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Eastman Kodak Company (EK)

Q2 2007 Earnings Call

August 2, 2007 11:00 am ET

Executives

Ann McCorvery - Director, Vice President, Investor Relations

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

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

Analysts

Jay Vleeschhouwer - Merrill Lynch

Carol Sabbagha - Lehman Brothers

Matt Troy - Citigroup

Shannon Cross - Cross Research

Ulysses Yannas - Buckman, Buckman & Reid

Presentation

Operator

Good day, everyone and welcome to the Eastman Kodak second quarter sales and earnings conference call. Today’s conference is being recorded. At this time, for opening remarks and introductions, I would like to turn the conference over to the Director and Vice President of Investor Relations, Ms. Ann McCorvery. Please go ahead, Madam.

Ann McCorvery

Good morning and welcome to our discussion of the second quarter earnings. I am here this morning with Antonio Perez, Kodak’s Chairman and CEO, as well as our 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 Reform Act of 1995. For example, references to the company's expectations for net cash generation, revenue growth, digital revenue, digital revenue growth, digital earnings, digital earnings growth, entertainment imaging film volumes, earnings from operations, unit volume, restructuring, , gross profit margin, target business model and target cost model are forward-looking statements.

These forward-looking statements are subject to a number of important risk factors and uncertainties, which are fully enumerated in our press release 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 certain important factors and uncertainties.

Also, Kodak has significantly reduced its references to non-GAAP measures. In those instances where they are used, they are fully reconciled to the nearest GAAP equivalents in the documentation released this morning, which can also be found on the website.

Now I would like to turn the conference call over to Antonio Perez.

Antonio M. Perez

Thanks, Ann and Good morning everyone. In the quarter, we were essentially on our plan for revenue and ahead of plan for earnings. Our cash usage in the first half was similar to last year and we continue to be committed to delivering full year net cash generation in excess of $100 million after spending about $600 million on restructuring, as we discussed on the first quarter call.

We have made significant progress and now we have a solid first half behind us, giving us confidence that we will achieve our full year key strategic objectives. I am especially pleased by our progress in expanding the breadth of our digital portfolio, as well as our significant progress in improving our supply chain management and platform design efficiencies.

The year-over-year improvement in gross profit margin illustrates that we are on track to achieve our target business model. We are capitalizing effectively on a significantly improved product portfolio, supply chain and go-to-market structure in our digital businesses. This has allowed us to reach another milestone of positive earnings from operations for our digital businesses in the second quarter for the first time. And we continue to take cost out ahead of the revenue decline in the traditional businesses.

Kodak employees around the world are working hard to deliver the SGA reductions required to achieve our business model and I am proud of their performance. Year-over year SGA was down $87 million or two percentage points of revenue.

Digital Revenue growth has begun to accelerate and while there is work to do in the second half, we look forward to achieving our goal of 3% to 5% percent digital revenue growth for the full year, which represents double digit growth for the second half driven by the expanded breadth of our digital portfolio, both in CDG and GCG.

Our confidence is reinforced by the positive reception we are receiving for our new line of consumer inkjet printers, our digital picture frames, our expanded line of NexPress digital color presses, and our workflow software for commercial printers. I am very pleased as well with the fact that we have designed and introduced the new Kodak EasyShare C513 digital camera to include a Kodak CMOS sensor, while we already started to design CMOS sensors for other companies.

Although we don't have any new intellectual property deals, our plan is on track to achieve the $250 million we reported previously.

Now let’s spend a few minutes on operational highlights for each business. We will start with the Film Products Group, FPG, which performed exceptionally well in the first half. During the second quarter, FPG revenues declined 15%, yet the business has been able to take manufacturing and go-to-market costs out ahead of the decline of revenue, improving both year-over-year gross profit margins and earnings from operations as a percentage of revenue.

Consumer film capture revenues declined 30% in the quarter, while entertainment imaging film revenues were consistent with last year. While entertainment imaging film revenue was up 3% for the first half, we continue to expect that for the full year entertainment imaging film revenue will be in line with our forecast and similar to the prior year.

We now expect FPG to end the year with earnings from operations at the upper-end of the 13% to 16% range.

Turning to Graphic Communications Group, GCG. As anticipated, GCG digital revenue growth accelerated during the second quarter, growing 6% year-over-year. We are pleased with the momentum generated by the second quarter sales success of our Digital Printing and Enterprise Solutions businesses. We feel comfortable we will achieve the targeted 6% to 9% digital revenue growth for the full year.

