康寧 (GLW) 2017 Q3 法說會逐字稿

Welcome to the Corning Incorporated Third Quarter 2017 Earnings Results.

It is my pleasure to turn the call over to Ann Nicholson, Division Vice President of Investor Relations.

Thank you, Greg, and good morning.

Welcome to Corning's third 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.

They'll 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 another excellent quarter.

Sales and EPS exceeded expectations, and progress on our growth initiatives continues to be outstanding.

Third quarter sales increased 6% year-over-year.

Sales in all of our business segments exceeded our expectations, highlighted by 15% year-over-year sales growth in Optical Communications and 26% growth in Specialty Materials.

Looking ahead, we expect to maintain this momentum and fully achieve our Strategy and Capital Allocation Framework goals.

As we have shared, the framework outlines our leadership priorities as we continue to focus our portfolio and utilize our financial strength to extend our leadership, drive our growth and reward our shareholders.

Under the framework, we target generating $26 billion to $30 billion in cash through 2019.

We are returning more than $12.5 billion to our shareholders through repurchases and dividends.

And we are investing $10 billion to sustain our leadership and deliver growth.

We've made outstanding progress against those goals since the framework was announced in October of 2015.

Our cash generation is on target.

And we have returned $8.5 billion through share repurchases and dividends.

Repurchases have reduced outstanding shares by about 29%.

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% annually in 2018 and, again, in 2019.

In addition to articulating our capital allocation goals, the framework outlines how we utilize our focused and cohesive portfolio to generate value for our shareholders and to delight our customers.

We are best in the world in 3 core technologies, 4 manufacturing and engineering platforms and 5 market access platforms.

We focus 80% of our resources on opportunities that use capabilities in at least 2 of these 3 categories.

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.

To advance our innovation initiatives, strengthen our product leadership in low-cost positions and ultimately, outperform our competitors, we are investing in research and development, enhancing our manufacturing capabilities and making bolt-on acquisitions.

Our growth investment since the introduction of the framework have been consistent with program needs.

Our progress has been terrific, and multiple projects are moving into the next phase of development.

So we've begun to accelerate investment in line with our 4-year plan to invest $10 billion.

And you can see the impact of these investments in our financial statements.

Tony is going to talk more about the investments.

But first let me review the progress, starting with Optical Communications.

We celebrated our major milestone in September.

We produced our 1 billionth kilometer of fiber.

That's 1/3 of the optical fiber ever produced in the history of the world.

It's also enough to go to the sun and back 3.5x.

But think about it this way.

It takes light about 1/10 of a second to go around the circumference of the earth.

It takes light 56 minutes to go 1 billion kilometers.

The milestone is a terrific measure of the success we have had over 40 years in leveraging our core technologies and manufacturing and engineering platforms.

Our dedicated employees have helped us become the world's largest manufacturer of optical fiber, the world's lowest-cost provider, and the home to some of the most precise manufacturing operations of any kind, anywhere in the world.

As a result, we're the world leader in Optical Communications and the only true end-to-end supplier of optical solutions.

We believe that the opportunities ahead of us are much greater than those that are behind us.

To capture these opportunities, we're investing to expand capacity, to innovate and to increase our market access.

Corning's unique co-innovation approach and technical capabilities position us to continue delighting our customers to distinctive innovation and manufacturing leadership.

These investments are paying off.

We are growing at more than twice the rate of the telecommunications industry with global leaders like Verizon turning to us in support of their vision.

We're well on our way to more than 15% sales growth for 2017, which keeps us on track to achieve $5 billion in optical sales by 2020.

Our mobile consumer electronics platform is much younger than our Optical Communications platform, but it also reached an important milestone this year.

The 10th anniversary of Corning Gorilla Glass.

Over the decade, we innovated to make Gorilla thinner, tougher and more damage-resistant than ever, with Gorilla Glass 5 showing dramatically improved drop performance over alternatives.

We've developed specialized processes to reduce glare, improve the aesthetics and enhance scratch resistance.

Today, Gorilla Glass is seeing broader adoption than ever before.

Over the past few months, leading smartphone manufacturers adopted our glass on their new devices.

Advanced glass offers several benefits over other materials like metal or plastic.

Along with improved wireless charging, advanced glass on the back also enables improved reception.

It allows for new levels of design and customization.

We're also realizing more value to our device through our innovations.

For example, Acer's new wearable, Leap Ware, is using Gorilla Glass SR+, our scratch-resistant glass composite.

