Corning - Earnings Call - Q3 2011

Transcript

Speaker 5

Ladies and gentlemen, thank you for standing by. Welcome to the Corning Incorporated Quarter Three 2011 results. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will be given at that time. If you need operator assistance, please dial star, then zero. It is my pleasure to turn the call over to Mr. Ken Sofio, Vice President of Investor Relations. Please go ahead, sir.

Speaker 0

Good morning. Welcome to Corning Incorporated's third quarter call. This morning, James Flaws, Vice Chairman, Chief Financial Officer, will have some prepared remarks before we move to the Q&A. These remarks do contain forward-looking statements that fall within the meaning of the Private Securities Litigation Reform Act of 1995. They involve a number of risks, uncertainties, and other factors that could cause our actual results to differ materially. These risks are detailed in the company's SEC reports. Jim?

Speaker 4

Thanks, Ken. Good morning, everyone. Hopefully, you've had a chance to read the press release we issued this morning on our third quarter results. If you haven't, a copy can be found on our Investor Relations website. We had a good quarter, with sales approaching $2.1 billion, which is up 30% year over year, and with EPS excluding special items at $0.48. In summary, telecom, environmental, specialty materials, and life sciences all had significant year-over-year growth. Glass volume in our wholly owned display business did better than our revised expectations from early September. SEP volumes did not decline as much as we anticipated, but were still down significantly sequentially. Our third quarter results did benefit from the strengthening of the yen. I'll come back to the quarter in a minute, but I'd like to highlight our key messages this morning.

First, third quarter glass volume in our wholly owned business was up sequentially in the mid-single digits, but down more than 20% at SEP. We did regain share at our wholly owned business in Q3, but SEP lost some share. Second, price declines in Q3 were in line with our expectations. Third, retail demand for LCD televisions remained strong throughout September. The data we have so far for October in the U.S. also shows good demand. Despite the continued strong retail environment, panel makers ran at much lower utilization rates during the third quarter, especially in Korea. The strong retail demand in Q3, coupled with lower production rates, led to a significant contraction in supply chain inventory during the quarter. We believe supply chain inventories exited the quarter around 14 weeks. Looking ahead, we expect Korean panel maker utilization rates on average to be higher in Q4 than Q3.

Utilization rates outside of Korea in Q4 will be comparable to Q3, but will vary by panel maker. Volume at our wholly owned business in Q4 will be flat to down slightly compared to the better-than-expected volume levels in Q3. Volume at SEP is expected to be up at least 20%, due primarily to our regaining share and higher utilization rates at panel makers. We expect pricing pressure to be more significant in Q4 than in previous quarters. As we told you before, our glass typically enjoys a price premium in the market. Pricing varies by customer depending on factors such as the amount of glass they purchase from us, but by and large, our glass sells at a premium worldwide. Over time, if that price premium becomes too high at a particular customer, we will feel more pressure to reduce price to narrow the gap.

Pressure could become even greater when there's excess glass capacity available, which is the case now. As a result, we will likely lower pricing to a greater degree than we have in previous quarters in order to keep our premium at an acceptable level and maintain our market position. At Dow Corning, we're seeing significant price declines in silicones. In polysilicones, spot pricing is declining and will now affect Hemlock's spot sales. Dow Corning's equity earnings could be down as much as 40% sequentially. We expect to see normal seasonal fourth quarter declines in other businesses such as telecom, environmental, and life sciences. In Specialty Materials, sales will be lower sequentially, reflecting lower parts demands for tablets, as well as a potential start of a cyclical downturn in the semiconductor industry.

Lastly, we are very pleased to announce we've reached an agreement with Samsung to increase the cash dividend from SEP effective in 2012. Now, turning to our third quarter results, Q3 sales were $2.1 billion, an increase of 3% over Q2 and 30% over last year. All of our segments posted solid double-digit % growth over last year. Earnings per share, excluding special items, were $0.48 in Q3 and consistent with Q2. Our Q3 EPS benefited from the reversal of compensation accruals in the quarter, which was probably $0.025. The strengthening yen also benefited our results by almost another $0.02. The third quarter gross margin in terms of dollars was an all-time record for Corning at $978 million. Gross margin % increased as we had expected, from 44.3% in Q2 to 47.1% in Q3. The growth was primarily driven by strong operating performance in Display and Specialty Materials.

Q3 gross margin included about $16 million in one-time benefits, including the adjusted compensation accruals. As a reminder, Q2 had included $8 million in project spending that did not repeat in Q3. Excluding these one-time items, gross margin increased about 2 % points in the quarters. SG&A was $216 million compared to $284 million in Q2. The significant decrease was primarily due to lower compensation accruals, as well as a $22 million post-transaction credit. We treated this credit as a special item. RD&E declined to $166 million, or 8% of sales, and was also impacted by the lower compensation accruals. Equity earnings were $324 million, a decrease of 24% from Q2, driven by lower volumes at SEP and softer silicone demand at Dow Corning.

Other income was $27 million in Q3 versus $43 million in Q2. The decrease was primarily due to lower royalty income, which is, of course, a direct result of lower sales at SEP. NPAT, excluding special items, was $766 million and up slightly versus the second quarter. Including special items, NPAT was $811 million and EPS $0.51. The special items included a foreign tax credit of $26 million and a post-transaction accounting adjustment. Both net profit after tax and earnings per share, excluding special items, are non-GAAP measures, and you can find a reconciliation to GAAP on our website. Now, I'd like to turn to the segment results, and I'll start with display. Sales were $815 million, an increase of 7% over Q2 and stronger than we expected. Volume was up in the mid-single-digit range, and price declines were in line with our expectations.