In conjunction with the digital revenue growth, GCG total gross profit margins improved one percentage point despite the fact that we had a negative impact from increased aluminum cost.

Now, Consumer Digital Imaging Group, CDG. CDG’s second quarter results are evidence that the improvements we began to implement in the second half of last year to our product portfolio and go-to-market structure are working. Total gross profit margin improved five percentage points with significant improvements in digital capture and devices, which was partially offset by the decline in the traditional business and the introduction of consumer inkjet printers.

CDG’s digital revenue was flat, reflecting the decline in snapshot printers, which was offset by the introduction of digital picture frames and the new consumer inkjet printers. We have a good line-up of digital products for the second half all across the CDG product lines, including competitive digital camera models at all key price points. This positions CDG digital for double-digit revenue growth in the remainder of the year.

I continued to be pleased with the progress we are making with our new line of consumer inkjet printers. Consumers are embracing our value proposition, especially the claim of being able to print with premium ink at up to 50% savings. This claim has been confirmed by Quality Logic, a third-party provider. Production is ramping up well and the third printer in our line has been added to the retail offerings.

As our capacity increases, we are expanding our distribution channels. As of now, our printers have become available as well on-line through Dell and Amazon and very soon we will be adding additional retail partners in addition to Best Buy and Office Depot in the U.S. and Dixons and Media Market in Europe.

Our goal continues to be to sell at least 500,000 units in 2007, which will put us in the path grow this business to achieve revenues on the order of $1 billion by 2010.

Now I will turn it over to Frank for the financial overview.

Frank S. Sklarsky

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

We are pleased that our second quarter performance was in line with our expectations. We are on track with our digital revenue growth, digital earnings, net cash generation, restructuring plans and in very good shape as it relates to cost reductions, including SG&A. We believe all of this positions us well for achieving our goals for the full year.

As we have messaged previously, we manage the company on an annual basis. Consequently, we are focusing on those quarterly performance metrics that reinforce our view of our full year performance.

Loss from continuing operations for the second quarter was $173 million pre-tax, and $135 million after tax, or $0.47 per share, compared to a loss from continuing operations of $294 million pre-tax and $355 million after tax, or $1.24 per share in the second quarter of 2006. This represents a pre-tax improvement of $121 million versus the prior year and an after tax improvement of $220 million, or $0.77 per share.

Second quarter results include items of expense impacting comparability totaling $266 million after tax or $0.92 cents per share. This is comprised mainly of restructuring charges of $248 million or $0.86 per share. The prior year’s second quarter included items of expense impacting comparability totaling $206 million after tax or $0.72 per share.

Both second quarter and first half revenues are essentially on plan. For the second quarter, Digital revenue grew by 3% while traditional revenue declined by 17%. Consolidated revenue declined by 7%, and included a 3% favorable exchange impact. Based upon our results to date, we are reiterating our goal of achieving 3% to 5% percent digital revenue growth for the year.

With respect to gross profit margin, we are very pleased with the continuing progress versus the prior year and prior quarter. The 26.2% margin in the second quarter compares quite favorably to the 21.4% from the prior year. This improvement of about five points was achieved through continued progress in manufacturing footprint and related cost reductions and slight improvements in mix and foreign exchange, partially offset by pricing, and to a lesser extent volume. This improvement was also achieved despite an increase of approximately $36 million in aluminum and silver costs.

Looking forward, based upon the seasonality of our business, we are still positioned to achieve our 2007 target gross profit margin of between 25% and 26% of revenue.

SG&A was reduced by $87 million or 17% and declined as a percent of revenue from 19% in the year ago quarter to 17% in the current quarter. Year-to-date, SG&A decreased by $199 million or 19%. We continue to show significant progress toward our target cost model, which is to achieve a run rate for SG&A as a percent of revenue of 16% by year-end. Given the substantial progress to date, we are confident in our ability to achieve this goal.

R&D costs totaled $128 million for the quarter, or about 5% of revenue, and in line with our plans. The spend as a percent of revenue is higher if applied to the revenue associated with our Digital businesses, where we focus most of our spending.

Second quarter pre-tax restructuring charges totaled $316 million versus $224 million in the year ago quarter. We completed the sale of a manufacturing site in Xiamen, China, which resulted in a non-cash restructuring charge to the P&L of approximately $238 million. Second quarter cash restructuring payments were approximately $120 million.

