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Corning Incorporated (NYSE:GLW)

Q3 2009 Earnings Call

October 26, 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

Christopher Muse - Barclays Capital

Steven Fox - CLSA

Jim Suva - Citigroup

Simona Jankowski - Goldman Sachs

Jeff Evanson - Sanford Bernstein

Nikos Theodosopoulos - UBS

Carter Shoop - Deutsche Bank Securities

Brendan Furlong - Miller Tabak & Co., LLC

John Roberts - Buckingham Research

Vijay Rakesh - Thinkpanmure LLC

Brian White - [Unidentified Firm]

Yair Reiner - Oppenheimer & Co.

Ajit Pai - Thomas Weisel Partners

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Corning Incorporated third quarter results. (Operator Instructions)

I'd now like to turn the conference over to our host, Division Vice President of Investor Relations Ken Sofio. Please go ahead.

Ken Sofio

Thanks. Good morning. Welcome to Corning's third quarter conference call.

Jim Flaws, our Vice Chairman and Chief Financial Officer will lead the discussion. Wendell Weeks, our Chairman and CEO, will join for the Q&A.

Today's remarks do contain forward-looking statements under the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks, uncertainties and other factors that could cause our 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 third quarter, which can be found on our Investor Relations website. We have posted the accompanying slides online as well.

In summary, we're very pleased with our third quarter results. Before I get into the details, I'd like to walk you through the key points we'll be covering this morning.

First, our third quarter sales and profitability were stronger than the second quarter. Sales were up sequentially in every one of our segments.

Second, we believe LCD supply chain inventories at the end of the third quarter were at appropriate levels to meet fourth quarter demand.

Third, anecdotal data suggests LCD television sales in China were very robust during Golden Week. It appears the amount of inventory built for the holiday week was appropriate to meet the strong demand there.

Fourth, retail sales of LCD televisions remained strong worldwide throughout third quarter. This helped pull a significant amount of product through the supply chain and kept inventory levels healthy. We anticipate the strong retail environment to continue in the fourth quarter.

Fifth, we want to be clear on what we believe may happen in the fourth quarter in the display industry. After significant increases in all applications for most of the year, we expect panel pricing to continue to gradually decline in the fourth quarter. We do not view gradual panel price declines in the fourth quarter as a negative.

We also believe panel makers may lower their utilization rates later in this quarter. Exact timing is up to the individual panel maker, and the decision will likely be driven by the strength of quarter four sell through, expectations for Q1, and the amount of panel inventory they want entering Q1. We do not believe utilization rates need to fall significantly, but barring a much stronger end market than we currently anticipate, they are likely to be reduced. This is important to the overall health of the supply chain and will help to maintain a reasonable level of inventory heading into Q1.

Sixth, given the anticipated lower utilization rates of panel makers, we expect the overall glass market to be slightly lower sequentially in the fourth quarter. We expect our wholly owned business volume to be flat to down slightly sequentially. As we announced last Monday, our Taichung facility recently suffered a power disruption. This reduced the amount of glass we can manufacture this quarter. Before the event we thought our wholly owned volume could be up as much as 5% sequentially.

Seventh, we expect our display glass prices to be flat in Q4 at both our wholly owned business and SCP.

Eight, we believe the glass industry has the appropriate amount of capacity to meet our expectations for the 2010 glass volume.

Lastly, with our current view of the end market demand and supply chain we are now forecasting the 2010 LCD glass market to be 2.7 billion square feet, up about 15% from this year.

Now turning to the details, our third quarter sales were $1.5 billion, a 6% increase from the second quarter. Our Q3 sales did benefit from changes in exchange rate by about $35 million.

Moving down the income statement, gross margin was 40.5% in Q3 compared to 41.2% in Q2. This slight decline was due to $22 million in incremental accelerated depreciation charges related to the Shizuoka plant following the August earthquake there. Excluding these charges gross margin Q3 would have been 42%. Both our Display segment, excluding Shizuoka, and our Environmental segment had good manufacturing performance in the quarter.

SG&A was $219 million or 15% of sales in the quarter.

R&D was $131 million in Q3, about 9% of sales.

Operating income was $48 million in Q3 compared to $41 million in Q2.

Equity earnings were $418 million in the third quarter, which is an all-time record for Corning and 16% higher than Q2. The significant increase was due to higher earnings at both Samsung Corning Precision and Dow Corning.

Our Q3 tax rate was 5% compared to zero in the prior quarter. This is a higher tax rate than previous quarters. It reflects a catch up this quarter for a higher tax rate for the year due to stronger second half earnings performance. We now expect our full year tax rate to be around 2%. For the first two quarters the tax rate was zero.

Net income excluding special items was $654 million in Q3 compared to $614 in Q2. About $24 million of the increase was due to favorable exchange rates.

Earnings per share excluding special items were $0.42 compared to $0.39 in Q2. About $0.015 of the increase was due to favorable exchange rates.

You should note that EPS and net income excluding special items are non-GAAP measures. The reconciliation to GAAP can be found on our website. Our GAAP net income includes $10 million in special items. You should note the $22 million in incremental accelerated depreciation charges are not considered to be a special item.

Our share count for the third quarter was 1.57 billion shares and consistent with the second quarter.

Now I'd like to turn to our segment results starting with Display. Third quarter sales were $679 million, slightly higher than Q2. Volume and pricing at our wholly owned business were flat sequentially. Sales benefited from the change in the yen to U.S. dollar exchange rate, which averaged 94 in Q3 versus 97 in Q2.

Display gross margin was slightly lower in Q3 compared to Q2 due to the accelerated depreciation. Besides not selling out inventory as we did in Q2, the stronger yen and good manufacturing performance at our Taiwan plants lifted our Display gross margin. In addition, the fixed cost drag from our Gen 10 plant was 350 basis points, lower than our original estimate of 550 basis points. Higher than expected volume production helped to offset the impact of fixed costs in Sakai City.

