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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(MARK ONE)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 1998
( ) 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: 1-14310
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IMATION CORP.
(Exact name of registrant as specified in its charter)
DELAWARE 41-1838504
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1 IMATION PLACE 55128
OAKDALE, MINNESOTA (Zip Code)
(Address of principal executive offices)
(651) 704-4000
(Registrant's telephone number, including area code)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of each exchange
Title of each class on which registered
Common Stock, $.01 per share New York Stock Exchange, Inc.;
Chicago Stock Exchange, Incorporated
Preferred Stock Purchase Rights New York Stock Exchange, Inc.;
Chicago Stock Exchange, Incorporated
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SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or Section 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes _X_ No___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by Reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Aggregate market value of voting stock of Imation Corp. held by
non-affiliates of the Registrant, based on the closing price of $15.938 as
reported on the New York Stock Exchange on March 1, 1999: $635 million.
The number of shares outstanding of the Registrant's common stock on March
1, 1999 was 39,994,616.
DOCUMENTS INCORPORATED BY REFERENCE
Selected portions of Registrant's Proxy Statement for Registrant's 1999
Annual Meeting are incorporated by reference into Part III.
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PART I
ITEM 1. BUSINESS.
INTRODUCTION
Imation Corp., together with its subsidiaries, (Imation or the
Company) was incorporated as a Delaware corporation in March 1996. The Company's
principal executive offices are located at 1 Imation Place, Oakdale, Minnesota
55128 (telephone number (651) 704-4000). Prior to July 1, 1996, Minnesota Mining
and Manufacturing Company (3M) operated the Company's business through various
divisions and subsidiaries.
3M formed the Company by spinning-off substantially all of the
businesses previously operated within 3M's data storage and imaging systems
groups (the Transferred Businesses). To effectuate the transaction, on June 18,
1996, the Board of Directors of 3M declared a dividend payable to the holders of
record of 3M common stock as of June 28, 1996, based upon a ratio of one share
of the Company's common stock, par value $0.01 per share (the Common Stock), for
every ten shares of 3M common stock owned on the record date. Effective July 1,
1996 (the Distribution Date), all of the outstanding shares of Common Stock were
distributed to 3M stockholders (the Distribution). In connection with the
Distribution, 3M and the Company entered into various agreements to facilitate
the transition of the Company to an independent business enterprise (see
"Relationship Between 3M and the Company"). As used herein, references to the
"Company" or "Imation" include the historical operating results and activities
of the business and operations which comprise the Company.
In connection with the Distribution, the Company implemented certain
reorganization actions in order to rationalize its manufacturing operations,
streamline its organizational structure and write-off impaired assets. In
addition, during 1997 the Company announced plans to further restructure its
worldwide operations in order to improve the Company's competitive position, to
focus resources on areas of strength and on growth opportunities, and to reduce
costs and eliminate unnecessary structure (see Note 5 of the Notes to
Consolidated Financial Statements). As a result of these programs, the Company
has recorded pre-tax charges, net of related adjustments, totaling $425.8
million since 1995. The Company recorded $166.3 million of these charges in its
1995 Statement of Operations. It subsequently recorded $76.4 million and $199.9
million in 1996 and 1997, respectively. In 1998 the Company recognized a
benefit, net of related adjustments, of $16.8 million.
Similarly, in conjunction with the acquisition of Luminous
Corporation (Luminous) in 1996 and Cemax-Icon, Inc. (Cemax) in 1997, the Company
recognized non-tax-deductible charges for in-process research and development
costs of $12.0 million in 1996 related to Luminous and $41.7 million in 1997
related to Cemax. In addition, in August of 1998, the Company announced its
intention to sell its medical imaging businesses (see Note 3 of the Notes to
Consolidated Financial Statements). The sale of the Company's medical imaging
businesses to Eastman Kodak Company (Kodak) was completed in November 1998.
The Company recorded a pre-tax gain of $65.0 million on the sale, net of related
costs.
As a result of all of these restructuring and other activities the
number of people employed by the Company has declined from approximately 12,300
on December 31, 1995 to approximately 6,400 on December 31, 1998. Approximately
3,400 of these reductions occurred during 1998, 1,600 in relation to the sale of
the medical imaging businesses and 1,800 related to other restructuring.
BUSINESS DESCRIPTION
The Company develops, manufactures and markets worldwide a wide
variety of products and services for color management, imaging and data storage
applications. The Company's product and service offerings are used to capture,
process, store, enhance, manipulate, reproduce and distribute information and
images in a wide range of commercial and consumer markets, including enterprise
data center computing, network computing, desktop and mobile computing,
commercial printing, marketing communications and graphic arts, and consumer
photography. A number of the Company's products and services are market leaders
in the recording, manipulation and storage of data and images and color
management in specific commercial and consumer applications. While established
products and services generate a substantial portion of the Company's revenues
today, the Company is seeking to expand its revenues by leveraging its existing
market positions to increase the use of its current products and services as
well as developing new digital-based products and more complete work flow
solutions in specific targeted markets.
The Company's current businesses are organized, managed and
internally reported as three segments differentiated primarily by their products
and services, but also by the markets they serve. These segments, whose results
are shown in Note 11 of the Notes to Consolidated Financial Statements, are Data
Storage and Information Management, Product Technologies, and Digital Solutions
and Services. In addition, the Company owned and managed a fourth segment,
Medical Imaging, which was sold to Kodak effective November 30, 1998 (see Note 3
of the Notes to Consolidated Financial Statements).
The Company's products and services are sold in more than 60
countries and nearly half of the Company's revenues are derived internationally.
Financial information by geographic area can be found in Note 11 of the Notes to
Consolidated Financial Statements.
DATA STORAGE AND INFORMATION MANAGEMENT BUSINESS
The Company is a supplier of branded removable media for data
storage applications across the major customer markets - mobile and desktop,
network and enterprise data center.
MOBILE AND DESKTOP - Major products include: Diskettes, SuperDisk(TM) Diskettes,
SuperDisk(TM) Drives, Travan(TM) minicartridges, Imation 1/4 inch cartridges, CD
Recordable discs, and CD Rewritable discs.
In the mobile and desktop arena, the Company is a worldwide leader
in diskette technology, with a leading market position for 1.44MB floppy disks.
The Company has introduced next-generation diskette technology, SuperDisk(TM)
120 MB drives and media - the first high-capacity removable storage device that
is fully compatible with both 1.44MB and 720KB diskettes. SuperDisk(TM) has been
adopted by more than 100 Original Equipment Manufacturers (OEMs), and businesses
and consumers are increasingly adapting their desktop and notebook removable
storage to the SuperDisk(TM) format. SuperDisk(TM) technology is now available
in several configurations which enables users to apply the technology across
multiple platforms, including IDE, ATAPI, SCSI, parallel port, USB and PCMCIA.
NETWORK - Major products include: Travan NS(TM), SLR, 4mm & 8mm DDS data tape,
and DLT tape cartridges.
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In the network computing market, the Company's 8 GB and 20 GB Travan
and Travan NS(TM) linear tape storage solutions offer users affordability,
reliability and scalability, while providing comparable capacity and performance
to DAT solutions. Imation's Travan NS(TM) solutions employ read-while-write and
hardware compression technology for entry-level server applications. Travan
technology solutions are supported by several drive manufacturers including
Seagate, Tecmar, AIWA, and Tandberg Data.
The Company also provides MLR and SLR 5.25 inch tape cartridges, 4mm
and 8mm DDS data tapes, and DLT tape cartridges - storage solutions targeted to
network workstation and mid-range computer system environments.
ENTERPRISE DATA CENTER - Major products include: half-inch tape cartridges and
half-inch computer tape.
The Company is a supplier of branded removable media to the
enterprise data center market. Within this market, the Company works with data
center drive manufacturers such as International Business Machines Corporation
(IBM) and Storage Technology Corp. (StorageTek) in the development of new
leading-edge storage technologies, including new 1/2 inch tape and midrange
network storage technologies, that are expected to meet the ever-expanding
requirements for greater capacity, speed and reliability.
Used for near-line data storage and retrieval, mass storage, and
archival storage of mission-critical data, Blackwatch(TM) and Royal Guard(TM)
1/2 inch tape cartridges are manufactured to high quality standards to ensure
data integrity. The Company's enterprise storage media - 9840, 9490EE, 3490,
3480, 3590, and SD-3 - are marketed based on performance, capacity, reliability,
scalability and compatibility.
PRODUCT TECHNOLOGIES BUSINESS
PRINTING AND PROOFING
The Company manufactures and markets products and provides service
and technical support for a broad range of applications in the capture,
enhancement management and transmission of images in selected markets for the
printing, publishing and graphic arts markets. Products include conventional
color proofing systems, digital color proofing systems and software, pre-press
software, laser films and image setting materials, metal printing plates,
graphic arts films, photographic chemicals, miscellaneous supplies and
Matchprint Laser proofing systems introduced in 1998.
The Company has strong market positions in certain product areas,
including the Matchprint(TM) color proofing system, an industry standard for
more than 20 years. The Company also offers a number of digital proofing
systems, which provide color proofs from digital data before a job is put on a
printing press. In addition to its two-page digital proofing system (the
Rainbow(TM) model 2730 digital proofer), the Company markets a two-page digital
proofer for professional applications (the Rainbow model 2740 digital proofer),
and a four-page (A2 size) ink jet digital proofing solution for users who
require large format, contract quality proofs (the Rainbow(TM) model 4700
proofer). The Company develops and markets a variety of desktop software
products for the prepress, print production, printing and graphic arts
industries. These products include Color Central, Media Manager, OPEN,
PressWise, PrintersWeb, TrapWise, Virtual Network and Virtual Network Pro.
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PHOTO COLOR AND OTHER BUSINESSES
The Company is one of the world's leading suppliers of private label
film for the amateur photography retail market. The Company's primary geographic
markets for color photographic film are the United States and Europe, which
represent approximately 70 percent of the global demand for film. The Company
manufactures a complete line of print and slide films for 35mm, 110, and 126
cameras used by consumers globally. The Company also markets single use cameras
which are sold pre-loaded with the Company's ISO 400 speed film. The Company's
color print film can be found in more than 125 private label brands.
The Company produces photo quality inkjet paper, which allows
desktop computer users to print photo-quality images on color ink jet printers.
This product is believed to provide superior image quality and color
reproduction, and significantly faster drying time than competitive products.
This product, which was designed for use with a variety of color ink jet
printers, is available through mass retail and photo stores. The Company also
markets carbonless paper products, such as multi-part business forms.
DIGITAL SOLUTIONS AND SERVICES BUSINESS
The Digital Solutions and Services business is a global service
organization, currently servicing the Company, 3M and targeted OEM end-user
customers' hardware systems. The Company's operational service infrastructure
includes field technicians, phone support, logistics and spare parts. The
Company also offers enhancement services, such as training, service engineering
and technical documentation. In addition to the operational and enhancement
services, the Company is expanding into customized solutions, with professional
services offerings for very specific vertical markets, such as Brand Asset
Management for the packaging production workflow, with close ties to the
Company's core businesses. The Company intends to expand its overall offerings
in both solutions and services to support and complement the Company's core
strategic focus in data storage and color management.
DIVESTED BUSINESSES
MEDICAL IMAGING
The Company sold its medical imaging business effective November 30,
1998 to Kodak, with the exception that the Company retained its manufacturing
facility in Ferrania, Italy, from which the Company agreed to manufacture x-ray
and wet laser medical imaging film for Kodak for a minimum of two years under a
supply agreement which became effective on November 30, 1998. The Company's
medical imaging business developed, manufactured and marketed diagnostic imaging
film, film processors and imaging systems for both x-ray and electronic imaging
systems. The Company's medical imaging customers included major hospital group
buying networks, as well as individual hospitals, medical imaging centers and
government healthcare institutions. The Company participated in the conventional
x-ray film market and was the world's leading supplier of high-quality laser
imaging systems for producing film output of the medical diagnostic images. In
addition, the Company provided software and systems integration services for a
variety of electronic medical imaging systems including Picture Archiving and
Communications Systems (PACS), teleradiology and 3D visualization software.
These electronic imaging offerings were acquired with the acquisition of Cemax
in 1997 and subsequently sold to Kodak.
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CD-ROM PRODUCTS
In 1998, as part of its 1997 restructuring, the Company sold its
CD-ROM replication business. CD-ROM products were produced on a made-to-order
basis and were used for the distribution of data and software to the personal
computer and mid-range markets. This business had manufacturing facilities in
Menomonie, Wisconsin; Fremont, California; and Breda, The Netherlands.
INDUSTRY BACKGROUND
The imaging and information industries in which the Company operates
are concerned with the management and storage of data on removable media and
with the creation, capture, manipulation, storage, production and distribution
of images and color. Advancements in digital technologies have profoundly
affected imaging applications by providing capabilities to accomplish those
tasks more efficiently, with greater accuracy and at lower cost. These
industries are also being profoundly impacted by the availability of new methods
of accessing, transporting and manipulating data and images through software,
networking and the World Wide Web.
Removable data storage solutions are used across all computing
platforms, including enterprise data centers, network servers, desktop systems
and mobile computing and in a wide variety of commercial, industrial and
consumer applications. Overall, the data storage media market is a growth
market, and is characterized by rapid changes in technology, significant price
competition and a variety of competing media formats. Demand for storage
capacity is increasing at an accelerating pace due to several factors, including
increases in both the number of software applications in use and the amount of
data being captured and stored. In addition, enhanced software capabilities
create larger databases that are critical business applications and therefore
create an increasing need to back up and store larger amounts of data. As the
size and price of computing devices continues to shrink and as people gain
access to information of all types from many sources, including the Internet,
the demand for portable, cost-effective and convenient data storage solutions is
also accelerating. This is true in both commercial and consumer markets.
Color and image management technologies also have been profoundly
impacted by advancements in digital technologies as many users begin to convert
their conventional/analog processes to proprietary digital processes to capture,
create, manipulate, enhance, process, transmit and store still and moving images
that incorporate color. Conventional/analog technologies rely upon chemical or
electrical processes which capture information onto paper, film or other media
by reacting to external stimuli. Digital technologies have significantly
increased the amount of information that can be used, managed and stored and
have reduced the need for film and chemicals in the color management and imaging
process. Many work processes in use today are hybrid systems in which users
continue to use conventional materials for certain processes in their work flows
while utilizing the speed of digital processing.
COMPETITION
The Company operates in a highly competitive environment. The
Company's principal competitors include large, well-capitalized technology
companies based in the United States, Europe and Japan. These competitors
include Kodak, Fuji Photo Film, Sony, Agfa, Konica, Maxell and DuPont. The
Company also competes in certain product markets with smaller, more specialized
firms such as Kodak-Polychrome, Scitex America and Iomega. Businesses in the
imaging and information industries compete on a variety of factors such as
price, value, product quality, customer service, breadth of product line and
availability of system solutions.
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SALES, MARKETS AND DISTRIBUTION METHODS
The Company's products and services are sold directly to users
through the Company's field sales organizations and through numerous channels of
distribution including wholesalers, retailers, jobbers, distributors and dealers
in over 60 countries. No one customer individually accounts for a material
amount of the Company's total sales.
RAW MATERIALS
The principal raw materials used by the Company are polyester film,
paper, resins, specialty chemicals, and silver. The Company makes significant
purchases of these and other materials and components used in the Company's
manufacturing operations from many domestic and foreign sources. The Company has
been able to obtain sufficient materials and components from sources around the
world to meet its needs. 3M continues to be a major supplier to the Company of
certain raw materials and intermediate products including film, specialty
chemicals and abrasives, and certain contract manufacturing services (see
"Relationship Between 3M and the Company--Supply, Service and Contract
Manufacturing Agreements").
RESEARCH AND PATENTS
Research and product development have historically played an
important role in the Company's activities. The Company has research
laboratories for the improvement of its existing products and development of new
products. The Company's research and development expenses were $139.8 million,
$194.9 million and $183.1 million for 1998, 1997 and 1996, respectively,
including charges of $41.7 million and $12.0 million in 1997 and 1996,
respectively, for in-process research and development costs related to certain
acquisitions. The Company expects its research and development expenses, as a
percent of total revenues, to be in the 5-7 percent range during the next
several years.
Approximately 106, 120 and 158 United States patents, owned by
either 3M or the Company, were issued in 1998, 1997 and 1996, respectively, for
which the Company receives rights in its business fields.
In connection with the Distribution, the Company was granted rights,
on both exclusive and non-exclusive terms, from 3M and others which enable it to
continue to use the intellectual property previously utilized by the Company
when it was part of 3M (see "Relationship Between 3M and the
Company--Intellectual Property Agreement"). The Company does not consider that
its business as a whole is materially dependent upon any one patent, license or
trade secret or any group of related patents, licenses or trade secrets, except
with respect to those rights granted from 3M.
MANUFACTURING
The core manufacturing competencies of the Company include coating,
fine chemical production for photographic film, state-of-the-art molding
capabilities and hardware prototyping. These competencies, combined with the
Company's reputation for quality, competency related to unit cost reduction and
research and development competencies of materials science, color management,
hard copy imaging, and magnetic and optical recording, give the Company a strong
technological base to take advantage of the opportunities in the evolving
information processing industry.
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EMPLOYEES
As of December 31, 1998, the Company had approximately 6,400
employees, approximately 3,600 in the United States and 2,800 internationally, a
reduction of approximately 3,400 employees from December 31, 1997. In connection
with restructuring plans announced in the fourth quarter of 1997, the Company
announced plans to reduce the total number of employees by approximately 1,700
by the end of 1998. The total actual reductions during 1998 numbered
approximately 1,800. Approximately half of these reductions occurred in the
United States; the other half occurred primarily in Europe. The separation costs
associated with these reductions were included in the restructuring charge
recorded by the Company in its 1997 consolidated financial statements (see Item
7. "Management's Discussion and Analysis of Financial Condition and Results of
Operations"). The Company's sale of its medical imaging business, effective
November 30, 1998, resulted in the reduction of an additional 1,600 employees
worldwide.
ENVIRONMENTAL MATTERS
The Company's operations are subject to a wide range of
environmental protection laws. The Company has remedial and investigatory
activities underway at some of its current facilities. In connection with the
Distribution, the Company assumed and agreed to indemnify 3M from all
liabilities relating to, arising out of or resulting from (i) operations at the
Company's facilities as conducted prior to the Distribution Date; (ii) the
disposal of hazardous materials from the Company's facilities before the
Distribution Date and at disposal sites operated by third parties (Superfund
Sites), where such liabilities are discovered after the Distribution Date; and
(iii) operations of the Company's businesses on and after the Distribution Date.
3M agreed to retain responsibility for environmental liabilities relating to
former premises which may have been associated with the Company's businesses
prior to the Distribution Date and known Superfund Sites associated with the
Company's properties as of the Distribution Date.
It is the Company's policy to accrue environmental remediation costs
if it is probable that a liability has been incurred and the amount of such
liability is reasonably estimable. As assessments and remediations proceed,
these accruals are reviewed periodically and adjusted, if necessary, as
additional information becomes available. The accruals for these liabilities can
change due to such factors as additional information on the nature or extent of
contamination, methods of remediation required, the allocated share of
responsibility among other parties, if applicable, and other actions by
governmental agencies or private parties. However, it is often difficult to
estimate the future impact of environmental matters, including potential
liabilities.
As of December 31, 1998, the Company had reserved approximately $6.7
million with respect to environmental liabilities. Although the Company believes
that its reserves are adequate, there can be no assurance that the amount of
expenses relating to remedial actions and compliance with applicable
environmental laws will not exceed the amounts reflected in the Company's
reserves.
RELATIONSHIP BETWEEN 3M AND THE COMPANY
For purposes of governing certain of the relationships between 3M
and the Company following the Distribution, 3M and the Company entered into the
Transfer and Distribution Agreement and various ancillary agreements to which
they are parties, including those described below. Certain of these agreements
have been included as exhibits to the Company's prior filings
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with the Securities and Exchange Commission, and the following summaries are
qualified in their entirety by reference to the agreements as filed.
TRANSFER AND DISTRIBUTION AGREEMENT
In connection with the Distribution, 3M and the Company entered into the
Transfer and Distribution Agreement, which provides for, among other things, the
principal corporate transactions required to effect the Distribution, the
transfer to the Company of the Transferred Businesses, the division between 3M
and the Company of certain liabilities and certain other agreements governing
the relationship between 3M and the Company following the Distribution.
