Eastman Kodak Co (KODK) 2010 Q2 法說會逐字稿

Good morning, ladies and gentlemen.

Thank you for standing by.

Welcome to the Eastman Kodak second quarter sales and earnings conference call.

(Operator instructions).

This conference is being recorded today, Wednesday, the 28th of July, 2010.

I would now like to turn the conference over to Ann McCorvey, Director of Investor Relations.

Please go ahead.

Thank you.

Good morning, and welcome to our discussion of the 2010 second quarter sales and earnings.

I'm here this morning with Antonio M.

Perez, Kodak's Chairman and CEO, as well as our Chief Financial Officer, Frank Sklarsky.

Antonio will begin this morning with his observations on the quarter, and then Frank will provide a review of the quarterly financial performance.

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

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 the Company's expectations regarding the following are forward looking statements; economic conditions, consumer discretionary spend, currency exchange rates, revenue, revenue growth, cost of goods sold, savings from restructurings and rationalizations, product pricing, gross margins, earnings, cash generation, demand for our products, including commercial inkjet, Consumer Inkjet, pocket video cameras, and motion picture film, new product introductions, electronic component supplies, potential revenue, cash and earnings from intellectual property, licensing, liquidity, and debt.

These forward-looking statements are subject to a number of important risk factors and uncertainties, which are fully enumerated on our quarterly report on Form 10-Q for the second quarter ended June 30, 2010, issued this morning.

Listeners are advised to read these important cautionary statements in their entirety, as forward-looking statements need to be evaluated in light of these important factors and uncertainties.

Now I'll turn the call over to Antonio.

Thanks, Ann, and good morning, everyone.

Before I go into detail about the results of the second quarter, I want to take a moment to remind everyone of the important context that is critical to understanding Kodak.

We are building a new Company during a difficult time, and we are making real progress.

Technology transitions are never easy, but on the whole I'm quite pleased both with the direction and the pace of our progress.

Our new digital businesses are gaining significant traction and providing access to large and profitable markets where Kodak has unique value propositions.

This makes me optimistic about the future.

With that, we're pleased to review our results with you today, and I would like to begin by highlighting several key items related to our second quarter performance that are important to consider when analyzing our total results.

First, we continue to be very successful with our Commercial and Consumer Inkjet businesses.

Based on the strength of our value proposition, Consumer Inkjet significantly outpaced the market, and we grew printer and ink revenue by 50% when compared to the same period last year.

We are achieving our three key objectives -- building an installed base, continuing to grow ink revenue in total and as a percentage of revenue, and continuing to improve and expand our hardware platforms while reducing product costs.

Our Consumer Inkjet business continues to be on plan and is gaining share, improving profitability, and we are on track to double our ink revenue year-over-year.

Commercial Inkjet also continued to gain significant traction in the second quarter.

Demand for our Kodak Versamark VL series printing systems more than doubled in the second quarter.

Installation of the PROSPER S10 Imprinting Systems are growing rapidly by meeting the demand to create customized output inline at offset production speeds.

In addition, in the second quarter, we announced the PROSPER S10 CMYK, which adds color capabilities.

The PROSPER S10 Imprinting solutions are ideal for highly effective marketing services, enabling short runs, personalization, and job versioning while leveraging existing offset printing and finishing equipment.

We are also achieving all milestones associated with the introduction of the PROSPER Press.

This early success has prepared us well for unit growth that will come in 2011.

Overall, Commercial Inkjet revenue grew 18% for the second quarter when compared to the same period a year ago.

Commercial and Consumer Inkjet are important to our long-term future and they continued to make significant contributions by improving both their top and bottom lines.

Second, demand is improving for our largest digital businesses.

Digital plate volume grew 9% and CTP output devices units grew 26% in the second quarter when compared to the same period a year ago.

Demand was particularly strong for these products in emerging markets.

Despite this strong unit growth, Graphic Communications Group second quarter revenue was down 2%, as prices remain under pressure due to excess industry capacity.

The second quarter unit demand increase is a positive indicator for the remainder of the year.

And when supply and demands become more in balance, we believe that pricing will stabilize.

Of course, the annuities associated with equipment growth will help as well.

Third, within Digital Cameras and Devices, sales of our pocket video cameras more than tripled, and our digital still camera volume was in line with the prior year as we continued to focus on profitability for this business.

And since the introduction of the -- our pocket video cameras in 2008, we have been rapidly gaining share in this category, and we have plans to continue expanding our participation in the second half of this year.

Digital Cameras and Devices revenue was negatively impacted by unfavorable price mix, driven by competitive pressures in the market, and declined 5% in the second quarter when compared to the same period a year ago.

The good news is that we have a very strong portfolio and we expect to grow revenue as consumers' discretionary spend increases toward the end of the year.

