UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

Commission file number 000-51593

SunPower Corporation

(Exact name of registrant as specified in its charter)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  o    Accelerated filer  x    Non-accelerated filer  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x

The total number of outstanding shares of the registrant’s class A common stock as of August 3, 2007 was 38,782,013.

The total number of outstanding shares of the registrant’s class B common stock as of August 3, 2007 was 44,533,287.

SunPower Corporation

INDEX TO FORM 10-Q

			Page
PART I. FINANCIAL INFORMATION
Item 1.		Financial Statements (unaudited)
		Condensed Consolidated Balance Sheets as of July 1, 2007 and December 31, 2006	3
		Condensed Consolidated Statements of Operations for the three and six months ended July 1, 2007 and July 2, 2006	4
		Condensed Consolidated Statements of Cash Flows for the six months ended July 1, 2007 and July 2, 2006	5
		Notes to Condensed Consolidated Financial Statements	6-28
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations	29-44
Item 3.		Quantitative and Qualitative Disclosure About Market Risks	45
Item 4.		Controls and Procedures	45
PART II. OTHER INFORMATION			46
Item 1A.		Risk Factors	46
Item 4.		Submission of Matters to a Vote of Security Holders	81
Item 6.		Exhibits	82
Signatures			83
Index to Exhibits

 

PART I. FINANCIAL INFORMATION

Item 1.                                     Financial Statements

SunPower Corporation

Condensed Consolidated Balance Sheets

(in thousands, except share data)

(unaudited)

		July 1, 2007			December 31, 2006
Assets
Current assets:
Cash and cash equivalents		$	150,352		$	165,596
Short-term investments		25,555			16,496
Accounts receivable, net		93,053			51,680
Costs and estimated earnings in excess of billings		23,459			—
Inventories		100,771			22,780
Deferred project costs		24,935			—
Prepaid expenses and other current assets		34,895			16,655
Current portion of advances to suppliers		10,238			15,394
Total current assets		463,258			288,601
Property, plant and equipment, net		295,776			202,428
Goodwill		179,734			2,883
Intangible assets, net		64,936			14,049
Advances to suppliers, net of current portion		82,984			62,242
Other long-term assets		23,604			6,633
Total assets		$	1,110,292		$	576,836
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		$	115,625		$	26,534
Accounts payable to Cypress		5,902			2,909
Accrued liabilities		40,207			18,585
Billings in excess of costs and estimated earnings		48,574			—
Current portion of customer advances		8,340			12,304
Total current liabilities		218,648			60,332
Convertible debt		200,000			—
Deferred tax liability		13,552			46
Customer advances, net of current portion		21,488			27,687
Other long-term liabilities		7,581			—
Total liabilities		461,269			88,065
Commitments and contingencies (Note 13)
Stockholders’ equity:
Preferred stock, $0.001 par value per share; 10,042,490 shares authorized; none issued and outstanding		—			—
Common stock, $0.001 par value; 375,000,000 shares authorized; 79,261,288 and 69,849,369 shares issued and outstanding at July 1, 2007 and December 31, 2006, respectively		76			70
Additional paid-in capital		684,469			522,819
Accumulated other comprehensive income (loss)		600			(2,101		)
Accumulated deficit		(36,122		)	(32,017		)
Total stockholders’ equity		649,023			488,771
Total liabilities and stockholders’ equity		$	1,110,292		$	576,836

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

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SunPower Corporation

Condensed Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)

		Three Months Ended						Six Months Ended
		July 1, 2007			July 2, 2006			July 1, 2007			July 2, 2006
Revenue:
Systems		$	104,037		$	—		$	182,532		$	—
Components		69,729			54,695			133,581			96,653
		173,766			54,695			316,113			96,653
Costs and expenses:
Cost of systems revenue		91,518			—			153,984			—
Cost of components revenue		52,456			43,248			99,912			79,514
Research and development		2,821			2,588			5,757			4,584
Purchased in-process research and development		—			—			9,575			—
Sales, general and administrative		26,109			4,985			48,480			9,366
Impairment of acquisition-related intangibles		14,068			—			14,068			—
Total costs and expenses		186,972			50,821			331,776			93,464
Operating income (loss)		(13,206		)	3,874			(15,663		)	3,189
Interest income		2,196			2,078			4,180			3,252
Interest expense		(1,085		)	(509		)	(2,204		)	(849		)
Other income (expense), net		(517		)	353			(243		)	490
Income (loss) before income taxes		(12,612		)	5,796			(13,930		)	6,082
Income tax provision (benefit)		(7,267		)	412			(9,825		)	443
Net income (loss)		$	(5,345	)	$	5,384		$	(4,105	)	$	5,639
Net income (loss) per share:
Basic		$	(0.07	)	$	0.08		$	(0.06	)	$	0.09
Diluted		$	(0.07	)	$	0.08		$	(0.06	)	$	0.08
Weighted-average shares:
Basic		75,123			64,040			74,428			62,583
Diluted		75,123			69,408			74,428			68,172

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

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SunPower Corporation

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

		Six Months Ended
		July 1, 2007			July 2, 2006
Cash flows from operating activities:
Net income (loss)		$	(4,105	)	$	5,639
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation		11,486			7,459
Amortization of intangibles		14,551			2,350
Amortization of debt issuance costs		479			—
Impairment of acquisition-related intangibles		14,068			—
Stock-based compensation		23,833			2,549
Purchased in-process research and development		9,575			—
Loss on disposal of fixed assets		—			48
Deferred income taxes and other tax liabilities		(10,568		)	(940		)
Changes in operating assets and liabilities, net of effects of acquisition:
Accounts receivable		(215		)	(8,765		)
Costs and estimated earnings in excess of billings		(14,323		)	—
Inventories		(49,438		)	(8,349		)
Prepaid expenses and other assets		(3,893		)	35
Deferred project costs		990			—
Advances to suppliers		(15,586		)	(19,176		)
Accounts payable and other accrued liabilities		14,169			11,675
Accounts payable to Cypress		2,993			729
Billings in excess of costs and estimated earnings		11,503			—
Advances from customers		(10,163		)	4,713
Net cash used in operating activities		(4,644		)	(2,033		)
Cash flows from investing activities:
Decrease in restricted cash		4,711			—
Purchase of property, plant and equipment		(103,844		)	(33,384		)
Purchase of available-for-sale securities		(25,555		)	(22,900		)
Proceeds from sale of available-for-sale securities		16,496			3,000
Note receivable from PowerLight		—			(10,000		)
Cash paid for acquisition, net of cash acquired		(98,645		)	—
Net cash used in investing activities		(206,837		)	(63,284		)
Cash flows from financing activities:
Proceeds from issuance of convertible debt		200,000			—
Convertible debt issuance costs		(6,030		)	—
Principal payments on line of credit and notes payable		(3,563		)	—
Proceeds from issuance of common stock, net		—			197,431
Proceeds from exercise of stock options		4,969			1,787
Net cash provided by financing activities		195,376			199,218
Effect of exchange rate changes on cash and cash equivalents		861			—
Net increase (decrease) in cash and cash equivalents		(15,244		)	133,901
Cash and cash equivalents at beginning of period		165,596			143,592
Cash and cash equivalents at end of period		$	150,352		$	277,493
Non-cash investing and financing activities:
Issuance of common stock for purchase acquisition		$	111,266		—
Stock options assumed in relation to acquisition		21,280			—
Change in goodwill relating to adjustments to acquired net assets		1,689			—

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

5

SunPower Corporation

Notes to Condensed Consolidated Financial Statements

Note 1. The Company and Basis of Presentation

The Company

SunPower Corporation (the “Company” or “SunPower”), a majority-owned subsidiary of Cypress Semiconductor Corporation (“Cypress”), was originally incorporated in the State of California on April 24, 1985. In October 1988, the Company organized as a business venture to commercialize high-efficiency solar cell technologies. The Company designs, manufactures and markets high-performance solar electric power technologies. The Company’s solar cells and solar panels are manufactured using proprietary processes and technologies based on more than 15 years of research and development. The Company’s solar power products are sold through the components business segment.

On November 10, 2005, the Company reincorporated in Delaware and filed an amendment to its certificate of incorporation to effect a 1-for-2 reverse stock split of the Company’s outstanding and authorized shares of common stock. All share and per share figures presented herein have been adjusted to reflect the reverse stock split.

In November 2005, the Company raised net proceeds of $145.6 million in an initial public offering (the “IPO”) of 8.8 million shares of class A common stock at a price of $18.00 per share. In June 2006, the Company completed a follow-on public offering of 7.0 million shares of its class A common stock, at a per share price of $29.50, and received net proceeds of $197.4 million. In July 2007, the Company completed a follow-on public offering of 2.7 million shares of its class A common stock, at a discounted per share price of $64.50, and received net proceeds of $167.7 million (see Note 16).

In February 2007, the Company issued $200.0 million in principal amount of its 1.25% senior convertible debentures and lent 2.9 million shares of its class A common stock to Lehman Brothers Inc. Net proceeds from the issuance of senior convertible debentures in February 2007 were $194.0 million. The Company did not receive any proceeds from the 2.9 million lent shares of its class A common stock, but received a nominal lending fee (see Note 15). In July 2007, the Company issued $225.0 million in principal amount of its 0.75% senior convertible debentures and lent 1.8 million shares of its class A common stock to Credit Suisse International.  Net proceeds from the issuance of senior convertible debentures in July 2007 were $220.1 million. The Company did not receive any proceeds from the 1.8 million lent shares of class A common stock, but received a nominal lending fee (see Note 16).

