Corning Inc. (GLW) Management Presents at Deutsche Bank Technology Conference (Transcript)

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About: Corning Inc. (GLW)
by: SA Transcripts

Corning Inc. (NYSE:GLW) Deutsche Bank Technology Conference Call September 12, 2018 12:00 PM ET

Executives

Tony Tripeny - Chief Financial Officer

Analysts

Vijay Bhagavath - Deutsche Bank

Vijay Bhagavath

Good morning, everybody. Welcome to the Deutsche Bank Tech Conference. Vijay Bhagavath, the lead data networking analyst here, honored to have Tony Tripeny, the CFO of Corning. It’s their first time, I would think.

Tony Tripeny

I think so, yes.

Question-and-Answer Session

Q - Vijay Bhagavath

Yes. So welcome to our clients. Why don’t we get started with a few questions and periodically open the floor for Q&A, want this to be very interactive. Tony, I think the first question is kind of what’s top of mind for investors if I may which is you guys are in an investment mode. It’s a capital-intensive business. Walk us through the investment and then the harvest post the investment and then how does hopefully improve free cash flow and the margin profile of the business?

Tony Tripeny

Sure, happy to do that. It’s been about 3 years now since we introduced the strategy and capital allocation framework and we introduced it with couple things that were significant. First is that we will generate $26 billion to $30 billion of cash. And with that, we would invest about $10 billion in our growth and sustained leadership and we return at least $12.5 billion to shareholders. We made great progress on that over the last 2.5 years. We feel very good about that. On the shareholder returns, we have returned $10.8 billion. We then increased the dividend by 50% since we started. I mean, that’s all on track. And on the investment side, we have also made good progress. We have invested about $6.7 billion over that timeframe. And what’s exciting about that investment is, is that we are, right now at that inflection point where those investments are starting to pay off. Over the last 18 months, we have spent a lot of effort on new plans and new capacity to meet committed demand, but that has shown up in both compressing our margins a bit and it’s also shown up in additional capital spending. And what we said at the beginning of the year is that by the end of the year, we would start seeing those investments paying off and we saw that in Q2 and our Q3 guide clearly showed that. And so we now expect the year to end the year 2018 at about $11.3 billion in sales or up 10% on a year-over-year basis. But even more important than that is what happens in the back half of the year. In the first half of the year, we were at a $10 billion run-rate and a 40% gross margin. In the second half of the year, we are going to be at a $12 billion run-rate and a 42% gross margin and it’s really that improvement and that growth showing up. It’s going to kind of guide the way on what’s going to happen from an operating cash flow standpoint on a going forward basis. It’s really the strength across all of our businesses and the investments that we have made paying off that we are now going to start to see that growth in a pretty significant way. And I think what’s most exciting about that it isn’t just one business that’s showing that growth. We see that growth in optical communications, where we think on a year-over-year basis we are going to be up high-teens and our organic growth is going to be up in the low-teens when we previously thought 10%. And this is in a market that isn’t growing anywhere close to that kind of growth rates and it’s really the innovation and the technology that we bring to bear there.

In specialty materials, in the last quarter, we introduced Gorilla Glass 6. We also introduced a couple of versions of Gorilla Glass DX and DX+ for wearables and those products are really going to drive continued growth in that business, in a business where the underlying smartphones are relatively flat, where we saw 25% growth last year and we expect to see growth again this year. And in environmental technologies, GPF is just beginning to take off. That business is going to grow to $0.5 billion as those regulations get put into place and that’s $0.5 billion on top of a $1 billion business, so that’s really significant growth. And so what you are going to see over the back half of this year and as we go into next year is a business that’s growing and you are going to see that show up in the operating cash flows. No doubt that we have to spend some capital to get there. In some ways, in the beginning of the framework, we only spent $1.2 billion. That may have felt a little bit better, but the reason we spent $1.2 billion is because we weren’t ready yet for that growth to happen. Now we have spent closer to $2 billion and that growth is occurring and that’s actually a better scenario even though, in the short-term, it hurts us from a free cash flow standpoint. So overall, we feel really great about where we stand and in particular, we feel great on operating metric like cash flow.

