form_10-q.htm
 

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________
 
FORM 10-Q
_____________________
 
x
  
 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
     
   
For the quarterly period ended June 29, 2008
     
OR
     
o
  
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ______________ to ______________
 
Commission file number 000-51593

SunPower Corporation
(Exact Name of Registrant as Specified in Its Charter)

Delaware
  
94-3008969
(State or Other Jurisdiction of
  
(I.R.S. Employer
Incorporation or Organization)
  
Identification No.)

3939 North First Street, San Jose, California 95134
(Address of Principal Executive Offices and Zip Code)

(408) 240-5500
(Registrant’s Telephone Number, Including Area Code)
_____________________

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

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

Large Accelerated Filer  x
Accelerated Filer  ¨
Non-accelerated filer  ¨
(Do not check if a smaller reporting company)
Smaller reporting company  ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

The total number of outstanding shares of the registrant’s class A common stock as of August 1, 2008 was 40,542,667.
The total number of outstanding shares of the registrant’s class B common stock as of August 1, 2008 was 44,533,287.

 
 
 
 
 
 
 
SunPower Corporation

INDEX TO FORM 10-Q

   
Page
3
     
Item 1.
3
     
 
3
       
 
4
     
 
5
     
 
6
     
Item 2.
32
     
Item 3.
48
     
Item 4.
49
     
50
       
Item 1.
  
50
       
Item 1A.
  
50
       
Item 4.
  
84
       
Item 6.
  
85
       
   
86
       
87

 
 
- 2 -
 
PART I. FINANCIAL INFORMATION

Item 1.
Financial Statements

SunPower Corporation 
 
Condensed Consolidated Balance Sheets
(In thousands, except share data)
(unaudited)

   
June 29,
2008
    
December 30,
2007
  
Assets
            
Current assets:
            
  Cash and cash equivalents
  
$
189,542
    
$
285,214
  
  Restricted cash, current portion
    
38,322
      
—
  
  Short-term investments
    
37,233
      
105,453
  
  Accounts receivable, net
    
249,459
      
138,250
  
  Costs and estimated earnings in excess of billings
    
50,784
      
39,136
  
  Inventories
    
200,268
      
140,504
  
  Deferred project costs
    
23,067
      
8,316
  
  Advances to suppliers, current portion
    
62,078
      
52,277
  
  Prepaid expenses and other current assets
    
61,044
      
33,110
  
Total current assets
    
911,797
      
802,260
  
Restricted cash, net of current portion
    
45,516
      
67,887
  
Long-term investments 
    
25,086
      
29,050 
  
Property, plant and equipment, net
    
451,969
      
377,994
  
Goodwill
    
195,930
      
184,684
  
Intangible assets, net
    
45,623
      
50,946
  
Advances to suppliers, net of current portion
    
96,400
      
108,943
  
Other long-term assets
    
55,642
      
31,974
  
Total assets
  
$
1,827,963
    
$
1,653,738
  
Liabilities and Stockholders’ Equity
                
Current liabilities:
                
  Accounts payable
  
$
187,847
    
$
119,869
  
  Accounts payable to Cypress
    
5,409
      
4,854
  
  Accrued liabilities
    
101,989
      
79,434
  
  Billings in excess of costs and estimated earnings
    
33,074
      
69,900
  
  Customer advances, current portion
    
15,340
      
9,250
  
  Convertible debt
    
200,000
      
425,000
  
Total current liabilities
    
543,659
      
708,307
  
Convertible debt
    
225,000
      
—
  
Deferred tax liability
    
9,285
      
6,213
  
Customer advances, net of current portion
    
59,665
      
60,153
  
Other long-term liabilities                                                                                      
    
22,176
      
14,975
  
Total liabilities
    
859,785
      
789,648
  
Commitments and Contingencies (Note 8)
                
Stockholders’ Equity:
                
  Preferred stock, $0.001 par value, 10,042,490 shares authorized; none issued and outstanding
    
—
      
—
  
  Common stock, $0.001 par value, 375,000,000 shares authorized: 85,533,004 and 84,803,006 shares issued; 85,365,521 and 84,710,244 shares outstanding, at June 29, 2008 and December 30, 2007, respectively
    
85
      
85
  
  Additional paid-in capital
    
935,028
      
883,033
  
  Accumulated other comprehensive income
    
20,684
      
5,762
  
  Accumulated earnings (deficit)
    
18,550
      
(22,815
)
     
974,347
      
866,065
  
  Less: shares of common stock held in treasury, at cost; 167,483 and 112,762 shares at June 29, 2008 and December 30, 2007, respectively
    
(6,169
)
    
(1,975
)
Total stockholders’ equity
    
968,178
      
864,090
  
Total liabilities and stockholders’ equity
  
$
1,827,963
    
$
1,653,738
  

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

 
 
- 3 -
 
SunPower Corporation
 
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(unaudited)

   
Three Months Ended
    
Six Months Ended
  
   
June 29,
2008
    
July 1,
2007
    
June 29,
2008
    
July 1,
2007
  
Revenue:
                        
  Systems
  
$
270,593
    
$
104,037
    
$
449,444
    
$
182,532
  
  Components
    
112,158
      
69,729
      
207,008
      
133,581
  
    Total revenue
    
382,751
      
173,766
      
656,452
      
316,113
  
Costs and expenses:
                                
  Cost of systems revenue
    
209,137
      
91,518
      
352,350
      
153,984
  
  Cost of components revenue
    
80,584
      
52,456
      
157,752
      
99,912
  
  Research and development
    
4,813
      
2,821
      
9,455
      
5,757
  
  Sales, general and administrative
    
43,208
      
26,109
      
77,066
      
48,480
  
  Purchased in-process research and development
    
—
      
—
      
—
      
9,575
  
  Impairment of acquisition-related intangibles
    
—
      
14,068
      
—
      
14,068
  
    Total costs and expenses
    
337,742
      
186,972
      
596,623
      
331,776
  
      Operating income (loss)
    
45,009
      
(13,206
)
    
59,829
      
(15,663
)
Other income (expense):
                                
  Interest income
    
2,289
      
2,196
      
6,436
      
4,180
  
  Interest expense
    
(1,411
)
    
(1,085
)
    
(2,875
)
    
(2,204
)
  Other, net
    
(2,240
)
    
(517
)
    
(1,953
) 
    
(243
) 
    Other income (expense), net
    
(1,362
)
    
594
      
1,608
      
1,733
  
Income (loss) before income taxes
    
43,647
      
(12,612
)
    
61,437
      
(13,930
)
  Income tax provision (benefit)
    
15,039
      
(7,267
)
    
20,072
      
(9,825
) 
Net income (loss)
  
$
28,608
    
$
(5,345
)
  
$
41,365
    
$
(4,105
) 
Net income (loss) per share:
                                
  Basic
  
$
0.36
    
$
(0.07
)
  
$
0.52
    
$
(0.06
) 
  Diluted
  
$
0.34
    
$
(0.07
)
  
$
0.49
    
$
(0.06
) 
Weighted-average shares:
                                
  Basic
    
79,412
      
75,123
      
79,188
      
74,428
  
  Diluted
    
84,036
      
75,123
      
83,848
      
74,428
  
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

 
 
- 4 -
 
SunPower Corporation
 
Condensed Consolidated Statements of Cash Flows
(In thousands)
(unaudited)

   
Six Months Ended
  
   
June 29,
2008
    
July 1,
2007
Note 1
  
Cash flows from operating activities:
              
 Net income (loss)
  
$
41,365
    
$
(4,105
) 
 Adjustments to reconcile net income (loss) to net cash used in operating activities:
                
  Depreciation
    
21,971
      
11,486
  
  Impairment of long-lived assets
    
5,489
      
—
  
  Amortization of intangible assets
    
8,351
      
14,551
  
  Impairment of acquisition-related intangibles
    
—
      
14,068
  
  Amortization of debt issuance costs
    
972
      
479
  
  Stock-based compensation
    
33,115
      
23,833
  
  Purchased in-process research and development
    
—
      
9,575
  
  Share in net income of joint venture
    
(1,874
)
    
—
  
  Excess tax benefits from stock-based award activity
    
(14,639
)
    
—
  
  Deferred income taxes and other tax liabilities
    
20,734
      
(10,568
) 
  Changes in operating assets and liabilities, net of effect of acquisitions:
                
     Accounts receivable
    
(103,132
)
    
(215
) 
     Costs and estimated earnings in excess of billings
    
(10,144
)
    
(14,323
) 
     Inventories
    
(53,048
)
    
(49,438
)
     Prepaid expenses and other assets
    
(25,032
)
    
(3,893
) 
     Deferred project costs
    
(14,751
) 
    
