Ann H. S. Nicholson - Division Vice President, Investor Relations Wendell P. Weeks - Chairman, President & Chief Executive Officer R. Tony Tripeny - Chief Financial Officer & Senior Vice President.

Patrick Newton - Stifel, Nicolaus & Co., Inc. Steven Fox - Cross Research LLC Mehdi Hosseini - Susquehanna Financial Group LLLP Douglas Clark - Goldman Sachs & Co. Vijay K. Bhagavath - Deutsche Bank Securities, Inc. Rod B. Hall - JPMorgan Securities LLC George C. Notter - Jefferies LLC Wamsi Mohan - Bank of America Merrill Lynch James E.

Faucette - Morgan Stanley & Co. LLC.

Welcome to the Corning Incorporated Quarter One 2016 Earnings Results. It is my pleasure to turn the call over to Ann Nicholson, Division Vice President of Investor Relations..

Thank you, Sean, and good morning. Welcome to Corning's first quarter conference call. With me today is Wendell Weeks, Chairman and Chief Executive Officer; Tony Tripeny, Senior Vice President and Chief Financial Officer; and Jeff Evenson, Senior Vice President and Chief Strategy Officer.

Before we begin our formal comments, I'd like to remind you that today's remarks contain forward-looking statements that fall within the meaning of the Private Securities Litigation Reform Act of 1995. These remarks involve a number of risks, uncertainties and other factors that could cause actual results to differ materially.

These factors are detailed in the company's financial reports. You should also note that we will report our results using core performance measures. These core performance measures are non-GAAP measures. A reconciliation can be found on our website.

We have slides posting live on our website that are accompanying our formal comments, and they will be available on our website later this morning. Now, I'll turn the call over to Wendell..

Thank you, Ann. Good morning, everyone. As we said in this morning's press release, we are pleased that first quarter sales in Display, Environmental, Specialty Materials, and Life Sciences met or exceeded expectations.

Demand in Optical Communications was as strong as we expected, but deployment issues with new manufacturing software interrupted our cabling production and interfered with our ability to fill customer orders.

Now, we are well down the path to resolving these problems, but we estimate that they reduced first quarter sales by approximately $100 million. The combination of reduced sales and spending to overcome the issues reduced first quarter net income by about $40 million.

Absent this, Optical Communications results would have been consistent with expectations. Even with this impact, however, core EPS was $0.28, consistent with consensus. We told you coming into the year that we expected the first quarter to be the weakest. Looking ahead, we are encouraged by the sequential growth that's beginning across our businesses.

We're also pleased with the progress we've made on our strategy and capital allocation framework. You'll recall that our priorities are to focus our portfolio and utilize our financial strength to grow, return cash to our shareholders, and create significant value.

As we shared with you in October, we expect to generate and deploy more than $20 billion through 2019.

We will distribute more than $10 billion to our shareholders, and we will invest $10 billion to grow and to sustain our industry leadership in our focused portfolio of three core technologies, four manufacturing and engineering platforms, and five market access platforms.

Recent successes include cash distributions, strategic transactions, product introductions, moderating pricing environment in Display, and our advancement of lowest cost manufacturing positions. Here are a few highlights in each area. We've distributed more than $2 billion to our shareholders since October.

We completed a $1.25 billion accelerated stock repurchase program in January. During the remainder of the quarter, we distributed an additional $751 million through share repurchases. In February, we announced a 12.5% increase in our quarterly dividend, in line with our plan to increase dividends per share by more than 10% annually.

We also initiated three transactions to focus our portfolio and advance our growth. In December, we announced the strategic realignment of Dow Corning. As a reminder, we plan to exchange Corning's 50% interest in Dow Corning Corporation for a subsidiary that will hold 40% ownership in Hemlock Semiconductor and $4.8 billion in cash.

The $4.8 billion is approximately 30 times the equity earnings from Dow Corning's silicones business. We expect this realignment to be substantially tax-free and to create tremendous value for our shareholders. We've made excellent progress and continue to anticipate that this transaction will close by June.

In January, we announced a joint venture with Saint-Gobain Sekurit to develop, manufacture, and sell light-weight automotive glazing solutions. Saint-Gobain is a leading global producer of automotive glazing. Corning will continue to produce and market Gorilla Glass to this JV and other glazers, retaining 100% ownership of the glass business.

This venture allows us to manufacture and sell glazing solutions with a premier glass glazing company that enjoys an excellent reputation among car manufacturers. It also provides a low-cost path for us to scale Gorilla Glass glazing solutions globally.

Two weeks ago, we announced an agreement to acquire Alliance Fiber Optic Products for approximately $270 million net of the cash required. We expect the acquisition to be accretive during 2016, and offer cost, product and customer synergies. This acquisition will expand our market access, and provide products that we can integrate into our solutions.

