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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
 
FORM 10-Q
 
T
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended October 3, 2010
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 001-34166
SunPower Corporation
(Exact Name of Registrant as Specified in Its Charter)
 
Delaware
 
94-3008969
 
 
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer 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  T    No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  T    No  o
 
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 o
Non-accelerated filer o
Smaller reporting company o
 
 
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  o    No  T
 
The total number of outstanding shares of the registrant's class A common stock as of November 5, 2010 was 55,863,951.
The total number of outstanding shares of the registrant's class B common stock as of November 5, 2010 was 42,033,287.

SunPower Corporation
 
INDEX TO FORM 10-Q
 
 
Page
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 6.
 
 
 
 
 
 
 
 

2

Index

PART I. FINANCIAL INFORMATION
 
Item 1.         Financial Statements
SunPower Corporation
 
Condensed Consolidated Balance Sheets
(In thousands, except share data)
(unaudited)
 
October 3, 2010
 
January 3, 2010 (1)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
281,212
 
 
$
615,879
 
Restricted cash and cash equivalents, current portion
37,209
 
 
61,868
 
Short-term investments
172
 
 
172
 
Accounts receivable, net
265,832
 
 
248,833
 
Costs and estimated earnings in excess of billings
114,093
 
 
26,062
 
Inventories
285,805
 
 
202,301
 
Advances to suppliers, current portion
26,422
 
 
22,785
 
Project assets - plants and land, current portion
162,935
 
 
6,010
 
Prepaid expenses and other current assets
236,647
 
 
98,521
 
Total current assets
1,410,327
 
 
1,282,431
 
 
 
 
 
Restricted cash and cash equivalents, net of current portion
119,323
 
 
248,790
 
Property, plant and equipment, net
589,690
 
 
682,344
 
Project assets - plants and land, net of current portion
19,328
 
 
9,607
 
Goodwill
344,861
 
 
198,163
 
Other intangible assets, net
77,222
 
 
24,974
 
Advances to suppliers, net of current portion
157,934
 
 
167,843
 
Other long-term assets
190,058
 
 
82,743
 
Total assets
$
2,908,743
 
 
$
2,696,895
 
 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Accounts payable
$
373,166
 
 
$
234,692
 
Accrued liabilities
238,905
 
 
114,008
 
Billings in excess of costs and estimated earnings
16,451
 
 
17,346
 
Short-term debt and current portion of long-term debt
 
 
11,250
 
Convertible debt, current portion
 
 
137,968
 
Customer advances, current portion
17,213
 
 
19,832
 
Total current liabilities
645,735
 
 
535,096
 
 
 
 
 
Long-term debt
 
 
237,703
 
Convertible debt, net of current portion
585,343
 
 
398,606
 
Customer advances, net of current portion
66,070
 
 
72,288
 
Long-term deferred taxes
11,927
 
 
6,777
 
Other long-term liabilities
171,170
 
 
70,045
 
Total liabilities
1,480,245
 
 
1,320,515
 
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, 150,000,000 shares of class B common stock authorized; 42,033,287 shares of class B common stock issued and outstanding; $0.001 par value, 217,500,000 shares of class A common stock authorized; 56,324,062 and 55,394,612 shares of class A common stock issued; 55,815,427 and 55,039,193 shares of class A common stock outstanding, at October 3, 2010 and January 3, 2010, respectively
98
 
 
97
 
Additional paid-in capital
1,561,312
 
 
1,520,933
 
Accumulated deficit
(87,836
)
 
(114,309
)
Accumulated other comprehensive loss
(29,553
)
 
(17,357
)
Treasury stock, at cost; 508,635 and 355,419 shares of class A stock at October 3, 2010 and January 3, 2010, respectively
(15,523
)
 
(12,984
)
Total stockholders' equity
1,428,498
 
 
1,376,380
 
Total liabilities and stockholders' equity
$
2,908,743
 
 
$
2,696,895
 
 
(1) As adjusted to reflect the adoption of new accounting guidance for share lending arrangements that were executed in connection with the Company's convertible debt offerings in fiscal 2007 (see Note 1).
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

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Index

SunPower Corporation
 
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(unaudited)
 
Three Months Ended
 
Nine Months Ended
 
October 3, 2010
 
September 27, 2009 (1)
 
October 3, 2010
 
September 27, 2009
Revenue:
 
 
 
 
 
 
 
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
 
Cost of revenue:
 
 
 
 
 
 
 
Utility and power plants
212,526
 
 
142,999
 
 
421,178
 
 
353,611
 
Residential and commercial
225,534
 
 
222,532
 
 
588,800
 
 
449,991
 
Total cost of revenue
438,060
 
 
365,531
 
 
1,009,978
 
 
803,602
 
Gross margin
112,585
 
 
99,830
 
 
272,179
 
 
172,743
 
Operating expenses:
 
 
 
 
 
 
 
Research and development
13,382
 
 
8,250
 
 
34,995
 
 
23,067
 
Sales, general and administrative
91,015
 
 
45,332
 
 
233,671
 
 
130,511
 
Total operating costs
104,397
 
 
53,582
 
 
268,666
 
 
153,578
 
Operating income
8,188
 
 
46,248
 
 
3,513
 
 
19,165
 
Other income (expense):
 
 
 
 
 
 
 
Interest income
742
 
 
 
 
1,294
 
 
1,949
 
Interest expense
(14,768
)
 
(9,992
)
 
(45,018
)
 
(26,026
)
Gain on deconsolidation of consolidated subsidiary
36,849
 
 
 
 
36,849
 
 
 
Gain on change in equity interest in unconsolidated investee
 
 
 
 
28,348
 
 
 
Gain (loss) on mark-to-market derivatives
(2,967
)
 
 
 
28,885
 
 
21,193
 
Other, net
(11,947
)
 
585
 
 
(28,344
)
 
(3,765
)
Other income (expense), net
7,909
 
 
(9,407
)
 
22,014
 
 
(6,649
)
Income from continuing operations before income taxes and equity in earnings of unconsolidated investees
16,097
 
 
36,841
 
 
25,527
 
 
12,516
 
Benefit from (provision for) income taxes
(3,376
)
 
(19,962
)
 
(19,493
)
 
4,457
 
Equity in earnings of unconsolidated investees
5,825
 
 
2,627
 
 
10,973
 
 
7,005
 
Income from continuing operations
18,546
 
 
19,506
 
 
17,007
 
 
23,978
 
Income from discontinued operations, net of taxes
1,570
 
 
 
 
9,466
 
 
 
Net income
$
20,116
 
 
$
19,506
 
 
$
26,473
 
 
$
23,978
 
Net income per share of class A and class B common stock:
 
 
 
 
 
 
 
Net income per share - basic:
 
 
 
 
 
 
 
Continuing operations
$
0.19
 
 
$
0.21
 
 
$
0.18
 
 
$
0.27
 
Discontinued operations
0.02
 
 
 
 
0.10
 
 
 
Net income per share - basic
$
0.21
 
 
$
0.21
 
 
$
0.28
 
 
$
0.27
 
Net income per share - diluted:
 
 
 
 
 
 
 
Continuing operations
$
0.19
 
 
$
0.20
 
 
$
0.18
 
 
$
0.26
 
Discontinued operations
0.02
 
 
 
 
0.09
 
 
 
Net income per share - diluted
$
0.21
 
 
$
0.20
 
 
$
0.27
 
 
$
0.26
 
Weighted-average shares:
 
 
 
 
 
 
 
Basic
95,840
 
 
94,668
 
 
95,519
 
 
89,764
 
Diluted (2)
105,648
 
 
105,031
 
 
96,741
 
 
91,513
 
 
(1)    
The Condensed Consolidated Statements of Operations for the three and nine months ended September 27, 2009 has been adjusted to reflect the adoption of new accounting guidance for share lending arrangements that were executed in connection with the Company's convertible debt offerings in fiscal 2007 (see Note 1).
(2)    
See Note 14 for the calculation of diluted net income per share under the if-converted method.
 
The accompanying notes are an integral part of these condensed consolidated financial statements.
 

4

Index

SunPower Corporation
Condensed Consolidated Statements of Cash Flows
(In thousands)
(unaudited)
 
Nine Months Ended
 
October 3, 2010
 
September 27, 2009 (1)
Cash flows from operating activities:
 
 
 
Net income
$
26,473
 
 
$
23,978
 
Less: Income from discontinued operations, net of taxes
9,466
 
 
 
Income from continuing operations
17,007
 
 
23,978
 
Adjustments to reconcile income from continuing operations to net cash provided by (used in) operating activities of continuing operations:
 
 
 
 
Stock-based compensation
38,064
 
 
34,204
 
Depreciation
75,680
 
 
60,348
 
Amortization of other intangible assets
28,039
 
 
12,296
 
Impairment (gain on sale) of investments
(1,572
)
 
1,997
 
Gain on mark-to-market derivatives
(28,885
)
 
(21,193
)
Non-cash interest expense
22,175
 
 
16,709
 
Amortization of debt issuance costs
2,621
 
 
2,454
 
Amortization of promissory notes
8,941
 
 
 
Gain on deconsolidation of consolidated subsidiary
(36,849
)
 
 
Gain on change in equity interest in unconsolidated investee
(28,348
)
 
 
Equity in earnings of unconsolidated investees
(10,973
)
 
(7,005
)
Excess tax benefits from stock-based award activity
(761
)
 
(7,127
)
Deferred income taxes and other tax liabilities
18,708
 
 
(14,760
)
Changes in operating assets and liabilities, net of effect of acquisition and deconsolidation:
 
 
 
Accounts receivable
(3,879
)
 
(43,285
)
Costs and estimated earnings in excess of billings
(80,719
)
 
(41,992
)
Inventories
(84,210
)
 
27,776
 
Project assets
(146,268
)
 
 
Prepaid expenses and other assets
(76,774
)
 
(6,615
)
Advances to suppliers
1,672
 
 
25,174
 
Accounts payable and other accrued liabilities
219,133
 
 
(13,142
)
Billings in excess of costs and estimated earnings
1,269
 
 
1,049
 
Customer advances
(7,961
)
 
(13,639
)
Net cash provided by (used in) operating activities of continuing operations
(73,890
)
 
37,227
 
Net cash used in operating activities of discontinued operations
(3,969
)
 
 
Net cash provided by (used in) operating activities
(77,859
)
 
37,227
 
Cash flows from investing activities:
 
 
 
Decrease (increase) in restricted cash and cash equivalents
64,674
 
 
(145,583
)
Purchase of property, plant and equipment
(104,623
)
 
(149,624
)
Proceeds from sale of equipment to third-party
5,284
 
 
9,878
 
Proceeds from sales or maturities of available-for-sale securities
1,572
 
 
29,545
 
Cash paid for acquisition, net of cash acquired
(272,699
)
 
 
Cash decrease due to deconsolidation of consolidated subsidiary
(12,879
)
 
 
Cash paid for investments in joint ventures and other non-public companies
(3,798
)
 
(1,500
)
Net cash used in investing activities of continuing operations
(322,469
)
 
(257,284
)
Net cash provided by investing activities of discontinued operations
33,950
 
 
 
Net cash used in investing activities
(288,519
)
 
(257,284
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of long-term debt, net of issuance costs
 
 
137,735
 
Proceeds from issuance of convertible debt, net of issuance costs
244,241
 
 
225,018
 
Proceeds from offering of class A common stock, net of offering expenses
 
 
218,781
 
Repayment of bank loans
(63,646
)
 
 
Cash paid for repurchase of convertible debt
(143,804
)
 
(75,636
)
Cash paid for purchased options
 
 
(97,336
)
Cash paid for bond hedge
(75,200
)
 
 
Proceeds from warrant transactions
61,450
 
 
71,001
 
Proceeds from exercise of stock options
670
 
 
1,408
 
Excess tax benefits from stock-based award activity
761
 
 
7,127
 
Purchases of stock for tax withholding obligations on vested restricted stock
(2,539
)
 
(3,708
)
Net cash provided by financing activities from continuing operations
21,933
 
 
484,390
 
Net cash provided by financing activities from discontinued operations
17,059
 
 
 
Net cash provided by financing activities
38,992
 
 
484,390
 
Effect of exchange rate changes on cash and cash equivalents
(7,281
)
 
5,462
 
Net increase (decrease) in cash and cash equivalents
(334,667
)
 
269,795
 
Cash and cash equivalents at beginning of period
615,879
 
 
202,331
 
Cash and cash equivalents at end of period
281,212
 
 
472,126
 
Less: Cash and cash equivalents of discontinued operations
 
 
 
Cash and cash equivalents of continuing operations, end of period
$
281,212
 
 
$
472,126
 
 
 
 
 
Non-cash transactions:
 
 
 
Property, plant and equipment acquisitions funded by liabilities
$
4,382
 
 
$
21,594
 
Non-cash interest expense capitalized and added to the cost of qualified assets
2,951
 
 
4,456
 
Issuance of common stock for purchase acquisition
 
 
1,471
 
 
(1)    
The Condensed Consolidated Statements of Cash Flows for the nine months ended September 27, 2009 has been adjusted to reflect the adoption of new accounting guidance for share lending arrangements that were executed in connection with the Company's convertible debt offerings in fiscal 2007 (see Note 1).
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

5

Index

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”) is a vertically integrated solar products and services company that designs, manufactures and delivers high-performance solar electric systems worldwide for residential, commercial and utility-scale power plant customers.
 
