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

Mehdi Hosseini - Susquehanna International Group Patrick Newton - Stifel, Nicolaus & Co., Inc. Rod B. Hall - JPMorgan Securities LLC Vijay Bhagavath - Deutsche Bank Securities, Inc. Steven Fox - Cross Research LLC Douglas Clark - Goldman Sachs & Co. Stanley Kovler - Citigroup Global Markets, Inc. (Broker) George C. Notter - Jefferies LLC.

Ladies and gentlemen, thank you for standing by and welcome to the Corning, Incorporated quarter two 2016 earnings results. It is my pleasure to turn the call over to Ann Nicholson, Division Vice President of Investor Relations. Please go ahead..

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

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

These factors are detailed in the company's financial reports. You should also note that we will be discussing our results using core performance measures, unless we specifically indicate our comments relate to GAAP. 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. We have slides posting live on our webcast to accompany our formal comments, and they will be available on our website later this morning. Now, I'll turn the call over to Wendell..

Thank you, Ann. Good morning, everyone. As you saw on this morning's press release, second quarter results exceeded our expectations, with core EPS up 32% sequentially to $0.37. We told you coming into this year that we expected the first quarter to be the weakest and that momentum would build throughout the year. We still expect that to be the case.

We're very encouraged by our second quarter improvement and we are confident that we will see both sequential and year-over-year growth in sales and EPS in the third quarter.

Tony will discuss our results in detail, but before he does, I want to offer some color on the great progress we're making against the strategy and capital allocation framework we announced last October.

You'll recall that our priorities are to focus our portfolio and utilize our financial strength to grow, return cash to our shareholders and create significant value. No doubt, a highlight of our second quarter progress was closing the realignment of our interest in Dow Corning.

In that transaction we exchanged Corning's 50% interest in Dow Corning Corporation for 100% of a subsidiary that holds an equity interest in Hemlock and approximately $4.8 billion in cash. The $4.8 billion is approximately 30 times the equity earnings from Dow Corning's silicones business, unlocking tremendous value for our shareholders.

Our continued ownership interest in Hemlock allows us to catch a potential upside from a rebound in the solar market, while also providing market insight and access for our semiconductor innovation programs.

Notably, the realignment was a significant milestone in delivering on our strategy to focus 80% of our resources on our three core technologies, four manufacturing and engineering platforms, and five market access platforms. We are also making steady progress on other aspects of our focused portfolio strategy. Let's take a look at a few examples.

We continue to leverage our competitive advantages and strong customer relationships in Display to stabilize returns and deliver new innovations that increase our revenue per display. In May, our Iris Glass earned a Display Component of the Year award at SID for enabling thinner displays with lower color shift.

This technology replaces plastic light guide plates, adding a third piece of glass to large edge-lit TVs. And I'm very pleased with the additional commercial transaction that we're gaining on this product.

In the automotive space, we are reapplying our core technologies and reusing our manufacturing assets to assist manufacturers looking toward connected cars and tighter regulations. Gorilla Glass for Auto is a great example.

It is 30% lighter than traditional auto glass, offers important safety advantages, and provides a superior surface for head-up displays. In April we presented a joint paper at SAE with Ford that demonstrated Gorilla Glass for Auto is two times to three times stronger in rock strikes with reduced spalling hazards, versus soda lime glass.

I'm very much looking forward to reporting more on this topic in the future. Our efforts to lead in gas particulate filters also advanced during the quarter. Remember that if adopted, this technology increases our revenue by three times to four times for gasoline direct injection engines.

The exciting news for us is that both Volkswagen and Mercedes-Benz announced that they will equip vehicles with gas particulate filters beginning as early as 2017. And we won several new GPF platforms in quarter two. In mobile consumer electronics, we just announced a new member of the Corning Gorilla Glass family, Gorilla Glass 5.

It has up to 1.8 times better damage resistance than Gorilla Glass 4, and delivers up to four times improvement in drop height to failure versus competitive glass designs. We expect this superior drop performance to translate into a meaningful price premium versus Gorilla Glass 4, and to expand the use of Gorilla.

Given that drop performance is the number one want from consumers, it's not surprising that traction at our customers has been strong. We should be hearing announcements from them in the near future.

In the growing Optical Communications market, we closed on the acquisition of Alliance Fiber Optic Products, bolstering our presence in the high-growth cloud data center market. This acquisition supports our optical market access platform by accelerating our co-innovation strategy and adding new products.

We see it strengthening our ability to deliver high-value optical solutions in network operations worldwide. We also announced a separate investment in a small company, Versalume, to commercialize our Fibrance light-diffusing fiber.

Fibrance combines Corning's strengths in glass, optical physics, and fiber manufacturing, but its benefits extend beyond Corning's current market focus.

Versalume will enable Fibrance technology to quickly get into the hands of designers and customers in architecture, auto lighting, medical devices, athletic apparel, aerospace, and other industries seeking to solve difficult lighting challenges.

