UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

OR

[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NUMBER 000-31687

EVERGREEN SOLAR, INC.

138 Bartlett Street
Marlboro, Massachusetts 01752
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

(508) 357-2221
(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

259 Cedar Hill Street
Marlboro, Massachusetts 01752
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT)

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [   ] No [X]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: As of October 29, 2004 there were 47,532,582 shares of common stock outstanding.

EVERGREEN SOLAR, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2004

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Evergreen Solar, Inc.

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

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Evergreen Solar, Inc.

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

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Evergreen Solar, Inc.

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

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Notes to Condensed Consolidated Financial Statements

1. Basis of Presentation

The accompanying condensed consolidated interim financial statements of Evergreen Solar, Inc. (“Evergreen Solar” or the “Company”) are unaudited and have been prepared on a basis substantially consistent with the Company’s audited financial statements for the year ended December 31, 2003. The condensed consolidated interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. Consequently, these statements do not include all disclosures normally required by generally accepted accounting principles for annual financial statements. These condensed consolidated interim financial statements should be read in conjunction with the Company’s audited financial statements for the year ended December 31, 2003, which are contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003, which was filed with the Securities and Exchange Commission on March 23, 2004 and as subsequently amended. The unaudited condensed consolidated interim financial statements, in the opinion of management, reflect all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the financial position at September 30, 2004, the results of operations for the three and nine month periods ended September 30, 2004 and 2003, and the cash flows for the nine month periods ended September 30, 2004 and 2003. The balance sheet at December 31, 2003 has been derived from audited financial statements as of that date. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for any other interim period or for the full fiscal year ending December 31, 2004.

The Company’s preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reported periods. Estimates are used when accounting for the collectibility of receivables, valuing deferred tax assets, provisions for warranty claims and inventory obsolescence.

The Company is subject to risks common to companies in the high technology and energy industries including, but not limited to, development by the Company or its competitors of new technological innovations, dependence on key personnel, protection of proprietary technology and compliance with government regulations. Any delay in the Company’s plan to scale up to full capacity may result in increased costs and could impair business operations.

The Company applies the accounting provisions of Accounting Principles Board (“APB”) Opinion 25, and related interpretations, as they relate to stock-based compensation and has elected the disclosure-only alternative permitted under Statement of Financial Accounting Standards, (“SFAS”) No. 123, “Accounting for Stock-Based Compensation.” The Company has disclosed herein pro forma net loss using the fair value based method. All stock-based awards to non-employees are accounted for at their fair market value, as calculated using the Black-Scholes model in accordance with SFAS No. 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure.”

Had compensation expense for the Company’s employee stock option plan been determined based on the fair value at the grant dates for options granted under the plan consistent with SFAS No. 123, the Company’s net loss would have been as follows (in thousands, except per share data):

2. Net Loss per Common Share

The Company computes net loss per common share in accordance with SFAS No. 128, “Earnings Per Share” (“SFAS 128”), and SEC Staff Accounting Bulletin No. 98 (“SAB 98”). Under the provisions of SFAS 128 and SAB 98, basic net loss per common share is computed by dividing net loss attributable to common stockholders by the weighted average number of common shares outstanding during the period. The calculation of diluted net loss per common share for the three and nine month periods ended September 30, 2004 and 2003 does not include

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10,621,004 and 30,042,944 potential shares of common stock equivalents outstanding at September 30, 2004 and 2003, respectively, as their inclusion would be anti-dilutive.

3. Inventory

Inventory consisted of the following at December 31, 2003 and September 30, 2004 (in thousands):

4. Fixed Assets

Fixed assets consisted of the following at December 31, 2003 and September 30, 2004 (in thousands):

During the second quarter of 2004 and as a result of the Company’s successful closing of the Common Stock Private Placement consummated on June 21, 2004, the Company disposed of several pieces of manufacturing equipment in order to replace them with more technologically advanced equipment expected to increase total manufacturing capacity in its Marlboro facility to a target level of 15 megawatts. Equipment with a gross value of $3.7 million was disposed of during the second quarter, for no proceeds, and the Company realized a loss on disposal of $2.0 million. The loss on disposal of fixed assets is included in cost of product revenues. In addition to the equipment disposals, the Company had accelerated the rate of depreciation of some of its other equipment in the second quarter of 2004 that was disposed at the end of the third quarter 2004, resulting in incremental depreciation expense of approximately $133,000 for the three month period ended June 30, 2004, and $400,000 for the three month period ended September 30, 2004, which is also included in cost of product revenues.

