Eastman Kodak Co (KODK) 2002 Q2 法說會逐字稿

Please stand by, we're about to begin.

Good day and welcome the Eastman Kodak second quarter earnings results conference call.

Today's conference is being recorded.

At this time, for opening remarks and introductions, I'd like to turn the conference over to the Director and Vice President of Investor Relations, Mr. Don Flick.

Please go ahead.

Good morning.

And thank you for joining our conference call this morning.

Before I turn the call over to Bob Brust, excuse me, and Dan Carp, I would first like to call your attention to our Safe Harbor statement.

Specifically, certain statements in this conference call may be forward-looking in nature, or forward-looking statements as defined in the Unites States Private Securities Litigation Reform Act of 1995.

For example, references to the company's second half 2002 earnings expectations are forward-looking statements.

Actual results may differ from those expressed or implied in these forward-looking statements.

The forward-looking statements contained in this conference call are subject to a number of important risk factors, which are fully enumerated in the company's financial releases this morning.

I would invite you to review these important risk factors as they relate to this morning's discussion.

Now I'd like to turn the call over to Kodak's Chief Financial Officer, Bob Brust.

Thanks Don.

And thank you all for joining our conference call this morning.

On July 11th we announced that our second earnings would exceed guidance of 60 to 70 cents per share.

It's a real pleasure to be dealing with performance that exceeded those expectations.

This morning we will

factors, which drove our better than planned performance for the quarter.

As we reported in our press release this morning, our second quarter reporting earnings are 97 cents per share, versus 12 a share last year.

Included in that figure this year is a one-time tax benefit of 15 cents per share, partially offset by three cents per share of write-downs in our venture capital portfolio, resulting in operating income of 85 cents per share this year versus a $1.12 this year.

This above expectation performance is a result of solid execution in a number of areas including cost reduction, improved manufacturing productivity and ongoing success in addressing operational issues.

As is the case for many U.S. companies reporting this quarter, these results are not the result of a better than expected economic environment.

We have been saying for some time that we have not seen any meaningful signs of economic recovery and the second quarter continues that trend.

will have more to say on that subject in a few minutes.

One the operational side the performance improvement in our health imaging business continued throughout the quarter, resulting in higher unit gross profit and net profit margins.

Our health team has clearly done an excellent job of correcting the operational problems we have been discussing, faster and more effectively than we anticipated.

We also benefited during the quarter from improved manufacturing productivity, higher volumes sequentially, improved yields, and some manufacturing processes and good cost discipline.

These positive factors partially offset by higher year-over-year incentive compensation accruals including our wage dividend and higher non-U.S. cost due to foreign exchange enabled Kodak to deliver a gross profit margin of 37.5 percent.

This versus 39.1 percent last year.

In summary the principle drivers from last year were a negative 1.9 percentage points of price, positive productivity of 1.2 points and a negative mix of one point.

Sequentially gross margin improved significantly from the first quarter, result of 31.7 percent to 37.5 percent reported for the second quarter.

SG&A is up on a year-over-year basis, both in terms of dollars and as a percent of sales.

The increase is due to a number of factors, including SG&A associated with acquisitions, planned higher levels of advertising, increased reserves for bad debt and other small one-time items.

Backing these items out results in SG&A spending more, now more than $30 million dollars on a year-over-year basis.

Our cash performance also continues to be very strong.

We delivered second quarter operating cash of $298 million.

While the first half operating cash performance improved $661 on a year-over-year basis.

The cash performance in the second quarter versus last year benefited from improved receivable performance of 267 million, 71 million in lower capital spending, and 128 million from a shift to semi-annual dividend payments as we've discussed.

Inventories reached our year-end goal of five turns during the quarter and were down 348 million from last year.

It is important to note that even excluding the dividend payments in the first half of 2001, the year-over-year, in the year-over-year comparison, Kodak's first day of operating cash flow improved by 405 million.

As a result we were able to retire approximately $200 of debt during the quarter, with the remainder reflected in higher cash balances.

Debt is now down nearly $800 million from the second quarter 2001 balances.

In the debt-to-capital ratio declined 3.5 points to 49.6%.

You will recall that one of our major objectives has been to manage our cash flow to the point where we can be cash flow positive in each of our four quarters.

We came very close to achieving this goal in the first quarter and I continue to be very pleased with our progress in the second quarter.

I feel confident that we will achieve our full year target of about 400 million in

cash flow which we define as after debit ends but before acquisitions.

Most important from my perspective, however, is the earnings recovery from the low point reached in the fourth quarter of last year and the first quarter of this year.

Many of you will recall a chart we have been showing investors since our January 24th New York investor meeting.

This chart depicted a sharp v shaped Kodak owning performance with earnings descending to the fourth and first quarter low point.

And then sharply recovering as we move to the second quarter.

Our second quarter results clearly indicate that we are established on that earnings recovery pay up.

