1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X Quarterly report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended September 30, 2003
or
Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from to
Commission File Number 1-87
EASTMAN KODAK COMPANY
(Exact name of registrant as specified in its charter)
NEW JERSEY 16-0417150
(State of incorporation) (IRS Employer
Identification No.)
343 STATE STREET, ROCHESTER, NEW YORK 14650
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 585-724-4000
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, and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act).
Yes X No
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Number of Shares Outstanding at
Class September 30, 2003
Common Stock, $2.50 par value 286,573,885
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Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Eastman Kodak Company and Subsidiary Companies
CONSOLIDATED STATEMENT OF EARNINGS
(in millions, except per share data)
Three Months Ended Nine Months Ended
September 30 September 30
------------------ ----------------
2003 2002 2003 2002
Net sales $3,447 $3,352 $9,539 $9,394
Cost of goods sold 2,320 2,062 6,472 5,990
------ ------ ------ ------
Gross profit 1,127 1,290 3,067 3,404
Selling, general and
administrative expenses 639 631 1,921 1,827
Research and development costs 194 188 567 567
Restructuring costs (credits)
and other 152 (9) 228 (9)
------ ------ ------ ------
Earnings from continuing
operations before interest,
other charges, and income
taxes 142 480 351 1,019
Interest expense 33 40 104 128
Other charges 9 21 39 74
------ ------ ------ ------
Earnings from continuing
operations before income taxes 100 419 208 817
(Benefit) provision for income
taxes (22) 83 (23) 154
------ ------ ------ ------
Earnings from continuing
operations 122 336 231 663
Earnings (loss) from discontinued
operations, net of income tax
benefits for the three and nine
months ended Sept. 30, 2002 of $2
and $4, respectively - (2) 15 (6)
------ ------ ------ ------
NET EARNINGS $ 122 $ 334 $ 246 $ 657
====== ====== ====== ======
Basic and diluted net earnings
(loss) per share:
Continuing operations $ .42 $ 1.16 $ .81 $ 2.27
Discontinued operations .00 (.01) .05 (.02)
------ ------ ------ ------
Total $ .42 $ 1.15 $ .86 $ 2.25
====== ====== ====== ======
Number of common shares used in
basic earnings (loss) per share 286.5 291.8 286.5 291.6
Incremental shares from
assumed conversion of options .1 - .1 -
------ ------ ------ ------
Number of common shares used in
diluted earnings (loss) per share 286.6 291.8 286.6 291.6
====== ====== ====== ======
Cash dividends per share $ .25 $ - $ 1.15 $ .90
====== ====== ====== ======
3
Eastman Kodak Company and Subsidiary Companies
CONSOLIDATED STATEMENT OF EARNINGS (Continued)
(in millions)
Three Months Ended Nine Months Ended
September 30 September 30
------------------ ----------------
2003 2002 2003 2002
CONSOLIDATED STATEMENT OF
RETAINED EARNINGS
Retained earnings at beginning
of period $7,462 $7,467 $7,611 $7,431
Net earnings 122 334 246 657
Cash dividends declared (72) - (330) (262)
Loss from issuance of treasury
stock (3) - (18) (25)
------ ------ ------ ------
Retained earnings
at end of quarter $7,509 $7,801 $7,509 $7,801
====== ====== ====== ======
- -----------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated
financial statements.
4
Eastman Kodak Company and Subsidiary Companies
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
(in millions)
Sept. 30, Dec. 31,
2003 2002
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 983 $ 569
Receivables, net 2,340 2,234
Inventories, net 1,202 1,062
Deferred income taxes 524 512
Other current assets 184 157
------- -------
Total current assets 5,233 4,534
------- -------
Property, plant and equipment, net 5,157 5,420
Goodwill, net 1,021 981
Other long-term assets 2,626 2,559
------- -------
TOTAL ASSETS $14,037 $13,494
======= =======
- -----------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and other current
liabilities $ 3,531 $ 3,351
Short-term borrowings 1,410 1,442
Accrued income taxes 619 709
------- -------
Total current liabilities 5,560 5,502
OTHER LIABILITIES
Long-term debt, net of current portion 1,480 1,164
Postretirement liabilities 3,436 3,412
Other long-term liabilities 637 639
------- -------
Total liabilities 11,113 10,717
SHAREHOLDERS' EQUITY
Common stock at par 978 978
Additional paid in capital 849 849
Retained earnings 7,509 7,611
Accumulated other comprehensive loss (552) (771)
Unearned restricted stock (8) -
------- -------
8,776 8,667
Less: Treasury stock at cost 5,852 5,890
------- -------
Total shareholders' equity 2,924 2,777
------- -------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $14,037 $13,494
======= =======
- -----------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated
financial statements.
5
Eastman Kodak Company and Subsidiary Companies
CONSOLIDATED STATEMENT OF CASH FLOWS
(in millions)
Nine Months Ended
September 30
------------------
2003 2002
Cash flows relating to operating activities:
Net earnings $ 246 $ 657
Adjustments to reconcile to net cash
provided by operating activities:
(Gain) loss from discontinued operations (15) 6
Equity in losses from unconsolidated affiliates 43 73
Gain on sale of assets (12) (17)
Depreciation and amortization 620 601
Restructuring costs, asset impairments and
other non-cash charges 41 (9)
(Benefit) provision for deferred taxes (4) 35
(Increase) decrease in receivables (68) 126
Increase in inventories (65) (56)
Decrease in liabilities excluding borrowings (55) (35)
Other items, net 93 (72)
------ ------
Total adjustments 578 652
------ ------
Net cash provided by continuing
operations 824 1,309
------ ------
Net cash provided by (used in)
discontinued operations 19 (9)
------ ------
Net cash provided by operating activities 843 1,300
------ ------
Cash flows relating to investing activities:
Additions to properties (353) (362)
Net proceeds from sales of businesses/assets 21 18
Acquisitions, net of cash acquired (88) (6)
Investments in unconsolidated affiliates (54) (96)
Marketable securities - purchases (62) (78)
Marketable securities - sales 62 61
------ ------
Net cash used in investing activities (474) (463)
------ ------
Cash flows relating to financing activities:
Net increase (decrease) in borrowings
with original maturity of 90 days or less 52 (69)
Proceeds from other borrowings 865 625
Repayment of other borrowings (641) (1,015)
Dividend payments (258) (262)
Exercise of employee stock options 12 2
------ ------
Net cash provided by (used in) financing
activities 30 (719)
------ ------
Effect of exchange rate changes on cash 15 (5)
------ ------
Net increase in cash and cash equivalents 414 113
Cash and cash equivalents, beginning of year 569 448
------ ------
Cash and cash equivalents, end of quarter $ 983 $ 561
====== ======
- -----------------------------------------------------------------
The accompanying notes are an integral part of these consolidated
financial statements.
6
Eastman Kodak Company and Subsidiary Companies
NOTES TO FINANCIAL STATEMENTS
NOTE 1: BASIS OF PRESENTATION
The consolidated interim financial statements are unaudited, and
certain information and footnote disclosure related thereto normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
omitted in accordance with Rule 10-01 of Regulation S-X. In the
opinion of management, the accompanying unaudited consolidated
financial statements were prepared following the same policies and
procedures used in the preparation of the audited financial statements
and reflect all adjustments (consisting of normal recurring
adjustments) necessary to present fairly the financial position of
Eastman Kodak Company and its subsidiaries (the Company). The results
of operations for the interim periods are not necessarily indicative of
the results for the entire fiscal year. These consolidated financial
statements should be read in conjunction with the Company's Annual
Report on Form 10-K for the year ended December 31, 2002.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 143 "Accounting
for Asset Retirement Obligations." SFAS No. 143 addresses the
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset
retirement costs. SFAS No. 143 applies to legal obligations associated
with the retirement of long-lived assets that result from the
acquisition, construction, development and/or normal use of the assets.
SFAS No. 143 requires that the fair value of a liability for an asset
retirement obligation be recognized in the period in which it is
incurred if a reasonable estimate of fair value can be made. The fair
value of the liability is added to the carrying amount of the
associated asset, and this additional carrying amount is expensed over
the life of the asset. The Company adopted SFAS No. 143 effective
January 1, 2003. The adoption of SFAS No. 143 did not have a material
impact on the Company's financial position, results of operations or
cash flows.
7
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 addresses
the financial accounting and reporting for costs associated with exit
or disposal activities and supercedes Emerging Issues Task Force (EITF)
Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs
Incurred in a Restructuring)." SFAS No. 146 requires recognition of
the liability for costs associated with an exit or disposal activity
when the liability is incurred. Under EITF No. 94-3, a liability for
an exit cost was recognized at the date of the Company's commitment to
an exit plan. SFAS No. 146 also establishes that the liability should
initially be measured and recorded at fair value. Accordingly, SFAS
No. 146 impacts the timing of recognition and the initial measurement
of the amount of liabilities the Company recognizes in connection with
exit or disposal activities initiated after December 31, 2002. The
Company adopted SFAS No. 146 effective January 1, 2003. The Company
primarily accounts for employee termination actions under SFAS No. 112,
which requires recording when such charges are probable and estimable.
As such, the adoption of SFAS No. 146 did not have a material impact
for the three and nine months ended September 30, 2003, as there were
no significant one-time severance actions or other exit costs that were
subject to SFAS No. 146.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others." FIN 45
requires that a liability be recorded in the guarantor's balance sheet
upon issuance of a guarantee. In addition, FIN 45 requires disclosures
about the guarantees, including indemnifications, that an entity has
issued and a rollforward of the entity's product warranty liabilities.
The disclosure provisions of FIN 45 were effective for financial
statements of interim periods or annual periods ending after December
15, 2002. In addition, the Company adopted the recognition provisions
of FIN 45 effective January 1, 2003 for guarantees issued or modified
after December 31, 2002. The adoption of FIN 45 did not have a
material impact on the Company's financial position, results of
operations or cash flows. See Note 8, "Guarantees."
In November 2002, the EITF reached a consensus on EITF Issue No. 00-21,
"Accounting for Revenue Arrangements with Multiple Deliverables." EITF
No. 00-21 provides guidance on how to determine when an arrangement
that involves multiple revenue-generating activities or deliverables
should be divided into separate units of accounting for revenue
recognition purposes, and if this division is required, how the
arrangement consideration should be allocated among the separate units
of accounting. The guidance in the consensus is effective for revenue
arrangements entered into in fiscal periods beginning after June 15,
2003. The adoption of EITF No. 00-21 did not have a material impact on
the Company's financial position, results of operations or cash flows.
8
The EITF has reached a consensus on EITF Issue No. 03-05,
"Applicability of AICPA Statement of Position 97-2 to Non-Software
Deliverables in an Arrangement Containing More-Than-Incidental
Software," which indicates that, for an arrangement that includes
software that is more than incidental to the products or services as a
whole, the software and software-related elements within that
arrangement are included within the scope of SOP 97-2. The guidance in
the consensus is effective for the Company for revenue arrangements
entered into after September 30, 2003. The Company is currently
evaluating the effect that the adoption of EITF 03-05 will have on the
Company's financial position, results of operations and cash flows.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities," which clarifies the
application of Accounting Research Bulletin (ARB) No. 51, "Consolidated
Financial Statements," relating to consolidation of certain entities.
First, FIN 46 will require identification of the Company's
participation in variable interest entities (VIEs), which are defined
as entities with a level of invested equity that is not sufficient to
fund future activities to permit them to operate on a stand alone
basis, or whose equity holders lack certain characteristics of a
controlling financial interest. Then, for entities identified as VIEs,
FIN 46 sets forth a model to evaluate potential consolidation based on
an assessment of which party to the VIE, if any, bears a majority of
the exposure to its expected losses, or stands to gain from a majority
of its expected returns. FIN 46 is effective for all new VIEs created
or acquired after January 31, 2003. Originally for VIEs created or
acquired prior to February 1, 2003, the provisions of FIN 46 were to be
applied for the first interim or annual period beginning after June 15,
2003. However, on October 8, 2003, the FASB deferred the latest date
by which all public entities must apply FIN 46 to the first reporting
period ending after December 15, 2003. FIN 46 also sets forth certain
disclosures regarding interests in VIEs that are deemed significant,
even if consolidation is not required. See Note 6, "Variable Interest
Entities" for these disclosures. The Company is currently evaluating
the effect that the adoption of FIN 46 will have on its financial
position, results of operations and cash flows.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities." SFAS No. 149
amends and clarifies the accounting for derivative instruments,
including certain derivative instruments embedded in other contracts,
and for hedging activities under SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 149 is
generally effective for contracts entered into or modified after June
30, 2003 and for hedging relationships designated after June 30, 2003.
The adoption of SFAS No. 149 did not have a material impact on the
Company's financial position, results of operations or cash flows.
9
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity." SFAS No. 150 requires that certain financial instruments,
which under previous guidance were accounted for as equity, must now be
accounted for as liabilities. The financial instruments affected
include mandatorily redeemable stock, certain financial instruments
that require or may require the issuer to buy back some of its shares
in exchange for cash or other assets and certain obligations that can
be settled with shares of stock. SFAS No. 150 is effective for all
financial instruments entered into or modified after May 31, 2003 and
must be applied to the Company's existing financial instruments
effective July 1, 2003, the beginning of the first fiscal period after
June 15, 2003. The Company adopted SFAS No. 150 on June 1, 2003. The
adoption of this statement did not have a material effect on the
Company's financial position, results of operations or cash flows.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior period to conform
to the 2003 presentation.
- -----------------------------------------------------------------------
NOTE 2: RECEIVABLES, NET
(in millions) September 30, December 31,
2003 2002
Trade receivables $2,011 $1,896
Miscellaneous receivables 329 338
------ ------
Total (net of allowances of $107 and $137) $2,340 $2,234
====== ======
Of the total trade receivable amounts of $2,011 million and $1,896
million as of September 30, 2003 and December 31, 2002, respectively,
approximately $488 million and $371 million are expected to be settled
through customer deductions in lieu of cash payment. However, because
the legal right of set-off does not exist for such deductions, which
represent rebates owed to the customer, these amounts are included in
accounts payable and other current liabilities in the accompanying
Consolidated Statement of Financial Position at each respective balance
sheet date.
- ----------------------------------------------------------------------
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NOTE 3: INVENTORIES, NET
(in millions) September 30, December 31,
2003 2002
Finished goods $ 929 $ 831
Work in process 314 322
Raw materials 320 301
------ ------
1,563 1,454
LIFO reserve (361) (392)
------ ------
Total $1,202 $1,062
====== ======
During the three and nine months ended September 30, 2003, inventory
usage resulted in liquidation of LIFO inventory quantities. In the
aggregate, these inventories were carried at the lower costs prevailing
in prior years as compared with the cost of current purchases. The
effect of these LIFO liquidations was to reduce cost of goods sold by
$12 million and $24 million in the three and nine months ended
September 30, 2003, respectively.
- ----------------------------------------------------------------------
NOTE 4: SHORT-TERM BORROWINGS AND LONG-TERM DEBT
SHORT-TERM BORROWINGS
Revolving Credit Facilities
On July 11, 2003, the Company completed the annual renewal of its $1,000
million, 364-day revolving credit facility. The terms and covenants are
unchanged from the prior 364-day revolving credit facility. Including
the Company's $1,225 million 5-year facility, which expires in July 2006,
the Company's total available committed revolving credit facilities
remain at $2,225 million. The Company issues letters of credit under the
5-year facility. As of September 30, 2003, there were $96 million of
letters of credit outstanding under the 5-year facility. The remainder
of the 5-year facility and the 364-day revolving credit facility was
unused at September 30, 2003.
11
LONG-TERM DEBT
In May 2003, the Company issued Series A fixed rate notes and Series A
floating rate notes under its then existing debt shelf registration
totaling $250 million and $300 million, respectively, as follows:
(in millions)
Annual
Interest
Type Principal Rate Maturity
- -------- --------- -------- -----------
Series A
fixed rate $250 3.625% May 2008
3-month
Series A LIBOR plus
floating rate 200 0.55% November 2004
3-month
Series A LIBOR plus
floating rate 100 0.55% November 2005
----
Total $550
====
Interest on the notes will be paid quarterly, and the Company may not
redeem or repay these notes prior to their stated maturities. After
these issuances, the Company had $650 million of remaining unsold
debt securities under its then existing debt shelf registration.
On September 5, 2003, the Company filed a shelf registration statement
on Form S-3 (the "new debt shelf registration") that effectively
registered $2,000 million of new debt securities. The new debt shelf
registration became effective on September 19, 2003. Pursuant to Rule
429 under the Securities Act of 1933, the $650 million of remaining
unsold debt securities, as described above, were included in the new
debt shelf registration, giving the Company the ability to issue up
to $2,650 million in public debt.
On October 10, 2003, the Company completed the offering and sale of
$500 million aggregate principal amount of Senior Notes due 2013 (the
"Notes"), which was made pursuant to the Company's new debt shelf
registration. Interest on the Notes will accrue at the rate of 7.25%
per annum and is payable semiannually. The Notes are not redeemable at
the Company's option or repayable at the option of any holder prior to
maturity. The Notes are unsecured and unsubordinated obligations and
rank equally with all of the Company's other unsecured and
unsubordinated indebtedness. After issuance of the above debt, the
Company has $2,150 million of availability remaining under the new debt
shelf registration.
12
Concurrent with the offering and sale of the Senior Notes, on October
10, 2003, the Company completed the private placement of $575 million
aggregate principal amount of Convertible Senior Notes due 2033 (the
"Securities") to qualified institutional buyers pursuant to Rule 144A
under the Securities Act of 1933. Interest on the Securities will
accrue at the rate of 3.375% per annum and is payable semiannually.
The Securities are unsecured and rank equally with all of the Company's
other unsecured and unsubordinated indebtedness.
The Securities contain a number of conversion features that include
substantive contingencies. The Securities are convertible by the
holders at an initial conversion rate of 32.2373 shares of the
Company's common stock for each $1,000 principal amount of the
Securities, which is equal to an initial conversion price of $31.02 per
share. The holders may convert their Securities, in whole or in part,
into shares of the Company's common stock under any of the following
circumstances: (1) during any calendar quarter, if the price of the
Company's common stock is greater than or equal to 120% of the
applicable conversion price for at least 20 trading days during a 30
consecutive trading day period; (2) during any five consecutive trading
day period following any 10 consecutive trading day period in which the
trading price of the Securities for each day of such period is less
than 105% of the conversion value, and the conversion value for each
day of such period was less than 95% of the principal amount of the
Securities (the "Parity Clause"); (3) if the Company has called the
Securities for redemption; (4) upon the occurrence of specified
corporate transactions such as a consolidation, merger or binding share
exchange pursuant to which the Company's common stock would be
converted into cash, property or securities; and (5) if the credit
rating assigned to the Securities by either Moody's or S&P is lower
than Ba2 or BB, respectively, which represents a three notch downgrade
from the Company's current standing, or if the Securities are no longer
rated by at least one of these services or their successors (the
"Credit Rating Clause").
The Company may redeem some or all of the Securities at any time on or
after October 15, 2010 at a purchase price equal to 100% of the
principal amount of the Securities plus any accrued and unpaid
interest. Upon a call for redemption by the Company, a conversion
trigger is met whereby the holder of each $1,000 Convertible Senior
Note may convert such note to shares of the Company's common stock.
The holders have the right to require the Company to purchase their
Securities for cash at a purchase price equal to 100% of the principal
amount of the Securities plus any accrued and unpaid interest on
October 15, 2010, October 15, 2013, October 15, 2018, October 15, 2023
and October 15, 2028 or upon a fundamental change as described in the
offering memorandum filed under Rule 144A in conjunction with the
private placement of the Securities.
13
The Company agrees to initially file within 90 days and make effective
within 180 days after the earliest date of original issuance of the
Securities, a shelf registration statement under the Securities Act of
1933 relating to the resale of the Securities and the common stock to
be issued upon conversion of the Securities pursuant to a registration
rights agreement. If the Company fails to comply with some of its
obligations under the registration rights agreement, until such
failures are cured, the Company would be required to pay the holders of
the Securities and the holders of the common stock issued upon
conversion an amount equal to .25% to .50%, depending on the length of
time taken to cure the failure (not to exceed .50% per annum), of the
aggregate principal amount of the Securities or the conversion price of
the stock per annum. The Company will hold in treasury stock a
sufficient number of shares to cover potential future conversions of
these Securities into common stock.
The Securities contain four embedded derivatives as defined under SFAS
No. 133, "Accounting for Derivative Instruments and Hedging
Activities". These four embedded derivatives include the Parity
Clause, any specified corporate transaction outside of the Company's
control such as a hostile takeover, the Credit Rating Clause, and the
provision that requires the Company to pay additional amounts if it
fails to comply with some of its obligations under the registration
rights agreement. A preliminary valuation indicated that these
embedded derivatives would not materially impact the Company's
financial position, results of operations or cash flows. A formal
external valuation is currently being performed to confirm the
preliminary assessment, and should be completed during the fourth
quarter of 2003. In addition, as the contingencies surrounding the
conversion features are substantive, the shares to be potentially
issued upon triggering a conversion event will be excluded from the
earnings per share calculation until such time as a contingency lapses
and the effect of issuing such shares is dilutive.
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14
NOTE 5: INCOME TAXES
The Company's annual effective tax rate was estimated to be 19% and 29%
for both the three and nine months ended September 30, 2003 and 2002,
respectively. The Company's estimated annual effective tax rate
decreased from 24% in the six month period ended June 30, 2003 to 19%
in the nine month period ended September 30, 2003. This decrease in
the estimated annual effective tax rate from 24% to 19% was primarily
attributable to an expected increase in benefits from the utilization
of foreign tax credits.
The Company recorded a tax benefit of $63 million during the three
months ended September 30, 2003 related to charges for focused cost
reductions of $185 million and a cash donation of $8 million.
During the nine months ended September 30, 2003, in addition to the
items described above, the Company recorded a tax benefit of $68
million, which was recorded in the six month period ended June 30,
2003, related to the following: focused cost reduction charges of $100
million; a $21 million charge for purchased in-process research and
development costs; a $14 million charge for the settlement of a patent
infringement claim; a $14 million charge for the settlement of certain
issues relating to a prior year acquisition; a $12 million charge
related to an intellectual property settlement; and a $9 million charge
relating to the impairment of the Burrell Companies' net assets held
for sale. In addition, the discrete period items also include a tax
benefit of $8 million relating to the donation of intellectual
property recorded in the first quarter of 2003.
The Company recorded a tax benefit of $46 million during the three
months ended September 30, 2002 relating to the consolidation of its
photofinishing operations in Japan and the loss realized from the
liquidation of a subsidiary as part of this consolidation. The Company
expects this loss to be utilized during the next five years to reduce
taxable income from operations in Japan.
15
During the nine months ended September 30, 2002, in addition to the
item described above, the Company recorded a tax benefit of $45
million relating to the closure of its PictureVision subsidiary. The
decision to close the subsidiary was preceded by unsuccessful attempts
to sell the subsidiary. As a result of these activities, the Company
made the formal decision in the second quarter of 2002 to close the
subsidiary, as a determination was made that the business was worthless
for tax purposes. Accordingly, the Company recorded a $45 million tax
benefit in the nine months ended September 30, 2002 based on the
Company's remaining tax basis in the PictureVision stock.