And we continue to see increased sales of Vibrant, our photo-realistic parts on notebooks and computers, with growing interest in the handheld space.

Wal-Mart recently introduced a new line of screen protectors under the name BLACKWEB, which uses our accessory glass.

And we continue to win at smartphone OEMs in emerging regions, including new devices at Positivo in Brazil, Lava in India and Polytron in Indonesia.

For the first 9 months of 2017, Specialty Materials segment sales grew 28% over last year, which clearly illustrates the power of our approach.

Our close customer relationships enable us to innovate jointly.

And we're on track to double sales in mobile consumer electronics over the next several years.

In our automotive market access platform, we're helping customers build cleaner, safer and more connected vehicles.

The gas particulate filter business is starting right now.

As the year began, we needed to win platforms, and we were waiting for regulations to be fully adopted.

Let's fast forward to today.

European regulations are in place with China expected to follow soon.

Most European and many Chinese OEMs have now declared platform awards and we won the majority.

In the third quarter, we had our first commercial sales, and we expect sales to ramp going forward.

The exclusive global supply agreement we announced in August for Groupe PSA's PureTech engine platform is a great example of our success.

PureTech engines power Groupe PSA's latest models in its Peugeot and Citroën brands.

All PureTech gasoline-direct-injection engine models in Europe and in China will be equipped with Corning GPFs beginning this month.

And we continue collaborating with OEMs globally on Gorilla Glass for auto.

We're making solid progress with Gorilla Glass on more than 25 auto platforms globally.

On the exteriors of cars, Gorilla Glass laminates are lighter and tougher than conventional auto glass, plus its superior optical quality allows larger, clearer head-up displays.

For interiors, Gorilla Glass makes cars more connected and durable with sophisticated capabilities you come to expect from your smartphones.

The Renault SYMBIOZ concept car unveiled at the Frankfurt Motor Show in September demonstrates this value proposition.

The SYMBIOZ reimagines the car as an interactive personal space.

At home, the car is designed in electric power system making another room.

On the road, [fuel] economy allows passengers to relax or focus on activities other than driving.

Everywhere Corning Gorilla Glass for auto interiors provides access to the digital world.

In our life sciences vessels platform, we're building a long-term multibillion-dollar franchise.

In our joint announcement with Merck and Pfizer in July, we unveiled Corning Valor Glass, a revolutionary breakthrough in pharmaceutical glass packaging.

It helps protect patients and improve pharmaceutical manufacturing by dramatically reducing particle contamination, breaks and cracks, while significantly increasing throughput.

Valor results from a combination of capabilities unique to Corning and demonstrates our focus and cohesive portfolio in action.

Although this industry moves at a deliberate pace, we believe Valor has the potential to power Corning's growth to the next decade and beyond.

The industry is excited about our innovation and announcement, and we continue to make strong progress.

We're also in the process of finalizing plans for manufacturing capacity, and we'll be announcing more details in the coming months.

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 years.

We continue to believe that Valor is an outstanding opportunity.

In display, our priority is to maintain stable returns and win in new display categories.

Our strategy focuses on lowest-cost manufacturing, stable share and supply-demand balance.

The benefits of this strategy continue to be encouraging.

We are the lowest-cost producer by a wide margin.

And our pricing has become consistently more favorable over the past 3 years.

And our new plant in Hefei, China, is on schedule to start shipping the world's first Gen 10.5 glass, another demonstration of our market leadership.

So that's the summary of progress across the company.

We're very happy with how 2017 is playing out.

We're outperforming on sales, seeing the first returns on near-term growth investment and making great progress on our longer-term growth initiatives.

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

Thank you, Wendell, and good morning.

As I reflect on our performance year-to-date and our expectations for the fourth quarter, every segment is meeting or beating the plan we set in January.

We have strong operating performance, and our innovation pipeline continues to achieve milestones and deliver the tangible proof points.

We have accelerated our growth investments accordingly and remain on track to deliver our framework goals.

Third quarter results reflect the strong performance, and our fourth quarter guidance incorporates our expectations for continued strength.

Let's start with GAAP and its impact on our hedge contract accounting.

GAAP accounting requires earnings translation hedge contracts settling in future periods to be mark-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 the third quarter, the Yen was relatively stable and the value of our hedge contracts was relatively unchanged.

