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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 June 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 June 30, 2003
Common Stock, $2.50 par value 286,520,200
2
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 Six Months Ended
June 30 June 30
------------------ ----------------
2003 2002 2003 2002
Net sales $3,352 $3,336 $6,092 $6,042
Cost of goods sold 2,236 2,082 4,152 3,928
------ ------ ------ ------
Gross profit 1,116 1,254 1,940 2,114
Selling, general and
administrative expenses 716 656 1,282 1,196
Research and development costs 179 192 373 379
Restructuring costs and other 44 - 76 -
------ ------ ------ ------
Earnings from continuing
operations before interest,
other charges, and income
taxes 177 406 209 539
Interest expense 34 44 71 88
Other charges 9 22 30 53
------ ------ ------ ------
Earnings from continuing
operations before income taxes 134 340 108 398
Provision (benefit) for income
taxes 22 54 (1) 71
------ ------ ------ ------
Earnings from continuing
operations 112 286 109 327
Earnings (loss) from discontinued
operations, net of income tax
benefits for the three and six
months ended June 30, 2002 of $1
and $2, respectively - (2) 15 (4)
------ ------ ------ ------
NET EARNINGS $ 112 $ 284 $ 124 $ 323
====== ====== ====== ======
Basic and diluted net earnings
(loss) per share:
Continuing operations $ .39 $ .98 $ .38 $ 1.12
Discontinued operations .00 (.01) .05 (.01)
------ ------ ------ ------
Total $ .39 $ .97 $ .43 $ 1.11
====== ====== ====== ======
Number of common shares used in
basic earnings (loss) per share 286.5 291.7 286.4 291.5
Incremental shares from
assumed conversion of options 0.1 0.1 0.2 0.1
------ ------ ------ ------
Number of common shares used in
diluted earnings (loss) per share 286.6 291.8 286.6 291.6
====== ====== ====== ======
Cash dividends per share $ .90 $ .90 $ .90 $ .90
====== ====== ====== ======
3
Eastman Kodak Company and Subsidiary Companies
CONSOLIDATED STATEMENT OF EARNINGS (Continued)
(in millions)
Three Months Ended Six Months Ended
June 30 June 30
------------------ ----------------
2003 2002 2003 2002
CONSOLIDATED STATEMENT OF
RETAINED EARNINGS
Retained earnings at beginning
of period $7,609 $7,445 $7,611 $7,431
Net earnings 112 284 124 323
Cash dividends declared (258) (262) (258) (262)
Loss from issuance of treasury
Stock (1) - (15) (25)
------ ------ ------ ------
Retained earnings
at end of quarter $7,462 $7,467 $7,462 $7,467
====== ====== ====== ======
- -----------------------------------------------------------------------
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)
June 30, Dec. 31,
2003 2002
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 838 $ 569
Receivables, net 2,462 2,234
Inventories, net 1,190 1,062
Deferred income taxes 512 512
Other current assets 157 157
------- -------
Total current assets 5,159 4,534
------- -------
Property, plant and equipment, net 5,289 5,420
Goodwill, net 992 981
Other long-term assets 2,636 2,559
------- -------
TOTAL ASSETS $14,076 $13,494
======= =======
- -----------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and other current
liabilities $ 3,538 $ 3,351
Short-term borrowings 1,474 1,442
Accrued income taxes 604 709
------- -------
Total current liabilities 5,616 5,502
OTHER LIABILITIES
Long-term debt, net of current portion 1,516 1,164
Postretirement liabilities 3,455 3,412
Other long-term liabilities 635 639
------- -------
Total liabilities 11,222 10,717
SHAREHOLDERS' EQUITY
Common stock at par 978 978
Additional paid in capital 849 849
Retained earnings 7,462 7,611
Accumulated other comprehensive loss (572) (771)
Unearned restricted stock (7) -
------- -------
8,710 8,667
Less: Treasury stock at cost 5,856 5,890
------- -------
Total shareholders' equity 2,854 2,777
------- -------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $14,076 $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)
Six Months Ended
June 30
------------------
2003 2002
Cash flows relating to operating activities:
Net earnings $ 124 $ 323
Adjustments to reconcile to net cash
provided by operating activities:
(Gain) loss from discontinued operations (15) 4
Equity in losses from unconsolidated affiliates 30 48
Depreciation and amortization 395 386
Restructuring costs, asset impairments and
other non-cash charges 37 -
Provision for deferred taxes 16 -
Increase in receivables (196) (117)
Increase in inventories (60) (13)
Decrease in liabilities excluding borrowings (217) (106)
Other items, net 100 9
------ ------
Total adjustments 90 211
------ ------
Net cash provided by continuing
operations 214 534
------ ------
Net cash provided by (used in)
discontinued operations 19 (6)
------ ------
Net cash provided by operating activities 233 528
------ ------
Cash flows relating to investing activities:
Additions to properties (236) (204)
Acquisitions, net of cash acquired (88) (6)
Investments in unconsolidated affiliates (41) (68)
Marketable securities - purchases (44) (55)
Marketable securities - sales 43 29
------ ------
Net cash used in investing activities (366) (304)
------ ------
Cash flows relating to financing activities:
Net increase in borrowings
with original maturity of
90 days or less 129 113
Proceeds from other borrowings 715 515
Repayment of other borrowings (466) (778)
Exercise of employee stock options 12 2
------ ------
Net cash provided by (used in) financing
activities 390 (148)
------ ------
Effect of exchange rate changes on cash 12 -
------ ------
Net increase in cash and cash
equivalents 269 76
Cash and cash equivalents, beginning of year 569 448
------ ------
Cash and cash equivalents, end of quarter $ 838 $ 524
====== ======
- -----------------------------------------------------------------
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 an impact for the
three and six months ended June 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 Company is currently evaluating the effect that the adoption
of EITF No. 00-21 will have on its financial position, results of
operations and cash flows.
8
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. For VIEs created or acquired prior
to February 1, 2003, the provisions of FIN 46 must be applied for the
first interim or annual period beginning after June 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 Company is currently evaluating whether or not the adoption of SFAS
No. 149 will have an effect on its financial position, results of
operations and cash flows.
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.
- -----------------------------------------------------------------------
9
NOTE 2: RECEIVABLES, NET
(in millions) June 30, December 31,
2003 2002
Trade receivables $2,148 $1,896
Miscellaneous receivables 314 338
------ ------
Total (net of allowances of $134 and $137) $2,462 $2,234
====== ======
Of the total trade receivable amounts of $2,148 million and $1,896
million as of June 30, 2003 and December 31, 2002, respectively,
approximately $429 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.
- ----------------------------------------------------------------------
NOTE 3: INVENTORIES, NET
(in millions) June 30, December 31,
2003 2002
Finished goods $ 905 $ 831
Work in process 317 322
Raw materials and supplies 334 301
------ ------
1,556 1,454
LIFO reserve (366) (392)
------ ------
Total $1,190 $1,062
====== ======
During the three and six months ended June 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
$4 million and $12 million in the three and six months ended June 30,
2003, respectively.
- ----------------------------------------------------------------------
10
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. There were no amounts outstanding under the
facilities in existence at June 30, 2003.
LONG-TERM DEBT
In May 2003, the Company issued Series A fixed rate notes and Series A
floating rate notes under its medium-term unsecured note program
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. The
Company has $1,250 million of notes outstanding and $650 million of
remaining availability under its medium-term note program at June 30,
2003. The total amount outstanding of $1,250 million is reflected in
long-term debt, net of current portion in the accompanying Consolidated
Statement of Financial Position, as all of the notes have maturities in
excess of one year from June 30, 2003.
- -----------------------------------------------------------------------
11
NOTE 5: INCOME TAXES
The Company's annual effective tax rate was estimated to be 24% and 29%
for the three and six months ended June 30, 2003 and 2002,
respectively.
The Company's estimated annual effective tax rate decreased from 26% in
the three month period ended March 31, 2003 to 24% in the six month
period ended June 30, 2003. The decreases in the estimated annual
effective tax rate from 29% to 26% and then down to 24% were primarily
attributable to further expected increased earnings from operations in
certain lower-taxed jurisdictions outside the U.S. relative to total
consolidated earnings. In addition to recording the Company's
estimated annual effective tax rate of 24% in the three month period
ended June 30, 2003, discrete period tax benefits of $31 million were
recorded in connection with the following items, all of which are taxed
in jurisdictions with tax rates greater than the estimated annual
effective tax rate: charges for focused cost reductions of $54 million;
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; and a $9 million charge relating to the
impairment of the Burrell Companies' net assets held for sale.
In addition to recording the Company's estimated annual effective tax
rate of 24% for the six months ended June 30, 2003, discrete period tax
benefits of $68 million were recorded, which include the $31 million of
discrete period tax benefits described above. The balance of $37
million, which was recorded in the three month period ended March 31,
2003, was recorded in connection with the following items, all of which
are taxed in jurisdictions with tax rates greater than the estimated
annual effective tax rate: net focused cost reduction charges of $46
million; a $21 million charge for purchased in-process research and
development costs; and a $12 million charge related to an intellectual
property settlement. In addition, the discrete period items also
include a tax benefit of $8 million, as described below, relating to
the donation of intellectual property.
During the three months ended March 31, 2003, the Company entered into
an agreement whereby intellectual property in the form of technology
patents was donated to a tax-qualified organization. The net book
value of the intellectual property was not material. Based on an
external determination of fair value, the related technology resulted
in a tax benefit of approximately $8 million, which the Company
recorded in the six months ended June 30, 2003.
12
For the three and six months ended June 30, 2002, the Company recorded
a discrete period 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 discrete period tax benefit of $45 million in the
three and six month periods ended June 30, 2002 based on the Company's
remaining tax basis in the PictureVision stock.
- -----------------------------------------------------------------------
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 June 30, 2003 were approximately
$493 million, $149 million and $8 million, respectively. The Company's
estimated maximum exposure to loss as a result of its continuing
involvement with ESF, NexPress and SK Display are $70 million, $126
million and $108 million, respectively. The maximum exposure to loss
represents the sum of the carrying value of the Company's investment
balances as of June 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.
- -----------------------------------------------------------------------
13
NOTE 7: COMMITMENTS AND CONTINGENCIES
Environmental
At June 30, 2003, the Company's undiscounted accrued liabilities for
environmental remediation costs amounted to $141 million and are
reported in other long-term liabilities in the accompanying
Consolidated Statement of Financial Position.
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 June 30, 2003, estimated future investigation
and remediation costs of $66 million are accrued on an undiscounted
basis by the Company and are included in the $141 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 June 30, 2003,
estimated future remediation costs of $48 million are accrued on an
undiscounted basis and are included in the $141 million reported in
other long-term liabilities.
