Q3'11 Top Investor Questions

The accounting treatment of streaming content generally depends upon whether the content qualifies as an asset to be recorded on the balance sheet. This qualification is determined by whether the license fee is known or reasonably determined for each specific title. When the license fee is known or reasonably determined for a specific title (or
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The accounting treatment of streaming content generally depends upon whether the content qualifies as an asset to be recorded on the balance sheet. This qualification is determined by whether the license fee is known or reasonably determined for each specific title. When the license fee is known or reasonably determined for a specific title (or the license fee is known for a set of titles and we are able to allocate the fee to specific titles,) the streaming content qualifies to be recorded as an asset on our balance sheet. If the agreement is for a set of content for which we cannot allocate the total fee to specific titles (for example, we do not know the specific titles we will receive because the content has not yet been produced), it cannot be recorded as an asset.

Specific title(s) and known fee per title(s)
Balance sheet impact:

• When we know the specific title or titles that will be received and the fees associated with the titles, we record an asset in the content library when the title is available for viewing. We separate our streaming content library assets by current and non-current based on when the content will be available. If it is available for viewing for 12 months or less, it is considered current; if it will be available longer than that, the remaining portion is considered long-term. If the fee for that title has not yet been paid, we also record a liability within accounts payable for the amounts due within one year. For the amounts beyond one year, we record a liability in other non-current liabilities.

Income statement impact

• When a specific title is recorded as an asset on the balance sheet within the content library, we generally amortize it on a straight-line basis over the life of that title. The amortization is reported within the "cost of revenues: subscription" line item on the income statement.

Impact on cash flow

• For streaming content that qualifies as an asset, the acquisition is recorded as a use of cash in the line item "additions of streaming content library," and amortization is reported in the line item "amortization of content library," which also includes DVD amortization.

Set of content with total fee unable to allocate to specific title
Balance sheet impact

• When we license a set of content in which we cannot allocate the total fee to specific titles, the content does not qualify to be recorded as an asset in our content library.
• We may make a periodic fixed prepayment for the set of content that is recorded as prepaid content on the balance sheet.
• Any future known payment obligation for this content is included in our contractual obligations table which is reported in the MD&A section of our 10Ks and 10Qs and is disclosed in the footnotes to our financial statements.

Income statement impact

• The license fee for the set of content is expensed on a straight-line basis over the life of the agreement and reported within the "cost of revenues: subscription" line item on the income statement.

Impact on cash flow

• The acquisition of streaming content that is not recorded as an asset on the balance sheet is expensed within "cost of revenues: subscription" and is reflected within the net income line.
• When the timing of payments for streaming content does not match exactly with the timing of when the expense is recorded, we will record either a payable or a prepaid content. The change in the payable or the prepaid content is shown on the cash flow statement within the change in streaming content liabilities or the change in operating assets or liabilities.

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The entertainment video market is attracting a large number of participants. Those participants operate in several business models: the pay-per-view model, which is very focused on new releases and includes VOD offerings from cable companies, Redbox, Amazon and Apple; the ad supported model, which includes Hulu and YouTube; and the subscription model, which is o
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The entertainment video market is attracting a large number of participants. Those participants operate in several business models: the pay-per-view model, which is very focused on new releases and includes VOD offerings from cable companies, Redbox, Amazon and Apple; the ad supported model, which includes Hulu and YouTube; and the subscription model, which is our focus and also includes PayTV and Hulu Plus. Consumers can maintain multiple relationships within the overall market. We believe that the large market opportunity allows all of these segments to be successful.

Our largest competitor over time is likely to be an improved MVPD service offering more Internet video on-demand, and thus reducing the number of people who will be attracted by a supplementary service like Netflix. Our task is to consistently improve the quality of our service and stay two steps ahead, so that consumers will continue to enjoy Netflix

The entertainment video market is highly competitive. Direct competition within the subscription model may come from any number of firms, such as Hulu or Amazon, or perhaps from some yet known entrepreneur. But, as you know, we have faced – and overcome – tough competition in the past. We view competition as a natural part of our business, and we're just focused on continuing to offer a superior customer experience. We believe that's the best way to address current and potential competitive challenges.

Our competitive advantages include outstanding value, a robust and growing selection of content that our subscribers want to watch, high levels of customer satisfaction that turn subscribers into advocates, and a personalized and adaptive user interface that helps our subscribers find movies they will love.

More fundamentally, our primary competitive advantage is our large and growing subscriber base which gives us tremendous operating efficiencies and, which we believe, drives the following virtuous cycles:

• More subscribers means more money to license content, which drives more subscriber growth
• More subscribers means more word-of-mouth from subscribers to those who are not yet subscribers, which drives more subscriber growth
• And more subscribers means we can increase R&D spend to improve our user experience, drives more subscriber growth

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