We still fully intend to complete the major restructuring this year. And, as we stated previously, we are also very confident in achieving our target cost model. We continue to track cost reductions along with restructuring charges and associated cash payments.

To date, we have been successful in reducing our costs in a very efficient manner. We’ll be sure to keep you posted as we continue to refine our analysis and as we work to complete the remaining restructuring in the back half of the year.

Second quarter digital EFO was $19 million versus a loss of $78 million in the year ago quarter, an improvement of $97 million. Year-to-date digital losses are $24 million compared to year-to-date losses of $169 million in the prior year, an improvement of $145 million. It is important to remember that the second half of the year is typically much stronger in terms of earnings performance in our digital CDG and GCG businesses, so we remain confident in our full year digital earnings forecast.

Consumer Digital Imaging Group EFO improved by $78 million from a $133 million loss in last year’s second quarter to a $55 million loss this year. The year-over-year improvement reflects the favorable impact of SG&A reductions, improved gross profit margins in digital capture and kiosks, and increased intellectual property royalties, partially offset by pricing in various product lines, volume declines in traditional retail printing and increased costs associated with the ramp up of our new Consumer Inkjet products.

EFO in the Graphic Communications Group for the current quarter was $44 million versus $16 million in the year ago quarter, an improvement of $28 million, primarily driven by higher volume in digital plates and workflow solutions, cost control initiatives in both manufacturing and SG&A, and favorable foreign exchange partially offset by the negative impact of aluminum and modest pricing changes.

As a result of cost improvements, the Film Products Group posted an EFO of $137 million for the second quarter versus $119 million in the year ago quarter, on a revenue decline of 15%. We continue to see year-over-year improvement in our total traditional earnings, reporting $112 million in earnings from operations in the current quarter compared to $81 million in the year ago quarter. This was driven by the continued strong performance in our Film Products Group.

Overall, other income and interest expense improved by $27 million versus the prior year quarter. This is primarily driven by the benefits to both interest income and interest expense from the impact of cash generated by the Health Group divestiture.

Net cash generation for the second quarter reflected a use of $251 million, an increase in usage versus the prior year quarter. For the first half of 2007, cash use of just over $700 million was in line with last year’s figure of $691 million. As expected, we are showing significant cash usage in the first half of the year, due primarily to seasonal effects and increases in working capital associated with projected second half revenue growth. We expect net cash generation to improve in the second half consistent with seasonality effects and planned initiatives to accelerate revenue. We also continue to focus on working capital efficiency initiatives across all elements of the cash conversion cycle.

Cash expenditures for the quarter were $59 million, down $24 million from the year ago figure of $83 million, reflecting improved efficiency around spending.

We ended the second quarter at $1.925 billion of cash and cash equivalents. This balance reflects the net effect of receiving pre-tax cash proceeds of $2.35 billion from the Health Group divestiture and fully repaying the $1.145 billion of the outstanding secured term debt. Our debt currently stands at $1.624 billion. We are very pleased with our strong balance sheet and the significant liquidity it provides us.

Overall, we remain confident that the company will achieve previously stated 2007 goals for digital revenue growth of 3% to 5%, net cash generation in excess of $100 million and our digital earnings goal in the range of $150 million to $250 million.

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

Question-and-Answer Session

Operator

(Operator Instructions) We’ll go to Jay Vleeschhouwer with Merrill Lynch.

Jay Vleeschhouwer - Merrill Lynch

Thanks. Good morning. Frank, I would like to ask a corporate level question first and then for Antonio, turn to the segments. Could you talk about where you see capital expenditures going? Do you see them continuing to tail off as we saw in the first-half, or where do you foresee having to still make significant commitments, if any, to capacity, notwithstanding the footprint reductions you’ve otherwise made in the company?

Secondly, there was a substantial year-over-year increase in inventories. Is that second half preparation for the home printers or is there something else as well driving the inventory change year-to-date? And then a question for Antonio.

Frank S. Sklarsky

Sure. On the CapEx, we still expect annual CapEx this year to come in between the $300 million to $350 million range, as previously communicated. A combination of capacity in various parts of the business, as well as new product tooling and things like that. So we are still holding to that number for this year.

As far as inventory goes, a couple of factors driving that. One, as you said, preparing for the double-digit digital revenue growth in the back half of the year in both CDG and GCG. Another factor that did impact us in the second quarter was a build in inventory related to paper as a result of the closing down of the Xiamen, China facility, so we built a little bit of a bank for the transition from that facility to other facilities.

