Selling, general and administrative expenses (SG&A) were $395 million for the first quarter of 2007 as compared with $507 million for the prior year quarter, representing a decrease of $112 million, or 22%. SG&A as a percentage of sales decreased from 22% in the first quarter of 2006 to 19% in the first quarter of 2007. The year-over-year dollar decrease in SG&A is primarily attributable to significant Company-wide cost reduction actions.
Research and development costs (R&D) were $137 million for the first quarter of 2007 as compared with $148 million for the first quarter of 2006, representing a decrease of $11 million, or 7%. R&D as a percentage of sales remained constant at approximately 6%. This absolute dollar decrease was primarily driven by the continuing realignment of resources, as well as the timing of development of new products.
Restructuring costs and other were $85 million for the first quarter of 2007 as compared with $138 million for the prior year quarter, representing a decrease of $53 million or 38%. This decrease is largely due to the timing of specific restructuring actions. These costs, as well as the restructuring-related costs reported in cost of goods sold, are discussed in further detail under "RESTRUCTURING COSTS AND OTHER" below.
The loss from continuing operations before interest, other income (charges), net and income taxes for the first quarter of 2007 was $188 million as compared with a loss of $324 million for the first quarter of 2006, representing an improvement in earnings of $136 million. This change is attributable to the reasons described above.
Interest expense for the first quarter of 2007 was $25 million as compared with $41 million for the prior year quarter, representing a decrease of $16 million, or 39%. Lower interest expense is a result of reductions in total debt levels, primarily from repayment of notes due in the third quarter of 2006 and prepayments of the Company's Secured Term Debt in the fourth quarter of 2006.
The other income (charges), net category includes interest income, income and losses from equity investments, gains and losses on the sales of assets and investments, and foreign exchange gains and losses. Other income for the current quarter was $23 million as compared with other income of $27 million for the first quarter of 2006. The decrease of $4 million is primarily attributable to lower interest income and lower gains on foreign exchange transactions.
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Income Tax (Benefit) Provision
For the first quarter of 2007, the Company recorded a benefit of $16 million on a pre-tax loss of $190 million, representing an effective rate of 8.4%. The difference of $51 million between the recorded benefit of $16 million and the benefit of $67 million that would result from applying the U.S. statutory rate of 35.0% is primarily attributable to: (1) losses generated within the U.S. and in certain jurisdictions outside the U.S., which were not benefited, and (2) the mix of the earnings from operations in certain lower-taxed jurisdictions outside the U.S. Other significant items that result in a difference from the statutory tax rate include non-U.S. tax benefits of $10 million associated with total worldwide restructuring costs; and a benefit of $56 million associated with the release of certain tax reserves in a foreign jurisdiction.
For the first quarter of 2006, the Company recorded a provision of $8 million on a pre-tax loss of $338 million, representing an effective rate of (2.4)%. The difference of $126 million between the recorded provision of $8 million and the benefit of $118 million that would result from applying the U.S. statutory rate of 35.0% is primarily attributable to: (1) losses generated within the U.S. and in certain jurisdictions outside the U.S., which were not benefited, and (2) the mix of earnings from operations in certain lower-taxed jurisdictions outside the U.S.Other significant items that result in a difference from the statutory tax rate include non-U.S. tax benefits of $29 million associated with total worldwide restructuring costs and asset impairments; and discrete tax charges relating primarily to purchase accounting, tax rate changes, and impacts from ongoing tax audits with respect to open tax years of $14 million.
Loss From Continuing Operations
The loss from continuing operations for the first quarter of 2007 was $174 million, or $.61 per basic and diluted share, as compared with a loss from continuing operations for the first quarter of 2006 of $346 million, or $1.21 per basic and diluted share, representing an improvement in earnings of $172 million. This improvement in earnings from continuing operations is attributable to the reasons described above.
CONSUMER DIGITAL IMAGING GROUP
As a result of the changes in reporting structure effective January 1, 2007, CDG results will be reported using the following structure:
- Digital Capture and Devices– digital cameras, imaging devices and accessories, memory products, snapshot printers and related media (formerly reported separately within CDG), and intellectual property royalties
- Retail Printing– color negative paper, photochemicals, service and support, photofinishing services (all formerly reported in FPG) and retail kiosks and related media
- Consumer Imaging Services– Kodak Gallery online printing and services
- Consumer Inkjet Systems– All in One printers, ink and media (formerly reported in All Other)
- Imaging Sensors(formerly reported in Digital Capture) – CCD and CMOS sensors
Worldwide Revenues
Net worldwide sales for CDG were $778 million for the first quarter of 2007 as compared with $902 million for the first quarter of 2006, representing a decrease of $124 million, or 14%. The decrease in net sales was comprised of volume declines, which reduced net sales by approximately 9.4 percentage points, and unfavorable price/mix, which reduced net sales by approximately 6.0 percentage points. The negative price/mix was primarily driven byDigital Capture and Devices, while the decrease in volumes was largely attributable to snapshot printing and the traditional portion ofRetail Printing. These declines were partially offset by favorable foreign exchange, which increased net sales by approximately 1.7 percentage points.
Net worldwide sales ofDigital Capture and Devices, which includes consumer digital cameras, accessories, memory products, snapshot printers and related media, and intellectual property royalties, decreased 20% in the first quarter of 2007 as compared with the prior year quarter, primarily reflecting negative price/mix and lower snapshot printing volumes. For digital still cameras, Kodak remains in the top three market position on a worldwide basis through March.
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Net worldwide sales ofRetail Printingdecreased 13% in the first quarter of 2007 as compared with the prior year quarter, reflecting volume declines and negative price/mix, partially offset by favorable foreign exchange. Sales of photofinishing services declined 41% from the first quarter of 2006, reflecting continuing industry film processing volume declines, but were partially offset by increased sales of kiosks and related media, which increased 13% from the prior year quarter. Sales of kiosks/media continue to be driven by strong consumables sales at retail locations, with 4x6 media volumes increasing 48% versus last year.
Digital Strategic Product Groups' Revenues
CDG digital product sales are comprised of digital capture and devices, kiosks/media, online printing, consumer inkjet systems, and imaging sensors.
Digital product sales for CDG were $461 million for the first quarter of 2007 as compared with $513 million for the prior year quarter, representing a decrease of $52 million, or 10%. The decrease was primarily driven by declines in sales of digital cameras and snapshot printers and media, partially offset by growth in kiosks/media, imaging sensors, and intellectual property royalty revenues.
Traditional Strategic Product Groups' Revenues
CDG traditional product sales are comprised of consumer and professional photographic paper, photochemicals and photofinishing services.
Traditional product sales for CDG were $317 million for the first quarter of 2007 as compared with $389 million for the first quarter of 2006, representing a decrease of $72 million, or 19%. This decrease was primarily driven by declines in photofinishing services and consumer photographic paper sold to retailers.
Gross Profit
Gross profit for CDG was $100 million for the first quarter of 2007 as compared with $108 million for the prior year quarter, representing a decrease of $8 million or 7%. The gross profit margin was 12.9% in the current quarter as compared with 12.0% in the prior year quarter. The 0.9 percentage point increase was primarily attributable to reductions in cost, which improved gross profit margins by approximately 5.0 percentage points, and favorable foreign exchange, which improved gross profit margins by approximately 1.1 percentage points. The reductions in cost were primarily driven by savings realized from manufacturing cost reduction initiatives and more effective product portfolio management, partially offset by product launch costs associated withConsumer Inkjet Systemsand by adverse silver costs. These improvements in gross profit margins were partially offset by unfavorable price/mix and volume declines. Price/mix negatively impacted gross profit margins by approximately 4.8 percentage points, primarily driven byDigital Capture andDevicesandRetail Printing, partially offset by the year-over-year increase in intellectual property royalties. Volume declines reduced gross profit margins by approximately 0.4 percentage points, primarily driven byDigital Capture and Devicespartially offset by kiosks and related media.