Even in the face of continuing economic weakness.

In summary, we are successfully reducing the cost structure of the company, effectively managing our cash, paying down debt and improving our operational effectiveness.

We are well positioned to benefit from the economic recovery when it arrives.

Now I'd like to turn the call over to Dan Carp for some comments on the second quarter market trends.

Thanks, Bob, and thank you everyone for tying into the call this morning.

From my perspective, the most important element of our second quarter performance is that we were managing well those things that are under our control.

Costs are down, manufacturing productivity is up, cash performance is strong, debt has been reduced,

imaging results have been sharply improved, US film market share is improving sequentially, and new products have been introduced into the market place.

The one thing that is missing is an improved economic performance, and however, we are positioning the company well for the upturn that will inevitably follow this current downturn.

The top line weakness spot mentioned is the divisible virtually across all of our businesses and across many of our geographies rather than concentrated in US consumer markets alone.

And while we have significant revenue softness in the US, outside the US revenue trends are at best mixed.

Latin America, well, it continues to be weak with Mexico particularly soft, as is Japan.

And we saw increasing weakness in western Europe late in the quarter.

However, we did see revenue growth in Asia generally, and China and India specifically.

Now looking at some key second quarter

for signs of a US film industry gross visible in the first quarter

have disappeared.

During the second quarter, historically our largest quarter of the year, US consumer film industry volume growth is down 6% on a year over year basis, a bit more than the negative 5% we estimated on July 11.

For the first half of the year, US film industry growth is down more than 3%.

This is significantly softer than we expected at this point in the year.

With digital substitution explaining only a small portion of this softness.

However, I am happy to report that our US consumer film market shares continue to show sequential improvement in line with plan, although still down year over year due to difficult comparisons as we've discussed.

As a result, I remain confident of reaching our full year share goals.

As a reminder that Kodak is more than just a US company, through the fourth quarter of last year, the most recent quarter for which we have data, Kodak continues to gain consumer film share on a worldwide basis.

US film prices, well, it continues to be competitive but not outside our range of expectation.

The combination of slower industry sales, lower prices, unfavorable year over year comparisons, and significant reductions in retail inventories, and stronger year ago sales created weak second quarter U.S. film sales performance on a year over year basis.

However, retail film inventory levels will respond positively to any sign of increased consumer activity, and our share management activities are showing the expected results.

So on a longer-term basis, I'm quite comfortable with my position within this market.

As I mentioned, the top line softness is seen across the breadth of our businesses.

Our commercial product and services in the photography segment continues to see economic weakness, with products in our motion picture and professional markets also experiencing sales declines.

Now for those of you who've tracked short-term digital camera market share movements, I want to give you a heads up.

The very good success of our EasyShare digital cameras have given us a temporary challenge, as the combination of this strong demand for this very popular line of cameras, coupled with some component shortages leaves us short of product to sell.

This will continue to trouble us from a market share perspective during the third quarter, but every sign says it'll be fully resolved in time for the all-important fourth quarter.

You know, seasonally, the most important period for digital camera markets by far is the fourth quarter.

And as Bob indicated, health imaging net margins continued to improve, peaking at 19.7 percent in the current quarter.

However I have agreed with health imaging's new President, Dan Kerpelman, on some increased investments to drive profitable growth in this business, that will result in the net margin performance moving to the mid to upper teens range going forward.

I'm very pleased with both the quality and the speed with which health imaging and the team led by Candy Obourn as COO tackled their problems.

And now with the recent addition of Dan Kerpelman, the health business is on a very sound footing.

Lastly, NexPress continues its impressive entry into the on-demand color printing market.

Over 100 units are in customer's hands, and print volumes, which of course drives consumables demand are running ahead of projection.

It's early, but it appears that NexPress is rapidly establishing a leadership position in this market.

Looking ahead, providing earnings' guidance for Kodak, and many other U.S. companies, is made difficult by the continuing weakness of the global economy.

Our current planning is based on low single-digit second half revenue growth, excluding exchange.

While we certainly do not rule out the opportunity for stronger growth in this, should this expectation be born out, our second half earnings will most likely fall into the lower half of our $1.35 to $1.75 guidance range.

We'll just have to wait and see.

While we all know that every downturn is followed by an upturn, the big question remains when.

We all know it's going to come, but the exact timing is still cloudy.

So, in summary, we at Kodak are doing what we said we'd do, we're driving down costs as rapidly as possible.

We're managing for cash, and effectively managing for cash.

We're driving operational improvements in our business.

We are intelligently and successfully managing our market position.

We're staying on our strategy.

And we continue to introduce new products, both analog and digital products.

But most importantly, we're showing the earnings recovery that we predicted from the fourth quarter and first quarter lows.

The only thing missing at this time is the economic recovery, which when it arrives, will restore top line growth.

We feel at Kodak we are well positioned for that to come.

And now I'll turn you back to the conference coordinator who will lead us through the Q&A session.

