Eastman Kodak Co (KODK) 2005 Q1 法說會逐字稿

Good day, and welcome to the Eastman Kodak first quarter sales and earnings conference call.

Today's conference is being recorded.

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

Please go ahead, sir.

Good morning, and thank you for joining our conference call this morning.

I'm here with Dan Carp, Kodak's Chairman and CEO;

Antonio Perez, our President and Chief Operating Officer; and Bob Brust, our Chief Financial Officer.

Before we get started, I need to attend to the usual housekeeping duties.

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

For example, references to the Company's earnings are such forward-looking statements.

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

These statements are subject to a number of important risk factors and uncertainties.

A listing and more thorough discussion of these risk factors can be found in our earnings release this morning.

I would encourage all listeners to carefully review this material.

Any forward-looking statements made during this call should be evaluated in light of these important factors and uncertainties.

Lastly, our discussion this morning will make use of a number of non-GAAP financial measures.

Where such measures are used, a reconciliation to the relevant GAAP measure can be found in the financial discussion document we released this morning.

Now, let me turn the call over to Dan Carp.

Thanks, Don.

Good morning, everyone, and thank you for joining us on our call this morning.

We reported a first quarter that was clearly off our expectations.

Now, having said that, we have said for some time that this transition makes it difficult to predict results over short time periods, such as any given 12-week quarter.

And that is precisely the reason we have been moving away from providing quarterly earnings guidance in favor of half-year and full-year guidance.

Now, this morning Bob and Antonio will provide more detail on our first quarter results, and importantly, why we are confident of returning to our expected trajectory for the full year.

From where I stand, our strategy continues to look very solid, although we will be making tactical adjustments, as required.

We have now closed on the Kodak Polychrome Graphics acquisition, and I expect the Creo acquisition to close later this summer.

The Company's product portfolio looks very strong.

The markets we have chosen to participate in are solid.

And we remain focused on execution.

Now, let me turn the call over to Bob for a discussion of the financials.

Thanks, Dan, and good morning, everyone.

Before getting into the first quarter results, let me make just a few comments about the conclusion of our 2004 10-K filing process.

As you know, we completed our accounting review at the end of March, and filed our 10-K for 2004, with a restatement of 2003 earnings and the first three quarters of 2004.

Most of the issues relating to the restatements were complex, technical areas, including tax and pension, that did not and will not affect revenue or cash.

I'm satisfied that we have effective corrective actions moving into place to eliminate the source of these errors.

This was not an inexpensive effort, costing us about $0.02 in the first quarter.

And we received an unqualified audit opinion from our external auditors.

Now let's move on to the results for the first quarter.

The quarter results, as Dan said, were fully below our expectations with improving earnings in March, more than offsetting combined operational losses from January and February.

From a sales perspective, January and February revenues declined 5%, with March sales up 1% from last year.

As a result, consolidated revenue in the quarter was down 3%, with foreign exchange contributing about 2 percentage points and the NexPress acquisition contributing approximately 2 percentage points for the quarter.

Digital products revenue grew 23%, with consumer and Health Digital Capture products falling short of plan for reasons Antonio will discuss in a few moments.

January and February digital revenues increased 17%, with strong momentum growing in March when digital sales advanced by 31%.

Traditional products revenue declined slightly more than forecast at 18%, as Kodak's worldwide sales of consumer film to dealers declined somewhat more than anticipated.

Primarily reflecting ongoing inventory reductions in retail channels of key regions throughout the world.

Emerging market sales declined by 3%, with generally soft sales in the principal countries.

China, in particular, experienced a 21% decline, largely reflecting the distributor inventory adjustments in the Consumer Products area.

Gross profit as a percent of sales was 28.1%.

A slight decline of four-tenths of a percentage point from last year.

As our cost reduction efforts were more than offset by unfavorable price and mix impacts, higher raw material costs and negative manufacturing variances resulting from our traditional product portfolio, plant slowdowns at the end of last year.

SG&A, excluding acquisitions, exchange and the negative impact of exiting a customer -- a consumer retail contract, declined by 3%, as we continue to make progress with our cost reduction plans.

With acquisitions, exchange and the contract buyout included, SG&A as a percent of sales increased from 19% to 21% year-over-year.

R&D, excluding acquisitions, was down 5%, as we continue to focus on cost reduction activities, and the related mix shift of resources in favor of digital R&D.

Including in acquired businesses, R&D increased 6%.

As a percent of sales, R&D was 7%.

Somewhat above our targeted 6% long-term rate.

However, as we integrate the acquisitions, implement other cost model actions, which is occurring as we speak, this rate of spending will return to target over time.

Operational EPS was $0.03, compared with last year's restated $0.24.

The decline was driven by the weak January and February revenue, and some execution issues which Antonio will discuss, as well as several one-time events and charges which were almost all negative.