Versalume demonstrates one way that we can keep our focus on the core 3, 4, 5 portfolio while still extending the impact of Corning innovation to new markets. Those projects illustrate just some of the ways that we will invest $10 billion under the strategy and capital allocation framework.

We believe the investments will produce significant sales growth by extending our leadership in existing markets and positioning us to win in new markets. Let's turn to the second part of our strategy and capital allocation framework, utilizing our financial strength.

We updated the framework in June to recognize significant progress across multiple fronts, including the closing of the Dow Corning transaction. We now expect to generate and deploy more than $26 billion through 2019, up from our previous plan to deploy more than $22 billion.

Notably, we raised the lower bound of our commitment to shareholder returns to $12.5 billion through 2019, up from $10 billion. Cumulatively, since October, we've already returned $3 billion under the framework, including $810 million in share repurchases during the second quarter.

Today, we are announcing our intention to execute a $2 billion accelerated share repurchase, which will approximately offset the EPS impact from the loss of Dow Corning's silicones earnings.

So to summarize, we are making solid progress delivering on our new framework, which is designed to deliver secular growth while consistently returning significant sums to our shareholders. We are utilizing our financial strength to invest in our focused portfolio and drive that growth.

We have raised our planned cash distributions to shareholders to more than $12.5 billion, which is equivalent to about half of Corning's current market capitalization. We look forward to launching our new $2 billion ASR tomorrow. Now I'll turn the call over to Tony, who will review our second quarter results and third quarter outlook.

Tony?.

Thank you, Wendell, and good morning. As we noted in today's press release, our Q2 core results reflect the sequential improvement we expected across most of our businesses and building momentum for a strong second half.

We were particularly pleased with our strong operating results, including the strong sequential sales and profit growth in Optical Communications and Display's moderate price declines and strong sequential volume growth.

In Optical Communications, cable production levels recovered during the second quarter from the first quarter software implementation issue. Combined with strong demand, the recovery resulted in sequential sales growth for Optical, up 28%, which was even better than the guidance we provided in April.

Looking ahead, we are encouraged by the further sequential and year-over-year growth we see in the third quarter. Now before I get into the details of our core performance and outlook, I want to briefly point to the two primary drivers between our GAAP and core results for this quarter.

First, our GAAP net income includes a $2.7 billion non-taxable gain on the strategic realignment of our ownership interest in Dow Corning. Second, similar to the first quarter, this quarter's GAAP results were affected by a $791 million non-cash mark-to-market loss that reflects the required accounting treatment for our currency hedge contracts.

I'd like to provide a bit of context. As you know, we sell LCD glass in yen, and a one-point move in the exchange rate affects our net income and cash flow translation by about $23 million annually at the current exchange rate.

As you also know, we have currency hedge contracts, predominantly in yen, to mitigate the impact of changes in currency exchange rates on our earnings and cash flow. By hedging, we increase the predictability of our results and our confidence that we can achieve our financial goals.

We are very pleased with the results of our hedging program and the economic certainty it delivers. Since the inception of this strategy, we have settled hedge contracts and received cash totaling $1.1 billion that offset much of the decline in displaced earnings due specifically to the weaker yen.

In January we increased our hedge coverage, which further reduced our risk and increased our confidence in achieving our financial goals. We have hedged approximately 70% of our projected yen exposure through 2022 at a blended rate of approximately 106 yen per dollar.

For any investor who was worried that a weakening yen could negatively impact our business, hedging earnings and cash flow through 2022 substantially mitigates that concern. Now let's move from the economic impact of our hedging program to GAAP accounting.

As we discussed in detail last quarter, GAAP requires earning translation hedge contracts settling in future periods to be marked to market and recorded at their current value in the current quarter, even though those contracts will not be settled in the current quarter.

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

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

In the first quarter this year, the yen sharply strengthened, driving a $599 million unrealized non-cash mark-to-market loss.

Macroeconomic factors, including concern around Brexit, caused further fluctuation in the yen exchange rate, and overall it strengthened again over the second quarter, which was the primary factor in the $791 million mark-to-market loss. Our GAAP results will continue to see this volatility when the yen rate moves.

To be clear, this GAAP accounting has no impact on our cash flow in the quarter. Actual cash flow in any quarter is determined by the amount of hedge contracts we settle in any given quarter.

Our contracts are designed so that the cash received or paid on the contracts substantially offset the change in Display's translated yen earnings and cash flow in that quarter. Our core reporting convention is designed to convey this matching and to simplify comparisons of underlying business trends.

For investors who have additional questions, there is a tutorial on FX hedge accounting on the Digital Media Disclosures section of our Investor Relations website. And as always, Ann and her team are available after the call. Now let's turn to the results for the second quarter. As a reminder, these are core performance metrics.

Sales in the quarter were $2.4 billion, up sequentially from $2.2 billion in Q1, and exceeding our expectations, driven by Optical Communications. Corporate gross margin was 43%, up more than 200 basis points sequentially and better than our guidance. The uptick reflected the added volume in Optical Communications.

