Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws. These forward-looking statements include, but are not limited to statements regarding: our core strategy, net subscriber additions, contribution margins, both domestically and internationally, international expansion, DVD and streaming subscriber trends, consolidated revenues, profitability, content payments and expense, free cash flow, deferred tax assets, stock repurchases and future contractual obligations. These forward-looking statements are subject to risks and uncertainties that could cause actual results and events to differ materially from those included in forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in our Annual Report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission ("SEC") on February 10, 2012, in particular the risk factors discussed under the heading "Risk Factors" in Part I, Item IA.

We assume no obligation to revise or publicly release any revision to any forward-looking statements contained in this Quarterly Report on Form 10-Q, unless required by law.

Overview

We are the world's leading Internet subscription service for enjoying TV shows and movies. Our subscribers can instantly watch as many TV shows and movies as they want, streamed over the Internet to their TVs, computers and mobile devices. Additionally, in the U.S., our subscribers can receive standard definition DVDs, and their high definition successor, Blu-ray discs (collectively referred to as "DVD"), delivered quickly to their homes.

Our core strategy is to grow our streaming subscription business domestically and globally. We are continuously improving the customer experience, with a focus on expanding our streaming content, enhancing our user interface and extending our streaming service to even more Internet-connected devices, while staying within the parameters of our consolidated net income (loss) and operating segment contribution profit (loss) targets. Contribution profit (loss) is defined as revenue less cost of revenues and marketing expenses.

We are a pioneer in the Internet delivery of TV shows and movies, launching our streaming service in 2007. Since this launch, we have developed an ecosystem of Internet-connected devices and have licensed increasing amounts of content that enable consumers to enjoy TV shows and movies directly on their TV's, computers and mobile devices. As a result of these efforts, we have experienced growing consumer acceptance of and interest in the delivery of TV shows and movies directly over the Internet. We believe that the DVD portion of our domestic service will be a fading differentiator to our streaming success. Historically, our acquisition of new subscriptions has been seasonal with the first and fourth quarters representing our strongest net subscription additions and our second quarter representing the lowest net subscription additions in a calendar year.

Prior to July 2011, in the U.S., our streaming and DVDs-by-mail operations were combined and subscribers could receive both streaming content and DVDs under a single "hybrid" plan. In July 2011, we introduced DVD only plans and separated the combined plans, making it necessary for subscribers who wish to receive both streaming services and DVDs-by-mail to have two separate subscription plans. This resulted in a price increase for our members who were taking a hybrid plan. We made a subsequent announcement during the third quarter of 2011 concerning the rebranding of our DVDs-by-mail service and the separation of the DVDs-by-mail and streaming websites. The consumer reaction to the price change, and to a lesser degree, the branding announcement, was very negative leading to significant customer cancellations. We subsequently retracted our plans to rebrand our DVDs-by-mail service and separate the DVDs-by-mail and streaming websites.

In September 2010, we began international operations by offering our streaming service in Canada. In September 2011, we expanded our streaming service to Latin America and the Caribbean. In January 2012, we launched our streaming service in the United Kingdom ("U.K.") and Ireland. We anticipate significant contribution losses in the International streaming segment in 2012. In April 2012, we announced that we anticipated expanding our International operations to another market in the fourth quarter of 2012.

As a result of the changes to our pricing and plan structure, we no longer offer a single subscription plan including both DVDs-by-mail and streaming in the U.S. Domestic subscribers who wish to receive DVDs-by-mail and watch streaming content must elect both a DVDs-by-mail subscription plan and a streaming subscription plan. Accordingly, beginning with the third quarter of 2011, management views the number of paid subscriptions as the key driver of revenues. The following metrics reflect these changes.