Selling, General and Administrative Expenses
SG&A expenses for CDG decreased $50 million, or 25%, from $202 million in the first quarter of 2006 to $152 million in the current quarter, and decreased as a percentage of sales from 22% for the first quarter of 2006 to 20% for the current quarter. This decrease was primarily driven by focused cost reduction initiatives and improved go-to-market structure.
Research and Development Costs
R&D costs for CDG decreased $11 million, or 15%, from $73 million in the first quarter of 2006 to $62 million in the current quarter and remained constant as a percentage of sales at 8%. This absolute dollar decrease is largely attributable to spending incurred in 2006 related to the development ofConsumer Inkjet Systems, which were introduced in the first quarter of 2007, and to cost reduction actions.
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Loss From Continuing Operations Before Interest, Other Income (Charges), Net and Income Taxes
The loss from continuing operations before interest, other income (charges), net and income taxes for CDG was $114 million in the first quarter of 2007 compared with a loss of $167 million in the first quarter of 2006, representing an improvement in earnings of $53 million or 32%, as a result of the factors described above.
FILM PRODUCTS GROUP
Worldwide Revenues
Net worldwide sales for FPG were $458 million for the first quarter of 2007 as compared with $500 million for the first quarter of 2006, representing a decrease of $42 million, or 8%. The decrease in net sales was comprised of: (1) lower volumes, which decreased first quarter sales by approximately 9.8 percentage points and were primarily attributable toConsumer Film Capture, and (2) declines related to negative price/mix, which reduced net sales by approximately 1.8 percentage points and were primarily attributable toConsumer Film CaptureandEntertainment Imaging. These decreases were partially offset by favorable foreign exchange, which increased net sales by approximately 3.1 percentage points.
Net worldwide sales ofConsumer Film Capture, including consumer roll film (35mm and APS film), one-time-use cameras (OTUC), professional films, and reloadable traditional film cameras, decreased 28% in the first quarter of 2007 as compared with the first quarter of 2006, primarily reflecting continuing industry volume declines and negative price/mix, partially offset by favorable exchange.
Net worldwide sales forEntertainment Imaging, which includes origination, intermediate, and print films for the entertainment industry increased 8%, primarily reflecting significant volume increases in print films and favorable exchange, partially offset by unfavorable price/mix.
Gross Profit
Gross profit for FPG was $158 million for the first quarter of 2007 as compared with $179 million for the prior year quarter, representing a decrease of $21 million or 12%. The gross profit margin was 34.5% in the current quarter as compared with 35.8% in the prior year quarter. The 1.3 percentage point decrease was primarily attributable to increased unit manufacturing and other costs, which reduced gross profit margins by approximately 3.0 percentage points, largely driven by adverse silver costs. These cost increases were partially offset by favorable foreign exchange, which increased gross profit margins by approximately 1.9 percentage points. The impact of price/mix on gross profit margins was not significant.
Selling, General and Administrative Expenses
SG&A expenses for FPG decreased $40 million, or 34%, from $117 million in the first quarter of 2006 to $77 million in the current quarter, and decreased as a percentage of sales from 23% in the prior year quarter to 17% in the current quarter. The decline in SG&A was attributable to the impacts of focused cost reduction actions.
Research and Development Costs
R&D costs for FPG decreased $4 million, or 36%, from $11 million in the first quarter of 2006 to $7 million in the current quarter and remained constant as a percentage of sales at 2%. The decrease in R&D was primarily attributable to further reductions in spending corresponding with film-related products and services.
Earnings From Continuing Operations Before Interest, Other Income (Charges), Net and Income Taxes
Earnings from continuing operations before interest, other income (charges), net and income taxes for FPG were $74 million in the first quarter of 2007 compared with $51 million in the first quarter of 2006, representing an increase of $23 million or 45%, as a result of the factors described above.
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GRAPHIC COMMUNICATIONS GROUP
As GCG continues its integration process in 2007 and further aligns the discrete businesses that were acquired in 2004 and 2005, GCG results will be reported using the following organizational structure:
- Enterprise Solutions– workflow software and digital controller development
- Digital Printing Solutions– all continuous inkjet and electrophotographic products, including equipment, consumables and service
- Prepress Solutions– prepress consumables, prepress equipment and related services
- Document Imaging Business– document scanners and services, media, and imaging services
Worldwide Revenues
Net worldwide sales for GCG were $864 million for the first quarter of 2007 as compared with $870 million for the prior year quarter, representing a decrease of $6 million, or 1%. The decrease in net sales was primarily attributable to volume declines, which reduced net sales by approximately 4.2 percentage points, and negative price/mix, which reduced net sales by approximately 1.0 percentage point, partially offset by favorable foreign exchange, which increased net sales by approximately 4.6 percentage points. The volume declines were primarily driven by the traditional products withinPrepress Solutions,as well asby equipment withinDigital Printing Solutions.Unfavorable price/mix was primarily attributable toDigital Printing SolutionsandEnterprise Solutions.
Net worldwide sales ofPrepress Solutionsincreased 1%, primarily driven by increased sales of digital plates, partially offset by declines in sales of analog plates, proofing media and equipment.
Net worldwide sales ofDocument Imagingincreased 1%, primarily driven by increased sales in scanners and services, partially offset by declines in sales of traditional document imaging media.
Net worldwide sales ofDigital Printing Solutionsdecreased 5%, primarily driven by declines in electrophotographic color printing equipment, partially offset by revenue growth in consumables and service. Equipment sales were higher in the first quarter of 2006 as compared with the first quarter of 2007, partially due to timing of equipment orders and installations. The year-over-year decline in equipment sales was also impacted by product mix and lower volumes, including lower sales of direct image press equipment. Printed page volumes continue to grow, resulting in revenue growth in electrophotographic color consumables and service of 25% versus the prior year quarter. Continuous inkjet consumables and service revenue grew 30% versus the prior year quarter.
Net worldwide sales ofEnterprise Solutionsdecreased 8%, primarily driven by declines in digital controller sales as a result of certain products being discontinued for which replacement products will be available in the second quarter.
Digital Strategic Product Groups' Revenues
GCG digital product sales are comprised ofEnterprise Solutions,Digital Printing Solutions, portions ofPrepress Solutions,andDocument Imaging.
Sales of digital products and services for GCG were $749 million for the first quarter of 2007 as compared with $737 million for the prior year quarter, representing an increase of $12 million, or 2%. The increase in digital products and services revenue was primarily attributable to increased sales from the digital portions ofPrepress SolutionsandDocument Imaging,partially offset by decreases inDigital PrintingandEnterprise Solutions.
Traditional Strategic Product Groups' Revenues
GCG traditional product sales are comprised of sales of traditional prepress consumables, including analog plates and graphics film, and traditional document imaging equipment and media. These sales were $115 million for the current quarter compared with $133 million for the prior year quarter, representing a decrease of $18 million, or 14%. The decrease in sales was primarily attributable to lower volumes of analog plates and graphics film.
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Gross Profit
Gross profit for GCG was $230 million for the first quarter of 2007 as compared with $254 million in the prior year quarter, representing a decrease of $24 million, or 9%. The gross profit margin was 26.6% in the current quarter as compared with 29.2% in the prior year quarter. The decrease in the gross profit margin of 2.6 percentage points was primarily attributable to aluminum and silver costs and other manufacturing costs, which together decreased gross profit margins by approximately 2.3 percentage points. Unfavorable price/mix decreased gross profit margins by approximately 0.7 percentage points. These declines in gross profit margins were partially offset by favorable foreign exchange, which increased gross profit margins by approximately 0.4 percentage points.
Selling, General and Administrative Expenses
SG&A expenses for GCG were $163 million for the first quarter of 2007 as compared with $182 million in the prior year quarter, representing a decrease of $19 million, or 10%, and decreased as a percentage of sales from 21% to 19%. The decrease in SG&A is largely attributable to integration synergies and targeted cost reduction strategies, partially offset by unfavorable foreign exchange.
