File Pursuant to Rule 424(b)4
Table of Contents

Filed pursuant to Rule 424(b)(4)
Registration No. 333-127854

7,700,000 Shares

 

LOGO

 

Class A Common Stock

 


 

We are selling 7,700,000 shares of class A common stock. Prior to this offering, there has been no public market for our class A common stock. The initial public offering price of our class A common stock is $18.00 per share. Our class A common stock has been approved for listing on The Nasdaq National Market under the symbol “SPWR.”

 

Following this offering, we will have two classes of authorized common stock: class A common stock and class B commonbsp; 19       (12 )                            




 


 


 

The underwriters have an over-allotment option to purchase a maximum of 1,155,000 additional shares of class A common stock from us and a selling stockholder on the same terms and conditions as set forth below if the underwriters sell more than 7,700,000 shares in this offering.

 

Investing in our class A common stock involves risks. See “ Risk Factors” beginning on page 10.

 

    

Price to

Public


   Underwriting
Discounts and
Commissions


   Proceeds
to SunPower


Per Share

   $18.00    $1.26    $16.74

Total

   $138,600,000    $9,702,000    $128,898,000

 

Delivery of the shares of class A common stock will be made on or about November 22, 2005.

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

   Credit Suisse First Boston   Lehman Brothers    

 


 

            SG Cowen & Co. 


 


 


Net cash used in investing activities

    (5,371 )     (14,802 )     (15,275 )     (17,231 )     (9,691 )     (47,971 )
   


 


 


 


 


 


Cash flows from financing activities

                                               

Proceeds from issuance of related party notes payable

    844                                

Proceeds from debt obligations to Cypress

          29,191       24,825       30,100       9,000       12,500  

Proceeds from issuance of preferred stock, net of issuance costs

    8,095                               7,000  

Proceeds from issuance of common stock to Cypress

                                  27,372  

Principal payments of debt

    (565 )                              

Principal payments of notes payable to Cypress

    (32 )     (359 )     (341 )     (495 )     (99 )     (248 )

Proceeds from exercise of warrants and stock options

    9       8       34       224       1       37  
   


 


 


 


 


 


Net cash provided by financing activities

    8,351       28,840       24,518       29,829       8,902       46,661  
   


 


 


 


 


 


Net increase (decrease) in cash and cash equivalents

    275       5,243       (2,930 )     (1,423 )     (389 )     16,546  

Cash and cash equivalents at beginning of period

    70       345       5,588       5,588       4,165       3,776  
   


 


 


 


 


 


Cash and cash equivalents at end of period

  $ 345     $ 5,588     $ 2,658     $ 4,165     $ 3,776     $ 20,322  
   


 


 


 


 


 


Non-cash transactions

                                               

Relative fair value of warrants issued (reduction related to debt conversion)

  $ 971     $ 80     $ 9,800     $ 11,023     $     $ (7,706 )

Conversion of Series A-E Preferred Stock to common

    7,365                                

Conversion of bridge loan to long term notes

    1,950                           First Albany Capital

 

The date of this prospectus is November 16, 2005


Table of Contents

LOGO


Table of Contents

 

TABLE OF CONTENTS

 

     Page

PROSPECTUS SUMMARY

   1

RISK FACTORS

   10

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

   37

USE OF PROCEEDS

   38

DIVIDEND POLICY

   38

CAPITALIZATION

   39

DILUTION

   41

SELECTED CONSOLIDATED FINANCIAL DATA

   43

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

   45

BUSINESS

   63

MANAGEMENT

   78
     Page

RELATED PARTY TRANSACTIONS

   87

PRINCIPAL AND SELLING STOCKHOLDERS

   99

DESCRIPTION OF CAPITAL STOCK

   101

SHARES ELIGIBLE FOR FUTURE SALE

   107

UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS FOR NON-UNITED STATES STOCKHOLDERS

   109

UNDERWRITING

   112

NOTICE TO CANADIAN RESIDENTS

   115

LEGAL MATTERS

   116

EXPERTS

   116

WHERE YOU CAN FIND ADDITIONAL INFORMATION

   116

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

   F-1

 


 

You should rely only on the information contained in this document or to which we have referred you. We have not authorized anyone to provide you with information that is different. This document may only be used where it is legal to sell these securities. The information in this document may only be accurate on the date of this document.

 

Dealer Prospectus Delivery Obligation

 

Through and including December 11, 2005 (25 days after commencement of the offering), all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to unsold allotments or subscriptions.


Table of Contents

PROSPECTUS SUMMARY

 

You should read the following summary together with the entire prospectus, including the more detailed information regarding us and the class A common stock being sold in this offering and our consolidated financial statements and the related notes appearing elsewhere in this prospectus. You should carefully consider, among other things, the matters discussed in the section entitled “Risk Factors.”

 

Our Company

 

We design, manufacture and sell solar electric power products, or solar power products, based on our proprietary processes and technologies. We have spent more than 15 years developing high performance solar cells, which are semiconductor devices that directly convert sunlight into electricity. We believe our solar cells have the highest conversion efficiency, a measurement of the amount of sunlight converted by the solar cell into electricity, available for the mass market. Based on third-party data, we believe our solar cells provide the following benefits compared with conventional solar cells:

 

    Superior performance, including the ability to generate up to 50% more power per unit area;

 

    Superior aesthetics with our uniformly black surface design which eliminates highly visible reflective grid lines and metal interconnect ribbons; and

 

    Efficient use of silicon, a key raw material used in the manufacture of solar cells.

 

We offer solar power products including solar cells, solar panels and inverters which convert sunlight to electricity compatible with the utility network. Our initial solar sales efforts have been focused on residential and commercial applications where the high performance and superior aesthetics of our solar power products provide compelling customer benefits. We sell our solar power products in many countries, principally in regions where government incentives have accelerated solar power adoption. In addition, we offer high performance imaging detectors based on our solar power technology, primarily for medical imaging applications. We also offer infrared detectors based on our high performance all back contact technology, primarily for use in computing and mobile phone applications.

 

We commenced commercial production of our solar cells in late 2004. We generated total combined revenue of $10.9 million in fiscal 2004 and total revenue of $49.4 million in the nine months ended September 30, 2005. We have incurred net losses since inception, including a net loss of $15.2 million in the nine months ended September 30, 2005, and as of September 30, 2005, we had an accumulated deficit of approximately $57.9 million.

 

Market Opportunity

 

The electric power industry is one of the world’s largest industrial segments, with annual revenue of approximately $1.06 trillion in 2004, according to Datamonitor, an industry consulting firm. Global electricity demand has shown consistent growth over the past decade and is expected to increase from 14.3 trillion kilowatt hours in 2003 to 26.0 trillion kilowatt hours by 2025, according to the United States Department of Energy’s International Energy Outlook 2005. Investments in generation, transmission and distribution to meet growth in electricity demand, excluding investments in fuel supply, are expected to be roughly $10 trottom">       

Conversion of notes payable to preferred stock

    1,270                               9,000  

Conversion of notes payable to common stock

                      1,950             76,036  

Conversion of accounts payable to common stock

                                  14,715  

Solar power has emerged as one of the most rapidly growing renewable energy sources primarily due to multiple advantages it offers over other renewable energy sources, including negligible impact on the environment,

 

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no fuel price or delivery risk, point-of-use power generation, price competitiveness with peak retail electric rates, maximum generation during peak energy demand periods, modularity and reliability. Since 1985, the market for solar power, as defined by worldwide shipments of solar power systems, has grown at a compound annual growth rate of over 20%, according to Strategies Unlimited, a research firm. Since 2000, the growth of the global solar power market, as defined by solar power system installations, has accelerated to an average rate of 38%, according to SolarBuzz, an industry consulting firm. The global solar power market had an estimated $6.5 billion in revenue in 2004.

 

While the cost of solar power has declined steadily over the past 30 years, it still remains more expensive than other power sources in applications without the support of government incentive programs. In addition, the solar market is dependent on polysilicon, an essential raw material. Currently, there is an industry-wide shortage of polysilico"> 

Conversion of preferred stock to common stock

                      814              

Cancellation of common stock

                      (10,449 )            

Supplemental cash flow information

                                               

Cash paid for interest

    44       149                          

Cash paid for income taxes

                           

 

Our Strengths

 

Solar power is an emerging high-growth power generation technology. Adoption of solar power is accelerating, driven partially by government programs, although solar power’s cost competitiveness versus other electricity generation alternatives and aesthetics are challenges to widespread acceptance of solar power. We believe we are a leader in producing high performance solar cells and believe our competitive advantages include:

 

       

 

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

 

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SunPower Corporation

 

Notes to Consolidated Financial Statements

 

Note 1. The Company and Summary of Significant Accounting Policies

 

The Company and Basis of Presentation

 

SunPower Corporation (the “Company” or “SunPower”), a majority owned subsidiary of Cypress Semiconductor Corporation (“Cypress”), was incorporated in the State of California on April 24, 1985. The Company was basically dormant until October 1988, when it was organized as a business venture to commercialize high-efficiency photovoltaic, or solar, cell technology. The Company designs, manufactures and sells solar electric power products based on its proprietary processes and technologies. In addition, the Company offers imaging detectors and infrared detectors based on its solar power technology.

 

Through funding provided by Cypress (see Note 2 and 9), the Company completed the construction of its wafer fabrication facility in the Philippines in late 2004, at which point it began volume commercial production. Currently the Company operates a 25 megawatt capacity per year solar cell production line and has ordered equipment for a second and third 25 megawatt capacity per year production lines.

 

In May 2002, Cypress acquired a 57% equity interest in the Company and entered into several equity and debt financing transactions with the Company. On November 9, 2004, the Company became a wholly-owned subsidiary of Cypress as a result of a merger transaction, whereby all of the minority shareholders exchanged their shares of SunPower common stock for Cypress common stock (see Note 2). Outstanding options to purchase SunPower common stock held by the Company’s officers, employees and other service providers and warrants held by Cypress to purchase SunPower common stock remained outstanding as of the closing of the merger. This transaction resulted in the “push down” of the effect of the acquisition of SunPower by Cypress and created a new basis of accounting. As a result, the balance sheet, statements of operations, cash flows and shareholders’ deficit for the periods up to November 8, 2004 are presented as the “Predecessor Company,” and all subsequent financial statements are presented as the “Successor Company.”

 

The consolidated financial statements of the Company reflect the historical results of operations, cash flows, assets and liabilities of the Company and all of its subsidiaries, including the goodwill, intangible assets and related deferred tax effect arising from the November 9, 2004 merger with Cypress.

 

The financial statements include allocations of certain Cypress expenses, including centralized 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 considered to be reasonable reflections 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, changes in equity 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 3 for additional information on the transactions with Cypress.

 

The Company is subject to a number of business risks, including, but not limited to, 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; the dependency on third-party subcontractors; the ability to obtain adequate financing to fund operating activities; dependence on key employees; and the ability to attract and retain additional qualified personnel.

 

Liquidity

 

The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As shown in the financial statements, the Company had, as of December 31, 2004 and September 30, 2005, a net accumulated deficit of $42.7 million and $57.9 million (unaudited), respectively, a working capital deficiency of $54.3 million and working capital of $26.4 million (unaudited), respectively, and a

 

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SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

history of operating losses. The Company’s continuation as a going concern is dependent upon continued financial support from Cypress, the Company’s ability to generate sufficient cash flows to meet its obligations on a timely basis, the Company’s ability to obtain additional financing or refinancing as may be required, or the Company’s ability to attain profitability.

 

Since May 2002, Cypress has been the primary source of funding for the Company’s investing and financing activities. Aside from the existing $30.0 million Line of Credit Agreement with Cypress, which is in place up to the earlier of the completion of the Company’s initial public offering or December 31, 2006, Cypress has no obligation to provide additional funding to the Company. Management believes that current cash and cash equivalents, along with the combination of cash received from Cypress and the conversion of debt and payables to Cypress into equity on July 18, 2005, and the existing $30.0 million line of credit agreement will be sufficient to enable the Company to meet its working capital and capital expenditure requirements for at least the next 12 months.

 

Principles of Consolidation

 

The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and include the accounts of the Company and all of its subsidiaries. Intercompany transactions and balances have been eliminated in consolidation.

 

Fiscal Year

 

For 2002, the Company’s fiscal year ended on December 31. In fiscal 2003, the Company began to report results of operations on the basis of 52 or 53 week periods, ending on the Sunday closest to December 31. Fiscal 2003 ended on December 28, 2003 and included 52 weeks. Combined periods of fiscal 2004 ended on January 2, 2005 and included 53 weeks. The Company’s fiscal quarters end 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. For presentation purposes only, the consolidated financial statements and notes refer to the calendar year end and month end of each respective period.

 

Management Estimates

 

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant estimates in these financial statements include allowances for doubtful accounts receivable, inventory write-downs, estimates for future cash flows and economic useful lives of property and equipment, asset impairments, certain accrued liabilities and income taxes and tax valuation allowances. Actual results could differ from those estimates.

 

Fair Value of Financial Instruments

 

The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties. The carrying values for cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their respective fair values due to their short maturities.

 

Comprehensive Loss

 

Comprehensive income (loss) is defined as the change in equity during a period from non-owner sources. The Company’s comprehensive loss is comprised of net loss and changes in unrealized gains (losses), net of tax, for derivatives such as the outstanding cash flow hedge forward contracts related to forecasted Euro revenue transactions (see Note 7). Comprehensive income (loss) is presented in the Consolidated Statements of Comprehensive Loss.

 

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SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

Cash and Cash Equivalents

 

Highly liquid investments with original or remaining maturities of ninety days or less at the date of purchase are considered cash equivalents.

 

Inventories

 

Inventories are stated at the lower of standard cost or net realizable value. Standard cost approximates actual cost on a first-in, first-out basis. The Company routinely evaluates quantities and values of inventory in light of current market conditions and market trends, and records reserves for quantities in excess of demand and product obsolescence. The evaluation may take into consideration historic usage, expected demand, anticipated sales price, new product development schedules, the effect new products might have on the sale of existing products, product obsolescence, customer concentrations, product merchantability and other factors. Market conditions are subject to change and actual consumption of our inventory could differ from forecast demand. The Company’s products have a long life cycle and obsolescence has not historically been a significant factor in the valuation of inventories. The Company also regularly reviews the cost of inventory against their estimated market value and records a lower of cost or market reserve for inventories that have a cost in excess of estimated market value. Inventory reserves once recorded are not reversed until the inventories have been subsequently disposed of.

 

Property and Equipment

 

Property and equipment are stated at cost, less accumulated depreciation. Depreciation is computed for financial reporting purposes using the straight line method over the estimated useful lives of the assets as presented below. Leasehold improvements are amortized over the shorter of the estimated useful lives of the assets or the remaining term of the lease. Repairs and maintenance costs are expensed as incurred.

 

     Useful Lives
in Years


Manufacturing Equipment

  
    Superior Conversion Efficiency.    We believe our solar cells have the highest conversion efficiency available for the mass market. Our proprietary all back contact design results in conversion efficiencies of up to 50% more power per unit area than conventional solar cells. This superior conversion efficiency results in decreased per watt panel packaging and installation costs and provides greater power generation on a given rooftop space.

 

    Superior Aesthetics.    Because all electrical contacts are located on the back, our solar cells have a uniformly black appearance that allows our solar panels to blend into customers’ rooftops, which we believe appeals to customers seeking a solution which is more aesthetically appealing.

 

    Efficient Silicon Utilization.    We believe our superior conversion efficiency allows us to use less silicon to generate the same amount of electricity as conventional solar cells of the same size. This superior conversion efficiency also provides our solar cells with more efficient utilization of silicon, the primary raw material used in solar cells, as defined by grams of silicon per watt, than that of conventional solar cells. Based on third-party data, the solar industry’s rate of silicon consumption is estimated to range from 11.5 grams per watt to 13 grams per watt. Our rate of consumption, as calculated by us, is 9.2 grams per watt.

 

    Ease of Assembly.    Our proprietary solar cell architecture simplifies panel assembly, allowing for backside connections, versus the traditional interconnect weaving process. We believe our architecture reduces the complexity and cost of assembling solar panels.

 

    Manufacturing Advantages.    We manufacture our solar cells at our facility in the Philippines, a low-cost production region. In addition, we believe our background and expertise in the semiconductor industry enable us to improve our manufacturing yields, cost, quality and product ramp predictability.

 

    Strong Management Team.    Our management team has a diverse set of industry skills and global operating experience, including backgrounds spanning the solar, semiconductor and optical media industries, as well as expertise running complex organizations and managing rapid growth. Our executive officers have an average of over 25 years of experience in the solar or high technology industries.

 

Our ability to maintain our competitive advantage is dependent on several factors, including the availability of polysilicon and other key components from third-party suppliers, uninterrupted operations at our Philippines

 

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facility, our ability to expand our customer base, our history in producing and shipping solar cells and solar panels in commercial volumes, our ability to compete, the market for solar power and our ability to retain key personnel and other factors set forth in “Risk Factors.”

 

Our Strategy

 

Our principal objective is to be the leader in high performance solar power products. We plan to achieve this objective by pursuing the following strategies:

 

    Maintain our Technology Advantage and Reduce Manufacturing Costs.    We intend to maintain our technology advantage by continuing to invest in research and development to improve solar cell efficiency and lower manufacturing costs.

 

    Continue to Expand Manufacturing Capacity.    Since late 2004, we have been operating a single 25 megawatts per year solar cell production line. This production line is capable of manufacturing over the course of a year solar cells with a cumulative rated capacity of 25 megawatts peak production, which is equivalent to over eight million A-300 solar cells per year. To meet the ongoing demand for our products, we have ordered manufacturing equipment for the second and third 25 megawatts per year production lines, which are expected to increase our manufacturing capacity to 75 megawatts per year in 2006. We are evaluating the timing of a fourth line in our existing facility and of a second production facility.

 

    Reduce our Dependence on Market Incentives.    Most of our current customers operate in markets that depend on a variety of government incentives to reduce the cost of solar power systems to end customers. In the short term, we intend to diversify our customer and market base to include non-incentivized markets. Over the long term, we plan to reduce our solar power system cost to reduce or eliminate the need for these market incentives.

 

    Build a Leading Brand.    We believe establishing strong brand name recognition is important to increase product awareness and to address the mass market. We intend to differentiate our brand by emphasizing our combination of high performance and superior product appearance.

 

    Drive Efficiency Improvements Through Relationships with Suppliers and Customers.    We intend to pursue relationships with, and investments in, our suppliers and customers to increase overall channel efficiency and reduce the cost of our products delivered to end customers.

 

Our Corporate History

 

We were incorporated in California in April 1985. We reincorporated in Delaware in November 2005. Our headquarters are located at 430 Indio Way, Sunnyvale, CA 94085 and our telephone number is (408) 991-0900. Our website is www.sunpowercorp.com. Information contained on, or that can be accessed through, our website does not constitute part of this prospectus. In this prospectus, “SunPower,” “we,” “us” and “our” refer to SunPower Corporation and its subsidiaries and not to the underwriters or Cypress.

 

SunPower is our registered trademark. The SunPower logo is our trademark. This prospectus also includes trade names, trademarks and service marks of other companies and organizations.

 

Our Relationship with Cypress Semiconductor Corporation

 

Cypress made a significant investment in us in 2002. On November 9, 2004, Cypress completed a reverse triangular merger with us in which all of the outstanding minority equity interest of SunPower was retired, effectively giving Cypress 100% ownership of all of our then outstanding shares of capital stock but leaving our unexercised warrants and options outstanding.

 

After this offering, CypreIZE="2">2 to 7

Computer Equipment

   2 to 7

Furniture and fixtures

   3 to 5

Leasehold improvements

   5 to 15

 

Long-Lived Assets

 

The Company evaluates its long-lived assets, including property and equipment and intangible assets with finite lives, for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Factors considered important that could result in an impairment review include significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of use of acquired assets and significant negative industry or economic trends. Impairments are recognized based on the difference between the fair value of the asset and its carrying value. Fair value is generally measured based on either quoted market prices, if available, or discounted cash flow analyses.

 

Goodwill and Intangibles Arising from Cypress’ Acquisition of the Company

 

The Company accounts for goodwill and other intangibles in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” Goodwill and intangibles with indefinite lives are not amortized but are tested for impairment on an annual basis or whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Intangible assets with finite useful lives are amortized using the straight-line method over their useful lives ranging primarily from 2 to 6 years and are reviewed for impairment in accordance with SFAS No. 144.

 

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SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

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 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. The warranty reserve includes specific accruals for known product issues and an accrual for an estimate of incurred but not reported product issues.

 

Revenue Recognition

 

The Company sells its products directly to system integrators and OEMs and recognizes revenue when persuasive evidence of an arrangement exists, delivery of the product has occurred and title and risk of loss has passed to the customer, the sales price is fixed and determinable, collectibility of the resulting receivable is reasonably assured and the rights and risks of ownership have passed to the customer. There are no rights of return and there are no significant post-shipment obligations, including installation, training or customer acceptance clauses with any of its customers that could have an impact on revenue recognition. As such, the Company records a trade receivable for the selling price when the above conditions are met, and reduces inventory for the carrying value of goods shipped. The Company’s revenue recognition policy is consistent across its product lines and sales practices are consistent across all geographic areas.

 

The Company also enters into development agreements with some of its customers. Development revenue is recognized under the proportionate performance method, with the associated costs included in research and development expense. The Company estimates the proportionate performance of its development contracts based on an analysis of progress toward completion.

 

Translation of Foreign Currencies

 

The Company uses the U.S. dollar as its functional currency for all foreign subsidiaries. Accordingly, assets and liabilities of these subsidiaries are translated using exchange rates in effect at the end of the period, except for non-monetary assets, such as property, plant and equipment, which are translated using historical exchange rates. Revenues and costs are translated using average exchange rates for the period, except for income items related to non-monetary assets and liabilities, such as depreciation, that are translated using historical exchange rates. As of December 31, 2003, there were no accounts receivables or accounts payables denominated in foreign currencies. As of December 31, 2004 and September 30, 2005, the Company had accounts receivable of Euro 1.9 million and Euro 8.4 million (unaudited), respectively, which translate into $2.6 million and $10.1 million (unaudited), respectively. As of December 31, 2004 and September 30, 2005, the Company had accounts payable of Euro 0.1 million and Euro 0.6 million (unaudited), respectively. The resulting translation gains and losses included in other income (expense) of the above combined with the other hedging activities were not significant to the consolidated statements of operations for the periods presented.

 

Concentration of Credit Risk

 

Financial instruments that potentially subject the Company to concentrations of credit risk are primarily cash, cash equivalents and trade accounts receivable. The Company’s investment policy requires cash and cash equivalents to be placed with high-credit quality institutions and to limit the amount of credit risk from any one issuer. The Company performs ongoing credit evaluations of its customers’ financial condition whenever deemed

 

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SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

necessary and generally does not require collateral. The Company maintains an allowance for doubtful accounts receivable based upon the expected collectibility of all accounts receivable, which takes into consideration an analysis of historical bad debts, specific customer creditworthiness and current economic trends. The allowance for doubtful accounts was $57,000, $59,000 and $529,000 (unaudited) as of December 31, 2003 and 2004 and September 30, 2005, respectively. Three customers accounted for 29%, 26% and 11% of accounts receivable as of December 31, 2003. Three customers accounted for 45%, 12% and 11% of accounts receivable as of December 31, 2004, respectively. Two customers accounted for 43% (unaudited) and 11% (unaudited) of accounts receivable as of September 30, 2005.

 

Accounting for Stock-Based Compensation

 

The Company accounts for its stock-based employee compensation plans under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”) and related Interpretations and complies with disclosure provisions of SFAS 148, Accounting for Stock-Based Compensation—Transition and Disclosure—an Amendment of SFAS 123. In certain instances, the Company reflects stock-based employee compensation cost in net income (loss). If there is any compensation under the rules of APB 25, the expense is amortized using an accelerated method prescribed under the rules of the Financial Accounting Standards Board (“FASB”) Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans (“FIN 28”). The following table illustrates the effect on net loss and related per share amounts if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), to all stock based employee awards (in thousands, except per share data).

 

    Predecessor Company

    Successor Company

 
   

Years Endss will hold in the aggregate 52,033,287 shares of class B common stock, representing approximately 87% of our total outstanding shares of common stock. At that time, Cypress is

 

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expected to hold 98% of the voting power of our outstanding capital stock. Cypress has advised us that it does not have any current plans to distribute to its stockholders the shares of our class B common stock that it beneficially owns, although it may elect to effect such a distribution in the future.

 

We design, manufacture and sell solar power products based on our proprietary processes and technologies. We have entered into various separation agreements with Cypress including a master separation agreement, an employee matters agreement, a tax sharing agreement, a master transition services agreement, a wafer manufacturing agreement, a lease for certain manufacturing assets, an investor rights agreement, and an indemnification and insurance matters agreement. These agreements will become effective upon completion of this offering, except for the tax sharing agreement and the lease for manufacturing assets which are currently effective. We also entered into an agreement with Cypress to extend our lease in the Philippines for an additional 15 years with a right to purchase the facility. See “Related Party Transactions.”

 

Under the terms of the master transition services agreement, we will pay Cypress for the services provided to us, at Cypress’ cost or at the rate negotiated with Cypress for a period of three years following this offering or upon a change of control, whichever occurs first. Under the terms of our lease agreement, we will pay Cypress at a rate equal to the cost to Cypress for the lease of our Philippines facility until the earlier of 10 years or a change of control of us. Thereafter, we will pay market rent for the facility for the remainder of the 15-year lease. Under the terms of the wafer manufacturing agreement, we will pay Cypress to make infrared and imaging detector products for us 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 next three years or until a change of control of us. See “Related Party Transactions.”

 

Cypress designs, develops, manufactures and markets a broad line of high-performance digital and mixed-signal integrated circuits for a broad range of markets, including networking, wireless infrastructure and handsets, computation, consumer, automotive and industrial. Cypress’ product portfolio includes a selection of wired and wireless USB devices, CMOS image sensors, timing solutions, network search engines, specialty memories, high-bandwidth synchronous and micropower memory products, optical solutions and reconfigurable mixed-signal arrays. Cypress stock is traded on the New York Stock Exchange under the symbol “CY.”

 

4


Table of Contents

THE OFFERING

 

Class A common stock offered by us

7,700,000 shares

 

Class A common stock to be outstanding after this offering

December 31,


   

Nine Months
Ended

September 30,
2004


    January 1,
2004 Through
November 8,
2004


   

November 9,

2004 Through
December 31,
2004


   

Nine Months

Ended

September 30,
2005


 
  2002

    20037,776,652 shares

 

Class B common stock to be outstanding after this offering

52,033,287(1) shares, representing approximately 87% of our total outstanding shares of capital stock and 98% of the voting power of our outstanding capital stock.

