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Corning (NYSE:GLW)

Q4 2013 Earnings Call

January 28, 2014, 8:30 a.m. ET

Executives

Ann Nicholson - Director of Investor Relations

James Flaws - Vice Chairman and Chief Financial Officer

Analysts

Wamsi Mohan - Bank of America Merrill Lynch

Mehdi Hosseini - Susquehanna Financial Group

Mark Sue - RBC Capital Markets

Amitabh Passi - UBS

Brian White - Cantor Fitzgerald

Patrick Newton - Stifel Nicolaus

Steven Fox - Cross Research

Ehud Gelblum - Citigroup

Simona Jankowski - Goldman Sachs

Joseph Wolf - Barclays

Rod Hall - JPMorgan

Operator

Welcome to the Corning Incorporated quarter four 2013 earnings conference call. [Operator instructions.] I would now like to turn the conference over to our host, Division Vice President of Investor Relations, Ms. Ann Nicholson. Please go ahead.

Ann Nicholson

Thank you, operator, and good morning. Welcome to Corning's fourth quarter conference call. With me today is Jim Flaws, vice chairman and chief financial officer. Before we begin our formal comments, I'd like to remind you that today's remarks contain forward-looking statements that fall within the meaning of the Private Securities Litigation Reform Act of 1995. These remarks involve a number of risks, uncertainties, and other factors that could cause actual results to differ materially. These factors are detailed in the company's SEC reports.

You should also note that this presentation contains a number of non-GAAP measures. A reconciliation can be found on our website. Now I’ll turn the call over to Jim.

James Flaws

Thanks, Ann. Good morning everyone. I’d like to begin today by looking back at what we said one year ago. In our January 2013 earnings call, we announced record sales for the fourth quarter 2012 and also for the full year of 2012. But far more importantly, we had reported our quarter four 2012 earnings per share were up year over year.

This was significant, as it marked the first of what has now become five consecutive quarters of year over year earnings growth. Coming into 2013, we told investors we made progress against our goal to [form bottom and march up], but still had work ahead of us. Specifically, our goal was to stabilize display earnings through LCD glass price decline moderation and drive earnings growth with our optical communications, specialty, environmental, and life science segments.

Now, as we look at our 2013 results, we can declare that we achieved our goal. We have formed bottom, and we’ve begun our march up. For the full year, we grew core sales 5%, we improved core gross margin, we reduced operating expense in dollars and as a percentage of sales, we grew our core NPAT at 13%. We retained our strong balance sheet while also returning more cash to shareholders in the form of an 11% dividend increase and execution of $1.5 billion in share repurchases. And aided by those share repurchases, we grew EPS 16%.

We also announced and have now just closed on a fantastic transaction with Samsung for the full ownership of our equity venture SCP. We believe the numerous strategic and financial benefits will strengthen the LCD business, broaden our relationship with Samsung, and provide outstanding returns to shareholders. I’ll be providing some more information on the consolidated NE for your modeling purposes in my outlook section.

I’d like to turn to our quarter four results, beginning with some highlights. Now, as a reminder, we provide core performance results in order to exclude nonperformance related items and increase the transparency of our operating results.

Core financial measures are a non-GAAP financial measure, and we continue to report our GAAP results. You’ll find detailed reconciliations on our website, outlining the differences between these non-GAAP measures and the most directly comparable GAAP measures.

We had a solid quarter that was better than we originally expected. With volume up almost 5% year over year and 2% sequentially, display set a new quarterly record for sales volume. LCD glass price declines were again moderate. LCD glass demand continues to be good, and we believe this is driven by good retail demand in Q4 for larger televisions and expectations for Q1, specifically the Chinese New Year.

In this morning’s press release, we announced that we expect higher price declines in quarter one of 2014 than in previous quarters. I want to be clear here that we believe this is a one-quarter phenomenon that we do not expect to repeat. And I’ll cover this in more detail in the display outlook section.

Optical communications, life sciences, and environmental all performed better for the quarter than we expected, and I’ll get to those details in a minute. Our one miss for the quarter was specialty materials. Gorilla Glass volume was lower than expected by approximately 10% and, along with product mix, reduced specialty materials profitability sequentially. On the other hand, specialty materials full year profits were only down slightly, despite the 13% decrease in year over year sales.

So let’s go to the fourth quarter. Our sales were $2 billion, down slightly versus last year. Gross margin was 40%, lower than our expectation of 42%. Two main factors drove the decreased gross margin. First, lower than expected volume for Gorilla Glass impacted gross margin versus forecast, and second, the additional sales in optical communications were in lower-margin products. And I’ll cover each of these in detail shortly.

SG&A spending was higher year over year, driven mainly by the increased accrual for performance-based compensation. RD&E was down versus a year ago, reflecting our cost control efforts. Other income included a payment for the settlement of a dispute over the use of fusion technology in China. Details can be found on our November 15, 2013 filing.

Gross equity earnings of $121 million were down about 20% year over year, driven by SEP’s year over year price declines on relatively consistent glass volume. And finally, our EPS was $0.29, up $0.01 versus a year ago.

