SAN DIEGO, July 26, 2004
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— Scott + Scott, LLC a U.S. law firm based in Connecticut with offices in Ohio and California (http://www.scott-scott.com ), announces that it has filed a complaint in the Northern District of California against Netflix, Inc. (“Netflix”) (Nasdaq: NFLX – News) for alleged acts in violation of U.S. securities fraud laws. You can contact Scott + Scott, LLC at 800/404-7770 (EDT) or 800/332-2259 (PDT); you can also dial direct at 860/537-3818 in Connecticut or 619/233-4565 in California. Those who purchased securities in Netflix can contact the firm to further discuss this matter.
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The complaint alleges that, between October 1, 2003, and July 15, 2004 (the Class Period), Netflix and its CEO Reed Hastings, CFO Barry McCarthy and Chief Marketing Officer Leslie Kilgore failed to disclose the number of subscriber cancellations being suffered by the Company, even as they repeatedly touted the large number of new subscribers being added to the Company’s subscriber base.
The complaint further alleges that they also consistently understated the Company’s churn rate (the percentage of its subscribers that cancelled per month). Netflix achieved this by using an improper calculation of the rate that produced an artificially low churn rate in quarters in which the Company was adding substantial numbers of new subscribers.
The standard definition of churn rate (and the definition used by other publicly-traded companies that report churn rate such as Sprint and Nextel Partners) is “the percentage of participants who discontinue their use of a service divided by the average number of total participants during a given period of time.” Netflix instead divided canceling subscribers by subscribers at the beginning of the period plus subscriber additions.
Because beginning subscribers plus new subscribers were consistently a larger number than average subscribers throughout the Class Period, the Company reported an artificially low churn rate throughout the Class Period by erasing the effect that canceling subscribers had on average subscribers during each period.
Moreover, it is alleged that the Company repeatedly made statements throughout the Class Period that its churn rate was declining to “record lows,” when in fact in some of these quarters its churn rate was markedly rising. For example, in the third quarter of 2003, Netflix claimed that its churn rate had reached a new record low of 5.2% when in fact its churn rate had risen from 7% to 7.7% during the quarter.
Disclosure of actual subscriber cancellations and the actual churn rate was critically important for investors analyzing the Company’s prospects and the potential of its business model. The Company spends approximately $35 in marketing expense to acquire each new subscriber. Had investors known that the Company was being forced continuously to replenish its subscriber base through additional marketing expenditures; it would have called into question the potential long-term profitability of the Company and the viability of its business model. In other words, the Company’s artificially low claimed churn rate obscured the fact that it was not retaining many subscribers long enough to break even on them.
The truth came to light when, after the market closed on July 15, 2004, the Company issued an earnings release which, for the first time, disclosed the number of subscriber cancellations during previous quarters. Specifically, the press release stated that, while the Company had added 537,000 new subscribers during the second quarter, it had suffered 422,000 subscriber cancellation, meaning 72% of the Company’s 583,000 new subscribers in the second quarter of 2004 had merely replaced subscribers who had cancelled. The release also showed that 41% of the Company’s 760,000 new subscribers in the second quarter had merely replaced subscribers who had cancelled, and 71% of the Company’s 327,000 new subscribers in the second quarter of 2003 had merely replaced subscribers who had cancelled.
In response, Netflix shares declined from $32 per share to $20 per share over the next two days, a decline of 38%. During the Class Period, the shares had traded as high as $39.77 per share, during which period Hastings, McCarthy and Kilgore sold approximately $13 million in Netflix shares.
Netflix, Inc. is an online movie rental subscription service in the United States, providing more than 2 million subscribers access to a library of movies, television and other filmed entertainment titles. For the standard subscription plan, subscribers can rent as many DVDs as they want, with three movies out at a time, and keep them for as long as they like. There are no due dates and no late fees. Subscribers select titles at the Company’s Netflix Website receive them on DVD by first-class mail and return them to Netflix at their convenience using prepaid mailers. Netflix also provides information on DVD movies, including critic reviews, member reviews, online trailers, ratings and personalized movie recommendations.
Scott + Scott, LLC, a Connecticut-based law firm with offices in Ohio and California, is a law firm with a national practice and reputation. Scott + Scott has dedicated itself to client communication and satisfaction. The firm is currently litigating major securities, antitrust and employee retirement plan cases throughout the United States and represents pension funds, charities, foundations, individuals and other entities worldwide — in both class and non-class cases. Please visit our website at http://www.scott- scott.com to learn more about the firm, its practice and other cases. If you wish to discuss this action with an attorney or have any questions concerning this notice, your rights or any matter within our expertise, please contact attorney Neil Rothstein at nrothstein@scott- scott.com or by calling 1/800- 404-7770 (EDT) or 1/800-332-2259 (PDT). You can dial direct in California at 1/619-233-4565. Scott + Scott, LLC is located at 108 Norwich Avenue, Colchester, CT 06415; phone: 860/537-3818; fax: 860/537- 4432. This release is issued in accordance with the applicable federal law of the United States. Other cases recently filed or under investigation by the firm include Seagate, Commerce Bancorp, Cardinal Health, KVH Industries, Red Hat, Yukos Oil, Washington Mutual Inc. and more.