Equity earnings from SCP's LCD glass business were $317 million in the third quarter, an increase of 12% compared to $284 million in Q2. Volume was up 7% sequentially and pricing was flat. SCP also benefited from changes in exchange rates. For your modeling purposes, SCP third quarter LCD sales were $1 billion, up 9% versus the second quarter. As a reminder, this represents SCP LCD sales only. Our public filings will report SCP's total sales, which include CRT glass and other product sales.

Net income in the Display segment, which includes equity earnings, was $600 million in the third quarter versus $555 million in the second quarter. As a reminder, Display's third quarter results include the $22 million in incremental accelerated depreciation.

Regarding our Shizuoka facility, the restart of production is on track. We restarted some capacity in September and more in October. We already have good glass from the first restarted tank.

Now would be a good time to give you an update on our Taichung facility. Last weekend the facility suffered a power disruption. There are backup systems in place, but for some of our tanks these systems did not respond as they should have. They're still working to determine the root cause of the incident and the actions to reduce our risk of this event occurring in the future.

The power disruption adversely impacted some of our tanks. These tanks will not have to be brought down to room temperature to be repaired, but it will still take between several weeks and two months to get them back online depending on the tank and the extent of the work involved. We're doing everything possible to accelerate the repairs and are very encouraged about the progress that has been made in just the last week.

In the meantime, we'll be leveraging our worldwide supply chain to secure additional glass supply for our customers. We will likely not be able to secure enough glass to offset all the lost capacity; however, between accelerating our repairs and obtaining glass from other sources, we believe glass volume at our wholly owned business could be flat to down slightly sequentially. Prior to this event we thought our wholly owned glass volume could have been up as much as 5% in Q4.

We'll incur about $11 million accelerated depreciation charges in Q4 related to the repairs from the power disruption.

I'd like to spend a few minutes discussing the current supply chain, starting with retail. Strong demand for LCD TVs continued throughout the third quarter. Worldwide, LCD television unit sales at retail were up 29% in July, 27% in August. We don't have complete data for September to provide a worldwide growth figure for that month, but for the regions that do have data it's continued to be positive. As a reminder, worldwide retail sell through is an aggregate of the data provided by different data vendors in each of the primary TV sales regions - China, Europe, Japan, and the U.S.

The most significant growth regions were Japan and China. In Japan LCD TV unit sales were up 61% in July, 57% in August, and 66% in September. Year-to-date sales are up 42% in Japan. In China unit sales were up 60% in July, 64% in August, and 75% in September. Year-to-date sales in China are up 70%. We also have some data on Golden Week sales which I'll discuss in a moment.

In Europe LCD TV unit sales were also very strong. In July and August sales were up 22% and 13%, respectively. We do not have September data yet for Europe.

In the United States LCD TV unit sales were up 13% in July, 16% in August and 22% in September. As a reminder, the U.S. data is provided by NPD and their data does not include Wal-Mart or Costco; however, Costco recently reported August LCD TV unit sales grew at 32% over the prior year and their September sales were up 35%. This higher growth rate supports our belief that U.S. sell through growth is likely more robust than NPD coverage indicates.

We also have the first week of October data for the U.S. LCD TV sales, which are up 23% versus last year, but recall that television sales were fairly weak in the first half of October last year in the United States.

So overall the data we have so far suggests worldwide LCD TV sales in Q3 remained robust.

I'd like to spend a few moments discussing Golden Week in China. This was a topic of concern for our investors earlier in Q3. There were many who feared there was too much inventory built in anticipation of Golden Week and that retail sales would not be strong enough, leaving too much inventory in the supply chain.

As you may recall, our modeling suggested there were about 8 to 9 weeks in inventory in China to go with about 4 million sets. We estimated about 2.4 million sets would need to be sold to justify this amount of inventory.

I'm pleased to say that our internal checks with set assemblers and retailers on the ground indicate that LCD TV sales during Golden Week were spectacular. Industry estimates indicate about 2.6 million sets were sold between October 1st and October 8th, at least double the amount of televisions sold last year in the holiday period. So in hindsight, the inventory build was justified.

Looking ahead, we believe inventory levels now in China are in line with volume expectations for the rest of the quarter, which are also expected to be robust.

Getting back to the overall supply chain, we believe the total inventory in terms of equivalent square feet of glass was about 8 million exiting Q3. This would be inventory at the panel makers, set assembly and at retail. This is in line with our original estimate. Given the market size and expectations for Q4, we would say this level of inventory is reasonable.

In terms of total panel making, inventory as measured in equivalent square feet. At the end of Q3 they were a little more than half of what they were in Q3 of last year.

At the set assembly level, inventories as measured in square feet have increased in comparison the second quarter as expected. At the end of Q3 our model suggests they're about 9% less than Q3 last year. We expect set assembly level inventories to decrease in Q4 as retail pulls more inventory out of the supply chain.

And at retail we believe inventories there also increased compared to Q2 and are up about 10% in comparison to the third quarter of last year. It's worth noting we estimate retail sales have been up over 15% year-over-year throughout the third quarter, so we do not consider these levels to be excessive, especially in light of the strong China holiday week sales.

Looking ahead to Q4, we expect retail inventory levels to decline.

So overall, inventory levels and supply chain appear to be at reasonable levels heading into Q4. I'll have some more comments on Q4 in the outlook section.

Moving to the Environment segment, sales in the third quarter were $167 million, an increase of 27% over the second quarter and much higher than we expected. Auto product sales were $103 million and up 21% sequentially. Sales were driven primarily by government incentives in China, Germany and the United States, which helped pull inventory out of the supply chain and increase demand for us.

We're pleased with the spike in demand, but we don't believe it's sustainable. The U.S. cash for clunkers program was a success, but overall we still expect worldwide auto sales to remain at depressed levels. As a result, we took certain restructuring actions in the third quarter to better align our capacity with a smaller market.

Diesel sales in the third quarter were $64 million, up 36% sequentially. Industry data indicated that September was the fourth straight month of increased heavy duty truck orders. We believe this order trend is driven by the industry activity ahead of the 2010 heavy duty emission mandate, so unfortunately it does not appear that our improved sales are as a result of a recovery in the freight industry.

