Avid 2005 Annual Report Download - page 43

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annual impairment tests as of the end of the fourth quarter of each year and to date have concluded that no impairment charge
was required. If future events cause the reporting units’ fair value to decline below its carrying value, an impairment charge may be
required.
In the identifiable intangibles impairment analysis, if events or circumstances exist that indicate that the carrying value of an asset
may not be recoverable, the fair value of each asset is compared to its carrying value. If the asset’s carrying value is not recoverable
and exceeds its fair value, we would record an impairment loss equal to the difference between the carrying value of the asset and
its fair value. The carrying value of an asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to
result from the use and eventual disposition of the asset.
Income Tax Assets
We record deferred tax assets and liabilities based on the net tax effects of tax credits and operating loss carryforwards and
temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used
for income tax purposes.
We regularly review deferred tax assets for recoverability taking into consideration such factors as historical losses after deductions
for stock compensation, projected future taxable income and the expected timing of the reversals of existing temporary differences.
SFAS No. 109, “Accounting for Income Taxes”, requires us to record a valuation allowance when it is more likely than not that
some portion or all of the deferred tax assets will not be realized. Based on the level of deferred tax assets as of December 31,
2005, the level of historical U.S. losses after deductions for stock compensation and the level of outstanding stock options, which
we anticipate will generate significant U.S. tax deductions in the future, we have determined that the uncertainty regarding
the realization of these assets is sufficient to warrant the continued establishment of a full valuation allowance against the U.S.
net deferred tax assets. In 2004, we removed the valuation allowance related to deferred tax assets in our Irish manufacturing
operations. This resulted in a non-cash $2.1 million tax benefit recorded through our 2004 provision for income taxes. The decision
to remove the valuation allowance was based on the conclusion that it was more likely than not that the deferred tax asset in Ireland
would be realized.
Our assessment of the valuation allowance on the U.S. deferred tax assets could change in the future based upon our levels of
pre-tax income and other tax related adjustments. Removal of the valuation allowance in whole or in part would result in a non-
cash reduction in the provision for income taxes during the period of removal. In addition, because a portion of the valuation
allowance as of December 31, 2005 was established to reserve certain deferred tax assets resulting from the exercise of employee
stock options, in accordance with SFAS No. 109 and SFAS No. 123(R), removal of the valuation allowance related to these assets
would occur upon utilization of these deferred tax assets to reduce taxes payable and would result in a credit to additional paid-
in capital within stockholders’ equity rather than the provision for income taxes. If the valuation allowance of $182.1 million as of
December 31, 2005 were to be removed in its entirety, a $66.8 million non-cash reduction in income tax expense, a $49.2 million
credit to goodwill related to Pinnacle net operating loss and tax credit carryforwards and temporary differences, and a $66.1 million
credit to additional paid-in capital would be recorded in the period of removal subject to, in the latter case, actual utilization as
described above. To the extent no valuation allowance is established for our deferred tax assets in future periods, future financial
statements would reflect a non-cash increase in our provision for income taxes.
RESULTS OF OPERATIONS
Prior to the third quarter of 2005, we had classified administrative expenses incurred in Europe both internally and externally
as marketing and selling expense because these costs were incurred primarily to support our sales function in Europe. With the
Pinnacle acquisition as well as with the acquisitions of M-Audio, NXN and Avid Nordic over the past two years, we have increased
the overall scope of our operations in Europe to include not only sales but also research and development, manufacturing, customer
service and other functions, and our general and administrative infrastructure has increased accordingly. For this reason, we have
decided to classify the administrative expenses being incurred in Europe to the general and administrative expense caption in
our income statement, as opposed to the marketing and selling expense caption. All comparative periods have been reclassified
to conform to the current year presentation. The amounts reclassified were $5.7 million and $4.0 million for 2004 and 2003,
respectively.