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MarketScreener Homepage  >  Equities  >  OTC Bulletin Board  >  STR Holdings, Inc.    STRI

STR HOLDINGS, INC.

(STRI)
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STR : Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

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08/14/2019 | 08:19am EDT

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, 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 industrial 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, ability to achieve or sustain profitability in the future and our ability to continue as a going concern; (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 packaging products; (3) our historical reliance on a single product line and our pursuit of new market opportunities; (4) that we will be able to achieve our anticipated revenue, earnings or payback from the production of packaging products; (5) that we will receive the required approvals to complete the sale of our facility in Johor, Malaysia on a timely basis, if at all; (6) our securing net sales to new customers, growing net sales to existing key customers and increasing our market share; (7) customer concentration in our business and our relationships with and dependence on key customers; (8) the outsourcing arrangements and reliance on third parties for the manufacture of a portion of our encapsulants; (9) 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; (10) competition; (11) excess capacity in the solar supply chain; (12) demand for solar energy in general and solar modules in particular; (13) our operations in India and our assets in India and China being subject to significant political and economic uncertainties; (14) limited legal recourse under the laws of India and China if disputes arise; (15) our ability to adequately protect our intellectual property, particularly during the outsource manufacturing of our products; (16) our lack of credit facility and our inability to obtain credit; (17) a significant reduction or elimination of government subsidies and economic incentives or a change in government policies that promote the use of solar energy; (18) volatility in commodity costs; (19) our customers' financial profile causing additional credit risk on our accounts receivable; (20) our dependence on a limited number of third-party suppliers for raw materials for our encapsulants and other significant materials used in our process; (21) potential product performance matters and product liability; (22) our substantial international operations; (23) the impact of changes in foreign currency exchange rates on financial results, and the geographic distribution of revenues; (24) losses of financial incentives from government bodies in certain foreign jurisdictions; (25) our ability to perform our supply agreement and modified-technology license agreement with our client; (26) that we will be able to obtain the funding for the loan we have been preliminary approved for from the Spain Ministry of Industry, Commerce and Tourism; and (27) 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. Our pioneering background in plastics also served as the foundation for a number of other plastics products we have manufactured over the years and led to our recent entrance into the high-end food packaging business.



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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 solar encapsulant business by investing in research and development and global production capacity.




Recent Developments



Liquidity Needs. We continue to incur substantial losses. We incurred net losses of $5.4 million for the six months ended June 30, 2019 and $5.8 million for the year ended December 31, 2018. As of June 30, 2019, our principal source of liquidity was $2.0 million of cash. In addition, our credit facilities are limited to our factoring arrangement in Spain and a €2.0 million economic development loan received in March 2019 from the regional government of Asturias, Spain. Unless and until our operating results improve, we do not expect that we will be able to obtain traditional bank debt. Furthermore, tight credit in the solar manufacturing industry may delay or prevent our customers from securing funding adequate to operate their businesses and purchase our products and could lead to an increase in our bad debt levels. We have recently entered into an agreement for the sale of our Johor, Malaysia facility for RM22.5 million (approximately $5.3 million, after realtor fees, as of June 30, 2019). The sale is subject to customary closing conditions, including the timely approval of the sale by the Johor Port Authority, and we cannot assure that we will be able to obtain the requisite approvals or that the sale will take place on a timely basis, if at all. Our Spanish subsidiary, Specialized Technology Resources España, S.A.U. ("STR Spain"), has received preliminary approval for a loan of approximately €2.6 million from the Spain Ministry of Industry, Commerce and Tourism. If funding is received STR Spain expects to use the loan proceeds to help finance the launch and operation of its food packaging products business. However, there can be no guarantee that the funding will be received on favorable terms, or at all.

If we do not generate sufficient cash flows from operations or obtain alternative or additional sources of capital to fund operations, we will not have sufficient liquidity to satisfy operating expenses, capital expenditures and other cash needs. This raises substantial doubt about our ability to continue as a going concern. If we are unable to timely complete the sale of our Malaysia facility or execute our strategic plans described in further detail herein, our liquidity and capital resources will be adversely affected and we may wind down or cease any or all of our operations. Any wind down or dissolution may be a lengthy, complex and costly process and, in such event, there can be no assurance that there will be any funds available for distribution to stockholders.

