Search the web
Welcome, Guest
[Sign Out, My Account]
EDGAR_Online

Quotes & Info
Enter Symbol(s):
e.g. YHOO, ^DJI
Symbol Lookup | Financial Search
STRI > SEC Filings for STRI > Form 10-K on 15-Mar-2013All Recent SEC Filings

Show all filings for STR HOLDINGS, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for STR HOLDINGS, INC.


15-Mar-2013

Annual Report


ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of the financial condition and results of our operations should be read together with Item 6-Selected Financial Data and our Consolidated Financial Statements and the related Notes included in Item 8 of this Annual Report on Form 10-K. This discussion contains forward-looking statements, based on current expectations and related to future events and our future financial performance, that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those set forth under Item 1A-Risk Factors in this Annual Report on Form 10-K.


Table of Contents

Overview

We were founded in 1944 as a plastic and industrial materials research and development company and evolved into two core businesses: solar encapsulant manufacturing and quality assurance services. We launched our former Quality Assurance business ("QA") in 1973 and we commenced sales of our solar encapsulant products in the late 1970s.

We are a global provider of encapsulant to the solar module industry. Encapsulant is a critical component used in solar modules. Our PhotoCap® products consist primarily of ethylene-vinyl acetate, or EVA, which is modified with additives and put through our proprietary manufacturing process to increase product stability and make the encapsulant suitable for use in extreme, long-term outdoor applications. Our encapsulants can be used in both crystalline silicon and thin-film solar modules.

Prior to its divestiture in September 2011, QA provided product development, inspection, testing and audit services that enabled retailers and manufacturers to determine whether products met applicable safety, regulatory, quality, performance and social standards.

Strategic Divestiture of QA

On September 1, 2011, we completed the sale of QA to Underwriters Laboratories, Inc. ("UL"). This strategic divestiture was executed to allow us 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. The following transactions occurred as a result of the divestiture:

º •
º We received $275.0 million, plus assumed cash in proceeds. The sale generated an after-tax gain of approximately $14.0 million that included an initially estimated tax liability of $105.9 million. This gain was recorded in discontinued operations in the Consolidated Statements of Comprehensive Income and the proceeds received were recorded in discontinued operations in the Consolidated Statements of Cash Flows in 2011. During the third quarter of 2012, the taxable gain associated with the sale of the QA business was finalized in conjunction with filing our 2011 income tax returns. As part of this process, we recorded an income tax benefit to discontinued operations of $4.2 million. Refer to Note 3 to the Consolidated Financial Statements located in Item 8-Financial Statements and Supplementary Data of this Annual Report on Form 10-K.

º •
º In order to sell the assets of the QA business free and clear of liens provided pursuant to our first lien credit agreement and second lien credit agreement (together, the "2007 Credit Agreements"), we terminated the 2007 Credit Agreements on September 1, 2011 by using approximately $237.7 million of the sale proceeds to repay all amounts outstanding thereunder to Credit Suisse AG as administrative and collateral agent. The cash payment was recorded in discontinued operations in 2011 in the Consolidated Statements of Cash Flows. The interest expense associated with the 2007 Credit Agreements is recorded in discontinued operations in the Consolidated Statements of Comprehensive Income and Consolidated Statements of Cash Flows for 2011 and 2010.

º •
º Upon termination of the 2007 Credit Agreements, we wrote-off unamortized deferred financing costs of $3.6 million. The write-off was recorded to continuing operations in 2011 in the Consolidated Statements of Comprehensive Income.

º •
º In conjunction with the sale, we entered into an agreement to lease our real property located at 10 Water Street, Enfield, Connecticut to a subsidiary of UL. Prior to the closing of the sale, the property served as the QA headquarters and a testing facility. The initial term of the lease was for one year. Since this property was expected to generate rental income of $0.3 million per year, we evaluated whether the carrying value of the property was recoverable. Based on this


Table of Contents

evaluation, an impairment loss of $1.9 million was recognized in continuing operations in 2011 in the Consolidated Statements of Comprehensive Income.

QA's historical operating results are recorded in discontinued operations in the Consolidated Statements of Comprehensive Income and Consolidated Statements of Cash Flows for all periods presented.

