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Corning Incorporated (NYSE:GLW)

Q1 2009 Earnings Call

April 27, 2009 8:30 am ET

Executives

Ken Sofio – Division VP, IR

Jim Flaws – Vice Chairman & CFO

Wendell Weeks – Chairman & CEO

Analysts

Mark Sue – RBC Capital Markets

Brian White – Collins Stewart

C. J. Muse – Barclays Capital

Jim Suva – Citi

Steven Fox – Calyon Securities

Jeff Evanson – Sanford Bernstein

John Harmon – Needham & Company

Vijay Rakesh – Thinkequity

Carter Shoop – Deutsche Bank

Yair Reiner – Oppenheimer & Co.

Andrew Abrams – Avian Securities

John Roberts – Buckingham Research

Ajit Pai – Thomas Weisel

Nikos Theodosopoulos – UBS

Brendan Furlong – Miller, Tabak & Co.

Operator

Welcome to Corning Incorporated’s first quarter results conference call. I will now turn the conference over to the Division Vice President of Investor Relations, Mr. Ken Sofio. Please go ahead, sir.

Ken Sofio

Thank you. Good morning and welcome to Corning’s first quarter conference call. This call is also being audio cast on our web site. Jim Flaws, Vice Chairman and Chief Financial Officer, will lead the discussion. Wendell Weeks, Chairman and Chief Executive Officer, will join for the Q&A.

Before I turn it over to Jim, you should note that today’s remarks do contain forward-looking statements under the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially. These risks are detailed in the company’s SEC reports.

Jim?

Jim Flaws

Thanks Ken. Good morning everyone. This morning we released our results for the first quarter, which can be found on our Investor Relations web site. We’ve also posted the accompanying slides on our Web site.

Before I get into the details I would like to make a few overall comments. We were very pleased with our first quarter performance given the difficult global economy. The biggest questions we had coming into this quarter were whether LCD television sales would continue to show good year-over-year growth in this tough environment and when would the display supply chain stop contracting.

We were pleased to see the continued strength of LCD television sales at retail worldwide throughout the first quarter. We were also pleased to see the demand for our glass pick up sooner than we anticipated. We believe this is one of several indicators during the quarter that the supply chain contraction was ending. Stronger glass demand contributed to better than expected sales and earnings performance this quarter.

Now let me turn to the details. Our first quarter sales were about $1 billion, a 9% decline from the fourth quarter. Quarter 1 sales benefited slightly from changes in exchange rates versus Q4. Moving down the income statement gross margin was 27% in Q1 compared to 28% in Q4. As a reminder, fourth quarter gross margin included $33 million in accelerated depreciation.

SG&A was $207 million or 21% of sales compared to $179 million or 17% for Q4. As a reminder, in Q4 we reversed $30 million of variable compensation accruals which lowered SG&A significantly. R&D was $151 million consistent with Q4. Other income was $20 million in Q1 versus other expense of $33 million in Q4. The swing from other expense to other income was primarily due to non-repeat of balance sheet hedge losses and losses from unwinding of hedges during quarter 4.

Gross equity earnings were $195 million in the first quarter compared to $288 million in the fourth quarter, a sequential decrease of 32%. The decrease is primarily due to lower earnings at both Samsung Corning Precision and Dow Corning. Q1 included the impact of $29 million of restructuring charges at Dow Corning. Net income excluding special items was $150 million, a sequential decrease of 28%. EPS excluding special items was $0.10 compared to $0.13 in Q4. You should know that EPS and net income excluding special items are non-GAAP measures. The reconciliation to GAAP can be found on our website. Our share count for the first quarter was 1.56 billion shares.

Our first quarter results also included restructuring results for the company of $165 million pre-tax, in line with our expectations. Restructuring actions that were implemented in Q4 and Q1 have been completed. We estimate annualized savings from these actions to be about $195 million. In Q2 we expect to see about $30 million in savings.

As I mentioned a moment ago, there were additional restructuring charges at Dow Corning. Our share of these was $29 million pre-tax.

Let me now turn to our segment results for the first quarter starting with display. First quarter sales were $357 million or 8% lower than Q4. Volume at our wholly owned business was down about 1% sequentially. As a reminder we had originally expected our total Q1 glass volume to be down 20-25%. In late February we began seeing an increase in glass demand which led us to revise our volume expectations for the quarter.

We believe the higher than expected glass demand was the result of strong end market demand and the supply chain contraction ending which I will discuss in more detail in a moment. We were able to meet this increased demand by selling glass out of inventory.

Price declines were higher than previous quarters but in line with our expectations. Display sales benefited slightly from positive exchange rate movement. Equity earnings from equity SCP LCD glass business were $180 million in the first quarter, a decrease of 9% compared to $198 million in Q4.

Volume was up 7% sequentially. Price declines at SCP were higher than our wholly owned business. Investors should know that price negotiations vary by customer so in any given quarter price declines may not be consistent between our wholly owned business and SCP. For your modeling purposes, SCP first quarter LCD sales were $659 million compared to $703 million in the fourth quarter, a decrease of 6%. As a reminder, this represents SCP LCD sales only. Our public filings report SCP’s total sales which includes CRT, glass and other product sales.