In the second quarter of fiscal 2010, the Company changed its segment reporting from its Components Segment and Systems Segment to its Utility and Power Plants (“UPP”) Segment and Residential and Commercial (“R&C”) Segment. Historically, Components Segment sales were generally solar cells and solar panels sold to a third-party dealer or original equipment manufacturer (“OEM”) who would re-sell the product to the eventual customer, while Systems Segment sales were generally complete turn-key offerings sold directly to the end customer. Under the new segmentation, the Company's UPP Segment refers to its large-scale solar products and systems business, which includes power plant project development and project sales, turn-key engineering, procurement and construction (“EPC”) services for power plant construction, and power plant operations and maintenance (“O&M”) services. The UPP Segment also makes components sales, which includes large volume sales of solar panels and mounting systems to third parties, often on a multi-year, firm commitment basis, and is a reflection of the growing demand of its utility and other large-scale industrial solar equipment customers. The Company's R&C Segment focuses on solar equipment sales into the residential and small commercial market through its third-party global dealer network, as well as direct sales and EPC and O&M services installing rooftop and ground-mounted solar systems for the commercial and public sectors. The Company's President and Chief Executive Officer, as the chief operating decision maker (“CODM”), has organized the Company and manages resource allocations and measures performance of the Company's activities between these two segments.
 
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. Fiscal year 2010 consists of 52 weeks while fiscal year 2009 consists of 53 weeks. The third quarter of fiscal 2010 ended on October 3, 2010 and the third quarter of fiscal 2009 ended on September 27, 2009.
 
Basis of Presentation
 
The accompanying condensed consolidated interim financial statements have been prepared under the rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting and include the accounts of the Company and all of its subsidiaries. Intercompany transactions and balances have been eliminated in consolidation. The year-end Condensed Consolidated Balance Sheet data was derived from audited financial statements as adjusted for the retrospective application of the new share lending guidance discussed below.
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("United States" or "U.S.") 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 percentage-of-completion 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, goodwill, other intangible assets and other long-term assets, asset impairments, investments in joint ventures, certain accrued liabilities including accrued warranty reserves, valuation of debt without the conversion feature, valuation of share lending arrangements, income taxes and tax valuation allowances. Actual results could materially differ from those estimates.
   
During the three and nine months ended October 3, 2010, the Company identified certain immaterial out-of-period adjustments that had the net effect of decreasing income from continuing operations before income taxes by $2.9 million and $1.9 million, respectively. The adjustments for the three months ended October 3, 2010 primarily represented adjustments which originated in the first and second quarters of fiscal 2010 and related to accounts payable and deferred compensation. The adjustments for the nine months ended October 3, 2010 related to prior years and consisted of adjustments to accounts payable, accrued liabilities, inventories, fixed assets and prepaid expenses. The effect of these adjustments, which resulted principally

6

Index

from the Company's continued efforts to remediate internal controls in its Philippines operations, is not material to current and prior period income from continuing operations and net income.
In the opinion of management, the accompanying condensed consolidated interim 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 October 3, 2010 and its results of operations for the three and nine months ended October 3, 2010 and September 27, 2009, and cash flows for the nine months ended October 3, 2010 and September 27, 2009. These condensed consolidated interim financial statements are not necessarily indicative of the results to be expected for the entire year.
 
Certain prior period balances have been reclassified to conform to the current period presentation in the Company's Condensed Consolidated Financial Statements and the accompanying notes. Such reclassification had no effect on previously reported results of operations or accumulated deficit.
 
Restatement of Previously Issued Condensed Consolidated Financial Statements
 
On November 16, 2009, the Company announced that its Audit Committee commenced an independent investigation into certain accounting and financial reporting matters at its Philippines operations (“SPML”). The Audit Committee retained independent counsel, forensic accountants and other experts to assist it in conducting the investigation.
 
As a result of the investigation, the Audit Committee concluded that certain unsubstantiated accounting entries were 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 the Company's cost of goods sold (referred to as “Cost of revenue” in its Condensed Consolidated Statements of Operations). The Audit Committee concluded that the efforts were not directed at achieving the Company's overall financial results or financial analysts' projections of the 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 entries. 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 the 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 the Company's disclosure controls and procedures see Part I - “Item 4: Controls and Procedures” in the Company's Quarterly Report on Form 10-Q for the quarter ended October 3, 2010.
 
Summary of Significant Accounting Policies
 
These condensed consolidated financial statements and accompanying notes should be read in conjunction with the Company's annual consolidated financial statements and notes thereto for the year ended January 3, 2010 included in its Annual Report on Form 10-K filed with the SEC.
 
Revenue Recognition of Power Plants
 
In connection with the Company's acquisition of SunRay Malta Holdings Limited (“SunRay”), the Company began to develop and sell solar power plants which generally include sale or lease of related real estate (see Note 2). Revenue recognition for these solar power plants require adherence to specific guidance for real estate sales, which provides that if the Company held control over land or land rights prior to the execution of an EPC contract, the Company would recognize revenue and the corresponding costs when all of the following requirements are met: the sale is consummated, the buyer's initial and any continuing investments are adequate, the resulting receivables are not subject to subordination and the Company has transferred the customary risk and rewards of ownership to the buyer. 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 the Company deferring revenue during construction, even if a sale was consummated, until the buyer's initial investment payment is received by the Company, at which time revenue would be recognized on a percentage-of-completion basis as work is completed. Revenue recognition methods for the Company's solar power plants not involving real estate remain subject to the Company's historical practice using the percentage-of-completion method.
 

7

Index

Recently Adopted Accounting Guidance
 
Share Lending Arrangements
 
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 the Company's class A common stock are required to be measured at fair value and amortized as interest expense in its Condensed Consolidated Financial Statements. In addition, in the event that counterparty default under the share lending arrangement becomes probable, the Company is required to recognize an expense in its Condensed Consolidated Statement of Operations equal to the then fair value of the unreturned loaned shares, net of any probable recoveries. The Company adopted the new accounting guidance effective January 4, 2010, the start of its fiscal year, and applied it retrospectively to all prior periods as required by the guidance.
 
The Company has two historical share lending arrangements subject to the new guidance. In connection with the issuance of its 1.25% senior convertible debentures (“1.25% debentures”) and 0.75% senior convertible debentures (“0.75% debentures”), the Company loaned 2.9 million shares of its class A common stock to Lehman Brothers International (Europe) Limited (“LBIE”) and 1.8 million shares of its 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 Company's class A common stock loaned and unreturned by LBIE is $213.4 million, which was expensed retrospectively in the third quarter of fiscal 2008. In addition, on a cumulative basis from the respective issuance dates of the share lending arrangements through January 3, 2010, the Company has recognized $1.6 million in additional non-cash interest expense (see Note 10).
 
As a result of the Company's adoption of the new accounting guidance for share lending arrangements, the Company's Condensed Consolidated Balance Sheet as of January 3, 2010 has been adjusted as follows:
 
(In thousands)
 
As Adjusted in this Quarterly
Report on Form 10-Q
 
As Previously Reported in the
2009 Annual Report
on Form 10-K (1)
Assets
 
 
 
 
Prepaid expenses and other current assets
 
$
98,521
 
 
$
104,442
 
Other long-term assets
 
82,743
 
 
91,580
 
Total assets
 
2,696,895
 
 
2,696,036
 
Stockholders' Equity
 
 
 
 
 
 
Additional paid-in capital
 
1,520,933
 
 
1,305,032
 
Retained earnings (accumulated deficit)
 
(114,309
)
 
100,733
 
Total stockholders' equity
 
1,376,380
 
 
1,375,521
 
 
(1)    
The prior period balance of “Other long-term assets” has been reclassified to conform to the current period presentation in the Company's Condensed Consolidated Balance Sheets which separately discloses “Project assets - plants and land, net of current portion.”
 
As a result of the Company's adoption of the new accounting guidance for share lending arrangements, the Company's Condensed Consolidated Statement of Operations for the three and nine months ended September 27, 2009 have been adjusted as follows:
 

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Index

 
 
Three Months Ended
 
Nine Months Ended
(In thousands, except per share data)
 
September 27, 2009
 
September 27, 2009
 
 
As Adjusted n this Quarterly
Report on Form 10-Q
 
As Previously Reported in
Quarterly Report on Form 10-Q/A
 
As Adjusted in this Quarterly
Report on Form 10-Q
 
As Previously Reported in
Quarterly Report on Form 10-Q/A
Interest expense
 
$
(9,992
)
 
$
(9,854
)
 
$
(26,026
)
 
$
(25,503
)
Income before income taxes and equity in earnings of unconsolidated investees
 
36,841
 
 
36,979
 
 
12,516
 
 
13,039
 
Net income
 
19,506
 
 
19,644
 
 
23,978
 
 
24,501
 
Net income per share of class A and class B common stock:
 
 
 
 
 
 
 
 
Basic
 
$
0.21
 
 
$
0.21
 
 
$
0.27
 
 
$
0.27
 
Diluted
 
$
0.20
 
 
$
0.20
 
 
$
0.26
 
 
$
0.27
 
 
As a result of the Company's adoption of the new accounting guidance for share lending arrangements, the Company's Condensed Consolidated Statement of Cash Flows for the nine months ended September 27, 2009 has been adjusted as follows:
 
 
 
Nine Months Ended
(In thousands)
 
September 27, 2009
 
 
As Adjusted in this Quarterly
Report on Form 10-Q
 
As Previously Reported in
Quarterly Report on Form 10-Q/A
Cash flows from operating activities:
 
 
 
 
Net income
 
$
23,978
 
 
$
24,501
 
Non-cash interest expense
 
16,709
 
 
16,186
 
Net cash provided by operating activities
 
37,227
 
 
37,227
 
 
Variable Interest Entities (“VIEs”)
 
In June 2009, the FASB issued new accounting guidance regarding consolidation of VIEs to eliminate the exemption for qualifying special purpose entities, provide a new approach for determining which entity should consolidate a VIE, and require an enterprise to regularly perform an analysis to determine whether the enterprise's variable interest or interests give it a controlling financial interest in a VIE. The new accounting guidance became effective for fiscal years beginning after November 15, 2009. The Company's adoption of the new accounting guidance in the first quarter of fiscal 2010 had no impact on its Condensed Consolidated Financial Statements (see Note 9).
 
