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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

Jay Vleeschhouwer - Merrill Lynch

Carol Sabbagha - Lehman Brothers

Matt Troy - Citigroup

Bill Shope - J.P. Morgan

Ulysses Yannus - Buckman, Buckman & Reid

Shannon Cross - Cross Research

Eastman Kodak Company (EK) Q4 2007 Earnings Call January 30, 2008 11:00 AM ET

Operator

Good day, everyone, and welcome to the Eastman Kodak fourth 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 McCorvey. Please go ahead, Madam.

Ann McCorvey

Good morning and welcome to our discussion of the fourth quarter earnings call. I am here this morning with Antonio 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 in this presentation 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 profitable growth, the commercial print market, consumer inkjet revenues, SGA reductions, cash outflow, and incremental rationalization and cost reduction activities 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 important factors and uncertainties.

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

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

Antonio M. Perez

Thanks, Ann and good morning, everyone. This is an exciting time at Kodak. I am thrilled to say that we achieved all of our key strategic imperatives for 2007. Digital Revenue grew 8%, three points above the top end of the range we forecasted. Digital earnings from operations were $176 million, well within the targeted range. Net cash generation was $333 million, more than $200 million above our goal, and we successfully entered the consumer inkjet market, surpassing our launch year goal.

The large, expensive and difficult corporate restructuring is over. We have now established a sustainable business model for the declining traditional business and our digital businesses are growing profitably.

I will discuss the outlook for 2008 in greater detail at the investor meeting in New York next week but for now I am proud to say that we enter 2008 with a great portfolio of products and great confidence about generating sustainable, profitable growth.

Now I would like to share some thoughts on the performance of each of our major segments.

Let’s start with GCG, Graphic Communications Group. Quarter after quarter the momentum builds for this business. GCG’s 2007 digital revenue grew 7%, in line with our targeted range of 6% to 9%.

The fourth quarter's 12% digital revenue growth was driven by our large digital plates business, along with strong growth in digital printing hardware and consumables.

This combination of good growth in both digital plates, made for offset printing, and digital presses, is another proof point that the commercial print market is a hybrid market and will remain in transition for a long period of time. Kodak is well positioned and well differentiated from our competitors in this market.

We offer the broadest range of digital and traditional solutions to assist commercial printers through each stage of their transition. They repeatedly tell us that that is what they need.

GCG’s fourth quarter decline in earnings from operations versus Q4 2006 was primarily driven by higher aluminum cost and the negative impact of a licensing settlement that is behind us now. However, the unit placements for plates and Digital presses were the best of the year, which will help with future earnings.

On top of that, for the total year GCG improved overall earnings from operations by 16% while absorbing significant commodity price increases, the negative impact of the decline in analog plates, and the strong investment in STREAM technology. We will introduce STREAM technology at Drupa in May, where we will continue to expand our broad product offering in Digital Production Presses with a breakthrough technology based on continuous inkjet that has been highly praised by industry analysts worldwide

We’ll tell you more details about our 2008 plans for GCG on February 7th.

Now turning to FPG, the Film Products Group; Kodak has a long and productive relationship with the Academy of Motion Picture Arts and Sciences. This year, for the 80th consecutive year, all of the Best Picture nominees were produced on Kodak film. In addition, The Academy has recently recognized Kodak with its ninth Oscar for the development of photographic emulsion technologies incorporated into Kodak’s VISION2 family of color negative films.

We know the motion picture industry very well and we will continue to set the benchmark for innovation and quality both in film and digital technologies.

FPG continued to deliver solid results and ended 2007 with earnings from operations equal to last year, a remarkable achievement considering the consumer film industry volume declines.

The great market acceptance of our products, together with the lean cost structure and the accelerated depreciation we implemented in the last few years, gives us extra confidence that we can continue to manage the decline in our traditional business while sustaining a profitable business model for years to come. That includes our next planning period of 2008 through 2011. We will discuss this in more detail next week.

Next, CDG, Consumer Digital Imaging Group; CDG had a strong fourth quarter. Digital revenues grew 17% and digital earnings from operations also improved. And for the year, CDG’s earnings improved by $148 million while absorbing the significant investment required to launch our first year of consumer inkjet.

The fourth quarter’s increase in digital revenue was driven by strong year-over-year growth in digital cameras, digital picture frames, increased revenues from intellectual property, expansion of products and services in Kiosk, and our new inkjet printers. This overall growth is noteworthy, as it was significantly reduced by the continued industry decline in snapshot printers.

We already have a significant and growing digital output business and this week at PMA, we announced a number of new breakthrough Retail Printing products that will redefine the photo-retailing category.

The first is our new family of digital dry mini labs called the KODAK Adaptive Picture Exchange, or APEX. This new product line is non-chemistry based, simpler to operate, requires less labor, floor space, and energy, and can grow in capacity and functionality as retailers’ needs change. Only Kodak makes it as simple as one media SKU that produces two finishes -- gloss and satin -- and three print sizes.

In addition to APEX, we are also introducing new Kiosk functionality, new papers for pro and consumer markets, and new Qualex Photo Services that will drive new profitable revenue streams for Kodak and for our retail customers.

And by the way, Wal-Mart just announced Kodak was awarded vendor of the year for the Photo Center/Electronics, and we are very proud of that.

We said that we would sell 500,000 units in 2007 of our new line of consumer inkjet printers and we surpassed that goal. What’s more, we have third-party directional data which indicates that we effectively reached the buyers that we were targeting -- consumers who print more than the average.

