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/div>
made at the direction of the Philippines-based finance personnel in order to report results for manufacturing operations that would be consistent with internal expense projections. The entries generally resulted in an understatement of our Company's cost of goods sold (referred to as “Cost of revenue” in our Condensed Consolidated Statements of Operations). The Audit Committee concluded that the efforts were not directed at achieving our Company's overall financial results or financial analysts' projections of our Company's financial results. The Audit Committee also determined that these accounting issues were confined to the accounting function in the Philippines. Finally, the Audit Committee concluded that executive management neither directed nor encouraged, nor was aware of, these activities and was not provided with accurate information concerning the unsubstantiated entr
ies. In addition to the unsubstantiated entries, during the Audit Committee investigation various accounting errors were discovered by the investigation and by management.
The nature and effect of the restatements resulting from the Audit Committee's independent investigation, including the impact to the previously issued interim condensed consolidated financial statements, were provided in our Company's Annual Report on Form 10-K for the year ended January 3, 2010. Prior year reports on Form 10-Q were restated and filed on May 3, 2010 by submission of Forms 10-Q/A. The amounts presented in this Form 10-Q
reflect the restatements filed in these amendments. For additional information regarding our Company's disclosure controls and procedures see Part I - “Item 4: Controls and Procedures” in our Company's Quarterly Report on Form 10-Q for the quarter ended October 3, 2010.
Critical Accounting Policies and Estimates
For a description of the critical accounting policies that affect our more significant judgments and estimates used in the preparation of our Condensed Consolidated Financial Statements, refer to our Annual Report on Form 10-K for the year ended January 3, 2010 filed with the Securities and Exchange Commission (“SEC”).
Recently Adopted Accounting Guidance and Issued Accounting Guidance Not Yet Adopted
For a description of accounting changes and issued accounting guidance not yet adopted, including the expected dates of adoption and estimated effects, if any, in our Condensed Consolidated Financial Statements, see Note 1 of Notes to our Condensed Consolidated Financial Statements.
Results of Operations for the Three and Nine Months Ended October 3, 2010 and September 27, 2009
Revenue
| | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
(In thousands) | October 3, 2010 | | September 27, 2009 | | October 3, 2010 | | September 27, 2009 |
Utility and power plants | $ | 257,803 | | | $ | 195,117 | | | $ | 521,896 | | | $ | 428,668 | |
Residential and commercial | 292,842 | | | 270,244 | | | 760,261 | | | 547,677 | |
Total revenue | $ | 550,645 | | | $ | 465,361 | | | $ | 1,282,157 | | | $ | 976,345 | |
Total Revenue: During the three and nine months ended October 3, 2010, total revenue of $550.6 million and $1,282.2 million, respectively, represented an increase of 18% and 31%, respectively, from total revenue reported in each of the comparable periods of fiscal 2009. The increase in total revenue during the three and nine mon
ths ended October 3, 2010 compared to the same periods in fiscal 2009 is attributable to revenue related to large scale projects completed or under construction and growing demand for our solar power products in the residential and commercial markets.
Sales outside the United States represented 68% of total revenue for each of the three and nine
months ended October 3, 2010, as compared to 68% and 54% of total revenue for the three and nine months ended September 27, 2009, respectively. The shift in revenue by geography in the nine months ended October 3, 201
0 as compared to revenue reported in the comparable period of fiscal 2009 is due to multiple large scale projects completed or under construction in Italy during the three and nine months ended October 3, 2010.
Concentrations: We had two and zero customers that accounted for 10 percent or more of total revenue in the three and nine months ended October 3, 2010, respectively. We had one customer that accounted for 10 percent or more of total revenue in each of
the three and nine months ended September 27, 2009.
| | | | | | | | | | | | |
| | | Three Months Ended | | Nine Months Ended |
(As a percentage of total revenue) | | October 3, 2010 | | September 27, 2009 | | October 3, 2010 | | September 27, 2009 |
Significant Customer: | Business Segment | | | | | | | | |
Etrion Corporation ("Etrion") | Utility and power plants | | 12 | % | | * | | | * | | * | |
Veronagest SpA | Utility and power plants | | 10 | % | | * | | | * | | * | |
SunRay | Utility and power plants | | ** | | | 15 | % | | ** | | * | <
td style="vertical-align:bottom;background-color:#cceeff;">
Florida Power & Light Company ("FPL") | Utility and power plants | | * | | | * | | | * | | 14 | % |
* denotes less than 10% during the period
** SunRay became a wholly-owned subsidiary of our Company on March 26, 2010
UPP Revenue: UPP revenue for the three and nine months ended October 3, 2010 was $257.8 million and $521.9 million, respectively, which accounted for 47% and 41%, respectively, of total revenue. UPP revenue for the three and nine months ended September 27, 2009 was $195.1 million and $428.7 million, respectively, which accounted for 42% and 44%, respectively, of total revenue. During the three and nine months ended October 3
, 2010, UPP revenue increased 32% and 22%, respectively, as compared to revenue reported in each of the comparable periods of fiscal 2009 primarily due to revenue related to large scale projects completed or under construction in Italy.
In the third quarter of fiscal 2010, our UPP Segment began providing solar technology to a customer under a large five-year supply contract. In addition, our UPP Segment com
pleted the sale of an 8 MWac solar power plant in Montalto di Castro, Italy, to Etrion, as well as recognized revenue under the percentage-of-completion method for seven solar power plants totaling 16.5 MWac in the Sicily region of Italy being constructed for Veronagest SpA and a 17 MWac solar power plant being constructed in Colorado for another customer.
In the third quarter of fiscal 2009, our UPP Segment recognized revenue from the ongoing construction of a 20 MWac solar power plant for SunRay in Montalto di Castro, Italy prior to our acquisition of that company. In addition, our UPP Segment completed the construction of a 25 MWac solar power plant for FPL in Desoto County, Florida and began the construction of a 10 MWac solar power plant for FPL at the Kennedy Space Center in Flori
da.
Revenue in our UPP Segment is susceptible to large fluctuations from quarter to quarter. Our UPP Segment is dependent on large scale projects and often a single project can account for a material portion of total revenue in a given quarter. In some cases, a delayed sale of a project could require us to recognize a gain on the sale of assets instead of recognizing revenue.
In general, a sale is consummated upon the execution of an agreement documenting the terms of the sale and a minimum initial payment by the buyer to substantiate the transfer of risk to the buyer. This may result in our deferral of revenue recognition during co
nstruction, even if a sale was consummated, until the buyer's initial investment payment is received, at which time revenue would be recognized on a percentage-of-completion basis as work is completed.
R&C Revenue: R&C revenue for the three and nine months ended October 3, 2010 was $292.8 million and $760.3 million, respectively, or 53% and 59%, respectively, of total revenue. R&C revenue for the three and nine months ended September 27, 2009 was $270.2 million and $547.7 million, respectively, or 58% and 56%, respectively, of total revenue. During the three
and nine months ended October 3, 2010, R&C revenue increased 8% and 39%, respectively, as compared to revenue reported in each of the comparable periods of fiscal 2009 primarily due to growing demand for our solar power products in the residential and commercial markets.
During the three and nine months ended October 3, 2010, R&C revenue was primary driven by demand in Germany, Italy and the United States, particularly in California and New Jersey, due to federal, state and local government incentives and strong demand in the residential and small commercial roof-top markets through our third-party global dealer network in both Europe and the United States. In addition, the R&C Segment began construction on several large commercial projects in New Jersey.
During the three and nine months ended September 27, 2009, R&C revenue was primary driven by demand in Germany, Italy and the United States, particularly in California, due to f
ederal, state and local government incentives and strong demand in the residential and small commercial roof-top markets through our third-party global dealer network in both Europe and the United States. In addition, the R&C Segment began the construction of an 8 MWac solar power plant in Chicago, Illinois.
Cost of Revenue
Details to cost of revenue by segment:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended |
| UPP | | R&C | | Consolidated |
(Dollars in thousands) | October 3, 2010 | | September 27, 2009 | | October 3, 2010 | | September 27, 2009 | | October 3, 2010 | | September 27, 2009 |
Amortization of other intangible assets | $ | 946 | | | $ | 683 | | | $ | 1,745 | | | $ | 2,119 | | | $ | 2,691 | | | $ | 2,802 | |
Stock-based compensation | 2,442 | | | 1,530 | | | 1,941 | | | 2,772 | | | 4,383 | | | 4,302 | |
Non-cash interest expense | 293 | | | 1
30 | | | 270 | | | 235 | | | 563 | | | 365 | |
Materials and other cost of revenue | 208,845 | | | 140,656 | | | 221,578 | | | 217,406 | | | 430,423 | | | 358,062 | |
Total cost of revenue | $ | 212,526 | | | $ | 142,999 | | | $ | 225,534 | | | $ | 222,532 | | | $ | 438,060 | | | $ | 365,531 | |
Total cost of revenue as a percentage of revenue | 82 | % |
| 73 | % | | 77 | % | | 82 | % | | 80 | % | | 79 | % |
Total gross margin percentage | 18 | % | | 27 | % | | 23 | % | | 18 | % | | 20 | % | | 21 | % |
| | | | | | | | | | | | | | <
/td> | | | | | | | | | |
| Nine Months Ended |
| UPP | | R&C | | Consolidated |
(Dollars in thousands) | October 3, 2010 | | September 27, 2009 | | October 3, 2010 | | September 27, 2009 | | October 3, 2010 | | September 27, 2009 |
Amortization of other intangible assets | $ | 2,409 | | | $ | 2,049 | | | $ | 5,994 | | | $ | 6,341 | | | $ | 8,403 | | &nb
sp; | $ | 8,390 | |
Stock-based compensation | 5,265 | | | 4,090 | | | 5,759 | | | 5,665 | | | 11,024 | | | 9,755 | |
Non-cash interest expense | 969 | | | 974 | | | 1,165 | | | 1,131 | | | 2,134 | | | 2,105 | |
Materials and other cost of revenue | 412,535 | | | 346,498 | | | 575,882 | | | 436,854 | | | 988,417 | | | 783,352 | |
Total cost of revenue | $ | 421,178 | | | $ | 353,611 | | | $ | 588,800 | | | $ | 449,991 | | | $ | 1,009,978 | | | $ | 803,602 | |
Total cost of revenue as a percentage of revenue | 81 | % | | 82 | % | | 77 | % | | 82 | % | | 79 | % | | 82 | % |
Total gross margin percentage | 19 | % | | 18 | % | | 23 | % | | 18 | % | | 21 | % | | 18 | % |
Total Cost of Revenue includes: (i) cost of raw materials to manufacture solar cells and a
ssemble solar panels; (ii) labor associated with the manufacturing of solar cells and solar panels; (iii) manufacturing overhead which includes plant and equipment depreciation as well as equipment maintenance and facility-related expenses; (iv) provisions for warranty reserves; (v) balance of system costs which includes mounting systems and inverters; and (vi) other project costs, including project management, engineering, development and construction costs.