This is a trend that has happened every year, even during recessionary years, and we expect it to happen again this year.

Fourth, and very importantly, our continued focus on improving profitability is showing results.

As evidenced during the second quarter, the overall gross margin for our digital businesses improved 3.6 points and overall operating margins for our digital businesses improved 1 percentage point year-over-year.

In fact, operating margins in four of our seven digital product lines improved, including Consumer Inkjet systems, digital printing, Prepress Solutions, and digital capture and devices.

This performance positions us well to drive digital topline growth in the consistently stronger second half of the year.

And finally, in our traditional businesses, there are a number of dynamics impacting the Entertainment Imaging industry.

The number of studio feature films being produced and released is down.

Fewer television commercials have been made in this economy, and financing continues to be constrained for the independent film market.

The growth in demand for 3-D movies and screen continues to drive digital substitution.

You will recall that we forecasted a modest recovery for Entertainment Imaging following the settlement of last year's labor issue.

We saw a brief recovery in the fourth quarter of 2009.

However, a sustained recovery has not yet occurred due to the factors I mentioned.

Entertainment Imaging's revenue declined 18% in the second quarter, consistent with last year's decline.

Based on the current decline rate, we now expect this year's Entertainment Imaging film volume decline to be higher than our previously forecasted single digit decline rate.

At the end of 2009, total digital screen substitution represented 18% of the worldwide first-run screens.

While digital screen installations will be higher this year, the industry continues to expect digital screen substitution to be in the 45% range by 2012.

A substitution of this magnitude is within our original operating projections, and we will continue to proactively implement cost structure changes to align with this migration rate.

I'm pleased with the work of our FPEG team, the work they are doing to manage this business.

FPEG first half 5% operating margin is essentially flat with the same period last year.

However, overall operating profits declined as industry related volume declines and significantly higher silver costs were partially offset by reduced SG&A, improved traditional photo finishing operations, and increased sales of non-photographic products, which grew 23% for the first half.

Now there are a few key observations that I would like to make regarding the Consumer Digital Imaging Group, CDG.

We continue to improve the profitability of our Digital Cameras and Devices business, and we have done so for the past four quarters.

Specifically, Digital Cameras and Devices' margins improved 8 percent points when compared to the second quarter of 2009, largely driven by better end of life management, improved platforming, and increased operational efficiencies.

We are committed to improving profitability and to providing our customers with innovative products to satisfy their needs.

Retail Systems Solutions, with approximately 100,000 touch points, is the clear worldwide category leader in photo retail kiosks, and we are committed to helping retailers profitably grow in this space.

Retail Systems Solutions' second quarter revenue decline was largely driven by the previously disclosed contract expiration with a major US customer.

However, we continue to aggressively pursue new opportunities, and in the last six months we have won Carrefour and several other large accounts both in the US and worldwide that increases our installed base and will drive annuities.

As of the end of the second quarter, we have secured new agreements with approximately 4,500 customer touch points at strategic accounts globally.

As I have already mentioned before, I'm very pleased with the progress of Consumer Inkjet, which is planned to achieve breakeven during 2011 and be profitable in 2012.

Now moving on to the Graphic Communications Group, GCG.

The most significant leading indicator of the print demand is increased orders for consumables first and then equipment.

We're clearly seeing both across a number of product lines, which bodes well for the remainder of the year.

Apart from the 9% digital plate volume growth and the 26% CTP output device unit growth that I mentioned before, we also continued to see growth in the global demand for digital printing consumables.

During the second quarter, demand for both Commercial Inkjet and Electrophotographic consumables grew more than 6% when compared to the year-ago period.

When you combine the increased demand for digital printing consumables with the unit growth in equipment, overall digital commercial printing revenues grew 9% in the second quarter compared to the same period a year ago.

These growth trends in digital printing, together with the unit growth in prepress, both in consumables and equipment, gives me confidence, as the economic environment continues to improve, that we have the product portfolio to take full advantage of the market improvement and to drive annuity growth.

As we look forward with optimism to the second half of the year, the largest variable outside the economy in our ability to meet our revenue goals will be foreign exchange.

It is difficult to predict with certainty what the rates will be in the back half of the year.

However, we'll continue to watch and adapt appropriately.

In our traditional businesses, we anticipate that Entertainment Imaging film volumes will continue to be negatively impacted by the industry slowdown in digital substitution, and we now expect FPEG to fall shy of its full-year revenue goals.

For our CDG business, our normal seasonality, combined with the introduction of new products and a modest improvement in consumer discretionary spending should drive a solid second-half growth for Digital Cameras and Devices, along with continued strong growth in Consumer Inkjet.

Although conditions are improving somewhat, supply constraint remains a concern as the industry gears up for higher volumes.

