Corning Incorporated (GLW) Earnings Call Transcript & Summary

Hello, everyone. Welcome. I think we're going to get going here. My name is Rod Hall, Goldman Sachs' hardware analyst. I do communications technology, consumer systems and Corning, which is a sector onto itself, it turns out. So welcome. I think I've got with me Jeff Evenson, who's the EVP and CFO for Corning. So welcome, Jeff. Great to have you here, Dr. Jeff Evenson, I should have said. I think you've got some opening remarks you wanted to make. So I want to hand over to you to do those, and then we'll jump into some questions.

Thanks, and thanks, everybody, for joining us. My remarks today are going to center on our long-term strategy. So obviously, I'm going to be making some forward-looking statements. You should check out our website to see reasons why actual results may differ materially from the perspectives that I share. I will also be discussing our results in terms of core performance measures. So let's start with our strategic intent. For technology companies at least, I think that the existential reality is that all product categories mature, and often just go away completely. So companies have a choice. And I think to remain vibrant, you either need to keep inventing or to migrate towards services. And at Corning, our choice is to keep inventing. We create value by successfully evolving over the long term through category-defining innovations by developing proprietary and scalable manufacturing platforms and by building strong trust-based relationships with customers who lead their industries. Our relentless commitment to R&D allows us to reinforce and extend our leadership and distinctiveness in vital capabilities. This puts us squarely at the center of secular trends that touch many facets of daily life and also creates the foundation for customer collaborations that advance their industries. For example, in optical communications, broadband is increasingly viewed as a basic human right. We are partnering with leaders in the industry to create a world with nearly infinite and ubiquitous bandwidth. And I'm going to use this to illustrate our overall strategic approach and how it drives growth. In 1970, Corning invented low-loss optical fiber and a scalable approach to make it. Since then, the world has installed enough glass to go to the sun and back about 20 times. Nevertheless, only about 19% of Americans connect through fiber in their homes. Today, we believe that the industry is at the beginning of a large multiyear wave of growth. Furthermore, we expect that the combination of private network and public infrastructure investments will create double-digit market growth for path of optics over the next few years. And Corning is well-positioned to capture this growth. We extend our leadership and support our customers by delivering solutions that help them realize their network visions better, cheaper and faster. And Corning's track record sets the standard for doing just that. We're seeing robust growth and customer demand as we create significant innovation programs in broadband, 5G and the cloud. To support this growing demand, we're increasing capacity for both cable and fiber. At the end of August, we announced that we're expanding our manufacturing capacity for optical cable by building a new plant in Arizona. It's supported by our long-term relationship with AT&T. Last week, we announced the opening of a new optical fiber manufacturing facility in Poland, which will significantly increase our ability to support the growing demand for broadband in EU. Overall, since 2020, we've invested $500 million in expanding our optical communications capacity. This has increased our ability to serve the U.S. market alone by approximately a factor of 2. Overall, we're witnessing a massive transformation that integrates digital technology and the related connectivity into almost every aspect of our lives. And we're still in the early days of this transformation. As the only large-scale end-to-end supplier of passive optics, Corning is uniquely positioned to support this transition. And our results demonstrate the progress. In the second quarter, Optical Communications was our biggest growth driver. It increased 10% sequentially and 22% year-over-year to $1.3 billion. Across the company, both commercially and technically, Corning is executing very well. In the first half of this year, we added approximately $700 million in revenue, up about 10% year-over-year and first half EPS grew even faster, up 14% from $0.97 to $1.11. And first half free cash flow of $611 million positions us for another strong year of cash generation. Turning to the current quarter. We're continuing to perform well. We're generating top and bottom-line growth in multiple businesses. All our businesses are performing in line with our expectations, except display technologies. In August, we saw panel maker output decline from already low levels due to rolling power outages in China. This reduces our outlook for the display glass volume in the quarter. And consequently, we now anticipate the third quarter coming in at the bottom or slightly below both sales and EPS ranges that we gave in July. Stepping back, I am confident in our ability to drive durable, profitable multiyear growth even as we navigate a challenging external economic environment. Maintaining a strong balance sheet and delivering solid free cash flow are top priorities. And our approach to investment decisions remains highly disciplined. Corning achieved strength and resilience through deep relevance to secular trends, unparalleled leadership and vital capabilities and the ability to drive more Corning content into markets. We're helping customers create a world with nearly perfect connectivity, a world with large lifelike displays where cars are autonomous and connected, where medicines are individualized, effective and safe, and where the most powerful applications can be experienced on the untethered devices that we all carry with us every day. I'd like to thank all of you for taking the time to meet and for being part of this journey. Happy to take questions, Rob.