They include the following -- The absence of a tax reserve reversal, which occurred in the first quarter of 2004, partially offset by an acquisition-related inventory adjustment, added $0.07 to last year's first quarter; anticipated NexPress dilution of $0.03, which remains negative on a comparative basis, until May 1st; planned higher spending of $0.03 on new digital technologies; higher raw material prices for silver and oil-related items, which had a negative year-over-year impact of $0.10; unfavorable manufacturing variances associated with extended factory shutdowns in the fourth quarter, which negatively impacted COGS by $0.07; a $16 million or $0.04 per share pretax SG&A charge to exit a consumer photo finishing customer contract; and $0.02 of incremental costs associated with our 2004 10-K filing and prior-year restatements.

These negative earnings impacts, as compared to last year were partially offset by $0.07 of favorable exchange, $0.02 of year-over-year benefit from lower interest rates, favorable LIFO of $0.03 and other positives totaling $0.03.

As you would expect, the timing and magnitude of some these items are difficult to predict within the bounds of any given quarter, and netted to reduce EPS by approximately $0.21 from last year.

We normally see a better balance of these types of items, but in the first quarter almost all were unfavorable.

I am expecting this balance to improve as we move through the year.

We recorded an operational tax rate for the quarter of 13%, compared with the first quarter 2004 restated tax rate of 21%.

As a greater proportion of our earnings are coming from lower tax rate locations.

In addition, the benefit from the Medicare, Prescription Drug Act of 2003, was absent from the year-ago quarter.

The 13% tax rate is in line with the guidance we provided in January of an 11 to 15% tax rate for the year.

Silver prices remain volatile, and difficult to forecast, with the average price running at approximately $7.19 per ounce during the quarter.

Because the rate remains above last year's rate, it remains very difficult to hedge effectively.

From a restructuring perspective, we continue to execute on our current cost reduction program.

During the quarter, the Company took actions to reduce employment by approximately 1,650 positions.

Bringing the program total, as part of our three-year plan, to more than 11,000 positions.

In addition, cost reduction actions, which included severance, accelerated depreciation, exit costs, and asset and inventory write-downs, resulted in pretax charges totaling approximately $210 million.

Including the impact of restructuring, the GAAP loss per share for the first quarter was $0.50 on a continuing operations basis.

We missed our inventory reduction goals during the quarter, due primarily to weaker-than-expected first quarter sales for some of our digital and traditional products.

We have adjusted production schedules that will continue to aggressively address this issue in accordance with our goals and cash flow targets.

Net trade receivable balances decreased 263 million, quarter sequentially, reflecting seasonably lower sales in the first quarter.

DSO was 46 days compared to 45 days for the fourth quarter, reflecting higher DSOs for acquired businesses.

Capital spending was $99 million, up 8 million year-over-year.

Operating cash flow in the quarter was a negative 305 million, compared to a negative 445 million booked in the year-ago quarter.

Driven primarily by lower acquisition spend in the current quarter, partially offset by higher inventory balance and an increase in year-over-year cash payments associated with restructuring.

During the quarter, cash flow benefited from the sales of traditional-related assets, which will continue as we look for opportunities to appropriately monetize assets no longer required in our traditional businesses.

Our long-term cash planning anticipates these types of inflows.

Investable cash flow, or operating cash flow before acquisitions, was negative 258 million, 118 million less than the first quarter of 2004.

We remain on track to achieve our targeted investable cash flow for the year of $400 to $600 million.

Debt increased by $88 million from year-end 2004 levels to 2.409 billion.

As previously announced, during 2005, that is expected to increase by approximately $900 million from year-end 2004 levels in order to fund the Creo acquisition upon closing.

Cash on hand at the end of the first quarter was 1.031 billion and debt-to-capital was 39.7% compared to 37.9% at year end 2004.

During the second quarter, we are expecting an improving earnings trend that will help us regain some of the lost earnings from January to February, which cost us about $0.25.

Some of this was execution-related, and some relates to the timing of one-time actions discussed earlier.

We will recover some of this shortfall in the second quarter, and expect to improve upon the $0.75 we reported in last year's second quarter.

But against our original first-half guidance of $1.10 to $1.20, we won't get it all back in the current quarter.

However, across the balance of the year, we remain committed to full-year operational earnings guidance of 2.60 to 2.90 per share.

Remember the shortfall was $80 to $90 million of earnings from operations and it's early in the year.

Plenty of time to recover.

Now I would like to turn the call over to Antonio for a discussion of operating results.

Thanks, Bob.

Before I get started on the operating summary for the quarter, I would like to add some perspective from my position as Chief Operating Officer of the Company.

My focus and the focus I require of my management team is to achieve our longer-term objectives for the year.

It's specifically to deliver on our digital sales and earning goals.

Second, successfully manage our declining traditional portfolio.

And third, effectively integrate the acquisitions we have made.

While it clearly would have been my preference to have a stronger first quarter performance, we remain intensely focused on our full-year goals, which I'm confident we will deliver.

Now, let me offer some comments about the first quarter performance.

First, our Digital & Film Imaging Systems segment had a mixed performance in this quarter.

The consumer output team continue their very effective efforts to improve the year-over-year financial performance of this business.

In the organized [ph] photofinishing business, we have taken cost out ahead of the mark in decline, resulting in significantly improved year-over-year financial performance.

We have also improved our U.S. mini-lab participation model, where we have moved to a self-referral basis.

While this will reduce our 2005 revenue by about $100 million, it creates a much more attractive participation model for us as a Company.

