UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(mark one)

For the Quarterly Period Ended June 30, 2019

Or

For the transition period from             to             

Commission file number 001–34529

STR Holdings, Inc.

(Exact name of registrant as specified in its charter)

(860) 272–4235

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o

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

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

At July 31, 2019, there were 20,152,029 shares of Common Stock outstanding.

INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

STR Holdings, Inc. and Subsidiaries

Three and Six Months Ended June 30, 2019

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

STR Holdings, Inc. and Subsidiaries

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)

All amounts in thousands except share and per share amounts

See accompanying notes to these condensed consolidated financial statements.

STR Holdings, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(unaudited)

All amounts in thousands except share and per share amounts

See accompanying notes to these condensed consolidated financial statements.

STR Holdings, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

All amounts in thousands

See accompanying notes to these condensed consolidated financial statements

NOTE 2—SIGNIFICANT ACCOUNTING POLICIES

Revenue is principally derived from the sale and licensing of highly engineered plastic sheet and film products. The Company receives specific purchase orders for the manufacture, sale and delivery of these products that identify the goods and/or services to be transferred, the price for those goods and other commercial terms of the order. The goods are generally purchased under EXW (or EX-Works) terms, meaning that the customer is responsible for arranging the shipping of the goods and title passes when the goods are picked up from the Company’s dock. Revenue is recognized upon the transfer of title, and there are no price concessions, volume discounts, rebates, refunds, credits, incentives, performance bonuses, royalties or other types of variable consideration.

In the specific case of the Equipment Purchase Agreement and a Technology License Agreement (collectively, the “Original Agreements”) signed on January 16, 2018 for an aggregate transaction price of $6,000, the Company will purchase from a third party specialized equipment (the “Equipment”) for the production of one of the Company’s proprietary encapsulants (the “Encapsulant”), resell the Equipment to the customer, install the Equipment at a facility of the customer and train the customer’s personnel in the Equipment’s use. Under the Technology and License Agreement, the Company has granted the customer the right to use the formula for the Encapsulant and certain of the Company’s production techniques to make or have made the Encapsulant for use in photovoltaic (PV) modules manufactured by the customer. For revenue recognition purposes, the Company defines the following three distinct major performance obligations of the Agreements and the corresponding transaction price allocated to those performance obligations:

Obligation 1 is considered to be separate and distinct from the other two obligations, in that the information provided under this obligation represents significant standalone value to the customer and the Company’s obligation to provide this information is separately identifiable from the other obligations in the agreements. Obligation 2 and Obligation 3 were also clearly identifiable, as defined by the Equipment Purchase Agreement (including delivery and installation by an agreed-upon date) and the license (“License”) granted pursuant to the Technology License Agreement (with an effective start date upon the receipt of an acceptance test payment).

The Company is applying a “cost-plus” approach to Obligation 1 and Obligation 2. As the Company had never before sold any type of license, had no established specific license pricing and had no knowledge of pricing for similar licenses, the Company is using the residual approach for Obligation 3. The License is perpetual, distinct and not combined with other goods and services, and is a right to use, rather than to access, functional intellectual property.

The Company also assessed whether it was acting in a principal or agent role in each performance obligation of the Original Agreements. In all obligations, the Company determined it was acting in the role of principal and therefore revenue is recognized on a gross basis.

On July 29, 2019 the Company entered into certain new agreements with respect to the Original Agreements. See Note 18.

Recent Accounting Pronouncements

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842).” This ASU requires a lessee to recognize in the statement of financial position a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term and also requires additional qualitative and quantitative disclosures. ASU 2016-02 is effective for reporting periods beginning after December 15, 2018, with early adoption permitted. After a thorough assessment, the Company determined that this pronouncement had no impact on its Condensed Consolidated Financial Statements.

There are no other new accounting pronouncements that the Company believes may have a material impact on its Condensed Consolidated Financial Statements.

