XNYS:STRI STR Holdings, Inc. Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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Table of Contents

 

 

 

 

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 June 30, 2012

 

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.)

 

 

 

1699 King Street, Enfield Connecticut

 

06082

(Address of principal executive offices)

 

(Zip Code)

 

(860) 758-7300

 (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 and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted 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 and post 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, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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 August 1, 2012, there were 41,677,626 shares of Common Stock, par value $0.01 per share, outstanding.

 

 

 



Table of Contents

 

INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

STR Holdings, Inc. and Subsidiaries

Three and Six Months Ended June 30, 2012

 

 

 

PAGE
NUMBER

PART I. FINANCIAL INFORMATION

 

 

 

 

 

Item 1. Financial Statements

 

2

Condensed Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011 (unaudited)

 

2

Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2012 and 2011 (unaudited)

 

3

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2012 and 2011 (unaudited)

 

4

Notes to Condensed Consolidated Financial Statements

 

5

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

 

15

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

31

Item 4. Controls and Procedures

 

32

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

 

Item 1. Legal Proceedings

 

32

Item 1A. Risk Factors

 

33

Item 6. Exhibits

 

33

SIGNATURE

 

35

 

1



Table of Contents

 

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

 

 

 

June 30,
2012

 

December 31,
2011

 

ASSETS

 

 

 

 

 

CURRENT ASSETS

 

 

 

 

 

Cash and cash equivalents

 

$

72,191

 

$

58,794

 

Accounts receivable, trade, less allowances for doubtful accounts of $521 and $225 in 2012 and 2011, respectively

 

11,464

 

14,535

 

Inventories

 

15,039

 

28,809

 

Prepaid expenses

 

1,198

 

1,234

 

Deferred tax assets

 

1,746

 

2,045

 

Income tax receivable

 

2,686

 

2,847

 

Other current assets

 

2,969

 

2,042

 

Total current assets

 

107,293

 

110,306

 

Property, plant and equipment, net

 

68,660

 

63,474

 

Intangible assets, net

 

139,696

 

143,912

 

Goodwill

 

 

82,524

 

Deferred financing costs

 

1,062

 

1,225

 

Other noncurrent assets

 

878

 

650

 

Total assets

 

$

317,589

 

$

402,091

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

CURRENT LIABILITIES

 

 

 

 

 

Accounts payable

 

$

7,396

 

$

4,647

 

Accrued liabilities

 

8,486

 

9,445

 

Income taxes payable

 

5,046

 

6,735

 

Total current liabilities

 

20,928

 

20,827

 

Deferred tax liabilities

 

46,165

 

48,585

 

Other long—term liabilities

 

2,121

 

2,174

 

Total liabilities

 

69,214

 

71,586

 

COMMITMENTS AND CONTINGENCIES (Note 8)

 

 

 

 

 

Stockholders’ Equity

 

 

 

 

 

Preferred stock, $0.01 par value, 20,000,000 shares authorized; no shares issued and outstanding

 

 

 

Common stock, $0.01 par value, 200,000,000 shares authorized; 41,669,734 and 41,666,012 issued and outstanding, respectively, in 2012 and 41,620,501 and 41,616,779 issued and outstanding, respectively, in 2011

 

413

 

412

 

Treasury stock, at cost

 

(57

)

(57

)

Additional paid—in capital

 

232,512

 

229,512

 

Retained earnings

 

18,660

 

103,212

 

Accumulated other comprehensive loss, net

 

(3,153

)

(2,574

)

Total stockholders’ equity

 

248,375

 

330,505

 

Total liabilities and stockholders’ equity

 

$

317,589

 

$

402,091

 

 

See accompanying notes to these condensed consolidated financial statements.

 

2



Table of Contents

 

STR Holdings, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

All amounts in thousands except share and per share amounts

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Net sales

 

$

25,119

 

$

71,677

 

$

56,202

 

$

139,655

 

Cost of sales

 

23,534

 

46,799

 

52,617

 

86,492

 

Gross profit

 

1,585

 

24,878

 

3,585

 

53,163

 

Selling, general and administrative expenses

 

6,708

 

7,406

 

14,454

 

14,828

 

(Recovery) provision for bad debt expense

 

(1,156

)

802

 

450

 

1,041

 

Goodwill impairment (Note 6)

 

 

 

82,524

 

 

Operating (loss) income

 

(3,967

)

16,670

 

(93,843

)

37,294

 

Interest (expense) income, net

 

(50

)

161

 

(111

)

235

 

Amortization of deferred financing costs

 

(81

)

(331

)

(163

)

(663

)

Other income (Note 8)

 

 

 

7,201

 

 

Foreign currency transaction gain (loss)

 

202

 

(93

)

(86

)

149

 

(Loss) earnings from continuing operations before income tax (benefit) expense

 

(3,896

)

16,407

 

(87,002

)

37,015

 

Income tax (benefit) expense from continuing operations

 

(1,475

)

5,233

 

(2,450

)

11,783

 

Net (loss) earnings from continuing operations

 

$

(2,421

)

$

11,174

 

$

(84,552

)

$

25,232

 

Discontinued operations (Note 3):

 

 

 

 

 

 

 

 

 

Loss from discontinued operations before income tax benefit

 

 

(1,985

)

 

(6,543

)

Income tax benefit from discontinued operations

 

 

(521

)

 

(1,861

)

Net loss from discontinued operations

 

 

(1,464

)

 

(4,682

)

Net (loss) earnings

 

$

(2,421

)

$

9,710

 

$

(84,552

)

$

20,550

 

Other comprehensive (loss) income:

 

 

 

 

 

 

 

 

 

Foreign currency translation (net of tax effect of $(846), $706, $(311) and $1,795, respectively)

 

(1,573

)

1,310

 

(579

)

3,333

 

Other comprehensive (loss) income

 

(1,573

)

1,310

 

(579

)

3,333

 

Comprehensive (loss) income

 

$

(3,994

)

$

11,020

 

$

(85,131

)

$

23,883

 

Net (loss) earnings per share (Note 4):

 

 

 

 

 

 

 

 

 

Basic from continuing operations

 

$

(0.06

)

$

0.27

 

$

(2.05

)

$

0.62

 

Basic from discontinued operations

 

 

(0.03

)

 

(0.12

)

Basic

 

$

(0.06

)

$

0.24

 

$

(2.05

)

$

0.50

 

 

 

 

 

 

 

 

 

 

 

Diluted from continuing operations

 

$

(0.06

)

$

0.27

 

$

(2.05

)

$

0.60

 

Diluted from discontinued operations

 

 

(0.04

)

 

(0.11

)

Diluted

 

$

(0.06

)

$

0.23

 

$

(2.05

)

$

0.49

 

Weighted—average shares outstanding (Note 4):

 

 

 

 

 

 

 

 

 

Basic

 

41,287,338

 

40,882,026

 

41,239,316

 

40,821,482

 

Diluted

 

41,287,338

 

42,012,274

 

41,239,316

 

42,129,184

 

 

See accompanying notes to these condensed consolidated financial statements.