Research and Development Costs
R&D costs for GCG increased $3 million, or 6%, from $48 million for the first quarter of 2006 to $51 million for the current quarter, and remained constant as a percentage of sales at 6%. The dollar increase is largely driven by increased investments in product portfolio development and unfavorable foreign exchange.
Earnings From Continuing Operations Before Interest, Other Income (Charges), Net and Income Taxes
Earnings from continuing operations before interest, other income (charges), net and income taxes for GCG were $16 million in the first quarter of 2007 compared with earnings of $24 million in the first quarter of 2006. This decrease in earnings is attributable to the reasons outlined above.
ALL OTHER
Worldwide Revenues
Net worldwide sales for All Other were $19 million for the first quarter of 2007 as compared with $20 million for the first quarter of 2006, representing a decrease of $1 million, or 5%.
Loss From Continuing Operations Before Interest, Other Income (Charges), Net and Income Taxes
The loss from continuing operations before interest, other income (charges), net and income taxes for All Other was $13 million in the current quarter as compared with a loss of $16 million in the first quarter of 2006. This improvement in earnings is primarily attributable to lower R&D spending related to the display business.
RESULTS OF OPERATIONS - DISCONTINUED OPERATIONS
On January 8, 2007, the Company’s Board of Directors authorized management to enter into a definitive agreement to sell all of the assets and business operations of the Health Group to Onex Healthcare Holdings, Inc. (“Onex”) (now known as Carestream Health, Inc.), a subsidiary of Onex Corporation, for up to $2.55 billion. This definitive agreement was signed on January 9, 2007. The sale price is composed of $2.35 billion in cash at closing and $200 million in additional future payments if Onex achieves certain returns with respect to its investment. If Onex investors realize an internal rate of return in excess of 25% on their investment, the Company will receive payment equal to 25% of the excess return, up to $200 million.
The sale closed on April 30, 2007. The Company will report the gain associated with this sale in its Form 10-Q for the second quarter of 2007. Because of tax-loss carryforwards and other tax attributes, the Company retained the vast majority of the initial $2.35 billion cash proceeds, a portion of which were used to fully repay its approximately $1.15 billion of Secured Term Debt. About 8,100 employees of the Company associated with the Health Group have transitioned to Carestream Health, Inc. as part of the transaction. Also included in the sale are manufacturing operations focused on the production of health imaging products, as well as an office building in Rochester, NY.
Upon authorization of the Company’s Board of Directors, the Company met all the requirements of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets,” for accounting for the Health Group segment as a discontinued operation. As such, the Health Group business ceased depreciation and amortization of long-lived assets. In accordance with EITF No. 87-24, “Allocation of Interest to Discontinued Operations,” the Company allocated certain interest expense on debt that is required to be repaid as a result of the sale. Interest expense allocated to discontinued operations totaled $23 million and $21 million for the first quarter of 2007 and 2006, respectively.
Total Company earnings from discontinued operations for three months ended March 31, 2007 and 2006 of $23 million and $48 million, respectively, were net of a provision for income taxes of $7 million, and a benefit for income taxes of $4 million, respectively.
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NET LOSS
The net loss for the first quarter of 2007 was $151 million, or a loss of $.53 per basic and diluted share, as compared with a net loss for the first quarter of 2006 of $298 million, or $1.04 per basic and diluted share, representing an improvement in earnings of $147 million or 49%. This improvement in earnings is attributable to the reasons outlined above.
RESTRUCTURING COSTS AND OTHER
The Company is currently undergoing the transformation from a traditional products and services company to a digital products and services company. In connection with this transformation, the Company announced a cost reduction program in January 2004 that would extend through 2006 to achieve the appropriate business model and to significantly reduce its worldwide facilities footprint. In July 2005, the Company announced an extension to this program into 2007 to accelerate its digital transformation, which included further cost reductions that will result in a business model consistent with what is necessary to compete profitably in digital markets.
In connection with its announcement relating to the extended "2004-2007 Restructuring Program," the Company has provided estimates with respect to (1) the number of positions to be eliminated, (2) the facility square footage reduction, (3) the reduction in its traditional manufacturing infrastructure, and (4) the total restructuring charges to be incurred.
The actual charges for initiatives under this program are recorded in the period in which the Company commits to formalized restructuring plans or executes the specific actions contemplated by the program and all criteria for restructuring charge recognition under the applicable accounting guidance have been met.
Restructuring Programs Summary
The activity in the accrued restructuring balances and the non-cash charges incurred in relation to all of the restructuring programs described below were as follows for the first quarter of 2007:
| | | | | | | | | | | | | | | | Other | | | |
| | | Balance | | | | | | | | | | | Adjustments | | Balance |
| | Dec. 31 | | Costs | | | | Cash | | Non-cash | | and | | March 31 |
| (in millions) | | 2006 | | Incurred (1) | | Reversals | | Payments (2) | | Settlements | | Reclasses (3) | | 2007 |
| 2004-2007 Restructuring Program: | | | | | | | | | | | | | | | | | | | | |
| Severance reserve | | $ | 228 | | $ | 70 | | $ | — | | $ | ( 84 | ) | $ | — | | $ | (18 | ) | $ | 196 |
| Exit costs reserve | | | 24 | | | 22 | | — | | | (20 | ) | | — | | | — | | | 26 |
| Total reserve | | $ | 252 | | $ | 92 | | $ | — | | $ | (104 | ) | $ | — | | $ | (18 | ) | $ | 222 |
| Long-lived asset impairments | | | | | | | | | | | | | | | | | | | | |
| and inventory write-downs | | $ | — | | $ | 11 | | $ | — | | $ | — | | $ | (11 | ) | $ | — | | $ | — |
| Accelerated depreciation | | $ | — | | $ | 65 | | $ | — | | $ | — | | $ | (65 | ) | $ | — | | $ | — |
| Pre-2004 Restructuring Programs: | | | | | | | | | | | | | | | | | | | | |
| Severance reserve | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — |
| Exit costs reserve | | | 11 | | | — | | (1 | ) | | (4 | ) | | — | | | — | | | 6 |
| Total reserve | | $ | 11 | | $ | — | | $ | (1 | ) | $ | (4 | ) | $ | — | | $ | — | | $ | 6 |
Total of allrestructuring
programs | | $ | 263 | | $ | 168 | | $ | (1 | ) | $ | (108 | ) | $ | (76 | ) | $ | (18 | ) | $ | 228 |
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____________________
| (1) | | The costs incurred include both continuing operations of $151 million and discontinued operations of $17 million. |
| |
| (2) | | During the three months ended March 31, 2007, the Company paid approximately $115 million related to restructuring. Of this total amount, $108 million was recorded against restructuring reserves, while $7 million was recorded against pension and other postretirement liabilities. |
| |
| (3) | | The total restructuring charges of $168 million, excluding reversals, include pension and other postretirement charges and credits for curtailments, settlements and special termination benefits. However, because the impact of these charges and credits relate to the accounting for pensions and other postretirement benefits, the related impacts on the Consolidated Statement of Financial Position are reflected in their respective components as opposed to within the accrued restructuring balances at March 31, 2007. Accordingly, the Other Adjustments and Reclasses column of the table above includes reclassifications to Other long-term assets and Pension and other postretirement liabilities for the position elimination-related impacts on the Company's pension and other postretirement employee benefit plan arrangements, including net curtailment and settlement losses and special termination benefits of $19 million. Additionally, the Other Adjustments and Reclasses column of the table above includes foreign currency translation of $1 million. |
The costs incurred, net of reversals, which total $167 million for the three months ended March 31, 2007, include $65 million and $1 million of charges related to accelerated depreciation and inventory write-downs that were reported in cost of goods sold in the accompanying Consolidated Statement of Operations for the three months ended March 31, 2007. Of the remaining costs incurred, net of reversals, $16 million was included in discontinued operations and $85 million was reported as restructuring costs and other in the accompanying Consolidated Statement of Operations for the three months ended March 31, 2007. The severance costs and exit costs require the outlay of cash, while long-lived asset impairments, accelerated depreciation and inventory write-downs represent non-cash items.
