Eastman Kodak Q3 2009 Earnings Call Transcript

Oct.29.09 | About: Eastman Kodak (KODK)

Eastman Kodak Company (EK) Q3 2009 Earnings Call October 29, 2009 11:00 AM ET

Executives

Ann McCorvey - Investor Relations

Antonio M. Perez - Chairman of the Board, Chief Executive Officer

Frank S. Sklarsky - Chief Financial Officer, Executive Vice President

Analysts

Richard Gardner - Citigroup

Shannon Cross - Cross Research

Ulysses Janice - Buckman, Buckman & Reed

Chris Whitmore - Deutsche Bank

Ananda Baruah - Brean Murray, Carret & Co.

Operator

Good morning, ladies and gentlemen and thank you for standing by. Welcome to the Eastman Kodak Company third quarter sales and earnings conference call. (Operator Instructions) I would now like to turn the conference over to Ann McCorvey, Director of Investor Relations. Please go ahead, Madam.

Ann McCorvey

Good morning and welcome to our discussion of the 2009 third quarter sales and earnings. I am here this morning with Antonio M. Perez, Kodak’s Chairman and CEO, as well as Chief Financial Officer Frank Sklarsky. Antonio will begin this morning with his observations on the quarter and then Frank will provide a review of the quarterly financial performance.

As usual, before we get started I have some housekeeping activities to complete. Certain statements during this conference call may be forward-looking in nature or forward-looking statements as defined in the United States Private Securities Litigation Act of 1995.

For example, references to the company’s expectations regarding the following are forward-looking statements: revenue, revenue growth, earnings, cash generation, increased demand for Kodak’s products, including commercial printing equipment and consumables, scanners and services, digital cameras and devices, consumer inkjet products, dry lab and motion picture film; new product introductions, potential revenue, cash and earnings from intellectual property transactions, restructuring and other cost reductions and liquidity.

These forward-looking statements are subject to a number of important risk factors and uncertainties which are fully enumerated in our press release issued this morning. Listeners are advised to read these important cautionary statements in their entirety as any forward-looking statement needs to be evaluated in light of these important factors.

Now I’ll turn the conference call over to Antonio M. Perez.

Antonio M. Perez

Thank you, Ann. Good morning, everyone. In the third quarter, we began to see real evidence that the market trends are positive, our top-line is stabilizing and our business is beginning to improve. We also continue to gain strong traction with our core investments and we are driving tangible results from our efficiency gains and rationalization activities. I am happy with the fact that, despite the continued challenges from the overall economy, we delivered positive cash generation before restructuring payments in the third quarter.

All of these positive factors are significant and sustainable and combined with the favorable market trends give me increased confidence that we are on track for a much improved fourth quarter which is our largest quarter of the year.

As I said, our top-line is stabilizing and some product lines are beginning to grow. Overall the demand for our cash generating businesses, Digital Capture and Devices, Retail System Solutions, PrePress Solutions, Document Imaging, and Entertainment Imaging stabilized in the third quarter. We expect significant improvement in that trend into the fourth quarter, especially for digital cameras and devices, digital plates, scanners and devices, and entertainment imaging films. We expect our cash generators to grow both on a quarterly sequential basis and year-over-year in the fourth quarter.

We continue to gain strong traction quarter after quarter with our core investments. These core investments are very important to our future growth and bottom line. The revenue growth of 128% in consumer inkjet hardware and inks in this current environment validates the competitive strength of our value proposition.

Industry and customer interest in our Stream inkjet technology, which has been commercialized under the KODAK PROSPER brand, continues to accelerate. Based on the growing number of letters of intent from customers, who are technology leaders across a broad spectrum of applications, we have an impressive order funnel for the PROSPER press which will be available in early 2010.

We are driving tangible results from our efficiency gains and rationalization activities. In this volatile economic environment, you have to control what you can control. In the third quarter, we saw positive and sustainable results from the numerous actions that we have implemented thus far. We have made significant progress in finding ways to reduce and variabilize our cost structure.

Consistent with our typical seasonality, we expect the fourth quarter to be our largest revenue quarter for our digital businesses. For the fourth quarter, we expect both continued quarterly sequential improvement for consumables in our commercial businesses and increased consumer demand. We also expect to benefit from a number of intellectual property transactions which will be executed in a manner that maximizes value for our shareholders.

We have visibility to our sell-in and that gives us optimism about our fourth-quarter sales. We believe we have strong product offerings and we are well represented in the market place. However, based on the continued economic weakness and in the pricing pressures that come with it, plus our increased focus on cash and earnings, we are now forecasting that our overall revenue rate will decline within the range, but at the high-end of the original full-year forecasted range.

As a result of the significant operational improvements implemented to-date, we expect full-year segment earnings to be within the original range we forecasted in February, as we are confident that any revenue shortfall will be offset by higher margins and the cost reduction actions.

What is our fourth quarter outlook dependant upon? The list remains the same as we outlined on the second quarter call. The third quarter margin improvement in digital cameras and devices was driven by the launch of our new higher-margin products and the correction of the first half inventory overhang. We expect to see continued margin improvement for digital cameras and devices in the fourth quarter. We also expect margin improvement within PrePress Solutions, in this case due to higher volume demand, that we have seen building up in the last few months, and an improved aluminum cost position. Our forecast also assumes that we will benefit from a number of Intellectual Property transactions.

Achieving this margin improvement along with continued discipline over working capital and capital expenditures will deliver full-year positive cash generation before restructuring, which continues to be our goal.

