Eastman Kodak Co (KODK) 2002 Q3 法說會逐字稿

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Good day, everyone.

Welcome to the Eastman Kodak third quarter conference call.

Today's conference is being recorded.

At this time for opening remarks and introductions, I'd like to turn the conference over to the Director of Investor Relations, Mr. Don flick.

Please go ahead, sir.

Good morning.

And thank you for joining us for our discussion of third quarter results today.

Before I turn the call over to Bob Brust and Daniel Carp, I'd like to briefly review the important Safe Harbor information that pertains to forward-looking statements that will be part of our discussion this morning.

Certain statements in 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 fourth quarter 2002 earnings expectations are such forward-looking statements.

Actual results may differ from those expressed or implied in forward-looking statements.

The forward-looking statements contained in this conference call are subject to a number of important risk factors.

The complete listing of these risk factors can be found in our press release and other releases we put on the wire this morning and a would encourage you to find and review those.

Any forward-looking statements in this conference call should be evaluated in light of these important risk factors.

Now I'd like to introduce Bob Brust, Kodak's Chief Financial Officer.

Thanks, govern.

Good morning, everyone.

I'll take a few minutes to discuss our performance in the quarter and then I'll turn the call over to Dan to cuss his view of the market dynamics that we are now experiencing.

The $1.15 reported earnings per benefitted from the net of several one-time events in the quarter including changes we have made to our photofinishing operations in Japan and the associated tax benefit, additional writedowns in our venture capital portfolio, and the reversal of some reserves associated with the 2001 restructurings as we complete these programs.

Excluding this net of 11 cents per share benefit, Kodak's operational earnings for the quarter were $1.04 per share, well ahead of our guidance.

As as you have seen from our release this morning, the top line came in about as expected, up one percent.

Excluding the exchange impact, sales were down one percent year-over-year.

We did see strong sales growth in our entertainment business and our consumer digital businesses while health imaging returned to growth for the first time in four quarters, moving away from the period where strong price declines impacted the year-over-year comparisons.

Kodak professional sales declined and the consumer businesses were essentially flat in the quarter.

Dan will have more to say about this later.

But we see little evidence of any economic uptick in our revenue results.

The real story in the quarter was our gross profit performance.

Historically, gross profit as a percent of sales declined seasonally from quarter 2 to Quarter 3 an average of more than a percentage point.

That was reflected in our expectation for the quarter.

However, gross profit instead of declining sequentially actually improved by nearly a percentage point and by 2.4 percentage points over last year.

That improvement from our expectation accounted for nearly 18 cents of the variance from forecast.

While we thought we were in an upside position we could not be sure until the quarter ended.

Good forecasting techniques dictate staying with long-term trends and we did so.

Our worldwide manufacturing organization turned in excellent savings from productivity, benefitting from a lower labor cost structure, improved product yields, and lower raw material costs.

Those of you who attended our September 18th meeting heard Dan talk about the successful Kodak operating system initiative and clearly that is part of what is working in our costs.

However, I think what we are seeing here in addition to a great job by a lot of people is the fact that we have successfully lowered the underlying structural costs of the company.

Our 2001 restructuring program has taken a lot of costs out of our company.

We have gotten our inventories under control.

And all that is being reflected back in our gross profit performance.

And once again, I can't say enough about the successful turnaround effort in our health imaging management team has put in place.

On the costs side of the discussion, SG&A was down both as a percent of sales and in dollars reflecting cost control and a decision to reduce advertising from planned levels as economic softness continued.

We were very successful in this effort and it also contributed to our better-than-forecast result.

R&D was down in the quarter reflecting continuing spending restraints.

An additional factor in the quarter's earnings story is the adjustment in the rate of incentive compensation accruals.

As many of you know, at the start of each year, the compensation committee of the board sets economic profit and revenue goals which define the size of the incentive compensation pool available to be paid to management and employees through the wage dividend program and the performance-based management bonuses.

We begin to accrue on the assumption that the company will reach the levels of the payout as defined by the Board and associated with those goals.

And adjusted as needed on a quarterly basis.

These revenue targets assumed a degree of economic and sales recovery during the second half of the year.

Kodak was -- has clearly done well in the economic profit side, but it is equally clear at the end of the third quarter that we will fall short of the revenue goals.

As a result, we corrected the first half accruals by about 6 cents per share and set the new accrual rate at about 3 cents per share lower in this -- in the third quarter.

So the actual adjustment had about a 9-cent per share positive impact for the quarter.

From an earnings viewpoint, the third quarter story is about good costs and manufacturing performance with some boost from incentive compensation accrual adjustment.

The other story in the quarter is our cash performance.

The company has been paying a great deal of attention to cash and the benefits of that focus continue to be visible in our results.

Our cash performance in the quarter is once again strong, benefitting from improved earnings, a reduction in receivables, and capital spending held below depreciation.

Our free cash generation before dividends in the quarter is up 159 million and our operating cash after dividends is up 25 million.

This in spite of the fact that we paid a $262 million semiannual dividend in July.

This cash performance has some very tangible benefits in terms of lower debt and contributing to lower interest expense of $12 million, or it 23 percent on a year-over-year basis during the quarter.

Kodak's debt now stands at $2.7 billion, down $1.3 billion from its peak of $4 billion in the first quarter of 2001.

The associated debt-to-capital number has also improved from 54.2 percent to 44.7 percent over the same period.

A good job by our company in a very toughen environment.

On the basis of this performance, we are raising our full year forecast to more than $700 million.

Our objectives for using this cash remain unchanged.