SG&A was 14% of sales at $342 million, as expected. RD&E costs were flat sequentially and versus last year at $192 million. Our effective tax rate for the quarter was 15%, as guided. Net income was $434 million, up almost $100 million from Q1, and EPS was $0.37 and above expectations.

Now let's look at the detailed segment results, beginning with Display Technologies. In the second quarter, the display market and our performance tracked with our observations in April. You may recall that in the first quarter, panel makers lowered utilization, which allowed the supply chain to reduce inventory.

Glass demand was down sequentially and year over year. We expected panel makers to increase utilization in Q2 to meet demand for the second half retail season and for glass demand to grow, and that's what we saw in industry dynamics in recent months.

At retail, sell-through data through May showed demand tracking to our overall expectations for glass area growth of 8% to 10% in 2016. Panel prices across most TV sizes increased, and panel makers turned up utilization rates to meet demand for the second quarter. Weeks of inventory in the supply chain ended the quarter at a healthy level.

Glass supply and demand remains balanced and our share is stable. As a result of these and other factors, our volume returned to year-over-year growth and was up high single digits sequentially. Price declines were moderate, as expected.

These dynamics inform our belief that we will see year-over-year volume growth continue in the second half, and that moderate pricing environment we've experienced over the last eight quarters will continue or even improve, which is good for Corning.

Second quarter sales and net income in Display were up 6% sequentially, driven by the stronger volume. Let's move to Optical Communications. Results snapped back from the first quarter due to strong demand and the return to full production in our cabling facilities towards the end of the quarter.

Q2 sales were $782 million, up 28% sequentially and better than we expected. Net income at $86 million was more than triple the first quarter. We are very pleased to be at full production and continue to work hard to meet our commitments to customers. In Environmental, Q2 sales were consistent with last year and in line with expectations.

Sales of light-duty products for auto were up year over year, driven by continued strong demand. This strength was offset by the continued weakness in North America and China for heavy-duty diesel products.

Truck production in North America is down this year, and China's production is also expected to be down for the second consecutive year, driven by the weakness in their economy. Net income was consistent with Q1, and in line with our expectations. Let's move to Specialty Materials.

For the quarter, sales were up 17% sequentially and net income was up 50% on the higher volume. The premium on Gorilla Glass 4 drove a 9% increase in year-over-year net income. That said, more broadly, the market for smart phones, tablets, and laptop computers is lower than we expected.

Worldwide macroeconomic conditions are slowing demand in emerging markets. Additionally, there had been fewer major product launches to drive demand, and the replacement cycle appears to be longer. Our customers are responding to this lower demand environment.

As a result, Gorilla Glass volume and Specialty Material sales did not meet expectations in Q2; segment sales were down 2% versus last year.

We anticipate this weaker handheld and IT end market environment will persist through the second half, and we now expect full-year sales in Specialty Materials to be consistent with or down slightly from 2015, driven primarily by our performance in Q1. We do expect sequential growth in each quarter.

Although we expect the overall market to be flat, we are extending our leadership in the cover glass market. First, we are gaining even more share in the aluminum silicate cover glass, and second, our ability to innovate and deliver value-add products at a premium price is playing out as we expected.

And as Wendell said, we are attacking again with our recent launch of Gorilla Glass 5. We look for innovations like this to drive revenue and income growth, even in a maturing market. In Life Sciences, Q2 sales were $215 million, and met our expectations for low single-digit growth.

Net income was $21 million, consistent with last year and higher than Q1 on higher sales. Now, let's turn to equity earnings. As Wendell said, the close of the Dow Corning realignment in June was a significant milestone for Corning.

The transaction adds $4.8 billion in cash to our balance sheet, or about 30 times Dow Corning's annual silicones equity earnings, and was essentially tax-free. The freedom to deploy that capital is a tremendous value driver for our shareholders.

Because of the timing of the transaction, the equity earning line in our second quarter financial statements reflect only two months of Dow Corning's silicones equity earnings, plus a full quarter of Hemlock's equity earnings. For your models, the way we will report Hemlock's equity earnings in our income statement going forward is changing.

Prior to restructuring, equity earnings in Hemlock was reported in equity earnings on an after-tax basis. Going forward, it will be reported on a pre-tax basis, and the taxes will be reported as part of Corning's total tax expenses. As you can see from this example on the slide, the contributions to our net income does not change.

If you have any questions on this, of course, Ann and her team are happy to help. Let's turn to our balance sheet and cash flow. We ended the quarter with $7.1 billion of cash, up $3.5 billion in cash at March 31, including approximately $5 billion in the United States.

Adjusted operating cash flow for the quarter was up significantly over Q1, as expected, at $595 million. The comparison to 2015 is challenging, because this year, we did not receive dividends from Dow Corning, in light of the realignment in June; we paid a onetime legal settlement; and net income was lower.

We expect operating cash flow to be up even more in the second half. Historically, most of our operating cash flow is generated in the back half of the year. Major drivers of the increase include higher net income, a reduction in working capital, and a non-repeat of front half-loaded cash expenses.