For example, it will deepen our relationships with growing cloud data center customers, expand our access to OEM and Asian customers, and enhance product sets in our fiber-to-the-home and data center portfolios. We're excited to bring AFOP on board. Turning to product introductions.

Earlier this month, we announced Vibrant Corning Gorilla Glass, which adds value to Gorilla and supports our strategy to double Corning's revenue per mobile device.

With fiber and Corning Gorilla Glass, Acer and other leading device makers can dramatically expand their options per device design with individually customized multicolor high resolution images on Corning's industry leading cover glass solution. These features add value for consumers and increase our revenue per device.

We also continue to leverage our competitive advantages and strong customer relationships in display to stabilize returns.

You will recall from our fourth quarter conference call in January that 2015 was the display industry's most challenging year in the last five years, and that panel makers began reducing utilization in the back half to help return supply chain inventory to a healthier level.

We also told you that even in this difficult environment, we expected continued moderation in LCD glass pricing, and that exactly what is playing out. After experiencing the smallest price decline in eight quarters during quarter four of 2015, our price declines in the first quarter equaled the best first quarter price decline in five years.

And we believe sequential price declines will further moderate in quarter two. We can now mark two years of moderate quarterly sequential price decline.

Finally, we enhanced our lowest cost positions through several moves to consolidate our manufacturing footprint and our progress on reducing energy consumption and cost was recognized by the EPA, who named Corning an ENERGY STAR partner for the third consecutive year. So to summarize, we're making solid progress delivering on our new framework.

We are creating significant value for shareholders by utilizing our financial strength both to enhance our focus portfolio by investing in growth and to distribute cash to shareholders. Now, I'll turn the call over to Tony, who will review our first quarter results and second quarter outlook.

Tony?.

Thank you, Wendell, and good morning. We met expectations in Display, Environmental, Specialty Materials, and Life Sciences in the first quarter. However, as Wendell said, we experienced an issue in Optical Communications due to the implementation of new manufacturing software in our cabling operations.

This interrupted production and seriously impacted our ability to meet customer demand in the quarter. The estimated impact to sales was about $100 million. The lower sales and additional cost to address these issues reduced net income by about $40 million.

As Wendell said, absent this issue, our Optical Communications business would have met expectations. We have been working with customers to minimize the impact to their operations and are making steady progress towards restoring production. We are confident that we will resolve the software implementation issue during the second quarter.

The financial impact in Q2 will be much smaller than Q1 and we expect to make up a good portion of the missed sales during the second half of 2016. Now let's get into the first quarter financials. As a reminder, these are core results. Sales in the quarter were $2.2 billion, down 11% versus last year.

Without the software implementation issue in Optical Communications, we estimate that sales would have been down approximately 6%, driven by lower volume and pricing in Display, but in line with expectations. Corporate gross margin was 41%, and in line with expectations.

SG&A and RD&E costs were relatively flat to Q1 of 2015 at $309 million and $109 million respectively. Our effective tax rate for the quarter was 14% and lower than expected due to lower profits in Optical Communications, which incur a tax rate above the corporate average. Net income was $340 million and lower than last year.

The lower year-over-year earnings reflect the lower volume and pricing and Display and also the software implementation issue in optical. EPS was $0.28 and met expectations. Now, these results are core.

In Q1, our GAAP results were significantly lower than our core results, driven almost entirely by the mark-to-market accounting treatment on our currency hedge contracts. I'd like to provide a bit of context.

As most of you know, we sell LCD glass in yen and a 1 point move in the exchange rate impacts net income and cash flow by about $23 million annually at the current exchange rate. We enter into currency hedge contracts, predominantly yen, to mitigate the impact of changes in currency exchange rates on our earnings and cash flow.

By hedging, we increase the predictability of our results and are confident that we can achieve our financial goals. We are very pleased with the results of our hedging program and the economic certainty it delivers.

Since the inception of this strategy, we have settled hedge contracts and received cash totaling $1.1 billion that offsets much of the decline in Display's earnings due to the weaker yen. We recently increased our hedge coverage which further reduced our risk and increased our confidence in achieving our financial goals.

We have hedged 70% of our projected yen exposure through 2022 at a blended rate of approximately ¥106 yen per $1. For any investor who has been worried that the weakening yen could negatively impact our business, hedging earnings and cash flows through 2022 substantially mitigates that concern.

Now, let's move from the economic impact of our hedging program to GAAP accounting. GAAP requires earning translation hedge contracts settling in future periods to be marked-to-market and recorded at their current value.

In other words, under GAAP accounting, each quarter we are required to revalue all of our existing contracts at the quarter end forward rates, and record the difference in value from the prior quarter through the P&L as unrealized gain or loss.

This requirement results in significant GAAP earning volatility if the exchange rate changes from quarter to quarter, and given the size of our hedge portfolio, these adjustments can be large. For example, in Q3 and Q4 of 2014, we had large unrealized non-cash gains after tax of $431 million and $410 million respectively as the yen weakened.