Pay our dividends, work down debt, fund targeted high value acquisitions, and continue to evaluate the share repurchase option.

On the subject of share repurchase, Will Share Associates, the consultants to our US pension plan, the Kodak retirement income plan or CRIP, recently completed a study of that plan.

Included in their results was a recommendation that CRIP divestiture share of Kodak shop.

The Kodak shares represent by part single largest equity holding of KRIP and willshare's recommendation is consistent with a vatgy to avoid excessive exposure to any one equity.

Kodak has offered to repurchase the shares from CRIP in a transaction expected to be completed before year end.

Given our increasing projection of cash for the year, the current price of the equity and the dividend yield on the stock, the opportunity to retire a large block of stock in a simple low-cost transaction is quite attractive.

This, however, should not be interpreted as a change in Kodak's share repurchase strategy.

This transaction will not impact our ability to support our dividend or achieve year-end debt reduction goals.

Looking ahead to our fourth quarter results, we have said that our best view despite the obvious uncertainties of forecasting in the current economic environment, is to generate operational earnings of between 60 and 70 cents per share.

This reflects an assumption of flat year-over-year sales and a sequential seasonal reduction from third quarter to fourth quarter in gross profit rate of about 4 percentage points.

The new news in our assumption of flat sale is the assumption of flat sales in the fourth quarter rather than up.

And a higher starting point of gross margin by 2 percentage points.

This sequential growth profit decline reflects the fact that every December we take planned factory shutdowns for maintenance, holiday observance, and the fact that we have shipped the Christmas requirements.

Last year, we extended and expanded these shutdowns as we were working down excess inventories while this year the actions will be more typical.

But nonetheless, the shutdowns will have a predictable sequential negative effect on our gross margins.

Let me say again, we have a long-term average of a 4-point reduction of gross profit from Q3 to Q4.

I see no reason at this time to change that assumption barring some big upset.

Lastly, we will continue actions to reduce the company's cost structure.

We are in the process of defining very focused initiatives to reduce assets and employment resulting in pre-tax charges of approximately $130 million to $170 million with approximately 120 to $150 million to be recorded in the fourth quarter.

About 1/2 of that's charges will be non-cash.

These are highly focused actions as I said before with very acceptable returns generated by our businesses.

These actions will eliminate approximately 1300 to 1700 positions, which about 1,000 of these occur during the fourth quarter.

We expect these actions to generate savings at an annual rate of approximately $200 million of which about half will be realized of that rate in 2003.

Now let me turn the call over to Dan Carp for his observations.

Thanks, Bob.

Good morning, everybody.

Thanks for joining us.

It is gratifying to see the strong cost in productivity performance of this company in the third quarter.

Clearly, Kodak is effectively managing those things under our control.

We will continue that focus going forward while we wait for an improvement in this current economic environment and it will eventually improve.

When I look at what we saw in the marketplace in the third quarter, there were a number of positives and negatives.

In the summer space, we continued to improve our US film market share position as we had predicted.

We remain confident that we will achieve for a fifth year running our full year US market share goals.

We have done particularly well in the one-time use camera market with our fun saver product against various private label offerings.

Our new value priced offering we just announced at Photokina the Fun Flash as it will be called in Europe, will be further strengthen that position.

The US consumer film price mix environment in the third quarter is essentially unchanged from that seen in the first half of this year down about 6 percent on a year-over-year basis.

So while pricing remains very competitive, there isn't any real change in the trajectory we have been dealing with in and talking to you about.

US film industry volumes which represent sales to consumers by retailers were down about 3 percent in the quarter as opposed to the 6 percent we saw in the second quarter.

While this reduction in rate of decline is encouraging, frankly, I had hoped that we would see a stronger performance as we moved into the easier comparisons in the latter part of the quarter.

In fact, the industry was down a bit in September, about 1 percentage point, against that very easy comparison.

Frankly, I'm a little disappointed industry sales weren't a bit better than that.

So while I'm proud of the results the team achieved in managing market share, I do not yet see any signs of a recovery in the US film market.

That said, we did well in managing our way through the digital camera component shortage we experienced during the quarter.

We believe we have the camera supply situation now well in hand for the important Christmas selling season.

And on the cost side, we saw substantial margin benefits in our move to China manufacturing.

Our consumer digital services which include our retail dot-com initiatives and our photo subsidiary continue to perform well with the largest part of the year ahead in the fourth quarter.

The entertainment business had a very strong quarter both in print and origination film.

As a result of improving television and feature film production.

In addition, the year-over-year comparisons were helped by last year's depressed industry levels that resulted from the effect of the threatened industry strikes and then the 9/11 attacks.

This business remains a great business for us where we have and will maintain an excellent relationship with our key customers.

As Bob commented, I can't say enough about the performance of the health imaging team for their successful turnaround program.

It's hard for me to be irritated at them for surprising me again with an upside in their margin performance.

Health imaging is our second largest business, a very solid, very important business for our company.

I look to the team led by Dan Kerpelman to make appropriate investments to promote profitable growth and ultimately that reinvestment will put some downward pressure on the net margins in that business.

As I look across the world I continue to see weakness in western Europe although positive foreign exchange impacts must and match much that while the emerging market portfolio is a mixed bag.

Latin America as all of -- as all of you know, particularly Brazil continues to be soft like Korea, India and Taiwan do show some growth and China and Russia are providing exceptional growth.

I have been saying for some time we have a good hand to play in China.

And I believe the team there continues to play it and play it well.

The Russia team is also showing some great creativity in that market finding new and innovative ways to drive growth in a small but rapidly growing market.

The good news, or I guess at least the better news, in the quarter relative to top line activity is sales improvement relative to the first half.

You'll recall that Kodak sales for the first half were down about 8 percent with all significant operating units reporting year-over-year declines.

In the third quarter consolidated sales are up 1 percent with most units showing flat or higher year-over-year sales.

We all realize that the third quarter year-over-year figures reflect easier comparisons.

However, it does suggest that maybe we found a bottom from a sales perspective.

Of course, the all-important key fourth quarter will be the key determinant of the trend.

In the quarter, we continue to move ahead with our critical strategies.

You'll recall those four strategies.

They're expand the benefits of film, grow output in all forums, make digital easier, and grow new businesses in new markets.

Of particular note I kicked off the Midwestern launch of Kodak perfect touch processing in Chicago just a few weeks ago.

The initial results in the test markets have been very strong.

Both improving Kodak's share in the photo finishing mix as well as improving pricing.

This program is designed to continue to strengthen our position and output and we will be rolling out Kodak Perfect Touch across the nation in 2003.

Finally, I know there is a lot of interest in Kodak's view of 2003.

In reality, we're in the middle of our planning process for next year at this time.

But I have to tell you when I list all the variables that I don't have a clear read on at this moment including the direction of the worldwide economies, what's going to happen with the US economy, changes in geo political situations and so on, the ability to say much about 2003 isn't there.

I can tell you with great certainty how I'm going to run the business.

We will remain focused on cash, ongoing cost reduction, productivity improvements, and executing those four critical strategies that I just listed.

So I have no difficulty describing Kodak's focus.

It's simply too early to address next year so I'm going to stay on my plan.

Get a good look at the important year end and holiday results and give you my best view of 2003 when we meet in New York on January 22nd.

I'm very pleased with the success we have had in recovering our earnings from the low point reached in the fourth quarter of last year and the first quarter of this year.

We plan and will build on that success with solid execution and a -- and away the the economic up turn that, as I said, is certain to come.

Now Bob and I will be happy to try to answer your questions.

Thank you, gentlemen.

Today's question-and-answer session will be conducted electronically.

If you would like to ask a question, please do so by pressing the star key followed by the digit 1 on your touch-tone telephone.

If you are using a speaker phone please make sure your mute function is turned off to allow your signal to reach our equipment.

We will proceed in the order that you signal us and we'll take as many questions as time permits.

Once again that's Star 1 to ask a question. (Pause) And our first question will come from [Gibbini Husky] of CS First Boston.

Thank you.

Two questions, one for Bob and one for Dan.

First for Bob, I was just looking and your former employer GE is paying out right now dividends about 44 percent of earnings.

And just thinking about obviously we're in a tough environment now, but just thinking about the optimal payout ratio for Kodak over time, is that about right?

Is that consistent given that Kodak is diversified and cyclical, is that the right type of level to be looking at?

And then I have a follow-up on that one.

Well, most of you uhm, -- GE's earnings have continued to grow through this recession because of their wide diversity.

As you know we took a real tumble as Dan mentioned in the fourth quarter and the first quarter so we're suffering from a low earnings year and the same dividend and so our payout ratio now is up in the mid 60s based on the expectation for the issues of profitability.

Right but --

That in itself is not a sustainable rate.

Dan and I couldn't continue to pay out that kind of rate over time so, we're going to have to wait and see how we come out of this economic recovery.

Certainly the Dow components right now, the Dow Jones Average payout is around 40 percent.

And GE is just a little higher than that.

We're much higher.

So as we get out of these tough economic times, we'll have to reevaluate that down the road but right now, we are going to maintain that absolute amount of dividend payout.

Well, isn't it -- mean, fair to say that, you know, at least you think it's conceptually possible that your earnings will recover to a level where you're kind of at that 40, 45 percent type of -- mean, why wouldn't you have cut it before in the middle, when things are worse if you didn't think there was a reasonable chance that the company's earnings would go back up to levels that would bring that payout down, is that fair?

Yeah, well, our objective is to lower the racial you through earnings improvement and, you know, that's our goal to do that.

Time will tell as we come out of this economy how well that's going to perform but, you know, our goal is to get back to where we used to be, which was down in that range by continually improving the operations of the company.

So, you know, again, we are going to have to wait a year or so or whenever this economy gets back to more normal to see what it looks like then.

Uhm --

But again, we plan to cut the ratio by increasing earnings.

Okay.

And my question for Dan is, I mean, it seems like digital camera business is back on track.

It's hard to get real excited about this business because it's still seems to be hurting earnings.

And is the right way to look at that business, I guess we look at the Inc.

Jet business where you lose money up front but there are after market supplies opportunities that are profitable and over the basket of products or, you know, the business is profitable and could you talk about, you know, some of those after market opportunities where you are relative to getting to profitability, getting to scale and what you see as a tax rate in terms of selling the digital camera.

Is that going to increase the possibility of Kodak paper?

Obviously, the attach rates are not as direct as in the Inc. to Inc.

Jet printer rate where there's a technical connection.

And therefore, we won't let digital cameras dig the kind of hole that some of the printers have to dig.

As I said before, we should be profitable on digital cameras in 2003.

Sometime.

And I don't see any reason why that won't happen frankly.

We have our production in China and we have some innovative products this year.

I like the road map a lot for next year.

And so we should be able to improve the earnings on cameras.

Now with that said, and by the way, let's all remember, also, there is not a big capital investment in digital cameras like there is in the traditional business as we deal with with Kodak.

Now with that said, obviously, the real engine here is consumeables and consumeables come through printing and we see continued linkages of our digital cameras with our Inc.

