Eastman Kodak Co (KODK) 2005 Q2 法說會逐字稿

Good day, everyone, and welcome to the Eastman Kodak second-quarter sales and earnings conference call. Today's conference is being recorded. At this time for opening remarks and introductions, I would like to turn the conference over to the Director and Vice President of Investor Relations, Mr. Don Flick. Mr. Flick, please go ahead, sir.

Good morning. Thank you for joining our conference call this morning. I'm here with Antonio Perez, Chief Executive 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 morning's conference call may be forward-looking statements as the find in the United States Private Securities Litigation Reform Act of 1995. For example, references to the Company's earnings from digital sources or cash-flow projections 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 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. Now, let me turn the call over to Mr. Antonio Perez.

Good morning and thank you for joining our call.

Our second-quarter results, although improved from the first quarter, were short of our expectations. Bob Brust will review these results with you in detail shortly.

Before he does, since this is really my first opportunity to speak to you as a CEO, I want to provide my assessment of the state of the business and the state of our transformation.

From one view point, Kodak has two very different portfolios, each with sharply different trajectories. Our Digital products and services for portfolio is growing rapidly, while our traditional portfolio continues in accelerating secular decline. Each presents very different opportunities and challenges.

Our disappointing start in the first part of the year makes it clear that I need to make some changes and make them now.

I don't need to change any of our old strategy. The further we get into this the better the strategy looks. But I need to dramatically accelerate some of the steps needed to get there.

One of the clear earnings from the first half of this year is that sales of our consumer traditional products are declining faster than expected. Now we cannot control the rate at which traditional markets will decline. But there is a lot I can do about the construction of our traditional portfolio, and I'm going to fix that now.

The further actions announced this morning essentially complete the restructuring of the traditional infrastructure within the next 24 months. When finished, we will have reduced our traditional manufacturing infrastructure from approximately $2.9 billion to approximately $1 billion. We will have eliminated approximately 7,000 positions, in addition to the 12,000 to 15,000 goal announced in January 2004.

The remaining asset base will be adequate to supply the traditional market needs and more efficient than what we have today. Any further reductions will not have a significant cash impact any more in the company. We need to establish an end point for this traditional transformation, and we need to get there soon.

The more rapid decline in portions of our traditional portfolio demands that I accelerate the implementation of the target digital model I described in January. We cannot achieve the desire profitability levels of our portfolio with our current legacy cost structure. As I have described to you before, the majority of our Digital businesses have very healthy gross margins. So over the next 24 months, we will take actions and will reduce the SG&A costs to the targeted 14% of sales by the end of 2007.

This is a critical job, which reduce SG&A by about $600 million. We will fundamentally change how we do our work to achieve a significantly lower structure of cost, more in line with how Digital Companies work. This will result in approximately 2,300 positions being eliminated.

So, although we have been moving rapidly to get our cost out and get the traditional infrastructure what it needs to be, it hasn't been fast enough. As CEO, I want to make it clear that we are picking up the pace dramatically. This is what a Company needs to succeed as a Digital Company.

However, it's important to know that our Digital portfolio is doing very well. We have 43% Digital revenue growth in the quarter. We've completed our acquisition program in our Graphic Communication's Group. We continue to do well in virtually all of our Digital markets. And year-over-year Digital profitability will improve substantially.

In January, I set the following 2005 goals for the Company: Digital revenue growth of 36%, Digital earnings between 275 and $325 million, investable cash generation between 400 and $600 million. I remain as confident in our ability to achieve these goals now, as I was then.

I also want to make clear that this three parameters are my focus in running this business for the balance of the transformation. Revenue from our Digital portfolio and result in profits are the heart of our future proposition. Cash is what enables us to create this new Company, and it's an excellent proxy for how well we are managing the declining traditional portfolio and driving Digital profitability. If we do a good job on these three parameters, everyone will be happy with the outcome.

I have one additional announcement to make this morning. It has become abundantly clear that operational earnings per share are no longer a useful measure to judge our success as we complete this transformation. I have already indicated the three methods that are my focus.

The complexity of storing nonrecruiting and nonoperational items from recurring items is modified by the increasing complexity by the accounting rules. Combined with the restructuring activities, the Company is implementing around the world, the process drives unpredictable operational cost impacts. As we embark upon accelerated and expanded restructuring around the world, this situation would only get more complicated. Trying to provide that kind of forecast with any reasonable precision has become extraordinarily difficult given all the moving parts. For these reasons we will discontinue earnings per share guidance for this -- from this point forward.

At the same time, I understand the need for the investment community to make informed decisions about product. Therefore, we intend to increase the disclosure of actual results, including reporting Digital earnings, beginning with the third quarter, as we continue to integrate the new Digital elements we have assembled.

Finally, I would like to offer a few comments about the second-quarter performance. Digital and Still Imaging System results show clearly that they are the center of the transformation. The Digital products are doing well in the market. Digital commerce performs well in market share, although the ongoing downward shift is causing some market erosion. While we feel we have an industry leading structure, we need further improvements such as those enabled by our overhead cost reduction program that we announced today.

Our Creo's Product continues steady growth against all parameters, as well as our on-line service continue to enjoy market success. On the traditional side, Entertainment Imaging had another strong quarter with revenues up 12%. And I -- as I already noted, the industry's consumer film sales are declining at a faster rate, in part due to an increasing rate of decline in emerging markets.