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NOTE 6: VARIABLE INTEREST ENTITIES
As a result of its continuing evaluation of the effect that the
adoption of FIN 46 will have on the Company's financial position,
results of operations and cash flows, the Company believes that it is
reasonably possible that its equity investments in Express Stop
Financing (ESF), NexPress and SK Display, relating to which Kodak's
interests therein were all created or obtained prior to February 1,
2003, will qualify as variable interest entities. ESF is an operating
entity formed to provide a long-term financing solution to Qualex's
photofinishing customers in connection with Qualex's leasing of
photofinishing equipment to third parties, as opposed to Qualex
extending long-term credit (see Note 7 under "Other Commitments and
Contingencies"). NexPress and SK Display are each operating entities
that were formed to develop, manufacture and commercialize specific
imaging products and equipment for sale to customers. Total assets for
ESF, NexPress and SK Display as of September 30, 2003 were
approximately $443 million, $143 million and $11 million, respectively.
The Company's estimated maximum exposure to loss as a result of its
continuing involvement with ESF, NexPress and SK Display are $63
million, $115 million and $104 million, respectively. The maximum
exposure to loss represents the sum of the carrying value of the
Company's investment balances as of September 30, 2003, the estimated
amounts that Kodak intends to or is committed to fund in the future for
each of these potential variable interest entities and the maximum
amount of debt guarantees under which the Company could potentially be
required to perform.
The Company has not created or obtained an interest in any variable
interest entities after January 31, 2003.
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NOTE 7: COMMITMENTS AND CONTINGENCIES
Environmental
At September 30, 2003, the Company's undiscounted accrued liabilities
for environmental remediation costs amounted to $140 million and are
reported in other long-term liabilities in the accompanying
Consolidated Statement of Financial Position.
16
The Company is currently implementing a Corrective Action Program
required by the Resource Conservation and Recovery Act (RCRA) at the
Kodak Park site in Rochester, NY. As part of this program, the Company
has completed the RCRA Facility Assessment (RFA), a broad-based
environmental investigation of the site. The Company is currently in
the process of completing, and in some cases has completed, RCRA
Facility Investigations (RFI) and Corrective Measures Studies (CMS) for
areas at the site. At September 30, 2003, estimated future
investigation and remediation costs of $65 million are accrued on an
undiscounted basis by the Company and are included in the $140 million
reported in other long-term liabilities.
The Company has retained certain obligations for environmental
remediation and Superfund matters related to certain sites associated
with the non-imaging health businesses sold in 1994. At September 30,
2003, estimated future remediation costs of $47 million are accrued on
an undiscounted basis and are included in the $140 million reported in
other long-term liabilities.
The Company has obligations relating to two former manufacturing sites
located outside the United States. At September 30, 2003, estimated
future investigation, remediation and monitoring costs of $21 million
are accrued on an undiscounted basis and are included in the $140
million reported in other long-term liabilities.
Additionally, the Company has approximately $7 million accrued on an
undiscounted basis in the $140 million reported in other long-term
liabilities at September 30, 2003 for remediation relating to other
facilities, which are not material to the Company's financial position,
results of operations, cash flows or competitive position.
Cash expenditures for many of the aforementioned investigation,
remediation and monitoring activities are expected to be incurred over
the next thirty years for each site. For these known environmental
exposures, the accrual reflects the Company's best estimate of the
amount it will incur under the agreed-upon or proposed work plans. The
Company's cost estimates were determined using the ASTM Standard E 2137-
01 "Standard Guide for Estimating Monetary Costs and Liabilities for
Environmental Matters," and have not been reduced by possible
recoveries from third parties. The overall method includes the use of
a probabilistic model which forecasts a range of cost estimates for the
remediation required at individual sites. The projects are closely
monitored and the models are reviewed as significant events occur or at
least once per year. The Company's estimate includes equipment and
operating costs for remediation and long-term monitoring of the sites.
The Company does not believe it is reasonably possible that the losses
for the known exposures could exceed the current accruals by material
amounts.
17
A Consent Decree was signed in 1994 in settlement of a civil complaint
brought by the U.S. Environmental Protection Agency and the U.S.
Department of Justice. In connection with the Consent Decree, the
Company is subject to a Compliance Schedule, under which the Company
has improved its waste characterization procedures, upgraded one of its
incinerators, and is evaluating and upgrading its industrial sewer
system. The total expenditures required to complete this program are
currently estimated to be approximately $23 million over the next six
years. These expenditures are incurred as part of plant operations
and, therefore, are not included in the environmental accrual at
September 30, 2003.
The Company is presently designated as a PRP under the Comprehensive
Environmental Response, Compensation, and Liability Act of 1980, as
amended (the Superfund Law), or under similar state laws, for
environmental assessment and cleanup costs as the result of the
Company's alleged arrangements for disposal of hazardous substances at
six such active sites. With respect to each of these sites, the
Company's liability is minimal. In addition, the Company has been
identified as a potentially responsible party (PRP) in connection with
the non-imaging health businesses in four active Superfund sites.
Furthermore, numerous other PRPs have also been designated at these
sites and, although the law imposes joint and several liability on
PRPs, the Company's historical experience demonstrates that these costs
are shared with other PRPs. Settlements and costs paid by the Company
in Superfund matters to date have not been material. Future costs are
also not expected to be material to the Company's financial position,
results of operations or cash flows.
The Clean Air Act Amendments were enacted in 1990. Expenditures to
comply with the Clean Air Act implementing regulations issued to date
have not been material and have been primarily capital in nature. In
addition, future expenditures for existing regulations, which are
primarily capital in nature, are not expected to be material. Many of
the regulations to be promulgated pursuant to this Act have not been
issued.
Uncertainties associated with environmental remediation contingencies
are pervasive and often result in wide ranges of outcomes. Estimates
developed in the early stages of remediation can vary significantly. A
finite estimate of cost does not normally become fixed and determinable
at a specific time. Rather, the costs associated with environmental
remediation become estimable over a continuum of events and activities
that help to frame and define a liability, and the Company continually
updates its cost estimates. The Company has an ongoing monitoring and
identification process to assess how the activities, with respect to
the known exposures, are progressing against the accrued cost
estimates, as well as to identify other potential remediation sites
that are presently unknown.
18
Estimates of the amount and timing of future costs of environmental
remediation requirements are necessarily imprecise because of the
continuing evolution of environmental laws and regulatory requirements,
the availability and application of technology, the identification of
presently unknown remediation sites and the allocation of costs among
the potentially responsible parties. Based upon information presently
available, such future costs are not expected to have a material effect
on the Company's competitive or financial position. However, such
costs could be material to results of operations in a particular future
quarter or year.
Other Commitments and Contingencies
In connection with the Company's investment in China that began in
1998, certain unaffiliated entities invested in two Kodak consolidated
companies with the opportunity to put their minority interests to Kodak
for cash at any time after the third anniversary, but prior to the
tenth anniversary, of the date on which the two companies were
established. The total exercise price in connection with the remaining
put options, which increases at a rate of 2% per annum, is
approximately $56 million at September 30, 2003. The Company expects
that the remaining two put options amounting to $56 million in total
will be exercised within the next three months.
Qualex, a wholly owned subsidiary of Kodak, has a 50% ownership
interest in Express Stop Financing (ESF), which is a joint venture
partnership between Qualex and a subsidiary of Dana Credit Corporation
(DCC), a wholly owned subsidiary of Dana Corporation. Qualex accounts
for its investment in ESF under the equity method of accounting. ESF
provides a long-term financing solution to Qualex's photofinishing
customers in connection with Qualex's leasing of photofinishing
equipment to third parties, as opposed to Qualex extending long-term
credit. As part of the operations of its photofinishing business,
Qualex sells equipment under a sales-type lease arrangement and records
a long-term receivable. These long-term receivables are subsequently
sold to ESF without recourse to Qualex. ESF incurs debt to finance the
purchase of the receivables from Qualex. This debt is collateralized
solely by the long-term receivables purchased from Qualex, and, in
part, by a $60 million guarantee from DCC. Qualex provides no
guarantee or collateral to ESF's creditors in connection with the debt,
and ESF's debt is non-recourse to Qualex. Qualex's only continued
involvement in connection with the sale of the long-term receivables is
the servicing of the related equipment under the leases. Qualex has
continued revenue streams in connection with this equipment through
future sales of photofinishing consumables, including paper and
chemicals, and maintenance.
19
Qualex has risk with respect to the ESF arrangement as it relates to
its continued ability to procure spare parts from the primary
photofinishing equipment vendor (the Vendor) to fulfill its servicing
obligations under the leases. This risk is attributable to the fact
that, throughout 2002, the Vendor was experiencing financial difficulty
which ultimately resulted in its filing for bankruptcy on December 24,
2002. Since that time, certain of its affiliates have also filed for
bankruptcy in the various countries in which they are organized.
Although the lessees' requirement to pay ESF under the lease agreements
is not contingent upon Qualex's fulfillment of its servicing
obligations, under the agreement with ESF, Qualex would be responsible
for any deficiency in the amount of rent not paid to ESF as a result of
any lessee's claim regarding maintenance or supply services not
provided by Qualex. Such lease payments would be made in accordance
with the original lease terms, which generally extend over 5 to 7
years. ESF's outstanding lease receivable amount was approximately
$396 million at September 30, 2003.
To mitigate the risk of not being able to fulfill its service
obligations, Qualex built up its inventory of these spare parts during
2002 and began refurbishing used parts. To further mitigate its
exposure, effective April 3, 2002, Kodak entered into certain
agreements with the Vendor under which the Company paid $19 million for
a license relating to the spare parts intellectual property, an equity
interest in the Vendor and an entity created to hold intellectual
property and certain other assets conveyed by the Vendor and its
affiliates related to spare parts, and an arrangement to purchase spare
parts from the Vendor or its affiliates. After entering into these
arrangements, the Company obtained the documentation and specifications
of the parts it sourced solely from the Vendor and a comprehensive
supplier list for the parts the Vendor sourced from other suppliers.
However, under these arrangements, Kodak had a use restriction, which
precluded the Company from manufacturing a limited number of parts that
were covered by patents owned by the Vendor and from purchasing such
parts directly from the Vendor's suppliers. This use restriction would
be effective until certain triggering events occurred, the most
significant of which was the filing for bankruptcy by the Vendor. As
indicated above, the Vendor filed for bankruptcy on December 24, 2002.
As part of the bankruptcy proceedings, the Company has acquired 100%
ownership of the entity that was created to own the above-described
intellectual property and certain other assets related to spare parts,
and the Company has finalized written agreements necessary to
facilitate the manufacture of the parts previously produced by the
Vendor. Also, as a result of the bankruptcy, new third-party companies
have been formed that have acquired assets from the Vendor and who are
now selling spare parts to Qualex and others. Additionally, the
Company has begun to source parts directly from the Vendor's suppliers.
Accordingly, the Company does not anticipate any significant situations
where it would be unable to fulfill its service obligations under the
arrangement with ESF.
20
Effective July 22, 2003, ESF entered into an agreement amending the
Receivables Purchase Agreement (RPA). Under the amended RPA
agreement, maximum borrowings were lowered to $257 million. Total
outstanding borrowings under the RPA at September 30, 2003 were $257
million. The amended RPA extends through July 2004, at which time the
RPA can be extended or terminated. If the RPA were terminated, ESF
would need to find an alternative financing solution for new borrowings
under the RPA. Pursuant to the ESF partnership agreement between
Qualex and DCC, commencing October 6, 2003, Qualex no longer sells its
lease receivables to ESF. Qualex currently is utilizing the services
of Imaging Financial Services, Inc., a wholly owned subsidiary of
General Electric Capital Corporation as an alternative financing
solution for prospective leasing activity with its customers.
At September 30, 2003, the Company had outstanding letters of credit
totaling $99 million and surety bonds in the amount of $108 million
primarily to ensure the completion of environmental remediations and
payment of possible casualty and workers' compensation claims. The
Company could be required to increase the dollar amount of its letters
of credit or other financial support up to $138 million in relation to
these matters if its Moody's or S&P long-term debt credit ratings are
reduced to below the current ratings of Baa3 and BBB-, respectively.
The Company and its subsidiary companies are involved in lawsuits,
claims, investigations and proceedings, including product liability,
commercial, environmental, and health and safety matters, which are
being handled and defended in the ordinary course of business. There
are no such matters pending that the Company and its General Counsel
expect to be material in relation to the Company's business, financial
position, results of operations or cash flows.
- -----------------------------------------------------------------------
21
NOTE 8: GUARANTEES
The Company guarantees debt and other obligations under agreements with
certain affiliated companies and customers. At September 30, 2003,
these guarantees totaled a maximum of $330 million, with outstanding
guaranteed amounts of $161 million. The maximum guarantee amount
includes guarantees of up to: $160 million of debt for Kodak Polychrome
Graphics (KPG), an unconsolidated affiliate in which the Company has a
50% ownership interest ($63 million outstanding); $6 million for other
unconsolidated affiliates and third parties ($6 million outstanding);
and $164 million of customer amounts due to banks in connection with
various banks' financing of customers' purchase of products and
equipment from Kodak ($92 million outstanding). The KPG debt facility
and the related guarantee mature on December 31, 2005, but may be
renewed at KPG's, the joint venture partners' and the bank's discretion.
The guarantees for the other unconsolidated affiliates and third party
debt mature between October 2003 and May 2006 and are not expected to be
renewed. The customer financing agreements and related guarantees
typically have a term of 90 days for product and short-term equipment
financing arrangements, and up to 3 years for long-term equipment
financing arrangements. These guarantees would require payment from
Kodak only in the event of default on payment by the respective debtor.
In some cases, particularly with guarantees related to equipment
financing, the Company has collateral or recourse provisions to recover
and sell the equipment to reduce any losses that might be incurred in
connection with the guarantee. This activity is not material.
Management believes the likelihood is remote that material payments will
be required under these guarantees. With respect to the guarantees that
the Company issued in the three and nine months ended September 30,
2003, the Company assessed the fair value of its obligation to stand
ready to perform under these guarantees by considering the likelihood of
occurrence of the specified triggering events or conditions requiring
performance as well as other assumptions and factors. Through internal
analysis and external valuations, the Company determined that the fair
value of the guarantees was not material to the Company's financial
position, results of operations or cash flows.
The Company also guarantees debt owed to banks for some of its
consolidated subsidiaries. The maximum amount guaranteed is $706
million, and the outstanding debt under those guarantees, which is
recorded within the short-term borrowings and long-term debt, net of
current portion components in the accompanying Consolidated Statement of
Financial Position, is $525 million. These guarantees expire in 2003
through 2005 with the majority expiring in 2004.
The Company may provide up to $100 million in loan guarantees to
support funding needs for SK Display Corporation, an unconsolidated
affiliate in which the Company has a 34% ownership interest. As of
September 30, 2003, the Company has not been required to guarantee any
of SK Display Corporation's outstanding debt.
22
Indemnifications
The Company issues indemnifications in certain instances when it sells
businesses and real estate, and in the ordinary course of business with
its customers, suppliers, service providers and business partners.
Further, the Company indemnifies its directors and officers who are, or
were, serving at Kodak's request in such capacities. Historically,
costs incurred to settle claims related to these indemnifications have
not been material to the Company's financial position, results of
operations or cash flows. Additionally, the fair value of the
indemnifications that the Company issued during the three and nine
months ended September 30, 2003 was not material to the Company's
financial position, results of operations or cash flows.
Warranty Costs
The Company has warranty obligations in connection with the sale of its
equipment. The original warranty period for equipment products is
generally one year or less. The costs incurred to provide for these
warranty obligations are estimated and recorded as an accrued liability
at the time of sale. The Company estimates its warranty cost at the
point of sale for a given product based on historical failure rates and
related costs to repair. The change in the Company's accrued warranty
obligations from December 31, 2002 to September 30, 2003 was as
follows:
(in millions)
Accrued warranty obligations at December 31, 2002 $ 43
Actual warranty experience (39)
Warranty provisions 40
Adjustments for changes in estimate -
----
Accrued warranty obligations at September 30, 2003 $ 44
====
The Company also offers extended warranty arrangements to its customers
that are generally one year, but may range from three months to three
years after the original warranty period. The Company provides both
repair services and routine maintenance services under these
arrangements. The Company has not separated the extended warranty
revenues and costs from the routine maintenance service revenues and
costs, as it is not practicable to do so. Costs incurred under these
extended warranty arrangements for the nine months ended September 30,
2003 amounted to $147 million. The change in the Company's deferred
revenue balance in relation to these extended warranty arrangements
from December 31, 2002 to September 30, 2003 was as follows:
(in millions)
Deferred revenue at December 31, 2002 $ 103
New extended warranty arrangements 282
Recognition of extended warranty arrangement
revenue (261)
-----
Deferred revenue at September 30, 2003 $ 124
=====
- -----------------------------------------------------------------------
23
NOTE 9: OTHER CHARGES
On April 3, 2003, the Company entered into a settlement agreement with
a third party with respect to alleged infringement of certain
technology. The settlement amount of approximately $12 million has
been included in selling, general and administrative expenses in the
accompanying Consolidated Statement of Earnings for the nine months
ended September 30, 2003.
The Company recorded a charge of approximately $14 million in the three
months ended June 30, 2003 reflecting the settlement of a patent
infringement claim. The charge is reflected in selling, general and
administrative expenses in the accompanying Consolidated Statement of
Earnings for the nine months ended September 30, 2003.
During the second quarter of 2003, the Company entered into a
settlement agreement with a third party to resolve certain issues in
connection with a prior year acquisition. In connection with the
settlement, the Company received a cash payment from the third party of
approximately $17 million during the three months ended June 30, 2003.
Prior to reaching the settlement agreement, the Company had a net long-
term asset relating to these issues on its Consolidated Statement of
Financial Position of approximately $31 million. Accordingly, the
Company recorded a charge of approximately $14 million in the three
months ended June 30, 2003. The charge is reflected in selling,
general and administrative expenses in the accompanying Consolidated
Statement of Earnings for the nine months ended September 30, 2003.
During the third quarter of 2003, the Company recorded a charge of
approximately $8 million in connection with its commitment to make a
cash donation to a technology enterprise. The charge is reflected in
selling, general and administrative expenses in the accompanying
Consolidated Statement of Earnings for the three and nine months ended
September 30, 2003.
- ------------------------------------------------------------------------
NOTE 10: RESTRUCTURING COSTS AND OTHER
Currently, the Company is being adversely impacted by negative global
economic conditions and a progressing digital transition. As the
Company continues to adjust its operating model in light of changing
business conditions, it is probable that ongoing cost reduction
activities will be required from time to time.
In accordance with this, the Company periodically announces planned
restructuring programs (Programs), which often consist of a number of
restructuring initiatives. These Program announcements provide
estimated ranges relating to the number of positions to be eliminated
and the total restructuring charges to be incurred. The actual charges
for initiatives under a Program are recorded in the period in which the
Company commits to formalized restructuring plans or executes the
specific actions contemplated by the Program and all criteria for
restructuring charge recognition under the applicable accounting
guidance have been met.
24
Fourth Quarter, 2002 Restructuring Program
During the fourth quarter of 2002, the Company announced a planned
Program consisting of a number of focused cost reduction initiatives
designed to deploy manufacturing assets more effectively in order to
provide competitively-priced products to the global market. In the
announcement, the Company discussed the restructuring initiatives under
its Fourth Quarter, 2002 Restructuring Program that would begin in the
fourth quarter of 2002 and extend into 2003. These initiatives were
expected to affect a total of 1,300 to 1,700 positions worldwide,
including approximately 150 positions in the Company's U.S. research
and development organizations, 500 positions in its U.S. one-time-use
camera assembly operations, 300 positions in its Mexico sensitizing
operations and 550 positions in its global manufacturing and logistics
organization. Specific initiatives included the relocation of the one-
time-use camera assembly operations in Rochester, New York and the
graphic arts and x-ray film sensitizing operations in Mexico to other
Kodak locations.
The total restructuring charge for continuing operations recorded in
the fourth quarter of 2002 for these initiatives that were implemented
was $116 million, which was composed of severance, inventory write-
downs, long-lived asset impairments and exit costs of $55 million, $7
million, $37 million and $17 million, respectively. The severance
charge related to the termination of 1,150 employees, including
approximately 525 manufacturing and logistics, 300 service and
photofinishing, 175 administrative and 150 research and development
positions.
The geographic composition of the 1,150 employees terminated included
approximately 775 in the United States and Canada and 375 throughout
the rest of the world. The charge for the long-lived asset impairments
includes the write-off of $13 million relating to equipment used in the
manufacture of cameras and printers, $13 million for sensitized
manufacturing equipment, $5 million for lab equipment used in
photofinishing and $6 million for other assets that were scrapped or
abandoned immediately. The reduction of 1,150 employees and the $72
million charge for severance and exit costs are reflected in the Fourth
Quarter, 2002 Restructuring Program table below. These amounts exclude
the fourth quarter termination of 150 employees and the restructuring
charges relating to the shutdown of Kodak Global Imaging, Inc., as
these charges were reflected in the loss from discontinued operations
for the year ended December 31, 2002.
During the first quarter of 2003, the Company recorded an additional
severance charge of $16 million in continuing operations relating to
450 positions that were contemplated under its Fourth Quarter, 2002
Restructuring Program. The reduction of 450 positions and the related
severance charge of $16 million are reflected in the Fourth Quarter,
2002 Restructuring Program table below.
25
During the second quarter of 2003, the Company recorded an additional
severance charge of $1 million in continuing operations relating to the
elimination of 25 manufacturing positions in Mexico, which were
associated with the relocation of Mexican sensitizing operations and
that were anticipated under its Fourth Quarter, 2002 Restructuring
Program. The reduction of 25 positions and the related severance
charge of $1 million are reflected in the Fourth Quarter, 2002
Restructuring Program table below.
During the third quarter of 2003, the Company recorded an additional
charge of $4 million in continuing operations relating to the
elimination of 200 U.S. manufacturing positions, which were eliminated
as a result of the relocation of the U.S. one-time-use camera assembly
operations and that were anticipated under the Fourth Quarter, 2002
Restructuring Program. The reduction of 200 positions and the related
severance charge of $4 million are reflected in the Fourth Quarter,
2002 Restructuring Program table below. All actions anticipated under
the Fourth Quarter, 2002 Restructuring Program have now been completed.
The following table summarizes the activity with respect to the
severance and exit cost charges recorded in connection with the focused
cost reductions that were announced in the fourth quarter of 2002 and
the remaining balance in the related reserves at September 30, 2003:
(dollars in millions)
Exit
Number of Severance Costs
Employees Reserve Reserve Total
--------- -------- ------- -------
Q4, 2002 charges l,l50 $ 55 $ 17 $ 72
Q4, 2002 utilization (250) (2) - (2)
------ ----- ---- ----
Balance at 12/31/02 900 53 17 70
Q1, 2003 charges 450 16 - 16
Q1, 2003 utilization (850) (24) (2) (26)
------ ----- ---- ----
Balance at 3/31/03 500 45 15 60
Q2, 2003 charges 25 1 - 1
Q2, 2003 utilization (500) (11) (4) (15)
------ ----- ---- ----
Balance at 6/30/03 25 35 11 46
Q3, 2003 charges 200 4 - 4
Q3, 2003 utilization (225) (8) (2) (10)
------ ----- ---- ----
Balance at 9/30/03 0 $ 31 $ 9 $ 40
====== ===== ==== ====
26
The severance charges taken in the third quarter and first three
quarters of 2003 of $4 million and $21 million, respectively, were
reported in restructuring costs and other in the accompanying
Consolidated Statement of Earnings for the three and nine months ended
September 30, 2003, respectively. The severance and exit costs require
the outlay of cash, while the inventory write-downs and long-lived
asset impairments represent non-cash items. Severance payments will
continue beyond 2003 since, in many instances, the terminated employees
can elect or are required to receive their severance payments over an
extended period of time. Most exit costs are expected to be paid
during 2003. However, certain costs, such as long-term lease payments,
will be paid over periods after 2003.