The following discussion and analysis of the financial condition and results of our operations should be read together with our Condensed Consolidated Financial Statements and the related Notes to the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements, based on current expectations and related to future events and our future financial performance, that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those set forth under Item 1A,—Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2018.

Forward-Looking Statements

This Quarterly Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to inherent risks and uncertainties. These forward-looking statements present our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business and are based on assumptions that we have made in light of our industrial experience and perceptions of historical trends, current conditions, expected future developments and other factors management believes are appropriate under the circumstances. However, these forward-looking statements are not guarantees of future performance or financial or operating results. Forward-looking statements include, but are not limited to, the statements regarding the following: (1) incurring substantial losses for the foreseeable future, ability to achieve or sustain profitability in the future and our ability to continue as a going concern; (2) the potential impact of pursuing strategic alternatives, restructuring our business to align with our customers’ geography and our investment in and pursuit of new market opportunities in film packaging products; (3) our historical reliance on a single product line and our pursuit of new market opportunities; (4) that we will be able to achieve our anticipated revenue, earnings or payback from the production of packaging products; (5) that we will receive the required approvals to complete the sale of our facility in Johor, Malaysia on a timely basis, if at all; (6) our securing net sales to new customers, growing net sales to existing key customers and increasing our market share; (7) customer concentration in our business and our relationships with and dependence on key customers; (8) the outsourcing arrangements and reliance on third parties for the manufacture of a portion of our encapsulants; (9) technological changes in the solar energy industry or our failure to develop and introduce or integrate new technologies could render our encapsulants uncompetitive or obsolete; (10) competition; (11) excess capacity in the solar supply chain; (12) demand for solar energy in general and solar modules in particular; (13) our operations in India and our assets in India and China being subject to significant political and economic uncertainties; (14) limited legal recourse under the laws of India and China if disputes arise; (15) our ability to adequately protect our intellectual property, particularly during the outsource manufacturing of our products; (16) our lack of credit facility and our inability to obtain credit; (17) a significant reduction or elimination of government subsidies and economic incentives or a change in government policies that promote the use of solar energy; (18) volatility in commodity costs; (19) our customers’ financial profile causing additional credit risk on our accounts receivable; (20) our dependence on a limited number of third-party suppliers for raw materials for our encapsulants and other significant materials used in our process; (21) potential product performance matters and product liability; (22) our substantial international operations; (23) the impact of changes in foreign currency exchange rates on financial results, and the geographic distribution of revenues; (24) losses of financial incentives from government bodies in certain foreign jurisdictions; (25) our ability to perform our supply agreement and modified-technology license agreement with our client; (26) that we will be able to obtain the funding for the loan we have been preliminary approved for from the Spain Ministry of Industry, Commerce and Tourism; and (27) the other risks and uncertainties described under “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in subsequent periodic reports on Form 10-K, 10-Q and 8-K. You are urged to carefully review and consider the disclosure found in our filings, which are available on http://www.sec.gov or http://www.strsolar.com. Should one or more of these risks or uncertainties materialize, or should any of these assumptions prove to be incorrect, actual results may vary materially from those projected in these forward-looking statements. We undertake no obligation to publicly update any forward-looking statement contained in this Quarterly Report, whether as a result of new information, future developments or otherwise, except as may be required by law.

Overview

STR Holdings, Inc. and its subsidiaries (“we”, “us”, “our” or the “Company”) commenced operations in 1944 as a plastics and industrial materials research and development company. Based upon our expertise in polymer science, we evolved into a global provider of encapsulants to the solar industry. Our pioneering background in plastics also served as the foundation for a number of other plastics products we have manufactured over the years and led to our recent entrance into the high-end food packaging business.

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

Recent Developments

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

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

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

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

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

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

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

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

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

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

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

We continue to reorganize our business to better align with customer geography, to reduce the cash burn related to unprofitable locations, to convert assets to cash for potential redeployment into more profitable endeavors and possible business opportunities and to evaluate other strategic alternatives. We cannot assure that any of these efforts will be successful.