990
  
     Advances to suppliers
    
3,641
      
(15,586
)
     Accounts payable and other accrued liabilities
    
81,811
      
17,910
  
     Accounts payable to Cypress
    
555
      
2,993
  
     Billings in excess of costs and estimated earnings
    
(38,886
)
    
11,503
  
     Customer advances
    
4,130
      
(10,163
)
        Net cash used in operating activities
    
(39,372
)
    
(903
)
Cash flows from investing activities:
                
 Decrease (increase) in restricted cash
    
(15,951
)
    
4,711
  
 Purchases of property, plant and equipment
    
(95,078
)
    
(107,585
)
 Purchases of available-for-sale securities
    
(50,970
)
    
(25,555
) 
 Proceeds from sales or maturities of available-for-sale securities
    
121,921
      
16,496
  
 Cash paid for acquisition, net of cash acquired
    
(13,484
)
    
(98,645)
  
 Cash paid for investments in joint ventures and other private companies
    
(22,625
)
    
—
  
        Net cash used in investing activities
    
(76,187
)
    
(210,578
)
Cash flows from financing activities:
                
 Proceeds from exercises of stock options
    
2,335
      
4,969
  
 Excess tax benefits from stock-based award activity
    
14,639
      
—
  
 Purchases of stock for tax withholding obligations on vested restricted stock
    
(4,194
)
    
—
  
 Proceeds from issuance of convertible debt
    
—
      
200,000
  
 Convertible debt issuance costs
    
—
      
(6,030
) 
 Principal payments on line of credit and notes payable
    
—
      
(3,563
) 
        Net cash provided by financing activities
    
12,780
      
195,376
  
        Effect of exchange rate changes on cash and cash equivalents
    
7,107
      
861
  
        Net decrease in cash and cash equivalents
    
(95,672
)
    
(15,244
) 
Cash and cash equivalents at beginning of period
    
285,214
      
165,596
  
Cash and cash equivalents at end of period
  
$
189,542
    
$
150,352
  
                 
Non-cash transactions:
                
  Additions to property, plant and equipment acquired under accounts payable and other accrued liabilities
  
$
3,838
    
$ 
3,741
  
  Change in goodwill relating to adjustments to acquired net assets
    
231
      
1,689
  
  Issuance of common stock for purchase acquisition
    
—
      
111,266
  
  Stock options assumed in relation to acquisition
    
—
      
21,280
  
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

 
- 5 -
 
SunPower Corporation
 
Notes to Condensed Consolidated Financial Statements
(unaudited)

Note 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
The Company
 
SunPower Corporation (together with its subsidiaries, the “Company” or “SunPower”), a majority-owned subsidiary of Cypress Semiconductor Corporation (“Cypress”), was originally incorporated in the State of California on April 24, 1985. In October 1988, the Company organized as a business venture to commercialize high-efficiency solar cell technologies. The Company designs, manufactures and markets high-performance solar electric power technologies. The Company’s solar cells and solar panels are manufactured using proprietary processes and technologies based on more than 15 years of research and development. The Company’s solar power products are sold through its components and systems business segments. 

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

In November 2005, the Company raised net proceeds of $145.6 million in an initial public offering (the “IPO”) of 8.8 million shares of class A common stock at a price of $18.00 per share. In June 2006, the Company completed a follow-on public offering of 7.0 million shares of its class A common stock, at a per share price of $29.50, and received net proceeds of $197.4 million. In July 2007, the Company completed a follow-on public offering of 2.7 million shares of its class A common stock, at a discounted per share price of $64.50, and received net proceeds of $167.4 million.
 
In February 2007, the Company issued $200.0 million in principal amount of its 1.25% senior convertible debentures to Lehman Brothers Inc. (“Lehman Brothers”) and lent 2.9 million shares of its class A common stock to an affiliate of Lehman Brothers. Net proceeds from the issuance of senior convertible debentures in February 2007 were $194.0 million. The Company did not receive any proceeds from the 2.9 million lent shares of its class A common stock, but received a nominal lending fee (see Note 10). In July 2007, the Company issued $225.0 million in principal amount of its 0.75% senior convertible debentures to Credit Suisse Securities (USA) LLC (“Credit Suisse”) and lent 1.8 million shares of its class A common stock to an affiliate of Credit Suisse. Net proceeds from the issuance of senior convertible debentures in July 2007 were $220.1 million. The Company did not receive any proceeds from the 1.8 million lent shares of class A common stock, but received a nominal lending fee (see Note 10).
 
In January 2007, the Company completed the acquisition of PowerLight Corporation (“PowerLight”), a privately-held company which developed, engineered, manufactured and delivered large-scale solar power systems for residential, commercial, government and utility customers worldwide. These activities are now performed by the Company’s systems business segment. As a result of the acquisition, PowerLight became an indirect wholly-owned subsidiary of the Company. In June 2007, the Company changed PowerLight’s name to SunPower Corporation, Systems (“SP Systems”), to capitalize on SunPower’s name recognition.
 
Cypress made a significant investment in the Company in 2002. On November 9, 2004, Cypress completed a reverse triangular merger with the Company in which all of the outstanding minority equity interest of SunPower was retired, effectively giving Cypress 100% ownership of all of the Company’s then outstanding shares of capital stock but leaving its unexercised warrants and options outstanding. After completion of the Company’s IPO in November 2005, Cypress held, in the aggregate, approximately 52.0 million shares of class B common stock. On May 4, 2007, Cypress completed the sale of 7.5 million shares of the Company’s class B common stock in an offering pursuant to Rule 144 of the Securities Act. Such shares converted to 7.5 million shares of class A common stock upon the sale. As of June 29, 2008, Cypress owned approximately 44.5 million shares of the Company’s class B common stock, which represented approximately 55% of the total outstanding shares of the Company’s common stock, or approximately 52% of such shares on a fully diluted basis after taking into account outstanding stock options (or 49% of such shares on a fully diluted basis after taking into account outstanding stock options and shares loaned to underwriters of the Company’s convertible indebtedness), and 90% of the voting power of the Company’s total outstanding common stock.
 
The condensed consolidated financial statements include purchases of goods and services from Cypress, including wafers, employee benefits and other Cypress corporate services and infrastructure costs. The expenses allocations have been determined based on a method that Cypress and the Company consider to be a reasonable reflection of the utilization of services provided or the benefit received by the Company. See Note 2 for additional information on the transactions with Cypress.

- 6 -
 
The Company is subject to a number of risks and uncertainties including, but not limited to, an industry-wide shortage of polysilicon, potential downward pressure on product pricing as new polysilicon manufacturers begin operating and the worldwide supply of solar cells and panels increases, the possible reduction or elimination of government and economic incentives that encourage industry growth, the challenges of achieving our goal to reduce costs of installed solar systems by 50% by 2012 to maintain competitiveness, the continued availability of third-party financing for the Company’s customers, difficulties in maintaining or increasing the Company’s growth rate and managing such growth, and accurately predicting warranty claims.
 
Summary of Significant Accounting Policies
 
Fiscal Years
 
The Company reports on a fiscal-year basis and ends its quarters on the Sunday closest to the end of the applicable calendar quarter, except in a 53-week fiscal year, in which case the additional week falls into the fourth quarter of that fiscal year. Both fiscal 2008 and 2007 consist of 52 weeks. The second quarter of fiscal 2008 ended on June 29, 2008 and the second quarter of fiscal 2007 ended on July 1, 2007.

Basis of Presentation

The accompanying condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. The year-end Condensed Consolidated Balance Sheets data was derived from audited financial statements. Accordingly, these financial statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 30, 2007.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant estimates in these financial statements include the “percentage-of-completion” revenue recognition method for construction projects, allowances for doubtful accounts receivable and sales returns, inventory write-downs, estimates for future cash flows and economic useful lives of property, plant and equipment, asset impairments, valuation of auction rate securities, certain accrued liabilities including accrued warranty reserves and income taxes and tax valuation allowances. Actual results could differ from those estimates.

In the opinion of management, the accompanying condensed consolidated financial statements contain all adjustments, consisting only of normal recurring adjustments, which the Company believes are necessary for a fair statement of the Company’s financial position as of June 29, 2008 and its results of operations for the three and six months ended June 29, 2008 and July 1, 2007 and its cash flows for the six months ended June 29, 2008 and July 1, 2007. These condensed consolidated financial statements are not necessarily indicative of the results to be expected for the entire year.
 
