Overview

We are the world's leading Internet television network with more than 33 million members in over 40 countries enjoying more than one billion hours of TV shows and movies per month, including original series. For one low monthly price, our members can watch as much as they want, anytime, anywhere, on nearly any Internet-connected screen. 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.

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 for Internet-connected devices and have licensed increasing amounts of content that enable consumers to enjoy TV shows and movies directly on their TVs, 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. 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.

Results of Operations
The following represents our consolidated performance highlights for the years ended December 31:

                                   2012              2011            2010                     Change
                                   (in thousands, except per share data)          2012 vs. 2011     2011 vs. 2010
Revenues                     $    3,609,282      $ 3,204,577     $ 2,162,625           13  %              48 %
Contribution profit                 498,687          762,038         511,431          (35 )%              49 %
Operating income                     49,992          376,068         283,641          (87 )%              33 %
Net income                           17,152          226,126         160,853          (92 )%              41 %
Diluted earnings per share             0.29             4.16            2.96          (93 )%              41 %
Free cash flow (1)                  (58,151 )        186,550         131,007           NM                 42 %

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

Consolidated revenues for 2012 increased as compared to prior years due to growth in streaming subscriptions. Operating income and Net income in 2012 both declined as compared to prior year reflective of increases in both cost of revenues due to streaming content investments and marketing to support our launch into new International markets.
Free cash flow for the year ended December 31, 2012 decreased $244.7 million as compared to 2011 to negative $58.2 million. Significant uses of cash in the year were cash payments for content (in excess of the expense), and cash payments related to income taxes. These uses of cash were partially offset by net income excluding the impact of non-cash stock compensation and deferred revenue. We expect excess content payments over expense to continue to fluctuate over time both domestically and internationally. Payment terms for certain streaming licenses, especially programming that initially airs in the

applicable territory on our service ("original programming") or that is considered output content, will typically require more up-front cash payments than other licensing agreements. Due to the expected receipt timing of original programming content, content cash payments in excess of expense and free cash flow will be materially more negative in the first quarter of 2013 as compared to the fourth quarter of 2012, but free cash flow is expected to improve in subsequent quarters.

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. 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 and expenses to the Domestic streaming and Domestic DVD segments prior to the fourth quarter of 2011.

Our core strategy is to grow a streaming subscription business domestically and internationally. 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. As we grow our streaming subscription segments, we have shifted spending away from the Domestic DVD segment to invest more in streaming content and marketing our streaming services.

• We define contribution profit as revenues less cost of revenues and marketing expenses. We believe this is an important measure of our operating segment performance.

• For the Domestic and International streaming segments, content licensing expenses, which includes the amortization of the streaming content library and other expenses associated with the licensing of streaming content, represent the vast majority of cost of revenues. Streaming content rights are generally specific to a geographic region and accordingly our international expansion will require us to obtain additional streaming content licenses to support new international markets. Other cost of revenues such as content delivery expenses, customer service and payment card fees tend to be lower as a percentage of total cost of revenues. We utilize both our own and third-party content delivery networks to help us efficiently stream content in high volume to our subscribers over the Internet. Content delivery expenses therefore also include equipment costs related to Open Connect and all third-party costs associated with delivering streaming content over the Internet. Cost of revenues in the Domestic DVD segment consists primarily of expenses related to the acquisition of content including amortization of DVD content library and revenue sharing expenses, content delivery and other expenses associated with our DVD processing and customer service centers. Content delivery expenses for the Domestic DVD segment consist of the postage costs to mail DVDs to and from our paying subscribers and the packaging and label costs for the mailers.

• For the Domestic and International streaming segments, marketing expenses consist primarily of advertising expenses and payments made to our affiliates and consumer electronics partners and also include 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. Marketing costs as a percentage of revenues are higher for the Domestic and International streaming segments given our focus on building consumer awareness of the streaming offerings. Marketing costs are immaterial for the Domestic DVD segment.

• As a result of our focus on growing the streaming segments, contribution margins for the Domestic and International streaming segments are lower than for our Domestic DVD segment. Also impacting the Domestic streaming segment was a loss of subscribers resulting from the negative consumer reaction to the pricing and plan changes announced in July 2011. We expect that the investments in content and marketing associated with the Domestic and International streaming segments will slow relative to revenues to allow for contribution margin expansion over time.