Q3 results also benefited from the stronger yen. Display gross margins were higher in Q3 versus Q2, a reflection of the higher volume. SEP volume was down more than 20% sequentially, and price declines were in line with our expectations. While the Korean panel makers did run at lower utilization rates on average in Q3 versus Q2, SEP also lost some share in the quarter. We expect to regain this share in Q4. For your modeling purposes, SEP's third quarter LCD sales were about $850 million, a decline of 23%, or $250 million from the second quarter. Our gross margins also fell significantly, driven by the lower volumes. Now, as a reminder, this represents SEP's LCD sales only. Our public filings will report their total sales, which include CRT glass and other products. Equity earnings from SEP's LCD business were $222 million, down 30% from Q2.

The lower earnings reflect a significant decline in volume and lower gross margin. All in all, our total glass volume, including SEP, was down about 10% in the quarter. This is a comparison to a worldwide glass market that also declined 10%. Now, this may be a good time to educate some of our newer analysts and investors to the display industry, specifically on differences between glass shipments, panel maker utilization rates, and panel shipments. Historically, there's been a high correlation between glass shipments and panel maker utilization rates. This makes sense intuitively because the higher production rate, the more components like glass are being used. However, there is little correlation between glass shipments and panel shipments. Most of our analysts know this, but it's worth the refreshers.

On this slide, you can see the sequential change in worldwide glass shipments to panel makers and then panel shipments to set assemblers by quarter for the last three years. Note that in six out of the last 15 quarters, one increased while the other declined. This is mainly due to fluctuations in panel inventory. The takeaway here is investors need to be cautious and not always assume glass shipment and panel shipments will move in the same direction every quarter. Now, as we told investors throughout September, panel inventories would likely decline during the quarter as panel makers would run at lower utilization rates, but demand for panels would continue. In Q3, panel shipments in total were up about 4%, while worldwide glass shipments were down about 10%. Again, the difference is panel inventories.

To parse it even further, panel shipments outside of Korea were flat sequentially, while industry glass shipments outside of Korea were down 5%. However, our glass shipments were up in the mid-single digits, indicating we regained share during the quarter. Now, turning to Korea, panel shipments were up 7% sequentially in Q3, while the industry's glass shipments in Korea were down 15%. SEP shipments were down more than 20%, so we did lose some share in Korea. Based on how much total glass shipments declined in Korea, it is not as much as some reports indicated. At the retail level, we believe shipments from retail to consumers increased 19% year over year in the third quarter, reflecting continued strong demand.

As a result of the lower glass shipments into the supply chain and the higher shipments of product out of the supply chain, weeks of inventory contracted significantly during the third quarter. We believe the supply chain contracted by about three weeks, from 17 weeks at the beginning of Q3 to 14 weeks exiting the quarter. Inventories in square feet are at a level we have not seen since early 2009. Now, turning to retail, we have complete worldwide data for August and some data by region for September. As a reminder, our retail data always lags. It takes between four and six weeks for our vendors to accumulate and analyze the data. As you can see on this slide, worldwide sales of LCD televisions were very robust in Q3. Unit sales were up 37% in July and 11% in August.

The lower August number reflects the completion of the digital conversion in Japan, which occurred at the end of July. For the first eight months of the year, LCD TV unit sales are up 20% year over year, in comparison to our full year forecast of 13%. We do have some September data as well. In the U.S., television demand grew up 13%, which is actually the strongest growth rate we've seen all year, following growth rates of 10% in July and August. For the first two weeks of October, sales in the U.S. are up 13%. In Japan, sales were down 51% in September, which is in line with our expectations. As a reminder, LCD television sales shot through the roof in the third and fourth quarter last year as the Echo Point program was ending. Comparisons will continue to get tougher.

Last September, the growth rate in Japan was 80%. It was 221% in October, and in November, it was 435%. I'd like to point out at the bottom of the slide are the unit growth rates year over year without Japan. We believe if you peel away the wide fluctuations driven by the ending of the Echo Point program last year and the digital conversion this year, you'll get to a cleaner picture of how growth rates have been this year. As you can see, actual growth rates are much smoother month to month. We also look at growth rates on an area basis versus the unit basis. It's actually a more meaningful metric to us since we sell glass by the square foot. On this chart, you'll see the growth rates by quarter, including and excluding Japan.

The call from the previous slide, we expect LCD TV units to grow 13% this year. However, the fastest growing category televisions has been 40 inches and larger, and this is happening in developing regions too. As a result, area growth is larger. All in all, LCD TV demand at retail continues to look good. I hope you all saw our product announcement yesterday. Lotus Glass is a new environmentally friendly, high-performance display glass developed to enable cutting-edge technologies, including OLEDs and next-generation LCD displays. The thermal consistency of Lotus Glass allows it to retain shape and surface quality during high-temperature processing. This helps guard against thermal sag and warp, which improves the integration of components onto the glass. Lotus is already in production in our factories. In telecommunications, demand continued to be robust in Q3. Sales were $560 million, up 2% versus Q2 and 21% versus last year.

Growth was in line with our expectations. Enterprise networks and fiber-to-the-home demand continues to be strong, both sequentially and year over year. Enterprise network sales were up 10% over last year, while fiber-to-the-home was up over 30%. Optical fiber demand was also very robust, up over 20% versus last year, driven primarily by North America, Europe, and China. Net income, excluding that one-time post-transaction accounting adjustment of $22 million, was $60 million in Q3, an increase of 30% sequentially and 46% year over year. In Environmental Technologies, third quarter sales were $247 million and slightly lower than Q2. Versus last year, sales were up 19%. Sales were slightly lower sequentially than our expectations due to lower market demand for light-duty filters. Net income was $32 million in the third quarter, flat for Q2, but up significantly over last year.