Recent Accounting Pronouncements
  
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles in the United States ("U.S. GAAP"), and expands disclosures about fair value instruments. This statement does not require any new fair value measurements; rather, it applies other accounting pronouncements that require or permit fair value measurements. The provisions of this statement are to be applied prospectively at the beginning of the fiscal year in which this statement is initially applied, with any transition adjustment recognized as a cumulative effect adjustment to the opening balance of retained earnings. The provisions of SFAS No. 157 were effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB released FASB Staff Position FAS 157-b—Effective Date of FASB Statement No. 157, delaying the effective date of SFAS No. 157 for one year for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The Company does not presently hold any financial assets or financial liabilities that would require recognition under SFAS No. 157 other than available-for-sale investments and foreign currency derivatives. With the exception of investments and foreign currency derivatives held, this deferral makes SFAS No. 157 effective for the Company beginning in the first quarter of fiscal 2009. The adoption of the relevant provisions under SFAS No. 157 in the first quarter of fiscal 2008 did not have a material impact on the Company’s financial position or results of operations (see Note 5). The Company is currently evaluating the potential impact, if any, of the adoption of SFAS No. 157 on measurement of fair value of its nonfinancial assets, including goodwill, and nonfinancial liabilities.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”), which provides companies an option to report selected financial assets and liabilities at fair value. SFAS No. 159 requires companies to provide information helping financial statement users to understand the effect of a company’s choice to use fair value on its earnings, as well as to display the fair value of the assets and liabilities a company has chosen to use fair value
 
- 7 -
 
for on the face of the balance sheet. Additionally, SFAS No. 159 establishes presentation and disclosure requirements designed to simplify comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The statement was effective for fiscal years beginning after November 15, 2007 and was adopted by the Company in the first quarter of fiscal 2008. The Company did not elect the fair value option for any of its financial assets or liabilities, and therefore, the adoption of SFAS No. 159 had no impact on the Company’s consolidated financial position, results of operations or cash flows.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141(R)”), which replaces SFAS No. 141, "Business Combinations" ("SFAS No. 141"). SFAS No. 141(R) will significantly change the accounting for business combinations in a number of areas including the treatment of contingent consideration, contingencies, acquisition costs, in-process research and development and restructuring costs. In addition, under SFAS No. 141(R), changes in deferred tax asset valuation allowances and acquired income tax uncertainties in a business combination after the measurement period will impact income tax expense. SFAS No. 141(R) is effective for fiscal years beginning after December 15, 2008 and will be adopted by the Company for any purchase business combinations consummated subsequent to December 28, 2008. 
 
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of Accounting Research Bulletin No. 51” (“SFAS No. 160”), which will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. This new consolidation method will significantly change the accounting for transactions with minority interest holders. SFAS No. 160 is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the potential impact, if any, of the adoption of SFAS No. 160 on its financial position and results of operations.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of SFAS No. 133” (“SFAS No. 161”), which expands the disclosure requirements for derivative instruments and hedging activities. SFAS No. 161 specifically requires entities to provide enhanced disclosures addressing the following: (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS No. 161 is effective for fiscal years and interim periods beginning after November 15, 2008. The Company is currently evaluating the potential impact, if any, of the adoption of SFAS No. 161 on its financial position, results of operations and disclosures.

In April 2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3, “Determination of Useful Life of Intangible Assets” (“FSP FAS 142-3”), which amends the factors that should be considered in developing the renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS 142, “Goodwill and Other Intangible Assets.” FSP FAS 142-3 also requires expanded disclosure related to the determination of intangible asset useful lives. FSP FAS 142-3 is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the potential impact, if any, of the adoption of FSP FAS 142-3 on its financial position and results of operations. 

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS No. 162”), which identifies the sources of accounting principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with U.S. GAAP. This Statement is effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.” The Company currently adheres to the hierarchy of U.S. GAAP as presented in SFAS No. 162, and does not expect its adoption will have a material impact on its financial position, results of operations and disclosures.

In May 2008, the FASB issued FSP APB 14-1, which clarifies the accounting for convertible debt instruments that may be settled in cash upon conversion. FSP APB 14-1 significantly impacts the accounting for instruments commonly referred to as Instruments B, Instruments C and Instruments X from Emerging Issue Task Force (“EITF”) Issue No. 90-19, “Convertible Bonds with Issuer Option to Settle for Cash upon Conversion,” and any other convertible debt instruments that allow settlement in any combination of cash and shares at the issuer’s option. The new guidance requires the issuer to separately account for the liability and equity components of the instrument in a manner that reflects interest expense equal to the issuer’s non-convertible debt borrowing rate. FSP APB 14-1 is effective for fiscal years and interim periods beginning after December 15, 2008, and retrospective application will be required for all periods presented. The new guidance may have a significant impact on the Company’s outstanding convertible debt balance of $425.0 million, potentially resulting in significantly higher non-cash interest expense on our convertible debt (see Note 10). The Company is currently evaluating the potential impact of the new guidance on its results of operations and financial condition.

Revision of Statement of Cash Flow Presentation Related to Purchases of Property, Plant and Equipment
 
The Company has corrected its Condensed Consolidated Statements of Cash Flows for the six months ended July 1, 2007 to exclude the impact of purchases of property, plant and equipment that remain unpaid and as such are included in “accounts payable and other accrued liabilities” at the end of the reporting period. Historically, changes in “accounts payable and other
 
- 8 -
 
accrued liabilities” related to such purchases were included in cash flows from operations, while the investing activity caption "Purchase of property, plant and equipment" included these purchases. As these unpaid purchases do not reflect cash transactions, the Company has revised its cash flow presentations to exclude them. The correction resulted in a decrease to the previously reported amount of cash used for operating activities of $3.7 million in the six months ended July 1, 2007, resulting from a reduction in the amount of cash used from the change in accounts payable and other accrued liabilities in that period. The corresponding correction in the investing section was to increase cash used for investing activities by $3.7 million in the six months ended July 1, 2007, as a result of the increase in the amount of cash used for purchases of property, plant and equipment in that period. These corrections had no impact on previously reported results of operations, working capital or stockholders’ equity of the Company. The Company concluded that these corrections were not material to any of its previously issued condensed consolidated financial statements, based on SEC Staff Accounting Bulletin No. 99-Materiality.
 
Note 2. TRANSACTIONS WITH CYPRESS
 
Purchases of Imaging and Infrared Detector Products from Cypress
 
The Company purchased fabricated semiconductor wafers from Cypress at intercompany prices consistent with Cypress’ internal transfer pricing methodology. In December 2007, Cypress announced the planned closure of its Texas wafer fabrication facility that manufactured the Company’s imaging and infrared detector products. The planned closure is expected to be completed in the fourth quarter of fiscal 2008. The Company evaluated its alternatives relating to the future plans for this business and decided to wind-down its activities related to the imaging detector product line in the first quarter of fiscal 2008. Accordingly, in the three-months ended March 30, 2008, cost of revenue included a $2.2 million impairment charge to long-lived assets primarily related to manufacturing equipment located in the Texas wafer fabrication facility. The Company did not purchase wafers from Cypress in the three months ended June 29, 2008. Wafer purchases totaled $0.6 million for the six months ended June 29, 2008 and $1.6 million and $3.1 million for the three and six months ended July 1, 2007, respectively.

Administrative Services Provided by Cypress
 
Cypress has seconded employees and consultants to the Company for different time periods for which the Company pays their fully-burdened compensation. In addition, Cypress personnel render services to the Company to assist with administrative functions such as employee benefits and other Cypress corporate services and infrastructure. Cypress bills the Company for a portion of the Cypress employees’ fully-burdened compensation. In the case of the Philippines subsidiary, which entered into a services agreement for such secondments and other consulting services in January 2005, the Company pays the fully burdened compensation plus 10%. The amounts that the Company has recorded as general and administrative expenses in the accompanying statements of operations for these services was approximately $1.6 million and $2.1 million for the three and six months ended June 29, 2008, respectively, and $0.4 million and $0.8 million for the three and six months ended July 1, 2007, respectively.

Leased Facility in the Philippines
 
In 2003, the Company and Cypress reached an understanding that the Company would build out and occupy a building owned by Cypress for its solar cell manufacturing facility in the Philippines. The Company entered into a lease agreement for this facility and a sublease for the land under which the Company paid Cypress at a rate equal to the cost to Cypress for that facility (including taxes, insurance, repairs and improvements). Under the lease agreement, the Company had the right to purchase the facility and assume the lease for the land from Cypress at any time at Cypress’ original purchase price of approximately $8.0 million, plus interest computed on a variable index starting on the date of purchase by Cypress until the sale to the Company, unless such purchase option was exercised after a change of control of the Company, in which case the purchase price would be at a market rate, as reasonably determined by Cypress. Rent expense paid to Cypress for this building and land was not material for the three months ended June 29, 2008 and July 1, 2007. Rent expense paid to Cypress for this building and land was approximately $0.1 million in each of the six months ended June 29, 2008 and July 1, 2007. In May 2008, the Company exercised its right to purchase the facility from Cypress and assumed the lease for the land from an unaffiliated third party for a total purchase price of $9.5 million. The lease for the land expires in May 2048 and is renewable for an additional 25 years.