We expect a lot of diligence around working capital in the back half of the year to get ourselves where we want to be.

Jay Vleeschhouwer - Merrill Lynch

Okay. For Antonio, first with respect to CDG, two things; could you comment on the restructuring benefits of the changes you made in your camera distribution and portfolio over the last year? Are you pretty much done with the retraction of your exposure in different markets? And are you now prepared to start seeing some year-over-year positive comps in cameras and in profitability for cameras? Longer term, which is I think more important, is it really the home inkjet printers you think that will provide the most earnings leverage in CDG or will it necessarily be elsewhere that you would get the best leverage and long-term profitability from CDG, namely retail printing?

Antonio M. Perez

We expect every product line to make money in the company. Some obviously will produce more than others but every single one has to stand by itself and contribute to the bottom line.

The first part of the question was about the work that we’ve done, the redesign that we’ve done in CDG. It affected a few things. The first one was the way we design our products. We have improved dramatically in the way we design our products. We use individual products. We use more platforms. This is something that you’ve heard me say now for three years and this has been a process, but the company has made terrific progress in being able to design out of the same platform, different products and therefore satisfy customer needs at a much lower cost and dealing a lot better with high cost parts.

This is one element that you can see the effects right now, the five points improvement in gross margins comes in part from that. In part as well because of the supply chain. We had a very a -- well, we thought it was an inefficient supply chain. By working through others and with others and taking advantage of the volumes that others have, we still have control of the whole process but at the same time we took advantage of a much lower cost and much more efficient way of doing our products and distributing our products. That you can see as well as part of the five point improvement.

I think as well there is the product portfolio growth. The product portfolio is a lot more balanced. We have products that we didn’t have before and they cover the size of the customer better than we have in the past, so we compete better against our competitors and we are in better shape.

Who is going to -- we are not betting the company on just one product line. The inkjet group is a very important part of the company but so is digital capture, and it is getting to be a very, very nice business. And as you noticed now, although you didn’t ask me the question, we are going back into the low end of the product line. If you remember a couple of years ago, a year-and-a-half ago, I mentioned that we were going to abandon the low-end of digital cameras because with the design strategy that we have, without the platform strategy and without the supply chain that was the profit for those products, that was not an effective business for us. I said at the time it was a temporary thing that we needed to do our work and then, of course, the third element is now we are putting our own CMOS sensor into those cameras, which obviously helps as well with the margins. It is the combination of those.

So inkjet is very important. So is kiosks, which continues to do very well. You are going to see quarters where you are going to see more top line growth, other quarters where you are going to see some bottom line growth. This particular one, we have a higher percentage of media, the new installs, and therefore less growth on the top line but phenomenal bottom line. That’s an important bottom line.

Retail printing is getting better too. So we don’t want to have any business in which we don’t see a way to make money with.

Jay Vleeschhouwer - Merrill Lynch

Finally, in GCG, your prepress business was up only 1%. I assume that’s even with currency benefits and your digital printing was also down 2%, so I assume that’s NexPress and Versimark. I guess the question is why do you continue, particularly in printing, to see such little year-over-year progress when the overall production printing market seems to be doing reasonably well? Are you seeing the joint benefit yet that you would like in terms of leveraging combined analog and digital sales, which was the strategy behind creating GCG?

Antonio M. Perez

Actually, we do. We see the benefits. You see, the numbers that you mentioned, they include everything there. They include black and white, they include color, they include all sorts of things. You can’t really go through the comparison and get to that conclusion doing that, Jay.

The color market, we are doing very well. We are very happy with the growth in the color market. We do have -- we just introduced a bunch of products that are very important in NexPress for the color market that we are going to see the effect more in the second half than in the first half, and we have seen already some of that effect in the second quarter, by the way.

You’ve seen how well we’ve done in enterprise software. That is the glue that links all these things, so -- and you mentioned serving the hybrid market, the type of hybrid industry that we decided to serve, is that working -- it is working. You can see the great growth that we had in enterprise software, which is basically serving as the glue for all of these customers to be able to deal with their online printing and remote printing and digital printing and the like.

So yes, the strategy is working well. The fact is that the digital part of GCG, which is the majority, has grown 6%. That’s, at the end of the day, that’s what counts. And they have improved their bottom line significantly. I can’t complain that it would have been a lot better without the aluminum. There’s nothing I can do about the aluminum but it would have been incredibly much better without the aluminum. So we hope one day that will slow down again.