Thank you sir.

Today's question-and-answer session will be conducted electronically.

If you would like to signal for a question, you may do so by pressing the star key, followed by the digit one on your touch-tone phone.

Once again, that is star-one on your touch-tone phone.

If you have queued up for a question and have found that your question has already been asked, you may remove yourself from the queue by pressing the pound key on your telephone.

We'll pause a moment to assemble our roster.

We'll take our first question from

with UBS Warburg.

Hi, good morning.

Hi

.

Hi, wanted to ask, obviously a few things.

First, with regard to the U.S. film market.

Could you just talk about what you meant with the retailers cutting inventories, where are we as far as weeks of inventory and how much longer will that continue and can you clarify that?

And then I have a follow-up on currency and cash flow.

OK.

Maybe the best way, maybe I ought to back up, because this is a complex area, although

you understand it as well as anybody.

You know, the U.S. film market down about six percent is a consumer take away right?

So what has happened is if you look at our sales in, they're impacted by three things.

One is a lower U.S. market this year versus last year.

The second piece is lower shares.

I mean, while I'm very pleased with the, in fact, I'm very, very pleased with the sequential improvement in market share, we knew that there would be some pressure on our sales, because the year-over-year comparisons are still negative in the consumer sell-in in the U.S. due to that abnormally high market share we carried through the first half of last year.

So that's the second piece.

And then the third piece is watching retail inventories.

Now what drives the retail inventory adjustment?

Well that drives their expectation of forward sales, as they look at the economy, not just for the photographic category, for everything from, you know, soup to nuts, and then their willingness to take risk in that.

And what we've seen is they have reduced their inventories, again.

They're not at zero.

It's hard to know exactly where it is, but for our discussion, let's say they're, and this isn't an exact science, but they're in the six to six-and-a-half week range, of course, that's a function of what you think the forward demand is, and in today's market, particularly in the United States of America, these retailers are really good at managing their inventories.

On the downside, they pull back.

The industry weakness described.

There's s logical response.

This is logical when we see this thing bounce back up and we will, they'll come in and we'll get a double whammy if you would, as they carry their inventories back up.

So that's kind of where we are in the, in sort of tying the film industry, which is weak, our market share, retail inventories through the calculation.

I thought, and I could be wrong, but I thought historically, given in the U.S. four to six was a pretty good level, and you know, and the good times can get as much as eight.

Does that sound you know, pretty realistic given today's times?

You know we got two trends going on here.

I think, I think six we would consider on the low side.

Now again, we're all projecting as a percent of forward sales, right?

You don't look at backward sales.

You look at what you what you think forward sales are.

So, our estimates of what they think is part of the estimating process here.

But, 6 looks a little low to us.

We think a more normal time would be in that 8 range.

On the other hand, if we kick back into those heavy days of double digit industry growth like we saw in the 90s, and I'm not predicting we'll get back there, they'll go up on that because you know, they are trying to stay ahead of the curve and we have seen inventories get up above 8 with no problem in those, what was it, 14% industry growth rate

.

OK, thanks.

And then, with regard to currency, could you just outline the impact on the bottom line and how that's going to go throughout the year sequentially, Bob, that'd be great and take into account your hedging program, which at times could cap your upside, please?

Yeah, the hedging program has capped our upside.

We had, if you add the

up, we generated about 4 cents in the second quarter from exchange, while the revenue was up a point due to exchange.

For the rest of the year, we're hedged out in the euro, in the Australian dollar, you know, those hedges aren't completely effective, but it will dampen the earnings upside.

So we'll probably see something like that in the third or fourth quarter, but I'm not sure yet.

So, you know, we will, you know, we hedge to dampen volatility, not to speculate.

So, you know, you won't see anything more than we saw in the second quarter for the rest of the year, because we are hedged out for the year.

OK.

Thanks.

And then, just finally, on the cash flow basis, free cash flow, Bob, correct me if I'm wrong, but year to date, you're at about 250 million in cash before dividends?

No, after dividends.

Well, you haven't paid a dividend yet, until last week, or something.

Good point.

And now, just for the rest of the year, to hit your goal, if my math is correct, you know, you'll need to generate another 700 million or so.

So if you could just talk about how cash flow goes sequentially and then, last year you had a billion in the fourth quarter.

I would assume that that's not repeatable.

Well, the fourth quarter of last year is we had a very good inventory performance as you might remember.

We took inventories in the second half down sharply in response to the 9/11 issues.

What changes as we move through the year is our profitability, which in the fourth and the first quarter is, you know, was down in the 10 cent range.

It gets much better now as we move through and so we start trading a little bit of working capital performance for the old fashioned way of earning income.

So we have to cover the dividend payments and, you know, we are comfortable with that and are comfortable with our 400 million.

Estimates for the year, so your calculations are right.

So, you just each quarter sequentially, you cover the dividend payment and then some for each of the quarters.

