Eastman Kodak Co (KODK) 2006 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.

Please go ahead, Sir.

Good morning and welcome to this morning's conference call.

I am here with Antonio Perez, KODAK's Chairman and CEO; and Bob Brust, our Chief Financial Officer.

Antonio will start the call this morning with his comments on the quarter; and then Bob will provide a review of the quarterly financial performance.

As usual, before we begin I have some housekeeping activities to complete.

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

For example, references to expectations for the Company's earnings, revenue and cash will be such forward-looking statements.

Actual results may differ from those expressed or implied in these forward-looking statements and these forward-looking statements are subject to a number of important risk factors and uncertainties, which are fully enumerated in our press release this morning.

Listeners are advised to read these cautionary statements in their entirety.

Lastly, although KODAK has significantly reduced its references to non GAAP measures, in those instances where they are used, they are fully reconciled to the nearest GAAP equipment equivalent in the documentation release this morning.

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

Thank you Don.

Good morning and thanks for joining the call.

I'll start the discussion this morning by reviewing the quarter's results and the context of our overall strategy followed by Bob providing you with an overview of the financials.

Second quarter results demonstrate continued progress in the transformation of the Company in the execution of the digital strategy.

A bit ahead in some areas, a bit behind in others - but generally on plan.

Specifically I will point to the following areas of progress.

We achieved our aggressive cash goals for the quarter which returns us to the previous year's first half cash trajectory and positions us to achieve our full year cash flows.

(indiscernible) photofinishing achieved its targeted 10% operating margins benefiting from the aggressive cost reduction actions we have been implementing. [They have a group] - operating margins - recovered through the quarter to be predicted low teens level.

Graphic communications continues its drive to build meaningful year-over-year profitability.

While perhaps less visible in the numbers, Consumer Digital continued to make progress and implemented its new operating model.

I am particularly pleased that we have achieved positive digital earnings in the second quarter.

This is two quarters ahead of last year's performance and ahead of my prediction that this would occur in the third quarter.

Let me expand on this high-level observations.

The Film and Photofinishing systems segment performed somewhat better than expected despite higher silver costs and declining revenues, as we continue to benefit from a reduction of manufacturing assets and employment in this area.

The ongoing restructuring actions - such as the recent announcement relative to our major facility in France - is an example of this drive to complete the rationalization of this business.

This action enabled the maintenance of gross and operating margins and, most importantly, cash generation.

To conclude, we are getting the cost out at least as fast as revenues decline.

The Health Group's financial performance rebounded from the first quarter primarily driven by strong performance on the traditional side of the business, partially offset by the drag from higher silver prices and the impact of shorter asset useful life assumptions.

Operating margins for the quarter of 12% returned to the target range we predicted earlier this year.

On a year-over-year basis the decline in earnings is explained by the impact of higher silver cost, shorter asset useful life assumptions and onetime costs associated with evaluating the strategic options for the business.

I continue to be pleased with the progress of our ongoing assessment of the strategic alternatives for the health business; and we will provide more details when we have something specific to announce.

The Graphic Communications Group experienced significant year-over-year earnings growth, driven by a combination of integration cost reductions and growing contributions from its portfolio of Digital Products.

In the quarter we saw strong sales from digital plates and its associated hardware, [NeXpress] color digital presses and document scanners.

You may recall that during our first quarter report I indicated full year operating margins for the GCG digital portfolio would exceed 5%.

We are well on our way as second quarter digital operating margins came in at about 5%.

Year-over-year revenues were helped by the closing of the Creo acquisition last June; so this will be the last quarter that our results are not directly compatible.

That said the integration of the acquisitions we made in this space continue to proceed better than planned from both a timing and realized cost savings perspective.

We continue to be pleased with the growth in the Digital Applications portion of the portfolio, clearly demonstrating the ongoing opportunity as the printing industry incorporates digital technology.

Our Consumer Digital Group or CDG is very much a work in progress.

It reminded me of where we were with the Graphics Communication business a year ago.

You will recall this unit was created by the split in the form of digital and film imaging systems segment into CDG and FPG at the end of last year.

In the quarter we saw good revenue growth in Consumer Digital Services up 32% which is principally the KODAK gallery and Kiosk and Media up 13%.

While Home Printing was essentially flat.

Digital Capture revenues declined 15%, leaving the total segment down 6%.

However from an earnings point of view, Digital Capture was essentially flat from a dollar point of view while Kiosk, Media and Home Printing earnings where down year-over-year.

As a result of the adoption of shorter useful life assumptions for the thermal asset and the year ago price reduction on media.

Both of these impacts will anniversary in the third quarter.

Let me provide a few words of context for what we are doing with Consumer Digital images.

We knew when we started with our digital strategy at the end of 2003 that we needed to get scale fast to be successful in this business.

Therefore one of our objectives when we created the Digital and Film Imaging business was to utilize the existing consumer traditional business infrastructure, to carry the new Consumer Digital business to the market.

This was certainly the fastest and in fact the only choice we had to achieve scale and share in our Consumer Digital business in a short time.

It was also an expensive way to proceed given the fact that the existing infrastructure was created to support high margin film products.

However it was effective.

Having achieved the get scale fast portion of our strategy, we needed to evolve to the next step.

Therefore, I announced in January the emphasis will move to margin expansion.

That requires the new Digital Operating model we have been describing not one attached to or -- a scale from a form of high margin film business.

We have been working hard to accomplish this task which is required not only to achieve the desired margin improvements in our present portfolio but to also create the operating model required for future additions to the product portfolio that will become meaningful in 2007.

