STR Holdings Management Discusses Q4 2012 Results - Earnings Call Transcript

Transcripts

STR Holdings (STRI) Q4 2012 Earnings Call March 14, 2013 4:30 PM ET

Executives

Joseph C. Radziewicz - Chief Financial Officer and Vice President
Robert S. Yorgensen - Chief Executive Officer, President and Director

Analysts

Eric Stine - Craig-Hallum Capital Group LLC, Research Division
Aaron Chew - Maxim Group LLC, Research Division
James Medvedeff

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2012 STR Holdings, Inc. Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Joseph Radziewicz, Vice President and Chief Financial Officer. Please proceed.

Joseph C. Radziewicz

Thank you, operator. Hello, everyone, and welcome to STR's Fourth Quarter 2012 Earnings Conference Call. With me today is STR's President and Chief Executive Officer, Robert Yorgensen. Our agenda for today's discussion is as follows. I will begin by covering a few administrative items. I will then turn the call over to Bob to discuss our strategic objectives and the actions taken since our last call, including our response to the loss of the First Solar business. After that, I will review our fourth quarter financial performance and provide our 2013 guidance. As a reminder, this call is being webcast and is available at the Investor Relations section of our website at www.strholdings.com.

The webcast will be available for 1 year. Our earnings press release and a supplemental presentation are also posted on our Investor Relations website.

Slide 1 of the supplemental presentation advises you that some information discussed on this conference call will contain forward-looking statements that involve risks, uncertainties and assumptions that are difficult to predict.

Such forward-looking statements are not a guarantee of performance and the company's actual results could differ materially.

Several factors that could cause or contribute to such differences are described in detail in the Risk Factors and other sections of STR's Form 10-K filed on March 14, 2012, with the SEC, as well as in our earnings press release and subsequent SEC filings.

These forward-looking statements speak only as of the date of this call, and the company undertakes no obligation to publicly update any forward-looking statements unless required by law.

Today's discussion also includes non-GAAP financial measures that we believe may be important to investors as metrics to assess the operating performance of our business.

Our earnings press release and supplemental presentation reconcile non-GAAP measures to GAAP in accordance with SEC rules. Let me now turn the call over to Bob.

Robert S. Yorgensen

Thanks, Joe and good afternoon, everyone. Today, I will update you on the actions we have taken since learning that First Solar will source encapsulant from another supplier and discuss our progress and strategic objectives to facilitate long-term growth. Joe will provide details during his remarks on our fourth quarter financial performance, which was within our guidance. Let me begin on Slide 3.

As we previously disclosed in January, First Solar notified us of their transition to another encapsulant supplier by the end of the first quarter of 2013. We expect 2013 full year sales to this customer to approximate $2.5 million to $3.5 million, compared to $39 million in 2012.

While I'm not at liberty to discuss the rationale of driving the change to a new supplier, I can inform you that the products we supplied to First Solar met their specifications. As such, we have not received nor do we expect to receive any claim from First Solar. We were an extremely capable and dependable supplier to First Solar for over 15 years, which was confirmed in December 2011 when they awarded STR their best-in-class supplier designation.

Based on very limited notice from First Solar, we have had to act decisively and quickly to reduce our cost structure and to assure our existing and prospective customer base that STR has every intention of continuing to provide high-quality, innovative encapsulant to the global market.

To better align our cost structure with anticipated demand and in light of the continued shift of module production to Asia, we have ceased production at our East Windsor, Connecticut facility. In addition, we expect to reduce our global headcount by approximately 160 employees during 2013. The majority of this restructuring action has already been completed in the first quarter.

We anticipate cash severance costs of approximately $1.8 million in 2013 that will generate annual pretax savings of approximately $8 million. We are currently in the process of reducing our fixed costs by consolidating our Connecticut facilities and are also exploring the options of a sublease or sale leaseback of a portion of our East Windsor building.

For our North American customers, we have worked hard to seamlessly transition their encapsulant orders to our Malaysia and Spain facilities. We have also assured our existing and prospective global customers they should expect the same high level of service going forward, as they've always received from STR. In most cases, we have delivered this message in writing and are followed up with visits by our senior management to reinforce our unwavering commitment.

