Corning Incorporated (GLW) Earnings Call Transcript & Summary

Okay. We'll get this started. Thank you, everybody, for making the time to come to the fireside chat with Corning. I would like to introduce, first of all, my name is Laurent [indiscernible]. I'm the telecom media analyst at Bernstein. It's my privilege to host Wendell Weeks, Chairman and CEO of Corning; and Jeff Evenson, Executive Vice President and Chief Strategy Officer. We will kick off the session with remarks from Wendell. Thank you.

Thanks, Laurent. Hi, everyone. A few quick remarks to give you a quick background on where we are right now and where we're going next. Before we get started, please remember, I will be making forward-looking statements because backward ones would be boring and actual results may differ materially. Additionally, I will be using car performance metrics. Today, what I want to quickly do is share insight on where we were focused during the pandemic period and now how our priorities are shifting as the world moves through the pandemic after effects that are still rippling across the economy in our markets and why we expect to emerge out the other side of this with really strong growth accompanied by very strong operating leverage. So let's dive in. Since the pandemic hit, our core priorities have been simple and straightforward. We wanted to protect our people, and we wanted to deliver for our customers. So we acted really swiftly to safeguard our employees and facilities around the world. We also contributed to the global health fight, refocusing our entire pharmaceutical packaging operation to directly combat the pandemic. We've supported now the delivery of more than 8 billion COVID-19 vaccines in more than 50 countries. And across the company, all of our actions reflected a fundamental commitment to our customers. For example, we had a very large number of our suppliers declared force majeure, and we've never declared one. So as a result, so when supply chain suffered from shortages, stalled due to transit challenges, our sourcing team ensured reliable supply when global shipping was crippled by log jams, we found a way to reach our customers with the product they needed, however, was required. Now to deliver to this level, we made some deliberate operational shifts. We operated with elevated staffing and higher-than-normal inventory levels. In addition, we faced persistent and often unpredictable inflation, which added to the cost of the raw materials we purchased, the cost to produce and ship our product, and the inventory we maintained. So of course, this prioritization of our people and our customers ultimately impacted our profitability and cash flow. And now that the world is beginning to recover from the pandemic's impacts, we believe that it was appropriate and urgent to focus on an additional priority, which is to improve our profitability and our cash flow and return our operations to pre-pandemic levels. So despite the fact that the external environment continues to reflect the aftereffects of the pandemic, with markets constituting about 70% of our sales, facing what is essentially recession-level demand. Despite that, we expect our profitability and cash flow to be on an upward slope. And here's what we're doing to drive that improvement. We're aligning our cost structure to demand levels. More importantly, we've been able to improve our yields, reduce our staffing levels and get closer to our benchmark historical productivity metrics, because it is not the requirement anymore to carry highly elevated staffing levels to make sure our factories run sort of no matter what is happening with the pandemic. We're making great progress, ensuring the right output at the right cost at every level and in every plant, and we no longer require elevated inventory to ensure our ability to meet customer needs. So we're bringing inventory down across the company. In terms of inflation, we've effectively raised prices and will continue to appropriately share inflated cost with our customers. The latest being our recently announced 20% increase in display glass substrate prices globally, which followed a significant fiber and cable price increase during the fourth quarter. So in total, we expect our actions to improve profitability and cash flow even at these depressed sales levels. And first quarter results really demonstrated the progress of that reprioritization. We said we expected sales to decline by greater-than-normal seasonality but that our margins would increase. That is exactly how it played out, despite a 7% sequential sales decline, core gross and operating margin, both expanded sequentially, 160 and 150 basis points, respectively. And as the aftereffects of the pandemic continue to impact the global economy, we expect our profitability and cash flow to continue to improve, despite temporarily muted sales levels. Looking further out, our sales will recover. And when they do, we expect to show significant operating leverage. In fact, as we move beyond recession level demand and other aftereffects of the pandemic, we believe our growth prospects are quite robust. Sort of across our portfolio, our capabilities play a central role in strong secular trends, which are playing out in both, our established markets as well as exciting new areas. At the heart of our growth strategy is what we call our More Corning approach. We invest to lead in technologies and capabilities that are vital to progress. And we apply that expertise to anticipate and evolve around important secular trends. In doing so, we help our customers move their industries forward, and we create opportunities to drive more of our content into their ecosystems. Consider our work in the automotive market, it's a good example. So as we've said before, we're pursuing $100 per car opportunity. I mean, so let's unpack that. Let's start with ICE vehicles, where we're seeing an excellent example of More Corning play out despite the shift to electric. This year marks the 50th anniversary of our emissions control business. And when we rose to the call, the Clean Air Act with our invention of cellular ceramic substrates which became the global standard for automotive catalytic converters. Over the past half century, we've leveraged our deep relationships in the industry to support the proliferation of clean air technologies, helping our customers meet increasingly stringent environmental regulations. As you're up in China, for example, have heightened regulations over time, our gasoline particulate filters have helped automakers eliminate harmful microscopic particles and meet new emission standards. So in More Corning terms, our original ceramic substrate content represents about $15 per car today. Adoption of our GPF technology tripled our dollar per car opportunity. As a result, GPF adoption has contributed to our outperformance over the past