2004 Annual Report

The joy of movies. 2004 ANNUAL REPORT . .the joy of Netflix. Netflix is the largest online movie rental subscription service, providing nearly 3 million subscribers access to more than 35,000 DVD titles of movies, television and filmed entertainment, spanning more than 200 genres. Our personalized recommendations and content-rich, uniquely customized website, make it easy for members to discover movies they will enjoy. We are the leader in the marketplace that we invented and we remain focused on providing the best online entertainment experience. Fast and free delivery. Netflix members enjoy free shipping both ways. Our proprietary logistics system includes 30 distribution centers throughout the United States, which allows us to provide more than 85 percent of our nearly 3 million subscribers with delivery of their DVDs within about one business day following shipment. 2004 ANNUAL REPORT Letter to Shareholders In our first annual report following our initial public offering in 2002 — a year in which our revenues doubled to $153 million and subscribers increased 88 percent to 857,000 — I told you that Netflix had experienced the type of rapid growth that many young companies promise, but few deliver. Today, I’m proud to report that we’ve sustained the rapid Reed Hastings growth we achieved as a newly public company two years ago. Chief Executive Officer, Since 2002, revenues and subscribers have more than tripled, President and Co-Founder to $506 million and 2.61 million subscribers, with revenues up 86 percent and subscribers up 76 percent in 2004. Moreover, we continued to far outdistance competitors in the market we invented, accounting for approximately 80 percent of all U.S. online movie rentals during 2004. After achieving our first net profit in 2003, GAAP net income more than tripled in 2004, reaching $21.6 million, and free cash flow increased 30 percent to $34.8 million. 2 [ REASONS TO LOVE NETFLIX ] Movies delivered at super spider speed. Spider-Man 2 has been rented by over 600,000 Netfl ix customers and is one of our top 50 movie rentals. Over 450,000 Netfl ix customers have rated the movie, with an average rating of 4 stars. [ REASONS TO LOVE NETFLIX ] Custom recommendations, whatever your taste. Mike Myers as Austin Powers in Goldmember. Other Austin Powers movies available through Netflix: International Man of Mystery and The Spy Who Shagged Me. Netflix carries 18 other Mike Myers titles and more than 50 different titles from the Saturday Night Live alumni. Personalized recommendations. We make it easier for members to find and discover movies they will enjoy. As members rate movies, our technology creates a customized, personal site based on each member’s movie tastes, which makes our titles more relevant and accessible to each subscriber. We have over 525 million ratings (and growing) in our database which enables us to continue to improve the efficiency with which we recommend films. Superior Product in a Great Market I stress this record of growth because 2004 was a year in which changes in the marketplace, including the entry of new and aggressive competition, made it easy to overlook some important facts: • The market for online rentals is strong and growing. In fact, it’s growing faster than even we had imagined, and the entrance of new players is accelerating that growth. • Netflix continues to succeed because we offer a superior product — the best service, the best inventory availability, and the most useful and engaging Web site — which has earned us the highest levels of customer satisfaction. Our results in 2004 clearly demonstrate that Netflix has built a business that our subscribers value for reasons beyond price, reflected in the fact that 95 percent of surveyed members say they would recommend Netflix to a friend. Let me talk about the market and our advantages in greater detail. First, the market. Market Dynamics Overall, online movie rentals in 2004 doubled to approximately $600 million, with an estimated total of 3.3 million subscribers, making it one of the fastest-growing large markets anywhere. That growth rate can’t last, but it shows no sign of slowing soon. Adams Media Research projects the number of online rental subscribers will approach 8 million by year-end 2006, which represents 60 percent growth each of the next two years. Not surprisingly, a $600 million market that is doubling year-over-year attracts serious competition. During 2004, Blockbuster aggressively launched its com- petitive service, and we anticipate additional entrants. Despite the competition’s aggressive pricing and substantial investment in marketing and operations, we achieved higher subscriber growth in 2004 than in 2003, and fourth-quarter 2004 subscriber churn was the lowest in our history. How were our subscriber retention and growth rates at record levels despite the aggressive competition? In part the answer, we believe, is that the entry of new competitors — and their incremental spending on