In the first quarter this year, the yen sharply strengthened and we had a $599 million unrealized non-cash mark-to-market loss. Our GAAP results will continue to see this volatility when the yen rate moves.

Now to be clear, the amount of hedge contracts we settle in any given quarter is designed so the cash received or paid on the contracts substantially offset the change in Display's translated yen earnings and cash flow in that quarter.

Our core reporting convention is designed to convey this matching and to simplify comparisons of underlying business trends. Now for investors who have additional questions, Ann and Stephen (17:33) are available after the call.

Also in our GAAP earnings for the first quarter are charges of about $109 million pre-tax associated with reducing our cost structure, enabling us to enhance our cost leadership position. We anticipate additional charges of approximately $40 million for the remainder of the year.

We estimate that the full year cash impact will be $40 million, and the annualized savings will be $50 million. So that's our first quarter from an overall P&L perspective. Now, let's look at the detailed segment results, beginning with Display Technologies.

As I described in the January call, there was a significant inventory buildup in the supply chain during the back half of 2015 because the industry overestimated retail demand.

We expected panel maker utilizations to decline sequentially in the first quarter in reaction to falling panel prices and a weaker end market, allowing the supply chain to reduce inventory. We expected this to result in sequential glass demand being down mid to high single digits.

Now despite this very tough environment, we expected Q1 prices to decline moderately sequentially, and that is exactly what happened. Panel makers reduced utilization and panel price declines improved to low single digits in March. Weeks of inventory ended the quarter in a healthier position. The glass market was down mid single digits.

Our volume was down mid single digits sequentially, and price declines were moderate as expected, matching the smallest sequential first quarter decline in five years. Display sales were $829 million and net income was $223 million.

Now during the quarter, we secured the remainder of our 2016 volume under customer agreement, helping us maintain stable share, which in turn enables us to be more efficient in planning, manufacturing and reducing costs. Let's move to Optical Communications. Q1 sales were $609 million, down 13% versus last year and below our expectations.

Net income was down 64% versus last year, primarily driven by lower sales volume and additional costs associated with software implementation issues. We expect a much smaller impact to sales and profits in Q2 and to resolve these issues during the second quarter.

In Environmental, Q1 sales were $264 million, down 6% versus last year, but better than the 10% decline that we expected. Stronger than expected demand for light duty substrates drove the beat as growth in North America and China produced record light duty substrate volume sales.

Segment sales are down year-over-year due to continued weakness in the US and Chinese heavy duty truck markets, as expected. Truck production in North America is down after a two-year peak and China's production is also expected to be down for the second year, driven by economic weakness.

As a result, year-over-year profitability was down for the segment, in line with expectations. Now during the quarter, we also made important progress on pioneering a new mobile emission control category that is not yet reflected in our sales. Let me explain.

Euro 6c, starting in 2017, introduces real world driving emission standards and requires an order of magnitude reduction in particulates generated by gasoline direct injection engines or GDI. GDI represents 23% of the global market now and it's growing at a 17% rate. Today, none use a filter.

The 2017 regulation will require, for the first time, a filter solution and we are well positioned to lead. We made progress in the first quarter by winning several new platforms designed to meet the upcoming Euro 6c regulation.

Since the filter is used in addition to products that we already sell, Euro 6c increases our total sales opportunities for GPF vehicles by a factor of three to four. Moving on to Specialty Materials, performance was in line with expectations. As expected, Gorilla Glass volume was down sequentially and versus a strong Q1 2015.

As a reminder, comparing year-over-year Gorilla Glass growth rates in individual quarters is challenging because the volume depends on when the supply chain is building in preparation for new product launches and the timing of OEM production ramps varies year to year.

Last year our Q1 volume was stronger because the supply chain was building, whereas this year we don't expect production ramps until later in the year. Advanced optic sales were consistent with last year. In total, segment sales were $227 million, down 17%. Net income was $32 million, down 30% versus last year on the lower sales.

In Life Sciences, Q1 sales were $204 million and met expectations. Net income was $18 million, down $1 million versus last year. First quarter gross equity earnings from Dow Corning were $58 million, and exceeded expectations of $45 million. Let's turn to our balance sheet and cash flow.

We ended the quarter with $3.5 billion of cash, including approximately $1.1 billion in the United States. We expect full year operating cash flow to be relatively consistent with last year. The first quarter is typically our lowest quarter of the year and Q1 adjusted operating cash flow was approximately $110 million.

Capital spending was $270 million. Now for the outlook. We expect second quarter sales to grow sequentially in all of our businesses, except Environmental, which will be down slightly, but consistent with the second quarter of 2015. Let's begin with Display.

For the full year, we continue to expect the overall glass market, measured in square feet, to be up mid single digits and for the retail market to be up 8% to 10%. While it's early in the year, we see some puts and takes that net out neutrally relative to our initial expectations for the year.

Preliminary data indicates that TV unit growth might be a little less than our 2% expectation, but that is offset by early evidence that diagonal screen size will increase by more than our 1.5 inch expectation.

The outlook for handheld and IT is lower than our initial expectations, but those segments are a relatively small part of the overall display glass market. Handheld and IT play a bigger role in our Specialty Materials segment, which I'll address in a minute.

We begin the second quarter with healthier supply chain inventory, and panel makers are increasing utilizations to meet demand for the second half retail season. We expect glass market and our volume to be up high single digits sequentially in the second quarter.

We expect our LCD glass prices to decline moderately sequentially and be more moderate than Q1. We are very pleased with this more stable environment. As we have previously explained, we expect this more favorable pricing environment to continue and maybe even improve, for two primary reasons.

First, the financial situation of our competitors continues to indicate they cannot continue historical price declines and remain profitable. And second, as we said before, we believe that glass supply and demand will remain balanced despite occasional dips in panel demand. We are keeping capacity offline to match our supply to our demand.

Other glass suppliers have said publicly that they have levers to take similar actions. For these and other reasons, we continue to believe that sequential pricing will be better for us going forward. Now moving to Optical Communications. For the second quarter, we expect sales to be up more than 20% sequentially.

Compared to last year, we expect sales to be down mid to high single digits. Two components of lower sales versus last year are sales impact of $20 million to $40 million from the software implementation issues, and last year's record second quarter included some service-oriented business that doesn't repeat.

For the full year, we previously guided Optical Communication sales up in the mid single digits, but now expect sales to be up low single digits, with the change due to the software implementation issues.

Demand in carrier and enterprise is as strong as we expect it, and we plan to recover a portion of the missed sales from the first half of the year. We expect sales in Optical Communications to be up more than 10% in the back half of 2016 versus last year. Now turning to Environmental.

We see continued strength in the auto market, but expect ongoing weakness in the heavy duty truck market in North America and China to continue. We expect second quarter Environmental sales to be consistent with 2015. In Specialty Materials, we expect second quarter Gorilla Glass volume to grow both sequentially and year over year.

As a result, we expect Specialty Materials sales to be up low single digits in Q2 versus 2015. For the full year, as I said earlier, the handheld and IT retail market outlook for 2016 has weakened, which impacts sales of Gorilla Glass. We now expect sales growth in Specialty Materials will be in the high, or the mid to high single digits.

On the cost side, we experienced a power outage in one of our glass technologies facilities at the end of March. We quickly recovered from the incident to meet customer shipments across all product lines.

We expect costs associated with recovery and repair expense to negatively impact gross margin percent and profitability and Specialty Materials in the second quarter. In Life Sciences, we expect Q2 sales to be up low single digits versus last year, despite drag from the weaker euro. Now we expect gross margin to improve sequentially in Q2.

Gross margins expand with growing volume in Display and higher sales in Optical Communications. The expansion would have been greater, except for the impact of the power outage. In total, we expect gross margins to be in the 41% to 42% range. We expect further gross margin expansion in the third quarter.

SG&A and RD&E will be approximately 14% and 8% of sales respectively. We expect other income, other expense, to be a net expense of approximately $55 million, and we expect Q2 equity earnings to be between $50 million and $70 million, depending on the closing date of the Dow Corning strategic realignment.

Once we close, we will no longer recognize equity earnings from Dow Corning's silicones business. Therefore, an earlier closing date corresponds to the lower end of our estimated range. We will update you more precisely when the transaction closes. And we expect our effective tax rate for 2016 to be in the range of 15% to 16%.

So that concludes our outlook for the second quarter. To summarize, in the first quarter, we met or exceeded expectations in most of our businesses, and we expect strong sequential growth in the second quarter.

We made great strides delivering on our four-year plan to focus our portfolio and utilize our financial strength to grow, return cash to our shareholders, and create significant value.

Ann?.

Thank you, Tony. Sean, we'll now open the lines for questions..

Thank you. And our first question will come from the line of Patrick Newton with Stifel. Please go ahead..

Yeah, Wendell, Tony, Jeff, thank you for taking my questions.

I guess number one is, given the expected close of the Dow JV in the current quarter, could you elaborate a little bit further on your intentions with the $4.8 billion in proceeds? I think that investors have varying opinions of the use of cash within your capital allocation framework and the pace at which it can be harnessed.

So I guess at a minimum, should we anticipate a buyback to offset dilution from the loss of equity earnings? And then given the substantially tax-free transaction, are there any structural timing issues that prevent the immediate access to the proceeds?.

So Patrick, good morning. Let me take that question. I think that from an overall standpoint, let me first start about the timing of the transaction. I mean we expect it to close sometime during this quarter. We're on track. We've made a lot of progress with everything that needs to get done. We feel pretty good about that.

We said all along that when we do close, that we would discuss more what we do plan to do from a cash standpoint.

