EDCI
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS IN LIQUIDATION (Liquidation
Basis)
(Tabular
Amounts in Thousands)
(Unaudited)
For
financial reporting purposes, EDCI adopted the liquidation basis of accounting
effective January 1, 2010. The Plan of Dissolution was approved by the Company’s
shareholders on January 7, 2010. Operating results during the stub period ended
January 7, 2010 were nominal. Under the liquidation basis of accounting, the
principal financial statements required are a Statement of Net Assets in
Liquidation and a Statement of Changes in Net Assets in Liquidation. Further,
under the liquidation basis of accounting, assets are stated at their estimated
net realizable value, which is the non-discounted amount of cash, or its
equivalent, into which an asset is expected to be converted in the due course of
business less direct costs, while liabilities are reported at their estimated
settlement amount, which is the non-discounted amounts of cash, or its
equivalent, expected to be paid to liquidate an obligation in the due course of
business, including direct costs. Additionally, under the liquidation basis of
accounting, we are required to establish a reserve for all future estimated
general and administrative expenses and other costs expected to be incurred
during the liquidation period. The reserve for these estimated expenses includes
primarily accruals for people costs (payroll and benefits), facilities,
professional services and litigation costs, and corporate expenses (insurance,
directors’ fees and statutory fees). Further, the estimates of our costs will
vary with the length of time necessary to complete the Plan of Dissolution.
These estimates will be periodically reviewed and adjusted as appropriate. There
can be no assurance that these estimated values will not materially change.
Accordingly, it is not possible to predict with certainty the timing or
aggregate amount which will ultimately be distributed to stockholders and no
assurance can be given that the distributions will equal or exceed the estimate
presented in the accompanying Statement of Net Assets in Liquidation. The
valuation of assets at their net realizable value and liabilities at their
anticipated settlement amount represent estimates, based on present facts and
circumstances, of the net realizable value of the assets and the costs
associated with carrying out the Plan of Dissolution. The actual values and
costs associated with carrying out the Plan of Dissolution may differ from
amounts reflected in the accompanying financial statements because of the plan’s
inherent uncertainty.
The
unaudited Statement of Net Assets in Liquidation and the Statement of Changes in
Net Assets in Liquidation have been prepared by the Company in accordance with
the rules and regulations of the Securities and Exchange Commission, and
should be read in conjunction with the audited Consolidated Financial Statements
previously filed on the Company’s Form 10-K for the year ended
December 31, 2009. In the opinion of management, the statements reflect all
adjustments necessary for a fair presentation of the net assets of EDCI. Certain
information and note disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America, which are not required for interim purposes, have been
condensed or omitted. The consolidated financial statements as of
December 31, 2009 and for the unaudited three months ended March 31, 2009
were prepared on the going concern basis of accounting. We issued these
unaudited condensed consolidated financial statements by filing with the SEC and
have evaluated subsequent events up to the time of filing.
|
3.
|
Adoption
of Liquidation Basis of Accounting
|
Upon the
adoption of the liquidation basis of accounting, the Company recorded the
following adjustment to adjust assets to estimated net realizable value and
liabilities to net settlement amounts:
|
Initial Adjustment of EDC Assets to Estimated Net
Realizable Value
|
|
Amount
|
|
Write
down of fixed assets
|
|
$ 15,613
|
|
Write
down of spare parts
|
|
3,011
|
|
|
|
$ 18,624
|
|
Initial Adjustment of Liabilities to Net
Settlement Amounts
|
|
Amount
|
|
Write
down of deferred taxes
|
|
(221)
|
|
Adjustment
of noncontrolling interest to estimated settlement value
|
|
(5,124)
|
|
|
|
$ (5,345)
|
The
adjustment to deferred income taxes of $0.2 million was the result of EDCI
updating its estimate of the net settlement value of this liability in
liquidation. The adjustment of noncontrolling interest in the amount
of $5.1 million was the result of this liability having a settlement amount upon
EDCI’s adoption of liquidation accounting of less than what was previously
recorded.
The
Company was required to make significant estimates and exercise judgment in
determining the accrued costs of liquidation as of January 1, 2010. Upon
transition to the liquidation basis of accounting, the Company accrued the
following costs expected to be incurred in liquidation:
|
Accrued Costs of
Liquidation
|
|
Amount
|
|
Payroll
and severance related
|
|
$ 3,104
|
|
Professional
fees
|
|
744
|
|
Wind
down costs related to EDC's UK facility
|
|
380
|
|
Accrual
of carrying costs related to EDC's Kings Mountain facility
|
1,800
|
|
Outside
services and other wind down expenses
|
|
2,233
|
|
|
|
$ 8,261
|
EDCI
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS IN LIQUIDATION (Liquidation
Basis)
(Tabular
Amounts in Thousands)
(Unaudited)
The
adjustment of wind down costs related to EDC’s UK facility in the amount of $0.4
million was the result of the Company’s updated estimate of the costs to wind
down the EDC Blackburn, UK operations, which were consolidated into EDC’s
operating facility in Hannover, Germany as of December 31, 2009. The accrual of
carrying costs associated with EDC’s Kings Mountain building is the result of
EDC recording estimated carrying costs expected to be incurred during the three
year liquidation period.
|
4.
|
Selected
Financial Data
|
Statement
of Net Assets in Liquidation - Consolidating
The
Statement of Net Assets in Liquidation presented below is consolidating and is
intended to illustrate which components of the consolidated Statement of Net
Assets in Liquidation are attributable to EDCI and EDC,
respectively.
