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Executives

Ann McCorvey – Director, IR

Phil Faraci – President and COO

Frank Sklarsky – EVP and CFO

Analysts

Richard Gardner – Citigroup

Shannon Cross – Cross Research

Ananda Baruah – Brean Murray Carret & Co.

Chris Whitmore – Deutsche Bank

Ulysses Yannas – Buckman, Buckman & Reid

Mark Kaufman – Rafferty Capital Markets

Arun Seshadri – Credit Suisse

Ben Winger [ph] – Talek Investments

Eastman Kodak Company (EK) Q1 2010 Earnings Call Transcript April 29, 2010 11:00 AM ET

Operator

Good morning, ladies and gentlemen, thank you for standing by. Welcome to Eastman Kodak's first quarter 2010 sales and earnings conference call. During today's presentation, all parties will be in a listen-only mode.

Following the presentation, the conference will be open for questions. (Operator instructions) This conference is being recorded today, Thursday, April 29th of 2010. I would now like to turn the conference over to Ms. Ann McCorvey, Director of Investor Relations. Please go ahead, ma’am.

Ann McCorvey

Good morning, and welcome to our discussion of the 2010 first quarter sales and earnings. I'm here this morning with Phil Faraci, Kodak's President and Chief Operating Officer; as well as Financial Officer, Frank Sklarsky. Antonio M. Perez, Kodak's Chairman and CEO, is unable to be with us today because of a medical emergency involving his adult daughter.

While Antonio obviously needs to be with his daughter, he has been directly involved in preparing the company's prospective that Phil will deliver on his behalf. 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 Reform Act of 1995. For example, references to the company's expectations regarding the following are forward-looking statements, revenue, revenue growth, earnings, cash generation, cost management, increased demand for and sales of Kodak's products, including commercial printing equipment and consumables, consumable inkjet products and digital cameras and devices, new product introductions, electronic component supplies, liquidity, debt, and potential economic growth.

These forward-looking statements are subject to a number of important risk factors and uncertainties which are fully enumerated in Kodak's Annual Report on Form 10-K for the year ended December 31st, 2009, and our quarterly report on Form 10-Q for the quarter ended March 31st, 2010 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 uncertainties.

Now I will turn the call over to Phil.

Phil Faraci

Thanks Ann and good morning everyone. I would like to begin by highlighting a number of important elements of our first quarter results that we believe are key to achieving our full-year goals.

First, we continue to see tangible results from our four growth initiatives, Consumer Inkjet, Commercial Inkjet, Workflow Software and Solutions, and Packaging Solutions. These are the businesses that offer differentiated value propositions, fill specific customer needs, and will drive higher margin annuities overtime. The combined revenues for these businesses grew 14% when compared to the first quarter of 2009, contributing to our overall digital revenue growth. In addition to strong revenue growth, gross profit dollars for these products improved more than $20 million year-over-year, which is significant since we expect revenues for these businesses to be higher in the remaining quarters of the year.

Together, these are two key factors critical to achieving our full-year goal of growing both the top and bottom line for these businesses. Second, our digital businesses achieved improved earnings. Unlike last year, we began 2010 with digital cameras and devices inventories at manageable levels. And as a result, gross margins improved in this business by 9 percentage points when compared to the first quarter of 2009.

Based on the strength of our newly launched higher margin products, we expect full year revenue growth and significant margin improvement from our digital cameras and devices business, as we go through the year. There is growing consumer interest in our new cameras, which have enhanced share features, and make it very easy to tag pictures for instant sharing to our picture frames, to Kodak Gallery, to Facebook, YouTube and various social media networks.

We are also generating robust industry response with our award-winning waterproof pocket video cameras the Kodak PLAYSPORT. The first quarter played out as we expected from both a revenue and margin perspective. We expect margins from our digital cameras and devices to continue to improve. The Graphics Communications Group is off to a good start with modest revenue growth in the first quarter and significantly improved segment earnings.

We believe these improvements are sustainable and they give us confidence that GCG will play a significant role in the company's year-over-year forecasted earnings improvement. Third, Film, Photofinishing and Entertainment Group continued to leverage its core competencies in materials science to pursue new markets with existing assets. External component sales into non-photographic applications grew 19% when compared to the year-ago quarter. This increase builds on the base and is another step toward our long-term stabilization plan for this business.

And finally, our cash performance improved significantly. We reduced our seasonal first quarter cash usage by more than $300 million when compared to last year's first quarter. It is important to note that this changing cash usage was largely driven by reduced usage of working capital and improved cash earnings.

Cash received from intellectual property licensing was essentially the same as it was in the first quarter of 2009. The global economy is improving slowly and markets in Asia and the emerging countries are recovering faster than the rest of the world. The modest topline growth of our commercial business is a positive leading indicator. Consumer spending seems to have stabilized at levels below the pre-recession peaks. As volumes increase, Kodak, like our industry peers, is working with our suppliers to mitigate the current electronic component supply constraint and to meet the needs of our customers. While we cannot be certain of the pace and slope of the economic recovery, we are certain there are growth opportunities available, and we are well-positioned to take advantage of them.

Overall, we are pleased with our first quarter performance as it shows we're on track to achieve our goals for the year. The first quarter is another solid step toward sustainable profitable growth. And so, now I want to turn it over into a segment discussion. I will start with FPEG. FPEG's first quarter revenue decline of 14% reflects the discontinuance of graphics film and a 13% decline in traditional photofinishing, which includes the impact of the 2009 closure of our US and Canada Qualex central labs. Entertainment imaging revenues were essentially in line with our plan at 10% below last year's first quarter.

