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Executives

Ann McCorvey - Investor Relations

Antonio M. Perez - Chairman of the Board, Chief Executive Officer

Frank S. Sklarsky - Chief Financial Officer, Executive Vice President

Analysts

Shannon Cross - Cross Research

Chris Whitmore - Deutsche Bank

Ananda Baruah - Brean Murray, Carret & Co.

Richard Gardner - Citigroup

Ulysses Janice - Buckman & Reed

Arun Sashandry - Credit Suisse

Eastman Kodak Company (EK) Q2 2009 Earnings Call July 30, 2009 11:00 AM ET

Operator

Good morning and afternoon, ladies and gentlemen and thank you for standing by. Welcome to the Eastman Kodak Company second quarter 2009 sales and earnings conference call. (Operator Instructions) At this time, I would like to turn the presentation over to the Director of Investor Relations, Ann McCorvey. Please go ahead, Madam.

Ann McCorvey

Good morning and welcome to our discussion of the second quarter sales and earnings. I am here this morning with Antonio M. Perez, Kodak’s Chairman and CEO, as well as Chief Financial Officer Frank Sklarsky. Antonio will begin this morning with his observations on the quarter and then Frank will provide a review of the quarterly financial performance.

As usual, before we get started I have some housekeeping activities to complete. Certain statements during this conference call may be forward-looking in nature or forward-looking statements as defined in the United States Private Securities Litigation Act of 1995.

For example, references to the company’s expectations regarding the following are forward-looking statements: revenue, revenue growth, earnings, profitability, margins, cash, cash generation, working capital, increased demand for company’s products, including commercial printing products, digital cameras, and devices and entertainment imaging film; new product introductions, potential revenue, cash and earnings from intellectual property licensing, growth in the company’s core investment business; the company’s ability to address the impact of the economic downturn, including the transformation of certain of its businesses; its employment reduction and cost savings under its restructuring program; contingencies such as litigation, liquidity, debt, commodity pricing, and benefit costs.

These forward-looking statements are subject to a number of important risk factors and uncertainties which are fully enumerated in our press release issued this morning. Listeners are advised to read these important cautionary statements in their entirety as any forward-looking statement needs to be evaluated in light of these important factors and uncertainties.

Now I’ll turn the call over to Antonio Perez.

Antonio M. Perez

Thank you, Ann and welcome, everyone to our second quarter sales and earnings call. While our second quarter results continue to reflect the impact of the global recession, they also demonstrate that the actions we outlined in February to optimize our product portfolio were the correct ones to enable Kodak to weather this very challenging economic environment.

There was a high level of uncertainty in the economy when we developed our 2009 plan. During the first half we took actions to address several headwinds including weak consumer discretionary spend, inventory overhang, tight credit markets and reduced inventories at retailers and distributors of commercial products.

By acting decisively and aggressively, we have been able to manage our way through these issues and our strategy remains on track. We will continue to monitor our assumptions and adjust our plans as the economy changes.

Our cash generating businesses, PrePress Solutions, Document Imaging, Digital Capture and Devices, Retail Systems Solutions and Entertainment Imaging have made significant changes to their cost structure and we expect them to deliver meaningful year-over-year earnings improvement. We continue to maintain our leading market share position for key products in these businesses and in line with the typical seasonality, expect more than 60% of 2009’s revenue in the second half.

As for our Core Investments, I am very happy with the continued market success of our consumer inkjet systems and the commercialization of our Stream inkjet technology under the KODAK PROSPER brand.

The beta sites for our KODAK PROSPER S10 Imprinting Systems are turning into sales and the KODAK PROSPER COLOR XL Press sales funnel is growing. Print industry analysts recently visited our Dayton site to review Kodak’s digital printing technologies and they were impressed with what they saw. In fact, when commenting on our new PROSPER presses, an analyst from Info Trends noted: it is clear that Kodak has put together a compelling and very possibly market-changing system.

I am glad to see that as the industry reviews this technology they agree with what we said at Drupa, this technology is a game changer. It is comforting to see the external excitement building for a technology that we will aggressively bring to market.

The story for Consumer Inkjet Systems continues to be one of market place success and financial improvement. Consumer inkjet printer and ink revenues grew 44% compared to the second quarter of 2008, significantly outpacing a market that was declining.

From a long-term earnings perspective we are achieving our three key objectives: building an installed base, continuing to grow ink revenue in total and as a percentage of revenue, and continuing to reduce product cost. Our Core Investments are on the right track and we expect continued growth as the year progresses.

For those businesses in transformation, we achieved significant year-over-year earnings improvement during a period in which revenues were declining.

I am particularly pleased with the year-over-year earnings improvement of Traditional Photofinishing and Electrophotographic Printing Solutions.

Traditional Photofinishing continues to make progress on creating a more variable cost model and is gaining momentum with customers. We expect Traditional Photofinishing to maintain the profitability it achieved in the second quarter for the remainder of the year and to generate positive cash flow for the year.

For our commercial printing customers, Kodak continues to focus on delivering solutions to help them improve productivity and differentiate their offerings.

Earlier this year we introduced the Kodak NEXPRESS Intelligent Dimensional Printing, which creates raised or 3D-image-effect printed output with a dimensional feel that mimics the surface of the items in the image. This raised image grabs the readers’ attention and helps the communication stand out in a crowded marketplace. Kodak Dimensional printing is the only inline digital, tactile printing available in the market and has promising growth potential.