In the three and nine months ended October&
nbsp;3, 2010, our two solar cell manufacturing facilities produced 152.1 MWdc and 425.4 MWdc, respectively. During the three and nine months ended September 27, 2009, our two solar cell manufacturing facilities produced 109.9 MWdc and 267.2 MWdc, respectively. Our manufacturing cost per watt decreased in the three and nine months ended October 3, 2010 as compared to the same periods of fiscal 2009 due to lower material cost and better material utilization as well as higher volume, resulting in increased economies of scale in production.
During the three and nine months ended October 3, 2010, total cost of revenue was $438.1 million and $1,010.0 million, respectively, which represented increases of 20% and 26%, respectively, compared to the total cost of revenue reported in the comparable periods of fiscal 2009. The increase in total cost of revenue corresponds with the increase of 18% and 31% in total revenue during the three and nine months ended October 3, 2010, respectively, compared to the same periods in fiscal 2009. As a percentage of total revenue, total cost of revenue increased to 80% in the three months ended October 3, 2010 as compared to 79% in the three months ended September 27, 2009 and decreased to 79% in the nine months ended October 3, 2010
as
compared to 82% in the nine months ended September 27, 2009. The increase in total cost of revenue as a percentage of total revenue in the three months ended October 3, 2010 as compared to the three months ended September 27, 2009 is primarily due to project costs related to systems being built in Italy and Colorado, partially offset by reduced charges for inventory write-downs related to declining average selling prices of third-party solar panels of $0.3 million and $3.4 million, respectively. The decrease in total cost of revenue as a percentage of total revenue in the nine months ended October 3, 2010 as compared to the nine months ended September 27, 2009 is reflective of: (i) reduced charges for inventory write-downs related to declining average selling prices of third-party solar panels of $0.7 million and $8.2 million, respectively; (ii) the reduction in large commercial balance of systems costs; and (iii) improvements attributable to continued manufacturing scale and reductions in our man
ufacturing cost per watt described above. Inventory written-down in fiscal 2009 that were sold in the first three quarters of fiscal 2010 improved our gross margin by an immaterial amount in the three and nine months ended October 3, 2010.
UPP Gross Margin: Gross margin was $45.3 million and $100.7 million for the three and nine months ended October 3, 2010, respectively, or 18% and 19%, respectively, of UPP revenue. Gross margin was $52.1 million and $75.1 million for the three and nine months ended September 27, 2009, respectively, or 27% and 18%, respectively, of UPP revenue. UPP gross margin for the three months ended October 3, 2010 primarily decreased due to a smaller proportion of components sales, which typically have a higher gross margin percentage than our utility projects, combined with lower gross margins on certain international EPC projects that were recognized during the period. UPP gross margin for the nine months ended October 3, 2010 primarily increased due to a greater proportion of components sales in the first half of fiscal 2010 which typically have a higher gross margin percentage than our utility projects as well as reduced charges for inventory write-downs and subsequent sales of aged third-party solar panel
s in the three and nine months ended October 3, 2010 as compared to the same periods in fiscal 2009.
R&C Gross Margin: Gross margin was $67.3 million and $171.5 million for the three and nine months ended October 3, 2010, respectively, or 23% each of R&C revenue. Gross margin was $47.7 million and $97.7 million for the three and nine months ended September 27, 2009, respectively, or 18% each of R&C revenue. Gross margin increased primarily due to: (i) the reduction in large commercial balance of systems costs; and (ii) improvements attributable to continued manufacturing scale and reductions in our manufacturing cost per watt described above, partially offset by the reduction in average selling prices of our solar power products.
Research and Development
| | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
(Dollars in thousands) | October 3, 2010 | | September 27, 2009 | | October 3, 2010 | | September 27, 2009 |
Stock-based compensation | $ | 1,886 | | | $ | 1,736 | | | $ | 5,822 | | | $ | 4,649 | |
Other research and development | 11,496 | | | 6,514 | | | 29,173 | | | 18,418 | |
Total research and development | $ | 13,382 | | | $ | 8,250 | | | $ | 34,995 | | | $ | 23,067 | |
Total research and development as a percentage of revenue | 2 | % | | 2 | % | | 3 | % | | 2 |
% |
During the three and nine months ended October 3, 2010, research and development expense was $13.4 million and $35.0 million, respectively, which represents increases of 62% and 52%, respectively, from research and development expense reported in the comparable periods of fiscal 2009. The increase in spending during the three and nine months ended October 3, 2010 as compared to the same periods in fiscal 2009<
/font> resulted primarily from: (i) personnel costs as a result of an increase in headcount; (ii) costs related to the improvement of our current generation solar cell manufacturing technology, development of our third generation of solar cells, development of next generation solar panels, development of next generation trackers and rooftop systems, and development of systems performance monitoring products; and (iii) less grants and cost reimbursements received from various government entities in the United States of $1.3 million and $5.2 million in the three and nine<
font style="font-family:inherit;font-size:10pt;"> months ended October 3, 2010, respectively, compared to $3.8 million and $6.1 million in the three and nine months ended September 27, 2009, respectively.
In fiscal 2007 through the third quarter of fiscal 2010 we benefited from a Solar America Initiative research and development agreement with the United States Department of Energy in which we have been awarded $24.1 million through October 3, 2010. Payments received under this contract offset our research and development expense by $5.2 million in the nine months ended October 3, 2010 as compared to $8.9 million, $7.0 million and $3.0 million in fiscal 2009, 2008 and 2007, respectively. The award was fully funded by the end of the third quarter of fiscal 2010.
Sales, General and Administrative
| | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
(Dollars in thousands) | October 3, 2010 | | September 27, 2009 | | October 3, 2010 | | September 27, 2009 |
Amortization of other intangible assets | $ | 8,887 | | | $ | 1,344 | | | $ | 19,636 | | | $ | 3,906 | |
Stock-based compensation | 9,396
| | 7,036 | | | 21,218 | | | 19,800 | |
Amortization of promissory notes | 6,022 | | | — | | | 8,941 | | | — | |
Other sales, general and administrative | 66,710 | | | 36,952 | | | 183,876 | | | 106,805 | |
Total sales, general and administrative | $ | 91,015 | | | $ | 45,332 | | | $ | 233,671 | | | $ | 130,511 | |
Total sales, general and administrative as a percentage of revenue | 17 | % | | 10 | % | | 18 | % | | 13 | % |
During the three and nine months ended October 3, 2010, sales, general and administrative (“SG&A”) expense was $91.0 million and $233.7 million, respectively, which represents increases of 101% and 79%, respectively, from SG&A expense reported in the comparable periods of fi
scal 2009. The increase in SG&A expense during the three and nine months ended October 3, 2010 as compared to the same periods in fiscal 2009 resulted primarily from: (i) SunRay's operating and development expenses being consolidated into our financial results from March 26, 2010 through October 3, 2010; (ii) higher amortization of other intangible assets related to project assets acquired from SunRay; (iii) SunRay acquisition-related costs and integration-related costs such as legal, accounting, valuation and other professional services; (iv) sales and marketing spending to expand our third-party global dealer network and global branding initiatives; and (v) $4.4 million of expenses incurred in the first quarter of fiscal 2010 associated with our Audit Committee independent investigation of certain accounting entries primarily related to cost of goods sold by our Philippines operations.
Other Income (Expense), Net
| | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
(Dollars in thousands) | October 3, 2010 | | September 27, 2009 | | October 3, 2010 | | September 27, 2009 |
Interest income | $ | 742 | | | $ | — | | | $ | 1,294 | | | $ | 1,949 | |
Total interest income as a percentage of revenue | — | % | | — | % | | — | % | | — | % |
Non-cash interest expense | $ | (5,844 | ) | | $ | (5,023 | ) | | $ | (20,041 | ) | | $ | (14,604 | ) |
Other interest expense | (8,924 | ) | | (4,969 | ) | | (24,977 | ) | | (11,422 | ) |
Total interest expense | $ | (14,768 | ) | | $ | (9,992 | ) | | $ | (45,018 | ) | | $ | (26,026 | ) |
Total interest expense as a percentage of revenue | 3 | % | | 2 | % | | 4 | % | | 3 | % |
Gain on deconsolidation of consolidated subsidiary | $ | 36,849 | | | $ | — | | | $ | 36,849 | | | $<
/div> | — | |
Total gain on deconsolidation of consolidated subsidiary as a percentage of revenue | 7 | % | | — | % | | 3 | % | | — | % |
Gain on change in equity interest in unconsolidated investee | $ | — |
| | $ | — | | | $ | 28,348 | | | $ | — | |
Total gain on change in equity interest in unconsolidated investee as a percentage of revenue | — | % | | — | % | | 2 | % | | — | % |
Gain (loss) on mark-to-market derivatives | $ | (2,967 | ) | | $ | — | | | $ | 28,885 | | | $ | 21,193 | |
Total gain (loss) on mark-to-mark derivatives as a percentage of revenue | 1 | % | | — | % | | 2 | % | | 2 | % |
Other, net | $ | (11,947 | ) | | $ | 585 | | | $ | (28,344 | ) | | $ | (3,7
65 | ) |
Total other, net as a percentage of revenue | 2 | % | | — | % | | 2 | % | | — | % |
Interest income represents interest income earned on our cash, cash equivalents, restricted cash, restricted cash equivalents and available-for-sale securities. The decrease in interest income in the three and nine months ended October 3, 2010 as compared to the same periods in fiscal 2
009 resulted from lower interest rates earned on cash holdings.
Interest expense during the three and nine months ended October 3, 2010 primarily relates to debt under our senior convertible debentures and fees for our outstanding letters of credit with Deutsche Bank AG New York Branch (“Deutsche Bank”). Interest expense during the three and nine months ended September 27, 2009 relates to borrowings under our senior convertible debentures, SunPower Malaysia Manufacturing Sdn. Bhd.'s ("SPMY") facility agreement with the Malaysian Government, the term loan with Union Bank, N.A. (“Union Bank”
) and customer advance payments. The increase in interest expense of 48% and 73% in the three and nine months ended October 3, 2010, respectively, as compared to the same periods in fiscal 2009 is due to: (i) additional indebtedness related to our $250.0 million in princip
al amount of 4.50% senior cash convertible debentures (“4.50% debentures”) issued in April 2010; and (ii) fees for our outstanding letters of credit with Deutsche Bank.
