 1. | Consolidated Financial Statements | |
| | |
| Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2012 and 2011 | |
| | |
| | |
| | |
Item 2. | | |
Item 3. | | |
Item 4. | | |
| Part II. Other Information | |
Item 1. | | |
Item 1A. | | |
Item 6. | | |
| | |
| | |
NETFLIX, INC.
Consolidated Statements of Operations
(unaudited)
(in thousands, except per share data)
|
| | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
| September 30, 2012 | | September 30, 2011 | | September 30, 2012 | | September 30, 2011 |
Revenues | $ | 905,089 |
| | $ | 821,839 |
| | $ | 2,664,043 |
| | $ | 2,329,002 |
|
Cost of revenues: | | | | | | | |
Subscription | 602,165 |
| | 471,823 |
| | 1,749,816 |
| | 1,277,018 |
|
Fulfillment expenses | 60,473 |
| | 64,794 |
| | 180,183 |
| | 187,728 |
|
Total cost of revenues | 662,638 |
| | 536,617 |
| | 1,929,999 |
| | 1,464,746 |
|
Gross profit | 242,451 |
| | 285,222 |
| | 734,044 |
| | 864,256 |
|
Operating expenses: | | | | | | | |
Marketing | 113,233 |
| | 89,108 |
| | 367,357 |
| | 288,350 |
|
Technology and development | 82,521 |
| | 69,480 |
| | 246,869 |
| | 178,250 |
|
General and administrative | 30,562 |
| | 29,792 |
| | 89,464 |
| | 83,460 |
|
Total operating expenses | 226,316 |
| | 188,380 |
| | 703,690 |
| | 550,060 |
|
Operating income | 16,135 |
| | 96,842 |
| | 30,354 |
| | 314,196 |
|
Other income (expense): | | | | | | | |
Interest expense | (4,990 | ) | | (4,915 | ) | | (14,970 | ) | | (15,083 | ) |
Interest and other income (expense) | 801 |
| | 1,696 |
| | 192 |
| | 3,574 |
|
Income before income taxes | 11,946 |
| | 93,623 |
| | 15,576 |
| | 302,687 |
|
Provision for income taxes | 4,271 |
| | 31,163 |
| | 6,321 |
| | 111,780 |
|
Net income | $ | 7,675 |
| | $ | 62,460 |
| | $ | 9,255 |
| | $ | 190,907 |
|
Earnings per share: | | | | | | | |
Basic | $ | 0.14 |
| | $ | 1.19 |
| | $ | 0.17 |
| | $ | 3.63 |
|
Diluted | $ | 0.13 |
| | $ | 1.16 |
| | $ | 0.16 |
| | $ | 3.53 |
|
Weighted average common shares outstanding: | | | | | | | |
Basic | 55,541 |
| | 52,569 |
| | 55,508 |
| | 52,599 |
|
Diluted | 58,729 |
| | 53,870 |
| | 58,829 |
| | 54,008 |
|
See accompanying notes to the consolidated financial statements.
NETFLIX, INC.
Consolidated Statements of Comprehensive Income
(unaudited)
(in thousands)
|
| | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
| September 30, 2012 | | September 30, 2011 | | September 30, 2012 | | September 30, 2011 |
Net income | $ | 7,675 |
| | $ | 62,460 |
| | $ | 9,255 |
| | $ | 190,907 |
|
Other comprehensive income (loss): | | | | | | | |
Foreign currency translation adjustments | 1,084 |
| | — |
| | 1,128 |
| | — |
|
Change in unrealized gains on available-for-sale securities | 1,565 |
| | (213 | ) | | 1,908 |
| | 172 |
|
Other comprehensive income (loss) before tax | 2,649 |
| | (213 | ) | | 3,036 |
| | 172 |
|
Income tax expense related to items of other comprehensive income | (604 | ) | | (83 | ) | | (736 | ) | | (334 | ) |
Other comprehensive income (loss), net of tax | 2,045 |
| | (296 | ) | | 2,300 |
| | (162 | ) |
Comprehensive income | $ | 9,720 |
| | $ | 62,164 |
| | $ | 11,555 |
| | $ | 190,745 |
|
See accompanying notes to the consolidated financial statements.
NETFLIX, INC.
Consolidated Balance Sheets
(in thousands, except share and par value data)
|
| | | | | | | |
| As of |
| September 30, 2012 | | December 31, 2011 |
| (unaudited) | | |
Assets | | | |
Current assets: | | | |
Cash and cash equivalents | $ | 370,298 |
| | $ | 508,053 |
|
Short-term investments | 428,057 |
| | 289,758 |
|
Current content library, net | 1,335,769 |
| | 919,709 |
|
Prepaid content | 33,152 |
| | 56,007 |
|
Other current assets | 57,742 |
| | 57,330 |
|
Total current assets | 2,225,018 |
| | 1,830,857 |
|
Non-current content library, net | 1,366,566 |
| | 1,046,934 |
|
Property and equipment, net | 133,603 |
| | 136,353 |
|
Other non-current assets | 83,646 |
| | 55,052 |
|
Total assets | $ | 3,808,833 |
| | $ | 3,069,196 |
|
Liabilities and Stockholders’ Equity | | | |
Current liabilities: | | | |
Content liabilities | $ | 1,280,885 |
| | $ | 935,036 |
|
Accounts payable | 91,511 |
| | 86,992 |
|
Accrued expenses | 70,681 |
| | 54,231 |
|
Deferred revenue | 155,146 |
| | 148,796 |
|
Total current liabilities | 1,598,223 |
| | 1,225,055 |
|
Non-current content liabilities | 1,030,979 |
| | 739,628 |
|
Long-term debt | 200,000 |
| | 200,000 |
|
Long-term debt due to related party | 200,000 |
| | 200,000 |
|
Other non-current liabilities | 62,791 |
| | 61,703 |
|
Total liabilities | 3,091,993 |
| | 2,426,386 |
|
Commitments and contingencies (Note 8) |
|
| |
|
|
Stockholders’ equity: | | | |
Common stock, $0.001 par value; 160,000,000 shares authorized at September 30, 2012 and December 31, 2011; 55,545,531 and 55,398,615 issued and outstanding at September 30, 2012 and December 31, 2011, respectively | 56 |
| | 55 |
|
Additional paid-in capital | 281,593 |
| | 219,119 |
|
Accumulated other comprehensive income, net | 3,006 |
| | 706 |
|
Retained earnings | 432,185 |
| | 422,930 |
|
Total stockholders’ equity | 716,840 |
| | 642,810 |
|
Total liabilities and stockholders’ equity | $ | 3,808,833 |
| | $ | 3,069,196 |
|
See accompanying notes to the consolidated financial statements.
NETFLIX, INC.
Consolidated Statements of Cash Flows
(unaudited)
(in thousands)
|
| | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
| September 30, 2012 | | September 30, 2011 | | September 30, 2012 | | September 30, 2011 |
Cash flows from operating activities: | | | | | | | |
Net income | $ | 7,675 |
| | $ | 62,460 |
| | $ | 9,255 |
| | $ | 190,907 |
|
Adjustments to reconcile net income to net cash provided by operating activities: | | | | |
| |
|
Additions to streaming content library | (744,714 | ) | | (539,285 | ) | | (1,883,859 | ) | | (1,344,187 | ) |
Change in streaming content liabilities | 274,196 |
| | 313,781 |
| | 631,802 |
| | 819,909 |
|
Amortization of streaming content library | 410,947 |
| | 187,446 |
| | 1,126,680 |
| | 417,849 |
|
Amortization of DVD content library | 13,132 |
| | 23,000 |
| | 49,482 |
| | 73,990 |
|
Depreciation and amortization of property, equipment and intangibles | 11,128 |
| | 11,913 |
| | 33,506 |
| | 31,921 |
|
Stock-based compensation expense | 18,472 |
| | 15,705 |
| | 56,254 |
| | 43,505 |
|
Excess tax benefits from stock-based compensation | (111 | ) | | (11,761 | ) | | (4,173 | ) | | (45,283 | ) |
Other non-cash items | (2,078 | ) | | (1,745 | ) | | (5,176 | ) | | (3,472 | ) |
Deferred taxes | (15,606 | ) | | (5,281 | ) | | (26,449 | ) | | (14,190 | ) |
Changes in operating assets and liabilities: | | | | |
| |
|
Prepaid content | 15,358 |
| | (17,335 | ) | | 22,855 |
| | (14,928 | ) |
Other current assets | (3,476 | ) | | (8,578 | ) | | 188 |
| | 4,935 |
|
Accounts payable | (6,652 | ) | | (7,052 | ) | | (7,807 | ) | | 3,949 |
|
Accrued expenses | 15,294 |
| | 23,489 |
| | 23,931 |
| | 59,241 |
|
Deferred revenue | 2,356 |
| | 13,992 |
| | 6,350 |
| | 33,746 |
|
Other non-current assets and liabilities | 4,229 |
| | (11,218 | ) | | 6,112 |
| | (5,646 | ) |
Net cash provided by operating activities | 150 |
| | 49,531 |
| | 38,951 |
| | 252,246 |
|
Cash flows from investing activities: | | | | | | | |
Acquisitions of DVD content library | (8,586 | ) | | (20,826 | ) | | (30,126 | ) | | (62,010 | ) |
Purchases of short-term investments | (67,779 | ) | | (7,673 | ) | | (430,549 | ) | | (100,536 | ) |
Proceeds from sale of short-term investments | 52,172 |
| | 37 |
| | 272,680 |
| | 31,508 |
|
Proceeds from maturities of short-term investments | 2,695 |
| | 1,805 |
| | 23,685 |
| | 18,440 |
|
Purchases of property and equipment | (13,883 | ) | | (14,080 | ) | | (22,293 | ) | | (39,026 | ) |
Other assets | 1,857 |
| | (844 | ) | | 6,323 |
| | 1,419 |
|
Net cash used in investing activities | (33,524 | ) | | (41,581 | ) | | (180,280 | ) | | (150,205 | ) |
Cash flows from financing activities: | | | | | | | |
Proceeds from issuance of common stock upon exercise of options | 318 |
| | 4,409 |
| | 2,066 |
| | 18,589 |
|
Financing costs | — |
| | — |
| | (759 | ) | | — |
|
Repurchases of common stock | — |
| | (39,602 | ) | | — |
| | (199,666 | ) |
Excess tax benefits from stock-based compensation | 111 |
| | 11,761 |
| | 4,173 |
| | 45,283 |
|
Principal payments of lease financing obligations | (587 | ) | | (526 | ) | | (1,723 | ) | | (1,547 | ) |
Net cash provided by (used in) financing activities | (158 | ) | | (23,958 | ) | | 3,757 |
| | (137,341 | ) |
Effect of exchange rate changes on cash and cash equivalents | 1,579 |
| | — |
| | (183 | ) | | — |
|
Net decrease in cash and cash equivalents | (31,953 | ) | | (16,008 | ) | | (137,755 | ) | | (35,300 | ) |
Cash and cash equivalents, beginning of period | 402,251 |
| | 175,207 |
| | 508,053 |
| | 194,499 |
|
Cash and cash equivalents, end of period | $ | 370,298 |
| | $ | 159,199 |
| | $ | 370,298 |
| | $ | 159,199 |
|
See accompanying notes to the consolidated financial statements.