 

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Total common stock to be outstanding after this offering

         
                (unaudited)                 (unaudited)  

Net loss, as reported

  $ (3,533 )   $ (14,545 )   $ (18,557 )   $ (23,302 )   $ (5,609 )   $ (15,203 )

Add :     Total stock-based employee compensation expense reported in net loss, net of related tax effects

                55       131       650       510  

Deduct:  Total stock-based employee compensation expense determined under SFAS 123 for all awards, net of related tax effects

    (11 )     (55 )     (928 )     (1,187 )           (370 )     (3,487 )
   


 


 


 


 


 


Pro forma net loss

  $ (3,544 )   $ (14,600 )   $ (19,430 )   $ (24,358 )   $ (5,329 )   $ (18,180 )
   

59,809,939 shares

 

Voting rights

Following this offering, we will have two classes of authorized common stock: class A common stock and class B common stock. Only Cypress, its successors in interest and its subsidiaries may hold shares of class B common stock unless Cypress distributes its shares of class B common stock to its stockholders in a tax-free distribution. The rights of the holders of class A and class B common stock are substantially similar, except with respect to voting, conversion and other protective provisions as set forth in this prospectus. The holders of class B common stock shall be entitled to eight votes per share and the holders of class A common stock shall be entitled to one vote per share. Each share of class B common stock is convertible into one share of class A common stock at any time. In the event that Cypress, its successors in interest and its subsidiaries collectively own less than 40% of the shares of all classes of our common stock then outstanding and Cypress has not effected a tax-free distribution of our class B common stock to its stockholders prior to such time, each outstanding share of class B common stock will automatically convert into one share of class A common stock. See “Description of Capital Stock.”

 

Use of proceeds

We intend to use approximately $45 million to $55 million of the net proceeds from this offering for the expansion of our manufacturing capacity and the remainder for general corporate purposes, including working capital. We may use approximately $10 million of the proceeds to purchase our Philippines manufacturing facility from Cypress, which we have the option to do under our lease. We may also use a portion of the net proceeds to acquire complementary technologies or businesses. See “Use of Proceeds.”

 

Nasdaq National Market symbol

“SPWR”


(1) All shares of class B common stock are currently held by Cypress. Only Cypress, its successors in interest and its subsidiaries may hold shares of our class B common stock unless Cypress distributes its shares of class B common stock to its stockholders in a tax-free distribution.

 

5


Table of Contents

The number of shares of class A and class B common stock to be outstanding immediately after this offering is based upon 76,652 shares of class A common stock and 52,033,287 shares of class B common stock outstanding as of September 30, 2005 and excludes:

 

    6,508,193 shares of class A common stock issuable upon the exercise of options outstanding as of September 30, 2005, at a weighted average exercise price of $2.97 per share; and

 

    283,126 shares of class A common stock reserved for future issuance as of September 30, 2005 under our 2005 Stock Incentive Plan.

 

As of September 30, 2005, 283,126 shares of class A common stock remained available for future issuance under our 1996 Stock Plan. Upon the completion of this offering, the 1996 Stock Plan will be terminated. No shares of our class A common stock will remain available under the 1996 Stock Plan or our 1988 Stock Incentive Plan other than for satisfying exercises of stock options granted under this plan prior to its termination.

 

We have also adopted our 2005 Stock Unit Plan, under which our board of directors awards participants the right to receive cash payments from us in an amount equal to the appreciation in our stock between the award date and the date the employee redeems the award. A maximum of 100,000 stock units may be subject to stock unit awards granted under this plan and as of September 30, 2005, 11,450 units have been granted.

 

Unless otherwise stated, all information in this prospectus assumes:

 

    the automatic conversion of all outstanding shares of our series one convertible preferred stock into 6,457,530 shares of class B common stock and all outs000">
 


 


 


 


 


Net loss per share:

                                               

Basic and diluted—as reported

  $ (1.11 )   $ (3.50 )   $ (4.41 )   $ (5.51 )   $ (2,804.50 )   $ (0.93 )
   


 


 


 


 

 

    no exercise of the over-allotment option granted to the underwriters; and

 

    a 2-for-1 reverse stock split of our common stock effected on November 10, 2005.

 

Upon completion of this offering, each share of series one convertible preferred stock will convert into 0.5 shares of class B common stock and each share of series two convertible preferred stock will convert into 0.5 shares of class B common stock. Except as otherwise stated, all information related to common stock and options and warrants to purchase common stock and earnings per share has been retroactively adjusted to give effect to the reverse stock split.

 


 

6


Table of Contents

SUMMARY CONSOLIDATED FINANCIAL DATA

 

The following tables present our summary consolidated historical financial information. You should read this information together with the consolidated financial statements and related notes and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

On November 9, 2004, Cypress completed a reverse triangular merger with us in which each share of our then outstanding capital stock not owned by Cypress was valued at $3.30 per share on a post-split basis, or $1.65 per share on a pre-split basis, and exchanged for an equivalent number of shares of Cypress common stock. This merger effectively gave Cypress 100% ownership of all of our then outstanding shares of capital stock but left our unexercised warrants and options outstanding. This transaction resulted in the “push down” of the effect of the acquisition of SunPower by Cypress and created a new basis of accounting. See note 2 of the notes to our consolidated financial statements. The consolidated balance sheet and statements of operations data in this prospec WIDTH="0" SIZE="3" NOSHADE ALIGN="left" COLOR="#ffffff">

 


Basic and diluted—pro forma

  $ (1.11 )   $ (3.51 )   $ (4.62 )   $ (5.76 )   $ (2,664.50 )   $ (1.12 )
   


 


 


 


 


 


 

F-13


Table of Contents

SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

The fair value of each stock option is estimated on the date of grant using the Black-Scholes pricing model with the following assumptions:

 

    Predecessor Company

  Successor Company

   

Year Ended

December 31,


 

Nine Months
Ended

September 30,
2004


   

January 1,

2004 Through
November 8,

2004


 

November 9,

2004 Through
December 31,

2004


 

Nine Months

Ended

September 30,

2005


    2002

 

 

The consolidated statements of operations data for the fiscal years ended December 31, 2002 and 2003, the period from January 1, 2004 to November 8, 2004, and the period from November 9, 2004 to December 31, 2004, have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The consolidated balance sheet at September 30, 2005, and the consolidated statement of operations data for the nine months ended September 30, 2004 and 2005 are derived from our unaudited consolidated financial statements included elsewhere in this prospectus. In 2002, we reported our results of operations on a calendar year-end basis. In fiscal 2003, we began to report our results of operations on the basis of 52 or 53 week periods, ending on the Sunday closest to December 31. Fiscal 2003 ended on December 28, 2003 and included 52 weeks. The combined periods of fiscal 2004 ended on January 2, 2005 and included 53 weeks. Our fiscal quarters end on the Sunday closest to the end of the applicable calendar quarter, except in a 53-week fiscal year in which the additional week falls into the fourth quarter of that fiscal year. For presentation purposes only, the consolidated financial statements and notes refer to the calendar year-end and month-end of each respective period.

 

Our consolidated financial statements include allocations of certain Cypress expenses, including centralized legal, tax, treasury, information technology, employee benefits and other Cypress corporate services and infrastructure costs. The expense allocations have been determined on bases that we and Cypress considered to be reasonable reflections of the utilization of services provided or the benefit received by us. The financial information included in this discussion and in our consolidated financial statements may not be indicative of our consolidated financial position, operating results, changes in equity and cash flows in the future, or what they would have been had we been a separate stand-alone entity during the periods presented. See note 3 of the notes to our consolidated financial statements for additional information on our relationship with Cypress.

 

7


Table of Contents
    Predecessor Company

    Successor Company

 
    Years Ended
December 31,


   

Nine Months
Ended

September&"bottom" ALIGN="center">2003


       
            (unaudited)             (unaudited)

Dividend yield

  0%   0%   0%     0%   0%   0%

Risk-free interest rate

  3.17% - 3.95%   2.13% - 3.20%   3.08% - 3.12%      3.08% - 3.58%       3.08% - 3.58%   3.5% - 4.15%

Expected life

  4.6 years   5 years   4 years     4 years   4 years   4 years

Volatility

  85%   78%   81%     81%   81%   74%

 

No options were granted to employees where the exercise price was less than the deemed fair value of common stock on the date of grant for the years endenbsp;30,
2004


    January 1,
2004 Through
November 8,
2004


    November 9,
2004 Through
December 31,
2004


    Nine Months
Ended
September 30,
2005


 
    2002

    2003

         
Consolidated Statements of Operations Data   ($ in thousands, except per share data)              

Revenue:

                                 

 

Earnings per Share

 

Basic net income (loss) per share is computed using the weighted-average common shares outstanding. Diluted net income 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 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 warrants.

 

For the fiscal years ended December 31, 2002 and 2003; the period from January 1, 2004 to November 8, 2004; the period from November 9, 2004 to December 31, 2004; and the nine months ended September 30, 2004 (unaudited) and 2005 (unaudited), outstanding convertible preferred stock, stock options to purchase common stock and warrants to purchase preferred and common stock, were excluded from the calculation of diluted net loss per share as the Company was in a net loss position and their inclusion would have been anti-dilutive. The following is a summary of all outstanding anti-dilutive potential common shares (in thousands):

 

                 

Product revenue

  $ 3,722     $ 4,245     $ 6,023     $ 6,708     $ 3,881     $ 49,242  

Other

    333       760       122       122       174       153  
   


 


Predecessor Company

  Successor Company

  Year Ended
December 31,


  Nine Months
Ended
September 30,
2004


 

January 1, 2004
Through

November 8, 2004


 



 


 


 


Total revenue

    4,055       5,005       6,145       6,830       4,055       49,395  
   


 


 


 


 


 


  November 9, 2004
Through
December 31, 2004


  Nine Months
Ended
September 30,
2005


    2002

  2003

       
            (unaudited)           (unaudited)

Convertible preferred stock

  14,308   14,308   14,308   12,915       12,915   44,915

Stock options

  517   1,745   3,875   3,644       4,285   6,508

Preferred stock warrants

  16,000   16,000     —        

Common stock warrants

  658   822   4,132   3,821       3,821  

 

Shipping and Handling Costs

 

The Company records costs related to shipping and handling in cost of revenue.

 

F-14


Table of Contents

SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

Costs and expenses:

                                               

Cost of revenue

    3,198       4,987       6,707       9,498       6,079       49,631  

Research and development

    2,532       9,816       11,035       12,118       1,417       4,508  

Sales, general and administrative

    1,396       3,238       3,997       4,713       1,111       6,880  
   
Advertising Expenses

 

Advertising expenses to date have not been significant.

 

Research and Development Costs

 

Research and development costs consist primarily of compensation and related costs for personnel, materials, supplies and equipment depreciation. Pre-production costs, incurred in connection with developing production capabilities at the Company’s Philippine solar cell manufacturing facility are included in research and development. All research and development costs are expensed as incurred. In March 2005, the Company entered into a three year cost-sharing research and development project with a government agency to fund up to $3 million, representing half of the project costs, to design the Company’s next generation solar panels. Amounts invoiced under this arrangement, which cannot exceed $1 million per year and are based on agreed milestones, are offset to research and development expense upon acceptance from the government agency. During the first nine months of 2005, the Company invoiced $352,000 (unaudited) for work performed, which was recorded as an offset to research and development expense.

 

Income Taxes

 

For financial reporting purposes, income tax expense and deferred income tax balances were calculated as if the Company were a separate entity and had prepared its own separate tax return. Deferred tax assets and liabilities are recognized for temporary differences between financial statement and income tax bases of assets and liabilities. Valuation allowances are provided against deferred tax assets when it is more likely than not that some portion or all of the deferred tax asset will not be realized.

 

The Company filed separate U.S. federal tax returns up to November 8, 2004. Subsequent to November 8, 2004 the Company has filed U.S. federal consolidated tax returns with Cypress. The Company filed California state tax returns on a separate entity basis up to December 31, 2002. Subsequent to December 31, 2002, the Company has filed combined returns with Cypress as a member of Cypress’ entity group. The computation of any income taxes has been done on a separate return basis for financial reporting purposes. Cypress and the Company have entered into a tax sharing agreement providing for each company’s obligations concerning various tax liabilities (see Note 5 and Note 14).

 

Recent Accounting Pronouncements

 

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” which changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS No. 154 replaces APB No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statement.” It requires retrospective application to prior period’s financial statements of a voluntary change in accounting principle unless it is impracticable. In addition, under SFAS No. 154, if an entity changes its method of depreciation, amortization, or depletion for long-lived, non-financial assets, the change must be accounted for as a change in accounting estimate effected by a change in accounting principle. SFAS No. 154 applies to accounting changes and error corrections made in fiscal years beginning after December 15, 2005 on a prospective basis. The Company does not expect the adoption in the first quarter of fiscal 2006 will have a material impact on its consolidated results of operations and financial condition.

 

In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations.” Interpretation No. 47 clarifies that an entity must record a liability for a “conditional” asset retirement obligation if the fair value of the obligation can be reasonably estimated. Interpretation No. 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. Interpretation No. 47 is effective no later than the end of the fiscal year ending after

 

F-15


Table of Contents

SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

December 15, 2005. The Company is currently evaluating the provision and does not expect the adoption in the fourth quarter of fiscal 2005 will have a material impact on its results of operations or financial condition.

 

In March 2005, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 107, which provides guidance on the implementation of Statement of Financial Accounting Standards (SFAS) No. 123 (R), Share-Based Payment (see discussion below). In particular, SAB No. 107 provides key guidance related to valuation methods (including assumptions such as expected volatility and expected term), the accounting for income tax effects of share-based payment arrangements upon adoption of SFAS No. 123(R), the modification of employee share options prior to the adoption of SFAS No. 123(R), the classification of compensation expense, capitalization of compensation cost related to share-based payment arrangements, first-time adoption of SFAS No. 123(R) in an interim period, and disclosures in Management’s Discussion and Analysis subsequent to the adoption of SFAS No. 123(R). SAB No. 107 became effective on March 29, 2005. The Company will apply the principles of SAB 107 in conjunction with the adoption of SFAS 123(R).

 

In December 2004, the FASB issued SFAS No. 123(R), which replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Under SFAS No. 123(R), companies are required to measure the compensation costs of share-based compensation arrangements based on the grant-date fair value and recognize the costs in the financial statements over the period during which employees are required to provide services. Share-based compensation arrangements include stock options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans. In April 2005, the SEC postponed the implementation date to the fiscal year beginning after June 15, 2005. The Company will adopt SFAS No. 123(R) in the first quarter of fiscal 2006. SFAS No. 123(R) permits public companies to adopt its requirements using one of two methods. The Company is currently evaluating which method to adopt. The adoption of SFAS No. 123(R) will have a significant adverse impact on the Company’s results of operations, although it will have no impact on its overall financial position. The precise impact of adoption of SFAS No. 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had the Company adopted SFAS No. 123(R) using the modified retrospective application for all prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described under the “Accounting for Stock-Based Compensation” section in Note 1. SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While the Company cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of operating cash flows recognized for such excess tax deductions were zero dollars in fiscal 2002, fiscal 2003, the period from January 1, 2004 to November 8, 2004 and the period from November 9, 2004 to December 31, 2004 and zero dollars for the nine months ended September 30, 2004 and 2005 (unaudited).

 

Unaudited Pro Forma Stockholders’ Equity

 

If the offering contemplated by this prospectus is completed, all of the redeemable convertible preferred stock outstanding will automatically convert into 22,457,530 shares of class B common stock, based on the shares of redeemable convertible preferred stock outstanding at September 30, 2005 and the initial conversion price. Unaudited pro forma stockholders’ equity, as adjusted for the assumed conversion of the redeemable convertible preferred stock, is set forth on the consolidated balance sheets.

 

Unaudited Interim Financial Statements

 

The consolidated statements of operations and cash flows for the nine months ended September 30, 2004 and 2005 and all related financial data are unaudited. These unaudited interim financial statements have been

 

F-16


Table of Contents

SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

prepared on the same basis as the annual financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary to state fairly their financial position and results of operations and cash flows for the nine months ended September 30, 2004 and 2005. The results for the nine months ended September 30, 2004 and 2005 are not necessarily indicative of the results for any interim period or for any year.

 

Note 2. Cypress Step Acquisition of SunPower

 

Effective November 9, 2004, SunPower became a wholly owned subsidiary of Cypress when Cypress exchanged Cypress common stock for all outstanding shares of SunPower common stock. Outstanding options to purchase SunPower common stock held by the Company’s officers, employees and other service providers and warrants held by Cypress to purchase SunPower common stock remained outstanding as of the closing of the merger. This was accomplished through two equity investments made by Cypress.

 

    On May 30, 2002, the Company (a) issued 12.1 million shares of series one convertible preferred stock to Cypress in exchange for $8.3 million in cash, and (b) converted approximately $0.5 million of promissory notes and accrued interest due to Cypress in exchange for 0.8 million shares of series one convertible preferred stock. In addition, the Company issued to Cypress a warrant to purchase 16 million shares of series two preferred stock at $1.00 per share, which warrant expired in January 2004, prior to being exercised by Cypress (see Note 9 and 10). As a result of this transaction, Cypress acquired an approximate 57% ownership of the Company’s outstanding voting stock. Although Cypress owned a majority of the outstanding voting stock of the Company, the non-Cypress shareholders had 50% of the board seats, which provided such minority shareholders with effective veto (and substantive participatory) rights.

 

    On November 8, 2004, all of the then outstanding shares of capital stock other than those shares owned by Cypress were valued at $3.30 per share, on a post-split basis, or $1.65 per share, on a pre-split basis, and were retired in exchange for the issuance of an equivalent number of Cypress common stock to the former holders of those retired shares in connection with a reverse triangular merger in which a wholly owned subsidiary of Cypress was merged into the Company after which SunPower remained as the surviving corporation and a wholly owned subsidiary of Cypress, with outstanding options to purchase SunPower common stock held by the officers, employees and other service providers and warrants held by Cypress to purchase SunPower common stock remaining outstanding after the closing of the merger. In this merger, 7.4 million shares of common stock of the Company held by the minority shareholders were retired in exchange for the fair value of approximately 2.5 million shares of Cypress common stock, including 235,000 shares of Cypress common stock issued to the CEO of Cypress and Chairman of the Board of SunPower. Cypress considered the acquisition of the minority interest in SunPower as the completion of the acquisition of SunPower’s voting securities. This transaction resulted in the “push down” of the effect of the acquisition of SunPower by Cypress and created a new basis of accounting.

 

Push down accounting requires an entity to establish a new cost basis of accounting for assets and liabilities based on the amount paid for the stock of SunPower. Cypress’ basis in SunPower is reflected in the consolidated financial statements of the Company effective November 9, 2004. This includes (a) Cypress’ investment on May 30, 2002 of $8.8 million; (b) the losses of SunPower recorded by Cypress from May 30, 2002 to November 8, 2004 of $37.1 million, as Cypress funded the losses of SunPower beginning May 2002; and (c) Cypress’ investment on November 8, 2004 of $23.2 million to acquire the minority interest of SunPower.

 

The determination of the fair value of SunPower’s net assets as of May 30, 2002 and November 8, 2004 resulted in valuation adjustments (intangible assets and related deferred income taxes) aggregating $3.7 million and $23.2 million, respectively, which were previously reported in the accounts of Cypress as of November 8,

 

F-17


Table of Contents

SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

2004. The amounts pushed down to SunPower financial statements at November 9, 2004, derived from the net carrying balance previously reported by Cypress on November 9, 2004 consisted of the following (in thousands):

 

Purchased Technology

   $ 18,139

Patents

    

 


 


 


3,811

Trademarks and other

 &nbsIDTH="0" SIZE="1" NOSHADE ALIGN="left" COLOR="#ffffff">  


 


Total costs and expenses

    7,126       18,041       21,739       26,329       8,607       61,019  
   


 


 


 


 


 


Operating loss

    (3,071 )     (13,036 )     (15,594 )     (19,499 )     (4,552 )     (11,624 )

Interest expense

    (493 )     (1,509 )     (2,960 )     (3,759 )     (1,072   2,066
    

       24,016

Goodwill

     2,883
    

     $ 26,899
    

 

Cypress accounted for its acquisition of SunPower in accordance with SFAS 141 “Business Combinations.” Accordingly, the purchase price at each investment date (May 30, 2002 and November 8, 2004) was allocated to the assets acquired and liabilities assumeNT>

)     (3,381 )

Other income (expense), net

    31       —         (3 )     (44 )     15       (198 )
   


 


 


 


 


 


Net loss

  $ (3,533 )   $ (14,545 )  On each investment date, the histONT> $ (18,557 )   $ (23,302 )       $ (5,609 )   $ (15,203 )
   


 


 


 


 


 


Net loss per share:

                                               

Basic and diluted(1)

  $ (1.11 )   $ (3.50 )   $ (4.41 )   $ (5.51 )   $ (2,804.50 )   $ (0.93 )

Pro forma basic and diluted(2)

                          $ (2.05 )   $ (0.86 )   $ (0.40 )

Weighted-average shares:

                                               

Basic and diluted(1)

    3,188       4,156       4,207       4,230       2       16,267  

Pro forma basic and diluted(2)

                            11,384       6,542       37,728  

(1) The basic and diluted net loss per share computation excludes potential shares of common stock issuable upon conversion of convertible preferred stock and exercise of options and warrants to purchase common stock as their effect would be antidilutive. See note 1 of the notes to our consolidated financial statements for a detailed explanation of the determination of the shares used in computing basic and diluted loss per share.

 

(2) For information regarding the computation of per share amounts, refer to note 1 of our consolidated financial statements included elsewhere in this prospectus. Pro forma basic and diluted net loss per share is presented for the period from January 1, 2004 through November 8, 2004, the period from November 9, 2004 through December 31, 2004 and the nine months ended September 30, 2005 to reflect per share data assuming the conversion of all our preferred stock into shares of class B common stock, which will occur upon completion of this offering, as if the conversion had taken place at the beginning of fiscal 2004.

 

8


Table of Contents

The following table presents a summary of our consolidated balance sheet data as of September 30, 2005.

 

    on an actual basis;

 

    on a pro forma basis to give effect to (a) the automatic conversion of all outstanding shares of our series one convertible preferred stock into 6,457,530 shares of class B common stock and all outstanding shares of our series two convertible preferred stock into 16,000,000 shares of class B common stock and (b) the filing of our restated certificate of incorporation upon completion of this offering; and

 

    on the pro forma basis described above, as adjusted to reflect the sale of shares of 7,700,000 class A common stock by us in this offering at the initial public offering price of $18.00 per share, after deducting underwriting discounts and commissions and estimated offering expenses payable by us, as described under “Use of Proceeds.”

 

     As of September 30, 2005

     Actual

   Pro Forma

   Pro Forma
As
Adjusted


     ($ in thousands)

Consolidated Balance Sheet Data

                    

Cash and cash equivalents

   $ 20,322    $ 20,322    $ 147,120

Working capital

     26,443      26,443      153,241

Total assets

     164,803      164,803      291,601

Notes payable to Cypress, net of current portion

              

Customer advances, net of current portion

     27,045      27,045      27,045

Convertible preferred stock

     24,552          

Total stockholders’ equity

     87,868      112,420      239,218

 

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RISK FACTORS

 

You should carefully consider the risks described below before making a decision to buy our class A common stock. If any of the following risks actually occur, our business, financial condition and results of operations could be harmed. In that case, the trading price of our class A common stock could decline and you might lose all or part of your investment in our class A common stock. You should also refer to the other information set forth in this prospectus, including “Special Note Regarding Forward-Looking Statements” and our consolidated financial statements and the related notes.

 

Risks Related to Our Business

 

We are currently experiencing an industry-wide shortage of polysilicon. The prices that we pay for polysilicon have increased recently and we expect these price increases to continue, which may constrain our revenue growth and decrease our gross margins and profitability.

 

Polysilicon is an essential raw material in our production of photovoltaic, or solar, cells. Polysilicon is created by refining quartz or sand. Polysilicon is melted and grown into crystalline ingots by companies specializing in ingot growth. We procure silicon ingots from these suppliers on a contractual basis and then slice these ingots into wafers. We also purchase wafers from third-party vendors. The ingots are sliced and the wafers are processed into solar cells in our Philippines manufacturing facility.

 

There is currently an industry-wide shortage of polysilicon, which has resulted in significant price increases. For example, according to SolarBuzz, an industry consulting firm, the average price of polysilicon increased from $25 per kilogram in 2004 to between $35 and $45 per kilogram for the first quarter of 2005. Based on our experience, we believe that the average price of polysilicon has continued to increase. Increases in polysilicon prices have in the past increased our manufacturing costs and may impact our manufacturing costs and net income in the future. As demand for solar cells has increased, many of our principal competitors have announced plans to add additional manufacturing capacity. As this manufacturing capacity becomes operational, it will increase the demand for polysilicon and further exacerbate the current shortage. Polysilicon is also used in the semiconductor industry generally and any increase in demand from that sector will compound the shortage. The production of polysilicon is capital intensive and adding additional capacity requires significant lead time. While we are aware that several new facilities for the manufacture of polysilicon are under construction, we do not believe that the supply imbalance will be remedied in the near term. We expect that polysilicon demand will continue to outstrip supply for the foreseeable future.

 

Although we have purchase orders and contracts for what we believe will be an adequate supply of silicon ingots through 2006, our estimates regarding our supply needs may not be correct and our purchase orders may be cancelled by our suppliers. The volume and pricing associated with these purchase orders and contracts may be changed by our suppliers based on market conditions. Our purchase orders are generally non-binding in nature. If our suppliers were to cancel our purchase orders or change the volume or pricing associated with these purchase orders, we may be unable to meet customer demand for our products, which could cause us to lose customers, market share and revenue. This would have a material negative impact on our business and operating results. If our manufacturing yields decrease significantly, our second manufacturing line becomes available earlier than anticipated or our suppliers cancel or fail to deliver, we may not have made adequate provision for our polysilicon needs for the balance of the year.

 

In addition, since some of these arrangements are with suppliers who do not themselves manufacture polysilicon but instead purchase their requirements from other vendors, it is possible that these suppliers will not be able to obtain sufficient polysilicon to satisfy their contractual obligations to us.

 

There are a limited number of polysilicon suppliers. Many of our competitors also purchase polysilicon from our suppliers. Since we have only been purchasing polysilicon in bulk for less than a year, these other competitors have longer and perhaps stronger relationships with our suppliers than we do. Many of them also have greater buying power than we do. Some of our competitors also have inter-locking board members with their polysilicon suppliers. Since we have committed to significantly increase our manufacturing output, an inadequate allocation of polysilicon would harm us more than it would harm our competitors.

 

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The inability to obtain sufficient polysilicon at commercially reasonable prices or at all would adversely affect our ability to meet existing and future customer demand for our products and could cause us to make fewer shipments, lose customers and market share and generate lower than anticipated revenue, thereby seriously harming our business, financial condition and results of operations.

 

We currently depend on four customers for a high percentage of our total revenue and the loss of, or a significant reduction in orders from, any of these customers, if not immediately replaced, would significantly reduce our revenue and harm our operating results.

 

Conergy AG, or Conergy, accounted for approximately 7% of our total combined revenue in fiscal 2004 and 47% of our total revenue in the nine months ended September 30, 2005. Solon AG, or Solon, accounted for approximately 19% of our total combined revenue in fiscal 2004 and 16% of our total revenue in the nine months ended September 30, 2005. General Electric Company, or GE, and its subcontracting partner, Plexus Corp., or Plexus, accounted for approximately 9% of our total combined revenue in fiscal 2004, and accounted for approximately 13% of our total revenue in the nine months ended September 30, 2005. Integration Associates accounted for 31% of our total combined revenue in fiscal 2004 and 5% of our total revenue in the nine months ended September 30, 2005. Currently, our largest customers for our solar power products are Conergy and Solon, our largest customers for our imaging detector products are GE and Plexus and our largest customer for our infrared detector products is Integration Associates. The loss of sales to any of these customers would have a significant negative impact on our business. Our agreements with these customers may be cancelled if we fail to meet certain product specifications or materially breach the agreement or in the event of bankruptcy, and our customers may seek to renegotiate the terms of current agreements or renewals. Most of the solar panels we sell to the European market are sold through our agreement with Conergy and we may enter into similar agreements in the future.