This resulted in an after-tax GAAP loss of $15 million when we mark 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 $1.6 billion under our hedge contracts.

These proceeds offset much of the Yen-related fluctuations in Display's earnings.

Hedging our earnings and cash flow through 2022 provides higher certainty for our growth investments and future shareholder distributions.

For information on the mechanics of these contracts, please refer to the tutorial on FX hedge accounting on the Digital Media Disclosure section of our Investor Relations website.

And as always, Ann and her team are available after the call.

Third quarter sales rose 6% year-over-year.

Core earnings were $433 million and EPS was $0.43, up 2%.

Third quarter growth highlights include 15% year-over-year growth in Optical Communications, 26% year-over-year growth in Specialty Materials and the first commercial sales of gas particulate filters.

The third quarter gross margin was 42% of sales with gross margin dollars up 3% versus last year.

SG&A was 14% of sales at $372 million and RD&E was 8% of sales at $213 million.

As we expected, investing in the growth opportunities that Wendell described is beginning to impact gross margin, SG&A and RD&E.

Our growth investments include capacity expansions for Optical Communications, our Gen 10.5 Hefei plant and gas particulate filters plus development for Gorilla Glass, Valor and a few other projects we're not quite ready to dive into publicly.

These along with higher tax rate are the primary reason our sales grew more rapidly than EPS.

Turning to the balance sheet.

We ended the quarter with $3.9 billion of cash, approximately 16% of which is in the U.S. Adjusted operating cash flow for the quarter was $765 million and keeps us on track to meet the goals of our 4-year capital allocation plan.

Now let's look at detail segment results and outlook beginning with Display Technologies.

Sales were $860 million and core earnings were $227 million.

Our Q3 volume was up mid-single digits sequentially, exceeding our July guidance.

Sequential LCD glass price changes were similar to last quarter and consistent with our expectations for a more favorable environment.

In addition, costs were up slightly sequentially in the quarter.

First because of the investment in the startup of our Gen 10.5 facility in Hefei.

And second, we're running a handful of tanks outside their optimal range for a few quarters to meet strong demand for our fusion assets across the company.

As a reminder, we use our fusion assets for display glass, Gorilla, Iris and automotive, so when aggregate demand is high, we have less flexibility to optimize our tank fleet.

For the fourth quarter, we expect the LCD glass market and Corning volume to be consistent with Q3.

Sequential glass price decline should remain moderate and similar to the third quarter sequential decline.

And for the reasons I just noted, we expect fourth quarter cost to be similar to Q3.

For the full year, we continue to expect that the retail market, as measured in square feet of glass, will be up mid-single digits, driven by increasing screen size.

We expect our glass demand will also be at mid-single digits in line with the overall market.

And we continue to see progress towards a more favorable pricing environment.

Our price declines in 2015 were smaller than in 2014.

And in 2016, they improved further.

This pattern is continuing this year.

For example, year-over-year price declines in the second half are on track to be less than 10%.

So we've entered single-digit year-on-year decline territory.

We expect this to continue and pricing to improve over time.

Three factors drive our view of the more favorable pricing: First, we expect glass supply to be balanced or even tight.

We will align our capacity to our demand, even as we ramp up new capacity.

Publicly available information indicates competitors are aligning their capacity to their demand.

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 investment in current and new capacity.

To generate acceptable returns on new investments, glass pricing will need to improve even further.

In summary, we remain very pleased with the current dynamics on our Display business and our progress in maintaining stable returns.

Let's move to Optical Communications where we had a very strong quarter.

Third quarter sales were up 15% and core earnings up 13% year-over-year.

Sales grew in both our enterprise and carrier businesses, with especially strong demand for our carrier products.

Capacity expansions and other growth investments account for the difference between sales and profit growth.

Without these investments, earnings would have grown much faster than sales.

Our growth stands out as we look across the telecom industry.

Our outstanding performance results from our choice to focus our portfolio on passive optical solutions that are replacing legacy copper, an incremental growth as we deliver unique solutions for next-generation networks.

We expect fourth quarter sales to be up high single digits over last year, and we're increasing our view of full-year sales growth to more than 15%.

We're on track to achieve our $5 billion annual sales goal for Optical Communications by 2020.

Turning to our environmental business.

Third quarter sales were $277 million, up 5% year-over-year.

Notably, these include our first commercial GPF sales.

Core earnings were $34 million consistent with last year.

Investments in our new gas particulate filter business partially offset the benefits of increasing sales.