These will include [CMOS model sensors], mobile imaging, inkjet, and digital services.

From a timing perspective, I believe we are a quarter ahead of our original plans in Graphics Communications and a quarter behind in Consumer Digital.

However significant progress has been made and momentum is on our side going into the third and fourth quarter.

Today's agreement with Flextronics is a big step on that path in our Digital Camera operations.

As you can imagine we have been working on this deal for some time.

Under this agreement Flextronics will manufacture and distribute product Consumer Digital cameras and will manage certain camera design and development functions.

For that we will retain its intellectual property and continue to develop a high level of systems design, a human interface as well as the product look and feel and will conduct advanced research and development.

The deal will include the sale of selective manufacturing assets, generate approximately 35 million in cash with approximately 550 employees moving from KODAK to Flextronics.

With Flextronics taking over these activities, we will achieve our goal of maximizing the variable cost components of this business and a more flexible, lower cost, less capital-intensive method of serving this market while incorporating the world-class operations of Flextronics.

In addition, several weeks ago we initiated a program to reduce approximately 10% of the CDG global workforce that joined CDG when we split DFIS - that is Digital and Filming Imaging systems.

We have established some real momentum with both of these efforts which will begin to deliver benefits in the second half of the year - again. a quarter behind our plan but in time to achieve our CDG goals for the year.

We are also dealing with the emerging of some interesting dynamics in the Consumer Digital marketplace relative to our portfolio.

We believe the worldwide digital camera market peaked from a revenue perspective in 2005 and will peak from a unit perspective this year.

Everything we have seen today reinforces that expectation.

That reality - coupled with our intent to forego revenues without adequate earnings potential - have resulted in declining revenues year-over-year.

My goal of remaining one of the top three marketshares is unchanged but until we get our operating model fully in place, I am quite comfortable with this lower revenue picture.

In the home printing segment we have seen a surprisingly rapid deceleration in market growth.

By way of reference the dedicated 4 by 6 Snapshot Print to Market grew almost 100% on an industry basis on 2005 and we had effective market growth on the order of 50% for 2006.

Our forecast suggested this market will [now] grow less than 20% this year as the Digital Print market continues to shift among alternatives at retail, online, and market function printers in the home.

In our view, the Snapshot Printer has become more of a camera accessory business and we will conduct it with that understanding.

This dynamic may give it more important for us to execute on our plans for CMOS Sensors, Mobile Imaging, Inkjet and Digital Services in 2007.

On another topic at the end of the second quarter, we have largely resold the excess dealer inventory issues that we commented on during the first quarter report, giving us position for an improved second half performance.

Looking forward our new CMOS Image Sensor business and our Mobile Imaging business our worthy of mention.

We are making good progress toward achieving assigned wins for our sensors, which will provide the entry point for us, in what we believe will be a margin expanded business as we go forward.

Likewise we are making excellent progress with new handset initiatives that will truly transform today's sale comps into real, compelling, digital cameras.

In summary, it will probably be the end of this year before this reengineered [and of the] Consumer Digital business is complete, but I remain confident in our ability to drive this business to essentially break-even status for the year as the benefit of this action take hold in the fiscally strong second half.

I am revising our total digital revenue for cash for the year from a range of 16 to 22 to approximately 10%.

This is the result of our choice for topline expectations in CDG, as we pursue a more profitable operating model.

For KODAK as a whole, I feel confident in our ability to deliver the full year invested with cash flow of $400 to $600 million and the full year digital earnings goal of 350 to $450 million.

Digital earnings forecast will be driven by the growing contribution from Graphic Communications, improving the performance in Consumer Digital in the third and the fourth quarter and a solid contribution from the Health Group.

By the way, I also would like to note that our annual strategy review meeting - which we have held in New York in September for the past several years - is now scheduled for November 15th.

This change of timing is necessary to align the meeting with our schedule for reviewing the strategy with our Board of Directors.

I will now turn the call over to Bob who will review our financial results in more detail.

Bob.

I'd like to spend sometime discussing our second quarter financial results and then Antonio and I will be happy to take your questions.

Before we get started I want to bring to your attention the 8-K document we recently filed, which provides comparable quarterly and full year 2005 results, reflecting changes implemented on January 1st, 2006.

They include - No. 1 - business segment structure realignments splitting the prior DFIS segment into a digital segment - Consumer Digital Group - and a traditional segment Film and Photofinishing Group.

No. 2, with the changes in cost allocation methodologies between business segments as we further refine our new business model.

Lastly a change in U.S. inventory costing methodology from LIFO, last in first out, to average product.

As Antonio indicated, this quarter's performance was generally in line with our expectations.

As a matter of fact, on the basis of GAAP loss before tax, the year-over-year results were essentially flat.

The defining driver of the year-over-year declining GAAP net earnings in EPS occurs on the tax line where we recorded a tax charge of 51 million in the current quarter against a tax credit of 68 million in the year ago quarter, creating a negative earnings swing of $119 million.

The tax charge of 51 million is largely attributable to a $29 million charge, recorded in connection with the finalization of Creo purchase accounting, and the fact that the Company remains in a valuation allowance position in the U.S. and, therefore, is not recording tax benefits on its U.S. losses.

Because the initial recording of the valuation allowance occurred in the third quarter of 2005 and due to the fact that the Company remains in a valuation allowance position today, this unfavorable year-over-year comparison will end next quarter.

For the third quarter of 2006, the tax line year-over-year comparison will be favorable due to the $900 million charge taken in the third quarter of 2005 to initially establish a valuation allowance against the U.S. deferred tax assets.