On October 31, we announced a $1 billion accelerated stock repurchase plan, which retired 47 million shares. We also repurchased $75 million of shares under our open market repurchase program during the quarter. So in 2013, in total, we used $1.5 billion of the $2 billion program that we had announced in April. We ended 2013 with 1.401 billion outstanding common shares.

For the year, sales were $7.95 billion, or almost $8 billion, up 5% over 2012. Corporate gross margin was up half a percentage point, driven by improved manufacturing efficiencies in optical communications, specialty materials, and environmental. Additionally LCD glass gross margins were down only slightly, driven by cost reduction programs.

We lowered S&A and R&D for the year in absolute dollars and as a percentage of sales, reflecting our cost control measures. Moving down the income statement, gross equity earnings were down 17%, reflecting the year over year price declines at SEP. Our effective tax rate for the year was 17%.

EPS for the year was $1.23, up 16%. This year over year improvement is the result of our ability to manage spending, improve profitability through manufacturing cost reductions and other programs, and maintain moderate price declines for LCD glass.

Now I’d like to turn to the detailed segment results, and I’ll start with display. Display sales were $665 million in Q4, a 5% decrease versus last year. Sequentially, Corning and SEP’s combined volume was up slightly. Overall, our market share remained stable and LCD glass price declines were moderate.

Gross equity earnings from our equity venture in Korea, SEP, were $85 million in Q4, a decrease of 24% versus last year. In addition to year over year price declines and slightly lower volume, SEP had had a high level sales back to Corning’s base display in Q4 of 2012 that did not repeat in Q4 of 2013. You may recall that our base display and Gorilla businesses were quite full in quarter four of 2012.

Now, for your modeling purposes, display equity affiliates fourth quarter display glass sales were about $522 million, a decrease of 19% from the prior year. As a reminder, this represents SEP’s LCD sales only. Our public filings will report display equity affiliates total sales, which include other products.

Net income was down 1%, reflecting the impact of price declines offsetting higher volume, and year over year cost reductions helped maintain these stable profits. For the year, our wholly owned display segment sales were $2.7 billion, up 7%. Higher volumes more than offset price declines. Net income was up slightly.

Display manufacturing efficiencies were impacted in the first half of the year by air freight costs, but for the full year, manufacturing cost per square foot decreased. The customer agreements that stabilized our share have helped the manufacturing organization manage capacity to demand, and we look forward to the renewed agreements maintaining that stability in 2014.

Now turning to the industry, we estimate the glass market at retail for 2013 was almost 4 billion square feet, up about 10%. Our preliminary estimates of TV sell in indicate year over year unit sales were up slightly. All regions except Europe and Japan grew unit sales year over year. Average TV screen size increased again in 2013, and drove glass market growth. We estimate TV area growth was up more than 10%, and 50 inch televisions grew 90% in 2013.

On the supply chain front, we estimate inventory ended the year at about 17 weeks, and is spread fairly evenly along the supply chain. This is in the range we would consider healthy and reasonable for entering 2014. I’ll talk more about the industry in our outlook shortly.

Now, we’ve renamed our telecommunications segment optical communications. For those of you not familiar with this 40-year-young business, we invented the world’s first low loss optical fiber in 1970. Over the last 40 years, in addition to manufacturing optical fiber and cable, we have increasingly moved into providing optical solutions that include hardware and equipment.

Today, we are a comprehensive provider of industry moving optical solutions across the broader communications industry. The new name better reflects the major communications groups that we serve, carrier, or public, networks, and enterprise, or private, networks. This segment will be classified in those two main categories, carrier networks and enterprise networks, and we’ll be providing more details in the upcoming 10-K.

In optical communications, Q4 sales were $605 million, up 12% versus last year and better than we had expected. Carrier sales in North America drove the increase versus expectations. Net income, however, was down 18%. The primary driver of the decline was product mix, with higher sales volume of lower margin products than in Q4 of 2013. Also contributing to the year over year earnings decline were price declines and our decision to scale back optical fiber production.

For the full year, sales were $2.3 billion, up 9%. Sales in all regions were up year over year. Carrier, including wireless and enterprise sales were both up, offsetting fiber weaknesses in China. We’re very pleased with these results. Optical communications annual net income in 2013 was up 43%. The additional sales volume and manufacturing efficiencies drove the improvement, offsetting the year over year price declines of certain products and the unfavorable mix.

Now in our environmental segment, Q4 sales were $238 million, up 9% versus last year, and better than we had expected. We saw positive indicators in the U.S. heavy duty truck market and European demand for light duty diesel products bounced back a little in the fourth quarter. Net income was up 124% versus a weak fourth quarter last year, driven by volume gains in diesel and auto.

For the full year, environmental sales were down 5%, driven primarily by lower sales of diesel products due to weak demand for diesel cars in Europe and lower class A truck production in North America. Now, despite these lower sales, environmental expanded their gross margins and grew net income by 9% in 2013, due to significant manufacturing efficiency improvements and reductions in operating expense.

We were delighted by the performance in environmental, and believe the business is now well-positioned with its improved margin structure and growth coming from the heavy duty market in China and Europe.