In Specialty Materials, Q3 sales were $299 million, an increase of 6% over Q2 and up almost 90% versus a year ago. We again saw a significant gross margin expansion in this segment led by Gorilla Glass. Segment income grew significantly from $23 million to $38 million. Gorilla Glass sales were $210 million in Q3, an increase of 11% over the second quarter. In Life Sciences, sales in the third quarter were $153 million and basically flat with Q2. Versus last year, sales were up about 22%. About half of that year-over-year growth is due to acquisitions. Now, turning to Dow Corning, Q3 sales were about $1.7 billion and were flat with Q2. We had stronger poly sales, but were offset by weaker silicone demand. Earnings were impacted by higher raw materials costs and also benefited there from lower compensation accruals in the quarter.

Equity earnings for us were $89 million in Q3 versus $95 million in Q2. I'll have some more details on Dow Corning and the outlook in a moment. Now, looking at the balance sheet, we ended Q3 with about $6.4 billion in cash and short-term investments versus our current and long-term debt of just $2.3 billion. Free cash flow was a positive $269 million in Q3. The largest outflow in the cash during the quarter was capital spending, about $640 million. CapEx will come in at, of course, slightly lower than our $2.4 billion estimate for this year. Looking ahead to 2012, we now anticipate our capital spending will be closer to $1.8 billion versus our previous estimate of $1.9 to $2 billion. As you know, we've been working for some time with Samsung to move towards a larger cash dividend on a more consistent basis from SEP.

As I mentioned in the past, we prefer increasing the percentage of annual dividend payout versus having to negotiate a special dividend. We are delighted to report today we've reached an agreement to increase the payout from 40% to 70% effective in 2012. This represents a significant increase in annual dividends from Samsung. Now, onto our outlook. In display, we expect our total glass volume, which includes our wholly owned business and SEP, to be up more than 10% sequentially. At our wholly owned business, we expect volumes to be flat to down slightly. Our panel maker utilizations are expected to be slightly higher on average in Taiwan. They are estimated to be lower in Japan. At SEP, volumes are forecasted to be up at least 20%, due primarily to the company regaining share and higher utilization rates at panel makers.

We expect gross margin to rebound close to Q2 levels on the higher volume. We expect the overall glass market to be up about 10% sequentially. As I mentioned in the opening, we expect pricing pressure to be more significant in Q4 than in previous quarters. We will likely lower pricing to a greater degree than we have in previous quarters in order to keep our price premium at an acceptable level, allowing us to maintain our market position. Pressure to lower prices has become greater due to the availability of excess glass in the market. Remember, as a glass maker, we have several levers to adjust our output. These levers include slowing new capacity, accelerating tank repair schedules, and delaying the relight of tanks that are coming out of repair.

Corning and SEP expect to implement these levers as required to align supply with demand and minimize any inventory build. We expect supply chain inventories to fall again during the quarter, assuming the pace of retail continues and that we've estimated panel maker utilization rates correctly. Based on our models, we expect weeks of inventory to fall below 14 exiting Q4. In our telecom segment, we expect fourth quarter sales to be down 10% to 15% sequentially. This reflects normal seasonality and project timing. Compared to last year, Q4 sales would be about 10% higher, and for the full year, telecom sales will be well north of $2 billion, or about 20% higher than 2010. We expect sales in our Environmental Technologies segment to be down 5% to 10% and Life Sciences to be slightly lower sequentially, reflecting the normal seasonal declines in these areas.

In Specialty Materials, sales are expected to decline 15% sequentially across all product lines, and this does include Gorilla. We don't have a lot of history on the seasonality in Gorilla yet, and also we do know our customers are now improving their yields with glass. Obviously, very alert to the potential impact to the economy on consumer spending for purchases of smartphones and tablets. Gorilla right now is one of our toughest businesses to forecast because we have no reliable reporting information on inventory. Moving to the income statement, we expect our Q4 corporate gross margin to decline approximately 3%, due primarily to the higher price declines in display, lower Gorilla Glass volume, as well as the non-repeat of the $16 million in one-time benefits in Q3, which, as a reminder, was mostly compensation accrual reversals.

SG&A is expected to be about 15% on a lower sales basis, RG&E around 9% of sales. We expect equity earnings to be down 5% sequentially. Higher equity earnings at Samsung Corning Precision Materials will be offset by lower earnings at Dow Corning. We anticipate Dow Corning sales to be flat sequentially, but gross margin earnings to be much lower. There's been softer demand in the worldwide silicone market, placing further pressure on pricing. Earnings will also be impacted by the non-repeat of lower compensation accruals. These are the primary reasons why we expect Dow Corning's equity earnings to be 40% lower sequentially. Dow Corning is also feeling the effects of the turmoil in the solar industry. The reduction of solar incentives and increasing inventories across the value chain have led to a softening in demand for solar materials, including poly.

We also already know one customer has announced they'll be exiting the solar module market, and there could be others. This softer market, combined with ample poly supply, has led to significant price declines in the poly spot market, which is likely to increase pricing pressure on Hemlock's long-term supply agreements. Now, as a reminder, it's important to remember that Dow Corning only owns 63% of Hemlock, and we own 50% of Dow Corning, so the relative impact of Corning's consolidated results is somewhat muted. However, we'll continue to monitor the solar situation, provide updates as needed. Lastly, in other equity earnings, there'll be a $12 million charge related to idling and manufacturing assets associated with Specialty Materials. Moving to taxes, we expect our Q4 and our overall 2011 tax rate to be around 15%. Investors should note that movements in the yen to U.S.

dollar exchange rate influence our results. For your modeling purposes, for every one point move in the yen, our sales and net income move by about $9 million. The net income impact includes SEP, where a stronger yen would also improve their results. Now, before we move to Q&A, I'd like to share some top-level thoughts about the display industry and glass market. You'll recall we entered 2011 forecasting the glass market to be approximately 3.7 billion square feet. In the end, it's likely to finish around 3.2 billion. About a half of this 500 million square foot disconnect was the result of weaker than expected PC and television demand. The other half is due to the contraction of the supply chain in the second half. In fact, this is the first time we have seen retail demand in square foot exceed glass demand for us in a given year.