But anyway, even with that, they have a great top line improvement and a very important bottom line improvement, and the best part for them is still to come in the second half. I am very pleased with that group.

Jay Vleeschhouwer - Merrill Lynch

Thank you very much.

Operator

We’ll go next to Carol Sabbagha with Lehman Brothers.

Carol Sabbagha - Lehman Brothers

Thanks very much. Just a couple of questions, one very broad on cash. Now that you have the cash on hand after the sale of health, can you talk about the process that you are going through to decide exactly how to use that cash? And over what time -- what is the timing when you may be able to share more details about what your plans are around the cash usage?

Antonio M. Perez

We don’t really have a timing, Carol. We haven’t changed from the last time we talked. We have those three options that we continue to examine with the Board. We are looking at the market as well. We are looking at our competitors. We are looking how internal investments are coming along. We are looking at the ecosystem to see if there is something that is attractive out there and we will keep examining the possibility of buying back stock.

We haven’t changed and we don’t want to put a deadline to ourselves. We are going to do what we think is best, so -- as soon as we have any indication of what we are going to do, we will go public with it.

Carol Sabbagha - Lehman Brothers

And then, a question on FPG. It has been, the margins have been up year over year in the first-half and nicely so. You talked about for the full year you now expect to be at the top end of the 13% to 16% range, but given the strong performance in the first half of the year to end up at 16% would imply that second half margins will be down year over year in that business. Is something changing in FPG in the second half of the year or is this just a way to be conservative?

Antonio M. Perez

Well, that is the conversation I have with Mary Jane Hellyar, as the person who runs it. We are trying to give you our best guess, and that is our best guess. Could it be better than that? Yes, it could be better than that but we are trying to give you the best guess that we have.

We believe very much in this business, especially EI and we believe that has a strong contribution to make to this company, but we did have an extremely, extremely successful first part of the year that was a little better than we thought it was going to be. Therefore, we are going to be prudent and say we don’t know that we have the same reasons to believe that this is going to continue at the same level. We can be wrong, obviously but this is our best guess. Our best guess is that the second half is going to be a little lighter than the first half in volumes but we can be wrong. One or two blockbusters could make it big and then we can be wrong.

But this is our best guess. Nothing else is changing. The structure of the business is the same. Nothing else except -- it is basically is the revenue going to be as high in the first half or it is going to be a little lower. That is going to be the difference.

Carol Sabbagha - Lehman Brothers

My last question is on aluminum. Can you talk about what you think the impact is -- what the impact was for the whole company of aluminum costs this quarter and what you think, what type of headwind is it going to be for the year?

Frank S. Sklarsky

It was about $21 million for aluminum, virtually all that in GCG, for this quarter. It is a difficult call for the rest of the year, quite honestly, but our internal planning horizon tells us that on a proportionate basis, the second quarter was about what we expected, so for modeling purposes and our internal planning purposes, that is about the right range on a quarterly basis.

At some point in time, Antonio said we hope it will level off but that was the impact this quarter.

Carol Sabbagha - Lehman Brothers

Okay, and you don’t expect the pricing actions to really kick in until next year in terms of starting to offset some of the headwinds, is that --

Antonio M. Perez

We expect some of those pricing actions that have been put in place already to get some effect in the second half.

Carol Sabbagha - Lehman Brothers

Got it. Thank you very much.

Antonio M. Perez

We won’t recover all, though. We won’t get it all back because this market like every market we are in is very competitive. There is only so much you can do but we put those actions in place.

Carol Sabbagha - Lehman Brothers

Terrific. Thanks a lot.

Operator

We’ll go next to Matt Troy with Citigroup.

Matt Troy - Citigroup

Frank, I had a question as I reconcile EPS to cash EPS, it looks like the depreciation and amortization fell about $50 million sequentially, accounting for about half the gross margin improvement. Those are rough estimates, just backed out from your cash flow statement.

Is $200 million or thereabouts a good run-rate for D&A to assume going forward? Is the majority or entirety of the facility rationalization done, so we can start to think about that number leveling out? I was just wondering if you could help me with the trajectory there.

Frank S. Sklarsky

You’re talking on a quarterly basis?

Matt Troy - Citigroup

Yes, a number to use for the second half in terms of D&A.