|
STATEMENT
OF NET ASSETS IN LIQUIDATION (LIQUIDATION BASIS)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March
31, 2010
|
|
|
|
(Unaudited)
|
|
|
|
EDC
(b)
|
|
EDCI
|
|
Eliminations
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
$ 22,527
|
|
$ 29,179
|
|
$ -
|
|
$ 51,706
|
|
Restricted
cash
|
23,989
|
|
-
|
|
-
|
|
23,989
|
|
Investments
|
-
|
|
870
|
|
-
|
|
870
|
|
Accounts
receivable, net
|
8,244
|
|
-
|
|
-
|
|
8,244
|
|
Due
from Universal
|
2,121
|
|
-
|
|
-
|
|
2,121
|
|
Inventories,
net
|
3,970
|
|
-
|
|
-
|
|
3,970
|
|
Prepaid
expenses and other current assets
|
6,597
|
|
1,206
|
|
-
|
|
7,803
|
|
Deferred
income taxes
|
1,812
|
|
-
|
|
-
|
|
1,812
|
|
Due
to EDCI from EDC (a)
|
-
|
|
2,753
|
|
(2,753)
|
|
-
|
|
Assets
held for sale
|
6,400
|
|
-
|
|
-
|
|
6,400
|
|
Total
assets
|
|
75,660
|
|
34,008
|
|
(2,753)
|
|
106,915
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND NET ASSETS IN LIQUIDATION
|
|
|
|
|
|
|
|
|
Accounts
payable
|
$ 7,414
|
|
$ -
|
|
|
|
$ 7,414
|
|
Accrued
expenses and other liabilities
|
13,141
|
|
694
|
|
-
|
|
13,835
|
|
Due
from EDC to EDCI (a)
|
2,753
|
|
-
|
|
(2,753)
|
|
-
|
|
Liquidation
accrual
|
2,180
|
|
5,242
|
|
-
|
|
7,422
|
|
Loans
from employees
|
1,506
|
|
-
|
|
-
|
|
1,506
|
|
Universal
rebate payable
|
1,836
|
|
-
|
|
-
|
|
1,836
|
|
Deferred
income taxes
|
-
|
|
66
|
|
-
|
|
66
|
|
Reserve
for uncertain tax positions
|
827
|
|
2,489
|
|
-
|
|
3,316
|
|
Pension
and other defined benefit obligations
|
34,422
|
|
692
|
|
-
|
|
35,114
|
|
Total
liabilities
|
64,079
|
|
9,183
|
|
(2,753)
|
|
70,509
|
|
Noncontrolling
interest at estimated value
|
-
|
|
146
|
|
-
|
|
146
|
|
Total
liabilities and noncontrolling interest
|
64,079
|
|
9,329
|
|
(2,753)
|
|
70,655
|
|
|
|
|
|
|
|
|
|
|
|
Net
assets in liquidation
|
$ 11,581
|
|
$ 24,679
|
|
-
|
|
$ 36,260
|
|
(a)
|
The
amount recorded as Due from EDC to EDCI represents an estimate EDC’s
portion of certain shared corporate costs which are anticipated to be
incurred during the dissolution period and which will be recovered from
EDC through intercompany settlements.
|
|
(b)
|
See
Note 1 regarding restrictions on our ability to transfer cash from EDC to
EDCI.
|
|
5.
|
Cash
and Cash Equivalents
|
Restricted
Cash
Restricted
cash of EDC’s European Operation at March 31, 2010 was $24.0 million. As part of
the acquisition of the Universal manufacturing and distribution operations, one
of Universal’s subsidiaries deposited these escrowed funds into an account
controlled by an Escrow Agreement restricting the disbursement of the funds.
Universal and EDC participate in determining and approving disbursement. The
earnings on the funds are paid to EDC monthly. A portion of the
restricted cash is being held in escrow to fund employee related obligations. On
June 1, 2010, the restrictions encumbering approximately $20.7 million of the
restricted cash expire and the cash will be released to EDC. We are
currently evaluating all options, subject to compliance with German law and tax
considerations and additional security obligations and U.S. legal and tax
considerations, in regards to the future usage of the portion of the restricted
cash that will be released from escrow on June 1, 2010. Amounts in
excess of federally insured limits are on deposit with various financial
institutions.
EDCI
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS IN LIQUIDATION (Liquidation
Basis)
(Tabular
Amounts in Thousands)
(Unaudited)
As of
March 31, 2010, the Company has one investment which is recorded at its
estimated net realizable value of $0.9 million in the accompanying Statement of
Net Assets in Liquidation. The investment consists of 10 units of
Auction Market Preferred Securities (“AMPS”) issued by the Boulder Total Return
Fund, Inc. (the “Fund”). The Fund’s AMPS have a liquidation
preference of $100,000 per share, plus any accumulated unpaid distributions,
whether or not earned or declared by the Fund but excluding interest thereon
(“Liquidation Value”) and have no set retirement date. The Fund retired 26
shares of AMPS through a privately negotiated transaction during 2009 at an
average price of $84,923 per share.
The
Company evaluates the fair value of its investment at each reporting period. The
estimated fair values could change significantly based on future market
conditions. The Company will continue to assess the fair value of its investment
for substantive changes in relevant market conditions, changes in financial
condition or other changes that may alter its estimates described above. The
Company may be required to record future write downs of its investment if it
determines that its investment has incurred a change in fair value.
|
7.
|
Employee
Benefit Receivable from Universal
|
Under the
terms of the share purchase agreement relating to the acquisition of Universal’s
European operations, Universal is required to reimburse EDC relating to the
liabilities net of accounts receivable and other receivables assumed by EDC at
the acquisition date. Amounts not paid or received in future periods for these
assumed liabilities and receivables, with the exception of the pension
obligations, will be adjusted through the receivable. The balance of
$2.1 million at March 31, 2010 relates to the long-term service award
plan.
