Corning Incorporated (GLW) Earnings Call Transcript & Summary

Good morning, everyone. Thank you. Welcome to day 2. And I'm Samik Chatterjee. I cover hardware companies at JPMorgan. For us kicking it off on day 2 here is Corning. I have the pleasure of hosting Edward Schlesinger, EVP and CFO of the company. Thank you for taking the time to come to the conference.

I'll get right into the questions, and we can take some audience questions as we go along. I did want to start with a few more long-term topics for you before we get into the more near-term macro, et cetera, discussion. Your long-term capital allocation decisions, in terms of how you prioritize investments across the different segments or the different market access platforms, is really what I want to start with. How you're thinking about the exposure that you have across these market access platforms to consumer versus enterprise or business spending? And how you're thinking about sort of long-term capital decisions about where to invest?

Yes, thanks, and thanks for having us today. Appreciate it. I would start off by saying we apply a very disciplined approach to capital allocation. We have a 3-4-5 framework that we use to invest 3 core technologies for manufacturing platforms. And we look to invent new capabilities or combinations of those core technologies, manufacturing platforms across the markets we serve. We do that through investing in research and development. The majority of our research and development spending is focused on the nearer term in terms of revenue opportunities. Think of that as sort of the 5-year, next 5-year window. We do spend a decent amount beyond that as well. And then what we look to do is once we feel like we have an opportunity to commercialize, we invest capital and we try to do that in a very disciplined way where we create a level of certainty in generating a return. We target a 20% return on that invested capital when it's fully up and running. We look to derisk that in ways by getting incentives or customer funding or long-term supply agreements. So that's kind of the approach we take. We prioritize organic growth across the markets that we serve. And if we're successful in doing that, we generate cash and then our goal is to return that cash to shareholders. And we think we have a lot of organic growth opportunities in the foreseeable future. So that's kind of how we're thinking about deploying capital in the near term.

No, great. The reason I sort of started with that is you have diversified end markets that you address. But when I look at overall, your exposure to consumer spending, you have limited diversification to overall consumer spending as sort of a driver. How are you thinking about the concentration of revenue drivers to consumer spending? Do you see more opportunities to diversify beyond consumers -- the leverage that you have to consumer spending?

Yes. So if I think about our consumer-focused markets first, display, Specialty Materials and auto, our goal is to outperform in those markets. We do that by adding content into those markets, and we grow -- we tend to grow faster. We look for technology curves, new technology curves. A great example is in the automotive space where the need for glass is becoming more relevant in automobile. So we have an opportunity to leverage up on that curve. We look for replacement cycles or new design cycles. And so that's our focus in those particular areas. And then we also have markets where we're chasing sort of a secular trend like in Optical Communications, the need for broadband, or in solar, the need for green energy. So we think we have a nice, diversified group of end markets. And again, our goal is to outperform in the consumer-based end markets.

Okay. On that front, you mentioned this in terms of more of the Corning product in every end market, but maybe we can go through the different segments. You did sort of touch on it briefly, but when we look at the different end markets, maybe flesh that out a bit more. How do you think about More Corning as a strategy in each of those?

Yes. I'll start maybe with Specialty Materials. So you can think of what we've done over the last decade is outperform a relatively flat smartphone market. We doubled the size of our business in that market. I think it's a good example. We invent new glass compositions. When we sell into the market, that allows us to value up in terms of the content we're providing. We're selling that at a higher price point, so higher sales, higher value. We also add content into the devices we serve in that space. Glass on the backs of phones was a huge growth driver. Camera lenses is a good example in more recent times, the cover glass that goes on a camera lens. In our automotive business, we think of that as $100 per auto market, if you think about it as sort of addressable market for us. But today, we're much smaller than that. We're in the $30 to maybe $40 per auto range. We sell substrates and filters primarily in the ICE vehicle space as well as on hybrid EVs, and we're looking to go from that $30 to $40 up to $100 by adding interior glass, which is a $30-plus opportunity. And then exterior glass, think of that as windows in the car, lighting, sensors and other glass materials that will go into autonomous vehicles and things of that nature. That's another $30 plus in terms of content. So that's a way to add More Corning into a market. And then even in the markets where we're chasing a secular trend, we have opportunities to add more content in. So if I think about Optical Communications, we have a product called EDGE Distribution. It's actually a solution that we sell into a data center that reduces the labor content to build out the data center, reduces the time to get the data center up and running, and it also happens to have a lower carbon footprint. It allows us to sell more content in a growing market as well.

