Corning Incorporated

Welcome to the Corning Incorporated Quarter 4, 2019 earnings call. To be placed into the Q&A queue, please depress 1 then 0. It is my pleasure to turn the call over to Ann Nicholson, Vice President of Investor Relations. Please go ahead.

Thank you, Steve, and good morning. And welcome to Corning's Fourth Quarter 2019 earnings call. With me today are Wendell Weeks, Chairman and Chief Executive Officer, Tony Trippini, Executive Vice President and Chief Financial Officer, and Jeff Evanson, Executive Vice President and Chief Strategy Officer. I'd like to remind you that today's remarks contain forward-looking statements that fall within the meaning of the Private Securities Litigation Reform Act of 1995. Those statements involve risks, uncertainties, and other factors that could cause actual results to differ materially. These factors are detailed in the company's financial reports. You should also note that we will be discussing our consolidated results using core performance measures unless we specifically indicate our comments relate to GAAP data. Our core performance measures are non-GAAP measures used by management to analyze the business. A reconciliation of core results to the comparable GAAP value can be found in the Investor Relations section of our website at corning.com. You may also access core results on our website with downloadable financials in the Interactive Analyst Center. Supporting slides are being shown live on our webcast, and we encourage you to follow along. They're also available on our website for downloading. And now I'll turn the call over to Wendell.