As a result of initiatives implemented under the Fourth Quarter, 2002
Restructuring Program, the Company recorded $3 million and $24 million
of accelerated depreciation on long-lived assets in cost of goods sold
in the accompanying Consolidated Statement of Earnings for the three
and nine months ended September 30, 2003, respectively. The
accelerated depreciation relates to long-lived assets accounted for
under the held and used model of SFAS No. 144, and the year-to-date
amount of $24 million was comprised of $15 million relating to
equipment used in the manufacture of cameras, $6 million for lab
equipment used in photofinishing and $3 million for sensitized
manufacturing equipment that will be used until their abandonment in
2003.
First Quarter, 2003 Restructuring Program
In the early part of the first quarter of 2003, as part of its
continuing focused cost-reduction efforts and in addition to the
remaining initiatives under the Fourth Quarter, 2002 Restructuring
Program, the Company announced its First Quarter, 2003 Restructuring
Program that included new initiatives to further reduce employment
within a range of 1,800 to 2,200 employees. A significant portion of
these new initiatives relate to the rationalization of the Company's
photofinishing operations in the U.S. and Europe. Specifically, as a
result of declining film and photofinishing volumes and in response to
global economic and political conditions, the Company began to
implement initiatives to 1) close certain photofinishing operations in
the U.S. and EAMER, 2) rationalize manufacturing capacity by
eliminating manufacturing positions on a worldwide basis and 3)
eliminate selling, general and administrative positions, particularly
in the Photography segment.
27
The total restructuring charge for continuing operations recorded in
the first quarter of 2003 relating to the First Quarter, 2003
Restructuring Program was $28 million, which represented severance
charges relating to 425 positions that are being eliminated. The
reduction of 425 positions and the total restructuring charge of $28
million are reflected in the First Quarter, 2003 Restructuring Program
table below.
The total severance charge of $44 million recorded in the first quarter
of 2003 relating to the Fourth Quarter, 2002 and the First Quarter,
2003 Restructuring Programs, represents the total termination of 875
employees, including approximately 450 manufacturing and logistics, 250
administrative and 175 photofinishing positions. The geographic
composition of the employees terminated include approximately 425 in
the United States and Canada and 450 throughout the rest of the world.
The total restructuring charges for continuing operations recorded in
the second quarter of 2003 for actions that were contemplated under the
First Quarter, 2003 Restructuring Program were $29 million, which was
composed of severance, inventory write-downs, long-lived asset
impairments and exit costs of $20 million, $1 million, $4 million and
$4 million, respectively. The severance charge related to the
termination of 500 employees, including approximately 250
photofinishing, 125 manufacturing and 125 administrative positions.
The geographic composition of the employees to be terminated include
approximately 200 in the United States and Canada and 300 throughout
the rest of the world. The reduction of 500 positions and the $24
million charge for severance and exit costs are reflected in the First
Quarter, 2003 Restructuring Program table below.
The total restructuring charges for continuing operations recorded in
the third quarter of 2003 for actions that were contemplated under the
First Quarter, 2003 Restructuring Program were $24 million, which was
composed of severance, long-lived asset impairments and exit costs of
$19 million, $1 million and $4 million, respectively. The severance
charge related to the termination of 925 employees, including
approximately 800 photofinishing and 125 administrative positions. The
geographic composition of the employees to be terminated include
approximately 700 in the United States and Canada and 225 throughout
the rest of the world. The reduction of the 925 positions and the $23
million charge for severance and exit costs are reflected in the First
Quarter, 2003 Restructuring Program table below. All actions
anticipated under the First Quarter, 2003 Restructuring Program have
now been completed.
28
The following table summarizes the activity with respect to the
severance and exit cost charges recorded in connection with the focused
cost reductions that were announced in the first quarter of 2003 and
the remaining balances in the related reserves at September 30, 2003:
(dollars in millions)
Exit
Number of Severance Costs
Employees Reserve Reserve Total
--------- -------- ------- -----
Q1, 2003 charges 425 $ 28 $ - $ 28
Q1, 2003 utilization (150) (2) - (2)
----- ---- ---- ----
Balance at 3/31/03 275 26 - 26
Q2, 2003 charges 500 20 4 24
Q2, 2003 utilization (500) (13) - (13)
---- ---- ---- ----
Balance at 6/30/03 275 33 4 37
Q3, 2003 charges 925 19 4 23
Q3, 2003 utilization (400) (12) (1) (13)
---- ---- ---- ----
Balance at 9/30/03 800 $ 40 $ 7 $ 47
==== ==== ==== ====
The first quarter charges of $28 million were reported in restructuring
costs and other in the accompanying Consolidated Statement of Earnings
for the nine months ended September 30, 2003. The second quarter
charges for severance, long-lived asset impairments and exit cost
reserves were reported in restructuring costs and other in the
accompanying Consolidated Statement of Earnings for the nine months
ended September 30, 2003. The third quarter charges for severance,
long-lived asset impairments and exit cost reserves were reported in
restructuring costs and other in the accompanying Consolidated
Statement of Earnings for the three and nine months ended September 30,
2003. The charges taken for inventory write-downs of $1 million were
reported in cost of goods sold in the accompanying Consolidated
Statement of Earnings for the nine months ended September 30, 2003,
respectively. The severance and exit costs require the outlay of
cash, while the inventory write-downs and long-lived asset impairments
represent non-cash items. Severance payments relating to the
First Quarter, 2003 Restructuring Program actions will be paid
during the period from 2003 through 2005 since, in many instances, the
terminated employees can elect or are required to receive their
severance payments over an extended period of time. Most exit costs
are expected to be paid during 2003. However, certain costs, such as
long-term lease payments, will be paid over periods after 2003.
29
In addition to the $29 million of restructuring charges recorded in the
second quarter of 2003 under the First Quarter, 2003 Restructuring
Program, the Company recorded $17 million of charges in the second
quarter associated with the Company's exit from the Photography
segment's Phogenix joint venture with Hewlett Packard. The $17 million
charge included approximately $2 million of inventory write-downs, $6
million of long-lived asset impairments and $9 million of exit costs.
The inventory write-downs were reported in cost of goods sold in the
accompanying Consolidated Statement of Earnings for the nine months
ended September 30, 2003. The long-lived asset impairments and exit
costs were reported in restructuring costs and other in the
accompanying Consolidated Statement of Earnings for the nine months
ended September 30, 2003. The exit costs, which represent the only
cash portion of the charge, are expected to be paid during the
remainder of 2003.
As a result of initiatives implemented under the First Quarter, 2003
Restructuring Program, the Company recorded $16 million of accelerated
depreciation on long-lived assets in cost of goods sold in the
accompanying Consolidated Statement of Earnings for the three and nine
months ended September 30, 2003. The accelerated depreciation relates
to long-lived assets accounted for under the held and used model of
SFAS No. 144. The year-to-date amount of $16 million relates to lab
equipment used in photofinishing that will be used until their
abandonment in 2003. The Company will incur accelerated depreciation
charges of $14 million in the fourth quarter of 2003, $13 million in
the first quarter of 2004 and $2 million in the second quarter of
2004 as a result of the initiatives implemented under the First
Quarter, 2003 Restructuring Program.
Third Quarter, 2003 Restructuring Program
During the third quarter of 2003, the Company announced that it intends
to implement a series of cost reduction actions during the last two
quarters of 2003 and the first two quarters of 2004, which are expected
to result in pre-tax charges totaling $350 million to $450 million. It
is anticipated that these actions will result in a reduction of
approximately 4,500 to 6,000 positions worldwide primarily relating to
the rationalization of global manufacturing assets, reduction of
corporate administration and R&D, and the consolidation of the
infrastructure and administration supporting the Company's consumer
imaging and professional products and services operations.
30
The Company implemented certain actions under this Program during the
third quarter of 2003. As a result of these actions, the Company
recorded a severance charge of $123 million in continuing operations
relating to the terminations of approximately 1,700 people, including
approximately 1,100 administrative, 275 manufacturing, 200
photofinishing and 125 research and development positions. The
geographic composition of the employees to be terminated include
approximately 1,075 in the United States and Canada and 625 throughout
the rest of the world. The reduction of the 1,700 positions and the
$123 million charge for severance costs are reflected in the Third
Quarter, 2003 Restructuring Program table below. In addition, during
the third quarter the Company took a $1 million charge for long-lived
asset impairments that was included in restructuring costs and other in
the accompanying Consolidated Statement of Earnings for the three and
nine months ended September 30, 2003.
The following table summarizes the activity with respect to the
severance charges recorded in connection with the focused cost
reductions that were announced in the third quarter of 2003 and the
remaining balances in the related reserves at September 30, 2003:
(dollars in millions)
Number of Severance
Employees Reserve Total
--------- -------- -----
Q3, 2003 charges 1,700 $123 $ 123
Q3, 2003 utilization (100) (3) (3)
----- ---- -----
Balance at 9/30/03 1,600 $120 $ 120
===== ==== =====
The severance charges taken in the third quarter of 2003 of $123
million were reported in restructuring costs and other in the
accompanying Consolidated Statement of Earnings for the three and nine
months ended September 30, 2003, respectively. The severance costs
require the outlay of cash, while the long-lived asset impairment
represents a non-cash item. Severance payments relating to the third
quarter restructuring actions will be paid during the period from 2003
through 2005, since, in many instances, the terminated employees can
elect or are required to receive their severance payments over an
extended period of time.
As a result of initiatives implemented under the Third Quarter, 2003
Restructuring Program, the Company recorded $14 million of accelerated
depreciation on long-lived assets in cost of goods sold in the
accompanying Consolidated Statement of Earnings for the three and nine
months ended September 30, 2003. The accelerated depreciation relates
to long-lived assets accounted for under the held and used model of
SFAS No. 144. The year-to-date amount of $14 million relates to
sensitized manufacturing facilities and equipment that will be used
until their abandonment in 2003 and 2004. The Company will incur
accelerated depreciation charges of $18 million in the fourth quarter
of 2003, $10 million in the first quarter of 2004, and $1 million in
the second quarter of 2004 as a result of the initiatives implemented
under the Third Quarter, 2003 Restructuring Program.
31
With respect to the Third Quarter, 2003 Program, the Company
anticipates completing the remaining initiatives originally
contemplated under the Program by the end of the second quarter of
2004. As a result of these initiatives, an additional 2,600 to 4,100
positions will be eliminated throughout the world by the end of the
second quarter of 2004. The estimated cost to complete these remaining
initiatives will be in the range of $200 million to $300 million.
2001 Restructuring Programs
At December 31, 2002 the Company had remaining severance and exit cost
reserves of $67 million and $18 million, respectively, relating to the
restructuring plans it implemented during 2001. During the first
quarter of 2003, the Company completed the severance actions associated
with the 2001 Restructuring Programs and recorded a reversal of $12
million of reserves through restructuring costs and other in the
accompanying Consolidated Statement of Earnings for the six months
ended June 30, 2003. The completion of the 2001 Restructuring Programs
resulted in the elimination of the remaining 200 positions included in
the original plans. A total of 6,425 personnel were terminated under
the 2001 Restructuring Programs.
The remaining severance reserve of $13 million as of September 30, 2003
has not been paid since, in many instances, the terminated employees
could elect or were required to receive their severance payments over
an extended period of time. However, substantially all of these
payments will be made by the end of 2003. Most of the remaining exit
cost reserves of $15 million as of September 30, 2003 represent long-
term lease payments, which will be paid over periods after 2003.
- ----------------------------------------------------------------------
32
NOTE 11: EARNINGS PER SHARE
Options to purchase 40.0 million and 35.3 million shares of common
stock at weighted average per share prices of $48.78 and $51.39 for the
three months ended September 30, 2003 and 2002, respectively, and
options to purchase 34.8 million and 27.7 million shares of common
stock at weighted average per share prices of $52.64 and $58.09 for the
nine months ended September 30, 2003 and 2002, respectively, were
outstanding during the periods presented but were not included in the
computation of diluted earnings per share because the options' exercise
price was greater than the average market price of the common shares
for the respective periods.
- -----------------------------------------------------------------------
NOTE 12: STOCKHOLDERS' EQUITY
$2.50 par value, 950 million shares authorized, 391 million shares
issued at September 30, 2003 and December 31, 2002. Treasury stock at
cost consists of approximately 105 million shares at both September 30,
2003 and December 31, 2002.
During the third quarter of 2003, the Company made a decision to reduce
its semi-annual dividend payment from a semi-annual dividend payment of
$.90 per share ($1.80 annually) to a semi-annual dividend payment of
$.25 per share ($.50 annually). Also during the third quarter, the
Company declared its second half of 2003 semi-annual cash dividend of
$.25 per share, payable on December 12, 2003 to shareholders of record
as of the close of business on November 3, 2003. The dividend amount
of approximately $72 million has been accrued as of September 30, 2003
and is reflected in accounts payable and other current liabilities in
the accompanying Consolidated Statement of Financial Position.
The Company accounts for its employee stock incentive plans under
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock
Issued to Employees" and the related interpretations under FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving
Stock Compensation." Accordingly, no stock-based employee compensation
cost is reflected in net income as all options granted had an exercise
price equal to the market value of the underlying common stock on the
date of grant. In accordance with SFAS No. 148, "Accounting for Stock-
Based Compensation - Transition and Disclosure," the following table
illustrates the effect on net income and earnings per share as if the
Company had applied the fair value recognition provisions of SFAS No.
123, "Accounting for Stock-Based Compensation," to stock-based employee
compensation.
33
(in millions, except per share data)
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2003 2002 2003 2002
Net income, as reported $ 122 $ 334 $ 246 $ 657
Deduct: Total stock-based
employee compensation expense
determined under fair value
method for all awards, net
of related tax effects (2) (60) (11) (95)
----- ----- ----- -----
Pro forma net income $ 120 $ 274 $ 235 $ 562
===== ===== ===== =====
Earnings per share:
Basic and diluted - as reported $ .42 $1.15 $ .86 $2.25
Basic and diluted - pro forma $ .42 $ .94 $ .82 $1.93
The total stock-based employee compensation amount, net of related tax
effects, for the three and nine months ended September 30, 2002, of $60
million and $95 million, respectively, includes a net of tax expense
impact of $50 million representing the grant of approximately 16
million new options awarded on August 26, 2002 in relation to the
voluntary stock option exchange program. These options were
essentially fully vested at the date of grant.
Additionally, the total stock-based employee compensation expense
amount, net of related tax effects, for the nine months ended September
30, 2002 of $95 million, also includes a net of tax expense impact of
$34 million representing the unamortized compensation cost of the
options that were canceled in the first quarter of 2002 in connection
with the 2002 voluntary stock option exchange program. This charge was
partially offset by reversals of compensation expense related to
forfeitures occurring in the nine months ended September 30, 2002,
which amounted to $27 million, net of taxes.
- -----------------------------------------------------------------------
34
NOTE 13: COMPREHENSIVE INCOME
(in millions)
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
2003 2002 2003 2002
Net income $122 $334 $246 $657
Unrealized gains on
available-for-sale
securities 4 6 9 8
Realized and unrealized
gains from hedging
activity 13 6 3 0
Currency translation
adjustments 4 (57) 207 72
---- ---- ---- ----
Total comprehensive income $143 $289 $465 $737
==== ==== ==== ====
- -----------------------------------------------------------------------
NOTE 14: ACQUISITIONS
The Company had a commitment under a put option arrangement with the
Burrell Companies, unaffiliated entities, whereby the shareholders of
those Burrell Companies had the ability to put 100% of the stock to
Kodak for total consideration, including the assumption of debt, of
approximately $63 million. The option first became exercisable on
October 1, 2002 and was ultimately exercised during the Company's
fourth quarter ended December 31, 2002. Accordingly, on February 5,
2003, the Company acquired the Burrell Companies for a total purchase
price of approximately $63 million, which was composed of approximately
$54 million in cash and $9 million in assumed debt.
At the end of the second quarter of 2003, the Company was in
negotiations to sell 100% of the stock in the Burrell Companies to an
unaffiliated company. As of that time, the Company believed that the
consideration it would receive in connection with the sale would not be
sufficient to recover the carrying value of its net assets in the
Burrell Companies as of June 30, 2003. Accordingly, the Company
recorded an impairment charge of $9 million in the three month period
ended June 30, 2003. The impairment charge is reflected in the
selling, general and administrative component within the accompanying
Consolidated Statement of Earnings for the nine months ended September
30, 2003. The Company ultimately closed on the sale of the Burrell
Companies on October 6, 2003. The difference between the sale proceeds
and the carrying value of the net assets in the Burrell Companies as of
September 30, 2003 was not material.
During the three months ended March 31, 2003, the Company paid
approximately $21 million for the rights to certain technology. As
this technology is still in the development phase and is not yet ready
for commercialization, it qualified as in-process research and
development. Additionally, management determined that there are no
alternative future uses for this technology. Accordingly, the entire
purchase price was expensed in the nine months ended September 30, 2003
as research and development costs in the accompanying Consolidated
Statement of Earnings.
35
During the second quarter, the Company purchased Applied Science
Fiction's proprietary rapid film processing technology and other assets
for approximately $32 million in cash. Of the $32 million in purchase
price, approximately $16 million represents goodwill. The balance of
the purchase price of approximately $16 million was allocated to the
acquired intangible assets, consisting of developed technologies, which
have useful lives ranging from two to six years.
On October 7, 2003, Kodak acquired all of the outstanding shares of
PracticeWorks, Inc., a leading provider of dental practice management
software and digital radiographic imaging systems, for $468 million in
cash and assumed net debt (debt less cash acquired) of $18 million. As
part of this transaction, Kodak also acquired 100% of PracticeWorks'
Paris-based subsidiary, Trophy Radiologie, S.A., a developer and
manufacturer of dental digital radiography equipment, which
PracticeWorks purchased in December 2002. This acquisition will enable
Kodak's Health Imaging business to offer its customers a full spectrum
of dental imaging products and services from traditional film to
digital radiography and photography. Due to the timing of the
acquisition relative to the Company's quarter end and the issuance date
of its third quarter results, Kodak is in the process of obtaining a
third-party valuation to assist in the purchase price allocation.
On August 1, 2003, the Company announced that it entered into an
agreement to purchase Laser-Pacific Media Corporation ("Laser-
Pacific"), a leading Hollywood based post-production company, for
approximately $31 million in cash. The transaction is subject to the
approval of Laser-Pacific's stockholders, regulatory approval and
certain other customary conditions. Kodak expects the acquisition to
close during the fourth quarter. The Laser Pacific acquisition is not
expected to have a material impact on the Company's earnings.
- ----------------------------------------------------------------------
36
NOTE 15: DISCONTINUED OPERATIONS
During the three month period ended March 31, 2003, the Company
repurchased certain properties that were initially sold in connection
with the 1994 divestiture of Sterling Winthrop Inc., which represented
a portion of the Company's non-imaging health businesses. The
repurchase of these properties will allow the Company to directly
manage the environmental remediation that the Company is required to
perform in connection with those properties, which will result in
better overall cost control (See Note 7, "Commitments and
Contingencies"). In addition, the repurchase eliminated the
uncertainty regarding the recoverability of tax benefits associated
with the indemnification payments that were previously being made to
the purchaser. Accordingly, the Company reversed a tax reserve of
approximately $15 million through earnings from discontinued operations
in the accompanying Consolidated Statement of Earnings for the nine
months ended September 30, 2003, which was previously established
through discontinued operations.
During the three month period ended March 31, 2003, the Company
received cash relating to the favorable outcome of litigation
associated with the 1994 sale of Sterling Winthrop Inc. The related
gain of $19 million was recognized in loss from discontinued operations
in the Consolidated Statement of Earnings for the year ended December
31, 2002. The cash receipt is reflected in the net cash provided by
(used in) discontinued operations component in the accompanying
Consolidated Statement of Cash Flows for the nine months ended
September 30, 2003.
The net loss from discontinued operations of $2 million and $6 million
in the accompanying Consolidated Statement of Earnings for the three
and nine months ended September 30, 2002, respectively, reflects the
loss from operations of Kodak Global Imaging, Inc., a wholly owned
subsidiary of Kodak.
- -----------------------------------------------------------------------
NOTE 16: SEGMENT INFORMATION
The Company has three reportable segments: Photography; Health Imaging;
and Commercial Imaging. The balance of the Company's operations, which
individually and in the aggregate do not meet the criteria of a
reportable segment, are reported in All Other.
Segment financial information is shown below.
37
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
(in millions) 2003 2002 2003 2002
Net sales from continuing
operations:
Photography $2,475 $2,409 $6,614 $6,601
Health Imaging 571 565 1,727 1,655
Commercial Imaging 373 352 1,127 1,060
All Other 28 26 71 78
------ ------ ------ ------
Consolidated total $3,447 $3,352 $9,539 $9,394
====== ====== ====== ======
Earnings (loss) from continuing
operations before interest,
other charges, and income taxes:
Photography $ 204 $ 324 $ 277 $ 597
Health Imaging 117 126 357 314
Commercial Imaging 33 42 117 143
All Other (19) (8) (58) (21)
------ ------ ------ ------
Total of segments 335 484 693 1,033
Venture investment impairments - (13) - (23)
Impairment of Burrell Companies'
net assets held for sale - - (9) -
Restructuring (costs) credits
and other (185) 9 (285) 9
Donation to technology enterprise (8) - (8) -
GE settlement - - (12) -
Patent infringement claim
settlement - - (14) -
Prior year acquisition settlement - - (14) -
----- ------ ------ ------
Consolidated total $ 142 $ 480 $ 351 $1,019
====== ====== ====== ======
(Loss) earnings from
continuing operations:
Photography $ 172 $ 232 $ 224 $ 410
Health Imaging 106 89 287 221
Commercial Imaging 22 23 67 72
All Other (21) (9) (52) (19)
------ ------ ------ ------
Total of segments 279 335 526 684
Venture investment impairments - (21) - (34)
Impairment of Burrell Companies'
net assets held for sale - - (9) -
Restructuring (costs) credits
and other (185) 9 (285) 9
GE settlement - - (12) -
Patent infringement claim
settlement - - (14) -
Prior year acquisition settlement - - (14) -
Interest expense (33) (40) (104) (128)
Other corporate items 2 4 8 9
Donation to technology enterprise (8) - (8) -
Tax benefit - donation
of patents - - 8 -
Tax benefit - PictureVision
subsidiary closure - - - 45
Tax benefit - Kodak Imagex
Japan - 46 - 46
Income tax effects on
above items and taxes
not allocated to segments 67 3 135 32
------ ------ ------ ------
Consolidated total $ 122 $ 336 $ 231 $ 663
====== ====== ====== ======
- ----------------------------------------------------------------------
38
NOTE 17: SUBSEQUENT EVENT
On October 22, 2003, the Company announced that it signed a 20-year
agreement with China Lucky Film Corp. Under the agreement, the Company
will acquire 20 percent of Lucky Film Co. Ltd. ("Lucky Film"), the
largest maker of photographic film in China, in exchange for
approximately $100 million in cash, plus other Kodak assets to be
determined as the cooperative contract between the two parties is
finalized. Also under the arrangement, the Company will provide Lucky
Film with technical support, training and equipment upgrades, and Lucky
Film will pay Kodak a royalty fee for the use of certain of the
Company's technologies as well as dividends on the Lucky Film shares
that Kodak will acquire. The final cooperative agreement is subject to
the approval of the Chinese government.