Jet paper, with photo and retail and I believe you'll see more consumers going into retailers with their digital cameras and looking for company-wide solutions to print their digital pictures at retail and as I have said many times I ultimately believe that will be one of the if not the biggest place where people print digital images and that's why our kiosks and the Kodak brand connecting digital cameras to the digital kiosk and building our programs with our retail partners to get people to bring those digital cameras in is so key.

So yeah, you're right but it doesn't have the same connect rate, therefore we can't allow ourselves to slip into losing a lot of money on digital cameras.

But is your internal research showing, you know, that there's any kind of relationship in terms of your propensity to use Kodak branded ink jet paper if you have a Kodak camera?

Is there some base you're seeing on --

There but you know what, it's hard to read inside the total Kodak brand.

We have an enormous brand leadership around the world in film, in traditional cameras.

That's carrying through in ink jet paper and that's why we call our photo a Kodak company and obviously the EasyShare software makes it easy to connect but it's the power of the brand is more than just a connection with our digital cameras.

It also connects to other people's digital cameras.

Right.

Thank you very much.

Yup.

Thank you.

Next we'll hear from Ben of UBS Warburg.

Yeah, good morning.

Hey, Ben

Hi.

A couple of things, first, on film.

Going into the fourth quarter, how do inventories look at retail?

And if you can make a comment on what's going on with single use cameras?

There was some competitive dynamics there I think that might have helped you out and are helping the fun savor at this time or are there?

The retail inventories did pick up in Q3 as retailers bought in anticipation of business getting better.

But I'll remind all of us that in particularly the US and western Europe now, retail inventories are well managed and if they don't see the sales come through, it will reset in our sales going in in Q4, right?

So it will rebalance.

It won't be a 2003 issue.

It will be sales in Q4 issue.

And in reality, no one knows yet.

It's too early to see that call.

It will happen right around Thanksgiving and we'll see how it plays out.

Fun saver we've announced some new products and they are going quite well. the big issue there as you know and have written about is private label situation.

And consumerss just aren't getting the quality out of those private label cameras in general and I think the quality of our cameras at these new low prices will allow us to be very competitive in that space even though they will continue at a price premium to others in the marketplace.

So one thing is the retail inventory tick-up, is that any more than just a few weeks?

It's about a week.

Okay.

And the fun Saver or the issue with single use cameras, you think that's sustainable you're saying?

It sounded like during the quarter there was some shifting around and it really helped you and you are saying it's probably sustainable into at least this fourth quarter?

Yeah.

I like our offering in the Q4.

In one-time use cameras.

Okay and then just on film pricing, what kind of trends are you seeing?

You've been very successful in gaining share since the first quarter which squared some of us and you, to your credit you have come right back.

Are some of your competitors just going to sit there and let you have it, or what do you think's going to happen into Christmas and beyond with that kind of share dynamic?

Well, first of all, let's be real careful we don't tie our share recovery just to any kind of pricing action.

In fact, we have gotten our share back with very little overt price action except in making one-time use more competitive against private label.

And our share recovery has not been, you know, break the thermometer kind of share recovery.

We have had a modest share recovery.

We didn't have a big concern about this thing would even out over the year and we'll end up our year with our goals intact.

So I don't think we will -- we should expect anything untoward in Q4.

But, you know, irrational as is this thing, you know, irrational things every once in a while break out and we will respond.

But we certainly aren't going to do anything untoward in Q4.

And I don't expect anybody else to at this stage although price something competitive.

As I said, it's down about 6 percent.

Let's be careful we don't start getting comfortable that minus 6 percent is a smart way to run a business.

It's not.

And the whole industry is leaving money on the table because consumers would pay more for film products if asked.

Okay.

And then just to conclude, Bob, just buying of the 7.4 million shares, what kind of price should we assume and what kind of cash out lay should we assume throughout the quarter?

This will be purchased back over a fixed number of days during the month of November.

And it will be at the market price.

And so the cash out lay will be, you know, whatever the market price is times 7.4 million shares.

Got it.

Thank you.

Okay.

Thank you.

Thank you, sir.

Moving on to Jack Kelly of Goldman Sachs.

Good morning.

Just a couple of questions.

Just maybe starting with health imaging, one of the issues that's arisen then in the past which has triggered pressure on margin has been renegotiation of contracts.

Can you just kind of look out maybe over the next six months or so and give us an indication of what might be happening there, major contracts, that is?

Secondly, Bob, if maybe you could just kind of give us a feel for pension fund expense this year, next, what you might be doing with your assumptions, et cetera?

And then fine incidentally, on the proposed option FAB, if it were phased in next year, what the impact would be.

I guess as one follow-up question on market share, regarding inventorys, if the market was down 3 percent, that was the consumer takeaway, and it sounds like you guys were up a bit.

It almost seems like that would translate through to more than one week uptick in inventories but maybe I'm just not viewing it correctly.

Well, let me answer that first.

Remember now, inventories are a percent average your forward expectations.

Okay?

And so we saw inventories go up but they normally go up at this time of year.

They just went up for a little more than we thought because they are little -- I can't say retailers are optimistic that wouldn't be fair.

They are saying there's not really a big risk of buying some film in because we can correct it pretty fast given the VMI connections with the company like Kodak.

So they did take the inventories up a tick.

And they go up some at this time of year anyhow.

So whether they're up the right amount or too much will be backward-looking assessment after we see what the sales were.

But that's Monday morning quarterbacking everybody.

The retailers and you guys, too.

Health, there is nothing in the next six months.