Specialty materials sales for the quarter were down 29% year over year and below our expectations. As you’ll recall, Gorilla Glass sales in Q4 of 2012 were very strong, as device manufacturers prepared for 2013. As 2013 unfolded, it became apparent that some of the 2012 Q4 strength created an inventory overhang that was with us through most of last year.

The softness versus our original expectations down 20% was due primarily to lower volume of Gorilla Glass for touch notebooks. Advanced optics sales were up year over year, driven by a recovery in the semiconductor industry.

Net income in Q4 was down year over year, driven by the volume decline of Gorilla Glass and year over year expected price declines. For the full year, specialty sales were down 13%. The decline was mainly driven by the supply chain overbuild I just described, and also by much lower sales of large cover glass for televisions, which had been about $40 million in 2012, as well as some yield improvements in the supply chain.

We believe consumption of cover glass was up about 27% in 2013, and will be up again in 2014. We expect to see volume growth of Gorilla Glass more in line with consumption in 2014, and we’ll be providing more details at our annual investor meeting on February 7. Advanced optics full year sales were consistent in 2012.

Net income for the full year is a very good story. Gorilla Glass had another year of manufacturing efficiency improvements that led to segment gross margin improvement of 13%. Net income was down only $5 million, or 2%, on 13% sales decline.

Now turning to life sciences, Q4 sales were up year over year due to additional sales from our acquisition, which closed on October 31 of 2012. Net income was up 31% on the additional sales. For the year, life sciences sales were $851 million, up 30%, primarily driven by the Discovery Labware acquisition. Net income was up 92%, driven by the increased volume from the acquisition and very tight control on S&A and RD&E costs.

We were also delighted by life science performance in 2013, with the excellent integration of the acquisition delivering incremental profits, and we accomplished this despite the reduced market due to lower NIH funding.

At Dow Corning, gross equity earnings from the silicone segment were up slightly in Q4, driven by the higher volume and lower taxes. Price and FX partially offset these gains. In 2013, Dow Corning sales were down slightly, driven by price and volume declines, particularly in Europe and China, but their net income and our equity earnings were up slightly for the year, as a result of restructuring actions we took in 2012.

Now, on the balance sheet we ended the fourth quarter with $5.2 billion in cash and short-term investments. We had strong free cash flow for the quarter of about $500 million, despite spending $337 million in capital spending, and also the cash payment made to the minority shareholders for their share of SEP. We were able to complete the buyout of the minority holders in December. The purchase of Samsung shares of SEP occurred in January.

During the quarter, we also issued $250 million of senior unsecured notes. As a reminder, free cash flow is a non-GAAP measure. A reconciliation to GAAP can be found on our website. We ended the quarter with approximately $1.6 billion of cash in the United States.

Capital spending for the year turned out to be only $1 billion and below our forecast. Some expansion projects slowed their pace of spending to meet the expected demand level during the back half of 2013.

So now I’ll go to the outlook, and I’ll start with display. Since we’ll be consolidating SEP, which has now been renamed to be Corning Precision Materials, or CPM, let me begin by how to estimate the impact on the display segment sales and earnings.

We expect approximately $2 billion in additional sales in the display segment this year and next from consolidating 100% of CPM’s LCD glass sales. You should calculate cost of goods sold based on your sales assumption, including depreciation, to get to gross margin. I urge you to remember that CPM did have lower performance in the back half of 2013, so please think about that performance level.

You must add their operating expense to SG&A and R&D. You’ll need to make an estimate of the impact of synergies to both cost of sales and SG&A. Now, we’re just completing the close in Q1, so the synergies in this quarter will be low. We expect them to ramp up rapidly in Q2 and through the remainder of the year. And finally, please remember that CPM will not have the benefit of interest income anymore, due to the dividend strip.

This obviously gets you to net profit before taxes for the display segment. Corning’s overall tax rate will change. Corning’s taxes will now include the taxes paid by CPM in Korea. Expect our total effective tax rate to move from 17% in 2013 to approximately 22% in 2014. We will have amortization of intangibles and goodwill from the acquisition. As with other deals, we record these outside core earnings.

Another area the consolidation impacts is our balance sheet. These changes are pretty straightforward. You need to subtract CPM from our investment balance and add the entity into assets and liabilities.

Finally, there are cash flows. In this case, you need to remember the $98 million cash dividend payment to Samsung, but remember, Corning will also no longer be getting cash dividends from CPM. However, we expect an additional $400 million to $500 million in free cash flow from CPM’s operations.

We’ll be providing detailed pro forma financial statements in March for investors to update their models with this information. Ann and Steven will be happy to answer any modeling questions you have as well.

Now turning to the industry, we feel good about the glass market as we enter 2014. Inventory levels appear healthy, glass supply seems aligned with demand, and we expect another year of glass volume growth at retail. Key contracts we entered into in late 2012 were renewed and extended into 2014. We expect our share to be stable in Q1 and throughout 2014.

Now, for the end market in 2014, we expect the retail market, as measured in square feet of glass, will be up mid to high single-digits. For reference, 2013 was nearly 4 billion square feet. We think LCD television units grow in the low to mid-single digits with area growth likely higher. We believe the trend of consumers to buy large televisions will continue.

