2023-03-07 13:57:24 ET
Corning Incorporated (GLW)
Morgan Stanley Technology, Media & Telecom Conference Call
March 7, 2023 11:00 ET
Company Participants
Edward Schlesinger - Executive Vice President & Chief Financial Officer
Conference Call Participants
Meta Marshall - Morgan Stanley
Presentation
Meta Marshall
Perfect. Welcome, everybody. Thanks so much for being here with us on the second day of the conference. I'm Meta Marshall. I cover the networking names here at Morgan Stanley. I'll start with a brief disclosure. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to our Morgan Stanley representative. We're delighted to have Corning here with us today, Edward Schlesinger, CFO of Corning.
Maybe let's start with, you've been in the CFO spot for a little over a year now. During that period, you guys have faced huge commodity pricing challenges, dramatic demand production shifts. What have you tried to stay focused around during that period?
Edward Schlesinger
Yes, thanks and thanks for having me. So yes, it's definitely been a challenging year 1 but -- no, a challenging '22, I think, for everybody. For us, at Corning, the most important thing has been serving our customers. We've been focused on that for the last few years in this environment. That's caused us to do things that have added cost into our business. So a big focus now is how to take that cost out, how do we improve our profitability. We've been fortunate. We've grown our sales significantly over the last few years and now it's time to improve our profitability, improve our cash flow.
And as CFO, I've been focused on ensuring that we continue to invest despite the environment. We've got a lot of great opportunities in front of us to continue to do that, maintain a strong balance sheet and reward shareholders as best we can in this environment.
Meta Marshall
Got it. In my conversations with investors, fiber is one of the areas that clearly they've been most focused as it's kind of a difficult -- there is a difficulty in finding ways to kind of play fiber investment that's happening. There's been a digestion period you guys are currently experiencing. But just how do you see that opportunity developing over the next couple of years? And just like what gives you confidence in that opportunity?
Edward Schlesinger
Yes. We are still really optimistic about this space. We think it will be the largest area of growth opportunity for us over the next few years. We've talked about a multiyear time period of high single, maybe low double-digit growth. And I think that will be supported by both private and public investment. There's a lot of public investment out there that's beginning to come online. It will come online in '23, '24, '25. And I think that will contribute to a lot of the growth. And in our discussions with customers, both on the fiber-to-the-home side, on the carrier side, as well as on the data center side, we're convinced that they're committed to continue to investing.
As you mentioned, we're certainly going through a digestion period. And I think in this space, it tends to be lumpy and we're in one of those periods where we'll work through that. And at some point, we'll begin to grow again. I think the second quarter should be better than first quarter. But how fast and sort of what the trajectory looks like, I think it's too early to tell.
Meta Marshall
The private investment you're talking about, carriers or is that cloud data centers or -- and what are you seeing as far as their trajectory?
Edward Schlesinger
Yes, I would say both carriers and cloud data centers for sure. Fiber-to-the-home build out in the United States, there's a lot of room to go there. I also think there's a lot of room in the data center space as the need for bandwidth continues to increase. We would see -- we would say that the likelihood of growth in both of those areas is similar.
Meta Marshall
Okay. Got it. Fiber has been one of your lowest margin products traditionally. But what have you -- but you've noted that there's ways to improve this over time. What actions are their [indiscernible]? And just how receptive have your customers been to some of these price increases thus far?
Edward Schlesinger
Yes. I think the most important thing to profitability in this business for us is to sell solutions. We make a lot more profit when we're able to sell solutions versus, say, selling component parts. We've been working to do that. We think a lot of the products we have provide cost savings opportunities for our customers. And as we can continue to sell up that value chain, that increases our profitability. Over the last couple of years, we've been ramping capacity. So that certainly impacted the profitability in this business. We've eaten inflation as you've talked about. And we have raised price. We most recently raised price again here in the fourth quarter and I expect that to kick in as we get into 2023 but that clearly depresses our margin percentage.
I think we'll get back to reducing cost and being more productive in our factories and that should improve profitability. So I think you will see in this business our profit go up as the sales start to go back up later in the year.
Meta Marshall
Okay. Got it. On to display, you noted in Q4 earnings that panel production had taken a step back with China reopening. Is there any update as far as what you're seeing with demand here?