Net income in the display segment which includes equity earnings was $218 million in the first quarter, slightly lower than the fourth quarter. Quarter 1 net income includes $34 million in restructuring charges. I would like to spend a few minutes discussing the supply chain and retail environment.

As I mentioned earlier we entered the first quarter with two key assumptions; first, LCD televisions would continue to exhibit good year-over-year growth at retail. Second, the supply chain would stop contracting by the end of Q1. We were correct on both.

Let me start first with retail. LCD televisions continue to be a resilient consumer purchase in the first quarter. Worldwide LCD television sales were up 54% in January and 32% in February. We do not have complete data for March to provide a worldwide growth figure for that month. In the United States, LCD television unit sales were up 39% in both January and February. Both months came in much higher than we had forecasted.

We believe the stronger sales may be due in part to the digital conversion as some consumers replaced their analog CRT’s in time for the original February conversion date. While the government ultimately pushed back the conversion date to June we believe up to 25% of U.S. television stations decided to convert their signals anyway in February.

We also believe the closing of Circuit City may have accelerated LCD television demand. Some consumers who were planning on purchasing an LCD later in Q1 may have been attracted by the close out pricing units. As a result, we are not surprised that the year-over-year growth rate in March was lower than the previous two months.

NPD’s preliminary estimate for March based on the weekly data is 9% which was still higher than our own expectations. In addition to the digital transition and Circuit City close out there were indications that strong January and February sell through lowered March retail inventories in the U.S. to about half their normal levels. This has led to stock-out’s of many popular LCD televisions across the country and will likely dampen the year-over-year growth rate.

In addition, we believe up to half of all Circuit City demand went to companies that are outside NPD’s coverage such as WalMart. Circuit City had about 8-10% of the U.S. market gross in televisions so our estimate is the actual growth rate for March could have been as high as 15-20%.

We have just received NPD’s data for the first week of April and it indicates LCD television unit sales in the United States grew 17% year-over-year. In other regions, LCD television unit sales in Japan were up 27% for the first quarter. China they were up 66% in the first quarter. In Europe we don’t have March data yet but unit sales were up significantly in both January and February.

As a result of the resilient first quarter demand we have increased our forecast for LCD TV sales from $111 million to $121 million this year. This would represent an 18% increase over last year.

Regarding screen size in unit terms we have seen all screen size categories show higher than expected year-over-year growth. In January and early February we saw particularly strong growth in the 10-29” size, temporarily reducing the average screen size sold at retail. We believe this is largely attributable to the digital transition. Since mid-February we have seen demand resume to very strong growth in the larger sizes with total area growth exceeding the unit growth.

Looking at the PC market, unit sales of both monitors and notebooks came in as expected in the first quarter. Consumer purchases of notebooks continue to be strong. However, we have data that suggests that corporate purchases of notebooks has slowed. As a result we have lowered our unit forecast for the remainder of the year. We now expect about 126 million notebooks to be sold versus our original estimate of 137. This is versus 131 million sold last year. As a reminder, we do not include netbooks in these numbers. Our forecast for monitors remains unchanged.

As a result of the changes made to our LCD television and notebook assumptions we have updated our forecast for the total LCD glass market this year. We now anticipate the glass market will grow 5-10% versus our original expectation of flat. Split the glass market between 2.1 and 2.2 billion square feet this year versus 2 billion square feet last year.

So, in summary, LCD television sales at retail remain positive. Now let me provide an update on the display supply chain.

There are several data points that suggest the supply chain contraction ended during the first quarter. First, we began to see increased glass orders starting in late February and those orders grew through March. Second, panel maker utilization rates and shipments increased month to month and panel prices stabilized. There is even evidence the panel makers experienced some rush orders from set assemblers. As I mentioned there was evidence of stock out’s in many LCD television sizes at retail.

Let me share some of the details starting with glass demand. As I mentioned a moment ago we began to see an increase in orders in late February. This likely corresponds to the higher utilization rate of our customers. In Taiwan panel utilization rates went from about 30% in January to almost 70% in March. In Korea, utilization rates started about 60% in January and rose to almost 90% in March.

For those investors who are interested in this data you should know many of the panel makers disclose their utilization rates each month. We believe Taiwan panel maker inventories in total contracted in the first quarter to around 3-4 weeks of supply. Korean panel makers are holding even less. Typically about 4.5 weeks of inventory is considered normal. We believe total panel maker inventories at the end of Q1 as measured in equivalent square feet of glass fell 10%.

We also saw a tightening of panel prices during the quarter for all key panel sizes. For monitors, panel prices have been increasing. We believe consistently rising panel prices are a good indicator of the tightness between panel supply and demand.

Moving to set assemblers, based on our models we believe inventory there as measured square feet of glass fell 15% in Q1. This could be the reason behind the rush orders of panels. At retail we believe inventories fell 25%. This is a significant decline and gives credence to many reports of LCD television stock outs during the quarter.

In summary, we believe total inventory in the supply chain as measured in square feet of glass fell from around 630 million square feet at the end of Q4 to around 500 million square feet at the end of Q1, a decline of 130 million square feet. The supply chain has not seen this level of inventory since the second quarter of 2007.

For reference, the amount of inventory in the supply chain at the end of the first quarter last year was 644 million square feet. I will cover our supply chain expectations for the second quarter and our decision to re-light tanks in the outlook discussion.