Thank you, Anne, and good morning, everyone. This morning we reported fourth quarter and full year 2019 results. For the fourth quarter, sales were $2.9 billion, net income was $406 million, and EPS was 46 cents. For the full year, sales increased 2% to $11.7 billion, net income was $1.6 billion, and EPS was $1.76. While our 2019 growth did not meet our long-term targets, we once again outperformed our underlying markets. We grew environmental sales 16% while car sales were down. We grew specialty material sales 8% while smartphone units were down. In life sciences, we exceeded industry growth on the strength of new products for bioprocess and advanced cell culture. In display, our glass volume grew mid-single digits while TV unit sales were down. And in optical, we outperformed the passive optical market, which declined a high single digit percentage. Changing market and customer dynamics impacted our 2019 performance significantly. Corning entered 2019 building on two years of strong growth, and that growth continued in the first half with sales up 11% and EPS up 24% year over year. In the second half, a supply chain correction in the display industry and weakness in the optical market, highlighted by capital spending reductions at two of our significant customers, led to declines in display technologies and optical communications. While we acted quickly to mitigate -than-expected second half demand in display and optical, we did not fully overcome these challenges. As a result, our second half sales were down versus 2018, and as our volume decreased, factory utilization declined, and so did our profitability, especially gross margin. We're confident that the situations in display and optical communications are temporary, and we expect the company to return to sales and profit growth in the second half. In display, we see indicators that the supply chain correction has ended, and we expect normal seasonality to resume with the majority of volume and growth in the second half. We also plan to start production at our next Gen 10.5 plants, which will support -than-market growth as the plants ramp. In optical, we expect -over-year growth in the second half, driven by projects for 5G, Fiber to the Home, and hyperscale data center deployments. We expect these higher volumes to increase factory utilization and support higher profitability, and we expect to benefit from the recent and ongoing cost actions in optical communications and display. Tony will provide additional segment details, and I will focus on our overall progress and outlook. 2019 was challenging from a financial perspective, but we remain committed to our new strategy and growth framework introduced last year. Our new framework is the evolution of our strategy and capital allocation framework, which we successfully completed last year. Building on the strong foundation of our original framework, we made excellent progress on many strategic initiatives during the year. We made commercial and regulatory progress on Baller. We opened a dedicated factory for our burgeoning auto interiors glass business, and grew our order books significantly. Display pricing remained moderate, and we advanced several compelling innovations in Gorilla Glass and optical communications. We met or exceeded all of the goals of our 2016 to 2019 strategy and capital allocation framework, including returning more than $12.5 billion to shareholders over four years through share repurchases and a 67% dividend per share increase, all while creating a better, stronger, more resilient company. Under our new strategy and growth framework, we expect to continue capturing significant organic growth and creating additional value for shareholders. From 2020 to 2023, we expect to deliver 6 to 8% compound annual sales growth and 12 to 15% compound annual EPS growth, expand operating margin and return on invested capital, invest between $10 and $12 billion with a focus on organic growth, and return $8 to $10 billion to shareholders through a combination of dividend increases and opportunistic share repurchases. How do we plan to achieve these goals? We are targeting an incremental $3 to $4 billion in annual sales, along with improved profitability by the end of 2023, driven primarily by our strategy to create and sell into new product categories that enhance our customers' offerings. As I've said before, we're not just counting on everybody buying more stuff. We're putting more corning into the products that people already buy. This provides a mechanism for us to grow even in challenging environments. We saw that happen during 2019 in environmental specialty materials and life sciences, as I outlined earlier. In short, a big part of Corning's story over the next four years is a content story, and we expect to see it across the company. Let's look at how we advanced our strategy in each market access platform in the fourth quarter and for the full year. In optical communications, we are currently feeling the impact of capital spending reductions in both the carrier and enterprise markets. We expect recovery driven by 5G, fiber to the home, and hyperscale data center deployments. Our goals in optical communications are to advance our product portfolio and align costs with demand in the near term. We're making progress in both areas. From a product perspective, in 2019 we continued to transform the way the world connects by enabling 5G solutions with industry leaders. New collaborations with Intel and Verizon demonstrate our commitment to helping our customers increase efficiency and address the challenges of new network deployment. We also extended our leadership in data centers as Altice Portugal, the country's largest provider of telecommunication services, selected our Edge product. Edge provides the increased speed, power, and capacity needed to withstand future pressure on servers and network capabilities. Edge has been playing a vital role in our continued success in enterprise. It's been deployed in 30 countries, used in 50,000 installations, and has received 10 global awards since its introduction. Stepping back, the long term trend in optical is strongly positive due to the benefits of photons replacing electrons in network after network. And we're uniquely situated to enable that shift. But it's not always a smooth line. As one network or segment upgrades to optics, there can be a pause before the next one begins. That pause is where we are right now. So we're aligning capacity and inventory to current market demand. We've idled equipment and reduced headcount, and we're delaying capital investments. In the long term, because of our leadership, we are positioned to continue putting more Corning solutions into every network that is built. We will return to growth as the inevitable optical trend continues. Turning to mobile consumer electronics, we're making significant progress on our goal of doubling sales. Since 2016, we've added $500 million in sales on a base of $1.1 billion. We grew sales 42% cumulatively, while smartphone unit sales did not grow. In 2019, we bolstered the presence of Corning content on and in mobile devices with Amplify screen protectors, decorative backs, and durable solutions for wearables. Apple announced that it is awarding $250 million from its advanced manufacturing fund to Corning, building on the $200 million we received from Apple's fund in 2017. Both investments support Corning's -the-art glass processes, equipment, and materials integral to the delivery of next-generation consumer devices. In 2019, as one of our prominent customers noted, we took a major step forward in -the-art cover glass. In 2020, we will continue to advance and introduce new glasses, and we are confident that the adoption of our technologies will enable us to our sales goal. So, stay tuned. Moving to the automotive market, our goal is to double sales by 2023. In 2019, we ramped production capacity in Hefei, China to meet committed demand for both our auto glass solutions and our gasoline particulate filter products. We are well on our way to building a $500 million plus GPF business by 2023. Sales in 2019 exceeded $250 million. And in 2019, automotive glass solutions delivered the industry's first auto-grade gorilla glass for 2D and 3D interiors, along with Corning's patented cold form technology. Earlier this month, we announced collaborations with industry leaders across the auto ecosystem, including Vistion, LGE, BOE, and Via Optronics. We are beginning mass production and have built an order book worth several hundred million dollars with nearly half of that book under contract. In life science vessels, we reached several exciting milestones in 2019. We exceeded $1 billion in sales in our life sciences segment as adoption of our industry-leading bioprocess and advanced cell culture products continues, driving our organic growth rate to 7%. And we continue to build momentum for Valor Glass. We signed commercial agreements with three leading pharmaceutical companies and received FDA approval for use of Corning Valor Glass as a primary package for a marketed drug product. These major milestones validate our strategy to build a long-term, multi-billion dollar franchise as we create a new standard in pharmaceutical glass packaging. In display, our goal is to stabilize returns. The market continues to shift to large-size TVs, which are most efficiently produced by our customers on Gen 10.5 FAPs. Our leadership in Gen 10.5 Glass supports medium and longer-term volume growth. In 2019, we continued to increase output at our first Gen 10.5 plant. In 2020, we plan to ramp additional Gen 10.5 capacity in tandem with our customers. And 2019 was a great year for display glass pricing. We saw low single-digit percentage price declines for the full year, which was even more moderate than anticipated. And we expect a moderate pricing environment again in 2020. You can see that across our markets, our strategic investments are well aligned with major trends and our relationships with industry-leading customers are creating new opportunities. We've got the structural steel in place. Our strategy is sound. We're advancing growth in each of our market access platforms. And we will overcome the challenges in display and optical. In 2020, three operational priorities drive our focus. Successfully ramping our next Gen 10.5 plants, aligning cost and capacity to current demand, and commercializing innovations to support our customers. Execution against these priorities will create the momentum needed to achieve our strategy and growth framework goals. Now let me turn the call over to Tony for more