From a segment earnings perspective, FPEG's operating margins improved by 2 percentage points when compared to last year's first quarter. This improvement was the result of continued cost discipline and the closure of the central labs operation, partially offset by increased commodity costs. We are confident that FPEG will sustain its track record of effectively managing costs to achieve its 2010 financial targets.

Now I'm going to focus on the digital businesses. First, CDG, Consumer Digital Imaging Group. CDG's $522 million revenue increase reflects the completion of the previously announced intellectual property transaction and growth in consumer inkjet, partially offset by reduced revenue arising from our decision to manage digital cameras and devices for improved profitability. Consumer inkjet, printer hardware and ink revenues grew 27% when compared to the first quarter of 2009. This was largely driven by a significant increase in ink cartridge volumes as we continue to attract high-volume users with our compelling value proposition.

This first quarter performance is a strong indicator that we are on track to achieve our full-year goal of doubling ink revenue. We also continue to gain market share as printer volumes outpaced the market and grew more than 21% in the first quarter. The growth rate accelerated later in the quarter as the impact of our increased advertising took hold. As in previous years, we expect the growth rates to build as we move through the year to expand distribution and add new products to our offering.

CDG's $572 million improvement in segment earnings reflects the completion of the intellectual property transaction, improved gross margins in digital cameras and devices, consumer inkjet and the improved earnings from our recently transformed image sensor business. I will end the segment discussion with GCG, Graphics Communications Group. GCG's 1% year-over-year revenue growth is a positive sign that the global economy is improving and print demand is recovering. This was led by our Asia-Pacific region, where revenues grew more than 25%. While the demand for printing equipment in developed nations remains soft, we continue to see growth in the global demand for printing consumables. For example, our digital plates as well as our commercial inkjet consumables grew by more than 5% in the first quarter.

The growth initiatives within GCG are progressing on plan. Our customers rely on Kodak products and services to deliver complex commercial printing projects. For example, our VL inkjet printers were used to print the more than 51 million personalized ballots for the upcoming elections in the Philippines. This reflects the confidence that our customers have in our digital printing presses and integrated software to help them attract new businesses through the use of variable data printing.

The commercialization of the PROSPER Press is proceeding well. The first PROSPER black and white press is in the marketplace, and we expect to complete installs and begin recognizing revenue in the back half of this year. GCG's $38 million segment earnings improvement was primarily driven by the completion of the transformation of the electrophotographic solutions business and gross profit improvements in prepress solutions.

The gross profit improvement in prepress solutions reflects last year's consolidation of manufacturing assets, reduced commodity costs, and a more streamlined product portfolio. We are pleased with the first quarter performance and the proof points it provides about the competitiveness of our product portfolio, the traction of our growth initiatives, and our ability to return to sustainable profitable growth.

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

Frank Sklarsky

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

Overall, during the first quarter, we continued to see signs of stabilization in our key digital businesses, and we gained traction in our strategic growth categories and initiatives. We also saw improved earnings performance driven by the operational leverage resulting from the actions we begun implementing almost 18 months ago to mitigate the impact of the global economic crisis.

For our consumer businesses, we benefited from the successful completion of the previously announced intellectual property transaction as the revenue earnings were recorded in the first quarter. Other parts of the consumer business were impacted somewhat by skepticism of consumers who continue to be cautious with their discretionary spending. This was particularly evident early in the quarter.

In our commercial business, we are seeing a modest recovery related to increased print demand. To date, this has impacted consumables more than equipment as our customers increased the capacity utilization of their installed base. It is nevertheless a positive indicator of gradually improving economic conditions.

Furthermore, our cash usage was significantly improved versus the prior year due to factors I will speak to in a few moments. Overall, our first quarter performance represents a positive milestone as we work toward achieving our full-year revenue, segment earnings and cash goals that we shared at our February investor meeting.

Turning to our first quarter results, consolidated revenues for the quarter grew 31% to $1.933 billion. This year-over-year increase is due primarily to the one-time benefit of the IP transaction, which was finalized in the first quarter. This resulted in the recording of $550 million in revenue. Excluding the benefit from the non-recurring intellectual property transaction, consolidated revenues for the quarter declined by 6 percentage points. This was due partly to anticipated volume declines in FPEG, including the absence of revenue from our graphic arts film business and the Qualex central lab operations in the US and Canada, both of which were closed last year.

The revenue change also reflects continued cautious discretionary consumer spending, which negatively impacted volume and price mix in our digital camera business. These reductions were partially offset by a modest recovery in print demand, evidenced by higher consumables volume within GCG and higher volume for our consumer inkjet printers and ink. Revenue was also benefited by foreign exchange, which represented approximately 3 percentage points of the changes compared to the prior year.

In the quarter, the company's gross profit margin was 41.1% versus 13.1% last year, an increase of 28 percentage points. This improvement in gross profit margin was attributable primarily to the non-recurring intellectual property transaction as previously mentioned. It is, however, particularly noteworthy that excluding the impact of the one-time IP transaction, gross profit margin improved by almost 5 percentage points due to improvements in costs and efficiencies in our digital camera and consumer inkjet businesses and in digital plates within our prepress solutions business.