I think in the fall, somewhere around September, October, there is the premiere contract coming due next year.

And, you know, that will be something that we will deal with in the marketplace.

But it's not a -- we don't have a lot of that contract right now, so I don't see a nig turmoil.

But you know, it's early to know what's going to happen in September.

Asked three questions.

That was two.

About pension funds.

Right.

You asked about Jack, would you repeat that question?

I was listening to the --

Sure.

There's been a lot of, you know, movement around here recent will in terms of companies actuarial assumptions on their pension fund getting, you know, maybe reducing the expected rate of return, you know --

Mm-hm.

Change the discount rate.

Just wondering what thoughts you were having on thats you looked ahead at '03 and if you were thinking about that, what impact it might have on, you know, pension income, pension expense, and then on the options side, just while there are no firm rules, some companies have adopted, others have made estimated in terms of expensing options, what that -- how that might hit EPS.

Okay.

On the pension issue, about 80 percent of our pension lies in the United States.

And that has been completely reviewed by Wilshire Associates.

We had income this year.

We will have income this year off that pension of about 120 million.

That should decline by a little over 100 million next year due to FAS 187 by reducing the rate assumption and the discount rate.

And so that's about a 26, 27-cent per share head wind next year.

We have the -- other 20 percent of our pensions lie in a lot of plans globally.

And those, as normal, are being reassessed now by powers and those results will be -- we will have those results at the end of November.

I am not expecting any significant income impact from our foreign pensions in the near future.

We will have that information and we will lay that out for you on January 22nd.

But the big near-term impact is going to be the US pensions.

They are going to cause 27, 28-cent head wind next year.

Earnings per share.

The discount rate we have is going from 750 -- 7.5 percent in 2001 to an estimated 7 percent in 2003 and the ROA drops from 9 1/2 to 9 according to, you know, the study we had with Wilshire.

Any cash that you got to put in, any cash contribution this year or next?

The US pension plan is in their view fully funded for the next five years so we don't anticipate any pension contributions to the US.

On our foreign pensions which represent a lot of little ones, our policy is to maintain all of our pensions whether US or foreign in a fully funded position.

And from time to time, we do make contributions to those as we review them.

Again, I don't know where our situation is going to be next year because that review is in process.

So there won't be any US.

Likely to be some sporadic contributions in Europe and Asia, but we'll lay all that out in January.

But nothing here that is of a significant hurdle for us that I can see right now.

Jack, on the stock option, I'm going to let Bob try to flip through his papers here and see what the last number we gave and the truth, we don't spend a lot of time reworking those numbers because we have chosen not to expense the options and we may not even have the number with us, but we have chosen not to expense the options until the thing settles down until we know what the rules are and so we won't with waste a lot of time efforts ton until the rules settle down.

I have to admit that, you know, I'm not a big fan of trying to expense options for company like Kodak that doesn't have an extraordinary large number of options that we give.

It putting against actuals the real forecast.

So we'll see Bob's turning pages here frantically to get to the footnotes.

What have you got?

It looks like around about 20 to 25 cents a share based on our information from last year, Jack.

Of course, that will vary going forward depending on what the earnings per share is and whatever the model is.

And so, you know, hard to tell right now.

Have to wait and see how this all settles down.

Thank you.

Thank you, Mr. Kelly.

Moving on to Carol Sabogga of Lehman Brothers.

Thank you.

Just a couple of quick questions.

Up with is about next year.

Not -- I know you're not going to give specific guidance and I'm not looking for it.

But conceptually, you've talked about one big head wind that you're facing next year which is the pension expense.

And then, you know, if we talk about generalities what are the potential things that could offset that?

What are some of the tail winds?

And then a quick follow-up on health imaging.

Well, the tailwinds are, you know, if we get a great fourth quarter in sales.

And that will be the big tailwind that we see right now.

What if we put the economy aside and assume sort of a weak economy or at the same level of economic activity this year as next -- next year as this year.

Carol, I'm going to see you in January.

Okay.

The next question just quickly on health image, the margins as you said that business continues to do extremely well.

And we have been sort of talking about a rise in investment potentially in that business.

I wanted to know what your current expectations when we should start to see the investment increase and the margins start to decline slightly.

And also, what type of investment in the business are we talking about?

Is this acquisitions?

Is this more R&D?

I'm going to not give you an exact timing on it.

I'm going to give the pot of stuff that we're looking at.

Okay.

We are probably going to add some to R&D as we -- and the timing of it will be a function of when we staff up in that area to cover it.

To improve -- you know, to make sure we stay in the forefront in our product competitiveness and we have some neat things on the product road map that will pay off over years.

But we got to fund it.

We probably will as the markets start to stabilize take some selective pricing actions to target market share particularly in the equipment area.

We have backed away a little bit now and our mix is probably too much toward the materials because, frankly, we have lost a little momentum in the equipment and I think we'll probably come back at that as -- and you know my feeling, you don't do that when things are down.

You do that when things start picking up.

And as the hospitals start coming back and increasing their capital expenditures, which is one of the reasons our equipment sales are down, and start bringing in more equipment, that's the time we'll go for some targeted increases in market share and there may be some small acquisitions but, frankly, Dan is still working through that and I don't have anything to report on that.

And -- but any kind of acquisition could be a bit dilutive in the short term.

But as I said, one of the things they are benefitting from in sort of a backhanded compliment in the -- is that some, you know, some customers have backed away from buying equipment right now.

They can't stay there.

You know, they need it for productivity.

But everybody's capital budget including hospitals' is under pressure.

