Eastman Kodak Co (KODK) 2003 Q2 法說會逐字稿

Good day everyone and welcome to Eastman Kodak Company's second quarter sales and earnings results conference call.Today's call 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. Donald Flick.

Please go ahead sir.

Good morning, and welcome to our discussion of second quarter earnings.

I'm her with Dan Carp, Kodak CEO and Antonio Perez, Kodak's President and , of course, Bob Brust, Kodak's Chief Financial Officer.

Before we get started, there are a few housekeeping issues I need to address.

First, relative to the recently adopted SEC rules for condition use of nonfinancial measures, in our discussion this morning we will be using our performance using both GAAP and nonGAAP measures, which we refer to as operational.

Where this is done, the reconciliation between the two measures is provided in detail in our financial discussion document, available via our wire service releases as well as our web site, www.Kodak.com.

Kodak believes income from other measures, excluding nonoperational items, provides an important additional measure of performance.

Where operational measures are provided, it is done so that investors have the same financial data the management uses and in the belief that it will assist the investment community to more properly asses the underlying performance of the company on a year over year sequential basis.

Lastly, let me call your attention to the Safe Harbor provisions that cover any forward-looking statements that would be made in the course of the this morning's discussions.

Of course, these are forward looking statements as defined in the United States Private Securities Litigation Reform Act of 1995.

Actual results may differ from those expressed or implied in such forward-looking statements and are subject to a number of important risk factors.

A complete discussion of these risk factors may be found in the press releases this morning as well as in Kodak regulatory filings.

I advise listeners to review these statements carefully.

Now, let me turn the call over to Bob Brust, Kodak's Chief Financial Officer.

Thanks, Don and thanks everyone for joining me for some guidance.

As you can see from our results this morning, we had a strong upside in the quarter.

If we are going to have a swing, that is the right direction that we want to go, but in reality we had a very strong finish to the second half of June.

When we were evaluating whether or not we had to revise our guidance lower, after we had seen the results in May, several facts were clear.

First, the results we had posted through May would require an exceptional June performance to meet our guidance range.

Second there were a number of factors having a negative impact in the quarter, particularly in the consumer business, the most obvious, which was the SARS impact in Asia, generally in China specifically.

That said, when we got the books closed on the quarter, we discovered that every business unit exceeded their June estimates for earnings, with consumer and health imaging, particularly, better than estimated.

In addition, the below EFO performance of our NexPress and Kodak polychrome graphics joint ventures also exceeded their expectations.

Plus, we picked up additional help from an unexpectedly lowered tax rate.

In total, everybody did better than we expected in mid June.

Let me now review some of the other key aspects of you're second quarter performance.

Our GAAP earnings were 39 cents a share, with the discontinued operations having no impact on the quarter.

The gap earnings from continuing operations included the following items on a pretax basis.

A $54 million charge associated with cost reduction actions, announced in the fourth quarter of 2002 and the first quarter of this year, settlement of a patent infringement claim for $14 million.

A 14 million charge, resulting from the settlement of issues related to a prior year acquisition, although the settlement did result in a small amount of cash coming to the company.

A charge of $9 million for the write down of Burrell companies net assets held for sale.

Net of these items, operational earnings were 60 cents per share compared to 86 cents per share in the year ago, quarter.

Revenues were about on expectations, essentially flat as reported and down approximately 6% excluding the benefit of positive foreign exchange.

The positive impact of foreign exchange, plus sales growth and commercial imaging and health imaging segments, were offset by lower photography segment revenues.

Results from slow sales in traditional services.

China, which had been experiencing strong double digit growth quarter after quarter, actually declined by 19% in the second quarter.

Had China experienced the growth rate over the last few quarters, the company sales would have grown 2% before exchange and as booked instead of the flat performance we reported.

We expect a slow recovery in the months ahead in China.

Sales in the U.S. were off 7% for the quarter, while sales outside the U.S. were up 7%, as booked or down %4, excluding exchange.

Sales in our European markets were up 12% as booked, or down 4%, without exchange.

Other big movers included Russia, which was up 32% and India, which was 12%, partially offset by a decline of %12 in Brazil.

As in the first quarter, while the company reported flat revenue, it is important to realize half the company's revenue were in businesses that reported top line growth despite the challenging economic climate, offset by the top line decline in the traditional consumer products and services.

Motion picture films reported a solid growth of 18%.

Our consumers digital and applied imaging business posted a 68% revenue growth, but the previously mentioned growth, in health and commercial imaging.

Operational gross profit as a percent of sales, declined 4% year over year to 33.6%.

The year over year decline resulted from unfavorable price mix of 3.5 points and negative manufacturing productivity of two points, partially offset by the favorable impact of exchange of about two points.

Productivity declines are directly related to the lower volumes experienced in our historic consumer business.

I was generally pleased with expense control in the quarter.

R and D was down year over year.

Operational SG&A up, but due, entirely, to the impact of foreign exchange on 9 U.S. dollar costs.

Operational earnings for the second quarter were 268 million at 36% year over year decrease, due to lower levels of gross profit.

Interest expense in the quarter was down ten million, year over year, as a result of lower interest rates and lower average borrowing levels compared to the year over year period.

Other income improved 13 million on a year over year basis as a result of increased income from Kodak, polychrome graphics, lower losses as a results from the Phogenic joint venture and improved economics performance from the Nexpress joint venture.

The operational tax rate for the quarter and the full year is estimated now to be 24%, down from the 26% booked in the first quarter.

This is simply the result of generating more income and lower tax jurisdictions.

Operating cash flow in the second quarter was a $53 million use of cash, which is a $355 million decline from the year over year period.

The reduce cash performance is primarily the result of lower earnings of 171 million and higher levels of incentive compensation payments, including the wage dividend of $130 million, earned in 2002 but paid in April of this year.

