Risks and Uncertainties Identified by the Board (April 25, 2012)
EB has identified a number of business, market and finance related risk factors and uncertainties that can affect the level of sales and profits.
Market Risks
On the ongoing financial period the global economic uncertainty may affect the demand for EB's services, solutions and products and provide pressure on e.g. pricing. On a short term it may affect, in particular, the utilization and chargeability levels and average hourly prices of R&D services.
As EB's customer base consists mainly of companies operating in the fields of automotive and telecommunications and defense and public safety authorities, the company is exposed to market changes in these industries. EB believes that expanding the customer base will reduce dependence on individual companies and that the company will thereby be mainly affected by the general business climate in automotive and telecommunication industries. The more specific market outlook is presented in the Interim Report published on April 26, 2012 under the "Business Segments' development during the first quarter 2012 and market outlook" section.
Business related risks
EB's operative business risks are mainly related to following items: uncertainties and short visibility on customers' product program decisions, their make or buy decisions and on the other hand, their decisions to continue, downsize or terminate current product programs, execution and management of large customer projects, ramping up and down project resources, availability of personnel in labour markets (in particular in Germany and Finland), timing and on the other hand successful utilization of the most important technologies and components, competitive situation and potential delays in the markets, timely closing of customer and supplier contracts with reasonable commercial terms, delays in R&D projects, realization of expected return on capitalized R&D investments, obsolescence of inventories and technology risks in product development causing higher than planned R&D costs. Revenues expected to come from either existing or new products and customers include normal timing risks. EB has certain significant customer projects and deviation in their expected continuation could result also significant deviations in the Company's outlook. In addition there are typical industry warranty and liability risks involved in selling EB's services, solutions and products.
Product delivery business model includes such risks as high dependency on actual product volumes and development of the cost of materials. The above-mentioned risks may manifest themselves as lower amounts product delivery or higher cost of production, and ultimately, as lower profit.
Some of EB's businesses operate in the industries that are heavily patented and therefore include risks related to management of intellectual property rights, on the one hand related to accessibility on commercially acceptable terms of certain technologies in the EB's products and services, and on the other hand related to an ability to protect technologies, which EB develops or licenses from others, from claims that third parties' intellectual property rights are infringed. Also parties outside of the industries operate actively in order to protect and commercialize their patents and therefore in their part increase the risks related to the management of intellectual property rights. At worst, claims that third parties' intellectual property rights are infringed, could lead to substantial liabilities for damages. Also EB has been formally requested by one of its customer for indemnification that is unspecified both in terms of the grounds and the amount. While the analysis of the situation is pending, based on preliminary information available it does not seem likely that the claim would result to a significant liability on a short term. It is possible that based on later information, the above views may need to be reconsidered.
Financing Risks
Global economic uncertainty may lead to payment delays and increase the risk for credit losses and on the other hand weaken the availability and terms of financing. To fund its operations, EB relies mainly on income from its operative business and may from time to time seek additional financing from selected financial institutions. EB has a binding overdraft credit facility agreement of EUR 10 million, valid until June 30, 2012. Based on EB's current understanding extension of the credit facility agreement is likely. However, in case EB would not be able to extend the credit facility agreement, it would need to secure its liquidity temporarily by other means.
Some parts of EB's business are more sensitive to customer dependency than others. Respectively, this may translate as accumulation of risk with respect to outstanding receivables and ultimately with respect to credit losses. On April 25, 2012, EB has significant receivables from TerreStar amounting to approximately USD 25.8 million (EUR 19.6 million as per exchange rate of April 25, 2012), which it has claimed in the Chapter 11 cases of both TerreStar Networks and TerreStar Corporation. In addition to the booked receivables, EB has also claimed additional costs in the amount of approximately USD 2.1 million (EUR 1.6 million as per exchange rate of April 25, 2012) and resulting mainly from the ramp down of the business operations between the parties. Thus, EB has asserted claims against each of the TerreStar entities in amounts totaling USD 27.9 million (EUR 21.2 million as per exchange rate of April 25, 2012). Due to uncertainties related to the accounts receivable, EB booked an impairment of the accounts receivable in the amount of EUR 8.3 million during the second half of 2010.
On October 19, 2010, TerreStar Networks and certain other affiliates of TerreStar Corporation and on February 16, 2011, the parent company TerreStar Corporation filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code to strengthen their financial position. Generally in a Chapter 11 case, any distribution of cash or other assets by a debtor to satisfy pre-bankruptcy claims of its creditors must be made under a Chapter 11 plan of reorganization or liquidation. Such plans must be approved by the United States Bankruptcy Court and (with limited exceptions) an affirmative vote of all classes of creditors whose claims will not be paid fully and immediately after the plan is approved by the court and becomes effective by its terms. Recoveries by holders of claims against TerreStar Networks and TerreStar Corporation are to be funded by separate pools or streams of assets.