Revenue Arrangements with Multiple Deliverables
 
In October 2009, the FASB issued new accounting guidance for revenue arrangements with multiple deliverables. Specifically, the new guidance requires an entity to allocate arrangement consideration at the inception of an arrangement to all of its deliverables based on their relative selling prices. In addition, the new guidance eliminates the use of the residual method of allocation and requires the relative-selling-price method in all circumstances in which an entity recognizes revenue for an arrangement with multiple deliverables. The new accounting guidance is effective in the fiscal year beginning on or after June 15, 2010. Early adoption is permitted. The Company adopted the new accounting guidance in the first quarter of fiscal 2010 and applied the prospective application for new or materially modified arrangements with multiple deliverables. The Company's adoption of the new accounting guidance did not have a material impact on its Condensed Consolidated Financial Statements.
 
Fair Value of Assets and Liabilities
 
In January 2010, the FASB issued updated guidance related to fair value measurements and disclosures, which will require the Company to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and to describe the reasons for the transfers. In addition, in the reconciliation for fair value measurements using

9

Index

significant unobservable inputs, or Level 3, the Company will disclose separately information about purchases, sales, issuances and settlements on a gross basis rather than on a net basis. The updated guidance also requires that the Company provide fair value measurement disclosures for each class of assets and liabilities and disclosures about the valuation techniques and inputs used to measure fair value for both recurring and non-recurring fair value measurements for Level 2 and Level 3 fair value measurements. The updated guidance is effective for interim or annual financial reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward activity in Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The Company's adoption of the updated guidance had no impact on its financial position, results of operations, or cash flows and only required additional financial statements disclosures as set forth in Notes 7, 10 and 12.
 
Issued Accounting Guidance Not Yet Adopted
 
There has been no issued accounting guidance not yet adopted by the Company that it believes is material, or is potentially material to the Company's Condensed Consolidated Financial Statements.
 
Note 2. BUSINESS COMBINATIONS
 
SunRay
 
On March 26, 2010, the Company completed its acquisition of SunRay, a European solar power plant developer company organized under the laws of Malta, under which the Company purchased all the issued share capital of SunRay for $296.1 million. As a result, SunRay became a wholly-owned subsidiary of the Company and the results of operations of SunRay have been included in the Condensed Consolidated Statement of Operations of the Company since March 26, 2010. As part of the acquisition, the Company acquired SunRay's project pipeline of solar photovoltaic projects in Italy, France, Israel, Spain, the United Kingdom and Greece. The pipeline consists of projects in various stages of development. SunRay's power plant development and project finance team consisted of approximately 70 employees.
 
Purchase Price Consideration
 
The total consideration for the acquisition was $296.1 million, including: (i) $263.4 million paid in cash to SunRay's class A shareholders, class B shareholders and class C shareholders; (ii) $18.7 million paid in cash to repay outstanding debt of SunRay; and (iii) $14.0 million in promissory notes issued by SunPower North America, LLC, a wholly-owned subsidiary of the Company, and guaranteed by SunPower. A portion of the purchase price allocated to SunRay's class A shareholders, class B shareholders and certain non-management class C shareholders ($244.4 million in total) was paid by the Company in cash and the remaining portion of the purchase price allocated to SunRay's class C management shareholders was paid with a combination of $19.0 million in cash and $14.0 million in promissory notes.
 
The $14.0 million in promissory notes issued to SunRay's management shareholders have been structured to provide a retention incentive. Since the vesting and payment of the promissory notes are contingent on future employment, the promissory notes are considered deferred compensation and therefore are not included in the purchase price allocated to the net assets acquired.
 
A total of $32.3 million of the purchase price paid and promissory notes payable to certain principal shareholders of SunRay will be held in escrow for two years following March 26, 2010, and be subject to potential indemnification claims that may be made by the Company during that period. The escrow fund consists of $28.7 million paid in cash and $3.6 million in promissory notes issued by SunPower North America, LLC. The escrow is generally tied to compliance with the representations and warranties made as part of the acquisition. Therefore, the $28.7 million in cash of the $263.4 million cash consideration is considered a part of the purchase price allocated to the net assets acquired. The funds in escrow, less any amounts relating to paid or pending claims, will be released two years following March 26, 2010.
 

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Index

Preliminary Purchase Price Allocation
 
The Company accounted for this acquisition using the acquisition method. The Company preliminarily allocated the purchase price to the acquired assets and liabilities based on their estimated fair values at the acquisition date as summarized in the following table. The allocation of the purchase price on March 26, 2010 was adjusted in this report as follows:
 
(In thousands)
 
As Adjusted
 
As Previously Reported
Net tangible assets acquired
 
$
54,915
 
 
$
44,686
 
Project assets
 
79,160
 
 
79,160
 
Purchased technology
 
1,120
 
 
1,120
 
Goodwill
 
146,895
 
 
157,124
 
Total purchase consideration
 
$
282,090
 
 
$
282,090
 
 
The fair value of net tangible assets acquired on March 26, 2010 was adjusted in this report as follows:
 
(In thousands)
 
As Adjusted
 
As Previously Reported
Cash and cash equivalents
 
$
9,391
 
 
$
9,391
 
Restricted cash and cash equivalents
 
36,701
 
 
36,701
 
Accounts receivable, net
 
1,958
 
 
1,958
 
Prepaid expenses and other assets
 
5,765
 
 
7,933
 
Project assets - plants and land
 
19,624
 
 
19,624
 
Property, plant and equipment, net
 
452
 
 
452
 
Assets of discontinued operations
 
199,071
 
 
186,674
 
Total assets acquired
 
272,962
 
 
262,733
 
Accounts payable
 
(4,324
)
 
(4,324
)
Other accrued expenses and liabilities
 
(11,688
)
 
(11,688
)
Debt (see Note 10)
 
(42,707
)
 
(42,707
)
Liabilities of discontinued operations
 
(159,328
)
 
(159,328
)
Total liabilities assumed
 
(218,047
)
 
(218,047
)
Net assets acquired
 
$
54,915
 
 
$
44,686
 
 
Since the Company's purchase price allocation was not fully complete as of the second quarter ended July 4, 2010, the Company recorded adjustments to the fair value of certain assets and liabilities as additional information became available in the third quarter ended October 3, 2010. These fair value adjustments were retrospectively applied to the acquisition date of March 26, 2010 as required by current accounting guidance. The Company is still in the process of reviewing the fair value of certain assets and liabilities acquired.
 
In the Company's determination of the fair value of the project assets and purchased technology acquired, it considered, among other factors, three generally accepted valuation approaches: the income approach, the market approach and the cost approach. The Company selected the approaches that it believed to be most indicative of the fair value of the assets acquired.
 
Project Assets
 
The project assets totaling $79.2 million represent intangible assets that consist of: (i) projects and EPC pipeline, which relate to the development of power plants; and (ii) O&M pipeline, which relate to maintenance contracts that are established after the developed plants are sold. The Company applied the income approach using the Multi-Period Excess Earnings Method based on estimates and assumptions of future performance of these project assets provided by SunRay's and the Company's management to determine the fair value of the project assets. SunRay's and the Company's estimates and assumptions regarding the fair value of the project assets is derived from probability adjusted cash flows of certain project assets acquired based on the varying development stages of each project asset on the acquisition date. The Company is amortizing the project assets to “Selling, general and administrative” expense based on the pattern of economic benefit provided using the same probability adjusted cash flows from the sale of solar power plants over estimated lives of 4 years from the date of acquisition.

11

Index

 
Purchased Technology
 
The Company applied the cost approach to calculate the fair value of internally developed technologies related to the project development business. The Company determined the fair value of the purchased technology totaling $1.1 million based on estimates and assumptions for the cost of reproducing or replacing the asset based on third party charges, salaries of employees and other internal development costs incurred. The Company is amortizing the purchased technology to “Cost of revenue” within the UPP Segment on a straight-line basis over estimated lives of 5 years.
 
Goodwill
 
Of the total estimated purchase price paid at the time of acquisition, $133.2 million had been initially allocated to goodwill within the UPP Segment during the first quarter ended April 4, 2010. During the second and third quarters in fiscal 2010, the Company recorded adjustments aggregating $13.7 million to increase goodwill related to the acquisition of SunRay on March 26, 2010 to $146.9 million. These adjustments were based upon the Company obtaining additional information on the acquired assets and liabilities as additional information became available in the second and third quarter of fiscal 2010. The adjustments included: (i) the elimination of a non-current tax receivable and a related non-current tax liability; (ii) changes to the value of certain assets and liabilities acquired in “Assets of discontinued operations” and “Liabilities of discontinued operations,” respectively; as well as (iii) changes to the value of certain acquired prepaid expenses, other current assets, accounts payable, other accrued liabilities and debt. These fair value adjustments were retrospectively applied to the acquisition date of March 26, 2010 as required by current accounting guidance. Goodwill represents the excess of the purchase price of an acquired business over the fair value of the underlying net tangible and other intangible assets and is not deductible for tax purposes. Among the factors that contributed to a purchase price in excess of the fair value of the net tangible and other intangible assets was the acquisition of an assembled workforce, synergies in technologies, skill sets, operations, customer base and organizational cultures.
 
Acquisition Related Costs
 
Acquisition-related costs of zero and $6.5 million recognized in the three and nine months ended October 3, 2010, respectively, include transaction costs such as legal, accounting, valuation and other professional services, which the Company has classified in “Selling, general and administrative” expense in its Condensed Consolidated Statements of Operations.
 
Utility and Power Plants Revenue
 
In the three and nine months ended October 3, 2010, SunRay's electricity revenue from discontinued operations totaled $3.2 million and $11.1 million, respectively (see Note 3). In addition, SunRay completed the sale of an 8 megawatt ("MWac") solar power plant in Montalto di Castro, Italy, to Etrion Corporation which represented 12% of the Company's total revenue in the third quarter of fiscal 1010 (see Note 16).
 
Pro Forma Financial Information
 
Supplemental information on an unaudited pro forma basis, as if the acquisition of SunRay was completed at the beginning of the first quarter in fiscal 2010 and 2009, is as follows:
 
 
 
Three Months Ended
 
Nine Months Ended
(In thousands, except per share amounts)
 
October 3, 2010
 
September 27, 2009
 
October 3, 2010
 
September 27, 2009
Revenue
 
$
550,645
 
 
$
321,199
 
 
$
1,281,568
 
 
$
832,183
 
Net income (loss)
 
20,116
 
 
(49,989
)
 
11,171
 
 
(63,751
)
Basic net income (loss) per share
 
0.21
 
 
(0.53
)
 
0.12
 
 
(0.71
)
Diluted net income (loss) per share
 
0.21
 
 
(0.53
)
 
0.12
 
 
(0.71
)
 
The unaudited pro forma supplemental information is based on estimates and assumptions, which the Company believes are reasonable. The unaudited pro forma supplemental information prepared by management is not necessarily indicative of the consolidated financial position or results of operations in future periods or the results that actually would have been realized had the Company and SunRay been a combined company during the specified periods.
 

12

Index

Note 3. SALE OF DISCONTINUED OPERATIONS
 
In connection with the Company's acquisition of SunRay on March 26, 2010, it acquired a SunRay project company, Cassiopea PV S.r.l (“Cassiopea”), operating a previously completed 20 MWac solar power plant in Montalto di Castro, Italy. In the period in which an asset of the Company is classified as held-for-sale, it is required to present the related assets, liabilities and results of operations associated with that asset as discontinued operations. Cassiopea's results of operations for the three and nine months ended October 3, 2010 were classified as “Income from discontinued operations, net of taxes” in the Condensed Consolidated Statements of Operations. On August 5, 2010, the Company sold the assets and liabilities of Cassiopea.
 
