NETFLIX, INC. This section of this Form 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the fiscal year endedDecember 31, 2021 .
Results of Operations
The following represents our consolidated performance highlights:
As of/ Year Ended December 31, Change
2022 2021 2020 2022 vs. 2021
(in thousands, except revenue per membership and percentages)
Financial Results:
Streaming revenues $ 31,469,852 $ 29,515,496 $ 24,756,675 7 %
DVD revenues 145,698 182,348 239,381 (20) %
Total revenues $ 31,615,550 $ 29,697,844 $ 24,996,056 6 %
Operating income $ 5,632,831 $ 6,194,509 $ 4,585,289 (9) %
Operating margin 18 % 21 % 18 %
Global Streaming Memberships:
Paid net membership additions 8,903 18,181 36,573 (51) %
Paid memberships at end of period 230,747 221,844 203,663 4 %
Average paying memberships 222,924 210,784 189,083 6 %
Average monthly revenue per paying membership $ 11.76 $ 11.67 $ 10.91 1 %
Consolidated revenues for the year ended December 31, 2022 increased 6% as
compared to the year ended December 31, 2021 , due to the 6% growth in average
paying memberships and a 1% increase in average monthly revenue per paying
membership. The increase in average monthly revenue per paying membership
resulted from our price changes, partially offset by the strengthening of the
U.S. dollar relative to certain foreign currencies.
The decrease in operating margin is primarily due to revenues growing at a
slower rate as compared to the 15% increase in content amortization. Revenue
growth during the year was impacted by fluctuations in foreign exchange rates,
while content amortization increased as a result of delays in content releases
due to the COVID-19 pandemic impacting the comparable prior year period.
The COVID-19 pandemic and the various responses to it created significant
volatility, uncertainty and economic disruption. Recently, there has been a
return to more normal societal interactions, including the way we operate our
business. We cannot predict the future impacts of this ongoing and any new
pandemic(s). See Part I, Item IA: "Risk Factors" in this Annual Report on Form
10-K for additional details.
Streaming Revenues
We derive revenues from monthly membership fees for services related to streaming content to our members. We offer a variety of streaming membership plans, the price of which varies by country and the features of the plan. As ofDecember 31, 2022 , pricing on our paid plans ranged from theU.S. dollar equivalent of$1 to$26 per month. We expect that from time to time the prices of our membership plans in each country may change and we may test other plan and price variations.
The following tables summarize streaming revenue and other streaming membership
information by region for the years ended
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As of/ Year Ended December 31, Change
2022 2021 2020 2022 vs. 2021
(inthousands, except revenue per membership and percentages) Revenues
$ 14,084,643 $ 12,972,100 $ 11,455,396 $ 1,112,543 9 % Paid net membership additions (losses) (919) 1,279 6,274 (2,198) (172) % Paid memberships at end of period (1) 74,296 75,215 73,936 (919) (1) % Average paying memberships 74,001 74,234 71,689 (233) - % Average monthly revenue per paying membership $ 15.86$ 14.56 $ 13.32 $ 1.30 9 % Constant currency change (2) 9 %
As of/ Year Ended December 31, Change
2022 2021 2020 2022 vs. 2021
(inthousands, except revenue per membership and percentages) Revenues
$ 9,745,015 $ 9,699,819 $ 7,772,252 $ 45,196 - % Paid net membership additions 2,693 7,338 14,920 (4,645) (63) % Paid memberships at end of period (1) 76,729 74,036 66,698 2,693 4 % Average paying memberships 73,904 69,518 60,425 4,386 6 % Average monthly revenue per paying membership $ 10.99$ 11.63 $ 10.72 $ (0.64) (6) % Constant currency change (2) 6 %Latin America (LATAM) As of/ Year Ended December 31, Change 2022 2021 2020 2022 vs. 2021 (in
thousands, except revenue per membership and percentages) Revenues
$ 4,069,973 $ 3,576,976 $ 3,156,727 $ 492,997 14 % Paid net membership additions 1,738 2,424 6,120 (686) (28) % Paid memberships at end of period (1) 41,699 39,961 37,537 1,738 4 % Average paying memberships 40,000 38,573 35,297 1,427 4 % Average monthly revenue per paying membership $ 8.48$ 7.73 $ 7.45 $ 0.75 10 % Constant currency change (2) 14 % Asia-Pacific (APAC) As of/ Year Ended December 31, Change 2022 2021 2020 2022 vs. 2021 (in
thousands, except revenue per membership and percentages) Revenues
$ 3,570,221 $ 3,266,601 $ 2,372,300 $ 303,620 9 % Paid net membership additions 5,391 7,140 9,259 (1,749) (24) % Paid memberships at end of period (1) 38,023 32,632 25,492 5,391 17 % Average paying memberships 35,019 28,461 21,674 6,558 23 % Average monthly revenue per paying membership $ 8.50$ 9.56 $ 9.12 $ (1.06) (11) % Constant currency change (2) (2) % 21