Gross profit margins were also favorably impacted by foreign exchange across all businesses, although the impact was less than 1 percentage point in total. As you know, due to a variety of factors, the Euro has weakened recently as compared to the US dollar. We continue to monitor this dynamic closely to determine the possible impact on total revenues for the year, and in addition, we are already pursuing operational countermeasures on the assumption that rates could remain in the current range for some time.

For the quarter, we also experienced lower costs for aluminum, partially offset by higher costs for silver, resulting in a $3 million net favorable impact to gross margin from these two commodities. R&D spending decreased by $26 million as compared to the prior year. The company continues to focus its efforts on investments in key strategic areas where we have the highest potential to offer unique value of propositions through product differentiation, near-term commercialization, and where we can achieve sustainable profitable growth.

We continue to utilize R&D resources where they will have the most impact, and we're focusing our spending on consumer inkjet, commercial inkjet including the PROSPER line of products based on Kodak's stream continuous inkjet technology, workflow software and solutions, and packaging solutions within our prepress business. As we said at the investor meeting, this is about maintaining and enhancing a strong R&D focus and discipline around our core strategic growth categories.

Regarding restructuring, the company recorded approximately $14 million in restructuring charges as compared to $116 million in the prior-year quarter. The company also incurred $37 million for restructuring-related payments from corporate cash in the first quarter as compared to $48 million in the prior-year quarter. Restructuring charges and cash payments are lower as compared to the prior year due to the completion of major actions that began in late 2008 and which continued in 2009 to rationalize the company's cost structure.

Interest expense was $38 million in the first quarter, an increase of $13 million from the $25 million in the year-ago quarter. This change is largely a result of our financing initiatives during 2009 and in the first quarter of 2010 and reflects modestly higher average interest rates along with the impact of the gradual accretion to maturity value of certain amounts of indebtedness that have been classified as equity for accounting purposes.

Additionally, the company recognized a net loss of $102 million associated with the early extinguishment of debt related to the repurchase of its $300 million of senior secured notes due in 2017 and a tender offer for $200 million of the company's 7.25% senior notes due in 2013. It's important to note that our recent financing transactions helped to further optimize our capital structure by extending our debt maturity dates.

We believe the company has a very manageable debt portfolio that provides us the flexibility we need to continue to confidently invest in our core strategic growth businesses, while maintaining adequate cash balances and liquidity for the foreseeable future.

First quarter GAAP earnings were $119 million or $0.40 per share on a diluted basis, largely reflecting improvements in operational gross margins, including the benefits from continued discipline over costs, the non-recurring intellectual property transaction, lower restructuring expenses and favorable foreign exchange. This was partially offset by higher interest expense, an increased tax provision primarily due to withholding taxes associated with the IP transaction, and the charge associated with early extinguishment of debt from the first quarter financing transactions.

Now, let's take a look at results by segment. FPEG revenue declined 14% to $431 million. This reduction in revenue was reflective of the industry-wide volume declines in film capture and traditional photofinishing. Additionally, revenue was down year-over-year due to the discontinuance of the businesses previously discussed.

The Entertainment Imaging business was down 10% due largely to the decline in print film as the number of movies released for wide distribution was reduced versus the prior year along with the impact of anticipated digital substitution patterns. Year-over-year earnings from operations improved by $8 million to $16 million for the quarter, due primarily to the continued reduction in costs in line with revenue changes, the exit of the Qualex central lab operations and favorable foreign exchange, partially offset by increased raw material costs and industry-related volume declines.

Consumer Digital Imaging Group revenue was $891 million. Without the benefit of the non-recurring IP transaction, CDG revenue was $341 million, which was a $28 million decrease from the prior year first quarter. This decline in revenue was due largely to lower volume and pricing for digital cameras and devices. As Phil indicated, we are focusing our efforts on profitability in our digital cameras and device business. At the same time, we are enhancing our advertising and marketing efforts for our newly introduced higher margin digital cameras, which incorporate the industry's best features for sharing and our exciting line of pocket video cameras.

We fully expect these efforts will drive profitable growth, which is also consistent with our goals to maintain a strong product portfolio and a solid leading market position in this category. The decline in digital cameras and devices was partially offset by higher volume for our consumer inkjet printer hardware and ink, improved performance in our image sensor business and favorable foreign exchange.

Segment earnings from operations increased by $572 million to $415 million, as compared to last year's first quarter segment loss from operations. Excluding the one-time benefit for revenue recognized on the IP transaction, CDG's earnings increased by $22 million or 14%. This improvement is mostly attributable to product cost reductions in digital cameras and devices, increased ink revenue in consumer inkjet, improved performance in our image sensor business, along with more focused R&D spend, offset partially by increased legal costs associated with IP and higher advertising costs.

Taking a look at the Graphic Communications Group, GCG's revenue was $611 million, an increase of $8 million versus the prior-year quarter. This increase in revenue is reflective of the modest improvement in worldwide print demand, which drove an increase in our consumables volume, particularly in digital plates within prepress solutions, along with favorable foreign exchange across all businesses, partially offset by negative price mix.

On the earnings side, GCG improved by $38 million to a $22 million segment loss in the first quarter. This favorable performance is due to operational improvements for our digital printing businesses, improved productivity, and lower aluminum costs in our plates business within prepress solutions, and more focused R&D spend, partially offset by negative price mix for consumables along with slightly increased advertising costs.

