Corning Incorporated (NYSE:GLW) Edward A. Schlesinger presents at J.P. Morgan 51st Annual Global Technology, Media and Communications Conference May 23, 2023 9:30 AM ET

Company Participants

Edward A. Schlesinger - Executive Vice President and Chief Financial Officer

Conference Call Participants

Samik Chatterjee - J.P. Morgan

Hi, good morning, everyone. Thank you. Welcome to day two, and I'm Samik Chatterjee, I cover hardware companies at J.P. Morgan, for us kicking it off on day two 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.

Question-and-Answer Session

Q - Samik Chatterjee

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, etcetera discussion. Your long-term capital allocation decisions in terms of how you prioritize investments across the different segments of the different market-access platforms, is really where I want to start with. How are you 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?

Edward A. Schlesinger

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 three, four, five framework that we use to invest three 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 near-term in terms of revenue opportunities. Think of that as sort of the five year -- next five 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 de-risk that in ways by getting incentives or customer funding or long-term supply agreement.

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.

Samik Chatterjee

Okay. No, great. The reason I sort of started with that is, you have diversified in 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 drive. How you're 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?

Edward A. Schlesinger

Yes. So, if I think about our consumer focused markets, first, display, specialty materials in 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 automobiles.

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.

Samik Chatterjee

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?

Edward A. Schlesinger

Yes. I'll start maybe with specialty materials. So, you can think of what we've done over the decade is outperform a relatively flat smartphone market. We've 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 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 a $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 a $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.

Samik Chatterjee

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

Edward A. Schlesinger

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, 20 million to 25 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.

Samik Chatterjee

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 they have 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?

Edward A. Schlesinger

Yes. I think in this space, I would first say, I'm cautious right now. I think the biggest indicator for us of what 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 kickoff 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.

Samik Chatterjee

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 it sort of looking at current trends, do you really see this as under-shipping demand and you are over-shipping demand for the last few years?

Edward A. Schlesinger

Yes. I think you have two dynamics going on right now. For sure there was no 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 that 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 its homes passed or data center capacity. So, we think those commitments still exist, and we think short-term is cash conservation and some inventory digestion.

Samik Chatterjee

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 if in the absence of volume improvement? 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 connector products, where should long-term margins be?

Edward A. Schlesinger

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, it 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.

Samik Chatterjee

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

Edward A. Schlesinger

Yes. Price -- we took pricing actions in optical, so that has for sure contributed to it. So far, so good, I think the place where we saw the tightest capacity was in fiber and cable. It's still reasonably imbalance 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'll 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.

Samik Chatterjee

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?

Edward A. Schlesinger

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.

Samik Chatterjee

Okay. And when you think about a rebound between the two segments, how do you think about that playing out? Do you see it playing out earlier in the enterprise? It sort of, is 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?

Edward A. Schlesinger

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'll come as it comes as opposed to it's more on the enterprise side or more on the carrier side.

Samik Chatterjee

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 spending hesitation that you're seeing from your customers. I know there are a lot of macro noise and other things playing out particularly discussions about the debt ceiling. When you think about when those get resolved as you talk to customers, do customers are waiting for some of these discussions to 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 or what the trigger might be for them to start spending again?

Edward A. Schlesinger

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 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 in to the second quarter, generally that's playing out. But in most of the other places, I think it's still wait and see.

Samik Chatterjee

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

Edward A. Schlesinger

Yes. For sure, we talked about capital in total being slightly less than what we spent in 2022 for the year of 2023. We’ll continue to be very measured in how we spend capital. As I mentioned at the onset, our goal is really to de-risk our return, and so part of doing that is not bringing the capital on too early.

Samik Chatterjee

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, rate up to general 1Q? And are you still continuing to see that improvement and would your expectations be that we see that improvement continue into 3Q as well?

Edward A. Schlesinger

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 is 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.

Samik Chatterjee

Okay. 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 a 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?

Edward A. Schlesinger

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.

Samik Chatterjee

Okay. Okay. On display pricing, it did decline I think slightly on a sequential basis in the March quarter, that was after, I think, eight quarters of stable rising prices. Why shouldn't we be thinking of this sort of as the turning point of pricing?

Edward A. Schlesinger

Yes. I think in display, we talk about a favorable pricing environment and I think, definitionally, the way we think about it is of course, we want prices to go up. But if prices are flat or slightly down, that kind of fits into that framework. We're looking to ensure prices don't take these big declines like we saw years in the past. And so I think a slight decline is reasonable, especially given the fact that utilization was really low for such a long period of time.

I think the drivers of why we're in that favorable environment or of the drivers of why we're in that favorable environment, our competitors being not profitable or losing money actually in the fourth quarter 2022 and in general not being profitable is a good driver for helping to sustain pricing in that industry. So, we feel pretty good about it going forward.

