Corning Incorporated (GLW) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Corning Incorporated Second Quarter 2020 Earnings Conference Call. [Operator Instructions] I would now like to hand the conference to your speaker today, Ann Nicholson, Vice President of Investor Relations. Please go ahead, ma'am.

Thank you, Joelle, and good morning. Welcome to Corning's Second Quarter 2020 Earnings Call. With me today are Wendell Weeks, Chairman and Chief Executive Officer; Tony Tripeny, Executive Vice President and Chief Financial Officer; and Jeff Evenson, Executive Vice President and Chief Strategy Officer. I'd like to remind you that today's remarks contain forward-looking statements that fall within the meaning of the Private Securities Litigation Reform Act of 1995. Those statements involve risks, uncertainties and other factors that could cause actual results to differ materially. These factors are detailed in the company's financial reports. You should also note that we will be discussing our consolidated results using core performance measures, unless we specifically indicate our comments relate to GAAP data. Our core performance measures are non-GAAP measures used by management to analyze the business. Reconciliation of core results to the comparable GAAP value can be found in the Investor Relations section of our website at corning.com. You may also access core results on our website with downloadable financials in the interactive analyst center. Supporting slides are being shown live on our webcast. We encourage you to follow along, and they're also available on our website for downloading. Now I'll turn the call over to Wendell.

Thank you, Ann, and good morning, everyone. This morning, we reported second quarter 2020 results. Sales were $2.6 billion. Net income was $218 million, EPS was $0.25, and free cash flow was $285 million. All increased sequentially. I have 2 primary observations on the quarter. First, we're effectively adjusting to this period of uncertainty with decisive action and operational execution. We're generating positive cash flow and maintaining a strong balance sheet. Second, even in these uncertain times, our strategy to deliver for our customers and outperform our markets is working. We're continuing to lead in the capabilities that make Corning distinctive. In fact, we advanced multiple growth initiatives during the quarter. Let's consider the first observation in more detail. In the second quarter, we completed adjustments to our operating plan and continued to execute across the board by delivering operational improvements that will generate significant cost savings through 2021. We delivered sequential growth in sales, EPS and free cash flow. We also completed the vast majority of our anticipated restructuring, including the reprioritization of R&D programs. We believe we're continuing to position Corning for strong long-term growth and improved profitability. Turning to my second observation. Our long-term strategy is sound and our growth drivers are intact. As I've said before, we're not just counting on everybody buying more stuff. We're putting more Corning into the products that people already buy. This provides a mechanism for us to outperform our end markets even in challenging environments. The relevance of our focused and cohesive portfolio remain strong and is actually increasing. Some of the secular trends benefiting us could accelerate as consumer lifestyles continue to adapt in a world with social distancing and as health care companies advance solutions to end the pandemic. There is a need for expanded network capacity and ubiquitous displays as people spend more time online. Safe widespread delivery of vaccines are among society's top priorities, and reduced fine particulate pollution appears to be helpful for reducing infection rates. All these needs fall directly within Corning's mission of improving lives through innovation, and we are well positioned to contribute. The progress we've made and the leadership position we leveraged across our markets in the second quarter speaks for itself. Let's take a closer look. In Life Sciences, we're mobilizing our capabilities to combat the virus wherever we can. Glass packaging is critical to the COVID-19 vaccine effort, and it is currently in short supply. Our Valor Glass innovation helps enable faster filling line speeds and increased patient safety. Valor Glass was selected by the U.S. Department of Health & Human Services and the Department of Defense to accelerate delivery of COVID-19 vaccines, and Corning was awarded $204 million in funding to expand Valor manufacturing capacity. 