Eastman Kodak Company
Q1 2011 Earnings Call Transcript

Published: 29 Apr 2011

[Operator:]

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the First Quarter 2011 Sales and Earnings Conference Call. [Operator Instructions] This conference is being recorded today, Thursday, April 28, 2011, and I'd now like to turn the call over to Ms. Sandy Rowland, Director of Investor Relations. Please go ahead, ma'am.

[Sandra Rowland:]

Good morning, and thank you for joining us today for Kodak's First Quarter 2011 Sales and Earnings Conference Call. Here with me today are Antonio M. Perez, Kodak's Chairman and CEO; as well as Ann McCorvey, Kodak's Chief Financial Officer. Antonio will begin this morning with his observations on the quarter, and then Ann will provide a review of the quarterly financial performance. Certain statements during this conference call and question-and-answer session, 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

[Antonio Perez:]

Thank you, Sandy, and good morning, everyone. When we met with you at our investor conference in February, we identified 2 key financial metrics for 2011. First, we must scale our 4 digital growth initiatives

[Antoinette McCorvey:]

Thanks, Antonio, and good morning, everyone. Our first quarter performance demonstrates that our focus on our 2 fundamental imperatives is delivering positive results. In aggregate, our 4 digital growth initiatives made progress, and we improved our cash generation before restructuring payments year-over-year. Before I discuss the details of the first quarter financial results, I want to remind you of the non-GAAP measure related to our operating earnings that we introduced at our February Investor Meeting. This measure excludes the effect of certain nonservice-related corporate components of pension and other postretirement benefit costs from our segment earnings. During the first quarter, we also changed our GAAP segment measures to exclude those corporate cost components as well. These components are driven primarily by changes in market performance. As we expected, our benefit costs shifted from income through expense in the first quarter. The combined impact of this year-over-year, noncash, unfavorable change on gross profit SGA and R&D were $34 million. Now for the first quarter. Consolidated revenues were $1.3 billion, a 31% decrease versus the prior year. This year-over-year decrease is primarily due to the onetime benefit of a nonrecurring IP transaction recognized in the first quarter of 2010 and the continued industry-related volume decline in our traditional businesses. This decline was partially offset by increased volumes to consumer inkjet printers and ink, digital plates and our production scanners. Our first quarter segment gross profit margin was 10.5% versus 41.2% in the year ago quarter. This decline is largely due to a nonrecurring intellectual-property licensing transaction in the first quarter of 2010. In addition, gross profit margins were negatively impacted, as we continued to invest in growing our install base of consumer inkjet printers, where unit sales increased 97%. However, Consumer Inkjet margins improved year-over-year driven by increased ink profits. Other factors which factors negatively impacting our gross profit margins are

[Operator:]

[Operator Instructions] Our first question comes from the line of Ananda Baruah with Brean Murray Investment.

[Ananda Baruah:]

Just a couple of things, if I could. Antonio, just given the rise, the ongoing rise in silver prices in the acknowledged comments around the impact to the cost structure, could you give us any sense of how this changes or what the impact of the headwinds here to your full year guidance might be? And then, is there any change to the metrics that you provided on an ongoing basis about kind of changes in the price equal to change in profitability?

[Antonio Perez:]

At this time, we're not going to make any change. We have found mechanisms to contain what has happened. Obviously, there's a big change in price. But nonetheless, we have internal mechanisms to deal with those changes. If this were to continue and at the same pace, it will be a different story. But up until now, when we started the year, we put in place contingencies to deal with a significant increase of silver price because the tendency was pretty obvious when we're doing the planning for the year. And so far, while the business, obviously, will continue to be cash-generating this year, it will be slightly less than what we had in our original plan, but it's a small number that doesn't make a change for the overall company. So for now, there's no change, and we put in place these 3 mechanisms that I just described to you today. With silver price, we are raising prices, we are indexing. There are contracts we are hedging, and we are moving as fast as we can with the part of the portfolio that is not silver-dependent. You put all those things together, and so far, we don't have to make a change for -- to the forecast for the year.

[Ananda Baruah:]

Okay, and I guess just a follow-up to that, and then maybe this is one for Ann. Can you give us some sense of what -- so I appreciate you're not changing the guidance here. But can you give us some sense, given the added pressure, what the increased impact to profitability is for every dollar change in silver like you typically have done?