- -----------------------------------------------------------------------
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
New Kodak Operating Model and Change in Reporting Structure:
On August 21, 2003, the Company introduced an organizational
realignment, which will become effective January 1, 2004, thus changing
the corporate segment reporting structure beginning with the first
quarter, 2004. The intent of these changes is to accelerate growth in
commercial and consumer digital imaging markets.
Kodak currently reports financial information for three reportable
segments (Photography, Health Imaging, and Commercial Imaging), and All
Other. The bridge from the previous segment reporting to the new
reporting structure is outlined below:
- - Digital and Film Imaging Systems: correlates to the current
Photography segment and is comprised of Consumer and Professional
Imaging products and services, Entertainment Imaging products and
services, and Digital and Applied Imaging products and services.
- - Health Imaging segment: remains unchanged.
- - Commercial Imaging segment: comprised of Document Imaging products
and services, Commercial and Government Systems products and
services, Services and Support, and Optics.
- - Commercial Printing segment: comprised of NexPress (Kodak's 50/50
joint venture with Heidelberg), Kodak Polychrome Graphics (Kodak's
50/50 joint venture with Sun Chemical), and the graphics and wide
format inkjet businesses.
- - All Other: includes Kodak's Display and Components business for OLED
(Organic Light Emitting Diode), sensors and other small,
miscellaneous businesses.
39
SUMMARY
(in millions, except per share data)
Three Months Ended Nine Months Ended
September 30 September 30
-------------------- ----------------------
2003 2002 Change 2003 2002 Change
Net sales $3,447 $3,352 + 3% $9,539 $9,394 + 2%
Earnings from continuing
operations before interest,
other charges, and income
taxes 142 480 -70 351 1,019 -66
Earnings from continuing
operations 122 336 -64 231 663 -65
Net earnings 122 334 -63 246 657 -63
Basic and diluted earnings
(loss) per share:
Continuing operations .42 1.16 -64 .81 2.27 -64
Discontinued operations .00 (.01) .05 (.02)
Total .42 1.15 -63 .86 2.25 -62
Net Sales from Continuing Operations by Reportable Segment and All
Other
(in millions)
Three Months Ended Nine Months Ended
September 30 September 30
--------------------- ---------------------
2003 2002 Change 2003 2002 Change
Photography
Inside the U.S. $1,009 $1,051 - 4% $2,668 $2,933 - 9%
Outside the U.S. 1,466 1,358 + 8 3,946 3,668 + 8
------ ------ --- ------ ------ ---
Total Photography 2,475 2,409 + 3 6,614 6,601 0
------ ------ --- ------ ------ ---
Health Imaging
Inside the U.S. 251 273 - 8 755 791 - 5
Outside the U.S. 320 292 +10 972 864 +13
------ ------ --- ------ ------ ---
Total Health Imaging 571 565 + 1 1,727 1,655 + 4
------ ------ --- ------ ------ ---
Commercial Imaging
Inside the U.S. 223 200 +12 657 593 +11
Outside the U.S. 150 152 - 1 470 467 + 1
------ ------ --- ------ ------ ---
Total Commercial Imaging 373 352 + 6 1,127 1,060 + 6
------ ------ --- ------ ------ ---
All Other
Inside the U.S. 13 13 0 35 40 -13
Outside the U.S. 15 13 +15 36 38 - 5
------ ------ --- ------ ------ ---
Total All Other 28 26 + 8 71 78 - 9
------ ------ --- ------ ------ ---
Consolidated total $3,447 $3,352 + 3% $9,539 $9,394 + 2%
====== ====== === ====== ====== ===
- -----------------------------------------------------------------------
40
Earnings (Loss) from Continuing Operations Before Interest, Other
Charges, and Income Taxes by Reportable Segment and All Other
(in millions)
Three Months Ended Nine Months Ended
September 30 September 30
--------------------- ----------------------
2003 2002 Change 2003 2002 Change
Photography $ 204 $ 324 - 37% $ 277 $ 597 - 54%
Percent of Sales 8.2% 13.4% 4.2% 9.0%
Health Imaging $ 117 $ 126 - 7% $ 357 $ 314 + 14%
Percent of Sales 20.5% 22.3% 20.7% 19.0%
Commercial Imaging $ 33 $ 42 - 21% $ 117 $ 143 - 18%
Percent of Sales 8.8% 11.9% 10.4% 13.5%
All Other $ (19) $ (8) -138% $ (58) $ (21) -176%
Percent of Sales (67.9%) (30.8%) (81.7%) (26.9%)
------- ------ ---- ------ ------ ----
Total of segments $ 335 $ 484 - 31% $ 693 $1,033 - 33%
9.7% 14.4% 7.3% 11.0%
Venture investment
impairments - (13) - (23)
Impairment of Burrell
Companies' net assets
held for sale - - (9) -
Restructuring (costs)
credits and other (185) 9 (285) 9
Donation to technology
enterprise (8) - (8) -
GE settlement - - (12) -
Patent infringement
claim settlement - - (14) -
Prior year acquisition
settlement - - (14) -
------- ------ ---- ------ ------ ----
Consolidated total $ 142 $ 480 - 70% $ 351 $1,019 - 66%
======= ====== ==== ====== ====== ====
- -----------------------------------------------------------------------
41
Earnings (Loss) From Continuing Operations by Reportable Segment and
All Other
(in millions)
Three Months Ended Nine Months Ended
September 30 September 30
--------------------- ----------------------
2003 2002 Change 2003 2002 Change
Photography $ 172 $ 232 - 26% $ 224 $ 410 - 45%
Percent of Sales 6.9% 9.6% 3.4% 6.2%
Health Imaging $ 106 $ 89 + 19% $ 287 $ 221 + 30%
Percent of Sales 18.6% 15.8% 16.6% 13.4%
Commercial Imaging $ 22 $ 23 - 4% $ 67 $ 72 - 7%
Percent of Sales 5.9% 6.5% 5.9% 6.8
All Other $ (21) $ (9) -133% $ (52) $ (19) -174%
Percent of Sales (75.0%) (34.6%) (73.2%) (24.4%)
------ ------ ---- ------ ----- ----
Total of segments $ 279 $ 335 - 17% $ 526 $ 684 - 23%
8.1% 10.0% 5.5% 7.3%
Venture investment
impairments - (21) - (34)
Impairment of Burrell
Companies' net assets
held for sale - - (9) -
Restructuring (costs)
credits and other (185) 9 (285) 9
Donation to technology
enterprise (8) - (8) -
GE settlement - - (12) -
Patent infringement
claim settlement - - (14) -
Prior year acquisition
settlement - - (14) -
Interest expense (33) (40) (104) (128)
Other corporate items 2 4 8 9
Tax benefit -
PictureVision
subsidiary closure - - - 45
Tax benefit - Kodak
Imagex Japan - 46 - 46
Tax benefit - donation
of patents - - 8 -
Income tax effects on
above items and taxes
not allocated to
segments 67 3 135 32
------ ---- ---- ------ ----- ----
Consolidated total $ 122 $336 - 64% $ 231 $ 663 - 65%
====== ==== ==== ====== ===== ====
- ----------------------------------------------------------------------
42
COSTS AND EXPENSES
(in millions)
Three Months Ended Nine Months Ended
September 30 September 30
--------------------- ----------------------
2003 2002 Change 2003 2002 Change
Gross profit $1,127 $1,290 -13% $3,067 $3,404 -10%
Percent of Sales 32.7% 38.5% 32.2% 36.2%
Selling, general and
administrative expenses $ 639 $ 631 + 1% $1,921 $1,827 + 5%
Percent of Sales 18.5% 18.8% 20.1% 19.4%
Research and development
costs $ 194 $ 188 + 3% $ 567 $ 567 0%
Percent of Sales 5.6% 5.6% 5.9% 6.0%
- -----------------------------------------------------------------------
2003 COMPARED WITH 2002
Third Quarter
RESULTS OF OPERATIONS - CONTINUING OPERATIONS
Consolidated
Net worldwide sales were $3,447 million for the third quarter of 2003
as compared with $3,352 million for the third quarter of 2002,
representing an increase of $95 million or 3%, or a decrease of 1%
excluding the favorable impact of exchange. The increase in net sales
was primarily due to increased volumes and favorable exchange, which
increased third quarter sales by approximately 3.7 and 4.1 percentage
points, respectively. The increase in volume was primarily driven by
consumer digital cameras and entertainment print films. These
increases were partially offset by decreases attributable to price/mix,
primarily driven by consumer film and consumer digital cameras, which
reduced third quarter sales by approximately 4.8 percentage points.
Net sales in the U.S. were $1,496 million for the third quarter of 2003
as compared with $1,537 million for the prior year quarter,
representing a decrease of $41 million, or 3%. Net sales outside the
U.S. were $1,951 million for the current quarter as compared with
$1,815 million for the third quarter of 2002, representing an increase
of $136 million, or 7% as reported, or remained unchanged excluding the
favorable impact of exchange.
43
The Company's operations outside the U.S. are reported in three
regions: (1) the Europe, Africa and Middle East region (EAMER), (2) the
Asia Pacific region and (3) the Canada and Latin America region. Net
sales in the EAMER region were $1,039 million for the third quarter of
2003 as compared with $973 million for the prior year quarter,
representing an increase of $66 million, or 7% as reported, or a
decrease of 2% excluding the favorable impact of exchange. Net sales
in the Asia Pacific region were $591 million for the current quarter as
compared with $557 million for the prior year quarter, representing an
increase of $34 million, or 6% as reported, or 1% excluding the
favorable impact of exchange. Net sales in the Canada and Latin
America region were $321 million in the current quarter as compared
with $285 million for the third quarter of 2002, representing an
increase of $36 million, or 13% as reported, or 7% excluding the
favorable impact of exchange.
The Company's major emerging markets include China, Brazil, India,
Mexico, Russia, Korea, Hong Kong and Taiwan. Net sales in emerging
markets were $677 million for the third quarter of 2003 as compared
with $633 million for the prior year quarter, representing an increase
of $44 million, or 7% as reported, or 4% excluding the favorable impact
of exchange. The emerging market portfolio accounted for approximately
20% of Kodak's worldwide sales and 35% of Kodak's non-U.S. sales in the
quarter. The increase in emerging market sales was primarily
attributable to sales growth in India, Russia, and China of 23%, 15%,
and 14%, respectively, which was partially offset by a sales decline in
Mexico of 8%.
The increase in sales in Russia is a result of continued growth in the
number of Kodak Express stores, which represent independently owned
photo specialty retail outlets, and the Company's efforts to expand the
distribution channels for Kodak products and services. Sales increases
in India were driven by the continued success from the Company's
efforts to increase the level of camera ownership and to increase the
number of Photoshop retail stores. Sales increases in China resulted
from strong business performance for all of the Company's operations in
that region and a return to more normal levels of industry growth in
consumer imaging after the Severe Acute Respiratory Syndrome (SARS)
situation. Sales declines in Mexico reflect the continued economic
weakness experienced there.
Gross profit was $1,127 million for the third quarter of 2003 as
compared with $1,290 million for the third quarter of 2002,
representing a decrease of $163 million, or 13%. The gross profit
margin was 32.7% in the current quarter as compared with 38.5% in the
prior year quarter. The 5.8 percentage point decrease was primarily
attributable to declines due to price/mix, driven primarily by consumer
film, photofinishing and consumer digital cameras, which reduced gross
profit margins by approximately 5.2 percentage points, and $33 million
of charges for accelerated depreciation associated with focused cost
reduction programs, which negatively impacted gross profit margins by
approximately 1.2 percentage points. These decreases were partially
offset by exchange, which favorably impacted gross profit margins by
approximately 0.6 percentage point.
44
Selling, general and administrative expenses (SG&A) were $639 million
for the third quarter of 2003 as compared with $631 million for the
prior year quarter, representing an increase of $8 million, or 1%. The
increase in SG&A is primarily attributable to: an $8 million charge
relating to a donation to a technology enterprise for research
purposes, and unfavorable exchange of $22 million. These items were
partially offset by cost savings in the current year quarter realized
from position eliminations associated with ongoing cost reduction
programs, a decrease in advertising spend in the current quarter as
compared with the prior year quarter, and asset write-down charges in
the prior year quarter of $13 million. SG&A decreased slightly as a
percentage of sales from 18.8% for the third quarter of 2002 to 18.5%
for the current quarter.
Research and development costs (R&D) were $194 million for the third
quarter of 2003 as compared with $188 million for the third quarter of
2002, representing an increase of $6 million, or 3%. The increase in
R&D is related to technology acquisitions. R&D as a percentage of
sales remained the same at 5.6%.
Earnings from continuing operations before interest, other charges, and
income taxes for the third quarter of 2003 were $142 million as
compared with $480 million for the third quarter of 2002, representing
a decrease of $338 million, or 70%. This decrease is primarily
attributable to (1) the reasons described above, and (2) focused cost
reduction charges of $185 million incurred during the third quarter of
2003.
Interest expense for the third quarter of 2003 was $33 million as
compared with $40 million for the prior year quarter, representing a
decrease of $7 million, or 18%. The decrease in interest expense is
primarily attributable to lower interest rates in the third quarter of
2003 relative to the prior year quarter.
The other charges component includes principally investment income,
income and losses from equity investments, foreign exchange, and gains
and losses on the sales of assets and investments. Other charges for
the current quarter were $9 million as compared with other charges of
$21 million for the third quarter of 2002. The improvement is
primarily attributable to increased income from the Company's equity
investment in Kodak Polychrome Graphics (KPG), decreased losses
incurred in relation to the Company's equity investment in the Phogenix
joint venture, which was dissolved in the second quarter of 2003, and
reduced losses from the Company's equity investment in the NexPress
joint venture.
45
The Company's estimated annual effective tax rate from continuing
operations for 2003 decreased from 24% to 19% in the current quarter.
This decrease is primarily attributable to an expected increase in
benefits from the utilization of foreign tax credits.
The Company's estimated annual effective tax rate from continuing
operations decreased from 29% for the prior year third quarter to 19%
for the third quarter of 2003. This decrease is primarily attributable
to further expected increased earnings from operations in certain lower-
taxed jurisdictions outside the U.S. relative to total consolidated
earnings and an expected increase in benefits from the utilization of
foreign tax credits.
During the third quarter of 2003, the Company recorded a tax benefit of
$22 million, representing an effective tax benefit rate from continuing
operations of approximately 22%. The effective tax benefit rate of 22%
for the quarter differs from the estimated annual effective tax rate of
19% due to the recording of discrete period tax benefits of $77 million
in connection with (1) the year-to-date impact through June 30, 2003 of
the decrease in the estimated annual effective tax rate from continuing
operations from 24% to 19% ($14 million) and (2) the following discrete
period items ($63 million), which occurred in the third quarter and
that are taxed in jurisdictions, which when aggregated, have tax rates
greater than the estimated annual effective tax rate: a $185 million
charge for focused cost reduction actions; and an $8 million charge for
a cash donation to a technology enterprise for research purposes.
The effective tax rate of 20% for the three months ended September 30,
2002 was lower than the Company's estimated annual effective tax rate
of 29% for 2002 due primarily to the recording of a discrete period tax
benefit of $46 million relating to the consolidation of the
photofinishing operations in Japan and the loss realized from the
liquidation of a subsidiary as part of this consolidation.
The earnings from continuing operations for the third quarter of 2003
were $122 million, or $.42 per basic and diluted share, as compared
with earnings from continuing operations for the third quarter of 2002
of $336 million, or $1.16 per basic and diluted share, representing a
decrease of $214 million. This decrease in earnings from continuing
operations is attributable to the reasons described above.
46
Photography
Net worldwide sales for the Photography segment were $2,475 million for
the third quarter of 2003 as compared with $2,409 million for the third
quarter of 2002, representing an increase of $66 million, or 3% as
reported, or a decrease of 2% excluding the favorable impact of
exchange. The increase in net sales was comprised of (1) increases
related to volume driven primarily by consumer digital and
entertainment products and services, which increased third quarter
sales by approximately 3.8 percentage points and (2) favorable exchange
which increased net sales by approximately 4.6 percentage points.
These increases were partially offset by declines due to price/mix,
primarily driven by consumer film, photofinishing and consumer digital
cameras, which reduced net sales by approximately 5.4 percentage
points.
Photography segment net sales in the U.S. were $1,009 million for the
current quarter as compared with $1,051 million for the third quarter
of 2002, representing a decrease of $42 million, or 4%. Photography
segment net sales outside the U.S. were $1,466 million for the third
quarter of 2003 as compared with $1,358 million for the prior year
quarter, representing an increase of $108 million, or 8% as reported,
or remained unchanged excluding the favorable impact of exchange.
Net worldwide sales of consumer film products, including 35mm film,
Advantix film and one-time-use cameras, decreased 12% in the third
quarter of 2003 as compared with the third quarter of 2002, reflecting
decreases due to declines in volume of approximately 12% and negative
price/mix of 4%, partially offset by favorable exchange of
approximately 4%. Sales of the Company's consumer film products within
the U.S. decreased 23%, reflecting declines in volume of approximately
20% and negative price/mix of approximately 3%. Sales of the Company's
consumer film products outside the U.S. decreased 3%, reflecting
declines in volume of approximately 7% and negative price/mix of
approximately 3%, partially offset by favorable exchange of
approximately 7%.
U.S. consumer film industry sell-through volumes decreased
approximately 6% in the third quarter of 2003 as compared with the
prior year quarter. A significant decrease in U.S. retailer
inventories accounted for the majority of Kodak's reduced sell-in
volume during the quarter. The most current U.S. market trends suggest
that, for the third quarter of 2003, digital substitution accounted for
the majority of the industry decline.
47
The Company's blended U.S. consumer film share decreased approximately
1% on a volume basis relative to the third quarter of 2002. Management
remains confident in maintaining approximate full year, 2002 year-over-
year U.S. market share as it has done for the past several consecutive
years.
Worldwide volumes of consumer color paper decreased mid single digits
in the third quarter of 2003 as compared with the third quarter of
2002, with U.S. volumes also declining low double digits and volumes
outside the U.S. decreasing slightly. Kodak will no longer report
sales trends for consumer color negative paper because paper and other
products are typically bundled together as a "systems sell" for
customer contracting purposes.
Net worldwide sales for photofinishing services (excluding equipment),
including Qualex in the U.S. and Consumer Imaging Services (CIS)
outside the U.S., decreased 17% in the third quarter of 2003 as
compared with the third quarter of 2002, reflecting lower volumes and
negative price/mix, partially offset by favorable exchange. In the
U.S., Qualex's sales for photofinishing services decreased 19%,
reflecting the effects of a continued weak film industry and consumer's
shifting preference to on-site processing.
Net sales from the Company's consumer digital products and services,
which include picture maker kiosks/media and retail consumer digital
services revenue primarily from Picture CD and Retail.com, increased
14% in the third quarter of 2003 as compared with the third quarter of
2002, driven primarily by an increase in sales of kiosks and related
media and consumer digital services.
The Company's Ofoto business increased its sales 43% in the third
quarter of 2003 as compared with the prior year quarter. Ofoto's sales
represented less than 1% of the Company's consolidated net worldwide
sales for the third quarter of 2003. Ofoto now has almost 10 million
members and continues to be the market leader in the online photo
services space.
Net worldwide sales of consumer digital cameras increased 117% in the
third quarter of 2003 as compared with the prior year quarter,
primarily reflecting strong increases in volume and favorable exchange,
partially offset by declines attributable to price/mix. Sales continue
to be driven by strong consumer acceptance of the EasyShare digital
camera system and an expanding product line. In addition, Kodak's new
Printer Dock products, which were introduced in the first quarter of
2003, experienced strong sales growth during the third quarter. During
the quarter, consumer digital cameras were profitable on a fully
allocated basis.
48
Kodak's U.S. consumer digital camera market share for the third quarter
of 2003 is on track to improve quarter sequentially as the Company
benefits from a refresh of its product portfolio and a transition to a
new, expanded line of digital cameras. While complete data for third
quarter market share is not yet available, all indications are that
Kodak continues to hold one of the top U.S. market share positions in
channels reporting share data, although some of Kodak's largest
channels do not report share data.
Net worldwide sales of inkjet photo paper increased 33% in the current
quarter as compared with the third quarter of 2002. The Company
continued to maintain its top two market share position in the United
States. The double-digit revenue growth and the maintenance of market
share are primarily attributable to strong underlying market growth,
successful merchandising efforts and the continued growth and
acceptance of a new product line of small format inkjet papers.
Net worldwide sales of professional film capture products, including
color negative, color reversal and black and white films, decreased 10%
in the third quarter of 2003 as compared with the third quarter of
2002, primarily reflecting declines in volume and negative price/mix,
partially offset by favorable exchange. Sales declines of professional
film capture products resulted primarily from the ongoing impact of
digital transition. Net worldwide sales of professional sensitized
output, including color negative paper and display materials, increased
6% in the third quarter of 2003 as compared with the third quarter of
2002, reflecting increases related to volume and favorable exchange,
partially offset by negative price/mix. In addition, net worldwide
sales of digital cameras and digital writers increased during the
quarter.
Net worldwide sales of origination and print film to the entertainment
industry increased 7% in the third quarter of 2003 as compared with the
prior year quarter, reflecting higher print film volumes and favorable
exchange, partially offset by negative price/mix.
Gross profit for the Photography segment was $807 million for the third
quarter of 2003 as compared with $931 million for the prior year
quarter, representing a decrease of $124 million or 13%. The gross
profit margin was 32.6% in the current year quarter as compared with
38.7% in the prior year quarter. The 6.1 percentage point decline was
comprised of decreases attributable to price/mix, primarily driven by
consumer film, photofinishing and consumer digital cameras, which
reduced gross profit margins by approximately 6.4 percentage points,
and increases in manufacturing cost, which reduced gross margins by
approximately 0.6 percentage point. These decreases were partially
offset by exchange, which favorably impacted gross profit margins by
approximately 0.9 percentage point.
49
SG&A expenses for the Photography segment increased $3 million, or 1%,
from $482 million in the third quarter of 2002 to $485 million in the
current quarter. The increase is primarily attributable to unfavorable
exchange of $18 million, partially offset by cost savings realized from
position eliminations associated with ongoing focused cost reduction
programs. SG&A decreased slightly as a percentage of sales from 20.0%
for the third quarter of 2002 to 19.6% for the current quarter.
R&D costs for the Photography segment decreased $7 million, or 6%, from
$125 million in the third quarter of 2002 to $118 million in the
current quarter and decreased as a percentage of sales from 5.2% in the
prior year quarter to 4.8%. The decrease in R&D was primarily
attributable to cost savings realized from position eliminations
associated with ongoing focused cost reduction programs.
Earnings from continuing operations before interest, other charges, and
income taxes for the Photography segment decreased $120 million or 37%,
from $324 million in the third quarter of 2002 to $204 million in the
third quarter of 2003, primarily as a result of the factors described
above.