NETFLIX, INC.
Notes to Consolidated Financial Statements
(unaudited)
1. Basis of Presentation and Summary of Significant Accounting Policies
The accompanying consolidated interim financial statements of Netflix, Inc. and its wholly owned subsidiaries (the “Company”) have been prepared in conformity with accounting principles generally accepted in the United States (“U.S.”) and are consistent in all material respects with those applied in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission (the “SEC”) on February 10, 2012. The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. Significant items subject to such estimates and assumptions include: the amortization policy of the Company’s content library; the valuation of stock-based compensation; and the recognition and measurement of income tax assets and liabilities. The Company bases its estimates on historical experience and on various other assumptions that the Company believes to be reasonable under the circumstances. The actual results experienced by the Company may differ from management’s estimates.
The interim financial information is unaudited, but reflects all normal recurring adjustments that are, in the opinion of management, necessary to fairly present the information set forth herein. The interim financial statements should be read in conjunction with the audited financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. Interim results are not necessarily indicative of the results for a full year.
The Company is organized into three operating segments: Domestic streaming, International streaming and Domestic DVD. Substantially all of the Company’s revenues are generated in the U.S., and substantially all of the Company’s long-lived tangible assets are held in the U.S. The Company’s revenues are derived from monthly subscription fees.
Certain prior period amounts have been reclassified to conform to current period presentation. These reclassifications did not impact total assets, total liabilities, stockholders’ equity, results of operations or cash flows.
There have been no material changes in the Company’s significant accounting policies as compared to the significant accounting policies described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.
2. Earnings Per Share
Basic earnings per share is computed using the weighted-average number of outstanding shares of common stock during the period. Diluted earnings per share is computed using the weighted-average number of outstanding shares of common stock and, when dilutive, potential outstanding shares of common stock during the period. Potential common shares consist of shares issuable upon the assumed conversion of the Company’s Senior Convertible Notes and incremental shares issuable upon the assumed exercise of stock options. The computation of earnings per share is as follows:
|
| | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
| September 30, 2012 | | September 30, 2011 | | September 30, 2012 | | September 30, 2011 |
| (in thousands, except per share data) |
Basic earnings per share: | | | | | | | |
Net income | $ | 7,675 |
| | $ | 62,460 |
| | $ | 9,255 |
| | $ | 190,907 |
|
Shares used in computation: | | | | | | | |
Weighted-average common shares outstanding | 55,541 |
| | 52,569 |
| | 55,508 |
| | 52,599 |
|
Basic earnings per share | $ | 0.14 |
| | $ | 1.19 |
| | $ | 0.17 |
| | $ | 3.63 |
|
| | | | | | | |
Diluted earnings per share: | | | | | | | |
Net income | $ | 7,675 |
| | $ | 62,460 |
| | $ | 9,255 |
| | $ | 190,907 |
|
Convertible Notes interest expense, net of tax | 49 |
| | — |
| | 146 |
| | — |
|
Numerator for diluted earnings per share | $ | 7,724 |
| | $ | 62,460 |
| | $ | 9,401 |
| | $ | 190,907 |
|
Shares used in computation: | | | | | | | |
Weighted-average common shares outstanding | 55,541 |
| | 52,569 |
| | 55,508 |
| | 52,599 |
|
Convertible notes shares | 2,331 |
| | — |
| | 2,331 |
| | — |
|
Employee stock options | 857 |
| | 1,301 |
| | 990 |
| | 1,409 |
|
Weighted-average number of shares | 58,729 |
| | 53,870 |
| | 58,829 |
| | 54,008 |
|
Diluted earnings per share | $ | 0.13 |
| | $ | 1.16 |
| | $ | 0.16 |
| | $ | 3.53 |
|
Employee stock options with exercise prices greater than the average market price of the common stock were excluded from the diluted calculation as their inclusion would have been anti-dilutive. The following table summarizes the potential common shares excluded from the diluted calculation:
|
| | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
| September 30, 2012 | | September 30, 2011 | | September 30, 2012 | | September 30, 2011 |
| (in thousands) |
Employee stock options | 1,782 |
| | 189 |
| | 1,199 |
| | 76 |
|
3. Cash, Cash Equivalents, Short-Term Investments and Fair Value Measurement
The Company’s investment policy is consistent with the definition of available-for-sale securities. The Company does not buy and hold securities principally for the purpose of selling them in the near future. The Company’s policy is focused on the preservation of capital, liquidity and return. From time to time, the Company may sell certain securities but the objectives are generally not to generate profits on short-term differences in price. The following table summarizes, by major security type, the Company’s assets that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy:
|
| | | | | | | | | | | | | | | |
| As of |
| September 30, 2012 |
| Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Estimated Fair Value |
| (in thousands) |
Cash | $ | 331,902 |
| | $ | — |
| | $ | — |
| | $ | 331,902 |
|
Level 1 securities (1): | | | | | | | |
Money market funds | 7,618 |
| | — |
| | — |
| | 7,618 |
|
Level 2 securities (2): | | | | | | | |
Corporate debt securities | 139,064 |
| | 1,709 |
| | (3 | ) | | 140,770 |
|
Government and agency securities | 202,466 |
| | 339 |
| | — |
| | 202,805 |
|
Asset and mortgage-backed securities | 119,179 |
| | 991 |
| | (40 | ) | | 120,130 |
|
| $ | 800,229 |
| | $ | 3,039 |
| | $ | (43 | ) | | $ | 803,225 |
|
Less: Restricted cash (1) | | | | | | | (4,870 | ) |
Total cash, cash equivalents and short-term investments | | | | | | | $ | 798,355 |
|
|
| | | | | | | | | | | | | | | |
| As of |
| December 31, 2011 |
| Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Estimated Fair Value |
| (in thousands) |
Cash | $ | 388,941 |
| | $ | — |
| | $ | — |
| | $ | 388,941 |
|
Level 1 securities (3): | | | | | | | |
Money market funds | 123,608 |
| | — |
| | — |
| | 123,608 |
|
Level 2 securities (4): | | | | | | | |
Corporate debt securities | 112,264 |
| | 603 |
| | (214 | ) | | 112,653 |
|
Government and agency securities | 175,464 |
| | 694 |
| | (56 | ) | | 176,102 |
|
Asset and mortgage-backed securities | 941 |
| | 62 |
| | — |
| | 1,003 |
|
| $ | 801,218 |
| | $ | 1,359 |
| | $ | (270 | ) | | $ | 802,307 |
|
Less: Restricted cash (3) | | | | | | | (4,496 | ) |
Total cash, cash equivalents and short-term investments | | | | | | | $ | 797,811 |
|
| |
(1) | Includes $2.7 million classified in cash and cash equivalents and $4.9 million of restricted cash classified in other non-current assets. |
| |
(2) | Includes $35.6 million classified in cash and cash equivalents and $428.1 million included in short-term investments in the Company’s consolidated balance sheets. |
| |
(3) | Includes $119.1 million classified in cash and cash equivalents and $4.5 million of restricted cash classified in other current assets and non-current assets. |
| |
(4) | Included in short-term investments. |
Fair value is a market-based measurement that should be determined based on the assumptions that market participants would use in pricing an asset or liability. The hierarchy level assigned to each security in the Company’s available-for-sale portfolio and cash equivalents is based on its assessment of the transparency and reliability of the inputs used in the valuation of such instrument at the measurement date. The fair value of available-for-sale securities and cash equivalents included in the Level 1 category is based on quoted prices that are readily and regularly available in an active market. The fair value of cash equivalents and available-for-sale securities included in the Level 2 category is based on observable inputs, such as quoted prices for similar assets at the measurement date; quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly. These values were obtained from an independent pricing service and were evaluated using pricing models that vary by asset class and may incorporate available trade, bid and other market information and price quotes from well-established independent pricing vendors and broker-dealers. The Company's procedures include controls to ensure that appropriate fair values are recorded, such as comparing prices obtained from multiple independent sources. See Note 5 to the consolidated financial statements for further information regarding the fair value of the Company’s Senior Convertible Notes and Senior Notes.