I'm very pleased, as well with the continued success of our kiosk business.

We have reported 68% year-over-year growth, led by strong growth in 4x6 media sales.

Even more importantly, we just opened our newest incremental manufacturing capacity for thermal media.

The thermal media supply constraints have now been resolved, freeing us from the self-imposed constraints in our kiosk sales efforts.

Similarly, we experienced 42% year-over-year growth in our home Printer Dock business, where we remain a leading market share player.

Our Digital Capture SPG had solid but somewhat lower than expected revenue growth of 24% for the quarter.

On a worldwide basis, this was the result of very strong sales performance at the value price portion of our lineup, with lower than expected sales at the top of our product line.

This product mix issue contributed to our low start in January and in February where we missed sales due to inadequate supplies of our value-priced offerings.

We responded rapidly midway through the quarter and we had a much better February and a very strong March.

In fact, in January, we grew only 1%, but then in February we grew 15 and in March 49% for a total of 24% for the quarter.

We have identified a number of learnings from this and we'll be incorporating this into our efforts going forward.

Our digital camera market share performance continues very strong.

In fact, recently released data indicates that Kodak moved into third place for market share on a worldwide basis for 2004.

While final market share numbers are not yet available for the first quarter of 2005, the available data indicates that we maintained our No. 1 share position in the U.S. market.

It is also clear that we have some improvement opportunities in some of our sales execution areas.

Last year, we moved to consolidate and rationalize our traditional and digital consumer sales force.

Our results indicate that we accomplished this very effectively, both in the U.S. and in Canada.

It is equally [ph] clear for us that we have some opportunities for improvement in Europe, and in China, where some of the softness experienced in digital and in traditional consumer products can be traced to these issues.

We are moving aggressively to resolve the shortcomings in the weeks ahead.

I will point out that our view of full year traditional consumer film industry volume declines remains unchanged, at a minus 30% in the U.S. and minus 20% worldwide.

Our entertainment products had another good quarter on the basis of solid industry dynamics and good execution.

During the quarter we announced the renaming of our Health Imaging segment to become the Health Group, reflecting a broader reach to the market.

I am disappointed with the first quarter results posted by Health, but I am confident in their plans to regain momentum as the year continues.

Two key factors emerged during the quarter, principally, in the digital portfolio that negatively impacted their results.

This included a product performance problem in a limited number of screens in our strongly profitable computer radiography portfolio.

The solution has been identified and is now being implemented in the market.

While it did cost us some sales and earnings momentum in the quarter, we're moving to rapidly regain our previous trajectory.

We also saw some delay installations in our Healthcare Information System business.

This is a long sales cycle enterprise software business, and it is hard to predict with certainty when the jobs will be completed, customer acceptance is signed and revenue recognized.

The Health Group team will be working hard to get this installation finished so we can get them booked.

This will have positive effects, both in earnings and in inventory reductions.

Kevin Hobert, the new Health Group leader and his team are working aggressively to return operating margins to our targeted mid-teens level for the year.

The performance issue has been resolved.

We have a number of new products scheduled for introduction during this year and digital seasonality will also provide some tailwind as we move through the year.

Our Graphic Communication business is proceeding solidly, as planned.

During the first quarter we announced agreements to acquire full interest in our Kodak Polychrome Graphics or KPG joint venture, as well as the purchase of Creo.

As we said at the time, the Creo acquisition marks the completion of the significant acquisition program we announced in September of 2003.

KPG is turned in a very strong performance in the first quarter, with sales and cash performance exceeding plan.

Of course, since the acquisition has not yet been closed, we only booked one-half of those results in our first quarter earnings.

Versamark and NexPress also turned in solid quarterly performance against plan.

The KPG acquisition closed on April 1st and we're moving ahead with our integration plans to create a Graphic Communication business that is greater than the sum of its parts.

Creo is expected to close this summer.

In summary, we got off to a slow start, as Dan and Bob said, particularly in January and in February, which reduce our respective first quarter earnings on the order of $0.25.

Since Q1 is the smallest quarter of the year, the effect is relatively small in the context of the full year and it's early, so we can react and we have reacted.

As we have discussed this morning, some of it was the result of execution issues that we are moving effectively to address, and some the result of -- and some result from the timing of one-time actions such as the photofinishing contract termination costs that was planned for later in the year, but we booked in this quarter.

We will recover some of this shortfall in the second quarter.

I am confident we will improve upon the $0.75 of earnings we posted in the second quarter last year.

But probably we will not be able to make up the full shortfall for the first quarter in the second quarter; however, across the remainder of the year, I'm comfortable we'll achieve our guidance range of 2.60 to 2.90.

Our two big goals of the year, digital revenues exceeding those of our traditional portfolio, and digital earnings growth exceeding traditional earnings decline continue to look very achievable.

Our strategy looks sound and we are very focused on achieving our goals.

Now, we will be happy to take your questions.

Thank you, Mr. Perez. [OPERATOR INSTRUCTIONS] We'll go first today to Jay Vleeschhouwer of Merrill Lynch.

Thanks.

Good morning.

Antonio, I would like to ask you first about the Health Group business, where the margins have been in a declining trend, as you pointed out for the quarter.