3 leading COVID-19 vaccine producers have entered supply agreements for Valor Glass. And we're also working with several other potential customers to capture additional opportunities. Additionally, we announced a long-term supply agreement with Pfizer to provide Valor Glass for currently marketed drugs in their portfolio. Our Life Sciences segment entered several long-term agreements with major customers for COVID-19 molecular diagnostic testing and antibody detection kits in quarter 2. We're seeing strong demand for these products currently, and we expect to accelerate shipments further in the second half. In Mobile Consumer Electronics, our Specialty Materials segment delivered 13% year-over-year sales growth while the smartphone market declined year-over-year. Our performance was driven by strong demand for premium products, and we announced 2 exciting milestones. Gorilla Glass has now been used on more than 8 billion devices worldwide. And we maintained our industry leadership with the launch of Gorilla Glass Victus. This is the toughest Gorilla Glass yet and features significantly better drop and scratch performance than any other Gorilla Glass or competitive glass from other manufacturers. Samsung will be the first customer to adopt Gorilla Glass Victus in the near future. In Automotive, our Environmental Technologies segment outperformed in a weak market. Strong adoption of our gasoline particulate filters continued, driving their sales growth to more than 20% year-over-year. Turning to Optical Communications. Corning grew sales 12% sequentially, driven by carrier network projects. We announced a collaboration with EnerSys to speed 5G deployment by simplifying the delivery of fiber and electrical power to small-cell wireless sites. We also announced that we're working with Qualcomm Technologies to deliver indoor networks that are 5G ready, easy to install and affordable. The Corning systems are expected to be among the first designed to deliver 5G and our capability over millimeter wave spectrum in the indoor segment. This includes enterprises such as offices, university campuses, hospitals, hotels, retail outlets and more. Our collaboration will enable a small footprint and low-power consumption platform for true high-bandwidth 5G for in-building networks. Customer deployment will begin in the fall. In Display, Corning generated consistent sequential net income as customer demand remained steady. And large screen TV sales continue to drive demand, supporting the opening of our Gen 10.5 facilities. Across our markets, you can see that we're successfully advancing our long-term growth initiatives. Additionally, near-term market conditions have improved. Auto factories are resuming operations in North America and Europe. And auto sales in China have returned to pre-pandemic levels. Telecommunication service providers and data center operators have resumed sending their technicians into the field, and they're rethinking their network needs to address greater demand for their services. Life Science labs are slowly reopening. We also expect television demand to remain resilient as in-home entertainment is more important than ever. And the demand for computing devices will be boosted by work and learn from home. So we're seeing some encouraging developments across our industries. On the other hand, disruptive forces from the pandemic, the civil unrest, to a worldwide recession and geopolitical struggles all remain in play, and they create uncertainty. We are united as a company to remain vigilant and adapt appropriately. We're rising to the challenge. I'll now turn the call over to Tony so he can give you some more detail on our quarter and our near-term outlook.