5. Guarantor Arrangements

The following is a summary of the Company’s agreements that are within the scope of FASB Interpretation No. 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”).

Product Warranty

The Company provides for the estimated cost of product warranties at the time revenue is recognized. Given the Company’s limited operating history, the Company uses historical industry solar panel failure rates as the basis for the accrued warranty costs during the period. While the Company engages in product quality programs and processes, including monitoring and evaluating the quality of component suppliers, its warranty obligation is affected by product failure rates and material usage and service delivery costs incurred in correcting a product failure. If the Company’s actual product failure rates, material usage or service delivery costs differ from these estimates, accrued warranty costs would be adjusted in the period that such events or costs become known. Since the Company has a limited operating history and its manufacturing process differs from industry standards, its

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experience may be different from the industry data used as a basis for its estimate. While the Company’s methodology takes into account these uncertainties, adjustments in future periods may be required as its products mature. The following table summarizes the activity regarding the Company’s warranty accrual:

Indemnification Agreements

The Company enters into standard indemnification agreements in its ordinary course of business. Pursuant to these agreements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally our business partners. The term of these indemnification agreements is generally perpetual any time after execution of the agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements under certain circumstances may be unlimited. However, the Company has never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. The Company believes the estimated fair value of agreements with parties is minimal as well.

The Company agreed to indemnify, defend and hold harmless each of the purchasers participating in the Company’s Series A Private Placement, their affiliates and their respective officers, directors, agents, employees, subsidiaries, partners, members and controlling persons to the fullest extent permitted by law from and against any and all losses, claims or written threats thereof, damages, expenses (including reasonable fees, disbursements and other charges of counsel) resulting from or arising out of the Company’s breach of any representation or warranty, covenant or agreement in the purchase agreement. The Company believes the estimated fair value of this indemnification agreement is minimal.

The Company agreed to indemnify, defend and hold harmless each of the purchasers participating in the Company’s Common Stock Private Placement, their affiliates and their respective officers, directors, agents, employees, subsidiaries, partners, members and controlling persons to the fullest extent permitted by law from and against any and all losses, claims or written threats thereof, damages, expenses (including reasonable fees, disbursements and other charges of counsel) resulting from or arising out of the Company’s breach of any representation or warranty, covenant or agreement in the purchase agreement. The Company believes the estimated fair value of this indemnification agreement is minimal.

6. Deferred Compensation

Prior to December 31, 2000, the Company recorded total cumulative deferred compensation of approximately $1.3 million, representing the difference between the fair market value of the Company’s common stock and the exercise price on the option grant date. These amounts were presented as a reduction of stockholders’ equity and are being amortized ratably over the vesting period of the options, which is generally four years. The amortization resulted in charges to operations of $207,000 and $67,000 for the nine months ended September 30, 2003 and 2004, respectively.

7. Segment Information

The Company operates as one operating segment. The following table summarizes the Company’s concentration of total revenue:

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8. Stockholders’ Equity

At September 30, 2004, 7,650,000 shares of common stock were authorized for issuance under the Company’s 2000 Stock Option Plan and 4,823,851 shares were reserved for issuance upon conversion of outstanding warrants issued in the Series A Private Placement and the Common Stock Private Placement.

On May 15, 2003, the Company consummated a private placement transaction with certain investors to raise $29.5 million through the issuance of 26,227,668 shares of Series A convertible preferred stock and the sale of a warrant to purchase 2,400,000 shares of common stock. The proceeds to the Company, net of offering costs of approximately $849,000, were approximately $28.6 million.