In the three and nine months ended October 3, 2010, condensed results of operations relating to Cassiopea are as follows:
 
 
 
Three Months Ended
 
Nine Months Ended
(In thousands)
 
October 3, 2010
 
October 3, 2010
Utility and power plants revenue
 
$
3,176
 
 
$
11,081
 
Gross margin
 
3,176
 
 
11,081
 
Income (loss) from discontinued operations before sale of business unit
 
(5,648
)
 
5,862
 
Gain on sale of business unit
 
7,937
 
 
7,937
 
Income before income taxes
 
2,289
 
 
13,799
 
Income from discontinued operations, net of taxes
 
1,570
 
 
9,466
 
 
Note 4. GOODWILL AND OTHER INTANGIBLE ASSETS
 
Goodwill
 
The following table presents the changes in the carrying amount of goodwill under the Company's reportable business segments:
 
(In thousands)
 
UPP
 
R&C
 
Total
As of January 3, 2010
 
$
78,634
 
 
$
119,529
 
 
$
198,163
 
Goodwill arising from business combination
 
146,895
 
 
 
 
146,895
 
Translation adjustment
 
 
 
(197
)
 
(197
)
As of October 3, 2010
 
$
225,529
 
 
$
119,332
 
 
$
344,861
 
 
The balance of goodwill within the UPP Segment increased $146.9 million as of October 3, 2010 due to the Company's acquisition of SunRay. This amount represents the excess of the purchase price over the fair value of the underlying net tangible and other intangible assets of SunRay (see Note 2). The translation adjustment for the revaluation of the Company's subsidiaries' goodwill into U.S. dollar equivalents decreased the balance of goodwill within the R&C Segment by $0.2 million during the nine months ended October 3, 2010.
 
In the second quarter of fiscal 2010, the Company changed its segment reporting structure to establish the UPP Segment and R&C Segment to better align its sales, construction, engineering and customer service teams based on end-customer segments rather than by sales channels. Management evaluated all the facts and circumstances relating to the change in its segment reporting structure and concluded that no impairment indicator existed as of July 4, 2010 that would require impairment testing of its new reporting units.
 
Goodwill is tested for impairment at least annually, or more frequently if certain indicators are present. A two-step process is used to test for goodwill impairment. The first step is to determine if there is an indication of impairment by comparing the estimated fair value of each reporting unit to its carrying value, including existing goodwill. Goodwill is considered impaired if the carrying value of a reporting unit exceeds the estimated fair value. Upon an indication of impairment, a second step is performed to determine the amount of the impairment by comparing the implied fair value of the reporting unit’s goodwill with its carrying value.
 

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Index

The Company conducts its annual impairment test of goodwill as of the Sunday closest to the end of the third fiscal quarter of each year. Impairment of goodwill is tested at the Company’s reporting unit level. Management determined the UPP Segment and R&C Segment each have two reporting units. In estimating the fair value of the reporting units, the Company makes estimates and judgments about its future cash flows using an income approach defined as Level 3 inputs under fair value measurement standards. The income approach, specifically a discounted cash flow analysis, included assumptions for, among others, forecasted revenue, gross margin, operating income, working capital cash flow, perpetual growth rates and long-term discount rates, all of which require significant judgment by management. The sum of the fair values of the Company's reporting units are also compared to its external market capitalization to determine the appropriateness of its assumptions and adjusted, if appropriate. These assumptions took into account the current recessionary environment and its impact on the Company’s business. Based on the impairment test as of October 3, 2010, the Company determined there was no impairment. As of October 3, 2010, the fair value of each reporting unit exceeded the carrying value under the first step of the goodwill impairment test, therefore, goodwill is not impaired.
 
Intangible Assets
 
The following tables present details of the Company's acquired other intangible assets:
 
(In thousands)
 
Gross
 
Accumulated
Amortization
 
Net
As of October 3, 2010
 
 
 
 
 
 
Project assets
 
$
79,160
 
 
$
(15,570
)
 
$
63,590
 
Patents and purchased technology
 
52,519
 
 
(50,054
)
 
2,465
 
Purchased in-process research and development
 
1,000
 
 
 
 
1,000
 
Trade names
 
2,639
 
 
(2,558
)
 
81
 
Customer relationships and other
 
28,759
 
 
(18,673
)
 
10,086
 
 
 
$
164,077
 
 
$
(86,855
)
 
$
77,222
 
 
 
 
 
 
 
 
 
 
 
As of January 3, 2010
 
 
 
 
 
 
 
 
 
Patents and purchased technology
 
$
51,398
 
 
$
(42,014
)
 
$
9,384
 
Purchased in-process research and development
 
1,000
 
 
 
 
1,000
 
Trade names
 
2,623
 
 
(2,212
)
 
411
 
Customer relationships and other
 
28,616
 
 
(14,437
)
 
14,179
 
 
 
$
83,637
 
 
$
(58,663
)
 
$
24,974
 
 
In connection with the acquisition of SunRay on March 26, 2010, the Company recorded $80.3 million of other intangible assets. All of the Company's acquired other intangible assets are subject to amortization. Aggregate amortization expense for other intangible assets totaled $11.6 million and $28.0 million in the three and nine months ended October 3, 2010, respectively, and $4.1 million and $12.3 million in the three and nine months ended September 27, 2009, respectively. As of October 3, 2010, the estimated future amortization expense related to other intangible assets is as follows:
 
(In thousands)
 
Amount
Year
 
 
2010 (remaining three months)
 
$
10,494
 
2011
 
27,505
 
2012
 
22,965
 
2013
 
16,153
 
2014
 
86
 
Thereafter
 
19
 
 
 
$
77,222
 
 

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Index

Note 5. BALANCE SHEET COMPONENTS
 
 
October 3, 2010
 
January 3, 2010
(In thousands)
 
 
 
 
Accounts receivable, net:
 
 
 
 
Accounts receivable, gross
 
$
272,316
 
 
$
253,039
 
Less: allowance for doubtful accounts
 
(4,912
)
 
(2,298
)
Less: allowance for sales returns
 
(1,572
)
 
(1,908
)
 
 
$
265,832
 
 
$
248,833
 
 
Inventories:
 
 
 
 
Raw materials
 
$
63,795
 
 
$
76,423
 
Work-in-process
 
41,087
 
 
20,777
 
Finished goods
 
180,923
 
 
105,101
 
 
 
$
285,805
 
 
$
202,301
 
 
Prepaid expenses and other current assets:
 
 
 
 
VAT receivables, current portion
 
$
92,811
 
 
$
27,054
 
Short-term deferred tax assets
 
2,273
 
 
5,920
 
Foreign currency derivatives
 
18,917
 
 
5,000
 
Income tax receivable
 
6,887
 
 
3,171
 
Note receivable (1)
 
10,000
 
 
 
Other receivables (2)
 
54,853
 
 
43,531
 
Other prepaid expenses
 
50,906
 
 
13,845
 
 
 
$
236,647
 
 
$
98,521
 
 
Other long-term assets:
 
 
 
 
Investments in joint ventures
 
$
106,836
 
 
$
39,820
 
Bond hedge derivative
 
44,694
 
 
 
Note receivable (1)
 
 
 
10,000
 
Investments in non-public companies
 
6,418
 
 
4,560
 
VAT receivables, net of current portion
 
7,056
 
 
7,357
 
Long-term debt issuance costs
 
11,954
 
 
6,942
 
Other
 
13,100
 
 
14,064
 
 
 
$
190,058
 
 
$
82,743
 
 
(1)    
In June 2008, the Company loaned $10.0 million to a third-party private company under a three-year note receivable that is convertible into equity at the Company's option.
(2)    
Includes tolling agreements with suppliers in which the Company provides polysilicon required for silicon ingot manufacturing and procures the manufactured silicon ingots from the suppliers (see Notes 8 and 9).
 

15

Index

 
 
October 3, 2010
 
January 3, 2010
(In thousands)
 
 
 
 
Accrued liabilities:
 
 
 
 
VAT payables
 
$
64,099
 
 
$
15,219
 
Foreign currency derivatives
 
79,422
 
 
27,354
 
Short-term warranty reserves
 
11,364
 
 
9,693
 
Employee compensation and employee benefits
 
29,986
 
 
18,161
 
Other
 
54,034
 
 
43,581
 
 
 
$
238,905
 
 
$
114,008
 
 
 
 
 
 
 
 
Other long-term liabilities:
 
 
 
 
 
 
Embedded conversion option derivatives
 
$
45,095
 
 
$
 
Warrants derivatives
 
37,044
 
 
 
Long-term warranty reserves
 
48,069
 
 
36,782
 
Uncertain tax positions
 
16,763
 
 
14,478
 
Other
 
24,199
 
 
18,785
 
 
 
$
171,170
 
 
$
70,045
 
 
 
 
 
 
 
 
Accumulated other comprehensive loss:
 
 
 
 
 
 
Cumulative translation adjustment
 
$
(2,961
)
 
$
(3,864
)
Net unrealized loss on derivatives, net of tax provision of $2.8 million and $2.3 million as of October 3, 2010 and January 3, 2010, respectively
 
 
(26,592
)
 
(13,493
)
 
 
$
(29,553
)
 
$
(17,357
)
 
Note 6. PROPERTY, PLANT AND EQUIPMENT, NET
 
 
 
October 3, 2010
 
January 3, 2010
(In thousands)
 
 
 
 
Land and buildings
 
$
13,913
 
 
$
17,409
 
Leasehold improvements
 
204,330
 
 
197,524
 
Manufacturing equipment (1)
 
547,340
 
 
547,968
 
Computer equipment
 
43,104
 
 
34,835
 
Solar power systems
 
10,040
 
 
8,708
 
Furniture and fixtures
 
5,123
 
 
4,540
 
Construction-in-process
 
26,944
 
 
57,305
 
 
 
850,794
 
 
868,289
 
Less: accumulated depreciation (2)
 
(261,104
)
 
(185,945
)
 
 
$
589,690
 
 
$
682,344
 
 
(1)    
Certain manufacturing equipment associated with solar cell manufacturing lines located at one of the Company’s facilities in the Philippines is collateralized in favor of a third-party lender. The Company provided security for advance payments received from a third party in fiscal 2008 totaling $40.0 million in the form of collateralized manufacturing equipment with a net book value of $30.2 million and $35.8 million as of October 3, 2010 and January 3, 2010, respectively.
 
(2)    
Total depreciation expense was $26.4 million and $75.7 million in the three and nine months ended October 3, 2010, respectively, and $21.4 million and $60.3 million in the three and nine months ended September 27, 2009, respectively.
 
Note 7. INVESTMENTS
 
The Company's investments in money market funds and bank notes are carried at fair value. Fair values are determined based on a hierarchy that prioritizes the inputs to valuation techniques by assigning 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

16

Index

prices included within Level 1.
 
Assets Measured at Fair Value on a Recurring Basis
 
The following tables present information about the Company's investments in available-for-sale debt and equity securities that are measured at fair value on a recurring basis and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value. Information about the Company's interest rate swaps derivatives, bond hedge and warrants derivatives, purchased options derivative, embedded conversion option derivative and over-allotment option derivative measured at fair value on a recurring basis is disclosed in Note 10. Information about the Company's foreign currency derivatives measured at fair value on a recurring basis is disclosed in Note 12. The Company does not have any nonfinancial assets or liabilities that are recognized or disclosed at fair value on a recurring basis in its condensed consolidated financial statements.
 
