Corning Incorporated (GLW) Earnings Call Transcript & Summary

All right. We're going to try to keep the trains running on time, even though people are still showing up. So good morning, everyone. Thanks for coming to the conference. I'm very pleased to have Tony Tripeny, the EVP and CFO of Corning, here with us. Tony, welcome.

Thank you, Rod. It's great to be here.

Welcome, again. And I'm Rod Hall, I'm the analyst for Goldman Sachs, covering the hardware arena, both the enterprise hardware as well as consumer hardware. With that, I guess, Tony, I'd like to hand over to you. Maybe you'll make a couple of opening comments for us, and then we'll kick into some questions.

That's great. First thing I want to do is just close out 2019. We met or exceeded all the goals in our original Strategy and Capital Allocation Framework. And then in the middle of last year, we introduced the Strategy & Growth Framework, which is our focus for the next 4 years. And although our back half of the year was challenging from a financial standpoint, we are still very committed to achieving the targets that were laid out as part of that Strategy & Growth Framework. And as I think about 2019, I mean, there was a lot of excellent progress that we made on a number of strategic initiatives. And when I think about 2020, we're really focused on 3 things. I mean one -- from an operational standpoint, one, is to ramp our Gen 10.5 factories. Second, is to align our cost and capacity to the current demand that we have, in particular, in optical communications. And then a whole bunch of areas on commercializing innovations to support our customers on a going-forward basis. In 2020, we have 3 businesses that performed very well in '19 and will continue to perform well in '20. Those are Specialty Materials, Environmental Technologies and Life Sciences. And we expect the 2 businesses that were softer in the back half of 2019, Display and Optical Communications, to remain a bit softer in the first half of the year but to get stronger in the back half of the year. And when they get stronger in the back half, Corning as a company will return to growth and our profitability will return to growth and our margins will also get back to the levels that they were in the first half of 2019. And then I just also want to just make a couple of comments on the coronavirus before we get started. We have a dedicated team that is focused on this evolving situation and we're obviously following all the recommendations of the CDC. And then we're also in close contact with all the local authorities in China. And the safety and the health of our employees, their families and the communities we operate in, is our number one priority. We're also in close contact with our customers and our suppliers. In our forecast, we've not factored anything material from an impact standpoint. The situation, we think, is very fluid. As everybody knows, people started to come back after the extended Chinese New Year's this week. We're in close contact with our customers and our suppliers and as we learn more over the next -- the rest of this quarter, we'll certainly keep investors informed.

Would you intend to update investors before the next earnings call, Tony, if there's something material to update on? Or you think it's just the next earnings call that we...

I think it just depends on where the situation actually evolves over the next 6 weeks or so. My guess is it will probably be more likely in the earnings calls. But of course, if something changes on that and it was material, of course, we would say something.

Okay. Appreciate that. Yes, it's no fun talking about a virus with a glass company. And we'll talk about glass. So let's talk about the panel market transition from Korea to China, that was a big feature on the earnings call. Can you talk a little bit about how that affects your guidance for mid-single-digits price declines this year?