Now let me talk specifically about our two digital segments. Starting with the Graphic Communications Group, GCG. As I said earlier, we continue to see quarterly sequential improvements in our consumables business. The revenue decline rate for digital plates, our largest consumable product, has been improving since the first quarter. We are maintaining our market share in digital plates and our current order trends suggests that we will see modest revenue growth in the fourth quarter. Global advertising spend is recovering and commercial printers are beginning to increase their consumable purchases. Despite the improvement in the global economic environment and our order funnel, we are taking a prudent approach by assuming that plate-setters equipment and the related software associated will not yet grow in the fourth quarter. Based on the combination of consumables growth partially offset by the decline in equipment, we are expecting a modest year-over-year decline in GCG revenues in the fourth quarter. We also expecting GCG’s margins to improve in the fourth quarter driven primarily by a favorable aluminum cost position and improved volumes.

GCG’s third quarter segment earnings from operations of $10 million were down $12 million from the third quarter of 2008, reflecting the negative impact of lower demand for consumables and equipment placements, partially offset by productivity improvements and rationalization actions, and the greatly improved performance of Electrophotographic Printing Solutions.

Turning to the Consumer Digital Imaging Group, CDG, CDG’s third quarter revenue declined 35% primarily driven by the year-over-year reduction in intellectual property royalty revenue, the timing of which varies every year within Digital Capture and Devices. However, we continue to see sequential improvement in the demand for digital cameras and devices. Based on our visibility to the sell-in, we are forecasting year-over-year growth for Digital Capture and Devices during the fourth quarter. We also expect nearly 100% of our digital camera revenue for the fourth quarter to come from new higher-margin models introduced during the third quarter. The Digital Capture & Device team has lowered their inventory risk for the fourth quarter and is focusing on margin improvement and cash management.

During the third quarter, the Retail Systems Solutions business performed well and continued to build on its global installed base of more than 100,000 Kiosk order stations and APEX dry labs. Retail Systems Solutions revenue declined only 3% when compared to the year ago quarter, a significant improvement in the quarter sequential decline rate. Due to the recent strong placements of APEX dry labs, Kodak now has the largest dry lab installed base in Europe. We will continue to drive placements and expect to continue to be the market leader based on the strength of our product offerings.

CDG’s third quarter segment loss from operations was $89 million as compared to segment earnings of $24 million in the prior year. This decrease was driven by a planned, year-over-year reduction of $157 million in intellectual property royalty revenue, partially offset by operational improvements in Digital Capture and Devices, Consumer Inkjet Systems and Retail Systems Solutions and including the impact of the intellectual property royalties, segment earnings would have improved.

Let me share with you the status of our intellectual property activities. We are pleased with the progress to-date and our outlook continues to assume we will achieve the intellectual property goals we set in February. As always, we like to maximize the value for our shareholders for these deals.

As a reminder, we continue to have three objectives for our intellectual property licensing program. These are: achieving design freedom; access to new markets and partnerships; and the continued generation of cash and income.

Consumer Inkjet Systems had another quarter of impressive sales growth and improved financial performance. We continued to gain market share with a revenue growth of 128% in the third quarter and close to 100% year-to-date for our inks and printer hardware. We are on track to achieve our goal of doubling our installed base while attracting the high-volume users. We are also increasing our average selling prices for our consumer inkjet printers, as Kodak is winning in the market place by bringing a very compelling value proposition.

Now I will focus on our traditional business, FPEG. FPEG’s revenue declined 25% in the quarter and 29% year-to-date. The decline rate for consumer film and traditional photofinishing has been improving each quarter and has more than offset the weak demand across all segments within entertainment imaging films which include commercials, television and feature films. For the largest segment, feature films, the declines are market-related and volume is expected to improve as the economy recovers. Our data shows that the rate of digital substitution for origination film did not increase in the third quarter and that we continue to maintain our overall market share. We began to see improved demand for both print and origination film in September and October.

FPEG’s third quarter segment earnings were $47 million, or 8% of revenue. We expect a full-year segment earnings as a percentage of revenue to be approximately 6% , which is one percentage point above the full year target we set in February. This improvement over target is being driven by continued variabilization of cost, especially within Traditional Photofinishing where the business delivered another quarter of positive earnings and cash contributions.

Now I will turn the call over to Frank who will provide more details on our financial performance.

Frank S. Sklarsky

Thanks, Antonio and good morning, everyone. I will provide a bit more information around our third quarter financial results and then Antonio and I will be happy to take your questions.

Looking at our financial performance, we are pleased that the operational improvements we implemented which helped us to achieve positive cash generation before restructuring for the third quarter. Our overall financial results continued to be impacted by global economic conditions. We have, however, begun to see some increased interest in many of our equipment lines and increased demand for consumables across our commercial and consumer product groups, including media burn growth in our Kiosk business. In addition, we continue to achieve a high level of market acceptance and market share improvement with our consumer inkjet products as evidenced by triple digit growth in hardware and ink. We are also pleased with the completion of actions to address our debt maturity schedule. As a result of those transactions, we have improved our near term liquidity and solidified our cash position. This will enable us to weather the remainder of the economic downturn and confidently continue to invest in our core portfolio in pursuit of our growth model. I will provide more specifics on these transactions later.

Turning to our third quarter results, consolidated revenues for the quarter were $1.781 billion, a decline of 26%. Foreign exchange represented two percentage points of the decline versus the prior year. Our Digital revenues for the quarter were $1.209 billion, a decline of 26% from the prior year quarter. The decline in our digital revenues is largely due to lower intellectual property licensing revenues, which were reflected in our plans. It also reflected continued market softness for digital cameras and devices and declines in most of our graphic communications businesses consistent with continued weakness in global print demand.