Because the Company does not intend to sell the investments that are in an unrealized loss position and it is not likely that the Company will be required to sell any investments before recovery of their amortized cost basis, the Company does not consider those investments with an unrealized loss to be other-than-temporarily impaired at September 30, 2012. There were no material other-than-temporary impairments or
credit losses related to available-for-sale securities in the three or nine months ended September 30, 2012 and 2011. In addition, there were no material gross realized gains or losses in the three or nine months ended September 30, 2012 and 2011.
The estimated fair value of short-term investments by contractual maturity as of September 30, 2012 is as follows:
|
| | | |
| (in thousands) |
Due within one year | $ | 17,011 |
|
Due after one year and through 5 years | 364,929 |
|
Due after 5 years and through 10 years | 7,091 |
|
Due after 10 years | 39,026 |
|
Total short-term investments | $ | 428,057 |
|
4. Balance Sheet Components
Content Library
Content library consisted of the following:
|
| | | | | | | | | | | | | | | | | | | | | | | |
| As of |
| September 30, 2012 | | December 31, 2011 |
| Streaming | | DVD | | Total | | Streaming | | DVD | | Total |
| (in thousands) |
Total content library, gross | $ | 4,021,055 |
| | $ | 525,634 |
| | $ | 4,546,689 |
| | $ | 2,552,284 |
| | $ | 599,155 |
| | $ | 3,151,439 |
|
Accumulated amortization | (1,343,859 | ) | | (500,495 | ) | | (1,844,354 | ) | | (632,270 | ) | | (552,526 | ) | | (1,184,796 | ) |
Total content library, net | 2,677,196 |
| | 25,139 |
| | 2,702,335 |
| | 1,920,014 |
| | 46,629 |
| | 1,966,643 |
|
Current content library, net | 1,335,769 |
| | — |
| | 1,335,769 |
| | 919,709 |
| | — |
| | 919,709 |
|
Non-current content library, net | $ | 1,341,427 |
| | $ | 25,139 |
| | $ | 1,366,566 |
| | $ | 1,000,305 |
| | $ | 46,629 |
| | $ | 1,046,934 |
|
Content Liabilities
Content liabilities consisted of the following:
|
| | | | | | | | | | | | | | | | | | | | | | | |
| As of |
| September 30, 2012 | | December 31, 2011 |
| Streaming | | DVD | | Total | | Streaming | | DVD | | Total |
| (in thousands) |
Content liabilities | $ | 1,260,999 |
| | $ | 19,886 |
| | $ | 1,280,885 |
| | $ | 915,796 |
| | $ | 19,240 |
| | $ | 935,036 |
|
Non-current content liabilities | 1,026,227 |
| | 4,752 |
| | 1,030,979 |
| | 739,628 |
| | — |
| | 739,628 |
|
Total content liabilities | $ | 2,287,226 |
| | $ | 24,638 |
| | $ | 2,311,864 |
| | $ | 1,655,424 |
| | $ | 19,240 |
| | $ | 1,674,664 |
|
The Company typically enters into multi-year streaming content licenses with studios and other distributors that may result in an increase in the streaming content library and a corresponding increase in streaming content liabilities. The payment terms for these streaming license fees may extend over the term of the license agreement, which typically ranges from six months to five years. In the nine months ended September 30, 2012, streaming content liabilities increased $631.8 million, as compared to a higher increase in streaming content library, net, of $757.2 million due to payments exceeding amortization of the streaming content library.
Property and Equipment, Net
Property and equipment and accumulated depreciation consisted of the following:
|
| | | | | | | | | |
| | | As of |
| | | September 30, 2012 | | December 31, 2011 |
| | | (in thousands) |
Computer equipment | | 3 years | $ | 79,851 |
| | $ | 67,090 |
|
Operations and other equipment | | 5 years | 100,226 |
| | 100,306 |
|
Software | | 3 years | 38,450 |
| | 35,356 |
|
Furniture and fixtures | | 3 years | 17,014 |
| | 17,310 |
|
Buildings | | 30 years | 40,681 |
| | 40,681 |
|
Leasehold improvements | | Over life of lease | 43,168 |
| | 44,473 |
|
Capital work-in-progress | | | 10,443 |
| | 822 |
|
Property and equipment, gross | | | 329,833 |
| | 306,038 |
|
Less: Accumulated depreciation | | | (196,230 | ) | | (169,685 | ) |
Property and equipment, net | | | $ | 133,603 |
| | $ | 136,353 |
|
5. Long-term Debt
Senior Convertible Notes
As of September 30, 2012, the Company had $200.0 million aggregate principal amount of zero coupon senior convertible notes due on December 1, 2018 (the “Convertible Notes”) outstanding. The Convertible Notes were issued in a private placement offering to TCV VII, L.P., TCV VII(A), L.P. and TCV Member Fund, L.P. A general partner of these funds also serves on the Company’s board of directors, and as such, the issuance of the notes was considered a related party transaction. At any time following May 28, 2012, the Company may elect to cause the conversion of the Convertible Notes into shares of the Company’s common stock when specified conditions are satisfied, including that the daily volume weighted average price of the Company’s common stock is equal or greater than $111.54 for at least 50 trading days during a 65 trading day period prior to the conversion date. The Convertible Notes include, among other terms and conditions, limitations on the Company’s ability to pay cash dividends or to repurchase shares of its common stock, subject to specified exceptions. At September 30, 2012 and December 31, 2011, the Company was in compliance with these covenants.
Based on quoted market prices of the Company’s publicly traded debt, the fair value of the Convertible Notes as of September 30, 2012 and December 31, 2011 was approximately $213.0 million and $206.5 million, respectively.
Senior Notes
As of September 30, 2012, the Company also had $200.0 million aggregate principal amount of 8.50% senior notes due November 15, 2017 (the “8.50% Notes”) outstanding. Interest on the 8.50% Notes is payable semi-annually at a rate of 8.50% per annum on May 15 and November 15 of each year.
On or after November 15, 2013, the Company may redeem the 8.50% Notes in whole or in part at specified prices ranging from 104.25% to 100% of the principal plus accrued interest. The 8.50% Notes include, among other terms and conditions, limitations on the Company’s ability to create, incur, assume or be liable for indebtedness (other than specified types of permitted indebtedness); dispose of assets outside the ordinary course (subject to specified exceptions); acquire, merge or consolidate with or into another person or entity (other than specified types of permitted acquisitions); create, incur or allow any lien on any of its property or assign any right to receive income (except for specified permitted liens); make investments (other than specified types of investments); or pay dividends, make distributions, or purchase or redeem the Company’s equity interests (each subject to specified exceptions). At September 30, 2012 and December 31, 2011, the Company was in compliance with these covenants.
Based on quoted market prices, the fair value of the 8.50% Notes as of September 30, 2012 and December 31, 2011 was approximately $213.0 million and $206.5 million, respectively.
6. Stockholders’ Equity
Stock Option Plan
In June 2011, the Company adopted the 2011 Stock Plan. The 2011 Stock Plan provides for the grant of incentive stock options to employees and for the grant of non-statutory stock options, stock appreciation rights, restricted stock and restricted stock units to employees, directors and consultants. As of September 30, 2012, 4.5 million shares were reserved for future grants under the 2011 Stock Plan.
In February 2002, the Company adopted the 2002 Stock Plan, which was amended and restated in May 2006. The 2002 Stock Plan provides for the grant of incentive stock options to employees and for the grant of non-statutory stock options and stock purchase rights to
employees, directors and consultants. In the first quarter of 2012, 1.2 million shares reserved for future grants under the 2002 Stock Plan expired.
A summary of the activity related to the Company’s stock option plans during the nine months ended September 30, 2012 is as follows:
|
| | | | | | | | | | | | | | | |
| | | Options Outstanding | | | | |
| Shares Available for Grant | | Number of Shares | | Weighted- Average Exercise Price | | Weighted-Average Remaining Contractual Term (in Years) | | Aggregate Intrinsic Value (in Thousands) |
Balances as of December 31, 2011 | 7,013,508 |
| | 2,957,754 |
| | $ | 66.59 |
| | | | |
Granted | (1,321,197 | ) | | 1,321,197 |
| | 75.95 |
| | | | |
Exercised | — |
| | (146,916 | ) | | 14.06 |
| | | | |
Canceled | 48 |
| | (48 | ) | | 35.95 |
| | | | |
Expired | (1,160,721 | ) | | — |
| | — |
| | | | |
Balances as of September 30, 2012 | 4,531,638 |
| | 4,131,987 |
| | 71.45 |
| | 6.97 | | $ | 50,057 |
|
Vested and exercisable at September 30, 2012 | | | 4,131,987 |
| | 71.45 |
| | 6.97 | | $ | 50,057 |
|
The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between the Company’s closing stock price on the last trading day of the third quarter of 2012 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on September 30, 2012. This amount changes based on the fair market value of the Company’s common stock. Total intrinsic value of options exercised for the three months ended September 30, 2012 and 2011 was $0.4 million and $32.2 million, respectively. Total intrinsic value of options exercised for the nine months ended September 30, 2012 and 2011 was $13.2 million and $125.6 million, respectively.
