Kodak 2001 Annual Report Download - page 43

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Graphics, an unconsolidated affiliate in which the Company has a 50%
ownership interest. The balance of the amount is principally comprised of
other loan guarantees and guarantees of customer amounts due to banks
in connection with various banks’ financing of customers’ purchase of
equipment and products from Kodak. These guarantees would require
payment from Kodak only in the event of default on payment by the
respective debtor. Management believes the likelihood is remote that
material payments will be required under these guarantees.
In connection with the formation of the SK Display Corporation with
SANYO Electric Co., Ltd., the Company will contribute approximately $119
million, comprised of $19 million in cash and $100 million in loan
guarantees during 2002 and 2003.
Qualex, a wholly-owned subsidiary of Kodak, has a 50% ownership
interest in Express Stop Financing (ESF), which is a joint venture
partnership between Qualex and Dana Credit Corporation (DCC), a
wholly-owned subsidiary of Dana Corporation. Qualex accounts for its
investment in ESF under the equity method of accounting. ESF provides a
long-term financing solution to Qualex’s photofinishing customers in
connection with Qualex’s leasing of photofinishing equipment to third
parties, as opposed to Qualex extending long-term credit. As part of the
operations of its photofinishing business, Qualex sells equipment under a
sales-type lease arrangement and records a long-term receivable. These
long-term receivables are subsequently sold to ESF without recourse to
Qualex. ESF incurs long-term debt to finance a portion of the purchase of
the receivables from Qualex. This debt is collateralized solely by the long-
term receivables purchased from Qualex and, in part, by a $60 million
guarantee from DCC. Qualex provides no guarantee or collateral to ESF’s
creditors in connection with the debt, and ESF’s debt is non-recourse to
Qualex. Qualex’s only continued involvement in connection with the sale
of the long-term receivables is the servicing of the related equipment
under the leases. Qualex has continued revenue streams in connection
with this equipment through future sales of photofinishing consumables,
including paper and chemicals, and maintenance.
Qualex has risk with respect to the ESF arrangement as it
relates to its continued ability to procure spare parts from the primary
photofinishing equipment vendor to fulfill its servicing obligations under
the leases. The primary photofinishing equipment vendor is currently
experiencing financial difficulty, which raises concern about Qualex’s
ability to procure the required service parts. Although the lessees’
requirement to pay ESF under the lease agreements is not contingent
upon Qualex’s fulfillment of its servicing obligations under the leases,
under the agreement with ESF, Qualex would be responsible for any
deficiency in the amount of rent not paid to ESF as a result of any
lessee’s claim regarding maintenance or supply services not provided by
Qualex. Such lease payments would be made in accordance with the
original lease terms, which generally extend over 5 to 7 years. ESF’s
outstanding lease receivable amount was approximately $570 million at
December 31, 2001. To mitigate the risk of not being able to fulfill its
service obligations, Qualex has built up its inventory of these spare parts
and has begun refurbishing used parts. Additionally, Qualex has entered
into spare parts escrow agreements under which bills of materials, parts
drawings, intellectual property and other information necessary to
manufacture the parts were put into escrow arrangements. In the event
that the primary photofinishing equipment vendor were unable to supply
the necessary parts to Qualex, Qualex would gain access to the
information in the escrow arrangements to either manufacture or have
manufactured the parts necessary to fulfill its servicing obligations.
Management is currently negotiating alternatives with the photofinishing
equipment vendor to further mitigate the above risks.
In December 2001, Standard & Poor’s downgraded the credit ratings
of Dana Corporation to BB for long-term debt and B for short-term debt,
which are below investment grade. This action created a Guarantor
Termination Event under the Receivables Purchase Agreement (RPA) that
ESF has with its banks under the RPA. To cure the Guarantor
Termination Event, in January 2002, ESF posted $60 million of additional
collateral in the form of cash and long-term lease receivables. At that
time, if Dana Corporation were downgraded to below BB by Standard &
Poor’s or below Ba2 by Moody’s, that action would constitute a
Termination Event under the RPA and ESF would be forced to renegotiate
its debt arrangements with the banks. On February 22, 2002, Moody’s
downgraded Dana Corporation to a Ba3 credit rating, thus creating a
Termination Event.
Under the Termination Event, the banks can require ESF to put up an
additional 6% collateral against the debt (on a debt balance of
approximately $405 million at the time of filing the annual report, the
additional collateral would be approximately $24 million), the interest rate
on the debt could be increased 2 percentage points and Qualex could be
precluded from selling any new receivables to ESF until the Termination
Event has been waived by the banks. ESF does not currently have the
ability to put up the additional collateral and, therefore, ESF would require
additional capital infusions by DCC and Qualex. If DCC and/or Qualex do
not provide the additional capital funding to ESF, the banks could
accelerate the debt and force ESF to liquidate its long-term lease
receivables to service the debt. Management believes that it is unlikely
that the banks would accelerate the debt, and force ESF to sell the
receivables to a third party to generate cash to satisfy the debt, due to
the high-quality nature of the underlying long-term receivable portfolio.
Furthermore, under this scenario, the banks would not have any recourse
against Qualex; rather, the impact on Qualex would be limited to the need
to find an alternative source of financing for future photofinishing
equipment placements. Additionally, under this scenario, it is not expected
that the operations of the customers who are leasing the equipment under
these long-term lease arrangements would be affected such that Qualex’s
revenue stream for future sales of photofinishing consumables would be
jeopardized. ESF is beginning negotiations with the banks to resolve the
Termination Event.