Corning Incorporated
Q1 2006 Earnings Call Transcript

Published: 26 Apr 2006

[Operator:]

Good morning and welcome to the first quarter results conference call. (Operator Instructions) I would now like to turn the call over to Mr. Ken Sofio, Director of Investor Relations. Sir, you may begin.

[Ken Sofio:]

Thank you. Good morning and welcome to Corning's first quarter conference call. This call is also being audiocast on our web site. Jim Flaws, Vice Chairman and Chief Financial Officer, will lead the discussion. Wendell Weeks, President and Chief Executive Officer will join for the Q&A. Before I turn it over to Jim, we should note today's remarks do contain forward-looking statements in the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially. These risks are detailed in the Company's SEC reports. Jim.

[Jim Flaws:]

Thanks, Ken. Good morning, everyone. Last night we released our results for the first quarter which can be found on our Investor Relations web site. In addition, for those of you with web access, we have posted several slides this morning that will summarize the important data from this morning's prepared remarks. These slides will be available on our web site after the call as well. Regarding our first quarter results we were obviously very pleased to be able to report sales and earnings per share that were higher than our expectations. Our sales were $1.26 billion, up 20% over last year. Our EPS before special items was $0.27, significantly over our guidance range of $0.21 to $0.23 and also over First Call consensus of $0.23. Before I go into more details on the quarter and our outlook I'd like to address our disclosure regarding our restatement of prior year's results. We discovered we had made an error in the accounting for the 2003 Pittsburgh Corning settlement. The error was discovered internally. We promptly reported the error to PricewaterhouseCoopers, our auditors and the audit committee of the board of directors. The adjustment impacts our reported results for the first quarter of 2003, the quarter we initially recorded our contribution to Pittsburgh Corning's settlement. You may recall that our contribution to the Pittsburgh Corning settlement not only included the 25 million Corning Incorporated shares, but also $140 million of cash to be paid over six years, some minor insurance proceeds and our 50% interest in Pittsburgh Corning Europe. Pittsburgh Corning Europe is a Belgian corporation and it's owned by Corning Incorporated and PPG. It is separate from Pittsburgh Corning in the United States and has generally been profitable. You may recall that PPG had reached a settlement on Pittsburgh Corning in early 2002 and they had contributed their 50% ownership of Pittsburgh Corning Europe, so it made sense for Corning to mirror this portion of their settlement. In 2003 two components of our settlement, our investment in Pittsburgh Corning Europe, and the minor insurance proceeds to be assigned were accounted for at book value. In addition, we suspended recognition of equity earnings from Pittsburgh Corning Europe as we had agreed to contribute it to the trust. At that time, we and our external auditors, PricewaterhouseCoopers, agreed that using book value for both was appropriate. However, we have now concluded that we should have used estimated fair value to comply with GAAP and that we should have continued to recognize equity earnings from Pittsburgh Corning Europe. PricewaterhouseCoopers concurs with our new conclusion. The accounting rules require that we show the liability of the trust at fair value while keeping the investment at Pittsburgh Corning Europe at book value under the equity method. When the settlement actually occurs, we will recognize a gain for the difference between the book value of PCE and the fair value of the liability we are settling. After consulting with our auditors and the audit committee we have also concluded that the Company will restate its historical financial statements to reflect the appropriate accounting. The primary impact of this restatement will be to increase the charge for the asbestos settlement which we treated as a special by $94 million pre-tax, $50 million after-tax, in the first quarter of 2003. And, to increase the deferred tax valuation allowance recorded in the third quarter of 2004 by about $50 million. The restatement will have no impact on our 2005 reported earnings per share. Please note these changes are to our GAAP numbers. The impact on our net income and EPS before special items will be negligible. Our balance sheet will also reflect slightly lower equity, but as a reminder, at the end of 2005, we had over $5 billion in equity. Going forward, we will continue to recognize changes in the fair value of all the components of the settlement until the settlement actually occurs, as we do with the value of foreign stock. Changes in PCE's value should be minor on a quarterly basis. We believe the Bankruptcy Court will issue their ruling in June but there may be appeals which, of course, could take some time to resolve. Further details of the restatement are included on a Form 8-K that we filed last night. We will also be filing an amended 2005 10-K and 10-Qs to properly reflect the restatement. We anticipate being able to file the amended Form 10-K and our first quarter Form 10-Q by May 10th. I'd like to stress that all the adjustments are non-cash and thus do not have any impact on Corning's financial health. We would not have violated any covenants at any time with these correcting entries. We have reviewed this matter with our rating agencies and bank group. Neither has expressed any concerns. I'd like to close this section by stressing that we take our accounting very seriously. We are disappointed that we had an error but pleased that we discovered it ourselves and plan to have amended financial statements on file promptly. I will be happy to answer questions on this item later in the call. Now I'd like to return to discussing the quarter, and here are the details. As I said, sales for the first quarter were $1.262 billion, an increase of 5% over the fourth quarter sales of $1.2 billion and higher than our expectations. The increase in sales was driven by growth across all segments. In comparison to the first quarter of last year, sales were up 20%. Net profit after-tax, excluding special items in the first quarter was $425 million, or 