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Edited Transcript of GLW earnings conference call or presentation 29-Jan-19 1:30pm GMT

Q4 2018 Corning Inc Earnings Call

Corning Jan 31, 2019 (Thomson StreetEvents) -- Edited Transcript of Corning Inc earnings conference call or presentation Tuesday, January 29, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ann H. S. Nicholson

Corning Incorporated - Division VP of IR

* R. Tony Tripeny

Corning Incorporated - Executive VP & CFO

* Wendell P. Weeks

Corning Incorporated - Chairman, CEO & President

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Conference Call Participants

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* Asiya Merchant

Citigroup Inc, Research Division - Research Analyst

* Mehdi Hosseini

Susquehanna Financial Group, LLLP, Research Division - Senior Analyst

* Roderick B. Hall

Goldman Sachs Group Inc., Research Division - MD

* Steven Bryant Fox

Cross Research LLC - MD

* Vijay Krishna Bhagavath

Deutsche Bank AG, Research Division - VP and Research Analyst

* Wamsi Mohan

BofA Merrill Lynch, Research Division - Director

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to the Corning Incorporated Quarter 3 2018 Earnings Call. As a reminder, today's conference is being recorded. It is now my pleasure to turn the conference over to Ann Nicholson, Division Vice President of Investor Relations. Please go ahead.

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Ann H. S. Nicholson, Corning Incorporated - Division VP of IR [2]

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Thank you, Tawny, and good morning. Welcome to Corning's Fourth Quarter 2018 Earnings Call. With me today are Wendell Weeks, Chairman and Chief Executive Officer; Tony Tripeny, Executive Vice President and Chief Financial Officer; and Jeff Evenson, Executive Vice President and Chief Strategy Officer.

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. Those statements involve 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 be discussing our consolidated results using core performance measures, unless we specifically indicate our comments relate to GAAP data. Our core performance measures are non-GAAP measures used by management to analyze the business. A reconciliation of core results to the comparable GAAP value can be found in the Investor Relations section of our website at corning.com.

You may also access core results on our website with downloadable financials in the interactive analyst center. Supporting slides are being shown live on our webcast. We encourage you to follow along. They're also available on our website for downloading.

And now I'll turn the call over to Wendell.

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Wendell P. Weeks, Corning Incorporated - Chairman, CEO & President [3]

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Thank you, Ann, and good morning, everyone.

This morning, we reported a very strong finish to an excellent 2018. For the fourth quarter, sales were $3.1 billion, up 15% year-over-year. Net income was $539 million, up 18% year-over-year. And EPS was $0.59, up 28% year-over-year. For the full year, sales were $11.4 billion, and EPS was $1.78, both up 11% from 2017. We also delivered on our goal to improve gross margin to 42% in the second half, a significant increase over last year and the first half of 2018.

All of our businesses produced year-over-year sales growth in 2018. Highlights include: Optical Communications sales up 18% for the second consecutive year; Environmental sales up 17%, as the adoption of gasoline particulate filters accelerated; Specialty Materials sales up 5% following an exceptional 2017 growth of 25%; Display sales up 4% as we ramp our new Gen 10.5 facility, and annual price declines reached the important milestone of mid-single digits in the second half. And full year pricing was the best in more than a decade; Life Science sales up 8% as we continue to outpace market growth.

For the past 3 years, we have invested for growth through our Strategy and Capital Allocation Framework. The significant benefits of these investments are evident in our financial performance. In 2018, we built new capacity, launched new products, grew sales by more than $1 billion and extended our leadership position in all businesses. We exited the year with strong execution, expanded margins and great momentum.

We expect our momentum to continue into 2019 and beyond, and we expect strong year-over-year growth in the first quarter and additional growth in subsequent quarters. In total, we anticipate another strong year for Corning.

We also feel confident that we're well positioned for long-term growth. Important trends, such as 5G and smart cars, connected homes and augmented reality are converging around Corning's unique capabilities. These interconnected ecosystems require technology that have been our fundamental strengths for a decade. Our proprietary manufacturing processes and deep expertise in glass, ceramics and optical physics are more relevant than ever. Overall, we're excited about 2019 and our future opportunities, as Tony will describe in more detail in just a few minutes.

Now let's turn to the Strategy and Capital Allocation Framework. Under the framework, we target generating $26 billion to $30 billion in cash through 2019. We plan to return more than $12.5 billion to our shareholders through repurchases and dividends and to invest $10 billion to extend our leadership and deliver growth.

As we've discussed within numerous times, we have continued to make great progress for the framework goals we announced in October 2015. As we enter the final year of our plan, we expect to meet our stated goals. Our cash generation is on target. And through the end of 2018, we have returned $11.8 billion to shareholders. We increased dividends per share by 50% since the framework began. Investments in RD&E, capital expenditures and acquisitions also remain on track to our 4-year plan totaling $8.2 billion to the end of 2018.

