EASTMAN KODAK

                                   4Q06 Sales & Earnings
                                     January 31, 2...
at $343 million, at the lower end of our aggressive target. We continued to have
success with our intellectual property pr...
And overall, I'm satisfied with the performance of our digital portfolio of products. If
                  you exclude the...
of 48 cents in the fourth quarter of 2005. Current quarter results included items of
expense impacting comparability total...
restructuring payments came in at approximately $550 million. Approximately 1,200
positions were eliminated during the fou...
ended the year with almost $1.5 billion in cash on the balance sheet despite
                   payments of approximately ...
up volume. Therefore, it was very important for us to have a stable base to launch
                   this product.

     ...
Antonio Perez:   They're all good options, the ones that you mentioned, Matt. I mean we look at every
                 bus...
Jack Kelly:      But the exiting out your own actions and the impact on revenues, you're basically
                 saying...
Jack Kelly:      OK. And just on the traditional side where the performance was – traditional film and
                 ph...
for sure is we will spend about $1.2 - $1.15 to pay debt. The rest, we have a variety
                  of options that ne...
memory serves me. What were the dynamics there that led to that divergence of
                  performance?

Antonio Pere...
Ulysses Yannas:   ... anything else?

Antonio Perez:    ...actually some of it is (paid) by itself because of the licenses...
anything. We keep testing in small communities different ideas. In the meantime,
                  we're just building up ...
Shannon Cross:      Can you tell us what you ended the year with in terms of deferred revenue from
                    lic...
Operator:        And at this time, this does conclude our question and answer session. I'd like to turn
                 t...
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eastman kodak 4Q 06 transcript

  1. 1. EASTMAN KODAK 4Q06 Sales & Earnings January 31, 2007 Operator: Good day everyone and welcome to the Eastman Kodak fourth quarter 2006 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, Mister Don Flick. Please go ahead, sir. Don Flick: Good morning and welcome to our discussion of fourth quarter earnings. I'm here this morning with Antonio 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. 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 R&D investment, margin improvement, the closing of and use of proceeds from the sale of the health group, successful monetization of intellectual property, and the launch of new product categories are such forward looking statements. Actual results may differ from those expressed or implied in forward looking statements. 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 important cautionary statements in their entirety. Also, 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 equivalent in the documentation released this morning which can also be found on our Web site. Lastly, as a definitional note, we have a minor change in terminology in that we are replacing the term investable cash with the equivalent term net cash generation. Now, I'd like to turn the conference call over to Antonio Perez. Antonio Perez: Thanks, Don. Good morning everyone and thank you for joining us for our discussion of fourth quarter earnings. I'll start this morning with my thoughts on the full year and the fourth quarter and then, I turn it over to Frank for his financial summary. As you will recall, Frank joined us during the fourth quarter as CFO and it's great to have him on board. Before I discuss the fourth quarter, I would like to reflect on the progress we made during the full year 2006. As I look back on the year's performance, I'm extremely pleased with our results with one exception, which I will discuss in a moment. On the positive side of the ledger for 2006, we came in on the top side of our expectations for net cash generation at $592 million versus a goal of $400 to $600 million. Digital earnings increased nearly fivefold on a year over year basis coming in -1
  2. 2. at $343 million, at the lower end of our aggressive target. We continued to have success with our intellectual property program, signing various agreements with Sony, Sony-Ericsson and a number of others as planned throughout the year. I fully expect that we will continue to be at least this successful in IP activities for 2007 and for several years to come. Graphic communications, as planned, reversed the previous year operating loss of $41 million recording earnings in 2006 of $141 million, a year over year improvement of $182 million. No less impressively, consumer digital, which posted an operating loss of $131 million in 2005, reached break even for full year 2006, a $132 million year over year improvement in line with our expectations. On the M&A side, we successfully concluded the study of strategic alternatives for our health group with the signing of an agreement to divest the business to Onex for up to $2.55 billion. Our CMOS Sensor business went from concept to revenue generation as we begin to build a meaningful business in this area during 2007. We made conclusive progress in our inkjet program in 2006 and we are now poised to make major announcements in this area. As a result, consumer digital will add this year two new major product categories, CMOS and inkjet, with significant margin opportunities as this businesses ramp up in volume. We also made significant progress on the cost side, with SG&A reduced by $279 million year over year. We exited a major traditional manufacturing plant in France, chemical manufacturing operations in the UK and the US and more recently, a logistics operation in Rochester. During 2006, our film and photofinishing group succeeded in meeting their targeted operating margins of 8.6 percent, as well as their cash commitments to the company. This is superb performance in the face of a 22 percent revenue decrease for the year which proves their ability to align costs as their revenue declines. And finally, as a further sign of how far along we have come in our transition, while 2005 was the first year when revenue from digital sources exceeded those from traditional sources, in 2006, we achieved another major milestone. Specifically, 2006 was the first year when the earnings growth from digital products exceeded the