25% higher than fourth quarter net profit of $339 million. The significant increase in net profit after-tax was primarily due to strong performance in our display and telecom segments, as well as higher equity earnings from Dow Corning, and in comparison to the first quarter of 2005, net profit after-tax excluding special items was up 69%. Earnings per share, excluding special items, were $0.27 in the first quarter and much higher than our expectations. This was an increase of 59% in comparison to our EPS ex-specials a year ago. Now as a reminder, our first quarter EPS concluded about $0.01 per share impact from stock option expense. You should note these are non-GAAP measures and a reconciliation to GAAP can be found on our Web site. You should also note the impact of changes in foreign exchange rates due to translation on the first quarter sales and net income versus the fourth quarter was negligible. Now let me quickly walk you through special items for the quarter. We recorded a pre-tax and after-tax charge of $185 million, primarily reflecting the increase in market value of Corning common stock to be contributed to the asbestos litigation related Pittsburgh Corning. Corning's share price had increased during the quarter from $19.66 to $26.92. In addition, we also recorded a pre-tax and after-tax gain of $38 million to reflect the release of certain deferred tax assets in Germany, as certain businesses in Germany have now demonstrated sustained profitability. Lastly, we reported a $21 million after-tax charge in equity earnings related to the impairment of some long-lived assets at our Samsung Corning CRT equity venture. You can find a reconciliation of all these special items on our Investor Relations Web site. Continuing down the income statement gross margins were 45% in the first quarter compared to 44% in the fourth quarter of last year. The increase was primarily due to stronger manufacturing performance in our telecommunications and environmental segments. We were very encouraged by the manufacturing performance in Environmental. SG&A was $223 million in the first quarter, or 17.7% of sales compared to $203 million in the fourth quarter. The increase was expected and was primarily due to the impact of option expense. Equity earnings were $200 million in the first quarter compared to $186 million in the fourth quarter. The increase is primarily due to strong performance at both Dow Corning and Samsung Corning Precision. I will discuss both equity companies in more detail in a moment. As I mentioned a moment ago, first quarter equity earnings include the $21 million impairment charge at Samsung Corning CRT. In addition, equity earnings included approximately $13 million in non-recurring gains in the first quarter that were not treated as special items. Other income was $20 million in the first quarter compared to $2 million in the fourth quarter. The increase is primarily due to a transfer tax that we had recorded in the fourth quarter. Our tax rate in the first quarter was 15% and lower than our guidance of 20% to 25%. This was primarily the result of higher than expected U.S. income, which is currently not taxed. Our share count for the first quarter was 1.59 billion shares, up slightly from our guidance of 1.57 billion. Change is primarily due to the increase in our stock price which pushed more stock options into the calculation of weighted average shares outstanding. Now let me turn to our segment results for the quarter, starting with display. Sales were $547 million in the first quarter, a 7% increase over fourth quarter sales of $513 million. The increase reflects sequential volume growth of 15%, which was much higher than we anticipated, partially offset by price declines. Price declines were in the upper single digits as expected. As a reminder, whenever I refer to LCD glass pricing it's on a mix weighted basis. The impact on the yen to U.S. dollar exchange rate, Q4 to Q1, was negligible. In comparison to the first quarter of last year, sales in our Display segment grew 73%, primarily due to volume gains of 111%, offset by price declines and unfavorable exchange rates. Equity earnings from SCP were $140 million in the first quarter and higher than fourth quarter equity earnings of $129 million. SCP's sequential volume growth was up 10% and also higher than our expectations. Year-over-year volume growth at SCP was 87%. Pricing was down slightly. Both the fourth and the first quarter at SCP included non-recurring gains between $5 million and $7 million. Sequential volume growth for our consolidated display segment, which includes our wholly owned business plus SCP, was up 13% in the first quarter. Net income in the display segment, which includes equity earnings, was $417 million the first quarter, up 13% compared to $368 million in the fourth quarter. The increase from net income was primarily the result of higher volume growth at our wholly-owned business and SCP. In comparison to the first quarter of last year, net income, including equity earnings, more than doubled. The gross margin percent in the first quarter in our wholly-owned business was consistent with the fourth quarter. We were very pleased to be able to maintain our gross margin in display despite the significant pricing pressure. We were able to achieve this result as a result of the higher volume of large size glass, non-recurrence of certain fourth quarter items and the benefit from our ongoing cost reduction program. Now I'd like to spend a few minutes updating you on end market trends during the first quarter. As always, I'd like to stress we don't have perfect information. We use a variety of sources ranging from services that are available to you such as display search along with retail tracking vendors, our own discussions with customers, as well as our own models. We think the information is useful but not perfect. With that in mind, you should also note the following data has been derived from this aggregate of industry sources that at this time are considered to be preliminary estimates. Final data for the first quarter will not be available for another month. To be clear, the data we reference here relates to shipments from PC manufacturers and TV set makers to retailers. In summary, the preliminary data indicates that the end market shipments remain strong and are tracking ahead of our forecast for all three products

