Corning Incorporated (GLW) Earnings Call Transcript & Summary

Hi. Good morning, everyone. Thank you for joining our virtual tech conference. I'm Wamsi Mohan, IT hardware and supply chain analyst at BofA. Normally, we would all be in a room at the Ritz in San Francisco, but these times are unique, and we're nonetheless happy that you're joining us here. We're delighted to welcome Corning EVP and CFO, Tony Tripeny, to our call today. Tony has been CFO for over 5 years, has obviously a very long history with Corning, knows the company extremely well. We'll jump into Q&A right after Tony's introductory remarks. So Tony, thanks again for joining us today, and over to you.

You bet, Wamsi. It's good to be here. First, just a reminder that statements made today may contain forward-looking information, and actual results may differ, material, from what we discuss today. We're obviously all confronting profound challenges as a result of COVID-19. Our thoughts are with those directly affected by the pandemic and the many people fighting it on the front lines. Now we have been responding to this pandemic since the early cases in Wuhan. All of our Corning sites maintain comprehensive preparedness plans and are operating under our best practices handbook. We've also mobilized our innovation capabilities to combat the pandemic more directly such as Valor Glass for vaccine clinical trials and using our advanced flow reactors to scale production of a small molecule antivirals to treat the virus. And we've donated Guardiant antimicrobial particles for an antiviral paint in Wuhan hospitals. From a priority standpoint, it's pretty straightforward. They're threefold: protect our employees and communities, deliver for our customers and preserve our financial strength. I think it's important to note that our balance sheet is built for times like these. We are committed to preserving our financial strength. We're currently adjusting our operating plans to reduce cost and capital spending, all while maintaining our customer commitments. We expect to maintain a strong cash balance and generate positive free cash flow for the year. Our plans are to maintain our current dividend, and we have a debt structure that is conservative by design. Over the next 2 years, we have under $70 million coming due. And while 80% of debt in the S&P 500 is coming due within 20 years, less than half of ours is due in that period of time. And our debt coming due over the next 20 years is $3.4 billion. The ratio for 20-year debt-to-EBITDA is about 1.1x. So clearly, the world and our outlook have changed significantly. And anticipating those lower sales, we are aggressively adjusting our operating plans and taking actions that will maintain our financial strength and result in positive cash flow for the full year. But it's also important to remember that we are built to last. What we know at Corning is that our underlying market drivers are intact and that we fully expect to resume growth. And when that growth resumes, most of the capital is already in place. We're operating on a strong financial foundation we built, and we're taking actions to position ourselves to come out of this slowdown even stronger. So Wamsi, I'll be happy to take your questions.

Great. Thanks for that quick introduction, Tony. So clearly, you laid out a bunch of things that you guys are doing, both from an operational standpoint and as well as from a financial standpoint. So can you maybe talk a little bit about how you're thinking about adjusting your cost structure in response to the pandemic? There have also been some organizational changes. How does that fit in, in this new dynamic?

Sure. In the anticipation of what we expect to be significantly lower sales, we've been focused on a number of actions, and they really fall into 4 major categories. We've been reducing our production levels across all of our businesses. In some cases, that's idling capacity. In a few cases, it's actually taking capacity off-line, but for the most part, it's idling capacity. We've also been adjusting our operating expenses with the majority of those savings that are going to be realized in the second half of the year. We've also been modifying our inventory plans and are focused on reducing inventory and improving working capital there, and we've also been focused on reducing capital spending. So I think it's important to keep in mind is that even though the outlook has changed significantly, we do expect to weather this current storm well, and we will grow when the world gets better. And I think it's also important to remember is that when the growth returns, our capital is already in place, so we do have that strong financial foundation, and we'll have strong, very strong operating leverage. So that as the economy returns, so will our financial results. From an organizational standpoint, we did announce a series of organization changes at the beginning of the second quarter. And the key one is that we are centering our operations around our market access platforms. And we were doing that because we think it positions Corning to be even more relevant in our markets. It gives us the ability to capture more customer insight, further leverage our distribution channels and open up new opportunities for innovations with the industry leaders that we work with. The second benefit of it, of course, comes that we're going -- we're moving to a new generation of leaders, which allows us to move forward as we pursue another 169 years in business. And then finally, we did have a new leadership position that we also announced, which was a Chief Operating Officer with Eric Musser. Eric's a Corning veteran with a strong track record for leadership and execution, and he'll enhance our process consistency, ensure we hit our targets across the company.