several years. Global auto production is actually down 15% since its peak in 2017, yet we've grown our auto sales more than 45% and in the same period. And what's exciting now is that the recent EPA proposal calling for greater emission standards here in the U.S. as the government continues to pursue cleaner air. GPFs would, therefore, be required if it is adopted to be used on internal combustion vehicles, boosting our content in a very large significant domestic market. So we expect GPF adoption in the U.S. to be an important component of our More Corning growth in our Environmental segment, even as BEV adoption increases throughout the decade. In fact, even if BEV adoption grows to over 40% of all vehicles bought worldwide, our environmental business in ICE will still grow. Next, Corning's capabilities are helping truly advance the rapid growth in battery electric vehicles. And we're positioned to benefit significantly as that adoption increases. We've been helping advance the industry's biggest transformation in the past 100 years by providing technical glass solutions where before there weren't any, new optics packages, part-making capabilities for everything from sensors to new laminate exteriors to large curved interior displays to curb mirrors for heads-up displays. And we're at the heart of these ongoing advancements in automotive design, connectivity and autonomy and as our auto glass business has already been awarded and is actively servicing over $1 billion of multiyear business, including several electric vehicles with over $100 of our content in those models already. So that's a prime example of More Corning. As the industry shifts to more battery electric vehicles, we have an even stronger market position and a greater content opportunity per car. Now I'd like to shift gears and talk about some of our new work in optical communications. And it's an area that's been garnering a lot of attention in the news. Trends in artificial intelligence create a very significant More Corning opportunity, large language models and other cutting-edge AI algorithms require big numerical calculations. And one way to quantify big uses the computational power necessary to train a model. Recent research identified 3 areas of AI based on the 121 milestone [ misteen ] -- the 121 milestone machine learning models that have been published between 1952 and 2022. The pre-deep learning area became -- really began in 1952 and ended in 2010. Training the initial model required about 30,000 floating point operations per second, and the requirement for future milestone models doubled about every 21 months. The pace is just slightly faster than Moore's Law, which observes that chip performance doubles about every 2 years. The deep learning era began in 2010, training the initial deep learning model required slightly more than 20 billion times the computational power of the initial machine learning model in 1952. Now this requires to train subsequent milestone models that just keeps doubling about every 6 months for equivalent to the factor of 16 over 2 years. So very dramatic growth in the computational requirements. The new large language model era began in 2015. Training the initial model required about 6 million times more computational power than the initial deep learning model. The requirements to train subsequent milestone models are doubling about every 10 months or more than a factor of 5 every 2 years. So although it may become less extreme over time, the divergence between Moore's Law of chip performance doubling every 2 years and AI training loads growing by a factor of 5 to 16 every 2 years is likely to remain for the foreseeable future. To address the divergence, AI leaders are increasingly increase in the number by a significant amount of GPUs. A machine to train a model such as current versions of ChatGPT uses about 5,000 GPUs. We expect to see 10,000 GPU machines soon. And for the number of GPUs per machine to grow significantly beyond that over the next few years. And leaders in AI will likely deploy many of these machines each year. Additionally, the GPUs in these machines will be highly interconnected, and this is the change statement for Corning. This is where More Corning comes into play. In today's hyperscale data centers, most of the traffic is sent to a top or middle of the rack switch and forwarded to a server for processing. In contrast, modern AI algorithms typically rely on sharing the resources through a second network within the machine. Sharing requires an additional fiber-rich network most often implemented using pre-terminated fiber links where we are a clear leader. So the takeaway is that the emerging AI architectures represent a step change in passive optical content. We estimate that 5 to 10x more optical connectivity will be required in future large language model data centers versus most of today's hyperscale architectures. So already, we're involved in designing those. And in many new projects with low single-digit hundreds of dollars per GPU in our passive optical content. So we also see multiple More Corning opportunities to grow our dollar content per GPU. So AI is really a big opportunity for us in addition to the passive optics. Corning is also a leader in the glass for EUV lithography, which is the primary approach to fabricating more advanced GPUs for AI. We're also a leader in Optical Components for the semiconductor test and measurement equipment and an ultra-pure polysilicon that is the starting point for every processor. Now I'd like to note just one more quick exciting area where a More Corning approach offers a compelling content opportunity, that is renewable energy. We've restarted idle capacity to capture growing demand for solar-grade polysilicon. And I believe we can make an additional contribution to a sustainable U.S.-based supply chain, which would involve us building a $1 billion plus solar business that generates hundreds of millions of dollars in net income in cash per year, more to come in that space. So here's where I'd like to leave you today. Near term, despite the fact that most of our end markets are depressed. We expect profitability and cash flow to improve. We're raising prices, restoring our traditional productivity ratios, bringing down inventory. Longer term, we feel really good about our growth portfolio, whether it's in automotive, cloud compute, broadband, 5G, solar, pharmaceutical packaging, next-gen displays and cover materials, augmented reality and semiconductors. And we're not just relying on recovery in our markets. We're building on this very deep relationships and insight we have because of our unique relationships with our customers. And so we're unlocking More Corning inventions to help bring really exciting technological transformations to life and help make the world just a little bit better. With that, back to you, Laurent.