[Ken Sofio:]

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

[Operator:]

(Operator Instructions) Our first question comes from Brantley Thompson with Goldman Sachs.

[Brantley Thompson:]

I was wondering if you could give us a little bit more color on the pricing environment that you're seeing in glass in general, how your competitors are behaving.

[Wendell Weeks:]

Well, the price environment is playing out exactly as we had predicted. You may recall in quarter three of last year, we said we thought we would see more competition on Gen 6. That occurred late in the fourth quarter for first quarter, and that's what led to us predicting upper single-digit declines and came in exactly as we expected in the first quarter. We anticipate that the number in the second quarter will be down from that, and that's what we said about three months ago. So I would say the pricing environment is basically remaining about what we had been thinking it was at this point in time. We are not seeing unusual price behavior by our competitors. We are getting more competition on Gen 6, but that's to be expected as we're now coming up on our three-year anniversary of having started shipping it. We are seeing a little less benefit to ourselves from mix because we're not getting quite the same ramping of large sizes compared to the very large embedded base. But that's not a material impact on us, but the pricing environment is not significantly different than our expectations.

[Brantley Thompson:]

How do you think it will progress in the second half?

[Wendell Weeks:]

Well, we're not giving guidance in the second half, but we clearly think that the business is seasonally strong in the third quarter and we think that, as we always said, has an impact on the pricing environment also.

[Brantley Thompson:]

Thank you.

[Operator:]

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

[Steven Fox:]

Hi. Good morning. Jim, just going back over the supply chain issues, thinking back to your analyst meeting you talked about in detail how you're trying to monitor what's going on in the supply chain. How are you getting surprised in terms of volumes? Just specifically with the inventories, you're saying it's more related to the panels than with glass, and if you can go into details on that, that would be appreciated.