2004-2007 Restructuring Program
The Company announced on January 22, 2004 that it planned to develop and execute a comprehensive cost reduction program throughout the 2004 to 2006 timeframe. The objective of these actions is to achieve a business model appropriate for the Company's traditional businesses, and to sharpen the Company's competitiveness in digital markets.
The program was expected to result in total charges of $1.3 billion to $1.7 billion over the three-year period, of which $700 million to $900 million are related to severance, with the remainder relating to the disposal of buildings and equipment. Overall, Kodak's worldwide facility square footage was expected to be reduced by approximately one-third. Approximately 12,000 to 15,000 positions worldwide were expected to be eliminated through these actions primarily in global manufacturing, selected traditional businesses and corporate administration.
The Company subsequently expanded the program to extend into 2007, and increased the expected employment reductions and total charges. On February 8, 2007, the Company updated the ranges for anticipated restructuring activity. The Company now expects that the total employment reductions will be in the range of 28,000 to 30,000 positions and total charges will be in the range of $3.6 billion to $3.8 billion.
The Company implemented certain actions under the program during the first quarter of 2007. As a result of these actions, the Company recorded charges of $168 million in the first quarter of 2007, which were composed of severance, long-lived asset impairments, exit costs, inventory write-downs, and accelerated depreciation of $70 million, $10 million, $22 million, $1 million, and $65 million, respectively. Included in these amounts, $17 million of severance is presented as discontinued operations. The severance costs related to the elimination of approximately 1,125 positions, including approximately 50 photofinishing, 625 manufacturing, 50 research and development and 400 administrative positions. The geographic composition of the positions to be eliminated includes approximately 425 in the United States and Canada and 700 throughout the rest of the world. The reduction of the 1,125 positions and the $92 million charges for severance and exit costs are reflected in the 2004-2007 Restructuring Program table below. The $10 million charge in the first quarter for long-lived asset impairments were included in restructuring costs and other in the accompanying Consolidated Statement of Operations for the three months ended March 31, 2007, respectively. The charges taken for inventory write-downs of $1 million were reported in cost of goods sold in the accompanying Consolidated Statement of Operations for the three months ended March 31, 2007.
PAGE 35
As a result of initiatives implemented under the 2004-2007 Restructuring Program, the Company also recorded $65 million of accelerated depreciation on long-lived assets in cost of goods sold in the accompanying Consolidated Statement of Operations for the three months ended March 31, 2007. The accelerated depreciation relates to long-lived assets accounted for under the held and used model of SFAS No. 144. The total amount of $65 million relates to $1 million of photofinishing facilities and equipment, $63 million of manufacturing facilities and equipment, and $1 million of administrative facilities that will be used until their abandonment. The Company will incur approximately $15 million of accelerated depreciation in the second quarter of 2007 as a result of the initiatives already implemented under the 2004-2007 Restructuring Program.
In April 2007, the Company entered into an agreement to sell its manufacturing site in Xiamen, China. This sale is expected to close in the second quarter of 2007 and will result in a non-cash charge of approximately $220 million. This action is part of the 2004-2007 Restructuring Program.
Under this program, on a life-to-date basis as of March 31, 2007, the Company has recorded charges of $2,899 million, which was composed of severance, long-lived asset impairments, exit costs, inventory write-downs and accelerated depreciation of $1,303 million, $360 million, $274 million, $69 million and $893 million, respectively. The severance costs related to the elimination of approximately 24,500 positions, including approximately 6,250 photofinishing, 11,525 manufacturing, 1,425 research and development and 5,300 administrative positions.
The following table summarizes the activity with respect to the charges recorded in connection with the focused cost reduction actions that the Company has committed to under the 2004-2007 Restructuring Program and the remaining balances in the related reserves at March 31, 2007:
PAGE 36
| (dollars in millions) | | | | | | | | | | | | | |
| | | | | | | | | | | Long-lived Asset | | | |
| | | | | | | Exit | | | | | Impairments | | | |
| | | Number of | | Severance | | Costs | | | | | and Inventory | | Accelerated |
| (dollars in millions) | | Employees | | Reserve | | Reserve | | | Total | | Write-downs | | Depreciation |
| 2004 charges - continuing operations | | 8,975 | | $ | 405 | | $ | 95 | | $ | 500 | | $ | 156 | | $ | 152 | |
| 2004 charges - discontinued operations | | 650 | | 13 | | 4 | | | 17 | | 1 | | — | |
| 2004 reversals - continuing operations | | — | | (6 | ) | (1 | ) | | (7 | ) | — | | — | |
| 2004 utilization | | (5,175 | ) | (169 | ) | (47 | ) | | (216 | ) | (157 | ) | (152 | ) |
| 2004 other adj. & reclasses | | — | | 24 | | (15 | ) | | 9 | | — | | — | |
| Balance at 12/31/04 | | 4,450 | | 267 | | 36 | | | 303 | | — | | — | |
| 2005 charges - continuing operations | | 7,850 | | 472 | | 82 | | | 554 | | 160 | | 391 | |
| 2005 charges - discontinued operations | | 275 | | 25 | | 2 | | | 27 | | 1 | | — | |
| 2005 reversals - continuing operations | | — | | (3 | ) | (6 | ) | | (9 | ) | — | | — | |
| 2005 utilization | | (10,225 | ) | (377 | ) | (95 | ) | | (472 | ) | (161 | ) | (391 | ) |
| 2005 other adj. & reclasses | | — | | (113 | ) | 4 | | | (109 | ) | — | | — | |
| Balance at 12/31/05 | | 2,350 | | 271 | | 23 | | | 294 | | — | | — | |
| 2006 charges - continuing operations | | 5,150 | | 266 | | 66 | | | 332 | | 97 | | 273 | |
| 2006 charges - discontinued operations | | 475 | | 52 | | 3 | | | 55 | | 3 | | 12 | |
| 2006 reversals - continuing operations | | — | | (3 | ) | (1 | ) | | (4 | ) | — | | — | |
| 2006 utilization | | (5,700 | ) | (416 | ) | (67 | ) | | (483 | ) | (100 | ) | (285 | ) |
| 2006 other adj. & reclasses | | — | | 58 | | — | | | 58 | | — | | — | |
| Balance at 12/31/06 | | 2,275 | | 228 | | 24 | | | 252 | | — | | — | |
| Q1 2007 charges - continuing operations | | 1,075 | | 53 | | 22 | | | 75 | | 11 | | 65 | |
| Q1 2007 charges - discontinued operations | | 50 | | 17 | | — | | | 17 | | — | | — | |
| Q1 2007 utilization | | (1,000 | ) | (84 | ) | (20 | ) | | (104 | ) | (11 | ) | (65 | ) |
| Q1 2007 other adj. & reclasses | | — | | (18 | ) | — | | | (18 | ) | — | | — | |
| Balance at 3/31/07 | | 2,400 | | $ | 196 | | $ | 26 | | $ | 222 | | $ | — | | $ | — | |
As a result of the initiatives already implemented under the 2004-2007 Restructuring Program, severance payments will be paid during periods through 2007 since, in many instances, the employees whose positions were eliminated can elect or are required to receive their payments over an extended period of time. Most exit costs have been paid or will be paid during 2007. However, certain costs, such as long-term lease payments, will be paid over periods after 2007.
The charges of $168 million recorded in the first quarter of 2007, excluding reversals, included $16 million applicable to FPG, $8 million applicable to CDG, $16 million applicable to the GCG, and $111 million that was applicable to manufacturing, research and development, and administrative functions, which are shared across all segments. The remaining $17 million is applicable to discontinued operations.