Perhaps if you could call it a day since you answered most of the questions I have here.

Awesome. I even gave you the French pronunciation of your name.

Laurent, yes. Thank you very much.

You are welcome.

Before we begin, dive into the questions, I would like to first recognize that you joined the company in 1983. So this year makes your 40th year with the company.

So you're saying I'm old.

No, not at all, but itself is an amazing accomplishment.

And before the questions here I wanted to ask an overarching question. Maybe one backdrop here is you joined the company in finance, various key roles throughout your career, eventually becoming CEO in 2005. And since 2005, when Corning's total revenue was around $4.5 billion, it's roughly more than 3x of that today, which is quite impressive given that Corning actually manufactures things that you sell, and those things actually usually last a quite long time like fiber optics. And over that past couple of decades, the environment, the verticals that you play in have become more and more competitive every year. So it's such an amazing accomplishment. So one overarching question I'd like to start off with is, could you share with us some pivotal moments, decisions that you've been part of that kind of shaped where the company is today?

Sure, 40 years now, yes. So I think probably the most important one, the most pivotal one for us was after the Internet bubble collapsed, and we were -- before that, we were so powerful in Opto that, that drove the bulk of our earnings. And so during that, really our earning power really collapsed, and we made a huge bet, which was we would double the amount of R&D, that we would invest as a percent of sales, we'd focus it on 3 areas that were unproven, but we believe strongly in, which was fiber-to-the-home despite the fact that everybody claimed they would never buy fiber again, right? The second is large-size LCD for entertainment TV despite the fact, back then, that was a novel idea. And then the final one was a new kind of filter for heavy-duty diesel to be able to make clean diesel -- clean -- to be able to make diesel clean. So we bet on all 3 of those as well as started seeding what became our sort of 3, 4, 5 strategy. And that investment has meant that we are the clear leaders in all of our businesses and though we invest about twice as much as most of our peers, we make even accounting for that investment about triple the amount of profitability. So that decision, that fundamental belief in our ability to advent our way through this structure has worked.