Okay. Great, Tony. The China trade rhetoric has stepped up again. We've seen a number of things happen as it pertains to IP around China and potential for new licensing requirements to sell things to China. How are you thinking about the footprint and exposure relative to China, especially in display?

I think you know that our strategy overall is to manufacture in the region where our customers are, and we do that for a variety of ways that we protect our IP and trade secrets in any place that we operate. Now there's lots of benefits to being able to do that, including the fact that it poses minimal trade and tariffs impacts. And we've seen that throughout all the trade disputes over the last 18 months or so is that direct impact on Corning has actually been pretty minimal. And then in addition to that, we do secure agreements to ensure that we have committed demand before we've invested. And in particular, on display, you've seen that, whereas there are 4 Gen 10.5 panel fabs being built in China, and we're going to supply 3 out of 4 of those. And most of that money to do those investments actually come from other places -- from other people.

Okay. Great. Maybe, Tony, let's touch on each segment and briefly talk about what you're seeing there, both from a near-term demand perspective and from a longer-term potential. So let's start with Display. Clearly, near-term volumes are challenged. As economies reopen, though, how do you see the trajectory of volumes playing out? And maybe you can address some of the other dynamics around pricing and inventory levels as well.

Sure. I'd be happy to do that. I mean, I think the first thing I would say in all the businesses that we feel very confident about their long-term potential. And the real question in the near-term is as economies start to open up again, what does that mean from a near-term standpoint? And as you know, we withdrew guidance in our April call because we just don't know for sure what that outlook is going to be like. So I'm going to share some data today, and I think some of it is current and some of it could be encouraging. But I just have to remind you and really remind ourselves that this is all very early data, and it's still going to be a while before we know. And it's hard to know whether this is -- necessarily represent trend lines or whether this is some sort of false spring there. So that's what we're focused on. In terms of Display, clearly, what happened in Q1 was impacted by the stay-at-home policies in China; and then in Q2, really how that's impacted in other parts of the world. We feel very comfortable long-term that as the economy grows, TV demand will grow again. I mean that has been the history through all past economic downturns and all recessions. And more importantly, we expect that the long-term trend of increasing screen sizes to continue. And of course, from a glassmaker standpoint, that clearly is what makes the difference. I think from a current supply chain, I think that you're beginning to -- you did see some drop-off in panel maker demand in the first quarter and the second quarter. That does seem to be picking up. I think the inventory levels in the supply chain are relatively healthy. And where we're really focused on is what's happening in China, partly because they're the first place to close down and they're also the first place to have the reopening. And if you look at the data in February when that economy was essentially shut down, on a year-over-year basis, TV units were off by a lot. In March, they were off by about half that amount. In April, kind of similar to the way March was. And even though it's only 10 days' worth of data through the holiday season in China on a year-over-year basis in May, sales were up just slightly. So -- TV unit sales. So from that standpoint, there are some indications of how economies may return, although it's -- as I said, it's a little too early to declare that being the case for the rest of the year. But as we look out in the future, we feel very confident about the sales growth and also the volume growth driven by screen size.

Okay. That's really encouraging to hear. So Tony, can you comment a little bit about the pricing dynamics as well? Clearly, in times of weak demand, there is always some concern around whether or not the pricing structure holds or not. And you guys have done an amazing job in being able to maintain glass price declines to decouple from panel price declines. And I was curious to know whether you think in this cycle, if that's going to hold true as well?

Yes, I do. I mean nothing has changed in terms of our outlook on pricing. We expect pricing declines by mid-single digits in 2020. And there are really 3 factors that drive that. First, glass supply continues to be balanced to demand. Corning takes actions to align our capacity with demand, and that includes pacing of our Gen 10.5 capital projects to align with panel makers' schedules. Secondly, as you know, our competitors continue to face profitability challenges at current pricing levels. And then finally, display glass manufacturing requires periodic investments in existing capacity to maintain operations. And glass prices must support an acceptable return on those investments. So I mean, we don't expect any change from a pricing standpoint than what we've been experiencing now for 5 or 6 years.

Tony, can you also talk a little bit about what is it that you're seeing in terms of screen size growth? Has there been a pause in that given COVID-19? Or is it like just not enough data to draw any such conclusions?