Supply Agreement and Technology License Agreement.As previously disclosed, on January 16, 2018, we entered into an Equipment Purchase Agreement and a Technology License Agreement (together, the "Original Agreements") with a manufacturer of solar photovoltaic modules (the "Purchaser") having an aggregate transaction price of $6.0 million. Under the Equipment Purchase Agreement, we agreed to purchase from a third party specialized equipment (the "Equipment") for the production of one of our proprietary encapsulants (the "Encapsulant"), resell the Equipment to the Purchaser, install the Equipment at a facility of the Purchaser and train the Purchaser's personnel in the Equipment's use. Under the Technology License Agreement, we granted the Purchaser the right to use the formula for the Encapsulant and certain of our production techniques to make or have made the Encapsulant for use in photovoltaic (PV) modules manufactured by the Purchaser. In connection therewith, the Purchaser paid us $1.8 million in the first quarter of 2018, following our satisfaction of the first performance milestone relating to the delivery of certain licensed technology to the Purchaser. We and the Purchaser (the "Parties") then progressed to the satisfaction of another key milestone, qualification of our Encapsulants within Purchaser's solar modules, before proceeding to the purchase of the Equipment.

In the fourth quarter of 2018, the Purchaser entered into negotiations with us aimed at converting the Original Agreements into a more customary supply arrangement, such that we, rather than the Purchaser, would purchase the required Equipment and produce Encapsulants for purchase by the Purchaser. During this time, the Parties substantially suspended their obligations under the Original Agreements while negotiations over terms of a new supply agreement took place.

On July 29, 2019, the Parties entered into new agreements (the "New Agreements") which included: (i) the agreement by Purchaser of $2.0 million due to us for work performed under the Original Agreements prior to their suspension, which was received in July 2019, (ii) the termination of the Equipment Purchase Agreement to effectively cancel any of our obligations to acquire Encapsulant manufacturing equipment for resale to the Purchaser, (iii) the modification of the Technology License Agreement to preserve certain rights for the Purchaser to use the proprietary Encapsulant developed for Purchaser, and (iv) the execution of a Supply Agreement (the "Supply Agreement") for our Encapsulant.



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The Supply Agreement includes a take-or-pay provision under which (i) the Purchaser must purchase a minimum quarterly volume or if not so purchased must compensate us for a percentage of the value of the volume shortfall, and (ii) we must provide a minimum supply quantity or if not so provided must compensate the Purchaser for added costs if required to obtain alternate sourcing. The Supply Agreement provides for a fixed price for Encapsulants supplied during 2020, subject to certain performance criteria, then allows price to be adjusted quarterly based on increases or decreases in the cost of raw materials. The term of the Supply Agreement is for a period of three years from commercial commencement of the new production capacity, to be set up at our expense. The term of the Supply Agreement renews annually for additional one-year periods unless cancelled by either Party. Commencement of the Supply Agreement is dependent upon completion of the qualification testing of the Encapsulant, our purchase and installation of equipment to produce the Encapsulant, and an initial ramp up period. Assuming the satisfaction of these conditions, we anticipate commencing sales under the Supply Agreement within one year.

We expect that the initial cost of the Equipment and its installation will be $3.0 million. Based upon current pricing, which is subject to adjustment, we anticipate that the minimum revenue we will receive under the Supply Agreement, if the Purchaser purchases its minimum requirements under this contract, will be approximately $5.0 million per quarter. We cannot assure that we will be able to successfully qualify our Encapsulant or timely complete the purchase and installation of the Equipment within budget, if at all. Even if successful in doing so, we cannot assure that we will be able to successfully manufacture the Encapsulant for the Purchaser. Our failure to so succeed could have a material adverse effect our business and prospects.

India Tolling Plan. At the beginning of 2017, our manufacturing operations in Asia were based in China. A review of our production records in China revealed that our sales volume had been shifting to customers in India. As a result of this shift, and a fire that affected our China operations, we decided to wind down our manufacturing operations in China in 2017 and subsequently entered into an agreement with a tolling partner in India. By the close of 2017, we effectively completed the wind down process in China, with only a small administrative team remaining in an office under a short-term lease, and commenced tolling operations in India. We sold our undamaged production line from our Chinese subsidiary, Specialized Technology Resources Solar (Suzhou) Co. Ltd. ("STR China"), to our India tolling partner, and in 2018 we sold an additional production line to the same partner to further increase its manufacturing capacity in India. The second line became operational at the end of the third quarter of 2018.