Regarding Gen 10 you may have seen Sharp’s announcement to begin ramping their fab starting in October. We are already manufacturing production quality Gen 10 glass and sending it through the automated delivery system between our factory and theirs. We are very pleased with the quality of the glass delivered. Plan on aligning additional capacity to our Gen 10 plant later this year to meet the increase in demand. This will result in additional fixed costs starting with Q2.

Moving to the environmental segment sales in the first quarter were $110 million, a 14% decrease versus fourth quarter sales of $128 million. Auto product sales were $64 million in Q1 compared to $77 million in Q4. Our business continues to feel the impact of a worldwide slow down in auto sales and production. Diesel product sales were $46 million in the first quarter compared to $51 million in quarter four. Segment net loss was $44 million in the first quarter versus a net loss of $23 million in quarter four. Quarter one segment net income includes $19 million in restructuring charges.

Restructuring charges have been taken in the auto business to align our capacity to what we see as lower worldwide level of auto production. We believe the annualized run rate of auto production in Q1 was 49 million units. This is compared to 67 million units last year. However, there are some signs the auto industry may have hit bottom. Worldwide auto sales in March were up for the first time since October led by incentive programs in Europe, strong fleet sales in the United States and the government stimulus in China. There still is uncertainty as to what the new annual level of production will ultimately be. As a result, we are still considering further restructuring actions in our auto business.

Moving to the telecom segment, sales in the first quarter were $385 million, a decrease of 5% versus Q4 and in line with our original expectations. Strong optical fiber demand in China was offset by weaker private network demand in North America and also weaker cable and hardware equipment sales in Europe.

Sales in our fiber and cable products in the first quarter were $192 million, a decrease of 4% sequentially. Lower sales in our base business offset stronger than expected demand for optical fiber. In fact, fiber demand has been so strong we recalled the fiber employees who were laid off in Q4. Sales of our hardware and equipment products were $193 million in Q1, a decrease of 6% sequentially primarily due to lower demand in North America and Europe. Fiber to home sales which are primarily hardware and equipment related were $82 million in the first quarter, up 3% sequentially and 8% year-over-year.

The segment incurred a net loss of $1 million in the first quarter compared to a net loss of $14 million in the fourth quarter. Q1 segment net income includes $15 million in restructuring charges. Q4 includes $22 million in restructuring charges.

Sales in our specialty materials segment were $60 million in Q1, down 29% versus Q4. The decline in sales was primarily related to the semiconductor industry downturn. The segment posted a $27 million loss for Q1 versus a $6 million in Q4. Quarter one segment income includes $18 million in restructuring charges.

In our life sciences segment sales in the first quarter were $66 million consistent with Q4. Segment net income was $8 million compared to $16 million in Q4. Q1 included $7 million in restructuring charges.

Turning to Dow Corning, equity earnings were $5 million in Q1 compared to $86 million in Q4. As a reminder, Q1 included restructuring charges of $29 million. Dow Corning is clearly seeing the worldwide economic slow down impact demand in its silicone businesses. Hemlock continues to be sold out but sales were lower due to a mix shift in semiconductor to solar and also lower prices in the spot market. For your modeling purposes Dow Corning sales were $1 billion in Q1 and $1.3 billion in Q4.

Turning to the balance sheet we ended the first quarter with about $2.6 billion in cash and short-term investments down from $2.8 billion last quarter. Free cash flow was basically break even in Q1. We were expecting a significant outflow but net income was higher than anticipated and CapEx lower than planned. Although we continue to expect it to be around $1.1 billion for the year. We received all of Dow Corning’s planned dividends for the total year in Q1. Free cash flow is a non-GAAP measure.

With the improvements in the financial markets and with our improved performance we are considering raising a small amount of cash via a debt issuance. This cash could be used to pre-fund debt obligations in 2010 as part of our clear runway strategy, make additional voluntary contributions to our pension plan or to fund small to medium acquisitions.

Inventory fell significant from $798 million at the end of Q4 to $731 million at the end of Q1. The biggest decline came in display as we sold glass out of inventory to meet demand. Inventory also benefited positively from exchange rate changes.

Now on to our outlook. We will not be providing quarterly sales and earnings guidance for Q2 at this time. However, some commentary to help you think about Q2 and the remainder of the year. We exact sales, gross margin and profitability to be significantly higher in Q2 versus Q1. The increase will primarily be driven by volume growth in our display segment. Our second quarter results will also benefit from our recently completed fixed cost reduction programs. We expect total glass volume which includes our wholly owned business and SCP to be up more than 40% sequentially.

At our wholly owned business, volume will be up more than 50% sequentially. Given the stronger than expected demand in Q1 and our expectations for Q2, we will be restarting some idle capacity sooner than we initially anticipated. At SCP volume will be up more than 25% sequentially.

Investors should not be surprised by the difference in growth rates at our wholly owned business and SCP. Taiwanese panel makers have been running at much lower utilization rates and therefore have much more room to move higher versus the Korean panel makers who are already around 90%. Since the Koreans are at 90% they are beginning to purchase panels again from the Taiwanese.