Health Imaging
Net worldwide sales for the Health Imaging segment were $571 million
for the third quarter of 2003 as compared with $565 million for the
prior year quarter, representing an increase of $6 million, or 1% as
reported, or a decrease of 2% excluding the favorable impact of
exchange. The increase in sales was comprised of (1) an increase in
volume of approximately 1.8 percentage points, driven primarily by
volume increases in digital media, digital capture equipment and
services and (2) an increase from favorable exchange of approximately
3.4 percentage points, which was partially offset by decreases
attributable to price/mix of approximately 4.1 percentage points,
primarily driven by digital media, digital capture equipment and analog
medical film.
Net sales in the U.S. were $251 million for the current quarter as
compared with $273 million for the third quarter of 2002, representing
a decrease of $22 million, or 8%. Net sales outside the U.S. were $320
million for the third quarter of 2003 as compared with $292 million for
the prior year quarter, representing an increase of $28 million, or 10%
as reported, or 3% excluding the favorable impact of exchange.
50
Net worldwide sales of digital products, which include laser printers
(DryView imagers and wet laser printers), digital media (DryView and
wet laser media), digital capture equipment (computed radiography
capture equipment and digital radiography equipment), services and
Picture Archiving and Communications Systems (PACS), increased 4% in
the third quarter of 2003 as compared with the prior year quarter. The
increase in digital product sales was primarily attributable to higher
volumes of digital media, digital capture equipment and services and
favorable exchange, which were partially offset by negative price/mix.
Net worldwide sales of traditional products, including analog film,
equipment, chemistry and services, decreased 3% in the third quarter of
2003 as compared with the third quarter of 2002. This decrease was
driven primarily by declines in volume and negative price/mix of
traditional products.
Gross profit for the Health Imaging segment was $250 million for the
third quarter of 2003 as compared with $246 million in the prior year
quarter, representing an increase of $4 million, or 2%. The gross
profit margin was 43.8% in the current quarter as compared with 43.5%
in the third quarter of 2002. The increase in the gross profit margin
of 0.3 percentage point was principally attributable to (1) a decrease
in manufacturing cost, which increased gross profit margins by
approximately 2.4 percentage points, and (2) favorable exchange, which
contributed approximately 0.7 percentage point to the gross profit
margin. These increases were partially offset by decreases due to
price/mix, which negatively impacted gross profit margins by 2.8
percentage points due to lower prices for digital media, analog medical
film and digital capture equipment.
SG&A expenses for the Health Imaging segment increased $7 million, or
9%, from $82 million in the third quarter of 2002 to $89 million for
the current quarter, and increased as a percentage of sales from 14.6%
to 15.6%. The increase in SG&A expenses is primarily attributable to
the unfavorable effects of foreign exchange and increased spending to
drive growth.
Third quarter R&D costs increased $6 million, or 16%, from $37 million
to $43 million, and increased as a percentage of sales from 6.6% for
the third quarter of 2002 to 7.5% for the current quarter. The segment
increased its R&D expense in the third quarter to drive growth in
selected areas of the product portfolio.
Earnings from continuing operations before interest, other charges, and
income taxes for the Health Imaging segment decreased $9 million, or
7%, from $126 million for the prior year quarter to $117 million for
the third quarter of 2003 due primarily to the reasons described above.
51
On October 7, 2003, the Company announced that it completed the
acquisition of all of the outstanding shares of PracticeWorks, Inc., a
leading provider of dental practice management software and digital
radiographic imaging systems for $468 million in cash and assumed net
debt of approximately $18 million. As part of this transaction, Kodak
also acquired 100% of PracticeWorks' Paris-based subsidiary, Trophy
Radiologie, S.A., a developer and manufacturer of dental digital
radiography equipment, which PracticeWorks purchased in December 2002.
The acquisition of PracticeWorks and Trophy is expected to contribute
approximately $215 million in sales to the Health Imaging segment
during the first full year. It is anticipated that the transaction
will be slightly dilutive to earnings from the date of acquisition
through the end of 2005 and accretive to earnings thereafter. This
acquisition will enable Kodak to offer its customers a full spectrum of
dental imaging products and services from traditional film to digital
radiography and photography and is expected to move Health Imaging into
the leading position in the dental practice management and dental
digital radiographic markets.
Commercial Imaging
Net worldwide sales for the Commercial Imaging segment were $373
million for the third quarter of 2003 as compared with $352 million for
the prior year quarter, representing an increase of $21 million, or 6%
as reported, or 3% excluding the favorable impact of exchange. The
increase in net sales was primarily comprised of (1) increases in
volume, which contributed approximately 5.3 percentage points to third
quarter sales, with imaging services and document scanners being key
drivers, and (2) an increase of approximately 2.6 percentage points due
to favorable exchange, which was partially offset by declines due to
price/mix of approximately 1.9 percentage points, primarily driven by
graphics products.
Net sales in the U.S. were $223 million for the current quarter as
compared with $200 million for the prior year quarter, representing an
increase of $23 million, or 12%. Net sales outside the U.S. were $150
million in the third quarter of 2003 as compared with $152 million for
the prior year quarter, representing a decrease of $2 million, or 1% as
reported, or a decrease of 7% excluding the favorable impact of
exchange.
Net worldwide sales of graphic arts products to Kodak Polychrome
Graphics (KPG), an unconsolidated joint venture affiliate in which the
Company has a 50% ownership interest, decreased 14% in the current
quarter as compared with the third quarter of 2002, primarily
reflecting volume declines and negative price/mix in graphic arts film.
This reduction resulted largely from digital technology transition and
the effect of continuing economic weakness in the commercial printing
market.
52
Despite a continued weakness in the global economy, KPG's earnings
performance continues to improve driven primarily by its leading
position in the growth segments of digital proofing and digital
printing plates, coupled with favorable foreign exchange. KPG's
operating profit has been positive for 13 consecutive quarters. The
Company's equity in the earnings of KPG contributed positive results to
other charges during the third quarter of 2003.
NexPress, the unconsolidated joint venture between Kodak and Heidelberg
in which the Company has a 50% ownership interest, continues to
experience good customer acceptance on its sales of the NexPress 2100
Digital Production Color Press despite a weak printing market, with
average monthly page volumes for these units running higher than
planned.
Gross profit for the Commercial Imaging segment was $93 million for the
third quarter of 2003 as compared with $109 million in the prior year
quarter, representing a decrease of $16 million, or 15%. The gross
profit margin was 24.9% in the current quarter as compared with 31.0%
in the prior year quarter. The decrease in the gross profit margin of
6.1 percentage points was primarily attributable to (1) an increase in
manufacturing cost which negatively impacted gross profit margins by
approximately 4.3 percentage points, (2) declines attributable to
price/mix, which reduced gross profit margins by approximately 1.5
percentage points primarily due to declining contributions from
traditional graphic arts products, and (3) negative exchange, which
reduced gross profit margins by approximately 0.3 percentage point.
SG&A expenses for the Commercial Imaging segment remained unchanged at
$49 million as compared with the prior year quarter, but decreased as a
percentage of sales from 13.9% to 13.1%.
Third quarter R&D costs for the Commercial Imaging segment decreased $7
million, or 39%, from $18 million for the third quarter of 2002 to $11
million for the current quarter, and decreased as a percentage of sales
from 5.1% to 2.9%. The decrease was primarily attributable to a
decrease in R&D for inkjet products.
Earnings from continuing operations before interest, other charges, and
income taxes for the Commercial Imaging segment decreased $9 million,
or 21%, from $42 million in the third quarter of 2002 to $33 million in
the third quarter of 2003. This decrease is primarily attributable to
the reasons described above.
All Other
Net worldwide sales for All Other were $28 million for the third
quarter of 2003 as compared with $26 million for the third quarter of
2002, representing an increase of $2 million, or 8%. Net sales in the
U.S. remained unchanged from the prior quarter at $13 million. Net
sales outside the U.S. were $15 million in the third quarter of 2003 as
compared with $13 million in the prior year quarter, representing an
increase of $2 million, or 15%.
53
SK Display Corporation, the OLED manufacturing joint venture between
Kodak and Sanyo, is currently supplying OLED screens to the Company for
its digital camera manufacturing and continues production scale-up with
the goal of supplying production quantity OLED screens to the marketplace
throughout the remainder of 2003.
The loss from continuing operations before interest, other charges, and
income taxes for All Other was $19 million in the current quarter as
compared with a loss of $8 million in the third quarter of 2002 primarily
driven by increased levels of investment for the Company's Display
business.
RESULTS OF OPERATIONS - DISCONTINUED OPERATIONS
The Company did not have earnings (loss) from discontinued operations,
net of income taxes in the third quarter of 2003. In the third quarter
of 2002, a loss from discontinued operations of $2 million, or $.01 per
basic and diluted share, was reported.
NET EARNINGS
Net earnings for the third quarter of 2003 were $122 million, or $.42
per basic and diluted share, as compared with net earnings for the
third quarter of 2002 of $334 million, or $1.15 per basic and diluted
share, representing a decrease of $212 million, or 63%. This decrease
is primarily attributable to the reasons outlined above.
54
Year to Date
Consolidated
Net worldwide sales were $9,539 million for the nine months ended
September 30, 2003 as compared with $9,394 million for the nine months
ended September 30, 2002, representing an increase of $145 million, or
2% as reported, or a decrease of 3% excluding the favorable impact of
exchange. The increase in net sales was primarily due to the favorable
impact from exchange of approximately 5.3 percentage points, and
increased volumes of approximately 0.6 percentage point, primarily
driven by digital cameras and entertainment print films, partially
offset by volume declines related to consumer film and photofinishing.
These increases were partially offset by decreases attributable to
price/mix, which reduced sales by approximately 4.1 percentage points,
primarily driven by consumer film, photofinishing and consumer digital
cameras.
Net sales in the U.S. were $4,115 million for the current year period
as compared with $4,357 million for the prior year period, representing
a decrease of $242 million, or 6%. Net sales outside the U.S. were
$5,424 million for the current year period as compared with $5,037
million for the prior year period, representing an increase of $387
million, or 8% as reported, or a decrease of 2% excluding the favorable
impact of exchange.
The Company's operations outside the U.S. are reported in three
regions: (1) the Europe Africa and Middle East region (EAMER), (2) the
Asia Pacific region and (3) the Canada and Latin America region. Net
sales in the EAMER region for the first nine months of 2003 were $2,879
million as compared with $2,621 million for the first nine months of
2002, representing an increase of 10% as reported, or a decrease of 4%
excluding the favorable impact of exchange. Net sales in the Asia
Pacific region for the first nine months of 2003 were $1,676 million as
compared with $1,619 million for the first nine months of 2002,
representing an increase of 4% as reported, or a decrease of 2%
excluding the favorable impact of exchange. Net sales in the Canada
and Latin America region for the first nine months of 2003 were $869
million as compared with $797 million for the first nine months of
2002, representing an increase of 9% as reported, or 5% excluding the
favorable impact of exchange.
The Company's major emerging markets include China, Brazil, India,
Mexico, Russia, Korea, Hong Kong and Taiwan. Net sales for Emerging
Market countries were $1,857 million for the nine months ended
September 30, 2003 as compared with $1,782 million for the nine months
ended September 30, 2002, representing an increase of $75 million, or
4% as reported, or 1% excluding the favorable impact of exchange.
Sales growth in Russia, India and China of 26%, 16% and 8%,
respectively, were the primary drivers of the increase in sales in
Emerging Market countries, partially offset by decreased sales in
Taiwan, Hong Kong, Brazil, and Mexico of 22%, 12%, 11% and 4%,
respectively.
55
The increase in sales in Russia is a result of continued growth in the
number of Kodak Express stores and the Company's efforts to expand the
distribution channels for Kodak products and services. Sales increases
in India were driven by continued success from the Company's efforts to
increase the level of camera ownership and to increase the number of
Photoshop retail stores. Sales growth in China resulted from strong
business performance for all Kodak's operations in that region in the
first and third quarters of 2003; however, this growth was partially
offset by the impact of SARS particularly for consumer and professional
products and services, which negatively impacted sales in China during
the second quarter. The sales declines experienced in Hong Kong and
Taiwan for the nine months ended September 30, 2003 are also a result
of the impact from SARS. The declines in Brazil and Mexico are
reflective of the continued economic weakness experienced in those
countries.
Gross profit was $3,067 million for the nine months ended September 30,
2003 as compared with $3,404 million for the nine months ended
September 30, 2002, representing a decrease of $337 million, or 10%.
The gross profit margin was 32.2% in the current year period as
compared with 36.2% in the prior year period. The decrease of 4.0
percentage points was comprised of declines attributable to price/mix,
driven by consumer film, photofinishing and consumer digital cameras,
which reduced gross profit margins by approximately 4.2 percentage
points, and $57 million of accelerated depreciation and inventory write-
downs associated with focused cost reduction programs which negatively
impacted gross profit margins by approximately 0.6 percentage point.
These declines were partially offset by favorable exchange, which
increased gross profit margins by approximately 0.8 percentage point.
SG&A expenses were $1,921 million for the nine months ended September
30, 2003 as compared with $1,827 million for the nine months ended
September 30, 2002, representing an increase of $94 million, or 5%.
SG&A increased as a percentage of sales from 19.4% for the prior year
period to 20.1% for the current year period. The net increase in SG&A
is primarily attributable to the following: a charge of $12 million
relating to an intellectual property settlement; a charge of $14
million relating to a patent infringement claim; a charge of $14
million associated with the settlement of outstanding issues relating
to a prior year acquisition; a charge of $9 million associated with the
write-down of the Burrell Companies' net assets held for sale; a charge
of $8 million relating to a donation to a technology enterprise for
research purposes; and unfavorable exchange of $84 million. These
items were partially offset by cost savings realized from position
eliminations associated with ongoing focused cost reduction programs
and asset write-down charges of $23 million in the nine month period
ended September 30, 2002.
R&D costs remained the same at $567 million for both the nine months
ended September 30, 2003 and nine months ended September 30, 2002. R&D
decreased slightly as a percentage of sales from 6.0% for the prior
year period to 5.9% for the current year period.
56
Earnings from continuing operations before interest, other charges, and
income taxes for the nine months ended September 30, 2003 were $351
million as compared with $1,019 million for the nine months ended
September 30, 2002, representing a decrease of $668 million, or 66%.
The decrease is primarily the result of (1) the decline in gross profit
margin and an increase in SG&A, and (2) net focused cost reduction
charges of $285 million incurred during the first three quarters of
2003, as compared with a net credit of $9 million recorded in the first
three quarters of 2002 for focused cost reduction activities.
Interest expense for the nine months ended September 30, 2003 was $104
million as compared with $128 million for the nine months ended
September 30, 2002, representing a decrease of $24 million, or 19%.
The decrease in interest expense is primarily attributable to lower
interest rates and lower average borrowing levels in the first nine
months of 2003 relative to the first nine months of 2002.
Other charges for the current year period were a net charge of $39
million as compared with a net charge of $74 million for the prior year
period. The decrease in other charges is primarily attributable to
increased income from the Company's equity investment in KPG and
decreased losses incurred in relation to the Company's equity
investment in the Phogenix joint venture, which was dissolved in the
second quarter of 2003.
The effective tax benefit rate for the nine months ended September 30,
2003 was approximately 11%, as compared with an effective tax rate of
19% for the nine months ended September 30, 2002. The decrease in the
effective tax rate is due to a decrease in the estimated annual
effective tax rate from 29% in the first three quarters of 2002 to 19%
in the first three quarters of 2003, as well as discrete period items,
which resulted in tax benefits of $131 million in the first three
quarters of 2003. The decrease in the estimated annual effective tax
rate from 29% for the first three quarters of 2002 to 19% for the first
three quarters of 2003 was primarily attributable to expected increased
earnings from operations in certain lower-taxed jurisdictions outside
the U.S. relative to total consolidated earnings, and an expected
increase in benefits from the utilization of foreign tax credits. The
discrete period items are attributable to the following items, all of
which are taxed in jurisdictions that, when aggregated, have tax rates
greater than the estimated annual effective tax rate: net focused cost
reduction charges of $285 million; a $21 million charge for purchased
in-process research and development costs; a $14 million charge for the
settlement of a patent infringement claim; a $14 million charge for the
settlement of certain issues relating to a prior year acquisition; a
$12 million charge related to an intellectual property settlement; a $9
million charge related to the impairment of the Burrell Companies' net
assets held for sale; and a $8 million charge for a cash donation to a
technology enterprise for research purposes. In addition, the discrete
period items also include a tax benefit of $8 million relating to the
donation of intellectual property to a tax-qualified organization.
57
The effective tax rate of 19% for the nine months ended September 30,
2002 was lower than the Company's estimated annual effective tax rate
of 29% for 2002 due to the recording of discrete period tax benefits of
$45 million in connection with the closure of the Company's
PictureVision subsidiary and a $46 million tax benefit relating to the
consolidation of the Company's photofinishing operations in Japan and
the loss realized from the liquidation of a subsidiary as part of that
consolidation.
Earnings from continuing operations for the nine months ended September
30, 2003 were $231 million, or $.81 per basic and diluted share, as
compared with earnings from continuing operations for the nine months
ended September 30, 2002 of $663 million, or $2.27 per basic and
diluted share, representing a decrease of $432 million, or 65%. The
decrease in net earnings is primarily attributable to the reasons
described above.
Photography
Net worldwide sales for the Photography segment were $6,614 million for
the nine months ended September 30, 2003 as compared with $6,601
million for the nine months ended September 30, 2002, representing an
increase of $13 million, or a decrease of 5% excluding the favorable
impact of exchange. The increase in net sales was due to the favorable
impact of exchange of approximately 5.5 percentage points. This
increase was offset by (1) decreases related to volume, driven
primarily by consumer film and photofinishing, which were partially
offset by increases in volume for consumer digital and entertainment
products and services, which in total, reduced net sales by 0.3
percentage point and (2) declines attributable to price/mix primarily
driven by consumer film, photofinishing and consumer digital cameras,
which reduced net sales by approximately 5.0 percentage points.
Photography segment net sales in the U.S. were $2,668 million for the
current year period as compared with $2,933 million for the prior year
period, representing a decrease of $265 million, or 9%. Photography
segment net sales outside the U.S. were $3,946 million for the current
year period as compared with $3,668 million for the prior year period,
representing an increase of $278 million, or 8% as reported, or a
decrease of 2% excluding the favorable impact of exchange.
Net worldwide sales of consumer film products, including 35mm film,
Advantix film and one-time-use cameras, decreased 9% in the nine months
ended September 30, 2003 as compared with the nine months ended
September 30, 2002, reflecting declines in volume and negative
price/mix of approximately 11% and 4%, respectively, partially offset
by favorable exchange of approximately 6%. Sales of the Company's
consumer film products within the U.S. decreased 17%, reflecting
declines in volume of approximately 15% and negative price/mix of
approximately 2%. The decrease in volume is largely attributable to
the decrease in U.S. consumer film industry volume in the first nine
months of 2003, as described below, which reflects the downward trend
in retail sales. Sales of the Company's consumer film products outside
the U.S. decreased 1%, reflecting declines in volume and negative
price/mix of approximately 9% and 2%, respectively, which was partially
offset by favorable exchange of approximately 10%.
58
The U.S. film industry volume decreased approximately 7% in the nine
month period ended September 30, 2003 as compared with the nine month
period ended September 30, 2002. The most current U.S. market data
trends suggest that, for the nine month period ended September 30,
2003, digital substitution accounted for the majority of the industry
decline.
The Company's blended U.S. consumer film share decreased slightly on a
volume basis in the first nine months of 2003 relative to the first
nine months of 2002. Management remains confident in maintaining full
year, 2002 year-over-year U.S. market share as it has done for the past
several consecutive years.
Worldwide volumes of consumer color paper decreased mid-single digits
in the nine month period ended September 30, 2003 as compared with the
nine month period ended September 30, 2002 with U.S. volumes declining
low double digits and volumes outside the U.S. decreasing mid-single
digits. Kodak will no longer report sales trends for consumer color
negative paper because paper and other products are typically bundled
together as a "systems sell" for customer contracting purposes.
Net worldwide sales of photofinishing services (excluding equipment),
including Qualex in the U.S. and CIS outside the U.S., decreased 16% in
the nine month period ended September 30, 2003 as compared with the
nine month period ended September 30, 2002, reflecting lower volumes
and negative price/mix, partially offset by favorable exchange. In the
U.S., Qualex's sales decreased 20% in the first nine months of 2003 as
compared with the first nine months of 2002, reflecting the effects of
a continued weak film industry, consumer's shifting preference to on-
site processing, and the adverse impact of several hundred store
closures by a major U.S. retailer.
Net sales from the Company's consumer digital products and services,
which include picture maker kiosks/media and retail consumer digital
services revenue from Picture CD and Retail.com, increased 6% in the
nine month period ended September 30, 2003 as compared with the nine
month period ended September 30, 2002, driven primarily by an increase
in sales of picture maker kiosks and consumer digital services.
The Company's Ofoto business increased its sales 58% in the first nine
months of 2003, as compared with the first nine months of 2002.
Ofoto's sales represented less than 1% of the Company's consolidated
net worldwide sales for the nine months ended September 30, 2003.
Ofoto now has almost 10 million members and continues to be the market
leader in the online photo services space.
59
Net worldwide sales of consumer digital cameras increased 73% in the
nine month period ended September 30, 2003 as compared with the nine
month period ended September 30, 2002, primarily reflecting strong
increases in volume and a favorable impact from exchange, partially
offset by declines due to price/mix. Sales continue to be driven by
strong customer acceptance of the EasyShare digital camera system and
an expanding product line. In addition, Kodak's new Printer Dock
products, which were introduced in the first quarter of 2003,
experienced strong sales growth during the period.
While complete data for third quarter consumer digital market share is
not yet available, Kodak's U.S. consumer digital camera market share
year-to-date through August 2003 is up 1 percentage point as compared
with the same period in 2002. All indications are that Kodak continues
to hold one of the top U.S. market share positions in channels
reporting share data; although some of Kodak's largest channels do not
report share data.
Net worldwide sales of inkjet photo paper increased 45% in the nine
month period ended September 30, 2003 as compared with the nine month
period ended September 30, 2002. The Company maintained its top two
market share position in the United States during the period. The
double-digit revenue growth and the maintenance of market share are
primarily attributable to strong underlying market growth, successful
merchandising efforts and the continued growth and acceptance of a new
line of small format inkjet papers.
Net worldwide sales of professional film capture products, including
color negative, color reversal and black and white films, decreased 10%
in the nine month period ended September 30, 2003 as compared with the
nine month period ended September 30, 2002, reflecting declines in
volume and negative price/mix, partially offset by favorable exchange.
Sales declines resulted primarily from the combined impacts of ongoing
digital evolution and continued economic weakness in markets worldwide.
Net worldwide sales of professional sensitized output, including color
negative paper and display materials, increased 1% in the first nine
months of 2003 as compared with the first nine months of 2002 due to
favorable exchange, which is partially offset by declines in volume and
negative price/mix. In addition, net worldwide sales of digital
writers and digital cameras increased in the current year period as
compared to the prior year period.
Net worldwide sales of origination and print film to the entertainment
industry increased 14% in the nine month period ended September 30,
2003 as compared with the nine month period ended September 30, 2002,
reflecting higher print film volumes due to a strong industry motion
picture release schedule, continued strong customer acceptance for the
new Vision 2 origination film and favorable exchange, which were
partially offset by negative price/mix.