details. Thank you, Wendell, and good morning. In the fourth quarter, we delivered on sales and EPS expectations. Sales in each of our businesses performed at or above expectations. And we generated over $1 billion in adjusted operating cash flow. We accelerated actions in optical communications to align production output and working capital to current customer demand. This impacted gross margin, which was below our fourth quarter guidance. For the full year, as expected, sales and profitability were down due to the challenges in display and optical communications. While we also face challenges in other markets, it's important to note that specialty materials, environmental technologies, and life sciences powered through and grew sales. As we turn to 2020, we expect continued strong growth in all three of these businesses. We also expect display and optical sales and profitability to grow year over year, beginning in the second half. As a result, we expect margins and profitability for the corporation to improve in the second half of the year. Now before I get into the details of our performance and results, I want to note that the largest difference between our gap and core results are related to charges associated with capacity realignment in display and optical communications and at our equity venture, Hemlock Semiconductor. Other differences between our gap and core results come from a non-cash, -to-market adjustment for our currency hedge contracts and a change in our tax reserves. Now with respect to -to-market adjustments, gap accounting requires earnings translation's hedge contracts and foreign debt settling in future periods to be -to-market and recorded at current value at the end of each quarter, even though those contracts will not be settled in the current quarter. For us, this impacted gap earnings in quarter four by $59 million. To be clear, this -to-market accounting has no impact on our cash flow. Our currency hedges protect us economically from foreign exchange rate fluctuations and provide higher certainty for our earnings and cash flow, our ability to invest for growth and our future shareholder distributions. Our non-gap or core results provide additional transparency into operations by using a constant currency rate aligned with the economics of our underlying transactions. We're very pleased with our hedging program and the economic certainty it provides. We've received $1.7 billion in cash under our hedge contracts since their inception more than five years ago. As shifting to results, fourth quarter sales were $2.9 billion. Net income was $406 million and EPS was $0.46. For the full year, sales were up 2% to $11.7 billion, Net income was $1.6 billion and EPS was $1.76. Now let's look at the detailed segment results and outlook. In display technologies, fourth quarter sales were $795 million and net income was $180 million. Q4 glass prices declined slightly sequentially, as expected. Our fourth quarter volume was up low single digit sequentially, better than expected. Displays full year sales were $3.3 billion and net income was $786 million. Our full year 2019 price decline was a low single digit percentage. Retail demand in 2019 was strong. Our preliminary view, with most but not all of the data in, is that retail display area increased mid single digits in 2019, driven by TV screen size growth. Glass market volume was up low single digits, less than retail, as set makers took a conservative stance in the back half of the year due to macro uncertainty. This conservativism drove panel maker utilization reductions and led to a supply chain correction. We believe that supply chain inventory exiting 2019 is healthy, and we think the correction is largely behind us. For full year 2019, our glass volume was up mid single digits, outperforming overall glass market, driven by our increased Gen 10.5 output during the year. The glass market shipped more volume in the first half than the second half due to the supply chain correction, and so did we. The lower shipments in the second half reduced our gross margin. For 2020, we again expect the retail market measured in square feet to be up by a mid single digit percentage, driven by TV screen size growth. And given that the supply chain is now at a healthier inventory level, we expect the glass market to increase in the mid single digits, and for our volume growth to be similar to the overall glass market. In the first quarter, we expect the glass market to be up low single digits sequentially, as panel maker utilization increases. We expect our volume to be down low single digits sequentially, underperforming the glass market because of a structural shift in the Korean panel market. Up until two years ago, South Korea was the leading provider of panels. Korean panel makers are going through structural changes that will reduce their capacity significantly, as the global center of panel making moves to China. This reduction impacts our shipments in Korea. In the second half of 2020, we expect to grow faster than the glass market as our new Gen 10.5 tanks in China fire up and absorb the panel demand that is shifting from South Korea. Given Corning's leadership with three of the four planned Gen 10.5 fabs, we expect the benefit from this regional shift. We expect more normal seasonality in 2020, and for almost all of our -over-year volume growth to incur in the second half. As our volume increases, we expect our margins to improve. Turning to pricing, we expect Q1 sequential glass price declines to be moderate. For 2020, with over 95% of our volume under contract, we expect full-year price declines to be at -single-digit percentage. We reached our goal of -single-digit -over-year declines in the second half of 2018, and had even more favorable changes for several subsequent quarters. More recently, as just discussed, the panel industry is working through a fundamental restructure of capacity, migrating from Korea to China. The fact that we continue to have moderate price declines while these changes are happening is positive. We believe that three factors continue to drive the favorable glass pricing environment we've been experiencing. First, we expect glass supply to continue to be balanced with demand or even tight. For Corning, we are aligning our capacity with demand. We are also pacing our Gen 10 1⁄2 capital projects to align with panel makers' schedules. Second, our competitors continue to face profitability challenges at current pricing levels. And third, display glass manufacturing requires periodic investments in existing capacity to maintain operations. Glass prices must support acceptable returns on those investments. Now to recap display, the industry is emerging from a temporary supply chain correction. Retail remains strong with the increase in TV screen size continuing to drive glass volume growth. We are well positioned with our customers and successfully ramping new Gen 10 1⁄2 facilities. And we expect to return to -over-year growth in volume, margins, and profitability in the back half of the year. In optical communications, fourth quarter sales were $903 million and net income was $62 million. Profitability was impacted by lower volume and reduced production output to bring down inventory. For the full year, sales were $4.1 billion, down 3% in a market that declined by a high single-digit percentage. Net income declined 17% to $489 million. In 2020, sales increased 13% -over-year in the first half and declined 16% in the back half. The lower volume in the back half negatively impacted sales, margins, and profitability. Nearly 90% of the second half -over-year decline can be explained by changes in spending by two large customers. A large carrier completed its fiber to the home build and redirected capital to pay down its debt. A hyperscale data center