At Print09 in September, our Electrophotographic Printing business team will introduce the KODAK NEXPRESS SE3600 Digital Production Color Press, the first device in the company’s new SE platform. The SE3600 will deliver unmatched productivity and image quality for applications such as direct mail, marketing collateral, catalogs, publications, and photo books. Also to be introduced at the show for direct mail applications will be the KODAK DIGIMASTER EX300, the fastest cut sheet black-and-white electrophotographic printing solution in the market.

Of course, all of our workflow and other products, along with the PROSPER Press Platform based on our Stream Inkjet Technology, will be prominently featured as well at the show.

Overall, for the total company, the second quarter and the first half year-over-year revenue decline of 29% was within our planning assumption range. During the second quarter, we began to see some positive indicators; stronger demand for digital plates in June; an increase in the number of quotation requests for commercial printing equipment; more optimism from retailers than we expected for the holiday season plan-a-gram; a significant increase in the demand for Retail Systems Solutions’ Kiosk media in Europe and new account wins for Document Imaging.

Now let’s talk about the second half -- in the second half of the year, we are anticipating improvement in the demand for Entertainment Imaging origination film. The signing of the Screen Actor’s Guild Contract and the first half growth in Global Box office receipts indicates that the Motion Picture industry continues to be healthy and validates the assumption that the second half demand for origination film will increase. We expect FPEG to end the year within the forecasted revenue range.

For the digital businesses, based on a normal seasonality in our negotiations with retailers, CDG is expecting modest improvement in consumer discretionary spend in the second half of 2009. We are also planning to complete the anticipated intellectual property licensing deals to achieve CDG’s target growth range. We expect commercial print demand to continue to stabilize and improve as the year progresses. Combined, we expect the digital businesses will return to low single digit revenue growth in the second half.

The earnings outlook correlates to our revenue outlook. Achievement of our earnings range is dependent upon improved margins in digital camera and devices, which will be driven by new product launches into what we believe will be a more receptive market now that we and the industry have largely corrected first half inventory overhang.

We also expect margin improvement within PrePress Solutions due to higher volume demand and improved commodity cost position and as I said before we are planning to complete the IP licensing deals.

Delivering positive cash flow before restructuring continues to be one of our top priorities for 2009. To achieve this cash goal, we continue to focus on working capital improvements as well as delivering the earnings I already discussed. We expect to end the year with a solid cash balance and a manageable debt level.

Now I will turn it to Frank to discuss more details on the second quarter.

Frank S. Sklarsky

Thanks, Antonio and good morning, everyone. I would like to spend a few minutes discussing our second quarter financial results and then Antonio and I will be happy to take your questions.

As Antonio indicated, during the second quarter, the company’s financial results continued to be impacted by global economic conditions. Despite the current economic weakness, there is clear evidence that the company is taking the right actions that will allow us to exit the recession with a significantly more streamlined operating structure and an improved and updated product portfolio. We continue to experience market success with our line of consumer inkjet products and there is growing enthusiasm for our new PROSPER platform based on Kodak’s innovative Stream inkjet print technology.

In addition, the company continued to substantially lower its structural cost in the second quarter. SG&A costs have been dramatically reduced and R&D spend has been honed and focused on those areas we believe to be most important to our future prosperity. We also continued to make progress in optimizing the performance of our businesses that are in transformation, both on the digital and traditional side.

These cost and transformational actions, while difficult, have been essential in enabling us to weather the current economic environment and will provide us with far better operating leverage once the economy improves.

Turning to our second quarter results, as we previously projected, our second quarter and first half revenue and earnings are lower as compared to the prior year due to the continued contraction in discretionary consumer spend and weak global print demand. This compares to the prior year, before the recession took hold, when we were growing our digital businesses at double-digit rates. Consolidated revenues for the quarter declined 29% to $1.766 billion. Foreign exchange represented five percentage points of the decline versus the prior year.

In the quarter, the company’s gross profit margin was 18.5% versus 23.6% last year. The decrease in gross profit margin was largely attributable to unfavorable price/mix across most product categories, lower intellectual property licensing revenues and unfavorable foreign exchange. These factors were partially offset by the favorable impact of improved consumer inkjet profitability driven by a lower cost platform, the benefit of higher shipments spread across our shared cost base, and the increase in the installed printer base, yielding a significant increase in ink cartridge revenue.

There were also significant manufacturing cost improvements in traditional photofinishing resulting in greatly improved profitability in that business. Additionally, stabilization of silver and aluminum prices at lower levels versus the prior year contributed about $16 million of earnings favorability during the quarter.

As I indicated earlier, our second quarter results reflect the company’s continued efforts to align its cost structure with external economic realities. SG&A costs decreased by $114 million, or 26% in the second quarter, and $192 million, or 23% year-to-date. In addition, the company has intensely focused its R&D spend on core investment categories key to our future success, and we have benefited from reductions enabled by platform introductions in certain product lines, including consumer inkjet. This allowed us to reduce total R&D spend by $51 million, or 38% in the second quarter versus the prior year and $80 million or 30% year to date.

Regarding restructuring, we incurred $46 million in restructuring charges for the second quarter and $162 million year-to-date. The company made restructuring-related payments from corporate cash of $55 million in the quarter and $103 million year-to-date.