Even with the significant increase in glass shipments, we do not believe panel makers will be building a material amount of inventory in the quarter. We expect panel maker shipments to set makers to be up significantly as well in Q2. Based on our model panel maker inventory as measured in square feet of glass, panel increased by 30 million square feet. We expect glass price declines at both our wholly owned business and SCP to be much more moderate in comparison to Q1. We told our investors our goal was to eventually return to the very moderate price declines we experienced in 2007 and 2008. We feel we are making good progress on reaching that goal as evidenced by the lower price declines expected this quarter.

As a result of the strong volumes, the restarting of capacity and lower price declines display gross margin should be significantly higher this quarter. Looking ahead we also anticipate additional volume growth in Q3 as well as the supply chain prepares for the fourth quarter demand. It is too early to estimate Q4 volume since we don’t know what the supply chain will do but as of now we are assuming demand might be slightly lower.

In our other segments we expect modest sequential growth in Q2. At Dow Corning we have seen improving monthly sales which could lead to notably better results for its Q2 earnings.

Moving to the income statement, SG&A and R&D will likely be consistent on a dollar basis despite the much higher sales level. For our tax rate, based on the mix of income by geographic region, we expect our tax rate to be zero in Q2. For the full year we are still estimating our tax rate to be between 0 and 8%.

Lastly, investors should use 1.56 billion shares in Q2 in their models. Regarding cash and free cash flow we expect it to be slightly negative in Q2 due to the delayed cash impact of Gen 10 capital that we discussed in the past. We are optimistic we will have positive free cash flow for this year.

Before we go to Q&A I want to briefly discuss our sales goal for the year. One of our key assumptions we gave investors in January was a goal to reach $5 billion in sales. We have been aligning our cost structure and employment levels to operate profitably at this sales rate. Based on our Q1 results and expectations for Q2, we are feeling more comfortable today on being able to reach this goal. Given our nature we continue to be cautious. There is still a worldwide recession that is ongoing. Our businesses and equity ventures are still feeling the impact, especially in the auto business in California. If we do not see continued growth into the second half of this year we will then consider taking further corporate-wide restructuring actions to improve profitability.

Ken?

Ken Sofio

Thank you. Operator, we are ready to take some questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Mark Sue – RBC Capital Markets.

Mark Sue – RBC Capital Markets

Jim, can you help us understand or help us think about the seasonality now that glass volumes have normalized? Maybe how we should think about that from a quarter-to-quarter basis? Separately, when you say gross margin should be up significantly can you put some parameters on that considering that you are taking some tax off idle and should it go back to 40% for example? Any help there would be great.

Jim Flaws

On seasonality, we did provide a slide showing what we view our forecast for total market demand at retail in glass in the slide that we showed this morning. Seasonality around the world, at retail we are not seeing much significant change. The impact on our glass business becomes more driven by television every quarter. You have to look at the different regions. As you know, China is much stronger in the early part of the year. The U.S. much stronger in the last four months of the year and weaker in the second quarter. Europe is similar to the U.S. but slightly more muted and then Japan is relatively more stable all year long.

As far as gross margin percent, we are not giving any corporate-wide forecast, but definitely the increased volume will be helping our gross margin a lot in display as well as obviously the corporation. As we begin to fire up glass tanks in May and June they have basically been absorbing the fixed cost of that with no production and now we will be able to generate additional gross margin from them. Lastly, in Q2 we will be ending selling out of inventory and that will also help our results.

Mark Sue – RBC Capital Markets

With better demand and inventories pretty lean how do you think about pricing overall in terms of what the panel makers or customers are asking of Corning?

Jim Flaws

My only comment on pricing with our panel makers is we have told them we will be lowering prices this quarter but on a much more moderate rate of decline than what we had in Q1. That is what we are expecting to achieve.

Operator

The next question comes from Brian White – Collins Stewart.

Brian White – Collins Stewart

On the pricing point here, have you sat down with the panel makers and negotiated for the June quarter yet?

Jim Flaws

Yes, we are talking to panel makers about June and have been starting in April.

Brian White – Collins Stewart

On the capacity coming back on line, I think originally you had spoken about bringing the tanks back on late in the June quarter. Now you are saying kind of May/June. You had taken off about half the tanks in the wholly owned subsidiary and 25% in Samsung Corning. Where can we think about that as we move into the September quarter?

Wendell Weeks

Obviously it is going to be higher but I would still count on us in the wholly owned being around half. It takes awhile to get these up and that is where we stand right now. We are going to have it climbing through the quarter.

Operator

The next question comes from C. J. Muse – Barclays Capital.

C. J. Muse – Barclays Capital

I was hoping to revisit the display gross margin question from earlier. I guess in terms of the moving parts there and considering your drop through was about 85% in 2008 how should we think about the progression here in 2009 and you talked about firing up additional tanks, selling inventory through Q2, that should help. Are there other parts we should be considering excluding I guess the slight increase to depreciation for the Sharp Gen 10? If you could highlight all the moving parts it would be very helpful.

Jim Flaws

I think you have probably got most of them. When we sell out of inventory we sell at a gross margin that isn’t as great as when the incremental gross margin when we are just making it on the tanks. So the good news, Q2 versus Q1, is that we will be ending the sell out of inventory probably a little bit earlier than what we expected. We will get some tanks back in production for June making glass and selling it so that will come at a very high variable gross margin rate as you know. Then, Gen 10 probably trims our gross margins by 2.5 points in Q2.