Cash received from option exercises for the three months ended September 30, 2012 and 2011 was $0.3 million and $4.4 million, respectively. Cash received from option exercises for the nine months ended September 30, 2012 and 2011 was $2.1 million and $18.6 million, respectively.
Stock Option Expense
Vested stock options granted before June 30, 2004 can be exercised up to three months following termination of employment. Vested stock options granted after June 30, 2004 and before January 1, 2007 can be exercised up to one year following termination of employment. Vested stock options granted after January 2007 will remain exercisable for the full ten year contractual term regardless of employment status. The following table summarizes the assumptions used to value stock option grants using the lattice-binomial model:
|
| | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
| September 30, 2012 | | September 30, 2011 | | September 30, 2012 | | September 30, 2011 |
Dividend yield | — | % | | — | % | | — | % | | — | % |
Expected volatility | 60 | % | | 52 | % | | 60% - 65% |
| | 51% - 52% |
|
Risk-free interest rate | 1.61 | % | | 2.98 | % | | 1.61 - 2.01% |
| | 2.98-3.42% |
|
Suboptimal exercise factor | 2.27 - 3.64 |
| | 2.26 - 3.63 |
| | 2.26 - 3.65 |
| | 2.17-3.63 |
|
The Company bifurcates its option grants into two employee groupings (executive and non-executive) based on exercise behavior and considers several factors in determining the estimate of expected term for each group, including the historical option exercise behavior, the terms and vesting periods of the options granted.
The weighted-average fair value of employee stock options granted during the three months ended September 30, 2012 and 2011 was $32.57 and $137.90 per share, respectively. The weighted-average fair value of employee stock options granted during the nine months ended September 30, 2012 and 2011 was $42.58 and $127.41 per share, respectively.
The following table summarizes stock-based compensation expense, net of tax, related to stock option plans which was allocated as follows:
|
| | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
| September 30, 2012 | | September 30, 2011 | | September 30, 2012 | | September 30, 2011 |
| (in thousands) |
Fulfillment expenses | $ | 103 |
| | $ | 206 |
| | $ | 260 |
| | $ | 1,446 |
|
Marketing | 690 |
| | 1,539 |
| | 2,911 |
| | 4,273 |
|
Technology and development | 10,510 |
| | 7,522 |
| | 31,550 |
| | 19,819 |
|
General and administrative | 7,169 |
| | 6,438 |
| | 21,533 |
| | 17,967 |
|
Stock-based compensation expense before income taxes | 18,472 |
| | 15,705 |
| | 56,254 |
| | 43,505 |
|
Income tax benefit | (7,128 | ) | | (5,228 | ) | | (21,709 | ) | | (16,066 | ) |
Stock-based compensation after income taxes | $ | 11,344 |
| | $ | 10,477 |
| | $ | 34,545 |
| | $ | 27,439 |
|
Stock Repurchases
Under the Company’s current stock repurchase plan, announced on June 11, 2010, the Company is authorized to repurchase up to $300.0 million of its common stock through the end of 2012. The Company did not repurchase stock during the nine months ended September 30, 2012. As of September 30, 2012, $41.0 million of this authorization remained. The timing and actual number of shares repurchased is at management’s discretion and will depend on various factors including price, corporate and regulatory requirements, debt covenant requirements, alternative investment opportunities and other market conditions.
7. Income Taxes
The effective tax rates for the three months ended September 30, 2012 and 2011 were 35.8% and 33.3%, respectively. The effective tax rates for the nine months ended September 30, 2012 and 2011 were 40.6% and 36.9%, respectively. These rates differed from the federal statutory rate due primarily to state taxes which were partially offset by the California R&D tax credit. The increase in the Company's effective tax rates for the three and nine months ended September 30, 2012 as compared to the three and nine months ended September 30, 2011 was primarily attributable to the expiration of the Federal R&D tax credit on December 31, 2011 and the expiration of the statute of limitations for years 1997 through 2007, resulting in a discrete benefit of $3.5 million in the third quarter of 2011.
As of December 31, 2011, the Company had $28.1 million of gross unrecognized tax benefits. During the nine months ended September 30, 2012, the Company had an increase in gross unrecognized tax benefits of approximately $1.1 million. The gross unrecognized tax benefits, if recognized by the Company, will result in a reduction of approximately $23.0 million to the provision for income taxes thereby favorably impacting the Company’s effective tax rate. The Company’s unrecognized tax benefits are classified as “Other non-current liabilities” on the Consolidated Balance Sheets. The Company includes interest and penalties related to unrecognized tax benefits within the "Provision for income taxes" on the Consolidated Statements of Operations. As of September 30, 2012, the total amount of gross interest and penalties accrued was $2.8 million, and is classified as “Other non-current liabilities” on the Consolidated Balance Sheets.
Deferred tax assets include $8.4 million and $10.0 million classified as “Other current assets” and $55.7 million and $28.3 million classified as “Other non-current assets” on the Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011, respectively. In evaluating its ability to realize the net deferred tax assets, the Company considered all available positive and negative evidence, including its past operating results and the forecast of future market growth, forecasted earnings, future taxable income, and prudent and feasible tax planning strategies. As of September 30, 2012 and December 31, 2011, it was considered more likely than not that substantially all deferred tax assets would be realized, and no significant valuation allowance was recorded.
Income tax benefits attributable to the exercise of employee stock options of $0.1 million and $11.6 million, during the three months ended September 30, 2012 and 2011, respectively, were recorded directly to "Additional paid-in capital" on the Consolidated Balance Sheets. Income tax benefits attributable to the exercise of employee stock options of $4.2 million and $45.0 million, during the nine months ended September 30, 2012 and 2011, respectively, were recorded directly to "Additional paid-in capital" on the Consolidated Balance Sheets.
The Company files U.S. federal, state and foreign tax returns. The Company is currently under examination by the IRS for the years 2008 through 2011. The Company is currently under examination by the state of California for the years 2006 and 2007. The years 1997 through 2005, as well as 2008 through 2011, remain subject to examination by the state of California. Given the potential outcome of the current examinations, as well as the impact of the current examination on the potential expiration of the statute of limitations, it is reasonably possible that the balance of unrecognized tax benefits could significantly change within the next twelve months. However, at this time, an estimate of the range of reasonably possible adjustments to the balance of unrecognized tax benefits cannot be made.
8. Commitments and Contingencies
Streaming Content
The Company had $5.0 billion and $4.8 billion of obligations at September 30, 2012 and December 31, 2011, respectively, including agreements to acquire and license streaming content that represent current or long-term liabilities or that are not reflected on the Consolidated Balance Sheets because they do not meet content library asset recognition criteria. The license agreements that are not reflected on the Consolidated Balance Sheets do not meet content library asset recognition criteria because either the fee is not known or reasonably determinable for a specific title or it is known but the title is not yet available for streaming to subscribers.
For those agreements with variable terms, the Company does not estimate what the total obligation may be beyond any minimum quantities and/or pricing as of the reporting date. For those agreements that include renewal provisions that are solely at the option of the content provider, the Company includes the commitments associated with the renewal period to the extent such commitments are fixed or a minimum amount is specified.
The Company has entered into certain license agreements that include an unspecified or a maximum number of titles that the Company may or may not receive in the future and/or that include pricing contingent upon certain variables, such as theatrical exhibition receipts for the title. As of the reporting date, it is unknown whether the Company will receive access to these titles or what the ultimate price per title will be. Accordingly, such amounts are not reflected in the commitments described below. However such amounts are expected to be significant and the expected timing of payments could range from less than one year to more than five years.
The expected timing of payments for these agreements to acquire and license streaming content that represent current or long-term liabilities as well as obligations not reflected on the consolidated balance sheet is as follows:
|
| | | | | | | | |
| As of | |
| September 30, 2012 | | December 31, 2011 | |
| (in thousands) | |
Less than one year | $ | 2,088,881 |
| | $ | 1,713,445 |
| (1) |
Due after one year and through 3 years | 2,391,629 |
| | 2,384,373 |
| |
Due after 3 years and through 5 years | 433,549 |
| | 650,480 |
| |
Due after 5 years | 58,968 |
| | 74,696 |
| |
Total streaming content obligations | $ | 4,973,027 |
| | $ | 4,822,994 |
| |
(1) Prior period amounts have been presented to conform to the current period presentation which includes the streaming portion of current "Content liabilities" reflected on the Consolidated Balance Sheets. Note that total streaming content obligations remain unchanged with this presentation. Specifically, payments for streaming content obligations expected to be made in less than one year as of September 30, 2012 and December 31, 2011, as shown above, include $1.3 billion and $0.9 billion, respectively, of current "Content liabilities" reflected on the Consolidated Balance Sheets.
The Company has licenses with certain performing rights organizations (“PRO”), and is currently involved in negotiations with other PROs, that hold certain rights to musical compositions used in connection with streaming content. For the latter, the Company accrues for estimated royalties that are due to PROs and adjusts these accruals based on any changes in estimates. These amounts are included in the Company's streaming content obligations. While the Company anticipates finalizing these negotiations, the outcome of these negotiations is uncertain. The results of any negotiation may be materially different from management’s estimates.