All right. Great, Jeff. Thank you. So I guess this is not news that display is weaker to any of us. We see TV demand weakening. We see the inventory situation. One of the things we've been puzzling over with respect to that particular issue is how much of this is normalization of demand off of very high levels of demand and how much of this is economically driven. And I know that's a difficult question to answer, but I'm curious what your thoughts on that are. And then you have that compounding problem of inventory and people in retail feeling they've got too much inventory. We've seen this across a lot of different types of technology [indiscernible] yesterday was saying the exact same thing with regards to inventory reduction at retailers. So just curious if you can stitch all that maybe back together for us, at least from your perspective and say what you think is happening out there today.

I think the medium and long term, we believe that the outlook for the display market is positive as people are doing more things at home as they're looking to upgrade to better entertainment experiences. The use of larger, more lifelike displays, we think will continue to be a priority. We think that the pandemic induced a lot of advanced purchases, probably accelerated those trends and pushed us up above the normal range of large TV units, which we see kind of in that 225 million to 235 million a year. I think there's been a correction in 2021, and we expect to see that again being below that range. I think longer term, though, the outlook is good. So I think right now, we expected when we gave our third quarter guidance that the inventory situation would drive lower panel maker utilization. On top of that, what changed is rolling power outages in China that impacted panel makers' ability to actually operate. As those normalize, we expect panel maker utilization to return in the third quarter will be the lowest demand for glass of the year.

When you think about end market demand next year, do you think TV units grow? We've had now it looks like 2 years of really abnormally low growth, although, as you say, we're coming off of an extreme period of demand here. So what do you think is going to happen in '23?

Our view is that this year, we -- that unit sales for TVs will be in the vicinity of what they were last year, could be a little down, could be a little up, probably not that different, below the lower end of that 225 million range. I would say that as long as the economy stays not too different than it is -- goes much lower than it is today and that there are not huge meaningful lockdowns associated with COVID. I'm not ready to give guidance for next year, but I think most likely it would be in the normal range that we have seen, which should be a little bit up from this year.

Right. This year, because last year was down, this year we've very rarely seen 2 down years in a row or never. I don't think we've ever seen that in TV units...

I think while LCD has been the dominant technology, I don't think that we've seen 2 consecutive down years. If you look historically for CRTs, I'm sure it's happened, but I think this is the first time for LCDs. And I think that the nature of people's consumption of content favors return to that normal range.

Just while we're on this subject, let me broaden it out a little bit and talk about consumer demand with you. What do you think is happening right now with broader consumer demand? What do you hear back of [ utilizing ] Corning is one layer removed from the actual demand? But what are you hearing back? What do you think is happening on the ground out there with regards to demand, particularly in the back-to-school season because we've heard a lot of different opinions on that.

