NFLX 10-Q Quarter ended June 30, 2011

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

June 30, 2011 For the quarterly period ended June 30, 2011

OR

For the transition period from                    to

Commission File Number: 000-49802

Netflix, Inc.

(Exact name of Registrant as specified in its charter)

100 Winchester Circle, Los Gatos, California 95032

(Address and zip code of principal executive offices)

(408) 540-3700

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    YES x NO ¨

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 ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).     Yes ¨ No x

As of June 30, 2011, there were 52,536,246 shares of the registrant’s common stock, par value $0.001, outstanding.

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NETFLIX, INC.

(unaudited)

(in thousands, except per share data)

See accompanying notes to the consolidated financial statements.

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NETFLIX, INC.

(unaudited)

(in thousands, except share and par value data)

See accompanying notes to the consolidated financial statements.

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NETFLIX, INC.

(unaudited)

(in thousands)

See accompanying notes to the consolidated financial statements.

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NETFLIX, INC.

Notes to Consolidated Financial Statements

(unaudited)

1. Basis of Presentation and Summary of Significant Accounting Policies

The accompanying consolidated interim financial statements of Netflix, Inc. and its wholly owned subsidiaries (the “Company”) have been prepared in conformity with accounting principles generally accepted in the United States (“U.S.”) and are consistent in all material respects with those applied in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. Significant items subject to such estimates and assumptions include the amortization methodology of the Company’s content library, the valuation of stock-based compensation and the recognition and measurement of income tax assets and liabilities. The Company bases its estimates on historical experience and on various other assumptions that the Company believes to be reasonable under the circumstances. The actual results experienced by the Company may differ from management’s estimates.

The interim financial information is unaudited, but reflects all normal recurring adjustments that are, in the opinion of management, necessary to fairly present the information set forth herein. The interim financial statements should be read in conjunction with the audited financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 filed with the Securities and Exchange Commission (the “SEC”) on February 18, 2011. Interim results are not necessarily indicative of the results for a full year.

The Company is organized into two operating segments: Domestic (the United States) and International. See Note 10 for further information about the Company’s operating segments.

Certain prior period amounts have been reclassified to conform to current period presentation. These reclassifications did not impact total assets, total liabilities, stockholders’ equity, results of operations or cash flows.

There have been no material changes in the Company’s significant accounting policies as compared to the significant accounting policies described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

2. Net Income Per Share

Basic net income per share is computed using the weighted-average number of outstanding shares of common stock during the period. Diluted net income per share is computed using the weighted-average number of outstanding shares of common stock and, when dilutive, potential common shares outstanding during the period. Potential common shares consist of incremental shares issuable upon the assumed exercise of stock options, and for 2010, shares that were purchasable pursuant to the Company’s employee stock purchase plan (“ESPP”) using the treasury stock method. The computation of net income per share is as follows:

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Employee stock options with exercise prices greater than the average market price of the common stock during the period were excluded from the diluted calculation as their inclusion would have been anti-dilutive. The number of options excluded is immaterial for all periods presented.

3. Short-Term Investments and Fair Value Measurement

The Company’s investment policy is consistent with the definition of available-for-sale securities. The Company does not buy and hold securities principally for the purpose of selling them in the near future. The Company’s policy is focused on the preservation of capital, liquidity and return. From time to time, the Company may sell certain securities but the objectives are generally not to generate profits on short-term differences in price. The following table summarizes, by major security type, our assets that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy:

Fair value is a market-based measurement that should be determined based on the assumptions that market participants would use in pricing an asset or liability. The hierarchy level assigned to each security in the Company’s available-for-sale portfolio and cash equivalents is based on its assessment of the transparency and reliability of the inputs used in the valuation of such instrument at the measurement date. The fair value of available-for-sale securities and cash equivalents included in the Level 1 category is based on quoted prices that are readily and regularly available in an active market. The fair value of available-for-sale securities included in the Level 2 category is based on observable inputs, such as quoted prices for similar assets at the measurement date; quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly. These values were obtained from an independent pricing service and were evaluated using pricing models that vary by asset class and may incorporate available trade, bid and other market information and price quotes from well established independent pricing vendors and broker-dealers. Our procedures include controls to ensure that appropriate fair values are recorded such as comparing prices obtained from multiple independent sources. See Note 4 for further information regarding the fair value of the Company’s 8.50% senior notes.

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Because the Company does not intend to sell the investments that are in an unrealized loss position and it is not likely that the Company will be required to sell any investments before recovery of their amortized cost basis, the Company does not consider those investments with an unrealized loss to be other-than-temporarily impaired at June 30, 2011. There were no material other-than-temporary impairments or credit losses related to available-for-sale securities in the three or six months ended June 30, 2011 and 2010. In addition, there were no material gross realized gains or losses in the three or six months ended June 30, 2011 and 2010.