In the quarter, the company’s gross profit margin was 20.3% versus 27.5% last year. The decrease in gross profit margin was largely attributable to the decline in intellectual property licensing revenues and unfavorable foreign exchange. Additionally, in the prior year quarter, gross profit was favorably impacted by a one-time change to other post employment benefit costs. These negative factors were partially offset by the favorable impact of improved consumer inkjet performance driven by a lower cost platform and a higher unit installed base resulting in continually increasing revenue from ink cartridges. We also had continued manufacturing cost improvements in Traditional Photofinishing. In addition, lower costs for silver and aluminum contributed approximately $25 million of earnings favorability during the third quarter versus the prior year. Excluding the impact of lower intellectual property royalties, the gross profit margin was essentially flat year-over-year for the quarter.

The company has also continued to adjust its structural costs to align with lower revenues. SG&A costs decreased by $51 million or 14% to $318 million in the third quarter. Excluding a one-time non-cash benefit to SG&A in the prior year quarter, SG&A would have decreased by $78 million or 20% . In addition, our emphasis on focusing significant R&D investments on our core portfolio categories, along with the maturing and commercialization of previous investments, has allowed us to reduce total R&D spend by $14 million, or 15% to $81 million in the third quarter versus the prior year quarter. Again, excluding the one-time non-cash benefit resulting from changes to other post employment benefits in the prior year, the decrease in R&D would have been $33 million, or 29%.

Regarding restructuring, we incurred $35 million in restructuring charges to the P&L for the third quarter and $197 million year-to-date. The company made restructuring-related payments from corporate cash of $40 million in the quarter and $143 million year-to-date. The company eliminated 575 positions during the quarter, bringing total reductions to 2,725 positions to date as part of the 2009 Cost Reduction Program. When combined with the actions from the fourth quarter of 2008, total reductions to date are 4,275 positions. Based on our progress to date, along with our analysis of actions to be completed for the remainder of the year, we continue to believe total restructuring charges for 2009 will be in the range of $250 to $300 million. We may, however, be at the low end of this range. Likewise, corporate cash payments for restructuring are likely to be at the low end of the $225 to $275 million range previously communicated. At the same time, because of the efficiency with which restructuring and rationalization activities are taking place, we are confident we will meet or exceed our cost reduction targets for the year and are very pleased with the operating leverage this will provide the company as the economy improves.

Third quarter GAAP loss from continuing operations was $111 million or $0.41 per share as compared to GAAP earnings of $101 million or $0.35 per share in the year ago quarter. This decline in earnings of $212 million or $0.76 per share from prior year ago quarter is primarily due to the decline of intellectual property licensing revenues and the continued impact on revenue, gross profit and earnings due to the difficult economic environment. The quarter was also impacted by lower interest income due to lower cash balances and interest rates. These factors were partially offset by the substantial reductions in SG&A and more focused R&D spending, as previously described.

Segment Earnings from Operations for the quarter was a negative $36 million. This compares to the range of negative $50 million to $60 million communicated as part of our updated outlook on September 16th. The improvement versus the prior guidance is due primarily to better performance than expected from operational efficiencies and rationalization initiatives.

Now let’s take a look at results by segment. Graphic Communications Group’s revenue was $674 million for the third quarter, as compared to $821 million in the prior year quarter, an 18% decline. Overall, the GCG business continues to be impacted by market softness in print demand although as Antonio indicated, we have begun to see some rebound for our consumables and increased indications of interest in our equipment categories. On the earnings side, GCG posted $10 million in earnings in the third quarter, as opposed to $22 million in the year ago quarter. The revenue and earnings decline primarily reflects continued industry weakness in commercial print demand which resulted in volume declines in Prepress and associated workflow software, along with lower digital printing equipment sales across the segment. These factors were partially offset by operational improvements in Electrophotographic Printing Solutions, reductions in SG&A costs, and more focused R&D spend with an emphasis on bringing to market our new line of PROSPER products, which are based on Kodak’s Stream continuous inkjet technology. We also saw an improvement in aluminum costs for the quarter.

Taking a look at the Consumer Digital Imaging Group, CDG revenue was $535 million in the current year quarter as compared to $820 million in the prior year quarter. The decline in revenue was mostly attributable to the decline of intellectual property licensing revenues, lower volumes for digital cameras and digital picture frames, and unfavorable foreign exchange. Segment loss from operations was $89 million versus a profit of $24 million in the prior year quarter. Excluding the impact of $157 million lower intellectual property licensing revenues in the current year quarter versus the prior year, CDG would have had an improvement in earnings largely due to shifting to a lower cost platform for Consumer Inkjet printers and product cost reductions in digital cameras along with reduced SG&A and R&D costs. Our CDG business has been successful in substantially reducing the inventory overhang of digital cameras and devices and will continue to improve margins in the fourth quarter, our largest revenue generating quarter, as the company’s sales will be highly focused on a mix of newer, more profitable products.

With respect to FPEG, revenue declined by 25% to $572 million as compared to the prior year quarter. This reduction in revenue was reflective of the industry-wide volume declines in Film Capture and Traditional Photofinishing. Our Entertainment Imaging business also had a 22% revenue decline in the quarter, which was largely due to lower volumes associated with the general economic environment and reduction of investments in feature films following the conclusion of the Screen Actors Guild contract negotiations.

Earnings from operations in the quarter were $47 million as compared to $77 million in the prior year ago quarter. This year-over-year decline is largely due to lower volumes and unfavorable foreign exchange across all businesses within FPEG and negative price mix within Entertainment Imaging. This decline was partially offset by reductions in SG&A and R&D and cost improvements in the Traditional Photofinishing business driven by progress toward an even leaner variable cost model. We continue to be very pleased with the major accomplishments this business has made despite the continued volume declines.

