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EX-32.1 - EXHIBIT 32.1 - NETFLIX INCnflx321_10kx2016.htm
EX-31.2 - EXHIBIT 31.2 - NETFLIX INCnflx312_10kx2016.htm
EX-31.1 - EXHIBIT 31.1 - NETFLIX INCnflx311_10kx2016.htm
EX-23.1 - EXHIBIT 23.1 - NETFLIX INCnflx231eyconsent123116.htm
EX-21.1 - EXHIBIT 21.1 - NETFLIX INCnflx211listofsignificantsu.htm
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 _____________________________________________________________________

FORM 10-K
 _____________________________________________________________________
(Mark One)
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2016
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)
 _____________________________________________________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of Exchange on which registered
Common stock, $0.001 par value
 
NASDAQ Stock Market LLC
 
 
(NASDAQ Global Select Market)
Securities registered pursuant to Section 12(g) of the Act: None
 _____________________________________________________________________

 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 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 definition 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 smaller reporting company)
 
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
As of June 30, 2016, the aggregate market value of voting stock held by non-affiliates of the registrant, based upon the closing sales price for the registrant’s common stock, as reported in the NASDAQ Global Select Market System, was $38,059,122,667. Shares of common stock beneficially owned by each executive officer and director of the Registrant and by each person known by the Registrant to beneficially own 10% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for any other purpose.
As of January 26, 2017, there were 430,411,593 shares of the registrant’s common stock, par value $0.001, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the registrant’s Proxy Statement for Registrant’s 2017 Annual Meeting of Stockholders are incorporated by reference into Part III of this Annual Report on Form 10-K.
 



NETFLIX, INC.
TABLE OF CONTENTS
 
 
 
Page
PART I
 
 
 
 
 
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
 
PART II
 
 
 
 
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
 
 
PART III
 
 
 
 
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
 
PART IV
 
 
 
 
 
Item 15.




PART I
Forward-Looking Statements

This Annual Report on Form 10-K 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; operating income and margin; the decline in our DVD memberships and the resources allocated to our DVD segment; seasonality; contribution margins; contribution profits (losses); liquidity, including cash flows from operations, available funds and access to financing sources; free cash flows; revenues; net income; profitability; stock price volatility; pricing changes; the impact of, and the company’s response to, new accounting standards; action by competitors; risk of material impairment of current investment portfolio; reinvestment of earnings in foreign subsidiaries; membership growth; timing of relocation to new facilities; nature of our content agreements; member viewing patterns; payment of future dividends; obtaining additional capital; our content and marketing investments, including investments in original programming; amortization; significance and timing of contractual obligations; and realization of deferred tax assets. These forward-looking statements are subject to risks and uncertainties that could cause actual results and events to differ. A detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included throughout this filing and particularly in Item 1A: "Risk Factors" section set forth in this Annual Report on Form 10-K. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to revise or publicly release any revision to any such forward-looking statement, except as may otherwise be required by law.
 
Item 1.
Business
ABOUT US
Netflix, Inc. (“Netflix”, “the Company”, “we”, or “us”) is the world’s leading internet television network with over 93 million streaming members in over 190 countries enjoying more than 125 million hours of TV shows and movies per day, including original series, documentaries and feature films. Our 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 United States ("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 added increasing amounts of content that enable consumers to enjoy TV shows and movies directly on their internet-connected screens. 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.
Our core strategy is to grow our streaming membership business globally within the parameters of our profit margin 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 extending our streaming service to more internet-connected screens. Our members can now download a selection of titles for offline viewing.
We continue to grow our streaming service both domestically and internationally. We began our international expansion with Canada in 2010 and have since launched our service globally, with the exception of The People's Republic of China and territories where U.S. companies are not allowed to operate. We have also expanded our streaming content offering to include more exclusive and original programming, including several Emmy, Golden Globe and Academy Award nominated original series and documentaries. Our original programming increasingly includes content that we produce.
 

BUSINESS SEGMENTS
The Company has three reportable segments: Domestic streaming, International streaming and Domestic DVD. The Domestic streaming segment derives revenues from monthly membership fees for services consisting solely of streaming content to our members in the United States. The International streaming segment derives revenues from monthly membership fees for services consisting solely of streaming content to our members outside the United States. The Domestic DVD segment derives revenues from monthly membership fees for services consisting solely of DVD-by-mail. For additional information regarding our segments, including information about our financial results by geography, see Note 11 of Item 8, Financial Statements and Supplementary Data.


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COMPETITION
The market for entertainment video is intensely competitive and subject to rapid change. We compete against other entertainment video providers, such as multichannel video programming distributors ("MVPDs"), internet-based movie and TV content providers (including those that provide pirated content), video gaming providers and DVD rental outlets and more broadly against other sources of entertainment that our members could choose in their moments of free time. We also compete against entertainment video providers in obtaining content that our members love, both for licensed streaming content and for original content projects.
While consumers may maintain simultaneous relationships with multiple entertainment sources, we strive for consumers to choose us in their moments of free time. We have often referred to this choice as our objective of "winning moments of truth." In attempting to win these moments of truth with our members, we are continually improving our service, including both our technology and our content, which is increasingly exclusive and curated, and includes our own original programming.
SEASONALITY
Our membership growth exhibits a seasonal pattern that reflects variations when consumers buy internet-connected screens and when they tend to increase their viewing. Historically, the first and fourth quarters (October through March)represent our greatest membership growth across our Domestic and International streaming segments. Our membership growth may be impacted by the release of certain high-profile original content. Internationally, we expect each market to demonstrate more predictable seasonal patterns as our service offering in each market becomes more established and we have a longer history to assess such patterns.
INTELLECTUAL PROPERTY
We regard our trademarks, service marks, copyrights, patents, domain names, trade dress, trade secrets, proprietary technologies and similar intellectual property as important to our success. We use a combination of patent, trademark, copyright and trade secret laws and confidentiality agreements to protect our proprietary intellectual property. Our ability to protect and enforce our intellectual property rights is subject to certain risks and from time to time we encounter disputes over rights and obligations concerning intellectual property. We cannot provide assurance that we will prevail in any intellectual property disputes.
EMPLOYEES
As of December 31, 2016, we had approximately 4,700 total employees. Of these employees, approximately 4,500 were full-time, including approximately 1,300 categorized as temporary.
OTHER INFORMATION
We were incorporated in Delaware in August 1997 and completed our initial public offering in May 2002. Our principal executive offices are located at 100 Winchester Circle, Los Gatos, California 95032, and our telephone number is (408) 540-3700.
We maintain a Web site at www.netflix.com. The contents of our Web site are not incorporated in, or otherwise to be regarded as part of, this Annual Report on Form 10-K. In this Annual Report on Form 10-K, “Netflix,” the “Company,” “we,” “us,” “our” and the “registrant” refer to Netflix, Inc. We make available, free of charge on our Web site, access to our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as soon as reasonably practicable after we file or furnish them electronically with the Securities and Exchange Commission ("SEC").
Investors and others should note that we announce material financial information to our investors using our investor relations Web site (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 social media channels listed on our investor relations Web site.


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Item 1A.
Risk Factors

If any of the following risks actually occur, our business, financial condition and results of operations could be harmed. In that case, the trading price of our common stock could decline, and you could lose all or part of your investment.
Risks Related to Our Business
If our efforts to attract and retain members are not successful, our business will be adversely affected.
We have experienced significant membership growth over the past several years. Our ability to continue to attract members will depend in part on our ability to consistently provide our members with compelling content choices, as well as a quality experience for selecting and viewing TV shows and movies. Furthermore, the relative service levels, content offerings, pricing and related features of competitors to our service may adversely impact our ability to attract and retain memberships. Competitors include other entertainment video providers, such as MVPDs, internet-based movie and TV content providers (including those that provide pirated content) and DVD rental outlets. If consumers do not perceive our service offering to be of value, including if we introduce new or adjust existing features, adjust pricing or service offerings, or change the mix of content in a manner that is not favorably received by them, we may not be able to attract and retain members. In addition, many of our members rejoin our service or originate from word-of-mouth advertising from existing members. If our efforts to satisfy our existing members are not successful, we may not be able to attract members, and as a result, our ability to maintain and/or grow our business will be adversely affected. Members cancel our service for many reasons, including a perception that they do not use the service sufficiently, the need to cut household expenses, availability of content is unsatisfactory, competitive services provide a better value or experience and customer service issues are not satisfactorily resolved. We must continually add new memberships both to replace canceled memberships and to grow our business beyond our current membership base. If we do not grow as expected, given, in particular that our content costs are largely fixed in nature and contracted over several years, we may not be able to adjust our expenditures or increase our (per membership) revenues commensurate with the lowered growth rate such that our margins, liquidity and results of operation may be adversely impacted. If we are unable to successfully compete with current and new competitors in both retaining our existing memberships and attracting new memberships, our business will be adversely affected. Further, if excessive numbers of members cancel our service, we may be required to incur significantly higher marketing expenditures than we currently anticipate to replace these members with new members.

Changes in competitive offerings for entertainment video, including the potential rapid adoption of piracy-based video offerings, could adversely impact our business.
The market for entertainment video is intensely competitive and subject to rapid change. Through new and existing distribution channels, consumers have increasing options to access entertainment video. The various economic models underlying these channels include subscription, transactional, ad-supported and piracy-based models. All of these have the potential to capture meaningful segments of the entertainment video market. Piracy, in particular, threatens to damage our business, as its fundamental proposition to consumers is so compelling and difficult to compete against: virtually all content for free. Furthermore, in light of the compelling consumer proposition, piracy services are subject to rapid global growth. Traditional providers of entertainment video, including broadcasters and cable network operators, as well as internet based e-commerce or entertainment video providers are increasing their internet-based video offerings. Several of these competitors have long operating histories, large customer bases, strong brand recognition and significant financial, marketing and other resources. They may secure better terms from suppliers, adopt more aggressive pricing and devote more resources to product development, technology, infrastructure, content acquisitions and marketing. New entrants may enter the market or existing providers may adjust their services with unique offerings or approaches to providing entertainment video. Companies also may enter into business combinations or alliances that strengthen their competitive positions. If we are unable to successfully or profitably compete with current and new competitors, our business will be adversely affected, and we may not be able to increase or maintain market share, revenues or profitability.
 
The long-term and fixed cost nature of our content commitments may limit our operating flexibility and could adversely affect our liquidity and results of operations.
In connection with obtaining streaming content, we typically enter into multi-year commitments with studios and other content providers, the payment terms of which are not tied to member usage or the size of our membership base (“fixed cost”) but which may be tied to such factors as titles licensed and/or theatrical exhibition receipts. Such commitments are included in the Contractual Obligations section of Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 5, Commitments and Contingencies in Item 8. Given the multiple-year duration and largely fixed cost nature of content commitments, if membership acquisition and retention do not meet our expectations, our margins may be