During the quarter, we repurchased $810 million worth of common shares outstanding. Now for the outlook. Let's begin with Display and the display market. For the full year, our view of end market and glass market growth is unchanged.

While there are puts and takes by region, we continue to expect worldwide TV unit growth of 2%, and screen size to increase by more than 1.5 inches. As I already mentioned, the outlook for handheld and IT market is lower than our prior expectations, but those segments are a relatively small part of the overall display glass market.

Therefore, in total for the year, we still expect the overall retail market in square feet to be up 8 to 10%, and we continue to expect the overall glass market, in terms of area, to be up in the mid-single digits. The first quarter supply chain inventory drawdown accounts for the difference.

Turning to our third quarter, we're seeing healthy supply chain inventory. Panel makers' inventory is lean, and they are further increasing utilization to meet increased demands from set makers. As a result, we expect the glass market and our volume to be up mid-single digits sequentially in the third quarter.

We also expect our LCD glass prices to decline moderately sequentially, consistent with Q2. As we have previously explained, we will maintain our stable share strategy and align our operating capacity with market demand, and we continue to expect the more favorable pricing environment will continue or possibly improve for two reasons.

First, we monitor utilization, end market demand, and other market factors very closely, and all indicate that glass supply should remain tight for the balance of the year, especially in the large gen sizes, as a result of strong TV demand. Second, our competitors' profitability is low.

Even though price declines had been moderate for two years now, their profitability has declined during that period. Therefore, we expect that their price declines will slow further as they try to remain profitable. For these and other reasons, we continue to believe that sequential pricing will be better for us going forward.

Moving to Optical Communications. For the third quarter, we expect sales to be up approximately 10% versus last year, driven by growth in fiber-to-the-home and data centers. Turning to Environmental. We see continued strength in the auto market, but expect weakness in the heavy duty truck markets in North America and China to continue.

We expect third quarter Environmental sales to be down slightly year-over-year, driven by foreign exchange. In Specialty Materials, we expect sales to be consistent with Q3 last year. This is an 8% up sequentially, driven mainly by volume growth in Gorilla Glass in preparation for new product launches later this year.

And for the full year, as I said earlier, the handheld and IT retail market for 2016 has weakened, which impact sales of Gorilla Glass. As a result, we now expect that sales in Specialty Materials will be consistent or down slightly from last year, but will be up sequentially each quarter.

In Life Sciences we expect Q3 sales to be up low single-digits versus last year, despite a drag from our foreign exchange. Turning to the consolidated outlook. We expect the gross margin to be approximately 43% and consistent with Q2. Gross margins expand versus last year with growing volume in Display and higher sales in Optical Communications.

SG&A and RD&E spending will be approximately 14% and 7% of sales, respectively. And we expect other income/other expense to be a net expense of approximately $60 million. We expect Q3 total gross equity earnings to be approximately $15 million. As a reminder, we no longer have silicones equity earnings.

We expect our effective tax rate for 2016 to be in the 15 to 16% range. Now, that concludes our outlook for the third quarter. Let me close by saying that we are pleased with the strong sequential growth in sales and the earnings in the second quarter.

We are confident that Corning's performance will continue to improve with year-over-year sales and EPS growth in both the third and fourth quarters, and we look forward to delivering on our long-term commitments to create strong value. We expect to generate more than $26 billion through 2019.

We will invest $10 billion to grow and sustain our leadership. We also plan to distribute more than $12.5 billion to our shareholders. We are focusing our portfolio to increase our probability of success, reduce the cost of innovation, and increase the barriers to entry for our competition, and we have a rich set of growth opportunities. Thank you.

Ann?.

Thank you, Tony. I will open the lines now for questions.

Cynthia?.

Certainly. Our first question will come from the line of Mehdi Hosseini with SIG. Your line is....

Thanks for taking my question. Going to your comment about pricing trend in the glass segment, you're talking about price decline moderating. Can you help us understand the magnitude? Is moderation a reference to, like, down low single digit or down 3% to 5%? Any additional color would be great, and I have a follow-up..

Sure. It is low single digits, and it's similar to what we experienced in Q2..

Okay. And then on the Gorilla side, I'm surprised that you're down-ticking again. Even if I were to look at the revised smartphone unit shipment, it still shows up 3% to 5% on a year-over-year basis, and the display size is actually growing.

So, why that you're down ticking? And I'm asking you in the context of, if there's any ASP pressure here?.

No, this is all about volume, and I think the piece that you're missing, Mehdi, is what's happening on the tablet market. And, of course, from a glass standpoint, tablets are bigger, so that has an outsized impact.

And I think both the outlook for smartphones and on tablets have come down in the second quarter, and that's the primary reason that we now believe that that market's going to be consistent to down slightly as opposed to that we thought it would grow in the past..

Okay, got it. Thank you..

Our next question will come from the line of Patrick Newton with Stifel. Your line is open..