Thank you, Wendell, and good morning. We came into this economic downturn with a balance sheet built for times like these, and we took actions during the quarter to ensure we have the financial resources needed for the duration. We generated $285 million in free cash flow, exited the quarter with $2.2 billion in cash and are on track to generate positive free cash flow for the year. Our financial position is strong. We are becoming more efficient, and we have the capacity in place to meet expected growth with minimal investment. We expect improved profitability and return on invested capital as we grow sales. As the quarter progressed, demand and visibility improved. We maintained our leadership across all of our market access platforms. As a result, we expect to grow sales and profits in the third quarter. As we said on our first quarter call, we've made aggressive adjustments to align our cost and operating plan with the lower anticipated sales. These actions were essentially completed in the second quarter and fall into 4 broad categories: reducing production levels across most of our businesses; adjusting operating expenses, with the majority of the savings to be realized in the second half; modifying inventory plans; and reducing capital expenditures. As a result, we expect $200 million in annualized cash savings. We reduced inventory by $120 million in the second quarter, and we reduced our CapEx by half versus Q1 to $288 million. We expect Q3 and Q4 CapEx to be consistent with the second quarter. We had strong operational performance with sequential improvement in sales, net income, EPS and free cash flow. Second quarter sales were $2.6 billion, up 2% quarter-over-quarter. Net income was $218 million, up 23% quarter-over-quarter. And EPS was $0.25, up 25% sequentially. And free cash flow was $285 million. Now before I get into further details of our performance and results, I want to note that the largest difference between our GAAP and core results stemmed from restructuring charges of $254 million, which was primarily noncash and included the reassessment and reprioritization of R&D programs. Other differences between our GAAP and core results come from a noncash mark-to-market adjustment for our currency hedge contracts. With respect to mark-to-market adjustments, GAAP accounting requires earning translations, hedge contracts and foreign debt 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. To be clear, this mark-to-market accounting has no impact on our cash flow. Our currency hedges protect us economically from foreign exchange rate fluctuations and provide higher certainty for our earnings and cash flow, our ability to invest for growth and our future shareholder distributions. Our non-GAAP or core results provide additional transparency into operations by using a constant currency rate aligned with the economics of our underlying transactions. So we're very pleased with our hedging program and the economic certainty it provides. We've received $1.7 billion in cash under our hedge contracts since their inception more than 5 years ago. Now let's review the business segments. In Display Technologies, second quarter sales were $753 million and net income was $152 million, both consistent with the first quarter. The Display glass volume grew by a low single-digit percentage sequentially as our Gen 10.5 customers bought more glass. Sequential price declines were moderate and as expected. As Wendell said, we expect that television demand will remain resilient as in-home entertainment is more important than ever and that demand for IT products will be boosted by work and steady-from-home trends. In the second quarter, worldwide TV sell-through units in Q2 increased slightly year-over-year, better than Q1 and better than the industry anticipated. Additionally, demand for notebook PCs was strong in the second quarter. Preliminary retail sell-through data for June and July indicate that demand recovery in China has held and that demand in North America and Europe remains robust, while emerging regions remain weak. While uncertainty exists around retail demand in the back half of the year, we remain confident that TV screen size will continue to grow in 2020 and beyond. TV's 65-inch or larger grew almost 40% year-over-year in the first half. And we are well positioned to capture the majority of that growth with Gen 10.5, which is the most efficient gen size for large TV manufacturing. We continue to expect Display pricing to decline by a mid-single-digit percentage in 2020. We believe that 3 factors drive a favorable glass pricing environment: first, we expect glass supply to continue to be balanced to demand. For Corning, we are aligning our capacity with demand. We are also pacing our Gen 10.5 capital projects to align with panel makers' schedules; second, our competitors continue to face profitability challenges at current pricing levels; and third, Display glass manufacturing requires periodic investments in existing capacity to maintain operations. Glass prices must support acceptable returns on those investments. In Optical Communications, second quarter sales grew 12% sequentially to $887 million as major carriers increased spending on cable deployments and access network projects. Net income grew by $52 million to $81 million on the higher volume and actions taken to align cost and capacity. The year-over-year decline in sales was consistent with the passive optical market decline. We maintain our view that the long-term trend in optical is strongly positive. Bandwidth demand has accelerated during the pandemic, consuming network headroom capacity. Evidence of that demand includes: AT&T's report that WiFi calling increased 100%; Verizon's report that VPN connections are up 72% over pre-COVID levels; and Zoom surpassing 300 million users from 10 million