Corning Q2 2007 Earnings Call Transcript

| About: Corning Inc. (GLW)
Wall Street Breakfast

Corning, Inc. (NYSE:GLW)

Q2 2007 Earnings Call

July 25, 2007 8:30 am ET


Ken Sofio - Division VP, Investor Relations

Jim Flaws - Vice Chairman and CFO

Wendell Weeks - President and CEO


C.J. Muse - Lehman Brothers

Steven Fox - Merrill Lynch

Nikos Theodosopoulos - UBS

John Harmon - Needham & Company

Curt Woodworth - JPMorgan Chase & Company

Jeff Evanson - Sanford C. Bernstein & Company

Ajit Pai - Thomas Weisel Partners

Brant Thompson - Goldman Sachs

Andrew Sussman – UBS



Welcome to today's Corning second quarter conference call. Following today's presentation, there'll be a formal question answer session. Today's conference is being recorded. If anyone has any objections, you may disconnect at this time. Leading today's conference call is Mr. Ken Sofio, Division Vice President of Investor Relations. Sir, you may begin.

Ken Sofio

Thank you and welcome to Corning's second quarter conference call. This call is also being audiocast on our website. Jim Flaws, Vice Chairman and CFO will lead the discussion; and Wendell Weeks, Chairman and CEO will join for the Q&A.

Before I turn it over to Jim, please note today's remarks do contain forward-looking statements under the meaning of the private securities litigation reform act of 1995. These statements involve a number of risks, uncertainties, and other factors that could cause actual results to differ materially. These risks are detailed in the company’s reports.

Jim Flaws

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

Overall, our second quarter results were excellent, primarily the result of better than expected performance in display. Our second quarter sales were $1.42 billion, an increase of 8% over the first quarter and a 12% increase over the second quarter year ago. Our EPS before special items was $0.34 and exceeded the top end of our guidance range by a $0.01.

Net profit after tax, excluding special items, was $546 million, an increase of 21% versus the first quarter. In comparison to the first quarter of 2006, net profit after tax, excluding special items, was $125 million, up 30%. You should note that EPS and net profit after tax, excluding special items, are non-GAAP measures. The reconciliation to GAAP can be found on our website.

We had two special items in the quarter. We recorded a pre- and after-tax charge of $76 million, primarily reflecting the increase in market value of Corning common stock to be contributed to settle the asbestos litigation related to Pittsburgh Corning. Corning’s share price increased during the quarter from $22.74 to $25.55.

We also incurred an after-tax gain of $19 million related to the sale of a non-strategic cabling operation. Including these two items, our second quarter GAAP EPS was $0.30 per share.

Continuing down the income statement, gross margin in the second quarter was 46.5%, slightly higher than the first quarter and an all-time record for Corning. SG&A was $229 million, about 16% of sales. RD&E was $137 million, about 10% of sales.

Equity earnings were $220 million in the second quarter compared to $216 million in the first quarter. Higher than expected earnings from Samsung Corning Precision were mostly offset by operating losses and $10 million in net restructuring charges at Samsung Corning CRT.

Our tax rate in the second quarter, excluding the impact of special items, was only 6% and much lower than we estimated. The lower tax rate was due in part to the release of reserve in the quarter, which was a result of a favorable tax ruling in Taiwan. The favorable ruling contributed $17 million or $0.01 per share to our second quarter EPS. In addition, we have now lowered our full-year tax rate forecast from our prior range of 15% to 18% to a range of 14% to 15%.

Wrapping up our income statement, our share count for the second quarter was 1.6 billion shares.

Now, let me start through the segments. Starting with display, sales were $610 million in the second quarter, a 16% increase compared to the first quarter sales of $524 million. Glass demand was stronger than we anticipated. Glass volume increased 20% sequentially in the second quarter versus our guidance of 8% to 12%. I'll comment on more detail on this in a moment.

Regarding glass pricing, our new strategy continued to work as we expected in the second quarter. Pricing declines were consistent with our guidance. It should come as no surprise that we will continue this pricing strategy in the third quarter.

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

Equity earnings from SCP were $132 million in the second quarter, an increase of 17% versus the first quarter equity earnings of $113 million. SCP sequential volume increased 20% in the second quarter, which was also much higher than we anticipated. As expected, price declines at SCP in the second quarter were in line with our wholly-owned business. For modeling purposes, SCP second quarter sales were $574 million compared to $484 million in the first quarter.

Net income in the display segment, which includes the equity earnings, was $486 million the second quarter, an increase of 28% compared to the first quarter net income of $380 million. The increase is primarily the result of the volume growth, strong operating performance and the lower taxes.