 

3



Table of Contents

 

STR Holdings, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

All amounts in thousands

 

 

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

OPERATING ACTIVITIES

 

 

 

 

 

Net (loss) earnings

 

$

(84,552

)

$

20,550

 

Net loss from discontinued operations

 

 

4,682

 

Net (loss) earnings from continuing operations

 

(84,552

)

25,232

 

Adjustments to reconcile net (loss) earnings to net cash provided by operating activities:

 

 

 

 

 

Depreciation

 

4,115

 

3,793

 

Goodwill impairment

 

82,524

 

 

Amortization of intangibles

 

4,216

 

4,216

 

Amortization of deferred financing costs

 

163

 

663

 

Stock—based compensation expense

 

2,978

 

2,200

 

Provision for bad debt expense

 

450

 

1,041

 

Deferred income tax benefit

 

(1,811

)

(580

)

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

2,490

 

(13,002

)

Income tax receivable

 

(2,686

)

 

Inventories

 

11,303

 

(12,237

)

Other current assets

 

4,122

 

(580

)

Accounts payable

 

2,863

 

(692

)

Accrued liabilities

 

(1,129

)

467

 

Income taxes payable

 

4,136

 

(8,679

)

Other, net

 

115

 

1,987

 

Net cash provided by continuing operations

 

29,297

 

3,829

 

Net cash used in discontinued operations

 

(5,786

)

(1,952

)

Net cash provided by operating activities

 

23,511

 

1,877

 

INVESTING ACTIVITIES

 

 

 

 

 

Capital expenditures

 

(9,425

)

(14,535

)

Net cash used in continuing operations

 

(9,425

)

(14,535

)

Net cash used in discontinued operations

 

 

(1,993

)

Net cash used in investing activities

 

(9,425

)

(16,528

)

FINANCING ACTIVITIES

 

 

 

 

 

Proceeds from exercise of stock options

 

 

596

 

Option exercise recognized tax benefit

 

 

77

 

Common stock issued under employee stock purchase plan

 

25

 

 

Net cash provided by continuing operations

 

25

 

673

 

Net cash used in discontinued operations

 

 

(925

)

Net cash provided by (used in) financing activities

 

25

 

(252

)

Effect of exchange rate changes on cash

 

(714

)

3,650

 

Net change in cash and cash equivalents

 

13,397

 

(11,253

)

Cash and cash equivalents, beginning of period

 

58,794

 

106,630

 

Cash and cash equivalents, end of period

 

72,191

 

95,377

 

Less cash and cash equivalents of discontinued operations, end of period

 

 

8,297

 

Cash and cash equivalents from continuing operations, end of period

 

$

72,191

 

$

87,080

 

 

See accompanying notes to these condensed consolidated financial statements.

 

4



Table of Contents

 

STR Holdings, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

All amounts in thousands except share amounts, per share amounts or unless otherwise noted

 

NOTE 1—BASIS OF PRESENTATION

 

The accompanying condensed consolidated financial statements and the related interim information contained within the notes to the condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and the applicable rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial information and quarterly reports on the Form 10—Q. Accordingly, they do not include all of the information and the notes required for complete financial statements. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2011, included in the Company’s Form 10—K filed with the SEC on March 14, 2012. The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements, and in the opinion of management, reflect all adjustments, consisting of only normal and recurring adjustments, necessary for the fair presentation of the Company’s financial position, results of operations and cash flows for the interim periods presented. The results for the interim periods presented are not necessarily indicative of future results.

 

The Quality Assurance (“QA”) business’ historical operating results and the interest expense associated with the Company’s prior first lien credit agreement and the second lien credit agreement (together, the “2007 Credit Agreements”) are recorded in discontinued operations in the Condensed Consolidated Statements of Comprehensive Income and the Condensed Consolidated Statements of Cash Flows for all periods presented.

 

The year—end Condensed Consolidated Balance Sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.

 

The preparation of financial statements in conformity with GAAP requires management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from management’s estimates.

 

NOTE 2—RECENT ACCOUNTING PRONOUNCEMENTS

 

In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011—05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. The FASB Accounting Standards Codification (“ASC”) 220 established standards for the reporting and presentation of comprehensive income and its components in a full set of general—purpose financial statements. Under the amendments, an entity has the option to present the total of comprehensive income, the components of net earnings and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate, but consecutive statements. In both choices, an entity is required to present each component of net earnings along with total net earnings, each financial component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. The entity is required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net earnings in the statement(s) where the components of net earnings and the components of other comprehensive income are presented. The amendments should be applied retrospectively. The amendments became effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The amendments did not require any transition disclosures. The Company early adopted this standard effective June 30, 2011, and it did not have a material impact on the Company’s condensed consolidated financial statements since the Company previously presented net earnings, other comprehensive income and its components and total comprehensive income in a continuous statement.

 

The FASB subsequently issued ASU No. 2011—12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items out of Accumulated Other Comprehensive Income in ASU No. 2011—05. The amendments to the Codification in ASU No. 2011—12 became effective at the same time as the amendments in ASU No. 2011—05, Comprehensive Income, so that entities are not required to comply with the presentation requirements in ASU No. 2011—05 that ASU No. 2011—12 deferred. Entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before ASU No. 2011—05. All other requirements in ASU No. 2011—05 were not affected by ASU No. 2011—12, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. This standard did not have a material impact on the Company’s condensed consolidated financial statements.

 

5



Table of Contents

 

STR Holdings, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

All amounts in thousands except share amounts, per share amounts or unless otherwise noted

 

NOTE 3—DISCONTINUED OPERATIONS

 

On August 16, 2011, the Company entered into an equity purchase agreement to sell its QA business to Underwriters Laboratories (“UL”) for $275,000 plus assumed cash. The QA business provided consumer product testing, inspection, auditing and consulting services that enabled retailers and manufacturers to determine whether products and facilities met applicable safety, regulatory, quality, performance, social and ethical standards. In addition, the Company and UL entered into a transition services agreement, pursuant to which the Company agreed to provide certain services to UL following the closing of the sale, including accounting, tax, legal, payroll and employee benefit services. UL agreed to provide certain information technology services to the Company pursuant to such agreement. On September 1, 2011, the Company completed the sale of the QA business for total net cash proceeds of $283,376, which included $8,376 of estimated cash assumed in certain QA locations. On September 1, 2011, pursuant to the terms and conditions of the equity purchase agreement, as amended, the Company transferred the applicable assets, liabilities, subsidiaries and employees of the QA business to Nutmeg Holdings, LLC (“Nutmeg”) and STR International, LLC (“International,” and together with Nutmeg and their respective subsidiaries, the “Nutmeg Companies”), and immediately thereafter sold its equity interest in each of the Nutmeg Companies to designated affiliates of UL. The Company decided to sell the QA business in order to focus exclusively on the solar encapsulant opportunity and to seek further product offerings related to the solar industry, as well as other growth markets related to the Company’s polymer manufacturing capabilities, and to retire its long—term debt.

 

In the fourth quarter of 2011, the Company received $2,727 in additional cash proceeds from UL related to the finalization of the excess cash and working capital adjustments in accordance with the purchase agreement.