As that comes back, we'll get an unfavorable mix and then we'll go for some market share increases because the time to do that is when business starts to recover and not during a downturn.

All you do is trigger some reaction you don't want to live with.

So if the business remains weak, it would be right to assume that the margins can continue to be above sort of where we think normalized margins should be in that business?

No.

Because we're go back in and do R&D and looking for some acquisitions.

Okay, thank you.

And Morgan Stanley, Sulin Choi has the next question.

Hi.

Thank you.

Just a couple of questions.

Just to follow up on Carol's first question, just putting the, you know, uncertain macro environment aside, there are a few puts and takes that you discussed at the past meeting and today and just tell me if, you know, this is sort of a fair assessment of some of the puts and takes for next year.

You've got the share buy back which is going to reduce your shares by 3 percent.

You've got the restructuring savings from the 4Q restructuring program half of which you'll recognize next year.

You've got potentially a lower tax rate.

And then you sprobl some additional savings that you've generated this year because it sounds like produce at this time improvements have been generateder than you expected.

Is that sort of a reasonable assessment of some of the possible tailwinds for next year?

Absolutely.

Those are all we've discussed.

And then of course the big unknown for us is volume.

And price.

And volume plays such a humongous impact on our productivity.

You know, we'll have a real good view of that or as good as anybody will have after we get through Christmas.

And, of course, price will always be, you know, what do you call it, a forecast of hard -- that's hard to make.

But yeah, the volume will be a key piece there.

Okay.

And then, uhm, just to dig a little bit deeper in terms of the gross margin performance in this quarter, as you said, you did, you know, a few points better than your original guidance, just specifically on the productivity and cost side, can you be more specific in terms of where the biggest upside surprises came from?

Was the move to China, it was raw material costs, was it better capital utilization?

You know, how much of it was FX, if any?

And do you feel that you've got the full benefits of it this quarter or will some of it carry over into the fourth quarter?

There's, you know, uhm, one -- this is Bob.

One of the things since last year we went through this very, very difficult two quarters and last year we took down inventories to very low levels as compared to our historic levels.

We took out a lot of SKUs.

We don't make as many SKUs as we do on a lot of things and as we come out of this environment with kind of a new cost structure it's hard to predict exactly what's going to happen.

We were surprised in the third quarter at that point that that percentage went up because it normally doesn't.

In there were some good material prices, good labor utilization, we did have reasonably output with less people and better liquidation of costs.

There was not in my judgment much toward moving around product and stuff like that.

It was material labor and burden primarily in our manufacturing plants.

And would you rank it in that order as -- as in terms of contribution to the --

You know, I don't know.

Okay.

You know, it's hard to segregate all these things.

And it was a -- it did get off, you know, as you do forecasts, they said my comments -- as I today.

My comments, it's hard to move off seasonal averages that have been established over the years unless you see something that's really disrupted and so we did forecast going down one because that's what it has been and it did go up one and so that was a surprise to us.

We kind of sensed it in September, but we wanted to make sure it happened.

In the fourth quarter, we're going to stay on the seasonal trend but we have upped the starting point, those two points.

And we now, you know, we have in the fourth quarter guidance a drop of around 4 points in our gross profit which happens every year at that average.

So he it's a general labor and overhead and some material prices so that's as far as we can go on that.

Okay.

And just so I understand the 4Q guidance, it's basically assuming that you're going to revert to the historical seasonality as opposed to, you know, building in even tougher price mix assumptions or, you know, uhm, factoring in inventory levels that may have been, you know, higher than you had expected, uhm --

Everything -- we're going into the fourth quarter with where we thought we would be on inventory within a few million dollars.

Okay.

The two big changes in our forecast is when we are starting the gross profit 2 points higher than we would have before because it's up 2 points higher.

The other big news is when we were talking before with you, we had a sales growth in the fourth quarter of 4 or 5 percent.

Now that's down to flattish.

And so the benefit we get by the higher absolute gross margins start to -- start period as offset by we expect to have less revenue in fact fourth quarter than we did before.

So that's why our guidance hasn't really changed a lot because one offsets the other.

Okay.

Okay.

Thank you.

The inventories are about where we thought, and, you know, we continue to move as we expected but the fourth quarter does have a sharp drop in it.

Okay.

Thank you.

Next we'll hear from Craig Ellis of Solomon Smith Barney.

Good morning, Dan.

Good morning, Bob.

Hey, Craig.

I'm just trying to understand your thinking as it relates to the announcement on the incremental cost action today and where we are with the objecttive on 450 million for the year.

One, when we look at cost savings, how should we look at how you are incorporating what you're achieving in your forward guidance?

That would be the first question.

And then secondly, as we look at the incremental cuts that you announced today, are those cuts really in place as we're trying to move margins and some of the expense lines back towards Year 2000 levels or are those really being put in place so that we can maintain margins at current sflevls it looks like with fourth quarter guidance expense and gross margin levels they are going to be about flat year on year.

So I'm trying to understand your thinking there.

On the restructuring savings from last year, we had previously guided that it was around $450 million this year.

It that certainly is on track.

I mean, we're very pleased with the progress we made on our cost reduction.

Both Dan and I, you know, are very happy about that that's verifying very well.

We said before about two-thirds of that's in cost and a third in SG&A and administrative cost and that's also playing out well.

Last year, we did a pretty big wide-ranging restructuring that was, uhm, 700 million or so and involved a large percentage -- large people component.

This year as we look after that, we find some areas that we probably should have gone after a little more rigorously.

Plus our businesses have come up with some targeted actions which help them with -- with their individual cost reduction programs.