Isn't it conceivable that rather than improving back to the mid-teens or better that they could continue to deteriorate, perhaps into only the single digits?

Or if not, do you anticipate having to go through some incremental restructuring or further cost reductions in that business?

Secondly, question about the KPG and Creo acquisitions.

One of the rationales for KPG, in particular, is the view that you have a broad portfolio of product that you can sell to customers in common.

And the question there is, for how much of the market do you really think that that one-stop shop phenomenon might really apply?

Okay, the first question.

The plan for the year for operating margins for the Health Group is 14 to 16% and are on that plan, we think we will achieve that.

The integration of business is exactly on plan.

We -- we haven't seen any change.

We had two issues that I described -- that I described a few minutes ago.

One of them we lost some revenue, but some of that revenue is simply delay in the case of CR so we hope that we can get it later on; although we lost some.

And then in the other case, with the Health Information System, we just have to get better to finish those installations on time so we can get them booked.

I mean, we have a significant number of units that are being sold, installed, but they cannot be booked, because we are still going through the -- through the installation process.

So for me, this is an operation -- operation issue.

We have good products.

We get a lot -- a lot of requests.

We get a lot of attention from customers.

We just have to continue to improve our operations.

But I don't see any fundamental reason why we wouldn't be able to get to this mid-teens that we have been announcing for years.

I know that in the past, we were higher than that, but Dan Carp used to say repetitively when I joined the Company, that the plan was to go into the mid-teens and that's our plan.

So we think we'll be between 14 and 16 for the year, when the year is done.

As far as Graphic Communications, I think a very large part of the market will benefit from that. 80% of the printing still is done in analog presses.

A lot of our customers, they are going to be hybrid, if not all, and they are all desperately want to have the ability to move to digital for the jobs that they need to, and as well they are looking for a work flow that is -- that is applicable in multiple -- in multiple size, and for -- and for the different -- and for the different technologies.

We think that it's a very high demand and we think applies for a very large part of the market.

Just one last one.

With respect to Consumer Imaging, could you say a bit more about the usage or the volume growth rates in the install base of kiosks?

Well, the -- a big part -- I can't tell you exactly the number -- but the big part of our growth which was huge, 68% was due to the usage.

We don't have numbers.

We know that last year -- I shared the numbers of the year before.

In 2004, from January to December, the usage grew six times.

Right now we are at the beginning of the quarter.

I don't have a number, but it is growing and that is why we put this new capacity in place, that has started to work actually a few weeks ago.

Thank you.

Ladies and gentlemen, we'll take our next question from Matthew Troy at Smith Barney.

Good morning, guys.

Hey, Matt.

A couple of questions, if I could.

I guess following onto Jay's point there, I'm glad to hear the facility is online.

I assume you mean the Colorado plant?

Yes.

Are we still online to see the Rochester facility come on sometime in early '06?

We're working on it.

And if you could just help me get a sense of capacity.

What is that -- what does that do in terms of your output capability, the New York.

Is that a doubling?

Where does that take us in terms of what you can crank out?

We have not completed the plan.

We want to make sure that we -- we know that we need a third one.

But we would like to do it as much as pay-as-you-go as possible.

So we -- we want to watch carefully what happens with the plant in Colorado that we can use it to its fullest and then we'll do well.

So it's early for us to select the volume for the plant here.

Okay.

Second question would revolve around China.

I think we had talked in the fourth quarter earnings meeting about the potential that that market might leap fog to digital and that Kodak remains comfortable with their film plans there.

Give than it is such a big piece of supporting the consumer film business, can you just give us a sense of your insight into that market later into '05?

And why your sense is that what you saw in weakness in the first quarter is only a hiccup and not the beginnings of a more concerning trend?

Okay, this is Dan.

You mixed a lot of things in there.

Let me back you up.

Yes.

We all along knew that the coastal cities would start moving toward digital, and they are.

And our success will be driven by our ability to get the bigger part of the country, but get them into photography through traditional.

And plans are there, and we're working through that and I wouldn't suggest there's any change to what we need to do.

The first quarter problem is a different problem.

The first quarter problem was our customers going into the Chinese New Year actually overstocked themselves on film.

And we try to hold them back but you have to do what your customer wants some.

And then the picture taking actually was a little weaker in the first quarter than what we thought around the Chinese New Year.

So they are stuck now with too much film in the channel.

And it will probably take us until the end of the second quarter to get all that flushed back out, but it's not -- what do I call it?

It's not a structural problem, it just needs to be worked out in a market that's hard to, for anybody, hard to predict.

So I don't see any problem there.

Okay.

Okay.

And I guess last question here would be just on the entertainment side.

I mean there's been a lot of visibility in the press recently surrounding initiatives for digital cinema.

I was wondering if you could give us a sense in terms of an update as to your plan and where you see that going, maybe timing, how that might scale in.

Obviously, it's not going to be similar to the consumer trends where we gradually adopted, went from freaks and geeks to soccer moms, nor do I see the market cutting over overnight.

Can you give us an update around --?

We don't normally disclose this, but just to get to with the topic quickly, we grew 6% this quarter.

So this is a market that a lot of people thinks is going down.