[Jim Flaws:]

Well, I hesitate to use the word surprised, Steve, but clearly our customers tell us as we enter a quarter what they think they're going to be taking but there's always some variability in that from various customers, both up and down, but as the quarter progressed we were seeing greater demand, and you may recall we talked about our glass demand being up 5% to 10% in our wholly-owned business, and it ended up being 15%. We do work very closely with our customers about how much glass they have. We're not sure they always give us perfect information, but we don't think that there's a lot of glass lying around, but we do have ways to check on that. But there clearly could be some of that. And then we think, just by looking at what happened on panel shipments, that they were down compared to glass going up, and this was quite wide differential that leads to us believe that some of this production ended up in finished panels, and therefore, that's likely to impact their demand for glass in the second quarter. We've never found a perfect correlation between panel shipments and our glass shipments. I think we've explained, tried to answer questions about that in recent quarters, but our preliminary data for panel shipments -- and this is a little rough, because the panel shipments can vary in size -- but looking at the Taiwanese and the Koreans it looks like panel shipments were down sequentially 5% in the quarter, and meanwhile our volume in glass, of course, measured in square foot, was up 13%. That's an unusual variation for us. We can often have our numbers be different from there's, but for theirs to be negative and ours to be up at that level; frankly, we just didn't expect we would have thought our glass would have been up only 5% to 10% and the customers buying more from us. We don't think it was simply share gains, so that's why we think there's some in inventory.

[Steven Fox:]

That's very helpful. And then just two quick financial questions. Any change to your expectations that free cash flow could be for the full year around $200 million? And then secondly, the taxes paid on a non-GAAP basis in dollars, can you just give us that number? I just wanted to check against our model.

[Jim Flaws:]

I'm going to have to have Ken give you that tax number. That's one number that's not on the top of my head. But on the free cash flow, I think we remain very confident about our ability to generate the $200 million despite having had the special investment in Samsung Corning Precision to get the better tax position, so we feel pretty good about our cash position for the year.

[Steven Fox:]

Thanks very much.

[Operator:]

Thank you. Our next question comes from C. J. Muse with Lehman Brothers.

[C.J. Muse:]

Good morning. A couple questions. First off, can you tell us which generation glass was impacted by the lightning strike?

[Jim Flaws:]

Well, in Shizuoka we actually make all generations there, so basically we were impacted across the board. This was a very widespread impact on us on almost all tanks that we had there. Did not impact Gen 8, but, you know, it impacted Gen 6, Gen 5, and the lower generations. It was a very unusual power strike. I hesitate calling this up as an excuse, but it was an exceptional power surge. It actually hit our backup line, not our main line, but we think it actually was so powerful that it jumped the breakers and then surged into our main line, and that's what caused the problem. So it's affected basically all of our generations except Gen 8, but we are already back producing on a number of those tanks as we speak.

[C.J. Muse:]

Can you sort of give us a rough estimate of how much capacity was impacted in the quarter?

[Jim Flaws:]

I won't give you a specific number. I'll use accounting language. It was material.

[C.J. Muse:]

Okay. Do you think that that material change will cause Asahi and/or [NEG] to pick up market share at least over the interim out of Japan?

[Jim Flaws:]

No, we do not. We believe we will have the ability to meet our customers' commitments. If there were a big upside in demand, which we're not anticipating, we might have less ability to do that but we don't expect to lose share as a result of this. We are going to, as I said, incur some extra costs by having to air freight, and we will have to buy some glass from SCP to handle this demand. As you know, we make less money ourselves when we do that, although SCP makes money.

[C.J. Muse:]

Got you. So I guess I can read from that that you do have some extra capacity of glass across the board?

[Wendell Weeks:]

What Jim is saying is that basically we're going to compress our inventory levels and the length of our own internal supply chain, and so in that way, we can move from shipping over ocean to air freight, you know, that gives you more glass now but you incur higher costs.