Edward Schlesinger
Yes. In display, I think it's helpful to go back a little bit in time in '22, kind of around the middle of the year, June time frame, we saw panel makers start to reduce their utilization levels. That sort of utilization reduction accelerated in the second quarter. We thought it had bottomed out in September, October timeframe at a very, very low level, levels that we hadn't seen for 10 years or so. And we started to see an uptick in November and in December and we were cautiously optimistic that we were maybe seeing the beginning of a recovery. And then as China reopened changed its COVID policy, we actually saw utilization drop back down significantly in January back to those really low levels that we saw in September and October.
And I think that was partly the ability to produce as people were getting sick. We went into Chinese New Year. We're now out of Chinese New Year. I think it's too early to tell what rate -- at what rate we would see utilization come back. But we're optimistic that it will come back. And again, I think similar to what I said about optical, I think second quarter is better than the first quarter. And then the only other data point which I think is helpful, a public data point, is panel prices are starting to tick up and that's a good sign and that tends to be one of the indicators to drive utilization up.
Meta Marshall
Got it. We've seen a period of maybe abnormally high or pricing conditions here, even able to pass on price increases quarter-on-quarter. Just as we come out of the supply chain challenges, COVID demand spikes, just how do you see pricing conditions evolving here?
Edward Schlesinger
Yes. The environment has, for sure, been favorable and we expect it to stay favorable. I think there are some dynamics in the industry that bode well. Our competitors are not that profitable and they can't really lower price. So I think that's one good dynamic. Glass makers like us as well as our competitors need to take tanks off-line, we can manage that to some extent. So we can manage our own inventories, our own supply. And if we keep supply and demand in balance, that bodes well. And then I think for Corning, in particular, we have 3 out of 4 Gen 10.5 facilities. We're very much tied with our customers. So I think that keeps the environment in a very favorable place. It doesn't mean that pricing cannot go down. I think it just means the likelihood of a significant move is very low.
Meta Marshall
Okay, got it. We don't get the question as much anymore but just how do you think about the threats of OLED or other competitors finally getting into the Gen 10 facilities market?
Edward Schlesinger
Yes. OLED, I think in the display space, we don't worry about it much. It's pretty small. I think it's a couple -- maybe 3% of the total volume in the display space. It's just too expensive to be competitive at that level. So we believe LCD is the dominant technology and remains that way. On smaller screen sizes, OLED works well and that's actually okay. We participate there. So I don't see really a technology shift in the foreseeable future in that regard.
And then with respect to Gen 10.5, I mean, we don't comment specifically on what our customers' plans are. I'm not aware of anybody doing anything. And like I said, we have 3 or 4 of those facilities. And I think -- and that puts us in a great position as we go forward.
Meta Marshall
Got it. You guys have always had a very healthy innovation engine between auto, Gorilla Glass, Life Sciences, Valor, what are the innovation opportunities that you're most excited about over the next couple of years?
Edward Schlesinger
Yes, I said this a little earlier. We continue to invest. We've continued to invest significantly over the past few years despite sort of all the economic impacts of the pandemic. I think we have great opportunities across all of our businesses. In some of our kind of existing businesses like in optical communications, we continue to introduce new products that reduce our customers' cost or are greener or reduced their footprint. And I think those are innovations that may fly under the radar but will drive revenue and growth for us in the short term. In auto, I think it's one of the ones -- if I think about the more longer-term things, automotive is more exciting to me in the sense that we've been winning a lot of business.
I think you'll start to see in auto glass us talking more about it and you'll see the impact of it in our revenues sooner than some of the other things that are maybe a little bit out into the future. Certainly, there's opportunities in mobile consumer electronics or in specialty materials, bendable glass, augmented reality are areas that I'd point.
Meta Marshall
Okay. Maybe getting -- you just talked about auto being someplace where you guys -- we should expect to hear more. You guys have continually talked about this kind of $100 per car opportunity. However, about $30 of that $100 that you guys have outlined is from external glass which has been harder to kind of make inroads into. Just should we think about interior as the major driver of growth here? Or is there a traction being made on external?
Edward Schlesinger
Yes. So I mean, as a reminder, a hunk of that $100 per car remains our environmental technologies business and that will continue to be strong. Vehicle production has certainly been down but we continue to do well there. On the glass side, in the shorter term, interior for sure, will drive the growth. That's where more of our wins are. It's where you're seeing a lot more glass on the interior of cars. Our cold-form technology plays well in large form factors or where shapes matter and you're seeing more and more of that in higher-end cars. So, I think that's -- in the shorter term in -- that's where more of the dollars per car will come. But we are actually seeing a lot happen on the exterior the use of specialized glass in some way or rugged glass to protect the things that carmakers are now trying to do for autonomous driving or safety features are requiring different types of glass compositions which we believe bode well for us from a technology perspective.
