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Corning, Inc. (NYSE:GLW)

Q1 2007 Earnings Call

April 25, 2007 8:30 am ET

Executives

Ken Sofio - Division VP, Investor Relations

Jim Flaws - Vice Chairman and CFO

Wendell Weeks - President and CEO

Analysts

C.J. Muse - Lehman Brothers

Nikos Theodosopoulos - UBS Securities

John Harmon - Needham & Company

Curt Woodworth - J.P. Morgan

Steven Fox - Merrill Lynch

Tim Daubenspeck - Pacific Crest Securities

Daryl Armstrong - Citigroup

Andrew Abrams - Avian Securities

Jeff Evenson - Sanford Bernstein

Ajit Pai - Thomas Weisel Partners

Presentation

Operator

Good morning, and welcome to the First Quarter Results Conference Call. All parties will be on a listen-only mode until the question and answer portion of the conference. This conference is being recorded. If you have any objections you may disconnect at this time.

I would now like to turn the call over to Mr. Ken Sofio, Division Vice President, Investor Relations. Sir, you may begin.

Ken Sofio

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

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

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Jim Flaws

Thanks Ken. Good morning everyone. This morning we released our results for the first quarter which can be found on our Investor Relations website. In addition, for those of you with web access, we've posted several slides that will summarize the important data from this morning's prepared remarks. These slides will be available on our website after our call as well.

Overall, our first quarter results were excellent, led by better than expected performance in Telecom and in Dow Corning.

Our first quarter sales were $1.31 billion at the top-end of our guidance range. Compared to the fourth quarter, sales declined 5% and compared to the first quarter of the year ago, sales were up 4%.

Our EPS before special items was $0.28 and exceeded the top-end of our guidance range by $0.01 and exceeded expectations by $0.02.

Net profit after-tax, excluding special items, in the first quarter was $452 million, a decrease of 7% versus the fourth quarter.

In comparison to the first quarter of 2006, net profit after-tax excluding special items was up $27 million or 6%.

You should note that EPS and net profit after-tax excluding special items are non-GAAP measures. Reconciliation to GAAP can be found on our website.

We had two special items in the first quarter. We recorded a pre-tax and after-tax charge of $110 million, primarily reflecting the increase in market value of Corning common stock to be contributed to the asbestos litigation related to Pittsburgh Corning. Corning’s share price increased during the quarter from $18.71 to $22.74.

In the first quarter, we also incurred a pre-tax and after-tax charge of $15 million related to retirement of debt. Including these two items our first quarter EPS was $0.20 per share.

Now, continuing down the income statement. Gross margin in the first quarter was 45%, slightly higher than the fourth quarter and in line with our expectations. It was also consistent with the first quarter of last year. SG&A was $214 million, about 16% of sales. R&D was $130 million, about 10% of sales.

Equity earnings were $216 million in the first quarter compared to $272 million in the fourth quarter. As a reminder, equity earnings in the fourth quarter had included a $28 million net nonrecurring gain.

Sequential decline in equity earnings was less than we had anticipated due to better than expected results at the both Dow Corning and Samsung Corning Precision.

Our tax rate in the first quarter excluding the impact of special items was 19%, is slightly higher than our guidance range of 15% to 18%. Our share count for the first quarter was 1.6 billion shares.

Now, let me turn to our segment results. Starting with Display sales were $524 million in the first quarter, a 15% decline compared to the fourth quarter sales of $619 million. First quarter glass volume declined 12% sequentially, as expected.

Regarding glass pricing, our new strategy appears to be working as we hoped. Sequential pricing is lower by just 1% to 2% in the base business. Equally important, there appears to be no material change in our market share in the first quarter. It comes as no surprise that we will continue this pricing strategy heading into the second quarter.

Regarding foreign exchange, the impact began, the U.S. dollar exchange rate was slightly negative during the first quarter compared to the fourth. As a reminder, all of our glass is sold in Yen. Pricing guidance would provide is on Yen per square foot basis. As a result changes in the Yen to dollar exchange rate do not impact the pricing.

Equity earnings from SCP were $113 million in the first quarter and lower than fourth quarter equity earnings of $147 million. SCP's sequential volume declined only 5% in the first quarter much better than we expected. Sequential price declines were in the upper single digits and in line with our expectations.

As a reminder SCP's price declines in 2006 were not as significant as our wholly-owned business. This catch-up is now occurred in quarter one. We expect price declines at SCP to be much more moderate in '02 and consistent with the wholly-owned business.

Re-modeling purposes, SCP first quarter sales were $484 million compared to $571 million in the fourth quarter.

Net income in the Display segment, which includes equity earning’s was $380 million in the first quarter down 18% prior to $461 million in the fourth quarter. A decrease in net income was primarily result of low volume in our wholly-owned business and lower volume and pricing at SCP.

Our gross margin percent in the first quarter declined very slightly in comparison to the fourth quarter.

Now, I would like to spend a few minutes updating you on our end market trends for the first quarter. We also have some final end market data from the fourth quarter.