Our approach to the solar business in India was deliberately "capital lite" to avoid putting STR-owned physical assets at undue risk, which is why we elected to work through a tolling partner rather than set up our own factory in India. The Indian solar market faces intense pricing pressure from Chinese imports, as is the case in nearly all global solar markets, and is therefore subject to the associated risk that domestic manufacturers are overrun by foreign competition. While India recently instituted a 25% safeguard duty on Chinese and Malaysian solar imports, the benefit to domestic manufacturers may not be enough to counteract the entrenched foreign competition.

The competitive conditions prevalent in the Indian solar market have resulted in slow payment for STR products from Indian manufacturers and credit risk that we are presently unwilling to accept. Along with this economic reality, and also because of our unwillingness to accept orders on uncertain credit terms, our tolling partner has informed us that they are no longer interested in cooperating with STR and intends to pursue the local market with their own line of solar products.

Given this backdrop, we have made the decision to unwind our tolling partnership and business in India and are presently working with our former partner to reconcile all related accounts including the collection of outstanding accounts receivable and the settlement of amounts owed by such former tolling partner to STR for equipment and inventory.

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. We cannot assure that any of these efforts will be successful.

High-End Food Packaging. In the fourth quarter of 2017, we initiated a significant investment through our wholly-owned subsidiary in Spain 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. The food packaging business is highly competitive, having market participants with substantially more resources and experience than us. We are a new entrant in this market, face challenges in loading the equipment with sufficient orders and cannot assure that we will be successful in this new endeavor.



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This project was supported in part by insurance proceeds we received for damage to our plastic manufacturing equipment that occurred in our China manufacturing facility in 2017. 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 have received from them payments totaling approximately $2.6 million. Of this reimbursement, $0.8 million was received in October 2017 and $1.8 million was received during 2018. To further support this project, in March 2019, we obtained a €2.0 million loan from the Regional Promotion Society ("SRP"), an agency of the government of Asturias, Spain. In addition, and as noted above, STR Spain has received preliminary approval for a loan of approximately €2.6 million from the Spain Ministry of Industry, Commerce and Tourism which, if funding is received, we expect to use to help finance the launch and operation of its food packaging products business. By the close of 2018, we had substantially completed the necessary renovations to one of our buildings in Asturias, Spain, including the construction of a tower required to accommodate our new equipment, as well as the installation and interconnection of a new, state-of-the-art multi-layer blown film extrusion line. This facility and equipment is now fully operational and ready for scale-up for the production of barrier film structures for the food packaging industry. During the last quarter, we have finalized the development of multiple competitive film products, completed and passed the compulsory food safety testing, successfully made samples of each product type for distribution to prospective customers and manufactured our first small production orders, which have reportedly run well on our customer's very high-speed food packaging equipment. Since installation, we have been focused on qualifying products and marketing and we have not received any significant orders to date.

Changes in the U.S. Solar Landscape. We believe that recent changes in U.S. Trade Policy, including tariffs imposed on solar panels and encapsulants, under Section 301 of the U.S. Trade Act of 1974, in combination with a reduction of the corporate income tax rate to 21% under the Tax Cuts and Jobs Act ("TCJA"), have resulted in a more attractive business climate for solar manufacturing in the United States. We have experienced a four-fold increase in encapsulant sales from our CT location for the six months ending June 30, 2019, as compared to the corresponding prior-year period. We attribute this increase to more domestic production of solar panels driven in part by tariffs on imports and the more internationally competitive corporate tax rate. Aside from those drivers, STR has continued to work with prospective customers to evaluate new proprietary encapsulant products and anticipates that these efforts may also translate into additional demand moving forward if and when these new products are ultimately qualified and selected. Tariffs, and tax rates under the TCJA, may change and disrupt the trajectory of recent gains in sales from our CT location or otherwise deteriorate current conditions.

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 27, 2019, as amended on April 26, 2019.























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Managers
NameTitle
Robert S. Yorgensen Chairman, President & Chief Executive Officer
Thomas D. Vitro Chief Financial & Accounting Officer, VP
Andrew M. Leitch Independent Director
John A. Janitz Lead Independent Director
Xin Lin Director
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