Yes. Let me separate those actually into 2 different questions because they're really 2 different dynamics. One is what's happening from a pricing standpoint; and then the second, what we see happening from a panel industry standpoint and the impact that's going to have on our volume in the first half of the year versus the back half of the year. From a pricing standpoint, we've been in a favorable pricing environment now for several years and we expect that to continue in 2020. We're quite pleased with the price declines moderating in 2019. More than 95%, actually now, 99% of all our contracts or all of our business is under contract for next year. And we think the price declines will be mid-single digits. And that mid-single digits, while it's a little bit more than the low single digits, when you really think about the difference between those numbers, they're not significant differences and it continues to be a favorable pricing environment. And the reason it's a favorable pricing environment is first, supply and demand is in balance. And if that were to change in due course, Corning has the ability to take capacity offline, and we have done that, and we certainly, on the new Gen 10.5 factories, we align those as they ramp up from a customer standpoint. Secondly, our competitors are not very profitable. So they can't really afford to continue to have significant price declines. And then, finally, you have to invest something in this business. And you have to get a return on those investments. So you can't expect prices to go down, given that you have to get those returns. So we feel good about the pricing environment. In terms of what's happening from a panel maker standpoint, it's important to remember that at the end of the day, what really matters is end market demand. And what happens in the TV market? Do people sell as many TVs as they did the year before? A little bit more, a little bit less. But are those TVs bigger? And we, on average, get about 1.5 inches growth a year, and that really drives the market kind of in the mid-single-digit size. And of course, the larger the TVs, these Gen 10.5 factories that are ramping up in China are really built to service that end of the market. So over the last year and into this year, you're seeing more of that panel maker capacity opening up in China and that is where the big TVs are really being manufactured. So it's having an impact on the Korean panel makers. A couple of years ago, they were the largest panel makers in the world. Between last year and this year, they're taking -- they've announced they're taking about 40% of their capacity offline. And the reason we mentioned it in the call is just that in the first half of the year, we'll grow a little bit less than the market because the impact that's happening in Korea. And in the back half of the year, we'll grow faster than the market as Gen 10.5 factories ramp up.

Yes. On our math, it seems like the most of the pricing impact is in Q1 and then the rest of the year is pretty moderate decline.

Yes. No, I think that's right. I mean that's very similar to what happens in most years, like 60% of most price declines happen in Q1.

Yes. So it's kind of normal, maybe a little bit more than we had forecasted first quarter.

Yes.

Okay. Supply chain correction in the display market. We've seen some corrections. Like you say, it's the balance of supply and demand there. We wonder what you think of inventory levels now. We know that inventory visibility has probably got worse over the years. But wonder if you could comment on where we are with inventory levels, at least your view of it. And do you feel we've reset back to normal or below normal levels of these things?

Yes. No, I think we've reset back to normal levels. I mean we think that for the most part, the supply chain correction is behind us. As I mentioned before, what really matters is what's happening in end market demand. And end market demand was strong in the fourth quarter, particularly strong in North America and Europe, even a little bit stronger than I think a lot of observers expected in China. And I think that panel makers got cautious because they were uncertain -- in our opinion, they were uncertain about what was happening from a trade standpoint. But with a stronger -- with the good demand in the back half of the year, we think we ended up, from an inventory standpoint, at a healthy level.

Okay. So you've received over $1 billion in customer incentives and deposits to help build these Gen 10.5 facilities. And it seems like that should drive higher ROIC from those facilities, but then we understand it's quite complex to figure out. Well, how do those deposits and incentives unwind through the whole -- the process? We know it's like a 10-year unwind maybe on the incentives. So is there anything you can say that would help investors to understand what the ROIC of these facilities might look like?

Yes. I mean the good news is, you're right, the ROICs are better than our average. And if you go back to our IR day, Jeff Evenson spent time talking about the ROIC on our build projects and that on average, they were greater than 20%. And these fall into that same category. We don't give specific project ROICs, but they do fall into that category. And at the end of the day, you get $2 out of every $3 are coming from somewhere else and sure, the money tends to come upfront. You spend it a little bit later. It kind of gets a little confusing as you take it through the cash flow statement. But at the end of the day, we're not investing a lot. And not only are we getting long supply contracts right next door to our customer for that product but we've also extended a lot of agreements on other generation size of products to secure business there. And so they are very attractive arrangements for us and with really good ROICs.

And is the -- on the incentives part of it, which is basically prepaid revenue, did those unwind in a linear fashion, more or less? Is that how we should think about when we model it? Or are they non-linear in the way they unwind?

Yes -- I mean, no, they unwind more or less in a linear fashion but it is over a very long period of time. So in any given year, when you think about the impact it has on the cash flow statement, it's pretty minor.