We believe there will be PC market growth. We’re expecting 7% to 12% year over year unit growth, with nearly all of it attributable to tablets. Monitor and notebook units are expected to be flat.

As we near the end of January, we see the Q1 LCD glass market declining low single digits sequentially. This reflects normal seasonality and of course the fewer shipping days in February compared to Q4. We expect our glass volume to be down in line with this market.

Recall Q2 is the slowest retail season, so the supply chain should moderate in Q1 to manage inventory. You should note the LCD glass market and our volumes in Q1 are up year over year, reflecting our overall larger market.

Now, we expect price declines in Q1 to be higher than the previous quarters. Recall that we first announced the new contracts in late 2012. They have mechanisms to adjust Corning’s customers in accordance with competitive pricing at that customer. The higher Q1 decline is driven by the price mechanisms in these contracts. We don’t know why the competition did the larger move. We suspect it may be related to compressing price differences among their customers.

We anticipate our price declines will return to more moderate levels after Q1 for several reasons. First, as I mentioned, we suspect the larger decline was related to competitors compressing price differences among their customers.

Second, we believe that if prices were to continue to decline like they are in Q1, our competition would soon be incurring losses. Publicly available information shows our competitors are already operating their businesses with thin margins. Prices can only go down so much further before these competitors will be at or below breakeven.

At those prices, though, Corning’s business would be still quite profitable. Our analysis shows our costs are already lower than our competitors by a substantial percentage, and we anticipate this big cost advantage will only get bigger as we integrate the manufacturing assets of CPM. So even if our competitors were to drop price to where they’d be at or below breakeven, we would still be generating a very healthy profit.

Now, as for our glass capacity, I want to reiterate we intend to diligently manage our capacity to supply. Our new Korean entity, CPM, provides access to low-cost capacity, enabling us to optimize our manufacturing footprint and preserve profitability.

Moving to optical communications, we expect Q1 sales to be up in the mid-teens versus Q1 of 2013. You may recall Q1 of 2013 was a slow start to last year, particularly in North America, Europe, and China, and did not have the sales from consolidation of an equity affiliated acquisition. We expect higher year over year sales in carrier and enterprise in all regions, except China.

In environmental, we expect Q1 sales to be up mid-single digits year over year, driven by the pickup in heavy duty diesel sales due to new regulations in Europe and China. We’re pleased to see this demand from the new regulations, and expect it to drive our growth in heavy duty sales and profitability in 2014. Of course, we’ll have more detail on this segment at our IR day next week.

We expect specialty materials sales to be consistent year over year in Q1. For comparative purposes, specialty materials sales have always been weakest in the first quarter, as you can see in this chart. We do believe Gorilla Glass volume will be up significantly for the year, and better aligned with cover glass consumption. We expect moderate price declines in 2014, similar to 2013.

Although 2013 was not what we expected in terms of sales, we remain excited by what lies ahead for Gorilla Glass. Those of you who went to the Consumer Electronics Show saw firsthand our new product introductions. Our legendary Gorilla Glass is now thinner. It is now available as the world’s first antimicrobial cover glass. It can be antireflective, and also manufactured in 3D shapes is extending in new markets. We will share more details at our investor meeting next week.

In life sciences, we expect sales to be consistent with last year’s first quarter. Equity earnings from Dow Corning should be up for the total year. However, Q1 will be down versus a year ago, because some one-time favorable items that occurred a year ago don’t repeat.

We expect gross margin to be almost 45%, driven by environmental’s additional volume and display. Display gross margins improved versus last year, due to having no air freight costs and of course the consolidation of CPM.

SG&A and R&D will be lower year over year as a percentage of sales. Modeling total equity earnings in Q1 and going forward will be predominantly from Dow Corning equity earnings. Our other equity ventures are relatively small, and do not materially add to our results.

Our effective tax rate for 2014 should be approximately 22%. The projected rate is higher than 2013, driven by the addition of CPM’s income, which is taxed at the Korean tax rate of 24%.

That concludes my opening comments. Ann?

Ann Nicholson

Thank you, Jim. Operator, we’ll now open the lines for questions.

Question-and-Answer Session

Operator

[Operator instructions.] Our first question today comes from the line of Wamsi Mohan with Bank of America.

Wamsi Mohan - Bank of America Merrill Lynch

Jim, you noted that this weaker pricing in Q1 could be temporary, but let’s say that there is irrational behavior in the market and it persists for a little bit longer in the year. Given your comments around what the retail square footage growth is, is it reasonable to assume a base case that display revenue would actually contract in 2014?

James Flaws

It obviously depends on whether the higher price declines continue all year long. So you can do the math as well as I can. I mean, you can make that case, but I emphasize again we believe that price declines will return to more moderate levels in Q2 and beyond.

Wamsi Mohan - Bank of America Merrill Lynch

But given the fact that the retail square footage is going to expand in the mid to high single digits, even if we go to traditional price declines of high single digit, we’re talking about roughly flattish. Is that right?

James Flaws

It’s very possible that’s how the math would work.

Wamsi Mohan - Bank of America Merrill Lynch

And as a quick follow up, can you address the weaker performance in specialty? Do you think the issue is anything unrelated to inventory? Can you maybe answer that in light of your competitive glass in sapphires and alternative materials?