Just to be clear then, in display, how do you think about the More Corning strategy?

Yes. I think in display, the biggest driver for us has been screen size. So if you think about TV units have been relatively flat. In fact, they've actually been down the last few years, but relatively flat, 225 million or so TVs per year, but the market volume has actually grown because TVs are getting bigger. We have Gen 10.5 factories, which service these large panel-making fabs that make large-sized TVs. It allows us to outperform in terms of the volume we get in a market that isn't growing that much.

Okay. Okay. Okay. Let's move to the segments. Starting with Optical, when you think about long-term demand drivers here, how do you think about those long-term drivers? Do they remain intact, particularly if you go through a recession now in consumer spending, and there, the average consumer spend towards some of these services like 5G, broadband were to moderate going forward, how do you think about the long-term demand drivers remaining intact?

Yes. I think in this space, I would first say, I'm cautious right now. I think the biggest indicator for us of what's happening in this space is our orders. Normally, we would see a seasonal increase in orders as we go from Q1 to Q2, and we're not really seeing that seasonal increase. That could be as big as 10% to 15%, if you go back in time and we're sort of not seeing that. So without that inflection in orders, it's hard to call an uptick in volume, and for sure, that could last for a period of time. On our Q1 earnings call, we talked about not really expecting an uptick in sales in this business. But that said, I think the drivers that are going to drive growth over the longer term are still intact, the need for broadband, the build-out of 5G, the build-out of cloud computing, I think those things are all intact. There's a lot of private commitment for that build-out and there's also a lot of public funding for that build-out as well. You have the BEAD Program here in the United States, which is set to kind of kick off in the near term, which will infuse a significant amount of capital into that industry. So we feel very optimistic long term but very cautious in the near term.

Okay. Great. Just on that front, though, maybe to look through sort of what's happened in the last few years, how much of the demand slowdown you're seeing right now is a function of pull forward of demand over the last few years? We've seen that across many other hardware categories. We feel that sort of looking at current trends, do you really see this as under-shipping demand and your over-shipping demand for the last few years?

Yes. I think you have 2 dynamics going on right now. For sure, there was over-shipping or inventory building up in the supply chain. I think that's definitely a factor. We're seeing that play out for sure in some of the customers or deployments where we participate. But I also think you're seeing a slowdown in deployment of capital by some of the large telcos and even in the data center space. And our view is that's a cash conservation approach by those customers. In this macro environment, they're conserving cash. Again, we haven't -- we talk to our customers all the time. So we're relatively close to what they're thinking about in the near term. And we haven't really heard anybody talk about reducing their long-term goals in terms of whether it's homes passed or data center capacity. So we think those commitments still exist, and we think the short term is cash conservation and some inventory digestion.

Okay. I'll move to a question on margins for the Optical segment. They were up year-over-year despite lower volumes in 1Q. How sustainable are the margin improvements in the near term in the absence of volume improvement? How -- and maybe a follow-up to that. Long-term margins in this business, particularly if you sort of think about the right balance between selling fiber and connected products, where should long-term margins be?

Yes. So as we ended 2022, even really sort of towards the middle of 2022, we acknowledge that our profitability in total wasn't where we wanted it to be. Difficult supply chain environment, we absorbed a lot of inflation. And so we set out to take a number of actions to improve our margins. We talked about that on our fourth quarter and on our first quarter call. Optical Communications is a business where we enacted all of those things. We increased our price. We improved the way we operate our factories. We talk about that as improving our productivity metrics. Think about it as running a much more efficient factory, and we just took cost out of our business. We still have more work to do in this space. But in total, and in Optical in particular, in Q1, our margins went up. Our sales were actually down and our margins went up, which is not what you would typically expect in that kind of an environment. I think that is sustainable for us. We definitely intend to continue to improve our margins. In Optical, I think we probably need volume to get back to where it was to see a step-up in margins, like a meaningful step-up in margins from where we are. If you go back to maybe the back half of 2018 or the front half of 2019, those margins were probably about as good as we had in this business. And I think that's sort of where we aspire to get to when we get our volume back and with the additional actions that we're taking.

Okay. Just a clarification there. Has -- what's the pricing benefit on that front? Is pricing contributing to it? And as some of this demand comes off, what are you seeing on the pricing front?

