UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(mark one)

 

x

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

 

For the Quarterly Period Ended September 30, 2018

 

Or

 

o

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

 

For the transition period from             to             

 

Commission file number 001–34529

 

STR Holdings, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware		27–1023344
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
10 Water Street, Enfield, Connecticut		06082
(Address of principal executive offices)		(Zip Code)

 

(860) 272–4235

(Registrant’s telephone number, including area code)

 

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 o

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S–T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). YES x NO o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non–accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b–2 of the Exchange Act.

 

Large accelerated filer o		Accelerated filer o
Non–accelerated filer o		Smaller reporting company x
		Emerging growth company filer o

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. YES o NO o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b–2 of the Exchange Act). YES o NO x

 

At October 31, 2018, there were 20,152,029 shares of Common Stock, par value $0.01 per share, outstanding.

 

 

---

 

INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

STR Holdings, Inc. and Subsidiaries

Three and Nine Months Ended September 30, 2018

 

	PAGE NUMBER
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements	2
Condensed Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017 (unaudited)	2
Condensed Consolidated Statements of Comprehensive (Loss) Income for the Three and Nine Months Ended September 30, 2018 and 2017 (unaudited)	3
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2018 and 2017 (unaudited)	4
Notes to Condensed Consolidated Financial Statements	5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3. Quantitative and Qualitative Disclosures About Market Risk	25
Item 4. Controls and Procedures	26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	26
Item 1A. Risk Factors	26
Item 5. Other Information	26
Item 6. Exhibits	27
SIGNATURE	28

 

 

 

 

 

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

STR Holdings, Inc. and Subsidiaries

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)

All amounts in thousands except share and per share amounts

 

 

See accompanying notes to these condensed consolidated financial statements.

 

STR Holdings, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(unaudited)

All amounts in thousands except share and per share amounts

 

 

See accompanying notes to these condensed consolidated financial statements.

 

STR Holdings, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

All amounts in thousands

 

 

See accompanying notes to these condensed consolidated financial statements.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Item 2.

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 our Condensed Consolidated Financial Statements and the related Notes to the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. 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 our Annual Report on Form 10-K for the year ended December 31, 2017, as amended by Form 10-K/A filed with the SEC on April 28, 2018.

 

Forward-Looking Statements

 

This Quarterly Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to inherent risks and uncertainties. These forward-looking statements present our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business and are based on assumptions that we have made in light of our industry experience and perceptions of historical trends, current conditions, expected future developments and other factors management believes are appropriate under the circumstances. However, these forward-looking statements are not guarantees of future performance or financial or operating results. Forward-looking statements include, but are not limited to, the statements regarding the following: (1) incurring substantial losses for the foreseeable future and our inability to achieve or sustain profitability in the future; (2) the potential impact of pursuing strategic alternatives, restructuring our business to align with our customers’ geography and our investment in and pursuit of new market opportunities in film products; (3) our reliance on a single product line and contemplated pursuits of new market sectors; (4) our securing net sales to new customers, growing net sales to existing key customers and increasing our market share; (5) customer concentration in our business and our relationships with and dependence on key customers; (6) the outsourcing arrangements and reliance on third parties for the manufacture of a portion of our encapsulants; (7) technological changes in the solar energy industry or our failure to develop and introduce or integrate new technologies could render our encapsulants uncompetitive or obsolete; (8) competition; (9) excess capacity in the solar supply chain; (10) demand for solar energy in general and solar modules in particular; (11) our operations in India and our assets in India and China being subject to significant political and economic uncertainties; (12) limited legal recourse under the laws of India and China if disputes arise; (13) our ability to adequately protect our intellectual property, particularly during the outsource manufacturing of our products; (14) our lack of credit facility and our inability to obtain credit; (15) a significant reduction or elimination of government subsidies and economic incentives or a change in government policies that promote the use of solar energy; (16) volatility in commodity costs; (17) our customers’ financial profile causing additional credit risk on our accounts receivable; (18) our dependence on a limited number of third-party suppliers for raw materials for our encapsulants and other significant materials used in our process; (19) potential product performance matters and product liability; (20) our substantial international operations and shift of business focus to India; (21) the impact of changes in foreign currency exchange rates on financial results, and the geographic distribution of revenues; (22) losses of financial incentives from government bodies in certain foreign jurisdictions; (23) the ability to successfully complete our investment in Spain on a timely basis or within budget, if at all, or that we will be able to achieve our anticipated revenue, earnings or payback from this new investment; (24) that we will be able to obtain the loan we have applied for from the regional government on favorable terms if at all; (25) our ability to meet our objectives under our equipment purchase agreement and related technology license described herein, so as to receive any or all of the expected payments and revenue under those agreements on a timely basis, if at all; and (26) the other risks and uncertainties described under “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in subsequent periodic reports on Form 10-K, 10-Q and 8-K. You are urged to carefully review and consider the disclosure found in our filings, which are available on http://www.sec.gov or http://www.strsolar.com. Should one or more of these risks or uncertainties materialize, or should any of these assumptions prove to be incorrect, actual results may vary materially from those projected in these forward-looking statements. We undertake no obligation to publicly update any forward-looking statement contained in this Quarterly Report, whether as a result of new information, future developments or otherwise, except as may be required by law.