Wendell Weeks

The other point I would add to the comments Jim is making on gross margin is also remember in terms of absolute levels that our operations folks have been very concentrated on bringing our inventory levels down, on what tanks we want up relative to anticipated demand, responding to the shifting regional demand patterns and as a result we have not been able to spend as much time as we normally do pushing down our cost curves. So rate of improvement is going to relate primarily to how much our volume increases during the current year rather than as you have grown used to us pushing down the cost curve to offset pricing moves in the near-term. We will get back on track going forward but it is going to take awhile to get realigned.

C. J. Muse – Barclays Capital

On the cost cutting side you talked about $30 million in savings in 2Q. Can you walk us through what your business should look like overall exiting calendar 2009, say Q4, without the incremental benefit to gross margin?

Jim Flaws

I will just say in Q2 about 2/3 of the benefit is coming to gross margin from that restructuring. We talked about achieving an annualized rate of about $195 million. Obviously the $30 million in Q2 is about $120 million rate so I think the savings will be proportionate as the gross margin and operating expense at the end of the year.

Operator

The next question comes from Jim Suva – Citi.

Jim Suva – Citi

It seems like the big topic that kind of emerged over the weekend was the swine flu. Could you maybe let us know a little bit of the history of what happened back when SARS came out with your company? Hopefully this doesn’t repeat into something like that but were there any type of logistical custom issues or something like that we should be aware of?

Wendell Weeks

The biggest area that we are watching right at the moment of course is our Mexican operations. We have some significant operations in the Reynosa area aimed primarily at supporting our telecommunications and life science businesses. First, we have seen no outbreaks in Reynosa or reports of outbreaks in Reynosa which is good news. Over the weekend we activated our flu response team at the corporate level. Once again this is a response level that we developed during the time of SARS. What we will do is we will monitor the situation and move to our level protocols accordingly. I would note that in dealing with the SARS issue we were able to do that without negatively impacting our operations in any significant way.

Jim Suva – Citi

As a quick follow-up, I found your comment about issuing some debt as an interesting. Could you give us a little more color on that? You mentioned for pensions, it looks like your cash position was actually pretty strong. Was it just that cash is in locations you can’t reach? How much cash do you need to run the business and what is your pension outflow we should keep in mind?

Jim Flaws

We have enough cash to run the business in the absence of any unexpected worldwide worsening. We feel fine in terms of our cash flow this year. We obviously have used up some cash from the beginning of the recession to when we got our costs normalized but we feel pretty good. That being said, we do have a balance sheet that we intend to run with always having some debt but with a clear runway strategy meaning we try to not have debt coming due in the short-term so we over time opportunistically will issue some debt and get ready with pre-funding it.

In terms of pensions, not when having to put more money in but we might put an extra $50-100 million in if the markets don’t improve. We are obviously under funded as you have seen in our 10K as a result of equity markets being down. Lastly, probably the stronger driver for why we might want to have more cash is we are seeing valuations come down on potential acquisition targets. I will stress of a small to medium size.

Operator

The next question comes from Steven Fox – Calyon Securities.

Steven Fox – Calyon Securities

First of all on telecom, at the Analyst meeting you talked about it being down 10-15% for the year. Can you just confirm whether that is still in your head as proper outlook? Within that, what are you seeing…you mentioned the private networks but what have you seen from the service providers in terms of their projects, either pushes or pulls?

Wendell Weeks

First, on the 10% down for the year, you are right to raise the question because we are doing better in telecom in the first quarter than what we would have anticipated. We would like to get a little deeper into the year to figure out where we are. I note that if you were to take a look at our current plans through quarter two compared to last year we would be down about double digit in revenue. So I think that we would like a little more time to think about whether or not we want to upgrade that or not. Part of the dynamic is that China is super hot and we have seen some slow down in North America and in Europe. We have seen less of that slow down in fiber to the home which is still up in quarter one some 8% year-over-year.

So we are seeing carriers prioritize their fiber to the home investment even as they are a little more cautious. We are beginning to see some evidence that some of the carriers around the world are beginning to release their capital plans. So you put that all in the mix and basically we end up saying give us a little more time and we will talk to you in quarter two.

Steven Fox – Calyon Securities

Lastly, on the LCD glass tanks are you saying that you are comfortable even with this surprising resurgence in demand in terms of where you are in rebuilding the tanks and getting glass to customers or are they asking for more than you can deliver in the near-term?

Jim Flaws

We say glass supply is tight right now but we certainly have the ability to respond and respond we will.

Operator

The next question comes from Jeff Evanson – Sanford Bernstein.

Jeff Evanson – Sanford Bernstein

I’m wondering if you could give us some commentary on Hemlock. I’m specifically wondering if any of the restructuring charges in Dow Corning this quarter apply to Hemlock and what is the outlook for maintaining your utilization around 100%?

Wendell Weeks

I don’t think there was any restructuring at Hemlock. I was just there actually on Friday and their demand is very strong. What they have begun to see some turn back in semiconductor from solar. You may recall we talked earlier about some of the semiconductor people have taken their contracts to solar and then benefited from the lowering in spot price. We have seen an increase in semiconductor demand as we are marching into April and they are still making everything they can and basically selling all they can. They have had no changes to their contracts with their customers. They have had nobody failing to make a prepayment on the various contracts. Things are going quite well there.

Jeff Evanson – Sanford Bernstein

Wondering given that glass supply is tight what you are anticipating your competitors in the LCD glass space to do in terms of their capacity additions and capacity changes and how that impacts when you decide to light tanks?

Jim Flaws

We believe that both of our large competitors have at the end of the quarter begun lighting tanks again. We would expect that to be in line with them drawing down their own inventories as we have and with the increased market demand. Our observation of that to the degree it is accurate is it is in line with what we would have expected for the market place. So we are not seeing any unusual behavior.

Operator

The next question comes from John Harmon – Needham & Company.

John Harmon – Needham & Company

I would just like to probe into one of your previous answers. I believe previously you had said that your capacity utilization is below 50%. Then with the 50% sequential increase in volume you are expecting at your wholly owned businesses I think you said your capacity utilization would still be about 50%. Would that mean it was around 30% and is going up to 50% or does it really take you practically the whole quarter to get the new tanks on line for the capacity being frozen for a quarter?

Jim Flaws

What we said is our glass utilization in our wholly owned business was less than 50%. As of the end of April we have not re-lit another tank yet so we are just now making decisions to start re-lighting the tanks. It takes us about a month to re-light a tank so if we press the button today basically the earliest we would get glass is June. So we are still running the exact same number of tanks as what we had at the end of last year. So that is why Wendell made that comment. We are drawing down our inventories at a much more rapid rate now that demand is going up and obviously making the decision to start multiple tanks as soon as possible to be ready for this increased demand.

John Harmon – Needham & Company

Secondly, based upon your improved view of what the glass market is this year do you have to add any new tanks or had you built enough last year to tide you through this growth?

Jim Flaws

We are not planning on starting footprint construction of any new tanks in Taiwan. We had some new tanks that never ran last year and may run this year and then obviously in Japan, as you know, we have multiple tanks for Gen 10.

Operator

The next question comes from Vijay Rakesh – Thinkequity.

Vijay Rakesh – Thinkequity

On the gross margin line, as you look at the second quarter your volume is going up 40% and in Q2 you are expecting better volumes and the pricing on the glass seems to be benign here going into the second quarter. Would you expect gross margins in that scenario to get to at least the low 40’s exiting calendar 2009?

Jim Flaws

I’m sorry; we are just not giving gross margin guidance going out.

Vijay Rakesh – Thinkequity

Just to bracket it on your comment on significantly improved margins in the second quarter. Given you are not bringing new furnaces on but your volumes are going up 40% how do you see that on the margin line?

Jim Flaws

We expect gross margins to be substantially higher in Q2 and for them to grow again in Q3 but we are not going to give specific numbers or even bracket it.

Vijay Rakesh – Thinkequity

Again, on the market share side, I was wondering how you see that trending through calendar 2009 versus the other two guys in the space.

Wendell Weeks

Well let’s start with this past quarter. So, if you have been following us for awhile you would know as we implement our pricing strategy what we try to make sure we do is we don’t over react to any near-term moves in share and instead try to make sure that we have the sort of stickiness required to get where we want to get over the sweep of time. In quarter one implementing that pricing strategy meant we probably lost some share although it is very hard to measure on a quarter-to-quarter basis. As this year is now seems to be evolving, barring any additional economic change with consumer preferences what we would expect is to regain some of that share as we go into quarter two. That is about as far as I would like to run through it in terms of seasonality. Overall our expectation is share will end up for the year about where it went in.

Operator

The next question comes from Carter Shoop – Deutsche Bank.

Carter Shoop – Deutsche Bank

I had a question with regard to the glass business. Can you talk a little bit about the costs associated with re-lighting the tanks? I’m trying to better understand the incremental benefit of bringing this capacity on line in 2Q relative to 3Q.

Jim Flaws

The incremental cost to light a tank is relatively small. We do have capital costs to rebuild the tank when we have taken it down. Actually we have rebuilt a lot of these tanks earlier in quarter one and then there will be some depreciation when they start up. It is not a big number. Then relative to the incremental cost of energy, sand and people it is relatively minor. That is why this is such a high variable gross margin business. So, I don’t think you really will see much impact from that.

Carter Shoop – Deutsche Bank

When we think about depreciation in the second quarter do you think where we are in 1Q that is a decent number here or is it going to be increasing from 1Q levels?

Jim Flaws

It will increase a small amount due to the lighting up of tanks and then also some from Gen 10.

Carter Shoop – Deutsche Bank

With regard to Gen 10 will we see that drag in 2Q reverse in 3Q or do you think that Gen 10 will continue to be a drag in the third quarter also?

Jim Flaws

It will continue to be a drag in quarter three because we will begin bringing up more capacity and we expect Sharp’s demand to be relatively small in the beginning of the year and then the question will be how quickly they begin ramping in Q4.

Carter Shoop – Deutsche Bank

Just to clarify that, would that be an incremental drag versus 2Q? 3Q over 2Q?

Jim Flaws

A slight incremental drag.