Legal Proceedings
From time to time, in the normal course of its operations, the Company is a party to litigation matters and claims, including claims relating to employee relations, business practices and patent infringement. Litigation can be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict and the Company’s view of these matters may change in the future as the litigation and events related thereto unfold. The Company expenses legal fees as incurred. The Company records a provision for contingent losses when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. An unfavorable outcome to any legal matter, if material, could have an adverse effect on the Company’s operations or its financial position, liquidity or results of operations.
On January 13, 2012, the first of three purported shareholder class action lawsuits was filed in the United States District Court for the Northern District of California against the Company and certain of its officers and directors. Two additional purported shareholder class action lawsuits were filed in the same court on January 27, 2012 and February 29, 2012, respectively, alleging substantially similar claims. These lawsuits have been consolidated and the Court has selected lead plaintiffs. Lead plaintiffs filed a consolidated complaint on June 26, 2012. The
consolidated complaint alleges violations of the federal securities laws and seeks unspecified compensatory damages and other relief on behalf of a class of purchasers of the Company's common stock between October 20, 2010 and October 24, 2011. The complaint alleges among other things, that the Company issued materially false and misleading statements regarding the Company’s business practices and violated accounting rules concerning segment reporting, which led to artificially inflated stock prices. Management has determined a potential loss is reasonably possible however, based on its current knowledge, management does not believe that the amount of such possible loss or a range of potential loss is reasonably estimable.
On November 23, 2011, the first of six purported shareholder derivative suits was filed in the Superior Court of California, Santa Clara County, against the Company and certain of its officers and directors. Five additional purported shareholder derivative suits were subsequently filed: two in the Superior Court of California, Santa Clara County on February 9, 2012 and May 2, 2012; and three in the United States District Court for the Northern District of California on February 13, 2012, February 24, 2012 and April 2, 2012. The purported shareholder derivative suits filed in the Northern District of California have been voluntarily dismissed. On July 5, 2012, the purported shareholder derivative suits filed in Santa Clara County were consolidated and lead counsel was appointed. A consolidated complaint has not yet been filed. The original complaints alleged, among other things, that the Company’s officers and directors breached their fiduciary duties, wasted valuable corporate assets, and were unjustly enriched as a result of causing the Company to buy back stock at artificially inflated prices to the detriment of the Company and its shareholders. Additionally, certain of the original complaints contained allegations regarding false and misleading statements surrounding the Company’s business practices and its contracts with content providers. Management has determined a potential loss is reasonably possible however, based on its current knowledge, management does not believe that the amount of such possible loss or a range of potential loss is reasonably estimable.
The Company is involved in other litigation matters not listed above but does not consider the matters to be material either individually or in the aggregate at this time. The Company’s view of the matters not listed may change in the future as the litigation and events related thereto unfold.
Indemnification
In the ordinary course of business, the Company has entered into contractual arrangements under which it has agreed to provide indemnification of varying scope and terms to business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of the Company’s breach of such agreements and out of intellectual property infringement claims made by third parties. In these circumstances, payment may be conditional on the other party making a claim pursuant to the procedures specified in the particular contract.
The Company’s obligations under these agreements may be limited in terms of time or amount, and in some instances, the Company may have recourse against third-parties for certain payments. In addition, the Company has entered into indemnification agreements with its directors and certain of its officers that will require it, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. The terms of such obligations vary.
It is not possible to make a reasonable estimate of the maximum potential amount of future payments under these or similar agreements due to the conditional nature of the Company’s obligations and the unique facts and circumstances involved in each particular agreement. No amount has been accrued in the accompanying financial statements with respect to these indemnification obligations.
9. Segment Information
Beginning in the fourth quarter of 2011, the Company has three operating segments: Domestic streaming, International streaming and Domestic DVD. Segment information is presented along the same lines that the Company’s chief operating decision maker reviews the operating results in assessing performance and allocating resources. The Company’s chief operating decision maker reviews revenue and contribution profit (loss) for each of the reportable segments. Contribution profit (loss) is defined as revenues less cost of revenues and marketing expenses.
Revenues and the related credit card fees are attributed to the operating segment based on the nature of the underlying subscription (DVD or streaming) and the geographic region from which the subscription originates. Cost of revenues are primarily attributed to the operating segment based on the amounts directly incurred by the segment to obtain content and deliver it to the specific region. Allocations of certain corporate costs related to customer service are included in the total cost of revenues within each operating segment. Marketing is primarily comprised of advertising expenses which are generally included in the segment in which the expenditures are directly incurred. Marketing also includes an allocation of the cost of revenues incurred by that segment related to free trials.
There are no internal revenue transactions between the Company’s reportable segments. The Company's chief operating decision maker does not review an allocation of assets by reportable segment. The Domestic and International streaming segments derive revenue from monthly subscription services consisting solely of streaming content. The Domestic DVD segment derives revenue from monthly subscription services consisting solely of DVDs-by-mail.
Between the fourth quarter of 2010 and the third quarter of 2011, the Company had two operating segments: Domestic and International. During this time, the Company’s domestic streaming service and DVDs-by-mail operations were combined. Subscribers in the U.S. were able to receive both streaming services and DVDs under a single hybrid plan. Accordingly, revenues were generated and marketing expenses were
incurred in connection with the subscription offerings as a whole. Therefore, it is impracticable to allocate revenues or marketing expenses or present discrete segment information for the Domestic streaming and Domestic DVD segments for periods prior to the fourth quarter of 2011.
In the third quarter of 2011, the Company made certain changes to its domestic pricing and plan structure which require subscribers who wish to receive both streaming services and DVDs-by-mail to have two separate subscription plans. Following this change, beginning in the fourth quarter of 2011, the Company was able to generate discrete financial information for its Domestic streaming and Domestic DVD operations and began reporting this information to the chief operating decision maker for review.
The following tables represent segment information for the quarter ended September 30, 2012:
|
| | | | | | | | | | | | | | | |
| As of/ Three months ended September 30, 2012 |
| Domestic Streaming | | International Streaming | | Domestic DVD | | Consolidated |
| (in thousands) |
Total subscriptions at end of period (1) | 25,101 |
| | 4,311 |
| | 8,606 |
| | — |
|
Revenues | $ | 556,027 |
| | $ | 77,744 |
| | $ | 271,318 |
| | $ | 905,089 |
|
Cost of revenues and marketing expense | 465,079 |
| | 170,121 |
| | 140,671 |
| | 775,871 |
|
Contribution profit (loss) | $ | 90,948 |
| | $ | (92,377 | ) | | $ | 130,647 |
| | $ | 129,218 |
|
Other operating expenses | | | | | | | 113,083 |
|
Operating income | | | | | | | 16,135 |
|
Other income (expense) | | | | | | | (4,189 | ) |
Provision for income taxes | | | | | | | 4,271 |
|
Net income | | | | | | | $ | 7,675 |
|
|
| | | | | | | | | | | | | | | |
| As of/ Nine months ended September 30, 2012 |
| Domestic Streaming | | International Streaming | | Domestic DVD | | Consolidated |
| (in thousands) |
Total subscriptions at end of period (1) | 25,101 |
| | 4,311 |
| | 8,606 |
| | — |
|
Revenues | $ | 1,595,397 |
| | $ | 186,142 |
| | $ | 882,504 |
| | $ | 2,664,043 |
|
Cost of revenues and marketing expense | 1,354,769 |
| | 470,629 |
| | 471,958 |
| | 2,297,356 |
|
Contribution profit (loss) | $ | 240,628 |
| | $ | (284,487 | ) | | $ | 410,546 |
| | $ | 366,687 |
|
Other operating expenses | | | | | | | 336,333 |
|
Operating income | | | | | | | 30,354 |
|
Other income (expense) | | | | | | | (14,778 | ) |
Provision for income taxes | | | | | | | 6,321 |
|
Net income | | | | | | | $ | 9,255 |
|
The following tables represent the Company’s segment information for the quarter ended September 30, 2011:
|
| | | | | | | | | | | |
| As of/ Three months ended September 30, 2011 |
| Domestic | | International | | Consolidated |
| (in thousands) |
Total unique subscribers at end of period (2) | 23,789 |
| | 1,480 |
| | 25,269 |
|
Revenues | $ | 799,152 |
| | $ | 22,687 |
| | $ | 821,839 |
|
Cost of revenues and marketing expense | 579,720 |
| | 46,005 |
| | 625,725 |
|
Contribution profit (loss) | $ | 219,432 |
| | $ | (23,318 | ) | | $ | 196,114 |
|
Other operating expenses | | | | | 99,272 |
|
Operating income | | | | | 96,842 |
|
Other income (expense) | | | | | (3,219 | ) |
Provision for income taxes | | | | | 31,163 |
|
Net income | | | | | $ | 62,460 |
|
|
| | | | | | | | | | | |
| As of/ Nine months ended September 30, 2011 |
| Domestic | | International | | Consolidated |
| (in thousands) |
Total unique subscribers at end of period (2) | 23,789 |
| | 1,480 |
| | 25,269 |
|
Revenues | $ | 2,275,140 |
| | $ | 53,862 |
| | $ | 2,329,002 |
|
Cost of revenues and marketing expense | 1,655,828 |
| | 97,268 |
| | 1,753,096 |
|
Contribution profit (loss) | $ | 619,312 |
| | $ | (43,406 | ) | | $ | 575,906 |
|
Other operating expenses | | | | | 261,710 |
|
Operating income | | | | | 314,196 |
|
Other income (expense) | | | | | (11,509 | ) |
Provision for income taxes | | | | | 111,780 |
|
Net income | | | | | $ | 190,907 |
|
(1) A subscription is defined as the right to receive either the Netflix streaming service or Netflix DVD service. In connection with the Company's subscription services, the Company offers free-trial memberships to new and certain rejoining members. A method of payment is required to be provided even during the free-trial period for the membership to be defined as a subscription and included in the above metrics. Total unique subscribers and total subscriptions include those subscribers who are on a free-trial. Paid unique subscribers and paid subscriptions exclude free trial memberships. A subscription would cease to be reflected in the above metrics as of the effective cancellation date. Voluntary cancellations become effective at the end of the monthly subscription period, while involuntary cancellation of the service, as a result of a failed method of payment, becomes effective immediately.