With respect to cash and liquidity, the company's position remains solid. The company's cash and cash equivalents at the end of the first quarter was $1.5 billion. As you know, the first quarter typically represents the period of highest cash usage during the calendar year. This year's first quarter use of $456 million before restructuring payments of $37 million from corporate cash was over $300 million better than the prior year cash usage as computed on the same basis. This improvement, as compared to the prior year, despite higher interest payments, was due primarily to higher segment earnings, improvements in working capital specifically in the area of trade payables, and lower restructuring payments.

In summary, we're committed to the financial goals outlined in our February investor meeting. We would note the outlook for GAAP earnings from continuing operations will be adjusted to include the impact of the $102 million charge for the early extinguishment of debt as previously discussed. Our forecast continues to assume a modest economic recovery, which will help us to achieve earnings growth driven by our new innovative products and by the operating leverage that has been created over the past few years. We continue to gain traction in the large digital markets we are targeting and with a strong cash balance and solid liquidity, we have a financial flexibility to confidently pursue our core strategy and profitable growth initiatives.

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

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from the line of Richard Gardner with Citigroup. Please go ahead.

Richard Gardner – Citigroup

Okay. Thank you. I wanted to ask about your consumer inkjet business. You talked about units sell-in being up about 21% year-over-year. The data from NPD actually showed pretty material year-over-year declines in your consumer inkjet sell-through in US retail. So, I am just wondering if you could maybe give us a little bit of color on whether that data is just wrong or whether there was a bit of inventory build in the quarter, whether there was a big delta between US and non-US performance? And then, maybe also if you could, just give us a sense of what the pricing and promotion environment was like in consumer ink jet during the quarter? Thank you.

Phil Faraci

Yes. We started the quarter, and this is Phil, by the way. We started the quarter on the slow side basically ended up very strong as we exited the quarter. We actually exited the quarter with very high double-digit growth rate. We also, by the way, very much expect for the year to exit with very high double-digit growth rate on the printer side as well as more than doubling the ink cartridge or ink usage, ink sales. So, that's our expectation through the year. As we mentioned, we did start off on the slow side in the quarter, again strengthening. The other thing is that NPD data doesn't include some of the mass channels including Wal-Mart, and for us, that's a substantive part of our mix in the US. Outside of the US, we're also growing at a very high rate.

Richard Gardner – Citigroup

Okay. And then Phil, could you talk about pricing and promotional activity in the quarter?

Phil Faraci

We find ourselves always trying to sit on top of, if you will, the competitive set where we charge a modest premium, and we will continue to put that kind of pressure on as we go forward. Pricing is always a key part of, along with advertising, and as I mentioned and Frank mentioned, as we turn on advertising and actually our advertising has a pretty direct effect in terms of changing that scale and we again started relatively slow in the quarter.

Richard Gardner – Citigroup

Okay. Great. If I could just ask for one more clarification, it doesn't sound like you would say that you saw any material change in the pricing or promotional environment for the consumer inkjet business during the quarter though?

Phil Faraci

We were very comfortable. It was very much inside of our expected range.

Richard Gardner – Citigroup

Okay. All right, thank you.

Operator

Thank you. And our next question comes from the line of Shannon Cross with Cross Research. Please go ahead.

Shannon Cross – Cross Research

Thank you very much for taking my questions. The first question I had is just, can you give us an idea on a geographic basis what you are hearing from your channel and from your customers both for consumer as well as for CDG – or GCG, sorry, in terms of demand levels? Any anecdotal evidence you can give us in terms of whether Europe's doing better or the US or Asia would be really helpful? And then I will have a couple follow-ups.

Phil Faraci

Yes, so in general, something that is pretty different from what historical recession recoveries have looked like is we are seeing a very clear emerging market-led recovery. And if you look at the prepress solutions or if you look at GCG in total where we had a 25% increase year-over-year in the first quarter in Asia, that's a pretty good indicator, if you will. And so, we see Asia driving the most growth, Latin America, the emerging regions of, I will call it Europe, so Eastern Europe, and Africa, Middle East, those areas are basically driving substantively more growth.

The developed countries of US and Western Europe, they're still in a bit of a decline or, if you will, a very slow position. We also see that the cautionary, if you will, retailer environment is still there where people are not trying to grow or hoard inventories. They are trying to run at lower inventory levels on a regular basis. And so, we see that efficiency, if you will, focused in the developed regions as well.

Shannon Cross – Cross Research

Okay. Great. And then a question for Frank, on the payables side and working capital side, can you give us some more details in terms of what you have done to sort of or what kind of changes have you made to pull more cash out of the business, clearly it’s good on a year-over-year basis this year? And how sustainable is that and just sort of if you can give us a framework for thinking about working capital?

Frank Sklarsky

Yes, a couple of things. Last year, as we were moving from Q4 of ’08 to Q1 of ’09, there was an overhang as revenue really declined in the back half of ‘08, but really we are left with a lot of bills associated with inventories that we brought on that had been scheduled before things really started turning down little late in that year. So, there is a big flop over of payables. But besides that, from a structural standpoint, we have had excellent cooperation from our supply base in helping us get our payment terms to what I would call a peer industry standard that is more consistent with the tech sector vis-a-vis where we were some years ago where we were focused more heavily in the traditional business. So, the average days of payable has moved more consistently toward to sort of our technology peer group and has actually moved by about 15 days, and we think we can sustain that going forward.