earnings decline from traditional products. As a result, I feel very good about 2006 and I'm very excited about our prospects for 2007. We have continued in each of the past three years of this company's transformation to make very visible and significant progress against the important and challenging goals we set. The only meaningful shortfall against our expectations for the year was our lower than planned digital revenue growth. This was basically the result of enforcing our clearly stated objectives to give priority to digital margin growth over revenue growth in our digital capture business that I announced to this audience on January 30th, 2006. As the year progressed, we saw more aggressive camera pricing, particularly at the lower price points that we had anticipated. As a result, we walked away from some consumer digital revenue in the fourth quarter and the year where prices were too low or where we didn't have yet a product with the appropriate cost basis to compete. Also, you may recall that we reduced the number of retailers in countries we serve directly around the world as we redesign our go to market model for better productivity. In the near term, this had a negative impact on revenue as well; however, this was the correct decision to make. They were an important factor in the turnaround in consumer digital earnings will serve us well in the future. -2
  3. 3. And overall, I'm satisfied with the performance of our digital portfolio of products. If you exclude the digital camera revenue that was affected by this one time adjustment in the low-end segment, the rest of our digital portfolio achieved low double-digit growth year over year as per plan. As we enter 2007, the results of the previous year give us a good foundation to work from as we invest for profitable growth in consumer areas, such as inkjets, CMOS, the Kodak Gallery and kiosks, as well as in graphic communications products and other attractive opportunities where we have work in progress. Let me now offer some comments specific to our fourth quarter performance. In the consumer digital segment, we remained in the top three worldwide for digital camera market share through November, the last month for which we have worldwide data, consistent with our stated goals. As far as the US market, the latest NPD Group's market share data indicates that we have retained number one market share in the US for the fourth quarter and full year even with our reduced revenue performance. We retained, as well, our number one share position in home printer docks. Our kiosk business showed excellent growth with a 52 percent year over year increase in media burn volumes. And our EasyShare Gallery contributed 36 percent year over year revenue growth and benefited from the positive margin mix associated with holiday cards, photo books, and calendars among other items. Graphic communications grew revenues three percent in the quarter with good sales growth in digital plates, Nexpress color presses, and Workflow, while Nexpress black and white printers and traditional products declined as expected. The film and photofinishing group turned in strong operating margin performance in the fourth quarter, improving from four percent of revenue last year's fourth quarter to eight percent of revenue in the current quarter, nearly doubling the operating margin rate in the face of the 16 percent fourth quarter year over year revenue decline is clearly excellent performance. In distinct contrast to the declining portion of the FPG portfolio, entertainment film revenues essentially held steady on a year over year basis. The health group in its last quarter as part of Kodak's results from continuing operations had a very satisfying quarterly performance. Healthcare information systems, digital capture and digital dental all experienced good growth while traditional radiography and digital output declined at their expected rate. The fourth quarter provided a very good end to a very good year. On February 8th, a week from tomorrow, I will be in New York with my senior management team to review our strategic outlook. At that time, we will provide a more extensive review of our roadmap going forward including new product introductions. Now, I'd like to turn the microphone over to Frank to continue our discussions on fourth quarter results. Frank Frank Sklarsky: Thanks, Antonio, and good morning everyone. I would like to spend some time discussing our fourth quarter financial results and then, Antonio and I would be happy to take your questions. As Antonio indicated, we were very pleased with our fourth quarter financial performance, with the exception of digital revenues where we made a conscious decision to forego sales in selected product categories in the interest of focusing on improving overall digital profit margins. GAAP earnings per share from continuing operations for the fourth quarter were six cents compared to a GAAP loss per share -3
  4. 4. of 48 cents in the fourth quarter of 2005. Current quarter results included items of expense impacting comparability totaling $152 million or 53 cents per share. The prior year fourth quarter included comparability items of expense totaling $1.02 per share. Of this year's items recorded in the fourth quarter, two were significant in nature. The first is a restructuring charge of 24 cents amounting to $82 million pretax or $69 million after tax. The second is the recording of a valuation allowance against deferred tax assets of 31 cents or $89 million after tax. Let me briefly explain the valuation allowance item associated with deferred tax assets. The assets reside in various international entities and the valuation allowances result from a number of factors, including cumulative loss positions driven in part by ongoing restructuring costs along with operating results to date. The recording of these allowances should not result in any near term cash impact and I would point out that we are not completely excluding the possibility that these particular deferred tax assets may still be realizable sometime in the future. Moving on to some other key metrics, fourth quarter consolidated revenue declined by nine percent and included a two percent favorable exchange impact. Fourth quarter gross profit margin was 26.4 percent versus 23 percent last year, an improvement of 3.4 percentage points. The favorable year over year change reflects improved operating margins in the business segments, particularly within consumer digital. This was driven by the