We have now largely cleared away the distributor of the stock that we had in China. Which has enabled us to clearer view of the underline demand. This has revealed that in the more affluent coastal markets in China, Digital substitution has begun to have a significant impact on film sales. We, of course, will continue to exploit the continuing opportunity for film in the secondary markets of China. But I'm operating under the assumption that the consumer film sales have peaked in this market.

Of course, this creates a corresponding opportunity for success on the Digital side of the business in China, which we will continue to address as aggressively as we are in other parts of the world. To that point, we have achieved number three Digital market share in China this year already.

Our Health Group made excellent progress in the second quarter. With operating margins improving from 11% in the first quarter to 16% in the second quarter. That is more in line with what we expect from this business.

While the traditional side of the business performs somewhat better than planned, I would like to see more growth on the Digital side of the business.

The Graphic Communications Group, which is larger Digital, continues to look better and better to me now that we have closed on all the elements. This is a great business, performing well, and I expect this unit to become a significant vector of earnings growth next year. Integration effort is moving into high gear following the Creo deal, so we can fully realize the value of this acquisition.

In summary, we are having success in our Digital market, and our acquisition strategy looks very solid. We just have to move faster and more definitely on cost in the face of accelerating traditional declines. And we're doing that.

Now, I want to turn the call over to Bob Brust for a review of our second-quarter results in a more detailed description of the plans we just have announced. Bob.

Thank you, Antonio. As you have seen in our press released this morning, we reported second-quarter operational earnings of $.53 per share. Which is well below our stated expectations of at least $.75 per share. While these results represent a substantial recovery from the first quarter, they are still clearly below where we wanted to be. There are four drivers of this quarter's results, which I'll discuss more fully in a few minutes. They include consumer film, health digital revenue growth, unfavorable exchange impacts and unexpected tax limits.

First there was a sharper than expected industry decline in consumer film sales, particularly in emerging markets. Where we are seeing an impact from Digital substitution in the most developed sectors of these markets.

The decline in the U.S. and European markets is about what we expected. The worldwide industry volume decline of consumer film in 2005 was previously forecast at approximately 20%, and we now believe that number for the full year will be in the range of 23 to 27%.

As Antonio indicated, the increasing rate of consumer film decline represents one more reason for the accelerated program to reduce our traditional manufacturing infrastructure. Whether the decline rate is at the top or the bottom of the forecast range is becoming increasingly irrelevant. As we are taking down the infrastructure at what we believe is the maximum rate possible. Therefore, we will be moving away from trying to make consumer film decline rate predictions in the future.

The second major component affecting the second quarter results is in our Health Group. On the positive side and as Antonio said, Health made significant progress in improving the performance quarter sequentially, reporting higher operating margins of 16% versus the 11% reported in the first quarter, and improving sales for computed radiography and healthcare information systems products.

However, overall Digital revenue growth was less than anticipated leading to the shortfall against expectation. In addition, we found ourselves fighting a number of headwinds during the quarter. The most significant of which was the strengthening of the U.S. dollar. This had two areas of impact which resulted in $.09 of unfavorable exchange versus our plan for the second quarter. $.06 was the result of unhedged U.S. dollar denominated Kodak Polychrome Graphics that was required to be marked to market. The second impact was a negative $.03 related to the impact of the strengthening dollar in the transition of $9 U.S. sales and costs.

Finally, unfavorable and unforecast tax changes and charges and accruals negatively impacted the quarter by $.06 related to a couple of state tax law changes that were picked up in the second quarter, evaluation allowances relating to the closure activities in Brazil, which we thought would all be in restructuring, but some came into operating earnings.

And lastly, we brought back some subsidiary dividends that required a small tax accrual. Consolidated revenue growth for the company was 6%. Driven primarily by the recent KPG and Creo acquisition, which together contributed 413 million of revenue in the quarter.

The revenue growth was favorly impacted by foreign exchange of $54 million or 2% year-over-year. Digital products revenue grew 43%. Driven primarily by our portfolio of consumer Digital products and services and the KPG and Creo acquisitions which closed during the quarter.

Traditional products revenue declined 15%, which is a bit of an improvement versus our estimate of a 17% decline rate for the year. As accelerating consumer film declines were partially offset by strong motion picture film sales and better-than-expected x-ray film sales. Emerging market sales increased 1%. Although, sales in China declined 6%, as a result of consumer film declines in the more developed parts of this market. Partially offset by strong sales of Health and Graphic Communications products.

Gross profit as a percent of sales was 29% on a GAAP basis. A decline of about 2.8 percentage points from last year, primarily driven by an increase in year-over-year nonoperational charges and costs of goods sold at 52 million, an unfavorable price and mix.

SG&A increased 33 million or 5% in the quarter, but decreased as a percent of sales from 17.8 to 17.6%. A combination of acquisition related costs of $77 million, and an unfavorable exchange of $8 million aided $85 million to SG&A. Which was partially offset by cost reduction activities during the quarter. Excluding acquisitions and exchange SG&A declined by 8%.

As part of our current restructuring program of approximately 2,200 positions were eliminated during the quarter. In addition, cost reduction actions which included severance, accelerated depreciation, exit cost, and asset and inventory write downs, resulted in pretax charges totaling 353 million or $.88 per share. Use of cash was 75 million higher than last year for restructuring.

