The opinion of the court was delivered by: WILLIAM ALSUP, District Judge
In this securities-fraud case, defendants move for dismissal of
plaintiffs' first amended consolidated complaint (hereinafter
"complaint") and for judicial notice of certain documents. The
request for judicial notice is unopposed and is GRANTED.
Because plaintiffs have failed to allege any false statements or
material omissions, the motion to dismiss for failure to state a
claim is GRANTED. Leave to amend previously being allowed, the
case is over at the district court. This time the dismissal is
without leave to amend.
Lead plaintiffs are four investors who purchased publicly
traded shares of securities in Netflix, Inc., a corporation based
in Los Gatos, California, that sold monthly subscriptions
allowing people to order DVDs on the Internet and to receive them
They allege that they purchased shares at prices that were
inflated by fraud committed by Netflix and three of its officers:
Reed Hastings, chief executive officer and board of directors chairman, Barry McCarthy, chief financial officer and
secretary, and Leslie Kilgore, chief marketing officer and
marketing vice president.
Lead plaintiffs claim that from April 17, 2003, to October 14,
2004, defendants made false and misleading statements, and failed
to disclose material facts required to make their other
statements not misleading. They allege such statements came in
press releases issued on wire services, in Securities and
Exchange Commission filings, in public presentations and in
telephone conference calls with investors and analysts. They
charge defendants with using a misleading calculation of the
average subscriber cancellation rate, also called "churn." That
metric was in turn used to calculate other financial measures.
Plaintiffs allege that investors relied upon these measures in
overvaluing the securities. Defendants do not contest that the
measures are material. The contested measures made Netflix appear
to be viable. In fact, say plaintiffs, the company's business
model was broken.
Defendants have asked for judicial notice of certain SEC
filings, calculations based upon information in those filings,
Netflix press releases and a publication on churn published by
the audit firm KPMG and referenced in the complaint (Defs.' Req.
for Judicial Notice).
A court must take judicial notice of adjudicative facts if a
party requests that it do so, supplies the necessary information
to decide the request and the facts are "not subject to
reasonable dispute" because they are "capable of accurate and
ready determination by resort to sources whose accuracy cannot
reasonably be questioned." FRE 201 (a), (b), (d).
The time has passed for plaintiffs to raise objections to
defendants' request. They have not done so. Defendants have met
the FRE 201 requirements. The documents are relevant to the
complaint. This order therefore takes notice of those facts.
2. PUBLIC STATEMENTS BEFORE THE CLASS PERIOD.
As Netflix was preparing to make its initial public offering of
securities, it notified the SEC on April 16, 2002, that "an
average of approximately 8% of  total subscribers cancelled
their subscriptions each month" in the twelve-month period that
had ended March 21. It repeated that statement to the SEC on May
6. Two weeks later, the company reported a similar cancellation rate for calendar year 2001. It further stated that
for the first quarter of 2002, the cancellation rate per month
was about seven percent, down from about ten percent in the first
quarter of 2001. Netflix repeated most of these statements in its
IPO Prospectus filed May 23, 2002 (Compl. ¶¶ 92, 94, 95). In
these statements, the corporation provided no definition of
On July 24, 2002, the company released a statement that churn
had declined to 6.7 percent. In an endnote linked to the first
mention of churn, the term was defined as "a monthly percentage
determined by subtracting from one, a quotient, the numerator of
which is the ending subscribers for the current quarter and the
denominator of which is the sum of the previous quarter's ending
subscribers plus the current quarter's new trial subscribers and
then dividing this resulting number by 3, which is the number of
months in the quarter." That formula was repeated in the
corporation's quarterly SEC filings for the second and third
quarters of 2002 (Hoffman Decl., Exhs. A, B, G).
3. ALLEGED FRAUD DURING THE CLASS PERIOD.
The first allegedly false statement made during the class
period came April 17, 2003, when the company announced that its
first quarter 2003 churn rate was a "record low" of 5.8 percent,
down from 7.2 percent a year earlier (Hoffman Decl., Exh. H). The
release also stated that "implied subscriber lifetime" the
average duration of subscriptions was defined as the inverse of
the reported churn rate.[fn*] The release's tabular material
containing the churn rate purportedly was "unaccompanied by, and
was not preceded by, any definition of how the churn rate was
calculated" (Compl. ¶¶ 104-05). That claim is untenable. The July
24, 2002, press release and the quarterly reports for the second
and third quarters of 2002 each disclosed how churn was
determined. This order takes judicial notice of those documents.
Also on April 17, Hastings and McCarthy spoke by conference
call with analysts. Hastings touted the company's "lowest churn
rate in [its] history," repeated the churn statistics for the
quarter, stated that the decrease was related to improving
customer satisfaction and credited the low churn rate with playing a central role in
"enabling [Netflix] to build a bigger and more profitable
business." He also stated that customer retention "is the just
the numeric inverse on churn." McCarthy stated that the churn
rate was one of the "trinity of metrics" guiding Netflix to
financial success (Compl. ¶ 106).
This news propelled average share price twenty percent higher
over the next two days, to $24.63, on volume five times its
normal level (Compl. ¶ 112).
Hastings repeated the churn-rate figures in a public
presentation at the Wharton School of Business at the University
of Pennsylvania on May 1, 2003, and three days later by Netflix
in its first-quarter SEC report. Tabular material in that filing
included a line listing the churn rate followed, on the next
line, by the average number of paid subscribers during the
quarter. The latter line was indented so that it appeared to be a
sub-component of the churn rate. No definition of churn was given
(Compl. ¶¶ 115, 117).
On July 17, 2003, Netflix announced that its churn rate was 5.6
percent in the second quarter. The term "churn" was followed by a
superscript numeral that led readers to an endnote definition
identical to earlier ones. Again, Hastings and McCarthy spoke by
conference call with analysts and touted the importance of
declining churn (Compl. ¶¶ 119, 120, 122).
On October 15, 2003, Netflix announced another churn-rate
decline, to 5.2 percent, and again defined the term. This time,
it was defined "as customer cancellations in the quarter divided
by the sum of beginning subscribers and gross subscriber
additions, divided by three months." This definition is
functionally identical to the more formal one given earlier.
Hastings and McCarthy hailed the results in a quarterly
conference call. Hastings said good service drove churn down.
McCarthy called churn a "primary driver" of financial
performance," and partly attributed its decline to an increase in
the number of movies Netflix's offered for rental (Compl. ¶¶ 124,
In an interview October 23, 2003, Hastings was asked by The
Motley Fool magazine how long the "median customer is maintaining
his Netflix membership?" Hastings responded by stating that the
"mean customer life" was "roughly one divided by the churn," a
definition identical to that previously applied to "implied
subscriber lifetime" (Compl. ¶ 129). On January 21, 2004, the company announced the churn had fallen
to 4.8 percent in the fourth quarter of 2003. It repeated the
definition of churn (Hoffman Decl., Exh. J). This achievement was
trumpeted in a conference call to analysts. On March 1, the
company repeated these results and the churn definition in ...