Corporate Structure

On June 15, 2007, DLJ Merchant Banking Partners IV, L.P. and affiliated investment funds ("DLJMB"), and its co-investors, together with members of our Board of Directors, our executive officers, certain prior investors and other members of management, acquired 100% of the voting equity interests in our wholly-owned subsidiary, Specialized Technology Resources, Inc., for $365.6 million, including transaction costs. In connection with the acquisition:

º •
º DLJMB and its co-investors contributed $145.7 million in cash for approximately 81.6% of the voting equity interests in STR Holdings LLC;

º •
º Dennis L. Jilot, our Chairman, Robert S. Yorgensen, our President and Chief Executive Officer, and Barry A. Morris, our Executive Vice President and Chief Operating Officer, exchanged a portion of their existing equity investments in Specialized Technology Resources, Inc., valued at approximately $11.5 million, for approximately 6.4% of the voting equity interests in STR Holdings LLC;

º •
º other stockholders of Specialized Technology Resources, Inc., including some current and former employees and former directors, exchanged a portion of their existing equity investments in Specialized Technology Resources, Inc., valued at approximately $21.5 million, for approximately 12.0% of the voting equity interests in STR Holdings LLC;

º •
º Specialized Technology Resources, Inc., as borrower, and STR Holdings LLC, as a guarantor, entered into a first lien credit facility providing for a fully drawn $185.0 million term loan facility and an undrawn $20.0 million revolving credit facility and a second lien credit facility providing for a fully drawn $75.0 million term loan facility, in each case, with Credit Suisse, as administrative agent and collateral agent; and

º •
º with the cash contributed from DLJMB and certain of its co-investors and the borrowings under our first lien and second lien credit facilities, STR Holdings LLC (i) purchased the remaining shares of stock in Specialized Technology Resources, Inc., for $324.7 million,
(ii) repaid $61.7 million of debt held by Specialized Technology Resources, Inc., (iii) settled Specialized Technology Resources, Inc. stock options for $1.5 million, (iv) paid financing costs of $7.9 million and transaction costs of $4.4 million; and (v) retained the remaining $5.5 million in proceeds for working capital purposes.

We refer to the foregoing transactions collectively as the "DLJ Transactions."

Prior to November 5, 2009, we conducted our business through STR Holdings LLC and its subsidiaries. STR Holdings (New) LLC ("NewCo"), a Delaware limited liability company, was formed on September 30, 2009 as an indirect subsidiary of STR Holdings LLC and held no material assets and did not engage in any operations.

Pursuant to the corporate reorganization on November 5, 2009, STR Holdings LLC liquidated. A subsidiary of NewCo merged with and into Specialized Technologies Resources, Inc. ("STRI") and, as a result, STRI became a wholly-owned subsidiary of NewCo. The unitholders of STR Holdings LLC became unitholders of NewCo. On November 6, 2009, NewCo converted from a limited liability company into a Delaware 'C' corporation, named STR Holdings, Inc., and the outstanding units of


Table of Contents

NewCo converted into a single class of common stock of STR Holdings, Inc. pursuant to the terms of the LLC agreement.

On November 12, 2009, we closed our IPO of 12,300,000 shares of common stock at an offering price of $10.00 per share, of which 3,300,000 shares were sold by us and 9,000,000 shares were sold by selling stockholders, resulting in net proceeds to us of approximately $25.0 million after deducting underwriting discounts, commissions and other offering costs of approximately $7.8 million. Effective with the conversion of NewCo into STR Holdings, Inc., our outstanding units were converted into shares of common stock and restricted common stock. In connection with our IPO, we repaid $15.0 million of borrowings under our first lien credit facility, and also paid $2.6 million to terminate an advisory services and monitoring agreement we entered into in connection with the DLJ Transactions.

The discussion contained herein relates to continuing operations unless otherwise noted.

Current Business Environment, Components of Net Sales and Expenses and Anticipated Trends

Net Sales

Our net sales are derived from the sale of encapsulants to both crystalline silicon and thin-film solar module manufacturers. We expect that our results of operations for the foreseeable future will depend primarily on the sale of encapsulants to a relatively small number of customers. We believe the concentration will increase as we expect a consolidation of module manufacturers driven by overcapacity that currently exists. Our customers are solar module manufacturers located in North America, Europe and Asia. Our largest crystalline silicon and thin-film customers for the past three years included some of the world's largest solar module manufacturers. First Solar accounted for 41%, 23% and 17% of our net sales for the years ended December 31, 2012, 2011 and 2010, respectively. Suntech Power Holdings Co. Ltd. accounted for 10% and 11% of our net sales for the years ended December 31, 2011 and 2010, respectively. Our top five customers accounted for approximately 61%, 53% and 43% of our net sales in 2012, 2011 and 2010, respectively. We were recently informed that our largest customer, First Solar, will commence sourcing encapsulant from an alternate supplier in the first quarter of 2013. First Solar accounted for $39.2 million, or 41%, of our 2012 net sales and we expect approximately $2.5 to $3.5 million of net sales to them in 2013.

Net sales to our customers are typically made through non-exclusive, short-term purchase order arrangements that specify prices and delivery parameters but do not obligate the customer to purchase any minimum amounts. We have frequently entered into, renewed or are in negotiations to enter into, contracts that are typically one year in duration. The contracts include general terms and conditions including pricing, payment terms, delivery and quality parameters as well as anticipated volume requirements. However, the majority of these contracts require the issuance of purchase orders for sales to be legally binding.

Our net sales are significantly driven by end-user demand for solar modules. As more solar modules are sold, there is greater demand from module manufacturers for encapsulants. The solar power industry is impacted by a variety of factors, including government subsidies and incentives, availability of financing, worldwide economic conditions, environmental concerns, energy costs, the availability of polysilicon and other factors. A key demand driver for solar module growth in the future will be the ability of solar module manufacturers to reduce their cost structure. During 2011, capacity expansion in the solar module supply chain increased. Increased competition, particularly from China, and continued vertical integration of many manufacturers in the solar supply chain contributed to the increase in capacity. These events caused many module manufacturers to significantly reduce the average selling price of their modules as the extra capacity drove a severe inventory build. From an industry standpoint, the reduction in module selling prices has improved rates of return on solar


Table of Contents

investments for the end-user and is a long-term industry trend that we believe will help to bring solar energy closer to grid-parity and will drive increased demand for encapsulants.

Demand for our encapsulants also depends in large part on government incentives aimed to promote greater use of solar energy. The type of government incentives vary from country to country and can change rapidly. For example, in Germany, which is currently the largest solar PV end-user market, the government enacted legislation that reduced feed-in tariffs beginning June 30, 2010. In early 2011, the German government enacted further legislation to accelerate the annual year-end feed-in tariff reduction to July 1, 2011 for roof-top systems and September 1, 2011 for ground-mount projects. If solar module demand in Germany continues to grow at a rate that the German government believes is excessive, the amount of PV installations that may qualify for feed-in tariff incentives could be capped, which would negatively impact our net sales as overall solar module growth in the world's largest PV market would be limited. Also, many European governments are currently experiencing fiscal issues. As such, a risk exists that some of these governments will have to reduce and/or eliminate current subsidies provided for PV installations in conjunction with overall tighter fiscal policies.

Even though we may see reduced solar module demand in the European Union in the next few years, we expect an increase in demand for solar energy in the United States as a result of continued cost reductions in the solar industry. Also, many states, including California, have enacted renewable portfolio standards that require utilities to increase their production of energy from renewable sources including solar PV. China, India, Taiwan, Japan and other countries have also announced plans to increase their use of renewable energy, including solar.

Pricing of our encapsulants is impacted by the competition faced by our customers, and the quality and performance of our encapsulant formulations, including their impact on improving our customers' manufacturing yields, their history in the field, our ability to meet our customers' delivery requirements, overall supply and demand levels in the industry and our customer service and technical support. Historically, we typically priced our encapsulants at a premium to our competition based on product attributes that among other benefits provide a high value proposition to our customers in a period of tight capacity. During 2012, the excess capacity that existed at most module manufacturers has reduced the value proposition of the throughput and other production efficiencies that our encapsulants provide and has caused encapsulant cost to become a more important factor in the procurement process for many customers. In addition, low-cost competition from China and increased entrants in the encapsulant market have intensified competition. Based on these factors, we experienced an average selling price ("ASP") decline of approximately 24% from the prior year.

During the past few years, our net sales have decreased significantly and we expect this trend to continue into 2013. In addition to the ASP pressure discussed above, our unit volumes have declined due to lost market share. Our market share loss was the result of some of our customers losing market share to certain Chinese module manufacturers who are currently not our customers and continuing intensified competition in the encapsulant market, including pressure on pricing and terms and competitive technologies entering the marketplace. Recently, competitors have introduced new encapsulant products to the market based upon POE. We believe that one of our former crystalline silicon customers is now using POE encapsulant for its modules. Although we have been pursuing the development of POE products, such products are not yet commercially available and it is uncertain as to when or if we will sell such products. In the event that solar module manufacturers switch to POE encapsulant products from EVA encapsulants and we do not offer a competitive POE product, such switch could adversely affect our business, financial condition and results of operations. We expect our market share to decline further in 2013 due to the decrease in net sales expected due to the loss of First Solar as a customer as described above.

In order to increase our market share and sales volume in the future, we are actively introducing our next generation encapsulant formulation, which is currently being evaluated by approximately


Table of Contents

30 module manufacturers, including 15 in China. We believe our next generation encapsulant formulations possess enhanced PID properties and have been specifically engineered for the manufacturing processes typically used in China. We have passed many internal customer qualification tests including the successful completion of damp heat testing with several prospective Chinese customers. Once internal qualification is obtained with a customer, our encapsulant must also be qualified by a third-party certification body, which typically requires approximately three additional months. The qualification process must occur with each prospective customer. The internal qualification process and timing are managed and customized by each module manufacturer. To date in 2013, we have received initial commercial orders from three new customers. We expect to receive further positive test results from other prospective customers in the first half of 2013 and to ramp our sales of this new product.

We also continue to develop our infrastructure in China with the intent of better penetrating module manufacturers located there. We have recently formed a wholly foreign-owned enterprise in China, received a business license, purchased land near Shanghai and have expanded our local sales and technical service teams in the Asia-Pacific region. We also established a technical service laboratory in China to improve our customer service and provide support in launching new products.

The future growth and success in our business depends on the ability of our customers to grow their businesses and our ability to meet any such growth and to grow by adding new customers. If our customers do not increase production of solar modules, there will be no corresponding increase in encapsulant orders. It is possible that our customers may reduce their purchases from us. If our customers do not grow their businesses or they find alternative sources for encapsulants to meet their demands, it could limit our ability to grow our business and increase our net sales. In addition, we have been actively attempting to sell our encapsulants to certain large Chinese module manufacturers. However, we did not generate any sales to these companies during 2012, as we continue to work with these module manufacturers to meet their production requirements. Although we intend to obtain market share with these companies, failure to do so could negatively affect our financial condition and results of operations.

Cost of Sales

We manufacture all of the products that we sell. Cost of sales consists of our costs associated with raw materials, direct labor, manufacturing overhead, salaries, other personnel-related expenses, write-offs of excess or obsolete inventory, quality control, freight, insurance, disposition of defective product, depreciation of fixed assets and amortization of intangibles as a result of the DLJ Transactions. Approximately 69% of our cost of sales is variable in nature; 11% is step-variable and relates to direct labor cost and is fixed in the short-term and the remaining 20% is fixed. Resin constitutes the majority of our raw materials costs at approximately 45% to 50% of our cost of sales, and paper liner is the second largest cost. The price and availability of resin and paper liner are subject to market conditions affecting supply and demand, have been volatile and we believe resin cannot be hedged in the commodity markets.

Overall, we expect our cost of sales, as a percentage of net sales, to decrease over the long-term. We expect to improve our cost structure to more than offset anticipated further reductions of average selling price of our encapsulants in response to lower overall module pricing driven by increased competition faced by our customers and ourselves. We believe we can improve our cost structure from current levels by: (i) decreased raw material costs due to active negotiations with our suppliers, favorable resin market dynamics and the removal of paper liner from our manufacturing process, (ii) more efficient absorption of fixed costs driven by economies of scale when expected sales growth resumes in 2014, (iii) improved raw material utilization and scrap rates and (iv) continued other cost-reduction efforts.


Table of Contents

Gross Profit

Gross profit is affected by numerous factors, including our average selling prices, fluctuations in foreign exchange rates, seasonality, our manufacturing costs and the effective utilization of our facilities. Another factor impacting gross profit is the time required for new production facilities and the expansion of existing facilities to reach full production capacity. In 2012, accelerated depreciation increased by $2.3 million due to the shortened useful lives of certain production equipment based on expected lower capacity utilization level. We also incurred $1.0 million of increased severance costs associated with our recent cost-reduction efforts.

Selling, General and Administrative Expenses

Our selling expenses consist primarily of salaries, travel and other personnel-related expenses for employees engaged in sales, marketing and support of our products and services, trade shows and promotions. General and administrative expenses consist mainly of outside professional fees and expenses for our executive, finance, administrative, information technology, legal and human resource functions.

