KODK

Eastman Kodak Company: Q2 2009 10-Q Summary

Business Context and Reporting Period

This report covers the quarterly period ended June 30, 2009. Eastman Kodak Company (Kodak) operates in three primary segments: Consumer Digital Imaging Group (CDG), Film, Photofinishing and Entertainment Group (FPEG), and Graphic Communications Group (GCG). The company is navigating a severe global economic downturn, resulting in significant declines in consumer discretionary spending and commercial print demand. Management has suspended cash dividends and implemented a targeted cost-reduction program (the "2009 Program") to align costs with reduced revenue expectations.

Key Financial Metrics

Note: Q2 2008 results included a $565 million IRS tax refund (net of tax), significantly inflating prior-year earnings.

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 29% year-over-year in Q2 2009, driven by volume declines across all segments due to the recession and unfavorable foreign exchange rates. CDG sales fell 33%, FPEG fell 30%, and GCG fell 24%.
• Profitability Erosion: Gross profit margin contracted from 23.6% in Q2 2008 to 18.5% in Q2 2009. The company reported a net loss of $189 million in Q2 2009 compared to a net income of $495 million in Q2 2008. Excluding the one-time tax refund in 2008, the operating performance deterioration is severe.
• Restructuring Costs: The company incurred $37 million in restructuring costs in Q2 2009 (up from $2 million in Q2 2008) and $146 million year-to-date. These costs are part of the 2009 Program aimed at reducing the workforce by 3,500 to 4,500 positions.
• Dividend Suspension: On April 30, 2009, the Board suspended future cash dividends to conserve cash.

Guidance, Outlook, and Risks

• Outlook: Management expects recessionary trends to continue affecting results for the balance of 2009. The company is focusing on core investments (consumer inkjet, commercial inkjet, enterprise workflow) and cash conservation.
• Restructuring Savings: The 2009 Program is expected to yield annualized cash savings of $200 million to $250 million. Combined with late 2008 actions, total annual savings are projected at $300 million to $350 million.
• Liquidity: Cash and cash equivalents decreased by $1.013 billion in the first six months of 2009. The company maintains a $500 million asset-based revolving credit facility (Amended Credit Agreement) with no borrowings outstanding as of June 30, 2009, but $131 million in letters of credit.
• Convertible Notes: The company holds $575 million in Convertible Senior Notes due 2033. Holders have the right to require the company to purchase these notes at 100% of principal plus accrued interest on October 15, 2010. Management believes it is probable these will be put to the company for cash.
• Risks: Key risks include the severity and duration of the economic downturn, credit rating downgrades (currently B3/B- with negative outlook), potential impairment of goodwill, and ongoing litigation regarding intellectual property and environmental liabilities.

Investor Verification Checklist

• Cash Burn Rate: Verify the sustainability of the $1.1 billion cash balance given the $942 million operating cash outflow in the first half of 2009.
• Convertible Note Put Risk: Assess the company's ability to fund the potential $575 million redemption of convertible notes in October 2010.
• Restructuring Execution: Monitor the realization of the projected $300-$350 million in annual cost savings and the timeline for workforce reductions.
• Intellectual Property Revenue: Track the recovery of royalty revenues, which declined significantly due to the expiration of certain licensing arrangements.
• Segment Performance: Evaluate the divergence between the declining traditional film/print businesses and the growth potential in the Consumer Inkjet Systems segment.