We've seen interest, for example, in our laminate windshields, Gorilla laminate windshields, they're much stronger than a traditional windshield. And if you've got a lot of optics baked into that windshield and you damage it, you can't just replace it on site. It's got to go back to the factory. So automakers thinking about ways to make the car safer and autonomous and other things like that, I think, play well for the exterior of the vehicle and we'll certainly see more of that in the next few years.
Meta Marshall
So that could not only just be windshield but if there's any sensors around the car, like that also is kind of having a Gorilla Glass.
Edward Schlesinger
Yes, cameras, LIDAR, think of all the things that help the car a lot of the safety features now that are what I would call semi-autonomous, right, like your car might redirect itself into the middle of the road requires some form of a sensor or a camera or something like that and that requires different types of glass to ensure that it's related. It can't get damaged and I think those are opportunities for us. We're sort of seeing a lot of that in the industry. I think as automakers get more sophisticated on the exterior, there's likely to be more opportunities.
Meta Marshall
Okay, that's interesting. I never thought of it that way. On environmental and kind of that environmental opportunity, are there still -- it's still -- we should just consider it tied to emission standards going up? We do get the question sometimes about penetration in electronic vehicles and whether there's kind of opportunities there. Just how to think about kind of the environmental performance?
Edward Schlesinger
Yes, I think 2 things that are noteworthy. One, we're still somewhat optimistic that the U.S. will pass some form of gas particulate regulation at some point in the 2020s. That actually opens up an enormous opportunity for us that today doesn't exist. And then hybrid vehicles require filters. So if you think of that as being a BEV like vehicle that actually takes more filters than an ICE vehicle. So I think that's also an opportunity in that space.
Meta Marshall
Okay. Got it. The Life Sciences business was obviously a huge -- saw a huge benefit from COVID vaccines which I think we're all thankful for. Can this process accelerate -- having gone through kind of the COVID accelerated process accelerate future approval process for Valor Glass? Or will it still be a drug-by-drug process?
Edward Schlesinger
Yes. I think the COVID period was a good learning experience for us in this space. We were able to ramp capacity very fast to meet significant demand which helped us learn a little bit about our own business which is helpful. It is still a sort of drug-by-drug approval process. We're working on accelerating that in various different ways, through different business models., For example, we have a Velocity product which uses a traditional borosilicate vial, type 1 vial but has our coding on the outside which has a different impact on how it would go through FDA approval and we hope would accelerate that. I didn't mention it earlier when you asked about innovation. We're clearly continuing to innovate in this space. I think the likelihood of us seeing significant revenue increases in the shorter term is less likely than in some of the other places but we're still optimistic about the future.
One other thing I would mention is you probably read about some of the partnerships that we've made in this space like West Pharmaceuticals is a good example where we're trying to find different channels for distribution of our products. So I think there's a lot going on but probably a ways off in terms of meaningful revenue.
Meta Marshall
Okay, got it. as with most of your markets, Gorilla Glass has not needed kind of core market growth to experience the segment growth. This is in part just due to more glass content, whether that be double-sided glass, better generations of glass. Can -- like, is there enough innovation still in this market or penetration into the smartphone market to kind of continue this trajectory for this segment?
Edward Schlesinger
Yes. I think -- maybe stepping back for a second, we've sort of doubled the size of this segment in a relatively flat, maybe even down smartphone market. The segment consists of Gorilla Glass as well as our Advanced Optics business which plays, for example, in the semiconductor space. So, I think there's opportunity to grow for sure in Advanced Optics. Semiconductor might be in a little bit of a long now. But certainly, as the globe thinks about the semiconductor supply chain, I think that plays well for that business. And then with respect to smartphones, I think there's room to run still for us in terms of innovation and the types of things we can bring to those types of devices. We can move up in price point, move up in content. We don't have anything to talk about today necessarily that's new. I hope at some point in the near term, we might have something to talk about but there's definitely opportunity there.
And then, I think there are other types of devices that could be in this space. Augmented reality I mentioned earlier, what that looks like, what the device looks like, the adoption rate and all that will have an impact but I think the content per device could be very high, higher than even what you would see on a smartphone. So I think there's definitely opportunities in this space to continue to grow. Some of it might require growth in new devices. Some of it will just be us continuing to innovate.
Meta Marshall
Okay, got it. Your solar Hemlock business is just seen a major resurgence just with the need for U.S. production, with some of the government bills passed. Just how are you judging investment here and what has traditionally been a very volatile space?
