Ladies and gentlemen, thank you for standing by. Welcome to the Corning Incorporated Quarter 1 2013 earnings results. It's my pleasure to turn the call over to Ms. Ann Nicholson, Director of Investor Relations. Please go ahead.
Thank you, John. Good morning. Welcome to Corning's first quarter conference call. With me today are Wendell Weeks, Chairman and Chief Executive Officer, and Jim Flaws, Vice Chairman and Chief Financial Officer. Before Wendell and Jim begin their 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 SEC reports. You should also note that this presentation contains a number of non-GAAP measures. A reconciliation can be found on our website. Now I'd like to turn the call over to Wendell.
Thanks, Anne. Good morning, everyone. At our investor day in February, we explained to investors why we believe Corning is a strong investment. We highlighted growth in our existing businesses, our expectations for solid cash generation, and a rich R&D portfolio with the potential to create entirely new businesses. We reminded investors of our goal to return to earnings growth. We outlined the progress we made in 2012. We noted that our fourth quarter results provided evidence that our strategy was working. I am very pleased to say that we started off 2013 with a strong quarter, exceeding analyst consensus. Our first quarter core earnings per share were up 15% year-over-year, up double digits year-over-year for the second quarter in a row.
You may recall that early in 2012, we identified two priorities for returning to earnings growth, reestablish positive momentum in display, and grow our other businesses. In display, our number one priority was to moderate LCD glass price declines. As expected, quarter one 2013 price declines for LCD glass were more moderate sequentially. We expect price declines to moderate further in quarter two. Going forward, we believe price declines will continue to be moderate as a result of the customer agreements we entered into last year, as well as the weakening yen. This improved price outlook, the stabilization of our share, and new product introductions are creating positive momentum again for display. Now for the second priority, to grow our other businesses. We believe that we are on the right track here too.
Our other businesses had solid operational results, combining to contribute 70% higher net income on a year-over-year basis. Jim will give you more color on our financial results. I just want to summarize by saying that the combination of moderating LCD glass price declines, improved operational performance, and two consecutive quarters of double-digit year-over-year earnings per share growth demonstrate that Corning has begun the march up in earnings. I would also like to take a moment to talk about our other announcement this morning. We previously told investors that we were entering a period where our strong operating cash flow and lower capital spending would allow us to devote more cash to shareholder returns. We are delivering on this commitment with a new $2 billion share repurchase. This comes on top of the $1.5 billion buyback that we completed in the fourth quarter of 2012.
This reflects our belief that the company is undervalued at the current stock price. We are also increasing the quarterly dividend to $0.10 per quarter. This 11% increase means that we have doubled our dividend level in the last 18 months. Finally, I would like to comment on the yen to US dollar exchange rate, which affects the translation of our Display and specialty segments results. We moved decisively in the first quarter to hedge Corning's exposure to changes in the yen exchange rate. Investors should be aware that Corning's risk exposure to changes in the yen to US dollar exchange rate is capped at 93. Now, I'll turn the call over to Jim.
Thanks, Wendell, and good morning. I hope you've had a chance to read our quarter one earnings press release this morning. In it, you'll see our results reported as core earnings. I'd like to begin my comments by explaining to you our rationale for changing to core earnings and its major components. In February, we said that we wanted to clearly show you our performance so you could directly assess the status of our plan to return to earnings growth. Core earnings excludes non-performance related items from our results, so you're better able to see operating results. Similar to our prior reporting, it also excludes special items like non-operating charges and certain accruals. Core earnings measures the performance of the company without two significant external factors. First, the yen exchange rate fluctuations. Second, the solar industry upheaval. Let me say a little more about each.
Sales of our Display products are currently priced in yen, so we must translate these sales back to US dollars for our financial statements. Additionally, our glass manufacturing costs in both Display and Gorilla Glass are primarily denominated in Asian currencies, including the yen. We must report our cost of goods sold in US dollars. As a result, movements in the yen to US dollar exchange rate can impact our results in Display and Gorilla as we report them in US dollars. We've experienced changes in the yen to US dollar exchange rate before, but typically these changes have been more gradual. Since November of 2012, the rate of change has been dramatic, with the JPY weakening by more than 20% since that time.
While we remain focused on managing and reducing our vulnerability to foreign exchange rate changes, we've decided to report our results with a constant yen. This reporting will allow you as investors to see the operating results without the impact of yen to U.S. dollar exchange rate changes. The use of constant exchange rate reporting is not uncommon for U.S. companies and is an accepted practice. The exchange rate that we will use, called out as a management rate, is 93 JPY per U.S. dollar. As Wendell explained in his remarks, the company moved decisively to hedge exposure to further weakening in the yen exchange rate. Our hedges protect the company from any further weakening above 93 JPY. Because we have this economic protection at the 93 JPY level, we chose this rate for the constant yen core performance reporting.