On the receivables side, we have better processes in place associated with collection of receivables, and our past due receivables over 60 days is miniscule quite honestly. And in the area of inventories, we have made significant progress based on simplification of our business, SKU rationalization, streamlining of the supply chain, commonization [ph] of platforms across some of our equipment businesses. That is an effort that continues. And we see further opportunity going forward.

So, while we were able to improve working capital so far this year on a structural basis and we are remaining with our guidance for, I think it was $50 million to $75 million improvement for the year, we're sticking with that for now. What we do see going out for the rest of the year is as the business continues to grow, you would naturally see usage of working capital in the realm of building receivables, inventory and payables as you go out through the year. That's a dynamic that occurs that we would not be sorry to see us, as the growth materializes. But from a structural standpoint, we have been able to do a number of things on all three elements of the cash conversion cycle. And we think those are sustainable.

Shannon Cross – Cross Research

Okay. Great. Thank you.

Operator

Thank you. And our next question comes from the line of Ananda Baruah with Brean Murray. Please go ahead.

Ananda Baruah – Brean Murray Carret & Co.

Hi guys, thanks for taking the question. I certainly hope everything goes as well with Antonio as it can. Phil, if you could for a moment, give us a sense for any areas of the business that maybe you feel better about now than you did when you entered the year? And then maybe if you could also, maybe if there's any talk about some of the areas of the business that maybe you don't feel quite as positively about?

Phil Faraci

In general, the growth businesses are really resonating again with traction with customers. I will highlight specifically the digital commercial press. The Philippine election activity was a real big deal. It was actually in the news almost every day because of the political dynamics associated with it. And to be able to go in a couple-month period, be able to have them go to where they do 52 million, 51 plus million individualized, personalized ballots, that was an enormous kind of positive message. And that message, by the way, spreads around the rest of the industry. So, the amount of pull that we're getting, and so, it is really a function of us getting that new technology complete and presses out, so that we can start to ramp, start to focus on the manufacturing side and ramping volume rather than the finalization of the commercialization activity that we have been on.

So, got to feel very positive about that. We're seeing also a lot of good uptake and traction in the consumer inkjet, which we mentioned before. We exited the quarter extremely strong and we see that continuing. We know very much that as our advertising kicks in, we basically see a very direct relationship to how that drives pull-through. So, very positive about that.

I would also say that the ISS or sensor business, while we had to go through and do a major transformation on it as well as on the transformation of EPS so our electrophotographic printing technologies, those two businesses also are performing incredibly well now. I would like to see us focus more on some growth associated with the EPS business. I believe we now have a very solid position in the productions base and that, that actually could drive some more growth.

So, I would say there are areas where I would feel that we can get more growth. I also think that we have given up some scale on the digital capture and devices business. We have made a tremendous profitability improvement, but it's time for us to take that tighter architecture, leaner, if you will, system and see the new products basically drive more growth. And so, that will start to come as we go through the year.

Ananda Baruah – Brean Murray, Carret & Co.

Okay, thanks. And just a follow-up if I could, on the guidance, the maintaining of the guidance, I guess by my count it suggests you guys will be forecasting maybe about $40 million in operating profit for the balance of the year. That would be to hit the high end of the guidance, which I guess intuitively feels like it could be kind of low given the leverage, given what the core business did this quarter if you peel away the non-recurring IP and some of the restructuring stuff that you did. So, I guess the question is, are you being conservative with that or are there things that are kind of still a play that might serve as headwinds other than sort of general economy as we move through the year?

Frank Sklarsky

I would say, we are still cautious about the general economic recovery, particularly on the consumer side. And as Phil indicated, it varies by region, but we are sticking with our outlook right now of the 350 to 450 on the EFO, and it's driven. If you peel out the IP in the first quarter, and by the way, that phase is differently this year than it did last year obviously, where we had the deals with LG in the back half of last year, and we are, actually booked the Samsung deal in the first quarter.

But really, the remainder of the year is going to be driven by continued improvements in profitability in digital capture and devices, consumer inkjet will clearly have a better year on both the topline and significantly on the bottom line. Prepress will be a key driver of improvements year-to-year as not only the revenue recovers, but also the margin as well as the entire supply chain around how that business is managed.

The digital print business will continue to improve and will be an improvement versus the prior year based on some of the comments that Phil made around EPS. But that said, obviously, there are some year-over-year anticipated planned declines in FPEG, due to secular trends, and we are also still in, from an absolute sense, a significant investment mode on the two inkjet businesses. That's all part of the plan. When you take the whole thing together, we're still looking at that outlook range that we saw in early February. So right now, we are pretty comfortable with that based on what we see.

Ananda Baruah – Brean Murray, Carret & Co.

Okay, great. Thank you.

Frank Sklarsky

Yes.

Operator

Thank you. And our next question comes from the line of Chris Whitmore with Deutsche Bank. Please go ahead.

Chris Whitmore – Deutsche Bank

Thanks very much. Wanted to ask a question about the inkjet business, specifically can you give us contributions to both the top and bottom line from inkjets in the quarter?

Frank Sklarsky

For the consumer inkjet business?

Chris Whitmore – Deutsche Bank

Yes, please.