We don't see it like that and we don't see it in our orders and bookings.

So it's fine.

It's doing fine, Matt.

Okay.

And it's in your plan?

I mean it's in your guidance through '07, you guys -- ?

Well, our plan was to -- was flat.

Actually it was more than we thought.

So it's doing better than we even thought so.

Okay.

Thank you.

And this is not the strongest part of the year, by the way.

Okay.

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

Thanks very much.

Just a quick question on guidance first.

You mentioned a couple of things that are likely to improve throughout the call as the year progresses, but if we were going to look at how to get to, let's say, the 2.60 to 2.90, any point in there that you want to talk about, what are the key things that we are expecting to happen as the year progresses to get us there?

Hi, Carol, it's Bob.

We have a lot of things going on on the last nine months, including a couple of major acquisitions.

The improvement we noted in March, I mean it was a dramatic shift in March, which more than recovered the losses we had in January and February.

That -- that improvement is likely to continue and that has to happen.

We did have a rash of negative one-timers in the first quarter.

I have been doing this for years and years and years and it was -- that can happen in a quarter, but generally does not continue for the whole year.

Your negatives and your positives tend to balance out over a year.

So I would anticipate that that trend won't continue.

And the other thing, the $0.25 is $80 or $90 million of EFO.

We make far more than that in a year and it's a small percentage, and we're going to take actions to get that 80 or 90 million back for the year.

It won't be smooth and it won't be so much each quarter, but we'll get it back by the end of the year, I feel pretty good about that.

Do you have anything, Antonio?

I think the first quarter is becoming less and less significant for us.

Not only small, but it doesn't show the trends of the market well.

I think the March was -- we did have issues that we -- I mean, we didn't understand, well, the consequences of our success in the fourth quarter in digital cameras.

So there's a raw mix of products and we miss a good number of orders in the first month.

As soon as we change our plans, we saw the orders coming back in a hurry and you saw -- I mentioned the growth.

So we feel very strong with the product lines and with our position and our products.

And if we take that ongoing success of March forward, plus the new acquisitions, the numbers according to our model gives those numbers, 2.60 to 2.90.

That's why we keep saying that we can do it.

Do you think you are going to have to accelerate restructuring as the year progresses?

I know early in -- I guess at the end of last year, early this year, you talked about restructuring being significantly smaller this year than it was last year, but you walked away from giving GAAP guidance in this quarter.

So I wonder if that kind of changed your view a little bit about what restructuring actions you might have to take this year.

I will let Bob talk about the cash flow of the Company in a minute.

This is Dan.

Look, we -- we laid out a plan, what was it, now two years ago, 2002? 2003?

A year and a half ago.

And as you look at the reductions we have made, we've moved pretty far through that plan.

That didn't -- that was never intended to be an ended plan.

I mean, this business is winding down on the traditional side.

We have committed to take the costs out in a way that keeps us ahead of that.

And so there will be continued drives to restructure as the business continues to wind down.

I wouldn't characterize them as much as when we got started with this, because there were big things we did up front.

But we will be marching forward and have planned in our plans to continue to wind this down.

Carol, we -- when we first talked about this plan, we talked about a 2004 and a 2007 being in the 1.2 to 1.7 billion of restructuring and 12,000 to 15,000 positions eliminated and all this stuff.

And that -- that kept us in good stead last year and so far this year with keeping ahead of the traditional decline.

Now we have to keep modifying that as we go on.

In the early parts of the restructuring, there were heavier cash outflows, as it was more severance related.

More and more as in the first quarter, these restructurings are now asset write-downs, inventory writeoffs, things that are -- have been paid for previously and are not cash outflows.

And as we are moving through this, we will now start to monetize some of the non-essential or non-required traditional based assets, which we did some in the first quarter, and that will have a cash flow inflow which will help offset some of these restructuring cash outflows, as you keep moving.

I got it.

I think, Carol, you got to look at this as we'll just keep modifying on the fly, as we have to, to stay ahead of the decline.

Great.

Thank you very much.

We'll take our next question from Jack Kelly at Goldman Sachs.

Morning.

Antonio, you had mentioned in the press release and I think on the call that you all took actions in mid-quarter that resulted in better -- in a better margin, and you gave a couple of the numbers in terms of March.

What were there exactly and what gives you the confidence that what you did is going to persist for the balance of the year?

It is a long conversation, Jack.

But basically, the topic was after the fourth quarter, after Christmas was gone, the demand on the Street for digital cameras -- that is what you are referring to I guess, was very much for low-end cameras.

And that is happening for several reasons, it's not a time of the year when people want to spend more, and as well because the low-end cameras, they are getting so good.

They have four and five megapixels, and getting so good that people are getting happy with those.

We had the wrong mix in manufacturing and we realized that after the first 30 days.

So we changed our mix.

Which meant that -- so we've put -- since we design these products like in platform basis, we have the ability to move rapidly from one model to another model with essentially a good number of parts that are the same.

So what we did immediately was to create a lot more low-end cameras by end of February, and we saw immediately the orders that we were losing in January, we started to get them back in February, and we came roaring back in March.

I guess that was your question.

I don't know if --

Yes, was there anything broader than that, though?

