November 3, 2011

Kodak’s Quarterly Report Highlights Progress in Business Transformation

Antonio Perez’ Letter to Kodak Employees

Kodak shared the following letter from Antonio M. Perez, Chairman and CEO, to the company’s employees that provides his perspective on the company’s latest financial report, released today:

Dear Colleagues,

If I could write the headlines for the Kodak news stories that will appear today, I'd write this:

Kodak Makes Steady Progress in Digital Transformation During Challenging Times

That headline, for me, is the message in the third-quarter results we released today. The results show, upon close examination, considerable progress in our digital growth businesses even as we contend with stubborn challenges in some of our cash-generating businesses.

The results also show that we ended the quarter with $862 million of cash in the bank, with plans to end the year with $1.3 billion to $1.4 billion in cash—and that's before the sale of our digital imaging patent portfolios, which would materially increase our cash balance. (By the way, we're pleased with the progress we've made on the patent sale, and we're confident that the value of these patents, which represent just 10% of our total patent portfolio, will be recognized in the marketplace and materially increase our cash position.) Importantly, 2010 and 2011 represent the peak years for cash usage by our business units during our corporate transformation. The good news is that in 2012, we expect cash usage attributed to the operating businesses to decline notably, stemming from significant profitability improvements in consumer and commercial inkjet as well as digital cameras. In short, we feel confident we will secure the resources necessary to complete our transformation to a profitable, sustainable digital company.

Our third-quarter sales were $1.462 billion, a 17% decrease from the year-ago quarter. But let's take a closer look. In last year's third quarter, we enjoyed the benefit of a $210 million non-recurring patent licensing transaction. Excluding that year-ago non-recurring intellectual property revenue and a 25% decline in the company's Digital Cameras & Devices business, which reflects the strategic decision this year to trade revenue for improved earnings, third-quarter digital revenue actually grew 3%. What's more, the new approach in digital cameras drove a $53 million earnings improvement in the Consumer Digital Imaging Group in the third quarter. That also contributed to a gross profit improvement for the company of 3 percentage points, excluding the prior-year non-recurring patent licensing revenue and certain higher raw material costs, yet another sign of better operating performance.

Helping to offset the digital camera revenue decline was the performance of our four core digital growth businesses—Consumer and Commercial Inkjet, Packaging Solutions, and Workflow Software & Services. Their sales increased 13% as a group, fueled by a 44% increase in Consumer Inkjet printers and ink, as well as an 89% increase in Packaging Solutions. Specific to Consumer Inkjet, our installed base of printers is now big enough that we expect to meet a key milestone in the fourth quarter—achieving positive gross profit for this business as a whole, driven by ink gross profit. In both businesses, customers continue to embrace our revolutionary technology. We are outpacing the market by a wide margin.

In Commercial Inkjet, we continued to incur higher-than-planned start-up costs for PROSPER systems in the quarter and associated delays in booking revenue, while demand declined for our legacy VERSAMARK inkjet products, resulting in a 9% revenue decline. But let's take a closer look at just the PROSPER product line, which is our big future play in this category. Revenue for the entire PROSPER product line rose 40% in the third quarter. We anticipate that sales of PROSPER presses will accelerate in the fourth quarter, based on installations already in the field and continued success in the marketplace. PROSPER customers are placing additional orders as they experience the revolutionary value proposition of offset-class quality and productivity combined with the flexibility and speed of digital. That's the best measure of success.

For all of 2011, we now are forecasting a growth rate from our four digital growth businesses of approximately 25%, in markets that are generally flat, because we are stealing market share from our competitors. That's lower than the 30%-40% growth we had predicted in late July, reflecting slower economic momentum. However, 25% is still a substantial improvement year-over-year and points to a very promising future for these businesses. It is for this future that we are making investments today. I know this is hard work, but hard work is what gets the reward.