High-End Food Packaging. In the fourth quarter of 2017, we initiated a significant investment through our wholly-owned subsidiary in Spain to enter the high-end food packaging business. This investment, which leverages our plastics expertise, includes the purchase of new, state-of-the-art plastics processing equipment and related building improvements along with the addition of experienced staff to pursue manufacturing and sales of high-end food packaging products. The food packaging business is highly competitive, having market participants with substantially more resources and experience than us. We are a new entrant in this market, face challenges in loading the equipment with sufficient orders and cannot assure that we will be successful in this new endeavor.

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

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

CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of our financial condition and results of operations are based upon our interim Condensed Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these Condensed Consolidated Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, net sales and expenses, and related disclosures of contingent assets and liabilities. We continually evaluate our estimates, including those related to bad debts, valuation of inventory, long-lived assets, product performance matters, income taxes, stock–based compensation and deferred tax assets and liabilities. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. The accounting policies we believe to be most critical to understand our financial results and condition and that require complex and subjective management judgments are discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies” in our Annual Report on Form 10–K filed with the Securities and Exchange Commission on March 27, 2019, as amended on April 26, 2019.

RESULTS OF OPERATIONS

Condensed Consolidated Results of Operations

The following tables set forth our condensed consolidated results of operations for the three and six months ended June 30, 2019 and 2018:

Net Sales

The decrease in net sales for the three months ended June 30, 2019 compared to the corresponding period in 2018 was driven by an approximate 21% decrease in sales volume combined with a 15% decrease in our average selling price (“ASP”).

The volume decline was primarily driven by a 54% decrease in Spain due to the further weakening of the European module manufacturing environment, a 31% decrease in India due to unwinding our partnership with our tolling partner there and a 100% decrease in volume in China, partially offset by volume increases to customers in the U.S.

The decrease in net sales for the six months ended June 30, 2019 compared to the corresponding period in 2018 was driven by a $1.0 million reduction in encapsulant sales combined with $1.8 million related to completed performance obligations under the Original Agreements that was recognized in 2018. The decrease in encapsulant sales was primarily attributable to an approximate 8% decrease in sales volume, as well as a 15% decrease in our ASP, relating to our discontinuance of lower-priced sales in China.

The volume decline was primarily driven by a 49% volume decrease in Spain and a 100% volume decrease in China, partially offset by sales to customers in the U.S.

Cost of Sales

The decrease in our cost of sales for the three months ended June 30, 2019 compared to the corresponding period in 2018 was primarily driven by the 21% decrease in encapsulant sales volume combined with a 1% decrease in raw material cost per unit. The lower raw material cost per unit was primarily driven by a 8% decrease in resin costs, as well as a 6% decrease in paperless sales mix. Direct labor decreased by $0.4 million partially attributable to the sales volume decrease in Spain. Overhead costs decreased by $0.3 million primarily due to continued cost-reduction actions.

The decrease in our cost of sales for the six months ended June 30, 2019 compared to the corresponding period in 2018 was primarily driven by the 8% decrease in encapsulant sales volume combined with a 3% increase in raw material cost per unit. The higher raw material cost per unit was primarily driven by a 8% decrease in paperless sales mix. Direct labor decreased by $0.5 million attributable to the sales volume decrease in Spain. Overhead costs decreased by $0.4 million primarily due to continued cost-reduction actions.

Gross (Loss) Profit

Gross loss, as a percentage of net sales, declined for the three months ended June 30, 2019 compared to the corresponding period in 2018 mainly as a result of the decrease in encapsulant sales volume combined with a decrease in paperless sales mix.

Gross (loss) profit as a percentage of net sales declined for the six months ended June 30, 2019 compared to the corresponding period in 2018 mainly as a result of recognition of $1.8 million related to completed performance obligations under the Original Agreements during 2018.