Frank Sklarsky

So, as we have stated, the year-over-year growth on the ink and printer side of the consumer inkjet was 27%. And the earnings improvement for the consumer inkjet business, I don't believe we give that number to give that specifically. But there was clearly an improvement in both top line and bottom line. We don't give the absolute numbers. And you'll see that improvement accelerate as we go up throughout the year. As Phil indicated, it was a slow start in January, but we saw significant uplift in the revenue growth rate later in the quarter and obviously that can translate to overtime to improved profitability as the proportion of ink sales increases.

Chris Whitmore – Deutsche Bank

Okay. And wanted to ask about the R&D cuts, maybe more specifically, you told us what you were spending on, but what did you cut? R&D was down about 30% year-over-year. I believe the strategy is to create your way into these new adjacent businesses, how do you do that when you are cutting your R&D budget by such a large amount?

Phil Faraci

Yes, as you would expect, this is Phil by the way, our R&D investment associated with the core technologies is continuing to spend. We are still making those major investments. Really, the predominance of the cuts were in the refocusing of the EPS business to be in that high volume productions base. We had previously a set of investments going on where we are looking at expansion associated with that product line. So, the transforming of that business and focusing in on that high volume commercial print market was a significant savings. Additionally, we went through and made the transformation in our image sensor business focusing in on the CCD business and moving away from our focus on CMOS. Those are the two primary drivers associated with R&D change.

Frank Sklarsky

Right. And so when you look at the net result of what remains, we are still well into the double digits in our two inkjet businesses in terms of percent of revenue and R&D as well as when you look at our workflow and money being put toward our packaging solution business within prepress, a substantial percentage being put to that. So, it's really a focus versus where we were before. And that's going quite well in terms of commercialization.

Chris Whitmore – Deutsche Bank

Moving on to the digital camera business, I was surprised to see units decline year-over-year against a very easy compare and where your competitors are showing pretty strong year-on-year growth in units as some of the inventory is starting to come back into the channel, etcetera. Help me understand what drove those significant declines year-on-year? When I look at the R&D cuts in the Consumer Group, I can't help to think that there may have been a strategy change here on consumer digital and the digital camera business. Is that true? Has there been a strategy change in consumer digital and maybe some more color on the declines there?

Phil Faraci

Yes, first, the overall industry basically was relatively flat on DSCs from nine to ten in terms of a projection. For us, however, last year, we had a substantive overhang as Frank mentioned earlier, and I believe I mentioned as well, on the end of 2008 going into 2009. We made sure we moved those but at a very expensive, if you will, cost. So, consequently, this year we said, look, we don't have that overhang, we don't have a large inventory going into the year, and we are focused much more on profitability.

So, we had a great profit growth. I think that we could have done a little better in terms of unit performance. And as we go through the year, we expect very much to grow in that business. In terms of a change in strategy, no, we still see DC&D as being a very critical part of our business. We see it as a primary scale and driver, it's the front end, if you will, to sharing your experiences, and we don't see that changing.

Frank Sklarsky

There's been a very strong reception by some of our major retailers to the new product portfolio that we are introducing this year. Dramatically positive reception from the PLAYSPORT and from some of the M series cameras where we see us meeting or exceeding our internal targets in terms of unit growth. And these are products, because of their nature, because of the platform and so on, that are carrying margins that are significantly higher than what we've seen historically.

Phil Faraci

I would add one other point. I think the enhanced functionality that we put into the share button is really being received incredibly well. It's a very significant simplification of being able to take images and then direct where they are going and how they will automatically show up on your picture frame or on your Facebook page or on your Gallery page, etcetera. So, I think you are going to see that receive very good reception in the marketplace.

Chris Whitmore – Deutsche Bank

Last question for me is on commodities, I think, Frank, you mentioned there is some tightness in your supply chain. Can you give us a little more color as to where there's tightness and when you expect that to be relieved? Thanks a lot.

Frank Sklarsky

Yes, I think where we see, where we are going to be chasing supply somewhat during the year and it is not unique to us really, it's in some of the fundamental electronic componentry, semiconductors and so on. A lot of the industry took out a whole ton of capacity during the recession, and I think things are returning in certain sectors much more quickly than folks anticipated particularly in the semiconductor side, and since we use some of those kinds of components, supply is tight for everybody.

On the commodity side of things, once components – on the commodity side, silver and aluminum, yes, we had some tailwind from aluminum in the first quarter. We had some headwind from silver, we have some hedges in place on each as we look out to the remainder of the year. We're seeing some modest headwinds overall for the year in total between the two. We are talking single digits, millions of dollars in total.

Chris Whitmore – Deutsche Bank

Thanks a lot.

Operator

Thank you. And our next question comes from the line of Ulysses Yannas with Buckman, Buckman & Reid. Please go ahead.

Ulysses Yannas – Buckman, Buckman & Reid

Yes, hi. I would like to focus on intellectual property. You are coming towards the end of what you can get out of your so-called camera type of patents. What happens next?

Phil Faraci

We typically don't telegraph, as you would expect, Ulysses, but we're very comfortable with our overall portfolio. We have in excess of 10,000, 11,000 patents across the board. About 10%, a little more than 10% of those fit into the digital capturing portfolio, as you mentioned. We are also comfortable with a set of additional activities inside of that portfolio. So, I don't see us having an end, we are very comfortable with the guidance of 250 to 350 through the planning period, as we mentioned, so we don't see that guidance, if you will, changing. It is a solid program, and I will mention that our priorities for our service [ph] is to have design freedom, second, sort of be able to establish business partnerships and opportunities, and third, to monetize. And we basically see that portfolio as providing us that pathway as we go forward.