customer concluded a period of unusually intense building. We have excellent relationships with these customers and continue to co-innovate with them. We expect our sales to increase at both companies as they spend more on optical passives. In 2020, we expect -over-year sales to be down 5 to 10% as the lower level of sales we experienced in the second half of 2019 continues throughout the first half of 2020. And we expect first quarter sales to be down about 25% versus the strong project spending in Q1 of 2019. In the back half of 2020, we expect -over-year growth in sales and profits to resume, driven by projects for 5G, fiber to the home, and hyperscale data center deployments. Now, the exact timing of these projects is hard to predict. If they proceed as expected, we'll be in the upper range of our guidance. If the projects start later, we'll be at the lower end of the range. When -over-year growth occurs, our factories will fill and our margins and profitability will improve. We are working closely with our customers and will keep you informed as the year progresses. Stepping back, we are innovating to improve network speed, cost, and capacity. We also continue to receive confirmation that optical is essential for 5G and hyperscale, and to secure long-term agreements with major industry players, all of which sustains our confidence in our ability to deliver long-term growth. In environmental technologies, fourth quarter sales were $374 million, up 17% -over-year and ahead of expectations. Continued adoption of gasoline particulate filters drove the growth. Net income was $64 million, driven by strong operational performance and successful ramping of additional GPF capacity in China. For the full year, sales were $1.5 billion, up 16%. Net income was $263 million. 2019 GPF sales exceeded $250 million, and we are well on our way to building a greater than $500 million gasoline particulate filter business. With a market-leading product, we continue to earn a majority position globally as automakers award platforms to meet Euro 6 and China 6 regulations. Sales are accelerating as Euro 6 regulations are in full effect and automakers are preparing for China 6 implementation in 2020. Our Hefei plant startup is ahead of schedule and has been key to delivering incremental sales and net income. We expect continued growth. Looking to 2020, despite continued weakness in the global auto markets and the expected downturn in the North America heavy duty market, we once again expect to grow -over-year, with sales up in the mid-single digits in the first quarter and for the full year. We expect GPF sales to exceed $350 million for the year. Specialty materials in 2019 strong, driven by demand for our premium glasses. Fourth quarter sales were $453 million, up 14% -over-year, and net income was $94 million. Full year sales were $1.6 billion, up 8% -over-year, and grew for the fourth straight year, despite essentially flat smartphone unit volume. Net income was $302 million. Similar to 2019, we expect our growth in 2020 to come from further advancement and adoption of our premium glasses, as well as our additional innovations for mobile consumer electronics. We expect specialty materials sales to be up by a high single digit percentage for the full year. We expect Q1 sales to be up a mid-single digit percentage -over-year. Life sciences also ended the year strong, exceeding expectations with fourth quarter sales of $256 million, an increase of 8% -over-year. Net income was $38 million, up 31% -over-year. For the full year, the business reached a milestone with sales of $1 billion, a 7% increase -over-year. Net income was $150 million, up 28% -over-year. For 2020, our market outlook and customer demand remain positive, and we expect growth to continue. With full year sales up mid-single digits, in the first quarter we also expect sales to be up mid-single digits -over-year. Now let's turn to the consolidated results and outlook. Operating cash flow in the quarter was $1.1 billion. As we said in October, we expected to reduce working capital in the second half. We did reduce working capital in Q3 and again in Q4. Full year adjusted operating cash flow was $2.1 billion, and CapEx was just under $2 billion. We are taking actions that will result in stronger operating cash flow and lower capital spending in 2020. We expect CapEx to be approximately $1.5 billion for the year. Gross margin in the fourth quarter was 37%. Gross margin was impacted by the lower volume and reduced production output to bring down inventory and display and optical communications. In the first half of 2019, gross margin was 40%. In the back half of the year, as display and optical communications volumes declined, gross margin also declined to 38%. In the first half of 2020, we expect display and optical volumes to remain low, impacting our gross margin percent. We expect volume and display and optical communications to grow sequentially and -over-year in the second half. When that happens, gross margins should improve to approximately 40%. In the first quarter, we expect sales to be seasonally lower than the fourth quarter and gross margin to be the lowest for the year, down 100 to 150 basis points from the fourth quarter. We expect gross margin dollars and percentage to increase sequentially thereafter. Moving on to the rest of our P&L, as a percent of sales, we expect SG&A and RD&E to be nearly 14% and approximately .5% respectively for the full year. In addition, we expect other income, other expense to be approximately $275 million in 2020. Full year gross equity earnings are expected to be approximately $170 million, down $67 million from the prior year. The expected decline in 2020 is due to lower expected sales at our Hemlock Semiconductor, JB. Most of Hemlock Semiconductor's business is under long-term -or-pay contracts, which include upfront cash payments. In the fourth quarter of 2019, similar to prior years, Hemlock settled some of their solar customer contracts. The settlements positively impacted their 2019 cash flow and reduced expectations for future sales in the solar segment. Hemlock took a charge related to realigning capacity to the lower sales level. The business remains quite profitable selling primarily semiconductor products, which are supported by Hemlock's quality leadership and long-term -or-pay contracts. We expect our effective tax rate for 2020 to be approximately 20 to 21%. Now before I close, I know there are a lot of questions on the impact of the coronavirus on corning. The safety and well-being of our people is our number one priority. We are in close contact with our employees, customers, and suppliers, and we are engaging with governments and health services organizations as we monitor the situation. At the same time, we have not factored any meaningful operational or financial impact in our guidance. The situation remains fluid, and as more information becomes available, we will update you accordingly. In closing, we expect 2020 to be in many ways the mirror image of 2019. We believe that the first half will remain challenging as markets and customer dynamics reflect what we have seen over the last six months. In the second half, we expect a return to growth and display and optical communications to improve, and as strong growth continues in environmental, specialty materials, and life sciences. As this happens, we expect the company to return to growing sales and profitability as we saw in the first half of 2019. Overall, Corning is operating on a strong foundation that we built over the past four years, and we continue to make progress in key areas as evidenced by our ongoing customer announcements. We are confident in our ability to achieve the objectives we laid out in our 2020 to 2023 strategy and growth framework. With that, let's move to Q&A.