I'll actually start with my role in demand and forecasting as Chief Strategy Officer. My second project, when I was at McKinsey, I spent a lot of time building models to estimate the sales of particular book titles because when you publish a book, at least at that time, there was a big fixed cost to set up the presses and then you had your variable costs. So I'm a physicist, I wanted to optimize -- minimize the fixed cost over the year given the uncertainty of demand. And a senior partner on the study looked at the work and he said, "I like what you did." But a fundamental lesson of business is that the best approach in situations like this is to make your fixed cost as low as possible so that you're less sensitive to demand. And that, I think, is a great piece of business advice. And in my role as Chief Strategy Officer, a big part of what I do is try to make Corning less sensitive to forecast or individual trends. And we do that in several ways. Probably the most prominent is our More Corning strategy where we try to drive our content into the things that people already buy. And so we're -- we can prosper or at least not be heard as bad even in weak economic segments. The second thing that we do is we repurpose and reutilize our capabilities, which makes us less sensitive to the timing or success of individual opportunities. When we are doing what we used to call fire for mobile consumer electronics we're introducing a meta structure, a very sophisticated coating on the surface of the glass that takes Gorilla Glass that has the best durability in the industry and brings it scratch resistance to almost the level of sapphire, which is an exceptional material in terms of that. Only diamond is better. What we learned doing that positioned us well to make camera lens covers, we utilize some of that technology in our auto business for anti-reflective coatings. We utilize some of those techniques when we do Velocity and Valor for the pharmaceutical packaging industry. So by repurposing and reutilizing, we're a little bit less sensitive. And so those are the things that we're -- the ways that we're trying to position the companies. I think the other thing in partnership with finance and the business leadership is getting strong customer commitments. And at the end of the day, it's those individual efforts that we're involved in that really make the difference. For example, in the second quarter, smartphones worldwide were down 11% year-over-year according to third parties. Our sales were roughly consistent with very robust sales in the second quarter of 2021. That's because we've introduced some really exceptional products, particularly for flagship phones. Flagship phones less impacted than other categories, and we continue to drive our content into the industry. So that's really -- things go up and down with markets, but if we can position ourselves to be less sensitive, it makes the company more robust and more successful over a long period. Having said that, we expect that the global economy will remain very mixed with pockets that are doing it very well, pockets that are really challenging, supply chain areas that are occasionally challenging others where we can improve our position. And we are positioning to do well regardless of what that market outcome comes. Sometimes you make your list of, here are the things that could go great for us in the quarter. Here are the things that we're really concerned about. I'd say that net-net, we probably have a few more concerns than really positive things currently.

Do you think that Wendell had said on the earnings call that he thought the high-end consumer wouldn't hold in there? I don't think there's necessarily with any evidence of that at that time, just an opinion. Any evidence from your point of view now as we sit here today that the high-end consumer might be weakening a little bit? Or that there's any thought...

I don't remember the comment specifically, and I don't have any solid data on that.

Great. Okay. Let's jump into some of the segments and talk about environmental a little bit. There are mixed opinions. I think the consensus opinion of the automotive industry is there's not enough inventory out there. They haven't been able to get parts. They need to build more cars, more vehicles. I've heard some people say that they believe because consumer demand is faltering maybe it won't be quite as strong enough uptick in demand. I'm curious what Corning's view on that is as we look into the back end of the year.

That's a place where we're very focused on operating our factories with #1 priority at current demand levels and nearly equal to that being ready, whatever happens, when the recovery takes off being in a good position to do that. I think that my colleagues in that business have really done an unbelievable job given some really dramatic swings in demand in aggregate and at specific levels of delivering reasonably attractive margin structure at an even lower sales level. We'll be ready to go when auto sales pick up. But I think for the time being, there are -- they're basically performing in line with our expectations, which were mostly the growth from second quarter to third quarter would be driven by an uptick in China, as some of the zero COVID restrictions came off.

Right. While we're on automotive, maybe a little more interesting question for you. It would be the $60 of content ex the filter and substrates that Corning has talked about. Could you -- and I guess most of that is glass. How is that progressing now? And could you talk a little bit about when you think we might hit that number, at least in a decent number of vehicles out there.

Sure. We've talked about $100 market opportunity per car for Corning content. And you've disaggregated that into the filter business and in the glass business, and I'd say that's roughly the correct disaggregation. There are several cars out there that today have more than $100 of Corning content on the car, at least by a little bit. They're not typical everyday automobiles, and it's a small number. I'm really encouraged with the progress that we've made in glass not only in the interior glass, which has driven the bulk of contracts that we've signed, but also with covers for some of the advanced sensors that go into cars and increasingly in the exterior glazing. I think that the next 12 to 18 months, we can really see where precision glass is going on the exterior glazing for the next tier of cars. We've been very successful with super high-end cars. But I think as EVs take off, and there's interest in more durable windshields, soundproofing, thermal management, that we can offer benefits that were lesser compelling for internal combustion engine cars and may further increase our market opportunity. I think that business has been growing well and has been signing contracts and winning contracts at our target rate. So I'm excited about our prospects for the auto glass business.