Ulysses Yannas – Buckman, Buckman & Reid

On another subject, on your 10-Q, you mentioned about the consumer inkjet systems increase in sales of 17%. In your press release and today's discussion, you talk of 27%, what's the difference?

Phil Faraci

The difference is we have a number of things in our inkjet media that are used in a range of other products that have been around for a long time. And that business has continued to decline as customers have gone to more generic media options and plain papers and so on.

Ulysses Yannas – Buckman, Buckman & Reid

Finally, if I may, you talk of paying back KKR $300 million and incurring a loss of $111 million. Does that make sense?

Frank Sklarsky

So, on that one, when we originally completed a financing transaction last September with KKR, there was a portion of that debt, of that $300 million debt in excess of $100 million that because of the accounting rules which require assigning of value to the warrants that are attached to that debt, that portion of the debt had to be classified as equity in the additional paid in capital section of the balance sheet.

When we repurchased that debt at par, even though we refinanced the same stated maturity value of the debt, that $300 million, we were required to write off the portion, that $111 million you referred to, as early extinguishment of debt even though they continue to hold the warrants, the accounting rules require us to take that write-down of that portion that was previously classified as equity. So, there was no cash impact there. It was merely the amount that was classified as equity that would have over the ensuing 8 or 9 years accreted up to the maturity value and gone into interest expense over a period of time. What we were required to do is take that charge all in the quarter that the repurchase transaction was completed.

Ulysses Yannas – Buckman, Buckman & Reid

If I may, a final question on your video cameras, how are they doing, relative to industry, relative to the flip?

Phil Faraci

They are doing extremely well. I think that they are doing well for a couple of reasons. I think first of all, again very high growth rates, kind of more consumer inkjet-ish if you will in terms of growth rate. But in addition to that, the kind of innovation that we brought into the different capabilities, we are winning lots and lots of awards. So, it's a very positive category and we expect it to continue to be a driver, if you will, for us for this year.

Ulysses Yannas – Buckman, Buckman & Reid

Thanks very much.

Phil Faraci

Okay.

Operator

Thank you. And our next question comes from the line of Mark Kaufman with Rafferty Capital Markets. Please go ahead.

Mark Kaufman – Rafferty Capital Markets

Hi. I have got a question about the backlog and the outlook for the PROSPER Press. And I know in the past, it's been rather a – had rather a heavy impact on your operating profit line. And so, I am looking at today's comments and assuming you are saying that you are going to start to recognize revenues from these printers in the second half of this year. So, we should finally start to see a diminution of the impact of the costs as I guess we could say, on the operating line starting at that point in time, and maybe if you could give a little more granularity as you see how that might accelerate the reduction of those losses going forward? And one other question, what the amortization component will be for interest expense for the converts going forward, on a quarterly basis if you don't mind?

Phil Faraci

Let me take the first one. If you go back to the February Investor Day, we actually tried to give you a model in terms of how we see the PROSPER Press and stream technology maturing overtime. But we expect the crossover to occur in the 2012 timeframe in terms of getting to a break-even sometime during 2012 for that. We very much, we're actually a little ahead of – we have been a little bit ahead of plan in terms of when we brought the black and white out. We have color planned to be coming out as we go into the next few months. So, we are seeing it basically go into the marketplace. We are then going to be ramping up volume, dealing with the various startup, if you will, issues, and we expect it to be then continually improving on in terms of profitability and becoming less of a drag getting to a break-even point in that 2012 timeframe.

Mark Kaufman – Rafferty Capital Markets

And now, that's operating profit that you would anticipate then that it would be generating some type of positive cash flow prior to that or is that break-even on an EBITDA basis?

Phil Faraci

I think the cash flow is going to actually tie to the, more to the growth rate and that kind of a conversion cycle, if you will. And then, I will let Frank go ahead and answer the other question.

Mark Kaufman – Rafferty Capital Markets

Thank you.

Frank Sklarsky

And the other one was on the interest expense, for this year, we messaged that interest expense in total to the P&L would be in the range of about $150 million, cash interest about $110 million of that because the remainder being the amount that would accrete up. Now, that's going to modestly change a little bit based on the fact that we did the financing transaction in February. As you look out into time, that number won't change substantially, but should come down modestly each year as a result of our paying about $50 million in debt off each year that was associated with the prior acquisition. And so, that's a few million dollars of interest expense. But generally, the range that you see in cash interest and interest expense will likely carry out into time.

Mark Kaufman – Rafferty Capital Markets

Thank you.

Frank Sklarsky

Thank you.

Operator

Thank you. And our next question comes from the line of Arun Seshadri with Credit Suisse. Please go ahead.

Arun Seshadri – Credit Suisse

Yes, hi guys. Thank you for taking my questions. First, I just wanted to understand in the CDG segment how we should think about SG&A, how that will trend for the rest of the year, should we be thinking about it purely as a percent of sales or how should we think about that?

Frank Sklarsky

I can take that one. The SG&A in CDG should be relatively stable throughout the year, when you talk about the general and administrative piece. When you look at the advertising component, which is less than half of the total, but still a significant amount, that tends to grow starting in Q2 and then tends to be relatively level for the remainder of the year. So, we started ramping advertising more later in the first quarter, that will ramp by an additional amount in Q2, and then we usually see a peak on CDG advertising somewhere around in the third quarter, and then for the year would stay steady after that.

