Corning Incorporated (GLW) Earnings Call Transcript & Summary

Good morning, everyone. This is Asiya Merchant. I'm at Citi's Technology Research Group here with Jim Suva. We look at tech hardware, tech supply chain and telecom equipment. Very pleased to welcome Tony from Corning. He's the CFO there at Corning. And before we kick off with some questions that we've prepared, I'd just like to mention that we have disclosures that have been made available to all investors and are available upon request. This event is only for Citi investors and clients. No media or press should be at these events. With that, I'd like to again welcome Tony and the Corning IR team. Tony, hope you're doing well.

I'm going to kick it off here with a question that I've been getting all throughout the summer, when -- and that's related to demand and supply volatility across several end markets that actually Corning participates in, whether it's consumer tech, autos, fiber, smartphones. As you sit here today, could you just talk to us about the market conditions in these end markets? And what is factored into your near to midterm outlook?

Sure. From an overall standpoint, the end markets have been strong for us all year. And in fact, we had an outstanding second quarter with significant growth in sales and profitability on a year-over-year basis but also from the first quarter, so from a sequential basis. And I think if you step back and think about our value creation strategy overall, we've had -- that value creation strategy and the more Corning strategy is clearly working. And I think the best evidence of that is to go back to where we were in the pre-pandemic times, in Q2 of 2019. I mean we've added $0.5 billion of sales in that 2-year period. $200 million was from our Hemlock transaction, but $300 million came from our organic businesses. And most of that actually came from either increasing the content in those markets or gaining share. About 30% of it or so came from the markets themselves growing, but a lot of it came from our more Corning content strategy. So we feel very good about that. In terms of the specifics, from a Display standpoint, there's been a lot of questions about what do you think is going to happen with TV demand in 2021 because it was up so significantly in 2020. Since 2014, which is kind of the beginning of the complete adoption of LCD displays, TVs, TV units have been kind of range bound between 225 million and 235 million units. And last year, they were higher than that. They were about 242 million units. The important thing, of course, from our standpoint is what happens in screen size, and it's usually about 1.5 inch now. Last year, it was a little bit less than that, about 1.2 inches. And the reason it was less than that, we believe, is a lot more smaller TVs were bought probably for the work from home and entertainment from home reasons for that. So all along, we expected the TV units to return to its traditional level, so go down this year, and we are experiencing that. But we thought the units would be up 1.5 inch. And through the -- halfway through the year, TV units were down about mid-single digits, but they were up 1.5 inch, and the glass market grew. So kind of playing out as we expected. And we do get the question about, well, what about next year? And just keep in mind, there's never been 2 years where TV units have gone down and never been a year with a World Cup where TV units have gone down. It doesn't mean it's not possible, but that's how we're thinking about it. So we feel good about that. In terms of optical communications, I mean, there's clearly lots of demand that's happening in the Optical Communications business. A lot of it is the expansions on the networks completely consume the headroom by what's happened from a COVID standpoint. In addition to that, very public comments from our customers. And so -- about the need to invest in the networks, in particular, the fiber parts of the network. So we're seeing that, and that demand continues to be strong. And in fact, we're expanding some of our operations in order to be able to meet that demand over a longer period of time. The automotive business is the one place where we're seeing it the most, but I mean we're no different than anybody else. But I think clearly, the chip shortages are impacting things from an automotive standpoint. And if it wasn't for that, we believe the demand would be strong enough that we'd be selling a little bit more there. And then in the Mobile Consumer Electronics business, that probably applies, to a lesser extent, the PCs, but maybe a little bit on smartphones, but we don't notice it as much on smartphones as we do on PC. So overall, we feel very good about where our demand is, and our results are showing it.

Yes. If we switch a little bit to the Display segment, you talked about year-to-date trends. If I think about the back half of the holiday season, that's generally an important time and a lot of TV units are pushed through your retail partners here. And typically, it does involve a pretty heavy promotional spending environment. The commentaries that we've heard, at least on day 1 of the conference, suggested that the promo spending environment is a little bit more muted relative to not 2020 but prior to that, given that -- just the supply shortages. There's no use advertising and marketing when there isn't enough on the shelves. Do you see that playing out in the back half of this year as it relates to TV retail sell-through, given that -- what we expect to be a little bit more tempered promo environment?