Leased Headquarters Facility in San Jose, California
 
In May 2006, the Company entered into a lease agreement for its 43,732 square foot headquarters, which is located in a building owned by Cypress in San Jose, California, for $6.0 million over the five-year term of the lease. In December 2006 and July 2007, the Company amended the lease agreement, increasing the rentable square footage and the total lease obligations to 51,228 and $6.9 million, respectively, over the five-year term of the lease. In the event Cypress decides to sell the building, the Company has the right of first refusal to purchase the building at a fair market price which will be based on comparable sales in the area. Rent expense paid to Cypress for this facility was approximately $0.4 million and $0.7 million for the three and six months ended June 29, 2008, respectively, and $0.3 million and $0.6 million for the three and six months ended July 1, 2007, respectively.
 
- 9 -
 
2005 Separation and Service Agreements
 
In October 2005, the Company entered into a series of separation and services agreements with Cypress. Among these agreements are a master separation agreement, a sublease of the land and a lease for the building in the Philippines (see above); a three-year wafer manufacturing agreement for detector products at inter-company pricing; a three-year master transition services agreement under which Cypress would allow the Company to continue to utilize services provided by Cypress such as corporate accounting, legal, tax, information technology, human resources and treasury administration at Cypress’ cost; an asset lease under which Cypress leased certain manufacturing assets from the Company; an employee matters agreement under which the Company’s employees would be allowed to continue to participate in certain Cypress health insurance and other employee benefits plans; an indemnification and insurance matters agreement; an investor rights agreement; and a tax sharing agreement. All of these agreements, except the tax sharing agreement and the manufacturing asset lease agreement, became effective at the time of completion of the Company’s IPO in November 2005. Since the Company’s IPO, the Company has hired and continues to hire additional personnel to perform services previously provided by Cypress in preparation of the expiration of the three-year master transition services agreement.

Master Separation Agreement
 
In October 2005, the Company entered into a master separation agreement containing the framework with respect to the Company’s separation from Cypress. The master separation agreement provides for the execution of various ancillary agreements that further specify the terms of the separation.
 
Master Transition Services Agreement
 
The Company has also entered into a master transition services agreement which would govern the provisions of services provided by Cypress, such as: financial services; human resources; legal matters; training programs; and information technology.

For a period of three years following the Company’s November 2005 IPO or earlier if a change of control of the Company occurs, Cypress would provide these services and the Company would pay Cypress for services provided to the Company, at Cypress’ cost (which, for purposes of the master transition services agreement, will mean an appropriate allocation of Cypress’ full salary and benefits costs associated with such individuals as well as any out-of-pocket expenses that Cypress incurs in connection with providing the Company those services) or at the rate negotiated with Cypress. Cypress will have the ability to deny requests for services under this agreement if, among other things, the provisions of such services creates a conflict of interest, causes an adverse consequence to Cypress, requires Cypress to retain additional employees or other resources or the provision of such services become impracticable as a result or cause outside of the control of Cypress. In addition, Cypress will incur no liability in connection with the provision of these services. The master transition services agreement also contains provides indemnities by the Company for the benefit of Cypress.
 
Lease for Manufacturing Assets
 
In 2005 the Company entered into a lease with Cypress under which Cypress leased from the Company certain manufacturing assets owned by the Company and located in Cypress’ Texas manufacturing facility. The term of the lease was 27 months, and it expired on December 31, 2007. Under this lease, Cypress reimbursed the Company approximately $0.7 million representing the net book value of the assets divided by the life of the leasehold improvements.
 
Employee Matters Agreement
 
In October 2005, the Company entered into an employee matters agreement with Cypress to allocate assets, liabilities and responsibilities relating to its current and former U.S. and international employees and its participation in the employee benefits plans that Cypress currently sponsors and maintains.
 
The Company’s eligible employees generally will remain able to participate in Cypress’ benefit plans, as they may change from time to time. The Company will be responsible for all liabilities incurred with respect to the Cypress plans by the Company as a participating company in such plans. The Company intends to have its own benefit plans established by the time its employees are no longer eligible to participate in Cypress’ benefit plans. Once the Company has established its own benefit plans, the Company will have the ability to modify or terminate each plan in accordance with the terms of those plans and its policies. It is the Company’s intent that employees not receive duplicate benefits as a result of participation in its benefit plans and the corresponding Cypress benefit plans.
 
All of the Company’s eligible employees will be able to continue to participate in Cypress’ health plans, life insurance and other benefit plans as they may change from time to time, until the earliest of, (1) a change of control of the Company occurs, which includes such time as Cypress ceases to own at least a majority of the aggregate number of shares of all classes of our common stock then outstanding, (2) such time as the Company’s status as a participating company under the Cypress plans is not permitted by a Cypress plan or by applicable law, (3) such time as Cypress determines in its reasonable judgment that its status as
 
- 10 -
 
a participating company under the Cypress plans has or will adversely affect Cypress, or its employees, directors, officers, agents, affiliates or its representatives, or (4) such earlier date as the Company and Cypress mutually agree. The Company’s employees are precluded from participating in Cypress’ stock option plans and stock purchase plans.
 
In July 2008, the Company transferred all accounts in the Cypress 401(k) Plan held by the Company’s employees to its recently established SunPower 401(k) Savings Plan.
 
Indemnification and Insurance Matters Agreement
 
The Company will indemnify Cypress and its affiliates, agents, successors and assigns from all liabilities arising from environmental conditions: existing on, under, about or in the vicinity of any of the Company’s facilities, or arising out of operations occurring at any of the Company’s facilities, including its California facilities, whether prior to or after the separation; existing on, under, about or in the vicinity of the Philippines facility which the Company occupies, or arising out of operations occurring at such facility, whether prior to or after the separation, to the extent that those liabilities were caused by the Company; arising out of hazardous materials found on, under or about any landfill, waste, storage, transfer or recycling site and resulting from hazardous materials stored, treated, recycled, disposed or otherwise handled by any of the Company’s operations or the Company’s California and Philippines facilities prior to the separation; and arising out of the construction activity conducted by or on behalf of us at Cypress’ Texas facility.
 
The indemnification and insurance matters agreement and the master transition services agreement also contains provisions governing the Company’s insurance coverage, which shall be under the Cypress insurance policies (other than our directors and officers insurance and insurance for our systems segment business, for which the Company intends to obtain its own separate policies) until the earliest of (1) a change of control of the Company occurs, which includes such time as Cypress ceases to own at least a majority of the aggregate number of shares of all classes of the Company’s common stock then outstanding, (2) the date on which Cypress’ insurance carriers do not permit the Company to remain on Cypress policies, (3) the date on which Cypress’ cost of insurance under any particular insurance policy increases, directly or indirectly, due to the Company's inclusion or participation in such policy, (4) the date on which the Company's coverage under the Cypress policies causes a real or potential conflict of interest or hardship for Cypress, as determined solely by Cypress or (5) the date on which Cypress and the Company mutually agree to terminate this arrangement. Prior to that time, Cypress will maintain insurance policies on the Company’s behalf, and the Company shall reimburse Cypress for expenses related to insurance coverage during this period. The Company will work with Cypress to secure additional insurance if desired and cost effective.
 
Investor Rights Agreement
 
The Company has entered into an investor rights agreement with Cypress providing for specified (1) registration and other rights relating to the Company’s shares of the Company’s common stock, (2) information and inspection rights, (3) coordination of auditing practices and (4) approval rights with respect to certain transactions.
 
Tax Sharing Agreement
 
The Company has entered into a tax sharing agreement with Cypress providing for each of the party’s obligations concerning various tax liabilities. The tax sharing agreement is structured such that Cypress will pay all federal, state, local and foreign taxes that are calculated on a consolidated or combined basis (while being a member of Cypress’ consolidated or combined group pursuant to federal, state, local and foreign tax law). The Company’s portion of such tax liability or benefit will be determined based upon its separate return tax liability as defined under the tax sharing agreement. Such liability or benefit will be based on a pro forma calculation as if the Company were filing a separate income tax return in each jurisdiction, rather than on a combined or consolidated basis with Cypress subject to adjustments as set forth in the tax sharing agreement.
 
After the date the Company ceases to be a member of Cypress’ consolidated group for federal income tax purposes and most state income tax purposes, as and to the extent that the Company becomes entitled to utilize on the Company’s separate tax returns portions of those credit or loss carryforwards existing as of such date, the Company will distribute to Cypress the tax effect, estimated to be 40% for federal income tax purposes, of the amount of such tax loss carryforwards so utilized, and the amount of any credit carryforwards so utilized. The Company will distribute these amounts to Cypress in cash or in the Company’s shares, at the Company’s option. As of December 30, 2007, the Company has $44.0 million of federal net operating loss carryforwards and approximately $73.5 million of California net operating loss carryforwards meaning that such potential future payments to Cypress, which would be made over a period of several years, would therefore aggregate approximately $19.1 million.
 