We are also continuing to execute our intellectual property licensing program.

For the business within GCG, we expect commercial print demand to continue to improve as the year progresses, following the trends of the second quarter unit growth for both consumables and equipment.

Overall, we continue to target full revenue of $7.5 billion to $7.7 billion, reflecting the increasing strength of our digital portfolio.

The earnings outlook correlates to our revenue outlook.

Achievement of our earnings range is dependent upon the factors I mentioned, including sustained margins in Digital Cameras and Devices and Prepress Solutions, continued traction in commercial and consumer inkjet businesses, and a stabilized foreign exchange environment.

Achieving positive cash flow before restructuring continues to be one of our top priorities for 2010.

To achieve this cash goal, we continue to focus on working capital improvements, as well as delivering the revenue and earnings I just discussed.

We expect to end the year with a solid cash balance and a manageable debt level.

So let me turn now to Frank to give you more details.

Thanks, Antonio, and good morning, everyone.

I would like to share a bit more information regarding our second quarter financial results, and then Antonio and I will be happy to take your questions.

As the global economy continues to recover, we continue to see signs of stabilization in most of our key businesses and, more importantly, we're seeing very positive momentum in our core strategic investment categories.

The Company benefited from continued growth in Consumer Inkjet in all of the markets where we participate, and Commercial Inkjet also showed healthy growth in North America, Asia and Latin America.

Asia continues to lead the global economic recovery, and in this region the Company experienced significant growth in many of our key product categories.

These included Digital Plates, Digital Cameras and Devices, Business Services and Solutions, and Commercial Inkjet Products.

The strong regional growth was offset by industry related declines in our traditional film and paper businesses.

Turning to our overall second quarter results, consolidated revenues for the quarter were $1.569 billion, a decline of 11% from the second quarter of 2009.

The majority of this decline is attributable to the industry related declines for the traditional consumer film and paper businesses, as well as a bit faster than anticipated decline in our Entertainment Imaging business.

Revenue was also negatively impacted by a volume decline for kiosk media and negative price mix in both the Digital Camera and Devices business, as well as Digital Plates within Prepress Solutions.

Foreign exchange also negatively impacted second quarter revenue by approximately 1 percentage point as compared to the year-ago quarter.

These factors were partially offset by increased unit volume for Digital Plates.

In the quarter, the Company's gross profit margin improved to 19.3% versus 18.5% last year.

Digital gross profit margin was 20.9% for the second quarter, an improvement of 3.6 percentage points as compared to 17.3% for the prior year quarter.

This improvement was due to continued platform and manufacturing cost efficiencies in our Digital Cameras and Devices business and the Prepress Output Device business, along with cost efficiencies and higher ink revenue in Consumer Inkjet.

Additionally, as it relates to total Company gross profit margin, we saw a net benefit of $10 million from commodity costs for the quarter, driven by a more stabilized aluminium market, partially offset by increased silver costs.

The foreign exchange impact on our gross profit margin was minimal for the quarter.

As for restructuring, the Company recorded approximately $11 million in restructuring charges for the second quarter and $25 million year-to-date.

Restructuring related payments from corporate cash were $22 million in the quarter, and $59 million year-to-date.

Given our continued progress on cost efficiencies, we are confident we will meet our cost targets for the year and are very pleased with the operating leverage this will provide the Company as the economy continues to improve.

As we've previously stated, some of the structural savings we're achieving are being redeployed toward advertising and other initiatives, which will enable the Company to grow profitably over time.

Interest expense was $41 million in the second quarter, an increase of $18 million from the $23 million in the year-ago quarter.

This change is largely a result of our financing initiatives during 2009 and in the first quarter of 2010, and reflects modestly higher average interest rates, along with the impact of the gradual accretion to maturity value, of certain amounts of indebtedness that have been classified as equity for accounting purposes.

Second quarter GAAP loss from continuing operations was $167 million or $0.62 per share, a $24 million improvement year-over-year, largely due to lower restructuring charges and the benefits from continued discipline over costs, partially offset by higher interest expense.

Now let's take a look at the results by segment.

FPEG revenue declined 21% to $466 million.

This reduction in revenue was reflective of the industry related volume declines in film capture and traditional photo finishing and the absence of revenue from the discontinued Graphic Arts Film business.

In addition, the Entertainment Imaging business was down 18% when compared to the year-ago quarter.

As Antonio indicated, for this year, we are experiencing a more significant volume decline in our Entertainment Imaging business than previously forecasted, due to the following factors; continued uncertainty associated with the overall economic environment resulting in the lower investments in film production, fewer movie releases and TV commercials, continued digital transformation further driven by 3-D, and longer days in theater movie run rates.

The EFO for FPEG was $29 million as compared to $51 million in the year-ago quarter.