Consistent with our business model, we have early data from NPD in the U.S. and GFK in Europe that shows that Kodak consumer inkjet printers are enjoying a 30% or greater price premium over the industry average. This is an early proof point that consumers are paying attention to our value proposition. They are willing to pay more for a Kodak printer because they understand the image quality and longevity provided by our premium pigmented inks and that they will be saving money every time they print.

We know that this is too early to draw long-term conclusions but this is certainly very encouraging. My experience tells me that this is an impressive first-year launch and a great start toward building a billion dollar business in 2010.

We will talk more about our exciting plans for inkjet and the overall CDG business at the investor meeting. We have a strong momentum in this business and we now have an effective business model in place to profitably introduce new capture and output products with innovative features and at price points that are appealing to consumers and retailers.

We have a traditional business with a sustainable business model and we have proven that we know how to manage a business with declining revenues and we have a $6.5 billion digital business with profitable revenue growth in front of us.

We hope that you will join us in New York next week to talk about the outlook for the new Kodak -- a Kodak focused on sustainable, profitable growth; cash generation and breakthrough innovation with continued cost discipline and great execution to create value for our shareholders.

Now I will turn it over to Frank.

Frank S. Sklarsky

Thanks, Antonio and good morning, everyone. I would like to spend some time discussing our fourth quarter financial results, summarize 2007 performance, and then Antonio and I will be happy to take your questions.

As Antonio indicated, we are extremely pleased with the company’s performance in the fourth quarter and for the full year. In short, the Kodak team delivered the financial and operational results that we set out to achieve.

We aggressively addressed the stranded cost from the Health Group divestiture and all other SG&A costs and attained our target cost level for the year. We completed the four-year corporate restructuring program at a cost lower than we had originally anticipated.

We delivered on essentially all other income statement metrics including revenue, gross profit margin, and earnings from operations. Our earnings are particularly noteworthy considering the significant investment in Kodak’s successful introduction of our new All-in-One Consumer inkjet products and we also surpassed a milestone by selling 520,000 units in our first year.

We also achieved digital revenue growth well in excess of our original targets, particularly in the Consumer Digital Imaging Group, while GCG gained significant momentum in the back-half of the year.

And we delivered the cash. Achieving our cash goals gives us the fuel we need to drive value-creating initiatives for our customers and our shareholders as part of a sustainable profitable growth model going forward.

So let’s look at the numbers.

For the fourth quarter, GAAP earnings per share from continuing operations were $0.31, compared to a GAAP loss per share of $0.05 in the fourth quarter of 2006. Please note that for the fourth quarter only and in contrast to the prior year quarter, fully diluted earnings per share reflects an impact of about $0.01 per share from the dilution associated with contingently convertible securities. The accounting rules require this, as the company was profitable overall in the fourth quarter.

Current quarter results included items of net expense impacting comparability totaling $28 million after-tax, or $0.09 per share. The prior year fourth quarter included items of net expense impacting comparability totaling $158 million, or $0.55 per share. As noted in our earnings release, comparability items for the current quarter included restructuring costs, gains on sale of property, an impairment charge related to our investment in Lucky Film in China, and various tax items. The prior year’s fourth quarter comparability items included tax valuation allowances against deferred taxes and restructuring.

Fourth quarter total consolidated revenue increased by 4% and included favorable foreign exchange of 5%. Full year total consolidated revenue declined by 3% and included a 3% favorable foreign exchange impact.

Digital revenue grew by 15% in the fourth quarter, driven by both CDG and GCG. This resulted from significant improvements in digital capture and devices including cameras, digital frames and intellectual property revenues, strong performance from our digital printing products and prepress solutions in GCG, along with the continued ramp-up of the new consumer inkjet products.

Traditional revenue declined by 15%, in line with our expectations. Full-year digital revenues grew by 8%, which was ahead of last February’s guidance of 3% to 5%. The better than expected performance in digital revenues for the year was due in large part to improvements in almost all digital categories within the Consumer Digital Imaging Group including digital cameras, frames, kiosks and intellectual property. This was partially offset by declines in the snapshot printer category.

Fourth quarter gross profit margin increased from 23.8% to 24.5%. This change reflects improvements in the company’s cost structure from the manufacturing footprint reduction and other supply chain efficiencies, intellectual property, and favorable foreign exchange, partially offset by increased commodity costs of about $26 million and price/mix impacts.

We are very pleased with net reduction of $186 million in SG&A costs for the year representing a reduction of 1.4 percentage points of revenue. This resulted from substantial structural cost reductions, partially offset by increased advertising and marketing for our new consumer inkjet printer products, along with charges associated with performance-based compensation for all of our employees. These latter impacts were the primary drivers behind the increased SG&A for the fourth quarter. We can continue to build on the structural cost reductions achieved throughout the year, which will help us to reduce SG&A costs as a percent of revenue in 2008.

For the quarter, our pre-tax restructuring charges totaled $68 million as compared to $77 million in the year ago quarter. For the total year 2007, pre-tax restructuring charges totaled $662 million compared with $698 million last year. Restructuring related payments from corporate cash were approximately $101 million for the 4th quarter and $446 million for the full year. Restructuring costs were lower than originally anticipated due to the efficiency of the manufacturing footprint reduction and the successful implementation of various business divestitures enabling us to reduce exit and severance costs.

We have now completed the restructuring plan we laid out four years ago and we are extremely pleased with the business model going forward. That said, we will continue to look for rationalization and cost reduction opportunities consistent with best practices followed by any world class company. As we said last February, we do anticipate some carryover cash payments in 2008 associated with restructuring actions and charges taken in 2007. Our current assessment is that corporate cash payments for these carryover actions will be in the range of $100 million to $150 million.