 

We currently sell to a relatively small number of customers, and we expect our operating results will likely continue to depend on sales to a relatively small number of customers for the foreseeable future, as well as the ability of these customers to sell solar power products that incorporate our solar cells. Our customer relationships have been developed over a short period of time and are generally in their preliminary stages. We cannot be certain that these customers will generate significant revenue for us in the future or if these customer relationships will continue to develop. If our relationships with our other customers do not continue to develop, we may not be able to expand our customer base or maintain or increase our revenue. This is exacerbated by our current manufacturing constraints for solar cells which limit our ability to sell to other customers and our contractual arrangements which require us to sell part of our future output to Conergy and Solon. In addition, our business is affected by competition in the market for the end products that each of Solon, Conergy and Plexus sell, and any decline in their business could harm our business and cause our revenue to decline.

 

The reduction or elimination of government and economic incentives could cause our revenue to decline.

 

We believe that the near-term growth of the market for “on-grid” applications, where solar power is used to supplement a customer’s electricity purchased from the utility network, depends in large part on the availability and size of government and economic incentives. Because a majority of our sales are in the on-grid market, the reduction or elimination of government and economic incentives may adversely affect the growth of this market or result in increased price competition, which could cause our revenue to decline.

 

Today, the cost of solar power exceeds the cost of power furnished by the electric utility grid in many locations. As a result, federal, state and local government bodies in many countries, most notably Germany, Japan and the United States, have provided incentives in the form of rebates, tax credits and other incentives to end users, distributors, system integrators and manufacturers of solar power products to promote the use of solar energy in on-grid applications and to reduce dependency on other forms of energy. These government economic incentives could be reduced or eliminated altogether. For example, Germany has been a strong supporter of solar power products and systems, and political changes in Germany could result in significant reductions or eliminations of incentives, including the reduction of feed-in tariffs over time. In addition, the federal incentive program in Japan is scheduled to expire at the end of 2005. Some solar program incentives expire, decline over time, are limited in total funding or require renewal of authority. For example, in California, the Emerging Renewables Program has finite funds that

 

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may not last through the current program period and the incentive levels are scheduled to decline on January 1, 2006 from $2.80 to $2.60 per alternating current, or AC, watt. Net metering policies in Japan and California could limit the amount of solar power installed in these locations. Reductions in, or eliminations or expirations of, incentives could result in decreased demand for our products and lower revenue.

 

Our quarterly revenue and operating results are difficult to predict, and if we do not meet quarterly financial expectations, our stock price will likely decline.

 

Our quarterly revenue and operating results are difficult to predict and have in the past, and may in the future, fluctuate from quarter to quarter. It is possible that our operating results in some quarters will be below market expectations. Our quarterly operating results are affected by a number of factors, including:

 

    the availability and pricing of raw materials, particularly polysilicon;

 

    the rate and cost at which we are able to expand our manufacturing capacity to meet customer demand, including costs and timing of adding personnel;

 

    timing, availability and changes in government incentive programs;

 

    unplanned additional expenses such as manufacturing failures, defects or downtime;

 

    unpredictable volume and timing of customer orders, some of which are not fixed by contract but vary on a purchase order basis;

 

    the loss of one or more key customers or the significant reduction or postponement of orders from these customers;

 

    foreign currency fluctuations, particularly in the Euro or Philippine peso;

 

    our currency hedging activities;

 

    our ability to establish and expand customer relationships;

 

    changes in our manufacturing costs;

 

    changes in the relative sales mix of our solar cells, solar panels and imaging detectors;

 

    the availability, pricing and timeliness of delivery of other products, such as inverters, necessary for our solar power products to function;

 

    our ability to successfully develop, introduce and sell new or enhanced solar power products in a timely manner, and the amount and timing of related research and development costs;

 

    the timing of new product or technology announcements or introductions by our competitors and other developments in the competitive environment;

 

    decreases in the overall average selling prices of our solar power products and imaging detectors;

 

    increases or decreases in electric rates due to fossil fuel prices; and

 

    shipping delays.

 

We base our planned operating expenses in part on our expectations of future revenue, and a significant portion of our expenses is relatively fixed in the short term. If revenue for a particular quarter is lower than we expect, we likely will be unable to proportionately reduce our operating expenses for that quarter, which would harm our operating results for that quarter. This may cause us to miss analysts’ guidance or any future guidance announced by us. If we fail to meet or exceed analyst or investor expectations or our own future guidance, even by a small amount, our stock price could decline, perhaps substantially.

 

We have incurred losses since inception and may not be able to generate sufficient revenue in the future to achieve or sustain profitability.

 

We have incurred net losses since inception and, at September 30, 2005, we had an accumulated deficit of approximately $57.9 million. To achieve profitability, we will need to generate and sustain higher revenue while

 

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maintaining reasonable cost and expense levels. We do not know if our revenue will grow, or if so whether it will grow sufficiently to outpace our expenses, which we expect to increase as we expand our manufacturing capacity. We may not be able to achieve or increase profitability on a quarterly or an annual basis. If we do not achieve or sustain profitability or otherwise meet the expectations of securities analysts or investors, the market price of our common stock will likely decline.

 

Our dependence on a limited number of third-party suppliers for key components for our solar power products could prevent us from delivering our products to our customers within required timeframes, which could result in order cancellations and loss of market share.

 

In North America, where we intend to increase our sales and marketing efforts, systems incorporating our solar cells and solar panels currently require a specialized inverter. We currently obtain the inverters we sell with our solar panels from a single supplier and expect to continue to obtain inverters from a single supplier for at least the next six months. We believe there are only a few suppliers of inverters which are compatible with our solar cells and solar panels, and our supplier is the only one that is currently in commercial production. We have no long-term commitments regarding supply or price from our supplier, which leaves us vulnerable to the risk that our supplier may stop supplying inverters to us for any reason, including its financial viability. If we or our customers cannot obtain substitute sources of inverters on a timely basis or on acceptable terms, these supply problems may cause our revenue to decline, increase our costs, delay solar power system installations, result in loss of market share or otherwise harm our business.

 

We manufacture all of our solar power products using components procured from a limited number of third-party suppliers. For example, we currently purchase glass from two suppliers and aluminum frames and plastic backsheet materials which we use in our products from a limited number of suppliers. If we fail to develop or maintain our relationships with these or our other suppliers, worical carrying value of the tangible assets and liabilities approximated the fair value. Management based their decision to capitalize the purchased technology on SFAS 141’s criteria that an intangible asset that arises from contractual or other legal rights shall be recognized apart from goodwill only if it is separable. These technology-based assets relate to innovations and technological advances of the Company. Any excess of the purchase price over the amounts allocated to the assets acquired and liabilities assumed was recorded as goodwill.

 

Investment by Cypress in 2002:

 

In connection with the 2002 transaction, Cypress invested $8.8 million which was based on arms-length negotiations and paid in cash. As a result, Cypress recorded $4.8 million of net tangible assets, $1.1 million of purchased technology, $0.4 million of trademarks and other, $2.2 million of in-process research and development and $2.9 million of goodwill. From May 30, 2002 to November 8, 2004, Cypress had recorded amortization expense associated with the intangible assets of $0.7 million, resulting in a net valuation adjustment on November 9, 2004 to be pushed down to SunPower of $3.7 million.

 

Purchased technology of $1.1 million was comprised of design and process technologies for the imaging detector and solar technologies. The acquired solar technology was comprised of design and process technologies that enable a crystalline silicon wafer to capture a high percentage of the sun’s energy into electricity. The acquired imaging detector technology was comprised of design and process technologies for high performance, back contact light sensor arrays and infrared detectors that convert incoming photons into electricity, and are designed for low current leakage and high sensitivity. The fair value attributed to purchased technology was determined using the income approach method, which was based on a discounted forecast of the estimated net future cash flows to be generated from the acquired imaging detector and solar technologies using a discount rate of 25%. The fair value of purchased technology is being amortized over it’s estimated useful life of 3 to 6 years on a straight-line basis.

 

The fair value of trademarks and other of $0.4 million was determined using the royalty savings approach method, which calculated the present value of the royalty savings related to the intangible assets using a royalty rate of 0.5% and a discount rate of 35%. The fair value of trademarks is being amortized over it’s estimated useful life of 2 to 6 years on a straight-line basis.

 

The amount of the purchase price allocated to in-process research and development in 2002 of $2.2 million was determined by estimating the stage of completion of one in-process research project (the A-300 solar cell project). At the date of acquisition management estimated the net present value of cash flows based on the incremental future cash flows from revenue expected to be generated by the technology in the process of being

 

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SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

developed, taking into account the characteristics and applications of the technology, the size and growth rate of existing and future markets and an evaluation of past and anticipated technology and product life cycles. Estimated net future cash flows included allocations of operating expenses and income taxes, but excluded the expected completion costs of the in-process research project. The discount rate applied to the net cash flows was 45%, which reflected the level of risk associated with the particular technology and the current return on investment requirements of the market at the time. e may be unable to manufacture our products or our products may be available only at a higher cost or after a long delay, which could prevent us from delivering our products to our customers within required timeframes and we may experience order cancellation and loss of market share. To the extent the processes that our suppliers use to manufacture components are proprietary, we may be unable to obtain comparable components from alternative suppliers. The failure of a supplier to supply components in a timely manner, or to supply components that meet our quality, quantity and cost requirements, could impair our ability to manufacture our products or decrease their costs, particularly if we are unable to obtain substitute sources of these components on a timely basis or on terms acceptable to us.

 

The steps we have taken to increase the efficiency of our polysilicon utilization are unproven at volume production levels and may not enable us to realize the cost reductions we anticipate.

 

Given the polysilicon shortage, we believe the efficient use of polysilicon will be critical to our ability to reduce our manufacturing costs. We are considering several measures to increase the efficient use of polysilicon in our manufacturing process. For example, we are considering the use of thinner wafers which requires less polysilicon and improved wafer-slicing technology to reduce the amount of material lost while slicing wafers, otherwise known as kerf loss. Although we have tested some of these measures in laboratory conditions, we have not implemented them at commercial production levels. These methods may have unforeseen negative consequences on our yields or our solar cell efficiency or reliability once they are put into commercial production or they may not enable us to realize the cost reductions we hope to achieve.

 

We depend on a combination of our own wafer-slicing operations and those of other vendors for the wafer-slicing stage of our manufacturing, and any technical problems, breakdowns, delays or cost increases could significantly delay our manufacturing operations, decrease our output and increase our costs.

 

We have historically depended on the wafer-slicing operations of third-party vendors to slice ingots into wafers. We recently established our own wafer-slicing operations, and in the third quarter of 2005, we sliced approximately 71% of our wafers. If our third-party vendors increase their prices or decrease or discontinue their shipments to us, as a result of equipment malfunctions, competing purchasers or otherwise, and we are unable to obtain substitute wafer-slicing from another vendor on acceptable terms, or increase our own wafer-slicing

 

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operations on a timely basis, our sales will decrease, our costs may increase or our business will otherwise be harmed.

 

We obtain capital equipment used in our manufacturing process from sole suppliers and if this equipment is damaged or otherwise unavailable, our ability to deliver products on time will suffer, which in turn could result in order cancellations and loss of revenue.

 

Some of the capital equipment used in the manufacture of our solar power products and in our wafer-slicing operations has been developed and made specifically for us, is not readily available from multiple vendors and would be difficult to repair or replace if it were to become damaged or stop working. In addition, we currently obtain the equipment for many of our manufacturing processes from sole suppliers and we obtain our wafer-slicing equipment from one supplier. If any of these suppliers were to experience financial difficulties or go out of business, or if there was any damage to or a breakdown of our manufacturing or wafer-slicing equipment at a time we are manufacturing commercial quantitiesAt the date of acquisition, technological feasibility of this in-process research project had not been reached and the technology had no alternative future uses without further development. Accordingly, Cypress expensed the portion of the purchase price allocated to in-process research and development. The stage of completion was determined by estimating the costs and time incurred to date relative to the costs and time incurred to develop the in-process technology into a commercially viable technology or product, while considering the relative difficulty of completing the various tasks and overcoming the obstacles necessary to attain technological feasibility. The stage of completion for the project was approximately 25% as of the acquisition date. Upon completion, cash flows from sales of products incorporating those technologies were estimated to commence in fiscal 2004.

 

Goodwill of approximately $2.9 million represented the excess of the purchase price over the fair value of the net tangible and intangible assets acquired. SunPower’s technology added solar power and imaging detector products and process technologies to Cypress’ existing portfolio and allowed Cypress to provide more comprehensive products and pursue an expanded market opportunity. These opportunities were the significant contributing factors to the establishment of the purchase price, resulting in the recognition of goodwill. Goodwill is not amortized but is tested for impairment on an annual basis or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.

 

Investment by Cypress in 2004:

 

In connection with the 2004 transaction, Cypress invested $23.2 million (the valuation adjustment), which was on or around the time that the A-300 solar cell project had reached technological feasibility. The purchase price paid by Cypress was based on arms-length negotiations and paid in Cypress shares, which were valued based on their market price. Cypress recorded, $17.3 million of purchased technology, $3.8 million of patents and $2.1 million of trademarks and other.

 < of our products, our business would suffer. In addition, a supplier’s failure to supply this equipment in a timely manner, with adequate quality and on terms acceptable to us, could delay our capacity expansion of our manufacturing facility and otherwise disrupt our production schedule or increase our costs of production.

 

We have one solar cell production line which is located in our manufacturing facility in the Philippines and if we experience interruptions in the operation of this production line or are unable to add additional production lines, it would likely result in lower revenue and earnings than anticipated.

 

We currently have only one solar cell production line in operation, which is located at our manufacturing facility in the Philippines. If our current production line were to experience any problems or downtime, including those caused by intermittent electricity supply at our Philippines facility, we would be unable to meet our production targets and our business would suffer. If any piece of equipment were to break down or experience down-time, it would cause our entire production line to go down. We have ordered equipment for a second and third 25 megawatts per year production line to decrease per unit operating costs and increase production output, and are evaluating the timing for a fourth line in our existing facility and for a second production facility. This expansion has required and will continue to require significant management attention and a significant investment of capital and substantial engineering expenditures and is subject to significant risks including:

 

    we may experience cost overruns, delays, equipment problems and other operating difficulties;

 

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Purchased technology of $17.3 million is comprised of design and process technologies for the imaging detector and solar technologies. The fair value attributed to purchased technology was determined using the income approach method, which was based on a discounted forecast of the estimated net future cash flows to be generated from the acquired imaging detector and solar technologies. A discount rate of 20% was used for the valuation of the imaging detector technology, compared to a 27% discount rate for the solar technology. The fair value of purchased technology is being amortized on a straight-line basis over 3 to 4 years for the imaging detector technology, and over 5 to 6 years for the solar technology.

 

The fair value of patents was determined using the royalty savings approach method, which calculated the present value of the royalty savings related to the intangible assets using a royalty rate of 4% and a discount rate of 27%. The fair value of patents are being amortized over its estimated useful life of 6 years on a straight-line basis.

 

The fair value of trademarks and other was determined using the royalty savings approach method, which calculated the present value of the royalty savings related to the intangible assets using a royalty rate of 0.5% and a discount rate of 27%. The fair value of trademarks is being amortized over its estimated useful life of 2 to 6 years on a straight-line basis.

 

No in-process research and development projects existed as of the acquisition date in November 2004. The A-300 solar cell project was considered purchased technology because the technology had been validated, and the manufacturing process was being completed to ramp up volume production in fiscal 2005.

 

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SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

The following presents details of the intangible assets, reflected on the Company’s balance sheets (in thousands):

 

     Gross

   Accumulated
Amortization


    Net

As of September 30, 2005 (unaudited)

                     

Purchased Technology

   $ 18,139    $ (3,111 )   $ 15,028

Patents

     3,811      (581 )     3,230

Trademarks and other

     2,066      (410 )     1,656
    

  


 

     $ 24,016    $     we may experience difficulties expanding our processes to larger production capacity;

 

    our custom-built equipment may take longer and cost more to engineer than planned and may never operate as designed; and

 

  (4,102 )   $ 19,914
    

  


 

 

 
     Gross

   Accumulated
Amortization


    Net

As of December 31, 2004

                     

Purchased Technology

   $ 18,139    $ (445 )   $ 17,694
we are incorporating first-time equipment designs and technology improvements, which we expect to lower unit capital and operating costs, but this new technology may not be successful.

 

If we experience any of these or similar difficulties, we may be unable to complete the addition of new production lines or expand our manufacturing facility and our manufacturing capacity could be substantially constrained. If this were to occur, our per unit manufacturing costs would increase, we would be unable to increase sales as planned and our earnings would likely be materially impaired.

 

We expect to continue to make significant capital expenditures, particularly in our manufacturing facility, and if adequate funds are not available or if the covenants in our credit agreements impair our ability to raise capital when needed, our ability to expand our manufacturing capacity and our business will suffer.

 

We expect to continue to make significant capital expenditures, particularly in our manufacturing facility, and anticipate that our expenses will increase substantially in the foreseeable future as we expand our manufacturing operations, hire additional personnel, pay more or make advance payments for raw material, especially polysilicon, increase our sales and marketing efforts and continue our research and development efforts with respect to our products and manufacturing technologies. We expect capital expenditures of

 

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approximately $26.0 million for the remainder of 2005 and approximately $55.0 million in 2006 as we continue to increase our manufacturing capacity. We believe that our current cash and cash equivalents and funds available under our credit facility with Cypress will be sufficient to fund our capital and operating expenditures over the next 12 months. We have retained the capacity to borrow up to $30.0 million from Cypress, which capacity will terminate upon the earlier of the completion of this offering or December 31, 2006. We are in negotiations with affiliates of Credit Suisse First Boston and Lehman Brothers regarding a new credit facility to be effective upon completion of this offering. However, if our financial results or operating plans change from our current assumptions, we may not have sufficient resources to support our business plan. If our capital resources are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity securities or debt securities or obtain other debt financing. The sale of additional equity securities or convertible debt securities would result in additional dilution to our stockholders. Additional debt would result in increased expenses and could require us to abide by covenants that would restrict our operations. The terms of our new credit agreement with affiliates of Credit Suisse First Boston and Lehman Brothers are expected to contain covenants which may restrict our ability to raise capital when we need it and may restrict our ability to pay dividends. If adequate funds are not available or not available on acceptable terms or terms consistent with any new our credit agreement we may enter into, our ability to fund our operations, develop and expand our manufacturing operations and distribution network, maintain our research and development efforts or otherwise respond to competitive pressures would be significantly impaired.

 

Because we have fixed-price agreements with two of our largest customers and operate on a purchase order basis with our third largest customer, our financial results, including gross margin, may suffer if our manufacturing costs were to increase or purchase orders were changed or cancelled.

 

Our agreements with Conergy and Solon provide that they will purchase our products from us on a fixed-price basis. Our agreement with Conergy expires at the end of this year and we are currently in negotiations with them regarding a new agreement. Our agreement with Solon provides for a fixed-price basis for the first two years of the agreement, which expires in 2010. However, our manufacturinD VALIGN="top">

Patents

     3,811      (75 )     3,736

Trademarks and other

     2,066      (53 )     2,013     

  


 

     $ 24,016    $ (573 )   $ 23,443     

  


 

 

Amortization of all purchased intangible assets, which is included in Cost of revenue in the accompanying Consolidated Statements of Operations, was $573,000 and $3.5 million (unaudited), for the period November 9, 2004 to December 31, 2004 and for the nine months ended September 30, 2005, respectively. The estimates for amortization of all intangible assets as of September 30, 2005 (unaudited) is as follows (in thousands):

 

Fiscal year:

 

Remainder of 2005

   $ 1,176

2006

     4,876

2007

     4,621

2008

    

 

We do not have a long-term agreement with Plexus but instead operate on a purchase order basis. Although we believe that cancellations to date have been insignificant, our customers may cancel or reschedule purchase orders with us on relatively short notice. Cancellations or rescheduling of customer orders could result in the delay or loss of anticipated sales without allowing us sufficient time to reduce, or delay the incurrence of, our corresponding inventory and operating expenses. In addition, changes in forecasts or the timing of orders from these or other customers expose us to the risks of inventory shortages or excess inventory. This in turn could cause our operating results to fluctuate.

 

Technological changes in the solar power industry could render our solar power products uncompetitive or obsolete, which could reduce our market share and cause our sales to decline.

 

The solar power markets are characterized by continually changing technology requiring improved features, such as more efficient and higher power output, improved aesthetics and smaller size. This requires us to continuously develop new solar power products and enhancements for existing solar power products to keep pace with evolving industry standards and changing customer requirements. Technologies developed by others may prove more advantageous than ours for the commercialization of solar power products and may render our technology obsolete. Our failure to further refine our technology and develop and introduce new solar power products could cause our products to become uncompetitive or obsolete, which could reduce our market share and cause our sales to decline. Our research and development expense was $2.5 million in fiscal 2002, $9.8 million in fiscal 2003, $13.5 million combined in fiscal 2004 and $4.5 million for the nine months ended September 30, 2005. We will need to invest significant financial resources in research and development to maintain our market position, keep pace with technological advances in the solar power industry and to effectively compete in the future.

 

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If our future innovations fail to enable us to maintain or improve our competitive position, especially with respect to solar cell efficiency, we may lose market share. Some solar cells designed by our competitors in laboratory conditions have demonstrated higher efficiency than our solar cells which are currently available for the mass market, and other companies have competing products in development. If we are unable to successfully design, develop and introduce or bring to market competitive new solar cells or other products, or enhance our existing solar cells, we may not be able to compete successfully. Competing solar power technologies may result in lower manufacturing costs or higher product performance than those expected from our solar cells. In addition, if we, or our customers, are unable to manage product transitions, our business and results of operations would be negatively affected.

 

Evaluating our business and future prospects may be difficult due to our limited history in producing and shipping solar cells and solar panels in commercial volumes.

 

There is limited historical information available about our company upon which you can base your evaluation of our business and prospects. Although we began to develop and commercialize high-efficiency solar cell technology for use in solar concentrators in 1988 and began shipping product from our pilot manufacturing facility in 2003, we shipped our first commercial A-300 solar cells from our Philippines manufacturing facility in late 2004. Relative to the entire solar industry, we have shipped only a limited number of solar cells and solar panels and have recognized limited revenue. Our future success will require us to continue to scale our manufacturing capacity in our Philippines facility significantly beyond its current capacity. In addition, our business model, technology and ability to achieve satisfactory manufacturing yields at higher volumes are unproven at significant scale. As a result, you should consider our business and prospects in light of the risks, expenses and challenges that we will face as an early-stage company seeking to develop and manufacture new products in a rapidly growing market.

 

Our reliance on government contracts to partially fund our research and development programs could impair our ability to develop and incorporate new technologies into our solar power products and could decrease our revenue.

 

Our government contracts enable us to develop new technologies more rapidly than we would have pursued otherwise. Funding from government contracts is recorded as an offset to our research and development expense. We recently entered into a cost-sharing research and development project with the National Renewable Energy Laboratory to fund the design of our next generation solar panels. Payments received under this contract help offset our research and development expense. This contract is expected to fund approximately $1.0 million per year of our research and development expense through May 2008. In the nine months ended September 30, 2005, funding from government contracts offset our research and development expense by approximately 8%. A reduction or discontinuance of these programs or of our participation in these programs would increase our expenses, which could affect our profitability and impair our ability to develop our solar power technologies.

 

In addition, contracts involving government agencies may be terminated or modified at the convenience of the agency. Other risks include potential disclosure of our confidential information to third parties and the exercise of “march-in” rights by the government. March-in rights refer to the right of the United States government or government agency to require us to grant a license to the technology to a responsible applicant or, if we refuse, the government may grant the license itself. The government can exercise its march-in rights if it determines that action is necessary because we fail to achieve practical application of the technology or because action is necessary to alleviate health or safety needs, to meet requirements of federal regulations or to give the United States industry preference. Our government-sponsored research contracts are subject to audit and require that we provide regular written technical updates on a monthly, quarterly or annual basis, and, at the conclusion of the research contract, a final report on the results of our technical research. Because these reports are generally available to the public, third parties may obtain some aspects of our sensitive confidential information. Moreover, the failure to provide these reports or to provide inaccurate or incomplete reports may provide the government with rights to any intellectual property arising from the related research. Funding from government contracts also may limit when and how we can deploy our technology developed under those contracts.

 

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Problems with product quality or product performance, including defects, in our solar cells could result in a decrease in customers and revenue, unexpected expenses and loss of market share.

 

Our solar cells are complex and must meet stringent quality requirements. Products as complex as ours may contain undetected errors or defects, especially when first introduced. For example, our solar cells and solar panels may contain defects that are not detected until after they are shipped or are installed because we cannot test for all possible scenarios. These defects could cause us to incur significant re-engineering costs, divert the attention of our engineering personnel from product development efforts and significantly affect our customer relations and business reputation. If we deliver solar cells or solar panels with errors or defects, or if there is a perception that our solar cells or solar panels contain errors or defects, our credibility and the market acceptance and sales of our solar power products could be harmed.

 

The possibility of future product failures could cause us to incur substantial expense to repair or replace defective products. Furthermore, widespread product failures may damage our market reputation and reduce our market share and cause sales to decline. We have agreed to indemnify our customers and our distributors in some circumstances against liability from defects in our solar cells. A successful indemnification claim against us could require us to make significant damage payments, which would negatively affect our financial results.

 

Product liability claims against us could result in adverse publicity and potentially significant monetary damages.

 

Like other retailers, distributors and manufacturers of products that are used by consumers, we face an inherent risk of exposure to product liability claims in the event that the use of the solar power products into which our solar cells and solar panels are incorporated results in injury. Since our solar power products are electricity producing devices, it is possible that our products could result in injury, whether by product malfunctions, defects, improper installation or other causes. In addition, since we only began selling our solar cells and solar panels in late 2004 and the products we are developing incorporate new technologies and use new installation methods, we cannot predict whether or not product liability claims will be brought against us in the future or the effect of any resulting negative publicity on our business. Moreover, we may not have adequate resources in the event of a successful claim against us. We have evaluated the potential risks we face and believe that we have appropriate levels of insurance for product liability claims. We rely on our general liability insurance to cover product liability claims and have not obtained separate product liability insurance. The successful assertion of product liability claims against us could result in potentially significant monetary damages and if our insurance protection is inadequate to cover these claims, they could require us to make significant payments.

 

Since we cannot test our solar panels for the duration of our standard 25-year warranty period, we may be subject to unexpected warranty expense.