Starting in the fourth quarter of 2006, the tax line will be stated on a comparable basis.

That was a mouthful but as we will discuss later the Company absorbed approximately $120 million of higher silver costs and costs associated with depreciation, due to shortened useful life assumptions during the quarter.

In addition, consolidated revenues declined 9% during the quarter and the Company on a pretax basis as I said had flattish earnings.

A sign that our heavy costs and restructuring activities are taking hold, and that digital earnings have turned positive.

The revenue decline of 9% had minimal impact from foreign exchange.

Digital revenue grew 6% year-over-year, driven primarily by the Creo and the KPG acquisitions within the Graphics Communication Group.

The closing of both of these purchases occurred in the second quarter of last year.

Traditional revenues declined 22% in line with our expectations.

The second quarter gross profit margin was 24.1% versus 28.2% last year - a decline of 229 million or 4.1 percentage points.

Gross profit included the following previously mentioned items.

No. 1, the negative impact of increasing silver prices which decreased gross profit by almost $60 million and No. 2, the increased depreciation expense of nearly $[60] million versus the year-ago quarter due in large part to the shortened useful life assumptions implemented in the second half of last year.

This negative comparison goes away in the third quarter.

As a result, manufacturing costs - which includes the impact of higher silver costs and depreciation - impacted gross profit by approximately 2.2 percentage points.

In the quarter, SG&A decreased $30 million or 5% but remained unchanged as a percentage of sales at 18% despite the revenue decline.

The dollar decrease was primarily driven by cost reduction activities within the Film Products Group segment, partially offset by GCG acquisition-related SG&A cost of $33 million and $8 million of costs associated with the Health Group's expiration of strategic alternatives and initiatives.

R&D declined 85 million or 31% as a result of significant cost reductions related to traditional products and services - partially offset by acquisition-related R&D costs of 11 million.

Also impacting the year-over-year comparison was the second quarter 2005 inclusion of $64 million of writeoffs for in-process R&D associated with the acquisitions of KPG and Creo.

Excluding in-process R&D from last year and the acquisition-related R&D costs from this year's second quarter, R&D expense declined by approximately $30 million as a result of cost reduction activities related to the traditional side of the business.

Cost restructuring efforts continued throughout the quarter with the second quarter pretax charges totaling $246 million or $0.75 per share versus 339 million or $0.84 per share in the year ago quarter. 1,625 positions were eliminated during the quarter, bringing the program total to date to more than 20,500 positions.

These charges also included accelerated depreciation, exit costs, and asset and inventory write-downs.

Based on the restructuring actions completed to date under the current cost reduction program and an understanding of the estimated remaining action to be taken, we now expect employment reductions and total charges will be in the range of 25,000 to 27,000 position eliminations, with total program charges of $3.0 to $3.4 billion.

The expected increase is due to several factors.

We include the need for additional cost reductions in FDG, the implementation of a new operating model within the Consumer Digital Group and the inclusion of the integration activities within GCG.

These activities are expected to be essentially completed in 2007 but the heavier expenditures incurring during the first half of next year.

On a segment basis, Consumer Digital revenue declined 6%.

As Antonio discussed, the revenue results in the Consumer Digital Group reflect an increased emphasis on margins as well as changes in market dynamics.

GCG Digital Revenue growth was 26%, driven primarily by the Creo and KPG acquisitions as well as strong sales from digital plates, next-pressed color digital presses, and document scanners.

Health Digital revenue declined 2%, driven primarily by expected declines in digital output product portfolio, partially offset by growth in Digital Capture, Digital Dental and Health Care information systems.

Total Health Group operating margins rebounded from the first quarter levels and returned to the targeted range of 12 to 14%, despite the absorption of increasing silver prices, higher depreciation resulting from the asset used for life changes, and costs associated with evaluating strategic options for the business.

Consolidated second quarter digital earnings from operations were a positive 4 million - an improvement of 29 million from last year's second quarter.

This positive earnings result is earlier than we expected by one quarter and being positive sooner than expected increases our confidence in achieving our year end digital earnings goals.

Digital losses for this Consumer Digital Group are 79 million versus 52 million in last year's second quarter.

Consumer Digital gross profit was negatively impacted by price mix from home printing and kiosk media as well as Consumer Digital cameras and write-downs associated with excess dealer inventory.

Digital earnings in the Health Group decreased from 53 million last year to 42 million this year, primarily as a result of our contribution to the digital output product portfolio which is being impacted by the growing industry shift to softcopy diagnosis.

This decline was partially offset by increasing earnings contributions from the health care information systems, Digital Capture and Digital Dental product portfolio.

Digital earnings in the Graphic Communications Group increased $65 million from a loss of $26 million last year to earnings of $39 million in this year's second quarter, primarily driven by strong demand for digital plates and related equipment.

However GCG's quarter sequential operating margin declined from 3.6% in the first quarter to 2.4% in the current quarter as a result of non-recurring charges relating to the position of the purchase accounting for the integration of the Creo acquisition.

These adjustments had an operating margin impact of 1.1% and will not repeat in subsequent quarters.

The business expects that the operating margin in the third quarter and beyond will be equal to or higher than the operating margin experience in the first quarter of 2006.

Traditional earnings rebounded from the seasonal low point in the first quarter and improved to 131 million for the second quarter versus 283 million in last year's second quarter.

The FPG segment which is the largest contributor to traditional earnings achieved an operating margin of approximately 10% for the second quarter, which is consistent with our expectations for this business.

FPG records most of the negative impact from the useful life changes and silver increases.