With respect to earnings, our fourth quarter digital EFO totaled $146 million as compared to $141 million in the year ago quarter, an improvement of $5 million. Full year digital earnings improved by $189 million to $176 million compared to losses of $13 million in the prior year, largely driven by increased volumes and IP revenues from CDG and improved cost. Also, for the total year the company’s overall segment EFO grew to $343 million compared to $161 million in the prior year, an increase of 113%.

The Film Products Group achieved 9% EFO in the current quarter versus 15% in the year-ago quarter. These results reflect impacts from volume and mix, along with seasonal production slow-downs in film manufacturing, some initial effects from the writer’s strike, higher silver costs, and the impact associated with new and renewed film agreements. Full year EFO was 19% of revenue compared to last year's 16% of revenue despite, a sales decline of 15%.

During the fourth quarter, our Consumer Digital Imaging Group improved their overall EFO by 21%, or $13 million to $76 million from $63 million in last year’s fourth quarter. CDG full-year EFO improved by $148 million to a $92 million loss in 2007 from a $240 million loss in the prior year. 2007 also marks the first year of profitability for the digital business within CDG driven by a stronger product portfolio, along with operational and other improvements in digital capture and devices.

Although the traditional portfolio within CDG experienced challenges, we continue to improve the cost structure for these businesses.

Earnings from Operations in the Graphic Communications Group for the current quarter were $33 million, a $14 million decline as compared to $47 million in the year-ago quarter. This was primarily due to higher aluminum and other costs, the impact of a licensing settlement, and decreased sales and gross profit of our traditional products. GCG full year EFO of $116 million is $16 million ahead of last year’s EFO of $100 million.

Turning to cash, our net cash generation for 2007 was $333 million, well in excess of our target of $100 million. We achieved this goal by generating cash from operations and through an intense discipline around the restructuring program as just described. We also focused on capital spending efficiency and completed planned actions that generated proceeds from the sale of real estate and other entities. We also generated a significant improvement in working capital through a concerted effort to collect past due receivables, effectively manage inventories in all of our business units, and by bringing accounts payable metrics more in line with our peer group.

We ended the fourth quarter with almost $3 billion in Cash and Marketable Securities. Our debt currently stands at just under $1.6 billion and we are very pleased with our strong balance sheet and the significant liquidity position it provides us.

As we have consistently messaged, we continue to manage both the company’s earnings and cash flow on an annual basis. In the 4th quarter we had impacts to EFO that included incremental advertising and performance-based compensation. At the same time, an efficient restructuring, great progress on working capital, effectively generating proceeds and maintaining discipline around capital spending enabled us to complete the year with cash generation well above target, and the company closed the year with a more efficient cost structure and with solid revenue momentum in our key digital businesses.

While there were some variations in the phasing of earnings and net cash generation between the fiscal quarters, we are extremely pleased with the overall performance for the year and where we are positioned as we look forward into 2008.

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

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from Jay Vleeschhouwer with Merrill Lynch.

Jay Vleeschhouwer - Merrill Lynch

Antonio, last year you stepped up your investment in the home inkjet business. It was several tens of millions of dollars of added investments to drive the new business. The question now -- is there anything similar that you are planning for any business in 2008 in terms of accelerated or incremental spending, given the multiple areas that you foresee for growth in any of the segments?

Antonio M. Perez

Jay, I would rather answer that question on the eighth when you see the whole portfolio that we have planned for 2008. It will be a much, much better time and place to answer that.

We are going to continue to invest heavily in those key product lines where we see a lot of opportunity for growth and for profit, obviously. Having said that, we expect a very good 2008. We have very good momentum that would allow us to do both, invest aggressively with the new products, with the new introductions and at the same time, you probably have seen how well the basic business is performing. CDG basic businesses without the new investment has improved dramatically year over year, thanks to a very effective cost structure and very effective supply chain. And that would allow us to invest into what we believe successfully new products, so let’s wait until the seventh. I won’t be able to describe all the new products, all the new initiatives for the company until that time but the answer is yes, we will continue to invest aggressively in those areas that we see great opportunity for growth.

Jay Vleeschhouwer - Merrill Lynch

The second question is on the last call, you acknowledge that you were facing something of a geography test, in as much as U.S. GCG was not doing so well as non-U.S. GCG and conversely you were doing better domestically for CDG than outside the United States. Do you think that you’ve put in place a better balance of performance geographically within each of those two important segments?

Antonio M. Perez

We think so. We’ve put a lot of investment -- basically the issue we had was actually not enough people in front of our customers for our digital presses, both Nexpress and Versamark. We started to do that at that time. We have hired more people. We have integrated into the company and the results in the fourth quarter, where we placed more units than we ever did during the rest of the year, showed that that is working.

We still have some more work to do in Europe, for that is a large region and we are not tending to our customers as well as we would like to, so we will continue investing in that for next year and it’s part of our plan for next year. But the results of the fourth quarter came up, proving that we solved some of that problem.

Jay Vleeschhouwer - Merrill Lynch

Finally, for Frank, can you elaborate on your IP results for ’07? And you may want to hold this until next week as well, but can you say anything more about your expectations for --

Antonio M. Perez

Yeah, I’m going to do it now, Jay. I’m going to do it myself because I know I am going to get this question 15 times and let’s start -- let’s get over with it. I said before that we were expecting at least $250 million for some previously signed agreements in IP. You know, the forecast that you are going to see for the period of 2008 to 2011 that you will see on the seventh calls for at least from $250 million to $350 million every year for each one of those four years.

Now, that is the net number that includes the royalties and the revenue that we get and the royalties and the revenue that we have to pay. We don’t win all of these cases, although likely for us the majority are positive for us.