-------------------------------------------------------------------------------- Table of Contents (1) A paid membership (also referred to as a paid subscription) is defined as a membership that has the right to receiveNetflix service following sign-up and a method of payment being provided, and that is not part of a free trial or certain other promotions that may be offered by the Company to new or rejoining members. Certain members have the option to add extra member sub accounts. These extra member sub accounts are not included in paid memberships. A membership is canceled and ceases to be reflected in the above metrics as of the effective cancellation date. Voluntary cancellations generally become effective at the end of the prepaid membership period. Involuntary cancellations, as a result of a failed method of payment, become effective immediately. Memberships are assigned to territories based on the geographic location used at time of sign-up as determined by the Company's internal systems, which utilize industry standard geo-location technology. (2) We believe constant currency information is useful in analyzing the underlying trends in average monthly revenue per paying membership. In order to exclude the effect of foreign currency rate fluctuations on average monthly revenue per paying membership, we estimate current period revenue assuming foreign exchange rates had remained constant with foreign exchange rates from each of the corresponding months of the prior-year period. For the year endedDecember 31, 2022 , our revenues would have been approximately$1,773 million higher had foreign currency exchange rates remained constant with those for the year endedDecember 31, 2021 .
Cost of Revenues
Amortization of content assets makes up the majority of cost of revenues.
Expenses directly associated with the acquisition, licensing and production of
content (such as payroll and related personnel expenses, costs associated with
obtaining rights to music included in our content, overall deals with talent,
miscellaneous production related costs and participations and residuals),
streaming delivery costs and other operations costs make up the remainder of
cost of revenues. We have built our own global content delivery network ("Open
Connect") to help us efficiently stream a high volume of content to our members
over the internet. Delivery expenses, therefore, include equipment costs related
to Open Connect, payroll and related personnel expenses and all third-party
costs, such as cloud computing costs, associated with delivering content over
the internet. Other operations costs include customer service and payment
processing fees, including those we pay to our integrated payment partners, as
well as other costs directly incurred in making our content available to
members.
Year Ended December 31, Change
2022 2021 2020 2022 vs. 2021
(in thousands, except percentages)
Cost of revenues $ 19,168,285 $ 17,332,683 $ 15,276,319 $ 1,835,602 11 %
As a percentage of revenues 61 % 58 % 61 %
The increase in cost of revenues for the year ended
Marketing
Marketing expenses consist primarily of advertising expenses and certain
payments made to our marketing partners, including consumer electronics ("CE")
manufacturers, multichannel video programming distributors ("MVPDs"), mobile
operators and ISPs. Advertising expenses include promotional activities such as
digital and television advertising. Marketing expenses also include payroll and
related expenses for personnel that support marketing activities.
Year Ended December 31, Change
2022 2021 2020 2022 vs. 2021
(in thousands, except percentages)
Marketing $ 2,530,502 $ 2,545,146 $ 2,228,362 $ (14,644) (1) %
As a percentage of revenues 8 % 9 % 9 %
Marketing expenses for the year ended
Technology and Development
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Technology and development expenses consist primarily of payroll and related
expenses for technology personnel responsible for making improvements to our
service offerings, including testing, maintaining and modifying our user
interface, our recommendations, merchandising and infrastructure. Technology and
development expenses also include costs associated with general use computer
hardware and software.
Year Ended December 31, Change
2022 2021 2020 2022 vs. 2021
(in thousands, except percentages)
Technology and development $ 2,711,041 $ 2,273,885 $ 1,829,600 $ 437,156 19 %
As a percentage of revenues 9 % 8 % 7 %
The increase in technology and development expenses for the year ended
General and Administrative
General and administrative expenses consist of payroll and related expenses for corporate personnel. General and administrative expenses also include professional fees and other general corporate expenses.