In June 2009, the Financial Accounting Standards Board (“FASB”) issued accounting guidance that changed how companies account for share lending arrangements that were executed in connection with convertible debt offerings or other financings. The new accounting guidance requires all such share lending arrangements to be valued and amortized as interest expense in the same manner as debt issuance costs. As a result of the new accounting guidance, existing share lending arrangements relating to our class A common stock are required to be measured at fair value and amor
tized as interest expense in our Condensed Consolidated Financial Statements. In addition, in the event that counterparty default under the share lending arrangement becomes probable, we are required to recognize an expense in our Condensed Consolidated Statement of Operations equal to the then fair value of the unreturned loaned shares, net of any probable recoveries. We adopted the new accounting guidance effective January 4, 2010, the start of our fiscal year, and applied it retrospectively to all prior periods as required by the guidance.
We have two historical share lending arrangements subject to the new guidance. In connection with the issuance of our 1.25% senior convertible debentures (“1.25% debentures”) and 0.75% senio
r convertible debentures (“0.75% debentures”), we loaned 2.9 million shares of our class A common stock to Lehman Brothers International (Europe) Limited (“LBIE”) and 1.8 million shares of our class A common stock to Credit Suisse International (“CSI”) under share lending arrangements. Application of the new accounting guidance resulted in higher non-cash amortization of imputed share lending costs in the current and prior periods, as well as a significant non-cash loss resulting from Lehman Brothers Holding Inc. (“Lehman”) filing of a petition for protection under Chapter 11 of the U.S. bankruptcy code on September 15, 2008, and LBIE commencing administration proceedings (analogous to bankruptcy) in the United Kingdom. The then fair value of the 2.9 million shares of the our class A common stock loaned and unreturned by LBIE is $213.4 million, which was expensed retrospectively in the third quarter of fiscal 2008. See Notes 1 and 10 of Notes to our Condensed C
onsolidated Financial Statements.
On July 5, 2010, we closed our joint venture transaction with AU Optronics Singapore Pte. Ltd. ("AUO"). Under the joint venture agreement our equity interest in SPMY, formerly a wholly-owned subsidiary, was reduced to 50% and the entity was renamed AUO SunPower Sdn. Bhd. (“AUOSP”). As a result of the shared power arrangement we deconsolidated AUOSP and account for our direct investment under the equity method of accounting. We recognized a non-cash gain of $36.8 million as a result of the deconsolidation of AUOSP in the third quarter of fiscal 2010 in our Condensed Consolidated Statement of Operations. For additional details see Note 9 of Notes to our Consolidated Financial Statements.
On June 30, 2010, Woongjin Energy Co., Ltd. (“Woongjin Energy”) completed its initial public offering (“IPO”) and the sale of 15.9 million new shares of common stock. We did not participate in this common stock issuance by Woongjin Energy. As a result of the new common stock issuance by Woongjin Energy in its IPO, our percentage equity interest in Woongjin Energy decreased from 42.1% to 31.3% of its issued and outstanding shares of common stock. In connection with the IPO, we recognized a non-cash
gain of $28.3 million in the second quarter of fiscal 2010 in our Condensed Consolidated Statement of Operations as a result of our equity interest in Woongjin Energy being diluted. For additional details see Note 9 of Notes to our Consolidated Financial Statements.
The $3.0 million net loss and $28.9 million net gain on mark-to-market derivatives during the three and nine<
/font> months ended October 3, 2010, respectively, relates to the change in fair value of the following derivative instruments associated with the 4.50% debentures: (i) the embedded cash conversion option; (ii) over-allotment option; (iii) bond hedge transaction; and (iv) warrant transaction. The changes in fair value of these derivatives are reported in our Condensed Consolidated Statement of Operations until such transactions settle or expire. The over-allotment option derivative settled on April 5, 2010 when the initial purchasers of the 4.50% debentures exercised the $30.0 million over-allotment option in full. The bond hedge and warrant transactions are meant to reduce our exposure to potential cash payments associated with the embedded cash conversion option. For additional details see Note 10 of Notes
to our Consolidated Financial Statements.
The $21.2 million non-cash gain on mark-to-market derivatives during the nine months ended September 27, 2009 relates to the change in fair value of certain convertible debenture hedge transactions (the “Purchased Options”) associated with
the issuance of our 4.75% senior convertible debentures (“4.75% debentures”) intended to reduce the potential dilution that would occur upon conversion of the debentures. The Purchased Options, which are indexed to our class A common stock, were deemed to be mark-to-market derivatives during the one-day period in which the over-allotment option in favor of the 4.75% debenture underwriters was unexercised. For additional details see Note 10 of Notes to our Consolidated Financial Statements.
The following table summarizes the components of other, net:
| | | | | | | | | | | | | | | | |
| | Three Months Ended | | Nine Months Ended |
(Dollars in thousands) | | October 3, 2010 | | September 27, 2009 | | October&n
bsp;3, 2010 | | September 27, 2009 |
Gain (loss) on derivatives and foreign exchange | | $ | (12,316 | ) | | $ | 696 | | | $ | (29,930 | ) | | $ | (1,852 | ) |
Gain on sale (impairment) of investments | |
— | | | (190 | ) | | 1,572 | | | (1,997 | ) |
Other income (expense), net | | 369 |
| | 79 | | | 14 | | | 84 | |
Total other, net | | $ | (11,94
7 | ) | | $ | 585 | | | $ | (28,344 | ) | | $ | (3,765 | ) |
Other, net was comprised of expenses totaling $11.9 million and $28.3 million during the three and nine months ended October 3, 2010, respectively, consisting primarily of: (i) losses totaling $11.3 million and $20.9 million, respectively, from expensing the time value of option contracts and forward points on forward exchange contracts; and (ii) losses totaling $1.0 million and $9.0 million, respectively, on foreign currency derivatives and foreign exchange largely due to the volatility in the current markets. These expenses during the three and nine mont
hs ended October 3, 2010 were partially offset by a $1.6 million gain on distributions from the Reserve Primary Fund in the first quarter of fiscal 2010.
Other, net was comprised of $0.6 million of income and $3.8 million of expenses during the three and nine months ended September 27, 2009, respectively, consisting primarily of $0.7 million of gains and $1.9 million of losses, respectively, on foreign currency derivatives and changes in foreign exchange rates largely due to the volatility in the currency markets as well as impairment charges of $0.2 million and $2.0 million, respectively, for certain money market funds and auction rate securities.
Income Taxes
| | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
(Dollars in thousands) | October 3, 2010 | | September 27, 2009 | | October 3, 2010 | | September 27, 2009 |
Benefit from (provision for) income taxes | $ | (3,376 | ) | | $ | <
font style="font-family:inherit;font-size:10pt;">(19,962 | ) | | $ | (19,493 | ) | | $ | 4,457 | |
Total benefit from (provision for) income taxes as a percentage of revenue | 1 | % | | 4 | % | | 2 | % | | — | % |
In the three and nine months ended October 3, 2010, our income tax provision of $3.4 million and $19.5 million, respectively, on income from continuing operations before income taxes and equity in earnings of unconsolidated investees of $16.1 million and $25.5 million, respectively, was primarily due to domestic and foreign income in certain jurisdictions, nondeductible amortization of purchased intangible assets, non deductible equity compensation, amortization of debt discount from convertible debentures, gain on change in equity interest in Woongjin Energy, mark-to-market fair value adjustments, changes in the valuation allowance on deferred tax assets, and discrete stock option deductions. In the three and nine months ended September 27, 2009, our income tax provision of $20.0 million and income tax benefit of $4.5 million, respectively, on income of $36.8 million and $12.5 million before income taxes and equity in earnings of unconsolidated investees, respectively, was primarily attributable to domestic and foreign income taxes in certain jurisdictions where our operations are profitable, net of nondeductible amortization of purchased other intangible assets, discrete stock option deductions and the discrete non-cash gain on Purchased Options of $21.2 million.
A significant amount of our total revenue is generated from customers located outside of the United States, and a substantial portion of our assets and employees are located outside of the United States. United States income taxes and foreign withholding taxes have not been provided on the undistributed earnings of our non United States subsidiaries as such earnings are intended to be indefinitely reinvested in operations outside the United States to extent that such earnings have not been currently or previously subjected to taxation of the United States.
We record a valuation allowance against deferre
d tax assets when management cannot conclude that it is more likely
than not that a portion or all of the deferred assets are recoverable. Based on the absence of sufficient positive objective evidence, management is unable to assert that it is more likely than not that we will generate sufficient taxable income to realize these remaining net deferred tax assets. Should we continue to project certain lev
els of profitability, we may be in a position to reverse the valuation allowance in the future.
Equity in earnings of unconsolidated investees
| | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
(Dollars in thousands) | October 3, 2010 | | September 27, 2009 | | October 3, 2010 | | September 27, 2009 |
Equity in earnings of unconsolidated investees | $ | 5,825 | | | $ | 2,627 | | | $ | 10,973 | | | $ | 7,005 | |
As a percentage of revenue | 1 | % | | 1 | % | | 1 | % | | 1 | % |
During the three and nine months ended October 3, 2010, our equity in earnings of unconsolidated investees were gains of $5.8 million and $11.0 million, respectively, as compared to $2.6 million and $7.0 million in the three and nine months ended September 27, 2009, respectively. Our share of Woongjin Energy's income totaled $5.7 million and $10.5 million in the three and nine months ended October 3, 2010, respectively, as compared to $2.6 million and $7.1 million in the three and nin
e months ended September 27, 2009, respectively. Our share of First Philec Solar Corporation's (“First Philec Solar”) income totaled $0.1 million and $0.4 million in the three and nine months ended October 3, 2010, respectively, as compared to income of zero and losses totaling $0.1 million in the three and nine months ended September 27, 2009, respectively, primarily due to increases in production since First Philec Solar became operational in the second quarter of fiscal 2008.
On July 5, 201
0, the first day of the third quarter in fiscal 2010, we deconsolidated our investment in AUOSP and account for such investment using the equity method of accounting. We will account for our share of AUOSP's net income or loss for the three months ended October 3, 2010 during the fourth quarter of fiscal 2010 due to a quarterly lag in reporting. For additional details see Note 9 of Notes to our Consolidated Financial Statements.
