Our mission is to transform Cypress Semiconductor Corporation (“Cypress”) from a traditional, broad-line semiconductor company to a leading supplier of programmable system solutions. We deliver high-performance, mixed-signal, programmable solutions that provide customers with rapid time-to-market and system value. Our offerings include the programmable system-on-chip (“PSoC”) products, universal serial bus (“USB”) controllers, general-purpose programmable clocks and memories. Cypress also offers wired and wireless connectivity solutions that enhance connectivity and performance in multimedia handsets. Cypress serves numerous markets including consumer, computation, data communications, automotive, industrial and, through our majority-owned subsidiary SunPower Corporation (“SunPower”), solar power.
As of the end of fiscal 2006, our internal organization was structured into the following reportable business segments:
Reportable Segments
Description
Consumer and Computation Division a product division focusing on general-purpose timing solutions, USB and PSoC products Data Communications Division a product division focusing on data communication devices for wireless handset and professional / personal video systems Memory and Imaging Division a product division focusing on static random access memories (“SRAM”), nonvolatile memories and image sensor products SunPower a majority-owned subsidiary of Cypress specializing in solar power products Other includes Silicon Light Machines (“SLM”), a majority-owned subsidiary of Cypress specializing in optical components, Silicon Valley Technology Center (“SVTC”), a division of Cypress, certain foundry-related services performed by us on behalf of others, and certain corporate expenses
We were incorporated in California in December 1982. The initial public offering of our common stock occurred in May 1986, at which time our common stock commenced trading on the Nasdaq National Market. In February 1987, we were reincorporated in Delaware and in October 1988, we began listing our common stock on the New York Stock Exchange under the symbol “CY.” Our corporate headquarters are located at 198 Champion Court, San Jose, California 95134, and our main telephone number is (408) 943-2600. We maintain a website at www.cypress.com. The contents of our website are not incorporated into, or otherwise to be regarded as part of, this Annual Report on Form 10-K.
Business Strategies
We have made substantial progress in our mission to become a leading “programmable solutions” company. In addition to building a comprehensive programmable product portfolio based on our PSoC platform, we have divested businesses that do not align with our long-term plans, and have made a successful shift to flexible manufacturing. We have also added senior management with broad experience defining and bringing to market new generations of high-performance programmable products. We exited fiscal 2006 with our most-focused product portfolio ever, which helped drive design wins to an all-time record.
We will continue to pursue the following key strategies:
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Drive programmability – Our proprietary programmable technology and programmable product leadership, led by our PSoC family of devices, is an important competitive advantage. Driven by current and anticipated demand, we will continue to define, design and develop new programmable products and solutions that offer our customers increased flexibility and efficiency, higher performance, and higher levels of integration. Ÿ
Extend technology leadership and drive “PSoC Everywhere” – The first and most important step of our programmability initiative is to drive “PSoC Everywhere,” meaning in any possible application. PSoC devices can be used in a wide array of applications ranging from MP3 players and handsets to running shoes, appliances, laptops and fitness equipment. The product’s easy-to-use PSoC Express programming software and broad range of development kits can facilitate rapid adoption across many different platforms. Ÿ
Expand our customer base – Cypress’ strategy is to grow its customer base rapidly through direct sales, independent sales representatives and distributors. No longer satisfied with a few thousand customers, Cypress, with its flagship PSoC product, is targeting tens of thousands of smaller customers who are looking to compete against larger competitors using the flexible, programmable PSoC platform. Ÿ
Collaborate with customers to build system-level solutions – Cypress works closely with customers from initial product design through manufacturing and delivery. Our sales, customer and technical support, product marketing and development efforts are organized to maximize our customers’ design efforts, helping them to speed time-to-market. Our engineering expertise is focused on developing whole product solutions, including software and reference designs. Ÿ
Flexible manufacturing – Our manufacturing strategy combines capacity from leading foundries with output from Cypress’ internal fabs. The initiative allows us to meet rapid swings in customer demand without the burden of high fixed costs, a capability that is particularly important in high-volume consumer markets that we serve with our leading programmable product portfolio. Ÿ
“ No More Moore ” – With many of our leading programmable products no longer requiring aggressive linewidth reductions, we abandoned our longstanding commitment to independent process technology development based on Moore’s Law. We will continue to have access to leading-edge processes for our products that do require world-class manufacturing processes through our foundry relationships. Ÿ
Continuing to build and support SunPower – We are the majority stockholder of SunPower and will continue to support SunPower to become the leader in high-performance solar power products. We will continue to work with SunPower to maintain its technology advantage, expand manufacturing capacity while reducing manufacturing costs, drive efficiency improvements through relationships with suppliers and customers, and develop a leading brand name. Ÿ
Exiting legacy or non-strategic, underperforming businesses – A focused business will allow us to better achieve our current objectives. Over the past year, we have divested certain business units that were inconsistent with our future initiatives and long-term plans. Exiting these businesses will allow us to focus our current resources and efforts on the core business model. Ÿ
Pursuing complementary strategic relationships – Complementary acquisitions can expand our markets and strengthen our competitive position. As part of our growth strategy, we continue to assess opportunities to develop strategic relationships, including acquisitions, investments and joint development projects with key partners and other businesses. As we continue to implement our strategies, there are internal and external factors that could impact our ability to meet any or all of our objectives. Some of these factors are discussed under Item 1A “Risk Factors.”
Business Segments and Product/Service Overview
Consumer and Computation Division:
The Consumer and Computation Division designs and develops solutions for many of the world’s leading manufacturers of consumer and computation end products. Its programmable product offerings are the linchpin of our programmable solutions strategy. This division’s products include PSoC devices, the industry’s broadest selection of USB controllers and WirelessUSB products, general-purpose programmable clocks and programmable-radio-on-a-chip (“PRoC”) products. PSoC products are used in various consumer applications such as MP3 players, mass storage, household appliances, laptop computers and toys. USB is used primarily in PC applications and is finding increased adoption rates in consumer devices such as MP3 players, mobile handsets and set-top boxes. During the third quarter of fiscal 2006, we sold our personal clock (“PC Clock”) product line, a component of this division, to Spectra Linear (see “Divestitures” below).
PSoC . Our PSoC products are mixed-signal arrays with an on-board microcontroller, providing a low-cost, single-chip solution for a variety of consumer, industrial and control applications. The mixed-signal arrays integrate a microcontroller and the analog and digital components that typically surround it in an embedded system. A single PSoC device can integrate as many as 100 peripheral functions with a microcontroller, saving customers design time, board space, power consumption, and system costs. Our PSoC CapSense device replaces dozens of mechanical switches and controls with simple, touch-sensitive controls. CapSense-based “button” and slider controls are more reliable than their mechanical counterparts because they are not prone to the environmental wear-and-tear that affects exposed buttons and switches. PSoC allows customers to modify designs at any time, providing unmatched flexibility.
USB Controllers. USB provides the primary connection between a PC and peripherals, including keyboards, mice, printers, joysticks, scanners and modems. It is also used to connect various non-PC systems, such as handheld games, digital still cameras and MP3 players. The USB standard facilitates a “plug-and-play” architecture that enables instant recognition and interoperability when a USB-compatible peripheral is connected to a system. We offer a full range of USB solutions, including low-speed (1.5 Mbps), full-speed (12 Mbps) and high-speed (480 Mbps) USB products. We also offer a variety of USB hubs, transceivers, serial interface engines and embedded-host products for a broad range of applications.
WirelessUSB. Designed for short-range wireless connectivity, WirelessUSB enables personal computer peripherals, gaming controllers, remote controls, toys, and other point-to-point or multipoint-to-point applications to “cut the cord” with a low-cost, 2.4-GHz wireless solution. The WirelessUSB system acts as a USB human interface device, so the connectivity is transparent to the designer at the operating system level. WirelessUSB also operates as a simple, cost-effective wireless link in a host of other applications including industrial, consumer, and medical markets.
Programmable Clocks . Programmable timing solutions such as Cypress’s InstaClock device combine high performance with the flexibility and fast time to market of field-programmable devices at a cost that is competitive against custom clocks at equivalent volumes. Working with our easy-to-use CyberClocks software, designers can optimize device parameters such as drive strength, phased-lock loop bandwidth and crystal input capacitive loading. Cypress’s programmable clocks are ideal for devices requiring multiple frequencies including Ethernet, PCI, USB, HDTV, and audio applications.
RoboClock Clock Buffers. Our RoboClock family of clock buffers feature programmable output skew, programmable multiply/divide factor, and user-selectable redundant reference clocks that provide fault tolerance. Designers can control output skew and multiply and divide factors to help accommodate last-minute changes. RoboClock offers a high-performance timing solution for designers of communications, computation and storage networking applications.
PRoC. PRoC includes two of our technologies—WirelessUSB and PSoC—in one integrated device. It offers access to a general-purpose mixed signal array with four programmable analog and four programmable digital
blocks, 8 Kbytes of flash program memory storage, 512 bytes of SRAM data storage, an 8-bit microcontroller, and a powerful direct sequence spread spectrum 2.4 GHz radio system. It is an ideal solution for quickly implementing highly integrated, space-saving, low-cost, wireless systems operating in the worldwide 2.4-GHz ISM band.
Data Communications Division:
The Data Communications Division focuses on communication products, peripheral controllers, dual-port interconnects, programmable logic devices and Power PSoC. Our communication products are primarily used in the networking and telecommunications market. This division also makes a line of HDMI switches, cable drivers and equalizers for the professional video market.
Our specialty memory products consist of first-in, first-out and dual port memories. First-in, first-out memories are used for applications such as switches and routers, and dual port memories are used in switching applications and handsets, including networking switches and routers, cellular base stations, mass storage devices, mobile handsets, and telecommunication equipment.