Now let me take a few minutes to discuss our recent financing transactions, along with how they are reflected on the balance sheet and then we will move onto cash.

As we have previously communicated, the company recently completed a re-financing of a portion of our capital structure. This resulted in the raising of $700 million in gross proceeds from a combination of new convertible debt and an investment by KKR. We then proceeded with a tender offer for the $575 million in existing convertible debt. For the $700 million in new debt, the accounting rules require both instruments to be split between their respective debt and equity components as each contains either a conversion option or warrants. Based upon the prescribed analysis, we have reported $486 million as long term debt and $187 million as paid in capital in the equity section of the balance sheet. This $187 million portion, classified as equity, along with $27 million of original issue discount and fees paid to holders of the notes, represent debt discount and will be amortized to interest expense, serving to accrete the debt balance to its stated principal amount over the term of the debt.

Now on to cash -- the Company’s cash and cash equivalents at the end of the third quarter was approximately $1.147 billion. Not included in this amount is the $575 million in restricted cash, which is the portion of the net proceeds from the recent financing transactions that the company placed into an account to enable the purchase of the existing convertible notes due in 2033. These convertible notes contained a put option allowing the holder to put the notes to the company for cash on October 15, 2010. The convertible notes can also be called by the company any time on or after October 15, 2010. Through October 19, 2009 the company received and accepted tenders for approximately $563 million of these convertible notes, resulting in a use of an equal amount of cash from the restricted account. The remaining balance of $12 million in the restricted accounts will be used to retire the remaining outstanding 2033 notes.

Moving on to cash for the quarter, despite a difficult economic environment and the impact it has had on our operations and earnings, the company generated $29 million of cash before restructuring in the third quarter. This compares to a use of $78 million in the year ago quarter, representing an improvement of $107 million. The cash performance for the third quarter is largely attributable to continued efficiency and cost rationalization actions across the enterprise, the company’s intense focus on working capital, tight discipline over capital spending and receipt of proceeds from sales of miscellaneous assets.

Looking forward to the fourth quarter and full year, we expect the company to deliver improved fourth quarter operating results both sequentially and as compared to the prior year. This includes anticipated margin improvements in our digital cameras business within CDG, and our Prepress business within GCG. We do, however, believe that the total revenue decline rate for the year will be at the high end of the 12% to 18% range previously communicated. This is expected to occur as a result of market conditions experienced year-to-date in both our consumer and commercial digital businesses along with our focus on earnings and cash performance. That said, we are still targeting segment earnings from operations of between $0 and $200 million for the year.

As for cash, we are retaining our goal of positive cash generation before restructuring for the full year. We intend to achieve this goal by delivering strong earnings performance from our digital businesses during their largest revenue quarter and by carefully managing our working capital consistent with our revenue trends.

We are also expecting to benefit from a number of intellectual property transactions which will be executed in a manner that maximizes shareholder value. As we have stated previously, our total year revenue, earnings and cash goals are predicated upon receiving the benefits from the IP negotiations, modest improvements in economic conditions in our consumer business, particularly in the area of digital cameras and devices, an increase in demand for products serving the commercial printing market including Prepress, and a recovery in Entertainment Imaging.

In summary, given overall economic conditions and where we are in our digital transformation, we’re pleased with our third-quarter performance and satisfied with our recent actions to solidify our near term liquidity and improve the balance sheet. Our businesses are showing signs of stabilization. We will continue to execute through this uncertain global economic environment by concentrating on the things under our control and operating with strict financial discipline in order to allow us to emerge from this difficult period as a leaner, more profitable enterprise focused on sustainable, profitable growth.

Thanks very much, and now Antonio and I would be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Richard Gardner with Citigroup.

Richard Gardner - Citigroup

Thank you. Antonio and Frank, I just wanted to ask about the IP negotiations with LG and Samsung. I was hoping you could give us an update on where we are in the process, how you expect this to unfold over the next weeks, several weeks and months, and I wanted to gauge your level of confidence that you will get the benefit that you hope to get from these negotiations during the fourth quarter. Thank you.

Antonio M. Perez

It’s hard for me to answer. We are not going to comment on a litigation that is ongoing, so I won't say anything about that.

I will talk about the process though. This is no different than any other year. I mean, you’ve been following us. You know that these things, they seem to -- they have a way of kind of settling at the end of the year -- not that we like it but that’s the way it goes and we are -- we are very confident about the strength of our portfolio. We invented the digital camera. We have a very deep, very strong portfolio in that space. We are very confident. We have already a large number of licensees and we want to get what is -- what our shareholders deserve, so we will continue to exercise our rights but I can't tell you more than that.

Richard Gardner - Citigroup

Okay, and just as a quick follow-up, Antonio, we’re at the end of October here but it still sounds like you are confident that you can get to the 250 to 350 range that you talked about back in February, is that correct?

Antonio M. Perez

Yeah, we haven’t change that.

Richard Gardner - Citigroup

Okay. All right, thank you.

Operator

Your next question comes from the line of Shannon Cross with Cross Research.

Shannon Cross - Cross Research

I wanted to go back to the revenue expectations for fourth quarter. Based on what it looks like here, you did about $9.4 billion of revenue in ’08, you are going into an 18%-ish year over year decline which would be about $7.7 billion, so clearly there is a substantial increase sequentially of about 50% from third quarter to fourth quarter, and 11% year-over-year growth rate for fourth quarter. So I guess -- I know you have talked about several different ways you were getting there -- can you maybe tell us in order of importance, any more color you can give us in terms of how you think the revenue is coming through, maybe talk about how the month has improved since the summer -- I don’t know. We’re just trying to get comfortable with the level of revenue because clearly it is above where people are expecting.