Looking forward, using the same metric, full year operating cash flow after debit ends and before acquisitions is forecast to come in at about $500 million.

Essentially unchanged from our previous forecast.

This represents dollars available for debt reduction and or acquisition activities.

Dan Carp will discuss future earnings estimates in a few minutes.

As noted in this morning's earning release, the company, based upon preliminary plans, expects to record charges of approximately $350 to $450 million during the next 12 months.

These charges address costs associated with reductions in corporate administration, R&D, consolidation of the infrastructure and professional products and services and with some rationalization of global manufacturing assets.

As a result the company expects to reduce employment by a range of 4,500 to 6,000 employees, beginning later this year.

This is a reduction of approximately 6 to 9%, from the company's worldwide employment of about 70,000 people at the end of last year.

We expect to generate annual savings of approximately $300 to $400 million from these new reductions, with between 275 to 325 million being realized in 2004.

As you are all aware, we announced on Monday of this week the acquisition of PracticeWorks, an attractive addition and extension of our dental products businesses for $500 million in cash.

I don't anticipate any difficulty in financing this business in closing.

Although, through a combination of debt and cash we will determine at that time.

It is important to remember just how much we have been able to strengthen the balance sheet over the past several of years.

A time period when many companies financial strength has eroded.

For example, at the end of 2000, Kodak's net debt or debt minus cash, was about 3.1 billion.

That improved to approximately 2 billion at the end of last year and stands at about 2.1 billion at the end of the second quarter.

Even with the PracticeWorks acquisition, our net debt should be in the 2.1 billion or 2.4 billion range at year end.

On the subject of the dividend as we discussed during our Monday conference call, regarding the PracticeWorks acquisition, Kodak's dividend policy remains unchanged.

As we have indicated for the past year or so, we had signed a high priority to maintaining the dividend, unless a superior use for cash is found.

In preparation for a board meeting, where the dividend will be considered, management considers the competing opportunities to employ cash based upon the facts in front of us and we make a recommendation to the board which then decides on the dividend policy.

The next time this dividend discussion will occur will be in September.

For the balance of the year, we will continue to drive hard on cash management with an intense focus on inventory reductions, continually improving receivable performance and capital spending restraints.

At year end, net debt, with the PracticeWorks acquisition completed, as I said before, should be in the 2.1 to 2.4 billion range.

Now, let me turn the call over to Dan Carp for his view of the second quarter performance.

Thanks, Bob and good morning, everyone.

Thanks for joining us.

Obviously, this was a fairly volatile quarter.

The post war rebound didn't really appear in the U.S.

The full effect of SARS in Asia became visible, western Europe remained soft and enthusiasm for photography continues to grow.

We saw excellent performance across a number of our businesses, including digital businesses and our health imaging businesses.

Let me start with a discussion of our consumer imaging business.

As you can see from my results this morning, the historical consumer space continues to be soft in developed markets, with the U.S. consumer film industry down approximately 7% in the quarter.

If I look at the first half of the year which removes the impact of Easter moving between the first and second quarter, the U.S. industry decline is approximately 8%.

We haven't seen a great deal of change in the industry trajectory during the first half of this year.

We did give up a small amount of U.S. share in the quarter.

But, that simply reflects the ongoing movement of share back and forth in this market.

I remain extremely confident we will conclude the year with our average share once again unchanged on a year over year basis.

Price mix in the U.S. film market was up 2% on a year over year basis.

This should not be interpreted as a change in the pricing dynamics in the U.S. market, rather we saw a significant shift in the quarter toward OTUC, one-time use cameras, plus the price mix benefit to the normal sell in including high definition film, and onetime use cameras plus digital.

Looking underneath these results, I would characterize the pricing dynamic in the U.S. market as unchanged to somewhat more competitive, relative to the trends of past several quarters.

Looking outside the United States, the downturn in Asian film sales is quite dramatic, reflecting the significant impact of SARS.

As an illustration, Kodak sales in China are down approximately 60% in volume on a year over year basis for the second quarter.

For comparison, China, year over year volume sales, were up 19% in the first quarter this year.

That represents approximately an 80 percentage point change in the trajectory in this important market.

The story is the same across much of Asia, as Hong Kong and Singapore felt the effects.

As Bob noted in his comments, the SARS induced decline had a noticeable impact on our revenue for the quarter.

The good news is SARS is fading from the scene and that will permit a recovery in this important market going forward.

Of course the exact rate and pace of this recovery is hard to predict.

Barring some type of recurrence the market will slowly come back.

On the subject of digital transition, we have updated on ongoing studies in the U.S. and western Europe on the impact of consumer digital photography on film.

This results indicate that the digital adoption is reducing U.S. film growth by 8 to 10% and now accounts for the great majority of the sales decline of film in the United States.

Given that we now know that digital has become the principal force depressing film sales, we're moving rapidly to adjust our cost structuring light of that reality .

I'll have a little more to say about that in a moment.

On the flip side of the consumer sales production, digital camera sales growing 65% year over year.

Market response to our new EasyShare printer dock, far exceeding our expectations.

And ink jet paper sales up 51%.

Ofoto sales up 56% .

I'm pleased to tell you during the first half of this year, our consumer digital cameras achieved break even financial performance with corporate allocations schedule.

This is ahead of the year end run target we announced and the cost reduction program we announced today, will directly attack the amount of shared costs in the corporation, moving the digital business to fully allocated profitability in the future.

During the quarter we also saw major initiatives by retailers to promote the printing of the images captured by digital cameras.

For me, it is very encouraging to see the retail industry to give consumers easy and cost effective ways to print pictures from the digital camera.

This obviously, is an important part of releasing the opportunity inherent in the growth due to digital photography.

Entertainment products and services experienced high teen sales growth in the quarter reflecting the continuation of strong motion picture print film sales.