Edward Schlesinger
Yes. So we turned on solar capacity a little over a year ago. The need for U.S.-based solar components has become critical. We were able to take advantage of that, turn on capacity. We've sold that out and it's fully operational and fully sold out for a period of time. We have the ability to turn on more capacity and the IRA, for sure, affords us an opportunity to look at the solar supply chain. We're excited about participating in a U.S.-based solar supply chain. We still have some work to do to figure out exactly what that means and how that will all play itself out. We'll certainly share our perspective with investors over time. You did hear Wendell on our earnings call talk about he's excited about potentially building out a $1 billion solar business. So I think there's plenty of opportunity for us here in figuring out how exactly we make it work is where we are right now.
Meta Marshall
I mean one of the things we discussed after earnings was that -- you guys weren't really -- we got some questions from investors on volatility in polysilicon pricing. And you kind of pointed out that maybe you guys don't have the same volatility there. Can you maybe outline or help investors think about that?
Edward Schlesinger
So -- Polysilicon prices, for sure, matter to us. We have mechanisms in our agreements that put a floor on the pricing. So that's one way to protect ourselves. Our goal is to make our poly work off of a different index, let's say, than Chinese poly. And in fact, you can't -- and there's -- polysilicon you can't bring into the United States. So we really are differentiated in that respect. And I think that helps us on the pricing side. I think there's more work to be done on how all that plays out over the next year or two but I wouldn't want people to think we're not impacted at all but we have mechanisms to protect ourselves.
Meta Marshall
Got it. Okay. Maybe turning to financials. Investors have generally looked at this kind of 40% gross margin bogey as -- if you can reach 40% gross margins, that means we're kind of getting into peak cash flow generation. Understanding we've had some depressed consumer demand, commodity pricing, all the hurdles that we've kind of well explored but are there hurdles to achieving this longer-term goal? Or is this still the goal that investors should be thinking about?
Edward Schlesinger
Yes. So for Corning, for me, improving our profitability is a very important. It's high priority our margins, if I think about will improve them from there. We've been impacted by inflation. We've been impacted by what I would call lack of productivity in our factories who were -- we were not running our factories at peak productivity levels just to ensure that we can supply our customers in a very complicated environment [ph]. We've made a lot of changes. We've taken pricing actions. Those things will improve our profitability. Another thing that will impact our profitability is the level of sales we have. So if you think about the first half of 2022 being kind of our past peak level of sales, you need to get back to that level of sales. I think the combination of that improved productivity and our pricing will improve our margins significantly from where they are.
2022; I think we were at 36% for the year. We will definitely go up from there. So to go to get to your sort of very specific question. I think 40% is a possibility. What I would caution is, I don't know how long it takes us to get back there and how things play out from a demand perspective, from a supply perspective over the next few years and I think that will have an impact. I don't know that there's anything structurally that really impacts us from getting back there.
Meta Marshall
Okay. I mean, because, I guess, I always wonder, is there a different bogey we should be thinking of because as fiber becomes a bigger portion of the business, that obviously makes it kind of harder to achieve those targets. And so I'm not asking for new financial targets but is that still a safe assumption that 40% is kind of that target cash flow? Or -- are we kind of using outdated expectations?
Edward Schlesinger
Yes. I think what I would say is we're going to be better than where we were in 2022. Our goal will be to maximize it and improve it over the next few quarters. We talked on our last earnings call about taking actions that gave us confidence that our margins would improve in the first quarter from the fourth quarter, even though our sales would go down which I think is a good demonstration that our profitability is going up, especially in a high fixed cost environment. So again, I wouldn't walk away from the 40% but I wouldn't put out a specific time-based target on it or anything like that.
Meta Marshall
Okay, that's really fine. The yen is obviously another big discussion point with Corning. It's been a meaningful overhang over the past year, just given how weak it's been. But in Q4 earnings, you noted you were able to kind of lock in attractive hedges here that could kind of keep the core rate where it's been over the past couple of years. I think investors are confused maybe to start with on how this was possible at JPY130, so being at JPY136 when you reported earnings. Just how did you accomplish this?
Edward Schlesinger
Yes. So maybe I'll back up a little bit on this one, too. When the yen started to weaken, we were fully hedged for 2022 and similarly for 2023. We took a little bit of action to make '23 more like '22 in that sort of beginning time period. But we talked about being hedged in '23 and keeping our core rate JPY107 in '23. And then most recently, we talked about 2024, keeping our core rate at JPY107 as well as being the majority of our exposure being hedged in '24. So we did have some hedges in place for '24. We weren't starting at 0. So I think that's important to note. It's also important to note that in December and January, the yen actually went below JPY130. So use that as maybe a reference point for recent low or recent strength in the yen. There are many tools available to us to use to hedge.