I will now discuss how we expect to grow our business. Slide 4 shows the key facets of our strategic imperatives to improve our market share in Asia. We believe the successful execution of the following 4 strategic actions will prepare us for sales volume growth and the return to profitability.

First, reducing our cost structure. Second, continuing the successful launch of our Next-Generation encapsulants. Third, driving products innovation. And fourth, maintaining our healthy balance sheet.

Let me now provide an update on certain of these initiatives beginning with our cost reduction program shown on Slide 5.

In 2012, we realized approximately $18 million in cost savings, compared to 2011. During the fourth quarter of 2012, we reduced headcount by 78 employees, incurring an approximate severance charge of $1.1 million. We anticipate this action will generate annual pretax savings of approximately $4.3 million on a go-forward basis.

In addition, we reduced our SG&A expense by 24% during 2012, discounting the impact of noncash stock-based compensation.

In 2013, we're implementing additional actions to further improve our cost structure. Our goal is to reduce our variable cost per unit by approximately 20% and our cash fixed costs by $4.5 million.

In addition to the headcount actions described earlier, we expect to achieve the cost savings through the following programs.

On the materials front, we continue to aggressively negotiate with our suppliers in a period of excess resin capacity resulting from new ethylene crackers coming online in the U.S. an EVA and ethylene capacity continuing to expand in the Middle East.

In addition, natural gas prices continue to remain very low. Based on these dynamics and current stock pricing, we expect our average price of resin to be approximately 10% lower than in 2012, and we expect forward pricing to remain a tailwind for the foreseeable future.

Aside from resin, we made further progress on removing the paper liner from our products. We expect approximately 40% of our 2013 sales to be paperless, compared to just 1% in 2012. Aside from the paper savings, removing this component from our end product will also allow us to significantly reduce scrap and facilitate recycling.

We expect approximately $4 million of SG&A and R&D cost savings in 2013, excluding fees paid to our financial advisors. The savings will be achieved through reduced corporate overhead, travel and R&D spending and by actively negotiating with or changing various service providers.

Let me now move to Slide 6 to provide an update on the commercialization of our Next-Generation EVA encapsulants. A new product introduction is progressing, with key milestones achieved during the fourth quarter. As a reminder, this new product line combined with premium properties of our legacy formulations with newly developed features such as higher light transmission, improved volume resistivity, enhanced curing properties and PID resistance.

We also plan to offer this product in a paperless format to further improve its cost competitiveness. We believe these products provide competitive advantages to module manufacturers and are able to compete cost-effectively with new materials entering the market, such as TOE, particularly in their ability to inhibit PID.

During the fourth quarter, we continued internal testing of this product line, completing 3,000 hours of damp heat testing, which indicated superb properties. Slide 6 shows the results of this testing, compared to the competition, while Slide 7 shows the impact to actual test modules.

In these electroluminescent images, the bright cell reflects good power output, while a darkened cell indicates poor output.

Turning now to Slide 8. As previously announced, we shipped initial production scale of orders to 2 new Chinese customers during the fourth quarter. We will recognize revenue for these orders in 2013 due to the shipping terms.

One of these customers has now completed production scale up, and we believe will be increasing their orders significantly in the coming months. In aggregate, our 2 new customers could provide approximately $8 million to sales in 2013. We have also received our first order for this material from a European customer in February.

To aid our product launch, I recently visited Asia to meet with senior executives and prospective customers. Many were encouraged by our recent product development efforts. We were informed that STR's strong brand recognition in China remains fully intact, reflecting our record of innovation in high-quality encapsulants, as well as our high level of bankability.

Based upon my visit earlier this month and the initial success of our Next-Generation product launch, I'm very excited to inform you that STR will move forward in establishing local manufacturing in China and expects to be operational in the third quarter of 2013.

We will commence our Chinese manufacturing in a leased facility, with an initial capacity of 1 gigawatt. We believe this approach is the most cost-effective and risk averse strategy as it will only require approximately $2 million of new capital spending, compared to approximately $15 million for a Greenfield facility.

It also accelerates our ability to manufacture locally in China at a pivotal time with our Next-Generation EVA launch. Let me now move to Slide 9 to discuss our strategic priority of driving product innovation to develop and commercialize innovative new encapsulant products.

