-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, U2bQhZHAF2q/rn2z/X3ERflXZa+0eOdWA8YZ31UnOZ0zOgTFQ2RjE1+9FyIDnQIQ p/Fy6Fm6tV08Gm05zf38fQ== 0000031235-99-000001.txt : 19990311 0000031235-99-000001.hdr.sgml : 19990311 ACCESSION NUMBER: 0000031235-99-000001 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990310 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EASTMAN KODAK CO CENTRAL INDEX KEY: 0000031235 STANDARD INDUSTRIAL CLASSIFICATION: PHOTOGRAPHIC EQUIPMENT & SUPPLIES [3861] IRS NUMBER: 160417150 STATE OF INCORPORATION: NJ FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-00087 FILM NUMBER: 99561732 BUSINESS ADDRESS: STREET 1: 343 STATE ST CITY: ROCHESTER STATE: NY ZIP: 14650 BUSINESS PHONE: 7167244000 10-K 1 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K X Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the year ended December 31, 1998 or Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to Commission File Number 1-87 EASTMAN KODAK COMPANY (Exact name of registrant as specified in its charter) NEW JERSEY 16-0417150 (State of incorporation) (IRS Employer Identification No.) 343 STATE STREET, ROCHESTER, NEW YORK 14650 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 716-724-4000 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered Common Stock, $2.50 par value New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark 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. X At December 31, 1998 322,798,358 shares of Common Stock of the registrant were outstanding. The aggregate market value (based upon the closing price of these shares on the New York Stock Exchange at January 12, 1999) of the voting stock held by nonaffiliates was approximately $25.7 billion. 2 PART I ITEM 1. BUSINESS Eastman Kodak Company (the Company or Kodak) is engaged primarily in developing, manufacturing and marketing consumer, professional, health and other imaging products. Kodak's sales, earnings and identifiable assets by operating segment for the past three years are shown in Note 18, Segment Information. - --------------------------------------------------------------------------- CONSUMER IMAGING SEGMENT Sales of the Consumer Imaging segment for 1998, 1997 and 1996 were (in millions) $7,164, $7,681 and $7,659, respectively. Kodak manufactures and markets various components of consumer imaging systems. For traditional consumer amateur photography, Kodak supplies films, photographic papers, processing services, photofinishing equipment, photographic chemicals, cameras (including single-use) and projectors. The Advanced Photo System is an amateur system of cameras, films and photofinishing which delivers a variety of consumer features such as drop- in loading, multiple print size options, index prints, and negatives returned in the cartridge. Kodak has also developed products that bridge traditional silver halide and digital products. These products include kiosks and scanning systems to digitize images, digital media for storing images, software for enhancing images and a network for transmitting images. Marketing and Competition. Kodak's consumer imaging products and services are distributed worldwide through a variety of channels. Individual products are often used in substantial quantities in more than one market. Most sales of the Consumer Imaging segment are made through retailers. Independent retail outlets selling Kodak amateur products total many thousands. In a few areas abroad, Kodak products are marketed by independent national distributors. In addition, certain consumer products may be purchased through the Internet. Kodak's advertising programs actively promote its consumer imaging products and services in its various markets, and its principal trademarks, trade dress and corporate symbol are widely used and recognized. Kodak's consumer imaging products and services compete with similar products and services of others. Competition in traditional and digital consumer imaging markets is strong throughout the world. Many large and small companies offer similar consumer products and services that compete with Kodak's business. Kodak's products are continually improved to meet the changing needs and preferences of its customers. Raw Materials. The raw materials used by the Consumer Imaging segment are many and varied and generally available. Silver is one of the essential materials in traditional photographic film and paper manufacturing. Digital electronic components are becoming more prevalent in product offerings. - ------------------------------------------------------------------------ 3 KODAK PROFESSIONAL SEGMENT Sales of the Kodak Professional segment for 1998, 1997 and 1996 were (in millions) $1,840, $2,272 and $2,367, respectively. Products of the Kodak Professional segment include films, photographic papers, digital cameras, printers and scanners, chemicals, and services targeted to professional customers. These products serve professional photofinishers, professional photographers and commercial printers and publishers. Kodak Polychrome Graphics, a 50/50 joint venture with Sun Chemical Corporation, was formed on December 31, 1997. The joint venture assumed responsibility for the photographic plate business, as well as for the marketing of Kodak graphic arts film, and proofing materials and equipment. Sales for the segment decreased in 1998 primarily because the Company now sells graphics products to the joint venture, rather than selling completed products to final customers. Marketing and Competition. Kodak's professional imaging products and services are distributed through a variety of channels, including the Internet. Most sales of the Kodak Professional segment are made to professional photographers, printers and publishers. Kodak's professional imaging products and services compete with similar products and services of other small and large companies. Strong competition exists throughout the world in these markets. Kodak's products are continually improved to meet the changing needs and preferences of its customers. Raw Materials. The raw materials used by the Kodak Professional segment are many and varied and generally available. Silver is one of the essential materials used in the manufacturing of professional photographic, industrial x-ray, and graphic arts film, and paper. Digital electronic components are becoming more prevalent in product offerings. - ------------------------------------------------------------------------ 4 HEALTH IMAGING SEGMENT Sales of the Health Imaging segment for 1998, 1997 and 1996 were (in millions) $1,526, $1,532 and $1,627, respectively. The products of the Health Imaging segment are used to capture, store, process, print and display images and information in a variety of forms for customers in the health care industry, for both primary and referral diagnoses. Products of the Health Imaging segment include medical films, chemicals, and processing equipment, as well as services for health care professionals. The Health Imaging segment serves customers for general radiology products and specialty health markets, including cardiology, dental, mammography, oncology and ultrasound imaging. On November 30, 1998, Kodak acquired the worldwide medical imaging business of Imation Corp., which includes Imation's manufacturing facilities in White City, Oregon and Oakdale, Minnesota, and all of the outstanding shares of Imation's Cemax-Icon subsidiary in Fremont, California. The acquired business generates approximately $500 million in revenues annually. See Note 16, Acquisitions and Joint Ventures. Marketing and Competition. Kodak's health imaging products and services are distributed through a variety of channels, primarily to health care organizations. Kodak's health imaging products and services compete with similar products and services of other small and large companies. Strong competition exists throughout the world in these markets. Kodak's products are continually improved to meet the changing needs and preferences of its health care customers. Raw Materials. The raw materials used by the Health Imaging segment are many and varied and generally available. Silver is one of the essential materials used in X-ray film manufacturing. - ------------------------------------------------------------------------ 5 OTHER IMAGING SEGMENT Sales of the Other Imaging segment for 1998, 1997 and 1996 were (in millions) $2,876, $3,053 and $4,315, respectively. Products of the Other Imaging segment include motion picture films, audiovisual equipment, certain digital cameras and printers, copiers, microfilm products, applications software, printers, scanners and other business equipment, as well as supplies and service agreements to support certain of these products. These products serve customers primarily in motion picture and television, office automation, and government markets. Marketing and Competition. Products and services of the Other Imaging segment are distributed through a variety of channels. The Company also sells and leases business equipment directly to users, and has a presence on the Internet. The Company manufactures copiers and sells them through its non-exclusive distributor, Danka Business Systems PLC (Danka), and through OEM (Original Equipment Manufacturer) channels. See Management's Discussion and Analysis of Financial Condition and Results of Operations for further discussion. These products and services compete with similar products and services of other small and large companies. Strong competition exists throughout the world in these markets. Kodak's products are continually improved to meet the changing needs and preferences of its customers. Raw Materials. The raw materials used are many and varied and generally available. Silver is one of the essential materials in traditional film manufacturing. Electronic components represent a significant portion of the cost of the materials used in the manufacture of business equipment. - --------------------------------------------------------------------------- 6 RESEARCH AND DEVELOPMENT Through the years, Kodak has engaged in extensive and productive efforts in research and development. Research and development expenditures for 1998, 1997 and 1996 were (in millions) $922, $1,230 and $1,028, respectively. The 1998 figure includes a $42 million charge for the write-off of in- process research and development associated with the acquisition of Imation Corp.'s worldwide medical imaging business on November 30, 1998. The 1997 figure includes a $186 million charge for the write-off of in-process research and development associated with the acquisition of Wang Laboratories' software unit on March 17, 1997. See Note 15, Acquisitions and Joint Ventures. Research and development groups are located principally in the United States in Rochester, New York. Outside the U.S., research and development groups are located principally in Australia, England, France, Japan and Germany. These groups, in close cooperation with manufacturing units and marketing organizations, are constantly developing new products and applications to serve both existing and new markets. It has been Kodak's general practice to protect its investment in research and development and its freedom to use its inventions by obtaining patents where feasible. The ownership of these patents contributes to Kodak's ability to use its inventions but at the same time is accompanied by patent licensing. While in the aggregate Kodak's patents are considered to be of material importance in the operation of its business, the Company does not consider that the patents relating to any single product or process are of material significance when judged from the standpoint of its total business. - --------------------------------------------------------------------------- ENVIRONMENTAL PROTECTION Kodak is subject to various laws and governmental regulations concerning environmental matters. Some of the U.S. federal environmental legislation having an impact on Kodak includes the Toxic Substances Control Act, the Resource Conservation and Recovery Act (RCRA), the Clean Air Act, and the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (the Superfund law). It is the Company's policy to carry out its business activities in a manner consistent with sound health, safety and environmental management practices, and to comply with applicable health, safety and environmental laws and regulations. Kodak continues to engage in a program for environmental protection and control. Environmental protection is further discussed in Item 3, Legal Proceedings, and in the Notes to Financial Statements. - --------------------------------------------------------------------------- EMPLOYMENT At the end of 1998, the Company employed 86,200 people, of whom 46,300 were employed in the U.S. - --------------------------------------------------------------------------- 7 Financial information by geographic areas for the past three years is shown in Note 18, Segment Information. - --------------------------------------------------------------------------- ITEM 2. PROPERTIES The Consumer Imaging segment of Kodak's business in the United States is centered in Rochester, New York, where photographic goods are manufactured. Another manufacturing facility near