I see. So those investments obviously playing out today, bringing the collecting the fruits of that decision today.

And then [ touchness ] of a flywheel where we then build that capability and then that turned into gorilla, because we had the ability to create more glass capacity with improving productivity in display. As that got bigger and bigger and then so we had a free shot on goal when Steve Jobs picks up the phone and calls me and ask for help. And that became our mobile consumer electronics business and turn our automotive glass business. And -- so these things when you build really core capabilities that you can reuse and repurpose, it takes and fundamentally changes the returns on innovation, so that we can become a company that can span 172 years and still keep growing sort of out while all being within our core capabilities, but exploring new markets.

Got it. Got it. So would like to definitely come back to your 3, 4, 5 strategy towards end of the discussion to kind of talk about the next horizon of the 3, 4, 5 strategy. But before we get there, I'd like to start off with some of the near-term kind of structure this discussion as if there's 3 parts, sort of the recent history, near-term performance and sort of the longer-term horizon strategy. So obviously, one thing that we all experienced is this period called COVID. And for all of us and especially for your company, there were some tailwinds that came with COVID, right? The consumer demand for devices has gone up, and enterprises and the carriers have invested in fiber and 5G and definitely kind of boosted your top line. You had record years during those times in terms of like every BEV you had, had record years. However, as you just mentioned and more recently in other calls, half of your business is facing recession-level demand, various outlets talking about softening demand and kind of reducing the forecast and then so forth. And you've obviously made some adjustments kind of facing those challenges last year as well as that -- those adjustments continuing. The first question with that backdrop is we understand what you've done, but how sustainable is that? Is that something that you believe is like the adjustments that you made for the period? Or is this something like have you found a new structure that could be sustainable in the foreseeable future? And a follow-up question. The second part of that question is, you also mentioned that in the fourth quarter of last year, a couple of your competitors actually had negative earnings while you guys were able to actually still sustain profitability. Why -- how are you able to make those adjustments while the competitors have not been able to do that quickly?

Right. So I think there's 2 separate questions in there. The first is, can we continue really to improve our profitability and cash flow despite operating in a time period where the wind is not at our back, right? And yes, I think we can sustain it primarily, because if we increase price, that improves our profitability. And if we bring our productivity ratios back to where we can run them, where we've done historically, before we even improve on it further, those 2 things, all by themselves are going to drive an expanding wedge of profitability. On cash flow, the other pieces, we ran with hugely elevated inventories, so that we could make sure our customers didn't get shut down. We had enough raw materials and everything, right? So that means that we don't need to carry that anymore. So we'll just sort of thoughtfully bring those down, which will then further get more cash flow flowing through the system. And we have in place the capacity we need to bounce up another, I don't know, $3 billion, $2 billion in revenue easily, right, without any new growth opportunities having to hit it, no new investment. So I think those things set the table well. Now we just got to figure out what will the revenue be? And we're trying to set a piece, so we can operate at these very depressed levels. To why we're profitable and others aren't, has less to do with our agility. And more to do is since we invented almost all of these businesses, we tend to run with anywhere between a 20% and a 40% cost advantage, sometimes as low as 10%. And so in that same business, a competitor will have a much higher cost than us. So they'll lose money, and we'll still make though. We like it better if our competitors make money and we make more money, right? That's my preferred model, which is one of the reasons we're raising display prices dramatically as our competitors are losing money, shutting down capacity. Yes, we're profitable. But you know what, that's not the appropriate sharing of the cost of dealing with the pandemic with our customers. And so now as my customers start to recover, we want to rebalance that supply chain, so that folks like us get the appropriate level of profitability.

Got it. So speaking of taking your share of the rebalancing in a category that you've invented, Optical Communications. It's -- obviously, it's the biggest part of your business, roughly 40% of the revenue, but it's also a lower margin product -- not low, but lower relative to other segments that you're in. And that kind of reflects the competitive environment and the demand that we're seeing in the market today over recent years. How do you plan to stay competitive in the industry as the competition intensifies? You recently raised prices. I think you clearly articulated the demand side of the equation, the demand is coming, we see that. And your competitors also seeing that demand as well, they'll try to be aggressive as well. How do you plan to stay competitive in the Optical Communications part of the business?