As always, I would like to stress that our first quarter market data information is only preliminary at this time. This data represents our view and it is based on a variety of sources. Be clear that data and records in here, relates to shipments from PC manufacturers and TV set makers to retailers.

In summary, the preliminary data indicates that the end market shipments for the first quarter were on track with our expectations, first quarter for notebooks and monitors. Where LCD televisions at preliminary end market data suggest shipments were higher than we expected.

Starting with notebooks, about 22 million were shipped in the first quarter inline with our expectations and slightly less than the fourth quarter shipments. As percentage of computer sold, notebooks grew slightly from 38% in the fourth quarter to an estimated 39% in the first quarter.

For LCD monitors, about 39 million were shipped in first quarter, also inline with our expectations. This was a slight increase versus the fourth quarter; we believe the penetration of LCD monitors grew slightly from 85% in fourth quarter to 86% in the first quarter.

Let me now move to LCD televisions. Start with our view to the final end market data for the fourth quarter. As a reminder, the market data we had provided on our January conference call and February investor meeting was preliminary at that time. Our final data indicates 17 million LCD televisions were shipped in the fourth quarter, about 2 million more televisions than our original estimates.

For the year, approximately 44 million LCD televisions were shipped, about 23% of all color televisions, which is higher than our previous estimate of 22% penetration. The average size at retail in quarter four was 29.7 inches and was 28.6 for the year.

Moving to the first quarter, the preliminary data suggested about 14 million LCD televisions were shipped, which is also higher than our expectations. More importantly, however the penetration of LCD TV into the worldwide color television market was estimated to be 31% in the first quarter up from 29% in the fourth quarter.

In light of the strong fourth quarter data, preliminary first quarter information we've increased our LCD TV shipment estimates for 2007. We now believe approximately 73 million LCD televisions will be shipped in 2007 up from our original estimate of 68 million.

As a result, our estimate for LCD television penetration for the year has increased from 33% to 36%. We also believe the average screen size this year will be approximately 31 inches and larger than our previous estimate of 30.5 inches.

The increase in penetration screen size has led to the revision of our market estimates for worldwide LCD glass volume. We now believe the LCD glass market volume will grow between 35% and 40% up from our original estimates of net 30% growth.

You should note this growth rate may vary by geographic region. We estimate that Thailand and Japan will grow at the upper end of the range, while Korea will grow at the lower end of this range. Historically, growth rates are varied by geographic region, and you should note that we have a much better estimate in the total market rather than individual geographies.

I would like to take a moment to discuss the estimated growth rate for glass versus some of our customer’s estimates. Based on our analysis, we believe panel area will grow approximately 45% a share, although chip panel makers have published higher growth numbers. However, when you look to paid-on area growth, for the entire industry we build the numbers closer to 45%.

The difference between the panel area growth estimates and our estimated growth rate for the glass market for the 35% to 40% is primarily the result of glass utilization improvements out of customers from process yield and panelization.

As we have told you previously, our estimated market growth for glass assumes our customer’s [available] on their fabs more efficiently overtime. This would result in less glass being wasted by them and more panels being produced and shipped in the same amount of glass and put it into a process.

We have always accounted the glass utilization improvements in our forecast between finished goods viewing area shipment growth in the glass substrate area growth due to our customer’s process improvements.

However, we believe it has been overlooked by investors due to the very high percentage growth for glass in recent years. This improvement by the customers is a good thing for the long-term health of the industry, despite them purchasing less glass for given number of finished goods. Our customers have low profitability and may need cost reduction to be able to reinvest in the growth.

I think the customer yields and process selects are well understood. Let me explain what we mean by panelization. Panelization refers to how many panels can be made out of a single piece of glass and what percentage the glass area is being effectively utilized by these panels.

We are now seeing panelization improvements as our customers move towards widescreen monitors. For example, the GEN 5 panel maker can make 6, 20 inch panels in the standard 4:3 format on the GEN 5 piece of glass, which leads panelization efficiency of about 60%. However, on that same piece of glass they are able to make 8, 20 inch wide monitors resulting in panelization efficiency of 70%.

The nano-glass going in process are the same but the outlook in terms of panel area has increased. Please note that panel makers may decide to run this panel size as more efficiently on either smaller of our [ultra] GEN sizes.

So for 2007, we have estimates for both yield improvements in panelization. And as a result, we believe our glass growth assumptions are reasonable compared to the panel industries area growth expectations.

Some investors have asked us if the glass industry can add additional capacity beyond this rate if needed. We believe the overall glass industry will have enough glass capacity to meet a 40% of growth rate, but not much more. This assumption is based on our own capacity plans plus other public announcements by our competitors.

For Corning, it takes us about six months to add melting efficient capacity assuming we have a building in place. We believe it takes others in the industry slightly a longer time to bring on new capacity.

The takeaway here since it's the end of April, making a decision today to add capacity, would not have a material impact on supply this year. As a result, based on our market forecast and industry capacity estimates, we still believe supply demand for glass will be tight in second half.