Income from discontinued operations, net of taxes
| | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
(Dollars in thousands) | October 3, 2010 | | September 27, 2009 | | October 3, 2010 | | September 27, 2009 |
Income from discontinued operations, net of taxes | $ | 1,570 | | | $ | — | | | $ | 9,466 | | | $ | — | |
As a percentage of revenue | — | % | | — | % | | 1 | % | | — | % |
In connection with our acquisition of SunRay on March 26, 2010, we acquired a SunRay project comp
any, Cassiopea, operating a previously completed 20 MWac solar power plant in Montalto di Castro, Italy. In the period in which an asset of our Company is classified as held-for-sale, we are required to present the related assets, liabilities and results of operations associated with that asset as discontinued operations. In the third quarter of fiscal 2010, we recognized a gain of $7.9 million for the sale of Cassiopea on August 5, 2010. Cassiopea's results of operations for the three and nine months ended October 3, 2010 were classified as “Income from disc
ontinued operations, net of taxes” in our Condensed Consolidated Statements of Operations. Cassiopea is the first of two phases of the solar power park being built in Montalto di Castro, Italy. Future delayed dispositions of projects could require us to recognize similar gains on the sale of assets instead of recognizing revenue. For additional details see Note 3 of Notes to our Consolidated Financial Statements.
Liquidity and Capital Resources
Cash Flows
A summary of the sources and uses of cash and cash equivalents is as follows:
| | | | | | | |
| Nine Months Ended |
(In thousands) | October 3, 2010 | | September 27, 2009 |
Net cash provided by (used in) operating activities of continuing operations | $ | (73,890 | ) | | $ | 37,227 | |
Net cash used in investing activities of continuing operations | (322,469 | ) | | (257,284 | ) |
Net cash provided by financing activities of continuing operations | 21,933 | | | 484,390 | |
Operating Activities
Net cash used in operating activities of continuing operations of $73.9 million in the nine months ended October 3, 2010 was primarily the result of: (i) increases in inventories and project assets of $84.2 million and $146.3 million, respectively, for construction of future and current projects in Italy; (ii) increases in costs and estimated earnings in excess of billings of $80.7 million related to contractual timing of system project billings; as well as (iii) other changes in operating assets and liabilities of $67.6 million, partially offset by an increase in accounts payable and other accrued liabilities of $219.1 million. In addition, net cash used in operating activities of continuing operations resulted from a $1.6 million gain on money market fund distributions a
nd non-cash income of $105.1 million related to our equity share in earnings of joint ventures, gain on deconsolidation of AUOSP, gain on change in equity interest in Woongjin Energy and a net gain on mark-to-market derivatives, offset by income from continuing operations of $17.0 million plus non-cash charges totaling $175.5 million for depreciation, amortization, stock-based compensation and non-cash interest expense.
Net cash provided by operating activities of $37.2 million in the nine months ended September 27, 2009 reflects our focus on working capital management and was primarily the result of net income of $24.0 million, plus non-cash charges totaling $128.0 million for depreciation, amortization, impairment of investments, stock-based compensation and non-cash interest expense, less non-cash income of $28.2 million related to a gain on Purchased Options and our equity share in earnings of joint ventures, as well as decreases in advances to suppliers of $25.2 million and inventories of $27.8 million due to improved inventory turns under management’s demand-driven manufacturing model. The increase was partially offset by an increase in accounts receivable of $43.3 million and costs and estimated earnings in excess of billings of $42.0 million related to contractual timing of system project billings, as well as other changes in operating assets and liabilities of $54.2 million.
Investing Activities
Net cash used in investing activities of continuing operations in the nine months ended October 3, 2010 was $322.5 million, of which: (i) $104.6 million relates to capital expenditures primarily associated with the continued construction of our third solar cell manufacturing facility (“FAB3”) in Malaysia prior to deconsolidation on July 5, 2010; (ii) $272.7 million in cash was paid for the acquisition of SunRay, net of cash acquired; (iii) $12.9 million relates to cash of AUOSP that was deconsolidated on July 5, 2010; and (iv) $3.8 million relates to cash paid for investments in AUOSP and non-public companies. Cash used in investing activities was partially offset by: (i) $64.7 million of decreases in restricted cash and cash equivalents primarily due to the deconsolidation of AUOSP and the repayment of the Piraeus Bank loan; (ii) $5.3 million in proceeds received from the sale of equipment to a third-party subcontractor
; and (iii) $1.6 million on money market fund distributions.
Net cash used in investing activities during the nine months ended September 27, 2009 was $257.3 million, of which: (i) $149.6 million relates to capital expenditures primarily associated with the completion of our second solar cell manufacturing facility (&
ldquo;FAB2”) in the Philippines and the continued construction of FAB3 in Malaysia; (ii) $145.6 million relates to increases in restricted cash and cash equivalents for the drawdown under the facility agreement with the Malaysian government; and (iii) $1.5 million relates to cash paid for investments in a non-public company. Cash used in investing activities was partially offset by $29.5 million in proceeds received from the sales or maturities of available-for-sale securities and $9.9 million in proceeds received from the sale of equipment to a third-party subcontractor.
Financing Activities
Net cash provided by financing activities of continuing operations in the nine months ended October 3, 2010 was $21.9 million and reflects cash received of: (i) $230.5 million in net proceeds from the issuance of $250.0 million in principal amount of our 4.50% debentures, after reflecting the payment of the net cost of the call spread overlay; (ii) $0.8 million in excess tax benefits from stock-based award activity; and (iii) $0.7 million from stock option exercises. Cash received in the nine months ended October 3, 2010 was partially offset by: (i) cash paid of $30.0 million to Union Bank to terminate our $30.0 million term loan; (ii) repayment of $33.6 million to Piraeus Bank to terminate our current account overdraft agreement in Greece; (iii) repurchase of $143.8 million in principal amount of our 0.75% debentures; and (iv) $2.5 million for treasury stock purchases that were used to pay withholding taxes on vested restricted stock.
Net cash provided by financing activities during the nine months ended September 27, 2009 reflects cash received of: (i) $218.8 million in net proceeds from our public offering of 10.35 million shares of our class A common stock; (ii) $198.7 million in net proceeds from the issuance of $230.0 million in principal amount of our 4.75% debentures, af
ter reflecting the payment of the net cost of the call spread overlay; (iii) Malaysian Ringgit 375.0 million (approximately $107.9 million based on the exchange rate as of September 27, 2009) from the Malaysian Government under our facility agreement; (iv) $29.8 million in net proceeds from Union Bank under our $30.0 million term loan; (v) $7.1 million in excess tax benefits from stock-based award activity; and (vi) $1.4 million from stock option exercises. Cash received during the nine months ended September 27, 2009 was partially offset by cash paid of $75.6 million t
o repurchase approximately $81.1 million in principal amount of our 0.75% debentures and $3.7 million for treasury stock purchases that were used to pay withholding taxes on vested restricted stock.
Debt and Credit Sources
Convertible Debentures
On April 1, 2010, we issued $220.0 million in principal amount of our 4.50% debentures and received net proceeds of $214.9 million, before payment of the net cost of the bond hedge and warrant transactions of $12.1 million. On April 5, 2010, the initial purchasers of the 4.50% debentures exercised the $30.0 million over-allotment option in full and we received net proceeds of $29.3 million, before payment of the net cost of the bond hedge and warrant transactions of $1.6 million. Interest on the 4.50% debentures is payable on March 15 and September 15 of each year, which commenced September 15, 2010. The 4.50% debentures mature on March 15, 2015. The 4.50% debentures are convertible only into cash, and not into shares of our class A common stock (or any other securities). Prior to December 15, 2014, the 4.50% debentures are conver
tible only upon specified events and, thereafter, they will be convertible at any time, based on an initial conversion price of $22.53 per share of our class A common stock. The conversion price will be subject to adjustment in certain events, such as distributions of dividends or stock splits. Upon conversion, we will deliver an amount of cash calculated by reference to the price of our class A common stock over the applicable observation period. The 4.50% debentures will not be convertible, in accordance with the provisions of the debenture agreement, until the first quarter of fiscal 2011. We may not redeem the 4.50% debentures prior to maturity. Holders may also require us to repurchase all or a portion of their 4.50% debentures upon a fundamental change, as defined in the debenture agreement, at a cash repurchase price equal to 100% of the principal amount plus accrued and unpaid interest. In the event of certain events of default, such as our failure to make certain payments or perform or observe certa
in obligations there-under, Wells Fargo Bank, N.A. (“Wells Fargo”), the trustee, or holders of a specified amount of then-outstanding 4.50% debentures will have the right to declare all amounts then outstanding due and payable. For additional details see Note 10 of Notes to our Condensed Consolidated Financial Statements.
In May 2009, we issued $230.0 million in principal amount of our 4.75% debentures and received net proceeds of $225.0 million, before payment of the net cost of the call spread overlay of $26.3 million. Interest on the 4.75% debentures is payable on April 15 and October 15 of each year, which commenced October 15, 2009. Holders of the 4.75% debentures are able to exercise their right to convert the debentures at any time into
shares of our class A common stock at a conversion price equal to $26.40 per share. The applicable conversion rate may adjust in certain circumstances, including upon a fundamental change, as defined in the indenture governing the 4.75% debentures. If not earlier converted, the 4.75% debentures mature on April 15, 2014. Holders may also require us to repurchase all or a portion of their 4.75% debentures upon a fundamental change at a cash repurchase price equal to 100% of the principal amount plus accrued and unpaid interest. In the event of certain events of default, such as our failure to make certain payments or perform or observe certain obligations there-under, Wells Fargo (the trustee) or holders of a specified amount of then-outstanding 4.75% debentures will have the right to declare all amounts then outstanding due and payable. For additional details see Note 10 of Notes to our Condensed Consolidated Financial Statements.
In February 2007, we issued $200.0 million in principal amount of our 1.25% debentures and received net proceeds of $194.0 million. In fiscal 2008, we received notices for the conversion of $1.4 million in principal amount of the 1.25% debentures which we settled for $1.2 million in cash and 1,000 shares of class A common stock. Interest on the 1.25% debentures is payable on February 15 and August 15 of each year, which commenced August 15, 2007. The 1.25% debentures mature on February 15, 2027. Holders may require us to repurchase all or a portion of their 1.25% debentures on each of February 15, 2012, February 15, 2017 and February 15, 2022, or if we experience certain types of corporate transactions constituting a fundamental change, as defined in the indenture governing the 1.25% debentures. Any repurchase of the 1
.25% debentures under these provisions will be for cash at a price equal to 100% of the principal amount of the 1.25% debentures to be repurchased plus accrued and unpaid interest. In addition, we may redeem some or all of the 1.25% debentures on or after February 15, 2012 for cash at a redemption price equal to 100% of the principal amount of the 1.25% debentures to be redeemed plus accrued and unpaid interest. For additional details see Note 10 of Notes to our Condensed Consolidated
Financial Statements.