The restructuring actions implemented during the first quarter of 2007 under the 2004-2007 Restructuring Program are expected to generate future annual cost savings of approximately $61 million and future annual cash savings of approximately $59 million. These cost savings began to be realized by the Company beginning in the first quarter of 2005, and are expected to be fully realized by the end of 2007 as most of the actions and severance payouts are completed. These total cost savings are expected to reduce future cost of goods sold, SG&A, and R&D expenses by approximately $24 million, $32 million, and $5 million, respectively.
Based on all of the actions taken to date under the 2004-2007 Restructuring Program, the program is expected to generate annual cost savings of approximately $1,446 million, including annual cash savings of $1,390 million, as compared with pre-program levels. The Company began realizing these savings in the second quarter of 2004, and expects the savings to be fully realized by the end of 2007 as most of the actions and severance payouts are completed. These total cost savings are expected to reduce cost of goods sold, SG&A, and R&D expenses by approximately $921 million, $383 million, and $142 million, respectively.
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The above savings estimates are based primarily on objective data related to the Company's severance actions. Savings resulting from facility closures and other non-severance actions that are more difficult to quantify are not included. The Company reaffirms its estimate of total annual cost savings including both employee-related costs and facility-related costs under the extended 2004-2007 Restructuring Program of $1.6 billion to $1.8 billion, as announced in July 2005, and does not expect the final annual cost savings to differ materially from this estimate.
Pre-2004 Restructuring Programs
At March 31, 2007, the Company had remaining exit costs reserves of $6 million, relating to restructuring plans committed to or executed prior to 2004. Most of these remaining exit costs reserves represent long-term lease payments, which will continue to be paid over periods throughout and after 2007.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flow Activity
The Company’s cash and cash equivalents decreased $443 million to $1,026 million at March 31, 2007. The decrease resulted primarily from $397 million of net cash used in continuing operations from operating activities, $63 million of net cash used in continuing operations from investing activities, and $19 million of net cash used in financing activities.
The net cash used in continuing operations from operating activities of $397 million was primarily attributable to increases in inventories of $152 million and a decrease in liabilities excluding borrowings of $609 million. The increase in inventories is primarily due to: 1) seasonal build of inventory in preparation for the second and third quarter sales volumes; and 2) seasonally lower first quarter 2007 sales compared with fourth quarter 2006. The decrease in liabilities is primarily due to restructuring-related severance benefits and exit costs, payment of trade payables and payment of incentive compensation accruals. These uses of cash were partially offset by decreases in receivables of $274 million. The decrease in receivables is a result of seasonally lower sales levels in the three month period ended March 31, 2007 compared with fourth quarter 2006 sales. In addition, the Company's net loss of $151 million, which, when adjusted for earnings from discontinued operations, net of income taxes; depreciation and amortization; the loss on sales of businesses/assets; restructuring costs, asset impairments and other non-cash charges; and provision for deferred taxes, provided $91 million of operating cash. Net cash provided by discontinued operations from operating activities was $43 million.
The net cash used in continuing operations from investing activities of $63 million was utilized primarily for capital expenditures of $66 million. Net cash used in discontinued operations from investing activities was $11 million. The net cash used in financing activities of $19 million was the result of a net decrease in borrowings.
The Company’s primary uses of cash include restructuring payments, debt payments, capital additions, dividend payments, employee benefit plan payments/contributions, and working capital needs.
Capital additions were $66 million in the first quarter of 2007, with the majority of the spending supporting new products, manufacturing productivity and quality improvements, infrastructure improvements, equipment placements with customers, and ongoing environmental and safety initiatives.
During the first quarter of 2007, the Company expended $115 million against restructuring reserves and pension and other postretirement liabilities, primarily for the payment of severance benefits. Employees whose positions were eliminated could elect to receive severance payments for up to two years following their date of termination.
The Company has a dividend policy whereby it makes semi-annual payments which, when declared, will be paid on the Company’s 10th business day each July and December to shareholders of record on the close of the first business day of the preceding month.
The Company made contributions (funded plans) or paid benefits (unfunded plans) totaling approximately $29 million relating to its major U.S. and non-U.S. defined benefit pension plans in the first quarter of 2007. The Company expects its contribution (funded plans) and benefit payment (unfunded plans) requirements for its major U.S. and non-U.S. defined benefit pension plans for the balance of 2007 to be approximately $87 million.
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The Company paid benefits totaling approximately $54 million relating to its U.S., United Kingdom and Canada postretirement benefit plans in the first quarter of 2007. The Company expects to pay benefits of $153 million for its U.S., United Kingdom and Canada postretirement plans for the balance of 2007.
The Company believes that its cash flow from operations, in addition to asset sales, will be sufficient to cover its working capital and capital investment needs and the funds required for future debt reduction, restructuring payments, dividend payments, employee benefit plan payments/contributions, and modest acquisitions. The Company's cash balances and its financing arrangements will be used to bridge timing differences between expenditures and cash generated from operations.
Short-Term Borrowings
As of March 31, 2007, the Company and its subsidiaries, on a consolidated basis, maintained $1,085 million in committed bank lines of credit and $593 million in uncommitted bank lines of credit to ensure continued access to short-term borrowing capacity.
Secured Credit Facilities
On October 18, 2005 the Company closed on $2.7 billion of Senior Secured Credit Facilities (Secured Credit Facilities) under a new Secured Credit Agreement (Secured Credit Agreement) and associated Security Agreement and Canadian Security Agreement. The Secured Credit Facilities consists of a $1.0 billion 5-Year Committed Revolving Credit Facility (5-Year Revolving Credit Facility) expiring October 18, 2010 and $1.7 billion of Term Loan Facilities (Term Facilities) expiring October 18, 2012.
The 5-Year Revolving Credit Facility can be used by Eastman Kodak Company (U.S. Borrower) for general corporate purposes including the issuance of letters of credit. Amounts available under the facility can be borrowed, repaid and re-borrowed throughout the term of the facility provided the Company remains in compliance with covenants contained in the Secured Credit Agreement. As of March 31, 2007, there was no debt outstanding and $144 million of letters of credit issued under this facility.
Under the Term Facilities, $1.2 billion was borrowed at closing primarily to refinance debt originally issued under the Company’s previous $1.225 billion 5-Year Facility to finance the acquisition of Creo Inc. on June 15, 2005. The $1.2 billion consists of a $920 million 7-Year Term Loan to the U.S. Borrower and $280 million 7-Year Term Loan to Kodak Graphic Communications Canada Company (KGCCC or, the Canadian Borrower). Pursuant to the terms of the Secured Credit Agreement, an additional $500 million was available to the U.S. Borrower under the seven-year term loan facility for advance at any time through June 15, 2006. On June 15, 2006, the Company used this $500 million to refinance $500 million 6.375% Medium Term Notes, Series A, due June 15, 2006. This term loan matures on October 18, 2012 and may be prepaid in whole or in part at specified interest reset dates without penalty. These obligations are secured through asset and equity pledges as described below.
At March 31, 2007, the balances for these secured credit facilities reported in Long-term debt, net of current portion, on the Consolidated Statement of Financial Position were $857 million and $277 million for the U.S. Borrower and the Canadian Borrower, respectively. The Secured Credit Agreement requires mandatory quarterly prepayment of .25% of the outstanding advances. Debt issue costs incurred of approximately $57 million associated with the Secured Credit Facilities were recorded as an asset and are being amortized over the life of the borrowings. As a result of the payment of secured debt in connection with the sale of the Health Group, a portion of these costs will be written off in the second quarter.