I think it is reasonable to assume that over a period of time, as we make this transaction, that we offset the dilution on the equity earnings at some point in time, although we're not actually talking about a very specific timing on that.

In terms of the cash availability, as we've mentioned that from an overall standpoint, there are restrictions relative to the cash availability, but that's cash that we need to control and manage internally from an investor standpoint. If we use the cash to invest in the business, then we're able to offset that with cash somewhere else.

So for example, if we were to make an acquisition, that we could use cash from that and that would offset cash in another place. So from an overall standpoint, that's how we're thinking about the Dow Corning transaction..

So Patrick, a little bit shorter version. After we close, we'll tell you. Okay. Until then, give us some time to not count our chickens before they're hatched, and then we'll be really clear on how we think about our overall capital allocation plan in terms of our total availability of cash for the company overall.

All right?.

Great. Thank you. And I guess just as a follow-up. Tony, you talked about recent strengthening in the yen. You talked about how your yen hedging practices have removed some of the volatility.

And I'm curious, if you're looking at using the current strengthening of the yen to bring your total hedge rate in the 2016 to 2022 timeframe to ¥99 relative to the average of ¥106 because that would remove any need to change the core reporting convention at some point in the future..

Patrick, that's a great question. I mean I think we are always looking at where the yen is, thinking about when we have opportunities to opportunistically add to our hedge portfolio. We made a big move in the first quarter, and that's something that we are evaluating and considering..

Great. Thank you for taking my questions. Good luck..

Thank you. Our next question will come from the line of Steven Fox from Cross Research. Please go ahead..

Thanks, good morning.

Just looking at the Optical business a little bit more and color, could you talk about some of the end markets and how they performed and how you think they're going to perform going into the second half of the year, specifically wireless, fiber to the home and data center? And then I'm just curious, given what I understand lead times to be on some of the optical cables, how you expect to make up some of the lost sales.

It doesn't sound like it's going to be an easy task to regain some of that share, given what might have shipped during the quarter. Thanks..

Thanks, Steven. So let's start with the situation in OpCo. First, the main dynamic in the numbers were the problems we had on implementing this software solution. This hurt. I mean, we've had to apologize to our customers who totally rely on us in certain segments.

Thank goodness that actually enterprise started a little slow this year, but our big telecom network providers totally felt this. And you got to remember, we've gained so much share over these last several years because of our advantaged product sets that we have customers that basically rely on us for 100% of their deployment.

So no question, our real extending lead times there have meant we've had to apologize to our customers and do our best to get those back on track. But also, we owe our investors an apology because we missed an opportunity to beat expectations and get off to a great start to the year.

So now it's further added degrees of difficulty for us to be able to climb steeply to the back half and still hit everybody's expectations for ourselves, but we think we can do it. So to your core question, enterprise started off slow, but we expect it to be strong, to come back. That's what we're hearing from all of our big customers.

So like I said, that ended up being a gift, but seldom is slow markets a gift, but it was for us. Second, in telecom for the core network stuff, we expect that demand to be strong this year.

Just because of where they rely on us and where they don't, we do expect to recover a significant hunk of our missed shipment set to just go into extended backlog. But we'll also lose some business too.

It's hard to exactly estimate that right now, Steven, but I think you integrate everything together and the way you should think about it is we're going to be growing in quarter three and quarter four with the software issue behind us, sort of in double digits in OpCo, despite any sort of lingering impact. So that's the way we're thinking about it.

As we get through quarter two we'll understand the actual customer impacts in a little more finer detail. But that's sort of the rough outline.

Does that make sense to you, sir?.

Yes, that's very helpful. I appreciate that.

And then just as a quick follow up, just directionally in terms of gaining content per device that you've talked about since the analyst meeting, should we expect some of that in the second half of the year? And if so, is there any hints you can give us on how that would sort of play out? And then I'll pass the baton. Thanks..

Well, one again, so on one hand in Gorilla, as you heard from Tony, we're seeing less growth. It's sort of IT and small, right. On the other hand, we see the opportunity for revenue enhancement and it's going to come in sort of two broad areas.

First, that as we introduce more advantaged glass products, just in our base glass business, we expect price to stop going down. Okay. That still has to happen, right, and the customers still have to love it, but that ought to be enhancing our gross margin.

And then second, we will be increasing our revenue per device through other ways by adding value. Right, and that's an example we just talked about on the Vibrant Corning Gorilla Glass, which basically moves us to selling a part, and then a customized part, in terms of the images that are on it.

We have other efforts going on in terms of the parts business to serve our customers at that higher revenue spot. And then finally, we have some other new value add products that you've heard us talk about, but now we expect to commercialize, like fire technology for wearables, et cetera.

Exact timing on how it comes in, my friend, is hard to call, because there's technology adoption. But yes, we would feel that that sort of revenue enhancement could help us close some of that gap that we see with the small end market..

Great. That's very helpful. Thanks very much..