60
Gross profit for the Photography segment was $2,066 million for the
nine month period ended September 30, 2003 as compared with $2,377
million for the nine month period ended September 30, 2002,
representing a decrease of $311 million, or 13%. The gross profit
margin was 31.2% in the current year period as compared with 36.0% in
the prior year period. The 4.8 percentage point decrease was comprised
of declines attributable to price/mix, primarily driven by consumer
film, photofinishing and consumer digital cameras, which decreased
gross profit margins by approximately 5.3 percentage points and
increases in manufacturing cost, which decreased gross profit margins
by approximately 0.5 percentage point. This decrease was partially
offset by favorable exchange, which increased gross profit margins by
approximately 1.0 percentage point.
SG&A expenses for the Photography segment increased $35 million, or 3%,
from $1,395 million for the nine month period ended September 30, 2002
to $1,430 million for the nine month period ended September 30, 2003.
As a percentage of sales, SG&A expense increased from 21.1% in the
prior year period to 21.6% in the current year period. The increase is
primarily attributable to unfavorable exchange of $68 million,
partially offset by cost savings realized from position eliminations
associated with ongoing focused cost reduction programs.
R&D costs for the Photography segment decreased $27 million, or 7%,
from $386 million in the nine month period ended September 30, 2002 to
$359 million in the nine month period ended September 30, 2003. As a
percentage of sales, R&D costs decreased from 5.8% in the prior year
period to 5.4% in the current year period. The decrease in R&D was
primarily attributable to cost savings realized from position
eliminations associated with ongoing focused cost reduction programs.
This decrease was partially offset by a $21 million charge recorded in
the first quarter of 2003 associated with the write-off of purchased in-
process R&D.
Earnings from continuing operations before interest, other charges, and
income taxes for the Photography segment decreased $320 million, or
54%, from $597 million in the nine month period ended September 30,
2002 to $277 million in the nine month period ended September 30, 2003,
primarily as a result of the factors described above.
61
Health Imaging
Net worldwide sales for the Health Imaging segment were $1,727 million
for the nine month period ended September 30, 2003 as compared with
$1,655 million for the first nine months of 2002, representing an
increase of $72 million, or 4% as reported, or a decrease of 1%
excluding the favorable impact of exchange. The increase in sales was
comprised of (1) an increase in volume of approximately 2.2 percentage
points, driven primarily by volume increases in digital media, digital
capture equipment and services, and (2) an increase from favorable
exchange of approximately 5.1 percentage points, which was partially
offset by a decrease attributable to price/mix of approximately 2.9
percentage points, primarily driven by digital media, digital capture
equipment and analog medical film.
Net sales in the U.S. were $755 million for the nine month period ended
September 30, 2003 as compared with $791 million for the first nine
months of 2002, representing a decrease of $36 million, or 5%. Net
sales outside the U.S. were $972 million for the first nine months of
2003 as compared with $864 million for the nine month period ended
September 30, 2002, representing an increase of $108 million, or 13% as
reported, or 3% excluding the favorable impact of exchange.
Net worldwide sales of digital products, which include laser printers
(DryView imagers and wet laser printers), digital media (DryView and
wet laser media), digital capture equipment (computed radiography
capture equipment and digital radiography equipment), services and
Picture Archiving and Communications Systems (PACS), increased 9% for
the nine month period ended September 30, 2003 as compared with the
first nine months of 2002. The increase in digital product sales was
primarily attributable to favorable exchange and higher volumes of
digital media, digital capture equipment and services, which were
partially offset by negative price/mix. Service revenues increased due
to an increase in digital equipment service contracts during the first
nine months of 2003 as compared with the prior year period.
Net worldwide sales of traditional products, including analog film,
equipment, chemistry and services, decreased 1% for the first nine
months of 2003 as compared with the first nine months of 2002,
reflecting declines in volume and negative price/mix of traditional
products, which were partially offset by favorable exchange.
62
Gross profit for the Health Imaging segment was $742 million for the
first nine months of 2003 as compared with $677 million for the nine
month period ended September 30, 2002, representing an increase of $65
million, or 10%. The gross profit margin was 43.0% in the current year
period as compared with 40.9% in the first nine months of 2002. The
increase in the gross profit margin of 2.1 percentage points was
principally attributable to (1) a decrease in manufacturing cost, which
increased gross profit margins by approximately 3.0 percentage points,
primarily due to favorable media and equipment manufacturing
productivity led by DryView digital media and digital capture
equipment, complemented by lower service costs and improved supply
chain management, and (2) favorable exchange, which contributed
approximately 1.1 percentage points to the gross profit margin. These
increases were partially offset by decreases attributable to price/mix,
which negatively impacted gross profit margins by 2.0 percentage points
due to lower prices for digital media, digital capture equipment and
analog medical film.
SG&A expenses for the Health Imaging segment increased $12 million, or
5%, from $253 million in the first nine months of 2002 to $265 million
for the nine month period ended September 30, 2003, but remained
unchanged as a percentage of sales at 15.3%. The increase in SG&A
expenses is primarily attributable to the unfavorable effects of
foreign exchange, which increased SG&A expenses by $11 million in the
current period relative to the prior year period and increased spending
to drive growth.
R&D costs increased $9 million, or 8%, from $111 million for the first
nine months of 2002 to $120 million for the first nine months of 2003,
and increased slightly as a percentage of sales from 6.7% to 6.9%. R&D
expenses increased in the first nine months as the segment increased
spending to drive growth in selected areas of the product portfolio.
Earnings from continuing operations before interest, other charges, and
income taxes for the Health Imaging segment increased $43 million, or
14%, from $314 million for the prior year period to $357 million for
the first nine months of 2003 due primarily to the reasons described
above.
On October 7, 2003, the Company completed the acquisition of all of the
outstanding shares of PracticeWorks, Inc., a leading provider of dental
practice management software and digital radiographic imaging systems
for $468 million in cash and assumed net debt of approximately $18
million. This acquisition is expected to contribute approximately $215
million in sales to the Health Imaging segment during the first full
year. It is anticipated that the transaction will be slightly dilutive
to earnings from the date of acquisition through the end of 2005 and
accretive to earnings thereafter. This acquisition will enable Kodak
to offer its customers a full spectrum of dental imaging products and
services from traditional film to digital radiography and photography
and is expected to move Health Imaging into the leading position in the
dental practice management and dental radiographic markets.
63
Commercial Imaging
Net worldwide sales for the Commercial Imaging segment were $1,127
million for the first nine months of 2003 as compared with $1,060
million for the nine month period ended September 30, 2002,
representing an increase of $67 million, or 6% as reported, or 3%
excluding the favorable impact of exchange. The increase in net sales
was primarily comprised of (1) increases in volume, which contributed
approximately 4.7 percentage points to the first nine months of 2003
sales, which was primarily attributable to imaging services and
document scanners, and (2) an increase of approximately 3.0 percentage
points due to favorable exchange, which was partially offset by
declines due to price/mix of approximately 1.4 percentage points,
primarily driven by graphics products.
Net sales in the U.S. were $657 million for the current year period as
compared with $593 million for the first nine months of 2002,
representing an increase of $64 million, or 11%. Net sales outside the
U.S. were $470 million in the first nine months of 2003 as compared
with $467 million for the prior year period, representing an increase
of $3 million or 1% as reported, or a decrease of 6% excluding the
favorable impact of exchange.
Net worldwide sales of graphic arts products to Kodak Polychrome
Graphics (KPG), an unconsolidated joint venture affiliate in which the
Company has a 50% ownership interest, decreased 16% in the nine month
period ended September 30, 2003 as compared with the first nine months
of 2002, primarily reflecting volume declines and declines due to
price/mix in graphic arts film. This reduction resulted largely from
digital technology evolution and the effect of continuing economic
weakness in the commercial printing market.
Despite a continued weakness in the global economy, KPG's earnings
performance continues to improve driven primarily by its world leading
position in the growth segments of digital proofing and digital
printing plates, coupled with favorable foreign exchange. KPG's
operating profit has been positive for 13 consecutive quarters and has
shown consistent improvement during that same period. The Company's
equity in the earnings of KPG contributed positive results to other
charges during the first nine months of 2003.
NexPress, the unconsolidated joint venture between Kodak and Heidelberg
in which the Company has a 50% ownership interest, continues to
increase unit placements of the NexPress 2100 Digital Production Color
Press despite a weak printing market, with good customer acceptance and
average monthly page volumes for these units running higher than
planned.
64
Gross profit for the Commercial Imaging segment was $305 million for
the first nine months of 2003 as compared with $333 million for the
nine month period ended September 30, 2002, representing a decrease of
$28 million, or 8%. The gross profit margin was 27.1% in the current
year period as compared with 31.4% in the first nine months of 2002.
The decrease in the gross profit margin of 4.3 percentage points was
primarily attributable to (1) declines attributable to price/mix, which
reduced gross profit margins by approximately 1.2 percentage points
primarily due to declining contributions from traditional graphic arts
products, (2) an increase in manufacturing cost which negatively
impacted gross profit margins by approximately 2.8 percentage points,
and (3) unfavorable exchange, which negatively impacted gross profit
margins by 0.3 percentage point.
SG&A expenses for the Commercial Imaging segment increased $4 million,
or 3%, from $144 million for the first nine months of 2002 to $148
million for the nine month period ended September 30, 2003, but
decreased as a percentage of sales from 13.6% to 13.1%. The increase
in SG&A expense was due to the impact of unfavorable exchange, which
accounted for the entire $4 million increase.
R&D costs for the Commercial Imaging segment decreased $6 million, or
13%, from $46 million for the first nine months of 2002 to $40 million
for the first nine months of 2003, and decreased as a percentage of
sales from 4.3% to 3.5%.
Earnings from continuing operations before interest, other charges, and
income taxes for the Commercial Imaging segment decreased $26 million,
or 18%, from $143 million in the first nine months of 2002 to $117
million in the first nine months of 2003. This decrease is primarily
attributable to the reasons described above.
All Other
Net worldwide sales for All Other were $71 million for the first nine
months of 2003 as compared with $78 million for the first nine months
of 2002, representing a decrease of $7 million, or 9%. Net sales in
the U.S. decreased $5 million, or 13%, from $40 million for the nine
month period ended September 30, 2002 to $35 million for the first nine
months of 2003. Net sales outside the U.S. were $36 million in the
first nine months of 2003 as compared with $38 million in the prior
year period, representing a decrease of $2 million, or 5%.
SK Display Corporation, the OLED manufacturing joint venture between
Kodak and Sanyo, is currently supplying OLED screens to the Company for
its digital camera manufacturing and continues production scale-up with
the goal of supplying production quantity OLED screens to the
marketplace throughout the remainder of 2003.
The loss from continuing operations before interest, other charges, and
income taxes for All Other was $58 million for the nine months ended
September 30, 2003 as compared with a loss of $21 million for the first
nine months of 2002, representing a decrease of $37 million. This
decrease was primarily driven by increased levels of investment for the
Company's Display business.
65
RESULTS OF OPERATIONS - DISCONTINUED OPERATIONS
Earnings from discontinued operations were $.05 per basic and diluted
share for the first nine months of 2003, as compared with a loss from
discontinued operations for the first nine months of 2002 of $.02 per
basic and diluted share. During the nine month period ended September
30, 2003, the Company reversed a tax reserve of $15 million through
discontinued operations. The reversal of the tax reserve was triggered
by the Company's repurchase of certain properties that were initially
sold in connection with the 1994 divestiture of Sterling Winthrop Inc.,
which represented a portion of the Company's non-imaging health
businesses. The repurchase of these properties will allow the Company
to directly manage the environmental remediation that the Company is
required to perform in connection with those properties, which will
result in better overall cost control. In addition, the repurchase
eliminated the uncertainty regarding the recoverability of tax benefits
associated with the indemnification payments that were previously being
made to the purchaser.
NET EARNINGS
Net earnings for the first nine months of 2003 were $246 million, or
$.86 per basic and diluted share, as compared with net earnings for the
first nine months of 2002 of $657 million, or $2.25 per basic and
diluted share, representing a decrease of $411 million, or 63%. This
decrease is primarily attributable to the reasons outlined above.
- -----------------------------------------------------------------------
66
RESTRUCTURING
Currently, the Company is being adversely impacted by negative global
economic conditions and a progressing digital transition. As the
Company continues to adjust its operating model in light of changing
business conditions, it is probable that ongoing cost reduction
activities will be required from time to time.
In accordance with this, the Company periodically announces planned
restructuring programs (Programs), which often consist of a number of
restructuring initiatives. These Program announcements provide
estimated ranges relating to the number of positions to be eliminated
and the total restructuring charges to be incurred. The actual charges
for initiatives under a Program are recorded in the period in which the
Company commits to formalized restructuring plans or executes the
specific actions contemplated by the Program and all criteria for
restructuring charge recognition under the applicable accounting
guidance have been met.
Fourth Quarter, 2002 Restructuring Program
During the fourth quarter of 2002, the Company announced a planned
Program consisting of a number of focused cost reduction initiatives
designed to deploy manufacturing assets more effectively in order to
provide competitively-priced products to the global market. In the
announcement, the Company discussed the restructuring initiatives under
its Fourth Quarter, 2002 Restructuring Program that would begin in the
fourth quarter of 2002 and extend into 2003. These initiatives were
expected to affect a total of 1,300 to 1,700 positions worldwide,
including approximately 150 positions in the Company's U.S. research
and development organizations, 500 positions in its U.S. one-time-use
camera assembly operations, 300 positions in its Mexico sensitizing
operations and 550 positions in its global manufacturing and logistics
organization. Specific initiatives included the relocation of the one-
time-use camera assembly operations in Rochester, New York and the
graphic arts and x-ray film sensitizing operations in Mexico to other
Kodak locations.
The total restructuring charge for continuing operations recorded in
the fourth quarter of 2002 for these initiatives that were implemented
was $116 million, which was composed of severance, inventory write-
downs, long-lived asset impairments and exit costs of $55 million, $7
million, $37 million and $17 million, respectively. The severance
charge related to the termination of 1,150 employees, including
approximately 525 manufacturing and logistics, 300 service and
photofinishing, 175 administrative and 150 research and development
positions.
67
The geographic composition of the 1,150 employees terminated included
approximately 775 in the United States and Canada and 375 throughout
the rest of the world. The charge for the long-lived asset impairments
includes the write-off of $13 million relating to equipment used in the
manufacture of cameras and printers, $13 million for sensitized
manufacturing equipment, $5 million for lab equipment used in
photofinishing and $6 million for other assets that were scrapped or
abandoned immediately. The reduction of 1,150 employees and the $72
million charge for severance and exit costs are reflected in the Fourth
Quarter, 2002 Restructuring Program table below. These amounts exclude
the fourth quarter termination of 150 employees and the restructuring
charges relating to the shutdown of Kodak Global Imaging, Inc., as
these charges were reflected in the loss from discontinued operations
for the year ended December 31, 2002.
During the first quarter of 2003, the Company recorded an additional
severance charge of $16 million in continuing operations relating to
450 positions that were contemplated under its Fourth Quarter, 2002
Restructuring Program. The reduction of 450 positions and the related
severance charge of $16 million are reflected in the Fourth Quarter,
2002 Restructuring Program table below.
During the second quarter of 2003, the Company recorded an additional
severance charge of $1 million in continuing operations relating to the
elimination of 25 manufacturing positions in Mexico, which were
associated with the relocation of Mexican sensitizing operations and
that were anticipated under its Fourth Quarter, 2002 Restructuring
Program. The reduction of 25 positions and the related severance
charge of $1 million are reflected in the Fourth Quarter, 2002
Restructuring Program table below.
During the third quarter of 2003, the Company recorded an additional
charge of $4 million in continuing operations relating to the
elimination of 200 U.S. manufacturing positions, which were eliminated
as a result of the relocation of the U.S. one-time-use camera assembly
operations and that were anticipated under the Fourth Quarter, 2002
Restructuring Program. The reduction of 200 positions and the related
severance charge of $4 million are reflected in the Fourth Quarter,
2002 Restructuring Program table below. All actions anticipated under
the Fourth Quarter, 2002 Restructuring Program have now been completed.
68
The following table summarizes the activity with respect to the
severance and exit cost charges recorded in connection with the focused
cost reductions that were announced in the fourth quarter of 2002 and
the remaining balance in the related reserves at September 30, 2003:
(dollars in millions)
Exit
Number of Severance Costs
Employees Reserve Reserve Total
--------- -------- ------- -------
Q4, 2002 charges l,l50 $ 55 $ 17 $ 72
Q4, 2002 utilization (250) (2) - (2)
------ ----- ---- ----
Balance at 12/31/02 900 53 17 70
Q1, 2003 charges 450 16 - 16
Q1, 2003 utilization (850) (24) (2) (26)
------ ----- ---- ----
Balance at 3/31/03 500 45 15 60
Q2, 2003 charges 25 1 - 1
Q2, 2003 utilization (500) (11) (4) (15)
------ ----- ---- ----
Balance at 6/30/03 25 35 11 46
Q3, 2003 charges 200 4 - 4
Q3, 2003 utilization (225) (8) (2) (10)
------ ----- ---- ----
Balance at 9/30/03 0 $ 31 $ 9 $40
====== ===== ==== ====
The severance charges taken in the third quarter and first three
quarters of 2003 of $4 million and $21 million, respectively, were
reported in restructuring costs and other in the accompanying
Consolidated Statement of Earnings for the three and nine months ended
September 30, 2003, respectively. The severance and exit costs require
the outlay of cash, while the inventory write-downs and long-lived
asset impairments represent non-cash items. Severance payments will
continue beyond 2003 since, in many instances, the terminated employees
can elect or are required to receive their severance payments over an
extended period of time. Most exit costs are expected to be paid
during 2003. However, certain costs, such as long-term lease payments,
will be paid over periods after 2003.
As a result of initiatives implemented under the Fourth Quarter, 2002
Restructuring Program, the Company recorded $3 million and $24 million
of accelerated depreciation on long-lived assets in cost of goods sold
in the accompanying Consolidated Statement of Earnings for the three
and nine months ended September 30, 2003, respectively. The
accelerated depreciation relates to long-lived assets accounted for
under the held and used model of SFAS No. 144, and the year-to-date
amount of $24 million was comprised of $15 million relating to
equipment used in the manufacture of cameras, $6 million for lab
equipment used in photofinishing and $3 million for sensitized
manufacturing equipment that will be used until their abandonment in
2003.
69
Cost savings resulting from the implementation of all Fourth Quarter,
2002 Restructuring Program actions are in line with the original
estimate and are still expected to be approximately $90 million to $95
million in 2003 and $205 million to $210 million on an annual basis
thereafter.
The $7 million of charges recorded in the third quarter of 2003 were
applicable to the Photography segment. The year-to-date charges of $45
million included $30 million of charges applicable to the Photography
segment, $3 million relating to the Commercial Imaging segment and $12
million associated with manufacturing, research and development, and
administrative functions, which are shared across all segments.
First Quarter, 2003 Restructuring Program
In the early part of the first quarter of 2003, as part of its
continuing focused cost-reduction efforts and in addition to the
remaining initiatives under the Fourth Quarter, 2002 Restructuring
Program, the Company announced its First Quarter, 2003 Restructuring
Program that included new initiatives to further reduce employment
within a range of 1,800 to 2,200 employees. A significant portion of
these new initiatives relate to the rationalization of the Company's
photofinishing operations in the U.S. and Europe. Specifically, as a
result of declining film and photofinishing volumes and in response to
global economic and political conditions, the Company began to
implement initiatives to 1) close certain photofinishing operations in
the U.S. and EAMER, 2) rationalize manufacturing capacity by
eliminating manufacturing positions on a worldwide basis and 3)
eliminate selling, general and administrative positions, particularly
in the Photography segment.
The total restructuring charge for continuing operations recorded in
the first quarter of 2003 relating to the First Quarter, 2003
Restructuring Program was $28 million, which represented severance
charges relating to 425 positions that are being eliminated. The
reduction of 425 positions and the total restructuring charge of $28
million are reflected in the First Quarter, 2003 Restructuring Program
table below.
The total severance charge of $44 million recorded in the first quarter
of 2003 relating to the Fourth Quarter, 2002 and the First Quarter,
2003 Restructuring Programs, represents the total termination of 875
employees, including approximately 450 manufacturing and logistics, 250
administrative and 175 photofinishing positions. The geographic
composition of the employees terminated include approximately 425 in
the United States and Canada and 450 throughout the rest of the world.
70
The total restructuring charges for continuing operations recorded in
the second quarter of 2003 for actions that were contemplated under the
First Quarter, 2003 Restructuring Program were $29 million, which was
composed of severance, inventory write-downs, long-lived asset
impairments and exit costs of $20 million, $1 million, $4 million and
$4 million, respectively. The severance charge related to the
termination of 500 employees, including approximately 250
photofinishing, 125 manufacturing and 125 administrative positions.
The geographic composition of the employees to be terminated include
approximately 200 in the United States and Canada and 300 throughout
the rest of the world. The reduction of 500 positions and the $24
million charge for severance and exit costs are reflected in the First
Quarter, 2003 Restructuring Program table below.
The total restructuring charges for continuing operations recorded in
the third quarter of 2003 for actions that were contemplated under the
First Quarter, 2003 Restructuring Program were $24 million, which was
composed of severance, long-lived asset impairments and exit costs of
$19 million, $1 million and $4 million, respectively. The severance
charge related to the termination of 925 employees, including
approximately 800 photofinishing and 125 administrative positions. The
geographic composition of the employees to be terminated include
approximately 700 in the United States and Canada and 225 throughout
the rest of the world. The reduction of the 925 positions and the $23
million charge for severance and exit costs are reflected in the First
Quarter, 2003 Restructuring Program table below. All actions
anticipated under the First Quarter, 2003 Restructuring Program have
now been completed.
The following table summarizes the activity with respect to the
severance and exit cost charges recorded in connection with the focused
cost reductions that were announced in the first quarter of 2003 and
the remaining balances in the related reserves at September 30, 2003:
(dollars in millions)
Exit
Number of Severance Costs
Employees Reserve Reserve Total
--------- -------- ------- -----
Q1, 2003 charges 425 $ 28 $ - $ 28
Q1, 2003 utilization (150) (2) - (2)
----- ---- ---- ----
Balance at 3/31/03 275 26 - 26
Q2, 2003 charges 500 20 4 24
Q2, 2003 utilization (500) (13) - (13)
---- ---- ---- ----
Balance at 6/30/03 275 33 4 37
Q3, 2003 charges 925 19 4 23
Q3, 2003 utilization (400) (12) (1) (13)
---- ---- ---- ----
Balance at 9/30/03 800 $ 40 $ 7 $ 47
==== ==== ==== ====
71
The first quarter charges of $28 million were reported in restructuring
costs and other in the accompanying Consolidated Statement of Earnings
for the nine months ended September 30, 2003. The second quarter
charges for severance, long-lived asset impairments and exit cost
reserves were reported in restructuring costs and other in the
accompanying Consolidated Statement of Earnings for the nine months
ended September 30, 2003. The third quarter charges for severance,
long-lived asset impairments and exit cost reserves were reported in
restructuring costs and other in the accompanying Consolidated
Statement of Earnings for the three and nine months ended September 30,
2003. The charges taken for inventory write-downs of $1 million
were reported in cost of goods sold in the accompanying
Consolidated Statement of Earnings for the nine months ended
September 30, 2003, respectively. The severance and exit costs require
the outlay of cash, while the inventory write-downs and long-lived
asset impairments represent non-cash items. Severance payments
relating to the First Quarter, 2003 Restructuring Program actions will
be paid during the period from 2003 through 2005 since, in many
instances, the terminated employees can elect or are required to
receive their severance payments over an extended period of time.