kiosk business, the Kodak Gallery, and continued success from licensing arrangements. The company also benefited from lower levels of restructuring related accelerated depreciation and inventory write-downs in the quarter, as well as manufacturing cost improvements and the favorable exchange mentioned previously. Partially offsetting these factors were lower revenues in certain areas and approximately $45 million in adverse silver and aluminum price impacts on a year over year basis. SG&A for the quarter decreased $172 million or 22 percent and declined as a percent of sales from 18.3 percent in the year ago period to 15.6 percent in the current quarter reflecting cost reduction activities amplified by fourth quarter revenue seasonality. R&D costs totaled $170 million for the quarter versus $212 million in the fourth quarter of 2005 led by reductions in the traditional products area and continued rationalization of GCG's acquired businesses. If you look at the parts of the business that call for the most impactful R&D investments, namely consumer digital and graphic communications, we're continuing to fund them at an annual rate of five to six percent of sales. We would also point out that going forward, we intend to incur a prudent level of future R&D investments in order to drive our intellectual property portfolio along with continued product innovations. Our restructuring efforts continued throughout the quarter with fourth quarter pretax charges totaling $82 million or $69 million after tax as previously mentioned versus $295 million pretax in the year ago quarter. These charges included severance, accelerated depreciation, exit costs, and asset and inventory write-downs. The reduction from the prior year fourth quarter is driven in large part by the absence of certain severance costs and accelerated depreciation charges recorded in international entities in the 2005 period. For full year 2006, total pretax restructuring charges totaled $768 million compared with approximately $1.1 billion for 2005. The 2006 amount was lower than we had originally anticipated for the full year. In addition to items impacting the reductions in the fourth quarter amounts, mentioned previously, certain other fourth quarter actions were retimed to 2007 for logistical and operational reasons and we achieved some pension related credits in certain areas that were greater than originally anticipated. Full year 2006 cash -4
  5. 5. restructuring payments came in at approximately $550 million. Approximately 1,200 positions were eliminated during the fourth quarter bringing the program to date total to approximately 23,400 positions. Consolidated fourth quarter GAAP earnings from operations were $222 million, an improvement of $393 million year over year as a result of lower restructuring charges, but more importantly, significant improvements in the area of SG&A costs. We believe this earnings improvement validates the strategy of focusing on profitable revenue that has and will continue to yield enhanced margins over time. Fourth quarter digital earnings from operations were $271 million, an improvement of $130 million from last year's fourth quarter as a result of our focus during 2006 on improving digital profit margins. From a full year perspective, we posted $343 million in digital earnings, a nearly fivefold improvement year over year and close to the aggressive target we set for the year. The consumer digital group posted earnings of $150 million in the fourth quarter, an improvement of $110 million from last year's fourth quarter primarily as a result of improved performance from the Kodak Gallery, the kiosk business, along with continuing contributions from licensing arrangements. The kiosk business improvement was driven by an increase in digital media volumes of 52 percent year over year. Fourth quarter health group earnings from operations were $86 million versus $87 million in the year ago quarter despite the impact of unfavorable costs for silver and costs associated with it's divestiture activities. Digital earnings in the health group remained unchanged at $58 million year over year despite a lower contribution from the digital output product portfolio which continues to be impacted by increased silver costs and the growing industry shift to soft copy diagnosis. This decline was offset by improvements from digital capture, healthcare information systems, and digital dental products. The graphic communications group posted strong fourth quarter earnings results by more than doubling their earnings from operations, from $28 million to $57 million. Digital earnings in the graphic communications group increased $18 million to $64 million in the fourth quarter as a result of improvements from Nexpress color presses and Workflow and prepress solutions. The commercial inkjet printing solutions business showed steady performance despite comparisons to a very strong fourth quarter last year. Overall, GCG's quarterly operating margin improved to almost six percent from three percent in the year ago quarter with digital operating margin running at almost eight percent. The FPG segment achieved an operating margin of eight percent for the quarter versus four percent in the year ago quarter despite revenue declines of 16 percent as a result of strong cost reduction activities. And on a total company basis, traditional earnings for the quarter improved to $98 million compared to $57 million in the prior year quarter, an increase of $41 million or 72 percent. This was driven in large part by the strong performance in the film and photo finishing group. The other income and charges category had a negative year over year swing of $27 million, primarily due to fewer contributions from asset sales. Interest expense was $60 million in the quarter, a decrease of $7 million from the fourth quarter of last year largely as a result of lower debt balances. Fourth quarter net cash generation, previously referred to as investable cash, was $916 million bringing full year net cash generation to $592 million which is at the upper end of the range we provided for the year. Inventory declined by approximately $270 million and trade receivables decreased $143 million. Capital expenditures for the year totaled $379 million, almost $100 million less than in 2005. Depreciation was $315 million in the current quarter versus $465 million in the year ago quarter primarily driven by higher ongoing restructuring activities in 2005. We -5