Windsor, Colorado, also produces sensitized photographic goods. Consumer imaging manufacturing facilities outside the United States are located in Australia, Brazil, Canada, China, England, France, India, Indonesia, Mexico and Russia. Kodak maintains marketing and distribution facilities in many parts of the world. The Company also owns processing laboratories in numerous locations worldwide. Products in the Kodak Professional segment are manufactured in the United States primarily in Rochester, New York. Manufacturing facilities outside the United States are located in Brazil, Canada, China, England, France, Germany, Japan and Mexico. Products in the Health Imaging segment are manufactured in the United States primarily in Rochester, New York; Windsor, Colorado; Oakdale, Minnesota; White City, Oregon; and Fremont, California. Manufacturing facilities outside the United States are located in Brazil, China, France, Germany, India and Mexico. Products in the Other Imaging segment are manufactured in the United States primarily in Rochester, New York and Windsor, Colorado. Manufacturing facilities outside the United States are located in Brazil, Canada, England, France, Germany, India, Ireland and Mexico. Properties within a country are generally shared by all segments operating within that country. Regional distribution centers are located in various places within and outside of the United States. The Company owns or leases administrative, manufacturing, marketing and processing facilities in various parts of the world. The leases are for various periods and are generally renewable. - --------------------------------------------------------------------------- Item 3. LEGAL PROCEEDINGS In April 1987, the Company was sued in federal district court in San Francisco by a number of independent service organizations who alleged violations of Sections 1 and 2 of the Sherman Act and of various state statutes in the sale by the Company of repair parts for its copier and micrographics equipment (Image Technical Service, Inc. et al v. Eastman Kodak Company, "ITS"). The complaint sought unspecified compensatory and punitive damages. Trial began on June 19, 1995 and concluded on September 18, 1995 with a jury verdict for plaintiffs of $23,948,300 ($71,844,900 after trebling). The Company appealed the jury's verdict, and on August 26, 1997 the 9th Circuit Court of Appeals rendered its decision affirming in part, reversing in part, and reversing and 8 remanding on the issue of used equipment damages. The court affirmed the jury's liability rulings, but reduced damages (after trebling) from $71,844,900 to $35,818,200, and narrowed the scope of the injunction under which the Company is required to make parts available. On April 27, 1998, the Supreme Court denied the Company's petition for Supreme Court review, effectively concluding all aspects of the case except plaintiffs' used equipment claim. The Company took a third quarter 1997 pre-tax charge of $46,000,000. Two cases that raise essentially the same antitrust issues as ITS are Nationwide, et al v. Eastman Kodak Company, filed March 10, 1995, and A-1 Copy Center, et al v. Eastman Kodak Company, filed December 13, 1993. Both cases were filed in federal district court in San Francisco. A-1 is a consolidated class action. The complaints in both cases seek unspecified compensatory and punitive damages. On September 16, 1998, the Company and plaintiffs in ITS, Nationwide, and A-1 engaged in a successful mediation, effectively concluding these cases. Under the terms of the mediated settlement, the Company will make payments to plaintiffs in return for plaintiffs' discontinuance of the litigation, with prejudice. The amount of the Company's payments, which was covered by previously recorded reserves, will not be material to the Company's financial position or results of operations. A fourth repair parts case, Broward Microfilm, Inc. v. Eastman Kodak Company, a purported national class action which was filed February 27, 1996 in federal district court in Miami, was dismissed without prejudice on May 13, 1998. On July 7, 1998, the Company received a proposed administrative Consent Order seeking unspecified penalties and a compliance schedule from the New York State Department of Environmental Conservation, to address alleged violations of the Environmental Conservation Law and regulations at the Company's Kodak Park manufacturing complex in Rochester, New York. The violations alleged are primarily comprised of air, water, and hazardous substance releases and incidents, largely accidental, that have been reported by the Company to the Agency over the past five years. The Company expects that it will be assessed a civil penalty in excess of $100,000. The entire matter is subject to negotiation, which can be expected to result in an administrative settlement that will include a penalty and a compliance schedule for implementation of maintenance, upgrade, and reporting activities. - --------------------------------------------------------------------------- 9 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. - -------------------------------------------------------------------------- EXECUTIVE OFFICERS OF THE REGISTRANT Pursuant to General Instructions G(3) of Form 10-K, the following list is included as an unnumbered item in Part I of this report in lieu of being included in the Proxy Statement for the Annual Meeting of Shareholders. (as of December 31, 1998) Date First Elected an to Executive Present Name Age Positions Held Officer Office George M. C. Fisher 58 Chairman of the Board, Chief Executive Officer 1993 1995 Joerg D. Agin 56 Senior Vice President 1996 1996 Michael P. Benard 51 Vice President 1994 1994 Richard T. Bourns * 64 Senior Vice President 1988 1990 Daniel A. Carp 50 President and Chief Operating Officer 1995 1997 Martin M. Coyne, II 49 Vice President 1997 1995 Jesse J. Greene, Jr. 53 Vice President, Finance 1998 1998 Carl E. Gustin, Jr. 47 Senior Vice President 1995 1995 Harry L. Kavetas 61 Chief Financial Officer and Executive Vice President 1994 1994 Robert J. Keegan 51 Senior Vice President 1997 1997 Carl F. Kohrt 55 Executive Vice President and Assistant Chief Operating Officer 1995 1995 Michael P. Morley 55 Senior Vice President 1994 1994 Candy M. Obourn 48 Vice President 1997 1991 E. Mark Rajkowski 40 Controller 1998 1998 Willy C. Shih 47 Vice President 1997 1997 Patrick T. Siewert 43 Vice President 1997 1995 Eric L. Steenburgh 57 Executive Vice President and Assistant Chief Operating Officer 1998 1998 Gary P. Van Graafeiland 52 General Counsel and Senior Vice President 1992 1992 * Retired February 1, 1999 10 Executive officers are elected annually in February. All of the executive officers have been employed by Kodak in various executive and managerial positions for more than five years, except Mr. Kavetas, who joined the Company on February 11, 1994; Mr. Greene, who joined the Company on June 20, 1994; Mr. Gustin, who joined the Company on August 15, 1994; Mr. Agin, who joined the Company on September 1, 1995; Mr. Coyne, who joined the Company on September 5, 1995; Mr. Keegan, who joined the Company on July 1, 1997; Mr. Shih, who joined the Company on July 7, 1997; Mr. Steenburgh, who joined the Company on April 13, 1998; and Mr. Rajkowski, who joined the Company on July 13, 1998. Prior to joining Kodak, Mr. Kavetas held executive positions with International Business Machines (IBM) Corporation, most recently as President, Chief Executive Officer and a director of IBM Credit Corporation. Prior to joining Kodak, Mr. Greene held executive positions with International Business Machines (IBM) Corporation, most recently as Assistant Treasurer. Prior to joining Kodak, Mr. Gustin held executive positions with Digital Equipment Corporation (DEC), which he joined in 1994, and Apple Computer. Prior to joining Kodak in 1995, Mr. Agin held executive positions with Universal Studios, most recently as Senior Vice President, New Technology and Business Development. Prior to joining Kodak in 1995, Mr. Coyne was president of his own consulting firm, "M. M. Coyne & Associates." Mr. Coyne was previously employed by Kodak, leaving early in 1995 from the position of Executive Director, Health Group Marketing. Prior to joining Kodak in 1997, Mr. Keegan held the position of Executive Vice President with Avery Dennison Corporation since 1995. Mr. Keegan was previously employed by Kodak, leaving in 1995 from the position of General Manager of Consumer Imaging for Kodak's European, Middle Eastern and African Region. Prior to joining Kodak, Mr. Shih was Vice President of Marketing for Technical Computing at Silicon Graphics Computer Systems, which he joined in 1995. Prior to joining that company, Mr. Shih held executive positions with DEC, which he joined in 1994, and IBM Corporation. Prior to joining Kodak in 1998, Mr. Steenburgh held senior management positions at Xerox Corporation, Ricoh Company, Ltd., Goulds Pumps, and most recently, President of the Industrial Pump Group Worldwide at ITT Fluid Technology Corporation, a part of ITT Industries. Prior to joining Kodak in 1998, Mr. Rajkowski was employed at Price Waterhouse LLP (now PricewaterhouseCoopers LLP) where he was the Upstate New York Technology Group Managing Partner and an Audit and Business Advisory Services Partner. There have been no events under any bankruptcy act, no criminal proceedings, and no judgments or injunctions material to the evaluation of the ability and integrity of any executive officer during the past five years. - --------------------------------------------------------------------------- PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Eastman Kodak Company common stock is principally traded on the New York Stock Exchange. There are 129,495 shareholders of record of common stock as of December 31, 1998. See Liquidity and Capital Resources, and Market Price Data in Management's Discussion and Analysis of Financial Condition and Results of Operations. - --------------------------------------------------------------------------- 11 ITEM 6. SELECTED FINANCIAL DATA Refer to Summary of Operating Data on page 68. - --------------------------------------------------------------------------- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SUMMARY
(in millions, except per share data) 1998 Change 1997 Change 1996 Sales $13,406 - 8% $14,538 - 9% $15,968 Earnings from operations 1,888 130 1,845 Earnings from continuing operations 1,390 5 1,011 Gain on sale of discontinued operations - - 277 Net earnings 1,390 5 1,288 Basic earnings per share 4.30 .01 3.82 Diluted earnings per share 4.24 .01 3.76
1998 The Company results for the year included the following: The sale of its NanoSystems subsidiary, resulting in a pre-tax gain of $87 million ($57 million after-tax). See Note 16, Sales of Assets and Divestitures. The sale of part of its investment in Gretag Imaging Group (Gretag), resulting in a pre-tax gain of $66 million ($44 million after-tax). See Note 16, Sales of Assets and Divestitures. A pre-tax charge of $132 million ($87 million after-tax) for asset write- downs and employee severance in the Office Imaging division of the Document Imaging business unit resulting from significant volume reductions by the primary customer for Office Imaging products, Danka Business Systems PLC (Danka) (the "Office Imaging charge"). See Note 16, Sales of Assets and Divestitures. A pre-tax charge of $45 million ($30 million after-tax), primarily for in- process research and development (R&D), associated with the acquisition of the medical imaging business of Imation Corp. (the "Imation charge"). See Note 15, Acquisitions and Joint Ventures. Excluding the above items, and pre-tax litigation charges of $35 million ($23 million after-tax) relating primarily to Health Imaging, net earnings would have been $1,429 million. Basic earnings per share would have been $4.42 and diluted earnings per share would have been $4.37. 12 1997 The Company results for the year included the following: A pre-tax charge of $1,455 million ($990 million after-tax) for restructuring, asset impairments and other charges. See Note 11, Restructuring Programs. A pre-tax charge of $186 million ($123 million after-tax) for a write-off of in-process R&D associated with the acquisition of Wang Laboratories' software unit (the "Wang charge"). See Note 15, Acquisitions and Joint Ventures. A pre-tax charge of $46 million ($30 million after-tax) taken as a reserve for payments required in connection with the Image Technical Service, Inc. litigation relating to the sale of micrographics and copier parts (the "ITS charge"). Excluding these charges, net earnings would have been $1,148 million. Basic earnings per share would have been $3.52 and diluted earnings per share would have been $3.46. 1996 The Company results for the year included the following: A pre-tax charge of $358 million ($256 million after-tax) for restructuring. See Note 11, Restructuring Programs. A pre-tax charge of $387 million ($252 million after-tax) related to the sale of the Office Imaging sales and services business (the "Office Imaging business"). See Note 16, Sales of Assets and Divestitures. After-tax income of $277 million from discontinued operations associated with the sale of the non-imaging health businesses in 1994. See Note 17, Discontinued Operations. Excluding these items, net earnings would have been $1,519 million. Basic earnings per share would have been $4.50 and diluted earnings per share would have been $4.43. 13 DETAILED RESULTS OF OPERATIONS