Anne? Thanks, Tony. Okay, Steve, we're ready for our first question.

As a reminder, if you have a question, please press 1 then 0. Our first question will come from the line of Rod Hall of Goldman Sachs. Please go ahead.

Yeah, thanks for the question. A couple of quick ones. So on display pricing, I wanted to start off, Tony and Wendell, too, whoever wants to answer this, on the movement of pricing through 2020. Understand that the -single-digit declines are being driven by the movement from Korea to China. But could you talk us through more of that dynamic? What is driving that? Are you assisting that movement with your own pricing, or is there a mix effect or something like that? And then could you also talk about the timing of that? Is the first half pricing view that we're going to see different from the second half in display? And then I also wanted to just quickly ask you about optical. I know Jeff's been working on modeling that, and it sounds like you feel like you've got some better visibility. I'm just wondering, on the low end of that guide, do you think you are adequately cautious? I guess the answer is yes. But how do you have any confidence in engaging the risk on optical? Thanks.

All right. Rob, let me first start with the pricing answer. As you know, most of our contracts get put in place in the fourth quarter. Seasonally, the largest price decline that we have in any quarter is in the first quarter, and that is the case here, too. And we expect more moderate price declines as items move out throughout the year. I think from a Korea standpoint, I think what's important to highlight here is that there's just a lot of change going on in the industry. I think Korea capacity is going to be down around 40 percent on a -over-year basis, so that's a pretty significant decline from a pricing standpoint or from a capacity standpoint. And as that capacity comes offline, it shows back up in China. So as we see our year flow out, we're going to see a little bit less volume in the market in the first half of the year and more volume in the back half of the year. And so I think that that's a trend that's been going on, and that's a trend that we really see the impact of on 2020. I

think if we just think through display, first, I think you've got a right rod on that, just the way in which we do our contracts, sort of the pattern of price through the year, being a little more weighted earlier in the year than later. I think what Tony was trying to get across is if you take a look at the Korean market, the Korean production and their share of the overall world market, just two years ago, they were the largest producer of large-sized panels in the world. And what's happening is Gen 10.5 plants in LCD are just so much lower cost. And you're seeing sort of the China industrial policy of that capital being underwritten in China that is giving our Korean customers a challenge to how do they compete when they haven't made that investment in Gen 10.5. So you're just seeing a pretty natural switch begin. And what Tony was talking about was that we've seen announcements out of the Koreans that over time you're going to see about a 40 percent reduction in their capacity. It won't all happen this year, but over that time period. And you're just going to see that shift towards China and the Gen 10.5 plants. Now when that shifts, there are players at the glass level who are better or worse positioned in that. We are extremely well positioned in that. But the overall industry structure just sort of has to move with that dislocation. And so the fact that we are able to maintain such really good, strong pricing performance in the face of this level of announcements for folks, I think is what Tony's getting at is why we feel that's really good news for the pricing environment. And then just sort of the data, since we're so well positioned in China, we'll just see that progress that he talked about in the back half just continue to accelerate

through time. Wendell, can I just ask you,

do you guys think that this year is the year that all this kind of, does this play out this year and then next year things go back to more of a normal trajectory? Or do you think this is a multi-year kind of transition and it'll continue next year to be strange?