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adversely impacted. Payment terms for certain content commitments, such as programming that is initially available in the applicable territory on our service (“original programming”), will typically require more up-front cash payments than other licensing agreements. To the extent membership and/or revenue growth do not meet our expectations, our liquidity and results of operations could be adversely affected as a result of content commitments and accelerated payment requirements of certain agreements. In addition, the long-term and fixed cost nature of our content commitments may limit our flexibility in planning for, or reacting to changes in our business and the market segments in which we operate. If we license content that is not favorably received by consumers in a territory, or is unable to be shown in a territory, acquisition and retention may be adversely impacted and given the long-term and fixed cost nature of our content commitments, we may not be able to adjust our content offering quickly and our results of operation may be adversely impacted.
We are devoting more resources toward the development, production, marketing and distribution of original programming, including TV series and movies. We believe that original programming can help differentiate our service from other offerings, enhance our brand and otherwise attract and retain members. To the extent our original programming does not meet our expectations, in particular, in terms of costs, viewing and popularity, our business, including our brand and results of operations may be adversely impacted.
If we are not able to manage change and growth, our business could be adversely affected.
We are expanding our operations internationally, scaling our streaming service to effectively and reliably handle anticipated growth in both members and features related to our service, ramping up our ability to produce original content, as well as continuing to operate our DVD service within the U.S. As our international offering evolves, we are managing and adjusting our business to address varied content offerings, consumer customs and practices, in particular those dealing with e-commerce and internet video, as well as differing legal and regulatory environments. As we scale our streaming service, we are developing technology and utilizing third-party “cloud” computing services. As we ramp up our original content production, we are building out expertise in a number of disciplines, including creative, marketing, legal, finance and other resources related to the development and physical production of content. If we are not able to manage the growing complexity of our business, including improving, refining or revising our systems and operational practices related to our streaming operations and original content, our business may be adversely affected.
We could be subject to economic, political, regulatory and other risks arising from our international operations.
Operating in international markets requires significant resources and management attention and will subject us to regulatory, economic and political risks that may be different from or incremental to those in the U.S. In addition to the risks that we face in the U.S., our international operations involve risks that could adversely affect our business, including:
the need to adapt our content and user interfaces for specific cultural and language differences, including licensing a certain portion of our content assets before we have developed a full appreciation for its performance within a given territory;
difficulties and costs associated with staffing and managing foreign operations;
management distraction;
political or social unrest and economic instability;
compliance with U.S. laws such as the Foreign Corrupt Practices Act, export controls and economic sanctions, and local laws prohibiting corrupt payments to government officials;
difficulties in understanding and complying with local laws, regulations and customs in foreign jurisdictions;
regulatory requirements or government action against our service, whether in response to enforcement of actual or purported legal and regulatory requirements or otherwise, that results in disruption or non-availability of our service or particular content in the applicable jurisdiction;
less favorable foreign intellectual property laws;
adverse domestic or international tax consequences such as those related to repatriation of cash from foreign jurisdictions into the United States, non-income related taxes such as value-added tax or other indirect taxes, changes in tax laws or tax rates or their interpretations and the related application of judgment in determining our global provision for income taxes, deferred tax assets or liabilities or other tax liabilities given the ultimate tax determination is uncertain;
fluctuations in currency exchange rates, which we do not use foreign exchange contracts or derivatives to hedge against and which could impact revenues and expenses of our international operations and expose us to foreign currency exchange rate risk;

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profit repatriation and other restrictions on the transfer of funds;
differing payment processing systems as well as consumer use and acceptance of electronic payment methods, such as payment cards;
new and different sources of competition;
censorship requirements that cause us to remove or edit popular content, leading to consumer disappointment or dissatisfaction with our service;
low usage and/or penetration of internet-connected consumer electronic devices;
different and more stringent user protection, data protection, privacy and other laws;
availability of reliable broadband connectivity and wide area networks in targeted areas for expansion;
integration and operational challenges as well as potential unknown liabilities in connection with companies we may acquire or control; and
differing, and often more lenient, laws and consumer understanding/attitudes regarding the illegality of piracy.
Our failure to manage any of these risks successfully could harm our international operations and our overall business, and results of our operations.
If we fail to maintain or, in newer markets establish, a positive reputation with consumers concerning our service, including the content we offer, we may not be able to attract or retain members, and our operating results may be adversely affected.
We believe that a positive reputation with consumers concerning our service is important in attracting and retaining members who have a number of choices from which to obtain entertainment video. To the extent our content, in particular, our original programming, is perceived as low quality, offensive or otherwise not compelling to consumers, our ability to establish and maintain a positive reputation may be adversely impacted. Furthermore, to the extent our marketing, customer service and public relations efforts are not effective or result in negative consumer reaction, our ability to establish and maintain a positive reputation may likewise be adversely impacted. With newer markets, we also need to establish our reputation with consumers and to the extent we are not successful in creating positive impressions, our business in these new markets may be adversely impacted.
Changes in how we market our service could adversely affect our marketing expenses and membership levels may be adversely affected.
We utilize a broad mix of marketing and public relations programs, including social media sites such as Facebook and Twitter, to promote our service to potential new members. We may limit or discontinue use or support of certain marketing sources or activities if advertising rates increase or if we become concerned that members or potential members deem certain marketing practices intrusive or damaging to our brand. If the available marketing channels are curtailed, our ability to attract new members may be adversely affected.
If companies that promote our service decide that we negatively impact their business, that they want to compete more directly with our business or enter a similar business or decide to exclusively support our competitors, we may no longer have access to such marketing channels. We also acquire a number of members who rejoin our service having previously cancelled their membership. If we are unable to maintain or replace our sources of members with similarly effective sources, or if the cost of our existing sources increases, our member levels and marketing expenses may be adversely affected
We face risks, such as unforeseen costs and potential liability in connection with content we acquire, produce, license and/or distribute through our service.
As a distributor of content, we face potential liability for negligence, copyright and trademark infringement, or other claims based on the nature and content of materials that we acquire, produce, license and/or distribute. We also may face potential liability for content used in promoting our service, including marketing materials and features on our Web site such as member reviews. As we expand our original programming, we have become responsible for production costs and other expenses, such as ongoing guild payments. We also take on risks associated with production, such as completion and key talent risk. Negotiations or renewals related to entertainment industry collective bargaining agreements could negatively impact timing and costs associated with our productions. To the extent we do not accurately anticipate costs or mitigate risks, including for content that we obtain but ultimately does not appear on our service, or if we become liable for content we acquire, produce, license and/or distribute, our business may suffer. Litigation to defend these claims could be costly and the expenses and

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damages arising from any liability or unforeseen production risks could harm our results of operations. We may not be indemnified against claims or costs of these types and we may not have insurance coverage for these types of claims.
If studios, content providers or other rights holders refuse to license streaming content or other rights upon terms acceptable to us, our business could be adversely affected.
Our ability to provide our members with content they can watch depends on studios, content providers and other rights holders licensing rights to distribute such content and certain related elements thereof, such as the public performance of music contained within the content we distribute. The license periods and the terms and conditions of such licenses vary. If the studios, content providers and other rights holders are not or are no longer willing or able to license us content upon terms acceptable to us, our ability to stream content to our members will be adversely affected and/or our costs could increase. Many of the licenses for content provide for the studios or other content providers to withdraw content from our service relatively quickly. Because of these provisions as well as other actions we may take, content available through our service can be withdrawn on short notice. As competition increases, we may see the cost of programming increase. As we seek to differentiate our service, we are increasingly focused on securing certain exclusive rights when obtaining content, including original content. We are also focused on programming an overall mix of content that delights our members in a cost efficient manner. Within this context, we are selective about the titles we add and renew to our service. If we do not maintain a compelling mix of content, our membership acquisition and retention may be adversely affected.
Music contained within content we distribute may require us to obtain licenses for such distribution. In this regard, we engage in negotiations with collection management organizations (“CMOs”) that hold certain rights to music interests in connection with streaming content into various territories. If we are unable to reach mutually acceptable terms with these organizations, we could become involved in litigation and/or could be enjoined from distributing certain content, which could adversely impact our business. Additionally, pending and ongoing litigation as well as negotiations between certain CMOs and other third parties in various territories could adversely impact our negotiations with CMOs, or result in music publishers represented by certain CMOs unilaterally withdrawing rights, and thereby adversely impact our ability to reach licensing agreements reasonably acceptable to us. Failure to reach such licensing agreements could expose us to potential liability for copyright infringement or otherwise increase our costs.
We rely upon a number of partners to make our service available on their devices.
We currently offer members the ability to receive streaming content through a host of internet-connected screens, including TVs, digital video players, television set-top boxes and mobile devices. We have agreements with various cable, satellite and telecommunications operators to make our service available through the television set-top boxes of these service providers. We intend to continue to broaden our capability to instantly stream TV shows and movies to other platforms and partners over time. If we are not successful in maintaining existing and creating new relationships, or if we encounter technological, content licensing, regulatory or other impediments to delivering our streaming content to our members via these devices, our ability to grow our business could be adversely impacted. Our agreements with our device partners are typically between one and three years in duration and our business could be adversely affected if, upon expiration, a number of our partners do not continue to provide access to our service or are unwilling to do so on terms acceptable to us, which terms may include the degree of accessibility and prominence of our service. Furthermore, devices are manufactured and sold by entities other than Netflix and while these entities should be responsible for the devices' performance, the connection between these devices and Netflix may nonetheless result in consumer dissatisfaction toward Netflix and such dissatisfaction could result in claims against us or otherwise adversely impact our business. In addition, technology changes to our streaming functionality may require that partners update their devices. If partners do not update or otherwise modify their devices, our service and our members' use and enjoyment could be negatively impacted.
Any significant disruption in or unauthorized access to our computer systems or those of third parties that we utilize in our operations, including those relating to cybersecurity or arising from cyber-attacks, could result in a loss or degradation of service, unauthorized disclosure of data, including member and corporate information, or theft of intellectual property, including digital content assets, which could adversely impact our business.
Our reputation and ability to attract, retain and serve our members is dependent upon the reliable performance and security of our computer systems and those of third parties that we utilize in our operations. These systems may be subject to damage or interruption from earthquakes, adverse weather conditions, other natural disasters, terrorist attacks, power loss, telecommunications failures, and cybersecurity risks. Interruptions in these systems, or with the internet in general, could make our service unavailable or degraded or otherwise hinder our ability to deliver streaming content or fulfill DVD selections. Service interruptions, errors in our software or the unavailability of computer systems used in our operations could diminish the overall attractiveness of our membership service to existing and potential members.

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Our computer systems and those of third parties we use in our operations are vulnerable to cybersecurity risks, including cyber-attacks such as computer viruses, denial of service attacks, physical or electronic break-ins and similar disruptions. These systems periodically experience directed attacks intended to lead to interruptions and delays in our service and operations as well as loss, misuse or theft of data. Any attempt by hackers to obtain our data (including member and corporate information) or intellectual property (including digital content assets), disrupt our service, or otherwise access our systems, or those of third parties we use, if successful, could harm our business, be expensive to remedy and damage our reputation. We have implemented certain systems and processes to thwart hackers and protect our data and systems. To date hackers have not had a material impact on our service or systems however this is no assurance that hackers may not be successful in the future. Our insurance does not cover expenses related to such disruptions or unauthorized access. Efforts to prevent hackers from disrupting our service or otherwise accessing our systems are expensive to implement and may limit the functionality of or otherwise negatively impact our service offering and systems. Any significant disruption to our service or access to our systems could result in a loss of memberships and adversely affect our business and results of operation.
We utilize our own communications and computer hardware systems located either in our facilities or in that of a third-party Web hosting provider. In addition, we utilize third-party “cloud” computing services in connection with our business operations. We also utilize our own and third-party content delivery networks to help us stream TV shows and movies in high volume to Netflix members over the internet. Problems faced by us or our third-party Web hosting, "cloud" computing, or other network providers, including technological or business-related disruptions, as well as cybersecurity threats, could adversely impact the experience of our members.
We rely upon Amazon Web Services to operate certain aspects of our service and any disruption of or interference with our use of the Amazon Web Services operation would impact our operations and our business would be adversely impacted.
Amazon Web Services ("AWS") provides a distributed computing infrastructure platform for business operations, or what is commonly referred to as a "cloud" computing service. We have architected our software and computer systems so as to utilize data processing, storage capabilities and other services provided by AWS. Currently, we run the vast majority of our computing on AWS. Given this, along with the fact that we cannot easily switch our AWS operations to another cloud provider, any disruption of or interference with our use of AWS would impact our operations and our business would be adversely impacted. While the retail side of Amazon competes with us, we do not believe that Amazon will use the AWS operation in such a manner as to gain competitive advantage against our service.
If the technology we use in operating our business fails, is unavailable, or does not operate to expectations, our business and results of operation could be adversely impacted.
We utilize a combination of proprietary and third party technology to operate our business. This includes the technology that we have developed to recommend and merchandise content to our consumers as well as enable fast and efficient delivery of content to our members and their various consumer electronic devices. For example, we have built and deployed our own content-delivery network (“CDN”). To the extent Internet Service Providers ("ISPs") do not interconnect with our CDN, or if we experience difficulties in its operation, our ability to efficiently and effectively deliver our streaming content to our members could be adversely impacted and our business and results of operation could be adversely affected. Likewise, if our recommendation and merchandising technology does not enable us to predict and recommend titles that our members will enjoy, our ability to attract and retain members may be adversely affected. We also utilize third party technology to help market our service, process payments, and otherwise manage the daily operations of our business. If our technology or that of third parties we utilize in our operations fails or otherwise operates improperly, our ability to operate our service, retain existing members and add new members may be impaired. Also, any harm to our members' personal computers or other devices caused by software used in our operations could have an adverse effect on our business, results of operations and financial condition.
If government regulations relating to the internet or other areas of our business change, we may need to alter the manner in which we conduct our business, or incur greater operating expenses.
The adoption or modification of laws or regulations relating to the internet or other areas of our business could limit or otherwise adversely affect the manner in which we currently conduct our business. In addition, the continued growth and development of the market for online commerce may lead to more stringent consumer protection laws, which may impose additional burdens on us. If we are required to comply with new regulations or legislation or new interpretations of existing regulations or legislation, this compliance could cause us to incur additional expenses or alter our business model.
Changes in laws or regulations that adversely affect the growth, popularity or use of the internet, including laws impacting net neutrality, could decrease the demand for our service and increase our cost of doing business. Certain laws

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intended to prevent network operators from discriminating against the legal traffic that traverse their networks have been implemented in many countries, including the United States and the European Union. In others, the laws may be nascent or non-existent. Given uncertainty around these rules, including changing interpretations, amendments or repeal, coupled with potentially significant political and economic power of local network operators, we could experience discriminatory or anti-competitive practices that could impede our growth, cause us to incur additional expense or otherwise negatively affect our business.
Changes in how network operators handle and charge for access to data that travel across their networks could adversely impact our business.
We rely upon the ability of consumers to access our service through the internet. If network operators block, restrict or otherwise impair access to our service over their networks, our service and business could be negatively affected. To the extent that network operators implement usage based pricing, including meaningful bandwidth caps, or otherwise try to monetize access to their networks by data providers, we could incur greater operating expenses and our membership acquisition and retention could be negatively impacted. Furthermore, to the extent network operators create tiers of internet access service and either charge us for or prohibit us from being available through these tiers, our business could be negatively impacted.
Most network operators that provide consumers with access to the internet also provide these consumers with multichannel video programming. As such, many network operators have an incentive to use their network infrastructure in a manner adverse to our continued growth and success. While we believe that consumer demand, regulatory oversight and competition will help check these incentives, to the extent that network operators are able to provide preferential treatment to their data as opposed to ours or otherwise implement discriminatory network management practices, our business could be negatively impacted. In some international markets, these same incentives apply however, the consumer demand, regulatory oversight and competition may not be as strong as in our domestic market.
Privacy concerns could limit our ability to collect and leverage our membership data and disclosure of membership data could adversely impact our business and reputation.
In the ordinary course of business and in particular in connection with merchandising our service to our members, we collect and utilize data supplied by our members. We currently face certain legal obligations regarding the manner in which we treat such information. Other businesses have been criticized by privacy groups and governmental bodies for attempts to link personal identities and other information to data collected on the internet regarding users' browsing and other habits. Increased regulation of data utilization practices, including self-regulation or findings under existing laws that limit our ability to collect, transfer and use data, could have an adverse effect on our business. In addition, if we were to disclose data about our members in a manner that was objectionable to them, our business reputation could be adversely affected, and we could face potential legal claims that could impact our operating results. Internationally, we may become subject to additional and/or more stringent legal obligations concerning our treatment of customer and other personal information, such as laws regarding data localization and/or restrictions on data export. Failure to comply with these obligations could subject us to liability, and to the extent that we need to alter our business model or practices to adapt to these obligations, we could incur additional expenses.
Our reputation and relationships with members would be harmed if our membership data, particularly billing data, were to be accessed by unauthorized persons.
We maintain personal data regarding our members, including names and billing data. This data is maintained on our own systems as well as that of third parties we use in our operations. With respect to billing data, such as credit card numbers, we rely on licensed encryption and authentication technology to secure such information. We take measures to protect against unauthorized intrusion into our members' data. Despite these measures we, our payment processing services or other third party services we use such as AWS, could experience an unauthorized intrusion into our members' data. In the event of such a breach, current and potential members may become unwilling to provide the information to us necessary for them to become members. Additionally, we could face legal claims or regulatory fines or penalties for such a breach. The costs relating to any data breach could be material, and we currently do not carry insurance against the risk of a data breach. For these reasons, should an unauthorized intrusion into our members’ data occur, our business could be adversely affected.

8


We are subject to payment processing risk.
Our members pay for our service using a variety of different payment methods, including credit and debit cards, gift cards, direct debit and online wallets.  We rely on internal systems as well as those of third parties to process payment.  Acceptance and processing of these payment methods are subject to certain rules and regulations and require payment of interchange and other fees.  To the extent there are disruptions in our payment processing systems, increases in payment processing fees, material changes in the payment ecosystem, such as large re-issuances of payment cards, delays in receiving payments from payment processors and/or changes to rules or regulations concerning payment processing, our revenue, operating expenses and results of operation could be adversely impacted.   In addition, from time to time, we encounter fraudulent use of payment methods, which could impact our results of operation and if not adequately controlled and managed could create negative consumer perceptions of our service.
If our trademarks and other proprietary rights are not adequately protected to prevent use or appropriation by our competitors, the value of our brand and other intangible assets may be diminished, and our business may be adversely affected.
We rely and expect to continue to rely on a combination of confidentiality and license agreements with our employees, consultants and third parties with whom we have relationships, as well as trademark, copyright, patent and trade secret protection laws, to protect our proprietary rights. We may also seek to enforce our proprietary rights through court proceedings. We have filed and we expect to file from time to time for trademark and patent applications. Nevertheless, these applications may not be approved, third parties may challenge any copyrights, patents or trademarks issued to or held by us, third parties may knowingly or unknowingly infringe our intellectual property rights, and we may not be able to prevent infringement or misappropriation without substantial expense to us. If the protection of our intellectual property rights is inadequate to prevent use or misappropriation by third parties, the value of our brand and other intangible assets may be diminished, competitors may be able to more effectively mimic our service and methods of operations, the perception of our business and service to members and potential members may become confused in the marketplace, and our ability to attract members may be adversely affected.
We currently hold various domain names relating to our brand, including Netflix.com. Failure to protect our domain names could adversely affect our reputation and brand and make it more difficult for users to find our Web site and our service. We may be unable, without significant cost or at all, to prevent third parties from acquiring domain names that are similar to, infringe upon or otherwise decrease the value of our trademarks and other proprietary rights.
Intellectual property claims against us could be costly and result in the loss of significant rights related to, among other things, our Web site, streaming technology, our recommendation and merchandising technology, title selection processes and marketing activities.
Trademark, copyright, patent and other intellectual property rights are important to us and other companies. Our intellectual property rights extend to our technology, business processes and the content on our Web site. We use the intellectual property of third parties in merchandising our products and marketing our service through contractual and other rights. From time to time, third parties allege that we have violated their intellectual property rights. If we are unable to obtain sufficient rights, successfully defend our use, or develop non-infringing technology or otherwise alter our business practices on a timely basis in response to claims against us for infringement, misappropriation, misuse or other violation of third-party intellectual property rights, our business and competitive position may be adversely affected. Many companies are devoting significant resources to developing patents that could potentially affect many aspects of our business. There are numerous patents that broadly claim means and methods of conducting business on the internet. We have not searched patents relative to our technology. Defending ourselves against intellectual property claims, whether they are with or without merit or are determined in our favor, results in costly litigation and diversion of technical and management personnel. It also may result in our inability to use our current Web site, streaming technology, our recommendation and merchandising technology or inability to market our service or merchandise our products. As a result of a dispute, we may have to develop non-infringing technology, enter into royalty or licensing agreements, adjust our merchandising or marketing activities or take other actions to resolve the claims. These actions, if required, may be costly or unavailable on terms acceptable to us.
We are engaged in legal proceedings that could cause us to incur unforeseen expenses and could occupy a significant amount of our management's time and attention.
From time to time, we are subject to litigation or claims that could negatively affect our business operations and financial position. As we have grown, we have seen a rise in the number of litigation matters against us. These matters have included patent infringements as well as consumer and securities class actions, each of which are typically expensive to defend. Litigation disputes could cause us to incur unforeseen expenses, could occupy a significant amount of our management's time and attention and could negatively affect our business operations and financial position.

9


We may seek additional capital that may result in stockholder dilution or that may have rights senior to those of our common stockholders.
From time to time, we may seek to obtain additional capital, either through equity, equity-linked or debt securities. The decision to obtain additional capital will depend on, among other things, our business plans, operating performance and condition of the capital markets. If we raise additional funds through the issuance of equity, equity-linked or debt securities, those securities may have rights, preferences or privileges senior to the rights of our common stock, and our stockholders may experience dilution.

We have a substantial amount of indebtedness and other obligations, including streaming content obligations, which could adversely affect our financial position.
We have a substantial amount of indebtedness and other obligations, including streaming content obligations. As of December 31, 2016, we had $3.4 billion aggregate principal amount of senior notes outstanding (“Notes”). As of December 31, 2016, we had approximately $6.5 billion of total content liabilities as reflected on our consolidated balance sheet. Such amount does not include streaming content commitments that do not meet the criteria for liability recognition, the amounts of which are significant. For more information on our streaming content obligations, including those not on our consolidated balance sheet, see Note 5, Commitments and Contingencies. Our substantial indebtedness and other obligations, including streaming content obligations, may:
make it difficult for us to satisfy our financial obligations, including making scheduled principal and interest payments on our Notes and our other obligations;
limit our ability to borrow additional funds for working capital, capital expenditures, acquisitions or other general business purposes;
limit our ability to use our cash flow or obtain additional financing for future working capital, capital expenditures, acquisitions or other general business purposes;
require us to use a substantial portion of our cash flow from operations to make debt service payments and pay our other obligations when due;
limit our flexibility to plan for, or react to, changes in our business and industry;
place us at a competitive disadvantage compared to our less leveraged competitors; and
increase our vulnerability to the impact of adverse economic and industry conditions.

We may not be able to generate sufficient cash to service our debt and other obligations.
Our ability to make payments on our indebtedness, including our Notes, and our other obligations will depend on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We may be unable to maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness, including the Notes, and other obligations, including amounts due under our streaming content obligations.
If our cash flows and capital resources are insufficient to fund our debt service and other obligations, we may be forced to reduce or delay investments and capital expenditures, or to sell assets, seek additional capital or restructure or refinance our indebtedness, including the Notes and obligations such as our streaming content obligations. These alternative measures may not be successful and may not permit us to meet our scheduled debt service and other obligations. We cannot assure you that we would be able to implement any of these alternatives on satisfactory terms or at all. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. We may not be able to consummate those dispositions or to obtain the proceeds that we could realize from them, and these proceeds may not be adequate to meet any debt service obligations or other obligations then due.
If we are unable to service our debt obligations from cash flows, we may need to refinance all or a portion of our debt obligations prior to maturity. Our ability to refinance or restructure our debt will depend upon the condition of the capital markets and our financial condition at such time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. We may not be able to refinance any of our indebtedness on commercially reasonable terms or at all.

We may lose key employees or may be unable to hire qualified employees.

10


We rely on the continued service of our senior management, including our Chief Executive Officer and co-founder Reed Hastings, members of our executive team and other key employees and the hiring of new qualified employees. In our industry, there is substantial and continuous competition for highly-skilled business, product development, technical and other personnel. We may not be successful in recruiting new personnel and in retaining and motivating existing personnel, which may be disruptive to our operations.
If our Domestic DVD segment declines faster than anticipated, our business could be adversely affected.
The number of memberships to our DVD-by-mail offering is declining, and we anticipate that this decline will continue. We believe, however, that the domestic DVD business will continue to generate significant contribution profit for our business. The contribution profit generated by our domestic DVD business will help provide capital resources to fund our growth internationally. To the extent that the rate of decline in our DVD-by-mail business is greater than we anticipate, our business could be adversely affected. We do not anticipate increasing resources to our DVD operations and the technology used in its operations will not be meaningfully improved. To the extent that we experience service interruptions or other degradations in our DVD-by-mail service, members' satisfaction could be negatively impacted and we could experience an increase in DVD-by-mail member cancellations, which could adversely impact our business.
If the U.S. Postal Service were to increase postal delivery rates or implement other changes to improve its financial position, such as closing mail processing facilities or service reductions, such changes could lead to a decrease in customer satisfaction and our Domestic DVD segment's contribution profit could be adversely affected.