The segment incurred a net loss of $4 million in the third quarter versus a net loss of $9 million in Q2.

Moving to the Telecommunications segment, sales in the third quarter were $450 million, an increase of 3% versus Q2 and in line with our expectations. We saw strong demand for optical fiber in China during the quarter. In North America, strong demand for private network products was offset by weaker fiber to the home product sales. In Europe our sales quarter to quarter were consistent; however, compared to last year the European telecom market this year has declined due to lower capital spending by our customers.

Sales of our fiber and cable products in the third quarter were $251 million, an increase of 7% sequentially. China's 3G build out was the primary driver again this quarter.

Sales of hardware and equipment products were $199 million in Q3, a slight decline from Q2.

Segment net income was $21 million in the third quarter compared to $18 million in the second quarter.

Sales in our Specialty Materials segment were $90 million in Q3, up 27% versus Q2 and more than we expected. The increase in sales was primarily due to strong demand for Gorilla glass and recovery in the semiconductor market. The segment incurred a net loss of $11 million in Q3, which was comparable to Q2.

In the Life Science segment, sales for the third quarter were $92 million compared to $81 million in the second quarter. Q3 sales included $7 million from the recently acquired company, Axygen. We believe Axygen's product portfolio and established distribution network will significantly strengthen Corning's Life Science platform. Segment net income was $12 million versus $9 million in Q2.

Turning to Dow Corning, equity earnings in Q3 were $92 million, up 59% versus second quarter's $58 million. This sequential increase was driven by higher demand in both the Silicone segment as well as Hemlock. Silicone sales have grown each month over the past several months. Hemlock benefited from capacity that came online during the quarter. For modeling purposes, Dow Corning sales were $1.4 billion in Q3 compared to $1.2 billion in Q2.

Moving to the balance sheet, we ended the third quarter with about $2.9 billion in cash and short-term investments, down from $3.1 billion last quarter. The decrease in cash was primarily due to the acquisition of Axygen in the quarter, which was approximately $400 million, as well as capital expenditures of $236 million.

Free cash flow was an outflow of $114 million in Q3. Free cash flow is a non-GAAP measure, and the GAAP reconciliation is on our website.

We were successful in reducing inventories again from $647 million at the end of Q2 to $618 million at the end of Q3. The biggest decline this quarter came from Environmental and Telecom.

Now I'd like to turn to our outlook, and I'll start with Display. We expect glass volume in our wholly owned business to be flat to down slightly sequentially, but SCP glass volume is expected to be flat quarter to quarter. We anticipate our glass pricing at both our wholly owned business and SCP to be flat sequentially. Gross margin in our Display business will be higher in the fourth quarter as the non-repeating Shizuoka repair costs will be only somewhat offset by repair costs at Taichung. Fixed cost drag from our Gen 10 plant in Q4 should be comparable to Q3.

I'd like to take a few minutes to discuss our view of what we anticipate will happen in the Display supply chain this quarter. We hope this will help investors understand what to expect and how to react to specific announcements. And I'll also have some early thoughts about Q1 and next year.

We believe investors currently have two main supply chain-related concerns that are shorter term in nature. First, how will the supply chain react to falling panel pricing? And second, will there be too much inventory heading into Q1? The answer to both questions will be driven to some extent by how well the panel makers manage panel prices and whether retail demand remains strong.

We expect panel makers to lower their utilization rates later this quarter. We think the panel makers remember the lessons learned last year when they kept running at higher utilization rates despite falling panel prices. As a reminder, we believe that a significant portion of panel maker costs are variable not fixed. However, we do not expect panel makers to reduce their utilization rates significantly. We expect more moderate reductions than we saw last year. We believe utilization rates for the panel makers outside of Korea will fall from about 90% to somewhere in the 70s later this quarter.

This type of rate cut would be viewed positively by us since running at lower rates will reduce the number of panels produced and hopefully be an additional pressure on panel prices. But exact timing of when panel makers will cut utilization is up to individual panel makers. Their decision will likely be influenced by the strength of sell through in Q4, expectations for Q1 demand, and the amount of panel inventory they want entering Q1. We expect panel prices to continue to gradually decline in the fourth quarter.

At this time we do not view this as a negative. As a reminder, panel prices rose significantly in all applications through most of the year. For example, a 32-inch television panel rose from $150 in January to $205 this fall.

You should note when we reference panel prices, whether or not they've increased or decreased, we are using what is known as the low estimate from WitsView. WitsView publishes panel pricing by end product every two weeks. It provides a low, average and high estimate. Based on our discussion with panel makers, we believe the low estimates are the best indicators of supply and demand.

We now have panel price data for October and noted that declines have been gradual. In the last two weeks of October television panel pricing was down $2 to $5, which we consider to be very reasonable, and notebook prices were flat in the last two weeks of October after being reduced by $3 in the first half of the month. Monitors have seen the most price declines in October. Prices have come down $3 to $4 in the first half and second half of October, respectively.

Regarding retail, the fourth quarter is shaking up to be stronger than we expected as evidenced by the data we shared earlier. There will be very attractive retail pricing for LCD televisions that should spur additional demand. A strong retail environment will pull inventory out of the supply chain. Panel makers running at lower utilization rates will help maintain healthy inventory levels into Q1.

Right now our supply chain models indicate there'll be approximately 750 million square feet of inventory exiting Q4. If this happens, we believe this is healthy in comparison to a market of this size. Obviously, if retail continues to be strong and panel makers manage their production levels appropriately, this will be better for glass demand in Q1.

So in summary, while it's possible there could be too much inventory headed into Q1, we do not view it as the most likely case. We feel good about the supply chain today and expect it to remain healthy heading into Q1.

Looking ahead to the first quarter, we expect the Taiwanese panel makers to reduce utilization rates further in Q1 to correspond with seasonally lower demand. As a result, we expect first quarter glass demand to be lower. In Korea we expect panel makers to also reduce their utilization rates but to a much lesser extent than in Taiwan.