James Flaws

We believe that specialty materials results, first in Q4 were weaker than our original expectations, because of touch on notebook missed our goal. Everything else was in line with what we expected. We believe we’ve been dealing with this supply chain issue that occurred in the fourth quarter of 2012 all year long. We think we’re done with that.

We do not feel we are losing market share to other aluminosilicate high performance glasses in any material amount. We do at lower end, items compete with soda lime, and we have yet to see any evidence of sapphire on any devices. So again, the performance last year we attribute to this carryover of a large amount of square feet in the supply chain and then second, the fact that touch on notebooks did not grow against our expectations.

Operator

The next question today comes from the line of Mehdi Hosseini with SIG.

Mehdi Hosseini - Susquehanna Financial Group

Jim, just a clarification. Did you say that on square foot, the TV application grew 10%, and this year it’s going to grow by 5%? Did I hear that right?

James Flaws

I said that TV area growth grew 10% last year, and that area growth this year could approach that number.

Mehdi Hosseini - Susquehanna Financial Group

And then for just overall glass consumption, how is the TV mix in ’13 going to look in ’14?

James Flaws

Televisions are in the low 60% range of total glass used.

Mehdi Hosseini - Susquehanna Financial Group

But no change from ’13 to ’14?

James Flaws

Nothing significant.

Mehdi Hosseini - Susquehanna Financial Group

And then one last question on the specialty material. Can you help me understand the mix of Gorilla as a percentage of overall specialty material, and how is that mix going to change in ’14?

James Flaws

I don’t have the number handy, but Gorilla Glass will grow as a percentage of overall specialty materials. And you can check in with Ann later if you want. She can get you the exact number.

Operator

The next question will come from Mark Sue with RBC Capital Markets.

Mark Sue - RBC Capital Markets

The working presumption when the pricing was adjusted for market share about a year ago was that the rational behavior should prevail. Yet when we see these pricing mechanisms kick in as competitors compress price, just wondering, recognizing that Corning’s [fiduciary] is to shareholders and your commitments to profitability and margins, you’re also competing with companies who seem more focused on employment and just kind of running the business, as opposed to profit. So is there any further thought that they will revert back to what is more normal in terms of pricing?

James Flaws

I want to be careful about commenting too much on our competitors, but I will draw your attention to the fact that after we put these agreements in, we announced them in October of 2012, we had a period of time where moderate price declines happened quarter after quarter.

We obviously can never know for sure what our competitors are doing and why, but as I outlined in my prepared comments, we suspect that they may have had a compression issue that they had to deal with between some of their customers, and that may have led them to make this larger decline in this quarter.

I can’t comment beyond that on our competitors’ motivations and what they’re intending to do. I can only point you to the fact that basically in the four quarters prior, of 2013, we had moderate price declines.

Mark Sue - RBC Capital Markets

And then maybe on capex, you underspent in capex in 2013. How should we recalibrate your assumptions for 2014? And along those lines, as we look for growth opportunities ahead, can you just talk about maybe what would be the new thing we should be looking for? Maybe touch notebooks? Automobile applications such as the BMW i8? What do you see kind of percolating for higher demand in the next few years?

James Flaws

Let me talk about capex. We had previously given guidance for 2014 of $1.3 billion. The lower spending in 2013 will not add to that. So the only thing that would add to it is CPM, which I think we’ve told you before would be about $200 million. So our guidance is $1.5 billion for 2014. There’s no carryover that’s going to affect and drive the number up, because we underspent last year.

As far as growth prospects going forward, I’d like to just reserve on that, because in about 10 days’ time, you’ll have an opportunity to see what we’re talking about in terms of growth. And actually, the whole theme of our investor relations day is about growing the company.

We, as I said in my opening remarks, feel like we’ve achieved our primary objective over the past year, which was to stop going down and start growing up. We’ve done that. But the key to us growing further is going to grow sales, and that will be a theme of the day, and we hope you’ll be able to attend.

Operator

The next question comes from the line of Amitabh Passi with UBS.

Amitabh Passi - UBS

A couple from me. Jim, I wanted to clarify the gross margin guidance of 45%, was that for the full year, or just the first calendar quarter?

James Flaws

That was for the first calendar quarter.

Amitabh Passi - UBS

And then any help in terms of how we should be thinking about your synergy expectations and how they flow through the year? I know you put out a schedule when you did the transaction. Are those numbers still reasonably accurate? Or can you give us any guidance in terms of the quarter to quarter progression on the synergy front?

James Flaws

The numbers overall are pretty accurate. And you’re not going to get much of it in Q1. I would say you take the amount we gave you and then divide it by three quarters. Q2 would probably be a little less than that, and then Q3 and Q4 will be in full bloom on that. And the CFO of the display sector yesterday that he’s prepared to report out on synergies to investors as we go along, he’s so confident. So we’ll be able to do that for you.

Amitabh Passi - UBS

And then just finally, assuming glass revenues for the display segment are relatively consistent this year, in 2013, given your commentary on synergies, is there still the potential to drive net income higher in 2014, given that we assume a flat to moderately really down sales scenario?