 
 
October 3, 2010
(In thousands)
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
Money market funds
 
$
328,983
 
 
$
 
 
$
172
 
 
$
329,155
 
 
 
 
January 3, 2010
(In thousands)
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
Money market funds
 
$
418,372
 
 
$
 
 
$
172
 
 
$
418,544
 
Bank notes
 
 
 
101,085
 
 
 
 
101,085
 
 
 
$
418,372
 
 
$
101,085
 
 
$
172
 
 
$
519,629
 
 
There have been no transfers between Level 1, Level 2 and Level 3 measurements during the nine months ended October 3, 2010. Available-for-sale securities utilizing Level 2 inputs to determine fair value are comprised of investments in bank notes totaling zero and $101.1 million as of October 3, 2010 and January 3, 2010, respectively. Available-for-sale securities utilizing Level 3 inputs to determine fair value are comprised of investments in money market funds totaling $0.2 million as of both October 3, 2010 and January 3, 2010.
 
Money Market Funds
 
The Company's money market fund instruments are classified within Level 1 of the fair value hierarchy because they are valued using quoted prices for identical instruments in active markets. Investments in money market funds utilizing Level 3 inputs consist of the Company's investment in the Reserve International Liquidity Fund which amounted to $0.2 million as of both October 3, 2010 and January 3, 2010. The Company has estimated the value of its investment in the Reserve International Liquidity Fund to be $0.2 million based on information publicly disclosed by the Reserve International Liquidity Fund relative to its holdings and remaining obligations.
 
Bank Notes
 
Investments in bank notes utilizing Level 2 inputs consist of short-term certificates of deposit and select interest bearing bank accounts. Such investments are not traded on an open market and reside with the bank. Bank notes are highly liquid with maturities of zero to ninety days. Due to the short-term maturities, the Company has determined that the fair value of these investments should be at face value. Bank notes totaled zero and $101.1 million as of October 3, 2010 and January 3, 2010, respectively.
 
The following table summarizes unrealized gains and losses by major security type designated as available-for-sale:
 

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October 3, 2010
 
January 3, 2010
 
 
 
 
Unrealized
 
 
 
 
 
Unrealized
 
 
(In thousands)
 
Cost
 
Gross Gains
 
Gross Losses
 
Fair Value
 
Cost
 
Gross Gains
 
Gross Losses
 
Fair Value
Money market funds
 
$
329,155
 
 
$
 
 
$
 
 
$
329,155
 
 
$
418,544
 
 
$
 
 
$
 
 
$
418,544
 
Bank notes
 
 
 
 
 
 
 
 
 
101,085
 
 
 
 
 
 
101,085
 
 
 
$
329,155
 
 
$
 
 
$
 
 
$
329,155
 
 
$
519,629
 
 
$
 
 
$
 
 
$
519,629
 
 
The classification of available-for-sale securities and cash deposits is as follows:
 
 
 
October 3, 2010
 
January 3, 2010
(In thousands)
 
Available-For- Sale
 
Cash Deposits
 
Total
 
Available-For- Sale
 
Cash Deposits
 
Total
Cash and cash equivalents
 
$
175,046
 
 
$
106,166
 
 
$
281,212
 
 
$
325,906
 
 
$
289,973
 
 
$
615,879
 
Short-term restricted cash and cash equivalents (1)
 
34,705
 
 
2,504
 
 
37,209
 
 
61,868
 
 
 
 
61,868
 
Short-term investments
 
172
 
 
 
 
172
 
 
172
 
 
 
 
172
 
Long-term restricted cash and cash equivalents (1)
 
119,232
 
 
91
 
 
119,323
 
 
131,683
 
 
117,107
 
 
248,790
 
 
 
$
329,155
 
 
$
108,761
 
 
$
437,916
 
 
$
519,629
 
 
$
407,080
 
 
$
926,709
 
 
(1)    
Includes cash collateralized bank standby letters of credit the Company provided to support advance payments received from customers and cash held in an escrow account for future advance payments by the Company.
 
The contractual maturities of available-for-sale securities are as follows:
 
(In thousands)
 
October 3, 2010
 
January 3, 2010
Due in less than one year
 
$
329,155
 
 
$
519,629
 
 
Minority Investments in Joint Ventures and Other Non-Public Companies
 
The Company holds minority investments comprised of common and preferred stock in joint ventures and other non-public companies. The Company monitors these minority investments for impairment, which are included in “Other long-term assets” in its Condensed Consolidated Balance Sheets and records 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. As of October 3, 2010 and January 3, 2010, the Company had $106.9 million and $39.8 million, respectively, in investments in joint ventures accounted for under the equity method and $6.4 million and $4.6 million, respectively, in investments accounted for under the cost method (see Note 9).
 
On September 28, 2010, the Company entered into a $0.2 million investment in a related party accounted for under the cost method. In connection with the investment the Company entered into licensing, lease and facility service agreements. Under the lease and facility service agreements the investee will lease space from the Company for a period of five years. Facility services will be provided by the Company over the term of the lease on a “cost-plus” basis. Payments received under the lease and facility service agreement totaled $0.1 million in both the three and nine months ended October 3, 2010. As of October 3, 2010, $0.8 million remained due and receivable from the investee related to capital purchases made by the Company on behalf of the investee. The Company will be required to provide additional financing of up to $4.9 million (see Note 8).
 
Note 8. COMMITMENTS AND CONTINGENCIES
 
Operating Lease Commitments
 
On June 29, 2009, the Company signed a commercial project financing agreement with Wells Fargo to fund up to $100

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million of commercial-scale solar system projects through May 31, 2010. Under the financing agreement, the Company 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 the Company. Separately, the Company entered into power purchase agreements with end customers, who host the systems and buy the electricity directly from the Company.
 
The Company 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, the Company entered into agreements to lease the systems back from Wells Fargo over minimum lease terms of 20 years. Each system has a separate lease and was separately evaluated under lease accounting guidance. The leases call for an initial term of 20 years, and at the end of the lease term, the Company has the option to purchase the system at fair value or remove the system. The Company classified the four systems as operating leases in accordance with accounting guidance and considers the leases as normal leasebacks. The deferred profit on the sale of the systems is being recognized over the minimum term of the leases as a reduction of rent expense.
 
In addition, the Company leases its San Jose, California facility under a non-cancelable operating lease from Cypress Semiconductor Corporation (“Cypress”), which expires in April 2011. 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. The Company also has various lease arrangements, including for 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, Oregon, Australia, England, France, Germany, Greece, Israel, Italy, Malta, Spain and South Korea, all of which are leased from unaffiliated third parties. In addition, the Company acquired a lease arrangement in London, England, which is leased from a party affiliated with the Company.
 
Future minimum obligations under all non-cancelable operating leases as of October 3, 2010 are as follows:
 
(In thousands)
 
Amount
Year
 
 
2010 (remaining three months)
 
$
5,065
 
2011
 
9,949
 
2012
 
8,161
 
2013
 
7,183
 
2014
 
6,154
 
Thereafter
 
27,820
 
 
 
$
64,332
 
 
Purchase Commitments
 
The Company purchases raw materials for inventory 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 on 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 disclosed purchase commitments arising from these agreements are firm, non-cancelable and unconditional commitments.
 
The Company also has agreements with several suppliers, including some of its non-consolidated joint ventures, for the procurement of polysilicon, ingots, wafers and solar panels which specify future quantities and pricing of products to be supplied by the vendors for periods up to 11 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.
 
As of October 3, 2010, total obligations related to non-cancelable purchase orders totaled $14.7 million and long-term supply agreements with suppliers, including joint ventures, totaled $5,583.4 million. Future purchase obligations under non-cancelable purchase orders and long-term supply agreements as of October 3, 2010 are as follows:
 

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(In thousands)
 
Amount
Year
 
 
2010 (remaining three months)
 
$
404,669
 
2011
 
675,002
 
2012
 
624,449
 
2013
 
636,165
 
2014
 
731,216
 
Thereafter
 
2,526,662
 
 
 
$
5,598,163
 
 
Total future purchase commitments of $5,598.2 million as of October 3, 2010 included tolling agreements with suppliers in which the Company provides polysilicon required for silicon ingot manufacturing and procures the manufactured silicon ingots from the supplier. Annual future purchase commitments in the table above are calculated using the gross price paid by the Company for silicon ingots and are not reduced by the price paid by suppliers for polysilicon. Total future purchase commitments as of October 3, 2010 would be reduced by $1,749.2 million to $3,849.0 million had the Company's obligations under such tolling agreements been disclosed using net cash outflows.
 
The Company expects that all obligations related to non-cancellable purchase orders for manufacturing equipment will be recovered through future cash flows of the solar cell manufacturing lines and solar panel assembly lines when such long-lived assets are placed in service. Factors considered important that could result in an impairment review include significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of use of acquired assets and significant negative industry or economic trends. Total obligations related to non-cancellable purchase orders for inventories match current and forecasted sales orders that will consume these ordered materials and actual consumption of these ordered materials are compared to expected demand regularly. The Company anticipates total obligations related to long-term supply agreements for inventories will be recovered because quantities are less than management's expected demand for its solar power products. However, the terms of the long-term supply agreements are reviewed by management and the Company establishes accruals for estimated losses on adverse purchase commitments as necessary, such as lower of cost or market value adjustments, forfeiture of advanced deposits and liquidated damages. Such accruals will be recorded when the Company determines the cost of purchasing the components is higher than the estimated current market value or when it believes it is probable such components will not be utilized in future operations.
 
Advances to Suppliers
 
As noted above, the Company has entered into agreements with various polysilicon, ingot, wafer and solar panel vendors that specify future quantities and pricing of products to be supplied by the vendors for periods up to 11 years. Certain agreements also provide for penalties or forfeiture of advanced deposits in the event the Company terminates the arrangements. Under certain agreements, the Company is required to make prepayments to the vendors over the terms of the arrangements. During the nine months ended October 3, 2010, the Company paid advances totaling $13.8 million in accordance with the terms of existing supply agreements. As of October 3, 2010 and January 3, 2010, advances to suppliers totaled $184.4 million and $190.6 million, respectively, the current portion of which is $26.4 million and $22.8 million, respectively. Two suppliers accounted for 75% and 17% of total advances to suppliers as of October 3, 2010, and 76% and 15% as of January 3, 2010.
 
The Company's future prepayment obligations related to these agreements as of October 3, 2010 are as follows:
 
(In thousands)
 
Amount
Year
 
 
2010 (remaining three months)
 
$
123,575
 
2011
 
117,402
 
2012
 
72,694
 
 
 
$
313,671
 
 
On October 4, 2010 and November 10, 2010, the Company paid advances totaling $110.0 million in accordance with the terms of existing supply agreements. On November 5, 2010, the Company and AUO SunPower Sdn. Bhd. ("AUOSP") entered into an agreement under which the Company will resell to AUOSP polysilicon purchased from a third-party supplier and AUOSP will provide prepayments to the Company related to such polysilicon, which prepayments will then be made by the

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Company to the third-party supplier. Prepayments to be paid by AUOSP to the Company total $100 million, $60 million and $40 million in the fourth quarter of fiscal 2010, fiscal year 2011 and fiscal year 2012, respectively (see Note 9).
 
Product Warranties
 
The Company generally warrants or guarantees the performance of the solar panels that it manufactures at certain levels of power output for 25 years. In addition, the Company passes through to customers long-term warranties from the OEMs of certain system components. Warranties of 25 years from solar panels suppliers are standard in the solar industry, while inverters typically carry warranty periods ranging from 5 to 10 years. In addition, the Company generally warrants its workmanship on installed systems for a period of 2, 5 or 10 years. The Company maintains reserves to cover the expected costs that could result from these warranties. The Company's expected costs are generally in the form of product replacement or repair. Warranty reserves are based on the Company's best estimate of such costs and are recognized as a cost of revenue. The Company continuously monitors product returns for warranty failures and maintains a reserve for the related warranty expenses based on various factors including historical warranty claims, results of accelerated lab testing, field monitoring, vendor reliability estimates, and data on industry averages for similar products. Historically, warranty costs have been within management's expectations.
 