On January 10, 2007, the Company announced that it had entered into an agreement to sell its Health Group to Onex Healthcare Holdings, Inc., a subsidiary of Onex Corporation. Under terms of the agreement, the Company agreed to sell its Health Group to Onex for up to $2.55 billion. The price is composed of $2.35 billion in cash at closing, plus up to $200 million in additional future payments if Onex achieves certain returns with respect to its investment. If Onex Healthcare investors realize an internal rate of return in excess of 25% on their investment, the Company will receive payment equal to 25% of the excess return, up to $200 million. The sale closed on April 30, 2007. Because of tax-loss carryforwards and other tax attributes, the Company retained the vast majority of the initial $2.35 billion cash proceeds. Consistent with the terms of the Secured Credit Agreement, on May 3, 2007 the Company used a portion of the proceeds to fully repay its approximately $1.15 billion of secured term debt.
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Pursuant to the Secured Credit Agreement and associated Security Agreement, each subsidiary organized in the U.S. jointly and severally guarantees the obligations under the Secured Credit Agreement and all other obligations of the Company and its subsidiaries to the Lenders. The guaranty is supported by the pledge of certain U.S. assets of the U.S. Borrower and the Company’s U.S. subsidiaries including, but not limited to, receivables, inventory, equipment, deposit accounts, investments, intellectual property, including patents, trademarks and copyrights, and the capital stock of "Material Subsidiaries." Excluded from pledged assets are real property, “Principal Properties” and equity interests in “Restricted Subsidiaries”, as defined in the Company’s 1988 Indenture.
"Material Subsidiaries" are defined as those subsidiaries with revenues or assets constituting 5 percent or more of the consolidated revenues or assets of the corresponding borrower. "Material Subsidiaries" are determined on an annual basis under the Secured Credit Agreement.
Pursuant to the Secured Credit Agreement and associated Canadian Security Agreement, Eastman Kodak Company and Kodak Graphic Communications Company (KGCC, formerly Creo Americas, Inc.), jointly and severally guarantee the obligations of the Canadian Borrower, to the Lenders. Subsequently, KGCC has been merged into Eastman Kodak Company. Certain assets of the Canadian Borrower in Canada were also pledged, including, but not limited to, receivables, inventory, equipment, deposit accounts, investments, intellectual property, including patents, trademarks and copyrights, and the capital stock of the Canadian Borrower's Material Subsidiaries.
Interest rates for borrowings under the Secured Credit Agreement are dependent on the Company’s Long Term Senior Secured Credit Rating. The Secured Credit Agreement contains various affirmative and negative covenants customary in a facility of this type, including two quarterly financial covenants: (1) a consolidated debt for borrowed money to consolidated earnings before interest, taxes, depreciation and amortization (EBITDA) (subject to adjustments to exclude any extraordinary income or losses, as defined by the Secured Credit Agreement, interest income and certain non-cash items of income and expense) ratio of not greater than: 3.50 to 1 as of December 31, 2006 and thereafter, and (2) a consolidated EBITDA to consolidated interest expense (subject to adjustments to exclude interest expense not related to borrowed money) ratio, on a rolling four-quarter basis, of no less than 3 to 1. As of March 31, 2007, the Company was in compliance with all covenants under the Secured Credit Agreement.
In addition, subject to various conditions and exceptions in the Secured Credit Agreement, in the event the Company sells assets for net proceeds totaling $75 million or more in any year, except for proceeds used within 12 months for reinvestments in the business of up to $300 million, proceeds from sales of assets used in the Company's non-digital products and services businesses to prepay or repay debt or pay cash restructuring charges within 12 months from the date of sale of the assets, or proceeds from the sale of inventory in the ordinary course of business, the amount in excess of $75 million must be applied to prepay loans under the Secured Credit Agreement.
The Company pays a commitment fee at an annual rate of 50 basis points on the undrawn balance of the 5-Year Revolving Credit Facility at the Company’s current credit rating of Ba3 and B+ from Moody's Investor Services, Inc. (Moody's) and Standard & Poor's Rating Services (S&P), respectively. This fee amounts to $5 million annually, and is reported as interest expense in the Company's Consolidated Statement of Operations.
In addition to the 5-Year Revolving Credit Facility, the Company has other committed and uncommitted lines of credit at March 31, 2007 totaling $85 million and $593 million, respectively. These lines primarily support borrowing needs of the Company’s subsidiaries, which include term loans, overdraft coverage, letters of credit and revolving credit lines. Interest rates and other terms of borrowing under these lines of credit vary from country to country, depending on local market conditions. Total outstanding borrowings against these other committed and uncommitted lines of credit at March 31, 2007 were $18 million and $8 million, respectively. These outstanding borrowings are reflected in the short-term borrowings in the accompanying Consolidated Statement of Financial Position at March 31, 2007.
At March 31, 2007, the Company had outstanding letters of credit totaling $144 million and surety bonds in the amount of $99 million primarily to ensure the payment of possible casualty and workers' compensation claims, environmental liabilities, and to support various customs and trade activities.
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Debt Shelf Registration and Convertible Securities
On September 5, 2003, the Company filed a shelf registration statement on Form S-3 (the primary debt shelf registration) for the issuance of up to $2.0 billion of new debt securities. Pursuant to Rule 429 under the Securities Act of 1933, $650 million of remaining unsold debt securities under a prior shelf registration statement were included in the primary debt shelf registration, thus giving the Company the ability to issue up to $2.65 billion in public debt. After issuance of $500 million in notes in October 2003, the remaining availability under the primary debt shelf registration was $2.15 billion.
The Company has $575 million aggregate principal amount of Convertible Senior Notes due 2033 (the Convertible Securities) on which interest accrues at the rate of 3.375% per annum and is payable semiannually. The Convertible Securities are unsecured and rank equally with all of the Company’s other unsecured and unsubordinated indebtedness. The Convertible Securities may be converted, at the option of the holders, to shares of theCompany’s common stock if the Company’s Senior Unsecured credit rating assigned to the Convertible Securities by either Moody’s or S&P is lower than Ba2 or BB, respectively. At the Company's current Senior Unsecured credit rating, the Convertible Securities may be converted by their holders.
The Company's $1.0 billion 5-year Committed Revolving Credit Facility, along with other committed and uncommitted credit lines, and cash balances, provide the Company with adequate liquidity to meet its working capital and investing needs.
Credit Quality
Moody's and S&P's ratings for the Company, including their outlooks, as of the filing date of this Form 10-Q are as follows:
| | | Senior | | | | Senior | | |
| | | Secured | | Corporate | | Unsecured | | |
| | | Rating | | Rating | | Rating | | Outlook |
| Moody's | | Ba1 | | B1 | | B2 | | Stable |
| S&P | | B+ | | B+ | | B | | Negative |
On May 7, 2007, Moody’s concluded a review for possible downgrade, which was initiated in May 2006 after the Company announced its intention to explore strategic alternatives for its Health business. As a result, the Company’s Corporate and Senior Unsecured ratings were confirmed at B1 and B2, respectively, and the Secured rating, reflecting the remaining 5-Year Revolving Credit Facility, was upgraded from Ba3 to Ba1. The rating outlook was changed from negative to stable.
Moody’s ratings reflect their views regarding the Company’s significant challenges to replace revenue and cash flow from declining legacy film businesses as well as the Company’s market position, operating profit margin and free cash flow volatility, asset returns (net of cash), financial leverage, and liquidity.
The stable rating outlook reflects Moody’s expectation that the Company will continue to maintain liquidity and generate earnings sufficient to withstand further secular declines of its legacy film businesses, lack of substantial profitability in certain of its digital businesses and its sizable new business start up costs.
On January 10, 2007, S&P stated that they would keep the Company on credit watch with negative implications, as the Company was placed on credit watch on August 2, 2006. They have concerns that the anticipated debt reduction associated with the sale of the Health Group (announced on January 10, 2007) will not fully offset their view of a negative shift in the Company's business portfolio.