The Company has obligations relating to two former manufacturing sites
located outside the United States. The Company's obligations with
respect to these two sites include an estimate of its cost to
repurchase one of the sites and demolish the buildings in preparation
for its reuse. At June 30, 2003, estimated future investigation,
remediation and monitoring costs of $23 million are accrued on an
undiscounted basis and are included in the $141 million reported in
other long-term liabilities.
Additionally, the Company has approximately $4 million accrued on an
undiscounted basis in the $141 million reported in other long-term
liabilities at June 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.
14
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.
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 $25 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 June
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 three 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.
15
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.
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 $60 million at June 30, 2003. The Company expects that
approximately $15 million of the remaining $60 million in total put
options will be exercised within the next six months.
16
Qualex, a wholly owned subsidiary of Kodak, has a 50% ownership
interest in ESF, which is a joint venture partnership between Qualex
and 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.
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
$416 million at June 30, 2003.
17
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.
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 June 30, 2003 were $280
million. The difference between the amended maximum borrowing amount
of $257 million and the outstanding balance at June 30, 2003 of $280
million is attributable to payments subsequent to June 30, 2003 through
the date of the amendment. The amended RPA extends through July 2004,
at which time the RPA can be extended or terminated. If the RPA were
terminated, Qualex would no longer be able to sell its lease
receivables to ESF and would need to find an alternative financing
solution for future sales of its photofinishing equipment. The term of
the ESF partnership agreement between Qualex and DCC continues through
October 6, 2003. In light of the timing of the partnership
termination, Qualex plans to utilize the services of Eastman Kodak
Credit Corporation, a wholly owned subsidiary of General Electric
Capital Corporation, as an alternative financing solution for
prospective leasing activity with its customers.
18
At June 30, 2003, the Company had outstanding letters of credit
totaling $99 million and surety bonds in the amount of $105 million
primarily to ensure the completion of environmental remediations and
payment of possible casualty and workers' compensation claims.
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.
- -----------------------------------------------------------------------
19
NOTE 8: GUARANTEES
The Company guarantees debt and other obligations under agreements with
certain affiliated companies and customers. At June 30, 2003, these
guarantees totaled a maximum of $329 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 ($71 million outstanding); $6 million for other
unconsolidated affiliates and third parties ($6 million outstanding);
and $163 million of customer amounts due to banks in connection with
various banks' financing of customers' purchase of products and
equipment from Kodak ($84 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 July 1, 2003 and May 31, 2005 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 six months ended June 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 $733
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 $567 million. These guarantees expire in 2003
through 2005 with the majority expiring in 2003.
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
June 30, 2003, the Company has not been required to guarantee any of SK
Display Corporation's outstanding debt.
20
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 six
months ended June 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 June 30, 2003 was as follows:
(in millions)
Accrued warranty obligations at December 31, 2002 $ 43
Actual warranty experience (23)
Warranty provisions 26
Adjustments for changes in estimate (1)
----
Accrued warranty obligations at June 30, 2003 $ 45
====
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 six months ended June 30, 2003
amounted to $96 million. The change in the Company's deferred revenue
balance in relation to these extended warranty arrangements from
December 31, 2002 to June 30, 2003 was as follows:
(in millions)
Deferred revenue at December 31, 2002 $ 103
New extended warranty arrangements 185
Recognition of extended warranty arrangement
revenue (163)
-----
Deferred revenue at June 30, 2003 $ 125
=====
- -----------------------------------------------------------------------
21
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 six months
ended June 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 three and six months ended June 30, 2003.
During the second quarter, 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 three and six months ended June 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.
22
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.
23
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 June 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
====== ===== ==== ====
The charges taken in the first and second quarters of 2003 for
severance of $16 million and $1 million, respectively, were reported in
restructuring costs and other in the accompanying Consolidated
Statement of Earnings for the six months ended June 30, 2003. 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. The
Company expects the actions contemplated by the reserve for exit costs
to be completed by the end of 2003. 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 $7 million and $21 million
of accelerated depreciation on long-lived assets in cost of goods sold
in the accompanying Consolidated Statement of Earnings for the three
and six months ended June 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 $21
million was comprised of $12 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. The Company will
incur accelerated depreciation charges of $3 million in the third
quarter of 2003 as a result of the initiatives implemented under the
Fourth Quarter, 2002 Restructuring Program.
24
With respect to the Fourth Quarter, 2002 Restructuring Program, the
Company anticipates completing the relocation of the U.S. one-time-use
camera assembly operation and Mexico sensitizing operations by the end
of 2003. Such initiatives are expected to result in the elimination of
an additional 200 to 300 positions with anticipated charges in the
range of $5 million to $10 million.
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.
25
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 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 June 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
==== ==== ==== ====
The first quarter charges of $28 million were reported in restructuring
costs and other in the accompanying Consolidated Statement of Earnings
for the six months ended June 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 three and six months ended
June 30, 2003. The charges taken for inventory write-downs were
reported in cost of goods sold in the accompanying Consolidated
Statement of Earnings for the three and six months ended June 30, 2003.
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 second 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. 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.
26
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 three and six
months ended June 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 three and six
months ended June 30, 2003. The exit costs, which represent the only
cash portion of the charge, are expected to be paid during the
remainder of 2003.
With respect to the First Quarter, 2003 Restructuring Program, the
Company anticipates completing the remaining initiatives originally
contemplated under the Program by the end of 2003. Specifically, the
Company expects to complete the closure of photofinishing labs in the
U.S. and EAMER under this Program by the end of 2003. Such closures
are expected to result in the elimination of an additional 700 to 800
positions with anticipated charges in the range of $25 to $30 million.
Approximately 100 to 200 additional administrative positions will be
eliminated throughout the world by the end of 2003 under this Program
at a cost of $5 to $10 million. 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. The Company expects the initiatives
contemplated by the reserve for exit costs to be completed by the end
of 2003. 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.
Future Expected Restructuring Actions
Over the next twelve months, Kodak intends to implement a series of
cost reduction actions, 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.
27
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 $21 million as of June 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 $16 million as of June 30, 2003 are expected to be utilized
during 2003. However, certain costs, such as long-term lease payments,
will be paid over periods after 2003.
- ----------------------------------------------------------------------
NOTE 11: EARNINGS PER SHARE
Options to purchase 39.9 million and 23.7 million shares of common
stock at weighted average per share prices of $49.08 and $61.46 for the
three months ended June 30, 2003 and 2002, respectively, and options to
purchase 24.7 million and 23.8 million shares of common stock at
weighted average per share prices of $54.57 and $61.44 for the six
months ended June 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 June 30, 2003 and December 31, 2002. Treasury stock at cost
consists of approximately 105 million shares at both June 30, 2003 and
December 31, 2002.
28
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 Financial
Accounting Standards Board (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.
(in millions, except per share data)
Three Months Ended Six Months Ended
June 30 June 30
------------------ ----------------
2003 2002 2003 2002
Net income, as reported $ 112 $ 284 $ 124 $ 323
Deduct: Total stock-based
employee compensation expense
determined under fair value
method for all awards, net
of related tax effects (4) (9) (8)
(35)
----- ----- ----- -----
Pro forma net income $ 108 $ 275 $ 116 $ 288
===== ===== ===== =====
Earnings per share:
Basic and diluted - as reported $ .39 $ .97 $ .43 $1.11
Basic and diluted - pro forma $ .38 $ .94 $ .41 $ .99
The total stock-based employee compensation expense amount for the six
months ended June 30, 2002 of $35 million, net of taxes, 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 six months
ended June 30, 2002, which amounted to $25 million, net of taxes.
- -----------------------------------------------------------------------
29
NOTE 13: COMPREHENSIVE INCOME
(in millions)
Three Months Ended Six Months Ended
June 30 June 30
------------------ ----------------
2003 2002 2003 2002
Net income $112 $284 $124 $323
Unrealized gains on
available-for-sale
securities 3 - 5 2
Realized and unrealized
(losses) gains from
hedging activity (8) (14) (10) (6)
Currency translation
adjustments 142 161 203 129
---- ---- ---- ----
Total comprehensive income $249 $431 $322 $448
==== ==== ==== ====
- -----------------------------------------------------------------------
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.
The Company is currently in negotiations to sell 100% of the stock in
the Burrell Companies to an unaffiliated company. The Company believes
that the consideration it will receive in connection with the sale will
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 three and six months ended
June 30, 2003.
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 quarter as research and development
costs in the accompanying Consolidated Statement of Earnings.
30
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. The Company expects to complete
the allocation of the purchase price of $32 million in the third
quarter of 2003. As of June 30, 2003, the total purchase price is
reflected in other long-term assets in the accompanying Consolidated
Statement of Financial Position.
- ----------------------------------------------------------------------
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 six
months ended June 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 six months ended June 30,
2003.
The net loss from discontinued operations of $2 million and $4 million
in the accompanying Consolidated Statement of Earnings for the three
and six months ended June 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.
31
Three Months Ended Six Months Ended
June 30 June 30
------------------ -----------------
(in millions) 2003 2002 2003 2002
Net sales from continuing
operations:
Photography $2,341 $2,378 $4,139 $4,192
Health Imaging 607 569 1,156 1,090
Commercial Imaging 382 361 754 708
All Other 22 28 43 52
------ ------ ------ ------
Consolidated total $3,352 $3,336 $6,092 $6,042
====== ====== ====== ======
Earnings (loss) from continuing
operations before interest,
other charges, and income taxes:
Photography $ 119 $ 257 $ 73 $ 273
Health Imaging 131 112 240 188
Commercial Imaging 40 53 84 101
All Other (22) (6) (39) (13)
------ ------ ------ ------
Total of segments 268 416 358 549
Venture investment impairments - (10) - (10)
Impairment of Burrell Companies'
net assets held for sale (9) - (9) -
Restructuring costs and other (54) - (100) -
GE settlement - - (12) -
Patent infringement claim
settlement (14) - (14) -
Prior year acquisition settlement (14) - (14) -
----- ------ ------ ------
Consolidated total $ 177 $ 406 $ 209 $ 539
====== ====== ====== ======
(Loss) earnings from
continuing operations:
Photography $ 87 $ 175 $ 52 $ 178
Health Imaging 101 82 181 132
Commercial Imaging 25 25 45 49
All Other (17) (4) (31) (10)
------ ------ ------ ------
Total of segments 196 278 247 349
Venture investment impairments - (13) - (13)
Impairment of Burrell Companies'
net assets held for sale (9) - (9) -
Restructuring costs and other (54) - (100) -
GE settlement - - (12) -
Patent infringement claim
settlement (14) - (14) -
Prior year acquisition settlement (14) - (14) -
Interest expense (34) (44) (71) (88)
Other corporate items 3 3 6 5
Tax benefit - donation
of patents - - 8 -
Tax benefit - PictureVision
subsidiary closure - 45 - 45
Income tax effects on
above items and taxes
not allocated to segments 38 17 68 29
------ ------ ------ ------
Consolidated total $ 112 $ 286 $ 109 $ 327
====== ====== ====== ======
- ----------------------------------------------------------------------
32
NOTE 17: SUBSEQUENT EVENT
On July 21, 2003, the Company announced that it has entered into an
agreement to acquire all of the outstanding shares of PracticeWorks
Inc., a leading provider of dental practice management software and
digital radiographic imaging systems for $500 million in cash. The
acquisition will be integrated into the Company's Health Imaging
segment. This acquisition will enable the Company 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 the Company's Health Imaging business into the leading position
in the dental practice management and dental radiographic markets.