What's important to note here is, despite a weaker retail environment, retail demand will still be up 13% year over year this year. This gives us confidence when supply chain correction ends, we'll see glass market growth again. Looking ahead to 2012, we expect retail demand to grow, potentially in the double-digit range again, and assuming the supply chain continues to run at these historically low inventory levels and does not contract further, glass demand would be consistent with retail demand. Of course, we could see even more robust glass market if the supply chain were to increase inventory levels, perhaps to 15 weeks. The bottom line here is the supply chain will enter 2012 at inventory levels close to historic lows, and if retail continues to hold up, then 2012 glass demand will be stronger. That completes my formal comments this morning, Ken.

Speaker 0

Great. Thank you, Jim. Robert, we're ready to take some questions now.

Speaker 5

Thank you. Ladies and gentlemen, if you wish to ask a question, press star then one on your touch telephone. You will hear a tone indicating that you've been placed in queue. If you are using a speakerphone, please pick up the handset before pressing the numbers. Once again, to ask a question, press star then one. Our first question comes from the line of Amir Praswedowski from Barclays. Please go ahead.

Speaker 4

Thank you very much, and good morning, Jim and Ken.

Speaker 0

Morning, Amir.

Speaker 4

Jim, just as your closing comments, you spend a lot of time talking about the retail demand on the end market versus glass shipments. Obviously, we're at historic lows here based on your estimates, and we've started to see some of the Korean folks indicate that they're picking up utilization rates. When do you think that transition could take place? Are you seeing any emerging signs that that transition could take place where glass shipments could more closely mirror retail demand here, or are you still cautious about that in terms of visibility? We are obviously coming closer to the holiday season here, and it feels like at some point there has to be a decision made in terms of utilization and increasing inventory in order to meet that demand.

Speaker 0

We have seen an increase in utilization in Korea already. That's where the biggest reduction was in Q3, and we think that they've now increased and obviously had the capability of getting televisions to retail around the world, both for the holiday season and, as a reminder, in the U.S., television demand remains strong in January and February, driven in some cases by things like the Super Bowl. We believe we are starting to see that. I can't say for sure that people won't drive inventory lower, but it definitely feels like there has been a response upward now after these cutbacks in Q3.

Speaker 4

Do you feel from a channel inventory perspective that this is sort of the new level at which folks are going to be operating, so that perhaps a pickup in demand wouldn't necessarily result in an increase in weeks of inventory, or do you feel like there has to be some level of snapback at some point to prior levels?

Speaker 0

That's a great question, Amir. We've actually commissioned a project to determine, as this industry moves into maturity, whether in fact it can run without creating out of stocks at a lower level inventory. There's some reason to think that in developed markets. On the other hand, we know the supply chain is actually longer to the less developed areas of the world where, of course, LCDs are now showing up in significant proportion. We'll have a more definitive answer in quarter one. I think our expectation is it's unlikely that we'll ever leap back up to the 17-week kind of level. We're hopeful that we can stay in the 13 to 14-week level. If it just stabilized there, then we could see this retail demand flow through to us as glass makers, and that'd be great.

Speaker 4

Fantastic. Lastly, if I may, I know there were some comments in your prepared remarks around the Specialty Materials growth and sort of lack of visibility in terms of forward growth outlook. I was wondering, obviously, our checks have been suggesting that tablet growth remains strong, smartphone growth remains fairly strong in this environment. How should we think about sort of the growth dynamics of that business? Do you expect that to be sort of dependent on specific product launches of your customers, or how should we think about sort of normalized growth levels there?

Speaker 0

It's very hard for us to give you a % in growth. We do expect significant growth next year. We continue to have, in the smartphone area, more people putting Gorilla Glass on phones. We're not experiencing competition as we go to get on a new phone. It happens, and people don't change glass on a phone mid-model. They do it when there's a new model. For the year next year, we're expecting growth in volume terms. It's a little harder for us to predict quarter by quarter because we have no reliable inventory information in this business, and also because it's such a new business. Customers actually have manufacturing losses as they finish the glass to put it into phones or tablets, and we think they've been improving their yields, and that is having some impact on our demand right now.

My last comment would be that one of the other things that we have is we do have a mixture of selling glass as well as selling finished parts. We don't sell finished parts to that many people. We do to some, and that's an area where in the fourth quarter we're seeing lower part demand, and that's really customer specific.

Speaker 4

Great, thank you very much for the incremental color.

Speaker 5

Thank you. Next, we'll go to the line of Mark Soon, RBC Capital Markets.

Speaker 1

Thank you. Jim, there's some notion that retail demand may be backwards or present-looking while panel makers' intentions are forward-looking. If the macro environment that we're in persists, can we get to a scenario where glass volumes can contract as they did in 2008, or is that magnitude highly unlikely? Just trying to think of the scenarios that you might be planning for internally. On the price cuts, is this just a one-quarter phenomenon? How do we think about prices going forward? Does the rate of decline return in the first quarter, or do customers become trained on potentially more price cuts?

Speaker 0

I'll take the latter one first on price cuts. Over the last five years, we've had several periods where price declines were stronger in a given quarter, and then they returned to be at a lower level. That's obviously our hope. I can't guarantee that, but I can demonstrate to you that there have been, this is the fourth time, but there have been three times before that over the last five years where there was a period of time when panel utilization was down. There was obviously excess glass demand that led to bigger price declines. We obviously don't want to give up our market position, and then after that, price declines went to a more moderate level. I can't guarantee that, but that's really what has happened in the past.

Relative to the economy, I'm actually not an economist, but clearly, with the high % growth we've seen in television so far this year, as you can see, we're not expecting that to be, when we get to the holiday season, that we'll have the same %, but we do expect them to be up. We have historically seen that, by and large, consumers continue to spend money in consumer electronics in tough times. In fact, last year in the U.S., an example when television demand was weak, we're not sure that it was really the economy so much as the industry got it wrong in trying to force a lot of high-priced product on them. We've seen historically that consumer electronics has been a good demand even in tough times, and we're not counting on that.