 

Our current standard product warranty for our solar panels includes a 10-year warranty period for defects in material and workmanship and a 25-year warranty period for declines in power performance as well as a one-year warranty on the functionality of our solar cells. We believe our warranty periods are consistent with industry practice. Due to the long warranty period and our proprietary technology, we bear the risk of extensive warranty claims long after we have shipped product and recognized revenue. We have sold solar cells only since late 2004. Any increase in the defect rate of our products would cause us to increase the amount of warranty reserves and have a corresponding negative impact on our financial statement. Although we conduct accelerated testing of our solar cells and have several years of experience with our all back contact cell architecture, our solar panels have not and cannot be tested in an environment simulating the 25-year warranty period. As a result, we may be subject to unexpected warranty expense, which in turn would harm our financial results.

 

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Existing regulations and policies and changes to these regulations and policies may present technical, regulatory and economic barriers to the purchase and use of solar power products, which may significantly reduce demand for our products.

 

The market for electricity generation products is heavily influenced by foreign, federal, state and local government regulations and policies concerning the electric utility industry, as well as policies promulgated by electric utilities. These regulations and policies often relate to electricity pricing and technical interconnection of customer-owned electricity generation. In the United States and in a number of other countries, these regulations and policies are being modified and may continue to be modified. Customer purchases of, or further investment in the research and development of, alternative energy sources, including solar power technology, could be deterred by these regulations and policies, which could result in a significant reduction in the potential demand for our solar power products. For example, without a regulatory mandated exception for solar power systems, utility customers are often charged interconnection or standby fees for putting distributed power generation on the electric utility grid. These fees could increase the cost to our customers of using our solar power products and make them less desirable, thereby harming our business, prospects, results of operations and financial condition.

 

We anticipate that our solar power products and their install="right">4,043

2009

     3,735

2010

     1,463
    

     $ 19,914
    

 

Note 3. 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. For each of the fiscal years ended December 31, 2002 and 2003, purchases of products from Cypress were not significant. Wafer purchases totaled $256,000, $471,000, $73,000 (unaudited) and $3.7 million (unaudited) for the period from January 1, 2004 through November 8, 2004, the period from November 9, 2004 through December 31, 2004, the nine months ended September 30, 2004 and 2005, respectively.

 

Manufacturing Services in Texas

 

The Company originally made its imaging and infrared detector and solar power products at its 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 of materials and Cypress personnel to operate the facility which made the Company’s pre-commercial

 

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Table of Contents

SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

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. The Company has paid the following amounts to Cypress for products produced and manufacturing services performed under this manufacturing service arrangement: $2.5 million, $40,000, $2.4 million (unaudited) and $129,000 (unaudited) for the period January 1, 2004 to November 8, 2004; for the period November 9, 2004 to December 31, 2004; and for the nine months ended September 30, 2004 and 2005, respectively.

 

 

Because the markets in which we compete are highly competitive and many of our competitors have greater resources than us, we may not be able to compete successfully and we may lose or be unable to gain market share.

 

We compete with a large number of competitors in the solar power market, including BP Solar International Inc., Evergreen Solar, Inc., Mitsubishi Electric Corporation, Q-Cells AG, Sanyo Corporation and Sharp Corporation. In addition, universities, research institutions and other companies are developing alternative technologies such as thin films and concentrators, which may compete with our technology. We expect to face increased competition in the future. Further, many of our competitors are developing and are currently producing products based on new solar power technologies that may ultimately have costs similar to, or lower than, our projected costs.

 

Many of our current and potential competitors have longer operating histories, greater name recognition, access to larger customer bases and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other resources than us. As a result, they may be able to respond more quickly to changing customer demands or to devote greater resources to the development, promotion and sales of their products than we can. Our business relies on sales of our solar power products and our competitors with more diversified product offerings may be better positioned to withstand a decline in the demand for solar power products. Some of our competitors own, partner with, have longer term or stronger relationships with polysilicon providers which could result in them being able to obtain raw materials on a more favorable basis than us. It is possible that new competitors or alliances among existing competitors could emerge and rapidly acquire significant market share, which would harm our business. If we fail to compete successfully, our business would suffer and we may lose or be unable to gain market share.

 

In addition, the solar power market in general competes with other sources of renewable energy and conventional power generation. If prices for conventional and other renewable energy resources decline, or if these resources enjoy greater policy support than solar power, the solar power market could suffer.

 

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We face competition in the market for our imaging detectors and infrared detectors, and if we fail to compete effectively, we will lose or fail to gain market share.

 

We compete with companies such as Hamamatsu Photonics K.K. and UDT Sensors, Inc. in the market for high performance imaging detectors. In addition we compete with companies such as Vishay Intertechnology, Inc., Rohm Co., Ltd. and Agilent Technologies, Inc. in the market for infrared detectors. We may face competition in the future from other manufacturers of high performance imaging detectors, infrared detectors or alternative devices. The use of alternative devices, including low power, high data rate wireless protocols, may replace existing detectors and limit our market opportunity. Our current and future competitors may have longer operating histories, greater name recognition and greater financial, sales and marketing, technical and other resources than us or may develop technologies superior to those incorporated in our imaging detectors and infrared detectors. If we New Roman" SIZE="2">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 centralized 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%. The amounts that the Company has recorded as general and administrative expenses in the accompanying statements of operations for these services was approximately $0, $1.7 million, $1.3 million, $171,000, $1.2 million (unaudited) and $1.5 million (unaudited) during the fiscal years ended December 31, 2002 and 2003; for the period January 1, 2004 to November 8, 2004; for the period November 9, 2004 to December 31, 2004; and for the nine months ended September 30, 2004 and 2005, respectively.

 

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. As of September 30, 2005, the Company has a rental agreement with Cypress for this facility which expires in July 2006. The Company has reached an agreement with Cypress to extend this lease for an additional 15 years, with a right to purchase the facility from Cypress at any time at Cypress’ original purchase price plus interest computed on a variable index starting on the date of purchase by Cypress until the sale to the Company (see Note 14). There was no rental expense under this agreement for the fiscal year ended December 31, 2002. Rental expense paid to Cypress for this building was $141,000, $235,000, $40,000, $266,000 (unaudited) and $206,000 (unaudifail to compete successfully, we may be unable to expand our customer base for our imaging detectors and our business would suffer.

 

The demand for products requiring significant initial capital expenditures such as our solar power products is affected by general economic conditions.

 

The United States and international economies have recently experienced a period of slow economic growth. A sustained economic recovery is uncertain. In particular, terrorist acts and similar events, continued turmoil in the Middle East or war in general could contribute to a slowdown of the market demand for products that require significant initial capital expenditures, including demand for solar cells and solar power systems and new residential and commercial buildings. In addition, increases in interest rates may increase financing costs to customers, which in turn may decrease demand for our solar power products. If the economic recovery slows down as a result of the recent economic, political and social turmoil, or if there are further terrorist attacks in the United States or elsewhere, we may experience decreases in the demand for our solar power products, which may harm our operating results.

 

Because of the lengthy sales cycles for our imaging detectors and the relatively fixed nature of a significant portion of our expenses, we may incur substantial expenses before we earn associated revenue and may not ultimately achieve our forecasted sales for our imaging detectors.

 

Our sales cycles from design to manufacture of our imaging detectors can typically take 12 to 18 months. Sales cycles for our imaging detectors are lengthy for a number of reasons, including:

 

  &#ted) during the fiscal years ended December 31, 2003; for the period January 1, 2004 to November 8, 2004; for the period November 9, 2004 to December 31, 2004; and for the nine months ended September 30, 2004 and 2005, respectively.

 

Note 4. Balance Sheet Components

 

Inventories consisted of the following (in thousands):

 

     Predecessor
Company


    Successor Company

    

December 31,

2003


   

December 31,

2004


  

September 30,

2005


                (unaudited)

Raw material

   $ 570            $ 3,085    $ 5,691

Work-in-process

     481       894  &nbs149;   our customers usually complete an in-depth technical evaluation of our imaging detectors before they place a purchase order;

 

    the commercial adoption of our imaging detectors is typically limited during the initial release of their products to evaluate performance and consumer demand;

 

      3,145

Finished goods

     217       437      1,581
    


 

  

     $ 1,268     $ 4,416    $ 10,417
    


 

  

 

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SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

Property and equipment consisted of the following (in thousands):

 

    

Predecessor

Company


    Successor Company

 
    

December 31,

2003


   

December 31,

2004


   

September 30,

2005


 
                 (unaudited)  

Manufacturing equipment

   $ 6,969            $ 31,441     $ 36,205  

Computer equipment

     1,207       1,033       1,092  

Furniture and fixtures

     114       124       124  

Leasehold improvements

     3,588       12,991       13,168  

Construction-in-process (manufacturing facility in the Philippines)

     13,679       6,242       48,721  
    


 


 


       25,557       51,831       99,310  

Less: Accumulated depreciation and amortization

     (2,784 )     (4,282 )     (9,085 )
    


 


 


     $ 22,773     $ 47,549     $ 90,225  
    


 


 


 

Total depreciation expense was $150,000, $1,319,000, $1,590,000, $556,000, $1,341,000 (unaudited), and $4,954,000 (unaudited) for the fiscal years ended December 31, 2002 and 2003; for the period January 1, 2004 to November 8, 2004; for the period November 9, 2004 to December 31, 2004; and for the nine months ended September 30, 2004 and 2005, respectively.

 

During the first quarter of fiscal 2005, the Company recorded charges to research and development of $461,000 related to the write-down of property and equipment that were removed from operations. These assets consisted primarily of manufacturing and test equipment that was decommissioned in a pilot wafer fab located in Cypress’ manufacturing facility in Texas. As management has committed to plans to dispose of these assets by sale, the Company classified the assets as held for sale and recorded the assets at the lower of their carrying amount or fair value less costs to sell. The valuation of the assets was based on management’s estimates and consideration of various factors including outside appraisals. The Company expects to complete the disposal of the restructured assets by the end of fiscal 2005.

 

Accrued liabilities consisted of the following (in thousands):

 

    

Predecessor

Company


    Successor Company

    

December 31,

2003


   

December 31,

2004


  

September 3Times New Roman" SIZE="2">failure to deliver a product in a timely manner can seriously delay or cancel introduction; and

 

    the development and commercial introduction of products incorporating complex technology frequently are delayed or canceled.

 

As a result of our lengthy sales cycles, we may incur substantial expenses before we earn associated revenue because a significant portion of our operating expenses is relatively fixed and based on expected revenue. If customer cancellations or product changes occur, this could result in the loss of anticipated sales without allowing us sufficient time to reduce our operating expenses.

 

We depend on third-party subcontractors in China to assemble our solar cells into solar panels and any failure to obtain sufficient assembly and test capacity could significantly delay our ability to ship our solar panels and damage our customer relationships.

 

We rely on Jiawei SolarChina and Jumao Photonic, Co., Ltd., third-party subcontractors in China, to assemble our solar cells into solar panels and perform panel testing and to manage test, packaging, warehousing and shipping of our solar panels. We do not have a long-term agreement with our subcontractors. We typically

 

19


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obtain services from these suppliers on a purchase order basis, and we0,

2005


                (unaudited)

Foreign exchange derivative liability

   $     $ 3,973    $ 794

Employee compensation and employee benefits

     356              673      845

Warranty reserve

           180      403

Other

  

 

As a result of outsourcing this final step in our production, we face several significant risks, including:

 

    lack of assembly and testing capacity and higher prices;

 

    limited control over delivery schedules, quality assurance and control, manufacturing yields and production costs; and

 

    delays resulting from an inability to move production to an alternate provider.

 

The ability of our subcontractors to perform assemblyLIGN="bottom"> 

2,087       2,546      2,873
    


 

 

If we do not achieve satisfactory yields or quality in manufacturing our solar cells, our sales could decrease and our relationships with our customers and our reputation may be harmed.

 

The manufacture of solar cells is a highly complex process. Minor deviations in the manufacturing process can cause substantial decreases in yield and in some cases, cause production to be suspended or yield no output. We have from time to time experienced lower than anticipated manufacturing yields. This often occurs during the production of new products or the installation and start-up of new process technologies or equipment. For example, we have ordered equipment for the second and third 25 megawatts per year production lines and are evaluating the timing for both a fourth line and a second production facility. As we expand our manufacturing capacity and bring additional lines or facilities into production, we may experience lower yields initially as is typical with any new equipment or process. We also expect to experience lower yields initially as we migrate our manufacturing processes to thinner wafers. If we do not achieve planned yields, our product costs could increase, and product availability would decrease.

 

Our ability to continue to manufacture our imaging detectors and our solar cells in our current facilities with our current and planned manufacturing capacities, and therefore to maintain and increase revenue and achieve profitability, depends to a large extent upon the success of our continued relationship with Cypress.

 

Our imaging detectors are manufactured for us by Cypress and are processed and tested in our Sunnyvale, California facility. We do not have a long-term agreement with Cypress for the manufacturing of our imaging detectors, but instead operate on a purchase order basis. The processes for manufacturing our imaging detectors are highly complex, specialized and proprietary. If Cypress determines to cancel its arrangement with us, our manufacturing output would be interrupted and delayed, and we would incur increased expenses in establishing relationships with alternative manufacturers at market prices. We may not be able to find alternative manufacturers on terms acceptable to us, and we may be unable to establish our own operations in a timely or cost-effective manner, if at all.

 

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We manufacture our solar cells in our Philippines manufacturing facility which we lease from Cypress. On October 6, 2005, we entered into an agreement with Cypress that will be effective upon the completion of this offering to extend this lease for an additional 15 years with a right to buy the facility. If we are unable to expand in our current facility or are required to move our manufacturing facility, we would incur significant expenses as well as lost sales. Furthermore, we may not be able to locate a facility that meets our needs on terms acceptable to us. Any of these circumstances would increase our expenses and decrease our total revenue and could prevent us from achieving profitability.

 

We have significant international activities and customers, and plan to continue these efforts, which subject us to additional business risks, including logistical complexity, political instability and currency fluctuations.

 

For the nine months ended September 30, 2005, approximately 70% of our sales have been made to customers outside of the United States. We currently have only one solar cell production line in operation, which is located at our manufacturing facility in the Philippines. In addition, our assembly functions are conducted by third-party subcontractors in China. Risks we face in conducting business internationally include:

 

    multiple, conflicting and changing laws and regulations, export and import restrictions, employment laws, regulatory requirements and other government approvals, permits and licenses;

 

    difficulties and costs in staffing and managing foreign operations such as our manufacturing facility in the Philippines, as well as cultural differences;

 

    difficulties and costs in recruiting and retaining individuals skilled in international business operations;

 

    increased costs associated with maintaining international marketing efforts;

 

    potentially adverse tax consequences;

 

    inadequate local infrastructure;

 

    financial risks, such as longer sales and payment cycles and greater difficulty collecting accounts receivable; and

 

  


     $ 2,443     $ 7,372    $ 4,915
    


 

  

 

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Table of Contents

SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

Note 5. Income Taxes

 

U.S. and non U.S. components of loss before income taxes consist of the following (in thousands):

 

     Predecessor Company

    Successor Company

 
    

Year Ended

December 31,


   

Nine Months

Ended

September 30,
2004


   

January 1,

2004 Through

November 8,

2004


   

November 9,
2004 Through
December 31,

2004


   

Nine Months
Ended
September 30,

2005


 
         2002    

        2003    

         
                 (unaudited)              
    political and economic instability, including wars, acts of terrorism, political unrest, boycotts, curtailments of trade and other business restrictions.

 

Specifically, we face risks associated with political and economic instability and civil unrest in the Philippines. In addition, in the Asia/Pacific region generally, we face risks associated with a recurrence of SARS, tensions between countries in that region, such as political tensions between China and Taiwan, the ongoing discussions with North Korea regarding its nuclear weapons program, potentially reduced protection for intellectual property rights, government-fixed foreign exchange rates, relatively uncertain legal systems and developing telecommunications infrastructures. In addition, some countries in this region, such as China, have adopted laws, regulations and policies which impose additional restrictions on the ability of foreign companies to conduct business in that country or otherwise place them at a competitive disadvantage in relation to domestic companies.

 

In addition, although base wages are lower in the Philippines, wages for our employees in the Philippines are increasing, which could result in increased costs to employ our manufacturing engineers. As of September 30, 2005, approximately 90% of our employees were located in the Philippines. We also are faced with competition in the Philippines for employees, and we expect this competition to increase as additional solar companies enter the market and expand their operations. In particular, there may be limited availability of qualified manufacturing engineers. We have benefited from an excess of supply over demand for college graduates in the field of engineering in the Philippines. If this favorable imbalance changes due to increased competition, it could affect the availability or cost of qualified employees, who are critical to our performance. This could increase our costs and turnover rates.

 

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Currency fluctuations in the Euro or the Philippine peso relative to the U.S. dollar could decrease our revenue or increase our expenses.

 

In fiscal 2004, on a combined basis, and the nine months ended September 30, 2005, approximately 44% and 70%, respectively, of our total revenue was generated outside the United States. We presently have currency exposure arising from both sales and purchases denominated in foreign currencies. A majority of our total revenue is denominated in Euros, including our fixed price agreements with Conergy and Solon, and a significant portion is denominated in U.S. dollars while a portion of our costs are incurred and paid in Euros and a smaller portion of our expenses are paid in Philippine pesos and Japanese yen.

 

We are exposed to the risk of a decrease in the value of the Euro relative to the U.S. dollar, which would decrease our total revenue. Changes in exchange rates between foreign currencies and the U.S. dollar may adversely affect our operating margins. For example, if these foreign currencies appreciate against the U.S. dollar, it will make it more expensive in terms of U.S. dollars to purchase inventory or pay expenses with foreign currencies. In addition, currency devaluation can result in a loss to us if we hold deposits of that currency as well as make our products, which are usually purchased with U.S. dollars, relatively more expensive than products manufactured locally. An increase in the value of the U.S. dollar relative to foreign currencies could make our solar cells more expensive for our international customers, thus potentially leading to a reduction in our sales and profitability. Furthermore, many of our competitors are foreign companies that could benefit from such a currency fluctuation, making it more difficult for us to compete with those companies. We currently conduct hedging activities, which involve the use of currency forward contracts. We cannot predict the impact of future exchange rate fluctuations on our business and operating results. In the past, we have experienced an adverse impact on our total revenue and profitability as a result of foreign currency fluctuations.

 

We may not be able to prevent others from using the SunPower name or similar mark in connection with their solar power products which could adversely affect the market recognition of our name and our revenue.

 

“SunPower” is our registered trademark in the United States for use with solar cells and solar panels. We are seeking similar registration of the “SunPower” trademark in foreign countries but we may not be successful in some of these jurisdictions. For example, we have received initial rejection of our application to register the “SunPower” trademark in Canada and Japan based on prior registration by other people. In the foreign jurisdictions where we are unable to obtain this registration or have not tried, others may be able to sell their products using the SunPower trademark which could lead to customer confusion. In addition, if there are jurisdictions where someone else has already established trademark rights in the SunPower name, we may face trademark disputes and may have to market our products with other trademarks, which also could hurt our marketing efforts. We may encounter trademark disputes with companies using marks which are confusingly similar to SunPower which if not resolved favorably could cause our branding efforts to suffer. For example, on August 9, 2005, we filed a lawsuit in the United States District Court for the Northern District of California alleging trademark infringement, unfair competition and related claims against Sun Power & Geothermal Energy Company, Inc. for its use of the name “Sun Power” in connection with its photovoltaic products and services and seeking an injunction and damages. Trademark litigation carries an inherent risk and we cannot guarantee that we will be successful in this litigation. In addition, we may have difficulty in establishing strong brand recognition with consumers if others use similar marks for similar products.

 

We rely primarily upon copyright and trade secret laws and contractual restrictions to protect our proprietary rights, and, if these rights are not sufficiently protected, our ability to compete and generate revenue could suffer.

 

We seek to protect our proprietary manufacturing processes, documentation and other written materials primarily under trade secret and copyright laws. We also typically require employees and consultants with access to our proprietary information to execute confidentiality agreements. The steps taken by us to protect our proprietary information may not be adequate to prevent misappropriation of our technology. In addition, our proprietary rights may not be adequately protected because:

 

    people may not be deterred from misappropriating our technologies despite the existence of laws or contracts prohibiting it;

 

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    policing unauthorized use of our intellectual property may be difficult, expensive and time-consuming, and we may be unable to determine the extent of any unauthorized use; and

 

    the laws of other countries in which we market our solar cells, such as some countries in the Asia/Pacific region, may offer little or no protection for our proprietary technologies.

 

Reverse engineering, unauthorized copying or other misappropriation of our proprietary technologies could enable third parties to benefit from our technologies without paying us for doing so. Any inability to adequately protect our proprietary rights could harm our ability to compete, to generate revenue and to grow our business.

 

We may not obtain sufficient patent protection on the technology embodied in the solar cells we currently manufacture and market, which could harm our competitive position and increase our expenses.

 

Although we rely primarily on trade secret laws and contractual restrictions to protect the technology in the solar cells we currently manufacture and market, our success and ability to compete in the future may also depend to a significant degree upon obtaining patent protection for our proprietary technology. As of September 30, 2005, we had 12 patent applications pending in the United States and eight applications pending in foreign jurisdictions which cover aspects of the technology in the solar cells we currently manufacture and market. Patents that we currently own or license-in do not cover the solar cells that we presently manufacture and market. Our patent applications may not result in issued patents, and even if they result in issued patents, the patents may not have claims of the scope we seek. In addition, any issued patents may be challenged, invalidated or declared unenforceable. The term of any issued patents would be 20 years from their filing date and if our applications are pending for a long time period, we may have a correspondingly shorter term for any patent that may issue. Our present and future patents may provide only limited protection for our technology and may not be sufficient to provide competitive advantages to us. For example, competitors could be successful in challenging any issued patents or, alternatively, could develop similar or more advantageous technologies on their own or design around our patents. Also, patent protection in certain foreign countries may not be available or may be limited in scope and any patents obtained may not be as readily enforceable as in the United States, making it difficult for us to effectively protect our intellectual property from misuse or infringement by other companies in these countries. Our inability to obtain and enforce our intellectual property rights in some countries may harm our business. In addition, given the costs of obtaining patent protection, we may choose not to protect certain innovations that later turn out to be important.

 

If the effective term of our patents is decreased due to changes in patent laws or if we need to refile some of our patent applications, the value of our patent portfolio and the revenue we derive from products protected by the patents may be decreased.

 

The value of our patents depends in part on their duration. A shorter period of patent protection means less value of a patent. For example, the United States patent laws were amended in 1995 to change the term of patent protection from 17 years after the date of the patent’s issuance to 20 years after the earliest effective filing date of the application for a patent, unless the application was pending on June 8, 1995, in which case the term of a patent’s protection expires either 17 years after its issuance or 20 years after its filing, whichever is later. Because the time required from the filing of patent application to issuance of a patent is often longer than three years, a 20-year patent term from the filing date may result in substantially shorter patent protection. Also, we may need to refile some of our patent applications and, in these situations, the patent term will be measured from the date of the earliest priority application to which benefit is claimed in such a patent application. This would also shorten our period of patent exclusivity. A shortened period of patent exclusivity may negatively impact our revenue protected by our patents.

 

Our intellectual property indemnification practices may adversely impact our business.

 

We are required by contract to indemnify some of our customers and our third-party intellectual property providers for certain costs and damages of patent infringement in circumstances where our solar cells are a factor creating the customer’s or these third-party providers’ infringement liability. This practice may subject us to significant indemnification claims by our customers and our third-party providers. We cannot assure you that

 

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indemnification claims will not be made or that these claims will not harm our business, operating results or financial condition.

 

We may face intellectual property infringement claims that could be time-consuming and costly to defend and could result in our loss of significant rights.

 

From time to time, we, our customers or third-parties with whom we work may receive letters, including letters from various industry participants, alleging infringement of their patents. Although we are not currently aware of any parties pursuing or intending to pursue infringement claims against us, we cannot assure you that we will not be subject to such claims in the future. Also, because patent applications in the United States and many other jurisdictions are kept confidential for 18 months before they are published, we may be unaware of pending patent applications that relate to our solar cells. Our third-party suppliers may also become subject to infringement claims, which in turn could negatively impact our business. We may also initiate claims to defend our intellectual property. We recently terminated a license as to which we have not paid royalties since the second quarter of 2004 because our current products do not use the licensed technology. However, the licensor could challenge our actions and litigate against us. Intellectual property litigation is expensive and time-consuming and could divert management’s attention from our business and could have a material adverse effect on our business, operating results or financial condition. If there is a successful claim of infringement against us, our customers or our third-party intellectual property providers, we may be required to pay substantial damages to the party claiming infringement, stop selling products or using technology that contains the allegedly infringing intellectual property, or enter into royalty or license agreements that may not be available on acceptable terms, if at all. Parties making infringement claims may also be able to bring an action before the International Trade Commission that could result in an order stopping the importation into the United States of our solar cells. All these judgments could materially damage our business. We may have to develop non-infringing technology, and our failure in doing so or obtaining licenses to the proprietary rights on a timely basis could have a material adverse effect on our business.

 

We may file claims against other parties for infringing our intellectual property that may be very costly and may not be resolved in our favor.

 

Although we are not aware of infringement of our intellectual property by other parties except potential trademark infringement, we cannot guarantee that such infringement does not exist now or that it will not occur in the future. To protect our intellectual property rights and to maintain our competitive advantage, we may file suits against parties who we believe infringe our intellectual property. For example, on August 9, 2005 we filed a lawsuit in the United States District Court for the Northern District of California alleging trademark infringement, unfair competition and related claims against Sun Power & Geothermal Energy Company, Inc. for its use of the name “Sun Power” in connection with its photovoltaic products and services. Intellectual property litigation is expensive and time consuming and could divert management’s attention from our business and could have a material adverse effect on our business, operating results or financial condition, and our enforcement effort may not be successful. In certain situations, we may have to bring such suit in foreign jurisdictions, in which case we are subject to additional risk as to the result of the proceedings and the amount of damage that we can recover. Certain foreign jurisdictions may not provide protection to intellectual property comparable to that in the United States. Our engagement in intellectual property enforcement actions may negatively impact our financial results.

 

The current tax holidays in the Philippines will expire within the next several years.

 

We currently benefit from income tax holiday incentives in the Philippines pursuant to our Philippine subsidiary’s registrations with the Board of Investments and Philippine Economic Zone Authority, which provide that we pay no income tax in the Philippines for four years pursuant to our Board of Investments non-pioneer status and Philippine Economic Zone Authority registrations, and six years pursuant to our Board of Investments pioneer status registration. Our current income tax holidays expire in 2010, and we intend to apply for extensions. However, these tax holidays may or may not be extended. We believe that as our Philippine tax holidays expire, (a) gross income attributable to activities covered by our Philippine Economic Zone Authority

 

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registrations will be taxed at a 5% preferential rate, and (b) our Philippine net income attributable to all other activities will be taxed at the statutory Philippine corporate income tax rate of 32%. As of yet no tax benefit has been realized from the income tax holiday due to operating losses in the Philippines.

 

(unaudited)  

U.S. loss

   $ (3,533 )   $ (12,810 )   $ (7,328 )   $ (7,351 )         $ (2,278 )   $ (13,770 )

Non U.S. loss

      <0px;margin-bottom:0px"> 

Future transactions may limit our ability to use our net operating loss carryforwards.

