Corning Incorporated (GLW) Earnings Call Transcript & Summary

Hi, everybody. I'm Meta Marshall. I head up the networking coverage here at Morgan Stanley. We're pleased here today to have Corning with us. We have Jeff Evenson, Head of Strategy at Corning, and Ann Nicholson is also present as well, who heads up IR. I'm going to start with the disclosure. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. With that, Jeff, is there any disclosure you wanted to read briefly?

Thanks, Meta. I just wanted to remind everybody that I will be making forward-looking statements. We have various disclosures on those on our website. And unless I say otherwise, I'm probably talking about core sales and EPS.

Great. Perfect. Well, I appreciate you being here virtually with us here today as we kick off the conference. So maybe starting with -- Corning has been committed to your 3-4-5 Strategy for going on probably 5-plus years now. How does that clarify some of the investments that you've made over the past 5 years? And as time passes, how is that strategy maturing?

Yes, 3-4-5 is both an economic model for us and an innovation model. As I think most people know that 3 is 3-core technologies, the 4 is 4 manufacturing and engineering platforms. Those go together because at Corning, we're innovating just as much on processes as we are on the materials formulations. Those are -- often go together to produce some of the distinctive properties. The economic part of it comes because we can repurpose, reapply, reuse. And we believe, over time, that's going to increase our probability of success, reduce our cost of innovation and allow us to bring really distinctive combinations to our customers. Right now, we're focused on applying those in 5 market access platforms, but we are really good at pivoting to bring new combinations to bear on behalf of our customers. I think auto glass is a great example. In auto glass, we're now bringing our optical physics, our glass science, fusion processes, how we strengthen glass, precision forming in a unique combination for the industry that addresses the real need that auto designers have as they move toward differentiating their cars based on the interior and making them more like smartphones. So I think that's a great example. What we were able to do with Guardiant, using our glass ceramic innovations and iron exchange to bring an antimicrobial that we've now shown, kills SARS-CoV-2 as well as many other bacteria and viruses. And we're offering that in a paint formulation. That's something that we're really able to focus on as part of the world's response to the current pandemic.

Got it. Some of your smaller markets or maybe kind of what you would consider not your largest markets like Life Sciences have really come to the forefront as a relative opportunity. How does that inform kind of the investment priorities between maintenance, surefire growth and kind of longer-term bets?

Yes. I think that right now, we are fortunate to be addressing multiple important trends really in each of our market access platforms. I think the good news is that because of the relevance of the 3 and 4 that I just talked about, we can often make it very far on innovations for relatively low investments. And that gets around some of the prioritization decisions that you might have to make very early. Instead, our prioritization decisions come more at the point that we have to build capacity because we've been so successful that demand has increased. The way we derisk that decision is we really require a customer commitment, and we're very disciplined around that. You saw us announce in the fourth quarter that we had received $15 million to expand pipette production for COVID-19 diagnostics. $15 million is not a lot of money, but I think that it shows the philosophy and the rigor with which we're applying it. And I think one of the things that people don't really recognize about us is how adherence to the focused portfolio, using combinations of the 3 and 4 has changed our ability to pursue long-term growth initiatives in a much more cost-effective way than Corning could do 20 years ago when I was starting as a consultant at Corning. I'll give you a couple of examples of that. One is quantum communications, where I think that's an exciting opportunity long term, but there are not a lot of sales today. Pretty much every quantum communications record has been set on our fiber. And we have a very active research program. We're working with lots of the leading groups in both quantum computing and quantum communications. We're able to do that because the work that you need to do fits exactly with what we're doing in ultra-low-loss fiber. And work we've done for quantum communications has helped us make advances that we're selling commercially today. Similarly, carbon capture is -- offers huge benefits for the world. I hope it's a long-term successful program. We are a leader in supplying the substrates for carbon capture technologies. We supply that using extra capacity we have during downtimes in our environmental technology kilns. So those are a couple of examples of how we are able to go after long-term opportunities that give us benefits in the short term. And when we can do that, it's a win for everybody. And now it's part of the thinking behind introducing 3-4-5. So we're trying to get rid of what used to be a big decision. And a mutually exclusive choice is we can do kind of both end.