In addition to restructuring, a number of nonoperational items were recorded during the quarter which include the following: A pretax charge of $644 million or $.13 per share relating to the write off of in process R&D associated with the acquisitions of KPG and Creo. A charge of $6 million or $.02 per share relating to the change in estimate of a tax benefit associated with a land donation from a prior period.

A pretax charge of 19 million or $.07 a share, relating to the write down of the Company's investment in Lucky Film reflecting a decline in its stock share value. These charges were partially offset by a credit of 13 million or $.03 per share relating to gains on the sale of real estate. Including the impact of restructuring and other nonoperational items, the GAAP loss per share for the second quarter was $.51on a continuing operation basis.

The other income and charges category had a negative swing of 46 million year-over-year primarily driven by first ,the previously mentioned $23 million of unfavorable exchange impact of the unedged U.S. dollar nominated KPG debt. Also, KPG equity income that moved from other income and charges to Graphic Communications segment, as a result of the Company's acquisition of Sun Chemical's 50% interest in the KPG joint venture, which closed on April 1st. And the Lucky Film evaluation impairment of 19 million, which was offset somewhat by gains of sales of the properties of $15 million.

We recorded an estimated effective annual tax rate of 15.5% for the quarter, reflecting the expected sequential upward trend that was predicted earlier this year. This trend is being driven by a rebound in the mix of where the Company is earning income.

In addition, there was a $29 million year-over-year change recorded in the benefit for income taxes. Which negatively impacted the current quarter operational earnings relative to the same quarter last year. A tax benefit of $9 million was recorded in the year-ago quarter relating to a tax reserve released resulting from an IRS settlement. In the current quarter, a tax charge of $20 million was recorded, as I previously mentioned, for changes in state tax laws, recording evaluation allowances, and the plan remittance of earnings from subsidiary companies outside the U.S.

Kodak's inventories of 1.523 billion increased 193 million quarters sequentially. Primarily as a result of Creo and KPG acquisition which added approximately $335 million of inventory. Excluding those acquisitions, inventories declined by more than $100 million.

We made significant progress during the quarter in bringing down traditional inventories and will continue to aggressively address this issue in line with our goals and cash flow targets. Net trade receivables increased $695 million during the quarter sequentially, primarily as a result of the Creo and KPG acquisitions.

In addition, we traditionally experience seasonally higher sales in the second quarter. Capital spending was $111 million in the second quarter, an increase of $20 million from last year's second quarter.

As expected, debt increased to 3.721 billion from the year-end 2004 levels of 2.2321 billion. As we close the KPG and Creo acquisitions during the second quarter. The Creo acquisition has been funded under our 1.225 billion, five-year revolver. We plan on trimming out a large portion of that debt soon and are in the process of renegotiating the revolver which expires next year. Both of these events should be concluded this summer.

We will now turn our attention to reducing debt for the next few years. Second quarter investable cash flow was a negative 297 million compared to a negative 39 million in the year-ago quarter. Net cash from operating activities was determined in accordance with GAAP, was a negative 207 million versus 60 million in the year-ago quarter driven primarily by lower earnings and an increase in cash payments associated with restructuring. Cash on hand at the end of the quarter totaled 555 million, which compares to 519 million last year at the same time, and an average of 490 million for the past five years. Despite our earnings short fall to date, we look for investable cash performance to be on plan for the year in the 400 to $600 million range, which equates to 1 billion to 1.2 billion in net cash provided by operating activities as determined in accordance with GAAP.

I'd like to take a minute to explain why I'm so confident in our ability to achieve our targeted cash goals given the higher expected use of restructuring cash and the lower year-over-year earnings.

First, with the traditional inventory pull of approximately 800 million, we have aggressive plans in place to decrease these inventories faster than the underling industry decline rates.

Second, we are finding additional opportunities to constrain capital spending as we migrate to a less capital intensive Digital infrastructure. As a result, our estimate for full-year capital spending has been reduced from 600 million to less than 500 million.

We continue to improve the quality of our receivables and have opportunities to improve past due performances in our acquired businesses. And we will continue to seek returns from our portfolio of intellectual property, as we believe there is value to unlock here.

And finally, we are creating surplus assets as a result of our restructuring actions, which we are working aggressively to monetize.

As Antonio mentioned, we will be implementing an accelerated cost restructuring program, which continues to demonstrate we will deal effectively with the realities of the declining traditional portfolio, while continuing to improve the profitability of our expanding portfolio Digital products and services.

The additional initiative that are expected to eliminate approximately 9,300 positions generate incremental annual savings of approximately $800 million and result in incremental cash charges of about $470 million over the life of the program. A significantly higher mix of write-offs included in these additional initiatives will result in a lower cash impact relative to the program announced in January 2004.

In total the combination of the existing programs and the extension announced today, as well as a number of smaller initiatives, will result in total employment reductions of 22.5 to 25, 000 from January 2004 levels. The total program costs of between 2.7 and 3 billion when fully implemented. About half of the cost will be noncash.

Because it has become increasingly difficult to predict short-term areas due to the complex nature of our transformation, we will no longer we providing per share earnings forecast. As we dismantle almost 2 billion of assets and reform our infrastructure during the next two years, accurate forecasting becomes very challenging, if not virtually impossible. As you have seen from our fully disclosure document distributed this morning, we will no longer include a discussion of operational earnings. Consistent with SEC recommended practices, we will report GAAP earnings only.