The industry dynamics are strong, with the continuing flow of movies into theatres and the ongoing trend of world wide, same day releases.

Our vision to origination film, continues to do very well, indicating that this market continues to reward product innovation.

Stepping outside the photography segment, health imaging reported sales increase of 7% or growth of 1% excluding exchange and net margins continued strong at 21.6%.

As all of you know, the big news in health is the acquisition of PracticeWorks, which we announced on Monday.

As we said in our conference call on Monday, this acquisition will move our dental business, a long leader in traditional dental imaging business, into a leadership position in the emerging direct radiography business and dental practice management software area.

This is a good example of the type of adjacency acquisitions we have and continue to seek out.

It is encouraging to note the strong second quarter performance that PracticeWorks reported, I think they reported last night.

Health imaging is a great business for Kodak with a strong management team and centered in an attractive market.

It is exciting to see them begin to execute this element of the growth strategy.

The commercial imaging group also increased revenues in the quarter led by growth in its imaging services and document scanner business.

The polychrome graphics joint venture continues to generate growth and cash led by the strong market position in digital proofing and digital play.

So, Kodak continues to do well outside of its historical consumer imaging space, particularly, in light of the current economic climate.

And the historical consumer products space, we intend to is sell a lot of these products for a very long time.

We will be adjusting the cost structure of that business consistent with the market realities, to ensure we remain the low-cost producer.

We recognize the opportunity for the historical consumer products in the emerging market and of course, will continue to drive those hard where we have had significant success.

We will continue to intelligently differentiate our products in the developed markets to offer consumers true choice such as we have demonstrated with high definition film.

Now, with that said, we are business in transition.

The cost reduction actions we are announcing today are consistent with the fact that the new growth areas of Kodak do not require the same level of infrastructure support and cost.

We'll trim that back.

We'll line our manufacturing capacity and the historic consumer products to the market demands.

These actions, in sum, will create a model consistent with the company we are transitioning to.

On the subject of the balance of this year, I have to admit it remains awful difficult to predict with any precision any future earnings performance, given all the moving parts we contend with.

Our current best estimates for the second half of the year are operating earnings between 85 and $1.15 per share with associated GAAP earnings of between 25 cents and 65 cents per share.

I would remind you, we do have an investor meeting scheduled for New York City on September 25, to discuss our strategy outlook.

This will offer us opportunity for an expanded discussion on the strategies we are pursuing and the associated opportunities for growth.

Now, Bob Antonio and I will be happy to take your questions.

Let me turn it back to the conference coordinator.

At this time, if you would like to ask a question, please press the star key followed by the digit one on your touch tone telephone.

Star one if you would like to ask a question.

We'll pause for just a moment to give everyone a chance to signal.

We'll take our first questions today from Ben Reitzes from UBS.

Thanks.

You guys did a pretty good job there trying to explain China.

I wondering if we could broaden it out to Asia Pacific region.

The sales were 537 million in the quarter.What do you think was the SARS hit there, on that number?

For all of Asia?

Yeah.

Ben, this is Bob.

I didn't look at all of Asia specifically.

We can get back to you later.

We didn't look at that specifically.

The primary emphasis was in China.

China is our second largest market and that's the one we focused our analysis on.

That's fair.

Just to qualify then, what was the SARS hit in China?

We'll get back to you on that this afternoon.

I just don't know.

Dan, it sounds like you're saying SARS is fading from the scene.

Based on what you're seeing, does that mean fourth quarter we get back to normal activity in China?

I don't think I can say that.

I believe, as you know, tourism is a key to this.

And every bit of data we see is that tourism is starting to pick up.

But, it is not shooting back up.

So, I think we have to assume it will be a slow trajectory out of the SARS situation.

Now, that's for the tourism from outside of China into China.

I do believe tourism in chain that will pick back up.

The government asked people to stay home on the May holiday.

I think by the time new year's comes around, which is really a first quarter occurrence next year, that people will start traveling around there and we might see some uptick in restocking in China in anticipation of that.

It is early to call, to say it is back to normal.

I think that is being too optimistic.

With regard to your restructuring, about $300 million in savings next year, is that all booked or is that done throughout the year?

That's your own booked portion, that $300 million, Bob?

The $300 million should occur throughout the year.

If we get a lot of the work done by the end of this year, it should accrue through the year.

A little heavier backward, in the back half of the year.

So that's a run rate.

Not all 300 flowing to the bottom line in that one year.

I think I said the run rate, let me look.

The run rate was higher.

We expect to generate next year 3 to 400 million.

I wanted to clarify that.

A run rate of 3 to 400 million, with 275 to 325 being realized next year.

I think somewhere around $300 million will be realized next year, spread across the quarters, but heavily in the back end.

So, we get, I guess, roughly 80 cents in savings.

How much do you think will be reabsorbed.

I know it is really hard to call, but it is a large portion, small portion, how much do you think will be reinvested into price reductions and what not, or that you will use to cut price or do you think that we really can see this hit the bottom line?

I think that it is way too early to make that call.

We have to see how things unfold the next several months.

We will be doing our detailed operating plans for 2004 in the fall.

And Ben and Antonio and I will get a chance to dig into this.

We'll give some guidance on next year based on where we think that will go you've set by this 80 cents.

We'll have to talk to you about this in the fall.

Thanks.

One last thing, Dan.

The digital substitution, almost doubling as a percent from the 4 to 6 as you said before to the 8 to 10.

Yep.

As a hit.

What does that imply for film volumes going forward?

I mean, obviously I can do some math in my head and I've seen the trend, but I just want to hear your view.

Does this imply double digit declines?

Or does this imply that we actually could still get a snap back where I think in the past you've talked about film volumes, perhaps, when the economy improves, you actually get a quarter to where you flatten out, it will be up.

Just qualitatively, if you could give me an idea of where film volumes go with that kind of cannibalization, vee si vee your prior expectations.