(2) For purposes of determining the number of unique subscribers, domestic subscribers who have elected both a DVD and a streaming subscription plan are considered a single unique subscriber.
| |
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws. These forward-looking statements include, but are not limited to statements regarding: our core strategy, contribution profit (losses) and margins both domestically and internationally, consolidated revenues, DVD and streaming subscription trends, investments in our international segment, cash use in connection with content acquisitions and international expansion, investments in content and marketing, consolidated revenue, content payments and expense, free cash flow and available funds, deferred tax assets, stock repurchases and future contractual obligations. These forward-looking statements are subject to risks and uncertainties that could cause actual results and events to differ materially from those included in forward-looking statements. These forward-looking statements can be identified by our use of words such as "anticipate", "expect", "will", "may" and derivations thereof. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in our Annual Report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission (“SEC”) on February 10, 2012, in particular the risk factors discussed under the heading “Risk Factors” in Part I, Item IA.
We assume no obligation to revise or publicly release any revision to any forward-looking statements contained in this Quarterly Report on Form 10-Q, unless required by law.
Overview
We are the world’s leading Internet subscription service for enjoying TV shows and movies. Our subscribers can instantly watch as many TV shows and movies as they want, streamed over the Internet to their TVs, computers and mobile devices. Additionally, in the U.S., our subscribers can receive standard definition DVDs, and their high definition successor, Blu-ray discs (collectively referred to as “DVD”), delivered quickly to their homes.
Our core strategy is to grow our streaming subscription business domestically and globally. We are continuously improving the customer experience, with a focus on expanding our streaming content, enhancing our user interface and extending our streaming service to even more Internet-connected devices, while staying within the parameters of our consolidated net income (loss) and operating segment contribution profit (loss) targets. Contribution profit (loss) is defined as revenue less cost of revenues and marketing expenses.
We are a pioneer in the Internet delivery of TV shows and movies, launching our streaming service in 2007. Since this launch, we have developed an ecosystem of Internet-connected devices and have licensed increasing amounts of content that enable consumers to enjoy TV shows and movies directly on their TVs, computers and mobile devices. As a result of these efforts, we have experienced growing consumer acceptance of and interest in the delivery of TV shows and movies directly over the Internet. We believe that the DVD portion of our domestic service will be a fading differentiator to our streaming success. Historically, our acquisition of new subscriptions has been seasonal with the first and fourth quarters representing our strongest net subscription additions and our second quarter representing the lowest net subscription additions in a calendar year.
Prior to July 2011, in the U.S., our streaming and DVDs-by-mail operations were combined and subscribers could receive both streaming content and DVDs under a single “hybrid” plan. In July 2011, we introduced DVD only plans and separated the combined plans, making it necessary for subscribers who wish to receive both streaming services and DVDs-by-mail to have two separate subscription plans. This resulted in a price increase for our members who were taking a hybrid plan. We made a subsequent announcement during the third quarter of 2011 concerning the rebranding of our DVDs-by-mail service and the separation of the DVDs-by-mail and streaming websites. The consumer reaction to the price change, and to a lesser degree, the branding announcement, was very negative leading to significant customer cancellations. We subsequently retracted our plans to rebrand our DVDs-by-mail service and separate the DVDs-by-mail and streaming websites.
In September 2010, we began international operations by offering our streaming service in Canada. In September 2011, we expanded our streaming service to Latin America. In January 2012, we launched our streaming service in the United Kingdom ("U.K.") and Ireland. In October 2012, we launched our streaming service in Norway, Denmark, Sweden and Finland. We anticipate significant contribution losses in the International streaming segment in 2012 and extending into 2013.
As a result of the changes to our pricing and plan structure, we no longer offer a single subscription plan including both DVDs-by-mail and streaming in the U.S. Domestic subscribers who wish to receive DVDs-by-mail and watch streaming content must elect both a DVDs-by-mail subscription plan and a streaming subscription plan. Accordingly, beginning with the third quarter of 2011, management views the number of paid subscriptions as the key driver of revenues. The following metrics reflect these changes.
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| As of /Three Months Ended, |
Subscription Metrics: | September 30, 2012 | | June 30, 2012 | | September 30, 2011 |
| (in thousands) |
Domestic streaming (1): | | | | | |
Net additions | 1,163 |
| | 528 |
| | |
Paid subscriptions at end of period | 23,801 |
| | 22,686 |
| | |
Total subscriptions at end of period | 25,101 |
| | 23,938 |
| | |
International streaming (1): | | | | | |
Net additions | 687 |
| | 559 |
| | 513 |
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Paid subscriptions at end of period | 3,689 |
| | 3,024 |
| | 989 |
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Total subscriptions at end of period | 4,311 |
| | 3,624 |
| | 1,480 |
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Domestic DVD (1): | | | | | |
Net losses | (634 | ) | | (849 | ) | | |
Paid subscriptions at end of period | 8,465 |
| | 9,145 |
| | |
Total subscriptions at end of period | 8,606 |
| | 9,240 |
| | |
Consolidated (2): | | | | | |
Net unique subscriber additions during period | 1,700 |
| | 979 |
| | (292 | ) |
Paid unique subscribers at end of period | 29,892 |
| | 28,254 |
| | 23,832 |
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Total unique subscribers at end of period | 31,818 |
| | 30,118 |
| | 25,269 |
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(1) | A subscription is defined as the right to receive either the Netflix streaming service or Netflix DVD service. In connection with our subscription services, we offer free-trial memberships to new and certain rejoining members. A method of payment is required to be provided even during the free-trial period for the membership to be defined as a subscription and included in the above metrics. Total unique subscribers and total subscriptions include those subscribers who are on a free-trial. Paid unique subscribers and paid subscriptions exclude free trial memberships. A subscription would cease to be reflected in the above metrics as of the effective cancellation date. Voluntary cancellations become effective at the end of the monthly subscription period, while involuntary cancellation of the service, as a result of a failed method of payment, becomes effective immediately. |
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(2) | For purposes of determining the number of unique subscribers, domestic subscribers who have elected both a DVD and a streaming subscription plan are considered a single unique subscriber. |
The following represents our consolidated performance highlights:
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| Three Months Ended | | Change |
| September 30, 2012 | | June 30, 2012 | | September 30, 2011 | | Q3'12 vs. Q2'12 | | Q3'12 vs. Q3'11 |
| (in thousands, except per share data) | | | | |
Revenues | $ | 905,089 |
| | $ | 889,163 |
| | $ | 821,839 |
| | 2 | % | | 10 | % |
Operating income | 16,135 |
| | 16,154 |
| | 96,842 |
| | — | % | | (83 | )% |
Net income | 7,675 |
| | 6,164 |
| | 62,460 |
| | 25 | % | | (88 | )% |
Diluted earnings per share | 0.13 |
| | 0.11 |
| | 1.16 |
| | 18 | % | | (89 | )% |
Free cash flow (3) | (20,462 | ) | | 11,168 |
| | 13,781 |
| | NM |
| | NM |
|
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(3) | See “Liquidity and Capital Resources” for a definition of “free cash flow” and a reconciliation of “net cash provided by operating activities” to “free cash flow.” |
Consolidated revenues, operating income and net income for the third quarter of 2012 were relatively flat as compared to the second quarter of 2012. We expect consolidated revenues to increase at a modest pace sequentially in future quarters driven by the growth in global streaming subscriptions and partially offset by a decline in domestic DVD subscriptions. Investments in streaming content and marketing to support new international markets may result in future consolidated net losses.
Free cash flow for the three months ended September 30, 2012 decreased $31.6 million as compared to the three months ended June 30, 2012 to negative $20.5 million. Significant uses of cash in the quarter were cash payments for content (in excess of the expense), cash payments for property and equipment (in excess of depreciation expense) primarily related to equipment for our Open Connect content delivery
program and reductions in miscellaneous accounts payable and accrued expenses. These uses of cash were partially offset by net income excluding the impact of non-cash stock compensation. The excess content payments over expense will continue to fluctuate over time based on new content licenses domestically and internationally and in particular may increase as a result of the timing of payments for original programming. Our movement into original programming will require more up-front cash payments than our typical licensing agreements, beginning in the fourth quarter of 2012 and increasing in 2013. We expect that free cash flow in future periods will be negatively impacted by investments in new international markets and in original content.
Segment Overview
The following tables set forth, for the periods presented, financial information for each of our reportable segments including revenues from subscriptions and contribution profit (loss) which is the measure of profitability used by our chief operating decision maker.