So those are the numbers that you are going to see. I want to remind you as well that the key objectives of the IP program is number one, design freedom; number two, getting to new businesses or new partnerships or have access to all the IP that we might need in the future and then number three is to generate revenue and earnings.

And I did say at least 250 to 350 every year as an average for the four years. Because of the strategy that I just described to you, it could very well happen in that one of those years will be a lot larger than that. It may be another year, a lot smaller than that and I can’t -- we can’t -- since the deals are coming and we have to decide between number one, two, and three, but I am pretty confident that those are the numbers for the full year period.

We see significant legs to our program and we know because of the context that we have with a number of companies in cases that we have in front of us.

Jay Vleeschhouwer - Merrill Lynch

All right. Thanks, Antonio.

Operator

We’ll take our next question from Carol Sabbagha with Lehman Brothers.

Carol Sabbagha - Lehman Brothers

Thank you very much. A quick question; stepping back a little bit, we’ve had a lot of companies report the view on the economy has been sort of mixed. Your fourth quarter revenue numbers were strong but just asking you broadly, what are you seeing out there in terms of demand in the consumer area, in the graphics area, and what is your outlook? Do you see any sort of broad slowing down in the economy you might be able to make, to gain share to make up for it? But sort of a very broad economic picture if you don’t mind.

Antonio M. Perez

Okay, Carol. That’s a difficult question but I’ll give you our best. We were watching the economy in the fourth quarter and we were watching the economy declining and we haven’t seen any effect on us. So we were happily surprised and we are rationalizing why that happened but we haven’t seen any effect.

Having said that, when you look at the plans that we have for the next four years, especially for 2008, you will see that even though they are going to look I believe very good and very aggressive, you are going to see that we are going to put range in our goals. And that range will give you an idea of how much we think the economy could do to us if it goes one way or another.

We still believe that we have, funny to say but because we are new in many of these categories, even if the categories don’t grow as much or don’t grow at all next year, for us it will be a lot of growth because we were not there before or we had a very small presence.

And then as far as the large businesses where we are in, we are more than 60% of our revenue is outside the U.S. We think that we have some good balance of how we can deal with these things but in any case, we were cautious and we -- you’ll see that the ranges of growth, although very positive and very good, there will be a range because we don’t really know how this is going to -- so we looked into kind of a best case, worst case and we went through a lot of modeling and that’s what you see in the range that we put there. We still feel very positive about 2008. The momentum we have created, I mean, if you look at the company first quarter, second, third and fourth, you certainly have to agree with me that there is a very strong momentum with all digital products both in the third and in the fourth quarter.

I hope that you agree with me.

Carol Sabbagha - Lehman Brothers

No, absolutely. I said that your revenues didn’t show it. I just wanted to know if it was more gaining share or no impact from the economy.

Antonio M. Perez

Well, it’s both. We gained share in many and share, in many cases we have very little so it wasn’t that difficult to gain share. We still have that situation coming.

We still feel very strong about SPEG. What I read about is a lot more negative than we feel. The truth is that year over year, we have -- this group has had outstanding performance. We keep signing multi-year deals with our customers, the ones that really should know [if film is going to be used or not] and they keep signing multi-year deals with us.

So we -- and then we have created a very low cost structure, so we feel very well with that business.

Carol Sabbagha - Lehman Brothers

Antonio, on inkjet, I know you’ve been very happy with the performance and the unit performance. I don’t know if you exactly said how many you placed for that year but you beat your 500K number. Can you distinguish between what sort of unit number you had on a sell-in basis versus sell-through basis?

Antonio M. Perez

We sold I think Frank said 520,000 to our numbers, I don’t know -- 520,000. The sell-through in the last month of the year was absolutely spectacular, to the point that all I can tell you, and I’m not very happy about this, is that if we don’t over perform, and I had a long meeting with Phil Faraci about this only a week ago -- if we don’t over perform in manufacturing in the first quarter, we are going to be out of product, out of stock in many places, which we are going to desperately try not to do that. That shows that will tell you -- and I think a lot of the data from sell-through is available there. We had a very, very strong sell-through all over the place and in fact, as you probably know, we ended up out of stock in several places in the fourth quarter.

So if the question is do we have an inventory in the channel, the answer is no. We have a lot less than we wanted to have to deal with the first quarter.

At the same time, we were trying to have little inventory there because we came with a new platform that you probably saw at CES that’s a much lower cost platform for us, with a similar performance and obviously we want to move as fast as we can all of our products to that platform. And that is the plan that we have for the year and we’ll talk more about that on February 7th.

Carol Sabbagha - Lehman Brothers

Okay. Last quick question on entertainment; can you just provide a little bit more detail about the writer’s strike, how that impacted you, how it should impact you, and then also you mentioned in the discussions about renewed film agreements. Were those in entertainment or in consumer film? It was hard to distinguish.

Antonio M. Perez

They were all over. They were all over. They were in entertainment imaging and they were in other parts of the -- and we don’t want to go deeper than that. And they did cost us some but it’s good news for us. It’s very good news for us.

The best information we have about EI year over year is that that 7% decline in revenue comes from three things -- from the writers’ strike, number one; number two is the title success. This business is a very lumpy business. It is very hard to go into seasonality in this business. When a group of very powerful titles come into the market, sales go through the roof. This is what happened, for instance, you know, fourth quarter in 2006 came with very strong titles and that continued over the first and even the second quarter of this year. There are weaker titles at this point in time, so those two were significant impacts, were the majority of the impact.

And then we have a manufacturing slowdown that we do normally this time of the year to get ready for the productivity for next year and obviously that hit us with the cost.

