Corning Incorporated
Q3 2005 Earnings Call Transcript

Published: 31 Oct 2005

[Operator:]

Good morning everyone. Welcome to the Corning third quarter Conference Call. OPERATOR INSTRUCTIONS I would now like to turn the call over to Mr. Ken Sofio, Direct of Investor Relations. Sir, you may begin.

[Ken Sofio:]

Welcome to our third quarter conference call. Also, welcome to the people on the webcast. Jim Flaws, Vice Chairman and Chief Financial Officer will lead the discussion this morning and Wendell Weeks, our President and Chief Executive Office will join for the Q&A. Before I turn it over to Jim, you should note that today's remarks do contain forward-looking statements under the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve number of risks, uncertainties and other factors that could cause actual results to differ materially. These risks are detailed in our SEC reports. Jim?

[Jim Flaws:]

Thanks, Ken. Good morning, everyone. Last night we released our results for the third quarter, which can be found on our Investor Relations website. In addition, for those of you with Web access we posted several slides this morning that will summarize the key data points from this morning's prepared remarks. The slides will be available on our Website after the call as well. Regarding our third quarter results, we are obviously very pleased to report sales near the top end of our estimate and earnings per share that were significantly higher than our expectations. Let me share with you some of the details. Sales for the third quarter were 1.188 billion, an increase of 4% over the second quarter sales of 1.14 billion. Third quarter sales driven primarily by higher volume in the display segment offset, by lower telecommunication segment sales. In comparison to the third quarter of last year sales were up 18%. Net profit after-tax excluding special items was $405 million in the third quarter, an increase of almost $100 million or 32% over the second quarter. In comparison to the second quarter of last year, net profit after tax excluding special items was up about 90%. A brief historical comment, this very strong NPAT is much higher than any quarter in 2000 when leaf fiber was at its peak. Earnings per share, excluding special items, were $0.26 in the third quarter and much higher than our expectations. This was an increase of 86% in comparison to our EPS x-specials a year ago. You should not, these are non-GAAP measures and a reconciliation to GAAP can be found on our Website. Our strong earnings performance was primarily the result of higher volume, improved manufacturing performance and display. I really should note that our third quarter results did benefit from nonrecurring tax benefits, which contributed almost $0.02 per share. Without this benefit, our EPS was still $0.02 above the top end of our guidance range. Now first, we were profitable in the U.S. during the third quarter, which helped reduce our overall corporate tax rate to 16%. Improved profitability was the result of higher royalty income and lower spending. In addition, we reached a settlement with the IRS on the audit of our 2001 and 2002 tax returns, which allowed us to release reserves about $15 million during the third quarter. This combination of these two items contributed about $0.02 to our third quarter results. You should not anticipate the same $0.02 benefit in the fourth quarter. You should also note that third quarter sales in NPAT were negatively impacted by foreign exchange used in translation during the third quarter versus the second quarter. Sales in NPAT were impacted by approximately $23 million each. Now, let me quickly walk you through the special items for the quarter. We reported a pre and after-tax charge of $68 million, or $0.04 a share, related to the ongoing mark to market adjustment on Corning shares to be contributed to the Pittsburgh Corning settlement. The charge was the result of substantial increase in Corning share price during the quarter 16.62 to 19.33. In September we had announced restructuring charges of $28 million pre and after tax, or $0.02 a share, primarily related to cost reduction initiatives in our telecom segment. We also announced in September, that Samsung Corning or equity invested that produces glass panels and funnels for CRT monitors and televisions would incur restructuring and impairment charges in the third quarter. Our share of their charges was $106 million after tax or $0.07 per share and is reflected in our equity earnings. This is the result of the rapid growth of LCD products, particularly LCD monitors, which has negatively impacted demand for conventional CRT products. We expect Samsung Corning to record additional impairment charges as future decisions on assets and work force are made. These decisions will likely not occur until 2006. We expect our share of those additional charges to be approximately 30 million. It is possible that the third quarter charges may be adjusted in future quarters as Samsung plans are finalized. One final reminder, these charges are all non-cash to Corning. We also, have determined that a separate impairment of Samsung Corning investment asset held on our books was not required in the third quarter. However, we will continue to monitor this closely as Samsung Corning completes its restructuring plans. For your reference, the asset value at September 30 on our books was $233 million. You should note that further deterioration of the CRT market could result in further restructuring charges at Samsung Corning and an impairment of the investment on our books. You can find a reconciliation of all these special items on our Investor Relations website. Gross margins were 46% in the third quarter, much higher than the second quarter and our own expectations. The substantial improvement