Well, I think what's most important there is what happens with large-screen TVs and greater than 65 inches. And we still feel very good about what's happened so far this year on that and what we expect to continue on a going-forward basis. I think the other place to pay attention to is -- which we don't talk about as much, but what happens in China on Singles Day, which is the next really big promotional opportunity from a China market standpoint. So clearly, we're looking at both of those areas. But I would note that right now, glass remains in short supply. It's very tight, which would be an indication that people are expecting a decent retail season. But of course, we have to actually go through the retail season to be sure.

Okay. And then when you look at all the glass supply coming on board in 2021, strong Gen 10.5 fabs, 3 of which are actually owned by Corning. How do you think about substrate pricing going forward? I mean you guys have benefited from very good pricing environment in '21. And can we expect that this mid-single-digit declines are maintained after a pretty strong '21? Or do we get to like a mean reversion, where we'll see a little bit more glass substrate price declines just given demand conditions?

No. I mean I think from an overall standpoint, we would expect the favorable pricing environment generally to speak -- to continue to be there because of the 3 factors that's been true up until now. I mean first, and as I said, right now, glass is in short supply, and we expect it to remain sort of tight into the future. Our competitors continue to face profitability challenges at the current pricing levels. And then, of course, display glass manufacturing requires investment in existing capacity. And so with -- when you add to that the kind of the increases in logistics, energy, raw material cost, precious metal costs, they affect all glass makers. So we think that a lot of this is even more relevant than ever. So as we look at pricing on a going forward basis, we'd expect the pricing environment to remain pretty favorable. The other thing to keep in mind, of course, is that these Gen 10.5 factories allow us to free up capacity at the older generations to support other business growth. So we shouldn't necessarily think about that as completely additional capacity for this market. It allows us to continue to grow the Gorilla Glass business and allows us to grow our automotive glass business.

Great. Can you tell us where you are in the rollout of the Gen 10.5 fabs? I mean where are they in terms of efficiency, utilization? And how we should think about just the net margins in the Display segment business, especially as you start doing more of your glass supply coming out of Gen 10.5, which, as you mentioned, are more cost efficient versus the older generation fabs?

Yes. The good news is we've been ramping them over the last year and 18 months, and you've seen the benefit of that being pretty well ramped up in our financial performance. If you were to look at our operating margins in the second quarter, for example there, nice expansion over the last couple of quarters before then. A little bit of that probably driven by pricing, but a lot of it being driven by the real efficiencies that you get with these larger generation sizes. And of course, they're the perfect size of facility to operate if you're selling more large screen TVs, which we believe the world is doing. And then in addition to that, from a shareholder standpoint, they're great because so much of the investment actually comes from other people in order to -- for us to be convinced this is a good thing to build. And so the returns are really nice on it. So -- and it's playing out pretty much as we had expected it to, and you can see that in our operating margins.

Okay. I would be remiss if I don't ask about panel pricing because you get a lot of investors figuring out, admittedly, panel pricing is not correlated to glass pricing, but it's still indicative, in their minds, in a lot of investors' minds, about end demand. Can you talk a little bit about why it doesn't impact glass pricing and why it doesn't faze you when you think about pricing in glass substrate being favorable into the back half of '21 and into '22?

Yes. I mean it's just a clear lack of correlation there. Panel prices have -- since 2015 have been periods of dramatic increases, and there have been periods of dramatic declines. And what's happened from a glass pricing standpoint has been a steady improvement over that period of time to the environment that we're in today of moderate price declines. So that is clearly how we think about it from a glass pricing standpoint. And it really is driven by the 3 things that I mentioned before. I mean the tightness from a supply and demand standpoint, the level of profitability at a competitor's level and the need to keep investing in this business and the need to get returns on those investments. And that's fundamentally why this has played out the way it has over the last 6 years.