Antonio M. Perez

There are a variety of things, Shannon. The first one may be we are only about 50% of our revenue in the consumer space is still to come, so that’s one. That’s a seasonality issue so that is an important factor. The other one is that we feel strong about the recovery of consumables in the case of digital plates. Those two are very large product lines and they make a good part of that recovery. There is revenue associated with the [ideas wall]. And then in general, we expect a sequential improvement, you know, in many of our product lines going into the fourth quarter, so you put all those things together, this is how we get to those numbers.

Shannon Cross - Cross Research

Okay, could you talk a little bit about what you have seen on a monthly basis and perhaps how October has looked, just again -- and then also --

Antonio M. Perez

I can say that October was good -- October was good. I mentioned that this is the call for the third quarter but since I did mention that, something that we thought it was useful to understand the trend in EI, that’s why I mentioned that September and October was the first time that we saw improvement in entertainment imaging and I think for us that is very significant and I thought you should all know that. But really we shouldn’t be talking about the fourth quarter yet.

Shannon Cross - Cross Research

Okay, and then how do we think about -- you know, if you are going to have these strong growth rates in the revenue side, can you talk a bit about how we should think about expenses? And clearly you have moved more to variable expenses but overall costs have come down dramatically. I mean, how do we think about how much of the revenue upside should fall to the bottom line and how are you -- in terms of the costs that you have reduced already, how many of them are sort of sustainable versus nobody can travel because -- which a lot of people have done, but nobody can travel because we are just really, really focused on this, so --

Antonio M. Perez

I’ll let Frank answer that.

Frank S. Sklarsky

A great percentage, a very high percentage of the cost reductions we have put in place, Shannon, we believe are very, very sustainable. Clearly as you go from Q3 to Q4 on a sequential basis, you will see some increases in advertising in order to support the revenue growth, particularly in the areas of the CDG categories, but even on the commercial side. So if you look at the various line items -- R&D, for instance, the run-rates of R&D if you take the year-to-date number, we think we can sustain that, focus our efforts on the areas, on our core investments and maintain a pretty good run-rate consistent with what we have seen so far this year and particularly as recently in the second and third quarter.

In core SG&A, we also believe that we can come pretty close in the fourth quarter, even though it’s a seasonal peak and you tend to pay things like commissions and things like that. We can sustain a pretty good rate because we are still completing the restructuring for the year, so the structural costs, the run-rate for general structural G&A, we believe that’s sustainable.

So the one area where you will see a bit of an up-tick in the cost is in that area of advertising, which is not really much of a different dynamic than we generally see on a sequential basis from Q3 to Q4 each year.

And in the area of cost of goods sold, which we don’t give a lot of transparency in for a number of reasons, we are going to continue to see the groups perform well in the area of structural COGS because of some of the simplification efforts, particularly as it relates to our product portfolios, our SKUs in the pre-press area, and just overall purchasing productivity that we’ve been able to achieve this year.

Shannon Cross - Cross Research

Okay, great, that was helpful. And then my last final question is can you just talk a little bit about the loss of the large contract you had on the retail photo finishing side? I believe it was Walmart but how should we think about the revenue impact -- clearly you say in there it’s not much of a profitability impact but how should we think about that? And then how do you plan on replacing that business?

Antonio M. Perez

We would love to win every deal and in that business, we’ve been winning basically every deal around the world. Sometimes it’s not possible. Sometimes it’s not a deal that will be -- that is possible for you and for your partner. And remember, we have a huge market share around the world -- you have to think about the other, the many, many other large accounts around the world. I mean, just as an example, DM in Germany, Rothman in Germany, Boots in the U.K., CVS and Target in the U.S. -- there are many, many other large accounts that use Kodak equipment. I can assure you that three years from now, we will be bidding again in the Walmart. We love the relationship with Walmart. It’s a great partner. But it’s -- we don’t see this as anything significant for us as far as cash generation. We would like to get that account back when we can and in another three years and life continues. In the meantime, we are only -- the U.S. is only 5% of the population of the world. This is about printing and this is about people who just became the number one shareholder in dry labs in Europe. For the installs that we had during 2009 in the U.S., we are the share leader. There is another company with about the same number of units. We are incredibly well-positioned worldwide, so you have to look at this in that context.

Shannon Cross - Cross Research

Okay, but no indication of just the revenue headwind you’ll face going forward from this?

Antonio M. Perez

Well, we’ll see -- I mean, there are going to be many other accounts coming. I mean, they come in every year so I am sure we will win most and I am sure we will lose some, unfortunately. But no, we won't make any comment about that. We think -- you know, this business we believe is going to be doing fine and this is not a dramatic situation for us in any way.

Shannon Cross - Cross Research

Thank you.

Operator

Your next question comes from the line of Ulysses Janice with Buckman, Buckman & Reed.

Ulysses Janice - Buckman, Buckman & Reed

When do you switch from costing out the [inaudible], the stream technology from R&D to cost of goods sold?

Frank S. Sklarsky

That will take place upon the shipment of the first units that we will revenue recognize in 2010, so when we look at placing units, we expect to place units and ship units in early 2010 and as the year progresses, we will recognize revenue and that’s when we will start rolling things into a cost of goods sold and it will be reflected in gross margin.

Ulysses Janice - Buckman, Buckman & Reed

So you are talking basically second quarter 2010, roughly?

Frank S. Sklarsky

Some time -- as we get into mid-year, you will see more significant numbers in terms of the revenue recognized, and most of it obviously in the back half.

