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STRI > SEC Filings for STRI > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for STR HOLDINGS, INC.

Form 10-Q for STR HOLDINGS, INC.


8-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations

OVERVIEW

STR Holdings, Inc. and its subsidiaries ("we", "us" or "our") are one of the leading global providers of encapsulants to the solar module industry. The encapsulant is a critical component used in solar modules. We were the first to develop the original ethylene-vinyl-acetate ("EVA") encapsulants used in commercial solar module manufacturing in the 1970s in conjunction with the Jet Propulsion Laboratory of the California Institute of Technology under a NASA contract for the U.S. Energy Research and Development Administration, which later became known as the U.S. Department of Energy. We supply encapsulants globally to many of the world's large solar module manufacturers. We believe this is due to our product performance, global manufacturing base, customer service and technical support. Our encapsulants are used in both crystalline silicon and thin-film solar modules.

STRATEGIC FOCUS

Our objective is to enhance our position as a leading global provider of encapsulants to solar module manufacturers. Our strategies to meet that objective are to (i) continue our history of product innovation, (ii) continue to execute our Asia Growth Strategy, (iii) further reduce our manufacturing costs and (iv) strengthen our balance sheet. We have recently executed on these strategic objectives as follows:

Innovation

We have continued to increase our investments in research and development, including the addition of technical personnel and research scientists. Our East Windsor, Connecticut facility houses a new, 20,000 square foot, state-of-the-art research and development laboratory that became operational in the second quarter of 2012. The laboratory increases our analytical, physical and electrical testing capabilities. We also have the ability to construct and laminate full-sized test modules. Our goal is to continue to develop high value-added products that can be commercialized quickly and with scale.

We have recently developed a high-light transmission formulation that enables light to better penetrate certain cells, which may enhance module output by approximately 1% on a relative basis.

We have introduced our next generation EVA-based encapsulant that we believe possesses enhanced potential induced degradation ("PID") resistant properties. PID is the loss of electrical output caused by sodium ion migration from the cover glass, through the encapsulant to the cell and is a factor that could adversely impact the energy yield of crystalline silicon solar modules. In addition, our next generation encapsulant also possesses high-light transmission, improved volume resistivity, excellent curing properties and superb long-term clarity. This product is currently being evaluated by many module manufacturers including approximately 15 located in China as more fully described below.

The production requirements of Chinese module manufacturers differ from manufacturers located in North America and Europe. As such, we have continued to invest in the development of products specifically engineered for the unique demands of Chinese module manufacturers.

We have established technical service laboratories at our Spain and Malaysia facilities and are currently constructing a laboratory in China. These laboratories will provide increased technical knowledge and support to our customers and will aid in the commercial launch of new products.

Asia Growth Strategy

In 2012, we relocated our Global Director of Sales and Marketing to China and have expanded our local sales and technical service teams in the Asia Pacific region. In late 2011, we also formed a wholly foreign-owned enterprise in China, received a business license and purchased land near Shanghai. As disclosed above, we are also currently constructing a technical service laboratory in China.

During 2011, we increased the floor space of our Malaysia facility to provide for total capacity of up to approximately 5.0 GW and increased our production capacity to 3.6 GW. We believe that our Malaysia plant has enhanced our competitive position in various Asian markets by allowing us to take advantage of reduced lead times, lower logistics costs and improved customer service.


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We are actively introducing our next generation encapsulant formulation that is currently being evaluated by approximately 15 module manufacturers in China. The launch of our next generation encapsulant is progressing well with favorable internal test results and the successful completion of damp heat testing with several prospective Chinese customers. We expect to receive further test results from other prospective customers in the fourth quarter of 2012 and in the first quarter of 2013.

Cost Reduction

We have actively engaged in a cost reduction program to partially offset anticipated price declines of our encapsulants and to improve our competiveness. We expect the cost reduction program to save approximately $18.0 million in 2012 of which $12.7 million has been realized through September 30, 2012. Key parts of our cost reduction program include the following actions:

During 2012, we reduced headcount by 39 employees at our Connecticut facilities. In conjunction with the headcount reduction, we recognized a severance charge of $0.4 million. We also entered into a Labor Force Adjustment Plan ("LFAP") with the union and the local government at our Spain facility that temporarily furloughed approximately 60 employees for the period of February 1, 2012 to July 31, 2012. In July 2012, we entered into an agreement to extend our LFAP at our Spain facility. Under the new LFAP agreement, we are responsible for 10% of the salary of any employees who were furloughed during the period from August 1, 2012 through October 31, 2012. On October 17, 2012, we permanently reduced headcount by 58 employees to better align our cost structure with current sales volumes. We anticipate recording an estimated severance charge of $0.8 million in the fourth quarter of 2012. We anticipate annual pre-tax savings of $3.4 million related to this action.

We ceased production at our St. Augustine, Florida plant in October 2011 and exited the 20,000 square foot leased facility as of December 31, 2011. The closure resulted in approximately $0.8 million in pre-tax charges, $0.5 million of which were non-cash. We expect annual pre-tax savings of $1.1 million as a result of this consolidation. We also expect the consolidation will have a positive impact on gross margin with improved absorption from higher capacity utilization.

We are in the process of introducing a paperless encapsulant that will offer a less expensive option to our customers while retaining the long-term quality benefits that we believe our encapsulants provide. Since this product does not require paper backing, we believe it can be commercialized at a lower price, yet generate similar gross margin as our existing products.

We are reducing our selling, general and administrative costs by optimizing travel spending, streamlining back office functions and obtaining cost reductions from certain existing and new service providers. As of September 30, 2012, we have realized savings of approximately $3.3 million. We expect a portion of such savings to be offset by increased investments in research and development and our sales organization.

Strengthen Our Balance Sheet

On September 1, 2011, we sold our Quality Assurance ("QA") business to Underwriters Laboratories ("UL") for total cash proceeds of $283.4 million, which included $8.4 million of estimated cash assumed in certain QA locations. The QA business provided consumer product testing, inspection, auditing and consulting services that enabled retailers and manufacturers to determine whether products and facilities met applicable safety, regulatory, quality, performance, social and ethical standards. We decided to sell the QA business in order to focus exclusively on the solar encapsulant opportunity and to seek further product offerings related to the solar industry, as well as other growth markets related to our polymer manufacturing capabilities, and to retire our long-term debt. As of September 30, 2012, we had $70.6 million of cash and no debt.

CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of our financial condition and results of operations are based upon our interim condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, net sales and expenses, and related disclosures of contingent assets and liabilities. We continually evaluate our estimates, including those related to bad debts, valuation of inventory, long-lived intangible and tangible assets, goodwill, product performance matters, income taxes, stock-based compensation and deferred tax assets and liabilities. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. The accounting policies we believe to be most critical to understand our financial results and condition and that require complex and subjective management judgments are discussed in "Management's


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Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies" in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 14, 2012.

In accordance with ASC 250-20-Presentation of Financial Statements-Discontinued Operations and ASC 740-20-Income Taxes-Intraperiod Tax Allocation, the accompanying Condensed Consolidated Statements of Comprehensive Income and Condensed Consolidated Statements of Cash Flows present the results of the QA business as discontinued operations. Prior to the sale, the QA business was one of our segments. We have no continuing involvement in the operations of the QA business and have no direct cash flows from the QA business subsequent to the sale. Accordingly, we have presented QA as discontinued operations in all periods presented in the condensed consolidated financial statements.

There have been no changes in our critical accounting policies during the quarter ended September 30, 2012.

IMPAIRMENT ANALYSIS

In accordance with ASC 350-Intangibles-Goodwill and Other and ASC 360-Property, Plant and Equipment, we assess the impairment of our long-lived assets including our definite-lived intangible assets, property, plant and equipment and goodwill whenever changes in events or circumstances indicate that the carrying value of such assets may not be recoverable. During each reporting period, we assess if the following factors are present which would cause an impairment review:
overall negative solar industry conditions; a significant or prolonged decrease in sales that are generated under our trademarks; loss of a significant customer or a reduction in demand for customers' products; a significant adverse change in the extent to or manner in which we use our trademarks or proprietary technology; such assets becoming obsolete due to new technology or manufacturing processes entering the markets or an adverse change in legal factors; and the market capitalization of our common stock. During the first quarter of 2012, the market capitalization of our common stock declined by approximately 50%. As a result of this decline that did not appear to be temporary, we determined that a triggering event occurred requiring us to test our long-lived assets and our reporting unit for impairment as of March 31, 2012.

We valued our reporting unit with the assistance of a valuation specialist and determined that our reporting unit's net book value exceeded its fair value as of March 31, 2012. We then performed step two of the goodwill impairment assessment which involved calculating the implied fair value of goodwill by allocating the fair value of the reporting unit to all of our assets and liabilities other than goodwill and comparing the residual amount to the carrying amount of goodwill. We determined that the implied fair value of goodwill was lower than our carrying value and recorded a goodwill impairment of $82.5 million. We estimated the fair value of our reporting unit under the income approach using a discounted cash flow method which incorporated our cash flow projections. We also considered our market capitalization, control premiums and other valuation assumptions in reconciling the calculated fair value to the market capitalization at the assessment date. Based on the other-than-temporary decline in our stock price and our net book value exceeding the market capitalization of our common stock during the first quarter of 2012, the market approach was given a higher weighting in determining fair value. We believe the cash flow projections and valuation assumptions used were reasonable and consistent with market participants. Inherent in our development of cash flow projections are assumptions and estimates, including those related to future earnings, growth prospects and the weighted-average cost of capital. Many of the factors used in assessing the fair value are outside our control, and these assumptions and estimates can change in future periods as a result of both our specific factors and overall economic conditions.

Prior to performing our goodwill impairment test, we first assessed our long-lived assets for impairment as of March 31, 2012. We concluded that no impairment existed as the sum of the undiscounted expected future cash flows exceeded the carrying value of our asset group which is our reporting unit ($333.4 million as of March 31, 2012) by $200.5 million. The undiscounted cash flows were derived from the same financial forecast utilized in our goodwill impairment analysis. The key assumptions driving the undiscounted cash flows are the forecasted sales growth rate and EBITDA margin. For this impairment analysis, we used undiscounted cash flows reflecting a sales decline of 23% in 2012 and a sales increase of 20% and 22% in 2013 and 2014, respectively. Subsequent to 2014, a normalized 3% annual sales growth rate was used for the remaining useful life. We estimated our EBITDA margin to range from 12% to 16%. We believe our recent net sales decline is temporary in nature compared to the expected useful lives of the long--lived assets and expect volumes to increase in 2013 and beyond based upon the factors discussed in the intangible asset section below. We believe our long-term EBITDA margin will be sustained due to increased sales volume and continued cost reductions offsetting future price reductions.

We performed sensitivity analysis to assess the remaining estimated useful lives of our intangible assets by considering the cash flows used in the step two goodwill fair value assessment and determined that the respective intangible assets' carrying balances are recoverable based on the projected cash flows for the asset group. In addition, we performed a qualitative assessment as discussed below.


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Customer Relationships

Although our recent sales performance has been negatively impacted by many of our customers losing market share and some declaring bankruptcy, we serve many of the largest module manufacturers with whom we have rapidly grown with. The remaining estimated useful life of this intangible asset was supported by our historical customer retention. We expect to continue to increase our net sales to many of these customers in conjunction with anticipated long-term growth in the industry due to greater adoption of solar energy. As such, we determined that no change in useful life was required.

Proprietary Technology

We, as well as our competitors, continue to develop new encapsulant technologies. We are in the process of introducing our next generation encapsulant that possesses additional attributes such as high-light transmission and exceptional PID resistance. We are also in development of a non-EVA encapsulant. However, our recently developed products and expected innovations leverage our core technology and possess the benefits that our legacy encapsulants provide, including long-term clarity provided by our formulations and dimensional stability provided by our extrusion manufacturing process. Based upon these factors and our recent successful trade-secret defense litigation as previously disclosed, we determined that no change in useful life was required.

Trademarks

Our trademarks are well known in the solar industry due to our reputation for innovation, customer service and having encapsulants perform in the field for over 30 years. As such, we determined that no change in useful life was required.

We did not need to test whether our long-lived assets were impaired as of September 30, 2012, as we concluded there was no significant triggering event that occurred during the third quarter of 2012 that was not already contemplated in our March 31, 2012 assessment and given the significant amount by which the undiscounted cash flows exceeded the carrying amounts of our long-lived assets. Although our sales volume continued to decline in the third quarter of 2012 and our estimated full-year 2012 net sales were revised lower, we believe that our recent product launches, customer service, quality, geographic footprint and continued focus on innovation will allow us to increase our net sales from anticipated 2012 levels as the solar industry continues to grow, driving increased demand for modules and as a result, our encapsulants. However, the solar industry continues to evolve rapidly. If we do not achieve anticipated sales volumes through existing and new products, retain customers, maintain pricing power in the future, or any adverse circumstances occur, certain of our long-lived assets may be subject to accelerated depreciation/amortization and/or future impairment.

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