What about the internal displays? You can't look at a new car today that there isn't a pretty good-sized internal display. How is that going?

Yes. So we have multiple -- using our thin glass, our auto-grade glass, which is basically a version of Gorilla optimized for the demands of the automotive market. It offers multiple benefits. Its readability, thin durable nature of the glass allows you to pass head impact tests without using anti-splitter films, which can reduce costs because it's so thin, it bends, which allows auto designers to use curve displays without expensive and low-yield and very high carbon-intensive hot processes. So we're doing very well in that business. Our factory has ramped up in China. The economics have improved as we expected as that has ramped up. We Have a large -- our bookings are large compared to our current sales, and our current sales are doing well.

And capacity in that factory is still...

We still have more to do in that factory. Overall, I think that we're getting customer commitments in place that could support additional capacity but we're a little ways away from that.

Okay. Let's shift gears to Optical and talk a little bit about that. That one is not particularly contested. I think we all believe there are very strong demand tailwinds there. As you said in your opening remarks. The -- one of the questions that we've started to get more from investors is, well, what about Europe, and that's not just for optical, it's for anything related to service providers and telecoms. So I'm curious if you have any comments on optical demand specific to Europe. And if you want to make any broader comments...

Sure. As I mentioned, at the end of last week, we did the formal opening for our new fiber manufacturing facility in Poland. There was a nice feature in the Financial Times with looking at Wendell and his comments on that, that I'd encourage everyone to read. The point of the article, number one, that there's a lot of opportunity to expand access to capable broadband in Europe at this point. There are a lot of opportunities in the United States, and there are even more in the EU. So that's important. Number two is that we think local manufacturing is highly beneficial overall and highly -- and particularly so in the optical business. We're happy to have a new facility that can provide a significant portion of the optical fiber needed in Europe from local manufacturing. And number three, I think that Corning is there as that happens, that we have been very effective in North America, working in partnership with our customers to develop products that they need that deliver on specifications that might not be obvious when you enter a market, like I would -- when I first looked at Corning's bend-insensitive fiber introduction more than 10 years ago, when I was an analyst, I didn't think that bend-insensitive fiber would be incredibly important for making small form factor connector boxes that would go on the outside of buildings for 5G. But it turns out that's the case. And the local conditions and needs in various European countries differ and we're happy to work in partnership with customers to figure out what they need and the best way that they can serve them and open to additional local manufacturing opportunities in Europe as that takes place.

I'm going to take that to mean you don't see any signs of softness or anything like that in Europe at this stage, I mean, from the service providers.

There are always ebbs and flows in individual customers even who have great long-term outlook. But I think the long-term outlook is excellent.

Okay. Capacity. Let's talk about optical capacity. You mentioned that -- is there anything you can do to help us link revenue potential of that capacity back to what you're deploying or any way to financially link those 2 things as opposed to just knowing there's more capacity coming.

We don't disclose our capacity in any detail. What I can say is that given infrastructure, we -- investments that we expect, both private and public, over the next 4 or 5 years. We think that passive optical networks in North America are likely to grow at a double-digit rate, and we're capacitizing to be ready to supply that from the United States.

Are you -- just with respect to the U.S., I think it was AT&T that has just made this comment, they don't believe that they certainly are doubling down on fiber investment now. Others, I've talked to are also saying, "Hey, there's only 2 ways to provide broadband now." It's really maybe 3, but it's fiber, it's wireless and maybe it's COAX, although COAX has some issues and limitations that I think if you're building new plant today, you probably wouldn't put it in. Although you might disagree with that. But I'm just curious what the -- is there anything on the event horizon of opticals that makes you think, hey, there's actually more demand than I thought there was 6 months ago out there. Anything changing with respect to people's thinking about it?

The rough rule of thumb is if you take the speed of transmission and you multiply it by the distance and it's greater than 100 gigabit meters per second, optical is the cheapest way to supply it at least from a greenfield perspective. So if you want to give someone 10 gigabits per second to their home, which is the 10G vision that Cable Labs talks about for the MSO space, if you -- if that takes you more than 10 meters, then optical is going to be the way to go. So what you're seeing is recognition that I would argue today, true broadband is probably something like 100 gigabits per second downstream and 20 gigabits per second upstream. The FCC definition is 25 and 3. I think that's not a modern definition.