in December. We expect carriers to expand capacity to meet growing bandwidth in the future, but the current environment makes timing uncertain. While network operators remain committed to their original capital plans for 2020, deployments are constrained by pandemic-related labor and site access constraints. We expect these factors to continue in the third quarter. Environmental Technologies faced a challenging market. During the quarter, OEMs temporarily halted production in both the automotive and diesel markets. To mitigate the impact, we swiftly adjusted our operations to pace with customer demand and reduced costs. Environmental Technologies' second quarter sales were $226 million and profitability was impacted by lower sales and production volumes. Our auto sales were down 31% year-over-year, beating the global auto production decline of 41 -- 45% year-over-year through continued adoption of gasoline particulate filters. The good news is that by the end of the quarter, auto sales in China returned to pre-lockdown levels, while North America and Europe OEMs began ramping production. In diesel, the anticipated cyclical downturn in North America heavy-duty truck market was made worse by shutdowns, with vehicle production dropping 73% year-over-year. Overall, we remain confident in our content and innovation-driven strategy in Environmental and expect to return to growth as markets improve through the second half and into next year. Specialty Materials sales were $417 million in the second quarter, up 13% year-over-year and in sharp contrast to the smartphone market, which declined year-over-year. Net income was $90 million, up 34% year-over-year. Sales growth was driven by 3 factors: first, premium glass demand increased in support of second half customer launches; second, work and study-from-home trends drove growth in our products for tablets and laptops; and third, the demand for advanced chips drove sales for our semiconductor equipment products. Looking ahead, we expect our outperformance relative to the 2020 mobile consumer electronics market to come from further adoption of our innovations. In Life Sciences, second quarter sales declined 7% year-over-year to $243 million. Net income was $31 million, down $9 million versus last year, on the lower sales volume. The business was impacted by the prolonged closure of nonessential laboratories, such as universes -- university research labs, particularly in the North American market. The impact has been somewhat offset by increased demand for consumables used in COVID-19 testing applications. Life Science lab reopenings picked up in late May and lab utilization has been steadily increasing since then. Going forward, we are confident in the opportunities ahead for Life Sciences and Valor, especially as we prepare for upcoming vaccine demand. Equity earnings were positively impacted in the second quarter as our Hemlock JV settled a contract with a solar customer. Going forward, Hemlock will largely sell products in the semiconductor industry. Hemlock's leadership position is backed by attractive long-term take-or-pay customer contracts with upfront payments. This creates stable revenue and profits and strong cash flow generation. Let's move to the balance sheet and our commitment to strong financial stewardship. We generated $285 million of free cash flow, a significant increase from the first quarter. We have $2.2 billion of cash, and we have a debt structure that is conservative by design and relatively unique. Our balance sheet is built for times like these. Today, our average debt maturity is about 25 years, the longest in the S&P 500. Over the next 18 months, we have under $70 million coming due. Less than half of our total debt is due within the next 20 years. And during this time, there is no single year with debt repayments over $500 million. Investors often evaluate credit and financial health based on total debt to EBITDA. For the S&P 500, the average company has a weighted average debt maturity of roughly 10 years, and more than 80% of debt is due within 20 years. Consequently, when investors calculate the debt to EBITDA, they are implicitly focusing mostly on debt due in the next 20 years. Corning's 20-year debt-to-EBITDA is 1.2x, consistent with an A credit rating and illustrative of the conservatism of our balance sheet. We expect to maintain a strong cash position and to maintain our dividend. As I've previously mentioned, we expect to generate positive free cash flow for the year. And we have paused share buybacks and do not expect to add material debt in 2020. So in total, we have a very strong balance sheet and we have the financial resources needed for the duration of the economic downturn. To wrap up, we had strong operational performance in the second quarter, with sequential improvements in sales, net income, EPS and free cash flow. As the quarter progressed, demand and visibility improved. This improvement has continued throughout July. As a result, we expect to grow sales and profits in the third quarter. However, we remain aware of the potential impact from the pandemic, the global recession, civil unrest and geopolitical tensions. So how much growth will depend on end market demand and economic activity during August and September? We will keep you updated as we move through the quarter. Stepping back, our underlying growth drivers are intact and we're successfully navigating the -- this crisis. As we grow sales, we expect improved profitability. Furthermore, we have the capacity in place to be able to meet the sales growth with minimal investment, which we expect to result in capital efficiency gains, including ROIC improvement. Altogether, this reaffirms our confidence that Corning is positioned to emerge from this crisis stronger than ever. Now I'll turn the call back over to Wendell.