Okay. Let's switch to Optical Communications. You talked a little bit about headroom there as well as public comments from your enterprise and -- or maybe your carrier customers. Can you just elaborate a little bit on what you're seeing in terms of rollouts for optical fiber?

Sure. I mean there has clearly been a lot of strength in this business, and you've seen it in our operating results on a year-over-year basis or a sequential basis. The pandemic really did leave a lasting headroom or an impact on network capacity. Operators are very publicly addressing the headrooms they lost during the pandemic. Broadband initiatives are out there with significant focus from a cable standpoint. And we continue to invest to meet that demand. And that demand, we expect to happen over the next 5 years. And then you add -- that's from a carrier standpoint, but you see exactly the same thing from a hyperscaler standpoint. Very strong demand to accommodate storage and processing in the cloud. So I mean, both of those businesses are very strong at this point. And if you think about some of the capacity constraints that -- or not constraints but some of the capacity investments that we made in 2018 and '19 and then the business fell off a little bit, well, all that capacity is getting itself built up. And we're back to investing in some of those areas. We've got a factory that's being expanded in Poland. And we have some connectivity investments that we're making. And then you think about public policy, whether it's the RDOF or some of the other broadband initiatives, the potential in the United States but really happening across the world. I mean, we -- whether it be fiber-to-the-home or RDOF or 5G or what's happening from a hyperscaler standpoint, I mean, we look at this as a long-term growth business and feel very good about that.

And then how should we think about margins in this segment? What are puts and takes to -- whether it's the mix shift that's going on? You obviously have the optical component business -- the passive optical component business. You have the connectivity business on top of that, that is margin accretive. What -- how should investors think about margins in this segment? And what could drive margin expansion within this segment?

Yes. I think the good news is that we are seeing the margin expansion. And again, if you look at the Q2 results, you can see that. And it's a combination of things. I mean, certainly, the -- some of it is just leverage that you get from greater sales. But a lot of it, I mean, you hit on it, is what's happening from a mix standpoint. We're the only really full line optical supplier that can provide solutions, and those solutions usually come at higher margins. The -- where the value comes from is that we reduce our customer installations times, like the amount of time they have to spend like, say, splicing the fibers in the field. We offer preconnectorized solutions for data centers and custom-made network solutions, where customers can measure ahead of time. We build it in the factory and then they install it. And any time we offer a solution like that, that does come at a bit of a higher margin because we're adding more value from a customer standpoint. So we would expect at least some -- we've seen some margin expansion. We'd expect that to continue to at least see some margin expansion.

And then you generally share some data points typically at your analyst event about how -- what one should see in terms of overall growth in this market and how Corning is able to grow in line with the market or exceed market expectations. Can you share with us sort of more -- any kind of updates to your overall growth forecast just broadly for the market at this point?

Yes. We have -- I mean we expect growth this year, and we expect growth next year. We haven't done anything in addition to that. We realize that, that is an area of investor interest. We take a lot of confidence in what our customers are saying. But in terms of specific projections, we're not prepared to do that.

Okay. And then just in terms of visibility, you talked a little bit about how you continue to see growth in the back half of '21 here into '22. Broadly speaking, what would you consider visibility in this market? I mean all we've heard from a lot of our hardware companies on day 1 of the conference has been good visibility, admittedly not necessarily in the same segments that Corning participates in. But just broadly, a lot of companies are talking about great visibility on the enterprise side of things. Enterprise compute is very strong. Storage, you already mentioned. So if you think about hyperscalers and optical, how would you just characterize visibility here?

I think visibility is pretty strong because they see the underlying trends that they are working to meet and they're pretty public about those underlying trends. And one thing that I think, you and I have talked about this before, that I really focus on is just the plain old order rates because that's where a lot of the words turn into what really matters from an operational standpoint. And we continue to see very strong order rates in this business. So I think all things considered, I think visibility is pretty strong right now.

And any impact from supply issues just broadly speaking, ICs, other materials? Of course, transportation and logistics, you already talked about, but just supply that could reduce potentially demand generation here and in the optical segment. Yes.