Carter Shoop – Deutsche Bank

Payables, there was a pretty significant drop there in the quarter. Anything going on there we should be aware of?

Jim Flaws

It really is the reflection of the capital spending that occurred prior that we are paying some bills on. Remember what I said earlier in this year is we will eventually be exiting this year running at a very low level of capital spending. We have been running at a rate approaching $2 billion and we will be exiting this year at a rate right between $500-600 million. So that is a big change too.

Operator

The next question comes from Yair Reiner – Oppenheimer & Co.

Yair Reiner – Oppenheimer & Co.

Another question on the gross margin maybe from a different angle. Obviously some puts and takes next quarter. On an absolute dollar basis do you expect COGS to inch up or do you think you can keep them flat with the Q1 levels?

Jim Flaws

That is a clever way of getting me to give gross margin forecast and I won’t answer the question.

Yair Reiner – Oppenheimer & Co.

It isn’t because you are not giving top line guidance. The other question is on sell through, obviously some indicators from China showing very strong demand there. It seems like a lot of incremental demand for the panel makers from the subsidies in rural areas. Do you have any data about sell through there?

Jim Flaws

The only data we have in China is with the panel we buy overall where demand has been quite strong. We have no parsing of the demand by rural area versus major cities on the coast. So I can’t help you there. It has been very strong demand this year in China throughout the quarters.

Yair Reiner – Oppenheimer & Co.

On the restructuring were there any restructuring savings already visible on the P&L in Q1 or is the $30 million savings in Q2 going to be all incremental?

Jim Flaws

The $30 million is incremental to Q1 but Q1 did have some savings versus Q4 because we had reduced some people in the telecom area in November that we saw savings so you would have gotten some savings from that in Q1 versus Q4. So the $30 million is all incremental.

Operator

The next question comes from Andrew Abrams – Avian Securities.

Andrew Abrams – Avian Securities

Back to pricing for one minute, I know you have kind of talked a little bit in the past about your pricing in first quarter was going to probably be unusually depressed and your comments this morning about things getting better in terms of pricing and also your comments in terms of the glass market being relatively tight indicate it is going to be considerably better than what it was in first quarter. Is there a way you can quantify a little bit in terms of what first quarter actually looked like in terms of your pricing?

Jim Flaws

Our pricing guidance we gave at quarter one was it was at the upper end of single digits and that is what it turned out to be. We expect it to be significantly lower in Q2 but not back to the level of 2% we experienced back in 2007 and early 2008.

Operator

The next question comes from John Roberts – Buckingham Research.

John Roberts – Buckingham Research

Do you expect that Gen 10 will have a material mix effect on pricing at some point in the next 12 months or the next four quarters?

Jim Flaws

No we don’t expect it to have any material impact from a mix point of view. As big as it is, the business is so large now that the introduction of any new fab doesn’t change the overall mix very much.

John Roberts – Buckingham Research

Are there any discussions underway, there were several other sort of tentative announcements on other Gen 10 by other potential customers in that market place? It all got put on hold when the industry turned down but now that things are picking up have any of those discussions re-started?

Jim Flaws

We have no new confirmations of construction start up of Gen 10 or Gen 11 at this stage.

Operator

The next question comes from Ajit Pai – Thomas Weisel.

Ajit Pai – Thomas Weisel

On cash flows you have shown some pretty impressive cash flow in this quarter and you have also talked about your CapEx falling and your demand side actually rising. Could you give us some indication for this year what you would expect your cash flow generation to be? Maybe even if you don’t want to give specific guidance if you do make a $5 billion top line number what it could look like?

Jim Flaws

Well if we make the $5 billion top line number we expect to see good free cash flow generation. I won’t dollarize it at this stage. We will give you more help on that in our July call. If we get to that level and things are playing out the way we expect in this way we should be in good shape to have strong, positive free cash flow this year. It certainly will not be as great as two years ago but it will be definitely very good.

Ajit Pai – Thomas Weisel

The second question would be just looking at your telecom business you talked about shedding some workers in the fourth quarter and then bringing them back in the first quarter. From an overall perspective, particularly on the fiber side of things could you give us some color as to what capacity utilization you’re at your [inaudible] are?

Jim Flaws

It is tiny.

Ajit Pai – Thomas Weisel

At both or at one it is close to 100% and at the other it is about half the plant or less than half? Higher than half?

Jim Flaws

We are not going to disclose that. For the glass we have running it is very tight. Demand is very strong relative to our ability to supply. You may note we were just over in China doing a ribbon cutting on a very significant expansion of our Shanghai fiber plant. That is timed very well to help meet the acceleration in the China market demand.

Ajit Pai – Thomas Weisel

The margin structure in China is it comparable to what you get for the fiberglass in the U.S. and also the profitability as related to, the pricing environment for fiber just given how tight your capacity is I’m not sure what the competitive dynamics are of capacity utilization at the competitors but is that pricing environment fairly benign?

Wendell Weeks

I think pricing being fairly benign in telecom is sort of a strange concept. You have the overall industry structure with relatively few very powerful buyers relative to the supply base right now. With pricing strategies played out in fiber like we have wanted them to and certainly pricing has become more moderate though I would not ever call the telecom pricing environment benign.

Ajit Pai – Thomas Weisel

In terms of mix, like China versus North America is there a major difference in margin structure?