Megabits per second.

Megabits per second, yes. Did I say giga, sorry.

I thought, wow, you have a different definition.

I have a lot of bandwidth going on in my [ head ], right? So, megabits per second. And I think at that rate, getting optical capabilities much, much closer to the home is the way that you do that. How you connect up at the very end, whether that's wireless, whether you could use HFC or you take fiber all the way, that depends a lot on local situations, what you already have in the ground, all could be viable approaches. The most attractive one for us is if you take fiber all the way, but there are things to do.

Right, right. So we thought the Life Sciences number in Q2 was a little bit light. You commented that was mostly due to mix shift. Could you give us your thoughts about how you're thinking about the mix in Life Sciences revenues moving forward?

Let me -- so I would say we thought it was a bit light, too. Let me say what happened with the mix is a year ago, we had disproportionate demand related to diagnostic test kits, COVID-related things that drove demand in products that we are not necessarily -- traditional huge volume for us, but we felt it was the right thing to do to gear up and do that. And now volume is coming back more in the cell manipulation tools, cell culture, things where we are very familiar with dealing with the products and leaders in the technology, all good things. I think unlike telecom where you have lots of SKUs that move around all the time every quarter, Life Sciences has historically been a business that fairly continuous and constant and the systems and processes that we had to match our manufacturing schedule to demand did not deliver at the level you would like. So it was both the shift in mix back to our traditional volume and leadership products and our inability to get our manufacturing in line with the actual demand that hurt the sales. We've made some changes in that business that I think will help us going forward. So we look forward to getting back to where the revenue in that business should be. Right now, we're really excited in our traditional Life Sciences business about the introduction of a platform for even higher density cell culture growth that has multiple applications from gene therapy to some advanced lab research or even other places people might want to grow cells. The beta tests have been great. The product rollout is starting. So I think that's exciting times for a new platform.

And the -- with respect to the manufacturing processes you're talking about, I assume that, that mix had been so constant over time. There wasn't really a need for a process that would deal with a dynamic mix shift like this. Is that a good way to think about it? And then you've had to put processes in place.

I think -- that's the way I think of it, whether it secured way or not, I don't know. But that is the simplest version of what happened.

What about Valor while we're on Life Sciences, give us an update. It's been very slow moving. I think you guys said -- you had said it would be, but I suspect it's been slower moving in terms of adoption maybe than you thought it would be with the possible exception of the pandemic and some of the adoption.

Definitely, during the pandemic, it significantly exceeded our demand expectations. We ended up doing what I think is quite heroic work using our pilot facility for significant production volumes, not the most profitable thing to do ever, but definitely the right thing to do. We are moving that to the high-volume manufacturing facilities that we've opened up in North Carolina. We have worked -- as we work closely with customers, we learned about opportunities to unpack the technology stack that Valor represents, ways to make a product that gives you some of the manufacturing benefits that is much easier for customers to adopt because you don't have to do any significant regulatory filings with it that gives them a higher throughput through their full and finished facilities. That's called Velocity. We looked at ways to use the strength of Valor Glass potentially for some opportunities that we're working with West Pharmaceuticals. So I think that, that business has proven it delivers significant value. How we package the value of Valor to be the best for the industry and the best for our shareholders, we're making progress on, but we have a ways to go before you see that in our numbers.

Okay. We're down to about 8 minutes left. I want to see if anybody in the audience has a question before I keep going. Does anybody out there have a question for Jeff? Okay. All right. Well, if you do, raise your hand, and we'll get you a mic. And I'll keep rolling. Specialty, let's talk about that. In this environment, things are pretty dynamic. I would say nobody really knows what's going to happen to demand. But I'm curious, you're a supplier into the consumer electronics category with Specialty. How much visibility do you have on the orders there? How far out can you see? And then beyond that point, I guess, you can't really see what's going to happen to demand?