Regarding inventory in the supply chain, our data suggest panel inventories remain within what we think are acceptable levels heading into the second quarter.

Our glass mix of GEN 5 and higher in the first quarter was 88% and slightly higher than the fourth quarter. The mix of GEN 5.5, 6, 7, and 8 glass was 52% in the first quarter and consistent with the fourth quarter.

Our GEN 8 glass capacity continues to ramp consistent with our contract with Sharp, the majority supplier for the GEN 8 glass makers.

You should also note there have been rumors of GEN 9 and GEN 10 fabs. We've begun development for these generations to be ready, if the industry moves in this direction. To put the size of a GEN 10 a perspective, it's almost a 100 square feet of glass compared to 56 square feet of glass for GEN 8. While there have been no formal announcements from panel makers yet, we expect you will hear something later this year.

I will wrap up Display by commenting on EAGLE XG. Our conversion continues to go well. We estimate that EAGLE XG represented about 40% of our glass production in the first quarter.

We are pleased to announce that SCP will soon begin producing EAGLE XG in response to customer demand in Korea.

Moving to the environmental segment, sales in the first quarter were $179 million, an increase of 15% over the fourth quarter sales of $155 million. The increase was due to substantially higher auto product sales versus traditionally lower fourth quarter.

Auto product sales were $123 million in the first quarter, up 17% over the fourth quarter sales of $105 million.

Diesel product sales were $56 million in the first quarter, an increase of 12% over the fourth quarter sales of $50 million.

Segmented income was a positive $9 million in the first quarter versus a loss of $8 million in the fourth quarter. A significant improvement in segments bottom line was a result of higher volumes in auto, much stronger manufacturing performance.

Higher volumes in diesel also resulted in improved manufacturing. Diesel sales increased 65% over last year's first quarter. We believe diesel sales are on track to grow over 60% this year. And while majority of this growth will come in the heavy-duty market in second half. We are also quite pleased with how the light-duty engine opportunity is progressing.

Hopefully investors saw the announcement last week regarding the supply group of Hyundai. Hyundai will be purchasing our new DuraTrap AT filter for select European passenger car models. Again shipping small quantities of filters at the end of 2006.

Investors should note that these sales to Hyundai will be driven purely by green marketing. The regulations currently in place today in Europe known as Euro 4, are not stringent enough to require these filters. This will change towards the end of the decade when regulation goes into effect between 2009 and 2011 requiring filters on diesel autos.

Re-modeling purposes the filter sales to Hyundai this year were included in our market estimates and guidance that we have provided in February.

In the Life Sciences segment sales in the first quarter was $76 million compared to the fourth quarter sales of $72 million. Segment was breakeven in the first quarter compared to a loss of $2 million in the fourth quarter.

Moving to the telecommunications segment, sales in the first quarter were $439 million, 9% increase over the fourth quarter, and better than expected. Compared to year ago, telecommunications sales were up 11%.

Sales for hardware and equipment products were $228 million in the first quarter, up 10% compared to $207 million in the fourth quarter. And compared to year ago, hardware and equipment sales were up 19%.

Sales in fiber and cable products in the first quarter were $211 million, an increase of 7% over the fourth quarter sales of $197 million. Compared to a year ago, fiber and cable sales were up 3%. Fiber-to-the-premise sales which are primarily hardware and equipment related were $69 million in the first quarter, representing a 35% increase over the fourth quarter sales of $51 million.

Net income in telecommunication segment was $29 million in the quarter, compared to a net loss of $54 million in the fourth quarter. As a reminder, the fourth quarter had included a $44 million in restructuring and impairment charges.

This significant improvement in bottom line was due to the higher volume and stronger operating performance. Hopefully most investors saw our other press release this morning. Before the market opened we announced a partial reopening of our Concord, North Carolina optical fiber manufacturing facility.

We will begin a limited start of this facility in the second half. As we stated previously it will take approximately six to nine months to start this limited production. I would like to be very clear here, at this time we are only planning in opening a portion of the facility. In the future as demand warrants we have the ability to restart additional capacity.

The decision to reopen a portion of Concord was due in part to the increased market demand for fiber we've seen over the past few years and our expectations for future growth. Over the past two years, the fiber market volume has grown more than 15% per year. The overwhelming majority of this demand has come from the access in metro segments, and we expect that trend to continue.

This partial startup of the Concord facility will ensure we have adequate capacity to capture the expanding market opportunity. Another factor in the decision to partially reopen Concord is our recent innovation to make higher performance [stepper] glass for semiconductor materials product from the optical fiber process.

In addition to producing optical fiber at our Wilmington, North Carolina facility, we now also manufacture high purity fused silica for semiconductor lithography applications.

Our semiconductor business is growing at double-digit rates, which is resulting the need to increase specially glass making capacity in Wilmington. This demand will display some of Wilmington’s fiber-making capacity.

We are delighted to have found a second use for our fiber manufacturing assets. For your modeling purposes, the cost of partially reopened Concord is not material to our overall results. We estimate the incremental earning or fixed cost is less than $5 million.