Because it sounded like you took actions other than in digital cameras, because it was a pretty big acceleration, not only in digital products, but it seemed like the whole Company.

Maybe that was driving the whole Company.

That was the big action that we took, as far as manufacturing.

We took some of the actions with Health, when we started to realize that we had an issue with limited number of screens.

Obviously, we'll look for another, we solved it.

And then we had the -- we have an issue with those installations of HCIS systems that we need to get better at and that is going to take us a little longer.

It's a more complex -- a more complex product.

But the sales are growing fast.

HCIS sales, they grew like, 50%, but we have to close those deals.

And the mix issue on digital cameras in the first quarter, since it is a small quarter, seasonally, doesn't change your view of profitability on whatever digital cameras might do this year?

No, we have the plan to manage that for profit.

That does not change.

There's not a big difference in profit between one -- I mean, it's a little more with the high end, but the volumes, as well give you some of the advantages when you buy parts.

This doesn't make a change.

Okay.

And, Dan, just revisiting the China issue.

It sounded -- inventory reductions clear at the retail level, but in the press release you mentioned that that was the primary problem.

So it sounded like final demand or consumer take-away was down too; is that correct?

No, consumer take-away is solid.

I will -- I will remind us that a key thing that we have to do now is get the interior taking pictures because we will run into that issue, Jack, with the coastal cities starting to convert to digital.

But in the quarter, it's primarily inventory.

I guess I probably should say it's all inventory, but I never know 100% of what's going on.

Okay.

Very good.

Thank you.

We'll take our next question from Shannon Cross at Cross Research.

Hi.

Good morning.

I wanted to follow up on inventory.

Your revenue was down 25%.

Your inventory was up 15%.

Obviously, higher than we had anticipated.

How should we think about inventory going forward?

And what -- at what levels do you think you can actually bring this down?

Because it has to be a pretty big driver of your cash flow this year.

Yes, Shannon, it's Bob.

We now have two models on inventory.

One is a digital model and this is a business that is expanding rapidly.

We have a guidance this year out for digital inventory -- or digital revenue to grow in the 30s and we're making some acquisitions.

So we're watching closely that that doesn't get out of hand and go faster than sales.

So that's a managed inventory effectively through heavy, high growth.

The traditional inventories did not decline as we had hoped they were in the first quarter, primarily because of the first two months.

We will be -- we will be putting a lot of emphasis on this traditional business.

We have people assigned to work on it specifically on how to get these inventories down.

It is a part of our cash flow.

Obviously, we do have the traditional -- the whole inventory thing, both of them, we've projected to come down somewhat during the year, but it's all -- more than offset by traditional.

So there will be a lot of emphasis on this.

I expect to report better results at the end of the second quarter.

And the plans are specifically calling for reducing the number of SKUs.

I think it's time to do that with the market going down like this, we need to and we will to reduce the number of SKUs.

That will help us to reduce the inventory immediately.

And, Bob, with regard to the cash flow number for the year, how should we think about inventory as a portion of that cash flow estimate?

I mean, when you factor in 400 to 600 million, what is your thought process in terms of where you should end the year at inventory levels -- what inventory levels did you end the year at?

We don't disclose that, especially since there are two different inventories that we are talking about.

It's -- when you combine the two, the growth in the digital and the reduction in the -- when the growth in the digital and the reduction of traditional, it's not a huge part of it, but it is a contributor.

Okay and then --

Shannon, we had said in -- in January 26th, that inventories would range -- reduction would range from 125 to 175 million, and I would say that's still -- that's still our goals.

Okay.

We just -- it's like we said, we got a little off in the first quarter.

We have nine months to get this thing repaired, and we will.

And then a follow-up on the digital camera comment.

Since it's low end that's selling, can you give us an idea of how the margins are coming along in digital cameras, as you get some of the volumes up?

They're low.

They are low margins.

They are very much as they were last year, maybe slightly less, but we are doing a lot of things with cameras.

We are doing a lot of bundles with printers.

You've probably seen them.

In fact, they are going all over the world and they are flying off the shelves.

So we said often that not only is it a business that we are going to make money with, but as well, it's a very important enabler for -- for our digital push into the consumer market.

They bring customers to -- to the [inaudible].

They bring a lot of customers to our printers.

They bring a lot of customers to our kiosks.

So you have to look at -- we never have plans -- ambitious plans to make a lot of money with digital cameras.

We just want to make some money with digital cameras, and then take advantage of the other good things that come from being in such -- such strong position in digital cameras.

Are you willing to run digital cameras, as a loss --

No.

No.

No.

And then one final question, on your printer dock, Antonio, you just mentioned that they're -- I think you said flying off the shelves.

Can you give us a little more granularity in terms of what you are seeing in the photo printer dock, and what you think your market share has done as there's been more and more competitors enter the field.

I don't have -- I don't have more recent data that we had in January.

But, we grew -- what did we grow? 42%.

We grew 42% year-to-year.

That -- that tells me that we are keeping our position or even improve it.

That's a pretty good number.

But I don't have anymore -- there's no more recent data now.

Okay.

And then do you want to give us any data on your inkjet initiatives?

It's going well.

Okay.