 

In accordance with ASC 250—20—Presentation of Financial Statements—Discontinued Operations and ASC 740—20—Income Taxes—Intraperiod Tax Allocation, the accompanying Condensed Consolidated Statements of Comprehensive Income and Condensed Consolidated Cash Flows present the results of the QA business as discontinued operations. Prior to the sale, the QA business was a segment of the Company. The Company has no continuing involvement in the operations of the QA business and does not have any direct cash flows from the QA business subsequent to the sale. Accordingly, the Company has presented the QA business as discontinued operations in these condensed consolidated financial statements.

 

As anticipated and in conjunction with the closing of the sale of the QA business, the Company triggered non—compliance with certain debt covenants that required the repayment of all debt outstanding at that time. Therefore and in order to sell assets of the QA business free and clear of all liens under the 2007 Credit Agreements, on September 1, 2011, the Company terminated the 2007 Credit Agreements and used approximately $237,732 from the proceeds of the sale to repay all amounts due to Credit Suisse AG, as administrative agent and collateral agent.

 

In connection with the payoff of all the existing debt, the Company also wrote off $3,586 of the remaining unamortized deferred financing costs associated with the 2007 Credit Agreements.

 

The following tables set forth the operating results of the QA business being presented as a discontinued operation for the three and six months ended June 30, 2012 and 2011, respectively:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Net sales

 

$

 

$

30,712

 

$

 

$

55,671

 

Loss from operations before income tax benefit

 

$

 

$

(1,985

)

$

 

$

(6,543

)

Net loss

 

$

 

$

(1,464

)

$

 

$

(4,682

)

 

6



Table of Contents

 

STR Holdings, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

All amounts in thousands except share amounts, per share amounts or unless otherwise noted

 

NOTE 4—EARNINGS PER SHARE

 

The calculation of basic and diluted (loss) earnings per share for the periods presented is as follows:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Basic and diluted net (loss) earnings per share

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net (loss) earnings from continuing operations

 

$

(2,421

)

$

11,174

 

$

(84,552

)

$

25,232

 

Net loss from discontinued operations

 

 

(1,464

)

 

(4,682

)

Net (loss) earnings

 

$

(2,421

)

$

9,710

 

$

(84,552

)

$

20,550

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted—average shares outstanding

 

41,287,338

 

40,882,026

 

41,239,316

 

40,821,482

 

Add:

 

 

 

 

 

 

 

 

 

Dilutive effect of stock options

 

 

719,030

 

 

845,263

 

Dilutive effect of restricted common stock

 

 

411,218

 

 

462,439

 

Weighted—average shares outstanding with dilution

 

41,287,338

 

42,012,274

 

41,239,316

 

42,129,184

 

 

 

 

 

 

 

 

 

 

 

Net (loss) earnings per share:

 

 

 

 

 

 

 

 

 

Basic from continuing operations

 

$

(0.06

)

$

0.27

 

$

(2.05

)

$

0.62

 

Basic from discontinued operations

 

 

(0.03

)

 

(0.12

)

Basic

 

$

(0.06

)

$

0.24

 

$

(2.05

)

$

0.50

 

 

 

 

 

 

 

 

 

 

 

Diluted from continuing operations

 

$

(0.06

)

$

0.27

 

$

(2.05

)

$

0.60

 

Diluted from discontinued operations

 

 

(0.04

)

 

(0.11

)

Diluted

 

$

(0.06

)

$

0.23

 

$

(2.05

)

$

0.49

 

 

Due to the loss from continuing operations for the three and six months ended June 30, 2012, diluted weighted—average common shares outstanding does not include shares of unvested restricted common stock as these potential awards do not share in any net loss generated by the Company and are anti—dilutive.

 

Since the effect would be anti—dilutive, there were 284 and 130 shares of common stock issuable upon the exercise of options issued under the Employee Stock Purchase Plan (“ESPP”) that were not included in the computation of diluted weighted—average shares outstanding for the three and six months ended June 30, 2012, respectively.

 

Since the effect would be anti—dilutive, there were 3,388,121 and 113,420 stock options outstanding that were not included in the computation of diluted weighted—average shares outstanding for the three months ended June 30, 2012 and June 30, 2011, respectively. Since the effect would be anti—dilutive, there were 3,388,121 and 77,557 stock options outstanding that were not included in the computation of diluted weighted—average shares outstanding for the six months ended June 30, 2012 and June 30, 2011, respectively.

 

NOTE 5—INVENTORIES

 

Inventories consist of the following:

 

 

 

June 30,
2012

 

December 31,
2011

 

Finished goods

 

$

3,796

 

$

3,112

 

Raw materials

 

11,243

 

25,697

 

Inventories

 

$

15,039

 

$

28,809

 

 

7



Table of Contents

 

STR Holdings, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

All amounts in thousands except share amounts, per share amounts or unless otherwise noted

 

NOTE 6—LONG—LIVED ASSETS AND GOODWILL

 

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

 

The Company tested its long—lived assets for impairment as of March 31, 2012. The Company concluded that no impairment existed as the sum of the undiscounted expected future cash flows exceeded its long—lived assets’ carrying values as of March 31, 2012. The Company also determined that no change to the estimated useful lives was required. The Company did not test its long—lived assets for impairment as of June 30, 2012, as it concluded that no triggering event occurred during the second quarter of 2012. However, if the Company continues to experience a significant reduction in sales volume or profitability in the future, or any adverse circumstances as discussed above, certain of its long—lived assets may be subject to accelerated depreciation/amortization and/or future impairment.

 

At March 31, 2012, the Company valued its reporting unit with the assistance of a valuation specialist and determined that its reporting unit’s net book value exceeded its fair value. The Company then performed step two of the goodwill impairment assessment which involved calculating the implied fair value of goodwill by allocating the fair value of the reporting unit to all of its assets and liabilities other than goodwill and comparing the residual amount to the carrying amount of goodwill. The Company determined that the implied fair value of goodwill was lower than its carrying value and recorded a goodwill impairment of $82,524. The Company estimated the fair value of its reporting unit under the income approach using a discounted cash flow method which incorporated the Company’s cash flow projections. The Company also considered its market capitalization, control premiums and other valuation assumptions in reconciling the calculated fair value to the market capitalization at the assessment date. Based on the other than temporary decline in the Company’s stock price and its net book value exceeding the market capitalization of its common stock during the first quarter of 2012, the market approach was given a higher weighting in determining fair value. The Company believes the cash flow projections and valuation assumptions used were reasonable and consistent with market participants. Inherent in management’s development of cash flow projections are assumptions and estimates, including those related to future earnings, growth prospects and the weighted—average cost of capital. Many of the factors used in assessing the fair value are outside the control of management, and these assumptions and estimates can change in future periods as a result of both Company—specific factors and overall economic conditions.

 

Goodwill was $0 at June 30, 2012 and $82,524 at December 31, 2011. Goodwill is not deductible for tax purposes.

