10-Q 1 nflx-063015x10qxdoc.htm 10-Q NFLX-06.30.15-10Q-DOC
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2015
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: 001-35727
 
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  x    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  x    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
x
 
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  x
As of June 30, 2015, there were 426,004,831 shares of the registrant’s common stock, par value $0.001, outstanding.




Table of Contents
 


2



NETFLIX, INC.
Consolidated Statements of Operations
(unaudited)
(in thousands, except per share data)

 
Three Months Ended
 
Six Months Ended
 
June 30,
2015
 
June 30,
2014
 
June 30,
2015
 
June 30,
2014
Revenues
$
1,644,694

 
$
1,340,407

 
$
3,217,823

 
$
2,610,496

Cost of revenues
1,121,752

 
914,848

 
2,168,153

 
1,784,034

Marketing
197,140

 
120,763

 
391,817

 
257,861

Technology and development
155,061

 
115,182

 
298,167

 
225,492

General and administrative
95,906

 
60,014

 
187,395

 
115,914

Operating income
74,835

 
129,600

 
172,291

 
227,195

Other income (expense):
 
 
 
 
 
 
 
Interest expense
(35,217
)
 
(13,328
)
 
(61,954
)
 
(23,380
)
Interest and other income (expense)
872

 
1,100

 
(31,421
)
 
2,501

Income before income taxes
40,490

 
117,372

 
78,916

 
206,316

Provision for income taxes
14,155

 
46,354

 
28,885

 
82,183

Net income
$
26,335

 
$
71,018

 
$
50,031

 
$
124,133

Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.06

 
$
0.17

 
$
0.12

 
$
0.30

Diluted
$
0.06

 
$
0.16

 
$
0.12

 
$
0.29

Weighted-average common shares outstanding:
 
 
 
 
 
 
 
Basic
425,340

 
419,974

 
424,486

 
419,349

Diluted
436,097

 
431,441

 
434,958

 
431,141













See accompanying notes to the consolidated financial statements.

3


NETFLIX, INC.
Consolidated Statements of Comprehensive Income
(unaudited)
(in thousands)
 
Three Months Ended
 
Six Months Ended
 
June 30,
2015
 
June 30,
2014
 
June 30,
2015
 
June 30,
2014
Net income
$
26,335

 
$
71,018

 
$
50,031

 
$
124,133

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustments 
5,560

 
1,918

 
(33,930
)
 
2,379

Change in unrealized gains on available-for-sale securities, net of tax of $25, $51, $158 and $342, respectively
(526
)
 
81

 
256

 
548

Total other comprehensive (loss) income
5,034

 
1,999

 
(33,674
)
 
2,927

Comprehensive income
$
31,369

 
$
73,017

 
$
16,357

 
$
127,060

























See accompanying notes to the consolidated financial statements.

4


NETFLIX, INC.

Consolidated Statements of Cash Flows
(unaudited)
(in thousands)
   
Three Months Ended
 
Six Months Ended
   
June 30,
2015
 
June 30,
2014
 
June 30,
2015
 
June 30,
2014
Cash flows from operating activities:
 
 
 
 
 
 
 
Net income
$
26,335

 
$
71,018

 
$
50,031

 
$
124,133

Adjustments to reconcile net income to net cash (used in) provided by operating activities:
 
 
 
 
 
 
 
Additions to streaming content library
(1,273,677
)
 
(813,314
)
 
(2,885,602
)
 
(1,562,713
)
Change in streaming content liabilities
191,154

 
78,359

 
817,479

 
120,603

Amortization of streaming content library
822,600

 
639,037

 
1,572,118

 
1,239,772

Amortization of DVD content library
20,813

 
16,923

 
41,998

 
33,044

Depreciation and amortization of property, equipment and intangibles
15,581

 
12,977

 
30,748

 
25,359

Stock-based compensation expense
28,590

 
29,285

 
56,031

 
55,110

Excess tax benefits from stock-based compensation
(39,427
)
 
(14,628
)
 
(68,428
)
 
(47,360
)
Other non-cash items
6,682

 
3,251

 
12,988

 
5,447

Deferred taxes
(4,232
)
 
(16,569
)
 
(41,274
)
 
(29,672
)
Changes in operating assets and liabilities:
 
 
 
 
 
 
 
Other current assets
(39,614
)
 
(20,685
)
 
(16,505
)
 
14,381

Accounts payable
6,447

 
(3,086
)
 
(4,178
)
 
19,726

Accrued expenses
41,624

 
59,008

 
77,546

 
58,566

Deferred revenue
16,414

 
11,315

 
27,168

 
25,563

Other non-current assets and liabilities
(633
)
 
3,133

 
21,155

 
10,424

Net cash (used in) provided by operating activities
(181,343
)
 
56,024

 
(308,725
)
 
92,383

Cash flows from investing activities:
 
 
 
 
 
 
 
Acquisition of DVD content library
(19,786
)
 
(20,981
)
 
(42,692
)
 
(35,895
)
Purchases of property and equipment
(27,538
)
 
(19,869
)
 
(40,574
)
 
(33,203
)
Other assets
(639
)
 
1,129

 
(414
)
 
1,424

Purchases of short-term investments
(67,949
)
 
(170,908
)
 
(158,889
)
 
(231,454
)
Proceeds from sale of short-term investments
48,412

 
89,662

 
100,360

 
232,710

Proceeds from maturities of short-term investments
19,170

 
92,014

 
51,057

 
95,104

Net cash (used in) provided by investing activities
(48,330
)
 
(28,953
)
 
(91,152
)
 
28,686

Cash flows from financing activities:
 
 
 
 
 
 
 
Proceeds from issuance of common stock
23,804

 
14,469

 
34,720

 
46,917

Proceeds from issuance of debt

 

 
1,500,000

 
400,000

Issuance costs
(397
)
 
(353
)
 
(17,629
)
 
(7,080
)
Excess tax benefits from stock-based compensation
39,427

 
14,628

 
68,428

 
47,360

Principal payments of lease financing obligations
(287
)
 
(271
)
 
(538
)
 
(538
)
Net cash provided by financing activities
62,547

 
28,473

 
1,584,981

 
486,659

Effect of exchange rate changes on cash and cash equivalents
6,221

 
1,250

 
(4,840
)
 
1,551

Net (decrease) increase in cash and cash equivalents
(160,905
)
 
56,794

 
1,180,264

 
609,279

Cash and cash equivalents, beginning of period
2,454,777

 
1,157,450

 
1,113,608

 
604,965

Cash and cash equivalents, end of period
$
2,293,872

 
$
1,214,244

 
$
2,293,872

 
$
1,214,244

Supplemental disclosure of non-cash investing activities:
 
 
 
 
 
 
 
Increase in accounts payable related to purchases of property and equipment
$
13,713

 
$
5,528

 
$
12,152

 
$
5,792

See accompanying notes to the consolidated financial statements.