Good morning, Wendell, Tony, and Jeff. I guess, Tony, a clarification on the guidance for the equity earnings of $15 million in the quarter.

I believe you said that will now exclude Hemlock Semiconductor, which is going to move up the P&L and I'm curious if you could help us understand what the contribution from Hemlock will be in the quarter?.

I'm sorry. I maybe didn't explain that very well. It will be on the equity earnings line still, and that $15 million is mostly from Hemlock. The difference is, is that previously Hemlock was reported on an after-tax basis, because the taxes were taken care of at the Dow Corning level, and now taxes are taken care of at the Corning level.

So, there's a slight change in the geography, but it's not off the equity earnings line..

Wonderful, thanks for the clarification. And then I guess just dovetailing off the prior Gorilla Glass question.

What are the volumes forecasted to be from a growth perspective in 2016 and then longer term? Can you walk us through what will return Gorilla Glass to growth, post a multi-year stagnation?.

So for us in Gorilla, I think as Tony said, when we came into the year, we felt the market was going to grow, albeit at a slower rate. And now, pretty widely reported that the expectations are for the market to be pretty flattish.

So, now then you start – where do our strategies begin to impact our revenue realization in that slower growth market as well as what will be the next uptick in the market one way or the other. So let's deal with the second first.

Uptick in the market, for us it really does get driven by how exciting a product our customers come out with and its impact on consumers. So I can't give much insight into that for you, but we do believe that we see some pretty exciting products coming that should help on the total market growth. Now then let's take a look at us in a more micro way.

We would normally expect that we're going to grow faster than the market. And that is because of our superior product, we should be always in a share gaining mode, as well as that as we introduce higher value-add products, we'll get higher revenue per device.

I think this year we have an interesting dynamic in that customer mix can really make an impact. We have some customers where we do virtually all of their cover glass needs and some where we just do the majority. So which customer gets impacted can impact us a little more outsized when you're dealing with a slower growth market.

And then second has just been timing on adoption of some of the higher value-add products and our ability to manufacture them. A good example of this is Phire, where we continue to get pretty good pull on Phire, especially for wearables.

But the difficulty of that manufacturing process has pushed us a little bit out in time versus our original launch dates. But overall, we would look over the long term for this business and for us to continue to have pretty robust growth and to be able over that four-year timeframe to double our revenue on this overall platform.

It also includes things like augmented reality, but more on that to come in the future..

Great, and just one more, if I may, is on the gross margin line. That was the largest positive surprise, I think, relative to our expectations. If we go back and look at multiyear trend, we've generally had a negative trajectory outside of acquisition benefits.

And so I guess my question to Tony is, can you walk us through, outside of the Optical Communication volumes, what drove gross margin to rebound? And based on the guidance of sustaining this level of 43%, and if we take maybe an intermediate to longer-term view, are we at a point where Corning's gross margin should be stable to having upward trajectory from current levels?.

Sure, I'd be happy to do that. I think compared to Q1, there are really two things. One was the Optical Communications improvement, both in terms of sales, but the amount of money that we were spending on our software project issue also reduced during the quarter.

And there was a lot of one-time manufacturing inefficiencies that got better in the second quarter. That helped us and the fact that we also had volume growth up in the high single digits on Display also helped us considerably, and that's how we ended up at the 43%. When you look out into Q3, we expect to see growth.

We see some of it in Optical Communications and some of it in Display and Specialty Materials. And when you average those out, keeping in mind that Optical Communications gross margins are lower than the corporate average and the others are higher, we end up back at that 43% level.

As you look forward, it obviously is going to depend on where the mix of our businesses are, but I think being in that 43%-plus level is certainly what we're aiming for from an overall business standpoint..

Great, thank you for taking my questions. Good luck..

Thanks..

Thank you. Our next question comes from the line of Rod Hall with JPMorgan. Your line is open..

Hi. Good morning, guys. Thanks for taking my questions. I just wanted to ask on Display. Tony, you guys are keeping the Display guidance unchanged for the full year, at least the market guidance. And the seasonality implication for that, at least on our calculations, is that Q4 ends up higher than normal seasonally.

So I wanted to see if we could get more color on why you see that occurring, given the weakness we see in smartphones and elsewhere in the consumer electronics market. And then secondly, I wonder if you guys could comment on the Specialty guidance reduction that is consistent with what we see in the market as well, which is weak demand. But I wonder.

Could you give us more color on regional demand weakness? Where do you see things incrementally developing weaker as you sit right now, and how do you think the regional demand plays out through the back end of the year? Thank you..

Okay, let me start with the Display demand question. What really drives this market, Rod, of course, is what happens in TVs. And even though it is true that IT and handheld demand is down, it has a small impact on the overall display market.

What really matters is what happens in TVs, and we expect that TV units are going to be up 2% on a year-over-year basis.

As we go through the year, we've seen some stronger demand than what we expected, in particular in North America but also in Europe, but there have been some areas that have been weaker like in Latin America, the Middle East and Africa, and also Japan's been a little bit weaker. But when you net that out, it comes back to that 2%.