In an attachment to this morning's press release, we provided you our 2012 results restated with this exchange rate so you can update your models and compare apples to apples. We'll also provide history for 2011 in the near future. Our second adjustment for core reporting relates to our equity venture, Dow Corning Corporation, that has a subsidiary, Hemlock Semiconductor Corporation. Hemlock makes polysilicon for the solar industry. I went into great detail on February 8th about the dire situation in the solar market, driven by the macro environment and the investigation by the Chinese government regarding dumping of polysilicon. Driven by these events, Hemlock's earnings over the last 18 months have been unpredictable, and we expect that to continue.
Pending the outcome of the investigation and the instability of the solar market, Hemlock may have to take actions to write off assets and call on their take or pay contracts. These potential actions, to whatever extent required, are unrelated to its core operations. Therefore, our core earnings also exclude equity earnings from Hemlock. This was a relatively minor impact in quarter one. Our core earnings are a non-GAAP financial measure. Of course, we will continue to report GAAP results, and you can refer to the GAAP reconciliations on our website. As always, Anne Nicholson, investor relations will be available after the call today to answer any questions you may have about the financial reconciliations as you update your models. Now I'd like to turn to our quarter one core earnings results. First quarter sales for the corporation were $1.8 billion, consistent with a year ago.
Gross margin was 43%, up 1 point year-over-year, and better than our original expectation of 41%. Telecom, especially material, had very good gross margin growth versus last year. Gross equity earnings of $180 million, and as a reminder, this is also at constant JPY, were consistent with a year ago. I'll provide some more color on this in a few minutes. Our core effective tax rate for Q1 was 16%. Note, we did have a special item, a $54 million tax benefit to record the impact of the American Taxpayer Relief Act, which was enacted on January 3rd, which we excluded from our core earnings. Investors may recall we actually excluded a loss from the same item in Q4. It was the unusual timing of Congress approving this bill on January 3rd that caused these two entries.
The most important impact of that bill was to allow us to have lower ongoing tax expense this year, and we expect this benefit to continue into 2014. Core EPS were $0.30, up $0.04 over a year ago, and well above analyst consensus. It's important to note that moving to core performance did not impact Q1 of this year's results because the actual rate in the quarter was 93%, and the same as our management reporting rate. Operating performance drove the core EPS improvement over analyst consensus. EPS stated here is a non-GAAP measure. As always, a reconciliation to GAAP can be found on our website. As a reference versus a year ago, SG&A and R&D were consistent as a percentage of sales. Now I'd like to go through our Q1 segment results, and I'll start with Display.
Core sales for Display, which exclude the impact of changes in the JPY exchange rate or at a constant JPY, were JPY 650 million in Q1, an increase of 7% versus last year. LCD glass volume was up significantly more than offsetting price declines. Gross equity earnings also measured at a constant JPY from our equity venture in Korea, SCP, were JPY 133 million in Q1, a decrease of 8% year-over-year. LCD glass volume at SCP was up slightly versus Q1 of 2012. For your modeling purposes, Display equity company's first quarter LCD sales in constant JPY were about $608 million, a decrease of 4% from last year. As a reminder, this represents SCP's LCD sales only. Our public filings will report SCP's total sales, which include various other products.
As we expected, our total LCD glass volumes were down mid-single digits sequentially and up mid-teens year-over-year. SCP's volume versus last year was up slightly, reflecting the Korean panel makers' relatively consistent utilizations. Our wholly owned business volume was up significantly versus the prior year, reflecting the growing Chinese television market. Last October, we explained that going forward after Q4, with our share stabilized and the industry maturing, we expected price declines to moderate at all of our customers, including those with new agreements. I'm very pleased to report that our share remained stable in Q1, and our price declines in Q1 were less than Q4. Core net income was up slightly versus Q1 of 2012, which is a good sign that we're stabilizing Display. We were able to have volume increases offset lower glass price declines.
On the supply chain front, we estimate that weeks of inventory grew in Q1. It's likely the result of several things in combination, a healthier cash position, the need to carry more inventory for growing emerging markets, and the proliferation of television screen sizes in preparation for China's May holiday. We continue to monitor the supply chain inventory closely, and I'll comment more on the supply chain in our outlook section. In Telecom, Q1 sales were $470 million, down 7% year-over-year. Fiber and cable sales in North America were down due to the decline in the U.S. government stimulus spending versus the prior year. Sales were also down versus our expectations, primarily driven by slower NBN ramp-up and a slower start than we expected in China for fiber and cable. We are seeing China fiber and cable market pick up in Q2.
Despite the sales decline, net income in telecom was up almost 70%. Lower volume was offset by improved manufacturing performance and the implementation of strong spending controls. In our environmental segment, sales were down 13% year-over-year, but actually slightly higher than our expectations. You may recall in Q1 of 2012, it was an unusually robust quarter for the auto and heavy-duty truck demand. Since then, the European auto market and the U.S. Class 8 truck build rate have softened. We do expect sales growth throughout 2013, with demand picking up in the coming quarters. I'll talk more about that in our outlook section. Net income was down 34% in this segment, driven by lower sales and production volumes. Specialty Materials quarter one sales were down 10% versus a year ago, driven primarily by advanced optics. The cyclically down semiconductor market impacted advanced optic sales.