However, we have and will continue to provide a description of nonoperational items and where they are recorded within the P&L. We will report quarterly consolidated Digital earnings from operations beginning in the third quarter and will further delineate Digital earnings by segment beginning with the first quarter of 2006 sales and earnings report. Going forward, the Company will continue to focus on the three most important metrics against which we should measure. Digital revenue growth, Digital earnings growth and cash flow. Antonio and I would now be happy to take your questions.

Thank you, Mr. Brust. Ladies and gentlemen, our question and answer session will be conducted electronically. (OPERATOR INSTRUCTIONS) For our first question, we go to Matthew Troy -- I apologize -- to Jay Vleeschhouwer with Merrill lynch.

Hello?

Yes.

Hi, Jay. Jay?

We lost him.

Please go ahead, sir, your line is open. Hear nothing response. We go next to Matthew Troy with Smith Barney.

Morning, guys, can you hear me?

Hi, Matt.

Quick question on (indiscernible) -- something you have talked about in the past.-- yet focusing on - (indiscernible) -- granted there is a lot on your plate, but still a very promising technology around which you guys with a great deal of IP. Just was wondering if you could give us an update of the strategy and progress in moving toward commercialization? Build versus license? How much investment is required to facilitate that process and has your thinking changed at all in the most cost effective means in technology?

Matt, we do have a very, very strong position in IP, and we continue to invest in R&D and new IP is coming out of our labs constantly. The business proposition for building products is not clear for us. For the time being, we will continue monetizing that intellectual property through gross licenses that we keep signing. And we signed some this quarter and we will continue to sign in the future. As well, we are evaluating partnerships. This is a business that requires a lot of capital. It is not our intentions to put a lot of capital to work in this business. Therefore, we are looking for partnerships where our know-how and our intellectual property will be our contribution by and large. But in the meantime, the business model is to monetize our IP.

Okay. Thank you for that. The next question I had revolved around Kiosks. Obviously, you folks have been very aggressive and successful in kind of peppering the landscape with the picture makers. I notice that the growth rate in that segment was down to 24% in the quarter versus 63% or so last quarter.

Understandable. Given that, I think the majority of your growth last year was hardware placement. I was wondering if you could give us an update in terms of mix, because, obviously, the model was to get them out there and then turning out that consumable. If I were to guess, last year at this time it was 90% hardware and 10% consumable. What does that mix look like now, and what are the trends through the kiosks meeting your expectation?

First of all these programs, these programs, they tend to run in lumps because you get a huge retailer in Europe and then all of a sudden, you get a huge order that comes a certain time in the quarter and you get a quarter with a lot of more units. And that influences, obviously, a lot of the revenue that you book. As far as the split, it is about 50/50. And the more we build the install base, obviously, the more the annuity is going to be larger. So it will be higher than 50%.

We are very pleased with our program. We are not only lowering the cost of goods, the cost of making the product, but as well, we have announced that soon we are going to implement the remote -- you know, remote monitoring. Once we do that, obviously, we won't do it all over the world at the same time, but we will implement monitoring. That would allow us to increase the functionality of the kiosks substantially, and, I think, it will raise the value of that device.

As well, it will offer, as well the possibility of locating kiosks in all the places that -- where there is a lot of traffic.

Overall the program is very successful . We're very pleased with it.

Okay. Last question that relates to film here in the U.S. given the secular decline that continues to, you know, exceed even the most negative outlooks. You know, my sense is a year or two ago people started reducing inventory at the retail level -- last year and this year -- it is, you know, diminishing .

You know, there is speculation out there that some retailers are looking to eliminate brands altogether. Now you guys on the high end would probably, I think, intuitively be a beneficiary in that trend because I think they want an entry label -- or entry level, private label and the premium level Kodak brand. Are you seeing that in the channel? Are you hearing from retailer that's they are looking to eliminate brands and do you see yourselves as a beneficiary?

We've seen that. We've seen retailers that they are trying to reduce space for good reasons. Especially in the retailer shop is very available. They are looking for turns - high turns, and slow the turns. We believe that that will be a benefit for the Kodak brand . Not many retailers will choose to eliminate the Kodak brand out of the category.

In fact, we are the category leader in many of those retailers. So, we've seen some benefit. I wouldn't put a number on it. But, yes, we have seen some benefit of that, and you can see when you walk through the retail stores that you only see the Kodak brand and the local brand. So, in that sense, yes, we are benefiting from that.

Okay. Thank you very much for the time.

Thank you.

And for our next question we go to Jay Vleeschhouwer with Merrill Lynch.

Thanks. Good morning, Antonio. Good morning, Bob

Hi, How are you doing.

Good. The first question regards your profitability mix. You talked about the 275 to 325 profitability contribution from Digital. When you come into the year, however, you talk about a negative 175 in traditional profitability. Is there perhaps an updated comment with respect to that?

Secondly with respect to the restructuring, could you overlay that in terms of your geographic view of the world? That is to say, I think, Antonio, you've taken a somewhat cautious view about Europe on the hull and you've taken an equally bullish view on Asia. Do you foresee as part of the restructuring a meaningful change in terms of asset allocation, people, products or any of that as it relates to the geographic consequences of the restructuring?

Yes, let me answer the second part and Bob will go through the first. There are a lot of numbers there. The restructuring. We have plants all over the world as you know. Wherever there is a plant, there is an opportunity and there is a need, you know, to reuse that infrastructure. So every single plant in the planet by and large with the few exceptions of the ones that are dedicated to Digital products or Digital components or Digital media, they will be one way or another affected by this.

