EASTMAN KODAK CO quarterly report, Q2 FY2019

Eastman Kodak Company — Q2 2019 Form 10-Q

Reporting period: Unaudited quarter and six months ended June 30, 2019. Amounts are in U.S. dollars; financial figures are in millions unless noted. Kodak reports six segments, with Print Systems its largest.

Financial performance and liquidity

Metric	Q2 2019	Q2 2018	Six months 2019	Six months 2018
Revenue	$307	$332	$598	$650
Gross profit / margin	$42 / 14%	$45 / 14%	$82 / 14%	$83 / 13%
Continuing operations, net	$(6)	$3	$(18)	$(22)
Net income (loss)	$201	$4	$183	$(21)
Operating cash flow	Not provided for quarter	Not provided for quarter	$(13)	$(49)

• Revenue fell 8% in both the quarter and first half. Management attributed the decline principally to lower Print Systems volume and pricing and unfavorable currency effects. Q2 currency reduced revenue by $9; the six-month impact was $20.
• Q2 net income included $207 of income from discontinued operations, principally the Flexographic Packaging business (FPD) divestiture. Continuing operations remained loss-making; reported net income is therefore not representative of recurring operating performance.
• Six-month investing cash flow was $297, including $302 of net proceeds from business and asset sales. Financing cash flow was $(294), including repayment of the Term Credit Agreement. Cash, cash equivalents and restricted cash ended at $258, down $9 from year-end; cash and cash equivalents alone were $216.
• At June 30, current assets were $729 versus current liabilities of $382. Total debt and finance leases were $106 carrying value, compared with $401 at December 31, 2018. The balance included $85 of convertible notes, $14 owed to RED-Rochester and other debt and finance leases.
• The $100 principal amount of 5% secured convertible notes was issued in May to repay the remaining term loan. Notes mature November 1, 2021; interest is payable at maturity or, at Kodak’s option, on conversion. The ABL facility had $24 of excess availability, with approximately $80 of letters of credit outstanding.

Material changes and business developments

• Kodak sold most of FPD in April for $320 net cash consideration at closing, plus assumption of certain liabilities; proceeds were used in part to repay approximately $312 of term loans. It repaid the remaining approximately $83 with proceeds from the convertible notes and terminated the Term Credit Agreement. The China portion closed July 1 for additional consideration, including $5.9 cash and a $1.6 promissory note.
• Print Systems revenue declined 9% in Q2 and 10% year to date, while segment Operational EBITDA rose to $7 in Q2 and $12 year to date. Cost improvements and aluminum tariff refunds helped offset declining revenue. Enterprise Inkjet Systems and Kodak Software reported lower revenue and weaker segment results; Brand, Film and Imaging improved segment EBITDA despite modest first-half revenue decline.
• Q2 restructuring charges were $3, including $1 in discontinued operations. First-half actions eliminated about 75 positions and are expected to generate approximately $7 in annual cash savings, with most savings expected to be in effect by the end of Q3 2019.
• Kodak adopted the new lease standard in 2019, recognizing operating lease right-of-use assets and liabilities. At June 30, operating lease assets were $44 and operating lease liabilities totaled $54.

Outlook, risks and contingencies

• Going concern: Management states that operating losses, negative cash flow, cash needs and uncertainty about returning to positive cash flow raise substantial doubt about Kodak’s ability to continue as a going concern. Management’s plans include profitable revenue growth, expense and organizational reductions, asset sales, and reducing or delaying product-development investment. The filing does not provide a clear earnings or cash-flow guidance target.
• Kodak expects 2019 capital expenditures of approximately $10–$20. It forecast about $11 of additional pension and postretirement contributions or benefit payments for the remainder of 2019, after approximately $11 in the first half.
• Liquidity is constrained by cash location: $90 of cash and cash equivalents was in the U.S.; $126 was outside the U.S. and may be restricted or costly to repatriate. Approximately $59 was held in China, where local limitations may affect transfers. The ABL availability threshold is $18.75; falling below it could trigger a minimum fixed-charge coverage test and cash dominion. Fixed charges exceeded defined EBITDA by approximately $6 at June 30.
• The convertible notes and Series A preferred stock carry significant dilution and governance implications. Notes purchasers also hold all Series A preferred shares; conversion of the notes could materially increase their voting power. Series A dividends had not been declared for four consecutive quarters through Q2 2019, and three payments were in arrears as of July 1. The preferred stock has a mandatory redemption date of November 15, 2021 unless converted or amended.
• Brazilian litigation and tax assessments are significant: claims aggregating approximately $159, including interest and penalties where applicable, had about $4 accrued; the filing identifies approximately $10 of unreserved contingencies with at least a reasonable possibility of loss. Kodak also reports other commercial, environmental, employment and intellectual-property matters, which it says are being defended.
• After quarter-end, Kodak agreed to sell its China graphic-communications entity and related assets to HuaGuang, with a supply and technology-licensing relationship. The expected closing proceeds were $22.5, with $15.5 to be placed in escrow in China; closing was subject to customary conditions. Kodak also filed proposals for restrictions and a tax-asset protection plan intended to preserve tax attributes under Section 382.

Important facts for investors to verify

• Whether Kodak can generate sustainable positive operating cash flow without relying on further asset sales, and how accessible its overseas cash is for U.S. needs.
• Actual proceeds, escrow restrictions and closing status of the HuaGuang transaction, and whether the planned restructuring savings are realized.
• ABL excess availability, borrowing-base changes, letters of credit, and compliance with facility covenants and reporting requirements.
• Refinancing or repayment plans for the November 2021 convertible notes and Series A preferred redemption, including accrued dividends and potential dilution or changes in voting control.
• Continuing-business results excluding the FPD gain, especially Print Systems revenue trends, segment profitability and the performance of growth investments.
• Developments in Brazilian and other legal contingencies, pension funding needs, and the effectiveness and timing of the Section 382 tax protections.