A Digital Warrior For Kodak

New CEO Perez vows to boost digital profits to offset the shrinking film biz

The sudden May 11 announcement that Eastman Kodak Co. (KO ) President Antonio M. Perez will replace CEO Daniel A. Carp on June 1 seemed familiar. It was just six years ago that onetime wunderkind George M.C. Fisher, who was recruited from Motorola Inc. (MOT ) to revive the flagging film giant, threw in the towel. Up stepped Carp to lead Kodak into the digital age. Fisher's departure was an outright admission of failure. This time the company is portraying Perez, long considered Carp's heir apparent and a former star at Hewlett-Packard Co. (HPQ ), as part of an orderly transition.

Maybe so -- yet Carp is leaving much earlier than expected. To his credit, Kodak has defied skeptics by building a fast-growing digital business, becoming the U.S. leader in digital camera sales. The problem is, Kodak earned just $46 million in operating profits on its $5.3 billion digital business last year. Meanwhile, the high-margin film business is shrinking fast. The company figures its $8.2 billion traditional businesses, which include film, will drop 17% this year, thanks in part to a 30% decline in U.S. consumer film sales.

Kodak's predicament was brought into sharp focus when the company badly missed its earnings targets for the first quarter, reporting a $142 million loss. Making matters worse, Kodak is taking on $1.4 billion more in debt to fund digital acquisitions. The moves led ratings agencies Standard & Poor's and Moody's Investors Service to lower the company's onetime AAA credit to junk-bond status in late April. By early May the stock had slumped some 30% below its 52-week high. "There are a lot of risks," says Steve Wilkinson, a credit analyst at S&P.

Can Perez surmount such huge challenges? "We need a digital leader to carry us through this transformation," Carp conceded. The market liked the news: Kodak's beleaguered shares rallied 4%, to $27. And Perez certainly has an impressive track record. During his 25-year run at HP, he spearheaded the explosive growth of HP's printer business into a highly profitable $10 billion giant. Earning a reputation as a relentless hard-charger, Perez pushed his troops to find new, creative uses for inkjet heads and for the super-profitable ink cartridges that go with them. First it was color inkjets, then large format, then all-in-ones, then photo printers. "I was obsessed with creating a new category every two years," Perez said in a 2002 interview with BusinessWeek.

Had Carp not brought Perez in, Kodak would probably be in even worse shape today. Under Perez, Kodak's digital unit rapidly increased its new-product launches. "I see a lot of Antonio's philosophy in recent product introductions from Kodak," says John Thompson, vice-chairman of executive search firm Heidrick & Struggles International Inc. (HSII ) "He is intense about getting the job done quickly, but also about getting it right."

FOCUSING ON PRINTS

Already, Perez is making big promises. He says Kodak will more than quintuple digital operating earnings, to at least $275 million this year. A key reason for the confidence: Consumers are increasingly turning to retailers to make prints of their digital images, which is far more profitable than selling low-margin digital cameras. "We are in the process of proving that this year our digital profits will grow faster" than the drop in film profits, Perez vows.

Still, as a whole, Kodak's far-flung digital business "is nowhere near as favorable as the traditional [film business]," says S&P's Wilkinson. He remains concerned about Kodak's ability to meet its ambitious targets. To keep wringing profits from film, Perez acknowledges that he must squeeze out costs. "The only way to keep generating cash is to aggressively cut costs to stay ahead of the decline" in film, he says.

Kodak still has a chance of pulling off the transformation that eluded AT&T (T ), Polaroid, and other icons that sank as new technology undercut their businesses. But Perez has a long way to go. And as more folks switch to digital, he and Kodak are racing the clock.

By William C. Symonds in Boston, with Peter Burrows in San Mateo, Calif.

— With assistance by Peter Burrows

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