What we've seen now, in the fourth quarter of 25002, we saw a lot of digital cameras go into homes.

We watched the consumption pattern on those and the impact on film sales in the second quarter, where there is enough picture taking going on that you get a read.

You can't tell much in the first quarter, there's not much picture taking.

It became obvious to us it is really accelerating now, Ben.

And so that's why we raised our impact to the 8 to 10%.

Now, we're getting to a point now where there will be a recovery in the film when the economy bounces back, but the acceleration of the digital substitution will make that hard to see, because the 8 to 10 will grow next year.

I haven't thought through enough yet, what that will be.

We'll get back to you in September, we'll give you a view of it.

It will acceleration.

It will be harder to see.

So, I think we're in a situation where we need to get on with the reality that the consumer traditional business, start business is going to be a slow decline.

It is not going to fall off the cliff.

The economy will stabilize and help it.

I think this year even with the reduction, it is 650 million rolls of film.

We're not talking chunk change here.

That will stay on a steady decline.

The consumer business will expand, now even faster, into the mass market, which is just a dream for us.

A, that's where our brand plays, we're demonstrating with our EasyShare cameras.

It is where people want the ease of use.

We can't make enough of dock printers.

Ofoto is the leading on-line service.

Our ink jet paper sales, arguably, are one or two share, depending on which country you're in.

That's the growth opportunity for us.

The whole system of economics around that, of connecting with consumers on cameras and offering them services and printers and paper, is a growth industry and we're right there in the middle of it.

The trick is to get the cost structure of the historical consumer business, ail be it the 600 million roll industry, down in reality with what it is heading.

That's what the cost reductions are about today.

I guess with 650 rolls this year, if we decline 10% next, is your capacity after this next restructuring going to be rationalized for that 350 million roll share or whatever it will be, 300 million roll share of the world?

That was a U.S. number.

Right.

I'm not going to have 50% share.

You and I know I'm not selling down to 50%.

Actually -- right.

Okay.

So it is double that.

You know what I'm trying to say, is your capacity --

I know.

I'm playing with you a bit this morning.

We're trying to get out ahead of it, and since it will be fairly slow, it is not big chunks at any one point in time.

We'll work it down over time.

It will be much more in line with that number.

Yes.

Thanks a lot.

One other thing to consider, our facilities in the U.S. just don't source the U.S.

We source the world from all of our facilities to different parts of the world.

We still expect growth in the emerging nation.

So, it is just not as easy as facility rationalization.

We continue to work on that.

Thanks.

Thanks, Ben.

We'll go next to Dale Wettlaufer with Legg Mason Funds.

Good morning, everybody.

Not to sound too retro, but that was a great quarter.

A question on the long term debt.

I'm just wondering what the movement in the debt was all about?

You notice we increased our long term debt a little bit during the quarter.

We went out with a $500 million offering.

We filled in the payouts in the blank years, out five or six years.

With the low rates we have now, Dale, we wanted to replace some of the commercial paper with longer term notes.

We have too high a balance of commercial paper short term versus long term.

We did a little rebalancing.

So our long term is up a billion and a half.

There is nothing -- there was a corresponding decrease in short term debt.

We paid some off during the quarter.

I've got, adding up total debt, I've got 2.7 billion at the end of Q 1.

Just a hair under 3 billion at the end of Q 2.

Our cash balance, our net debt didn't change that much.

Our cash balance went up to $900 million.

So our net debt was 2.1, about where it was at the end of last year.

We pull our cash up a little bit at the end -- right before the dividend payments, because we paid a dividend on July 15.

But, our net debt didn't change much during the quarter.

Okay.

Great.

Thank you very much.

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

This is Megan Talbott calling on behalf of Carol.

This quarter's performance, I wonder if you could help out a little bit, in terms of your out performance, based on your revised guidance.

How much of that on the consumer side, was due to this increase in price mix, this quarter?

Can you help quantify?

This is Bob.

Most of the improvement we had, more than half the improvement we had -- it was about 100 million on improvement on the guidance in the middle of June.

More than half of that was the different business units out performing.

A small part of that was in our consumer business.

So, you know, the improvement -- the impact of that price, which was primarily driven by new product introductions, high resolution of film and a better, stronger mix of onetime use cameras, was not a material change.

It did help that portion of it.

We're not going to disclose exactly what that was.

Okay.

In terms of your guidance for the second half of the year, can you tell us, sort of, what gets you to the higher end of that guidance?

Yes.

I mean, it really spins off of revenue growth.

You know, we're trying to peg where the revenue growth will be in the year.

We see a strong consumer digital second half.

We see a solid health imaging second half.

The consumer traditional business will be under pressure.

We have to watch the pricing activity.

As I said in my remarks, it is slightly more competitive right now.

As the volume industry tails off, we could find more pricing pressure, which will push us to the lower end of the range.

It really is around the revenue.

I think we've got a reasonably good handle on our cost.

That is kind of how the revenue plays out.

Okay.

Great.

Thank you.

We'll go next to Jack Kelly with Goldman Sachs.

Good morning.

Good morning.

Just coming back to the digital substitution, Dan, I want to get a sense of how the number of digital camera owners relate to the substitution.

I know it is a tough question.

But, if we look at last year, roughly 20% of the U.S. households had a digital still camera.

As a result of that, we getting 8 to 10% hit to traditional film.

Is there any kind of way that you guys look at it, when it moves to 30 or 40, because it will eventually, how does that relate to impacting the hand for traditional film.

I'm sure it isn't linear.

I think at some point it becomes more geometric.

It sounds like it has here the last few couple of quarters.

It is a really complicated algorithm.

I'm not in a position to forecast much further than I have in the 8 to 10%.

I'll tell you the elements we watch and I'll give you an update probably at the end of this year when I see how the next big picture taking season, around Christmas, fares through the digital substitution.