Our growing R&D capability featuring a greatly enhanced team, together with our new 20,000 square foot state-of-the-art facility is the centerpiece of this strategy. Due to the development of new encapsulant technologies and extremely intensified competition, I believe it was vital to STR's long-term viability to establish our Technology Center and develop a strong R&D capability.

This already paid dividends in relation to the quick commercialization of our Next-Generation EVA encapsulant and we have made even faster strides with our in-process POE product line.

Although we believe that our Next-Generation EVA performs competitively with POE in relation to key properties such as High-Light Transmission, BID and dimensional stability, we believe it is important to ensure we develop a diversified product line to meet the needs of in-module manufacturing.

And while we continue to believe that EVA will remain the predominant solar encapsulant material, our POE does offer potential performance advantages for certain module designs. As such, we intend to offer a diversified product portfolio to meet evolving technical requirements for Solar Panel encapsulation.

We commenced our POE development effort approximately 1 year ago. In this short time, we have successfully developed a product that we believe is world-class. Our confidence is bolstered by the fact that our POE encapsulant has been selected by a large Asian module manufacturer in a highly competitive development program that we believe included numerous competitors. Our product has passed 3,000 hours of damp heat testing with minimal power loss. Our R&D team has been actively refining this formulation based upon customer feedback and is working closely with our process engineering function to manufacture this product consistently and cost-effectively for commercial scale production. We believe the rapid deployment of this new encapsulant demonstrates the technological savvy of our enhanced R&D function.

Our strategic investment in R&D and process engineering is vital to our future growth and has tangibly improved our commercialization efforts.

In conjunction with our organic strategy execution, and as previously disclosed, we have engaged advisers to explore strategic options for the company. Our advisors will help assess the full range of options to maximize shareholder value including, but not limited to, finding an attractive acquisition or joint venture partner in the encapsulant or other solar materials space. At the moment, we are actively exploring all potential options to maximize our value.

In summary, and as depicted on Slide 10, we're working very hard to execute our strategy and mitigate the loss of First Solar. During 2013, we will drive our Next-Generation EVA launch, establish local manufacturing in China, further improve our cost structure, continue to develop our POE product line and maintain a strong cash position.

And currently, we will work with our financial advisors to assess opportunities to transform our company and enhance shareholder value.

Let me now turn the call back to Joe to discuss our fourth quarter financial performance, liquidity and guidance. Joe?

Joseph C. Radziewicz

Thanks, Bob. Let me begin on Slide 12. Our Q4 2012 net sales of $16.1 million were down 56% year-over-year and 30% sequentially, but were slightly higher than our guidance. The year-over-year decline reflects approximately 43% lower volume and 23% lower ASP. Sequentially, volume decreased approximately 25% while ASP was 7% lower.

And price shipments for the fourth quarter of 2012 totaled 450 megawatts, compared to approximately 600 megawatts in the third quarter.

Slide 13 shows the main components of the sequential $6.6 million gross profit decline. The decrease was primarily driven by restructuring charges of $1 million and $2.8 million of accelerated depreciation for the short and useful lives of certain production equipment based upon expected lower utilization.

A Q4 gross margin of negative 37.5% was substantially lower than our third quarter gross margin of 2.5%. Excluding restructuring and accelerated depreciation, Q4 gross margin was negative 13%, driven by lower ASP and unfavorable absorption associated with a 21% sequential decline in production.

Slide 14 shows our selling, general and administrative expenses. For Q4, our SG&A was $4.3 million, compared to $4.8 million last quarter, equating to a decrease of approximately $500,000 or 10%. The reduction was mainly driven by $900,000 of lower stock-based compensation expense and continued cost-reduction efforts. These favorable items were partially offset by approximately $600,000 of financial advisory fees and expenses related to a VAT audit.

Turning to Slide 15, our intangible assets were fully impaired as of December 31, 2012. The $135.5 million impairment was driven by continued pricing pressure, increased competition and the loss of First Solar as a customer. These factors also contributed to a non-cash impairment of $37.4 million relating to certain of our production lines and other fixed assets.

At December 31, 2012, our net book value was approximately $3.05 per common share. Our effective tax rate from continuing operations for the fourth quarter and full year 2012 was a benefit of 33.1% and 23.9%, respectively.

Our Q4 effective tax rate benefit was lower than planned due to our pretax loss being significantly higher than anticipated, driven by the asset impairments, which lowered the rate benefit that we received from our Malaysian tax holiday.