 

Overview

 

STR Holdings, Inc. and its subsidiaries (“we”, “us”, “our” or the “Company”) commenced operations in 1944 as a plastics and industrial materials research and development company. Based upon our expertise in polymer science, we evolved into a global provider of encapsulants to the solar industry. Encapsulant is a critical component used to protect and hold solar modules together.

 

We were the first to develop ethylene-vinyl acetate (“EVA”) based encapsulants for use in commercial solar module manufacturing. Our initial development effort was conducted while under contract to the predecessor of the U.S. Department of Energy in the 1970s. Since that time, we have expanded our business by investing in research and development and global production capacity.

 

Recent Developments

 

Wind-down of China Manufacturing Operations. Our business unit in China (“STR China”) incurred a loss of approximately $5.8 million during 2016, including a bad debt expense of $1.5 million. In October 2016, a fire destroyed one of our two China-based production lines and caused substantial damage to our building and some of our ancillary equipment (the “Manufacturing Facility Fire”). In light of continued poor financial results of STR China, as well as the effects of the fire, we conducted an orderly wind down of our China manufacturing operations to reduce operating losses related to this business unit. By the close of 2017, we effectively completed the wind down process, with only a small administrative team remaining in an office under a short-term lease.

 

India Tolling Plan. A review of our production in China revealed that our sales volume was shifting to customers in India. Moreover, our customers in India generally were more reliable in terms of payment and pricing than our customers in China. In conjunction with our wind down of manufacturing operations in China, we have entered into an agreement with a tolling partner in India. We sold our undamaged production line from STR China to this tolling partner and it is now in commercial operation making STR-formulated encapsulant products. By using a tolling partner, our goal is to continue to serve and grow our customer base in India without having to make a significant direct capital investment. We had not worked with our tolling partner in India prior to 2017 and we cannot ensure that the tolling partner will provide us with the support we anticipate or that we can otherwise successfully manage our collaboration with our tolling partner. If problems develop in our relationship with our India tolling partner, or if such party fails to perform as expected, it could lead to product defects, manufacturing and shipping delays, significant cost increases, changes in our strategies, and even failure of our initiatives, each of which may have a material adverse effect on our business, financial condition, and results of operations. We cannot assure that the India tolling plan will be successful or sustainable in the long term. We have also sold an additional production line to our tolling partner to further increase its manufacturing capacity in India, which became operational at the end of the third quarter.

 

We continue to reorganize our business to better align with customer geography, to reduce the cash burn related to unprofitable locations, to convert assets to cash for potential redeployment into more profitable endeavors and possible business opportunities and to evaluate other strategic alternatives.

 

High-End Food Packaging. In the fourth quarter of 2017, we initiated a significant investment through our wholly-owned subsidiary in Spain to expand our film product offering to enter the high-end food packaging business. This investment, which leverages our plastics expertise, includes the purchase of new, state-of-the-art plastics processing equipment and related building improvements along with the addition of experienced staff to pursue manufacturing and sales of high-end food packaging products. As anticipated, we have received and applied certain conditional insurance proceeds to this project (see “Manufacturing Facility Fire” below), helping to offset our net capital investment. These insurance proceeds were available to the Company only if we invested in new plastics manufacturing equipment. We have been advised by our insurer that our investment qualified for reimbursement under the terms of our policy and have received from them payments totaling approximately $2.6 million, as we had anticipated. Of this reimbursement, $0.8 million was received in October 2017 and $1.8 million was received during 2018. We have also applied for loans of up to €2.0 million from the regional government of Asturias, Spain to further support the project. Subject to the timely purchase and installation of equipment, we expect to begin production by 2019. The food packaging business is highly competitive having market participants with substantially more resources and experience than us. We will be a new entrant in this market and we cannot assure you that we will be successful in this new endeavor. In particular, we cannot assure that we will be able to successfully complete our investment in this new business on a timely basis or within budget, if at all, or that we will be able to achieve our anticipated revenue or earnings from this new investment. Nor can we assure that we will be able to obtain the loan(s) we have applied for from the regional government on favorable terms if at all.

 

Alternative Transactions. In the event that we are not successful in restructuring our plastics manufacturing business, in entering into the high-end food packaging business, or in completing other strategic transactions, we also intend to consider alternatives, including without limitation, the acquisition of another business, the divestiture of all or certain of our assets, joint ventures and other transactions outside the ordinary course of business.

 

If we are unsuccessful in executing on our strategic plans to ultimately achieve profitability by reorganizing our plastics manufacturing business and entering the high-end packaging business, we may also decide to wind down or cease any or all of our operations.

 

In addition, any wind-down or dissolution may be a lengthy and complex process, yield unexpected results and delay any potential distributions to our stockholders. Such process may also require the further expenditure of our resources, such as legal, accounting and other professional fees and expenses and other related charges, which would decrease the amount of assets available for distribution to our stockholders.