Yeah, and we're still, our forecast

.

A little bit more for the rest of the year.

You know, we told you early in the year our priorities this year are to maintain the dividends, hold down that, and then if there's any, you know small niche type acquisitions that came along, that really no

those.

But right now, that's a big factor this year, as you know, so we're on track to doing that 400 million for the year which includes generating about that much in the second half.

You know, each quarter, our long term goal now is to not have these big negative quarters and the, be it 0 or positive cash flow in every quarter, and the second half, it looks like we'll be able to do that.

And the target debt to cap if you achieve that goal?

The debt to cap down below 50, as you know, this quarter.

It'll move down a little bit this year.

The target is we want to get it down in the 35 to 40 percent range, but that might be, you know, a year or so away, because we'll, you know, as we continue to slowly pull the debt down.

Next year, next year we'll probably make a little more progress on that because we're not going to be doing anything I know at the lower equity, like restructuring, that I know of right now.

And we, and we'll probably continue to generate good cash, or pay down debt.

So probably in another year or so, looking more like, you know, in the 35 to 40.

Thanks Bob.

Our next question comes from

with Credit Suisse First Boston.

Thank you very much.

My first question is sort of conceptual in nature, and then I have a follow-up that's more specific.

Just looking at, right now, it's obviously in very difficult economic times, it just, thinking conceptually what happens to your P&L as you come into a recovery mode?

It seems first of all, you know, your markets should show greater volume growth, you wont have some of the channel inventory reductions.

It seems like volumes are positive, given that you're a fairly fixed cost business, that should help boost gross margins, you know, in that type of environment.

But at the same time there's an offset, probably you're going to have higher equipment sales, which is going to pull gross margins down.

So conceptually, if you look at your Q2 performance, 37 and a half percent gross margin, in a comparable quarter in a recovery mode, you know, given that, you know, things there were pretty weak still in Q2, can you see yourself doing a higher gross margin?

I mean, directionally can you improve it beyond that level?

Let me, that's a very complex issue, as you, as you laid it out.

And there's probably as many moving parts in there as anything.

Let me start with a couple of them.

On the, on the factual side, the gross margin in the Q2 was our seasonally our highest gross margin.

So we have to expect gross margins to come down after that, given the seasonality of our business.

I mentioned in my comments this is the biggest consumer film month.

Also putting pressure on gross margins will be continued price and even geographic mix, as we know the margins are not quite as strong in emerging markets as they are in developed markets.

On the plus side, and that was one of the reasons we had a good quarter, is we continue to be pleasantly, I hate to use the word surprised, because everybody goes nuts, but the truth is pleasantly surprised as even as we put some small volumes through our plants, with the strong fixed costs, it's a real pop.

Now that only comes about if you're really tenacious on costs, right, if you, if you let your costs drift up as the volumes drift up, then you give it back.

And we're pretty, we pretty much got our hands on the cost dials here.

So, the big up tick will come, will come when we see the recovery.

We should get a good bounce up on margins.

The question is where does it start from, given the seasonal nature and given the pricing environment and mix environment that we're in.

Just to, you know, both of your two major global competitors, Fuji and Agfa, kind of have given guidance explicitly, or implicitly in a recovery mode of getting back at least to sort of a 40 percent plus gross margin level.

I mean, given your scale, is that achievable with the Kodak at this point, given the business mix?

And, you know, I'm talking, you know, I understand there's seasonality, but at some point?

No, I'm not, I'm not really ready to go there.

I would, I would argue that we're going to stay true to our strategies in the info imaging space.

A big help to our gross profits will be to continue to get our digital products that are profitable, more profitable, and the ones that are losing, profitable.

And I think some of our mix is pretty clear there, that we have a pretty good market share leadership in a lot of the digital products, particularly in health and a consumer, and so we'll just have to see how we play it out.

I can't make a forecast right now in gross profits, other than what I've said.

OK.

And the second, more specific question, I mean historically, Q3 has been so much a challenge for the company the last few years and always seems to be something.

And just with the guidance sort of having slight single digit type of revenue growth, I understand it's to have compared, but I mean what are the things that you're factoring in in terms of additional channel, inventory reductions, is that factored in in terms of what your expectations are on the pricing environment?

I mean, you know, what's the risk kind of you fall a little bit short on the revenue given that historically is has been a tough quarter for you and certainly this environment's pretty tough.

How have you thought about sort of the risk to that number?

The, I'll give the good, the plusses and the watch outs here.

We don't have, you know, considering that, even within the third quarter, with the events of 9-11, we saw sharp drop-off in sales for the last couple weeks in September and so the low single digits is a big, I'll call it disappointing that we're not seeing more up take.

In addition to that, we've assumed weakening in Western Europe, which we saw in the month of June, and we've gone back and looked at the numbers pretty carefully, not just for us, but for other, some other categories, and a lot of weakness in the month of June in the consumers space, weaker than April and May.