So we're not looking at a big large charge here.

We are look at targeted actions which have high returns.

Now, this has a mix of high returns on it.

And so it's kind of finishing up from last year and finding some new ideas.

As we look across our company and as our business conditions change across the company.

Okay.

And then just understanding the thinking as it relates to your fourth quarter guidance, can you help us understand how you're incorporating the cost savings benefit into the guidance range of 60 to 70 cents?

Well, what we've done is we've -- the primary things we did is we -- as I just said a few minutes ago, is we have the downside is we have lowered our sales estimate for the -- the growth of the sales estimate in the fourth quarter and that's, uhm, that's because of what we're seeing in the economy.

As Dan said, we're a little disappointed in the compares we had at the end of September.

The second thing is we are forecasting a historically normal drop in gross profit.

All these new actions we have taken will have no impact in the fourth quarter.

Right.

Right.

The the fourth quarter is residual of the actions we took last year.

And so the new news is we have lowered our sales estimate but we are starting at a high gross profit -- higher gross profit by 2 points.

And that's how we did that you know, there's a lot of uncertainties about what's going on in this top line, here, Europe and in South America.

So it is a tough especially environment to do forecasting in.

No question you guys are doing a good job with cost savings.

Understanding some of the balance sheet parameters a little bit more clearly, it looks like inventory turns are starting to stabilize, Bob?

And it looks like accounts receivable DSO are continuing to trend down.

Are those good trajectories to use looking forward into 2003?

Well, we stated before on the inventories we are going to try to get that up to six turns next year.

It's running around fiveish now.

Where we will make the progress on inventories is generally in the first half of the year when we get into our production build.

Right now, you know, inventories will be more or less stabilized because we are going into the shutdown season and in the last half of the fourth quarter.

Inventory, I'm very pleased with the receivable days.

Our gang has done a great job in a tough environment and much of the progress has been made in past dues using cash calls and stuff like that.

I would say we're on track to make the target both inventories and receivables next year.

Okay.

Thanks.

And then just lastly, there was a comment on real strong entertainment imaging momentum in the third qeemplt is that something that was really just for the quarter or is that extending out into the fourth quarter?

And how robust is it is that trend?

It was really, really good in the third quarter, and the compares were very easy.

But it was very good in the third quarter.

It won't -- our expectation is it won't keep those kind of momentum but we'll just have to wait and see.

As you know, the motion picture industry is made up of two things.

It's made up of making movies and then distributing movies.

We have real good insight to making movies because when Tom Cruise shows up, our film darn well better be there.

And so we are sure it's there the printing and distributing of the movies gets into a lot of complex questions about where the movie industry decides what else is in the theater, what else is in the box office, do I want to hold it until Christmas?

Do I want to hold it until after Christmas?

And -- hold it until after Christmas?

And we have a real tight supply chain with the labs.

So we sell them the film when the movies say let's print.

And so that's a little harder to predict.

Okay.

And can you get us in the ballpark on what the growth looks like in entertainment?

No.

Okay.

Dan, Bob, thanks.

Are you clear on that Dan? [ Laughter ] Okay.

And moving on to Ulysses Yanis of Buckman, Buckman, Reed.

Dan, do I understand it correctly that you are more or less hitting capacity on your ability to make your sale single use cameras?

I missed --

That's why you are outsourcing part of the fun saver, right, or the fun flash?

Oh.

As I understand it.

Which implies you might be hitting capacity?

No.

We're okay on capacity.

We have our capacity about where we want it the.

We do do some outsourcing for two reasons.

One, that allows to us buffet some ups and downs in the industry.

And two, it keeps us honest on our cost structure because nothing like seeing what others are making it for to challenge yourself to do better.

We do that in some raw materials like our paper base and some things and it's a pretty clever way our manufacturing guys and our consumer guys keep themselves raising the bar to keep pushing ahead.

Your move into the lower end of the single use camera market, that implies you are instead of just trying to keep your market share, that you might want to increase it?

Well, single-use cameras are continuing to be a great business.

They're a great business on maybe multiple levels.

One it's a very profitable business obviously.

Two, it does have growth associated with it.

And three, it will -- it's clear to us that single-use cameras will still be in the game way, way in the future.

In other words, households that use digital cameras will still be using single use cameras so it's important for us to be strong in that area.

Some of the private label activity has troubled me a little bit and I wasn't happy with where we were in share and just like you can't get your price premium too high in any product category, you have to pay attention to private label and so we did get a little more aggressive against the private label space.

Nothing shocking in there but I wasn't happy where that was.

We do believe we're -- we have the ability to be a low-cost provider and so... we feel pretty good about where we are but we can't let the price gap open up too much at any period of time or you sell share and that's not smart.

Does that apply also to film meaning the mix?

If you look at units rather than dollars, is it fair to assume that your units of lower end 100 and 200 are holding up better than the max?

I don't know exactly the answer to that tell you the true.

I will tell you that we continue to have a strategy that emphasizes higher speed films and higher speez one-time-use cameras primarily because consumers get better pictures and when they get better pictures they like our products.

So we continue to do that.

And so in general, our shares tend to be a little stronger at the higher end.

But it's not driven out of a share strategy as much as it is to give the consumer the best value.

And as you are moving to the output side of the equation, with your emphasis now on making it easier to print digital, is it fair to assume that you can use some of your film plant capacity to move it exclusively to paper? -- coating?

Well, you know, most of the coating in Kodak is on the -- biggest coating we do is on paper.

And the second biggest coating is on motion picture film.

So there is some trade-off there.

But we still see good growth in the paper business because of just what you said, which is absolutely right.