The other income and charges category had a positive year-over-year swing of $39 million, contributing to the year-over-year changes favorable exchange and a the recording of an impairment related to the Lucky Film investment in last year's second quarter.

Interest expense was $66 million in the current quarter, an increase of 17 million from the second quarter of last year as a result of increased levels of debt associated with recent acquisitions.

As a result of these factors mentioned, KODAK reported a GAAP loss of 282 million or $0.98 a year on a continuing operations basis.

Turning to cash, we successfully achieved our cash goals in the quarter by significantly reducing inventory and tightly focusing on receivables and capital expenditures.

The inventory reduction reflects the success we are having a breaking the old paradigm of building inventories in the advance of the summer season with quarter sequential inventories decreasing more than $230 million.

From the end of June of 2005 to the end of June at 2006, inventories have decreased by approximately $400 million.

As we indicated in the first quarter our cash performance at the halfway point in the year would be essentially equal to the first half of last year; and we have achieved that goal by making significant progress during the second quarter.

We are on track to achieve our investable cash flow of 4 to 600 million for the year and expect to have a cash balance of $1.2 to $1.4 billion at year-end.

Second quarter investable cash flow was a positive 15 million compared to a negative 297 million in the year ago quarter.

Net cash from operating activities as determined in accordance with GAAP was 80 million positive in the second quarter, versus a negative 207 million in the year ago quarter.

Cash on hand at the end of the quarter totaled $1.055 billion - which compares to 553 million at the end of last year's second quarter.

As you know we had 500 million of medium term debt due in June and utilized the delay draw option on our 1.7 billion term loan to pay that debt.

However, our intention is to retire that debt in the second half of the year with a seasonally more favorable cash flow.

Overall we remain committed to reducing debt by about $800 million for the year.

Silver prices continue to be a headwind with silver prices averaging $12.27 per ounce during the second quarter, resulting in a negative pretax earnings impact -- pretax earnings impact of almost $60 million.

Going forward we will look for opportunities to hedge our silver position by taking advantages of declines in market price where possible.

Overall the Company looks well positioned to achieve its principal goals for the year.

They are investable cash of 4 to 600 million, digital earnings of 350 to 450 million, and revised digital revenue growth of approximately 10%.

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

(OPERATOR INSTRUCTIONS) Jay Vleeschhouwer, Merrill Lynch.

I would like to ask first about the Consumer Digital business.

Can you elaborate on your expectations for the Flex deal, both in terms of timing of the implementation and how much of an improvement or reduction you would expect from your current cost of revenue structure from the current camera manufacturing arrangements?

And then, secondly, also on CDG your capture unit volume is down year-over-year.

However for the year to date the camera business hasn't been doing too badly overall; the growth rates I think have turned out to be better than most of us might have anticipated at the beginning of the year.

So the question is, how willing are you to continue to lose share?

Will Flex put you in a better position at some point perhaps to try to regain share as compared to the first half?

I will try to answer the 15 questions.

First, the Flextronics.

We have been working on this deal for a long time.

We knew that -- we are basically, I mean, first of all Flextronics is a great company and we want to use their -- what they do the best which is, they have a scale in purchasing that we don't have because they made a lot of progress.

They use similar components.

And they can have an advantage with that.

They have on a scale and manufacturing for low-end products that we don't have too; and then that will give us a lot of flexibility and lower costs.

Then they have a logistics systems that are perfectly designed to deal with this type of products that we don't have and we don't want to build either.

That's what they bring to the party.

So this don't bring just only low-cost and efficiency and distribution but as well they bring their own knowledge about the industry.

We would then retreat to the things that we do really well.

The things that have to do with system design, human interface, in the science, you know - look and feel, things that we do really really well that we are good at.

I think the combination is great.

I wish we would have done this maybe a quarter earlier.

As I said before, these things are hard to get an agreement.

We have a very good relationship; but these things need to be discussed in detail.

So we are where we are.

I think it is quite have a very significant effect on our product line for the future.

Starting with the fact that, now, it will happen in the first month because we are going to be transferring assets slowly to them.

Certainly we will get the benefit for the year.

I don't have a number to give you.

We have obviously all sorts of modelings that we are dealing with but it is -- it will be a significant impact for us, positive.

The rest of the questions have to do with how to expect for the rest of the year.

Normally we do very well in the third and the fourth quarter.

As far as marketshare we don't mind losing between two or three points of marketshare but we will still be one of the top three players.

That was always our objective.

There are some [minimum level] will ever remain there.

There will be a time that we might aspire to more than that but we are concentrated and the middle of the portfolio.

We are very selective with the very low incomers for obvious reasons.

And we don't have any plans to go into the very high-end.

I think our role is in the [midend] is the largest part of market and the one that we can get the better margins.

When you think about Digital Capture you have to think about the rest of the story that we have, the rest of our plan.

That includes everything that I mentioned about cellphones and how do we believe that next year you are going to start to see cellcoms are going to be real compelling digital cameras.

We have an enormous activity dedicated to that - not only in the similar space but as well with our image signs and the codesigner of those phones.

You have to put all these things together.

I am very positive about the Digital Capture.

Our IP is going to be better than last year.

As it normally is.

We are getting more deals and it keeps improving.

They tend to come as well as last year in the later part of the year.

When you put all these things together I'm confident that we can get the breakeven for the year.

On GCG, one of your objectives has been to increase the level of hybrid or multiproduct or cross-selling transactions.

Have you in fact continued to see more of that?

And it would appear that the Creo contribution was somewhat less than the pre-merger run rate.

Is that a temporary retrenchment in Creo?