We do think television manufacturers will continue to fine-tune their offerings, perhaps to be more on the lower end. As a reminder from us, from a glass point of view, we're happy to sell the same amount of glass in a low-end 40-inch television as a high-end 40-inch television. In terms of smartphones and tablets, we think they're likely to remain a viable purchase. In tough times, people back away from cars, they back away from homes, they back away from going out to dinner. They do go to movies. We're not sure, but maybe the panel makers are right. Maybe they're seeing something that we're not, but I think that we think most of the reduction has been around inventory, and when you don't make much money, you don't want to take much inventory risk.

Speaker 1

That's helpful. Maybe just on Gorilla Glass, as we look at that opportunity, have you had some time to kind of recalibrate the magnitude of that? Is it still kind of an $800 million opportunity? Does that nudge higher considering the resilience of some of the products? What are your thoughts on just kind of cover glass for Gorilla applications on TVs? Is that starting to percolate as well? How should we kind of think about that over the longer term?

Speaker 0

We're obviously disappointed with cover glass on televisions for our experience this year. First of all, Sony did not put them on as many models as we expected. Second of all, we haven't gotten any other manufacturer to move ahead on this. That being said, Corning is kind of a stubborn or patient company. We actually believe frameless designs will become more successful, and we hope that Gorilla Glass will be part of that. We think as television manufacturers figure out a way to make the picture go closer to the edge of the screen, that they, in fact, will be likely to adopt more of a frameless design, and we think there's technologies that could enable that to happen. It's been a disappointment.

Investors probably shouldn't count on a lot of help from TV cover glass for Gorilla Glass this year and next, but we're long-term players, and we think it definitely could be an opportunity going forward.

Speaker 1

That's helpful. Thank you, and good luck, gentlemen.

Speaker 0

Thank you.

Speaker 5

Thank you. We'll go to the line of Rod Hall from JPMorgan.

Speaker 6

Good morning, guys. Thanks for taking my question. Jim, I guess my main question is regarding this. The inventory shrinks out there in a channel, and it doesn't feel like we know exactly what the bottom is. You would think that the manufacturers might be looking to suppliers like you to help buffer some of that, the lack of inventory out there to make sure supplies continue to run. I'm just wondering whether you would anticipate having to carry more inventory yourself in order to somehow buffer out that lower inventory out in the channel, if there are any other effects on your business that way that we ought to be thinking about.

Speaker 0

We haven't experienced that yet. We definitely have rebuilt our inventories to be what we call normal level, but obviously now have excess glass capacity. I mean, we try to limit our own glass capacity to be closer to end demand, but obviously, we're going to retain some flexibility. Should our customers crank up suddenly, we can try to respond to them. We right now are not planning on carrying excess inventory.

Speaker 6

Okay, they're not pushing you to build buffers or anything like that.

Speaker 0

That's correct.

Speaker 6

Okay. I just wanted to follow up. You'd mentioned the manufacturing asset for Specialty Materials that you shut down. Could you give us more color on that? I'm not sure if you said anything in the comments. I didn't catch anything.

Speaker 0

Gorilla is not going to hit our original estimates, so we are throttling back manufacturing of Gorilla because we're obviously not above $800 million this year. We had the capacity to do that, and we don't have the demand. Obviously, the biggest miss is TV cover. We are throttling back some of that manufacturing, and that's going to be a drag in Q4.

Speaker 6

Is that like one tank worth or more? Can you give us any idea of what the order of magnitude of the reduction in capacity is?

Speaker 0

No, I'm sorry. I won't do that for competitive reasons.

Speaker 6

Okay. All right. Thanks a lot, Jim.

Speaker 0

Thanks, Rod.

Speaker 5

Thank you. Next, we'll go to the line of Wamsi Mohan from Bank of America Merrill Lynch.

Speaker 1

Yes. Thank you. Good morning. Jim, can you help reconcile the commentary around the expectation of glass inventory exiting this year below 14 weeks or well below 2009 levels, yet increased pricing pressure given excess glass supply? I guess my question is, is there a certain number of weeks of inventory that we can look to to expect the price pressure to revert back to normal declines?

Speaker 0

I wouldn't relate the pricing pressure at all to the weeks of inventory and supply chain. I just want to remind you what the weeks we're talking about. We're talking about the combination of panel inventories, set assembly inventories, and retail inventories as we measure in that total square foot equivalence against retail demand. We don't think that really has much impact on pricing. Where it has an impact on pricing is not the absolute level. It's when panel makers are trying to reduce inventory. They're obviously selling more than what they're buying from us. Therefore, that's a period of time when they try to appeal for higher price cuts. Clearly, the glass industry in total had built capacity around the growth this year, as I indicated in my remarks, to get up to potentially service 3.7 billion square feet. Clearly, there's enough glass capacity to do that.

It's when you have a combination of more glass capacity than demand, and that is accentuated when the panel makers are cutting inventory that you get more price pressure.

Speaker 1

The net conclusion being 14 weeks of inventory, but there's a lot more at glass than at other parts of the supply chain?

Speaker 0

We don't measure the supply chain other than when we say the supply chain, we're measuring what is glass embedded in panels at a panel maker, what is glass embedded in finished sets at a set assembly level, and what is glass embedded in televisions at a retail level.

Speaker 1

Okay. Thanks. As a follow-up, can you give a little more color on what changed in the end of September that caused the volumes at SEP to be down 20% versus the 35% that you expected when you reported last quarter? Did you institute any price cuts within the course of the third quarter itself? You might have mentioned it. I might have missed that. Thanks.