 

Manufacturing Facility Fire. During the fourth quarter of 2016, we recorded a $0.9 million loss on disposal of fixed assets attributable to our Manufacturing Facility Fire. During 2017, STR China received interim payments totaling RMB12.7 million (approximately $1.8 million as of September 30, 2018) from our local China insurance carrier related to the existing fire insurance claim. During 2017, we also received $0.8 million in the U.S. under the master property insurance plan related to the same claim. Our U.S. entity received an additional $1.8 million reimbursement during 2018 as we have continued to make qualifying capital investment under the packaging project. These payments complete the final settlement.

 

Equipment Purchase Agreement and Technology License Agreement. On January 16, 2018, we entered into an equipment purchase agreement and a technology license agreement (together, the “Agreements”) with a manufacturer of solar photovoltaic (PV) modules (the “Purchaser”).

 

Under the equipment purchase agreement, the Company will purchase from a third party specialized equipment (the “Equipment”) for the production of one of the Company’s proprietary encapsulants (the “Encapsulant”), resell the Equipment to the Purchaser, install the Equipment at a facility of the Purchaser and train Purchaser personnel in the Equipment’s use. Under the technology license agreement, the Company has granted the Purchaser the right to use the formula for the Encapsulant and certain of the Company’s production techniques to make or have made the Encapsulant for use in PV modules manufactured by the Purchaser. The license granted to the Purchaser pursuant to the technology license agreement is exclusive with respect to specified types of PV modules manufactured by the Purchaser, and nonexclusive as to all other types of PV modules. The Purchaser may also sublicense its rights under the technology license agreement to licensees of its PV module manufacturing processes.

 

Under the Agreements, the Purchaser will pay the Company an aggregate of $6.0 million. Billing and payment under the Agreements follows a schedule involving certain milestones relating to the qualification of the Encapsulant and installation, acceptance and operation of the Equipment. The Company received the initial payment of $1.8 million during the first quarter of 2018, with the balance to follow during the remainder of 2018 and 2019 as milestones occur. For revenue recognition purposes under ASC 606, $1.8 million was recorded as revenue during the first quarter of 2018 as initial performance obligations were satisfied, and the Company expects that the balance of the $6.0 million aggregate amount will be recognized as revenue when the remaining performance obligations are fulfilled. See Note 2 to the Consolidated Financial Statements.

 

The Company does not expect the Agreements to impact or otherwise displace any of its existing business in the solar encapsulant market.

 

2014 Transaction with Zhenfa

 

In 2014, we entered into certain definitive agreements with Zhenfa Energy Group Co., Ltd., a Chinese limited liability company (“Zhenfa”), and its indirect wholly owned subsidiary, Zhen Fa New Energy (U.S.) Co., Ltd., a Nevada corporation (“Zhenfa U.S.”).

 

Purchase Agreement

 

On August 11, 2014, we entered into a Stock Purchase Agreement (the “Purchase Agreement”) with Zhenfa U.S., pursuant to which Zhenfa U.S. acquired approximately 51% of our then outstanding shares of common stock on December 15, 2014 (the “Closing Date”).

 

Sales Service Agreement

 

In connection with the execution of the Purchase Agreement, Specialized Technology Resources, Inc., our wholly owned subsidiary, entered into a sales service agreement (the "Sales Service Agreement") with Zhenfa, whereby Zhenfa agreed, among other things, to assist us in a number of endeavors, including, without limitation, marketing and selling our products in China, acquiring local raw materials, hiring and training personnel in China, and complying with Chinese law. The Sales Service Agreement became effective on the date of Closing, for an initial term of two years, and automatically renews for one year periods unless terminated earlier. The Sales Service Agreement may also be terminated by either party at such time as Zhenfa and its affiliates own less than 10% of our outstanding common stock.

 

As we have substantially discontinued operations in China, Zhenfa is not currently providing us with any material services under this agreement. Any activities with Zhenfa under the Sales Service Agreement are subject to the oversight of our Special Committee of Continuing Directors.

 

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 (“GAAP”). 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 assets, 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 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 16, 2018, as amended by Form 10-K/A filed with the SEC on April 28, 2018.

 

There have been no changes in our critical accounting policies during the quarter ended September 30, 2018.

 

RESULTS OF OPERATIONS

 

Condensed Consolidated Results of Operations

 

The following tables set forth our condensed consolidated results of operations for the three and nine months ended September 30, 2018 and 2017:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2018				2017				2018				2017
Net sales		$	2,547			$	3,533			$	8,808			$	10,303
Cost of sales			3,006				3,392				8,941				11,297
Gross (loss) profit			(459	)			141				(133	)			(994	)
Selling, general and administrative expenses			1,342				1,554				4,414				4,834
Research and development expense			200				225				605				775
Provision (recovery) for bad debt expense			380				(483	)			386				(863	)
Operating loss			(2,381	)			(1,155	)			(5,538	)			(5,740	)
Interest income (expense), net			6				1				21				(6	)
Other income, net (Note 8)			880				321				2,083				1,527
Loss on disposal of fixed assets			(38	)			(369	)			(421	)			(382	)
Foreign currency transaction gain (loss)			9				123				(153	)			48
Loss before income tax (benefit) expense			(1,524	)			(1,079	)			(4,008	)			(4,553	)
Income tax expense (benefit)			(221	)			(173	)			50				(316	)
Net loss		$	(1,303	)		$	(906	)		$	(4,058	)		$	(4,237	)

 

Net Sales

 

		Three Months Ended September 30,																								Nine Months Ended September 30,
		2018								2017								Change								2018								2017								Change
		Amount				% of Total Net Sales				Amount				% of Total Net Sales				Amount				%				Amount				% of Total Net Sales				Amount				% of Total Net Sales				Amount				%
Net sales		$	2,547				100.0	%		$	3,533				100.0	%		$	(986	)			(27.9	)%		$	8,808				100.0	%		$	10,303				100.0	%		$	(1,495	)			(14.5	)%

 

The decrease in net sales for the three months ended September 30, 2018 compared to the corresponding period in 2017 was driven by an approximate 20% decrease in sales volume as well as a 9% decrease in our average selling price (“ASP”) mainly on Spain sales.