Yes, price -- we took pricing actions in Optical, so that has, for sure, contributed to it. So far, so good. I think we -- the place where we saw the tightest capacity was in fiber and cable. It's still reasonably imbalanced supply-demand. So I think it's reasonable to assume that the pricing holds. I have not yet really seen significant deflation in cost. So I think to the extent that happens, that will be something for us to watch. Now that's positive. But the question is will we be able to hold our pricing increases in that environment?

Okay. You do give us the split for the Optical business in terms of revenue by carrier and enterprise. And if you look at 1Q, carrier was down year-over-year, enterprise was up. The question on that front was going to be, is overall enterprise still holding up a bit better? Is there more risk to downside than in the coming quarters from the enterprise side?

I think in general for us, it's very customer specific in terms of where we're seeing declines or where we're seeing sort of the pacing of projects. Enterprise was down sequentially from Q4 and capital spending at a lot of the large hyperscalers has definitely declined from the run rate where it was. But you're right; I think the more marked impact was in carrier. I think, again, in the near term, we very much are focused on sort of the order rates. I think we factored in, generally speaking, both of those sides of the business in terms of how we're pacing right now.

Okay. And when you think about a rebound between the 2 segments, how do you think about that playing out? Do you see it playing out earlier in the enterprise? Sort of is it a shorter overall or down-cycle for them? Or how are you really thinking about it? Any signs as well of a rebound from either of them?

Yes. No signs of a rebound at this point in any -- again, very customer specific. There are certainly customers that are continuing to spend and deploy, but no signs of kind of a general rebound and I don't know that I would say that -- I think it will come as it comes as opposed to it's more on the enterprise side or more on the carrier side.

Okay. For some of the other companies I've hosted, generally, we've started with a question about the macro. And maybe this is the right point to ask you in terms of the capital sort of spending hesitation that you're seeing from your customers. I know there are a lot of macro sort of noise and other things playing out, particularly sort of discussions about the debt ceiling. When you think about sort of when those get resolved as you talk to customers, do customers sort of are waiting for some of these discussions to sort of play out and then wait for a more calmer period before they start spending again? Or any insights from your discussions with customers as to what their inflection not sort of what the trigger might be for them to start spending again?

Yes. I would say I'm not sure that I have any insight on that in terms of how the debt ceiling issue plays out and whether customers are tying their spending to anything in particular other than just their cost, their cost of borrowing or whatever it is, their cost of capital and the consumer demand or the end demand in the markets that they're in. We continue to pace our own capital and make sure that we're thoughtful in how we spend, and we'll continue to do that until we see demand pick back up. In different industries we're in, we're in different places, for sure in Display, we saw the bottoming out of Display much earlier than we did in other industries, and we talked about this in the first quarter. We saw an inflection at the end of Q1 in terms of panel maker utilization coming back. So we're starting to see spending there come back, and I expect that to continue into the second quarter. Generally, that's playing out. But in most of the other places, I think it's still wait and see.

Okay. Last one on Optical. You have the new capacity or the additional capacity you're bringing on in Arizona. Given the broader pullback you're seeing, how you're thinking about pacing it? Is there a more measured approach in bringing that capacity online?

Yes, for sure. We talked about capital in total being slightly less than what we spent in 2022 for the year of '23. We'll continue to be very measured in how we spend capital. As I mentioned at the onset, our goal is really to derisk our return. And so part of doing that is not bringing the capital on too early.

Okay. Let's switch to Display. Panel maker utilization, you commented on what you've seen in March. I think the obvious question is going to be, how did it track in the month of April related to general 1Q? And are you still continuing to sort of see that improvement? And would your expectations be that we see that improvement continue into 3Q as well?

Yes. I think the good news is things in Q2 are generally playing out as we expected. Utilization levels are up. We think panel makers were producing well below demand for quite some time and inventory has sort of normalized in that industry. So I think we feel pretty good about the rate of deployment. We talked about our volume being up in Q2 as compared to Q1. I think it's probably too early to call anything specific for Q3 or Q4. But given where we are now, we don't really see anything materially changing from what's happening in the second quarter.

The reason to ask about that is I think the sequential increase from 1Q to 2Q is pretty significant. Based on what you're seeing, are you expecting a similar sequential increase or something more moderate? Like if panel maker utilization continues to move up, as you're seeing in April, do you continue to see a strong sequential improvement into 3Q as well?

Yes. I think it's just probably too early for us to call that. I mean I would not expect a decline, but I wouldn't call anything specific for Q3 at this point.