5


NETFLIX, INC.
Consolidated Balance Sheets
(in thousands, except share and par value data)

 
As of
   
June 30,
2015
 
December 31,
2014
 
(unaudited)
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
2,293,872

 
$
1,113,608

Short-term investments
502,886

 
494,888

Current content library, net
2,510,946

 
2,125,702

Other current assets
292,806

 
206,271

Total current assets
5,600,510

 
3,940,469

Non-current content library, net
3,640,767

 
2,773,326

Property and equipment, net
171,396

 
149,875

Other non-current assets
242,188

 
192,981

Total assets
$
9,654,861

 
$
7,056,651

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Current content liabilities
$
2,556,180

 
$
2,117,241

Accounts payable
211,729

 
201,581

Accrued expenses
150,406

 
69,746

Deferred revenue
301,754

 
274,586

Total current liabilities
3,220,069

 
2,663,154

Non-current content liabilities
1,942,624

 
1,575,832

Long-term debt
2,400,000

 
900,000

Other non-current liabilities
60,093

 
59,957

Total liabilities
7,622,786

 
5,198,943

Commitments and contingencies (Note 9)


 


Stockholders’ equity:
 
 
 
Common stock, $0.001 par value; 4,990,000,000 and 160,000,000 shares authorized at June 30, 2015 and December 31, 2014, respectively; 426,004,831 and 422,910,887 issued and outstanding at June 30, 2015 and December 31, 2014, respectively
1,200,880

 
1,042,870

Accumulated other comprehensive loss
(38,120
)
 
(4,446
)
Retained earnings
869,315

 
819,284

Total stockholders’ equity
2,032,075

 
1,857,708

Total liabilities and stockholders’ equity
$
9,654,861

 
$
7,056,651





See accompanying notes to the consolidated financial statements.

6


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, 2014 filed with the Securities and Exchange Commission (the “SEC”) on January 29, 2015. 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 streaming content library amortization policy; the recognition and measurement of income tax assets and liabilities; and the valuation of stock-based compensation. The Company bases its estimates on historical experience and on various other assumptions that the Company believes to be reasonable under the circumstances. On a regular basis, the Company evaluates the assumptions, judgments and estimates. Actual results may differ from these 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, 2014. Interim results are not necessarily indicative of the results for a full year.
The Company has three reportable segments: Domestic streaming, International streaming and Domestic DVD. The majority of the Company’s revenues are generated in the United States, and substantially all of the Company’s long-lived tangible assets are held in the United States. The Company’s revenues are derived from monthly membership fees.
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, 2014.
Prior to January 1, 2015, the functional currency of certain of the Company's European entities was the British pound. The Company changed the functional currency of these entities to the euro effective January 1, 2015 following the redomiciliation of the European headquarters and the launch of the Netflix service in several significant European countries. The change in functional currency was applied prospectively from January 1, 2015. Monetary assets and liabilities have been remeasured to the euro at current exchange rates. Non-monetary assets and liabilities have been remeasured to the euro using the exchange rate effective for the period in which the balance arose. As a result of this change of functional currency, the Company recorded a $21.8 million cumulative translation adjustment included in other comprehensive loss for the six months ended June 30, 2015.
On July 14, 2015, the Company completed a seven-for-one stock split in the form of a stock dividend. References made to outstanding shares or per share amounts in the accompanying consolidated financial statements and applicable disclosures have been retroactively adjusted to reflect this seven-for-one stock split. The number of authorized shares as reflected on the Consolidated Balance Sheet were not affected by the stock split and accordingly have not been adjusted. See Notes 2 and 6 for additional information.
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers (Topic 606) which amended the existing accounting standards for revenue recognition. ASU 2014-09 establishes principles for recognizing revenue upon the transfer of promised goods or services to customers, in an amount that reflects the expected consideration received in exchange for those goods or services. In July 2015, the FASB deferred the effective date for annual reporting periods beginning after December 15, 2017 (including interim reporting periods within those periods). Early adoption is permitted to the original effective date of December 15, 2016 (including interim reporting periods within those periods). The amendments may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of initial application. The Company is currently in the process of evaluating the impact of adoption of the ASU on its consolidated financial statements, but does not expect the impact to be material.
In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs which changes the presentation of debt issuance costs in financial statements. ASU 2015-03 requires an entity to present such costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs will continue to be reported as interest expense. It is effective for annual reporting periods beginning after December 15, 2015. Early adoption is permitted. The Company will adopt ASU 2015-03 on January 1, 2016, at which time the Company will reclassify approximately $30 million of debt issuance costs associated with the Company's long-term debt from other noncurrent assets to long-term debt. A reclassification will also be applied retrospectively to each prior period presented.
In April 2015, the FASB issued ASU 2015-05, Customer's Accounting for Fees Paid in a Cloud Computing Arrangement, which provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If the arrangement does not include a software license, the customer should account for a cloud computing arrangement as a service contract. It is effective for annual periods beginning after December 15, 2015. Early adoption is permitted. The amendment may be

7


adopted either prospectively to all arrangements entered into or materially modified after the effective date or retrospectively. The Company has elected to early adopt the ASU in the third quarter of 2015 and will apply the guidance prospectively to all future arrangements. The Company does not expect the impact of the adoption of the ASU to be material to its consolidated financial statements.


2. Earnings Per Share
In June 2015, the Company's Board of Directors declared a seven-for-one stock split in the form of a stock dividend that was paid on July 14, 2015 to all shareholders of record as of July 2, 2015 ("Stock Split").
Outstanding share and per-share amounts disclosed as of June 30, 2015 and for all other comparative periods provided have been retroactively adjusted to reflect the effects of the Stock Split. 
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 common shares outstanding during the period. Potential common shares consist of incremental shares issuable upon the assumed exercise of stock options. The computation of earnings per share, as adjusted to reflect the effects of the Stock Split, are as follows:
 
Three Months Ended
 
Six Months Ended
 
June 30,
2015
 
June 30,
2014
 
June 30,
2015
 
June 30,
2014
 
(in thousands, except per share data)
Basic earnings per share:
 
 
 
 
 
 
 
Net income
$
26,335

 
$
71,018

 
$
50,031

 
$
124,133

Shares used in computation:
 
 
 
 
 
 
 
Weighted-average common shares outstanding
425,340

 
419,974

 
424,486

 
419,349

Basic earnings per share
$
0.06

 
$
0.17

 
$
0.12

 
$
0.30

 
 
 
 
 
 
 
 
Diluted earnings per share:
 
 
 
 
 
 
 
Net income
$
26,335

 
$
71,018

 
$
50,031

 
$
124,133

Shares used in computation:
 
 
 
 
 
 
 
Weighted-average common shares outstanding
425,340

 
419,974

 
424,486

 
419,349

Employee stock options
10,757

 
11,467

 
10,472

 
11,792

Weighted-average number of shares
436,097

 
431,441

 
434,958

 
431,141

Diluted earnings per share
$
0.06

 
$
0.16

 
$
0.12

 
$
0.29


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, as adjusted to reflect the effects of the Stock Split:
 
Three Months Ended
 
Six Months Ended
 
June 30,
2015
 
June 30,
2014
 
June 30,
2015
 
June 30,
2014
 
(in thousands)
Employee stock options
80

 
693

 
938

 
490




8


3. Short-term Investments
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 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 tables summarize, 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 and where they are classified on the Consolidated Balance Sheets:
 
As of June 30, 2015
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
(in thousands)
Cash
$
2,193,203

 
$

 
$

 
$
2,193,203

Level 1 securities:
 
 
 
 
 
 
 
Money market funds
105,603

 

 

 
105,603

Level 2 securities:
 
 
 
 
 
 
 
Corporate debt securities
271,569

 
419

 
(130
)
 