Or is there something else going on there perhaps affecting the value of that acquisition?

I don't see it like that.

I don't that like that at all.

Remember it is very hard to track Creo today from what it was before.

Creo has been integrated into the Company.

There is work flow that goes with pieces of equipment.

They are bundled deals that we make.

It's very hard to make a point-to-point comparison.

Creo is a fundamental part of the whole strategy.

It is the glue of this motion under which we created this business which was, this is going to be a hybrid environment for years to come.

And the only way to deal with that is to create the glue that is represented by the work flow and the [cell] work on to Creo.

I feel very well with the contributions of Creo and so do our customers.

GCG from my point of view is doing fine.

In fact, I think they are about a quarter ahead of what I thought we were going to be at this point of time.

And the same way CDG is about a quarter behind but GCG is doing fine and our goal to get the 5% operation earnings for the digital part of the GCG - which is about 85% of the group - is very much on track and doing well.

Thanks.

Caroline Sabbagha, Lehman Brothers.

Antonio, just a couple of follow-ups on the Consumer Digital business.

You remain confident that it is going to be breakeven for this year.

Can you talk about what are the factors that need to occur in the fourth quarter?

I'm guessing that is where it all happens to have such a big swing to bring the business to breakeven for the fourth quarter?

Maybe if possible rank order the importance of those factors?

I will give you a list.

You saw what happened last year.

Last year as well, there was a huge improvement in the fourth quarter.

A lot has to do with volume.

Which I expected in a better improvement from volume because of this deal that we just announced with Flextronics.

I think we will be doing better and take more advantage of the higher volumes of the third and the fourth quarter.

It is going to be [IP], IP was very good last year.

You know that we don't disclose the numbers but we keep saying that it keeps growing and will keep growing it this year too.

And we know it is going to grow this year.

I think as well, we -- the fact that we don't get to sell so many units at $99 obviously.

It is not a pleasant thing to see that your revenue is not going the same way; but as far as the bottom line, it's very comforting, I can assure you.

So that will help with that too.

And then the cost actions.

I keep saying that we made this group, we put this group together and use DSIS with a very expensive go-to-market structure because that was the only way to get rapidly to scale that we needed for so many things.

We needed for the brand value, we needed to learn how to commercialize digital products.

We learned to take to market all of our imaging technology, all sorts of reasons that we needed to do that for.

We did that but we knew as well that it was a very expensive way to do it.

And this is the time to take care of it.

We took the actions this year.

We have announced those and that will impact that.

You start to add all those things and you get to the breakeven.

We do [it with] inventory too because we're much more efficient in running the business so keep adding and you'll get to the breakeven.

If all of these things work well it will be better than breakeven.

Just we take [plus and cons] in those things and we think breakeven is a very achievable number.

A follow-up, also, on the Flex deal.

Looking at longer-term not just for the second half of this year, what does that position you for in terms of margin and Consumer Digital capture?

Sort of when you negotiated where did you want to end up being in potential margins in that business?

Digital Capture, as you know very well, includes all the things that they are not involved with.

It includes the IP and all that.

So but as far as digital camera we don't out have a number.

I think it is going to take us a few months to have a comfortable business model that we can share about what this has given us.

We are going to gain a few points of margin.

It's just hard to say - because we are starting with a few models - and then we will have a full portfolio so you have to give us a little time.

A quick question on the strategic alternatives for Health.

You are three months into the process right now.

Has anything changed in your view about what the likely outcomes may be?

And then I think you had mentioned previously that by August or beginning or end of August - don't remember - that you wanted to have narrowed down the list of potential buyers to a handful and then go into more serious negotiations at that time.

Are we at that stage yet?

We are right at that stage.

We haven't settled exactly.

But we are right at that stage.

The comments I can make is that as you know, there is a lot of money in private equity, in case you didn't know.

Lot of money out there.

This is a very attractive business for many people.

Our objective is to do this right for our customers, for our shareholders, and for our employees.

And we will execute in accordance to those goals if there is a lot of interest - there's no lack of interest.

So I feel well.

It is going to be complex because the carveout is complicated.

This Company has been so intertwined and tangled up between factories and share services and all that, that we have been spending a lot of time trying to untangle all of this.

And we've done a lot of it as you know.

But the carveout is the issue that might make the feel that it is going to be a challenge to finish this before the end of the year.

But the theme so far has told me that the way things are going, we should be able to finish before the end of the year or right around that time.

Thank you very much.

Matthew Troy, Citigroup.

When I think about potential uses of cash from the Health Care spinoff, I mean it is not contemplated in your cashbook items currently.

I think the conventional wisdom is that you take that money to significantly reduce the debt burden.

I was wondering if at the same time you might send a message of confidence and buy back stock given where it is today.

Is there any reason to think that you would not be able to do that from a covenant perspective?

No.

We can do all of those, all of the above.

I think the first objective is debt; the second objective is debt; the third objective is debt; and then the fourth objective will be to buy stuff back.

The Board obviously is going to be heavily involved just a little too early to make this plan but it is in our minds that this is -- will be good use of the proceeds.

If I think about your efforts to monetize assets in the portfolio, one of the things you folks have is a tremendous plug and play into the commercial print end market.

If I look at Xerox having scaled the learning curve and figured out how to interact with that market I also look competitively at folks like Canon - which are coming with significant new product introductions.

You folks have a relationship with Canon.

You've got access, they've got product breadth, which is something which has historically potentially been lacking relative to your concentration with NeXpress.

Are you exploring your strategic alternatives to expand the Digital Print offering?

Might that be a build versus a partner decision?

How do you think about that?