Most exit costs are expected to be paid during 2003. However, certain
costs, such as long-term lease payments, will be paid over periods
after 2003.
In addition to the $29 million of restructuring charges recorded in the
second quarter of 2003 under the First Quarter, 2003 Restructuring
Program, the Company recorded $17 million of charges in the second
quarter associated with the Company's exit from the Photography
segment's Phogenix joint venture with Hewlett Packard. The $17 million
charge included approximately $2 million of inventory write-downs, $6
million of long-lived asset impairments and $9 million of exit costs.
The inventory write-downs were reported in cost of goods sold in the
accompanying Consolidated Statement of Earnings for the nine months
ended September 30, 2003. The long-lived asset impairments and exit
costs were reported in restructuring costs and other in the
accompanying Consolidated Statement of Earnings for the nine months
ended September 30, 2003. The exit costs, which represent the only
cash portion of the charge, are expected to be paid during the
remainder of 2003.
As a result of initiatives implemented under the First Quarter, 2003
Restructuring Program, the Company recorded $16 million of accelerated
depreciation on long-lived assets in cost of goods sold in the
accompanying Consolidated Statement of Earnings for the three and nine
months ended September 30, 2003. The accelerated depreciation relates
to long-lived assets accounted for under the held and used model of
SFAS No. 144. The year-to-date amount of $16 million relates to lab
equipment used in photofinishing that will be used until their
abandonment in 2003. The Company will incur accelerated depreciation
charges of $14 million in the fourth quarter of 2003, $13 million in
the first quarter of 2004 and $2 million in the second quarter of 2004
as a result of the initiatives implemented under the First Quarter,
2003 Restructuring Program.
72
Cost saving resulting from the implementation of all First Quarter,
2003 Restructuring Program actions are expected to be approximately $35
million to $50 million in 2003 and $65 million to $85 million on an
annual basis thereafter.
The charges of $40 million recorded in the third quarter of 2003
included $36 million applicable to the Photography segment. The
remaining $4 million was applicable to administrative functions, which
are shared across all segments. The charges of $97 million recorded in
the nine months ended September 30, 2003 included $76 million
applicable to the Photography segment and $5 million applicable to the
Commercial Imaging segment. The remaining $16 million was applicable
to manufacturing, research and development, and administrative
functions, which are shared across all segments.
Third Quarter, 2003 Restructuring Program
During the third quarter of 2003, the Company announced that it intends
to implement a series of cost reduction actions during the last two
quarters of 2003 and the first two quarters of 2004, which are expected
to result in pre-tax charges totaling $350 million to $450 million. It
is anticipated that these actions will result in a reduction of
approximately 4,500 to 6,000 positions worldwide primarily relating to
the rationalization of global manufacturing assets, reduction of
corporate administration and R&D, and the consolidation of the
infrastructure and administration supporting the Company's consumer
imaging and professional products and services operations. The Company
expects the 2004 cost savings as a result of these actions to be $275
million to $325 million, with annual savings of $300 million to $400
million thereafter.
The Company implemented certain actions under this Program during the
third quarter of 2003. As a result of these actions, the Company
recorded a severance charge of $123 million in continuing operations
relating to the terminations of approximately 1,700 people, including
approximately 1,100 administrative, 275 manufacturing, 200
photofinishing and 125 research and development positions. The
geographic composition of the employees to be terminated include
approximately 1,075 in the United States and Canada and 625 throughout
the rest of the world. The reduction of the 1,700 positions and the
$123 million charge for severance costs are reflected in the Third
Quarter, 2003 Restructuring Program table below. In addition, during
the third quarter the Company took a $1 million charge for long-lived
asset impairments that was included in restructuring costs and other in
the accompanying Consolidated Statement of Earnings for the three and
nine months ended September 30, 2003.
73
The following table summarizes the activity with respect to the
severance charges recorded in connection with the focused cost
reductions that were announced in the third quarter of 2003 and the
remaining balances in the related reserves at September 30, 2003:
(dollars in millions)
Number of Severance
Employees Reserve Total
--------- -------- -----
Q3, 2003 charges 1,700 $123 $123
Q3, 2003 utilization (100) (3) (3)
----- ---- ----
Balance at 9/30/03 1,600 $120 $120
===== ==== ====
The severance charges taken in the third quarter of 2003 of $123
million were reported in restructuring costs and other in the
accompanying Consolidated Statement of Earnings for the three and nine
months ended September 30, 2003, respectively. The severance costs
require the outlay of cash, while the long-lived asset impairment
represents a non-cash item. Severance payments relating to the third
quarter restructuring actions will be paid during the period from 2003
through 2005, since, in many instances, the terminated employees can
elect or are required to receive their severance payments over an
extended period of time.
As a result of initiatives implemented under the Third Quarter, 2003
Restructuring Program, the Company recorded $14 million of accelerated
depreciation on long-lived assets in cost of goods sold in the
accompanying Consolidated Statement of Earnings for the three and nine
months ended September 30, 2003. The accelerated depreciation relates
to long-lived assets accounted for under the held and used model of
SFAS No. 144. The year-to-date amount of $14 million relates to
sensitized manufacturing facilities and equipment that will be used
until their abandonment in 2003 and 2004. The Company will incur
accelerated depreciation charges of $18 million in the fourth quarter
of 2003, $10 million in the first quarter of 2004, and $1 million in
the second quarter of 2004 as a result of the initiatives implemented
under the Third Quarter, 2003 Restructuring Program.
The charges of $138 million recorded in the third quarter of 2003
included $51 million applicable to the Photography segment, and $5
million applicable to the Commercial Imaging segment. The remaining
$82 million was applicable to manufacturing, research and development,
and administrative functions, which are shared across segments.
With respect to the Third Quarter, 2003 Program, the Company
anticipates completing the remaining initiatives originally
contemplated under the Program by the end of the second quarter of
2004. As a result of these initiatives, an additional 2,600 to 4,100
positions will be eliminated throughout the world by the end of the
second quarter of 2004. The estimated cost to complete these remaining
initiatives will be in the range of $200 million to $300 million. The
Company now expects the 2004 cost savings as a result of all actions
contemplated under the Third Quarter, 2003 Restructuring Program to be
$250 million to $300 million in 2004, with annual savings of $275
million to $375 million thereafter.
74
2001 Restructuring Programs
At December 31, 2002 the Company had remaining severance and exit cost
reserves of $67 million and $18 million, respectively, relating to the
restructuring plans it implemented during 2001. During the first
quarter of 2003, the Company completed the severance actions associated
with the 2001 Restructuring Programs and recorded a reversal of $12
million of reserves through restructuring costs and other in the
accompanying Consolidated Statement of Earnings for the six months
ended June 30, 2003. The completion of the 2001 Restructuring Programs
resulted in the elimination of the remaining 200 positions included in
the original plans. A total of 6,425 personnel were terminated under
the 2001 Restructuring Programs.
The remaining severance reserve of $13 million as of September 30, 2003
has not been paid since, in many instances, the terminated employees
could elect or were required to receive their severance payments over
an extended period of time. However, substantially all of these
payments will be made by the end of 2003. Most of the remaining exit
cost reserves of $15 million as of September 30, 2003 represent long-
term lease payments, which will be paid over periods after 2003.
- -----------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents increased $414 million to $983
million at September 30, 2003. The increase resulted primarily from
$843 million of net cash provided by operating activities and $30
million of net cash provided by financing activities, partially offset
by $474 million of net cash used in investing activities.
The net cash provided by operating activities of $843 million was
partially attributable to net earnings of $246 million, which, when
adjusted for the earnings from discontinued operations, equity in
losses from unconsolidated affiliates, gain on sale of assets,
depreciation and amortization, benefit from deferred taxes, and
restructuring costs, asset impairments and other charges, provided $919
million of operating cash. Also contributing to the net cash provided
by operating activities were the cash receipt of $19 million in
connection with the Sterling Winthrop Inc. settlement and the $93
million impact of the change in long-term assets and other items, net,
which were partially offset by increases in receivables of $68 million
and inventories of $65 million and a decrease in liabilities excluding
borrowings of $55 million. The net cash used in investing activities
of $474 million was utilized primarily for capital expenditures of $353
million, business acquisitions of $88 million and investments in
unconsolidated affiliates of $54 million, which were partially offset
by net proceeds from sales of assets of $21 million. The net cash
provided by financing activities of $30 million was primarily the
result of a net increase in borrowings of $276 million, partially
offset by $258 million of dividend payments.
75
As of September 30, 2003, the Company's working capital was a negative
$327 million. The negative working capital has been driven primarily
by the level of outstanding short-term debt. Short-term debt has been
issued or repaid to meet seasonal requirements and provide flexibility
on timing for the issuance of long-term debt to meet potential long-
term capital needs associated with investing activities. The Company
regularly accesses the commercial paper (short-term debt) market in
managing its working capital to fund its operating and investing
activities. During the second quarter of 2003, the Company issued $550
million of long-term debt to replace $550 million of short-term debt
resulting in improved working capital. Additionally, on October 10,
2003, the Company issued $1,075 million of long-term debt, comprised of
$500 million of Senior Notes due 2013 and $575 million of Convertible
Senior Notes due 2033, a portion of which will be used to repay
commercial paper as it comes due and to further improve working
capital. See further discussion in this section relating to these long-
term debt issuances.
The Company maintains $2,485 million in committed bank lines of credit
and $1,717 million in uncommitted bank lines of credit to ensure
continued access to short-term borrowing capacity. On July 15, 2003,
the Company's Board of Directors authorized the filing of a new shelf
registration statement that would allow the Company to register an
additional $2,000 million of long-term public debt securities. On
September 5, 2003, the Company filed a shelf registration statement on
Form S-3 (the "new debt shelf registration") for the issuance of up to
$2,000 million of new debt securities. Pursuant to Rule 429 under the
Securities Act of 1933, $650 million of remaining unsold debt
securities under a prior shelf registration statement were included in
the new debt shelf registration, thus giving the Company the ability to
issue up to $2,650 million in public debt. These funding alternatives
provide the Company with sufficient flexibility and liquidity to meet
its working capital and investing needs. However, the success of
future public debt issuances will be dependent on market conditions at
the time of such an offering. Net working capital, excluding short-
term borrowings, increased to $1,083 million from $474 million at year-
end 2002. Including short-term borrowings, net working capital
increased to negative $327 million from negative $968 million at year-
end 2002. This increase is mainly attributable to higher cash,
receivables and inventories balances, and lower accrued income taxes
balances, partially offset by higher accounts payable and other current
liabilities.
76
The Company has a dividend policy whereby it makes semi-annual payments
which, when declared, will be paid on the Company's 10th business day
each July and December to shareholders of record on the first business
day of the preceding month. On April 15, 2003, the Company's Board of
Directors declared a semi-annual cash dividend of $0.90 per share on
the outstanding common stock of the Company. This dividend was paid on
July 16, 2003 to shareholders of record at the close of business on
June 2, 2003. On September 24, 2003, the Company's Board of Director's
approved the reduction of the amount of the annual dividend to $.50 per
share. On that same date, the Company's Board of Directors declared a
semi-annual cash dividend of $.25 per share on the outstanding common
stock of the Company. This dividend will be paid on December 12, 2003
to shareholders of record as of the close of business on November 3,
2003.
Capital additions were $353 million in the first three quarters of
2003, with the majority of the spending supporting new products,
manufacturing productivity and quality improvements, infrastructure
improvements and ongoing environmental and safety initiatives. The
Company has been working on plans to reduce capital spending. For the
full year 2003, the Company now expects its capital spending, excluding
acquisitions and equipment purchased for lease, to be approximately
$500 million. Based on the year-to-date experience, the capital
spending is in line with the full-year plan.
The Company believes that its cash flow from operations will be
sufficient to cover its working capital and capital investment needs
and the funds required for potential future debt reduction, dividend
payments, modest acquisitions or the repurchase of shares of the
Company's common stock. The Company's cash balances and financing
arrangements will be used to bridge timing differences between
expenditures and cash generated from operations.
77
The Company has $2,225 million in committed revolving credit
facilities, which are available to support the Company's commercial
paper program and for general corporate purposes. The credit
facilities are comprised of the $1,000 million 364-day committed
revolving credit facility (364-Day Facility) expiring in July 2004 and
a 5-year committed facility at $1,225 million expiring in July 2006 (5-
Year Facility). If unused, they have a commitment fee of $4.5 million
per year, at the Company's current credit rating of Baa3 and BBB- from
Moody's and Standard & Poors (S&P), respectively. Interest on amounts
borrowed under these facilities is calculated at rates based on spreads
above certain reference rates and the Company's credit rating. Under
the 364-Day Facility and 5-Year Facility, there is a financial
covenant, which requires the Company to maintain a debt to EBITDA ratio
of not greater than 3 to 1. In the event of violation of the covenant,
the facility would not be available for borrowing until the covenant
provisions were waived, amended or satisfied. The Company was in
compliance with this covenant at September 30, 2003. The Company does
not anticipate that a violation is likely to occur.
The Company has other committed and uncommitted lines of credit at
September 30, 2003 totaling $260 million and $1,717 million,
respectively. These lines primarily support borrowing needs of the
Company's subsidiaries, which include term loans, overdraft coverage,
letters of credit and revolving credit lines. Interest rates and other
terms of borrowing under these lines of credit vary from country to
country, depending on local market conditions. Total outstanding
borrowings against these other committed and uncommitted lines of
credit at September 30, 2003 were $161 million and $384 million,
respectively. These outstanding borrowings are reflected in the short-
term borrowings and long-term debt, net of current portion balances in
the accompanying Consolidated Statement of Financial Position at
September 30, 2003.
At September 30, 2003, the Company had $849 million in commercial paper
outstanding, with a weighted average interest rate of 1.81%. To
provide additional financing flexibility, the Company has an accounts
receivable securitization program, which provides for borrowings up to
a maximum of $250 million. At September 30, 2003, the Company had
outstanding borrowings under this program of $63 million. The
estimated annualized interest rate under this program is 2.04%.
On September 5, 2003, the Company filed a shelf registration statement
on Form S-3 (the "new debt shelf registration") for the issuance of up
to $2,000 million of new debt securities. The new debt shelf
registration became effective on September 19, 2003. Pursuant to Rule
429 under the Securities Act of 1933, $650 million of remaining unsold
debt securities under a prior shelf registration statement were
included in the new debt shelf registration, giving the Company the
ability to issue up to $2,650 million in public debt.
78
On October 10, 2003, the Company completed the offering and sale of
$500 million aggregate principal amount of Senior Notes due 2013 (the
"Notes"), which was made pursuant to the Company's new debt shelf
registration. Interest on the Notes will accrue at the rate of 7.25%
per annum and is payable semiannually. The Notes are not redeemable at
the Company's option or repayable at the option of any holder prior to
maturity. The Notes are unsecured and unsubordinated obligations and
rank equally with all of the Company's other unsecured and
unsubordinated indebtedness. After issuance of the above debt, the
Company has $2,150 million of availability remaining under the new debt
shelf registration.
Concurrent with the offering and sale of the Senior Notes, on October
10, 2003, the Company completed the private placement of $575 million
aggregate principal amount of Convertible Senior Notes due 2033 (the
"Securities") to qualified institutional buyers pursuant to Rule 144A
under the Securities Act of 1933. Interest on the Securities will
accrue at the rate of 3.375% per annum and is payable semiannually.
The Securities are unsecured and rank equally with all of the Company's
other unsecured and unsubordinated indebtedness.
The Securities contain a number of conversion features that include
substantive contingencies. The Securities are convertible by the
holders at an initial conversion rate of 32.2373 shares of the
Company's common stock for each $1,000 principal amount of the
Securities, which is equal to an initial conversion price of $31.02 per
share. The holders may convert their Securities, in whole or in part,
into shares of the Company's common stock under any of the following
circumstances: (1) during any calendar quarter, if the price of the
Company's common stock is greater than or equal to 120% of the
applicable conversion price for at least 20 trading days during a 30
consecutive trading day period; (2) during any five consecutive trading
day period following any 10 consecutive trading day period in which the
trading price of the Securities for each day of such period is less
than 105% of the conversion value, and the conversion value for each
day of such period was less than 95% of the principal amount of the
Securities (the "Parity Clause"); (3) if the Company has called the
Securities for redemption; (4) upon the occurrence of specified
corporate transactions such as a consolidation, merger or binding share
exchange pursuant to which the Company's common stock would be
converted into cash, property or securities; and (5) if the credit
rating assigned to the Securities by either Moody's or S&P is lower
than Ba2 or BB, respectively, which represents a three notch downgrade
from the Company's current standing, or if the Securities are no longer
rated by at least one of these services or their successors (the
"Credit Rating Clause").
79
The Company may redeem some or all of the Securities at any time on or
after October 15, 2010 at a purchase price equal to 100% of the
principal amount of the Securities plus any accrued and unpaid
interest. Upon a call for redemption by the Company, a conversion
trigger is met whereby the holder of each $1,000 Convertible Senior
Note may convert such note to shares of the Company's common stock.
The holders have the right to require the Company to purchase their
Securities for cash at a purchase price equal to 100% of the principal
amount of the Securities plus any accrued and unpaid interest on
October 15, 2010, October 15, 2013, October 15, 2018, October 15, 2023
and October 15, 2028 or upon a fundamental change as described in the
offering memorandum filed under Rule 144A in conjunction with the
private placement of the Securities.
The Company agrees to initially file within 90 days and make effective
within 180 days after the earliest date of original issuance of the
Securities, a shelf registration statement under the Securities Act of
1933 relating to the resale of the Securities and the common stock to
be issued upon conversion of the Securities pursuant to a registration
rights agreement. If the Company fails to comply with some of its
obligations under the registration rights agreement, until such
failures are cured, the Company would be required to pay the holders of
the Securities and the holders of the common stock issued upon
conversion an amount equal to .25% to .50%, depending on the length of
time taken to cure the failure (not to exceed .50% per annum), of the
aggregate principal amount of the Securities or the conversion price of
the stock per annum. The Company will hold in treasury stock a
sufficient number of shares to cover potential future conversions of
these Securities into common stock.
Certain of the conversion and other features contained in the
Securities are deemed to be embedded derivatives as defined under SFAS
No. 133, "Accounting for Derivative Instruments and Hedging
Activities". These embedded derivatives include the Parity Clause, any
specified corporate transaction outside of the Company's control such
as a hostile takeover, the Credit Rating Clause, and the provision that
requires the Company to pay additional amounts if it fails to comply
with some of its obligations under the registration rights agreement.
A preliminary valuation indicated that these embedded derivatives would
not materially impact the Company's financial position, results of
operations or cash flows. A formal external valuation is currently
being performed to confirm the preliminary assessment, and should be
completed during the fourth quarter of 2003. In addition, as the
contingencies surrounding the conversion features are substantive, the
shares to be potentially issued upon triggering a conversion event will
be excluded from the earnings per share calculation until such time as
a contingency lapses and the effect of issuing such shares is dilutive.
80
On July 21, 2003, S&P lowered its rating on Kodak's long-term debt from
BBB+ to BBB. S&P further stated that the Company's long-term and short-
term debt ratings would remain on CreditWatch, with negative
implications. On July 22, 2003, Fitch reaffirmed the Company's long-
term debt and commercial paper ratings at BBB and F2, respectively, but
changed the Rating Outlook to negative from stable. On July 23, 2003,
Moody's placed the Company's long-term and short-term debt ratings of
Baa1 and Prime 2, respectively, on Review for possible downgrade. On
August 8, 2003, Moody's lowered the Company's long-term debt rating to
Baa2 from Baa1, and the long-term and short-term debt ratings were kept
on Review. On August 11, 2003, Fitch lowered the Company's long-term
debt rating to BBB- from BBB, lowered its commercial paper rating to F3
from F2, and reaffirmed its outlook as negative. On September 19,
2003, Moody's lowered the Company's long-term debt rating to Baa3 from
Baa2, lowered its short-term debt rating to Prime-3 from Prime-2, and
changed its outlook to negative. This action concluded a Review that
was announced on July 23, 2003. On September 25, 2003, S&P lowered its
long-term and short-term debt ratings to BBB- and A-3 from BBB and A-2,
respectively, and removed these ratings from CreditWatch.
Additionally, S&P revised its outlook to stable from negative.
The long-term and short-term debt rating downgrades and negative
outlooks reflect the rating agencies' concerns about (1) the Company's
weakened sales and profitability in the core photographic businesses
due to continuing pricing pressure from competitors, (2) continued
digital substitution, including doubts about the profit potential of
digital imaging relative to conventional photography, (3) unfavorable
economic factors, including reduced leisure travel, (4) potential
future restructuring actions that may restrict cash flow, slowing
efforts to reduce debt, (5) reduced financial flexibility resulting
from the acquisition of PracticeWorks, Inc., (6) the likelihood that
debt reduction will be slowed in the short to medium term due to the
Company's rising business risk and investment strategies and (7) the
financial burden of its significant unfunded postretirement benefit
liabilities. The reaffirmations of the Company's credit ratings and
stable outlooks reflect the rating agencies' views about (1) the
Company's leading position in the U.S. and global markets for
traditional photography products and services, (2) its good geographic
diversity, (3) its solid position in the health imaging area, and (4)
the expectation that the Company's 72% dividend cut will enable it to
reduce debt over the near term while still investing for growth in
existing and new imaging businesses.
81
These credit rating actions have limited the Company's access to
commercial paper borrowings. As a result and as noted before, on
October 10, 2003, the Company issued $1,075 million of long-term debt
through an offering and sale of $500 million of Senior Notes due 2013
and a concurrent private placement of $575 million of Convertible
Senior Notes due 2033. With the proceeds received from the $1,075
million of long-term debt issued, the Company plans to fund the U.S.
portion of the PracticeWorks, Inc. acquisition and to repay commercial
paper as it comes due. The replacement of the outstanding commercial
paper with new long-term debt will cause the Company's interest expense
to increase. For example, the Company's outstanding commercial paper
at September 30, 2003 had a weighted average annual interest rate of
1.81% as compared with an annual interest rate of 7.25% on the Senior
Notes and 3.375% on the Convertible Senior Notes, representing a
weighted average difference of 3.33 percentage points.
The Company is in compliance with all covenants or other requirements
set forth in its credit agreements and indentures. Further, the
Company does not have any rating downgrade triggers that would
accelerate the maturity dates of its debt, with the exception of the
following: $32 million in term notes that will amortize through 2005
that can be accelerated if the Company's credit rating from S&P or
Moody's were to fall below BBB- and Baa3, respectively; and the
outstanding borrowings under the accounts receivable securitization
program if the Company's credit ratings from S&P or Moody's were to
fall below BBB- and Baa3, respectively, and such condition continued
for a period of 30 days. Additionally, the Company estimates that
letters of credit or other financial support could be required in
support of insurance, environmental and supplies obligation of up to
$138 million. Further downgrades in the Company's credit rating or
disruptions in the capital markets could impact borrowing costs and the
nature of its funding alternatives. However, the Company has access to
$2,225 million in committed revolving credit facilities to meet
unanticipated funding needs should it be necessary.