 

As of September 30, 2005, we had U.S. federal tax net operating loss carryforwards of approximately $36.4 million. These net operating loss carryforwards may be used to offset future taxable income and thereby reduce our U.S. federal income taxes otherwise payable. Section 382 of the Internal Revenue Code of 1986, as amended, or the Code, imposes an annual limit on the ability of a corporation that undergoes an “ownership change” to use its net operating loss carry forwards to reduce its tax liability. Due in part to equity financings, we experienced “ownership changes” as defined in Section 382 of the Code. Accordingly, our use of the net operating loss carryforwards and credit carryforwards may be limited by the annual limitations described in Sections 382 and 383 of the Code.

 

We may not be able to increase or sustain our recent growth rate, and we may not be able to manage our future growth effectively.

 

We may be unable to continue to expand our business or manage future growth. Our recent expansion has placed, and our planned expansion and any other future expansion will continue to place, a significant strain on our management, personnel, systems and resources. We plan to purchase additional equipment to significantly expand our manufacturing capacity and to hire additional employees to support an increase in manufacturing, research and development and our sales and marketing efforts. To successfully manage our growth and handle the responsibilities of being a public company, we believe we must effectively:

 

  &/TD>     (1,735 )     (11,229 )     (15,951 )     (3,331 )     (1,433 )
    


 


 


 

hire, train, integrate and manage additional qualified engineers for research and development activities, sales and marketing personnel, and financial and information technology personnel;

 

    retain key management and augment our management team, particularly if we lose key members;

 

    continue to enhance our customer resource management and manufacturing management systems;

 

    implement and improve additional and existing administrative, financial and operations systems, procedures and controls, including the need to integrate our financial internal control systems in our Philippines facility with those of our Sunnyvale, California headquarters;

 

    expand and upgrade our technological capabilities; and

 

    manage multiple relationships with our customers, suppliers and other third parties.

 

We may encounter difficulties in effectively managing the budgeting, forecasting and other process control issues presented by rapid growth. If we are unable to manage our growth effectively, we may not be able to take advantage of market opportunities, develop new solar cells and other products, satisfy customer requirements, execute our business plan or respond to competitive pressures.

 

We had approximately 762 full-time employees as of September 30, 2005, and we anticipate that we will need to hire a significant number of highly skilled technical, manufacturing, sales, marketing, administrative and accounting personnel if we are to successfully develop and market our products and expand and operate our expanded manufacturing facility. The competition for qualified personnel is intense in our industry. We may not be successful in attracting and retaining sufficient numbers of qualified personnel to support our anticipated growth. We may have more difficulty attracting personnel after we become a public company because of the perception that the stock option component of our compensation package may not be as valuable.

 

The success of our business depends on the continuing contributions of our key personnel.

 

We rely heavily on the services of our key executive officers, including Thomas H. Werner, our Chief Executive Officer, Emmanuel T. Hernandez, our Chief Financial Officer, Dr. VALIGN="bottom" STYLE="BORDER-RIGHT:1px solid #000000">


 


 


Loss before income taxes

   $ (3,533 )   $ (14,545 )   $ (18,557 )   $ (23,302 )   $ (5,609 )   $ (15,203

 

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member of our management team, particularly Thomas H. Werner, Emmanuel T. Hernandez, Dr. Richard Swanson and PM Pai, could adversely impact our operations. In addition, our technical personnel represent a significant asset and serve as the source of our technological and product innovations. We believe our future success will depend upon our ability to retain these key employees and our ability to attract and retain other skilled managerial, engineering and sales and marketing personnel. However, we cannot guarantee that any employee will remain employed at the Company for any definite period of time since all of our employees, including Messrs. Werner, Hernandez, Swanson and Pai, serve at-will and may terminate their employment at any time for any reason.

 

Our headquarters, research and development and manufacturing facilities, the facilities of our subcontractors upon which we rely to assemble and test our solar panels and facilities of our suppliers of silicon ingots, are located in regions that are subject to earthquakes and other natural disasters.

 

Our headquarters, including research and development operations, our manufacturing facility and the subcontractor upon which we rely to assemble and test our solar panels are located in countries that are subject to earthquakes and other natural disasters. Our headquarters and research and development operations are located in the United States, our manufacturing facility is located in the Philippines, and our subcontractor for assembly and test of solar panels is located in China. Since we do not have redundant facilities, any earthquake, tsunami or other natural disaster in these countries could materially disrupt our production capabilities and could result in our experiencing a significant delaE="Times New Roman" SIZE="2">)

    


 


 


 


   

Changes to financial accounting standards may affect our results of operations and cause us to change our business practices.

 

We prepare our financial statements to conform with generally accepted accounting principles, or GAAP, in the United States. These accounting principles are subject to interpretation by the American Institute of Certified Public Accountants, the SEC and various bodies formed to interpret and create appropriate accounting policies. A change in those policies can have a significant effect on our reported results and may affect our reporting of transactions completed before a change is announced. Changes to those rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business. For example, accounting policies affecting many aspects of our business, including rules relating to employee stock option grants, have recently been revised. The Financial Accounting Standards Board, or the FASB, and other agencies have made changes to U.S. generally accepted accounting principles, or GAAP, that will require us, starting in our first quarter of fiscal 2006, to record a charge to earnings for employee stock option grants and other equity incentives. We may have significant and ongoing accounting charges resulting from option grant and other equity incentive expensing that could reduce our overall net income or increase our net loss. In addition, since we historically have used equity-related compensation as a component of our total employee compensation program, the accounting change could make the use of equity-related compensation less attractive to us and therefore make it more difficult to attract and retain employees.

 

If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud. As a result, current and potential stockholders could lose confidence in our financial reporting, which could harm our business and the trading price of our common stock.

 

Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. We have in the past discovered, and may in the future discover, areas of our internal controls that need improvement. In addition, Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate and report on our internal controls over financial reporting and have our independent registered public accounting firm annually attest to our evaluation, as well as issue their own opinion on our internal control over financial reporting, which may be required for the first time in connection with our Annual Report on Form 10-K for the fiscal year ending December 31, 2006. Although Cypress completed its Section 404 compliance for its Annual Report on Form 10-K for the fiscal year-ended December 31, 2004, the review of our internal controls as part of this process was limited in scope and you should not conclude from this Cypress process that our internal controls were adequate to the extent required of an independent public company at that time. We are preparing

 




 


 

The tax provision (benefit) differs from the amounts obtained by applying the statutory U.S. federal tax rate to loss before taxes as shown below:

 

     Predecessor Company

    Successor Company

 
    

Year Ended

26


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for compliance with Section 404 by strengthening, assessing and testing our system of internal controls to provide the basis for our report. However, the continuous process of strengthening our internal controls and complying with Section 404 is expensive and time consuming, and requires significant management attention. We cannot be certain that these measures will ensure that we will maintain adequate control over our financial processes and reporting. Furthermore, as we rapidly grow our business, our internal controls will become more complex and will require significantly more resources to ensure our internal controls overall remain effective. Failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. If we or our independent registered public accounting firm discover a material weakness, the disclosure of that fact, even if quickly remedied, could reduce the market’s confidence in our financial statements and harm our stock price. In addition, future non-compliance with Section 404 could subject us to a variety of administrative sanctions, including the suspension or delisting of our common stock from The Nasdaq National Market and the inability of registered broker-dealers to make a market in our common stock, which would further reduce our stock price.

 

Compliance with environmental regulations can be expensive, and noncompliance with these regulations may result in adverse publicity and potentially significant monetary damages and fines.

 

We are required to comply with all foreign, federal, state and local laws and regulations regarding pollution control and protection of the environment. In addition, under some statutes and regulations, a government agency, or other parties, may seek recovery and response costs from operators of property where releases of hazardous substances have occurred or are ongoing, even if the operator was not responsible for such release or otherwise at fault. We use, generate and discharge toxic, volatile and otherwise hazardous chemicals and wastes in our research and development and manufacturing activities. Any failure by us to control the use of, or to restrict adequately the discharge of, hazardous substances could subject us to potentially significant monetary damages and fines or suspensions in our business operations. In addition, if more stringent laws and regulations are adopted in the future, the costs of compliance with these new laws and regulations could be substantial. To date such laws and regulations have not had a significant impact on our business and we believe that we have all necessary permits to conduct our business as it is presently conducted. If we fail to comply with present or future environmental laws and regulations, however, we may be required to pay substantial fines, suspend production or cease operations. Under our separation agreement with Cypress, we will indemnify Cypress from any environmental liabilities associated with our operations and facilities in Sunnyvale, California and the Philippines, whether prior to or after the separation.

 

We may engage in acquisitions that could adversely affect our operating results, dilute our stockholders’ equity, or cause us to incur additional debt or assume contingent liabilities.

 

To increase our business and maintain our competitive position, we may acquire other companies. Acquisitions involve a number of risks that could harm our business and result in the acquired business not performing as expected, including:

 

    insufficient experience with technologies and markets in which the acquired business is involved, which may be necessary to successfully operate and integrate the business;

 

    problems integrating the acquired operations, personnel, technologies or products with the existing business and products;

 

    diversion of management time and attention from our core business to the acquired business;

 

    potential failure to retain key technical, management, sales and other personnel of the acquired business;

 

    difficulties in retaining relationships with suppliers and customers of the acquired business; and

 

    subsequent impairment of the acquired assets, including intangible assets.

 

In addition, acquisitions could require investment of significant financial resources and may require us to obtain additional equity financing, which may dilute our stockholders’ equity, or to incur additional indebtedness.

 

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We maintain self-insurance for certain indemnities we have made to our officers and directors.

 

Our certificate of incorporation, by-laws and indemnification agreements require us to indemnify our officers and directors for certain liabilities that may arise in the course of their service to us. We self-insure with respect to potential indemnifiable claims. Although we have insured our officers and directors against certain potential third-party claims for which we are legally or financially unable to indemnify them, we intend to self-insure with respect to potential third-party claims which give rise to direct liability to such third-party or an indemnification duty on our part. If we were required to pay a significant amount on account of these liabilities for which we self-insure, our business, financial condition and results of operations could be seriously harmed.

 

Risks Related to Our Relationship with Cypress Semiconductor Corporation

 

As long as Cypress controls us, your ability to influence matters requiring stockholder approval will be limited.

 

After this offering, Cypress will own all 52,033,287 shares of class B common stock, representing approximately 87% of the total outstanding shares of common stock or 98% of the voting power of outstanding capital stock. The holders of our class A common stock and our class B common stock have substantially similar rights, preferences, and privileges except with respect to voting and conversion rights and other protective provisions as set forth in this prospectus. Holders of our class B common stock will be entitled to eight votes per share of class B common stock, and the holders of our class A common stock will be entitled to one vote per share of class A common stock. If Cypress transfers shares of our class B common stock to any party other than a successor in interest or a subsidiary of Cypress prior to a tax-free distribution to its stockholders, those shares would automatically convert into class A common stock. Other than through such transfers or voluntary conversions by Cypress of class B common stock to class A common stock, only at such time, if at all, as Cypress, its successors in interest and its subsidiaries collectively own less than 40% of the shares of all classes of our common stock then outstanding and Cypress has not effected a tax-free distribution of our class B common stock to its stockholders prior to such time will all shares of our class B common stock automatically convert into shares of our class A common stock on a one-for-one basis. For so long as Cypress, its successors in interest and its subsidiaries hold shares of our class B common stock, Cypress will be able to elect all of the members of our board of directors.

 

In addition, until such time as Cypress, its successors in interest and its subsidiaries collectively own less than 40% of the shares of all classes of our common stock then outstanding and Cypress is no longer consolidating us for accounting purposes, Cypress will have the ability to take stockholder action without the vote of any other stockholder, and investors in this offering will not be able to affect the outcome of any stockholder vote during this period. As a result, Cypress will have the ability to control all matters affecting us, including:

 

    the composition of our board of directors and, through our board of directors, any determination with respect to our business plans and policies, including the appointment and removal of our officers;

 

    any determinations with respect to mergers and other business combinations;

 

    our acquisition or disposition of assets;

 

    our financing activities;

 

    changes to the agreements providing for our separation from Cypress;

 

    the allocation of business opportunities that may be suitable for us and Cypress;

 

    the payment of dividends on our common stock; and

 

    the number of shares available for issuance under our stock plans.

 

Cypress’ voting control may discourage transactions involving a change of control of us, including transactions in which you as a holder of our class A common stock might otherwise receive a premium for your shares over the then current market price. Cypress is not prohibited from selling a controlling interest in us to a

 

28


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third party and may do so without your approval and without providing for a purchase of your shares of class A common stock. Accordingly, your shares of class A common stock may be worth less than they would be if Cypress did not maintain voting control over us.

 

Our historical financial information as a business segment of Cypress may not be representative of our results as an independent public company.

 

The historical financial information we have included in this prospectus does not necessarily reflect what our financial position, results of operations or cash flows would have been had we been an independent entity during the historical periods presented. The historical costs and expenses reflected in our consolidated financial statements include an allocation for certain corporate functions historically provided by Cypress, including centralized legal, tax, treasury, information technology, employee benefits and other Cypress corporate services and infrastructure costs. These expense allocations were based on what we and Cypress considered to be reasonable reflections of the utilization of services provided or the benefit received by us. The historical financial information is not necessarily indicative of what our results of operations, financial position, cash flows or costs and expenses will be in the future. We have not made adjustments to reflect many significant changes that will occur in our cost structure, funding and operations as a result of our separation from Cypress, including changes in our employee base, changes in our tax structure, potential increased costs associated with reduced economies of scale and increased costs associated with being a publicly traded, stand-alone company. For additional information, see “Selected Consolidated Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our historical consolidated financial statements and notes thereto.

 

Our ability to operate our business effectively may suffer if we are unable to cost-effectively establish our own administrative and other support functions in order to operate as a stand-alone company after the expiration of our services agreements with Cypress.

 

As a subsidiary of Cypress, we have relied on administrative and other resources of Cypress to operate our business. In connection with our separation from Cypress, we have entered into various service agreements to retain the ability for specified periods to use these Cypress resources. See “Related Party Transactions.” Thereafter, we will need to create our own administrative and other support systems or contract with third parties to replace Cypress’ systems. In addition, we must also establish disclosure controls and procedures and internal controls over financial reporting as part of our becoming a separate public company. These services may not be provided at the same level as when we were a wholly owned subsidiary of Cypress, and we may not be able to obtain the same benefits that we received prior to the separation. These services may not be sufficient to meet our needs, and after our agreements with Cypress expire, we may not be able to replace these services at all or obtain these services at prices and on terms as favorable as we currently have with Cypress. Any failure or significant downtime in our own administrative systems or in Cypress’ administrative systems during the transitional period could result in unexpected costs, impact our results and/or prevent us from paying our suppliers or employees and performing other administrative services on a timely basis. See “Relan-top:0px;margin-bottom:0px" ALIGN="center">December 31,


   

Nine Months

Ended

September 30,
2004


   

January 1,

2004 Through

November 8,

2004


   

November 9,
2004 Through
December 31,

2004


   

Nine Months
Ended
September 30,

2005


 
 

 

After this offering, we may experience increased costs resulting from a decrease in our purchasing power and we may have difficulty obtaining new customers due to our relatively small size after our separation from Cypress.

 

Prior to this offering, we were able to take advantage of Cypress’ size and purchasing power in procuring goods, technology and services, including insurance, employee benefit support and audit services. As a result of this offering and the transactions described in “Related Party Transactions—Relationship with Cypress Semiconductor Corporation,” we will be a smaller company than Cypress, and we cannot assure you that we will have access to financial and other resources comparable to those available to us prior to the offering. As an independent company, we may be unable to obtain goods, technology and services at prices or on terms as favorable as those available to us prior to our separation from Cypress, which could increase our costs and reduce our profitability. In addition, as a smaller, separate, stand-alone company, we may encounter more customer concerns about our viability as a separate entity, which could harm our business, financial condition and results

 

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of operations. Our future success depends on our ability to maintain our current relationships with existing customers, and we may have difficulty attracting new customers.

 

Our agreements with Cypress require us to indemnify Cypress for certain tax liabilities, including liabilities that may arise in connection with actions we take after a distribution of our class B common stock by Cypress. These indemnification obligations may limit our ability to obtain additional financing or participate in future acquisitions for up to two years.

 

We have entered into a tax sharing agreement with Cypress, under which we and Cypress agree to indemnify one another for certain taxes and similar obligations that the other party could incur under certain circumstances. In general, we will be responsible for taxes relating to our business. Furthermore, we may be held jointly and severally liable for taxes determined on a consolidated basis even though Cypress is required to indemnify us for its taxes pursuant to the tax sharing agreement. After the date we cease to be a member of Cypress’ consolidated, combined or unitary group for federal or state income tax purposes, as and to the extent that we become entitled to utilize on our separate tax returns portions of those credit or loss carryforwards existing as of such date, we will distribute to Cypress the tax effect (estimated to be 40%) of the amount of such tax loss carryforwards so utilized and TD>

       2002    

        2003    

         
                 (unaudited)                 (unaudited)  

Statutory rate

     35 %    

If Cypress distributes our 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 our voting power or economic value is acquired as part of a plan or series of related transactions that includes the distribution of our stock. The tax sharing agreement includes our obligation to indemnify Cypress for any liability incurred as a result of issuances or dispositions of our stock after the distribution, other than liability attributable to certain dispositions of our stock by Cypress, that cause Cypress’ distribution of shares of our stock to its stockholders to be taxable to Cypress under Section 355(e) of the Code. Under current law, following a distribution by Cypress and up to two years thereafter, our obligation to indemnify Cypress will be triggered only if we issue stock or participate in a transaction in which 50% or more of our voting power or economic value is acquired in a financing or acquisition transaction that is part of a plan or series of related transactions that includes the distribution. If such an indemnification obligation is triggered, the extent of our liability to Cypress will generally equal the product of (a) Cypress’ top marginal federal and state income tax rate for the year of the distribution, and (b) the difference between the fair market value of our class B common stock distributed to Cypress stockholders and Cypress’ tax basis in such stock as determined on the date of the distribution. Our ability to use our equity to obtain additional financing or to engage in acquisition transactions for a period of time after a distribution will be restricted if we can only sell or issue a limited amount of our stock before triggering our obligation to indemnify Cypress for taxes it incurs under Section 355(e) of the Code.

 

For example, under the current tax rules, if after the completion of this offering Cypress were to make a complete distribution of its class B common stock and our total outstanding capital stock at the time of such distribution was 67,000,000, unless we qualified for one of several safe harbor exemptions available under the Treasury Regulations, in order to avoid our indemnification obligation to Cypress, we could not, for up two years from Cypress’ distribution, issue 67,000,000 or more shares of class A common stock, nor could we participate in a transaction in which 33,500,000 or more shares of our then existing class A common stock is to be acquired in connection with a plan or series of related transactions that includes the distribution. If we were to participate in such a transaction, assuming Cypress held 52,000,000 shares at the time of their distribution, Cypress’ top

 

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marginal income tax rate is 40%, the fair market value of our class B common stock is $15.00 per share and Cypress’ tax basis in such stock is $10.00 per share on the date of their distribution, then our liability under our indemnification obligation to Cypress would be approximately $104,000,000.

 

Third parties may seek to hold us responsible for liabilities of Cypress.

 

Third parties may seek to hold us responsible for Cypress’ liabilities. Under our separation agreements with Cypress, Cypress will indemnify us for claims and losses relating to liabilities related to Cypress’ business and not related to our business. However, if those liabilities are significant and we are ultimately held liable for them, we cannot assure you that we will be able to recover the full amount of our losses from Cypress.

 

Our inability to resolve any disputes that arise between us and Cypress with respect to our past and ongoing relationships may result in a significant reduction of our revenue.

 

Disputes may arise between Cypress and us in a number of areas relating to our past and ongoing relationships, including:

 

    35 %     35 %     35 %           35 %     35 %

Tax at U.S. statutory rate

   $ (1,237 )   $ (5,091 )   $ (6,495 )   $ (8,156 )   $ (1,963 )   $ (5,321 )

Foreign losses with no tax benefit

           607       3,930       5,583       1,166         labor, tax, employee benefit, indemnification and other matters arising from our separation from Cypress;

 

    the cost of wafers for our imaging detectors;

 

    employee retention and recruiting;

 

    business combinations involving us;

 

    pricing for transitional services;

 

    sales or distributions by Cypress of all or any portion of its ownership interest in us;

 

    the nature, quality and pricing of services Cypress has agreed to provide us; and

 

    business opportunities that may be attractive to both Cypress and us.

&nbTD VALIGN="bottom" ALIGN="right">502

 

Benefit of net operating losses not recognized

     1,237       4,484       2,565

We may not be able to resolve any potential conflicts, and even if we do, the resolution may be less favorable than if we were dealing with an unaffiliated party.

 

The agreements we entered into with Cypress may be amended upon agreement between the parties. While we are controlled by Cypress, we may not have the leverage to negotiate amendments to these agreements if required on terms as favorable to us as those we would negotiate with an unaffiliated third party.

 

Some of our directors and executive officers may have conflicts of interest because of their ownership of Cypress common stock, options to acquire Cypress common stock and positions with Cypress.

 

Some of our directors and executive officers own Cypress common stock and options to purchase Cypress common stock. For information regarding the ownership of Cypress common stock and options to purchase Cypress common stock, see “Management—Stock Ownership of Directors and Executive Officers.” In addition, some of our directors are executive officers and/or directors of Cypress. Ownership of Cypress common stock and options to purchase Cypress common stock by our directors and officers after this offering and the presence of executive officers or directors of Cypress on our board of directors could create, or appear to create, conflicts of interest with respect to matters involving both us and Cypress. For example, corporate opportunities may arise that concern both of our businesses, such as the potential acquisition of a particular business or technology that is complementary to both of our businesses. In these situations, our amended and restated certificate of incorporation provides that directors and officers who are also directors or officers of Cypress have no duty to communicate or present such corporate opportunity to us unless it is specifically and primarily applicable to converting solar energy into electrical energy and using the resulting electrical energy other than in applications for consumers where photodiode technology is combined with micro-controllers and other integrated circuits made by Cypress, have the right to deal with such corporate opportunity in their sole discretion and shall not be liable to us or our stockholders for breach of fiduciary duty by reason of the fact that such director or officer pursues or acquires such corporate opportunity for itself or for Cypress. In addition, we have not established at

 

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this time any procedural mechanisms to address actual or perceived conflicts of interest of these directors and officers and expect that our board of directors, in the exercise of its fiduciary duties, will determine how to address any actual or perceived conflicts of interest on a case-by-case basis. If any corporate opportunity arises and if our directors and officers do not pursue it on our behalf pursuant to the provisions in our amended and restated certificate of incorporation, we may not become aware of, and may potentially lose, a significant business opportunity.

 

Because Cypress is not obligated to distribute our common stock that it owns to its stockholders, we will continue to be subject to the risks described above relating to Cypress’ control of us if Cypress does not complete such a distribution.

 

Cypress has advised us that it does not have any current plans to distribute to its stockholders the shares of our class B common stock that it beneficially owns. Completion of any such distribution in the future would be contingent upon, among other things, the receipt of a favorable tax ruling from the Internal Revenue Service and/ or a favorable opinion of Cypress’ tax advisor as to the tax-free nature of the distribution for U.S. federal income tax purposes. However, Cypress is not obligated to undertake the distribution, and the distribution may not occur for the foreseeable future or at all.

 

Unless and until such a distribution occurs or Cypress otherwise disposes of shares so that it, its successors in interest and its subsidiaries collectively own less than 40% of the shares of all classes of our common stock then outstanding, we will continue to face the risks described above relating to Cypress’ control of us and potential conflicts of interest between Cypress and us. We may be unable to realize potential benefits that could result from such a distribution by Cypress, such as greater strategic focus, greater access to capital markets, better incentives for employees and more accountable management, although we cannot guarantee that we would realize any of these potential benefits if such a distribution did occur. In addition, speculation by the press, investment community, our customers, our competitors or others regarding whether Cypress intends to complete such a distribution or otherwise dispose of its controlling interest in us could harm our business.

 

So long as Cypress continues to hold a controlling interest in us or is otherwise a significant stockholder, the liquidity and market price of our class A common stock may be adversely impacted.

 

Through potential control of our board of directors, Cypress may cause our board to act in Cypress’ best interests which may diverge from the best interests of other stockholders and make it difficult for us to recruit quality independent directors.

 

Cypress may at any time replace our entire board of directors. Furthermore, some actions of our board of directors require the approval of 75% of our directors except to the extent this condition is waived by Cypress. As a result, unless and until Cypress, its successors in interest and its subsidiaries collectively own less than 40% of the shares of all classes of our common stock then outstanding and Cypress is no longer consolidating us for accounting purposes, Cypress could effectively control and direct our board of directors, which means that to the extent the interests of Cypress and we diverge, Cypress can cause us to act in Cypress’ best interest to the detriment of the value of our class A common stock. Under these circumstances, persons who might otherwise accept our invitation to join our board of directors may decline.

 

Risks Related to this Offering

 

Our stock price may be volatile, and you may not be able to resell shares of our class A common stock at or above the price you paid, or at all.

 

Prior to this offering, our class A common stock has not been traded in a public market. We cannot predict the extent to which a trading market will develop or how liquid that market might become. The initial public offering price for the shares was determined by negotiations between us and the representatives of the underwriters and may not be indicative of prices that will prevail in the trading market. The trading price of our class A common stock could be subject to wide fluctuations due to the factors discussed in this risk factors

 

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section and elsewhere in this prospectus. In addition, the stock market in general and The Nasdaq National Market and technology companies in particular have experienced extreme price and volume fluctuations. These trading prices and valuations may not be sustainable. These broad market and industry factors may decrease the market price of our class A common stock, regardless of our actual operating performance. In addition, in the past, following periods of volatility in the overall market and the market price of a company’s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.

 

If securities or industry analysts do not publish research or reports about us, our business or our market, or if they change their recommendations regarding our stock adversely, our stock price and trading volume could decline.

 

The trading market for our class A common stock will be influenced by the research and reports that industry or securities analysts publish about us, our business or our market. If one or more of the analysts who cover us change their recommendation regarding our stock adversely, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

 

Substantial future sales of our class A common stock in the public market could cause our stock price to fall.

 

Additional sales of our class A common stock in the public market after this offering, or the perception that these sales could occur, could cause the market price of our class A common stock to decline. Upon completion of this offering, we will have 7,776,652 shares of class A common stock outstanding and Cypress will own 52,033,287 outstanding shares of our class B common stock, representing approximately 87% of the outstanding shares of our common stock which Cypress may convert into class A common stock at any time. Cypress has no contractual obligation to retain its shares of our common stock, except that it has agreed not to sell or distribute any of its shares of our common stock without the consent of Credit Suisse First Boston LLC and Lehman Brothers Inc. on behalf of the underwriters of this offering until 270 days after the date of this prospectus, subject to certain exceptions, as described under “Underwriting.” Subject to applicable U.S. federal and state securities laws, Cypress may sell or distribute to its stockholders any or all of the shares of our common stock that it owns, which may or may not include the sale of a controlling interest in us, either (1) after the expiration of this 270-day period or (2) before the expiration of this 270-day period with the consent of Credit Suisse First Boston LLC and Lehman Brothers Inc. on behalf of the underwriters.