Core net income in this segment was up 39%, with very significant improvement in Gorilla Glass gross margins versus the prior year. We are very pleased with Gorilla's improvement in gross margins over the last several quarters. In life sciences, Q1 sales were up 34% due to the additional sales from our Discovery Labware acquisition, which closed on October 31st of last year. The acquisition integration is just underway, but it's going very smoothly, and it was accretive to this segment this quarter. Year-over-year, core net income doubled on the additional sales. I'll turn to Dow Corning, and as a reminder, we excluded Hemlock. Gross equity earnings were up 31%. On the balance sheet, we entered the first quarter with $5.8 billion in cash and short-term investments, with about $1.2 billion in the United States.
We did repay a loan in China during the quarter using about $500 million of cash. Our net cash position is $2.8 billion. Capital spending for the quarter was $194 million, and we remain on track to spend approximately $1.3 billion for the year. Free cash flow for the quarter was $323 million. As a reminder, free cash flow is actually a non-GAAP measure, and a reconciliation to GAAP on this measure can be found on our website. Let me turn to the outlook. As I mentioned at the beginning of my commentary, we have begun showing our results as core earnings, which exclude the impact of fluctuations in foreign exchange rates. We've also told you we want to mitigate the negative impact of the weakening yen.
In February, management obtained authorization from the board of directors to execute a series of foreign exchange contracts over a two-year period to hedge our exposure to movements in the Japanese yen and its impact on our earnings. We completed the execution of purchase collar options in late February. These will settle quarterly for a total of eight quarters. The simplest way to think about these transactions is they protect our P&L from the yen moving higher than 93, which is good given that the current yen exchange rate is 99. The protection above 93 is the reason that we chose 93 for our management rate for constant yen reporting. We've kept the cost of this hedge low by implementing a collar structure. If the yen average is above 93, we get a hedge benefit, and it offsets the negative translation impact.
If the JPY exchange rate is between 87 and 93, we currently will not have any hedge settlements in those quarters. If the JPY is below 87, Corning will owe on the hedges, but of course, our Display Technologies segment would be experiencing favorable translation results to offset these hedge payments. In summary, we think we've moved aggressively to protect the company and investors from the unprecedented sudden weakening JPY driven by the new Japanese government. Let me turn to the display outlook. Let's start with the current view of the end market in 2013. We still expect the retail market, as measured in square feet of glass, to be up mid-to-high single digits. For reference, 2012 was 3.5 billion square feet. We think LCD TV units will grow in the mid-to-high single digits with area growth higher.
Large-size televisions continue to sell well in many regions. Through February, 50-inch-plus TV sales are actually up 107%. You've probably seen reports regarding weakness in the PC market. We're not bullish on the PC market either, expecting only 10% year-over-year growth with more than all of that attributable to tablets. Monitor units are actually expected to be down about 5%. Let's talk about quarter two. As we near the end of April, we see Q2 LCD glass market at a consistent level sequentially. Our wholly owned business and SCP are combined to expect to be consistent with Q1 volumes as well. While Q2 is the seasonally slowest quarter of retail, glass volumes are actually up year-over-year in a slightly bigger market.
We believe inventory will grow again in absolute square feet and is measured in weeks during Q2, before beginning to deplete in the back half of the year when demand at retail peaks. Quarter two, we expect our share will remain stable and that our price declines will further moderate. We expect LCD glass price declines will decline by only 2%-3% sequentially. Going forward, we believe price declines will continue to be moderate as a result of the customer agreements we entered into last year, as well as the weakening JPY. The change in JPY-USD exchange rate actually helps most of our customers as they sell their LCD panels in USD and buy our glass in JPY. The change in JPY-USD rate actually increases their profits on our glass, which we believe should decrease their pressure on us for price declines.
Turning to the telecom outlook, we expect Q2 sales to be up slightly versus Q2 of 2012. This will be driven by the NBN ramp. Sequentially, we expect Q2 sales to be up approximately 20% coming off a slower than expected start to the year. In environmental, we expect Q2 sales to be up slightly sequentially. This is flat to down slightly year-over-year across the light and heavy-duty business compared to a stronger market Q2 of 2012, which had much higher levels of U.S. Class 8 truck builds. For the full year, we believe auto production will grow, driven by strength in North America and Asia. We believe tighter regulations in Europe and China will be leading to growth in demand for our heavy-duty diesel products. Specialty materials sales are expected to increase sequentially about 15%-20% in Q2, which is about 5% up year-over-year.