marketing — helped to fuel consumer awareness of online rental, which, in turn, drove accelerated 5 35,000 titles and counting. Netflix provides a comprehensive DVD library of movie, television and other filmed entertainment titles, giving our members the best selection anywhere. Our collection is intelligently categorized, subcategorized, and cross-referenced, which combined with our personalized recommendations, helps members sort through the 35,000 titles to find the 35 best for them. market growth. As the saying goes, “A rising tide lifts all boats.” We invented the online DVD rental market, and we intend to remain its leader, but we believe this market can support multiple competitors. How large can this market become? Frankly, we don’t know, but our experience in the Oakland/San Jose/San Francisco metropolitan area gives an indication of its potential. Since we began offering our service there five years ago, our market penetration has reached 9 percent. Based on our own consistent year-over-year growth, we believe 20 percent household penetration rates are possible, and someday 20 million households in the U.S. may be renting movies online. The growth of the market reflects both convenience and the fact that online subscription rental is a phenomenal value, approximately 50 percent cheaper than the same store-based subscription rental. Imagine the market potential if an online car dealer sold cars for 50 percent less than the local bricks-and-mortar dealer. Our cost advantage is structural and unassailable. For example, it takes more than 500 video stores to serve the Los Angeles area, while we serve the same market with only one warehouse. The Netflix Advantage The reason we can both drive the growth of the market and be the primary beneficiary of this rapid growth is the clear superiority of our product. Simply put, Netflix continues to do online DVD rental better than anyone on the planet. Our success is directly attributable to the fact that online rental has been our sole passion for more than five years, and we have worked constantly to strengthen and improve every aspect of our operations. We have more distribution centers and better inventory availability than the competition. We have the most useful recommendation system anywhere, with more than 525 million movie ratings to help consumers sort through the 35,000 films we carry to find the 35 best for them. The result is that that we consistently deliver the best experience, keep our customers happy, and generate outrageously positive word-of-mouth advertising. And we continue to invest to provide greater value to our subscribers. Improve- ments in 2004 included the fourth-quarter launch of “Friends,” which allows consumers to share movie ratings and recommendations with their friends and 6 [ REASONS TO LOVE NETFLIX ] A monster movie selection. Boris Karloff as Frankenstein’s monster. Netflix has 23 movies inspired by Mary Shelley’s classic book, everything from the 1931 Karloff original to a 2004 production whose cast includes William Hurt and Donald Sutherland. Although this pales besides the 207 vampire titles we carry. Even werewolves do better with 49 titles. [ REASONS TO LOVE NETFLIX ] Share your favorites with your best terrestrials. E.T. the Extra-Terrestrial is the fourth highest grossing film of all time, with $453 million, in theatrical revenue. The other top five films are also all available through Netflix: Titanic (1), Star Wars Episode IV (2), Shrek 2 (3), and Star Wars Episode I (5). But Netflix’s top renting title, Mystic River, only grossed $90 million in U.S. theatrical revenue. Introducing Friends. Friends is our latest enhancement to the Netflix experience. It expands on the social nature of movies, allowing customers with the click of a button to share lists of their favorite movies, television and other filmed entertainment with select family and friends. family who are also Netflix subscribers. We think Friends has tremendous potential to redefine and expand the online movie proposition beyond simply selecting movies, to enable our subscribers to become heavily engaged with the social nature of movies… talking about movies, watching what your friends, parents and siblings are watching. The result is clear: The best keeps getting better. Maintaining Our Market Leadership 2004 was also a year in which we demonstrated our willingness to make hard choices — including lowering prices and deferring profitability — to protect our market leadership. We believe market share leadership is key to long-term category leadership. It is hard to predict what competitors will do, but no one should doubt our resolve to maintain our leadership or our financial ability to support that resolve. Our superior product, exceptional brand strength, and deep operational experience give us what we believe are the highest gross margin and the lowest operating costs in our business… attributes that strengthen our confidence in our ability to prevail over the competition.

Load more