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| Three months ended September 30, 2012 |
| Domestic Streaming | | International Streaming | | Domestic DVD | | Consolidated |
| (in thousands) |
Revenues | $ | 556,027 |
| | $ | 77,744 |
| | $ | 271,318 |
| | $ | 905,089 |
|
Cost of revenues and marketing expense | 465,079 |
| | 170,121 |
| | 140,671 |
| | 775,871 |
|
Contribution profit (loss) | $ | 90,948 |
| | $ | (92,377 | ) | | $ | 130,647 |
| | $ | 129,218 |
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| | | | | | | | | | | | | | | |
| Three months ended June 30, 2012 |
| Domestic Streaming | | International Streaming | | Domestic DVD | | Consolidated |
| (in thousands) |
Revenues | $ | 532,705 |
| | $ | 64,973 |
| | $ | 291,485 |
| | $ | 889,163 |
|
Cost of revenues and marketing expense | 449,533 |
| | 154,400 |
| | 157,719 |
| | 761,652 |
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Contribution profit (loss) | $ | 83,172 |
| | $ | (89,427 | ) | | $ | 133,766 |
| | $ | 127,511 |
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| Three months ended September 30, 2011 (1) |
| Domestic | | International | | Consolidated |
| (in thousands) |
Revenues | $ | 799,152 |
| | $ | 22,687 |
| | $ | 821,839 |
|
Cost of revenues and marketing expense | 579,720 |
| | 46,005 |
| | 625,725 |
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Contribution profit (loss) | $ | 219,432 |
| | $ | (23,318 | ) | | $ | 196,114 |
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(1) | Presented using our segment reporting prior to the fourth quarter of 2011. Prior to the fourth quarter of 2011, our domestic streaming service and DVDs-by-mail operations were combined. |
Our core strategy is to grow a streaming subscription business domestically and globally. As we grow our streaming subscription segments, we have shifted spending away from the Domestic DVD segment to invest more in streaming content and marketing our streaming services. Content acquisition and licensing expenses are higher as a percentage of revenues for the Domestic and International Streaming segments as compared to the Domestic DVD segment. Content delivery expenses and fulfillment expenses tend to be lower for the streaming business. Marketing costs for the streaming business are higher as a percentage of revenues given our focus on building consumer awareness of the streaming offerings. Marketing costs are immaterial for the Domestic DVD segment. As a result of our focus on growing the streaming segments, contribution margins for the Domestic and International Streaming segments are lower than for our Domestic DVD segment. Also impacting the Domestic streaming segment was the loss of subscribers resulting from the consumer reaction to the pricing and plan changes made in the third quarter of 2011. We expect that the investments in content and marketing associated with the streaming service segments will slow relative to revenue to allow for contribution margin expansion over time. Streaming content rights are generally specific to a geographic region and accordingly our international expansion will require us to obtain additional streaming content licenses to support new global markets.
Our Domestic Streaming segment had a contribution margin of 16% for the third quarter of 2012. We expect further contribution margin expansion as investments in domestic content and marketing grow slower than domestic streaming revenue. Average number of paying domestic streaming subscriptions for the three months ending September 30, 2012 increased 4% from the prior quarter, driving the increase in Domestic streaming revenues. Content acquisition and licensing expense for our Domestic streaming segment represent the vast majority of expenses for this segment and increased 5% quarter over quarter. Marketing decreased by 7% due to reduced spending in TV and Radio
advertising partially offset by an increase in online and direct-mail advertising. Content delivery and fulfillment expenses were immaterial for this period for the Domestic streaming segment.
Our International Streaming segment does not benefit from the established subscriber base that exists for the Domestic Streaming segment. As a result of having to build a member base from zero, investments in streaming content and marketing for our International segment are larger initially relative to revenues, in particular as new territories are launched. Marketing expenses incurred by our International streaming segment have been significant and will fluctuate dependent upon the number of International territories in which our streaming service is offered and the timing of the launch of new territories. Typically for a specific territory, marketing expenses represent a larger percentage of total expenses at launch. The contribution losses for our International segment have been significant and we expect will continue to be significant as we expand globally. Our International streaming segment had a contribution loss of $92.4 million for the third quarter of 2012 compared to a contribution loss of $89.4 million for the second quarter of 2012 due to increased investments in our content library to drive more membership growth and viewing. International streaming subscriptions increased 19% from June 30, 2012 to September 30, 2012, and the number of average paid subscriptions increased even more at 24% from the second to third quarters of 2012 due to conversion of free trial members. The increase in average paid subscriptions was the driver of the increase in International streaming revenues in the third quarter of 2012 as compared to the second quarter of 2012. International streaming subscriptions account for 15% of total streaming subscriptions at the end of the third quarter. The increase in revenues was partially offset by increases in content acquisition and licensing expenses of 14%. Content acquisition and licensing expense for our International streaming segment represent the vast majority of costs of revenues. Content delivery and fulfillment expenses were immaterial for this period and are not a material contributor to the contribution loss in our International segment.
The Domestic DVD segment had a small increase in contribution margin to 48% compared to 46% in the second quarter of 2012 due to a lower revenue mix in content utilization subject to revenue sharing agreements. Given that our core strategy is to grow a streaming subscription business both domestically and internationally, we do not expect future investments in DVD content, technology or marketing to be material. Current and future expenses for the Domestic DVD segment are primarily variable in nature such as shipping and packaging associated with delivery of DVDs-by-mail. As a result, contribution margins for the Domestic DVD segment are expected to increase slightly for the remainder of the year, while DVD subscription declines continue to moderate. DVD subscriptions as of September 30, 2012 decreased 7% from June 30, 2012, due to cancellations during the quarter, resulting in a 7% decrease in Domestic DVD revenues.
Consolidated Results of Operations
The following table sets forth, for the periods presented, the line items on our Consolidated Statements of Operations as a percentage of total revenues.
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| Three Months Ended | | Nine Months Ended |
| September 30, 2012 | | June 30, 2012 | | September 30, 2011 | | September 30, 2012 | | September 30, 2011 |
Revenues | 100 | % | | 100 | % | | 100 | % | | 100 | % | | 100 | % |
Cost of revenues: | | | | | | | | | |
Subscription | 66 | % | | 65 | % | | 57 | % | | 66 | % | | 55 | % |
Fulfillment expenses | 7 | % | | 7 | % | | 8 | % | | 7 | % | | 8 | % |
Total cost of revenues | 73 | % | | 72 | % | | 65 | % | | 73 | % | | 63 | % |
Operating expenses: | | | | | | | | | |
Marketing | 13 | % | | 13 | % | | 11 | % | | 14 | % | | 12 | % |
Technology and development | 9 | % | | 9 | % | | 8 | % | | 9 | % | | 8 | % |
General and administrative | 3 | % | | 4 | % | | 4 | % | | 3 | % | | 4 | % |
Total operating expenses | 25 | % | | 26 | % | | 23 | % | | 26 | % | | 24 | % |
Operating income | 2 | % | | 2 | % | | 12 | % | | 1 | % | | 13 | % |
Other income (expense): | | | | | | | | | |
Interest expense | (1 | )% | | (1 | )% | | — | % | | (1 | )% | | — | % |
Interest and other income (expense) | — | % | | — | % | | — | % | | — | % | | — | % |
Income before income taxes | 1 | % | | 1 | % | | 12 | % | | — | % | | 13 | % |
Provision for income taxes | — | % | | — | % | | 4 | % | | — | % | | 5 | % |
Net income | 1 | % | | 1 | % | | 8 | % | | — | % | | 8 | % |
Revenues
We derive our revenues from monthly subscription fees and recognize subscription revenues ratably over each subscriber’s monthly subscription period. We currently generate substantially all of our revenues in the U.S.
In the Domestic streaming segment, we derive revenues from services consisting solely of streaming content offered through a subscription plan priced at $7.99 per month. In the Domestic DVD segment, we derive revenues from our DVDs-by-mail subscription services. The price per plan for DVDs-by-mail varies from $4.99 to $43.99 per month based on the number of DVDs that a subscriber may have out at any given point. Customers electing access to high definition Blu-ray discs in addition to standard definition DVDs pay a surcharge ranging from $2 to $4 per month for our most popular plans.
In July 2011, in the U.S., we introduced DVD only plans and separated DVDs-by-mail and streaming making it necessary for subscribers who opt to receive both streaming and DVDs-by-mail to have two separate subscription plans. As subscribers were able to receive both streaming and DVDs-by-mail under a single hybrid plan prior to the fourth quarter of 2011, it is impracticable to allocate revenues to the Domestic streaming and Domestic DVD segments prior to the fourth quarter of 2011.
In the International streaming segment, we derive revenues from services consisting solely of streaming content offered through a subscription plan priced at approximately the equivalent of USD7.99 per month. In September 2010, we began international operations in Canada. We expanded to Latin America in September 2011 and the U.K. and Ireland in January 2012. In October 2012, we launched our streaming service in Norway, Denmark, Sweden and Finland.
Three months ended September 30, 2012 as compared to the three months ended September 30, 2011
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| Three Months Ended | | Change |
| September 30, 2012 | | September 30, 2011 | | Q3'12 vs. Q3'11 |
| (in thousands, except percentages) |
Revenues (1) | $ | 905,089 |
| | $ | 821,839 |
| | 10 | % |
Domestic | 827,345 |
| | 799,152 |
| | 4 | % |
International | 77,744 |
| | 22,687 |
| | 243 | % |
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(1) | Presented using our segment reporting prior to the fourth quarter of 2011. The Domestic segment consists of both our domestic streaming service and DVDs-by-mail as prior to the fourth quarter of 2011, our domestic streaming service and DVDs-by-mail operations were combined. |
The $83.3 million increase in our consolidated revenues was due to the $28.2 million increase in domestic revenues and a $55.1 million increase in international revenues. Domestic revenues increased 4% as a result of the 12% growth in the domestic average number of unique paying subscribers driven by new streaming subscriptions. This increase was offset in part by a 7% decline in domestic average monthly revenue per unique paying subscriber, resulting from the popularity of the streaming subscription service and a decline in the percentage of unique paying subscribers electing both a streaming and a DVD subscription.