The company eliminated approximately 550 positions during the quarter, bringing total reductions to approximately 2,100 positions to date as part of the 2009 cost reduction program. When combined with the actions from the fourth quarter of 2008, total reductions to date are approximately 3,700. We previously communicated total company reductions for the combined period of 3,500 to 4,500 positions.

Given our substantial progress on cost reduction, we are confident the company will be able to exceed its cost savings targets this year, which will provide substantial operating leverage as we enter 2010.

Second quarter GAAP loss from continuing operations was $191 million or $0.71 per share, reflecting the significant year-over-year impact on revenue, gross profit and earnings due to the difficult economic environment. The quarter was also impacted by higher restructuring costs, various non-cash adjustments for tax related items, and lower interest income due to lower cash balances and interest rates. These factors were partially offset by the substantial reductions in SG&A and more focused R&D spending, as previously described.

Now let’s take a look at results by segment. Graphic Communications Group’s revenue was $670 million for the second quarter, as compared to $880 million in the prior year. Foreign exchange negatively impacted revenue by 5 percentage points. We would note that the GCG annuities businesses, including those within Prepress Solutions business, began to see increased demand in June. On the earnings side, GCG posted a $28 million loss in the second quarter, as compared to a $13 million profit in the year ago quarter. The revenue and earnings decline primarily reflects continued industry weakness in commercial print demand which resulted in volume declines in Prepress and associated workflow software, along with lower equipment sales across the segment. Unfavorable foreign exchange impacted GCG gross margins for the quarter by approximately 1 percentage point. These factors were partially offset by cost reductions in SG&A and more focused R&D spend.

Taking a look at the Consumer Digital Imaging Group, CDG revenue was $503 million in the current year quarter as compared to $756 million in the prior year quarter. Foreign exchange negatively impacted revenue by 5 percentage points. The revenue declines were also largely due to lower volumes and negative price mix for digital cameras & digital picture frames and lower intellectual property licensing revenues. Segment loss from operations was $99 million versus a loss of $49 million in the prior year quarter. Unfavorable foreign exchange impacted gross margins for the quarter by just over 5 percentage points.

Excluding the impact of intellectual property licensing revenues in each year’s second quarter, CDG’s earnings performance was essentially in line with the prior year quarter. Significant cost improvements in digital cameras and shifting to the lower cost platform for Consumer Inkjet printers, along with reduced SG&A and R&D costs helped to mitigate the impact of the volume declines and price mix effects across most product lines.

During the first half of the year the company has also been successful in reducing inventory of digital cameras and devices which will enable us to improve price mix and margins as we continue to introduce newer, more profitable products.

As we messaged last quarter, the decline in intellectual property licensing revenue, which was largely in our plan, is primarily related to arrangements where our obligations were fulfilled as of the end of 2008. Intellectual property licensing revenue and earnings have been very much in line with our plan for the quarter and year-to-date. We continue to forecast an average of at least $250 million to $350 million in IP revenue for 2009 and the next few years.

With respect to FPEG, revenue declined by 30% to $593 million when compared to the prior year quarter. Foreign exchange negatively impacted revenue by 6 percentage points. This reduction in revenue was reflective of the industry wide volume declines in Film Capture and Traditional Photofinishing along with volume declines in Entertainment Imaging related to credit availability for independent filmmakers and the impact from the previously unsettled labor issue associated with the Screen Actors Guild, which has now been resolved.

FPEG posted $51 million in earnings from operations, roughly in line with the $54 million in earnings in the year ago quarter despite large volume declines and unfavorable foreign exchange across all businesses within FPEG, and negative price mix within Entertainment Imaging. Unfavorable foreign exchange impacted gross margins for the quarter by just under 4 percentage points.

Entertainment Imaging print film volume increased from the prior year quarter, as the global box office remains strong in an otherwise down economy. The headwinds impacting FPEG in the quarter were largely offset by reductions in Other Post Employment Benefits, SG&A, and cost improvements in the Traditional Photofinishing business driven by progress toward an even leaner variable cost model. We are extremely pleased with the major accomplishments this business has made in spite of the significant volume declines.

Now let’s talk for a few minutes about cash, liquidity and our balance sheet. Before I move onto cash, I want to reference an item noted in our public filings related to a decline in our Other Long Term Assets account on the balance sheet. This decline, from approximately $1.7 billion at year-end 2008 to approximately $1.2 billion at the end of the second quarter 2009 is due principally to a change in the net over-funded position of our major U.S. pension plan.

This change is associated with the accounting impact caused by a combination of: first half pension portfolio investment returns, which were lower than the actuarial assumption for that period, a change in the value in the liability caused by a decline in our benchmark interest rate used to determine the liability balance, and severance payments out of the plan assets along with normal current service and interest cost. It is important to note that our major U.S. pension plan remains fully funded and we are able to fulfill our benefit obligations as they come due.

Now onto cash -- despite a difficult economic environment and the impact it has had on our operations, the company continues to maintain a significant cash position. The company’s cash and cash equivalents at the end of the second quarter was approximately $1.1 billion and our total debt balance was approximately $1.3 billion. The cash balance is particularly noteworthy given that the period we are exiting has been arguably the most challenging economic and business environment in the company’s history.

The company’s cash generation before restructuring for the second quarter represented a use of $136 million, as compared with prior year usage of $158 million, an improvement of $22 million. The prior year figure excludes the substantial IRS refund received during that period.