Another thing I think most people understand but I think it's important to note is when you think about hedging out in the future, what matters is sort of where the yen curve is, the forward point curve is. And there's actually a pretty big gap today between, let's say, today's spot rate and a year from now or 2 years from now and so on, it could be as much as JPY6 or JPY7 depending on where the curve is. So if you think about the yen being in the high 120s and there being a JPY6 or JPY7 delta, you could hedge a year out in the low 120s and there are tools available that you can actually reduce that rate even further at a relatively low cost. So we use all of that. It's relatively proprietary. We don't sort of share all the details. But it allowed us to get from where we were to have the majority of our exposure hedged.
We continue to look for ways to improve our position. Right now the yen is at JPY136, so it's not helpful necessarily to have it there but we have time to work on the years past 2024.
Meta Marshall
I mean in terms of just considerations of -- I think we also get the question of, well, just how much does the yen actually matter to the display business anymore? Is it becoming a smaller portion of the consideration? Or I guess, is it just as important in the hedging program, just as important as it ever was?
Edward Schlesinger
Yes. It's -- yes, we've had a long-standing hedge program going back 10 years. Display glass is priced in yen. So essentially, all the revenues in display are priced in yen. So it is important for us. It remains important for us. There are industrial commercial solutions to help if the yen doesn't improve from where it is. But right now, we've been focused on using the financial tools that we have to do that.
Meta Marshall
Okay, got it. You guys have been able to pull off a remarkable amount of co-investment or kind of better utilization of your balance sheet to drive higher ROI over the past couple of years. Every time I think that all of those different programs, there's not another one kind of around the corner, there are. And so just kind of what helps kind of keep that sustainable or is it sustainable to kind of have as much co-investment as you have had?
Edward Schlesinger
Yes. We invest. It's what we do. It's what makes us successful. So we invest a significant amount in research development engineering and then eventually in capital when we look to commercialize. So it is important to us to find ways to get a great return on that investment. I'll talk about that in a second but also to mitigate the cost for doing that investment. So we have customers who we've been working with for years that understand the value we bring for them. They're willing to pay for that in some way. Oftentimes, that's co-investment. A lot of times, it's a commercial arrangement that gives us a certainty on the returns we get. When we get to sort of really spending money like putting capital in the ground, we look to get a 20% return. That's kind of our hurdle rate. And one of the best ways to do that is to reduce the amount of capital you actually deploy. So getting others to pay for that capital or help pay for that capital is important, getting government incentives and other things like that.
We've also looked at that and been pretty successful in recent times. We will absolutely continue to do that. I think it is a very viable thing. And especially when we bring something to the customer that no one else can bring, they're willing to give us some of that cash upfront which creates a level of certainty for us on our return.
Meta Marshall
Got it. Clearly, the past couple of years have provided some hurdles to kind of achieving capital return plans. But how should investors think about those plans today?
Edward Schlesinger
Yes. So I think the good news is over the last few years, despite sort of the external environment, we grew our sales about 8% since 2019. Our profitability and our cash flow have lagged what we want -- what we expected to achieve, what we wanted to achieve and that sales growth. And that's what we're focused on right now. That will help us have better capital allocation opportunities as we go forward. The way we think about it is we've got a lot of opportunities in our existing businesses and in the spaces where we're investing to innovate and we're going to prioritize capital allocation around organic growth and we'll continue to do that.
That's our number one priority. We think that brings the most value for shareholders. We will also look to reward shareholders. We continue to raise our dividend. Over the last few years, we've raised it 35% since 2019. It was our 13th year in a row of raising the dividend. It's one way of returning cash to shareholders. We're very committed to that. We bought back about 4% of our outstanding shares in 2021 and we'll continue to look for ways to be opportunistic there. And I think M&A is probably secondary to those things, we'll be opportunistic if the opportunities present themselves but it's not as high a priority as those other things.
Meta Marshall
Got it. Well, with that, we're basically out of time. So thanks so much for being here today and it's been a pleasure.
Edward Schlesinger
Thank you very much.
Question-and-Answer Session
End of Q&A
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Corning Incorporated (GLW) Morgan Stanley Technology, Media & Telecom Conference (Transcript)