Advanced optic sales are expected to be down year-over-year, given the continued end market softness. Gorilla Glass volumes are up significantly year-over-year in quarter two. For the year, we believe there will be double-digit market growth for Gorilla Glass driven by the penetration of touch on notebooks and the continued growth of smartphones. We'll likely see most of this impact in the second half. In life sciences, we expect sales to be up about 35%-40% year-over-year, mostly due to added sales from our acquisition. We expect equity earnings from Dow Corning Silicones segment to be up about 20% year-over-year. Continuing down the rest of our Q2 forecast on the P&L, we expect core gross margin % to be similar to Q1. This is up year-over-year, driven by manufacturing efficiencies and increased sales.
SG&A is expected to be down versus last year as a percentage of sales, while R&D spending should be consistent, core equity earnings should be down about 15% versus last year.
Our effective tax rate for 2013 should stay around 16%. That concludes my opening remarks. Ann?
Thank you, Jim. John, we're ready to take questions.
Certainly. Ladies and gentlemen, if you would like to ask a question today, please press the star one. You'll hear a tone indicating you've been placed in the queue. If your question gets answered or you wish to remove yourself from the queue, please press the pound key. Once again, star one if you have a question. First, we'll go to Jim Suva with Citi. Please go ahead.
Thank you very much. If we just take a step back and look at the big picture of how you kind of see the macro supply-demand balance shaking out kind of currently, as well as looking forward to, say, to the rest of the year. Can you help us understand the supply-demand dynamics? We know Corning, I believe, has in the past year or so opened up a couple plants, and there's some more efficiency gains not only from Corning, but also competitors to improve or increase the supply. On the demand front, we are seeing TV unit growth, which I think is kind of in the mid-single to upper mid-single digit growth. Surface areas increasing with TVs. Can you just maybe take a step back and let us know the supply-demand equilibrium today, and looking forward, how you see it there at Corning? Thank you.
Sure, Jim. Basically, things look relatively in balance right now. It's just that simple. There's, of course, going forward, there's always dynamics on both the supply and demand side, but our opinion right now is things look relatively in balance, which helps in addition to our contracts that we've entered into and the weakening JPY, with our view of a relatively more benign price environment.
I'd like to add on to that, if I could. That is, I think that the market is in balance partially because of the discipline that Corning Incorporated is doing and some of the other manufacturers are. As you know, we continue to keep capacity offline in Korea, we will do that to make sure that we stay in balance.
Great. Thank you very much.
Next we'll go to Wamsi Mohan with Bank of America. Please go ahead.
Yes, thank you. Good morning. Jim, I think you said the yen is hedged out for two years and settled quarterly. Can you talk about the cost to implement this collar? I have a follow-up.
The cost was about $100 million for the two years.
That would be realized all as the hedge continues, so it'll be implemented over the course of the two years?
It's spread over the two years.
Okay, great. Thanks. Then can you talk a little bit of some of the new capacity that's anticipated to come online this year, and if LG Chem's early shipments are changing anything at all from a pricing dynamic or share dynamic?
In terms of new capacity coming online for us?
For the market. NEG has some capacity coming online, and LG Chem, too.
NEG has capacity coming online. They've announced that they're building a tank in Korea, and I believe their expectations are that for the back half of the year. They have said in the original announcement that they will be shutting down capacity in Japan when that occurs, and we are taking that at their stated announcement. Their second tank is not till sometime late next year, per their statements. LG Chem has one tank running, and it's actually been running almost two years now. The second tank, as far as our surveillance is, consists of only a few steel pilings in the ground. We are not feeling LG Chem is a significant supplier in the industry.
Thanks a lot. I'll get back with you.
Next we go to Patrick Newton with Stifel. Please go ahead.
Thank you, Jim, Wendell, and Anne, for taking my questions. I guess sticking to the hedge questions, you talked about taking care of translation exposure between 87 and 93 on the yen exchange rate, but you still have transaction exposure. I guess if we look at your 10-K and take that as a base, I think previously, and prior to these hedges, a 10% move in the yen-dollar FX rate would impact net income by about 6%. Using that metric, where would that stand post your hedge?
Well, you have no further impact. That amount between 93 and 87, you would see that impact of about, I think it's about $5 million per yen on an annualized basis. You could calculate that between 93 and 87 if you want. We're reporting basically at 93.
The key element to what we sought to accomplish with the yen hedge is to basically take the risk off the table for the next couple of years. Right? That capping the exposure at 93, it puts us in a spot where it gives us a much more stable earnings pattern going forward. The relative degree of gain on that hedge or not will depend on what the yen actually performs like. One of the reasons we did it, why we moved to core earnings in Q1, was because it really didn't impact quarter one earnings per share, because the actual yen in quarter one are close to the same thing. No matter how you looked at our earnings gap, our normal way of ex specials or our core earnings, we're significantly better than consensus.
As we go forward, if the yen stays where it is right now for quarter two, and it's closer to JPY 100 to the US dollar, we'd experience some significant gains on the hedge, which would offset any of the translation loss of bringing our yen-based pricing deterioration in the yen back into US dollars. Does that make sense?