In order to satisfy the Company’s existing capital requirements and to fund the continuing capacity expansion of its Marlboro, Massachusetts manufacturing facilities, on June 21, 2004, the Company consummated a $18.8 million private placement financing transaction, net of offering costs of approximately $1.2 million, whereby the Company issued 7,662,835 shares of its common stock, and warrants to purchase up to 2,298,851 shares of its common stock, to certain institutional investors pursuant to a stock and warrant purchase agreement dated June 16, 2004, and a warrant agreement dated June 21, 2004 (“Common Stock Private Placement”). Additionally, in connection with the Common Stock Private Placement, the Company issued a warrant to purchase 125,000 shares of common stock to CRT Capital Group LLC, as compensation for CRT Capital Group’s services as the placement agent for the Common Stock Private Placement. The terms of the placement agent warrant is identical to the terms of the warrants issued to the investors participating in the Common Stock Private Placement. The shares of common stock were sold at a per share price of $2.61, which represented a 10% discount to the $2.90 closing price of shares of the Company’s common stock on the Nasdaq National Market as of the close of business on June 15, 2004. The warrants entitle the holders to shares of the Company’s common stock at an exercise price of $3.34. The warrants are exercisable at any time on or after December 22, 2004 and prior to June 22, 2009. The warrants provide that they may only be exercised with respect to 350,000 shares of common stock in the aggregate prior to approval of the exercisability of the remaining warrants by stockholders of the Company.

On April 21, 2004, the Company’s Board of Directors approved a resolution increasing the number of authorized shares of common stock from 70,000,000 to 100,000,000 and correspondingly increasing the total number of authorized shares of capital stock from 96,227,668 to 127,227,668.

The Company’s shareholder meeting was subsequently held on August 20, 2004. At this meeting, the shareholders approved a resolution increasing the number of authorized shares of common stock from 70,000,000 to 100,000,000 and correspondingly increasing the total number of authorized shares of capital stock from 96,227,668 to 127,227,668.

The Company used the proceeds of the Series A Private Placement and intends to use the proceeds of the Common Stock Private Placement to execute its business plan and for further capital expenditures required over the next six months to increase the capacity at the Company’s manufacturing facility to its target level of 15 megawatts for both manufacturing lines, an increase from its previous target of 10 to 14 megawatts, as well as for operating expenditures. In addition to the capacity expansion, the Company intends to use a portion of the proceeds to increase research and development spending on promising next generation technologies and to explore opportunities for further expansion.

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Dividend Rights of Series A Convertible Preferred Stock

On June 21, 2004, holders of all outstanding shares of Series A convertible preferred stock agreed to convert all of their shares of Series A convertible preferred stock into shares of our common stock in connection with the Common Stock Private Placement. During the first quarter of 2004, the Series A preferred stock earned a dividend of approximately $0.7 million, which the Company elected to add to the liquidation preference of the Series A convertible preferred stock.

As an inducement to convert their shares into common stock in connection with the Common Stock Private Placement consummated on June 21, 2004, the remaining Series A preferred shareholders received the dividend earned for the period between April 1, 2004 and June 21, 2004 in cash, which totaled approximately $0.5 million. In addition, the Series A preferred shareholders received a cash conversion premium of 7% of the accreted value of Series A Preferred Stock as of March 31, 2004, which totaled $1.7 million. Therefore, the total dividend charged recorded by the Company for the nine month period ended September 30, 2004 was approximately $2.9 million.

9. Short-term Borrowings

On August 26, 2004, the Company entered into a one-year revolving credit facility in the amount of $5.0 million with Silicon Valley Bank pursuant to a Loan and Security Agreement dated August 26, 2004 (the “Loan Agreement”). The credit facility is collateralized by a first-priority security interest granted to Silicon Valley Bank by the Company in substantially all of the Company’s assets.

Borrowings under the Loan Agreement bear interest at a rate per annum equal to the sum of 2% and the “Prime Rate”, which is defined in the Loan Agreement as the greater of 4.00% or the rate announced from time to time by Silicon Valley Bank as its “Prime Rate.” Interest is payable on a monthly basis with the principal payable upon the maturity date of the credit facility, the maturity date being 364 days from the date of the Loan Agreement. However, upon the occurrence and during the continuance of any event of default set forth in the Loan Agreement, Silicon Valley Bank may accelerate and declare all or any portion of the Company’s obligations to Silicon Valley Bank due and payable. The repayment obligations of the Company are guaranteed by the Company’s wholly owned subsidiary, Evergreen Solar Securities Corp. Additionally, the Company issued a warrant to purchase 89,955 shares of common stock to Silicon Valley Bank, as compensation for establishing the revolving credit facility. The warrant entitles Silicon Valley Bank to shares of the Company’s common stock at an exercise price of $3.34. The warrants are exercisable at any time on or prior to August 25, 2009. The fair value of the warrant (approximately $187,000) has been recorded as a deferred financing charge, along with $100,000 of other direct expenses associated with the revolving credit facility, and will be charged to interest expense ratably over the term of the facility, which is twelve months.