[C.J. Muse:]

I understand that. But I thought particularly at the leading edge glass capacity was very tight, and if that was a material impact, how much capacity you could supply from your other factories to Japan?

[Wendell Weeks:]

It's going to be tight, as far as we're concerned, to work our way through this, but it's looking like the combination of our operational efforts and our efforts to be able to source some from Samsung Corning Precision, as well as compressing our inventory levels looks right now like we won't materially impact our customers. That being said, as Jim says, it certainly takes away some of our upside capability should customer demand surprise positively.

[C.J. Muse:]

Got you. Then in terms of the inventory question, in terms of pull-in to 1Q and slightly lower growth in 2Q, is that excess glass at your customers? Or I think you've alluded to that being finished product. If that's the case, I've got to think that given the comments from panel makers, they're not lowering their utilization rates, so that given the capacity expansion in 2Q that we would see stronger growth in volume and flats up 5%. Can you comment on that and help me out with that?

[Wendell Weeks:]

I'm not sure that I got the question exactly right, C.J., so let us give it a shot, and if we don't get it right, ask us again. Okay? We started out looking as quarter two as not being a very strong ramping quarter from our customer base in terms of new fab capacity ramp-ups. So we had expected quarter two to not be as robust a growth as we would experience in quarter one and quarter three to begin with, just because of the scheduling of how new fabs were coming up and utilization was coming up. So then you combine a relatively shallow quarter, in terms of growth rate anticipated, with then the dynamics around what actually happened in quarter one that Jim explained, and that's what's leading us to guide to the more modest volume growth, C.J.

[C.J. Muse:]

Great. That's very helpful. And one last housekeeping question. Can you tell what us say SCP revenues were?

[Wendell Weeks:]

SCP revenues in the quarter?

[C.J. Muse:]

Yes.

[Wendell Weeks:]

$175 million?

[Jim Flaws:]

No. We'll get it back to you. Next question.

[Operator:]

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

[Trideep Bhattacharya:]

Hi this is Trideep Bhattacharya on behalf of Nikos. Jim, first question for you. Given the first quarter declines in LCD pricing of roughly 8% to 9% and the implied guidance of potentially another zero to 5% decline in second quarter, would you say we're at a new sort of pricing paradigm where we might see pricing down 10% to 15% year-on-year whereas in the past I think it's generally been below 10%?

[Jim Flaws:]

Let me first give the follow-up answer to C. J. that SCP sales were $495 million. So we would say we're not in a new pricing paradigm. We can't observe that yet. I think at our analyst meeting we talked about that we had one year before had price declined of 12%. What we saw was extreme drop in quarter one based on that's where we saw the biggest shift on Gen 6, where we had significant competition, but just as we saw in last year, where in quarter one we had the higher price declines and then basically had nothing in quarter two, which was helped by quite a bit by mix, this time in quarter two we're not really getting as much mix effect. So we would say we're not seeing a new paradigm. Clearly, if we do see one we'll tell you about that, but we think that we're seeing price declines moderate in the second quarter versus the first as they've done before. It has occurred in this industry before where price declines in a given year were over 10%. That, nevertheless, we've said we've been long preparing for the day that there would be price competition, and the key for us is to keep driving down our costs.

[Trideep Bhattacharya:]

Thank you. Just to follow-up to that, so if we did assume that pricing does fall, say close to 15% a year, do you still feel comfortable about your ability to maintain margins in the LCD business segment?

[Jim Flaws:]

Putting aside items like a lightning strike, which we can never predict, we showed you that we have on average over the last ten years driven our costs down 14% a year, and I think Pete Volanakis said that he feels very confident in our ability in the short-term to continue reducing costs at a higher rate. So if demand comes in as expected I think we have the ability to do that. And that's really been our goal; is if there's reasonable price declines is to at least keep up with that with our cost reductions. I think we have a good shot at doing that this year because we're feeling quite confident about as we bring up capacity in Taiwan.

[Trideep Bhattacharya:]

Great. Then just a clarification. Did you say you expect that sequential growth in the hardware and equipment sales as part of the telecom group to be 15% to 20%?