  6. 6. ended the year with almost $1.5 billion in cash on the balance sheet despite payments of approximately $550 million in restructuring cash and debt repayment of $805 million. We achieved our full year debt payment goal by paying $561 million of debt in the fourth quarter which includes $542 million of our secured term debt. We recently announced plans – our plans to sell our health group to Onex for $2.35 billion in cash at closing plus up to $200 million in additional future payments. The transaction is expected to close by mid-year and we will initially use $1.15 billion of our anticipated proceeds to repay the remaining outstanding secured term debt. As Antonio mentioned, we will be in New York for an investor meeting on February 8th and I look forward to meeting many of you in person for the first time at that meeting. Thanks very much and now Antonio and I will be happy to take your questions. Operator: Thank you. The question and answer session will be conducted electronically. If you would like to ask a question, please do so by pressing the star key followed by the digit one on your touch-tone telephone. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. We will proceed in the order that you signal us and will take as many questions as time permits. Once again, please press star one on your touch-tone phone at this time to ask a question. We'll take our first question from Jay Vleeschhouwer with Merrill Lynch. Jay Vleeschhouwer: Yes, good morning. Antonio, I'd like to ask you about the licensing business. In Q4 that was a substantial part of the profitability of CDG even more so than in the third quarter. I believe you said in your prepared remarks that you think the IP licensing could be similar in ‘07 as to ‘06 and the question is, what gives you the basis for that expectation? I would think that IP licensing is somewhat unpredictable. Secondly, with respect to CDG, have you changed your priorities at all from ‘06? Are you still predominantly margin focused? Or are you at the point now where you could begin to resume some more focus on driving growth? Then I'll follow up. Thanks. Antonio Perez: OK. Well, first, I didn't say – I said there will be at least as good. So actually, I expect it to be better than that. Why do I say that? I've been – I've said a few times before that these deals are very complex because what we do is we look for a combination of things in these deals. Normally, it's a multi-year contribution that we receive. In the majority of the deals that we make, there is a multi-year contribution that will come to Kodak. On top of that, we have business relationships and supply agreements across the companies. We have co-design in certain cases. There's a variety of things that for competitive reasons, we don't disclose. But to answer your point about why would I say that at least as good is because since most of these deal have been signed already in the last few years, I know for a fact at least we are going to get in 2007 and we have other prospects. That's why. I think the third part of the question was did we change our strategy as far as growth. In the past, I have said that the first two years, digital growth was mandatory for us to get to this scale necessary to be able to design with efficiency, purchase with efficiency, distribute with efficiency. We have those volumes. I said as well that the last two years of the transformation we will be focusing more; it's not that we won't focus in digital growth, but we will be focusing more in digital margins. And part of the reason is because this second part of the transformation, the last two years, which is only one left, we are going to introduce a series of new products that are based on Kodak technology that although they are very – they have a very high value creation imbedded in the business model, they will have losses while they're ramping -6
  7. 7. up volume. Therefore, it was very important for us to have a stable base to launch this product. Now, I'm not saying that we're not going for growth next year. We will go into more detail on the 8th, but we will start getting growth from our digital businesses next year and we'll talk about it on the 8th. Jay Vleeschhouwer: All right. The follow up is with respect to GCG. You had mid teens growth in the digital prepress area and I'm wondering if you think that is a sustainable level of growth for that part of the business and do you expect that GCG, as a proportion of the company, can and will continue to grow, disproportionately, particularly given that it's gross margin structure is several hundred basis points higher than that of consumer digital. Antonio Perez: I will answer simply saying that the possibilities for growth for GCG next year are higher than the possibilities for growth in consumer digital given the status of both portfolios. But, yes, they have opportunities for growth in many areas. Jay Vleeschhouwer: Thanks, Antonio. Antonio Perez: Thank you. Operator: We'll take our next question from Matt Troy with CitiGroup. Matt Troy: Good morning. I had a question, first, on the film business and Antonio, your thought process there. You've now realigned those businesses under a more streamlined operating structure under a single umbrella and I think certainly you've proven you've been able to make difficult decisions in terms of moving the camera business to Flex, moving the health business to Onex. If film is going in one direction, I guess... Antonio Perez: Matt, we didn't move the camera business to Flex. The camera business is a Kodak business. Matt Troy: OK. So are you reversing your call earlier in the year that you would partner with them and move that business to them? Antonio Perez: ... that we partner with Flex. Yes, we didn't move the camera business to Flex, we partnered with Flex. Matt Troy: hey're going to make the cameras, right? Antonio Perez: we design the cameras. We make key elements of the cameras. They complete the cameras and then, we sell the camera. Matt Troy: All right. I fully understand that. My point is you're making some good ... Antonio Perez: ... the whole industry does that, Matt. The whole industry does that. Matt Troy: Right. And then, half your business was that or roughly thereabouts before, so again, I think it's the right decision. My question is, since you're making those tough decisions, if film is going in one direction and arguably long term there may be only needs to be one person making film, is film a business that you need to be in? If I think about your thought process, it's a very strong cash flow (over term) business, I realize, but I think about the options, outright sale, contract manufacturing, or continue to wind the business down, how do you think about the film business over the next three to five years? If there's going to be one man standing, does it need to be Kodak? And then, I have a follow up. -7