Thank you. Our next question will come from the line of Mehdi Hosseini from SIG. Please go ahead..

Thanks for taking my question.

Just as a follow up to the Gorilla commentary, what gives you confidence that this is not ASP pressure and just a reflection of lower volume due to demand?.

Well Mehdi, as we take a look at what we expected at the beginning of the year versus today, and what's really has happened in the market, is lower demand for handheld, and also lower demand from a tablet standpoint. We expected tablets to be down this year, but they're going to be down a little bit more than that.

And so that takes our overall area growth, which we had expected to be up in the mid single digits or so down to the low single digits. From a pricing standpoint, our contracts get set at the early part of the year. So we feel good from an overall pricing standpoint.

And the reason that we think our sales can be up mid to high single digits has to do with the value adds that Wendell talked about in the previous answer..

Got it. Thank you. And then just looking at your cash flow, there was a cash burn from operation, and can you help me understand what happened there? I see you're – go ahead. Go ahead..

Yeah, sure. So, I think the first thing that's important to focus on is our adjusted cash flow, which also includes the impact from the hedges, and when you take those positive impacts from the hedges, we had about $110 million of cash flow from operations.

That was down from last year, and two major drivers of that, the first being lower profitability in the overall business, and then the second item is, we had a big cash tax payment that happened in the first quarter of this year.

As we look out for the entire year, we feel good about our ability to generate the operating cash flow kind of consistent in line with what we did last year. So there's nothing to be concerned or alarmed about on that, and Q1 is usually or always our lowest cash flow generating quarter..

Got it. Thank you..

Thank you. Our next question will come from Doug Clark from Goldman Sachs. Please go ahead..

Hi. Thanks for taking my question. Two quick ones and then a follow up.

The first one is on, have you seen any impact from the earthquakes in China? Not as much for your facilities or the glass industry, but for the rest of the TV supply chain? And then secondly, can you help quantify how big the impact to gross margins is for the corporate average in the second quarter from the power outage in the Specialty Materials segment?.

Sure. I think from an overall supply chain standpoint, it is our understanding that there was some impact on the Taiwan earthquake. And so we clearly would have seen that in March, in terms of some of the utilizations.

In terms of the impact in gross margin, of course it will depend a little bit on how this all gets itself resolved, but we would have guided our gross margins to be 42% if we hadn't had this issue. So think of it somewhere, half a point, something like that..

Okay, great. And then a follow-up question, interesting that nobody's really asked on the Display business yet. But there, I think you mentioned during the prepared remarks that utilizations from the panel makers have started to move back higher.

Does that suggest that the first quarter indeed was kind of the lowest point for utilizations and we should see a recovery throughout the rest of the year? And then similarly and relatedly, are you seeing further shift to thinner glass, kind of 0.3, 0.4 millimeter glass, and if that's having any impact on productions?.

So, the answer to your first question is absolutely, we think that Q1 is the low point. I mean, we had said in the call last quarter, and we still continue to believe that Q1 would be the low quarter and we'd start seeing increases in demand.

And as our guidance shows, is that we're looking at the market and our own volumes to be up in the high single digits. So we feel good about where the market is on glass, and where our volume is going to be in the second quarter, but even in the second half of the year.

So the short answer is, is that we thought that was going to be the case, and it's absolutely turning out to be the case.

Do you want to talk about thin, or?.

I'd say that no definitive move yet to the 0.4 or 0.3 millimeter in a broad sense. But certainly an awful lot of dialogue; 0.4 millimeter is growing some. We'll have to see how some of the big players end up working through the changes they have to make in panel making, and how that interacts with what they see as the value prop on the thinner glass.

So more to come. Watch this space..

Next question, Sean..

Thank you. Our next question comes from the line of Vijay Bhagavath, from Deutsche Bank. Please go ahead..

Yeah, hi. Good morning. Hi, Wendell, Tony. Two questions, if I may. The first is, if you look at your Optical Communication business, in addition to the manufacturing issues you noted, was there any weakness in any of the end markets you sell into in Optical? Would be very helpful to hear. Thanks..

Okay, well I think Wendell talked about that before. The enterprise market did start off a little weak at the beginning of the year. If you take a look at our slides, you'll see that sales were down, a lot of that of course driven by the issue with our software implementation.

But it did start off a little weak, but it definitely picked up as the quarter progressed, and is very strong right now. And the carrier market has been strong the entire time. So we feel very good about the end markets in Optical..

Perfect. And then, Tony, a quick follow on for you. Cash flow generation in Q1 was quite weak. Help us understand what drove the weakness in cash flow. Thanks..

Sure. I mean, I think I already answered that, Vijay..

Perfect. Thanks..

Thank you. Our next question will come from the line of Rod Hall from JPMorgan. Please go ahead..