 

The volume decline was primarily driven by a 50% volume decrease in Spain and a 100% volume decrease in China, partially offset by sales to customers in India through our tolling partner. The decrease in volume in China, was due to the discontinuance of our manufacturing and sales in China. We attribute the volume decrease in Spain primarily due to further weakening of the European module manufacturing environment.

 

The decrease in net sales for the nine months ended September 30, 2018 compared to the corresponding period in 2017 was driven by a $3.3 million reduction in encapsulant sales partially offset by recognition of $1.8 million related to completed performance obligations in the first quarter of 2018 under the equipment purchase agreement and the technology license agreement. The decrease in encapsulant sales was primarily attributable to an approximate 37% decrease in sales volume that was partially offset by an approximate 9% increase in our ASP, relating to our discontinuance of our lower priced sales in China

 

On a sequential basis, net sales increased by less than $0.1 million, or 1.3%, compared to the three months ended June 30, 2018. This increase was primarily driven by a 22% increase in sales volume partially offset by a 16% decrease in ASP.

 

Cost of Sales

 

		Three Months Ended September 30,																								Nine Months Ended September 30,
		2018								2017								Change								2018								2017								Change
		Amount				% of Total Net Sales				Amount				% of Total Net Sales				Amount				%				Amount				% of Total Net Sales				Amount				% of Total Net Sales				Amount				%
Cost of sales		$	3,006				118.0	%		$	3,392				96.0	%		$	(386	)			(11.4	)%		$	8,941				101.5	%		$	11,297				109.6	%		$	(2,356	)			(20.9	)%

 

The decrease in our cost of sales for the three months ended September 30, 2018 compared to the corresponding period in 2017 was primarily driven by the 20% decrease in encapsulant sales volume partially offset by a 1% increase in raw material cost per unit. The higher raw material cost per unit was primarily driven by a 4% increase in resin costs partially offset by a 12% increase in paperless sales mix. Direct labor decreased by less than $0.1 million, associated with the sales volume decrease.

 

The decrease in our cost of sales for the nine months ended September 30, 2018 compared to the corresponding period in 2017 was primarily driven by the 37% decrease in encapsulant sales volume partially offset by an approximate 9% increase in raw material cost per unit. The higher raw material cost per unit was primarily driven by a 7% increase in resin costs partially offset by a 2% increase in paperless sales mix. Direct labor increased by $0.1 million mainly due to $0.4 million of restructuring charges partially offset by the sales volume decrease.

 

Gross (Loss) Profit

 

		Three Months Ended September 30,																								Nine Months Ended September 30,
		2018								2017								Change								2018								2017								Change
		Amount				% of Total Net Sales				Amount				% of Total Net Sales				Amount				%				Amount				% of Total Net Sales				Amount				% of Total Net Sales				Amount				%
Gross (loss) profit		$	(459	)			(18.0	)%		$	141				4.0	%		$	(600	)			(425.5	)%		$	(133	)			(1.5	)%		$	(994	)			(9.6	)%		$	861				86.6	%

 

Gross (loss) profit, as a percentage of net sales, declined for the three months ended September 30, 2018 compared to the corresponding period in 2017 mainly as a result of a decrease in sales volume combined with an increase in raw material prices.

 

Gross loss, as a percentage of net sales, improved for the nine months ended September 30, 2018 compared to the corresponding period in 2017 mainly as a result of recognition of $1.8 million related to completed performance obligations under the equipment purchase agreement and the technology license agreement. This was partially offset by $0.5 million of restructuring charges related to eliminating certain positions at our Spain facility, as well as a decrease in sales volume combined with an increase in raw material prices.

 

Selling, General and Administrative Expenses (“SG&A”)

 

		Three Months Ended September 30,																								Nine Months Ended September 30,
		2018								2017								Change								2018								2017								Change
		Amount				% of Total Net Sales				Amount				% of Total Net Sales				Amount				%				Amount				% of Total Net Sales				Amount				% of Total Net Sales				Amount				%
SG&A		$	1,342				52.7	%		$	1,554				44.0	%		$	(212	)			(13.6	)%		$	4,414				50.1	%		$	4,834				46.9	%		$	(420	)			(8.7	)%

 

SG&A decreased by $0.2 million for the three months ended September 30, 2018 compared to 2017. This decrease was primarily driven by a $0.1 million decrease in stock-based compensation expense and a $0.1 million decrease in annual incentive compensation expense and restructuring charges.