Moving to our other segments; sales in the first quarter were $89 million, down from $119 million in the fourth quarter. Finally, it’s due to an expected drop off in specialty material sales.

Turning to Dow Corning, equity earnings were $92 million compared to $84 million in the fourth quarter. Both quarter had benefited from a lower than normal tax rate. Sales for Dow Corning which were not consolidated were $1.2 billion. Compared to a year ago sales were up 15% and equity earnings were up 33%.

Now moving to the balance sheet; we ender the quarter with about $2.9 billion in cash and short-term investments, down from $3.2 billion at the end of the fourth quarter. Decline was primarily due to our decision to use $246 million in cash to retire long-term debt during the quarter, it's part of our clear runway strategy.

As a result, you will note that our cash and excessive debt remained about 1.4 million. Free cash flow was a negative $69 million in the first quarter, this is fairly typical given the first quarter usually includes high working capital out-falls. In addition we made a contribution to our pension plan of approximately $100 million in the quarter.

Based on our internal forecast we remain on track for free cash this year in excess of $400 million. As a reminder free cash flow is a non-GAAP measure. We continue to receive questions from investors about our future plans for our cash. Our Board of Director will be meeting later this year considering usage for this cash which could include share repurchases and/or the reinstatement of the cash dividend.

Moving down to balance sheet; accounts receivable were $781 million at the end of the first quarter, up from $746 million at the end of the fourth quarter. The increase is primarily due to higher sales in the month of March compared to the month of December.

As expected, our inventory increased during the quarter from $639 million to $685 million in quarter one. The most significant increase was in telecom as we continue to gear up for the stronger seasonal pull in quarter two and quarter three, and partially due to the foreign exchange.

Display inventory also decreased in preparation for a seasonally stronger second half. I'd like to ramp up by providing you our guidance for the second quarter. We expect sales to be between $1.4 billion and $1.45 billion, and the EPS excluding specials in between $0.30 and $0.33.

We expect the LCD glass buying to be up 8% to 12% sequentially in the second quarter for both the wholly-owned business and SCP. We believe that we'll begin to see the pull from the supply chain as the industry gears up for the second half.

As I mentioned a few minutes ago, some panel makers area growth guidance is higher than our glass guidance for the quarter, difference is yield, panelization, and timing of shipment.

As a reminder, as we discussed in the past panel shipments and glass shipments data do not always correlate in any given quarter.

As I mentioned earlier, our pricing strategy in the second quarter will be consistent with the first quarter for our wholly-owned business. And for SCP, we expect sequential price declines to be consistent with the wholly-owned business. We still anticipate a majority of our glass shipments to occur in the second half of the year.

As a result, we believe market demand for glass will strengthen significantly as the year progresses, glass supply will be tight. As a result, our pricing strategy should allow us to minimize price declines, as we head into the seasonally stronger second half.

Moving on to Telecommunications segment, we anticipate second quarter sales to be up between 10% and 15% sequentially. We anticipate growth in the fiber and cable will be towards the upper end of the range, while hardware and equipment will grow towards the lower end.

We anticipate environmental segment to grow about 5% sequentially led by strong demand for diesel products. This growth is expected to offset weaker demand for auto.

In Life Sciences, we expect sales to increase 5% sequentially. And our other segment sales are expected to be up 10% to 15% sequentially in the second quarter.

Moving down to the income statement, for remodeling purposes, gross margin for the company should be between 45% and 47%. SG&A is expected to be approximately 16% of sales. R&D is expected to be around 10% of sales.

Anticipated equity earnings in the second quarter to be up about 5% compared to the first quarter. Higher equity earnings at SCP will be offset by slightly lower earnings at Dow Corning.

As I mentioned earlier, Dow Corning benefited from lower tax rate in quarter one, but it's not expected to continue into quarter two. Absent this, Dow Corning's second quarter equity earnings should be fairly consistent with the strong first quarter.

Regarding our tax rate for remodeling purposes, you should continue to use the range of 15% to 18% in the second quarter.

Lastly, you should again use 1.6 billion shares for the second quarter for calculating EPS before special items.

One other comment on shares, as I mentioned in the last eight conference calls, you should expect some executive selling over the next few weeks. As always for executives who decide to sell stock, we encourage them to use the period immediately after our quarterly earnings announcement.

I would like to comment on executives selling in general. Our senior executives can have as much as 75% of compensation of Corning stock. We expect them to monetize some of these earnings, in fact encourage them to sell small amounts of their holdings every quarter regardless of price.

One note on the impact of foreign exchange on our guidance; the under dollar rate would average 5 points higher or lower in the second quarter. We estimate that our overall sales would be impacted by approximately $20 million and our MPAT by approximately $15 million. This includes projected impact of our currency hedging program. Ken?

Ken Sofio

Thank you, Jim. Lisa, we are ready to take some questions now.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from C.J. Muse with Lehman Brothers.