Well, I think you're going to see the bulk of it happen with the, this year with just the fact of how clear the Korean panel makers have become just on their future. You know, we had always anticipated much like the move from Japan to Taiwan and Korea happened, and then we pre-positioned for that, that we'd see this move to China. I think this year what was surprising to everybody in the industry is as we went through this last supply chain correction is that the Chinese players continued to produce pretty strongly and pretty aggressive pricing for panels. And this made the Korean customers sharply act and sort of implement sort of some long-term strategy thought they had in nearer term. And they're just focusing their guns on next-gen innovations for their Korean-based panel capacity. And while their set arms are sourcing more and more out of the Chinese panel makers. So I view that the bulk of this move has been announced. You know, we'll feel, the industry will continue to feel its after effects. It's a pretty big change. But I think the bulk of it's going to be behind us this year,

sir. Okay. Thank you. And optical visibility?

Yeah, I think from an optical visibility standpoint, you're right. Jeff and his team have been doing a lot of work relative to what the future, especially in the near term, looks like over the next year or so. And we've tried to integrate that work along with what we know from a business standpoint and what our customers are telling us. And the range is really informed by both of those, both of that work. And at the minus 5% of the range, that's an indication that we've got certain customer projects and we're following those closely. And if that happens, we'll be closer to that. And at the lower end of the range, the minus 10%, that would be reflective of what some of those projects actually get themselves pushed out. So that's how we've done the work. And clearly we've really focused on getting better at that over the last six months.

Okay. Great. Thank you, guys. Appreciate it.

Our next question will be from the line of Wamsi Mohan, Bank of America. Please go ahead.

Yes, thank you. I was wondering if you could maybe talk a little bit about your plans to use this capacity that's going to be stranded in LCD in Korea. What timeframe can or should we expect asset redeployment and that to show up in your financial results? And I will follow up.

So basically we've already done most of that. Korea is a low-cost production facility for us. So what we're doing and what we've been planning for is to continue to use that as a strong melting source for full sheet to feed some of our finishing operations in China. So therefore the main piece that we'll see will be on that part of the plans, which is where we finish the glass, cut it into the right sizes. So that's where we'll primarily see that. We've made those adjustments. We have to continue to work our way through just sort of what the appropriate way is to work our way through all the workforce implications. And we're continuing to do that. But remember, so much of our higher cost capacity in display, we have evolved to play into our Gorilla plays. And in Korea as well, we've taken a hunk of their panel making production and instead put that into Gorilla. So this is all playing out on our long-term planning. It's just it's happening in a little more accelerated fashion,

Wamsi. Okay. Thank you, Wendell. And just as a follow-up, you know, there was obviously a meaningful step down here in your CAPEX plans for this year. How should we think about sort of the next couple of years given what we know about the demand environment here? Is this sort of a level that we should expect that we can sustain over a couple of year timeframe? Or is this something that, you know, given the market conditions and given sort of the, you know, more elevated CAPEX levels over the last couple of years that this is sort of more of a one-time? How should we think about this CAPEX levels over the next few years? Thank you.

Well, Wamsi, as you know, our CAPEX is really kind of divided into two different pieces. One is what it takes to kind of sustain and continue to improve our businesses. And then the second is what it takes to build and grow the businesses, especially as we get new customer demand. And so what's always going to matter in the longer term is, you know, how much additional customer demand and commitments do we get? And what is that going to drive as far as capital spending? Now, of course, you know, once we start those projects, it takes a couple of years for the, you know, for both the sales and the revenues to show up. And, you know, if you think back on to IR day, I think Jeff did a good description of that. But I think as, you know, as we look at in 2020, there are, you know, certain projects that we're finishing up with customer demand that will drive growth in 2021 and 2022. And, you know, exactly what we'll spend in 2021 and 2022 will just depend on how our innovations continue to evolve and how much customer commitment we get there. So, you know, overall, we said we'd spend six to eight billion dollars. And I think these numbers are really consistent with that.

I think the way to think about the timing is we've got now sort of the bulk of the investment that we need to deliver the revenue and earnings growth that we laid out on our strategy and growth framework.

Okay. Thank you for the context. That's helpful. Okay.