There definitely hasn't been a pause on it. I think if you look at the data as frequently as we get it in, you probably could point to a few data points that say, well, geez, when economies, especially the U.S. economy, went into lock down, smaller screen size TVs, there was a little bit of a surge in demand for them. Because either getting a second or third TV in the home or in some cases, monitors were hold -- hard to get hold of. So it was another way to get a monitor. But that didn't -- that was more of an anomaly in the data. And as you looked at, especially in the -- both the U.S. but in the China market, I mean, both those markets are showing screen size growth along the lines of what you'd expect. So I think we believe that in most years, screen size growth is about 1.5 inch a year. And I suspect when we get to January of 2021 and look back on this year, we'll be right in that same area.

Okay. Can you maybe, just to wrap up on display before we move onto other segments. Can you talk about what your outlook is on longer-term growth here? Clearly, there has been a lot of shift in terms of where the glass is getting manufactured. Can you also talk about longer-term profitability in the same context?

Sure. I mean, I think what really matters the most in terms of our longer-term outlook is the screen size growth trend that has been true for a long time, and we'd expect to continue to be true. And that should drive mid-single-digit volume growth. And if -- to the degree that TV units grow, which you'd expect after a year -- a couple of years where they haven't been growing for them to pick up then you're at the high end of that range or maybe even closer to 8%, 9% in volume. And so I mean, that's really what the growth driver is. And given the size of the market, what that really requires is roughly a Gen 10.5 factory to be brought online on average about every year. And as you know, of the 3 of the 4 Gen 10.5 factories that are currently being constructed or are up and operating, Corning is going to be the supplier of those. So that positions us well from a volume standpoint going into the future. We talked about the pricing dynamics. And of course, all this technology gives us the ability to continue to reduce costs. So our objective is, we like to say internally, is to have this business age gracefully and continue to generate lots of cash flow, and we expect that to happen into the future.

Okay. Great. Maybe shifting gears to Optical Communication. The business obviously came under some pressure back half of last year. Can you talk about where we are currently? Where are the pockets of weakness and strength and same thing around pricing and inventory for Optical as well?

Sure. I think from an overall standpoint, the long-term trends in Optical in this stay-at-home policies definitely are very positive from an overall business standpoint. If you talk to our customers, you're seeing plenty of positive statements regarding their network constraints, their increased demand for bandwidth and their plans to continue to invest in 5G and in data centers. Telecom networks, whether it's a carrier or a hyperscale data center, tend to be built out about in an 18-month horizon. And clearly, right now, a lot of that 18-month horizon capacity is being used, which then means that each of our customers are evaluating when do they start investing again. And in addition to that, they have been dealing with some COVID-19 restrictions in terms of how their workforce can be deployed and the like. So it varies kind of customer-by-customer, but I think from a longer-term trend standpoint, that all feels very strong from a business standpoint. The place that isn't as strong as you'd expect it would be is not a surprise, is in the small and medium business enterprises and even some of the corporate customers that are constraining investments until they have a little bit better understanding of what's happening from an overall business stand point. But I'd say carriers and cloud computing feels stronger, some of enterprise customers maybe not as strong. But from a longer-term standpoint given what we've experienced over the last couple of months and expect to for the next couple of years, all of it points to the need for scaling network capacity and making investments in technologies like fiber-to-the-home, 5G and cloud computing.

Tony, on 5G specifically, right, we heard actually not so long ago, just now as part of our tech conference from Nokia CEO as well, very bullish on sort of the longer-term 5G potential. Can you talk about 5G specifically as it pertains to Corning? And how should investors think about what the optionality that 5G brings to the business model is?

Well, I mean, I think over the longer-term period of time, and that's 3, 4, 5 years, 5G we believe will be as big as fiber-to-the-home, maybe even bigger. And if you go back to our Investor Day last year, we showed a couple of slides about how 5G really takes -- deploys an architecture which is so much more fiber-rich than the current wireless architecture. I mean -- and I think we even showed one city map that had like 100x as much fiber deployed in that city than the current 4G wireless infrastructure. So we absolutely believe that the best way to connect to get 5G is a lot of cells and cell towers, and connecting all of that requires fiber. So we are -- we would agree with the Nokia CEO that there's lots of good potential in the longer-term for Corning with 5G.

Tony, on Environmental Technologies, clearly, I mean, auto volumes have been pretty challenged here with COVID. But you've spoken in the past about how Corning has these levers around content. So can you talk about within Environmental, what those content levers are? And how do you overcome some of the negative mix associated with EVs, if there is a negative mix that you perceive?