C.J. Muse - Lehman Brothers

Yeah. Good morning. Couple of quick questions here, I guess first, given how tight it looks glass will be particularly tight in the second half. I was hoping you could comment on your pricing strategy. Would you expect the scenario, where you could see flat pricing or have you contracted with your customers, where you've guaranteed at least some price declines throughout the year?

Wendell Weeks

So, we're taking pricing quarter-by-quarter. As we said at the beginning of the year, we are implementing our new pricing strategy in the results. In the first quarter, we're very encouraging. And we've given you the guidance for the second quarter. You are right, glass should be tighter in the back half, and therefore prices should be somewhat less. But we're not at this time given any guidance to the back half of the year on pricing.

C.J. Muse - Lehman Brothers

Okay. And then, in terms of your glass capacity that's coming online. Can you better understand the quarterly ramp?

Jim Flaws

We are not giving out our capacity by quarter. But basically, we will be bringing on additional capacity every quarter, as we go through the course of year.

C.J. Muse - Lehman Brothers

And last question from me. Can you talk about the impact of growing fiber in the higher margins associated within the telecom side on your overall gross margins? How we should think about that through the year?

Jim Flaws

Well, fiber not cable, but fiber itself has extraordinary high incremental margins and also to a degree that we can fill up only till this year that rate, those sales with that high a variable rate actually helped the corporation because that incremental rate is above the corporate average of 45%.

When Concord began its production, we indicated there is a certain and incremental fixed cost, but basically the variable rate will also be very high there on the production, which isn't going to start for six to nine months.

C.J. Muse - Lehman Brothers

Very helpful. Thank you.

Operator

Thank you. Our next question comes from Nikos Theodosopoulos with UBS.

Nikos Theodosopoulos - UBS Securities

Yes, thank you. I had a couple of questions on the LCD business, your comment in the release or in the discussion was that you told the market would now grow 35% to 40% this yearend. In the first quarter, you didn't believe that you would lose shares. So, just wanted to, it sounds to me like you think Corning, your plan is not to lose share this year and you should show growth in that 35% to 40% range, is that a reasonable assumption at this point?

Jim Flaws

No, we never intend to lose share. So, we don't give our guidance for the year, but we are not entering in this market to lose share. At this time, when we felt we had most opportunity to would be effective by share loss would have been in quarter one, and may be a little in quarter two. We don't think we really saw any share loss in quarter one beside from the fact that some glass that shift back to aside when they are [thinking] back up, we never regarded that as a share shift a lot in the fourth quarter. So, we don't intend to lose share this year.

Nikos Theodosopoulos - UBS Securities

Okay. And on LCD gross margin, you mentioned that it was down slightly in the quarter and it looks like in SCP results that it was also down. Given the increase in volumes that you now are going to show throughout the year, and those sequential increases should accelerate for you to get that 35% to 40% volume growth, and the pricing strategy that you have of 1% to 2% a quarter. Is there a reason that margins on LCD should expand throughout the year. If all this holds true, were there other factors that would cause it not to expand other than the accelerating sequential volumes and 1% to 2% price decline?

Wendell Weeks

Well, I think you have to think we’ve always said that our cost reduction programs don't happen smoothly quarter-by-quarter. So, we tend to think about our cost reduction over the course of the entire year. We think we'll have a very good robust cost reduction program again this year if our glass volumes are accurate. As we said, we can never guarantee that it will hit this 14% that we've had over last few years. But we think it’ll be very robust. And depending on the mix of that relative to and price declines will influence where our margins end up. We are frankly delighted to have gross margins as far as they are. And what we really like to do is be able to sustain these margins with this higher rated growth for the long period of time and that's what we are trying to achieve.

Nikos Theodosopoulos - UBS Securities

Okay. Great, thank you.

Operator

Thank you. Our next question comes from John Harmon with Needham & Company.

John Harmon - Needham & Company

Hi, good morning.

Jim Flaws

Good morning.

John Harmon - Needham & Company

Just a couple of questions, I was wondering first of all, I know it’s a ways out though, when Verizon transits to GE-PON its access network. Does that offer any additional revenue or margin opportunities for you? And the second question is you've talked about allocating some of the space in Concord to advance materials. Does that it is coming from your step programs and [is that] business performing?

Jim Flaws

Let me take the second question first. So what I said is that we are allocating some of the capacity at Wilmington actually to the semiconductor business. And we will be making Telecom products at Concord.

Wendell Weeks

So, that building on Jim’s answer for the high purity to silica. The newest generation of stepper systems use very high quality pure silica lensing systems and what we've done is we have introduced the product that builds on the incredible purity that we are capable of manufacturing of optical fiber to introduce an advantage product for that market and its growing well and we are very pleased with our progress on that product.

To GE-PON, we think that it will not have a positive impact for us although it is primarily a change in the active system. It will significantly advantage fiber optic systems versus all other alternatives. And we believe it offers opportunities for further cost reduction for our customers. So, overall, this is something we are very excited about and look forward to being introduced.