And the only thing that now we turn to is what happens in the period after that? And then how much strong demand will we see then? And then we'll just have to start early because it takes a while to build those facilities. So that's a little bit far out in the future for us to be able to dial up exactly. And as we get closer to it, we'll be a lot more clear with you,

sir. Okay. Great. Thank you.

Our next question will come from the line of Mata Marshall, Morgan Stanley. Please go ahead.

Great. Thanks. I wanted to dig a little bit into kind of the growth and specialty materials next year and just, you know, it seems as if just get a sense of how much of that is just from newer generations of Gorilla Glass versus kind of new use cases. And then maybe second, just a little bit of a description of kind of what, you know, what is the difference between core and non-core growth margins kind of backing out one-time effects that impacted in Q4 and just how that carries forward to Q1 would be helpful. Thank you.

Well, why don't I start with that? I think that there's, as we do the various restructuring actions, some of that shows up into the gross margin. And since that isn't part of our ongoing operations, you know, that ends up in our gap results, but not in our core results. You know, we did a number of things during the quarter, in particular in optical communications and in our display business. And, you know, those are one-time charges. And that's where you see that.

And in specialty, the bulk of our financial drivers are the new generations of glass. But we will also see some revenue growth out of our new innovation sets that are non-glass, especially our group of very durable optical treatments. And that has a little bit lower gross margin percent than glass. But clearly this next year we're counting on our glass innovations to get adopted and that providing strong growth in an overall unit growth market, which we are not anticipating to grow strongly.

Got it. Thank you.

Our next question will come from the line of Sameek Chatterjee, JP Morgan. Please go ahead.

Hi. Thanks for taking the question. If I can just start off on environmental technologies and kind of the, if you can talk to the, what you're expecting, what's the driver for the moderation and growth that you're expecting from the teens growth rate you had this year in 2019 to more of a mid-single digit in 2020? Is that kind of content moderation on automotive or is that more driven by the diesel segment, which obviously has a more challenging outlook, I believe?

It is mostly driven by the change in the diesel segment. GPF, we feel, continues to be very strong. And we expect sales to be up $100 million in 2020. They were up more than that in 2019. But, you know, we're well on our way to the half a billion dollar goal that we set out for this business where we are clearly the market leader and continue to have great success.

Okay. Thank you. In the diesel segment, you're going to see us, because you're going to see the North American heavy duty diesel market, as you'll see from talking to our customers, that we expected to go through a down cycle here. But we're replacing that with our gains as the Chinese adopt some of our new tech and their diesel market. So that's why it's sort of moderating.

Tony, if you can quickly clarify what's driving the confidence in improving cash flow in 2020 versus 2019 when the outlook on the profitability or profit side seems to be more kind of flagged down more modestly?

So there's a couple of things there. I mean, I think the first thing is that in 2019 we built a lot of working capital. Now, you know, we always build inventory and working capital as we expect businesses to grow. But obviously, you know, compared to the first part of the year, our businesses didn't grow as much. So there's, you know, we wouldn't be growing as much working capital in 2020 as we did in 2019. And then the second thing is in the back half of the year we do expect to see growth on a -over-year basis. And I think that will help us from a cash flow standpoint. And then, of course, finally, we are going to also reduce our capital spending compared to what we spent in 2019. So from an overall standpoint, you know, we expect our free cash flow to be much greater than it was this year.

Thank you. Thanks for taking the questions.

And once again, if you have a question, please press 1-0. Our next question will come from the line of Stephen Fox of Cross Research. Please go ahead.

Hi. Good morning. I had a couple questions on Optical, actually. First of all, I was curious on your view on just the industry supply situation. My understanding is that there's quite a bit of excess capacity in China for fiber and cable. I understand it can't all move seamlessly across the globe, but it seems to be making its way into Europe. Are you guys factoring in any of that excess supply into your model? Should we be concerned about pricing pressure risks as the year goes on? And then I have a follow-up.

I think on that one, Steve, you're seeing that the extent that it's going to impact us is already in our financials. The actual level of excess inventory in China has been trending down. There is still some to come. I think how rapidly the Chinese market tightens up will depend a lot on this upcoming tender that we'll see out of China Mobile. We anticipate that as part of this, they will lay forward a little more clearly what their 5G plans are. And therefore, what they'll need to densify that network. If that comes out with a very aggressive set of 5G builds, then the China market itself will tighten up very significantly. If it's not quite as aggressive, we'll just have a little bit longer tail. Do you think we've got the bulk of that in these numbers,

sir? Okay. That's very helpful. Thanks for that. And then just in terms of the optical margins, I guess the rough math is you did about 9% pre-tax margins this quarter, which is about half of what you were doing a few quarters ago. So I guess maybe just – I think I understand the walk from 18 to 9, but if there's anything you want to point out there. But more importantly, when you get to the second half of the year, if you're executing or demand is where you think it's going to be, are the 18% margins reasonable or should we think about that as taking a little longer to come back? Thanks.