In January 2007, the Company completed the acquisition of PowerLight Corporation (“PowerLight”), a privately-held company which developed, engineered, manufactured and delivered large-scale solar power systems for residential, commercial, government and utility customers worldwide. These activities are now performed by the Company’s systems business segment. As a result of the acquisition, PowerLight became an indirect wholly owned subsidiary of the Company. In June 2007, the Company changed PowerLight’s name to SunPower Corporation, Systems (“SP Systems”), to capitalize on SunPower’s name recognition. The Company believes the acquisition will enable the Company to develop the next generation of solar products and solutions that will accelerate solar system cost reductions to compete with retail electric rates without incentives and simplify and improve customer experience. The total consideration for the transaction was $334.4 million, consisting of $120.7 million in cash and $213.7 million in common stock and related acquisition costs (see Note 6).

Cypress made a significant investment in the Company in 2002. On November 9, 2004, Cypress completed a reverse triangular merger with the Company in which all of the outstanding minority equity interest of SunPower was retired, effectively giving Cypress 100% ownership of all of the Company’s then outstanding shares of capital stock but leaving its unexercised warrants and options outstanding. After completion of the Company’s IPO in November 2005, Cypress held, in the aggregate, 52,033,287 shares of class B common stock. On May 4, 2007, Cypress completed the sale of 7,500,000 shares of the Company’s class B common stock in an offering pursuant to Rule 144 of the Securities Act. Such shares converted to 7,500,000 shares of class A common stock upon the sale. As of July 1, 2007, including the effect of the sale completed in May 2007 and the secondary public offering in June 2006, Cypress owned 44,533,287 shares of the Company’s class B common stock, which represented approximately 59% of the total outstanding shares of the Company’s common stock, or approximately 55% of such shares on a fully diluted basis after taking into account outstanding stock options (or 53% of such shares on a fully diluted basis after taking into account outstanding stock options and loaned shares to underwriters of the Company’s convertible indebtedness), and  91% of the voting power of the Company’s total outstanding common stock. After the public offerings of class A common stock and senior convertible debentures on July 31, 2007, Cypress held approximately 57% of the total outstanding shares of the Company’s common stock, or approximately 53% of such shares on a fully diluted basis after taking into account outstanding stock options (or 50% of such shares on a fully diluted basis after taking into account outstanding stock options and loaned shares to underwriters of the Company’s convertible indebtedness) and 90% of the voting power of the Company’s total outstanding common stock.

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The financial statements include allocations of certain Cypress expenses, including legal, tax, treasury, information technology, employee benefits and other Cypress corporate services and infrastructure costs. The expense allocations have been determined based on a method that Cypress and the Company consider to be a reasonable reflection of the utilization of services provided or the benefit received by the Company. The financial information included herein may not be indicative of the consolidated financial position, operating results, and cash flows of the Company in the future, or what they would have been had the Company been a separate stand-alone entity during the periods presented. See Note 8 for additional information on the transactions with Cypress.

As of July 1, 2007, the Company had an accumulated deficit of $36.1 million and, with the exception of fiscal 2006 and the quarter ended April 1, 2007, has a history of operating losses. The Company is subject to a number of business risks including, but not limited to, integration difficulties as a result of the acquisition of SP Systems, an industry-wide shortage of polysilicon, an essential raw material in the production of solar cells, limited suppliers for capital equipment, concentration of revenue among few customers, competition from other companies with a longer operating history and significantly greater financial resources, dependency on a third-party subcontractor, dependence on key employees, and the ability to attract and retain additional qualified personnel.

Fiscal Year

The Company reports on a fiscal-year basis and ends its quarters on the Sunday closest to the end of the applicable calendar quarter, except in a 53-week fiscal year, in which case the additional week falls into the fourth quarter of that fiscal year. Both fiscal 2006 and 2007 consist of 52 weeks. The second quarter of fiscal 2007 ended on July 1, 2007 and the second quarter of fiscal 2006 ended on July 2, 2006.

Significant Accounting Policies

The Company’s significant accounting policies are disclosed in the Company’s Form 10-K for the year ended December 31, 2006 and have not changed materially as of July 1, 2007, with the exception of the following:

In connection with the acquisition of SP Systems on January 10, 2007, the following accounting policies were adopted as of the quarter ended April 1, 2007.

Revenue and Cost Recognition for Construction Contracts

The Company recognizes revenues from fixed price contracts under AICPA Statement of Position (“SOP”) 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts,” using the percentage-of-completion method of accounting. Under this method, revenue is recognized as work is performed based on the percentage of incurred costs to estimated total forecasted costs utilizing the most recent estimates of forecasted costs.

Incurred costs include all direct material, labor, subcontract costs, and those indirect costs related to contract performance, such as indirect labor, supplies, tools and repairs. Job material costs are included in incurred costs when the job materials have been installed. Where contracts stipulate that title to job materials transfers to the customer before installation has been performed, revenue is deferred and recognized upon installation, in accordance with the percentage-of-completion method of accounting. Job materials are considered installed materials when they are permanently attached or fitted to the solar power system as required by the job’s engineering design.

Due to inherent uncertainties in estimating cost, job costs estimates are reviewed and/or updated by management working within the systems segment. The systems segment determines the completed percentage of installed job materials at the end of each month; generally this information is also reviewed with the customer’s on-site representative. The completed percentage of installed job materials is then used for each job to calculate the month-end job material costs incurred. Direct labor, subcontractor, and other costs are charged to contract costs as incurred. Provisions for estimated losses on uncompleted contracts, if any, are recognized in the period in which the loss first becomes probable and reasonably estimable. Contracts may include profit incentives such as milestone bonuses. These profit incentives are included in the contract value when their realization is reasonably assured.

As of July 1, 2007, the asset “Costs and estimated earnings in excess of billings,” which represents revenues recognized in excess of amounts billed, was $23.5 million. The liability “Billings in excess of costs and estimated earnings,” which represents billings in excess of revenues recognized, was $48.6 million.

Cash in Restricted Accounts

Cash in restricted accounts represents collateral for letters of credit issued by a commercial bank in favor of Company’s suppliers and customers. Generally, the funds will be released upon payment to the suppliers and the successful completion of the customer contracts. As of July 1, 2007, the Company did not have cash in restricted accounts.

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Deferred Project Costs

Deferred project costs represent uninstalled materials on contracts for which title had transferred to the customer and are recognized as deferred assets until installation. As of July 1, 2007, deferred project costs totaled $24.9 million.

Foreign Currency Translation

Assets and liabilities of SP Systems’ wholly-owned foreign subsidiaries are translated from their respective functional currencies at exchange rates in effect at the balance sheet date, and revenues and expenses are translated at average exchange rates prevailing during the applicable period. The resulting translation adjustment as of July 1, 2007 was $1.9 million and is reflected as a component of accumulated other comprehensive income (loss) in stockholders’ equity.

Basis of Presentation

The accompanying condensed consolidated interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. The year-end condensed balance sheet data was derived from audited financial statements. Accordingly, these financial statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. In the opinion of management, the accompanying condensed consolidated financial statements contain all adjustments, consisting only of normal recurring adjustments, which the Company believes are necessary for a fair statement of the Company’s financial position as of July 1, 2007 and its results of operations for the three and six months ended July 1, 2007 and July 2, 2006, respectively. These condensed consolidated financial statements are not necessarily indicative of the results to be expected for the entire year.

Recent Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, and Related Implementation Issues” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a Company’s financial statements in accordance with FASB 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attribute for a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The Company adopted FIN 48 in the first quarter of fiscal 2007 (see Note 11).

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value instruments. This statement does not require any new fair value measurements; rather, it applies under other accounting pronouncements that require or permit fair value measurements. The provisions of this statement are to be applied prospectively as of the beginning of the fiscal year in which this statement is initially applied, with any transition adjustment recognized as a cumulative effect adjustment to the opening balance of retained earnings. The provisions of SFAS No. 157 are effective for fiscal years beginning after November 15, 2007. The Company has not determined the effect, if any, the adoption of this statement will have on its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” (“SFAS No. 159”) which provides companies an option to report selected financial assets and liabilities at fair value. SFAS No. 159 requires companies to provide information helping financial statement users to understand the effect of a company’s choice to use fair value on its earnings, as well as to display the fair value of the assets and liabilities a company has chosen to use fair value for on the face of the balance sheet. Additionally, SFAS No. 159 establishes presentation and disclosure requirements designed to simplify comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The statement is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. The Company has not determined the effect, if any, the adoption of this statement will have on its consolidated financial statements.