I think the critical thing is regionalization is what's happening here, right? So first of all, the profitability tends to track with how much capital we need to deploy, right? So we have some aspects of Opto where we deploy very low capital amounts that tend to generate less margin. But -- so what's happened and one of the big change statements is this, we're back around when we used to almost half of China's fiber business. Chinese made a decision which is they didn't want something as vital as their telecommunications network to be dependent on a U.S. flag. So they did a series of actions all within -- it's not worth talking about. But anyway, they took and drove our share down from that level. What's happened now is now other regions around the world have actually realized that what they want is an ability to do something as important as telecommunications, at least broadly within their region. And so today, in something like fiber optics, we are the only real folks who can stand with us at all are namely part of a highly subsidized Chinese ecosystem. As barriers have gone up, in U.S., in Europe, right, as also -- which are government-related barriers. But then on top of that, big important customers saying, like, no kidding, I need to have local supply chains, because this can't really continue the way it is, has took -- meant the fact that our values that we've always had, which is always making the region where our customers are, have tremendously increased in value. So I would say competitive intensity is largely less than it used to be. And now the key question is as fiber optics works its way into new areas, how does that cycle work? How do our customers who need to do it make their own investment model work, and at what rate are they going to go? I mean, I think that to me is the real question more than a competitive one.

Okay. Got it. Then switching gears to then your display one, which may not be a regional business, that does seem like more global business. I think there are estimates like couple 220 million display panels...

Good for you, yes.

Were here, et cetera, right.

Pretty good for next telecom guy.

Thank you very much. Obviously, there's more demand and the sophistication and manufacturing technology becoming more and more important, because the panel size become bigger. The quality of the display is obviously very important. You increased, again, the prices. You just mentioned 20%, which is actually a pretty substantial price increase. Maybe an obvious question, but just to clarify, like given, again, the competition in the market, especially in the display side, what is the competitive advantage that you have that enables you to increase prices pretty substantially in a pretty short period of time? And the second part of that question is, again, how sustainable is that in the foreseeable future?

Well, on the price increase, let's see how I do, right? So we've announced it, right? No one's ever done anything like that at the display glass level. Panel makers have done it, right? But -- so let's see how I do before I talk about how much I sustain it. The competitive position now is largely driven by, we have shifted to great big Gen 10.5 plants to manufacture most of the TVs you look at. One of -- and that's integrated with our customers. And so you look at one of those things, one of a typical one would be about 5 kilometers around. We run 5000 races around them, right? Ours and our customers' piece and the product goes right from our factory into theirs. So really, the bulk of the competitive intensity is, did you win at the beginning or not? And so that has helped reduce competitive intensity. But this move is primarily driven by the fact that it's just -- we're not going to have our shareholders have to support the needs of what our customers need for capital. I mean we have to make sure that business works. It's been working well, but it can do better. Anything you'd add to that...

No, I think that was great.

The next question is on your Environmental Technology business or Renewable Energy business and Hemlock business. And maybe Jeff, you could start with -- but if you don't mind, I'd like to start with you on this one. So obviously, this is a growth business. It has grown quite a bit in the past in recent years, but not necessarily a very profitable one at this point, which is not expected. There is a need to invest in growth, of course. What do you think are the key levers to generate profitable growth for this business here? Or is it more hindered by the structure of the industry near term?

Sure. I think as you look at the supply chain for solar, profitability varies across the supply chain. We're focused on polysilicon that goes into making the wafers that get deployed in a solar farm, for instance. We are a leader in the purity of that gets usually used for semiconductors and then there's a solar [ grid ] that we sell into the solar market. We recently opened significant capacity in that because it became a profitable business again. And I think as we look at the supply chain and our ability to deliver capacity, our ability to verify the [indiscernible] of our -- this is French -- so that was a little...

Well played, well played.