Domestic Segments


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                                 As of /Year Ended December 31,         Change
                                     2012               2011         2012 vs. 2011
                                       (in thousands, except percentages)
Subscriptions:
Domestic Streaming
Net additions                           5,475                             n/a
Subscriptions at end of
period                                 27,146            21,671            25  %
Paid subscriptions at end
of period                              25,471            20,153            26  %

Domestic DVD
Net losses                             (2,941 )                           n/a
Subscriptions at end of
period                                  8,224            11,165           (26 )%
Paid subscriptions at end
of period                               8,049            11,039           (27 )%

Subscribers:
Unique Domestic
Net additions                           4,973             4,894             2  %
Subscribers at end of
period                                 29,368            24,395            20  %
Paid subscribers at end of
period                                 27,613            22,858            21  %

Contribution profit:
Domestic Streaming
Revenues                      $     2,184,868                             n/a
Cost of revenues                    1,558,864                             n/a
Marketing                             276,072                             n/a
Contribution profit                   349,932                             n/a
Contribution margin                        16 %

Domestic DVD
Revenues                      $     1,136,872                             n/a
Cost of revenues                      591,432                             n/a
Marketing                               7,374                             n/a
Contribution profit                   538,066                             n/a
Contribution margin                        47 %

Total Domestic
Revenues                      $     3,321,740       $ 3,121,727             6  %
Cost of revenues                    2,150,296         1,932,419            11  %
Marketing                             283,446           324,121           (13 )%
Contribution profit                   887,998           865,187             3  %
Contribution margin                        27 %              28 %

2012 Domestic Segment Results

Revenues

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 $4.99 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.

The $200.0 million increase in our domestic revenues in 2012 as compared to 2011 was primarily due to the 15% growth in the domestic average number of unique paying subscribers driven by new streaming subscriptions. This increase was offset in part by an 8% decline in domestic average monthly revenue per unique paying subscriber, resulting from the decline in DVD subscriptions. We expect streaming subscriptions domestically to continue to grow while DVD subscription declines continue to moderate.

Cost of Revenues

The $217.9 million increase in domestic cost of revenues in 2012 as compared to 2011 was primarily due to the following factors:

• Content acquisition and licensing expenses increased by $397.7 million. This increase was primarily attributable to continued investments in existing and new streaming content available for viewing to our subscribers as compared to the prior year.

• Content delivery expenses decreased by $162.0 million primarily due to a 41% decrease in the number of DVDs mailed to paying subscribers driven by a decline in the number of DVD subscriptions.

• Other costs associated with content processing and customer service center expenses decreased by $13.9 million primarily due to a decrease in hub operation expenses resulting from the declines in DVD shipments, offset partially by increases in customer service center expenses to support our growth in domestic subscriptions.

Marketing

Marketing expenses decreased $40.7 million in 2012 as compared to 2011 primarily due to a decrease in marketing program spending in television, radio and direct mail advertising partially offset by increases in online advertising.

Contribution Profit
Our Domestic streaming segment had a contribution margin of 16% for 2012 and our Domestic DVD segment had a contribution margin of 47%. The Domestic segments collectively had a contribution margin of 27% in 2012 down slightly from 28% in 2011 with the decrease driven primarily by investments in our streaming content. We expect contribution margins for the Domestic DVD segment to decline sequentially due to a seasonal increase in usage in the first quarter of 2013 and the expected USPS rate increase of $0.01 each way which takes effect in January 2013. Contribution margins for the Domestic streaming segment are expected to expand as investments in domestic content and marketing grow slower than domestic streaming revenues and contribution profit may exceed the Domestic DVD contribution profit in the first quarter of 2013.