Vijay Bhagavath

I mean, I do understand the investor conundrum. I mean, they want to see free cash flow growth, but let’s be honest, it’s a capital-intensive business. And my hope is you are investing ahead of true demand versus build it and they will come.

Tony Tripeny

So I think that, that’s maybe the most important takeaway here is that the investments that we have been making have been based on demand that is there. So, let’s take a Gen 10.5 factory in Hefei, for example. First of all, we are getting a lot of money from other people to build that factory, but that is ramping in tandem with our customer who is building that production for large sized TVs. And so that is in a speculative build that is very much tied to a customer demand. Optical communications is the same thing and the Verizon announcement of a little over a year ago is what gave us the confidence to build the increased capacity that we need in that business. That capacity is coming online in the second and the third quarter and it’s really that capacity filling up right away, which is driving us to a higher sales growth in that business and it’s part of the reason why we raised our guidance in that business and GPF exactly the same way. I mean, we have won a majority of the business that’s been awarded in GPF that caused us first to expand our factory in Germany and also our factory in China and eventually caused us to build a new factory there, but it’s all because the business is there and so we get to fill that up pretty quickly and that’s how we get it to margin point improvement is filling that up in the back half of the year.

Vijay Bhagavath

Perfect, yes. Thanks, Tony. Few more questions from me and then we open the floor for questions from the audience. I want to zoom in a bit into the optical business, in particular. Production most recently on Corning is one of our top ideas on 5G and also on the fiber edition, if you may call it, in hyperscale clouds, walk us through – just two questions, one is you obviously have an unprecedented if I may longer term supply agreement with Verizon, I mean in my recollection. Haven’t heard Verizon do long-term agreements with anybody, walk us through, do you have any other such longer term supply agreements? And then on the hyperscale cloud side, give us some visibility and color on that part of the opportunity because I see the company amplifying and talking about Verizon, but not as much on the hyperscale cloud complex?

Tony Tripeny

Yes. So I think that what’s really driving the growth in this business is a combination of continued growth in fiber to the home, the beginning stages of 5G wireless and the infrastructure that has to be built there and then what’s happening in hyperscale data centers. And how we can talk about any given customer is of course up to the customers to decide, but the growth that we have experienced and a significant growth, I think, 15%, 16% in ‘17 and this year, in the high-teens or even in the low-teens, without the 3M acquisition is really an indication of what’s happening both in that marketplace and the very strong position that Corning has by co-innovating with our customers and providing them solutions that they can use, whether it’s in a fiber-to-the-home network, whether it’s the beginning stages of 5G or whether it’s in their hyperscale deployment and so we are seeing growth in all those areas. And a lot of the capacity that we have put in place is to meet that demand, some of it’s in the fiber, but a lot of it is also in the cable because they take specialized kind of cables that are a lot denser, lot more fiber count than what traditional cables are. We have invented those. They are easy to handle and a lot of – in some cases they actually get connectorized in our factory, so they are easy to install. We have done a lot of innovations in those areas and that gets us very close to those customers and means that they are installing their network, so that their outside plant networks or hyperscale data center networks, they are coming to Corning for those solutions.

Vijay Bhagavath

Perfect. One more zoom in, Tony if I may on the optical business. 3M was a very interesting acquisition, solid asset. Just bigger picture, when you look at your M&A or inorganic growth strategy, what’s the thought process and are there any obvious gaps in the portfolio that you will be looking to fill?