 

Our directors and officers and all of our existing stockholders have entered into 180-day lock-up agreements with us or with Credit Suisse First Boston LLC and Lehman Brothers Inc., subject to certain exceptions, as described in “Underwriting,” except that Cypress has agreed to a 270-day lock-up period. We have agreed to stop our optionholders from engaging in similar transactions for a period of 180 days after the date of this prospectus. All shares sold in this offering will be freely transferable without restriction or additional registration under the Securities Act of 1933, or the Securities Act. Subject to the lock-up arrangements described in “Underwriting” and volume and other restrictions as applicable under Rule 144 and 701 under the Securities Act and assuming no exercise by the underwriters of their over-allotment option to purchase additional shares of common stock from us or the selling stockholder, 76,652 of the remaining shares of class A common stock outstanding after this offering will be available for sale immediately upon expiration of the 180-day lock-up agreement, subject to volume and other restrictions as applicable under Rule 144 and 701 of the Securities Act. If Cypress elects to convert its shares of class B common stock into class A common stock, an additional 52,033,287 shares of class A common stock will be available for sale 270 days following the date of this prospectus, subject to volume and other restrictions as applicable under Rule 144 and 701 of the Securities Act.

 

Any or all of these shares may be released prior to expiration of the lock-up period at the discretion of both Credit Suisse First Boston LLC and Lehman Brothers Inc. without prior notice. To the extent shares are released before the expiration of the lock-up period and these shares are sold into the market, the market price of our common stock could decline. The remaining shares of our common stock will become available for sale at various times thereafter upon the expiration of one-year holding periods.

 

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Immediately after this offering, we intend to file a registration statement on Form S-8 under the Securities Act covering 6,508,193 shares of class A common stock issuable under outstanding options under our 1988 Incentive Stock Plan, under our 1996 Stock Plan and under non-plan options granted to employees and consultants and 283,126 shares reserved for future issuance as of September 30, 2005 under our 2005 Stock Incentive Plan. This registration statement will automatically become effective upon filing. Shares registered under this registration statement will be available for sale in the open market, subject to the lock-up arrangements described above, although sales of shares held by our affiliates will be limited by Rule 144 volume limitations.

 

In addition, Cypress has the right to cause us to register the sale of its shares of our common stock under the Securities Act. Registration of these shares under the Securities Act would result in these shares, other than shares purchased by our affiliates, becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of the registration.

 

If Cypress distributes shares of our common stock that it owns to its stockholders, which it has agreed not to do for at least 270 days after the date of this prospectus, substantially all of these shares would be eligible for immediate resale in the public market. We are unable to predict whether significant amounts of our common stock would be sold in the open market in anticipation of, or after, any such distribution. We also are unable to predict whether a sufficient number of buyers for shares of our class A common stock would be in the market at that time.

 

Purchasers in this offering will immediately experience substantial dilution in net tangible book value.

 

Because our common stock has in the past been sold at prices substantially lower than the initial public offering price that you will pay, you will suffer immediate dilution of $14.38 per share in net tangible book value, based on the initial public offering price of $18.00 per share of common stock. The exercise of outstanding options and warrants may result in further dilution.

 

Our management will have broad discretion in using the net proceeds of this offering, and you will not have the opportunity, as part of your investment decision, to assess whether the proceeds are being used appropriately.

 

We intend to use the net proceeds from this offering to expand our manufacturing capacity and for general corporate purposes, including working capital. We may use approximately $10 million of the proceeds to purchase our Philippines manufacturing facility from Cypress, which we have the option to do under our lease. We may also use a portion of the net proceeds to acquire or invest in businesses, products and technologies that we believe will complement our business. However, depending on future developments and circumstances, we may use some of the proceeds for other purposes. We do not have more specific plans for the net proceeds from this offering. Therefore, our management will have broad discretion in applying the net proceeds of this offering. The net proceeds could be applied in ways that do not improve our operating results. The actual amounts and timing of these expenditures will vary significantly depending on a number of factors, including the amount of cash used in or generated by our operations and the market response to the introduction of any new product offerings.

 

The difference in the voting rights of our class A aNOWRAP VALIGN="bottom"> 

    2,573       797       4,819  
    


 


 


 


 


 


 

The rights of the holders of class A and class B common stock are substantially similar, except with respect to voting, conversion and other protective provisions as set forth in this prospectus. The holders of class B common stock shall be entitled to eight votes per share and the holders of our class A common stock shall be entitled to one vote per share. The difference in the voting rights of our class A and class B common stock both before and after any distribution of our class B common stock by Cypress to its stockholders could harm the value of the class A common stock to the extent that any investor or potential future purchaser of our common stock ascribes value to the right of the holders of our class B common stock to eight votes per share. The existence of two classes of common stock could result in less liquidity for either class of common stock than if there were only one class of our common stock. See “Description of Capital Stock” for a description of our common stock and rights associated with it.

 

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Delaware law and our corporate charter and bylaws contain anti-takeover provisions that could delay or discourage takeover attempts that stockholders may consider favorable.

 

Provisions in our restated certificate of incorporation, as amended and restated upon the closing of this offering, may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following:

 

 

Total

   $     $     $     $     $     $  
    


 


 


 


 


 


 

Temporary differences and carryforwards, which give rise to significant portions of deferred tax assets and liabilities, are as follows (in thousands):

 

     Predecessor
Company


    Successor Company

 
     December 31,
2003


   

December 31,

2004


    September 30,
2005


 
  the right of the board of directors to elect a director to fill a vacancy created by the expansion of the board of directors;

 

    the prohibition of cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates;

 

    the requirement for advance notice for nominations for election to the board of directors or for proposing matters that can be acted upon at a stockholders’ meeting;

 

    the ability of the board of directors to issue, without stockholder approval, up to 10,042,490 shares of preferred stock with terms set by the board of directors, which rights could be senior to those of common stock; and

 

    in the event that Cypress, its successors in interest and its subsidiaries no longer collectively own shares of our common stock equal to at least 40% of the shares of all classes of our common stock then outstanding and Cypress is no longer consolidating us for accounting purposes:

 

    our board of directors will be divided into three classes of directors, with the classes to be as nearly equal in number as possible;

 

    no action can be taken by stockholders except at an annual or special meeting of the stockholders called in accordance with our bylaws, and stockholders may not act by written consent;

 

    stockholders may not call special meetings of the stockholders; and

 

    our board of directors will be able to alter our bylaws without obtaining stockholder approval.

 

Until such time as Cypress, its successors in interest and its subsidiaries collectively own less than 40% of the shares of all classes of our common stock then outstanding and Cypress is no longer consolidating us for accounting purposes, the affirmative vote of at least 75% of the then-authorized number of members of our board of directors will be required to: (a) adopt, amend or repeal our bylaws or certificate of incorporation; (b) appoint or remove our chief executive officer; (c) designate, appoint or allow for the nomination or recommendation for election by our stockholders of an individual to our board of directors; (d) change the size of our board of directors to be other than five members; (e) form a committee of our board of directors or establish or change a charter, committee responsibilities or committee membership of any committee of our board of directors; (f) adopt any stockholder rights plan, “poison pill” or other similar arrangement; or (g) approve any transactions that would involve a merger, consolidation, restructuring, sale of substantially all of our assets or any of our subsidiaries or otherwise result in any person or entity obtaining control of us or any of our subsidiaries. Cypress may at any time in its sole discretionom"> 

               (Unaudited)  

Net operating loss carryforwards

   $ 8,619     $ waive this requirement to obtain such a supermajority vote of our board of directors.

 

In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law. These provisions may prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us. These provisions in our restated certificate of incorporation, bylaws and under Delaware law could discourage potential takeover attempts and could reduce the price that investors might be willing to pay for shares of our common stock in the future and result in the market price being lower than they would without these provisions.

 

We will incur increased costs as a result of being a public company.

 

9,153

    $ 13,029  

Research and development credit and California manufacturing credit carryforwards

     796       2,005       2,006  

Reserves and accruals

     1,770       1,992       2,470  

Capitalized research and development expenses

     309       864       788  
    


 


 


Total deferred tax asset

     11,494       14,014       18,293  

Valuation allowance

     (11,494 )           (5,049 )     (10,695 )
    


 


 


Total deferred tax asset, net of valuation allowance

           8,965       7,598  

Deferred tax liability

           (8,965 )     (7,598 )
    


 


 


Net deferred tax assets

   $     $     $  
    


 


 


 

The Company had federal net operating loss carryforwards of approximately $36.4 million (unaudited) as of September 30, 2005, which may be applied to future taxable income until these benefits begin to expire in 2011

 

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SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

through 2025. The Company had California net operating loss carryforwards of approximately $4.8 million (unaudited) as of September 30, 2005, which may be applied to future taxable income until these benefits begin to expire in 2006 through 2015. The Company had research and development credit carryforwards of approximately $1.2 million for federal and approximately $1.2 million for state tax purposes.

 

Statement of Financial Accounting Standard 109, Accounting for Income Taxes, (“SFAS 109”) requires a valuation allowance to reduce the deferred tax assets reported if, based on the weight of the evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Due the Company’s continuing losses and accumulated deficit, the Company has recorded a full valuation allowance on the deferred tax asset.

 

The Company’s ability to utilize the net operating loss carryforwards ibottom:0px; text-indent:4%">As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented

 

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by the SEC and The Nasdaq Stock Market, have required changes in corporate governance practices of public companies. We expect these new rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly. For example, as a result of becoming a public company, we intend to add independent directors, create additional board committees and adopt policies regarding internal controls and disclosure controls and procedures. In addition, we will incur additional costs associated with our public company reporting requirements. We also expect these new rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified persons to serve on our board of directors or as executive officers. We are currently evaluating and monitoring developments with respect to these new rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This prospectus contains forward-looking statements that involve risks and uncertainties. The forward-looking statements are s dependent upon the Company being able to generate taxable income in future periods and may be limited due to restrictions imposed on utilization of net operating loss and credit carryforwards under Federal and state laws upon a change in ownership, such as the transaction with Cypress.

 

The Company is subject to a tax holiday in the Philippines, where it manufactures its products. This tax holiday is scheduled to expire in 2010, unless extended. As of yet, no tax benefit has been realized from the income tax holiday due to operating losses incurred in the Philippines.

 

Note 6. Commitments and Contingencies

 

Operating Lease Commitments

 

The Company leases its Sunnyvale, California facility under a non-cancelable operating lease, which expires on May 31, 2006. The lease also requires the Company to pay property taxes, insurance and certain other costs. The Company also leases its wafer fabrication facility in the Philippines from Cypress, which expires in July 2006 (see Note 3 and 14). Future minimum obligations under all noncancelable operating leases as of September 30, 2005 are as follows (in thousands):

 

Fiscal Year (unaudited)


    

Remainder of 2005

  

 

    our expectations regarding our expenses, sources of revenues and international sales and operations;

 

    our anticipated cash needs and our estimates regarding our capital expenditures, capital requirements and our needs for additional financing;

 

    the performance, features and benefits of our products, plans for future products and for enhancements of existing products and product shipment dates;

 

    the supply and price of components and raw materials, including polysilicon;

 

    future pricing of our products and systems in which they are incorporated;

 

    plans for and timing of expanding our manufacturing capacity;

 

    our ability to attract customers and develop and maintain customer and supplier relationships;

 

    our ability to retain our current key executives and to attract and retain other skilled managerial, engineering and sales and marketing personnel;

 

    our competitive position and our expectation regarding key competitive factors;

 

    elements of our marketing, growth and diversification strategies including our strategy to reduce our dependence on market incentives;

 

  $ 131

2006

     250
    

Total

   $ 381
    

 

Rent expense, including the rent paid to Cypress for the wafer fabrication facility in the Philippines (see Note 3), was $521,000, $662,000, $681,000, $115,000, $850,000, (unaudited) and $475,000 (unaudited) for the fiscal years ended December 31, 2002 and 2003; for the period January 1, 2004 to November 8, 2004; for the period November 9, 2004 to December 31, 2004; and the nine months ended September 30, 2004 and 2005, respectively.

 

The Company has a royalty bearing license agreement covering certain solar cell technology. The Company is in the process of terminating this agreement because its current products do not use the licensed technology. Royalty expense (included in cost of revenue) was not significant for any of the periods presented.

 

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 criteria, as defined by the Company, or that establish parameters defining the Company’s requirements. In certain instances, these agreements allow the Company the option to

 

F-24


Table of Contents

SunPower CE="2">•

  use of the proceeds of this offering;

 

    our intellectual property and our continued investment in research and development;

 

    anticipated trends and challenges in our business and the markets in which we operate; and

 

    statements regarding our potential legal proceedings.

 

In some cases, you can identify forward-looking statements by such terms as “may,” “might,” “will,” “objective,” “intend,” “should,” “could,” “can,” “would,” “expect,” “believe,” “estimate,” “predict,” “potential,” “plan,” “is designed to” or the negative of these terms, and similar expressions intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this prospectus. We do not intend to update any of these forward-looking statements to reflect circumstances or events that occur after the statement is made.

 

You should read this prospectus and the documents that we reference in this prospectus and have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements.

 

This prospectus also contains statistical data that we obtained from government and industry publications and reports generated by SolarBuzz, Datamonitor, Strategies Unlimited, the Energy Information Administration of the United States Department of Energy and other Department of Energy sources,orporation

 

Notes to Consolidated Financial Statements—(Continued)

 

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, noncancelable and unconditional commitments. As of September 30, 2005, the Company estimated its obligations under such agreements to be approximately $13.8 million (unaudited).

 

Product Warranties

 

The following summarized activity within accrued warranty (in thousands):

 

 

We have not yet determined all of our anticipated expenditures and therefore cannot estimate the amounts to be used for all of the purposes discussed above. The amounts and timing of any expenditures will vary depending on the amount of cash generated by our operations, competitive and technological developments and the rate of growth, if any, of our business. Accordingly, our management will have broad discretion in applying the net proceeds from this offering. Pending the uses described above, we intend to invest the net proceeds from this offering in short-term, interest-bearing, investment-grade securities.

 

DIVIDEND POLICY

 

We have never declared or paid any cash dividends on our capital stock, and we do not currently intend to pay any cash dividends on our common stock in the foreseeable future. We expect to retain future earnings, if any, to fund the development and growth of our business. Our board of directors will determine future dividends, if any.

 

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CAPITALIZATION

 

The following table describes our capitalization as of September 30, 2005:

 

     Predecessor
Company


    Successor Company

 
     December 31,
2003


    December 31,
2004


   September 30,
2005


 
                (unaudited)  

Balance at the beginning of the period

   $            $    $ 180  

Accruals for warranties issued during the period

    

 

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USE OF PROCEEDS

 

We estimate that we will receive net proceeds of $126.8 million from our sale of the shares of class A common stock offered by us in this offering, after deducting underwriting discounts and commissions and estimated offering expenses payable by us. If the underwriters’ over-allotment option is exercised in full, we estimate that our net proceeds will be approximately $145.6 million. We will not receive any proceeds from the sales of the shares being sold by the selling stockholder if the over-allotment option is exercised.

 

The principal purposes for this offering are to increase our working capital, create a public market for our class A common stock, facilitate our future access to the public capital markets and increase our visibility in our markets. We intend to use approximately $45 million to $55 million of the net proceeds for the expansion of our manufacturing capacity and the remainder of the net proceeds for general corporate purposes, including working capital. We may use approximately $10 million of the proceeds to purchase our Philippines manufacturing facility from Cypress, which we will have the option to do under our lease agreement. We may also use a portion of the net proceeds to acquire businesses, products and technologies that we believe will complement our business. We do not have more specific plans for the net proceeds from this offering.

      180      240  

Settlements made during the period (in cash or in kind)

      
    on an actual basis;

 

    on a pro forma basis to give effect to: (a) the automatic conversion of all outstanding shares of series one convertible preferred stock into 6,457,530 shares of class B common stock and all outstanding shares of series two convertible preferred stock into 16,000,000 shares of class B common stock and (b) the filing of our restated certificate of incorporation upon completion of this offering; and

 

    on the pro forma basis described above, as adjusted to reflect the sale of 7,700,000 shares of class A common stock by us in this offering at the initial public offering price of $18.00 per share, after deducting underwriting discounts and commissions and estimated offering expenses payable by us, as described under “Use of Proceeds.”

 

You should read this table together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes appearing elsewhere in this prospectus.

 

     As of September 30, 2005

 
           Actual      

        Pro Forma    

   

Pro Forma

         (17 )
    


 

  


Balance at the end of the period

   $     $ 180    $ 403  
    


 

  


 

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 and cooperating with the Company pursuant to the procedures specified in the particular contract. This usually allows 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.

 

Legal Matters

 

      

($ in thousands except share and per share data)

 

Convertible preferred stock, no par value per share; 65,000,000 shares authorized, 44,915,060 shares issued and outstanding, actual; no shares authorized, issued and outstanding, pro forma and pro forma as adjusted

   $ 24,552     $     $       


 


 


Stockholders’ equity:

                        

Preferred stock, $0.001 par value per share; no shares authorized, issued and outstanding, actual; 10,042,490 shares authorized, no shares issued and outstanding, pro forma and pro forma as adjusted

The Company is a party to litigation matters and claims that are normal in the course of its operations. While the Company believes that the ultimate outcome of these matters will not have a material adverse effect on the Company, the outcome of these matters is not determinable and negative outcomes may adversely affect the Company’s financial position, liquidity or results of operations.

 

Note 7. 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.

 

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SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

There were no hedging activities for the fiscal years ended December 31, 2002 and 2003. As of December 31, 2004 and September 30, 2005, the Company’s hedge instruments consisted entirely of forward contracts. The Company calculates the fair value of its forward contracts based on spot rates and interest differentials from published soGN="bottom">                  

Class A common stock, $0.001 par value per share; 217,500,000 shares authorized, 76,652 shares issued and outstanding, actual and pro forma; and 7,776,652 shares issued and outstanding pro forma as adjusted

                 8  

Class B common stock, $0.001 par value per share; 157,500,000 shares authorized, 29,575,757 shares issued and outstanding, actual; 157,500,000 shares authorized, 52,033,287 shares issued and outstanding, pro forma and pro forma as adjusted

     29       52       52  

Additional paid-in capital

     145,302       169,831       296,621  

Accumulated other comprehensive income

     430       430  

In accordance with SFAS 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 shareholders’ equity (deficit) in the Consolidated Balance Sheets. Amounts deferred in accumulated other comprehensive income (loss) are reclassified into the 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, beginning in late 2004, was $(2.4) million and $2.8 million (unaudited) for the period from November 9, 2004 to December 31, 2004, and the nine months ended September 30, 2005, respectively.

 

Fair Value Hedges: On occasion, the Company commits to purchase equipment in foreign currency, predominantly Euro. 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 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 Consolidated Balance Sheet and in Other income (expense), net in the Consolidated Statement of Operations.

 

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. As of December 31, 2004 and September 30, 2005, the Company had outstanding cash flow hedge forward contracts with an aggregate notional value of $34.0 million and $34.4 million (unaudited), respectively, and outstanding fair value hedge forward contracts with an aggregate notional value of $0 and $9.5 million (unaudited), respectively. The maturity dates of the outstanding contracts ranged from October 2005 to July 2006.

 

In addition, the Company began hedging the net balance sheet effect of Euro denominated assets and liabilities in 2005. 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 and (expense), net. The gains or losses on these contracts are substantially offset by transaction gains or losses on the underlying balances being hedged. As of September 30, 2005, the Company held forward contracts with an aggregate notional value of $23.3 million (unaudited) to hedge the risks associated with Euro foreign currency denominated assets and liabilities.

 

Note 8. Customer Advances

 

In April 2005, the Company entered into an agreement with one of its customers to supply solar cells. As part of this agreement, the Customer agreed to fund future expansion of its manufacturing facility to support this customers’ solar cell product demand. Beginning January 1, 2006, the Company will be obligated to pay interest on any remaining unpaid balance. The Company’s settlement of principal on the advances is to be recognized over product deliveries at a specified rate on a per-unit-of-product-delivered basis through December 31, 2010. As of September 30, 2005, the Company received advances of $32.5 million (unaudited). Of the $32.5 million received, $5.4 million has been classified in current portion of customer advances and $27.1 million in long term customer advances as of September 30, 2005 (unaudited) based on projected product shipment dates. As of

 

F-26


Table of Contents

SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

September 30, 2005 (unaudited), the Company has utilized all funds as advanced by this customer towards expansion of the Company’s manufacturing facility.

 

In June 2005, the Company entered into an agreement with another customer who advanced $1.2 million towards the purchase of future solar cells. These advances will be reduced as shipments occur in the next twelve months. As of September 30, 2005 shipments of $0.4 million (unaudited), have been made to this customer.

 

From time to time, the Company enters into agreements where customers make advances for future purchases of solar power products. These advances will be applied as shipments of product occur.

 

Note 9. Debt

 

Related Party Subordinated Convertible Promissory Notes

 

In connection with the sale of series one preferred stock in Ma">      430  

Accumulated deficit

     (57,893 )     (57,893 )     (57,893 )     


 


 


Total stockholders’ equity

     87,868       112,420       239,218       


 


 


Total capitalization

   $ 112,420     $ 112,420     $ 239,218       


 


 


 

39


Table of Contents

The number of pro forma as adjusted shares of class A and class B common stock shown as issued and outstanding in the table above is based on the number of shares of our class A and class B common stock outstanding as of September 30, 2005, and excludes:

 

    6,508,193 shares of class A common stock issuable upon the exercise of options outstanding as of September 30, 2005, at a weighted average exercise price of $2.97 per share; and

 

    283,126 shares of class A common stock reserved for future issuance as of September 30, 2005 under our 2005 Stock Incentive Plan.

 

As of September 30, 2005, 283,126 shares remained available for future issuance under our 1996 Stock Plan. Upon the completion of this offering, the 1996 Stock Plan will be terminated. No shares of our class A common stock will remain available under the 1996 Stock Plan or our 1988 Stock Incentive Plan other than for satisfying exercises of stock options granted under this plan prior to its termination.

 

We have also adopted our 2005 Stock Unit Plan, under which our board of directors awards participants the right to receive cash payments from us in an amount equal to the appreciation in our stock between the award date and the date the employee redeems the award. A maximum of 100,000 stock units may be subject to stock unit awards granted under this plan and as of September 30, 2005, 11,450 units have been granted.

 

40


Table of Contents

DILUTION

 

Our net tangible book value as of September 30, 2005 was approximately $89.6 million, or $1.72 per share of common stock, assuming the conversion of all outstanding shares of our convertible preferred stock into 22,457,530 shares of class B common stock. Net tangible book value per share represents the amount of our total tangible assets less total liabilities, divided by the number of shares of common stock outstanding as of September 30, 2005 assuming the conversion of all outstanding shares of oy 2002, the convertible promissory notes held by non-Cypress investors were amended into subordinated convertible promissory notes, convertible into common stock. These notes were initially issued to certain investors of the Company. The principal balance of these notes was $1.9 million (along with accrued interest) and was convertible into 1.7 million shares of common stock. These notes bore interest at a rate of 3.21% annually and accrued interest until either the outstanding principal was paid in full or was converted in full. As a result of the November 9, 2004 merger transaction with Cypress, these notes were converted into 1.7 million shares of common stock in accordance with the terms of the Second Amended and Restated Articles of Incorporation. Furthermore, as part of the same transaction, in accordance with the terms of the Agreement and Plan of Reorganization entered into by the Company and Cypress, these common shares were retired.

 

Borrowings from Cypress

 

From the period February 2003 through June 30, 2005, the Company borrowed a total of $71.8 million from Cypress in the form of Promissory Notes, Senior Convertible Promissory Notes, and Promissory Notes issued under a Line of Credit Agreement. Amounts outstanding are as follows (in thousands):

 

"margin-top:0px;margin-bottom:0px; text-indent:4%">The Company entered into a $30.0 million Note Purchase and Line of Credit Agreement with Cypress in May 2002, which was subsequently amended in May 2004. From May 2002 to June 2005, Cypress loaned the Company an aggregate of $29.2 million. Amounts outstanding under the line of credit agreement require monthly interest payments at an annualized rate of 7%. Based on the terms of the agreement, principal is due in 60 equal monthly installments beginning June 2007 through May 2012. Amounts outstanding at December 31, 2003, 2004 and September 30, 2005 were $23.7 million, $31.7 million and $0 million (unaudited), respectively. In connection with loans made under the line of credit agreement, the Company issued warrants to Cypress to purchase 2,142,858 shares of common with an exercise price of $0.14 per share (see Note 10).

 

In March 2005, $6.9 million of principal and interest was converted into class A common stock as part of the $58 million common stock issuance to Cypress (see Note 10).

 

In July 2005, the remaining principal balance and related interest was converted into class A common stock as part of the July 2005 common stock issuance to Cypress. In addition, Cypress amended the terms of the line of credit agreement to expire on the earlier of the completion of the Company’s initial public offering or December 31, 2006.

 

F-28


Table of Contents

SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

Total interest expense related to all borrowings from Cypress (including interest expense attributed to the relative fair value of the warrants that were issued to Cypress in connection with these loans and amortized using the effective interest method) totaled $1.5 million, $ 3.8 million, $1.0 million, $3.0 million (unaudited), and $3.4 million (unaudited), for the fiscal year ended December 31, 2003; the period from January 1, 2004 to November 8, 2004; for the period November 9, 2004 to December 31, 2004; and nine months ended September 30, 2004 and 2005, respectively.

 

Note 10. Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit)

 

At December 31, 2004 (restated, see Note 13), the Company was authorized to issue 74.5 million shares of $0.001 par value common stock and 66.0 million shares of no par value preferred stock. At September 30, 2005, the Company was authorized to issue 375 million shares of $0.001 par value common stock and 65.0 million shares of no par value preferred stock (see Note 14).

 

Redeemable Convertible Preferred Stock.

 

At December 31, 2004, the Company’s redeemable convertible preferred stock consists of two series designated as series one and series two preferred stock. At December 31, 2002 and 2003, Cypress and the chief executive officer of Cypress were the Company’s majority preferred shareholders, owning a majority of the series one preferred stock outstanding. At November 8, 2004, December 31, 2004 and September 30, 2005, Cypress was the Company’s sole preferred shareholder, owning 100% of the series one and two preferred stock outstanding.

 

At December 31, 2001, the Company had outstanding shares of series A, series B1, series C, series D and series E preferred stock. In May 2002, the shareholders, each as a separate class voted to convert all 4,530,084 of these preferred shares into 5,215,451 shares of common stock. Additionally, the Company amended its Articles of Incorporation to eliminate all previous series of preferred stock and created two new series of preferred stock, series one which consists of 17,650,000 designated shares and series two which consists of 16,000,000 designated shares. The Company then issued 12,130,868 shares of series one preferred stock at $0.69 per share for $8.3 million in cash. Furthermore, Cypress, Cypress’ chief executive officer and other bridge note holders converted approximately $1.3 million of bridge notes and accrued interest into 2,117,231 shares of series one preferred stock, representing a price per share of $0.58 per share, or 85% of the face value of series one preferred stock in accordance with the convertible promissory note agreement.

 

In conjunction with the November 8, 2004 merger, the Company issued 32 million shares of series two convertible preferred stock in exchange for $16.0 million. Of the $16.0 million, $9.0 million was received as an advance from Cypress in December 2004 and $7 million in January 2005.