Looking ahead to the second quarter, we expect utilization rates at the Taiwanese panel makers to snap back as they prepare to meet seasonally stronger second half demand. In this environment, we expect second quarter glass demand to increase significantly.

Another shorter term investor concern is the amount of industry glass capacity heading into seasonally lower Q1. Overall, we believe the glass industry has the appropriate amount of capacity to meet 2010 demand expectations. We do not believe we will have a significant amount of excess capacity given our expectations of 2010 demand.

In Q1 we're likely to continue to run our tanks and build some inventory. We also have routine maintenance scheduled on a few tanks in the first quarter. If it appears that we do not need the capacity from those tanks, we could decide to repair them but not restart them until they're needed. Given our expectations for end market demand next year and glass supply in the industry, we believe the glass market will be balanced to tight next year post Q1.

Our recent forecast suggests the worldwide glass market will be about 2.7 billion square feet in 2010, an increase of around 15%. We expect about 156 million LCD TV unit sales next year, up from around 130 million this year.

I also have some guidance for other segments. In our Telecom segment we expect Q4 sales to be down 15%. As a reminder, fourth quarter sales are normally lower compared to the third quarter.

In our Environmental segment we expect Q4 sales to be between 10% to 15% lower sequentially. This decline reflects normal seasonality plus the expected drop off in demand following the end of the cash for clunkers program in the United States.

In Life Sciences we anticipate Q4 sales to grow more than 25% sequentially, all due to Axygen, which is the company we acquired in mid September. Excluding Axygen, Life Science sales would have been just slightly lower. In Specialty Materials we expect Q4 sales to be flat to down 5%.

And at Dow Corning we're expecting another good quarter. We believe equity earnings could grow 10% to 15% sequentially.

Moving to the income statement, we expect our corporate gross margin will be consistent with the third quarter as the increase in Display will be offset by lower volumes in Environmental and Telecom. SG&A will be slightly higher, reflecting normal year end accruals. R&D will likely be around 10% of sales. We expect our tax rate to be between 2% and 3% in Q4.

Investors should note that our results can be materially influenced by the yen to U.S. dollar exchange rate. For Q3 the yen averaged 93. For every 1-point move in the yen our net income moves by about $9 million. So if the yen were to average 91 in Q4, net income would benefit by about $18 million or roughly $0.01 of earnings per share.

Before I head into Q&A, I'd like to make some overall comments. At the beginning of the year we told investors our sales plan for the year was $5 billion. If you recall, this was not universally accepted by investors and rightly so since our sales at the time were only about $1 billion a quarter. But we had a plan to get there as well as actions to reduce our cost structure. At this time we believe we're on track to exceed the $5 billion sales plan, and based on Street estimates so do most of you. Our cost structure is certainly better although there are some actions that needed to be completed this quarter.

That being said, not all lights are green in the worldwide economy, so we continue to be cautious with our expectations until we see more improvement. Outside of LCD television, which continues to be a resilient consumer purchase worldwide, and China, which has created significant demand for fiber and auto substrates, there's still room for caution.

With that, we're happy to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mark Sue - RBC Capital Markets.

Mark Sue - RBC Capital Markets

Jim, have you started to see retail inventory levels decline as we head into the holidays or is it too early to tell? And can we see a scenario where retailers don't have enough inventory? And conversely, if we don't get the sell through that we're anticipating, are there indications that the panel makers will move faster this time around to adjust their utilization rates?

Jim Flaws

We think retail inventories are appropriate right now. I guess you can imagine a scenario where demand is very strong and maybe there would be shortages, but right now we think they're at an appropriate level and that retailers have built a little to get ready for the holiday season in this country and in Europe, in particular.

It's hard for us to predict the reaction of panel makers to demand. I think everybody remembers last year when panel prices fell so dramatically, but we don't feel we're seeing a repeat of that, so we think it's unlikely that we'll see drastic reductions in utilizations. But it's difficult to forecast.

Mark Sue - RBC Capital Markets

And separately, Jim, as you have more visibility into your planning as your overall demand picture firms up for next year, how shall we think about operating expenses, R&D in particular, as we start 2010?

Jim Flaws

I think you'll see R&D levels be relatively consistent year-over-year, so I don't think you'll see a big shift there. SG&A will probably [inaudible] with inflation, but, again, I don't think you should expect to see big changes in SG&A.

Operator

Your next question comes from Christopher Muse - Barclays Capital.

Christopher Muse - Barclays Capital

Jim, I appreciate the outlook in terms of seasonal volume for the first half. I was hoping maybe you could comment on what you would expect for Display gross margins if what you presented occurs?

Jim Flaws

For which period of time, C.J.?

Christopher Muse - Barclays Capital

For Q1 and Q2?

Jim Flaws

Well, obviously, we hope to have no repeats of various upsets like the earthquake or the power disruption, so that's an improver to gross margin. We expect volume to grow at our Gen 10 factory, so that should help. And even though demand will be down slightly we're thinking that we will continue to run our tanks, so we should not be seeing a down draft from cutting off demand there. So I would say we expect gross margins to be better in Q1 versus Q4.

Christopher Muse - Barclays Capital

And then I guess moving to Dow Corning, I kind of think of it as a late cycle traditional type business with Hemlock added to the mix, which at some point I would think we would start to see some pricing risk there. How do you think about the growth rate for that business into 2010 and 2011, and what kind of both earnings and dividends should we expect?

Jim Flaws

I'm not ready to give guidance on Dow Corning for next year at this stage. We have seen increased demand for silicones all year long. And we saw something very unusual for Dow Corning in late December of '08 and January of 2009, where usually we don't see a violent a move in terms of destocking by our customers as we saw this time. I think we're past that and we've seen consistent robust demand overall, some saying it's stronger than others, but they have a very high R squared versus economic growth around the world, so it all depends on what you think a growth rate is. If economies grow they will grow in silicones.

Hemlock, it's much more difficult to predict. Obviously, spot prices are down quite a bit, but our customers all continue to take their contractual obligations. And so we'll just have to see how the solar spot market develops.

Christopher Muse - Barclays Capital

Can you comment on where pricing is for contracts relative to spot?