                                       As of /Year Ended December 31,         Change
                                           2011               2010         2011 vs. 2010
                                             (in thousands, except percentages)
Subscribers:
Unique Domestic
Net additions                                 4,894             7,233           (32 )%
Subscribers at end of period                 24,395            19,501            25  %
Paid subscribers at end of period            22,858            17,935            27  %

Total Domestic
Revenues                            $     3,121,727       $ 2,159,008            45  %
Cost of revenues                          1,932,419         1,350,542            43  %
Marketing                                   324,121           284,917            14  %
Contribution profit                         865,187           523,549            65  %
Contribution margin                              28 %              24 %

2011 Domestic Segment Results

Revenues
The $962.7 million increase in our domestic revenues in 2011 as compared to 2010 was primarily due to the 49% growth in the domestic average number of unique paying subscribers driven by new streaming subscriptions. This increase was offset in part by a 3% decline in domestic average monthly revenue per unique paying subscriber, resulting from the popularity of the streaming subscription plans (introduced in November 2010) and a decline in the percentage of unique paying subscribers electing both a streaming and a DVD subscription following the pricing changes announced in July 2011.

Cost of Revenues
The $581.9 million increase in domestic cost of revenues in 2011 as compared to 2010 was due to the following factors:
• Content acquisition and licensing expenses increased by $584.3 million. This increase was primarily attributable to continued investments in streaming content resulting in an increase in the streaming content available for viewing to our domestic subscribers as compared to the prior year.

• Content delivery expenses decreased $41.8 million primarily due to a 14% decrease in the number of DVDs mailed to paying subscribers. The decrease in the number of DVDs mailed was driven by a 22% decline in monthly DVD rentals per average paying DVD subscriber primarily attributed to the migration of our DVD subscribers toward lower priced plans. 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.

• Other costs increased due to a $28.9 million increase in credit card fees as a result of the growth in revenues, and a $19.1 million increase in costs associated with customer service call centers to support our growing subscriber population. These increases were partially offset by an $8.6 million decrease in expenses related to content processing due primarily to the 14% decrease in the number of DVDs mailed to paying subscribers.

Marketing

Marketing expenses increased $39.2 million in 2011 as compared to 2010 primarily due to an increase in marketing program spending in television, radio and online advertising coupled with an increase in payments to our affiliates. These increases were partially offset by a decrease in direct mail and inserts, and payments made to our consumer electronic partners. The increase in marketing program spending was partially offset by decreases in the costs of free trials.

International Streaming Segment
                                 As of /Year Ended December 31,           Change
                                     2012                2011          2012 vs. 2011
                                        (in thousands, except percentages)
Subscriptions:
Net additions                           4,263               1,349             216 %
Subscriptions at end of
period                                  6,121               1,858             229 %
Paid subscriptions at end
of period                               4,892               1,447             238 %

Contribution profit:
Revenues                      $       287,542       $      82,850             247 %
Cost of revenues                      475,570             107,482             342 %
Marketing                             201,283              78,517             156 %
Contribution loss                    (389,311 )          (103,149 )           277 %

2012 International Streaming Segment Results

Revenues

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 USD 8.00 per month. In September 2010, we began international operations in Canada. We expanded to Latin America in September 2011 and the U.K. and Ireland in January 2012. In October 2012, we launched our streaming service in Finland, Denmark, Sweden and Norway. The $204.7 million increase in our international revenues in 2012 as compared to 2011 was primarily due to the 260% growth in the international average number of unique paying subscribers driven by a full year of service offering in Latin America as well as our launches in the U.K. and Ireland and Nordic regions. International streaming subscriptions account for 18% of total streaming subscriptions at the end of 2012. We expect international streaming subscriptions to continue to grow.
Cost of Revenues

International cost of revenues increased by $368.1 million in 2012 as compared to 2011 primarily due to a $347.5 million increase in content licensing costs resulting from the continued investments in streaming content available for viewing in Canada and Latin America and to support our launches in the U.K. and Ireland and Nordic regions.

Marketing
Marketing expenses incurred by our International streaming segment have been significant and will fluctuate dependent upon the number of International territories in which our streaming service is offered and the timing of the launch of new territories.

