as well as an increase in DVD revenue sharing costs.



The increase in cost of subscription revenues in absolute dollars for 2007 as compared to 2006 was primarily attributable to the following factors:

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The number of DVDs mailed to paying subscribers increased 20%. This was driven by a 32% increase in the number of average paying subscribers, partially offset by a decline in monthly movie rentals per average paying subscriber attributed to the continued growth of our lower priced plans.

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Postage and packaging expenses increased by 24%. This was primarily attributable to the increase in the number of DVDs mailed to paying subscribers, as well as an increase in the rate of first class postage of 2 cents in May 2007.



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Content expenses increased by 26%. This increase was primarily attributable to the increased acquisition of DVD library with the remaining increase attributable to the investment in streaming content as we introduced Internet delivery of content in January 2007.

The increase in fulfillment expenses in absolute dollars in 2008 as compared to 2007, and 2007 as compared to 2006, was primarily attributable to an increase in personnel-related costs resulting from the higher volume of activities in our shipping centers and customer service location, coupled with higher credit card fees as a result of the growth in the average number of paying subscribers. In addition, the increase in fulfillment expenses was attributable to an increase in facility-related costs resulting from the addition of new shipping centers, and for 2007, the expansion of our customer service center.

Gross Margin

The decrease in gross margin in 2008 as compared to 2007, and 2007 as compared to 2006, was primarily due to an increase in postage rates effective May 2008 and 2007 and a reduction in the prices of our most popular subscription plans during the second half of 2007. In addition, costs related to our streaming content have been included in cost of subscriptions beginning January 2007.

We anticipate that gross margin will decline in 2009, due to increased investment in content library coupled with an expected increase in postage rates effective May 2009.

Operating Expenses

Technology and Development

The increase in technology and development expenses in absolute dollars for 2008 as compared to 2007 was primarily the result of an increase in personnel-related costs due to growth in headcount and expenses related to the development of solutions for streaming content and continued improvements to our service.

The increase in technology and development expenses in absolute dollars for 2007 as compared to 2006 was primarily the result of an increase in personnel-related costs due to growth in headcount and expenses related to the development of solutions for streaming content.

The decrease in marketing expenses in absolute dollars in 2008 as compared to 2007 was primarily attributable to a decrease in marketing program spending, principally in direct mail and inserts. In the second half of 2007, we lowered prices on our most popular subscription plans and decided to partially offset the cost of our investment in lower prices by