Got it. And we got a chance -- the sell-side community had a chance to see that carbon capture technology last year, and it really was pretty fascinating. So shifting back to Display. There's been a lot of confusion on the demand side over the past year as Korean set maker shut down panel facilities, BOE kind of stopped some investment in LCD. And then on the supply side, there has been a competitor experiencing production disruption. What is the secondary impact to glass demand beyond just kind of normal seasonality right now?

Well, I would say glass supply is very tight that in the first quarter, we expect pricing to be flat with the fourth quarter of 2020. And if you look at that in a historical context over the last decade or so, right now is the most attractive first quarter pricing environment that we've seen. So I think that demand is stronger than normal seasonally because glass supply is so tight, and pricing environment more attractive than you would expect from historical averages as well.

Okay. Perfect. And so we've heard that we've had a year of kind of macro disruption due to COVID, obviously, but there's still been a lot of demand for TVs, for screens. What do you see with volumes in 2021? Do you still expect kind of a normal year where size kind of -- size of devices kind of mandates kind of how much greater the volume increases will be? Or just kind of what type of seasonality could we see on the volume front in 2021?

We expect glass to be up in the mid-single digits year-over-year. That results from continued strength in unit demand for TVs. We expect diagonal size to keep increasing. I think diagonal size is in the mid-40s overall. Do you know the number from 2020, Ann?

I think it's actually 48.

48 inches. It's -- I think as we move to 4K and 8K, significantly larger sets are very attractive. And also, there is just the supply chain capacity and inventory situation that probably keeps demand up throughout the year kind of regardless of what happens at the retail level. So I think that we have multiple drivers of continued tightness and growth in 2021.

Great. Turning into Optical, investors realize that networks need to get more fiber-rich. However, kind of the timing of that demand has kind of created some questions in the market. How do you think about how visibility has changed as we start to emerge from COVID? And how have the disruption over the past 18 months kind of informed how you forecast that business?

Yes. Growth has returned in Optical and we think it's here for the foreseeable future. Sort of middle of last year, we started seeing comments from customers on their expectations for increasing investment in our optical networks. The difference is, starting in the fourth quarter, we saw those statements begin to materialize as new orders on our books and a higher run rate for Optical Communications, that continues. The nature of our conversations has changed pretty fundamentally over the last 6 months with multiple Optical customers. And we're seeing good demand on both the carrier side and the cloud data center portion of enterprise.

And just in terms of visibility, do you feel like you have a greater sense of visibility than maybe you did 18 months ago or -- in terms of time line? Or is it still -- do you feel better about it, but visibility is still kind of difficult to determine on a quarter-on-quarter basis?

Yes. I think -- so visibility in Optical Communications is good, early in programs because they're early in programs. As you get to the end of a program, exactly when they stop, it tends to be hard to call. And I think what has started in sort of in the fourth quarter is that we've seen customers get back into their programs. So we feel good about them sustaining them for some longer period of time. So I do feel visibility is better than it was 18 months ago. And I think that you always have the context in Optical Communications of their good underlying long-term demand because bandwidth is growing, the shift to cloud continues, customers are asking for more capable access connections. All that's good news for us, and I don't see that slowing down anytime soon. Exactly how that translates to what customers are doing in their networks is the question. And I think right now, visibility is better, and we're in the early stages of programs, which is usually good news for sustained growth.

Got it. And I just want to remind the audience that if you have any questions, send them through the global meet platform, and I have them up on the screen here and can ask them throughout the call. Maybe turning back to Valor for a second. There's been a lot of interest right now on vaccine glass. Your glass pre-pandemic was set to be approved kind of on a drug-by-drug basis by the FDA. Just how do you see kind of the Valor Glass business developing post-vaccine and kind of over this vaccine time line?

There's been no change in the way that our packaging gets approved. It has to be done on a drug-by-drug basis. I think that, that becomes easier as regulatory agencies get more familiar with our technology. The value proposition of Valor has been illustrated to the pharmaceutical and biotech industry as a result of COVID. I think that bodes well for us long term. We are expanding our capacity with a significant portion of that expansion getting funded by the U.S. government. So I think that we feel really good about our progress. I think in terms of material revenue, that's more of a 2023 expectation. And you just have to remember, for right now, we are scaling capacity and doing it as rapidly as we possibly can. We've already shipped vials sufficient for over 100 million doses of the COVID vaccines. But remember that each vial holds 6 to 10 doses. So there maybe aren't as many as people would have in their back of the envelope calculation.

