3Ware 2002 Annual Report Download - page 37

Inventory Valuation
Our policy is to value inventories at the lower of cost or market on a part-by-part basis. This policy requires
us to make estimates regarding the market value of our inventories, including an assessment of excess or obsolete
inventories. We determine excess and obsolete inventories based on an estimate of the future demand for our
products within a specified time horizon, generally 12 months. The estimates we use for demand are also used for
near-term capacity planning and inventory purchasing and are consistent with our revenue forecasts. If our
demand forecast is greater than our actual demand we may be required to take additional excess inventory
charges, which will decrease gross margin and net operating results in the future. In addition, as a result of the
expansion of our internal manufacturing capacity during fiscal 2001 and the subsequent downturn in the
communications industry, we have excess capacity in our manufacturing facilities. Currently, we are not
capitalizing any inventory costs related to this excess capacity as the recoverability of such costs is not certain.
The application of this policy adversely affected our gross margin in fiscal 2002.
Goodwill and Intangible Asset Valuation
The identification of intangible assets and determination of the fair value of certain assets and liabilities
acquired is subjective in nature and often involves the use of significant estimates and assumptions. Determining
the fair values and useful lives of intangible assets especially requires the exercise of judgment. To assist us in
this process we used an independent valuation firm. While a number of different methods can be used for the
estimation of the value of intangibles acquired, we primarily used the discounted cash flow method. This method
relies on a number of estimates and assumptions, including projected future cash flows, residual growth rates and
discount factors. Most of these assumptions were made based on available historical information and industry
averages. The judgments made in determining the estimated useful lives assigned to each class of assets acquired
can also significantly affect net income. Under the new guidance of Statement of Financial Accounting Standards
142 (“SFAS 142”), which we will adopt in the first quarter of fiscal 2003, we will no longer amortize goodwill or
other intangible assets with indefinite lives. If we had been able to identify more intangible assets with definite
lives and recorded less goodwill in our acquisitions, our future reported results would have been lower.
The value of our intangible assets, including goodwill, is exposed to future adverse changes if we
experience declines in operating results or significant negative industry or economic trends or if our future
performance is below projections. We periodically review our intangible assets and goodwill for impairment. Our
impairment review is based on a discounted cash flow approach. The estimates we have used are consistent with
the plans and estimates that we use to manage our business. If we fail to gain market acceptance or if our market
projections are too high, our revenue and cost forecasts will not be achieved, and we will incur impairment
charges to goodwill.
In the first quarter of fiscal 2003, we will adopt the new rules contained in SFAS 142 for measuring the
impairment of goodwill and certain intangible assets. The estimates and assumptions described above, as well as
the determination as to how goodwill will be allocated to our operating segments, will affect the amount of any
impairment to be recognized upon adoption of SFAS 142.
Valuation of Strategic Equity Investments
We enter into certain equity investments for the promotion of business and strategic objectives. Our policy
is to value these investments at our historical cost. In addition, our policy requires us to periodically review these
investments for impairment. For these investments, an impairment analysis requires significant judgment,
including an assessment of the investees’ financial condition, existence and valuation of subsequent rounds of
financing and the impact of any contractual preferences, as well as the investees’ historical results, projected
results and prospects for additional financing. If the actual outcomes for the investees are significantly different
from our estimates, our recorded impairments may be understated, and we may incur additional charges in future
periods.
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