Jim Flaws

In quarter three spot was still above our contracts.

Operator

Your next question comes from Steven Fox - CLSA.

Steven Fox - CLSA

First of all on Gen 10, given the better than expected or less than expected drag in the quarter, why does the Gen 10 factory still have the same type of margin drag this quarter? And if you can also just sort of play out when it would get sort of to a neutral effect on margins.

Jim Flaws

Because we're bringing on an additional unit of capacity in this quarter, which, with fixed costs it'll just be starting up and there'll be no production off the tank that we're starting up. So even though there's more volume, we have some more additional fixed costs that's not producing.

And I would say as we exit next year, assuming that our customers are taking all the volume that they've said they're going to, it shouldn't be a drag.

Steven Fox - CLSA

I think I heard that you said the fiber to home business or sales into that type of market were less than expected or a negative offset. Can you just talk about what's going on in that market, how it's being affected by the economy and how it could play out into next year from what you're hearing from the carriers?

Jim Flaws

Well, for fiber to the home what we're seeing is more of a slowdown in some of the major projects around the world. Some of it's inventory correction at those carriers where fiber to the home is well established and just how they're managing their projects, but in Europe we're seeing a little bit more of a slowdown versus what we expected. And I think that's driven by a combination of regulatory debate and just timing on more full commitments from some of the major players there.

Steven Fox - CLSA

So does that make you more cautious about that market for next year at this point?

Jim Flaws

I would say it's too early for us to comment on Telecom next year. Telecom tends to be a business that is going to lag into any slowdown and lag out of any slowdown because of the difficulty and complexity of the civil works projects. I think it makes it not react one for one with the economy in the same timeframe.

I think the real news on Telecom this year is we predicted it to be down in the double digits, and around that world that's been pretty true with the exception of China, which has just been on fire. So China's really offset especially Europe, which is a little slower than what we thought, and we expect China demand to continue into the early part of next year, so that's good.

Operator

Your next question comes from Jim Suva - Citigroup.

Jim Suva - Citigroup

Just to help us clarify - and I've got a couple of questions from investors on this - as you talk about how the panel makers are going to fluctuate their production, you know, seasonally down in Q4 and down in Q1, then up in Q2, when I look at your inventory, which was down this quarter about 4.5% and you talk about some production issues because of the earthquake and the power outage, it looks like you indeed do need to rebuild inventory. Can you help us figure out or understand your production Q4/Q1 levels? It looks like you would probably have to run a little bit more output relative to the panel makers just to rebuild inventory. Is that the best way to think of it?

Jim Flaws

The answer's yes. In Q4 we're going to be running everything we possibly can to meet the demand of the panel makers given the issue we had with the tanks in Taichung. And as I said in my remarks, in Q1 we will likely rebuild inventories in Q1 because we don't have any inventory for all practical purposes in the display business right now. So we will keep our tanks running and build some inventory back to more normalized levels, and we're very comfortable with that given that we have almost none today and obviously we believe Q2 will be very robust demand next year.

Jim Suva - Citigroup

And I thought, though, that you had a couple of comments about Q1 - you may take some off for repairs?

Jim Flaws

No, I said that we have some scheduled for normal repairs, and to a certain degree we almost have tanks every quarter have normal repairs. And what I was commenting was if for some reason we saw something adverse in the marketplace we could just leave them down after the normal repair. But we have no plans to do that.

Jim Suva - Citigroup

A lot of the panel makers have been putting up some panel making production in mainland China. Can you just comment, do you have plans to put up a glass site in China at some point or is just not the supply chain up to speed there as we kind of notice once in awhile when there's a power outage or loss of water or earthquake or something like that, even in more developed countries, you're already starting to have some challenges there, so any thoughts about glass production in mainland China? And what tax rate should we expect for full year 2010?

Wendell Weeks

Let me start with China, and then Jim can address the tax rate question.

So what we've seen is a number of panel maker announcements of doing a panel production site in very large size panel facilities. What we're doing and we've been investigating it for awhile now is we're engaged with the appropriate people in China and our customers working through a decision on what to do about melting in China. Today we currently do glass finishing in China. And we'll work our way through that decision over the coming set of months and come to a decision on if we're going to put melting in China then, if so, where and how that will tie with the various panel production announcements that we've seen around the country.

There aren't particular things about the infrastructure that concern us. We do extensive manufacturing in China in large number of our businesses today, and we feel very confident we've had the ability to do that in LCD as well.

Jim Suva - Citigroup

And then on the tax rate for 2010.

Jim Flaws

The tax rate for 2010 we expect to be just slightly below 10%, but that is very dependent on what Congress does on the tax extenders bill. If they were to pass a tax extenders bill, it could be a lower rate than that, but obviously it's very difficult to forecast whether that's going to happen or not. So as soon as we know more about that we'll let you know, but if they don't pass it, it'll be slightly under 10%.

Operator

Your next question comes from Simona Jankowski - Goldman Sachs.

Simona Jankowski - Goldman Sachs

I just wanted to make sure I heard you correctly when you said that you think panel makers outside Korea may bring down utilization to about 70%. I believe they've guided to 90% in the fourth quarter, so I just wanted to see if your comment was more about a point in time and how you'd reconcile those two?

Jim Flaws

So that would be our point of view as we are exiting the fourth quarter. I'm not talking about the fourth quarter as an average. I'll say it again - that's our point of view; it's not what the panel makers are saying. It's just what our belief is likely to occur.

Simona Jankowski - Goldman Sachs

And so if it weren't to occur then you would presumably think that inventories could exit higher in Q4 than what you're foreseeing right now?

Jim Flaws

Well, I think it would depend on what their reason was for doing that and whether they felt that their inventories were too low or what retail demand was. The absolute math is yes; if we're right on demand they run more than what we said then there would be some more inventory.

Wendell Weeks

At this time we're expecting the overall supply chain inventory in glass to drop between the end of quarter three and the end of quarter four, so the dialogue around which panel makers run at what utilization, it's main impact will be around how much is that supply chain reduced overall. We would like it to end a little lower because Q1 tends to be a seasonally low demand quarter.