[Jim Flaws:]

Yes, we did. Most of the lift in the second quarter is coming in hardware and equipment from the fiber-to-the-premise opportunity.

[Trideep Bhattacharya:]

Okay. Thank you.

[Operator:]

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

[Daryl Armstrong:]

Thank you very much. A couple of questions. First of all, in terms of the tax rate, usually the geographic mix in terms of growth in profits has a pretty big impact on your tax rate. Given the fact that you expect that the rate will be between 15% to 20% through the rest of the year, what does that mean from a geographic standpoint in terms of your business? Then second of all, could you provide a little bit of color as you think about the demand side of the picture for LCD in terms of your assumptions for monitor and laptop and LCD television shipments during the second quarter?

[Jim Flaws:]

Well, let me start on the tax rate geography-wise, and I'll turn it over to Wendell on the demand side in LCD. The biggest variability we've got, Daryl, is really how much money we make in the United States versus from where we opened the year; it looks and feels to us like the U.S. businesses are doing better. Telecom clearly is doing a little bit better than what we originally expected, and we were delighted by the improvement in manufacturing and environmental. So those two things continue that we will believe that's going to help us a great deal on having more U.S. income, and therefore, you know, edging the tax rate down. I think we came into the year, we told you 20% to 25%, although I think I've said in a number of conferences I expected it to be at the low end of the rate. We clearly have acknowledged that and moved down now into a lower range but it's driven primarily by North America. There's a little bit of balancing that goes on between Japan and Taiwan in terms of tax rate in the LCD business. In Japan the tax rate is a little bit higher, so we make a little more income in Taiwan. That helps us there, and obviously the Shizuoka outage will occur in Japan. Wendell, any comments on demand?

[Wendell Weeks:]

End market demand continues to look robust. This is preliminary data for us, but in quarter one we saw LCD penetration in the range of 79% for monitors. On notebooks, as you heard Jim say as a percent of total computers 35%, and then TV doing better than what we had anticipated with 17% in quarter one versus the 16% level which we anticipated. TV, which is a key one for driving TV penetration for this year, we're anticipating that reaching into the 19% range for on average this year.

[Daryl Armstrong:]

Then one last question. There's been a lot of coverage relative to the recovery in terms of optical spinning patterns, particularly within North America. I was wondering if you could talk about relative to your fiber business. Aside from the momentum that you're seeing from Verizon, have you picked up indications or have the conversations from carriers, at least on the fiber side, again, excludes fiber-to-the-home, have they picked up at all?

[Wendell Weeks:]

So I'd say that really the action on the fiber side is in the access market. Primarily fiber-to-the-premise, but also fiber-to-the-node activity from other carriers in the U.S. and as well as Europe and Asia. We're not seeing any significant strength in long haul or other major regional builds in fiber.

[Daryl Armstrong:]

Thank you very much, and good quarter.

[Wendell Weeks:]

Thank you.

[Operator:]

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

[Jeff Evanson:]

In the past we've heard you discuss start-up costs associated with bringing on new LCD glass capacity. When should we anticipate those costs hitting for the Gen 8 ramp?

[Jim Flaws:]

Gen 8 starts in quarter two with one tank operating and then we'll have another tank later in the year, so you'll begin to see it then.

[Jeff Evanson:]

Does that contribute much to the degradation of the gross margin that you're anticipating for the second quarter?

[Jim Flaws:]

No, I think the biggest impact clearly is the Shizuoka outage. I think you can do the math. We're talking about it being costing us a penny. You can see how much of an impact that is on the business.

[Jeff Evanson:]

Can you give us an update on the progress in green lasers?

[Wendell Weeks:]

Sure. We continue to have very strong customer interest in our product for green lasers, and we continue to make excellent technical progress. I think that as we come to the end of the year, we're going to begin to make some decisions on the pacing of that overall project, and if customer interest continues to be as robust as it is now, and if we can make the technical and cost progress that we hope to, then I think we're going to be moving along rather briskly on that project.