Wendell Weeks

I wouldn’t want to start to talk about by region margin structure. Mix overall what I would say is that high data rate projects as well as private network type projects have been impacted more than some of our base business projects. Therefore, the relative weight of standard single mode is higher than sort of a high data rate fiber or private networks and that will tend to be a little bit negative on mix for us.

Operator

The next question comes from Nikos Theodosopoulos – UBS.

Nikos Theodosopoulos – UBS

On the $195 million cost reduction, just a couple of clarifications on that. In the second quarter you said you would get an additional $30 million in savings but most of that will be in COG if I heard that right. What was the actual savings you had in the first quarter? I’m trying to get a sense by the end of Q2 where you will be versus the full target.

Jim Flaws

I just don’t have that handy. I will get something and we will get you back.

Nikos Theodosopoulos – UBS

Even though most of the savings in 2Q will be in COG, ultimately half of the savings will be in OpEx and half in COGS? Is that the way to look at it?

Jim Flaws

No. I think it will still be slightly weighted towards cost of goods sold in the second.

Nikos Theodosopoulos – UBS

On LCD gross margin given the volume ramp in the next couple of quarters and more stable pricing if this continues is there a scenario where you can get back to the gross margins you had in the LCD business in the first nine months of 2008? Some time in the next year or so or are those margins not going to be achievable based on the resetting of the bar here in the first quarter?

Jim Flaws

Let me start out by saying our gross margin in March was very nice for us in the display business. It moved up each month. In terms of an exit rate from the year the way we think about it is we will probably end up with a 12-month period of time with quite a bit of price decline obviously mostly driven by the quarter one being down. Unfortunately we won’t have had the same opportunity to work on what we call our normalized cost reductions over the course of the year driven principally by the fact we spent a lot of time shutting down plants and bringing them back up. I am not expecting our gross margin gets back to the level it was by the end of the year. I do expect it to be quite high and to be an extremely profitable business. Whether it gets better over time I think will be very dependent on the ratio of price declines in 2010 relative to our ability to work on cost reductions.

As you know, there have been years in the past where we had cost reductions exceeding our price declines. If we get one of those again it will help inch our way back. As of right now I am not expecting to get back to quite the level that we had in the first half of last year in our wholly owned business but I do expect the margins to be very, very high.

Nikos Theodosopoulos – UBS

On acquisitions, at the Analyst Day and maybe it is just me over-analyzing this, I got a sense at the analyst day the company was more aggressively looking at acquisitions and today on this call it is kind of like we might do a small or medium one and we might not. Did something change over the last couple of months or is it pretty much the same approach you had at Analyst Day?

Wendell Weeks

I would say it is pretty much the same approach we had at the Analyst Day. Remember, for us we have two things that are going to tend to balance out and we will see how opportunities arise one way or the other on that. On one side valuations are down and we are very strong financially so that raises the probability of us doing some smart external development. On the other hand, we are never going to do anything that challenges the fundamental stability of Corning and we always aim at being here another 150 years with independence and innovation but that tends to make us be conservative and not over-reach. So no change in approach. We will just see. If we get an opportunity that manages to fit through that cycle of being something we would be outstanding at, the valuation being right and at the same time being totally consistent with our strategic framework.

Operator

The next question comes from Brendan Furlong – Miller, Tabak & Co.

Brendan Furlong – Miller, Tabak & Co.

On the telecom side you mentioned that the data com/enterprise spending part of the telecom was weak in Q1. Any further color on that into Q2?

Jim Flaws

As we take a look going into quarter two we expect overall telecom sales to be modestly higher. That being driven really around the same dynamics, we expect relative flatness in some of the areas that we are down and continued strength in those areas we are up.

Brendan Furlong – Miller, Tabak & Co.

On firing up the tanks, say firing them up in May and June it would be a way to characterize the impact on gross margin in Q3 as significant again?

Wendell Weeks

Yes. Basically you are going to get the glass coming off those tanks, assuming the volume remains as we think it is, to come in at extremely high variable gross margins.

Brendan Furlong – Miller, Tabak & Co.

On the pricing front, I have you roughly down 8% quarter-over-quarter on pricing and normally 2%. You are more moderate in Q2. Do you think you can get half way back to the more normalized level?

Wendell Weeks

I’m sorry; I’m not going to confirm that.

Jim Flaws

Just a couple of quick investor related announcements. First, Ken and I will be in London on Tuesday, May 5th meeting investors. We will have an open luncheon that day and if there is anybody interested in attending you should call Ken. Second, I will be presenting at the JP Morgan Technology Conference in Boston on Monday, May 18th. Lastly, Wendell will be presenting at the Sanford Bernstein Strategic Decisions Conference on May 28th.

We hope to see you at one of these events. Ken?

Ken Sofio

Thank you Jim. Thank you Wendell. Thank you all for listening today. A play back of the call will be available starting at 10:30 a.m. ET today through 5:00 p.m. ET on Monday, May 11. To listen dial 800-475-6701. The access pass code will be 994513. The audio cast is also available on our website during that time. John that concludes our call. Please disconnect all lines.

Operator

Ladies and gentlemen you may now disconnect.

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Source: Corning Incorporated Q1 2009 Earnings Call Transcript
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