John Harmon - Needham & Company

Thank you.

Operator

Thank you. Our next question comes from Curt Woodworth with J.P. Morgan.

Curt Woodworth - J.P. Morgan

Yeah, hi, good morning. If you look at the performance of SCP, you are down about 23% sequentially on income. Your volume was better than expected. Can you just comment on gross margin performance, out of that segment maybe now how it compares to the wholly-owned business?

Jim Flaws

Gross margin did decline at SCP sequentially versus quarter four. That was driven primarily by the big price down within the quarter. I mentioned that prices were down in the upper single digits and so you could combine that with price, with the volume being down, that's the blended gross margin being down a little bit. It's still slightly higher than our wholly-owned business.

Curt Woodworth - J.P. Morgan

Great. And in terms of the inventories in the market being at pretty reasonable levels and your comments that the industry cannot support growth over 40% and that's the high-end of your guidance. What is the strategy you think you are going to employ may be the industry is going to employ to handle that volume? Do you plan building safety stocks? And are you are hearing from your panel customers that may be they are going to buy more in Q2 as a hedge on that?

Jim Flaws

Just to clarify the 40% I talked about was glass.

Curt Woodworth - J.P. Morgan

Correct.

Jim Flaws

We believe the area shipments from panel makers would be greater than that.

Curt Woodworth - J.P. Morgan

Right.

Jim Flaws

But we are expecting that we would see our customers begin raising the utilizations in the second quarter. We are really delighted that they didn't do what they did last year, which I remember they built inventory in first quarter and then ended up having to take it out. We think they are approaching the market on a very rational basis.

From our point of view, we did build some inventory in quarter one and we will build some inventory in quarter two, because we believe it satisfy demand in the back half of the year, we will have to sell some amount of inventory just as we did last year in the fourth quarter.

Wendell Weeks

And one small add I would make to that. I think you are right to take a look at the dynamic for our customers and their customers to set manufacturers that there is always the potential when people get concerned about panel supply getting tight. That they could move around the timing of their purchases and then you can get an outsize impact in any given quarter. But, so far, we haven't seen that.

Curt Woodworth - J.P. Morgan

Great. And one final question. Last year around the August timeframe, you locked in the pricing for the majority of the back half of the year. Given the expectation for the market to tighten pretty dramatically in the back half of the year, are you trying to may be lower the pricing time pay line as some guys like to go over quarter or more than that out. I am just curious what your thoughts are on that?

Wendell Weeks

Remember, at the beginning of the year, what we said at our investors meeting, as we were going to do this new pricing strategy based on our deeper understanding of the seasonality of the market. And that's what we were going to try to do is chart our course and not overreact to seasonality and changes in the pipeline. And that's exactly what we are doing and we are off to a good start. And we would expect to continue that pricing strategy as we work our way through the year.

Curt Woodworth - J.P. Morgan

Great. Thank you.

Operator

Thank you. Our next question comes from Steven Fox with Merrill Lynch.

Steven Fox - Merrill Lynch

Hi, good morning. Two questions, first of all on fiber, the restart of the Concord facility. What are the implications for pricing? Do you anticipate a more benign pricing environment now for fiber?

Wendell Weeks

Well. What we believe is that pricing pressure did moderate some last year. However, we continue to face a downward movement in pricing in this business on a pretty continual basis. And so we'd hope that everyone would recall the lessons of two years ago. But I think, it's too early to tell whether or not there's any significant change in the pricing environment one way or the other. We don't expect the addition of the Concord capacity have any material impact on relative pricing behavior in the marketplace.

Steven Fox - Merrill Lynch

Wendell, are you seeing any other competitors bring up, leaf stalk fiber capacity?

Wendell Weeks

We haven't seen any significant moves above and beyond the utilization of the facilities that they had started. Note that our view though inside what our competitors utilization is and their capacity plans is it isn't incredibly accurate.

Steven Fox - Merrill Lynch

Okay. And then, lastly on the LCD glass business, on GEN 8 glass, are you guys expecting one of your competitors to become an important second supplier during the course of the year. And given your comments on tightness in glass in the second half, what does that mean for the risk to GEN 8 supply of glass later on in the year, if they don't do that?

Wendell Weeks

So, we do believe that already there is another supplier of GEN 8 glass and we would expect that to continue. But we believe that we will be able to supply our customer’s needs for GEN 8, although it is part of the overall larger situation of some relative tightness in glass supply into back half.

Steven Fox - Merrill Lynch

Thank you.

Operator

Thank you. Our next question comes from Tim Daubenspeck with Pacific Crest Securities.

Tim Daubenspeck - Pacific Crest Securities

Thank you. Just in terms of starting up a new fiber fab, you've been fairly cautious in terms of approach in increasing volume, you talked about the discussions you've had with some customers, whether there are any guarantees and the type of visibility you have around demand in the next couple of years?

Jim Flaws

We don't have any guarantee, assuming no. We approached this with caution as you have indicated because we wanted to start this when we had a higher degree of confidence that this would be consistently needed. The breadth of demand that we've seen from our customers has led us to that but there is no guarantee from our customers that they will continue buying at this level.