So big question about where that goes.

We're assuming that continues to stay weak.

On the plus side of all that is again, relatively easy compares.

One weak month in Western Europe does not make a trend, although this was really weak.

And on the other, the additional plus upside, you know, could be our cost structure.

We've taken out most of what we said we would make in headcount reduction, but we haven't, actually we're a tad big behind where we thought.

The reason we had a good second quarter is the factories did better.

What could happen going forward is the factories productivity will slow down a bit unless the volume's better than what we're predicting, offsetting that is we'll finish strong on getting the people out of here for the second half.

So, you know, I think this is the best we can give you.

We've got some good; we have some upside opportunities.

We have some downside opportunities.

And I'm not in a position to predict what the industry will do, but assuming it doesn't just tank into a classic double-dip, we should be OK within the guidance that we've given, including the fact,

that we said, you know, with the business where it is, it'll probably be the lower end of that range of what we've given.

And just as a follow-up, of those 450 million of savings you're expecting, what have you achieved at this point?

We don't, you know, give that kind of detail

, but our savings are very close to what we projected this year, and you know, obviously they have to be to get the performance we have.

So it's on schedule to be achieved fully for this year.

Is it like majority done, half done, I mean, at least just a general sense?

Well the majority of the actions have been taken place, you know, we're just waiting now.

There's some small part of the headcount reduction has yet to come and a few other actions.

But the majority of the actions were taken in the fall of last year and the first quarter of this year.

But in Q2, your SG&A and R&D were both up and you explained the reasons.

Did that reflect sort of the majority of the benefits of the cost-cutting plan, or is, you know?

SG&A will drift down for the rest of the year slightly.

OK.

But assuming there's no more one-time items which, as you know, is a real risky assumption, but as we look forward, assuming no more one timers, you should expect the SG&A to be, you know slightly continually stripped down, but it is running below, on an apples and apples base it is running below last year.

Great.

Thank you very much.

And

we didn't have a planned big reduction in R&D.

You know, I felt all along if I can manage the company to take cost out, particularly around SG&A and manufacturing costs, and generate the kind of cash that we generated, pay the dividend and pay down debt, and stay true to our R&D budget, that would position us as well as anything for the uptake and for the

imaging space which continues to come together in a, you know, a big way, about the opportunity.

So I haven't used R&D to make the numbers.

Great.

Thank you.

We'll now go to Jonathon Rosenweig with Salomon Smith Barney.

Hi guys.

Hey, Jonathon.

Hi, Jonathon.

A couple things, some following up on prior questions.

Following up on

's questions.

With regard to the restructuring, if I recall correctly, I think you still have, like, 1400 left to go in the head count reduction?

Yep.

And, so, wouldn't that suggest that there should be another 70 million or so of savings that ought to come from them?

I mean, it's generally 50 thousand dollars in salary per employee, something like that?

Yeah, those people, Jonathon, will be gone by the end of the year.

OK.

The full impact of that savings will be next year.

There will be some in the second half and that's why I say, costs will continue to drift down.

But the full impact of that analysis will be next year because those people will go our during the second half of the year.

OK.

Now as far as productivity, and actually production, I know that part of the benefit you had in gross margins this year in this quarter relative to last year, that last year from Q1 to Q2 you cut inventory dramatically, this quarter you're production was at more normal, a little bit more normal levels although your volumes are obviously under pressure from the economy.

I guess the question is, since the volumes are coming down a little bit more than you thought, the demand has been a little bit lower than you anticipated, revenue is, I think, a little bit lower.

Does this mean that we need to take a second look at production levels and that maybe production has got to come down a little bit and might that affect the gross margins going forward?

This is Dan, I didn't do a good job before with

and, that was what I was trying to say.

I think, now that we've lowered a little bit of our expectations for the second half.

That'll put some pressure on

and the manufacturing guys to continue to, because we're not going to let our inventory get out of line.

Offsetting that though, will be, just our plan, we'll take more people out in the second half than we had originally thought.

Not more for the year.

Just timing.

And I think that'll allow us to bring our cost in pretty much where we think it will.

A lot of moving parts underneath that simple statement but that's where I think we are.

OK.

And then, just two quick follow up questions.

One is, you gave the guidance for the second half, not so much so though, in terms of third quarter versus fourth quarter and I think Bob, originally you had an intention of trying to end the year somewhere around 75, 80 cents.

I would imaging we're now looking at, you know something that would be, Q3 is generally higher than Q4.

So I would imagine that we're not looking to end the year probably somewhere closer to the 70 cent range and be somewhere, maybe a little north of that in the third quarter.

Is that a fair way to look at it?

We're not giving guidance by quarter right now.

You know, we're sticking to the range we've been going through, we've been telling you all year, I think, you know, the economy in the state it is, with, the, you know, the lower half of that range.

So we haven't split this out by quarter

.

