Eastman Kodak Company — Q3 2010 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010. Amounts are in U.S. dollars; financial statement amounts are in millions, except per-share data. Kodak operates Consumer Digital Imaging (CDG), Film, Photofinishing and Entertainment (FPEG), and Graphic Communications (GCG).
Financial performance and liquidity
- Third-quarter revenue: $1.758 billion, down 1% from $1.781 billion a year earlier. Gross profit was $476 million versus $361 million; gross margin improved to 27.1% from 20.3%.
- Third-quarter earnings: Operating earnings before interest, other items and taxes were $58 million, compared with an $81 million loss. Kodak nevertheless recorded a $43 million net loss, or $0.16 per share, versus a $111 million loss, or $0.41 per share. The $71 million tax provision exceeded pretax income of $28 million.
- Nine-month results: Revenue was $5.260 billion, up 5%; gross profit was $1.574 billion and gross margin 29.9%, compared with $881 million and 17.5% in 2009. Kodak reported a $92 million net loss, or $0.34 per share, versus a $653 million loss, or $2.44 per share.
- Cash flow: Operations used $504 million in the first nine months, an improvement from $958 million used in 2009. Investing used $64 million and financing used $63 million. Cash and cash equivalents declined $627 million from year-end 2009 to $1.397 billion.
- Balance sheet and debt: Total assets were $6.929 billion and total liabilities $7.142 billion, leaving a $213 million deficit. Debt was approximately $1.250 billion, including $61 million current and $1.189 billion long-term. Pension and other postretirement liabilities were $2.628 billion.
- Available liquidity: At September 30, the asset-based credit facility had $224 million available after letters of credit and collateral deductions; no borrowed-money balance was outstanding under it. Cash held in the U.S. was subject to a $250 million minimum covenant. Management said cash, expected operating cash flows, asset-sale proceeds and credit arrangements should meet anticipated needs.
Material changes versus prior periods
- Third-quarter consolidated sales were nearly flat, but segment results diverged: CDG sales rose 25% to $670 million and segment earnings were $82 million versus an $89 million loss; FPEG sales fell 25% to $431 million and earnings declined to $20 million from $47 million; GCG sales fell 3% to $657 million and shifted to a $19 million loss from $10 million of earnings.
- For the first nine months, CDG sales rose 43% to $2.008 billion, while FPEG sales fell 20% to $1.328 billion and GCG sales declined 1% to $1.924 billion. Licensing income and cost improvements drove much of the consolidated gross-profit improvement; the filing describes the licensing arrangements as non-recurring and says future timing and amounts are difficult to predict.
- Cash used in operations improved year over year, partly because cash received from non-recurring intellectual-property licensing agreements was $240 million higher and working capital improved. Cash nevertheless remained a substantial use.
- Interest expense increased to $117 million for nine months from $75 million. A $102 million loss on early debt extinguishment was recorded in 2010, primarily related to refinancing and repurchases.
Outlook, management commentary and risks
- Management’s 2010 goals included improving segment earnings, accelerating digital revenue growth, investing in growth markets, exploiting operating leverage and generating positive cash flow before restructuring. The filing does not provide a clear numeric full-year revenue or earnings forecast.
- Management cited cautious U.S. consumer spending, price pressure, electronic-component supply constraints, improving demand in some commercial printing markets, and continuing secular declines in traditional film and photofinishing. It also noted exposure to commodity prices and foreign exchange.
- Restructuring charges were $29 million in Q3 and $54 million for the first nine months. Actions eliminated about 650 positions year to date and were expected to produce approximately $45 million in annual cash savings; most were expected to be realized by year-end. Severance and exit payments extend into 2011 and beyond.
- In March, Kodak issued $500 million of 9.75% senior secured notes due 2018, using proceeds to repurchase $300 million of 2017 secured notes and tender for $200 million of 2013 notes. The next significant debt maturity was identified as 2013. The new notes are secured, carry restrictive covenants, and Kodak reported compliance with debt covenants at September 30.
- Subsequent to quarter-end, non-extending lender commitments expired on October 18, reducing facility commitments to $410 million, with the possibility of adding commitments up to the $500 million maximum. Also in October, Kodak’s U.K. pension subsidiary paid $56 million and agreed to minimum annual contributions of $50 million in 2011–2014 and $90 million in 2015–2022, subject to stated conditions and funding needs.
- Key risks include substantial leverage, operating cash outflows, pension funding requirements, declining traditional businesses, reliance on unpredictable licensing receipts, competitive pricing, product and supplier risks, and intellectual-property litigation. Kodak reported $100 million of accrued environmental liabilities and approximately $59 million of unreserved Brazilian tax contingencies for which loss was reasonably possible. The filing says litigation outcomes are inherently unpredictable.
Most important facts for investors to verify
- Whether recurring business performance and cash generation can improve without relying on large, non-recurring licensing agreements.
- Current cash levels, U.S. minimum-cash covenant compliance, borrowing-base availability and the effect of the October 18 facility commitment reduction.
- Debt service capacity and refinancing needs, particularly the remaining 2013 maturities and the cost and collateral terms of the 2018 notes.
- Cash requirements for U.K. pension funding, other benefit plans, restructuring and environmental matters.
- Progress in CDG and GCG growth initiatives, and whether FPEG’s secular decline or other market changes could trigger goodwill impairment; no goodwill impairment was indicated in the September 2010 test.