And the other really important factor is what happens with screen size. And from a screen size standpoint, we're looking at screen size growth greater than 1.5 inches. So when you add all that together, even though it's a little bit weaker on other mobile consumer electronic products, that still puts us in that 8% to 10% range..

Tony, do you see seasonality better than normal though in Q4? Because that's what seems to be implied by that assumption..

Yes, we do. And keep in mind that last year, a lot of that just depends on where the overall demand actually is and how panel makers are adjusting their inventories at a given point in time. And given the strength in demand, we do see that..

And, Rod, it's a very legitimate question. Because in that fourth quarter, it's a lot about value chain management. And we're coming off a period where you can remember last year in quarter four and quarter one, we were seeing a correction of the value chain, and we think that's behind us.

But you're right that that quarter four, it's going to get influenced a lot on how people feel about that selling season. So always worth some thought, but that's the way we see it..

Okay. Thanks, Wendell.

And then what about just how you see regional demand developing on IT and handhelds?.

I don't think we have that much remarkable there. Developing markets overall were part of the spot weakness, I think, as you take a look at that space. But I think it's a little – the data at that level, I think we have a little bit less clarity on than we do on something like TV that really drives glass demand.

But I think by peeling apart some of the comments by our customers in conversations with them, that's what we're picking up is that the developing market will be weaker and less excitement about product launch this year..

Great, okay. Thank you, guys..

Thank you. Our next question will come from the line of Vijay Bhagavath at Deutsche Bank. Your line is open..

Yeah. Hey, good morning. Yeah, strong results here. I have a question on the strength you note in data center and fiber – fiber-to-the-home. Help us understand the sales dynamics.

Like, would you have multi-quarter design wins at one of the major cloud companies for these data center and fiber build-outs, and similar design wins at the major service providers, publicly announced outside client fiber build-outs? I want to better understand the sales design win dynamics in Optical. Thanks..

It sounds like you actually understand them, Vijay. That's exactly right. The only little correction I'd make is it's a lot more than multi-quarter. When we do something like fiber-to-the-home systems, our development cycles with our customers go for a pretty long time.

And then it sets and locks on this is the design that they're going to use and then away we go. And then what really provides the dynamic there is that really share shift and things like that. It basically comes down to, these are our Works efforts and where they want to build networks. So, it sounds to me like you got a good understanding.

The hyper data centers, the data center pieces, our share has been growing. And both our share of overall spend as Optical and then sort of within in Optical. And that's another one where our position is strong, so the more they build, the better we get..

And then a quick follow-on, thanks to you. The AFOP, line fiber acquisition, is it helping you open doors in Asia Pacific in particular? Thanks..

Interesting. Yes. They have some position especially in some of the OEMs that we don't have in the Asia Pacific. And well, we're really, really interested in that.

It wasn't the primary driver of the transaction, which is we want to get as big as we can in hyper data centers, but I think you've made a good observation there, and we think that could be a nice surprise, nice added benefit for us if it continues to evolve the way it seems like it could, Vijay..

Thanks, great results. Congratulations to you and your team..

Thank you, sir..

Thank you. Our next question will come from the line of Steven Fox with Cross Research. Your line is open..

Thanks, good morning. Two questions from me, please. First on Gorilla Glass. You noted how Gorilla Glass 4 mix is actually helping your profitability now.

Can you sort of talk about how that mix plays out in terms of where you are as a percentage of maybe shipments, roughly, and then how Gorilla 5 sort of impacts that mix maybe over the next few quarters and also the profits going forward? And then, secondly, Tony, I know you mentioned that the cash flows are back-end loaded for the year, but are we still looking at similar expectations as to what you were thinking a quarter ago at the analyst meeting for cash flow from operations around $3 billion or is that maybe a little lighter now? Thanks..

I'll start with that question. Probably from an overall standpoint, it's a little bit lighter than that. If you think about what drives our cash flow, we did have a onetime payment, a legal settlement, that wouldn't had been in that projections originally.

And then, of course, the other big factor is where income actually ends up on a year-over-year basis. And our first quarter was obviously softer than what we originally projected, but it's still going to be quite strong. Still going to be well – closer to $3 billion than it would be to say $2.5 billion..

To your first question, Steven, I would love to answer that question, but they're not letting me tell you. So, let me describe it in a little broader sense rather than give you my direct answer about what we're trying to do. So, the market has a certain dynamic in that how do our customers want to position themselves relative to consumers.

And so, that's why we have open to us different products at different price points. So, the way Gorilla Glass 3 plays out is we really sort of aim out at those of our customers who are seeking to get benefits of Gorilla relative to Soda Lime or other aluminosilicate providers that are highly price-sensitive.

And so the more of that we gain, that's all great, because as you know the margins in Gorilla are terrific, right? But that price will be moving direct in response to competitors.

GG4, GG5, what we're seeking to do there is for those of our customers who want to create absolute premium products that are as thin as can be and as damage-resistant as can be, they're willing to pay for that innovation, and therefore, we introduced those products at a premium.