As for the stubborn challenges, in our Graphic Communications Group, we continue to see pricing pressure on digital plates as industry growth slows. This issue is compounded by higher raw material costs, especially aluminum. We are working hard to address this issue. Another business facing cost pressure is our Film, Photofinishing and Entertainment Group. Yet FPEG's third-quarter sales were better than expected at a decline of 10%, while earnings also came in better than expected at $15 million. This reflects successful pricing efforts and other cost controls that helped to offset significantly higher raw material costs, particularly silver.

So that's the closer look at today's Kodak—a company that's making steady progress in its growth businesses while managing the challenge of businesses that are mature or in decline. We are on a path to complete the transformation by the end of 2012. The key measures of success will be for our major digital growth businesses to reach break-even or better profitability in the fourth quarter of next year. We are on track to achieve that.

In times like these, it is useful to seek wisdom from those who've had to travel a tough road. My thoughts turn to the great American civil rights leader, Martin Luther King Jr., who famously said:

"The ultimate measure of a man is not where he stands in moments of comfort and convenience, but where he stands at times of challenge and controversy."

The world is taking our measure today, and we, the determined employees of Kodak, will measure up. We will continue to serve our customers with innovative products and solutions, especially in the critical remaining months of the fourth quarter. We will continue to meet our commitments and fulfill our obligations. We will not be distracted by the noise and speculation that surround us.

In time, we will be rewarded for our perseverance and for the work we do on behalf of our customers and, ultimately, our stakeholders.

I thank all of you for your hard work, your resilience, and your dedication. Let's stay true to the path we have set for ourselves, however challenging and controversial, because it is the surest way to achieve this historic transformation.

Antonio

ROCHESTER, NY—Nov. 03, 2011—Eastman Kodak reported steady progress toward becoming a profitable and sustainable digital company as third-quarter digital earnings improved, excluding non-recurring patent licensing revenue in the prior-year period, and sales increased in its core digital growth businesses. Total company revenue declined largely because of lower sales of traditional products, a planned reduction in digital camera sales, and the absence—compared to the year-ago period—of significant non-recurring patent licensing revenue.

Third-quarter sales were $1.462 billion, a 17 percent decrease from the year-ago quarter or only 5 percent when excluding the benefit of a $210 million non-recurring patent licensing transaction in the year-ago period. Third-quarter digital revenue grew 3 percent, excluding that year-ago intellectual property revenue and a 25 percent decline in the company’s Digital Cameras & Devices business, which reflects the strategic decision this year to trade revenue for improved earnings.

Revenue from the core digital businesses—Consumer and Commercial Inkjet, Workflow Software & Services, and Packaging Solutions—increased 13 percent, fueled by 44 percent revenue growth in Consumer Inkjet printers and ink, and 89 percent revenue growth in Packaging Solutions. The revenue decline rate for the company’s Film, Photofinishing and Entertainment Group slowed to 10 percent in the third quarter.

On the basis of U.S. generally accepted accounting principles (GAAP), the company reported a third-quarter loss from continuing operations of $222 million, compared with a loss from continuing operations on the same basis of $43 million in the year-ago period. The results largely reflect the absence of sizable patent licensing revenue in this year’s third quarter versus the year-ago period and the continued secular decline of traditional products¸ partially offset by better operating performance, excluding non-recurring intellectual property revenue, in the company’s digital businesses.

“More than anything, the results of this quarter reflect our continued progress toward establishing digital growth businesses that will form the nucleus of a new Kodak,” said Antonio M. Perez, chairman and CEO, Eastman Kodak. “In Consumer Inkjet, ink gross profit dollars doubled in the third quarter and year-to-date. Our installed base of printers is now sufficiently large that we expect to meet a key milestone in the fourth quarter—achieving positive gross profit for this business as a whole, driven by ink gross profit. Packaging Solutions sales increased 89 percent in the quarter and more than 130 percent year-to-date. In Commercial Inkjet, revenue for the entire PROSPER product line rose 40 percent in the third quarter, and we anticipate that revenue recognition for PROSPER presses will accelerate in the fourth quarter, based on installations already in the field and continued success in the marketplace.