James Flaws

Sure, we’re still backing what we said in October, that we believe we can drive the fully diluted EPS for the company up 20% this year.

Operator

Our next question comes from the line of Brian White from Cantor Fitzgerald.

Brian White - Cantor Fitzgerald

I’m wondering if you could talk a little bit about 4K TVs, curved TVs, kind of what you think it means to the TV market over the next couple of years. And also, some of the antimicrobial glass, what does that mean to Gorilla in terms of margins, upgrades, so on and so forth? Because I think there’s obviously big demand for that type of product.

James Flaws

On antimicrobial, we believe it enhances the results of Gorilla. We have not detailed yet the pricing of it, and the impact, but we believe it will enhance it. The key for us is obviously getting our first customer on a mobile device. We have our first customer, as we showed at CES, already, which is Steelcase, which are using it on their little LCD panels they have for offices. But we need to get a cell phone. But we believe it will be an enhancer over time, and we’re quite delighted by that.

Relative to television demand, we think ultra high definition will be a driver of replacement rate, but the pace of it we’re a little unsure of right now. We think it’s important. Curved TVs, it’s perhaps a little bit in the eye of the beholder. For some people, I think that that will be a reason that they would want to purchase a new television. For us, it doesn’t make any difference. The glass in the curved large televisions is the same as our normal glass. But again, at our IR day, we’re going to talk about how we see the replacement rate and the impact on the growth in televisions going forward.

I would say that our observation is, ultra high definition is going to ultimately be a big driver of replacement rate, but the pace at which it happens is a little unclear to us now.

Operator

Our next question is from the line of Patrick Newton with Stifel.

Patrick Newton - Stifel Nicolaus

I guess my first one for Jim, you discussed Gorilla Glass and its expectations, almost entirely due to touch on notebook in 4q. And touch on notebook largely disappointed as we moved through 2014. So I’m curious if you could comment on why touch on notebook missed expectations. Is it lack of penetration in touch SKUs relative to what you were hoping for? Is it sell through that was soft? Is it overall consumers actually have a preference towards tablets rather than touch on notebook? What is that dynamic? And they how do you expect that to change as we move into 2014?

James Flaws

I guess it’s a lot of all of the above. Touch on notebooks has not grown as rapidly as we had hoped, and I think as the industry hopes. The detachables clearly have not turned out to be a very big part of the market. So that’s been a disappointment. Our own forecasts are that it will grow this upcoming year.

And then the other thing that we’re experiencing, particular to us, on particularly low-end clamshell notebooks, is we’re having to compete with soda lime. This is not with other aluminosilicate glasses. And that’s clearly a challenge for us, and we’re working on a solution to it. But I think overall the biggest thrust of this has been the disappointing take rate of touch on notebooks by consumers.

Patrick Newton - Stifel Nicolaus

And then a few quarters ago you discussed LG10 and talked about perhaps the second tank being a 2014 event, and that you did not see them as a significant supplier in the industry. And I was just wondering if you could update us as to your expectations on a review of LG10 as a competitor, especially as we move through 2014.

James Flaws

We do not feel LG10 is a significant competitor at all. Our observation, obviously based on publicly available data and looking from outside the gate, is that the second tank is not lit and is likely to be a year later than they originally planned.

Patrick Newton - Stifel Nicolaus

And just one clarification on your tax rate. If I look at your corporate tax rate for 2013, and we incorporate the SEP 24% tax rate, to get to that 22% tax rate guidance, it would either imply that your core tax rate is increasing somewhat substantially year over year, or that SEP earnings are going to accelerate. Are one of those two a fair assumption?

James Flaws

There’s always things going on in our tax rate that we get some benefits, some things that may not repeat the next year, but I’m going to be addressing the tax rate in more detail at the IR event, so I’ll try to answer it more specifically then.

Operator

Our next question is from the line of Steven Fox with Cross Research.

Steven Fox - Cross Research

Just a couple of questions on Gorilla Glass for me. First, I know you want to save some stuff for the analyst day, but relative to the types of consumption growth of 27% that you talked about, what kind of growth are you looking for 2014? And without putting a number on it, can you talk qualitatively where you think things are better or worse?

And then secondly, where are we at with potential further improvements in Gorilla Glass margins? Have you optimized those exiting the year? And then lastly, just one minor detail, is Gorilla Glass going to remain as part of specialty materials going forward? Or would there be a reorg coming with the SEP deal?

James Flaws

There’s no reorganization coming. Gorilla remains in specialty materials, which remains part of our Corning Glass Technologies Group, which is led by Jim [Clapton]. So no change on reorganization.

I expect our Gorilla Glass shipments, in terms of volume, to be up at least 30%, maybe a little bit higher than that, this upcoming year. And I didn’t quite catch your second question on gross margin?

Steven Fox - Cross Research

I know margins on Gorilla Glass have been improving during the year. Is there still more room to improve margins off of that type of volume? Or how optimized are Gorilla Glass margins at this point?

James Flaws

There’s fundamentally more opportunity to improve the gross margin. One of the most exciting things I think about the acquisition of CPM is that we have traditionally made some of our Gorilla Glass on some of our older tanks, and as you know, CPM had some low-cost tanks that were available, so Gorilla can be made there. So we clearly think we can improve margins on Gorilla going forward.