Within the first four months of its Chapter 11 case, TerreStar Networks filed, then withdrew, a proposed plan of reorganization. Subsequently, on July 7, 2011, the United States Bankruptcy Court approved the sale of substantially all TerreStar Networks' assets to Gamma Acquisition L.L.C., an acquisition subsidiary formed by Dish Network Corporation for about USD 1.375 billion. Based upon filings made by TerreStar Networks with the Bankruptcy Court, USD 1.345 billion of the purchase price has been funded to date, with the remainder of the purchase price payable at closing, and payments have been made to secured creditors from the sale proceeds in the amount of about USD 1.128 billion. However, the sale will not result in an immediate distribution to general unsecured creditors. Any such distribution must be provided for under a Chapter 11 plan of liquidation that has been filed, voted on and submitted to the court for approval. On December 6, 2011, TerreStar Networks again filed, and thereafter amended, a Chapter 11 plan. In its hearing on February 14, 2012 the Bankruptcy Court approved the TerreStar Networks' second amended plan, which will provide each holder of an unsecured claim (such as EB) with a pro rata share of cash available for distribution. Based upon information contained in the debtors' disclosure statement accompanying the plan, the reorganized debtors' first post-confirmation status report, or otherwise available to EB, EB estimates that its pro rata distribution may be in the range of 8-10% of the face amount of its claim. However, this estimate is subject to various assumptions, and therefore the amount and timing of EB's distribution cannot be predicted with certainty at this time. On March 29, 2012 EB received the USD 650,890 distribution on the priority portion of its claim from TerreStar Networks.
On July 22, 2011, TerreStar Corporation filed a plan of reorganization, which was thereafter amended on December 27, 2011 and further amended on January 12, 2012. The second amended plan proposes that unsecured claims (such as EB's), if allowed by the Bankruptcy Court, will be exchanged for new notes to be issued by a reorganized TerreStar Corporation in the face amount of the claim. The notes are to be issued as unsecured notes in a total aggregate principal amount not to exceed USD 35 million, with a seven-year maturity, bearing interest at the rate of 6% per annum. Payment of the note obligations is to be funded by future revenues and profits of reorganized TerreStar Corporation. It is premature to speculate regarding distributions to creditors under this plan because the plan TerreStar Corporation filed may or may not obtain the necessary approvals, and the terms of the plan may change through negotiation with creditors. EB filed a preliminary objection to an earlier version of the plan, asserting that it failed to satisfy applicable provisions of the Bankruptcy Code and therefore could not be confirmed. EB has voted against the second amended plan of TerreStar Corporation and intends to file a further objection to the proposed plan and vigorously contest confirmation of the plan at a hearing to be held by the Bankruptcy Court in May, 2012 (on a date to be announced).
As part of the process of reconciling accounts in preparation for making distributions under a plan, Chapter 11 debtors often challenge the amount or validity of some creditor claims. On November 16, 2011, after EB filed its preliminary objection to the proposed Chapter 11 plan of TerreStar Corporation, two objections to EB's claim were filed, one by TerreStar Corporation and its affiliated debtors (not including TerreStar Networks) and a joint objection by a group of holders of TerreStar Corporation preferred stock that support the proposed plan. The preferred stockholders alleged, among other things, that EB's guaranty claim in the amount of approximately USD 24.8 million (at least) should be disallowed pursuant to various legal theories. TerreStar Corporation joined in the preferred stockholders' argument that TerreStar Corporation has no liability to EB under its guaranty. On December 12, 2011, EB filed a sworn opposition to both objections, stating that the objections are flawed as a matter of law and wholly without evidentiary support, and maintaining its right to payment in the full amount claimed. It is anticipated that the Bankruptcy Court will schedule a trial on the merits of EB's claim and the objections on a date to be announced, within 4-6 weeks following the hearing on confirmation of the proposed Chapter 11 plan of TerreStar Corporation. EB intends to vigorously defend such objections to its claims, but speculation regarding the likely outcome of these contested matters is premature at this time. To date neither TerreStar Networks nor the liquidating trustee of The TerreStar Networks, Inc. Liquidating Trust (the trust having been formed in connection with confirmation of the Chapter 11 plan of TerreStar Networks) has asserted an objection to the amount or validity of EB's claims in its bankruptcy proceeding, and EB is not aware that any such objection is contemplated.
Further, as part of the Chapter 11 process, debtors often seek to recover payments previously made to creditors pursuant to various provisions of the Bankruptcy Code. The risk that the TerreStar debtors may attempt to recover payments from EB, or that such recovery actions, if attempted, may be successful, likewise cannot be ruled out at this time.
Based on EB's current understanding, there is no reason to believe that there would be further impairment losses on EB's account receivable from TerreStar Networks and TerreStar Corporation. EB aims to collect the amounts owed to it in full through the Chapter 11 cases of TerreStar Networks and TerreStar Corporation, and/or for example through selling of the earlier mentioned accounts receivable. It is possible that based on later information related to the TerreStar Networks' and TerreStar Corporation's Chapter 11 cases, the above views may need to be reconsidered. Despite the TerreStar companies' efforts to reorganize, it is possible that the credit risk may still grow during 2012. Should the accounts receivable not be collected at all, either from TerreStar Networks or TerreStar Corporation, an impairment loss and costs related to the collection process would additionally lower EB's operating result on a non-recurring basis by approximately EUR 10 million, at maximum (USD-nominated items as per exchange rate of April 25, 2012). However, this would not have any significant negative effect on the EB's cash flow.