As outlined in our framework, Corning is best in the world in 3 core technologies, 4 manufacturing and engineering platforms and 5 market access platforms. Our capabilities are interrelated and reinforcing. We focused 80% of our resources on opportunities that use capabilities in at least 2 of these 3 categories. This increases our probability of success, reduces the cost of innovation, creates stronger competitive advantages and most importantly, delights our customers.

Now I'll turn to progress in each of our market access platforms, starting with Optical Communications. Our performance in Optical Communications continues to be outstanding, and we expect to surpass our goal of $5 billion in 2020 sales with further growth beyond. We remain the world leader in passive optical solutions and the only true end-to-end supplier of integrated solutions.

2018 was an excellent year for our Optical Communications business. Recognition of the value created by our solution and co-innovation approach continues to grow as we secured additional multiyear contracts with industry leaders in the carrier and data center segments, which will add significant sales and profit in 2019 and beyond. This committed demand supports our additional investments in manufacturing capacity.

Another highlight of the year was completing the acquisition of 3M's Communications Markets Division. In addition to bringing us a talented group of employees, it extends our market reach and access to global customers, while expanding our portfolio in rapidly growing optical solutions markets.

Next, we achieved product milestones that demonstrate our long track record of innovation and industry expertise. Our pre-connectorised, fiber to the home solution have passed more than 45 million homes around the world. We introduced products in 2018, such as extreme density cable tailored for next-generation hyperscale data center architectures as well as a fiber that offers significant advantages for high throughput transmission.

[All] products continue to reduce network costs and increase the speed of installations. And we earned industry accolades in multiple customer segments, including data centers and access networks.

Interestingly, beyond the hardware solutions, we've also developed software tools that speed up installation. For example, FiberPass helps accelerate typical installations from weeks to just days. Bruce Furlong, Bell's Vice President of Deployment and Access, described the benefits this way: "The efficiency and accuracy of the FiberPass solution has contributed to the rapid expansion of Bell's broadband network and our fast-growing Fibe TV and Internet services."

Our investments in capacity clearly paid off in the second half of 2018, with strong sales growth and even greater growth and profitability. As we turn to 2019, committed demand supports additional investments and will lead to additional growth. Overall, we expect to continue to grow more than twice as fast as the communications infrastructure market.

Now let's turn to Mobile Consumer Electronics, where we are the world leader in glass for smartphones, tablets and emerging categories, like wearables and augmented reality devices. Our goal has been to double Mobile Consumer Electronics sales over the next several years despite a maturing smartphone market, and we've been making significant progress toward that goal.

Here's how. First, we're capturing more value per device. We extended our leadership in the cover glass market with the launch of Gorilla Glass 6 in July. Leading OEMs are continuing to design our premium glasses into their devices. We expect more than 10 new models with Gorilla Glass 6 to launch throughout this year.

We're not only benefiting from adoption of our premium glasses but also from more glass on each phone. Glass back penetration on smartphones doubled, from 15% in 2017 to 30% in 2018. And we expect continued growth in 2019.

We're also significantly expanding our presence in the aftermarket. As announced this month, we will collaborate with OtterBox, the #1 selling smartphone case brand in the U.S. to introduce the Amplify line of glass screen protectors. This will offer extra protection for consumers and add a third piece of our glass to devices.

Second, we are winning in new and emerging device categories. We launched Corning Gorilla Glass DX and DX+ in July, which provide enhanced antireflective optics and scratch resistance for wearables. These new glass composites are continuing to gain traction in the wearable market, with several launches slated during the first half. We're also partnering with leading consumer electronics makers on augmented reality devices and precise 3D-sensing technology. For example, at CES, we announced an agreement with WaveOptics to help enable sleek augmented reality wearables. The ultra-flat, high-index class that Corning supplies, coupled with our proprietary laser processing and characterization tools, enable optimizing this quality and sleek device form factors. So overall, we're off to a great start to meet our goal: to double sales in Mobile Consumer Electronics.

A quick fun fact, since 2016, smartphone unit sales have been relatively flat. We, however, grew our sales in this space 30% due to our innovations. We'll continue to innovate for our customers, and you'll continue to see more Corning in your devices.

Turning to Automotive market access platforms. Our materials expertise is helping to propel the auto industry into a new era of cleaner cars with enhanced cockpit functionality, connectivity and design. Our objectives are to build on our base business with the gasoline particulate filter opportunity and to launch an automotive glass business. 2018 was an exciting year for both objectives. Our gasoline particulate filter technology makes cars significantly cleaner. We exceeded $50 million in GPF sales in 2018 as European regulations took effect. And we expect more than $150 million in 2019 GPF sales. China will be the next to introduce GPFs, with initial filter sales this year as OEMs prepare for the first phase of China 6 regulations in mid-2020. We are ramping dedicated capacity in China to support a robust pipeline of business resulting from upcoming Chinese regulations.