The majority of these net operating loss carryforwards were created by employee stock transactions. Because there is uncertainty as to the realizability of these loss carryforwards, the portion created by employee stock transactions are not reflected on the Company’s Condensed Consolidated Balance Sheets.
 
- 11 -
    
    Upon completion of its follow-on public offering of common stock in June 2006, the Company is no longer considered to be a member of Cypress’ consolidated group for federal income tax purposes. Accordingly, the Company will be subject to the obligations payable to Cypress for any federal income tax credit or loss carryforwards utilized in its federal tax returns in subsequent periods, as explained in the preceding paragraph.
 
The Company will continue to be jointly and severally liable for any tax liability as governed under federal, state and local law during all periods in which it is deemed to be a member of the Cypress consolidated or combined group. Accordingly, although the tax sharing agreement allocates tax liabilities between Cypress and all its consolidated subsidiaries, for any period in which the Company is included in Cypress’ consolidated group, the Company could be liable in the event that any federal tax liability was incurred, but not discharged, by any other member of the group.
 
Subject to certain caveats, Cypress has obtained a ruling from the Internal Revenue Service (“IRS”) to the effect that a distribution by Cypress of the Company’s class B common stock to Cypress stockholders will qualify as a tax-free distribution under Section 355 of the Internal Revenue Code (the “Code”). Despite such ruling, the distribution may nonetheless be taxable to Cypress under Section 355(e) of the Code if 50% or more of the Company’s voting power or economic value is acquired as part of a plan or series of related transactions that includes the distribution of the Company’s stock. The tax sharing agreement includes the Company’s obligation to indemnify Cypress for any liability incurred as a result of issuances or dispositions of the Company’s stock after the distribution, other than liability attributable to certain dispositions of the Company’s stock by Cypress, that cause Cypress’ distribution of shares of the Company’s stock to its stockholders to be taxable to Cypress under Section 355(e) of the Code.
 
    The tax sharing agreement further provides for cooperation with respect to tax matters, the exchange of information and the retention of records which may affect the income tax liability of either party. Disputes arising between Cypress and the Company relating to matters covered by the tax sharing agreement are subject to resolution through specific dispute resolution provisions contained in the agreement.
 
Note 3. BUSINESS COMBINATION, GOODWILL AND INTANGIBLE ASSETS

Business Combination

On January 8, 2008, the Company completed the acquisition of Solar Solutions, a solar systems integration and product distribution company based in Faenza, Italy. Solar Solutions was a division of Combigas S.r.l., a petroleum products trading firm. Active since 2002, Solar Solutions distributes components such as solar panels and inverters, and offers turnkey solar power systems and standard system kits via a network of dealers throughout Italy. Prior to the acquisition, Solar Solutions had been a customer of the Company since fiscal 2006. As a result of the acquisition, Solar Solutions became a wholly-owned subsidiary of the Company. In connection with the acquisition, the Company changed Solar Solutions’ name to SunPower Italia S.r.l. (“SunPower Italia”). The acquisition of SunPower Italia was not material to the Company’s financial position or results of operations.

Goodwill

The following table presents the changes in the carrying amount of goodwill under the Company's reportable business segments:

(In thousands)
  
Components
Business Segment
    
Systems
Business Segment
    
Total
  
As of December 30, 2007
  
$
2,883
    
$
181,801
    
$
184,684
  
Goodwill acquired
    
10,284
      
—
      
10,284
  
Adjustments
    
962
      
—
      
962
  
As of June 29, 2008
  
$
14,129
    
$
181,801
    
$
195,930
  
 
Changes to goodwill during the six months ended June 29, 2008 resulted from the acquisition of SunPower Italia. Approximately $10.3 million had been allocated to goodwill within the components segment, which represents the excess of the purchase price over the fair value of the underlying net tangible and intangible assets of SunPower Italia. SunPower Italia is a Euro functional currency subsidiary, therefore, the Company records a translation adjustment for the revaluation of the subsidiary’s goodwill and intangible assets into U.S. dollar. As of June 29, 2008, the cumulative translation adjustment increased the balance of goodwill by $0.8 million. Also during the six months ended June 29, 2008, the Company recorded an adjustment to increase goodwill by $0.2 million to adjust the value of acquired investments.

- 12 -
 
In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” (“SFAS No. 142”), goodwill will not be amortized but instead will be tested for impairment at least annually, or more frequently if certain indicators are present. The Company conducts its annual impairment test of goodwill as of the Sunday closest to the end of the third calendar quarter of each year. Based on its last impairment test as of September 30, 2007, the Company determined there was no impairment. There were no events or circumstances from that date through June 29, 2008 indicating that an interim assessment was necessary. In the event that management determines that the value of goodwill has become impaired, the Company will incur an accounting charge for the amount of the impairment during the fiscal quarter in which the determination is made.

Intangible Assets

The following tables present details of the Company's acquired identifiable intangible assets:

(In thousands)
  
Gross
    
Accumulated
Amortization
    
Net
  
As of June 29, 2008
                  
 Patents and purchased technology
  
$
51,398
    
$
(25,976
)
  
$
25,422
  
 Tradenames
    
2,215
      
(1,244
)
    
971
  
 Backlog
    
11,787
      
(11,787
)
    
—
  
 Customer relationships and other
    
25,612
      
(6,382
)
    
19,230
  
   
$
91,012
    
$
(45,389
)
  
$
45,623
  
                         
As of December 30, 2007
                        
 Patents and purchased technology
  
$
51,398
    
$
(20,630
)
  
$
30,768
  
 Tradenames
    
1,603
      
(808
)
    
795
  
 Backlog
    
11,787
      
(11,460
)
    
327
  
 Customer relationships and other
    
23,193
      
(4,137
)
    
19,056
  
   
$
87,981
    
$
(37,035
)
  
$
50,946
  
 
In connection with the acquisition of SunPower Italia, the Company recorded $2.7 million of intangible assets and $0.2 million of cumulative translation adjustment for acquired intangibles in the six months ended June 29, 2008. In connection with the acquisition of SP Systems, the Company recorded $79.5 million of intangible assets in the first quarter of fiscal 2007, of which $15.5 million was related to the PowerLight tradename. The determination of the fair value and useful life of the tradename was based on the Company’s strategy of continuing to market its systems products and services under the PowerLight brand. Based on the Company’s change in branding strategy and changing PowerLight’s name to SunPower Corporation, Systems, during the quarter ended July 1, 2007, the Company recognized an impairment charge of $14.1 million, which represented the net book value of the PowerLight tradename.

All of our acquired identifiable intangible assets are subject to amortization. Aggregate amortization expense for intangible assets totaled $4.0 million and $8.4 million for the three and six months ended June 29, 2008, respectively, and $7.7 million and $14.6 million for the three and six months ended July 1, 2007, respectively. As of June 29, 2008, the estimated future amortization expense related to intangible assets is as follows (in thousands):

2008 (remaining six months)
  
$
8,041
  
2009
  
15,461
  
2010
  
13,948
  
2011
  
4,152
  
2012
  
3,916
  
Thereafter
  
105
  
   
$
45,623
  

- 13 -

Note 4. BALANCE SHEET COMPONENTS
 
  (In thousands)
  
June 29,
2008
    
December 30,
2007
  
Costs and estimated earnings in excess of billings on contracts in progress and billings in excess of costs and estimated earnings on contracts in progress consists of the following:
            
   Costs and estimated earnings in excess of billings on contracts in progress
  
$
50,784
    
$
39,136
  
   Billings in excess of costs and estimated earnings on contracts in progress
    
33,074
      
69,900
  
   
$
17,710
    
$
(30,764
) 
Contracts in progress: 
                
   Costs incurred to date
  
$
824,289
    
$
481,340
  
   Estimated earnings to date
    
269,201
      
145,643
  
   Contract revenue earned to date
    
1,093,490
      
626,983
  
   Less: Billings to date, including earned incentive rebates
    
(1,075,780
) 
    
(657,747
) 
   
$
17,710
    
$
(30,764
)
Inventories:
                
   Raw materials(1)
  
$
98,534
    
$
89,604
  
   Work-in-process
    
3,972
      
2,027
  
   Finished goods
    
97,762
      
48,873
  
   
$
200,268
    
$
140,504
  
(1) In addition to polysilicon and other raw materials for solar cell manufacturing, raw materials includes solar panels purchased from third-party vendors and installation materials for systems projects.
                