Year Ended December 31, Change
2022 2021 2020 2022 vs. 2021
(in thousands, except percentages)
General and administrative $ 1,572,891 $ 1,351,621 $ 1,076,486 $ 221,270 16 %
As a percentage of revenues 5 % 5 % 4 %
The increase in general and administrative expenses for the year ended
Interest Expense
Interest expense consists primarily of the interest associated with our
outstanding debt obligations, including the amortization of debt issuance costs.
See Note 6 Debt in the accompanying notes to our consolidated financial
statements included in Part II, Item 8, "Financial Statements and Supplementary
Data" of this Annual Report on Form 10-K for further detail on our debt
obligations.
Year Ended December 31, Change
2022 2021 2020 2022 vs. 2021
(in thousands, except percentages)
Interest expense $ 706,212 $ 765,620 $ 767,499 $ (59,408) (8) %As a percentage of revenues 2 % 3 % 3 % Interest expense for the year endedDecember 31, 2022 consisted primarily of$698 million of interest on our Notes. The decrease in interest expense for the year endedDecember 31, 2022 as compared to the year endedDecember 31, 2021 was due to the lower average aggregate principal of interest bearing notes outstanding. 23
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Interest and Other Income (Expense)
Interest and other income (expense) consists primarily of foreign exchange gains
and losses on foreign currency denominated balances and interest earned on cash,
cash equivalents and short-term investments.
Year Ended December 31, Change
2022 2021 2020 2022 vs. 2021
(in thousands, except percentages)
Interest and other income (expense) $ 337,310 $ 411,214 $ (618,441) $ (73,904) (18) %
As a percentage of revenues 1 % 1 % (2) %
Interest and other income (expense) decreased primarily due to a foreign
exchange gain of $282 million for the year ended December 31, 2022 as compared
to a gain of $403 million for the year ended December 31, 2021 . The foreign
exchange gain in the year ended December 31, 2022 was primarily driven by the
non-cash $353 million gain from the remeasurement of our Senior Notes
denominated in euros, partially offset by the remeasurement of cash and content
liability positions in currencies other than the functional currencies. The
foreign exchange gain in the year ended December 31, 2021 was primarily driven
by the non-cash $431 million gain from the remeasurement of our Senior Notes
denominated in euros, partially offset by the remeasurement of cash and content
liability positions in currencies other than the functional currencies.
Provision for Income Taxes
Year Ended December 31, Change
2022 2021 2020 2022 vs. 2021
(in thousands, except percentages)
Provision for income taxes
$ 48,130 7 % Effective tax rate 15 % 12 % 14 % The increase in our effective tax rate for the year endedDecember 31, 2022 as compared to the year endedDecember 31, 2021 is primarily due to a reduction in excess tax benefits of stock-based compensation and an increase in foreign taxes, partially offset by the impact of international provisions of the Tax Cuts and Jobs Act and theFederal and California Research and Development ("R&D") credits.
In 2022, the difference between our 15% effective tax rate and the Federal statutory rate of 21% was primarily due to the impact of international provisions of the Tax Cuts and Jobs Act, Federal and California R&D credits, and the recognition of excess tax benefits of stock-based compensation.
Under the Tax Cuts and Jobs Act of 2017, research and development costs are no longer fully deductible and are required to be capitalized and amortized forU.S. tax purposes effectiveJanuary 1, 2022 . The mandatory capitalization requirement increases our deferred tax assets and cash tax liabilities. OnAugust 16, 2022 ,Congress passed the Inflation Reduction Act of 2022. The tax provisions most applicable to us are the newly introduced 15% corporate alternative minimum tax on book income and 1% excise tax on stock repurchases, which are both effectiveJanuary 1, 2023 . While we do not anticipate these changes to be significant, they could impact our consolidated financial position and we will continue to monitor as new information and guidance becomes available. 24
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Liquidity and Capital Resources
Year Ended December 31, Change
2022 2021 2022 vs. 2021
(in thousands, except percentages)
Cash, cash equivalents, restricted cash and
short-term investments $ 6,081,858 $ 6,055,111 $ 26,747 - %
Short-term and long-term debt 14,353,076 15,392,895 (1,039,819) (7) %
Cash, cash equivalents, restricted cash and short-term investments increased $27
million in the year ended December 31, 2022 primarily due to cash provided by
operations, partially offset by acquisitions, the repayment of debt and
purchases of property and equipment.