Display gross margin percent increased in the second quarter compared to the first quarter. In comparison to the second quarter of last year, sales in our display segment increased 32% as volume gains of 57% were partially offset by price declines and unfavorable foreign exchange rate movements.

As I mentioned a moment ago, our second quarter display volume was higher than we anticipated. We believe this was mostly supply chain driven and not resulting from a change in end market demand, although we don't have final end market statistics yet, and we have seen some reports of stronger IT demand.

We believe the supply chain's approach to meeting the impact of television seasonality on the overall LCD industry is continuing to evolve. Clearly the panel makers’ decisions to run at lower utilizations in the first quarter and maintain smaller amounts of panel inventory was a refreshing change from last year. Our customer checks in May and June indicate the aggregate panel inventory is currently within acceptable levels. Further evidence of this can be found in the panel makers’ decisions to maintain, or actually slightly raise, panel prices in the second quarter.

We have a hypothesis that the supply chain has built some inventory at the set assembly level. As we have stated in the past, the set assembly level is the more opaque portion of the supply chain to us. We model the glass impact of shipments to panel makers, from panel makers to set assembly, from set assembly to retail, and finally retail sales to customers. We feel that we have good information on the inventories of glass at our panel makers and of their panel inventories. We must model the inventories at the set level. We have no evidence that our estimate of inventories at the set assembly level is successive. We think the supply chain may be acting more rationally to build inventory slightly earlier for the second half demand levels.

We think this would be consistent with our view that we expressed earlier this year that panel-making capacity would be tighter this year, especially in the second half. We told investors earlier that we felt the panel makers actually could limit the end market if they began their ramp too late. We also suspect that rising panel prices may have led some set makers to purchase panels sooner than expected, in an effort to avoid higher price panel purchases later in the year. These factors may have contributed for the stronger demand for us in the second quarter.

As I mentioned, we have no change to our full-year forecast of glass market growth. We still believe the glass market will grow between 35% and 40% and the glass capacity is capped at around 40% for the industry. This all means that we ship some glass slightly earlier in the year than we originally expected.

On the retail side, our preliminary data suggests the end market demand remained on track. As always, I'd like to stress that our second quarter market information is only preliminary at this time. This data represents our view and is based on a variety of sources. Be clear, the data we reference here relates to shipments from PC manufacturers and TV set makers to retailers.

Starting with notebooks, about 22 million were shipped in the second quarter, in line with our expectations and fairly consistent with the first quarter. As a percentage of computers sold, notebooks remained about 39%.

For LCD monitors, about 37 million were shipped in the second quarter, also in line with our expectations and consistent with the first quarter. We believe the penetration of LCD monitors remained at 88%.

Moving to LCD television, about 15 million units were shipped compared to 14 million in the first quarter. More importantly, however, the penetration of LCD television into the worldwide color television market was estimated to be 34% in the second quarter, up from 31% in the first quarter.

We know there was some investor reaction earlier in quarter 2 to announcements by two U.S. consumer electronics retailers that their flat panel television shipments were lower compared to the previous quarter. Those announcements were not a surprise to us. Second quarter is typically the weakest quarter for television sales in the U.S., especially compared to a seasonally strong first quarter, which includes Super Bowl discounts. Investors should also note that only about 20% of all color televisions sold worldwide are sold in the United States. Our view of worldwide television demand remains unchanged. We still anticipate approximately 73 million LCD televisions will be shipped this year.

Now moving to an update on our glass mix. Mix of Gen 5 and higher in the second quarter was 88%, consistent with the first quarter. Mix of Gen 5.5, 6, 7, and 8 glass was 52% in the second quarter and slightly higher than the first quarter.

I'll wrap up display by commenting on Eagle XG. Our conversion continues to go well. Eagle XG represented over 70% of our glass production at the end of the second quarter. We are well on track to convert close to 100% of our glass to Eagle XG by the end of the year. SCP has also now begun ramping up Eagle XG production in the second quarter and we have now begun discussions with several brand manufacturers and retailers about promoting the green in our glass as an additional selling point.

Now moving to the environmental segment, sales in the second quarter were $191 million, an increase of 7% over the first quarter sales of $179 million. The increase was due to the continued ramp of heavy duty diesel products and strong auto demand in Europe. Auto product sales were about $128 million in the second quarter, up slightly over the first quarter sales of $123 million. Diesel product sales were $63 million in the second quarter, an increase of 12% over the first quarter sales of $56 million.