Yes. I think in the optical segment, it's always hard to know for sure at the very margins. But I don't think that's the case at least in a material sense. Certainly not like what you see with chips in automotive, for example. Are there some places where people are maybe not being able to ramp up their capacity quite as fast as they would otherwise for whatever reason? There probably are some places like that. But again, I mean, a lot of that is more anecdotal than I think you're really going to see from a results standpoint.

Okay. All right. Then let's switch a little bit to specialty material because you already talked about Gorilla Glass here. You guys had a very strong calendar 2020. And maybe you can talk about growth drivers for this segment and specifically about newer product introductions that you're coming out with specialty glass.

Sure. I mean, we have consistently grown this business, year in and year out, even though what's happened from a smartphone standpoint has actually been flat to a slightly declining market. This year, we do believe after a market that declined last year, smartphones will increase. And of course, some of our innovations are now at a full year, Ceramic Shield, for example, as opposed to roughly a half year last year. But we expect to continue to see our growth really driven by the innovations that we're bringing to the marketplace. Things like Gorilla Glass Victus, which should gain greater adoption, newer footholds in product categories like wearables and touch notebooks. And then the one that we introduced last quarter that I think is pretty exciting is the lens covers, and that will be on the new Samsung phones. And that really has the opportunity to add pretty significant content on a device, and it really does -- cameras and photo capabilities is one place premium phones can distinguish themselves from each other. And the more optics they put in there, the more protection they need and the less reflection they need from the lights and our Gorilla Glass DX and DX+ product lines really offer that in a big way. And a lot of investors -- unfortunately, we're not in a room that I can show you, but I have DX+ on my Samsung Watch. And you can stand right smack in the middle of sun and read e-mails. And I cannot obviously do that on other devices. So I mean I think that really has the potential for some continued growth. And then there were some other products that impacted our margins in the second quarter that we're also in the process of introducing. So we think that our whole more Corning value creation model here in Specialty Materials continues and we'd expect to continue to see that growth. And our goal has been to double that business, and we think we're going to get there.

Great. So switching now to automotive. You again talked about, obviously, there's chip shortages that is widely known. But you do -- you guys do have a goal of getting to $500 million or so in gas particulate filters at some point to diversify the offerings in that segment. So as you sit here today, can you remind us what's going on and what are the puts and takes to get to that goal? Is it something -- I know you guys talked about initially that you were on an accelerated time line to get there. And I guess one of the questions that I also get from investors is, as you accelerate to electronic vehicles and electrification in vehicles, could we get to that target sooner? Is there a negative impact to Corning as we get to more electrification in vehicles?

Yes. So I think from an overall standpoint on GPF, what really has driven that business has been a combination of regulations that have been adopted in Europe and in China, which are on track. They have been adopted. So to the degree that the chip shortages impact sales or production of vehicles there in the short term, then clearly, that has a little bit of an impact. But the bigger step-up is what's happened from an adoption of those regulation standpoint and then how much share of that we get. And I think that's where our real innovation has made a difference, and we've gotten a very large share of that business. And then we just recently introduced the next generation of those products for even tighter regulations. And so we feel good about that. Our original goal was to do that by the 2023 time frame. And I'm sure that we'll be ahead of that from an overall standpoint. So we feel good about that. From an electrification standpoint, from an overall standpoint, we think that's a part of the driver on how we get to $100 of vehicle content, which is what -- has been a goal that we've stated for several years now. Now some of that comes from GPF. I mean the content prior to GPF was $10 to $15 a vehicle. GPF takes that up to $45, $50 a vehicle. But a lot of the rest of it really comes from what the industry refers to as CASE: connected, autonomous, shared and electrified. And we think there's real opportunities there, particularly in our auto glass business, both from an exterior glass standpoint, which we don't talk so much about anymore. But from an interior glass standpoint, you've seen some of these really -- we've highlighted some of these really big panels, and I think it makes a big difference. And then from an electrification standpoint, a lot of what is going to happen, we believe, over the next 8 to 10 years in that is actually going to be also an increase in hybrid vehicles. And hybrid vehicles actually need more of our product on them from a pollution standpoint because the start-stop is where a lot of that pollution actually gets created. So we think overall, it's a pretty positive trend for us. And our objective remains to increase the content to the point of getting the possibility of $100 a vehicle.