Sometimes it will be affected to the point that it will be closed down and some of the times it will be affected to the point by a significant reduction What we're trying to do is not only reduce our manufacturing capacity, but as well, to do it in an effective way so the machine that's we have that are very expensive and very complex to operate, they have a very high level of utilization. So we -- we're not ready now to disclose in any particular place in the world, but by and large, unless -- unless a part of the factory or a factory is dedicated to Digital products that the opportunity can grow. Everything in every factory that is dedicated to the traditional products and especially the ones dedicated to the traditional product that are declining rapidly, they will be affected significantly.

Jay, I think that you asked -- we earlier in the year projected Digital earnings of between 275 and 325 million. And we're -- we're still on track for that and we've recommitted today to achieving those numbers. And the second part of your question was that we have projected 175 million or so decline in Digital earnings -- traditional. Yes, traditional, excuse me. I'm going to get thrown out of the room here. In traditional earnings. And will that still hold. In the traditional business, the film decline rates accelerating especially in emerging nation is making that target a little more difficult.

The second thing that makes it more difficult is this whole transformation we're going through now. And that's virtually all in our traditional businesses. And as we move into the really sharp declines now and removing 2 billion of assets, the line between operational and nonoperational is getting too blurry.

For instance during this quarter as we close down our Brazilian facility, it was unclear which costs were going to go to operational and which were going to go to restructuring, and that was one of the things that hurt our operational earnings this quarter. So the traditional businesses will benefit the most from this restructuring as we try to pull those costs down from the decline rate. But that gap will be almost impossible to measure in the next 18 or 24 months as we get through this rapid decommission of $2 billion of assets.

So I hope that answers your question, but the big point is, we're still on track to achieve our Digital results for the year.

And one last one then. In the press release, you talk about how you have number one market share in a number of Digital categories, like high speed inkjet printers, consumer cameras in the U.S. and so forth. Is there a direct relationship between market share, particularly, we number one and profitability? Or maybe you could talk about how that relationship works now and how you foresee it working in the future, where share gain and install base gain, perhaps, translates into a better margin case?

Sure. Depends on the category. And in the Digital commerce, you know, our commitment for the year is that we're going to make money. The margins are not going to be high. They have never been high. They will not be high. But we won't lose money. We will be making money.

It is a very important enabler for the Company, not only for the grand presses, but as well as a key -- it is a key entry point for our printer strategy and for our easy share gallery strategy and as well for our kiosks strategy. So this is a very important piece of the puzzle.

Our objective there is to be one of the top three players in the world. Our objective there's is to, you know, learn and lead the industry in the imaging pipeline that you have to develop to get these products -- to get the whole system successful. And our objective is -- you know, it is to make some money, although, we are realistic and we know we are not going to make a lot of money with Digital cameras, but it is an important part of our portfolio. But the rest of the product, you know, market share equates, you know -- on a -- at a certain time, you know, with profit. With printer, you have to continue to build the install base until your annuity reaches a point that is, you know, larger than, you know, than your hardware. With your hardware you are going to be selling , you you know, a little more than your variable costs.

Obviously, as high as you can, but, you know, there is a lot of competition and we know the limits with which you can sell those products. So the margins where the hardware is going to be low and then the margins with the annuity will be high. So, you know, market share is crucial because if -- it builds the annuity. The more you have the more you make. We have very high margins with every customer. So, you know directly.

And kiosks, the same thing. Kiosk is a beautiful product. You make money with the hardware and you make it with the annuity and you make it with the service. That's the beauty. Then you can go into the other products. Versamark. Versamark, we made one-third of our profits with the product, one-third of the profit with the ink and one-third of the profit with the service. Approximately. The more we have, the better it is going to be for us.

And I can go on and on. By and large, I don't want to go through all the product lines we have in the Company, By and large, we describe, generally, we are looking for further lines where we have very strong know how, very high IP, where our brand plays very strongly and areas where we can have hardware , services and annuities. And that's -- when you look at the portfolio we have, that's what we are building. In general, market share is profit for us.

Thank you.

And for our next question we go to Carol Sabbagha with Lehman Brothers.

Thanks very much. Just a couple quick questions. With the focus now being on Digital revenues earnings and cash flow and if we look beyond '05 more specifically around cash flow, do you think the 4 to 600 million that you are targeting for '05, if you look forward over the next several years, is that likely to go up? Stay flat as traditional declines replaces it, or it could be a little on a decline for several years, then it should go up from those levels ?

Carol, you know, it is hard to predict that, but what should happen is our Digital earnings are now in a rapid growth phase, and as you saw the last time we displayed that down in New York City, we expect Digital earnings to accelerate rapidly in the next few years. Especially in our Graphic Communications business and that helps cash.

We also will not be spending the same capital in the Digital business, as we used to in the traditional business. Plus the inventories we have, as I mentioned, and we have around $800 million of traditional inventories, and we need to pull those down with the asset pull down that we're seeing in our other assets. So it seems to me that our cash -- our cash -- our 4 to 600 million cash of anything will have an upside in the coming years. We also -- people sometimes say , you know, you are going to sell -- maybe sell some restructured assets. But we are spending a lot of cash on this restructuring. And as we pull back from that and get those assets freed up, we will monetize those in the next couple years as part of our cash program. We are setting up with some lower info.