The Company is in compliance with all covenants or other requirements set forth in its credit agreements and indentures. Further, the Company does not have any rating downgrade triggers that would accelerate the maturity dates of its debt. However, the Company could be required to increase the dollar amount of its letters of credit or provide other financial support up to an additional $71 million at the current credit ratings. As of the filing date of this Form 10-Q, the Company has not been requested to materially increase its letters of credit or other financial support. However, at the current Senior Unsecured Rating of B2 by Moody's and B by S&P, Convertible Securities holders may, at their option, convert their Convertible Securities to common stock. Further downgrades in the Company’s credit rating or disruptions in the capital markets could impact borrowing costs and the nature of its funding alternatives. However, further downgrades will not impact borrowing costs under the Company's $1.0 billion 5-Year Committed Revolving Credit Facility.
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OFF-BALANCE SHEET ARRANGEMENTS
The Company guarantees debt and other obligations of certain customers. At March 31, 2007, these guarantees totaled a maximum of $151 million, with outstanding guaranteed amounts of $112 million. The maximum guarantee amount includes guarantees of up to: $149 million of customer amounts due to banks and leasing companies in connection with financing of customers' purchases of product and equipment from the Company ($112 million outstanding), and $2 million to other third parties (less than $1 million outstanding).
The guarantees for the third party debt mature between 2007 and 2011. The customer financing agreements and related guarantees typically have a term of 90 days for product and short-term equipment financing arrangements, and up to five years for long-term equipment financing arrangements. These guarantees would require payment from the Company only in the event of default on payment by the respective debtor. In some cases, particularly for guarantees related to equipment financing, the Company has collateral or recourse provisions to recover and sell the equipment to reduce any losses that might be incurred in connection with the guarantees.
Management believes the likelihood is remote that material payments will be required under any of the guarantees disclosed above. With respect to the guarantees that the Company issued in the quarter ended March 31, 2007, the Company assessed the fair value of its obligation to stand ready to perform under these guarantees by considering the likelihood of occurrence of the specified triggering events or conditions requiring performance as well as other assumptions and factors.
The Company also guarantees debt owed to banks and other third parties for some of its consolidated subsidiaries. The maximum amount guaranteed is $746 million, and the outstanding debt under those guarantees, which is recorded within the short-term borrowings and long-term debt, net of current portion components in the accompanying Consolidated Statement of Financial Position, is $247 million. These guarantees expire in 2007 through 2013. Pursuant to the terms of the Company's $2.7 billion Senior Secured Credit Agreement dated October 18, 2005, obligations under the $2.7 billion Secured Credit Facilities and other obligations of the Company and its subsidiaries to the $2.7 billion Secured Credit Facilities lenders are guaranteed.
The Company issues indemnifications in certain instances when it sells businesses and real estate, and in the ordinary course of business with its customers, suppliers, service providers and business partners. Further, the Company indemnifies its directors and officers who are, or were, serving at the Company's request in such capacities. Historically, costs incurred to settle claims related to these indemnifications have not been material to the Company’s financial position, results of operations or cash flows. Additionally, the fair value of the indemnifications that the Company issued during the quarter ended March 31, 2007 was not material to the Company’s financial position, results of operations or cash flows.
OTHER
As of March 31, 2007, there has been no material change in the Company's environmental liability exposure and, therefore, no material change in the undiscounted accrued liabilities for environmental remediation costs relative to December 31, 2006 or March 31, 2006.
RECENT ACCOUNTING PRONOUNCEMENTS
FASB Statement No. 155
In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments (an amendment of FASB Statements No. 133 and 140)." This Statement permits fair value measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. SFAS No. 155 is effective for all financial instruments acquired, issued, or subject to a remeasurement event occurring after the beginning of an entity's first fiscal year that begins after September 15, 2006 (year ending December 31, 2007 for the Company). Additionally, the fair value option may also be applied upon adoption of this Statement for hybrid financial instruments that had been bifurcated under previous accounting guidance prior to the adoption of this Statement. The adoption of SFAS No. 155 in the first quarter of 2007 did not have a material impact on the Company’s Consolidated Financial Statements.
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FASB Interpretation No. 48
In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" (FIN 48). FIN 48 clarifies the accounting and reporting for uncertainty in income taxes recognized in accordance with SFAS No. 109, "Accounting for Income Taxes." This Interpretation prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on various related matters such as derecognition, interest and penalties, and disclosure. The adoption of FIN 48 in the first quarter of 2007 did not have a material impact on the Company’s Consolidated Financial Statements. Further information regarding the adoption of FIN 48 is disclosed in Note 5, "Income Taxes."
FASB Statement No. 157
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements," which establishes a comprehensive framework for measuring fair value in GAAP and expands disclosures about fair value measurements. Specifically, this Statement sets forth a definition of fair value, and establishes a hierarchy prioritizing the inputs to valuation techniques, giving the highest priority to quoted prices in active markets for identical assets and liabilities and the lowest priority to unobservable inputs. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The provisions of SFAS No. 157 are generally required to be applied on a prospective basis, except to certain financial instruments accounted for under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," for which the provisions of SFAS No. 157 should be applied retrospectively. The Company will adopt SFAS No. 157 in the first quarter of 2008.
FASB Statement No. 159
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities," which permits entities to choose to measure, on an item-by-item basis, specified financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected are required to be reported in earnings at each reporting date. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The provisions of this statement are required to be applied prospectively. The Company expects to adopt SFAS No. 159 in the first quarter of 2008.
CAUTIONARY STATEMENT PURSUANT TO SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Certain statements in this report may be forward-looking in nature, or "forward-looking statements" as defined in the United States Private Securities Litigation Reform Act of 1995. For example, references to the Company's expectations for sales of assets, restructuring plans and charges, new products, depreciation, cost savings, cash savings, and employment reductions are forward-looking statements.
Actual results may differ from those expressed or implied in forward-looking statements. In addition, any forward-looking statements represent the Company's estimates only as of the date they are made, and should not be relied upon as representing the Company's estimates as of any subsequent date. While the Company may elect to update forward-looking statements at some point in the future, the Company specifically disclaims any obligation to do so, even if its estimates change. The forward-looking statements contained in this report are subject to a number of factors and uncertainties, including the successful:
- execution of the digital growth and profitability strategies, business model and cash plan;
- implementation of the cost reduction programs;
- transition of certain financial processes and administrative functions to a global shared services model andthe outsourcing of certain functions to third parties;
- implementation of, and performance under, the debt management program, including compliance with theCompany's debt covenants;
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- development and implementation of go-to-market, product launch and e-commerce strategies;
- protection, enforcement and defense of the Company's intellectual property, including defense of itsproducts against the intellectual property challenges of others;
- implementation of intellectual property licensing and other strategies;
- completion of information systems upgrades, including SAP, the Company's enterprise system software;
- completion of various portfolio actions;
- reduction of inventories;
- integration of acquired businesses;
- improvement in manufacturing productivity and techniques;
- improvement in receivables performance;
- improvement in supply chain efficiency; and
- implementation of the strategies designed to address the decline in the Company's traditional businesses.
The forward-looking statements contained in this report are subject to the following additional risk factors:
- inherent unpredictability of currency fluctuations, commodity prices and raw material costs;
- competitive actions, including pricing;
- changes in the Company's debt credit ratings and its ability to access capital markets;
- the nature and pace of technology evolution;
- changes to accounting rules and to tax laws, as well as other factors which could impact the Company'sreported financial position or effective tax rate;
- general economic, business, geo-political and regulatory conditions;
- market growth predictions;
- continued effectiveness of internal controls; and
- other factors and uncertainties disclosed from time to time in the Company's filings with the Securities andExchange Commission.
Any forward-looking statements in this report should be evaluated in light of these important factors and uncertainties.
Item 3. Quantitative And Qualitative Disclosures About Market Risk
The Company, as a result of its global operating and financing activities, is exposed to changes in foreign currency exchange rates, commodity prices, and interest rates, which may adversely affect its results of operations and financial position. In seeking to minimize the risks associated with such activities, the Company may enter into derivative contracts.