Major drivers of second quarter cash usage were lower cash earnings related to factors previously described, seasonal working capital usage, restructuring payments of $55 million and the absence of significant proceeds from asset sales. Cash generated from earnings for the second quarter 2009 was impacted by certain non-cash items within Earnings from Operations including lower depreciation and reduced benefit accruals.

These impacts were offset by cash received from intellectual property licensing arrangements, for which the company recognized earnings in 2008, and a 52% reduction in capital spending, from $71 million in the prior year to $34 million in this year’s second quarter. The company is focusing much of its capital spending on commercial capital and we are pleased that our liquidity position continues to allow us to place equipment with our very important credit worthy retail and commercial digital printing customers.

As we look toward the back half of the year, the pace of economic recovery in the sectors impacting our consumer and commercial businesses remains uncertain. Based on what we do know, we are targeting our second half digital revenue to increase by a percentage in the low single digits and total company revenue to decline by a percentage in the mid single digits. For the full year, this would lead to the total company’s revenue declining within the previously communicated range of 12% to 18%.

With respect to earnings from operations, we continue to have as our goal, a range of $0 to $200 million for the year. Achievement of these goals will be contingent upon seeing modest improvement in economic conditions and business momentum later this year. This applies to our consumer businesses and to the demand for commercial print, particularly during the fourth quarter, which is typically our seasonal peak, and also to the expected recovery in Entertainment Imaging origination film. Based upon what we are seeing, along with signals from our customers, we do have reason for cautious optimism, but of course conditions can change and we will adjust our plans accordingly. Along with our revenue and earnings targets, achievement of our cash goals is also contingent upon our anticipated completion of intellectual property licensing arrangements, along with improvement in working capital in the back half of the year. We will continue to pursue the sale of selected assets and we will do so in a way that maximizes economic value to our shareholders. Overall, as we stated in February, our goal continues to be achieving positive cash flow before restructuring for the year.

In summary, our businesses are showing signs of stabilizing. We are a global company and there is still a high degree of uncertainty in the global economic environment. As a result, we are reducing our structural cost, focusing our continued investment on those areas core to our future prosperity and we are implementing all of the vital operational and transformational changes required to make progress towards our target business model. We will continue to focus on the things under our control and operate with strict financial discipline in order to drive the company toward sustainable, profitable growth once the economy recovers. And we have a great team dedicated to doing just that.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will come from the line of Shannon Cross with Cross Research. Please go ahead.

Shannon Cross - Cross Research

Thank you very much for taking my questions. The first one I have is just Frank, can you talk a little bit about the sustainability of the cost reduction, how we should think about how much of the cost down, like $91 million, for instance, for R&D is sort of a base level to go with, how we should think about what you’ve done in terms of [hurdles] and other things that might rebound and theoretically the economy improves -- just any color you can give on that, and I have a couple of follow-ups.

Frank S. Sklarsky

Sure. I think that the cost reductions are sustainable and we really are targeting toward that business model that we showed in February, so if you look out into the next few years, having that model that gets us between 14% and 15% of SG&A long-term and 5% to 6% of R&D long-term obviously dependent upon what happens to the top line, we think that’s sustainable.

We still have a little bit more to go this year, although a good portion of that is done. But we really have reduced the structural cost of the company and a lot of that has to do with where we are focusing our investments, where we are focusing our time, and the level of complexity. So it goes to legal entity structuring, it goes to SKUs, it goes to streamlining the supply chain. So if you look across the organization, whether it’s COGS, SG&A, and R&D, it’s really a matter of focus and discipline and driving simplicity and on that basis, we really think it’s sustainable.

Shannon Cross - Cross Research

Okay, great and then Antonio, can you talk a little bit about linearity in the quarter? I think -- Frank, I think you mentioned somewhere in your comments about some improvement in GCG in June but I don’t know, Antonio, can you talk about what you saw as you exited the quarter and then what you are hearing from your retail partners in terms of how they are looking at back to school and Christmas and inventory levels?

Antonio M. Perez

Let me start with the retailers. The retailers, as you know, they are making deals for the planograms. They already made most of their deals for their planograms for the big season and based on those deals that we know we have and based on the attitude that they have and the plans that they have, which obviously are based on their own information about the traffic in the stores, those are positive signs. We were happily surprised with the type of deals that we were able to make and not only the margins, the numbers all those things, which were better than we thought because we didn’t have a very optimistic view of the second half of the year. We knew it was going to be hopefully slightly better than the first. We knew the first was going to be disaster but that was a confirmation that that’s -- that could certainly happen.

Now, we have to see what happens in back-to-school. I think that will be the first real data of what the mood of the households is as far as spending money. But so far, so good.

And it’s been -- you know, starting in May, June we’ve been seeing those things. In the commercial space, it was a clear change starting May and June for the request for quotations and as well increased orders for digital plates, so there is -- and you know, remember that all of those distributors, they actually didn’t -- they’ve been cutting inventory for the first six months, as well as the retailer, so the inventory in the channel is pretty light now. So any improvement that may happen, if it continues the way that we’ve seen it in the last two months, it will go straight into sales.

Shannon Cross - Cross Research

Okay, great and then one final question, just on IP -- I know you expecting hopefully a settlement of the outstanding issues with the two companies, you know, second half of the year, but as we go forward and we look at 2010, you’ll have I assume Nokia, Motorola, Samsung, LG -- you know, a lot of the big guys should be done and paying something. How should we sort of think about IP going forward? I mean, are there other big deals you can sign or is this now where you are going to be sort of dependent on unit volumes that your partners are producing?