Yeah, that makes sense. In essence, though, no transaction exposure at the yen-dollar level.
That's what you will see in our results.
Okay, perfect. I guess something, Jim, it seemed like in your prepared remarks, you kind of inflected in your voice on that LCD prices are currently priced in yen. Maybe I'm reading too much into that, but I'd love you to discuss the likelihood of changing to pricing U.S. dollars. Just thoughts on could that happen within kind of this two-year hedge window and the pros and cons of what has kept you from changing in the past and perhaps with the change in the FX rate, what makes it more attractive in the future?
It clearly is a possibility, as we talked about at our IR day in February, that we could convert over to U.S. dollar pricing, clearly, it could occur during this two-year hedge period of time. It's obviously a complex shift because you have to figure out what rate you're going to do it at, and you've got to get your customers to agree. Of course, we also have to think about what our competition will do. I didn't mean to imply anything with my inflection, clearly, I will state to you that the possibility of us going to U.S. dollar pricing for our display business is very real.
I'll add to it. I would agree with James' statements. When we told you at the beginning of the year that our time and attention was going to the yen, and making sure that we would be taking the appropriate action, we looked both at commercial changes, like shifting to the dollar in the near term, as well as doing what we did in the hedge. What we did is cover these next two years. It'll give us time to figure out what the appropriate commercial change is, as well as opportunities to reach very considered opinions on how we should handle the yen going forward.
All right. Thank you for taking my questions.
Next we'll go to Mark Sue with RBC Capital Markets. Please go ahead.
Thank you. Gentlemen, the pricing change as it relates to market share, it's good to see that things are stabilizing on price. What's the staying power and what's been the competitive response, if any, and are we getting indications that rationality for the display industry can prevail on a going-forward basis, just as we look through the back half of the year and into next year?
Clearly, what we're seeking to accomplish is just that. All we really control are our actions. What we've done with the series of agreements we've put in place is to stabilize our share, develop a fixed relationship between our price and market price, which should make for economic decision-making by all the players involved. We're encouraged by the progress that we've made in quarter one as well as quarter two. Only time will tell how this all turns out, but we're encouraged.
Will it be a quarter or so where you could kind of call success to the change in pricing, or is this a ongoing thing that we have to kind of monitor?
Clearly, getting another quarter under our belt with this continued moderation, we'd feel even better. At the core of it, pricing and pricing strategy is always going to be important in this business. We think we can reduce the volatility, and we're making some progress towards just that, but it will continue to take a good amount of time and attention.
Okay. Understood. Separately, if the regional demand for Display Technologies continues to change around the world, does that make you reconsider your CapEx by region? I understand the plans for this year at $1.3 billion. Just thinking about if things move around in 2014 and beyond.
Not quite sure I follow your question, Mark, about regionally. Are you asking about spending in glass business?
Yes, in Display Technologies, as you try to move closer to your end customers, we understand the plans that you're making for this year in China, for example. Do things change in the following year? Do you concentrate your production and capacity in certain regions, and does that require changes in CapEx longer term?
No, I don't think in 2014 you should expect to see much change in the company's capital spending for our glass business. We're really at what we would call more of a maintenance level in the Display Technologies area now, because of the results of thin, we think we're in good shape there. We feel that we can regionally supply very effectively between Taiwan, Japan, and Korea. We don't feel that the fact that China is growing very rapidly causes us a problem. We've been shipping glass to China for a long time. The capital spending, you should feel pretty good about the one three this year. Right now, as I think we've told you, we think it's one three again next year. Display Technologies is not a big portion of that. It really is driven by some spending in our other businesses, including Environmental.
Yeah, we're pretty happy with our asset platform in China as well. That's all been previously announced. What we're doing in productivity there looks really good.
All right. Thank you, gentlemen. Good luck.
Our next question's from Amitabh Passi with UBS. Please go ahead.
Hi, thank you. I just had a couple of questions. Jim, on the $2 billion buyback plan you announced, from a funding perspective, will you need to repatriate any cash, or do you think you can fund that based on what you have on shore? I just wanted to clarify your gross margin of 42.4% came in about 200 basis points above, your expectations. Given all the restatements, can you just help me understand, is that "a clean number"? How does it compare to last year's gross margin? It seems like it was flattish. I had one other follow-up.
On gross margin, the 200 basis point improvement was driven by very strong manufacturing within particularly telecom and Gorilla, really drove the improvement in expectations. I can't remember what last year's number is. Maybe Ann can look it up in the script. I just can't remember off the top of my head. Your first question was on
Just the funding mechanism of the $2 billion buyback plan. Would you need to repatriate any cash, or do you think you have enough onshore to fund the $2 billion buyback if you chose to go through the entire amount?
We don't have a need to repatriate the cash. We are not changing our assertion that it's permanently invested during the timeframe that we're talking about.