Tony Tripeny

I think that for the most part we said we would spend $1 billion to $3 billion in M&A over a 4-year period. And most of that we thought would be in the optical communications area. Now there is a couple of reasons for that. One is that we are very large there and so it gives you an opportunity to take smaller companies, add them into – kind of bolt them on, get some synergies out of there and feel good from a financial return standpoint that you are spending the shareholder’s monies wisely. And so as we have thought through, if you look at most of our deals, they really fall into a couple of categories maybe somebody that has products that we could sell through our existing channels and we had a couple of deals like that. It could be people who have existing channels that we could sell our products from. 3M had actually a little bit of both. They had some products that are very exciting to our existing channels, but they also were much more global than what our business has been. And there is a couple of places in particular in France and in Mexico, where their presence there, we think is a real asset. Some of the other deals we did actually had good presence at some of the hyperscale customers that we are benefiting from today. So, as we look out at possible acquisition targets, it’s really along the lines of products that we can sell in existing channels or people that have channels that we are not as strong at. And then in that area, in particular, I think outside of North America is a place where we are looking from a channel standpoint.

Vijay Bhagavath

Perfect. And then want to talk about your growth drivers to the so-called optionalities and the model, auto glass and Valor Glass, talk to us about those. When would they become significant? When should we start kind of tracking them more actively? And then the investment and harvest phase for Gorilla Glass in cars and also in pharma glass?

Tony Tripeny

So I think what’s particularly exciting about our growth prospects right now is that, that growth is happening from businesses that we are in today and that growth is occurring right now and that’s whether it be in our automotive business with gas particulate filters, whether it be in optical communications as we have just talked about, whether it be in our traditional Gorilla Glass business. And that’s what’s really going to drive the growth over the next several years. And so that means that the businesses there are things like automotive glass. In Valor, while they are really great big growth opportunities, we don’t have to deliver on those in the next couple of years to see growth at Corning. Now as we think about those businesses, I will start with the automotive glass business, that’s really two different types. There is the windshields kind of the exterior glass and there is the interior glass. And there has been a lot of good progress on the inside of cars. People want better interiors. They want the kind of connectivity that they have in their homes. They want the kind of designs that you would expect that you can get from being able to bend and shape glass and the like. And then of course they need a lot of treatments with that glass. Antiglare, antireflective becomes really important inside a car. In a cellphone, if you are standing in the wrong place in the sun, you just move. It’s a little bit harder to do that with the car. And so a lot of those treatments become very important. All of this plays great to Corning’s strengths. It really plays well to our technologies.

What we said on the last conference call is that we have had several $100 million worth of business that we have won. We are not quite ready yet to provide the level of details that give you exactly when that is going to start showing up and how to think about it, because we have some more work to do there. But we should feel good about the fact that we are actually building a factory to meet that demand. I mean, that’s a reflection of what we have talked about earlier. We put that capacity in place when we are comfortable that there is actually the demand to be met there, so that’s what we are in the process of doing. And we realized that we owe investors more details on that. And as we move into 2019, I think that will be the timeframe when we will be able to explain more along those lines. On the glass on the outside that has right now continued to be mostly a niche market of high-end vehicles, where the performance really matters, the light-weighting and the performance that you get from that. I think there is still a good value proposition in terms of the light-weighting and how it does from a miles per gallon standpoint, but that has not been adopted on a kind of everyday car as what you really needed it for to do to see some growth there. But we are still excited about that opportunity, where that we see a little bit longer term and it’s the interiors that we see more from a short-term standpoint.

Vijay Bhagavath

Perfect. Just a quick follow-on and then want to move to this place, which is, is it reasonable to assume that auto glass and pharma glass would kind of start out as being in the other category of disclosure or would you put them in the environmental or displays or spec materials or optical?

Tony Tripeny

I think in the early days, we will definitely have them in the other category. It’s interesting. I mean, the reason we do that is that we want people who are working on these products, in these programs to get up everyday and only think about these programs until they go to bed at night and hopefully not sleep and get backup the next day and focus on it. And we find that to have separate management teams to be the most effective way to do that. But at some point, they start scaling to a certain level and it makes sense to use all the infrastructure of our existing businesses. And so when we get to that point, we will think about where the right place from the reporting standpoint is.

Vijay Bhagavath

So one more question before we open the floor, you cannot escape or avoid this question of tariffs in China, what’s your latest thoughts there?

Tony Tripeny

So, I think from an overall standpoint and what we said on the call is that while we paid deep attention to this and we have a lot of infrastructure in place to understand every time there is new tariffs out there what the impact to us and how do we mitigate that impact. And I think it’s how we mitigate the impact, which is of course from a leadership standpoint, really important, we don’t think this is going to be a significant overriding impact to Corning. And there is really three reasons for that. First of all, TVs are not on the tariff list. And so that’s obviously an area that a lot of investors have been concerned about, but even if they were on the tariffs list, a lot of TVs that go into North America are assembled in Mexico. And supply chains do have a way of adjusting if they need to, but I think that’s the first reason. The second reason is we have an underlying philosophy from an operational standpoint and that is to manufacture close to our customers. There is a number of reasons for that, but one of the real benefits to that of course is there is not a lot of cross-border transactions. And so unlike other companies that they have been mostly doing their manufacturing in one region and exporting or importing to another region, we do less of that. So that has less of an impact to us. And then the third area is we are not big consumers of aluminum and steel and of course those are areas that have been particularly hard hit. So as we look at things, I mean, we really didn’t see an impact in Q2. We are not going to see an impact in Q3. As we go forward, while there would be a little bit of an impact, I think there certainly possibly could be a little bit of an impact. But compared to lots of other companies that are concerned about it, it isn’t on that same of a concern from our standpoint and it is something that we definitely monitor everyday.

Vijay Bhagavath

Perfect. So we are at half time here. We’d like to get some questions.

Tony Tripeny

Yes. So the question is given the plants in North Carolina and the storm that’s happening there, just kind of give an update there. I mean, clearly, we take this very seriously and mostly the concern for the safety for our employees. We have been through these kind of storms in the past. We are ramping down some of the production in particular in the Wilmington plant, which is right on the coast. All of our other plants continue to operate at kind of full production. What normally happens in these situations is that we will bring staff into the plant to continue operating during the storm. We don’t think this is going to be a big impact. It certainly doesn’t change the demand or anything else like that. So we are – it’s something that we take seriously, but I think from a financial standpoint, you won’t see a big impact of it.

Vijay Bhagavath

Any other questions? Tony, I mean, let’s continue here. I want to get your views on displays inescapable not to ask on pricing demand, like unit volumes, screen sizes, what are your thoughts there?

Tony Tripeny

Yes. So I think this year is playing out very much as we thought it would at the beginning of the year. We think the market will grow in the mid single-digits. And what’s really driving the glass market to grow like that is underlying demand at TVs and the size of TVs that people buy. So over the last number of years, every time someone goes buy the new TV, they buy a bigger one than they did before. And that has led to about an 1.5 inch increase in the average size every year and that has turned out to – that’s playing out right now actually underlying TV demand. As things get little bit stronger than a lot of people thought it was going to be, the panel price decreases that happened in the back half of last year, now showing up in lower TV prices and that’s stimulating some demand. The second quarter, TV demand was strong. So far, the month of July is the only part of the third quarter that’s been reported across the world, but that continued that strength. So we think the underlying strength of the business is good and that of course is the most important thing relative to the demand. I think the second piece is what’s happening from a pricing standpoint. And as we said on the call, this is the best pricing environment for LCD glass in more than a decade. In the third quarter, we are going to hit the important milestones of year-over-year pricing being in the mid single-digits. What we think drives that is glass supply and demand being in balance. There is a Gen 10.5 factory that’s being brought online, but of course that’s being brought online with a glass factory, our glass factory and they are coming online in tandem. And that customer factory is really aimed at very large TVs, which is where a lot of the market growth is happening. Below Gen 10.5, there isn’t any publicly available announcement that anybody is actually adding any capacity there. And so that, we believe, is going to remain tight, so tight and in balance supply and demand in the glass market. Secondly, from a competitor standpoint, their profitability is pretty low for them to continue at those low levels, we need to see more moderate price declines. And we think that, that’s playing out. And then of course the third area is although this is a more mature business, you still have to invest in this business and you need to get returns on those investments. So, when you add those things together, we believe that this more moderate pricing environment will continue into the future.

Vijay Bhagavath

Perfect. And I would like to get similar commentary on the environmental business, it’s not very well debated in consensus, but you seem to be excited about this.

Tony Tripeny

Yes. We are very excited about the environmental business. I mean, I have always been excited about the environmental business because we are a market leader in this business. It’s something that we invented back in the 1970s and it’s always generated good profits and good cash flow. It’s very – well above 10% ROIC. What’s different today is kind of it’s going through a growth phase, which isn’t always the case here when we expect, actually sales to be up in the mid-teens on a year-over-year basis. Some of that is the strength that’s happening in the car market on a global basis. Some of it is the strength that’s happening in the heavy duty diesel market in North America and then that’s actually what’s driving most of the growth. But the other exciting piece is what’s happening in the gas particulate filters. And if you are adding $0.5 billion business to a business over time to a business that’s about $1 billion and we do that over the next 3, 4, 5 years, you are going to see growth in the 8% plus range I think in over the next several years. I mean, that’s – it doesn’t work that way month in and month out. Of course, it doesn’t, but that’s the kind of growth that we expect to experience there. And of course, the returns that we are going to get on that gas particulate filter business is very similar to the good returns that we get on our existing business.

Vijay Bhagavath

Could we have any other questions, probably, anyone?

Tony Tripeny

Yes. So the question was on the hyperscale data center, a little bit about the competition and what the growth from a quantitative viewpoint looks like. I mean, clearly, there is a lot of people who are pursuing this business. I think where we get our advantage of course is the kind of solutions that we can provide and we are a full line supplier starting with the fiber, the cable, the connectors, the connectivity, the kind of other hardware that goes in, being able to work and co-innovate with our customers and provide them customized solutions, which not only help them from an economic standpoint, but also helps them with the speed of their installations. And so we have a number of hyperscale customers that we are very close to and that we work closely with. In terms of – and as we look out into the market, I mean, this is one of the major drivers of the market growth and along with fiber-to-the-home and along with what’s happening in 5G wireless over time. And so what we haven’t done is go segment by segment and give our own projections on what was going to happen there. But as when we say that we believe that we can grow twice as fast over time as the market, it’s really because of our position in the highest growth areas of the market and the technology that we bring to those highest growth areas of the market.

Vijay Bhagavath

Perfect. I want to go back into the M&A topic. My question is around many of these acquisitions you have done are quite solid, but how is the thought process in terms of top line and also OpEx synergies? Do you run these businesses like 3M, mostly arm’s length or are they like native Corning? And then also what’s the thought process on these acquisitions? Do they primarily help with time expansion just a more well-rounded portfolio for example in 5G or in data centers or is it more focused on mix and margins, just walk us through the whole thought process from your lens?

Tony Tripeny

Yes. I think that for the most part, what we are thinking about is how do we make our existing businesses stronger and that’s where a bulk of our acquisition activities have been. And in particular, in the optical communications business, it’s all about how can we both grow the top line and operate more efficiently. So generally speaking, we integrate those businesses directly into our existing businesses and we focus on taking advantage if there is a channel that they are bringing that we don’t have, making sure that we take advantage of that channel. If there is products that they are bringing to bear that are complementary or good for our existing customers making sure that those get to marketplace. And so that’s the primary focus of our strategy. I mean, occasionally, we may do an acquisition for slightly different reasons. I mean as we have some of these new innovations like the automotive glass and like Valor in some cases finding channel that helps us get those products to the marketplace becomes important. So maybe 3.5, 4 years ago, we bought a current existing technology glassmaker in the Valor glass business from Gerresheimer, the tubing business. And the reason we did that is to give us some experience and some knowledge of the marketplace and to be able to have somewhat of an existing channel there. So, there may be sometimes more strategic reasons and when we do something like that, we still expect to have the returns on it and we are getting the returns in that business. And in the early days of the automotive glass business, we spent some time asking ourselves, would a window glass company make sense or not? We concluded we would be better to partner with the largest window glass company and that was our Saint-Gobain joint venture, but that’s clearly something that we look at. But I would say that maybe 25% of what we look at, 75% is really about making our existing businesses stronger.