In Specialty Materials, we're heavily influenced in terms of our demand by our customers' product cycles. And we are there to support their needs. So there's a lot of input on how they see that product cycle shaping up. The demand may vary if they're doing something brand new with our materials versus if they're using something that's quite close to what they've already done or even identical. Those can vary a lot. So those impacts dominate our near-term performance, and we're focused on understanding those and supporting customers. So it's less the case that we're trying to do a global assessment of where the market is and instead looking at what do our customers need in terms of products for what they're doing in their own portfolios. On -- for 2022, certainly, the brightest spots for those have been more of the flagship phones as well as some of the parts that we have done have been pretty good markets this year. And then in Specialty Materials also includes a significant component of sales related to the semiconductor industry, particularly for EUV and some of the test and measurement equipment that we make that enables higher throughput in the industry overall. During the second quarter, we actually announced that we're making a significant expansion to our manufacturing facilities outside Rochester, New York, to better support the semiconductor industry in the U.S. and beyond.

Okay. Let me ask one question on that. Advanced Optics. Can you give us any quantification of how big it is within Specialty or...

Sure. We do that in our 10-K every year, and I don't -- it's -- I don't know the number well enough from last year to give it to you. It's north of $500 million.

Right. Definitely bigger than last year, obviously, things have gotten a lot better for that business.

Yes, yes, yes.

Okay. Let's talk about the financials a little bit as we close out. Gross margins, we know that you put some price escalators in. You've talked about that in contracts. Optical, it's getting to be a bigger and bigger share of the mix, that carries lower margins compared to some segments like Specialty and Display now. So pretty good margins. Can you walk through how all of that mix and price comes together for gross margins, particularly as investors look out over the next year or so. Anything you can say about what that does to gross margin trajectories?

Yes, I would say I can think of meaningful gross margin opportunities in all of our individual businesses. For example, in Display, you were repairing a lot of tanks right now. So that gives you an opportunity to better produce -- to build more efficient capacity. It also -- the lower panel maker utilization gives us an opportunity to restore our inventories to a more appropriate level, which cuts down on shipping, for instance. In Specialty Materials, we have some new products that you can get better at in manufacturing them over time. In Automotive, clearly, we're not operating at full capacity. There's a significant fixed cost. So that helps us out. In Life Sciences, we talked about the mix shift that's going on. In optical, I think there are 2 big drivers to improve margins from where we are now. One is to the extent that customers prefer solutions that tends to be a higher margin opportunity for us because by disintermediating labor, we create so much value for the consumer that we're able to -- for the customer that we're able to share in some of that as sales. Also, we've had some meaningful impacts from inflation that we expect to recover from both through our own supply chain actions and through some of the price inflators that we put in place that haven't fully taken effect yet, although the majority have.

Okay. What about OpEx? And I'll ask a 2-part question here, which will cover the macro side of things as well. What is your macro assumption? Or what sort of an economic assumption is Corning making informing your planning? And then how does that assumption affect your OpEx thinking as we look out over -- again, over the next 6 to 12 months.

I think one of the responses that we have made from a financial perspective, during the pandemic is to become much more flexible on our near-term plans that we've built in tools and processes that help us look where the market is where our ability to serve that market is, help them align, take specific efforts based on what's happening in real time and not because of what our annual plan actually was because things were just changing too fast. And I think part of the organizational structure with a Chief Operating Officer that we implemented in the middle of 2020 was designed to help us with lots of issues, but that kind of real-time responsiveness is one. I would say, as I engage my operating colleagues on what they're seeing that nobody is assuming in a big general way that the economy is going to help them out meaningfully in the real near term. When things are going to help us out, it's much more about a customer product launch, the amelioration of lockdowns in China and things like that, not a massive boost in spending that's about to happen in some area. So I would say we're operating to the best of our ability to what the demand situation at the current time is with a little bit of an underlying bias that the macro economy is weak. And we should be focusing on more Corning opportunities and not necessarily a brand-new product category.

All right. 30 seconds lightning round on capital allocation. As interest rates go up, is your thinking about the balance of dividends and buybacks changing at all? Or does it remain constant even as interest rates increase?

We think rewarding shareholders through dividends and buybacks is important, and we think there are a lot of our shareholders who particularly value that dividend so do we, so it's important to protecting -- for us to protect and grow that over time. for sure.

Great. Okay. That's a good way to end it. Thanks, Jeff, very much. Out of time. Thank you, everybody, for coming.