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Note 2. Balance Sheet Components

(In thousands)		July 1, 2007			December 31, 2006
Inventories:
Raw materials*		$	52,970		$	8,703
Work-in-process		1,314			79
Finished goods		46,487			13,998
		$	100,771		$	22,780
* Raw materials include solar panels purchased from third party vendors, installation materials for systems projects, polysilicon and other raw materials for solar cell manufacturing as of July 1, 2007.
Prepaid expenses and other current assets:
Deferred tax asset, current portion		$	7,501		$	1,446
Note receivable from PowerLight		—			10,000
Unbilled earned rebates		5,168			—
Prepaid materials		4,531			—
VAT receivable, current portion		2,651			48
Prepaid corporate insurance		1,306			460
Other receivables		7,675			1,452
Other prepaid expenses		6,063			3,249
		$	34,895		$	16,655
Property, plant and equipment, net:
Land and buildings		$	7,482		$	7,304
Manufacturing equipment		129,718			120,104
Computer equipment		8,091			2,496
Furniture and fixtures		152			83
Leasehold improvements		49,598			45,175
Construction-in-process (manufacturing facility in the Philippines)		138,287			53,252
		333,328			228,414
Less: Accumulated depreciation and amortization		(37,552		)	(25,986		)
		$	295,776		$	202,428
Intangible assets:
Patents and purchased technology		$	51,398		$	21,950
Tradenames		1,603			1,603
Backlog		11,787			—
Customer relationships and other		23,193			463
		87,981			24,016
Accumulated amortization of intangible assets:
Patents and purchased technology		(14,562		)	(8,973		)
Tradenames		(678		)	(548		)
Backlog		(5,566		)	—
Customer relationships and other		(2,239		)	(446		)
		(23,045		)	(9,967		)
		$	64,936		$	14,049
The estimated future amortization expense related to intangible assets as of July 1, 2007 is as follows:
2007 (remaining six months)		$	13,716
2008		15,350
2009		14,740
2010		13,228
2011 and beyond		7,902
		$	64,936

 

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(In thousands)		July 1, 2007			December 31, 2006
Other long-term assets:
Investment in joint venture		$	4,792		$	4,994
Debt issuance costs		5,559			—
VAT receivable, net of current portion		12,751			—
Other		502			1,639
		$	23,604		$	6,633
Accrued liabilities:
Warranty reserve, current portion		$	8,460		$	3,446
Employee compensation and employee benefits		13,488			3,961
Foreign exchange derivative liability		3,559			4,849
Income taxes payable		4,681			1,995
Other		10,019			4,334
		$	40,207		$	18,585
Long-term liabilities:
Warranty reserve, net of current portion		$	5,854		$	—
Other		1,727			—
		$	7,581		$	—

 

Note 3. Investments

Cash and cash equivalents and short-term investments classified as available-for-sale securities were comprised of the following:

		July 1, 2007												December 31, 2006
					Unrealized												Unrealized
(In thousands)		Cost			Gross Gains			Gross Losses			Fair Value			Cost			Gross Gains			Gross Losses			Fair Value
Corporate securities		$	9,600		$	—		$	—		$	9,600		$	13,400		$	—		$	—		$	13,400
Money market securities		95,425			—			—			95,425			135,298			—			—			135,298
Commercial paper		38,388			—			—			38,388			28,739			—			(4		)	28,735
Total available-for-sale securities		$	143,413		$	—		$	—		$	143,413		$	177,437		$	—		$	(4	)	$	177,433

 

The classification and contractual maturities of available-for-sale securities is as follows:

(In thousands)		July 1, 2007			December 31, 2006
Included in:
Cash and cash equivalents		$	117,858		$	160,937
Short-term investments		25,555			16,496
		$	143,413		$	177,433
Contractual maturities:
Due in less than one year		$	133,813		$	164,033
Due from one to 30 years		9,600			13,400
		$	143,413		$	177,433

 

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From time to time the Company invests in auction rate securities, which are bought and sold in the marketplace through a bidding process sometimes referred to as a “Dutch Auction,” and which are classified as short-term investments and carried at their market values. After the initial issuance of the securities, the interest rate on the securities resets periodically, at intervals set at the time of issuance (e.g., every seven, twenty-eight, or thirty-five days; every six months; etc.), based on the market demand at the reset period. The “stated” or “contractual” maturities for these securities, however, generally are 20 to 30 years. Despite the long-term maturities, the Company has the ability and intent, if necessary, to liquidate any of these investments in order to meet the Company’s working capital needs within its normal operating cycles. At July 1, 2007, the Company had $9.6 million invested in auction rate securities as compared to $13.4 million invested in auction rate securities at December 31, 2006.

The Company classifies these investments as available-for-sale securities under Statement of Financial Accounting Standards No. 115 “Accounting for Investment in Certain Debt and Equity Securities” (SFAS No. 115). As these securities trade at their par values, no gains or losses are recorded in comprehensive income.

Note 4. Net Income (Loss) per Share

Basic net income (loss) per share is computed using the weighted-average common shares outstanding. Diluted net income (loss) per share is computed using the weighted-average common shares outstanding plus any potentially dilutive securities outstanding during the period using the treasury stock method, except when their effect is anti-dilutive. In computing dilutive net income (loss) per share, the average stock price for the period is used in determining the number of shares assumed to be purchased from the exercise of stock options or warrants. Dilutive securities include stock options and restricted stock. As of July 1, 2007, holders of the $200.0 million in principal amount of the Company’s 1.25% senior convertible debentures issued in February 2007 did not have the right to convert the debentures into shares of the Company’s class A common stock (see Note 15).  Therefore, the senior convertible debentures are excluded from the summary of all outstanding anti-dilutive potential common shares in the table below.

The following is a summary of all outstanding anti-dilutive potential common shares:

		As of
(In thousands)		July 1, 2007		July 2, 2006
Stock options		142		74
Restricted stock		300		—

 

The following table sets forth the computation of basic and diluted weighted-average common shares:

		Three Months Ended				Six Months Ended
(In thousands)		July 1, 2007		July 2, 2006		July 1, 2007		July 2, 2006
Basic weighted-average common shares		75,123		64,040		74,428		62,583
Effect of dilutive securities:
Stock options		—		5,317		—		5,555
Restricted stock		—		51		—		34
Weighted-average common shares for diluted computation		75,123		69,408		74,428		68,172

 

Basic weighted-average common shares includes 1.1 million shares of class A common stock issued in relation to the acquisition of SP Systems which are subject to certain transfer restrictions and a repurchase option by the Company, both of which lapse on one quarter of the shares semi-annually over a two-year period. In addition, basic weighted-average common shares excludes 2.9 million shares of class A common stock lent to Lehman Brothers Inc. in connection with the issuance of $200.0 million in principal amount of its 1.25% senior convertible debentures in February 2007 (see Note 15).

Note 5. Comprehensive Income (Loss)

Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Comprehensive income (loss) includes unrealized gains and losses on the Company’s available-for-sale investments, derivatives and cumulative translation adjustments.

The components of comprehensive income (loss), net of tax, were as follows:

		Three Months Ended						Six Months Ended
(In thousands)		July 1, 2007			July 2, 2006			July 1, 2007			July 2, 2006
Net income (loss)		$	(5,345	)	$	5,384		$	(4,105	)	$	5,639
Cumulative translation adjustment		1,561			—			1,897			—
Unrealized gain (loss) on derivatives, net of tax		349			(1,429		)	804			(2,305		)
Total comprehensive income (loss)		$	(3,435	)	$	3,955		$	(1,404	)	$	3,334

 

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Note 6. Business Combinations

PowerLight Acquisition

On January 10, 2007 (the “Effective Date”), the Company completed its merger transaction (the “Merger”) involving PowerLight. The results of PowerLight have been included in the consolidated results of the Company from January 10, 2007. As a result of the Merger, all of the outstanding shares of PowerLight, and a portion of each vested option to purchase shares of PowerLight, were cancelled, and all of the outstanding options to purchase shares of PowerLight (other than the portion of each vested option that was cancelled) were assumed by the Company in exchange for aggregate consideration of (i) approximately $120.7 million in cash plus (ii) a total of 5,708,723 shares of the Company’s class A common stock, inclusive of (a) 1,601,839 shares of the Company’s class A common stock which may be issued upon the exercise of assumed vested and unvested PowerLight stock options, which options vest on the same schedule as the assumed PowerLight stock options, and (b) 1,145,643 shares of the Company’s class A common stock issued to employees of PowerLight in connection with the Merger which, along with 530,238 of the shares issuable upon exercise of assumed PowerLight stock options, are subject to certain transfer restrictions and a repurchase option by the Company, both of which lapse over a two-year period under the terms of certain equity restriction agreements. The Company under the terms of the Merger agreement also issued an additional 204,623 shares of restricted class A common stock to certain employees of PowerLight, which shares are subject to certain transfer restrictions which will lapse over 4 years. In June 2007, the Company changed PowerLight’s name to SunPower Corporation, Systems, or SP Systems, to capitalize on SunPower’s name recognition.

The total consideration related to the acquisition is as follows:

(In thousands)		Shares		Fair Value at January 10, 2007
Purchase consideration:
Cash		—		$	120,694
Common stock		2,961		111,266
Stock options assumed that are fully vested		618		21,280
Direct transaction costs		—		2,958
Total purchase consideration		3,579		256,198
Future stock compensation:
Restricted stock		1,146		43,046
Stock options assumed that are unvested		984		35,126
Total future stock compensation		2,130		78,172
Total purchase consideration and future stock compensation		5,709		$	334,370

 

Purchase Price Allocation

Under the purchase method of accounting, the total purchase price as shown in the table above was allocated to SP Systems’ net tangible and intangible assets based on their estimated fair values as of the Effective Date. The purchase price has been allocated based on management’s best estimates. The fair value of the Company’s class A common stock issued was determined based on the average closing prices for a range of trading days around the announcement date (November 15, 2006) of the transaction. The fair value of stock options assumed was estimated using the Black-Scholes model with the following assumptions: volatility of 90%, expected life ranging from 2.7 years to 6.3 years, and risk-free interest rate of 4.6%.