Inventories,
net at March 31, 2010, relate to EDC’s European Operation and consisted
of:
|
|
March
31,
|
|
|
2010
|
|
Raw
materials
|
$ 3,423
|
|
Finished
goods
|
157
|
|
Work
in process
|
390
|
|
Total
|
$ 3,970
|
At March
31, 2010 reserves were approximately $0.9 million.
Assets
Held for Sale as of March 31, 2010, consists of EDC’s Kings Mountain, North
Carolina facility (“Kings Mountain Facility’), which formerly housed EDC’s U.S.
manufacturing operations. EDC has listed the Kings Mountain Facility
for sale since the second quarter of 2009 and is currently unable to predict
when a successful transaction involving the sale of this facility will
occur. Annual carrying costs related to maintaining the Kings
Mountain Facility in a condition to be sold are estimated to be approximately
$0.6 million. Due to EDC’s uncertainty in regards to the timing of a
successful sale transaction, three years of carrying costs have been accrued as
part of the liquidation accrual as of March 31, 2010.
|
|
March
31,
|
|
|
2010
|
|
Payable
to Universal - undiscounted
|
2,186
|
|
Employee
Loans
|
1,506
|
|
Subtotal
|
3,692
|
|
Less:
Unamortized Discount
|
(350)
|
|
Total
Debt
|
$ 3,342
|
Universal
Under the
terms of the supply contracts that EDC entered into as part of EDC’s purchase of
Universal’s European disc manufacturing and distribution operation, EDC is
obligated to pay to Universal deferred acquisition
payments. Scheduled payments of $0.5 million are due on December 31
for the next five years, ending in 2014.
Employee
Loans
Employees
of EDC’s European Operations participate in a government regulated employee
savings plan whereby a portion of their earnings are held by us in savings
accounts and are therefore treated as loans to us. These loans are for six-year
terms and are signed annually in January. The loans, including all accumulated
interest, are paid at the end of the term. Interest rates are determined prior
to the loans being assigned and remain constant for the six-year period. In
addition to interest, each participant receives a grant of approximately €0.1
million ($0.2 million), which is included in the employee loan balance. The
value of the loans outstanding at March 31, 2010 totaled $1.5 million. Funds for
these loans are held in escrow as restricted cash. See Note 5. These loans are
100% guaranteed by several different banks and are not convertible. Under
certain hardship conditions the employee loan may be paid out
early. The employee savings plan is closed to new
entrants.
EDCI
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS IN LIQUIDATION (Liquidation
Basis)
(Tabular
Amounts in Thousands)
(Unaudited)
During
the three months ended March 31, 2010, the amount of gross unrecognized tax
benefits was reduced by $0.3 million primarily due to the expiration of certain
statutes of limitation, which offset the impact of additional interest and
exchange rate fluctuations. Of the unrecognized tax benefits recorded
as of March 31, 2010, it is anticipated that over the next 12 months
various tax-related statutes of limitation will expire which will cause a
$2.4 million reduction in the unrecognized tax benefits, consisting of
$1.4 million in taxes and $1.0 million in accrued interest and
penalties and thus net assets in liquidation will increase by a like
amount. These unrecognized tax benefits relate primarily to transfer
pricing.
|
12.
|
Employee
Benefit Plans
|
Post
retirement benefit obligation consisted of the following
components:
|
|
March
31,
|
|
|
2010
|
|
Pension
obligation
|
29,324
|
|
Post-retirement
health care benefit costs
|
260
|
|
Long-term
service award plan
|
2,760
|
|
Early
retirement program
|
2,770
|
|
|
35,114
|
(a)
Pension Obligations
As a
result of the May 31, 2005 acquisition of EDC, certain obligations of various
defined benefit plans were assumed. Employees and managing directors of EDC’s
European Operations participate in the pension plans. These benefits are based
on pay, years of service and age. As of March 31, 2010, EDC has
accrued approximately $28.9 million related to this plan. EDCI has a pension
plan which covers two retired former employees of EDCI’s Messaging
business. EDCI has accrued approximately $0.4 million related to this
pension plan. The plans are not funded and therefore have no plan
assets. These pension plans are closed to new entrants.
(b)
Long-term service award plan
EDC
maintains a long-term service awards program, a defined benefit plan, for
qualified employees of EDC’s European Operation, which allows qualified
employees to receive a lump sum service gratuity (“Jubilee”) payment once they
have reached a certain number of years of service. The Jubilee payment is
determined based on 1/12
th
of
the employee’s annual salary. A portion of the long-term service
obligations is funded by Universal (see Note 7).
(c)
Early Retirement Program
In
Germany, Altersteilzeit (“ATZ”) is an early retirement program established by
law, and is designed to create an incentive for employees, within a certain age
group, to transition from (full or part-time) employment into retirement before
their legal retirement age. The German government provides a subsidy to
employers taking advantage of this legislation for bonuses paid to the employee
and the additional contributions paid into the German government pension scheme
under an ATZ arrangement for a maximum of six years. To receive this subsidy, an
employer must meet certain criteria established by the German government.
EDC accrues for ATZ based
on current and future contracts.
(d)
Post retirement health care benefit obligations
EDCI
provides certain U.S. employees of its former Messaging business with certain
health care benefits upon retirement assuming the employees met minimum age and
service requirements as of the date of disposition of the Messaging business.
EDCI’s policy is to fund benefits as they become due. Consequently, the plan has
no assets. For non-funded plans, the expected employer contributions equal the
benefit payments. The plan is closed to new
participants. EDCI has accrued approximately $0.3 million related to
this pension plan
|
13.
|
Commitments
and Contingencies
|
Litigation
In
addition to the legal proceedings discussed below, we are, from time to time,
involved in various disputes and legal actions related to our business
operations. While no assurance can be given regarding the outcome of these
matters, based on information currently available, we believe that the
resolution of these matters will not have a material adverse effect on our
financial position or results of our future operations.