271,858

Government securities
197,919

 
364

 
(7
)
 
198,276

Certificate of deposits and commercial paper
6,100

 

 

 
6,100

Agency securities
26,621

 
31

 

 
26,652

Total
$
2,801,015

 
$
814

 
$
(137
)
 
$
2,801,692


 
As of December 31, 2014
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
(in thousands)
Cash
$
1,007,543

 
$

 
$

 
$
1,007,543

Level 1 securities:
 
 
 
 
 
 
 
Money market funds
111,759

 

 

 
111,759

Level 2 securities:
 
 
 
 
 
 
 
Corporate debt securities
295,500

 
432

 
(199
)
 
295,733

Government securities
168,749

 
120

 
(95
)
 
168,774

Asset and mortgage-backed securities
112

 

 

 
112

Certificate of deposits
3,600

 

 

 
3,600

Agency securities
26,665

 
5

 
(1
)
 
26,669

Total
$
1,613,928

 
$
557

 
$
(295
)
 
$
1,614,190


 
As of
 
June 30, 2015
 
December 31, 2014
 
(in thousands)
Cash and cash equivalents
$
2,293,872

 
$
1,113,608

Short-term investments
502,886

 
494,888

Other non-current assets (1)
4,934

 
5,694

Total
$
2,801,692

 
$
1,614,190


(1) Primarily restricted cash that is related to workers compensation deposits.

Fair value is a market-based measurement that is 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 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

9


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 debt instruments.

There were no investments in a material unrealized loss position as of June 30, 2015 or December 31, 2014. There were no material other-than-temporary impairments or credit losses related to available-for-sale securities in the three or six months ended June 30, 2015 and 2014. In addition, there were no material gross realized gains or losses in the three or six months ended June 30, 2015 and 2014.
The estimated fair value of short-term investments by contractual maturity as of June 30, 2015 is as follows:
 
(in thousands)
Due within one year
$
172,268

Due after one year and through five years
330,618

Total short-term investments
$
502,886



4. Balance Sheet Components
Content Library
Content library consisted of the following:
 
As of
 
June 30,
2015
 
December 31,
2014
 
(in thousands)
Total content library, gross
$
10,253,672

 
$
8,497,403

Accumulated amortization
(4,101,959
)
 
(3,598,375
)
Total content library, net
6,151,713

 
4,899,028

Current content library, net
2,510,946

 
2,125,702

Non-current content library, net
$
3,640,767

 
$
2,773,326


Content library includes costs capitalized for licensed streaming content, for production of original content and for DVD content.
Property and Equipment, Net
Property and equipment and accumulated depreciation consisted of the following:
 
 
As of
 
 
 
 
June 30,
2015
 
December 31,
2014
 
Estimated Useful Lives

 
 
(in thousands)
 
 
Information technology assets
 
$
185,943

 
$
189,274

 
3 years
Furniture and fixtures
 
25,825

 
25,758

 
3 years
Building
 
40,681

 
40,681

 
30 years
Leasehold improvements
 
61,453

 
57,339

 
Over life of lease
DVD operations equipment
 
89,132

 
89,144

 
5 years
Capital work-in-progress
 
50,135

 
12,495

 

Property and equipment, gross
 
453,169

 
414,691

 
 
Less: Accumulated depreciation
 
(281,773
)
 
(264,816
)
 
 
Property and equipment, net
 
$
171,396

 
$
149,875

 
 

Capital work-in-progress as of June 30, 2015 consists primarily of $41.5 million of leasehold improvements and furniture for the Company's headquarters expansion not yet placed into service.



10


5. Long-term Debt

As of June 30, 2015, the Company had aggregate outstanding principal of $2.4 billion in long-term notes with varying maturities (the "Notes"). Each of the Notes were issued at par and are senior unsecured obligations of the Company. Interest is payable semi-annually at fixed rates.

The following table provides a summary of the Company's long-term debt as of June 30, 2015 and December 31, 2014:
 
 
 
 
 
 
 
 
 
Level 2 Fair Value (1) as of
 
Principal Amount at Par
 
Issuance Date
 
Maturity
 
Interest Due Dates
 
June 30,
2015
 
December 31, 2014
 
(in millions)
 
 
 
 
 
 
 
(in millions)
5.375% Senior Notes
$
500.0

 
February 2013
 
2021
 
February 1 and August 1
 
$
518.8

 
$
520.0

5.750% Senior Notes
400.0

 
February 2014
 
2024
 
March 1 and September 1
 
411.0

 
416.0

5.50% Senior Notes (2)
700.0

 
February 2015
 
2022
 
April 15 and October 15
 
722.8

 

5.875% Senior Notes (2)
800.0

 
February 2015
 
2025
 
April 15 and October 15
 
828.1

 


(1) Based on quoted market prices in less active markets.
(2)
The net proceeds to the Company for the 5.50% and 5.875% Senior Notes issued in the first quarter of 2015 were an aggregate $1,482.4 million. Debt issuance costs of $17.6 million were recorded in "Other non-current assets" on the Consolidated Balance Sheets and are amortized over the term of the notes as "Interest expense" on the Consolidated Statements of Operations.

Each of the Notes are repayable in whole or in part upon the occurrence of a change of control, at the option of the holders, at a purchase price in cash equal to 101% of the principal plus accrued interest. The Company may redeem the Notes prior to maturity in whole or in part at an amount equal to the principal amount thereof plus accrued and unpaid interest and an applicable premium. The Notes include, among other terms and conditions, limitations on the Company's ability to create, incur or allow certain liens; enter into sale and lease-back transactions; create, assume, incur or guarantee additional indebtedness of certain of the Company's subsidiaries; and consolidate or merge with, or convey, transfer or lease all or substantially all of the Company's and its subsidiaries assets, to another person. As of June 30, 2015 and December 31, 2014, the Company was in compliance with all related covenants.


6. Stockholders’ Equity

Stock Split
In March 2015, the Company's Board of Directors adopted an amendment to the Company's Certificate of Incorporation, to increase the number of shares of capital stock the Company is authorized to issue from 170,000,000 (160,000,000 shares of common stock and 10,000,000 shares of preferred stock), par value $0.001 to 5,000,000,000 (4,990,000,000 shares of common stock and 10,000,000 shares of preferred stock), par value $0.001. This amendment to the Company's certificate of incorporation was approved by the Company's stockholders at the 2015 Annual Meeting held on June 9, 2015.
On June 23, 2015, the Company's Board of Directors declared a seven-for-one stock split in the form of a stock dividend that was paid on July 14, 2015 to all shareholders of record as of July 2, 2015. Outstanding share and per-share amounts disclosed as of June 30, 2015 and for all other comparative periods presented have been retroactively adjusted to reflect the effects of the Stock Split. 
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 June 30, 2015, 18.1 million shares, as adjusted for the Stock Split, were reserved for future grants under the 2011 Stock Plan.

