Intel 2014 Annual Report Download - page 38

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
We recognize liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for
recognition by determining whether the weight of available evidence indicates that it is more likely than not that the position will be
sustained on audit, including resolution of related appeals or litigation processes, if any. If we determine that a tax position will
more likely than not be sustained on audit, the second step requires us to estimate and measure the tax benefit as the largest
amount that is more than 50% likely to be realized upon ultimate settlement. We consider many factors when evaluating and
estimating our tax positions and tax benefits, which may require periodic adjustments and may not accurately forecast actual
outcomes. Determining whether an uncertain tax position is effectively settled requires judgment. Such a change in recognition or
measurement would result in the recognition of a tax benefit or an additional charge to the tax provision.
We have not recognized U.S. deferred income taxes on certain undistributed non-U.S. earnings because we plan to indefinitely
reinvest such earnings outside the U.S. Remittances of non-U.S. earnings are based on estimates and judgments of projected cash
flow needs as well as the working capital and investment requirements of our non-U.S. and U.S. operations. Material changes in our
estimates of cash, working capital, and investment needs in the various jurisdictions could require repatriation of indefinitely
reinvested non-U.S. earnings, which would be subject to U.S. income taxes and applicable non-U.S. income and withholding taxes.
Inventory
Intel has a product development lifecycle that corresponds with substantive engineering milestones. These engineering milestones
are regularly and consistently applied in assessing the point at which our activities, and associated costs, change in nature from R&D
to cost of sales. In order for a product to be manufactured in high volumes and sold to our customers under our standard warranty, it
must meet our rigorous technical quality specifications. This milestone is known as product release qualification (PRQ). We have
identified PRQ as the point at which the costs incurred to manufacture our products are included in the valuation of inventory.
To determine which costs can be included in the valuation of inventory, we must determine normal capacity at our manufacturing and
assembly and test facilities, based on historical loadings compared to total available capacity. If the factory loadings are below the
established normal capacity level, a portion of our manufacturing overhead costs would not be included in the cost of inventory;
therefore, it would be recognized as cost of sales in that period, which would negatively impact our gross margin. We refer to these
costs as excess capacity charges. Excess capacity charges were zero in 2014 ($319 million in 2013 and $540 million in 2012).
Inventory is valued at the lower of cost or market based upon assumptions about future demand and market conditions. Product-
specific facts and circumstances reviewed in the inventory valuation process include a review of our customer base, the stage of
the product life cycle of our products, consumer confidence, customer acceptance of our products, and an assessment of selling
price in relation to product cost. If the estimated market value of the inventory is less than the carrying value, we write down the
inventory and record the difference as a charge to cost of sales. Inventory reserves increased by approximately $290 million in
2014 compared to 2013. This increase was driven primarily by higher production costs on 14nm treated as period charges and
pre-qualification product costs. These increases were partially offset by the sell-through of written-down inventory and previously
non-qualified units.
The valuation of inventory also requires us to estimate obsolete and excess inventory as well as inventory that is not of saleable
quality. The demand forecast is utilized in the development of our short-term manufacturing plans to enable consistency between
inventory valuation and build decisions. The estimate of future demand is compared to work-in-process and finished goods
inventory levels to determine the amount, if any, of obsolete or excess inventory. If our demand forecast for specific products is
greater than actual demand and we fail to reduce manufacturing output accordingly, we could be required to write off inventory,
which would negatively impact our gross margin.
Loss Contingencies
We are subject to loss contingencies, including various legal and regulatory proceedings and asserted and potential claims,
accruals related to repair or replacement of parts in connection with product errata, as well as product warranties and potential
asset impairments that arise in the ordinary course of business. An estimated loss from such contingencies is recognized as a
charge to income if it is probable that a liability has been incurred and the amount of the loss can be reasonably
estimated. Disclosure of a loss contingency is required if there is at least a reasonable possibility that a material loss has been
incurred. The outcomes of legal and administrative proceedings and claims, and the estimation of product warranties and asset
impairments, are subject to significant uncertainty. Significant judgment is required in both the determination of probability and the
determination as to whether a loss is reasonably estimable. At least quarterly, we review the status of each significant matter, and
we may revise our estimates. These revisions could have a material impact on our results of operations and financial position.
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