Thanks, Tony. During the second quarter, we made great strides in positioning Corning to emerge stronger from the global health crisis and resume growth. Sales, net income, EPS and free cash flow all increased sequentially. Corning advanced multiple initiatives throughout the second quarter, including the launch of Corning Gorilla Glass Victus and continued innovation with 5G industry leaders. On the COVID-19 front, we continue to seek ways to leverage our deep technology, manufacturing and engineering capabilities to combat the pandemic directly. We were delighted that Valor Glass was selected by the U.S. Department of Health & Human Services and the Department of Defense to accelerate delivery of COVID-19 vaccines. Overall, our decisive action and operational execution resulted in positive free cash flow and continued leadership in the capabilities that make Corning distinctive. We're delivering for our customers. We're outperforming our markets, and we're preserving our financial strength. I'll conclude with an additional important development. For nearly 170 years, our company has been dedicated to creating innovations that have a positive impact on the world while conducting business in a way that has positive impact on our people and our communities. Now we have an opportunity to make additional contributions. We're setting up an office to further build racial and social unity within the walls of Corning and in our communities. Lewis Steverson, our Chief Legal and Administrative Officer, will lead this office. With that, let's move to Q&A. Ann?

Thanks, Wendell. Operator, we are ready for the first question.

[Operator Instructions] Our first question comes from Samik Chatterjee with JPMorgan.

Yes. If I can just start off with Display. You've talked about kind of demand being resilient on the TV side, but as we're looking at some of the data points from panel makers, they're guiding to a substantial improvement in panel shipments quarter-on-quarter going to 3Q or something in the magnitude of 20%. So wanted to get a sense of what you're seeing in terms of -- or hearing in terms of demand from your panel customers? Where does inventory stand? Because I think last quarter, you were a bit concerned about the inventory level going in.

Yes. Thanks, from an -- Samik, from an overall standpoint, the TV demand has clearly been resilient. The data points that we saw in the second quarter was the fact that either TV units were up on a year-over-year basis. And then by -- that was certainly better than Q1 and it was also better than, well, most people who are expecting as we went into the quarter. In addition to that, if you look at what happened in the preliminary data in June and July, I mean that data was also very strong. In China, you didn't see a change in that data, though that demand remained robust. And in North America and Europe, it was strong during the whole quarter and that continued. So, yes, I -- we think TV demand is resilient. And we also think the supply chain change is perfectly healthy. I mean we ended the year in a healthy supply chain situation. Of course, nobody knew exactly what was going to happen in the second quarter. But given what did happen in the second quarter and the way things are going now, we don't see any supply chain issues there.

Okay. And if I can just follow-up on the cash flow here. So you had a strong free cash flow quarter through the working capital improvements that you're driving. Just help me think about how sustainable those are as you start to kind of go through the recovery in terms of revenue. How much of that improvement is kind of something you have to get back as you burn working capital? Just to trying to think about kind of how does this impact your free cash flow conversion in the long run.

Well certainly a lot of that was by reducing inventory. We reduced inventory over $100 million during the quarter. And if you recall, over the last 18 months or so, as we thought our sales were going to be more stronger than they actually turned out to be, they actually built up a fair amount of inventory. So we think there's the opportunity to continue to reduce inventory. And then just from an overall operational standpoint, one of our real focus areas of the company is on inventory management and how to get better at that. So I think that at least that is sustainable for at least a couple more quarters. No doubt when we grow again, we'll have to consume working capital. The other thing that was a big improvement during the quarter, of course, was what happened on capital spending. And as you know, in the first quarter, a lot of that was the expansion capital ramping up on some of our biggest projects, such as Gen 10.5. And although we still have some of that that's going on, we reduced it significantly in Q2, and we'd expect Q3 and Q4 to be at those same levels.

I think stepping back and looking at free cash flow conversion. Fundamentally, when we're not in a build cycle, our free cash flow conversion is excellent. And that's where we are right now, right? So it's less really about the specific programs and specific things we're doing. It's more just since it takes us a couple of 3 years to build one of our major low-cost factories, there's a cycle where we invest for the future and it is that investment that drives down our free cash flow conversion. We're in a period right now where we've gotten ahead of that. So we're in a spot where we're just in a reinvestment stage. And if we work like that, we're going to have really high free cash flow conversion, and you can expect that to continue.

Our next question comes from Steven Fox with Fox Advisors.

Wendell, I was wondering if you could maybe step back and give us a bigger-picture view on the new Optical cycle. You talked about network headroom basically going away. And it sounds like site access is still an issue, but not as big of an issue. So if you wanted to think about maybe the next 4 to 6 quarters versus how you performed in the year or 2 before the downturn in Optical, how do we think about that under the sort of new world we're living in?