We were also pleased to see another quarter of improvement in the environmental segment net income. Segment net income was $14 million in the second quarter, up from $9 million in the first quarter. The improvement in net income was primarily due to higher volumes and stronger manufacturing.

In comparison to a year ago, the environmental segment sales increased 26%, driven by the higher auto and diesel volume. Diesel sales increased 62% over last year's second quarter. While we still anticipate sale of diesel products to grow around 60% for the full year, the ramp of heavy duty diesel products has been slower than we originally anticipated and the lower U.S. engine sales caused by last year's prebuy, as well as some impact of the slowdown in domestic freight shipments.

In the life sciences segment, sales in the second quarter were $78 million, a slight increase over the first quarter sales of $76 million. Segment results were breakeven in the second quarter and consistent with the first quarter.

Now turning to the telecommunications segment, sales in the second quarter were $438 million and consistent with the first quarter. Our second quarter sales were impacted by the divestiture of a non-strategic cabling operation at the end of April. Excluding this divestiture, telecom sales would have been up 5% sequentially. The growth in second quarter sales was lower than we expected, primarily due to weaker equipment sales in Europe caused in part by a labor strike at major customer and a more level purchasing pattern by our major fiber to the premise customer.

Sales of hardware and equipment products were $219 million in the second quarter, a decrease of 4% from the first quarter sales of $228 million. The lower sales were due in part to a labor strike at one of our larger European customers. Sales in our fiber cable products in the second quarter were $219 million, an increase of 4% over the first quarter sales of $211 million. Sales increase is primarily due to strong fiber demand, including projects for premium fiber. Fiber to the premises sales, which are primarily hardware and equipment-related, were $73 million in the second quarter and only slightly higher than the first quarter.

In summary, we believe the weaker-than-expected sales performance in telecom was event-driven, rather than beginning of a market trend. This is evidenced by our higher expectations for the third quarter, which I'll discuss in the outlook.

Net income on the telecommunications segment was $40 million in the second quarter compared to $29 million in the first quarter. As a reminder, the second quarter included $19 million and a one-time gain on the sale of the non-strategic business.

You may have seen our announcement last week about the upcoming expansion of draw capacity at our Shanghai fiber manufacturing facilities. Fiber market volume in China is expected to more than double this decade. Expansion of our Shanghai facility will ensure that we have adequate capacity to meet this opportunity and maintain our strong position in the China fiber market. Expansion will begin immediately and is expected to be completed in 2009. Capital required is included in our previously announced spending plans for the year.

We are also very excited by the new breakthrough optical fiber technology that we announced earlier this week: The technology is based on a nanostructure optical fiber design that will allow cable fiber to be bent around very tight corners with virtually no signal loss. The technology will solve a current technical challenge for telecommunication carriers installing fiber to the home networks, especially in multiple dwelling units. By making fundamental changes in the way light travels in the fiber, we were able to create a new optical fiber that is 100 times more bendable than a standard fiber.

With over 600 million multiple dwelling units around the world and over 25 million in the United States alone, there is a sizable addressable market. We plan on introducing a full suite of new optical fiber, cable, and hardware equipment products based on this nanostructure technology at the fiber to the home conference in Orlando on September 30th.

Now moving to our other segment, sales in the second quarter were $101 million, up 13% compared to the first quarter sales of $89 million.

Moving on to Dow Corning, equity earnings were $88 million compared to $92 million in the first quarter. Excluding the change in tax rates, which drove a one-time gain in the first quarter, equity earnings were sequentially flat as expected. Sales for Dow Corning, which are not consolidated were $1.23 billion, a 16% increase over the last year. Equity earnings for Dow Corning were up 24% compared to quarter 2 of 2006, excluding their major IRS settlement last year.

[MWalk] is having another good year. We don't have any major new capacity coming on stream this year. [MWalk] operations group is trying to maximize output this year. The silicone side of Dow Corning has struggled with raw material costs increases in the first half. They have worked to raise prices to recover some of the gap. We think we have seen the peak in some of these material costs, and are more hopeful for the second half.

Moving to our balance sheet, we ended the second quarter with about $3.2 billion in cash and short-term investments, up from $2.9 billion at the end of the first quarter. Free cash flow was $257 million in the second quarter. Based on our strong free cash flow in the first half and our forecast for the second half, we now believe our free cash flow this year will be in excess of $600 million.

I'm very pleased to report that we recently achieved two very important financial milestones. First of all, all three rating agencies have now upgraded us to BBB+ or the equivalent in the last month.