Third quarter year-over-year automotive sales were driven by worldwide market growth and from share gains.

As anticipated, the North America heavy-duty diesel market returned to year-over-year growth and is showing signs of a steady upturn.

Our new gas particulate filter business delivered its first commercial sales as the first phase of Euro 6 regulations went into effect.

We also delivered additional platform wins in the quarter, extending our majority position of platforms awarded to date.

Once regulations are fully implemented in Europe next year, and China in early 2020, we estimate the GPF opportunity will exceed $0.5 billion of annual sales for Corning and offer margins and ROIC similar to our existing businesses.

In total for the fourth quarter, we expect low teens year-over-year sales growth, driven by improvement in heavy-duty diesel and the successful launch of GPFs.

So for the full year, we now expect the environmental sales to be up mid-single digits over last year.

Let's move to Specialty Materials, where third quarter sales rose 26% over last year and core earnings were up 61% year-over-year.

Both were ahead of our expectations, driven by strong shipments of Gorilla Glass and support at new phone launches.

We're clearly seeing the financial benefits of our focused and cohesive portfolio.

Overall, we're thrilled with our performance in Specialty Materials and expect sales in the fourth quarter to be up low to mid-teens over a very strong 2016 fourth quarter.

As Wendell covered, we expect strong demand to continue as we make progress in all 3 of our approaches to grow sales.

At the beginning of the year, we said we will grow in 2017.

Exactly how much will depend on the timing and extent of customers adopting our innovations.

We can now say the extent and timing has been outstanding, and we expect 2017 sales growth to exceed 20%.

We are well on our way to our goal of doubling sales for mobile consumer electronics over the next several years.

In life sciences, third quarter sales were $223 million and core earnings were $21 million.

For the fourth quarter, we expect mid-single-digit sales growth year-over-year.

As a reminder, our new pharmaceutical packaging business continues to be reported in our other reporting segment, along with other new product lines and 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 fourth quarter, we expect gross margin as a percentage sale to be consistent with the third quarter or about 42%.

As I said earlier, our growth investments are also affecting our operating expenses.

SG&A and RD&E should be a bit above 14% and 8% of sales, respectively.

We expect other income, other expense to be a net of expense of approximately $45 million to $55 million.

And fourth quarter total gross equity earnings are expected to be approximately $110 million to $120 million, predominantly from Hemlock Semiconductor, implying full year growth equity earnings to be in the $200 million to $210 million range.

This is higher than we expected, driven by slightly higher volume and better business performance at Hemlock.

We expect our effective tax rate for the fourth quarter to be approximately 19%, and for the full year 2017, to be approximately 18.5%.

Our U.S. income is up from 2016, which raises our effective tax rate.

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 third quarter, we have returned $8.5 billion.

In the third quarter, we returned $1.1 billion, bringing the year-to-date total to $2.5 billion.

As you may recall, in February, the board increased the cash dividend per share by 14.8%.

Let me close by saying that we are very pleased with our continued positive momentum.

We're focused on closing out a very strong 2017 and keeping that momentum heading into next year.

We remain on track to deliver the overall goals of our Strategy and Capital Allocation Framework and are excited about the rich set of opportunities ahead of us.

With that let's move to Q&A.

Ann?

Thank you, Tony.

Hey, Greg, we can open the line for questions.

(Operator Instructions) Your first question comes from the line of Vijay Bhagavath with Deutsche Bank.

It will be helpful to get color, Wendell, Tony, from -- in terms of order strength, in the optical fiber business, that I'm coming from is, is the demand primarily driven at hyperscale clouds?

And are you seeing any timing delays at any of the major service providers for fiber-to-the-home or metro optical buildouts?

We're seeing very -- thanks, Vijay.

We're seeing really very, very strong demand.

And we're feeling the most strength out of our carrier business.

And we're also seeing good strength in enterprise.

We're really tight, which is why you heard from Tony about our investments in capacity.

We expect that tightness to continue for the foreseeable future until we are able to get that capacity up and running.

So right now, the market seems very, very strong to us.

Your next question comes from the line of Joseph Wolf from Barclays.

I had a question about the Gorilla Glass business.

And just if you can give us a little bit more detail about the mix.

If we look at the growth of new customers, adoption rates for the first time, which you talked about in a couple of countries, the mix of versions 3, 4 and 5 and how good 5 -- how well 5 is doing right now?