“That said, we continued to incur higher-than-planned start-up costs for PROSPER systems in the third quarter and associated delays in revenue recognition, while demand declined for legacy VERSAMARK inkjet presses. Of particular note is that customers of the PROSPER press are beginning to place additional orders as they experience the revolutionary value proposition of offset-class quality and productivity combined with the flexibility and speed of digital,” Perez continued.

“As for our cash-generating businesses, the digital product lines, led by Digital Cameras & Devices, significantly improved their cash and earnings performance in the quarter on an operational basis, and we expect the improved performance to continue in the fourth quarter and through 2012,” he aded. “Our traditional business also generated a profit despite significant headwinds from high raw material costs, especially silver.

“We now expect to end the year with as much as $1.4 billion in cash, before any proceeds from the sale of our digital imaging patent portfolios, reflecting the company’s seasonal generation of cash in the fourth quarter,” Perez noted. “Remember as well that the eventual sale of our digital patent portfolios will materially increase our cash balance and help to accelerate our efforts to complete the transformation.

“What’s more, 2011 represents the peak year for cash usage by our business units during this transformation. In 2012, we expect cash usage attributed to the operating businesses to decline notably, stemming from significant profitability improvements in consumer and commercial inkjet as well as digital cameras. We remain confident that we are creating a digital Kodak that will help our customers grow their business through high-quality and innovative products and services. We continue to make progress against that goal, and we look forward to reporting additional progress in the months ahead.”

Other third-quarter 2011 details:

• Excluding the prior-year non-recurring patent licensing revenue and certain higher raw material costs, Gross Profit improved 3 percentage points. On a GAAP basis, Gross Profit was 14 percent of sales, as compared to 27 percent of sales in the year-ago period. This decrease in margin was primarily driven by the timing of the patent licensing revenue, increased raw material costs, partially offset by improvement in the gross margins of the company’s strategic growth businesses as a group.

• Operating expenses, on a GAAP basis, continue to decline as a result of company-wide cost reductions:

* Selling, General and Administrative (SG&A) expenses were $284 million, a $29 million decline from the prior-year quarter.

* Research and Development (R&D) expenses were $68 million, a $14 million decline from the prior-year quarter.

• Primarily reflecting the timing of patent licensing revenue, third-quarter 2011 cash usage, before restructuring payments, was $189 million, compared with the cash generation of $123 million in the year-ago quarter. This corresponds to net cash used in continuing operations from operating activities on a GAAP basis of $191 million in the third quarter, compared with net cash generated in continuing operations from operating activities on a GAAP basis of $140 million in the third quarter of 2010, which included $269 million from non-recurring intellectual property licensing receipts.

• Kodak held $862 million in cash and cash equivalents as of September 30, 2011.

Segment sales and earnings from continuing operations before interest, taxes, and other income and charges (segment earnings from operations), are as follows:

• Reflecting the strategic decision this year to focus on earnings in the digital camera market and to accept lower camera revenue, Consumer Digital Imaging Group third-quarter sales were $408 million, compared with $664 million in the prior-year quarter. This decline also reflects the timing of patent licensing revenue, which was partly offset by growth in the Consumer Inkjet business. Excluding the year-ago patent licensing revenue, the segment’s results improved by $53 million, reflecting the continued growth of ink gross profit within Consumer Inkjet, reduced operating costs stemming from the participation choices in Digital Cameras & Devices, as well as improved operational performance across the entire group. The segment’s third-quarter loss from operations was $90 million, compared with earnings of $67 million in the prior-year quarter, which included the benefit of the non-recurring patent licensing revenue.