Operator

The next question is from the line of Ehud Gelblum with Citigroup.

Ehud Gelblum - Citigroup

First of all, a clarification. There was a $338 million other income in the P&L, much larger than last quarter. And you’d mentioned something about a settlement in China that I missed. Are they related? And can you just go over again what that settlement from China was, and was that what drove that $338 million?

James Flaws

The $338 million you’re referring to is our GAAP numbers. That’s where the FX hedge has to be. Remember, what we did with core earnings is we do it flat at the 93.5 yen exchange rate. Our hedge really, because the yen has moved up so much, we actually have a big gain on the hedge that we have to mark to market. You’ll see fluctuations on that. We do that in the GAAP. So that’s what’s in the GAAP numbers. You’ve got to look at the other income and expense under core.

But in core, we actually had some other income, other expense, as we call that line. We did have some favorable items in that this quarter. Principally, it was a settlement that we reached on an intellectual property dispute in China, and I think we outlined some of the details of that back in November.

Ehud Gelblum - Citigroup

Do we have a size on how large that was?

James Flaws

I don’t think we’ve disclosed that yet.

Ehud Gelblum - Citigroup

Back to the price declines in Q1, competitive, what is the mechanism for you to learn of this? Do your customers, because you have these contracts with all your customers, is it that on November 30, one of them comes to you and says, hey, this is the price I’m getting, you need to match it? Do they all come to you? At what point did you learn about this? And can you give us a sense as to, magnitude-wise, how much larger than the normal moderate price declines should we expect Q1 to be?

James Flaws

First, we don’t have these contracts at all our customers. We only have them at several. The way the contracts work, which is what we talked about back in the fall of 2012, is that at the end of the quarter, and I really mean the end of the quarter, our customers who have these contracts are required to tell us what the price that they got from competitors, through a mechanism at that customer. When they do that, then that becomes potentially our price under this contract. And we have chosen to operate that way with these contracts and renew them. So that’s how it happens. So it happens literally at the end of the quarter. Relative to the level that we’re seeing this upcoming quarter, I would say it’s probably about double what we’ve been seeing.

Ehud Gelblum - Citigroup

And remind me again, if customer A comes to you and tells you that they got a price lower than what you’ve been giving them, the contract implies that you must match that at that customer. Do you then have to take that to customers B, C, and D that are under these same contracts, and offer that same price, even if they hadn’t been offered that by your competitor?

James Flaws

No, it’s very specific. The price at the customers who have this contract, it is set by this relationship at that customer.

Ehud Gelblum - Citigroup

And can we infer, then, that therefore this price reset that is causing the lower price only happened at several customers and not at all customers that had the contract?

James Flaws

I’m not going to say anything further about where it occurred.

Ehud Gelblum - Citigroup

[NEG] seems to be adding capacity in China and opening up a new plant there. Is that something that you’re factoring into your numbers? And finally, I have a final question on notebooks and [NBT].

James Flaws

Relative to NEG, the announcement on Friday of them building melting capacity, it’s our understanding from the public statements as well as what we’ve seen in analyst’s reports, that they’re going to be adding capacity, which is similar in size to what they added in Korea. The public statements and also what has been reported by analysts is similar to what they did in Korea, that they’ll be taking Japanese capacity offline and transferring equipment.

We don’t believe this new capacity, based on what we’ve seen, shows up in China for I think 2015 and 2016. And we think it’s similar in size, as I said, to Korea. So we’re not anticipating much impact of this short term. We believe that NEG would have been supplying China from their Japanese capacity and then as this new capacity comes up, obviously with transferred equipment, that some of the Japanese capacity goes down.

It’s pretty obvious to us that NEG, over the last few years, has moved from being an all-Japan model to having dispersed their capacity closer to their customers and perhaps away from earthquake zones. So it seems rational to us.

Ehud Gelblum - Citigroup

And then finally, on touch notebooks, a target that you had several times during the year, and I think you were going to exit the year at 10% - not that you would exit the year 10%, but that 10% of notebooks would be touch exiting the year - it sounds like now you think that was a lower number. How much lower do you think it was? And do you have some sort of a target that you’re looking for in 2014?

And you mentioned soda lime. As we go into Best Buy and you see pretty much almost all notebooks seem to have touch now, maybe they have soda lime. It’s hard to tell. But how does your [NBT], that was basically supposed to compete with soda lime and the price point, how is that competing. Just trying to differentiate the market versus your competitive offering.

James Flaws

I don’t have much information right now about NBT. If you come to the investor day, you can talk to Jim Steiner. He can give you an update on how it’s going. I think overall the year, touch on notebook was 11%. I think in the fourth quarter we estimated it was at 13%.

Operator

Next we’ll go to the line of Simona Jankowski with Goldman Sachs.

Simona Jankowski - Goldman Sachs

Just one more question on the pricing. What is the incentive for competitors to lower the price when you’re contractually locked into a certain market share? Or is that just a play to try to take share between the three suppliers? And I just want to clarify the pricing reset was just at one customer, or several?