Arun Seshadri – Credit Suisse

Okay. Great. That's very helpful. And then, same thing on the FPEG side, we saw in SG&A a fairly significant decline sequentially as well as year-over-year, how should we think about SG&A in that segment going forward?

Frank Sklarsky

That business continues to do a masterful job of variablizing [ph] costs consistent with revenue changes. We will continue to see similar kinds of scaling as the revenue changes. We are not really anticipating what I would call major sequential revenue declines in FPEG, so that absolute dollars of SG&A will be relatively steady as you go quarter-to-quarter for the remainder of 2010.

Arun Seshadri – Credit Suisse

Okay. Great. And then can you comment a little bit about all of the changes that you have done on the Kodak Gallery side? Where is that in terms of profitability right now?

Frank Sklarsky

Yes. Thank you. As a matter of fact, I would encourage everybody on the phone to look at it as a Mother's Day and Father's Day gifting opportunity. So, that will be my marketing plug here for you. We actually went through and we brought out a new platform. It was a very difficult thing for to us do in the fourth quarter of last year simply because that's our big season. Going into this year, we have been adding substantial application-specific capabilities on to that platform. And so, it's now getting to become a pretty robust overall platform. And if you actually check it on a periodic basis, you will see through the second quarter here, it's actually becoming a very solid and very capable competitive, if you will, platform.

So, we are pretty happy with how that transformation of the architecture's gone, but from a scale and from an overall standpoint, we have given up a lot of ground in terms of overall size. And so, you are going to see us start to grow that back as we go forward. And it's been in investment mode for us, and we knew we would take a hit going to the new platform but had to do it.

Arun Seshadri – Credit Suisse

Okay. And then finally, I just wanted to get a sense for restructuring. Obviously, you spent $37 million, should we assume that the cash restructuring is relatively another 60-odd million spent for the rest of the year, should we assume that is relatively flat for the remaining quarters? And then your 450 that you were expecting, looks like you sort of ratably got a fourth of that this quarter, should we assume that's also flat for the rest of the year? Thanks.

Frank Sklarsky

I will take the second question first. The payments received on the intellectual property are expected to be received ratably throughout the year, and of course, there would be the withholding tax coming off of that. And then on the restructuring, we are pretty comfortable with the guidance we provided in early February, meaning that the total charges for the year will be between $50 million and $60 million, of which we incurred $14 million in the first quarter. So, we are right on track there. And then the cash payments would be in the range of about $100 million for the year, half of which would be to discharge some of the actions that we executed in 2009 and the remainder for the actions and charges that we are trying to get done as quickly as possible during this year. But obviously, the whole thing is at a much lower level than in the past. Okay?

Arun Seshadri – Credit Suisse

Thanks, guys.

Frank Sklarsky

Okay. Thanks.

Operator

Thank you. And our next question comes from the line of Ben Winger [ph] with Talek Investments. Please go ahead.

Ben Winger – Talek Investments

Hi. Thanks for taking my call. Just had a question regarding the interpretation of the IP income forecast. At the beginning of last year, it was the same, the same forecast was provided which was $250 million to $350 million of IP income on average per year through 2012. And then that was also I believe at the start of 2009 although at that point in time, the forecasting period was 2011. But are we to interpret that as looking at what you all generated in IP income in 2009 around $430 million plus at least $550 million this year, and looking for that to substantially drop off in 2011 and 2012, just so the four-year average would be something like $250 million to $350 million, is that correct?

Phil Faraci

No. Actually what we said was that we knew it would be higher in 2010 because at the time we did the presentation we already had basically agreed in principle with Samsung that we were waiting for the approval from the court. So, we said that it would be between $250 million and $350 million in 2011 and 2012 specifically.

Ben Winger – Talek Investments

Okay, great. And then also, did you all recognize any non-cash pension income this quarter?

Frank Sklarsky

There would have been some modest amount of non-cash pension income in the quarter, something in, I think it was a little less than $20 million. And so, if you look back to our investor presentation, it was something in the high double-digits pension income for the year, and that would be recognized ratably throughout the year.

Ben Winger – Talek Investments

Right. I think in the presentation, it was $75 million through the course of 2010. So, about a fourth of that was recognized, and would that be – that is recognized in EBIT, is that correct?

Frank Sklarsky

Yes. That is actually embedded in segment earnings, that's correct.

Ben Winger – Talek Investments

Okay. All right. Great. Thanks very much.

Frank Sklarsky

Okay. Thanks.

Operator

Thank you. And at this time, I would like to turn the call back over to Mr. Phil Faraci for closing comments.

Phil Faraci

I just want to make a few quick points. First of all, the year is off to a good start. It's good for to us be focused on growth again comparing to last year. We are seeing traction with our growth initiatives. We have launched our new consumer products into a gradually improving economic environment, print demand is recovering, and we have a lean cost structure which we can continue to leverage. I would like to thank everybody for joining the call.

Operator

Thank you, sir. Ladies and gentlemen, that does conclude today's Eastman Kodak first quarter 2010 sales and earnings conference call. Thank you for your participation and for using ACT Conferencing. You may now disconnect.

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Source: Eastman Kodak Company Q1 2010 Earnings Call Transcript

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