TAX SHARING AND INDEMNIFICATION AGREEMENT
3M and the Company entered into a Tax Sharing and Indemnification
Agreement (the Tax Sharing Agreement), providing for their respective
obligations concerning various tax liabilities. The Tax Sharing Agreement
provides that 3M shall pay, and indemnify the Company if necessary, with respect
to all federal, state, local and foreign income taxes relating to the
Transferred Businesses for any taxable period ending on or before the
Distribution Date except that the Company shall indemnify 3M for any income
taxes arising out of the failure of the Distribution or any of the transactions
related to it to qualify as tax free as a result of certain actions taken by the
Company or any of its subsidiaries. Prior to the Distribution, 3M received a
ruling from the Internal Revenue Service that 3M shareholders who received
shares of the Company's common stock in connection with the Distribution would
not recognize income, gain or loss upon receipt of such shares, except in
connection with any cash received in lieu of fractional shares. 3M also
generally agreed to pay all other taxes (other than those which are imposed
solely on the Company) that were payable in connection with the Distribution and
the transactions related to it, the liability for which arose on or before the
Distribution Date. The Tax Sharing Agreement further provides for cooperation
with respect to certain tax matters, the exchange of information and the
retention of records which may affect the income tax liability of either party.
CORPORATE SERVICES TRANSITION AGREEMENT
3M and the Company entered into a Corporate Services Transition
Agreement (the Corporate Services Agreement) pursuant to which 3M agreed to
provide to the Company certain services, including engineering and environmental
services, logistics and information technology services, financial services,
human resources administration services and employee benefits administration,
which 3M historically provided to the Transferred Businesses prior to the
Distribution Date. The length of time that 3M is required to provide such
services and the amount that the Company is required to pay for such services
varies based on the type of service. The Corporate Services Agreement is
terminable by each party upon 90 days notice, provided that 3M is not permitted
to terminate certain specified services, which the parties have determined will
require a longer period to replace. The costs associated with the services
provided by 3M are either a fixed dollar amount based on the estimated cost of
the services provided, or an amount determined pursuant to a formula based on
the services actually provided. Ongoing services required by the Company are
based on costs incurred plus an 8 percent mark-up. Certain foreign subsidiaries
of the Company and 3M entered into corporate services agreements pursuant to
which 3M agreed to provide to such subsidiaries services similar to those being
provided to the Company pursuant to the Corporate Services Agreement. The cost
of all such services supplied by 3M to the Company totaled approximately $26.0
million during 1998. After 1998, the Company does not
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expect to require any material amount of services from 3M pursuant to the
Corporate Services Agreement.
ENVIRONMENTAL MATTERS AGREEMENT
3M and the Company entered into an Environmental Matters Agreement
(the Environmental Matters Agreement) providing for their respective obligations
concerning environmental liabilities arising out of the operation of the
premises of the Transferred Businesses and other environmental matters.
Under the Environmental Matters Agreement, the Company assumed and
agreed to indemnify 3M for all liabilities relating to, arising out of or
resulting from (i) operations at the Company's facilities as conducted before
the Distribution Date; (ii) the disposal of hazardous materials from the
Company's facilities before the Distribution Date and at Superfund Sites, where
such liabilities are discovered after the Distribution Date; and (iii)
operations of the Transferred Businesses on and after the Distribution Date. 3M
agreed to retain responsibility for environmental liabilities relating to former
premises which may have been associated with the Transferred Businesses and
known Superfund sites associated with the properties of the Transferred
Businesses on or before the Distribution Date.
INTELLECTUAL PROPERTY AGREEMENT
3M and the Company entered into an Intellectual Property Rights
Agreement (the Intellectual Property Agreement) pursuant to which 3M granted to
the Company, effective as of the Distribution Date, rights to use certain
intellectual property (such as patent rights, copyrights, mask work rights and
proprietary information) exclusively in the fields of use in which the
Transferred Businesses operated as of the Distribution Date and non-exclusively
in certain other fields. In addition, 3M transferred to the Company title to
certain intellectual property rights previously used by the Transferred
Businesses, subject to certain rights of 3M to continue to use such intellectual
property rights. The Intellectual Property Agreement further provided for cross-
licensing of certain future intellectual property developed during a transition
period which expired on June 30, 1998. In addition, for various transition
periods specified in the Intellectual Property Agreement (such periods
commencing on the Distribution Date and continuing for two, three or five years
thereafter), the Company is granted the right to use certain 3M trademarks under
a royalty-bearing license. Trademarks used only by the Transferred Businesses
were assigned to the Company as of the Distribution Date.
The Intellectual Property Agreement provides that the costs
associated with the procurement and maintenance of patents and trademarks
licensed to either party by the other under the Intellectual Property Agreement
are the responsibility of the party owning the particular patent or trademark.
However, with respect to patents, either party may designate a patent or patent
application under which it is licensed by the other party to be of "common
interest." The licensed party is granted certain rights to participate in
decisions involving such common interest patents and patent applications, and
the costs thereof are shared by the parties. The costs of enforcing licensed
patents against an infringer will be borne by the party instituting the lawsuit
unless the parties agree otherwise. For jointly-owned patents, enforcement costs
are shared if both parties desire to participate. The licensed party's
enforcement of patents requires prior approval by the party owning the patent.
With the exception of licensed trademark rights, no royalties or
fees are payable by the Company to 3M for the assignment and license of
intellectual property to the Company under the
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Intellectual Property Agreement. With respect to licensed trademarks, the
Company is required to pay a royalty, which the Company believes is reasonable,
through cash payments, commitments to purchase product from 3M and/or engaging
in certain other activities benefiting 3M. Cash payments to 3M for royalties
associated with licensed trademark were not significant in 1998.
The parties also granted cross-licenses to each other under certain
patents and proprietary information developed by each party during the two year
period ended June 30, 1998. The cross-licenses are royalty-free and generally of
the same scope (i.e., exclusive or non-exclusive in defined fields) as the
licenses granted to and retained by the Company and 3M, respectively, under the
patents and proprietary information existing at the time of the Distribution.
3M and the Company agreed not to compete with each other in their
respective businesses for a period of five years following the Distribution
Date. 3M agreed that, except for ancillary activity involving an insubstantial
business, it would not compete directly or indirectly in the Company's Exclusive
Fields (which, as defined in the Intellectual Property Agreement, are generally
the fields of business in which the Company was engaged as of the Distribution
Date). The Company agreed that, except for ancillary activity involving an
insubstantial business, it would not compete, directly or indirectly in the 3M
Business Fields (which, as defined in the Intellectual Property Agreement, are
generally the fields of business in which 3M was engaged as of the Distribution
Date). However, this provision does not preclude the Company from indirect
activity, outside of the 3M Reserved Fields (which, as defined in the
Intellectual Property Agreement, are generally fields closely related to the
Company's Exclusive Fields where 3M has retained exclusive rights), involving
working with a third party on that party's imaging and electronic information
processing needs, internal or external, as long as the activity does not
benefit, in more than an ancillary way, a product or service of the third party
which competes with a product or service in the 3M Business Fields.
SUPPLY, SERVICE AND CONTRACT MANUFACTURING AGREEMENTS
3M and the Company entered into various product and service supply
agreements (the Supply Agreements) providing for the supply by 3M to the Company
and by the Company to 3M, of certain products and services. Under the Supply
Agreements, 3M supplies to the Company certain raw materials and intermediate
products including film, specialty chemicals and abrasives and provides to the
Company certain contract manufacturing services, primarily equipment assembly
services. Under the Supply Agreements, the Company supplies to 3M certain
semi-finished products and components and provides to 3M certain contract
manufacturing and other services, including converting, slitting and coating
services and technical field service. The prices for products supplied by either
party under the Supply Agreements are based on the cost of supplying such
product plus a 15 percent mark-up. The prices paid for contract manufacturing
services provided by either party vary depending on the services provided but
generally are based on costs incurred plus an 8 percent mark-up. The amount paid
by the Company to 3M for products and services delivered pursuant to the Supply
Agreements totaled approximately $45.0 million in 1998.
EXECUTIVE OFFICERS OF THE COMPANY
The executive officers of the Company on March 26, 1999, together
with their ages and business experience, are set forth below.
WILLIAM T. MONAHAN, age 51, is Chairman of the Board, President and
Chief Executive Officer, positions he has held since the Company spun-off from
3M on July 1, 1996. From June
10
1993 to March 1996, he was Group Vice President responsible for 3M's Electro and
Communications Group, and from May 1992 to May 1993, he was Senior Managing
Director of 3M Italy. From September 1989 to May 1992, he was Vice President of
3M's Data Storage Products Division.
BARBARA M. CEDERBERG, age 45, is Vice President and President,
Product Technologies. Prior to her appointment in October 1998, she was General
Manager of Printing and Publishing Products for the Company. Prior to joining
the Company at spin-off on July 1, 1996, she held various positions at 3M.
ROBERT L. EDWARDS, age 43, is Senior Vice President, Chief Financial
Officer and Chief Administrative Officer. He joined the Company in April 1998
after twenty years of experience in the transportation and energy industries
with Santa Fe Industries affiliated or predecessor companies. From 1991 to 1995,
he was Senior Vice President, Treasurer and Chief Financial Officer, and from
1995 to 1998, he was Senior Vice President, Business Development of Santa Fe
Pacific Pipelines, Inc.
MICHAEL A. HOWARD, age 49, is Vice President and President, Digital
Solutions and Services. He joined the Company in June 1998 from Digital
Equipment Corporation, where he held several executive sales positions over the
past twenty-two years and most recently was Vice President, Microsoft/Digital
Alliance.
STEVEN D. LADWIG, age 41, is Vice President and President, Data
Storage and Information Management. He joined the Company in July 1998 after
nineteen years with IBM. Most recently he was General Manager for Network
Computing and Software for Global Small and Medium Businesses from October 1996
to June 1998. From 1994 to October 1996, he was Vice President of Development,
AS/400 Division.
JOHN L. SULLIVAN, age 44, is Vice President, General Counsel and
Secretary. He joined the Company in July 1998 from Silicon Graphics, Inc., where
he held several legal counsel positions and most recently was Vice President -
General Counsel. Prior to joining Silicon Graphics, he held several positions
with Cray Research, Inc. from 1989 to 1997, including the positions of General
Counsel and Corporate Secretary from 1989 to 1997. Cray Research, Inc. became
part of Silicon Graphics in 1996.
DAVID H. WENCK, age 55, is Vice President, International, a position
he has held since March 1998. Prior to assuming his current responsibilities, he
was Vice President, Asia, Latin America and Canada, assuming that role at
spin-off. From May 1995 to July 1996, he was General Manager of 3M's Data
Storage Optical Technology Division. From December 1994 to April 1995, he was
Department Manager of 3M's Software Media and CD-ROM Services Department, and
from July 1986 to September 1994, he was Project Manager of 3M's Optical
Recording Project.
PAUL R. ZELLER, age 38, is Corporate Controller, a position he has
held since May 1998. He joined the Company at spin-off and held accounting
manager and division controller positions with the Company prior to assuming his
current responsibilities. Prior to joining the Company, he held several
accounting management positions with 3M prior to spin-off.
11
ITEM 2. PROPERTIES.
The Company's headquarters are located in Oakdale, Minnesota. During
1998, the Company completed construction of a research and development facility
at its Oakdale site in order to consolidate its headquarters operations. The
Company's major facilities (all of which are owned by the Company, except where
noted), and the products manufactured at such facilities are listed below. The
Company's facilities are in good operating condition suitable for their
respective uses and adequate for the Company's current needs.
FACILITY PRODUCTS
United States
- -------------
Camarillo, California Data tape
Menomonie, Wisconsin (leased) Laserdisc
Nekoosa, Wisconsin Carbonless paper
Oakdale, Minnesota Headquarters/laboratory facility
Pine City, Minnesota Micrographic cards
St. Paul, Minnesota (leased) Administration/laboratory facilities
Tucson, Arizona Data tape
Wahpeton, North Dakota Diskettes/molding
Weatherford, Oklahoma Diskettes/photographic film/matchprint and
conventional proofing
International
- -------------
Bracknell, United Kingdom Administrative
Beauchamp, France (leased) Printing plates
Milan, Italy (leased) Administrative
Amsterdam, Netherlands (leased) Administrative
Rotterdam, Netherlands (leased) Administrative
Ferrania, Italy X-ray films/photographic film
London, Ontario, Canada (leased) Administrative
The Company is in the process of liquidating certain properties in Middleway,
West Virginia and Florida, Argentina, where manufacturing operations ceased in
1998.
ITEM 3. LEGAL PROCEEDINGS.
The Company is the subject of various pending or threatened legal
actions in the ordinary course of its business. All such matters are subject to
many uncertainties and outcomes that are not predictable with assurance.
Consequently, the Company is unable to ascertain as of December 31, 1998 the
ultimate aggregate amount of any monetary liability or financial impact that may
be incurred by the Company with respect to these matters. While these matters
could materially affect operating results of any one quarter when resolved in
future periods, it is management's opinion that after final disposition, any
monetary liability or financial impact to the Company beyond that provided in
the consolidated balance sheet as of December 31, 1998 would not be material to
the Company's financial position or annual results of operations or cash flows.
In connection with the Distribution, the Company assumed substantially all
liabilities for legal proceedings relating to the Company's businesses as
conducted prior to the Distribution Date (see Item 1. "Business--Relationship
Between 3M and the Company--Transfer and Distribution Agreement").
12
On November 30, 1998 the Company closed on the sale of its medical
imaging business to Kodak. In connection with that sale, the Company and Kodak
settled civil litigation concerning certain intellectual property disputes
between the companies in the United States and Italy. Criminal investigation of
the matters being disputed was also terminated, with no action taken by the
authorities.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
As of March 1, 1999, there were 39,994,616 shares of the Company's
common stock, $.01 par value (Common Stock), outstanding held by approximately
56,475 shareholders of record. The Company's Common Stock is listed on the New
York and Chicago Stock Exchanges under the symbol of IMN. The Company did not
pay any dividends during 1998. Future dividends will be determined by the
Company's Board of Directors.
The following table sets forth, for the periods indicated, the high
and low sales prices of Common Stock as reported on the New York Stock Exchange
Composite Transactions.
1998 SALES PRICES 1997 SALES PRICES
----------------- -----------------
HIGH LOW HIGH LOW
First Quarter $19.00 $13.56 $30.38 $25.00
Second Quarter $19.69 $15.94 $27.38 $22.25
Third Quarter $19.25 $14.94 $29.69 $22.31
Fourth Quarter $19.00 $14.56 $24.25 $15.56
13
ITEM 6. SELECTED FINANCIAL DATA.
SELECTED CONSOLIDATED FINANCIAL DATA*
1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------------
(Dollars in millions, except per share data)
Statement of Operations Data:
Net revenues $ 2,046.5 $ 2,201.8 $ 2,278.2 $ 2,245.6 $ 2,280.5
Gross profit 676.3 716.2 754.9 682.5 793.4
Selling, general and administrative 488.3 526.0 522.5 497.2 486.4
Research and development 139.8 194.9 183.1 222.4 211.2
Gain on sale of medical imaging business
and related charges (65.0) -- -- -- --
Restructuring (16.8) 170.0 53.9 111.8 --
Operating income (loss) 130.0 (174.7) (4.6) (148.9) 95.8
Income (loss) before tax and
minority interest 109.9 (206.0) (15.0) (166.8) 81.3
Net income (loss) (1) 57.1 (180.1) (20.5) (85.0) 54.3
Basic and diluted earnings (loss)
per common share 1.45 (4.54) (0.49) (2.02) 1.28
Balance Sheet Data:
Working capital $ 497.8 $ 538.9 $ 607.3 $ 658.4 $ 714.0
Property, plant and equipment, net 233.8 381.6 480.1 513.2 654.9
Total assets 1,322.2 1,665.5 1,573.3 1,541.5 1,671.7
Long-term debt 32.7 319.7 123.1 -- --
Total liabilities 561.1 983.3 643.0 392.8 371.7
Total shareholders' equity 761.1 682.2 930.3 1,148.7 1,300.0
Other Information:
Current ratio 2.2 2.0 2.5 3.2 3.5
Days sales outstanding (2) 80 76 77 78 76
Months in inventory (2) 3.2 3.4 3.2 3.4 4.0
Assets/equity 1.7 2.4 1.7 1.3 1.3
Return on average assets (3) 1.0% 1.3% 2.6% 0.2% 3.4%
Return on average equity (3) 2.0% 2.5% 3.9% 0.3% 4.3%
Capital expenditures (4) $ 132.4 $ 116.3 $ 167.4 $ 180.2 $ 182.7
Number of employees 6,400 9,800 9,400 12,300 13,000
- -------------------
* See Item 7. "Management's Discussion and Analysis of Financial Condition and
Results of Operations--General Overview" for a description of the basis of
presentation of the financial information presented in this table.
(1) Net income, excluding gain on sale of the medical imaging business,
restructuring and other special charges, in 1998, 1997, 1996 and 1995 was
$14.7 million, $20.3 million, $40.1 million and $3.3 million, respectively
(see Note 3 and 5 of the Notes to Consolidated Financial Statements).
(2) 1998 excludes impact of the medical imaging business which was sold on
November 30, 1998.
(3) Return percentages are calculated using net income excluding restructuring
and other special charges noted in (1) above for 1998, 1997, 1996 and
1995.
(4) Capital expenditures in 1998 include $67.5 million for the purchase of the
Company's research and development facility previously under a synthetic
lease.
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
GENERAL OVERVIEW
Effective July 1, 1996, the Company began operations as an
independent, publicly held company (see Item 1. "Business--Introduction"). Prior
to July 1, 1996, the financial statements of the Company reflect the results of
operations, financial position and cash flows of the Transferred Businesses as
they operated within 3M. As a result, the financial statements of the Company
prior to July 1, 1996 have been carved out from the financial statements of 3M
using the historical results of operations and historical basis of the assets
and liabilities of such businesses. The Company's statements of operations prior
to July 1, 1996 include all of the related costs of doing business, including
charges for the use of facilities and for employee benefits, and include an
allocation of certain general corporate expenses of 3M which were not directly
related to these businesses, including costs for corporate logistics, corporate
research and development, information technologies, finance, legal and corporate
executives. Management believes these allocations were made on a reasonable
basis. The financial information included herein for periods prior to July 1,
1996, may not necessarily be indicative of the results of operations, financial
position and cash flows of the Company had the Company been a separate,
independent company during the periods presented.
On November 30, 1998, the Company sold its worldwide medical imaging
business to Kodak. As a result, the Company's Consolidated Statement of
Operations and Statement of Cash Flows for 1998 include only eleven months of
the medical imaging business results. The Company retained its manufacturing
facility in Ferrania, Italy, from which the Company agreed to manufacture x-ray
and wet laser medical imaging film for Kodak for a minimum of two years under a
supply agreement which became effective on November 30, 1998.
The following table displays the Company's results of operations for
1998, 1997 and 1996, as reported, compared to adjusted results which exclude the
gain on the sale of the medical imaging business, restructuring and other
special charges, acquisition-related charges and other year-end adjustments, as
applicable. Reported and adjusted results also include certain expenses
previously classified as selling, general and administrative expenses
reclassified as cost of goods sold in current and prior years' financial
statements, with no impact on net income (loss) in any year.
- -------------------------------------------------------------------------------------------------------------------
1998 1997 1996
(In millions, --------------------------------------------------------------------
except per share data) Reported Adjusted Reported Adjusted Reported Adjusted
- -------------------------------------------------------------------------------------------------------------------
Net revenues $2,046.5 $2,046.5 $2,201.8 $2,201.8 $2,278.2 $2,278.2
- -------------------------------------------------------------------------------------------------------------------
Gross profit 676.3 676.3 716.2 731.2 754.9 762.8
- -------------------------------------------------------------------------------------------------------------------
Selling, general and administrative 488.3 488.3 526.0 516.5 522.5 507.9
- -------------------------------------------------------------------------------------------------------------------
Research and development 139.8 139.8 194.9 153.2 183.1 171.1
- -------------------------------------------------------------------------------------------------------------------
Gain on sale of medical imaging business and
related charges (65.0) -- -- -- -- --
- -------------------------------------------------------------------------------------------------------------------
Restructuring (16.8) -- 170.0 -- 53.9 --
- -------------------------------------------------------------------------------------------------------------------
Operating income (loss) 130.0 48.2 (174.7) 61.5 (4.6) 83.8
- -------------------------------------------------------------------------------------------------------------------
Net income (loss) 57.1 14.7 (180.1) 20.3 (20.5) 40.1
- -------------------------------------------------------------------------------------------------------------------
Basic and diluted earnings (loss) per common
share $ 1.45 $ 0.37 $ (4.54) $ 0.51 $ (0.49) $ 0.97
- -------------------------------------------------------------------------------------------------------------------
15
RESULTS OF OPERATIONS
The following table sets forth the percentage relationship to
revenue of certain items in the Company's Consolidated Statements of Operations
for the years indicated.