No, I think from an overall standpoint, our margins in this business and its display are all about volume. And we had significant decline in volume in the back half of last year, 16% on a -over-year basis. And that really impacts our factory utilizations and the like, and that clearly causes our margins to go down. And we do expect to return to growth in the back half of 2020. And when that happens, we get both the benefit of that volume, but of course we've also done some cost reductions during that period of time. So we expect from an overall company standpoint, we'd get back to the 40% gross margins. And both optical and display would also get back to where they were before.

Great. Very helpful. Thank you.

Our next question will come from the line of Asia Merchant of Citigroup. Please go ahead.

Oh, great. Thank you for taking my questions. A lot of them have been answered. But just had a quick question on specialty materials, knowing that this primarily goes into a lot of smartphones. We're starting to see smartphones inflect to growth this year, calendar 20 driven by 5G models, etc. The growth rates that you talked about, should we expect some inflection there? I think you're guiding for growth rates to be similar to what it was this year, given there was a slightly down market for smartphones. Thank you.

Yeah, I think from an overall standpoint, clearly if smartphones started to grow, that would certainly impact our business. But what really has made the difference from our business standpoint is the content that we provide on those smartphones. As Wendell said, we've grown 40% over four years, grown every single year the last four years, even though the number of smartphone units have been down in most of those years. So yes, I think as you get more smartphones, that might put us at the higher end of the high single digits. But what really matters there is our premium glass strategy and some of our other innovations, and that's what's really driving our growth.

And so should we expect that 5G phones would have higher content? I think you guys have talked a lot about higher content in other consumer electronics as well. So if you could just maybe talk a little bit about that. And then just on margin, sorry to keep talking about that, the 40%, inflecting to 40%, is that something we expect in the third quarter, third calendar quarter, is it more towards the fourth quarter? It really depends on how quickly, or is it just simply a matter of that 5% to 10% range that you talked about within the optical segment? Thank you.

Let me start with the 5G phone, and then I'll turn it over to Tony on the profitability. So yes, I think your hypothesis on 5G using more of our content is true. We don't anticipate that 5G becomes a very large segment in smartphones here in this coming year. But you are right. It has more of our content. It tends to be their most premium phones, which use our very best glass. And because of the nature of what it takes to deliver 5G, you have an increase in the need for RF transparency, which tends to increase the amount of glass required on those phones. I have sort of a question back for you. We would be very interested if you are now predicting a positive inflection point in smartphone unit sales. We currently aren't counting on that, so if you have any insight into that, that would be helpful to us. And

then on margins, you are absolutely right. I think what requires for the margins to get back to the 40% is the volume increase that we expect in the back half of the year. And exactly where that ends up in the timing of that volume increase is what is going to drive us back to 40%. In the back half of the year, we should be back at the 40% number.

Great. Thank you.

Operator Roy, we have time for one more question.

And that question will come from the line of Tim Long of Barclays. Please go ahead.

Thank you. Let me just squeeze two quick ones in if I could. I just wanted to go back to the GPF market. You highlighted better than expected results in 2019 and 100 million additional next year. Just talk a little bit about what you think drove the outperformance feed this year. Do you think it was better share? Were there any advanced sales into the China market? What specifically drove that and the help in the trajectory next year? And then on the AutoGlass side, can you just give us an update on timing there? It sounds like still a lot of wins, but when can we start to see more meaningful contribution there? Thank you.

So on the GPF side, our product strength, the relative advantages of our product led to us winning more than we originally planned. So that is one driver. The other is that with the move to real world driving, the automotive companies are envisioning perhaps use of GPF and even some more advanced GPF technologies on more and more of their vehicle platforms. So that's more of a longer term piece. I think pretty much everything that we've learned so far has been positive about our relative position in GPF and the need for this technology to help clean up cars even further, especially in a city environment.

And then on the AutoGlass piece, clearly we're winning these awards and our factory is ramping. So we will see some increased sales this year, but as you know, the automotive market and the supply chain takes longer than say the mobile consumer electronic supply chain. So the bigger impact of that will be in 2021, but we will see some increases as we go through each quarter this year.

Yes, and then after we break through that sort of $100 million revenue run rate level, our analytics will be able to click in and be a lot more helpful to you and us in being able to guide the trajectory going forward. We just need a little more data and we need to get implanted in a few more places. Let's break through that run rate and then we should be able to be a little more accurate for you,

sir. Okay. Thank you very much.

Thanks. All right. Thank you everybody for joining us today. Before we close, I wanted to let you all know that we're going to be at the Goldman Sachs Technology and Internet Conference on February 11, Mobile World Congress on the 26th of February, and at the Susquehanna Technology Conference on March 12. So once again, thanks for joining us. Steve, you can please disconnect all lines.