- -----------------------------------------------------------------------
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
SUMMARY
(in millions, except per share data)
Three Months Ended Six Months Ended
June 30 June 30
-------------------- ---------------------
- -
2003 2002 Change 2003 2002 Change
Net sales $3,352 $3,336 0% $6,092 $6,042 + 1%
Earnings from continuing
operations before interest,
other charges, and income
taxes 177 406 -56 209 539 -61
Earnings from continuing
operations 112 286 -61 109 327 -67
Net earnings 112 284 -61 124 323 -62
Basic and diluted earnings
(loss) per share:
Continuing operations .39 .98 -60 .38 1.12 -66
Discontinued operations .00 (.01) .05 (.01)
Total .39 .97 -60 .43 1.11 -61
33
Net Sales from Continuing Operations by Reportable Segment and All
Other
(in millions)
Three Months Ended Six Months Ended
June 30 June 30
--------------------- --------------------
- -
2003 2002 Change 2003 2002 Change
Photography
Inside the U.S. $ 972 $1,083 -10% $1,659 $1,882 -12%
Outside the U.S. 1,369 1,295 + 6 2,480 2,310 + 7
------ ------ --- ------ ------ ---
Total Photography 2,341 2,378 - 2 4,139 4,192 - 1
------ ------ --- ------ ------ ---
Health Imaging
Inside the U.S. 266 270 - 1 504 518 - 3
Outside the U.S. 341 299 +14 652 572 +14
------ ------ --- ------ ------ ---
Total Health Imaging 607 569 + 7 1,156 1,090 + 6
------ ------ --- ------ ------ ---
Commercial Imaging
Inside the U.S. 221 204 + 8 434 393 +10
Outside the U.S. 161 157 + 3 320 315 + 2
------ ------ --- ------ ------ ---
Total Commercial Imaging 382 361 + 6 754 708 + 6
------ ------ --- ------ ------ ---
All Other
Inside the U.S. 11 16 -31 22 27 -19
Outside the U.S. 11 12 - 8 21 25 -16
------ ------ --- ------ ------ ---
Total All Other 22 28 -21 43 52 -17
------ ------ --- ------ ------ ---
Consolidated total $3,352 $3,336 0% $6,092 $6,042 + 1%
====== ====== === ====== ====== ===
- -----------------------------------------------------------------------
34
Earnings (Loss) from Continuing Operations Before Interest, Other
Charges, and Income Taxes by Reportable Segment and All Other
(in millions)
Three Months Ended Six Months Ended
June 30 June 30
--------------------- ---------------------
- -
2003 2002 Change 2003 2002
Change
Photography $ 119 $ 257 -54% $ 73 $ 273 -73%
Percent of Sales 5.1% 10.8% 1.8% 6.5%
Health Imaging $ 131 $ 112 +17% $ 240 $ 188 +28%
Percent of Sales 21.6% 19.7% 20.8% 17.2%
Commercial Imaging $ 40 $ 53 -25% $ 84 $ 101 -17%
Percent of Sales 10.5% 14.7% 11.1% 14.3%
All Other $ (22) $ (6) $ (39) $ (13)
Percent of Sales (100.0%) (21.4%) (90.7%) (25.0%)
------- ------ --- ------ ----- ---
Total of segments $ 268 $ 416 -36% $ 358 $ 549 -35%
8.0% 12.5% 5.9% 9.1%
Venture investment
impairments - (10) - (10)
Impairment of Burrell
Companies' net assets
held for sale (9) - (9) -
Restructuring costs and
other (54) - (100) -
GE settlement - - (12) -
Patent infringement
claim settlement (14) - (14) -
Prior year acquisition
settlement (14) - (14) -
------- ------ ---- ------ ----- ---
Consolidated total $ 177 $ 406 -56% $ 209 $ 539 -61%
======= ====== ==== ====== ===== ===
- -----------------------------------------------------------------------
35
Earnings (Loss) From Continuing Operations by Reportable Segment and
All Other
(in millions)
Three Months Ended Six Months Ended
June 30 June 30
--------------------- ---------------------
- -
2003 2002 Change 2003 2002
Change
Photography $ 87 $ 175 -50% $ 52 $ 178 -71%
Percent of Sales 3.7% 7.4% 1.3% 4.2%
Health Imaging $ 101 $ 82 +23% $ 181 $ 132 +37%
Percent of Sales 16.6% 14.4% 15.7% 12.1%
Commercial Imaging $ 25 $ 25 0% $ 45 $ 49 - 8%
Percent of Sales 6.5% 6.9% 6.0% 6.9
All Other $ (17) $ (4) $ (31) $ (10)
Percent of Sales (77.3%) (14.3%) (72.1%) (19.2%)
------ ------ --- ------ ----- ---
Total of segments $ 196 $ 278 -29% $ 247 $ 349 -29%
5.8% 8.3% 4.1% 5.8%
Venture investment
impairments - (13) - (13)
Impairment of Burrell
Companies' net assets
held for sale (9) - (9) -
Restructuring costs
and other (54) - (100) -
GE settlement - - (12) -
Patent infringement
claim settlement (14) - (14) -
Prior year acquisition
settlement (14) - (14) -
Interest expense (34) (44) (71) (88)
Other corporate items 3 3 6 5
Tax benefit -
PictureVision
subsidiary closure - 45 - 45
Tax benefit - donation
of patents - - 8 -
Income tax effects on
above items and taxes
not allocated to
segments 38 17 68 29
------ ---- --- ------ ----- ---
Consolidated total $ 112 $286 -61% $ 109 $ 327 -67%
====== ==== === ====== ===== ===
- ---------------------------------------------------------------------
36
COSTS AND EXPENSES
(in millions)
Three Months Ended Six Months Ended
June 30 June 30
--------------------- ----------------------
2003 2002 Change 2003 2002 Change
Gross profit $1,116 $1,254 -11% $1,940 $2,114 -8%
Percent of Sales 33.3% 37.6% 31.8% 35.0%
Selling, general and
administrative expenses $ 716 $ 656 + 9% $1,282 $1,196 +7%
Percent of Sales 21.4% 19.7% 21.0% 19.8%
Research and development
costs $ 179 $ 192 - 7% $ 373 $ 379 -2%
Percent of Sales 5.3% 5.8% 6.1% 6.3%
- -----------------------------------------------------------------------
2003 COMPARED WITH 2002
Second Quarter
RESULTS OF OPERATIONS - CONTINUING OPERATIONS
Consolidated
Net worldwide sales were $3,352 million for the second quarter of 2003
as compared with $3,336 million for the second quarter of 2002,
representing an increase of $16 million, or a decrease of 6% excluding
the favorable impact of exchange. The increase in net sales was
primarily due to favorable exchange, which increased second quarter
sales by approximately 6.2 percentage points. This increase was
partially offset by decreases attributable to price/mix, primarily
driven by consumer film and photofinishing and consumer digital
cameras, which reduced second quarter sales by approximately 3.3
percentage points, and volume, primarily driven by consumer traditional
film and photofinishing, which reduced second quarter sales by
approximately 2.1 percentage points.
Net sales in the U.S. were $1,470 million for the second quarter of
2003 as compared with $1,573 million for the prior year quarter,
representing a decrease of $103 million, or 7%. Net sales outside the
U.S. were $1,882 million for the current quarter as compared with
$1,763 million for the second quarter of 2002, representing an increase
of $119 million, or 7% as reported, or a decrease of 4% excluding the
favorable impact of exchange.
37
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 $1,045 million for the second quarter of
2003 as compared with $932 million for the prior year quarter,
representing an increase of $113 million, or 12% as reported, or a
decrease of 4% excluding the favorable impact of exchange. Net sales
in the Asia Pacific region were $537 million for the current quarter as
compared with $557 million for the prior year quarter, representing a
decrease of $20 million, or 4% as reported, or a decrease of 9%
excluding the favorable impact of exchange. Net sales in the Canada
and Latin America region were $300 million in the current quarter as
compared with $274 million for the second quarter of 2002, representing
an increase of $26 million, or 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 in emerging
markets were $602 million for the second quarter of 2003 as compared
with $605 million for the prior year quarter, representing a decrease
of $3 million, or a decrease of 4% excluding the favorable impact of
exchange. The emerging market portfolio accounted for approximately
18% of Kodak's worldwide sales and 32% of Kodak's non-U.S. sales in the
quarter. Sales growth in Russia, India and Mexico of 32%, 12% and 1%,
respectively, was offset by declines in China and Brazil of 19% and
12%, respectively.
The increase in sales in Russia is a result of Kodak Express 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 declines in China resulted from the impact of SARS particularly
for consumer and professional products and services. Declines in
Brazil are reflective of continued economic weakness in that emerging
market country.
Gross profit was $1,116 million for the second quarter of 2003 as
compared with $1,254 million for the second quarter of 2002,
representing a decrease of $138 million, or 11%. The gross profit
margin was 33.3% in the current quarter as compared with 37.6% in the
prior year quarter. The 4.3 percentage point decrease was primarily
attributable to declines in price/mix, driven primarily by consumer
film and consumer digital cameras, which reduced gross profit margins
by approximately 3.5 percentage points and manufacturing
productivity/cost, which negatively impacted gross profit margins by
approximately 1.8 percentage points. These decreases were partially
offset by exchange, which favorably impacted gross profit margins by
approximately 1.0 percentage points.
38
Selling, general and administrative expenses (SG&A) were $716 million
for the second quarter of 2003 as compared with $656 million for the
prior year quarter, representing an increase of $60 million, or 9%.