  8. 8. Antonio Perez: They're all good options, the ones that you mentioned, Matt. I mean we look at every business constantly to see what is the best way for us to manage those businesses. Whether we should keep them within ourselves, whether we should partner. So you mentioned a few options, those options are in front of us and right now – the first thing we needed to do was to get the cost structure to align with the revenue decline. I think we've proven that we know how to do it and it's performing very well. We will keep watching the development of this business and we’ll make decisions that will lead to the best value for our shareholders. We don't exclude any of the options that you mentioned there. We have not made any decision on any of these things. Matt Troy: OK. Then on the GCG side, certainly the progress with Nexpress is impressive. One of the questions I think I ask every quarter or every other quarter is, product breadth is obviously a focus, relative to Xerox ((inaudible)) folks out there that are making concentrated bets in this segment. If I think about build versus buy, if you could just help me in terms of your thought process around the digital press technology, can you move page speeds up and down in-house? Or might you seek to partner with someone like Canon or Konica or a Japanese OEM to expand that portfolio later into ‘07? Thanks. Antonio Perez: So, full agreement with you that we need to expand the portfolio. We've been trying, it hasn't been easy – an easy thing to do. At this point of time, we have partnerships planned that will help us to do that but we're not quite there yet. But the preferred path for us will be a partnership. Matt Troy: OK. Thank you. Operator: And we'll go next to Jack Kelly with Goldman Sachs. Jack Kelly: Good morning. Antonio, just going – looking at CDG, if we look at revenues in the fourth quarter, they were down 25 percent. You had indicated earlier that Kodak made a conscious decision to not participate in certain portions of the market. Should we conclude that all of that 25 percent was due to that decision? Or can you share with us what the market might have declined? So what I'm trying to discern is 25 percent down in revs, how much because of your decision versus what happened to the market in the fourth quarter? Antonio Perez: Most of it, I think, most of it was our own decision and it was our choice. Either we didn't have the right cost for the product to participate in those very low prices or the prices were so low that we wouldn't participate in any case. We still have as on objective to be one of the top three suppliers. So which we watch very carefully and we think we can. We think we have the technology, the brand power, the distribution and the product portfolio to do so. We just have to manage carefully the earnings because although this is a great enabler for the company, it's very important for our printing strategy, it's very important for all sorts of relationships that we have in the market. We know that the margins of digital cameras were never going to be huge, but what we're trying to do is balancing – being a strong participant in certain segments of that market because it's important for all of the other things that I've said and at the same time, increase margins from where we were last year and the year before. This is the plan we have. I look at this action last year as a one time deal. I don't expect – we'll talk on the 8th about this – but I don't expect similar results as far as the decline next year. We'll talk in detail about the size of the market and what we expect to do, but it wouldn't be anything even close to what we have done this year. -8
  9. 9. Jack Kelly: But the exiting out your own actions and the impact on revenues, you're basically saying the market for digital capture products was down in the fourth quarter and looking out into ‘07, do you see any change in that? And the underlying... Antonio Perez: I'm not sure that's the case. I mean you're talking about revenues or units? Jack Kelly: No, I'm just – well, talking about revenue and/or units, but you did disclose the revenue number, so that's – the 25 percent decline, was that all of you? Or is the market weak? And if the market was weak, how does that play out in ‘07? Antonio Perez: The best understanding that we have the data of the market is coming little by little now, so I don't know that we have all of that data that I would need to answer your questions precisely, but I believe the most of that decline was caused by us, by our decision. We believe that the market grew overall, about 11 percent for the year. That's the best data we have. Jack Kelly: OK. OK. Antonio Perez: So and so this is – it was caused by our decision which, by the way, I would like to remind everybody that this decision was taken on January 30th, 2006 and the reason why we took that decision is that the actual results of the industry during the 2005 holiday season were not as good as anybody in the industry thought they were going to be. And we could smell, at the time, that this increased pressure in price was going to happen over the year because it was going to be a lot of inventory and therefore, especially in the low end business, going to happen. That's why we took the decision so early. Jack Kelly: OK. And then, just moving over to gross profit for CDG; it rose $76 million fourth quarter over the fourth quarter based on the discussion you had in the MD&A, it appears that about $66 million of that came from incremental licensing revenues. And so, assuming those numbers are right, the thrust of the question is it doesn't look like the underlying profitability of the business excluding licensing improved a lot. Antonio Perez: I don't know what you call the underlying. For me, the IP revenues and the IP profits are part of the businesses. It is the way we decide to use our IP portfolio. You can understand that you can use your IP portfolio to stop people participating, which I don't think is the wise thing to do which obviously will help you with your profit margins or the logical thing to do and that's what the industry does is you get an agreement with those companies and you find a mutually beneficial deal. The same patents and the same investment that was put into developing those patents is the investment that now you charge on the cost of the digital cameras and is not fair to say that IP doesn't count. Ideally, you should put all of these costs associated with R&D across everything that you get from the R&D including IP. Of course, because ((inaudible)) cost in the ((inaudible)) you can do that in the interest of reporting this way, but for me, this is part of the business. This is integral part of the business and that's why specifically I put a note in my comments today that said that we expect to get at least the same in 2007 and for years to come. Jack Kelly: Yes. Well, it's not – it definitely counts because it's real, but the point is that everything else in that group in terms of products, don't look like fourth quarter over fourth quarter the earnings improved. And so that's really the thrust of the question, it's not dismissing the IP, it's there, it just doesn't – and I say underlying or the product revenues or the product profitability don't – it doesn't look like it picked up much. Antonio Perez: We did mention that improvement, a clear improvement in kiosk, a clear improvement in Gallery. So I don't know. I don't think your statement is correct. -9
  10. 10. Jack Kelly: OK. And just on the traditional side where the performance was – traditional film and photo finishing where the performance was pretty impressive with an 8.6 percent margin. The question is, Antonio, do you think from this point on that even with revenues declining there you can improve margins so that we're going to continue to get a positive earnings performance even though the revenues are continuing to tail off? Antonio Perez: That's what we're going to try and if we cannot achieve that, then we'll look for another alternative. Jack Kelly: Which would be cutting costs. OK and just finally... Antonio Perez: Not just cutting costs. It would be otherwise through this parts of the business or do something else. If the business is not sustainable for our shareholders, we'll find ways to deal with it. Jack Kelly: To actually sell at some point, if it didn't – if you couldn't get a decent profitability, sell the film and photo finishing business? Antonio Perez: Yes. Now, what we know as of today is that business has been improving year over year. We have great performance. We're very happy with the business. We're looking at this year with similar performance and then we will be seeing how the industry evolves, how big are the declines, what happens with the raw materials, how many people remain in that business supply and there are a lot of elements that can influence this. Jack Kelly: OK. And just finally, last... Antonio Perez: And by the way, remember that the biggest part of that business is EI and that was steady, again, as last year and the year before and the year before. Jack Kelly: Yes. Entertainment, yes, got it. And just finally, last year at this time, you offered up your estimate of what total digital profits for the company would be which was the $350 to $400 number. You did the $343 this year. What would be a good range for ‘07 for total digital profits ... Antonio Perez: We'll do that on the 8th. We'll keep improving, but let me wait until the 8th to get into that conversation. I could explain better why the numbers we'll do there. Jack Kelly: OK. Good. Thank you. Antonio Perez: Thank you. Operator: Again, ladies and gentlemen, if you would like to ask a question today, it is star one on your touch-tone phones. Star one at this time please. We'll go next to Jake Kemeny with Morgan Stanley. Jake Kemeny: Hey, good afternoon. Would it be possible for you to outline your cash priorities for 2007, seeing as pro forma for the sale of the health business, you're going to have a very large cash position? And assuming that the large cash restructurings go away in ‘07, your free cash flow should be better than it was in ‘06. Antonio Perez: OK. A couple of points, in ‘07, the restructuring cash will not go away. 2008 it will, but not in 2007. 2007 is the last year of the restructuring. As much as we would like to, I would like to have my hands on that cash. We don't have it yet. The deal has to be closed. We think it's going to be closed sometime in the first half. What we know -10
  11. 11. for sure is we will spend about $1.2 - $1.15 to pay debt. The rest, we have a variety of options that need to be discussed with the Board and we – I don't have an answer for you yet. Jake Kemeny: OK. And would it be possible to give us some sense of what you think investable cash flow or what you now call net cash generation will be in ‘07? Antonio Perez: For the year, on the 8th, again, we'll talk to that. If I give you a number now, I won't have the time to explain why we have reached that number. That's why we have the two - three hour meeting on the 8th. We'll do a much better job at that time. Jake Kemeny: OK. OK. I tried. Thank you. Antonio Perez: Thank you. Operator: And we'll take our next question from Carol Sabbagha with Lehman Brothers. Carol Sabbagha: Thanks. A couple of questions. Going back to the cost cutting which significantly showed through this quarter, what was the inflection point or what happened this quarter that finally allowed the significant cost cutting that you've been doing to show through the results in such a big fashion? Antonio Perez: Carol, there's been so many things that we've been touching. I don't know that I can point at one that is an inflection point. When you start with this restructuring, which has been so long, for three years already, there are things that appear the moment you make the announcement and others that keep coming along. It's like a string of things that come along. And then, a building gets empty, completely, and then something else comes as a bunch. I can't point out one thing that happened this quarter that was different than anything else. Maybe the fact that this is a high revenue quarter then you see the SG&A as a percentage of revenue lower, but when you look year over year, we've been reducing SG&A every single year. Carol Sabbagha: OK. Antonio Perez: And Frank, do you have anything else? Frank Sklarsky: Yes. I mean you've got a full run rate during the quarter on a partnership with Flextronics in CDG. You've got G&A and footprint full quarter impact on some actions in FPG and you have some improvements in the rate of rationalization of GCG. So across the