Next, we experienced strong call for Gorilla Glass for automotive in 2018. We are capitalizing on long-term industry trends to the driving demand for technical glass. At CES, automakers confirmed the trend towards larger, longer, shaped and more integrated displays. We also saw a strong call for Corning's industry-first auto grade glass solutions for automotive interiors, launched exclusively with customers at CES. These new solutions are making it easier and more affordable for automakers to bring curved and flat displays to market.

In total, we've been awarded more than 55 platforms to-date globally. Demand is materializing faster than we expected, and we are accelerating our investments accordingly.

In our Life Sciences Vessels platform, we continue to make strong progress on the path to a new long-term multi-billion dollar franchise. Valor Glass substantially reduces particle contamination breaks and cracks while significantly increasing throughput. Valor helps protect patients and improve pharmaceutical manufacturing.

Key customers are advancing towards the FDA certification required for the use of Valor. We continue to make progress with our development partners, Merck and Pfizer, and shipments are increasing to other major pharmaceutical manufacturers to support their individual drug regulatory filings. Total shipments of Valor Glass increased fourfold compared to 2017, indicating growing progress towards certification across more pharmaceutical companies.

In parallel, we're supporting customers by scaling up our production capabilities on case with market adoption. We brought new capacity online in 2018 and expanded our range of products. We're also progressing with the construction of the new high-volume manufacturing facility in North Carolina that we announced in April.

Finally, industry poll remains favorable. Regulatory concerns about the need for improved glass packaging were highlighted in the lead story of the January PDA letter, reinforcing the need for new solutions such as Valor Glass. In addition, Valor Glass was named one of the top 6 pharmaceutical and medical packaging developments in 2018 by Packaging Digest. We continue to believe Valor has the potential to power Corning's growth to the next decade and beyond. We remain closely engaged with the FDA and support its efforts to address this important public health issue. We look forward to being able to share additional updates soon.

In Display, we're delivering stable returns. During 2018, we extended our global leadership by successfully ramping the world's first Gen 10.5 glass plant. This accomplishment allow us to grow volume faster than the overall market. Also, the Display glass pricing environment continues to improve.

We reached the important milestone of mid-single-digit year-over-year price declines in the second half of 2018. In fact, 2018 was the best pricing environment in more than a decade. We expect the pricing environment to improve further in 2019 and reach mid-single-digit declines for the full year. We're off to a great start, with first quarter price declines expected to be significantly better than quarter 1 2018 and the best quarter 1 in a decade. Display will continue to execute its proven strategy to deliver stable returns.

So we continue to make significant progress across all our market access platforms. Ultimately, we remain on track to fully achieve our Strategy and Capital Allocation Framework goals. In 2018, we leveraged our investments to meet increased demand from our customers, grow sales and significantly improve profitability in the second half, just as we said we would.

Looking ahead, we are confident in our ability to deliver sustained performance. We have multiple businesses driving our growth. Our capabilities are becoming increasingly vital to important trends. Our relationships with industry-leading customers are opening new opportunities. And our strategic investments are paying off. We're not only succeeding at building a bigger company. We're building a stronger, more resilient one. We look forward to outlining the next phase of our strategic framework in the coming months.

Now let me turn the call over to Tony for a review of our results and outlook.

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R. Tony Tripeny, Corning Incorporated - Executive VP & CFO [4]

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Thank you, Wendell, and good morning. We had another outstanding quarter, and our full year results exceeded our expectations. In 2018, we did what we said we were going to do, which was to expand our manufacturing capacity in the first half and begin leveraging those growth investments in the second half. In 2019, we expect to build on this momentum and keep growing across all of our businesses.

Before I get into the details of our performance and results, I want to note that the primary difference between our GAAP and core results is, again, a noncash marked-to-market adjustment for our currency hedge contracts. As we've discussed before, GAAP accounting requires earning translation hedge contracts settling in future periods to be marked-to-market and recorded at current value at the end of each quarter even though those contracts will not be settled in the current quarter. For us, this resulted in an after-tax GAAP loss of $180 million for the fourth quarter. To be clear, this mark-to-market accounting has no impact on our cash flow.

Our currency hedges protect us economically from foreign exchange rate fluctuations and provide higher certainty for our earnings and cash flow, our ability to invest for growth and our future shareholder distributions. Our non-GAAP, or core results, provides additional transparency into operations by using a constant currency rate aligned with the economics of our underlying transactions. We're very pleased with our hedging program and the economic certainty it provides. We have received $1.7 billion in cash under our hedged contracts since their inception slightly over 5 years ago.

Now, that brings me to our results and outlook. For the fourth quarter, sales were up 15% year-over-year to $3.1 billion, net income rose 18% to $539 million, and EPS is $0.59, up 28%. For the full year, sales were $11.4 billion, and EPS was $1.78, both up 11%. As Wendell noted, this strong growth resulted from customers adopting our innovations and from us factoring the benefits of our capacity investments. As a reminder, our capacity expansion projects in 2018 supported strong committed customer demand across all businesses. These investments include capacity expansion for optical fiber and cable, Gen 10.5 Display glass, gasoline particulate filters and multiple development projects, such as Gorilla Glass for mobile devices and automotive.

2018 capital spending totaled $2.2 billion. As our new capacity ramped towards full production levels, our sales run rate climbed and our gross margin expanded at 42% in the second half of the year.

Turning to the balance sheet. We ended the quarter with $2.4 billion of cash. Adjusted operating cash flow for the year was $3.2 billion and on track for the cumulative target in the 4-year capital allocation plan.

Now let's look at the detailed segment results and outlook. In Display Technologies, we're delivering stable returns. Our full year sales were $3.3 billion, up 4% year-over-year. Fourth quarter performance was in line with our expectations. Sales were $899 million, and net income was $240 million. 2018 was the best pricing environment in more than a decade. As expected, fourth quarter price declines were very moderate, at a mid-single-digit percentage year-over-year, and even more moderate than Q3. With over 90% of our volume under contract, we expect our full year 2019 price declines to improve further through a mid-single-digit percentage and to be even better than they were in 2018.

For the first quarter of 2019, we expect sequential price declines to be significantly better than the first quarter of 2018 and be the most favorable first quarter price change in over a decade.

Now 3 factors continue to drive our view that this favorable pricing environment will continue: first, we expect glass supply to continue to be balanced or even tight. Our new Gen 10.5 plant supports the expected growth of large-sized TVs. It is co-located with, and dedicated to, our customer BOE. We pace and align capacity in tandem with BOE to ensure a Gen 10.5 glass supply is balanced to demand. The ramp is on schedule. We expect the glass supply-demand balance below Gen 10.5 to continue to be tight, as public information indicates there's little capacity growth planned in this segment. Second, our competitors continue to face profitability challenges at current pricing levels. Therefore, we expect their price declines will slow further as they try to remain profitable. And third, display glass manufacturing requires ongoing investment in current capacity to maintain our operations. To generate acceptable returns on investments, glass pricing will need to improve even further. For Corning, we will only add capacity if we can get an attractive return for our shareholders.

In the fourth quarter, Display glass market volume grew low-single digits sequentially and our volume grew faster, as expected, due to the ramp of our Gen 10.5 plant. For the full year, the Display glass market volume increased mid-single digits as expected, driven by growth in TV screen size. We expect mid-single-digit growth again in 2019, also driven by growth in TV screen size. We also expect our volume to grow more than the market once again, resulting from the ramp of our Gen 10.5 plant during that 2018.

In the first quarter of 2019, we expect the Display glass market to be at mid-single digits year-over-year and our volume to be up significantly more. Sequentially, we expect the market and our volume to decline by a mid-single-digit percentage, consistent with normal seasonality.

In summary, we remain very pleased with the current dynamics in our Display business, including our ability to cash our higher productivity and margin through fleet optimization and the Gen 10.5 ramp. And most importantly, the fact that we are now delivering stable returns.

Let's move to our fastest-growing segment, Optical Communications. Full year sales were $4.2 billion, up 18% for the second consecutive year. The business is on track to surpass its goal of $5 billion in 2020 sales. Net income was up 26% year-over-year. In the fourth quarter, sales exceeded $1 billion for the third consecutive quarter, and we were up 26% over 2017. Net income for the quarter, was up 60% year-over-year. Sales growth for the year and the quarter were driven by multiyear data center and carrier projects, availability of new manufacturing capacity as well as sales from the recently acquired 3M Communication Markets Division. As planned, we are leveraging our capacity investments to drive higher volume and earnings.

Our midyear acquisition of 3M's Communications Market Division contributed about $200 million to 2018 sales. We are pleased with our progress on integrating this acquisition and continue to expect it to be accretive to EPS in 2019. Looking forward, we expect first quarter sales to be up in the low-20% range year-over-year. We expect another year of growth, with full year 2019 sales up low teens. Key growth drivers include customer projects and the full year of sales from the 3M acquisition.

Our customers, the world's leading network and cloud operators, continue to deploy Corning's optical solutions to densify their 4G, 5G and data center networks. We continue to be very excited about the growth ahead of us.

