Ann H. S. Nicholson - Corning, Inc. Wendell P. Weeks - Corning, Inc. R. Tony Tripeny - Corning, Inc..

Joseph Wolf - Barclays Capital, Inc. Steven Fox - Cross Research LLC Rod Hall - JPMorgan Securities LLC Jess Lubert - Wells Fargo Securities LLC Patrick Newton - Stifel, Nicolaus & Co., Inc. Vijay Bhagavath - Deutsche Bank Securities, Inc. Mehdi Hosseini - Susquehanna International Group Stanley Kovler - Citigroup Global Markets, Inc..

Welcome to the Corning Incorporated Quarter Two 2017 Earnings Results. It is my pleasure to turn the call over to Ann Nicholson, Division Vice President of Investor Relations..

Thank you, Cynthia, and good morning, everyone. Welcome to our 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 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. Slides are being shown live on our webcast to accompany our formal comments, and we encourage you to follow along. It will also be available on our website for downloading.

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

Thank you, Ann. Good morning, everyone. This morning we reported second quarter results that exceeded our expectations. Sales were up 6% and EPS was up 14% over last year, with strong sales growth continuing in Optical Communications and Specialty Materials.

Our Display business performed in line with our expectations, including price declines that continued to moderate. We remain on track to deliver our Strategy and Capital Allocation Framework goals due to strong operating results and solid progress on innovation.

We believe that the strategic and financial benefits of our Framework are becoming even more apparent during its second year. The Framework outlines our leadership priorities and is designed to create significant value for shareholders by focusing our portfolio and leveraging our financial strength.

As we have discussed, 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 we will invest $10 billion to sustain our leadership and deliver growth. We have made great progress against those goals.

Since October of 2015, our cash generation is on target and we have returned $7.4 billion in share repurchases and dividends. Through our repurchases, we have reduced our outstanding shares by approximately 26%. We increased the dividend 14.8% in February and 12.5% last year, for a combined increase of 29%.

We expect to increase the dividend by at least 10% in 2018 and in 2019. In addition to articulating our capital allocation goals, our Framework outlines how we have and will continue to utilize our focused and cohesive portfolio to generate value for our shareholders and to delight our customers.

We are best in the world in three core technologies, four manufacturing and engineering platforms, and five market access platforms. We focus 80% of our resources on opportunities that use capabilities in at least two of these three categories.

We are investing in research and development, capital expansion and acquisitions to advance our innovation initiatives, strengthen our product leadership and low cost positions, and ultimately outperform our competitors.

By pursuing our focused strategy, we believe our likelihood of success increases, our cost of innovation decreases, and we create higher and more sustainable competitive barriers.

Our focus in leadership also attract some of the world's leading companies to collaborate with Corning because they know how our expertise and unique combination of capabilities can help address some of their toughest challenges.

During the first quarter earnings call in April, I discussed how our joint announcement with Verizon illustrates the power of our Optical Communications market access platform. Verizon's commitment to our optical solutions is one outcome of the deep dialogue we are having with major telecom players across the globe.

They are anticipating transformations in communications, education, healthcare, transportation and eventually the way we all live, and they are turning to Corning for our unique co-innovation approach. Since then, Apple joined us to announce its $200 million investment in our advance glass manufacturing capabilities in Harrodsburg, Kentucky.

Apple's commitment for future innovations illustrates the leadership of our mobile consumer electronics platform. Today, I would like to focus on how our cohesive set of capabilities is attracting leading pharmaceutical and biotech companies to seek our help to transform pharmaceutical packaging.

We work closely with our development partners who are also long-standing customers of our life science vessels platform.

As a senior scientist at one of these partners remarked, Corning took a macroscopic set of problems, followed them to their root cause, dissected each cause to its science and rebuilt a solution at the molecular level on up to create a totally redesigned pharmaceutical package.

This remarkable product, Corning Valor Glass packaging dramatically reduces particle contamination, breaks and cracks, while significantly increasing throughput. As a result, Valor helps protect patients and improve pharmaceutical manufacturing.

In March of 2011, the FDA issued an advisory on glass lamellae or the tiny flakes of glass that can be shed from the inside of the container, contaminating the product. This is just one of the many issues Valor addresses. Consequently, there is significant excitement in the industry. Now, our customers' endorsements are far more powerful than my words.

When announcing Valor at the White House last week, Merck's CEO, Ken Frazier, said biologic medicines and vaccines remain on the leading edge of scientific innovation, and Valor Glass represents a similar advancement in materials science, a glass that is purpose-built for medicines and vaccines.