So long winded answer to your question, I think there is more of an upside of this rather than a downside going forward.

Okay. And talking about the restructuring, I think that has been one of the surprises on cash. Can you tell us how much you spent on restructuring so far this year on cash out and how much you think the year will end up?

Yes, I'm not going to tell you how much we spent so far this year, but the cash -- the estimate for the year now is between 6 and 650 million of cash out flow. Last year that was -- and we told you it was around 480 million. So it is a higher number this year. I would guess it is the peak of the period.

We should see that diminishing a little bit going through this and holding down the assets as we get further into the program, there will be more write-offs and less cash . The cash is heavily determined by severance payments. Later in the period as we write down these facilities it will be noncash. So 480 last year, 6 to 650 this year and then diminishing next year.

Okay. And then a question also on the restructuring and the new restructuring and hearing Antonio when you talk about it a little bit, it implied that part of the SG&A cuts or part of this restructuring is going to relate to the Digital businesses. Would that be a fair take away and how much do you think of the new restructuring will relate to the Digital businesses and improving their profitability?

No, I didn't mean to say that. What happens is -- well the way that is for the following reasons. We have corporate structures. We have corporate structures that are supporting, or they are designed to support all the businesses of the Company.

And they are -- they are designed for our legacy business, for our old business. Those corporate structures, we have been acknowledging for awhile that they are too large and in many ways unnecessary for the way, you know -- for the way we run if the Digital businesses. So in that sense, the Digital businesses will be benefiting from the SG&A . But we're not going to cut -- we're not going to cut SG&A in the heart of the Digital businesses.

With the exception that in the go to market organizations that we have now combined and -- and they do both, the traditional and the Digital, obviously, they are going to become more and more digitally focused, so -- and because there is less tradition to be sold, there is going to be, you know, some, you know, employment reduction there simply because there is -- simply because there is less to sell. And then there is something else that is Digital too and it is SG&A which is the consolidation of GCG. The consolidation of GCG will have SG&A reductions because there are synergies. These companies, they operate within the same space, and it is an opportunity in the back-office. And in the front office and in the photo market to, you know, optimize the number of people and how we do function.

So all of those things will affect Digital, but it is fundamental for us to pass the message that we're not getting SG&A actually from the heart of the Digital businesses, but, you know that is because it is through the consolidation of acquisitions, or because of the corporate center, that was designed with a different of set of objectives in mind that we don't need today for the Digital businesses.

That's helpful. One last quick question on the working down the traditional assets to 1 billion to 2.9 billion. I don't -- well, the question is, I don't think you will answer, but what is that infrastructure going to look like when you are all said and done? And maybe this is the part you would answer. Is part of doing this to kind of try to also consolidate manufacturing by business or more of your consumers in the same plants and more is done in the same plants, et cetera? raw?

I'll answer the second part. The first part, you know, I cannot answer.

That's what I figured. I thought I would ask it.

The second part, yeah. The second part. Yes. You would end up with a consolidation of manufacturing that will be very much aligned with the businesses. Yes.

And the last one on that is, how much is the China plant on your books for currently? About?

It's high.

Is it over a billion?

I think the net's about 550 million right now, Carol.

Okay. Thank you very much.

And for our next question we go to Jack Kelly with Goldman Sachs.

Hi, Jack.

Good morning. Antonio, in the photo finishing area results were down 45% or so . And obviously, you know, the printing of pictures is shifting to other venues. Could it be -- that seems to be more than that? Is there something else going on in terms of loss of share? Can you give us some color there?

We are losing money in that business, if you didn't know.

Right.

So less revenue makes me happy, if you know what I mean. So there is a lot more printing that is going into on-line and is going into One lab and going into kiosks and going into home printing. There is still a lot more digital capture that is taking place. Some of it doesn't go anywhere.

It becomes for viewing and soft copy screens and, you know, Kodak gallery and cell phones and the like. So it's a combination of that there is many other ways of getting your pictures taken and as well the fact that we only want to be in businesses where we make money.

And we used to have a lot of deals where we didn't make any money and we just -- we are just not interested in keeping market share in a place -- it is something that is lowering and is going down and it is going away and we don't make money. So we are getting out of those deals, as we have been announcing for the last two years. And we will continue to do that -- to do that. We will have a significant impressions and centralize overnight printing because we think it still is the lowest possible cost for a print, and I think it will have value for a long time. But it is going to be reduce, focus and profitable.

Okay. So we should think about an '05 versus '04, despite the fact that revenues are down by this magnitude for the full year that the losses and photo finishing in '05 will be Less than they were in 04?

Significantly less. Like beautifully low. It is still loose, but a lot less.

Okay. It is something close to break even it sounds like.

I won't answer that.

Okay. And yeah, just a follow-up on the China question in terms of the cost structure there. Clearly in the last six months, the model has changed pretty dramatically and your statement that conventional film has peaked.

In China.

Yes, in China. And it is switching to digital more than you thought. Does that require and given the number you gave, Bob, in terms of the investment there, is the investment consistent with the way the business is structured now or will that require more write-offs for the next year or two?

I don't know if I understand. The investment in China?

Investment in China, you know, with -- I know you took a little bit of a write-off on Lucky films this quarter. I guess I'm saying, given the shift in the model in China away from traditional film, is that going to trigger more write-downs of the infrastructure that you have there for traditional film?