Frank S. Sklarsky

That might be a little bit heavy on a quarterly basis for the second half. It is going to continue to taper off as we finalize and complete the footprint reduction. I think we said somewhere in the range of $700 million plus for this year. It will probably be a little bit less next year, so 200 a quarter is probably a little heavy.

Matt Troy - Citigroup

Okay. Antonio, I know it is still early days in the wake of the CMOS announcement, but based on your initial conversations, I’d be interested in your thoughts -- where do you see the opportunity with that product as I turn the dial? Is it selling co-manufactured chips into handset makers, is it licensing it to other chip manufacturers, is it putting it into your own cameras? I know it is some combination thereof, but I’m just wondering where you see, at last in the next 12 to 36 months, the largest opportunity based on your conversations so far?

Antonio M. Perez

I think the largest is in the handset. As you know, we have a close relationship with Motorola. We are working diligently to help them develop improved cell phones with our CMOS sensors. I am anxious to be able to announce, for them to announce something like that. We are working very hard to get it to market quickly. That is the best opportunity, not just with Motorola but our plan is to serve anybody that is in the digital capture market.

Having said that, we have one camera that is going to come with our CMOS sensors and we would like to see many more, and other people using our CMOS sensors, like today, some of our competitors, they use our CCD sensors already in their cameras, so we don’t see a reason why if we have the quality that we believe we do have and the differentiation that we believe we do have and the pixel technology and the imaging technology that we embed in those sensors, we should be able to get a good share of that market.

Our tentative goal that we have shared with investors so far is that I don’t see a reason why we shouldn’t get to $300 million by 2010. If we hit it, well, it could be a lot more than that but that is the number that we are planning to for this purpose.

Matt Troy - Citigroup

Last question, or series of questions, relates to DRUPA, obviously a big technology show from you and a lot of other folks, potential. I was wondering -- are we still on track to see at least a demonstration of the Versimark stream product? That would be question one.

Two would be have you seen -- I would expect not yet, but we are starting to hear grumblings elsewhere in the industry some deferral on hardware purchases, obviously an externality you can’t control but I would be interested to see on the hardware system side if you are seeing any deferral in spending as people hold off ahead of that.

And then three, echoing questions I’ve asked earlier, now that the Canon co-product is out, is there opportunity and are you in discussions to further partner to flesh out that product line by filling in the book ends you have in the market today? Thanks, guys.

Antonio M. Perez

We are right on track for DRUPA. It is a very important moment for GCG. We have been working now for more than three years on getting the stream to be something that we can put in a product, so yes we are and we will have, even if -- will demonstrate the power of that technology and the possibilities of that technology.

No, I haven’t seen any purchase delayed to that. I think that the people need to see that that works, but we have been talking about it. We’ve been talking about this to many, many people in the industry. Just a few days ago I talked to 400 owners of printing houses, and we talked about that too.

So we are trying to make sure that the industry understands that this is coming and try to raise that interest to see -- I mean, there are a lot of applications that they can get into and we have a lot of respect for the power of offset but we think we can make a dent -- mind you, a small dent at the beginning in that market and get some of those jobs to this technology.

What was the third question, Matt?

Matt Troy - Citigroup

Partnering. It’s something I’d asked for 18 months and the Canon product finally came. I’m just wondering if there’s opportunity to further increase the breadth, filling in the book ends or taking the technology higher.

Antonio M. Perez

We keep looking for that, obviously but the relationship is going well. As you know, they sell their own product, we sell our own product. We use their engine but we have a very significantly different product and by the way, it is going very well. We are doing extremely well with that product. We’ve got a lot of awards and we got a lot of sales with it, so we are very pleased with the relationship and where this is going and we’ll keep looking to expand the pro line, obviously.

Matt Troy - Citigroup

Great, thanks for the time.

Operator

We’ll go next to Shannon Cross with Cross Research.

Shannon Cross - Cross Research

Good afternoon, or I guess good morning. Sorry, I’m rushing things. A couple of questions; I’m curious if you could talk a little bit about the impact of the inkjet business on working capital and how we should think about that, both for this year and next as it runs through the model?

Frank S. Sklarsky

So far this year, I wouldn’t say it is a -- you know, that the biggest part of the working capital change as we are ramping up and because of the model that we have, it hasn’t been a huge impact in the second quarter. That will increase in the back half of the year as we invest in the inventory to supply the other channels that we have announced and still have not yet announced.

I can’t really give you a number right now but you will see a ramp up in that. The good news is however, that because of the way we structure the model and the supply arrangement, a good part of the inventory will not be on our books, so it is mainly going to be in the area of receivables where you will see that ramp in the working capital.