Merck plans to convert several injectable products to this exceptional new glass packaging solution, pending appropriate regulatory approvals. And Pfizer's CEO, Ian Read, stated we believe that our collaboration with Corning is a game-changer. The glass industry represents about $4 billion in expenditures for the pharmaceutical industry.

But subsequent issues, potential shards or breakages require strong quality control to ensure that it doesn't get through to patients. The subsequent costs are multiples of the glass cost, to ensure that we deliver a high-quality product to patients. So Valor is a major innovation, a major way that we can be more competitive.

This strong pull from our customers led us to announce an initial investment of $0.5 billion. Total investments over time could reach $4 billion, in sync with global demand and customer commitments for additional sales. Planned investments are included in our Strategy and Capital Allocation Framework.

We ultimately expect about $1 of annual sales for every $1 of investment and profitability that exceeds our corporate average. Now, you've heard me say before that the timing and revenues of disruptive innovation are difficult to predict. This is especially true in highly regulated industries, such as drug packaging.

The good news is that the regulatory environment derisks our investment by providing clear advance notice of demand and by creating stable sales that recur over many, many years. In sum, we are extremely excited about this opportunity. You can watch for customer and regulatory announcements as proof points to mark our progress.

Valor also provides a powerful example of what happens when our focused and cohesive portfolio meets a customer opportunity. We started out with major customers from our life science vessels platform.

We reapplied our expertise in glass science, optical physics, vapor deposition, precision forming and extrusion to develop a breakthrough product that we believe has the potential to power Corning's growth for the next decade and beyond.

Stepping back, the announcements with Verizon, Apple, Merck and Pfizer show how global leaders are attracted to participate deeply in our ecosystem, and inviting us to participate in theirs. We think this indicates that we're on the right track and bodes well for our future growth.

Now, let me turn the call over to Tony for a review of our results and details on our outlook for 2017..

Thank you, Wendell, and good morning. As we noted in today's release, our second quarter core results reflect strong year-over-year improvement that exceeded what we expected, and we are very pleased with our operating performance.

We remain on track to deliver both the full-year business objectives that we laid out in January, and our overall framework goals. Now before I get into the details of our performance and results, I want to address GAAP and its impact on our hedge contract accounting.

GAAP accounting requires our earnings translation hedge contracts settling in future periods to be marked to market and recorded at their current value at the end of each quarter, even though those contracts will not be settled in the current quarter. During the second quarter, the yen weakened, increasing the value of our hedge contracts.

This resulted in an after-tax GAAP gain of $94 million when we marked the contracts to market as required by GAAP. To be clear, this mark-to-market accounting has no impact on our cash flow. We remain very pleased with the results of our hedging program and the economic certainty it delivers.

Since its inception, we have received cash totaling $1.5 billion under our hedge contracts. These proceeds offset much of the yen-related fluctuations in Display's earnings. Hedging our earnings and cash flows through 2022 substantially mitigates risk from a weakening yen.

For investors who have additional questions on the mechanics of these contracts, please refer to the 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.

Also as a reminder, last year's GAAP net income included a $2.7 billion non-taxable gain on the strategic realignment of our ownership interest in Dow Corning. Now, let's turn to the core results. Second quarter sales rose 6% year-over-year. Core earnings were $431 million, consistent year-over-year.

On an apples-to-apples comparison that excludes silicones' equity earnings from the second quarter of 2016, core earnings grew 12% year-over-year. Second quarter EPS was $0.42, up 14%. Second quarter sales reflected strong growth in Optical Communications on healthy demand in the fiber-to-the-home market.

Strong growth in Specialty Materials with continued strength in Gorilla Glass volume and LCD glass volume growth with continued moderate pricing declines. Gross margin of 42.4% was in line with our expectations and consistent with Q1. SG&A was 14% of sales at $358 million, and RD&E was 8% of sales at $207 million.

Total gross equity earnings were $38 million, largely from Hemlock Semiconductors, which exceeded expectations predominantly because of the timing of Hemlock sales between the second and third quarter. We are changing our view that full year gross equity earnings should be about $150 million. Our effective tax rate for the quarter was 18%.

Turning briefly to the balance sheet, we ended the quarter with $4.2 billion of cash, approximately 25% of which is in the U.S. Adjusted operating cash flow for the quarter was $479 million and keeps us on track to meet the goals of our four-year capital allocation plan.

Now let's look at the detailed segment results and outlook, beginning with Display Technologies. The second quarter display market and our results met expectations. Sales were $841 million and core earnings were $240 million. Volume and pricing were in line with expectations. The glass market and our volume were up low-single digit sequentially.

Sequential LCD glass price declined moderately. And as we expected, the decline in this quarter was substantially less than the first quarter. We continue to expect that the full-year 2017 retail market, as measured in square feet of glass, will be up mid-single digits, driven by demand for larger screen size TVs.

For the year, we expect our glass demand will be up mid-single digits, in line with the overall market. We continue to see progress towards a more moderate pricing environment. Our price declines in 2015 were smaller than in 2014, and in 2016, they were smaller still.

We expect this pattern to continue with our glass prices declining 10% or less this year. Now, three factors drive our view of the more favorable pricing. First, global glass supply and demand remain balanced. We are successfully aligning our capacity to our demand. Publicly available information indicates competitors are doing the same.

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, LCD glass manufacturing requires ongoing investments in current and new capacity.

To generate acceptable returns on new investments, glass pricing will need to moderate even further. For the third quarter, we expect the LCD glass market and Corning volume to be up low-single digits. Sequential price declines should be moderate and similar to the second quarter sequential declines.

Looking into the supply chain, panel makers and total supply chain inventories expanded slightly at the end of Q2 as we expected. Total supply chain inventory should continue to expand in Q3 in preparation for a seasonally-strong fourth quarter retail demand, which we anticipate will then draw inventory down.

Year-end inventory will depend on Q4 sell-through and we continue to expect total supply chain inventory at the end of 2017 will be in a healthy range. In summary, we remain very pleased with the current dynamics in our Display business and our progress in stabilizing returns.

Let's move to Optical Communications where the second quarter results were strong, with sales up 13% and core earnings up 26%. The growth was primarily driven by the North America fiber-to-the-home market. Throughout this year, we have been saying we expect low-teen sales growth for 2017.

In line with this, we expect third quarter sales to be up more than 10%. Now, given the strong momentum in the first half, Optical sales have the potential to be up mid-teens for the full year like many sell-side analysts are modeling.

That said, we are always cautious about our guidance to you because sales are driven by large civil works projects that are subject to delays that can lead to quarterly volatility. This introduces a measure of conservatism and leads to our guidance. The good news is, we continue to see major carriers shifting more spending towards optical solutions.

This is a long-term positive for Corning and transcends fluctuations in individual quarters. This is an exciting time for our Optical business. Overall, we expect to grow significantly faster than the optical markets we serve, and we enable next – as we enable next-generation networks and our customers benefit from our unique set of capability.

We are on track to achieve our goal for Optical Communications of $5 billion in annual sales by 2020. Now, while the vast majority of this growth is expected to come from organic initiatives, we also plan to acquire or gain strategic advantages by strengthening our portfolio or increasing our market access.

We are excited about last week's announcements that we acquired SpiderCloud which will help us accelerate the deployment of fiber inside buildings. Turning to our Environmental business, second quarter sales were $263 million, up slightly year-over-year.

Core earnings were $32 million, down year-over-year due to investments for the development and introduction of our new gas particulate filter. Second quarter year-over-year automotive sales rose on worldwide growth in the automotive market and additional business wins that allow us to grow faster than the market.

In addition, the North America heavy-duty diesel market appears to be stabilizing. Our total diesel sales were flat sequentially. As we previously noted, we're leveraging our position in mobile emissions controls by building a significant new business for gas particulate filters, or GPFs.

Evidence strongly suggest that having a GPF is the most effective way for automakers to meet new environmental regulations in Europe and China. We continue to win the majority of platforms and have agreements for more than 50 models from 20 automakers, with new wins in the past month and more to come.

Our GPF platform wins require select capacity and engineering investments. In the near term, you will see both cost on the P&L and capital expenditures. We will see our first commercial sales in the third quarter.

We're excited because our sales per vehicle increased by a factor of 3 times to 4 times, with profitability similar to our current Environmental business. Once regulations are fully implemented in Europe and China in the early 2020s, we estimate this opportunity will exceed $0.5 billion for Corning.

In total, for the third quarter, we expect low-single digit sales growth. For 2017 overall, we expect sales to be consistent to up slightly from 2016. Let's move to Specialty Materials where our goal is to double sales for mobile consumer electronics despite maturing smartphone unit growth.

Second quarter sales rose 27% over last year and core earnings were up 21% year-over-year, both ahead of our expectations, driven by stronger Gorilla Glass shipments to support new product launches. We had record shipments of Gorilla Glass and expect strong demand to continue for the remainder of the year.

Now, we made progress on all three of our approaches to grow sales. In particular, we again saw the benefit of Gorilla Glass 5 which leads the market for drop performance and is now on 22 devices. Also, we continue to see strong adoption of Gorilla Glass on devices being introduced in developing markets, with brands such as Micromax of India.

We also had growth on other major programs to increase sales per device. Overall, our growth prospects remain strong in mobile consumer electronics. Our innovative products provide added value for consumers, particularly in terms of durability and create new opportunities for us to increase sales.

We expect sales growth in the third quarter to be up in the low to mid-teens year-over-year. Exactly how much growth we will see for the full year continues to be dependent on the timing and extent of customers deploying Gorilla Glass 5 and other Corning innovations.

Through the first half, sales are up 29%, so we are clearly pleased with the adoption so far this year. In Life Sciences, second quarter sales were $221 million and core earnings were $19 million. For the full year 2017 and the third quarter, we continue to expect low-single digit sales growth year-over-year.

Also, we've had a number of investors ask if our new pharmaceutical packaging business will be included with the Life Sciences business in our financial results or remain in our Other reporting segment. For now, it will remain in Other along with other new product line in development projects.

We group our emerging opportunities in Other to better manage their goals and objectives independent from a fully commercialized business. Shifting to the full company P&L, for the third quarter, we expect our gross margin as a percent of sales to remain in line with the first half of this year at about 42.5%.

SG&A and RD&E spending should be approximately 14% and 8% of sales, respectively. We expect other income, other expense to be a net expense of approximately $25 million to $35 million.

Third quarter total gross equity earnings are expected to be approximately $10 million to $20 million due to the timing of Hemlock's Q2 earnings that I mentioned earlier. We continue to believe full year gross equity earnings will be approximately $150 million, predominantly from Hemlock.

And we expect our effective tax rate for the third quarter and full year 2017 to be approximately 18%, and CapEx for the year to be approximately $1.5 billion. Finally, let me update you on our plan to return at least $12.5 billion to shareholders under our framework. Through the end of the second quarter, we have returned $7.4 billion.

In the second quarter, we returned $780 million, bringing the year-to-date total to $1.3 billion. As you may recall, in February, the board increased the cash dividends per share by 14.8%. Let me close by saying that we are very pleased with our continued positive momentum.

We remain on track to deliver our 2017 objectives and the overall goals of our Strategy and Capital Allocation Framework. We feel very good about the rich set of opportunities ahead of us. With that, let's move to Q&A..

Thanks, Tony. Cynthia, you can start the line for questions..

Thank you. Our first question will come from the line of Joseph Wolf with Barclays. Your line is open..

Thank you. Good morning. A question on the partnerships that you were describing. With the Apple one, it seems like there was an investment from the company of $200 million.

It wasn't clear to me from the Life Sciences whether Merck and Pfizer contributed to this initial work or if that was all current Corning dollars? And I'm just wondering how that progresses. And then you also mentioned we should be watching with that $1 in sales per $1 of investment milestones about announcements.

But I expect that those are not going to come for a couple of years.

Is there anything else we should be looking at in terms of a decision-making process in terms of milestones for the incremental opportunity? And then finally, just to add on to this long question, is this opportunity even bigger than the Gorilla Glass for auto, internal and external?.

Thank you, Joseph. Let's try to take them in order. The development partners did contribute to some of the development expense that is related to creation of this product. This is a significant development effort for us and a significant development effort for them. So they were a critical part of getting us to the announcement the other day.

That being said, their major contribution is to adopt our product over time across their product lines. As you noted, with something as significant as new pharmaceutical packaging, what the pharmaceutical companies need to do is, because it's existing marketed product already, is take and show that new product in the new package to the FDA.

And when they do that, it's got to be already based on them having done stability testing, machine ability and a number of things. This means it will take a while for the revenue of this business to ramp. That being said, there are actually a number of other milestones you'll be able to see.

You will be able to see some of the FDA submissions as they go in. You will hear from other customers as they take our product for different ones of their products. So I think we're going to be able to really clearly set out a map for you.

And as we start to build out this business, it will become pretty clear sort of how large a breakout it will become. I think your last question, which was dealing with how large is this opportunity, and you used as an example comparing to our Gorilla Glass for automotive. I think there is no question that the size of this opportunity is larger.

The key here is how much of a breakout does it become.

If truly this product picks up very strong regulatory support and we also, if our data that we've gathered so far with our development partners holds true on its tremendous benefits, patients, as well as increased throughput for pharmaceutical companies, this is going to be a very, very large business.

It is going to grow for decades, and that's why we've been pursuing it so strongly. But that being said, last week was our breakthrough moment. We have a lot of work ahead of us for it to turn into the size of breakout that I just described..

Thanks. Just one quick follow-on, and, Tony, you talked about this a little bit.

But if we look at the strong performance in Gorilla Glass, and you look at the guidance for the rest of the year and even into 2018, can you give us any more color on what the SKU is in terms of that growth? Whether it's the units which seem kind of to be kind of flat? Is it just pricing being stronger on the Gorilla Glass 5? Or is it the more glass per phone option in that?.

Well, certainly the more glass per phone is pretty significant, and as you know, we talked about in the last quarter several devices that have put glass on the back of a phone, including the Samsung Galaxy X8 (sic) [S8]. And so that is a significant part of the growth that we have year-over-year.

Now the adoption of the Gorilla Glass 5 is also a significant part because as we've talked in the past, that creates real value for our customers and we're able to charge a higher price for that. So it's a combination of all these items.

The overall underlying market, as we said, is relatively flat and consistent, and our ability to grow really has to do with our innovations..

Perfect. Thank you..

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

Thanks. Good morning, everyone. First question for me, recently there's been sort of a blip-down in LCD panel prices for large sizes. And I know, Tony, you just mentioned that you're pretty comfortable with where inventories are right now.

I was wondering if you could just sort of react to that near-term trend and what you make of it and what you think the risks are relative to the outlook you've provided just for LCD glass. And then I had a follow-up..

Sure. It's true that panel prices have started to decline on a sequential basis in the last quarter. They're still really close to record highs. I think it's important to remember they've risen significantly every quarter since Q2 of 2016.

And this has resulted in both record panel maker profitability and we believe that prices have room to move down to more sustainable levels. So this should enable lower set prices to stimulate some second half demand. I think it's important from a supply chain standpoint to remember that in 2017, panel maker capacity does not grow significantly.

So our panel makers have to run at high utilizations to build inventory for Q4 selling season, and we saw that happen in Q2 just as we expected, and in Q3 set maker demand is strong and set makers will be building inventory for that seasonally strong Q4 demand, and we anticipate that's going to draw down inventory.

So when we look at this from an overall standpoint, we think the 2017 is going to end in a healthy range..

Great. That's helpful. And then just as a follow-up. Wendell, I was wondering, you mentioned the AT&T (sic) [Verizon] agreement is probably not going to be unique within the industry.

I'm sure you can't talk about specific timing, but I'm wondering if there's any other near-term drivers that maybe could lead to other announcements, say, before the end of the year? Or are we thinking this is more something to watch out for – as you get into next year and year after? Thanks..

So, I believe when you say AT&T, you mean Verizon..

Oh, I'm sorry, Verizon..

That's no problem. So, the Verizon agreement is not unique among the deep conversations we are having around the globe with telecom players. Whether or not we will announce those or not deals more with our customers' preference.

In Verizon's case, they felt that it was so strategic to their densification plans; they wanted to do it for their own purposes. And for us, we put our customers' needs first. Some will probably want to be public, some will probably not want to be public, and that's how we'll make a decision around announcements..

Okay. That's helpful. And then just very quickly, the Optical profits are growing faster than the sales in the most recent quarter. I was wondering if you could just explain why that dynamic happened most recently. Thanks..

Sure. I mean, I think that from a leverage standpoint, an awful lot of fixed costs that are in the Optical business, actually in all of our businesses, so generally speaking, you'd expect over time for our profits to grow faster than sales in any of our business segments. The exception being in the Display business where we're looking for stability.

And we certainly saw that in the second quarter in Optical Communications. It's important to realize that while that's happening, we're also investing a lot. We're investing in particular in some of the expansions that we've talked about to keep up with demand.

So – but from an overall standpoint, I think it's safe to assume that in the Optical business, in most quarters, we'll see profits grow faster than sales..

Great. Thank you very much..

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

Yeah. Good morning, guys. Thanks for the question. I guess I wanted to open up with just a tax question in light of the Valor announcement and the administration backing for that.

I wonder, Wendell, could you just maybe give us an update on your thinking on tax reform generally just kind of how that's moving along in timing? And are there going to be disproportionate advantages for people that build manufacturing onshore here? And then I have a follow-up..

As to tax reform, I think it's easy to be confident long term that the current tax policy of the United States is not stable over time, that it leads to things that are not good for our economy or jobs, and that ultimately that's going to get fixed. And I think that's – that I feel quite confident about.

What I am much less confident about is how the political math works in any given year. So I think calling timing on that one is above my pay grade. I do believe that there are significant advantages to be gained by manufacturing where your customers are. And that is the core of our investment philosophy.

We believe we can serve our customers better, we believe that serves the communities better, and we believe it's part of being a good citizen and a spectacular competitor. And so that tends to guide our philosophy, and that's what all these various announcements you've been seeing recently really deal with about us.

Valor Glass is aimed at the pharmaceutical industry. The U.S. is the powerhouse of biotech and pharmaceutical manufacturing, and we believe this is the right place to put it..

Okay. Thanks for that. And then I wanted to – my follow-up, I just wanted to come back to Tony on Display. Samsung has recently cut their expectations for demand later in the year. I know your commentary suggests that things are relatively on track. But I wonder if you could just talk about what you think is happening with end-market demand right now.

Are we just seeing some temporal weakness and as we move into the back end of the year, you feel that demand will be relatively normal? Or any other color you can give us on what you guys are seeing on end market demand would be helpful. Thanks..

Yeah, sure. I mean, I think that if you look at the data from January to May, it does show the TV viewing area, some weakness in China and Western Europe, while all the other regions are up on a year-over-year basis.

But I think what's important to remember about this is, retail demand is clearly back-end loaded, and we're just now entering the significant selling season. So it's hard to draw a conclusion based on the first five months' worth of data. Second thing I'd remind you is, is that what really drives the growth of our business is the size of TVs.

And we said that TVs would grow more than an inch-and-a-half, and all the data in the first five months confirms that, we feel very confident about that..

Great. Okay. Thanks, guys..

Thank you. Our next question comes from the line of Jess Lubert with Wells Fargo. Your line is open..

Hi, guys. Good morning. I have two questions. First, for Wendell, I was hoping you could comment on the breadth of strength you're seeing in the U.S.

optical market; how much is coming from the Tier 1 telcos like Verizon, how much is coming from cable or other verticals? And then perhaps you can help us understand what you're seeing internationally, and are you seeing any improvement there that could become an optical tailwind later this year or next? And then for, Tony, I was hoping you could comment on the gross and operating margin trajectory.

Both were down sequentially relative to Q1. It seems like you're expecting similar trends during Q3. So I guess I was hoping you can help us understand if you believe these are the margin levels we should be thinking about over time, or do you still see the potential to drive some margin improvement..

So in Optical – I think that's a really excellent question. First, note that our growth is really strongly driven by our organic innovations. And second is that exact timing of when those are being pulled into these major network builds can be quite challenging to call accurately.

That being said, you are right to note that you're seeing the major telecom players are driving a hunk of our growth at this point in time. That being said, we are seeing the same type of momentum being built in our dialogues really across the spectrum of our Communications business.

And this, together with the growth that we are also seeing in the cloud-based optical systems and around the world, is what is leading us to believe that though any given quarter could come out different ways.

There is the potential here for a building wave of demand in our Optical Communications business largely because as fiber pushes closer and closer and deeper and deeper in the network, right, what happens is the amount of demand for our particular type product goes up significantly. And so that's what we're feeling around the world.

But like I say, these are major programs, and calling exact timing can be quite challenging. But I think we're seeing at least the basis of a long-term secular momentum building for our tech..

And from a margin standpoint, I mean, we were happy with our margin performance in the second quarter. Gross margin was doing 42.4%, very consistent with where we were in Q1, which I think was 42.3%, and we expect the rest of the year to be in the 42.5% range.

But I think it's important to remember, and I mentioned it a little bit when I was answering the Optical question, is that we are beginning to invest in a number of growth areas that we've talked about, and that increases spending slightly.

It increases it in the cost of goods sold, it increases it in S&A and RD&E, not above any of the percentages – normal ranges we've given you, 14% in SG&A, 8% in RD&E, gross margins in the 42% to 43% range. But you do see some of that that's occurring in our businesses.

So we don't see anything unusual about that, and we're actually quite pleased with where we are..

Thanks, guys..

Thank you. Our next question comes from the line of Patrick Newton with Stifel. Your line is open..