Speaker 0

We did not institute any pricing in Q3, or pricing was as we had expected. It wasn't 35%. It was 30%, I believe, and we were above 20%. I'll just say that, in the end, from what we thought when we got Labor Day, what our customers finally took was a little bit more, but there was no special action on our part to make that happen.

Speaker 1

Okay, thanks, Jim.

Speaker 5

Thank you. We'll go to the line of Nicholas Diodasopoulos from UBS. Please go ahead.

Speaker 3

Yes. Thank you. I guess the first question, just getting back to the Gorilla outlook for the fourth quarter, the sequential decline, how confident are you that this is not a share loss situation? It just seems to me that it's still young in the business, and since you haven't sold a lot of TV cover glass, that you should be tracking pretty well the growth of smartphone and tablets, which I think people are expecting to be up sequentially in the fourth quarter.

Speaker 0

Nicholas, we're pretty confident it's not competition. We're very hard-pressed to actually find a competitive device that actually has any of our competitors' glass in it, except for one earlier this year when we couldn't supply everybody. We're not feeling them in terms of when we go into competition with somebody and price pressure, so we're pretty confident against competition. What we have less visibility on is the amount of inventory people have bought, how rapidly they're improving their yields, which were quite low initially, and that may be having an impact on us. We think those things probably are having more impact on us than any competition is. We're also struggling a little bit with mix among our customers. Some customers have not been as successful as others, and that's had some impact on us against our expectations. Clearly, those customers did build some inventory.

Speaker 3

Got it. Okay. Back on the pricing commentary, it seemed like your competitors used price specific to Korea in the quarter to capture share, and you're responding. What's your sense of why that doesn't continue into the first quarter next year, given the weak demand outlook? What's the confidence that it doesn't persist beyond the fourth quarter?

Speaker 0

I won't comment on our competition and what they're doing. I'll just say, as I did in my earlier commentary, we've experienced periods in the past where we've had a combination of where glass demand has been weaker, whether that's from retail, but usually, it's from panel makers wanting to cut the amount of inventory they have and glass capacity in the industry being greater than that. That's often the opportunity where we see more price declines. We then would reduce our price premium over our competition, and we'd move back to more normal price declines. As I said earlier, I can't guarantee that's going to happen, but clearly, that's what we want to happen, and that's what's happened in the past. We intend to price to maintain our position. We're not the price leaders, but we intend to price to maintain our position.

Speaker 3

Okay. Just one last question, Jim. You know, from time to time, you give updates on cost reduction that you've achieved in display. Do you have a sense of what that will be this year for the company?

Speaker 0

I think it's going to be quite good, but I'm not prepared to give out a number this year. I mean, we'll probably talk about it at our investor meeting in February.

Speaker 3

Okay, thank you.

Speaker 5

Next, we'll go to the line of Jim Suva from Citi. Please go ahead.

Speaker 3

Thank you, Jim, and congratulations to you and your team there, Corning.

Speaker 0

Thank you, Jim.

Speaker 3

Can you maybe quantify a little bit by what you mean by pricing pressure to be a little bit more significant? I mean, there's ranges out there all the way. Are we talking down 5%, 10%, 15% quarter over quarter? It really does move the model quite a bit, and a little bit of commentary that would be appreciated. The follow-up question, Jim, would be, is with Chinese New Year now earlier this year and China surpassing North America for sales, thereby underscoring the importance of China, shouldn't kind of calendar Q4 demand for glass and pricing kind of be strongest in Q4? What are we looking at for seasonality going forward, given the importance of China compared to North America used to be the most important continent?

Speaker 0

I would say in Q4, we would think that the glass demand will be the highest, slightly higher than it was in Q2. That hasn't always been the case in this industry. Clearly, China is very important. The holidays in China, as you know, are more difficult to gauge because even though some of them fall exactly on the same date every year, sometimes they move around. Also, what's really happened in China is the promotions around holidays have expanded. It's made it a little more difficult to say, "It fell exactly during this period of time." Definitely, China is becoming more important. That's one of the reasons why we're investing in China, and particularly around our supply to BOE, who's starting to ramp their Gen 8.5. China is an important part of our mix going forward, and we expect it to provide quite a bit of growth.

Regarding pricing, I'm sorry I have to disappoint you. I'm not going to quantify it, but I will just say in Q4, it'll be up significantly over Q1, Q2, and Q3.

Speaker 3

Okay, thank you very much, Jim.

Speaker 5

We'll go to the line of George Notter from Jefferies. Please go ahead.

Speaker 4

Hi. Thanks very much. I just wanted to ask about some of the other kind of non-traditional competitors in the glass market. Are you seeing AvanStrate? Are you seeing LG Chem? Any signs that those guys are finally going to produce quality glass at some point in the future? Thanks.

Speaker 0

Avenstroth has always produced quality glass. They just have not been that large a player in terms of capacity, nor that much of an upsetter to the industry in terms of significant price moves or capacity additions. Basically, they have been, you know, they can make glass for all generations, including Gen 8. LG Chem, we haven't experienced at all. We know they've started melting glass in, I think, May or June, and we have not felt them at all. We know that they have made a few pieces that they provided to panel makers. We'd love to get a piece to test, but we don't believe they're making quantities of good glass at all.

Speaker 4

Do you anticipate that those guys can come into the market at some point in the future and be successful competitors, or is that still a view that says the barriers to entry in the space are really significant? For example, I think in times past, you guys have been pretty downbeat about the idea that they could be a real competitor longer term. Is that still the case?

Speaker 0

The challenge is pretty great for them. They're using the float technology, which only one of our competitors uses. We're well down the cost curve, and they're just getting in for the first time, and the product requirements keep getting higher. For example, going to thin, the glass keeps getting thinner. It's not when they made this decision to get into the business three years ago, the product line has changed, and our customers' requirements continue to ramp up also. For example, recent announcement of Lotus for OLEDs. Clearly, our customers want a higher temperature-capable glass. We'd say the barriers remain very steep, but we'll see if they come out and put this on our chief query in life.