Sure. I mean, I think from a big picture standpoint, the need for clean air technology, I think, is becoming even more and more evident over time, and lots of countries are dealing with that and introducing new regulations. I mean Europe last year and China is in the process of doing that and really driving our gasoline particulate filter products, and that is a big content story for us. And as you know, we believe that we get that to at least $0.5 billion in sales as those regulations get adopted. And in addition to that, I think during this COVID crisis, it's become more apparent that having cleaner air is very important from an illness standpoint. And there was the Harvard study at the School of Public Health that connects fine particulate air pollution with the higher death rates from COVID-19 in the U.S., and that's exactly what GPFs are designed to deal with. I think from an EV standpoint, I think what you -- what we've talked about in the past and you have to keep in mind is, is that most movement to -- away from gasoline engines are actually to hybrid vehicles. And hybrid vehicles actually require more pollution control content than less. And the reason is, is because it's where a lot of that pollution occurs is at the very beginning of the start-stop. And you get a lot more start-stop in a hybrid vehicle than you do in just a traditional gasoline vehicle. And so as we look out, we actually see that we'll see greater content as the decade progresses and as the types of cars that are being built change.

Okay. Great. Maybe on Specialty Materials, can you talk a little bit about what you see as the near-term impact from what's happening with smartphone volumes? And what sort of pricing trends have you seen for cover glass? There were some, I guess a couple of years ago, there was some intent to move lower into the smartphone market with cover glass. Is that something that you see still as value-add? And I'll throw in one more thing in there. Just on the auto glass opportunity, can you just talk about how you see that progressing as well? And what impact that can have on the margin structure?

Sure. Let me start with the smartphone market, which is, of course, the biggest driver of Gorilla Glass for us today. I think coming into the year pre-COVID, most observers thought smartphones would be flat to maybe up slightly in terms of units. And now I think most observers are thinking it will be down somewhere in the mid-teens. Of course, it's hard to know for sure, much like the other markets, we are tracking closely, in particular what's happening in China as the first place to shut down and the first place to open back up. And as we see some of the data in the first quarter was clearly down on a year-over-year basis. But in April, it was actually up. Now it's preliminary data, and it's hard to know, was that pent-up demand from the first quarter in the month of April and the like. But that's the kind of information and the kind of data that we've been tracking. We still believe in the long-term ability for us to double sales in this business. And a lot of that is a content, more Corning story. And some of that content does come from having -- being more competitive in the lower end markets and lower end models, the more value models. And we've made actually good success on that over the last 18 months, in particular, in India. In other emerging markets, it's -- we made some headway in China. It's been a little bit more difficult with the variety of the trade issues, and now it's hard to get into, sometimes to do the commercial relationships in China. So maybe not as much success there as we'd like, but we still see that as a very good opportunity. But it's really the innovations and technologies that we're bringing to bear that is what's going to cause that market -- for us to grow considerably faster than the market and be able to double our sales. And a good example of that is some of the antireflective, antiglare glasses that we've been providing on wearables, is being a good example. And of course, another good example was the announcement that we made last October along with Apple, in terms of their continued investment in our technologies and how they're going to deploy that into the future. In terms of the auto glass opportunity, well, clearly, things have slowed down because the automotive market has slowed down. But I think the long-term drivers in that business really haven't changed and we believe that once the automotive market picks back up and people start -- not only do people start producing cars, which will happen in the near term, but people buy those cars that are being produced. We think that all the reasons in terms of connectivity and the advantage from a display standpoint and the need to have those displays being antireflective and antiglare and the value propositions that we bring there, we think that, that all continues to be a real positive. From a margin standpoint in that business, of course, the glass will be at glass margins. In some cases, we'll be processing that glass, and those -- that may be at relatively smaller, lower margins, but it is also less capital. So from a return on invested capital standpoint, we feel good about that.

Okay. Great. And then on Life Sciences, Tony, so clearly, you've had some exciting announcements around Valor Glass. Can you help us think through -- I mean, this has sort of been more of a stable business, but where is the growth opportunity here? And do you see that coming sort of faster than previously thought given COVID?