Lower volume across each of the businesses impacted earnings in FPEG, as well as higher petroleum-based materials and silver costs.

These factors were partially offset by improvements in SG&A and other costs.

Going forward, we will continue to aggressively manage the cost side of the equation in FPEG in ways that will enable the business to continue as a cash generator.

Moving on to the Consumer Digital Imaging Group, CDG's revenue was $447 million, an 11% decline from the prior-year quarter.

This decline in revenue was due largely to negative price mix as a result of increased sales of lower end digital cameras.

The Company did, however, further improve profitability in Digital Cameras and Devices business, and we expect this trend to continue.

CDG's revenue decline was also impacted by reduced volumes for kiosk media related to the previously communicated expiration of a contract with a significant US retailer, as well as adjustments to inventories by some of our customers.

However, as Antonio indicated, we continue to be the market leader in both instant and dry thermal printing, and we're working aggressively to successfully replace this revenue.

We are also working with our customers to profitably grow this category.

The revenue decline in certain parts of CDG was partially offset by greatly improved sales of our pocket video cameras, which continued to receive industry accolades.

We also experienced higher volume for our Consumer Inkjet printer hardware and ink, and a significant improvement in our newly focused CCD Image Sensor business.

CDG's segment loss from operations was $110 million, a modest increase of $11 million versus the prior-year quarter.

This increased loss was driven primarily by the lower kiosk volumes, as previously discussed, and higher advertising costs, partially offset by improvements to product costs in Digital Cameras and Devices, increased ink revenue and improved costs in Consumer Inkjet, along with improved performance in our Image Sensor business.

Taking a look at the Graphic Communications Group, the GCG business continues to see increased unit demand for Digital Plates, which a positive indicator that the global economic environment is gradually improving and print demand is recovering.

Additionally, we continued to increase the number of placements for PROSPER S10 Imprinting systems and VL Drop on Demand digital printers.

For the second quarter, GCG's revenue declined 2% to $656 million from $670 million in the prior-year quarter.

This revenue decline was largely driven by a negative price mix for Digital Plates within Prepress Solutions.

This was driven by price pressures as a result of the industry's current overcapacity for Digital Plates.

On the earnings side, GCG improved by $28 million.

This more favorable performance is due to operational improvements for our digital printing businesses, improved productivity and lower aluminum costs in our plates business within Prepress Solutions, and more focused R&D spend, partially offset by negative price mix for plate consumables, along with slightly increased advertising costs associated with the Ipex Global Print and Publishing trade show held in Europe in May.

With respect to cash and liquidity, the Company's cash position remains solid.

The Company's cash and cash equivalents at the end of the second quarter was $1.3 billion.

It is important to note that our cash balance is approximately $200 million higher than it was at the end of last year's second quarter.

Cash generation for the second quarter represented a use of $192 million, which was in line with the prior-year quarter.

For the first half, the Company's cash generation before restructuring payments was a use of $626 million as compared with a prior-year first half usage of $893 million.

This improvement as compared to the prior-year was due primarily to higher segment earnings, improvements in working capital -- specifically in the area of trade payables -- and lower restructuring payments.

As we look toward the back half of the year, our full year forecast continues to assume a modest economic recovery.

Our results will be driven by new innovative products for our consumer and commercial customers, continued improvements in profitability in DC&D, and an increase in print demand, which will enable continued revenue recovery and growth for our Digital Plates and Digital Printing Equipment and Consumables.

We will also continue our intellectual property licensing program.

Additionally, as the economy improves, enabling top line growth, we will continue to improve digital earnings as we exploit the benefits of the operating leverage that we've created over the past few years.

At the same time, we expect a continuation of industry-related volume declines in our traditional film and paper business, and we also expect the decline rate for Entertainment Imaging film will be higher than the originally forecasted single digital decline rate for this year, due to the factors previously described.

Relative to our full-year guidance, it is important to note there are still some potential headwinds that we monitor closely.

We will, however, continue to pursue operational countermeasures to mitigate possible impacts.

The first of these potential headwinds is the impact of currency rate volatility, particularly as it relates to the US dollar versus the Euro.

Approximately one-third of the Company's total revenue comes from Europe, and about one-half to two-thirds of this revenue is exposed to the US-Euro exchange rate.

Based on Kodak's sensitivity to changes in this rate, there is an approximate $10 million to $12 million full-year impact to revenue and a $3 million to $4 million full-year impact to earnings for every $0.01 change in the US dollar to Euro rate.

The second possible headwind is higher than planned silver price.

As a reminder, for every dollar change in Troy ounce in the price of silver, the full-year impact is $10 million to $15 million, although a portion of this silver exposure is hedged.

Taking this all into account, given the solid digital unit growth in the first half of the year, the Company continues to target full-year revenue of $7.5 billion to $7.7 billion, along with the corresponding earnings and cash targets as communicated in our earnings release.