                                                         As of /Three Months Ended,
                                                 March 31,       December 31,     March 31,
                                                    2012             2011           2011
                                                               (in thousands)
Domestic streaming:
Net additions                                       1,739                223
Paid subscriptions at end of period                22,022             20,153
Total subscriptions at end of period               23,410             21,671
International streaming:
Net additions                                       1,207                378           294
Paid subscriptions at end of period                 2,409              1,447           674
Total subscriptions at end of period                3,065              1,858           803
Domestic DVD:
Net losses                                         (1,076 )           (2,763 )
Paid subscriptions at end of period                 9,958             11,039
Total subscriptions at end of period               10,089             11,165
Total domestic:
Net unique subscriber additions during period       1,679                606         3,296
(1)
Total domestic unique subscribers at end of        26,074             24,395        22,797
period (1)
Consolidated:
Net unique subscriber additions during period       2,886                984         3,590
(1)
Paid unique subscribers at end of period (1)       27,083             24,305        22,079
Total unique subscribers at end of period (1)      29,139             26,253        23,600

(1) For purposes of determining the number of unique subscribers, domestic subscribers who have elected both a DVD and a streaming subscription plan are considered a single unique subscriber.

The following represents our consolidated performance highlights:

                                                   Three Months Ended                            Change
                                      March 31,         December 31,      March 31,      Q1'12 vs.     Q1'12 vs.
                                         2012               2011             2011          Q4'11         Q1'11
                                          (in thousands, except per share data)
Revenues                            $   869,791       $      875,575     $  718,553         (0.7 )%       21.0  %
Operating income (loss)                  (1,935 )             61,872        102,240       (103.1 )%     (101.9 )%
Net income (loss)                        (4,584 )             35,219         60,233       (113.0 )%     (107.6 )%
Net income (loss) per share-diluted       (0.08 )               0.64           1.11       (112.5 )%     (107.2 )%
Free cash flow (2)                        2,149               33,921         79,303        (93.7 )%      (97.3 )%

(2) See "Liquidity and Capital Resources" for a definition of "free cash flow" and a reconciliation of "net cash provided by operating activities" to "free cash flow."

Domestic streaming subscriptions increased 8% from December 31, 2011 to March 31, 2012. Net subscription additions are expected to be seasonally low in the second quarter of 2012, increasing in the third and fourth quarters. Our contribution margin for the Domestic streaming segment was 13.1% for the first quarter of 2012, up from 10.9% in the fourth quarter of 2011, and we expect further contribution margin expansion.
International streaming subscriptions increased 65% from December 31, 2011 to March 31, 2012 and account for 12% of total streaming subscriptions at the end of the first quarter. In the first quarter of 2012, our International streaming segment reported a contribution loss of $102.7 million. The $42.9 million increase in the contribution loss as compared to the fourth quarter of 2011 is primarily due to our expansion to the U.K. and Ireland in January 2012. We expect a continued contribution loss in our International streaming segment as we launch additional international markets, the next of which is planned for the fourth quarter of 2012.
DVD subscriptions decreased 10% from December 31, 2011 to March 31, 2012, due to cancellations during the quarter. We expect

continued decreases in the number of DVD subscriptions which will offset the growth in domestic and consolidated revenues expected from streaming subscription increases. Domestic DVD contribution margins are expected to be relatively flat in coming quarters.
Consolidated revenues for the first quarter of 2012 were flat as compared to the fourth quarter of 2011 and consolidated net income (loss) decreased by 113.0% to a consolidated net loss of $4.6 million. We expect consolidated revenues to increase at a modest pace sequentially in future quarters driven by the growth in global streaming subscriptions and partially offset by a decline in domestic
DVD. We believe that the consolidated net loss will decline in the second quarter of 2012 and we may be at or near consolidated net income. Future investments in new international markets, such as that which we have planned to launch in the fourth quarter of 2012, may result in future consolidated net losses. Free cash flow for the three months ended March 31, 2012 decreased as compared to the three months ended December 31, 2011 to $2.1 million. Free cash flow was $6.7 million higher than the net loss of $4.6 million, primarily due to non-cash expenses related to stock-based compensation, depreciation expense associated with our property and equipment, and accrued interest expense for our 8.50% Notes, partially offset by differences between the cash payments for taxes and the benefit for income tax and the excess streaming and DVD content payments over expense. The excess streaming and DVD content payments over expense will continue to fluctuate over time based on new content licenses domestically and internationally and in particular may increase as a result of higher up-front cash requirements for original content. We expect that free cash flow in future periods will be negatively impacted by investments in new international markets and the cash requirements for original content and that we may use cash in 2012.