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

SG&A decreased by $0.2 million for the three months ended June 30, 2019 compared to 2018. This decrease was primarily driven by a $0.1 million reduction in non-cash stock compensation expense and a $0.1 million decrease in restructuring expense

SG&A decreased by $0.5 million for the six months ended June 30, 2019 compared to 2018. This decrease was primarily driven by a $0.2 million reduction in non-cash stock compensation expense, a $0.1 million decrease in restructuring expense and a $0.1 million decrease in professional fees.

Research and Development Expense (“R&D”)

Research and development expense decreased by less than $0.1 million for the three and six months ended June 30, 2019 compared to 2018, mainly due to activities related to our entrance into the packaging business in 2018.

Provision for Bad Debt Expense

The provision for bad debt expense for the three and six months ended June 30, 2019 primarily related to the aging of accounts receivable under our policy, primarily in the U.S and India.

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

Other (Expense) Income, net

On March 27, 2018, following the approval of the Company’s Special Committee of Continuing Directors, STR China entered into an agreement to terminate its Huhui Supply Agreement (the “Termination Agreement”) with Zhangjianang Huhui Segpy Co. Ltd (“Huhui”). In connection with the supply agreement, Huhui had provided us with an approximately $1.1 million deposit during the year ended December 31, 2015. Pursuant to the Termination Agreement, Huhui agreed that STR China would retain the deposit, and each of Huhui and STR China agreed to release the other from any liability or further obligations under the Supply Agreement. As a result of the Termination Agreement, we recorded other income of $1.0 million during the first six months of 2018.

Foreign Currency Transaction (Loss) Gain

The foreign currency transaction impact was a gain of $0.1 million for the three months ended June 30, 2019 compared to a loss of $0.1 million for the three months ended June 30, 2018. This change was primarily the result of volatility in the Euro spot exchange rate versus the U.S. dollar.

The foreign currency transaction impact was $0.0 million for the six months ended June 30, 2019 compared to a loss of $0.2 million for the six months ended June 30, 2018.

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

Income Tax (Benefit) Expense

During the three and six months ended June 30, 2019, we recorded an income tax benefit of $0.2 million and $0.3 million, respectively, resulting in an effective tax rate of 7.8% and 5.3%, respectively. This effective tax rate for the three months ended June 30, 2019 differs from the U.S. statutory tax rate primarily due to the effect of taxes on foreign earnings.

During the three and six months ended June 30, 2018, we recorded an income tax expense of $0.2 million and $0.3 million, respectively, resulting in an effective tax rate of (5.9%) and (10.9%), respectively. This effective tax rate for the three months ended June 30, 2018 differs from the U.S. statutory tax rate primarily due to the effect of taxes on foreign earnings.

Cost-Reduction Actions

On March 7, 2017 we made the decision to wind down our China manufacturing operations substantially by the end of the second quarter of 2017. The decision was consistent with ongoing efforts to reorganize our business to better align with customer geography, to reduce losses related to unprofitable locations and to convert assets to cash for potential redeployment into more profitable endeavors. In connection with the restructuring, we recorded $0.1 million of severance charges during the first six months of 2017 and the first six months of 2018. The Company sold certain production and testing equipment from the China facility to its tolling partner in India during the third quarter of 2017.

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

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

The restructuring accrual consisted of $0.1 million and $0.1 million for severance and benefits as of June 30, 2019 and 2018, respectively.

Financial Condition, Liquidity and Capital Resources

We continue to incur substantial losses. We incurred net losses of $5.4 million and $5.8 million for the six months ended June 30, 2019 and for the year ended December 31, 2018, respectively. As of June 30, 2019, our principal source of liquidity was $2.0 million of cash, of which $0.8 million was located in jurisdictions outside of the United States. In addition, our credit facilities are limited to our factoring arrangement in Spain and a €2.0 million economic development loan received in March 2019 from the regional government of Asturias, Spain. Unless and until our operating results improve, we do not expect that we will be able to obtain traditional bank financing. Furthermore, tight credit in the solar manufacturing industry may delay or prevent our customers from securing funding adequate to operate their businesses and purchase our products and could lead to an increase in our bad debt levels. We have entered into an agreement for the sale of our Johor, Malaysia facility for RM22.5 million (approximately $5.3 million, after realtor fees, as of June 30, 2019). The sale is subject to customary closing conditions, including the timely approval of the sale by the Johor Port Authority, and we cannot assure that we will be able to obtain the requisite approvals or that the sale will take place on a timely basis, if at all. If we are unable to timely complete the sale of our Malaysia facility, or execute our strategic plans, our liquidity and capital resources will be adversely affected and we may wind down or cease any or all of our operations. Any wind down or dissolution may be a lengthy, complex and costly process and, in such event, there can be no assurance that there will be any funds available for distribution to stockholders.