Tim Daubenspeck - Pacific Crest Securities

Okay. And then, we are not going to get capacity from the partial opening of the fab until '08, but can you comment at all about trends in terms of cash margins within telecom x-depreciation in may be '07 versus '06?

Jim Flaws

The cash margins have been improving in this business. So, again it's very good but they have been improving.

Tim Daubenspeck - Pacific Crest Securities

Okay, thank you.

Operator

Thank you. Our next question comes from Daryl Armstrong with Citigroup.

Daryl Armstrong - Citigroup

Thank you very much. A couple of questions, first on the LCD side, I think earlier in the year you said that you had about 50% of your annual glass capacity tied up, could you provide an update in terms of what that percentage is today?

And then second of all on the fiber front, with the partial opening of the Corning facilities that the lead time would be six to nine months, if you found that you need the incremental capacity from that facility, would the lead time still be that same interval or would it be shorter?

Wendell Weeks

Let me take the second question, and let Jim to handle the first one. In terms of incremental capacity, we have the ability to respond to uptakes in the market demand this year with low maintenance and passing gear that we have there. We're really bringing this on an anticipation of continued growth. So, I think we're going to be okay, to be able to fulfill our customer’s requirements from our total system of production.

Jim Flaws

Daryl, I don't have a current number on the amount of glass is under contract, I would be surprised that it would change materially though.

Daryl Armstrong - Citigroup

And then one last question, in terms of your pricing strategy that you seem to be seeing there. Do you think it’s the function of competitors also understanding the same type of supply demand situation in the industry and not trying to under cut you? Are you finding that customers were just so concerned about tightness and supply that they are just simply trying to lock up glass anywhere they can?

Wendell Weeks

I can't really comment on the mindset of our competitors. I don't know why, they are choosing to, what they are choosing to do. What I would comment on is that is we laid out this new pricing strategy and how seasonality would impact it and how we would chart our course to the year that were very encouraged by the start and that reality is playing out as we had hoped that it would.

Daryl Armstrong - Citigroup

Thank you very much.

Operator

Thank you. Our next question comes from Andrew Abrams with Avian Securities.

Andrew Abrams - Avian Securities

I wonder if we could just talk for a minute about the pricing strategy. Maybe you could comment a little bit on the total number of customers that are really working off this strategy, and is SCP part of that program, number one? And maybe a comment on what this does to correlation between panel pricing and glass pricing or your pricing given the new circumstances that we are working under right now?

Jim Flaws

In our wholly-owned business every customer is under the new strategy with the exception of -- we have a few customers that had contracts that had a price built in. But essentially we are approaching this with all of our customers since we are in wholly-owned business. And SCP going forward, we will be operating to the same strategy.

Andrew Abrams - Avian Securities

And do you think it’s going to change the correlation at all between panel pricing and glass pricing?

Jim Flaws

No, we have never really seen any real correlation between the two. Panel prices have come down far greater than glass prices over a period of time. That's partially because glass has been the enabler in a lot of cases for the cost reduction that our customers will have, which has allowed them to reduce their prices. So I mean obviously glass is a significant cost component to our customers, though materials in any case, has been 15% for a large television but our customers know that we are going to reduce our prices over time. And that’s a commitment. It’s just at a lower rate than it was last year.

Andrew Abrams - Avian Securities

Just lastly on the swing factor for you guys with new policy, if you guys are in a 1% or 2% changed position for a given quarter, would you come out slightly ahead of where you would normally be given last year's policy versus this year's policy? Or is there no appreciable change in a small glass price change environment like than that?

Jim Flaws

I'm sorry. I didn't follow your question, the change in what?

Andrew Abrams - Avian Securities

If there is only a small change in glass pricing over a period of time, meaning a quarter, how would it affect you differently this year than it would have affected you last year?

Jim Flaws

Last year prices were coming down between 4% and 5% every quarter and so that's a benefit to us. And than the other question will be our costing relative to that, if we are running full, we should be doing quite well.

Andrew Abrams - Avian Securities

Thank you.

Operator

Thank you. Our next question comes from Jeff Evenson with Sanford Bernstein.

Jeff Evenson - Sanford Bernstein

Hi, couple of questions on equity earnings. First, I was wondering if you could give us an update on polysilicon and in particular what that's contributing to the 15% year-over-year Dow Corning growth rate?

And second, a question on Samsung Corning, that this quarter looks like it contributed about $28 million to your equity earnings, which you identify as non-recurring. As I look through their products, they are doing a number of new things, including backlights for LCDs and I am just wondering what your thinking is on making all of these non-recurring?

Jim Flaws

That's kind of a $28 million non-recurring. It was last quarter, not this quarter.

Jeff Evenson - Sanford Bernstein

Okay. Thanks Jim

Jim Flaws

That's in Samsung Corning, and backlights were not helping at all. Regarding Hemlock, on a year-over-year basis they were quite strong because of the comparison of both pricing and volume compared to quarter one a year ago. And Hemlock was about 18% of revenue of the company in the first quarter.