Risks Related to Our Stock Ownership
Provisions in our charter documents and under Delaware law could discourage a takeover that stockholders may consider favorable.
Our charter documents may discourage, delay or prevent a merger or acquisition that a stockholder may consider favorable because they:
authorize our board of directors, without stockholder approval, to issue up to 10,000,000 shares of undesignated preferred stock;
provide for a classified board of directors;
prohibit our stockholders from acting by written consent;
establish advance notice requirements for proposing matters to be approved by stockholders at stockholder meetings; and
prohibit stockholders from calling a special meeting of stockholders.
As a Delaware corporation, we are also subject to certain Delaware anti-takeover provisions. Under Delaware law, a corporation may not engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the stock for three years or, among other things, the board of directors has approved the transaction. Our board of directors could rely on Delaware law to prevent or delay an acquisition of us.
In addition, a merger or acquisition may trigger retention payments to certain executive employees under the terms of our Amended and Restated Executive Severance and Retention Incentive Plan, thereby increasing the cost of such a transaction.
Our stock price is volatile.
The price at which our common stock has traded has fluctuated significantly. The price may continue to be volatile due to a number of factors including the following, some of which are beyond our control:
variations in our operating results, including our membership acquisition and retention, revenues, contribution profits, net income and free cash flow;
variations between our actual operating results and the expectations of securities analysts, investors and the financial community;
announcements of developments affecting our business, systems or expansion plans by us or others;
competition, including the introduction of new competitors, their pricing strategies and services;
market volatility in general;

11


the level of demand for our stock, including the amount of short interest in our stock; and
the operating results of our competitors.
As a result of these and other factors, investors in our common stock may not be able to resell their shares at or above their original purchase price.
Following certain periods of volatility in the market price of our securities, we became the subject of securities litigation. We may experience more such litigation following future periods of volatility. This type of litigation may result in substantial costs and a diversion of management’s attention and resources.
Financial forecasting may differ materially from actual results.
Given the dynamic nature of our business, and the inherent limitations in predicting the future, forecasts of our revenues, contribution margins, net income and number of total and paid membership additions and other financial and operating data may differ materially from actual results. Such discrepancies could cause a decline in the trading price of our common stock.
 
Item 1B.
Unresolved Staff Comments
None.

12


Item 2.
Properties
Our corporate headquarters are located in Los Gatos, California and consist of leased space aggregating approximately 600,000 square feet.
In the United States, we lease other offices in various locations, including Beverly Hills, California for content acquisition, marketing and general and administrative operations and Fremont, California for our DVD operations. In 2017, we expect to relocate from Beverly Hills to Los Angeles in a new leased space of approximately 400,000 square feet. We also lease office space in other countries to support international streaming operations.
We believe that our existing facilities are adequate to meet current requirements, and that suitable additional or substitute space will be available as needed to accommodate any further physical expansion of operations and for any additional offices.
 
Item 3.
Legal Proceedings
Information with respect to this item may be found in Note 5 of Item 8, Financial Statements and Supplementary Data, under the caption "Legal Proceedings" which information is incorporated herein by reference.
 
Item 4.
Mine Safety Disclosures
Not applicable.

13


PART II
 
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common stock is traded on the NASDAQ Global Select Market under the symbol “NFLX”. The following table sets forth the intraday high and low sales prices per share of our common stock for the periods indicated, as reported by the NASDAQ Global Select Market. The per share amounts are adjusted for our seven-for-one stock split that occurred in July 2015. Further information on the stock split can be found in Note 7 of Item 8, Financial Statements and Supplementary Data.
 
 
 
2016
 
2015
 
 
High
 
Low
 
High
 
Low
First quarter
 
$
122.18

 
$
79.95

 
$
69.50

 
$
45.26

Second quarter
 
111.85

 
84.81

 
100.89

 
58.46

Third quarter
 
101.27

 
84.50

 
129.29

 
85.50

Fourth quarter
 
129.29

 
97.63

 
133.27

 
96.26

Holders
As of January 26, 2017, there were approximately 290 stockholders of record of our common stock, although there is a significantly larger number of beneficial owners of our common stock.
Dividends
We have not declared or paid any cash dividends, and we have no present intention of paying any cash dividends in the foreseeable future.




14


Stock Performance Graph
Notwithstanding any statement to the contrary in any of our previous or future filings with the Securities and Exchange Commission, the following information relating to the price performance of our common stock shall not be deemed “filed” with the Commission or “soliciting material” under the Securities Exchange Act of 1934 and shall not be incorporated by reference into any such filings.
The following graph compares, for the five year period ended December 31, 2016, the total cumulative stockholder return on the Company’s common stock, as adjusted for the Stock Split, with the total cumulative return of the NASDAQ Composite Index, the S&P 500 Index and the RDG Internet Composite Index. Measurement points are the last trading day of each of the Company’s fiscal years ended December 31, 2011December 31, 2012December 31, 2013, December 31, 2014, December 31, 2015 and December 31, 2016. Total cumulative stockholder return assumes $100 invested at the beginning of the period in the Company’s common stock, the stocks represented in the NASDAQ Composite Index, the stocks represented in the S&P 500 Index and the stocks represented in the RDG Internet Composite Index, respectively, and reinvestment of any dividends. In prior years, the Company used the S&P North American Technology Internet Index, which was discontinued in March 2016. Accordingly, the Company now uses the RDG Internet Composite Index as a replacement for the discontinued index. Historical stock price performance should not be relied upon as an indication of future stock price performance.

a2016totalreturnlinegraph.jpg




15


Item 6.
Selected Financial Data
The following selected consolidated financial data is not necessarily indicative of results of future operations and should be read in conjunction with Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8, Financial Statements and Supplementary Data. The following amounts related to earnings per share and shares outstanding have been adjusted for the Stock Split for all periods reported. See Note 7 of Item 8, Financial Statements and Supplementary Data for further detail on the Stock Split.
Consolidated Statements of Operations:
 
 
Year ended December 31,
 
 
2016
 
2015
 
2014
 
2013
 
2012
 
 
(in thousands, except per share data)
Revenues
 
$
8,830,669

 
$
6,779,511

 
$
5,504,656

 
$
4,374,562

 
$
3,609,282

Operating income
 
379,793

 
305,826

 
402,648

 
228,347

 
49,992

Net income
 
186,678

 
122,641

 
266,799

 
112,403

 
17,152

Earnings per share:
 
 
 
 
 
 
 
 
 
 
Basic
 
$
0.44

 
$
0.29

 
$
0.63

 
$
0.28

 
$
0.04

Diluted
 
$
0.43

 
$
0.28

 
$
0.62

 
$
0.26

 
$
0.04

Weighted-average common shares outstanding:
 
 
 
 
 
 
 
 
 
 
Basic
 
428,822

 
425,889

 
420,544

 
407,385

 
388,648

Diluted
 
438,652

 
436,456

 
431,894

 
425,327

 
412,327



Consolidated Statements of Cash Flows:
 
 
Year Ended December 31,
 
 
2016
 
2015
 
2014
 
2013
 
2012
 
 
(in thousands)
Net cash (used in) provided by operating activities
 
$
(1,473,984
)
 
$
(749,439
)
 
$
16,483

 
$
97,831

 
$
21,586

Free cash flow (1)
 
(1,659,755
)
 
(920,557
)
 
(126,699
)
 
(16,300
)
 
(58,151
)
 

(1)
Free cash flow is defined as net cash (used in) provided by operating and investing activities, excluding the non-operational cash flows from purchases, maturities and sales of short-term investments. See Liquidity and Capital Resources for a reconciliation of "free cash flow" to "net cash (used in) provided by operating activities."
Consolidated Balance Sheets:
 
 
As of December 31,
 
 
2016
 
2015
 
2014
 
2013
 
2012
 
 
(in thousands)
Cash, cash equivalents and short-term investments
 
$
1,733,782

 
$
2,310,715

 
$
1,608,496

 
$
1,200,405

 
$
748,078

Total content assets, net
 
11,000,808

 
7,218,815

 
4,939,460

 
3,838,364

 
2,934,099

Working capital
 
1,133,634

 
1,902,216

 
1,263,899

 
883,049

 
553,887

Total assets
 
13,586,610

 
10,202,871

 
7,042,500

 
5,404,025

 
3,961,781

Long-term debt
 
3,364,311

 
2,371,362

 
885,849

 
491,462

 
195,782

Long-term debt due to related party
 

 

 

 

 
198,109

Non-current content liabilities
 
2,894,654

 
2,026,360

 
1,575,832

 
1,345,590

 
1,076,622

Total content liabilities
 
6,527,365

 
4,815,383

 
3,693,073

 
3,121,573

 
2,443,469

Total stockholders’ equity
 
2,679,800


2,223,426

 
1,857,708

 
1,333,561

 
744,673

 



16




Other Data:
 
 
As of / Year Ended December 31,
 
 
2016
 
2015
 
2014
 
2013
 
2012
 
 
(in thousands)
Net global streaming membership additions during period (1)
 
19,034

 
17,371

 
13,041

 
11,083

 
9,738

Global streaming memberships (1)
 
93,796

 
74,762

 
57,391

 
44,350

 
33,267


(1)
A membership (also referred to as a subscription or a member) is defined as the right to receive the Netflix service following sign-up and a method of payment being provided. Memberships are assigned to territories based on the geographic location used at time of sign-up as determined by our internal systems, which utilize industry standard geo-location technology. We offer free-trial memberships to new and certain rejoining members. Total members include those who are on a free-trial as long as a method of payment has been provided. 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 except in limited circumstances where a short grace period is offered to ensure the streaming service is not interrupted for members who are impacted by payment processing delays by our banks or integrated payment partners. The number of members in a grace period at any given point is not material.




17



Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview and Results of Operations
The following represents our consolidated performance highlights:
 
 
As of/ Year Ended December 31,
 
Change
 
 
2016
 
2015
 
2014
 
2016 vs. 2015
 
2015 vs. 2014
 
 
(in thousands, except revenue per membership and percentages)
Global streaming memberships
 
93,796

 
74,762

 
57,391

 
25
%
 
30
 %
Global streaming average monthly revenue per paying membership
 
$
8.61

 
$
8.15

 
$
8.20

 
6
%
 
(1
)%
Revenues
 
$
8,830,669

 
$
6,779,511

 
$
5,504,656

 
30
%
 
23
 %
Operating income
 
$
379,793

 
$
305,826

 
$
402,648

 
24
%
 
(24
)%
Net income
 
$
186,678

 
$
122,641

 
$
266,799

 
52
%
 
(54
)%
Consolidated revenues for the year ended December 31, 2016 increased as compared to the year ended December 31, 2015 due to growth in the average number of paid streaming memberships globally, the majority of which was growth in our international memberships reflecting our expansion and focus on Netflix as a global internet TV network. The impact from membership growth was coupled with an increase in global streaming average monthly revenue per paying membership resulting from price changes and plan mix partially offset by unfavorable foreign currency fluctuations impacting our International streaming segment. The increase in operating income and net income is due primarily to increased revenues partially offset by increased content expenses as we continue to acquire, license and produce content, including more Netflix originals, as well as increased marketing and headcount costs to support our international expansion. Net income was further impacted by the increase in interest expense associated with our debt issuances as well as to an increase in our effective tax rate, slightly offset by gains on foreign currency denominated transactions. We intend to focus on growing our global operating margin in 2017.
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 "standard" plan is our most popular streaming plan and is priced at $9.99 per month and includes access to high definition quality streaming on two screens concurrently. Our "premium" plan is priced at $11.99 per month and includes access to high definition and ultra-high definition quality content on four screens concurrently. Internationally, the membership plans are structured similarly to the U.S. and range in price from the U.S. dollar equivalent of approximately $5.00 to $18.00 per month.
We expect that from time to time the prices of our membership plans in each country may change. For instance, in May 2014, in the U.S., we increased the price of our standard plan from $7.99 per month to $8.99 per month with existing memberships grandfathered for a two year period. In October 2015, in the U.S., we increased the price of this same standard plan from $8.99 per month to $9.99 per month with existing memberships grandfathered for a one year period. In 2016, we phased out grandfathered pricing, giving members the option of electing the basic streaming plan at $7.99 per month, continuing on the standard streaming plan at the higher price of $9.99 per month, or electing the premium plan at $11.99 per month.

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

We define contribution profit (loss) as revenues less cost of revenues and marketing expenses incurred by the segment. 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 assets and other expenses associated with the licensing and acquisition of streaming content, represent the vast majority of cost of revenues. Streaming content rights were generally obtained for our current geographic regions. As we expanded internationally, we obtained additional rights for the new geographies. With our global expansion, we now aspire to obtain global rights for our content. We allocate this content between the Domestic and International segments based on estimated fair market value. Other cost of revenues such as streaming delivery expenses, customer service and payment processing fees, including those we pay to our integrated payment partners, tend to be lower as a percentage of total cost of revenues . We have built our own global content delivery network ("Open Connect") to help us efficiently stream a high volume of content to our members over the internet. Streaming

18


delivery expenses, therefore, include equipment costs related to Open Connect and all third-party costs, such as cloud computing 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 assets 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 partners including device partners, MVPD's, mobile platforms and ISP's. Advertising expenses include promotional activities such as digital and television advertising. Payments to our partners include fixed fee and /or revenue sharing payments. Marketing expenses are incurred by our Domestic and International streaming segments given our focus on building consumer awareness of the streaming offerings, and in particular our original content. Marketing expenses incurred by our International streaming segment have been significant and 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 have demonstrated our ability to grow domestic streaming contribution margin as evidenced by the increase in contribution margin from 17% in 2012 to 36% in 2016. 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.