Dual-Port Memories. Dual ports, which can be accessed by two different processors or buses simultaneously, target shared-memory and switching applications, including networking switches and routers, cellular base stations, mass storage devices and telecommunications equipment. We offer a portfolio of over 160 synchronous and asynchronous dual-port interconnects ranging in densities from 8 Kbits to 36 Mbits with speeds of up to 250 MHz. Our dual ports are the compelling solutions for interprocessor communication in a broad range of applications. For high-volume multiprocessor applications (wireless handsets, PDAs, consumer) we offer the MoBL dual port, providing a low cost, quick time-to-market interconnect solution with the industry’s lowest power-consumption.
First-In, First-Out (“FIFO”) Memories. FIFOs are used as a buffer between systems operating at different frequencies. Our high-performance FIFO products provide the ideal solution to interconnect problems such as flow control, rate matching, and bus matching. Our FIFO portfolio is comprised of more than 100 synchronous and asynchronous memories in a variety of speeds, bus widths, densities and packages. Using industry-standard pinouts, these products are easily integrated into new and existing designs. Unidirectional, bidirectional, tri-bus and double sync configurations are available with built-in expansion logic and message-passing capabilities for various markets including video, data communications, telecommunications and network switching/routing.
Physical Layer Devices. Our portfolio includes HOTLink, HOTLinkDX and HOTLinkII.These transceiver families cover data transmission rates of 50 Mbps up to 1.5 Gbps. These flexible devices are ideal for proprietary serial backplane applications. They also comply with many industry standards such as 10 Gbps Ethernet, gigabit Ethernet, Fibre Channel, Enterprise System Connection, Digital Video Broadcast, and high-definition television. In addition, we supply a chipset for the transmission of digital video signals. This chipset is based on our HOTLink family and is widely used in professional digital video equipment such as editing, routing, recording and storage.
Programmable Logic Devices (“PLDs”) . System logic performs non-memory functions such as floating-point mathematics or the organization and routing of signals throughout a computer system. We manufacture several types of PLDs, that facilitate the replacement of multiple standard logic devices with a single programmable device, increasing flexibility and reducing time to market. Our wide range of PLDs includes products ranging from 32 to more than 3,000 macrocells.
Peripheral Bridge Controllers. Our West Bridge Antioch peripheral controller, targeting the handsets market, is the first in a family of new devices that enables users to talk on the phone while downloading music from their PC. The device uses Cypress Simultaneous Link to Independent Multimedia architecture to free the phone’s processor from USB and storage-management tasks and to enable high-performance data transfers.
Memory and Imaging Division:
The Memory and Imaging Division consists of our memory business and image sensor business. Our memory business designs and manufactures SRAM products and nonvolatile memories (“nvSRAMs”) which are used to store and retrieve data in networking, wireless infrastructure and handsets, computation, consumer, automotive, industrial and other electronic systems. Our memory products target a variety of markets including networking, telecommunications, wireless communications and consumer applications. Our image sensor products are used in high-end industrial, medical and aeronautic applications.
Asynchronous SRAMs. We manufacture a wide selection of fast asynchronous SRAMs with densities ranging from 16 Kbits to 4 Mbits. Our fast asynchronous portfolio includes the high-performance 16-bit-wide and 24-bit-wide families, which are optimized for the latest generation of fast digital signal processors. These memories are available in many combinations of bus widths, packages and temperature ranges and are ideal for use in network switches and routers, IP phones, IC testers, DSLAM Cards and automotive electronics.
Synchronous SRAMs. Our high-speed synchronous SRAMs include standard synchronous pipelined, No Bus Latency (“NoBL”), Quad Data Rate, and Double Data Rate SRAMs, and are typically used in networking applications. NoBL synchronous SRAMs are optimized for high-speed applications that require maximum bus bandwidth, including those in the networking, instrumentation, video and simulation businesses. Quad Data Rate products are targeted toward next-generation networking applications, particularly switches and routers that operate at data rates beyond 300 MHz. Double Data Rate SRAMs target network applications and servers that operate at data rates up to 400 MHz.
MicroPower SRAMs. Our family of micropower SRAM products provides solutions for wireless and other battery-powered applications, such as cell phones, pagers, radios, handheld games, and GPS systems. Available in densities of up to 32 Mbits, these low-speed, low-power SRAMs extend the operating time of battery-powered products.
nvSRAMs. Cypress makes high-speed nonvolatile SRAM devices that can store data for more than 20 years without battery backup, ensuring data integrity in the event of a power outage. The memories are ideal for copy machines, point-of-sale terminals redundant array of independent disks (“RAID”) storage arrays and consumer electronics.
Pseudo SRAMs (“PSRAMs”). Our Specialty Dynamic Random Access Memory (“DRAM”) business unit manufactures PSRAMs, which is a memory technology that combines a DRAM (a high-density, low-cost-per-bit, random access memory device that provides high-speed data storage and retrieval) with an asynchronous SRAM external interface. PSRAM combines the minimal power consumption of SRAM with a much lower cost-per-bit to provide an economical alternative to SRAM. The target applications include mobile phones and other low-power applications that need low-power SRAM or PSRAM.
Image Sensors. Our CMOS image sensor portfolio spans both the high-end and consumer mass markets where we deliver high-performance sensors for custom and high-end digital photography; ultra high-speed and high dynamic range imaging solutions for machine vision and motion analysis. Our LUPA-300, used in machine vision and motion-analysis applications, features a high frame rate and a fully synchronous snapshot shutter, enabling it to read one image while the next is being acquired and to capture moving objects without distortion.
Other:
Optical Navigation Sensors . SLM’s Ovation-ONS laser-based optical navigation sensor is targeted at high-end and mid-range wired and wireless mice. The sensor delivers fast and precise tracking on more surfaces than other sensors on the market, using our patented OptiCheck technology, which offers outstanding accuracy and a variable resolution ranging from 800 to 2,400 counts per inch.
Grating Light Valve (“GLV”). Designed by SLM, GLV technology switches, modulates and attenuates light in a variety of applications. The GLV is used for applications in the communications, digital imaging, simulation, display and direct-to-print markets.
SVTC. SVTC offers startups and established companies the opportunity to develop and characterize novel silicon-based technologies cost effectively using a shared research and development environment. SVTC provides customers access to a state-of-the-art manufacturing-like fab environment and semiconductor toolset, allowing customers to bring their technologies to mass production quickly and without a costly investment in equipment. During the first quarter of fiscal 2007, we announced our plan to divest SVTC to two private equity firms.
SunPower
SunPower designs, develops, manufactures, markets and sells solar electric power products, systems and services. SunPower’s products are based on its proprietary processes and technologies. It has spent more than 15 years developing high performance solar cells, which are semiconductor devices that directly convert sunlight into electricity. SunPower believes its solar cells have the highest conversion efficiency, a measurement of the amount of sunlight converted by the solar cell into electricity, available for the mass market. During the first quarter of fiscal 2007, SunPower completed the acquisition of PowerLight Corporation (“PowerLight”).
During fiscal 2005, SunPower completed the initial public offering of 8.8 million shares of its class A common stock. During fiscal 2006, SunPower completed a follow-on public offering of 7.0 million shares of its class A common stock. Currently, SunPower has two classes of authorized common stock: class A and class B common stock. As of December 31, 2006, Cypress owned 52.0 million shares of SunPower class B common stock, representing approximately 75% of SunPower’s total outstanding shares of capital stock (approximately 70% of SunPower’s total outstanding shares of capital stock on a fully diluted basis, and approximately 96% of the total voting power of SunPower’s outstanding shares of capital stock).
Only Cypress, its successors in interest and its subsidiaries may hold shares of SunPower class B common stock unless Cypress distributes the shares to its stockholders in a tax-free distribution. Cypress currently does not have any plans to distribute to its stockholders shares of SunPower class B common stock, although Cypress may elect to do so in the future. Cypress is continuing to explore ways in which to allow its stockholders to fully realize the value of its investment in SunPower. There can be no assurance that Cypress will commence or conclude a transaction, or take any other actions, in the short term, or at all.
In conjunction with SunPower’s acquisition of PowerLight, Cypress has entered into an agreement with PowerLight in which Cypress has agreed not to solicit to sell, make any agreement to sell, or make any demand registration rights for any of its 52.0 million SunPower class B common shares until the earlier of (1) June 30, 2007 and (2) 60 days after the date on which the Registration Statement on Form S-3 is filed with the Securities and Exchange Commission in connection with the resale of SunPower class A common stock issued in the PowerLight acquisition.
In addition, in conjunction with the issuance of SunPower’s senior convertible debentures, Cypress has entered into an agreement with SunPower’s underwriters in which Cypress has agreed not to solicit to sell, make any agreement to sell, or make any demand registration rights for any of its 52.0 million SunPower class B common shares for a period up to 60 days beginning February 2, 2007.
See Note 3 and Note 22 of Notes to Consolidated Financial Statements under Item 8, Part II of this Annual Report on Form 10-K for further discussion on the acquisition and the issuance of the senior convertible debentures by SunPower.
Product Overview:
Solar Cells. Solar cell s are semiconductor devices that directly convert sunlight into electricity. SunPower’s current standard solar cell product is the A-300 solar cell, a silicon solar cell with a specified power value of 3.1
watts and a conversion efficiency of between 20% and 21.5%. SunPower believes the A-300 solar cell has the highest conversion efficiency available for the mass market. SunPower’s A-300 solar cell is designed without highly reflective metal contact grids or current collection ribbons on the front of the solar cells. This feature enables SunPower’s solar cells to be assembled into solar panels that exhibit a more uniform appearance than conventional solar panels. SunPower’s next generation solar cells are expected to deliver 3.3 watts and begin commercial production in the second quarter of fiscal 2007.