Environmental Technologies' 2018 sales were $1.3 billion, up 17% year-over-year, driven by growth in all product categories and accelerated by emerging sales of GPFs. Net income grew faster than sales at 26% year-over-year. 2018 GPF sales were more than $50 million, as demand ramp strongly in the second half of the year, primarily in Europe. We are now starting to sell into China with early adoption of China 6 regulations. Dedicated capacity and engineering investments support the ramp of this business.

Fourth quarter Environmental sales grew 10% year-over-year. Looking to 2019, we expect first quarter sales growth of mid-single digits and full year sales to be up high single digits year-over-year. We expect $150 million of GPF sales in 2019. And we continue to add capacity to meet the additional demand.

In Specialty Materials, 2018 results were strong after an exceptional year of 25% sales growth in 2017. Full year sales rose 5% as OEMs adopted our portfolio of premium glass products. And the use of glass backs double to about 30% of smartphones in 2018. Fourth quarter sales were $399 million, in line with our expectations, and up 2% versus a very strong fourth quarter in 2017, when customers built aggressively to support launch cycles.

Overall, we are pleased with our performance in Specialty Materials. Our results demonstrate the value of our premium glasses, the strength of our innovation portfolio and the continued adoption of glass smartphone backs. For the first quarter, we expect sales to grow mid- to high single digits year-over-year. We also expect to grow again for the full year despite a mature market. Exactly how much will depend on the adoption rate of our innovations.

In Life Sciences, 2018 sales were $946 million, up 8% year-over-year, with strong fourth quarter sales, as we continue to outpace market growth. Net income was up 23% year-over-year, driven by higher sales volume and manufacturing efficiencies. We expect sales growth to be a low to mid-single-digit percentage year-over-year for the first quarter and full year.

In summary, 2018 was a terrific year. All of our businesses have strong momentum. And we expect another year of sales, gross margin, net income and EPS growth in 2019. We expect 2019 gross margin dollars, in percent, to expand due to the manufacturing capacity that came online in 2018, our improved utilization of that capacity and the strength of our sales growth. The percentage increase will be somewhat muted due to our continuing investments in 2019 to meet committed demand for Optical Communications, GPFs and automotive glass.

We expect to see the sales and margin benefit that means additional investments start in Q2 and build throughout the remainder of the year.

In the first quarter, we expect double-digit year-over-year sales, gross margin dollars and net income growth. We expect gross margin percent to improve slightly from Q1 2018. Sequentially, we expect Q1 gross margin dollars and percent to be down due to seasonality in Display and Specialty, as is typical. We expect both to improve in Q2 and to continue climbing throughout the year.

Annual operating expenses should remain consistent with last year as a percentage of sales. For the full year, SG&A is expected to be about 14% of sales, and RD&E between 8% and 8.5%. We expect other income, other operating expenses to be approximately $250 million for the year. Full year of gross equity earnings are expected to be approximately $210 million, predominantly from Hemlock Semiconductor, with the first quarter at approximately $20 million, consistent with typical seasonality. Fourth quarter 2018 gross equity earnings were $152 million.

Our tax rate should be between 21% and 22% for the year and for the quarter. The slide we posted gives you additional modeling-related details for the first quarter and the full year. In 2019, we expect to spend just over $2 billion on capital expenditures with programs in every market access platform. How much more will depend on how quickly we ramp some of our investments. We'll provide more detail as the year progresses.

Finally, I would like to make a couple of comments on the economic environment, in particular, China. First, as we said previously, we do not expect the material impact from the enacted tariffs. Second, we incorporated conservative estimates for China end market demand for TVs and autos in our strong guidance and outlook for 2019. If Chinese demand is better, there's an opportunity for upside.

In closing, 2018 demonstrates that we are delivering on our priorities to grow and extend our leadership. Results were outstanding, with 11% sales growth and second half margin expansion. Our strong guidance reflects the rich set of opportunities ahead of us in 2019 and beyond as we continue to grow faster than the market across all of our businesses. We are also rewarding investors by returning more than $12.5 billion to shareholders, which compounds the benefit of our future growth for long-term shareholders.

With that, let's move to Q&A. Ann?

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Ann H. S. Nicholson, Corning Incorporated - Division VP of IR [5]

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Tawny, we are ready for this first question.

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Questions and Answers

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Operator [1]

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Our first question comes from the line of Steven Fox with Cross Research.

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Steven Bryant Fox, Cross Research LLC - MD [2]

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Wendell, a bit of an open-ended question for you on Optical. So you obviously are growing a lot faster than markets. I was just curious if you could maybe: one, talk about some of the key end markets you're serving, and what you're expecting in terms of spending there? And then, what are the key innovations that are driving the outgrowth and the satellite data center broadband and wireless?