Speaker 5

Next, we'll go to the line of Joshua Spector from Goldman Sachs. Please go ahead.

Speaker 2

Thanks very much. Jim, can you just also update us on your latest thoughts on OLED specifically, especially now that you have come out with a product for that technology? Certainly, it seems like Samsung is getting more optimistic on the ramp there, and it's our understanding that OLED TVs will use one less piece of glass longer term. How do you view the penetration of that technology and its potential negative impacts on your opportunity?

Speaker 0

We feel we're delighted with our Lotus introduction. We have a glass that Samsung is qualified to use in their small generation OLEDs. They remain effectively the world's only volume producer of OLEDs. We work at providing a glass for OLED production in larger formats. We are looking to improve our glass for use in TFT oxide production capability. We have a customer who wants to use Eagle XG for that, and we're working to improve the thermal characteristics of that. As always, you've heard us say before, we're fundamentally arms merchants, and we will make a glass that will meet our customer's needs. If, in fact, someone's going to go to only one piece of glass, we'll have to deal with that. We don't expect that to be the case.

We have some information that some of the large OLED televisions that are being shown this week in Asia, again, are still using two pieces of glass. I think this remains a hope from some people that they can go to one piece of glass. It's not clear to us that they'll get to performance, nor the cost, because the cost of glass continues to go down at a very rapid rate. We're alert to it, but I think our Lotus development is exactly what we expect to continue to do. As people try to move to Gen 8 OLEDs, we'll have a product for them, and we think in the end, we'll be able to prove that glass can be the second piece in the product. We've obviously got to make that happen, and that's what we're working on.

Speaker 2

Thank you for that. Just another follow-up on the pricing dynamics. In the past, when you've had those couple of examples or instances when you had to take corrective action in pricing, it was pretty short-lived. This time, though, it seems like we've had a negative profit margin for the panel makers for more than three quarters now, and it looks like it's going to last well into next year. If you add into that mix the OLED transition and the move to thin glass, wouldn't you kind of paint a picture that maybe structurally we're entering a period of a greater pace of glass price decline?

Speaker 0

I think that's speculation. I mean, we know what history was. We know that we will be assertive about maintaining our market position, but I'm not going to speculate on the quarters going forward. I think our job is to deliver a product to our customers that helps them by being better and improving their processes. We will be price competitive, but I can't, you know, I'm not going to make speculation about where the industry is going going forward.

Speaker 2

Okay. Thank you, Jim.

Speaker 5

Thank you. We'll go to the line of Ann Nicholson from Barclays. Please go ahead.

Speaker 3

Yeah, good morning.

Speaker 0

Good morning.

Speaker 3

A couple of quick questions. The first is on your telecom business. It was probably the strongest quarter in terms of revenue and profitability you've delivered, I think, in almost 10 years, since 2001. Just looking at that, I know you've guided to normal seasonality for the December quarter, but can we expect those metrics over the next couple of years to continue to improve, or do you think we're at some kind of peak? Also, first that, and then I'll ask the others.

Speaker 0

We think telecom is in a very good position. Obviously, you know it remains a capital spending decision by our customers, so they always can change. We think our innovation has really paid off, and we're quite confident about the fiber-to-the-home projects. Our technology in enterprise has been a winner, and clearly, the world needs more fiber, and a lot of that is driven by data usage is up, wireless is up, and a very strong demand for fiber. You know, I won't say that it will improve, but you know our own plans show for good growth for telecom over the next few years.

Speaker 3

Is it safe to assume that the margins from these sort of operating margins of 20% plus can continue for that business?

Speaker 0

Yes. I believe that our operating margin in this business will be strong. The products that are seeing the most demand are a higher margin mix. I think our operating margins in telecom will remain strong.

Speaker 3

Are there any capacity constraints for Corning right now in that business to continue to grow?

Speaker 0

There definitely are capacity constraints, and we are spending some capital in telecom for the first time in basically 10 years.

Speaker 3

Got it. The second question is just looking at what's happening in the photovoltaic or the solar markets, and you've given us some commentary on Dow Corning or Hemlock seeing some weakness there. Have you reprioritized your investments in glass for the overall photovoltaic opportunity on the TFT side?

Speaker 0

No. We're completing the tank that we designed specifically for this. We still remain hopeful that we will have a customer committed to it. We think the overall developments in the solar industry actually put more reason why someone should turn to using a thin film, using a glass that raises their efficiency, and we continue to believe our glass will do that. We've had some exciting new developments in terms of the progress we're making on proving our glass is good for our customers and their efficiency. We're continuing to move ahead with it. It might be wrong, but we're continuing to move ahead, and I think we still remain hopeful for next year.

Speaker 3

Got it. The last question is, just looking at the stepped-up dividend from Samsung Corning and users of cash, the M&A environment, you talked about focusing a little bit more on M&A over the past couple of years. Could you give us some color as to whether that focus has changed or you're still looking at potentially bolstering your other businesses outside of display? I think you've talked about telecom and life sciences as potential areas. Has there been any change in that or greater interest in that?

Speaker 0

I'd say there's greater interest in us using some of our excess cash flow to supplement our growth in telecom and life sciences, and we're trying to do that. We obviously want to spend the money wisely, but we definitely have that as a higher priority.

Speaker 3

Got it. Thank you so much.

Speaker 0

Thank you.

Speaker 4

This is Ken. I'm going to interject quick. We're approaching 9:30 A.M., and I'm going to be respectful of folks who got to jump off at the market open. We're going to take one more call. I know there's quite a few people who are still in the queue. If your question did not get answered, please call Ann and I after the call. Rob, we'll take one last call.

Speaker 5

Thank you. We'll go to the line of Ehud Gelblum from Morgan Stanley.