Second, I'm sure most of you saw our announcement about our decision to return cash to our shareholders. Last week our board approved the distribution of a third quarter dividend of $0.05 per share and approved the repurchase of 500 million of common stock between now and the end of 2008. The aggregate third quarter dividend is estimated to be approximately $80 million in cash.

We have come a long way in improving the financial health of the company to be in the position to take these steps. This decision reflects our confidence in our ability to continue to generate positive free cash flow in the future and being able to continue to invest in our current businesses and emerging technologies. Ultimately, these investments are the primary driver to create value.

We believe the company's on the verge of one of the most productive R&D decades in our history. We will need to make continued investments in research and development and capital spending to commercialize these emerging technologies. These would include, Epic, green laser, single crystal silicon and glass and micro reactors. We believe these investments have the potential to create significant long-term value for our shareholders. I'd like to give you a brief update on some of them in the outlook later on.

Moving down the balance sheet, accounts receivable was $793 million at the end of the second quarter, up slightly from $781 million at the end of the first quarter. Our inventory decreased slightly during the quarter from $685 million to $677 million.

Now turning to the outlook, I would like to wrap up providing guidance on the third quarter. We expect sales to be between $1.525 billion and $1.75 billion and EPS, excluding specials, to be between $0.34 and $0.37.

Moving to our segment guidance, we expect LCD glass volume to be up 10% to 15% sequentially in the third quarter for our wholly-owned business. Based on our first half volume and Q3 guidance, we expect our glass volume to be 37% to 40% higher for the first three quarters over last year. We expect glass volume at SCP to be up between 5% and 10% sequentially in the third quarter.

As a reminder, investors should not model what happened last year in terms of quarterly glass shipments to this year. It is now evident that the supply chain is behaving differently this year as part of its evolution. We are actually pleased with the cycle as it's playing out so far in 2007.

Regarding our third quarter glass pricing, our strategy will be consistent with the first and second quarters.

Moving on to the telecommunications segment, we anticipate third quarter sales to be up around 10% sequentially, excluding the sales from the business we divested in quarter 2. Growth will be driven by an increase in private network projects and demand for hardware and equipment sales in Europe. Equipment demand will be driven by renewed purchasing from a major customer in Germany, as well as a new European fiber to the premise customer.

For your modeling purposes, the cabling business that we divested in the second quarter had $118 million in annual sales last year and made no money.

We anticipate our environmental segment sales will be flat sequentially as increased demand for our diesel products will be offset by seasonally weaker auto demand.

In the life sciences segment, we expect sales to be flat to down 5% sequentially as market demand is seasonally weaker in quarter 3.

Other segment sales are expected to be up 10% to 15% sequentially in the third quarter.

Moving down the income statement for your modeling purposes, gross margins for the company will be between 47% and 48% in the third quarter, a slight increase over our record in the second quarter. SG&A is expected to be approximately 15% to 16% of sales and R&D expected to be around 10% of sales in the third quarter. We anticipate equity and earnings in the third quarter to be up about 10% sequentially, due primarily to increased volume at SCP. Dow Corning’s equity earnings will be consistent with Q2.

Regarding our tax rate for the third quarter, it's expected to be around 17%. The positive one-time tax event that lowered our tax rate in Q2 doesn't reoccur in Q3. The 17% rate includes our forecasted annual rate of 14% to 15%, plus a $14 million increase in tax expense to adjust for taxes caused by a rate change in Germany.

While on the subject of taxes, in February we promised investors we would provide more transparency on this call about when we would have to begin recognizing tax expense on U.S. income. We know this issue is on some investors' minds. I'm delighted to say after our recent in-depth review of our deferred tax asset, we believe that it is likely that Corning will not have to recognize tax expense on U.S. income until 2009 at the earliest. Based on our forecast, we believe our tax rate would move to a mid-20% rate when we do start recognizing U.S. tax expense.

As a reminder, as a company we don't anticipate paying cash taxes on United States generated income for many years. Our net operating loss is approximately $5 billion and does not begin to expire until the year 2023. We'll continue to review our deferred tax assets and update investors in the future if there are any material changes.

Lastly for your modeling purposes, you should again use 1.6 billion shares for the third quarter when calculating EPS before special items. One other comment on shares, as I mentioned in the past, you should expect some executive selling over the next few weeks. As always, for executives who decide to sell stock, we encourage the use of the period after our quarterly earnings announcement. Our senior executives can have as much of 75% of their compensation in Corning stock, and we expect them to monetize some of these earnings, and in fact encourage them to sell small amounts of their holdings every quarter, regardless of price.