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The allocation of the purchase price and the estimated useful lives associated with certain assets on January 10, 2007 was as follows:

(In thousands)		Amount			Estimated Useful Life
Net tangible assets		$	13,925		n.a.
Patents and purchased technology		29,448			4 years
Tradenames		15,535			5 years
Backlog		11,787			1 year
Customer relationships		22,730			6 years
In-process research and development		9,575			n.a.
Unearned stock compensation		78,172			n.a.
Deferred tax liability		(21,964		)	n.a.
Goodwill		175,162			n.a.
Total purchase consideration and future stock compensation		$	334,370

 

Net tangible assets acquired on January 10, 2007 consisted of the following:

(In thousands)		Amount
Cash and cash equivalents		$	22,049
Restricted cash		4,711
Accounts receivable, net		40,080
Costs and estimated earnings in excess of billings		9,136
Inventories		28,146
Deferred project costs		24,932
Prepaid expenses and other assets		23,740
Total assets acquired		152,794
Accounts payable		(60,707		)
Billings in excess of costs and estimated earnings		(35,887		)
Other accrued expenses and liabilities		(42,275		)
Total liabilities assumed		(138,869		)
Net assets acquired		$	13,925

 

Acquired identifiable intangible assets. The fair value attributed to purchased technology and patents was determined using the relief from royalty method, which calculated the present value of the royalty savings by applying a royalty rate of 2.5% and a discount rate of 25% to the appropriate revenue streams. The fair value of purchased technology and patents is being amortized over 4 years on a straight-line basis. Amortization expense for the three and six months ended July 1, 2007 was as follows:

(In thousands)		Three Months Ended			Six Months Ended
Cost of systems revenue		$	5,564		$	10,510
Selling, general and administrative		947			1,789
Total amortization expense		$	6,511		$	12,299

 

The fair value of tradenames was determined using the royalty savings approach method, using a royalty rate of 1% and a discount rate of 25%. The fair value of tradenames was valued at $15.5 million and ascribed a useful life of 5 years. The determination of the fair value and useful life of the tradename was based on the Company’s strategy of continuing to market its systems products and services under the PowerLight brand. Based on the Company’s change in branding strategy, during the three-month period ended July 1, 2007, the Company recognized an impairment charge of $14.1 million, which represented the net book value of the PowerLight tradename.

The fair value attributed to customer relationships was determined using the multi-period excess earnings method with a discount rate of 22%. The fair value of customer relationships is being amortized over 6 years on a straight-line basis.

The fair value attributed to order backlog was determined using the multi-period excess earnings method with a discount rate of 20%. The fair value of order backlog is being amortized over 1 year on a straight-line basis.

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In-process research and development. SP Systems’ in-process research and development primarily consists of two components, design automation tool and tracking systems and other, which have not yet reached technological feasibility and have no alternative future uses.

Goodwill. Approximately $175.2 million had been allocated to goodwill within the systems segment, which represents the excess of the purchase price over the fair value of the underlying net tangible and intangible assets of SP Systems. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill will not be amortized but instead will be tested for impairment at least annually (more frequently if certain indicators are present). In the event that management determines that the value of goodwill has become impaired, the Company will incur an accounting charge for the amount of the impairment during the fiscal quarter in which the determination is made. During the three months ended July 1, 2007, the Company recorded a $1.7 million adjustment to increase goodwill acquired in connection with the purchase of SP Systems on January 10, 2007. This adjustment was recorded to reflect an additional loss provision on a construction project that was contracted as of the acquisition date and which has subsequently been determined to have a larger loss than originally estimated as well as adjustments to the value of certain acquired assets and liabilities. Goodwill that resulted from the acquisition of SP Systems is not deductible for tax purposes.

Of the cash and shares issued in the acquisition, approximately $20.5 million in cash and 824,000 shares, with a total aggregate value of $72.5 million as of July 1, 2007, are being held in escrow as security for the indemnification obligations of certain former SP Systems shareholders and will be released over a period of five years from the date of acquisition. In addition, the Company issued an additional 204,623 shares of restricted class A common stock to certain employees of SP Systems, which shares are subject to certain transfer restrictions that lapse over four years.

In conjunction with the acquisition, Cypress entered into a commitment letter with the Company during the fourth quarter of fiscal 2006 under which Cypress agreed to lend to the Company up to $130.0 million in cash to be used to facilitate the financing of the acquisition or working capital requirements. In February 2007, Cypress and the Company mutually terminated the commitment letter. No borrowings were outstanding at the termination date.

The Company accounted for its acquisition of SP Systems in accordance with SFAS 141, “Business Combinations.” Accordingly, all intercompany receivables and payables related to SP Systems were eliminated in purchase accounting effective January 10, 2007.

Supplemental information on an unaudited pro forma basis, as if the acquisition of SP Systems were completed at the beginning of the years 2007 and 2006, is as follows:

		Three Months Ended						Six Months Ended
(In thousands, except per share amounts)		July 1, 2007			July 2, 2006			July 1, 2007			July 2, 2006
Revenue		$	173,766		$	88,433		$	318,427		$	157,016
Net loss		$	(5,345	)	$	(20,124	)	$	(6,213	)	$	(41,504	)
Basic net loss per share		$	(0.07	)	$	(0.30	)	$	(0.08	)	$	(0.63	)

 

The unaudited pro forma supplemental information is based on estimates and assumptions, which the Company believes are reasonable. The unaudited pro forma supplemental information includes non-recurring in-process research and development charge of $9.6 million recorded in the first quarter ended April 1, 2007 and April 2, 2006. The unaudited pro forma supplemental information prepared by management is not necessarily indicative of the condensed consolidated financial position or results of income in future periods or the results that actually would have been realized had the Company and SP Systems been a combined company during the specified periods.

In-Process Research and Development (“IPR&D”) Charge

In connection with the acquisition of SP Systems, the Company recorded an IPR&D charge of $9.6 million in the first quarter of fiscal 2007, as technological feasibility associated with the in-process research and development projects had not been established and no alternative future use existed.

The Company identified in-process research and development projects in areas for which technological feasibility had not been established and no alternative future use existed. These in-process research and development projects consist of two components: design automation tool and tracking systems and other. In assessing the projects, the Company considered key characteristics of the technology as well as its future prospects, the rate technology changes in the industry, product life cycles, and various projects’ stage of development.

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The value of in-process research and development was determined using the income approach method, which calculated the sum of the discounted future cash flows attributable to the projects once commercially viable using a 40% discount rate, which were derived from a weighted-average cost of capital analysis and adjusted to reflect the stage of completion of the projects and the level of risks associated with the projects. The percentage of completion for each project was determined by identifying the research and development expenses invested in the project as a ratio of the total estimated development costs required to bring the project to technical and commercial feasibility. The following table summarizes certain information of each significant project:

Design Automation Tool		Stage of Completion		Total Cost Incurred to Date			Total Costs for the Project			Completion Date
As of January 10, 2007(acquisition date)		5%		$	0.2 million		$	2.6 million		Dec 2010
As of July 1, 2007		30%		$	0.8 million		$	2.6 million		Jun 2008

 

Tracking System and Other		Stage of Completion		Total Cost Incurred to Date			Total Costs for the Project			Completion Date
As of January 10, 2007 (acquisition date)		30%		$	0.2 million		$	0.8 million		Jul 2007
As of July 1, 2007		100%		$	0.8 million		$	0.8 million		Jun 2007

 

Status of In-Process Research and Development Projects:

As of July 1, 2007, the Company has incurred total post-acquisition costs of approximately $0.6 million related to the design automation tool project and estimates that an additional investment of $1.8 million will be required to complete the project. The Company expects to complete the design automation tool project by June 2008, approximately two and a half years earlier than the original estimate.

During the second quarter of fiscal 2007, the Company has completed the tracking systems project and incurred total project costs of $0.8 million, of which $0.6 million was incurred after the acquisition.

The development of the design automation tool remains a significant risk due to factors including the remaining efforts to achieve technical viability, rapidly changing customer markets, uncertain standards for new products, and competitive threats. The nature of the efforts to develop these technologies into commercially viable products consists primarily of planning, designing, experimenting, and testing activities necessary to determine that the technologies can meet market expectations, including functionality and technical requirements. Failure to bring these products to market in a timely manner could result in a loss of market share or a lost opportunity to capitalize on emerging markets and could have a material adverse impact on the Company’s business and operating results.

Note 7. Advances to Suppliers and Other Current Assets

The Company has entered into agreements with various polysilicon, ingot, wafer, solar cells and solar module vendors and manufacturers. These agreements specify future quantities and pricing of products to be supplied by the vendors for periods up to 13 years. Certain agreements also provide for penalties or forfeiture of advanced deposits in the event the Company terminates the arrangements (see Note 13).

Furthermore, under certain of these agreements, the Company is required to make prepayments to the vendors over the terms of the arrangements. In the second quarter of fiscal 2007, the Company paid advances totaling $15.6 million in accordance with the terms of existing supply agreements. The Company may also, from time to time, make advance payments in connection with purchases of services and manufacturing equipment from a variety of vendors and suppliers. As of July 1, 2007, advances to suppliers totaled $93.2 million, the current portion of which is $10.2 million.