Arbitration Claim under the
International Distribution Agreement.
On
February 27, 2009, EDC, at its election, provided notice to Universal
International Music (“UIM”) of its demand to arbitrate certain allegations by
UIM, which EDC believes lack any merit, that EDC had triggered
certain “Key Failures” (or defaults) as defined in the International
Distribution Agreement between EDC and UIM dated May 31, 2005 as amended (the
“International Distribution Agreement”). UIM is part of Universal,
which is EDC’s largest customer. EDC’s demand to arbitrate was in
response to a notice from UIM dated February 19, 2009 alleging certain Key
Failures related to EDC’s performance levels in July through December of
2008. In connection with the February 19, 2009 notice, UIM withdrew a
prior Failure Notice issued on December 11, 2008, which notice EDC had also
objected to and which EDC and UIM had been attempting to resolve in an amicable
manner. The February 19, 2009 notice from UIM purported to be a
substitution and restatement of many of the same underlying allegations set
forth in the withdrawn December 11, 2008 notice, EDC determined that further
attempts to resolve the matter amicably would not be successful. Accordingly,
EDC determined to proceed to binding arbitration under the International
Distribution Agreement and a hearing is scheduled for June 2010, although a
final decision is not currently expected to be rendered until the third quarter
of 2010.
EDCI
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS IN LIQUIDATION (Liquidation
Basis)
(Tabular
Amounts in Thousands)
(Unaudited)
Under the
International Distribution Agreement, EDC has various service level obligations
it is required to maintain. Repeated failures to meet those service level
obligations can result in Key Failures. In its February 19, 2009
notice, UIM alleged that EDC had incurred two Key Failures. EDC
believes neither of the Key Failures is valid. Even if a Key Failure
had been validly established by UIM, EDC is generally provided with a
contractual opportunity to cure such, although as described below, based upon
the nature of the Key Failures alleged by UIM and the timeframes in which they
occurred, EDC would also face penalties for those two Key Failures – if they are
both held to be valid – even if both Key Failures were cured.
There are
various penalties for both cured and uncured Key Failures. Depending
on whether one or two Key Failures were found valid at arbitration, and whether
EDC were able to cure any such valid Key Failures, EDC could face the
following: Upon each of the first two uncured Key Failures occurring
within a five-year period, UIM has the right to source 30% of its distribution
requirements under the International Distribution Agreement and / or 30% of its
manufacturing requirements under the International Manufacturing Agreement
between UIM and EDC dated May 31, 2005 (together with the International
Distribution Agreement, the “Supply Agreements”) from a third party for a period
of 12 months or receive liquidated damages in the amount of $0.6
million as a credit against its payments under such contract. In
addition, based upon the nature of the Key Failures alleged by UIM and the
timeframes in which they occurred, EDC would also face penalties for those two
Key Failures – if they are both held to be valid – even if both Key Failures
were cured. The penalty in such an event, for both uncured Key
Failures combined, would be the right by UIM to source 30% of its requirements
under the Supply Agreements from a third party for a period of 12 months or
receive liquidated damages in the amount of approximately $0.6 million
as a credit against its
payments under such contract. EDC expects that UIM's entire
contractually committed distribution and manufacturing volume under the Supply
Agreements will represent approximately 88% of EDC's total manufacturing and
distribution volume in 2010.
Upon the
occurrence of additional Key Failures (which UIM has not asserted), additional
penalties apply as follows. Upon the occurrence of three Key Failures within a
five year period of the same category, UIM has the right to either source 100%
of its distribution requirements under the International Distribution Agreement
from a third party for the remaining term of the contract, terminate such
contract outright or receive liquidated damages in the amount of $1.9 million as
a credit against its payments under such contract. Upon the
occurrence of four Key Failures within a five year period of any category, UIM
has the right to either source 30% of its distribution requirements under the
International Distribution Agreement from a third party for a period of 12
months, terminate such contract outright or receive liquidated damages in the
amount of $0.6 million as a credit against its payments under such
contract. The occurrence of five Key Failures within a five year
period of any category, whether cured or uncured, would provide UIM with the
same damages as three Key Failures within a five year period of the same
category.
As
described above, EDC believes that no Key Failures have occurred and intends to
vigorously defend its position in arbitration but at this early stage in these
matters, EDC is not able to assess the likelihood of a favorable outcome. If EDC
is unsuccessful in arbitration, the alleged Key Failures could result in
substantial liquidated damages or the loss of volumes that, based on the high
fixed cost nature of EDC’s distribution operations, would have a material
adverse effect on results of operations and cash flows, however, an amount
cannot be estimated at this time. EDC may also be successful in its claim that
no Key Failures have occurred, but the arbitration panel could reject EDC’s
interpretation of the underlying service levels as they are applicable to future
performance, increasing the risk of future potential Key Failures. As described
above, subsequent Key Failures – even if cured – could result in even greater
damages and the ultimate right of UIM to terminate the International
Distribution Agreement.
Anticipatory Breach of Manufacturing
and Related Service Agreement Claim.
