NetFlix 2009 Annual Report Download - page 35

Additionally, the terms of certain DVD direct purchase agreements with studios and distributors provide for
volume purchase discounts or rebates based on achieving specified performance levels. Volume purchase
discounts are recorded as a reduction of DVD library when earned. We accrue for rebates as earned based on
historical title performance and estimates of demand for the titles over the remainder of the title term.
We obtain content distribution rights in order to stream movies and TV episodes without commercial
interruption to subscribers’ computers and TVs via Netflix Ready Devices. We account for streaming content in
accordance with the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification
(“ASC”) topic 920 Entertainment—Broadcasters. Cash outflows associated with the streaming content are
classified as cash flows from operating activities on our consolidated statements of cash flows.
We classify our streaming content obtained through a license agreement as either a current or non-current
asset in the consolidated balance sheets based on the estimated time of usage after certain criteria have been met,
including availability of the streaming content for its first showing. We amortize licensed streaming content on a
straight-line basis generally over the term of the related license agreements or the title’s window of availability.
We also obtain DVD and streaming content through revenue sharing agreements with studios and
distributors. We generally obtain titles for low initial cost in exchange for a commitment to share a percentage of
our subscription revenues or to pay a fee, based on utilization, for a defined period of time, or the Title Term,
which typically ranges from six to twelve months for each title. The initial cost may be in the form of an upfront
non-refundable payment. This payment is capitalized in the content library in accordance with our DVD and
streaming content policies as applicable. The initial cost may also be in the form of a prepayment of future
revenue sharing obligations which is classified as prepaid revenue sharing expense. The terms of some revenue
sharing agreements with studios obligate us to make minimum revenue sharing payments for certain titles. We
amortize minimum revenue sharing prepayments (or accrete an amount payable to studios if the payment is due
in arrears) as revenue sharing obligations are incurred. A provision for estimated shortfall, if any, on minimum
revenue sharing payments is made in the period in which the shortfall becomes probable and can be reasonably
estimated. Under the revenue sharing agreements for our DVD library, at the end of the Title Term, we generally
have the option of returning the DVD to the studio, destroying the DVD or purchasing the DVD.
Stock-Based Compensation
Stock-based compensation expense is estimated at the grant date based on the fair value of the awards
expected to vest and is recognized as expense ratably over the requisite service period, which is the vesting
period.
We calculate the fair value of new stock-based compensation awards under our stock option plans using a
lattice-binomial model. We use a Black-Scholes model to determine the fair value of employee stock purchase
plan shares. These models require the input of highly subjective assumptions, including price volatility of the
underlying stock. Changes in the subjective input assumptions can materially affect the estimate of fair value of
options granted and our results of operations could be materially impacted.
•Expected Volatility: Our computation of expected volatility is based on a blend of historical volatility
of our common stock and implied volatility of tradable forward call options to purchase shares of our
common stock. Our decision to incorporate implied volatility was based on our assessment that implied
volatility of publicly traded options in our common stock is more reflective of market conditions and,
therefore, can reasonably be expected to be a better indicator of expected volatility than historical
volatility of our common stock.
•Suboptimal Exercise Factor: Our computation of the suboptimal exercise factor is based on historical
option exercise behavior and the terms and vesting periods of the options granted and is determined for
both executives and non-executives.
We grant stock options to our employees on a monthly basis. We have elected to grant all options as
non-qualified stock options which vest immediately. As a result of immediate vesting, stock-based compensation
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