As I said before, every single plant that we have in the world, especially the ones that are working on traditional product and especially the one that's are working on traditional consumer film, they are going to be affected by this. There is no doubt. Manufacturing in China doesn't only Supply China, it supplies the other parts of the world. So we will look at all those things.

But the message is every single side where we have made manufacturing -- we do manufacturing of traditional products . With the traditional products going down more rapidly than we thought. Where we established the first program two years ago, they need to be readjusted. And the way we want to do this and they -- and we have designed the end of the product. We cannot continue with this bleeding year after year. We have designed the end of the process. And it will executed between now and 2007. And that will affect everybody that is involved in there.

Okay. And the confidence -- you used the word "end". What gives you the confidence that given these additional charges that by the middle of 2007 you have achieved the end. I mean, obviously, can't give us how much you are cutting capacity. But what gives you the confidence that you get there that -- that's it?

Well, we made a series of analysis in modeling of what the volumes could be. There is a range of volumes that will still exist in 2007. The way we will distribute manufacturing of this products has allowed us to cover the minimum and the maximum volume that's could possibly exist at that time in a much more effective way.

Therefore we know the film is not going to go completely to zero. It is going to be a tail. It is going to be a tail. So with that -- so with that 900 million or 1billion will remain there for the rest of eternity? No. Eventually it will go out. But it will be trickling down and it will be not significant and it is not going to be a topic you guys will be asking us about.

Okay good. Thank you.

And we go next to Philip Olsen with UBS.

Yes, just -- I guess looking for a little more detail with respect to your capital structure plans . First, on the bank negotiations, is it your current intention to replace what had been your one year and your existing five year with a new facility, a single facility? If you could maybe give us an idea of the maturity of that facility, the size of it and a structure in terms of confidence?

And as a follow-up in terms the financing for the Creo deal, the size of that is a billion dollars the type of range we should be thinking of? And structurally , will that be Perry Pasu or will it be identical to those in your existing public debt? Thanks.

Okay. I'll start with the revolver. We have carried two revolvers. One was a standard 364-day revolver -- that was around a billion dollars that expired earlier this month. We had decided not to renew that. It is a lot of trouble. -- it is a lot of trouble. It is an annual affair in New York to arrange that financing.

So we have decided to go for a new revolver that will be a billion, a billion 2, a billion 3 or something like that that would be a 5-year deal much like the one we have that expires next July. That is in process of being negotiated right now. And as I said this morning, that should be resolved this summer. Which means in the next few months.

We did -- as we are arranging the final financing package for Creo, put that under the current revolver of 1225 that expires in a year. We are in the process of arranging the debt on that. It will probably be a 4 to 7-year type term that for the billion dollars --that should be arranged this summer -- and right now, I don't want to tell you too much more about that because we have not gone out publicly with what we're doing yet on that. So two new facilities. -- in Creo and a new revolver that will be in the 1, 1-2, 1-3 billion range.

I guess, two quick follow-ups, I understand you don't want to give a lot of details with respect to these new financings.

We will in -- within the summer when we get them finalized you will get all the details.

But would it be your intention to have both of those on the nonsecured basis? Or do you think there is the potential that either the banks would gain security given where your ratings have moved to?

Yeah, this site's facility we're going to have to have some collateral. There is no question about that. We are no longer investment grade. It would be -- it would be next to impossible to do this without some collateral.

Okay. Thank you.

We go next to Sam Doctor with J.P. Morgan.

Hello?

Hello.

I have a couple of questions on your employment levels . Where are we right now and where do we see that going the end of 2007?

Who has the numbers? At the end of last year, we were about 54, 000. And the annual rate you saw 54, 000.

From Creo and KPG though, haven't we?

Yeah. And during the first half we made two acquisitions and we will be continuing to reduce people. I think, based on these things, it will be hard to tell.

The acquisitions added about 8,000. So that will get us into the low 60's . What we announced today was another 9 or 10 going out. So we'll probably not be much different than we were in the beginning of the year. Maybe in the low 50's when the dust settles.

And at this point, how many of these 62,000 or 63,000 are in traditional manufacturing?

I don't know that.

The one that's we have today in traditional manufacturing?

Yeah.

We'll come back to you on that one.

We'll have to come back to you on that. I can guess the number, but it is about 20,000, but I would hate to -- I don't know if it is 19 or 22, but it is around that number.

Okay.

I agree with him.

That is going down 50% in the next two years?

That is going down as we announced in the -- right.

Is it more than 50% or less than 50% for the next two years?

No, we didn't say that.

But what would we -- what should we be modeling?

Well, , you know, in September we will talk a little more about that. But we are trying to increase , as I said before, the utilization rate of all the machine that's we have. So you cannot -- you cannot , you know, make a confusion with the number of people with the manufacturing capacity. I don't think it would be problem.

All right. Thank you.

Thank you.

And for our next question we go to Ulysses Yannas with Buckman, Buckman and Reid.

Hi.

Hi, Ulysses.

Good morning. The reduction of 7,000 in manufacturing, is that implying a model where you would -- your company would concentrate on manufacturing centralized goods and basically out sources everything else? While were you concentrating on your intellectual property and the marketing of the product?

No, Ulysses, we will continue to be A manufacturing company. But the -- we would only have capacity in the operation of the businesses despite volumes that we expect, you know, we're going to have. We have too much capacity today. That's simply what it is.