But, it is an algorithm built on the point you made about the number of digital cameras in households.

That's gone up.

It is also about -- the second key piece of the algorithm is the reduction on the film in the household.

Remember, film doesn't go to zero.

Does it go down 50 percent or 65%.

That differs by the sophistication of the household.

Finally, it is about general economic conditions, which sets the basic appetite for images.

So, I know I'm not giving you the forecast you want.

I'm not in a position -- I want to see another round of strong picture taking interval.

It is pretty clear to me now that we're in a period of decline of film in the U.S. and now we're talking about, what is the shape of the curve?

And that translates, of course, to an exploding -- we're running like crazy to keep up on the opportunities in the digital space.

We could sell a lot more printer docks than we thought this year.

That's great news, by the way, because those cart rages of material that float through that forever.

People are printing their pictures.

We've also got the retailers now, jumping on getting digital images printed by retail.

You've seen our partners run the campaign throughout the country, particularly in the northeast, and that is starting to kick in.

So, I feel good about the transition, I just can't give you the slope of the line right now.

I would rather wait until another time.

Just the other piece of that equation, trying to get a feel for the U.S., the plus 2% price mix, compares with kind of adjusting to the first quarter of this year, 5% for the last couple of quarters.

Right.

You mentioned the market may be deteriorating a little bit underneath it all in the quarter, how quickly do you think we reverse to this trend, if you want to call it, to the minus 5.

In other words when do we get over the pipeline filling?

I think we're pretty over it in the second quarter.

I expect to be the more normal trend surfacing again in the third quarter.

As I said, you know, I'm a little nervous that this thing could open up on us a little bit.

That's what happened in most markets that go into a decline.

We'll take a lot of cost out of the consumer space to remain the low-cost producer.

On a revenue standpoint -- this isn't a prediction of the third quarter.

But, over the next year or so, if we get 8 to 10% negative on substitution, something deteriorates, we go back to 5, we might be talking revenues down mid teens.

I got lost.

I'm sorry.

Do it again.

Just kind of looking out over the next year, assuming the 8 to 10% digital substitution remains the number, and we revert to kind of the trend, which is 5% on price mix overall revenues, assuming we don't get a big recovery in the economy, it could be kind of a mid teens decline?

No.

I think -- here's the piece you're missing.

First of all pictures are exploding in the digital space.

But, if you go back to the historical space, the 20-year trend was a 4 to 5% fundamental exposure growth.

There will be some closure growth you subtract the 8 to 10% from and layer the price on it.

The debate is on really what will be the fundamental exposure growth you subtract those two from.

The 20-year trend it was 4 to 5%.

I don't think there was one year it was 4 to 5%.

Therein lies the art.

Okay.

Bob, maybe I missed it, the cash restructuring charge in '02 and '03, what are the cash outlays going to be for re structuring.

In 03, we estimate that the -- we have about 50 to 60 million more to go from the restructuring announced at the end of last year and beginning this year.

The first half of the year only a couple hundred total for the two-year period, about 50 or 60 to go from that.

So, what would the totals then be for '02 and '03?

I'll have to get back to you on that.

I can't recall what the '02 was?

Maybe a couple hundred total?

I don't have that specifically on the tip of my tongue.

I'll get back to you.

I'll call you back.

It is 50 or 60 to go.

It is probably going to end up around 200 million before the year is over.

Yeah.

Okay.

About 200 million.

Last questions,?

Terms of tax rates, as earnings are recovery next year, the tax rate is going to go up from the 24% level this year or is there anything --

The problem we have is that we earn more money in the lower tax rates now.

Not a problem.

But it is a mix issue.

Many of the cost reductions we're doing this year will be centered in the U.S. where we have the highest taxes.

So, if there is a recovery in economy and these things will certainly create more income in the U.S., the answer would be upward pressure of the tax rate.

Thank you.

We have to balance all of these things together.

And also the downward pressure, China recovers from the incidence they had.

We have to balance this out.

Okay.

Good, Thanks.

We'll go next to Adam Camero with Intrust Capital.

Two quick questions.

On is on the 500 million free cash load target you have for this year.

Yes.

It looks for the first half it was flat, minus 60.

How do we anticipate the next 500 million coming over the next couple of quarters.

We historically are a strong generator of cash in the second half and a user of cash in the first half.

If you look at the last two years, we generate an average of $740 million in cash after dividends,in the last two years.

I think, we probably won't do that well this year, because of the lower earnings estimate.

But, what we see we're working on inventories and the cap expenditures and everything, I'm pretty confident we can do the $560 we need to do around the $500 million for the year.

This is before acquisitions, after dividends, before acquisitions.

More third quarter or fourth quarter?

Pardon me?

Where does it fall out, between the third quarter or the fourth quarter?

We're not that precise.

It will be heavily skewed in the fourth quarter.

It should be positive cash in the third quarter.

So I understand, your net debt targets, it sound liked based on the net debt of 2.1 to 2.4 , the free cash flow is really 200 to 500, in the second half.

I don't follow that.

Could you net debt right now is 2.1.

So, you've got -- you know, if you have 500 going out for the acquisition, I'm trying to understand, I've given a wide range in the debt.

I'm trying to make sure that jives with your free cash flow target.

Yeah, it does.

My second question is, there is a sentence in your discussion of the results talking about net sales from the company's digital products and services increased 1% second quarter this year as compared to the second quarter of last year.

Did that encompass all of your digital processes business?

On the consumer side, your digital cameras, digital kiosks, everything on the digital side.

That does include digital still cameras.

It includes kiosks, network informs space.

It is a relatively small space at the current time.

Okay.

Thank you.

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

Hi, a couple of questions.

First, a follow-up from the last question, just to be specific.