OK.

You had, although it wasn't official guidance, back a while ago you had talked about a goal of hopefully getting to something closer to 320 in 2003.

Given that, you know, the base that we're working with in 2002 has obviously been more challenging to you guys than a little of people anticipated, I would imagine that, you know, we'd obviously have to rethink that as well.

Is that, is that fair?

Well you got the 80 cents, but way back in January, when we said we were, that wasn't a goal, that was just a, if we got the earnings' level back up to 80 cents, four times that's 320, but that was not ...

Right.

... guidance, it was not an estimate, it was just a mathematical fact.

Yes, I guess this is another way of asking, is there, you know, if the bases come down here somewhat, is there another action that can be taken to help drive more savings that help get you up to that kind of level of the run rate sometime in '03, or do we assume lower base means, you know, just lower going forward?

Well we have an analysts meeting scheduled for September 18th, in New York City, and I think you're invited, and what we're going to try to do is that Dan and I'll take a look at the rest of the summer, how the film shares are going, and how things are going, and we'll update that.

We have no official guidance on the street for next year, but we will, we will give some, probably give some guidance at that meeting

.

And I don't want to say anything now about next year, there's still too many uncertainties.

just to, just to put in perspective the kind of roller coaster, and we're trying our best to be as open and honest and frank on this as we can, January was a terrific month.

February weakened, March kind of ugly, we made first quarter what we thought back dated by a bit.

I'm talking about sales and industry kind of things.

Being, you know, January's weaker, February, March.

April, bang, off to a great start, we were high-fiving ourselves around here.

May weakened, and then June really weakened, both here and Western Europe.

So with that kind of volatility, all that says is that, as I said last time, it's sort of like my lawnmower.

You know, we can sense the string is being pulled and it's trying to catch, but every time this thing dips down like it did in the last month of the quarter, you know, we have to just admit the truth to ourselves, that it's just hard to call, and that's whey we're staying true to our cost programs, until we really see some sustainable up tick in the economy, in our business, driven by economic factors.

Great.

Thanks a lot guys.

We'll now go to

with HG Wellington.

Thank you, the question has been answered.

Thank you.

Our next question comes form

with Buckman, Buckman and Reid.

You were ...

Hi.

Hi.

You were talking of savings of something like the neighborhood of $450 million for the full year.

The assumption, at least my assumption was that, oh maybe two-thirds of that would be out of SG&A.

How's that playing out?

In essence, what seems to be happening at this stage is your SG&A overall seems to be increasing because of the great, let's call it service component, of your business.

And you, the savings then are being offset by increases because of the change in the mix?

Yes.

Let's see, I'm going to let Bob give you some background on the SG&A.

It's a little, it's a little complex this quarter because we got good cost reduction underneath there, but some other changes.

Never along did we expect the majority of the productivity to come out of SG&A.

It really, it was broad based, and a big chunk of it came out of manufacturing and distribution kinds of operations.

So let me, if I could, I'll ask Bob to give you a little more granularity on the SG&A in particular.

Yes, we have, the

guiding this reduction is about two-thirds in cost of goods sold, and you're seeing a lot of that in the improving manufacturing productivity that

talked about earlier.

And about one-third of that effort comes out of SG&A, which gets a little bit offset by the fact that it's our business plan and we've been talking about it, of increasing advertising as the year goes on.

So you're going to see a better reaction in the cost of goods sold, because there's no known or planned offset to that and in SG&A, you know, SG&A is where things that bad debt and some of those things we talked about in this year reside.

That'll be offset somewhat by advertising.

You know, advertising, we'll watch that as the year goes on and try to balance that.

So, at any rate, the big part will be in cost of goods sold.

The good productivity you saw in the second quarter was responsive to that.

And looks like that's going to pan out for the year in that direction.

I will use your question now to put a plug in for something that seems to be working.

We've launched in test markets, the Kodak perfect touch campaign.

And while, and I know,

you understand this very well, it takes time to build momentum, the time to consumer advertising campaign

, but the early results in the test market are very good in terms of consumers understanding seeking out Kodak processing, gives them a better picture.

So early results are in on that.

Now as

said, how much we'll fund that in the third and fourth quarter has to take into account what the business environment's like.

But assuming it's like we are, we'll see some up tick in advertising in Q4, particularly to take advantage of what I think we've had as a good program.

Can you give us some idea as to what you're advertising was like this quarter as a percent of sales?

I can tell you it was up about 10 million.

I can't, I don't have the number in front of me exact level, it was up about 10 million.

OK.

You have had great success, I believe with

.

This is my particular pet.

Do you, can you give us some idea as to what's the number of people that now actively

and whether you're planning on charging something for our storing our images there?

What's been, for me, it's where things are managed, so

computer.

I'll send you a bill right after the conference call.

The

is growing nicely.

It's doubling, and it'll double for the year.

It's on a relatively small base, still, less than, it'll be less than 50 million this year.