Samik Chatterjee

Okay. Let me open it up here to the audience and see if any questions anyone has. Let me then continue on display. One more question, and this is in the third-party of the public data that we track on display, and I don't know if you've seen this trend overall because on the display side, you cater to more of the larger panels. But clearly through the last year or so, there was a decline or moderation of the average increase in the panel sizes that was evident in third-party data, more recently it has started to reflect, again in terms of the increase year-over-year in panel sizes. How should I interpret that? Is that generally a tailwind for you going forward or because you really are more concerned on the larger sizes, you didn't see the down moderation on the panel sizes impacting your business? You really won't be a beneficiary on the up-cycle as well?

Edward A. Schlesinger

Yes. I think, we think of screen size as generally driving a few percentage points of growth for glass in the industry, right. So selling, it means we sell more glass into the industry even if the units are flat. We talked about that as being in maybe an inch and a half of screen size per year. Last year, you're right, that was low. The overall growth rate was lower than that.

I think an inch, inch and a half is probably the right number to think about for the next several years. It's certainly favorable for us in general. I don't know that we'll get any kind of a significant increase. I think it really just depends on how that plays out, relative to what happened in 2022.

Samik Chatterjee

Okay. Let me switch to specialty materials. You've been as you outlined outperforming the underlying market there. As you look forward, is there a lot more sort of in terms of new use cases to look on when you particularly focus on the smartphone market in terms of driving content opportunity or is more of the increase going to come from like wearables and other products that you can go into?

Edward A. Schlesinger

Yes. I think we still have some headroom in smartphones to continue to add new glass compositions, and even new components into the devices. I don't know that the headroom is the same as what we saw let's say over the last decade, but I think there's definitely some headroom. New device categories, for sure, we’ll continue to contribute growth, wearable is a good example. I think longer term you have AR, which is certainly an opportunity in that space.

Samik Chatterjee

Okay. I mean, maybe this is sort of going one level down, but in terms of innovation that you're working on in that area, what does that pipeline look like because a question that we often get from investors is, you really don't have that much sort of performance improvement on the smartphone glass to really go after anymore. There's probably a bit more on the wearable side as you outlined, but in terms of your innovation pipeline, we've made these visits to your facilities. There's always like new features, new sort of characteristics that you're introducing, what does that innovation pipeline look like?

Edward A. Schlesinger

Yes. We have not talked a lot publicly, so I don't have anything new to share with specifics on innovation. I mean bendable something -- bendable glass is something we've talked about. The adoption of that isn't necessarily significant in the near-term, but I certainly think that glass composition is an opportunity. We definitely have many things in the pipeline. We work very much with our customers directly. So, we typically aren't sharing anything publicly until they're ready for us to do that.

Samik Chatterjee

Okay. Can we talk about the opportunity around AR, VR? Have you sized it up? What that means on the glass side? And is that more of a bendable sort of a higher content opportunity than the normal glass you would do on a smartphone?

Edward A. Schlesinger

Yes. I mean, I think the way to think about AR, this is my opinion, I mean the way to think about it is, there's probably no device today that's really at scale from a cost or design perspective. So, it means it's a ways out in time, before it's something. I don't know how many units eventually get sold, but I think the content per unit could be significantly greater than a smartphone for Corning.

So, you don't necessarily need the same number of units to see a relatively large market size. So, if you believe AR is successful. I think it's certainly a TAM or an addressable market that could be significant for us.

Samik Chatterjee

Okay. The same question, but on the smartphone side and foldable phones.

Edward A. Schlesinger

Yes.

Samik Chatterjee

I think, one of your primary customers is probably now the only customer that hasn't introduced a foldable phone. So, the question on that front is going to be, when you think about content per smartphone, how much of an uplift could a foldable phone be? What are you working in terms of innovation to make that sort of glass more essential to a foldable phone? And maybe give us some sense of how long before a customer launches a product with you, something that as radical as a foldable phone, how long before do you start engaging with them in developing that product?

Edward A. Schlesinger

Yes. So, the last part of the question, I mean it could be years, the innovation cycle could be long, depending on the customer and depending on the nature what they're trying to do. So, certainly there could be a relatively long cycle. I don't have anything new to share in this space. I certainly won't talk about what any of our customers are intending to do?

Samik Chatterjee

Okay. Yes, please go. Actually just wait for the mic, sorry.

Unidentified Analyst

How do you make sure you're balancing the margin opportunities in the content per vehicle so you're not chasing after commodity spaces, where there's revenue opportunities?

Edward A. Schlesinger

Yes, for us, if I think about auto glass, which is really, where today we have a relatively small business, very large market sized opportunity. We tend to participate where the glass challenge is hard, so the margin opportunity is greater. You can think of on the interior form factor or size, as opposed to a small display screen where you might have a much lower margin. So, that's the place where we do better. Those are the business opportunities that we chase.

On the exterior, I think it's still a little earlier to figure out what's going to happen there. But if you think about like LiDAR or autonomous or semi-autonomous driving, the materials that are going to be required to do a lot of that are going to be higher end glass compositions where again it works well for a company like Corning, as opposed to a generic composition of glass.

So, I think the margin opportunity is good in that space. How it all plays out, it's just early, really to know. We've got a lot of orders in backlog. We've got over $1 billion of orders that we've won in the auto glass space. Think of that as revenue over a few years of time, not an individual year. And as new model -- new car models come out, you'll start to see that. Most of that's on the interior, but we are certainly seeing many opportunities to bid on the exterior and in specialized glass opportunities as well.