The Loan Agreement contains certain financial and other covenants that restrict the Company’s ability to, among other things, dispose of property, incur indebtedness, make certain acquisitions, merge into another entity, declare or pay dividends above an aggregate threshold of $500,000 and redeem, retire, repurchase or otherwise acquire shares of capital stock of the Company in excess of $500,000 in the aggregate. In addition, the Company must comply with certain financial thresholds including minimum tangible net worth and minimum cash or excess availability.

As of September 30, 2004, the Company has drawn $1.5 million under the revolving line of credit.

10. Other Comprehensive Income

Other comprehensive income (loss) consists of unrealized gains and losses on marketable securities. For the three months ended September 30, 2003 and 2004, the Company recorded other comprehensive income of $22,000, and $18,000 which, when added to net loss, results in comprehensive losses of $3.2 million and $4.6 million, respectively. For the nine months ended September 30, 2003 and 2004, the Company recorded other comprehensive losses of $39,000 and $0, respectively, which, when added to net loss, results in comprehensive losses of $9.8 million and $15.8 million, respectively.

11. Foreign Currency Hedging Transactions

The Company enters into foreign currency forward contracts to hedge against potential losses relating to fluctuations in its receivables denominated in Euros. As of September 30, 2004, the Company had forward currency contracts with a notional amount of approximately $2.8 million. The Company recognized gains of approximately $41,000

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and $49,000 for the three and nine month periods ended September 30, 2004, respectively in connection with the marking to market of its forward contracts.

12. Recent Accounting Pronouncements

In March 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue 03-6, “Participating Securities and the Two-Class Method under Financial Accounting Standards Board (“FASB”) Statement No. 128, “Earnings per Share.” This issue involves the computation of earnings per share for companies that have multiple classes of common stock or have issued securities other than common stock that participate in dividends with common stock (participating securities). The EITF concluded that companies having participating securities are required to apply the two-class method to compute earnings per share. The two-class method is an earnings allocation method under which earnings per share is calculated for each class of common stock and participating security considering both dividends declared (or accumulated) and participation rights in undistributed earnings as if all such earnings had been distributed during the period. This issue is effective for fiscal periods beginning after March 31, 2004. The Company has incurred losses for the three and nine month periods ended September 30, 2004 and 2003 and as its Series A preferred shares outstanding did not have a contractual obligation to share in the losses of the Company, EITF 03-6 has no effect on its reported earnings per share.

13. Subsequent Event

On October 21, 2004, the Company filed a registration statement on Form S-3 with the U.S. Securities and Exchange Commission. After the registration statement is declared effective by the SEC, the Company will be able to offer and sell up to an aggregate of $75 million of its common stock, preferred stock, depositary shares, warrants and debt securities from time to time in one or more public offerings. The terms of any such future offerings will be established at the time of such offerings.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTION CONCERNING FORWARD-LOOKING STATEMENTS

We caution readers that statements in this Quarterly Report on Form 10-Q that are not strictly historical statements, including, but not limited to: statements reflecting our expectations regarding the timing, cost, and success of our manufacturing scale-up at our facility in Marlboro, Massachusetts and future manufacturing expansion and production, as well as related financing requirements; future financial performance; our technology and product development, cost and performance; our current and future strategic relationships and future market opportunities; and our other business and technology strategies and objectives, constitute forward-looking statements which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements may be identified with such words as “we expect”, “we believe”, “we anticipate” or similar indications of future expectations. These statements are neither promises nor guarantees and involve risks and uncertainties, which could cause our actual results to differ materially from such forward-looking statements. Such risks and uncertainties may include, among other things, those risks and uncertainties described below under the heading “RISK FACTORS” and elsewhere in this Quarterly Report and in our other filings with the Securities and Exchange Commission, copies of which may be accessed through the SEC’s Web Site at http://www.sec.gov. We caution readers not to place undue reliance on any forward-looking statements contained in this Quarterly Report, which speak only as of the date of this Quarterly Report. We disclaim any obligation to publicly update or revise any such statements to reflect any change in our expectations, or events, conditions, or circumstances on which any such statements may be based, or that may affect the likelihood that actual results will differ from those set forth in such forward-looking statements.

