SanDisk 2006 Annual Report Download - page 87

With respect to all equity investments, we review the degree of control that our investment and other
arrangements give us over the entity we have invested in. Generally, after considering all factors, if we hold equity
interests representing less than 20% of the outstanding voting interests of an entity we invested in, we use the cost
method of accounting. If we hold at least 20% but less than a majority of the outstanding voting interests of an entity
we invested in, we use the equity method of accounting.
We have the financial capability and the intent to hold our loans to the ventures with Toshiba until maturity and
accordingly those loans are carried at cost and their value in our financial statements is not adjusted to market value.
Changes in our intent could materially impact our financial statements.
Deferred Tax Assets. We must make certain estimates and judgments in determining income tax expense for
financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and
liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial
statement purposes.
We must assess the likelihood that we will be able to recover our deferred tax assets. We consider historical
levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and
feasible tax planning strategies in assessing the need for the valuation allowance. If recovery is not likely, we must
increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate
will not ultimately be recoverable. We carried a valuation allowance on our deferred tax assets of $60.1 million and
$14.9 million at December 31, 2006 and January 1, 2006, respectively, based on our view that it is more likely than
not that we will not be able to take tax a benefit for certain net operating loss carryforwards, certain capitalized
expenses and certain unrealized capital losses on our investments in foundries.
Share-Based Compensation — Employee Incentive Plans and Employee Stock Purchase Plans. Beginning
on January 2, 2006, we began accounting for stock awards and ESPP shares under the provisions of Statement of
Financial Accounting Standards No. 123(R), or SFAS 123(R), Share-Based Payments, which requires the recog-
nition of the fair value of share-based compensation. The fair value of stock awards and ESPP shares was estimated
using a Black-Scholes-Merton closed-form option valuation model. This model requires the input of assumptions in
implementing SFAS 123(R), including expected stock price volatility, expected term and estimated forfeitures of
each award. The parameters used in the model are reviewed and adjusted on a quarterly basis. We elected the
modified-prospective method for adoption of SFAS 123(R). We recognized compensation expense for the fair
values of these awards, which have graded vesting, on a straight-line basis over the requisite service period of each
of these awards, net of estimated forfeitures at a rate of 7.74%. We make quarterly assessments of the adequacy of
the APIC credit pool generated by previous share-based excess tax benefits to determine if there are any tax
deficiencies which require recognition in the condensed consolidated statements of income. Prior to the imple-
mentation of SFAS 123(R), we accounted for stock awards and ESPP shares under the provisions of Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and made pro forma footnote
disclosures as required by Statement of Financial Accounting Standards No. 148, or SFAS 148, Accounting For
Stock-Based Compensation — Transition and Disclosure, which amended Statement of Financial Accounting
Standards No. 123, Accounting For Stock-Based Compensation. Pro forma net income and pro forma net income
per share disclosed in the footnotes to the consolidated condensed financial statements were estimated using a
Black-Scholes-Merton closed-form option valuation model to determine the estimated fair value and by attributing
such fair value over the requisite service period on a straight-line basis for those awards that actually vested. The fair
value of restricted stock units was calculated based upon the fair market value of our common stock on the date of
grant.
Business Combinations. In accordance with the provisions of Statement of Financial Accounting Standard
No. 141, or SFAS 141, Business Combinations, we allocate the purchase price of acquired companies to the tangible
and intangible assets acquired, liabilities assumed, and in-process research and development based on their
estimated fair values. We engage third-party appraisal firms to assist management in determining the fair values of
certain assets acquired and liabilities assumed. Such a valuation requires management to make significant estimates
and assumptions, especially with respect to intangible assets.
Management makes estimates of fair value based upon assumptions believed to be reasonable. These estimates
are based on historical experience and information obtained from the management of the acquired companies and
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