Solar Panels. Solar panels are solar cells electrically connected together and encapsulated in a weatherproof package. SunPower believes solar panels made with its solar cells are the highest efficiency solar panels available for the mass market. Because SunPower’s A-300 solar cells are more efficient relative to conventional solar cells, when SunPower’s solar cells are assembled into panels, the assembly cost per watt is less because more power can be incorporated into a given size package. Higher solar panel efficiency allows installers to mount a solar power system with more power within a given roof or site area and reduces per watt installation costs.
Inverters. Inverters transform direct current electricity produced by solar panels into the more common form of alternating current electricity. Inverters are used in virtually every on-grid solar power system and typically feed power either directly into the home electrical circuit or into the utility network. SunPower’s inverter product line currently includes five models spanning a power range of 2.5 to 5.2 kilowatts. SunPower’s packaged system designs optimize performance through the appropriate combinations of these inverters with its solar panels.
Imaging Detectors and Infrared Detectors. SunPower’s imaging detectors are high performance, back contact light sensor arrays for medical imaging applications where digital flat panel and computed tomography systems are replacing conventional film-based X-ray imaging. Digital imaging is a demanding application for imaging detectors. X-rays pose a risk of radiation exposure, and this risk of exposure limits the practical dose that can be applied to the patient. A sensor must therefore maximize the conversion of incoming photons into electricity, the same fundamental challenge of solar power generation. SunPower’s imaging detectors are designed to have low current leakage and high sensitivity.
SunPower also offers infrared detectors based on its high performance all back contact technology. SunPower’s infrared detectors are semiconductors which detect light signals primarily for use in computing and mobile phone applications. SunPower’s infrared detectors are used in devices such as personal digital assistants to beam information from one device to another.
Acquisition
The markets in which we compete require a wide variety of technologies, products and capabilities. As discussed above, we are committed to the ongoing evaluation of strategic opportunities and, where appropriate, to the acquisition of additional products, technologies or businesses that are complementary to, or broaden the markets for, our products.
PowerLight:
During the fourth quarter of fiscal 2006, SunPower signed a definitive agreement to acquire PowerLight. The acquisition was subsequently completed during the first quarter of fiscal 2007. PowerLight is a leading global provider of large-scale solar power systems. PowerLight designs, manufactures, markets and sells solar electric power system technology that integrates solar cells and solar panels manufactured by SunPower and other suppliers to convert sunlight to electricity compatible with the utility network. PowerLight also provides solar power systems to end customers on a turn-key, whole-solution basis by developing, engineering, procuring permits and equipment for, managing construction of, offering access to financing for, and providing monitoring, operations and maintenance services for large-scale roof-mounted and ground-mounted solar power applications. PowerLight was a significant customer of SunPower accounting for 16% of SunPower’s revenue in fiscal 2006. SunPower expects that the results of operations of the PowerLight business will be material to its overall operating results in future periods.
See Note 3 and Note 22 of Notes to Consolidated Financial Statements under Item 8, Part II of this Annual Report on Form 10-K for further discussion on the acquisition by SunPower.
Divestitures
In fiscal 2006, we began our efforts to transform Cypress from a traditional, broad-line semiconductor company to a leading supplier of programmable system solutions. This mission is the focus of a restructuring effort that has included, among other initiatives, the divestitures of businesses that do not align with our new long-term business plan. The following table summarizes the divestitures we have successfully completed in fiscal 2006 or announced in the first quarter of fiscal 2007:
Business Units
Reportable Segments Buyers
Consideration
A portion of Network Search Engines (“NSE”) (1)
Data Communications Division NetLogic Microsystems
(“NetLogic”) 1.7 million NetLogic common shares valued at $58.5 million.
PC Clock (1)
Consumer and Computation Division Spectra Linear $8.0 million in cash and 7.4 million Spectra preferred stock valued at $6.4 million.
SVTC (2)
Other Private equity firms $53.0 million in cash.
A portion of Image Sensors (2)
Memory and Imaging Division Sensata Technologies $11.4 million in cash. (1) Completed in fiscal 2006. (2) Expected to be completed by the end of the first quarter of fiscal 2007.
See Note 4 and Note 22 of Notes to Consolidated Financial Statements under Item 8, Part II of this Annual Report on Form 10-K for further discussion on the divestitures.
Manufacturing
During fiscal 2006, we manufactured approximately 81% of our semiconductor products at our wafer fabrication facilities in Round Rock, Texas and Bloomington, Minnesota. These fabrication facilities utilize our proprietary 90-nanometer and 0.13 through 0.8-micron CMOS, 0.25 and 0.8-micron BiCMOS, and 0.35-micron Silicon Nitride Oxide Silicon (“SONOS”) processes. Wafer foundries manufactured the balance of our products.
In December 2005, we entered into a strategic foundry partnership with Grace Semiconductor Manufacturing Corporation (“Grace”), located in Shanghai, China. Under the terms of the agreement, we will transfer certain of our proprietary process technologies to Grace. This agreement will provide additional production capacity to augment output from our manufacturing facilities in Texas and Minnesota. During fiscal 2006, we completed the transfer of our .35-micron SONOS process to Grace and began purchasing products from Grace that were manufactured using this process.
We conduct assembly and test operations, excluding SunPower products, at our highly automated assembly and test facility in the Philippines. This facility accounted for approximately 51% of our total assembly output and 82% of our total test output in fiscal 2006. Various subcontractors in Asia performed the balance of the assembly and test operations.
Our Philippines facility manufactures primarily volume products and packages where our ability to leverage manufacturing costs is high. This facility has nine fully integrated, automated manufacturing lines enabling complete assembly and test operations with minimal human intervention. These autolines have shorter manufacturing cycle times than conventional assembly/test operations, which enable us to respond more rapidly to changes in demand.
SunPower produces its solar cells at its manufacturing facility in the Philippines. SunPower currently operates four solar cell manufacturing lines in this facility, with a total manufacturing capacity of approximately 108 megawatts per year. SunPower has recently started construction of a second solar cell manufacturing facility in the Philippines, which is designed to house up to ten additional manufacturing lines. SunPower expects three manufacturing lines in the new facility to be operational by the end of fiscal 2007, which will give SunPower an aggregate rated manufacturing capacity of approximately 207 megawatts per year. Currently, most of SunPower’s
solar panels are assembled by a third-party subcontractor in China. SunPower supplements this capacity with in-house production at its automated panel assembly factory located in the Philippines. SunPower expects to produce up to 30 megawatts of solar panels per year from its first manufacturing line. The panel assembly factory has sufficient space to expand capacity to 90 megawatts per year.
Research and Development
Research and development expenses are primarily focused on the development and design of new semiconductor and solar power products. Our goal is to increase efficiency in order to maintain our competitive advantage. Our research and development organization works closely with our manufacturing facilities, suppliers and customers to improve our semiconductor and solar cell designs and lower manufacturing costs. Our process technology research focuses primarily on developing derivatives of our .13-micron and 90-nanometer technologies for use in new products. We spent $244.1 million, $226.8 million and $261.6 million on research and development expenses in fiscal 2006, 2005 and 2004, respectively.
We have both central and division-specific design groups that focus on new product creation and improvement of design methodologies. These groups conduct ongoing efforts to reduce design cycle time and increase first pass yield through structured re-use of intellectual property blocks from a controlled intellectual property library, development of computer-aided design tools and improved design business processes. We currently have approximately 40 design teams working on new product designs. Design and related software development work primarily occurs at design centers located in the United States, Europe, India and China.
Sales and Marketing
We sell our products through several channels: sales through global domestically-based distributors; sales through international distributors, trading companies and representative firms; sales by our sales force to direct original equipment manufacturer; and sales by manufacturing representative firms. SunPower’s products are sold worldwide to system integrators and original equipment manufacturers through a direct sales force. Our marketing and sales efforts are organized around four regions: North America, Europe, Japan and Asia/Pacific. We also have a strategic-account group and a contract-manufacturing group which are responsible for specific customers with worldwide operations. We augment our sales effort with field application engineers, specialists in our products, technologies and services who work with customers to design our products into their systems. Field application engineers also help us to identify emerging markets and new products.
Sales to distributors accounted for approximately 59% of our total revenues in fiscal 2006, compared with 53% in fiscal 2005 and 50% in fiscal 2004. International revenues accounted for 72% of our total revenues in fiscal 2006, compared with 70% in fiscal 2005 and 66% in fiscal 2004. No customer accounted for more than 10% of our total revenues in fiscal 2006. Sales to one distributor accounted for 11% and 15% of total revenues in fiscal 2005 and 2004, respectively.
Backlog
Our sales typically rely upon standard purchase orders for delivery of products. Customer relationships are generally not subject to long-term contracts. However, we have entered into long-term supply agreements with certain customers. With the exception of certain long-term supply agreements entered into by SunPower that contain minimum firm purchase commitments, our long-term supply agreements generally do not contain such purchase commitments. Products to be delivered and the related delivery schedules are frequently revised to reflect changes in customer needs. Accordingly, our backlog at any particular date is not representative of actual sales for any succeeding period and we believe that our backlog is not a meaningful indicator of future revenues.
Competition
We face competition from domestic and foreign integrated circuit manufacturers, many of which have advanced technological capabilities and have increased their participation in the markets in which we operate.