One note on the impact of foreign exchange rates on our guidance. Our third quarter guidance is based on a yen to U.S. dollar rate of 122. If the yen to dollar rate were to average two points higher or lower in the third quarter, we estimate our overall sales and net income after tax would be impacted by about $10 million. This includes the projected impact of any currency hedging programs.

Investors should note that we translate our display results every day, so the yen would have to make a drastic move upward at the beginning of a quarter and remain there for the remainder of the quarter to have any material impact on our results compared to our guidance.

Now before moving on to Q&A, I'd like to provide some transparency into our emerging businesses. There has been much investor interest in our R&D program. We will start with Epic, the world’s first high throughput, label-free drug screening system. The system consists of a proprietary reader and a 384 well microplate. Each system will be capable of reading 40,000 wells in an eight-hour shift. The good news here is that the microplates are disposable so you can think about them as our razor blades. We plan on having more than a dozen of these reader machines in place at major labs across the country by the end of the year. There are a number of machines already in place today in the early feedback from those customers has been very positive.

Moving to green lasers, we continue to receive very positive feedback from potential customers on the use of this technology. Our green laser, when with available red and blue lasers and a light engine, can create a full color video capability with high-quality image. The technology could be used in microprojectors for heads-up displays in automobiles, and small portable applications such as cell phones and PDAs. We currently have several customers testing our prototypes. Please stay tuned for further updates.

One more comment on our EPS guidance of $0.34 to $0.37 per share. Keep in mind that our Q2 results are about $0.01 higher due to the one-time Taiwanese tax benefits I mentioned earlier. In the third quarter, we anticipate an adjustment to our German tax rate, which will negatively impact our quarter 3 results by $0.01. The impact of this event will not be treated as a special and is included in our EPS guidance of $0.34 to $0.37.

Ken Sofio

Thank you, Jim. We're ready to take some questions now.

Question-and-Answer Session


(Operator Instructions) Your first question comes from C.J. Muse - Lehman Brothers.

C.J. Muse - Lehman Brothers

First on the tax rate. Jim, can you talk about the negative impact of the $0.01 out of Germany? Is that included in the 17% tax rate guidance?

Jim Flaws

Yes, it is.

C.J. Muse - Lehman Brothers

Could you also provide what a tax rate range would look like for 2008?

Jim Flaws

The tax rate for third quarter is 17% and includes the $0.01. The tax rate for the full year of the company will be 14% to 15%. I don't know for sure the tax rate next year, but I would be very surprised if it was materially different from the 14% to 15%.

C.J. Muse - Lehman Brothers

Some concerns out there about building TV inventory. Can you tell us what kind of visibility you have from your customers, the panel makers, and how far that extends?

Jim Flaws

Well the panel makers give our forecast to us that go out well over a year. The difficulty is always that that they can change those forecasts. Generally they don't do that any shorter than a month away, but we have good forecasts going out well into next year.

Basically, as we saw in the second quarter, people did take more than what they had previously told us they would. So we actually got to a rate of shipping a little bit higher than what we had expected the past quarter, and actually we ended up reducing our inventory. Remember, you may recall we were planning to meet some of the second half demand out of our inventory that we made in the second quarter.

C.J. Muse - Lehman Brothers

On the ASP side of things, do you see a mix benefit coming in the second half? And then for Samsung Corning CRT, is there going to be ongoing negative impact from that business?

Jim Flaws

I don't think you'll see a real positive mix going forward. The overall demand is so large that if there were to be one, it would be very, very slight. Samsung CRT is a challenge to us. You will see in our 10-Q that we release in a few days that we're talking about we expect to see charges of $50 million to $100 million over the course of the next year.

We're obviously, as the CRT business is winding down, their operations are declining, they are laying off people, we're hoping to keep that, a minimal amount, into our regular operating results and hopefully most of the write-offs will be specials going forward.


Our next question comes from Steven Fox - Merrill Lynch.

Steven Fox - Merrill Lynch

First of all, on the bendable fiber product, I was wondering if there's any color you can add about how quickly that could be meaningful to revenues? Is this more like a 2009 type of story? Could it have some kind of impact next year?

Wendell Weeks

We will introduce it later this year. We have a whole brand new suite of products based on this nano structure technology that we're going to introduce at the fiber to the home conference in Orlando on September 30th. We would expect to be in commercial production late this year and we would expect some impact from this beginning in '08.

I think that makes this a little bit difficult to call on timing, Steve, is that this is such a unique product set. There's nothing really like it out there today. Basically you can bend it like copper but you've got the bandwidth like fiber. When you have something that that's dramatically different, it really acts like a platform technology. What we have to do is develop the specific applications and have our customers get used to this really brand new product set. As you may have seen in the Fortune article, Verizon’s comments are extremely positive about it, and they can’t wait for us to finish our development and get it into commercial production.