The Company’s future prepayment obligations related to these agreements as of July 1, 2007 and inclusive of prepayment obligations entered into on July 16, 2007 (see Note 16) are as follows (in thousands):

2007 (remaining six months)		$	60,490
2008		56,040
2009		48,840
2010		11,100
		$	176,470

 

On July 2, 2007, the Company paid an additional advance of $10.0 million in accordance with the terms of an existing supply agreement.

Note 8. Transactions with Cypress

Purchases of Imaging and Infrared Detector Products from Cypress

The Company purchases wafers from Cypress at intercompany prices which are consistent with Cypress’ internal transfer pricing methodology.

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Manufacturing Services in Texas

The Company originally made its imaging and infrared detector and solar power products at its former Sunnyvale, California facility. In May 2002, the Company installed certain tenant improvements to build a pilot wafer fabrication line for a newly designed solar cell in a Cypress facility located in Texas. The Company then paid pro rata costs for materials and Cypress personnel to operate the facility which made the Company’s pre-commercial production solar cells until the Philippines facility came on line in November 2004. In late 2004, the Company moved its imaging and infrared detector production lines to the Cypress Texas facility and continues to pay the costs of materials and Cypress personnel to operate the facility.

Administrative Services Provided by Cypress

Cypress has seconded employees and consultants to the Company for different time periods for which the Company pays their fully-burdened compensation. In addition, Cypress personnel render services to the Company to assist with administrative functions such as legal, tax, treasury, information technology, employee benefits and other Cypress corporate services and infrastructure. Cypress bills the Company for a portion of the Cypress employees’ fully-burdened compensation. In the case of the Philippines subsidiary, which entered into a services agreement for such secondments and other consulting services in January 2005, the Company pays the fully-burdened compensation plus 10%. Amounts paid for these services are recorded as general and administrative expenses in the accompanying statements of operations.

Leased Facility in the Philippines

In 2003, the Company and Cypress reached an understanding that the Company would build out and occupy a building owned by Cypress for its wafer fabrication facility in the Philippines. The Company entered into a lease agreement for this facility, which expires in July 2021. Under the lease, the Company will pay Cypress at a rate equal to the cost to Cypress for that facility (including taxes, insurance, repairs and improvements) until the earlier of November 2015 or a change in control of the Company occurs, which includes such time as Cypress ceases to own at least a majority of the aggregate number of shares of all classes of the Company’s common stock then outstanding. Thereafter, the Company will pay market rate rent for the facility. The Company will have the right to purchase the facility from Cypress at any time at Cypress’ original purchase price of approximately $8.0 million, plus interest computed on a variable index starting on the date of purchase by Cypress until the sale to the Company, unless such purchase option is exercised after a change of control of the Company, in which case the purchase price shall be at a market rate, as reasonably determined by Cypress. The lease agreement also contains certain indemnification and exculpation provisions by the Company for the benefit of Cypress as lessor.

Leased Facility in California

On May 15, 2006, the Company entered into a lease agreement for its 43,732 square foot headquarters, which is located in a building owned by Cypress in San Jose, California, for $6.0 million over the five-year term of the lease. On July 1, 2007, the Company entered into an amendment to the lease agreement, increasing the rentable square footage and the total lease obligations to 51,228 and $7.1 million, respectively, over the five-year term of the lease. In the event Cypress decides to sell the building, the Company has the right of first refusal to purchase the building at a fair market price which will be based on comparable sales in the area.

Purchases of imaging and infrared detector products from Cypress, manufacturing services provided by Cypress in Texas, administrative services provided by Cypress and the facilities leased from Cypress in the Philippines and in California aggregated $2.2 million and $4.5 million for the three and six months ended July 1, 2007, respectively, and $3.3 million and $6.1 million for the three and six months ended July 2, 2006, respectively.

2005 Separation and Service Agreements

On October 6, 2005, the Company entered into a series of separation and services agreements with Cypress. Among these agreements are a master separation agreement, a sublease of the land and a lease for the building in the Philippines (see above); a three-year wafer manufacturing agreement for detector products at inter-company pricing; a three-year master transition services agreement under which Cypress would allow the Company to continue to utilize services provided by Cypress such as corporate accounting, legal, tax, information technology, human resources and treasury administration at Cypress’ cost; an asset lease under which Cypress will lease certain manufacturing assets from the Company; an employee matters agreement under which the Company’s employees would be allowed to continue to participate in certain Cypress health insurance and other employee benefits plans; an indemnification and insurance matters agreement; an investor rights agreement; and a tax sharing agreement. All of these agreements, except the tax sharing agreement and the manufacturing asset lease agreement, became effective at the time of completion of the Company’s initial public offering in November 2005.

Master Separation Agreement

In October 2005, the Company entered into a master separation agreement containing the framework with respect to the Company’s separation from Cypress. The master separation agreement provides for the execution of various ancillary agreements that further specify the terms of the separation.

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Wafer Manufacturing Agreement

The Company has entered into an agreement with Cypress to continue to make infrared and imaging detector products for the Company at prices consistent with the then current Cypress transfer pricing, which is equal to the forecasted cost to Cypress to manufacture the wafers, for the earlier of the next three years or until a change in control of the Company occurs, which includes until such time as Cypress ceases to own at least a majority of the aggregate number of shares of all classes of the Company common stock then outstanding, after which a new supply agreement may be negotiated or the Company and Cypress will negotiate a reasonable winding-up procedure. In addition, the Company may use other Cypress fabs for development work on a cost per activity basis.

The Company will indemnify Cypress for any liabilities that arise only to the extent that they are based on claims of infringement based on the Company’s design specifications that the Company submits to Cypress for the manufacture of the Company’s products. Cypress will indemnify the Company for liabilities that arise only to the extent that they are based on claims that the manufacturing, assembling, product testing or packaging process that Cypress uses for the Company’s products infringes or violates upon the intellectual property rights of third parties or Cypress’ unauthorized use of the Company’s design specifications or proprietary information.

Master Transition Services Agreement

The Company has also entered into a master transition services agreement which would govern the provisions of services to us by Cypress, such as: financial services, human resources, legal matters, training programs, and information technology.

For a period of three years following the Company’s November 2005 initial public offering of 8.8 million shares of class A common stock (“IPO”) or earlier if a change of control of the Company occurs, Cypress would provide these services and the Company would pay Cypress for services provided to the Company, at Cypress’ cost (which, for purposes of the master transition services agreement, will mean an appropriate allocation of Cypress’ full salary and benefits costs associated with such individuals as well as any out-of-pocket expenses that Cypress incurs in connection with providing the Company with those services) or at the rate negotiated with Cypress. Cypress will have the ability to deny requests for services under this agreement if, among other things, the provisions of such services creates a conflict of interest, causes an adverse consequence to Cypress, requires Cypress to retain additional employees or other resources or the provision of such services become impracticable as a result or cause outside of the control of Cypress. In addition, Cypress will incur no liability in connection with the provision of these services. The master transition services agreement also contains certain indemnification provisions by the Company for the benefit of Cypress.

Lease for Manufacturing Assets

In 2005 the Company entered into a lease with Cypress under which Cypress leases from the Company certain manufacturing assets owned by the Company and located in Cypress’ Texas manufacturing facility. The term of the lease is 27 months and it expires on December 31, 2007. Under this lease, Cypress is reimbursing the Company’s cost of approximately $0.7 million divided over the life of the leasehold improvements.

Employee Matters Agreement

The Company entered into an employee matters agreement with Cypress to allocate assets, liabilities and responsibilities relating to its current and former U.S. and international employees and its employees’ participation in the employee benefits plans that Cypress sponsors and maintains.

The Company’s eligible employees generally remain able to participate in Cypress’ benefit plans, as they may change from time to time. The Company is responsible for all liabilities incurred with respect to the Cypress plans by the Company as a participating company in such plans. The Company intends to have its own benefit plans established by the time its employees no longer are eligible to participate in Cypress’ benefit plans. Once the Company has established its own benefit plans, the Company will have the ability to modify or terminate each plan in accordance with the terms of those plans and the Company’s policies. It is the Company’s intent that employees not receive duplicate benefits as a result of participation in its benefit plans and the corresponding Cypress benefit plans.

All of the Company’s eligible employees are able to continue to participate in Cypress’ health plans, life insurance and other benefit plans as they may change from time to time, until the earliest of, (1) a change of control of the Company occurs, which includes such time as Cypress ceases to own at least a majority of the aggregate number of shares of all classes of the Company’s common stock then outstanding, (2) such time as the Company’s status as a participating company under the Cypress plans is not permitted by a Cypress plan or by applicable law, (3) such time as Cypress determines in its reasonable judgment that the Company’s status as a participating company under the Cypress plans has or will adversely affect Cypress, or its employees, directors, officers, agents, affiliates or its representatives, or (4) such earlier date as the Company and Cypress mutually agree. However, to avoid redundant benefits, the Company’s employees will generally be precluded from participating in Cypress’ stock option plans and stock purchase plans.

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With respect to the Cypress 401(k) Plan, the Company is obligated to establish its own 401(k) Plan within 90 days of separation from Cypress, and Cypress will transfer all accounts in the Cypress 401(k) Plan held by the Company’s employees to the Company’s 401(k) Plan.

Indemnification and Insurance Matters Agreement

The Company will indemnify Cypress and its affiliates, agents, successors and assigns from all liabilities arising from environmental conditions existing on, under, about or in the vicinity of any of the Company’s facilities, or arising out of operations occurring at any of the Company’s facilities, including the California facilities, whether prior to or after the separation; existing on, under, about or in the vicinity of the Philippines facility which the Company occupies, or arising out of operations occurring at such facility, whether prior to or after the separation, to the extent that those liabilities were caused by the Company; arising out of hazardous materials found on, under or about any landfill, waste, storage, transfer or recycling site and resulting from hazardous materials stored, treated, recycled, disposed or otherwise handled by any of the Company’s operations or the Company’s California and Philippines facilities prior to the separation; and arising out of the construction activity conducted by or on behalf of the Company at Cypress’ Texas facility.

The indemnification and insurance matters agreement and the master transition services agreement also contain provisions governing the Company’s insurance coverage, which are under the Cypress insurance policies (other than the Company’s directors and officers insurance, for which the Company has its own separate policy) until the earliest of (1) a change of control of the Company, which includes such time as Cypress ceases to own at least a majority of the aggregate number of shares of all classes of the Company’s common stock then outstanding, (2) the date on which Cypress’ insurance carriers do not permit the Company to remain on Cypress policies, (3) the date on which Cypress’ cost of insurance under any particular insurance policy increases, directly or indirectly, due to the Company’s inclusion or participation in such policy, (4) the date on which the Company’s coverage under the Cypress policies causes a real or potential conflict of interest or hardship for Cypress, as determined solely by Cypress or (5) the date on which Cypress and the Company mutually agree to terminate this arrangement. Prior to that time, Cypress will maintain insurance policies on the Company’s behalf, and the Company shall reimburse Cypress for expenses related to insurance coverage during this period. The Company will work with Cypress to secure additional insurance if desired and cost effective.

Investor Rights Agreement

The Company has entered into an investor rights agreement with Cypress providing for specified (1) registration and other rights relating to the Company’s shares of the Company’s common stock, (2) information and inspection rights, (3) coordination of auditing practices and (4) approval rights with respect to certain transactions.

Tax Sharing Agreement

The Company has entered into a tax sharing agreement with Cypress providing for each of the party’s obligations concerning various tax liabilities. The tax sharing agreement is structured such that Cypress will pay all federal, state, local and foreign taxes that are calculated on a consolidated or combined basis (while being a member of Cypress’ consolidated or combined group pursuant to federal, state, local and foreign tax law). The Company’s portion of such tax liability or benefit will be determined based upon its separate return tax liability as defined under the tax sharing agreement. Such liability or benefit will be based on a pro forma calculation as if the Company were filing a separate income tax return in each jurisdiction, rather than on a combined or consolidated basis with Cypress subject to adjustments as set forth in the tax sharing agreement.

After the date the Company ceases to be a member of Cypress’ consolidated group for federal income tax purposes or state income tax purposes, as and to the extent that the Company becomes entitled to utilize on the Company’s separate tax returns portions of those credit or loss carryforwards existing as of such date, the Company will distribute to Cypress the tax effect, estimated to be 34% for federal income tax purposes, of the amount of such tax loss carryforwards so utilized, and the amount of any credit carryforwards so utilized. The Company will distribute these amounts to Cypress in cash or in the Company’s shares, at the Company’s option. As of December 31, 2006, the Company has approximately $50.6 million of federal net operating loss carryforwards and approximately $4.8 million of California net operating loss carryforwards meaning that such potential future payments to Cypress, which would be made over a period of several years, would therefore aggregate approximately $15.0 million.

Upon completion of its follow-on public offering of common stock in June 2006, the Company is no longer considered to be a member of Cypress’ consolidated group for federal income tax purposes. Accordingly, the Company will be subject to the obligations payable to Cypress for any federal income tax credit or loss carryforwards utilized in its federal tax returns in subsequent periods, as explained in the preceding paragraph.

The Company will continue to be jointly and severally liable for any tax liability as governed under federal, state and local law during all periods in which it is deemed to be a member of the Cypress consolidated or combined group. Accordingly, although the tax sharing agreement allocates tax liabilities between Cypress and all its consolidated subsidiaries, for any period in which the Company is included in Cypress’ consolidated group, the Company could be liable in the event that any federal tax liability was incurred, but not discharged, by any other member of the group.

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If Cypress distributes the Company’s class B common stock to Cypress stockholders in a transaction intended to qualify as a tax-free distribution under Section 355 of the Code, Cypress intends to obtain an opinion of counsel and/or a ruling from the Internal Revenue Service to the effect that such distribution qualifies under Section 355 of the Code. Despite such an opinion or ruling, however, the distribution may nonetheless be taxable to Cypress under Section 355(e) of the Code if 50% or more of the Company’s voting power or economic value is acquired as part of a plan or series of related transactions that includes the distribution of the Company’s stock. The tax sharing agreement includes the Company’s obligation to indemnify Cypress for any liability incurred as a result of issuances or dispositions of the Company’s stock after the distribution, other than liability attributable to certain dispositions of the Company’s stock by Cypress, that cause Cypress’ distribution of shares of the Company’s stock to its stockholders to be taxable to Cypress under Section 355(e) of the Code.

The tax sharing agreement further provides for cooperation with respect to tax matters, the exchange of information and the retention of records which may affect the income tax liability of either party. Disputes arising between Cypress and us relating to matters covered by the tax sharing agreement are subject to resolution through specific dispute resolution provisions contained in the agreement.

Note 9. Foreign Currency Derivatives

The Company has non-U.S. subsidiaries that operate and sell the Company’s products in various global markets, primarily in Europe. As a result, the Company is exposed to risks associated with changes in foreign currency exchange rates. It is the Company’s policy to use various hedge instruments to manage the exposures associated with purchases of foreign sourced equipment, net asset or liability positions of its subsidiaries and forecasted revenues and expenses. The Company does not enter into foreign currency derivative financial instruments for speculative or trading purposes.

As of July 1, 2007, the Company’s hedge instruments consisted of foreign currency option contracts and foreign currency forward exchange contracts. The Company calculates the fair value of its option and forward contracts based on market volatilities, spot rates and interest differentials from published sources.

In accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” the Company accounts for its hedges of forecasted foreign currency revenues as cash flow hedges and hedges of firmly committed purchase contracts denominated in foreign currency as fair value hedges.

Cash Flow Hedges: Hedges of forecasted foreign currency denominated revenues are designated as cash flow hedges and changes in fair value of the effective portion of hedge contracts are recorded in accumulated other comprehensive income (loss) in stockholders’ equity in the Condensed Consolidated Balance Sheets. Amounts deferred in accumulated other comprehensive income (loss) are reclassified into the Condensed Consolidated Statement of Operations in the periods in which the hedged exposure impacts earnings. The effective portion of unrealized gains (losses) recorded in accumulated other comprehensive income (loss), net of tax, was a $0.3 million gain and a $1.4 million loss for the three months ended July 1, 2007 and July 2, 2006, respectively, and a $0.8 million gain and a $2.3 million loss for the six months ended July 1, 2007 and July 2, 2006, respectively. As of July 1, 2007 and December 31, 2006, the Company had outstanding cash flow hedge forward contracts with an aggregate notional value of $60.2 million and $89.6 million, respectively. As of July 1, 2007 and December 31, 2006, the Company had outstanding cash flow hedge option contracts with an aggregate notional value of $53.2 million and $16.0 million, respectively. The maturity dates of the outstanding contracts ranged from July 2007 to April 2008.

Fair Value Hedges: On occasion, the Company commits to purchase equipment in foreign currency, predominantly Euros. When these purchases are hedged and qualify as firm commitments under SFAS No. 133, they are designated as fair value hedges and changes in the fair value of the firm commitment derivative contract are recognized in the Condensed Consolidated Statement of Operations. Under fair value hedge treatment, the changes in the firm commitment on a spot to spot basis are recorded in property and equipment, net, in the Condensed Consolidated Balance Sheet and in other income (expense), net in the Condensed Consolidated Statement of Operations. As of July 1, 2007, the Company had no outstanding fair value hedges.

Both cash flow hedges and fair value hedges are tested for effectiveness each period on a spot to spot basis using the dollar-offset method. Both the excluded time value and any ineffectiveness, which were not significant for all periods, are recorded in other income and (expense), net.

In addition, the Company began hedging the net balance sheet effect of Euro denominated assets and liabilities in 2005 primarily for Euro denominated receivables from customers, prepayments to suppliers and advances received from customers. The Company records its hedges of foreign currency denominated monetary assets and liabilities at fair value with the related gains or losses recorded in other income. The gains or losses on these contracts are substantially offset by transaction gains or losses on the underlying balances being hedged. As of July 1, 2007 and December 31, 2006, the Company held forward contracts with an aggregate notional value of $29.8 million and $37.6 million, respectively, to hedge the risks associated with Euro foreign currency denominated assets and liabilities.

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Note 10. Stock-Based Compensation

The following table summarizes the consolidated stock-based compensation expense, by type of awards:

		Three Months Ended						Six Months Ended
(In thousands)		July 1, 2007			July 2, 2006			July 1, 2007			July 2, 2006
Employee stock options		$	4,847		$	1,018		$	9,593		$	2,172
Non-employee stock options		—			19			—			304
Restricted stock		8,572			108			14,548			143
Amounts capitalized in inventory		(189		)	(8		)	(308		)	(70		)
Total stock-based compensation expense		$	13,230		$	1,137		$	23,833		$	2,549

 

The following table summarizes the consolidated stock-based compensation expense by line item in the Consolidated Statements of Operations:

		Three Months Ended						Six Months Ended
(In thousands)		July 1, 2007			July 2, 2006			July 1, 2007			July 2, 2006
Cost of revenue		$	3,198		$	243		$	5,448		$	436
Research and development		348			264			849			684
Sales, general and administrative		9,684			630			17,536			1,429
Total stock-based compensation expense		$	13,230		$	1,137		$	23,833		$	2,549

 

As stock-based compensation expense recognized in the Condensed Consolidated Statements of Operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

Consolidated net cash proceeds from the issuance of shares under the Company’s employee stock plans were $3.0 million and $5.0 million for the three and six months ended July 1, 2007, respectively, and $1.4 million and $1.8 million for the three and six months ended July 2, 2006, respectively. No income tax benefit was realized from stock option exercises during the three and six months ended July 1, 2007 and July 2, 2006. As required, the Company presents excess tax benefits from the exercise of stock options, if any, as financing cash flows rather than operating cash flows.

The following table summarizes the unrecognized stock-based compensation costs by type of awards:

(In thousands, except years)		As of July 1, 2007			Weighted- Average Amortization Period (in years)
Stock options		$	31,403		1.8
Restricted stock		29,941			3.4
Shares subject to re-vesting restrictions		31,949			1.5
Total unrecognized stock-based compensation balance		$	93,293

 

Equity Incentive Program

On May 4, 2007, the Company’s stockholders approved an additional increase in the number of shares available for future issuance by 925,000 shares under the Company’s Amended and Restated 2005 Stock Incentive Plan under which the Company may issue restrictive shares, stock appreciation rights, stock units, incentive or non-statutory stock options to purchase common stock or stock purchase rights to directors, employees and consultants.

The following table summarizes the Company’s stock option activities:

		Shares  (in thousands)		Weighted- Average Exercise Price Per Share
Options outstanding as of December 31, 2006		4,980		$	3.97
Options exchanged/assumed in connection with SP Systems acquisition		1,602		5.54
Exercised		(720	)	2.78
Forfeited		(33	)	19.13
Options outstanding as of April 1, 2007		5,829		4.47
Granted		18		56.20
Exercised		(1,153	)	2.57
Forfeited		(35	)	10.64
Outstanding as of July 1, 2007		4,659		5.09
Exercisable as of July 1, 2007		1,345		3.69

 

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Information regarding the Company’s outstanding stock options as of July 1, 2007 was as follows:

		Options Outstanding										Options Exercisable
Range of Exercise Price		Shares (in thousands)		Weighted- Average Remaining Contractual Life (in years)		Weighted- Average Exercise Price per Share			Aggregate Intrinsic Value (in thousands)			Shares (in thousands)		Weighted- Average Remaining Contractual Life (in years)		Weighted- Average Exercise Price per Share			Aggregate Intrinsic Value (in thousands)
$    0.04—0.75		837		4.51		$	0.29		$	52,509		233		5.17		$	0.48		$	14,608
0.88—2.66		350		7.16		1.98			21,348			100		6.41		1.72			6,156
3.30—4.95		2,660		7.35		3.33			158,864			881		7.28		3.31			52,608
7.00—16.20		421		8.15		8.34			23,071			91		8.14		8.24			4,974
17.00—56.20		391		9.00		26.63			14,263			40		8.51		25.46			1,504
		4,659		7.03		5.09			$	270,055		1,345		6.94		3.69			$	79,850

 

The aggregate intrinsic value in the preceding table represents the total pre-tax intrinsic value, based on the Company’s closing stock price of $63.05 at July 1, 2007, which would have been received by the option holders had all option holders exercised their options as of that date. The total number of in-the-money options exercisable was 1.3 million shares as of July 1, 2007.

The following table summarizes the Company’s non-vested stock options and restricted stock activities:

		Stock Options					Restricted Stock
		Shares  (in thousands)		Weighted- Average Exercise Price Per Share			Shares  (in thousands)		Weighted- Average Grant Date Fair Value Per Share
Outstanding as of December 31, 2006		3,141		$	4.45		229		$	35.40
Granted		1,602		5.54			269		41.68
Vested		(993	)	2.75			(16	)	33.34
Forfeited		(33	)	2.78			(4	)	39.86
Outstanding as of April 1, 2007		3,717		5.39			478		38.97
Granted		18		56.20			337		57.19
Vested		(386	)	5.71			(31	)	56.58
Forfeited		(35	)	2.57			(15	)	57.13
Outstanding as of July 1, 2007		3,314		5.66			769		45.62

 

Stock Unit Plan:

As of July 1, 2007, the Company has granted approximately 192,431 units to approximately 1,734 employees in the Philippines at an average unit price of $32.75 in relation to its 2005 Stock Unit Plan, under which participants are awarded the right to receive cash payments from the Company in an amount equal to the appreciation in the Company’s common stock between the award date and the date the employee redeems the award. A maximum of 300,000 stock units may be subject to stock unit awards granted under the 2005 Stock Unit Plan. For the three and six months ended July 1, 2007, total compensation expense associated with the 2005 Stock Unit Plan was $0.4 million and $0.8 million, respectively.

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Note 11. Income Taxes

The Company’s effective rate of income tax benefit was 58% and 71% for the three and six months ended July 1, 2007, respectively, and the effective rate of income tax provision was 7% for each of the three and six months ended July 2, 2006. The tax benefit for the first two quarters of fiscal 2007 was primarily attributable to the recognition of deferred tax assets as a result of the Company’s acquisition of SP Systems and the effect of amortization of purchased intangible assets on deferred tax liability, partially offset by non-U.S. taxes on income earned in certain countries that was not offset by current year net operating losses in other countries. The tax provision for the second quarter of fiscal 2006 was attributable to non-U.S. taxes on income earned in certain countries that was not offset by current year net operating losses in other countries.

Unrecognized Tax Benefits

The Company adopted the provisions of FIN 48 on January 1, 2007. As of January 1, 2007, the total amount of unrecognized tax benefits recorded in the Condensed Consolidated Balance Sheet was approximately $1.1 million, which, if recognized, would affect the Company’s effective tax rate. The additional amount of unrecognized tax benefits accrued during the first two quarters of fiscal 2007 was $2.0 million. Management believes that events that could occur in the next 12 months and cause a change in unrecognized tax benefits include, but are not limited to, the following:

·                  completion of examinations of the Company’s tax returns by the U.S. or foreign taxing authorities; and

·                  expiration of statue of limitations on the Company’s tax returns.

The calculation of unrecognized tax benefits involves dealing with uncertainties in the application of complex global tax regulations. Uncertainties include, but are not limited to, the impact of legislative, regulatory, and judicial developments, transfer pricing and the application of withholding taxes. Management regularly assesses the Company’s tax positions in light of legislative, bilateral tax treaty, regulatory and judicial developments in the countries in which the Company does business. Management determined that an estimate of the range of reasonably possible change in the amounts of unrecognized tax benefits within the next 12 months cannot be made.

Classification of Interest and Penalties

The Company’s policy is to classify interest expense and penalty, if any, as components of income tax provision in the Condensed Consolidated Statements of Operations. No material amount has been accrued through the first half of fiscal 2007.

Tax Years and Examination

The following table summarizes the Company’s major tax jurisdictions and the tax years that remain subject to examination by these jurisdictions as of January 1, 2007:

Tax Jurisdictions		Tax Years
United States		2003 and onward
California		2002 and onward

 

Additionally, while years prior to 2003 for the U.S. corporate tax return are not open for assessment, the IRS can adjust net operating loss and research and development carryovers that were generated in prior years and carried forward to 2003.

The Internal Revenue Service (“IRS”) is currently conducting an audit of PowerLight’s federal income tax returns for fiscal 2004. As of July 1, 2007, no material adjustments have been proposed by the IRS.   Changes to PowerLight’s pre-acquisition tax liabilities, if any, would be recorded as a purchase price adjustment.  Management believes that the ultimate outcome of the IRS examination will not have a material impact on the Company’s financial position or results of operations.

Note 12. Segment and Geographical Information

Prior to fiscal year 2007, the Company operated in one business segment comprising the design, manufacture and sale of solar electric power products, imaging and infrared detectors based on its proprietary processes and technologies. Effective January 10, 2007, the Company operated in two business segments: systems and components. The systems segment generally represents sales directly to systems owners of engineering, procurement, construction and other services relating to solar electric power systems that integrate the Company’s solar panels and balance of systems components, as well as materials sourced from other manufactures. The components segment primarily represents sales of the Company’s solar cells, solar panels and inverters to solar systems installers and other resellers. In addition, the components segment includes sales of imaging and infrared detectors to OEMs. The Chief Operating Decision Maker (CODM), as defined by SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (SFAS No. 131), assesses the performance of both operating segments using information about its revenue and gross margin.

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The following tables present revenue by geography and segment, gross margin by segment, revenue by significant customer and property, plant and equipment information based on geographic region. Revenue is based on the destination of the shipments. Property, plant and equipment are based on the physical location of the assets:

		Three Months Ended				Six Months Ended
		July 1, 2007		July 2, 2006		July 1, 2007		July 2, 2006
Revenue by geography:
United States		37	%	25	%	38	%	28	%
Germany		8	%	52	%	11	%	51	%
Spain		38	%	—	%	31	%	—	%
Austria		10	%	—	%	9	%	—	%
Rest of Europe		5	%	16	%	6	%	12	%
Asia		1	%	5	%	5	%	6	%
Others		1	%	2	%	—	%	3	%
		100	%	100	%	100	%	100	%
Revenue by segment:
Systems		60	%	—	%	58	%	—	%
Components		40	%	100	%	42	%	100	%
		100	%	100	%	100	%	100	%
Gross margin by segment:
Systems		12	%	—	%	16	%	—	%
Components		25	%	21	%	25	%	18	%

 

Significant Customers:				Three Months Ended						Six Months Ended
Customer		Business Segment		July 1, 2007			July 2, 2006			July 1, 2007			July 2, 2006
SolarPack		Systems		34	%		—	%		20	%		—	%
Solon AG		Components		11	%		29	%		11	%		28	%
MMA Renewable Ventures		Systems		10	%		—	%		8	%		—	%
Conergy AG		Components		7	%		22	%		8	%		22	%
Elecnor		Systems		4	%		—	%		10	%		—	%
PowerLight Corporation		Components		n.a.			15	%		n.a.			14	%

 

(In thousands)		July 1, 2007			December 31, 2006
Property, plant and equipment by geography:
United States		$	10,517		$	8,051
Philippines		285,259			192,335
China		—			2,042
		$	295,776		$	202,428

 

Note 13. Commitments and Contingencies

Operating Lease Commitments

The Company leases its San Jose, California facility under a non-cancelable operating lease from Cypress, which expires on April 30, 2011 (see Note 8). The lease also requires the Company to pay property taxes, insurance and certain other costs. The Company also leases its solar cell manufacturing facility in the Philippines from Cypress, under a lease which expires in July 2021 (see Note 8). In December 2005, the Company entered into a 5-year operating lease from an unaffiliated third party for an additional building in the Philippines. The Company also has various lease arrangements for offices in Berkeley, California which expire between 2007 and 2009, as well as for a field office in New Jersey, which expires in 2011. In December 2006, the Company (through SP Systems acquired on January 10, 2007) entered into an eleven-year lease agreement for its facility in Richmond, California, which the Company expects to occupy in the fourth quarter of 2007. Future minimum obligations under all non-cancelable operating leases as of July 1, 2007 are as follows (in thousands):

2007 (remaining six months)		$	1,547
2008		4,095
2009		4,200
2010		4,248
2011		3,102
Thereafter		19,665
		$	36,857

 

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Purchase Commitments

The Company purchases raw materials for inventory, services and manufacturing equipment from a variety of vendors. During the normal course of business, in order to manage manufacturing lead times and help assure adequate supply, the Company enters into agreements with contract manufacturers and suppliers that either allow them to procure goods and services based upon specifications defined by the Company, or that establish parameters defining the Company’s requirements. In certain instances, these agreements allow the Company the option to cancel, reschedule or adjust the Company’s requirements based on its business needs prior to firm orders being placed. Consequently, only a portion of the Company’s recorded purchase commitments arising from these agreements are firm, non-cancelable and unconditional commitments.

The Company also has agreements with several suppliers of polysilicon, ingots, wafers, solar cells and solar panels and which specify future quantities and pricing of products to be supplied by the vendors for periods up to 13 years and provide for certain consequences, such as forfeiture of advanced deposits and liquidated damages relating to previous purchases, in the event that the Company terminates the arrangements (see Note 7).

At July 1, 2007, total obligations related to such supplier agreements was $2.0 billion of which $250.3 million was related to a joint venture (as discussed below). The Company’s non-cancelable purchase orders related to equipment and building improvements totaled approximately $80.7 million.

Future minimum obligations under supplier agreements and non-cancelable purchase orders as of July 1, 2007 and inclusive of minimum obligations under the supply agreement entered into on July 16, 2007 (see Note 16) are as follows (in thousands):

2007 (remaining six months)		$	179,731
2008		264,944
2009		341,756
2010		272,739
2011		300,479
Thereafter		676,041
		$	2,035,690

 

Joint Venture

In the third quarter of fiscal 2006, the Company entered into an agreement with Woongjin Coway Co., Ltd. (“Woongjin”), a provider of environmental products located in Korea, to form Woongjin Energy Co., Ltd (“Woongjin Energy”), a joint venture to manufacture monocrystalline silicon ingots. Under the joint venture, the Company and Woongjin will fund the joint venture through capital investments. In addition, Woongjin Energy will obtain a $33.0 million loan to be guaranteed by Woongjin. Additionally, the Company will supply polysilicon and technology required for the silicon ingot manufacturing to the joint venture, and the Company will procure the manufactured silicon ingots from the joint venture. Woongjin Energy is expected to begin manufacturing in the fourth quarter of fiscal 2007, and the Company expects to purchase approximately $250 million of silicon ingots from Woongjin Energy under a five-year agreement.

The Company has invested $4.8 million in the joint venture comprised of a 19.9% equity investment valued at $1.5 million and a $3.3 million convertible note that is convertible at the Company’s option into an additional 20.1% equity ownership in the joint venture. The entire investment is classified as “Other Long-Term Assets” in the July 1, 2007 consolidated balance sheet. The Company accounted for its joint venture in Woongjin Energy using the equity method, in which the minority interest in the consolidated statements of operations is immaterial for the three and six-month period ended July 1, 2007. Neither party has contractual obligations to provide any additional funding to the joint venture. As of July 1, 2007, the joint venture was in the development stage and had no operations.

Product Warranties

The Company warrants or guarantees the performance of its solar panels at certain levels of conversion efficiency for extended periods, often as long as 25 years. It also warrants or guarantees the functionality of solar cells and imaging detectors for at least one year. Therefore, the Company maintains warranty reserves to cover potential liability that could result from these guarantees. The Company’s potential liability is generally in the form of product replacement. Warranty reserves are based on the Company’s best estimate of such liabilities and are recognized as a cost of revenue. The Company

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continuously monitors product returns for warranty failures and maintains a reserve for the related warranty expenses based on historical experience of similar products as well as various other assumptions that are considered reasonable under the circumstances. Warranty charges were $1.4 million and $5.6 million during the three and six months ended July 1, 2007, respectively, and $1.3 million and $1.6 million during the three and six months ended July 2, 2006, respectively.

The Company generally provides warranty on systems for a period of five years. The Company’s estimated warranty cost for each project is accrued and the related costs are charged against the warranty accrual when incurred. It is not possible to predict the maximum potential amount of future warranty-related expenses under these or similar contracts due to the conditional nature of the Company’s obligations and the unique facts and circumstances involved in each particular contract. Historically, warranty costs related to contracts have been within management’s expectations.

The following summarizes activity within accrued warranty:

		Three Months Ended						Six Months Ended
(In thousands)		July 1, 2007			July 2, 2006			July 1, 2007			July 2, 2006
Balance at beginning of the period		$	13,560		$	642		$	3,446		$	574
SP Systems accrued balance at date of acquisition		—			—			6,542			—
Accruals for warranties during the period		1,441			1,346			5,588			1,577
Settlements made during the period		(687		)	—			(1,262		)	(163		)
Balance at the end of the period		$	14,314		$	1,988		$	14,314		$	1,988

 

Indemnifications

The Company is a party to a variety of agreements pursuant to which it may be obligated to indemnify the other party with respect to certain matters. Typically, these obligations arise in connection with contracts and license agreements or the sale of assets, under which the Company customarily agrees to hold the other party harmless against losses arising from a breach of warranties, representations and covenants related to such matters as title to assets sold, negligent acts, damage to property, validity of certain intellectual property rights, non-infringement of third-party rights, and certain tax related matters. In each of these circumstances, payment by the Company is typically subject to the other party making a claim to the Company pursuant to the procedures specified in the particular contract. These procedures usually allow the Company to challenge the other party’s claims or, in case of breach of intellectual property representations or covenants, to control the defense or settlement of any third-party claims brought against the other party. Further, the Company’s obligations under these agreements may be limited in terms of activity (typically to replace or correct the products or terminate the agreement with a refund to the other party), duration and/or amounts. In some instances, the Company may have recourse against third parties and/or insurance covering certain payments made by the Company.

Note 14. Line of Credit

On December 2, 2005, the Company entered into a $25.0 million three-year revolving credit facility (the “Facility”) with affiliates of Credit Suisse Securities (USA) LLC and Lehman Brothers, Inc. The Facility was collateralized by substantially all of the Company’s assets, including the stock of its foreign subsidiaries. Borrowings under the Facility were conditioned upon customary conditions as well as (1) with respect to the first $10.0 million drawn on the Facility, maintenance of cash collateral to the extent of outstanding borrowings (excluding amounts borrowed), and (2) with respect to the remaining $15.0 million of the Facility, satisfaction of a coverage test which was based on the ratio of the Company’s cash flow to capital expenditures. There were no borrowings ever made under the Facility. The Company terminated its agreement with Credit Suisse Securities (USA) LLC and Lehman Brothers, Inc., on July 13, 2007.

In connection with the SP Systems acquisition on January 10, 2007, the Company assumed a line of credit SP Systems had with Union Bank of California, N.A. (“UBOC”) with an outstanding balance of approximately $3.6 million. During the first quarter of fiscal 2007, the Company paid off the outstanding balance in full.

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