Thank you very much.

We'll now take a question from Ulysses Yannas at Buckman, Buckman & Reid.

As a follow up, from what you are saying, is it fair to assume that the printer docks have better profit margins than cameras?

Well, do you have -- depends.

Yes, you have to look at the -- you have to look at what we call the after market.

I mean, there is an MPV value, when you sell one of the printers that it is associated with two or three years, they go after, as you know very well, where media is going to be used.

So that is the profitability that we look for.

That is the number that we are looking for.

We are not looking -- we don't look at the instrument sale as the whole objective of the sale, obviously.

We don't -- so we -- we are -- we try to sell at variable costs plus something, as much as we can and then we want to make money more with the after market.

Is it fair to assume that a good part of your 42% gain in sales of the printer dock family was in media?

Meaning that media was up more than 42%?

Taken separately?

It's probably true, but I don't -- I don't have the numbers with me.

Okay.

Another question on media.

Colorado, did that increase -- the expansion in Colorado, did that increase your capacity by more than 100%?

I don't know the number.

I don't think -- I don't think it's 100%, but it is -- we'll come back to you.

We'll tell you.

I don't want to say a number in front of 140 people that is wrong.

So I will -- it's a -- we build these machines such that we can -- that we can grow -- grow as we go too.

So we -- we put a -- a first -- first phase capacity only that is known to be 100%, but I think the capability of that is going to be -- I wouldn't say 100%, but close to it.

We need to.

And then you said about the Rochester, that's depending on how you progress or how fast you progress in using your capacity with -- in Colorado, you are going to start expanding in Rochester, right?

That's right.

What we decided was this is the right place.

That is the decision that was made and we know where it's going to be located and why, and the -- the environment in which we're going to work and what building and everything else.

And then we are -- we want to watch the development of the usage, and what kind of capacity we need.

How long does it take to install capacity like that?

A year?

Yes.

Building -- building the machine it take -- maybe not a year, but close to it.

I mean you have to buy very special parts and you have to put into work early enough.

It is work.

There's work to be done.

With the increased availability of media for the [inaudible] kiosks, are you continuing to outsource also part of your demand, or your needs?

We still do that.

We still do that, because we think it's a healthy thing to do, to deal with the peaks and honestly as well as it will keep you on your toes to be better in cost and quality and everything else.

So, yes, we will continue to do that.

I am assuming from what you said that your ability to ship kiosks was restrained this quarter and last.

Is that true?

Basically the fourth quarter -- this quarter we started already to unleash that -- the sales force.

So I think some of the results you have seen is because we've been -- we freed up the ability to sell more kiosks because we were going to have media.

But your question is, should this increase that number?

We're going to try to.

We're going to try to.

We'll see how it goes.

Finally, on China.

You had a 20% increase in sales in the first quarter of last year, I assume because you had problems with the viruses the year before in 2003.

Is that also part of the reason the shipments were down from last year?

That's part of it.

I'm sure.

But the major piece is the inventory got backed up.

Okay.

Thanks a lot.

We'll take our next question from Philip Olsen at UBS.

Yes, hi, just a couple of quick questions.

First, in terms of your permanent financing plans for the KPG and Creo deals, can you just maybe give us little details of how you intend to finance those?

Phil, it's Bob.

The KPG is done, we've paid for that.

It was approximately $317 million and that required no financing.

That came out of our operating cash.

Creo, dependent on when it does close, which as Antonio said, we are expecting it this summer, we will do -- likely do regular bond issuance to finance that.

That's being reviewed and worked on as we speak.

And it ought to be a normal debt, straight debt.

And would that be the same -- I think you have about 300 million public debt maturities coming up later this year, would you also look to just refinance those in the term debt market?

Probably pay those down and issue new debt, but we are working on that to see which is the best in this rising interest rate environment to get the best interest costs for the Company.

So I'm not sure -- our goal is to only let that increase by the $900 million for the year.

Those alternatives will be worked out in the second quarter as we get closer to the event.

Okay.

Just two final quick questions.

First on -- have you been able to talk with Moody's to kind of give them an update following the first quarter numbers?

And if so, do you expect a similar reaction from them, as what S&P has already done today?

We keep the rating agencies appraised of what's going on.

I do not know what their reaction is going to be.

They will have to decide that.

We had expected the S&P reaction, and I don't think there's any -- I think most people did.

But we'll have to let Moody's decide what they're going to do and announce it.

I will put it differently.

Do you expect a Moody's action?

I am not going to comment on that.

We are -- the S&P action, we -- that's not going to cause us a problem with funding Creo.

We are set to go on that thing.

Our bankers are set to go, and we were kind of anticipated S&P.

We'll have to wait on what Moody's says.

I'm not going to try to predict what they're going to say.

Just the final question, in terms of the guidance you gave back in January from a digital EFO for 2005 of 2.75 to 3.25, is that still the range that you see for this year.

Yes, sir.

All right.

Thanks a lot.

We'll take our next question from Jamelah Leddy at McAdams Wright Ragen.

Thank you.

Returning to the mix issue, with respect to the digital cameras, I'm wondering if you can comment a little bit on what you see going forward for the remainder of the year.

