Corning Incorporated (GLW) Q4 2011 Earnings Report, Transcript and Summary

Ladies and gentlemen, welcome to the Corning Incorporated Fourth Quarter Earnings Results. It's my pleasure to turn the call over to Mr. Ken Sofio, Vice President of Investor Relations. Please go ahead.

Good morning, and welcome to Corning's fourth quarter conference call. This morning we have Jim Flaws, our Vice Chairman, Chief Financial Officer, to read some prepared remarks before we move to the Q&A. And those remarks do contain forward-looking statements under 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, and these risks are detailed in the company's SEC reports. Jim?

Thanks, Ken. Good morning, everyone. Hopefully, you had a chance to read the press release we issued this morning on our fourth quarter and full year results. If you haven't, a copy can be found on our Investor Relations website. Looking back at 2011, it was a year when the company achieved many milestones but encountered significant headwinds. From a financial standpoint, Corning had an outstanding year. In 2011, the company set records for sales, gross margin and operating income without specials. All of our businesses achieved increased sales year-over-year, sales of Corning Gorilla Glass almost tripled. We achieved our eighth year in a row of positive free cash flow, we maintained our very strong balance sheet, raised our dividend and initiated a sizable share repurchase program. We also brought significant new innovations to the market as our patient investments in research are paying off. Newer products, such as Lotus Glass for OLEDs and now a new, much thinner cover glass in Gorilla Glass 2 have been very well received by customers. We believe this is an outstanding list of achievements, despite less-than-robust growth in the developed economies around the world. However, it does not tell the entire story. We also encountered significant challenges in the second half of the year. In the third quarter, the display supply industry began a significant contraction. Ultimate resulting in the first year in LCD's history, where the supply chain inventory at the end of the year was lower than the amount at the beginning of the year. Our customers, panel makers, continue to operate on unhealthy financial levels. And in the fourth quarter, we experienced significant pricing pressure and a dispute at one of SCP's largest customers. Lastly, we witnessed significant upheaval in the solar industry, which impacted demand and price for polysilicon…

Thank you, Jim. John, we're ready to take some calls now.

[Operator Instructions]. First in the line is Wamsi Mohan with Bank of America Merrill Lynch.

Jim, clearly you're communicating to the LCD business growth and profit profiles different. How should we think about the CapEx profile for LCD glass without any new capacity additions? And could you also talk about plans for the Beijing, BOE-related glass melting facility?

So we are going to finish our Beijing facility. So you'll see that in capital spending. We believe our primary customer, the BOE, will be a very successful panel maker as the Chinese market grows. We obviously are going to pace the startup of that factory, and we will plan to do that. We're expecting the startup to occur in the second half. In terms of capital spending for Display, we are finishing up our earthquake preparedness capital spending we've outlined to you before. But in terms of any additional capacity in Display, either in our wholly-owned or SCP, you should not see us initiating anything new.

And as a follow-up, is there a level of price decline on the LCD glass quarter-after-quarter, after which you would rather walk away from the incremental volumes?

I could just tell you, Wamsi, that the LCD business remains extraordinarily profitable, despite these 2-quarter price declines we have. And the incremental margins are very high. So we definitely intend to maintain our position in the business. And we'll obviously respond to situations as they come along. But beyond that, I won't speculate.

If I could just squeeze in one last one in here. You noted Gorilla Glass pricing could decline in 2012. Did it decline in 2011? And can you talk about some of the drivers of these competitive reasons, excess inventory or just incremental pressures from customers?

We really haven't seen much in the way of price changes in this business in its early years. We always expected that this would be the year we'd begin to see some. It is not excessive price declines. I think some people are speculating that, that is not the case. In fact, we haven't even reached agreement with all our customers yet. But we're just assuming that in the consumer electronics business, that we will feel the fact that our customers always want to be lowering the price of their end product. And so we are highlighting to you that this is the year we might see some price declines. We have not agreed on those yet with customers. We are not feeling any competitive pressure. And if the excitement that we heard from customers on Gorilla Glass 2 at the Consumer Electronics Show continues, we don't expect to feel any competitive pressure.