[Antonio Perez:]

Ananda, at this time, we're not changing it. Because on a cost basis, the impact remains about the same, the $10 million to $12 million. And as we talked about it in February, we're clearly doing things that we believe that by the time we get to 2012, we will have reduced it. But in this short period of time, on a cost basis, that's the same kind of sensitivity. So the actions we're taking around pricing and indexing our pricing and, of course, continuing to hedge are the things we're doing to keep the net profits in line.

[Ananda Baruah:]

And then just last one for me here. Just following on your comments around actions taken in the Digital Camera business. It sounds like, I guess, the comments on the call were increased profitability in the second half of the year. Are you suggesting that, I guess do you think that there can be -- with the actions you've taken, do you think they can be profitable for the full year? On a full year basis? And could you just, I guess, maybe give us a more specific sense of some of the things that you're going to be doing?

[Antonio Perez:]

No, it won't be profitable for the full year, but it will be a very significant improvement in performance versus last year. It's very significant. Now come 2012, you can ask me that question again, and the answer will be different.

[Ananda Baruah:]

Any more specifics on the actions that you guys are going to be taking?

[Antonio Perez:]

In cameras, what we've done is we have selected the geographies, the models, the channels, and it has been working very well, actually. We -- in certain cases, we're not in the stores, but we are in the online stores. In other cases, we haven't used -- we took away the models that we're losing, they had negative margins. I mean, there's a combination of things. It's been a very aggressive program. It's been run effectively, and we are optimistic for the second half. Of course, let me finish, at the cost of top line. There is a top line that we're leaving behind, and that's what we tried to tell you in February. There was a significant top line that we were going to leave behind, if we were going to improve our bottom line.

[Operator:]

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

[Shannon Cross:]

My first question is a sort of follow-on, if it's not profitable and it's going to be challenging, and I would assume that you're going to face pricing pressures next year, maybe even get your cost in order, I don't know, but why actually stay in the Digital Camera business at this point? And are there geographies that are actually profitable, so you're shifting there or segments? Or is this something where you need to actually just sort of reduce the overall cost structure, since I know you've already outsourced a lot of your manufacturing?

[Antonio Perez:]

Yes, but there's a variety of things. Many of the things that you said are true. There are geographies where, yes, they are profitable. Then there are as well parts of the portfolio that are profitable, such as the video cameras as well. There is an important element of our presence in Digital Cameras that is very important for our IP strategy, And then as well it's an important part for some of our retailers although less and less. But it was a very important part for our -- it make us more important in front of the retailers when we're introducing our consumer inkjet. Today, the fact is consumer ink jet stands by itself, and we don't need the support of the presence of our digital cameras to have a strong presence with printers. But during all these years, the digital cameras was the entry car for us to have presence in retail. But first, the industry is in decline. So we're going to select the areas, the geographies and the products where we can make money and abandon the rest. If that's what you're saying, yes, that's what we're doing. And at the same time, the rest of the portfolio now can stand by itself, because it has the size and the presence to fight for shelf space without any problem.

[Shannon Cross:]

And you'd mention that it's important for your IP strategy. I think a lot of the IP licenses you've signed are actually for prior patents. Are there sort of ongoing relationships that require you to continue to invest R&D in the digital camera space? Or is it more sort of historical?

[Antonio Perez:]

No, there's nothing to do with historical, Shannon. This has to do that view it's a lot easier to claim damage when are in the business than when you're not.

[Shannon Cross:]

That's fair. And with regard to the pricing increases, I clearly understand why you're doing it, given what's going on with commodity side. So what percent of your portfolio is exposed? Are there any long-term contracts that will take time for them, for the pricing to actually run through? What do you think your competitors are doing? What are you hearing out there? I know in the Entertainment Imaging side, you don't have a ton of competition, but what are you hearing from some of the others?

[Antonio Perez:]

Well, I won't comment about competitors. As you can imagine, they can do whatever they want. But the price -- the cost of commodities has getting to a point that we don't -- our customers don't even fight it. So this is a very logical step and both in digital plates and in film products, and we're just starting to apply it and we will continue. I mean, this is just a way of doing business. There's nothing else to say.

[Shannon Cross:]

Anyway, I understand. It's just that when you do face competition, if your competitors don't take their prices up, there's an opportunity for potentially losing market share. My last question is, you typically disclose some growth rates within your press release and your Qs, and I was curious, with Entertainment Film growth rates, digital camera growth rates, I'm sorry if I missed them, but do you think you could provide a little bit more color on sort of the segments in what you saw growing and what you saw under pressure?

[Antoinette McCorvey:]

Digital Camera's growth rate, I think Antonio actually disclosed it in the script. I think it was down 15%...

[Antonio Perez:]

14%.

[Antoinette McCorvey:]

14%. And when you think about the Entertainment Imaging decline, it's in line with FPEG kind of decline. It's sort of a...

[Antonio Perez:]

14%. It happens to be 14% too. I think we disclosed those. If you have any other questions, you can call us, but we disclosed those.

[Shannon Cross:]

Just my last question is on the Commercial Inkjet business. You're spending a little bit more there. Is that because you're seeing increased demand? Can you be a little bit more specific? I know you said a little bit more in terms of services, but how should we think about the increased expenditures sort of rolling off as we go through the year?

[Antonio Perez:]

Did you say Commercial Inkjet or Consumer Inkjet?

[Shannon Cross:]

Yes, Commercial Inkjet, yes.

[Antonio Perez:]

I think Ann went through the explanation. There are 2 factors that we expected that will be there, and they are. One is that the first installations we are building -- doing anything we can to make those installations to be incredibly successful So they will be the showcases that we can use for the future. And now, we have a bunch of them, a number of them, and there are some costs associated with that. And then, we still are making very few and, they are making, basically, they're made by hand. So there is a moment in time in which we will soon reach that point in which all of the sub-assemblies would be automized (sic) [automated], and then the prices go down dramatically, but you don't do that until you set the expectations and get everything right. This is a very typical, very common process with any new product, especially of this complexity. Those are the 2 elements. We'll not worry about it, which is we know that we have to go through this phase.

[Operator:]

And our next question comes from the line of Richard Gardner with Citigroup.

[Richard Gardner:]

A couple of questions. First of all, thank you for clarifying the growth rate in Consumer Inkjet, but I was hoping you could also talk about the pricing environment in Consumer Inkjet, especially given that Lexmark cited a much more promotional market in Consumer Inkjet on its call 2 days ago.

[Antonio Perez:]

I did specify the 97% because of revenue report, Richard, for you. The pricing number, we're getting a lot of demand for our Consumer Inkjet Printers. And we expected that, that was going to happen because the business model is better known. We have a lot of customers that are very satisfy, and they tell to their friends. So this is building up, it's building up. So we're very pleased, and we were expecting significant growth, maybe, not, 97%. Honestly, maybe a little less than that, but we're obviously very happy with that. The pricing environment is very tough. It's very tough because the market is basically flat, so the incumbent obviously, they're acting very aggressively and the average selling price of the printers has gone down. With that, what we have to do is go down, too, but maintaining our price premium. This is what we did last year. This is what we will continue to do. At the end of the day, what matters to us is to keep business in this install base, and then get this Ink revenue that keeps growing beautifully year-over-year. And this is so very much in track for the 2012 positive EFO. But yes, the environment pricing is tough. It's competitive.

[Richard Gardner:]

And then, well actually, just to stay on that point, could you talk about whether it's become materially tougher here during the past, say, 3 months, even than it was before?

[Antonio Perez:]

I wouldn't say -- it's been hard from the beginning. Since we came with this new business model that was so dramatically different from the industry, the industry, as you would expect, reacted aggressively. This was a threat for the rest of the industry, and the industry reacted aggressively, more than anything else with a lot of prices and promotions and everything else. This has been our life since the very beginning, and I wouldn't say that it's harder than it was 2 years ago.

[Richard Gardner:]

Okay, great. And then, I guess a question for Ann. Ann, you mentioned that you're not changing your $1 per troy ounce equals $10 million to $15 million in profit sensitivity for silver pricing. But just to be clear, if you do the simple math on the recent increases we've had in silver prices, it does suggest that FPEG'S profits would have been much worse this quarter than they were. So it does appear that the actions you're taking, the indexing, the price increases and so forth are materially changing that sensitivity. And I just wanted you to clarify that and, hopefully, get a little bit more detail on how to model that sensitivity going forward, given that it is so important for the portfolio.

[Antoinette McCorvey:]

I understand. As you can imagine, the silver price is changing rapidly. We just -- we've been announcing price increases. We've been working with our customers to get the indexing in place. And even as we were doing that, silver was continuing to change. And so, with one quarter behind us and a lot of quarters in front of us and not knowing exactly where silver price is going, it's probably not appropriate yet to change that sensitivity. But it does give you a feel for what it does to our cost structure, which is set. It continues to be the case, and you can see what we're trying to do with pricing to keep the profitability under control or mitigate the loss.

[Richard Gardner:]

Okay and then, Ann, could you also just address very quickly, what is the change in your interest expense expectation this year based on the recent debt restructuring actions, refinancings that you've taken? You had said I think back in February $150 million net in interest expense for the year, how should we model that now, please?