[Jeff Evanson:]

Thanks.

[Operator:]

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

[Curt Woodworth:]

Hi. Good morning. A question on the gross margin performance this quarter was almost a record and I understand that 2Q is going to be lower from the Telecom net as well as, based on my math, it's about 150 basis point hit from the outage. But looking to the back half of the year and certainly into '07 it seems to me that gross margins should really only be trending higher for the Company as you get into the next generation glass phase and the diesel starts to ramp. Can you give us any insight into how we should think about modeling? I'm not asking for pinpoint guidance. But in terms of that progression is it the expectation that you still have a lot of opportunity to increase gross margins looking out the next 12 to 18 months?

[Jim Flaws:]

In terms of the mix effect on the corporate gross margin, let's get past the lightning strike impact, and then our starting point was the 65% gross margin that LCDs had, and you have to make an assumption what you think we're going to be able to do on cost reduction versus price in the back half of the year, but then you can also begin putting the mix effect of higher revenues of LCDs against the total corporation. So that's one positive. The second thing is you called out is I think that diesel helps us in the back half of the year as we begin ramping up. Pete has told you his expectations in the fourth quarter of getting that diesel business to breakeven. We also were very encouraged, as I mentioned, on our automotive environmental business where we've been struggling a little bit in the past but appear to be maybe have turned the corner, so that's a positive for us. I think really the only negative in the back half of the year is the question on the seasonality of telecom is does it continue at this higher rate we are seeing or in the fourth quarter do we see some fall away. But generally I think factors are more positive for our gross margin going forward. I won't speculate on '07, but obviously we expect diesel to be improved in '07 versus '06.

[Wendell Weeks:]

I think the only thing that I'd add is that, something that Jim often says, which is we experience very strong gross margins in display; and that they are so strong, it's hard to anticipate the continued robust growth and the richness of that business. Not saying it won't happen, not saying it can't happen, but those are very healthy gross margins.

[Curt Woodworth:]

Right. But they're still way above the Company average, and display is growing quicker, so the mix benefit should be positive.

[Wendell Weeks:]

Yes.

[Curt Woodworth:]

All right. Final question on telecom. Can you comment at all on the connectivity rates you're seeing and what Verizon has been telling you? I saw the hardware and equipment numbers were down year-on-year. Anything to take away from that?

[Wendell Weeks:]

Since last we talked to you, I think Verizon has spoke publicly on at least three occasions and what they have come out with I think has been pretty encouraging in terms of data service, penetration progress in the files, regions that they're offering. I think what seeing is after nine months at a 14% penetration, where they've actually added video service is that is expanding, they've done ten new files, TV communities have been announced now for a total of 29. In those areas where they're talking publicly they're seeing service penetration around Keller at around 23% after five months; Herndon, Virginia, about 5% after a little under 4% and Temple Terrace, Florida at 11% after 2.5 months. So pretty robust penetration rates. We anticipate, as you heard in the guidance offered by Jim, very robust growth in quarter two as well. I think you have to be careful with taking our particular revenues and relating it directly to penetration in any given quarter, because the inventory and pipeline effects within Verizon itself are quite significant.

[Jim Flaws:]

That's particularly true in quarter one of a year ago, if the comparison you're making. Where one year ago we know they bought too much inventory which had showed up in lower quarter two revenues.

[Curt Woodworth:]

Right. Okay. Great. Thank you very much.

[Operator:]

Thank you. Our next question comes from John Roberts with Buckingham.

[John Roberts:]

Morning, guys.

[Jim Flaws:]

Good morning, John.

[John Roberts:]

I'm on Page 4 of the release on the segment results the after-tax display income is $275 million and the taxes are 29%. So that's a low tax rate in display technologies. There's no European, and I would assume the U.S. operations were kind of stable. What drove that low tax rate in display?

[Jim Flaws:]

Display has a low tax rate because we have a very low tax rate Taiwan, and so that really helps us quite a bit. The highest tax rate is in Japan, but Taiwan has a very low rate.