Steve, I think that's an excellent question. And to sort of balance up the known versus the unknown, and then try to come to a conclusion. On the known side, both our cloud providers as well as our network service providers, all are experiencing very strong growth, as you heard from Tony and you've heard from me during this call. That strong growth, and they see an opportunity for more revenue production going forward, and they see that fiber-based networks have -- are just lower cost. And you're starting to see some commentary, especially from the network providers, about how they can combine and merge all the various services on to one high-capacity fiber network and therefore open up lots of avenues towards revenue creation, all off one capital investment. So all that is stacking up for sort of powerful forces to put Optical Communications back in a cycle of growth. On the unknown side, real people have to install these networks. Real people have to show up to put in place these massive cloud-based data centers. And even though people are resuming putting technicians in the field, it is as -- at a much less rate than what it would be -- what would be needed to support historical build cycles. So we still have the pandemic here, and so that makes actual prediction just quarter-to-quarter what will happen to be difficult. But I think as you said, Steve, because that's what's behind the question, the fundamentals look really strong. Our market position looks really strong. We should be entering a growth cycle. Now we just got to see how the world deals with the pandemic.

Our next question comes from Asiya Merchant with Citigroup.

Great. Congratulations on a good quarter. A couple of questions. One just on Optical. There was commentary that the Optical segment performed sort of in line with the passive Optical market decline. And Wendell just talked about all the labor constraints, et cetera, that's going on. How should we think about -- Corning's always maintained their leadership across their end markets. When do we expect or when should we expect Corning to, again, resume growth that outpaces the broader market? And then I have another follow-up on capacity and margins.

This year, if we're doing our job. And that's the way we think about it. We should be outpacing the market, and we will get on with that post haste.

Okay. And then just on margins, if I think about -- obviously, you guys are making some progress here sequentially in the third quarter, that's the commentary. And typically, 3Q is up 5% or so on the top line and as the top line falls through the margins, et cetera. There's some investor confusion around how idling capacity should help margins. If somebody can walk us through the dynamics there. Typically, idling capacity would lead to perhaps a hit on margins. And how should we think about the margin improvements in the back half?

You're -- Asiya, you're correct. I think when we idle capacity, that does hurt the margins, especially if you're having less production than you're actually selling as you also take down inventory, which is, of course, what we did in Q2 and Q3. On the other side though, we did a lot of cost reduction efforts, and that ends up helping margins. And so we ended up in Q2 with margins very similar to what we had in Q1. On a gross margin level and then on an operating margin level, of course, we did better than that. So as we look forward, the key here is, is to increase sales. And as we put more sales through our factories and more sales through our OpEx structure, we'll see expansion in margins.

Our next question comes from George Notter with Jefferies.

I guess I wanted to ask about just the fundamentals in the Display business. I'm thinking more strategically. There's a lot of moving parts there, of course. You guys are pacing some of your investment in Gen 10.5. You've got pending exits of some of the LCD panel-making facilities in Korea. Certainly, we hear about CBC rumored to be for sale. I mean can you just talk about what you're seeing over there? And how that kind of plays into your dynamics strategically as you look forward?

Thanks for the question. What you've heard from us in the past really remains -- those fundamental drivers remain in place, which is we have been preparing for a number of years for the ascendancy of the Chinese panel-making infrastructure. And because of the particular way that economy works, that would leave what was the strongest region in terms of production, Korea, at a cost disadvantage. Once they made the decision not to go to Gen 10.5, that sort of was -- the die was cast. So that's why we have been on our investment cycle in China with 3/4 of the support coming from our customers or the Chinese government in one form or another. So those trends look like they continue to move in our direction. It all just happened a little bit faster than we were planning because Korea ended up -- Samsung specifically ended up making decisions a little faster than what was their original plan. So we don't really have all of our Gen 10.5 facilities up to support all that demand yet, and that's what we're working through. CBC, of course, is a strong customer of ours. We would expect our market position to continue to grow as the trends towards China continue and the trends towards our long-term strategic partners continue. Did that answer your question, George?

Very well, yes.

Our next question comes from Shannon Cross with Cross Research.

I was just curious, given the vaccine, and obviously, you've gotten some funding from the government, but just in general, sort of this push to move manufacturing back to the U.S. then and clearly, a significant amount of government dollars that are out there right now. If this has changed really your thought process on time line for Valor to provide meaningful contribution to the business.

The simple answer, Shannon, is yes.

Any idea of the magnitude of the pull-in of time line? [indiscernible] if you think about it.