11


A summary of the activities related to the Company’s stock option plans, as adjusted for the Stock Split, 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, 2014
20,025,208

 
22,845,417

 
$
21.65

 
 
 
 
Granted
(1,916,299
)
 
1,916,299

 
66.07

 
 
 
 
Exercised


 
(3,093,944
)
 
11.01

 
 
 
 
Balances as of June 30, 2015
18,108,909

 
21,667,772

 
$
27.09

 
6.40
 
$
1,446,423

Vested and exercisable as of June 30, 2015
 
 
21,667,772

 
$
27.09

 
6.40
 
$
1,446,423


The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on the last trading day of the second quarter of 2015 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 the last trading day of the second quarter of 2015. This amount changes based on the fair market value of the Company’s common stock.
A summary of the amounts related to option exercises, is as follows:
 
Three Months Ended
Six Months Ended
 
June 30,
2015
June 30,
2014
 
June 30,
2015
June 30,
2014
 
(in thousands)
Total intrinsic value of options exercised
$
114,783

$
46,179

 
$
195,621

$
147,720

Cash received from options exercised
$
23,804

$
14,469

 
$
34,720

$
46,917

Stock-based Compensation
The following table summarizes the assumptions used to value stock option grants using the lattice-binomial model and the valuation data, as adjusted for the Stock Split:
 
Three Months Ended
 
Six Months Ended
 
June 30,
2015
 
June 30,
2014
 
June 30,
2015
 
June 30,
2014
Dividend yield
%
 
%
 
%
 
%
Expected volatility
36
%
 
45
%
 
36
%
 
 45% - 48%

Risk-free interest rate
2.05
%
 
2.66
%
 
2.03% - 2.05%

 
2.66% - 2.83%

Suboptimal exercise factor
2.47

 
2.66 - 4.20

 
2.47 -2.48

 
2.66 - 4.20

Valuation data:
 
 
 
 
 
 
 
Weighted-average fair value (per share)
$
32.52

 
$
28.13

 
$
29.24

 
$
29.69

Total stock-based compensation expense (in thousands)
$
28,590

 
$
29,285

 
$
56,031

 
$
55,110

Total income tax benefit related to stock options (in thousands)
$
10,796

 
$
11,225

 
$
21,188

 
$
21,124


The Company considers several factors in determining the suboptimal exercise factor, including the historical and estimated option exercise behavior and the employee groupings. Prior to January 1, 2015, the Company bifurcated its option grants into two employee groupings (executive and non-executive) to determine the suboptimal exercise factor. Beginning on January 1, 2015, the Company began aggregating employee groupings for its determination of the suboptimal exercise factor as the previous bifurcation into two groupings did not have a material impact on the fair value of the options granted.
Prior to January 1, 2015, the Company's computation of expected volatility was based on a blend of historical volatility of its common stock and implied volatility of tradable forward call options to purchase shares of its common stock, as low trade volume of its tradable forward call options prior to 2011 precluded sole reliance on implied volatility. Beginning on January 1, 2015, expected volatility is based solely on implied volatility. The Company believes that implied volatility of publicly traded options in its common stock is more reflective of market conditions, and given consistently high trade volumes of the options, can reasonably be expected to be a better indicator of expected volatility than historical volatility of its common stock.
In valuing shares issued under the Company’s employee stock option plans, the Company bases the risk-free interest rate on U.S. Treasury zero-coupon issues with terms similar to the contractual term of the options. The Company does not anticipate paying any cash

12


dividends in the foreseeable future and therefore uses an expected dividend yield of zero in the option valuation model. The Company does not use a post-vesting termination rate as options are fully vested upon grant date.


7. Accumulated Other Comprehensive Loss

The following table summarizes the changes in the accumulated balance of other comprehensive loss, net of tax, for the three and six months ended June 30, 2015:
 
Foreign currency
 
Change in unrealized gains on available-for-sale securities
 
Total
 
(in thousands)
Balance as of March 31, 2015
$
(44,105
)
 
$
951

 
$
(43,154
)
Other comprehensive (loss) income before reclassifications
5,560

 
(413
)
 
5,147

Amounts reclassified from accumulated other comprehensive loss

 
(113
)
 
(113
)
Net increase (decrease) in other comprehensive (loss) income
5,560

 
(526
)
 
5,034

Balance as of June 30, 2015
$
(38,545
)
 
$
425

 
$
(38,120
)

 
Foreign currency
 
Change in unrealized gains on available-for-sale securities
 
Total
 
(in thousands)
Balance as of December 31, 2014
$
(4,615
)
 
$
169

 
$
(4,446
)
Other comprehensive (loss) income before reclassifications
(33,930
)
 
433

 
(33,497
)
Amounts reclassified from accumulated other comprehensive loss

 
(177
)
 
(177
)
Net increase (decrease) in other comprehensive (loss) income
(33,930
)
 
256

 
(33,674
)
Balance as of June 30, 2015
$
(38,545
)
 
$
425

 
$
(38,120
)
As discussed in Note 1, other comprehensive loss for the six months ended June 30, 2015 includes the impact of the change in functional currency for certain of the Company's European entities.

All amounts reclassified from accumulated other comprehensive loss were related to realized gains on available-for-sale securities. These reclassifications impacted "Interest and other income (expense)" on the Consolidated Statements of Operations.


8. Income Taxes
The effective tax rates for the three months ended June 30, 2015 and 2014 were 35% and 39%, respectively. The effective tax rates for the six months ended June 30, 2015 and 2014 were 37% and 40%, respectively. The effective tax rates for the three and six months ended June 30, 2015 and 2014 differed from the federal statutory rate primarily due to state taxes, foreign taxes and non-deductible expenses, partially offset by the California R&D credit.
The decrease in the Company's effective tax rates for the three and six months ended June 30, 2015 as compared to the three and six months ended June 30, 2014 was primarily attributable to lower tax reserves on uncertain tax positions following an IRS Appeals settlement in the fourth quarter of 2014.
Gross unrecognized tax benefits were $38.1 million and $34.8 million as of June 30, 2015 and December 31, 2014, respectively. The gross unrecognized tax benefits, if recognized by the Company, will result in a reduction of approximately $31.5 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 June 30, 2015, the total amount of gross interest and penalties accrued was $0.4 million, and is classified as “Other non-current liabilities” on the Consolidated Balance Sheets.
Deferred tax assets include $15.8 million and $13.4 million classified as “Other current assets” and $145.7 million and $106.9 million classified as “Other non-current assets” on the Consolidated Balance Sheets as of June 30, 2015 and December 31, 2014, 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

13


planning strategies. As of June 30, 2015 and December 31, 2014, it was considered more likely than not that all deferred tax assets would be realized.
Income tax benefits attributable to the exercise of employee stock options of $39.1 million and $14.6 million, during the three months ended June 30, 2015 and 2014, respectively. Income tax benefits attributable to the exercise of employee stock options of $67.9 million and $47.1 million, during the six months ended June 30, 2015 and 2014, respectively. These benefits 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 2010 through 2013. The Company is also currently under examination by the state of California for the years 2006 and 2007. California has completed its Field Exam of the 2006 and 2007 California tax returns and has issued a Notice of Proposed Assessment primarily related to the Company's R&D Credits claimed in those years. The Company has filed a protest against the proposed assessment and is currently in the midst of the Franchise Tax Board Protest process. The years 1997 through 2005, as well as 2008 through 2013 remain subject to examination by the state of California. The Company has no significant foreign jurisdiction audits underway. The years 2011 through 2014 remain subject to examination by foreign jurisdictions. 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.


