Corning - Q1 2024

Transcript

Operator (participant)

Welcome to the Corning Incorporated Quarter One 2024 earnings call. To place yourself into the Q&A queue, please push star one, one. It is my pleasure to introduce to you Ann Nicholson, Vice President of Investor Relations.

Ann Nicholson (VP of Investor Relations)

Thank you, and good morning, everyone. Welcome to Corning's first quarter 2024 earnings call. With me today are Wendell Weeks, Chairman and Chief Executive Officer, and Ed Schlesinger, Executive Vice President and Chief Financial Officer. I'd like to remind you that today's remarks contain forward-looking statements that fall within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks, uncertainties, and other factors that could cause actual results to differ materially. These factors are detailed in the company's financial reports. You should also note that we'll be discussing our consolidated results using core performance measures, unless we specifically indicate our comments relate to GAAP data. Our core performance measures are non-GAAP measures used by management to analyze the business.

For the first quarter, the difference between GAAP and core EPS primarily reflected constant currency adjustment, translated earnings contract gains, and translation gains on Japanese yen-denominated debt. As a reminder, the mark-to-market accounting has no impact on our cash flow. A reconciliation of core results to the comparable GAAP value can be found in the investor relations section of our website at corning.com. You may also access core results on our website with downloadable financials in the Interactive Analyst Center. Supporting slides are being shown live on our webcast. We encourage you to follow along, and they're also available on our website for downloading. Now I'll turn the call over to Wendell.

Wendell Weeks (Chairman and CEO)

Thank you, Ann. Good morning, everyone. Today, we announced first quarter 2024 results. Sales were nearly $3.3 billion, and EPS was $0.38. Year-over-year gross margin grew 160 basis points to 36.8%, and free cash flow improved by $300 million. These results were at the high end of our guidance. More importantly, we're seeing encouraging signs of improving market conditions. We continue to expect that the first quarter will be the low quarter for the year. We are executing our plans to add more than $3 billion in annualized sales within the next three years, and we already have the required capacity and capabilities in place. As a result, we're poised to deliver powerful incremental profit and cash flow and generate substantial shareholder value.

Last quarter, we outlined a framework under which we expect to drive stronger returns on our existing innovation and capacity investments, and we shared our expectation that these returns will begin in 2024. The framework has three primary components. First, we believe that the first quarter will be the lowest quarter for the year. We will improve from here. Second, we expect to grow by more than $3 billion in annualized sales in the mid-term, which we define as within the next three years. The outlook in each of our markets remains positive, and our market positions are quite strong. Third, as we capture this growth, we expect to deliver powerful incrementals. We already have the required production capacity and technical capabilities in place, and the cost and the capital are already reflected in our financials. This is a tremendous opportunity for our shareholders.

In the three months since our last call, our confidence in these three components has only increased. We expect our sales to grow from here, and we have reflected this in our second quarter guidance. Today, I'd like to review each component of the framework and share some of the reasons why our confidence has grown. Let me begin with the first component, our expectation that quarter one will be the lowest quarter of 2024. Near term, we expect Optical and Display to be the biggest drivers of our improvement. In Optical Communications, carrier inventory drawdowns have been the primary source of our below-trend sales. Once carrier inventory starts returning to more normal levels and our customers resume purchasing to support their deployment rates, we would expect to see our order book grow. That's exactly what is happening. Our order book grew nicely from fourth quarter levels.

This, and our regular conversations with large carrier customers, indicate that the gap between our sales and customer deployments is moderating. As a result, we expect carrier sales to increase from first quarter levels. Additionally, in the enterprise portion of our Optical business, we expect that our recent wins for AI data centers will translate into orders and sales during the year. In Display, panel makers increased their utilization rates late in the first quarter, and we expect the higher utilization to continue into the second quarter, driven by expected growth in retail demand resulting from mid-year promotions. For the full year 2024, our expectations for the retail glass market remain unchanged from our January view, and consistent with industry expectations. We anticipate relatively flat television unit volume, another year of television screen size growth, and some recovery in PC demand.

This leads to mid-single digit percentage growth in glass volume at retail versus 2023. As a result, we expect our financial performance in Display to improve significantly from our first quarter run rate. Ed will share more details on that in just a few moments. Now, let's move to the second component of our framework, our expectation that we will add more than $3 billion in annualized sales within the next three years. Our positive outlook for each of our market opportunities results from our leadership positions and the power of the secular trends that we're addressing through innovation and close collaboration with customers. There's a lot More Corning to be had in our markets. In Optical Communications, fiber is the ascendant technology, and we are the clear market leader. As I've covered in the last two calls, fiber shipments are more than 30% below trend.