On July 23, 2009, UIM
provided notice to EDC of its claim that EDC was in anticipatory breach of the
Manufacturing and Related Services Agreement between EDC and UIM dated May
31
st
,
2005, as amended (the “Manufacturing Agreement”) by taking steps to close EDC’s
Blackburn facility. UIM claimed that the maintenance by EDC of a
facility in the United Kingdom to service UIM’s UK manufacturing requirements is
a “fundamental implied term of the Manufacturing Agreement.” As a
result, UIM claimed that EDC forfeited its right to continue to service 100% of
UIM’s UK manufacturing requirements, and UIM is entitled to sub-contract the
entirety of such volume to a UK - located third party of its
choice. UIM at that time did not elect to enforce that remedy but
reserved the right to do so by written notice. On July 28, 2009, EDC
sent written notice to UIM forcefully refuting its claims and also asserting
that UIM is attempting to imply a term into the Manufacturing Agreement that has
been expressly dealt with in amendments to the agreement providing that EDC
“will use its commercially reasonable endeavors to manufacture the majority of
UIM’s Manufacturing Requirements for the UK at the Blackburn
Facility.” As previously disclosed in March 2009, management of EDC
determined and EDC’s Board of Directors confirmed that it was no longer
commercially reasonable to continue operating the Blackburn manufacturing
facility. EDC stated in its July 28, 2009 response that UIM’s claims
in its July 23, 2009 letter constitute a gross violation of the covenant of good
faith and fair dealing implied into the Manufacturing Agreement. EDC
further provided notice to UIM that if UIM did not withdraw its claims in the
July 23, 2009 notice within seven days of EDC’s July 28, 2009 response, it would
refer this matter to arbitration seeking a declaration that there is no breach
by EDC of the Manufacturing Agreement as a result of the Blackburn – Hannover
Consolidation and seeking damages for the losses incurred by EDC as a direct
result of the July 23, 2009 letter and the continued breaches by UIM of the
implied covenant of good faith and fair dealing. UIM did not withdraw
its claims, and EDC therefore submitted the matter to arbitration in August
2009. The arbitration tribunal was finalized in April 2010 but no
date for the arbitration has been set.
In
subsequent correspondence related to this matter, UIM indicated that it would
begin to order 40% of its UK manufacturing requirements from third party
manufacturers in 2010, while maintaining its claim that EDC had forfeited its
right to continue to service 100% of those UK requirements. UIM also advanced
additional theories under which EDC's closure of the Blackburn facility and the
manufacture of UIM's UK volume out of EDC's Hannover facility would constitute a
breach of the Manufacturing Agreement - including that EDC would be unable to
meet its contractual service level obligations ("SLAs") for UIM UK requirements
manufactured out of Hannover - and EDC's actions constitute a material breach of
the Manufacturing Agreement entitling UIM to terminate the entire Manufacturing
Agreement. EDC responded that these additional theories also lacked merit, that
EDC could satisfy the SLAs and warned UIM of the legal consequences of breaching
the Manufacturing Agreement by procuring 40% of its UK requirements from third
parties. However, on January 14, 2010 EDC confirmed that UIM had begun to order
certain of its UK requirements from third parties.
EDCI
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS IN LIQUIDATION (Liquidation
Basis)
(Tabular
Amounts in Thousands)
(Unaudited)
In
consultation with counsel, EDC continues to believe UIM's claims and remedies
lack merit. In particular, the Manufacturing Agreement expressly provides that
EDC is only obliged to use its "commercially reasonable endeavors" to
manufacture the majority of UIM's UK requirements at its Blackburn facility, and
as previously disclosed in March 2009, at that time management of EDC determined
and EDC's Board of Directors confirmed that it was no longer commercially
reasonable to continue operating the Blackburn manufacturing
facility. Further, EDC believes it can meet all SLAs for UIM's UK
requirements manufactured from its Hannover facility and believes that certain
of the UK requirements ordered by UIM were in fact ordered from Austria, a
location that is geographically more distant from the UK than EDC’s Hannover
facility. However, if UIM were successful in its claims in arbitration EDC would
face material and adverse consequences. The loss of 40% of UIM's UK
requirements, based on the high fixed cost nature of EDC's manufacturing
operations, would have a material adverse effect on its operating results. If
UIM were to prevail in its new argument that EDC's breach provides UIM with the
right to terminate the entire Manufacturing Agreement and UIM so elected, EDC
would lose substantially all of its contractually committed manufacturing
business. EDC expects that UIM's entire contractually committed manufacturing
volume will represent approximately 75% of EDC's total manufacturing volume in
2010, that the UK requirements account for approximately 20% of EDC's total
manufacturing volume, and thus 40% of the UK requirements account for
approximately 8% of EDC's total manufacturing volume.
EDC
believes UIM has breached its obligations to EDC with regard to certain of its
UK requirements, and until resolved UIM will likely continue that breach by
procuring up to 40% of its UK requirements from third parties, as it experienced
in the quarter ended March 31, 2010. EDC will seek to recover those losses,
other losses and punitive damages from UIM in arbitration. However, UIM's
actions will also force EDC to evaluate and develop other cost-reduction
measures in Hannover to mitigate those damages in the short run.
EDC does
not believe UIM’s claim has merit and intends to vigorously defend and prosecute
its position in arbitration but at this early stage in these matters, EDC is not
able to assess the likelihood of a favorable outcome. However, if UIM
were successful in its claim and enforced its alleged remedy, EDC could suffer
loss of volumes that, based on the high fixed cost nature of EDC’s manufacturing
operations, would have a material adverse effect on its
profitability.
Other UIM Matters.
In
April 2010, UIM indicated to EDC its intent to procure certain units currently
serviced in accordance with the Distribution Agreements from third parties
before the end of 2010.