And then how much of the growth that you're seeing is coming from the double-sided opportunity?

And how widespread you think that will go down the cost curve of the handset vendors?

So we cannot break out our mix by generation.

So let me try to be responsive to your question, Joseph.

We -- the GG5 is the most successful Gorilla Glass launch we've had since the beginning.

It is exceeding our expectations in terms of penetration, and we expect that to continue.

Its performance is much, much better than any of the alternatives.

And that performance is what is leading to not only its rapid adoption versus GG4 and GG3, but also putting glass in new places like the back of the phone.

We still have a lot more innovation to do to solve the core problem, which is to develop a transparent material that when you drop your phone, it doesn't break, no matter what innovative new way you have found to drop your phone.

And we have many generations ahead of us, but what you see in the financial performance and why you're seeing that really strong income performance together with the sales performance is the increased richness of GG5 and its very rapid adoption.

I think it's too early yet to opine on how rapidly the glass -- total glass enclosure penetration will grow.

It's obviously off to an encouraging start, which you can tell from watching the news.

I think in the end, it will depend on how much we can continue to improve the glass to make sure that the customers' ultimate experience of this product has all the great benefits of glass; wireless charging, improved perceptions, improved aesthetics, but at the same time to have the type of durability you'd see from more opaque materials.

Was that responsive, Joseph?

Does that get to what you want to, sir?

Yes, it's gone in the right direction.

Can I -- just a follow-up related to the investment.

On the capital allocation plan, the pace on the cash giveback is, if you take it just a -- if you straight-line the 4 or 5 -- 4-year plan, it will be ahead of plan.

If you think about the $10 billion in investment and Tony went through a couple of areas where the investment is going, but how do we think about that $10 billion in terms of the pace up till the 2019 plan and where you are in dollar wise?

Sure.

I think as you think going forward, as we continue to have greater success, we will increase that investment.

If you think about capital spending, for example, in the first year, we just spent $1.2 billion.

We're going to spend more than $1.5 billion this year because of the success that we are having with the capacity expansions that are required right now.

I think the second thing to keep in mind is that from an RD&E standpoint, we're consistently investing there, but there will be opportunities to continue to grow that a little bit as we continue to have success.

The other thing to remember is that, that is no more than 10% from a growth standpoint, some of that comes from M&A.

And that M&A depends on just when those opportunities actually make themselves available.

But clearly, we spent in the first half a little bit less than what you would expect.

And so likely we'll spend a little bit more in the second half of the 4-year plan, mostly as long as those opportunities are there, it makes a lot of sense to invest in them.

Yes.

I think stepping back from this, the key thing to keep an eye on is, we don't expect to invest more than $10 billion, [moving to] $10 billion in the capital allocation and when we put it together, we had all these things in mind.

Now it is true that the exact timing of the different innovations and the exact timing of when you need capacity is really hard to call within any given 6-month time period.

But also, I think, we plan -- we're going to invest $10 billion.

We don't see the need to invest more.

And how the timing works out, it's going to follow the flow of programs and probably, its predictability isn't worth spending a ton of time on, because the total capital allocation flow is going to be what we described.

Your next question comes from the line of Mehdi Hosseini from SIG.

Two follow-up.

Historically, panel prices have correlated very closely to Corning's Display revenue.

But this time is different, especially, you've done relatively well compared to panel price decline.

Other than competitors, balance sheet that constrained, what else is out there that makes historical correlation no longer valid?

And then I have a follow-up with -- for Tony.

Can you just remind me of the capital -- of the overall capital return program budget of $2.5 billion?

Where are you now?

Can you give us an update on how much accumulatively you have already spent?

Yes, so let me start with the panel price question.

We've laid out over the last 3 years, we've been on a favorable trend relative to pricing.

And we just reported that we've entered a period of single-digit decline territory, and we expect this to continue.

And if you think about over the last 3 years, pricing has improved every single year despite what's happening from panel price, whether panel price is increasing or the panel prices are decreasing, we're seeing that pricing environment from a glass standpoint to improve.

And the reason we think that's the case is driven by the factors we laid out in the past, glass supply-demand, which we expect to remain balanced or even tight, our competitor profitability, and then finally, the need for glass makers to generate acceptable returns on manufacturing investments.

And so those are the reasons that we think on a going forward basis, we're going to continue to see the more moderate glass pricing as we go forward.