Sales by Operating Segment (in millions) 1998 Change 1997 Change 1996 Consumer Imaging Inside the U.S. $ 3,342 - 4% $ 3,477 + 5% $ 3,319 Outside the U.S. 3,822 - 9 4,204 - 3 4,340 ------- --- ------- --- ------- Total Consumer Imaging 7,164 - 7 7,681 - 7,659 ------- --- ------- --- ------- Kodak Professional Inside the U.S. 725 -22 927 + 1 917 Outside the U.S. 1,115 -17 1,345 - 7 1,450 ------- --- ------- --- ------- Total Kodak Professional 1,840 -19 2,272 - 4 2,367 ------- --- ------- --- ------- Health Imaging Inside the U.S. 668 - 2 682 - 4 707 Outside the U.S. 858 + 1 850 - 8 920 ------- --- ------- --- ------- Total Health Imaging 1,526 - 1,532 - 6 1,627 ------- --- ------- --- ------- Other Imaging Inside the U.S. 1,558 - 7 1,681 -31 2,434 Outside the U.S. 1,318 - 4 1,372 -27 1,881 ------- --- ------- --- ------- Total Other Imaging 2,876 - 6 3,053 -29 4,315 ------- --- ------- --- ------- Total Sales $13,406 - 8% $14,538 - 9% $15,968 ======= === ======= === =======
Earnings (Loss) From Operations by Operating Segment - See Note 18, Segment Information. Net Earnings (Loss) by Operating Segment - See Note 18, Segment Information. 1998 COMPARED WITH 1997 CONSOLIDATED - ------------ Worldwide sales for 1998 were 8% lower than in 1997, largely due to the transfer of a portion of Kodak's graphics business to a joint venture, Kodak Polychrome Graphics, on December 31, 1997 (see Note 15, Acquisitions and Joint Ventures) and the reclassification of certain promotional expenses by the Company (the "promotion reclass," see discussion in Consumer Imaging section below). Excluding these effects, sales decreased 5% from the prior year. In addition, currency changes against the dollar unfavorably affected sales by $344 million in 1998 compared with 1997. Excluding the effects of currency rate changes and the above items, sales decreased 2%. A significant portion of this decrease resulted from volume declines in emerging markets, reflecting economic conditions. 14 Overall gross profit margins improved approximately one percentage point from 44.5% in 1997 to 45.6% in 1998, adjusting for the promotion reclass. Excluding $165 million of charges related to the 1997 restructuring program and $68 million of the Office Imaging charge recorded to cost of goods sold in 1998, gross profit margins improved from 45.7% in 1997 to 46.1% in 1998. This increase is primarily attributable to cost reductions and manufacturing productivity which more than offset the unfavorable effects of foreign currency rate changes, lower effective selling prices, and volume declines in emerging markets. Goodwill amortization increased to $116 million in 1998 from $80 million in 1997 primarily as a result of the Company's acquisitions in China (see Note 15, Acquisitions and Joint Ventures). Selling, general and administrative (SG&A) expenses for the Company decreased 16% from 26.9% of sales in 1997 to 24.6% of sales in 1998. Adjusting 1997 for the promotion reclass and excluding $64 million of the Office Imaging charge recorded to SG&A in 1998 and the impact of the graphics business from both years, SG&A decreased 9% from 26.0% of sales to 24.9% of sales. This decrease is primarily attributable to the benefits associated with the Company's cost reduction program. Excluding the Imation charge in 1998 and the Wang charge in 1997, R&D expenses decreased 16% from 7.2% of sales in 1997 to 6.6% of sales in 1998 as a result of improved expense management and reduced cost structure. See Note 15, Acquisitions and Joint Ventures, for discussion of the Imation charge and the Wang charge and estimated costs to complete in-process R&D projects. Earnings from operations increased $1,758 million from the prior year. Excluding from 1997 the $1,455 million charge for restructuring costs, asset impairments and other charges, and the $186 million Wang charge, and excluding from 1998 the $132 million Office Imaging charge and the $45 million Imation charge, earnings from operations for the Company increased 17%, as cost reductions and manufacturing productivity more than offset lower effective selling prices and the unfavorable effects of foreign currency rate changes. Other income (charges) increased significantly from $21 million in 1997 to $328 million in 1998. This increase is primarily attributable to gains on the sales of NanoSystems and part of the Company's investment in Gretag, gains from sales of real estate, and the divestiture of some relatively small businesses, offset by litigation charges recorded in 1998. Interest expense increased 12% from the prior year, to $110 million, as a result of higher average borrowings. The effective tax rates were 34% in both 1998 and 1997, excluding restructuring costs, asset impairments and other charges of $1,455 million and the related tax benefit of $465 million from 1997. 15 From the beginning of the fourth quarter of 1997 through December 31, 1998, approximately 11,950 employees have left the Company under the 1997 and 1996 restructuring programs (see Note 11, Restructuring Programs). In addition, another 800 employees left the Company under a reserve taken in the second quarter of 1997. In connection with the restructuring programs, the Company reduced its operating costs by approximately $730 million in 1998. This amount includes approximately $95 million of lower pension and health care costs due to reduced headcount resulting from the restructuring programs. The 1998 savings of $730 million does not include the benefit of divestitures or the effects of changes in exchange rates, and is net of increased investments. Cost reductions were achieved across all business operations and also reflect the benefits of lower employee compensation. Many of the remaining headcount reductions under the restructuring programs are associated with portfolio actions and business exits which will generate a lower rate of savings in future periods. In the fourth quarter of 1998, the Company increased its minimum target for the cost reduction program to $1.2 billion by the end of 1999. Savings from this program will continue to be reflected in earnings, which not only allows the Company to improve its results of operations, but also enhances its competitiveness. In addition, the Company will continue to invest in growth opportunities in both traditional photographic and digital imaging. In connection with the sale of the Office Imaging business on December 31, 1996, the Company and Danka entered into agreements whereby the Company supplied high-volume copiers and printers to Danka and Danka provided the Company with R&D funding. Danka is the Company's primary customer for Office Imaging products, accounting for approximately 90% of Office Imaging's annual sales. Financial difficulties on the part of Danka affected its ability to fulfill the original terms of certain of its agreements with the Company in the fourth quarter of 1998. As a result, in December 1998, the Company's supply agreement and certain other agreements with Danka were terminated and interim arrangements for the supply by the Company to Danka of copier equipment, parts and supplies were established on a month-to-month basis. As a result of significant volume reductions by Danka, the Company was required to take action in the fourth quarter of 1998 that resulted in charges for employee severance (800 personnel) and write-downs of working capital and equipment. Such pre-tax charges amounted to $132 million and were recorded to cost of goods sold ($68 million) and SG&A expenses ($64 million). All actions with respect to this charge, including employee terminations, were taken by the Company in 1998. The Company continues to assess its strategic options for its Office Imaging business and may need to take further action in 1999 which could have a material impact on the Company's results of operations. As described in Note 15, Acquisitions and Joint Ventures, the Company acquired Imation Corp.'s worldwide medical imaging business on November 30, 1998. The business acquired by Kodak generates approximately $500 million in revenues annually. This strategic acquisition strengthens the Company's Health Imaging segment with "dry" imaging output technology. 16 As described in Note 15, Acquisitions and Joint Ventures, the Company made investments in two newly formed companies operating in China in 1998. Under terms of agreements announced in 1998, the Company plans to invest more than $1 billion in China over the next several years. The investment will be used to upgrade technology, improve manufacturing capacity and expand distribution and marketing capability needed to build and support a strong domestic Chinese imaging industry. On April 30, 1998, the Company and Intel Corporation announced a series of agreements that cover joint development efforts in digital imaging products and platforms, a broad patent cross-license, upgrading of Kodak's Qualex photofinishing laboratories with Intel architecture based scanning equipment, and collaborative consumer-oriented marketing efforts which could amount to $150 million (each company contributing half) over a three- year period. On May 19, 1998, the Company and America Online, Inc. (AOL) announced an alliance to offer AOL members an exclusive new online service called "You've Got Pictures!"(sm). The service entails consumers taking pictures with traditional cameras and film, followed by photofinishers developing the film and then scanning and uploading pictures to AOL via Kodak PhotoNet online. Using an integrated feature of their AOL account, AOL members can view their pictures, organize them into an AOL Picture Album and allow others to access their images. CONSUMER IMAGING - ---------------- Consumer Imaging segment sales for the year decreased 7%. Adjusting 1997 for the promotion reclass discussed below, segment sales for the year decreased 5%, due to lower effective selling prices, the unfavorable effects of foreign currency rate changes and lower unit volumes. Sales inside the U.S. increased 1%, as higher unit volumes were mostly offset by lower effective selling prices. Sales outside the U.S. decreased 9%, due to the unfavorable effects of foreign currency rate changes, lower unit volumes and lower effective selling prices. Removing from both years sales of Fox Photo, Inc., which was sold in 1998 (see Note 16, Sales of Assets and Divestitures), worldwide segment sales decreased 4% and sales inside the U.S. increased 3%. Excluding the effects of currency rate changes and Fox Photo sales, worldwide segment sales decreased 1% and sales outside the U.S. decreased 5%. In the Consumer Imaging segment, certain U.S. promotional expenses which are shown as sales price reductions in 1998 were shown as advertising and promotion expenses in 1997 and 1996. The amounts of those expenses were $164 million in 1997 and approximately $70 million in 1996. When comparing 1998 to 1997 and 1996, these amounts should be deducted from 1997 and 1996 sales as well as advertising expense. Worldwide film sales decreased 7% from the prior year, adjusting 1997 for the promotion reclass, due to lower unit volumes, the unfavorable effects of foreign currency rate changes and lower effective selling prices. Sales inside the U.S. decreased 5%, as slightly higher unit volumes were more than offset by lower effective selling prices. Sales outside the U.S. decreased 8%, as higher effective selling prices were more than offset by lower unit volumes and the unfavorable effects of foreign currency rate changes. 