Okay. I got a question in from an investor. If you can have any updates on this auto glass business? I know at some point, right now, it's still within your other segment line. Is there anything to call out there and when you think you could actually start breaking that segment out?

Yes. We -- right now, we do have it in the other -- in our other segment. One of the reasons that we do that is so that, that team is completely focused on what it takes for auto glass to be successful and that we have the rest of our auto team on the kind of our traditional business. But one of the changes that we made about 15 months ago or so is we put a market access platform leader responsible for both of those so that we make sure that we're getting all the right appropriate synergies and the like. And then we have kind of an internal debate at what size does it have to get to that we would feel that it's the right appropriate time to break it out. And we've kicked around numbers like $100 million to $150 million or so, and we're getting into that general direction. So whether we do that for 2022 or we wait another year, we just haven't made that decision yet.

Okay. Another question from investors I get all the time. Things are humming along. You guys are adding more sales than you were pre-COVID, obviously, at higher levels than you were at pre-COVID. What about margin? Is it reasonable to expect overall corporate gross margins are -- can rebound to where they were pre-COVID? And I think that was around the 40% mark. Assuming some of these transitory costs such as freight and logistics that you talked about normalize, are there anything else that we should keep in mind as we build out our models for when Corning could get to those levels?

Yes. I mean, clearly, what we've experienced, and I know lots of other people have experienced, and I know it was a hot topic of your conference yesterday and I suspect for the rest of the days, is what's happened from a supply chain and freight and logistics cost standpoint. And at the end of Q1, we thought the impact on that was about 150 basis points, and we had plans to make improvements on that. We actually made those improvements, especially in the freight area. But what happened, of course, was that the freight rates went up and then demand remained strong. So there were some places where that happened and where we weren't previously seeing it. And then on top of that, you had other increases like resin cost increases and other raw material cost increases. So we ended up with Q2 kind of at that same 150 basis points impact. And we'd expect something in that general neighborhood to occur in Q3. And the guidance we've given assumes that's going to be the case. Now if you took our gross margin and we're able to mitigate all that, then you would be at the 40% level. So then I think really the question is how long does it take to work your way through that. And then how much of that is not just a change from a cost and logistics standpoint, but what opportunities also are there from a price increase standpoint? And that is a big focus of what we've been working on all year long but particularly in the third quarter.

Are you getting any pushback from customers on this? Again, commentary in the day 1, which was on compute, was that customers are not pushing back on any kind of price increases that OEMs have to pass through, given all the raw material and supply chain costs.

Yes. I think -- I mean, given the broad spectrum of customers that we have, I think it depends on what part of our supply chain that you are talking about. Clearly, our top priority is to not create stockouts and make sure that we're taking care of customers that way and then kind of settling up as time goes on. But yes, I mean, I think we are seeing some success in some of our price increases. And you saw at the place where we're most public about, talking about price as opposed to in some other places where we just talk to our customers about prices, of course, in Display. And we've had 2 quarters of price increases in Display.

Investors are also often focused on your CapEx. And I know you guys have this great framework of build versus maintain CapEx. So can you just talk a little bit about where you are in that cycle, Tony? And what should investors expect out of sort of CapEx commitments over the next, let's say, 3 to 4 quarters?

Yes. So I think from an overall standpoint, while we are making some expand capacity, that's different than build capacity, which is really building new factories and just kind of starting from the ground up. We've been filling that build capacity for the last couple of years. And we talked a little bit on the call, we've increased our return on invested capital by about 3 percentage points since the 2015, 2016 time frame. And most of that increase has been successfully adding the build capacity and then filling up those build capacity because our build capacity has greater than 20% return on invested capital. So right now, a lot of our focus is finishing filling that up and then expanding it to meet this increasing demand that we talked about at the beginning of the call. I would expect capital spending for the next -- this year to be kind of in line with what it was last year, maybe a little bit more. And as I think about over the next 4 quarters, maybe a little bit more for this increased demand but not a significant amount.