Antonio M. Perez

The funnel is not small -- the funnel is large and I won't comment on what companies or what industries and what IP but we do have a very powerful IP portfolio. I know that you heard me saying this now for so many years but we do have that portfolio and we are trying to monetize the portfolio with deals with a variety of companies in several segments of this industry.

So first the list that you were mentioning, that’s not complete, by no means. They are all players there that we are talking to and there are other areas as well, and obviously this is very confidential and we don’t want to share with anybody but it is -- but what we do say is based on our portfolio of IP, based on the funnel of deals that we can envision for the period over the next four years, we have kept that guidance that we gave of at least 250 to 350 every year and we have been executing that extremely well and I don’t have any reason to believe that that’s not going to be the same for the next period of four years.

Shannon Cross - Cross Research

Okay. Thank you very much.

Operator

Your next question comes from the line of Chris Whitmore with Deutsche Bank.

Chris Whitmore - Deutsche Bank

Thanks very much. I’m curious to understand your comments earlier about being on track for the year strategically in terms of cash flow, and can you reconcile that with the shelf filing you made earlier today? Why file a shelf if you are on track?

Frank S. Sklarsky

The shelf registration is really in the category of general housekeeping. The new rules basically cause the expiration of these standard shelf registrations every three years. Ours expired in December. We concentrated most of our efforts in the first quarter on getting through the new revolving credit agreement, and so we just got this new shelf in place in the second quarter and it tends to be more convenient administratively to get that done concurrent with earnings release, so I wouldn’t read anything into that. It’s for an indeterminate amount. It covers all different kinds of debt and equity securities, would not read anything into that other than wanting to have one in place just like the vast majority of other companies have one in place.

Chris Whitmore - Deutsche Bank

Can you comment on your outlook for the put coming due next fall? How are you positioned to pay that? Are you anticipating to re-finance that or pay that out of cash?

Frank S. Sklarsky

We are -- first of all, we are anticipating that based on current share prices, market conditions, that that instrument will be put to us and we believe based on all of our projections that we will have ample liquidity to pay that off. There are obviously other options that we could pursue in addressing that and I guess we are pretty pleased that the credit markets have thawed significantly over the past few months, so that opens up a variety of options. But our intention is right now the default, the base case is to pay that off.

Chris Whitmore - Deutsche Bank

Your cash flow guidance for the year implies about an $800 mm to $1 billion release of cash -- can you comment on maybe the top two or three drivers of that improved cash flow?

Frank S. Sklarsky

Well, we always have -- really, the vast majority or virtually all of our cash flow generated in the back half of the year. If you recall back in the fourth quarter of 2008, we generated about $500 million of cash flow, only a minority portion of which was IP licensing and that was a quarter which was probably the most difficult in our history.

So we expect again, based on our seasonality, to generate a significant amount of cash flow in the back half, particularly in the fourth quarter as well as a significant portion by the successful completion of our licensing agreements before the end of the year.

And in addition to that, we also have an improvement based on working capital and we continue to very tightly manage receivables, inventories, and we’ve moved our accounts payable to be in line with our peer group in terms of payment terms, so those are really the factors driving it but we’ve had a number of years where we’ve generated that amount or more in the back half of the year.

Antonio M. Perez

Well, don’t forget our earnings expectation, our gross margins, we expect those gross margins to be high in the second half of the year for the reasons that we described in the call. Up until now in the consumer space, we couldn’t introduce any new products because there was so much in the channel. We just announced a few days ago a barrage of new products, all those new products come with higher margins than the one we’ve been selling in the first six months, for obvious reasons. New platforms, better productivity and as well, there’s no discounting of the extra inventory.

And then in the commercial space, a slightly higher volume that we expect for plates, for instance, it will be as well compounded positively by the fact that we have lower commodity costs that we’ve been suffering with because of the hedges that we had last year.

So you have to put all those things together.

Chris Whitmore - Deutsche Bank

How significant is the IP income expectation in the second half versus the first half? Or maybe another way, how much IP income have you realized year-to-date?

Antonio M. Perez

We keep -- our only guidance and I know that most of you would like more guidance than this but it is the best thing for us, given the complexity of these deals year over year is that we will stay with the guidance that we gave. We know, we believe we will make at last 250 to 350 for the year.

Frank S. Sklarsky

What we can say is there were no significant non-recurring deals in the first half of the year, number one, and number two if you go through the 10-Q and you look at [inaudible] receivables disclosures and liquidity disclosures, we did say that we did receive some cash in the first quarter associated with deals that we closed in 2008.

Chris Whitmore - Deutsche Bank

Okay. Last one for me is on asset sales -- any color you can provide on progress on selling assets and expectations around that -- updated expectations around the $150 million you expect to realize? Thanks.

Antonio M. Perez

It’s a bad time to sell anything. We do -- we keep looking but we have decided with the board that we are not going to sell those assets under pressure for the wrong price, so we will continue to look. I can tell you right now if we will execute those sales or not but we keep looking. But we will not sell if we don’t think the price is the appropriate thing.

Operator

Your next question comes from the line of Ananda Baruah with Brean Murray.

Ananda Baruah - Brean Murray, Carret & Co.

Thanks for taking the questions. I guess just sort of a general one about the business model, the margins, operating margins all in came in a little bit better than I had been modeling. I’m interested in getting your take on how you guys did relative to your internal plan for the quarter.

