Hazy Picture At Polaroid

It still must figure out how to make the transition to digital cameras

Last year, Polaroid Corp. (PRD) finally broke out of its long stupor. In a brilliant stroke, it developed the $25 I-Zone instant camera that produces stamp-size sticker prints and became a runaway hit with the teenybopper crowd. Kids used the tiny pictures to decorate everything from their lockers to their clothes, and adults discovered uses for the sticky pics that Polaroid never imagined, such as affixing photos of their shoes to shoeboxes. The I-Zone quickly became the world's best-selling camera, in terms of units, and helped Polaroid finish in the black for the first time in five years.

But it's now clear that Polaroid is going to need a lot more than the I-Zone to deliver on its long-promised turnaround. With the U.S. economy slowing, the Cambridge (Mass.)-based company announced in October that big retailers did not place their usual flood of holiday orders in September. As a result, Polaroid earned $18 million on sales of $458 million in the third quarter, or 26% lower profits than the Street had expected. Investors hammered the stock, which has plunged to a 15-year low of less than $9 a share.

STAGGERING. Even more critical, however, is the question of Polaroid's next act. The company is moving aggressively to meet the exploding demand for digital cameras, but the returns there are uncertain--no one has yet figured out how to make much money in this intensely competitive market. At the same time, Polaroid is carrying a staggering debt load of $830 million, partly a vestige of the company's struggle to avoid a takeover by Shamrock Holdings Inc. in the late 1980s. Interest payments of $63 million ate up 58% of operating profits through the first nine months of the year. With $61 million in cash on hand as of Sept. 30, the company has little margin for error. "The question is whether they'll be able to carry through with their turnaround, or whether they're dead on the vine," says Brett Barner, manager of the STI Small Cap Growth Fund, one of Polaroid's largest investors.

While readily conceding these are tough days for Polaroid, Chief Executive Gary T. DiCamillo insists that his recovery plan is on track. "Turnarounds take a long time," he says. Having given Polaroid fresh momentum with the I-Zone, he is rolling out cameras that combine digital technology with instant film. That will be followed in a year or two by an all-new print technology he says will be higher quality and cheaper than traditional 35mm prints. "We have as good a chance as anyone" to make it in the digital world, DiCamillo says.

It has been slow going so far. In 1999, Polaroid eked out $9 million in earnings on $1.9 billion in sales. The consensus among analysts is for 2000 earnings to climb 17%, to about $10.5 million, says First Call Corp. Sales are expected to grow slightly, possibly rising to about $2 billion. The company has been considered takeover bait for several years for companies such as Agfa-Gevaert Group or Sony Corp. (SNE) But even as its market cap has shriveled to a mere $375 million--down from $2.4 billion in August, 1997--hopes for a takeover have faded. The disappointing third quarter didn't help. Sales in that period fell 1%, on accelerated erosion of one of its core businesses--peel-apart instant film. Sales of the film fell by about 30%, to roughly $60 million, because the professional photographers who use it are rapidly switching to digital technology, says Ulysses A. Yannas, an analyst at Buckman, Buckman & Reid, a New York brokerage firm.

But DiCamillo insists that the worries about the fall results are misplaced. He says the previously delayed Christmas orders have started to roll in, and digital camera sales are now running ahead of expectations. But he acknowledges that the company's debt load is about $200 million too high. On Nov. 16, he announced the first step in reducing that debt: Polaroid said it plans to vacate and sell an I.M. Pei-designed factory near Boston that analysts estimate is worth more than $100 million.

JUMP-START. DiCamillo knows a tough turnaround when he sees one. He took the helm in 1995 after a highly successful stint as CEO of Black & Decker Corp. (BDK), where he is credited with revitalizing the company's consumer power-tool business by introducing lots of new products. The first outside CEO at Polaroid, DiCamillo says he quickly discovered that the company's problems were worse than he expected. They included a lack of any R&D aimed at improving the company's core product, instant film. He responded with a three-pronged strategy. To cut costs, he slashed the workforce by 27%, from 12,300 to 9,000 workers, and sold unprofitable commercial businesses for more than $50 million. Then he jump-started the effort to find new products in the company's billion-dollar, instant-film operation, which provides more than 90% of the company's profits. Finally, he began moving Polaroid into the digital age. "Not only do we have to rejuvenate our core business," he says, "we also have to adapt to technological change."

Instant photography had been languishing for so long that it was unfamiliar to two generations of customers. The company had been concentrating on developing specialty products such as an imaging film designed to replace X-rays, which turned into a costly bomb. DiCamillo abruptly shifted direction to focus more on the consumer market. He hired a new design team, introduced loads of new products, and revitalized marketing.

The company now introduces about 20 to 25 products a year. Another big hit last year besides the I-Zone was the JoyCam, which produces bigger prints. This Christmas, the company is introducing about a dozen products, including more variations on the I-Zone, digital picture frames that display images downloaded from the Internet, and the Webster, a tiny scanner that makes digital images of I-Zone photos. Retailers are enthusiastic. "This brings the fun back into photography and introduces it to the younger shutterbug," says Shawn Haynes, director of photography sales at Amazon.com Inc.'s (AMZN) Web site, where eight of his recent top 10 sellers were I-Zone or JoyCam products.

Polaroid's prospects in digital photography are less certain. It's a market leader in low-end digital cameras, with its best-seller costing $175. And it is one of the few companies making a profit on them. But its 5% to 10% margins on digital cameras are tiny compared with the 60%-plus margins it makes on instant film. And the field is only growing more crowded, with more than 100 companies fighting it out.

Moreover, as digital cameras proliferate, they suck the life out of Polaroid's older instant-film products. It's only a question of how rapidly these products will fall. Already, instant-camera users are making the transition. Tom Alexander, an agent with DeWolfe Real Estate in Boston, says he now rarely uses his Polaroid: "If you want to advertise on the Internet, it's useful to have a digital camera."

Polaroid's best hope next year is for the I-Zone to stay hot and for new hybrid digital/instant cameras to kick in. That's the reasoning behind Wall Street's projections of further profit growth for the company in 2001. Still, investors have pushed the stock to new lows because of the long-term doubts. "The consumer market for hybrid products is not big," says Edward Y. Lee, a consultant at Lyra Research in Cambridge, Mass.

Count the Polaroid board among the optimists: Last December, 10 months before DiCamillo's contract was set to expire, the board extended his term to the end of 2002. But if he's going to make it that far, he'll have to start mastering a digital transition that has already claimed such CEOs as Eastman Kodak Co.'s (EK) George Fisher. The picture at Polaroid is anything but clear.

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