Ulysses Janice - Buckman, Buckman & Reed

So in essence, that would imply an increasing cost of goods sold and a declining R&D?

Frank S. Sklarsky

Not necessarily a declining R&D overall for the company as we shift our allocation of R&D to different initiatives, so we will still continue to spend R&D as we introduce some of the new products and models in that SPG as well as other businesses next year. You will see an increase in COGS in that particular business unit. That may not be transparent publicly but along with that will go the revenue and the good part about that business is the equipment becomes profitable very quickly and so there is a shorter time to break even in that business then on the consumer side.

Ulysses Janice - Buckman, Buckman & Reed

Better margins on equipment than you have [inaudible] equipment?

Frank S. Sklarsky

Better margin on the stream prosper?

Ulysses Janice - Buckman, Buckman & Reed

Yes.

Frank S. Sklarsky

-- than on the hardware from consumer inkjet, yes.

Ulysses Janice - Buckman, Buckman & Reed

Finally, do you still believe you can do a 4% next year in sales overall?

Antonio M. Perez

What was the question again?

Ulysses Janice - Buckman, Buckman & Reed

Do you expect to do a 4% increase in sales next year?

Frank S. Sklarsky

We’ll provide an update for 2010 at our investor meeting in early February. We haven’t finalized that.

Antonio M. Perez

I think we need to see the results of the fourth quarter. That was originally our plan. We need to see what the fourth quarter ends up being. I think that will be fair for us to wait before we answer that question.

Ulysses Janice - Buckman, Buckman & Reed

Finally, you still expect a re-doubling next year on inkjet printers?

Antonio M. Perez

Again, our plan is to continue to gain printed pages, so we will -- we will announce a plan for next year. We are doing very well this year. I have no reason to believe why we wouldn’t do that but we haven’t set a plan for next year yet, so we are -- we have a lot of traction, the business proposition obviously talks loud to a lot of people. The print, you know, they print enough, they print a lot. The new technologies actually are going to help us a lot because in the past, you will have maybe two or three printers in a home and you will be printing little in each one of the printers. Now with all the wireless connections that we are providing, by the way, with our new printers, you don’t need to have that -- you can have one single printer in the house and you can print from anywhere, from any device and use the same printer. That actually fits incredibly well with our value proposition because again, it is going to make more people higher printers as far as usage than they thought they were in the past. And then the number of printers is going to become maybe less relevant and the number of prints will become more and more relevant.

So we will keep -- the intention is what you just said. I just want to give you right metric for the goals that we have. We make money not with the number of printers but we make money with the prints. That’s how we make money. But intentionally, directionally that is what we want to do. Let us give you the right metric and obviously we will justify what the right metric is when we come to February.

Ulysses Janice - Buckman, Buckman & Reed

So in essence -- this is very interesting. You are talking about the possibility of increasing the use [inaudible] printer from ink cartridges that seems to be in average use now.

Antonio M. Perez

If wireless technologies get adapted rapidly in homes, we believe that will happen. You don’t have to have a printer for each one of your children or one or the wife, one for the husband, or whatever it is. There are several printers in many homes, or in businesses, small businesses for that matter, you will be just getting a good, solid printer, the best in the market, which is ours, with the best value proposition, which is ours, with the best resolution, with the best permanence -- yes, it happens to be ours and I think that will help us.

Ulysses Janice - Buckman, Buckman & Reed

And as far as the printer itself is concerned, when do you expect to turn to positive gross margins?

Frank S. Sklarsky

Well, we haven’t really commented on the specific elements of that portfolio, the ink, the hardware, and so on, the media as to when each individual component will turn positive. The business model that most of the industry has is relatively lean margins, even when you are at scale on the hardware with the predominant amount of money and the gross margin made on the consumables. So that is why we are saying during 2011 break-even, when you cross that -- cross over the point where you have more than half of your revenue from the ink cartridges, that is where the real gross margin is in the business.

Ulysses Janice - Buckman, Buckman & Reed

Thank you very much.

Operator

Your next question comes from the line of Chris Whitmore with Deutsche Bank.

Chris Whitmore - Deutsche Bank

Thanks very much. I wanted to follow-up on Rich’s questions around IP income -- specifically, how much IP income has been realized year-to-date? Or up another way, what are you anticipating or what is factored into your guidance for Q4 IP income?

Frank S. Sklarsky

Chris, we want to stick to our guidance that we’ve been saying all along, that our goal is on average $250 million to $350 million from IP on average per year over the period. Now some years will be higher and some years will be lower but we would like to stick to that right now. Obviously as -- the question we answered before, there is clearly on a month that we have baked in in terms of how we are going to achieve our fourth quarter and the fourth quarter is somewhat predicated upon that, as well as the other factors we’ve talked about, so there is significant amount that is assumed in the fourth quarter but we don’t really want to get into specifics at this point in terms of exact dollar amounts that we’ve assumed, so 250 to 350 on average per year, at least, yes.

Chris Whitmore - Deutsche Bank

During the course of Q4, are there any scheduled milestones or expected rulings that we can monitor in order to give us some insight as to your progress relative to that goal?

Frank S. Sklarsky

For the IP, that’s what you are talking, Chris?

Chris Whitmore - Deutsche Bank

Yes.

Antonio M. Perez

No, it’s very hard to -- this is a very fluid kind of negotiation and especially in this case, two of the parties with which we are negotiating, we are in litigation with which makes it practically impossible for us to comment on anything about it. There will be maybe some communications from the court along the way and those will be public and you can go through those but we won't be making any comments until we have a deal with them. And then with the other parties that are not -- we are not in litigation with, we will continue to negotiate.