Our independent auditors have indicated in their report on our December 31, 2018 financial statements that there is substantial doubt about our ability to continue as a going concern. This “going concern” opinion indicates that the financial statements have been prepared assuming we will continue as a going concern and do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets, or the amounts and classification of liabilities that may result if planned events do not occur or do not occur timely and we do not continue as a going concern. Therefore, you should not rely on our consolidated balance sheet as an indication of the amount of proceeds that would be available to satisfy claims of creditors, and potentially be available for distribution to stockholders, in the event of liquidation. If we are unable to continue as a going concern we cannot assure that any funds will be available for distribution to stockholders.

Management has evaluated whether relevant conditions or events, considered in the aggregate, indicate that there is substantial doubt about our ability to continue as a going concern. Substantial doubt exists when conditions and events, considered in the aggregate, indicate it is probable that we will be unable to meet our obligations as they become due during the next 12 months. The assessment is based on the relevant conditions that are known or reasonably knowable as of the date of this report.

If we do not generate sufficient cash flows from operations, complete the sale of our Malaysian facility or obtain alternative or additional sources of capital to fund operations, we will not have sufficient liquidity to satisfy operating expenses, capital expenditures and other cash needs. This raises substantial doubt about our ability to continue as a going concern.

Our wholly owned Spanish subsidiary, STR Spain, has a factoring agreement to sell, with recourse, certain European, U.S. and other foreign company-based receivables to Eurofactor Hispania S.A.U., who was later acquired by Credit Agricole Leasing & Factoring Sucursal en España during the first quarter of 2017. Under the current terms of the factoring agreement, the maximum amount of outstanding advances at any one time is €1.5 million (approximately $1.7 million as of June 30, 2019), which is subject to adjustment based on the level of eligible receivables, restrictions on concentrations of receivables and the historical performance of the receivables sold. The annual discount rate is 2% plus EURIBOR for Euro-denominated receivables and 2% plus LIBOR for all other currencies. The agreement renews annually unless terminated by either party with 90 days prior written notice. As of June 30, 2019, €0.2 million (approximately $0.2 million as of June 30, 2019) was outstanding, and €1.3 million (approximately $1.5 million as of June 30, 2019) was available (subject to receivables then outstanding) under the factoring agreement.

As noted above, on January 10, 2019 we entered into a Purchase and Sale Agreement for our Malaysia facility, pursuant to which we would sell the facility to the buyer for RM22.5 million (approximately $5.3 million, after realtor fees, as of June 30, 2019). The agreement provides that the closing of the sale is subject to various customary and regulatory approvals and conditions, including the approval of the Johor Port Authority. The agreement further provides that if the closing does not occur within six months, either party may terminate the agreement, however the Company and the buyer agreed to extend the closing window an additional six months to allow for potential delays in obtaining the necessary approvals.

In the fourth quarter of 2017, the Company initiated a significant investment through STR Spain to enter the high-end food packaging business. This investment, which leverages our plastics expertise, includes the purchase of new, state-of-the-art plastics processing equipment and related building improvements along with the addition of experienced staff to pursue manufacturing and sales of high-end food packaging products. We have received and applied certain conditional insurance proceeds to this project, helping to offset our net capital investment. These insurance proceeds were available to the Company only if we invested in new plastics manufacturing equipment. We were advised by our insurer that our investment qualified for reimbursement under the terms of our policy and, accordingly, they have paid our U.S. entity the amount of $0.8 million in October 2017, to cover the cost of the deposit for the primary capital equipment. Our U.S. entity also received an additional $1.8 million reimbursement during 2018 as we continued to make qualifying capital investment under the packaging project.