EDC is not currently aware of the exact volume of units that could be
implicated, or UIM’s specific legal grounds for doing so. However, after
consultation with counsel, EDC currently believes that a significant percentage
of such units are likely to be part of the contractually committed volumes under
the Distribution agreement and thus EDC would expect to pursue legal
remedies should UIM order such units from third parties, including seeking
injunctive relief as well as by pursuing arbitration. In addition, EDC is
engaging in discussions with UIM to determine if there is a commercial
solution. While EDC is not currently aware of the exact volume of units
that could be implicated, it is likely that the volumes at issue could be
significant. As a result, if UIM began to order such volume from third
parties, and based on the high fixed cost nature of EDC’s operations, UIM’s
actions could have a material adverse effect on EDC’s operating
performance.
Patent Litigation
: In March
2008, EDC was served as a defendant in an action by Koninklijke Philips
Electronics N. V. and U.S. Philips Corporation, pending in the U. S. District
Court for the Eastern District of Texas, Beaumont Division, filed on January 18,
2008. This complaint was dismissed without prejudice on April 30, 2008 and a
substantially similar action was filed in the U.S. District Court for the
Southern District of New York (the “NY Complaint”) on April 30, 2008. In the NY
Complaint, plaintiffs allege breach of contract for failure to pay royalties
and
patent infringement and claim unspecified damages and, in addition to naming EDC
and the Company, named James Caparro and Jordan Copland as defendants
in their capacities as former CEOs of EDC. In 2009, the Court denied plaintiffs’
motion for a summary judgment that EDC breached the contract. Pending before the
Court was a motion for summary judgment that there is no patent infringement.
The Court has terminated the motion for summary judgment pending a decision on
claim construction, a hearing for which was held in December, 2009 and a
decision for which was rendered in May, 2010, as a result of which EDC plans to
submit a modified motion for summary judgment accounting for the court’s claim
construction. On January 22, 2010, the Court dismissed the action against the
individual defendants, Messrs. Caparro and Copland. In April of 2010, the
defendants objected to a request by Philips to amend its complaint to add
additional claims (including additional allegations of breach of contract, and
new claims for fraud in the inducement, unjust enrichment, tortuous interference
with business relations and civil conspiracy) a decision for which was rendered
in May, 2010 stating that Philips could not amend its complaint to add new
claims but could add specificity to its previously pled breach of contract
allegations. EDC does not believe the complaint has merit, intends to
vigorously defend this action and believes it has indemnification rights under
certain contractual arrangements covering a substantial portion of the alleged
infringement but at this early stage in the matter, EDC is not able to assess
the likelihood of a favorable outcome. The case is still pending and discovery
and motion practice are continuing.
ITEM
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
We, from
time to time, make “forward-looking statements” within the meaning of the
Private Securities Litigation Reform Act of 1995. Such statements reflect the
expectations of management at the time such statements are made. The reader can
identify such forward-looking statements by the use of words such as “may,”
“will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,”
“predicts,” “intend(s),” “potential,” “continue,” or the negative of such terms,
or other comparable terminology. Forward-looking statements also include the
assumptions underlying or relating to any of the foregoing
statements.
These
forward-looking statements are not guarantees of future performance and involve
risks, uncertainties and assumptions that are difficult to predict. All
forward-looking statements included in this quarterly report on Form 10-Q are
based on information available to us on the date hereof. We assume no obligation
to update any forward-looking statements and do not intend to do
so.
Overview
On
September 9, 2009, our Board of Directors unanimously approved recommending a
dissolution process to EDCI’s stockholders, and on October 14, 2009 approved the
final Plan of Dissolution. At a Special Meeting held on January 7, 2010 the
stockholders of EDCI approved the voluntary dissolution and liquidation of EDCI
pursuant to the Plan of Dissolution. Delaware law provides that a corporation
may dissolve upon the recommendation of the Board of Directors of the
corporation, followed by the approval of its stockholders. As the Plan of
Dissolution was approved by the requisite vote of our stockholders at the
Special Meeting, we filed a certificate of dissolution with the Delaware
Secretary of State in January 2010.
The Plan
of Dissolution provides for the voluntary dissolution, liquidation and winding
up of EDCI. As of January 2010, we have ceased all of EDCI’s business
activities except for those relating to winding up EDCI’s business and affairs
during a minimum three-year period required under Delaware law, including, but
not limited to, gradually settling and closing its business, prosecuting and
defending suits by or against EDCI, seeking to convert EDCI’s assets into cash
or cash equivalents, discharging or making provision for discharging EDCI’s
known and unknown liabilities, making cash distributions to our stockholders,
withdrawing from all jurisdictions in which EDCI is qualified to do business
and, if EDCI is unable to convert any assets to cash or cash equivalents by the
end of the three-year period, distributing EDCI’s remaining assets in-kind among
our stockholders according to their interests or placing them in a liquidating
trust for the benefit of our stockholders, and, subject to statutory
limitations, taking all other actions necessary to wind up the Company’s
business and affairs.
EDCI’s
ownership of 97.99% of the membership units of EDC is an asset of EDCI that is
subject to the Plan of Dissolution. The Plan of Dissolution does not
directly involve the operating business, assets, liabilities or corporate
existence of EDC and its subsidiaries, and EDC plans to continue to honor the
terms of its long term customer agreement that expires in May
2015. Beginning in January 2010, EDCI’s consolidated financials are
required to reflect the value of EDC’s assets and liabilities under liquidation
accounting and it should be noted that during EDCI’s three-year dissolution
period, EDCI will continue to seek value for its investment in EDC by exploring
strategic alternatives and seeking, as appropriate, cash distributions, subject
applicable legal requirements. While EDC is currently examining the
possibility of making a distribution, including from EDC's European Operations
to EDCI, such a distribution remains subject to the future operating performance
of EDC’s European Operations and compliance with German law and tax
considerations, and the distribution of any cash from EDC to EDCI is subject to
additional security obligations and additional U.S. legal and tax
considerations. However, EDCI is unable to provide any assurance that its
efforts to seek value for its investment in EDC will result in
any proceeds. In particular, the cooperation of Universal, EDC’s
largest customer, is critical to any sale of EDC’s European Operations and based
on negotiations with a potential acquirer during the fourth quarter of 2009 and
first quarter of 2010, EDC does not believe Universal will cooperate on
acceptable terms with any such transaction. As a result, any
transaction involving the sale of EDC’s European Operations in the near term is
unlikely. If EDCI continues to own any interest in EDC at the end of
the three year dissolution period, EDCI anticipates transferring such interests
to a liquidating trust, for the benefit of our stockholders.