 

NOTE 7—INCOME TAXES

 

The Company’s effective income tax rate from continuing operations for the three months and six months ended June 30, 2012 was 37.9% and 2.8%, respectively, compared to the U.S. federal statutory tax rate of 35.0%. The Company’s effective tax rate from continuing operations was approximately 31.9% and 31.8%, respectively, for the three and six months ended June 30, 2011.

 

8



Table of Contents

 

STR Holdings, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

All amounts in thousands except share amounts, per share amounts or unless otherwise noted

 

NOTE 7—INCOME TAXES (Continued)

 

In 2011, the Company generated income in the U.S. that was taxed at the U.S. federal statutory rate of 35%, prior to the impact of any deductions or non-deductible expenses. The 2011 income tax expense was reduced by the Company’s permanently invested Malaysia earnings where it benefits from a zero percent tax holiday. In 2012, the Company’s operations are expected to generate a taxable loss in the U.S. as the solar industry continues to shift and expand in Asia. As such, the Company expects to receive an income tax benefit that will reduce its expected loss at the U.S. federal statutory rate of 35%, prior to the impact of any deductions or non-deductible expenses. In addition, the Company expects to continue to benefit from anticipated earnings in Malaysia that are permanently reinvested at a zero percent tax rate.

 

The effective tax rate from continuing operations for the six months ended June 30, 2012 also reflects discrete items recorded in the first quarter relating to the goodwill impairment for which no tax benefit is recorded and settlement of income tax audits resulting in a $1,000 benefit.

 

A shift in the mix of the Company’s expected geographic earnings, primarily in Malaysia, could cause its expected effective tax rate to change significantly.

 

On March 7, 2012, the Internal Revenue Service issued Revenue Procedures 2012—9 and 2012—20 (“Revenue Procedures”) that provide a procedure for a taxpayer to follow in order to obtain automatic consent of the Commissioner to change its methods of accounting. This change was made to comply with the tangible property temporary regulations (“Temporary Regulations”) that were issued on December 23, 2011. The Revenue Procedures allow taxpayers to change their method of accounting for tax years beginning on or after January 1, 2012. Accordingly, taxpayers may not early adopt the provisions in the Temporary Regulations. The Company is assessing the impact, if any, of this procedure.

 

NOTE 8—COMMITMENTS AND CONTINGENCIES

 

The Company is a party to claims and litigation in the normal course of its operations. Management believes that the ultimate outcome of these matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.

 

The Company typically does not provide contractual warranties on its products. However, on limited occasions, the Company incurs costs in connection with specific product performance claims. The Company has accrued for specific product performance matters that are probable and estimable based on its best estimate of ultimate cash expenditures that it will incur for such items. The following table summarizes the Company’s product performance liability that is recorded in accrued liabilities in the Condensed Consolidated Balance Sheets:

 

 

 

June 30,
2012

 

June 30,
2011

 

Balance as of beginning of year

 

$

4,762

 

$

4,109

 

Additions

 

109

 

512

 

Reductions

 

(892

)

(136

)

Balance as of end of period

 

$

3,979

 

$

4,485

 

 

The majority of this accrual relates to a quality claim by one of the Company’s customers in connection with a non—encapsulant product that the Company purchased from a vendor in 2005 and 2006 and resold. The Company stopped selling this product in 2006 and is currently attempting to resolve this matter.

 

During 2010, the Company performed a Phase II environmental site assessment at its 10 Water Street, Enfield, Connecticut location. During its investigation, the site was found to contain a presence of volatile organic compounds. The Company has been in contact with the Department of Environmental Protection and has engaged a licensed contractor to remediate this circumstance. Based on ASC 450—Contingencies, the Company has accrued the estimated cost to remediate of $350. During the six months ended June 30, 2012 the Company utilized $148 of this accrual, leaving a balance of $202 as of June 30, 2012.

 

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Table of Contents

 

STR Holdings, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

All amounts in thousands except share amounts, per share amounts or unless otherwise noted

 

NOTE 8—COMMITMENTS AND CONTINGENCIES (Continued)

 

Galica/JPS

 

As previously disclosed, the Company entered into a Global Settlement Agreement and Release (the “Settlement Agreement”) with JPS Industries Inc., JPS Elastomerics Corp. and James P. Galica (collectively “JPS”). Pursuant to the Settlement Agreement, the parties agreed to (i) payment by JPS of $7,131 to the Company, (ii) dismissals of pending actions in state and federal courts and all associated appeals and proceedings, (iii) the satisfaction of outstanding judgments in the state court action, (iv) the disbursement to the Company of $70, deposited with and held in escrow by the court, (v) the discharge of attachments of certain assets of JPS, (vi) the modification of the injunction issued in the state court action: (a) reducing the term of a production injunction from five years to four years, (b) permitting JPS to permanently bond encapsulant to fiberglass mesh and laminate non—low shrink encapsulant to paper, (c) the deletion of JPS’s obligations with respect to the review and deletion of certain documents, (vii) the delivery to the Company by JPS of certain components of an equipment line purchased by it, (viii) the deletion by JPS of certain data, (ix) the general release of claims by the parties related to the state and federal court actions, subject to the retention by the Company of certain rights, (x) the covenant by JPS not to sue the Company (and its affiliates) with respect to matters related to the federal court action, (xi) the agreement by JPS and Galica to cooperate with the Company in connection with investigations related to the potential dissemination of the Company’s trade secrets, and (xii) certain other customary terms and conditions.

 

The Company received the $7,201 payment during the first quarter of 2012, which is recorded in Other Income on its Condensed Consolidated Statements of Comprehensive Income for the six months ended June 30, 2012.

 

Alpha Marathon

 

On October 7, 2011, the Company filed a Statement of Claim with the Ontario Superior Court of Justice against Alpha Marathon Film Extrusion Technologies Inc. (“Alpha Marathon”) an equipment line manufacturer located in Ontario, Canada, seeking damages resulting from Alpha Marathon’s misappropriation of trade secrets and an injunction barring use of those trade secrets.

 

NOTE 9—STOCKHOLDERS’ EQUITY

 

Changes in stockholders’ equity for the six months ended June 30, 2012 are as follows:

 

 

 

Common Stock

 

Treasury Stock

 

Additional
Paid
In

 

Retained

 

Accumulated
Other
Comprehensive

 

Total
Stockholders’

 

 

 

Issued

 

Amount

 

Acquired

 

Amount

 

Capital

 

Earnings

 

Loss

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2011

 

41,191,468

 

$

412

 

3,722

 

$

(57

)

$

229,512

 

$

103,212

 

$

(2,574

)

$

330,505

 

Stock—based compensation

 

140,796

 

1

 

 

 

2,977

 

 

 

2,978

 

Employee stock purchase plan

 

4,497

 

 

 

 

23

 

 

 

23

 

Net loss

 

 

 

 

 

 

(84,552

)

 

(84,552

)

Foreign currency translation, net of tax

 

 

 

 

 

 

 

(579

)

(579

)

Balance at June 30, 2012

 

41,336,761

 

$

413

 

3,722

 

$

(57

)

$

232,512

 

$

18,660

 

$

(3,153

)

$

248,375

 

 

Preferred Stock

 

The Company’s Board of Directors has authorized 20,000,000 shares of preferred stock, $0.01 par value. At June 30, 2012, there were no shares issued or outstanding.