Simona Jankowski - Goldman Sachs

Okay, and then just a couple of quick questions on the Specialty Materials business. I saw very nice growth there of about 27% sequentially, but net losses were flat. I just wanted to see if you can comment on what it would take for profitability there to improve. And then looking into the fourth quarter, you're guiding that business down slightly. I would have thought that would be an ongoing very significant upturn in the semiconductor equipment cycle in addition to the real glass uptake you would see sequential growth in Q4 again.

Wendell Weeks

For us what will move the profitability, we have a mix affect going on with a positive push from Gorilla but still negative from the very low utilization in our semiconductor optics plants. Even with an uptick in semiconductor demand, remember there is a significant gap in time between equipment demand and uptick in actual semiconductor sales.

Operator

Your next question comes from Jeff Evanson - Sanford Bernstein.

Jeff Evanson - Sanford Bernstein

Looking forward to 2010, wondering how you think your growth might compare to the overall market in glass. And what I'm wondering is given the production issues that you've had outside of Korea over the last couple of months, it's probably fair to say you've lost a little bit of share. I'm wondering if you could get that back next year?

Wendell Weeks

What typically happens in this market is that share losses that come from events like we've been experiencing tend to be pretty temporary in nature. That's one of the reasons why, despite an expectation of the market to be sort of flat to down slightly in quarter four, we originally expected to be up versus that market, up as much as 5%. And that is because in quarter three we would have had a drag from our inability to supply our customers everything that they wanted.

So that has been our experience in the business. We would hope that that experience would extend into the future and that, as some of our production issues come under control, that we'll be able to relatively quickly recapture our position in the marketplace.

Jeff Evanson - Sanford Bernstein

You had some strength in private networks in the Telecom business. I'm wondering if you could give us some color on what applications that went into and how your Multimode ClearCurve is doing.

Wendell Weeks

Well, I think in a way your second part of the question helps address the first, which is we saw it in some major data centers and also we're seeing some great pull for us for our brand-new product suite that's enabled by the ClearCurve Multimode fiber. We call this product suite the Landscape [Preterminated] Solution, and demand there has been very strong. And we're seeing the value prop really hold up, up to 35% faster deployment, 25% faster moves, and about 100% more density than traditional preterminated solutions. So we're very happy with how that's going.

And the private networks business did a little better this year than what we'd thought going in, and we're pleased to see that resilience.

Operator

Your next question comes from Nikos Theodosopoulos - UBS.

Nikos Theodosopoulos - UBS

Just a clarification on the LCD gross margin - it looked like it was up sequentially if I strip out this accelerated depreciation charge. Is that correct?

Jim Flaws

I'll have to check, Nikos. I didn't think about it that way. I'll get back with you on it.

Nikos Theodosopoulos - UBS

I guess while you're looking that up, can you give an update on the Gen 10 competitive situation? You're starting to ship now. What's your sense of how you're doing competitively? Are other shipping or do you feel like you're the sole source? Can you give some comments on that?

Wendell Weeks

All along for us in Gen 10 we anticipated that although we would be far and away the majority supplier that we would have some alternative suppliers in the supply chain. We see nothing that would have us conclude differently than that original set of assumptions. What we're delighted with is the start up for both ourselves and our customers have been very good and better than actually our previous experience has been on introducing a new generation in Japan.

So we're seeing some of the benefits of the level of integration that we have in Sakai City. It's still early to over conclude from that data that this early experience will continue into the future. But we feel really good right now about Gen 10, and our customer feels very good about the way in which this new integrated facility is working.

Jim Flaws

To answer your question, gross margin was up slightly without the accelerated depreciation.

Nikos Theodosopoulos - UBS

And just one last one on gross margin. Do you have the SCP gross margin? I know last quarter there was a phenomenonal gross margin. I'm just curious what happened this quarter.

Jim Flaws

I don't have it in front of me, but it was phenomenonal again.

Operator

Your next question comes from Carter Shoop - Deutsche Bank Securities.

Carter Shoop - Deutsche Bank Securities

A quick question here on overall outlook for glass in 2010. You're looking for 15% growth. I was hoping you could give us a little commentary in regards to where you see the most risk to that number, both on the upside and the downside. Where can you be wrong here?

Jim Flaws

We've proven we can be wrong just about everywhere. I think we feel probably the least risk about television. Obviously, we're looking for IP growth next year, and we could be wrong about that. I mean, it could be that IT doesn't grow as much, so I would say there's more risk in IT than there is in television. And then the other place, when we give you the glass market we obviously are making an assumption about what the supply chain will do cumulatively on inventories for the year, and therefore what they'd be exiting 2010 looking into 2011.

So I think in terms of impact on our 15% assumption, that's where we could have the most variability; second-most would be IT and then last would be television.

Wendell Weeks

I'd echo what Jim is saying. I think one of the most interesting things about this year is in the face of the strong economic headwinds that the business continued to perform and grow very strongly, so we feel pretty good about that. And the top issue tends to be how does the supply chain interact and how does that cycle through the year as well as regional dynamics, so I would echo what Jim says.

Carter Shoop - Deutsche Bank Securities

When we think about panel capacity growth next year, 15% glass [growth], what do you have looking capacity growth next year?

Wendell Weeks

Where panel capacity starts out, we think they have today enough panel capacity to meet demands next year, and there are some additional panel capacity going up.

Jim, would you like to add anything to that?

Jim Flaws

We think it's going to grow again next year probably greater than our 15% slightly. But, again, there's always a difference between what people put the capacity in place and then how much they run it. And so I think clearly there are some new plants coming up next year.

Carter Shoop - Deutsche Bank Securities

Moving to ASPs, it sounds like, given your gross margin commentary for 1Q in Display, you're not expecting ASPs to come under too much pressure on the glass side. What about for the full year for 2010? I know you don't want to give formal guidance, but could we think about kind of a normal year in regards to ASP declines in 2010 being in kind of the mid to high single digits? Is that a reasonable assumption?