9. Commitments and Contingencies

Streaming Content
As of June 30, 2015, the Company had $10.1 billion of obligations comprised of $2.5 billion included in "Current content liabilities" and $1.9 billion of "Non-current content liabilities" on the Consolidated Balance Sheets and $5.7 billion of obligations that are not reflected on the Consolidated Balance Sheets.
As of December 31, 2014, the Company had $9.5 billion of obligations comprised of $2.1 billion included in "Current content liabilities" and $1.6 billion of "Non-current content liabilities" on the Consolidated Balance Sheets and $5.8 billion of obligations that are not reflected on the Consolidated Balance Sheets.
The expected timing of payments for these streaming content obligations is as follows:
 
As of 
 
June 30,
2015
 
December 31,
2014
 
(in thousands)
Less than one year
$
4,271,285

 
$
3,747,648

Due after one year and through three years
4,791,033

 
4,495,103

Due after three years and through five years
961,784

 
1,164,308

Due after five years
49,307

 
44,053

Total streaming content obligations
$
10,073,409

 
$
9,451,112


A streaming content obligation is incurred at the time the Company enters into an agreement to obtain future titles. Once a title becomes available, a content liability is generally recorded on the Consolidated Balance Sheets. Certain agreements include the obligation to license rights for unknown future titles, the ultimate quantity and/or fees for which are not yet determinable as of the reporting date. The Company does not include any estimated obligation for these future titles beyond the known minimum amount. However, the unknown obligations are expected to be significant and the expected timing of payments could range from less than one year to more than five years.
The Company has entered into certain licenses with performing rights organizations ("PROs"), and is currently involved in negotiations with other PROs, that hold certain rights to music and other entertainment works "publicly performed" in connection with streaming content into various territories. Accruals for estimated license fees are recorded and then adjusted based on any change in estimates. These amounts are included in the streaming content obligations. The results of these negotiations are uncertain and may be materially different from management's estimates.
Legal Proceedings
From time to time, in the normal course of its operations, the Company is subject 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

14


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 alleging substantially similar claims.  These lawsuits were consolidated into In re Netflix, Inc., Securities Litigation, Case No. 3:12-cv-00225-SC, and the Court selected lead plaintiffs. On June 26, 2012, lead plaintiffs filed a consolidated complaint which alleged violations of the federal securities laws. The Court dismissed the consolidated complaint with leave to amend on February 13, 2013. Lead plaintiffs filed a first amended consolidated complaint on March 22, 2013. The Court dismissed the first amended consolidated complaint with prejudice on August 20, 2013, and judgment was entered on September 27, 2013. Lead plaintiffs filed a motion to alter or amend the judgment and requested leave to file a second amended complaint on October 25, 2013. On January 17, 2014, the Court denied that motion. On February 18, 2014, lead plaintiffs appealed that decision to the United States Court of Appeals for the Ninth Circuit. 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 into In re Netflix, Inc. Shareholder Derivative Litigation, Case No. 1-12-cv-218399, and lead counsel was appointed. A consolidated complaint was filed on December 4, 2012, with plaintiffs seeking compensatory damages and other relief. The consolidated complaint alleges, among other things, that certain of the Company's current and former officers and directors breached their fiduciary duties, issued false and misleading statements primarily regarding the Company's streaming business, violated accounting rules concerning segment reporting, violated provisions of the California Corporations Code, and wasted corporate assets. The consolidated complaint further alleges that the defendants caused the Company to buy back stock at artificially inflated prices to the detriment of the Company and its shareholders while contemporaneously selling personally held Company stock. The Company filed a demurrer to the consolidated complaint and a motion to stay the derivative litigation in favor of the related federal securities class action on February 4, 2013. On June 21, 2013, the Court granted the motion to stay the derivative litigation pending resolution of the related federal securities class action. 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 consolidated financial statements with respect to these indemnification obligations.


10. Segment Information
The Company has three reportable segments: Domestic streaming, International streaming and Domestic DVD. Segment information is presented in the same manner that the Company’s chief operating decision maker ("CODM") reviews the operating results in assessing performance and allocating resources. The Company’s CODM reviews revenues and contribution profit (loss) for each of the reportable segments. Contribution profit (loss) is defined as revenues less cost of revenues and marketing expenses directly incurred by the segment. The Company has aggregated the results of the International operating segments into one reportable segment because these operating segments share similar long-term economic and other qualitative characteristics.

15


The Domestic and International streaming segments derive revenues from monthly membership fees for services consisting solely of streaming content. The Domestic DVD segment derives revenues from monthly membership fees for services consisting solely of DVD-by-mail. Revenues and the related payment card fees are attributed to the operating segment based on the nature of the underlying membership (streaming or DVD) and the geographic region from which the membership originates. There are no internal revenue transactions between the Company’s segments.
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. Content rights increasingly include multiple geographies as the Company aspires to obtain global content rights to support global expansion. The Company allocates this content between the International and Domestic segments based on estimated fair market value. Marketing expenses are primarily comprised of advertising expenses which are generally included in the segment in which the expenditures are directly incurred.
The Company's long-lived tangible assets were located as follows:
 
As of
 
June 30,
2015
 
December 31,
2014
 
(in thousands)
United States
$
160,135

 
$
138,704

International
11,261

 
11,171

The following table represents segment information for the quarter ended June 30, 2015:
 
 
As of/ Three Months Ended June 30, 2015
 
Domestic
Streaming
 
International
Streaming
 
Domestic
DVD
 
Consolidated
 
(in thousands)
Total memberships at end of period (1)
42,300

 
23,251

 
5,314

 

Revenues
$
1,025,913

 
$
454,763

 
$
164,018

 
$
1,644,694

Cost of revenues
612,691

 
422,966

 
86,095

 
1,121,752

Marketing
73,427

 
123,713

 

 
197,140

Contribution profit (loss)
$
339,795

 
$
(91,916
)
 
$
77,923

 
$
325,802

Other operating expenses
 
 
 
 
 
 
250,967

Operating income
 
 
 
 
 
 
74,835

Other income (expense)
 
 
 
 
 
 
(34,345
)
Provision for income taxes
 
 
 
 
 
 
14,155

Net income
 
 
 
 
 
 
$
26,335


 
As of/ Six Months Ended June 30, 2015
 
Domestic
Streaming
 
International
Streaming
 
Domestic
DVD
 
Consolidated
 
(in thousands)
Total memberships at end of period (1)
42,300

 
23,251

 
5,314

 

Revenues
$
2,010,445

 
$
870,160

 
$
337,218

 
$
3,217,823

Cost of revenues
1,195,220

 
798,244

 
174,689

 
2,168,153

Marketing
162,978

 
228,839

 

 
391,817

Contribution profit (loss)
$
652,247

 
$
(156,923
)
 
$
162,529

 
$
657,853

Other operating expenses
 
 
 
 
 
 
485,562

Operating income
 
 
 
 
 
 
172,291

Other income (expense)
 
 
 
 
 
 
(93,375
)
Provision for income taxes
 
 
 
 
 
 
28,885

Net income
 
 
 
 
 
 
$
50,031



16



The following table represents segment information for the quarter ended June 30, 2014:
 
As of/ Three Months Ended June 30, 2014
 
Domestic
Streaming
 
International
Streaming
 
Domestic
DVD
 
Consolidated
 
(in thousands)
Total memberships at end of period (1)
36,244

 
13,801

 
6,261

 

Revenues
$
838,225

 
$
307,461

 
$
194,721

 
$
1,340,407

Cost of revenues
546,223

 
266,697

 
101,928

 
914,848

Marketing
64,727

 
56,036

 