19


Segment Results

Domestic Streaming Segment
 
 
As of/ Year Ended December 31,
 
Change
 
 
2016
 
2015
 
2014
 
2016 vs. 2015
 
2015 vs. 2014
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net additions
 
4,693

 
5,624

 
5,694

 
(931
)
 
(17
)%
 
(70
)
 
(1
)%
Memberships at end of period
 
49,431

 
44,738

 
39,114

 
4,693

 
10
 %
 
5,624

 
14
 %
Paid memberships at end of period
 
47,905

 
43,401

 
37,698

 
4,504

 
10
 %
 
5,703

 
15
 %
Average monthly revenue per paying membership
 
$9.21
 
$8.50
 
$8.14
 
$0.71
 
8
 %
 
$0.36
 
4
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contribution profit:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
 
$
5,077,307

 
$
4,180,339

 
$
3,431,434

 
$
896,968

 
21
 %
 
$
748,905

 
22
 %
Cost of revenues
 
2,855,789

 
2,487,193

 
2,201,761

 
368,596

 
15
 %
 
285,432

 
13
 %
Marketing
 
382,832

 
317,646

 
293,453

 
65,186

 
21
 %
 
24,193

 
8
 %
Contribution profit
 
1,838,686

 
1,375,500

 
936,220

 
463,186

 
34
 %
 
439,280

 
47
 %
Contribution margin
 
36
%
 
33
%
 
27
%
 
 
 
 
 
 
 
 
Year ended December 31, 2016 as compared to the year ended December 31, 2015
In the Domestic streaming segment, we derive revenues from monthly membership fees for services consisting solely of streaming content to our members in the United States. The increase in our domestic streaming revenues was due to a 12% growth in the average number of paid memberships and an 8% increase in average monthly revenue per paying membership. The average monthly revenue per paying membership for the fourth quarter of 2016 increased by 15% compared to the same quarter in prior year. These increases in average monthly revenue per paying membership resulted from our price changes and plan mix. In 2016, we phased out grandfathered pricing and cancellations by members whose grandfathered pricing expired were not material. Our standard 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 $335.4 million increase in content expenses relating to our existing and new streaming content, including more exclusive and original programming. In addition, we had a $33.2 million increase in other costs, such as payment processing fees and customer service call centers, due to our growing member base.
Domestic marketing expenses increased primarily due to an increase in advertising and public relations spending as well as increased payments to our partners.
Our Domestic streaming segment had a contribution margin of 36% for the year ended December 31, 2016, which increased as compared to the contribution margin of 33% for the year ended December 31, 2015 due to growth in paid memberships and revenue, which continued to outpace content and marketing spending.

Year ended December 31, 2015 as compared to the year ended December 31, 2014
The increase in our domestic streaming revenues was due to a 17% growth in the average number of paid memberships and a 4% increase in average monthly revenue per paying membership resulting from our price changes and plan mix.
The increase in domestic streaming cost of revenues was primarily due to a $208.1 million increase in content expenses relating to our existing and new streaming content, including more exclusive and original programming. In addition, we had a $37.9 million increase in streaming delivery expenses and a $39.4 million increase in other costs, such as payment processing fees and customer service call centers, 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 year ended December 31, 2015, which increased as compared to the contribution margin of 27% for the year ended December 31, 2014 due to growth in paid memberships and revenue, which continued to outpace content and marketing spending.

20



International Streaming Segment
 
 
As of Year Ended December 31,
 
Change
 
 
2016
 
2015
 
2014
 
2016 vs. 2015
 
2015 vs. 2014
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net additions
 
14,341

 
11,747

 
7,347

 
2,594

 
22
 %
 
4,400

 
60
 %
Memberships at end of period
 
44,365

 
30,024

 
18,277

 
14,341

 
48
 %
 
11,747

 
64
 %
Paid memberships at end of period
 
41,185

 
27,438

 
16,778

 
13,747

 
50
 %
 
10,660

 
64
 %
Average monthly revenue per paying membership
 
$7.81
 
$7.48
 
$8.34
 
$0.33
 
4
 %
 
$(0.86)
 
(10
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contribution loss:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
 
$
3,211,095

 
$
1,953,435

 
$
1,308,061

 
$1,257,660
 
64
 %
 
$
645,374

 
49
 %
Cost of revenues
 
2,911,370

 
1,780,375

 
1,154,117

 
1,130,995

 
64
 %
 
626,258

 
54
 %
Marketing
 
608,246

 
506,446

 
313,733

 
101,800

 
20
 %
 
192,713

 
61
 %
Contribution loss
 
(308,521
)
 
(333,386
)
 
(159,789
)
 
(24,865
)
 
(7
)%
 
173,597

 
109
 %
Contribution margin
 
(10
)%
 
(17
)%
 
(12
)%
 
 
 
 
 
 
 
 
In the International streaming segment, we derive revenues from monthly membership fees for services consisting solely of streaming content to our members outside the United States. We launched our streaming service in Canada in September 2010 and have expanded our services internationally as shown below.
timelineupdateda04.jpg
Year ended December 31, 2016 as compared to the year ended December 31, 2015

The increase in our international revenues was due to the 57% growth in the average number of paid international memberships and a 4% increase in average monthly revenue per paying membership. The average monthly revenue per paying membership for the fourth quarter of 2016 increased by 10% compared to the same quarter in prior year. These increases in average monthly revenue per paying membership were due to price changes and plan mix, offset partially by unfavorable fluctuations in foreign exchange rates. We estimate that international revenues would have been approximately $174 million higher in the year ended December 31, 2016 if foreign exchange rates had remained consistent with those for the year ended December 31, 2015. If foreign currency exchange rates fluctuate more than expected, revenues and average revenue per paying membership may differ from our expectations. Average paid international streaming memberships accounted for 43% of total average paid streaming memberships as of December 31, 2016, as compared to 35% of total average paid streaming memberships as of December 31, 2015.
The increase in international cost of revenues was primarily due to a $998.5 million increase in content expenses relating to our existing and new streaming content, including more exclusive and original programming. Other costs increased $132.5 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, partially offset by decreases resulting from exchange rate

21


fluctuations.
International marketing expenses increased mainly due to expenses for territories launched in the last eighteen months.
International contribution losses decreased $24.9 million year over year due to growth in paid memberships and revenue, which outpaced the growth in marketing spending.

Year ended December 31, 2015 as compared to the year ended December 31, 2014

The increase in our international revenues was due to the 66% growth in the average number of paid international memberships offset partially by a 10% 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 our pricing changes and plan mix. We believe international revenues would have been approximately $331 million higher in 2015 if foreign exchange rates had remained consistent with those for the year ended December 31, 2014.
The increase in international cost of revenues was primarily due to a $522.1 million increase in content expenses primarily relating to expenses for territories launched in the last eighteen months, coupled with existing and new streaming content, including more exclusive and original programming. Other costs increased $104.2 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, partially offset by decreases resulting from exchange rate fluctuations. Average paid international streaming memberships accounted for 35% of total average paid streaming memberships as of December 31, 2015, as compared to 27% of total average paid streaming memberships as of December 31, 2014.
International marketing expenses for the year ended December 31, 2015 increased as compared to the year ended December 31, 2014 mainly due to expenses for territories launched in the last eighteen months.
International contribution losses increased $173.6 million year over year due to our increased spending for our international expansion and the impact of foreign currency exchange rate fluctuations.

Domestic DVD Segment
 
 
As of/ Year Ended December 31,
 
Change
 
 
2016
 
2015
 
2014
 
2016 vs. 2015
 
2015 vs. 2014
 
 
(in thousands, except revenue per membership and percentages)
Memberships:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net losses
 
(790
)
 
(863
)
 
(1,163
)
 
(73
)
 
(8
)%
 
(300
)
 
(26
)%
Memberships at end of period
 
4,114

 
4,904

 
5,767

 
(790
)
 
(16
)%
 
(863
)
 
(15
)%
Paid memberships at end of period
 
4,029

 
4,787

 
5,668

 
(758
)
 
(16
)%
 
(881
)
 
(16
)%
Average monthly revenue per paying membership
 
$10.22
 
$10.30
 
$10.29
 
$(0.08)
 
(1
)%
 
$0.01
 
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contribution profit:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
 
$
542,267

 
$
645,737

 
$
765,161

 
$
(103,470
)
 
(16
)%
 
$
(119,424
)
 
(16
)%
Cost of revenues
 
262,742

 
323,908

 
396,882

 
(61,166
)
 
(19
)%
 
(72,974
)
 
(18
)%
Contribution profit
 
279,525

 
321,829

 
368,279

 
(42,304
)
 
(13
)%
 
(46,450
)
 
(13
)%
Contribution margin
 
52
%
 
50
%
 
48
%
 
 
 
 
 
 
 
 
Year ended December 31, 2016 as compared to the year ended December 31, 2015
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 $14.99 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 15% decrease in the average number of paid memberships.
The decrease in domestic DVD cost of revenues was primarily due to a $14.0 million decrease in content expenses and a $32.8 million decrease in delivery expenses resulting from a 18% 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

22


members. Other costs, primarily those associated with processing and customer service expenses, decreased $14.4 million primarily due to a decrease in hub operation expenses resulting from the decline in DVD shipments.
Our Domestic DVD segment had a contribution margin of 52% for the year ended December 31, 2016, up from 50% for the year ended December 31, 2015 due to the decrease in DVD usage by paying members.

Year ended December 31, 2015 as compared to the year ended December 31, 2014
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 $21.0 million decrease in content expenses and a $38.9 million decrease in delivery expenses resulting from a 21% 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 $13.1 million primarily due to a decrease in hub operation expenses resulting from the decline in DVD shipments.
Our Domestic DVD segment had a contribution margin of 50% for the year ended December 31, 2015, up from 48% for the year ended December 31, 2014 due to the decrease in DVD usage by paying members.


Consolidated Operating Expenses
Technology and Development
Technology and development expenses consist of payroll and related costs incurred in making improvements to our service offerings, including testing, maintaining and modifying our user interface, our recommendation, merchandising and streaming delivery technology and infrastructure. Technology and development expenses also include costs associated with computer hardware and software.
 
 
 
Year Ended December 31,
 
Change
 
 
2016
 
2015
 
2014
 
2016 vs. 2015
 
2015 vs. 2014
 
 
(in thousands, except percentages)
Technology and development
 
$
852,098

 
$
650,788

 
$
472,321

 
$
201,310

 
31
%
 
$
178,467

 
38
%
As a percentage of revenues
 
10
%
 
10
%
 
9
%
 
 
 
 
 
 
 
 
Year ended December 31, 2016 as compared to the year ended December 31, 2015
The increase in technology and development expenses was primarily due to a $162.3 million increase in personnel-related costs resulting from an increase in compensation for existing employees and a 20% growth in average headcount supporting continued improvements in our streaming service and our international expansion. In addition, third-party expenses, including costs associated with cloud computing, increased $27.3 million.
Year ended December 31, 2015 as compared to the year ended December 31, 2014
The increase in technology and development expenses was primarily due to a $133.2 million increase in personnel-related costs resulting from an increase in compensation for existing employees and a 20% growth in average headcount supporting continued improvements in our streaming service and our international expansion. In addition, third-party expenses, including costs associated with cloud computing, increased $23.8 million.
General and Administrative
General and administrative expenses consist of payroll and related expenses for corporate personnel, as well as professional fees and other general corporate expenses.
 