James Flaws

We have not commented on the number of customers. It occurred at the customers we have the contracts with. In terms of the incentive, I can’t really comment on motivations by our competitors. The one that you talk about is obviously something that could have occurred, but I can’t know for sure what our competitors are doing and why.

Simona Jankowski - Goldman Sachs

And then I just wanted to ask a little bit about your assumptions for the markets for this year. It sounded like you’re assuming flat PC growth outside of tablets, and given that PCs have been declining, I was just curious why you’d think that that improved this year. And then on the TV side, what are you seeing in the supply chain as we approach the World Cup? And is that historically the kind of event that has any impact on TV demand?

James Flaws

I’ll deal with the latter first. Sporting events do provide some increase in the television markets. We have seen that historically with World Cups, as well as Summer Olympics. One issue that we see is that often the impact on television consumption is higher, but less than what investors want it to be. We expect to see a similar phenomenon for the World Cup that occurs in the middle of this year.

I don’t have the PC demand with me, but we think tablets are providing, I think, most of the growth for this year, and that we’ve got, I think the notebooks, we have relatively flat.

Simona Jankowski - Goldman Sachs

Right, that was my question. PCs have actually been declining, so just curious why you think it will be flat this year. Is there just something specific you’re seeing? Or how high is your confidence on that forecast?

James Flaws

My confidence is medium about the IT, but I would hope you come to the IR day, and you can talk to the guys running the business. They’ll explain why they came up with the number.

Operator

The next question comes from the line of Joseph Wolf with Barclays.

Joseph Wolf - Barclays

Just two questions. One on the glass inventory, you mentioned it’s 17 weeks, and thinking that that’s stable. Is that the right number given the high number of different panel sizes, screen sizes, across the different devices? Or do you think that that moves seasonally like it did in 2013?

James Flaws

If you go back a couple of years, we would have said 17 weeks was high. But we believe the comment that you’re making about the number of additional panel sizes has led people to carry more. So what we’ve developed is, over the past year, we think 17 is acceptable.

In terms of the cycle of the weeks, remember, the weeks the way we do it is forward-looking, always. So as we get to the square footage of glass and look at quarter two, at the end of quarter one, the number will climb, simply because Q2 goes lower. So you always have to look at the two things in combination, the absolute inventory and the weeks, based on the forward-looking. But we feel pretty good about the inventory levels right now.

Operator

Our final question today will come from the line of Rod Hall with JPMorgan.

Rod Hall - JPMorgan

I guess I’m going to have to go back to the pricing commentary. It sounds like you’re saying that the competitors converged toward some lower price point that was in the market. At least that’s what you’re thinking. What I don’t understand is, and usually you have a good reason for saying things like this, why you have confidence that after Q1 that will rebound. Is there some dynamic we should be thinking about that would cause that pricing to come back in Q2?

And then just a really quick second question. The Chinese fusion agreement, did you manage to stop them from using fusion technology altogether? Beyond the money, can you just tell us what else transpired in that deal that might be helpful to you?

James Flaws

On the latter, there are limitations on their ability to use the fusion technology. And that’s all I’ll discuss at this point in time.

On pricing, obviously this is a forecast. It is based on what we think happened, and therefore we were right on why it happened. We think there would be no reason for it to repeat in quarter two. I can’t guarantee that, but we believe that what was happening with this compression and adjustment that had to be made by competitors among their customers ended up affecting us through this contractual arrangement. And we don’t think that has to repeat, and that’s why we’re confident right now that Q2 will come back to more moderate price declines.

Okay, so we have a couple of IR announcements as a wrap up. First of all, as we mentioned several times today, we’ll be holding our annual investor day in New York City, February 7, at the same location, Cipriani’s, hopefully with no snow. We will have numerous hands-on demonstrations at our business exhibits, and as I mentioned earlier, we’ll be giving an overview of our growth expectations for 2014.

So in addition to myself, we will have our chief executive officer, Wendell Weeks, our new chief technology officer, and three business group leaders, who will be speaking to you about their plans to continue the march up of our earnings growth. It’s going to be very informative, hands on, and I hope you will consider attending in person.

To summarize the results of the call, we finished 2013 with a very solid quarter, and achieved our goal of [forming the bottom, marching up], with the year over year earnings growth in every quarter this past year. We completed a major acquisition that we think brings the company and our shareholders numerous benefits, including media accretion and additional cash flows.

We’ve continued to improve manufacturing efficiencies and control operating costs in most of our businesses, and ultimately, we grew earnings per share 16% year over year in 2013. Finally, we returned cash to shareholders with our share buyback program and 11% dividend increase.

We’re coming into 2014 with expectations for continued growth in sales and even more in earnings. We intend to maintain stable display earnings with moderate price declines, very diligent management of our glass capacity, and continued cost reductions. And the prospects for growth in optical communications, especially materials, environmental and life sciences, are strong.

So stay tuned for more details at our IR meeting next week. Ann?

Ann Nicholson

Thank you, Jim, and thank you all for joining us today. A playback of this call is available beginning at 11 a.m. Eastern time today, and will run until 5 p.m. Eastern on Tuesday, February 11. To listen, dial 800-475-6701. The access code is 314670. The audiocast, of course, is available on our website during that time. Operator, that concludes our call.

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