But let me tell you something else about that business -- the admissions have grown 1% in the U.S. for the data that we have and a lot more outside the U.S. This is how we explain that even though the number of theaters that have moved to digital at about 7%, but film is basically flat. And this is due to the fact that we have new -- many more new theaters that have been open and as well the fact that we are gaining share. That is how we ended up with basically flat sales for us for the year with the 7% digital screens.

But as long as the audience keeps going to the movies, and the audience actually keeps growing a lot faster, double-digit, I believe, outside the U.S., that’s even better for us because the transition to digital is a lot slower there, if any.

At the same time, I don’t want you to forget that we are in the digital business too. We haven’t talked much about it but we have great technology and we are going to -- we are participating already in it. But as far as the film, that’s the story.

Carol Sabbagha - Lehman Brothers

Antonio, a quick follow-up, a dumb question -- the writers’ strike, I thought it only impacted TV but obviously it sounds like it’s impacted movies too. Is that --

Antonio M. Perez

Well, we have a big business in TV. We sell a lot of 16-millimeters for TV productions, Carol, so that -- and as well, there is a whole -- you know, the studios, actually they closed earlier this year. That caused another issue for us so it has impacted more TV than film, but it is affecting everything.

Carol Sabbagha - Lehman Brothers

Okay. Thank you very much.

Operator

We’ll take our next question from Matt Troy with Citigroup

Matt Troy - Citigroup

Antonio, I had a question -- can you refresh us on your thoughts for deployment of cash? You had articulated a framework when the stock was at 27. The stock has obviously headed south, 30% or so, but the cash balance has moved nicely upwards, close to $3 billion at roughly half the market cap. Given those two parameters, has the thinking changed about the priorities for cash deployment in the next three years?

Antonio M. Perez

Sorry, Matt, it’s the same answer I gave you at the time, is that we -- our objectives are the same -- internal growth, we will be looking for opportunities for inorganic growth. In one hand, this is a good time to do these things, since everything is suffering as far as market cap and enterprise value. On the other hand, it is getting more and more difficult to get good deals in which the seller doesn’t keep all the benefit, all the value. So we keep looking for that.

And then third, we still consider buy-back. We were considering it before. Luckily we didn’t exercise the buy-back two months ago.

We feel that we have to wait and see. The market is too volatile and all I can tell you is we are going to be aggressive with our internal investment, looking to capitalize on the technologies that we have and you know my opinion. We have even a lot more than we have shown you, so that’s going to be the first objective. It’s not a bad thing to have this liquidity with a market that is so unstable, but obviously we want to put that cash to the better use for our shareholders and we’ll do that. We are working on this a lot but we have no news to report.

Matt Troy - Citigroup

I understand. If I could then I guess segue for a question to Frank on the cash flow issue; obviously ending the seasonally strongest fourth quarter with a lot of cash on balance sheet, I was wondering under the new business model, one, how do we think of Kodak as a net consumer of cash over the next quarter or two, the seasonally weaker part of the year? What is the potential burn rate under the new model?

And I guess looking forward three to five years when this model as just stated and you are comfortable with the debt levels and the ratings, how much cash on balance sheet do you think you will have to maintain? I mean, I would think it is very structurally lower than where we are today but is there a broad parameter where you could just directionally point us in terms of the cash requirements for running the new business model?

Frank S. Sklarsky

The first question around seasonality, you could probably plot the proportionate seasonality in the last couple of years and if you look towards 2008, you would see something that is not too dissimilar, although what I would say is that the more our graphic communications business continues to grow, and that has a very good geographic dispersion across the globe, you might see gradually a little less seasonality over time. Not necessarily that significant in 2008 but as you go out through time and you are asking longer term, that -- and as you continue to get more annuities, an annuity stream from consumables from both our consumer business and graphic communications business, that will over time tend to have a smoothing out effect.

Again, it won’t be as significant in ’08 but as we go through time, it will have a beneficial impact on the seasonality.

The second question around the cash on the balance sheet and what the requirement will be, because over time we will have a lower impact of seasonality, it will tend to reduce the overall minimum cash cushion we need. I wouldn’t say that in terms of where our ratings are now and where our seasonality is now that we are going to come off necessarily in the next few months that $1 billion which we’ve been messaging as our cash cushion, so that will probably remain in place, at least in the near-term.

But you are correct -- longer term, we certainly would not want to have the requirement to have that amount of cash on the balance sheet and over time, I would suspect that we’d be able to bring that down.

Antonio M. Perez

Matt, 60% of the digital business that we are building, already 60% of that revenue is what we call output businesses. This is a combination of both the consumer and the commercial space, and those businesses are there because they generate a very, very healthy annuity stream.

And that is exponential growth, so the more we see this digital presses and these printers and these kiosks and these retail printing devices that we just announced, all of the -- you put all those things together -- and the plates, actually, because when you get into a deal, you keep serving that customer for a long time. The more you do this, the more you are going to see that the company is going to have a lot less variability of the quarter. So that was the whole intention of this, right?

So it’s already 60% of the revenue. We are very pleased with that and we are selling those products aggressively, selling in most of the time [cost deals] some, but it’s a very good business. It’s a very good return for our shareholders and it’s already 60%.

Matt Troy - Citigroup

On that annuity stream, the plate business, or I guess GCG more broadly came in slightly light. I understand what aluminum prices can do to that business. That said, the industry as a whole had pushed through some price increases a few quarters ago and I think of sources of potential leverage in your business model, if those price increases hit in ’08, you get a tail-off in aluminum, you could actually see some very nice leverage in that annuity stream.

I was wondering --

Antonio M. Perez

I hope you are right.