Shannon Cross - Cross Research

Okay, and then if you could talk a little bit about your IP licensing revenue. I don’t believe you had anything that was big enough to call out from a non-recurring standpoint in the quarter, since it wasn’t in the release. But maybe what you could do to help us out if you could is of the $250 million approximate goal for the year, what percent of that has already been reached? That will give us an idea of how to think about the second half of the year.

Frank S. Sklarsky

We did say at least $250 million for the year. We are still on track for that, and if you were to look at both the second quarter and the first half of the year, I would say that on a proportionate basis, that puts us on track.

Shannon Cross - Cross Research

Okay, but no idea of what percentage you’ve done so far?

Frank S. Sklarsky

Not an exact percentage. I would just say proportionately, we are on track and you are correct -- there were no significant new deals in the second quarter.

Shannon Cross - Cross Research

Okay, and just to clarify, there were no significant deals either in the first quarter, is that correct?

Antonio M. Perez

No, no, I said there were no new deals.

Shannon Cross - Cross Research

No, for first quarter, not second.

Antonio M. Perez

No significant -- we don’t have new deals. That’s, I said in my speech --

Shannon Cross - Cross Research

No, no, I said first quarter. I just meant for the first half of the year.

Frank S. Sklarsky

Correct.

Shannon Cross - Cross Research

Okay, I just -- just clarifying.

Antonio M. Perez

No, first half we didn’t have, so it is just the ongoing licensing.

Shannon Cross - Cross Research

Okay, and then, Antonio, perhaps you can talk a little bit about your thoughts on the Entertainment Film business. It was flat this quarter, obviously it was up significantly in first quarter. How should we think about Entertainment Film as we go through the latter half of the year?

Antonio M. Perez

As I said to Carol, we think, our best guess is it is going to be flat year over year. Flat year over year as far as revenue. We still have the efficiencies of the new cost structure, obviously, and the fact that we do all the film in just one site and everything. We have those efficiencies that work in our favor.

But for revenues, the best information we have is that the second half should be a little more than the first half and it will make for a flat year overall. It is an industry that could move. You get a couple of blockbusters, as I said before, and all of a sudden you get a different mood and things start to change. But what we know, we know the movies that are coming. We know the deals that we have with the studios. We know the amount of people that go to the theater. As we put all that -- we have a complicated chart to get through all of this and it looks like it is going to be flattish for the year. That’s our best information.

Shannon Cross - Cross Research

That’s very helpful. Just one final question on inkjet. When you launched inkjet, I think it was March, you talked about having, I think Phil talked about having three product lines by the end of the year, or more. I don’t want to put words in anybody’s mouth. I’m trying to think of what exactly it was but addition products. So I’m just curious as to the pipeline and how you are feeling, your comfort level with your manufacturing capabilities in order to meet your internal targets of new products as opposed to just units.

Antonio M. Perez

I am getting more confident with time. We had what I would call normal ramping up issues that I’ve lived through all my life and we had them again. But we went through those and we solved those. We finally put the third product into the line just two or three weeks ago, I believe, so we finally have the three products that we wanted.

I feel more confident now, that we went through all of this, that we are capable of bringing more products into the line now. Of course, you know that I am not going to tell you when and what but I feel much more comfortable now that we went through this start-up and learning and learning not just ourselves but with our partners. As you know, we have a value chain that is very distributed. It is very efficient financially but it is slightly harder to control than if you have it all in one building and you control everything. But if you make it work, it is very attractive so that is what we are trying to do, we need to do to compete with whom we are competing.

I feel a lot more comfortable and anxious to see new products in the product line and I hope we can call you soon with those.

Shannon Cross - Cross Research

Thank you very much.

Operator

We’ll take our final question from Ulysses Yannas with Buckman, Buckman & Reid.

Ulysses Yannas - Buckman, Buckman & Reid

Antonio, I hope that you don’t fall in the same trap as two of your predecessors as far as using your cash. I noticed on your balance sheet you have $5.7 billion worth of treasury stock, 100 million shares. Buying stock at a multiple of book value doesn’t exactly enhance shareholder value. It creates a nice float for traders. Any thoughts on the subject?