Our next question is from Mark Sue with RBC Capital Markets.

Jim, you're doing the necessary things with pricing concessions in the near term. But how do we know that your actions don't create a change in future behaviors for your customers, creating a new price tier and undoing some of the pricing strategy changes that you implemented 3 to 4 years ago?

Well, I can never guarantee what the future's going to be, Mark. But I can tell you what we did coming out of 2006, is we adopted a strategy and communicated very broadly that we thought the best thing for our customers and for the industry was to have consistent price declines every quarter, keeping up with the fact that consumer electronics prices are going down. And we intended to do that. There have been several times since then, when we had price declines above that. But I would say, in general, what has led to that strategy, working for us in the industry, was for the glass makers to not have capacity substantially above what the real demand was. The biggest problem that occurred this past year, in my opinion, and take this as a Jim Flaws opinion, please, is that the glass industry, which has to shoot ahead of the duck in terms of thinking about capacity, expected retail demand to grow in 2011 by a certain level. And then it didn't grow quite that strongly. I think ultimately retail glass grew about 12%. And maybe a little bit more than that. But we had assumed, originally, that retail demand would grow 18%. So we had capacity in place for that. Second, in our models, for the prior 4 years, the 2010, '09, '08 and '07, the aggregate amount of square footage in the supply chain, in any one of those years, either grew 100 million square feet at a minimum or over 200 million square feet. We had anticipated the industry would build inventory again. It didn't. Not only did it not build, it actually declined. Those 2 things led to overcapacity in the glass industry by above 20%. That leaves the opportunity for our customers, who are always putting price pressure on us, to have a more effective way to do it when demand and supply and balance for glass gets out of whack by that greater amount. What I believe, Jim Flaws' opinion, what's going to happen is that we will not see the same precipitous drop in inventories going forward. Retail demand will grow, it may not be as great as what we'd all like, but we are going to be bringing the glass capacity in line, closer to end-demand, and that becomes a recipe for more moderate price declines. I cannot guarantee you that, that's our strategy, that's why we announced the 25% capacity offline in the fourth quarter.

Jim, as we look towards stable pricing declines after quarter 1, is there a promise or maybe a gentleman's agreement from your customers that once their margins improve, that subsequently, there's more rational and less inclination for discounts from Corning?

We have no promises or gentleman agreements with pricing on our customers.

And we'll go to Rod Hall with JPMorgan. Rod B. Hall - JP Morgan Chase & Co, Research Division: I just got 2. One is on the pricing declines. If you could just elaborate, Jim, on where you are in the process of renegotiating prices among the panel makers for glass. Are we halfway through that process, are we a quarter of the way through, where are we in the process and the price levels resetting because that kind of thing is likely to happen beginning in Q4? And then my second question is on inventory. If could just talk about you said that we can expect for a half of week in inventory compression this year. Do you expect that to be more toward the first half of the year or do you think that's going to be spread across the whole year? I'm kind of trying to get a feel for whether you think inventory is stabilizing to earlier in the year or not until later this year?

So I don't have a perspective on the half of week of inventory. I mean we have done that saying, as that chart we showed, that we believe, over time, inventories will -- efficiency will continue to improve. We haven't gotten so specific to say we know that's exactly occurring in which quarter. In terms of pricing, we're basically done on price agreements with our customers with the exception of the one customer in Korea, so we're very far along. Rod B. Hall - JP Morgan Chase & Co, Research Division: Okay. And Jim, do you think that, that one customer -- do you think you can finish that in Q1 or do you have a feel for when that completes?

I just won't speculate. I mean this obviously has been a very difficult situation. And my ability to forecast how quickly we can do it has obviously been proven wrong, so I won't speculate anymore on them.

Our next question is from Amir Rozwadowski with Barclays Capital.

