Table of content
2. Statement of earnings
3. Balance sheet
3.3 Shareholder's equity
4. Statement of Cash Flow
4.1 Cash inflows
4.2 Cash outflows
5. Comprehensive analysis
5.1 Background: Firm and industry
5.2 Key financial ratios
5.3 Segments information
5.4 Growth strategy
5.5 Summary of analysis
The objective of this essay is to evaluate the Kodak financial report 2004 from an investor's point of view. Unlike the management's perspective, which often tries to present the most positive picture possible this analysis is designed to most clearly and critically reflect financial reality, in order to arrive at an estimate of its future potential and value. In deciding whether to buy, hold or sell the company's securities, answers to such questions as follows will be determined in this analysis:
- What is the company's record with regard to growth and stability of earnings and cash flow from operations?
- How well has the company performed and why? What operating areas have contributed to success and which have not?
- What are the company's strengths and weaknesses? How are areas of strengths and weaknesses affecting the company's financial condition and performance?
- How risky is the company's financial structure?
- How does the company's operating performance compare with its industry competitors?
The following chapters will try to concentrate on this questions by dealing with the most important information in a financial report, which is the basic set of financial statements: income statement, balance sheet and statement of cash flows. The statement of shareholder's equity will not be part of this essay, as it is not widely used for analysis and will be shortly covered in the balance sheet chapter. The statements will be discussed and analyzed in detail in the chapters 2-4. In the last chapter, Kodak's background with regard to its firm, industry and economy will be outlined; furthermore, key financial ratios will be calculated and compared to the industrial average. Finally, the investment decision will explained by estimating the future potential and value of the company.
2. Statement of Earnings
The Statement of earnings focuses on what has traditionally been considered as the company’s financial success – its earnings in a given period. At the end of each year, the bottom – line figure – its profit for the previous year is compared to what the previous results and to what has been announced by the company. Kodak reported the following figures for 2004, 2003 and 2002:
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Table 1: Statement of Earnings; Source: http://www.kodak.com/
In 2004, net sales increased by 4.7 percent compared to 2003 and by 7.7 percent compared to 2002 and net earnings by incredible 119.8 percent (-27.8 percent). At the first glance, it seems like Kodak did a good job. Unfortunately, the earnings and sales figures often bear little relationship how well the company has actually performed and figures may be misleading.
One explanation is based on the accrual basis principle of accounting used by US companies. Under this principle, revenues (sales) are recorded when earned rather than when cash is received and even if the sale has been made on credit, and the customer has not yet paid, the sale is recorded.
The relationship between accounts receivables and sales is a good tool to analyse the company’s accounting approach. In the same period where sales increased by 4.7 percent, accounts receivables increased by 9.3 percent, which is almost double the amount and indicates that Kodak records sales in a relatively aggressive way.
Another reason for caution is based on the growth in sales compared to inventories: inventory increased by 7.4 percent, which is also far more than sales increased.
Despite the growth in sales, Kodak was not able to generate a growth in gross profit, which declined by 4.9 percent compared to 2003 and by 12.3 percent compared to 2002 and can be explained by increasing cost of good sold (+9.3 percent, 19.0 percent), described in the management's discussion and analysis as "price/mix declines in the D&FIS segment." The gross profit margin, calculated as gross profit / sales, declined from 36.1 percent to 32.3 percent and to 29.4 percent. This combination signals another caution flag, because sales and earnings move into different directions, which indicates that the company may be growing too fast, costs may be out of line or revenue recognition may be too aggressive. Concerning Kodak in particular, it is probably a combination of the two last mentioned reasons, as costs increased and sales seem to have been recorded in a fairly aggressive way.
Selling, general and administrative expenses decreased by 4.2 percent mainly due to a reduction in marketing expenses from $596 million to $ 513 million, as explained in the notes to the financial statements. The concern for analysis is whether reductions in advertising may finally result in lower sales and earnings.
Research and development costs is another so-called discretionary expense for Kodak, which, like advertising is crucial to achieve long-term success. Unlike the marketing budget, research and development activities were expanded by 10.1 percent (12.8 percent). However, management's discussion and analysis states, that the number in percentage of sales was maintained at six percent.
Restructuring costs increased by significant rates of 45.1 percent and even 609.2 percent compared to 2002 ), which indicates that Kodak is either currently changing its strategy and restructuring its business, or is trying to take enormous write-offs in one period in order to improve profits in future periods (big bath).
Operating profit, which measures the success of a company in its normal, ongoing business operations apart from financing and investing activities and tax considerations, decreased significantly from $1,168 Mio. to $302 Mio. in 2003 and to $-87 Mio. in 2004, which raises three caution flags:
First, sales and earnings move into different directions (sales increased, whereas earnings decreased significantly), which again can be traced back to a fairly aggressive way of accounting and too high costs.
Second, Kodak does not generate any profit with its core business activities, which is cause for serious concern.
And finally, sales and earnings figures were highly volatile in the recent accounting periods, instead of growing in constant, moderate figures, which would be the ideal case.
Interest expense increased by 14.3 percent (-2.9 percent), showing that either financing costs rose or Kodak has paid off debt.
In 2004, Kodak reported a $175 million tax benefit, as earnings before taxes were negative.
Only by having this tax benefit, Kodak’s net earnings from continuing operations remain positive in 2004; however the decline in net earnings relative to the previous year is 57.1 percent and even 89.4 percent compared to 2000. As already mentioned, it signals two caution flags – on the one hand, revenues and earnings move into different directions, on the other hand Kodak does not generate profit with its core business activities (as net earnings would have been negative without the tax benefit).
Surprisingly, total net earnings amount to $556 million, which is a 119.8 percent increase compared to 2003 and a 27.8 percent compared to 2002. However, the vast majority of these net earnings are generated through discontinuing operations, which show an incredible 642.2 percent increase compared to the previous accounting period and an even more significant increase of 5177.8 percent compared to 2002. Through these operations, Kodak was able to increase its net profit margin, calculated as net earnings / sales, from 1.9 percent in 2003 to 4.1 percent in 2004 (in 2002 it was 6.1 percent)
As mentioned, the operating profit margin was negative (!!!), signalling another caution flag. Furthermore, total net earnings also developed in a highly volatile way, which raises doubts about a successful, on-going long-term strategy.
Another major concern with regard to the statement of earnings is based on the huge share of discontinued earnings, that contribute to the overall net earnings - 85.4 percent of all earnings are generated through discontinued operations. This raises serious concern about how Kodak wants to be successful in the future and possibly explains why the dividend was reduced by 56.5 percent.
 Source: Understanding the Corporate annual report, page 24