Eastman Kodak Company — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Dollar amounts are in millions unless otherwise noted. Comparisons are with the corresponding 2010 periods, except balance-sheet comparisons, which are with December 31, 2010.
Business context and financial performance
Kodak reported three segments: Consumer Digital Imaging Group (CDG), Graphic Communications Group (GCG), and Film, Photofinishing and Entertainment Group (FPEG). Management’s stated 2011 priorities included growing digital initiatives and generating positive cash before restructuring payments.
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $1,485 | $1,555 | $2,807 | $3,469 |
| Gross profit / margin | $211 / 14% | $303 / 20% | $336 / 12% | $1,096 / 32% |
| Loss from continuing operations | $(179) | $(167) | $(428) | $(48) |
| Net loss attributable to Kodak | $(179) | $(168) | $(425) | $(49) |
| Basic and diluted loss per share | $(0.67) | $(0.63) | $(1.58) | $(0.18) |
| Cash flow from operating activities | Not separately stated | Not separately stated | $(847) | $(644) |
Q2 sales fell 5%; first-half sales fell 19%. The first-half comparison includes a $550 non-recurring intellectual-property licensing agreement in Q1 2010, with no comparable agreement in 2011. Excluding no such item from reported totals, that prior-year license also materially lifted comparative gross profit. Q2 gross margin contracted six percentage points, with pricing pressure, higher silver costs, and GCG manufacturing costs among the cited factors.
Segment sales and operating results before interest, other income/charges, and taxes were: CDG $404 sales and $(92) loss in Q2; GCG $685 sales and $(45) loss; FPEG $396 sales and $2 earnings. For the first half, CDG had $734 sales and a $(260) loss, GCG $1,310 sales and a $(116) loss, and FPEG $763 sales and a $(13) loss. Digital growth product-line revenue increased 22% year over year in the first half; consumer inkjet revenue rose 47%.
Cash, debt and liquidity
- Cash and cash equivalents were $957 at June 30, down from $1,624 at year-end. First-half cash decreased $667.
- Operating cash use was $847; investing cash use was $26; financing provided $191. Capital expenditures were $56, while proceeds from asset and business sales were $76.
- Total debt carrying value was $1,451, including $50 current and $1,401 long-term, versus $1,245 at year-end. Long-term debt fair value was reported as $1,366. Debt includes $250 million principal of 2013 notes still outstanding.
- Kodak issued $250 million principal of 10.625% secured notes due 2019, receiving approximately $247 million, and used $50 million to repurchase 2013 notes. The remaining proceeds went to general corporate purposes.
- The amended asset-based revolving facility was $400 million. At quarter-end, $235 million was available after specified letters of credit and collateral; there were no borrowings under the facility. The company reported covenant compliance and availability above the covenant trigger.
- Total liabilities were $6,753 and shareholders’ deficit was $1,421 (total deficit $1,419). Pension and other postretirement liabilities were $2,600.
Material changes, outlook and risks
- Drivers of performance: Management attributed first-half revenue and profitability declines to the absent prior-year licensing agreement, industry volume declines in FPEG, competitive pricing, and higher commodity costs—particularly silver. GCG sales grew 4% in both Q2 and the first half, but its margin was pressured by commercial printing system start-up costs and higher prepress distribution and aluminum costs.
- Management outlook: Kodak said it expected its cash balance, operating cash flows, planned asset-sale proceeds, and financing arrangements to meet anticipated needs. It also cited uncertainty, investment needs, competition, commodity costs, and uncertainty around intellectual-property licensing. The filing provides no specific revenue or earnings guidance. Management expected price increases, silver-indexed contracts, and hedging to affect FPEG results more significantly in the second half of 2011.
- Restructuring: First-half charges were $71; approximately 775 positions were eliminated. Management estimated $67 of annual cash savings from first-half actions, with most expected in effect by year-end. Cash restructuring payments were $36 in the first half.
- Unusual items and estimates: Q2 included an $18 foreign-exchange gain correcting an equal Q1 overstatement, with no first-half earnings impact. First-half results included a $62 gain on the sale of CMOS image-sensor patents and a $5 bargain-purchase gain. A change in estimated useful lives of certain legacy assets increased first-half continuing-operations earnings by $12. The IRS audit settlement generated a $50 tax benefit; Kodak also recorded a $23 provision for a foreign deferred-tax valuation allowance.
- Contingencies and risk factors: Kodak accrued $102 for environmental liabilities, generally expected to be paid over 25–30 years. It could not estimate loss likelihood or range for the Passaic River matter; the overall cleanup could cost several billion dollars. Unreserved Brazilian tax contingencies with at least a reasonable possibility of loss were approximately $81. Patent disputes involving Apple and RIM may affect licensing prospects; Kodak was also pursuing litigation and exploring strategic alternatives for its digital-imaging patent portfolios. Credit ratings carried negative outlooks (Moody’s Caa1 corporate rating; S&P CCC).
- The company cited economic weakness, successful execution of strategic investments, competition, product commercialization, IP outcomes, cash generation, pension funding, currency and commodity movements, customer financing, and supplier reliance as risks. It reported disclosure controls effective and no material quarterly change in internal control over financial reporting.
Investor verification priorities
- Assess liquidity and cash burn against the $957 cash balance, $847 first-half operating cash use, debt maturities, pension funding obligations, and availability under the borrowing base.
- Separate underlying sales and profitability trends from the $550 prior-year licensing comparison and 2011 patent-sale and tax-related gains.
- Track whether consumer and commercial inkjet growth can become profitable, and whether pricing actions, silver hedges, and cost reductions improve margins.
- Review the timing and terms of remaining debt obligations, the 2019 notes’ covenants, and credit-rating developments.
- Monitor patent litigation and licensing outcomes, the Passaic River exposure, Brazilian tax disputes, and the assumptions behind environmental and pension liabilities.