Monday, September 05, 2005

Churn 'Em and Burn 'Em

The credits appear to be rolling in the Netflix securities class action, with Judge Fern M. Smith (N.D. Cal.) granting all Defendants' (the company, the CEO, CFO, and CMO) motions to dismiss. Judge Smith, in one of her last orders issued before her retirement, began by noting that the "allegedly false and misleading statements concerned the Company's rate of 'churn,' a metric relating to loss of subscribers; the Company's improving service and growth; the Company's competition; and the Company's relationship with TIVO, Inc." Although Judge Smith evaluated all four of these areas, the investors' primary claim seems to be centered on the churning allegations, with the judge quickly dismissing the other three areas of alleged false statements.

Basically, Plaintiffs claimed "that defendants overemphasized subscriber growth rate and understated subscriber churn to mislead investors as to the true state of subscriber retention." "Using plaintiffs' formula to calculate churn results in chum rates that are 25% to 30% higher than the rates obtained by using the Netflix formula." Unfortunately for Plaintiffs, Judge Smith found that "there is, however, no official formula for calculating churn. Plaintiffs call their method of calculating churn 'actual churn,' but offer no authority for the proposition that their method is proper and Netflix's method is improper. Defendants point out and plaintiffs concede that there exists no official GAAP methodology for calculating churn. Importantly, Netflix clearly and repeatedly disclosed its formula for calculating churn. Given Netflix's disclosure of its method of calculating churn, Netflix's reporting of the churn rates obtained by using this formula cannot be considered to be false."

It remains to be seen if this movie is actually over though, as although Judge Smith said she "has serious reservations as to whether plaintiffs' allegations regarding churn and cancellations, improved service, competition, and TiVo can be successfully resurrected," she allowed Plaintiffs 30 days to amend. A quick check of the file reveals that Plaintiffs did in fact file an amended complaint, although they dropped the service and growth, competition, and the TIVO claims in the new version. Judge William Alsup is now presiding.

You can read In re Netflix, Inc. Securities Litigation, issued June 23, 2005, at 2005 U.S. Dist. LEXIS 18765.

Nugget: "Even in the financial reports in which the number of subscriber cancellations was not expressly disclosed, this number could be calculated through simple arithmetic using other numbers that were disclosed."

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