International marketing expenses increased $122.8 million in 2012 as compared to 2011 primarily due to increases in marketing program spending online and in television and radio advertising to support our launches in the U.K. and Ireland and Nordic regions.
Contribution Loss
Our International streaming segment does not benefit from the established subscriber base that exists for the Domestic segments. As a result of having to build a member base from zero, investments in streaming content and marketing for our International segment are larger initially relative to revenues, in particular as new territories are launched. The contribution losses for our International segment have been significant and increased due to increased investments in streaming content and marketing programs to drive more membership growth and viewing in existing and new markets. We expect a sequential improvement in International contribution loss in the first quarter of 2013 with more modest sequential improvements expected in subsequent quarters. However, contribution losses will continue to be significant as we expand internationally.

2011 International Streaming Segment Results

                                 As of /Year Ended December 31,           Change
                                     2011                2010          2011 vs. 2010
                                        (in thousands, except percentages)
Subscriptions:
Net additions                           1,349                 509             165 %
Subscriptions at end of
period                                  1,858                 509             265 %
Paid subscriptions at end
of period                               1,447                 333             335 %

Contribution profit:
Revenues                      $        82,850       $       3,617           2,191 %
Cost of revenues                      107,482               6,813           1,478 %
Marketing                              78,517               8,922             780 %
Contribution loss                    (103,149 )           (12,118 )           751 %

Revenues
The $79.2 million increase in our international revenues in 2011 as compared to 2010 reflects a full year of service offering in Canada as well as our launch in Latin America.

Cost of Revenues

International cost of revenues increased by $100.7 million in 2011 as compared to 2010 primarily due to an increase of $90.1 million in content licensing costs resulting from the continued investments in streaming content available for viewing in Canada and to support our launch in Latin America.

Marketing
International marketing expenses increased $69.6 million in 2011 as compared to 2010 primarily due to increases in marketing program spending in television and online to support our launch in Latin America.

Consolidated Operating Expenses
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, merchandising,
and content delivery technology, as well as, our telecommunications systems and
infrastructures. Technology and development expenses also include costs
associated with computer hardware and software.

                                 Year Ended December 31,            Change
                                   2012            2011       2012 vs. 2011
                                      (in thousands, except percentages)
Technology and development    $    329,008      $ 259,033               27 %
As a percentage of revenues              9 %            8 %

The $70.0 million increase in technology and development expenses was primarily the result of a $63.4 million increase in personnel-related costs, including a $12.7 million increase in stock-based compensation. These increases are primarily due to a 35% growth in average headcount supporting continued improvements in our streaming service and international expansion.

                                 Year Ended December 31,            Change
                                   2011            2010       2011 vs. 2010
                                      (in thousands, except percentages)
Technology and development    $    259,033      $ 163,329               59 %
As a percentage of revenues              8 %            8 %

The $95.7 million increase in technology and development expenses was primarily the result of an $83.0 million increase in personnel-related costs, including an $18.7 million increase in stock-based compensation expense. These increases are primarily due to a 54% growth in average headcount supporting continued improvements in our streaming service and international expansion. General and Administrative
General and administrative expenses consist of payroll and related expenses for executive and administrative personnel, as well as professional fees and other general corporate expenses. General and administrative expenses also include the gain on disposal of DVDs.

                                 Year Ended December 31,            Change
                                   2012            2011       2012 vs. 2011
                                      (in thousands, except percentages)
General and administrative    $    119,687      $ 126,937            (6 )%
As a percentage of revenues              3 %            4 %

The $7.3 million decrease in general and administrative expenses was primarily attributable to a $9.0 million expense in 2011 related to the settlement of a legal claim related to our compliance with the Video Privacy Protection Act, a $5.8 million increase in the gain on sale of previously viewed DVDs, and a $8.6 million decrease in miscellaneous expenses related to the use of outside and professional services, taxes, insurance costs and to costs associated with various legal claims against us. These decreases were partially offset by an increase in personnel-related costs of $16.1 million attributed to an 11% increase in average headcount and a $3.5 million increase in stock-based compensation. We expect legal costs to continue at a high level for the foreseeable future as we defend claims against us.

                                 Year Ended December 31,            Change
                                   2011             2010      2011 vs. 2010
                                      (in thousands, except percentages)
General and administrative    $    126,937       $ 64,461               97 %
As a percentage of revenues              4 %            3 %

The $62.5 million increase in general and administrative expenses was primarily attributable to an increase in personnel-related costs of $33.6 million . . .