- ----------------------------------------------------------------------------------------------------------------------
Percentage of dollar
Percentage of revenue increase (decrease)
- ----------------------------------------------------------------------------------------------------------------------
1998 1997 1996 1998 vs 1997 1997 vs 1996
- ----------------------------------------------------------------------------------------------------------------------
100.0% 100.0% 100.0% Net revenues (7.1)% (3.4)%
- ----------------------------------------------------------------------------------------------------------------------
33.0 32.5 33.1 Gross profit (5.6) (5.1)
- ----------------------------------------------------------------------------------------------------------------------
23.8 23.9 22.9 Selling, general and administrative (7.2) 0.7
- ----------------------------------------------------------------------------------------------------------------------
6.8 8.8 8.0 Research and development (28.3) 6.4
- ----------------------------------------------------------------------------------------------------------------------
Gain on sale of medical imaging
(3.2) -- -- business and related charges -- --
- ----------------------------------------------------------------------------------------------------------------------
(0.8) 7.7 2.4 Restructuring (109.9) 215.4
- ----------------------------------------------------------------------------------------------------------------------
6.4 (7.9) (0.2) Operating income (loss) n/m n/m
- ----------------------------------------------------------------------------------------------------------------------
1.0 1.5 0.5 Non-operating expense, net (35.8) 201.0
- ----------------------------------------------------------------------------------------------------------------------
2.6 (1.2) 0.2 Income tax provision (benefit) n/m n/m
- ----------------------------------------------------------------------------------------------------------------------
2.8 (8.2) (0.9) Net income (loss) n/m n/m
- ----------------------------------------------------------------------------------------------------------------------
n/m: not meaningful
The following table includes the same information as above, but
excludes the impact of the gain on sale of the medical imaging business,
restructuring and other special charges as discussed in "General Overview"
above.
- ---------------------------------------------------------------------------------------------------------------------------
Percentage of revenue (excluding gain on sale
of medical imaging, restructuring and other Percentage of dollar increase
special charges) (decrease)
- ---------------------------------------------------------------------------------------------------------------------------
1998 1997 1996 1998 vs 1997 1997 vs 1996
- ---------------------------------------------------------------------------------------------------------------------------
100.0% 100.0% 100.0% Net revenues (7.1)% (3.4)%
- ---------------------------------------------------------------------------------------------------------------------------
33.0 33.2 33.5 Gross profit (7.5) (4.1)
- ---------------------------------------------------------------------------------------------------------------------------
23.8 23.4 22.3 Selling, general and administrative (5.5) 1.7
- ---------------------------------------------------------------------------------------------------------------------------
6.8 7.0 7.5 Research and development (8.7) (10.5)
- ---------------------------------------------------------------------------------------------------------------------------
2.4 2.8 3.7 Operating income (21.6) (26.6)
- ---------------------------------------------------------------------------------------------------------------------------
0.9 1.2 0.5 Non-operating expense, net (32.4) 149.0
- ---------------------------------------------------------------------------------------------------------------------------
0.8 0.7 1.4 Income tax provision 4.6 (54.6)
- ---------------------------------------------------------------------------------------------------------------------------
0.7 0.9 1.8 Net income (27.6) (49.4)
- ---------------------------------------------------------------------------------------------------------------------------
16
NET REVENUES
Net revenues in 1998, 1997 and 1996 were $2,046.5 million, $2,201.8
million and $2,278.2 million, respectively. Net revenues decreased 7.1 percent
in 1998 compared to a decrease of 3.4 percent in 1997. Revenues declined in 1998
primarily due to continuing price erosion, lack of one month of the medical
imaging business and, to a lesser extent, unfavorable changes in currency
exchange rates. Volume increases in Asia were offset by declines in Canada and
Europe. The Company expects 1999 revenues to be positively impacted by growth in
certain products in the Data Storage business, including network products (DLT
tape offerings and Travan NS(TM) technologies) and mobile and desktop products
(SuperDisk(TM)), as well as growth in the Digital Solutions and Services
business areas of Digital Asset Management and Operational Services.
Approximately 45 percent of the Company's net revenues in 1998 were from sales
outside the United States compared to 47 percent in 1997 and 49 percent in 1996.
GROSS PROFIT
Gross profit for 1998 was $676.3 million. Gross profit for 1997 was
$716.2 million, which includes the impact of $15.0 million in special charges
related primarily to the write-down of inventory. Gross profit for 1996 was
$754.9 million, which includes the impact of $7.9 million in special charges
primarily related to the write-off of certain packaging materials in connection
with the Distribution. Gross profit was 33.0 percent of revenues in 1998.
Excluding the impact of special charges, gross profit in 1997 and 1996 would
have been $731.2 million and $762.8 million, or 33.2 percent and 33.5 percent of
revenues, respectively. The relatively consistent level of gross margin
percentage reflects the Company's ability to offset negative effects of price
erosion with productivity improvements. As previously discussed, gross profit
includes certain expenses previously classified as selling, general and
administrative expenses reclassified as cost of goods sold.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
In 1998, 1997 and 1996, selling, general and administrative expenses
were $488.3 million, $526.0 million and $522.5 million, respectively. Selling,
general and administrative expenses were 23.8 percent of revenues in 1998.
Excluding special charges of $9.5 million in 1997 and $14.6 million in 1996,
selling, general and administrative expenses would have been $516.5 million and
$507.9 million, or 23.4 percent and 22.3 percent of revenues, in 1997 and 1996,
respectively. The increase in selling, general and administrative expenses as a
percentage of revenues is due to the decline in revenues, the Company's
investment in its SuperDisk(TM) program and costs attributable to the Company's
IT infrastructure development, partially offset by benefits resulting from the
Company's 1997 restructuring program. The 1997 and 1996 selling, general and
administrative expenses include $20.8 million and $41.8 million, respectively,
of start-up costs related to designing and implementing more efficient business
processes and developing the Company's brand identity. In 1998, the Company
began amortizing capitalized software development costs associated with the
design, testing and implementation of the Company's new IT systems.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses in 1998, 1997 and 1996 were $139.8
million, $194.9 million and $183.1 million, respectively. Expenses in 1997
include a non-tax-deductible charge of
17
$41.7 million for acquired in-process research and development costs related to
the Company's acquisition of Cemax, while 1996 expenses include a
non-tax-deductible charge of $12.0 million for acquired in-process research and
development costs related to the Company's acquisition of Luminous. Research and
development expenses were 6.8 percent of revenues in 1998. Excluding the impact
of acquisition-related charges, research and development expenses in 1997 and
1996 would have been $153.2 million and $171.1 million or 7.0 percent and 7.5
percent of revenues, respectively. The decrease in 1998 expenses of $13.4
million (excluding 1997 special charges) compared with 1997, reflects the impact
of the Company's 1997 restructuring program. The decrease in 1997 expenses of
$17.9 million (excluding special charges) compared with 1996, is due to research
and development cost structure improvements.
GAIN ON SALE OF MEDICAL IMAGING BUSINESS AND RELATED CHARGES
In 1998, the Company sold its worldwide medical imaging business to
Kodak. The Company recorded a pre-tax gain of $65.0 million on the sale, net of
related costs. These costs include the impairment of certain manufacturing
assets which were not sold to Kodak of $40.8 million, determined based on
estimated recoverable costs. In addition, these costs include the write-off of
capitalized software costs of approximately $27.9 million which were directly
related to the medical imaging business, reflecting the abandonment of certain
functionality and utility, pension and other curtailment and settlement costs
related to employees transferred to Kodak of $16.9 million and other direct
costs of the transaction.
RESTRUCTURING
The Company recorded restructuring charges of $170.0 million and
$53.9 million in 1997 and 1996, respectively. These charges relate to the
Company's reorganization and restructuring activities and include costs
associated with employee separation benefits, fixed asset write-offs, and other
business exit costs.
In 1998, the Company recorded a $16.8 million net benefit in the
restructuring line of the Statement of Operations, consisting of a $3.6 million
benefit reflecting final adjustments of the restructuring reserves established
in the fourth quarter of 1995 and a $26.2 million reversal of restructuring
reserves established in the fourth quarter of 1997, offset by $13.0 million of
new charges, primarily related to asset write-downs. The $26.2 million
adjustment to the 1997 restructuring charge resulted primarily from three
factors: a better than expected result from the sale of the Company's CD-ROM
business, lower than expected costs from closing certain research and
development facilities (primarily the facility in the United Kingdom) and lower
than expected costs associated with employee terminations.
OPERATING INCOME (LOSS)
Operating income for 1998 was $130.0 million. Operating loss for
1997 and 1996 was $174.7 million and $4.6 million, respectively. Operating
income in 1998 was benefited by the restructuring reversals and the gain on the
sale of the medical imaging business and related charges discussed above. The
operating losses in 1997 and 1996 were negatively impacted by the restructuring
and other special charges discussed above. Excluding these gains and charges,
operating income would have been $48.2 million, $61.5 million and $83.8 million
in 1998, 1997 and 1996, respectively. The decrease of $13.3 million in 1998
reflects a decline in Data Storage as the Company invested in its SuperDisk(TM)
program, offset by an increase in medical imaging. The
18
decrease of $22.3 million in 1997 reflects lower gross profit and higher
selling, general and administrative costs offset by lower research and
development costs.
NON-OPERATING EXPENSE
Non-operating expense was $20.1 million, $31.3 million and $10.4
million for 1998, 1997 and 1996, respectively. The decrease in 1998 is due to
investment income and reduced currency transaction losses, offset by the
increase in interest expense on outstanding borrowings. Also, in connection with
the termination of the Company's revolving credit agreement, the Company
incurred $2.6 million of costs primarily related to the interest swap agreement.
The increase in 1997 was primarily due to increased interest expense on
outstanding borrowings and foreign currency transaction losses. The Company
utilizes certain financial instruments to manage risks associated with interest
rate and foreign currency risks. See Note 8 of the Notes to Consolidated
Financial Statements for a description of financial instruments held by the
Company.
INCOME TAX
Excluding the gain on the sale of the medical imaging business,
restructuring and other special charges, the Company's effective tax rate was
52.1 percent (using the same tax rates applied to reported results), 42.9
percent and 45.9 percent of pre-tax income for 1998, 1997 and 1996,
respectively. While the Company continues to earn profits in high tax
jurisdictions, future profits and the benefits of a tax effective structure are
expected to decrease future tax rates. The Company has performed an analysis of
the recoverability of deferred tax assets and has recorded valuation allowances
for certain amounts not considered recoverable. At December 31, 1998, the
Company had deferred tax assets, net of valuation allowances, of $65.4 million.
The future recoverability of the Company's net deferred tax assets is dependent
upon the generation of future taxable income, primarily in the U. S. The Company
believes that it will generate sufficient future taxable income to recover the
Company's recorded net deferred tax assets.
NET INCOME (LOSS)
Net income for 1998 was $57.1 million or $1.45 per share, compared
with a net loss for 1997 of $180.1 million or $4.54 per share, and a net loss of
$20.5 million or $0.49 per share in 1996. Excluding the gain on the sale of the
medical imaging business, restructuring and other special charges, net income
would have been $14.7 million or $0.37 per share, $20.3 million or $0.51 per
share and $40.1 million or $0.97 per share, in 1998, 1997 and 1996,
respectively.
PERFORMANCE BY GEOGRAPHIC AREA
In 1998, United States net revenues totaled $1,123.2 million, down
3.4 percent from $1,162.3 million in 1997 due primarily to price erosion. In
1998, international net revenues totaled $923.3 million, down 11.2 percent from
$1,039.5 million in 1997, due to price erosion and unfavorable currency
translation, offset slightly by volume increases.
PERFORMANCE BY SEGMENTS
The Company's current businesses are organized, managed and
internally reported as three segments differentiated primarily by their products
and services, but also by the markets they serve. These segments, whose results
are shown below, are Data Storage and Information Management, Product
Technologies and Digital Solutions and Services. In addition, the Company owned
and managed a fourth segment, Medical Imaging, which was sold to Kodak effective
19
November 30, 1998 (see Note 3 of the Notes to Consolidated Financial
Statements). Results for this segment are also included below through the date
of sale.
DATA STORAGE AND INFORMATION MANAGEMENT
Data Storage and Information Management net revenues of $714.2
million for 1998, decreased $62.4 million from 1997, which had declined $80.7
million from 1996. These decreases were driven by the Company's more mature
mobile and desktop products, including standard diskettes and desktop tape
cartridges, offset partially by increases in net revenues from SuperDisk(TM)
drives and diskettes, as well as by certain network and enterprise data center
products. 1998's operating loss of $30.4 million represented a profitability
decline of $53.1 million from operating income of $22.7 million in 1997. This
decline was driven primarily by the Company's investment in SuperDisk(TM) and
other Data Storage technologies and, to a lesser extent, by declines in other
mobile and desktop products. 1997 operating income declined by $34.5 million
from the prior year driven primarily by declines in desktop tape and optical
products.
PRODUCT TECHNOLOGIES
Product Technologies net revenues declined $72.6 million to $575.0
million in 1998 compared to 1997. Declines were experienced across most major
product categories. Net revenues in 1997 decreased $57.5 million to $647.6
million from the prior year driven primarily by declines in printing plates and
film and, to a lesser extent, by photo color products. Operating income of $53.2
million declined $1.7 million from 1997, which was up $13.0 million from 1996.
The increase in 1997 was driven primarily by improvements in color proofing
products. Beginning in December 1998, the operating results from the supply
agreement for the manufacture of certain medical imaging products are included
in the Product Technologies segment (see Note 11 of the Notes to Consolidated
Financial Statements).
DIGITAL SOLUTIONS AND SERVICES
Digital Solutions and Services 1998 net revenues of $143.5 million
declined $24.6 million from 1997, with declines experienced across most product
and service platforms. 1997 net revenues remained relatively unchanged from 1996
at $168.1 million. 1998 operating loss was $3.3 million versus operating income
of $5.3 million in 1997, reflecting investments in new business opportunities.
1997 operating income was relatively unchanged from 1996.
MEDICAL IMAGING - DIVESTED BUSINESS
Medical Imaging 1998 net revenues of $552.6 million increased $21.4
million from 1997. 1998 Medical Imaging revenues include 11 months of results as
the business was sold to Kodak on November 30, 1998. 1997 net revenues of $531.2
million increased $46.2 million from 1996. These increases were driven by
Dryview(TM) products partially offset by decreases in conventional x-ray and wet
electronics imaging film products. Operating income of $26.5 million in 1998
improved from an operating loss in 1997 of $20.7 million. This improvement was
driven by Dryview(TM) and, to a lesser extent, by conventional x-ray and wet
electronics imaging film products, partially offset by profit declines in the
Company's medical solutions business. 1996 showed an operating loss of $18.9
million.
20
FINANCIAL POSITION
In general, most balance sheet accounts as of December 31, 1998
decreased as a result of the sale of the medical imaging business (see Note 3 of
the Notes to Consolidated Financial Statements). The Company had 3.2 months of
inventory on hand at December 31, 1998 (excluding the effect of the medical
imaging business sold on November 30, 1998), compared to 3.4 months at December
31, 1997. This decrease is primarily related to improved inventory management as
well as certain products which were in backorder. The sale of the medical
imaging business had no significant impact on the decrease in the months of
inventory on hand. The accounts receivable days sales outstanding (DSO) was 80
days at December 31, 1998, (excluding the effect of the medical imaging business
sold on November 30, 1998), up from 76 days at December 31, 1997. The December
31, 1998 DSO calculation now excludes the medical imaging business, which
carried a higher average DSO. Despite the benefit from excluding the medical
imaging business, DSO still increased by four days driven by transitory timing
impacts of the IT implementation. Other current assets were $265.7 million at
December 31, 1998 compared to $141.7 million at December 31, 1997. This increase
is primarily due to $143.0 million of restricted cash from the sale of the
medical imaging business (see Note 3 of the Notes to Consolidated Financial
Statements for further discussion).
The net book value of property, plant and equipment at December 31,
1998 was $233.8 million, a decrease of $147.8 million from $381.6 million at
December 31, 1997. This decrease is due to the sale of medical imaging assets
and the disposal of assets as part of the Company's reorganization and
restructuring process, offset by a $67.5 million increase related to the
purchase of the Company's research and development facility previously under a
synthetic lease structure.
LIQUIDITY
Cash used in operating activities was $6.4 million in 1998, while
cash provided by operating activities was $133.5 million in 1997 and $306.0
million in 1996. The adjustments to net income included depreciation and
amortization of $129.4 million, $147.5 million and $181.1 million in 1998, 1997
and 1996, respectively, and a net restructuring benefit of $16.8 million in
1998. Restructuring and other special charges totaled $241.6 million and $88.4
million in 1997 and 1996, respectively. Changes in working capital used $123.1
million and $24.8 million of cash in 1998 and 1997, respectively, and provided
$40.3 million of cash in 1996. During 1998 the Company made net cash payments
related to restructuring charges of approximately $45.0 million.
Cash provided by investing activities was $247.6 million in 1998,
with $240.6 million and $184.6 million used in 1997 and 1996, respectively. As
discussed in Note 3 of the Notes to Consolidated Financial Statements, in 1998
the Company sold its worldwide medical imaging business to Kodak for
approximately $532.2 million in cash, of which $143.0 million is restricted
until the European businesses are legally transferred to Kodak. The Company
expects these legal transfers to be completed in the first half of 1999. In
addition, proceeds from the sale of other businesses were $38.0 million. Capital
spending totaled $132.4 million in 1998, which includes $67.5 million for the
purchase of the Company's research and development facility previously under a
synthetic lease structure. The Company expects capital spending in 1999 to be
approximately $65.0 million. The Company also capitalized $59.3 million, $97.8
million and $13.5 million of software expenditures in 1998, 1997 and 1996,
respectively, primarily related to the development, testing and implementation
of the Company's new IT systems. Net cash paid in 1997 and 1996 related to
business acquisitions totaled $29.0 million and $10.3 million, respectively.
21
Prior to July 1, 1996, cash and equivalents and debt were not
allocated to the Company from 3M since 3M used a centralized approach to cash
management and the financing of its operations. The Company's financing
requirements prior to July 1, 1996 are represented by cash transactions with 3M
and are reflected in "Net cash paid to 3M" in the Consolidated Statements of
Cash Flows. This financial support was discontinued following the Distribution.
At December 31, 1998, the Company had outstanding borrowing of $31.0
million under its $350.0 million revolving credit facility with a syndicate of
banks (the Credit Agreement). During the fourth quarter of 1997 and the first
quarter of 1998, the Company obtained waivers of compliance with and amendment
of certain financial covenants through January 5, 1999 under the Credit
Agreement to accommodate the restructuring and other special charges recorded in
the fourth quarter of 1997. During this waiver period, borrowings under the
Credit Agreement were collateralized by substantially all of the Company's
assets; the Company was required to maintain a specified minimum level of
earnings before interest, income taxes, depreciation and amortization (EBITDA);
and the Company was subject to increased borrowing margins. The Credit Agreement
also contained a number of provisions restricting the Company's ability to take
certain actions, including the incurrence of additional indebtedness, the
creation of additional liens, the making of certain restricted payments and the
sale of substantial assets of the Company. It also contained certain ongoing
reporting requirements, including computations regarding the Company's financial
condition, absence of events of default and absence of material adverse changes
in the financial condition or results of operations of the Company. On January
4, 1999, the Company repaid the amounts outstanding and terminated the Credit
Agreement.
On December 31, 1998, the Company entered into a three-year $175.0
million Loan and Security Agreement (the Loan Agreement) with a group of banks.
The Loan Agreement provides for a revolving credit, including letters of credit,
with borrowing availability based on eligible accounts receivable, inventories
and manufacturing machinery and equipment not to exceed $175.0 million.
Borrowing availability at December 31, 1998 was $149.9 million, of which $31.0
million was subsequently drawn in connection with the termination of the Credit
Agreement. The Loan Agreement is collateralized by substantially all the
domestic assets of the Company, excluding the land and buildings at the
Company's headquarters in Oakdale, Minnesota, and a pledge of 65 percent of the
stock of certain of the Company's foreign subsidiaries. Covenants include
maintenance of a minimum tangible net worth and borrowing base availability,
with certain restrictions on the incurrence of additional indebtedness, sale of
assets, mergers and consolidation, transactions with affiliates, creation of
liens, and certain other matters. As of January 4, 1999, the initial funding
date of the Loan Agreement, the Company was in compliance with all covenants and
restrictions.
In addition, certain subsidiaries have arranged borrowings locally
outside of the agreements discussed above. As of December 31, 1998, $23.8
million of short-term borrowings were outstanding under such arrangements.
In March 1997, the Company entered into a synthetic lease facility
to fund the cost of construction of a new research and development facility at
the Company's headquarters. The facility also required that the Company comply
with the financial covenants contained in the Company's Credit Agreement, or a
replacement thereof, provided that any amendment or waiver of such covenants
approved by the lenders under the Credit Agreement was also effective under the
synthetic lease facility. To facilitate entering into the new Loan Agreement as
noted above, the
22
Company prepaid this financing and purchased the building in December 1998.