17 Worldwide color paper sales decreased 4% from the prior year, adjusting 1997 for the promotion reclass, as higher unit volumes were more than offset by lower effective selling prices and the unfavorable effects of foreign currency rate changes. Sales inside the U.S. increased 1%, as higher unit volumes were mostly offset by lower effective selling prices. Sales outside the U.S. decreased 7%, as modest increases in unit volumes were more than offset by the unfavorable effects of foreign currency rate changes and lower effective selling prices. SG&A expenses for the segment decreased 9% from 28.6% of sales in 1997 to 27.4% of sales in 1998, after adjusting 1997 for the promotion reclass. Excluding advertising expenses, SG&A expenses decreased 9% from 19.7% of sales in 1997 to 18.9% of sales in 1998. R&D expenses decreased 9% from 5.3% of sales in 1997 to 5.1% of sales in 1998. Earnings from operations increased 1%, as cost reductions and manufacturing productivity were almost entirely offset by lower effective selling prices and the unfavorable effects of foreign currency rate changes. Net earnings for the segment increased 8%, as a result of the gain on the sale of part of the Company's investment in Gretag, as well as decreased losses on foreign exchange. KODAK PROFESSIONAL - ------------------ Kodak Professional segment sales for the year decreased 19%. Excluding the impact of the graphics business from both years as a result of the joint venture discussed above, segment sales decreased 6%. This decrease is primarily due to the unfavorable effects of foreign currency rate changes, lower unit volumes and lower effective selling prices. Sales inside the U.S. decreased 22%, or 3% excluding the impact of the graphics business from both years, due to lower unit volumes. Sales outside the U.S. decreased 17%, or 8% excluding the impact of the graphics business from both years, due to the unfavorable effects of foreign currency rate changes and lower unit volumes. SG&A expenses for the segment decreased 41% from 27.6% of sales in 1997 to 20.3% of sales in 1998. Excluding the impact of the graphics business from both years, SG&A expenses decreased 12% from 27.9% of sales in 1997 to 26.2% of sales in 1998. Excluding advertising expenses and the impact of the graphics business from both years, SG&A expenses decreased 11% from 23.9% of sales in 1997 to 22.7% of sales in 1998. Excluding the impact of the graphics business from both years, R&D expenses decreased 2%, increasing slightly from 11.5% of sales in 1997 to 11.9% of sales in 1998. Earnings from operations increased 16%, as a result of reduced segment operating costs associated with the formation of the Kodak Polychrome Graphics joint venture and improvements in manufacturing productivity, offset by lower effective selling prices and the unfavorable effects of foreign currency rate changes. Net earnings for the segment increased 23%, as a result of improvements in earnings from operations, the Company's earnings from its 50% interest in Kodak Polychrome Graphics and lower foreign exchange losses. 18 HEALTH IMAGING - -------------- Sales of the Health Imaging segment were essentially level with 1997. However, excluding sales from the medical imaging business acquired from Imation in 1998, segment sales decreased 3%, due to the unfavorable effects of foreign currency rate changes and lower effective selling prices. Sales inside the U.S. decreased 2%, or a decline of 5% excluding Imation, due to lower effective selling prices and lower unit volumes. Sales outside the U.S. increased 1%, or a decrease of 2% excluding Imation, as higher unit volumes were more than offset by the unfavorable effects of foreign currency rate changes. Including one month of results from the medical imaging business acquired from Imation, SG&A expenses decreased 5% from 21.7% of sales in 1997 to 20.7% of sales in 1998. Excluding advertising expenses, SG&A expenses decreased 4% from 20.6% of sales in 1997 to 19.7% of sales in 1998. Excluding the 1998 Imation charge, R&D expenses decreased 13% from 8.0% of sales in 1997 to 6.9% of sales in 1998. Earnings from operations increased 1%, including the Imation charge. Excluding the Imation charge, earnings from operations increased 15% as a result of cost reductions and manufacturing productivity which more than offset lower effective selling prices and the unfavorable effects of foreign currency rate changes. Net earnings for the segment decreased 4%, due to litigation charges. Excluding the Imation charge, net earnings increased 10%. OTHER IMAGING - ------------- Sales of the Other Imaging segment decreased 6% for the year, primarily as a result of significant declines in Document Imaging (DI) and Commercial & Government Systems. Sales inside the U.S. decreased 7%, due to lower unit volumes and lower effective selling prices. Sales outside the U.S. decreased 4%, due to the unfavorable effects of foreign currency rate changes, lower unit volumes and lower effective selling prices. In the Office Imaging division of DI, sales fell sharply in the fourth quarter as a result of the primary customer for Office Imaging products, Danka, experiencing financial difficulties which resulted in significant volume reductions. In the Business Imaging Systems division of DI, sales declined as a result of portfolio changes which improved earnings performance. In Commercial & Government Systems, sales were negatively impacted by the completion of several large programs in 1997 for which follow-on programs were not fully underway in 1998. SG&A expenses increased 3% from 20.9% of sales in 1997 to 22.8% of sales in 1998. Excluding advertising expenses, SG&A expenses increased from 18.6% of sales in 1997 to 19.8% of sales in 1998. Excluding the Wang charge, R&D expenses decreased 24% from 9.9% of sales in 1997 to 8.0% of sales in 1998, primarily due to reductions in Digital & Applied Imaging and DI. 19 Earnings from operations increased $245 million. Excluding the Wang charge in 1997 and the Office Imaging charge in 1998, earnings from operations increased $191 million. This increase is primarily attributable to the benefits of portfolio changes in the Business Imaging Systems division and improved performance in Digital & Applied Imaging. Net earnings for the segment increased $248 million as a result of improvements in earnings from operations and gains on sales of properties. 1997 COMPARED WITH 1996 CONSOLIDATED - ------------ Worldwide sales for 1997 were 9% lower than in 1996, largely due to the sale of the Company's Office Imaging business in December 1996 and the significant adverse effects of the stronger U.S. dollar. Currency changes against the dollar unfavorably affected sales by $558 million in 1997 compared with 1996. Excluding the effects of currency rate changes and the sale of Office Imaging, sales increased 3%. Removing the impact of the Office Imaging business from both years, overall gross profit margins as a percentage of sales decreased from 49.9% in 1996 to 45.8% in 1997. Excluding from 1997 $165 million of charges related to the 1997 restructuring program, gross profit margins decreased to 47.0% of sales, as the benefits of higher unit volumes and manufacturing productivity were more than offset by lower effective selling prices, the unfavorable effects of foreign currency rate changes and other charges including preproduction start-up costs and inventory write-offs. Goodwill amortization increased to $80 million in 1997 from $66 million in 1996 primarily due to the acquisition of Wang Laboratories' software unit. Removing the impact of the Office Imaging business from both years, SG&A expenses for the Company decreased 2% from 27.7% of sales in 1996 to 27.5% of sales in 1997, as the favorable effects of foreign currency rate changes more than offset increased expenditures. R&D expenditures were $1,044 million (excluding the Wang charge of $186 million) in 1997 and $1,028 million in 1996. Excluding the Wang charge, R&D expenses increased 2% from 6.4% of sales in 1996 to 7.2% of sales in 1997 as a result of increased expenditures across operating segments. Earnings from operations declined 93%. Excluding restructuring costs, asset impairments and other charges totaling $1,455 million in 1997 and $358 million in 1996, earnings from operations declined 28% as the benefits of higher unit volumes and manufacturing productivity were more than offset by lower effective selling prices, the Wang charge and the unfavorable effects of foreign currency rate changes. Approximately $221 million of the decline in earnings from operations was due to currency rate changes. Excluding from 1996 the $387 million loss on the sale of the Office Imaging business, other income (charges) decreased from $181 million in 1996 to $21 million in 1997, primarily due to lower interest income, the ITS charge and higher losses on foreign exchange. 20 The effective tax rates were 34% in both 1997 and 1996, excluding restructuring, asset impairments and other charges from both years, and the sale of the Office Imaging business from 1996. In 1997, the Company's Board of Directors approved a fourth-quarter $1.5 billion charge for restructuring related to the strategic realignment of the Company's worldwide manufacturing, sales and marketing, R&D, administrative, and photofinishing operations. About half of the charge represented separation payments for approximately 16,100 employees whose positions would be eliminated. The other half of the charge related to asset write-downs and other costs associated with plans to reposition certain non-strategic businesses. In 1996, the Company's Board of Directors approved a fourth-quarter $358 million charge for restructuring related to severance and other termination benefits and exit costs associated with the realignment of the Company worldwide. About two-thirds of the charge represented separation payments for approximately 3,900 employees whose positions would be eliminated. The remainder of the charge related to asset write-downs and other costs associated with plans to reposition certain non-strategic businesses. See Note 11, Restructuring Programs. CONSUMER IMAGING - ---------------- Consumer Imaging segment sales for the year were level, as higher unit volumes were offset by the unfavorable effects of foreign currency rate changes and lower effective selling prices. Without the effect of currency rate changes, sales increased 4%. Sales increased 5% in the U.S. and decreased 3% outside the U.S. Of the $158 million increase in the U.S., $117 million resulted from the inclusion of a full year's revenue in 1997 for Fox Photo, Inc., which was acquired in October 1996. Worldwide film sales were level, as a 7% volume increase was offset by the unfavorable effects of foreign currency rate changes and lower effective selling prices. U.S. film sales increased 3%, with 5% volume growth partially offset by lower effective selling prices. Outside the U.S., film sales decreased 2%, with 9% volume growth more than offset by the unfavorable effects of foreign currency rate changes and lower effective selling prices. Worldwide color paper sales decreased 4%, as 8% volume gains were more than offset by lower effective selling prices and the unfavorable effects of foreign currency rate changes. U.S. sales decreased 13%, due to a 7% decline in unit volumes caused by consolidation of the U.S. photofinishing industry, as well as lower effective selling prices. Paper sales outside the U.S. increased 2%, driven by a 17% volume increase partially offset by lower effective selling prices and the unfavorable effects of foreign currency rate changes. Sales increases reflect the impact of continuing growth in emerging markets and new customers gained in Europe. 21 Earnings from operations decreased 19%, as higher unit volumes were more than offset by lower effective selling prices and the unfavorable effects of foreign currency rate changes. Net earnings for the segment decreased 20%, as a result of the decrease in earnings from operations as well as increased losses on foreign exchange. KODAK PROFESSIONAL - ------------------ Sales of the Kodak Professional segment decreased 4%, as higher unit volumes were more than offset by the unfavorable effects of foreign currency rate changes and lower effective selling prices. Sales inside the U.S. increased 1%, due to higher unit volumes. Sales outside the U.S. decreased 7%, as higher unit volumes were more than offset by the unfavorable effects of foreign currency rate changes and lower effective selling prices. Earnings from operations decreased 11%, primarily due to a functional transfer of R&D expenses from certain operations in the Other Imaging segment. The benefits of manufacturing productivity and higher unit volumes were offset by the unfavorable effects of foreign currency rate changes and lower effective selling prices. Net earnings for the segment decreased 14%, primarily as a result of the decrease in earnings from operations. HEALTH IMAGING - -------------- Sales of the Health Imaging segment decreased 6%, as higher unit volumes were more than offset by the unfavorable effects of foreign currency rate changes and lower effective selling prices. Sales inside the U.S. decreased 4%, as higher unit volumes were more than offset by lower effective selling prices. Sales outside the U.S. decreased 8%, as higher unit volumes were more than offset by the unfavorable effects of foreign currency rate changes and lower effective selling prices. Earnings from operations decreased 15%, as higher unit volumes and manufacturing productivity were more than offset by lower effective selling prices and the unfavorable effects of foreign currency rate changes. Net earnings for the segment decreased 17%, primarily as a result of the decrease in earnings from operations. OTHER IMAGING - ------------- Sales of the Other Imaging segment decreased 29%, primarily due to the sale of the Office Imaging business. Sales inside the U.S. decreased 31% and sales outside the U.S. decreased 27%. Excluding the effect of the sale of Office Imaging, segment sales were level, as increases in Entertainment Imaging and Digital & Applied Imaging offset decreases in other business units. Earnings from operations decreased $273 million, due to the Wang charge, operational losses in the new Eastman Software business unit, and increased losses in the Digital & Applied Imaging business unit. Net earnings decreased $234 million, as a result of the decrease in earnings from operations, and the ITS charge. 