Debt, net of debt issuance costs, decreased $1,040 million primarily due to the
repayment upon maturity of the $700 million aggregate principal amount of our
5.500% Senior Notes in February 2022 , coupled with the remeasurement of our
euro-denominated notes. The amount of principal and interest due in the next
twelve months is $682 million . The amount of principal and interest due beyond
the next twelve months is $17,529 million . As of December 31, 2022 , no amounts
had been borrowed under our $1 billion Revolving Credit Agreement. See Note 6
Debt in the accompanying notes to our consolidated financial statements.
We anticipate that our future capital needs from the debt market will be more
limited compared to prior years. Our ability to obtain this or any additional
financing that we may choose to, or need to, obtain will depend on, among other
things, our development efforts, business plans, operating performance and the
condition of the capital markets at the time we seek financing. We may not be
able to obtain such financing on terms acceptable to us or at all. If we raise
additional funds through the issuance of equity or debt securities, those
securities may have rights, preferences or privileges senior to the rights of
our common stock, and our stockholders may experience dilution.
In March 2021 , our Board of Directors authorized the repurchase of up to
$5 billion of our common stock, with no expiration date. Stock repurchases may
be effected through open market repurchases in compliance with Rule 10b-18 under
the Exchange Act, including through the use of trading plans intended to qualify
under Rule 10b5-1 under the Exchange Act, privately-negotiated transactions,
accelerated stock repurchase plans, block purchases, or other similar purchase
techniques and in such amounts as management deems appropriate. We are not
obligated to repurchase any specific number of shares, and the timing and actual
number of shares repurchased will depend on a variety of factors, including our
stock price, general economic, business and market conditions, and alternative
investment opportunities. We may discontinue any repurchases of our common stock
at any time without prior notice. As of December 31, 2022 , the Company has
repurchased 1,182,410 shares of common stock for an aggregate amount of
$600 million . As of December 31, 2022 , $4.4 billion remains available for
repurchases.
Our primary uses of cash include the acquisition, licensing and production of
content, marketing programs, streaming delivery and personnel-related costs, as
well as for strategic acquisitions and investments. Cash payment terms for
non-original content have historically been in line with the amortization
period. Investments in original content, and in particular content that we
produce and own, require more cash upfront relative to licensed content. For
example, production costs are paid as the content is created, well in advance of
when the content is available on the service and amortized. We expect to
continue to significantly invest in global content, particularly in original
content, which will impact our liquidity. We currently anticipate that cash
flows from operations, available funds and access to financing sources,
including our revolving credit facility, will continue to be sufficient to meet
our cash needs for the next twelve months and beyond.
Our material cash requirements from known contractual and other obligations
primarily relate to our content, debt and lease obligations. As of
Obligations (in thousands): Total Next 12 Months Beyond 12 Months Content obligations (1)$ 21,831,947 $ 10,038,483 $ 11,793,464 Debt (2) 18,210,739 681,993 17,528,746 Operating lease obligations (3) 3,363,091 477,451 2,885,640 Total$ 43,405,777 $ 11,197,927 $ 32,207,850 25
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(1)As ofDecember 31, 2022 , content obligations were comprised of$4.5 billion included in "Current content liabilities" and$3.1 billion of "Non-current content liabilities" on the Consolidated Balance Sheets and$14.2 billion of obligations that are not reflected on the Consolidated Balance Sheets as they did not then meet the criteria for recognition. Content obligations include amounts related to the acquisition, licensing and production of content. An obligation for the production of content includes non-cancelable commitments under creative talent and employment agreements and other production related commitments. An obligation for the acquisition and licensing of content is incurred at the time we enter into an agreement to obtain future titles. Once a title becomes available, a content liability is recorded on the Consolidated Balance Sheets. Certain agreements include the obligation to license rights for unknown future titles, the ultimate quantity and/or fees for which are not yet determinable as of the reporting date. Traditional film output deals, or certain TV series license agreements where the number of seasons to be aired is unknown, are examples of these types of agreements. The contractual obligations table above does not include any estimated obligation for the unknown future titles, payment for which could range from less than one year to more than five years. However, these unknown obligations are expected to be significant and we believe could include approximately$1 billion to$4 billion over the next three years, with the payments for the vast majority of such amounts expected to occur after the next twelve months. The foregoing range is based on considerable management judgments and the actual amounts may differ. Once we know the title that we will receive and the license fees, we include the amount in the contractual obligations table above.