In July 2007, we issued $225.0 million in principal amount of our 0.75% debentures and received net proceeds of $220.1 million. In fiscal 2009, we repurchased $81.1 million in principal amount of the 0.75% debentures for $75.6 million in cash. In the third quarter of fiscal 2010, we repurchased $143.8 million in principal amount of the 0.75% debentures for $143.8 million in cash, of which $143.3 million was pursuant to the contracted debenture holder put on August 2, 2010. As of October 3, 2010, an aggregate principal amount of $0.1 million of the 0.75% debentures remain issued and outstanding. Interest on the 0.75% debentures is payable on February 1 a
nd August 1 of each year, which commenced February 1, 2008. The 0.75% debentures mature on August 1, 2027. Holders of the remaining 0.75% debentures could require us to repurchase all or a portion of their debentures on each of August 1, 2015, August 1, 2020 and August 1, 2025, or if we experienced certain types of corporate transactions constituting a fundamental change, as defined in the indenture governing the 0.75% debentures. The 0.75% debentures were classified as long-term liabilities and short-term liabilities in our Condensed Consolidated Balance Sheets as of October 3, 2010 and January 3, 2010, respectively, due to the ability of the holders to require us to repurchase their 0.75%
debentures commencing on August 1, 2015 and August 2, 2010, respectively. Any repurchase of the 0.75% debentures under these provisions will be for cash at a price equal to 100% of the principal amount of the 0.75% debentures to be repurchased plus accrued and unpaid interest. In addition, we could redeem the remaining 0.75% debentures on or after August 2, 2010 for cash at a redemption price equal to 100% of the principal amount of the 0.75% debentures to be redeemed plus accrued and unpaid interest. For additional details see Note 10 of Notes to our Condensed Consolidated Financial Statements.
Debt Facility Agreement with the Malaysian Government
On December 18, 2008, AUOSP, then our wholly-owned subsidiary, entered into a facility agreement with the Malaysian Government. As of January 3, 2010, AUOSP had outstanding Malaysian Ringgit 750.0 million ($219.0 million based on the exchange rates as of January 3, 2010) under the facility agreement to finance the construction of FAB3 in Malaysia. On July 5, 2010, the joint venture closed between our Company, through SunPower Technology, Ltd. (“SPTL”), an indirect subsidiary of our Company, AUOSP, AUO, and AU Optronics Corporation, the ultimate parent company of AUO (“AUO Taiwan”). Under the terms of the joint venture agreement, our Company, through SPTL, and AUO each own 50% of the AUOSP joint venture. AUOSP retains the existing debt facility agreement and the outstanding balance was deconsolidated by our Company on July 5, 2010 d
ue to the shared power arrangement. We do not guarantee or collateralize the debt facility held by AUOSP. For additional details see Note 9 of Notes to our Condensed Consolidated Financial Statements.
Mortgage Loan Agreement with International Finance Corporation (“IFC”)
On May 6, 2010, SPML and SPML Land, Inc. (“SPML Land”), both subsidiaries of our Company, entered into a mortgage loan agreement with IFC. Under the loan agreement, SPML may borrow up to $75.0 mi
llion during the first two years, and SPML shall repay the amount borrowed, starting 2 years after the date of borrowing, in 10 equal semiannual installments over the following 5 years. SPML shall pay interest of LIBOR plus 3% per annum on outstanding borrowings, and a front-end fee of 1% on the principal amount of borrowings at the time of borrowing, and a commitment fee of 0.5% per annum on funds available for borrowing and not borrowed. SPML may prepay all or a part of the outstanding principal, subject to a 1% prepayment premium. As of October 3, 2010, SPML had not borrowed any funds under the mortgage loan agreement.
On November 12, 2010, SPML borrowed $50 million under the mortgage loan agreement. A
total of $25 million remains available for borrowing under the mortgage loan agreement. For additional details see Notes 10 and 17 of Notes to our Condensed Consolidated Financial Statements.
Term Loan with Union Bank
On April 17, 2009, we entered into a loan agreement with Union Bank under which we borrowed $30.0 million for a three year term at an interest rate of LIBOR plus 2%. As of January 3, 2010, the outstanding loan balan
ce was $30.0 million of which $11.3 million and $18.7 million had been classified as “current portion of long-term debt” and “Long-term debt,” respectively, in our Condensed Consolidated Balance Sheet, based on projected quarterly installments commencing June 30, 2010. On April 9, 2010 we repaid all principal and interest outstanding under the term loan with Union Bank. For additional details see Note 10 of Notes to our Condensed Consolidated Financial Statements.
Revolving Credit Facility with Union Bank
On October 29, 2010, we entered into a revolving credit facility agreement with Union Bank. Until the maturity date of October 28, 2011, we may borrow up to $70.0 million under the revolving credit facility. Amounts borrowed may be repaid and reborrowed until October 28, 2011. The revolving credit facility may be increased up to $100.0 million at our option and upon receipt of additional commitments from lenders. On October 29, 2010, we drew down $70.0 million under the revolving credit
facility.
The amount available for borrowing under the revolving credit facility is further capped at 30% of the market value of our shares in Woongjin Energy ("Borrowing Base"). If at any time the amount outstanding under the revolving credit facility is greater than the Borrowing Base, we must repay such difference within two business days. In addition, upon a material adverse change which, in the sole judgment of Union Bank, would adversely affect the ability of Union Bank to promptly sell the Woongjin Energy shares, including but not limited to any unplanned closure of the Korean Stock Exchange that lasts for more than one tr
ading session, we must repay all outstanding amounts under the revolving credit facility within five business days, and the revolving credit facility will be terminated. As security under the revolving credit facility, we pledged our holding of 19.4 million shares of common stock of Woongjin Energy to Union Bank.
We are required to pay interest on outstanding borrowings of, at our option, (1) LIBOR plus 2.75% or (2) 1.75% plus a base rate equal to the highest of (a) the federal funds rate plus 1.5%, (b) Union Bank's prime rate as announced from time to time, or (c) LIBOR plus 1.0%, per annum; a front-end fee of 0.40% on the available borrowing; and a commitment fee of 0.25% per annum on funds available for borrowing and not borrowed. For addition
al details see Note 10 of Notes to our Condensed Consolidated Financial Statements.
Letter of Credit Facility with Deutsche Bank
On April 12, 2010, we entered into a letter of credit facility agreement with Deutsche Bank, as issuing bank and as administrative agent, and the financial institutions parties thereto from time to time. The letter of credit facility provides for the issuance, upon our request, of letters of credit by the issuing bank in order to support our o
bligations, in an aggregate amount not to exceed $350.0 million (or up to $400.0 million upon the agreement of the parties). Each letter of credit issued under the letter of credit facility must have an expiration date no later than the earlier of the second anniversary of the issuance of that letter of credit and April 12, 2013, except that: (i) a letter of credit may provide for automatic renewal in one-year periods, not to extend later than April 12, 2013; and (ii) up to $100.0 million in aggregate amount of letters of credit, if cash-collateralized, may have expiration dates no later than the fifth anniversary of the closing of the letter of credit facility. For outstanding letters of credit under the letter of credit facility we pay a fee of 0.50% plus any applicable issuances fees charged by its issuing and correspondent banks. We also pay a commitment fee of 0.20% on the unused portion of the facility. As of Oc
tober 3, 2010, letters of credit issued under the letter of credit facility totaled $224.3 million and were collateralized by restricted cash on our Condensed Consolidated Balance Sheet. For additional details see Note 10 of Notes to our Condensed Consolidated Financial Statements.
Amended Credit Agreement with Wells Fargo
On April 12, 2010, we entered into an amendment of our credit agreement with Wells Fargo. Under the amended credit agreement, letters of credit outstanding under the collateralized letter of credit facility will remain outstanding through November 29, 2010. On April 26, 2010, the uncollateralized letter of credit subfeature expired and as of October 3, 2010 all outstanding letters of credit on the subfeature had been moved to either the Deutsche Bank letter of credit facility or the Wells Fargo collateralized letter of credit facility. Letters of credit totaling $2.4 million and $150.7 million were issued by Wells Fargo under the collateralized letter of credit facil
ity as of October 3, 2010 and January 3, 2010, respectively, and were collateralized by restricted cash on our Condensed Consolidated Balance Sheets. We pay fees of 0.2% to 0.4% depending on maturity for outstanding letters of credit under the collateralized letter of credit facility. For additional details see Note 10 of Notes to our Condensed Consolidated Financial Statements.
Commercial Project Financing Agreement with
Wells Fargo
On June 29, 2009, we signed a commercial project financing agreement with Wells Fargo to fund up to $100 million of commercial-scale solar system projects through May 31, 2010. Under the financing agreement, we designed and built the systems, and upon completion of each system, sold the systems to Wells Fargo, who in turn, leased back the systems to us. Separately, we entered into PPAs with end customers, who host the systems and buy the electricity directly from us.
We sold two solar system
projects to Wells Fargo in the third quarter of fiscal 2010 and two solar system projects to Wells Fargo in the fourth quarter of fiscal 2009. Concurrent with the sale, we entered into agreements to lease the systems back from Wells Fargo over minimum lease terms of 20 years. The deferred profit on the sale of the systems is being recognized over the minimum term of the lease. At the end of the lease term, we have the option to purchase the system at fair value or remove the system. For additional details see Note 8 of Notes to our Condensed Consolidated Financial Statements.
Liquidity
As of October 3, 2010, we had unrestricted cash and cash equivalents of $281.2 million as compared to $615.9 million as of January 3, 2010. The decrease in the balance of our cash and cash equivalents as of October 3, 2010 as compared to the balance as of January 3, 2010 was primarily due to: (i) net cash paid of $272.7 million for the acquisition of SunRay completed on March 26, 2010; (ii) cash paid of $207.4 million in the aggregate to repurchase $143.8 million in principal amount of the 0.75% debentures and to repa
y $63.6 million in bank loans in the nine months ended October 3, 2010, partially offset by the receipt of aggregate net proceeds of $230.5 million from the issuance of $250.0 million in principal amount of our 4.50% debentures in April 2010, after deducting the underwriters' discounts and commissions and offering expenses payable by us (including $13.7 million paid as the net cost of the call spread overlay). For additional details refer to the summary of the sources and uses of cash and cash equivalents above.
