2010



Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

With 20 million subscribers as of December 31, 2010, we are the world’s leading Internet subscription service for enjoying TV shows and movies. Our subscribers can instantly watch unlimited TV shows and movies streamed over the Internet to their TVs, computers and mobile devices and, in the United States, subscribers can also receive DVDs delivered quickly to their homes.

Our core strategy is to grow our streaming subscription business within the United States and globally. We are continuously improving the customer experience, with a focus on expanding our streaming content, enhancing our user interfaces, and extending our streaming service to even more Internet-connected devices, while staying within the parameters of our operating margin targets.

By continuously improving the customer experience, we believe we drive additional subscriber growth in the following ways:

 

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Additional subscriber growth enables us to obtain more content, which in turn drives more subscriber growth.



 

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Additional subscriber growth leads to greater word-of-mouth promotion of our service, which in turn leads to more subscriber growth at an increasingly cost-effective marketing spend.



 

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Additional subscriber growth enables us to invest in further improvements to our service offering, which in turn leads to more subscriber growth.

The increase in total subscribers, as well as the acceleration in our net subscriber additions, has fueled the significant growth in our revenues. These increases are offset partially by a reduction in the average revenue per paying subscriber which reflects the popularity of our lower priced plans.

In 2010, we passed a significant milestone with the majority of our subscribers viewing more of their TV shows and movies via streaming than by DVD. Streaming hours are currently growing faster than DVD hours and while DVD shipments have grown 9.7% in 2010, we expect shipments will be flat to declining in future periods.

In September 2010, we began international operations by offering an unlimited streaming plan without DVDs in Canada. Substantially all of our revenues, operating income and net income are still generated in the United States; however initial results from our Canada expansion indicate positive operating margins may be achieved during 2011. As a result of this early success, we anticipate further international expansion into additional markets in the second half of 2011 and will manage our business going forward with two distinct operating segments: United States and International. In 2011 operating margins for the United States are expected to increase, while international operating margins are expected to be negative as we invest in our international operations.

Results of Operations

The following table sets forth, for the periods presented, the line items in our consolidated statements of operations as a percentage of total revenues. The information contained in the table below should be read in conjunction with the financial statements and notes thereto included in Item 8,