(2)Debt obligations include our Notes consisting of principal and interest payments. See Note 6 Debt in the accompanying notes to our consolidated financial statements for further details.
(3)See Note 5 Balance Sheet Components in the accompanying notes to our consolidated financial statements for further details regarding leases. As ofDecember 31, 2022 , the Company has additional operating leases for real estate that have not yet commenced of$419 million which has been included above. Total lease obligations as ofDecember 31, 2022 decreased$153 million from$3,516 million as ofDecember 31, 2021 to$3,363 million as ofDecember 31, 2022 due to payments made on lease liabilities. In addition, as ofDecember 31, 2022 , we had gross unrecognized tax benefits of$227 million , of which$155 million was classified in "Other non-current liabilities" in the Consolidated Balance Sheets. At this time, an estimate of the range of reasonably possible adjustments to the balance of unrecognized tax benefits cannot be made. Free Cash Flow We define free cash flow as cash provided by (used in) operating activities less purchases of property and equipment and change in other assets. We believe free cash flow is an important liquidity metric because it measures, during a given period, the amount of cash generated that is available to repay debt obligations, make strategic acquisitions and investments and for certain other activities like stock repurchases. Free cash flow is considered a non-GAAP financial measure and should not be considered in isolation of, or as a substitute for, net income, operating income, net cash provided by operating activities, or any other measure of financial performance or liquidity presented in accordance with GAAP. In assessing liquidity in relation to our results of operations, we compare free cash flow to net income, noting that the major recurring differences are excess content payments over amortization, non-cash stock-based compensation expense, non-cash remeasurement gain/loss on our euro-denominated debt, and other working capital differences. Working capital differences include deferred revenue, excess property and equipment purchases over depreciation, taxes and semi-annual interest payments on our outstanding debt. Our receivables from members generally settle quickly. 26
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Year Ended December 31, Change
2022 2021 2020 2022 vs. 2021
(in thousands)
Net cash provided by operating activities
(505,354) 736,539 55 %
Net cash provided by (used in) financing
activities (664,254) (1,149,776) 1,237,311 (485,522) (42) %
Non-GAAP reconciliation of free cash flow:
Net cash provided by operating activities 2,026,257 392,610 2,427,077 1,633,647 416 %
Purchases of property and equipment (407,729) (524,585) (497,923) (116,856) (22) %
Change in other assets - (26,919) (7,431) 26,919 100 %
Free cash flow $ 1,618,528 $
(158,894)
Net cash provided by operating activities increased$1,634 million from the year endedDecember 31, 2021 to$2,026 million for the year endedDecember 31, 2022 primarily driven by a$1,918 million or 6% increase in revenues, coupled with a decrease in cash payments for content assets. The payments for content assets decreased$810 million , from$17,469 million to$16,660 million , or 5%, as compared to the increase in the amortization of content assets of$1,796 million , from$12,230 million to$14,026 million , or 15%. In addition, we had increased payments associated with higher operating expenses, primarily related to increased personnel costs to support our continued improvements in our streaming service and our international expansion.
Net cash used in investing activities increased
Net cash used in financing activities decreased$486 million primarily due to there being no repurchases of common stock in the year endedDecember 31, 2022 as compared to repurchases of common stock for an aggregate amount of$600 million in the year endedDecember 31, 2021 , partially offset by the repayment upon maturity of the$700 million aggregate principal amount of our 5.500% Senior Notes inFebruary 2022 as compared to the repayment upon maturity of the$500 million aggregate principal amount of our 5.375% Senior Notes inFebruary 2021 . Free cash flow was$2,873 million lower than net income for the year endedDecember 31, 2022 primarily due to$2,634 million of cash payments for content assets over amortization expense,$353 million of non-cash remeasurement gain on our euro-denominated debt, and$461 million other non-favorable working capital differences, partially offset by$575 million of non-cash stock-based compensation expenses. Free cash flow was$5,275 million lower than net income for the year endedDecember 31, 2021 primarily due to$5,239 million of cash payments for content assets over amortization expense,$431 million of non-cash remeasurement gain on our euro-denominated debt and$8 million other non-favorable working capital differences, partially offset by$403 million of non-cash stock-based compensation expenses.
Indemnifications
The information set forth under Note 8 Guarantees - Indemnification Obligations in the accompanying notes to our consolidated financial statements included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K is incorporated herein by reference.