22 YEAR 2000 In 1996, the Company established a formal global program office to assess the impact of the Year 2000 issue on the software and hardware utilized in the Company's internal operations and included in its product offerings to customers. The assessment addresses software applications, systems software, information technology (IT) infrastructure, embedded manufacturing control technology, and products and services. Representatives of the global program office and operating divisions meet monthly with the Chief Financial Officer to monitor program status and address issues. In June 1998, an independent third party completed a comprehensive review of the Company's overall Year 2000 program. In October and December 1998 and February 1999, Senior Line Management presented status reports to the Board of Directors. The project phases include: inventorying affected technology and assessing the impact of the Year 2000 issue; developing solution plans; modification; testing and certification; implementation; and developing contingency plans. All components of software and hardware of the Company are presently in various phases. The Company expects to have its mission- critical IT systems and server infrastructure tested and compliant by the end of the first quarter of 1999, and manufacturing control systems Year 2000 compliant by mid-year 1999. The Company also expects that actively supported products and services, which are presently in the first five phases, will be compliant by the end of August 1999. The product commercialization process has been modified so that it will produce compliant products. During the fourth quarter of 1998, the project team continued to increase its global mission-critical IT compliance, used mainframe test facilities to simulate remaining mission-critical formal applications, completed assessment and solution plans for the Company's U.S. server network and allocated resources to support the 1999 workplan. The project team drove advances in remediation of products and services, and in compliance of operating divisions and third parties. The Company relies on third-party suppliers for many systems, products and services including telecommunications and data center support. The Company will be adversely impacted if these suppliers do not make necessary changes to their own systems and products successfully and in a timely manner. The Company has a formalized comprehensive supplier compliance program in place. As a third-party supplier to other companies, the Company has posted its own product compliance plan on its Internet web site (www.kodak.com/go/year2000), which was enhanced during the third quarter of 1998 to support customer and business partner inquiries. 23 Costs of software and hardware remediation were $13 million in 1997, $27 million in 1998, and are estimated to be $12 million and $6 million in 1999 and 2000, respectively. These remediation efforts, almost entirely for software, will not materially increase the Company's spending on information technology because some normal development and maintenance work has been postponed. Furthermore, some non-compliant systems will be eliminated in 1999 as the Company installs Year 2000 compliant globally deployed ERP/SAP software in connection with its enterprise resource planning project. A charge for the total cost of customer product modification of $20 million was accrued in 1997. At December 31, 1998, the Company had a reserve of $6 million to cover remaining product modifications. Management of the Company believes it has an effective program in place to resolve the Year 2000 issue in a timely manner. However, since it is not possible to anticipate all possible future outcomes, especially when third parties are involved, there could be "worst-case scenarios" in which the Company would be unable to take customer orders, manufacture and ship products, invoice customers or collect payments. In addition, the Company could be subject to litigation for Year 2000-related product failure, including equipment shutdown or failure to properly date business or medical records, and for health, environmental and safety issues relating to its facilities. The amount of potential liability and lost revenue cannot be reasonably estimated. The Company has contingency plans for some mission-critical applications and is working on plans for others. For example, plans for the U.S. payroll system have been in place since January 1998, while detailed plans for sensitized goods manufacturing will be completed by mid-year 1999. An Executive Steering Committee is closely monitoring the progress of enterprise and business process contingency plans involving, among other actions, manual workarounds, increased inventories and extra staffing. THE EURO The Treaty on European Union provided that an economic and monetary union (EMU) be established in Europe whereby a single European currency, the euro, replaces the currencies of participating member states. The euro was introduced on January 1, 1999, at which time the value of participating member state currencies was irrevocably fixed against the euro and the European Currency Unit (ECU) was replaced at the rate of one euro to one ECU. For the three-year transitional period ending December 31, 2001, the national currencies of member states will continue to circulate but be sub- units of the euro. New public debt will be issued in euro and existing debt may be redominated into euro. At the end of the transitional period, euro banknotes and coins will be issued, and the national currencies of the member states will cease to be legal tender no later than June 30, 2002. The countries which adopted the euro on January 1, 1999 are Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, The Netherlands, Portugal, and Spain. Other countries are expected to follow later. The Company has operations in all of these countries. 24 As a result of the euro conversion, it is probable that selling prices of the Company's products and services will experience downward pressure, as current price variations among countries are reduced due to easy comparability of euro prices across countries. Prices will tend to harmonize, although value added taxes and transportation costs will still justify price differentials. Adoption of the euro will probably accelerate existing market and pricing trends including pan-European buying and general price erosion. On the other hand, currency exchange and hedging costs will be significantly reduced; lower prices and pan-European buying will benefit the Company in its purchasing endeavors; the number of banks and suppliers needed will be reduced; there will be less variation in payment terms; and it will be easier for the Company to expand into new marketing channels such as mail order and Internet marketing. The Company is in the process of making changes in areas such as marketing and pricing, purchasing, contracts, payroll, taxes, cash management and treasury operations. Billing systems will be modified so that, in 1999, the Company will be able to show total gross, value added tax, and net in euros on national currency invoices, to enable customers to pay in the new euro currency if they wish to do so. Systems for pricing, payroll and expense reimbursements will continue to use national currencies until year- end 2001. The functional currencies of the Company's operations in affected countries will remain the national currencies until approximately year-end 2000, when they will change to the euro. The systems costs of adopting the euro are estimated to be less than $4 million since many non-euro-compliant systems will be eliminated as the Company installs ERP/SAP software in connection with its enterprise resource planning project. The Company plans to be at least minimally euro- compliant when necessary, and is preparing contingency plans to address potential delays in systems implementation. LIQUIDITY AND CAPITAL RESOURCES Net cash provided by operating activities in 1998 was $1,483 million. Net earnings, adjusted for depreciation and amortization, provided $2,243 million of operating cash. This was partially offset by decreases in liabilities (excluding borrowings) of $516 million relating primarily to severance payments for restructuring programs, and other changes in working capital. Net cash used in investing activities of $1,839 million in 1998 was utilized primarily for capital expenditures of $1,108 million and acquisitions, net of cash acquired, of $949 million. Net cash provided by financing activities of $77 million in 1998 was the result of net increases in borrowings of $776 million, and employee stock options exercised of $128 million, offset by $569 million of dividend payments and $258 million of stock repurchases. Cash dividends per share of $1.76, $1.76 and $1.60, payable quarterly, were declared in 1998, 1997 and 1996, respectively. Total cash dividends of approximately $569 million, $567 million and $539 million were paid in 1998, 1997 and 1996, respectively. 25 Net working capital (excluding short-term borrowings) increased to $939 million from $909 million at year-end 1997. This increase is primarily attributable to the Imation acquisition, offset somewhat by the decrease in cash as discussed above. The Company repurchased $258 million, $850 million and $623 million of its shares in 1998, 1997 and 1996, respectively, under the $2 billion repurchase program initiated in 1996. In 1996, the Company also repurchased $700 million of its shares under a previous repurchase program. Completion of the $2 billion stock repurchase program will be funded by available cash reserves and cash from operations. Remaining capacity under the Company's $2 billion repurchased program at December 31, 1998 is approximately $269 million. Total short-term and long-term borrowings were $2,022 million at year-end 1998 and $1,196 million at year-end 1997. The Company has access to a $3.5 billion revolving credit facility expiring in November 2001. The Company also has a shelf registration statement for debt securities with an available balance of $2.2 billion. Capital additions in 1998 and 1997 by segment are included in Note 18, Segment Information. See Note 8, Commitments and Contingencies, for environmental matters and other commitments of the Company. - --------------------------------------------------------------------------- OTHER In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement requires that an entity recognize all derivatives as either assets or liabilities and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as a hedge. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. This Statement must be adopted by the Company by the year 2000, but may be adopted in any earlier fiscal quarter, and is not to be applied retroactively. If the Company had adopted SFAS No. 133 in 1998, the impact would not have been material to its results of operations or financial position. The Company has not yet determined when it will adopt this Statement. Kodak is subject to various laws and governmental regulations concerning environmental matters. See Note 8, Commitments and Contingencies. - ------------------------------------------------------------------------ 26 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 Private Securities Litigation Reform Act of 1995. Forward-looking statements in this Form 10- K relate to the Company's Year 2000 compliance efforts, including expectations about compliance timetables and costs. Also, references to the Company's $1.2 billion cost reduction initiative and to expected savings in 1999 are forward-looking statements. Actual results may differ from those expressed or implied in forward- looking statements. With respect to any forward-looking statements contained in this report, the Company believes that its results are subject to a number of risk factors, including: the Company's ability to implement its product strategies (including its digitization strategy and its plans for digital products and Advantix products), to develop its business in emerging markets, and to assimilate acquisitions quickly; uncertainty in the Company's Office Imaging business; the inherent unpredictability of currency fluctuations; competitive actions, including pricing; the ability to realize cost reductions and operating efficiencies, including the ability to implement headcount reduction programs timely and in a manner that does not unduly disrupt business operations, and the ability to identify and to realize other cost reduction opportunities; the nature and pace of technology substitution; general economic and business conditions; the ability of the Company to identify and address successfully Year 2000 issues in a timely manner, and at costs that are reasonably in line with projections; and the ability of the Company's vendors to identify and address successfully their own Year 2000 issues in a timely manner. Any forward-looking statements in this report should be evaluated in light of these important risk factors. - --------------------------------------------------------------------------- MARKET PRICE DATA
1998 1997 4th Qtr 3rd Qtr 2nd Qtr 1st Qtr 4th Qtr 3rd Qtr 2nd Qtr. 1st Qtr Price per share: High $85-1/4 $88-15/16 $76-3/16 $67- 3/4 $67 $81-1/4 $85-1/8 $94-3/4 Low 70 72-13/16 62-3/4 57-15/16 53-5/16 55-3/4 73-1/8 75-7/8 - ---------------------------------------------------------------------------