Jim, in talking about that one Korean customer, I mean obviously, your guidance here has a decent amount of variability for shipments out of SCP dependent on what happens with that customer. Can you give us a little bit of color as to sort of what's on the flat side versus the down 10% side, is it sort of a share recovery, expectation on one side or is it that share would remain the same at sort of new levels with that customer?

I think I have to decline to be too specific on it. This customer remains taking quite a bit of glass from SCP, they're just well below the original agreement that we had with them. And as you know, the dynamics that I walked through with you, unfortunately in November and December, is we thought we had reached agreement with them and then they took the share back up and took it back down. And so I think it's inappropriate for me to comment on the exact numbers in it. But depending on the outcome, because the quarter 4 had so much variability in the months of October, November and December, there's a situation that we could see where the aggregate amount obviously is good, or it could get worse. And I just won't forecast it, and that's why I wanted to give you a range there.

Okay. That's helpful. And then lastly on the pricing front, obviously you're working with the panel makers given their challenged profitability here. Are you still looking to maintain a premium in terms of pricing in the marketplace versus competitors, dependent on sort of your pricing actions? I'm just trying to get a sense in terms of what you're seeing for yourself and also your competitors in the market.

Sure. We expect to get -- have a slight premium. As you know, the premium is fairly small but we expect to get it. From our eyes, we expect to get the premium because we think our product performs best. On the other hand, from our competition's eyes, they probably always want to be below us as a mechanism to try and do well with our customers. So we in general, expect to always have a slight price premium versus our competition.

And we'll go to Nikos Theodosopoulos with CBS.

I had some, hopefully, some simple numeric questions and then a general question. Jim, I did not actually hear a CapEx outlook for 2012, can you give us an expectation there.

Nikos, it's Ken. We gave it out a couple of months ago, it's around $1.8 billion.

Okay. So that didn't change? I guess that was my question, no change in that?

It did not change, no.

Okay. And then the second question is, do you have for the full year of 2011, the LCD price declines in SCP and the wholly consolidated business?

Nikos, for both SCP and the wholly-owned business they were around 15%, maybe a little north of there for the full year of 2011.

Okay. And then my question here is, when you idle capacity in LCD, can you elaborate what in fact that means? In other words, how long does it stay idle? What's the process -- more importantly, what's the duration to get it back when in fact, you want to get it back? And as part of that question, is there any commitment Corning has made regarding the Beijing plant in terms of a completion date or minimum capacity there?

A lot of questions. So in Beijing, we do have a commitment to operate the factory. The pace of when it starts and how much it does in a given quarter is not a commitment, but obviously we have a very important customer there, located right next to us. So we expect to supply glass to them from that facility. We're now forecasting the startup to be in the second half of 2012, we're actually shipping that customer from capacity in our other locations today, as they have begun their ramp-up of the Gen 8.5. In terms of the overall capacity situation, I think, as you know we have smaller tanks than our competition, and a lot of them. And what we basically do when we talk about capacity going offline is we try to get -- unless we think we're going to need it again in a very short period of time, we let the tank go cold. And the tank goes cold. We have a choice, do we repair it immediately or do we delay the repair, and that will depend on our outlook. In general, we by and large usually repair fairly quickly. You should think about the repair not being very expensive. It's just primarily rebuilding the refractory, swapping out the precious metals and putting in a new one and taking the old one out to be reformed. Neither that situation does not take a lot of time. And then once we decide to relight it, we have to heat up the tank. You can't go from basically the ambient air temperature to 2,300 degrees instantaneously, it takes a while because you don't want everything to crack. And so it takes a period of time to bring it up. But we can do that, it's not a significant issue in terms of timing. But I do want to emphasize, I mean, what we have done is said, we've taken this capacity offline, we don't have plans to bring a lot of this capacity back based on our outlook for the market and we're intending to stick to that for now.

Would there be a write-down if that capacity never got turned up? How would we measure it with the potential write-down on something like that?