But really unfortunately, there isn't a lot more capacity coming on at Hemlock right now. There is year-over-year because they brought on some in the middle of last year, but right now there is not much more coming on. A lot of it comes on next year. But Hemlock was a big contributor to the year-over-year improvement. I will say though that the other part of the business, that's what we call the silicon's part of the business, had a very strong year-over-year performance also. So, Dow Corning had a great quarter in both poly and regular silicon.

Jeff Evenson - Sanford Bernstein

Thanks.

Ken Sofio

Lisa, we have time for one more question.

Operator

Thank you. Our final question will come from Ajit Pai with Thomas Weisel Partners.

Ajit Pai - Thomas Weisel Partners

Yeah. Good morning and congratulations on a very solid quarter.

Jim Flaws

Thank you.

Ajit Pai - Thomas Weisel Partners

Just looking at your fiber business right now, I know that you are planning to bring Concord on and you've talked about some of the growth rates there. But, in terms of industry structure right now and the pricing environment over there, could you give us some color as to what you currently expect the industry utilization to be and I think you had a significant cost advantage over there. Whether those costs have come closer to yours and where you would expect to put pricing going forward?

Wendell Weeks

So, as far as the overall industry demand and supply balance, if you would account in that portion of the capacity that is [mouthful], we still think there is significantly more potential capacity or potential capacity in the industry than demand for fiber. We've said before, we think its approximate price as much and we think that that ratio has not been changing significantly.

We continue to feel very good about our cost position, but this is going to be an industry that will always be highly competitive, and then we need to continually drop our costs to meet our customers pricing requirements.

Ajit Pai - Thomas Weisel Partners

Right. And then, what do you think the impact from the pricing point of view will be? I think about three years ago, when we talked about your costs relative to their costs, you had mentioned that if they were at their marginal costs, you'd still have sort of a 200 points advantage. Where do you see that right now?

Wendell Weeks

I have to refresh my knowledge on that. I admit that it is coming up for me in the middle of the year. We are going to take another look at that in depth. And if you ask us that a little bit later, we should be able to answer that question for you with greater accuracy, sir.

Ajit Pai - Thomas Weisel Partners

Okay. Thank you so much.

Jim Flaws

I've a couple of closing comments, including some Investor Relations announcements. Tomorrow is our Annual Shareholder Meeting at Corning, New York and [all for the year end] plan attending, we look forward to seeing you here.

Our Corning executives will be here and we have many investment events over the next few weeks. On May 1, Peter Volanakis and I will be attending the Merrill Lynch Technology Conference in New York City. On May 16, Wendell Weeks and I will be at the Deutsche Bank Technology Conference at San Francisco. Wendell will also be speaking on May 21 at the J.P. Morgan Technology Conference in Boston, and at the Bernstein Strategic Decisions Conference in New York City on May 31.

Lastly, Kathy Asbeck, Senior VP of Finance will speak at the Lehman Wireless, Wireline & Media Conference in New York City on June 1st. We hope to see you at one of these conferences.

Regarding the first quarter, we hope you were as pleased with our performance as we were. We believe our quarter one results were an excellent start to the year. And based on our second quarter guidance, we see this order trend continuing. We expect the display industry to begin to prepare for the seasonally stronger second half, driving our volume up. Pricing strategy implemented in the first quarter worked exactly as we have planned and we will continue this strategy in the second quarter.

The long-awaited industry demand for heavy-duty diesel products is finally here. We are looking forward to revenue growth and margin improvements in this business. And we are anticipating our heavy-duty diesel business to reach profitability by the end of the year.

In telecom, we experienced strong growth in the first quarter and anticipate this trend to continue into the second quarter. We're quite pleased with the increased level of telecom activity around the world. Obviously, we need to see this order trend continue into the second half.

While switching gears, we would like to end this conference call by saying thanks to Jamie Houghton. As many of you know, Jamie will be stepping down as Chairman at our Annual Shareholder Meeting tomorrow at Corning, New York. Jamie will remain on the Board for one more year. Jamie has been involved with Corning for over 40 years and helped guide Corning out of its most difficult time back in 2002.

I know many of you had a chance to meet Jamie during his first time as Chairman from '83 to '96 or during his second run starting in 2002. On behalf of the employees at Corning, we want to thank him for his leadership and wish him continued health and success in his second retirement from Corning. Ken?

Ken Sofio

Thank you Jim, thank you Wendell. Thank you all for joining us today. A playback of the call will be available beginning at 10:30 am Eastern Time this morning and until 5:00 pm Eastern Time on May 9th. To listen, dial 402-998-1237. No password is required. The audio-cast will also be available on our website during that time. Lisa that concludes our call, please disconnect all lines

Operator

Thank you. This concludes today's teleconference. Thank you for your participation. Have a great day.

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Source: Corning Q1 2007 Earnings Call Transcript
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