As of December 31, 1998, the Company's ratio of debt to total
capital was 7.1 percent as compared with 34.0 percent at December 31, 1997. The
decrease in the ratio is principally attributable to the debt payments and
increase in shareholders' equity associated with the sale of the medical imaging
business (see Note 3 of the Notes to Consolidated Financial Statements). The
Company expects that cash and equivalents, together with cash flow from
operations and availability of borrowings under its current and future sources
of financing, will provide liquidity sufficient to operate the Company.
In February and March of 1997, the Company's Board of Directors
authorized the repurchase of up to six million shares of the Company's common
stock. During the first and second quarters of 1997, approximately 2.5 million
shares were repurchased. As of December 31, 1998, the Company held 1.9 million
shares of treasury stock acquired at an average price of $24.34 per share. On
January 26, 1999, the Company announced an increase in the share repurchase
authorization to a total of 10 million shares under which approximately 2.5
million shares at a cost of $40 million have been subsequently purchased through
March 25, 1999.
EURO CONVERSION STATUS
On January 1, 1999, 11 of the 15 member countries of the European
Union adopted the Euro as their new common currency. The Euro is trading on
currency exchanges and can be used for noncash transactions. Local currencies
will remain legal tender until December 31, 2001. By no later than December 31,
2001, participating countries will issue new Euro-denominated bills for use in
cash transactions. By no later than July 1, 2002, participating countries will
begin using the Euro as the legal tender and will withdraw all legacy
currencies.
The Euro conversion may lead to increased competition between
countries and potential erosion of margins as prices in different countries are
more readily comparable. The Company is reviewing its marketing strategies to
address possible increased competition and is also reviewing and testing its
software compatibility with the Euro conversion. The Company will continue to
review the impact of the conversion to the Euro; however, the Company does not
expect that the Euro conversion will have a material impact on the Company's
results of operations and financial position.
MARKET RISKS
The Company is exposed to various market risks, including volatility
in foreign currency exchange rates, interest rates and commodity prices. These
exposures primarily relate to the sale of products to foreign customers,
purchases from foreign suppliers, acquisition of raw materials from both
domestic and foreign suppliers, and changes in interest rates. The Company
utilizes derivative financial instruments, including forward exchange contracts,
futures contracts, options and swap agreements to manage certain of these
exposures when it is considered practical to do so in accordance with
established policies and procedures. The Company does not hold or issue
derivative financial instruments for trading purposes and is not a party to
leveraged derivative transactions.
As a global company, changes in the exchange rates of foreign
currencies relative to the U.S. dollar affect the Company's financial results.
The Company, from time-to-time, enters into forward foreign exchange contracts
principally to hedge transactions denominated in foreign currencies, that when
remeasured according to generally accepted accounting principles, impact
23
the income statement. For certain markets, particularly Latin America, where
forward exchange contracts are not available or determined not to be cost
effective, the Company attempts to minimize currency exposure risk through
pricing and working capital management. There can be no assurances that such an
approach will be successful, especially in the event of a significant and sudden
decline in the value of local currencies. Factors that could impact the
effectiveness of the Company's hedging include accuracy of sales forecasts,
volatility of the currency markets and availability of hedging instruments.
Although the Company attempts to utilize transaction hedging to reduce the
impact of changes in currency exchange rates, when the U.S. dollar sustains a
strengthening position against currencies in which the Company sells products or
a weakening exchange rate against currencies in which the Company incurs costs,
the Company's sales or costs are adversely impacted.
At December 31, 1998, the Company had $218.7 million notional amount
of foreign exchange contracts of which $214.0 million hedged recorded balance
sheet exposures. A hypothetical adverse change of 10 percent in year-end foreign
currency exchange rates would reduce the fair value of foreign currency
contracts outstanding at December 31, 1998 by $10.9 million; however, less than
$0.5 million of this change would impact earnings since the gain (loss) on the
majority of these contracts would be offset by an equal gain (loss) on the
underlying exposures being hedged.
To manage interest rate risk on a portion of the variable rate
borrowings under its revolving credit agreement, the Company has utilized and in
the future may utilize interest rate swaps. These interest rate swap hedging
instruments have the effect of locking in, for a specified period, the base
interest rate (excluding credit margin) the Company will pay on the notional
principal amount established in the swap. As a result, while these hedging
arrangements are structured to reduce the Company's exposure to interest rate
increases, they also limit the benefit the Company might otherwise have received
from any interest rate decreases. These swaps are usually cash settled
quarterly, with interest expense adjusted for amounts paid or received.
The Company did not have any interest rate swaps as of December 31, 1998.
From time-to-time, the Company has used silver commodity forward
contracts, and may use these and other commodity forward contracts, to manage
the Company's exposure to price risk of commodities used in production. These
commodity forward contract hedging instruments have the effect of locking in,
for specified periods, the prices the Company will pay for the volumes to which
the hedge relates. As a result, while these hedging arrangements are structured
to reduce the Company's exposure to price increases, they also limit the benefit
the Company might otherwise have received from any price decreases associated
with the hedged commodity. These contracts are usually cash settled as opposed
to taking physical delivery of the commodity. Realized and unrealized gains and
losses on contracts qualifying as hedge instruments are deferred until
offsetting gains and losses on the underlying transactions are recognized in
earnings as part of cost of goods sold. The Company did not have any commodity
forward contracts as of December 31, 1998.
YEAR 2000 COMPLIANCE
Introduction (Phases)
In preparation for the change in the millennium, the Company's Year
2000 (Y2K) Operating Team has instituted a seven-phase plan to address the
Company's Y2K readiness in the
24
following areas: internal IT systems, non-IT systems (including plants,
facilities, process control and building control equipment, communications
systems, laboratory and test equipment, etc.), the Company's products, and
external business relationships. The seven phases of the plan are: (1) perform
inventory of all items potentially subject to Y2K effect and prioritize on the
basis of business criticality; (2) develop a plan for assessing Y2K compliance
of all inventoried items; (3) determine whether inventoried items are Y2K
compliant; (4) design a remediation strategy (e.g., remediate, replace, retire,
etc.) for non-compliant inventoried items and develop contingency plans; (5)
develop and test remediation solutions; (6) implement remediation solutions; and
(7) document verification of compliance of remediated solutions.
Inventories of each area have been completed and determinations have
been made regarding Y2K impact. Inventoried items have been prioritized,
assessment plans have been completed and remediation solutions are being
developed. Field implementation of remediation solutions for critical Y2K items
is targeted for completion by the end of June 1999, with remediation of least
critical items targeted for completion by the end of September 1999.
Verification of compliance of remediated solutions is planned to occur
contemporaneously with the field installation of solutions. Contingency plans
are being developed to address potential Y2K related failures that could affect
critical Company operations.
IT System
A significant portion of the Company's new global IT infrastructure
has been completed with the remaining portion expected to be completed by
September 1999. The Company required a new IT system after the Company's
spin-off from 3M, and a significant factor in the Company's selection of this
system was its Y2K compliance status. The Company believes that the new system
will significantly reduce the likelihood of Y2K-related interruptions to normal
operations. The Company must, however, test all system software applications
added to the new IT system and custom code written for the system, as well as
certain other systems not replaced by the new global IT infrastructure, for Y2K
compliance. Although the Company does not foresee a material adverse effect on
its business, results of operations, or financial position related to Y2K issues
and the Company's IT system, risk is not eliminated until the system is fully
tested and all non-compliant code is identified, corrected, and re-verified.
Non-IT Systems
The Company is assessing its non-IT systems in its plants and
facilities on a worldwide basis for issues of Y2K compliance. This assessment
includes reviewing not only the Company's manufacturing process control
equipment, but also systems that control temperature, utility equipment,
telephone systems, and security systems. Laboratory and test equipment are also
being evaluated. While the Company does not believe that it is likely to
experience material adverse effects related to Y2K in the area of non-IT
systems, failure to identify all Y2K vulnerable controls or equipment, or
failure to remediate them in a timely way, could result in the inability of a
particular plant or facility to manufacture or test product or conduct business
in the ordinary course.
Products
The majority of Company's products do not have electronic date
functionality. Those products that do have electronic date functionality have
been assessed and remediation strategies have been developed to address any
issues of Y2K non-compliance. The Company believes it has sufficient resources
dedicated to product compliance activities and it does not foresee any material
25
adverse impact on the Company's business, results of operations, or financial
position due to Y2K product issues. However, there remains the possibility that
the Company could fail to identify all susceptible products or be unable to
implement all field remediations for which it is responsible prior to January 1,
2000.
Third Parties
Y2K preparedness of third parties with whom the Company does
business could impact the Company's ability to deliver products and services in
the new millennium. This constitutes an area of potentially significant risk to
the Company's business, results of operations, and financial position. Suppliers
of critical raw materials and providers of utility and communication services
could particularly impair the Company's ability to conduct business in the
ordinary course if those third parties fail to successfully assess and remediate
their own products and internal operations. While third party risk related to
the Y2K problem is difficult to quantify or control, the Company is taking steps
in an effort to try to minimize the potential adverse effect of Y2K problems
that could arise based on the Company's external business relationships.
Y2K surveys have been sent to the Company's suppliers asking them
for the Y2K compliance status of their products and internal operations. The
Company is re-contacting the Company's most critical suppliers and conducting
Y2K phone surveys with them. At the present time, the feedback being received
from the phone surveys has been favorable.
The Company plans to develop third party contingency plans as it
identifies critical partners evidencing inadequate Y2K preparations. The
Company's contingency plans may include plans to accumulate extra inventory
and/or establish alternative sources of supply and channels of distribution.
However, even with diligent planning, third party providers pose an uncertain
risk which cannot be entirely eliminated.
Expenditures
Aside from expenditures made by the Company in implementing its new
corporate IT system, the Company has not incurred any significant Y2K-related
costs to date.
Based on current information and resources, the Company estimates
that it could potentially spend up to $6 million on completing its Y2K program,
excluding costs already anticipated for completion of the Company's IT system.
This estimated expenditure would most likely occur in the non-IT systems area.
This estimate is subject to change as the Company moves through final phases of
its Y2K plan.
While the Company's management does not believe that the Company's
Y2K costs will have a material adverse effect on the Company's business, results
of operations, or financial position, Y2K costs could increase if currently
unknown Y2K deficiencies are discovered in Company IT systems, non-IT systems,
products, or external business partners.
Summary
Due to the uncertain nature of the Y2K problem, the Company's
management cannot say with certainty whether Y2K issues will have a material
adverse effect on the Company's business, results of operations, or financial
position. The Company believes it is taking reasonable steps to address the Y2K
problem, but the Y2K problem is very complex. If several of the Company's
external business partners should fail to implement successful Y2K programs, or
if the Company
26
should fail to identify Y2K deficiencies in critical IT and non-IT systems, or
if the Company's product remediations should fail to be implemented in the field
by January 1, 2000, Y2K problems could have a material adverse effect on the
Company's business, results of operations, or financial position.
The projected expenditures and dates contained in this discussion
are based on the Company's best estimates and are derived from assumptions about
future events, including the availability of resources and other factors. The
Company does not guarantee that these estimates will be achieved and results may
vary due to uncertainties.
The forward-looking statements contained in this section under the
heading "Year 2000 Compliance" should be read in conjunction with the Company's
disclosure below under the heading "Forward Looking Statements."
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued SFAS
No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. This
standard establishes accounting and reporting standards for derivative
instruments and hedging activities. The Company must adopt this standard no
later than January 1, 2000. The Company is reviewing the requirements of this
standard and has not yet determined the impact of this standard on the financial
statements of the Company.
In March 1998, the American Institute of Certified Public
Accountants issued Statement of Position (SOP) 98-1, ACCOUNTING FOR THE COSTS OF
COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE, which provides
guidance on accounting for the costs of computer software intended for internal
use. The Company adopted this standard effective January 1, 1999. The Company
does not believe that the impact of this standard will be material to the
financial statements of the Company.
FORWARD LOOKING STATEMENTS
The Company and its representatives may from time-to-time make
written or oral forward looking statements with respect to future goals of the
Company, including statements contained in this report, the Company's other
filings with the Securities and Exchange Commission and in the Company's reports
to shareholders.
The words or phrases "will likely result," "are expected to," "will
continue," "is anticipated," "estimate," "project," "believe" or similar
expressions identify "forward looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. Such statements are subject to
certain risks and uncertainties that could cause actual results to differ
materially from historical results and those presently anticipated or projected.
The Company wishes to caution readers not to place undue reliance on any such
forward looking statements, which speak only as of the date made. Among the
factors that could cause the Company's actual results in the future to differ
materially from any opinions or statements expressed with respect to future
periods are the following:
THE COMPANY'S ABILITY TO ESTABLISH A NEW BRAND AND IDENTITY - Prior
to the Distribution, the Transferred Businesses had the right to use certain 3M
trademarks in marketing their products. Pursuant to agreements entered into with
3M, the Company continues to have the use of certain 3M trademarks for an agreed
upon period of time following the Distribution. The Company's
27
right to use certain 3M trademarks (such as the Scotch(TM) trademark) expired on
June 30, 1998, while the right to use other 3M trademarks expires on June 30,
1999. The Company has made and continues to make significant investments in the
development of the Company's independent identity and brand. However, there can
be no assurance that the Company will be successful in this regard or that the
loss of use of 3M trademarks might not have an adverse effect on the business of
the Company.
COMPETITIVE INDUSTRY CONDITIONS - The Company operates in highly
competitive environments. The Company's competitors are both larger and smaller
than the Company in terms of resources and market shares. The marketplaces in
which the Company operates are generally characterized by rapid technological
change, frequent new product introductions, a variety of distribution channels,
relatively large and aggressive marketing efforts, evolving customer needs away
from product purchases and towards increasing integrated business solutions, and
declining prices in certain product lines.
Driving demand in the data storage industry is a greatly expanding
need to manage and store information more rapidly and at lower cost, with
greater accuracy and reliability. Similarly, the demand for image management and
color management products, services and work flow solutions continues to grow as
the use of images and color continues to expand in both commercial and consumer
applications. These offerings are characterized by increasing use of digital
technologies, including software and services, replacing analog-based products
where the Company currently has a strong market position in several areas.
In particular, the data storage industry is undergoing rapid
technology and market changes, the varieties of data storage media formats
available for customers is increasing and the choice of data storage media is
not one of the top three strategic decisions made by an IT professional or a
consumer. In fact, many customers would prefer not to have to perform data
backup, which is the largest application for removable storage media. Data
storage media sales account for less than 2 percent of IT spending. The data
storage market is characterized by short product development cycles that are
driven by rapidly changing technology and consumer preferences as well as
declining product prices. Success in introducing and gaining acceptance of new
data storage media is dependent on the ability to develop relationships with
distributors and OEM's.
In these highly competitive markets, the Company's success will
depend to a significant extent on its ability to continue to develop and
introduce differentiated and innovative products, services and customer
solutions cost effectively and on a timely basis. The success of the Company's
offerings is dependent on several factors including competitive technology
capabilities, differentiation from competitive offerings, effectiveness of
marketing programs and low costs. Although the Company believes that it can take
the necessary steps to meet the competitive challenges of these marketplaces, no
assurance can be given with regard to the Company's ability to take these steps,
the actions of competitors, some of which will have greater resources than the
Company, or the pace of technological changes.
There can be no assurance that the Company will be able to continue
to introduce new products or maintain competitive technology competencies, that
the markets will be receptive to its new products, that the Company's marketing
programs will be successful, or that the Company's competitors will not
introduce more advanced products ahead of the Company. In addition, while the
Company currently has access to significant proprietary technologies through
internal development and licensing arrangements with third parties, there can be
no assurance that it will continue to have access to new competitive
technologies that may be required to introduce new products. In addition, new
technological innovations generally require a substantial investment
28
before any assurance is available as to their commercial viability. Therefore,
the Company must make strategic decisions from time to time as to the
technologies in which the Company desires to invest. If the Company is not
successful in executing any of the above described risks, the Company may incur
a material adverse impact on its business and financial results.
INTERNATIONAL OPERATIONS AND FOREIGN CURRENCY - The Company does
business in more than 60 countries outside the United States. International
operations, which comprised approximately 45 percent of the Company's revenues
in 1998, may be subject to various risks which are not present in domestic
operations, including political instability, the possibility of expropriation,
restrictions on royalties, dividends and currency remittances, local government
involvement required for operational changes within the Company, requirements
for governmental approvals for new ventures and local participation in
operations such as local equity ownership and workers' councils. In addition,
the Company's business and financial results are affected by fluctuations in
world financial markets, including foreign currency exchange rates. The
Company's foreign currency hedging policy attempts to mitigate some of these
risks over near term periods; however, these risk management activities are not
comprehensive and there can be no assurance that these programs will offset more
than a portion of the adverse financial impact resulting from unfavorable
movements in foreign exchange rates or that medium and longer term effects of
exchange rates will not be significant.
INTELLECTUAL PROPERTY RIGHTS - The Company's success depends in part
on its ability to obtain and protect its intellectual property rights and to
defend itself against intellectual property infringement claims of others. If
the Company is not successful in defending itself against claims that may arise
from time-to-time alleging infringement of the intellectual property rights of
others, the Company could incur substantial costs in implementing remediation
actions, such as redesigning its products or processes or acquiring license
rights. Such costs or the disruption to the Company's operations occasioned by
the need to take such actions could have a material adverse effect on the
Company. In addition, the Company utilizes valuable non-patented technical
know-how and trade secrets in its product development and manufacturing
operations. Although the Company utilizes confidentiality agreements and other
measures to protect such proprietary information, there can be no assurance that
these agreements will not be breached or that competitors of the Company will
not acquire the information as a result of such breaches or through independent
development. The Company has pursued a policy of enforcing its intellectual
property rights against others who may infringe those rights. In connection with
such enforcement actions, the Company may incur significant costs for which the
Company may or may not be reimbursed by the alleged infringer.
SALE OF MEDICAL IMAGING BUSINESS - As discussed in Note 3 of the
Notes to Consolidated Financial Statements, on November 30, 1998, the Company
sold its worldwide medical imaging business to Kodak. The Company, however,
retained its manufacturing facility in Ferrania, Italy, from which the Company
agreed to manufacture x-ray and wet laser medical imaging film for Kodak for a
minimum of two years under a supply agreement which became effective on November
30, 1998. Under the terms of the Asset Purchase Agreement, Kodak is obligated to
make a cash payment to the Company of up to $25.0 million no later than the date
the Ferrania Supply Agreement terminates. Under terms of the agreement with
Kodak, the Company is prohibited from selling medical imaging products to third
parties other than Kodak during the duration of and subsequent to the
termination of the supply agreement. As a result, the Company cannot reasonably
predict the ultimate utilization of the Ferrania facility upon termination of
the supply agreement. The Company cannot predict with certainty what, if any,
costs may result upon termination of the supply agreement, but believes that
such costs could be significant.
29
TRANSITION SERVICES AND DISTRIBUTION AGREEMENTS - Associated with
the Company's sale of its medical imaging business to Kodak on November 30,
1998, the Company will receive reimbursement from Kodak for certain services
under transition services and distribution agreements that the Company has
agreed to provide Kodak while Kodak integrates the medical imaging businesses
into its accounting and information systems. These include information
technology, logistics, finance, telecommunications, office space, human
resources and site services. The Company has agreed to provide such services
under the transition services agreement for a period of up to two years
primarily in the United States and, to a lesser extent, in Asia and Latin
America, and under a distribution agreement through the dates of individual
country closings for the European Businesses. Kodak, at its option, may
terminate the transition services agreement with respect to individual
categories of service upon prior notice, the length of which varies according to
the nature of the service. As a result, the Company can not project with
certainty the duration of and expected cost reimbursements, associated with the
transition services and distribution agreements.
RESTRUCTURING CHARGES - While the Company's restructuring plans are
designed to reduce the Company's cost structure and improve its profitability,
there can be no assurance that the Company will be successful in achieving its
financial improvement goals in the future. In addition, if it becomes necessary
for the Company to shut down or restructure additional businesses and operations
in the future, it could incur substantial additional charges in the process. The
recording of these charges could have a material adverse impact on the Company's
financial condition.
FLUCTUATIONS IN THE COMPANY'S STOCK PRICE - The Company's stock
price may be subject to significant volatility. If revenue or earnings in any
quarter fail to meet the investment community's expectations, there could be an
immediate impact on the Company's stock price. The stock price may also be
affected by broader market trends unrelated to the Company's performance.
FUTURE CAPITAL REQUIREMENTS - On December 31, 1998, the Company
entered into a three-year $175.0 million loan agreement with a group of banks.
The loan agreement provides for revolving credit, including letters of credit,
with borrowing availability based on eligible accounts receivable, inventory and
manufacturing machinery and equipment not to exceed $175.0 million. Borrowing
availability at December 31, 1998 was $149.9 million, of which $31.0 million was
drawn on January 4, 1999 for repayment of funds drawn under the Company's prior
credit agreement, which was then immediately terminated. The Company expects
that cash and equivalents, together with cash flow from operations and
availability of borrowing under its current and future sources of financing,
will provide liquidity sufficient to operate the Company.