Are you saying that -- and, again, I wondered that myself, in terms of the debt, if you end up at 2.4 in terms of debt, does that mean that you're actually falling short of the 500 million you're now paying in terms of cash flow?

You know, we're trying to capture a lot of moving parts in here.

There are some other things I know are going to happen in the second quarter, what I think is going to happen in the second half.

That I factored in there.

Are you talking acquisitions?

These are small things, not big ones like we just announced.

I factored that in.

If we don't do them we end up around 2.1.

If we do do them, we could end up as high as 2.4.

That's not a statement on the cash generation, that's a statement on some other things that might happen in the second half.

If I may add, the company is generating good solid cash.

One of the questions was our target.

We'll move around targets for our debt.

I think what Bob is saying there, the company is in good sold financial condition, which is really unusual, for some companies, that have come through what has happened since 911.

I'm very confident, as confident as you can be, that we'll generate somewhere around 500 million of cash before acquisitions and after dividends.

How we deploy that cash in the second half isn't clear.

But, that's why I made that statement.

That should be somewhere between 2.1 as it is now and go up a little bit if we do some other things with cash.

Okay.

Then if we can go back to your digital camera comments, where you're now profitable on a not fully allocated basis.

Can you give us an indication of what you mean by fully allocated and how you're looking at from a profitability standpoint.

Obviously,it has to be profitable across the whole base.

As the digital business grows, it ends up picking up more of the corporate expense items like the general finance, part of legal and things like that.

Our first goal, by the end of this year, is get that profitable before the moving sands of the allocation, because as they grow and the other part of the business shrinks, they pick up a bigger piece.

With that said, we do not need the kind of infrastructure to run the business going forward that was necessary in the model of a high margin business, with high barriers to entry, I might add, of the past.

So, what you see in the announcement on the cost reductions o today, not only are there because of the historical consumer business getting smaller, but the model of the company we're driving to does not need the kind of infrastructure we have, and we're getting it down, which with will help the total profitability of all of our consumer digital products and the rest of the company.

I would also say, consumer digital cameras really have turned out to be what we dreamed it would be, a great acquisition point to sell other products and services to consumers.

The connect rate on our printer dock is terrific, with Kodak consumer digital cameras.

It is an annuity stream just the way we hoped it would be.

Our new cameras coming out, connect with those docks.

It will be a great play going forward.

Okay.

Sort of a little follow-up to some of the things you said.

In terms of the restructuring specifically, can you give us an idea geographically what you're planning on cutting, are the cuts in the consumer film business, one of the questions I had looking at the numbers is, if you go back to 2001, you guys laid off 6500 people and took charge of $750 million, 450 which was cash.

Now you're going to layoff 6,000 people and you've got between 350 and 450 in terms of yor total charge.

So, I'm trying to understand what the differential is there and is the amount of layoffs actually attainable based on the numbers you put out?

They are attainable.

We wouldn't have --

Don't pay as much in severance.

You cut the severance packages.

The nature of some of these, which are corporate staffs, are skewed to the U.S. , they're our corporation head quarters.

We will use every full fledge package of -- packages to help our people through this difficult period, including helping them do training and searching for jobs.

But,the fact of the matter is, the U.S. tends to be less cash intensive, than say, Europe, where many of them were before.

As we unfold more announcements of this, it will become clear how this is.

I think what Dan said, it is a different mix of people.

It is more into the corporate administrative staff type positions.

So, it has a different mix.

You'll see that as it unfolds.

But, I would assume you're planning on closing manufacturing facilities, as well, given the continuing decline in volume.

There is some manufacturing impact.

There is some reduction of accruing and some reduction of overhead in manufacturing.

But, we've been doing a good job getting our capacity down as we go along.

That's not the biggest piece of the pie.

Okay.

One final question.

You noted a strong sell in for your new premium products in the film business.

Are you taking shelf space from others or are these replacing other Kodak products that were out there.

What are you seeing?

Some of both.

Some of both.

Any early indications from retailers as to sell through for some of these new products.

The early indications are very good, but it is early.

It is hard to draw a trend line on it.

Both the digital one time use camera and the high definition film seem to be selling quite well, if they are merchandised correctly by the retailer.

We'll go next to John Reledge with Citigroup.

I was trying to see if you could give me a little bit more color on just the maturity of the debt, both in '03 and '04, following the refinancing you did earlier this year.

There is no significant maturities left this year.

As I recall next year, our maturity schedule I think is around $250 million, of fixed debt.

That's it for the next two years.

We paid -- our schedule payments were in the second quarter of this year.

I think we would summarize around $250 million next year.

Just to make sure, there's been a lot of questions about it, that I understand correctly, the cash component of the 350 to 450 million charge you announced, is 200 million, what you're anticipating for this year?

No, no.

The new restructure we just talked about today, it will not be a significant cash component this year from that, because it is going to be mostly skewed into next year.

We are still paying down from some we announced last year and the first quarter of this year.

Two different topics.

This one we just talked about, no material cash this year.

There is some hangover cash from preceding restructuring, which is by and large mostly been expended.

And that's --

There's about $50 million of that to go this year fr the rest of the year, $50, $60 million.

A minor amount due to the restructure.

Very good.

Thank you.

We'll go next to Ulysses Yannas with Buckman Buckman and Reed.

Dan, have you been dieting?

Yeah, I have, as a matter of fact.

You looked good this morning on CNBC.

Antonio is here, and I have to get up at 2:00 in the morning to get up on the treadmill.

I can get up a little later.

Can you tell us a little bit about OLED, you've been assigning new license agreements like crazy.

Can you give us an idea of what the income streams, there are a number of income streams on OLED done.

Yes, there are.

You have license fees?

Yeah.

You have materials, right?

That's right.

We have license fees on the technology.

We have materials that we sell to those who want to work in this space and we have the -- what do you call it?

The joint venture with SANYO.

So, all we're doing is recognizing that they are more than just one stream.