We compete with a large number of companies primarily in the telecommunications, data communications, computation and consumer markets. Companies who compete directly with some of our products include Altera, Applied Micro Circuits, Atmel, Freescale Semiconductor, Integrated Device Technology, Lattice Semiconductor, Microchip Technology, Micron Technology, National Semiconductor, OmniVision Technologies, PMC-Sierra, Samsung Electronics, Standard Microsystems, STMicroelectronics, Synaptics, Texas Instruments, Vitesse Semiconductor and Xilinx.
SunPower faces competition from solar power product manufacturers, including BP Solar International, Evergreen Solar, Mitsubishi Electric Corporation, Q-Cells AG, Sanyo Corporation, Sharp Corporation, First Solar and Suntech Power Holdings. In addition, SunPower competes with Hamamatsu Photonics and UDT Sensors in the market for high-performance imaging detectors, and Vishay Intertechnology, Rohm Co. and Agilent Technologies for infrared detectors.
The semiconductor and the solar power industries are intensely competitive and continually evolving. This intense competition results in a challenging operating environment for most companies in these industries, including Cypress and SunPower. This environment is characterized by potential erosion of product sale prices over the life of each product, rapid technological change, limited product life cycles and strong domestic and foreign competition in many markets. Our ability to compete successfully depends on many factors, including:
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our success in developing new products and manufacturing technologies;
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delivery, performance, quality and price of our products;
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diversity of our product line;
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cost effectiveness of our design, development, manufacturing and marketing efforts;
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quality of our customer service, relationships and reputation;
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pace at which customers incorporate our products into their systems;
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number and nature of our competitors and general economic conditions; and
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power efficiency and aesthetic appearance of SunPower’s solar power products. We believe that we currently compete effectively in the above areas to the extent they are within our control; however, our current abilities are not a guarantee of future success. If we are not able to compete successfully in this environment, our business, operating results and financial condition will be harmed.
Environmental Regulations
We use, generate and discharge hazardous chemicals and waste in our research and development and manufacturing activities. United States federal, state and local regulations, in addition to those of other countries in which we operate, impose various environmental rules and obligations, which are becoming increasingly stringent over time, intended to protect the environment and in particular on the management and disposal of hazardous substances. We are committed to the continual improvement of our environmental systems and controls. However, we cannot provide assurance that we have been, or will at all times be, in complete compliance with all environmental laws and regulations. Other laws impose liability on owners and operators of real property for any contamination of the property even if they did not cause or know the contamination. While to date we have not experienced any material adverse impact on our business from environmental regulations, we cannot provide assurance that environmental regulations will not impose expensive obligations on us in the future, or otherwise result in the incurrence of liability such as the following:
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a requirement to increase capital or other costs to comply with such regulations or to restrict discharges;
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liabilities to our employees and/or third parties; and
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business interruptions as a consequence of permit suspensions or revocations or as a consequence of the granting of injunctions requested by governmental agencies or private parties. Intellectual Property
We rely on a combination of patents, copyrights, trade secrets, trademarks and proprietary information to maintain and enhance our competitive position. As of December 31, 2006, we had approximately 1,490 issued patents and approximately 750 additional patent applications on file with the United States Patent and Trademark Office. We are preparing to file more than 160 new patent applications in fiscal 2007. In addition to factors such as innovation, technological expertise and experienced personnel, we believe that patents are increasingly important to remain competitive in our industry. We have an active program to obtain patent and other intellectual property protection.
We have entered into, and in the future may continue to enter into, technology license agreements with third parties that give those parties the right to use patents and other technology developed by us. Some of these agreements also give us the right to use patents and other technologies developed by such other parties, some of which involve payment of royalties. Historically, these arrangements have not been a material source of revenues to us.
Financial Information about Geographic Areas
Financial information about geographic area is incorporated herein by reference to Note 21 of Notes to Consolidated Financial Statements under Item 8, Part II of this Annual Report on Form 10-K.
International revenues historically accounted for a significant portion of our total revenues. Our manufacturing, assembly and test operations located in the Philippines, as well as our international sales offices and design centers, face risks frequently associated with foreign operations including:
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currency exchange fluctuations;
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the devaluation of local currencies;
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political instability;
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labor issues;
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changes in local economic conditions;
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import and export controls;
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potential shortage of electric power supply; and
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changes in tax laws, tariffs and freight rates. To the extent any such risks materialize, our business, financial condition or results of operations could be seriously harmed.
Employees
As of December 31, 2006, we had approximately 5,800 employees worldwide, including SunPower. Geographically, 3,100 employees were located in the Philippines, 2,100 employees were located in the United States and 600 employees were located in other countries. Of the total employees, approximately 4,200 employees were engaged in manufacturing, 900 employees in research and development, and 700 employees in selling, general and administrative functions. None of our employees is represented by a collective bargaining agreement, nor have we ever experienced organized work stoppages.
Executive Officers
Certain information as of December 31, 2006 regarding each of our executive officers is set forth below:
| Name |
Age | Position | ||
| T. J. Rodgers |
58 | President, Chief Executive Officer and Director | ||
| Brad W. Buss |
42 | Executive Vice President, Finance and Administration and Chief Financial Officer | ||
| Ahmad R. Chatila |
40 | Executive Vice President, Memory and Imaging Division | ||
| Sabbas A. Daniel |
44 | Executive Vice President, Quality | ||
| Paul D. Keswick |
49 | Executive Vice President, New Product Development | ||
| Dinesh Ramanathan |
37 | Executive Vice President, Data Communications Division | ||
| Christopher A. Seams |
44 | Executive Vice President, Sales and Marketing and Operations | ||
| Shahin Sharifzadeh |
42 | Executive Vice President, Manufacturing and Research and Development | ||
| Norman P. Taffe |
40 | Executive Vice President, Consumer and Computation Division | ||
| Thomas H. Werner |
46 | Chief Executive Officer, SunPower | ||
| Hal Zarem |
47 | Chief Executive Officer, Silicon Light Machines |
T.J. Rodgers is a co-founder of Cypress and has been a Director and its President and Chief Executive Officer since 1982. Mr. Rodgers serves as a director of Bloom Energy (formerly Ion America), Silicon Light Machines and SunPower. Mr. Rodgers is also a member of the Board of Trustees at Dartmouth College.
Brad W. Buss joined Cypress in 2005 as Executive Vice President, Finance and Administration and Chief Financial Officer. Prior to joining Cypress, Mr. Buss served as Vice President of Finance at Altera Corporation. Mr. Buss spent seven years as a finance executive with Wyle Electronics, culminating as Chief Financial Officer and Secretary of the Atlas Services division. Mr. Buss was also a member of Cisco System’s worldwide sales finance team. In addition, Mr. Buss served as Senior Vice President of Finance and Chief Financial Officer and Secretary at Zaffire, Inc. Mr. Buss currently serves as a board member of Silicon Light Machines.
Ahmad R. Chatila was appointed Executive Vice President, Memory and Imaging Division, in 2005. Prior to his current position, Mr. Chatila served as managing director of the low power memory business unit in the Memory and Imaging Division. Mr. Chatila has been with Cypress since 1991, and has held a number of management roles in wafer technology development, manufacturing and sales.
Sabbas A. Daniel was appointed Executive Vice President, Quality, in 2006. Prior to his current position, Mr. Daniel has held various management positions responsible for Cypress’s reliability and field quality organizations. Before joining Cypress in 1998, Mr. Daniel held management roles at Samsung Semiconductor in Korea.
Paul D. Keswick is the Executive Vice President, New Product Development, since 1996. Prior to his current position, Mr. Keswick has held various management positions, including vice president and general manager for various business divisions. Mr. Keswick has been with Cypress since 1986.
Dinesh Ramanathan was named Executive Vice President, Data Communications Division, in 2005. Prior to his current appointment, Dr. Ramanathan was a business unit director for the specialty memory and communications business units. Prior to joining Cypress in 2004, Dr. Ramanathan held senior marketing and engineering positions at Raza Microelectronics, Raza Foundries and Forte Design Systems.
Christopher A. Seams was named Executive Vice President, Sales and Marketing and Operations, in 2005. Prior to his current appointment, Mr. Seams was Executive Vice President, Manufacturing and Research and Development. Mr. Seams joined Cypress in 1990 and has held a variety of positions in technical and operational management in manufacturing, development and foundry.
Shahin Sharifzadeh was named Executive Vice President, Manufacturing and Research and Development, in 2005. Dr. Sharifzadeh directs our process technology research and development and wafer manufacturing operations worldwide. Prior to his current position, Dr. Sharifzadeh served as Vice President, Research and Development, where he was responsible for all aspects of technology development. Dr. Sharifzadeh joined Cypress in 1989.
Norman P. Taffe was named Executive Vice President, Consumer and Computation Division, in 2005. Prior to his current position, Mr. Taffe has held numerous positions, including marketing director of the programmable logic and interface products divisions, managing director of our mergers and acquisitions and venture funds, managing director of the wireless business unit and most recently, Vice President of the Personal Communications Division. Mr. Taffe joined Cypress in 1989.
Thomas H. Werner has served as SunPower’s Chief Executive Officer and as a member of SunPower’s board of directors since 2003. Prior to joining SunPower, Mr. Werner served as Chief Executive Officer of Silicon Light Machines from 2001 to 2003. Prior to Silicon Light Machines, Mr. Werner was a vice president and general manager at 3Com Corp. Mr. Werner currently serves as a board member of Three-Five Systems, Silicon Light Machines and Cree.
Hal Zarem has served as Silicon Light Machines’ Chief Executive Officer since 2003. Dr. Zarem joined Silicon Light Machines in 2002 as Vice President, Sales and Marketing. Prior to joining Silicon Light Machines, Dr. Zarem held several management positions within the sales and marketing organizations at JDS Uniphase. Dr. Zarem also served as a general manager at Ortel Corporation (since acquired by Agere Corporation).
There are no family relationships between any of our directors or executive officers, nor are any of the above adverse to Cypress in any pending litigation or investigations.
Available Information
We make available our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended, free of charge on our website at www.cypress.com , as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission. The contents of our website are not incorporated into, or otherwise to be regarded as part of, this Annual Report on Form 10-K.
ITEM 1A. RISK FACTORS
We face significant volatility in supply and demand conditions for our products and this volatility, as well as any failure by us to accurately forecast future supply and demand conditions, could materially and negatively impact our business.
The semiconductor industry has historically been characterized by wide fluctuations in the demand for, and supply of, semiconductors. Demand for our products depends in large part on the continued growth of various electronics industries that use our products, including:
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wireless telecommunications equipment;
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computers and computer-related peripherals;
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memory and image sensor;
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networking equipment;
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consumer electronics, automotive electronics and industrial controls; and
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solar power products. In addition, certain of our products, including USB micro-controllers and clocks, are incorporated into computer and computer-related products, which have historically experienced, and may in the future experience,
significant fluctuations in demand. Any downturn or reduction in the growth of these industries could seriously harm our business, financial condition and results of operations.
We order materials and build our products based primarily on our internal forecasts and secondarily on existing orders, which may be cancelled under many circumstances. Because our markets are volatile and subject to rapid technological and price changes, our forecasts may be wrong causing us to make too many or too few of certain products. Also, our customers frequently place orders requesting product delivery almost immediately after the order is made, which makes forecasting customer demand even more difficult, particularly when supply is abundant. In addition, we have in the past spent, and will continue to spend, significant amounts of money to upgrade and increase our wafer fabrication, assembly and test manufacturing capability and capacity. If we experience inadequate demand or a significant shift in the mix of product orders that makes our existing capacity and capability inadequate, our fixed costs per semiconductor produced will increase, which will harm our financial condition and results of operations. Alternatively, if we should experience a sudden increase in demand, we will need to quickly ramp our inventory and/or manufacturing capacity to adequately respond to our customers. If we are unable to ramp our inventory or manufacturing capacity in a timely manner or at all, we risk losing our customers’ business, which could have a negative impact on our financial performance and reputation.
Our business, financial condition and results of operations will be seriously harmed if we fail to compete successfully in our highly competitive industry and markets.
The semiconductor industry is intensely competitive. This intense competition results in a difficult operating environment that is marked by erosion of average selling prices over the lives of each product and rapid technological change resulting in limited product life cycles. In order to offset selling price decreases, we attempt to decrease the manufacturing costs of our products and to introduce new, higher priced products that incorporate advanced features. If these efforts are not successful or do not occur in a timely manner, or if our newly introduced products do not gain market acceptance, our business, financial condition and results of operations could be seriously harmed. Furthermore, we expect our competitors to invest in new manufacturing capacity and achieve significant manufacturing yield improvements in the future. These developments could dramatically increase the worldwide supply of competitive products and result in further downward pressure on prices.
A primary cause of this highly competitive environment is the strength of our competitors. The industry consists of major domestic and international semiconductor companies, many of which have substantially greater financial, technical, marketing, distribution and other resources than we do. We face competition from other domestic and foreign high-performance integrated circuit manufacturers, many of which have advanced technological capabilities and have increased their participation in markets that are important to us. We believe that there is a variety of competing technologies under development by other companies that could result in lower manufacturing costs than those expected for our products. Our development efforts may be rendered obsolete by the technological advances of others, and other technologies may prove more advantageous for the commercialization of solar power products and semiconductors generally.
Our ability to compete successfully in the rapidly evolving semiconductor technology industry depends on many factors, including:
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our success in developing new products and manufacturing technologies;
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the quality and price of our products;
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the diversity of our product line;
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the cost effectiveness of our design, development, manufacturing and marketing efforts;
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our customer service;
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our customer satisfaction;
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the pace at which customers incorporate our products into their systems;
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the number and nature of our competitors and general economic conditions; and
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our access to and the availability of capital. Although we believe we currently compete effectively in the above areas to the extent they are within our control, given the pace of change in the industry, our current abilities are not a guarantee of future success. If we are unable to compete successfully in this environment, our business, financial condition and results of operations will be seriously harmed.
Our financial results could be adversely impacted if we fail to develop, introduce and sell new products or fail to develop and implement new technologies.
Like many semiconductor companies, which frequently operate in a highly competitive, quickly changing environment marked by rapid obsolescence of existing products, our future success depends on our ability to develop and introduce new products that customers choose to buy. We introduce significant numbers of products each year, which are important sources of revenue for us. If we fail to introduce new product designs in a timely manner or are unable to manufacture products according to the requirements of these designs, or if our customers do not successfully introduce new systems or products incorporating our products, or market demand for our new products does not exist as anticipated, our business, financial condition and results of operations could be seriously harmed.
For us and many other semiconductor companies, introduction of new products is a major manufacturing challenge. The new products the market requires tend to be increasingly complex, incorporating more functions and operating at faster speeds than prior products. Increasing complexity generally requires smaller features on a chip. This makes manufacturing new generations of products substantially more difficult than prior generations. Ultimately, whether we can successfully introduce these and other new products depends on our ability to develop and implement new ways of manufacturing semiconductors. If we are unable to design, develop, manufacture, market and sell new products successfully, our business, financial condition and results of operations would be seriously harmed.
The complex nature of our manufacturing activities makes us highly susceptible to manufacturing problems and these problems can have a substantial negative impact on us when they occur.
Making semiconductors is a highly complex and precise process, requiring production in a tightly controlled, clean environment. Even very small impurities in our manufacturing materials, difficulties in the wafer fabrication process, defects in the masks used to print circuits on a wafer or other factors can cause a substantial percentage of wafers to be rejected or numerous chips on each wafer to be non-functional. We, and similarly, our third party foundry partners, may experience problems in achieving an acceptable success rate in the manufacture of wafers and the likelihood of facing such difficulties is higher in connection with the transition to new manufacturing methods. The interruption of wafer fabrication or the failure to achieve acceptable manufacturing yields at any of our facilities, or the facilities of our third party foundry partners, would seriously harm our business, financial condition and results of operations. We may also experience manufacturing problems in our assembly and test operations and in the introduction of new packaging materials.
In addition, the manufacturing of SunPower’s solar cells is a highly complex process. Minor deviations in the manufacturing process can cause substantial decreases in yield and in some cases, cause production to be suspended or yield no output. SunPower has from time to time experienced lower than anticipated manufacturing yields. This often occurs during the production of new products or the installation and start-up of new process technologies or equipment. For example, SunPower recently acquired equipment for a fourth cell production line and purchased a building to house its second solar cell manufacturing facility. As SunPower expands its manufacturing capacity and brings additional lines or facilities into production, it may experience lower yields initially as is typical with any new equipment or process. SunPower also expects to experience lower yields initially as it migrates its manufacturing processes to thinner wafers. If SunPower does not achieve planned yields, its product costs could increase, and product availability would decrease resulting in lower revenues than expected.
Problems in the performance or availability of other companies we hire to perform certain manufacturing and transport tasks can seriously harm our financial performance.
A high percentage of our products are currently fabricated in our manufacturing facilities located in Texas, Minnesota and the Philippines. However, we also increasingly rely on independent contractors to manufacture some of our products. If market demand for our products exceeds our internal manufacturing capacity and available capacity from our foundry partners, we may seek additional foundry manufacturing arrangements. A shortage in foundry manufacturing capacity, which is more likely to occur at times of increasing demand, could hinder our ability to meet demand for our products and therefore adversely affect our operating results. We cannot guarantee that any foundries that supply our wafers will not experience manufacturing problems, including yield deficiencies or delays in the realization of advanced manufacturing process technologies. In addition, greater demand for wafers produced by any such foundries without an offsetting increase in foundry capacity raises the likelihood of potential wafer price increases.
While a high percentage of our products are assembled, packaged and tested at our manufacturing facility located in the Philippines, we rely on independent subcontractors to assemble, package and test the balance of our products. We cannot be certain that these subcontractors will continue to assemble, package and test products for us on acceptable economic and quality terms or at all and it might be difficult for us to find alternatives if they do not do so.
We also rely on independent carriers and freight haulers to move our products between manufacturing plants and our customers. Transport or delivery problems due to their error or because of unforeseen interruptions in their business due to factors such as strikes, political instability, terrorism, natural disasters or accidents could seriously harm our business, financial condition and results of operations and ultimately impact our relationship with our customers.
SunPower is currently facing an industry-wide shortage of polysilicon. The prices that SunPower pays for polysilicon have increased recently and SunPower expects these price increases to continue, which may constrain revenue growth and decrease gross margins and profitability. In addition, an inability to secure adequate polysilicon supplies could severely hurt operations and result in a significant decrease in SunPower’s and Cypress’ revenues and profits.
Polysilicon is an essential raw material in SunPower’s production of photovoltaic, or solar, cells and also in the solar cells and modules used by its PowerLight business to produce solar power systems. There is currently an industry-wide shortage of polysilicon, which has resulted in significant price increases. SunPower expects that the average price of polysilicon will continue to increase. Increases in polysilicon prices have in the past increased SunPower’s manufacturing costs and may impact its manufacturing costs and net income in the future. As demand for solar cells has increased, many of SunPower’s principal competitors have announced plans to add additional manufacturing capacity. As this manufacturing capacity becomes operational, it will increase the demand for polysilicon and further exacerbate the current shortage. Polysilicon is also used in the semiconductor industry generally and any increase in demand from that sector will compound the shortage. The production of polysilicon is capital intensive and adding additional capacity requires significant lead time. While SunPower is aware that several new facilities for the manufacture of polysilicon are under construction, it does not believe that the supply imbalance will be remedied in the near term. SunPower expects that polysilicon demand will continue to outstrip supply throughout 2007 and potentially for a longer period.