Yeah, hi, guys. Thanks for the question. I guess I have two. The first one is, we're tracking a lot of OLED capacity provisioning out in the marketplace, and I'm just curious if you guys have an expectation for when OLED really starts to take share in the smartphone market.

Is that next year that you would expect that, late this year? Can you just give us some color on that? And then, what the impact on your own business would be? And then secondly, on Optical Communications, I just wanted to follow up. I think, Wendell, you had said that carriers are very reliant on you guys.

I'm assuming that means you haven't really lost much share, but it's more an impact on projects. And I wonder if you could comment on regionally at least, where projects may have been slowed down in terms of optical build out. Thanks..

Thanks, Rod, and thanks especially for the question on OLED because I was worried if no one asked, I would just have to tell them. So that when Tony and Ann go out to talk to investors, they'd be able to have a reference point. So, but let's start with your OpCo question. Very observant, Rod.

So a rough piece is, that's why we expect to recover in the back half a significant hunk of our OpCo businesses is there's some of it that you just can't get the product or the systems anywhere else. But there's also a hunk in cable that is just going to be lost, that you could get an alternative at the cable component level.

The region you feel it the most in for us has been North America, right. So that's the region that's felt it the worst. We felt it everywhere, because once we get a constraint of our capacity, we sort of draw it down.

But North America has felt it the worst, because that's the area where we had the software implementation points, and telecom customers tend to qualify specific product sets in particular production facilities. So that's where we felt it.

It's why we're pretty encouraged we can recover, as well as the fact that things are really tight right now in fiber and cable. So that's our thought on OpCo.

Before I move to OLED, does that work for you, Rod?.

Yeah, that'd be great, Wendell. Thank you..

So OLED. So for those of you who aren't following it quite as closely as Rod, the OLED capacity that has been largely announced or discussed has been for a technology called polyimide OLED. Let me start with what the impact is on us and then give you a little background.

So the impact on us is that the adoption of this P-OLED technology will increase Corning glass sales. Now, that seems unusual, right, so probably we should take a moment to explain it.

So a little over five years ago when OLEDs first began emerging as a number of the different OEMs started to promote them, we developed a strong point of view on how OLED would play out versus LCD. So the first step is you got to separate between large size and small.

These are very different applications and they use different types of display technology, today and going forward.

In the large size, which is 90% of glass volume roughly, we believed strongly then and continue to believe that OLEDs will be at best a niche product, and we thought that because we could see how LCDs would continue to improve and what we believed is that OLED's incremental cost would not be worth their shrinking benefits relative to LCD.

And that's played out where we've gone from three major OEMs promoting OLED strongly to now just one. And certainly the market has played out in terms of demand, as we expected. We continue to expect that technological outcome for the foreseeable future. Now, in small there is a different matter. Small, about 10% of the market.

We thought then and now that polyimide OLEDs were very, very interesting and we thought they were interesting because you could potentially conform them behind a nice piece of our Corning Gorilla Glass and get a very different customer experience where you'd have displays bending around corners, and therefore very small bezels, and long term, the potential for a flexible display.

So that's where we focused our strategic and technical energy. And as a result, what we've done is we've developed a very advantaged product and very, very, very high market shares. So as a result, even though polyimide OLED consumes less glass, this is way more than offset by our share gain in this technology.

Plus, because this is a small part of the market, we don't see any overall impact to overall glass supply and demand in any sort of meaningful way. Rigid OLED versus LTPS, LCD, they're going to split that market. That's not that big a deal.

Now as goes to timing, so we have a really good idea on timing, but we can't really discuss it, because that would disclose our knowledge of our customers' exact product plans and that wouldn't be appropriate..

Is it, Wendell, is it fair to say that most of that capacity in the industry comes online next year as opposed to this?.

So I think what makes that question hard to answer is I don't know whether or not you've got the totality of what people's capacity plans are, right. Clearly we are going to see very robust growth in capacity in this space.

How that will then tie to how and when products are introduced is a little more complicated question that starts to get more confidential. But, usually you can count on announced capacity increases by the types of players that can actually manufacture this to be relatively reliable..

Okay. Great. Thank you..

Thank you. Our next question comes from the line of George Notter from Jefferies. Please go ahead..

Hi, thanks guys. I wanted to ask about the cost downs you mentioned. I have to apologize, I think I missed some of the details here, but I think it was $40 million in cost downs. I think you were talking about the Display business.

Can you kind of walk back through the numbers you were referencing? And then what precisely are you doing there and why call it out this quarter as opposed to kind of the normal cost reduction efforts you guys go through? Thanks..

I think you're referring to the charge that we took in the first quarter that's not in our core results, but is in our GAAP results. It was about $109 million and it was across a number of businesses, particularly some industry, or some facility consolidations.

And what we were highlighting was one, why the charge was there and then the second item was just it continues in our journey to always be the lowest cost manufacturer. From a cash standpoint, it equates to, once all the charges are taken, that it's about $40 million of cash. The annual savings is about $50 million and that's obviously why we did it..

