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  • singhlion2001 singhlion2001 Nov 4, 2012 8:19 PM Flag

    Isn't the point of running a business to make money?

    Lead Plaintiffs Arkansas Teacher Retirement System and State-Boston
    Retirement System (together, “Lead Plaintiffs”), individually and on behalf of all
    other persons and entities who purchased or acquired the common stock of Netflix,
    Inc. (“Netflix” or the “Company”) during the period between October 20, 2010 and
    October 24, 2011, inclusive (the “Class Period”), and who were damaged thereby,
    hereby allege the following based upon personal knowledge as to themselves and
    their own acts, and upon information and belief as to all other matters.
    Lead Plaintiffs’ allegations are based on Lead Counsel’s investigation,
    which included, among other things: (i) a review and analysis of Netflix’s public
    filings with the U.S. Securities and Exchange Commission (“SEC”); (ii) a review
    and analysis of research reports issued by financial analysts concerning Netflix;
    (iii) a review and analysis of other publicly available information concerning
    Netflix and its senior officers and directors, including Reed Hastings, David Wells
    and Barry McCarthy (collectively, the “Individual Defendants”); (iv) interviews
    with former Netflix employees on a confidential basis, each of whom have
    specific, personal knowledge of the facts alleged herein; and (v) discussions with
    and analyses prepared by consulting experts. Many of the facts supporting Lead
    Plaintiffs’ allegations are known only by Netflix and the Individual Defendants
    (collectively, “Defendants”), or are exclusively within their custody and control.
    Lead Plaintiffs believe that substantial additional evidentiary support will be
    revealed after a reasonable opportunity for discovery.
    I. NATURE OF THE ACTION
    1. This securities class action arises from material misstatements and
    omissions concerning the disparate profitability between Netflix’s streaming
    segment—which Defendants touted as its “core” business strategy—and the
    Company’s legacy DVD segment, which was supposedly nothing more than a 2

    CONSOLIDATED CLASS ACTION COMPLAINT - 3:12-CV-00225-SC
    “fading differentiator.” In reality, as investors eventually learned, the streaming
    segment carried a mere 8% contribution profit.
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    2. Netflix purports to be the world’s leading internet subscription service
    for viewing TV shows and movies, and offers subscription plans to (i) “stream”
    such content over the Internet to subscribers’ TVs, computers and media devices,
    (ii) rent standard definition DVDs and high definition blue-ray disks (collectively,
    “DVDs”) that are delivered and returned by mail, or (iii) a combination thereof.
    3. On October 20, 2010, the first day of the Class Period, Hastings
    proclaimed that Netflix was “by every measure . . . primarily a streaming company
    that also offers DVD-by-mail,” and represented that Netflix’s “evolution to a
    streaming company has just been phenomenal.” Further, Hastings claimed that
    Netflix was already reaping the benefits of a “virtuous cycle,” whereby the
    Company was “acquir[ing] more streaming content which helps grow [Netflix’s]
    subscriber base and lessen[s] [Netflix’s] DVD-by-mail expense, which in turn
    provides [Netflix] with greater financial resources to acquire more streaming
    content, improve the user interface and continue to grow the subscriber base.” In
    shorthand, the Company’s most cited virtuous cycle (the “virtuous cycle”) boils
    down to: more subscribers = more money for content = more subscribers.
    4. Throughout the Class Period, Defendants continued to echo these
    material misstatements, claiming that the “virtuous cycle” referenced above was
    not only enabling the growth and profitability of the Company’s streaming
    segment, but provided the Company with a distinct “competitive advantage.”

    1
    Contribution profit is defined as revenue less cost of revenues and marketing
    expenses. Netflix describes the usefulness of “contribution profit” as follows:
    “Management believes that contribution profit is useful in assessing the relative
    contribution to operating income of each segment by eliminating any allocation of
    Technology & Development and G&A expenses that apply across these segments.”
    (October 24, 2011, Letter to Shareholders). 3