Okay. Just as a quick follow-up, maybe one for you, Wendell. The sequential growth in telecom and Gorilla Glass, can you give us any insight in terms of what the drivers are, where you're seeing that sequential growth coming from?
Definitely, and I'll add quick briefly to Jim's previous comment. I think your question was right on, are these results clean and given our move to core earnings. Great question, and they are. It's one of the reasons we're doing it this quarter and to try to match going forward. The economic reality of being hedged out at 93 ought to be able to help us and help you all be able to get a nice, clean, forward-looking forecast as well. Now on to that forecast and sequentials. In telecom, we would expect the sequential ups to be driven by season out of normal to a little bit above normal seasonality increases out of China especially, as well as some uptick in our enterprise business.
In specialty and in Gorilla, we'll see that uptick be linked more to new product launches. We'd expect that to ramp through the year. For example, something like the Galaxy S4, which is just gonna start really ramping up their supply chain in quarter two with Gorilla Glass 3.
Just to follow up on your gross margin question, Ann tells me quarter one of a year ago was 42%.
Okay, perfect. Thank you.
Our next question's from Steven Fox with Cross Research. Please go ahead.
Thanks. Good morning. Couple questions from me. Just following up on that last question, can we talk about SG&A in a similar manner? It looks like it came in, by my count, $30, $35 million less than you guys were originally guiding to. I was curious if that's sustainable. Secondly, Jim, just on the equity earnings line, that came in greater than expected. How much was that related to not including the solar polysilicon results in the numbers? By not including it, is that sort of an admission that we're definitely gonna see a write-down of those assets? Thanks.
On the latter, I think it was $5 million, so Hemlock was not a significant exclusion. No, it's not an admission. Our choice on taking Hemlock out is we really feel it's so much influenced by what's happening in the trade war between China and the U.S. and Europe, that you really run the risk of the results being affected by that rather than really what we focus on, which is making and selling product. We do not have a ruling from MOFCOM. They delayed it again. We now think it's gonna be in June. We don't know what it's going to be. We're not predicting that, but we just decided it would be easier for you to not have the potential swings in Hemlock in our results. In quarter one, it was a very tiny amount.
I think some of the SG&A gain is sustainable from quarter one, but not all of it.
Just one quick follow-up on the equity earnings line. Just a little bit more color around Dow Corning. It looks like, I guess, the core silicones business is improving more. Is that?
outlook now for that business recovering as the year goes on?
Yeah, we're expecting it to improve again in quarter two. Silicones does go through a cycle. A cycle is driven somewhat by capacity adds in the industry. Dow Corning did that as well as some of our competition. There has been raw material pressure. 2012 probably was our low point if you look at silicone margins. We think as the industry grows into some of that new capacity, with moderation in some raw material pricing, we think that we're starting to move up on the margin cycle. We're expecting improvement in silicones in quarter two, as of now, I have no reason to not expect the back half of the year to be good year-over-year also.
Thanks very much.
Next we go to Simona Jankowski with Goldman Sachs. Please go ahead.
Hi. Thanks very much. I just wanted to ask first what the EPS would've been in the quarter under the old accounting, or maybe kind of put another way, I just wanted to understand in terms of the FX impact that was included. Clearly, the cost of the hedge is excluded, but what about the move of the yen up to 93? Was that included in the quarterly results, or if not, what would that have looked like if it had not been excluded?
Well, the yen, there really is no change, because the yen was 93. There really was no impact. The cost of the hedge for the quarter after tax was a very small amount.
Okay.
I think the core answer to your question is no difference.
Got you.
That's one of the reasons we wanted to do it this quarter. Core earnings are about going forward on the volatility standpoint and to be able to link to our actual hedge.
Okay, that's helpful. The other question is on your guidance for a relatively flat volume into the second quarter. That seemed a bit weaker than I would've expected given that you had some correction in the first quarter and seasonality and even some of your customers like LG Display had guided for something a bit higher. Can you just go into the drivers of that view and then what you see in terms of inventory downstream?
What goes into that view is our reflection on the fact that inventories grew again in quarter one and are likely to grow a little in quarter two. We think that level will temper a little the potential volume that the panel makers will take. We recognize we could be wrong in that, and I would say if we had to say where the error would come, it might be stronger. Clearly, the demand right now from our panel maker customers is quite strong. We're actually air shipping in order to meet their demand. It could be that we'll actually see it go up. It's just that our caution as we measure the amount of inventory in the supply chain north of where the panel makers are, is we're worried that it's built up quite a bit and therefore that's what led us to our flat guidance.
I think it's on the high side of healthy, but to your point, we'd like to see the May sales in China, and then it could be that we're underestimating where the market's going to be.
In your view, what explains that disconnect between your customers requiring you to air ship while at the same time having excess levels of inventory?
I don't think they're in excess. We'd say they're just on the high side of healthy. Right?
Okay.
I think what it really comes down to is how big a sales cycle do they see, especially in China as the retailers get ready for the May Day sales.