International revenues increased by $55.1 million primarily due to our launch in Latin America in September 2011 and our launch in the U.K. and Ireland in January 2012.
Nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011
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| Nine Months Ended | | Change |
| September 30, 2012 | | September 30, 2011 | | YTD'12 vs. YTD'11 |
| (in thousands, except percentages) |
Revenues (2) | $ | 2,664,043 |
| | $ | 2,329,002 |
| | 14 | % |
Domestic | 2,477,901 |
| | 2,275,140 |
| | 9 | % |
International | 186,142 |
| | 53,862 |
| | 246 | % |
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(2) | Presented using our segment reporting prior to the fourth quarter of 2011. Prior to the fourth quarter of 2011, our domestic streaming service and DVDs-by-mail operations were combined. |
The $335.0 million increase in our consolidated revenues was due to the $202.8 million increase in domestic revenues and $132.3 million increase in international revenues. Domestic revenues increased 9% as a result of the 14% growth in the domestic average number of unique paying subscribers driven by new streaming subscriptions. This increase was offset in part by a 5% decline in domestic average monthly
revenue per unique paying subscriber, resulting from the popularity of the streaming subscription service and a decline in the percentage of unique paying subscribers electing both a streaming and a DVD subscription.
International revenues increased by $132.3 million primarily due to our launch in Latin America in September 2011 and our launch in the U.K. and Ireland in January 2012.
Three months ended September 30, 2012 as compared to the three months ended June 30, 2012
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| Three Months Ended | | Change |
| September 30, 2012 | | June 30, 2012 | | Q3'12 vs. Q2'12 |
| (in thousands, except percentages) |
Revenues | $ | 905,089 |
| | $ | 889,163 |
| | 2 | % |
Domestic streaming | 556,027 |
| | 532,705 |
| | 4 | % |
International streaming | 77,744 |
| | 64,973 |
| | 20 | % |
Domestic DVD | 271,318 |
| | 291,485 |
| | (7 | )% |
The $15.9 million increase in our consolidated revenues was due to the $23.3 million increase in Domestic streaming revenues and the $12.8 million increase in International streaming revenues. Domestic streaming revenues increased 4% as a result of the growth in the average number of paying streaming subscriptions. International streaming revenues increased 20% as a result of the growth in the average number of paying international streaming subscriptions resulting from continued subscription growth across all international regions. These increases in streaming revenues were offset by a $20.2 million decrease in Domestic DVD revenue due to an 8% decrease in the average number of paying DVD subscriptions.
We expect streaming subscriptions both domestically and internationally to continue to grow and DVD subscription declines to continue to moderate. As a result, we expect consolidated revenues to increase at a modest pace sequentially in future quarters.
Cost of Revenues
Cost of revenues consists of expenses related to the acquisition and licensing of content, content delivery expenses and fulfillment expenses. Costs related to free-trial periods are allocated to marketing expenses.
Content acquisition and licensing expenses consist primarily of amortization of streaming content licenses, which may or may not be recognized in the streaming content library, amortization of DVD content library and revenue sharing expenses. We obtain content through streaming content license agreements, DVD direct purchases and DVD revenue sharing agreements with studios, distributors and other suppliers. Content agreements are made in the ordinary course of business and our business is not substantially dependent on any particular agreement.
Content delivery expenses consist primarily of the postage costs to mail DVDs to and from our paying subscribers and the packaging and label costs for the mailers. We utilize both our own and third-party content delivery networks to help us efficiently stream content in high volume to our subscribers over the Internet. Content delivery expenses therefore also include equipment costs related to our own streaming content delivery networks ("Open Connect") and all third party costs associated with delivering streaming content over the Internet.
Fulfillment expenses represent those expenses incurred in content processing including operating and staffing our DVD shipping centers, as well as receiving, encoding, inspecting and warehousing our content library. Fulfillment expenses also include operating and staffing our customer service centers and credit card fees.
Three months ended September 30, 2012 as compared to the three months ended September 30, 2011
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| Three Months Ended | | Change |
| September 30, 2012 | | September 30, 2011 | | Q3'12 vs. Q3'11 |
| (in thousands, except percentages) |
Total cost of revenues | $ | 662,638 |
| | $ | 536,617 |
| | 23 | % |
As a percentage of revenues | 73 | % | | 65 | % | | |
The $126.0 million increase in cost of revenues was primarily due to the following factors:
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• | Content acquisition and licensing expenses increased by $171.2 million. This increase was primarily due to a 26% increase in the Domestic segment. Additionally, the launches in Latin America and the U.K. and Ireland have contributed to a 14% increase in our content expenses in the International segment. The increases in both Domestic and International content acquisition expense are due to the continued investments in existing and new streaming content available for viewing to our subscribers. |
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• | Content delivery expenses decreased $40.8 million primarily due to a 43% decrease in the number of DVDs mailed for paid subscriptions. The decrease in the number of DVDs mailed was driven by the decrease in the average number of paid DVD subscriptions. Costs associated with our use of our own and third-party streaming content delivery networks increased 37% but were not a significant contributor to the total variance in content delivery expense. |
Nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011
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| Nine Months Ended | | Change |
| September 30, 2012 | | September 30, 2011 | | YTD'12 vs. YTD'11 |
| (in thousands, except percentages) |
Total cost of revenues | $ | 1,929,999 |
| | $ | 1,464,746 |
| | 32 | % |
As a percentage of revenues | 73 | % | | 63 | % | | |
The $465.3 million increase in cost of revenues was primarily due to the following factors:
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• | Content acquisition and licensing expenses increased by $608.9 million. This increase was primarily due to a 44% increase in the Domestic segment. Additionally, the launches in Latin America and the U.K. and Ireland have contributed to an increase in our content expenses in the International segment. The increases in both Domestic and International content acquisition expense were due to the continued investments in existing and new streaming content available for viewing to our subscribers. |
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• | Content delivery expenses decreased $136.1 million primarily due to a 43% decrease in the number of DVDs mailed for paid subscriptions. The decrease in the number of DVDs mailed was driven by the decrease in the average paid DVD subscriptions. Costs associated with our use of our own and third-party streaming content delivery networks increased 41% but were not a significant contributor to the total variance in content delivery expense. |
Three months ended September 30, 2012 as compared to the three months ended June 30, 2012
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| Three Months Ended | | Change |
| September 30, 2012 | | June 30, 2012 | | Q3'12 vs. Q2'12 |
| (in thousands, except percentages) |
Total cost of revenues | $ | 662,638 |
| | $ | 643,428 |
| | 3 | % |
As a percentage of revenues | 73 | % | | 72 | % | | |
The $19.2 million increase in cost of revenues was primarily due a $20.1 million increase in content acquisition and licensing expenses. This increase was attributable to a 14% increase in the International segment due to an increase in streaming content titles available in our International locations and to the 5% increase in the Domestic streaming segment due to the continued investments in existing and new streaming content available for viewing to our domestic subscribers. These increases were offset by a decrease in the Domestic DVD segment of 18%.
Marketing
Marketing expenses consist primarily of advertising expenses and also include payments made to our affiliates and consumer electronics partners and payroll related expenses. Advertising expenses include promotional activities such as television and online advertising as well as allocated costs of revenues relating to free trial periods. Payments to our affiliates and consumer electronics partners may be in the form of a fixed-fee or may be a revenue sharing payment.
Three months ended September 30, 2012 as compared to the three months ended September 30, 2011
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| Three Months Ended | | Change |
| September 30, 2012 | | September 30, 2011 | | Q3'12 vs. Q3'11 |
| (in thousands, except percentages) |
Marketing | $ | 113,233 |
| | $ | 89,108 |
| | 27 | % |
As a percentage of revenues | 13 | % | | 11 | % | | |
The $24.1 million increase in marketing expenses was primarily due to a $25.0 million increase in marketing program spending primarily in online advertising. International marketing expenses increased by 166% as expenses were higher in the third quarter of 2012 to support the marketing of our service in Latin America and U.K. and Ireland. Domestic marketing expenses decreased by 6%.
Nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011
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| Nine Months Ended | | Change |
| September 30, 2012 | | September 30, 2011 | | YTD'12 vs. YTD'11 |
| (in thousands, except percentages) |
Marketing | $ | 367,357 |
| | $ | 288,350 |
| | 27 | % |
As a percentage of revenues | 14 | % | | 12 | % | | |
The $79.0 million increase in marketing expenses was primarily due to an $85.8 million increase in marketing program spending primarily in online and television advertising. International marketing expenses increased by 220% as expenses were higher in the nine months ended September 30, 2012 to support the launch of our service in the U.K. and Ireland and continued marketing in Latin America and Canada. Domestic marketing expenses decreased by 9%.
Three months ended September 30, 2012 as compared to the three months ended June 30, 2012
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| Three Months Ended | | Change |
| September 30, 2012 | | June 30, 2012 | | Q3'12 vs. Q2'12 |
| (in thousands, except percentages) |
Marketing | $ | 113,233 |
| | $ | 118,224 |
| | (4 | )% |
As a percentage of revenues | 13 | % | | 13 | % | |