 
Year Ended December 31,
 
Change
 
 
2016
 
2015
 
2014
 
2016 vs. 2015
 
2015 vs. 2014
 
 
(in thousands, except percentages)
General and administrative
 
$
577,799

 
$
407,329

 
$
269,741

 
$
170,470

 
42
%
 
$
137,588

 
51
%
As a percentage of revenues
 
7
%
 
6
%
 
5
%
 
 
 
 
 
 
 
 

23


Year ended December 31, 2016 as compared to the year ended December 31, 2015
General and administrative expenses increased primarily due to a $148.9 million increase in personnel-related costs, including stock-based compensation expense, resulting from a 39% increase in average headcount primarily to support our international expansion and increased production of original content, and an increase in compensation for existing employees. In addition, facilities-related costs increased $16.2 million due to the growth in average headcount.

Year ended December 31, 2015 as compared to the year ended December 31, 2014
General and administrative expenses increased primarily due to a $120.1 million increase in personnel-related costs, including stock-based compensation expense, resulting from a 51% increase in average headcount primarily to support our international expansion and increased production of original content, and an increase in compensation for existing employees.
Interest Expense
Interest expense consists primarily of the interest associated with our outstanding long-term debt obligations, including the amortization of debt issuance costs, as well as interest on our lease financing obligations.
 
 
 
Year Ended December 31,
 
Change
 
 
2016
 
2015
 
2014
 
2016 vs. 2015
 
2015 vs. 2014
 
 
(in thousands, except percentages)
Interest expense
 
$
(150,114
)
 
$
(132,716
)
 
$
(50,219
)
 
$
17,398

 
13
%
 
$
82,497

 
164
%
As a percentage of revenues
 
2
%
 
2
%
 
1
%
 
 
 
 
 
 
 
 
Year ended December 31, 2016 as compared to the year ended December 31, 2015
Interest expense for the year ended December 31, 2016 consists primarily of $143.3 million of interest on our notes. The increase in interest expense for the year ended December 31, 2016 as compared to the year ended December 31, 2015 is due to the higher aggregate principal of interest bearing notes outstanding.
Year ended December 31, 2015 as compared to the year ended December 31, 2014
Interest expense for the year ended December 31, 2015 consists primarily of $127.1 million of interest on our notes. The increase in interest expense for the year ended December 31, 2015 as compared to the year ended December 31, 2014 is due to the higher aggregate principal of interest bearing notes outstanding.

Interest and Other Income (Expense)
Interest and other income (expense) consists primarily of foreign exchange gains and losses on foreign currency denominated balances and interest earned on cash, cash equivalents and short-term investments.
 
 
Year Ended December 31,
 
Change
 
 
2016
 
2015
 
2014
 
2016 vs. 2015
 
2015 vs. 2014
 
 
(in thousands, except percentages)
Interest and other income (expense)
 
$
30,828

 
$
(31,225
)
 
$
(3,060
)
 
$
62,053

 
199
%
 
$
(28,165
)
 
(920
)%
Year ended December 31, 2016 as compared to the year ended December 31, 2015
Interest and other income (expense) increased primarily due to foreign exchange. In the year ended December 31, 2016, the foreign exchange gain of $22.8 million was primarily driven by the remeasurement of significant content liabilities denominated in currencies other than functional currencies.

Year ended December 31, 2015 as compared to the year ended December 31, 2014
Interest and other income (expense) decreased primarily due to foreign exchange. In the year ended December 31, 2015, the foreign exchange loss of $37.3 million was primarily driven by the remeasurement of significant content liabilities denominated in currencies other than functional currencies in our European entities coupled with the strengthening of the U.S. dollar.


24


Provision for Income Taxes
 
 
Year Ended December 31,
 
Change
 
 
2016
 
2015
 
2014
 
2016 vs. 2015
 
2015 vs. 2014
 
 
(in thousands, except percentages)
Provision for income taxes
 
$
73,829

 
$
19,244

 
$
82,570

 
$
54,585

 
284
%
 
(63,326
)
 
(77
)%
Effective tax rate
 
28
%
 
14
%
 
24
%
 
 
 
 
 
 
 
 
Year ended December 31, 2016 as compared to the year ended December 31, 2015
The increase in our effective tax rate is mainly due to a $13.4 million release of tax reserves in 2015 and an increase in foreign taxes. In 2016, the difference between our 28% effective tax rate and the Federal statutory rate of 35% was $17.3 million primarily due to the 2016 Federal and California research and development (“R&D”) credits partially offset by state income taxes, foreign taxes, and nondeductible expenses.
 
Year ended December 31, 2015 as compared to the year ended December 31, 2014
The decrease in our effective tax rate is mainly due to an increase in R&D credits and a decrease in state and local income taxes. In 2015, the difference between our 14% effective tax rate and the Federal statutory rate of 35% was $30.4 million primarily due to a $13.4 million release of tax reserves on previously unrecognized tax benefits as a result of an IRS audit settlement leading to the reassessment of our reserves for all open years, $16.5 million related to the retroactive reinstatement of the 2015 Federal R&D credit, as well as the California R&D credit; partially offset by state income taxes, foreign taxes and nondeductible expenses. On December 18, 2015, the Protecting Americans from Tax Hikes Act of 2015 (H.R. 2029) was signed into law which retroactively and permanently extended the Federal R&D credit from January 1, 2015. As a result, we recognized the retroactive benefit of the 2015 R&D credit as a discrete item in the fourth quarter of 2015, the period in which the legislation was enacted.

Liquidity and Capital Resources
Cash, cash equivalents and short-term investments decreased $576.9 million from $2,310.7 million as of December 31, 2015 to $1,733.8 million as of December 31, 2016. In October 2016, we issued $1,000.0 million of long-term debt. The decrease in cash, cash equivalents and short-term investments in the year ended December 31, 2016 was primarily driven by an increase in cash used in operations, partially offset by cash received from the issuance of debt. Long-term debt, net of debt issuance costs, was $3,364.3 million and $2,371.4 million as of December 31, 2016 and 2015, respectively. See Note 4 to the consolidated financial statements for additional information.
Our primary uses of cash include the acquisition, licensing and production of content, streaming delivery, marketing programs and personnel-related costs. Investments in original content, and in particular content that we produce and own, require more cash upfront relative to licensed content. We expect to significantly increase our investments in global streaming content, particularly in original content, which will impact our liquidity and may result in future negative free cash flows even after we achieve material global profitability.
We currently anticipate that cash flows from operations, together with available funds and access to financing sources, will continue to be sufficient to meet our cash needs for at least the next twelve months. Our ability to obtain any additional financing that we may choose to, or need to, obtain will depend on, among other things, our development efforts, business plans, operating performance, financial condition and the condition of the capital markets at the time we seek financing. We may not be able to obtain such financing on terms acceptable to us or at all. If we raise additional funds through the issuance of equity, equity-linked or debt securities, those securities may have rights, preferences or privileges senior to the rights of our common stock, and our stockholders may experience dilution.
As of December 31, 2016, cash and cash equivalents held by our foreign subsidiaries amounted to $278.5 million. If these funds are needed for our operations in the U.S., we would be required to accrue and pay U.S. income taxes and foreign withholding taxes on the portion associated with undistributed earnings for certain foreign subsidiaries.
Free Cash Flow
We define free cash flow as cash provided by (used in) operating and investing activities excluding the non-operational cash flows from purchases, maturities and sales of short-term investments. We believe free cash flow is an important liquidity metric because it measures, during a given period, the amount of cash generated that is available to repay debt obligations, make investments in content and for certain other activities or the amount of cash used in operations, including investments in global streaming content. Free cash flow is considered a non-GAAP financial measure and should not be considered in isolation

25


of, or as a substitute for, net income, operating income, cash flow (used in) provided by operating activities, or any other measure of financial performance or liquidity presented in accordance with GAAP.
In assessing liquidity in relation to our results of operations, we compare free cash flow to net income, noting that the three major recurring differences are excess content payments over expense, non-cash stock-based compensation expense and other working capital differences. The excess content payments over expense is variable based on the payment terms of our content agreements and is expected to increase as we enter into more agreements with upfront cash payments, such as licensing and production of original content. In the last 12 months, the ratio of content payments over content expense was 1.4. Working capital differences include deferred revenue, taxes and semi-annual interest payments on our outstanding debt. Our receivables from members generally settle quickly and deferred revenue is a source of cash flow.

 
Year Ended December 31,
 
2016
 
2015
 
2014
 
(in thousands)
Net cash (used in) provided by operating activities
$
(1,473,984
)
 
$
(749,439
)
 
$
16,483

Net cash provided by (used in) investing activities
49,765

 
(179,192
)
 
(42,866
)
Net cash provided by financing activities
1,091,630

 
1,640,277

 
541,712

 
 
 
 
 
 
Non-GAAP free cash flow reconciliation:
 
 
 
 
 
Net cash (used in) provided by operating activities
(1,473,984
)
 
(749,439
)
 
16,483

Acquisition of DVD content assets
(77,177
)
 
(77,958
)
 
(74,790
)
Purchases of property and equipment
(107,653
)
 
(91,248
)
 
(69,726
)
Other assets
(941
)
 
(1,912
)
 
1,334

Non-GAAP free cash flow
$
(1,659,755
)
 
$
(920,557
)
 
$
(126,699
)

Year ended December 31, 2016 as compared to the year ended December 31, 2015

Cash used in operating activities increased $724.5 million resulting in net cash used in operating activities of $1,474.0 million for the year ended December 31, 2016. The significant net cash used in operations is due primarily to the increase in investments in streaming content that require more upfront payments. The payments for streaming content assets increased $2,271.4 million, from $4,609.2 million to $6,880.6 million, or 49%. In addition, we had increased payments associated with higher operating expenses. The increased use of cash was partially offset by a $2,051.2 million or 30% increase in revenues.
Cash provided by investing activities increased $229.0 million, primarily due to an increase of $243.6 million in the proceeds from sales and maturities of short-term investments, net of purchases, partially offset by a $16.4 million increase in the purchases of property and equipment, primarily driven by the expansion of our Los Gatos, California headquarters, as well as our new office space in Los Angeles, California.
Cash provided by financing activities decreased $548.6 million primarily due to the $1,482.4 million net proceeds from the issuance of the 5.50% Notes and the 5.875% Notes in the year ended December 31, 2015 as compared to the $989.3 million net proceeds from the issuance of the 4.375% Notes in the year ended December 31, 2016.
Free cash flow was $1,846.4 million lower than net income for the year ended December 31, 2016 primarily due to $2,092.1 million of cash payments for streaming content assets over streaming amortization expense partially offset by $173.7 million of non-cash stock-based compensation expense and $72.0 million of favorable other working capital differences.

Year ended December 31, 2015 as compared to the year ended December 31, 2014

Cash provided by operating activities decreased $765.9 million resulting in net cash used in operating activities of $749.4 million for the year ended December 31, 2015. The significant net cash used in operations is due primarily to the increase in investments in streaming content that require more upfront payments. The payments for streaming assets increased $1,429.3 million, from $3,179.9 million to $4,609.2 million or 45%. In addition, we had increased payments associated with higher operating expenses. The increased use of cash was partially offset by a $1,274.9 million or 23% increase in revenues.
Cash used in investing activities increased $136.3 million, primarily due to a decrease of $108.4 million in the proceeds from sales and maturities of short-term investments, net of purchases. In addition, purchases of property and equipment increased by $21.5 million, primarily driven by the expansion of our Los Gatos, California headquarters.

26


Cash provided by financing activities increased $1,098.6 million primarily due to the $1,482.4 million net proceeds from the issuance of the 5.50% Notes and the 5.875% Notes in the year ended December 31, 2015 as compared to the $392.9 million net proceeds from the issuance of the 5.750% Notes in the year ended December 31, 2014.
Free cash flow was $1,043.2 million lower than net income for the year ended December 31, 2015 primarily due to $1,203.9 million of cash payments for streaming content assets over streaming amortization expense partially offset by $124.7 million of non-cash stock-based compensation expense and $36.0 million of favorable other working capital differences.
Free cash flow was $393.5 million lower than net income for the year ended December 31, 2014 primarily due to $523.6 million of cash payments for streaming content assets over streaming amortization expense partially offset by $115.2 million of non-cash stock-based compensation expense and $14.9 million of favorable other working capital differences.


