Western Digital 2006 Annual Report Download - page 60

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* For purposes of computing diluted income per share, common share equivalents with an exercise price that exceeded
the average fair market value of common stock for the period are considered antidilutive and have been excluded from
the calculation for employee stock options.
Stock-Based Compensation
Effective July 2, 2005, the Company accounts for all stock-based compensation in accordance with the fair value
recognition provisions in SFAS No. 123-R, “Share-Based Payment.” Under the fair value recognition provisions of
SFAS No. 123-R, stock-based compensation cost is measured at the grant date based on the value of the award and is
recognized on a straight-line basis as expense over the vesting period. Under SFAS No. 123-R, the Company is required
to use judgment in estimating the amount of stock-based awards that are expected to be forfeited. If actual forfeitures
differ significantly from the original estimate, stock-based compensation expense and the results of operations could be
materially impacted.
Prior to the adoption of SFAS No. 123-R, the Company accounted for stock-based employee compensation plans
(including shares or other equity instruments issued under its stock incentive plans and employee stock purchase plan) in
accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and its
related interpretations (“APB No. 25”), and followed the pro forma net income, pro forma income per share, and stock-
based compensation plan disclosure requirements set forth in SFAS No. 123, “Accounting for Stock-Based
Compensation.”
The fair values of all stock options granted subsequent to January 1, 2005 were estimated using a binomial model
and the fair values of all options granted prior to December 31, 2004 and all ESPP shares were estimated using the Black-
Scholes-Merton option pricing model. Both the binomial and the Black-Scholes-Merton models require the input of
highly subjective assumptions.
Other Comprehensive Income
Other comprehensive income refers to revenue, expenses, gains and losses that are recorded as an element of
shareholders’ equity but are excluded from net income. The Company’s other comprehensive income is comprised of
unrealized gains and losses on foreign currency contracts and marketable securities categorized as available for sale under
SFAS No. 115.
Foreign Exchange Contracts
Although the majority of the Company’s transactions are in U.S. Dollars, some transactions are based in various
foreign currencies. The Company purchases short-term, forward exchange contracts to hedge the impact of foreign
currency fluctuations on certain underlying assets, liabilities and commitments for operating expenses and product costs
denominated in foreign currencies. The contracts have maturity dates that do not exceed six months. The Company does
not purchase short-term forward exchange contracts for trading purposes.
The Company applies the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging
Activities”, as amended, which establishes accounting and reporting standards for derivative instruments embedded in
other contracts and for hedging activities. The Company had outstanding forward exchange contracts with commercial
banks for the Thai Baht, British Pound Sterling and Euro with values of $263.8 million and $151.4 million at June 30,
2006 and July 1, 2005, respectively. Thai Baht contracts are designated as cash flow hedges under SFAS No. 133. If the
derivative is designated as a cash flow hedge, the effective portion of the change in fair value of the derivative is initially
deferred in other comprehensive income (loss), net of tax. These amounts are subsequently recognized into earnings when
the underlying cash flow being hedged is recognized into earnings. Hedge effectiveness is measured by comparing the
hedging instrument’s cumulative change in fair value from inception to maturity to the underlying exposure’s terminal
value. The Company has determined that all of its hedging instruments for all years presented were fully effective as
defined under SFAS No. 133.
54
WESTERN DIGITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)