 

Common Stock

 

The Company’s Board of Directors has authorized 200,000,000 shares of common stock, $0.01 par value. At June 30, 2012, there were 41,669,734 shares issued and 41,666,012 shares outstanding of common stock. Each share of common stock is entitled to one vote per share. Included in the 41,666,012 shares outstanding are 41,336,761 shares of common stock and 329,251 shares of unvested restricted common stock.

 

10



Table of Contents

 

STR Holdings, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

All amounts in thousands except share amounts, per share amounts or unless otherwise noted

 

NOTE 9—STOCKHOLDERS’ EQUITY (Continued)

 

Treasury Stock

 

In connection with the Company’s former debt agreements, the Company was allowed to repurchase its equity interest owned by terminated employees in connection with the exercise of stock options or similar equity based incentives in an aggregate amount not to exceed $2,000 in any fiscal year. At June 30, 2012, there were 3,722 shares held in treasury that were purchased at a cost of $57.

 

NOTE 10—STOCKBASED COMPENSATION

 

On November 6, 2009, the Company’s Board of Directors approved the Company’s 2009 Equity Incentive Plan (the “2009 Plan”) which became effective on the same day. A total of 4,750,000 shares of common stock are reserved for issuance under the 2009 Plan. The 2009 Plan is administered by the Board of Directors or any committee designated by the Board of Directors, which has the authority to designate participants and determine the number and type of awards to be granted, the time at which awards are exercisable, the method of payment and any other terms or conditions of the awards. The 2009 Plan provides for the grant of stock options, including incentive stock options and nonqualified stock options, collectively, “options,” stock appreciation rights, shares of restricted stock, or “restricted stock,” rights to dividend equivalents and other stock—based awards, collectively, the “awards.” The Board of Directors or the committee will, with regard to each award, determine the terms and conditions of the award, including the number of shares subject to the award, the vesting terms of the award, and the purchase price for the award. Awards may be made in assumption of or in substitution for outstanding awards previously granted by the Company or its affiliates, or a company acquired by the Company or with which it combines. Options outstanding generally vest over a four—year period and expire ten years from date of grant. There were 1,006,352 shares available for grant under the 2009 plan as of June 30, 2012.

 

The following table summarizes the options activity under the Company’s 2009 Plan for the six months ended June 30, 2012:

 

 

 

Options Outstanding

 

 

 

Number
of
Shares

 

Weighted
Average
Exercise
Price

 

Weighted
Average
Remaining
Contractual
Term

(in years)

 

Weighted
Average
Grant
Date
Fair Value

 

Aggregate
Intrinsic
Value(1)

 

Balance at December 31, 2011

 

3,400,121

 

$

11.63

 

7.96

 

$

4.82

 

$

(24,039

)

Options granted

 

 

 

 

 

 

Exercised

 

 

 

 

 

 

Canceled/forfeited

 

(12,000

)

$

18.80

 

 

$

9.66

 

$

171

 

Balance at June 30, 2012

 

3,388,121

 

$

11.61

 

7.46

 

$

4.80

 

$

(23,886

)

Vested and exercisable as of June 30, 2012

 

3,110,329

 

$

11.39

 

7.40

 

$

4.61

 

$

(21,244

)

Vested and exercisable as of June 30, 2012 and expected to vest thereafter

 

3,388,121

 

$

11.61

 

7.46

 

$

4.80

 

$

(23,886

)

 


(1) The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the closing stock price of $4.56 of the Company’s common stock on June 30, 2012.

 

As of June 30, 2012, there was $1,703 of unrecognized compensation cost related to outstanding employee stock option awards. This amount is expected to be recognized over a weighted—average remaining vesting period of approximately two years. To the extent the actual forfeiture rate is different from what the Company has anticipated, stock—based compensation related to these awards will be different from its expectations.

 

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Table of Contents

 

STR Holdings, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

All amounts in thousands except share amounts, per share amounts or unless otherwise noted

 

NOTE 10—STOCKBASED COMPENSATION (Continued)

 

The following table summarizes the restricted common stock activity of the Company for the six months ended June 30, 2012:

 

 

 

Unvested
Restricted Shares

 

 

 

Number of
Shares

 

Weighted
Average
Grant
Date
Fair Value

 

Unvested at December 31, 2011

 

425,311

 

$

10.08

 

Granted

 

44,736

 

$

3.82

 

Vested

 

(140,796

)

$

9.96

 

Canceled

 

 

 

Unvested at June 30, 2012

 

329,251

 

$

9.30

 

Expected to vest after June 30, 2012

 

329,251

 

$

9.30

 

 

As of June 30, 2012, there was $1,356 of unrecognized compensation cost related to employee and director unvested restricted common stock. This amount is expected to be recognized over a weighted—average remaining vesting period of approximately 2.5 years. To the extent the actual forfeiture rate is different from what the Company has anticipated, stock—based compensation related to these awards will be different from its expectations.

 

On November 9, 2010, the Company’s Board of Directors adopted the STR Holdings, Inc. 2010 Employee Stock Purchase Plan (“ESPP”) and reserved 500,000 shares of the Company’s common stock for issuance thereunder. The ESPP was made effective upon its approval by the votes of the Company’s stockholders on May 24, 2011 during the Company’s annual meeting for the purpose of qualifying such shares for special tax treatment under Section 423 of the Internal Revenue Code of 1986, as amended.

 

Under the ESPP, eligible employees may use payroll withholdings to purchase shares of the Company’s common stock at a 10% discount. The Company has established four offering periods in which eligible employees may participate. The first offering period commenced in the fourth quarter of 2011. The Company purchases the number of required shares each period based upon the employees’ contribution plus the 10% discount. The number of shares purchased times the 10% discount is recorded by the Company as stock—based compensation. The Company recorded $1 and $3 as stock—based compensation expense relating to the ESPP for the three and six months ended June 30, 2012, respectively. There were 495,503 shares available for purchase under the ESPP as of June 30, 2012.

 

Stock—based compensation expense was included in the following Condensed Consolidated Statements of Comprehensive Income categories for continuing operations:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Cost of sales

 

$

1

 

$

 

$

1

 

$

 

Selling, general and administrative expense

 

$

1,503

 

$

1,100

 

$

2,977

 

$

2,200

 

Total option exercise recognized tax benefit

 

$

 

$

23

 

$

 

$

25

 

 

NOTE 11—REPORTABLE SEGMENT AND GEOGRAPHICAL INFORMATION

 

ASC 280—10—50—Disclosure about Segment of an Enterprise and Related Information, establishes standards for the manner in which companies report information about operating segments, products, geographic areas and major customers. The method of determining what information to report is based on the way that management organizes the operating segment within the enterprise for making operating decisions and assessing financial performance. Since the Company has one product, sells to global customers in one industry, procures raw materials from similar vendors and expects similar long—term economic characteristics, the Company has one reporting segment and the information as to its operation is set forth below.