Okay. So let's talk about optical a little bit. You've guided for revenue to decline 5% or 10% -- 5% to 10% this year but forecasting has been notoriously difficult in that segment. So I wonder if you could talk a little bit about the range and your confidence in that range and risk in both directions. We know, for instance, the Chinese tender is out there and may affect it and so on and so forth.

Yes. I think that that's a little bit wider range than what we normally give because a lot of the change that we're expecting is in the back half of the year and it's just harder to know for certain on the back half. I mean what happened to us in 2019 is almost all of the change from the first half to the back half was driven by 2 customers, one who prioritized debt reduction over capital spending; and another one that had finished a very intense level of investment. They continue to invest heavily but not at that same level of intensity. And we, for the most part, expect that to continue in the first half of the year. Now Q1 is always seasonally down for us versus Q4 and then picks back up in the second quarter and we expect that but what we really think the growth that is going to occur in the back -- is going to be in the back half of the year. And at the high end of the range, so the minus 5%, that assumes that there is some pickup in some fiber-to-the-home, 5G and hyperscale data center jobs. Not one big job that has to happen but a number of customers who have told us that we expect -- that they expect to buy more in the back half of the year. And at the low end of the range, the minus 10%, that is -- the assumption is, is that actually gets pushed out, probably in late Q4 into 2021. And so I feel confident that those jobs will occur, that, that investment will happen and the timing of that is just more variable, and that's why we gave a wider range.

Do you -- just asking about the way that you're now forecasting, I know that Jeff is taking a look at trying to get more granular, maybe project-oriented in this forecast. Could you talk a little bit about that forecasting process, maybe just so investors understand where you were in terms of forecasting and now where Corning is in terms of trying to predict what happens there?

Yes. I mean, I think where we were was a lot of conversations with customers and what did they expect to happen over a certain period of time and then kind of rolling that up and then using our own judgments in terms of, well does that seem feasible or not. What we've done over the last 6 to 9 months is applied all kinds of different forecasting techniques, some of which are just based on actual performance along with order rates and making predictions. And then some of them is just much more about understanding where you think the drivers of this growth could come from and the timing of those drivers. And so I'm sure that our forecasting capabilities will get better over time. In fact, I think in the third and the fourth quarter, we actually did exceed the guidance that we gave, which was an indication that some of those are improving our forecasting capabilities. But of course, any time you've had a reset like this, it takes many quarters before either you're comfortable internally or you'd be comfortable as investors that things are under better control.

Do you feel pretty confident that 2021 will be a year when 5G rollout will be benefiting Corning? Is it better part of the year?

Absolutely. I think at the end of the day, all -- no matter what kind of architecture you're using from a 5G standpoint, it's all pretty fiber-rich architecture. And I think that as that continues to happen, I mean, we're in a very unique position to really deliver on that because we bring together both the fiber and the cable and the connectivity technology together. So much like we had very good position over the 10-plus years of fiber-to-the-home deployments, we'd expect the same thing in 5G.

So one of the things we struggle with on optical in terms of modeling it, is just understanding how much of your revenue comes from different parts of optical, hyperscale versus fiber-to-the-home, versus maybe 5G and so on. Is there anything you could say that would help us understand, at least maybe even qualitatively, where the bulk of it is? And how you see that in 2020, whether that mix might change in '21?

Well, we tend to think about it in terms of the carrier market and the enterprise market. And the hyperscale data centers are in the enterprise market. They're about 1/3 of our total sales and the carriers, 2/3 or 70-30, something like that. A lot of the growth in the enterprise market does come from the hyperscale data center area. And last year, we did see growth overall in the enterprise business and a lot of that came from hyperscale data centers. In the carrier market, the growth can come from all kinds of different investments, fiber densification for 5G or fiber-to-the-home or MSOs deploying greater fiber for their competitive reasons. And so I think that, at least from our standpoint, we find those 2 splits to be the most useful.