Matt Troy - Citigroup

What is the penetration or hit rate in terms of price increases? Because these are --

Antonio M. Perez

We haven’t been -- we didn’t do very well in price increases this year. We did try, believe me, but it still is a very good margin business, the digital plates, and the choice was to lose revenue with a very good margins or raise the price.

So we haven’t done very well raising the prices because of the aluminum, so we didn’t get much back, unfortunately for us. We started to hedge some aluminum, so we have a little more control over that but we didn’t get much of that.

But that is -- I mean, it’s a phenomenal business for us and when you think about the digital business of this company, if I look at the stability of the digital business of this company, you have to look -- when you think of 2008, you have to look at two businesses; consumer digital capture, which is very strong coming into next year. The combination of products and IP looks very strong for next year. And the digital plates, which is a very stable business where we have the number one position worldwide. The combination of those two businesses is two-thirds of our digital revenue, so I have to feel strong about next year because I know that those two businesses are incredibly well-positioned, like they’ve never been.

And then we have the rest of the businesses in which the role is growing market share and investing in them, which we will continue to do.

But the answer, we didn’t get much of that price increase.

Frank S. Sklarsky

But to Antonio’s point, we don’t break out individual product lines in terms of growth rates or revenue or whatever, but as you know, you saw the overall growth rate for GCG and for prepress. Rest assured that the digital side of that, of prepress, grew very, very nicely in the fourth quarter and --

Antonio M. Perez

Double digits.

Frank S. Sklarsky

Double digits, yeah.

Matt Troy - Citigroup

You had talked in the past about the manufacturing capacity for the digital plates being close to a limit and that potentially a catalyst for the business would be migrating some of analog capacity to do the digital plates. Is that process done? Is that still ahead of your or is that something?

Antonio M. Perez

Well, we opened China, which has been a big liberation of the -- you know, the China plant was opened three months ago, so that’s going to help us a lot. And we keep moving, we keep moving customers from analog to digital and we are, whenever we can, not in 100% of the manufacturing places, we can actually move that capacity from analog to digital.

In fact, we are considering we are doing a little bit of that now, doing some contract manufacturing outside for the analog plates, so we can use more effectively those internal resources for digital plates.

Matt Troy - Citigroup

Excellent. Thank you for the detail.

Operator

We’ll take our next question from Bill Shope with J.P. Morgan.

Bill Shope - J.P. Morgan

Thanks. On inkjets, I know obviously you are in the very early stages and still clearly in share gain mode, but how should we think about seasonality in that business, or whether or not we’ll see any as we get into the first half of the year?

Antonio M. Perez

Well, the back of the year, we’re still going to be very strong. That’s an industry issue. Now again, we are small, as you said, so we still have a lot of room to grow but having said that, our business model is one that fits very well with a percentage of the users. You can put a -- I don’t want to put a number on it but it doesn’t fit with every user. It fits only well with those users that print more than the average. Those are the only ones that are going to see the value of buying our printers, honestly. If you don’t know that you are going to print enough, there is no reason for you to buy, unless you like the better quality that we have, but other than that, you are not going to have a cost reason to buy our printers.

So we don’t -- we’re not addressing the whole marketplace with this business model. We know that and this is in our model.

Now, with time, we’ve got a -- the external data shows that we’ve been selling our printers 30% over the average price of the industry. The truth is this is slightly higher than what we wanted to do. We didn’t want to do that as much. We want to do that because we want to reinforce the value proposition we have and obviously we can sell the printers higher, the happier we will be obviously, but there is no fundamental reason why we have to sell our printers at a higher price than any of the others, with the exception of the fact that we have a head in the printer that the other thermal printers do not have. That cost of the head, that is the difference but it’s a small number compared to the total price of the printer.

In contrast, our competitors in thermal inkjet, they have a head in every cartridge. And that is a number that is significant compared to the price of the cartridge. So that is the strategy that we picked.

With those two combinations, what I am trying -- I am trying to answer your questions all around. We still have a lot of room to grow, so we should be able to grow all across the year. We have only introduced one platform. We just announced ones in the second and at CES, as you can imagine, without pre-announcing anything. Obviously we have plans to announce new products with our platform as soon as we can, so we think that’s going to help us with growth.

So we still are -- as I said, we are small, we are in a growth mode so we will have maybe less of a seasonality. We will still have the big season to deal with.

Bill Shope - J.P. Morgan

Okay, and then a second question on that; obviously considering the constraints on availability, how did you look at your shelf space trends in the fourth quarter and how should we think about your goals on shelf space going into 2008 as well as the expanded distribution opportunities?

Antonio M. Perez

We are going to keep expanding. We are going to keep expanding. At this point in time, every retailer that I know of -- maybe I don’t know all of them -- has an interest in having this value proposition in his store.

So while at the beginning, we had to defend our value proposition even to the retailers, for obvious reasons, that is not the case now. The printers are getting phenomenal reports everywhere. Our database, which obviously is internal data and you have to realize that I am sharing with you internal data that I am not pretending that is generic in any way, shape or form, shows that our customers self-report to us that they are printing a lot more color and a lot more full density pages and images because the ink is cheaper.

Again, it’s early to make any statement about that. I will suggest that you go to the retailers that you know and ask them to what is the attach rate of cartridges. That is -- normally when you buy an inkjet printer, the average of the industry is about 0.5 cartridges extra that get bought with that printer. It would be good for you guys to check what is the attach rate for us.

I can tell you that the data that we have is anecdotal, that we got it the same way that you can get it, going and talking to the retailers, is 1.5.

Now, I don’t want to get too happy about this because it is early but it is really very encouraging. This has never happened in the industry, that people go buy the printer and they buy already so many cartridges with the printer.