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Wendell P. Weeks, Corning Incorporated - Chairman, CEO & President [3]

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Thanks for the question, Steve. So the primary reason we're growing faster in the market really has sort of has 2 layers to it. First of all, you're just seeing new networks being put in place that used to be fiber-poor and because of the requirements in our innovations are going to be fiber-rich. So in a way, for us you can think about is as it's not just more networks, right, but basically it's more us in the network. And that's why you're going to -- you start to see us begin to differentiate from the industry growth. Take something like wireless, as everybody's heard a lot about 4G densification or 5G. Wireless, today, is relatively fiber lean architecture. As you move to the wireless of the future, you end up adding a lot of glass. So as they talk about wireless networks densifying, right, what that really means is they're glassifying. And so if you compare us to others who are already in the wireless market, we were pretty small, but now we're getting pretty big because of our innovations and the requirements, what it is are unique fiber optics expertise offers. You see a similar dynamic happening in data centers, with the continued strong growth really at the percent of the load that's cloud-based, which is then allows -- when you do things like public cloud and in very large private clouds -- you to concentrate much more processing power, right, that is shared across many. That then makes it more economical, since you have that bandwidth all in one place, to start using fiber where you used to use copper. So once again, a substitution of that. Now all of these things are furthered by the dynamic that we have a set of unique innovations in all of those areas that gives us an additional advantage versus other players. So that's why you tend to see the difference. Now that you asked another question which is where do we expect to see the growth here in these coming years. We expect to see it being driven in access networks, especially with an accent on wireless densification. And then, we do expect to see a hyperscale data center business to continue to grow strongly and has now this new concept of sort of more EDGE compute and more EDGE cloud to that also opening up some opportunities for us. So sorry for the long answer, Steven. Does that get it at the core of what you're talking about?

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Steven Bryant Fox, Cross Research LLC - MD [4]

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Yes, it does. Just one other clarification. On the hyperscale build, can you just sort of talk about how that plays out? It tends to be lumpy in general. Do these new contracts actually smooth out the business for you? And like what's involved in them? If you can to the extent, you expand on that?

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Wendell P. Weeks, Corning Incorporated - Chairman, CEO & President [5]

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That's a really good question. So you're right since they tend to be pretty big construction projects that are little like our access network builds which are also big civil works projects, they can be kind of lumpy. I think what the new contracts do, it is not so much as change the civil works of reality of putting in these large facilities. As it does -- as it increases both the size of our business and the number of different areas that we're doing. The number of different customers that were doing it with and the number of different locations we're building at. So by increasing the number of projects, in a way, it becomes a little smoother, not because the individual projects aren't lumpy -- they are, but that they end up being in slightly different stages at different times. But I am quite sure, at some point, we'll hit a time where -- we'll hit a time where things will go a little lumpier because number of the projects go together.

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Operator [6]

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Our next question comes from the line of Mehdi Hosseini.

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Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [7]

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Tony, your Display net income margin averaged 25% for 2018. And it was in the 28% range for '17. You're talking about continued improvement. Should I assume that it's going to take you full years to get back to that 28% margin? Or is there any other measure that you can provide so that we could better see how the margin improvement, especially for Display kind of track? And then, for Wendell, Specialty Material, you have been investing in diversifying outside of the smartphone. It's great to know that you have a higher content in the smartphone. But can you provide us an update on diversification as of the smartphone and into auto end market?

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R. Tony Tripeny, Corning Incorporated - Executive VP & CFO [8]

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Sure. Let me take the Display question first. And clearly, what happened to us in Display in the first half of the year is that we saw our -- some margin contraction and that was driven both by our investment in Gen 10.5, but then was also driven by our fleet optimization. And what we saw in the second half of the year was the benefit of those things to occur. And you saw it in the fourth quarter results where our profits were up more than our -- the sales were on a year-over-year basis. And so when we've always talked about stabilization, what we talked about is getting to a certain profit level and continuing that on a going-forward basis. And we think that we feel good about the stabilization we saw in the second half. In fact, the fact that we grew profits in the second half and we think that's evidence as the strategy that we have been working on for a number of years really starting to pay off.

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Wendell P. Weeks, Corning Incorporated - Chairman, CEO & President [9]

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Great. And then for the content piece and where we're going outside of smartphones. We, of course, expect smartphones for the foreseeable future being people's primary device. But where we're making really strong progress is in the areas like wearables, notebooks and augmented reality, right. And so in wearables and notebooks, what we've done in both those areas is introduce by using our vapor deposition technologies, new composite materials that take our value on something like a wearable and a notebook up like a factor of 5. And so really even outside smartphones, you see us playing with the same basic approach, which is getting our new innovations adopted in those areas that also allows and adds value. Then you have entirely new device categories like the augmented reality, where you're seeing the potential start to take shape for really significant innovation in a vast new device category. But it's too soon to get too excited about it. There's a time for all the positioning, innovations. And that's something that years from now will offer a larger opportunity for us than what it is smartphones do today. But that's going to take a while to develop.