Yeah. Good morning, Wendell and Tony. I guess first question is on your Other Sales. They seem to have broken out sequentially and year-over-year. I'm curious if you could help us understand what is driving this, perhaps commenting on auto trends or whether Valor Glass trials are driving some incremental revenue.

And could you also remind us what businesses or products are embedded in Other Sales?.

Sure. We have a lot of our development programs are in our Other Sales. It includes the business that we acquired a couple years ago from Gerresheimer that's part of our some pharmaceutical packaging technology business and it includes a variety of other programs that we have in there.

And I wouldn't say that those specific trends are a reflection of anything specifically that's going on. The proof points you ought to look at are the ones we've talked about in each of these programs..

And auto is in this bucket as well.

Correct?.

Yeah. Auto is in this bucket as well..

Okay. And then, Wendell, you talked about Valor Glass having a uphill climb for regulatory purposes and making timing of adoption difficult to predict.

And I guess just given that backdrop, is there any long-term timeframe that you could provide to us to help us understand the potential timing of when Valor Glass could become a meaningful impact to your P&L? And then on the profitability side of Valor, I think with your purchase of Gerresheimer's glass tubing operations, you did form an equity venture that's about 75% owned by Corning.

So does this mean that Gerresheimer's going to receive 25% of future Valor business profit?.

So let's handle both questions. Let's start with the timing one. I think it's a little early for us to be able to give a good idea on what the ramp is going to look like next year.

We'll start to see the submissions go into the FDA and we'll begin to get a feeling for what type of regulatory process they want to bring it through and how accelerated they want to make the adoption of Valor if they choose a highly accelerated rate, then we're going to move much more quickly towards breakout, right.

If they choose a more typical conservative rate, then it's going to move a little slower towards breakout.

I think the beauty of this particular business is though the regulatory nature of it can make adoption a little slower, it makes it way more certain that allows us to put the – we can put capacity up faster than a particular cycle of adoption of regulatory approval. So it derisks our investment very significantly.

And then second, once you win that, it's forever business. So we like it. It can be a little frustrating in the early stages, but long term, I think it builds the type of very robust business that, assuming we have a breakout here, we are just going to be delighted with over the next decade and beyond.

And then the Gerresheimer question, so the Gerresheimer piece, yes, we acquired their glass tubing business as we explained at the time, when they've got a early look at what it was Valor was. They understood what it is they were looking at, and decided to have us become the glassmaker for tubing.

And it allowed us to get a lower cost platform for us to do what we just announced. One of the expansions we have is to build a new glass manufacturing line there and that helps us on our cost structure. As to the go-to-market for the actual vials and cartridges, that is all still in development.

You would have seen an announcement from Gerresheimer and from Stevanato just the other day saying how delighted they are to be cooperating with us on this. How we actually end up resolving that go-to-market, what goes through venture, what goes to 100% us, what's pieces of the value chain are carried where, I think that's all ahead of us.

Our first hunks of investment that we just announced, they're flowing through 100% owned a play and we'll see how it develops over time. It's all going to be about the best way to serve our customers and the best way to create value for our shareholders..

Thank you for taking my questions. Good luck..

Thank you..

Thank you. Our next question comes from the line of Vijay Bhagavath with Deutsche Bank. Your line is open..

Yeah. Hi, good morning. Just a bigger picture question here on 5G, like to hear your thoughts there and how you see it impacting your Optical Fiber business heading into next year.

Do you see mostly tactical opportunities next year like fiber updates to small cells, or you foresee a bigger, broader fiber build-out opportunity kind of kicking in as 5G starts to unravel at big service providers like Verizon, AT&T, et cetera? Thanks..

It's a great question. We view 5G as having the potential to be an extremely significant demand driver for our product.

If truly 5G as it is defined by the industry becomes the standard way to do wireless connectivity, then we are looking at a very significant secular driver for our product, perhaps one of the more significant that we have seen in our long and storied history in this business.

It is still too early to make a call on what exact architectures will be used to deploy this tech. If Verizon's view, with the right technology to deploy, the right architecture to deploy, is correct, this is a huge opportunity.

So we'll have to see as our own work progresses, as our deep engagement with other customers progresses, how will the architectures evolve? But there's just no question that it is a positive momentum driver for us. The only question is the size, scale and timing of that momentum.

As we get better acuity, we will make sure that we share it with you because of its significant importance to our shareholders..

Thank you..

Thanks, Vijay. Cynthia, we have time for a couple more questions..

Okay. The next question will be from the line of Mehdi Hosseini with SIG. Your line is open..