Okay. And is there opportunity for Valor Glass to kind of be used outside of the U.S.? Or just how do we think about it becoming more maybe post vaccine just being used kind of outside of FDA approval, kind of some of the other approvals you might need globally?

Yes. We think Valor Glass and Valor Glass technology needs that apply globally. We began our regulatory filings in the United States. We have, at the end of last year, submitted the core regulatory filings in Europe. But so far, we've only been approved in the United States.

Okay. Got it. The Specialty Materials business has had a great year, not only just because we're in kind of an iPhone upgrade cycle, but the development of new materials for Apple, the Ceramic Shield. As we think about specialty growth going forward, how much of it is still just glass for devices and getting you on more devices versus kind of higher generation Gorilla Glass and kind of the additive properties there?

I think both will still be powerful levers for us. I think that which one is the most powerful lever will depend on the year. Certainly, last year, when unit volumes for smartphones were down mid-single digits and we were up 18%, a lot of that came from that we appropriately share in the value that we create for customers. I think as we look forward, Specialty Materials has the primarily cover glass oriented segment, where there are opportunities in wearables, there are opportunities in the IT segment. And we can just keep advancing the performance of our products for smartphones. I think 5G creates a need to have more glass or glass ceramics on the devices. And then I think the other part of Specialty Materials Advanced Optics has really interesting growth opportunities as well. Last year, EUV-related components were very attractive for us. We're the leader in the core materials for the lenses that go into EUV. And over time, I think augmented reality devices could be a really exciting segment and we have multiple products that go into augmented reality devices. So I think lots of interesting underlying growth potential in our Specialty Materials segment.

Got it. I think laptops and kind of some of these 5G devices that people just don't think about, like on a relative sense, how much is a -- I guess, what is the content that goes into a laptop versus kind of your standard single-pane, not double-pane smartphone?

I don't know the ratio off hand. I'll tell you how to think about it. One is that a laptop has different strength requirements than a smartphone and there's a lot more. So that would probably -- those lower requirements would probably tend to reduce your ASP, but the area is much higher, which would increase your ASP. And do you know how to give a better ratio? I don't -- they're both attractive segments. And it always depends what you're selling into them. Sometimes for laptops, we're actually making the part, which would make it much more attractive overall ASP for us. But the steps that you go through to convert pristine piece of technical glass into a cover are more socialized than the piece that goes into making the glass itself. So it's a lower margin opportunity.

Got it. I think -- yes, I thought at one of your events at some point, it seems like it can see upwards of multiples of ASP difference once you get into kind of some of those...

But even within handsets, there's meaningful differences in our price, depending what generation of Gorilla we're selling, depending on the -- whether they're using front and backs. So could you find a laptop where we do $20 of content? Yes, absolutely. Could you find a handset where we're doing $20 of content? I can't think of one.

Yes, all right. Enough of the trick questions on my front.

Maybe by the end of my career, some of these ideas we have work out maybe.

Yes, exactly. It would be a very big phone and it will be indestructible. All right. So autos has moved from maybe a future growth driver to a real growth driver or a material growth driver in 2019 as your inside cabin business started to scale. This driver got lost a little bit in kind of the auto production disruptions in 2020. But how do you think about the scale and growth of this business? And what kind of additional visibility do you have just by the fact that these can kind of be 3-, 4-, 5-year platform cycles of -- in autos?

Yes. We were very happy with our progress in auto glass in 2020. We now have our plant in Hefei operating at close to full capacity. We're pleased with the way that ramped, and we are having good success commercially. So all the things that you'd want to see happening in a new business are happening there. Despite the lower auto sales last year, we had very significant growth in auto glass, which, in a way, is demonstrating the power of more Corning that we aren't counting on people just buying more cars. We're counting on the cars that they buy having more Corning content. The way I think of it is in 2017, our addressable market per car was somewhere around $15. We were selling the substrate for catalytic converters. Some were a little lower, maybe some were a little higher, but $15 was a pretty good opportunity. When gas particulate filters began in -- at the end of 2018, that suddenly increases our addressable market per car to the mid-40s. And with the advent of center console, other materials that we -- glass materials that we see for cars on exteriors, covers for LIDAR sensors and things like that. That adds more than $50 a car. So we think right now, the total addressable market per car, we could argue, is $100. And in fact, there is one care you can buy that has more than $100 of Corning content in it. So I think that, that is really showing our mindset of why we organized around market access platforms because we want to take the knowledge that we have of customers, take their road maps and then understand how we can best support them by bringing unique combinations of our 3 and our 4 to bear. And I think we have lots to do in auto beyond the $100 that I talked about.