And then if they self-report that they are going to use more because it is cheaper -- I mean, I’m just trying to give you all we’ve got. All we’ve got is an early indication, some data that is external that you can check and some of the data that you have to go and check by yourself. But it is very, very encouraging, you know, for me being in this industry for more than 20 years.

Bill Shope - J.P. Morgan

Thank you. That was very helpful.

Operator

We’ll take our next question from Ulysses Yannus from Buckman, Buckman & Reid.

Ulysses Yannus - Buckman, Buckman & Reid

I saw at the electronics show a new TV from Sony. It’s an OLED-based TV. Finally OLED seems to be coming of age. You are participating in this area. Is Sony part of what you are doing?

Antonio M. Perez

No, we did disclose that we have a wide cross-license deal with Sony. It was announced last year. We cannot disclose anymore but it was a wide cross-license and soon after that, they [inaudible] with our product and we are very happy that OLED becomes, is becoming more of a standard product although they were just showing the product. They were not talking about the cost or anything else --

Ulysses Yannus - Buckman, Buckman & Reid

Apparently they are [inaudible] very well in Japan.

Antonio M. Perez

Well, I’m very happy for that because this is good news for us. The issue with -- Sony has both elements of the technology. They have the deposition technology, in which we are a leading company, if not the leader. And then it’s the back plane technology that we don’t have and they do have.

We are still in our process of finding an appropriate back plane leader, but having said that, you probably saw as well that LCD has made incredible inroads into the industry. I don’t know if you noticed, there were LCD screens with LED back light. The LED back light has made the size of the LCDs very, very thin -- thinner, actually, very close to what OLED can do today.

You probably noticed as well that the reviews, the amount of energy that is needed to run those products and as well that the visibility from different angles is much better than it was before.

So LCD has improved dramatically too, which probably leads to us to conclude that the biggest opportunity for OLED is really in the small size and less in the large size at this point. For that reason, and as well because it’s very hard to get the back plane to work properly with LED for large size.

So we are in the same position we were in the last few years. We keep in investing in the parts of the technology that we have, that we are very strong and we have a value there that we can use, we can monetize in several ways, and we keep looking for the opportunity for a partner that has the same interest that we have in the application of this technology.

Ulysses Yannus - Buckman, Buckman & Reid

Talking of investment, your investments in inkjet this year were higher than what you had last year, weren’t they?

Antonio M. Perez

Oh, yes, yes. You know, significantly higher, not only in R&D because we are getting into now different platforms that you will see, you will be seeing during 2008 but as well, we are getting into volume so we have more investment in the go-to-market, yeah.

Ulysses Yannus - Buckman, Buckman & Reid

Judging from the $50 million plus costs associated with a project in the fourth quarter, you must have gone way over $100 million.

Antonio M. Perez

Yes, we went over $100 million, but we don’t disclose that. We have to -- you have to in this business. We have a great value proposition but we are late and we have a value proposition that needs to be understood by customer that have been using this industry for 20 years in one way.

So we know that it’s an up-hill but we know as well that our costs for our products are going down dramatically from platform to platform. We know that the value proposition is being very well-accepted and we just have to get it through and make it well-known.

But we don’t disclose how much we invest because that would be competitive data.

Ulysses Yannus - Buckman, Buckman & Reid

I have done [really well] at attempts to indicate that the average soccer mom can recoup her investment in one of your printers in less than 18 months. Is that out of sight? I mean, is this --

Antonio M. Perez

If [she’s a working mother] like my wife, it will be a lot quicker than that. I mean, it depends how much you print. You can recover very quickly. I mean, look at the different --

Ulysses Yannus - Buckman, Buckman & Reid

No, I mean your average customer, [inaudible] the whole world. The high-end users.

Antonio M. Perez

And that is the data that I was trying to give to J.P. Morgan -- it is too early for me to establish that formally. That would be naïve. I’ve been in this business for too long to do that.

The data that we have is that our customers are going to use significantly more cartridges than the average but I don’t know if in another year-and-a-half, in another year maybe when we have more of an extensive consumer installed base, I will be able to say that. I sure hope that it will continue to be higher and I believe it will be higher than the average, but how high, I don’t know. The data we have now is phenomenal but logically, the first customers that go for this product are the ones that print a lot, so with those, the data is very favorable. If I will extrapolate that to the whole business, this would be a paradise.

And I can’t do that but -- you know, your statement generically will be true. If you use -- I mean, the industry is about 4.5 cartridges a year. That’s an industry number. You can go from there.

So you can do any modeling that you want. If you assume that our customer uses, I don’t know, five, six, you see how quickly they save. They save very quickly -- very quickly. So the average inkjet user in the market, according to the external data, uses 4.5 cartridges a year. And ours we believe will use slightly more. We can’t tell you more because the data we have is limited and we won’t put a number there yet. We believe it will be more, so you can do that modeling and you’ll get very quickly to what you concluded. You’ll get actually to a much quicker time.

Ulysses Yannus - Buckman, Buckman & Reid

Finally, if I may ask a question, your friends at Xerox in the fourth quarter didn’t have the kind of performance you had in your commercial printing division. In addition to that, they’ve been talking about 10% price declines. Have you been experiencing price declines? And the other side, you must be gaining market share.

Antonio M. Perez

I don’t have third-party data to put on this phone call to answer that, and I --

Ulysses Yannus - Buckman, Buckman & Reid

How about pricing?

Antonio M. Perez

Yeah, we have pricing. You know, not all of the electronic products, no matter what, prices just keep going down year over year but that’s part of our -- that’s part of our planning. We always plan that that’s -- I think the biggest difference, I think Xerox has a tremendous portfolio but is mostly concentrated in digital presses, by and large. The advantage that we may have, or the ones that we claim that we have is that we have a very broad portfolio. We serve both the analog printing, all the offset machines, which remember is still 85% of the printing. And then we serve as well digital presses.