Wendell Weeks

I'm not going to give pricing guidance for next year. Obviously, it's our hope that we have very overall moderate price declines and that we're able to recover that through our own cost reduction.

Carter Shoop - Deutsche Bank Securities

On Taiwan, can we talk about utilization rates there, if you could kind of walk though where you think utilization rates were in 3Q, where you see them exiting 4Q and possibly where you see them exiting 1Q?

Jim Flaws

Are you talking about for panel makers?

Carter Shoop - Deutsche Bank Securities

Yes, panel makers utilization.

Jim Flaws

That's way too specific for this call. I think they've been running relatively full in Q3. We expect at the end of Q4 that there'll be reductions, not through all of Q4. We expect them to stay down for part of Q1, and then as they exit Q1 we expect them to be ramping up. But I'm not going to give you specific numbers month by month.

Carter Shoop - Deutsche Bank Securities

This last question might be a little too detailed also, but I'm going to give it a shot. Just on Dow Corning, as it becomes a relative large portion of the earnings here I was hoping to get a little bit more color in regards to the earnings breakout in regards to Hemlock versus the Dow Corning segment of the business. Do you have a sense on the earnings contribution there in the most recent quarter?

Wendell Weeks

I do, but we're not giving out that detail. What we've said in the past is Hemlock is extraordinarily profitable, and it's much closer to Display than it is to Telecom, so that's the way you ought to think about it. But other than that we don't give out details.

Operator

Your next question comes from Brendan Furlong - Miller Tabak & Co., LLC.

Brendan Furlong - Miller Tabak & Co., LLC

Looking into 2010, with your exposure to Taiwanese guys who have consequent exposure to the Chinese TV manufacturers, is it a reasonable assumption to think that you will outgrow your 15% volume growth, the industry volume growth, next year?

Jim Flaws

Regional mix is probably the hardest thing to call, so I think what is the most reliable is, given your assumptions around market growth, is that together between our joint venture in Korea, Samsung Corning Precision and our wholly owned operations in Taiwan, Japan, and mainland China, that we will perform with the market barring any minor shamoos one or the other.

Calling down at the next level of detail how much flows in a given region has proven to be too challenging for us to do consistently and well because it goes directly to our customers strategies, how they choose to run, what they're choosing to invest, how their brand performance goes. So it's just a little too tough for us to call with any great degree of precision. We'll comment on our beliefs about that as we roll into the beginning of the year next year in our normal analyst discussions in February.

Brendan Furlong - Miller Tabak & Co., LLC

Okay, a quick follow on from that one down to your 20% TV growth for next year, what are you expecting the Chinese TV market to grow at within that?

Jim Flaws

We're looking for China to probably grow close to 50%.

Brendan Furlong - Miller Tabak & Co., LLC

My last question is on Q4, the Telecom segment, the 15% decline, is the majority of that decline coming out of the fiber segment?

Wendell Weeks

This follows our normal seasonality. For us in that business always quarter four tends to be a little bit lower, but I wouldn't say that fiber is down more than our cable systems business is. Because of the strong exposure in China I'd say fiber will be down a little bit less.

Operator

Your next question comes from John Roberts - Buckingham Research.

John Roberts - Buckingham Research

Update us on your plans to make thin film solar substrate on some of the LCD capacity.

Wendell Weeks

So our solar project aimed at introducing a competitively advantaged substrate or superstrate for the various thin film solar production techniques continues to do very well versus our internal milestones. Laboratory level testing continues to reinforce our hypothesis that we have some innovations that can increase the conversion efficiency of thin film technology. And, once again, laboratory experiments continue to confirm our assumption that we could make thin glasses be incredibly durable and withstand the various significant testing that they must for a solar plant's lifetime.

So we continue to be encouraged by our progress in this program and, as we continue to make notable progress, within the confines of our confidentiality agreements we will make sure we share that with you.

John Roberts - Buckingham Research

And secondly, should we think about the automotive environmental technology segment being more levered to U.S./European production or to global production? It sounds like your comments really track more the U.S./European post-clunkers program whereas the global numbers are a lot more stable, I think.

Jim Flaws

The only thing you're leaving out - you're leaving out Japan, Korea and China. China's very robust for us right now. We do well in Korea; Japan, I think, has always been our weakest market. So I think we've seen consistently strong demand in China, so our comments about the up and then down has been more related to what's happening with the impact of the incentive programs in the United States and Europe.

Wendell Weeks

Yes, I'd echo that. It's the sequentials is where you get caught up in the Europe and U.S. piece, but our overall footprint here is exactly as Jim has described it.

Operator

Your next question comes from Vijay Rakesh - Thinkpanmure LLC.

Vijay Rakesh - Thinkpanmure LLC

Looking out into the first quarter, I know you mentioned you needed to build back some inventory, but that combined with the fact that panel guys probably reduced their [inaudible] 70% exiting Q4, which is that [inaudible] in 1Q. Do you think net-net is it fair to assume that volumes probably, glass volumes probably still come down into 1Q for you seasonally?

Jim Flaws

Yes.

Vijay Rakesh - Thinkpanmure LLC

And just big picture, looking at 2010 on the glass supply side, this year we had earthquakes in Japan. You had a pretty nice stimulus in China and a [inaudible] here, so glass pricing has been pretty firm. Next year should it be more kind of in balance on the supply demand side?

Wendell Weeks

I'm not sure I follow your question.

Vijay Rakesh - Thinkpanmure LLC

I was wondering does glass pricing come back into more normal trends next year versus this year when glass pricing has been flat to up mostly through the year.

Wendell Weeks

Glass pricing this year was down dramatically in the first quarter, down a little bit less in Q2, and then no declines in Q3 and Q4. We're not giving guidance for next year, but our hope for this industry over the long term is that we have moderate price declines year in, year out.

Operator

Your next question comes from Brian White - [Unidentified Firm].

Brian White - Unidentified Firm

Just another question on glass pricing. When we look into fourth quarter, utilization rates are coming down. I think the panel makers have definitely taken a turn for the worse more recently, and their prices are coming down. So why do you think pricing for glass will be flat in the fourth quarter?