We fully expect that gap to close, adding more than 40% to our overall Optical Communication sales. In conversations with our large carrier customers during the quarter, they reinforced their commitment to increasing fiber deployments in 2024 and beyond. Additionally, we expect BEAD-related projects for network builds in underserved areas to add to our addressable market for the next several years. The industry expects funding approvals to begin late this year, leading to spending in 2025. Next, generative AI is an especially attractive opportunity for us. It creates significant demand for passive optical connectivity solutions and strengthens our value proposition and our competitive advantages. All data centers consist of a front-end network connecting racks of CPUs. To meet the computational demands of AI, customers are building a new fiber-rich second network to connect GPUs, which increases our market opportunity.

Now, we'll see this in our financials as customers begin to build large GPU clusters and adopt our latest high-density innovations. Customers want fast deployment. Our pre-connectorized structured cabling solutions offer big installation time advantages, and the GPU clusters, which pack a very large amount of computing power per rack, require smaller tensor cables, making connector size and cable diameter important requirements. To meet these high-density requirements, we've introduced new-to-the-world fiber, cable, and connectivity products. At OFC, a few weeks ago, we introduced RocketRibbon cable with Flow Ribbon Technology that can reduce cable diameter by 60%, with fibers per cable approaching 7,000. A key part of delivering this innovation is our Contour optical fiber, which has a 40% smaller cross-sectional area than legacy fibers.

Now, our ability to integrate innovations across fiber, cable, and connectors to create end-to-end solutions is a unique competitive advantage, and we're accumulating significant customer wins for upcoming AI data center builds. In our recent customer wins, our revenue is low single-digit hundreds of dollars per GPU. We believe the customer density needs, combined with our technology's superior performance, will sustain these attractive sales attach rates long term. Let's turn to automotive. The U.S. EPA announced new multi-pollutant standards last month. They include a strong particulate emissions limit that will require gasoline particulate filter adoption on U.S. gasoline vehicles, including hybrids, as early as 2026, for model year 2027. We are the inventor and the clear market leader in GPF, and these standards increase our environmental technologies content opportunity by two-three times per U.S. ICE vehicle.

This adoption offers hundreds of millions of dollars of growth for us in the U.S. alone, even in the face of BEV adoption. Keep in mind, we're also pursuing additional More Corning content opportunities in the automotive industry by introducing our Automotive Glass Solutions, which are building success and momentum and are being adopted by both ICE and BEV platforms. In mobile consumer electronics, our goal is to outpace the market by increasing the content we provide for each device. Our sales have consistently outpaced the market over the last decade, and we expect that to continue to be the case going forward. We've done this by advancing the state-of-the-art for cover materials and adding more content per device, a classic More Corning play.

We have a strong innovation portfolio in support of our close collaborations with leading OEMs, and we expect to continue delivering new products that increase our value per device. In Display, we expect volume growth at retail to be driven mainly by television screen size growth. In fact, in the first quarter, sales of 85-inch TVs increased by more than 50% year-over-year. Overall, we expect to capture growth in Display because we are the undisputed technology leader. Our successful development of Gen 10.5 and advanced capabilities align with the continued move to larger-sized TVs produced on the lowest-cost platforms for large displays. Finally, we continue to build entirely new product platforms to capture opportunities in new categories. Examples include Automotive Glass Solutions to support high autonomy systems, the growing opportunity to localize U.S. solar supply, and pharmaceutical packaging.

In sum, we expect the power of our market leadership positions and More Corning innovations to allow us to grow faster than our markets and advance our $3 billion+ opportunity. Now I'd like to move to the third component of the framework, our expectation for powerful incrementals as we add sales. In the fourth quarter of 2022, we initiated a set of actions to restore historic pro-productivity ratios and also to raise price to share the impact of inflation more equitably with our customers. Since we initiated these activities, we have expanded our gross margin by 320 basis points, despite sales being down almost $400 million. Our actions have established a significantly stronger profitability and cash flow base, even while our P&L includes the costs and technical capabilities necessary to support $3 billion+ in additional sales.