SG&A increased as a percentage of sales from 19.7% for the second
quarter of 2002 to 21.4% for the current quarter. The increase in SG&A
is primarily attributable to the following charges: $14 million
relating to a patent infringement claim, $14 million associated with
the settlement of outstanding issues related to a prior year
acquisition, $9 million associated with the write-down of the Burrell
Companies' net assets held for sale and unfavorable exchange of $34
million. These items were partially offset by cost savings realized
from position eliminations associated with the prior year's cost
reduction programs.
Research and development costs (R&D) were $179 million for the second
quarter of 2003 as compared with $192 million for the second quarter of
2002, representing a decrease of $13 million, or 7%. R&D decreased as
a percentage of sales from 5.8% for the second quarter of 2002 to 5.3%
for the current quarter. The net decrease in R&D is the result of cost
savings realized from position eliminations associated with the prior
year's cost reduction programs.
Earnings from continuing operations before interest, other charges, and
income taxes for the second quarter of 2003 were $177 million as
compared with $406 million for the second quarter of 2002, representing
a decrease of $229 million, or 56%. This decrease is primarily
attributable to (1) the decline in the gross profit margin and
increases in SG&A, as described above, and (2) focused cost reduction
charges of $54 million incurred during the second quarter of 2003, with
no such costs incurred in the prior year quarter.
Interest expense for the second quarter of 2003 was $34 million as
compared with $44 million for the prior year quarter, representing a
decrease of $10 million, or 23%. The decrease in interest expense is
primarily attributable to lower interest rates and lower average
borrowing levels in the second 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
$22 million for the second quarter of 2002. The improvement is
primarily attributable to increased income from the Company's
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 NexPress joint venture.
39
The Company's estimated annual effective tax rate decreased from 26% in
the three month period ended March 31, 2003 to 24% in the three month
period ended June 30, 2003. This decrease was primarily attributable
to further expected increased earnings from operations in certain lower-
taxed jurisdictions outside the U.S. relative to total consolidated
earnings.
The Company's estimated annual effective tax rate decreased from 29%
for the second quarter of 2002 to 24% for the second quarter of 2003.
The decrease in the estimated annual effective tax rate was primarily
attributable to expected increased earnings from operations in certain
lower-taxed jurisdictions outside the U.S. relative to total
consolidated earnings.
The effective tax rate for the three months ended June 30, 2003 was
approximately 16%, which is unchanged as compared with the effective
tax rate for the three months ended June 30, 2002. The effective tax
rate of 16% for the three months ended June 30, 2003 is lower than the
Company's estimated annual effective tax rate of 24% for 2003 due to
the recording of discrete period tax benefits of $31 million in
connection with the following items, all of which are taxed in
jurisdictions with tax rates greater than the estimated annual
effective tax rate: charges for focused cost reductions of $54 million;
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; and a $9 million charge relating to the
impairment of the Burrell Companies' net assets held for sale.
The effective tax rate of 16% for the three months ended June 30, 2002
was lower than the Company's estimated annual effective tax rate of 29%
for 2002 due to the recording of a discrete period tax benefit of $45
million in connection with the closure of the Company's PictureVision
subsidiary.
The earnings from continuing operations for the second quarter of 2003
were $112 million, or $.39 per diluted share, as compared with earnings
from continuing operations for the second quarter of 2002 of $286
million, or $.98 per diluted share, representing a decrease of $174
million. This decrease in earnings from continuing operations is
attributable to the reasons described above.
40
Photography
Net worldwide sales for the Photography segment were $2,341 million for
the second quarter of 2003 as compared with $2,378 million for the
second quarter of 2002, representing a decrease of $37 million, or 2%
as reported, or 8% excluding the favorable impact of exchange. The
decrease in net sales was comprised of (1) decreases related to volume
driven primarily by volume declines for traditional consumer products
and services, which were partially offset by increases in volume for
consumer digital and entertainment products and services, which in
total reduced second quarter sales by approximately 4.0 percentage
points and (2) declines in price/mix primarily driven by consumer film
and photofinishing and consumer digital cameras, which reduced net
sales by approximately 4.1 percentage points. These declines were
partially offset by favorable exchange, which increased net sales by
approximately 6.5 percentage points.
Photography segment net sales in the U.S. were $972 million for the
current quarter as compared with $1,083 million for the second quarter
of 2002, representing a decrease of $111 million, or 10%. Photography
segment net sales outside the U.S. were $1,369 million for the second
quarter of 2003 as compared with $1,295 million for the prior year
quarter, representing an increase of $74 million, or 6% as reported, or
a decrease of 6% excluding the favorable impact of exchange.
Net worldwide sales of consumer film products, including 35mm film,
Advantix film and one-time-use cameras, decreased 6% in the second
quarter of 2003 as compared with the second quarter of 2002, reflecting
decreases due to declines in volume of approximately 13%, partially
offset by an increase in price/mix of 1% and favorable exchange of
approximately 6%. Sales of the Company's consumer film products within
the U.S. decreased 9%, reflecting declines in volume of approximately
11% offset by positive price/mix of approximately 2%. The decrease in
volume is largely attributable to the decrease in U.S. consumer film
industry volume in the second quarter of 2003, as described below,
which reflects the downward trend in retail sales. Positive price/mix
trends in the U.S. were the result of better than expected one-time-use
camera mix driven by the HQ, black and white and one-time-use plus
digital family of products, as well as new premium film products
including High Definition and black and white films. It also reflects
the initial retailer inventory build in support of the launch of this
new family of premium one-time-use camera and film products. Sales of
the Company's consumer film products outside the U.S. decreased 2%,
reflecting declines in volume of approximately 14%, partially offset by
favorable exchange of approximately 12%.
U.S. consumer film industry volume decreased 7% in the second quarter
of 2003 as compared with the prior year quarter. The most current U.S.
market trends suggest that, for the second quarter of 2003, digital
substitution accounted for the majority of the industry decline. The
most current U.S. market data trends also indicate that, for the full
year 2003, the U.S. film industry volume will decrease 7% to 8% year-
over-year. The same data suggests that digital substitution will
account for the majority of the industry decline.
41
The Company's blended U.S. consumer film share decreased approximately
1% on a volume basis relative to the second quarter 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 low double digits
in the second quarter of 2003 as compared with the second quarter of
2002. With U.S. volumes also declining low double digits and volumes
outside the U.S. decreasing high single digits. Kodak will no longer
report sales trends for color negative paper because paper and other
products are typically bundled together as a "systems sell" for
customer contracting purposes.
Net worldwide photofinishing sales, including Qualex in the U.S. and
Consumer Imaging Services (CIS) outside the U.S., decreased 16% in the
second quarter of 2003 as compared with the second quarter of 2002,
reflecting lower volumes and price/mix, partially offset by favorable
exchange. In the U.S., Qualex's sales decreased 22%, 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 1%
in the second quarter of 2003 as compared with the second quarter of
2002, driven primarily by an increase in sales of kiosks and consumer
digital services.
The average penetration rate for the number of rolls scanned at
Qualex's wholesale labs averaged 7.4% in the second quarter of 2003, an
increase from the 7.0% rate recorded in the second quarter of 2002.
The growth was driven by continued consumer acceptance of Picture CD
and Retail.com. However, the number of images scanned versus the second
quarter of 2002 decreased 15% due to the negative photofinishing trends
at Qualex resulting from a weak consumer film industry and consumer's
changing preferences towards on-site processing.
The Company's Ofoto business increased its sales 56% in the second
quarter of 2003 as compared with the prior year quarter. Ofoto now has
more than 8 million members and continues to be the market leader in
the online photo services space.
Net worldwide sales of consumer digital cameras increased 65% in the
second quarter of 2003 as compared with the prior year quarter,
primarily reflecting strong increases in volume and favorable exchange,
partially offset by a decline in price/mix. Sales continue to be
driven by strong consumer acceptance of the EasyShare digital camera
system. In addition, Kodak's new Printer Dock 6000, introduced to the
market in March of this year, exceeded sales expectations during the
second quarter.
42
Similar to the prior year, Kodak's U.S. consumer digital camera market
share declined slightly during the second quarter of 2003 on a quarter
sequential basis as the Company refreshes its product portfolio and
transitions to a new line of digital cameras becoming available
throughout the third quarter. While complete data for second quarter
consumer digital 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, however, some of Kodak's largest
channels do not report market share data.
Net worldwide sales of inkjet photo paper increased 51% in the current
quarter as compared with the second quarter of 2002. The Company
maintained its top two market share position in the United States
quarter sequentially. 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 sensitized films, including color
negative, color reversal and black and white films, decreased 14% in
the second quarter of 2003 as compared with the second quarter of 2002,
primarily reflecting declines in volume and price/mix, partially offset
by favorable exchange. Net worldwide sales of professional sensitized
output declined 3% in the second quarter of 2003 as compared with the
second quarter of 2002, reflecting declines in volume and 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. These declines were
partially offset by worldwide sales increases in the current quarter
related to digital cameras, digital writers, Event Imaging solutions,
digital systems and solutions, display materials and thermal equipment.
Net worldwide sales of origination and print film to the entertainment
industry increased 18% in the second quarter of 2003 as compared with
the prior year quarter, reflecting higher print film volumes due to a
strong industry motion picture release schedule and favorable exchange.
The new Vision 2 origination film continues to gain strong customer
acceptance.
Gross profit for the Photography segment was $757 million for the
second quarter of 2003 as compared with $896 million for the prior year
quarter, representing a decrease of $139 million or 16%. The gross
profit margin was 32.3% in the current year quarter as compared with
37.7% in the prior year quarter. The 5.4 percentage point decline was
primarily attributable to declines in price/mix primarily driven by
consumer film and consumer digital cameras, which reduced gross profit
margins by approximately 4.4 percentage points and decreases in
manufacturing productivity/cost, which reduced gross margins by
approximately 2.2 percentage points. These decreases were partially
offset by exchange, which favorably impacted gross profit margins by
approximately 1.2 percentage points.
43
SG&A expenses for the Photography segment increased $19 million, or 4%,
from $507 million in the second quarter of 2002 to $526 million in the
current quarter, and increased as a percentage of sales from 21.3% to
22.5%. The increase is primarily attributable to unfavorable exchange
of $28 million, partially offset by cost savings realized from position
eliminations associated with the prior year's cost reduction programs.
R&D costs for the Photography segment decreased $19 million, or 14%,
from $132 million in the second quarter of 2002 to $113 million in the
current quarter and decreased as a percentage of sales from 5.5% 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 the prior year's cost reduction programs.
Earnings from continuing operations before interest, other charges, and
income taxes for the Photography segment decreased $138 million, from
$257 million in the second quarter of 2002 to $119 million in the
second quarter of 2003, primarily as a result of the factors described
above.
Health Imaging
Net worldwide sales for the Health Imaging segment were $607 million
for the second quarter of 2003 as compared with $569 million for the
prior year quarter, representing an increase of $38 million, or 7% as
reported, or 1% excluding the favorable impact of exchange. The
increase in sales was comprised of (1) an increase in volume of
approximately 3.6 percentage points, driven primarily by volume
increases in digital media, digital capture equipment and equipment
services and (2) an increase from favorable exchange of approximately
6.0 percentage points, which was partially offset by a decrease in
price/mix of approximately 2.7 percentage points, primarily driven by
digital media, laser printers and analog medical film.
Net sales in the U.S. were $266 million for the current quarter as
compared with $270 million for the second quarter of 2002, representing
a decrease of $4 million, or 1%. Net sales outside the U.S. were $341
million for the second quarter of 2003 as compared with $299 million
for the prior year quarter, representing an increase of $42 million, or
14% 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 11% in
the second quarter of 2003 as compared with the prior year quarter.
The increase in digital product sales was primarily attributable to
favorable exchange and higher volumes of digital media, digital capture
equipment and equipment services. Service revenues increased due to an
increase in digital equipment service contracts during the current
quarter as compared with the second quarter of 2002.
44
Net worldwide sales of traditional products, including analog film,
equipment, chemistry and services, increased 2% in the second quarter
of 2003 as compared with the second quarter of 2002 due to favorable
exchange and higher specialty film volumes. Traditional analog film
products (excluding specialty films) decreased 3% in the second quarter
of 2003 as compared with the prior year quarter due to lower price/mix,
partially offset by higher volumes and favorable exchange.
Gross profit for the Health Imaging segment was $263 million for the
second quarter of 2003 as compared with $236 million in the prior year
quarter, representing an increase of $27 million, or 11%. The gross
profit margin was 43.3% in the current quarter as compared with 41.5%
in the second quarter of 2002. The increase in the gross profit margin
of 1.8 percentage points was principally attributable to (1) favorable
cost and manufacturing productivity, which increased gross profit
margins by approximately 2.2 percentage points, and (2) favorable
exchange, which contributed approximately 1.3 percentage points to the
gross profit margin. These increases were partially offset by
decreases in price/mix, which negatively impacted gross profit margins
by 1.7 percentage points due to lower prices for digital media, analog
medical film and laser printers.
SG&A expenses for the Health Imaging segment increased $7 million, or
8%, from $87 million in the second quarter of 2002 to $94 million for
the current quarter, and increased as a percentage of sales from 15.3%
to 15.5%. The increase in SG&A expenses is primarily attributable to
the unfavorable effects of foreign exchange, which accounted for $4
million of this change, and increased spending to drive growth.
Second quarter R&D costs increased $1 million, or 3%, from $37 million
to $38 million, but decreased as a percentage of sales from 6.5% for
the second quarter of 2002 to 6.3% for the current quarter.
Earnings from continuing operations before interest, other charges, and
income taxes for the Health Imaging segment increased $19 million, or
17%, from $112 million for the prior year quarter to $131 million for
the second quarter of 2003 due primarily to the reasons described
above.
On July 21, 2003, the Company announced that it has entered into an
agreement to acquire all of the outstanding shares of PracticeWorks
Inc., a leading provider of dental practice management software and
digital radiographic imaging systems for $500 million in cash. 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.
45
Commercial Imaging
Net worldwide sales for the Commercial Imaging segment were $382
million for the second quarter of 2003 as compared with $361 million
for the prior year quarter, representing an increase of $21 million, or
6% as reported, or an increase of 3% excluding the favorable impact of
exchange. The increase in net sales was primarily comprised of (1)
increases in volume, which contributed approximately 3.0 percentage
points to second quarter sales, with imaging services and document
scanners being key drivers, and (2) an increase of approximately 3.1
percentage points due to favorable exchange, which was partially offset
by price/mix declines of approximately 0.4 percentage points.
Net sales in the U.S. were $221 million for the current quarter as
compared with $204 million for the prior year quarter, representing an
increase of $17 million, or 8%. Net sales outside the U.S. were $161
million in the second quarter of 2003 as compared with $157 million for
the prior year quarter, representing an increase of $4 million or 3% as
reported, or a decrease of 5% 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 current
quarter as compared with the second quarter of 2002, primarily
reflecting volume and price/mix declines 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 12 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 second quarter 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.
Gross profit for the Commercial Imaging segment was $105 million for
the second quarter of 2003 as compared with $115 million in the prior
year quarter, representing a decrease of $10 million, or 9%. The gross
profit margin was 27.5% in the current quarter as compared with 31.9%
in the prior year quarter. The decrease in the gross profit margin of
4.4 percentage points was primarily attributable to (1) manufacturing
productivity which negatively impacted gross profit margins by
approximately 3.0 percentage points, (2) declines in price/mix, which
reduced gross profit margins by approximately 0.9 percentage points
primarily due to declining contributions from traditional graphic arts
products, and (3) negative exchange, which reduced gross profit margins
by 0.5 percentage points.
46
SG&A expenses for the Commercial Imaging segment increased $2 million,
or 4%, from $48 million for the second quarter of 2002 to $50 million
for the current quarter, but decreased as a percentage of sales from
13.3% to 13.1%. The increase in SG&A expense was due to the
unfavorable impact of exchange, which accounted for the entire $2
million increase.
Second quarter R&D costs for the Commercial Imaging segment increased
$1 million, or 7%, from $14 million for the second quarter of 2002 to
$15 million for the current quarter, but remained unchanged as a
percentage of sales at 3.9%.
Earnings from continuing operations before interest, other charges, and
income taxes for the Commercial Imaging segment decreased $13 million,
or 25%, from $53 million in the second quarter of 2002 to $40 million
in the second quarter of 2003. This decrease is primarily attributable
to the reasons described above.
All Other
Net worldwide sales for All Other were $22 million for the second quarter
of 2003 as compared with $28 million for the second quarter of 2002,
representing a decrease of $6 million, or 21%. Net sales in the U.S.
were $11 million in the current quarter as compared with $16 million in
the second quarter of 2002. Net sales outside the U.S. were $11 million
in the second quarter of 2003 as compared with $12 million in the prior
year quarter, representing a decrease of $1 million, or 8%.
SK Display Corporation, the OLED manufacturing joint venture between
Kodak and Sanyo, continued 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 $22 million in the current quarter as
compared with a loss of $6 million in the second 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 second quarter of 2003. In the second
quarter of 2002 a loss from discontinued operations of $2 million, or
$.01 per diluted share, was reported.
NET EARNINGS
Net earnings for the second quarter of 2003 were $112 million, or $.39
per diluted share, as compared with net earnings for the second quarter
of 2002 of $284 million, or $.97 per diluted share, representing a
decrease of $172 million, or 61%. This decrease is primarily
attributable to the reasons outlined above.
47
Year to Date
Consolidated
Net worldwide sales were $6,092 million for the six months ended June
30, 2003 as compared with $6,042 million for the six months ended June
30, 2002, representing an increase of $50 million, or 1% as reported,
or a decrease of 5% excluding the favorable impact of exchange. The
slight increase in net sales was primarily due to a positive impact
from exchange of approximately 6.0 percentage points. This increase
was almost entirely offset by decreases attributable to price/mix,
which reduced sales by approximately 3.8 percentage points, primarily
driven by consumer film, photofinishing and consumer digital cameras,
and volume, which reduced sales by approximately 1.1 percentage points,
primarily driven by consumer traditional film and photofinishing.
Net sales in the U.S. were $2,619 million for the current year period
as compared with $2,820 million for the prior year period, representing
a decrease of $201 million, or 7%. Net sales outside the U.S. were
$3,473 million for the current year period as compared with $3,222
million for the prior year period, representing an increase of $251
million, or 8% as reported, or a decrease of 3% 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 six months of 2003 were $1,840
million as compared with $1,648 million for the first six months of
2002, representing an increase of 12% as reported, or a decrease of 4%
excluding the favorable impact of exchange. Net sales in the Asia
Pacific region for the first six months of 2003 were $1,085 million as
compared with $1,061 million for the first six months of 2002,
representing an increase of 2% as reported, or a decrease of 4%
excluding the favorable impact of exchange. Net sales in the Canada
and Latin America region for the first six months of 2003 were $548
million as compared with $513 million for the first six months of 2002,
representing a decrease of 7% as reported, or 3% excluding the negative
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 $1,180 million for the six months ended June 30,
2003 as compared with $1,149 million for the six months ended June 30,
2002, representing an increase of $31 million, or 3%, with no impact
from exchange. Sales growth in Russia, India and China of 35%, 13% and
4%, respectively, were the primary drivers of the increase in sales in
Emerging Market countries, partially offset by decreased sales in
Brazil, Hong Kong, Taiwan and Mexico of 18%, 17%, 22% and 2%,
respectively.
48
The increase in sales in Russia is a result of Kodak Express 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 quarter of 2003;
however, this growth was partially offset by the impact of SARS
particularly for consumer and professional products and services. The
declines in Hong Kong and Taiwan are also a result of the impact from
SARS. The declines in Brazil are reflective of the continued economic
weakness in that country.
Gross profit was $1,940 million for the six months ended June 30, 2003
as compared with $2,114 million for the six months ended June 30, 2002,
representing a decrease of $174 million, or 8%. The gross profit
margin was 31.8% in the current year period as compared with 35.0% in
the prior year period. The decrease of 3.2 percentage points was
primarily attributable to declines in price/mix and manufacturing
productivity/cost, which reduced gross profit margins by approximately
3.7 and 0.4 percentage points, respectively. The declines in price/mix
relate primarily to consumer film and consumer digital cameras. These
declines were partially offset by favorable exchange, which increased
gross profit margins by approximately 0.9 percentage points.
SG&A expenses were $1,282 million for the six months ended June 30,
2003 as compared with $1,196 million for the six months ended June 30,
2002, representing an increase of $86 million, or 7%. SG&A increased
as a percentage of sales from 19.8% for the prior year period to 21.0%
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; and unfavorable exchange of $62
million. These items were partially offset by cost savings realized
from position eliminations associated with the prior year's cost
reduction programs.
R&D costs were $373 million for the six months ended June 30, 2003 as
compared with $379 million for the six months ended June 30, 2002,
representing a decrease of $6 million, or 2%. R&D decreased slightly
as a percentage of sales from 6.3% for the prior year period to 6.1%
for the current year period. The net decrease in R&D is the result of
cost savings realized from position eliminations associated with the
prior year's cost reduction programs, which were partially offset by a
$21 million R&D charge in the first quarter of 2003 relating to the
Company's purchase of rights to certain print technology that is
currently in development and not yet ready for commercialization. This
technology qualifies as in-process R&D and, therefore, was written off
in the first quarter of 2002.
49
Earnings from continuing operations before interest, other charges, and
income taxes for the six months ended June 30, 2003 were $209 million
as compared with $539 million for the six months ended June 30, 2002,
representing a decrease of $330 million, or 61%. 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 $100
million incurred during the first half of 2003, with no such costs
incurred in the prior year period.
Interest expense for the six months ended June 30, 2003 was $71 million
as compared with $88 million for the six months ended June 30, 2002,
representing a decrease of $17 million, or 19%. The decrease in
interest expense is primarily attributable to lower interest rates and
lower average borrowing levels in the first six months of 2003 relative
to the first six months of 2002.
Other charges for the current year period were a net charge of $30
million as compared with a net charge of $53 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 rate for the six months ended June 30, 2003 was
approximately 1%, as compared with 18% for the six months ended June
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 half
of 2002 to 24% in the first half of 2003, as well as discrete period
items, which resulted in tax benefits of $68 million in the first half
of 2003. The decrease in the estimated annual effective tax rate from
29% for the first half of 2002 to 24% for the first half 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. The discrete period items are attributable to
the following items, all of which are taxed in jurisdictions with tax
rates greater than the estimated annual effective tax rate: net 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 related 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 to a tax-qualified organization.
The effective tax rate of 18% for the six months ended June 30, 2002
was lower than the Company's estimated annual effective tax rate of 29%
for 2002 due to the recording of a discrete period tax benefit of $45
million in connection with the closure of the Company's PictureVision
subsidiary.
50
Earnings from continuing operations for the six months ended June 30,
2003 were $109 million, or $.38 per basic and diluted share, as
compared with earnings from continuing operations for the six months
ended June 30, 2002 of $327 million, or $1.12 per basic and diluted
share, representing a decrease of $218 million, or 67%. The decrease
in net earnings is primarily attributable to the reasons described
above.
Photography
Net worldwide sales for the Photography segment were $4,139 million for
the six months ended June 30, 2003 as compared with $4,192 million for
the six months ended June 30, 2002, representing a decrease of $53
million, or 1% as reported, or 7% excluding the positive impact of
exchange. The decrease in net sales was comprised of (1) decreases
related to volume, driven primarily by consumer traditional 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 2.7 percentage points and (2) declines in
price/mix primarily driven by consumer film and consumer digital
cameras, which reduced net sales by approximately 4.7 percentage
points. These declines were partially offset by favorable exchange,
which increased net sales by approximately 6.5 percentage points.
Photography segment net sales in the U.S. were $1,659 million for the
current year period as compared with $1,882 million for the prior year
period, representing a decrease of $223 million, or 12%. Photography
segment net sales outside the U.S. were $2,480 million for the current
year period as compared with $2,310 million for the prior year period,
representing an increase of $170 million, or 7% as reported, or a
decrease of 4% excluding the positive impact of exchange.
Net worldwide sales of consumer film products, including 35mm film,
Advantix film and one-time-use cameras, decreased 7% in the six months
ended June 30, 2003 as compared with the six months ended June 30,
2002, reflecting declines in volume and negative price/mix of
approximately 11% and 3%, respectively, partially offset by favorable
exchange of approximately 7%. Sales of the Company's consumer film
products within the U.S. decreased 14%, reflecting declines in volume
of approximately 13% and negative price/mix of approximately 1%. The
decrease in volume is largely attributable to the decrease in U.S.
consumer film industry volume in the first half 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 3%, respectively, which was partially offset by favorable
exchange of approximately 11%.
51
The U.S. film industry volume decreased approximately 8% in the six
month period ended June 30, 2003 as compared with the six month period
ended June 30, 2002. The most current U.S. market data trends suggest
that, for the six month period ended June 30, 2003, digital
substitution accounted for the majority of the industry decline. The
most current U.S. market data trends also indicate that, for the full
year 2003, the U.S. film industry volume will decrease 7% to 8% year-
over-year. The same data suggests that digital substitution will
account 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 half of 2003 relative to the first half 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 high single digits
in the six month period ended June 30, 2003 as compared with the six
month period ended June 30, 2002 with U.S. volumesdeclining low double
digits and volumes outside the U.S. decreasing mid-single digits.
Kodak will no longer report sales trends for color negative paper
because paper and other products are typically bundled together as a
"systems sell" for customer contracting purposes.
Net worldwide photofinishing sales, including Qualex in the U.S. and
CIS outside the U.S., decreased 16% in the six month period ended June
30, 2003 as compared with the six month period ended June 30, 2002,
reflecting lower volumes and price/mix, partially offset by favorable
exchange. In the U.S., Qualex's sales decreased 22% in the first half
of 2003 as compared with the first half 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 2% in the
six month period ended June 30, 2003 as compared with the six month
period ended June 30, 2002, driven primarily by an increase in sales of
picture maker kiosks and consumer digital services.
The average penetration rate for the number of rolls scanned at
Qualex's wholesale labs averaged 7.6% for the six month period ended
June 30, 2003, reflecting an increase from the 7.0% rate in the six
month period ended June 30, 2002. The growth was driven by continued
consumer acceptance of Picture CD and Retail.com. However, the number
of images scanned versus the first half of 2002 decreased 11% due to
negative photofinishing trends at Qualex resulting from a weak customer
film industry and consumer's changing preference towards on-site
processing.
52
The Company's Ofoto business increased its sales 69% in the first half
of 2003, as compared with the first half of 2002. Ofoto now has more
than 8 million members and continues to be the market leader in the
online photo services space.
Net worldwide sales of consumer digital cameras increased 50% in the
six month period ended June 30, 2003 as compared with the six month
period ended June 30, 2002, primarily reflecting strong increases in
volume and a favorable impact from exchange, partially offset by a
decline in price/mix. Sales continue to be driven by strong customer
acceptance of the EasyShare digital camera system. In addition,
Kodak's new Printer Dock 6000, introduced in March of this year,
exceeded sales expectations during the period.
While complete data for second quarter consumer digital market share is
not yet available, Kodak's U.S. consumer digital camera market share
year-to-date through May 2003 is up over 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; however, some of Kodak's largest channels do not
report market share data.
Net worldwide sales of inkjet photo paper increased 51% in the six
month period ended June 30, 2003 as compared with the six month period
ended June 30, 2002. The Company maintained its top 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 sensitized films, including color
negative, color reversal and black and white films, decreased 11% in
the six month period ended June 30, 2003 as compared with the six month
period ended June 30, 2002, reflecting declines in volume and
price/mix, partially offset by favorable exchange. Net worldwide sales
of professional sensitized output decreased 2% in the first half of
2003 as compared with the first half of 2002, reflecting declines in
volume and 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.
These declines were partially offset by worldwide sales increases in
the current year period as compared with the prior year period related
to display materials, digital writers, scanners, digital systems and
solutions, thermal media and equipment, digital cameras, Event Imaging
solutions, and Kodak Weddings.
Net worldwide sales of origination and print film to the entertainment
industry increased 18% in the six month period ended June 30, 2003 as
compared with the six month period ended June 30, 2002, reflecting
higher print film volumes due to a strong industry motion picture
release schedule and favorable exchange. The new Vision 2 origination
film continues to gain strong customer acceptance.
53
Gross profit for the Photography segment was $1,259 million for the six
month period ended June 30, 2003 as compared with $1,446 million for
the six month period ended June 30, 2002, representing a decrease of
$187 million or 13%. The gross profit margin was 30.4% in the current
year period as compared with 34.5% in the prior year period. The 4.1
percentage point decrease was primarily attributable to decreases in
price/mix primarily driven by consumer film and consumer digital
cameras, which decreased gross profit margins by approximately 4.7
percentage points and decreases in manufacturing productivity/cost,
which decreased gross profit margins by approximately 0.5 percentage
points. This decrease was partially offset by favorable exchange,
which increased gross profit margins by approximately 1.1 percentage
points.
SG&A expenses for the Photography segment increased $33 million, or 4%,
from $912 million for the six month period ended June 30, 2002 to $945
million for the six month period ended June 30, 2003. As a percentage
of sales, SG&A expense increased from 21.8% in the prior year period to
22.8% in the current year period. The increase is primarily
attributable to unfavorable exchange of $50 million, partially offset
by cost savings realized from position eliminations associated with the
prior year's cost reduction programs.
R&D costs for the Photography segment decreased $20 million or 8% from
$261 million in the six month period ended June 30, 2002 to $241
million in the six month period ended June 30, 2003. As a percentage
of sales, R&D costs decreased from 6.2% in the prior year period to
5.8% in the current year period. The decrease in R&D was primarily
attributable to cost savings realized from position eliminations
associated with the prior year's cost reduction programs. This
decrease was partially offset by the $21 million charge associated with
the write-off of purchased in-process R&D as noted above.
Earnings from continuing operations before interest, other charges, and
income taxes for the Photography segment decreased $200 million, or
73%, from $273 million in the six month period ended June 30, 2002 to
$73 million in the six month period ended June 30, 2003, primarily as a
result of the factors described above.
54
Health Imaging
Net worldwide sales for the Health Imaging segment were $1,156 million
for the six month period ended June 30, 2003 as compared with $1,090
million for the first half of 2002, representing an increase of $66
million, or 6% as reported, or remained unchanged excluding the
favorable impact of exchange. The increase in sales was comprised of
(1) an increase in volume of approximately 2.4 percentage points,
driven primarily by volume increases in digital media, digital capture
equipment and equipment services, and (2) an increase from favorable
exchange of approximately 6.1 percentage points, which was partially
offset by a decrease in price/mix of approximately 2.3 percentage
points, primarily driven by digital media, laser printers and analog
medical film.
Net sales in the U.S. were $504 million for the six month period ended
June 30, 2003 as compared with $518 million for the first half of 2002,
representing a decrease of $14 million, or 3%. Net sales outside the
U.S. were $652 million for the first half of 2003 as compared with $572
million for the six month period ended June 30, 2002, representing an
increase of $80 million, or 14% as reported, or 2% 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 11% for
the six month period ended June 30, 2003 as compared with the first
half of 2002. The increase in digital product sales was primarily
attributable to favorable exchange and higher volumes of digital media,
digital capture equipment and equipment services. Service revenues
increased due to an increase in digital equipment service contracts
during the first half of 2003 as compared with the prior year period.
Net worldwide sales of traditional products, including analog film,
equipment, chemistry and services, were consistent in the first half of
2003 as compared with the first half of 2002, reflecting favorable
exchange that was offset by declines in price/mix. Traditional analog
film products (excluding specialty films) decreased 1% in the first
half of 2003 as compared with the first half of 2002 due to lower
price/mix, partially offset by favorable exchange and higher volumes.
55
Gross profit for the Health Imaging segment was $492 million for the
first half of 2003 as compared with $432 million for the six month
period ended June 30, 2002, representing an increase of $60 million, or
14%. The gross profit margin was 42.6% in the current year period as
compared with 39.6% in the first half of 2002. The increase in the
gross profit margin of 3.0 percentage points was principally
attributable to (1) favorable cost and manufacturing productivity,
which increased gross profit margins by approximately 3.2 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 1.3 percentage points to the gross profit margin. These
increases were partially offset by decreases in price/mix, which
negatively impacted gross profit margins by 1.5 percentage points due
to lower prices for digital media, analog medical film and laser
printers.
SG&A expenses for the Health Imaging segment increased $5 million, or
3%, from $170 million in the first half of 2002 to $175 million for the
six month period ended June 30, 2003, but decreased as a percentage of
sales from 15.6% to 15.1%. The increase in SG&A expenses is
attributable to the unfavorable effects of foreign exchange, which
increased SG&A expenses by $8 million in the current period relative to
the prior year period. The decrease in SG&A expense as a percentage of
sales is primarily attributable to expense management.
R&D costs increased $3 million, or 4%, from $74 million for the first
half of 2002 to $77 million for the first half of 2003, but decreased
slightly as a percentage of sales from 6.8% to 6.7%. R&D expenses
increased in the first half 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 $52 million, or
28%, from $188 million for the prior year period to $240 million for
the first half of 2003 due primarily to the reasons described above.
On July 21, 2003, the Company announced that it has entered into an
agreement to acquire all of the outstanding shares of PracticeWorks
Inc., a leading provider of dental practice management software and
digital radiographic imaging systems for $500 million in cash. 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.
56
Commercial Imaging
Net worldwide sales for the Commercial Imaging segment were $754
million for the first half of 2003 as compared with $708 million for
the six month period ended June 30, 2002, representing an increase of
$46 million, or 6% as reported, or an increase of 3% excluding the
favorable impact of exchange. The increase in net sales was primarily
comprised of (1) increases in volume, which contributed approximately
4.4 percentage points to first half of 2003 sales, and (2) an increase
of approximately 3.1 percentage points due to favorable exchange, which
was partially offset by price/mix declines of approximately 1.1
percentage points.
Net sales in the U.S. were $434 million for the current year period as
compared with $393 million for the first half of 2002, representing an
increase of $41 million, or 10%. Net sales outside the U.S. were $320
million in the first half of 2003 as compared with $315 million for the
prior year period, representing an increase of $5 million or 2% as
reported, or a decrease of 5% 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 six month
period ended June 30, 2003 as compared with the first half of 2002,
primarily reflecting volume and price/mix declines 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 12 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 half 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.
Gross profit for the Commercial Imaging segment was $212 million for
the first half of 2003 as compared with $224 million for the six month
period ended June 30, 2002, representing a decrease of $12 million, or
5%. The gross profit margin was 28.1% in the current year period as
compared with 31.6% in the first half of 2002. The decrease in the
gross profit margin of 3.5 percentage points was primarily attributable
to (1) declines in price/mix, which reduced gross profit margins by
approximately 1.1 percentage points primarily due to declining
contributions from traditional graphic arts products, (2) manufacturing
productivity which negatively impacted gross profit margins by
approximately 2.1 percentage points, and (3) unfavorable exchange,
which negatively impacted gross profit margins by 0.3 percentage point.
57
SG&A expenses for the Commercial Imaging segment increased $4 million,
or 4%, from $95 million for the first half of 2002 to $99 million for
the six month period ended June 30, 2003, but decreased as a percentage
of sales from 13.4% 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 increased $1 million, or
4%, from $28 million for the first half of 2002 to $29 million for the
first half of 2003, but decreased as a percentage of sales from 4.0% to
3.8%.
Earnings from continuing operations before interest, other charges, and
income taxes for the Commercial Imaging segment decreased $17 million,
or 17%, from $101 million in the first half of 2002 to $84 million in
the first half of 2003. This decrease is primarily attributable to the
reasons described above.
All Other
Net worldwide sales for All Other were $43 million for the first half
of 2003 as compared with $52 million for the first half of 2002,
representing a decrease of $9 million, or 17%. Net sales in the U.S.
decreased $5 million, or 19%, from $27 million for the six month period
ended June 30, 2002 to $22 million for the first half of 2003. Net
sales outside the U.S. were $21 million in the first half of 2003 as
compared with $25 million in the prior year period, representing a
decrease of $4 million, or 16%.
SK Display Corporation, the OLED manufacturing joint venture between
Kodak and Sanyo, continued 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 $39 million for the six months ended
June 30, 2003 as compared with a loss of $13 million for the first half
of 2002, representing a decrease of $26 million. This decrease was
primarily driven by increased levels of investment for the Company's
Display business.
58
RESULTS OF OPERATIONS - DISCONTINUED OPERATIONS
Earnings from discontinued operations were $.05 per diluted share for
the first half of 2003, as compared with a loss from discontinued
operations for the first half of 2002 of $.01 per diluted share.
During the six month period ended June 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 half of 2003 were $124 million, or $.43 per
diluted share, as compared with net earnings for the first half of 2002
of $323 million, or $1.11 per diluted share, representing a decrease of
$199 million, or 62%. This decrease is primarily attributable to the
reasons outlined above.
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59
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.
60
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.
The following table summarizes the activity with respect to the
restructuring and asset impairment 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 June 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
====== ===== ==== ====
61
The charges taken in the first and second quarters of 2003 for
severance of $16 million and $1 million, respectively, were reported in
restructuring costs and other in the accompanying Consolidated
Statement of Earnings for the six months ended June 30, 2003. 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. The
Company expects the actions contemplated by the reserve for exit costs
to be completed by the end of 2003. 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 $7 million and $21 million
of accelerated depreciation on long-lived assets in cost of goods sold
in the accompanying Consolidated Statement of Earnings for the three
and six months ended June 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 $21
million was comprised of $12 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. The Company will
incur accelerated depreciation charges of $3 million in the third
quarter of 2003 as a result of the initiatives implemented under the
Fourth Quarter, 2002 Restructuring Program.
With respect to the Fourth Quarter, 2002 Restructuring Program, the
Company anticipates completing the relocation of the U.S. one-time-use
camera assembly operation and Mexico sensitizing operations by the end
of 2003. Such initiatives are expected to result in the elimination of
an additional 200 to 300 positions with anticipated charges in the
range of $5 million to $10 million.
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 $8 million of charges recorded in the second quarter of 2003
included $7 million of charges applicable to the Photography segment
and $1 million associated with manufacturing, which is shared across
all segments. The year-to-date charges of $38 million included $23
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.
62
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.
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.
63
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 June 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
==== ==== ==== ====
The first quarter charges of $28 million were reported in restructuring
costs and other in the accompanying Consolidated Statement of Earnings
for the six months ended June 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 three and six months ended
June 30, 2003. The charges taken for inventory write-downs were
reported in cost of goods sold in the accompanying Consolidated
Statement of Earnings for the three and six months ended June 30, 2003.
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 second 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. 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 three and six
months ended June 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 three and six
months ended June 30, 2003. The exit costs, which represent the only
cash portion of the charge, are expected to be paid during the
remainder of 2003.
64
With respect to the First Quarter, 2003 Restructuring Program, the
Company anticipates completing the remaining initiatives originally
contemplated under the Program by the end of 2003. Specifically, the
Company expects to complete the closure of photofinishing labs in the
U.S. and EAMER under this Program by the end of 2003. Such closures
are expected to result in the elimination of an additional 700 to 800
positions with anticipated charges in the range of $25 to $30 million.
Approximately 100 to 200 additional administrative positions will be
eliminated throughout the world by the end of 2003 under this Program
at a cost of $5 to $10 million. 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. The Company expects the initiatives
contemplated by the reserve for exit costs to be completed by the end
of 2003. 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.
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 $29 million recorded in the second quarter of 2003
included $20 million applicable to the Photography segment and $5
million applicable to the Commercial Imaging segment. The remaining $4
million was applicable to manufacturing, research and development, and
administrative functions, which are shared across all segments. The
charges of $57 million recorded in the six months ended June 30, 2003
included $40 million applicable to the Photography segment and $5
million applicable to the Commercial Imaging segment. The remaining
$12 million was applicable to manufacturing, research and development,
and administrative functions, which are shared across all segments.
Future Expected Restructuring Actions
Over the next twelve months, Kodak intends to implement a series of cost
reduction actions, 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.
65
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 $21 million as of June 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 $16 million as of June 30, 2003 are expected to be utilized
during 2003. However, certain costs, such as long-term lease payments,
will be paid over periods after 2003.
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LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents increased $269 million to $838
million at June 30, 2003. The increase resulted primarily from $233
million of net cash provided by operating activities and $390 million
of net cash provided by financing activities, partially offset by $366
million of net cash used in investing activities.
The net cash provided by operating activities of $233 million was
partially attributable to net earnings of $124 million, which, when
adjusted for the earnings from discontinued operations, equity in
losses from unconsolidated affiliates, depreciation and amortization,
provision for deferred taxes, and restructuring costs, asset
impairments and other charges, provided $587 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 $100 million impact of the change in
long-term assets and other items, net, which were partially offset by
increases in receivables of $196 million and inventories of $60 million
and a decrease in liabilities excluding borrowings of $217 million.
The net cash used in investing activities of $366 million was utilized
primarily for capital expenditures of $236 million, business
acquisitions of $88 million and investments in unconsolidated
affiliates of $41 million. The net cash provided by financing
activities of $390 million was primarily the result of a net increase
in borrowings of $378 million.
66
The Company regularly accesses the commercial paper (short-term debt)
market in managing its working capital to fund its operating and
investing activities. At any point in time, the Company is typically
in a negative working capital position. The negative working capital
is driven primarily by the level of outstanding short-term debt. Short-
term debt is 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.
During the second quarter the Company issued $550 million of long-term
debt to replace $550 million of short-term debt resulting in improved
working capital.
The Company maintains $2,482 million in committed bank lines of credit
and $1,841 million in uncommitted bank lines of credit to ensure
continued access to short-term borrowing capacity. The Company has a
medium-term note program with $650 million available for the issuance
of new long-term debt as of June 30, 2003. On July 15, 2003, the
Company's Board of Directors authorized the filing of a new debt shelf
registration that would allow the Company to issue $2,000 million of
long-term public debt. These funding alternatives provide the Company
with sufficient flexibility and liquidity to meet its working capital
and investing needs. Net working capital, excluding short-term
borrowings, increased to $1,017 million from $474 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.
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.
Capital additions were $236 million in the first half 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.
67
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 $3 million
per year, at the Company's current credit rating of BBB (as revised by
Standard & Poor's (S&P) on July 21, 2003) and Baa1 (Moody's). 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 certain
EBITDA ratio. 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 June 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 June
30, 2003 totaling $257 million and $1,841 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 June 30, 2003 were
$160 million and $411 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 June 30, 2003.
At June 30, 2003, the Company had $888 million in commercial paper
outstanding, with a weighted average interest rate of 1.42%. 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 June 30, 2003, the Company had
outstanding borrowings under this program of $105 million. The
estimated annualized interest rate under this program is 1.81%.
The Company has a medium-term note program of $2,200 million for
issuance of debt securities due nine months or more from date of issue.
At June 30, 2003, the Company had debt securities outstanding of $1,250
million under this medium-term note program, with none of this balance
due within one year. The Company has remaining availability of $650
million under its medium-term note program for the issuance of new
notes.
68
On April 15, 2003, S&P revised its outlook on Kodak to negative from
stable and reaffirmed its BBB+ corporate credit rating. The action was
attributable to S&P's focus on unfunded pension and other
postretirement benefit obligations. On May 20, 2003, Fitch lowered the
Company's long-term credit rating from A- to BBB, but reaffirmed the
short-term credit rating at F-2. The downgrade in the Company's long-
term credit rating is attributable to Fitch's concerns about the
Company's weakened sales and profitability in the core photographic
businesses due to continuing pricing pressure from competitors, digital
substitution and unfavorable economic factors. In connection with its
downgrade, Fitch changed the Company's outlook from negative to stable.
The stable outlook reflects Fitch's expectation that the Company's
restructuring efforts combined with its emphasis on cash flow
generation will result in continuing debt reduction. The stable
outlook also reflects Fitch's belief that the Company's leading market
position in the U.S. consumer film market and strong shares in
international markets, along with lower leverage will allow the Company
more time to stabilize operations. On June 18, 2003, S&P placed the
Company's long-term credit rating of BBB+ and short-term credit rating
of A-2 on CreditWatch, with negative implications. The action is
attributable to S&P's concerns about the weak economy, continued
competitive pressures, reduced leisure travel, continued digital
evolution and potential future restructuring actions that may reduce
earnings and restrict cash flow, slowing efforts to further reduce
debt. On July 21, 2003, S&P lowered its rating on Kodak's long-term
debt from BBB+ to BBB as a result of the Company's planned cash
acquisition of PracticeWorks Inc. In S&P's view, the cash purchase of
PracticeWorks Inc. will hinder the Company's debt reduction efforts
over the near-term. S&P further stated that the Company's credit
ratings would remain on CreditWatch, with negative implications, as
they remain concerned with the pressures on Kodak's revenue and
earnings resulting from the transition from conventional to digital
imaging, tough competition and weak economic and leisure travel
conditions. S&P commented that further reductions in the Company's
credit rating is currently expected to be limited to one notch. On
July 22, 2003, Fitch reaffirmed the Company's long-term and short-term
credit ratings at BBB and F-2, respectively, but changed the Company's
outlook to negative from stable. The negative outlook was a direct
result of the Company's announcement to acquire PracticeWorks Inc., and
reflects Fitch's concerns about the Company's reduced financial
flexibility as a result of this transaction. In addition, over the
longer term, Fitch anticipates that digital substitution, competitive
pricing pressures, and unfavorable economic factors will continue to
stress revenue and operating earnings, which could force the Company to
enter into additional acquisitions to augment growth opportunities over
time. As of and for the six months ended June 30, 2003, these credit
rating actions did not materially impact the operations of the Company.
However, if the Company's credit ratings were to be reduced further,
such actions could potentially affect access to commercial paper
borrowing. If such an event did take place, the Company could use
alternative sources of borrowing, including the long-term debt market
and its revolving credit facilities.
69
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: $35 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 Baa2, 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. 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.
The Company guarantees debt and other obligations under agreements with
certain affiliated companies and customers. At June 30, 2003, these
guarantees totaled a maximum of $329 million, with outstanding
guaranteed amounts of $161 million. The maximum guarantee amount
includes guarantees of up to: $160 million of debt for KPG ($71 million
outstanding); $6 million for other unconsolidated affiliates and third
parties ($6 million outstanding); and $163 million of customer amounts
due to banks in connection with various banks' financing of customers'
purchase of products and equipment from Kodak ($84 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 July 1, 2003 and May 31,
2005 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 six months ended June 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.
70
The Company also guarantees debt owed to banks for some of its
consolidated subsidiaries. The maximum amount guaranteed is $733
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 $567 million. These guarantees expire in 2003
through 2005 with the majority expiring in 2003.
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 June 30, 2003,
the Company has not been required to guarantee any of the SK Display
Corporation's outstanding debt.
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 six months
ended June 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 $60 million at June 30, 2003. The Company expects that
approximately $15 million of the remaining $60 million in total put
options will be exercised within the next six months.
71
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 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.
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
$416 million at June 30, 2003.
72
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.
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 June 30, 2003 were $280 million. The
difference between the amended maximum borrowing amount of $257 million
and the outstanding balance at June 30, 2003 of $280 million is
attributable to payments subsequent to June 30, 2003 through the date
of the amendment. The amended RPA extends through July 2004, at which
time the RPA can be extended or terminated. If the RPA were
terminated, Qualex would no longer be able to sell its lease
receivables to ESF and would need to find an alternative financing
solution for future sales of its photofinishing equipment. The term of
the ESF partnership agreement between Qualex and DCC continues through
October 6, 2003. In light of the timing of the partnership
termination, Qualex plans to utilize the services of Eastman Kodak
Credit Corporation, a wholly owned subsidiary of General Electric
Capital Corporation, as an alternative financing solution for
prospective leasing activity with its customers.
73
At June 30, 2003, the Company had outstanding letters of credit
totaling $99 million and surety bonds in the amount of $105 million
primarily to ensure the completion of environmental remediations and
payment of possible casualty and workers' compensation claims.
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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.
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 an impact for the
three and six months ended June 30, 2003, as there were no significant
one-time severance actions or other exit costs that were subject to
SFAS No. 146.
74
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 Company is currently evaluating the effect that the adoption
of EITF No. 00-21 will have on its 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. For VIEs created or acquired prior
to February 1, 2003, the provisions of FIN 46 must be applied for the
first interim or annual period beginning after June 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.
75
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 Company is currently evaluating whether or not the adoption of SFAS
No. 149 will have an effect on its financial position, results of
operations and cash flows.
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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76
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 July 23, 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.
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.
77
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 June 30, 2003 and 2002, the fair value of open
forward contracts would have increased $16 million, and decreased $22
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 June 30, 2003 and 2002, the fair
value of open forward contracts would have decreased $6 million and $1
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.
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 30 basis points) higher at June 30, 2003, the fair
value of short-term and long-term borrowings would have decreased $1
million and $13 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 42 basis points)
higher at June 30, 2002, the fair value of short-term and long-term
borrowings would have decreased $2 million and $20 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 June 30, 2003 was not
significant to the Company.
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78
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 Company concluded that the
design and operation of its 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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79
Item 4. Submission of Matters to a Vote of Security Holders
The 2003 Annual Meeting of Shareholders of Eastman Kodak Company was
held on May 7.
A total of 233,327,990 of the Company's shares were present or
represented by proxy at the meeting. This represented more than 81% of
the Company's shares outstanding.
The individuals named below were re-elected to a three-year term as
Class I Directors:
Name Votes Received Votes Withheld
Martha Layne Collins 226,610,392 6,717,598
Timothy M. Donahue 207,889,387 25,438,603
Delano E. Lewis 227,721,593 5,606,397
Paul H. O'Neill 208,802,026 24,525,964
The individual named below was elected to a one-year term as Class II
Director:
Name Votes Received Votes Withheld
William H. Hernandez 226,806,478 6,521,512
William W. Bradley, Hector de J. Ruiz, Laura D'Andrea Tyson, Richard S.
Braddock, Daniel A. Carp, Durk I. Jager and Debra L. Lee all continue as
directors of the Company.
The election of PricewaterhouseCoopers LLP as independent accountants
was ratified, with 221,225,497 shares voting for, 9,177,027 shares
voting against, and 2,925,466 shares abstaining.
The shareholder proposal requesting the indexing of stock options was
defeated, with 20,318,783 shares voting for, 167,190,515 shares voting
against, 4,856,580 shares abstaining, and 40,962,112 non-votes.
The shareholder proposal requesting the expensing of stock options was
approved, with 104,410,216 shares voting for, 80,996,183 shares voting
against, 6,959,479 shares abstaining, and 40,962,112 non-votes. This
shareholder proposal received a majority of the votes cast. The
Company's Board of Directors did not oppose the expensing of stock
options in principle, but recommended a vote against this proposal
because of the absence of a uniform methodology for the expensing of
stock options and the lack of comparability arising from the fact that
most large companies were not taking this step. The Board of Directors
has considered the shareholders' vote, and has concluded that it is
advisable to await the issuance of any final rule by the Financial
Accounting Standards Board on the subject before taking any action.
The shareholder proposal requesting the adoption of a chemicals policy
was defeated, with 10,573,975 shares voting for, 155,897,524 shares
voting against, 25,894,379 shares abstaining, and 40,962,112 non-votes.
80
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 81.
(b) Reports on Form 8-K.
On April 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 first fiscal quarter ended
March 31, 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 July 25, 2003
Robert P. Rozek
Controller
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81
Eastman Kodak Company and Subsidiary Companies
Index to Exhibits and Financial Statement Schedules
Exhibit
Number
(10) M. Martin M. Coyne Agreement dated November 9, 2001.
(Incorporated by reference to the Eastman Kodak
Company Annual Report of Form 10-K for the fiscal
year ended December 31, 2001, Exhibit 10.)
Letter, dated July 9, 2003.
(99.1) Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
(99.2) Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
(99.3) Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(99.4) Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.