EXECUTIVE OVERVIEW

We develop, manufacture and market solar power products for the global marketplace. Solar cells are semiconductor devices that convert sunlight into electricity and form the building block for all solar power products. To date, our product sales have been primarily solar panels, which have been used to generate electricity for on-grid and off-grid applications. Off-grid applications have included the electrification of rural homes, lighting for small, rural schools and power supplies for water pumping. More recently, the substantial majority of our products have been used by on-grid customers as a clean, renewable source of alternative or supplemental electricity.

We made significant progress on our capital expansion program aimed at roughly quadrupling our production capacity by adding a second manufacturing line, which we expect to be completed by the end of 2004. During the

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first nine months of 2004, our product sales were constrained by our manufacturing capacity despite the fact that by September 2004, we had approximately tripled our manufacturing capacity over 2003. By quarter end, we had increased our plant’s annual capacity to approximately 10 megawatts and all single ribbon and Gemini I furnaces have been converted to Gemini II (representing our most cost-effective, dual-ribbon furnace technology) – about six weeks ahead of schedule. Since product revenue has been capacity limited, the planned expansion should enable additional revenue growth during the remainder of 2004, and the increased production volumes should also improve our product gross margins. We have already begun to realize revenue growth resulting from the expansion that has been completed thus far. Specifically, our product revenues for the nine months ended September 30, 2004 represent a 104% increase over our product revenues from the same period of the previous fiscal year. In addition, our recent common stock and warrant financing consummated on June 21, 2004 (the “Common Stock Private Placement”) provided us with the capital to further expand the Marlboro manufacturing facility to a target of 15 megawatts, an increase from the previously reported target of 10-14 megawatts. In addition to the Common Stock Private Placement, on August 27, 2004 we secured a $5.0 million working capital line of credit facility with Silicon Valley Bank. The facility will be used to further support our ongoing expansion plans and our strategy to be a leader in the global solar energy industry. A portion of the proceeds from the Common Stock Private Placement will also be used to increase research and development spending on promising next generation technologies and to explore further expansion opportunities.

Implementing our Gemini II technology, increasing production volume, adding key positions to staff across the organization, expanding and establishing key customer relationships, and consummating the Common Stock Private Placement and working capital line of credit facility were the key factors in determining our performance. We continue to demonstrate our Gemini II technology on an increasing production basis, which we expect to substantially lower our manufacturing cost of growing silicon wafers and roughly double the capacity of a single string ribbon furnace. We added several key staff in sales, administration, manufacturing and research and development to better position ourselves for the anticipated continued growth of the company. Most notably, we hired Richard M. Feldt as our new President and CEO in December 2003.

Financing Transactions

In order to satisfy our existing capital requirements and to fund the continuing capacity expansion of our Marlboro, Massachusetts manufacturing facilities, on June 21, 2004, we consummated a $18.8 million private placement financing transaction, net of offering costs of approximately $1.2 million, whereby we issued 7,662,835 shares of our common stock, and warrants to purchase up to 2,298,851 shares of our common stock, to certain institutional investors pursuant to a stock and warrant purchase agreement dated June 16, 2004, and a warrant agreement dated June 21, 2004. Additionally, in connection with the Common Stock Private Placement, we issued a warrant to purchase 125,000 shares of common stock to CRT Capital Group LLC, as compensation for CRT Capital Group’s services as the placement agent for the Common Stock Private Placement. The terms of the placement agent warrant is identical to the terms of the warrants issued to the investors participating in the Common Stock Private Placement. The shares of common stock were sold at a per share price of $2.61, which represented a 10% discount to the $2.90 closing price of shares of our common stock on the Nasdaq National Market as of the close of business on June 15, 2004. The warrants entitle the holders to shares of our common stock at an exercise price of $3.335. The warrants are exercisable at any time on or after December 22, 2004 and prior to June 22, 2009. The warrants provide that they could only be exercised with respect to 350,000 shares of common stock in the aggregate prior to approval of the exercisability of the remaining warrants by our stockholders, which was approved by our stockholders at our annual meeting of stockholders on August 20, 2004.