Net loss from continuing operations on a GAAP basis during the fourth quarter was $123.4 million, or $2.97 per diluted share, primarily due to the noncash impairments and associated deferred tax liability impact. This compares to a GAAP net loss during the third quarter of $3.6 million or $0.09 per diluted share.

Diluted non-GAAP earnings per share for the fourth quarter reflected a loss of $0.09, compared to a loss of $0.03 for the third quarter of 2012. Although we slightly exceeded our fourth quarter sales guidance, we are at the low end of our non-GAAP EPS range due to the higher than expected effective tax rate and one-off SG&A items as previously mentioned.

Let me now discuss our liquidity and balance sheet on Slide 16. We ended the year with cash of $82 million and no debt. This equates to approximately $1.97 per share in cash. During the quarter, we had strong operating cash flow from continuing operations of $5.3 million, primarily due to the receipt of income tax refunds of $4 million. Absent receipt of the income tax refunds, operating cash flow from continuing operations would have been $1.3 million, driven by working capital benefit that more than offset $1.3 million of severance and financial advisory payments.

In 2013, we expect to receive approximately $5 million of additional income tax refunds that will aid in the preservation of our cash until our anticipated sales volume increase occurs in the second half. We remain committed to maintaining our balance sheet and a strong cash position.

I will now provide our 2013 guidance on Slide 17. We continue to have core visibility in a highly volatile market and are in the process of executing many of our strategic initiatives, such as our Next-Generation EVA rollout, TOE launch and continued migration to a paperless product platform. Based upon this backdrop, we are revising our guidance policy. Since we are late in the quarter, we will provide first quarter non-GAAP EPS in sales estimate. Going forward, we plan to provide annual sales and non-GAAP EPS guidance only. We may elect to update our guidance periodically depending on circumstances.

Due to the importance that many investors are placing on our cash balance, we will provide an estimated range of our first quarter's ending cash position. In addition, we will also provide annual guidance ranges for free cash flow and our year end cash balance.

For the first quarter of 2013, we expect net sales of $9 million to $10 million. We expect a diluted non-GAAP EPS loss of between $0.08 and $0.10 per share. We expect to finish the quarter with approximately $77 million to $79 million of cash, a reduction from 2012, primarily due to severance payments and financial advisor fees of approximately $2.3 million, which will not recur.

We think it is very important for our investors to know that STR is not anticipating to utilize significant cash in 2013. The planned capital expenditures are growth related and should enable us to achieve improved paperless and POE capabilities and local manufacturing in China, all of which are key strategic objectives to maintain our long-term vitality.

Our first quarter estimate is based upon the following assumptions. An average exchange rate of $1.31 per euro, an effective tax rate benefit of approximately 20% and 41.7 million diluted shares outstanding. As Bob mentioned, we will recognize the first commercial sales of our Next-Generation EVA encapsulant in the first quarter. However, the commercial ramp will be gradual and we do not expect significant sales of this new product until mid-2013. We expect our Next-Generation EVA and TOE product introductions to drive a stronger second half performance and contribute to net sales of $45 million to $55 million for the full year 2013.

We anticipate full year 2013 diluted non-GAAP EPS between a loss of $0.15 and $0.25 per share.

Our full year guidance includes the following assumptions. An average exchange rate of $1.26 per euro and effective tax rate benefit of approximately 20% and 41.9 million diluted shares outstanding. We expect free cash to be negative by $4 million to $7 million, driven by $3.8 million of capital investments related to the establishment of manufacturing operations in China and costs necessary to support our paperless and POE initiatives.

In addition, we will incur approximately $2 million to $3 million of restructuring and financial advisor outlays during the first 6 months of the year. These items will be partially offset by approximately $5 million of anticipated income tax refunds. In order to be conservative in connection with our product launch, our guidance assumes some prudent use of cash in 2013 that may be required for working capital to support our second half projected sales growth.

However, the use of this cash is merely timing related as we should convert any required working capital to cash in 2014. Based upon these factors, we expect to finish 2013 with approximately $75 million to $78 of million cash. Our cash estimate can be favorably or negatively impacted based upon changes in timing of working capital requirements associated with our product launches. Our continuous strong cash position is a result of savings realized from restructuring and cost reduction actions, our high variable cost business model and continuous management of working capital, as well as anticipated income tax refunds.

