Hi, good morning, everyone. Thank you. Welcome to day two. I'm Samik Chatterjee. I cover hardware companies at JP 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, of the company. Thank you, for taking the time to come to the conference. I'll get right into the questions. 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.
Yeah, 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, 4 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 5-year, you know, next 5-year window. We do spend a decent amount beyond that as well.
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 agreements. 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. We think we have a lot of organic growth opportunities, you know, in the foreseeable future, that's kind of how we're thinking about deploying capital in the near term.
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 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?
Yeah. 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 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. We also have markets where our we're chasing sort of a secular trend, like in optical communications, the need for broadband, or in solar, the need for green energy.
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, but 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?
Yeah. I'll start maybe with specialty materials. You can think of what we've done over the last 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 at a higher price point, higher sales, higher value. We also add content into the devices we serve in that space. You know, 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. Today, we're much smaller than that. We're in the $30-$40 per auto range. We sell substrates and filters primarily in the ICE vehicle space, as well as on hybrid EVs. We're looking to go from that $30-$40 up to $100 by adding interior glass, which is, you know, a $30+ opportunity, and then exterior glass, think of that as win-windows in the car, lighting, sensors, and other glass materials that'll go into autonomous vehicles and things of that nature. That's another $30+ in terms of content. That's a way to add more Corning into a market.
Even in the markets where we're chasing a secular trend, we have opportunities to add more content in. 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, you know, in a growing market as well.
Just to be clear then, in display, how do you think about the more Corning strategy?
Yeah. I think in display, the biggest driver for us has been screen size. If you think about TV units have been relatively flat. In fact, they've actually been down the last few years, but relatively flat, you know, 225 million or so TVs per year. 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, fair. 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 we go through a recession now in consumer spending and 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?
Yeah. I think in this space, you know, 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%-15% if you go back in time, and we're sort of not seeing that. 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. 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 kinda kick off in the near term, which will infuse a significant amount of capital into that industry. 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. If you're sort of looking at current trends, do you really see this as undershipping demand and you were overshipping demand for the last few years?
Yeah. I think you have two dynamics going on right now. For sure, there was, you know, overshipping 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, you know, customers or deployments where we participate. 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. Our view is that's a cash conservation, you know, approach by those customers. In this macro environment, they're conserving cash.
We talk to our customers all the time, you know, 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. 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 if in the absence of volume improvement? 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?
As we ended 2022, even really sort of towards the middle of 2022, we acknowledged that our profitability in total wasn't where we wanted it to be. Difficult supply chain environment. We absorbed a lot of inflation. 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. 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, I think that's sort of where we aspire to get to, you know, when we get our volume back and with the additional actions that we're taking.
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?
Yeah, price. We took pricing actions in optical, so that has for sure contributed to it. So far so good. I think we, you know, the place where we saw the tightest capacity was in fiber and cable. It's still reasonably, you know, imbalanced supply-demand, so I think it's, you know, reasonable to assume that the pricing holds. I have not yet really seen significant deflation in cost. I think to the extent that happens, that'll be something for us to watch. Now, that's positive.
Mm.
You know, the question is, will we be able to hold our pricing increases in that environment?
Okay. Okay. You do give us the split for the optical business in terms of revenue by carrier and enterprise. 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, you know, 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. You're right, I think the more marked impact was in carrier. I think you know, 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, you know, sides of the business in terms of how we're pacing right now.
Okay. 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?
Yeah, no signs of a rebound at this point. You know, again, very customer specific. There are certainly customers that are continuing to spend and deploy, but no signs of kind of a general rebound. I, you know, I don't know that I would say that. You know, I think it'll 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? Any insights from your discussions with customers as to what their inflection or sort of what the trigger might be for them to start spending again?
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, you know, 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. You know, we continue to pace our own capital and make sure that we're thoughtful in, you know, how we spend, and, you know, 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.
You know, we talked about this in the first quarter, you know, 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. In most of the other places, I think, you know, 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?
Yeah, for sure. you know, 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. You know, as I mentioned at the onset, our goal is really to de-risk our return, 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? 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?
I think the good news is things in Q2 are generally playing out as we expected. Utilization levels are up. We think, you know, panel makers were producing well below demand for quite some time, and inventory is sort of normalized in that industry. 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 bit of strong sequential improvement into 3Q as well?
Yeah. 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.
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 to rising prices. Why shouldn't we be thinking of this sort of as the turning point on pricing?
Yeah. I think in display, we talk about a favorable pricing environment, 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, you know, years in the past. 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 are competitors being, you know, not profitable or losing money actually in the fourth quarter of 2022, and in general, not being profitable is a good driver for helping to sustain pricing in that industry. We feel pretty good about it, going forward.
Okay. Let me open it up here to the audience and see if any questions anyone has. Let me continue on display. One more question, this is in the 3rd 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. 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 3rd-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?
Because you really are more concentrated on the larger sizes and didn't see the down, moderation on the panel sizes impacting your business, you really won't be a beneficiary on the upcycle as well.
I think we think of screen size as generally driving, you know, a few percentage points of growth for glass in the industry, right? You know, it means we sell more glass into the industry even if the units are flat. You know, we talked about that as being in maybe 1.5 inches of screen size per year. Last year, you're right, that was, you know, the overall growth rate was lower than that. I think 1.5 inches 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, you know, relative to what happened in 2022.
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 sort of 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?