                 
Prepaid expenses and other current assets:
                
   VAT receivables, current portion
  
$
25,308
    
$
7,266
  
   Deferred tax assets, current portion
    
8,438
      
8,437
  
   Other receivables
    
16,458
      
9,946
  
   Other prepaid expenses
    
10,840
      
7,461
  
   
$
61,044
    
$
33,110
  
Property, plant and equipment, net:
                
   Land and buildings
  
$
8,923
    
$
7,482
  
   Manufacturing equipment
    
237,457
      
194,963
  
   Manufacturing equipment held for sale(2)
    
768
      
—
  
   Computer equipment
    
14,676
      
12,399
  
   Furniture and fixtures
    
3,920
      
2,648
  
   Leasehold improvements
    
130,425
      
113,801
  
   Construction-in-process (manufacturing facility in the Philippines)
    
127,178
      
99,945
  
     
523,347
      
431,238
  
   Less: Accumulated depreciation(3)
    
(71,378
)
    
(53,244
)
   
$
451,969
    
$
377,994
  
 
 
  (In thousands)
  
June 29,
2008
    
December 30,
2007
  
(2) During the three months ended March 30, 2008, certain manufacturing equipment with a net book value of $4.1 million were replaced with new processes. The Company determined that the expected realizable value for the resale of such manufacturing equipment is $0.8 million, therefore, the Company incurred an impairment charge of $3.3 million in the first quarter of fiscal 2008.
                
(3) Total depreciation expense was $11.9 million and $22.0 million for the three and six months ended June 29, 2008, respectively, and $5.9 million and $11.5 million for the three and six months ended July 1, 2007, respectively.
                
                 
Other long-term assets:
                
   VAT receivable, net of current portion
  
$
15,422
    
$
24,269
  
   Investments in joint ventures
    
14,803
      
5,304
  
   Note receivable(4)
    
10,000
      
—
  
   Other
    
15,417
      
2,401
  
   
$
55,642
    
$
31,974
  
(4) In June 2008, the Company loaned $10.0 million to a third-party private company pursuant to a three-year interest-bearing note receivable that is convertible into equity at the Company’s option.
                
                 
Accrued liabilities:
                
   VAT payables
  
$
28,592
    
$
18,138
  
   Employee compensation and employee benefits
    
14,858
      
15,338
  
   Income taxes payable
    
15,316
      
11,106
  
   Warranty reserves
    
13,393
      
10,502
  
   Foreign exchange derivative liability
    
11,261
      
8,920
  
   Other
    
18,569
      
15,430
  
   
$
101,989
    
$
79,434
  

Note 5. INVESTMENTS

On December 31, 2007, the Company adopted SFAS No. 157, which refines the definition of fair value, provides a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy assigns the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities ("Level 1") and the lowest priority to unobservable inputs ("Level 3"). Level 2 measurements are inputs that are observable for assets or liabilities, either directly or indirectly, other than quoted prices included within Level 1. The following table presents information about the Company’s available-for-sale securities measured at fair value on a recurring basis as of June 29, 2008 and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value in accordance with the provisions of SFAS No. 157:

  (In thousands)
  
Quoted Prices in Active
 Markets for Identical
Instruments
(Level 1)
    
Significant Other
Observable Inputs
(Level 2)
    
Significant
Unobservable Inputs
(Level 3)
    
Balance as of
June 29, 2008
  
Asset
                                
  Money market funds
  
$
160,108
    
$
—
    
$
—
    
$
160,108
  
  Corporate securities
    
—
      
33,244
      
25,086
      
58,330
  
  Commercial paper
    
—
      
23,989
      
—
      
23,989
  
    Total available-for-sale securities
  
$
160,108
    
$
57,233
    
$
25,086
     $
242,427
  

Available-for-sale securities utilizing Level 3 inputs to determine fair value are comprised of auction rate securities which are bought and sold in the marketplace through a bidding process sometimes referred to as a “Dutch auction,” and which are classified as short-term investments or long-term investments and carried at their market values. After the initial issuance of the auction rate securities, the interest rate on the securities resets periodically, at intervals set at the time of issuance (e.g., every seven, twenty-eight, or thirty-five days; every six-months; etc.), based on the market demand at the reset period. The “stated” or
 
- 15 -
 
“contractual” maturities for these securities generally are between 20 to 30 years. The Company classifies auction rate securities as available-for-sale securities under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS No. 115”).
 
At June 29, 2008, the Company had $25.1 million invested in auction rate securities as compared to $50.8 million invested in auction rate securities at December 30, 2007. These auction rate securities are typically over collateralized and secured by pools of student loans originated under the Federal Family Education Loan Program (“FFELP”) that are guaranteed by the U.S. Department of Education, and insured. In addition, all auction rate securities held are rated by one or more of the Nationally Recognized Statistical Rating Organizations (“NRSRO”) as triple-A. Beginning in February 2008, the auction rate securities market experienced a significant increase in the number of failed auctions, resulting from a lack of liquidity, which occurs when sell orders exceed buy orders, and does not necessarily signify a default by the issuer.
 
As of August 8, 2008, all of the Company’s auction rate securities invested in at June 29, 2008 had failed to clear at auctions. For failed auctions, the Company continues to earn interest on these investments at the maximum contractual rate as the issuer is obligated under contractual terms to pay penalty rates should auctions fail. Historically, failed auctions have rarely occurred, however, such failures could continue to occur in the future. In the event the Company needs to access these funds, the Company will not be able to do so until a future auction is successful, the issuer redeems the securities, a buyer is found outside of the auction process or the securities mature. Accordingly, auction rate securities at June 29, 2008 and December 30, 2007 that were not sold in a subsequent period totaling $25.1 million and $29.1 million, respectively, are classified as long-term investments on the Condensed Consolidated Balance Sheets, because they are not expected to be used to fund current operations and consistent with the stated contractual maturities of the securities.
 
The Company determined that use of a valuation model was the best available technique for measuring the fair value of its auction rate securities. The Company used an income approach valuation model to estimate the price that would be received to sell its securities in an orderly transaction between market participants ("exit price") as of June 29, 2008. The exit price was derived as the weighted average present value of expected cash flows over various periods of illiquidity, using a risk adjusted discount rate that was based on the credit risk and liquidity risk of the securities.  While the valuation model was based on both Level 2 (credit quality and interest rates) and Level 3 inputs, the Company determined that the Level 3 inputs were the most significant to the overall fair value measurement, particularly the estimates of risk adjusted discount rates and ranges of expected periods of illiquidity. The valuation model also reflected the Company's intention to hold its auction rate securities until they can be liquidated in a market that facilitates orderly transactions. The following key assumptions were used in the valuation model:
 
·           5 years to liquidity;
·           continued receipt of contractual interest which provides a premium spread for failed auctions; and
·           discount rates ranging from 3.8% to 5.9%, which incorporate a spread for both credit and liquidity risk.

Based on these assumptions, the Company estimated that the auction rate securities would be valued at approximately 96% of their stated par value, representing a decline in value of approximately $1.0 million. The following table provides a summary of changes in fair value of the Company’s available-for-sale securities utilizing Level 3 inputs as of June 29, 2008:
 

  (In thousands)
  
Auction Rate Securities
  
         
Balance at December 31, 2007
  
$
     —
  
  Transfers from Level 2 to Level 3
    
29,050
  
  Purchases of auction rate securities
    
10,000
  
  Unrealized loss included in other comprehensive income
    
(1,445
)
 Balance at March 30, 2008
    
37,605
  
  Sales of auction rate securities
    
(13,000
)
  Unrealized gain included in other comprehensive income
    
481
  
 Balance at June 29, 2008
  
$
25,086
  
 
    In the second quarter of fiscal 2008, the Company sold auction rate securities with a carrying value of $12.5 million for their stated par value of $13.0 million. The
 
- 16 -
 
following table summarizes the fair value and gross unrealized losses of the Company’s available-for-sale securities, aggregated by type of investment instrument and length of time that individual securities have been in a continuous unrealized loss position:
 
   
As of June 29, 2008
  
   
Less than 12 Months
    
12 Months or Greater
    
Total
  
  (In thousands)
  
Fair Value
    
Gross Unrealized Losses
    
Fair Value
    
Gross Unrealized Losses
    
Fair Value
    
Gross Unrealized Losses
  
Corporate securities
  
$
48,283
    
$
(1,054
)
  
$
—
    
$
—
    
$
48,283
    
$
(1,054
) 

   
As of December 30, 2007
  
   
Less than 12 Months
    
12 Months or Greater
    
Total
  
  (In thousands)
  
Fair Value
    
Gross Unrealized Losses
    
Fair Value
    
Gross Unrealized Losses
    
Fair Value
    
Gross Unrealized Losses
  
Corporate securities
  
$
25,536
    
$
(50
)
  
$
—
    
$
—
    
$
25,536
    
$
(50
)
Commercial paper
    
24,002
      
(2
)
    
—
      
—
      
24,002
      
(2
) 
   
$
49,538
    
$
(52
)
  
$
—
    
$
—
    
$
49,538
    
$
(52
) 
 
    Of the $1.1 million gross unrealized losses of the Company’s corporate securities, $1.0 million resulted from the decline in the estimated fair value of auction rate securities primarily due to their lack of liquidity. The decline in fair value for the remaining available-for-sale securities was primarily related to changes in interest rates. The Company has concluded that no other-than-temporary impairment losses occurred in the six months ended June 29, 2008 because the lack of liquidity in the market for auction rate securities and changes in interest rates are considered temporary in nature for which the Company has recorded an unrealized loss within comprehensive income (loss), a component of stockholders' equity. The Company has the ability and intent to hold these securities until a recovery of fair value. In addition, the Company evaluated the near-term prospects of the available-for-sale securities in relation to the severity and duration of the impairment. Based on that evaluation and the Company’s ability and intent to hold these investments for a reasonable period of time, the Company did not consider these investments to be other-than-temporarily impaired. If it is determined that the fair value of these securities is other-than-temporarily impaired, the Company would record a loss in its Condensed Consolidated Statements of Operations in the future, which could be material.
 