Although SunPower has contracted with vendors for what it believes will be an adequate supply of silicon ingots through 2007, SunPower’s estimates regarding its supply needs may not be correct and its purchase orders and contracts may be cancelled by its suppliers. The volume and pricing associated with these purchase orders and contracts may be changed by its suppliers based on market conditions. SunPower’s purchase orders are generally non-binding in nature. If SunPower’s suppliers were to cancel its purchase orders or change the volume or pricing associated with these purchase orders and/or contracts, SunPower may be unable to meet customer demand for its products, which could cause SunPower to lose customers, market share and revenue. This would
have a material negative impact on SunPower’s business and operating results. If SunPower’s manufacturing yields decrease significantly, it adds manufacturing capacity faster than currently planned or its suppliers cancel or fail to deliver, SunPower may not have made adequate provision for its polysilicon needs for the balance of the year. In addition, SunPower currently purchases polysilicon and makes advances to suppliers to secure future polysilicon supply, which adversely affects its liquidity. These advances may in the future take the form of equity issuances, which would result in additional dilution to SunPower’s stockholders, including Cypress.
The inability to obtain sufficient polysilicon, ingots or wafers at commercially reasonable prices or at all would adversely affect SunPower’s ability to meet existing and future customer demand for its products and could cause SunPower to make fewer shipments, lose customers and market share and generate lower than anticipated revenue, thereby seriously harming SunPower’s and Cypress’ business, financial condition and results of operations.
SunPower will continue to be dependent on a limited number of third-party suppliers for key components for its products, which could prevent it from delivering products to its customers within required timeframes, which could result in installation delays, cancellations, liquidated damages and loss of market share.
In addition to SunPower’s reliance on a small number of suppliers for its solar cells and panels, SunPower’s newly acquired PowerLight business relies on a limited number of third party suppliers for key components for its solar power systems, some of whom are competitors of SunPower. If certain of our competitors who are currently supplying solar panels to PowerLight were to terminate or reduce their supply commitments, PowerLight would be unable to meet customer demand which would adversely impact SunPower’s and Cypress’ financial results.
If SunPower fails to develop or maintain its relationships with these or its other suppliers, SunPower may be unable to manufacture its products or its products may be available only at a higher cost or after a long delay. To the extent the processes that SunPower’s suppliers use to manufacture components are proprietary, SunPower may be unable to obtain comparable components from alternative suppliers. The failure of a supplier to supply components in a timely manner, or to supply components that meet SunPower’s quality, quantity and cost requirements, could impair SunPower’s ability to manufacture its products or decrease their costs. If SunPower cannot obtain substitute materials on a timely basis or on acceptable terms, SunPower could be prevented from delivering its products to its customers within required timeframes, which could result in installation delays, cancellations, liquidated damages and loss of market share, any of which could have a material adverse effect on SunPower’s and Cypress’ business and results of operations.
A limited number of SunPower’s customers are expected to continue to comprise a significant portion of its revenues and any decrease in revenue from these customers could have an adverse effect on SunPower.
Even though SunPower’s customer base is expected to increase and its revenue streams to diversify as a result of its acquisition of PowerLight in the first quarter of fiscal 2007, a large portion of SunPower’s net revenues will likely continue to depend on sales to a limited number of customers as well as the ability of those customers to sell solar power products that incorporate SunPower’s solar cells and panels. Furthermore, PowerLight directly competes, as a distributor of solar panels and systems, with many of SunPower’s customers. For example, both Conergy AG and Solon AG, two of SunPower’s largest customers, actively compete with PowerLight’s business in the large-scale solar power plant market. SunPower’s customer relationships have been developed over a short period of time. SunPower cannot be certain that these customers will generate significant revenue in the future or if these customer relationships will continue to develop in light of the PowerLight acquisition. If SunPower’s relationships with its other customers do not continue to develop, it may not be able to expand its customer base or maintain or increase its revenues. The loss of sales to any of these customers would have a significant negative impact on SunPower’s and Cypress’ business.
If the market for solar power products takes longer to develop than SunPower anticipates or does not develop at all, or if SunPower fails to compete successfully in the solar power market, its revenue and profitability could be adversely affected.
The market for solar power products manufactured by SunPower is emerging and rapidly evolving. If solar power technology proves unsuitable for widespread commercial deployment or if demand for SunPower’s products or solar power products generally fails to develop sufficiently or at all, SunPower’s revenues and profitability could be affected adversely. In addition, demand for solar power products in the markets and geographic regions SunPower targets may develop more slowly than it anticipates or not at all. Many factors will influence the adoption of solar power technology as well as SunPower’s ability to compete in the solar power products market, including:
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cost effectiveness of solar power technologies as compared with conventional and non-solar alternative energy technologies;
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performance and reliability of solar power products as compared with conventional and non-solar alternative energy products;
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success in developing new products and manufacturing technologies;
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ability to continue to ramp SunPower’s manufacturing capacities;
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the quality and price of SunPower’s products;
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the availability of the raw materials, including polysilicon, used in the production of solar cell products;
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the number and nature of SunPower’s competitors and general economic conditions;
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access to and the availability of capital;
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success of alternative power generation technologies;
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fluctuations in economic and market conditions which impact the viability of conventional and non-solar alternative energy sources, such as increases or decreases in the prices of oil and other fossil fuels;
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the possibility of future product failures and the warranty implications thereof;
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availability of, and dependence on, subsidies and other incentives provided by various governmental agencies; and
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existing or future regulations and policies that may present additional technical, economic or regulatory barriers. SunPower generally does not have long-term agreements with its customers and, accordingly, could lose customers without warning.
SunPower does not have long-term agreements with customers, but instead operates on a purchase order basis. Although SunPower believes that cancellations on its purchase orders to date have been insignificant, its customers may cancel or reschedule purchase orders with SunPower on relatively short notice. Cancellations or rescheduling of customer orders could result in the delay or loss of anticipated sales without allowing SunPower sufficient time to reduce, or delay the incurrence of, its corresponding inventory and operating expenses. In addition, changes in forecasts or the timing of orders from these or other customers expose SunPower to the risks of inventory shortages or excess inventory. This in turn could cause SunPower’s operating results to fluctuate.
Although SunPower expects the acquisition of PowerLight to be beneficial, such benefits may not be realized because of integration difficulties or other challenges.
During the first quarter of fiscal 2007, SunPower completed the acquisition of PowerLight, a privately-held leading provider of large-scale solar power systems. PowerLight has global operations that will need to be integrated successfully in order for SunPower to realize the benefits anticipated from the acquisition. Realizing these benefits will require the integration of technology, operations and personnel of SunPower and PowerLight into a single organization. SunPower expects the integration to be a complex, time-consuming and expensive process that, even with proper planning and implementation, could cause significant disruption. The challenges that SunPower may face include, but are not limited to, the following:
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consolidating operations, including rationalizing corporate information technology and administrative infrastructures;
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management gaining sufficient experience with technologies and markets in which the PowerLight business is involved, which may be necessary to successfully operate and integrate the business;
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implementing and monitoring PowerLight’s revenue recognition policy on a “percent completion” basis;
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coordinating sales and marketing efforts between the two companies;
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overcoming any perceived adverse changes in business focus or model;
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realizing synergies necessary to meet SunPower’s long-term margin targets, given PowerLight’s historical margins;
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coordinating and harmonizing research and development activities to accelerate introduction of new products and technologies with reduced cost;
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preserving customer, supplier, distribution and other important relationships of SunPower and PowerLight and resolving any potential conflicts that may arise;
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retaining key employees and maintaining employee morale;
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addressing differences in the business cultures of SunPower and PowerLight;
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coordinating and combining operations, relationships and facilities outside of the United States, which may be subject to additional constraints imposed by geographic distance, local laws and regulations; and
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creating a consolidated internal control over financial reporting structure so that SunPower and its independent auditors can report on the effectiveness of SunPower’s internal controls over financial reporting. SunPower may not be able to successfully integrate the operations of PowerLight in a timely manner, or at all. In addition, SunPower may not realize the anticipated benefits and synergies of the acquisition to the extent or when anticipated. Even if the integration of SunPower and PowerLight’s operations, products and personnel is successful, it may place a significant burden on SunPower’s management resources. The diversion of management’s attention and any difficulties encountered in the transition and integration process could harm SunPower’s business, financial condition and operating results.
SunPower intends to recognize most of their revenues generated from PowerLight on a “percent completion” basis and upon the achievement of contractual milestone, so any delay or cancellation of a project could adversely affect SunPower’s and Cypress’ results of operations.
PowerLight, which was acquired by SunPower in the first quarter of fiscal 2007, recognizes revenue on a “percent completion” basis and, as a result, the revenue from this business is driven by its performance of its contractual obligations, which is generally driven by timelines for the installation of its solar power systems at customer sites. SunPower intends to recognize revenue from projects of the PowerLight business on a similar basis. As a consequence, SunPower will delay the recognition of revenue from sales of cells and panels to PowerLight until PowerLight recognizes revenue. This could result in unpredictability of SunPower’s revenue and, in the near term, a revenue decrease, both of which could negatively impact SunPower’s and Cypress’ results of operations.