Chris Whitmore - Deutsche Bank

Along those lines, can you comment on visibility on IP income into 2010 and 2011? What are your expectations? And can you give us any color in terms of the parties on the other side of the negotiations?

Antonio M. Perez

No, we won't be able to, Chris. I can’t mention the people that we are having friendly negotiations with to solve these problems. They wouldn’t be happy with me if I mentioned that, and if we are to have any legal action against anybody, I wouldn’t be able to do it. I really want to answer your question but it’s really -- it is really a difficult question to answer, being helpful. I don’t know how to do it.

Frank S. Sklarsky

And Chris, all we can really say again is that 250 to 350 is a number that on average per year, we think is a good guideline to use over the plan period ’09 through ‘012. Some years will be higher, some will be lower but over that period, that 250 to 350 per year for that four year period is what -- we will stick to that guidance for now.

Chris Whitmore - Deutsche Bank

Okay and my last question has to do with the recently elected board members from KKR -- what impact, if any, do you expect them to have on either the strategy, cost programs, restructuring plans, et cetera -- any color you can provide? Should we expect any kind of changes at all as a result of that?

Antonio M. Perez

First, they are two very competent individuals, first of all, and so we are very happy with them. The reason why they came into such minority position in the company, it was obviously and they said that -- they said that many times is because they love the strategy, they like the strategy, they like the people that are behind the strategy, and they believe that creating a new company is a hard thing to do but they believe that the fundamentals in which we based our creation is something that they trust. They obviously tend to be longer term investors, so they don’t mind to wait a few years for the returns and they believe that our stock is very under-valued. Obviously I am telling you things that you know but this is why they got into this.

They are going to be like any other board members. We have -- we are now 14 board members, including me. Many of them, they are very active. They talk constantly with us, not only during board meetings but as well they have meetings with different units. I would expect that both the KKR members, they will be that type of board member, one that is -- they will call me regularly, they will meet with some of our units, they will look for synergies with some of the companies that they manage, and they manage a huge portfolio of companies. That’s what we expect. I don’t think they are going to have any -- there’s not going to be a change in strategy. Our cost management has been we believe excellent over the years. I don’t think that is the area of focus. I think the area of focus for this company is scaling. We have to scale the company, especially with the businesses that they have the biggest opportunities. I expect them to be working and helping us with that as much as they can.

Chris Whitmore - Deutsche Bank

Can I just ask one more question on cash flow? Frank, in mid-September, you provided a cash flow range -- now you lowered it about six weeks later. I just wanted to get a feel for what changed on the cash flow line relative to the op income kind of expectations for the year?

Frank S. Sklarsky

Are you referring to the previous range that had a 75 and now we are saying positive? We had a range in February of between 75 and 325. At the end of the second quarter, we said we would likely be at the lower end of that range but even in February, we said that our real goal was to get positive cash flow before restructuring. We retained that goal and I would say that we made some great momentum in the third quarter. We are pleased that we went into positive territory before restructuring. We got good control over cost, over CapEx and so on, and we’ve said what the year, that positive number before restructuring, what that is predicated upon in the fourth quarter between CEG, GCG, and the IP deals.

Chris Whitmore - Deutsche Bank

Thanks a lot.

Operator

Your next question comes from the line of Ananda Baruah with Brean Murray, Carret & Co.

Ananda Baruah - Brean Murray, Carret & Co.

Thanks, guys. This one is probably I guess for Frank -- is there any way you can give us a sense of what the savings -- I guess with the year-over-year impact mitigated from commodities, prices could be in the December quarter?

Frank S. Sklarsky

I can't give you that right now but let me give you a couple of trends. So we said about $25 million benefit in the third quarter. That compares to a negative 14 last year versus 2007, so we had about a $39 million flip in the third quarter in that sense. That was not too dissimilar from the flip that we saw in the first and the second quarter. We are anticipating improvement in Q4 -- if things were to stay right where they are today, we would assume there would be more improvement in the fourth quarter versus prior year fourth quarter. Can I say it would be the same $25 million we saw in the third quarter? No, it could be a little more, it could be a little less but we do expect an improvement and of course, these markets, the silver and the aluminum markets and the oil markets, which impacts resin costs and so on, they may change daily. They change by the minute, obviously but we are expecting another improvement.

Ananda Baruah - Brean Murray, Carret & Co.

I guess by improving, you mean the $39 million flip, you expect that to flip a little bit more in your favor?

Frank S. Sklarsky

I am really thinking in terms of the 25 benefit that we saw Q3 over Q3. We expect another improvement in Q4, not sure if it is going to be greater or less than the 25. I was just trying to give you that 39 as we’ve seen a very nice turnaround and you will continue to see progress as the hedges roll off on the aluminum and those markets have very, very much stabilized. Aluminum has been between $0.85 and $0.90 a pound for some time now. Silver has been in the $16, $17 category per troy ounce for quite a while, so we are happy to see the stabilization, at least.

Ananda Baruah - Brean Murray, Carret & Co.

Thanks, and I guess -- I don’t have it at the fingertips in my model, I’m flipping through here, I can't find it. Just off the top of your head, do you happen to know what the year-over-year impact was in the December quarter of ’08?

Frank S. Sklarsky

I’m trying to recall -- I don’t have that in front of me right now. We can get back to you.

Ananda Baruah - Brean Murray, Carret & Co.

Yeah, yeah, I’m flipping through -- I have -- was it $15 million?

Frank S. Sklarsky

We can get back to you with that number.

Ananda Baruah - Brean Murray, Carret & Co.