was due to higher volume and strong manufacturing performance in our display segment. Equity earnings were $74 million in the third quarter, including the $106 million charge related to Samsung Corning. Excluding that charge, third quarter equity earnings were higher compared to the second quarter earnings of 172. The higher equity earnings were primarily the result of strong volume performance at Samsung Corning Precision, offset slightly by lower equity earnings at Dow Corning, which had been expected. I'll discuss SCP and Dow Corning results in more detail in a moment. So, let's move on to our segment results for the quarter. Starting with display, sales were $489 million in the third quarter, an 18% increase over second quarter sales of $415 million. The increase reflects sequential volume growth of 22%, flat pricing and an unfavorable change in the end. As a reminder, when I refer to LCD glass pricing it is on a mix weighted basis. Equity earnings from SCP were $114 million in the third quarter and much higher than their second quarter equity earnings of $85 million. As a reminder, equity earnings in the second quarter for them included approximately $10 million of one-time charges. Sequential volume growth for SCP was up 22% and their pricing was flat also, As a result, Sequential volume growth for our consolidated display segment, including our wholly business plus SCP was up 22% in the third quarter. Net income in display segment, which includes equity earnings, grew almost 50% from $243 million to $363 million. The significant growth in display segment net income was primarily the result of the volume growth, strong manufacturing improvement and also our lower tax rate in the Corning in the quarter. We recognize that the allocation taxes can be confusing and that is why we show it is a line item in our segment results. Where it fundamentally displays incremental sales translated into margin at a high rate. Gross margin in the third quarter, our wholly owned business, approached levels closer to SCP's performance. The increase in gross margin was the result of strong manufacturing performance. In comparison to the third quarter of last year, sales in our display segment grew 65%, primarily due to volume gains of 73%, offset by price declines of 2% and unfavorable exchange rates. Net income, including equity earnings, increased 155% in comparison to the third quarter of last year. Now, I'd like to spend a few minutes updating you on end market trends during the third quarter. I would like to stress we do not have perfect information. We use a variety of sources ranging from services that are available to you such as display search and retail tracking vendors; as well as our own discussions with customers and our own models. We think this information is useful but it is not perfect. With that in mind, you should know the following data has been derived from this aggregated industry. Sources that are considered this time to be only preliminary estimates. Final data for the third quarter will not be available for another month. Be clear, the data I'm referencing here relates to shipments from PC manufacturers and television set makers to retailers. The preliminary data end market shipments is tracking ahead of our forecast for all three end products, notebooks, monitors and televisions. Starting with notebooks, about 15 million was shipped in the third quarter, which is higher than our expectations. Increase of 13% over the 13 million shipped in the second quarter. Overall, we believe notebooks were about 31% of all computers sold. Turning to LCD monitors. About 24.5 million were shipped in the third quarter. Also higher than our expectations. In third quarter, we believe penetration of LCD monitors to total monitors sold was 69%, compared to 67% in the second quarter. For LCD televisions, approximately 5 million were shipped in the third quarter, a 16% increase over the second quarter. LCD television penetration was about 10% in the third quarter and consistent with the second quarter. We continue to believe that LCD television penetration is on track to be 10% of televisions sold for the entire year. As a result of the strong LCD television shipments to date, we now believe the market may do better than the 19 million shipped for year, which original which is higher than our original forecast at 18 million. A crucial factor for what will drive LCD television demand will be pricing. And we are encouraged by the pricing environment over the last 12 months. During that time retail prices for 32 and 26-inch televisions have fallen over 40%. You should note that our third quarter volume was the result of increased demand for Gen5 and higher glass. In second quarter Gen5 and higher accounted third quarter 77%, which was up from 75% in the second quarter. The mix of Gen5.5, 6 and 7 glass was about 33% in the third quarter, up from about 25% in the second quarter. Regarding our Taiwanese customers and their ongoing mix fab ramps, they appear to be generally on track. We're pleased to see that Taiwan panel shipments in September hit another all record high. Regarding our customer deposits, we received $155 million in cash in the third quarter and additional $13 million in October as expected. Including the $234 million received in the first half, our total cash from customer deposits this year was $402 million. We're pleased that all the deposits this year have been received on time. In the second quarter we also began issuing credits against these deposits as the customers began to purchase glass under the agreements. Credits issued $11 million in the third quarter and are now $13 million year-to-date. I would like to take a few minutes to address several market related topics that investors have asked us about over the past. You