 
120,763

Contribution profit (loss)
$
227,275

 
$
(15,272
)
 
$
92,793

 
$
304,796

Other operating expenses
 
 
 
 
 
 
175,196

Operating income
 
 
 
 
 
 
129,600

Other income (expense)
 
 
 
 
 
 
(12,228
)
Provision for income taxes
 
 
 
 
 
 
46,354

Net income
 
 
 
 
 
 
$
71,018

 
As of/ Six Months Ended June 30, 2014
 
Domestic
Streaming
 
International
Streaming
 
Domestic
DVD
 
Consolidated
 
(in thousands)
Total memberships at end of period (1)
36,244

 
13,801

 
6,261

 

Revenues
$
1,636,842

 
$
574,579

 
$
399,075

 
$
2,610,496

Cost of revenues
1,063,317

 
511,964

 
208,753

 
1,784,034

Marketing
144,985

 
112,876

 

 
257,861

Contribution profit (loss)
$
428,540

 
$
(50,261
)
 
$
190,322

 
$
568,601

Other operating expenses
 
 
 
 
 
 
341,406

Operating income
 
 
 
 
 
 
227,195

Other income (expense)
 
 
 
 
 
 
(20,879
)
Provision for income taxes
 
 
 
 
 
 
82,183

Net income
 
 
 
 
 
 
$
124,133


17



The following table represents the amortization of the content library:
 
Domestic
Streaming
 
International
Streaming
 
Domestic
DVD
 
Consolidated
 
(in thousands)
Three months ended June 30,
 
 
 
 
 
 
 
2015
$
462,228

 
$
360,372

 
$
20,813

 
$
843,413

2014
409,896

 
229,141

 
16,923

 
655,960

Six months ended June 30,
 
 
 
 
 
 
 
2015
894,217

 
677,901

 
41,998

 
1,614,116

2014
796,211

 
443,561

 
33,044

 
1,272,816

The following table represents total content library, net:
 
Domestic
Streaming
 
International
Streaming
 
Domestic
DVD
 
Consolidated
 
(in thousands)
As of June 30, 2015
$
4,213,101

 
$
1,910,847

 
$
27,765

 
$
6,151,713

As of December 31, 2014
3,476,226

 
1,392,701

 
30,101

 
4,899,028



(1)
A membership (also referred to as a subscription or member) is defined as the right to receive either the Netflix streaming service or Netflix DVD service. Memberships are assigned to territories based on the geographic location used at time of sign up as determined by the Company's internal systems, which utilize industry standard geo-location technology. The Company offers free-trial memberships to new and certain rejoining members. For inclusion in the definition of a membership in the above metrics, a method of payment is required to be provided even during the free-trial period. Total memberships therefore include those who are on a free-trial and have provided a method of payment. A membership is canceled and ceases to be reflected in the above metrics as of the effective cancellation date. Voluntary cancellations become effective at the end of the prepaid membership period, while involuntary cancellation of the service, as a result of a failed method of payment, becomes effective immediately.




18



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; the impact of, and the Company’s response to, new accounting standards; pricing; dividends; impact of foreign currency; investments in marketing and content, including original content; international expansion and investments related thereto; cash use in connection with content acquisitions and licensing and international expansion; contribution margin and free cash flow trends; deferred tax assets; accessing and obtaining additional capital 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. 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, 2014 filed with the Securities and Exchange Commission (“SEC”) on January 29, 2015, 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.
Investors and others should note that we announce material financial information to our investors using our investor relations website (http://ir.netflix.com), SEC filings, press releases, public conference calls and webcasts. We use these channels, as well as social media, to communicate with our members and the public about our company, our services and other issues. It is possible that the information we post on social media could be deemed to be material information. Therefore, we encourage investors, the media, and others interested in our company to review the information we post on the United States ("U.S.") social media channels listed on our investor relations website.

Overview
We are the world’s leading Internet television network with over 65 million memberships in over 50 countries enjoying more than 100 million hours of TV shows and movies per day, including original series, documentaries and feature films. Members can watch as much as they want, anytime, anywhere, on nearly any Internet-connected screen. Members can play, pause and resume watching, all without commercials or commitments. Additionally, in the U.S., our members can receive DVDs delivered quickly to their homes.
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 for Internet-connected screens and have licensed and acquired 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. Historically, our acquisition of new memberships has been seasonal with the first and fourth quarters representing our strongest net membership additions and our second quarter representing the lowest net membership additions in a calendar year.
Our core strategy is to grow our streaming membership business globally within the parameters of our consolidated net income and contribution profit (loss) targets. We are continuously improving our members' experience by expanding our streaming content with a focus on a programming mix of content that delights our members. In addition, we are perpetually enhancing our user interface and expanding our streaming service to more Internet-connected screens.

Results of Operations

The following represents our consolidated performance highlights:
 
Three Months Ended
 
Change
 
June 30,
2015
 
June 30,
2014
 
Q2'15 vs. Q2'14
 
(in thousands, except percentages)
Global streaming memberships
65,551

 
50,045

 
31
 %
Revenues
$
1,644,694

 
$
1,340,407

 
23
 %
Operating income
74,835

 
129,600

 
(42
)%
Net income
26,335

 
71,018

 
(63
)%

Consolidated revenues for the three months ended June 30, 2015 increased $304.3 million as compared to the three months ended June 30, 2014 due to growth in global streaming memberships, partially offset by the impacts of foreign currency exchange rate fluctuations. Cost of revenues and operating expenses increased due to increased expenses relating to our streaming content as well as to our international expansion. Net income decreased $44.7 million in the three months ended June 30, 2015 as compared to the three months ended June 30, 2014 as a result of the decrease in operating income and a $21.9 million increase in interest expense primarily related to our additional debt issued in February 2015.

19


We offer three types of streaming membership plans. In the U.S. our basic plan is priced at $7.99 per month and includes access to standard definition quality streaming on a single screen at a time. Our most popular streaming plan, which includes access to high definition quality streaming on two screens concurrently, is priced at $8.99 per month for memberships which commenced after the second quarter of 2014 when we had increased the membership fee from $7.99 per month. Existing memberships were grandfathered in at $7.99 for two years, as long as they remain a member. Our premium plan, which we introduced in the second quarter of 2013, is priced at $11.99 per month and includes access to high definition and ultra-high definition quality content on four screens concurrently. Internationally, pricing for the three types of membership plans is structured similarly to the U.S. and ranges from the U.S. dollar equivalent of approximately $5.00 per month to $19.00 per month. We expect that from time to time the prices of our membership plans may change.

The following represents the key elements to our segment results of operations:

We define contribution profit as revenues less cost of revenues and marketing expenses. We believe this is an important measure of our operating segment performance as it represents each segment's performance before global corporate costs.