Critical Accounting Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted inthe United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported periods.The Securities and Exchange Commission ("SEC") has defined a company's critical accounting policies as the ones that are most important to the portrayal of a company's financial condition and results of operations, and which require a company to make its most difficult and subjective judgments. Based on this definition, we have identified the critical accounting policies and judgments addressed below. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. 27 -------------------------------------------------------------------------------- Table of Contents Content We acquire, license and produce content, including original programming, in order to offer our members unlimited viewing of video entertainment. The content licenses are for a fixed fee and specific windows of availability. Payment terms for certain content licenses and the production of content require more upfront cash payments relative to the amortization expense. Payments for content, including additions to content assets and the changes in related liabilities, are classified within "Net cash provided by (used in) operating activities" on the Consolidated Statements of Cash Flows. We recognize content assets (licensed and produced) as "Content assets, net" on the Consolidated Balance Sheets. For licensed content, we capitalize the fee per title and record a corresponding liability at the gross amount of the liability when the license period begins, the cost of the title is known and the title is accepted and available for streaming. For produced content, we capitalize costs associated with the production, including development cost, direct costs and production overhead. Participations and residuals are expensed in line with the amortization of production costs. Based on factors including historical and estimated viewing patterns, we amortize the content assets (licensed and produced) in "Cost of revenues" on the Consolidated Statements of Operations over the shorter of each title's contractual window of availability or estimated period of use or ten years, beginning with the month of first availability. The amortization is on an accelerated basis, as we typically expect more upfront viewing, and film amortization is more accelerated than TV series amortization. On average, over 90% of a licensed or produced content asset is expected to be amortized within four years after its month of first availability. We review factors that impact the amortization of the content assets on a regular basis. Our estimates related to these factors require considerable management judgment. In the normal course of business, we, or a third-party producing content on our behalf, may qualify for tax incentives through eligible spend on productions. The accounting for tax incentives is dependent on the particular type of incentive, including the nature of the benefit and the location the incentive is earned. In general, tax incentives are realized as cash receipts and may be received prior to or after a title launches on our service. Upon a title's launch, any amounts we are eligible for through qualified production spend but have not received, are recognized in "Other current assets" or "Other non-current assets" on the Consolidated Balance Sheets as receivables. Tax incentives are generally accounted for as a reduction to the cost basis of content assets (presented in "Content assets, net") and reduces content amortization over the life of the title (as presented in "Cost of revenues") on the Consolidated Statement of Operations. Our business model is subscription based as opposed to a model generating revenues at a specific title level. Content assets (licensed and produced) are predominantly monetized as a group and therefore are reviewed at a group level when an event or change in circumstances indicates a change in the expected usefulness of the content or that the fair value may be less than unamortized cost. To date, we have not identified any such event or changes in circumstances. If such changes are identified in the future, these aggregated content assets will be stated at the lower of unamortized cost or fair value. In addition, unamortized costs for assets that have been, or are expected to be, abandoned are written off. Income Taxes We record a provision for income taxes for the anticipated tax consequences of our reported results of operations using the asset and liability method. Deferred income taxes are recognized by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases as well as net operating loss and tax credit carryforwards. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance for any tax benefits for which future realization is uncertain. Although we believe our assumptions, judgments and estimates are reasonable, changes in tax laws or our interpretation of tax laws and the resolution of any tax audits could significantly impact the amounts provided for income taxes in our consolidated financial statements. In evaluating our ability to recover our deferred tax assets, in full or in part, we consider all available positive and negative evidence, including our past operating results, and our forecast of future earnings, future taxable income and prudent and feasible tax planning strategies. The assumptions utilized in determining future taxable income require significant judgment and are consistent with the plans and estimates we are using to manage the underlying business. Actual operating results in future years could differ from our current assumptions, judgments and estimates. However, we believe that it is more likely than not that most of the deferred tax assets recorded on our Consolidated Balance Sheets will ultimately be realized. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. As ofDecember 31, 2022 the valuation allowance of$343 million was related to theCalifornia research and development credits and certain foreign tax attributes that we do not expect to realize. 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 28
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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. AtDecember 31, 2022 , our estimated gross unrecognized tax benefits were$227 million of which$155 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 10 Income Taxes to the consolidated financial statements for further information regarding income taxes.
Recent Accounting Pronouncements
The information set forth under Note 1 to the consolidated financial statements under the caption "Basis of Presentation and Summary of Significant Accounting Policies" is incorporated herein by reference.
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