 

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Table of Contents

 

STR Holdings, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

All amounts in thousands except share amounts, per share amounts or unless otherwise noted

 

NOTE 11—REPORTABLE SEGMENT AND GEOGRAPHICAL INFORMATION (Continued)

 

Adjusted EBITDA is the main metric used by the management team and the Board of Directors to plan, forecast and review the Company’s segment performance. Adjusted EBITDA represents net earnings from continuing operations before interest income and expense, income tax expense, depreciation, amortization of intangible assets, goodwill impairment, stock—based compensation expense, amortization of deferred financing costs and certain non—recurring income and expenses from the results of operations.

 

The following tables set forth information about the Company’s operations by its reportable segment and by geographic area:

 

Operations by Reportable Segment

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Reconciliation of Adjusted EBITDA to Net (Loss) Earnings from Continuing Operations

 

 

 

 

 

 

 

 

 

Adjusted EBITDA

 

$

2,124

 

$

21,720

 

$

7,105

 

$

47,652

 

Depreciation and amortization

 

(4,385

)

(4,043

)

(8,331

)

(8,009

)

Amortization of deferred financing costs

 

(81

)

(331

)

(163

)

(663

)

Interest (expense) income, net

 

(50

)

161

 

(111

)

235

 

Income tax benefit (expense)

 

1,475

 

(5,233

)

2,450

 

(11,783

)

Goodwill impairment

 

 

 

(82,524

)

 

Stock—based compensation

 

(1,504

)

(1,100

)

(2,978

)

(2,200

)

Net (Loss) Earnings from Continuing Operations

 

$

(2,421

)

$

11,174

 

$

(84,552

)

$

25,232

 

 

Operations by Geographic Area

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Net Sales

 

 

 

 

 

 

 

 

 

Spain

 

$

12,025

 

$

27,410

 

$

23,351

 

$

56,684

 

Malaysia

 

8,019

 

20,989

 

21,410

 

39,837

 

United States

 

5,075

 

23,278

 

11,441

 

43,134

 

Total Net Sales

 

$

25,119

 

$

71,677

 

$

56,202

 

$

139,655

 

 

LongLived Assets by Geographic Area

 

 

 

June 30,

 

December 31,

 

 

 

2012

 

2011

 

LongLived Assets

 

 

 

 

 

United States

 

$

30,866

 

$

25,369

 

Malaysia

 

20,246

 

21,063

 

Spain

 

15,583

 

17,039

 

China

 

1,958

 

 

Hong Kong

 

7

 

3

 

Total LongLived Assets

 

$

68,660

 

$

63,474

 

 

Foreign sales are based on the country in which the sales originate. Net sales to one of the Company’s major customers that exceeded 10% of the Company’s consolidated net sales for the three and six months ended June 30, 2012, was $8,009 and $18,549, respectively. Accounts receivable from this customer amounted to $1,295 and $399 as of June 30, 2012 and December 31, 2011,

 

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Table of Contents

 

STR Holdings, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

All amounts in thousands except share amounts, per share amounts or unless otherwise noted

 

NOTE 11—REPORTABLE SEGMENT AND GEOGRAPHICAL INFORMATION (Continued)

 

respectively. For the three and six months ended June 30, 2011, net sales to two of the Company’s major customers who each exceeded 10% of the Company’s consolidated net sales were $20,801 and $39,877, respectively.

 

NOTE 12—RESEARCH AND DEVELOPMENT EXPENSE

 

The Company has a long history of innovation dating back to its establishment in 1944 as a plastic and polymer research and development firm. As the Company’s operations have expanded from solely providing research and development activities into the manufacturing of encapsulants, it has created a separate research and development function for employees and costs that are fully dedicated to research and development activities. Research and development expense is recorded in selling, general and administrative expenses. The Company incurred $1,114 and $301, of research and development expense for the three months ended June 30, 2012 and 2011, respectively. The Company incurred $2,191 and $847, of research and development expense for the six months ended June 30, 2012 and 2011, respectively.

 

Due to the Company’s legacy of innovation, other employees spend some of their time related to research and development activities. However, the Company does not allocate such costs or allocate overhead to research and development.

 

NOTE 13—COST REDUCTION ACTIONS

 

During the first six months of 2012, the Company reduced headcount by 19 employees at its Connecticut facilities. In conjunction with the headcount reduction, the Company recognized severance of $0 and $42 in cost of sales for the three and six month periods ending June 30, 2012, respectively. The Company recognized severance of $135 and $149 in selling, general and administrative expense for the three and six month periods ended June 30, 2012. The Company also entered into a Labor Force Adjustment Plan (“LFAP”) with the union and the local government at its Spain facility that temporarily furloughed approximately 60 employees for the period of February 1, 2012 to July 31, 2012.

 

NOTE 14—SUBSEQUENT EVENT

 

The Company has entered into an agreement to extend its LFAP at its Spain facility. Under this agreement, the Company will be responsible for 10% of the salary of any employees that may be furloughed during the period from August 1, 2012 through October 31, 2012.

 

14



Table of Contents

 

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

 

OVERVIEW

 

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

 

STRATEGIC FOCUS

 

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

 

Innovation

 

·                  We have continued to increase our investments in research and development, including the addition of technical personnel and research scientists. Our East Windsor, Connecticut facility houses a new, 20,000 square foot, state—of—the—art research and development laboratory that became operational in the second quarter of 2012. Our goal is to continue to develop high value—add products that can be commercialized quickly and with scale.

 

·                  We are in the process of trying to commercialize our recently developed premium high—light transmission formulation that enables light to better penetrate certain cells, which may enhance module output by approximately 1%. We also continue to invest in the development of products engineered for the specific requirements of Chinese module manufacturers and commenced a significant product introduction of our next generation encapsulant that we believe will possess enhanced potential induced degradation (“PID”) resistant properties. PID is the loss of electrical output caused by sodium ion migration from the cover glass, through the encapsulant to the cell and is a factor that could adversely impact the energy yield of crystalline silicon solar modules. This encapsulant formulation is currently being evaluated and tested by many large Chinese module manufacturers. The testing is expected to be completed in the second half of 2012.

 

Cost Reduction

 

·                  We expanded our manufacturing and supply chain expertise in 2011 with the hiring of a Chief Operating Officer, Solar and a Director of Global Supply Chain. Both individuals focus their efforts on cost reduction, supply chain optimization and process improvement.

 

·                  During the first six months of 2012, we reduced headcount by 19 employees at our Connecticut facilities. In conjunction with the headcount reduction, we recognized severance of $0.2 million. We also entered into a Labor Force Adjustment Plan (“LFAP”) with the union and the local government at our Spain facility that will temporarily furlough approximately 60 employees for the period of February 1, 2012 to July 31, 2012. We recently entered into an agreement to extend our LFAP at our Spain facility. Under the new LFAP agreement, we will be responsible for 10% of the salary of any employees that may be furloughed during the period from August 1, 2012 through October 31, 2012.