As with any project-related business, there is the potential for delays within any particular customer project. Variation of project timelines and estimates may impact SunPower’s ability to recognize revenue in a particular
period. In addition, certain customer contracts may include payment milestones due at specified points during a project. Because SunPower’s PowerLight business usually must invest substantial time and incur significant expense in advance of achieving milestones and the receipt of payment, failure to achieve such milestones could adversely affect SunPower’s and Cypress’ business and results of operations.
Our ability to meet our cash requirements depends on a number of factors, many of which are beyond our control.
As of December 31, 2006, our outstanding debt obligations primarily included $599.0 million of aggregate principal amount of our 1.25% convertible subordinated notes (“1.25% Notes”). During the first quarter of fiscal 2007, we called for redemption of all of our 1.25% Notes, resulting in total cash payment of approximately $179.7 million to the holders of the 1.25% Notes and the issuance of 33.0 million shares of our common stock.
Our ability to meet our cash requirements is dependent upon our future performance, which will be subject to financial, business and other factors affecting our operations, many of which are beyond our control. We cannot guarantee that our business will generate sufficient cash flows from operations to fund our cash requirements or to meet our debt service obligations. If we are unable to meet our cash requirements from operations, we would be required to fund these cash requirements by alternative financing. The degree to which we may be leveraged could materially and adversely affect our ability to obtain financing for working capital, acquisitions or other purposes, could make us more vulnerable to industry downturns and competitive pressures or could limit our flexibility in planning for, or reacting to, changes and opportunities in our industry, which may place us at a competitive disadvantage. There can be no assurance that we would be able to obtain alternative financing, that any such financing would be on acceptable terms or that we will be permitted to do so under the terms of our existing financing arrangements. In the absence of such financing, our ability to respond to changing business and economic conditions, make future acquisitions, react to adverse operating results, meet our debt service obligations, or fund required capital expenditures may be adversely affected.
Any guidance that we may provide about our business or expected future results may prove to differ from actual results.
From time to time we have shared our views in press releases or SEC filings, on public conference calls and in other contexts about current business conditions and our expectations as to potential future results. Identifying correctly the key factors affecting business conditions and predicting future events is inherently an uncertain process. Our analyses and forecasts have in the past and, given the complexity and volatility of our business, will likely in the future, prove to be incorrect. We offer no assurance that such predictions or analysis will ultimately be accurate, and investors should treat any such predictions or analyses with appropriate caution.
We consolidate SunPower’s financial results in the results of operations we report to the public in press releases and our SEC filings. SunPower’s financial performance may be affected by a number of factors, including, but not limited to:
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the average selling price of its solar cells and modules;
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the availability and pricing of raw materials, particularly polysilicon;
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the rate and cost at which it is able to expand its manufacturing capacity to meet customer demand;
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timing, availability and changes in government incentive programs;
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unplanned additional expenses such as manufacturing failures, defects or downtime;
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the loss of one or more key customers or the significant reduction or postponement of orders from these customers;
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foreign currency fluctuations, particularly in the Euro or Philippine peso;
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currency fluctuations and the effect of its currency hedging activities;
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changes in the relative sales mix of its solar cells, solar panels and imaging detectors;
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the availability, pricing and timeliness of delivery of other products, such as inverters, necessary for its solar power products to function; Ÿ
decreases in the overall average selling prices of its solar power products and imaging detectors; and
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increases or decreases in electric rates due to fossil fuel prices. Any analysis or forecast that we make which ultimately proves to be inaccurate may adversely affect our stock price.
The trading price for our common stock has been and may continue to be volatile and can be affected by the trading price of SunPower class A common stock and/or speculation about the possibility of future actions we might take in connection with our SunPower holdings.
The trading price of our common stock has been and will likely continue to be volatile. The trading price of our common stock may fluctuate widely in response to various factors, some of which are beyond our control, including:
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quarterly variations in our results of operations or those of our competitors;
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announcements by us or our competitors of acquisitions, new products, significant contracts, commercial relationships or capital commitments;
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perceptions of general market conditions in the semiconductor industry;
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our ability to develop and market new and enhanced products on a timely basis;
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any major change in our board or management;
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changes in governmental regulations or in the status of our regulatory compliance;
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recommendations by securities analysts or changes in earnings estimates concerning us;
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announcements about our earnings that are not in line with analyst expectations;
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announcements by our competitors of their earnings that are not in line with analyst expectations;
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short sales, hedging and other derivative transactions on shares of our common stock;
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economic conditions and growth expectations in the markets in which our customers participate; and
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general economic conditions. In addition, the implied market value of the shares of class B common stock of SunPower we hold has, since SunPower’s initial public offering, been significant relative to the total value of our outstanding common stock. As a result, the trading price of our common stock has been and likely will continue to be affected by several factors related to SunPower, including:
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the trading price for SunPower class A common stock; and
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actions taken or statements made by us, SunPower or others concerning the potential separation of SunPower from us, including by spin-off, split-off or sale. Further, the stock market in general, and the market for technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. These broad market and industry factors may seriously harm the market price of our common stock, regardless of our actual operating performance. In the past, following periods of volatility in the overall market and the market price of a company’s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.
We may be unable to protect our intellectual property rights adequately and may face significant expenses as a result of ongoing or future litigation.
Protection of our intellectual property rights is essential to keeping others from copying the innovations that are central to our existing and future products. Our flexible fab initiative requires us to enter into technology transfer agreements with external foundry partners, providing third party access to our manufacturing intellectual property and resulting in additional risk to our intellectual property. Consequently, we may become involved in litigation to enforce our patents or other intellectual property rights, to protect our trade secrets and know-how, to determine the validity or scope of the proprietary rights of others or to defend against claims of invalidity. We are
also from time to time involved in litigation relating to alleged infringement by us of others’ patents or other intellectual property rights.
Intellectual property litigation is frequently expensive to both the winning party and the losing party and could take up significant amounts of management’s time and attention. In addition, if we lose such a lawsuit, a court could find that our intellectual property rights are invalid, enabling our competitors to use our technology, or require us to pay substantial damages and/or royalties or prohibit us from using essential technologies. For these and other reasons, this type of litigation could seriously harm our business, financial condition and results of operations. Also, although in certain instances we may seek to obtain a license under a third party’s intellectual property rights in order to bring an end to certain claims or actions asserted against us, we may not be able to obtain such a license on reasonable terms or at all.
For a variety of reasons, we have entered into technology transfer and/or license agreements with third parties that give those parties the right to use the patents and other technology developed by us and/or give us the right to use the patents and other technology developed by them. In some cases, these technology transfer and/or license agreements are governed by foreign law, which could afford less protection and/or result in increased costs to enforce such agreements. We anticipate that we will continue to enter into these kinds of licensing arrangements in the future. It is possible, however, that licenses we want will not be available to us on commercially reasonable terms or at all. If we lose existing licenses to key technology, or are unable to enter into new licenses that we deem important, our business, financial condition and results of operations could be seriously harmed.
It is critical to our success that we are able to prevent competitors from copying our innovations. Therefore, we intend to continue to seek intellectual property protection for our technologies. The process of seeking patent protection can be long and expensive and we cannot be certain that any currently pending or future applications will actually result in issued patents, or that, even if patents are issued, they will be of sufficient scope or strength to provide meaningful protection or any commercial advantage to us. Furthermore, others may develop technologies that are similar or superior to our technology or design around the patents we own.
We also rely on trade secret protection for our technology, in part through confidentiality agreements with our employees, consultants and third parties. However, these parties may breach these agreements and we may not have adequate remedies for any breach. Also, others may come to know about or determine our trade secrets through a variety of methods. In addition, the laws of certain countries in which we develop, manufacture or sell our products may not protect our intellectual property rights to the same extent as the laws of the United States.
The unfavorable outcome of litigation or investigations pending against us could materially impact our business.
Our financial results could be materially adversely impacted by unfavorable outcomes to any pending or future litigation or investigations. There can be no assurances as to the favorable outcome of any litigation or investigations. Although management currently believes that resolving all of these matters, individually or in the aggregate, will not have a material adverse impact on our financial position or results of operations, such litigation, investigations and other claims are subject to inherent uncertainties and management’s view of these matters may change in the future. There exists the possibility of a material adverse impact on our financial position and the results of operations for the period in which the effect of an unfavorable final outcome becomes probable and reasonably estimable.
We face additional problems and uncertainties associated with international operations that could seriously harm us.
International revenues historically accounted for a significant portion of our total revenues. Our manufacturing, assembly and test operations located in the Philippines, as well as our international sales offices and design centers, face risks frequently associated with foreign operations including:
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currency exchange fluctuations;
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the devaluation of local currencies;
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political instability;
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labor issues;
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changes in local economic conditions;
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import and export controls;
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potential shortage of electric power supply; and
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changes in tax laws, tariffs and freight rates. To the extent any such risks materialize, our business, financial condition or results of operations could be seriously harmed.
SunPower’s efforts to establish an effective, unified system of internal control over financial reporting with respect to PowerLight could present challenges, and SunPower, and as a result Cypress on a consolidated basis, may not be able to accurately report financial results or prevent fraud.