For the Domestic and International streaming segments, content expenses, which include the amortization of the streaming content library and other expenses associated with the licensing and acquisition of streaming content, represent the vast majority of cost of revenues. Streaming content rights are generally specific to a geographic region, but increasingly include multiple geographies as we aspire to obtain global content rights to support our global expansion. We allocate these content rights between the International and Domestic segments based on estimated fair market value. Our international expansion will require us to obtain additional streaming content to support new international markets. Other cost of revenues such as streaming delivery expenses, customer service and payment processing fees tend to be lower as a percentage of total cost of revenues as compared to content licensing expenses. We utilize both our own and third-party content delivery networks to help us efficiently stream a high volume of content to our members over the Internet. Streaming delivery expenses, therefore, also include equipment costs related to our content delivery network ("Open Connect") and all third-party costs associated with delivering streaming content over the Internet. Cost of revenues in the Domestic DVD segment consist primarily of delivery expenses, content expenses, including amortization of DVD content library and revenue sharing expenses, and other expenses associated with our DVD processing and customer service centers. Delivery expenses for the Domestic DVD segment consist of the postage costs to mail DVDs to and from our members and the packaging and label costs for the mailers.

For the Domestic and International streaming segments, marketing expenses consist primarily of advertising expenses and payments made to our affiliates and device partners. Advertising expenses include promotional activities such as online and television advertising. Payments to our affiliates and device partners include fixed fee and/or revenue sharing payments. Marketing expenses are primarily incurred by our Domestic and International streaming segments given our focus on building consumer awareness of the streaming offerings. 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. We do not incur marketing expenses for the Domestic DVD segment.

We have demonstrated our ability to grow domestic streaming contribution margin as evidenced by the increase in contribution margin from 12% when we first began separately reporting Domestic streaming results in the fourth quarter of 2011 to 33% in the second quarter of 2015. 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. Investments in content and marketing associated with the International streaming segment will continue to fluctuate dependent upon the number of international territories in which our streaming service is offered and the timing of the launch of new territories.



20


Domestic Streaming Segment
Three months ended June 30, 2015 as compared to the three months ended June 30, 2014
 
 
As of/ Three Months Ended
 
Change
 
 
June 30,
2015
 
June 30,
2014
 
Q2'15 vs. Q2'14
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
Net additions
 
903

 
570

 
333

 
58
%
Memberships at end of period
 
42,300

 
36,244

 
6,056

 
17
%
Paid memberships at end of period
 
41,057

 
35,085

 
5,972

 
17
%
Average monthly revenue per paying membership
 
$
8.41

 
$
8.04

 
$
0.37

 
5
%
 
 
 
 
 
 
 
 
 
Contribution profit:
 
 
 
 
 
 
 
 
Revenues
 
$
1,025,913

 
$
838,225

 
$
187,688

 
22
%
Cost of revenues
 
612,691

 
546,223

 
66,468

 
12
%
Marketing
 
73,427

 
64,727

 
8,700

 
13
%
Contribution profit
 
339,795

 
227,275

 
112,520

 
50
%
Contribution margin
 
33
%
 
27
%
 
 
 
 

In the Domestic streaming segment, we derive revenues from monthly membership fees for services consisting solely of streaming content. The increase in our domestic streaming revenues was primarily due to the 17% growth in the average number of paid memberships, as well as the 5% increase in average monthly revenue per paying membership resulting from our price increase and introduction of higher priced plans. Our two-screen high-definition plan continues to be the most popular plan choice for new memberships.
The increase in domestic streaming cost of revenues was primarily due to a $54.3 million increase in content expenses relating to our existing and new streaming content, including more exclusive and original programming. In addition, streaming delivery expenses increased by $5.1 million and other costs, such as payment processing fees and customer service call centers, increased $7.1 million due to our growing member base.
Domestic marketing expenses increased primarily due to an increase in advertising and public relations spending.
Our Domestic streaming segment had a contribution margin of 33% for the three months ended June 30, 2015, which increased as compared to the contribution margin of 27% for the three months ended June 30, 2014 due to growth in paid memberships and revenue which continued to outpace content and marketing spending.

Six months ended June 30, 2015 as compared to the six months ended June 30, 2014
 
 
As of/ Six Months Ended
 
Change
 
 
June 30,
2015
 
June 30,
2014
 
YTD'15 vs. YTD'14
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
Net additions
 
3,186

 
2,824

 
362

 
13
%
Memberships at end of period
 
42,300

 
36,244

 
6,056

 
17
%
Paid memberships at end of period
 
41,057

 
35,085

 
5,972

 
17
%
Average monthly revenue per paying membership
 
$
8.41

 
$
8.05

 
$
0.36

 
4
%
 
 
 
 
 
 
 
 
 
Contribution profit:
 
 
 
 
 
 
 
 
Revenues
 
$
2,010,445

 
$
1,636,842

 
$
373,603

 
23
%
Cost of revenues
 
1,195,220

 
1,063,317

 
131,903

 
12
%
Marketing
 
162,978

 
144,985

 
17,993

 
12
%
Contribution profit
 
652,247

 
428,540

 
223,707

 
52
%
Contribution margin
 
32
%
 
26
%
 
 
 
 


21


The increase in our domestic streaming revenues was primarily due to the 18% growth in the average number of paid memberships, as well as the 4% increase in average monthly revenue per paying membership resulting from our price increase and introduction of higher priced plans.
The increase in domestic streaming cost of revenues was primarily due to a $103.5 million increase in content expenses relating to our existing and new streaming content, including more exclusive and original programming. In addition, streaming delivery expenses increased by $13.6 million and other costs, such as payment processing fees and customer service call centers, increased $14.8 million due to our growing member base.
Domestic marketing expenses increased primarily due to an increase in advertising and public relations spending.
Our Domestic streaming segment had a contribution margin of 32% for the six months ended June 30, 2015, which increased as compared to the contribution margin of 26% for the six months ended June 30, 2014 due to growth in paid memberships and revenue which continued to outpace content and marketing spending.

International Streaming Segment
Three months ended June 30, 2015 as compared to the three months ended June 30, 2014
 
 
As of /Three Months Ended
 
Change
 
 
June 30,
2015
 
June 30,
2014
 
Q2'15 vs. Q2'14
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
Net additions
 
2,374

 
1,118

 
1,256

 
112
 %
Memberships at end of period
 
23,251

 
13,801

 
9,450

 
68
 %
Paid memberships at end of period
 
21,649

 
12,907

 
8,742

 
68
 %
Average monthly revenue per paying membership
 
$
7.40

 
$
8.31

 
$
(0.91
)
 
(11
)%
 
 
 
 
 
 
 
 
 
Contribution profit (loss):
 
 
 
 
 
 
 
 
Revenues
 
$
454,763

 
$
307,461

 
$
147,302

 
48
 %
Cost of revenues
 
422,966

 
266,697

 
156,269

 
59
 %
Marketing
 
123,713

 
56,036

 
67,677

 
121
 %
Contribution loss
 
(91,916
)
 
(15,272
)
 
(76,644
)
 
502
 %
Contribution margin
 
(20
)%
 
(5
)%
 
 
 