should note the following represents our opinions based on historical data, our models and discussions with customers. Our objective here is to share that data with you so you can form your own opinion on these topics. First topic pertains to inventory in the supply chain. There were several reports during the quarter that there was excess inventory in the channel especially for televisions. While we feel that there will always be a risk of excess inventory in the channel, we are not seeing it right now. In fact, recent announcements by Sharp indicated shortage of 32 and 37-inch TV panels. Our own analysis indicates LCD television inventories have increased marginally but within normal levels for this time of year. The TV business is more seasonal and the level expected to be double last year. So, we should be seeing more inventory to support the end market. Please remember the LCD television level is doubling versus last year. We have also called 14 set makers and their observations are that there is not excess inventory. Back supplies of certain large sizes are tight. We also believe there is not a significant amount of panel inventory at our customers' panel makers. As a reminder, there are certain metrics that investors can look at to gauge the level of panel inventory. One way is to monitor the monthly panel shipment data that is published each month by the Taiwanese panel makers. Another way is to monitor panel pricing. In times of rising panel inventory, panel makers will typically lower panel prices significantly to stimulate demand. Current data indicates the panel pricing was fairly flat in September for both LCD monitors and LCD televisions across all sizes. Nevertheless, we intend to watch inventories closely and sell through and be prepared to moderate production if we detect a backup. There has also been concerns expressed about panel over supply in the first half of 2006. While we cannot predict what the panel supply demand balance will be in future quarters, we can share with you how we view this balance and what we have seen historically. First, you should note that the panel supply and demand is hardly ever in perfect balance. In fact, since our record keeping began in 1998 the panel market has either been in a state of shortage or surplus. For most of 1998 there was a surplus of panels in the range of 5% to 15%. In '99 there was a shortage of between 10% to 15%. In 2000 to 2001 there was a surplus between 10% and 15%. And from '02 to '04 the panel market fluctuated between surplus and shortage. The takeaway here is panel supply and demand is always in flux. For investors, the key question here should be what levels of shortage and surplus are acceptable? What decisions were made by the panel makers during previous over supply and shortages? And what happened to glass demand during these previous cycles? Regarding what is an acceptable level of panel shortage or surplus, there is no clear-cut answer. To gain an understanding of the current market, we review the number of weeks of panel inventory and panel makers, monitor set makers and TV set makers. Today our analysis shows that inventory did grow during the third quarter but at expected levels given the seasonal nature of the consumer electronics industry. We believe inventories should peak within next month and then begin to decline as seasonal purchases accelerate in November and December. Regarding an over supply next year, there was a research firm report in September that predicted a 10% panel over supply in the first half of '06. It is too soon to comment on next year because we have not seen the fourth quarter sell-through. But investors should know that the industry has experienced 10% or higher over supply several times over the past eight years, without an impact to glass demand. While we cannot predict what will happen in ‘06, the determining factor for glass demand next year, will be the continued penetration rate of LCD monitors and LCD televisions. It is also important to note how panel makers have traditionally behaved during periods of panel shortage and panel surplus. During a shortage of panels, panel makers have typically increased prices, leading to higher profits and to capital spending for investment in new capacity. This eventually has led to over capacity and excess panels. During periods of this excess panels, panel makers reduced prices to stimulate demand, hurting their profits and reducing the amount of capital to invest. These lower prices eventually fuel demand, which again tightens available capacity and starts the cycle again. It is important to note these historical surpluses that drive panel prices down are necessary to drive the penetration to the overall industry growth. The take away here is there is a long history of panel shortage and surplus and panel makers adjust both price and capacity accordingly. The last question is; what has happened to glass demand since 1998 during these periods of panel shortage and surplus. Despite these shortages and surpluses, LCD glass demand has grown each year since 1998. In '99 during the 15% surplus of panels LCD glass demand grew 39%. During the 10% to 15% panel shortage of '99, LCD glass grew 85%. In 2001, LCD glass demand grew 40%, despite a surplus of panels by as much as 15%. And for those investors who are worried about glass pricing in times of panel over supply, the average price decline since 1997 has been 5% per year. Excluding '03 and '04 when glass pricing was relatively flat, pricing has fallen in the upper single digits on average since 1997. The main point here is even in times of panel over supply there may not be a correlating impact to glass volume and price. The key for us remains, to pace our glass demand with end markets not panel capacity. Which brings me to