Our cash balances are held in numerous locations throughout the world, including substantial amounts held outside of the United States. The amounts held outside of the United States representing the earnings of our foreign subsidiaries, if repatria
ted to the United States under current law, would be subject to United States federal and state tax less applicable foreign tax credits. Repatriation of earnings that have not been subjected to U.S. tax and which have been indefinitely reinvested outside the U.S. could result in additional United States federal income tax payments in future years.
On July 5, 2010, the joint venture closed between our Company, through SPTL, AUOSP, AUO and AUO Taiwan. Under the terms of the joint venture agreement, our Company, through SPTL, and AUO each own 50% of the AUOSP joint venture. Both SPTL and AUO are obligated to provide additional funding to AUOSP in the future. On July 5, 2010, SPTL and AUO each contributed initial funding of Malaysian Ringgit 45.0 million and w
ill contribute additional amounts from fiscal 2011 to 2014 amounting to $335 million by each shareholder, or such lesser amount as the parties may mutually agree (see the Contractual Obligations table below). In addition, if AUOSP, SPTL or AUO requests additional equity financing to AUOSP, then SPTL and AUO will each be required to make additional cash contributions of up to $50 million in the aggregate. On November 5, 2010, our Company and AUOSP entered into an agreement under which we will resell to AUOSP polysilicon purchased from a third-party supplier and AUOSP will provide prepayments to us related to such polysilicon, which we will use as prepayments to the third-party supplier. Prepayments to be paid to us by AUOSP total $100 million, $60 million and $40 million in the fourth quarter of fiscal 2010, fiscal year 2011 and fiscal year 2012, respectively. For additional details see Notes 8 and 9 of Notes to our Condensed Consolidated Financial Statements.
Beginning in the first quarter of fiscal 2011 through the fourth quarter of fiscal 2014, the 4.50% debentures are convertible only upon specified events and, thereafter, they will be convertible at any time, based on an initial conversion price of $22.53 per share of our class A common stock. The 4.50% debentures are convertible only into cash, and not into shares of our class A common stock (or any other securities). Upon conversion, we will deliver an amount of cash calculated by reference to the price of our class A common stock over the applicable observation period. Concurrent with the issuance of the 4.50% debentures, we entered into privately negotiated convertible debenture hedge transactions (collectively, the "Bond Hedge") and warrant transactions (collectively, the "Warrants" and together with
the Bond Hedge, the “CSO2015”), with certain of the initial purchasers of the 4.50% cash convertible debentures or their affiliates. The CSO2015 is meant to reduce our exposure to potential cash payments upon conversion of the 4.50% debentures. For additional details see Note 10 of Notes to our Condensed Consolidated Financial Statements.
If the closing price of our class A common stock equaled or exceeded 125% of the initial effective conversion price governing the 1.25% debentures for 20 out of 30 consecutive trading days in the last month of the fiscal quarter, then holders of the 1.25% debentures have the right to convert the debentures into cash and shares of class A common stock any day in the following fiscal quarter. Because the closin
g price of our class A common stock on at least 20 of the last 30 trading days during the fiscal quarter ending October 3, 2010 and January 3, 2010 did not equal or exceed $70.94, or 125% of the applicable conversion price for our 1.25% debentures, holders of the 1.25% debentures are unable to exercise their right to convert the debentures, based on the market price conversion trigger, on any day in the first and fourth quarters of fiscal 2010. Accordingly, we classified our 1.25% debentures as long-term in our Condensed Consolidated Balance Sheets as of both October 3, 2010 and January 3, 2010. This test is repeated each fiscal quarter, therefore, if the market price conversion trigger is satisfied in a subsequent quarter, the 1.25% debentures may again be reclassified as short-term. For additional details see Note 10 of Notes to our Condensed Consolidated Financial Statements.
In addition, the holders of our 1.25% debentures would be able to exercise their right to convert the debentures during the five consecutive business days immediately following any five consecutive trading days in which the trading price of our 1.25% debentures is less than 98% of
the average closing sale price of a share of class A common stock during the five consecutive trading days, multiplied by the applicable conversion rate.
We expect total capital expenditures, excluding cash paid for the construction of solar power systems, in the range of
$125 million to $150 million in fiscal 2010. Total capital expenditures in the nine months ended October 3, 2010 of $104.6 million primarily relates to the continued construction of FAB3 in Malaysia prior to deconsolidation on July 5, 2010. Capital expenditures anticipated to occur in the fourth quarter of 2010 relate to improvements of our current generation solar cell manufacturing technology and other projects. The development of solar power plants can require long periods of time and substantial initial investments. Our efforts in this area may consist of all stages of development, including land acquisition, permitting, financing, construction, operation and the eventual sale of the projects. We will often choose to bear the costs of such efforts prior to the final sale to a customer. This involves significant upfront investments of resources (including, for exampl
e, large transmission deposits or other payments, which may be non-refundable), and in some cases the actual costs of constructing a project, in advance of the signing of PPAs and EPC contracts and the receipt of any revenue, much of which is not recognized for several additional months or years following contract signing. The delayed disposition of such projects could have a negative impact on our liquidity.
We believe that our current cash and cash equivalents, cash generated from operations and funds available under our mortgage loan agreement with IFC and our revolving credit facility with Union Bank will be sufficient to meet our working capital and fund our committed capital expenditures over the next 12 months. However, there can be no assurance tha
t our liquidity will be adequate over time. Our capital expenditures and use of working capital may be greater than we expect if we decide to accelerate ramping our manufacturing capacity both internally and through capital contributions to joint ventures, make additional investments in solar power plants and subsequently the sale of the solar power plant and associated cash proceeds are delayed as described above, as well as making unexpected payments for supply of raw materials and balance of system costs. 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. Effective October 29, 2010, certain limitations regarding our ability to sell additional equity securities pursuant to our tax sharing agreement with Cypress have expired. However, the sale of additional equity securities or convertible debt securities would result in additional dilution to our stockholders and may not be avai
lable on favorable terms or at all, particularly in light of the current crises in the financial and credit markets. Additional debt would result in increased expenses and would likely impose new restrictive covenants which may be similar or different than those restrictions contained in the covenants under the letter of credit facility with Deutsche Bank, mortgage loan agreement with IFC, the revolving credit facility with Union Bank, the 4.50% debentures, 4.75% debentures and 1.25% debentures. Financing arrangements may not be available to us, or may not be available in amounts or on terms acceptable to us.
Contractual Obligations
The following summarizes our contractual obligations as of October 3, 2010:
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| | | | Payments Due by Period |
(In thousands) | | Total | | 2010 (remaining 3 months) | | 2011-2012 | | 2013-2014 | | Beyond 2014 |
Convertible debt, including interest (1) | | $ | 770,953 | | | $ | 6,165 | | | $ | 245,752 | | | $ | 266,613 | | | $ | 252,423 | |
Future financing commitments (2) | | 339,940 | | | 170 | | | 141,600 | | | 198,170 | | | — | |
Customer advances (3) | | 83,283 | | | 4,303 | | | 22,980 | | | 16,000 | | | 40,000 | |
Operating lease commitments (4) | | 64,332 | | <
/div> | 5,065 | | | 18,110 | | | 13,337 | | | 27,820 | |
Utility obligations (5) | | 750 | | | — | | | — | | | — | | | 750 | |
Non-cancelable purchase orders (6) | <
/font> | 14,729 | | | 14,729 | | | — | | | — | | | — | |
Purchase commitments under agreements (7) | | 5,532,321 | | | 331,273 | | | 1,299,452 | | | 1,367,381 | | <
/td> | 2,534,215 | |
Total | | $ | 6,806,308 | | | $ | 361,705 | | | $ | 1,727,894 | | | $ | 1,861,501 | | | $ | 2,855,208 | |
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(1) | Convertible debt and interest on convertible debt relate to the aggregate of $678.7 million in outstanding principal amount of our senior convertible debentures on O
ctober 3, 2010. For the purpose of the table above, we assume that all holders of the 4.50% debentures and 4.75% debentures will hold the debentures through the date of maturity in fiscal 2015 and 2014, respectively, and all holders of the 1.25% debentures and 0.75% debentures will require our Company to repurchase the debentures on February 15, 2012 and August 1, 2015, respectively, and upon conversion, the values of the 1.25% debentures and 0.75% debentures will be equal to the aggregate principal amount of $198.7 million with no premiums (see Note 10 of Notes to our Condensed Consolidated Financial Statements). |
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(2) | On July 5, 2010, SPTL and AUO each contributed to AUOSP total initial funding of Malaysian Ringgit 45.0 million and will contribute additional amounts from 2011 to 2014 amounting to $335 million by each shareholder, or such lesser |
amount as the parties may mutually agree (see Notes 8 and 9 of Notes to our Condensed Consolidated Financial Statements).
Further, on September 28, 2010, we invested $0.2 million in a related party. In connection with the related purchase agreement we will be required to provide additional financing of up to $4.9 million, subject to certain condition
s (see Note 8 of Notes to our Condensed Consolidated Financial Statements).
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(3) | Customer advances relate to advance payments received from customers for future purchases of solar power products and future polysilicon purchases by a third party that manufactures ingots which are sold back to us under an ingot supply agreement.