This is, of course, predicated upon a modest improvement in the global economic environment, stabilization of foreign exchange, the introduction of new higher margin products and the continued implementation of the Company's intellectual property licensing program.

Finally, we continue to gain traction in the large digital markets we're addressing, and the Company has a strong cash balance and solid liquidity, thereby giving us the financial flexibility to pursue our core strategy and profitable growth initiatives.

Thanks very much, and now Antonio would be happy to take your questions.

(Operator Instructions).

Our first question comes from the line of Shannon Cross.

Please go ahead.

Thank you very much.

Good morning.

Good morning.

I just had a few questions.

Can you talk a bit about -- provide a bit more information on sort of where you are with IP licensing, how we should think about it?

Antonio, there was the article -- I think it was in the Wall Street Journal -- that sort of talked about how you were thinking about life after IP licensing.

So I'm just kind of curious -- which I don't think was a change to your plans anyway -- but I'm curious as to your thoughts on that.

You had mentioned in the past that there might be other areas you could focus on, so just any more details you can give would be great.

Well, I won't be able to make -- Shannon, I won't be able to make any comments about the litigation or the lawsuits, and the litigation.

We will continue with the licensing plans that we have had for years.

We do have a large portfolio, as I said before.

We -- when we mentioned that we would continue with our licensing program for the rest of the year, and for all the years, is because we are in touch with several other companies apart from the ones that are in the public eye because of the lawsuits, so there is an ongoing process that we started a long ago.

We've been very careful about this program.

We think that -- we invented -- this company invented many things, and I think it's -- we have to fight for the shareholders' benefit for those inventions, and so far we've been involved in about 30 cases and we've been -- we have been able successfully to reach the settlements of some kind with those 30 companies, and we'll continue to do that.

My comments in that article were within the context that I explained before, that you've just said, that in the future we would like to use our IP portfolio more towards relationships in business creation than cash generation, and I was referring to that in that article that come 2012, the large investments that we're making in the Company will be positive, as I said today and as Frank said today, and therefore we'll have the freedom to use those negotiations for other purposes other than cash.

Okay, great.

And then I had a question, I don't know if you want to take it or Frank wants to take it.

If Entertainment Imaging is in more of a decline than you had anticipated, and clearly that's a pretty high margin business, where are the offsets that are allowing you to maintain sort of your full-year guidance?

And has there been a change in terms of the margin profile on EI's such that we maybe need to shift our models around?

Yes, I'll talk about EI a little bit and then I'll give it to Frank if he wants to add certain things.

There are -- there's a combination of factors that have affected the decline of EI.

We believe we understand pretty well the digital substitutions, the 3-D, the new screens and all that.

That is completely within the expectations that we have and within the margins that we have.

What we did not calculate well was the recovery of the industry as a whole.

The industry went into decline at the time of the labor issues, and at the time, and that got combined as well quickly with lack of accessibility for funding for independents.

We were expecting that to come back more than it did.

It did come back a little bit in the fourth quarter.

If you will remember, it came back a little bit, but a sustained comeback has not occurred.

That is outside the forecast that we had.

It is not the digital part, which is important, obviously.

But it was more than we were expecting at this time that the studios and the independents that will be generating and releasing more feature films, and they are not.

And I think as well we expected a slightly higher number of TV commercials, and that has not happened either.

It is hard to predict when this is going to happen.

We believe we have a conservative approach for the rest of the year, so we are planning now for the numbers that you just heard, that EI is going to be -- is going to have a decline that will be in the teens -- higher than the single digits that we planned before.

Okay.

Great.

And then just my final question is on the Graphic Communications businesses, can you talk about what you are seeing in terms of the end market?

How healthy are the commercial printers?

Are they getting access to credit?

How are you sort of addressing that?

And clearly beyond even your PROSPER lineup, what are you seeing for some of the other products that you have out there?

Thank you.

The industry is getting better, without any doubt.

I think there is still going to be some consolidation and some of the printers out there are not going to make it.

But overall, the printing volume has grown significantly.

In the first quarter -- I did mention some in the fourth quarter, too -- that we saw an increase in consumables that was a leading indicator for an increase in product orders soon after that, and it has happened clearly in the second quarter.

26% CTP output devices growth is very significant and very healthy, and obviously, these devices are going to generate a significant amount of annuities after they've been installed.

I think as well, the growth in digital presses, our VL systems, is very indicative that the industry obviously is getting orders and is printing a lot more than they did last year.

The plates itself, a 9% growth in units is very healthy.

We're not happy with the price pressures.