On
February 1, 2010, pursuant to the previously noted EDCI Plan of Dissolution,
EDCI made an initial dissolution distribution of $3.12 per share of its common
stock. In aggregate, approximately $21.0 million of EDCI’s cash was
returned to its shareholders.
Results
of Operations
Consolidated
statements of operations and statement of cash flows are presented on a going
concern basis of accounting and therefore only include results for the 2009
period and as a result, no comparative discussion is presented.
Financial
Condition and Liquidity
Overview
At March
31, 2010, we had cash and cash equivalents totaling $51.7 million, of which
$29.2 million was cash held by the EDCI and $22.5 was cash held at EDC. At March
31, 2010, the principal sources of liquidity were our unrestricted cash and cash
equivalents. On February 1, 2010, EDCI made an initial dissolution
cash distribution of $3.12 per share on common stock outstanding. In
the aggregate, approximately $21.0 million of EDCI’s cash was returned to
shareholders pursuant to this initial distribution. At March 31, 2010, EDCI had
investments of $0.9 million in one auction-rate security.
EDCI
plans to use its cash and cash equivalents in connection with the Plan of
Dissolution. EDC expects to use its cash and cash equivalents for
working capital and other general corporate purposes. We believe that
the liquidity position of each of EDCI and EDC is adequate to fund their
operating needs and to provide EDC with flexibility to respond to further
changes in its business environment. The challenges of the present business
environment and disagreements with its primary customer may cause a material
reduction in EDC’s liquidity as a result of an adverse change in its cash flow
from operations or its access to credit or other capital. In
addition, EDCI does not guarantee any of the liabilities of EDC.
Capital
Expenditures
Capital
expenditures amounted to approximately $1.0 million in the three months ended
March 31, 2010 and are anticipated to be approximately $1.9 million for the
remaining nine months of 2010. All capital expenditures in 2010
relate to EDC’s European Operations and consist primarily of normal equipment
and facility, replacement and upgrades and efficiency improvements.
Update
on Plan of Dissolution
On
February 1, 2010, pursuant to the previously noted Plan of Dissolution, EDCI
made an initial dissolution distribution of $3.12 per share of its common
stock. In aggregate, approximately $21.0 million of EDCI’s cash was
returned to its shareholders. EDCI expects to make further distributions
to its shareholders of its remaining cash and investments, less any amount
reserved to cover ongoing expenses during the three-year dissolution period and
any amounts reserved for, known and unknown contingent
liabilities. The amounts reserved will be based on a determination by
the board of directors, including consultation with management and outside
experts as reasonably required, if the board of directors determines that it is
advisable to retain such experts, and a review of, among other things, our
estimated known and unknown contingent liabilities and our estimated ongoing
expenses, including, but not limited to, payroll, legal expenses, regulatory
filings and other miscellaneous expenses. Each shareholder will
receive his or her pro rata share of any future distribution based on the number
of shares held at the time of the record date for such
distribution.
EDCI had
previously advised its shareholders that it was in the process of analyzing the
structure and feasibility of a potential tender offer for up to $10 million, and
that any tender offer would be contingent on EDCI obtaining guidance from the
Securities and Exchange Commission (the “SEC”) that it will be successful in
obtaining relief from certain continued SEC reporting requirement. In
preliminary conversations with the SEC, EDCI was not able to obtain such
guidance and therefore, consistent with the alternatives described in the
Company’s proxy statement related to the approval of the Company’s dissolution,
the Company now plans to ask its shareholders to approve a proposal to effect a
reverse stock split of the Company’s outstanding Common Stock which, if
approved, would reduce the number of record holders of the Company’s Common
Stock to a number that would enable the Company to remove its Common Stock from
registration under the Securities Exchange Act of 1934 (the “Exchange
Act”). If the reverse stock split proposal is approved by its
shareholders, the Company intends to terminate its status as a reporting Company
under the Exchange Act, thereby eliminating the requirement that the Company
file periodic reports with the SEC and eliminating the expenses of being a
reporting company. The reverse split transaction would add further costs
and would require cashing-out a number of our smaller
stockholders. The Company has engaged a financial advisor to assist a
special committee of the Board of Directors in establishing the cash-out
price. Cashing-out shareholders would require using a portion of the
$10 million previously reserved for the potential tender offer and would also
put EDCI’s net operating losses at risk, and thus may limit or preclude
additional purchases of shares through a contemplated tender
offer. EDCI believes it is prudent to continue to protect those
tax-loss carryforwards at this time, as they would limit EDCI’s taxes in the
event of any distributions from EDC’s European Operations. Therefore,
at this time, EDCI will defer any further consideration of a potential tender
offer until after the contemplated reverse split is either completed or rejected
by EDCI’s stockholders. If EDCI ultimately determines not to effect
any tender offer, any portion of the $10 million amount that had been reserved
for the contemplated tender offer would be subsequently distributed as a
dissolution distribution payment. The Company intends to file a preliminary
proxy statement with the SEC setting forth this and related proposals in the
third quarter of 2010. The range of dissolution proceeds in the
Company’s proxy statement filed November 16, 2009 did not include any estimates
as to potential distributions from EDC due to the uncertainty of the value of
EDCI’s investment in EDC at that time. EDC is currently examining the
possibility of making a distribution from EDC, including from EDC's European
Operations, but such a distribution remains subject to the future operating
performance of EDC’s European Operations and compliance with German law and tax
considerations, and the distribution of any cash from EDC to EDCI is subject to
additional security obligations and additional U.S. legal
considerations.