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, will continue to contribute growth. Wearables is a good example. I think longer term, you have AR, which is certainly an opportunity in that space.
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? 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, you'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?
Yeah. We have not talked a lot publicly. I don't have anything new to share with specifics on innovation. I mean, bendable glass is something we've talked about. You know, the adoption of that isn't necessarily significant in the near term. 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. We typically aren't sharing anything publicly until they're ready for us to do that.
Okay. Can we talk about the opportunity around AR/VR? Have you sized it up, what that means on the glass side? Is that more of, again, of a bendable sort of a higher content opportunity than the normal glass you would do on a smartphone?
Yeah. 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 a 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. You don't necessarily need the same number of units to see a relatively large market size. If you believe AR is successful, I think it's certainly a, a TAM or an addressable market that could be significant for us.
Okay. Okay. The same question, but on the smartphone side and foldable phones.
Yeah.
I think one of your primary customers is probably now the only customer that hasn't introduced a foldable phone. 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? Maybe give us some sense of how long before a customer launches a product with you on something that's as radical as a foldable phone, how long before do you sort of start engaging with them in developing that product?
Yeah. The last part of the question, I mean, could be years. You know, the innovation cycle could be long, depending on the customer and depending on the nature of what they're trying to do. 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.
Okay. Yeah, please go. Actually, just wait for the mic. Sorry.
You talked about the automotive marketplace and trying to go after content per vehicle. 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?
Yeah. For us, if I think about auto glass, which is really, you know, where today we have a relatively small business, very large market-sized opportunity, we tend to participate where the glass challenge is hard. 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. That's the place where we do better. Those are the, you know, business opportunities that we chase. On the exterior, I think it's still a little earlier to figure out what's gonna happen there.
If you think about, like, LIDAR or autonomous or semi-autonomous driving, the materials that are gonna be required to, you know, do a lot of that are gonna be higher-end glass compositions, where, again, it works well for, you know, a company like Corning as opposed to, you know, a generic composition of glass. I think the margin opportunity is good in that space. How it all plays out, it's just early really to know. You 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, you know, an individual year. As 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.
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. I think even if I today look at third-party forecasts for automotive, they're expecting modest growth for the year. I mean, 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 sort of help us balance that out with sort of what are you seeing on the diesel side?
Yeah. I mean, on, you know, 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. You know, recent U.S. emissions, EPA emissions regulations actually bode well. We think that will require new gasoline particulate filters on U.S. cars starting in the 2026/2027 timeframe, which is a huge opportunity from a content perspective for us. I think there's definitely room to grow, even in the ICE vehicle space, you know, going forward for us.
More cars being built would be good. I don't, you know, I don't have an opinion on when that really starts to tick up.
Okay. Okay. In the time we have left, let me go through a few questions on the financials or mostly cash flow, because that's where I get a lot of questions from investors. 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 sort of start investing again in terms of higher CapEx? How should we think about the go forward?
Yeah. For 2023 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, you know, 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, you know, 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 outflow of capital, like incentives, government incentives, or customer funding. That helps. Take-or-pay contracts also give us, you know, a level of certainty on that capital. 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. You know, 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.
Okay. One of the questions I did receive from investors over email even before coming to the conference was clearly your 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 sort of see a leg of CapEx just to sort of keep up with the growth that you're probably expecting on the rebound?
I mean, you know, for sure there's maintenance of, you know, business capital that we need to spend in display. We don't have any intentions, you know, of doing anything significant. I think we have capacity to be able to meet what we would see as increasing demand there.
Free cash flow conversion, in relation to net income, that's largely, if I remember the numbers right, on average, been around 60%-70%. Most companies we cover are higher than that, and that's obviously a function of your capital intensity. As you sort of look at this model longer term, do you see areas where you can sort of tweak things to improve that conversion over time?
I think in the short term, the best thing we can do is, you know, improve our profitability. I talked about that a little bit earlier. Our profitability's been impacted by inflation and, you know, the global supply chain environment. Improving our profitability for sure improves cash. Improving our inventory, that also improves our operating cash flow. If we can do those things, that should improve our conversion a little bit. I think being more measured on the capital is definitely gonna help. You know, I don't know that we can convert at, you know, a much higher rate than that, but if we can continue to convert at least at that rate and grow, I think, you know, you should start to see us improve our free cash flow in total.
On that front, the ROIC hurdle rate that you have of 20%, is that now largely being followed across all segments, or do certain segments like display sort of get a pass because they've already been sort of grandfathered in?
Yeah. The way to think about it is new capital. You know, if we're gonna build a factory or add a significant addition on to a new factory, whatever business it's in, that's the target rate that we go after. Of course, we want it to be much higher than that, but, you know, that's sort of the cutoff for us as we think about where we put our capital.
Okay. Last one. Just, you've refrained from doing open market repurchases for a while now. I think we understand the buyback that you need to do from Samsung. How should we think about maybe starting some open market repurchases? What could the timing for that look like?
Yeah. In 2021, we bought back about 4% or 5% of the company, through a transaction with Samsung. We paid for that over 3 years. In April of 2023, we made the last payment on that buyback. The good news is we now, going forward, will have some firepower because we don't have to make any more of those payments. That was a half a billion dollars we spent in April of 2023. I think the good news is we're, you know, going forward, we have the opportunity to do that. As I mentioned at the onset, our sort of 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, you know, as we go forward.
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.
Thank you.