the next topic, seasonality. We've received a lot of questions on seasonality and how it impacts glass demand. Up till now glass demand has been driven by the penetration of LCD monitors and now starting LCD televisions. Seasonality has actually been more of an undercurrent to our demand. Something that we knew was there but did not impact us significantly. That will not always be the case. We clearly understand now that our glass business is strongest in the second and third quarters. However, if LCD television penetration progresses the way we think it will next year, this may overshadow the impact of seasonality. You should also note, it takes about three to four months for our glass to show up in a television monitor at retail level. So by and large the glass we shipped in the fourth quarter will be for products sold at retail in the first quarter. Glass shipments made in the first quarter show up, for the most part, in retail stores in the second quarter. With that in mind let me spend a few minutes discussing seasonality trends. First, for desktop monitors, sales have remained fairly evenly distributed by quarter for the last several years. Even sales of LCD monitors are fairly consistent quarter to quarter with only a slight trend upward towards the end of the year. Despite the fourth quarter up tick, you should note over the last five years, LCD monitor unit sales have been flat to up 15% sequentially in the first quarter due to penetration. Color TV sales have historically been more weighted to the fourth quarter but not as much as what you may think. You might be surprised to learn that the second biggest month of color television sales worldwide is January. As consumers make decisions ahead of such events as the SuperBowl and Chinese New Year and every four years, the Olympics. Over the last five years between 27% and 30% of all color TV sales in a given year occurred in the fourth quarter. So, while there is some sequential decline in color TV sales in the first quarter, it does not tend to be significant. For LCD television sales there obviously is less historical data. The data does suggest an even heavier weighting towards the fourth quarter. Over the last four years, between 37% and 41% of LCD televisions sold in a given year were sold in the fourth quarter. As a result, there has also been a sequential decline in LCD television sales into the first quarter. However, given the increased LCD television penetration, declines have been comparable to what we've seen historically in color television overall. So, while we're not providing specific display volume guidance for the first quarter, I can offer a few thoughts. Our glass demand will be driven by the continued penetration of LCD monitors and televisions. We expect the penetration of monitors and televisions to grow sequentially in the first quarter. We believe there will be a normal sequential decline in LCD TV unit sales in the first quarter. Although, we do expect to see twice as many LCD televisions sold in comparison to the first quarter of '05. Lastly, our first quarter glass shipments will most likely be used to fill the growing pipeline to meet second quarter end market demand. The last topic I would like to address for the investors is the potential impact of higher energy costs on consumers decisions to purchase big ticket items such as an LCD television. Why we cannot predict the future and the decisions consumers may make in light of higher living costs, we can share with you how color TV sales have fared during other historical re cessionary periods. This may provide some groundwork for your modeling regarding LCD television demand. In summary, the data indicate that during re cessionary times consumers continue to purchase color TV's. What we've found is the worldwide color television sales have increased almost every year since 1963 when they were first introduced en masse to the public. Going back to '63 there have been a number of recessions in the U.S. and worldwide. Specifically, in the United States we had recessions in '80, '82 and '90. In each of those periods, color television increased on an annual basis of 4% to 8%, which is in line with color TV growth projections today. We believe this was due to consumers need to save costs by traveling reducing travel and staying close to home and eliminating other entertainment choices. The only period of time when color television sales fell in consecutive years was during the global recession of '73 to '75. And during those two years color TV sales fell 13%. The '73, '75 recession is now 30 years and ago and we need to be careful translating consumer behavior then to today. It's important to point out, there are fundamental differences between that market and the one that exists today. First in 1973 color TV represented 50% of all televisions sold. In other words, in about ten years color TV had penetrated half the market dominated by black and white TV's. Today, LCD television represents 10% of television sales and its footprint is much smaller. In addition, there are numerous market factors that influence consumers decision to purchase a television today that did not exist in the '70s. Back then your choice was either black and white or color. Today consumers have a wide range of different TV choices. From LCD to plasma to DLP and other projection technologies. In addition, consumers are often driven to purchase these higher end televisions because of better content, technology such as the 16 by 9 format, high definition DVD and DVD players. High definition television content and digital signals overall. In summary, we do not believe that today's higher energy prices will materially impact consumer decisions to increase 23

[Ken Sofio:]

Great. Thank you Jim and we are ready to take questions now.