[Antoinette McCorvey:]

So you should probably add approximately an additional $20 million on a full year basis. Obviously, this is 3/4 of it.

[Operator:]

Our next question comes from the line of Mark Kaufman with Rafferty Capital Markets.

[Mark Kaufman:]

I've got 2 questions. My first is, you're at the beginning now of the Commercial Inkjet process, and I was wondering what the time is between getting the printer into a print shop and set up, educating the printshop workforce, et cetera, and so that it's to a point where you can actually report it in revenues? And where you think or where you might like that process to go on a timeline basis? As you said before, you're making sure, you're bringing out all the guns, basically, to make sure that everything is done perfectly. So that these are examples for the rest of the industry. And if you could give me an idea of that timeline and how you might see it shrinking as you commented before in the actual manufacture of those printers. And my other question was, I missed it, what was the growth of Consumer Inkjet Ink sales in the quarter?

[Antonio Perez:]

The Consumer Inkjet was 85% growth.

[Mark Kaufman:]

That's what I thought I heard.

[Antonio Perez:]

The Ink, 85%. When we install a Commercial Inkjet System now, from the beginning we start to sell consumables. So consumables they come immediately. As soon as the press is working, we get consumables immediately. Now the process of installation is complicated now, because you have to train people, too. This is a very different technology. It's complicated. It takes -- sometimes it replaces 3 or 4 or 5 or 6 of the other machines they have there. It's a process. So it will take -- it could take now even up to 4 months, to do this right. What would be ideal? I think with time this should be 1 to 2 months, and no more than that.

[Operator:]

And we have a question from the line of Ulysses Yannas with Buckman Reed.

[Ulysses Yannas:]

Based on the numbers that you gave us on your press release, it seems that sales of your inkjet increased from $25 million to $38 million, while your gross profit loss declined from $63 million to $43 million. This in terms leaves us with a decline in sales of various forms of business from $309 million to $292 million and an increase -- a decrease in gross profit from $75 million to $34 million. Can you give me some idea as to what extent the decline in profitability of the rest of the business was due to your decline in -- or your attempt to liquidate your camera inventory? And what happened to sales of the other components of the business, which is essentially kiosks and the Gallery?

[Antoinette McCorvey:]

Okay, so let me, Ulysses, I want to make sure I understand, you're talking about the year-over-year decline in gross profits within CDG?

[Ulysses Yannas:]

Yes.

[Antoinette McCorvey:]

And so, you've made some statements about what you thought was the revenue for Consumer Inkjet, because we're not providing that level of detail. So I won't try and confirm or -- those numbers. But if you look at the gross profits for CDG, obviously, the biggest decline there was associated with the nonrecurring IP from last year.

[Ulysses Yannas:]

That, I'm excluding.

[Antoinette McCorvey:]

Once you exclude that, then the next thing is, as we talk about kiosks, Consumer Inkjet became a bigger percentage of the overall revenue. And while their gross profit margins certainly improved because a bigger piece of their revenue and profits were coming from ink, as a particular product within that portfolio, the gross profit margins in Consumer Inkjet is lower than the rest of the portfolio. The other thing attacking the gross profits for CDG is, as Antonio talked about, is the fact that we had pricing pressures on digital cameras, in particular, as we were moving out the fourth quarter inventories. And we've talked about the fact that we're really driving that business toward maybe a smaller top line, but driving it towards profitability and some of the actions that we will be taking there that you will be seeing more of the results in the back half of the year. The other products in there, as Retail Systems Solutions and the Gallery, and they were kind of flat. There certainly was still some issues [indiscernible] as it relates to pricing pressures as we hit the last year of last quarter of the impact of Wal-Mart U.S. change. Does that help?

[Ulysses Yannas:]

Yes, it does help. The other question, of course, is since your inventory for the quarter was up, despite a sharp decline in sales. Is this inventory concentrated in your Consumer Digital Group?

[Antoinette McCorvey:]

No, I wouldn't say the inventory is concentrated in Consumer Digital. As you know, we have an outsourced supply chain for Consumer Digital. And so, it's not the bigger piece of the inventory there.

[Ulysses Yannas:]

So what part of the inventory is the one that really increased by that much?

[Antoinette McCorvey:]

I would say the inventory in GCG would be the largest piece of that increase.

[Ulysses Yannas:]

Okay, then maybe I can ask another question. When do you expect inkjet sales to equal printer dollar sales?

[Antonio Perez:]

You mean Inkjets Ink?