    The classification and contractual maturities of available-for-sale securities is as follows:
 
  (In thousands)
  
June 29, 
2008
    
December 30, 
2007
  
Included in:
            
 Cash equivalents
  
$
96,270
    
$
249,582
  
 Short-term restricted cash(1)
    
38,322
      
—
  
 Short-term investments
    
37,233
      
105,453
  
 Long-term restricted cash(1)
    
45,516
      
67,887
  
 Long-term investments
    
25,086
      
29,050
  
   
$
242,427
    
$
451,972
  
Contractual maturities:
                
 Due in less than one year
  
$
171,826
    
$
396,228
  
 Due from one to two years (2)
    
2,382
      
4,994
  
 Due from two to 30 years
    
68,219
      
50,750
  
   
$
242,427
    
$
451,972
  
(1)
The Company provided security in the form of cash collateralized bank standby letters of credit for advance payments received from customers.
(2)
The Company classifies all available-for-sale securities that are intended to be available for use in current operations as short-term investments.

- 17 -
 
Note 6. ADVANCES TO SUPPLIERS

The Company has entered into agreements with various polysilicon, ingot, wafer, solar cells and solar module vendors and manufacturers. These agreements specify future quantities and pricing of products to be supplied by the vendors for periods up to 12 years. Certain agreements also provide for penalties or forfeiture of advanced deposits in the event the Company terminates the arrangements (see Note 8). Under certain of these agreements, the Company is required to make prepayments to the vendors over the terms of the arrangements. As of June 29, 2008, advances to suppliers totaled $158.5 million, the current portion of which is $62.1 million.

The Company’s future prepayment obligations related to these agreements as of June 29, 2008 are as follows (in thousands):
 
2008 (remaining six months)
  
$ 
56,040
  
2009
  
78,006
  
2010
  
59,642
  
2011
  
19,792
  
   
$
213,480
  

On June 30, 2008, the Company paid an advance of $5.6 million in accordance with the terms of an existing supply agreement.
 
Note 7. STOCK-BASED COMPENSATION
 
    During the preparation of its condensed consolidated financial statements for the six months ended June 29, 2008, the Company identified errors in its financial statements related to the year ended December 30, 2007, which resulted in $1.3 million overstatement of stock-based compensation expense. The Company corrected these errors in its condensed consolidated financial statements for the six months ended June 29, 2008, which resulted in a $1.3 million credit to income before income taxes and net income. The out-of-period effect is not expected to be material to estimated full-year 2008 results, and, accordingly has been recognized in accordance with APB 28, Interim Financial Reporting, paragraph 29 as the error is not material to any financial statements of prior periods.
 
The following table summarizes the consolidated stock-based compensation expense, by type of awards:
 
   
Three Months Ended
    
Six Months Ended
  
(In thousands)
  
June 29,
2008
    
July 1,
2007
    
June 29,
2008
    
July 1,
2007
  
Employee stock options
  
$
1,014
    
$
4,847
    
$
2,201
    
$
9,593
  
Restricted stock
    
10,229
      
3,266
      
18,130
      
4,520
  
Shares and options released from re-vesting restrictions
    
7,627
      
5,306
      
13,633
      
10,028
  
Change in stock-based compensation capitalized in inventory
    
(263
)
    
(189
)
    
(849
)
    
(308
)
 Total stock-based compensation expense
  
$
18,607
    
$
13,230
    
$
33,115
    
$
23,833
  

In connection with the acquisition of SP Systems on January 10, 2007, 1.1 million shares of the Company’s class A common stock and 0.5 million stock options issued to employees of SP Systems, which were valued at $60.4 million, are subject to certain transfer restrictions and a repurchase option held by the Company. The Company is recognizing expense as the re-vesting restrictions of these shares lapse over the two-year period beginning on the date of acquisition. The value of shares released from such re-vesting restrictions are included in stock-based compensation expense in the table above.

The following table summarizes the consolidated stock-based compensation expense by line items in the Condensed Consolidated Statements of Operations:
 
   
Three Months Ended
    
Six Months Ended
  
(In thousands)
  
June 29,
2008
    
July 1,
2007
    
June 29,
2008
    
July 1,
2007
  
Cost of systems revenue
  
$
2,239
    
$
2,189
    
$
4,750
    
$
4,186
  
Cost of components revenue
    
2,890
      
1,009
      
4,093
      
1,262
  
Research and development
    
972
      
348
      
1,783
      
849
  
Sales, general and administrative
    
12,506
      
9,684
      
22,489
      
17,536
  
 Total stock-based compensation expense before income taxes
    
18,607
      
13,230
      
33,115
      
23,833
  
    Tax effect on stock-based compensation expense
    
—
      
—
      
—
      
—
  
 Total stock-based compensation expense after income taxes
  
$
18,607
    
$
13,230
    
$
33,115
    
$
23,833
  

- 18 -
 
Consolidated net cash proceeds from the issuance of shares in connection with exercises of stock options under the Company’s employee stock plans were $1.2 million and $2.3 million for the three and six months ended June 29, 2008, respectively, and $3.0 million and $5.0 million for the three and six months ended July 1, 2007, respectively. The Company recognized an income tax benefit from stock option exercises of $10.2 million and $14.6 million for the three and six months ended June 29, 2008, respectively. No income tax benefit was realized from stock option exercises during the three and six months ended July 1, 2007. As required, the Company presents excess tax benefits from the exercise of stock options, if any, as financing cash flows rather than operating cash flows.
 
The following table summarizes the unrecognized stock-based compensation cost by type of awards:
 
(In thousands, except years)
  
As of
June 29,
2008
    
Weighted-Average
Amortization Period
(in years)
  
Stock options
  
$
10,365
      
2.7
  
Restricted stock
    
103,227
      
3.0
  
Shares subject to re-vesting restrictions
    
15,423
      
0.5
  
 Total unrecognized stock-based compensation cost
  
$
129,015
          
 
For stock options issued prior to the adoption of SFAS No. 123(revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”) and for performance based awards, the Company recognizes its stock-based compensation cost using the graded amortization method. For all other awards, stock-based compensation cost is recognized on a straight-line basis. Additionally, the Company issues new shares upon exercises of options by employees.
 
Valuation Assumptions
 
The Company estimates the fair value of its stock-based awards using the Black-Scholes valuation model (the "Black-Scholes model"). The determination of fair value of share-based payment awards on the date of grant using the Black-Scholes model is affected by the stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors.
 
Assumptions used in the determination of fair value of share-based payment awards using the Black-Scholes model were as follows:
 
 
Three Months Ended
  
Six Months Ended
  
 
July 1, 2007
  
July 1, 2007
  
Stock Option Plans:
            
  Expected term
  
6.5 years
    
6.5 years
  
  Risk-free interest rate
    
4.56%
      
4.62%
  
  Volatility
    
90%
      
70.3%
  
  Dividend yield
    
0%
      
0%
  
                 
No stock options were granted in the six months ended June 29, 2008.
                

For the Three and Six Months Ended July 1, 2007:
 
The Company utilized the simplified method under the provisions of Staff Accounting Bulletin No. 107 (“SAB No. 107”) for estimating expected term, instead of its historical exercise data. The Company elected not to base the expected term on historical data because of the significant difference in its status before and after the effective date of SFAS No. 123(R). The Company was a privately-held company until its IPO, and the only available liquidation event for option holders was Cypress’s buyout of minority interests in November 2004. At all other times, optionees could not cash out on their vested options. From the time of the Company’s IPO in November 2005 through May 2006 when lock-up restrictions expired, a majority of the optionees were unable to exercise and sell vested options.
 