Contractual Obligations
For the purpose of this table, contractual obligations for purchases of goods or services are defined as agreements that are enforceable and legally binding and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. The expected timing of the payment of the obligations discussed below is estimated based on information available to us as of December 31, 2016. Timing of payments and actual amounts paid may be different depending on the time of receipt of goods or services or changes to agreed-upon amounts for some obligations. The following table summarizes our contractual obligations at December 31, 2016:
 
 
 
Payments due by Period
Contractual obligations (in thousands):
 
Total
 
Less than
1 year
 
1-3 years
 
3-5 years
 
More than
5 years
Streaming content obligations (1)
 
$
14,479,487

 
$
6,200,611

 
$
6,731,336

 
$
1,386,934

 
$
160,606

Debt (2)
 
4,730,369

 
181,556

 
358,250

 
844,813

 
3,345,750

Lease obligations (3)
 
640,840

 
64,502

 
144,766

 
124,037

 
307,535

Other purchase obligations (4)
 
350,366

 
185,023

 
81,707

 
39,278

 
44,358

Total
 
$
20,201,062

 
$
6,631,692

 
$
7,316,059

 
$
2,395,062

 
$
3,858,249

 
(1)
As of December 31, 2016, streaming content obligations were comprised of $3.6 billion included in "Current content liabilities" and $2.9 billion of "Non-current content liabilities" on the Consolidated Balance Sheets and $8.0 billion of obligations that are not reflected on the Consolidated Balance Sheets as they did not then meet the criteria for recognition.
Streaming content obligations increased $3.6 billion from $10.9 billion as of December 31, 2015 to $14.5 billion as of December 31, 2016 primarily due to multi-year commitments associated with the continued expansion of our exclusive and original programming.
Streaming content obligations include amounts related to the acquisition, licensing and production of streaming content. An obligation for the production of content includes non-cancelable commitments under creative talent and employment agreements. An obligation for the acquisition and licensing of content is incurred at the time we enter into an agreement to obtain future titles. Once a title becomes available, a content liability is 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. Traditional film output deals, like the U.S. output deal with Disney, or certain TV series license agreements where the number of seasons to be aired is unknown, are examples of these types of agreements. The contractual obligations table above does not include any estimated obligation for the unknown future titles, payment for which could range from less than one year to more than five years. However, these unknown obligations are expected to be significant and we believe could include approximately $3 billion to $5 billion over the next three years, with the payments for the vast majority of such amounts expected to occur after the next twelve months. The foregoing range is based on considerable management judgments and the actual amounts may differ. Once we know the title that we will receive and the license fees, we include the amount in the contractual obligations table above.
 
(2)
Long-term debt obligations include our Notes consisting of principal and interest payments. See Note 4 to the consolidated financial statements for further details.

27



(3)
Lease obligations include lease financing obligations of $18.5 million related to our current Los Gatos, California headquarters for which we are the deemed owner for accounting purposes, commitments of $530.2 million for our expanded headquarters in Los Gatos, California, and our new office space in Los Angeles, California and other commitments of $92.1 million for facilities under non-cancelable operating leases. These leases have expiration dates varying through approximately 2027.

(4)
Other purchase obligations include all other non-cancelable contractual obligations. These contracts are primarily related to streaming delivery, DVD content acquisition, and miscellaneous open purchase orders for which we have not received the related services or goods.

As of December 31, 2016, we had gross unrecognized tax benefits of $19.7 million which was classified in “Other non-current liabilities” and a reduction to deferred tax assets which was classified as "Other non-current assets" in the consolidated balance sheets. At this time, an estimate of the range of reasonably possible adjustments to the balance of unrecognized tax benefits cannot be made.
Off-Balance Sheet Arrangements
We do not have transactions with unconsolidated entities, such as entities often referred to as structured finance or special purpose entities, whereby we have financial guarantees, subordinated retained interests, derivative instruments, or other contingent arrangements that expose us to material continuing risks, contingent liabilities, or any other obligation under a variable interest in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to us.
Indemnifications
The information set forth under Note 6 to the consolidated financial statements under the caption “Indemnification” is incorporated herein by reference.
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported periods. The Securities and Exchange Commission ("SEC") has defined a company’s critical accounting policies as the ones that are most important to the portrayal of a company’s financial condition and results of operations, and which require a company to make its most difficult and subjective judgments. Based on this definition, we have identified the critical accounting policies and judgments addressed below. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates.

Streaming Content
We acquire, license and produce content, including original programing, in order to offer our members unlimited viewing of TV shows and films. The content licenses are for a fixed fee and specific windows of availability. Payment terms for certain content licenses and the production of content require more upfront cash payments relative to the amortization expense. Payments for content, including additions to streaming assets and the changes in related liabilities, are classified within "Net cash used in (provided by) operating activities" on the Consolidated Statements of Cash Flows.
For licenses we capitalize the fee per title and record a corresponding liability at the gross amount of the liability when the license period begins, the cost of the title is known and the title is accepted and available for streaming. The portion available for streaming within one year is recognized as “Current content assets, net” and the remaining portion as “Non-current content assets, net” on the Consolidated Balance Sheets.
For productions, we capitalize costs associated with the production, including development cost and direct costs. We include these amounts in "Non-current content assets, net" on the Consolidated Balance Sheets. Participations and residuals are expensed in line with the amortization of production costs.
Based on factors including historical and estimated viewing patterns, we amortize the content assets (licensed and produced) in “Cost of revenues” on the Consolidated Statements of Operations, over the shorter of each title's contractual window of availability or estimated period of use, beginning with the month of first availability. The amortization period typically ranges from six months to five years. For content where we expect more upfront viewing, for instance due to additional merchandising and marketing efforts, we amortize on an accelerated basis. We review factors that impact the

28


amortization of the content assets on a regular basis. Our estimates related to these factors require considerable management judgment. In the third quarter of 2016, we changed the amortization method of certain content given changes in estimated viewing patterns of this content. The effect of this change in estimate was a $19.8 million decrease in operating income and a $12.3 million decrease in net income for the year ended December 31, 2016. The effect on both basic and diluted earnings per share was a decrease of $0.03 for the year ended December 31, 2016. Changes in our estimates could have a significant impact on our future results of operations.
Our business model is subscription based as opposed to a model generating revenues at a specific title level. Therefore, content assets, both licensed and produced, are reviewed in aggregate at the operating segment level when an event or change in circumstances indicates a change in the expected usefulness or that the fair value may be less than amortized cost. To date, we have not identified any such event or changes in circumstances. If such changes are identified in the future, these aggregated content assets will be stated at the lower of unamortized cost, net realizable value or fair value. In addition, unamortized costs for assets that have been, or are expected to be, abandoned are written off. No material write-down from unamortized cost was recorded in any of the periods presented.
Income Taxes
We record a provision for income taxes for the anticipated tax consequences of our reported results of operations using the asset and liability method. Deferred income taxes are recognized by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases as well as net operating loss and tax credit carryforwards. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance for any tax benefits for which future realization is uncertain. There was no significant valuation allowance as of December 31, 2016 or 2015.
Although we believe our assumptions, judgments and estimates are reasonable, changes in tax laws or our interpretation of tax laws and the resolution of any tax audits could significantly impact the amounts provided for income taxes in our consolidated financial statements.
In evaluating our ability to recover our deferred tax assets, in full or in part, we consider all available positive and negative evidence, including our past operating results, and our forecast of future earnings, future taxable income and prudent and feasible tax planning strategies. The assumptions utilized in determining future taxable income require significant judgment and are consistent with the plans and estimates we are using to manage the underlying businesses. Actual operating results in future years could differ from our current assumptions, judgments and estimates. However, we believe that it is more likely than not that substantially all deferred tax assets recorded on our Consolidated Balance Sheets will ultimately be realized. In the event we were to determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to earnings in the period in which we make such determination.
We did not recognize certain tax benefits from uncertain tax positions within the provision for income taxes. We may recognize a tax benefit only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. At December 31, 2016, our estimated gross unrecognized tax benefits were $19.7 million of which $17.0 million, if recognized, would favorably impact our future earnings. Due to uncertainties in any tax audit outcome, our estimates of the ultimate settlement of our unrecognized tax positions may change and the actual tax benefits may differ significantly from the estimates. See Note 9 to the consolidated financial statements for further information regarding income taxes.
Stock-Based Compensation
We grant fully vested non-qualified stock options to our employees on a monthly basis. As a result of immediate vesting, stock-based compensation expense is fully recognized on the grant date, and no estimate is required for post-vesting option forfeitures. Stock-based compensation expense at the grant date is based on the total number of options granted and an estimate of the fair value of the awards.
Expected Volatility: The Company calculates expected volatility based solely on implied volatility. We believe that implied volatility of publicly traded options in our 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 our common stock. An increase/decrease of 10% in our computation of expected volatility would increase/decrease the total stock-based compensation expense by approximately $14.4 million for the year ended December 31, 2016.

29


Suboptimal Exercise Factor: Our computation of the suboptimal exercise factor is based on historical and estimated option exercise behavior. An increase/decrease in the suboptimal exercise factor of 10% would increase/decrease the total stock-based compensation expense by approximately $6.0 million for the year ended December 31, 2016.
Recent Accounting Pronouncements
The information set forth under Note 1 to the consolidated financial statements under the caption “Basis of Presentation and Summary of Significant Accounting Policies” is incorporated herein by reference.



Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
We are exposed to market risks related to interest rate changes and the corresponding changes in the market values of our investments, debt and foreign currency fluctuations.
Interest Rate Risk
The primary objective of our investment activities is to preserve principal, while at the same time maximizing income we receive from investments without significantly increased risk. To achieve this objective, we follow an established investment policy and set of guidelines to monitor and help mitigate our exposure to interest rate and credit risk. The policy sets forth credit quality standards and limits our exposure to any one issuer, as well as our maximum exposure to various asset classes. We maintain a portfolio of cash equivalents and short-term investments in a variety of securities. These securities are classified as available-for-sale and are recorded at fair value with unrealized gains and losses, net of tax, included in “Accumulated other comprehensive loss” within Stockholders' equity in the Consolidated Balance Sheets.
For the year ended December 31, 2016, we had no impairment charges associated with our short-term investment portfolio. Although we believe our current investment portfolio has very little risk of material impairment, we cannot predict future market conditions or market liquidity and can provide no assurance that our investment portfolio will remain materially unimpaired. Some of the securities we invest in may be subject to market risk due to changes in prevailing interest rates which may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the value of our investment will decline. At December 31, 2016, our cash equivalents were generally invested in money market funds, which are not subject to market risk because the interest paid on such funds fluctuates with the prevailing interest rate. Our short-term investments were comprised of corporate debt securities, government and agency securities and asset backed securities.
Changes in interest rates could adversely affect the market value of the securities we hold that are classified as short-term investments. The table below separates these investments, based on stated maturities, to show the approximate exposure to interest rates as of December 31, 2016.
 
 
 
(in thousands)
Due within one year
 
$
61,833

Due after one year and through 5 years
 
204,373

Total
 
$
266,206

A sensitivity analysis was performed on our investment portfolio as of December 31, 2016. The analysis is based on an estimate of the hypothetical changes in market value of the portfolio that would result from an immediate parallel shift in the yield curve of various magnitudes. This methodology assumes a more immediate change in interest rates to reflect the current economic environment.
The following table presents the hypothetical fair values of our debt securities classified as short-term investments assuming immediate parallel shifts in the yield curve of 50 basis points (“BPS”), 100 BPS and 150 BPS. The analysis is shown as of December 31, 2016:    
 
Fair Value as of December 31, 2016
(in thousands)
-150 BPS 
 
-100 BPS
 
-50 BPS
 
+50 BPS
 
+100 BPS
 
+150 BPS
$
271,745

 
$
270,151

 
$
268,180

 
$
264,234

 
$
262,261

 
$
260,289

 

30


 Based on investment positions as of December 31, 2016, a hypothetical 100 basis point increase in interest rates across all maturities would result in a $3.9 million incremental decline in the fair market value of the portfolio. As of December 31, 2015, a similar 100 basis point increase in the yield curve would have resulted in a $6.6 million incremental decline in the fair market value of the portfolio. Such losses would only be realized if the Company sold the investments prior to maturity.

As of December 31, 2016, we had $3.4 billion of debt, consisting of fixed rate unsecured debt in five tranches. Refer to Note 4 to the consolidated financial statements for details about all issuances. The fair value of our debt will fluctuate with movements of interest rates, increasing in periods of declining rates of interest and declining in periods of increasing rates of interest.