Steven Fox - Merrill Lynch

Just around the margins, Jim. when I looked at the telecom margins if I did my math right, it looked like they improved even though there was some revenue drag during the quarter. Can you give a little detail on why that happened? With the ramp of green glass in the quarter, is that a net drag or benefit to margins reported for the display business?

Jim Flaws

Telecom gross margin actually was slightly lower than versus Q1, just slightly, so margins didn't really change there. The loss business in Europe was slightly higher mix benefit to us so that was a disappointment. It was a material move, but it was a slight down.

Eagle XG is one of the things that is contributing to our ability to sustain this very high rate of cost reduction. It is a not a negative to us, it is a positive to us. As you saw, our overall performance on gross margins did improve in the display business, and Eagle XG is part of that.


Your next question comes from Nikos Theodosopoulos - UBS.

Nikos Theodosopoulos - UBS

First on the FTTP business. Historically in the last couple of years the business has typically been lower in the second half of the year versus the first half. Do you think that that's the normal seasonality this year, as well? Given the ramps of the deployment do you think the seasonality will be different this year?

Jim Flaws

Well, actually we have yet to have a consistent pattern on this, seasonality on this, perfectly quarter by quarter. But what we do believe is that Verizon with their new ordering systems is more level-loaded. So we're hopeful of that as we go through the course of the year.

Wendell Weeks

One thing I'd add to that is, you may have missed it in the comments, I think the best news on fiber to the premise for this quarter is in our guidance for quarter 3, which is we are saying that we're expecting to add in our revenues in quarter 3 a new significant fiber to the premise customer in Europe. So that will also once again sort of change the pattern of the sales revenue as we bring that other new, significant customer on stream.

Nikos Theodosopoulos - UBS

And on my second question, in listening to some of the panel makers in their recent earnings calls as they give preliminary outlooks for 2008, initial comments from them kind of suggest glass volume growth in the 20% to 25% range.

I know it's early, but do you have a view as to whether that number is a reasonable estimate? Does it look conservative given that the growth this year is going to be 35% to 40%?

Jim Flaws

Well, the percent is going to continue to come down simply because of the embedded base. What we talked about is we grew about 400 million square feet last year; a little over 400 million this year. Our last public update was about another 400 million growth next year. So as a percent, the number is definitely is going to be coming down. We haven't updated that outlook and we will do so the back half of the year after we see the strength of television. The percent definitely has been slowing and frankly it's been slowing for three years.

Wendell Weeks

Nikos, with the quality of your models, what you should be paying attention to is the actual square feet. In our last public update we said it was another 400 million square feet next year and we'll continue to update that as we know more.


Your next question comes from John Harmon - Needham.

John Harmon - Needham

First of all, on the new fiber that you announced is that a platonic band gap fiber and is it manufacturable with normal draw towers or do you need to develop special tools? Secondly, I was curious if there was a way to discuss how aggressively you had to implement your new pricing strategy on LCD glass amidst rapidly growing volumes.

Wendell Weeks

So to the first question on the new nano structured base fiber, I think one of the most exciting things about this product is it's fully standards compliant. It's fully field compliant unlike the platonic band gap fibers, which by the way, I think we still have the highest performing platonic band gap fiber, as well.

The next part was that we can make this on our existing manufacturing platforms, which I think is also very exciting and makes our customers feel very comfortable that we can do it in volume and get good, strong, productivity in cost performance over time. So we are able to get significantly new product features without having to fundamentally change our manufacturing base.

Jim Flaws

On your question for pricing for LCD, maybe you can rephrase, John; I'm not sure I caught what you meant by aggressively.

John Harmon - Needham

On a scale of 1 to 10 or how actively have you really had to withhold volume to keep pricing where you want it to be since you were fairly surprised on the upside?

Jim Flaws

Well, we aren't withholding volume at all to achieve pricing. What we've done is moderately reduced pricing in the first couple of quarters and expect to do that again consistently in the third quarter. While our customers, some of them aren't thrilled with the moderate level compared with the prior year, they're all taking glass and obviously in some cases taking more than they originally told us. We're not doing any withholding to achieve the pricing.


Your next question comes from Curt Woodworth - JP Morgan.

Curt Woodworth - JP Morgan

I was wondering if you could comment on the sequential margin performance in the display business. It seemed like margins were only up a little bit sequentially despite a pretty massive operating leverage ramp on the volume. Any thoughts there would be appreciated.