Yes. Thanks for taking my question. I have one regarding margins. When I look at the Display group, revenues were fairly flat, but the net income margin was down. And also with Specialty Materials relative to Q4 of last year, revenues were kind of flat, but net income margin was down there as well.

I just want to better understand the dynamics and how we should think about given what has happened with a specific segment net margin over the past couple of quarters, and I have a follow-up..

Yeah, Mehdi, on the Display, in Q1, we received a technology payment that didn't repeat itself in Q2, and that's the whole difference between the two. Otherwise, given where price and volume was on a sequential basis, income was flat.

And in terms of Specialty Materials in the second quarter, we had a lot of ramp-up costs for new production that happened in the second quarter that didn't happen in the fourth quarter of last year..

Okay. Got it. And as a follow-up to Specialty Materials, it seems to me that there was some kind of a pull in, in revenues, and some of the handset OEMs are introducing their new product later in the year.

And in that context, how should we think about; A, the volume shipment; and B, the increased content? Is it going to be lumpy? Or the initial material push is done, and now we have to wait to see how demand is going to look like, which means there could be a spillover into Q1 of next year.

Just trying to understand the dynamics of the specific part of the Specialty Materials..

Yeah, for sure it's going to be lumpy. I mean, our Specialty Materials business has always been lumpy since we've gotten into the Gorilla Glass business, and we'd expect that to continue on a going-forward basis. We said in Q3 we think we'll be up low to mid-teens.

Where we're going to end up for the full year, we're not sure because it depends on the adoption of the technologies, but there's no doubt that this will be lumpy as we go forward..

But could there be a scenario where March quarter will be less seasonal if the new product introduction has a tailwind?.

Sure..

Would it be a more than 50% probability?.

No, I'm not going to – I'm not going to handicap – I appreciate the question, but I'm – we're not going to talk about Q1..

Okay. Thank you..

Yeah..

Last question..

Our final question will come from the line of Stanley Kovler with Citi Research. Your line is open..

Thanks for squeezing me in. I'll be quick. I just wanted to ask a question about the use of cash and potential M&A. After SpiderCloud, it seems like you're continuing to make some small acquisitions, particularly in the Optical space. And kind of as we head into 5G, I just wanted to follow-up on the question about M&A.

Should we expect to wait on more significant M&A as – Wendell, you talked about some architectural things that you still have to shake out in the industry before you can make bets on how to augment or add complementary technology to your Optical offerings? And I'll squeeze my follow-up in; it's just on free cash flow.

How should we think about that going into the second half of the year and planning for next year as well? Thanks very much..

Why don't you start with free cash flow, and I'll handle 5G..

Okay. Sure. I think from a free cash flow standpoint, we've said our capital spending part of free cash flow will be about $1.5 billion. It could be on the heavier side of that, given all of the investments that we're making today, but somewhere in that neighborhood.

And then in terms of operating cash flow, remember, the second half of the year is where we generate very strong operating cash flow. So it will certainly be stronger than it was in the first half of the year, and relatively consistent with what we did last year..

And as to how do we see the role of acquisitions, what we currently perceive is that far and away, the bulk of our growth is going to be organically-driven and innovation-driven.

That being said, we're in a very privileged position, have deep knowledge as we work with our customers on these architectures, really whether it's in the cloud, in buildings, or in 5G network densifications fiber-to-the-home.

You can expect us to take advantage of that privileged position if we start to believe in a technology that can augment what we do and be driven through our market access platform. That's really the story of SpiderCloud.

It was a small acquisition, right, but we really like the tech, and it has an opportunity for us to significantly increase demand for our fiber in the horizontal in buildings and run right through our market access platform. Expect us to continue to do that, but the bulk of our growth is all driven organically and about innovation.

I hope that answers your question..

Thank you very much..

Thanks, Stan.

Wendell, closing comment?.

First, thank you to everyone for joining us today. I just want to close by reiterating how pleased we are with the continued positive momentum in both our financial results and against our Framework goals. Our focused and cohesive portfolio continues to produce milestones, and we're particularly excited to share our breakthrough moment with Valor.

We look forward to staying in touch..

Thanks, Wendell. Before we close, I just wanted to let everyone know that Investor Relations is going to be at the Jefferies Conference at the end of August, and we'll be meeting with investors at the Citi Conference in early September. A web replay of today's call will be available on our site for one year starting later this morning.

There's also a telephone replay available for the next two weeks with details in today's news release. Once again, thank you all for joining us. 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. You may now disconnect..