Antonio M. Perez

Give me again, Ulysses. I don’t know if I follow you. I couldn’t follow the numbers that you were --

Ulysses Yannas - Buckman, Buckman & Reid

Okay, your balance sheet carries treasury stock at $5.8 billion. That represents 100 million shares, which in turn tells me that you -- two of your predecessors used --

Antonio M. Perez

Sorry, Ulysses. As a company, I think twice we bought back stocks. Is that what you mean?

Ulysses Yannas - Buckman, Buckman & Reid

Yes.

Antonio M. Perez

Yes, we did that. I can’t remember the years but I did go through the history, yes, and I remember with you, and I looked actually, since we are doing all of this investigation, we looked into the effect for the company in doing that and it was pitiful.

Ulysses Yannas - Buckman, Buckman & Reid

Yes.

Antonio M. Perez

It was pitiful. Okay, I got your point, I got your point, and I appreciate you telling me this, Ulysses. I will be very careful with this.

Ulysses Yannas - Buckman, Buckman & Reid

I have another question, if I may.

Antonio M. Perez

Sure.

Ulysses Yannas - Buckman, Buckman & Reid

Last year, it appears that your printer, which was in the other category, cost you $26 million in the second quarter. It was higher or lower this year?

Antonio M. Perez

You mean the inkjet printer?

Ulysses Yannas - Buckman, Buckman & Reid

Yes.

Antonio M. Perez

It will be more. It will be more, yes. We have all the cost of the ramping up. We have all the costs of -- you know, we are building all sorts of things and relationships, so it will be higher than that.

Ulysses Yannas - Buckman, Buckman & Reid

Then can I ask the question about when do you expect to start seeing lower losses?

Antonio M. Perez

What we said is some time in -- the beauty of this business model is that the moment you get to a point where the revenue that you bring from hardware equals the revenue that you bring from ink, life becomes a paradise, right? It becomes a paradise, so it is up to us to -- and then we brought a business model that should be attractive, in our view, to people that print the most. Therefore, we expect to have a slightly higher burn than our competitors if we achieve, if we pass the message appropriately, we should be able to have a slightly higher burn,

Ulysses Yannas - Buckman, Buckman & Reid

Than the five average of your competitors?

Antonio M. Perez

Yes. For the whole year, in our plan, we have been publicly saying that for the whole year, we would like to be profitable in 2010. If we achieve the profile of customers that we are looking for, it is very possible that some time during 2009, we will hit break-even and then we will starting moving out of there, but it is really early to know.

But a lot is going to depend on our ability to pass the message appropriately and get the type of customers that we would like to have with this business model.

Ulysses Yannas - Buckman, Buckman & Reid

You also had a loss from the transfer of the -- I’m sorry, photofinishing and printer business. Was this loss bigger or smaller?

Antonio M. Perez

Smaller.

Ulysses Yannas - Buckman, Buckman & Reid

Smaller -- so in essence, the improvement you had in the CDG was despite an increase in costs associated with the printer.

Antonio M. Perez

Yes. We had those five points of gross profit improvement, they come through operational issues, really, better operations. We have better pricing, better margins in the products that we are selling. We have lower cost in the distribution -- we just have a much more efficient operation that is allowing us to go now into lower price points that will help with the volume and the overall cost of the unit.

So the IP, as you will see, was slightly better than last year but based on the same deals we had last year, but most of -- I don’t know, two-thirds or so of the improvement are operational improvements.

Ulysses Yannas - Buckman, Buckman & Reid

Incidentally, let me congratulate on the speed with which you are reducing your SG&A.

Antonio M. Perez

Well, you have to congratulate about 35,000 people because they are working really, really hard on this. This is the hardest thing that we have to do and thank God we are almost done.

Ulysses Yannas - Buckman, Buckman & Reid

Thanks very much and good luck.

Antonio M. Perez

Thank you. Well, I think this closes the call. Thank you again for joining the call. To give you my summary, we remain focused on delivering on this year’s key strategic objectives: Completing the restructuring to achieve our targeted business model is fundamental, achieving market success with our new products is critical, driving double digital revenue growth for the second half -- we haven’t done this, as you know, organically so this is a challenge for us but we think we have the portfolio and the cost structure and the go-to-market and the supply chain to do that and we feel very confident, and obviously we want to deliver on our goal of digital earnings growth and net cash generation after the large cash restructuring, the last one, the last year that we have to do that. I believe this quarter is a great step to being the Kodak that we want. Thank you very much.

Operator

That does conclude today’s call. Again, thank you for your participation. Have a good day.

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Source: Eastman Kodak Q2 2007 Earnings Call Transcript
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