And with that operator, please open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Eric Stine with Craig-Hallum.

Eric Stine - Craig-Hallum Capital Group LLC, Research Division

Maybe to start with the 2 Chinese customers and initial shipments there. I'm just curious, what type of visibility you have into that $8 million that you're indicating and sounds like that's second half weighted? So that will be part 1 and then part 2, just any thoughts on what type of penetration that number is with those 2 customers?

Robert S. Yorgensen

Sure. On the first part, Eric, the 2 Chinese customers, actually Barry Morris and I just visited them last week or the week before. And I think we're solid with them. They like the material. It offers them some advantages that the competition can't offer. And because of that, I think our relationship will be strong. So you're correct, they are weighted more into the second half of the year, but we expect them to be picking up between now and then. As far as our share with them, I don't know that I can share that with you in both cases. In one, I think we're between 30% and 40%. And in the other, I'm not sure. I can't tell you as I sit here.

Eric Stine - Craig-Hallum Capital Group LLC, Research Division

Okay, got it, but I mean is that an $8 million number that potentially there's a little upside to or -- I mean, any thoughts on that? I mean, this is a customer that 30% to 40% with one of them, do you anticipate that, that grows over time?

Robert S. Yorgensen

I hope so. I mean, I think, there's definitely upside in the numbers. However, that's what we're planning on and guiding to.

Eric Stine - Craig-Hallum Capital Group LLC, Research Division

Okay. No, understood. Just curious, I guess relative to these customers, but also I think the list is 20 that you're working to get qualified with. I mean, have you done an analysis historically, what's a reasonable assumption for penetration with these customers whether it's in year 1, year 3 and then more long-term, how should we think about that?

Robert S. Yorgensen

I don't know that it applies across the board quite that neatly. I think it depends very much on the customer. We're learning a lot about how to sell our products in China and how to market ourselves there. And I think the customers that we're getting penetration with are, right now, just a few that we're able to announce, but we're getting very close with many others as well. The testing that's ongoing right now is going very well. The results that are coming back are very positive. So I think there are substantial opportunities there for us to increase penetration there. As far as customer by customer, I think there are a few that we know of that are very, very difficult to penetrate due to very long-standing relationships with our current supply base, but they would be the outliers. The rest I think are very much up for grabs. Across China it seems very common that customers are concerned about reliability and quality, and that's driving them to our product and of course, the tests that they're performing right now in our products are coming out very well in most cases. So I think there's great upside there. That should help us increase market share as we go forward. And the transition that we're in right now towards Asia, I think it's easy to point out when you look at our top 10. In 2012, 3 out of our top 10 customers were in Asia. In 2013, we think that number will be 7 out of 10. So the transition is occurring as we had hoped.

Eric Stine - Craig-Hallum Capital Group LLC, Research Division

Okay, that is very helpful. So -- but you are thinking of these -- and I don't know if you can answer this are not, but I mean are you looking at these where -- I mean, can you say the majority of these you are going after hopefully being one of the main suppliers rather than a second tier or a third tier supplier for these companies?

Robert S. Yorgensen

I want to make sure I'm clear on your question. You're asking if we are looking to be a primary supplier?

Eric Stine - Craig-Hallum Capital Group LLC, Research Division

How do you feel -- I mean, as this process plays out, you've got -- if the number is 20, do you think a majority of these -- you are being considered to be a meaningful percentage, a 30%, a 40% share rather than maybe a third source as a backup in a much smaller percentage? I guess, how you think about that?

Robert S. Yorgensen

Yes. So, I have a couple of comments there. I think we're definitely looking at being in a very substantial supply relationship position with the customers that we're pursuing. We're really not going after scraps. We're going after long-term supply relationships, who work very hard to develop the relationships on a personal basis. And our goal is to be major suppliers to these targets. The second thing that I wanted to get across is when we look at the customers in China that we think are the sweet spot of our addressable market that we can actually get into and service, the opportunity there looks like more than 10 gigawatts, in terms of the customers we can address near term. So I think the upside there is tremendous. And long-term, that's what our goal is, is to increase market share dramatically from where we are right now and we're going after it.

Operator

Your next question comes from the line of Aaron Chew with Maxim Group.