Jim Flaws

Well, we were delighted with the gross margin moving up. It's not going to move around violently. Pricing was down a little bit in our cost performance was also down and two of those things contributed to a slight uptick in gross margin. But we were delighted by the improvement. You should not expect to see gross margins move up and down 5 points in a quarter. The business doesn't move that way.

Curt Woodworth - JP Morgan

So it looks like margins were up about 100 basis points on a 20% ramp in volume. That's kind of a fair way to characterize the leverage?

Jim Flaws

The gross margins were up slightly more than that but it's very complicated. It depends on how much glass we ran, whether we were taking it out of inventory, running the finishing lines. It's not a simplistic this is what the fixed cost is. As you may remember, what is best for us is to run our glass tanks full all the time.

Curt Woodworth - JP Morgan

In terms of your comments on the inventory build at the set top maker level, are you seeing that reflected in any change in panel-maker utilization rates currently today?

Jim Flaws

No, we are not. That's what leads us to believe that the panel-making industry is behaving quite rationally about this. We don't think there's any alarm out there about it being backed up at the set assembly level. We think this is a more rational approach to dealing with the dynamics of television being so second half loaded. So we have not seen any change in utilization rates in the third quarter as a result. In fact, we are seeing demand move up move up in the third quarter.

One of the things that I'm hopeful investors understand is that when you think about our original expectations for the quarter and what we would have had as expectation in the third quarter in terms of sequential increases, we moved up quicker in the second quarter. We're not seeing it go down. They're moving up again, getting to the level we would have expected.

Curt Woodworth - JP Morgan

On the new fiber customer in Europe, can you quantify at all the potential there? The fiber to the home deployment or any other color would be appreciated.

Wendell Weeks

This is a full fiber-to-the-premise application, so fiber-to-the-home. It will have a revenue opportunity per home similar to what we have with our existing U.S. fiber to the premise customer. It is significant in size. So if they continue with this program, it is a very significant add for us.


Your next question comes from Jeff Evanson - Sanford Bernstein.

Jeff Evanson - Sanford Bernstein

A couple questions on the bendable fiber. One is wondering if you could give us any insight into your revenue opportunity per home? Second, Jonathan Swartz, Sun CEO recently commented on his blog that in their designs for data centers, they are often limited in what they can do by the bend radius of fiber, and wondering if your new fiber has any opportunities on the private network side?

Wendell Weeks

Two great questions. It is early, still Jeff for us to give guidance on the pricing with which we will enter the market with this new product. It will be a premium product, but the exact amount of it we have yet to determine, or at least we're unwilling to talk about at this point in time.

To the second point that you raise about data centers, private networks and that in many ways bend radius is a significant problem in those applications, this a platform technology. We expect to turn next to the premises and data center market. That would be the next priority and we think this definitely has applications in that market, as well.

I should also add that right now where you hear us concentrating is on the fundamental concept of you can bend this like copper, but you still have the bandwidth like fiber. You should also note that this is another very interesting attribute from this process which we developed to embed the nano structures in the cladding to better capture light in the core that brings other optical properties that is we think we can exploit in a variety of different markets and applications above and beyond; and be used in the public network as you point out, data centers.


Your next question comes from Ajit Pai - Thomas Weisel Partners.

Ajit Pai - Thomas Weisel Partners

Just looking at your fiber demand, a lot of it right now is being driven by FTTX and just given some of the shorter reach applications also typically require less of strands of fiber within a cable. Can you give us some color as to your overall volume how much is FTTX right now? Over the next two to three years, total number of fiber miles, how much you'd expect that to shift to?

Secondly, I think you did talk about the fiber demand. In the near term, you are probably not seeing a trend. Can you give us a status update on Concord and whether things there are ramping at the pace which you expected? Also when you'd sort of reach a capacity utilization benchmark of above 20%?

Wendell Weeks

Well, let's adjust both questions. Let me start with your second question because I think it is important to note that in Q2, the event we were talking about with a major European customer having a labor strike, that primarily impacted our hardware and equipment business. Overall demand in Europe for fiber was pretty good.

We continue to be on track in Concord and then you seen our announcement in China, as well. We anticipate China demand to double in this decade on an annual basis, which is why we're expanding our Shanghai operations, as well. The bulk of this demand will be in the access piece of the market.

Yes, the strands are as you point out, shorter, but there's a lot more of them. Really 80% or more of the future fiber demand is tied up in the access pieces of the market because there's so many more connections to be done.