[John Roberts:]

Lower than recent quarters, though. Is it going to stay this low?

[Jim Flaws:]

Yeah, you know, as the mix effect at Taiwan gets larger on our results, that has an impact.

[John Roberts:]

Okay. And it looked like excluding the charge that you had in Samsung Corning CRT, it swung down to a $50 million loss if Dow Corning was where it was targeted. I think Dow Corning is expected to be about $60 million in the quarter. Is it going to stay down or is this write-down that you took over there going to bring that back to breakeven?

[Jim Flaws:]

Talking about Samsung Corning CRT?

[John Roberts:]

Yes.

[Jim Flaws:]

I think you should not look for very encouraging results there. This was an impairment of assets that we took of $21 million but their actual operating results I think you should not look for much encouragement, but I don't think you should see big variability up or down from that. As we've had in our risk factors for quite awhile, I think you can expect that there will be impairments in the future. The outlook for CRTs are obviously not great over the longer term. Unfortunately, the timing of how the accounting rules work, we just can't suddenly go in and impair the whole thing at one time, regretfully.

[Ken Sofio:]

Anything else, John?

[John Roberts:]

Thank you.

[Ken Sofio:]

Okay. Lisa, we have time for one more question.

[Operator:]

Our last question comes from Ajit Pai with Thomas Weisel Partners.

[Ajit Pai:]

Good morning and congratulations on a very solid quarter. Just looking at your deferred tax assets, end of '04 you had about $2.3 billion in gross deferred tax assets, at the end of '05 that increased to about $3.8 billion. There's about a $1.4 billion delta there with the understanding of what happened in terms of stock from Pirelli, et cetera. But when you look at your valuation allowances, that's gone up even substantially more, $1.9 billion. So why when your profitability is improving so materially, are your valuation allowances increasing even faster than your deferred tax assets are growing?

[Jim Flaws:]

I think we had referenced the Dow Corning item that we had reserved -- I think it was in the fourth quarter. I think that's the biggest change in that.

[Ajit Pai:]

Right. But the valuation allowance, at what point would you have the ability to actually start reducing those valuation allowances?

[Jim Flaws:]

Well as we just proved with our German trade tax entry we made this quarter, it takes about three years usually for the accountants to declare victory that there's been a change statement, so we're a ways from in that terms of thinking about our North American income.

[Ajit Pai:]

But there's no effective impact in your being able to use them for profit; it's just that you can't take it on your balance sheet like to reduced the allowance.

[Jim Flaws:]

You don't mean for profits you mean used for cash purposes?

[Ajit Pai:]

Cash purposes.

[Jim Flaws:]

There's no effect. The timing of accounting has nothing to do with the fact that we're able to take this on our tax returns.

[Ajit Pai:]

Thank you so much.

[Ken Sofio:]

Jim, do you have some closing comments?

[Jim Flaws:]

I do. First, a couple of Investor Relations announcements. Pete Volanakis, our Chief Operating Officer, will be meeting with investors next week at Merrill Lynch's Technology Gathering in New York City on May 2nd. On May 22nd, Kay Asbeck, Corning's Senior VP of Finance will be presenting at the Lehman Brothers Worldwide Wireless, Wireline and Media conference in New York City. On May 24th, Wendell will be presenting at the JP Morgan Technology Conference in San Francisco. We really hope to see you at one or all of these events. Second, just say we were delighted by our first quarter results especially the $0.27 and hope investors are also. LCD continued its very strong track record and we got a lift from all our other segments; all our other segments were up in the first quarter versus the fourth quarter. We remain very confident about our prospects for LCD television for this year and its impact on demand for us.

[Ken Sofio:]

Thank you, Jim. Thank you, Wendell. Thank you all for joining us this morning. A playback of the call will be available beginning at 10

[Operator:]

Thank you. This concludes today's teleconference. Thank you for your participation and have a great day. You may disconnect. Thank you.