Okay. And then -- and do they change at all in '21? Would you expect that split to remain constant? Or...

Given the size of the numbers, there will be years where you get maybe more growth in hyperscale. But of course, a lot of the enterprise business is not just hyperscale, and that's going to grow at a slower rate. And even in carriers, where you might have a big 5G deployment but the whole carrier business is more than that. So -- and I think that split will be roughly the same.

And how -- while we're on optical and talk about enterprise, how do you feel about the enterprise spending environment right now? Just generally speaking, do you think that affects fiber spending much for enterprises, not really, such a big driver?

I think it can be a driver. But I think generally speaking, at least in the developed markets like in North America, I think the economy is reasonably good. And the enterprise spending has been reasonably strong and we expect that to continue in '20 and '21.

And is -- we always fixate on these particular deals and on the goal, but we're never sure whether they really make that big of a difference and we have the China mobile tender right now we're thinking about. Is that something that investors should be focused on in terms of its size and contribution to overall optic -- the overall optical segment? Or is it really not such a big deal, and it's more about the bigger trends? Or...

Well, I think certainly, the bigger trends is what really matters. I think from a Corning standpoint, a lot -- our market share in China isn't really large, but this is a case of a lot of market demand happening and a lot of people that have built capacity in order to meet that demand. And of course, a lot of it is driven by their own interest in the fiber densification for 5G. So I think it's an important thing to be watching. I don't -- I think the bigger, longer-term trends is what's going to drive the business. But I think it's a data point worth watching.

Do you think the public health crisis there puts any injects -- does it just delay things, but they're kind of inevitably going to happen this year? Or do you think that there are decisions that -- is there a whole chain of events that could affect over the next 6 months?

It's hard to speculate on that. I mean, I think, certainly, in the longer term, it's going to happen. And I just think the situation is just too fluid to really have good insight into that.

Right. Okay. Let's move on to some of the other parts of the business. So just wondering on Environmental, you say it will slow materially from mid-teens growth over the next -- last couple of years to just mid-single digits, though GPF particulate filters are ramping. Could you help us understand the reason for the increased caution or at least a slower growth, let's say -- not say caution, but lower growth?

Yes, it really isn't caution. I mean, I think the simple way to think about it is, is in 2019, GPF went from about a $50 million business in '18 to a $250 million business in '19. So that's $200 million of sales and that's about 15% growth. And in '20, it goes from $250 million to $350 million. And so that's just $100 million, and that's about mid-single-digit growth. So the drivers in both cases were really the content, the more Corning of GPF is just that in 2019, as Europe was adopting the regulations and China was getting ready to adopt the regulations, it turned out to be a bigger number than it's going to be in 2020. And this is all against the backdrop that less cars are going to be produced in '20, we believe, than in '19 and maybe less cars were produced in '19 than '18. So you'd actually expect this business to be in a slight decline. And in all cases, we've been growing. And it's a great example of how our technology, working with our customers, can really make a difference in our business.

Yes. I've had investors ask, what's so hard about just -- isn't this like pushing Play-Doh through a mold and you get a thing on the other side? I don't know, it looks a little more difficult than that.

I think it's a little bit more complicated than that, and there aren't very many people in the world that do it. So it's -- and as you know, I mean, we actually invented this industry in the '70s, in response to the Clean Air Act and have been market leader in it ever since then. And the nice thing about GPFs is that in any of the new technologies that are adopted with new regulations, whoever gets to the marketplace first and cements a position there tends to have that for a long period of time. And in this case, we have the best technology. We've got more than our 50% share from a market standpoint, and this -- that will benefit us from a business standpoint for the next 5 to 10 years.

Is it another business like glass where the process technology is very difficult to duplicate?

Yes. I think the process technology is difficult to duplicate. I think actually, some of the ceramic science is pretty complicated, too. And so I mean, this business is almost 40 years old, and I think has been a pretty successful business for us.