Ajit Pai - Thomas Weisel Partners

The second question would be just looking at your competitor dynamics and capacity coming online at the two competitors in the display business, [Sahi] and NEG the two largest, could you give us some color as to you think the amount of capacity they are bringing online is exceeding market growth or whether it's lower than your projected market growth?

Jim Flaws

We believe that our major competitors are bringing on capacity just slightly above our view of the end market growth. It's not even by quarter. Both of them have very large tanks. When they bring on a tank in a quarter, it might seem like a large mount.

What we have seen by their public announcements and obviously looking at construction of their sites, we think what they're bringing on is basically just slightly above the end market growth that we've been forecasting for glass.


Your next question comes from Brant Thompson - Goldman Sachs.

Brant Thompson - Goldman Sachs

I was wondering as we look into the back of the year and into next year it seems in the back of this year you will certainly running your glass tanks pretty close to full. You'll be transitioning almost everything to the Eagle XG glass and the cost reductions that you have been doing on an annual basis over the last several years seem on track, too.

We've seen gross margins increase pretty steadily for the overall company for the last couple of quarters. Why shouldn't that continue into next year? Should we be thinking about margins closer to 50% for next year as we look at that trajectory and those trends in your business? Thanks.

Jim Flaws

Brant, I'm not quite ready to give 2008 guidance. But what we believe is if our pricing strategy and LCDs continues to work in the next year at moderate level and we keep up cost reduction, that would be good for display business. We're quite delighted with the high margins in display where they are today. Depending on the relative mix of display within the overall corporation and the growth rate in the other businesses, that will determine the corporate rate.

Clearly, diesel should be a real help again next year if we are correct about the impact of prebuy fading away, and we should see a big improvement from diesel. It's more likely that our gross margin for the corporation will grow again next year, but I'm not prepared to give a number at this point.


Our final question comes from Andrew Sussman - UBS.

Andrew Sussman – UBS

My question centers on the transition from production of fiber from Wilmington over to Concord. The first thing I was hoping that you could remind me as to when that is going to stop. I also wanted to know the new nano-enhanced product, the fiber product, is that going to be produced in Concord or in Wilmington? The final question is, how should I think about the operating, gross and other margins during that transition?

Wendell Weeks

First, Andrew, we're not transitioning from one plant to another. What we're doing is we're actually just adding to our overall production by restarting our Concord plant. Also, of course, with our expansion in China, as well. Our current plan is to produce the nanostructure enhanced fiber in Wilmington.

Jim, I'll leave it to you on the margin answer.

Jim Flaws

What we've talked about before is the Concord restart would cost us about $5 million. So it really is not material to this year. Once Concord has restarted next year, its variable margins will actually be the same as Wilmington. It'll be a contributor at that point in time. It really isn't going to be much of a distortion this year and will be a contributor this year.

To wrap up I have a few comments. First of all, Wendell and I will be meeting with investors during a lunch session in Boston on July 31st. If you're interested in attending, please contact Ken.

Wendell will also be presenting at the Citigroup technology conference in New York City on September 5th. On September 19th, Kay Asbeck, our SVP of Finance, will be presenting at the Bank of America conference in San Francisco. So we hope to see you at one of those events.

Regarding our results for the second quarter, we could not have been more pleased. The company hit all time records for gross margin, net profit after-tax, and EPS before special items. A very pleasing accomplishment, particular when you note that our current gross margins are actually higher than at any time during the telecom market boom of '99 and 2000.

We think we're heading into the third quarter with excellent momentum. In display the television market looks solid, Eagle XG is well on track and our pricing strategy is working. In diesel, we're seeing the 60% year-over-year revenue growth and in telecom, there's obviously a lot of excitement about our new bendable fiber.

We hope that investors are pleased with the news on our tax rate for this year being lower than we originally expected and also the longer term view for 2008 and 2009. We also hope investors are pleased with the share buyback and dividend announcements from this past week. We promised investors that management and the board would address this topic this year and we have.

Lastly, looking forward, we continue to believe our strategic framework is working. We are executing on the businesses of today. We're investing for the businesses of tomorrow and are continuing to protect the financial health of the company.

Thanks for joining us this morning and we look forward to seeing you in the very near future. Ken.

Ken Sofio

Thank you Jim, thank you, Wendell and thank you all for joining us. A play back of the call will be available beginning at 10:30 a.m. Eastern time today and will run through 5 p.m. Eastern time on Wednesday, August 8th. To listen dial 402-220-9725. No password is required. The audiocast is also available on our website during that time.

Operator, that concludes our call this morning. Please disconnect all lines.

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