Results of Operations
The following table sets forth, for the periods presented, the line items on 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
consolidated financial statements, notes to the consolidated financial
statements and the entirety of this Management's Discussion and Analysis of
Financial Condition and Results of Operations.

                                                Three Months Ended
                                     March 31,     December 31,    March 31,
                                        2012           2011           2011
Revenues                               100.0  %       100.0  %       100.0  %
Cost of revenues:
Subscription                            64.8  %        58.6  %        52.5  %
Fulfillment expenses                     6.9  %         7.1  %         8.5  %
Total cost of revenues                  71.7  %        65.7  %        61.0  %
Operating expenses:
Marketing                               15.6  %        13.1  %        14.5  %
Technology and development               9.5  %         9.2  %         7.1  %
General and administrative               3.4  %         3.9  %         3.2  %
Legal settlement                           -  %         1.0  %           -  %
Total operating expenses                28.5  %        27.2  %        24.8  %
Operating income (loss)                 (0.2 )%         7.1  %        14.2  %
Other income (expense):
Interest expense                        (0.6 )%        (0.6 )%        (0.7 )%
Interest and other income (expense)        -  %           -  %         0.2  %
Income (loss) before income taxes       (0.8 )%         6.5  %        13.7  %
Provision (benefit) for income taxes    (0.3 )%         2.5  %         5.3  %
Net income (loss)                       (0.5 )%         4.0  %         8.4  %

Revenues
We derive our revenues from monthly subscription fees and recognize subscription revenues ratably over each subscriber's monthly subscription period. We currently generate substantially all of our revenues in the U.S.
In the Domestic streaming segment, we derive revenues from services consisting solely of streaming content offered through a subscription plan priced at $7.99 per month. In the Domestic DVD segment, we derive revenues from our DVDs-by-mail subscription services. The price per plan for DVDs-by-mail varies from $7.99 to $43.99 per month based on the number of DVDs that a subscriber may have out at any given point. Customers electing access to high definition Blu-ray discs in addition to standard definition DVDs pay a surcharge ranging

from $2 to $4 per month for our most popular plans.
In July 2011, in the U.S., we introduced DVD only plans and separated DVDs-by-mail and streaming making it necessary for subscribers who opt to receive both DVDs-by-mail and streaming to have two separate subscription plans. As subscribers were able to receive both streaming and DVDs-by-mail under a single hybrid plan prior to the fourth quarter of 2011, it is impracticable to allocate revenues to the Domestic streaming and Domestic DVD segments prior to the fourth quarter of 2011.
In the International streaming segment, we derive revenues from services consisting solely of streaming content offered through a subscription plan priced at approximately the equivalent of USD7.99 per month. In September 2010, we began international operations in Canada. We expanded to Latin America and the Caribbean in September 2011 and the U.K. and Ireland in January 2012.

Three months ended March 31, 2012 as compared to the three months ended March 31, 2011 (1)

                     Three Months Ended             Change
                   March 31,         March 31,    Q1'12 vs.
                     2012              2011         Q1'11
                    (in thousands, except percentages)
Revenues      $     869,791         $  718,553        21.0 %
Domestic            826,366            706,274        17.0 %
International        43,425             12,279       253.7 %