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(4) | Operating lease commitments primarily relate to: (i) four solar power systems leased from Wells Fargo over minimum lease terms of 20 years; (ii) a 5-year lease agreement with Cypress for our headquarters in San Jose, California which expires in April 2011 (we will enter in
to another operating lease arrangement for a San Jose, California facility before our current agreement with Cypress expires); (iii) an 11-year lease agreement with an unaffiliated third party for our administrative, research and development offices in Richmond, California; and (iv) other leases for various office space (see Note 8 of Notes to our Condensed Consolidated Financial Statements). |
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(5)
; | Utility obligations relate to our 11-year lease agreement with an unaffiliated third party for our administrative, research and development offices in Richmond, California. |
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(6) | Non-cancelable purchase orders relate to purchases of raw materials for inventory and manufacturing equipment from a variety of vendors (see Note 8 of Notes to our Condensed Consolidated Financial Statements). |
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(7) | Purchase commitments under agreements relate to arrangements entered into with s
everal suppliers, including joint ventures, for polysilicon, ingots, wafers and solar panels as well as agreements to purchase solar renewable energy certificates from solar installation owners in New Jersey. These agreements specify future quantities and pricing of products to be supplied by the vendors for periods up to eleven years and there are certain consequences, such as forfeiture of advanced deposits and liquidated damages relating to previous purchases, in the event that we terminate the arrangements (see Note 8 of Notes to our Consolidated Financial Statements). |
As of October 3, 2010 and January 3, 2010, total liabilities associated with uncertain tax positions were $16.8 million and $14.5 million, respectively, and are included in “Other long-term liabilities” in our Condensed Consolidated Balance Sheets as they are not expected to be paid within the next twelve months. Due to the complexity and uncertainty associated with our tax positions, we cannot make a reasonably reliable estimate of the period in which cash settlement will be made for our liabilities associated with uncertain tax positions in other long-term liabilities, therefore, they have been excluded from the table above. For additional details see Note 10 of Notes to our Consolidated Financial Statements.<
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On October 29, 2010, we drew down $70.0 million under the revolving credit facility with Union Bank. In addition, on
November 12, 2010, SPML borrowed $50 million under the mortgage loan agreement with the IFC. These transactions are excluded from the table above because they occurred in the fourth quarter in fiscal 2010. For additional details see Notes 10 and 17 of Notes to our C
ondensed Consolidated Financial Statements.
Off-Balance-Sheet Arrangements
As of October 3, 2010, we did not have any significant off-balance-sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Foreign C
urrency Exchange Risk
Our exposure to movements in foreign currency exchange rates is primarily related to sales to European customers that are denominated in Euros. Revenue generated from European customers represented 61% and 59% of total revenue in the three and nine months ended October 3, 2010, respectively, as compare to 63% and 49% in the three and nine months ended September 27, 2009, respectively. A 10% change in the Euro exchange rate would have impacted our revenue by $33.6 million and $75.6 million during the three and nine months ended October 3, 2010, respectively, as compared to $29.3 million and $47.8 million during the three and nine months ended September 27, 2009, respectively.
In the past, we have experienced an adverse impact on our revenue, gross margin and profitability as a result of foreign currency fluctuations. When foreign currencies appreciate against the U.S. dollar, inventories and expenses denominated in foreign currencies become more expensive. Weakening of the Korean Won against the U.S. dollar could result in a foreign currency remeasurement loss by Woongjin Energy which in turn negatively impacts our equity in earnings of the unconsolidated investee. In addition, strengthening of the Malaysian Ringgit against the U.S. dollar will increase AUOSP's liability
under the facility agreement with the Malaysian Government which in turn negatively impacts our equity in earnings of the unconsolidated investee. An increase in the value of the U.S. dollar relative to foreign currencies could make our solar power products more expensive for international customers, thus potentially leading to a reduction in demand, 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 option and forward contracts to address our exposure to changes in the foreign exchange rate between the U.S. dollar and other currencies. As of October 3, 2010, we had outstanding hedge option contracts and forward contracts with an aggregate n
otional value of $241.5 million and $858.0 million, respectively. As of January 3, 2010, we held option and forward contracts totaling $228.1 million and $466.4 million, respectively, in notional value.
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 revenue, gross margin and profitability as a result of foreign currency fluctuations. For additional details see Note 12 of Notes to our Condensed Consolidated Financial Statements.
Credit Risk
We have certain financial and derivative instruments that subject us to credit risk. These consist primarily of cash and cash equivalents, restricted cash and cash equivalents, investments, accounts receivable, note receivable, advances to suppliers, foreign currency option contracts, foreign currency forward contracts, bond hedge and warrant transactions, purchased options and share lending arrangements for our class A common stock. We are exposed to credit losses in the event of nonperformance by the counterparties to our financial and derivative instruments.
We enter into agreements with vendors that specify future quantities and pricing of polysilicon to be supplied for periods up to 11 years. Under cer
tain agreements, we are required to make prepayments to the vendors over the terms of the arrangements. As of October 3, 2010 and January 3, 2010, advances to suppliers totaled $184.4 million and $190.6 million, respectively. Two suppliers accounted for 75% and 17% of total advances to suppliers as of October 3, 2010, and 76% and 15% of total advances to suppliers as of January 3, 2010.
We enter into foreign currency derivative contracts and convertible debenture hedge transactions with high-quality financial institutions and limit the amount of credit exposure to any one counterparty. The foreign currency derivative contracts are limited to a time period of less than one year. Our bond hedge and warrant transactions intended to reduce the potential cash payments upon conversion of the 4.50% debentures expire in 2015. Our class A common stock purchased options to purchase up to 8.7 million shares of our class A common stock (convertible debenture hedge transactions intended to reduce the potential dilution upon conversion of our 4.75% debentures) expire in 2014. We regularly evaluate the credit standing of our counterparty financial institutions.
In fiscal 2007, we entered into share lending arrangements of our class A common stock with high-quality financial institutions for which we received a nominal lending fee of $0.001 per share. We loaned 2.9 million shares and 1.8 million shares of our class A common stock to LBIE and CSI, respectively. Physical settlement of the shares is required when the arrangement is terminated. However, on September 15, 2008, Lehman filed a petition for protection under Chapter 11 of the U.S. bankruptcy code, and LBIE commenced administration proceedings (analogous to bankruptcy) in the United Kingdom. The Company filed a claim in the LBIE proceeding for $240.9 million and a corresponding claim in the Lehman Chapter 11 proceeding under Lehman's guaranty of LBIE's obligations. For additional details see Notes 8, 10 and 12 of Notes to our
Condensed Consolidated Financial Statements.
Interest Rate Risk
We are exposed to interest rate risk because many of our customers depend on debt financing to purchase our solar power systems. An increase in interest rates could make it difficult for our customers to secure the financing necessary to purchase our solar power systems on favorable terms, or at all, and thus lower demand for our solar power products, reduce revenue and adversely impact our operating results. An increase in interest rates could lower a customer's return on investment in a system or make alternative investments more attractive relative to solar power systems, which, in each case, could cause our customers to seek alternative investments that promise higher returns or demand higher returns from our solar power systems, reduce gross margin and adversely impact our operating results. This risk is significant to our business because our sales model is highly sensitive to interest rate fluctuat
ions and the availability of credit, and would be adversely affected by increases in interest rates or liquidity constraints.
In addition, our investment portfolio consists of a variety of financial instruments that exposes us to interest rate risk including, but not limited to, money market funds and bank notes. These investments are generally classified as available-for-sale and, consequently, are recorded on our balance sheet at fair market value with their related unrealized gain or loss reflected as a component of accumulated other comprehensive loss in stockholders' equity. Due to the relatively short-term nature of our investment portfolio, we do not believe that an immediate 10% increase in interest rates would have a material effect
on the fair market value of our portfolio. Since we believe we have the ability to liquidate substantially all of this portfolio, we do not expect our operating results or cash flows to be materially affected to any significant degree by a sudden change in market interest rates on our investment portfolio.
Minority Investments in Joint Ventures and Other Non-Public Companies
Our investments held in joint ventures and other non-public companies expose us to equity price risk. As of October 3, 2010 and January 3, 2010, investments of $106.9 million and $39.8 million, respectively, are accounted for using the equity method, and $6.4 million and $4.6 million, respectively, are accounted for using the cost method. These strategic investments in third parties are subject to risk of changes in market value, which if determined to be other-than-temporary, could result in realized impairment losses. We generally do not attempt to reduce or eliminate our market exposure in equity and cost method investments. We monitor these investments for impairment and record reductions in the carrying values when necessary. Circumstances that indicate an other-than-temporary decline include valuation ascribed to the issuing company in subsequent financing rounds, decreases in quoted market price and declines in operations of the issuer. There can be no assurance that our equity and cost method investments will not face risks of loss in the future. For additional details see Notes 7 and 9 of Notes to our Condensed Consolidated Financial Statements.
Convertible Debt
The fair market value of our 0.75%, 1.25%, 4.50% and 4.75% convertible debentures is subject to interest rate risk, market price risk and other factors due to the convertible feature of the debentures. The fair market value of the debentures will generally increase as interest rates fall and decrease as interest rates rise. In addition, the fair market value of the debentures will generally increase as the market price of our class A common stock increases and decrease as the market price of our class A common stock falls. The interest and market value changes affect the fair market v
alue of the debentures but do not impact our financial position, cash flows or results of operations due to the fixed nature of the debt obligations except to the extent increases in the value of our class A common stock may provide the holders of our 4.50% debentures, 1.25% debentures and/or 0.75% debentures the right to convert such debentures into cash in certain instances. The aggregate estimated fair value of the 4.75% debentures, 4.50% debentures, 1.25% debentures and 0.75% debentures was $626.7 million as of October 3, 2010 and the aggregate estimated fair value of the 4.75% debentures, 1.25% debentures and 0.75% debentures was $582.8 million as of January 3, 2010, based on quoted market prices as reported by an independent pricing source. A 10% increase in quoted market prices would increase the estimated fair value of our then-outstanding debentures to $689.3 million and $641.1 million as of October 3, 2010 and January 3, 2010, respectively, and a 10% decrease in the quoted market prices would decrease the estimated fair value of our then-outstanding debentures to $564.0 million and $524.5 million as of October 3, 2010 and January 3, 2010, respectively. For additional details see Note 10 of Notes to our Condensed Consolida
ted Financial Statements.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are designed to ensure that information required to be disclosed in reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.
Management of the Company, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures as of October 3, 2010.
As previously disclosed under Item 9A, “Controls and Procedures” in our Annual Report on Form 10-K for the fiscal year ended January 3, 2010, we concluded that our disclosure controls and procedures were not effective at that time based on the following material weaknesses identified in our Philippines operations:
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• | There was not an effective control environment in our Philippines operations. Specif
ically, certain of the Company's employees in the Philippines violated the Company's code of business conduct and ethics. Individuals in the Company's Philippines finance organization intentionally proposed and/or approved journal entries that were not substantiated by actual transactions or costs. |
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• | We did not maintain in the Philippines operations, a sufficient complement of personnel with an appropriate level of accounting knowledge, experience and training to ensure that our controls, and specifically our controls ov
er inventory variance capitalization, were effective. |
These material weaknesses led to misstatements which ultimately resulted in the Company restating its financial statements as of and for the year ended December 28, 2008 and financial data for each of the quarterly periods for the year then ended and for the first three quarterly periods in the year ended January 3, 2010. As described below, management is actively engaged in efforts to remediate these material weaknesses.