SUMMARY OF OPERATING DATA A summary of operating data for 1998 and for the four years prior is shown on page 68. - --------------------------------------------------------------------------- 27 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company, as a result of its global operating and financing activities, is exposed to changes in foreign currency exchange rates, commodity prices, and interest rates which may adversely affect its results of operations and financial position. In seeking to minimize the risks and/or costs associated with such activities, the Company manages exposures to changes in commodity prices, interest rates and foreign currency exchange rates. See Note 9, Financial Instruments, for further discussion of the Company's policy for managing such exposures. The majority of foreign currency forward contracts are denominated in Australian, British, French, German, Irish and Spanish currencies. The magnitude and nature of such hedging activities are explained further in Note 9, Financial Instruments. If foreign currency exchange rates at December 31, 1998 and 1997 increased 10%, the Company would incur a $92 million and $72 million loss on foreign currency forward contracts outstanding at December 31, 1998 and 1997, respectively. Such losses would be substantially offset by gains from the revaluation or settlement of the underlying positions hedged. Increased foreign currency exchange rate risk from December 31, 1997 is caused by a higher notional value of contracts to buy French francs offset by a lower notional value of contracts to sell British pounds. The Company has used silver option and forward contracts to minimize almost all of its exposure to increases in silver prices in 1998 and will continue to do so in 1999. As of December 31, 1998, the Company had open forward contracts hedging the majority of its planned silver requirements for 1999. Based on broker-quoted termination values, if the price of silver decreased 10% from $5.01 and $5.99 per troy ounce at December 31, 1998 and 1997, respectively, the fair value of silver forward contracts would be reduced by $25 million and $17 million, respectively. Increased silver price risk from December 31, 1997 is caused by a higher notional amount of silver hedging contracts outstanding at December 31, 1998. Such losses in fair value, if realized, would be offset by lower costs of manufacturing silver- containing products. The Company is exposed to interest rate risk primarily through its borrowing activities and less so through investments in marketable securities. The Company utilizes U.S. dollar-denominated commercial paper and borrowings as well as foreign currency-denominated borrowings to fund its working capital and investment needs. The majority of short-term and long-term borrowings and marketable securities 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 quantifiable or predictable because of the variability of future interest rates and business financing requirements. Using a yield to maturity analysis, if December 31, 1998 interest rates increased 10% (about 49 basis points) with the December 31, 1998 level of short-term and long-term borrowings, there would be decreases in fair value of short-term and long-term borrowings of $1 million and $10 million, respectively. If December 31, 1997 interest rates increased 10% (about 51 basis points) with the December 31, 1997 level of debt and marketable securities, there would be decreases in fair value of marketable securities, short-term and long-term borrowings of $1 million, $3 million and $13 million, respectively. 28 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS Management is responsible for the preparation and integrity of the consolidated financial statements and related notes which appear on pages 30 through 67. These financial statements have been prepared in accordance with generally accepted accounting principles and include certain amounts that are based on management's best estimates and judgments. The Company's accounting systems include extensive internal controls designed to provide reasonable assurance of the reliability of its financial records and the proper safeguarding and use of its assets. Such controls are based on established policies and procedures, are implemented by trained, skilled personnel with an appropriate segregation of duties, and are monitored through a comprehensive internal audit program. The Company's policies and procedures prescribe that the Company and all employees are to maintain the highest ethical standards and that its business practices throughout the world are to be conducted in a manner which is above reproach. The consolidated financial statements have been audited by PricewaterhouseCoopers LLP, independent accountants, who were responsible for conducting their audits in accordance with generally accepted auditing standards. Their resulting report is shown below. The Board of Directors exercises its responsibility for these financial statements through its Audit Committee, which consists entirely of non- management Board members. The independent accountants and internal auditors have full and free access to the Audit Committee. The Audit Committee meets periodically with the independent accountants and the Director of Corporate Auditing, both privately and with management present, to discuss accounting, auditing and financial reporting matters. George M. C. Fisher Harry L. Kavetas Chairman and Chief Financial Officer, Chief Executive Officer Executive Vice President and Director January 13, 1999 January 13, 1999 29 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Eastman Kodak Company In our opinion, the accompanying consolidated financial statements listed in the index appearing under Item 14(a)(1) and (2) on page 71 of this Annual Report on Form 10-K present fairly, in all material respects, the financial position of Eastman Kodak Company and subsidiary companies at 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. PricewaterhouseCoopers LLP Rochester, New York January 13, 1999 30 Eastman Kodak Company and Subsidiary Companies CONSOLIDATED STATEMENT OF EARNINGS
For the Year Ended December 31, (in millions, except per share data) 1998 1997 1996 Sales $13,406 $14,538 $15,968 Cost of goods sold 7,293 7,976 8,327 ------- ------- ------- Gross profit 6,113 6,562 7,641 Selling, general and administrative expenses 3,303 3,912 4,410 Research and development costs 880 1,044 1,028 Purchased research and development 42 186 - Restructuring costs and asset impairments - 1,290 358 ------- ------- ------- Earnings from operations 1,888 130 1,845 Interest expense 110 98 83 Other income (charges) 328 21 (206) ------- ------- ------- Earnings before income taxes 2,106 53 1,556 Provision for income taxes 716 48 545 ------ ------- ------- Earnings from continuing operations 1,390 5 1,011 Gain on sale of discontinued operations - - 277 ------ ------- ------- NET EARNINGS $1,390 $ 5 $ 1,288 ====== ======= ======= Basic earnings per share: From continuing operations $ 4.30 $ .01 $ 3.00 From discontinued operations - - .82 ------ ------- ------- Basic earnings per share $ 4.30 $ .01 $ 3.82 ====== ======= ======= Diluted earnings per share: From continuing operations $ 4.24 $ .01 $ 2.95 From discontinued operations - - .81 ------ ------- ------- Diluted earnings per share $ 4.24 $ .01 $ 3.76 ====== ======= ======= Earnings from continuing operations used in basic and diluted earnings per share $1,390 $ 5 $ 1,011 Number of common shares used in basic earnings per share 323.3 327.4 337.4 Incremental shares from assumed conversion of options 4.5 4.5 5.3 ------ ------- ------- Number of common shares used in diluted earnings per share 327.8 331.9 342.7 ====== ======= ======= The accompanying notes are an integral part of these financial statements.
31 Eastman Kodak Company and Subsidiary Companies CONSOLIDATED STATEMENT OF FINANCIAL POSITION
(in millions, except share and per share data) At December 31, 1998 1997 ASSETS CURRENT ASSETS Cash and cash equivalents $ 457 $ 728 Marketable securities 43 24 Receivables 2,527 2,271 Inventories 1,424 1,252 Deferred income tax charges 855 958 Other 293 242 ------- ------- Total current assets 5,599 5,475 ------- ------- PROPERTIES Land, buildings and equipment at cost 13,482 12,824 Less: Accumulated depreciation 7,568 7,315 ------- ------- Net properties 5,914 5,509 ------- ------- OTHER ASSETS Goodwill (net of accumulated amortization of $534 and $473) 1,232 548 Long-term receivables and other noncurrent assets 1,705 1,231 Deferred income tax charges 283 382 ------- ------- TOTAL ASSETS $14,733 $13,145 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Payables $ 3,906 $ 3,832 Short-term borrowings 1,518 611 Taxes - income and other 593 567 Dividends payable 142 143 Deferred income tax credits 19 24 ------- ------- Total current liabilities 6,178 5,177 OTHER LIABILITIES Long-term borrowings 504 585 Postemployment liabilities 2,962 3,075 Other long-term liabilities 1,032 1,083 Deferred income tax credits 69 64 ------- ------- Total liabilities 10,745 9,984 ------- ------- SHAREHOLDERS' EQUITY Common stock, par value $2.50 per share 950,000,000 shares authorized; issued 391,292,760 shares in 1998 and 1997 978 978 Additional paid in capital 902 914 Retained earnings 6,163 5,343 Accumulated other comprehensive loss (111) (202) ------- ------- 7,932 7,033 Treasury stock, at cost 68,494,402 shares in 1998 and 68,225,820 shares in 1997 3,944 3,872 ------- ------- Total shareholders' equity 3,988 3,161 ------- ------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $14,733 $13,145 ======= ======= The accompanying notes are an integral part of these financial statements.
32 Eastman Kodak Company and Subsidiary Companies CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(in millions, except number of shares) Accumulated Additional Other Common Paid In Retained Comprehensive Treasury Stock* Capital Earnings Income (Loss) Stock Total Shareholders' Equity December 31, 1995 $974 $ 803 $ 5,189 $ 88 $(1,933) $5,121 Net earnings - - 1,288 - - 1,288 ------ Other comprehensive loss: Unrealized holding losses - - - - - (3) Currency translation adjustments - - - - - (18) ------ Other comprehensive loss - - - (21) - (21) ------ Comprehensive income - - - - - 1,267 Cash dividends declared - - (539) - - (539) Retained earnings - other changes - - 1 - - 1 Common stock issued under employee plans (1,718,141 shares) 4 64 - - - 68 Treasury stock repurchased (17,625,850 shares) - - - - (1,323) (1,323) Treasury stock issued under employee plans (1,851,710 shares) - (25) - - 96 71 Tax reductions - employee plans - 68 - - - 68 ---- ----- ------- ----- ------- ------ Shareholders' Equity December 31, 1996 978 910 5,939 67 (3,160) 4,734 Net earnings - - 5 - - 5 ------ Other comprehensive income (loss): Unrealized holding gains - - - - - 15 Currency translation adjustments - - - - - (247) Minimum pension liability adjustment ($57 million pre-tax) - - - - - (37) ------ Other comprehensive loss - - - (269) - (269) ------ Comprehensive loss - - - - - (264) Cash dividends declared - - (577) - - (577) Retained earnings - other changes - - (24) - - (24) Treasury stock repurchased (11,315,800 shares) - - - - (850) (850) Treasury stock issued under employee plans (2,540,868 shares) - (31) - - 138 107 Tax reductions - employee plans - 35 - - - 35 ---- ----- ------- ----- ------- ------ Shareholders' Equity December 31, 1997 978 914 5,343 (202) (3,872) 3,161
33 Eastman Kodak Company and Subsidiary Companies CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY Cont'd.
(in millions, except number of shares) Accumulated Additional Other Common Paid In Retained Comprehensive Treasury Stock* Capital Earnings Income (Loss) Stock Total Shareholders' Equity December 31, 1997 978 914 5,343 (202) (3,872) 3,161 Net earnings - - 1,390 - - 1,390 ------ Other comprehensive income (loss): Unrealized holding gains arising during the period ($122 million pre-tax) - - - - - 80 Reclassification adjustment for gains included in net earnings ($66 million pre-tax) - - - - - (44) Currency translation adjustments - - - - - 59 Minimum pension liability adjustment ($7 million pre-tax) - - - - - (4) ------ Other comprehensive income - - - 91 - 91 ------ Comprehensive income - - - - - 1,481 Cash dividends declared - - (570) - - (570) Treasury stock repurchased (3,541,295 shares) - - - - (258) (258) Treasury stock issued under employee plans (3,272,713 shares) - (58) - - 186 128 Tax reductions - employee plans - 46 - - - 46 ---- ----- ------- ----- ------- ------ Shareholders' Equity December 31, 1998 $978 $ 902 $ 6,163 $(111) $(3,944) $3,988 ==== ===== ======= ===== ======= ====== * There are 100 million shares of $10 par value preferred stock authorized, none of which have been issued. Accumulated unrealized holding gains/losses as of December 31, 1998, 1997 and 1996 were $43 million gain, $7 million gain and $8 million loss, respectively. Accumulated translation adjustments as of December 31, 1998, 1997 and 1996 were $(113) million, $(172) million and $75 million, respectively. Accumulated minimum pension liability adjustment as of December 31, 1998 and 1997 was $(41) million and $(37) million, respectively. The accompanying notes are an integral part of these financial statements.