Frank S. Sklarsky

Sure, I’ll take that. I think there were really no major surprises consistent with the remarks that we made on the call, and I think what we saw is if you look at the sequentials from Q1 to Q2, we had some up-lift in some certain areas. DC&D was one of them where we had a significant revenue increase, which is typical from a seasonal basis and that contributed a pretty good chunk and that excludes IP licensing, so cameras based on a lower cost in that business at the gross margin line, as well as improved volume drove that.

In the RSS business, a continued improved mix of media as a proportion of the total, as well as a sequential improvement of almost 75%. When you look at consumer inkjet, the combination of the lower cost platform, a higher proportion of ink as the total, that contributed. Pre-press even on a sequential basis improved because revenue was up in the teens, a percent, and we are getting better absorption because a lot of that obviously is our own manufacturing, as well as a little help versus the prior year on commodities and also the benefits of complexity reduction, SKU reduction.

And then the other two in the traditional business, PNOS benefiting greatly from cost, structural cost as well as a little help from silver, and volume increased sequentially. And then film capture, same thing -- over 50% improvement sequential on revenue for film, consumer film capture and then significant additional cost reductions and a little benefit from silver there. So we’re seeing it as we went from first to second quarter, we saw some improvements and we’ll continue to see improvements as we go through the year.

Antonio M. Perez

There wasn’t one key driver. It was a lot of little things that are getting better either because of the structure changes we made or because the market is slightly better than in the first quarter and in the second quarter, but there was nothing -- there was no one single driver that you could point to.

Ananda Baruah - Brean Murray, Carret & Co.

Okay, yeah, that’s helpful. Thanks on the sequential comments. And I guess Frank, just on commodities and the impact to expect in the second half of the year, I mean, just in reading the comments in the Q it sounded like, and you know, hearing your comments on the call and afterwards, it sounds like well at least relative to what I was expecting a little bit better, a little bit more of a benefit in the second quarter than I was originally anticipating. Is that sort of what you guys saw as well? Because I know you have in effect, I guess, lack of a better term, negative hedges at this point. Are those wearing off more quickly than you originally anticipated?

Frank S. Sklarsky

I wouldn’t say that it’s going more quickly than we anticipated on that particular factor. What I would say is we got a fairly stable environment right now on silver, as you can see, and so we got some benefit from that versus the prior year. We had extreme volatility and very high prices in the first half of last year, so we did some hedging but we also have an amount that’s not hedged in silver and we benefited from that net price position versus the prior year and we can’t predict the future but it’s been a relatively stable market for silver.

When it comes to aluminum, yes, I mean, we hedged at various points last year when we had extreme volatility. Prices were headed up and then they headed down very precipitously. As things roll off and a high proportion of our usage is at the spot rate, particularly as we get very late into the year and into next year, we’ll continue to benefit from the net cost of aluminum.

Ananda Baruah - Brean Murray, Carret & Co.

Okay, great. And then I guess maybe just the last one -- the impact I guess of the Screen Actors Guild strike ending, timing wise, how should we think about the ability of that to positively impact the P&L? Is that something that immediately gets turned on or is there sort of -- I don’t know if it’s a month or two months or a quarter, whatever -- you know, that they need to sort of get things up and running again, and then you’ll sort of see things flow through the P&L ratably over time.

Antonio M. Perez

It is -- can’t give you a date. It is certainly a few months for new movies to start and the whole process to begin but it will happen during the second half and it may happen more towards the end but it will happen in the second half.

Ananda Baruah - Brean Murray, Carret & Co.

And then -- sorry.

Antonio M. Perez

We believe that they haven’t been producing the same number of new movies that they have been doing in the past and since the box office is working very well, I think there’s going to be an inclination in the industry to go back and produce new movies, otherwise they won't have new movies.

Ananda Baruah - Brean Murray, Carret & Co.

Thanks, Antonio and I guess if I can follow-up on that with you -- just order of magnitude, do you think that it’s been the economy that’s had a bigger impact on entertainment film or is it really -- has it been the strike?

Antonio M. Perez

I think the economy has affected mostly the independents because they couldn’t get access to the finance that they need to do their movie, so that was clearly what happened. And then you have to put on top that even the studios, they wouldn’t go ahead and start productions because of the pending strike, so you have to combine both.

Ananda Baruah - Brean Murray, Carret & Co.

Okay, thanks.

Operator

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

Richard Gardner - Citigroup

Thank you very much. A couple of questions, if I could -- first of all, Frank, you were willing to tell us what the impact on earnings was year over year from declines in commodity prices. As I take a look at silver and aluminum prices, it looks like they are going to be down less year over year in the third quarter than they were in the second quarter but then offsetting that, I suspect that more of your hedges are going to be coming off. Would you be willing to help us out with roughly what the impact is going to be on earnings year over year, assuming current spot prices and given what you know about your hedges?

Frank S. Sklarsky

I am hesitant to give forward-looking guidance on that specific category but I think the way you are thinking about it is correct, is that sequentially there’s not going to be much change in the price of silver and as we go through the back half of the year, the changes versus the prior year will be more minimal if we stay at current spot rates. So if our hedges and the current spot rate are roughly in line with each other as we go through time and the market stays relatively stable, you will see less and less of a benefit from silver and less of a penalty, conversely.