That would be helpful.

We are exploring (inaudible).

We are talking to many companies about it.

We are looking for the midsize and its low midsize press space; it would probably be a relationship.

Obviously we are cutting cost in what we bought but to go lower than that, I think logical thing for us to be a partnership so we are looking into that.

And it's in progress.

The group is doing well.

The other issue that we have to deal with that group before you ask me - because you are going to ask me - is that we have to develop our consultancy business for the implant which we said that was after we have been very busy with integration.

It is doing well but that will be -- those two things are the two next things on the horizon that you can see for that group.

The mid end and low mid end as far as pressures and consulting implant activities.

And further than that we have all plans for growth, too, but it will be another time.

Thank you for that.

Bob?

A question on the cash flow.

Object is 400 to 600.

You folks confident those are obtainable?

Could you just refresh us on how much of that will be comprised of asset or land sales?

Concern being that it is hard to predict the timing and if something slips from November, December into January or February.

I'm just trying to sense how that might impact that guidance?

Yes and that was just the problem we had last year - getting all this lined up, but we have a fairly significant number in there.

Somewhat similar to last year.

Based on the way things are going, when you make a commitment like that to you guys, we try to have it backed up.

So if we miss something we can still make those numbers.

So, we do have some backup plans.

We're working hard on inventories.

We still have some receivables work to do and we get much more profitable in the second half which helps cash.

So I felt pretty confident about it.

We have done well in this year after year and in the second quarter.

So I think we are in pretty good shape.

Many of the deals that we need to do are going to -- some of them are going to go in the third quarter, which makes me feel much better.

We will discuss those at the third quarter call.

Thanks for the visibility.

Jack Kelly, Goldman Sachs.

Good morning.

I have a question about the digital earnings.

If we take the midpoints of your range, give us about $400 million in digital revenues -- excuse me -- digital earnings for the year and if I understood you correctly in answer to an earlier question you thought the Consumer Digital imaging portion of that would be a breakeven for the year, suggesting you earn a total of $400 million from Graphic Communications and Health.

I guess the way that -- if that is the correct way to look at it, it just seems like that is a very healthy number for Graphic Communications to be able to contribute something (technical difficulties) 200 million.

I guess the issue is, was I wrong in understanding that if Consumer Digital imaging breaks even or are you just talking about in the fourth quarter and it makes money before that or -- ?

Jack, I'm losing you.

You said the CDG was breakeven?

Yes.

In other words if I look at your total forecast for the year, for the digital earnings for the Company the midpoint would be $400 million.

Yes.

So these numbers they have plus or minus 10%. (MULTIPLE SPEAKERS) breakeven with CDG.

Our numbers go slightly below breakeven to a plus something.

I don't want to put numbers -- I don't want to put numbers.

Let's just assume it is breakeven.

It just looks like Graphic Communications -- that means Graphic Communications and Health Care has earned a total of basically 400 million.

That looks like a heavy load for Graphic Communications.

I don't know why Jack.

Last year the Health Group did almost $200 million.

So (indiscernible) a little less this year.

Maybe a little less.

If you take the run rate of GCG I don't know why you wouldn't get to -- getting close to the $200 million and then a little more that will get here and there.

I don't know why you don't get to those numbers.

Fair enough.

Secondly, Bob, on the use of proceeds, I think you had answered on the last conference call that the covenants would indicate you'd have to pay 1.5 billion back in terms of any asset sales.

1.2 billion.

1.2 billion.

1.2 billion.

1.2 billion.

Yes.

So should we kind of interpret that comment in the sense that if the proceeds -- anything above 1.2 billion is fair game for stock repurchase or can we read it that you pay down that -- if you pay down the debt of 1.2 because that's what the covenants said but then you have the ability to maybe borrow that back so to speak and buy stock?

Or how are you thinking about that?

Well, I, you know.

-- more than that -- .

First of all we are still evaluating all of these different options.

If it should end up that we do sell the business we would have to do the 1.2 billion.

We [aren't] going to do 800 million out of this year's operating proceeds so that would be -- that's a pretty good position by the end of the year.

What happens after that is up to Antonio and the Board and we discuss that at some link when that happens.

We are not there yet but clearly we would take out 800 million this year which we were going to do anyway and then -- .

Yes there are basically three options.

One is to continue to pay more debt.

We'll have to evaluate what kind of leverage we want in the Company and how the excess of leverage has been costing some of the shorts or the many shorts that we have in there, in the stock.

We have to evaluate the benefits from the shareholder point of view of buying back stock and one fair use will be to invest in some of the Company's -- my feeling right now is we have enough on our plate to do for this year and next year.

If you ask me one year later - we certainly have a lot of thoughts about things that we could do, we would like to do - but for the next two years I don't think the idea of investing in some other company, some other technology should be a priority for us.

So we are left with those two options.

Decide to pay more debt or buy stock or a combination of those.

And I don't think that we know any more than what I'm telling you right now.

Thank you.

Ulysses Yannas, Buckman, Buckman & Reid.

Antonio, by year-end and looking at three years back, you will have invested over $0.5 billion in new technologies.

You are spending currently $50 million a quarter.

Does this thing ever end?

We will always have to invest in new technologies.

But I do agree that this is a high percentage; but remember we are trying to build a new digital company.

You can't -- you can't package technology and IP know-how without money.

So obviously the beginning of the ramp you have to put a lot of money behind a lot of people to be able to come out to package that technology (technical difficulty) products.

Of course those products will eventually give us the revenue that we know it's going to give us then, as a percentage of revenue you won't feel as bad as you feel today.