So if the capacity was never used again, ever, then yes, there could be a potential write-off. There are 2 write-offs that occur, if a tank has not finished its life, there's a small amount of capital that has to be written off, because once you take it cold it's useless. You've seen that happen to us before. For example, in quarter 4 of 2008. I think you're asking more about a longer-term issue is if we never need some of these capacity again. Yes, there would be a write-off. I can't estimate it for you because I don't know which tanks would do. I will remind you that these tanks are very flexible tanks. Not only can we make LCD glass, we'll be able to make OLED glass. We can make Gorilla Glass and we can make photovoltaic glass in these. So in terms of saying that there will be a write-off of this capacity, it will be permanently never needed ever again. I'm just not sure that, that's an imminent decision that we're facing.

Our next question is from Steven Fox with Cross Research.

Just one question for me on the gross margin outlook. Jim, you're talking about gross margins being down about one full percentage point, but it's in a quarter where your wholly-owned business isn't growing, Gorilla Glass isn't growing and you have price pressures. So I'm just trying to see why the margin shouldn't be down a little bit more. What else is going on within the gross margin line?

It's Ken, Steve. It's a corporate gross margin forecast. Clearly, we do expect some good margin performance in our other segments during the quarter and that's going to help offset some of the things you mentioned in your question in Display.

And in particular, I'll draw your attention to Gorilla, where we had very low utilization in this quarter, where we were -- basically, we expect Gorilla demand to grow, so we didn't turn the tanks off.

And we'll go to Jim Suva with Citi.

Can you quickly touch upon, I believe, the licensing agreement between SCP and Corning expired the end of last year and maybe just let us -- or at the end of 2011, and let us know what the outcome of that was. And then on the second note, can you just kind of revisit one more time your commentary about the hope for improved pricing or more stable pricing in 2012. Because if we're thinking about the supply chain and connecting the dots that the panel makers and also the OEMs are not profitable, I would assume that they're hoping for these panels -- or these glass prices to significantly continue to decline in the future. So what's the indications that's giving you that hope?

Okay. On the former Samsung agreement, as we've talked about before, the Samsung agreement expired, I think at the end of November last year. Embedded in that is a step down in the royalty rate. And we'll be talking some more about it at the IR Day. So I'd ask you to hold until that day because we do intend to address it then. So what leads to our belief around the potential to get back to more moderate price declines? It is all based on the fact that we believe the industry is correcting to get glass capacity more in line with what will be the demand. And when that occurs, we believe there's an opportunity for more moderate price declines. That is and had been the primary strength of why we had moderate price declines during those periods over the last 5 years. It is very obvious from our customers' perspective, they would love to have these price declines at this higher rate continue in perpetuity. And the tension is whether they have enough strength to force that upon the glassmaking industry or not. We believe that the capacity balance situation and competitive dynamics will ultimately lead to more moderate price declines. And our hope is that occurs as soon as quarter 2.

And we'll go to George Notter with Jefferies. George C. Notter - Jefferies & Company, Inc., Research Division: I guess I was trying to better understand the relationship between price erosion on LCD TVs at retail and the size of the glass market. If I look back at 2011, it looks like pricing at retail came down around 6%. I think that was actually quite a bit below what you guys were originally thinking about coming into the year. And looking forward, 2012, it kind of feels like price erosion is going to be around the same place, 5%. I think if you look at the DisplaySearch numbers -- I think if you look at the glass market, you guys are talking about 11% kind of growth this year in volume terms. I mean, how do you feel about how those 2 numbers correlate? Is it possible that you guys could be overestimating the growth in the market if you only get 5% price erosion on TVs at retail?

So I don't think we actually agree with your TV pricing data down. I don't have it right in front of me, but I think we think it was higher than that 5%. And we have never seen an exact correlation between pricing and retail and our pricing to us. But we think we've got right the end market growth for televisions. Obviously we do realize that even though consumer television is a fairly resistant purchase in tough times, there is the possibility of weakened economic fence. I mean if Europe goes into a serious recession, then maybe we could be wrong. But we think we've got it right. In fact, if anything, I think we got surprised a little bit on the upside in terms of units of television in the back half this past year. So we remain comfortable with our estimate. Obviously, we could be wrong.