30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Imation Corp.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, shareholders' equity and cash flows
present fairly, in all material respects, the financial position of Imation
Corp. and its subsidiaries as of December 31, 1998 and 1997, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Minneapolis, Minnesota
February 8, 1999
31
IMATION CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 1998 1997 1996
- ----------------------------------------------------------------------------------------------
(In millions, except per share amounts)
Net revenues $ 2,046.5 $ 2,201.8 $ 2,278.2
Cost of goods sold 1,370.2 1,485.6 1,523.3
- ----------------------------------------------------------------------------------------------
Gross profit 676.3 716.2 754.9
Operating expenses:
Selling, general and administrative 488.3 526.0 522.5
Research and development 139.8 194.9 183.1
Gain on sale of medical imaging
business and related charges (65.0) -- --
Restructuring (16.8) 170.0 53.9
- ----------------------------------------------------------------------------------------------
Total operating expenses 546.3 890.9 759.5
Operating income (loss) 130.0 (174.7) (4.6)
Interest expense 20.5 15.7 14.2
Losses related to change
in credit facility 2.6 -- --
Other, net (3.0) 15.6 (3.8)
- ----------------------------------------------------------------------------------------------
Income (loss) before tax
and minority interest 109.9 (206.0) (15.0)
Income tax provision (benefit) 52.8 (25.9) 5.9
Minority interest -- -- (0.4)
- ----------------------------------------------------------------------------------------------
Net income (loss) $ 57.1 $ (180.1) $ (20.5)
==============================================================================================
Basic and diluted earnings (loss)
per common share $ 1.45 $ (4.54) $ (0.49)
==============================================================================================
Weighted average basic shares outstanding 39.4 39.7 41.3
Weighted average diluted shares outstanding 39.5 39.7 41.3
==============================================================================================
The accompanying notes to consolidated financial statements are an integral part
of these statements.
32
IMATION CORP.
CONSOLIDATED BALANCE SHEETS
As of December 31, 1998 1997
- -----------------------------------------------------------------------------------------------
(In millions, except per share amounts)
ASSETS
Current assets
Cash and equivalents $ 64.2 $ 103.5
Accounts receivable, net 326.3 459.3
Inventories 263.7 399.9
Other current assets 265.7 141.7
- -----------------------------------------------------------------------------------------------
Total current assets 919.9 1,104.4
Property, plant and equipment, net 233.8 381.6
Other assets 168.5 179.5
- -----------------------------------------------------------------------------------------------
Total assets $ 1,322.2 $ 1,665.5
===============================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable $ 125.5 $ 182.2
Accrued payroll 23.8 38.3
Short-term debt 25.2 31.3
Other current liabilities 247.6 313.7
- -----------------------------------------------------------------------------------------------
Total current liabilities 422.1 565.5
Other liabilities 106.3 98.1
Long-term debt 32.7 319.7
Commitments and contingencies
Shareholders' equity
Preferred stock, $.01 par value, authorized
25 million shares, none issued and outstanding -- --
Common stock, $.01 par value, authorized
100 million shares, 42.9 million issued 0.4 0.4
Additional paid-in capital 1,027.7 1,025.8
Accumulated deficit (123.9) (171.1)
Accumulated other comprehensive income (68.5) (78.1)
Unearned ESOP shares and other compensation (27.6) (37.3)
Treasury stock, at cost, 1.9 million and 2.3 million shares
as of December 31, 1998 and 1997, respectively (47.0) (57.5)
- -----------------------------------------------------------------------------------------------
Total shareholders' equity 761.1 682.2
- -----------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 1,322.2 $ 1,665.5
===============================================================================================
The accompanying notes to consolidated financial statements are an integral part
of these statements.
33
IMATION CORP.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Retained Accumulated Unearned
Additional Earnings Other ESOP Shares Net Total
Common Paid-In (Accumulated Comprehensive and Other Treasury Investment Shareholders'
(In millions, except share amounts) Stock Capital Deficit) Income Compensation Stock by 3M Equity
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 -- -- -- $ (39.1) -- -- $1,187.8 $1,148.7
Net equity
transactions with 3M (164.0) (164.0)
Issuance of common
stock to 3M shareholders
(41,930,187 shares) $ 0.4 $ 991.7 (992.1) --
Loan to ESOP $ (50.0) (50.0)
Amortization of
unearned ESOP shares 0.4 3.4 3.8
Issuance of common
stock (922,845 shares)
in connection with
Luminous acquisition 14.6 14.6
Value of stock options
issued in connection
with Luminous acquisition 4.8 4.8
Exercise of stock
options (26,848 shares) --
Comprehensive loss:
Net income (loss) $ 11.2 (31.7) (20.5)
Net change in cumulative
translation adjustment (7.1) (7.1)
--------
Comprehensive loss (27.6)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 0.4 1,011.5 11.2 (46.2) (46.6) -- -- 930.3
Amortization of
unearned ESOP shares 0.5 9.3 9.8
Purchase of treasury stock
(2,488,132 shares) $ (60.9) (60.9)
Exercise of stock options
(190,120 shares) 0.2 (2.2) 3.4 1.4
Value of stock options and
warrants issued in connection
with Cemax acquisition 13.6 13.6
Comprehensive loss:
Net loss (180.1) (180.1)
Net change in cumulative
translation adjustment (31.9) (31.9)
--------
Comprehensive loss (212.0)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 0.4 1,025.8 (171.1) (78.1) (37.3) (57.5) -- 682.2
Amortization of
unearned ESOP shares (0.9) (2.0) 11.1 8.2
Exercise of stock options
(416,732 shares) (7.9) 10.5 2.6
Other unearned compensation 1.6 (1.4) 0.2
Tax benefit from shareholder
transactions 1.2 1.2
Comprehensive income:
Net income 57.1 57.1
Net change in cumulative
translations adjustment 9.6 9.6
--------
Comprehensive income 66.7
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 $ 0.4 $1,027.7 $ (123.9) $ (68.5) $ (27.6) $ (47.0) -- $ 761.1
===================================================================================================================================
The accompanying notes to consolidated financial statements are an integral part
of these statements.
34
IMATION CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 1998 1997 1996
- --------------------------------------------------------------------------------------------------------
(In millions)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 57.1 $ (180.1) $ (20.5)
Adjustments to reconcile net income (loss) to
net cash (used in) provided by operating activities:
Depreciation 110.5 144.2 181.0
Amortization 18.9 3.3 0.1
Deferred income taxes 23.7 (45.2) 12.6
Restructuring and other special charges (16.8) 241.6 88.4
Gain on sale of medical imaging business
and related charges (65.0) -- --
Accounts receivable (57.6) 0.4 --
Inventories 46.3 (22.0) 22.3
Other current assets (1.4) (30.4) (29.8)
Accounts payable (33.0) (11.6) 85.7
Accrued payroll and other current liabilities (77.4) 38.8 (37.9)
Other (11.7) (5.5) 4.1
- --------------------------------------------------------------------------------------------------------
Net cash (used in) provided by operating activities (6.4) 133.5 306.0
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (132.4) (116.3) (167.4)
Capitalized software (59.3) (97.8) (13.5)
Acquisitions, net of cash acquired -- (29.0) (10.3)
Proceeds from sale of medical imaging business 389.2 -- --
Other 50.1 2.5 6.6
- --------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 247.6 (240.6) (184.6)
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in short-term debt (9.4) 5.8 25.4
Other borrowings of debt 201.7 505.2 270.3
Other repayments of debt (486.2) (312.6) (146.3)
Purchase of treasury stock -- (60.9) --
Exercise of stock options 2.6 1.4 --
Decrease in unearned ESOP shares 11.1 9.3 3.4
Loan to ESOP -- -- (50.0)
Net cash paid to 3M -- -- (155.9)
- --------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (280.2) 148.2 (53.1)
Effect of exchange rate changes on cash (0.3) 0.7 (6.6)
- --------------------------------------------------------------------------------------------------------
Change in cash and equivalents (39.3) 41.8 61.7
Cash and equivalents - beginning of year 103.5 61.7 --
- --------------------------------------------------------------------------------------------------------
Cash and equivalents - end of year $ 64.2 $ 103.5 $ 61.7
========================================================================================================
The accompanying notes to consolidated financial statements are an integral part
of these statements.
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- BACKGROUND AND BASIS OF PRESENTATION
BACKGROUND
Imation Corp. (the Company) became an independent, publicly-held company as of
July 1, 1996 (the Distribution Date), when Minnesota Mining and Manufacturing
Company (3M) spun off its data storage and imaging systems businesses as an
independent, publicly owned company (the Distribution). One share of the
Company's common stock was issued for every ten shares of 3M common stock
outstanding to stockholders of record on June 28, 1996. The Company is a global
leader in the data storage and imaging industries, providing products and
services for data storage, medical imaging, printing and publishing, and
photographic applications.
BASIS OF PRESENTATION
SUBSEQUENT TO THE DISTRIBUTION. The consolidated financial statements include
the accounts and operations of the Company on a stand-alone basis. 3M and the
Company entered into a number of agreements to facilitate the transition of the
Company to an independent business enterprise.
PRIOR TO THE DISTRIBUTION. The consolidated financial statements for the periods
prior to July 1, 1996 reflect the revenues and expenses that were directly
related to the Company as it was operated within 3M. The Company's Consolidated
Statements of Operations include all of the related costs of doing business
including an allocation of certain general corporate expenses of 3M which were
not directly related to the Company, including costs for corporate logistics,
corporate research and development, information technologies, finance, legal and
corporate executives. These allocations were based on a variety of factors
including, for example, personnel, space, time and effort, and sales volume.
Management believes these allocations were made on a reasonable basis.
The Consolidated Statements of Operations include an allocation of 3M's interest
expense (see Note 7). The Company's financing requirements were represented by
cash transactions with 3M and are reflected in the "Net Investment by 3M"
account (see Consolidated Statements of Shareholders' Equity).
The Company also participated in 3M's centralized interest rate risk management
function. As part of this activity, derivative financial instruments were
utilized to manage risks generally associated with interest rate market
volatility. 3M did not hold or issue derivative financial instruments for
trading purposes. 3M was not a party to leveraged derivatives. The Consolidated
Statements of Operations and Statements of Cash Flows reflect an allocation of
the related gains and losses. Such gains and losses were recognized by 3M as
interest expense over the borrowing period and, as a result, are reflected in
the effective interest rates utilized by the Company in deriving its interest
expense.
The minority interest within the Consolidated Statements of Operations gives
recognition to the Company's share of net income (loss) of certain majority
owned subsidiaries of 3M.
The financial information included herein for 1996 may not necessarily be
indicative of the results of operations or cash flows of the Company if it had
been a separate, independent company during the entire year.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION. Commencing with the Distribution, the consolidated financial
statements include the accounts of the Company and its majority-owned
subsidiaries. Prior to the Distribution, the consolidated financial statements
include the accounts of the Company as described in Note 1. Intercompany
transactions and balances have been eliminated.
36
USE OF ESTIMATES. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Principal
areas requiring the use of estimates include: the allocation of financial
statement amounts between the Company and 3M for periods prior to the
Distribution, the determination of allowances for uncollectible accounts
receivable and obsolete/excess inventories, the evaluation of costs associated
with restructuring activities, the determination of certain accrued and other
liabilities, the valuation of certain intangibles, and the assessments of
recoverability of deferred tax assets and certain long-lived assets.
RECLASSIFICATIONS. Certain expenses previously classified as selling, general
and administrative expenses have been reclassified as cost of goods sold in
current and prior years' financial statements with no impact on net income or
loss in any year.
FOREIGN CURRENCY. Local currencies are considered the functional currencies
outside the U.S., except for Imation Europe B.V., the Company's European holding
company, and subsidiaries located in highly inflationary economies. For
operations in local currency environments, assets and liabilities are translated
at year-end exchange rates with cumulative translation adjustments included as a
component of shareholders' equity. Income and expense items are translated at
average rates of exchange prevailing during the year. For operations in which
the U.S. dollar is considered the functional currency, certain financial
statement amounts are translated at historical exchange rates, with all other
assets and liabilities translated at year-end exchange rates. These translation
adjustments are reflected in the results of operations. Net foreign currency
exchange losses included in results of operations were $13.8 million in 1997 and
were not material in 1998 and 1996.
FINANCIAL INSTRUMENTS. The Company uses, or may use from time-to-time, interest
rate swaps and foreign currency and commodity forward and option contracts to
manage risks generally associated with interest rate, exchange rate and
commodity market volatility. All hedging instruments are designated as, and
effective as, hedges and are highly correlated as required by generally accepted
accounting principles. Instruments that do not qualify for hedge accounting are
marked to market with changes recognized currently in the results of operations.
The Company does not hold or issue derivative financial instruments for trading
purposes and is not a party to leveraged derivatives.
Realized and unrealized gains and losses on foreign currency and commodity
forward and option contracts for qualifying hedge instruments are deferred until
offsetting gains and losses on the underlying transactions are recognized in
earnings. These gains and losses generally are recognized as an adjustment to
cost of goods sold for inventory-related hedge transactions, or as adjustments
to foreign currency transaction gains/losses included in non-operating expenses
for foreign denominated payables- and receivables-related hedge transactions.
For interest rate swaps, the differential paid or received on the swaps is
recognized on an accrual basis as an adjustment to interest expense. Gains and
losses on terminated foreign currency and commodity forward and option contracts
are deferred until the underlying hedged item is recognized in the results of
operations. Gains and losses on terminated interest rate swaps are amortized and
reflected in interest expense over the remaining term of the underlying debt.
Cash flows attributable to these financial instruments are included with cash
flows of the associated hedged items.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES. This standard establishes accounting and
reporting standards for derivative instruments and hedging activities. The
Company must adopt this standard no later than January 1, 2000. The Company is
reviewing the requirements of this standard and has not yet determined the
impact of this standard on the financial statements of the Company.
37
FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS. The Company's financial
instruments consist of cash, investments and short-term receivables and
payables, for which their current carrying amounts approximate fair market
value.
CONCENTRATIONS OF CREDIT RISK. The Company sells a wide range of products and
services to a diversified base of customers around the world and performs
ongoing credit evaluations of its customers' financial condition, and therefore
believes there is no material concentration of credit risk.
CASH EQUIVALENTS. Cash equivalents consist of temporary investments purchased
with original maturities of three months or less. The carrying value of cash
equivalents approximates the fair value as of December 31, 1998 and 1997.
INVENTORIES. Inventories are stated at the lower of cost or market, with cost
generally determined on a first-in, first-out basis.
PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment are recorded at
cost. Plant and equipment are generally depreciated on a straight-line basis
over their estimated useful lives. Maintenance and repairs are expensed as
incurred. Periodic reviews for impairment of the carrying value of property,
plant and equipment are made based on undiscounted expected future cash flows.
The cost and related accumulated depreciation of assets sold or otherwise
disposed of are removed from the related accounts and resulting gains or losses
are reflected in operating income (loss).
INTANGIBLE ASSETS. Intangible assets consist primarily of goodwill and
capitalized software. The Company capitalizes certain external and internal
costs related to the design and implementation of internally developed software,
along with related interest. Intangible assets are amortized over their
estimated useful lives, which currently range from five to eight years. The
carrying amount of intangible assets is periodically reviewed to assess
recoverability based on undiscounted expected future cash flows.
PENSION PLANS. Effective December 31, 1998, the Company adopted SFAS No. 132,
EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITS. The
provisions of SFAS No. 132 revise employers' disclosures about pension and other
postretirement benefit plans. This standard does not change the measurement or
recognition of these plans; however, it standardizes the disclosure requirements
for pensions and other postretirement benefits to the extent practicable.
REVENUE RECOGNITION. Revenue is recognized upon shipment of goods to customers
or upon performance of services. Revenues from service contracts are deferred
and recognized over the life of the contracts as service is performed.
RESEARCH AND DEVELOPMENT COSTS. Research and development costs are charged to
expense as incurred.
ADVERTISING COSTS. Advertising costs are charged to expense as incurred and
totaled approximately $59 million, $83 million and $73 million in 1998, 1997 and
1996, respectively. Advertising costs in 1997 and 1996 include approximately $14
million and $22 million, respectively, related to start-up costs for identity
development. These costs were not material in 1998.
INCOME TAXES. Upon the Distribution, the Company became responsible for its
income taxes and the filing of its own income tax returns. Prior to the
Distribution, the Company did not file separate tax returns but rather was
included in the income tax returns filed by 3M. For purposes of the Company's
consolidated financial statements prior to the Distribution, the Company's
allocated share of 3M's income tax provision was based on the "separate return"
method, except that the tax benefit of the Company's tax losses in certain
jurisdictions was allocated to the Company on a current basis if such losses
could be utilized by 3M in its tax returns and an assessment of realizability of
certain deferred tax assets was made assuming the availability of future 3M
taxable income.
38
TREASURY STOCK. The Company's repurchases of shares of common stock are recorded
as treasury stock and are presented as a reduction of shareholders' equity. When
treasury shares are reissued, the Company uses a last-in, first-out method and
the excess of repurchase cost over reissuance price is treated as an adjustment
to retained earnings (accumulated deficit).
STOCK-BASED COMPENSATION. The Company accounts for stock-based compensation
using the intrinsic value approach under Accounting Principles Board Opinion No.
25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. Accordingly, compensation cost for
employee stock options is measured as the excess, if any, of the quoted market
price of the Company's common stock at the date of the grant over the amount an
employee must pay to acquire the stock.
COMPREHENSIVE INCOME. The Company adopted SFAS No. 130, REPORTING OF
COMPREHENSIVE INCOME, in 1998. Comprehensive income (loss) for the Company
includes net income (loss) and the effects of currency translation, which are
charged or credited to the cumulative translation adjustment account within
shareholders' equity. Comprehensive income for all periods presented is included
in the Consolidated Statements of Shareholders' Equity.
EARNINGS PER SHARE. In 1997, the Financial Accounting Standards Board issued
SFAS No. 128, EARNINGS PER SHARE, which the Company has adopted for all periods
presented. SFAS No. 128 requires companies to compute earnings per share under
two different methods, basic and diluted earnings per share. Prior period
amounts were restated to conform with this standard.
Basic earnings per share is calculated using the weighted average number of
shares outstanding during the period adjusted for Employee Stock Ownership Plan
(ESOP) shares not committed. Diluted earnings per share is computed on the basis
of the weighted average basic shares outstanding plus the dilutive effect of
outstanding stock options using the "treasury stock" method. The following table
sets forth the computation of the weighted average basic and diluted shares
outstanding for:
Years ended December 31, 1998 1997 1996
(In millions)
- --------------------------------------------------------------------------------
Weighted average number of shares outstanding
during the period (1) 40.8 41.5 42.1
Weighted average number of shares held by the
ESOP not committed to be released (1.4) (1.8) (0.8)
- --------------------------------------------------------------------------------
Weighted average common shares outstanding (2) 39.4 39.7 41.3
Common shares equivalents resulting from the
assumed exercise of stock options 0.1 0.2 0.2
- --------------------------------------------------------------------------------
Total weighted average common shares and
common share equivalents 39.5 39.9 41.5
================================================================================
(1) Prior to July 1, 1996, the Company was not a separate, independent company,
but rather was comprised of the Company's businesses operated within 3M. As
such, the number of shares used to compute earnings per share for the
periods prior to July 1, 1996 is based on one-tenth of the average 3M shares
outstanding based on the distribution ratio of one share of the Company's
common stock for every ten shares of 3M common stock held on the record
date.
(2) For 1997 and 1996, represents weighted average common shares outstanding
used for both basic and diluted loss per share as common stock equivalents
are anti-dilutive.
39
NOTE 3 -- SALE OF MEDICAL IMAGING BUSINESS AND AQUISITIONS
SALE OF MEDICAL IMAGING BUSINESS
On November 30, 1998, the Company sold its worldwide medical imaging business to
Eastman Kodak Company (Kodak). In connection with the sale, Kodak immediately
acquired the assets and assumed the liabilities of the Company's medical imaging
businesses in North America, Latin America and Asia, including manufacturing
facilities in Oregon and Minnesota and all the outstanding shares of Cemax Icon,
Inc. (Cemax), a wholly-owned subsidiary of the Company. The formal closings of
the sale of the Company's medical imaging businesses in Europe (European
Businesses) to Kodak are scheduled to occur on a country-by-country basis as the
businesses are integrated into Kodak's accounting and information systems
through April 1, 1999 and in any event not later than May 31, 1999. Under the
terms of the Asset Purchase Agreement (as defined below), beginning December 1,
1998, Kodak is entitled to the operating results and cash flows of the European
Businesses.
Under the terms of the Asset Purchase Agreement dated as of July 31, 1998 and
amended and restated as of November 30, 1998 between the Company and Kodak (as
amended and restated, the Asset Purchase Agreement), Kodak has paid the Company
$532.2 million in cash as of December 31, 1998, of which $18.0 million
represents a nonrefundable deposit under the Ferrania Supply Agreement (as
defined below). Of the $532.2 million cash proceeds, the Company is restricted
from using $143.0 million until the medical imaging businesses in Europe are
legally transferred to Kodak; this amount is classified in other current assets
in the December 31, 1998 Consolidated Balance Sheet. On November 30, 1998, the
Company entered into a Distribution Agreement with Kodak under which the Company
will act as Kodak's exclusive distributor for the European Businesses during the
period from December 1, 1998 through the formal closings of each of the European
Businesses.
The formal closings of the European Businesses are subject to certain limited
closing conditions, including the condition that there be no injunction
prohibiting the acquisition of such European Businesses at the time of such
acquisition. Antitrust clearance of the transaction in Europe has been received
from the European Economic Union.
The Company recorded a pre-tax gain of $65.0 million on the sale, net of related
costs. These costs include the impairment of certain manufacturing assets which
were not sold to Kodak of $40.8 million, determined based on estimated
recoverable costs. In addition, these costs include the write-off of capitalized
software costs of $27.9 million which were directly related to the medical
imaging business, reflecting the abandonment of certain functionality and
utility, pension and other curtailment and settlement costs related to employees
transferred to Kodak of $16.9 million and other costs of the transaction.
The Company will receive reimbursement from Kodak for certain services under
transition services and distribution agreements that the Company has agreed to
provide Kodak while Kodak integrates the medical imaging businesses into its
accounting and information systems. These include information technology,
logistics, finance, telecommunications, office space, human resources and site
services. The Company has agreed to provide such services under the transition
services agreement for a period of up to two years primarily in the United
States and, to a lesser extent, in Asia and Latin America, and under a
distribution agreement through the dates of individual country closings for the
European Businesses. Kodak, at its option, may terminate the transition services
agreement with respect to individual categories of service upon prior notice,
the length of which varies according to the nature of the service.
40
The Company retained its manufacturing facility in Ferrania, Italy, from which
the Company agreed to manufacture x-ray and wet laser medical imaging film for
Kodak for a minimum of two years under a supply agreement which became effective
on November 30, 1998 (the Ferrania Supply Agreement). Under the terms of the
Asset Purchase Agreement, Kodak is obligated to make a cash payment to the
Company of up to $25.0 million no later than the date the Ferrania Supply
Agreement terminates. Under a separate supply agreement, Kodak will supply
document imaging products to the Company from its White City, Oregon
manufacturing facility for up to five years.
Principal products included in the medical imaging business were: DryView(TM)
laser imaging systems and film, wet laser imaging systems and film, Imation
chest system, Trimax(TM) x-ray films, conventional x-ray film processing systems
and film, and Cemax-Icon digital picture-archiving and communication systems
(PACS) products.
Summarized financial information of the medical imaging business segment is
included in Note 11.
AQUISITIONS
In August 1997, the Company acquired all of the outstanding common shares of
Cemax for $51.8 million, consisting of $29.0 million in cash (net of cash
acquired) and non-cash amounts consisting of $9.2 million representing the
Company's previous investment in Cemax preferred shares and $13.6 million
related to the fair value of stock options and warrants to acquire approximately
971,000 shares of the Company's common stock to replace stock options and
warrants previously granted by Cemax. In addition, the Company issued certain
contingent payment rights which allow Cemax shareholders to receive additional
payments of up to $44.8 million if Cemax attains certain revenue targets in the
twelve month periods ended June 30, 1998 and 1999. In connection with the sale
of the Company's medical imaging business, as discussed above, the contingent
payment obligations were transferred to Kodak. Cemax designs, manufactures, and
markets medical imaging and information systems.
The acquisition was accounted for using the purchase method of accounting. The
Company allocated a portion of the purchase price to in-process research and
development projects that had not yet reached technological feasibility and had
no probable alternative future uses, which resulted in a one-time
non-tax-deductible charge of $41.7 million. The excess of the initial purchase
price over net assets acquired and in-process research and development of $17.7
million was allocated to goodwill and was amortized over seven years. Operating
results for Cemax are included in the Company's results of operations from the
date of acquisition through November 30, 1998, when Cemax was sold as part of
the medical imaging business sale.
The following unaudited pro forma summary combines the consolidated results of
operations of the Company and Cemax as if the acquisition had occurred at the
beginning of the years presented after giving effect to certain adjustments,
including amortization of goodwill, increased interest expense on acquisition
debt, and related income tax effects. The pro forma information excludes the
non-recurring charge of $41.7 million related to purchased in-process research
and development. The pro forma information does not necessarily reflect the
results of operations that actually would have been achieved had the acquisition
been consummated as of that time.
Pro Forma Summary
-----------------
(Unaudited)
Year Ended December 31,
(In millions, except per share amounts) 1997 1996
--------------------------------------------------------------------
Net revenues $2,218.7 $2,299.4
Net loss (144.4) (25.1)
Basic and diluted loss per common share (3.64) (0.61)
--------------------------------------------------------------------
41
In October 1996, the Company acquired all of the outstanding common and
preferred shares of Luminous Corporation (Luminous) for $29.7 million,
consisting of $10.3 million in cash and non-cash amounts consisting of $14.6
million related to the issuance of approximately 923,000 shares of the Company's
common stock and $4.8 million related to the fair value of stock options to
acquire approximately 317,000 shares of the Company's common stock to replace
stock options previously granted by Luminous. Luminous is a developer and
marketer of desktop software to the pre-press, print production, printing and
graphic arts industries. The acquisition was accounted for using the purchase
method of accounting. The Company allocated a portion of the purchase price to
in-process research and development projects that had not yet reached
technological feasibility and had no probable alternative future uses, which
resulted in a one-time non-tax-deductible charge of $12.0 million. The Company
has allocated the remaining excess purchase price over net assets acquired to
goodwill which is being amortized over seven years. Operating results for
Luminous are included in the Company's results of operations from the date of
acquisition. The pro forma effect on prior periods' results of operations is not
material.
42
NOTE 4 -- SUPPLEMENTAL BALANCE SHEET INFORMATION
(In millions) 1998 1997
- --------------------------------------------------------------------------
ACCOUNTS RECEIVABLE
Accounts receivable $ 345.5 $ 484.9
Less allowances (19.2) (25.6)
- --------------------------------------------------------------------------
Accounts receivable, net $ 326.3 $ 459.3
INVENTORIES
Finished goods $ 166.4 $ 272.6
Work in process 48.8 59.7
Raw materials and supplies 48.5 67.6
- --------------------------------------------------------------------------
Total inventories $ 263.7 $ 399.9
OTHER CURRENT ASSETS
Deferred taxes $ 50.7 $ 71.7
Restricted cash 143.0 --
Other 72.0 70.0
- --------------------------------------------------------------------------
Total other current assets $ 265.7 $ 141.7
PROPERTY, PLANT AND EQUIPMENT
Land $ 7.1 $ 8.4
Buildings and leasehold improvements 193.9 190.5
Machinery and equipment 1,135.5 1,491.2
Construction in progress 18.1 14.4
- --------------------------------------------------------------------------
Total 1,354.6 1,704.5
Less accumulated depreciation (1,120.8) (1,322.9)
- --------------------------------------------------------------------------
Property, plant and equipment, net $ 233.8 $ 381.6
OTHER ASSETS
Deferred taxes $ 14.7 $ 19.4
Capitalized software 126.4 113.0
Other 27.4 47.1
- --------------------------------------------------------------------------
Total other assets $ 168.5 $ 179.5
OTHER CURRENT LIABILITIES
Employee separation costs $ 33.6 $ 91.5
Accrued rebates 36.4 42.2
Deferred income 15.1 25.1
Taxes other than income taxes 21.5 44.6
Other 141.0 110.3
- --------------------------------------------------------------------------
Total other current liabilities $ 247.6 $ 313.7
OTHER LIABILITIES
Employee severance indemnities $ 29.1 $ 39.3
Pension accrual 33.7 28.3
Other 43.5 30.5
- --------------------------------------------------------------------------
Total other liabilities $ 106.3 $ 98.1
- --------------------------------------------------------------------------
43
NOTE 5 -- RESTRUCTURING CHARGES AND OTHER SPECIAL CHARGES
In late 1995, the Company initiated a review of all of its operations, including
its organizational structure, manufacturing operations, products and markets. In
connection with this review, the Company adopted a reorganization plan to
rationalize its manufacturing operations, streamline its organizational
structure and write-off impaired assets.
The Company reflected pre-tax restructuring and other special charges in its
financial statements, partially in 1995 and partially in 1996 based upon the
timing recognition criteria required for the restructuring charges.
The restructuring and other special charges of $88.4 million, recorded in 1996,
included $53.9 million primarily for employee separation programs related to the
reduction of approximately 1,600 employees and $22.5 million of special charges
associated with start-up activities which are included in costs of goods sold
and selling, general and administrative expenses. The unpaid restructuring
charges for the employee separation programs as of June 30, 1996 were retained
by 3M pursuant to the Distribution. In addition to the above charges, the
Company also recognized a non-tax-deductible charge of $12.0 million for the
in-process research and development related to the Luminous acquisition (see
Note 3).
In 1997, the Company announced plans to further restructure its worldwide
operations in order to improve the Company's competitive position, to focus
resources on areas of strength and on growth opportunities, and to reduce costs
and eliminate unnecessary structure. The Company recorded a $199.9 million
pre-tax charge ($158.7 million after taxes) to fourth quarter 1997 earnings. The
charge included approximately $170.0 million in restructuring charges primarily
associated with employee separation benefits and fixed asset write-offs and
additional special charges of $29.9 million included in cost of goods sold,
selling, general and administrative expenses, and non-operating expenses,
primarily associated with restructuring-related asset write downs and other
year-end adjustments. Specific planned actions include the restructuring of
European operations, the sale of the CD-ROM business, and the realignment and
reduction of general and administrative, manufacturing, marketing, and selected
research and development areas, the majority of which have been completed as of
December 31, 1998. The Company's 1997 results also include a third quarter
non-tax-deductible charge of $41.7 million for in-process research and
development costs related to the Cemax acquisition (see Note 3).
In 1998, the Company recorded a $26.2 million benefit in the restructuring line
of the Statement of Operations as an adjustment of the restructuring charge
recorded in 1997. This benefit resulted primarily from three factors: a better
than expected result from the sale of the Company's CD-ROM business, lower than
expected costs from closing certain research and development facilities
(primarily the facility in the United Kingdom) and lower than expected costs
associated with employee terminations. This benefit was recorded as a result of
the Company's policy to evaluate its restructuring reserves quarterly and adjust
such reserves to reflect changes in estimates as information becomes available.
In addition, the Company approved and recorded an additional restructuring
charge of $13.0 million, primarily related to asset write-downs, reflecting
further portfolio rationalizations.
The following table represents the cumulative activity related to the Company's
1997 and 1998 restructuring programs, including certain reclassifications in the
1997 original charge:
1997 Original 1998 Adjustments Balance at
(In millions) Charge Usage and New Programs December 31, 1998
- --------------------------------------------------------------------------------
Severance $ 75.1 $ (34.6) $ (6.9) $33.6
Asset impairments 61.5 (55.3) (6.2) -
Other 33.4 (31.7) (0.1) 1.6
- --------------------------------------------------------------------------------
Total $170.0 $(121.6) $(13.2) $35.2
================================================================================
44
During 1998, the Company made cash payments of $45.0 million related to the
restructuring activities and reduced its headcount by approximately 1,800. As
part of this restructuring plan, the Company closed a research facility in the
United Kingdom, closed an optical manufacturing operation and sold its CD-ROM
business. The Company also exited its metal printing plates manufacturing
facility in Middleway, West Virginia. The remaining severance payments are
expected to be made throughout the first nine months of 1999 related to 1998 and
1999 employee separations.
In 1998, the Company also recorded a $3.6 million benefit in the restructuring
line of the Statement of Operations reflecting final adjustments of the
restructuring reserves established in the fourth quarter of 1995. For the year
ended December 31, 1998, the Company recorded a net restructuring benefit of
$16.8 million.
NOTE 6 -- INCOME TAXES
The components of income (loss) before tax and minority interest are as follows:
(In millions) 1998 1997 1996
- --------------------------------------------------------------------------------
U.S. $ 101.7 $ (131.1) $ (16.9)
International 8.2 (74.9) 1.9
- --------------------------------------------------------------------------------
Total $ 109.9 $ (206.0) $ (15.0)
================================================================================
The income tax provision (benefit) is as follows:
(In millions) 1998 1997 1996
- --------------------------------------------------------------------------------
Currently payable (refundable)
Federal $ 11.1 $ 1.2 $ (9.9)
State 1.2 0.1 (0.4)
International 16.8 18.0 3.9
Deferred
Federal 26.0 (33.2) 3.3
State 2.9 (3.7) (0.4)
International (5.2) (8.3) 9.4
- --------------------------------------------------------------------------------
Total $ 52.8 $ (25.9) $ 5.9
================================================================================
The components of net deferred tax assets and (liabilities) are as follows:
(In millions) 1998 1997
- --------------------------------------------------------------------------------
Receivables $ (0.3) $ (0.1)
Inventories 14.1 19.1
Capitalized software (23.3) (19.7)
Property, plant and equipment (8.7) 13.2
Payroll and severance 27.8 35.7
Foreign tax credit carryforwards 14.3 14.3
Net operating loss carryforwards - 23.4
Accrued liabilities 39.9 14.3
Other, net 15.9 3.2
- --------------------------------------------------------------------------------
Total 79.7 103.4
Valuation allowance (14.3) (14.3)
- --------------------------------------------------------------------------------
Net deferred tax assets $ 65.4 $ 89.1
================================================================================
A valuation allowance of $14.3 million was provided to account for uncertainties
regarding the recoverability of certain foreign tax credit carryforwards.
45
The provision (benefit) for income taxes differs from the amount computed by
applying the statutory U.S. income tax rate (35 percent) because of the
following items:
(In millions) 1998 1997 1996
- --------------------------------------------------------------------------------
Tax at statutory U.S. tax rate $ 38.5 $ (73.2) $ (5.3)
State income taxes, net of
federal benefit 3.4 (5.2) (1.2)
International taxes in excess of
statutory U.S. tax rate 3.6 35.9 7.1
Non-deductible expenses 5.3 17.5 4.9
Other 2.0 (0.9) 0.4
- --------------------------------------------------------------------------------
Income tax provision (benefit) $ 52.8 $ (25.9) $ 5.9
================================================================================
As of December 31, 1998, approximately $165.0 million of earnings attributable
to international subsidiaries (inclusive of earnings prior to the Distribution
for certain international subsidiaries) were considered to be permanently
invested. No provision has been made for taxes that might be payable if these
earnings were remitted to the U.S. It is not practical to determine the amount
of incremental tax that might arise if these earnings were to be remitted.
Cash paid for income taxes was $26.5 million in 1998, $10.9 million in 1997 and
was not material for the period from July 1, 1996 to December 31, 1996. Prior to
July 1, 1996, 3M paid all taxes and received all tax refunds on the Company's
behalf.
NOTE 7 -- DEBT
The components of long-term debt as of December 31 are as follows:
(In millions) 1998 1997
- --------------------------------------------------------------------------------
Revolving credit facility $ 31.0 $ 313.0
Other 3.1 7.6
- --------------------------------------------------------------------------------
34.1 320.6
Less current portion (1.4) (0.9)
- --------------------------------------------------------------------------------
Total long-term debt $ 32.7 $ 319.7
================================================================================
In December 1998, proceeds from the sale of the medical imaging business were
utilized to repay borrowings under the Company's $350.0 million revolving credit
facility with a syndicate of banks (the Credit Agreement). In conjunction with
such repayment, the interest rate swap (see Note 8) was terminated. As of
December 31, 1998 and 1997, respectively, borrowings of $31.0 million, at an
interest rate of 8.75 percent, and $313.0 million, at interest rates ranging
from 6.49 percent to 6.55 percent, were outstanding under the Credit Agreement.
The commitment fee for the Credit Agreement is based on the Company's interest
coverage ratio, and as of December 31, 1998, 1997 and 1996, was 0.50 percent,
0.25 percent and 0.15 percent, respectively, on the total amount of the credit
facility per annum. On January 4, 1999, the Company repaid the amounts
outstanding and terminated the Credit Agreement. As of December 31, 1998, the
Company had outstanding letters of credit of $151.9 million in the U.S.,
primarily related to and collateralized by the $143.0 million of restricted cash
received from Kodak in connection with the sale of the medical imaging business
(see Note 3).
46
On December 31, 1998, the Company entered into a three-year $175.0 million Loan
and Security Agreement (the Loan Agreement) with a group of banks. The Loan
Agreement provides for revolving credit, including letters of credit, with
borrowing availability based on eligible accounts receivable, inventory and
manufacturing machinery and equipment not to exceed $175.0 million. Borrowing
availability at December 31, 1998 was $149.9 million, of which $31.0 million was
subsequently drawn for the Credit Agreement repayment as noted above. The Loan
Agreement provides for, at the option of the Company, borrowings at either a
floating interest rate based on a defined prime rate or a fixed rate related to
the London Interbank Offering Rate (LIBOR), plus a margin based on the Company's
interest expense coverage. The margins over a defined prime rate and LIBOR range
from zero to 0.75 percent and 1.25 to 2.25 percent, respectively. Letter of
credit fees are equal to the LIBOR margins and a commitment fee of 0.375 percent
per annum is payable on the unused line. The Loan Agreement is collateralized by
substantially all the domestic assets of the Company, excluding the corporate
campus land and buildings, and a pledge of 65 percent of the stock of certain of
the Company's foreign subsidiaries. Covenants include maintenance of a minimum
tangible net worth and borrowing base availability, with certain restrictions on
the incurrence of additional indebtedness, sale of assets, mergers and
consolidation, transactions with affiliates, creation of liens, and certain
other matters. As of January 4, 1999, the initial funding date of the Loan
Agreement, the Company was in compliance with all covenants and restrictions.
Long-term debt maturities, which reflect the re-financing of the amounts
outstanding under the Credit Agreement with the Loan Agreement, are as follows:
(In millions) 1999 2000 2001 2002 2003 Thereafter Total
- ---------------------------------------------------------------------------------------------
Long-term debt maturities $ 1.4 $ 1.1 $31.1 $ 0.1 $ 0.1 $ 0.3 $34.1
- ---------------------------------------------------------------------------------------------
Short-term debt, excluding the current portion of long-term debt, as of December
31, 1998 and 1997, was $23.8 million and $30.4 million, respectively, which
consisted primarily of local borrowings by international subsidiaries. These
borrowings have original maturities of one year or less and have a weighted
average interest rate of 5.8 and 3.4 percent as of December 31, 1998 and 1997,
respectively. As of December 31, 1998, the Company had an additional $44.3
million available under credit facilities held by various subsidiaries outside
the U.S.
The Company estimates that the fair value of short-term and long-term debt
approximates the carrying amount of debt as of December 31, 1998 and 1997.
The Company's interest expense for 1998, 1997 and 1996 was $20.5 million (net of
$1.8 million capitalized), $15.7 million (net of $2.5 million capitalized) and
$14.2 million, respectively. Cash paid for interest in these periods was $24.3
million, $13.2 million and $6.2 million, respectively. Interest expense for 1996
includes a $7.4 million allocation of 3M's interest expense for the period prior
to the Distribution, based on an assumed non-ESOP debt level of $250.0 million
at an interest rate of 6.4 percent, which reflects 3M's weighted average
effective interest rate on non-ESOP debt during this period.
NOTE 8 -- FINANCIAL INSTRUMENTS
To manage interest rate risk, in March 1997, the Company entered into a
three-year interest rate swap agreement for a notional amount of $100.0 million.
The swap agreement provided for the Company to pay a fixed rate of 6.63 percent
and receive a variable rate of three-month LIBOR. This interest swap was
terminated in the fourth quarter of 1998 in connection with repayment of the
Credit Agreement.
To manage risks associated with foreign currency transaction exposures, the
Company utilizes foreign currency forward and option contracts. Additionally,
the Company has from time-to-time entered into silver commodity forward
contracts to reduce the volatility of raw material purchase prices. These
contracts generally have maturities of less than six months. The notional amount
and fair value of forward and options contracts as of December 31, 1998 and 1997
are as follows:
47
(In millions) 1998 1997
- --------------------------------------------------------------------------------
Notional Fair Notional Fair
Amount Value Amount Value
- --------------------------------------------------------------------------------
Foreign currency forward contracts $218.7 $(0.4) $93.9 $1.5
Foreign currency option contracts purchased - - 1.8 -
Silver commodity forwards contracts - - 8.4 1.2
- --------------------------------------------------------------------------------
The fair values of these contracts as noted above approximated the book values
as of December 31, 1998 and 1997. The estimated fair market values were
determined using available market information or other appropriate valuation
methodologies.
The Company is exposed to credit loss in the event of nonperformance by
counter-parties in interest rate swaps, and foreign currency and commodity
forward and option contracts, but does not anticipate nonperformance by any of
these counter-parties. The Company actively monitors its exposure to credit risk
through the use of credit approvals and credit limits, and by selecting major
international banks and financial institutions as counter-parties.
NOTE 9 -- LEASES
In March 1997, the Company entered into a Master Lease and Security Agreement in
connection with the construction of a new research and development facility at
the Company's headquarters site. The facility was completed in May 1998 and
lease payments commenced at that time. In December 1998, the Company acquired
the building, at which time all future lease obligations were terminated.
Rent expense under operating leases, which primarily relate to equipment and
office space, amounted to $22.1 million, $23.5 million and $15.1 million in
1998, 1997 and 1996, respectively. The following table sets forth the minimum
rental payments under operating leases with non-cancelable terms in excess of
one year as of December 31, 1998:
(In millions) 1999 2000 2001 2002 Total
- --------------------------------------------------------------------------------
Minimum lease payments $13.3 $ 8.4 $ 3.8 $ 2.0 $27.5
- --------------------------------------------------------------------------------
NOTE 10 -- SHAREHOLDERS' EQUITY
The Company maintains a shareholder rights plan (Rights Plan) under which the
Company has issued one preferred share purchase right (Right) for each common
share of the Company. Each Right will entitle its holder to purchase one
one-hundredth of a share of Series A Junior Participating Preferred Stock at an
exercise price of $125, subject to adjustment. The Rights are exercisable only
if a person or group (Acquiring Person) acquires beneficial ownership of 15
percent or more of the Company's outstanding common stock (Common Stock). As of
January 12, 1999, the Company amended the Rights Plan to exclude any Acquiring
Person who becomes the beneficial owner of 15 percent or more of the shares of
Common Stock then outstanding as a result of a reduction in the number of shares
of Common Stock outstanding due to the repurchase of Common Stock by the Company
unless and until such person, after becoming aware of such, acquires beneficial
ownership of any additional shares of Common Stock. The Rights expire on July 1,
2006 and may be redeemed earlier by the Board of Directors for $0.01 per Right.
48
In February and March of 1997, the Company's Board of Directors authorized the
repurchase of up to six million shares of the Company's common stock. During the
first and second quarters of 1997, approximately 2.5 million shares were
repurchased. As of December 31, 1998, the Company held 1.9 million shares of
treasury stock acquired at an average price of $24.34 per share. On January 26,
1999, the Company announced an increase in the share repurchase authorization to
a total of 10 million shares.
In connection with the acquisition of Cemax, the Company assumed certain
outstanding warrants on Cemax stock which the Company agreed to convert into
warrants to acquire 93,375 shares of the Company's common stock. The warrants
have an exercise price of $20.77 and became exercisable upon the acquisition of
Cemax by the Company. In January 1999, the Company entered into an agreement to
terminate these warrants.
NOTE 11 -- BUSINESS SEGMENT INFORMATION
The Company adopted SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE
AND RELATED INFORMATION, for the year ended December 31, 1998. Prior period
amounts have been presented in a format that conforms with the 1998 presentation
as required by this statement.
The Company's current businesses are organized, managed and internally reported
as three segments differentiated primarily by their products and services, but
also by the markets they serve. These segments, whose results are shown below,
are Data Storage and Information Management, providing removable data storage
media for use in the mobile and desktop, network and enterprise data center
markets; Product Technologies, whose principal products include printing and
color proofing systems, printing films and plates for the graphic arts
marketplace, private label film for the amateur photographic retail market, and
carbonless paper, such as multi-part business forms; and Digital Solutions and
Services, which provides 24-hour technical service and support for equipment
sold by the Company as well as by other third party equipment vendors, and
offers digital workflow solutions principally in the areas of color and data
management. In addition, the Company owned and managed a fourth segment, Medical
Imaging, which was sold to Kodak effective November 30, 1998 (see Note 3).
Results for this segment are also included below through the date of sale.
Effective with the sale of the medical imaging business to Kodak, the Company
entered into a supply agreement with Kodak to supply certain medical imaging
film products. The management and internal reporting of this ongoing medical
imaging activity was transferred to the Product Technologies business segment on
December 1, 1998. Principal products included diagnostic imaging films, film
processors and imaging systems for both x-ray and electronic imaging systems
sold to hospital buying groups, individual hospitals, medical imaging centers
and government healthcare institutions.
49
Business Data Digital
Segment Storage and Solutions Corporate,
Information Information Product and Medical Other and Total
(In millions) Management Technologies Services Imaging Unallocated Company
- -----------------------------------------------------------------------------------------------------------------------
Net revenues (1) 1998 $ 714.2 $ 575.0 $ 143.5 $ 552.6 $ 61.2 $2,046.5
1997 776.6 647.6 168.1 531.2 78.3 2,201.8
1996 857.3 705.1 167.1 485.0 63.7 2,278.2
- -----------------------------------------------------------------------------------------------------------------------
Operating 1998 $ (30.4) $ 53.2 $ (3.3) $ 26.5 $ 84.0 $ 130.0
income (loss)(1) 1997 22.7 54.9 5.3 (20.7) (236.9) (174.7)
1996 57.2 41.9 2.7 (18.9) (87.5) (4.6)
- -----------------------------------------------------------------------------------------------------------------------
Assets(2) 1998 $ 367.7 $ 323.8 $ 55.5 $ -- $ 575.2 $1,322.2
1997 392.0 338.3 72.0 351.3 511.9 1,665.5
1996 432.7 372.6 71.6 354.3 342.1 1,573.3
- -----------------------------------------------------------------------------------------------------------------------
Depreciation 1998 $ 48.3 $ 33.2 $ 6.5 $ 35.2 $ 6.2 $ 129.4
and 1997 69.9 27.3 4.0 33.6 12.7 147.5
Amortization (1) 1996 96.2 52.4 3.9 17.8 10.8 181.1
- -----------------------------------------------------------------------------------------------------------------------
Capital 1998 $ 33.0 $ 6.4 $ 1.0 $ 15.4 $ 76.6 $ 132.4
Expenditures (1) 1997 41.5 21.6 2.0 40.0 11.2 116.3
1996 90.7 29.5 0.2 40.3 6.7 167.4
=======================================================================================================================
(1) The Corporate, Other and Unallocated amounts for net revenues, operating
income (loss), depreciation and amortization, and capital expenditures
primarily include the results for certain businesses not included in the
Company's disclosable business segments, as well as restructuring-related
charges and credits, acquisition-related special charges, and the gain on
sale of the medical imaging business to Kodak.
(2) Segment assets primarily include accounts receivable, inventory, and net
property, plant and equipment. Assets included in Corporate, Other and
Unallocated are cash and equivalents, deferred income taxes, certain
unallocated net property, plant and equipment and other miscellaneous
assets.
The following table presents information about the company by geographic area.
United Total
(In millions) States International Company
- ------------------------------------------------------------------------------------------
Net revenues 1998 $1,123.2 $ 923.3 $2,046.5
1997 1,162.3 1,039.5 2,201.8
1996 1,159.5 1,118.7 2,278.2
- ------------------------------------------------------------------------------------------
Long-lived (1) 1998 $ 299.3 $ 88.3 $ 387.6
assets 1997 383.4 158.3 541.7
1996 382.3 154.3 536.6
==========================================================================================
(1) Includes net property, plant and equipment, intangible and other non-current
assets excluding deferred income taxes.
50
NOTE 12 -- RETIREMENT PLANS
The Company adopted SFAS No. 132, EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND
OTHER POSTRETIREMENT BENEFITS, for the year ended December 31, 1998. Prior
period amounts have been presented in a format that conforms with the 1998
presentation as required by this statement.
The Company has various non-contributory defined benefit employee pension plans
covering substantially all U.S. employees and certain employees outside the U.S.
Prior to the Distribution, employees of the Company participated in various
3M-sponsored retirement plans. For U.S. employees, 3M has retained
responsibility for the benefits earned under the 3M plan prior to the
Distribution. For plans outside the U.S., the Company generally has assumed the
assets and related liabilities. Total pension expense was $35.9 million, $26.5
million (including $6.5 million recognized as restructuring charges) and $21.3
million in 1998, 1997 and 1996, respectively.
The following provides a reconciliation of benefit obligations, plan assets and
funded status of the plans.
U.S. PLAN
(In millions) 1998 1997
- --------------------------------------------------------------------------------------------------------------
CHANGE IN PROJECTED BENEFIT OBLIGATION
Projected benefit obligation, beginning of year $ 32.1 $ 7.5
Service cost 16.4 16.7
Interest cost 2.4 0.6
Actuarial loss 3.7 1.0
Benefits paid (2.0) (0.2)
Special termination benefits (1) 16.9 6.5
- --------------------------------------------------------------------------------------------------------------
Projected benefit obligation $ 69.5 $ 32.1
CHANGE IN PLAN ASSETS
Plan assets at fair value, beginning of year $ 7.0 $ --
Actual return on plan assets 4.5 --
Company contributions 29.4 7.2
Benefits paid (2.0) (0.2)
- --------------------------------------------------------------------------------------------------------------
Plan assets at fair value $ 38.9 $ 7.0
ACCRUED PENSION COST
Funded status of the plan $ (30.6) $ (25.1)
- --------------------------------------------------------------------------------------------------------------
Total recognized $ (30.6) $ (25.1)
ASSUMPTIONS 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------
Discount rate 6.50% 7.25% 8.00%
Expected return on plan assets 8.00% 9.00% 9.00%
Rate of compensation increase 4.75% 4.75% 4.75%
Net periodic pension cost includes the following components:
July 1 - December 31
(In millions) 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------
TOTAL COST
Service cost $ 16.4 $ 16.7 $ 7.5
Interest cost 2.4 0.6 --
Expected return on plan assets (1.5) (0.2) --
Special termination benefits (1) 16.9 6.5 --
- --------------------------------------------------------------------------------------------------------------
Net periodic pension cost $ 34.2 $ 23.6 $ 7.5
- --------------------------------------------------------------------------------------------------------------
51
(1) In 1998, $16.9 million was recognized for curtailment and other benefits
for employees transferred to Kodak as part of the sale of the medical
imaging business (see Note 3). In 1997, $6.5 million was recognized for
restructuring charges.
INTERNATIONAL PLANS
(In millions) 1998 1997
- -----------------------------------------------------------------------------------------------
CHANGE IN PROJECTED BENEFIT OBLIGATION
Projected benefit obligation, beginning of year 59.3 60.3
Service cost 1.4 2.6
Interest cost 2.8 4.2
Foreign exchange rate changes 0.9 (3.1)
Plan participant contributions -- 0.3
Actuarial loss (gain) 5.9 (1.4)
Benefits paid (0.6) (0.5)
Amendments 0.9 (3.1)
Transfer of obligations (2) (15.5) --
- -----------------------------------------------------------------------------------------------
Projected benefit obligation 55.1 59.3
CHANGE IN PLAN ASSETS
Plan assets at fair value, beginning of year 57.9 52.5
Actual return on plan assets 7.1 5.9
Foreign exchange rate changes 0.7 (2.7)
Company contributions 1.3 2.4
Plan participant contributions -- 0.3
Benefits paid (0.6) (0.5)
Transfer of assets (2) (17.1) --
- -----------------------------------------------------------------------------------------------
Plan assets at fair value 49.3 57.9
ACCRUED PENSION COST
Funded status of the plan (5.8) (1.4)
Unrecognized items 5.2 0.9
- -----------------------------------------------------------------------------------------------
Total recognized (0.6) (0.5)
AMOUNT RECOGNIZED IN FINANCIAL STATEMENTS
Prepaid pension cost 2.5 2.7
Accrued pension liability (3.1) (3.2)
- -----------------------------------------------------------------------------------------------
Total recognized (0.6) (0.5)
ASSUMPTIONS 1998 1997 1996
- -----------------------------------------------------------------------------------------------
Discount rate 5.60% 6.70% 8.00%
Expected return on plan assets 7.00% 7.80% 8.30%
Rate of compensation increase 3.20% 4.60% 6.20%
52
Net periodic pension cost includes the following components:
July 1 - December 31
(In millions) 1998 1997 1996
- ---------------------------------------------------------------------------------------------------
TOTAL COST
Service cost $ 1.4 $ 2.6 $ 1.5
Interest cost 2.8 4.2 2.0
Expected return on plan assets (2.3) (5.9) (2.0)
Amortization of unrecognized items 0.5 2.0 0.3
Settlements and curtailments (0.7) -- --
- ---------------------------------------------------------------------------------------------------
Net periodic pension cost $ 1.7 $ 2.9 $ 1.8
- ---------------------------------------------------------------------------------------------------
(2) Includes certain benefit obligations and related plan assets transferred to
3M and other defined contribution plans.
In addition to the above, the Company's Italian subsidiary sponsors an employee
severance indemnity plan as required by law. The accrued liability for this
severance indemnity plan is included in other liabilities and was $29.1 million
and $39.3 million as of December 31, 1998 and 1997, respectively. The Company
measures the vested benefit obligation as the amount that would be payable if
the employees under the plan would separate currently. Expense for this plan was
$3.9 million, $4.7 million and $5.0 million in 1998, 1997 and 1996,
respectively.
NOTE 13 -- EMPLOYEE SAVINGS AND STOCK OWNERSHIP PLANS
The Company sponsors a 401(k) retirement savings plan under which eligible U.S.
employees may choose to save up to 15 percent of eligible compensation on a
pre-tax basis, subject to certain IRS limitations. The Company matches employee
contributions 100 percent on the first three percent of eligible compensation
and 25 percent on the next three percent of eligible compensation. The Company
also sponsors a variable compensation program, in which the Company will
contribute up to three percent of eligible employee compensation to employees'
401(k) retirement accounts, depending upon Company performance.
53
The Company established an Employee Stock Ownership Plan (ESOP) during 1996 as a
cost-effective way of funding the employee retirement savings benefits noted
above. The ESOP borrowed $50.0 million from the Company in 1996 and used the
proceeds to purchase approximately 2.2 million shares of the Company's common
stock, with the ESOP shares pledged as collateral for the debt. The Company
makes monthly contributions to the ESOP equal to the debt service plus an
applicable amount so that the total contribution releases a number of shares
equal to that required to satisfy the Company's matching requirements. As the
debt is repaid, shares are released from collateral and allocated to employee
accounts. The shares pledged as collateral are reported as unearned ESOP shares
in the Consolidated Balance Sheets. The Company reports compensation expense
equal to the current market price of the shares released, and released shares
are considered outstanding for the computation of earnings per share.
The ESOP shares as of December 31, 1998 and 1997, are as follows:
1998 1997
- --------------------------------------------------------------------------------
Released and allocated shares 1,035,484 551,164
Unreleased shares 1,140,403 1,624,723
- --------------------------------------------------------------------------------
Total ESOP shares 2,175,887 2,175,887
- --------------------------------------------------------------------------------
Fair value of unreleased shares as of December 31 $19,957,000 $25,996,000
================================================================================
Prior to July 1, 1996, U.S. employees of the Company participated in a
3M-sponsored employee savings plan under Section 401(k) of the Internal Revenue
Code. 3M matched employee contributions of up to six percent of compensation at
rates ranging from 35 to 85 percent depending upon financial performance. The
Company's allocation of the expense related to the 3M employee savings plan was
$2.3 million in the period from January 1, 1996 to June 30, 1996. Total expense
related to employee savings and stock ownership plans was $8.3 million, $8.5
million and $7.4 million in 1998, 1997 and 1996, respectively.
NOTE 14 -- EMPLOYEE STOCK PLANS
The Company currently has stock options outstanding under the Imation 1996
Employee Stock Incentive Program (the Employee Plan), the Imation 1996 Directors
Stock Compensation Program (the Directors Plan), the Imation Corp. Stock Option
Plan for Employees of Luminous Technology Corporation (the Luminous Plan) and
the Imation Corp. Stock Option Plans for Employees of Cemax-Icon, Inc. (the
Cemax Plan).
The Employee Plan was approved and adopted by 3M on June 18, 1996, as the sole
shareholder of the Company, and became effective on July 1, 1996, at
Distribution. The total number of shares of common stock that may be issued or
awarded under the Employee Plan may not exceed 6,000,000. All shares subject to
awards under the Employee Plan that are forfeited or terminated will be
available again for issuance pursuant to awards under the Employee Plan.
Generally grant prices are equal to the fair market value of the Company's
common stock at date of grant. The options normally have a term of ten years and
generally become exercisable from one to five years after grant date. At
December 31, 1998 and 1997, there were 2,321,470 and 1,915,170 shares available
for grant under the Employee Plan, respectively.
The Directors Plan was also approved and adopted by 3M prior to the
Distribution, as the sole shareholder of the Company, and became effective on
July 1, 1996. The total number of shares of common stock that may be issued or
awarded under the Directors Plan may not exceed 800,000. The outstanding options
are non-qualified options with a term of ten years and generally become
exercisable one year after grant date. Grant prices are equal to the fair market
value of the Company's common stock at the date of grant. As of December 31,
1998 and 1997, there were 584,177 and 676,750 shares available for grant under
the Directors Plan, respectively.
54
The Luminous Plan was approved and adopted by the shareholders of Luminous prior
to the acquisition of Luminous by the Company (see Note 3). In connection with
the acquisition, the Company assumed certain obligations pursuant to outstanding
stock options held by Luminous employees and agreed to convert such options into
options to purchase 317,062 shares of the Company's common stock. The
outstanding options were amended to accelerate the dates on which the options
become exercisable. No additional grants may be made pursuant to the Luminous
Plan.
The Cemax Plan was approved and adopted by the shareholders of Cemax prior to
the acquisition of Cemax by the Company (see Note 3). In connection with the
acquisition, the Company assumed certain obligations pursuant to outstanding
stock options held by Cemax employees and agreed to convert such options into
options to purchase 877,554 shares of the Company's common stock. The
outstanding options were amended to accelerate the dates on which the options
become exercisable. No additional grants may be made pursuant to the Cemax Plan.
The majority of the options granted under the Cemax Plan were cancelled on
November 30, 1998 upon the sale of Cemax to Kodak in connection with the medical
imaging business sale.
The following table summarizes stock option activity for 1998, 1997 and 1996:
Year Ended December 31, 1998 Year Ended December 31, 1997 July 1- December 31, 1996
---------------------------- ---------------------------- -------------------------
Weighted Average Weighted Average Weighted Average
Stock Options Exercise Price Stock Options Exercise Price Stock Options Exercise Price
- ------------------------------------------------------------------------------------------------------------------------------------
Outstanding beginning of year 5,184,676 $ 21.47 2,648,157 $ 21.31 -- --
Granted 583,053 16.86 2,903,244 21.11 2,699,530 $ 21.14
Exercised (416,732) 6.54 (190,120) 11.50 (26,848) 2.16
Forfeited (1,655,687) 17.38 (176,605) 23.84 (24,525) 22.54
- ------------------------------------------------------------------------------------------------------------------------------------
Outstanding, end of year 3,695,310 22.49 5,184,676 21.47 2,648,157 21.31
Exercisable, end of year 1,882,800 22.47 2,121,243 19.95 131,857 10.58
The following table summarizes information about stock options outstanding as of
December 31, 1998:
Range of Options Weighted Options Options Options
Exercise Prices Outstanding Average Outstanding- Exercisable Exercisable-
Remaining Weighted Weighted
Contractual Life Average Exercise Average Exercise
Price Price
- -----------------------------------------------------------------------------------------------------------
$0.31 58,709 4.0 years $0.31 58,709 $0.31
$14.15 to $19.50 471,852 9.6 years $17.16 18,782 $14.89
$21.35 to $22.90 1,694,311 7.6 years $22.60 1,370,314 $22.66
$24.41 to $26.80 1,470,438 8.6 years $24.89 434,995 $25.18
- -----------------------------------------------------------------------------------------------------------
$0.31 to $26.80 3,695,310 1,882,800
The Company has adopted the disclosure only provisions of SFAS No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION. Accordingly, no compensation expense
has been recognized for the stock option plans. If the fair value of options
granted had been recognized as compensation expense on a straight-line basis
over the vesting periods in accordance with the provisions of SFAS No. 123, pro
forma pre-tax income would have been $8.5 million lower ($5.1 million after
taxes or $0.13 per basic and diluted share) for 1998, and pro forma pre-tax loss
would have been $16.0 million higher ($9.8 million after taxes or $0.23 per
basic and diluted share) for 1997 and $9.4 million higher ($5.1 million after
taxes or $0.12 per basic and diluted share) for 1996.