On August 26, 2004, we entered into a one-year revolving credit facility in the amount of $5.0 million with Silicon Valley Bank pursuant to a Loan and Security Agreement dated August 26, 2004 (the “Loan Agreement”). The credit facility is secured by a first-priority security interest granted to Silicon Valley Bank by the Company in substantially all of our assets.

We believe that our current cash, cash equivalents and short-term investments and revolving credit facility will be sufficient to fund our planned manufacturing capacity expansion to our target level of 15 megawatts for both lines and to fund our operating expenditures over the next twelve months. We will need to raise additional capital in order to further enhance our operating infrastructure and to further increase capacity through the construction of a second manufacturing facility. We may also require additional capital to respond to competitive pressures and acquire complementary businesses or necessary technologies. We do not know whether we will be able to raise additional financing or financing on terms favorable to us. If adequate funds are not available or are not available on acceptable terms, our ability to fund our operations, develop and expand our manufacturing operations and distribution network, or otherwise respond to competitive pressures would be significantly limited.

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of consolidated financial statements in accordance with generally accepted accounting principals requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:

Revenue Recognition and Allowance for Doubtful Accounts

We recognize product revenue if persuasive evidence of an arrangement exists, shipment has occurred, risk of loss has transferred to the customer, sales price is fixed or determinable, and collectibility is reasonably assured. The market for solar power products is emerging and rapidly evolving. We currently sell our solar power products primarily to distributors, system integrators and other value-added resellers within and outside of North America, which typically resell our products to end users throughout the world. We currently do not have any post-shipment obligations, including installation, training or customer acceptance clauses with any of our distributors that could have an impact on revenue recognition. For new customers requesting credit, we evaluate creditworthiness based on credit applications, feedback from provided references, and credit reports from independent agencies. For existing customers, we evaluate creditworthiness based on payment history and known changes in their financial condition.

We also evaluate the facts and circumstances related to each sales transaction and consider whether risk of loss has not passed to the customer upon shipment. We consider whether our customer is purchasing our product for stock, and whether contractual or implied rights to return the product exist or whether our customer has an end user contractually committed. To date, we have not offered rights to return our products other than for normal warranty conditions. Other than early payment discounts in the ordinary course of business, we offer no other sales incentive, discounts or credits, or any other special arrangements with any of our distributors, that could have an impact on revenue recognition.

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, such that their ability to make payments was impaired, additional allowances could be required.

Revenue from research grants is recognized as services are rendered to the extent of allowable costs incurred over the term of the contract.

Inventory

Inventory is valued at the lower of cost or market. Certain factors may impact the realizable value of our inventory including, but not limited to, technological changes, market demand, changes in product mix strategy, new product introductions and significant changes to our cost structure. Given our current production levels and the market value of our products, we currently sell our finished goods inventory at prices that are below the sum of our fixed and variable costs per unit. Accordingly, we write down our finished goods inventory to realizable value equal to the difference between the cost of inventory and the estimated market value. In addition, estimates of reserves are made for obsolescence based on the current product mix on hand and its expected net realizability. If actual market conditions are less favorable or other factors arise that are significantly different than those anticipated by management, additional inventory write-downs or increases in obsolescence reserves may be required. We treat lower of cost or market adjustments and inventory reserves as an adjustment to the cost basis of the underlying inventory. Accordingly, the effects of favorable changes in market conditions are not considered in our evaluation of previously established obsolescence reserves in subsequent periods.

Warranty

We provide for the estimated cost of product warranties at the time revenue is recognized. Given our limited operating history, we use historical industry solar panel failure rates as the basis for our warranty provision calculation. While we engage in product quality programs and processes, including monitoring and evaluating the quality of our component suppliers, our warranty obligation is affected by product failure rates and material usage and service deliv