On the aluminum side, we expect to see more substantial improvements in the net cost of silver -- aluminum, sorry, aluminum much later in the year and into 2010 when some of the hedges that were put in place in 2008 during a period of high volatility were put in place. But I wouldn’t want to quantify that right now because even looking at aluminum on a day-to-day basis, there’s still some volatility there.

And the other thing I would mention too is that we will -- oil, while it’s been a bit volatile over the past few days, has an impact on our transportation costs, on our plant operating costs, and also anything that’s resin based. It’s at a substantially lower level than the prior year and if it continues to trade within the ranges that it has been, we’ll be in a better shape than we were in the first half of last year.

Richard Gardner - Citigroup

Okay. So we should expect more benefit from aluminum hedges coming off and also it looks like aluminum prices are down a lot more on a year-over-year basis than --

Frank S. Sklarsky

Later in the year though I think is where you will see more of the benefit -- not as much in the third quarter but more later in the year and into 2010.

Richard Gardner - Citigroup

Okay. And then turning to the electrophotographic business, Antonio, you sounded a little more upbeat on that business in your commentary than I’ve heard you in recent history and you’ve obviously talked about that being one of the businesses where you needed to make some changes or pursue partnerships or do something. Has the business improved to such an extent or are you optimistic enough about the new products coming in September that you are no longer looking to make some strategic change in that business?

Antonio M. Perez

Yeah, I mean, first I am always upbeat about all of my businesses but yeah, that business has to go through transformation and they’ve done a marvelous job in a very short period of time. What we’ve done is -- I mean, the business had ambitious plans to create a very large portfolio. What we have done, what the business has done is refocus all of their resources in the part of the portfolio where we are the strongest, which is the high-volume printing -- high-volume, high quality color printing. And in the very high speed black-and-white. And they just concentrated on those and they have done a marvelous job in the last six months and it is very exciting how they have improved year-over-year their earnings significantly but while they are doing that, they came with a barrage of new products that I think show a lot of potential.

So yes, I am much more optimistic than I was in the third quarter last year when we saw what was coming to us and we had plans that did not line up with the marketplace. But yeah, I am very pleased with that.

Richard Gardner - Citigroup

Can we take that off the list of businesses that needs to be transformed now, Antonio? And then secondarily, can --

Antonio M. Perez

-- in February, you know, when we go back next year I think we will give you -- when we talk to you in February next year, we will tell you what we’ve done with each one of those and I am sure some of those will come out of that list and some of us will have some other solutions for them.

Richard Gardner - Citigroup

Okay, and then just one final one for me -- would you be willing to give us your view on what the magnitude of declines in page volumes has been within your installed base of digital press equipment?

Antonio M. Perez

I don’t have that data with me but -- do you have the data?

Richard Gardner - Citigroup

Many of your competitors are saying double-digits. I’m just curious if you think that it’s been that severe.

Antonio M. Perez

The color NexPress printing volumes, they went up 11%.

Richard Gardner - Citigroup

Okay.

Antonio M. Perez

Up 11%.

Richard Gardner - Citigroup

Great. Thank you.

Operator

Your next question comes from the line of Ulysses Janice with Buckman & Reed.

Ulysses Janice - Buckman & Reed

Two questions on some neglected areas -- the gallery, Kodak Gallery -- you announced the program where you are trying to monetize some of the -- of us who have had pictures stored in your gallery. Last time if my memory serves me right you were at 75 million. How many accounts did you lose because of this charge now?

Antonio M. Perez

It wasn’t significant. The majority of the people that uses the gallery, they do something with it. We didn’t think it was fair for them or for anybody else, including us, to have it just as a free storage place, so we communicated that. That’s our responsibility to do something with those assets for our shareholders and I think it came fine. It went out very well.

You know, some customers left. We didn’t lose anything by losing those customers. You know, you have to realize that those customers that we lose, they were not real customers. They were just users of the storage but the majority of the customers, since they were not affected because they were doing something, at least they were doing their Christmas cards or some -- you know, some photo book here and there, so they were not affected. So not an issue.

Ulysses Janice - Buckman & Reed

On another subject, CMOS, I saw your new video camera you announced. It’s using a 5-megapixel CMOS. I assume it’s your CMOS.

Antonio M. Perez

No, it’s not ours, no. It’s not ours.

Ulysses Janice - Buckman & Reed

Not yours?

Antonio M. Perez

No.

Ulysses Janice - Buckman & Reed

How is that project going?

Antonio M. Perez

CMOS is one of the businesses that is in transformation. If you look at the industry, you know the industry is under distress, as you know. If you look at the comments of the large users, such as Nokia, you know, Motorola, Samsung and all the others, they all predict significant declines for next year so it is a tough time to make investments in the business, you know, whose projection is pretty poor for the next few years. So we are still looking for what is the best alternative for the shareholders as far as monetizing those assets.

Ulysses Janice - Buckman & Reed

As far as the commercial inkjet is concerned, what percentage of your revenue at this stage is ink compared to hardware? Is it anywhere close to 40% for ink?

Antonio M. Perez

Well, the mathematics work different in that business model than in the consumer inkjet, remember. In commercial inkjet --

Ulysses Janice - Buckman & Reed

No, no, I’m sorry -- I got confused. I meant consumer inkjet.