Got it. Thank you..

Thank you. And then our next question will come from the line of Wamsi Mohan from BoA Merrill Lynch. Please go ahead..

Yes, thanks for taking the question. One of your initiatives, if we just step back here and look at sort of over the last few years has been bringing stability to the Display business.

Now in the context of seeing the best pricing you've seen in five years in Q1 and improving from here on and improving inventory situation, your Display core net income declined 24% on a year on year basis.

So can you talk about stabilizing the business from a profit context in the context of these results? And you're still guiding 300 basis points of gross margins decline year on year. Can you talk about why the gross margin isn't improving more sequentially when you are seeing such a nice uptick in display volumes? Thank you..

Sure. Let me take the first question. What it's going to take to stabilize our display earnings, we've always said it's a combination of two things. One is moderate price declines and the second is volume growth. And what you saw in the first quarter, although the price declines were moderate, our volume on a year over year basis was actually down.

And so that's the key driver of the reduction in profitability. In terms of from a, and so as you look out moving forward, as we get into quarters where we have moderate price declines and we have significant volume increases, we certainly are going to get much closer to having stability in our display industry, or in our Display business.

That's fundamentally what we have been focused on and we do believe that what's happened from a pricing standpoint over the last two years gives us greater confidence in the ability to do that. On your second question in terms of gross margins, we would have had a greater expansion on gross margins if it wasn't for the power outage in Taiwan.

It will depend a little bit on actually how much that ends up costing us. But you could think of it in terms of half a point from a gross margin standpoint.

So that when we get into the second half of the year, when we don't have that impact, we don't have the impact from the software implementation, and we have higher volumes, we expect continued gross margin expansion getting much closer to where we were in the first half of last year..

Thanks, Tony. Operator, we'll take one last quick question..

Thank you. Our last question will come from the lane of James Faucette from Morgan Stanley. Please go ahead..

Thanks very much.

Wendell, I wanted to follow up on the OLED question on a couple of just updates on other future initiatives, particularly what progress you've seen if any around Iris, as well as what feedback has been after kind of the reports you've released in conjunction with Ford on the auto glass opportunity, especially coming out of some of the recent trade shows and supplier shows in that space.

Thanks..

Great. Well thanks for the question. Iris continues to get strong engagement from the grants and you're right to ask that in or around OLEDs because it is a way to get sort of sub 5-millimeter thick LCD technology, which is starting to put you right in the zone of OLEDs. So that is part of one of those technological innovations.

So we're continuing to see good, strong interest in it. Fascinatingly enough, the fastest moving set of brands in this space are in China. And what we are seeing is real up and coming brands use this as a way to differentiate their very large TVs. So it's way too early to call this idea a success, to add a third piece of glass to a TV.

I think let's keep asking the question as we roll forward. We should know a hunk more by the end of this year, how much momentum this tech has got or not. But so far, I would color it as continuing to be quite intriguing to our brands, basically because you can get thinner TVs with smaller bezels, and that helps you versus OLED.

So it will all be about how does the economics work with that value prop, and more to come. On auto, I think you rightly noticed the amount of sort of coverage we've been getting, mainly because one of our big brands has been promoting it so strongly.

It's really on the back of our customers being so excited about this, that we've getting all this press. And the most recent one has been, is what they basically announced is sort of a joint technical study that they've done with us, that shows not only is the glass lighter weight, but that it breaks a lot less.

So you have the potential for a reduction in rock strike breaks by up to half. And so, they got really excited about that, and they believe it's the only way to get to very thin lightweight glazing, and the traditional ways to do it with soda lime just won't work technically and be safe.

So they got really excited about that and published those papers. Expect more pieces on that. That all being said, I will say about this business what I've said from the beginning, is don't get too excited until we actually see an everyday platform brand adopted.

And until we get there, I don't think we've reached a tipping point, no matter how excited our customers seem to be. Until I get by that point, I won't feel confident in being able to predict that we've really got something here.

Does that make sense?.

It does. Thank you..

Okay..

Thanks, Wendell..

Great. Well, thanks everyone for listening. Once again, apologize for the execution issue in telecom. Other than that, we are marching along as we anticipated to do. We look forward to updating you on strong sequential growth and the closing of the Dow Corning transaction..

Thanks, Wendell. We have a few IR announcements. Our annual shareholder meeting is this Thursday, and you can listen in on the web. We will also be at the JPMorgan conference on May 24 in Boston, and the Sanford Bernstein conference on June 2 in New York City. Thank you all for joining in.

A playback of the call is available beginning at 11:00 today Eastern, and will run until 5 p.m., Tuesday, May 10. To listen dial 800-475-6701. The access code is 390718. The audio cast of course is available on our website during that time. Sean, that concludes our call. Please disconnect all lines..

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thanks for your participation and for using AT&T Executive TeleConference. You may now disconnect..