And we go to Simona Jankowski with Goldman Sachs.

I just wanted to clarify, Jim, some of the comments you made at the very beginning of your prepared remarks, where you talked about approaching a bottoming profitability but not expecting the Display segment to grow. Was that a comment looking out beyond Q1? If you can just talk a little bit about your longer-term expectations in the Display segment. And also, since you termed the margin decline this quarter as a reset as opposed to a decline, that implies some level of permanence. And so I just wanted to see if you can address how much of your gross margins you think you can recover beyond Q1? And also if you're thinking about offsetting some of that decline with actions at the R&D or SG&A line?

That was a lot of questions in one. So our comment about Display was a long-term comment. And we think we're reaching the point where the unit growth and the volume growth, even with moderate price declines, will give us periods of time when there basically is no net sales growth for Display. This may have come a little earlier than what we expected, I think we have been expecting it maybe this occurring in 2014 or 2015, rather than 2012 and beyond. But basically, it appears that we maybe at that point now. So that was a longer-term comment, that wasn't a quarter-by-quarter comment. Your second question was?

Just along the same lines. When you talk about a reset in profitability, does that imply that you view your gross margin permanently coming down to a lower level even beyond the big issues in Q1?

So I would say, with what we know today, we believe that the gross margin has come down in Display. And we don't see a set of factors that would drive it back up. To drive it back up, what would have to occur is that we would have to have a period of time where price declines were very, very minor and then we ran our tanks full and then cost reduction exceeded price declines. Right now, I can't, in all candor, tell you that I see a set of conditions that will allow that to occur. So that's what's leading us to say, with this double quarter down, double digits, significant, cumulative, we think we have driven the margin of Display down. I will point out, it remains extraordinarily profitable, it's still our most profitable business, but that's why we're calling it a reset. I'd love to have a situation outlined that occurred that we get to a few quarters of no price declines. If that happens, then I can reverse my comment.

And then just the last part of that was, would you consider just offsetting some of that with lower OpEx investment in the business given that the growth in margin profile there has changed?

Yes. In the Display business itself, you will see actions taken to reduce the OpEx.

Okay. So the op margin impact you would think would be more muted, but still some relative to the gross margin impact?

I'll just comment Simona that the operating expense of this business is pretty tiny to start with, so the moves that we can make in OpEx here are not going to overcome the gross margin declines from pricing.

Our next question is from Ehud Gelblum with Morgan Stanley.

Couple things. From your study that you did with McKinsey, did they give a sense as to, as you go forward, how low inventories can sustainably get? I'm sure they looked at other industries and saw kind of where they went to. Could we be looking at, eventually down the line, a 10-, 11-, 12-week cycle or do you think it stays somewhere around 13, 14. And then in negotiations with this major customer out of SCP, what are the points of negotiation? What can you actually work with them aside from price or is it really just hitting a price point and that's it? I understand there's still a premium to be had for the level of quality of glass that you have versus your competitors. But what else can you provide to them besides price? I'm just wondering kind of -- or is it a matter of who just decides to finally give in? And then the commentary on the significant price declines over the next 2 quarters or actually over Q4 and Q1? Can you give us a sense as to the significant double-digit decline? Can you bracket that, is that 15% to 20%? 10% to 15%? 13% to 18%? Something that we can just make sure we're all sort of on the same page.

So I'll go in reverse order, I'm not going to be more specific on the numbers. Cumulatively, it's a significant double-digit decline and we're not giving out a more specific number. Relative to the customer in Korea, the thing we can always offer is that we believe that we are an extraordinarily reliable supplier. We believe our glass actually runs the best in their process. And those are the things that we would think that would lead them to want us to have at some share level. From their perspective, obviously price is probably the preeminent one. So beyond that, we hope to reach agreement with them and have them as a customer. And your first question was?

Inventory, how low can it go?

What McKinsey said was over -- they can't forecast in perpetuity here. But they did say, they believed over the next 4 years that we could see, going down 1/2 week per year, obviously, with the potential always that the economy is much different, that could change. So if you think over 4 years, that knocks another 2 weeks off.