In terms of the capital allocation plan, what we had said all along that we would return more than $12.5 billion over the 4-year period and what we returned through the end of this quarter was about $8.5 billion of that.

Would that -- does that suggest that you would end up increasing, given the pace that you're returning the cash to investors?

Or would you hit that $12.5 billion sooner than later?

I think that -- we've always said it's greater than $12.5 billion.

And certainly, at the pace we've been at, I suspect that we will hit it sooner than later.

But the reason that we've been going at the pace we have is that we don't believe that investors really have all the growth prospects in our stock, and we found very opportunistic to be able to do share buybacks.

And in fact, of the share buybacks we've done, the average price have been a little over $22 and we feel pretty good about that.

Your next question comes from the line of Patrick Newton from Stifel.

Wendell and Tony, I guess, first I wanted to focus on Gorilla Glass.

Clearly seeing some improved demand trends there, from new launches and also glass on both sides of multiple products from multiple OEMs.

I guess, my question is, how comfortable are you with the current supply-demand dynamics for Gorilla Glass given the product has a history of having unexpected supply swings on one side and then there is also some well-documented manufacturing challenges associated with a large new customer product ramp?

So Patrick, I think, you're right to note that the exact predictability of the mobile consumer electronics supply chain can be problematic.

Now given that, when we -- we sort of express the way, we're feeling right now and how we're experiencing that supply chain, right now, we continue to see very, very strong pull as we look forward through this quarter.

So that's the way we're experiencing it.

We are not experiencing a slowdown.

And you see that in our own way in which we're operating our tank fleets, right, we're actually having to run a little bit longer than maybe would have liked and a little bit less than on an optimum utilization base and it's really because of that strength.

It doesn't mean that all of a sudden the supply chain in mobile consumer electronics has become highly predictable.

It has not, but this is -- I hope it helps that you get a sense to how we're experiencing at least our piece of that supply chain at this time.

That's helpful.

I guess, Tony, I wanted to shift to a question on your margin profile, great results, great guidance, especially, on the topline side.

But if I wanted to nitpick on something, it'd be on the gross margin, which was a little bit disappointing.

I'm curious if we take an intermediate term view, how should investors over the next several years think about the balance of accelerating growth from optical, environmental, life sciences, et cetera, which I believe are margin dilutive relative to a Display business, which should decline as a percentage of revenue.

So I guess is it reasonable to think that gross margin is relatively sticky around current levels, while op margin could see some pressure in the near term from both mix and investments, but then an eventual expansion from the scale?

Yes, I think the issue always with our gross margin is -- this is to your point, it really is a mix of our different businesses, and how they are going to grow and contribute is hard to know for certainty.

We see a lot of growth that's going on right now.

In our Optical Communications, a lot of that growth and you're right, that's a little bit below the corporate average.

On the other hand, Specialty Materials is above the corporate average.

The way that we always look at it is how is each of those businesses performing relative to their competition.

Are they the low-cost producer?

Are they doing better than the competition?

And that's clearly what's happening.

I think from a near-term standpoint, still our gross margin was 42%, a little bit less than it was in Q2.

But our cost -- that really driven by our cost in Display being up slightly sequentially.

They were down on a year-over-year basis.

That was a combination of the startup of our Gen 10.5 factory and then as I mentioned we're running a handful of tanks outside of our optimal range for the quarter.

But I think it's important to note that even though our gross margin percent was impacted, because we got more sales in Display and Gorilla than we expected, we did make more money.

So while it was a little bit less on the percentage, it was better on the bottom line, and that's, of course, what we always consider to be the most important thing.

I think that we think about gross margin long term, if that's your core question.

Because I think in the medium term, in the near term, I think, Tony is right on that, a, what we're trying to do is just make more money for our shareholders.

And we pay a lot more attention to that, and to win in all of the various markets.

And so then that becomes really a mix question.

But if you think longer term, our businesses that are capital intense are we're going to generate extremely high gross margins on.

And some of the business we talked about mix being a little bit less gross margin percent, right, like [Oppo] tend to be a lot more capital light.

And so what's really driving us is how do we generate that really powerful return on invested capital.

The capital that we deploy in the certain businesses where to generate that gross margin percent must be very, very high, right.

And as for other businesses that are relatively asset light, that we'll tend to have a little less gross margin percent, but a lot faster turn, and so as we work our way through that, I think as you think long term about the business, we're still going to be pretty capital intense.