The weighted average fair values at date of grant for options granted by the
Company in 1998, 1997 and 1996 are as follows:
55
1998 1997 1996
---- ---- ----
Exercise price equals market price on grant date: $7.33 $ 9.55 $ 8.96
Exercise price less than market price on grant date: $8.10 $17.71 $21.97
As part of 3M, certain employees of the Company were granted stock options prior
to the Distribution to purchase 3M stock. Options granted to the Company's
employees under 3M's General Employees' Stock Purchase Plan (GESPP) were for
72,522 shares in the period from January 1, 1996 to June 30, 1996. The weighted
average fair value per option granted under the GESPP in 1996 was $10.37.
Pursuant to the Distribution, options granted to the Company's employees while
part of 3M have not been converted into options to purchase shares of the
Company's stock.
The fair values at date of grant were estimated using the Black-Scholes option
pricing model with the following weighted average assumptions:
1998 1997 1996
--------------------------------------------------------------
Volatility 40% 40% 40%
Risk free interest rate 5.35% 6.47% 6.38%
Expected life (months) 51 52 49
Dividend growth Zero Zero Zero
NOTE 15 -- SUPPLEMENTAL NON-CASH ITEMS
In connection with the November 30, 1998 sale of the medical imaging business
to Kodak (see Note 3), the Company received cash of $143.0 million that is
restricted until the medical imaging businesses in Europe are legally
transferred to Kodak. The restricted cash is classified as part of other current
assets in the December 31, 1998 Consolidated Balance Sheet and, as a result, is
excluded from the proceeds of the sale reflected in the Consolidated Statements
of Cash Flows.
Pursuant to the Distribution on July 1, 1996, certain assets and liabilities
with a net value of $8.1 million were retained by 3M, primarily comprised of
certain deferred tax assets of $26.9 million and severance obligations of $23.9
million. Non-cash items related to acquisitions are described in Note 3.
NOTE 16 -- COMMITMENTS AND CONTINGENCIES
In connection with the Distribution, the Company assumed substantially all
liabilities for legal proceedings relating to the Company's businesses as
conducted prior to the Distribution.
The Company is the subject of various pending or threatened legal actions in the
ordinary course of its business. All such matters are subject to many
uncertainties and outcomes that are not predictable with assurance.
Consequently, the Company is unable to ascertain as of December 31, 1998 the
ultimate aggregate amount of any monetary liability or financial impact that may
be incurred by the Company with respect to these matters. While these matters
could materially affect operating results of any one quarter when resolved in
future periods, it is management's opinion that after final disposition, any
monetary liability or financial impact to the Company beyond that provided in
the consolidated balance sheet as of December 31, 1998 would not be material to
the Company's financial position or annual results of operations or cash flows.
In connection with the sale of its medical imaging business to Kodak, the
Company and Kodak settled civil litigation concerning certain intellectual
property disputes between the companies in the United States and Italy. Criminal
investigation of the matters being disputed was also terminated.
56
NOTE 17 -- QUARTERLY DATA (UNAUDITED)
(In millions,
except per share amounts) First Second Third Fourth Total
- -------------------------------------------------------------------------------------------------------------------------
1998 (1)(2)
Net revenues $ 519.4 $ 517.1 $ 520.8 $ 489.2 $2,046.5
Gross profit 171.8 168.4 182.8 153.3 676.3
Operating income 10.2 17.6 32.8 69.4 130.0
Net income 2.0 4.8 13.4 36.9 57.1
Basic and diluted earnings
per common share 0.05 0.12 0.34 0.94 1.45
- -------------------------------------------------------------------------------------------------------------------------
1997 (1)(3)
Net revenues $ 547.7 $ 554.8 $ 529.5 $ 569.8 $2,201.8
Gross profit 184.4 178.8 178.5 174.5 716.2
Operating income (loss) 28.2 10.0 (32.0) (180.9) (174.7)
Net income (loss) 12.0 4.4 (38.7) (157.8) (180.1)
Basic and diluted earnings
(loss) per common share 0.29 0.11 (1.00) (4.05) (4.54)
=========================================================================================================================
(1) Includes the reclassification of certain expenses as cost of goods sold that
were previously classified as selling, general and administrative expenses.
(2) Includes a pre-tax net gain of $65.0 million, recorded in operating
expenses, related to the sale of the medical imaging business in the fourth
quarter and $2.6 million of costs, recorded in non-operating expenses,
related to the change in the company's credit facility in the fourth
quarter, a net adjustment in restructuring of $13.2 million in the third
quarter and a $3.6 million benefit in restructuring in the second quarter.
(3) Includes a non-tax-deductible charge of $41.7 million in the third quarter
for in-process research and development costs related to the Cemax
acquisition and a $199.9 million pre-tax charge ($158.7 million after taxes)
in the fourth quarter including $170.0 million of restructuring charges
primarily related to employee separation benefits and fixed asset write-offs
and $29.9 million of other restructuring related asset write-downs and other
year-end adjustments (see Note 5).
57
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III
Certain information required by Part III is omitted from this Report
on Form 10-K. The Company will file its definitive Proxy Statement for its
Annual Meeting of Shareholders to be held on June 9, 1999, pursuant to
Regulation 14A of the Securities Exchange Act of 1934, as amended (the Proxy
Statement), not later than 120 days after the end of the fiscal year covered by
this Report. Certain information included in the Proxy Statement is incorporated
herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
A list of the Company's directors, together with a description of
their business experience, is set forth below:
RICHARD E. BELLUZZO is Chairman and Chief Executive Officer of
Silicon Graphics, Inc. (a supplier of high-performance solutions with its family
of computer workstations, supercomputers and servers) since 1998. Prior to such
time, he held the position of Executive Vice President and General Manager of
Hewlett-Packard Company. Mr. Belluzzo is also a member of the board of directors
of Specialty Laboratories. Mr.Belluzzo has been a director of the Company since
August 1998.
LAWRENCE E. EATON served as Executive Vice President of the
Information, Imaging and Electronic Sector and Corporate Services of 3M (a
diversified manufacturer) from 1991 to his retirement in August 1996. Prior to
1991, Mr. Eaton served in various other capacities at 3M, including from 1986 to
1991 as Group Vice President, Memory Technologies Group. Mr. Eaton has been a
director of the Company since July 1996.
MICHAEL S. FIELDS is President of The Fields Group (a management
consulting firm), a position he has held since May 1997. In June 1992, Mr.
Fields founded Open Vision (supplier of computer systems management applications
for open client/server computing environments). Mr. Fields served as Chairman
and Chief Executive Officer of that company from July 1992 to July 1995 and
continued to serve as Chairman of the Board until April 1997. Prior to such
time, Mr. Fields held a number of executive positions at Oracle Corporation. Mr.
Fields has been a director of the Company since January 1998 and is also a
director of WinVista, Adamation, ReachCast, The Paragon Company, Unisource
Systems, Uniteq and the Hurwitz Group.
WILLIAM W. GEORGE is Chairman and Chief Executive Officer of
Medtronic, Inc., (a medical technology company, based in Minneapolis). He joined
Medtronic in 1989 as President and Chief Operating Officer, was elected Chief
Executive Officer in 1991 and became Chairman of the Board in August 1996. Prior
to such time, Mr. George served as the President of Honeywell Space and Aviation
Systems and the President of Honeywell Industrial Automation and Control. Mr.
George has been a director of the Company since July 1996 and is also a director
of Dayton Hudson Corporation and Allina Health System.
LINDA W. HART is Vice Chairman and Chief Executive Officer of Hart
Group, Inc. (a diversified group of companies primarily involved in insulation
manufacturing and residential and
58
commercial services). Prior to joining Hart Group in 1990, Ms. Hart was engaged
in the private practice of law in Dallas, Texas. Ms. Hart is a former director
of both Conner Peripherals, Inc. and WordPerfect Corporation and is currently a
director of NeTrust Lease Equities, Inc. (REIT) and each of the Hart Group
companies; Hart Group, Inc. (management services and investments), Rmax, Inc.
(insulation manufacturing), Axon, Inc. (residential and commercial services),
Hart Leasing, Inc. (vehicle and equipment leasing) and L&M Acquisitions, Inc.
(investment company). Ms. Hart has been a director of the Company since July
1996.
RONALD T. LEMAY is President and Chief Operating Officer of Sprint
Corporation (a telecommunications company). He was appointed to that position in
February 1996. He became a director of Sprint in 1993. From March 1995 to
September 1996, Mr. LeMay served as the Chief Executive Officer of Sprint
Spectrum, a partnership among Sprint, Tele-Communications, Inc., Comcast
Corporation and Cox Communications. From October 1989 to March 1995, Mr. LeMay
served as President and Chief Operating Officer of Sprint Long Distance. Mr.
LeMay has been a director of the Company since July 1996 and is also a director
of Yellow Corporation and Ceridian Corp.
MARVIN L. MANN is Chairman of the Board of Lexmark International,
Inc. (a supplier of network and personal printers and information processing
supplies), a position he has held since the Company was formed in 1991. From
March 1991 through May 1998 he also served as Chief Executive Officer and from
March 1991 through February 1997 he also served as President of the Company.
Prior to such time, Mr. Mann served in a number of executive positions at IBM.
Mr. Mann has been a director of the Company since January 1997 and is also a
director of M. A. Hanna Company, Dynatech, Inc., and is a member of the Fidelity
Investments Board of Trustees.
WILLIAM T. MONAHAN was elected Chairman of the Board, President and
Chief Executive Officer of the Company when the Company was formed in March 1996
in connection with the spin-off from 3M. From June 1993 to March 1996, Mr.
Monahan served as Group Vice President responsible for the Electro and
Communication Group of 3M, and from May 1992 to May 1993, he served as Senior
Managing Director of 3M Italy. From September 1989 to May 1992, Mr. Monahan was
Vice President of the Data Storage Products Division of 3M.
DARYL J. WHITE served as the Senior Vice President of Finance and
Chief Financial Officer of Compaq Computer Corporation (a computer equipment
manufacturer) from 1988 to May 1996. Prior to such time, he held the positions
of Corporate Controller and Director of Information Management at Compaq.
Mr. White has been a director of the Company since July 1996.
The information contained in the sections entitled "Information
Concerning Directors" and "Section 16(a) Beneficial Ownership Reporting
Compliance" contained in the Company's Proxy Statement for its 1999 Annual
Shareholders Meeting is incorporated herein by reference. See also "Executive
Officers of the Company" in Part I above.
ITEM 11. EXECUTIVE COMPENSATION.
The sections entitled "Compensation of Executive Officers" and
"Compensation of Directors" contained in the Company's Proxy Statement for its
1999 Annual Shareholders Meeting is incorporated herein by reference. The
information appearing under the heading "Committee Report on Executive
Compensation" is not incorporated herein.
59
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information contained in the sections entitled "Security
Ownership of Certain Beneficial Owners" and "Security Ownership of Management"
contained in the Company's Proxy Statement for its 1999 Annual Shareholders
Meeting is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information contained in the section entitled "Indebtedness of
Management" contained in the Company's Proxy Statement for its 1999 Annual
Shareholders Meeting is incorporated by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
1. FINANCIAL STATEMENTS
The following Report of Independent Accountants and consolidated
financial statements of the Company are contained in Part II of this Report:
Page
----
Report of Independent Accountants ............................. 31
Consolidated Statements of Operations for the Years Ended
December 31, 1998, 1997 and 1996 .......................... 32
Consolidated Balance Sheets as of December 31, 1998 and 1997... 33
Consolidated Statements of Shareholders' Equity for the Years
Ended December 31, 1998, 1997 and 1996..................... 34
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996........................... 35
Notes to Consolidated Financial Statements .................... 36
2. FINANCIAL STATEMENT SCHEDULES
All financial statement schedules are omitted because of the absence
of the conditions under which they are required or because the required
information is included in the Consolidated Financial Statements or the notes
thereto.
3. EXHIBITS
The following Exhibits are filed as part of, or incorporated by
reference into, this Report:
Exhibit
Number Description of Exhibit
------ ----------------------
2.1 Amended and Restated Asset Purchase Agreement dated as
of November 30, 1998, between the Company and Eastman
Kodak Company
60
(incorporated by reference to Exhibit 2.1 to the
Company's Form 8-K Current Report dated December 16,
1998)
3.1 Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 to
Registration Statement on Form 10, No. 1-14310)
3.2 Amended and Restated Bylaws of the Company (incorporated
by reference to Exhibit 3.2 to the Company's Annual
Report on Form 10-K for the year ended December 31,
1996)
4.1 Rights Agreement, dated as of June 18, 1996 between the
Company and Norwest Bank Minnesota, N.A., as Rights
Agent (incorporated by reference to Exhibit 4.1 to
Registration Statement on Form 10, No. 1-14310)
4.2 Amendment No. 1 to the Rights Agreement dated as of
January 12, 1999 between the Company and Norwest Bank
Minnesota, N.A., as Rights Agent (incorporated by
reference to Exhibit 4.2 to the Company's Form 8-K
Current Report dated February 8, 1999)
4.3 Certificate of Designations, Preferences and Rights of
Series A Junior Participating Preferred Stock of the
Company (incorporated by reference to Exhibit 4.2 to
Registration Statement on Form 10, No. 1-14310)
4.4 Loan and Security Agreement dated as of December 31,
1998 by and among the Company and Imation Enterprises
Corp., the Lenders named therein, Bankamerica Business
Credit, Inc. as Agent and Collateral Agent, and
BankBoston, N.A. and NBD Bank and Syndication Agents and
Co-Agents (incorporated by reference to Exhibit 4.3 to
the Company's Form 8-K Current Report dated February 8,
1999)
10.1 Transfer and Distribution Agreement, dated as of July 1,
1996, between Minnesota Mining and Manufacturing Company
(3M) and the Company (incorporated by reference to
Exhibit 2.1 to Registration Statement on Form 10, No.
1-14310)
10.2 Tax Sharing and Indemnification Agreement, dated as of
July 1, 1996 between 3M and the Company (incorporated by
reference to Exhibit 10.1 to Registration Statement on
Form 10, No. 1-14310)
10.3 Corporate Services Transition Agreement, dated as of
July 1, 1996 between 3M and the Company (incorporated by
reference to Exhibit 10.2 to Registration Statement on
Form 10, No. 1-14310)
10.4 Environmental Matters Agreement dated as of July 1, 1996
between 3M and the Company (incorporated by reference to
Exhibit 10.3 to Registration Statement on Form 10, No.
1-14310)
10.5 Intellectual Property Rights Agreement, dated as of July
1, 1996 between 3M and the Company (incorporated by
reference to Exhibit 10.10 to Amendment No. 2 to
Registration Statement on Form S-4, No. 333-28837)
10.6 Supply Agreement, dated as of July 1, 1996, between 3M
and the Company (incorporated by reference to Exhibit
10.5 to Registration Statement on Form 10, No. 1-14310)
10.7* Employment Agreement, dated as of July 1, 1996, between
William T. Monahan and the Company (incorporated by
reference to Exhibit 10.7 to Registration Statement on
Form 10, No. 1-14310)
10.8* Imation 1996 Employee Stock Incentive Program
(incorporated by reference to Exhibit 10.8 to
Registration Statement on Form 10, No. 1-14310)
10.9* Imation Excess Benefit Plan (incorporated by reference
to Exhibit 10.10
61
to Registration Statement on Form 10, No. 1-14310)
10.10* Imation 1996 Retirement Investment Plan (incorporated by
reference to Exhibit 10.11 to Registration Statement on
Form 10, No. 1-14310)
10.11* Imation 1996 Directors Stock Compensation Program, as
Amended (incorporated by reference to Exhibit 10.12 to
Annual Report on Form 10-K for the year ended December
31, 1996)
10.12* Imation 1998 Success Sharing Program (incorporated by
reference to Exhibit 10.13 to Annual Report on Form 10-K
for year ended December 31, 1997)
10.13* Form of Indemnity Agreement between the Company and each
of its directors (incorporated by reference to Exhibit
10.13 to Annual Report on Form 10-K for the year ended
December 31, 1996)
10.14* Employment Agreement dated as of April 1, 1998, between
Robert L. Edwards and the Company (incorporated by
reference to Exhibit 10.1 of the Company's Form 10-Q for
the quarter ended March 31, 1998).
10.15* Letter dated July 6, 1998 to Steven D. Ladwig regarding
executive compensation (incorporated by reference to
Exhibit 10.1 of the Company's Form 10-Q for the quarter
ended September 30, 1998).
10.16* Negotiated Settlement and Release of All Claims dated as
of December 23, 1998, between David G. Mell and the
Company
10.17* Negotiated Settlement and Release of All Claims dated
December 29, 1998, between Charles D. Oesterlein and the
Company
10.18* Negotiated Settlement and Release of All Claims dated
December 31, 1998, between Clifford T. Pinder and the
Company
21.1 Subsidiaries of Imation Corp.
23.1 Consent of Independent Accountants
24.1 Power of Attorney
27.1 Financial Data Schedule
- ---------------
*Items that are management contracts or compensatory plans or arrangements
required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.
(b) REPORTS ON FORM 8-K
A Form 8-K Current Report dated December 16, 1998 was filed relating
to the Company's sale of its medical imaging business to Kodak.
62
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
IMATION CORP.
By: /s/ WILLIAM T. MONAHAN
-----------------------
William T. Monahan
CHAIRMAN, PRESIDENT AND
CHIEF EXECUTIVE OFFICER
Date: March 29, 1999
63
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ WILLIAM T. MONAHAN Chairman, President, Chief March 29, 1999
- ---------------------- Executive Officer and Director
William T. Monahan
/s/ ROBERT L. EDWARDS Sr. Vice President, Chief Financial March 29, 1999
- --------------------- Officer and Chief Administrative
Robert L. Edwards Officer
* Corporate Controller March 29, 1999
- --------------------
Paul R. Zeller
* Director March 29, 1999
- --------------------
Richard E. Belluzzo
* Director March 29, 1999
- --------------------
Lawrence E. Eaton
* Director March 29, 1999
- --------------------
Michael S. Fields
* Director March 29, 1999
- --------------------
Linda W. Hart
* Director March 29, 1999
- --------------------
William W. George
* Director March 29, 1999
- --------------------
Ronald T. LeMay
* Director March 29, 1999
- --------------------
Marvin L. Mann
* Director March 29, 1999
- --------------------
Daryl J. White
By: /s/ JOHN L. SULLIVAN
--------------------
John L. Sullivan
Attorney-in-fact
64
EXHIBIT INDEX *
How
Exhibit Filed
- ------- -----
(2) Plan of acquisition, reorganization, arrangement, liquidation or
succession
(2.1) Amended and Restated Asset Purchase
Agreement between Imation Corp. and
Eastman Kodak Company**
(3) Restated Certificate of Incorporation and Amended and Restated Bylaws**
(4) Instruments defining the rights of security holders, including indentures
(4.1) Rights Agreement, dated June 18, 1996**
(4.2) Amended Rights Agreement, dated January 12,1999**
(4.3) Certificate of Designations, Preferences and Rights of Series A
Junior Participating Preferred**
(4.4) Loan and Security Agreement, dated December 31, 1998**
(10) Material Contracts
(10.1) Transfer and Distribution Agreement**
(10.2) Tax Sharing and Indemnification Agreement**
(10.3) Corporate Services Transition Agreement**
(10.4) Environmental Matters Agreement**
(10.5) Intellectual Property Rights Agreement**
(10.6) Supply Agreement**
(10.7) Employment Agreement, dated July 1, 1996, between William T.
Monahan and the Company**
(10.8) Imation 1996 Employee Stock Incentive Program**
(10.9) Imation Excess Benefit Plan**
(10.10) Imation 1996 Retirement Investment Plan**
(10.11) Imation 1996 Retirement Directors Stock Compensation Program, as
Amended**
(10.12) Imation 1998 Success Sharing Program**
(10.13) Form of Indemnity Agreement between the Company and each of its
directors.**
(10.14) Employment Agreement, dated April 1, 1998, between Robert L.
Edwards and the Company**
(10.15) Letter dated July 6, 1998 to Steve Ladwig regarding
executive compensation**
(10.16) Negotiated Settlement and Release between David G. Mell and the
Company. (1)
(10.17) Negotiated Settlement and Release between Charles D. Oesterlein
and the Company (1)
(10.18) Negotiated Settlement and Release between Clifford T. Pinder and
the Company (1)
(21) Subsidiaries of Imation Corp. (1)
(23) Consents of experts and counsel (1)
(24) Power of Attorney (1)
(27) Financial data schedule (1)
* The exhibits are included only with the copies of this report that are filed
with the Securities and Exchange Commission. However, copies of the exhibits
may be obtained from Imation Corp. by writing to the Corporate Secretary,
Imation Corp, 1 Imation Place, Oakdale, MN. 55128.
** These items are incorporated by reference as permitted under Rule 12b-32.
(1) Filed Electronically herewith.