PowerLight has not been required to prepare a report on the effectiveness of its internal controls over financial reporting because it was not subject to the informational requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act. In August 2006, PowerLight’s audit committee received a letter from its independent auditors identifying certain material weaknesses in its internal controls over financial reporting relating to its audits for 2005, 2004 and 2003. These material weaknesses included problems with financial statement close processes and procedures, inadequate accounting resources, unsatisfactory application of the percentage of completion accounting method, inaccurate physical inventory counts, incorrect accounting for complex capital transactions and inadequate disclosure of related party transactions. In addition, PowerLight had to restate its 2004 and 2003 financial statements to correct previously reported amounts primarily related to its contract revenue, contract costs, accrued warranty, California state sales tax accrual and inventory items. SunPower has begun remediation efforts with respect to the material weaknesses identified by PowerLight’s independent auditors. Although initiated, SunPower’s plan to improve the effectiveness of the internal controls and processes at PowerLight is not complete. It will take some time to put in place the rigorous disclosure controls and procedures desired by SunPower’s management and board of directors. While SunPower expects to complete this remediation process as quickly as possible, doing so depends on several factors beyond SunPower’s control, including the hiring of additional qualified personnel and, as a result, SunPower cannot at this time estimate how long it will take to complete the steps identified above. SunPower’s management will continue to evaluate the effectiveness of the control environment at PowerLight and will continue to refine existing controls. SunPower, or Cypress, cannot assure you that the measures SunPower has taken to date or any future measures will remediate the material weaknesses reported by PowerLight’s independent auditors. Additional deficiencies in PowerLight’s or SunPower’s internal controls may be discovered in the future. Any failure to develop or maintain effective controls, or any difficulties encountered in their implementation or improvement, could harm SunPower’s operating results or cause SunPower to fail to meet its reporting obligations and may result in a restatement of prior period financial statements. Ineffective internal controls could also cause investors to lose confidence in SunPower’s and Cypress’ consolidated reported financial information, which would likely have a negative effect on the trading price of SunPower’s and Cypress’ securities.
We compete with others to attract and retain key personnel, and any loss of, or inability to attract, such personnel would harm us.
To a greater degree than most non-technology companies, we depend on the efforts and abilities of certain key members of management and other technical personnel. Our future success depends, in part, upon our ability to retain such personnel and to attract and retain other highly qualified personnel, particularly product and process engineers. We compete for these individuals with other companies, academic institutions, government entities and other organizations. Competition for such personnel is intense and we may not be successful in hiring or retaining new or existing qualified personnel. If we lose existing qualified personnel or are unable to hire new qualified personnel, as needed, our business, financial condition and results of operations could be seriously harmed.
We are subject to many different environmental, health and safety lows, regulations and directives, and compliance with them may be costly.
We are subject to many different international, federal, state and local governmental laws and regulations related to, among other things, the storage, use, discharge and disposal of toxic, volatile or otherwise hazardous chemicals used in our manufacturing process and the health and safety of our employees. Compliance with these regulations can be costly. We cannot assure you that we have been, or will be at all times in complete compliance with such laws and regulations. If we violate or fail to comply with these laws and regulations, we could be fined or other wise sanctioned by the regulators. Under certain environmental laws, we could be held responsible, without regard to fault, for all of the costs relating to any contamination at our or our predecessors’ past or present facilities and at third party waste disposal sites. We could also be held liable for any and all consequences arising out of human exposure to such substances or other environmental damage.
Over the last several years, there has been increased public awareness of the potentially negative environmental impact of semiconductor manufacturing operations. This attention and other factors may lead to changes in environmental regulations that could force us to purchase additional equipment or comply with other potentially costly requirements. If we fail to control the use of, or to adequately restrict the discharge of, hazardous substances under present or future regulations, we could face substantial liability or suspension of our manufacturing operations, which could seriously harm our business, financial condition and results of operations.
We face increasing complexity in our product design as we adjust to new and future requirements relating to the materials composition of our products, including the restrictions on lead and other hazardous substances that apply to specified electronic products put on the market in the European Union (Restriction on the Use of Hazardous Substances Directive 2002/95/EC, also known as the “RoHS Directive”) and similar legislation in China and California. Other countries, including at the federal and state levels in the United States, are also considering laws and regulations similar to the RoHS Directive. We are redesigning our products regulated under the RoHS Directive in order to be able to continue to offer them for sale. Certain electronic products that we maintain in inventory may be rendered obsolete if not in compliance with the RoHS Directive or similar laws and regulations, which could negatively impact our ability to generate revenue from those products. Our customers and other companies in the supply chain may require us to certify that our products are RoHS compliant. Although we cannot predict the ultimate impact of any such new laws and regulations, they will likely result in additional costs or decreased revenue, and could require that we redesign or change how we manufacture our products.
Our operations and financial results could be severely harmed by certain natural disasters.
Our headquarters, manufacturing facilities in the Philippines and some of our major vendors’ facilities are located near major earthquake faults or are subject to seasonal typhoons. We have not been able to maintain insurance coverage at reasonable costs. Instead, we rely on self-insurance and preventative/safety measures. If a major earthquake or other natural disaster occurs, we may need to spend significant amounts to repair or replace our facilities and equipment and we could suffer damages that could seriously harm our business, financial condition and results of operations.
The failure to integrate our business and technologies with those of companies that we or SunPower have recently acquired, or that we or SunPower may acquire in the future, could adversely affect our financial results.
We and SunPower have made acquisitions and pursued other strategic relationships in the past and may pursue additional acquisitions in the future. If we or SunPower fail to integrate these businesses successfully or properly, our quarterly and annual results may be seriously harmed. Integrating these businesses, people, products and services with our existing business could be expensive, time-consuming and a strain on our resources. Specific issues that we and SunPower face with regard to prior and future acquisitions include:
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integrating acquired technology or products;
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integrating acquired products into our manufacturing facilities;
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assimilating and retaining the personnel of the acquired companies;
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coordinating and integrating geographically dispersed operations;
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our ability to retain customers of the acquired company;
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the potential disruption of our and our suppliers’ ongoing business and distraction of management;
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the maintenance of brand recognition of acquired businesses;
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the failure to successfully develop acquired in-process technology, resulting in the impairment of amounts currently capitalized as intangible assets;
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unanticipated expenses related to technology integration;
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the development and maintenance of uniform standards, corporate cultures, controls, procedures and policies;
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the impairment of relationships with employees and customers as a result of any integration of new management personnel; and
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the potential unknown liabilities associated with acquired businesses. We may incur losses in connection with loans made under our stock purchase assistance plan.
We have outstanding loans, consisting of principal and cumulative accrued interest, of $37.4 million as of December 31, 2006, to employees and former employees under our stockholder-approved 2001 employee stock purchase assistance plan. We made the loans to employees for the purpose of purchasing our common stock. Each loan is evidenced by a full recourse promissory note executed by the employee in favor of Cypress and is secured by a pledge of the shares of our common stock purchased with the proceeds of the loan. In accordance with the plan, the Chief Executive Officer and the Board of Directors did not participate in this program. To date, bad debt write- offs have been immaterial. As of December 31, 2006, we had an allowance for uncollectible loans of $8.4 million. In determining the allowance for uncollectible loans, management considered various factors, including a review of borrower demographics (including geographic location and job grade), loan quality and an independent fair value analysis of the loans and the underlying collateral. While the loans are secured by the shares of our stock purchased with the loan proceeds, the value of this collateral would be adversely affected if our stock price declined significantly. Our security interest in the collateral is currently reflected in security agreements executed by each participant and account control agreements executed by and between us, the participant and the third party service provider who helps administer the plan. We have received notice that the third party vendor who helped administer the plan terminated its relationship with us. While the security agreement executed by each participant precludes them from taking certain action without our consent, the termination of the account control agreements could adversely impact our ability to collect on the collateral in the event of a default by the participant. We are actively pursuing a new third party service provider to administer the plan.
Our results of operations may be adversely affected if a significant amount of these loans were not repaid. Similarly, if our stock price were to decrease, our employees bear greater repayment risk and we would have increased risk to our results of operations. Further, it is likely that our ability to recover outstanding loan amounts from current employees will be greater than our ability to recover these amounts from ex-employees who have left Cypress. However, we are willing to pursue every available avenue, including those covered under the Uniform Commercial Code, to recover these loans by pursuing employees’ and ex-employees’ personal assets should the borrower not repay these loans.
During the second quarter of fiscal 2006, we implemented certain new terms for the SPAP program in an effort to minimize risks and collect the outstanding accrued interest and principal balances. These changes to the SPAP program include, but are not limited to, a requirement to make interest payments after the first quarter of fiscal 2006, a collateral requirement, changes in the interest rates charged on outstanding loan balances, and the requirement to use a portion of the proceeds from the sale of stock options or shares under our employee stock plans to pay down the outstanding balances in certain circumstances.
We maintain self-insurance for certain indemnities we have made to our officers and directors.
Our certificate of incorporation, by-laws and indemnification agreements require us to indemnify our officers and directors for certain liabilities that may arise in the course of their service to us. We self-insure with respect to these indemnifiable claims. If we were required to pay a significant amount on account of these liabilities for which we self-insure, our business, financial condition and results of operations could be seriously harmed.
Recently implemented regulations related to equity compensation could adversely affect our ability to attract, retain and motivate key personnel.
Historically, we have used stock options and other long-term equity incentives as a fundamental component of our employee compensation packages. We believe that stock options and other long-term equity incentives directly motivate our employees to maximize long-term stockholder value and, through the use of vesting, encourage employees to remain with Cypress. The adoption of SFAS No. 123(R) required us to expense stock-based compensation provided to employees and directors beginning in the first quarter of fiscal 2006. This regulation has made it more expensive to grant stock options to employees and has negatively impacted our reported earnings in fiscal 2006. In addition, regulations implemented by the New York Stock Exchange that prohibit NYSE member organizations from giving a proxy to vote on equity-compensation plans unless the beneficial owner of the shares has given voting instructions could make it more difficult for us to grant options to employees in the future. To the extent that new regulations make it more difficult or expensive to grant stock options to employees, we may change our equity compensation strategy, which may make it difficult to attract, retain and motivate key employees, which in turn could materially and adversely affect our business.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