    CONSOLIDATED CLASS ACTION COMPLAINT - 3:12-CV-00225-SC
    Indeed, when a securities analyst asked Hastings whether rising content costs
    would derail this cycle, Hastings specifically represented that Netflix’s “subscriber
    base [wa]s growing fast enough, and DVD shipments [were] growing slow enough,
    that [Netflix could] afford to pay for the existing streaming content [it had], and
    also get more content.”
    5. Beyond these material misrepresentations, Netflix’s publicly filed
    financial statements fraudulently concealed the highly material fact that, contrary
    to Defendants’ misstatements, the streaming segment that had purportedly become
    the Company’s “core strategy,” was, in fact, significantly less profitable than its
    “fading” DVD segment. Defendants did so by improperly aggregating the reported
    financial data for Netflix’s streaming and DVD segments—including its costs and
    revenue—in direct violation of SEC disclosure rules and U.S. Generally Accepted
    Accounting Principles (“GAAP”). In addition, Defendants further concealed the
    information required under Regulation S-K regarding known trends and
    uncertainties.
    6. Fueled by these material misstatements and omissions, Netflix’s stock
    price soared to all-time highs, nearly doubling in price between the first day of the
    Class Period and July 2011, when it closed at $298.73 per share. In fact, just one
    day into the Class Period, Netflix’s stock price increased from $153.15 per share to
    $172.69 per share upon Defendants’ announcement that Netflix was “by every
    measure primarily a streaming company” and that this “evolution . . . has just been
    phenomenal.” In turn, securities analysts issued a series of highly positive reports
    that characterized Netflix’s streaming segment as “compelling,” and highlighted
    the benefits that the Company was purportedly deriving from its virtuous cycle.
    7. Lead Plaintiffs’ investigation has uncovered specific facts which
    demonstrate that Defendants were tracking and monitoring operating metrics for