 

F-29


Table of Contents

SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

Convertible preferred stock consisted of the following as of December 31, 2003 and 2004 and September 30, 2005 (in thousands except share data):

 

     Predecessor
Company


    Successor Company

     December 31,
2003


    December 31,
2004


    September 30,
2005


               &nur convertible preferred stock into common stock. Dilution in net tangible book value per share to new investors represents the difference between the amount per share paid by purchasers of shares of class A common stock in this offering and the net tangible book value per share of common stock immediately after completion of this offering.

 

After giving effect to the sale of the 7,700,000 shares of class A common stock by us in this offering at the initial public offering price of $18.00 per share, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us, our net tangible book value as of September 30, 2005 would have been approximately $216.4 million, or $3.62 per share of common stock. This represents an immediate increase in net tangible book value of $1.90 per share of class A and class B common stock to existing stockholders and an immediate dilution in net tangible book value of $14.38 per share to new investors purchasing shares of class A common stock in this offering.

 

The following table illustrates this per share dilution:

 

/TD>

Initial public offering price per share of class A common stock

        $ 18.00

Net tangible book value per common share as of September 30, 2005

   $1.72       

Increase in net tangible book value per share attributable to existing stockholders

   1.90       
    
      

Net tangible book value per share as adjusted after this offering

   (unaudited)

Promissory note (February 2003)

   $ 2,142     $ 1,683     $  —

Unsecured senior convertible promissory notes, including accrued interest of $19,000 in 2003 and $72,000 in 2004

     3,695       3,672      

Promissory notes (March 2004), including accrued interest of $0 in 2003 and $803,000 in 2004 respectively

           3.62
         

Dilution per share to new investors

        $ 14.38
        24,803      

Promissory notes issued under line of credit, including accrued interest of $575,000 in 2003 and $2.5 million in 2004, respectively

     23,666        

 

The following table summarizes, as of September 30, 2005, the number of shares of class A common stock purchased from us at the initial public offering price of $18.00 per share, the total cash consideration paid and the average cash price per share paid by existing and new investors purchasing shares of class A common stock in this offering, before deducting underwriting discounts and commissions and estimated offering expenses, and after giving effect to the conversion of all outstanding shares of our convertible preferred stock into 22,457,530 shares of class B common stock.

 

     Shares Purchased

    Total Consideration

    Average
Price
Per Share


     Number

   Percent

    Amount

   Percent

   

Existing common and preferred stockholders

   52,109,939    87.1 %   $ 170,114,000    55.1 %   $ 3.26

New investors

   7,700,000    12.9       138,600,000    44.9       18.00
    
  

 

&n" STYLE="BORDER-RIGHT:1px solid #000000">      31,740        

Discount representing the relative fair value of warrants issued

     (66 )         (9,201 )      
    


 


 

       29,437

     

Total

   59,809,939    100.0 %   $ 308,714,000    100.0 %   $ 5.16
    
  

 

  

     

 

 

    52,697        

Less: Current portion

     (24,125 )     (31,024 )      
    


 


 

Long-term debt, net of current portion

   The table above also assumes no exercise of any outstanding stock options or warrants outstanding as of September 30, 2005. As of September 30, 2005, there were 6,508,193 shares of class A common stock issuable upon exercise of outstanding stock options at a weighted average exercise price of $2.97 per share. As of September 30, 2005, 283,126 shares remained available for future issuance under our 1996 Stock Plan. Upon the completion of this offering, the 1996 Stock Plan will be terminated. No shares of our class A common stock will remain available under the 1996 Stock Plan or our 1988 Stock Incentive Plan other than for satisfying exercises of stock options granted under this plan prior to its termination.

 

We have also adopted our 2005 Stock Unit Plan, under which our board of directors awards participants the right to receive cash payments from us in an amount equal to the appreciation in our stock between the award date and the date the employee redeems the award. A maximum of 100,000 stock units may be subject to stock unit awards granted under this plan and as of September 30, 2005, 11,450 units have been granted.

 

41


Table of Contents

As of September 30, 2005, assuming (a) the conversion of all outstanding shares of convertible preferred stock into 22,457,530 shares of class B common stock and (b) the exercise and payment of all outstanding options and after giving effect to this offering, net tangible book value would have been approximately $235.8 million, representing dilution of $14.45 per share to new investors. The table below assumes the exercise of all options to purchase shares of our class A common stock outstanding at September 30, 2005:

 

     Shares Purchased

    Total Consideration

   

Average
Price

Per Share


$ 5,312     $ 21,673     $
    


 


 

 

F-27


Table of Contents

SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

Promissory Note (February 2003)

 

In February 2003, the Company entered into a $2.5 million promissory note agreement with Cypress. This note bore interest at 7%, and was due in 60 equal monthly payments of $50,000, representing principal and interest. Amounts outstanding at December 31, 2003 and 2004 were $2.1 million and $1.7 million respectively. In connection with the issuance of this note, the Company granted a warrant to Cypress to purchase 178,571 shares of its common stock with an exercise price of $0.14 per share (Note 10).

 

In March 2005, the entire principal balance and related interest was converted into class A common stock as part of the $58 million common stock issuance to Cypress (see Note 10).

 

Unsecured Senior Convertible Promissory Notes

 

In accordance with the Note Purchase and Line of Credit Agreement signed in May 2002, Cypress funded the Company $400,000 per month from April 2003 through December 2003. In connection with this agreement, the Company issued to Cypress a warrant to purchase 16 million shares of series two preferred stock with an exercise price of $1.00 per share. This warrant expired unexercised in January 2004 (see Note 10). As of December 31, 2003 and 2004, the Company had borrowed a total of $3.6 million at interest rates between 1.21% and 1.68% based on the date of the note. These notes continued to accrue interest until the outstanding principal and interest was settled in March 2005.

 

In March 2005, the entire principal balance and related interest was converted into class A common stock as part of the $58 million common stock issuance to Cypress (see Note 10).

 

Promissory Notes (March 2004)

 

From March 2004 to June 2005, Cypress loaned the Company an aggregate of $36.5 million pursuant to 10 demand promissory notes. These notes bore interest at 7%. In connection with the issuance of those notes, the Company issued warrants to Cypress to purchase 1,500,000 shares of its common stock with an exercise price of $0.14 per share (see Note 10).

 

In March 2005, the entire principal balance and related interest was converted into class A common stock as part of the $58 million common stock issuance to Cypress (see Note 10).

 

Line of Credit Agreement

 

 

   Number

   Percent

    Amount

   Percent

   

Existing common and preferred stockholders

   52,109,939
     Predecessor
Company


     Successor Company

    

December 31,

2003


    

December 31,

2004


  

September 30,

2005


                 (unaudited)

Series One

                      

Authorized—17,650,000 shares at December 31, 2003, 14,297,593 shares at December 31, 2004 and 12,915,060 shares at September 30, 2005

         78.6 %   $ 170,114,000    51.8 %   $ 3.26

Shares subject to options

   6,508,193    9.8       19,329,000    5.9       2.97
    
  

 

  

     

Subtotal

   58,618,132    88.4       189,443,000    57.7       3.23

New investors

   7,700,000    11.6       138,600,000    42.3       18.00
    
  

 

  

     

Total

   66,318,132    100.0 %   $ 328,043,000    100.0 %   $ 4.95
&NT>                

Outstanding—14,308,099 shares at December 31, 2003 and 12,915,060 shares at December 31, 2004 and September 30, 2005

                      

Liquidation preference of $9,821 at December 31, 2003 and $8,865 at December 31, 2004 and September 30, 2005

   $ 9,366      $ 8,552    $ 8,552

Series Two

                      

Authorized—16,000,000 shares at December 31, 2003 and 32,000,000 shares at December 31, 2004 and September 30, 2005

                      

Outstanding—None at December 31, 2003 and 2004, 32,000,000 shares at September 30, 2005

                      

Liquidation preference of $16,000 at September 30, 2005

                 16,000
    


  

  

     $ 9,366      $ 8,552    $ 24,552
    


  

  

 

The rights, preferences, and privileges of the holders of series one and two preferred stock as of December 31, 2004 are as follows (see Note 14):

 

Dividends—Preferred Stock

 

When and if declared by the Board of Directors, the holders of the preferred shares are entitled to receive noncumulative annual dividends in the amount of eight percent (8%) of the initial sales price of $0.69 and $0.50 for series one and series two preferred stock, respectively. If dividends actually declared are inadequate to satisfy the full dividennbsp;   


  

 

  

     

 

If the underwriters’ over-allotment option is exercised in full and assuming no exercise of any such outstanding stock options to purchase our common stock, the number of shares of common stock held by existing stockholders will be reduced to 85.5% of the total number of shares of common stock to be outstanding after this offering; and the number of shares of class A common stock held by the new investors will be increased to 8,855,000 shares or 14.5% of the total number of shares of common stock outstanding after this offering.

 

42


Table of Contents

SELECTED CONSOLIDATED FINANCIAL DATA

 

The following selected consolidated financial data should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

On November 9, 2004, Cypress completed a reverse triangular merger with us in which each share of our then outstanding capital stock not owned by Cypress was valued at $3.30 per share on a post-split basis, or $1.65 per share on a pre-split basis, and exchanged for an equivalent number of shares of Cypress common stock. This merger effectively gave Cypress 100% ownership of all of our then outstanding shares of capital stock but left our unexercised warrants and options outstanding. This transaction resulted in the “push down” of the effect of the acquisition of SunPower by Cypress and created a new basis of accounting. See note 2 of the notes to our consolidated financial statements. The consolidated balance sheet and statements of operations data in this prospectus prior and up to November 8, 2004, refer to the Predecessor Company and this period is referred to as the pre-merger period, while the consolidated balance sheet and statements of operations data subsequent to November 8, 2004 refer to the Successor Company and this period is referred to as the post-merger period. A black line has been drawn between the accompanying financial statements to distinguish between the pre-merger and post-merger periods.

 

The selected consolidated balance sheet data as of December 31, 2003 and 2004, and the selected consolidated statements of operations data for the fiscal years ended December 31, 2002 and 2003, the period from January 1, 2004 to November 8, 2004 and the period from November 9, 2004 to December 31, 2004 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The selected consolidated balance sheet data as of December 31, 2000, 2001 and 2002 and the selected consolidated statements of operations data for the years ended December 31, 2000 and 2001 have been derived from our audited consolidated financial statements not included in this prospectus. The selected consolidated balance sheet data as of September 30, 2005 and the selected consolidated statement of operations data for the nine months ended September 30, 2004 and 2005, are derived from our unaudited consolidated financial statements included elsewhere in this prospectus.

 

The unaudited interim financial statements have been prepared on the same basis as our audited financial statements and, in our opinion, reflect all adjustments, which include only normal recurring adjustments, necessary to state fairly the results of operations and financial position for those periods and as of that date. The historical results are not necessarily indicative of the results to be expected for any future periods and the results for the nine months ended September 30, 2005 should not be considered indicative of results expected for the full fiscal year.

 

Our consolidated financial statements include allocations of certain Cypress expenses, including centralized legal, tax, treasury, information technology, employee benefits and other Cypress corporate services and infrastructure costs. The expense allocations have been determined on bases that we and Cypress considered to be reasonable reflections of the utilization of services provided or the benefit received by us. The financial information included in this discussion and in our consolidated financial statements may not be indicative of our consolidated financial position, operating results, changes in equity and cash flows in the future, or what they would have been had we been a separate stand-alone entity during the periods presented. See note 3 of the notes to our consolidated financial statements for additional information on our relationship with Cypress.

 

In 2000, 2001 and 2002, we reported our results of operations on a calendar year-end basis. In fiscal 2003, we began to report our results of operations on the basis of 52 or 53 week periods, ending on the Sunday closest to December 31. Fiscal 2003 ended on December 28, 2003 and included 52 weeks. Combined periods of fiscal 2004 ended January 2, 2005 and included 53 weeks. Our fiscal quarters end on the Sunday closest to the end of the applicable calendar quarter, except in a 53-week fiscal year in which the additional week falls into the fourth quarter of that fiscal year. For presentation purposes only, the consolidated financial statements and notes refer to the calendar year-end and month-end of each respective period.

 

We have also presented below our selected consolidated balance sheet data as of September 30, 2005 on a pro forma basis to give effect to (a) the automatic conversion of all outstanding shares of our series one convertible preferred stock into 6,457,530 shares of class B common stock and all outstanding shares of our

 

43


Table of Contents

series two convertible preferred stock into 16,000,000 shares of class B common stock and (b) the filing of our restated certificate of incorporation upon completion of this offering (in thousands except per share data).

 

    Predecessor Company

    Successor Company

 
    Years Ended December 31,

    Nine Months
Ended
September 30,
2004


   

Jan. 1
Through

Nov. 8

2004


   

Nov. 9
Through
Dec. 31

2004


    Nine Months
Ended
September 30,
2005


 
    2000

    2001

    2002

    2003

         
Consolidated Statements of Operations
Data
             

 

Liquidation Preferences—Preferred Stock

 

In the event of any liquidation, dissolution, or winding up of the Company, the holders of preferred shares shall be entitled to be paid $0.69 per share for series one preferred shares and $0.50 per share for series two preferred stock, subject to adjustment plus all declared but unpaid preferred dividends (the “Liquidation Amount”).

 

If the Company’s assets are insufficient to pay the distribution, then the assets and the funds of the Company will be distributed ratably among the holders of preferred stock in proportion to the amount of such stock owned by each such holder. Any amounts available for distribution in excess of the Liquidation Amount will be distributed to the holders of common stock and preferred stock, on an as-if-converted basis, pro-rata based on the number of shares held.

 

Conversion—Preferred Stock

 

Each share of series one and series two preferred stock is convertible, at the option of the holder, into the number of fully paid and nonassessable shares of common stock as determined by dividing the preferred stock original issue price by the conversion price in effect at the time of conversion. The initial conversion prices of series one and series two preferred stock are $0.69 and $0.50, respectively, and are subject to adjustment in accordance with anti-dilution provisions contained in the Company’s Articles of Incorporation, as amended and restated.

 

F-30


Table of Contents

SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

After November 9, 2004, the series one preferred stock became convertible into class A common stock and the series two preferred stock became convertible into class C common stock. Once the 2-for-1 reverse stock split in the common stock described in Note 13 occurs, each share of series one and two preferred stock will be convertible into 0.5 shares of class B common stock.

 

The preferred stock will be automatically converted into common stock upon the closing of the Company’s sale of common stock pursuant to a registration statement under the Securities Act of 1933, as amended, in which the aggregate net proceeds are equal to at least $20.0 million and in which the price per share of common stock is at least $2.07 (adjusted to reflect subsequent stock dividends, stock splits or recapitalization).

 

Voting Rights—Preferred Stock

 

The holders of series one and series two preferred stock shall be entitled to the number of votes equal to the number of shares of common stock into which their preferred shares are convertible.

 

Common Stock

 

Until November 8, 2004, there was only one class of common stock. After the merger on November 9, 2004, three classes of common stock were authorized for issuance, classes A, B and C common stock. On September 30, 2005, SunPower amended its articles of incorporation to have two classes of common stock (see Note 14).

 

On July 7, 2005, SunPower’s board of directors authorized the management of SunPower to proceed with the reincorporation of the Company in Delaware prior to completion of the Company’s initial public offering (see Note 13). On August 12, 2005, SunPower’s board of directors, subject to shareholder approval, approved the form of certificate of incorporation which provides for class B common stock having eight votes per share in lieu of the current class B and class C common stock and for various provisions in the certificate of incorporation and bylaws to provide Cypress with various protections, primarily by requiring 75% board vote for certain actions.

 

The outstanding options and warrants became exercisable for the class A common stock, and the series one and series two preferred stock became convertible into class B common stock.

 

At December 31, 2002, 2003 and 2004 and on November 8, 2004, immediately prior to the merger, all shares of common stock were held by non-Cypress shareholders. At November 9, 2004, immediately after the merger, no common stock was outstanding while on September 30, 2005, a majority of the common shares were owned by Cypress.

 

In March 2005, the Company issued to Cypress 17,575,757 shares of its class A common stock at a price of $3.30 per share, the consideration for which was $7.1 million cash and the cancellation by Cypress of $50.9 million of promissory notes and related interest held by Cypress (see Note 9). Accordingly, the net amount of $47.4 million comprising of the $50.9 million debt less the unamortized discount of $3.5 million was credited to equity.

 

On July 18, 2005, SunPower issued 12,000,000 shares of class A common stock to Cypress at a price of $7.00 per share the consideration for which was $20.2 million cash, the cancellation by Cypress of $25.2 million promissory notes and related interest held by Cypress, the cancellation of payables to Cypress of $14.7 million and the cancellation of warrants to purchase 3.8 million shares of SunPower class A common stock held by Cypress at an exercise price of $0.14 per share. The Company also reduced the net carrying value of the associated unamortized debt discount of $4.2 million, which was reflected in equity as part of this conversion of related party debt into class A common stock. As a result, the net impact to equity for the issuance of common stock upon cancellation of the related party debt was approximately $21.0 million.

 

F-31


Table of Contents

SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

Common stock (restated, see Note 13) consisted of the following as of December 31, 2003 and 2004 and September 30, 2005 (in thousands except share data).

 

     Predecessor
Company


    Successor Company

     December 31,
2003


    December 31,
2004


   September 30,
2005


                (unaudited)

Common stock, $0.001 par value; 16,825,000 shares authorized at December 31, 2003, none authorized at December 31, 2004, and September 30, 2005; 4,172,926 shares issued and outstanding at December 31, 2003, none at December 31, 2004 and September 30, 2005

   $ 4        $  —    $

Class A common stock, $0.001 par value; no shares authorized at December 31, 2003; 42,500,000 shares authorized at December 31, 2004; and 217,500,000 shares authorized at September 30, 2005; 1,901 shares issued and outstanding at December 31, 2004, 76,652 shares issued and outstanding at September 30, 2005

               

Class B common stock, $0.001 par value; no shares authorized at December 31, 2003; 16,000,000 shares authorized at December 31, 2004; and 157,500,000 shares authorized at September 30, 2005; no shares issued and outstanding at December 31, 2004, and 29,575,757 shares issued and outstanding at September 30, 2005

                29

Class C common stock, $0.001 par value per share; no shares authorized at December 31, 2003; 16,000,000 shares authorized at December 31, 2004; and no shares authorized at September 30, 2005; no shares issued and outstanding at December 31, 2004 and September 30, 2005

               
    


 

  

Total common stock

   $ 4     $    $ 29
    


 

  
 
                               
Revenue:                                                                

Product revenue

  $ 8,787     $ 4,988     $ 3,722     $ 4,245     $ 6,023     $ 6,708     $ 3,881     $ 49,242  

Other

    922       589       333       760       122       122       174       153  
   


 


 


 


 


 


 


 


Total revenue

    9,709       5,577       4,055       5,005  

 

As of December 31, 2004, the voting and dividend rights of the common stock were as follows (see Note 14):

 

Voting Rights—Common Stock

 

Class B and class C common stock are identical, except with respect to voting for directors and conversion. The holders of class A and C common stock, voting together shall be entitled to elect that number of directors which is the largest whole number less than or equal to 20% of the authorized number of directors; the holders of class B common stock are entitled to elect the remaining directors. Each share of class C common stock is convertible into one share of class A common stock and each share of class B common stock is convertible into one share of class A common stock at any time, on a oIGN="bottom"> 

  6,145       6,830       4,055       49,395  
   


 


 


 


 


 


 


 


Costs and expenses:

                                                     

 

Dividends—Common

 

When and if declared by the board of directors, and subject to the preferences applicable to any preferred stock outstanding, the holders of class A, class B and class C common stock are entitled to receive equal per share dividends. In the case of a dividend or distribution payable in the form of common stock, each holder of class A, class B and class C is only entitled to receive the class of stock that they hold.

 

F-32


Table of Contents

SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

Preferred and Common Stock Warrants

 

The following table summarizes information about warrants outstanding:

 

ext-indent:-1.00em">Warrants granted

    Preferred Stock
Warrants


    Common Stock
Warrants


    Series Two
Shares


    Exercise
Price


    Shares

    Exercise
Price


Outstanding as of December 31, 2001 (Predecessor Company)

      $              

Cost of revenue

    7,652       5,977       3,198       4,987       6,707       9,498       6,079       49,631  

Research and development

    1,024       914       2,532       9,816       11,035       12,118       1,417   672,317     $ 0.12

Warrants granted

  16,000,000       1.00           0.12

Warrants exercised

            (14,311 )     0.12

Warrants canceled

                   
        4,508  

Sales, general and administrative

    967       1,334       1,396       3,238       3,997       4,713       1,111       6,880  
   


 


 


 


 


 


 


 


Total costs and expenses

    9,643       8,225       7,126       18,041       21,739       26,329       8,607       61,019  
   


 


 


 


 


 


 


 


Operating income (loss)

    66       (2,648 )     (3,071 )     (13,036 )     (15,594 )     (19,499 )     (4,552 )     (11,624 )

Interest expense

    (444 )     (240 )     (493 )     (1,509 )     (2,960 )     (3,759 )     (1,072 )     (3,381 )

Other income (expense), net

    67       0       31             (3 )     (44 )     15       (198 )
   


 


 


 


 


 


 


 


Net loss

  $ (311 )   $ (2,888 )   $ (3,533 )   $ (14,545 )   $ (18,557 )   $ (23,302 )   &nbom">

         

     

Outstanding as of December 31, 2002 (Predecessor Company)

  16,000,000       1.00     658,006       0.12

Warrants granted

            178,571       0.14

Warrants exercised

                 

Warrants canceled

            (14,358 )     0.12
   

         

     

Outstanding as of December 31, 2003 (Predecessor Company)

  16,000,000       1.00     822,219       0.12

Warrants granted

            3,642,858       0.14

Warrants exercised

            (631,721 )     0.12

Warrants canceled

  (16,000,000 )     (1.00 )   (11,927 )     0.12
   

         

     

Outstanding as of November 8, 2004 (Predecessor Company)

            3,821,429       0.14

Warrants granted

                 

Warrants exercised

  $ (5,609 )   $ (15,203 )
   


 


 


 


 


 


 

 
               

Warrants canceled

                 
   

         

     

Outstanding as of December 31, 2004 (Successor Company)

            3,821,429
 


Net loss per share:

                                                               

Basic and diluted(1)

        0.14
   

 


 

     

$

(0.08 )   $ (0.76 )   $ (1.11 )   $ (3.50 )   $ (4.41 )   $ (5.51 )   $ (2,804.50 )   $ (0.93 )
   


 


 


 


 


 


 


 


Pro forma basic and diluted(2)

                                          $ (2.05 )   $ (0.86 )   $ (0.40 )
                                                       

Warrants exercised

                 

Warrants canceled

            (3,821,429 )     0.14
   

         

     

Outstanding as of September 30, 2005 (Successor Company) (unaudited)

                 
   

         

     

 

From 1998 through 2001, the Company issued 696,219 warrants to purchase common stock in connection with the issuance of term loans. The Company valued the warrants using the Black-Scholes option pricing model on the date of grant resulting in a fair value of $169,000 which was fully recognized as interest expense prior to 2002.

 

In connection with the issuance of series one preferred stock in May 2002, the Company entered into a Note Purchase and Line of Credit Agreement with Cypress and issued a warrant to Cypress to purchase up to 16 million shares of series two preferred stock at an exercise price of $1.00 per share expiring on December 31, 2003. The fair value of the warrant was estimated on the date of grant using the Black-Scholes pricing model with the following assumptions: no dividend yield, risk-free interest rate of 3.17%, volatility of 85% and an expected term of 1.6 years. The Company amortized the fair value of these warrants of $971,000 to interest expense in the amount of $358,000 and $613,000 in 2002 and 2003, respectively using the effective interest method. In December 2003, Cypress was granted a five week extension to exercise the warrant, thereby extending the expiration date from December 2003 to January 2004. However, the warrant expired unexercised in January 2004.

 

In February 2003, in connection with the issuance of the $2.5 million promissory note to Cypress maturing in March 2008 (see Note 9), the Company granted a warrant to Cypress to purchase 178,571 shares of its

 

F-33


Table of Contents

SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

common stock with an exercise price of $0.14 per share and a term of ten years. The fair value of the warrant was estimated on the date of grant using the Black-Scholes pricing model with the following assumptions: no dividend yield; risk-free rate of 3.95%; volatility of 85% and expected life of five years. The Company recorded the relative fair value of this warrant of $80,000 as a discount to debt. The fair value of the warrant was amortized to interest expense over the original term of the note (60 months) using the effective interest method. During the year ended December 31, 2003; the period from January 1, 2004 to November 8, 2004; the period November 9, 2004 to December 31, 2004; and the nine months ended September 30, 2005 $13,000, $10,000, $3,000 and $7,000 (unaudited) of the amount relating to the warrants was amortized to interest expense, respectively. The net unamortized discount of approximately $47,000 was reflected in equity as part of the conversion of this related party debt into common stock in March 2005 (see Note 9).

 

In connection with the November 9, 2004 merger transaction with Cypress, holders of warrants, other than Cypress, were required as a condition to the merger to exercise their warrants so that they held common stock immediately prior to the merger. As a result, warrants to purchase 631,721 shares of common stock were exercised and 11,927 were cancelled, prior to the merger.

 

In May 2004, the Company signed an amended note purchase and line of credit agreement, finalizing the terms of a $30 million loan from Cypress requiring principal payments between June 2007 and May 2012. As of September 30, 2005, no amount (unaudited) was outstanding under this facility. In connection with the issuance of this line of credit, (originally signed in May 2002), the Company granted warrants to purchase 2,142,857 shares of its common stock with an exercise price of $0.14 per share and a term of ten years. The fair value of the warrants was estimated on the date of grant using the Black-Scholes pricing model with the following assumptions: no dividend yield; risk free rate of 2.63%; volatility of 81.15% and expected life of three years. The Company recorded the relative fair value of these warrants of $6.6 million as a discount to the debt. The relative fair value of the warrant is being amortized to interest expense over the original term of the note using the effective interest method. During the period from January 1, 2004 to November 8, 2004, the period November 9, 2004 to December 31, 2004 and the nine months ended September 30, 2005, $939,000, $306,000 and $1.2 million (unaudited) of the amount relating to the warrants was amortized to interest expense, respectively. The remaining $4.2 million (unaudited) of the unamortized discount was reflected in equity as part of the conversion of the related party debt into common stock completed in July 2005.

 

From March 2004 through June 2005, Cypress loaned the Company $36.5 million for operations and equipment financing. These loans were demand loans bearing interest at 7%. In conjunction with the issuance of these loans, the Company granted warrants to Cypress to purchase 1,500,000 shares of its common stock with an exercise price of $0.14 per share and a term of ten years. The relative fair value of the warrants was estimated on the date of grant using the Black-Scholes pricing model with the following assumptions: no dividend yield; risk free rate of 1.86%-3.10%; volatility of 81.15% and expected life of three years. The Company recorded the fair value of these warrants of $4.4 million as a discount to debt. The fair value of the warrant was amortized to interest expense using the effective interest method. During the period from January 1, 2004 to November 8, 2004, the period November 9, 2004 to December 31, 2004 and the nine months ended September 30, 2005, $416,000, $215,000 and $297,000 (unaudited) of the amount relating to the warrants was amortized to interest expense. The remaining $3.5 million of the unamortized discount was reflected in equity as part of the conversion of this related party debt into common stock in March 2005 (see Note 9).