Our overall desire is that, overall, we can continue to push down the cost of Gorilla while having the price on average sort of not fall so much. And that's exactly what we're trying to do in increasing sort of our – one piece of increasing our revenue per device.

Now, why their folks don't want us to give guidance on anything like that, is back to the customer mix question that I addressed before. Now, which customer does what starts to get really important if you're trying to pick from your gross margin model how everything's going to work out.

And in a market that's already pretty tough to predict, given how the value chain moves, that added degree of complexity won't make us too accurate. But you're on exactly what it is we're trying to do, and then it will be a mix of how much value-type brands are going in a certain quarter versus a sort of premium cycle upgrade to the new glass.

That makes sense, Steven?.

Yeah, that's very helpful. I appreciate all that color. Thanks so much..

All right..

Thank you. We'll go to the line of Doug Clark with Goldman Sachs. Your line is open..

Great, thanks for taking my question. First one on Display and glass pricing. I notice you didn't mention the FX environment and the yen move.

I've gotten a number of questions that wanted to kind of get your opinion if the recent strengthening of the yen has any impact or could factor into conversations about future glass pricing?.

Sure, and I will be happy to answer that. We've got to obviously answer this based on our analysis of the situation. And we do recognize that the yen fluctuates, and that will impact both the glass procurement cost for our customers, and they buy glass in yen, they sell the panels in dollars.

And we also know that our competitors, the Japanese glass makers, could also get a temporary translation benefit when the yen strengthens, or of course a temporary loss when it weakens against the countries they manufacture. But we don't think this is going to be a big impact. The effect on customers is not as big as it used to be.

Glass used to be 15% to 20% of the customer material cost; it's now only about 8%. And then the second factor is our competitors are not as profitable as they used to be. And any benefit they get from yen appreciation may only be temporary, so for these reasons we don't expect to see a meaningful pricing impact, a result of the yen movement.

And the perfect example of that is what happened in Q2, where the yen strengthened considerably but price declines were moderate. So we don't believe this is going to have a big impact, but we recognize there are a couple of areas where we need to – we are obviously monitoring it..

Worthy question, Doug, worthy question..

Sure, Wendell, that makes sense and thanks for the detail. Second question related to more glass volumes and what's been happening in the supply chain, there seems to be a bit of a shift from LCD panel capacity to OLED panel capacity. I'm wondering if that impacts glass volumes either near-term or kind of leads to industry rationalization long-term..

So LCD, OLED, let me start macro, and then I'll get right down into the micro, particular customer capacity shifts one way or the other. So in macro, basically when we talk about OLED, you're only really talking about mobile consumer electronics, right, really phone-type business, which is a relatively small, right. I mean, really small.

Sounds like under the single-digit percent sort of small, sort of percent of where, sort of glass changes in total. Now, and overall I think all the adjudication of large-size OLED versus large-size LCD, LCD continues to just get stronger and stronger relative. So all we're talking about is that piece.

Now there have been rumors about one of our major customers taking some of their capacity that currently makes LCD, large-size, and take that same plant and make more of the small-size polyimide OLED. We can't comment on is that true or not. So let's deal with it in a more theoretical way. So here's what happens.

What sets the overall glass demand is going to be what happens in the market. Which customer of ours makes it, okay? Does it impact, is the glass demand there or not? In micro, we have some customers where we have incredibly high share and some customers where we have more moderate share.

So what we would expect overall though is that we pick up what our average share is of whatever that market is. So we don't expect that to be a really big market shift for us.

And specific for us on polyimide OLED, is demand there? Net increases demand on us for glass, because our relative share there is very, very high and our relative share in the displays it is replacing, all right, which is just basically low-temperature polysilicone displays for phones, is lower.

So I think overall though you can get some temporal impact, I'm not looking at that as being a huge driver.

Makes sense?.

That does, thanks for that extra detail. I appreciate it..

Thank you. We'll go to the line of Stanley Kovler with Citi Research. Your line is open..

Hi, good morning, and thanks for taking the question. I just wanted to ask, this is actually a similar set but a different vein, so if the yen strengthened and you have some opportunity for additional hedging in the out years, given multiyear lows for the yen, were there any discussions or additional hedging taken? And then I have a follow-up.

Thank you..

There were not any additional hedges taken. There was lots of discussion about it. We are 70% hedged out through 2022, and so it's something that we are spending time modeling. Also, thinking both in terms of what the outlying demand is out in those years, maybe different instruments that we could be using as opposed to the forwards we've been using.

And so we're doing a lot of work on it, but we didn't do anything in the second quarter..

Got it, thanks. And back to Display, during the quarter, in late May you started to suggest that there is a possibility of unit volumes tracking towards more like 1.5% growth versus the original 2% guidance, and now back to 2%. That really is interesting because it didn't really impact your screen size inputs as well.

I would think that with the strengthening of the TV space in general that there would be some discussion about maybe screen size tracking closer to two inches as well. I know those are two separate topics, but just the market in general.