We expect our selling, general and administrative expenses to decrease in absolute terms as a result of decreased headcount resulting from recent cost-reduction actions to match expenditures with anticipated lower net sales.

Research and Development Expense

We have a long history of innovation dating back to our establishment in 1944 as a plastic and polymer research and development firm. As our operations have expanded from solely providing research and development services into the manufacturing of solar encapsulants, we have created a separate research and development function that tracks employees and costs that are fully dedicated to research and development activities. Our research and development expense consists primarily of salaries and fringe benefit costs and the cost of materials and outside services used in our pre-commercialization process and product development efforts. We also record depreciation expense for equipment that is used specifically for research and development activities.

We incurred $4.4 million, $2.6 million and $1.8 million of research and development expense in 2012, 2011 and 2010, respectively. Our research and development expense has increased over the past three years due to the opening of our 20,000 square foot state-of-the-art laboratory in 2012 and the addition of scientific equipment and scientific and engineering talent.

Provision for Bad Debt Expense

We reserve for estimated losses that may result from the inability of our customers to make required payments. We review the collectability of our receivables on an ongoing basis and reserve for uncollectible accounts after reasonable collection efforts have been made and collection is deemed doubtful.

Interest (Expense) Income, Net

Interest (expense) income, net is comprised of interest income earned on our cash and cash equivalents and our annual commitment fee incurred on our Credit Agreement.

Amortization of Deferred Financing Costs

We capitalize debt issuance costs and amortize the costs to expense over the term of the related debt facility. In conjunction with the sale of QA, our 2007 Credit Agreements were paid in full. As such, the related unamortized deferred financing costs of $3.6 million were expensed immediately for


Table of Contents

the year ended December 31, 2011. In connection with entering into our new Credit Agreement in 2011, we incurred $1.3 million of issuance costs. As disclosed in Note 13, we amended our Credit Agreement in 2012 and incurred less than $0.1 million of issuance costs. In addition, we wrote-off $0.8 million of the remaining prior capitalized issuance costs based on the proportion of our new borrowing capacity compared to our prior availability. Amortization of deferred financing costs was $1.1 million, $4.6 million and $1.3 million for the years ended December 31, 2012, 2011 and 2010, respectively.

Other Income

Other income consists of the $7.2 million payment received from the settlement of the JPS lawsuit. Refer to Item 3-Legal Proceedings.

Foreign Currency Transaction Gain/(Loss)

Foreign currency transaction gain/(loss) is primarily the result of changes in the Euro, Hong Kong dollar and Malaysian ringgit exchange rates. The majority of our foreign exchange exposure is due to a Euro denominated liability in the U.S., the settlement of intercompany transactions, U.S. cash balances held in foreign locations and non-resin costs incurred by our Malaysia subsidiary whose functional currency is the U.S. dollar which is the currency that it uses to invoice customers and procure resin.

Income Taxes

Income tax (benefit) expense is comprised of federal, state, local and foreign taxes based on income in multiple jurisdictions and changes in uncertain tax positions. We expect our effective tax rate to trend lower over time as we benefit from our tax holiday in Malaysia and increased investment in research and development that qualifies for tax deductions in certain jurisdictions.

Critical Accounting Policies

Our discussion and analysis of our consolidated financial position and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, net sales and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an ongoing basis, including those related to revenue recognition, accounts receivable, bad debts, valuation of inventory, long-lived intangible and tangible assets, goodwill, product performance matters, income taxes and stock-based compensation. We base our estimates on historical experience and on various . . .

  Add STRI to Portfolio     Set Alert         Email to a Friend  
Get SEC Filings for Another Symbol: Symbol Lookup
Quotes & Info for STRI - All Recent SEC Filings
Sign Up for a Free Trial to the NEW EDGAR Online Pro
Detailed SEC, Financial, Ownership and Offering Data on over 12,000 U.S. Public Companies.
Actionable and easy-to-use with searching, alerting, downloading and more.
Request a Trial      Sign Up Now


Copyright © 2014 Yahoo! Inc. All rights reserved. Privacy Policy - Terms of Service
SEC Filing data and information provided by EDGAR Online, Inc. (1-800-416-6651). All information provided "as is" for informational purposes only, not intended for trading purposes or advice. Neither Yahoo! nor any of independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. By accessing the Yahoo! site, you agree not to redistribute the information found therein.