82
The Company guarantees debt and other obligations under agreements with
certain affiliated companies and customers. At September 30, 2003,
these guarantees totaled a maximum of $330 million, with outstanding
guaranteed amounts of $161 million. The maximum guarantee amount
includes guarantees of up to: $160 million of debt for KPG ($63 million
outstanding); $6 million for other unconsolidated affiliates and third
parties ($6 million outstanding); and $164 million of customer amounts
due to banks in connection with various banks' financing of customers'
purchase of products and equipment from Kodak ($92 million outstanding).
The KPG debt facility and the related guarantee mature on December 31,
2005, but may be renewed at KPG's, the joint venture partners' and the
bank's discretion. The guarantees for the other unconsolidated
affiliates and third party debt mature between October 2003 and May 2006
and are not expected to be renewed. The customer financing agreements
and related guarantees typically have a term of 90 days for product and
short-term equipment financing arrangements, and up to 3 years for long-
term equipment financing arrangements. These guarantees would require
payment from Kodak only in the event of default on payment by the
respective debtor. In some cases, particularly for guarantees related
to equipment financing, the Company has collateral or recourse
provisions to recover and sell the equipment to reduce any losses that
might be incurred in connection with the guarantee; however, this
activity is not material. Management believes the likelihood is remote
that material payments will be required under any of these guarantees
disclosed above. With respect to the guarantees that the Company issued
in the three and nine months ended September 30, 2003, the Company
assessed the fair value of its obligation to stand ready to perform
under these guarantees by considering the likelihood of occurrence of
the specified triggering events or conditions requiring performance as
well as other assumptions and factors. Through internal analysis and
external valuations, the Company determined that the fair value of the
guarantees was not material to the Company's financial position, results
of operations or cash flows.
The Company also guarantees debt owed to banks for some of its
consolidated subsidiaries. The maximum amount guaranteed is $706
million, and the outstanding debt under those guarantees, which is
recorded within the short-term borrowings and long-term debt, net of
current portion components in the accompanying Consolidated Statement of
Financial Position, is $525 million. These guarantees expire in 2003
through 2005 with the majority expiring in 2004.
The Company may provide up to $100 million in loan guarantees to support
funding needs for SK Display Corporation, an unconsolidated affiliate in
which the Company has a 34% ownership interest. As of September 30,
2003, the Company has not been required to guarantee any of the SK
Display Corporation's outstanding debt.
83
The Company issues indemnifications in certain instances when it sells
businesses and real estate, and in the ordinary course of business with
its customers, suppliers, service providers and business partners.
Further, the Company indemnifies its directors and officers who are, or
were, serving at Kodak's request in such capacities. Historically,
costs incurred to settle claims related to these indemnifications have
not been material to the Company's financial position, results of
operations or cash flows. Additionally, the fair value of the
indemnifications that the Company issued during the three and nine
months ended September 30, 2003 was not material to the Company's
financial position, results of operations or cash flows.
In connection with the Company's investment in China that began in
1998, certain unaffiliated entities invested in two Kodak consolidated
companies with the opportunity to put their minority interests to Kodak
for cash at any time after the third anniversary, but prior to the
tenth anniversary, of the date on which the two companies were
established. The total exercise price in connection with the remaining
put options, which increases at a rate of 2% per annum, is
approximately $56 million at September 30, 2003. The Company expects
that the remaining two put options amounting to $56 million in total
will be exercised within the next three months.
Qualex, a wholly owned subsidiary of Kodak, has a 50% ownership
interest in Express Stop Financing (ESF), which is a joint venture
partnership between Qualex and a subsidiary of Dana Credit Corporation
(DCC), a wholly owned subsidiary of Dana Corporation. Qualex accounts
for its investment in ESF under the equity method of accounting. ESF
provides a long-term financing solution to Qualex's photofinishing
customers in connection with Qualex's leasing of photofinishing
equipment to third parties, as opposed to Qualex extending long-term
credit. As part of the operations of its photofinishing business,
Qualex sells equipment under a sales-type lease arrangement and records
a long-term receivable. These long-term receivables are subsequently
sold to ESF without recourse to Qualex. ESF incurs long-term debt to
finance the purchase of the receivables from Qualex. This debt is
collateralized solely by the long-term receivables purchased from
Qualex and, in part, by a $60 million guarantee from DCC. Qualex
provides no guarantee or collateral to ESF's creditors in connection
with the debt, and ESF's debt is non-recourse to Qualex. Qualex's only
continued involvement in connection with the sale of the long-term
receivables is the servicing of the related equipment under the leases.
Qualex has continued revenue streams in connection with this equipment
through future sales of photofinishing consumables, including paper and
chemicals, and maintenance.
84
Qualex has risk with respect to the ESF arrangement as it relates to
its continued ability to procure spare parts from the primary
photofinishing equipment vendor (the Vendor) to fulfill its servicing
obligations under the leases. This risk is attributable to the fact
that, throughout 2002, the Vendor was experiencing financial difficulty
which ultimately resulted in its filing for bankruptcy on December 24,
2002. Since that time, certain of its affiliates have also filed for
bankruptcy in the various countries in which they are organized.
Although the lessees' requirement to pay ESF under the lease agreements
is not contingent upon Qualex's fulfillment of its servicing
obligations, under the agreement with ESF, Qualex would be responsible
for any deficiency in the amount of rent not paid to ESF as a result of
any lessee's claim regarding maintenance or supply services not
provided by Qualex. Such lease payments would be made in accordance
with the original lease terms, which generally extend over 5 to 7
years. ESF's outstanding lease receivable amount was approximately
$396 million at September 30, 2003.
To mitigate the risk of not being able to fulfill its service
obligations, Qualex built up its inventory of these spare parts during
2002 and began refurbishing used parts. To further mitigate its
exposure, effective April 3, 2002, Kodak entered into certain
agreements with the Vendor under which the Company paid $19 million for
a license relating to the spare parts intellectual property, an equity
interest in the Vendor and an entity created to hold intellectual
property and certain other assets conveyed by the Vendor and its
affiliates related to spare parts, and an arrangement to purchase spare
parts from the Vendor or its affiliates. After entering into these
arrangements, the Company obtained the documentation and specifications
of the parts it sourced solely from the Vendor and a comprehensive
supplier list for the parts the Vendor sourced from other suppliers.
However, under these arrangements, Kodak had a use restriction, which
precluded the Company from manufacturing a limited number of parts that
were covered by patents owned by the Vendor and from purchasing such
parts directly from the Vendor's suppliers. This use restriction would
be effective until certain triggering events occurred, the most
significant of which was the filing for bankruptcy by the Vendor. As
indicated above, the Vendor filed for bankruptcy on December 24, 2002.
As part of the bankruptcy proceedings, the Company has acquired 100%
ownership of the entity that was created to own the above-described
intellectual property and certain other assets related to spare parts,
and the Company has finalized written agreements necessary to
facilitate the manufacture of the parts previously produced by the
Vendor. Additionally, the Company has begun to source parts directly
from the Vendor's suppliers. Accordingly, the Company does not
anticipate any significant situations where it would be unable to
fulfill its service obligations under the arrangement with ESF.
85
Effective July 22, 2003, ESF entered into an agreement amending the
Receivables Purchase Agreement (RPA). Under the amended RPA agreement,
maximum borrowings were lowered to $257 million. Total outstanding
borrowings under the RPA at September 30, 2003 were $257 million. The
amended RPA extends through July 2004, at which time the RPA can be
extended or terminated. If the RPA were terminated, ESF would need to
find an alternative financing solution for borrowings under the RPA.
Pursuant to the ESF partnership agreement between Qualex and DCC,
commencing October 6, 2003, Qualex no longer sells its lease
receivables to ESF. Qualex currently is utilizing the services of
Imaging Financial Services, Inc., a wholly owned subsidiary of General
Electric Capital Corporation as an alternative financing solution for
prospective leasing activity with its customers.
At September 30, 2003, the Company had outstanding letters of credit
totaling $99 million and surety bonds in the amount of $108 million
primarily to ensure the completion of environmental remediations and
payment of possible casualty and workers' compensation claims. The
Company could be required to increase the dollar amount of its letters
of credit or other financial support up to $138 million in relation to
these matters if its Moody's and S&P long-term debt credit ratings are
reduced to below the current ratings of Baa3 and BBB-, respectively.
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RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 143 "Accounting
for Asset Retirement Obligations." SFAS No. 143 addresses the
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset
retirement costs. SFAS No. 143 applies to legal obligations associated
with the retirement of long-lived assets that result from the
acquisition, construction, development and/or normal use of the assets.
SFAS No. 143 requires that the fair value of a liability for an asset
retirement obligation be recognized in the period in which it is
incurred if a reasonable estimate of fair value can be made. The fair
value of the liability is added to the carrying amount of the
associated asset, and this additional carrying amount is expensed over
the life of the asset. The Company adopted SFAS No. 143 effective
January 1, 2003. The adoption of SFAS No. 143 did not have a material
impact on the Company's financial position, results of operations or
cash flows.
86
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 addresses
the financial accounting and reporting for costs associated with exit
or disposal activities and supercedes Emerging Issues Task Force (EITF)
Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs
Incurred in a Restructuring)." SFAS No. 146 requires recognition of
the liability for costs associated with an exit or disposal activity
when the liability is incurred. Under EITF No. 94-3, a liability for
an exit cost was recognized at the date of the Company's commitment to
an exit plan. SFAS No. 146 also establishes that the liability should
initially be measured and recorded at fair value. Accordingly, SFAS
No. 146 impacts the timing of recognition and the initial measurement
of the amount of liabilities the Company recognizes in connection with
exit or disposal activities initiated after December 31, 2002. The
Company adopted SFAS No. 146 effective January 1, 2003. The Company
primarily accounts for employee termination actions under SFAS No. 112,
which requires recording when such charges are probable and estimable.
As such, the adoption of SFAS No. 146 did not have a material impact
for the three and nine months ended September 30, 2003, as there were
no significant one-time severance actions or other exit costs that were
subject to SFAS No. 146.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others." FIN 45
requires that a liability be recorded in the guarantor's balance sheet
upon issuance of a guarantee. In addition, FIN 45 requires disclosures
about the guarantees, including indemnifications, that an entity has
issued and a rollforward of the entity's product warranty liabilities.
The disclosure provisions of FIN 45 were effective for financial
statements of interim periods or annual periods ending after December
15, 2002. In addition, the Company adopted the recognition provisions
of FIN 45 effective January 1, 2003 for guarantees issued or modified
after December 31, 2002. The adoption of FIN 45 did not have a
material impact on the Company's financial position, results of
operations or cash flows. See Note 8, "Guarantees."
In November 2002, the EITF reached a consensus on EITF Issue No. 00-21,
"Accounting for Revenue Arrangements with Multiple Deliverables." EITF
No. 00-21 provides guidance on how to determine when an arrangement
that involves multiple revenue-generating activities or deliverables
should be divided into separate units of accounting for revenue
recognition purposes, and if this division is required, how the
arrangement consideration should be allocated among the separate units
of accounting. The guidance in the consensus is effective for revenue
arrangements entered into in fiscal periods beginning after June 15,
2003. The adoption of EITF No. 00-21 did not have a material impact on
the Company's financial position, results of operations or cash flows.
87
The EITF has reached a consensus on EITF Issue No. 03-05,
"Applicability of AICPA Statement of Position 97-2 to Non-Software
Deliverables in an Arrangement Containing More-Than-Incidental
Software," which indicates that, for an arrangement that includes
software that is more than incidental to the products or services as a
whole, the software and software-related elements within that
arrangement are included within the scope of SOP 97-2. The guidance in
the consensus is effective for the Company for revenue arrangements
entered into after September 30, 2003. The Company is currently
evaluating the effect that the adoption of EITF 03-05 will have on the
Company's financial position, results of operations and cash flows.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities," which clarifies the
application of Accounting Research Bulletin (ARB) No. 51, "Consolidated
Financial Statements," relating to consolidation of certain entities.
First, FIN 46 will require identification of the Company's
participation in variable interest entities (VIEs), which are defined
as entities with a level of invested equity that is not sufficient to
fund future activities to permit them to operate on a stand alone
basis, or whose equity holders lack certain characteristics of a
controlling financial interest. Then, for entities identified as VIEs,
FIN 46 sets forth a model to evaluate potential consolidation based on
an assessment of which party to the VIE, if any, bears a majority of
the exposure to its expected losses, or stands to gain from a majority
of its expected returns. FIN 46 is effective for all new VIEs created
or acquired after January 31, 2003. Originally, for VIEs created or
acquired prior to February 1, 2003, the provisions of FIN 46 were to be
applied for the first interim or annual period beginning after June 15,
2003. However, on October 8, 2003, the FASB deferred the latest date
by which all public entities must apply FIN 46 to the first reporting
period ending after December 15, 2003. FIN 46 also sets forth certain
disclosures regarding interests in VIEs that are deemed significant,
even if consolidation is not required. See Note 6, "Variable Interest
Entities" for these disclosures. The Company is currently evaluating
the effect that the adoption of FIN 46 will have on its financial
position, results of operations and cash flows.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities." SFAS No. 149
amends and clarifies the accounting for derivative instruments,
including certain derivative instruments embedded in other contracts,
and for hedging activities under SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 149 is
generally effective for contracts entered into or modified after June
30, 2003 and for hedging relationships designated after June 30, 2003.
The adoption of SFAS No. 149 did not have a material impact on the
Company's financial position, results of operations or cash flows.
88
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity." SFAS No. 150 requires that certain financial instruments,
which under previous guidance were accounted for as equity, must now be
accounted for as liabilities. The financial instruments affected
include mandatorily redeemable stock, certain financial instruments
that require or may require the issuer to buy back some of its shares
in exchange for cash or other assets and certain obligations that can
be settled with shares of stock. SFAS No. 150 is effective for all
financial instruments entered into or modified after May 31, 2003 and
must be applied to the Company's existing financial instruments
effective July 1, 2003, the beginning of the first fiscal period after
June 15, 2003. The Company adopted SFAS No. 150 on June 1, 2003. The
adoption of this statement did not have a material effect on the
Company's financial position, results of operations or cash flows.
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CAUTIONARY STATEMENT PURSUANT TO SAFE HARBOR PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
Certain statements in this report may be forward-looking in nature, or
"forward-looking statements" as defined in the United States Private
Securities Litigation Reform Act of 1995. For example, references to
the Company's revenue, cash flow expectations and future focused cost
reductions are forward-looking statements.
Actual results may differ from those expressed or implied in forward-
looking statements. In addition, any forward-looking statements
represent our estimates only as of October 22, 2003, and should not be
relied upon as representing our estimates as of any subsequent date.
While we may elect to update forward-looking statements at some point
in the future, we specifically disclaim any obligation to do so, even
if our estimates change. The forward-looking statements contained in
this report are subject to a number of risk factors, including the
successful: implementation of product strategies (including category
expansion, digitization, OLED, and digital products); implementation of
intellectual property licensing strategies; development and
implementation of e-commerce strategies; completion of information
systems upgrades, including SAP; completion of various portfolio
actions; reduction of inventories; improvement in manufacturing
productivity; improvement in receivables performance; reduction in
capital expenditures; improvement in supply chain efficiency;
implementation of future focused cost reductions, including personnel
reductions; and development of the Company's business in emerging
markets like China, India, Brazil, Mexico, and Russia. The forward-
looking statements contained in this report are subject to the
following additional risk factors: inherent unpredictability of
currency fluctuations and raw material costs; competitive actions,
including pricing; the nature and pace of technology evolution,
including the analog-to-digital shift; continuing customer
consolidation and buying power; general economic and business
conditions; and other risk factors disclosed herein and from time to
time in the Company's filings with the Securities and Exchange
Commission.
89
Any forward-looking statements in this report should be evaluated in
light of these important risk factors.
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Item 3. Quantitative And Qualitative Disclosures About Market Risk
The Company, as a result of its global operating and financing
activities, is exposed to changes in foreign currency exchange rates,
commodity prices, and interest rates, which may adversely affect its
results of operations and financial position. In seeking to minimize
the risks and/or costs associated with such activities, the Company may
enter into derivative contracts.
Foreign currency forward contracts are used to hedge existing foreign
currency denominated assets and liabilities, especially those of the
Company's International Treasury Center, as well as forecasted foreign
currency denominated intercompany sales. Silver forward contracts are
used to mitigate the Company's risk to fluctuating silver prices. The
Company's exposure to changes in interest rates results from its
investing and borrowing activities used to meet its liquidity needs.
Long-term debt is generally used to finance long-term investments,
while short-term debt is used to meet working capital requirements.
The Company does not utilize financial instruments for trading or other
speculative purposes.
Using a sensitivity analysis based on estimated fair value of open
forward contracts using available forward rates, if the U.S. dollar had
been 10% weaker at September 30, 2003 and 2002, the fair value of open
forward contracts would have increased $49 million and $18 million,
respectively. Such gains or losses would be substantially offset by
losses or gains from the revaluation or settlement of the underlying
positions hedged.
Using a sensitivity analysis based on estimated fair value of open
forward contracts using available forward prices, if available forward
silver prices had been 10% lower at September 30, 2003 and 2002, the
fair value of open forward contracts would have decreased $4 million
and $4 million, respectively. Such losses in fair value, if realized,
would be offset by lower costs of manufacturing silver-containing
products.
The Company is exposed to interest rate risk primarily through its
borrowing activities and, to a lesser extent, through investments in
marketable securities. The Company utilizes U.S. dollar denominated
and foreign currency denominated borrowings to fund its working capital
and investment needs. The majority of short-term and long-term
borrowings are in fixed-rate instruments. There is inherent rollover
risk for borrowings and marketable securities as they mature and are
renewed at current market rates. The extent of this risk is not
predictable because of the variability of future interest rates and
business financing requirements.
90
Using a sensitivity analysis based on estimated fair value of short-
term and long-term borrowings, if available market interest rates had
been 10% (about 38 basis points) higher at September 30, 2003, the fair
value of short-term and long-term borrowings would have decreased $1
million and $15 million, respectively. Using a sensitivity analysis
based on estimated fair value of short-term and long-term borrowings,
if available market interest rates had been 10% (about 39 basis points)
higher at September 30, 2002, the fair value of short-term and long-
term borrowings would have decreased $1 million and $17 million,
respectively.
The Company's financial instrument counterparties are high-quality
investment or commercial banks with significant experience with such
instruments. The Company manages exposure to counterparty credit risk
by requiring specific minimum credit standards and diversification of
counterparties. The Company has procedures to monitor the credit
exposure amounts. The maximum credit exposure at September 30, 2003
was not significant to the Company.
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Item 4. Controls and Procedures
In accordance with the Securities Exchange Act Rules 13a-15 and 15d-15,
the Company's management, under the supervision of the Chief Executive
Officer and Chief Financial Officer, conducted an evaluation of the
effectiveness of the design and operation of the Company's disclosure
controls and procedures as of the end of the period covered by this
report. Based on that evaluation, the Chief Executive Officer and
Chief Financial Officer concluded that the design and operation of the
Company's disclosure controls and procedures were effective. There
have been no significant changes in internal controls over financial
reporting or in other factors that could significantly affect internal
controls over financial reporting subsequent to the date of such
evaluation.
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Part II. OTHER INFORMATION
Item 1. Legal Proceedings
Effective July 2, 2003, Eastman Kodak Company and the New York State
Department of Environmental Conservation entered into an administrative
Consent Order that resolved Kodak's civil/administrative liability for
alleged violations, under the New York State chemical bulk storage
regulations, associated with certain spills and releases, and for
alleged violations of the New York State hazardous waste program, at
the Company's Kodak Park facility in Rochester, New York, from August
1999 to May 2003. Pursuant to the terms of the Consent Order, Kodak
paid a civil penalty of $210,000.
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91
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits and financial statement schedules required as part of
this report are listed in the index appearing on page 92.
(b) Reports on Form 8-K
On July 21, 2003, the Company furnished (not filed) under Item 5 the
press release issued July 21, 2003 relating to the agreement by the
Company to acquire the shares of PracticeWorks, Inc.
On July 23, 2003, the Company furnished (not filed) pursuant to Item 12
under Item 9 (in accordance with the interim filing guidance for these
Items) the press release and related financial discussion document
relating to the results of its second fiscal quarter ended June 30,
2003, which was also filed as an exhibit under Item 7.
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SIGNATURES
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.
EASTMAN KODAK COMPANY
(Registrant)
Date October 24, 2003
Robert P. Rozek
Controller
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92
Eastman Kodak Company and Subsidiary Companies
Index to Exhibits and Financial Statement Schedules
Exhibit
Number
(12) Statement Re Computation of Ratio of Earnings to Fixed Charges.
(31.1) Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
(31.2) Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
(32.1) Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(32.2) Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
1 Exhibit (12) Eastman Kodak Company and Subsidiary Companies Computation of Ratio of Earnings to Fixed Charges (in millions, except for ratios) Nine Months Ended Sept. 30, 2003 Earnings from continuing operations before income taxes $ 208 Adjustments: Minority interest in income of subsidiaries with fixed charges 18 Undistributed loss of equity method investees 33 Interest expense 104 Interest component of rental expense (1) 41 Amortization of capitalized interest 20 ----- Earnings as adjusted $ 424 ===== Fixed charges: Interest expense 104 Interest component of rental expense (1) 41 Capitalized interest 2 ----- Total fixed charges $ 147 ===== Ratio of earnings to fixed charges 2.9x (1) Interest component of rental expense is estimated to equal 1/3 of such expense, which is considered a reasonable approximation of the interest factor.
1 Exhibit (31.1) CERTIFICATION PURSUANT TO 18 U.S.C. Section 1350, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Daniel A. Carp, certify that: 1. I have reviewed this quarterly report on Form 10-Q; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
2 d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: October 24, 2003 /s/ Daniel A. Carp Daniel A. Carp Chief Executive Officer
1 Exhibit (31.2) CERTIFICATION PURSUANT TO 18 U.S.C. Section 1350, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Robert H. Brust, certify that: 1. I have reviewed this quarterly report on Form 10-Q; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
2 d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: October 24, 2003 /s/ Robert H. Brust Robert H. Brust Chief Financial Officer
1
Exhibit (32.1)
CERTIFICATION PURSUANT TO
18 U.S.C. Section 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Eastman Kodak
Company (the "Company") on Form 10-Q for the three and
nine month periods ended September 30, 2003 as filed
with the Securities and Exchange Commission on the date
hereof (the "Report"), I, Daniel A. Carp, Chief
Executive Officer of the Company, certify, pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002, that to the best
of my knowledge:
1) The Report fully complies with the requirements
of section 13(a) or 15(d) of the Securities Exchange Act
of 1934; and
2) The information contained in the Report fairly
presents, in all material respects, the financial
condition and results of operations of the Company.
/s/ Daniel A. Carp
Daniel A. Carp
Chief Executive Officer
October 24, 2003
1 Exhibit (32.2) CERTIFICATION PURSUANT TO 18 U.S.C. Section 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Eastman Kodak Company (the "Company") on Form 10-Q for the three and nine month periods ended September 30, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Robert H. Brust, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: 1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Robert H. Brust Robert H. Brust Chief Financial Officer October 24, 2003