So -- okay. So you're not going back to where you were in the 2018, 2019 time frame. There's still a lot of demand -- there's still a lot of capacity there, yes.

Yes. There's still the ability to expand that capacity as opposed to have to start from a build. Now what I, of course, really want is that build capacity to be needed because that's indicative of a really strong business environment and a customer commitment. I mean I think it's the customer commitment part that is really important from a build capacity standpoint.

Yes. And then related to that capital allocation, I know you guys have a very strong -- a strong capital allocation framework that you guys shared at your analyst event. It typically spans like 4 years. Can you remind us where you are on that and how you think about that framework? And of course, COVID -- due to COVID, you had to kind of make some adjustments to it. So now as you kind of look at that framework, where you are and how you think about that.

Yes. I mean we have a very clear approach to how we think about capital allocation, which is we generate a lot of operating cash flow. And with that operating cash flow, we invest to continue to grow the business. And we do that through R&D, capital spending and M&A. And then all the rest of the cash, we return to shareholders. We do it by increasing our dividends every year, and we also do it by opportunistic stock buybacks. And of course, we didn't -- we increased the dividend during COVID. We did put our opportunistic stock buybacks on hold last year. But we had another 9% increase in dividend in the first quarter, and we reinstated stock repurchases by buying back 4% of the company with our Samsung transaction. So that is fundamentally how we look at it. In terms of some of our other objectives, which had to do with growth in terms of sales and returns, we feel good about where we are on those 2. I mean I think our more Corning approach and our more Corning strategy is clearly paying off. The $0.5 billion of sales increase, most of it coming from organic growth and most of that coming from -- having more Corning is a good example of that. And then the return on invested capital improvement also being a good example on that.

Got an investor question on acquisitions -- the Hemlock acquisition. Anything else to keep in mind as you think about the demand generation that you're seeing going forward? Should we be expecting any more tuck-in acquisitions here?

Yes. I mean I think that, that clearly is our overall strategy, which is to find strategic acquisitions that we can have and create value. The Hemlock acquisition has been outstanding. I mean that acquisition has really paid off in terms of the cash flow generation we've created, keeping in mind we didn't put any money into it. So I mean that has been a really great acquisition. And then we continue to look in our other businesses where there are opportunities that -- to do the same sort of thing. I mean I think that the place that often we look, of course, is in optical communications, where we have a huge market access machine that can really help us. And acquisitions can either improve things from a geographic standpoint or from a product standpoint. We actually saw both of those when we did the 3M transaction with them 3 or 4 years ago. So we continue to look there. But really, in all of our businesses, we are exploring opportunities like that. But they're not strategic, change the face of the company kind -- they're not transformational change the face of the company acquisitions. They're strategic acquisitions that can really make our market access platform stronger.

Okay. And as we wrap it here, Tony, when you think about just Corning, Corning shares, where they're priced today, what gets you excited -- I mean what's the parting message you'd like to give to Corning investors or those who're looking to invest on why they should be looking at Corning shares?

Yes. So we believe that our value creation strategy is absolutely working. I mean we're the best in the world in 3 core technologies, 4 manufacturing and engineering platforms and 5 market access platforms. And when we bring those together in trends in industries that are growing, we can add content in a way that other people can't. And so we can see the growth not just comes from being in those markets by increasing the content in those markets. And I think if you think about what's happened over the last 18 months, you've seen lots of evidence in our capabilities of doing that. And then once we do that, we generate an awful lot of operating cash flow, which we invest in continued growth, but we also return that to shareholders once we've been able to invest in the growth that's out there.

Okay. Great. With that, I'd like to say thank you to Tony and the rest of the Corning IR team for coming to this conference. And I wish you best of luck in all your other investor meetings. Take care.

Thanks, Asiya.

Thank you, Tony. Good seeing you. Bye-bye.

Good seeing you, too.