NetFlix 2012 Annual Report Download - page 43

We did not recognize certain tax benefits from uncertain tax positions within the provision for income taxes.
We may recognize a tax benefit only if it is more likely than not the tax position will be sustained on examination
by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the
financial statements from such positions are then measured based on the largest benefit that has a greater than
50% likelihood of being realized upon settlement. At December 31, 2012, our estimated gross unrecognized tax
benefits were $43.3 million of which $35.7 million, if recognized, would favorably impact our future earnings.
Due to uncertainties in any tax audit outcome, our estimates of the ultimate settlement of our unrecognized tax
positions may change and the actual tax benefits may differ significantly from the estimates. See Note 8 of
Item 8, Financial Statements and Supplementary Data for further information regarding income taxes.
Stock-Based Compensation
Stock-based compensation expense at the grant date is based on the total number of options granted and an
estimate of 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 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. We include the historical volatility in our computation due to low trade
volume of our tradable forward call options in certain periods thereby precluding sole reliance on implied
volatility. An increase of 10% in our computation of expected volatility would increase the total stock-
based compensation expense by approximately $3.3 million for the year ended December 31, 2012.
•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. An increase in the suboptimal exercise factor of 10% would increase
the total stock-based compensation expense by approximately $3.0 million for the year ended
December 31, 2012.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The primary objective of our investment activities is to preserve principal, while at the same time
maximizing income we receive from investments without significantly increased risk. To achieve this objective,
we follow an established investment policy and set of guidelines to monitor and help mitigate our exposure to
interest rate and credit risk. The policy sets forth credit quality standards and limits our exposure to any one
issuer, as well as our maximum exposure to various asset classes. We maintain a portfolio of cash equivalents
and short-term investments in a variety of securities. These securities are classified as available-for-sale and are
recorded at fair value with unrealized gains and losses, net of tax, included in “Accumulated other
comprehensive income” within stockholders equity in the Consolidated Balance Sheets.
For the year ended December 31, 2012, we had no material impairment charges associated with our short-
term investment portfolio. Although we believe our current investment portfolio has very little risk of material
impairment, we cannot predict future market conditions or market liquidity and can provide no assurance that our
investment portfolio will remain materially unimpaired. Some of the securities we invest in may be subject to
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