Consumers are going to be printing at retail and silver paper is the best way to do that and in fact where prices are it's very competitive there.

The film area the big user of film capacity in terms of sensitizing is the motion picture industry.

The traditional film industry is not -- while we make a lot of it, is not anywhere near the square footage that's used up in the motion picture industry.

Finally, and I thanks you too much, is it fair to assume that once you start hitting this 4 to 5 percent growth, next -- for 3, 4 years, your margins instead can go back to about the 40 percent trade your gross margin rather than the 45 you used before?

You know, we are going to have to wait and see.

So much of that spins off pricing.

And this has been a tough industry on pricing.

We'll just have to see how that plays out.

What we're focused on is innovating with new products because that does give you the ability to general right price increases like we're doing with Kodak Touch perfect touch.

Investing in strategies that I articulated because I think we've superior play across film output digital and new businesses liked OLED and taking cost out on a regular basis because I think that's what a smart business does today.

And we'll see where the margins fall based on the pricing.

So in essence, one of the things what you're telling us is that your so-called - non-recurring will continue to recur, charges?

No.

I -- I think that's a little rough if I might say so. [ Laughter ] Okay.

We've got a business here that is in transition.

And it's in it transition from silver halide --

So it's normal to keep taking those courses.

It's normal.

I would argue that as business transfer to developing markets, the developing markets if you don't take costs out you'll underfund the opportunity in develop markets.

Right.

So we take costs out every day if we're on our game and we have been on our game this year anyhow.

And once in a while, we get to a big bucket of costs that needs to come out at once and we'll announce it.

But we're just going to keep tenaciously chasing the cost because that's where the money for reinvestment comes from.

Finally, on the employment side, you are approaching a level maybe 70,000 worldwide where you couldn't go much clor because the service component that seems to be increasing uses more people, isn't it?

We're at about -- last year we were about 75,000 people worldwide and what we announced today was probably the toughest part of managing is take people out.

But it was something we needed to do to stay competitive.

We didn't announce areas we are adding people to today.

So, you know, we'll see where that shakes out.

I don't think it's a structural question.

It's more an opportunistic question.

Thanks very much.

Thank you.

And David Swartzman of Westmoreland Capital has our next question.

Yeah.

Hi.

What portion of your photography sales are digital cameras and digital accessories versus paper, analog film and, uhm, analog cameras?

Well, you know, I don't even not answer to that, tell you the truth.

And we want to make sure we're careful here that the health business is a big portion of the company, the commercial imaging group is a big portion of the company.

So I don't -- if you are saying just in the consumer business, I frankly don't know the answer to that right now and I don't have the numbers in front of me.

But keep in mind that digital is a lot more than digital cameras and ink jet paper.

Digital cameras are the kiosks -- our digital products are the kiosks in the stores.

That's all primarily digital capture and thermal media which is a digital media.

And the new Kodak Perfect Touch processing which is all aimed at improving pictures from one-time-use cameras and rolls of film that go into our retail partners is digital technology in the wholesale lab that allows that to happen.

So we have long decided we cannot break what percent of the company is digital apart because digital cuts across so many things.

It's enhancing the traditional business and it's new business opportunities.

So I don't -- I can't really get to the core question which is what percent of the company is digital and what percent is non-digital.

And I don't have the digital camera percent of sales in front of me.

Would you say that it's, uhm, at least anecdotally does it feel like it's increasing in the digital proportion and, you know, is there some feel for that?

Yeah, it is.

It is increasing in digital proportion, no question.

Growth rates in digital are faster than the growth rates in traditional.

Traditional, the industry continues to show some decline.

But it's not a step function.

It's a slow decline, I think primarily driven by the economic conditions.

Although there is digital substitution going on that's very clear.

Looks like you're doing a nice job managing the trainings.

Thank you.

Thank you.

Appreciate that compliment.

We work hard at that time.

And Laura Star of Equinox Capital Management.

Hi, how are you?

I just wanted to know if you could give us an update on what's going on with OLED and what opportunities next year, and I don't know if you said, uhm, anything about the profitability of o-photo in this quarter and where you are in that process.

OLED is still making good progress against its goals to get off of, if you works the R&D bench.

Which was Kodak into the production bench which is the joint venture between Kodak and Sanyo.

There is no big news to report there.

They're trying to ramp up manufacturing and they won't have a material impact on any sales next year.

They have never -- it never was expected tomorrow.

And no, we're not commenting on o-photo productivity but obviously, it continues to grow and is a leveraged game.

And so you know, let's hold off trying to nail that down until we see kind of how the -- what the slope of that ramping is and then we'll give you some insight into it.

Okay.

Thank you.

Yup.

Thank you.

And Mr. Carp, at this time, there appears to be no further questions.

We'll turn the conference back over to you for any additional or closing remarks.

Yeah.

Thank you.

First of all, thank you, everyone, for your questions and being on the call.

We really are pleased with this third quarter.

It really feels good.

We would be remiss in not saying that in the third quarter of last year, things looked pretty bleak.

We knew we had to put our shoulder to the wheel.

And improve our situation in terms of cash generation, make sure we held our market share and stayed true to our strategy.

And the Kodak people did that.

And I'm very proud of them.

Now going forward, we've unfortunately got to take some more costs out.

That's the prudent thing to do and we are dealing with that right now.

And at the same time, staying focused on the things we can control.

And the company's running quite well right now and I'm very proud of it.

So thank you all very much.

And we'll see you in January in New York.

Thank you, gentlemen.

That does conclude today's teleconference.

We thank you for your participation.