34 Eastman Kodak Company and Subsidiary Companies CONSOLIDATED STATEMENT OF CASH FLOWS
For the Year Ended December 31, (in millions) 1998 1997 1996 Cash flows from operating activities: Earnings from continuing operations $1,390 $ 5 $1,011 Adjustments to reconcile to net cash provided by operating activities: Depreciation and amortization 853 828 903 Purchased research and development 42 186 - Loss on sale of Office Imaging business - - 387 Restructuring costs, asset impairments and other charges, net of cash spent - 1,415 358 Provision (benefit) for deferred income taxes 202 (502) (17) (Gain) loss on sale/retirement of assets (166) 25 65 (Increase) decrease in receivables (1) 165 15 (Increase) decrease in inventories (43) 77 (130) (Decrease) increase in liabilities excluding borrowings (516) (349) 18 Other items, net (278) 230 (126) ------ ------ ----- Total adjustments 93 2,075 1,473 ------ ------ ------ Net cash provided by operating activities 1,483 2,080 2,484 ------ ------ ------ Cash flows from investing activities: Additions to properties (1,108) (1,485) (1,341) Proceeds from sale of assets 297 109 124 Cash flows related to sales of businesses (59) (194) 681 Acquisitions, net of cash acquired (949) (341) (128) Marketable securities - sales 162 15 59 Marketable securities - purchases (182) - (31) ------ ------ ------ Net cash used in investing activities (1,839) (1,896) (636) ------ ------ ------ Cash flows from financing activities: Net increase (decrease) in borrowings with original maturities of 90 days or less 894 177 (206) Proceeds from other borrowings 1,133 1,472 1,529 Repayment of other borrowings (1,251) (1,526) (1,420) Dividends to shareholders (569) (567) (539) Exercise of employee stock options 128 96 126 Stock repurchase programs (258) (850) (1,323) ------ ------ ------ Net cash provided by (used in) financing activities 77 (1,198) (1,833) ------ ------ ------ Effect of exchange rate changes on cash 8 (35) (2) ------ ------ ------ Net (decrease) increase in cash and cash equivalents (271) (1,049) 13 Cash and cash equivalents, beginning of year 728 1,777 1,764 ------ ------ ------ Cash and cash equivalents, end of year $ 457 $ 728 $1,777 ====== ====== ======
35 Eastman Kodak Company and Subsidiary Companies CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)
SUPPLEMENTAL CASH FLOW INFORMATION (in millions) Cash paid for interest and income taxes for continuing operations was: 1998 1997 1996 Interest, net of portion capitalized of $41, $33 and $29 $ 90 $ 81 $ 78 Income taxes 498 517 275
The following transactions are not reflected in the Consolidated Statement of Cash Flows:
1998 1997 1996 Contribution of assets to Kodak Polychrome Graphics joint venture $ - $216 $ - Liabilities assumed in acquisitions 473 144 128 Minimum pension liability adjustment 4 37 - The accompanying notes are an integral part of these financial statements.
36 Eastman Kodak Company and Subsidiary Companies NOTES TO FINANCIAL STATEMENTS NOTE 1: SIGNIFICANT ACCOUNTING POLICIES COMPANY OPERATIONS Eastman Kodak Company (the Company or Kodak) is engaged primarily in developing, manufacturing, and marketing consumer, professional, health and other imaging products. The Company's products are manufactured in a number of countries in North and South America, Europe, Australia and Asia. The Company's products are marketed and sold in many countries throughout the world. BASIS OF CONSOLIDATION The consolidated financial statements include the accounts of Eastman Kodak Company and its majority owned subsidiary companies. Intercompany transactions are eliminated and net earnings are reduced by the portion of the earnings of subsidiaries applicable to minority interests. The equity method of accounting is used for investments in associated companies which are not controlled by Kodak and in which Kodak's interest is generally between 20% and 50%. 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 year end and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. FOREIGN CURRENCY For most subsidiaries and branches outside the U.S., the local currency is the functional currency and translation adjustments are accumulated in a separate component of shareholders' equity. Translation adjustments are not tax-effected since they relate to investments which are permanent in nature. For subsidiaries and branches that operate in U.S. dollars or whose economic environment is highly inflationary, the U.S. dollar is the functional currency and gains and losses that result from translation are included in earnings. The effect from foreign currency translation was a gain of $6 million in 1998, a loss of $7 million in 1997 and a loss of $4 million in 1996. The Company hedges certain foreign currency transactions and firm commitments by entering into forward exchange contracts. Gains and losses associated with currency rate changes on forward contracts hedging foreign currency transactions are recorded currently in earnings. The effects from foreign currency transactions, including related hedging activities, were losses of $26 million in 1998, $66 million in 1997, and $37 million in 1996. Gains and losses related to hedges of firm commitments are deferred and recognized in earnings or as adjustments of carrying amounts when the transactions occur. 37 CASH EQUIVALENTS All highly liquid investments with an original maturity of three months or less at date of purchase are considered to be cash equivalents. MARKETABLE SECURITIES AND NONCURRENT INVESTMENTS At December 31, 1998, investments of $26 million included in marketable securities were considered held to maturity. Investments of $17 million included in marketable securities, and $112 million of long-term marketable securities and other investments which were included in other noncurrent assets, were considered available for sale. At December 31, 1997, investments of $24 million included in marketable securities, and long-term marketable securities of $26 million which were included in other noncurrent assets, were considered held to maturity. Investments of $49 million included in other noncurrent assets were considered available for sale. INVENTORIES Inventories are valued at cost, which is not in excess of market. The cost of most inventories in the U.S. is determined by the "last-in, first-out" (LIFO) method. The cost of other inventories is determined by the "first- in, first-out" (FIFO) or average cost method, which approximates current cost. The Company provides inventory reserves for excess, obsolete or slow- moving inventory based on changes in customer demand, technology developments or other economic factors. PROPERTIES Properties are recorded at cost reduced by accumulated depreciation. Depreciation expense is provided based on historical cost and estimated useful lives ranging from approximately five years to fifty years for buildings and building equipment and three years to twenty years for machinery and equipment. The Company generally uses the straight-line method for calculating the provision for depreciation. GOODWILL Goodwill is charged to earnings on a straight-line basis over the period estimated to be benefited, not exceeding fifteen years. The Company regularly assesses all of its long-lived assets for impairment when events or circumstances indicate their carrying amounts may not be recoverable, in accordance with Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." This is accomplished by comparing the estimated undiscounted future cash flows of the asset grouping with the respective carrying amount as of the date of assessment. Should aggregate future cash flows be less than the carrying value, a write-down would be required, measured as the difference between the carrying value and the discounted future cash flows. 38 REVENUE Revenue is recognized from the sale of film, paper, supplies and equipment (including sales-type leases for equipment) when the product is shipped; from maintenance and service contracts over the contractual period, or as the services are performed; from rentals under operating leases in the month in which they are earned; and from financing transactions at level rates of return over the term of the lease or receivable. RESEARCH AND DEVELOPMENT COSTS Product development costs are charged to operations during the period incurred. ADVERTISING Advertising costs are expensed as incurred and included in "selling, general and administrative expenses." Advertising expenses amounted to $756 million, $988 million and $1,026 million in 1998, 1997 and 1996, respectively. ENVIRONMENTAL COSTS Environmental expenditures that relate to current operations are expensed or capitalized, as appropriate, in accordance with the American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 96-1, "Environmental Remediation Liabilities." Remediation costs that relate to an existing condition caused by past operations are accrued when it is probable that these costs will be incurred and can be reasonably estimated. INCOME TAXES Income tax expense is based on reported earnings before income taxes. Deferred income taxes reflect the impact of temporary differences between the amounts of assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes. EARNINGS PER SHARE Earnings per share is presented in accordance with the provisions of SFAS No. 128, "Earnings Per Share." Basic earnings per share computations are based on the weighted-average number of shares of common stock outstanding during the year. Diluted earnings per share calculations reflect the assumed exercise and conversion of employee stock options. STOCK-BASED COMPENSATION The Company applies Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," which requires compensation costs to be recognized based on the difference, if any, between the quoted market price of the stock on the grant date and the exercise price. 39 SEGMENT REPORTING In the fourth quarter of 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," for all periods presented. The Company has four operating segments. The basis for determining the Company's operating segments is the manner in which financial information is used by the Company in its operations. Management operates and organizes itself according to business units which comprise unique products and services across geographic locations. RECLASSIFICATIONS Certain reclassifications of 1997 and 1996 financial statement and related footnote amounts have been made to conform with the 1998 presentation. - --------------------------------------------------------------------------- 40 NOTE 2: RECEIVABLES (in millions) 1998 1997 Trade receivables $2,167 $1,930 Miscellaneous receivables 360 341 ------ ------ Total (net of allowances of $169 and $112) $2,527 $2,271 ====== ====== The Company sells to customers in a variety of industries, markets and geographies around the world. Receivables arising from these sales are generally not collateralized. Adequate provisions have been recorded for uncollectible receivables. There are no significant concentrations of credit risk. - -------------------------------------------------------------------------- NOTE 3: INVENTORIES (in millions) 1998 1997 At FIFO or average cost (approximates current cost) Finished goods $ 907 $ 788 Work in process 569 538 Raw materials and supplies 439 460 ------ ------ 1,915 1,786 LIFO reserve (491) (534) ------ ------ Total $1,424 $1,252 ====== ====== Inventories valued on the LIFO method are approximately 57% and 56% of total inventories in 1998 and 1997, respectively. - --------------------------------------------------------------------------- NOTE 4: PROPERTIES (in millions) 1998 1997 Land $ 193 $ 185 Buildings and building equipment 2,681 2,693 Machinery and equipment 9,764 9,062 Construction in progress 844 884 ------- ------- 13,482 12,824 Accumulated depreciation (7,568) (7,315) ------- ------- Net properties $ 5,914 $ 5,509 ======= ======= - --------------------------------------------------------------------------- 41 NOTE 5: PAYABLES AND SHORT-TERM BORROWINGS (in millions) 1998 1997 Trade creditors $ 947 $ 943 Accrued advertising and promotional expenses 392 322 Employment-related liabilities 897 709 Restructuring programs 