[Ulysses Yannas:]

Ink will equal Printer in dollars.

[Antonio Perez:]

We're getting very close to that point. What has happened this quarter is that our Printer growth grew extraordinarily, which is a great thing for the future. So we're not complaining about that. We...

[Ulysses Yannas:]

It must have grown extraordinarily in units, but not in dollars, because, otherwise, how did the whole thing was up only 54% against inkjet sales of 85%.

[Antonio Perez:]

As I said before, the average selling price of the inkjet printers have gone down over the years, and that was the competitive nature of this business, and we're still maintaining our price premium, but the base is lower. Nonetheless, the profitability of the business doesn't change because the profitability comes from the Ink, and the Ink is associated with the number of printers they serve in the process.

[Ulysses Yannas:]

Finally, you were given a present by Mr. [John] Chambers of Cisco by eliminating Flip. You had mentioned years ago in an interview in the New York Times, if my memory serves me right, that you thought that the low end of the camera market would really be more or less move to cellphones. Do you think the same thing might happen to video cameras?

[Antonio Perez:]

It's not the same. A lot of these video cameras are used for applications in sporty situation and environments that where they have to be very robust, and it's not the same. It's not the same. And by different people, it's not the same. Although some of the videos, obviously, will be done by the -- but now within this, this has a longer life and it has better margins and still is at the very beginning of the development of this category.

[Ulysses Yannas:]

Presumably, you had a decent increase in sales in the first quarter of video cameras.

[Antonio Perez:]

Yes, we grew. I don't have a number, but we've been growing share since we started with this program. So I don't have the numbers here.

[Ulysses Yannas:]

So in essence, what we are saying, the second half of the year, when Flip inventories disappear, you should then have a significant increase in sales there, don't you?

[Antonio Perez:]

I don't know what to say. I will -- I don't know what Cisco is going to do. I read what you read, but I'm not in a position to comment. But we've been gaining share over everybody, including them, again and again and again, and our plan is to continue to do that.

[Operator:]

And we have a question from the line of Arun Seshadri with Crédit Suisse.

[Arun Seshadri:]

I just wanted to basically start with asking you about the purpose of your recent debt raise in the high-yield market. I just wanted to understand, you've given guidance that your cash flow, your overall cash, you expect it to remain flattish after restructuring. So what was the purpose for your recent raise of capital?

[Antoinette McCorvey:]

So yes. We did that capital raise. The credit markets were significantly improving, and we thought it was a good time to take advantage of that improvement and to raise some additional capital that would give us some flexibility as we continue to invest in the growth initiatives and drive the company to the sustainable digital profitable company we'd like to become. So it gives us some flexibility as we move through this major transformation, to have that little additional liquidity available to us.

[Antonio Perez:]

I think as well we used that as a leverage for the negotiation for the revolver, which has worked very well for us.

[Arun Seshadri:]

Okay. So as far as the revolver is concerned, are you allowed to draw on that revolver to retire 2013 unsecured bonds?

[Antoinette McCorvey:]

Yes.

[Arun Seshadri:]

Is there anything inside your second-lien bonds covenants that will now not allow you to do that, meaning, can you, at this point, really draw on the revolver to pay off 2013?

[Antoinette McCorvey:]

Yes.

[Arun Seshadri:]

Yes?

[Antoinette McCorvey:]

Yes.

[Arun Seshadri:]

Okay. So the last thing I wanted to understand is then why don't you retire these 2013s early because that will lift a lot of people's concern regarding your near-term maturities. Is -- I mean how do you think about retiring those 2013s? are you not focused on it? Is it something for a future date?

[Antonio Perez:]

I think for a future date. I think we may or may not. It's something that we will decide on, on the way. There is still a long time to go. We have time to think about it and find the best methodology to do it, if we decide to do it.

[Operator:]

And ladies and gentlemen, this concludes the question-and-answer session. Mr. Perez, please continue.

[Antonio Perez:]

Well, first of all, thank you all for joining the call. Again, I'm pleased with the traction that we have with the digital growth business. We have strong momentum going into the second quarter, and we expect to finish the year with a 40% aggregate growth for this business. As far as cash, we'll continue with the focus in cash, and we expect to finish the year with positive cash generation before restructuring. And again, thank you for attending the call.

[Operator:]

Ladies and gentlemen, this concludes the First Quarter 2011 Sales and Earnings Conference Call. If you'd like to listen to a replay of today's conference, please dial 1 [phone] and enter the access code of 4430195. Thank you for your participation. You may now disconnect.