In the International streaming segment, we derive revenues from monthly membership fees for services consisting solely of streaming content. We launched our streaming service in Canada in September 2010 and have continuously expanded our services internationally with launches in Latin America in September 2011, the U.K. and Ireland in January 2012, Finland, Denmark, Sweden and Norway in October 2012, the Netherlands in September 2013, and Germany, Austria, Switzerland, France, Belgium and Luxembourg in September 2014. In the first quarter of 2015, we launched our service in Australia and New Zealand. Later this year, in keeping with our global strategy, we expect to launch in additional markets, including Japan, Spain, Portugal and Italy.
The increase in our international revenues was due to the 66% growth in the average number of paid international memberships offset partially by an 11% decrease in average monthly revenue per paying membership. The decrease in average monthly revenue per paying membership was due to the impact of exchange rate fluctuations and to a lesser extent the impact of absorbing higher VAT rates across our European markets beginning January 1, 2015. These decreases were partially offset by the price increase on our most popular streaming plan and the introduction of the premium plan in 2014. We believe international revenues would have been approximately $83 million higher if foreign exchange rates had remained consistent with the foreign exchange rates from the second quarter of 2014. Average paid international streaming memberships account for 33% of global average paid streaming memberships as of June 30, 2015, as compared to 26% of global average paid streaming memberships as of June 30, 2014.
The increase in international cost of revenues was primarily due to a $134.8 million increase in content expenses relating to existing and new streaming content, including streaming content for territories launched in the last twelve months as well as more exclusive and original programming. Other costs increased $21.5 million primarily due to increases in our streaming delivery expenses, costs associated with our customer service call centers and payment processing fees, all driven by our growing member base. The increases in content and other costs were partially offset by a decrease resulting from exchange rate fluctuations.
International marketing expenses for the three months ended June 30, 2015 increased as compared to the three months ended June 30, 2014 mainly due to expenses for territories launched in the last twelve months.

22


International contribution losses increased for the three months ended June 30, 2015 as compared to the three months ended June 30, 2014, due to increased spending for our international expansion and due to the impact of foreign currency exchange rate fluctuations. Had foreign exchange rates remained consistent with foreign exchange rates from the second quarter of 2014, we believe international contribution losses would have been approximately $27 million lower in the second quarter of 2015. Our International streaming segment does not benefit from the established member base that exists for the Domestic streaming segment. Therefore our investments in streaming content and marketing programs which drive membership growth and viewing in our International markets have been significant and are larger initially relative to revenues, in particular as new territories are launched.

Six months ended June 30, 2015 as compared to the six months ended June 30, 2014
 
 
As of /Six Months Ended
 
Change
 
 
June 30,
2015
 
June 30,
2014
 
YTD'15 vs. YTD'14
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
Net additions
 
4,974

 
2,871

 
2,103

 
73
 %
Memberships at end of period
 
23,251

 
13,801

 
9,450

 
68
 %
Paid memberships at end of period
 
21,649

 
12,907

 
8,742

 
68
 %
Average monthly revenue per paying membership
 
$
7.53

 
$
8.30

 
$
(0.77
)
 
(9
)%
 
 
 
 
 
 
 
 
 
Contribution profit (loss):
 
 
 
 
 
 
 
 
Revenues
 
$
870,160

 
$
574,579

 
$
295,581

 
51
 %
Cost of revenues
 
798,244

 
511,964

 
286,280

 
56
 %
Marketing
 
228,839

 
112,876

 
115,963

 
103
 %
Contribution loss
 
(156,923
)
 
(50,261
)
 
(106,662
)
 
212
 %
Contribution margin
 
(18
)%
 
(9
)%
 
 
 
 
The increase in our international revenues was due to the 67% growth in the average number of paid international memberships offset partially by a 9% decrease in average monthly revenue per paying membership. The decrease in average monthly revenue per paying membership was due to the impact of exchange rate fluctuations and to a lesser extent the impact of absorbing higher VAT rates across our European markets beginning January 1, 2015. These decreases were partially offset by the price increase on our most popular streaming plan and the introduction of the premium plan in 2014. We believe international revenues would have been approximately $129 million higher in the first half of 2015 if foreign exchange rates had remained consistent with the foreign exchange rates from the first half of 2014.
The increase in international cost of revenues was primarily due to a $242.8 million increase in content expenses relating to expenses for territories launched in the last twelve months, coupled with existing and new streaming content, including more exclusive and original programming. Other costs increased $43.5 million primarily due to increases in our streaming delivery expenses, costs associated with our customer service call centers and payment processing fees, all driven by our growing member base. The increases in content and other costs were partially offset by a decrease resulting from exchange rate fluctuations.
International marketing expenses for the six months ended June 30, 2015 increased as compared to the six months ended June 30, 2014 mainly due to expenses for territories launched in the last twelve months.
International contribution losses increased for the six months ended June 30, 2015 as compared to the six months ended June 30, 2014, due to our increased spending for our international expansion and due to the impact of foreign currency exchange rate fluctuations. Had foreign exchange rates remained consistent with foreign exchange rates from the first half of 2014, we believe international contribution losses would have been approximately $42 million lower in the first half of 2015.


23


Domestic DVD Segment
Three months ended June 30, 2015 as compared to the three months ended June 30, 2014
 
 
As of/ Three Months Ended
 
Change
 
 
June 30,
2015
 
June 30,
2014
 
Q2'15 vs. Q2'14
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
Net losses
 
(250
)
 
(391
)
 
(141
)
 
(36
)%
Memberships at end of period
 
5,314

 
6,261

 
(947
)
 
(15
)%
Paid memberships at end of period
 
5,219

 
6,167

 
(948
)
 
(15
)%
Average monthly revenue per paying membership
 
$
10.23

 
$
10.24

 
$
(0.01
)
 
 %
 
 
 
 
 
 
 
 
 
Contribution profit:
 
 
 
 
 
 
 
 
Revenues
 
$
164,018

 
$
194,721

 
$
(30,703
)
 
(16
)%
Cost of revenues
 
86,095

 
101,928

 
(15,833
)
 
(16
)%
Contribution profit
 
77,923

 
92,793

 
(14,870
)
 
(16
)%
Contribution margin
 
48
%
 
48
%
 
 
 
 

In the Domestic DVD segment, we derive revenues from our DVD-by-mail membership services. The price per plan for DVD-by-mail varies from $4.99 to $43.99 per month according to the plan chosen by the member. DVD-by-mail plans differ by the number of DVDs that a member may have out at any given point. Members 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.
The decrease in our domestic DVD revenues was due to a 16% decrease in the average number of paid memberships.
The decrease in domestic DVD cost of revenues was primarily due to a $3.9 million decrease in content expenses and a $9.7 million decrease in delivery expenses resulting from a 20% decrease in the number of DVDs mailed to members. The decrease in shipments was driven by a decline in the number of DVD memberships coupled with a decrease in usage by these members. Other costs, primarily those associated with processing and customer service expenses, decreased $2.2 million primarily due to a decrease in hub operation expenses resulting from the decline in DVD shipments.
Our Domestic DVD segment contribution margin was flat for the three months ended June 30, 2015 as compared to the three months ended June 30, 2014.

Six months ended June 30, 2015 as compared to the six months ended June 30, 2014
 
 
As of/ Six Months Ended
 
Change
 
 
June 30,
2015
 
June 30,
2014
 
YTD'15 vs. YTD'14
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
Net losses
 
(453
)
 
(669
)
 
(216
)
 
(32
)%
Memberships at end of period
 
5,314

 
6,261

 
(947
)
 
(15
)%
Paid memberships at end of period
 
5,219

 
6,167

 
(948
)
 
(15
)%
Average monthly revenue per paying membership
 
$
10.30

 
$
10.25

 
$
0.05

 
 %
 
 
 
 
 
 
 
 
 
Contribution profit:
 
 
 
 
 
 
 
 
Revenues
 
$
337,218

 
$
399,075

 
$
(61,857
)
 
(16
)