We are investing doing very focused programs.

If you notice we have CMOS, we have InkJet, we have continuous Inkjet for commercial printing.

And we have a lot of software activities and we have OLED and that is it.

We are betting in few things and we are betting big because we believe there are big opportunities.

But it is a lot of money.

I can't tell you that it's not.

It is a lot of money.

I think it is well spent and I think we are going to bring very good return to the shareholder.

When do you expect some revenue to start flowing through out of these projects?

Next year.

Next year -- I think by the end of next year you will be able to model, do some modeling about what CMOS Sensors will be for this Company.

What the mobile co-design will mean for us.

What Inkjet is going to mean for this Company.

I'm not saying they are going to be huge businesses but you will see a trajectory.

You will see a path.

You'll see revenue for sure and, hopefully, as well with Digital Services although it might take a little longer.

But, certainly, for those three you'll be able to do a valuation of how much that investment is going to bring back to the shareholders within the next few years.

Do you still expect to introduce an inkjet project product by year-end?

We will keep working on it.

Keep working on it.

I am going to continue.

I know I am getting very annoying with this topic but I think I don't have much to gain with disclosing and I'm not going to disclose.

We are working very hard on that and when it's time, we will disclose.

If I may.

Price increases.

First time in quite a number of years.

Are they holding? (technical difficulties) increases.

I said in the last conference call that they are going to hold because (technical difficulty) went over the change rate.

I think for too many years we have seen the increase in the price that we paid for our components and petrochemicals and silver and everything else.

Transportation.

All the things that we have and passed back to customers.

We can't do that anymore.

We don't have that option.

So they are going to speak because we are not going to change them.

I think it's a fair thing to do.

If your question is would our competitors do the same?

I don't know.

I really don't know.

All I know is there was a public statement by Fuji saying they were going to raise prices but I can't tell you what their plans are.

But as far as KODAK is concerned, those price increases are going to stick, because we are not going to change them.

Finally, and I hate to take so much of your time, you had expected to reduce costs in Creo and KPG by I believe 140, $150 million.

Where are you in this plan now?

Ahead of plan.

That was a plan for three years.

It was about -- it was by 2007.

That included a little bit about $30 million last year.

About I think it was 80 this year.

And then the rest in 2007.

And we are ahead of plan.

Thank you very much.

I apologize for taking so much of your time.

Shannon Cross, Cross Research.

Good morning.

The first one is just on the Inkjet and I'm not -- actually it's not on Inkjet it's on Printers and sort of what you are seeing in home printing.

Antonio, you don't have talk about specifically what you are going to do -- .

Thank you.

I'm just curious about the trends you are seeing.

It sounds like photoprinting may be shifting more toward retail.

How much do you think the decline in demand for the 4x6 printers is actually a mix shift within home printers to All-In-1s and how much do you think is actually a change in -- continuing change -- in consumer behavior toward retail and online?

I think it is all of the above.

It is very hard to read.

The industry expected - not just us - the whole industry expected a much higher growth looking back to what happened the last [two] years.

So we got surprised like the rest of the industry.

I think there's a combination of all of those things.

I think there are very good choices in all lines and people are choosing that.

There are very good choices with multifunction products in the home and, obviously, retail have been gaining share of those prints.

I think it is a combination of all those.

The fact for us is to what's very important for us is to understand the role of the 4x6 appliance kind of printer, which is what this is.

There is a role for it.

And we got surprised first with the growth that we got in the last few years.

We couldn't believe it, that it was growing so fast and now I guess is, reality steps in and this is an appliance and it is behaving more and more like an accessory to the cameras and is going to have very high volumes.

When the cameras have very high volumes, we tend to be in the third and the fourth quarter and much lower volumes than the rest of the year.

I think it's a combination of all those.

I think it will settle, maybe in another year, but I can't tell you exactly what percentage is going here and there.

Because I think it changes with the populations, countries, and everything else.

So basically usage -- you think usage on these printers are substantially different from the usage you would get off an Inkjet where, maybe, it is more balanced?

Is that fair?

No -- well Inkjet has the advantage that it is flexible.

You can print anything you want.

You can do photos, you can do text.

You can do anything.

Obviously, it has much more capability.

The advantage of the single-use device like the printer dock is that, first of all, the quality is impeccable and it's much more robust than Inkjet.

And for many applications, that will always have a role.

Mine is in the kitchen and it is the perfect device for the kitchen.

But we don't expect everybody to have a multifunction printer and a printer dock in every station in the house.

We don't expect that.

We have been -- still it is going to grow maybe 15, 18% this year.

It is not that it is not growing.

It is not growing at the incredible -- with the incredible momentum that it was growing before.

And then just a clarification.

The level of layoffs that you have announced today, if you could just clarify.

Is that still in line with what you had announced prior or is there some incremental headcount in there?

There's a little more.

There's a little more.

We haven't changed what we're going to -- neither the nature or the timing of it but where you get -- we announced the 25,000 a couple of years ago.

We have been implementing.

We have done 20,500 as far as I can count, I think.

So we are getting very close to the end; and when you get close to the end you have better definition of what it is and we think it is going to be between 25 and 27.

There is no change in what we are going to do or the timing.

It is just that we have a better definition of it.

Thank you.

Sam Doctor, J.P. Morgan.

Thank you.

Antonio, I had a question for you on the Flextronics deal.

Is there a risk of distraction on your operations as you put the Flextronics near the end of the year?

And do you plan to build inventory ahead of the transition?

We are doing it already.

We will start before the end of the year.

The plan is that -- but we do, we did think about that.