On March 13, 2019, STR Spain also obtained a €2.0 million ($2.3 million as of June 30, 2019) loan (the “STR Spain Loan”) from the regional government of Asturias, Spain to further support our entry into the high-end food packaging business. STR Spain is required to use the loan proceeds to help finance the launch and operation of its food packaging products business. The STR Spain Loan matures on December 31, 2025, with principal due and payable in equal quarterly installments of €0.1 million each, commencing on March 31, 2021. Interest, which is payable quarterly in arrears, accrues at the annual EURIBOR rate (as such term is defined in the loan agreement) plus an applicable margin. During the first two years, the applicable margin is 2%, and thereafter increases by 1% per year until the applicable margin is 5% in the fifth year of the loan. The loan may be prepaid at any time without premium or penalty. The loan is secured by a mortgage of STR Spain’s business and certain facilities, and contains customary covenants, including a covenant prohibiting STR Spain from making distributions to us, as sole shareholder, without the prior approval of the lender. In connection with the STR Spain Loan, we have also agreed to provide STR Spain with resources to support the loan and the continuity of the packaging initiative. In addition, STR Spain has received preliminary approval for an additional loan of approximately €2.6 million from the Spain Ministry of Industry, Commerce and Tourism which, if funded, we expect to use to help finance the launch and operation of its food packaging products business. However, there can be no guarantee that the funding will be received on favorable terms, or at all.

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

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

As noted above, due to, among other things, the difficulty repatriating cash to the U.S., we may have limited access to the $0.2 million of cash located in China for use outside the country.

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

Cash Flows

Cash Flow from Operating Activities

Net cash used in operating activities was $4.5 million for the six months ended June 30, 2019 compared to $2.1 million for the six months ended June 30, 2018. Net loss plus and minus non-cash adjustments (“cash loss”) declined by approximately $2.0 million for the six months ended June 30, 2019 compared to the same period in 2018. This decline was primarily driven by the receipt of the initial payment of $1.8 million under the Original Agreements during 2018.

Cash Flow from Investing Activities

Net cash used in investing activities was $1.2 million and net cash provided by investing activities was $0.2 million for the six months ended June 30, 2019 and 2018, respectively. We expect remaining 2019 consolidated capital expenditures to be approximately $2.4 million, of which $0.4 million is related to the high-end food packaging equipment as well as cost reduction products and $2.0 million is related to the New Agreements.

Cash Flow from Financing Activities

Net cash provided by financing activities was $2.1 million and net cash used in financing activities was less than $0.1 million for the six months ended June 30, 2019 and 2018, respectively, primarily due to funds received by STR Spain related to the STR Spain loan in 2019.

Off-Balance Sheet Arrangements

We have no significant off-balance sheet financing arrangements.

Effects of Inflation

Inflation generally affects us by increasing costs of raw materials, labor and equipment. During the first six months of 2019, we were not materially affected by inflation.

Recently Issued Accounting Standards

There are no new accounting pronouncements that we believe may have an impact on our consolidated financial statements.

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

Disclosure Controls and Procedures

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

As of June 30, 2019, we carried out an evaluation, under the supervision and with the participation of our management, including our Chairman, President and Chief Executive Officer and our Vice President, Chief Financial Officer and Chief Accounting Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based upon that evaluation, our Chairman, President and Chief Executive Officer and our Vice President, Chief Financial Officer and Chief Accounting Officer concluded that our disclosure controls and procedures are effective.

Changes in Internal Control Over Financial Reporting

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the second fiscal quarter of our fiscal year ended December 31, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

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

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

Item 1A. Risk Factors

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

None.

SIGNATURE

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

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