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Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [10]

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Can I have a follow-up here, if I may? It seems to me in the Specialty Material and Environmental Technology, you're executing and able to increase content either for smartphone or for auto application. As to end market, diversification is maybe a couple of years away. Is that the best way to summarize this?

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Wendell P. Weeks, Corning Incorporated - Chairman, CEO & President [11]

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Yes. It's really interesting what you've noted, because we think it's one of the things that's making us more resilient from an economic standpoint. As you've noted that in those 2 areas, we're not necessarily talking about more devices. You're talking about more on Corning. And if you're listening when I answered Steven's question of why are we growing faster, and communications then -- and communications infrastructure, once again, it's an answer of more of our content. It's more us. Necessarily, we'll add more networks. In automotive which you heard Tony talk about is we're not counting on more cars. What we're counting on is more content from us with gas particulate filters, our auto glass solutions. So you're right, you're not seeing us diversify out of our core market access platforms, our 5. Instead, you're seeing us get more product opportunities within it. We believe this is going to reduce cyclically the economic sensitivity and increase the resilience of our growth that really observe it. Thank you for asking that.

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Operator [12]

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Our next question comes from the line of Wamsi Mohan with Bank of America.

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Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [13]

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Tony, can you address sort of the overall gross margins in 2019. You have pretty compares from Q1 of last year when you were ramping your Gen 10, but you're talking about only a marginal uplift here in Q1 of this year, and you noted some investments. So could you just give us some sense on some of the magnitude of these investments and the overall magnitude of gross margin improvement, like is it 50 basis points, 100 basis points in 2019? And a quick follow-up to your comment about China end market assumptions being conservative. Can you maybe quantify those? Are you talking about auto production down 10%, like what are smartphone assumptions within TV? What are these assumptions? That would be helpful.

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R. Tony Tripeny, Corning Incorporated - Executive VP & CFO [14]

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Sure. Wamsi, overall, we're really pleased with our gross margin performance. We said at the beginning in 2018 that we're investing intensely and that would lead to significant growth and margin expansion in the back half. And that's exactly what happened. Our sales were up 16% in the back half over the first half. And our gross margins expanded about 150 basis points. And we expect, going forward, continued strong margin performance, both in dollars and the percentages, but those get somewhat muted by investments that we're making. And the good news is those investments are for committed growth in Optical Communications, GPF and in auto glass. And we're going to start seeing those investments starting in Q2, the benefits of those investments and it's going to expand from there. And in any given quarter, trends are going to be impacted by seasonality of our businesses, like it is in the first quarter, by the various mixes that we have in the businesses. But we're happy with our each of our businesses' performances as they're the best in the industries. And also, just like the total impact of these investments. So in Q1, you see some of these investments impacting us. But the main reason why Q1 is down versus Q4 is really the seasonality, not the investment. In terms of China, we were happy with the approach we took in the third and the fourth quarter. It turned out that we're exactly right on both in terms of where the auto production ended up in China and also from a TV standpoint. So we feel good about that. And as we go forward into next year, we're assuming the declines in both of those markets and the strong guidance that I gave you for the year.

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Ann H. S. Nicholson, Corning Incorporated - Division VP of IR [15]

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Next question?

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Operator [16]

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The next question comes from the line of Rod Hall with Goldman Sachs.

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [17]

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I just had a real quick question on the full year guidance. Maybe I have two-parter actually. So the guidance is better than we expected. The most bullish point of it is Display. And I wondered if within Display, you could talk about the interplay of your share assumptions versus unit growth assumption? So any color you could give us on which of those how much share you expect to gain for example would be interesting. And then on Specialty, is all of the weakness and the slowdown in Specialty, China? Or are there other macro issues that you see or demand issues? Just any further color on that would also be helpful in that full year guidance.

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R. Tony Tripeny, Corning Incorporated - Executive VP & CFO [18]

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Sure. Let me start with the Display guidance. Fundamentally, what drives our -- the glass market and Display of course is screen size. And in 2018, the screen size grow -- drove the market growth to the mid-single digits. And that's what we expect to happen again. Now we also benefited a little bit in 2018 where the number of TV units went up. But that's still -- what really matters here is the screen size growth. As we go into 2019, we, again, think the market is going to grow about the mid-single digits and what's driving that is the screen size growth. Now most people looking at the market think the TV unit themselves are going to be flat-to-down a little bit. A lot of that being driven in China. And we've factored that into our projections. But what really drives the market is the screen size growth, and we expect that once again to be in the about mid-single digits. Now, we're growing faster than that because of the Gen 10.5 ramp but you know generally speaking, it's about the mid-single digits. Relative to Specialty Materials, again, what really drives the growth there is the technology adoption of our products, as Wendell would say, having more Corning in those products. Last year, I think most people believed smartphones were down a little bit. That's what they're projecting again for this year, a lot of that being driven in China. But the reason that we're confident that we can be up is because of the adoption of the technologies. How much we're going to be up will depend on the actual timing of that adoption, but we feel pretty good about that.