EDC
Business Update
Having
completed the sale and wind down of EDC’s U.S. operations and the
Blackburn-Hannover consolidation, the sole EDC focus has shifted to maximizing
the profitability at its remaining international operations in Hannover,
Germany. While the Blackburn-Hannover Consolidation will improve
profitability at our remaining Hannover facility, we anticipate decline rates of
CD and DVD volumes in Europe in the 10-15% range for 2010. As in
2009, EDC will continue its cost-savings initiatives and plan to right size
operating capacity in 2010 to deal with forecasted and actual volume declines.
In January 2010, Universal began to place a portion of its UK manufacturing
requirements with another manufacturer. EDC has placed Universal on
notice that it will seek both recompense and damages for this action via
the ongoing arbitration process. See “Notes to Consolidated Financial Statements
– Note 13. Commitments and Contingencies – Litigation”.
Blackburn
– Hannover Consolidation
In March
of 2009, EDC’s Board of Directors made a clear determination that it was no
longer commercially reasonable to continue serving EDC’s customers out of the
Blackburn manufacturing facility. As a result, EDC’s Board approved a plan to
consolidate, into EDC’s Hannover, Germany operation, manufacturing volumes
historically produced in EDC Blackburn, UK. The consolidation plan continues to
run on schedule with all necessary consents obtained. The Blackburn, UK plant
ceased production at the end of December, the vast majority of the workforce has
been terminated and we are now clearing and remediating the site prior to
exiting at the expiration of our lease in June. The Universal UK
catalogue has been successfully transferred to the Hannover, Germany plant, the
relocation of required equipment from Blackburn to Hannover has been completed
and the installation and commissioning of the equipment is
advanced.
Critical
Accounting Policies and Estimates
For
financial reporting purposes, EDCI adopted the liquidation basis of accounting
effective January 1, 2010. The Plan of Dissolution was approved by the Company’s
shareholders on January 7, 2010. Operating results during the stub period ended
January 7, 2010 was nominal. Under the liquidation basis of accounting, the
principal financial statements required are a Statement of Net Assets in
Liquidation and a Statement of Changes in Net Assets in Liquidation. Further,
under the liquidation basis of accounting, assets are stated at their estimated
net realizable value, which is the non-discounted amount of cash, or its
equivalent, into which an asset is expected to be converted in the due course of
business less direct costs, while liabilities are reported at their estimated
settlement amount, which is the non-discounted amounts of cash, or its
equivalent, expected to be paid to liquidate an obligation in the due course of
business, including direct costs. Additionally, under the liquidation basis of
accounting, we are required to establish a reserve for all future estimated
general and administrative expenses and other costs expected to be incurred
during the liquidation period. The reserve for these estimated expenses includes
primarily accruals including people costs (payroll and benefits), facilities,
professional services and litigation costs, and corporate expenses (insurance,
directors’ fees and statutory fees). Further, the estimates of our costs will
vary with the length of time necessary to complete the Plan of Dissolution.
These estimates will be periodically reviewed and adjusted as appropriate. There
can be no assurance that these estimated values will be realized. The valuation
of assets at their net realizable value and liabilities at their anticipated
settlement amount represent estimates, based on present facts and circumstances,
of the net realizable value of the assets and the costs associated with carrying
out the Plan of Dissolution. The actual values and costs associated with
carrying out the Plan of Dissolution may differ from amounts reflected in the
accompanying financial statements because of the plan’s inherent
uncertainty. These differences may be material. In particular, the
net asset value attributed to the Company’s EDC subsidiary in the accompanying
Statement of Net Assets in Liquidation is subject to numerous uncertainties and
the ultimate value of EDC to its shareholders in liquidation may be
substantially different from that as presented herein. Further, the estimates of
our costs will vary with the length of time necessary to complete the Plan of
Dissolution. Accordingly, it is not possible to predict with certainty the
timing or aggregate amount which will ultimately be distributed to stockholders
and no assurance can be given that the distributions will equal or exceed the
estimate presented in the accompanying Statement of Net Assets in
Liquidation.
ITEM
4. CONTROLS AND PROCEDURES
As of the
end of the period covered by this report, we carried out an evaluation, under
the supervision and with the participation of our management, including our
Chief Executive Officer and Chief Accounting Officer, of the effectiveness of
the design and operation of our “disclosure controls and procedures” (as defined
in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange
Act”)) pursuant to Rule 13a-15 of the Exchange Act. It should be noted that
any system of controls, however well designed and operated, can provide only
reasonable, and not absolute, assurance that the objectives of the system are
met. Based on that evaluation, our management, including our Chief Executive
Officer, concluded that our disclosure controls and procedures were effective as
of March 31, 2010.
During
the quarter ended March 31, 2010, there were no changes in our internal control
over financial reporting that have materially affected, or are reasonably likely
to materially affect, our internal control over financial
reporting.
PART
II – OTHER INFORMATION
ITEM
1. LEGAL PROCEEDINGS
See Note
13 in Part I, Item 1, which discusses material pending legal
proceedings to which the Company or its subsidiaries is party and is
incorporated herein by reference.
ITEM 6. EXHIBITS
The
exhibits required to be filed as a part of this quarterly report on Form 10-Q
are listed in the accompanying Exhibit Index which is hereby incorporated
by reference
.