Vijay Bhagavath

Certainly. Any last questions from the audience?

Unidentified Analyst

[Question Inaudible]

Tony Tripeny

Yes. I mean, the advantage of Gorilla Glass 6 of course is the number of times that you can drop it. The advantage of Gorilla Glass 5 was the height you could drop it. Some of that is not as important inside of vehicle. And so you are going to use different versions. In some cases, it would be exactly what we might have used in the mobile consumer electronics market. In some cases, it might be things that are designed or engineered slightly different to maximize for the customers in the automotive space.

Unidentified Analyst

[Question Inaudible]

Tony Tripeny

Yes. I mean, I think we are bringing a certain level of technology to bear there and the solutions with the same glass and some of the treatments and the like that we are doing and if we apply our technologies correctly, we ought to be able to compete successfully against alternative technologies like soda lime glass. And if we are able to do that, then the adoption obviously will be faster.

Vijay Bhagavath

Okay. So Tony, it’s been very helpful. Last two questions quickly. Smartphone market is the next inflection honestly these 5G phones, which will be perhaps 2021 or is there an earlier demand inflection in your view on smartphone? And the very last question would be on use of cash, the hedging strategy and any just concluding remarks from you?

Tony Tripeny

Sure. I think from a smartphone market standpoint, what we are more focused on is assuming that, that market is going to be relatively stable, maybe grow a little bit maybe shrink a little bit. But what we want to really focus on is growing the amount of content we have on those devices. So building a glass, developing a glass that was strong enough that you could put on the back, which you then could put more antennas on from a 4G and 5G wireless standpoint and which you can also use for wireless charging was a really big step there. And then once you have that on the back, it doesn’t have to be transparent. So what kind of designs can we do? So, we have a whole bunch of interesting products using vibrant technology that from a design standpoint and the like. And then for those that want to have a screen protector, are there glasses that we could manufacture that are particularly optimized to be a good screen protector, for example or as people as wearables take off, are there types of glasses that we can do that are really good from a wearable standpoint? And I proudly wear a Galaxy S3 and that’s because it has Gorilla Glass on it and it’s a very good device. And we think there is a lot of growth opportunities there. So from our standpoint, our focus is assuming that the market is relatively stable, how do we grow our content in there and how can we double the size of our business in that marketplace in the mobile consumer electronics market.

In terms of our hedging program, we have been very successful and very proud of that hedging program. What it brought was a certainty of cash flows to our investors. And we have been in that hedging program now for about 5 or 6 years. We are hedged through 2023. The reason that we were able to hedge out that long and feel good about it was because we have long-term supply agreements that go out well past that. And so now, we are focused on continuing to add a year every year to that program and also look at are there any opportunities that if there are opportunistic situations where the end is either really strong or really weak, is there something we can do to our advantage? But roughly speaking, we feel good about our hedging program and we feel like that’s in very good shape.

And then from an overall standpoint, I will just repeat with what I tried to start with is that with our strategy and capital allocation framework and how we create value with a 3-4-5 framework is what we really have been focused on as a company for the last 2.5 years. And we think those payoffs are really beginning to show up today. And we are going to exit the year at a much bigger business than we began the year at. And leading up to that, of course, not only have we invested a lot in our growth and sustained leadership, but we have also returned a lot of that cash to shareholders. And a lot of that, we have done through repurchases. So for remaining shareholders, the value of that growth is going to be even greater. So, we feel halfway through – or more than halfway through the 4 years, we feel pretty good about our position.

Vijay Bhagavath

Perfect. Any last questions from audience? So, okay, Tony thanks again. Thanks to our clients for being here. Have a good rest of day.

Tony Tripeny

Sure. Great, thank you.