Mostly in Europe, there are enormous price pressures, and in fact this -- because there is -- if you look at the industry, the capacity has not gone down to the level that the demand has gone down, and now that the demand is coming up, I still -- we will still have some time for those to kind of balance, and when that will happen, I think it will be -- prices will stabilize a little bit better.

And so I see the industry -- I see the GCG business very positively ,including the fact that a lot of our growth is coming from Asia and Asia is booming, and we have very strong presence in Asia.

And in fact, 25% -- I don't know the most recent numbers, but as of a few months ago, 25% of our digital plate business was in that part of the world.

So that is very healthy for us.

We have a very strong presence and with very good growth.

And the only thing that I would add, Shannon -- this is Frank -- to the previous question, along with this one, is if you look at our operating margins, there is really -- I would not underestimate the substantial improvement in productivity and simplification and also some impact from aluminum in the Prepress business.

But if you lock across GCG, there were some pretty dramatic improvements in gross profit margins Q2 to Q2, and we expect that to continue.

It crosses Prepress, it crosses the IPS business; and of course we had the transformation going on in the EPS business last year and we're getting a full-year impact of that this year.

That is also a significant source of improvement.

And on the consumer side, we expect to continue that pretty healthy margin improvement in Digital Cameras and Devices, which we've seen so far this year.

And of course Inkjet -- Consumer Inkjet is a very, very significant improvement in gross margin; still in investment mode, but as we go through the remainder of the year, as we build volume and build ink annuities, that gross margin is improving substantially also.

So I guess basically, are those the areas where there's better -- I guess better performance than you had anticipated, which will offset the weakness in Entertainment Imaging?

Or were you just more conservative, I guess, going into the year than the -- just like it's -- where is the --

You are correct.

I think those -- the areas that I mentioned and Frank mentioned are the areas that we believe will compensate for the -- for the extra decline of EI that we did not see coming.

Okay.

Thank you.

Thank you.

Our next question comes from the line of Ananda Baruah with Brean Murray.

Please go ahead.

Thanks, guys.

I guess along that same vein, Antonio, I guess just kind on CDG, gross margins improved year-over-year, operating margins were a little bit softer.

Can you just sort of peel back the components of what led to the softer gross margins -- softer operating margins year-over-year, the gross margin component and the OpEx component?

I think this is all operational.

I think -- even though I still think that our profile of sales is still too much towards the very low end of our portfolio, the end of life management that we have done, the team has done a formidable job.

When I look at the year-to-date and I look at the retail inventory, I feel very well in both -- on several accounts.

First of all, the number of units when you look at digital cameras, which is the most significant as far as being right with the number of units on the shelf.

And not only do we have less than last year, maybe to the tune of 50,000 to 100,000 units less than last year; but even more important, the profile is a lot better than last year.

Most of our legacy models are gone, and what we are facing the rest of the year is -- or what we do want to face the rest of the year, which are the new products which normally has higher margins and better acceptance, is based on this, that we expect this business to continue to improve their performance.

And, Ananda, we have -- to your OpEx question, if you look at the structural part of G&A and the focused R&D, those continue to show improvements; but as we were saying on the call, the -- some of that is being redeployed towards some advertising and marketing initiatives to drive the topline in the back half.

So we are taking some of those structural savings and redeploying it to our growth initiative, so that is why you see a little bit more modest impact on the bottom line versus the gross margin line.

We're still investing in the top line.

And, guys, what's the -- I guess, what's the right way for us to think about the balance of the -- I guess of the ongoing investments and the new products coming out sort of through the second half of the year?

As you think about margins, can -- should we expect you guys to get back to operating margins improving year-over-year beginning in the September quarter, or is it more like something that we'll have to wait until the December quarter to see again?

We have diabolic seasonality here.

It tends to go towards the end of the year.

We haven't chosen that, it's just the way it is.

You'll see improvements, but inevitably because of the costs associated with building product and volume for the large part of the year, the majority of the benefit, you are going to see it in the fourth quarter.

That's -- I mean, it is almost inevitable.

Okay, thanks.

And then, Frank, this might be one for you.

I guess, how should we think about the Euro impacting the operating margins?

Say that again, the -- repeat that, Ananda.

The Euro impact to the operating margins, if there is one?

Oh, the Euro?

Euro, yes.

So yes, the sensitivity we gave was on an annualized basis.

For every $0.01 change in the dollar to Euro on an annualized basis, about $10 million to $12 million on the topline, about $3 million to $4 million on the bottom line.

We gave some assumptions in February that our planning assumption was between $1.40, $1.50, and we all know that the Euro had weakened considerably in the first half of the year.

Don't really have a crystal ball, other than we know what the rate is today -- it's $1.29, $1.30.

But we're not really making any predictions for the remainder of the year, just to say that's what the sensitivities are.

So if it restrengthens that is good news.

If it stays kind of where it was in the first half, obviously that is a headwind versus the plan.