I just want to make sure you understand that the inventories we're talking about are not at the panel makers.
It is our estimation of what exists at a set assembly in a retail. The panel makers are continuing to run strong. In order to keep up with them, we're doing some air shipping, which regretfully is costing us a little bit in gross margin. If China, the May holidays perform as well as what we saw in the New Year's holidays, we could be surprised on the upside and do a little bit better than what our guidance has been.
Okay. That's very clear. Thank you.
Finance questions from Ehud Gelblum with Morgan Stanley. Please go ahead.
Hey guys. Thanks. I appreciate it. A couple of clarifications. First, Jim, the $100 million hedge expenses, where does that show up and where are we going to see that in the P&L? Also the change in pension accounting that you made, did that have an impact on EPS this quarter? What do you expect that to be for the year? I have some fundamental follow-ups.
On the pension, it basically was $0.01, it's in both this year and last year. It really isn't making a change statement. The cost of the hedge we exclude from core performance. As you divide the 100 by 8 quarters and tax affected, it's a very small amount.
Okay. That is helpful. Digging a little bit deeper into the equity earnings, the 173 versus we had about 120. [Calculated SCP] was probably around $17 million of that. The rest, does that come basically from silicones? Can you just give more color on what is driving that? You did make some comments that you think it's sustainable and it comes back, just what are the drivers there, so we can understand the moving pieces. Then on cash, someone asked before, and I'm not sure, I quite got the answer. What is your U.S. cash balance right now? I think it was $1.5 billion at the end of last year.
Cash balance is $1.2 billion right now.
In the U.S.?
In the U.S.
Okay.
In terms of equity earnings, we believe that silicone business is doing quite well in the current quarter, and it's going to continue to do well in the second quarter.
Any drivers behind that? What is creating that? Something that we can track?
We'd say demand is good, pricing has been okay. Raw material costs have been improving versus where they were. Those are the primary things. Demand is good in China, good in the U.S., weak in Europe.
I've always thought of silicones as more being somewhat of a GDP-related thing because they go into a lot of different areas. Is that a comment on macro in general looking better from the perspective of products that silicones go into?
Well, it's interesting. They have a very high correlation with GDP or industrial production. It depends on which segment of the usage of it. I think the thing that you have to remember, as emerging economies start to move up the scale, if you will, of development. They actually use more silicone per population. You actually get a multiplier effect, even though, say, China's GDP is 7.7%, as an example. The growth in silicones would be higher because we consistently see in developing economies is more silicones per person, if you will, as they move up the scale of life. That's where we think we're seeing some of the strength.
China's GDP was even stronger last year, and yet it wasn't really helping you then. I'm just trying to find out what was the turning point or what's happening now that wasn't happening previously that seems to be bringing that category back up again. Is there anything you can pinpoint?
It's just because last year, you were seeing the effect of more price competition, and we're not seeing that right now.
Overlaying the GDP pieces and those factors, Ehud, you also have just sort of the supply-demand cycles that you get in silicones over time, and feel like it bottomed out last year and starting its walk up as an industry, as they get better and better balance between demand and supply.
From your experience, is this a one, two, three-year cycle? This is the beginning of a multi-year upswing, or does it happen every year? It goes up and down.
No. We think silicones is coming off a low point in terms of margin performance. Assuming the world's economies behave, sales should grow. The unknown for us is really going to be Europe. It's really hard to tell what's going to happen in the European economies, and that's clearly been a drag on Dow Corning. I think if we're starting to stabilize a little, even though it's at a lower level, that's helpful for Dow Corning.
Helpful. Thank you.
Next, we'll go to Rod Hall with JPMorgan. Please go ahead.
Hi, guys. Good morning. Thanks for taking my question. First of all, congrats on the hedging. That's a pretty cheap price, Jim, to get for all that, for $5.2 billion worth of hedges.
Thanks.
A couple of questions on the rest of the business. I wanted to just check in on the inventory again and see. You've been talking about this structural reduction in inventory over time. I wonder, based on what we're seeing now, do you think that we're coming to an end of that and that inventory is actually kind of reaching a stability point? You think this is just kind of a short-term fluctuation in inventory we're observing? I also wanted to talk a little bit about the, or get you to talk a little bit about the panel supply-demand situation as we head into the back end of the year. We see a lot of these panel manufacturers running pretty high utilization rates now, and we're not at the peak season.
I wonder, do you think there's going to be enough supply in the second half of the year to meet demand, even in a more cautious economic scenario? I've got a follow-up to that as well.
With the structural reduction inventory that we talked about in December of 2011, we still believe that that can occur. What has surprised us is the willingness of the supply chain to carry more inventory than what we expected, and we continue to struggle a little bit as to the reasons. As outlined in my prepared remarks, we clearly think that there could be some impact from the fact that panel prices have been relatively stable. What has often driven supply chain fluctuations has been when, particularly when people think there's about to be a big reduction in panel prices. No one wants to look dumb and buy when they're seeing that. We think that stability may be playing into effect.