Speaker 4

Hi, Ken. Hi, Jim. Thank you very much. I appreciate getting in there. Jim, on the lower CapEx guidance, can we interpret that to mean that you're converting less tanks to Gorilla after you replace them? Is that the reason for that?

Speaker 0

It's in our glass industry that we are spending less capital.

Speaker 4

Okay. Appreciate that. On the Gorilla side, there's been a lot of talk here about strong end-user demand for iPads and such for Gorilla in Q4. Is there, which is out of concert with what you're talking about for your Gorilla shipments, but is there any lead time involved? For instance, did you ship a lot of Gorilla, perhaps, in Q3 that will go into that strong Q4, and perhaps are we looking at maybe your Q4 Gorilla shipments are more to supply the end demand in Q1, or the lead time is only a couple of weeks, so we should assume that retail demand in a particular quarter is equal to your Gorilla demand?

Speaker 0

We don't have a good metric on exactly how long the supply chain is yet for Gorilla Glass, so it's hard for me to judge. I will say that we believe we shipped a little bit more in September as a result of the Chinese holiday, and therefore, there's a shutdown in production. That may be part of it. We just don't have a good model yet, like we do in display, about exactly how much inventory the yields at our customers and how much inventory they're carrying.

Speaker 4

Appreciate that. On the glass side, I appreciate you're not wanting to talk about your own pricing actions in Q4. Is there a sense that you can give us as to what your competitors do with pricing in Q3?

Speaker 0

No, I think you'll have to ask them.

Speaker 4

Okay. A quick question on the telecom side. There have been comments from other companies further and further down the supply chain in the equipment vendor side, claiming that there have been fiber shortages in various parts of the world in the telecom side. Are you seeing demand for fiber outstripping yours and others' supply? I mean, does that jive with what you're seeing that there could actually be expanding lead times on telecom fiber?

Speaker 0

Fiber has definitely been tight for most of this year, so that's definitely the case in terms of lead times expanding. We do not believe it goes to double ordering, though.

Speaker 4

Okay. Finally, on the thin glass, we've seen some reports out of panel makers recently talking about there being a big move towards thin glass over the next couple of years, much faster than I was expecting, so that possibly in 2013 or so, we could see a vast majority of TVs from certain manufacturers start moving over to thin glass. How quickly do you think that, are you seeing that, first of all, and how quickly do you think we're going to get to 50%, 60%, 70% of your glass shipments into TVs being thin glass? From what I saw, it looked a little bit faster than I'm expecting.

When that happens and your competitors actually will fully get there as well, how do you measure or balance the pluses of having better gross margins out of your tanks from producing thin glass versus there being additional supply of glass, therefore, in the market than there was today, maybe 40% or so more, and how that impacts pricing? How do you balance those two forces?

Speaker 0

What we would say is that, first of all, we continue to see good acceptance of thin by our customers. As a reminder, our customers have to change their process a little to take thin glass, so it's not as easy as when they just make a composition change, but we're continuing to see that move ahead. It is in our plans, and I think in most of the industry's plans, that over the next four-year period of time, the thin moves up well over half the glass being taken. I think all the glass-making industry has taken this into account in planning their incremental glass additions. We think the glass industry will be slowing its glass capacity additions quite a bit, and you should expect to see that reflect in our numbers, and it wouldn't surprise me if we saw it in the entire industry.

I think the industry is preparing for this, and I don't think the pace is going to come as a surprise to many people.

Speaker 4

Terrific. One last question, if I could, on the Hemlock side. The expansion that's either occurring now or shortly will be occurring in Tennessee, would there be any change to those expansion plans given what seems to be going on in the market?

Speaker 0

We expect to continue with our Tennessee expansion. Whether how many phases of it, I think, is something that obviously has to be looked at, but clearly, right now, we have a need for the first part of it.

Speaker 4

Appreciate it. Very helpful. Thanks so much.

Speaker 0

Thanks to you, Jim. Just a couple of closing remarks, if I could. First of all, we will be presenting at three conferences this quarter. November 15th will be at the UBS Technology Conference in New York. November 29th will be at the CES First Boston Technology Conference in Scottsdale. On December 8th, we'll be at the Barclays Technology Conference in San Francisco, and we really hope you can join us at one of these events. We also have a date now for our annual investor meeting in New York City. It will be held on Friday, February 3rd, starting at 8:00 A.M., and we'll end around noon. If you would like to see more details or register, go to our Investor Relations website.

Speaker 5

A couple of other comments. It's obviously a difficult economic environment, and we're dealing with a significant contraction in the display supply chain in the second half. I remind people we're on pace to reach $7.9 billion in sales this year, which would be the highest level in Corning's history. Even during these tough times, our telecom business will top $2 billion, and our diesel business will actually exceed $500 million for the first time ever. Our newest product, Gorilla Glass, is expected to triple in sales, and it already has become our second highest gross margin product. We think the sales growth this year gives us confidence that we're still on track to reach our goal of $10 billion by 2014. Lastly, we continue to feel very confident about our long-term business prospects and our ability to generate cash on a consistent basis.

We recently took action consistent with this long-term outlook. We announced a $1.5 billion stock buyback program and a 50% increase in our quarterly dividend. Increased dividends move our yield up to approximately 2.5% based on our current stock price. Regarding the share buyback, our decision was based on the opinion that the company's current stock price represented a significant discount to the real value of Corning's businesses. We understand the short-term concerns relative to recent macro events, but our board's recent action reflects our belief that the long-term value of our businesses is substantially greater than our current share price. We expect to be active in the market, repurchasing our stock very soon.

Speaker 0

Ken, thank you, Jim, and thanks to everyone for joining us today. A playback of this call will be available beginning at 10:30 A.M. Eastern Time and will run until 5:00 P.M. Eastern Time on Wednesday, November 9. To listen, please dial 800-475-6701. The access code is 219706. Audiocast is also available on our website during that time. Robert, that concludes our call this morning. Please disconnect all lines.