So, we have done some licensing and done some material sales.

But, of course the big play there over time is to grow the FK display joint venture with Sanyo.

I will tell you, it is hard getting this product through the production line.

Maybe, harder than we originally thought.

But that's not that unusual with revolutionary technology.

On the other hand, the quality is as good as we thought and the consumer acceptance is terrific.

Our digital camera, that is primarily for sale in Asia, is flying off the shelves with the OLED screen on it.

So, we're optimistic about it, but it has proven to be hard technology, but not one we have many concerns about.

But, new technology coming off the R & D bench, sometimes is harder than what people think.

As we look out three years, the biggest component then is going to be Sanyo?

Of the revenue streams, the biggest component you expect to be Sanyo?

The biggest component will be the sales of screens coming out of the Kodak Sanyo joint venture.

Okay.

Another subject , medical imaging margins, they were exceptional, because it means that you start really going at it in terms of material rather than equipment?

No.

It was heavily mixed this year.

As I've said before, those margins I think are still too high.

That's what they keep on telling us.

I know.

But, everybody has got cost pressure.

And so a lot of the hospitals are putting off buying additional equipment.

We have had share loss in equipment placements.

New products are rolling out, we think we'll get a stronger mix of equipment going forward.

Even with that, there will be some reluctance on hospitals and radiology centers to buy equipment right now, because of budgetary problems, from anybody.

On another favorite subject of mine if you don't mind, digital cameras, you are approaching profitability, right?

Yeah.

Your friends over at Olympus as well as [INAUDIBLE] are out sourcing about 90% of the digital [INAUDIBLE] -- when are you going to go after it?

I'm going to ask Antonio to talk about his view of how the outsourcing will play out for Kodak, going forward.

You know, he has a lot of experience with a combination of insourcing and outsourcing of products in the digital space.

I'll let him give you his views of how that will go over time.

Hi, Ulysses.

Antonio here.

Let me describe first, the business that we have built with the commerce.

We are very proud we have gotten to where we are playing basically in the low-end of the market.

We've been able to get very large volumes.

We've been able to get to break-even status, playing only in the most difficult part of the market, the one in which is more difficult to get profits.

But, that was done on purpose, because we wanted to build the basis for an industry-leading co-structure for that business, which is absolutely fundamental to last in that business.

So now, in order to do that, what we did at the beginning was, we did some of the manufacturing by ourselves, in-house.

But , the future of the business, to answer your question, will be more and more to continue some of the manufacturing that we have, continue with that, is very important to learn new processes and to put into practice some of the ideas that we have for new cameras.

But, the next big volumes will come with concept manufacturing.

Right now, we are probably about 50/50.

I'm not sure, probably about at that rate and the rest, the next growth will come with outside manufacturing.

Now, we are working in that business as well now, is to take advantage of those cameras.

As you know, the strength of the company has been always to make it easy for consumers to get access to all kind of pictures.

We are planning to do that in the digital world.

For that, it is very important to have this digital camera, a business.

Now attached serious developments to those cameras as well as a very powerful network.

We'll be talking about these things more in September.

Are you considering the financial labor cost there with onetime use cameras?

You plan to outsource more of that?

You are talking 20, 25 cents in China.

You were close to a buck in the U.S.

You're probably around 50 cents in Mexico.

In the onetime use camera space, as you know, not the film piece --

Correct.

The camera body.

The camera parts, we've already made a commitment to move that primarily to China and some to Mexico.

We find we're better at doing that internally.

A, we have a low cost base in those countries and B, the key element of that is the efficient recycling of components.

You can do away with a lot of profitability if you start putting out cameras that are not taking advantage of really smart recycling.

We're better doing that inside than outsourcing the recycling effort.

You know, it is about sorting through the parts and knowing which ones can last another term.

Right, you can use the flash in the second, a number of times over.

Right.

Coming to your favorite Euro photo operation, as the membership seems to be growing at a rate of something like a million and a quarter, that's approaching the level where I thought you might consider charging, including myself, a fee for sorting the photographs.

It came through to start charging you.

But, I turned that down.

Just you.

Yeah.

When does that happen?

I don't know.

Antonio, why don't you give him your thoughts on that, too.

We're building a great customer base here and at some point the model will move more to a premium services.

Too early right now.

I think certainly -- I don't think we have a sufficient large base to do that.

I think as well we're still testing the type much services the customers want to pay for.

There is a lot of things that are coming to the business, one of them very important is the phone com business, will certainly end up being a service.

So, that will be maybe one way by which people will learn and get a service we'll have to pay for.

You know, there is no doubt we'll be going that way.

I think not yet.

Thank you very much.

Can you give me finally your capital expenses for the next year?

This year and next.

Capital expenses, we've been estimating $500 million this year.

I see no reason to make a major change on that.

We're putting pressure on it.

You know, next year, we haven't finalized that yet.

A lot depends on where we go in the digital -- this digital issue.

So, probably next year, somewhere around this year's range or maybe slightly lower.

Somewhere around this year's range.

At one point you told me about $400 million was the so-called maintenance part of the budget.

Is that going down?

Maintenance is going down.

But, there are expenditures made for new product introductions, cameras.

Expenditures made from everything from systems software and everything.

The maintenance budget should be coming down over time is absolutely right.

You're seeing part of that.

We used to spend over a billion a year.

We've cut that more than in half.

You should see that general trend continue.

So in essence, we should expect, maybe staring next year, your depreciation charges to start going down?

Ulysses, if we could wrap that up, because we're running out of time.

Right.

We'll give you those when we meet in September.

We're not prepared to talk about September yet.

Thanks a lot.

I appreciate it.

We'll go next to Andrew Gillis with ING.

Pardon me, I did have to join your call late this morning.

Did you make any explicit statements, or are we to wait until September to hear more specifics on that dividend pay out policy and issues around that?

