Kodak's Turnaround Keeps Developing

After eight quarters of losses, CEO Antonio Perez finally has something to crow about, as his digital strategy starts to pay off

Kodak Chief Executive Antonio Perez has been promoting his company's transformation from sleepy, shrinking photographic film maker to hot digital tech star since he took over almost two years ago. Finally on Jan. 31, he had something to show for his efforts to cut costs while spending heavily to develop new digital products. The Rochester (N.Y.) company reported its first quarterly profit in two years—a slender $16 million on sales of $3.8 billion. But analysts were impressed, and profits are expected to rise further this year.

After being decimated for years by the rapidly disappearing traditional film business, growth in Kodak's (EK) digital plays, including sales of cameras, online prints, and digital snapshot-producing kiosks, came to the rescue in the fourth quarter. The consumer digital division earned a gross profit of $323 million, a 31% increase from the fourth quarter of 2005, vs. a $243 million profit for the film group, a 27% decrease.

Just a year ago, the old-fashioned film group's gross profit exceeded the consumer digital unit's by $86 million. "This quarter was a very clear demonstration that they've made it," says Ulysses Yannas, a securities analyst with Buckman, Buckman & Reid in New York. The digital group's improving profits "impressed the hell out of me," he adds.

Profits Over Prices

Following several billion dollars of red ink, not to mention tens of thousands of job cuts, the news gave Kodak shares a push in the right direction (see BusinessWeek.com, 8/2/06, "Kodak: Is this the Darkest Hour? "). The shares, which have climbed over 30% since August, gained almost 2% in afternoon trading, closing at $25.86.

Kodak shareholders are likely to hear more good news on Feb. 8 when the company meets with analysts and unveils some new products. Analysts say they expect a line of ink-jet printers, possibly to be sold through an alliance with Dell Computer (DELL), as well as news about Kodak's fast-growing commercial-printing offerings.

The fourth-quarter results demonstrate that Perez was right to forsake market share for profits in the cutthroat digital-camera business. Investors cringed last January, when the CEO declared that Kodak wouldn't slash prices to keep pace with rivals in the camera business if it couldn't make a profit. The strategy paid off though, as profits increased even as total sales dropped by 9%. The company's gross profit margin in its consumer digital segment shot up to 28% from 18.5% a year ago.

New Revenue Streams

And a deal announced in August to outsource camera manufacturing to Flextronics (FLEX) as well as licensing agreements for silicon chip designs in cell phones should help keep margins robust this year (see BusinessWeek.com, 9/4/06, "Kodak Rewrites the Book on Printing").

A substantial chunk of the quarter's profits came from the new licensing deals. The company has publicly disclosed an agreement with Sony (SNE) resolving a 2004 lawsuit, and Perez told analysts Jan. 31 on a conference call that Kodak has struck other arrangements with "many more" companies that it isn't required to disclose.

Revenue from intellectual property licensing is likely to grow in coming years, Perez said to the surprise of some analysts on the earnings call. "I said that will be at least as good. So actually, I expect it to be better than that," he told one analyst who asked if the revenues might be a one-time benefit.

There was little talk of Kodak's health-care business. Once a cornerstone of the company's transformation, Kodak agreed two weeks ago to sell the segment to Onex for $2.35 billion with up to another $200 million to follow depending on the unit's future performance. The unit, which makes X-ray machines and other high-tech imaging equipment, couldn't keep up with larger rivals like General Electric (GE) and Siemens (SI). Perez said Wednesday that the deal is expected to close in the first half of 2007, and at least half of the proceeds would likely be used for debt reduction.

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