 

SG&A decreased by $0.4 million for the nine months ended September 30, 2018 compared to 2017. This decrease was primarily driven by $0.2 million in lower labor and benefits, a $0.2 million decrease in stock-based compensation expense, $0.1 million in decreased annual incentive compensation expense and $0.1 million in reduced dues and fees expense. These were partially offset by a $0.2 million increase in restructuring expense.

 

Research and Development Expense (“R&D”)

 

		Three Months Ended September 30,																								Nine Months Ended September 30,
		2018								2017								Change								2018								2017								Change
		Amount				% of Total Net Sales				Amount				% of Total Net Sales				Amount				%				Amount				% of Total Net Sales				Amount				% of Total Net Sales				Amount				%
R&D		$	200				7.9	%		$	225				6.4	%		$	(25	)			(11.1	)%		$	605				6.9	%		$	775				7.5	%		$	(170	)			(21.9	)%

 

Research and development expense decreased by less than $0.1 million and $0.2 million for the three and nine months ended September 30, 2018, respectively, compared to 2017, as we continued to economize these activities.

 

Provision (Recovery) for Bad Debt Expense

 

		Three Months Ended September 30,																								Nine Months Ended September 30,
		2018								2017								Change								2018								2017								Change
		Amount				% of Total Net Sales				Amount				% of Total Net Sales				Amount				%				Amount				% of Total Net Sales				Amount				% of Total Net Sales				Amount				%
Provision (recovery) for bad debt expense		$	380				14.9	%		$	(483	)			(13.7	)%		$	863				178.7	%		$	386				4.4	%		$	(863	)			(8.4	)%		$	1,249				144.7	%

 

The provision for bad debt expense recorded during the three months ended September 30, 2018 is primarily related to the aging of accounts receivable under our policy, primarily in the U.S. The recovery for bad debt expense for the three months ended September 30, 2017 is primarily related to receiving cash for previously aged accounts receivable that were reserved for under our policy, primarily in China.

 

The provision for bad debt expense recorded during the nine months ended September 30, 2018 is primarily related to the aging of accounts receivable under our policy, primarily in the U.S. The provision was partially offset by receiving cash for previously aged accounts receivable that were reserved for under our policy, primarily in China. The recovery for bad debt expense for the nine months ended September 30, 2017 is primarily related to receiving cash for previously aged accounts receivable that were reserved for under our policy, primarily in China.

 

Other Income (Expense), net

 

		Three Months Ended September 30,																								Nine Months Ended September 30,
		2018								2017								Change								2018								2017								Change
		Amount				% of Total Net Sales				Amount				% of Total Net Sales				Amount				%				Amount				% of Total Net Sales				Amount				% of Total Net Sales				Amount				%
Other income (expense), net		$	880				34.6	%		$	321				9.1	%		$	559				174.1	%		$	2,083				23.6	%		$	1,527				14.8	%		$	556				36.4	%

 

On March 27, 2018, following the approval of the Company’s Special Committee of Continuing Directors, STR China entered into an agreement to terminate the Huhui Supply Agreement (the “Termination Agreement”). Pursuant to the Termination Agreement, Huhui agreed that STR China would retain the deposit, and each of Huhui and STR China agreed to release the other from any liability or further obligations under the Supply Agreement. As a result of the Termination Agreement, we recorded other income of $1.0 million during the first quarter of 2018.

 

During the three and nine months ended September 30, 2017, our China subsidiary received interim payments of $0.2 million and $1.7 million, respectively, from our local China insurance carrier related to the existing fire insurance claim. During the three months ended September 30, 2018, we received $1.8 million in the U.S. under the master property insurance plan related to the same claim. This payment completed the final settlement.

 

In July 2015, we announced a restructuring plan that included the closure of our Malaysia facility, effective August 2, 2015. During 2016, we entered into a definitive Purchase and Sale Agreement for the land-use right and the building for a purchase price of RM25.0 million (approximately $6.0 million as of September 30, 2018). As a result of the pending sale (which was subject to the approval of the Johor Port Authority), a gain on assets held for sale of $0.1 million and a loss on assets held for sale of $0.2 million, related to the foreign currency fluctuation of the Malaysian Ringgit, was recorded during the three and nine months ended September 30, 2017, respectively. As noted above, this agreement terminated prior to the consummation of the sale.

 

On November 1, 2018, we received a non-binding letter of intent from a potential buyer for our Malaysia facility for RM22.5 million (approximately $5.3 million after realtor fees as of September 30, 2018) with an expected closing date to occur in the first half of 2019. The sale of the property is part of the Company’s focus to reduce its footprint and operating costs. As a result of the pending sale, a loss on assets held for sale of $0.9 million was recorded during the three months ended September 30, 2018.

 

Foreign Currency Transaction Gain (Loss)

 

		Three Months Ended September 30,																								Nine Months Ended September 30,
		2018								2017								Change								2018								2017								Change
		Amount				% of Total Net Sales				Amount				% of Total Net Sales				Amount				%				Amount				% of Total Net Sales				Amount				% of Total Net Sales				Amount				%
Foreign currency transaction gain (loss)		$	9				0.4	%		$	123				3.5	%		$	(114	)			(92.7	)%		$	(153	)			(1.7	)%		$	48				0.5	%		$	(201	)			(418.8	)%

 

The foreign currency transaction impact was a gain of less than $0.1 million and $0.1 million for the three months ended September 30, 2018 and September 30, 2017. Both amounts are primarily the result of volatility in the Euro spot exchange rate versus the U.S. Dollar.