Because of the limited history of its stock trading publicly, the Company does not believe that its historical volatility would be representative of the expected volatility for its equity awards. Accordingly, the Company has chosen to use the historical volatility rates for a publicly-traded U.S.-based direct competitor as the basis for calculating the volatility for its granted options.
 
The interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. Since the Company does not pay and does not expect to pay dividends, the expected dividend yield is zero.
 
- 19 -
 
Equity Incentive Programs
 
Second Amended and Restated 2005 SunPower Corporation Stock Incentive Plan:
 
    In May 2008, the Company’s stockholders approved an increase of 1.7 million shares and an automatic annual increase beginning in fiscal 2009 in the number of shares available for grant under the Company’s Second Amended and Restated 2005 SunPower Corporation Stock Incentive Plan under which the Company may issue incentive or non-statutory stock options, restricted stock awards, restricted stock units, or stock appreciation rights to directors, employees and consultants. The majority of shares issued are net of the minimum statutory withholding requirements that the Company pays on behalf of its employees. During the three and six months ended June 29, 2008, the Company withheld approximately 15,000 shares and 52,000 shares, respectively, to satisfy $0.9 million and $4.2 million, respectively, of employees’ tax obligations. The Company paid this amount in cash to the appropriate taxing authorities. Shares withheld are treated as common stock repurchases for accounting and disclosure purposes and reduce the number of shares outstanding upon vesting.
 
    The following table summarizes the Company’s stock option activities:
 
   
Shares
(in thousands)
    
Weighted-
Average
Exercise
Price Per Share
  
Outstanding as of December 30, 2007
    
3,701
    
$
5.44
  
 Granted
    
—
      
—
  
 Exercised
    
(703
)
    
3.32
  
 Forfeited
    
(32
)
    
7.86
  
Outstanding as of June 29, 2008
    
2,966
      
5.92
  
Exercisable as of June 29, 2008
    
1,329
      
4.22
  
 
    The following table summarizes the Company’s non-vested stock options and restricted stock activities thereafter:
 
   
Stock Options
    
Restricted Stock Awards and Units
  
   
Shares
(in thousands)
    
Weighted-
Average
Exercise Price
Per Share
    
Shares
(in thousands)
    
Weighted-
Average
Grant Date Fair
Value Per Share
  
Outstanding as of December 30, 2007
    
2,454
    
$
6.29
      
1,174
    
$
68.74
  
 Granted
    
—
      
—
      
579
      
79.48
  
 Vested(1)
    
(786
)
    
4.13
      
(195
)
    
56.33
  
 Forfeited
    
(31
)
    
7.45
      
(30
)
    
79.70
  
Outstanding as of June 29, 2008
    
1,637
      
7.30
      
1,528
      
78.58
  
                                 
(1) Restricted stock awards and units vested includes shares withheld on behalf of employees to satisfy the minimum statutory tax withholding requirements.
  
 
- 20 -
 
    Information regarding the Company’s outstanding stock options as of June 29, 2008 follows:
 
 
Options Outstanding
  
  Options Exercisable
Range of Exercise Price
Shares 
(in thousands)
Weighted-
Average
Remaining
Contractual
Life
(in years)
Weighted-
Average
Exercise
Price per
Share
  
Aggregate
Intrinsic
Value 
(in thousands)
  
Shares 
(in thousands)
Weighted-
Average
Remaining
Contractual
Life
(in years)
Weighted-
Average
Exercise
Price per
Share
  
Aggregate
Intrinsic
Value
(in thousands)
$
  0.04—
0.75
465
3.64
$
0.31
  
$
33,667
  
260
4.61
$
0.49
  
$
18,801
 
  0.88—
2.66
191
6.40
  
2.09
  
13,487
  
58
6.04
  
1.99
  
4,084
 
  3.30—
4.95
1,661
6.37
  
3.33
  
115,258
  
851
6.40
  
3.32
  
59,089
 
  7.00—
16.20
327
7.17
  
8.51
  
21,011
  
100
7.18
  
8.75
  
6,401
 
17.00—
62.51
322
8.02
  
27.03
  
14,711
  
60
7.93
  
27.84
  
2,680
   
2,966
        
$
198,134
  
1,329
        
$
91,055
 
The aggregate intrinsic value in the preceding table represents the total pre-tax intrinsic value, based on the Company’s closing stock price of $72.71 at June 29, 2008, which would have been received by the option holders had all option holders exercised their options as of that date. The total number of in-the-money options exercisable was 1.3 million shares as of June 29, 2008.
 
Stock Unit Plan:
 
As of June 29, 2008, the Company has granted approximately 236,000 stock units to 2,200 employees in the Philippines at an average unit price of $39.80 in relation to its 2005 Stock Unit Plan, under which participants are awarded the right to receive cash payments from the Company in an amount equal to the appreciation in the Company’s common stock between the award date and the date the employee redeems the award. A maximum of 300,000 stock units may be subject to stock unit awards granted under the 2005 Stock Unit Plan. Pursuant to a voluntary exchange offer that concluded in November 2007, approximately 53,000 stock units were exchanged for approximately 32,000 restricted stock units issued under the Company’s Second Amended and Restated 2005 SunPower Corporation Stock Incentive Plan. The Company conducted a second voluntary exchange offer that concluded in May 2008, in which approximately 109,000 stock units were exchanged for approximately 50,000 restricted stock units issued under the Company’s Second Amended and Restated 2005 SunPower Corporation Stock Incentive Plan.  For the three and six months ended June 29, 2008, total compensation expense associated with the 2005 Stock Unit Plan was zero as compared to $0.4 million and $0.8 million in the three and six months ended July 1, 2007, respectively.
 
Note 8. COMMITMENTS AND CONTINGENCIES
 
Operating Lease Commitments
 
The Company leases its San Jose, California facility under a non-cancelable operating lease from Cypress, which expires in April 2011 (see Note 2). The lease requires the Company to pay property taxes, insurance and certain other costs. In addition, the Company leases its Richmond, California facility under a non-cancelable operating lease from an unaffiliated third party, which expires in September 2018. In December 2005, the Company entered into a 5-year operating lease from an unaffiliated third party for a solar panel assembly facility in the Philippines. The Company also has various lease arrangements, including its European headquarters located in Geneva, Switzerland under a lease that expires in September 2012, as well as sales and support offices in Southern California, New Jersey, Germany, Spain, Italy and South Korea, all of which are leased from unaffiliated third parties. Future minimum obligations under all non-cancelable operating leases as of June 29, 2008 are as follows (in thousands):

2008 (remaining six months)
  
$
2,547
  
2009
    
5,144
  
2010
    
4,839
  
2011
    
3,547
  
2012
    
3,140
  
Thereafter
    
24,651
  
   
$
43,868
  
 
- 21 -
 
Rent expense, including the rent paid to Cypress for the San Jose, California facility and the solar cell manufacturing facility in the Philippines (see Note 2), was $1.6 million and $3.5 million for the three and six months ended June 29, 2008, respectively, and $0.8 million and $1.4 million for the three and six months ended July 1, 2007, respectively.

Purchase Commitments
 
The Company purchases raw materials for inventory, services and manufacturing equipment from a variety of vendors. During the normal course of business, in order to manage manufacturing lead times and help assure adequate supply, the Company enters into agreements with contract manufacturers and suppliers that either allow them to procure goods and services based upon specifications defined by the Company, or that establish parameters defining the Company’s requirements. In certain instances, these agreements allow the Company the option to cancel, reschedule or adjust the Company’s requirements based on its business needs prior to firm orders being placed. Consequently, only a portion of the Company’s recorded purchase commitments arising from these agreements are firm, non-cancelable and unconditional commitments.
 
The Company also has agreements with several suppliers, including joint ventures, for the procurement of polysilicon, ingots, wafers, solar cells and solar panels which specify future quantities and pricing of products to be supplied by the vendors for periods up to 12 years and provide for certain consequences, such as forfeiture of advanced deposits and liquidated damages relating to previous purchases, in the event that the Company terminates the arrangements (see Note 6).
 
At June 29, 2008, total obligations related to such supplier agreements was $3.5 billion and non-cancelable purchase orders related to equipment and building improvements totaled approximately $155.2 million. In addition, the Company has entered into agreements to purchase solar renewable energy certificates (“SRECs”) from solar installation owners in New Jersey. The Company primarily sells SRECs to entities that must either retire a certain volume of SRECs each year or face much higher alternative compliance payments. At June 29, 2008, total obligations related to future purchases of SRECs was $2.7 million.
 
Future minimum obligations under supplier agreements, non-cancelable purchase orders and SRECs as of June 29, 2008 are as follows (in thousands):
 
2008 (remaining six months)
  
$
302,461
  
2009
    
431,894
  
2010
    
534,751
  
2011
    
543,726
  
2012
    
344,639
  
Thereafter
    
1,532,215
  
   
$
3,689,686
  
 
 Joint Ventures