Yes. I think that first, before I get to the Valor Glass piece, our traditional Life Science business has been negatively impacted by the closing of nonessential laboratories, but we've also seen an increase in demand for consumables used in COVID testing applications. So on the whole, I think we think that business is holding up pretty well. But for sure, the real exciting piece of this is in Valor Glass. And as you know, last week, we announced jointly with Pfizer the execution of a long-term purchase-and-supply agreement for Valor. It's a multiyear agreement that provides for the supply of Valor Glass vials to a portion of their currently marketed Pfizer drugs, pending regulatory approval. So from that standpoint, I think we feel very good about that. And I think from an overall standpoint, we think that this could be maybe the opportunity where Valor Glass accelerates. It is a product that is much safer from a packaging standpoint. You don't have laminates that end up being in your drugs, and you also don't have the through-crack problem where your drugs could become sterile. But equally as important is the increase in throughput that you get from a manufacturing standpoint. And that clearly becomes very important, especially if you've got a high-volume drug or a high-volume vaccine that you're focused on. So we are working with a number of customers. Pfizer, last week announcement, just being 1 example of those, and clearly people that are working on vaccines. So it's hard to know for sure that this is going to be kind of a change point. As we've talked about in the past, exactly the pace that this business will pick up is hard to know, but we think we've definitely got the right product. And I think that we'll see more of that over the next 6 months.

Okay. Great. We're getting pretty close to the end of time here. So let me hit on 2 or 3 things really quickly, Tony. Gross margins have been under pressure from lower volumes, especially in Display. Can investors expect Corning to be a low 40% gross margin company? Or will the faster growing, lower-margin businesses continue to pressure gross margins? And I have a couple of cash questions.

Yes. No, I mean I think the main issue from a gross margin standpoint is what's happened with our volumes. We have a lot of operating leverage, and that hurts when volumes go down. Of course, it's great when volumes go up, but it hurts when volumes go down. We have a very high fixed cost structure. And in addition to that, we're in the process from a cash standpoint of building less products than we're selling. So when you add those 2 things together, that does create a lot of margin pressure. You saw that in our Q1 margins, you'll see that in our Q2 margins. But the capital's in place, and our fixed cost structure is in place, and so when that volume does return, our gross margins will expand.

Okay. And just quickly on cash, how should investors think about peak and trough cash flow that this business model can drive? And then maybe to wrap it up, can you maybe summarize, from your standpoint, what do you think is misunderstood about the company and why investors should invest in Corning?

Sure. I think from a cash flow standpoint, we always tend to think about our cash flow split between operating cash flow generation and then the amount of capital spending that's required in the business. I think from an operating cash flow statement, I mean, all of that gets better and gets to the levels which we had operated before when the sales return, because it is a -- it's a highly -- we have a high operating leverage business. And that includes at the end of the day, not only impacts our gross margin, but more importantly, our operating margin and our operating cash flow. And then from a capital spending standpoint, I mean, we have a certain amount of capital spending that we need to reinvest to be competitive in their existing businesses, but a lot of what we've spent over the last several years have been about new growth opportunities. And so I think it's always important to think about those in 2 separate buckets, and most of those growth opportunities have been invested in. And so when those sales return, unless there's additional growth opportunities out into the future, which there will be, but maybe not in the nearer future with maybe the exception of Valor, you're going to see capital spending at levels less than they have been in the last couple of years. And then I think from an overall standpoint, in terms of Corning and how to think about the company. The way I think about it, we know what we're doing. We're leaders in nearly all of our businesses in terms of technology and cost. We invest to extend those leadership positions. We're real innovators. We build trusted relationships with industry leaders, so they turn to us to help solve their challenges. And that gives us the ability to improve our knowledge, reapply our capabilities and make sure our customers are more successful. And that's why we're in industries for decades, I mean, literally decades. And the places where we're positioned today are well positioned for growth. And we've talked about those, whether it be in Optical Communications or getting the stability in Display for strong cash flow generation or the growth that we see in the automotive market, the growth we see in mobile consumer electronics or the growth now that's becoming more apparent in Life Sciences with Valor. But then I think the thing that is important and the reason that we've talked more about kind of some of our financial structures and -- is just to remember that we are absolutely built to last. Across 3 centuries, we've navigated through natural disasters, world wars and economic catastrophes. So we know what to do to get through these uncertain times. And given our long-term growth drivers and thinking about the lifestyle changes that are not going to be temporary, the physical distancing and remote work that requires expanded network capacity and sophisticated communications solutions, the focus on fine particulate pollutions and safe delivery of vaccines, I mean it really has a very bright future from a Corning standpoint.

Great. Well, Tony, unfortunately, we're out of time. So really appreciate all your time over here, and stay safe and look forward to speaking to you soon.

All right. Thanks, Wamsi. You stay safe, too.

Thank you.