 

The foreign currency transaction loss for the nine months ended September 30, 2018 was $0.2 million compared to a gain of less than $0.1 million for the nine months ended September 30, 2017.

 

Our primary foreign currency exposures are intercompany loans, U.S. dollar cash balances in foreign locations and some U.S. dollar denominated accounts receivable at our Spain and China facilities.

 

Income Tax (Benefit) Expense

 

		Three Months Ended September 30,																								Nine Months Ended September 30,
		2018								2017								Change								2018								2017								Change
		Amount				% of Total Net Sales				Amount				% of Total Net Sales				Amount				%				Amount				% of Total Net Sales				Amount				% of Total Net Sales				Amount				%
Income tax (benefit) expense		$	(221	)			(8.7	)%		$	(173	)			(4.9	)%		$	(48	)			(27.7	)%		$	50				0.6	%		$	(316	)			(3.1	)%		$	366				115.8	%

 

During the three and nine months ended September 30, 2018, we recorded an income tax benefit of $0.2 million and an income tax expense of $0.1 million, resulting in an effective tax rate of 14.5% and (1.2%), respectively. The effective tax rate for the three and nine months ended September 30, 2018 differs from the U.S. statutory tax rate primarily due to the effect of taxes on foreign earnings.

 

During the three months ended September 30, 2018, the Company did not record any measurement period adjustments to the provisional estimates recorded at December 31, 2017 relating to the Tax Cuts and Jobs Act. Final accounting for these impacts is expected in the fourth quarter of 2018 subsequent to the Company’s completion of the 2017 tax return.

 

During the three and nine months ended September 30, 2017, we recorded an income tax benefit of $0.2 million and $0.3 million, respectively, resulting in an effective tax rate of 16.0% and 6.9%, respectively. The income tax benefit was primarily related to the allocation of tax expense between operations and other comprehensive income when applying the exception to the ASC 740 intra-period allocation rule. The projected annual effective tax rate, excluding the intraperiod allocation, is 0.0% as compared to the U.S. federal statutory rate of 35.0%. The annual effective tax rate is principally driven by changes in valuation allowances.

 

Cost-Reduction Actions

 

On March 7, 2017 we made the decision to wind down our China manufacturing operations substantially by the end of the second quarter of 2017. The decision was consistent with ongoing efforts to reorganize our business to better align with customer geography, to reduce losses related to unprofitable locations and to convert assets to cash for potential redeployment into more profitable endeavors. In connection with the restructuring, we do not expect any significant asset impairment charges and recorded $0.1 million of severance charges and benefits in cost of sales and less than $0.1 million of severance and benefits in selling, general and administrative expenses during the first nine months of 2017 and $0.1 million during the first nine months of 2018. The Company sold certain production and testing equipment from the China facility to its tolling partner in India during the third quarter of 2017.

 

In June 2018, we eliminated certain positions at our Spain facility effective June 18, 2018. We recorded $0.6 million of severance and benefits in cost of sales and $0.1 million of severance and benefits in selling, general and administrative expenses during the second quarter of 2018.

 

A roll-forward of the severance and other exit cost accrual activity was as follows:

 

		September 30, 2018				September  30, 2017
Balance as of beginning of year		$	0.1			$	0.3
Additions			0.8				0.2
Reductions			(0.8	)			(0.2	)
Reversals			—				(0.1	)
Balance as of end of period		$	0.1			$	0.2

 

The restructuring accrual consisted of $0.1 million and $0.2 million for severance and benefits as of September 30, 2018 and 2017, respectively.

 

Financial Condition, Liquidity and Capital Resources

 

We have funded our operations primarily through our sales and existing cash balance. As of September 30, 2018, our principal source of liquidity was $10.6 million of cash. Our principal needs for liquidity have been, and for the foreseeable future we expect will continue to be, for working capital and capital investments. We are also seeking to sell our Johor, Malaysia facility, as discussed herein. With respect to China, evolving currency control regulations may limit our access to the $0.4 million of cash located in China as of September 30, 2018 for use outside the country. Payment terms are currently longer in India than in many other locations, which result in delayed cash receipts from certain of our customers. Although we believe that our available cash will be sufficient to meet our liquidity needs, including capital investments, through at least the next 12 months, if we are unable to collect our accounts receivable or fail to receive payment in a timely fashion, our financial condition and results of operations will be negatively affected.

 

Our wholly owned Spanish subsidiary, Specialized Technology Resources España S.A.U. (“STR Spain”), has a factoring agreement to sell, with recourse, certain European, U.S. and other foreign company-based receivables to Eurofactor Hispania S.A.U., who was later acquired by Credit Agricole Leasing & Factoring Sucursal en España during the first quarter of 2017. Under the current terms of the factoring agreement, the maximum amount of outstanding advances at any one time is €1.5 million (approximately $1.7 million as of September 30, 2018), which is subject to adjustment based on the level of eligible receivables, restrictions on concentrations of receivables and the historical performance of the receivables sold. The annual discount rate is 2% plus EURIBOR for Euro-denominated receivables and 2% plus LIBOR for all other currencies. The agreement renews annually unless terminated by either party with 90 days prior written notice. As of September 30, 2018, €1.3 million (approximately $1.5 million as of September 30, 2018) was available under the factoring agreement based upon receivables outstanding.