Obviously, in March, it was a -- or first quarter of the year, the lower-end cameras were selling faster, and I'm wondering if you believe that was primarily a seasonal issue, or I think as Antonio mentioned, some of the lower price point cameras are improving so much, do you think that consumers are just really requiring lower priced cameras going forward and this will be a permanent shift.

I think so.

I think that that's what -- I think that's what's happening.

I think that the SLRs [ph] are coming down in price, as you probably know.

You can buy an SLR [ph] now for $800, and so that puts pressure on the rest of the lineup of digital cameras and it has compressed the pricing.

I think that will be the case.

We're ready for it.

Okay.

And then one more question with respect to China.

As you've mentioned, the need to -- to get interior time at taking more pictures with traditional cameras, what is your strategy to -- to do that?

I mean, is it a marketing issue or distribution or what?

What can you do to really accelerate that?

The answer is yes.

You have to get into these -- they are small towns.

They are only 2 or 3 million people, right?

But you have to get into these small towns and get a network of -- of photofinishing outlets, we call them Kodak Express.

We don't own them, but get them set up.

And then you do marketing in those communities to get people taking pictures.

It's not a person buying a camera in these kinds of situations, it's usually a family buying a camera.

We have done this in eastern Europe, we've done this in Latin America.

I think we know how to do it, we've just got to keep making it better.

Some of the programs that work really well, is you give the camera for free, basically when you buy four rolls.

Right.

This is -- we use this in many of the countries that have the same issues and it has worked, but it takes -- it takes time.

It takes time and you have to build the Kodak Express infrastructure.

And so we -- we have to get better at it, but we have done it before and it works.

Okay.

And can you tell me, are you just starting this now in interior China or have you been working on this for some time?

Or how do you measure your progress there?

No, we have been working on it.

We knew that there would be -- that's a big opportunity for us.

We've got people on the ground there now for, I guess -- been now maybe two years, that are building that infrastructure out and trying different things to get people to start taking pictures.

So, no, this has been actually in the China plans since the get-go to start on the shore, and as that matured, move inland, as the economy -- Chinese government is working hard to get the economies in the interior and the west to improve and as they are doing that, people have the money to get into photography.

Okay.

Great.

Thank you very much.

Ladies and gentlemen, we will take our last question today from John Beale at Standard Pacific Capital.

Hey, guys.

Just talking about the entertainment film business.

So as I understand it, it's like 25% of your EBIT is from that business.

And the previous caller mentioned the article in the Washington Post and Investor's Business Daily, which I actually just saw, said that the movies studios are really close to rolling out digital projectors to most of those theatres starting this year.

So it seems like that would immediately wipe out most of your profits in that segment, and given the shared manufacturing, it could actually be worse, right?

Because it's like 1 billion of revenue that could just drop to the bottom line.

What's the impact of that?

Well, I think you have to read the article a little better, John.

I don't think -- the issue is a little more complicated than a projector.

First, you have to have movies.

So you have to do movies.

You have to have projectors.

You have to find a way for people to buy those projectors to make money, otherwise they won't buy them.

It's a whole infrastructure issue.

Now, we know that this is going to go digital, don't get me wrong and we have our own digital plan.

We are -- we have more than 1,300 maybe right now more cinemas where we have our own digital system that is used right now for -- for advertising, but it has the -- it has the ingredients, if it is -- if it is upgraded to -- to go with digital movies.

But, I mean, I can -- I can tell you -- this will take an hour to tell you why we think this business is going to stay.

We don't see any change in the next ASR.

For us the ASR is the next four years.

We don't see any significant change in this business, and it's -- it's a series of equations.

It is a lot of things.

This notion about having digital cinemas has been going on for many years.

This is not first announcement.

It won't be the last.

Right.

Right.

But they have agreed to standards now, the studios are getting financing.

It will cost like $3 billion, and they will repay the loan with the cost that they save without having to put movies on your film, which just pretty much gets rid of your profits.

That's a news report and I wouldn't bank on that.

But that's been worked out and there are still a lot of questions about -- if you can imagine this, if the studios do something like that, and then they make movies and they want to pay that off based on the success of their movie, how do they redistribute that debt?

And then how do you redistribute the payoff?

As Antonio said, the theaters are very careful.

There's now two standards out there, 4-K and 2-K; although there's no 4-K projector that really is in production.

Not yet.

And -- and the studios, of course, have watched the music industry.

With that all said, it will go digital, but it's nowhere -- it's not going to happen right away.

Is that all for you?

That is all for us.

Thank you, ladies and gentlemen.

I would like to now turn the call back to Mr. -- oh, I'm sorry.

I'm Dan Carp.

That's me.

Yes, I'm sorry.

To Mr. Dan Carp.

You're going to hurt my feelings there. [Laughter] Okay.

This quarter wasn't what we wanted.

We are disappointed in the results.

It is not something we would like to do.

But we know what we have to do.

Antonio has got a really world-class team.

A lot of moving parts in this Company, but a world-class team to manage them, and that's why we're going to deliver the year we said we'd deliver.

Thank you all very much.

Ladies and gentlemen, thank you so much for joining us for our conference today.

This does conclude the call and you may now disconnect.