Antonio M. Perez

Consumer inkjet, okay. No, it’s not 40%. If we were at 40%, we would be basically breaking even at this point in time. It’s not -- but it’s growing very rapidly. We still have an average of about eight cartridges per user, which is extraordinary and I can’t tell you how happy I am. I’ve never seen that in my whole life. We are obviously doing something well with the customers that buy our printers, they use so many cartridges. Obviously they like the printer but they like the price, which is the whole idea behind this model.

It is growing rapidly, the revenue that comes from ink, but you won't see it growing as rapidly maybe because we are growing the number of printers very rapidly too, so since we are still growing the installed base rapidly, even though more and more of the revenue comes from ink, you won't see the exponential change because we are still in a phase where we are growing very rapidly the number of printers. As I said, you know, we are really over-performing in a market that was declining, so we are very pleased with the plan.

We are very much on track and I would say even better than track but obviously I won't say it because I have to wait for the third and the fourth quarter, where the majority of the volume will come but if it was up until now for the first two quarters, I would say we are better than plan but we’ll see what happens in the third and the fourth quarter. We are very optimistic but we have to wait and see.

Ulysses Janice - Buckman & Reed

So it sounds like you are reiterating your estimate that you will be -- printers that are in use will increase, will double from the 1,050,000 that you had last year?

Antonio M. Perez

Yes, sir, yes, sir.

Ulysses Janice - Buckman & Reed

Which means you will ship more than a million units this year.

Antonio M. Perez

Very good math, yes.

Ulysses Janice - Buckman & Reed

Thank you, sir.

Antonio M. Perez

Absolutely.

Operator

Your next question comes from the line of [Arun Sashandry] with Credit Suisse.

Arun Sashandry - Credit Suisse

Thanks for taking my question. I just have a couple of clarifications -- to start off on your cash, your revised cash flow guidance for the year indicates that you will probably be at somewhere between $1.9 billion and $2 billion of cash balance by year-end. How sensitive is that to earnings in the fourth quarter? I mean, if earnings are flat year over year this year in the fourth quarter versus last year, do you still feel comfortable you can get close to that target range of $1.9 billion to $2 billion?

Frank S. Sklarsky

If you look where we were, $1.1 billion at the end of the second quarter and we were to get positive cash generation before restructuring, it would say -- you’re right. We’d have to generate, you know, some $800 million but we do have a $50 million debt payment that normally comes due in September which we intend to pay, so you could sort of say more closer to $1.8 billion.

But as we did say, it is predicated upon having a modest improvement in the economic environment and consequently our revenue and earnings in the fourth quarter, which is our seasonal peak. So we need to get that and have the successful completion of the IP and have some improvement in working capital. And the working capital one is important because you refill and replenish the accrual bucket for accounts payable as economic activity continues, and that has an impact on the cash flow statement. So having that momentum in the fourth quarter and a forward-looking optimism into the first quarter has really the biggest impact, along with the IP, in achieving that target.

Antonio M. Perez

The only reference that we can give you is last year’s fourth quarter, in a terrible environment, we generated $500 million. That will not be enough for this year, obviously but at the same time, we don’t expect to have the same environment that we had in the last quarter -- I mean, last year’s fourth quarter.

Arun Sashandry - Credit Suisse

Okay. I mean, I guess -- let me just ask it a different way. I guess normally in terms of where the cash generation from working capital comes from, roughly $200 million in the back half comes from AR inventory declines, typically, and another couple hundred million from build-up of accounts payable. Obviously given that AR inventory are much lower this year, that’s kind of why I’m sort of trying to understand whether those expectations for working capital, cash generation are predicated on a blow-out fourth quarter or fairly decent fourth quarter on a year-over-year basis.

Antonio M. Perez

A blow-out fourth quarter -- it’s a very modest -- a very modest improvement but again, going back to the variety of things is that this year we are going to have all the new products introduced as we speak for the second half. Normally we don’t have that. We have those coming, some at the end of the first quarter. We couldn’t do it this year because of the inventory. That is going to change the profile of the gross profit of that business favorably towards the back half of the year.

As far as earnings again, the digital plates, digital plates will show improvement -- it’s showing already improvement in volume versus the first five months of the year. That makes a big difference because there is a high fixed cost in that business and obviously that volume makes -- that extra volume makes a huge difference for the results of that business. Together with that and the last question we talked about the effect of aluminum. We are going to have clear positive effect with the cost of aluminum for us in the fourth quarter -- very clear. That is -- if you combine that with higher volumes that we had last year, that makes a big difference for the results of the company.

Then we have the IP -- those three are three huge drivers, since most of the IP this year is coming towards the end of the year and these two large businesses will be favorably affected, according to our plans. You have to put those three things together. That’s how we come up with our forecast.

Operator

Thank you. Management, at this time I would like to turn the conference back to you for any further remarks.

Antonio M. Perez

Thank you very much for attending the call. We appreciate that very much, your interest in the company. A few final thoughts -- our strategy remains on track. We will deliver better results in the second half of the year than the first half. We are sustaining our leading market share positions in our key products and continue to improve our cost structure. There are a number of positive signs for both our consumer and commercial businesses for the second half of the year. We clearly understand what we have to do to achieve our goal and we are going to work very hard to get there. Thank you very much.

Operator

Thank you. Ladies and gentlemen, at this time we will conclude today’s teleconference presentation. We thank you for your participation. At this time, you may now disconnect and please have a pleasant day.

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Source: Eastman Kodak Q2 2009 Earnings Call Transcript
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