The estimated fair value of short-term investments by contractual maturity as of June 30, 2011 is as follows:

As of June 30, 2011, the Company had $200.0 million of long-term debt outstanding. The debt consists of $200.0 million aggregate principal amount of 8.50% senior notes due November 15, 2017 (the “Notes”). Interest on the Notes is payable semi-annually at a rate of 8.50% per annum on May 15 and November 15 of each year, commencing on May 15, 2010.

The Notes include, among other terms and conditions, limitations on the Company’s ability to create, incur, assume or be liable for indebtedness (other than specified types of permitted indebtedness); dispose of assets outside the ordinary course (subject to specified exceptions); acquire, merge or consolidate with or into another person or entity (other than specified types of permitted acquisitions); create, incur or allow any lien on any of its property or assign any right to receive income (except for specified permitted liens); make investments (other than specified types of investments); or pay dividends, make distributions, or purchase or redeem our equity interests (each subject to specified exceptions). At June 30, 2011 and December 31, 2010, the Company was in compliance with these covenants.

Based on quoted market prices, the fair value of the Notes as of June 30, 2011 and December 31, 2010 was approximately $224.5 million and $225.0 million, respectively.

5. Balance Sheet Components

Content Library, Net

Content library and accumulated amortization are as follows:

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Property and Equipment, Net

Property and equipment and accumulated depreciation are as follows:

Accounts Payable and Other Non-Current Liabilities

Accounts payable consisted of the following:

Other non-current liabilities consisted of the following:

The Company typically enters into multi-year licenses with studios and other distributors that may result in an increase in content library and a corresponding increase in accounts payable and other non-current liabilities. The payment terms for these license fees may extend over the term of the license agreement, which typically range from six months to five years. As of June 30, 2011, streaming content accounts payable and non-current streaming content liabilities increased $298.8 million and $203.1 million, respectively, as compared to December 31, 2010, due to the $804.9 million in additions to streaming content library.

6. Other Comprehensive Income

Comprehensive income was $68.5 million and $43.8 million for the three months ended June 30, 2011 and 2010, respectively. Comprehensive income was $128.6 million and $76.3 million for the six months ended June 30, 2011 and 2010, respectively. The primary difference between net income as reported and comprehensive income is unrealized gains and losses on available-for-sale securities, net of tax.

7. Stockholders’ Equity

Stock Repurchases

Under the current stock repurchase plan, announced on June 11, 2010, the Company is authorized to repurchase up to $300.0 million of its common stock through the end of 2012. During the three months ended June 30, 2011, the Company repurchased 216,000 shares at an average price of $238 per share for an aggregate amount of $51.4 million. As of June 30, 2011, $80.6 million of this authorization is remaining. The timing and actual number of shares repurchased will depend on various factors including price, corporate and regulatory requirements, debt covenant requirements, alternative investment opportunities and other market conditions.

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Shares repurchased by the Company are accounted for when the transaction is settled. As of June 30, 2011, there were no unsettled share repurchases. Shares repurchased and retired are deducted from common stock for par value and from additional paid-in capital for the excess over par value. If additional paid- in capital has been exhausted, the excess over par value is deducted from retained earnings. Direct costs incurred to acquire the shares are included in the total cost of the shares. For the three and six months ended June 30, 2011, $10.2 million and $33.1 million, respectively, were deducted from retained earnings related to share repurchases.

Stock-Based Compensation

A summary of the activity related to the Company’s stock option plans during the six months ended June 30, 2011 is as follows:

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between the Company’s closing stock price on the last trading day of the second quarter of 2011 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on June 30, 2011. This amount changes based on the fair market value of the Company’s common stock. Total intrinsic value of options exercised for the three months ended June 30, 2011 and 2010 was $49.3 million and $33.1 million, respectively. Total intrinsic value of options exercised for the six months ended June 30, 2011 and 2010 was $93.4 million and $55.9 million, respectively.

The following table summarizes the assumptions used to value stock option grants using the lattice-binomial model:

In the first and second quarters of 2011, the Company used a suboptimal exercise factor of 3.39 and 3.54, respectively, for executives and 2.17 and 2.22, respectively, for non-executives, resulting in a calculated expected life of the option grants of eight years for executives and five years for non-executives. In the first and second quarters of 2010, the Company used a suboptimal exercise factor of 2.15 and 2.30, respectively, for executives and 1.78 and 1.97, respectively, for non-executives, resulting in a calculated expected life of the option grants of five years for executives and four years for non-executives.

The weighted-average fair value of employee stock options granted during the three months ended June 30, 2011 and 2010 was $134.77 and $45.08 per share, respectively. The weighted-average fair value of employee stock options granted during the six months ended June 30, 2011 and 2010 was $122.16 and $35.24 per share, respectively.

The following table summarizes the assumptions used to value employee stock purchase rights for the offering period commencing in May 2010, using the Black Scholes option pricing model. There were no ESPP offerings in 2011, and the Company does not expect any future ESPP offerings.