• Graphic Communications Group third-quarter 2011 sales were $665 million, a 1 percent increase over the prior-year period. The third-quarter loss from operations for the segment was $55 million, compared with a loss of $35 million in the year-ago quarter. The results primarily reflect start-up costs to support growth opportunities in Commercial Inkjet, unfavorable price/mix for digital plates, and increased raw material costs.

• Film, Photofinishing and Entertainment Group third-quarter sales were $389 million, a 10 percent decline from the year-ago quarter, driven by continuing industry-related volume declines. Third-quarter earnings from operations for the segment were $15 million, compared with earnings of $28 million in the year-ago period. This decrease in earnings was primarily driven by significantly increased raw material costs, particularly silver, and industry-related declines in volumes, largely offset by cost reductions and price actions across the segment.

Update on Intellectual Property Activities

As the company has previously discussed, Kodak’s intellectual property strategy has three goals: To provide the company with design freedom to develop and introduce innovative new products, to provide access to new markets and new partnerships, and to generate income and cash.

In recent years, in keeping with that strategy, the company has actively monetized its intellectual property through a series of individual transactions as a way to fund its digital transformation. Throughout this period, as previously discussed, the company has also contemplated, at an appropriate point in time, shifting its monetization approach.

Given the recent trends in the IP marketplace, and a heightened demand for premier intellectual property portfolios, now is the appropriate time to make this change. As a result, the company announced in July its intention to explore strategic alternatives for approximately 1,100 U.S. digital imaging patents, which represent about 10 percent of its patent portfolio and which are not core to its future. The company is pleased with the progress and level of interest in the portfolios. When the sale of these portfolios does occur, the company anticipates the proceeds will materially increase its cash balance.

The company’s updated outlook, detailed below, does not include any income or cash flow from the sale of its digital imaging patent portfolios, nor does it contemplate any resolution of the intellectual property litigation currently before the U.S. International Trade Commission. The company remains confident that it will ultimately prevail in its current litigation involving Apple and Research In Motion.

2011 Outlook

• For the full year, the company now expects its total revenue to be in the range of $6.3 billion to $6.4 billion. Previously, the company forecasted full-year revenue to be in the range of $6.4 billion to $6.7 billion.

• Kodak continues to build the scale of its digital growth businesses – Consumer and Commercial Inkjet, Workflow Software & Services, and Packaging Solutions – and now expects to achieve 2011 full-year aggregate revenue growth from these businesses of approximately 25 percent. Previously, the company forecasted aggregate full-year revenue growth in a range of 30 percent to 40 percent.

• Kodak now expects 2011 segment losses to be closer to $300 million, which is within the previously forecasted segment loss range of $100 million to $300 million. On a GAAP basis, the company now expects earnings from continuing operations before interest expense, other income (charges), net, and income taxes in the range of a negative $300 million to negative $400 million, reflecting lower earnings and lower gains on asset sales. Previously, the company forecasted GAAP earnings in the range of $50 million to negative $150 million.

• Kodak is now targeting a 2011 loss from continuing operations in the range of $400 million to $600 million. Previously, the company forecasted a loss in the range of $200 million to $400 million.

• The company now expects a year-end cash balance of $1.3 billion to $1.4 billion, excluding the proceeds of any sale of its digital imaging patent portfolios. Previously, the company forecasted a year-end cash balance of $1.6 billion to $1.7 billion. The company continues to expect $250 million to $350 million in cash this year from intellectual property licensing transactions. The company now expects proceeds from sales of non-core assets to be approximately $200 million.

The outlook detailed above reflects, on the revenue and earnings side, the impact of slowing economic momentum globally; the strategic decision to trade digital camera revenue for improved profitability; lower demand than previously forecasted for digital plates; lower growth, in the aggregate, for the four digital growth businesses; and higher than planned start-up costs for the Prosper press platform. The updated cash outlook excludes the proceeds of any sale of the company’s digital imaging patent portfolios, as well as lower than planned earnings and the delay in the timing of proceeds from asset sales.

Source: Kodak.

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