 

In connection with our continued efforts to return our business to profitability, on July 24, 2015, our Board approved a restructuring of our business that included the shut-down of our Malaysia manufacturing facility, effective August 2, 2015. We are seeking to sell our Johor, Malaysia facility having already sold most of its production and ancillary equipment. In connection with the shut-down and potential sale of the Malaysia facility, we incurred approximately $1.3 million of associated non-recurring costs during the second half of 2015. In 2016, in connection with the potential sale of the Malaysia facility (specifically, the land-use right and building), an analysis of the asset group was performed and an impairment of assets held for sale of $1.7 million was recorded. As previously noted, we entered into an agreement to sell our rights to the facility for RM25.0 million (approximately $6.0 million as of September 30, 2018), however that agreement terminated during 2017 prior to consummation of the transaction. On November 1, 2018, we received a non-binding letter of intent from a potential buyer for our Malaysia facility for RM22.5 million (approximately $5.3 million after realtor fees as of September 30, 2018) with an expected closing date to occur in the first half of 2019.

 

In the fourth quarter of 2017, the Company initiated a significant investment through STR Spain to enter the high-end food packaging business. This ongoing investment, which leverages our plastics expertise, includes the purchase of new, state-of-the-art plastics processing equipment and related building improvements along with the addition of experienced staff to pursue manufacturing and sales of high-end food packaging products. We have received and applied certain conditional insurance proceeds to this project, helping to offset our net capital investment. These insurance proceeds were available to the Company only if we invested in new plastics manufacturing equipment. We were advised by our insurer that our investment qualified for reimbursement under the terms of our policy and, accordingly, they have paid our U.S. entity the amount of $0.8 million in October 2017, to cover the cost of the deposit for the primary capital equipment. Our U.S. entity also received an additional $1.8 million reimbursement during 2018 as we continued to make qualifying capital investment under the packaging project. We have also applied for loans of up to $2.4 million from the regional government of Asturias, Spain to further support the project. Subject to the timely purchase and installation of equipment, we expect to begin production by 2019. The food packaging business is highly competitive having market participants with substantially more resources and experience than us. We will be a new entrant in this market and we cannot assure that we will be successful in this new endeavor. In particular, we cannot assure that we will be able to successfully complete our investment in this new business on a timely basis or within budget, if at all, or that we will be able to achieve our anticipated revenue or earnings from this new investment. Nor can we assure that we will be able to obtain the loan(s) we have applied for from the regional government on favorable terms if at all.

 

We remain open to exploring possible business opportunities, alternate geographic markets, as well as other strategic alternatives. We cannot assure that we will be able to successfully pursue any such potential opportunities. If we are successful in pursuing any such opportunities, we may be required to expend significant funds, incur debt or other obligations or issue additional securities, any of which could significantly dilute our current stockholders and may negatively affect our operating results and financial condition. We cannot assure that any such strategic opportunities or related transactions, or any financing in connection therewith, would be available on favorable terms, if at all, or that we will realize any anticipated benefits from any such transactions that we complete. In the event that we are not successful in restructuring our business or pursuing other strategic opportunities, we also intend to consider alternatives, including, without limitation, the acquisition of another business, the divestiture of all or certain of our assets, joint ventures and other transactions outside the ordinary course of business.

 

If we are not able to fund our working capital needs, we will have to slow our projected growth, which may further impede or delay our attempt to return to sustainable profitability. We expect to fund our cash requirements with our existing cash, leveraging our European factoring facility and other potential working capital financing arrangements.

 

Our cash and cash equivalents balance is located in the following geographies (dollars in thousands):

 

 

		September 30, 2018
United States		$	7,454
Spain			2,494
China			353
Malaysia			156
Hong Kong			98
India			1
Consolidated		$	10,556

 

Due to the difficulty repatriating cash to the U.S., among other factors, we may have limited access to the $0.4 million of cash located in China for use outside the country. In 2017 we applied for, and received approval for, a reduction of the registered capital associated with STR China, enabling us to move $5.0 million out of China. In 2018 we received a further reduction of $3.0 million that was used to settle intercompany loans ultimately flowing back to the United States.

 

We do not permanently re-invest our Malaysia subsidiary’s earnings. Based upon the Malaysia subsidiary’s liabilities to us, we expect the undistributed earnings of our Malaysia subsidiary will be repatriated to the U.S. in a tax-free manner. We do not permanently re-invest our Spain earnings, so this cash balance is available for dividend repatriation (less any applicable withholding taxes). We have not elected to permanently re-invest our Hong Kong and China earnings and plan to utilize our cash located in Hong Kong and China to fund working capital requirements and wind-down costs. Our goal is to achieve and maintain self-sufficiency in each of our manufacturing locations to meet local cash requirements. We cannot assure that we will continue to fund the manufacturing operations in any location, if such operations would require investment of additional cash from other jurisdictions.