Foreign Currency Risk

International revenues and cost of revenues account for 36% and 48%, respectively, of consolidated amounts for the year ended December 31, 2016. The majority of international revenues and a smaller portion of expenses are denominated in currencies other than the U.S. dollar and we therefore have foreign currency risk related to these currencies, which are primarily the euro, the British pound, the Canadian dollar, the Australian dollar and the Brazilian real.
Accordingly, changes in exchange rates, and in particular a weakening of foreign currencies relative to the U.S. dollar may negatively affect our revenue and contribution profit (loss) of our International streaming segment as expressed in U.S. dollars. For the year ended December 31, 2016, we believe our international revenues would have been approximately $174.4 million higher had foreign currency exchange rates remained consistent with those for the year ended December 31, 2015.
We have also experienced and will continue to experience fluctuations in our net income as a result of gains (losses) on the settlement and the remeasurement of monetary assets and liabilities denominated in currencies that are not the functional currency. In the year ended December 31, 2016, we recognized a $22.8 million foreign exchange gain which resulted primarily from the remeasurement of significant content liabilities denominated in currencies other than functional currencies.
We do not use foreign exchange contracts or derivatives to hedge any foreign currency exposures. The volatility of exchange rates depends on many factors that we cannot forecast with reliable accuracy. Our continued international expansion increases our exposure to exchange rate fluctuations and as a result such fluctuations could have a significant impact on our future results of operations.


Item 8.
Financial Statements and Supplementary Data
The consolidated financial statements and accompanying notes listed in Part IV, Item 15(a)(1) of this Annual Report on Form 10-K are included immediately following Part IV hereof and incorporated by reference herein.

Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.

Item 9A.
Controls and Procedures
(a)
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Annual Report on Form 10-K. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K were effective in providing reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Netflix have been detected.

31


 
(b)
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934 as amended (the Exchange Act)). Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2016. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control—Integrated Framework (2013 framework). Based on our assessment under the framework in Internal Control—Integrated Framework (2013 framework), our management concluded that our internal control over financial reporting was effective as of December 31, 2016. The effectiveness of our internal control over financial reporting as of December 31, 2016 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report that is included herein.
 
(c)
Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting that occurred during the quarter ended December 31, 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 

32


Report of Independent Registered Public Accounting Firm


The Board of Directors and Stockholders of Netflix, Inc.

We have audited Netflix, Inc.’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). Netflix, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Netflix, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Netflix, Inc. as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2016 of Netflix, Inc. and our report dated January 27, 2017 expressed an unqualified opinion thereon.



 
/s/ Ernst & Young LLP
San Jose, California
 
January 27, 2017
 




33




Item 9B.
Other Information
None.

34


PART III
 
Item 10.
Directors, Executive Officers and Corporate Governance
Information regarding our directors and executive officers is incorporated by reference from the information contained under the sections “Proposal One: Election of Directors,” “Section 16(a) Beneficial Ownership Compliance” and “Code of Ethics” in our Proxy Statement for the Annual Meeting of Stockholders.
 
Item 11.
Executive Compensation
Information required by this item is incorporated by reference from information contained under the section “Compensation of Executive Officers and Other Matters” in our Proxy Statement for the Annual Meeting of Stockholders.
 
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information required by this item is incorporated by reference from information contained under the sections “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information” in our Proxy Statement for the Annual Meeting of Stockholders.
 
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Information required by this item is incorporated by reference from information contained under the section “Certain Relationships and Related Transactions” and “Director Independence” in our Proxy Statement for the Annual Meeting of Stockholders.
 
Item 14.
Principal Accounting Fees and Services
Information with respect to principal independent registered public accounting firm fees and services is incorporated by reference from the information under the caption “Proposal Two: Ratification of Appointment of Independent Registered Public Accounting Firm” in our Proxy Statement for the Annual Meeting of Stockholders.

35


PART IV
 
Item 15.
Exhibits, Financial Statement Schedules
(a)
The following documents are filed as part of this Annual Report on Form 10-K:
(1)
Financial Statements:
The financial statements are filed as part of this Annual Report on Form 10-K under “Item 8. Financial Statements and Supplementary Data.”
(2)
Financial Statement Schedules:
The financial statement schedules are omitted as they are either not applicable or the information required is presented in the financial statements and notes thereto under “Item 8. Financial Statements and Supplementary Data.”
(3)
Exhibits:
See Exhibit Index immediately following the signature page of this Annual Report on Form 10-K.

36


Item 16.
Form 10-K Summary

None.





37



NETFLIX, INC.
INDEX TO FINANCIAL STATEMENTS
 



38


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders of Netflix, Inc.


We have audited the accompanying consolidated balance sheets of Netflix, Inc. as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Netflix, Inc. at December 31, 2016 and 2015, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Netflix, Inc.’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) and our report dated January 27, 2017 expressed an unqualified opinion thereon.




 
/s/ Ernst & Young LLP
San Jose, California
 
January 27, 2017
 





39


NETFLIX, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
 
  
 
Year ended December 31,
  
 
2016
 
2015
 
2014
Revenues
 
$
8,830,669

 
$
6,779,511

 
$
5,504,656

Cost of revenues
 
6,029,901

 
4,591,476

 
3,752,760

Marketing
 
991,078

 
824,092

 
607,186

Technology and development
 
852,098

 
650,788

 
472,321

General and administrative
 
577,799

 
407,329

 
269,741

Operating income
 
379,793

 
305,826

 
402,648

Other income (expense):
 
 
 
 
 
 
Interest expense
 
(150,114
)
 
(132,716
)
 
(50,219
)
Interest and other income (expense)
 
30,828

 
(31,225
)
 
(3,060
)
Income before income taxes
 
260,507

 
141,885

 
349,369

Provision for income taxes
 
73,829

 
19,244

 
82,570

Net income
 
$
186,678

 
$
122,641

 
$
266,799

Earnings per share:
 
 
 
 
 
 
Basic
 
$
0.44

 
$
0.29

 
$
0.63

Diluted
 
$
0.43

 
$
0.28

 
$
0.62

Weighted-average common shares outstanding:
 
 
 
 
 
 
Basic
 
428,822

 
425,889

 
420,544

Diluted
 
438,652

 
436,456

 
431,894


See accompanying notes to consolidated financial statements.

40


NETFLIX, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
 
Year ended December 31,
 
2016
 
2015
 
2014
Net income
$
186,678

 
$
122,641

 
$
266,799

Other comprehensive loss:


 


 


Foreign currency translation adjustments 
(5,464
)
 
(37,887
)
 
(7,768
)
Change in unrealized gains (losses) on available-for-sale securities, net of tax of $126, $(598), and $(156), respectively
207

 
(975
)
 
(253
)
Total other comprehensive loss
(5,257
)
 
(38,862
)
 
(8,021
)
Comprehensive income
$
181,421

 
$
83,779

 
$
258,778


See accompanying notes to consolidated financial statements.

41


NETFLIX, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
  
 
Year Ended December 31,
  
 
2016
 
2015
 
2014
Cash flows from operating activities:
 
 
 
 
 
 
Net income
 
$
186,678

 
$
122,641

 
$
266,799

Adjustments to reconcile net income to net cash (used in) provided by operating activities:
 
 
 
 
 
 
Additions to streaming content assets
 
(8,653,286
)
 
(5,771,652
)
 
(3,773,019
)
Change in streaming content liabilities
 
1,772,650

 
1,162,413

 
593,125

Amortization of streaming content assets
 
4,788,498

 
3,405,382

 
2,656,279

Amortization of DVD content assets
 
78,952

 
79,380

 
71,491

Depreciation and amortization of property, equipment and intangibles
 
57,528

 
62,283

 
54,028

Stock-based compensation expense
 
173,675

 
124,725

 
115,239

Excess tax benefits from stock-based compensation
 
(65,121
)
 
(80,471
)
 
(89,341
)
Other non-cash items
 
40,909

 
31,628

 
15,282

Deferred taxes
 
(46,847
)
 
(58,655
)
 
(30,063
)
Changes in operating assets and liabilities:
 
 
 
 
 
 
Other current assets
 
46,970

 
18,693

 
(9,198
)
Accounts payable
 
32,247

 
51,615

 
83,812

Accrued expenses
 
68,706

 
48,810

 
55,636

Deferred revenue
 
96,751

 
72,135

 
58,819

Other non-current assets and liabilities
 
(52,294
)
 
(18,366
)
 
(52,406
)
Net cash (used in) provided by operating activities
 
(1,473,984
)
 
(749,439
)
 
16,483

Cash flows from investing activities:
 
 
 
 
 
 
Acquisition of DVD content assets
 
(77,177
)
 
(77,958
)
 
(74,790
)
Purchases of property and equipment
 
(107,653
)
 
(91,248
)
 
(69,726
)
Other assets
 
(941
)
 
(1,912
)
 
1,334

Purchases of short-term investments
 
(187,193
)
 
(371,915
)
 
(426,934
)
Proceeds from sale of short-term investments
 
282,484

 
259,079

 
385,300

Proceeds from maturities of short-term investments
 
140,245

 
104,762

 
141,950

Net cash provided by (used in) investing activities
 
49,765

 
(179,192
)
 
(42,866
)
Cash flows from financing activities:
 
 
 
 
 
 
Proceeds from issuance of debt
 
1,000,000

 
1,500,000

 
400,000

Issuance costs
 
(10,700
)
 
(17,629
)
 
(7,080
)
Proceeds from issuance of common stock
 
36,979

 
77,980

 
60,544

Excess tax benefits from stock-based compensation
 
65,121

 
80,471

 
89,341

Other financing activities
 
230

 
(545
)
 
(1,093
)
Net cash provided by financing activities
 
1,091,630

 
1,640,277

 
541,712

Effect of exchange rate changes on cash and cash equivalents
 
(9,165
)
 
(15,924
)
 
(6,686
)
Net (decrease) increase in cash and cash equivalents
 
(341,754
)
 
695,722

 
508,643

Cash and cash equivalents, beginning of year
 
1,809,330

 
1,113,608

 
604,965

Cash and cash equivalents, end of year
 
$
1,467,576

 
$
1,809,330

 
$
1,113,608

Supplemental disclosure:
 
 
 
 
 
 
Income taxes paid
 
$
26,806

 
$
27,658

 
$
50,573

Interest paid
 
138,566

 
111,761

 
41,085

Change in investing activities included in liabilities
 
27,504

 
(4,978
)
 
12,295

See accompanying notes to consolidated financial statements.

42


NETFLIX, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
 
 
 
As of December 31,
  
 
2016
 
2015
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
1,467,576

 
$
1,809,330

Short-term investments
 
266,206

 
501,385

Current content assets, net
 
3,726,307

 
2,905,998

Other current assets
 
260,202

 
215,127

Total current assets
 
5,720,291

 
5,431,840

Non-current content assets, net
 
7,274,501

 
4,312,817

Property and equipment, net
 
250,395

 
173,412

Other non-current assets
 
341,423

 
284,802

Total assets
 
$
13,586,610

 
$
10,202,871

Liabilities and Stockholders’ Equity
 
 
 
 
Current liabilities:
 
 
 
 
Current content liabilities
 
$
3,632,711

 
$
2,789,023

Accounts payable
 
312,842

 
253,491

Accrued expenses
 
197,632

 
140,389

Deferred revenue
 
443,472

 
346,721

Total current liabilities
 
4,586,657

 
3,529,624

Non-current content liabilities
 
2,894,654

 
2,026,360

Long-term debt
 
3,364,311

 
2,371,362

Other non-current liabilities
 
61,188

 
52,099

Total liabilities
 
10,906,810

 
7,979,445

Commitments and contingencies (Note 5)
 


 


Stockholders’ equity:
 
 
 
 
Preferred stock, $0.001 par value; 10,000,000 shares authorized at December 31, 2016 and 2015; no shares issued and outstanding at December 31, 2016 and 2015
 

 

Common stock, $0.001 par value; 4,990,000,000 shares authorized at December 31, 2016 and December 31, 2015, respectively; 430,054,212 and 427,940,440 issued and outstanding at December 31, 2016 and December 31, 2015, respectively
 
1,599,762

 
1,324,809

Accumulated other comprehensive loss
 
(48,565
)
 
(43,308
)
Retained earnings
 
1,128,603

 
941,925

Total stockholders’ equity
 
2,679,800

 
2,223,426

Total liabilities and stockholders’ equity
 
$
13,586,610

 
$
10,202,871


See accompanying notes to consolidated financial statements.

43


NETFLIX, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, except share data)
 
 
Common Stock and Additional Paid-in Capital
 
Accumulated
Other
Comprehensive Income (Loss)
 
Retained
Earnings
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
 
 
 
 
 
Balances as of December 31, 2013
417,249,007

 
$
777,501

 
$
3,575

 
$
552,485

 
$
1,333,561

Net income