Provisions for warranty reserves charged to cost of revenue were $8.6 million and $18.3 million during the three and nine months ended October 3, 2010, respectively, and $6.8 million and $15.7 million during the three and nine months ended September 27, 2009, respectively. Activity within accrued warranty for the three and nine months ended October 3, 2010 and September 27, 2009 are summarized as follows:
 
 
 
Three Months Ended
 
Nine Months Ended
(In thousands)
 
October 3, 2010
 
September 27, 2009
 
October 3, 2010
 
September 27, 2009
Balance at the beginning of the period
 
$
51,991
 
 
$
34,108
 
 
$
46,475
 
 
$
28,062
 
Accruals for warranties issued during the period
 
8,604
 
 
6,756
 
 
18,309
 
 
15,749
 
Settlements made during the period
 
(1,162
)
 
(1,069
)
 
(5,351
)
 
(4,016
)
Balance at the end of the period
 
$
59,433
 
 
$
39,795
 
 
$
59,433
 
 
$
39,795
 
 
System Put-Rights
 
EPC projects often require the Company to undertake customer obligations including: (i) system output performance guarantees; (ii) system maintenance; (iii) penalty payments or customer termination rights if the system the Company is constructing is not commissioned within specified timeframes or other construction milestones are not achieved; (iv) guarantees of certain minimum residual value of the system at specified future dates; and (v) system put-rights whereby the Company could be required to buy-back a customer's system at fair value on specified future dates if certain minimum performance thresholds are not met. Management believes the likelihood of a customer exercising its system put-rights is remote and, to date, no such repurchases have been triggered.
 
Future Financing Commitments
 
As specified in the Company's joint venture agreement with AU Optronics Singapore Pte. Ltd. ("AUO"), the Company and its joint venture parter (the shareholders) contributed certain funding on July 5, 2010. The shareholders will each contribute additional amounts from fiscal 2011 to 2014 amounting to $335 million, or such lesser amount as the parties may mutually agree. In addition, if the shareholders or the joint venture requests additional equity financing to the joint venture, then each shareholder will be required to make additional cash contributions of up to $50 million in the aggregate.
 
On September 28, 2010, the Company invested $0.2 million in a related party, accounted for under the cost method. The Company will be required to provide additional financing of up to $4.9 million, subject to certain conditions.
 
The Company's future financing obligations related to these agreements as of October 3, 2010 are as follows:
 

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(In thousands)
 
Amount
Year
 
 
2010 (remaining three months)
 
$
170
 
2011
 
65,730
 
2012
 
75,870
 
2013
 
101,400
 
2014
 
96,770
 
 
 
$
339,940
 
 
Tax Sharing Agreement
 
The Company has a tax sharing agreement with its former parent, Cypress Semiconductor Corporation (“Cypress”), providing for each of the party's obligations concerning various tax liabilities while it was a wholly-owned subsidiary of Cypress. To the extent that the Company becomes entitled to utilize the Company's separate tax returns portions of any tax credit or loss carryforwards, the Company will distribute to Cypress the tax effect, estimated to be 40% for federal and state 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 Cypress's option. As of January 3, 2010, the Company had $27.6 million of California net operating loss carryforwards, $2.6 million of federal credit carryforwards and $1.4 million of California credit carryforwards, meaning that such potential future payments to Cypress, which would be made over a period of several years, would therefore aggregate $2.2 million. These amounts do not reflect potential adjustments for the effect of the restatement of the Company's consolidated financial statements in fiscal 2009 and 2008. In fiscal 2009, the Company paid $16.5 million in cash to Cypress, of which $15.1 million represents the federal component and $1.4 million represents the state component.
 
The Internal Revenue Service (“IRS”) is currently conducting audits of Cypress's federal income tax returns for fiscal 2006, 2007 and 2008. As of October 3, 2010, Cypress has not notified the Company of any adjustments to the tax liabilities that have been proposed by the IRS. However, the IRS has not completed its examination and there can be no assurance that there will be no material adjustments upon completion of their review. Additionally, while years prior to fiscal 2006 for Cypress's U.S. corporate tax return are not open for assessment, the IRS can adjust net operating loss and research and development carryovers that were generated in prior years and carried forward to fiscal 2006 and subsequent years. If the IRS sustains tax assessments against Cypress for years in which SunPower was included in Cypress's consolidated federal tax return, SunPower may be obligated to indemnify Cypress under the terms of the tax sharing agreement.
 
 
Uncertain Tax Positions
 
Total liabilities associated with uncertain tax positions were $16.8 million and $14.5 million as of October 3, 2010 and January 3, 2010, respectively, and are included in "Other long-term liabilities" in the Company's 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 its tax positions, the Company cannot make a reasonably reliable estimate of the period in which cash settlement will be made for its liabilities associated with uncertain tax positions in other long-term liabilities (see Note 13).
 
Indemnifications
 
The Company is a party to a variety of agreements under which it may be obligated to indemnify the other party with respect to certain matters. Typically, these obligations arise in connection with contracts and license agreements or the sale of assets, under which the Company customarily agrees to hold the other party harmless against losses arising from a breach of warranties, representations and covenants related to such matters as title to assets sold, negligent acts, damage to property, validity of certain intellectual property rights, non-infringement of third party rights and certain tax related matters. In each of these circumstances, payment by the Company is typically subject to the other party making a claim to the Company under the procedures specified in the particular contract. These procedures usually allow the Company to challenge the other party's claims or, in case of breach of intellectual property representations or covenants, to control the defense or settlement of any third party claims brought against the other party. Further, the Company's obligations under these agreements may be limited in terms of activity (typically to replace or correct the products or terminate the agreement with a refund to the other party), duration and/or amounts. In some instances, the Company may have recourse against third parties and/or insurance covering certain payments made by the Company.
 

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Legal Matters
 
Audit Committee Investigation and Related Litigation
 
In November 2009, the Audit Committee of the Company's Board of Directors initiated an independent investigation regarding certain unsubstantiated accounting entries. See Note 1 for information regarding the Audit Committee's investigation. The Audit Committee announced the results of its investigation in March 2010.
 
Three securities class action lawsuits were filed against the Company and certain of its 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 the Company's 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 the Company'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. The Company believes it has meritorious defenses to these allegations and will vigorously defend itself 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. The Company is currently unable to determine if the resolution of these matters will have an adverse effect on the Company's financial position, liquidity or results of operations.
 
Derivative actions purporting to be brought on the Company's behalf have also been filed in state and federal courts against several of the Company's 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. The Company intends to oppose the derivative plaintiffs' efforts to pursue this litigation on the Company's behalf. The Company is currently unable to determine if the resolution of these matters will have an adverse effect on the Company's financial position, liquidity or results of operations.
 
The Company is also a party to various other litigation matters and claims that arise from time to time in the ordinary course of its business. While the Company believes that the ultimate outcome of such matters will not have a material adverse effect on the Company, their outcomes are not determinable and negative outcomes may adversely affect the Company's financial position, liquidity or results of operations.
 
Note 9. JOINT VENTURES
 
Joint Venture with Woongjin Energy Co., Ltd. ("Woongjin Energy")
 
The Company and Woongjin Holdings Co., Ltd. (“Woongjin”) formed Woongjin Energy in fiscal 2006, a joint venture to manufacture monocrystalline silicon ingots in Korea. The Company and Woongjin have funded the joint venture through capital investments. In addition, Woongjin Energy obtained a $33.0 million loan originally guaranteed by Woongjin. The Company supplies polysilicon, services and technical support required for silicon ingot manufacturing to the joint venture. Once manufactured, the Company purchases the silicon ingots from the joint venture under a nine-year agreement through 2016. As of October 3, 2010 and January 3, 2010, $14.6 million and $19.3 million, respectively, remained due and receivable from Woongjin Energy related to the polysilicon the Company supplied to the joint venture for silicon ingot manufacturing. Payments to Woongjin Energy for manufacturing silicon ingots totaled $44.7 million and $134.0 million during the three and nine months ended October 3, 2010, respectively, and $36.0 million and $110.8 million during the three and nine months ended September 27, 2009, respectively. As of October 3, 2010 and January 3, 2010, $24.9 million and $29.2 million, respectively, remained due and payable to Woongjin Energy.
 
 On June 30, 2010, Woongjin Energy completed its initial public offering ("IPO") and the sale of 15.9 million new shares of common stock. Shares of Woongjin Energy's common stock are now traded publicly on the Korean Exchange. The Company did not participate in this common stock issuance by Woongjin Energy. The Company continues to hold 19.4 million shares of Woongjin Energy's common stock with a market value of $312.3 million on October 1, 2010. As a result of the new common

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stock issuance by Woongjin Energy in its IPO, the Company's 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, the Company recognized a non-cash gain of $28.3 million in the second quarter of fiscal 2010 as a result of its equity interest in Woongjin Energy being diluted. In connection with Woongjin Energy's IPO, the Company entered into an agreement to, among other things, restrict its selling or transferring such shares for a period of six months following June 30, 2010. There is no obligation or expectation for the Company to provide additional funding to Woongjin Energy. On October 29, 2010, the Company entered into a revolving credit facility with Union Bank, N.A. ("Union Bank"), and all shares of Woongjin Energy held by the Company have been pledged as security under the revolving credit facility (see Notes 10 and 17).
 
As of October 3, 2010 and January 3, 2010, the Company had a $72.7 million and $33.8 million, respectively, investment in the joint venture in its Condensed Consolidated Balance Sheets which represented a 31.3% and 42.1% equity investment, respectively. The Company accounts for its investment in Woongjin Energy using the equity method of accounting in which the investment is classified as “Other long-term assets” in the Condensed Consolidated Balance Sheets and the Company's share of Woongjin Energy's income totaling $5.7 million and $10.5 million for the three and nine months ended October 3, 2010, respectively, and $2.6 million and $7.1 million for the three and nine months ended September 27, 2009, respectively, is included in “Equity in earnings of unconsolidated investees” in the Condensed Consolidated Statements of Operations. The Company's maximum exposure to loss as a result of its involvement with Woongjin Energy is limited to the carrying value of its investment.
 
The Company recognized zero and $0.3 million in revenue during the three and nine months ended October 3, 2010 related to the sale of solar panels to Woongjin Energy. As of October 3, 2010 no amounts remained due and receivable from Woongjin Energy related to the sale of these solar panels.
 
Summarized financial information adjusted to conform to U.S. GAAP for Woongjin Energy, as it qualifies as a “significant investee” of the Company as defined in SEC Regulation S-X Rule 10-01(b)(1) for the nine months ended October 3, 2010 and September 27, 2009 is as follows:
 
Statement of Operations
 
 
Nine Months Ended
(In thousands)
 
October 3,
2010
 
September 27,
2009
Revenue
 
$
91,944
 
 
$
67,249
 
Cost of revenue
 
49,895
 
 
30,618
 
Gross margin
 
42,049
 
 
36,631
 
Operating income
 
37,194
 
 
33,121
 
Net income
 
28,413
 
 
15,463
 
 
In the past, the Company concluded that it was not the primary beneficiary of the joint venture since, although the Company and Woongjin were both obligated to absorb losses or had the right to receive benefits from Woongjin Energy that were significant to Woongjin Energy, such variable interests held by the Company did not empower it to direct the activities that most significantly impacted Woongjin Energy's economic performance. In reaching this determination, the Company considered the significant control exercised by Woongjin over the venture's Board of Directors, management and daily operations, Woongjin's guarantee of the venture's debt, as well as the relative strategic importance of the venture to both parties. Furthermore, as a result of Woongjin Energy completing its IPO and the sale of 15.9 million new shares of common stock on June 30, 2010, the Company has concluded that Woongjin Energy is no longer a VIE.
 