So what we're doing with it is we are growing it slowly, or growing it fast of a small base, and we are promoting it.

The new easy share software certainly does that, but we're also enabling our retail partners through the

initiative that we started to get their own online service, because it's pretty clear to us that people, those consumers, some consumers want to do it at home, some consumers want to print in store; some consumers who want to point online, want to print online and have it come back in the mail; some people who want to print online want to go to a store and pick it up, and if they don't like it, have a human being to talk to.

So that's why we're trying to help our retail partners get to an online offering there too.

Now within that piece, which was one of those four, which is direct online through the mail, that's the piece we're talking about growing, doubling over a small base being less than 50 million this year, and we are studying how to give new products and services, of which storing could be one to them, and see what they would like and is it worth the investment to make it happen or are we better just to stay with giving them albums and large prints and greeting cards?

And of course, our retail partners who are with us will benefit by that data information because we'll share that same data with them.

So it's along way to answer that we do believe that we're on a big idea.

We don't believe it takes over the industry, we believe it's one of four possible ways and we believe we're gathering a lot of information right in line with what you're saying including CRM, how to motivate people to go back in and get extra prints on days they hadn't thought about it and then we'll share that with our retail partners and one plus one should equal five, out of that.

So essentially, you're looking forward to some kind of a lab?

It'll be a business, but right now, given that is

, we're using it not only as a business and we will continue to grow it, but also as a lab, for our customers who are partners because we want to grow the output piece of this digital business as fast as possible.

Thank you, sir.

We will now go to

with Morgan Stanley.

Yes, hi, thank you.

I think the question was asked before, but I apologize, I wasn't sure if I heard the answer.

As far as pricing assumptions for the second half are concerned, can you provide a little color there in terms of what you're assuming?

We think the pricing environment will be competitive.

That's what's in our plan.

But no major, you know, no stepwise change in either direction anywhere in the world.

OK.

So, down 6% on the consumer film side, that's if

to carry over into the second half?

I'm not gonna, I'm sorry, I'm not going to give any kind of assumption there.

We have our plans, we have our plans with our retail partners, we kind of know what they are, but I'm sure it's not going to give any signal to anybody, from what our pricing plans are.

OK.

And then, just switching over to cash flow.

It looks like cap ex continues to track below, I think your target had been 550 to 600 million for this year.

Is that still a good estimate for this year, or should we assume something lower than that?

I would stay with the current estimate you have on the cash flow.

We have been tight on it, we've managed it tightly.

There will be an uptake in cap ex in the second half and that's normal.

Normal, we spend most of our cap ex in the back end of the year.

This year it'll be a little higher than that, but stay with that estimate for now.

OK.

And then, just finally, with respect to the additional spending, in health imaging, in the second half.

Could you just provide a little bit more detail in terms of where that spending is going to go to and could you, envision a scenario where, you know, you continue to delay some of that spending and the margins actually do come back into the high teens as we saw in the second quarter?

You know, we see a little increased spending across the board.

We see it in SGA with additional sales and service support as we see an opportunity there.

We think the mix will change a bit, back to more printers as budgets of our customers, you know, start to run out towards the end of the year, as you all know, big accounts sometimes spend their budget.

Everybody was cautious in the first half.

So printer sales were a lower percent of the mix because no one knew what was going to happen but as large hospitals and purchasing organizations now get deeper into the year, we expect them to come back in the market for printers and we, you'll, we'll supply them printers.

That's the annuity stream for the materials business going forward.

I expect maybe some uptake in R&D in the health business as we work on the future now that the business is stable.

We pulled that stuff way back until I, until I was convinced they got things under control.

And so that's kind of what we'll see in the second half, and then, and then as I said, you know, we think this could be in the mid teens kind of range.

I'm not going to squeeze this business way too high and, squeeze this business way too high and miss a great opportunity to carry it forward.

OK.

Great, thank you.

We'll go now to

with Merrill Lynch.

Good morning, or almost good afternoon, we're getting close.

Couple of questions for you.

First of all, can we get just a little bit more into, you know, how you've been able to cut production costs, did you close lines?

Any sort of major changes in the way that you guys have been producing some of your films, such that either it'll, you know, continue on, or maybe we'll see it bounce back like you said, with the gross margins later in the year as production comes down?

But I mean, specifically in terms of the production of the film, were there any major changes in the last couple of quarters?

No, there was no, there was no, what's the right word, stepwise change.

We've been on a long-term process called the Kodak operating system.

We changed the way we run our plants, and so we harvest, or we took advantage of where we were in that program.

And that's paying some dividends that will come in fits and starts.

It just so happen a big, a big - we got some of it now and we're continuing to work it.

Second thing, we jumped on this.

I mean, we saw, we saw problems in demand, and we went after both indirect and direct labor costs as fast as we could.

We have a world-class purchasing organization, and when we saw what was coming, we sent them out with aggressive targets for our suppliers.