Samik Chatterjee

Any other questions? Okay. Let me actually follow-up on the automotive question here. There are concerns around the automotive market, but still for the early part of the year, it's held up pretty well. And I think even if I today look at third-party forecast for automotive, they expect to be modest growth for the year. How -- I mean it seems like that should be then a segment that you're relatively more positive about relative to some of the others for the year. How are you thinking about automotive and help us balance that out with what are you seeing on the diesel side?

Edward A. Schlesinger

Yes. I mean on autos, I think it's going to be the fourth year in a row, where less cars are built than the end market demand, assuming the end market demand hasn't really structurally changed. We're not predicting any real significant growth in units in 2023, that's kind of how we think about it. We continue to outperform. Recent U.S. emissions, EPA emissions regulations actually bode well. We think that will require new gas particulate filters on U.S. cars starting in the ‘26, ‘27 timeframe, which is a huge opportunity from a content perspective for us.

So, I think there's definitely room to grow even in the ICE vehicle space, going forward for us. More cars being built would be good, but I don't have an opinion on when that really starts to tick up.

Samik Chatterjee

Okay. In the time we have left, let me go through a few questions on the financials, mostly cash flow because that's where I get a lot of questions from investors. So, free cash flow generation for the last couple of years has been good on account of low CapEx investments. How should we think about capital spending intensity going forward? Are we sort of at a point where you need to start investing again in terms higher CapEx, how should we think about the go forward?

Edward A. Schlesinger

Yes. So for ‘23 specifically, we intend to spend a little less capital than we did in 2022. We are trying to be very measured and thoughtful about when we add capital. Our goal is to de-risk the return that we try to get. It's possible we go through a growth cycle and we need capital. I wouldn't preclude that from happening, but I think that's good news in the sense that means we have a level of certainty.

We use many different tools. We've been using a lot of tools lately to minimize the out flow of capital like incentives, government incentives or customer funding that helps, take-or-pay contracts also give us a level of certainty on that capital. So, I don't know that you can ever think of Corning as not being capital intense. It's capital intense to some extent to melt glass. But our goal is to try to make sure that we generate a return on that capital, that's reasonable in a short period of time.

Samik Chatterjee

Okay. One, of the questions I did receive from investors over email even before coming to the conference was, clear display business is the one that's poised to do very well through this year. What does that mean for capital investment through the year, where is display in terms of utilization of your own facilities? Do we need to see a leg of CapEx just to keep up with the growth that you're probably expecting on the rebound?

Edward A. Schlesinger

Yes. I mean, for sure there's maintenance of business capital that we need to spend in display. We don't have any intentions about doing anything significant. I think we have capacity to be able to meet what we would see as increasing demand there.

Samik Chatterjee

Okay. Free cash flow conversion in relation to net income, that's largely if I remember numbers right on average being around sort of 60%, 70%. Most companies we cover are higher than that, and that's obviously a function of your capital intensity. But as you sort of look at this model longer term, do you see the areas where you can tweak things to improve that conversion over time?

Edward A. Schlesinger

Yes. I think in the short-term, the best thing we can do is improve our profitability. I talked about that a little bit earlier, our profitability has been impacted by inflation and the global supply chain environment. So, improving our profitability for sure improves cash. Improving our inventory, that also improves our operating cash flow. We can do those things that should improve our conversion a little bit. And I think being more measured on the capital is definitely going to help.

I don't know that we can convert at a much higher rate than that, but if we can continue to convert at least at that rate and grow, I think you should start to see us improve our free cash flow in total.

Samik Chatterjee

On that front, the ROIC hurdle rate that you have of 20%, is that now largely being followed across all segments or does -- do certain segments like display get a pass, because they've already been grandfathered in?

Edward A. Schlesinger

Yes. The way to think about it is new capital. So, if we're going to build a factory or add a significant addition on to a new factory, whatever business is in, that's the target rate that we go after. Of course, we want it to be much higher than that, but that's sort of the cutoff for us as we think about where we put our capital.

Samik Chatterjee

Okay. Last one, just you've refrained from doing open-market repurchases for a while now. So, I think we understand the buyback that you need to do from Samsung, but how should we think about maybe starting some open-market repurchases? What could the timing for that look like?

Edward A. Schlesinger

Yes. So in 2021, we bought back about 4%, 5% of the company through a transaction with Samsung. We paid for that over three years. In April of ‘23, we made the last payment on that buyback. So, the good news is, we now going forward, we’ll have some firepower because we don't have to make any more of those payments. That was $0.5 billion we spent in April of ‘23. So, I think the good news is going forward, we have the opportunity to do that. And as I mentioned at the onset, our capital allocation approach is to prioritize organic investment and then to find ways to return cash to shareholders. We pay a nice dividend and we intend to use buybacks as a tool as we go forward.

Samik Chatterjee

Okay. I'll wrap it up there, we're close to end of time. Thank you. Thanks for coming to the conference. Thank you everyone.

Edward A. Schlesinger

Thank you.