The second thing, again, hard to prove, is the LCD television market basically gets to full penetration, and we are capturing the more emerging parts of China, as an example, and other parts around the world. It may be that the supply chains are just less efficient. The third factor that we're seeing is that the panel industry To improve their own efficiencies and also position themselves better, we're seeing a proliferation of new sizes. At one time, life was pretty simple. It was either 32 or 37 or 40 or 42 or 46. Now you see these new sizes, like 39 coming in. The more models you have, the more inventory you have. We still believe over time that the supply chain will become efficient and will go down, but it's definitely carrying more than what we originally expected.
Do you have any comment on the panel supply, Wendell? In terms of, we know there's more capacity coming on in China as the year progresses, we're hopeful that that is enough to supply the demand. I don't have a lot of current data on panel supply.
It's hard to tell at this point in time, I'd say, boy, it would really be good if you were right.
Yeah, exactly. Okay. I need my follow-up. Jim, I don't know if you could make any comment on your cash return policy going forward, particularly the dividend, how you're thinking about metrics there. Do you have a payout ratio in mind or a yield in mind, or can you just give us any feeling for how you're thinking about that looking forward?
We have not yet set a firm policy with the board as either a yield or a percentage of our free cash flow. I can tell you that the board's deliberations that went into the announcement today is that we're really dedicating our free cash flow over this year and next year to shareholder returns through a combination of dividend and share repurchase. I think as always, we'd love to continue to increase the dividend as our earnings go up. We want to be cautious not to get too strong on the dividend because you never want to have to lower it, and we lived through that once before.
I think you can expect to see the dividend continue to go up as our earnings go up, and us dedicate the free cash flow, the remainder of the free cash flow, against share repurchases as long as we feel the company's undervalued, which we clearly do.
Thank you.
John, we have time for one more question, I think.
That'll be from the line of Jagadish Iyer with Piper Jaffray. Please go ahead.
Yeah, thanks for taking my question. Two questions. First, Wendell, if the yen continues to weaken further, the prognosis being much closer to 115 to 125 or something like that over the next 12 months, how do you think that your competitors are likely to respond in terms of pricing? Given that you have hedged, do you think that it doesn't matter anymore? I would like to have your thoughts on that, at least from the qualitative perspective, and then I have a follow-up.
Well, what economically you would believe, if they were microeconomic decision-makers, is that it ought to have a very moderating effect on pricing, because customers are getting the benefits from that, and actually, the weakening yen hurts their financials because of the way their cost structures are built and the way their P&L works. That ought to give strong motivation to them to be more moderate in their pricing behavior, if indeed they're microeconomic decision-makers.
Okay. Just as a follow-up, Jim, you alluded in your prepared remarks that the gross margins on Gorilla Glass was getting better. Just wanted to get your thoughts on the puts and takes in terms of how the ASP declines were in Gorilla Glass and how your cost reduction initiatives have become. Thank you.
Our cost reduction is exceeding our ASP declines on Gorilla. Just a reminder on Gorilla. This remains a relatively new business and new product, and we're making improvements in our cost structure as we making the glass thinner, and improving our yields. We are moving up the gross margins to that, and the profitability remains well above the corporate average, and it's improving.
Jim, you have a closing statement?
Yes, I do. A couple of quick wrap-up comments for me. First of all, we do have one investor relations announcement. We'll be attending the JPMorgan TMT conference on May 14th in Boston, and we hope to see a number of you there. I'd like to just summarize the call this morning. First, we think we've made great progress on stabilizing display and then turning that business to positive momentum. We didn't talk a lot this morning, but we continue to do well with new products for various usages. Second, we're executing our goal to grow our earnings in our other businesses. You saw very strong aggregate growth in profitability from our other businesses.
Third, we grew core earnings per share year-over-year by double digits, both in Q4 and Q1. We think this is very strong evidence that we are marching up on our earnings. We think we've moved very assertively and appropriately to protect the company investors with our yen hedges. We remain very committed to shareholder returns, and we've acted on that commitment by increasing our dividend for the third time in 18 months, effectively doubling it, and announcing a $2 billion share repurchase. You should consider these new actions as approximately a $3.2 billion commitment over the next two years, essentially putting our free cash flow to work for shareholders in line with our belief the company is undervalued at its current price.
Finally, looking ahead to Q2, we are very confident that we will have a third consecutive quarter of year-over-year core earnings growth, driven by moderate LCD glass price declines and excellent growth in telecom, Gorilla Glass, and life sciences. Anne?
Thank you, Jim, and thank you all for joining us today. A playback of the call is available beginning at 10:30 A.M. Eastern today and will run until 5:00 P.M. Eastern on Wednesday, May 8th. To listen, dial 800-475-6701. The access code is 287833. The audiocast, of course, is available on our website during that time. John, that concludes our call. Please disconnect all lines.