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Wendell P. Weeks, Corning Incorporated - Chairman, CEO & President [19]

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Just to comment briefly on your share question. We tend not to think about it so much as share, as what's happening is with this constant move to larger sized TVs and this new Gen 10.5 plants that are getting built, when those happen, we co-locate and build the Gen 10.5 glass plant with our customer. And since those plants have a much lower cost platform for overall wireless television panels, what we expect of that category of Gen 10.5 to take more and more of the market. And it just so happens that because of our lead technically, right, that ends up being more us than in the below Gen 10.5. So that's another dynamic this what's leading to the more of than Tony's comments to the overall market growth. Does that answer your question, Rod?

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [20]

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Yes.

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Operator [21]

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Your next question comes from the line of Asiya Merchant.

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Asiya Merchant, Citigroup Inc, Research Division - Research Analyst [22]

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Quick question on optical. You guys have been posting strong net income margin growth in that segment. Obviously, as you scale, it's still obviously below Display. How should we think about the improvement in utilization, helping to kind of bridge that gap. Are we ever going to get to margins, not net income, but even on the gross margin line, getting corporate average, given the additional investments you're going to be making in 2019?

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R. Tony Tripeny, Corning Incorporated - Executive VP & CFO [23]

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Yes. We're really thrilled with our performance in our Optical Communications business, and we've both been growing sales significantly and we've been growing our profitability even greater than that. And that's what the real focus is on any given business unit at Corning. I mean, that's how we measure the business units' success, and we're having great success in Optical Communications. We have had some margin expansion in that business and I'd expect to continue to have some margin expansion in that business. And I think that's the way the model. We don't spend a lot of time comparing business-to-business because each of them have different economics and different levels of investment, but I mean, we feel great about the Optical Communications performance.

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Asiya Merchant, Citigroup Inc, Research Division - Research Analyst [24]

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Great. And just if I may. Given that you are annualizing the 3M acquisition in 2019, the core organic, is that still growing at low teens? Or is there any downshift in expectations there?

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R. Tony Tripeny, Corning Incorporated - Executive VP & CFO [25]

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I've said we feel great about our organic growth. And in fact, if you look at the Q1 numbers, the organic growth is almost about 20% on a year-over-year basis. So we feel really good about organic growth.

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Ann H. S. Nicholson, Corning Incorporated - Division VP of IR [26]

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We have time for one more question we can squeeze in.

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Operator [27]

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And our last question comes from the line of Vijay Bhagavath.

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Vijay Krishna Bhagavath, Deutsche Bank AG, Research Division - VP and Research Analyst [28]

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My question is not from the Optical this time, it's on auto glass. Continue to hear a lot of news flow but on auto grade glass, you're getting into automotive interiors. Can you talk to us about how that business kind of unravels heading into the rest of the year?

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Wendell P. Weeks, Corning Incorporated - Chairman, CEO & President [29]

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Thanks for noticing all that our customers say about us. As I shared last quarter, basically, our auto-grade interior opportunity has come a lot faster than we were ready for operationally. And so we're investing in a dedicated plant that uses our unique vapor deposition technologies and a part-making capability to be able to set up the start to serve that really strong committed demand that we're getting. I think this year is going to be that year where you're seeing the real breakthrough and you'll start to see the revenues really start to flow. Getting it exactly right of where on the adoption curve we are, we're still a little early, right, to be able to accurately call, wow I think the rate of adoption is going to be X and our revenue growth is going to be Y. We're still a little bit early to be able to call it but the great news is that's going to be a real business. And it's going to have real revenues and we'll investing against it and ultimately, we think it's going to be a real big business. If we're right on our innovations and this product is as cool as we think it is we're going to like this.

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Ann H. S. Nicholson, Corning Incorporated - Division VP of IR [30]

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And I just want to close by saying, "thank you all for joining us. I also want to let you know that we'll be at the Goldman Sachs Technology and Internet Conference on February 12. And we'll be hosting an Investor Day in New York City on June 14. We'll also be posting some virtual presentations and webcast on business topics throughout the year. Finally, the web replay of today's call will be available on our site starting later this morning. Once again, thank you all for joining us. Tawny, that concludes our call. Please disconnect all lines.

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Operator [31]

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