(1) Presented using the Company's segment reporting prior to the fourth quarter of 2011. The $151.2 million increase in our consolidated revenues was due to the $120.1 million increase in domestic revenues and a $31.1 million increase in international revenues. Domestic revenues increased 17.0% as a result of the 20.8% growth in the domestic average number of unique paying subscribers driven by new streaming subscriptions. This increase was offset in part by a 3.2% decline in domestic average monthly revenue per unique paying subscriber, resulting from the popularity of the streaming subscription and a decline in the percentage of unique paying subscribers electing both a streaming and a DVD subscription. During the three months ended March 31, 2012, 87.8% of our new gross domestic unique subscribers chose only a streaming subscription compared to 54.4% in the three months ended March 31, 2011. As of March 31, 2012, only 28.5% of our domestic unique subscribers had both a streaming and DVD subscription compared to 81.4% as of March 31, 2011. International revenues increased by $31.1 million primarily due to our launch in Latin America and the Caribbean in September 2011 and our launch in the U.K. and Ireland in January 2012. Three months ended March 31, 2012 as compared to the three months ended

December 31, 2011

                              Three Months Ended           Change
                         March 31,      December 31,     Q1'12 vs.
                            2012            2011           Q4'11
                            (in thousands, except percentages)
Revenues                $   869,791    $      875,575       (0.7 )%
Domestic streaming          506,665           476,334        6.4  %
International streaming      43,425            28,988       49.8  %
 Domestic DVD               319,701           370,253      (13.7 )%

The $5.8 million decrease in our consolidated revenues was primarily a result of the 15.5% decrease in the number of average paying DVD subscriptions offset by a 58.3% increase in the average number of paying international subscriptions coupled with a 3.7% increase in the average number of paying domestic streaming subscriptions.
We expect the streaming subscription plans offered both domestically and internationally to continue to grow as a percentage of our total paid subscriber base. We expect that as a result of the increase in streaming subscription plans both domestically and internationally partially offset by declines in DVD subscriptions, consolidated revenues will increase at a modest pace sequentially in future quarters.

Cost of Revenues

Cost of revenues consists of cost of subscription revenues and fulfillment expenses.

Cost of subscription revenues consists of expenses related to the acquisition and licensing of content, as well as content delivery costs related to providing streaming content and shipping DVDs to subscribers. Costs related to free-trial periods are allocated to marketing expenses.

Content acquisition and licensing expenses consist primarily of amortization of streaming content licenses, which may or may not be recognized in the streaming content library, amortization of DVD content library and revenue sharing expenses. We obtain content through streaming content license agreements, DVD direct purchases and DVD revenue sharing agreements with studios, distributors and other suppliers. Content agreements are made in the ordinary course of business and our business is not substantially dependent on any particular agreement.

Content delivery expenses consist of the postage costs to mail DVDs to and from our paying subscribers, the packaging and label costs for the mailers and all costs associated with delivering streaming content over the Internet. We utilize third-party content delivery networks to help us efficiently stream content in high volume to our subscribers over the Internet.

Fulfillment expenses represent those expenses incurred in content processing including operating and staffing our shipping centers as well as receiving, encoding, inspecting and warehousing our content library. Fulfillment expenses also include operating and staffing our customer service centers and credit card fees.

Three months ended March 31, 2012 as compared to the three months ended

March 31, 2011

                                  Three Months Ended           Change
                               March 31,        March 31,    Q1'12 vs.
                                 2012             2011         Q1'11
                                (in thousands, except percentages)
Total cost of revenues      $    623,933       $ 438,151         42.4 %
As a percentage of revenues         71.7 %          61.0 %

The $185.8 million increase in cost of revenues was primarily due to the following factors:
• Content acquisition and licensing expenses increased by $234.6 million. This increase was primarily attributable to continued investments in existing and new streaming content available for viewing to our domestic subscribers. The increase is also partially attributable to an increase in streaming content titles available in our International locations.

• Content delivery expenses decreased $47.5 million primarily due to a 41.8% decrease in the number of DVDs mailed for paid subscriptions. The decrease in DVD delivery expenses was partially offset by an increase in costs associated with our use of third-party delivery networks resulting from an increase in the total number of hours of streaming content viewed by our subscribers.