So you should expect us to have pretty sticky gross margins, sort of in the very high level relative to other companies, that in combination with being the lowest-cost producer in the world certainly helps.

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

Wendell, Tony, you've done a great job at capital return here, and you address sort of you're 2/3 of the way already to your $12.5 billion plus target.

Can you maybe address what sort of levers you have to drive that $12.5 billion higher over the next couple of years?

Is it capital, is there other -- is there business strength that's going to drive that?

Do you think that there is potentially other portfolio changes that are in the works?

And then I have a follow-up.

I think it really comes down to something pretty straightforward, Wamsi, which is that -- in Tony's answer, we said greater than $12.5 billion to start when we put this together.

And really it just comes down to the cash generation, which we are right on target for.

So if we continue to be right on target for cash generation, you can expect it to be above $12.5 billion, right?

And as we do -- we think we can get done what we need to get done to be able to drive growth over the next decade with our $10 billion.

So that's a good way to think about it, if you want to think about it analytically, at such time as we're ready to be able to discuss openly a decision to go to get a little more specific rather than greater than $12.5 billion, we'll make sure to get back to you.

This, of course, is something we have to work through with our Board of Directors.

And I wouldn't expect an announcement relatively rapidly.

We're only part of the way through this.

But this is something that is always top of mind with us.

And you can expect us to give it really crisp and due consideration.

Okay.

I appreciate the color there.

And as my follow-up.

In Gorilla historically, the supply chain has been quite long and ramps for -- to support new product introductions have happened earlier in the year.

Clearly, you guys are seeing some significant uptick, you're running tanks at, lower-than-expected utilization rates, or maybe suboptimally not utilization rates, but that do you -- that would suggest sort of a tighter correlation to product launch timing versus what you're seeing in your Gorilla business?

I'm wondering has something really changed in the Gorilla supply chain that is causing the ramp to happen at a later point?

Or is it just that the volumes that you see may be further out or are quite significant and so you're -- the upside that you're seeing now is addressing sort of future volume pickup, but the supply chain has not really changed?

I think that's a really astute question.

I think we don't have enough data yet to be able to reach a high confidence conclusion.

Very sound question though.

Working on the mobile consumer electronic supply chain, understanding the clarity and correlation between our shipments and new product launch is something that occupies a good amount of our analytics time.

But at this point in time, we just don't have enough data to reach a high confidence call, but great question.

Your next question comes from the line of Steven Fox from Cross Research.

Two questions from me.

First off, when you think about the investments that you've highlighted that maybe you're putting a little bit of a down tick on gross margins.

Can you talk about where you'd see maybe a peak level of investments relative to revenue starting to ramp and absorb some of those investments?

And maybe excluding the Gorilla Glass seasonality from that?

And then secondly, Wendell, you did mention some more momentum around automotive for -- Gorilla Glass for automotive applications.

Is there anything specifically you're thinking about there?

Or is it similar to the progress you've talked about at the meeting in June?

Let me take the investment question first.

Clearly, we've been investing more as the year has gone on this year, and we always factor that into our guidance, both on gross margin and SG&A and OpEx.

And so we've invested a little bit more in Q3 than we did in Q2.

Investments in Q4 are pretty similar to what we did in Q3, maybe a little bit more.

The good news is that, so is the sales growth that's happening there.

What you've [got] is that we're really focused in 3 primary areas from an investment standpoint, that's our Optical Communications map, that's our mobile consumer electronics map, that's our automotive map.

And we think back of the areas where we've seen the growth as those are the 3 areas that we're growing.

So we feel pretty good about the alignment between the investments and when the growth is happening, especially in the near term.

And just the question on auto for -- Gorilla Glass for auto?

Yes, we're seeing really nice momentum.

Now that being said, this is an industry that moves at a very deliberate pace.

So we tend not to try to get overly excited because you win today for revenue, that's in the farther future.

But we're feeling really good and it's interesting.

In any innovation that is pretty disruptive like this one is, then what you tend to try to do is you'll get positive surprises and negative surprises.

And when you get the positive surprises, you start to double down on them.

I'd say we're getting some really nice positive surprises right now, in automotive interiors.

People's vision for what they want to do in the interior of vehicles is quite stirring, and it's driving them very much into the arms of our material setting, our co-innovation approach.

So we're actually been investing an awful lot of time and attention into that, and we're getting really, really nice pull.