The good news is by being out with aggressive targets for suppliers, when the business did slow down, both suppliers were very responsive.

And we've made progress, taking advantage of a bad economic environment to make sure we were first in Q1 low supplier component cost.

And then, the digital camera moving to China, last year I told you we were doing it, and we're pretty much there.

I think we are there.

And so we got a better cost structure out of that.

So it's a lot of, a lot of points alike.

Now we'll tell you, that we'll say that maybe we even surprised ourselves on the productivity in the plant.

Not, you know, you can calculate headcount pieces, but the yields that we got and the way we're getting materials, and I'm glad we did given that the volume really wasn't as high as we thought.

And on digital cameras, I was under the impression that you, that the newest line of EasyShare were still being made in the U.S., and that some of the older models were in China.

Has, how does that migration occur?

Lets see, I probably miscommunicated somehow here.

I apologize.

We haven't made EasyShare cameras in the U.S. in many, many years.

The cameras, most of our cameras were originally, as the industry, were made in Japan.

That was the center of the digital camera business early on, we were there like everybody else.

We're one of the early ones, but others are right with us now, moving into China.

And so we've been on a program to move the production to China.

Most of the design remains in Japan.

OK, but most of the cameras are now being made in China?

Absolutely.

At this point time.

OK, and then, I just, a clarification when you talk about the SG&A and one-time charges and all of the talk about advertising.

I guess I'm trying to figure out, are you considering some of your advertising programs to be one-timers, or, because to me that seems like an ongoing just business expense or was there something special?

There was nothing special;.

It was, I was, we were trying to look at SG&A excluding advertising, and the one-time comment really referred to the bad debt and some other miscellaneous stuff.

Advertising will continue to move up through the year and not be a one-time charge, but it was my mis-wording of the paragraph when I was describing.

Don't consider advertising as one-time.

Yes, I figured, I just wanted to ...

Reoccur.

To clarify.

OK, and then are there any large contracts that are coming up in the next quarter or so?

I mean, you know,

about Sam's Club and some of the others, but is there anything on the health imaging side or on the film side that we need to be cognizant of and watching for.

Contracts come and go and nothing unusual coming in any of our businesses, but contracts are always up.

Anything that's immaterial percentage of revenue.

Not that I know of.

Other than the Sam's coming up.

Sam's as been reported.

It's been reported and I don't know of any large ...

But we also will not start reporting contracts, because those are customers responsibility, not mine.

OK.

OK.

Thank you.

Our next question comes from

with Deutsche Bank.

Hi, yes, thanks.

I wanted to get some color around your earlier comments about the digital market and its impact on the U.S. film market, and basically why you believe that the digital substitution was a small part of the softness.

Well, you know, we track digital camera usage, and we follow that very carefully.

The impact to the industry growth rate this year looked like it would continue to take about two to two-and-a-half points off the industry growth from what it would have been.

As I said in my comments, industry has reached the peak of the traditional business, growing around 14 plus percent a year, so if it was running at that peak, then two to two-and-a-half points would have said, it would have been down in, what's that 12 percent range or something like that, or eleven-and-a-half percent.

But in fact with the industry down six percent, that means it would have run minus three or something, had there not been the digital substitution effect.

And that swing is really a bigger issue, not particularly and we'll get back to 14, but that swing is a bigger issue than the digital camera.

Digital camera's a slow transition as the number of digital cameras in use grow, the number of traditional cameras in use remain the same, but people don't use them as much.

So it's a slow transition.

All I was trying to point out that the majority of the swing we see now from what we would expect in quote normal times, whenever that is, is much more due to the slowdown in travel.

We've seen it reported from the airline industry.

The slowdown in the size of vacations.

People are still taking their vacations, but they're taking them close to home, and frankly the overall consumer sentiment and the unemployment levels, which in the U.S. still remain troubling.

And now we're seeing unemployment reach recent highs in Western Europe and so you know, it's those things that are affecting the short-term much more than digital substitutions.

That's great.

Thanks.

Thank you.

We have no further questions at this time.

I'd like to turn the conference back over to Mr. Carp for any additional or closing remarks.

OK, well these are interesting times everybody, right?

I mean this, figuring out this economy.

We do that, we'll all hold hands and be in good shape.

What we have to do at Kodak is manage given the vagaries as what I hope most companies are doing.

For us, it's managing for cash, being tough on cost.

Continuing to gain market share or manage our high market share positions very well by staying close to our customers in being competitively advantaged with our products, our marketing and our services.

And position this company for the upturn.

It will occur.

And we're going to stay true to our R&D investments because even after the upturn the

imaging space still looks very attractive space compared to many other market segments.

And we're just going to have to keep our head down in going through this and I am pleased with the Kodak team's response through fourth quarter of last year and the first two quarters of this year.

Thank you very much and have a good day.

That concludes today's presentation.

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