Got it. Okay. Spending the last few minutes on financials. Corning, along with a lot of other organizations, underwent some cost-cutting in 2020 to improve operations in light of kind of macro disruptions. Are there still areas where you believe you can create cost savings to improve leverage? And then how much of that leverage continues as demand comes back?

Sure. If I think about last year, our cost cutting probably decreased our expenses by about $200 million annualized, and about half of that was we cut compensation -- cash compensation to most employees and that, we've restored. So half of that is going to be reabsorbed this year. Now I think we have -- we'll have much higher sales this year. We're going to grow. So -- but I think everybody should be aware of that. The other half, I think those were changes where we just got more efficient. And while I think you should expect our operating expenses to grow more slowly over time than our sales, so you'll see some leverage out of that.

Got it. Another area that you've cut in 2020, you've cut CapEx a fair amount, removing some of the maybe growth projects or kind of longer-term projects. How does that change? How do you think about that investment returning? And just how has any of the ROI thresholds change that they have?

So we expect CapEx in 2021 to be similar to the CapEx in 2020. It's possible that in the second half of the year, we would get additional customer commitment that we would need to build additional capital for. If that happens, we would come back and tell you what the nature of those customer commitments is and why we're doing it. I think that would be great news. When we build additional capacity, we are typically seeing at normal utilization that we would expect when the plant's full that we would get ROIC on our new investments in the vicinity of 20% or a little bit higher. We did not see those materialize in 2020 because utilizations were low. I guess the benefit of that is we don't need to invest significant capital at the moment to build. I don't think that our criteria for investing in new capacity have changed other than our adherence to really get strong customer commitments and make them stronger the more limited we think the customer demand for a product is. You -- I talked about the pipette tips, the $15 million. Other prominent examples of that recently would be Verizon, Apple's investment for Ceramic Shield.

Okay. Great.

Well, the capacity we built in Display.

Okay. Got it. You noted at kind -- at the -- on Q4 earnings that you feel comfortable being opportunistic with share repurchases again in 2021 after pausing in 2020. Just how do you think about current balance sheet utilization and just priorities set out in the 2020, 2023 capital return plan?

Yes. Our balance sheet continues to be very strong. We ended the year with $2.7 billion in cash after generating $948 million in operating cash flow last year. We expect operating cash flow to grow in 2021. We think we've reached a point where we can continue to meet our top priorities of investing in our organic growth and still return additional cash to shareholders. You saw last month, our Board increased the quarterly dividend by $0.02 to $0.24 per quarter, and we'll give you updates on our plans with respect to share repurchases as the year moves along.

Got it. We got a question from the audience of just -- of the -- you talked about the $200 million of cost savings, $100 million of that being kind of variable comp that's come back and then the other $100 million being areas where you could be more efficient. Is any of that -- the question is just are any of those volume related so that if you're back to kind of 2019 volumes or 2018 volumes that -- in certain segments that a part of that $100 million would come back?

Some comes back. There's certainly some volume-related things in our manufacturing facilities for sure. But I think that we've made other changes in operating expenses, in SG&A and RD&E that would be much, much slower to come back.

Okay. Got it. And then maybe just last question for me. Free cash flow generation will likely be up in 2021 versus 2020. Just how do you think about M&A? How do you think about just that piece of the kind of capital strategy and priority?

Yes. We are always looking for bolt-on acquisitions, particularly in Optical Communications and Life Sciences. I'd say in the near term that we may have some of those. And I think there are a few places that are small opportunities to increase the focus of our portfolio go through divestitures. I wouldn't expect any -- if we do a few small deals a year, either acquiring or divesting, I'd expect that to be the case for the next few years as well.

Got it. Perfect. Well, with that, we're at time. And so Jeff, Ann, thank you so much for being here today, and it was great to catch up.

Nice to see you. Take care.

Thanks, Meta.