SanDisk 2007 Annual Report Download - page 85

our products within specific time horizons, generally six to twelve months. To the extent our demand forecast for
specific products is less than our product on hand and our noncancelable orders, we could be required to record
additional inventory reserves, which would have a negative impact on our gross margin.
Accounting for Variable Interest Entities. We evaluate whether entities in which we have invested are
variable interest entities within the definition of the Financial Accounting Standards Board, or FASB, Interpretation
No. 46R, or FIN 46R, Accounting for Variable Interest Entities. If those entities are variable interest entities, or
VIEs, we then determine whether we are the primary beneficiary of that entity by reference to our contractual and
business arrangements with respect to expected gains and losses. The assessment of the primary beneficiary
includes an analysis of the forecast and contractual stipulations of the VIE. Determining whether we would
consolidate or apply the equity method to a particular VIE requires review of the VIE’s forecast, which involves
analysis of company specific data, industry data, known trends and uncertainties, which are inherently subjective.
Consolidating a VIE under FIN 46R rather than using the equity method can materially impact revenue, gross
margin and operating income trends.
Deferred Tax Assets. We must make certain estimates in determining income tax expense for financial
statement purposes. These estimates 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. In
determining the need for and amount of our valuation allowance, we assess the likelihood that we will be able to
recover our deferred tax assets using historical levels of income, estimates of future income and tax planning
strategies. While we have been profitable over the last several years, we compete in an industry with recurring
average selling price declines. These price declines require us to apply judgment related to our forecast of future
profitability and our recoverability of net deferred tax assets. Unanticipated downturns, alternative technologies or
other negative factors in a continually changing high technology industry could result in declining future
profitability and have an adverse impact on the recoverability of deferred tax assets.
Our estimates for tax uncertainties require substantial judgment based upon the period of occurrence,
complexity of the matter, available federal tax case law, interpretation of foreign laws and regulations and other
estimates. There is no assurance that domestic or international tax authorities will agree with the tax positions we
have taken which could materially impact future results.
Share-Based Compensation — Employee Incentive Plans and Employee Stock Purchase Plans. Accounting
for share-based compensation awards and accounting for Employee Stock Purchase Plan, or ESPP, shares are based
upon the provisions of Statement of Financial Accounting Standards No. 123(R), or SFAS 123(R), Share-Based
Payments, which requires the recognition of the fair value of share-based compensation. The fair value of share-
based awards and ESPP shares was estimated using a Black-Scholes-Merton closed-form option valuation model.
The Black-Scholes-Merton 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 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 7.59%. We make quarterly assessments of the adequacy of the APIC
credit pool generated by previous share-based compensation excess tax benefits to determine if there are any tax
deficiencies which require recognition in the consolidated statements of income. 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 Standards
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. Management makes significant estimates and assumptions, which are believed to be
reasonable, in determining the fair values of certain assets acquired and liabilities assumed, especially with
respect to intangible assets. These estimates are based on historical experience and information obtained from the
management of the acquired companies and are inherently uncertain. Critical estimates in valuing certain of the
intangible assets include but are not limited to future expected cash flows from product sales, customer relation-
ships, acquired developed technologies and patents, expected costs to develop the in-process research and
development into commercially viable products and estimated cash flows from the projects when completed,
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