So I think that's what you're sort of sensing is the exteriors is going about how we've been anticipate with the normal deliberate pacing, and we're getting really nice positive surprises that we're doubling down on in interiors.

And what's interesting is the type of innovations that they want, a very high revenue generation want because of the value-add they want from us around optics, around shape.

So that revenue opportunities looking very attractive.

Your next question comes from the line of George Notter from Jefferies.

I appreciate it.

I guess I wanted to ask you about the Optical business.

As I go back to the end of Q2, I felt like you guys hesitated a bit in terms of the full year guidance for Optical, and I think, part of the narrative was just around timing of certain customer projects.

Can you talk about what's changed now versus how you saw things coming out of Q2?

Is it -- is it just a customer project or 2?

Is it the Verizon 1 project?

Or is it something more broad-based you're seeing in the industry that's really helping that business?

I'm not so sure there's been a tremendous amount of change since the end of Q2.

I think what we were trying to communicate in Q2, which was -- which we didn't do a good job of because a lot of people thought it was a hesitation, it is just a lumpiness that happens in this business.

And it's just going on a forward basis, there will be a time when this is just going to show up.

And we just wanted to remind investors of that.

We didn't mean to imply that we thought that was going to show up in Q3 or in Q4.

And that's clearly what some investors interpreted it as.

And so -- from an underlying standpoint, as Wendell said, we see strength in carriers, we see strength in the enterprise business.

And from an overall standpoint, we think we're going to be up more than 15%.

So we feel very good about Optical Communications.

Got it.

And then just one last follow-up.

I'd love to ask you about the FX rate, certainly constant currency, I think you guys are talking about adjusting that rate going into 2018.

Can you kind of remind us where you are in that process?

And when you might address that?

I assume you would address it for both the constant currency yuan as well as the yen?

Yes, that is correct.

I mean, as we stand right now, we have about 70% of our yen exposure from 16 to 22 hedged, and the blended rate of that hedge is about 106.

We're obviously fully hedged in '17.

And we're actually pretty high percentage hedged in '18 and '19.

The near-term years, where we have more confidence in those results.

And what we plan to do in the January call is talk about a new core rate.

The core rate today is 99.

We'll make an adjustment, and when we make that adjustment, we'll go back and recast '16 and '17.

So it will be easy to make comparisons between -- based on where the core rate adjustment is.

And so it'll be easy to understand what our underlying business performance is.

Your next question…

We've time for -- sorry, we've time for one more question.

Okay.

That question comes from the line of Rob Cihra from Guggenheim.

I'll sneak in just a quick one.

In Optical, carrier has been the driver, continues to look like the driver, but enterprise has been choppy.

It looks like it actually maybe stabilized a bit after being choppier the last few quarters.

I mean, are there any trends you're seeing there?

I mean, do you think from here -- I mean, looking better or worse, I guess, in enterprise and data center versus last few quarters?

So I think it is great accurate to make the observation that we're adding a lot of strength in carrier and that in enterprise and cloud, the predictability, the consistency of that has been a little bit less than carrier.

That being said, even though the total actual pacing of how that whole market works, that can be little more difficult to predict.

One of the reasons that you see -- what you see in our numbers is growing adoption of more and more of our product set and more and more cloud-based providers.

So I don't know, if you can necessarily look at our revenue alone and then conclude what exactly is going on in the total market.

Because you're having a combination of, yes, some wind in the total, but also we're getting up some more sale area, the people are liking, our customers are liking our product set more and more across a wider footprint.

That makes sense to you, sir?

Great.

Wendell, do you have any closing comments that you'd like to express?

Well, first of all, let me thank everyone for joining us today.

And let me reiterate how pleased we are with our continued positive momentum.

Our focus is on closing out 2017 strong and then keeping that momentum headed into next year.

As we've said, we're on track to deliver the overall goals of our Strategy and Capital Allocation Framework.

And we're excited about the rich set of opportunities ahead of us, and we look forward to staying in touch.

Great.

I want to thank you too for joining us today.

And before we close, let you know that we will be meeting with investors at the Crédit Suisse Conference in late November.

And that a web replay of today's call will be available on our site for 1 year starting later this morning.

There's also a telephone replay available for the next 2 weeks with details in today's news release.

Once again, thank you for joining us.

Greg, that concludes our call.

Please disconnect all lines.

Thank you.

Ladies and gentlemen, that does conclude your conference for today.

Thank you for your participation and for using AT&T Executive Teleconference.

You may now disconnect.