Foreign currency forward contracts are used to hedge existing foreign currency denominated assets and liabilities, especially those of the Company’s International Treasury Center, as well as forecasted foreign currency denominated intercompany sales. Silver forward contracts are used to mitigate the Company’s risk to fluctuating silver prices. The Company’s exposure to changes in interest rates results from its investing and borrowing activities used to meet its liquidity needs. Long-term debt is generally used to finance long-term investments, while short-term debt is used to meet working capital requirements. The Company does not utilize financial instruments for trading or other speculative purposes.
Using a sensitivity analysis based on estimated fair value of open forward contracts using available forward rates, if the U.S. dollar had been 10% weaker at March 31, 2007 and 2006, the fair value of open forward contracts would have increased $8 million and decreased $30 million, respectively. Such gains or losses would be substantially offset by losses or gains from the revaluation or settlement of the underlying positions hedged.
There were no open forward contracts hedging silver at March 31, 2007. Using a sensitivity analysis based on estimated fair value of open forward contracts using available forward prices, if available forward silver prices had been 10% lower at March 31, 2006, the fair value of open forward contracts would have decreased $1 million. Such losses in fair value, if realized, would be offset by lower costs of manufacturing silver-containing products.
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The Company is exposed to interest rate risk primarily through its borrowing activities and, to a lesser extent, through investments in marketable securities. The Company may utilize borrowings to fund its working capital and investment needs. The majority of short-term and long-term borrowings are in fixed-rate instruments. There is inherent roll-over risk for borrowings and marketable securities as they mature and are renewed at current market rates. The extent of this risk is not predictable because of the variability of future interest rates and business financing requirements.
Using a sensitivity analysis based on estimated fair value of short-term and long-term borrowings, if available market interest rates had been 10% (about 64 basis points) higher at March 31, 2007, the fair value of short-term and long-term borrowings would have decreased less than $1 million and $58 million, respectively. Using a sensitivity analysis based on estimated fair value of short-term and long-term borrowings, if available market interest rates had been 10% (about 61 basis points) higher at March 31, 2006, the fair value of short-term and long-term borrowings would have decreased $1 million and $64 million, respectively.
The Company’s financial instrument counterparties are high-quality investment or commercial banks with significant experience with such instruments. The Company manages exposure to counterparty credit risk by requiring specific minimum credit standards and diversification of counterparties. The Company has procedures to monitor the credit exposure amounts. The maximum credit exposure at March 31, 2007 was not significant to the Company.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. The Company’s management, with participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. The Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this Quarterly Report on Form 10-Q, the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were effective.
Changes in Internal Control over Financial Reporting
There have been no changes in the Company’s internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
During March 2005, the Company was contacted by members of the Division of Enforcement of the SEC concerning the announced restatement of the Company's financial statements for the full year and quarters of 2003 and the first three unaudited quarters of 2004. An informal inquiry by the staff of the SEC into the substance of that restatement is continuing. The Company continues to fully cooperate with this inquiry, and the staff has indicated that the inquiry should not be construed as an indication by the SEC or its staff that any violations of law have occurred.
On or about November 9, 2005, the Company was served with a purported shareholder derivative lawsuit that had been commenced against the Company, as a nominal defendant, and eleven current and former directors and officers of the Company, in the New York State Supreme Court, Monroe County. The Complaint seeks to allege claims on behalf of the Company that, between April 2003 and September 2003, the defendant officers and directors caused the Company to make allegedly improper statements, in press release and other public statements, which falsely represented or omitted material information about the Company’s financial results and guidance. The plaintiff alleges that this conduct was a breach of the defendants’ common law fiduciary obligations to the Company, and constituted an abuse of control, gross mismanagement, waste and unjust enrichment. On March 8, 2007, the court approved plaintiff's discontinuance of this action with prejudice, and therefore, this matter is concluded.
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The Company is named a Potentially Responsible Party (“PRP”) along with seven other companies in connection with certain alleged environmental contamination at the Rochester Fire Academy, located in Rochester, New York. The Company provided flammable materials to the Fire Academy, which were used in fire-fighting training. The Company and the seven other PRPs have been negotiating with the New York State Attorney General’s office. On November 15, 2005, the New York State Attorney General filed a complaint in the U.S. District Court, Western District of New York against all eight PRPs seeking recovery of expenses to remediate the site. The companies have reached a conceptual settlement with the NYS Attorney General, which when approved by the court, will result in the Company paying approximately $196,000.
The Company is one of several Potentially Responsible Parties named in connection with the closure of the LWD, Inc. site; a former permitted hazardous waste treatment facility in Calvert City, Kentucky. The Company has entered into a Consent Order with the EPA based upon evidence that the Company sent waste to the facility for incineration. The Company’s expected cost in connection with this matter is estimated to be $150,000.
Item 6. Exhibits
(a) Exhibits required as part of this report are listed in the index appearing on page 47.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | | EASTMAN KODAK COMPANY | |
| | | (Registrant) | |
| | | |
| Date: | May 9, 2007 | /s/ Diane E. Wilfong | |
| | | Diane E. Wilfong | |
| | | Controller | |
PAGE 47
Eastman Kodak Company and Subsidiary Companies
Index to Exhibits
| Exhibit | | | |
| Number | | | |
| (10) | | | | A. | | Philip J. Faraci Agreement dated November 3, 2004.
(Incorporated by reference to the Eastman Kodak Company Annual Report on Form 10-K for the fiscal year ended December 31, 2005, Exhibit 10.) |
| | | | |
| | | | | | Amendment, dated February 28, 2007, to Philip J. Faraci Letter Agreement dated November 3, 2004.
(Incorporated by reference to the Eastman Kodak Company Current Report on Form 8-K, filed on March 1, 2007, Exhibit 99.2.) |
| |
| | | | M. | | James Langley Agreement dated August 12, 2003.
(Incorporated by reference to the Eastman Kodak Company Annual Report on Form 10-K for the fiscal year ended December 31, 2004, Exhibit 10.) |
| | | | |
| | | | Amendment, dated February 28, 2007, to James T. Langley Letter Agreement dated August 12, 2003.
(Incorporated by reference to the Eastman Kodak Company Current Report on Form 8-K, filed on March 1, 2007, Exhibit 99.3.) |
| | | | |
| | | | V. | | Antonio M. Perez Agreement dated March 3, 2003.
(Incorporated by reference to the Eastman Kodak Company Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2003, Exhibit 10 Z.) |
| | | | |
| | | | Letter dated May 10, 2005, from the Chair, Executive Compensation and Development Committee, to Antonio M. Perez.
(Incorporated by reference to the Eastman Kodak Company Current Report on Form 8-K, filed on May 11, 2005, Exhibit 10.2.) |
| | | | | |
| | | | Notice of Award of Restricted Stock with a Deferral Feature Granted to Antonio M. Perez, effective June 1, 2005, pursuant to the 2005 Omnibus Long-Term Compensation Plan.
(Incorporated by reference to the Eastman Kodak Company Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005, Exhibit 10 CC.) |
| | | | |
| | | | Amendment, dated February 27, 2007, to Antonio M. Perez Letter Agreement dated March 3, 2003.
(Incorporated by reference to the Eastman Kodak Company Current Report on Form 8-K, filed on March 1, 2007, Exhibit 99.1.) |
| | | | |
| | | | CC. | | Asset Purchase Agreement between Eastman Kodak Company and Onex Healthcare Holdings, Inc., dated as of January 9, 2007. |
| | | | |
| | | | Amendment No. 1 To the Asset Purchase Agreement |
| | | | |
| (12) | | | | Statement Re Computation of Ratio of Earnings to Fixed Charges. |
| | | | |
| (31.1) | | | | Certification. |
| | | | |
| (31.2) | | | | Certification. |
| | | | |
| (32.1) | | | | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | | | |
| (32.2) | | | | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