We did think that we are going to do this in the middle of the high volume so we have a plan to transfer those things that are easy to transfer without disrupting the flow.

We both have a lot of expertise in doing that.

They do.

We do.

So that is why it is hard to -- it was hard for me to give Carol a number, what the effect is going to be because it is going to be a process with different steps.

We will start to move first certain things and then others, until we are finished with the whole manufacturing.

Great.

Does Flextronics actually produce anything for your write down in the camera business?

Say again.

I didn't hear that.

Does Flextronics produce any cameras for you right now?

No.

What are your plans for your printer docks or [PS] manufacturing strategy going forward?

Our manufacturing stride in general for the consumer business - Asset Light is the best way I can define it to you.

That is that, from the very beginning, the blueprint of our strategy in 2003 was to consider an asset life strategy for the consumer organization.

That means that we are going to concentrate in the higher level part of the supply chain and we are going to look in any business, cameras, and otherwise for partners to do things where they have the scale that we don't have and they have the flexibility that we don't have.

You can expect every single business we have - we have done a lot of that in kiosks already and we are in the same pack with every other single thing that we do including CMOS and everything else.

It is an asset life strategy.

Different than -- and the commercial business of course, we're (MULTIPLE SPEAKERS).

Right.

So that's the plan.

Okay.

If I may paraphrase your Consumer Digital strategy.

Your strategy has been to sell lots of cameras and lots of printers and dock effects and the (indiscernible) base grows.

You see the margin benefit from in (indiscernible).

How does that change now that we are seeing that the digital camera volumes are peaking this year?

The home printer docks are beginning to slow down and you hope --?

Yes.

I wouldn't define our strategy the way you did.

I actually define it in a different way.

We want to be the No. 1 supplier of Digital Capture, Products, and Services for the consumer space.

Digital Camera had a role to play as I described before.

I don't want to go through it again but so that the other things we invested in - CMOS, we invested in, and cellphones -- we believe the cellphones and all the portable devices are basically going to take away a lot of the picture taken.

We know for a fact that, next year, you are going to see cellphones that will be phenomenal digital cameras.

And so we are aiming at becoming the No. 1 supplier of components and total solutions in this space that we call Digital Capture for the Consumer Digital imaging.

Cameras had a role and the role is -- we won't abandon digital cameras but we will concentrate in the midsection of the point and shoot where we can make the business contribution.

And we will link that to our product gallery and to our printing and everything else.

Finally, could you give us a sense of how many design wins do you have and are you close to having -- can you give us any kind of guidance on the cellphone side?

Well, we have a few design wins.

I think it is too early to disclose.

I'm sorry.

But we do -- you will see CMOS sensors in cellphones soon.

Will it begin this year?

No.

Not this year, next year.

We will be at the beginning of next year, some time in the first, second quarter, you'll see that.

And you'll see body design elements of the handsets along the year as well.

Thank you so much.

[Peter Couch], Banc of America.

Quick question.

Could you tell me when the last time was you met with the rating agencies?

Any thoughts there on both your strategy for the rest of the year, as well as thoughts on the impact of potential sale for the Health Care business and the resulting pay down in debt?

We try to meet with the rating agencies every quarter.

They are very interested in the outcome of that and they know, as well as everybody else, we are exploring our alternatives there and we don't have a definitive idea.

The rating agencies are very interested in two things.

The increasing digital profitability to offset the decline of our traditional business and, two, getting the debt levels down.

So we are trying to get both, both of us should work out better this year.

Our debt levels will go down by at least $800 million and - depending on the resolution of Health (indiscernible) - another 1.2 billion over that or more.

With the digital earnings at midpoint -- of digital earnings around 400 million that growth would more than offset the decline in traditional.

So those are the two things that rating agencies would like to see us sustain over time and get ourselves back on track.

So we do meet with them once a quarter.

Either Bill [Lovin] and I - sometimes Bill Lovin, Antonio and I and sometimes Bill.

But we see them every quarter.

Just a follow-up.

S&P, there's a lot of adjusting to the debt numbers potentially on adjusting the debt to include operating leases, postretirement benefits, otherwise balance sheet items and they just EBITDA - accordingly - somewhat different than from that which is in your covenants.

How do you discuss that methodology with them and your thoughts on that?

(MULTIPLE SPEAKERS)

(MULTIPLE SPEAKERS) number of about eight times EBITDA.

For instance if they report in their press release when all those things are considered.

We have so much things going on with the transformation and the restructuring and everything right now that we don't get into the in-depth discussion on those things right now.

That will be more of the discussion next year.

Right now with the enormous amount of restructuring and the enormous amount of cash going out in restructuring, as we say 650 or so. -- million -- 650 million this year.

That's the paramount discussions.

I look forward to those days when we start to wind down and we can get into those discussions.

But I know that we have -- it's really not meaningful right now to discuss that in our situation.

Okay?

Thank you very much.

At this time, I would like to turn the conference over to Antonio Perez for any additional or closing remarks.

Thank you very much for your attending again.

I will repeat what I said.

I think GCG is better than I thought it would be.

It was going to be FPG, the film business, is slightly better.

Health is very much as expected.

And we are a little behind in CDG.

I still believe that we can catch up in CDG for the rest of the year since there is a large part of the year, the most important by a lot, I feel very well.

I feel very positive about cash and digital earnings and the real challenge - the biggest challenge we have for now till the end of the year as you all know - is CDG.

We are working hard at it.

I think we have the momentum on our side.

And I feel confident that we are going to achieve the breakeven goal.

Thank you very much.

That does conclude today's presentation.

We thank you for your participation.