We have too much capacity to, you know, to produce traditional products. So we're just trying to align, you know, the capacity. And the methodologies -- you know, the production methodologies for the end gain. For the end gain. You don't organize yourself in manufacturing the same way when you are growing.

I mean, It is just a very different system that you have when you are -- you are already aware of what the end gain is going to be. That's what we will design in the next few years. We will have a manufacturing structure that is -- that is, you know, that will be effective for low volume. For instance, a lot more flexible, that will be able to do several types of products rather than the one we have today in which a machine is, you know, is specified and optimized for one product because you have this huge volumes they have to deal with.

So with no restructuring, it is not only just that we are going to eliminate positions, we are going to recreate the way we manufacture products. So the facilities that will remain, you know, will be the ones that will have machines and, you know, intellect and know how to be a lot more flexible, so they can do different products. And actually you can change from one to the other with, you know, minimum, you know , less interruptions. So all of that is going.

But we will continue to manufacture products. Both in the digital space and In the manufacturing -- and in the traditional space. In the traditional space, obviously we will concentrate only on manufacturing those elements of the value chain where we have something to offer that is better, you know, than anybody else. If we think we can get that particular part or that particular subsystem from a subcontractor that has an effective way of doing it with, you know, with the quality requirements we have, we'll use them without any doubt. But we will continue to manufacture many things in Kodak.

When you talk flexibility, for example, you are talking about using the same coating equipment to do film and/or paper rather than dedicating to paper and indicating to film, is that the idea?

We will do all sorts of combinations that I don't think we have time to discuss. But, yes, that's the thought. We will, when possible. There are things you cannot do in the same machine, as you know. But there are many machine that's we can do several products. So all of that is the exercise that we are going through now.

On another subject. Creo just about completed the $24 million restructuring. The cost restructure reduction. I assume from the number of employees that these people had that there is at least another 50 million you can take out of the operation. Is that number more or less ballpark?

The nature of the synergies with the Creo is not so much with Creo, but it is the combination of Creo with KPG, with Nexpress and with Versamark and the old Kodak. When you put all those things together you go through your different functions and you look at R&D, and you look at distributions, and you look at marketing, and you see what you can get -- you see where you can get synergies. That's what Jim Langely is doing. And that's the way we are looking at the high number, that's we think we can get out of the -- out of the combination of all this -- of all these companies that were serving -- a very similar market.

So, what we are talking about then in terms of the new reductions in personnel. If I understood your question? Your answer previously , the 8,000 that you are required between Creo and KPG, that is also -- being affected by the course of restructure. It includes those people?

That is not included. That is not included in the numbers that you saw today in the press release. We thought that that was already clear from our -- from our -- from our previous announcement.

Our previous announcement when we introduced the acquisition of Nexpress, Creo, KPG, and all that, we already said at that time, we didn't have a number, but we did say we are going to integrate these companies, and as a consequence, we will -- we will see the reduction in employment because of the quality of jobs or combination of jobs and go to market, R&D and everything else. Those numbers we haven't touched and are not included in the numbers that we disclose today. Those are -- if you want to look at it that way on top of that .

Okay. So anything that happens with this 8,000 people is on top of the total of 22,000. That is the end of the reduction. We have 62,300 at the end of 2003 (ph)? The total is down from 40 and then picking up some from the 8,000 that you require.

That's about right.

Okay. Thanks a lot, Antonio, appreciate it.

And for our final question. We go to Laura Star with Equinox Capital Management.

Hi, How are you all? I was just wondering back to the restructuring of the plants, is there something you can provide, maybe not now, but if you're meeting in September, some information on the real estate, the buildings? Not all buildings are created equal. And are you going to be make something decision that might be based on "We can get more money by disposing of some of this real estate and other real estate". And just so we have some idea what that might be worth to you all?

Yes, we will disclose a lot more in September for sure, Laura. We will do that. The biggest decision making process is going to be driven by more of the supply chain and the know how and the utilization of the machines more than the -- whatever is the remain -- the value of whatever, you know, whatever remains.

That's what we're going to get -- that's where we're going to get the biggest benefit. And if you know that the problems that you are going to be building are going to be sold, you know, I know -- 50 miles from this plant -- mostly in all of the rest of the world, you will not close that plant.

If you know that this particular unit, this particular machine, that is more modern and it works very well and it is more flexible, you don't close that one. You go -- you go -- if you know there is a series of expertise because of the type of people or the knowledge accumulated over the years in certain areas that you need, then you keep that. And that would be kind of the processes. And, obviously, we have been working for awhile on this. So we have a very good idea of what's going to happen.

Okay. Thanks.

Thank you, Laura.

And with that, Mr. Perez, I'll turn the conference over to you for any closing remarks.

Well, I want to thank you very much for attending the conference call. It has been a little long this time. We believe, we know what we have to do to build this, you know, sustainable , profitable, you know, growing Digital Company. This is what this -- this is what it's all about.

And we are going to concentrate on the three metrics that were described to you. We feel very strong that we can -- we can get those numbers for the year and we feel that we are doing very well in that sense. We're disappointed with the operating earnings, but we already explained the complication of those calculations In the -- you know the accounting part. The traditional part of Kodak is healthy, and we feel very strong about it. Thank you very much.

And ladies and gentlemen , this does conclude today's Eastman Kodak second-quarter sales and earnings conference call. We do appreciate your participation and you may disconnect at this time.