board, a lot of things picking up steam and full quarter impact. Carol Sabbagha: OK. Great. Thank you. Couple more questions. I mean you've always talked about or the company's always talked about considering different options for all the businesses. You got the question from Matt about the film business. When you talk about potentially considering other options, is photo finishing part of that discussion? Or now that we're going to move photo finishing into CDG that you believe that's core to the future digital profitability of the company? Antonio Perez: No. We think photo finishing is an integral part of our future, Carol. There might be different technologies that are played, it might be different business model, but we think retail is a crucial destination for customers when it comes to photographic products and that we don't have any plans to abandon that. Carol Sabbagha: OK. And my last question is on the graphics business, revenues came in better than expected, but if I look at the breakout between the US and international, it seems like international did really well, but the US was weak, down I think 10 percent, if my -11
  12. 12. memory serves me. What were the dynamics there that led to that divergence of performance? Antonio Perez: ... think is normally like that, Carol. We always had a better business in place internationally than we had in the US. And our presence in some of the digital printing, as well is stronger internationally. We keep growing our presence in the US. The balance of that business has been always favorable to international versus the US. Carol Sabbagha: OK. Antonio Perez: I don't – I can't point at any issue that we have in the US. It's just keep growing the business wherever we have, both sides of the ocean. Carol Sabbagha: OK. Thank you. Operator: We'll take our next question from Ulysses Yannas with Buckman, Buckman, & Reed. Ulysses Yannas: Antonio, the rate of decline in film and photo finishing seems to be going down. What do you attribute that on? Antonio Perez: Hard question, Ulysses. I wish I know the answer to if that decline is going to slow down more or not. I mean it's really hard to know. We need to track that quarter by quarter. We still think it's going to continue to go down. There is this theory that one day it will stop going down and we don't put that in our numbers. In our plan of record, we continue to assume that film based products, I'm not talking about paper, but film based products will continue to go down significantly still. There might be a time when that will slow down, but it's not going to be within the next two years. We don't think. What's happening with silver halide paper as part of the film printing is actually a very competitive printing technology for the mid sized volumes that are necessary in retail. That is the reason why we are moving paper to the – to CDG next year because and in fact it has become part of the digital workflow. You might go to retail and print your pictures – take your pictures from your digital camera, but it will be printed with a silver halide paper because there is the opportunity to do so and it's very competitive. So we believe the paper is going to remain there for a long – for much longer because there's no other media marking technology today that could compete efficiently with the cost and the quality of silver halide. Therefore, paper, we have hopes for much longer life. Film, so far, we continue to believe it's going to go down and we will plan for it. Ulysses Yannas: On another subject, favorite of mine, you had in the other category a loss of $214 million, $71 million in the fourth quarter. Can you give us some idea as to what percentage of these losses are created by your inkjet project? Antonio Perez: A lot. Would that help? Ulysses Yannas: A lot. Meaning more than 50 percent? Antonio Perez: It's a lot, Ulysses, a lot, but ... Ulysses Yannas: What are the other components? You have OLED in there, yes, but it can't be as big as the inkjet project. Antonio Perez: Oh, no, no, no... -12
  13. 13. Ulysses Yannas: ... anything else? Antonio Perez: ...actually some of it is (paid) by itself because of the licenses that we have. Ulysses Yannas: Yes. Antonio Perez: So the licenses paid for some of their own investment. The majority is inkjet. And we'll have news about inkjet on February 8th. Ulysses Yannas: So in theory, as you move from development to marketing of the inkjet projects, these losses should start declining, don't you think? Antonio Perez: Well, yes and no. In the inkjet business, you still have to build your installed base for a while. So of course you're going to get revenues and that will help, but you're going to have losses. But you get revenues. Ulysses Yannas: ...that's a question – beginning of magnitude that... Antonio Perez: Yes. Yes. Yes. Your statement is correct in principal, yes. Ylysses Yannas: The last question and I hate to keep you that long. ShutterFly is talking of gross margins at their online business of 56 percent. They are smaller than you are, considerably smaller. So in theory, your gross margin should be at those levels, shouldn't they? Antonio Perez: The business – the Kodak Gallery is a great business for the fourth quarter. We made good money in the fourth quarter because of the volumes. What we have to get with the Kodak Gallery is raise the volumes a little more during the rest of the year and we'll have a great business in our hands. And that's what we're doing, we keep growing and we'll get there. Ulysses Yannas: How about charging for storage? Antonio Perez: We actually do have programs that charge for storage, Ylysses. I would like to you to join... Ulysses Yannas: I thought you abandoned them. Antonio Perez: ...one of the premium packages, I think you should sign for that. Ulysses Yannas: I had signed for it, but they are not charging me anymore. Antonio Perez: Oh, they are charging. Well, make sure that they charge you. It's not much, it's like $24 a year, but you get incredible benefits out of it. It's just the adoption rate is low for those things. Ulysses Yannas: Have you considered doing it a bit differently? Antonio Perez: es, we do. We have... Ulysses Yannas: Meaning based on the volume of storage rather than a flat fee for storage? Antonio Perez: We have all sorts of options that we tried in focus groups and small communities and we keep trying. Yes, we have a variety of them. Some are based on the – certain usage, you don't pay anything others are if you allowed advertising, you don't pay -13