Management believes, through the actions described below, that we have remediated the design deficiencies associated with the material weaknesses disclosed in our Annual Report on Form 10-K for the year ended January 3, 2010. However, these controls and procedures have not been tested, nor have they operated for a sufficient period of time to allow us to conclude that they are effective; therefore, we have concluded that our disclosure controls and procedures were ineffective as of October 3, 2010. These controls and procedures will be tested in connection with the preparation of the Company's Annual Report on Form 10-K for the year ended January 2, 2011.
Remedial Effects to Address the Material Weaknesses
To address the two material weaknesses described above, subsequent to January 3, 2010, the following remedial actions have been completed:
Reinforcement of the Company's Code of Business Conduct and Ethics:
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• | During the first, second and third fiscal quarter of 2010, we re-emphasized management's expectations to all accounting and finance employees in our Philippines operations regarding adherence to our policies and ethical business standards; |
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• | During the first and second fiscal quarters of 2010, we developed and implemented additional training programs to increase awareness of our code of business conduct and ethics and “whistle-blower” policies; |
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• | During the third fiscal quarter of 2010, we mandated related training as part of the new employee orientation process for the Philippines accounting and finance staff; and |
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• | We continue to reinforce corporate policies as part of the all-hands meetings and month-end close meetings held with employees of our Philippines operations; |
Resources, Employee Actions and Reporting Relationships
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• | During the first fiscal quarter of 2010, we appointed a new vice president and controller - Asia region; |
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• | During the first fiscal quarter of 2010, we added resources to our corporate finance team to support enhancements for enterprise resource planning systems; |
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p; | During the first and second fiscal quarters of 2010, we terminated employees due to involvement in unethical activities or insufficient qualifications to perform assigned activities; |
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• | During the first and second fiscal quarters of 2010,
we reorganized reporting structures so that accounting employees in the Philippines report directly on a centralized basis to the chief financial officer's organization; |
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• | During the first, second and third fiscal quarters of 2010, we added corporate management presence in the Philippines; |
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• | During the first, second and third fiscal quarters of 2010, we hired additional qualified employees in our Philippines finance organization for key leadership positions; and |
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• | During the first, second and third fiscal quarters of 2010, we segregated duties between the financial planning and accounting functions and added additional layers of accounting review; |
Process Improvements in Philippines
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• | During the first fiscal quarter of 2010, we standardized and documented our process for capitalizing manufacturing variances; |
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• | During the first fiscal quarter of 2010, we added specific reviews for required manual journal entries; |
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• | During the first and second fiscal quarters of 2010, we established a formal proc
ess for certifications and sub-certifications of financial reports; |
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• | During the second fiscal quarter of 2010, we trained responsible employees on the proper method to capitalize manufacturing variances; |
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• | During the third fiscal quarter of 2010, we standardized and documented key accounting policies and job descriptions for all accounting employees; and |
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• | During the third fiscal quarter of 2010, we improved our monthly and quarterly closing processes by enabling functions within our enterprise resource planning system, standardizing reports generated from the system and providing implementation training. |
Our management is committed to maintaining a strong control environment, high ethical standards, and financial reporting integrity throughout the Company, including our Philippines operations. Although management believes that we have remediated the design deficiencies
associated with the material weaknesses described above, there can be no assurance that our testing will confirm that our internal control over financial reporting will be effective as of January 2, 2011, the date as of which management will next report on internal control over financial reporting under Sarbanes-Oxley Section 404. If the remedial measures described do not sufficiently address the material weaknesses, or any additional deficiency that may arise in the future, material misstatements in our interim or annual financial statements may occur in the future.
Further, any system of controls, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the system of controls are or will be met, and no evaluatio
n of controls can provide absolute assurance that all control issues within a company have been detected or will be detected under all potential future conditions.
Changes in Internal Control over Financial Reporting
As described above, there have been changes in our internal control over financial reporting during the quarter ended October 3, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Audit Committee Investigation and Related Litigation
In November 2009, the Audit Committee of our Board of Directors initiated an independent investigation regarding certain unsubstantiated accounting entries. The Audit Committee announced the results of its investigation in March 2010. For information regarding the Audit Committee's investigation, see P
art I - “Item 1: Notes to Condensed Consolidated Financial Statements - Note 1,” “Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations - Restatement of Previously Issued Condensed Consolidated Financial Statements” and our Company's Annual Report on Form 10-K for the year ended January 3, 2010. For a description of the control deficiencies identified by management as a result of the investigation and our internal reviews, and management's plan to remediate those deficiencies, see Part I - “Item 4: Controls and Procedures.”
Three securities class action lawsuits were filed against our Company and certain of our current and former officers and directors in the United States District Court for the Northern District of California on behalf of a class consisting of those who acquired our securities from April 17, 2008 through November 16, 2009. The cases were consolidated as Plichta v. SunPower Corp. et al., Case No. CV-09-5473-RS (N.D. Cal.), and lead plaintiffs and lead counsel were appointed on March 5, 2010. Lead plaintiffs filed a consolidated complaint on May 28, 2010. The actions arise from the Audit Committee's investigation announcement on November 16, 2009. The consolidated complaint alleges that the defendants made material misstatements and omissions concerning our Com
pany's financial results for 2008 and 2009, seeks an unspecified amount of damages, and alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Sections 11 and 15 of the Securities Act of 1933. We believe we have meritorious defenses to these allegations and will vigorously defend ourselves in these matters. The court held a hearing on the defendant's motions to dismiss the consolidated complaint on November 4, 2010, and took the motions under submission. We are currently unable to determine if the resolution of these matters will have an adverse effect on our financial position, liquidity or results of operations.
Derivative actions purporting to be brought on our behalf have also been filed in state and federal courts a
gainst several of our current and former officers and directors based on the same events alleged in the securities class action lawsuits described above. The California state derivative cases were consolidated as In re SunPower Corp. S'holder Derivative Litig., Lead Case No. 1-09-CV-158522 (Santa Clara Sup. Ct.), and co-lead counsel for plaintiffs have been appointed. The complaints assert state-law claims for breach of fiduciary duty, abuse of control, unjust enrichment, gross mismanagement, and waste of corporate assets. Plaintiffs are scheduled to file a consolidated complaint on or before December 3, 2010. The federal derivative complaints were consolidated as In re SunPower Corp. S'holder Derivative Litig., Master File No. CV-09-05731-RS (N.D. Cal.), and lead plaintiffs and co-lead counsel were appointed on January 4, 2010. The complaints assert state-law claims for breach of fiduciary duty, waste of corporate assets, and unjust enrichment, and seek an unspecified amount of damages. We intend to oppose
the derivative plaintiffs' efforts to pursue this litigation on our behalf. We are currently unable to determine if the resolution of these matters will have an adverse effect on our financial position, liquidity or results of operations.
We are also a party to various other litigation matters and claims that arise from time to time in the ordinary course of our business. While we believe that the ultimate outcome of such matters will not have a material adverse effect on our Company, their outcomes are not determinable and negative outcomes may adversely affect our financial position, liquidity or results of operations.
ITEM 1A: RISK FACTORS
In addition
to the other information set forth in this report, you should carefully consider the risk factors discussed in “PART I. Item 1A: Risk Factors” in our Annual Report on Form 10-K for the year ended January 3, 2010, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K and below are not the only risks facing our company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or future results.
In
addition to the other risk factors contained in our Annual Report on Form 10-K, we have updated the following risk factors to reflect changes during the nine months ended October 3, 2010. Certain of the risk factors from our Annual Report on Form 10-K have been updated below to reflect the change in our reporting segments beginning the quarter ended July 4, 2010. The following risk factors should be read in connection with the risk factors discussed in “PART I. Item 1A: Risk Factors” in our Annual Report on Form 10-K.
Risks Related to Our Supply Chain
If third-party manufacturers become unable or unwilling to sell their solar cells and panels to us, our business and results of operations may be materially negatively affected.
We plan to purchase a portion of our total product mix from third-party manufacturers of solar cells and panels. Such products increase our inventory available for sale to customers in some markets. Howev
er, such manufacturers may not be willing to sell solar cells and panels to us at the quantities and on the terms and conditions we require. In addition such manufacturers may be our direct competitors. If they are unable or unwilling to sell to us, we may not have sufficient products available to sell to customers and satisfy our sales commitments, thereby materially and negatively affecting our business and results of operations. In addition, warranty and product liability claims may result from defects or quality issues in connection with third party solar cells and panels that we incorporate into our solar power products. See also “Risks Related to Our Sales Channels-We may incur unexpected warranty and product liability claims that could materially and adversely affect our financial condition and results of operations.”
Risks Related to Our Sales Channels
Our operating results will be subject to fluctuations and are inherently unpredictable.
We do not know if our revenue will grow, or if it will grow sufficiently to outpace our expenses, which we expect to increase as we expand our manufac
turing capacity. For example, in the second fiscal quarter of 2010 we experienced a net loss. We may not be profitable on a quarterly basis. Our quarterly revenue and operating results will be difficult to predict and have in the past fluctuated from quarter to quarter. In particular, revenue in our UPP Segment is difficult to forecast and is susceptible to large fluctuations. The amount, timing and mix of sales in our UPP Segment, often for a single medium or large-scale project, may cause large fluctuations in our revenue and other financial results as, at any given time, our UPP Segment is dependent on large scale projects and often a single project can account for a material portion of our total revenue in a given quarter. Further, our revenue mix of high margin materials sales versus lower margin project sales can fluctuate dramatically from quarter to quarter, which may adversely affect our revenue and financial results in any given period. Any decrease in revenue from our large UPP Segment customers,
whether due to a loss of projects or an inability to collect, could 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. In the event of bankruptcy, our customers may seek to renegotiate the terms of current agreements or renewals. In addition, the failure by any significant customer to pay for orders, whether due to liquidity issues or otherwise, could materially and adversely affect our results of operations. Our inability to execute upon the sale of our projects as planned, or any delay in obtaining the required initial payments to begin recognizing revenue under real estate accounting, and the corresponding revenue impact under the percentage-of-completion method of recognizing revenue, may similarly cause large fluctuations in our revenue and other financial results. Finally, a delayed disposition of a project could require us to recognize a gain on the sale of a
ssets instead of recognizing revenue. Any of the foregoing may cause us to miss any current and future revenue or earnings guidance announced by us and negatively impact liquidity.
We base our planned operating expenses in part on our expectations of future revenue and a significant portion of our expenses is 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 any revenue or earnings guidance announced by us.
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We may incur unexpected warranty and product liability claims that could materially and adversely affect our financial 