    Sentiment: Strong Sell

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    • the streaming segment, but concealed the weak profit margins of that segment from
      investors at the time these statements were made. For example:
      • CW1, a former Director of Product Management, attended
      Netflix’s quarterly meetings that were attended by Hastings and
      other executives, during which he personally observed discussions
      regarding the amount of streaming business, including the
      streaming usage and rate of growth (see ¶¶130-131);
      • Certain of Defendants’ public disclosures demonstrate that the
      Company was reviewing, tracking and monitoring the operating
      metrics for the DVD and streaming businesses as separate
      segments both before and during the Class Period (see ¶¶137-
      146);
      • Defendants also implemented critical changes to the Company’s
      plan offerings that would have been virtually impossible without
      having actual knowledge of the discrete financial data of each
      business segment (see ¶¶147-155); and
      • Defendants substantially ignored two letters from the SEC, dated
      April 28, 2011 and June 24, 2011, demanding greater transparency
      in Netflix’s public disclosures, including discrete financial data for
      the Company’s DVD and streaming segments so that “investors
      can observe and analyze such data for [its] most recent five years
      of operation” (see ¶¶114-128).
      8. Defendants profited handsomely from their possession of this
      material, adverse information by selling their Netflix stock at artificially inflated
      prices, reaping almost $85 million during the Class Period. As explained herein,
      these insider sales were highly unusual and suspicious, as measured by: (1) the
      dollar amount of shares sold and the profits generated therefrom; (2) the 5
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      CONSOLIDATED CLASS ACTION COMPLAINT - 3:12-CV-00225-SC
      comparison with Defendants’ own prior and subsequent trading history and those
      of other insiders; (3) the timing of stock buybacks and stock sales by Netflix, and
      (4) the timing of the insider sales.
      9. Investors learned the truth about the disparate profitability between
      Netflix’s streaming and DVD segments, and the related failure of its “virtuous
      cycles,” between September 1, 2011 and October 25, 2012. In total, Netflix’s
      stock price plummeted from $233.27 per share on September 1, 2011 to $77.37
      per share on October 25, 2011, representing an aggregate decline of almost 67%.
      10. Securities analysts were stunned by these disclosures. As one analyst
      stated on October 25, 2011: “[t]he other surprise was the disclosure that the DVD
      business currently generates 80%+ of the company’s profits (even though it is only
      about 40% of revenue). Overall, visibility on the company’s earnings has further
      deteriorated.” That same day, another analyst acknowledged that “[i]nvestors are
      now seriously questioning the ‘virtuous cycle’ (more subscribers=more
      content=more subscribers) that Netflix has long celebrated.”
      II. JURISDICTION AND VENUE
      11. The claims asserted herein arise under and pursuant to Sections 10(b)
      20(a) and 20A of the Securities Exchange Act of 1934 (“Exchange Act”), 15
      U.S.C. §§ 78j(b), 78t(a), 78-t1(a), and Rule 10b-5 promulgated under Section 10 of
      the Exchange Act, 17 C.F.R. §240.10b-5.
      12. This Court has jurisdiction over the subject matter of this action
      pursuant to Section 27 of the Exchange Act, 15 U.S.C § 78aa. In addition, because
      this is a civil action arising under the laws of the United States, this Court has
      jurisdiction pursuant to 28 U.S.C. § 1331.
      13. Venue is proper in this District pursuant to Section 27 of the
      Exchange Act, 15 U.S.C. §§ 78aa, and 28 U.S.C. § 1391(b). Netflix resides and
      transacts business in this District, and maintains its principal executive offices in 6
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      CONSOLIDATED CLASS ACTION COMPLAINT - 3:12-CV-00225-SC
      this District at 100 Winchester Circle, Los Gatos, CA 95032. Many of the acts that
      constitute the violations of law complained of herein, including the preparation and
      public dissemination of materially false and misleading statements, occurred in
      substantial part in this District.
      14. In connection with the acts alleged herein, Defendants, directly or
      indirectly, used the means and instrumentalities of interstate commerce, including,
      but not limited to, the U.S. mails, interstate telephone communications and the
      facilities of the national securities markets, including NASDAQ.
      III. PARTIES
      A. Lead Plaintiffs
      15. On April 27, 2012, this Court appointed Arkansas Teacher Retirement
      System (“Arkansas Teacher”) and State-Boston Retirement System (“StateBoston”) to serve as Lead Plaintiffs for the Class in this consolidated class action
      pursuant to the Private Securities Litigation Reform Act of 1995 (the “PSLRA”).
      16. Arkansas Teacher is a cost-sharing, multiple-employer defined benefit
      pension plan that provides retirement benefits to public school and other public
      education related employees in the State of Arkansas. Arkansas Teacher was
      established by Act 266 of 1937, as an Office of Arkansas State government, for the
      purpose of providing retirement benefits for employees of any school or other
      educational agency participating in the system. Arkansas Teacher had
      approximately $11.7 billion in net assets held in trust for pension benefits, and
      includes more than 113,291 members as of May 1, 2011. As set forth in its
      PSLRA certification attached hereto, Arkansas Teacher purchased a total of 8,273
      shares, and sold 523 shares of Netflix common stock on the open market during the
      Class Period and suffered damages as a result of the securities law violations
      alleged herein.7
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      CONSOLIDATED CLASS ACTION COMPLAINT - 3:12-CV-00225-SC
      17. As set forth in its certification filed herewith, Arkansas Teacher
      purchased Netflix securities contemporaneously with Defendant Hastings’ sales of
      Netflix stock during the Class Period. Specifically, on March 10, 2011, and
      August 25, 2011, Arkansas Teacher purchased 1,440 shares and 2,510 shares of
      Netflix common stock, respectively. On each of those same dates, Hastings sold
      5,000 shares of Netflix common stock. On two other occasions, Arkansas Teacher
      purchased stock within a day of Hastings’ sale of Netflix common stock.
      18. State-Boston is an institutional investor that provides retirement
      benefits for the employees of the City of Boston, Massachusetts. It had
      approximately 37,000 active and retired participants, representing approximately
      $4.4 billion in assets as of August 1, 2011. As set forth in its PSLRA certification
      attached hereto, State-Boston purchased a total of 10,400 shares, and sold 7,600
      shares of Netflix common stock on the open market during the Class Period and
      suffered damages as a result of the securities law violations alleged herein.
      19. As set forth in its certification filed herewith, State-Boston purchased
      Netflix securities contemporaneously with Defendant Hastings’ sales of Netflix
      stock during the Class Period. Specifically, on March 24, 2011, September 15,
      2011 and September 22, 2011, State-Boston purchased 500 shares, 900 shares, and
      2,300 shares, respectively. On each of those same dates, Hastings sold 5,000
      shares of Netflix common stock. On five other occasions, State-Boston purchased
      Netflix common stock within two days of Hastings’ sale of Netflix common stock.
      B. Defendant Netflix
      20. Netflix purports to be the world’s leading internet subscription service
      for viewing TV shows and movies. Subscribers can instantly watch unlimited
      available TV shows and movies by “streaming” the content over the Internet to
      their TVs, computers and mobile devices. Subscribers can also receive DVDs to
      their homes. Netflix is incorporated in Delaware and maintains its principal place

      Sentiment: Strong Sell

 
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