 

Cash Flows

 

Cash Flow from Operating Activities

 

Net cash used in operating activities was $2.6 million for the nine months ended September 30, 2018 compared to net cash provided by operating activities of $0.9 million for the nine months ended September 30, 2017. Net loss plus and minus non-cash adjustments improved by approximately $1.5 million for the nine months ended September 30, 2018 compared to the same period in 2017. This improvement was primarily driven by the conversion of bank acceptance notes.

 

Cash Flow from Investing Activities

 

Net cash used in investing activities was $0.2 million and $0.1 million for the nine months ended September 30, 2018 and September 30, 2017, respectively. The 2018 capital investments were primarily related to renovations to our Spain facility for the food packaging equipment. We expect remaining 2018 consolidated capital expenditures to be approximately $4.0 million related to the high-end food packaging equipment.

 

Cash Flow from Financing Activities

 

Net cash used in financing activities was $0.2 million and net cash provided by financing activities was $0.1 million for the nine months ended September 30, 2018 and 2017, respectively, primarily due to funds received by our Spanish subsidiary related to the factoring agreement.

 

Off-Balance Sheet Arrangements

 

We have no significant off-balance sheet financing arrangements.

 

Effects of Inflation

 

Inflation generally affects us by increasing costs of raw materials, labor and equipment. During the first nine months of 2018, we were not materially affected by inflation.

 

Recently Issued Accounting Standards

 

There are no new accounting pronouncements that we believe may have an impact on our Condensed Consolidated Financial Statements.

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

We are not required to provide this Item 3 because we are a smaller reporting company.

 

Item 4.

Controls and Procedures

 

Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports to the Securities Exchange Act of 1934, as amended (“Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chairman, President and Chief Executive Officer and our Vice President, Chief Financial Officer and Chief Accounting Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

 

As of September 30, 2018, we carried out an evaluation, under the supervision and with the participation of our management, including our Chairman, President and Chief Executive Officer and our Vice President, Chief Financial Officer and Chief Accounting Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based upon that evaluation, our Chairman, President and Chief Executive Officer and our Vice President, Chief Financial Officer and Chief Accounting Officer concluded that our disclosure controls and procedures are effective.

 

Changes in Internal Control Over Financial Reporting

 

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the third fiscal quarter of our fiscal year ended December 31, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

 

From time to time, we are and have been a party to litigation that arises in the ordinary course of our business.

 

In October 2016, a complaint was filed by Solaria Energia y Medio Ambiente S.A. (“Solaria”) against the Company and its Spanish subsidiary, STR Spain, in the Court of the First Instance No. 8 in Oviedo, Spain, relating to a product quality claim in connection with a non-encapsulant product that STR Spain purchased from a vendor in 2005 and 2006 and resold to Solaria. The Company stopped selling this product in 2006. Solaria is seeking approximately €3.3 million (approximately $3.8 million as of September 30, 2018), plus interest, in damages. A trial was held on April 6, 2017, in Oviedo, Asturias, Spain. The Company is currently awaiting a ruling from the court.

 

In 2016, the Company filed suit against CEEG (Nanjing) Renewable Energy Co., Ltd. (“NRE”), the parent company of our former customer CSUN in Nanjing Jiangning District People’s Court, China( the “Nanjing Court”). In a hearing held on August 10, 2016, the Nanjing Court found NRE delinquent in making payment against bona fide invoices dating back to April 2015 and ordered NRE to pay the Company the amount of RMB8.8 million for encapsulant sold to CSUN, court fees, interest and attorney fees. Following the subsequent failure of NRE to pay according to the order of the Nanjing Court, the Company initiated enforcement proceedings in the enforcement department of Nanjing Court and ultimately agreed to accept installment payments managed through the Nanjing Court, the first of which came due on February 28, 2018 and remains unpaid. The Company has since filed an application for the resumption of enforcement, for which the Nanjing Court has acknowledged receipt. The Nanjing Court has informed the Company that it will schedule another hearing to take further actions against NRE and its Chairman, Mr. Lu Tingxiu, to compel NRE to pay the Company according to the court order currently in force.

 

Item 1A. Risk Factors

 

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017, as amended by Form 10-K/A filed with the SEC on April 28, 2018, which could materially affect our business, financial position and results of operations. There have been no material changes to the risk factors as disclosed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017, as amended by Form 10-K/A filed with the SEC on April 28, 2018.

 

Item 5. Other Information

 

None.

 

Item 6. Exhibits

 

31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14 Securities Exchange Act Rules 13a-14(a) and 15d-14(a), pursuant to section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14 Securities Exchange Act Rules 13a-14(a) and 15d-14(a), pursuant to section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS		XBRL Instance Document
101.SCH*		XBRL Taxonomy Extension Schema Document
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF		XBRL Definition Linkbase Document
101.LAB		XBRL Taxonomy Extension Label Linkbase Document
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

 

 

 

 

 

 

 

SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	STR HOLDINGS, INC.
	(Registrant)
Date: November 14, 2018	/s/ Thomas D. Vitro
	Name:	Thomas D. Vitro
	Title:	Vice President, Chief Financial Officer and Chief Accounting Officer
		(Duly Authorized Officer and Principal Financial Officer)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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