But that said, we have got a pretty agile management team in Europe and around the world, and we look for countermeasures to offset it in the areas of cost, pricing opportunities, whatever we can do.

So we're going to continue to watch it very closely, but we'll adapt in any way we can.

And quite honestly, this is an impact that is faced by our Asian competitors, too, as the dollar versus the Asian currencies haven't moved that much.

It's really everybody versus the Euro.

Thanks.

And I guess just this last one for me, you guys mentioned some of the Retail Systems wins -- incremental wins -- you've had of late.

Should we expect any sort of, I guess, positive contribution to the operating margin as we go through the second half the of the year?

It should be improving in the second half of the year.

I mean, those units -- some of those deals were already there and they just expanded.

Some orders are new deals.

But they are -- it's a large number of installations and you -- I expect to see improvement in the third and the fourth quarters due to that.

Yes.

Okay.

Thanks a lot.

Thank you.

Our next question comes from the line of Ulysses Yannas with Buckman & Reid.

Please go ahead.

Good morning.

You had two excellent interviews, if I may say so.

The one in the Wall Street Journal where you are talking about intellectual property, may I hit the subject one more time up?

I know that you have a large intellectual property in nanotechnology.

Is that true?

Yes, it is true.

Is that an area where you could expand on it?

I have no comments about that.

How about sales of your new printer for the home and office market?

How is that going?

They are starting very well.

They are not yet significant, but we are attacking some vertical markets and we are pleased with the results; but we will see a lot more in the rest of the year.

So there are two areas of growth for us there, is that, vertical applications for small businesses and home-based businesses, for which our printer is ideal for all sorts of reasons.

Those people in many of these businesses that are distributed the end user, even in spite of the big network actually pays for the cost of his or her office.

So they are very sensitive about the cost of print.

And they are very, very sensitive about the quality and the durability of the print.

Both of those two characteristics are extremely strong and very differentiated from our printer, so we have very nice -- very good expectations.

The other thing is our geographies.

We -- we've been very careful going into this market, realizing that we are competing against formidable companies for which we have tremendous respect.

So we've been country by country, segment by segment, inch by inch.

And -- but we keep gaining in the new geographies where we are entering, ad so we -- those are two very significant areas of growth that are going to drive this business very nicely.

And talking of areas of growth, in your interview with the Rochester Business Journal, where you articulated, I think, extremely well where Kodak is going from here on out, you mentioned four areas of major growth.

We know about inkjet for the consumer, we know about PROSPER.

You talk about work flow solutions and about packaging.

Would you mind commenting how these two are doing?

Work flow solutions and packaging?

They are both doing very well.

They are small.

That is why we don't talk much about them.

But they both grew significantly, and you will hear, as mentioned in more and more things -- especially packaging, because the business opportunity is enormous, we have technologies both in place that have been -- we've been receiving every award that you can think of as far as our packaging plates for their simplicity and for their high quality, that has been compared to gravure, and we are getting tremendous demand for that.

We can certainly talk more about it in our next phone call.

Packaging is something as well that will never go away.

I mean, it is actually improving, and it is driven out of Asia, which has very high growth.

So we have a lot of expectations for packaging.

Those are the four areas of growth that I've been repeating many times in comp calls and in presentations, it is about Consumer Inkjet, Commercial Inkjet, packaging and work flow.

Work flow, even though the numbers are not spectacular, the margins are good; but more important that is the glue that makes this solution and the transition to digital something that printers can do easily.

And we are leaders.

We are leaders in work flow.

And we think that, with time, this is going to be -- it is now -- but with time, it will be even a more important differentiation in that market.

Finally, if I may, I have been very intrigued with the work you are doing at FPG in creating extra businesses out of existing assets.

You talked about an increase of 23%.

I also noticed that you have thin film for touch screens.

Say again?

Thin film for touch screens.

Oh, yes, yes.

For -- it used to be for cell phones, cameras; now it is for notebooks, iPads, et cetera.

This is an area that should be expanding very fast.

Do you have enough capacity there?

Yes.

We do have capacity.

We have, as well, a differentiated technology.

We're still in -- we are only entering in that market.

And in fact, we are able to enter in that market because our film market unfortunately, is going -- is declining, which is leaving capacity for us to use in some of these new businesses.

We believe those non-film opportunities will be to the order of $500 million by 2015 or so.

Or so.

That's big.

So essentially, you are using for thin film some of the plants you've been using for film.

Yes.

Not all the -- not all the machinery is usable, but many of the technologies and the expertise is usable.

Finally, if I may ask you, you've been increasing your advertising costs against declines in the prior three years.

What is the order of magnitude of the increase?

What percentage increase do you expect?

Can you talk about that?