Jim Flaws

Because that's what we've negotiated with our customers already.

Brian White - Unidentified Firm

Okay, so negotiation for the fourth quarter is already finished?

Jim Flaws

Yes.

Brian White - Unidentified Firm

And then just back to China. What type of lead time do you need to build fabs in China, and are there any local competitors we should be aware of?

Wendell Weeks

We know of a number of players who are trying to enter the LCD glass market in China. So far we have not seen any strong progress for many of them. We currently do finishing of LCD glass in China ourselves.

So as far as the timeline, it's a little too early for us to talk about that. A lot depends on the scale of what we would do, so what we first have to do is decide sort of whether we're going to put glass melting there, then where and how much, and then we'll be able to provide a little bit better guidance on timeframe.

I'd note it is a relative long period of time. This isn't something that's going to sneak up on us or our investors. It takes a good amount of time to build a productive glass plant.

Brian White - Unidentified Firm

And if you wanted to, could you transfer equipment over to China from other sites in Taiwan, Japan, Korea?

Wendell Weeks

Sure.

Operator

Your next question comes from Yair Reiner - Oppenheimer & Co.

Yair Reiner - Oppenheimer & Co.

Yes, I want to give a try to a question that was asked previously. Obviously, over the course of 2009 there's been a big discrepancy in utilization between Korea and Taiwan. It seems like some of the underlying factors of that in terms of FX are beginning to reverse. One look at 2010, I mean, should we be expecting some kind of convergence in Korean and Taiwanese utilization rates?

Wendell Weeks

Once again, we think that in many ways is one of the hardest things to predict. We tend to think of that as our regional mix, and the level of competition and the complexity of that competition makes it incredibly hard to predict.

You're right; to the extent that the FX advantage, the yuan is diminished, that will help other players around the world. But note also in Korea you have relatively strong brand alliances, which is also a factor.

So very difficult to predict. I think you're thinking about it directionally in the right way, but I would not over conclude.

Yair Reiner - Oppenheimer & Co.

It seems as though LG and AUO both forecast some growth in their shipments for the fourth quarter. You indicated that you thought that shipments for the industry would be flattish. Do you think that what they're seeing is some share gains relative to smaller players or what else might explain the delta between your view and their view of the market in the fourth quarter?

Wendell Weeks

Relatively consistently we find differences between what specific panel makers predict and what we predict. Some of this has to do with the level in the supply chain and timing of how long it takes them to take our product and turn it and transform it into a finished panel. Some of it has to do with individual beliefs about relative share. Some of it has to do with differing individual beliefs about the end market.

By and large we have found it to be a relatively fruitless exercise to try to directly correlate with each of the individual players. Instead, we manage our capacity around our view of the end market, and that has proven to be at least as good as anybody else's view though far from perfect.

Ken Sofio

Operator, we're running a little over. Let's just do one more phone call.

Operator

Certainly. Your last question comes from Ajit Pai - Thomas Weisel Partners.

Ajit Pai - Thomas Weisel Partners

Two questions. The first is, just looking at your revenue mix, I think right now from a long-term perspective in Display you've said that you expect the two businesses, the consolidated and then Samsung Corning, position to be about the same size. In this quarter you reported I think almost 50% higher revenues from the Korean operations. So on a go forward basis, do you expect the current scenario to stay there?

And also just a better understanding of the manner in which you recognize revenue. It's still the case where the revenue is recognized not where you produce the glass, in what geography, but where it's sold, so we'd just like some color on that.

Jim Flaws

I think we said for many years despite our thinking it would be different that our wholly owned in Korea turned out to be relatively equal. But that clearly has been tilted now with what happened really post the first half of 2008, where the Korean panel makers carried through the recession much stronger than what happened to the panel makers our wholly owned business provided. So we have not said for a long period of time now over the year that we would expect them to be relatively equal.

As Wendell said, we have a hard time predicting exactly what the balance will be going forward, and that will get exacerbated over the next few years by what decisions are made in China. But we no longer are saying they're going to be equal.

I'm not sure I understood your second question.

Ajit Pai - Thomas Weisel Partners

Which is that the manner in which you recognize revenues for the two, for consolidated and for the Samsung Corning Precision, is not on where you produce the glass but more on where you sell it, the customer you sell it to. Is that still the case?

Jim Flaws

You recognize the revenues by the entity that sells it to the customer, so if we sell in Taiwan and that glass came to us from Korea, Korea would sell it to our entity in Taiwan and then we'd recognize it in Taiwan. Does that help answer your question?

Ajit Pai - Thomas Weisel Partners

So it would be recognized - if you sell it to Taiwan but the glass came from Korea it would be recognized as part of the consolidated sales?

Jim Flaws

That's correct.

Ajit Pai - Thomas Weisel Partners

And then the second question is just on the M&A front. You've said that you were looking at acquisitions quite actively in the middle of the year, and you've made your first material acquisition. Are you still active in looking at further traditional acquisitions right now, and could you give us some color on how rich the pipeline is?

Jim Flaws

As we said earlier this year, we've definitely turned our sites to supplement our organic growth with growth from acquisitions, and we are continuing to focus on that. But you shouldn't expect anything imminent.

Ken Sofio

Jim?

Jim Flaws

Just a few wrap up comments related to our Investor Relations program. We'll be in Toronto hosting an investor luncheon on Wednesday, November 5th. Looking out to December, we'll be in New York City hosting investors at a luncheon on Thursday, December 3rd. If you're interested in attending either of those, please contact Ken or Ann. And lastly, we'll be presenting at the Barclays Technology Conference in San Francisco on December 9th, so we hope to see you at one of these events.

Ken?

Ken Sofio

Thank you, Jim. Thank you, Wendell. Thank you all for joining us this morning.

A playback of the call will be available beginning at 10:30 a.m. Eastern Time today. It will run until 5:00 p.m. Eastern Time on Monday, November 9th. To listen, dial 800-475-6701. The access code is 117492. The audiocast is also available on our website during this time.

And that concludes our call today. Please disconnect all lines.

Operator

Thank you.

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