Three months ended March 31, 2012 as compared to the three months ended

December 31, 2011

                                  Three Months Ended           Change
                             March 31,      December 31,     Q1'12 vs.
                                2012            2011           Q4'11
                                (in thousands, except percentages)
Total cost of revenues      $  623,933     $     575,155          8.5 %
As a percentage of revenues       71.7 %            65.7 %

The $48.8 million increase in cost of revenues was primarily due to the following factors:

• Content acquisition and licensing expenses increased by $55.2 million. This increase was primarily attributable to an increase in streaming content titles available in our International locations. The increase is also partially attributed to continued investments in existing and new streaming content available for viewing to our domestic subscribers.

• Content delivery expenses decreased $3.8 million primarily due to a 6.0% decrease in the number of DVDs mailed for paid subscriptions. The decrease in the number of DVDs mailed was driven by a 15.5% decline in the number of average paying DVD subscriptions offset by an 11.2% increase in monthly DVD rentals per average paying DVD subscriber. The decrease in DVD delivery expenses was partially offset by an increase in costs associated with our use of third-party delivery networks resulting from

an increase in the total number of hours of streaming content viewed by our subscribers.

Marketing
Marketing expenses consist primarily of advertising expenses and also include
payments made to our affiliates and consumer electronics partners and payroll
related expenses. Advertising expenses include promotional activities such as
television and online advertising as well as allocated costs of revenues
relating to free trial periods. Payments to our affiliates and consumer
electronics partners may be in the form of a fixed-fee or may be a revenue
sharing payment.

Three months ended March 31, 2012 as compared to the three months ended
March 31, 2011

                                  Three Months Ended           Change
                               March 31,        March 31,    Q1'12 vs.
                                 2012             2011         Q1'11
                                (in thousands, except percentages)
Marketing                   $    135,900       $ 104,259         30.3 %
As a percentage of revenues         15.6 %          14.5 %

The $31.6 million increase in marketing expenses was primarily due to a $35.3 million increase in marketing program spending primarily in television and online advertising due to our launch in Latin America and the Caribbean and in the U.K. and Ireland. These increases were partially offset by a decrease in direct mail marketing.
Three months ended March 31, 2012 as compared to the three months ended

December 31, 2011

                                  Three Months Ended           Change
                             March 31,      December 31,     Q1'12 vs.
                                2012            2011           Q4'11
                                (in thousands, except percentages)
Marketing                   $  135,900     $     114,288         18.9 %
As a percentage of revenues       15.6 %            13.1 %

The $21.6 million increase in marketing expenses was primarily due to a $19.5 million increase in marketing program spending primarily in online advertising due to our launch in the U.K. and Ireland in January 2012.

Technology and Development
Technology and development expenses consist of payroll and related costs
incurred in making improvements to our service offering, including testing,
maintaining and modifying our user interface, our recommendation and
merchandising technology, as well as, telecommunications systems and
infrastructure and other internal-use software systems. Technology and
development expenses also include costs associated with computer hardware and
software.

Three months ended March 31, 2012 as compared to the three months ended
March 31, 2011

                                  Three Months Ended           Change
                               March 31,        March 31,    Q1'12 vs.
                                 2012             2011         Q1'11
                                (in thousands, except percentages)
Technology and development  $     82,801       $  50,905         62.7 %
As a percentage of revenues          9.5 %           7.1 %

The $31.9 million increase in technology and development expenses was primarily the result of a $26.2 million increase in personnel-related costs, including a $5.3 million increase in stock-based compensation. This increase in personnel-related costs is due to a 58% growth in average headcount supporting continued improvements in our streaming service and our international expansion.

Three months ended March 31, 2012 as compared to the three months ended December

31, 2011
                                  Three Months Ended           Change
                              March 31,      December 31,    Q1'12 vs.
                                2012             2011          Q4'11
                                (in thousands, except percentages)
Technology and development  $    82,801     $     80,783          2.5 %
As a percentage of revenues         9.5 %            9.2 %

Technology and development expenses were relatively flat as compared to the prior period.

General and Administrative
General and administrative expenses consist of payroll and related expenses for
. . .