 

Stock Option Program

 

The Board of Directors has approved the 1988 Incentive Stock Plan (the “1988 Plan”) and the 1996 Incentive Stock Plan (the “1996 Plan”). Under the terms of the plans, the

     


 


 


Weighted-average shares:

                                                        Company may issue incentive or nonstatutory stock options or stock purchase rights to employees and consultants to purchase common stock. Currently, the maximum number of shares of common stock authorized for issuance under the 1988 Plan is

 

F-34


Table of Contents

SunPower Corporation

 

Notes to Consolidated Financial Statements—(Continued)

 

425,000 shares and under the 1996 Plan is 7,013,170 shares. The Company has also granted 114,000 options to employees and consultants outside of the 1988 and 1996 Plans.

 

As of September 30, 2005, the Company had 283,126 shares (unaudited) available under the 1996 Plan for grant and no shares available under the 1988 Plan.

 

Incentive stock options may be granted at no less than the fair value of the common stock on the date of grant. Nonqualified stock options and stock purchase rights may be granted at no less than 85% of the fair value of the common stock at the date of grant. The options and rights become exercisable when and as determined by the Board of Directors, although these terms are generally not to exceed ten years for stock options and six months for stock purchase rights. The options typically vest over five years with a one year cliff and monthly vesting thereafter.

 

Activity under the Company’s stock option plans is presented in the following table (in thousands except per share data):

 

    Predecessor Company

    Successor Company

   

Year Ended

December 31, 2002


  Year Ended
December 31,
2003


  Period From
January 1, 2004
through
November 8, 2004


          

Basic and diluted(1)

    3,614       3,782       3,188       4,156       4,207       4,230       2      

Period From
November 9, 2004

through
December 31, 2004


 

Nine Months

Ended

September 30, 2005


    Shares

    Weighted
Average
Exercise
Price


  Shares

    Weighted
Average
Exercise
Price


  Shares

    Weighted
Average
Exercise
Price


    Shares

    Weighted
Average
Exercise
Price


  Shares

    Weighted
Average
Exercise
Price


              16,267  
   


 


 


 


 


 


 


 


Pro forma basic and diluted(2)

                                            11,384       6,542       37,728  
                                           


 


 



(1) The basic and diluted net loss per share computation excludes potential shares of common stock issuable upon conversion of convertible preferred stock and exercise of options and warrants to purchase common stock as their effect would be antidilutive. See note 1 of the notes to our consolidated financial statements for a detailed explanation of the determination of the shares used in computing basic and diluted loss per share.

 

(2) For information regarding the computation of per share amounts, refer to note 1 of our consolidated financial statements included elsewhere in this prospectus. Pro forma basic and diluted net loss per share is presented for the period from January 1, 2004 through November 8, 2004, the period from November 9, 2004 through December 31, 2004 and the nine months ended September 30, 2005 to reflect per share data assuming the conversion of all our preferred stock into shares of class B common stock, which will occur upon completion of this offering, as if the conversion had taken place at the beginning of fiscal 2004.

 

    Predecessor Company

    Successor Company

    December 31,

    December 31,
2004


   

September 30,

2005


  September 30,
2005
Pro Forma


    2000

    2001

    2002

    2003

       

Consolidated Balance Sheet Data

                                                   

Cash and cash equivalents

  $ 131     $ 70     $ 345     $ 5,588     $ 3,776     $ 20,322   $ 20,322

Working capital (deficiency)

    (661 )     (3,674 )     (3,090 )     (28,574 )           (54,314 )     26,443     26,443

Total assets

    2,185       1,212       9,254       30,891       89,646       164,803     164,803

Notes payable to Cypress, net of current portion

                      5,312       21,673          

Customer advances, net of current portion

                                  27,045     27,045

Convertible preferred stock

    7,347       7,365       9,366       9,366       8,552       24,552    
 

Total stockholders’ equity (deficit)

    (655 )     (10,834 )     (6,022 )     (20,479 )     (10,664 )     87,868     112,420

 

44


Table of Contents

 

                                    (unaudited)

Options outstanding at

                                                             

Beginning

  437     $ 0.64   517   MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion of our financial condition and results of operations should be read together with the consolidated financial statements and related notes that are included elsewhere in this prospectus. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” or elsewhere in this prospectus. See “Risk Factors” and “Special Note Regarding Forward-Looking Statements.” In 2002, we reported our results of operations on a calendar year-end basis. In fiscal 2003, we began to report our results of operations on the basis of 52 or 53 week periods, ending on the Sunday closest to December 31. Fiscal 2003 ended on December 28, 2003 and included 52 weeks. The combined periods of fiscal 2004 ended on January 2, 2005 and included 53 weeks. Our fiscal quarters end on the Sunday closest to the end of the applicable calendar quarter, except in a 53-week fiscal year in which the additional week falls into the fourth quarter of that fiscal year. For presentation purposes only, the consolidated financial statements and notes refer to the calendar year-end and month-end of each respective period.

 

On November 9, 2004, Cypress completed a reverse triangular merger with us in which all of the outstanding minority equity interest of SunPower was retired, effectively giving Cypress 100% ownership of all of our then outstanding shares of capital stock, but leaving our unexercised warrants and options outstanding. This transaction resulted in the “push down” of the effect of the acquisition of SunPower by Cypress and created a new basis of accounting. See note 2 of the notes to our consolidated financial statements. The consolidated balance sheet and statements of operations data in this prospectus prior and up to November 8, 2004, refer to the Predecessor Company and this period is referred to as the pre-merger period, while the consolidated balance sheet and statements of operations data subsequent to November 8, 2004 refer to the Successor Company and this period is referred to as the post-merger period. A black line has been drawn between the accompanying financial statements to distinguish between the pre-merger and post-merger periods.

 

In our discussion of our fiscal year 2004, we refer to each line item in the statement of operations as “combined” for comparative purposes. These combined amounts represent the sum of the financial data for SunPower Corporation for the period from January 1, 2004 to November 8, 2004, our pre-merger period, and from November 9, 2004 to December 31, 2004, our post-merger period. We are including these combined amounts to improve the comparative analysis versus the prior period, which included a full fiscal year. These combined amounts are for informational purposes only and do not purport to represent what our financial position would have been in such periods.

 

Our consolidated financial statements include allocations of certain Cypress expenses, including centralized legal, tax, treasury, information technology, employee benefits and other Cypress corporate services and infrastructure costs. The expense allocations have been determined on bases that we and Cypress considered to be reasonable reflections of the utilization of services provided or the benefit received by us. The financial information included in this discussion and in our consolidated financial statements may not be indicative of our consolidated financial position, operating results, changes in equity and cash flows in the future, or what they would have been had we been a separate stand-alone entity during the periods presented. See note 3 of the notes to our consolidated financial statements for additional information on our relationship with Cypress.

 

General

 

We design, manufacture and sell solar power products, based on our proprietary processes and technologies. We have spent more than 15 years developing high performance solar cells, which are semiconductor devices that directly convert sunlight into electricity. We believe our solar cells have the highest conversion efficiency, a measurement of the amount of sunlight converted by the solar cell into electricity, available for the mass market. We believe our solar cells provide superior performance, including the ability to generate up to 50% more power per unit area, superior aesthetics with our uniformly black surface design and efficient use of silicon compared with conventional solar cells.

 

45


Table of Contents

We offer solar power products including solar cells, solar panels and inverters which convert sunlight to electricity compatible with the utility network. Our initial solar sales efforts have been focused on residential and commercial applications where the high performance and superior aesthetics of our solar power products provide compelling customer benefits. We sell our solar power products in many countries, principally in regions where government incentives have accelerated solar power adoption. In addition, we offer high performance imaging detectors based on our solar power technology, primarily for medical imaging applications, and infrared detectors for use primarily in computing and mobile phone applications.

 

Overview

 

SunPower was incorporated in 1985 by Dr. Richard Swanson to develop and commercialize high-efficiency photovoltaic, or solar, cell technology. Our solar cells were initially used in solar concentrator systems, which concentrate sunlight to reflective dish systems. From 1988 to 2000, we focused our efforts on developing our high-efficiency solar cells and marketing our infrared detectors. In 2001, NASA used our solar cells in the Helios solar-powered airplane to achieve aFONT>

  $ 0.58   1,745     $ 0.50        3,644     $ 2.12   4,285     $ 2.30

Granted

  122       0.40   1,360    

In May 2002, Cypress made its initial investment in us of $8.8 million in exchange for 12,915,060 shares of our series one preferred stock, at which time it became our majority shareholder. This investment funded our operations and the initial development of our A-300 solar cell. During 2003, we built a pilot wafer fabrication line at Cypress’ Round Rock, Texas wafer fabrication facility. In 2003 and 2004, we continued our A-300 solar cell product and manufacturing process development efforts. In late 2004, we completed the construction of our 215,000 square foot wafer fabrication facility in the Philippines, which is capable of housing four solar cell production lines with a total production capacity of approximately 100 megawatts per year, and we installed and qualified our first 25 megawatts per year production line. We funded these activities and our continuing operations through additional loans from Cypress.

 

In late 2004, we shipped our first commercial A-300 solar cells from our Philippines manufacturing facility. On November 9, 2004, Cypress completed a reverse triangular merger with us in which each share of our then outstanding capital stock not owned by Cypress was valued at $3.30 per share on a post-split basis, or $1.65 per share on a pre-split basis, and exchanged for an equivalent number of shares of Cypress common stock. This merger effectively gave Cypress 100% ownership of all of our then outstanding shares of our capital stock but left our unexercised warrants and options outstanding.

 

In January 2005, Cypress invested an additional $16.0 million in us in exchange for 32,000,000 shares of our series two convertible preferred stock. In March 2005, Cypress invested $58.0 million in us in exchange for 17,575,757 shares of our class A common stock. This investment, along with customer advances, funded the purchase of equipment for our second and third 25 megawatts per year production lines in our Philippines manufacturing facility. In July 2005, Cypress purchased an additional 12,000,000 shares of our class A common stock in exchange for approximately $20.2 million of cash, cancellation of all of our then outstanding debt and payables to Cypress, which totaled approximately $39.8 million, and cancellation of warrants to purchase 3,821,429 shares of class A common stock issued to Cypress in connection with earlier loans. As a result, we no longer have any outstanding indebtedness to Cypress. On September 30, 2005, Cypress exchanged all of its outstanding shares of class A common stock for an equal number of shares of class B common stock pursuant to an exchange agreement by and between SunPower and Cypress. For additional discussion regarding our financing arrangements with Cypress, see “Related Party Transactions—Arrangements Between SunPower Corporation and Cypress Semiconductor Corporation.”

 

Our employee base has increased from 66 full-time employees as of December 31, 2002 to 762 as of September 30, 2005 with most of them"> 

  0.50   2,205       3.20     644       3.30 & increase coming from hiring at our facility in the Philippines related to our increased manufacturing capacity. We have also increased headcount in research and development as well as sales, general and administrative functions as we prepare for growth of our business.

 

46


Table of Contents

We sell our solar power products to system integrators and original equipment manufacturers, or OEMs. Our solar panels are assembled for us by third-party subcontractors located in China. System integrators typically design and sell complete systems that include our solar panels along with additional required system components. In North America, our system integrators also incorporate our inverters in their system offerings. Our two largest customers for our solar power products are Conergy and Solon.

 

In addition, we offer imaging and infrared detectors based on our solar power technology. Our imaging detectors are manufactured for us by Cypress and are processed and tested in our Sunnyvale, California facility. We sell our imaging detectors to OEMs. Our primary customer for our imaging detectors is Plexus, a subcontractor to GE which uses our imaging detectors in its medical imaging products. We offer infrared detectors for use primarily in computing and mobile phone applications. For example, our infrared detectors are used in personal digital assistants to beam information from one device to another.

 

To date, substantially all of our revenue from our solar power products has been generated from two systems integrator customers in Europe. A significant number of the systems designed and manufactured by our customers are then sold to OEMs, who in turn sell the systems to end customers, including to customers outside of Europe. Our international sales accounted for approximately 58% and 29% of our total revenue in fiscal 2002 and fiscal 2003, respectively, 44% of our total combined revenue in fiscal 2004, and 70% of our total revenue in the nine months ended September 30, 2005. We anticipate that a significant amount of our total revenue will continue to be generated by sales to customers outside the United States. A significant portion of our sales are denominated in Euros.

 

Cypress has agreed to provide specified manufacturing and support services such as legal, tax, treasury and employee benefits services to us for a limited period from the date of our initial public offering so long as Cypress owns a majority of the aggregate number of shares of all classes of our common stock. These services may not be provided at the same level as they were prior to this offering, and we may not be able to obtain the same benefits that we received prior to the separation from Cypress. See “Related Party Transactions—Agreement Between SunPower Corporation and Cypress Semiconductor Corporation” and “Risk Factors—Risks Related to Our Relationship with Cypress Semiconductor Corporation” for a description of these services and risks. The historical financial informationbsp;

2,373       4.06

Canceled

  (29 )     0.64   (112 )     0.56   (28 )     1.18     (1 )     0.60   (75 )     1.86

Exercised

  (13 )     0.56   (20 )     0.40   (278 )     0.54     (2 )     0.64   (75 )     0.49
   

       

       

         

       

     

Options outstanding at end of period

  517     $ 0.58   1,745     $ 0.50   3,644     $ 2.12  

 

Financial Operations Overview

 

The following describes certain line items in our statements of operations:

 

Total Revenue

 

We generate product revenue from sales of our solar cells, solar panels, inverters, imaging detectors and infrared detectors. Solar power products accounted for 1% and 4% of our product revenue in fiscal 2002 and 2003, 36% of our combined product revenue in fiscal 2004 and 81% of our product revenue in the nine months ended September 30, 2005. Detector products and other revenue accounted for 99% and 96% of our product revenue in fiscal 2002 and 2003, 64% of our combined product revenue in fiscal 2004 and 19% of our product revenue in the nine months ended September 30, 2005. Factors affecting our revenue include unit volumes shipped, average selling prices, product mix and product demand. We have experienced quarter-over-quarter unit volume increases in our solar power products for the past four quarters as we continued to increase our production. During this period, we have experienced relatively stable average selling prices for our solar power products primarily due to the strength of end-market demand. We expect average selling prices for our solar power products to decline over time as the market becomes more competitive, as certain products mature and as manufacturers are able to lower their manufacturing costs and pass on some of the savings to their customers, similar to our experience historically in our detector products.

 

Cost of Revenue

 

Our cost of revenue consists primarily of silicon ingots and wafers for the production of solar cells, along with other materials such as chemicals and gases that are needed to transform silicon wafers into solar cells.

 

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Other factors contributing to cost of revenue include amortization of intangible assets, depreciation, salaries, personnel-related costs, facilities expenses and manufacturing supplies associated with solar cell fabrication. For our solar panels, our cost of revenue includes raw materials such as glass, frame, backing and other materials, as well as the assembly costs we pay to our third-party subcontractors in China. For our detector products, our cost of revenue includes the cost of silicon wafers, which is charged to us by our manufacturing contractor, Cypress, and our packaging and test costs. We expect cost of revenue to increase in absolute dollars as we bring on additional capacity and increase our product volume. Potential increases in our suppliers’ cost of polysilicon can also contribute to higher cost of revenue. Despite the absolute increase in cost of revenue dollars, we expect our cost of revenue to fluctuate as a percentage of revenue.

 

On November 9, 2004, Cypress completed a reverse triangular merger with us in which each share of our then outstanding capital stock not owned by Cypress was valued at $3.30 per share, or $1.65 per share on a pre-split basis, and exchanged for an equivalent number of shares of Cypress common stock. This merger effectively gave Cypress 100% ownership of all of our then outstanding shares of capital stock but left our unexercised warrants and options outstanding. As a result of that transaction, we were required to record Cypress’ cost of acquiring us in our financial statements, including its equity investment and pro rata share of our losses by recording intangible assets, including purchased technology, patents, trademarks and distribution agreement. The fair value for these intangibles is being amortized over two to six years on a straight-line basis. For additional discussion regarding amortization of acquired intangibles, please see note 2 of the notes to our consolidated financial statements.

 

Our gross profit each quarter is affected by a number of factors, including average selling prices for our products, our product mix, our actual manufacturing costs, the utilization rate of our wafer fabrication facility and changes in amortization of intangible assets. Presently, due to strong end-market demand for solar power products, we are able to manufacture and ship products at or near the manufacturing capacity of our first 25 megawatts per year production line, which allows us to spread a significant amount of our fixed costs over full production volume, thereby reducing our per unit fixed cost. As we build additional manufacturing lines or facilities, our fixed costs will increase, and the overall utilization rate of our wafer fabrication facility could decline, which could negatively impact our gross profit. This decline may continue until a line’s manufacturing output reaches its rated capacity.

 

From time to time, we enter into agreements where the selling price for certain of our solar power products is fixed over a defined period. An increase in our manufacturing costs, including silicon ingots and wafers, over such a defined period could have a negative impact on our overall gross profit. Our gross profit may also be impacted by certain adjustments for inventory reserves. We expect our gross profit to increase over time as we improve our manufacturing process and as we grow our business and leverage certain of our fixed costs. An expected increase in gross profit based on manufacturing efficiencies, however, could be partially or completely offset by increased raw material costs. Our inventory policy is described in more detail under “Critical Accounting Policies and Estimates.”

 

Operating Expenses

 

Our operating expenses include research and development expense and sales, general and administrative expense. Research and development expense consists primarily of salaries and related personnel costs, depreciation and the cost of solar cells and solar panel materials and services used for the development of products, including experiment and testing. We expect our research and development expense to increase in absolute dollars as we continue to develop new processes to further improve the conversion efficiency of our solar cells and reduce their manufacturing cost, and as we develop new products to diversify our product offerings. We expect our research and development expense to decrease as a percentage of revenue over time. We have recently entered into a three-year cost-sharing research and development project with the National Renewable Energy Laboratory to fund the design of our next generation solar panels. Payments received under this contract help offset our research and development expense. This contract is expected to fund approximately $1.0 million per year of our research and development expense through May 2008.

 

Sales, general and administrative expense consists primarily of salaries and related personnel costs, professional fees, insurance and other selling expenses. We expect our sales, general and administrative expense

 

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to increase in absolute dollars as we expand our sales and marketing efforts, hire additional personnel, improve our information technology infrastructure and incur other costs related to the anticipated growth of our business. We also expect sales, general and administrative expense to increase to support our operations as a public company, including compliance-related costs. However, we expect our sales, general and administrative expense to decrease as a percentage of revenue.

 

Interest expense

 

Interest expense consists of interest expense associated with debt we owed Cypress and the fair value of warrants issued in connection with these losses which are reflected as interest expense using the effective interest method for financial reporting purposes.

 

Other income (expense), net

 

Other income (expense), net consists primarily of gains or losses from foreign exchange, hedging contracts, and, to a lesser extent, interest earned on our cash and investments.

 

Provision for Income Taxes

 

For financial reporting purposes, income tax expense and deferred income tax balances were calculated as if we were a separate entity and had prepared our own separate tax return. Deferred tax assets and liabilities are recognized for temporary differences between financial statement and income tax bases of assets and liabilities. Valuation allowances are provided against deferred tax assets when it is more likely than not that some portion or all of the deferred tax asset will not be realized. We will pay federal and state income taxes in accordance with the tax sharing agreement with Cypress. See note 1 and note 5 of the notes to our consolidated financial statements.

 

As of September 30, 2005, we had federal net operating loss carryforwards of approximately $36.4 million. These federal net operating loss carryforwards expire at various dates from 2011 through 2025, if not utilized. We had California state net operating loss carryforwards of approximately $4.8 million as of September 30, 2005, which may be applied to future taxable income until these benefits begin to expire in 2006 through 2015. We also had research and development credit carryforwards of approximately $1.2 million for federal and approximately $1.2 million for state tax purposes. We have provided a valuation allowance on our deferred tax assets, consisting primarily of net operating loss carryforwards, because of the uncertainty of their realizability. Due in part to equity financings, we experienced “ownership changes” as defined in Section 382 of the Code. Accordingly, our use of the net operating loss carryforwards and credit carryforwards is limited by the annual limitations described in Sections 382 and 383 of the Code.

 

We currently benefit from income tax holiday incentives in the Philippines pursuant to our Philippine subsidiary’s registrations with the Board of Investments and Philippine Economic Zone Authority, which provide that we pay no income tax in the Philippines for four years pursuant to our Board of Investments non-pioneer status and Philippine Economic Zone Authority registrations, and six years pursuant to our Board of Investments pioneer status registration. Our current income tax holidays expire in 2010, and we intend to apply for extensions. However, these tax holidays may or may not be extended. We believe that as our Philippine tax holidays expire, (a) gross income attributable to activities covered by our Philippine Economic Zone Authority registrations will be taxed at a 5% preferential rate, and (b) our Philippine net income attributable to all other activities will be taxed at the statutory Philippine corporate income tax rate of 32%. As of yet, no tax benefit has been realized from the income tax holiday due to operating losses in the Philippines.

 

Critical Accounting Policies and Estimates

 

Our discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses. We base our estimates on historical experience and on various other assumptions that we believe to be

 

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reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our most critical policies include: (a) revenue recognition, which impacts the recording of revenue; (b) allowance for doubtful accounts, which impacts general and administrative expense; (c) warranty reserves, which impact cost of revenue and gross margin; (d) valuation of inventories, which impacts cost of revenue and gross margin; (e) stock option valuation, which impacts disclosure and cost of revenue and operating expenses; (f) valuation of long-lived assets, which impacts write-offs of goodwill and other intangibles; (g) valuation of goodwill impairment, which impacts operating expense and net income; and (h) accounting for income taxes which impacts our net income. We also have other key accounting policies that are less subjective, and therefore, their application would not have a material impact on our reported results of operations. The following is a discussion of our most critical policies, as well as the estimates and judgments involved.

 

Revenue Recognition

 

We sell our products to system integrators and OEMs and recognize revenue when persuasive evidence of an arrangement exists, delivery of the product has occurred and title and risk of loss has passed to the customer, the sales price is fixed and determinable, collectibility of the resulting receivable is reasonably assured and the rights and risks of ownership have passed to the customer. We do not currently have any significant post-shipment obligations, including installation, training or customer acceptance clauses with any of our customers that could have an impact on revenue recognition. As such, we record a trade receivable for the selling price when the above conditions are met, reduce inventory for the carrying value of goods shipped, and record the gross margin. Our revenue recognition is consistent across product lines and sales practices are consistent across all geographic locations.

 

We also enter into development agreements with some of our customers. Development revenue is recognized under the proportionate performance method, with the associated costs included in research and development expense. We estimate the proportionate performance of our development contracts based on an analysis of progress toward completion.

 

Allowance for Doubtful Accounts

 

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We make our estimates of the collectibility of our accounts receivable by analyzing historical bad debts, specific customer creditworthiness and current economic trends. The allowance for doubtful accounts was $59,000 and $529,000 as of December 31, 2004 and September 30, 2005, respectively. If the financial condition of our customers were to deteriorate such that their ability to make payments was impaired, additional allowances could be required.

 

Warranty Reserves

 

It is customary in our business and industry to warrant or guarantee the performance of our solar panels at certain levels of conversion efficiency for extended periods, often as long as 25 years. It is also customary to warrant or guarantee the functionality of our solar cells and imaging detectors for at least one year. We therefore maintain warranty reserves to cover potential liability that could arise from these guarantees. Our potential liability is generally in the form of product replacement. Our warranty reserves reflect our best estimate of such liabilities and are based on our analysis of product returns, results of industry-standard accelerated testing and various other assumptions that we believe to be reasonable under the circumstances. We have sold solar cells only since late 2004, and accordingly have a limited history upon which to base our estimates of warranty expense. We recognize our warranty reserve as a component of cost of revenue. Our warranty reserve includes specific accruals for known product issues and an accrual for an estimate of incurred but not reported product issues based on historical activity. Due to effective product testing and the short turnaround time between product shipment and the detection and correction of product failures, warranty expenses based on historical activity were not significant as of and for the fiscal years or interim periods presented.

 

 

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Valuation of Inventory

 

Inventory is valued at the lower of cost or market. Certain factors could impact the realizable value of our inventory, so we continually evaluate the recoverability based on assumptions about customer demand and market conditions. The evaluation may take into consideration historic usage, expected demand, anticipated sales price, new product development schedules, the effect new products might have on the sale of existing products, product obsolescence, customer concentrations, product merchantability and other factors. The reserve or write-down is equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory reserves or write-downs may be required that could negatively impact our gross margin and operating results. If actual market conditions are more favorable, we may have higher gross margin when products that have been previously reserved or written down are eventually sold.

 

Stock-Based Compensation

 

We have elected to follow the intrinsic value-based method prescribed by Accounting Principles Board, or APB, Opinion 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for employee stock options rather than adopting the alternative fair value accounting provided under Statement of Financial Accounting Standards, or SFAS, No. 123, Accounting for Stock-Based Compensation. Therefore, we do not record any compensation expense for stock options we grant to our employees where the exercise price equals the deemed fair market value of the stock on the date of grant and the exercise price, number of shares issuable under the options and vesting period are fixed. We comply with the disclosure requirements of SFAS No. 123 and SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, an Amendment of Financial Accounting Standards Board, or FASB, Statement No. 123, which require that we disclose our pro forma net income or loss and net income or loss per common share as if we had expensed the fair value of the options. In calculating this fair value, there are certain assumptions that we use, as disclosed in note 1 of the notes to our consolidated financial statements, consisting of the expected life of the option, risk-free interest rate, dividend yield and volatility.

 

We grant options to employees and consultants. Stock-based compensation includes the fair value of instruments issued to consultants and the deferred stock compensation associated with options to employees. The fair value of instruments issued to consultants is based on management’s estimates using Black-Scholes option pricing models. Instruments issued to consultants which are not fully vested are subject to periodic revaluation, or variable accounting, over the vesting term. These fair value estimates are based on a number of variables, including the fair value of the stock underlying the instrument, which are subject to change over the lives of the instruments.

 

We record deferred stock-based compensation which consists of the amounts by which the estimated fair value of the stock underlying the employee option exceeds the exercise price at the date of grant or other measurement date, if applicable. In determining the fair value of our common stock at the dates of grant of stock awards, we were unable to rely on a public trading market for our stock, but in certain cases were able to rely on recent stock sales or transactions to unrelated third parties as well as third-party valuations of our common stock. We have also relied on numerous objective and subjective factors and methodologies to value our common stock at different stages of our growth.

 

Valuation of Long-Lived Assets

 

Our long-lived assets include manufacturing equipment and facilities as well as certain intangible assets. Our business requires heavy investment in manufacturing facilities that are technologically advanced but can quickly become significantly under-utilized or rendered obsolete by rapid changes in demand for solar power products produced in those facilities. On November 9, 2004, Cypress completed a reverse triangular merger with us in which each share of our then outstanding capital stock not owned by Cypress was exchanged at a value of $3.30 per share on a post-split basis, or $1.65 per share on a pre-split basis, for shares of Cypress common stock having an equivalent aggregate value. This merger effectively gave Cypress 100% ownership of all of our outstanding shares of capital stock but left our unexercised outstanding warrants and options outstanding. As a result of that

 

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4,285     $ 2.30   6,508     $ 2.97
   

       

       

         

       

     

Options exercisable at end of period

  251     $ 0.52   310     $ 0.54   599     $ 0.94     662     $ 0.96   1,364     $ 1.87