And then looking out into next year, you talked about your share being relatively stable, irrespective of where customers are.

But if that customer of yours does shift to a different technology and let's say sells off the equipment for Gen 7 and that goes to even a different region, how should we think about your share in other regions and with new customer entrants in the panel space? Thank you..

So you're absolutely right on the TV demand. What we saw in the data in the last couple of months was stronger demand in North America and Europe, and a lot of those were larger-size TVs. And so there was also a little bit of tick up in our projection on screen sizes. But when you add it all up, we're still in that range of 8% to 10%.

And we realize as we get data every month, that can change the absolute number a little bit, but it doesn't change what we think is the overall underlying demand, which is up in the 8% to 10% range..

And on the moving around of capacity, I think what's really important to remember is how small one Gen 7 fab is in the overall scheme of the enormous size of this market. And so in a way, that capacity could end up one place or another, but you're within the error bars on the overall market range.

And I think a good way to just think about it is wherever it goes, we'll probably end up one way or the other maintaining a pretty stable share, our average share across the entire market just because it's just not that big a deal – relative. There was a time when one Gen 7 fab, that occupied most of my life. But now it's like, eh, another Gen 7 fab..

Thanks, Stan. Cynthia, we have time for one more question we can squeak in..

And that will come from the line of George Notter with Jefferies. Your line is open..

Hi, thanks very much, guys. I guess I was curious, going back to the TV unit assumptions, positive 2% year on year. If I look at, for example, the market research firm IHS, I know those guys are looking for year-on-year comparisons that are negative on TV sales, and obviously it's such a huge variable for you guys.

Do you guys have any comments on why your assumptions might be different from theirs? And then also I wanted to ask on Iris, I think you said earlier in the monologue that you're seeing more commercial traction. Any detail you can give us on exactly what you're seeing there in terms of design wins or revenue would be great. Thanks..

Sure. On the TV unit size, we do recognize that some forecasters have different projections than we do, but it's so important to us that we spend a lot of time looking at things by region. And you could pack a lot of intelligence, understanding at the very end markets on what's happening. And we feel very good about the idea that we'll be up about 2%.

And especially what's happened in the last couple of months relative to the TV demand, in particular in North America where it is a good bit stronger than what we projected at the beginning of the year..

And just to add, I think what, TV units, there are legitimate point of view differences.

But whether or not you thought TV units were going to be up 1%, up 2%, or even relatively flat, that you can remember, I think we actually showed it to you on this slide on the 2016 outlook when Tony was going through his talk, that TV units up about 2% would be a growth contribution in glass area by about 2%.

But the screen size being up greater than 1.5 inches, that's driving 5% to 6% growth. And so what we're hearing from the market is television unit growth may be a little bit softer than what we would have thought at the very beginning of the year.

But actually like the previous question, screen size is maybe a little bit bigger than what we thought, so it's pushing us in those ranges. But it can be very legitimate that, rather than coming in around 2%, it comes in around 1%.

All that is within the range of possibility, and that's why we try to give you sort of an idea of how to factor the various pieces so you can plug in what it is your opinion is and then figure out from that what's going to happen in glass demand. And the final piece is value chain adjustments.

Are you going to be bigger than that television unit piece? And that's how we all end up at the bottom line of mid-single digits in square footage growth for us, for the market, and I think that's okay..

About Iris?.

Iris, right. So, Iris is continuing to get some really good commercial transaction with – now we're up to a number of customers that are really evaluating it very strongly, and some are choosing to launch with it, right? It's still early days.

As many of you may have heard me speak, I tend to think about disruptive innovations like this, because it's highly disruptive, you're displacing an incumbent technology, a PMMA, with a brand-new material set, to be able to make televisions thinner and with smaller bezels, that it tends to go in phases.

You go from the idea then you get a breakthrough. And then if it's really good, you can get a breakout and then you have to defend your really strong position. I'm getting increasingly confident we're going to have a breakthrough. It's going to penetrate large edge-lit TVs, and it's going to have a meaningful penetration into that.

Now, whether or not we got a breakout and this becomes a really dominant technology choice for edge-lit, it's just too early to tell. But the good news is the increased commercial transaction is increasing our confidence that you're going to start to see some multiple sets introduce using this technology and we're going to penetrate the market some.

But to be significant, we've still got a ways to go..

Thank you. That was our last question..

Great, thanks to everyone for listening and the terrific questions. We wish you an enjoyable summer and look forward to updating you on framework progress and results throughout the rest of the quarter. Be well..

Thank you, Wendell. Just a couple of announcements from IR. We will be at the City Conference on September 7 in New York. Telephonic playback of this call is available beginning at 11:00 AM Eastern today and will run until 5:00 PM on Wednesday, August 10. To listen, dial 800-475-6701 and the access code is 397185.

The audiocast is available on our website for one year. Cynthia, that concludes our call. Please disconnect all lines..

Thank you. And ladies and gentlemen that does conclude your conference call for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect..