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In re Netflix, Inc., Securities Litigation

United States District Court, N.D. California

February 13, 2013

In re NETFLIX, INC., SECURITIES LITIGATION.

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[Copyrighted Material Omitted]

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Michael Walter Stocker, Christopher J. Keller, Eric J. Belfi, Kimberly Kalmanson, Serena Hallowell, Stephen W. Tountas, Labaton Sucharow LLP, Jonathan M. Plasse, Goodkind Labation Rudoff & Sucharow LLP, Matthew M. Houston, Robert I. Harwood, Harwood Feffer LLP, Jeffrey M. Norton, Newman Ferrara LLP, New York, NY, Shawn A. Williams, Aelish Marie Baig, Ekaterini Maria Polychronopoulos, Robbins Geller Rudman and Dowd LLP, Jiangxiao Athena Hou, Zelle Hofmann Voelbel & Mason LLP, Rosemary M. Rivas, Finkelstein Thompson LLP, Jason A. Pikler, Robert C. Schubert, Willem F. Jonckheer, Schubert Jonckheer & Kolbe LLP, San Francisco, CA, Darren Jay Robbins, David Conrad Walton, Eric I. Niehaus, Jonah H. Goldstein, Matthew I. Alpert, Robbins Geller Rudman & Dowd LLP, San Diego, CA, Vincent Ian Parrett, Motley Rice LLC, Lionel Z. Glancy, Michael M. Goldberg, Glancy Binkow & Goldberg LLP, Los Angeles, CA, Mark P. Kindall, Izard Nobel LLP, West Hartford, CT, for Plaintiff.

Keith E. Eggleton, Boris Feldman, Luke Anthony Liss, Rodney Grant Strickland, Jr., Wilson Sonsini Goodrich & Rosati, a Professional Corporation, Palo Alto, CA, for Defendant.

ORDER GRANTING MOTION TO DISMISS

SAMUEL CONTI, District Judge.

I. INTRODUCTION

Plaintiffs Arkansas Teacher Retirement System and State-Boston Retirement System (" Plaintiffs" ) bring this putative securities class action against Netflix, Inc. (" Netflix" ); Netflix Co-Founder, Chairman of the Board, and CEO Reed Hastings (" Hastings" ); current Netflix CFO David Wells (" Wells" ); and Barry McCarthy (" McCarthy" ), Netflix's CFO until

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December 10, 2010 (collectively " Defendants" ). Now before the Court is Defendants' Motion to Dismiss Plaintiffs' Consolidated Class Action Complaint (" CCAC" ). ECF No. 91 (" MTD" ). The motion is fully briefed, ECF Nos. 94 (" Opp'n" ), 97 (" Reply" ), and is suitable for determination without oral argument, Civ. L.R. 7-1(b). For the reasons set forth below, the Court GRANTS Defendants' Motion to Dismiss and DISMISSES the CCAC with leave to amend.

II. BACKGROUND

Netflix is a public corporation that purports to be the leading Internet subscription service for viewing movies and television shows (collectively " movies" ). ECF No. 89 (CCAC) ¶ 20. Netflix currently allows consumers to watch movies either by streaming them over the Internet directly to their televisions, computers, or mobile devices, or by receiving DVDs sent to their homes. Id.

Netflix provided no streaming services— only DVDs by mail— from 1999 to 2007. Id. ¶¶ 38-49. In 2007 Netflix began to allow its subscribers to stream movies via the " hybrid plan," the only plan it offered at the time, which allowed subscribers both to stream movies and to receive DVDs. Id.

In November 2010, as part of its plan to develop its streaming services further, Netflix decided to offer its subscribers a standalone streaming plan in addition to the hybrid plan. Id. ¶ 76. The hybrid plan cost $9.99 per month, and the new streaming-only plan cost $7.99 per month. See id. Shortly before this change, in October 2010, Defendants explained the " virtuous cycle" that would drive Netflix's transition to a streaming-focused company: " [A]s Netflix gained subscribers, it could afford to license more streaming content, which would increase its appeal, and therefore, allow [Netflix] to acquire more subscribers, and the cycle would thus continue." Id. ¶ 65. The cycle was important because Netflix's library of streaming content, unlike Netflix's DVD library, demanded continuous licensing negotiations and would require Netflix to continually increase its subscriber base in order to acquire and maintain streaming content. See id. ¶¶ 50-65. Netflix planned to offset some of the increasing content costs by decreasing DVD-related expenditures. See id.

From June 2010 to July 2011, Netflix's subscriber count steadily increased each quarter. Id. ¶ 91. Its stock price followed suit, rising from a closing price of $153.15 on October 20, 2010 to a high of $298.73 on July 13, 2011. Id. ¶¶ 70, 73-74.

On July 12, 2011, however, Netflix announced that effective September 1, 2011 for existing subscribers and immediately for new ones, it would no longer offer its hybrid plan. Id. ¶ 351. Instead, it would offer separate DVD-only and streaming-only plans, both for $7.99 per month. Id. ¶¶ 351, 407. Subscribers who previously had access to both DVD and streaming services for $9.99 per month under the hybrid plan would now have to pay $15.98 to subscribe to the new, separate plans. See id. ¶¶ 350-51. Netflix's subscribers were unhappy, and Netflix experienced a net loss in customers for the first time in years. Id. ¶¶ 377-78.

Netflix's fortunes fell further in September 2011. First, on September 2, the cable channel Starz announced that it would not renew its streaming contract with Netflix effective February 28, 2012. Id. ¶ 372.

Second, on September 15, Netflix reported that it expected to lose one million subscribers during the third quarter of 2011-the first quarter in years that would close with a net loss in subscribers. After the announcement, Netflix's stock price dropped by $39.46 to close at $169.25. Id.

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¶¶ 376-79. Plaintiffs state that " the investing public understood that the subscriber drop-off was due, in large part, to the price increases in July 2011." Id. ¶ 378. Nevertheless, Netflix stood behind its decision as " the right choice." Id. ¶ 380.

Third, on September 19, 2011, Netflix announced that it planned to spin off its DVD services into a new subsidiary called " Qwikster." Id. ¶ 152. Netflix planned to continue to provide streaming services via its own subscription plans and website, separately from the Qwikster subsidiary. Id. Netflix's customers again recoiled from this change, and Netflix lost still more subscribers. ECF No. 93 (Request for Judicial Notice) (" RJN" ) Ex. 3, at 15.[1] Netflix soon abandoned the Qwikster idea, but continued its planned separation of the DVD-only and streaming-only plans, thereby doing away with the hybrid plan altogether. CCAC ¶¶ 148, 149, 154.

Shortly thereafter, on October 24, 2011 in documents related to the fourth quarter of 2011 (" 4Q11" ), Netflix began to report segmented financial information for the now-entirely-separate DVD-only and streaming-only plans— information that had previously been unavailable. Id. ¶ 225. Before 4Q11, Netflix reported its financial results under the single " Domestic" segment, which included customers on the hybrid plan and those on the newer streaming-only plan, but did not provide segmented financial information for the then-intertwined DVD and streaming services. See id. ¶¶ 149, 151, 407; RJN Ex. 4 at 71.

In its 4Q11 reports, Netflix announced that its " contribution margin for domestic streaming [would] be low in 4Q11 at around 8% ... due to [its] increasing content spend," whereas Netflix's DVD business had a contribution profit of 50-52%. Id. ¶¶ 382-85. Netflix continued to stand by its decision to offer the DVD and streaming subscription plans as separate services with separate prices, but admitted that it had made the change too quickly, compounding the problem " with [a] lack of explanation about the rising cost of the expansion of streaming content, and steady DVD costs." Id. ¶ 389. Netflix stated further that more long-term members canceled their subscriptions in response to the pricing changes than expected, thereby making Netflix's 4Q11 profits and revenues lower than predicted, though Netflix would remain profitable overall. Id. ¶ 390. After this announcement, Netflix's stock price fell $41.47 per share to close at $77.37 per share on October 25, 2011. Id.

Plaintiffs, Netflix shareholders, now sue Defendants for alleged violations of the federal securities laws. Their claims are all based on the theory that, between October 20, 2010 and October 24, 2011, inclusive (the " Class Period" ), Defendants misled investors about the prospects of the new streaming-focused model, thereby artificially inflating Netflix's stock price and leading to a stock drop of almost 67 percent after the alleged falsity of those statements was revealed. See id.

Plaintiffs allege that all Defendants violated Section 10(b) of the Securities Exchange

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Act of 1934, 15 U.S.C. § 78j(b), and Securities Exchange Commission (" SEC" ) Rule 10b-5; that the individual Defendants violated Section 20(a) of the Act; and that Hastings ...


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