Okay, thanks, that’s helpful. And I guess just going back to the IP income, if I -- this is really high level but if I calibrate the model to 50% sequential revenue growth in the December quarter and Frank kind of calibrates OpEx around the comments that you gave earlier on the call, to get to the low-end of your annual guidance I need to set gross margins at about 30% or so, which are levels which you guys haven’t done in the fourth quarter since ’03, ’04, which would suggest that I guess a couple of things -- which would suggest that you are actually expecting or hopeful that the settlement is going to come in in the fourth quarter and then be actually quite favorable and I would kind of suggest it would probably be -- you have to come in above the 350 for the year in IP income -- I know you are not going to give guidance around it but I guess what my question is, is I believe on the ITC website, one of the milestone dates that they provided is kind of towards the end of December as an initial ruling. I guess from what I understand, this whole thing will be -- come down to some sort of negotiation anyway, regardless of what that initial ruling is, so -- Antonio, I guess this is for you -- is there any possibility -- I don’t know how the mechanics of this process work -- is there any possibility that since you guys are going to have to settle through negotiations of some sort anyway that you can negotiate prior to these milestones that the ITC sort of sets out there?

Antonio M. Perez

All of that is possible. We could settle tomorrow. We could settle today. There is no limit to that. There are certain regulations with the ITC on the process for settling but there is no limitation on when you can settle.

Ananda Baruah - Brean Murray, Carret & Co.

Okay.

Frank S. Sklarsky

The other thing I want to add, Ananda, is I don’t think we should minimize the progress that we are making in the other parts of the business. If you look at Q4 last year and Q4 this year, and you also look at what we are anticipating in terms of sequential improvement from Q3 to Q4, let’s take the [DC&D] business excluding IP -- we’re looking forward to a significant improvement in the margins in that business because of the mix of the portfolio being towards newer products, because we don’t have the inventory overhang that we had last year or the price protections you have to have when things drop as precipitously as they did in last year’s fourth quarter. That’s one example.

Another example is it greatly improved margins for the inkjet business overall because of higher cartridge revenue and the lower cost platform for the hardware. Likewise for the gallery and for several of the businesses within GCG because of some of the rationalization that’s been done.

So it’s -- IP is certainly a big piece of it, no question. There are a lot of other improvements in the operational parts of the business that we think are very, very sustainable. Pre-press, cameras, document imaging, inkjet systems, and so on, so we don’t want to minimize that.

Ananda Baruah - Brean Murray, Carret & Co.

Yeah, no -- I mean, I understood and I guess just from our perspective, I mean, even if we model really, really, really strong seasonal revenue growth patterns, you know, just I guess on -- if we do any sort of trend analysis with the margins [kind of have done] even in some recent years that have been solid, it is still tough to get there so we are just trying to bridge sort of the improvements that are invisible to us versus something like IP income, which is almost -- basically 100% kind of gross profit positive.

I guess -- hey, one other question, I guess more of a clarification item -- Antonio, I think when originally you said you were expecting some incremental improvement in the plate business in the fourth quarter but I also thought you said we are being conservative in what we are building into expectations, so for GCG, you are actually modeling into your own internal model like a slightly down, or -- those are my words, not your words -- moderately down, I think you said, year over year. And that’s baked into your December quarter guidance, so -- I guess that would almost suggest something else needs to be much better.

Antonio M. Perez

We did that because even though the demand for print is certainly increasing and we see that by the increase in consumables, the lowest point in consumables demand was actually the first quarter. Since then, we have seen quarter after quarter increase, so that is a very good trend and we believe that that is a real trend because it has been going on for a while now in this economy.

But we still see, especially in Europe, issues with financing for new equipment, new capacity and some of those printers, they are struggling to make that jump and they might not make it this year yet. They probably want to see more sustainable improvement. That is why we plan for, as far as the plate setters, just the ones that later on are going to originate demand for plates, that is why we plan a negative growth -- although getting better but negative growth. And we think that will be better next year but -- so we are planning for the fourth quarter carefully because this has been a very difficult time and we don’t want to overshoot.

Ananda Baruah - Brean Murray, Carret & Co.

And I guess just last one for me, on your digital commercial business, can you just comment what I guess ink or supply trends were, or printed page trends were this quarter sequentially relative to maybe last quarter? Any change there, what you are seeing, just general tone?

Antonio M. Perez

A significant improvement.

Ananda Baruah - Brean Murray, Carret & Co.

Are there any numbers you can share with us, sequential growth rates on supplies, commercial supplies?

Ann McCorvey

I don’t have those with me handy, so we’ll provide those to you offline.

Ananda Baruah - Brean Murray, Carret & Co.

Okay. Thanks, guys.

Antonio M. Perez

Let me close the conference. First of all, thank you very much for attending this. I just want to remind you of the three significant and sustainable factors that we have seen in the third quarter -- the stabilization of our top line with beginning to see growth in certain product lines, and very good [inaudible] for the fourth quarter in many of them; the strong traction with our core investments, again we are very proud, the growth of consumer inkjet in a market like this is certainly a proof that this is a very powerful value proposition. And then the costs work that we have done in the company, which is sustainable, is showing its benefit now. So we are on track for a much improved fourth quarter and we are certainly a leaner and a stronger company that will have a lot of leverage as the company -- as the economy recovers. So thank you very much again for attending.

Operator

Ladies and gentlemen, this concludes the Eastman Kodak company third quarter sales and earnings conference call. If you’d like to listen to a replay of today’s conference, please dial 800-406-7325 or 303-590-3030, with the pass code 4161485. ACT would like to thank you for your participation and you may now disconnect.

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