When people say that we are competing in GCG with HP and with Xerox, I hope that they realize that only in 25% of our business we compete with them. The other part of the business, they don’t have the products that we have. They don’t have plates, they don’t have the -- at least the variety of workflow software that we have.

So maybe the advantage and maybe an explanation for your call will be we cover the whole business, they cover one side, very strongly. They are the number one, without any doubt in digital presses. They have a very big portfolio. We have a small portfolio.

The answer is we only serve with digital presses the production side of the market. They go lower than that. They go into copiers, they go into [inaudible] and we don’t go into that space.

So it’s hard to compare without looking at both companies completely.

Ulysses Yannus - Buckman, Buckman & Reid

Thank you very, very much, Antonio.

Operator

We’ll take our last question from Shannon Cross with Cross Research.

Shannon Cross - Cross Research

Thank you for taking my questions. The first one is with regard to the inkjets and Antonio, I just wanted to confirm or clarify your comment that with the new, I think it’s the ESP3 lineup, you essentially expect to transition out the three that you launched about seven months ago and you are now moving on to another product platform? Or do you anticipate having both of them side by side in the channel for a while?

Antonio M. Perez

No, there will be both. There will be both. What I meant to say is that we have created a basic engine with the same performance that is a much lower cost for us. That was the intention and that engine eventually will replace a good part of the value proposition that we have with the different -- but it will be over time.

Shannon Cross - Cross Research

Okay, and then a question on the IP that you talked about, the $250 million to $350 million on average over the next -- I guess that’s three years, four years -- how much of that is actually signed contracts sitting at Kodak right now that you can look at and know and how much is --

Antonio M. Perez

I won’t say that, Shannon. It is -- a good part of this is signed contracts. We won’t put a number there. And then the other part is new deals that we know they are in the pipeline and by looking back at the last four years, we have a pretty good experience in how long it takes to settle those deals. And right now, we have a pretty good feeling on how many of those deals are going to be trading IP one with the other, or which one of those are going to be revenue generating. And it’s based on that that I put that number.

And I keep saying that it’s “at least” -- and I don’t know what else to say. We want to have the full freedom of the world to go for design freedom, or making deals to work with companies and products that otherwise we cannot get into. And only if those two things do not work for whatever reason, then we will try to make a deal with them that will generate revenue and cash.

Having said all of that, that’s what we put into this analysis that will be put in the forecast. We feel pretty strong that those will be the numbers, at least 250 to 350 average for the four years. And I say average because those deals, sometimes they will come in the fourth quarter or in the first quarter and they might be higher one day and lower the next year, but that’s the best view we have.

Shannon Cross - Cross Research

Okay. I guess -- you understand all the questions, right? Because obviously it’s such an important part of your profitability, so --

Antonio M. Perez

I do, I -- well, yes, it is. It’s an important part of our profitability, as it is the profitability of many other businesses. And we can’t just look at one -- I don’t look at it anyway, Shannon, at just one part of the profitability. I mean, if I wouldn’t be investing so much money in inkjet, it will be seen very profitable other products in CDG. This is a company that is managed -- that we manage the portfolio overall. That is an important part of the company. We said it already from 2003. We said that if we didn’t have the portfolio of IP that the company created for the last 20 years, we wouldn’t have a chance to do what we are doing, yeah and we are very proud and it is very important and we’ve got to capitalize on it for as long as we can.

Shannon Cross - Cross Research

Okay, and then one other question with regard to CMOS because I don’t think we’ve had a lot of discussion on CMOS -- any update on where you stand on that, both with regard to internal Kodak as well as deals with say Motorola or any of the other carriers?

Antonio M. Perez

We’ll do more on February 7th but we just introduced one camera with our own CMOS in it and it is selling very well and it allowed us to go into a lower price point and keep our margins in good shape.

We have the deal with Motorola that we’ll be delivering. Motorola has to announce introductions, I cannot, but in the next six months, you should be seeing products from Motorola and our contribution.

And you will see an announcement that will come between now and the seventh, so I’m pre-announcing, which I shouldn’t be doing but I’m doing it anyway since I started, and we are going to -- we announced a series of breakthrough technologies about six months ago or something like that. Those are becoming a product and we will be announcing that that will be a product available for sale in the industry. I won’t tell you anymore but it will come in the next few days.

We are making a lot of progress. This is a long cycle business. We have very good technology, good partnerships, so I feel very well about the business but it takes time to build this business.

Shannon Cross - Cross Research

And just to clarify, the contract with Motorola is take or pay, so if they don’t actually ever use your product -- because it’s been months and we’ve been talking about this for a long time and I understand you can’t control Motorola, but just from a Kodak shareholder standpoint, if they don’t use your stuff, they still have to pay you.

Antonio M. Perez

I can’t answer that, Shannon.

Shannon Cross - Cross Research

Okay. Thank you.

Antonio M. Perez

Thank you very much.

Operator

And this does conclude today’s question-and-answer session. At this time, I would like to turn the conference back over to Mr. Perez for any additional or closing remarks.

Antonio M. Perez

Thank you so much, all of you and thank you for the people that asked the questions. We feel that we had a great year. I think many of the pieces of the new company have come together and we have delivered on all of the key objectives that we had for 2007. We launched what we like to call a new Kodak, so we’ll see you next week to tell you more about it. Thank you very much.

Operator

And this does conclude today’s conference. Thank you for your participation. You may now disconnect.

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Source: Eastman Kodak Q4 2007 Earnings Call Transcript

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