  14. 14. anything. We keep testing in small communities different ideas. In the meantime, we're just building up the base which is the most important thing. Ulysses Yannas: Your base is now $50 million or more? Antonio Perez: It's a little more than that. It's more than that. Ulysses Yannas: Thank you very much and I apologize for taking so much of your time. Antonio Perez: OK. Thank you. Operator: We'll go next to Shannon Cross with Cross Research. Shannon Cross: Hi, good morning. Antonio Perez: Good morning, Shannon. Shannon Cross: Just one clarification and I'm not beating the IP bandwagon of whether or not we should include it, all I'm trying to find out here is, when you say that you expect IP to be up in ‘07 versus ‘06, you had I think $315 million in non-recurring IP license revenue in 2006. Are you saying that basically the recurring, which we don't know because you don't breakout, plus the $315 will be up in ‘07? Or are you saying ... Antonio Perez: I think that number was cash, Shannon, if I recall well. Did you say revenue? Shannon Cross: Well, I'm sorry. I meant – however you want to look at it, what I'm trying to figure out, I'm taking any data that you guys have given us. So ... Antonio Perez: Yes. Listen ... Shannon Cross: ... if we think about from a cash standpoint... Antonio Perez: Yes. OK. Yes. First of all, Shannon, it's not that we don't want to hide these numbers, OK? We're very proud of our IP program and I think we should. It shows that we have a very valuable asset. We are building relationships with very serious companies and there are certain ways in which these deals are made. And so, I'm not at liberty to share data that maybe you would like to have. What I was trying to say, not matter how you read the IP program that we had in 2006, my expectation is to be at least like that in 2007. So whatever conclusion you get from the data, from the proxy, from wherever it is, whatever conclusion you get from that, you can assume that it's going to be about the same in 2007. You will be fine. Shannon Cross: OK. I guess people are just trying to figure out what's recurring versus what's one time because one time or more like... Antonio Perez: Yes. This is because the deals that get published with names are only – because if you have a legal case, then you have to publish the name of the company. But we had deals with many more than those two companies that were published. Shannon Cross: OK. Antonio Perez: So and out of all of those deals that we have, the majority I said 80 percent - 85 percent of them are multi-year deals they are recurring in some shape or form, whether it's cash or revenue or – and then the other 20 percent are deals that are concluded and they are non-recurring. Approximate. -14
  15. 15. Shannon Cross: Can you tell us what you ended the year with in terms of deferred revenue from licensing? Antonio Perez: No. We don't do that, Shannon. Shannon Cross: You'll put it in the 10-K, though, right? Because it was last year. Antonio Perez: You can probably figure out. Yes, when you see the 10K. Shannon Cross: ... it was published last year. I'm just verifying that ... Antonio Perez: Yes. I know, I know. On the 10-K, you'll probably get your best analogies of the deferred revenue that we get from these deals. And I think it will be a pretty clear view of it. Shannon Cross: OK. My other question is just with regard to entertainment film. Obviously, Eric left. I'm just curious what your thoughts are in terms of that business, flat this year or flat this quarter, but how are you going to continue to drive the business since Eric's gone? And how comfortable can we feel with the management team that's in place? Just any update because we really haven't talked about it since he left. Antonio Perez: I still think it's a wonderful business, Shannon. I think, obviously, I know that digital will come one day and it will take first a portion and then more. But for many reasons, I believe that this is a very valuable businesses for us and we're going to manage this year exactly as we managed in 2006. Are we looking at our options we have? We're always looking at options that we have for that business and for any other one. And we will be watching the key players in this market, the producers, the studio, the technology, and then we will judge if there is an imminent risk to the business and what is it that we should do about it. We don't see it like that today, contrary to many of the things that you're reading in the generic press. And the proof is that we've been dealing with this issue since I came here three years ago and the truth is nothing has happened. The business continues to be very stable, very profitable and it's a great business. As far as the management team, Mary Jane Hellyar is an incredible leader of this company. She used to work in R&D. She worked with all the film business in the company. She's a phenomenal leader and I think she's the right person to run the show. Shannon Cross: OK. Thank you. Antonio Perez: Thank you. Operator: And ladies and gentlemen, we have time for one final question today. It comes from William Dietrick with CitiGroup. William Dietrick: Yes, hi, guys. I noticed that you had a nice cash balance at the end of the quarter and just wanted to check and confirm that you're revolving facility was still undrawn and ask if you had any plans to do anything with that facility in the future. Thanks. Frank Sklarsky: No imminent plans for any changes to that facility and that remains undrawn. Given the cash balance and the strong balance sheet, we don't have any draw on that currently. William Dietrick: That's great. Thank you. -15
  16. 16. Operator: And at this time, this does conclude our question and answer session. I'd like to turn the call back over to Mister Perez for any closing remarks. Antonio Perez: Well, thank you for attending. Again, I feel this was a great quarter for a great year for us. Sorry. One more year to go with restructuring; hopefully, not a full year, maybe only nine months. I'm very excited with the new product introductions that we'll talk about on the 8th and the improvement in every single portfolio of the company, basically, that we've done this year. So I think we – I feel more excited than ever with the possibilities of this company. Thank you very much. Operator: This does conclude today's conference call. We appreciate your participation. You may disconnect at this time. END -16

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