Joint Venture with First Philec Solar Corporation (“First Philec Solar”)
 
The Company and First Philippine Electric Corporation (“First Philec”) formed First Philec Solar in fiscal 2007, a joint venture to provide wafer slicing services of silicon ingots to the Company. The Company and First Philec have funded the joint venture through capital investments. The Company supplies to the joint venture silicon ingots and technology required for slicing silicon. Once manufactured, the Company purchases the completed silicon wafers from the joint venture under a five-year wafering supply and sales agreement through 2013. As of October 3, 2010 and January 3, 2010, $3.2 million and $1.3 million, respectively, remained due and receivable from First Philec Solar related to the wafer slicing process of silicon ingots supplied by the Company to the joint venture. Payments to First Philec Solar for wafer slicing services of silicon ingots totaled $23.4 million and $61.6 million during the three and nine months ended October 3, 2010, respectively, and $13.8 million and $29.6 million during the three and nine months ended September 27, 2009, respectively. As of October 3, 2010 and January 3,

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Index

2010, $5.9 million and $3.1 million, respectively, remained due and payable to First Philec Solar related to the purchase of silicon wafers.
 
As of October 3, 2010 and January 3, 2010, the Company had a $6.4 million and $6.0 million, respectively, investment in the joint venture in its Condensed Consolidated Balance Sheets which represented a 20% equity investment. The Company accounts for its investment in First Philec Solar using the equity method of accounting since the Company is able to exercise significant influence over the joint venture due to its board positions. The Company's investment is classified as “Other long-term assets” in the Condensed Consolidated Balance Sheets and the Company's share of First Philec Solar's income of $0.1 million and $0.4 million in the three and nine months ended October 3, 2010, respectively, and income of zero and losses of $0.1 million in the three and nine months ended September 27, 2009, respectively, is included in “Equity in earnings of unconsolidated investees” in the Condensed Consolidated Statements of Operations. The amount of equity in earnings increased in the three and nine months ended October 3, 2010 as compared to the same periods in 2009 due to increases in production since First Philec Solar became operational in the second quarter of fiscal 2008. The Company's maximum exposure to loss as a result of its involvement with First Philec Solar is limited to the carrying value of its investment.
 
The Company has concluded that it is not the primary beneficiary of the joint venture since, although the Company and First Philec are both obligated to absorb losses or have the right to receive benefits from First Philec Solar that are significant to First Philec Solar, such variable interests held by the Company do not empower it to direct the activities that most significantly impact First Philec Solar's economic performance. In reaching this determination, the Company considered the significant control exercised by First Philec over the venture's Board of Directors, management and daily operations, as well as the relative strategic importance of the venture to both parties.
 
Equity Option Agreement with NorSun
 
In January 2008, the Company entered into an Option Agreement with NorSun, a manufacturer of silicon ingots and wafers, under which the Company would deliver cash advance payments to NorSun for the purchase of polysilicon under a long-term polysilicon supply agreement. The Company paid a cash advance totaling $16.0 million to an escrow account as security for NorSun's right to future advance payments. This $16.0 million cash advance was reflected as restricted cash on the Condensed Consolidated Balance Sheets as of both October 3, 2010 and January 3, 2010. In addition, the Company paid a cash advance of $5.0 million to NorSun during the fourth quarter of fiscal 2009 that was reflected as advances to suppliers on the Condensed Consolidated Balance Sheets as of both October 3, 2010 and January 3, 2010. Under the terms of the Option Agreement, the Company could exercise a call option and apply the advance payments to purchase from NorSun a 23.3% equity interest, subject to certain adjustments, in a joint venture that is being constructed to manufacture polysilicon in Saudi Arabia. The Company could exercise its option at any time until six months following the commercial operation of the Saudi Arabian polysilicon manufacturing facility. The Option Agreement also provided NorSun an option to sell the 23.3% equity interest to the Company. NorSun's option was exercisable through the six months following commercial operation of the polysilicon manufacturing facility. The Company accounted for the put and call options as one instrument, which were measured at fair value at each reporting period. The changes in the fair value of the combined option were recorded in “Other, net” in the Condensed Consolidated Statements of Operations and have not been material.
 
On July 2, 2010, NorSun exercised its option to sell the 23.3% equity interest in the joint venture to the Company at a price of $5.0 million, equivalent to the cash advance paid to NorSun by the Company during the fourth quarter of fiscal 2009. The Company and NorSun anticipate that the share transfer will occur in the fourth quarter of fiscal 2010. Beginning on the date the shares are transferred, the Company will account for its investment in the joint venture using the equity method of accounting.
 
The Company has concluded that it is not the primary beneficiary of the joint venture since, although the Company, NorSun and other private equity and principal investment firms that own equity in the joint venture are each obligated to absorb losses or have the right to receive benefits from the joint venture that are significant to the venture, such variable interests held by the Company do not empower it to direct the activities that most significantly impacts the joint venture's economic performance. In reaching this determination, the Company considered the significant control exercised by NorSun and other private equity and principal investment firms over the venture's Board of Directors, management and daily operations, as well as the relative strategic importance of the venture to all parties.
 
Joint Venture with AUO
 
On May 27, 2010, the Company, through its subsidiaries SunPower Technology, Ltd. (“SPTL") and AUOSP, formerly SunPower Malaysia Manufacturing Sdn. Bhd. ("SPMY"), entered into a joint venture agreement with AUO, and AU Optronics Corporation, the ultimate parent company of AUO (“AUO Taiwan”). The joint venture transaction closed on July 5, 2010. The

25

Index

Company, through SPTL, and AUO each own 50% of the joint venture AUOSP. AUOSP owns a solar cell manufacturing facility ("FAB3") in Malaysia and will manufacture solar cells and sell them on a “cost-plus” basis to the Company and AUO.
 
On July 5, 2010, the Company and AUO also entered into licensing and joint development, supply, and other ancillary transaction agreements. Through the licensing agreement, SPTL and AUO licensed to AUOSP, on a non-exclusive, royalty-free basis, certain background intellectual property related to solar cell manufacturing (in the case of SPTL), and manufacturing processes (in the case of AUO). Under the seven-year supply agreement with AUOSP, renewable by the Company for one-year periods thereafter, the percentage of AUOSP's total annual output allocated on a monthly basis to the Company, which the Company is committed to purchase, ranges from 95% in the fourth quarter of fiscal 2010 to 80% in fiscal year 2013 and thereafter. The Company and AUO have the right to reallocate supplies from time to time under a written agreement. As required under the joint venture agreement, on November 5, 2010, the Company and AUOSP entered into an agreement under which the Company will resell to AUOSP polysilicon purchased from a third-party supplier and AUOSP will provide prepayments to the Company related to such polysilicon, which prepayment will then be made by the Company to the third-party supplier (see Note 8).
 
The joint venture agreement provides for both equity and debt financing components. The shareholders will not be permitted to transfer any of AUOSP's shares held by them, except to each other and to their direct or indirect wholly-owned subsidiaries. On July 5, 2010, the Company, through SPTL, and AUO each contributed total initial funding of Malaysian Ringgit 45.0 million and will 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. 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 (See Note 8).
 
AUOSP retains the existing debt facility agreement with the Malaysian Government for FAB3 and AUO has agreed to arrange for additional third-party debt financing for AUOSP. If such third-party debt financing is not so obtained, then AUO has agreed to procure or provide to AUOSP, on an interim basis, the debt financing reasonably necessary to fund in a timely manner AUOSP's business plan, until such time as third-party financing is procured and replaces such interim financing.
 
The Company has concluded that it is not the primary beneficiary of the joint venture since, although the Company and AUO are both obligated to absorb losses or have the right to receive benefits, the Company alone does not have the power to direct the activities of the VIE that most significantly impact its economic performance. As a result of the shared power arrangement the Company deconsolidated AUOSP in the third quarter of fiscal 2010 and accounts for its investment in the joint venture under the equity method of accounting. The Company recognized a non-cash gain of $23.0 million as a result of deconsolidating the carrying value of AUOSP as of July 5, 2010. Under the deconsolidation accounting guidelines, an investor's opening investment is recorded at fair value on the date of deconsolidation. The Company recognized an additional non-cash gain of $13.8 million representing the difference between the initial fair value of the investment and its carrying value. The total non-cash gain of $36.8 million upon deconsolidation is classified as "Other income" in both the three and nine months ended October 3, 2010 within the Company's Condensed Consolidated Statements of Operations.
 
In determining the fair value of the opening investment in AUOSP the Company used a combination of the cost, market and income approaches. The gain resulting from the fair value of the initial investment is primarily related to the intellectual property contributed by both shareholders under the licensing agreement. The contributed technology under the licensing agreement with AUOSP was valued using a relief from royalty method, which applies a royalty rate based on an analysis of market-derived royalty rates for guideline intangible assets. The royalty rate was applied to anticipated revenue which is projected over the expected remaining useful life of the technology.
 
As of October 3, 2010, the Company had a $27.7 million investment in AUOSP in its Condensed Consolidated Balance Sheet which represents its 50% equity investment. The Company accounts for its investment in AUOSP using the equity method of accounting in which the investment is classified as “Other long-term assets” in the Condensed Consolidated Balance Sheet. The Company will account for its share of AUOSP's net income or loss for the three months ended October 3, 2010 in “Equity in earnings of unconsolidated investees” in the Condensed Consolidated Statement of Operations during the fourth quarter of fiscal 2010 due to a quarterly lag in reporting. As of October 3, 2010, $0.7 million remained due and payable to AUOSP and $6.2 million remained due and receivable from AUOSP. The Company's maximum exposure to loss as a result of its involvement with AUOSP is limited to the carrying value of its investment.
 
Note 10. DEBT AND CREDIT SOURCES
 
The following table summarizes the Company's outstanding debt as of October 3, 2010 and their related maturity dates:
 

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Index

 
 
 
 
Payments Due by Period
(In thousands)
 
Face Value
 
2010
(remaining
three months)
 
2011
 
2012
 
2013
 
2014
 
Beyond
2014
Convertible debt:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
4.50% debentures
 
$
250,000
 
 
$
 
 
$
 
 
$
 
 
$
 
 
$
 
 
$
250,000
 
4.75% debentures
 
230,000
 
 
 
 
 
 
 
 
 
 
230,000
 
 
 
1.25% debentures
 
198,608
 
 
 
 
 
 
198,608
 
 
 
 
 
 
 
0.75% debentures
 
79
 
 
 
 
 
 
 
 
 
 
 
 
79
 
 
 
$
678,687
 
 
$
 
 
$
 
 
$
198,608
 
 
$
 
 
$
230,000
 
 
$
250,079
 
 
 Convertible Debt
 
The following table summarizes the Company's outstanding convertible debt:
 
 
 
October 3, 2010
 
January 3, 2010
(In thousands)
 
Carrying Value
 
Face Value
 
Fair Value (1)
 
Carrying Value
 
Face Value
 
Fair Value (1)
4.50% debentures
 
$
176,709
 
 
$
250,000
 
 
$
232,910
 
 
$
 
 
$
 
 
$
 
4.75% debentures
 
230,000
 
 
230,000
 
 
212,693
 
 
230,000
 
 
230,000
 
 
270,250
 
1.25% debentures
 
178,555
 
 
198,608
 
 
180,982
 
 
168,606
 
 
198,608
 
 
172,789
 
0.75% debentures
 
79
 
 
79
 
 
74
 
 
137,968
 
 
143,883
 
 
139,746
 
 
 
$
585,343
 
 
$
678,687
 
 
$
626,659
 
 
$
536,574
 
 
$
572,491
 
 
$
582,785
 
 
(1)    
The fair value of the convertible debt was determined based on quoted market prices as reported by an independent pricing source.
 