312 813 Other 1,358 1,045 ------ ------ Total payables $3,906 $3,832 ====== ====== Short-term bank borrowings totaled $1,518 million at year-end 1998 and $611 million at year-end 1997. Borrowings included $1,196 million and $227 million of commercial paper at year-end 1998 and 1997, respectively. The weighted-average interest rate was 5.5% in 1998 and 6.0% in 1997. The Company has a $3.5 billion unused revolving credit facility established in 1996 and expiring in November 2001 which is available to support the Company's commercial paper program and for general corporate purposes. If unused, it has a commitment fee of $1.9 million per year, at the Company's current credit rating. Interest on amounts borrowed under this facility is calculated at rates based on spreads above certain reference rates. - --------------------------------------------------------------------------- NOTE 6: LONG-TERM BORROWINGS (in millions) Description and Interest Maturity Dates Rates of 1998 Borrowings of 1998 Borrowings 1998 1997 Notes: 5.27% - 8.25% 1999 - 2004 $198 $198 9.20% - 9.95% 2003 - 2021 191 191 Debentures: 1.35% - 13.75% 1999 - 2004 147 171 Other: .05% - 15.8% 2000 - 2021 46 28 ---- ---- 582 588 Current maturities (78) (3) ---- ---- Total $504 $585 ==== ==== Annual maturities (in millions) of long-term borrowings outstanding at December 31, 1998 are as follows: 1999: $78; 2000: $68; 2001: $72; 2002: $22; 2003: $282 and 2004 and beyond: $60. The Company has a shelf registration statement for debt securities with an available balance of $2.2 billion. - --------------------------------------------------------------------------- 42 NOTE 7: OTHER LONG-TERM LIABILITIES (in millions) 1998 1997 Deferred compensation $ 160 $ 152 Restructuring programs 102 295 Liabilities related to sales of businesses 172 195 Minority interest in Kodak companies 128 24 Other 470 417 ------ ------ Total $1,032 $1,083 ====== ====== - --------------------------------------------------------------------------- NOTE 8: COMMITMENTS AND CONTINGENCIES Environmental Expenditures for pollution prevention and waste treatment for continuing operations at various manufacturing facilities were as follows: 1998 1997 1996 (in millions) Recurring costs for managing hazardous substances and pollution prevention $ 75 $ 88 $ 76 Capital expenditures to limit or monitor hazardous substances and pollutants 25 25 37 Site remediation costs 4 2 3 ---- ---- ---- Total $104 $115 $116 ==== ==== ==== At December 31, 1998 and 1997, the Company's undiscounted accrued liabilities for environmental remediation costs amounted to $91 million and $118 million, respectively. The Company anticpates the above expenditures to increase in the future. However, it is not expected that these costs will have an impact which is materially different from 1998's environmental expenditures on financial position, results of operations, cash flows or competitive position. A Consent Decree was signed in 1994 in settlement of a civil complaint brought by the U.S. Environmental Protection Agency and the U.S. Department of Justice under which the Company is subject to a Compliance Schedule by which the Company improved its waste characterization procedures, upgraded one of its incinerators, and is evaluating and upgrading its industrial sewer system. The total expenditures required to complete this program are currently estimated to be approximately $43 million over the next eight years. These expenditures are primarily capital in nature. 43 The Company is presently designated as a potentially responsible party (PRP) under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended (the Superfund law), or under similar state laws, for environmental assessment and cleanup costs as the result of the Company's alleged arrangements for disposal of hazardous substances at approximately seven active Superfund sites. With respect to each of these sites, the Company's actual or potential allocated share of responsibility is small. Furthermore, numerous other PRPs have similarly been designated at these sites and, although the law imposes joint and several liability on PRPs, as a practical matter, costs are shared with other PRPs. Settlements and costs paid by the Company in Superfund matters to date have not been material. Future costs are also not expected to be material to the Company's financial position or results of operations. In addition to the foregoing environmental actions, the Company is currently implementing a Corrective Action Program required by the Resource Conservation and Recovery Act (RCRA) at the Kodak Park site in Rochester, NY. As part of this Program, the Company has completed the RCRA Facility Assessment (RFA), a broad-based environmental investigation of the site. While future expenditures associated with any remediation activities could be significant, the Company is currently in the process of completing a number of RCRA Facility Investigations (RFIs) and Corrective Measures Studies (CMS) for areas at the site. Upon completion of these activities, the Company expects to have fully developed estimates of the required remediation costs. The Clean Air Act Amendments were enacted in 1990. Expenditures to comply with the Clean Air Act implementing regulations issued to date have not been material and have been primarily capital in nature. Future capital expenditures cannot be reasonably estimated at the present time, as many of the regulations to be promulgated pursuant to this Act have not been issued. The Company has retained certain obligations for environmental remediation and Superfund matters related to the non-imaging health businesses sold in 1994. Actions to fulfill these obligations are not expected to be completed in the near term and costs related to the obligations are included in remediation accruals recorded at December 31, 1998. Included in these obligations are responsibilities for the liabilities associated with the non-imaging health businesses as a PRP in approximately eight active Superfund sites. Other Commitments and Contingencies The Company has entered into agreements with several companies which provide Kodak with products and services to be used in its normal operations. The minimum payments for these agreements are approximately $124 million in 1999, $106 million in 2000, $80 million in 2001, $68 million in 2002, $68 million in 2003 and $115 million in 2004 and thereafter. The Company has also guaranteed debt and other obligations under agreements with certain affiliated companies and customers. At December 31, 1998, these guarantees totaled approximately $195 million. The Company does not expect that these guarantees will have a material impact on the Company's future financial position or results of operations. 44 The Company has issued letters of credit totaling $76 million to ensure the completion of environmental remediations and payment of possible casualty and Workers' Compensation claims. Rental expense, net of minor sublease income, amounted to $149 million in 1998, $182 million in 1997 and $207 million in 1996. The approximate amounts of noncancelable lease commitments with terms of more than one year, principally for the rental of real property, reduced by minor sublease income, are $106 million in 1999, $81 million in 2000, $58 million in 2001, $34 million in 2002, $23 million in 2003 and $47 million in 2004 and thereafter. The Company and its subsidiary companies are involved in lawsuits, claims, investigations and proceedings, including product liability, commercial, environmental, and health and safety matters, which are being handled and defended in the ordinary course of business. There are no such matters pending that the Company and its General Counsel expect to be material in relation to the Company's business, financial position or results of operations. - -------------------------------------------------------------------------- NOTE 9: FINANCIAL INSTRUMENTS The following table presents the carrying amounts and the estimated fair values of financial instruments at December 31, 1998 and 1997; ( ) denotes liabilities: 1998 1997 (in millions) Carrying Fair Carrying Fair Amount Value Amount Value Marketable securities: Current $ 43 $ 43 $ 24 $ 24 Long-term 89 89 26 26 Other investments 23 25 49 48 Long-term borrowings (504) (540) (585) (627) Foreign currency forwards 9 9 12 (1) Silver options - - 1 17 Silver forwards - 7 - 15 Marketable securities and other investments are valued at quoted market prices, except for $3 million and $25 million of equity investments included in other investments at December 31, 1998 and 1997, respectively, which are reflected at their carrying value because quoted market prices do not exist. The fair values of long-term borrowings were determined by reference to quoted market prices or by obtaining quotes from dealers. The fair values for the remaining financial instruments in the above table are based on dealer quotes and reflect the estimated amounts the Company would pay or receive to terminate the contracts. The carrying values of cash and cash equivalents, receivables, short-term borrowings and payables approximate their fair values. The Company, as a result of its global operating and financing activities, is exposed to changes in foreign currency exchange rates, commodity prices, and interest rates which may adversely affect its results of operations and financial position. In seeking to minimize the risks and/or costs associated with such activities, the Company manages exposures to changes in commodity prices, interest rates and foreign currency exchange rates. 45 Foreign currency forward contracts are used to hedge certain firm commitments and the currency risk inherent in the deposit-taking and lending activities of the Company's International Treasury Center. Option and forward contracts are used to mitigate the Company's risk to fluctuating commodity 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. Derivative instruments are not presently used to adjust the Company's interest rate risk profile. The Company does not utilize financial instruments for trading or other speculative purposes, nor does it utilize leveraged financial instruments. The table below summarizes by major currency the notional amounts of foreign currency forward contracts in U.S. dollars. The counter-currency for the majority of the contracts is the U.S. dollar, while some contracts are cross-currency with one foreign currency traded for another. Foreign currency amounts are translated at rates current at the reporting date. The "buy" amounts represent the U.S. dollar equivalent of commitments to purchase foreign currencies, and the "sell" amounts represent the U.S. dollar equivalent of commitments to sell foreign currencies. Substantially all of the Company's foreign currency forward agreements will mature during 1999. The market risk related to foreign currency forward contracts is substantially offset by changes in the valuation and cash flows of the underlying positions hedged. 1998 1997 (in millions) Buy Sell Buy Sell Australian dollar $ - $ 65 $ - $ 69 British pound - 385 - 477 French franc 288 - 105 - German mark 79 - 54 - Irish punt - 83 - 84 Spanish peseta - 31 - 36 Others 65 31 75 121 ---- ---- ---- ---- Total $432 $595 $234 $787 ==== ==== ==== ==== The Company has used silver option and forward contracts to minimize almost all of its exposure to increases in silver prices in 1998 and will continue to do so in 1999. As of December 31, 1998, the Company had open forward contracts hedging the majority of its planned silver requirements for 1999. Silver forwards outstanding at December 31, 1998 have notional amounts of $241 million. All silver hedging contracts are settled in cash. Gains and losses related to silver hedges are recorded as adjustments to the carrying amount of silver inventory when purchased, and recognized in results of operations as silver-containing products are sold. The market risk related to silver options and forward contracts is substantially offset by changes in the cost of silver purchased. The Company's financial instrument counterparties are high quality investment or commercial banks with significant e