As we were talking about one of the previous questions while we reduced the structural costs -- I'll give a for instance.

For instance, in the second quarter, about half of the structural cost in SG&A was redeployed back toward advertising on a year-over-year basis.

So we want to catch some of the savings, but some of it is going back toward advertising, both on the corporate and the FPEG segment side, and so that's probably the best characterization.

So if you look at our year-over-year SG&A savings, it was about some $20 million overall, and a portion of that is going back.

Yes, in fact my opinion is that we are -- we've been forced to increase our advertising budget, only because if you look at the consumer expenditure this year in the US, it has grown 3.5%, which is true.

But the fact is that the majority of that is being used in deals, in special promotions, things of that nature.

Impulse buying has not come back yet.

And when that happens, if you are not in the -- if you don't spend some money in advertising, you are not in the -- within the companies that is going to be selling.

And so this -- there -- there's just another angle of this economic recession.

Well, the reason that I asked the question is because I feel that you are underspending in advertising.

Well, yes, that is what my team tells me all the time.

Thank you for helping me.

I mean, we did spend about $270 million last year, as disclosed in the 10-K, toward advertising, and that will increase a little bit this year.

Thanks very much.

Thank you.

Thank you.

The next question come from the line of Chris Whitmore with Deutsche Bank.

Please go ahead.

Thanks very much.

Wanted to come back to the revenue guidance question.

I'm trying to understand what your expectations are for underlying growth.

If I back out the IP income, it assumes by my math that the second half year-over-year revenue is about flat versus what you just posted.

Is that about accurate?

And if so, what are the top two or three drivers of that improvement?

Yes, I'll take this one, Chris.

So yes, if you look at the back half -- and again, let's go back to what we said in the release in terms of the second half results are predicated upon -- modest economic recovery, some foreign exchange stabilization, continuation of the intellectual property program -- and with the economic recovery, obviously, you continue to get some economic uplift from both the consumer digital products, as well as graphic communications, offset, of course, by the continuation of the trend in FPEG.

So it's -- your math is not far off at all.

And -- but it is a mixed bag.

It is the decline in FPEG; but we do see a significant uplift -- continued significant uplift from Consumer Inkjet, as that continues to gain steam, particularly in the area of ink revenue, which will more than double this year; Digital Cameras and Devices, and particularly in the area of pocket video cameras which are nicely profitable and tend to carry a slightly higher than average selling prices; and then you have the dynamic of Prepress, which will continue its recovery through the remainder of the year.

So, I mean, that combined with a few other smaller areas is really where things are taking place.

An uplift in CDG, GCG, continuation of the IP program offset by FPEG, and your math of it being relatively in line year-over-year overall is correct.

Is there a large IP income deal factored into your guidance for the back half?

We haven 't given any specific guidance around any particular IP.

All we have said is on average -- in the average year over the next few years, 250 to 350.

Obviously, the number is higher this year because we had the $550 million in the first quarter from completion of the one large deal.

But -- so we haven't -- for a variety of reasons, we don't want to give any particular guidance for the back half of the year in terms of how many deals or what specific dollar amount might be or might not be assumed for the back half.

But it -- but it's fair to say that our results are going to be predicated upon continuation of the implementation of the IP licensing program.

Okay.

And a quick question on the camera business, wanted to understand what kind of competition your traditional digital cameras are seeing from the handset space, and to what extent do you expect handsets or cell phones to compete in the digital camera -- the video camera and digital video camera space moving forward?

Thanks.

They are competing already, Chris.

I still think that -- I think there's going to be a hybrid well where the people who care the most about the video will tend to go for a higher quality device.

There are many -- they are one of the -- one of the great successes of our portable video camera was the waterproof camera that -- we can't make enough of those.

I think the feature set of both types of devices will be slightly different and will appeal to different people.

We -- when phones started to come with sensors in it, with cameras, our first impression was that they were going to wipe out the low end of the standalone digital camera, and it did not happen.

It is not happening.

And so I guess that there is some influence, but I think it's going to be hybrid environment with different usage, different populations, and there's room for both.

Well, and with --

Management, that concludes the question --

Are you there -- Go ahead.

This concludes the question-and-answer session.

Mr.

Perez, please continue with any closing remarks.

Well, thank you all very much for attending this.

I just wanted to close with three points.

First, we're very pleased with our digital -- with the growth of our digital businesses.

They are gaining significant traction, and we are outpacing the competition.

Second, the first half digital profitability performance is positioning us very well for digital topline growth in the second half, which is seasonally stronger every year.

And third, we'll continue to drive towards our overall revenue target, reflecting the digital strength of our digital portfolio.

And so I look forward to reporting to you on the third quarter results.

Thank you very much.

Ladies and gentlemen, this concludes the Eastman Kodak second quarter sales and earnings conference call.

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