That's helpful. I noticed you didn't mention the $10 billion revenue target that you have in the past. You also mentioned the CapEx and you said that was the same. But I'm wondering if that $10 billion revenue target is still out there for you? And then finally you mentioned that there is an imbalance right now with too much glass out there. We know you're taking capacity out of the market, Asahi is taking a similar amount of capacity out of the market, that leaves only one player that doesn't seem to be doing that. If that one player doesn't actively take glass out of the market, do you think you can still get to a supply balance or will they constantly be acting as a spoiler?

I'll have to let you talk to that competitor and see what their plans are in terms of running capacity or not building capacity. I'm just not going to comment on them. On the $10 billion, yes, I think the $10 billion is still possible. Obviously, Display will not be as strong as it was before. The flip side, Telecom is actually stronger than we originally expected and Environmental is stronger than we expected. So I still think it's possible. We'll probably talk some more about that next week. The mix will probably be different. But we certainly haven't given up on the goal. We do need some help. I think everybody forgot one of the assumptions we said on getting on our way to $10 billion is we can't have global a economic malaise. And so if Europe goes into recession, then I get more worried.

John, it's Ken. I want to recognize that we're past the market open and in respect of folks' time, we'll take one more call. But for those that are in the queue, Ann and I, we'll be in our offices right after the call, we can help answer your questions. But John, we'll take one more caller.

And that will be from with Ajit Pai with Stifel, Nicolaus. Ajit Pai - Stifel, Nicolaus & Co., Inc., Research Division: A couple of quick questions. I think the first one is just to the same point on the pricing side. You talked about, in the fourth quarter and the first quarter, working with your customers in trying to help them to get to better profitability. But could you give us some indication as to the competitive dynamics? And is some of the price reduction being driven by what your competitors are doing, or is it primarily customer-driven? And then the second question is, you've talked about M&A and also bolstering your businesses outside of Display and potentially even Display. But could you give us some color as to whether in 2012 you can expect greater activity there? I think you have highlighted Life Sciences and Telecom as the 2 focus areas, whether that's still the case or it's broader than that?

So in terms of M&A, you should expect greater activity in 2012 than 2011. The primary segments that we're looking on remain Life Sciences and Telecom. But we definitely are moving to be more active. We're going to see more free cash flow and we think we can put it to work appropriately in M&A. In terms of the pricing dynamic, be sure, competitive price dynamics play into this also. Obviously, that's driven a lot of what happened in Korea in Q3 and Q4. So I don't mean to imply that it's just us being nice guys with our customers, clearly the competition has something to do with this too. But I think we clearly went to our customers, acting to help them in this situation. In Korea, obviously, we are feeling the competitive pressure. Ken?

Jim, any closing comments?

Yes. Just a couple. I think that I want to emphasize again, overall, the strength of Corning this past year. We had a very great year. I've mentioned the records in sales, gross margin and operating margin, eighth year in a row of free cash flow, raised the dividend and share repurchase. And the great performance in our business is outside Display. I think that right now the conversation is obviously dominated by pricing in Display. We recognize this reset has occurred. But we definitely intend to get the company at a new level of profitability and then Wendell and I are committed to get the company to grow off of that level. And so we think that's going to happen. And just one more reminder. Obviously, we'd love to see you in New York City. I promise you a very exciting event. Wendell is going to do some very creative work, and so we'd like to see you in person. And also, we, of course, will be presenting in February at the Goldman Sachs Technology and Internet Conference on February 14. And on February 28 at the Morgan Stanley Technology and Media Conference. So hope to see you there, if not in New York. Ken?

Thank you, Jim, and thank you all for joining us this morning. A playback of this call will be available beginning at 10:30 a.m. Eastern Time today. It's going to run until 5:00 p.m. Eastern Time on Wednesday, February 8. To listen, dial 800-475-6701. The access code is 233477. Audiocast obviously is available on the website during this time. And John, that concludes our call this morning. Please disconnect all lines.