What I said earlier when I was talking, we have made no change in our current policy.

What we do as a management team, prior to the board meeting, the dividend policy is decided, we assess all the current uses and needs for cash.

Dan and Antonio and I will go to the board and recommend what we should do with our dividends.

They of course have the final decision.

That next meeting is in September.

We just paid a dividend on July 15.

We went through that process in May.

Right now there is no change in our dividend policy.

Can the assertion be made that even though the businesses that you're perhaps acquiring or certainly growing into are growth businesses and would have the need for, in a very broad sense, investment or not perhaps throwing off as much cash as the old businesses debt, because there is a high and increasing portion of outsourcing.

The capital demands would be diminished from perhaps what they would be from the traditional business?

That's high-growth business, consumer digital business we've been recently talking about, which are [INAUDIBLE] a billion in revenue, up from 0 five or six years ago.

That is primarily an outsourced business.

There is not nearly the capital required in the film businesses.

So, the new model we're going toward in the digital world will be less capital intensive, as it looks today than the old model.

Thank you.

Thank you.

We'll go next to Steven Corne [INAUDIBLE]

I just wanted to clarify Adam's question regarding cash flow.

I'm looking at a presentation, I think you guys gave at the end of last year, where you gave a range of earnings between $2.35 and $2.95 and broke it down between 4.50 and 650.

We presented that at the January 24 analyst meeting.

We remember it well.

So if I take the low end of the range, you had income of 740.

And income then drops on a GAAP basis close to 400 million.

I'm trying to understand where the other pieces start to add up to get the 500 million.

When we made the forecast, we had a contingency.

We're taking a much more aggressive stand on our inventories.

Our inventories, because of the lower demand for film, we can pull the inventories down more than we envisioned in that meeting.

We will also be a bit down in our cap ex.

We're taking steps to offset some of that earnings drop and maintain our cash around 500 million.

The part that is coming out of earnings is being replaced by some other actions and those things we can control.

So it is primarily -- here you have capital of $600 million.

We're taking that down and taking inventories down.

We'll have lower receivables, because our revenue and some of that will be lower.

We were worried about that going into the year with all of uncertainties coming into this year.

It wasn't clear when we made that forecast, what was going to happen with Iraq.

We were just starting to hear the word SARS.

We were still in a recession.

So, we left ourselves a backup plan, if the income fell to still maintain the cash flow in the company.

It looks like we can do it.

I'm pretty confident.

In the last two years we generated about $740 million cash in the second half, with higher earnings and I think 500 million -- 560, which we'll have to generate, is certainly within range.

Can you guys give any sort of gross margin or approximations of digital business and what you think it can ramp up to?

Antonio and Dan will be talking about that when we get together in September, some more information on that, we should do that in a second quarter conference call.

Okay.

Thanks a lot.

We'll go next to Michael Weisberg with ING

A couple things if I could.

The ink jet paper business, how profitable is that for you now?

We're making money in the ink jet paper business.

Would that be a high margin business?

You would think it would be.

A solid margin business.

I don't want to go any further than that.

It's a good margin business.

To do a billion in reps in the digital business, is the biggest piece digital cameras?

Today it is.

The second biggest would be the inch jet paper?

Yeah, that's right.

Are you still losing money on the Ofoto.

Yeah.

We're still losing some money.

Not a lot in Ofoto, as we still are acquiring customers as we talked about earlier.

Great.

What is the margin expectations in health imaging for the second half that is embedded in your forecast?

It will come down from where they are right now.

And, again, is that because as hospitals and other buyers start buying new equipment, that will have lower margins than the sort of reusables that are higher margins than you're selling now.

Yeah.

I want to be real careful with this.

The equipment business is picking up some speed here again.

That's due to some new products from us and as well as we're getting toward the end of the budget cycles in hospitals and there is a spend it or lose it kind of mentality.

I've said all along, I think this business settles comfortably in the mid to high teens in terms of operating margin.

In any given quarter, that could be low or high depending on the mix.

You emit the high teens margin.

That's where this settles nicely.

When are you moving the single use camera business to China and Mexico?

Is that fourth quarter?

I think it is underway right now.

Or close to being done.

I think it is just about finished, within the next month.

Where is digital camera production now?

As an Antonio said, half of it is inside Kodak, half out, and the majority of it is in China.

All of it is in China.

Great.

One final thing, they announced restructures, you said there will be minimal cash impact in '03.

What kind of cash impact in '04.

We haven't got all the detail planning on this.

If we do this right, we will pay out cash early and get cash in late.

There will be, certainly, a cash outflow of maybe as much as $200 million next year.

Depending on the timing of everything, we'll have to play that out.

We'll have more guidance on that this fall as we get the detailed plans in.

I would use no more than 200 million next year.

As the ink jet business grows and maybe possible entrance into the market, do you see your margins going up or down into that business as we get into '04?

It is a price competitive business.

The trick is to take costs out to keep up with the inevitable pressure due to price.

On the other hand , the Kodak brand travels very well.

It is a self service business.

You don't go to a retail clerk to buy it.

People walk by looking for photo ink jet paper and the Kodak brand calls out to them.

Okay.

Thanks a lot.

Yep, thank you.

This concludes today's question and answer session.

At this time I would like to turn the conference back over to Mr. Dan Carp for closing comments.

Thanks again.

I know how busy everybody is.

Bob and Antonio and I appreciate you taking the time.

I'm pleased with how the second quarter came out.

We've got a lot of work to do.

But the imaging business is a strong business.

The task for us is to continue to invest in the opportunities, particularly in health, commercial, imaging and the consumer digital space and then manage smartly the transition out of the historic consumer space.

It all can be done and the task is clearly in our sights.

Thanks a lot.

And this concludes today's conference call.

We thank everyone for joining today.

You may now disconnect.