4.50% Debentures
 
On April 1, 2010, the Company issued $220.0 million in principal amount of its 4.50% senior cash convertible debentures (“4.50% debentures”) and received net proceeds of $214.9 million, before payment of the net cost of the call spread overlay described below. On April 5, 2010, the initial purchasers of the 4.50% debentures exercised the $30.0 million over-allotment option in full and the Company received net proceeds of $29.3 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 the Company's class A common stock (or any other securities). Prior to December 15, 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 the Company's 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, the Company will deliver an amount of cash calculated by reference to the price of its 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. The Company may not redeem the 4.50% debentures prior to maturity. Holders may also require the Company 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 the Company's 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 4.50% debentures will have the right to declare all amounts then outstanding due and payable.
 
The 4.50% debentures are senior, unsecured obligations of the Company, ranking equally with all existing and future senior unsecured indebtedness of the Company. The 4.50% debentures are effectively subordinated to the Company's secured indebtedness to the extent of the value of the related collateral and structurally subordinated to indebtedness and other liabilities of the Company's subsidiaries. The 4.50% debentures do not contain any sinking fund requirements.
 
The embedded cash conversion option within the 4.50% debentures and the over-allotment option related to the 4.50% debentures are derivative instruments that are required to be separated from the 4.50% debentures and accounted for separately as derivative instruments (derivative liabilities) with changes in fair value reported in the Company's Condensed Consolidated

27

Index

Statements of Operations until such transactions settle or expire. The initial fair value liabilities of the embedded cash conversion option and over-allotment option of $71.3 million and $0.5 million, respectively, were classified within “ Other long-term liabilities” and simultaneously reduced the carrying value of “Convertible debt, net of current portion” (effectively an original issuance discount on the 4.50% debentures of $71.8 million) in the Company's Condensed Consolidated Balance Sheet.
 
From April 1, 2010 to April 5, 2010, the date the initial purchasers of the 4.50% debentures exercised the $30.0 million over-allotment option in full, the Company incurred a non-cash loss of $1.4 million related to the change in fair value of the over-allotment option during that period. The non-cash loss of $1.4 million is reflected in “Gain (loss) on mark-to-market derivatives” in the Company's Condensed Consolidated Statements of Operations for the nine months ended October 3, 2010. Upon the exercise of the over-allotment option, the ending fair value liability of the over-allotment option on April 5, 2010 of $1.9 million was reclassified to the original issuance discount of the 4.50% debentures.
 
In addition, the initial $10.0 million fair value liability of the embedded cash conversion option within the $30.0 million of additional principal of the Company's 4.50% debentures purchased upon exercise of the over-allotment option was classified within “Other long-term liabilities” and simultaneously reduced the carrying value of “Convertible debt, net of current portion” (the total original issuance discount on the 4.50% debentures was $79.9 million) in the Company's Condensed Consolidated Balance Sheet. In the three and nine months ended October 3, 2010, the Company recognized a non-cash loss of $4.0 million and a non-cash gain of $36.3 million, respectively, recorded in “Gain (loss) on mark-to-market derivatives” in the Company's Condensed Consolidated Statements of Operations related to the change in fair value of the embedded cash conversion option. The fair value liability of the embedded cash conversion option as of October 3, 2010 totaled $45.1 million and is classified within “Other long-term liabilities” in the Company's Condensed Consolidated Balance Sheet.
 
The embedded cash conversion option and the over-allotment option derivative instruments are fair valued utilizing Level 2 inputs consisting of the exercise price of the instruments, the Company's class A common stock price, the risk free interest rate, the contractual term and the Company's class A common stock volatility. Such derivative instruments are not traded on an open market as the banks are the counterparties to the instruments. The over-allotment option was exercised during the second quarter of fiscal 2010 and the final value of the over-allotment option represented the difference between the value of the embedded cash conversion option at the original trade date of the initial $220.0 million in principal amount of the 4.50% debentures and the trade date of the over-allotment option. This final value was adjusted against the original issuance discount of the cash convertible bond.
 
Significant inputs for the valuation of the embedded cash conversion option as of October 3, 2010 are as follows:
 
 
Embedded option (1)
Stock price
$
14.06
 
Exercise price
$
22.53
 
Interest rate
1.04
%
Stock volatility
51.50
%
Maturity date
February 18, 2015
 
 
(1)    
 The valuation model utilizes these inputs to value the right but not the obligation to purchase one share at $22.53. The Company utilized a Black-Scholes model to value the embedded cash conversion option. The underlying input assumptions were determined as follows:
(i)    
Stock price. The closing price of the Company's class A common stock on the last trading day of the quarter.
(ii)    
Exercise price. The exercise price of the embedded conversion option.
(iii)    
Interest rate. The Treasury Strip rate associated with the life of the embedded conversion option.
(iv)    
Stock volatility. The volatility of the Company's class A common stock over the life of the embedded conversion option.
 
The Company recognized $2.5 million and $5.7 million in non-cash interest expense during the three and nine months ended October 3, 2010, respectively, related to the amortization of the debt discount on the 4.50% debentures. The principal amount of the outstanding 4.50% debentures, the unamortized discount and the net carrying value as of October 3, 2010 was $250.0 million, $73.3 million and $176.7 million, respectively. As of October 3, 2010 the remaining weighted average period over which the unamortized debt discount associated with the 4.50% debentures will be recognized is as follows:
 

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Index

 (In thousands)
 
Debt Discount
2010 (remaining three months)
 
$
3,248
 
2011
 
13,368
 
2012
 
15,225
 
2013
 
17,340
 
2014
 
19,748
 
Thereafter
 
4,362
 
 
 
$
73,291
 
   
Call Spread Overlay with Respect to 4.50% Debentures (“CSO2015”)
 
Concurrent with the issuance of the 4.50% debentures, the Company 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 the Company's exposure to potential cash payments upon conversion of the 4.50% debentures. The net cost of the CSO2015 was $12.1 million and $1.6 million in the first and second quarters of fiscal 2010, respectively.
 
Under the terms of the Bond Hedge, the Company bought from affiliates of certain of the initial purchasers' options to acquire, at an exercise price of $22.53 per share, subject to anti-dilution adjustments, cash in an amount equal to the market value of up to 9.8 million shares of the Company's class A common stock. Each Bond Hedge is a separate transaction, entered into by the Company with each option counterparty, and is not part of the terms of the 4.50% debentures. The Company paid aggregate consideration of $66.2 million and $9.0 million for the Bond Hedge on March 25, 2010 and April 5, 2010, respectively.
 
Under the terms of the Warrants, the Company sold to affiliates of certain of the initial purchasers of the 4.50% cash convertible debentures warrants to acquire, at an exercise price of $27.03 per share, subject to anti-dilution adjustments, cash in an amount equal to the market value of up to 9.8 million shares of the Company's class A common stock. Each Warrant transaction is a separate transaction, entered into by the Company with each option counterparty, and is not part of the terms of the 4.50% debentures. The Warrants were sold for aggregate cash consideration of $54.1 million and $7.4 million on March 25, 2010 and April 5, 2010, respectively.
 
The CSO2015, which are indexed to the Company's class A common stock, are derivative instruments that require mark-to-market accounting treatment due to their cash settlement features until such transactions settle or expire. The initial fair value of the Bond Hedge of $75.2 million was classified as “Other long-term assets” and the initial fair value of the Warrants of $61.5 million was classified as “Other long-term liabilities” in the Company's Condensed Consolidated Balance Sheet. As of October 3, 2010, the fair value of the Bond Hedge is $44.7 million, a decrease of $30.5 million, and the fair value of the Warrants is $37.0 million, a decrease of $24.5 million. The change in fair value of these two derivative instruments resulted in a mark-to-market net non-cash gain of $1.0 million and a net non-cash loss of $6.0 million in “Gain on mark-to-market derivatives” in the Company's Condensed Consolidated Statements of Operations during the three and nine months ended October 3, 2010, respectively.
 
The Bond Hedge and Warrants derivative instruments are fair valued utilizing Level 2 inputs consisting of the exercise price of the instruments, the Company's class A stock price, the risk free interest rate, the contractual term and the Company's class A common stock volatility. Such derivative instruments are not traded on an open market. Valuation techniques utilize the inputs described above in addition to liquidity and institutional credit risk inputs.
 
The Bond Hedge and Warrants described above represent a call spread overlay with respect to the 4.50% debentures. Assuming full performance by the counterparties, the transactions effectively reduce the Company's potential payout over the principal amount on the 4.50% debentures upon conversion of the 4.50% debentures into cash.
 
Significant inputs into the valuation of the Bond Hedge and Warrants at the October 3, 2010 measurement date are as follows:
 

29

Index

 
Bond Hedge (1)
 
Warrants (1)
Stock price
$
14.06
 
 
$
14.06
 
Exercise price
$
22.53
 
 
$
27.03
 
Interest rate
1.04
%
 
1.04
%
Stock volatility
51.50
%
 
48.80
%
Credit risk adjustment
1.18
%
 
Not applicable
 
Maturity date
February 18, 2015
 
 
July 7, 2015
 
 
(1)    
The valuation model utilizes these inputs to value the right but not the obligation to purchase one share at $22.53 and $27.03 for the Bond Hedge and Warrants, respectively. The Company utilized a Black-Scholes model to value the Bond Hedge and Warrants. The underlying input assumptions were determined as follows:
(i)    
Stock price. The closing price of the Company's class A common stock on the last trading day of the quarter.
(ii)    
Exercise price. The exercise price of the Bond Hedge and Warrants.
(iii)    
Interest rate. The Treasury Strip rate associated with the life of the Bond Hedge and Warrants.
(iv)    
Stock volatility. The volatility of the Company's class A common stock over the life of the Bond Hedge and Warrants.
(v)    
Credit risk adjustment. Represents the average of the credit default swap rate of the counterparties.
 
4.75% Debentures
 
In May 2009, the Company issued $230.0 million in principal amount of its 4.75% senior convertible debentures (4.75% debentures”) and received net proceeds of $225.0 million, before payment of the net cost of the call spread overlay described below. 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 the Company's 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 the Company 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 the Company's 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.
 
The 4.75% debentures are senior, unsecured obligations of the Company, ranking equally with all existing and future senior unsecured indebtedness of the Company. The 4.75% debentures are effectively subordinated to the Company's secured indebtedness to the extent of the value of the related collateral and structurally subordinated to indebtedness and other liabilities of the Company's subsidiaries.
 
Call Spread Overlay with Respect to 4.75% Debentures (“CSO2014”)
 
Concurrent with the issuance of the 4.75% debentures, the Company entered into certain convertible debenture hedge transactions (the “Purchased Options”) with affiliates of certain of the underwriters of the 4.75% debentures. The Purchased Options allow the Company to purchase up to 8.7 million shares of the Company's class A common stock and are intended to reduce the potential dilution upon conversion of the 4.75% debentures in the event that the market price per share of the Company's class A common stock at the time of exercise is greater than the conversion price of the 4.75% debentures. The Purchased Options will be settled on a net share basis. Each convertible debenture hedge transaction is a separate transaction, entered into by the Company with each option counterparty, and is not part of the terms of the 4.75% debentures. The Company paid aggregate consideration of $97.3 million for the Purchased Options on May 4, 2009. The exercise price of the Purchased Options is $26.40 per share of the Company's class A common stock, subject to adjustment for customary anti-dilution and other events.
 
The Purchased Options, which are indexed to the Company's 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 u