 

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

 

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

 

15



Table of Contents

 

Strengthen Our Balance Sheet

 

·                  On September 1, 2011, we sold our Quality Assurance (“QA”) business to Underwriters Laboratories (“UL”) for total cash proceeds of $283.4 million, which included $8.4 million of estimated cash assumed in certain QA locations. The QA business provided consumer product testing, inspection, auditing and consulting services that enabled retailers and manufacturers to determine whether products and facilities met applicable safety, regulatory, quality, performance, social and ethical standards. We decided to sell the QA business in order to focus exclusively on the solar encapsulant opportunity and to seek further product offerings related to the solar industry, as well as other growth markets related to our polymer manufacturing capabilities, and to retire our long—term debt.

 

Global Infrastructure and Asia Growth Strategy

 

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

 

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

 

CRITICAL ACCOUNTING POLICIES

 

Our discussion and analysis of our financial condition and results of operations are based upon our interim condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, net sales and expenses, and related disclosures of contingent assets and liabilities. We continually evaluate our estimates, including those related to bad debts, valuation of inventory, long—lived intangible and tangible assets, goodwill, product performance matters, income taxes, stock—based compensation and deferred tax assets and liabilities. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. The accounting policies we believe to be most critical to understand our financial results and condition and that require complex and subjective management judgments are discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in our Annual Report on Form 10—K filed with the Securities and Exchange Commission on March 14, 2012.

 

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

 

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

 

IMPAIRMENT ANALYSIS

 

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

 

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We tested our long—lived assets for impairment as of March 31, 2012. We concluded that no impairment existed as the sum of the undiscounted expected future cash flows exceeded our long—lived assets’ carrying values as of March 31, 2012. We also determined that no change to the estimated useful lives was required. We did not test our long—lived assets for impairment as of June 30, 2012, as we concluded no triggering event occurred during the second quarter of 2012. However, if we continue to experience a significant reduction in sales volume or profitability in the future, or any adverse circumstances as discussed above, certain of our long—lived assets may be subject to accelerated depreciation/amortization and/or future impairment.

 

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

 

RESULTS OF OPERATIONS

 

Condensed Consolidated Results of Operations

 

The following tables set forth our condensed consolidated results of operations for the three months ended June 30, 2012 and 2011 and for the six months ended June 30, 2012 and 2011.

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Net sales

 

$

25,119

 

$

71,677

 

$

56,202

 

$

139,655

 

Cost of sales

 

23,534

 

46,799

 

52,617

 

86,492

 

Gross profit

 

1,585

 

24,878

 

3,585

 

53,163

 

Selling, general and administrative expenses

 

6,708

 

7,406

 

14,454

 

14,828

 

(Recovery) provision for bad debt expense

 

(1,156

)

802

 

450

 

1,041

 

Goodwill impairment

 

 

 

82,524

 

 

Operating (loss) income

 

(3,967

)

16,670

 

(93,843

)

37,294

 

Interest (expense) income, net

 

(50

)

161

 

(111

)

235

 

Amortization of deferred financing costs

 

(81

)

(331

)

(163

)

(663

)

Other income

 

 

 

7,201

 

 

Foreign currency transaction gain (loss)

 

202

 

(93

)

(86

)

149

 

(Loss) earnings from continuing operations before income tax (benefit) expense

 

(3,896

)

16,407

 

(87,002

)

37,015

 

Income tax (benefit) expense from continuing operations

 

(1,475

)

5,233

 

(2,450

)

11,783

 

Net (loss) earnings from continuing operations

 

$

(2,421

)

$

11,174

 

$

(84,552

)

$

25,232

 

 

Net Sales

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

Change

 

2012

 

2011

 

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

 

$

25,119

 

100.0

%

$

71,677

 

100.0

%

$

(46,558

)

(65.0

)%

$

56,202

 

100.0

%

$

139,655

 

100.0

%

$

(83,453

)

(59.8

)%

 

The decrease in net sales for the three months ended June 30, 2012 compared to the corresponding period in 2011 was

 

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primarily driven by an approximate 53% decrease in sales volume combined with an approximately 21% decrease in our average selling price (“ASP”). Also, an 11% weaker Euro provided a negative impact in the foreign exchange translation of our European net sales.

 

The decrease in net sales for the six months ended June 30, 2012 compared to the corresponding period in 2011 was mainly due to a 47% decrease in sales volume and an approximate 22% decrease in our ASP. Also, an 8% weaker Euro provided a negative impact in the foreign exchange translation of our European net sales.

 

We believe the decline in volume for both the three and six months ended June 30, 2012 was the result of losing market share due to some of our customers losing market share to certain Chinese module manufacturers who are currently not our customers and continuing intensified competition. Our legacy encapsulant’s formulations are highly complex and have not performed optimally with certain module manufacturers located in China. However, we are in the process of introducing our next generation encapsulant formulation that we believe possesses enhanced PID properties and is specifically engineered for the manufacturing process utilized by certain module manufacturers in China. We expect that demand for our encapsulant will remain soft until we receive orders from new customers for our next generation encapsulant, specifically certain Tier 1 Chinese module manufacturers.

 

The ASP decline was driven by price reductions granted during contract renewals for 2012 and continued overall pricing pressure experienced by most companies in the solar supply chain.

 

Cost of Sales

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

Change

 

2012

 

2011

 

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

 

$

23,534

 

93.7

%

$

46,799

 

65.3

%

$

(23,265

)

(49.7

)%

$

52,617

 

93.6

$

86,492

 

61.9

%

$

(33,875

)

(39.2

)%

 

The decrease in our cost of sales for the three months ended June 30, 2012 compared to the corresponding period in 2011 reflects an approximate 53% decrease in sales volume. Raw material costs decreased by approximately $19.4 million due to lower volume and the utilization of lower priced raw materials. Direct labor costs decreased by $1.8 million due to lower volume and the benefit of prior cost reduction measures. Overhead costs decreased by approximately $2.0 million mostly due to the savings associated with the closure of our Florida manufacturing facility. Also, an 11% weaker Euro decreased the translation impact of our European subsidiary’s cost of sales.

 

The decrease in our cost of sales for the six months ended June 30, 2012 compared to the corresponding period in 2011 reflects an approximate 47% decrease in sales volume. Raw material costs decreased by approximately $30.0 million due to lower volume and utilization of lower priced raw materials. Direct labor costs decreased by approximately $2.3 million due to lower volume and the positive effect of prior cost reduction measures. Overhead costs decreased by approximately $1.5 million mostly due to the savings from the closure of our Florida facility. These savings were partially offset by the costs associated with the expansion of our Malaysia facility that was completed in the second half of 2011 and the costs associated with consolidating our Connecticut operations into our East Windsor facility that was completed in June 2012. Also, an 8% weaker Euro decreased the translation impact of our European subsidiary’s cost of sales.

 

Non—cash intangible asset amortization expense of $2.1 million and $4.2 million was included in cost of sales for each of the three and six months ended June 30, 2012 and 2011, respectively.

 

Gross Profit

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

Change

 

2012

 

2011

 

Change

 

 

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

%

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

%

 

Gross profit

 

$

1,585

 

6.3

%

$

24,878

 

34.7

%

$

(23,293

)

(93.6

)%

$

3,585

 

6.4

%

$

53,163

 

38.1

%

$

(49,578

)

(93.3

)%

 

Gross profit as a percentage of net sales declined for the three and six month periods ended June 30, 2012 mainly as a result of decreased net sales due to lower ASP and the negative impact of lower sales volume that reduced capacity utilization and fixed cost absorption.

 

Non—cash intangible asset amortization expense of $2.1 million and $4.2 million reduced gross profit for each of the three and six months ended June 30, 2012 and 2011, respectively.

 

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

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

Change

 

2012

 

2011

 

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

 

$

6,708

 

26.7

%

$

7,406

 

10.3

%

$

(698

)

(9.4

)%

$

14,454

 

25.7

%

$

14,828

 

10.6

%

$

(374

)

(2.5

)%

 

SG&A decreased $0.7 million for the three months ended June 30, 2012 compared to the corresponding period in the prior year. This decrease was driven by lower professional fees of $1.6 million primarily due to entering into the JPS settlement and $0.6 million of lower labor and benefits, including incentive compensation expense. These decreases were partially offset by $0.8 million of increased research and development expense as we continue to expand this function with the goal of developing a pipeline of innovative encapsulant products. We also incurred approximately $0.4 million of increased non—cash stock—based compensation expense primarily related to the accelerated vesting of restricted stock under our Executive Chairman’s amended employment agreement that became effective in the first quarter of 2012.

 

SG&A decreased $0.4 million for the six months ended June 30, 2012 compared to the corresponding period in the prior year. This decrease was driven by lower professional fees of $3.0 million primarily due to entering into the JPS settlement and $0.3 million lower labor and benefits, including incentive compensation expense. These decreases were partially offset by $1.4 million of increased research and development expense as we continue to expand this function with the goal of developing a pipeline of innovative encapsulant products. We incurred approximately $0.8 million of increased non—cash stock—based compensation expense primarily related to the accelerated vesting of restricted stock under our Executive Chairman’s amended employment agreement that became effective in the first quarter of 2012. Property taxes and insurance premiums increased by $0.4 million as a result of recent capacity expansions.

 

(Recovery) Provision for Bad Debt Expense

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

Change

 

2012

 

2011

 

Change

 

 

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

%

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

%

 

(Recovery) provision for bad debt expense

 

$

(1,156

)

(4.6

)%

$

802

 

1.1

%

$

(1,958

)

(244.1

)% 

$

450

 

0.8

%

$

1,041

 

0.7

%

$

(591

)

(56.8

)%

 

During the second quarter of 2012, we collected long outstanding receivable balances from certain customers in Asia that were reserved for and resulted in the recovery of bad debt expense. In 2011, the bad debt expense was primarily driven by aging accounts receivable from certain European customers.

 

Goodwill Impairment

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

Change

 

2012

 

2011

 

Change

 

 

 

Amount

 

% of
Total

Net
Sales

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

%

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

%

 

Goodwill

 

$

 

%

$

 

%

$

 

%

$

82,524

 

146.8

%

$

 

%

$

82,524

 

100.0

%

 

Goodwill was fully impaired at the end of the first quarter of 2012 after we determined that our implied fair value of goodwill was lower than our carrying value. The goodwill impairment resulted from reduction in sales and a decline in the market capitalization of our common stock.

 

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Table of Contents

 

Interest (Expense) Income, Net

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

Change

 

2012

 

2011

 

Change

 

 

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

%

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

%

 

Interest (expense) income, net

 

$

(50

)

(0.2

)%

$

161

 

0.2

%

$

(211

)

(131.1

)%

$

(111

)

(0.2

)%

$

235

 

0.2

%

$

(346

)

(147.2

)%

 

The decrease in interest income, net was primarily the result of lower interest bearing cash balances for the three and six months ended June 30, 2012 compared to the corresponding 2011 periods resulting from the repayment of our 2007 Credit Agreements. In addition, our Credit Agreement has lower commitment fee expense compared to the 2007 Credit Agreements.

 

Amortization of Deferred Financing Costs

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

Change

 

2012

 

2011

 

Change

 

 

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

%

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

%

 

Amortization of deferred financing costs

 

$

81

 

0.3

%

$

331

 

0.5

%

$

(250

)

(75.5

)%

$

163

 

0.3

%

$

663

 

0.5

%

$

(500

)

(75.4

)%

 

Amortization of deferred financing costs decreased as a result of lower deferred financing costs associated with our new Credit Agreement compared to our 2007 Credit Agreements.

 

Other Income

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

Change

 

2012

 

2011

 

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

 

$

 

%

$

 

%

$

 

%

$

7,201

 

12.8

%

$

 

%

$

7,201

 

100.0

%

 

We received $7.2 million in connection with the settlement of the JPS lawsuit during the first quarter of 2012.

 

Foreign Currency Transaction Gain (Loss)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

Change

 

2012

 

2011

 

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)

 

$

202

 

0.8

%

$

(93

)

(0.1

)%

$

295

 

317.2

%

$

(86

)

(0.2

)%

$

149

 

0.1

%

$

(235

)

(157.7

)%

 

The foreign currency transaction gain (loss) for the three and six months ended June 30, 2012 was $0.2 million and $(0.1) million, respectively, compared to a loss of $(0.1) million and a gain of $0.1 million in the corresponding 2011 periods. These changes were the result of volatility in the Euro exchange rate which decreased by 11% and 8% for the three and six months ended June 30, 2012, respectively, compared to the corresponding 2011 periods.

 

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Table of Contents

 

Income Tax (Benefit) Expense

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

Change

 

2012

 

2011

 

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

 

$

(1,475

)

(5.9

)%

$

5,233

 

7.3

%

$

(6,708

)

(128.2

)%

$

(2,450

)

(4.4

)%

$

11,783

 

8.4

%

$

(14,233

)

(120.8

)%

 

Our effective income tax rate benefit from continuing operations for the three months and six months ended June 30, 2012 was 37.9% and 2.8%, respectively, compared to the U.S. federal statutory tax rate of 35.0%. Our effective tax rate from continuing operations was approximately 31.9% and 31.8%, respectively, for the three and six months ended June 30, 2011. The effective tax rate is impacted by our decision to permanently reinvest our Malaysia subsidiary’s earnings locally. Our effective tax rate for the three months ended June 30, 2012 is higher than the U.S. federal statutory rate since we are expecting a taxable loss that will provide a federal tax benefit of 35.0% and we will also benefit from our Malaysia tax holiday. The effective tax rate from continuing operations for the six months ended June 30, 2012 reflects discrete items recorded in the first quarter relating to the goodwill impairment for which no tax benefit is recorded and settlement of income tax audits resulting in a $1.0 million benefit. A shift in the mix of our expected geographic earnings, primarily in Malaysia, could cause our expected effective tax rate to change significantly.

 

Net (Loss) Earnings from Continuing Operations

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

Change

 

2012

 

2011

 

Change

 

 

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

%

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

% of
Total
Net
Sales

 

Amount

 

%

 

Net (loss) earnings from continuing operations

 

$

(2,421

)

(9.6

)%

$

11,174

 

15.6

%

$

(13,595

)

(121.7

)%

$

(84,552

)

(150.4

)%

$