Importantly, we have put processes and governance mechanisms in place to generate operating leverage as we grow sales. So, as I close today, here's what I'd like to leave you with. Our first quarter results show encouraging signs of improving market conditions. We continue to expect that this quarter will be the lowest quarter for the year. Additionally, we've established a higher profitability and cash flow base. Finally, as our markets improve, we have the opportunity to increase our annualized sales by more than $3 billion. As we capture that growth, we expect to deliver powerful incrementals because the required capacity and technical capabilities are already in place and the costs are already in our financials. This represents a terrific opportunity for our shareholders. Our second quarter guidance reflects higher sales and strong incremental profit, and you'll hear more about this from Ed.

We will continue making progress on this opportunity in 2024. Think of us as continuing to march up. I look forward to updating you at investor conferences in the next few months. Now, before I turn the call over to Ed, I'd like to take a moment to recognize Jeff Evenson, Executive Vice President and Chief Strategy Officer, who will retire from Corning at the end of May. I want to thank Jeff for his 13 years of outstanding leadership at our company. During his tenure, he's helped grow the company, develop frameworks that define our priorities and guide our actions, and raised awareness of glass as a key enabling material. He also increased Corning's focus on sustainability. Jeff, we wish you the very best. With that, I'll turn things over to Ed.

Ed Schlesinger (EVP and CFO)

Thank you, Wendell, and good morning, everyone. Our first quarter sales were $3.26 billion, and EPS was $0.38 at the high end of our guidance. Our actions to increase price and improve productivity ratios are paying off. In the first quarter, despite lower year-over-year sales, we grew gross margin by 160 basis points. We also grew free cash flow by more than $300 million versus the first quarter of 2023. Overall, we have established a significantly stronger profitability and cash flow base, and we expect to grow from first quarter levels. In the second quarter, we expect sales of approximately $3.4 billion, with strong incremental profit and EPS in the range of $0.42-$0.46. Let's take a closer look at our segment results.

In Optical Communications, sales for the first quarter were $930 million, down 17% year over year, reflecting temporarily lower carrier demand as customers continued to draw down inventory. Net income for the quarter was $100 million, down 37% year-over-year, reflecting the lower volume. We're seeing clear signs of improving market conditions, and we think Q1 represents an inflection point. Sequentially, sales grew in both carrier and enterprise in the first quarter, which is more favorable than normal seasonality, and our order rates are steadily increasing as some of our carrier customers are reaching the end of their inventory drawdowns. We believe we're well-positioned to take advantage of the industry's long-term growth drivers, specifically broadband, 5G, cloud computing, and AI.

We will also benefit from public infrastructure investments to help connect the unconnected and bring broadband to a much larger share of the U.S. population. Moving to Display Technologies. As we shared with you in January, panel makers reduced their utilization levels in the fourth quarter in response to a softer retail selling season. Additionally, as expected, panel makers' utilization levels remained low in the first quarter to align supply to demand. Our first quarter sales were $872 million, up 14% year-over-year, and net income was $201 million, up 26% year-over-year. The increase in net income was primarily driven by higher volume and pricing actions taken in the second half of 2023. First quarter glass price was consistent with the fourth quarter of 2023, as expected.

Now, it's worth noting that first quarter net income was negatively impacted by our decision to reduce our production to align to the lower volume we experienced in the fourth and first quarters. Our profitability will be higher in the second quarter. Looking ahead to the second quarter, we expect panel makers to run at higher utilization rates, driven by growth in retail demand resulting from mid-year promotions, and we will return our production volume to more normal levels. We expect the second quarter glass market and our volume to increase sequentially as a result of higher panel maker utilization, and we expect glass price to be consistent with the first quarter. For the full year, our expectations for the retail market remain unchanged from our January view and are consistent with industry expectations.

Specifically, we anticipate relatively flat television unit volume, another year of TV screen size growth, and some recovery in PC demand. This adds mid-single-digit percentage growth in glass volume at retail versus 2023. Overall, we expect the pricing environment to remain favorable. Before I move on, I want to take a minute to address currency exchange rates. As a reminder, we have actively hedged our foreign currency exposure over the past decade. This serves as an effective tool to reduce earnings volatility, protect our cash flow, enhance our ability to invest and protect shareholder returns. We're very pleased with our hedging program and the economic certainty it provides, and we've received more than $2.5 billion in cash under our hedge contracts since their inception.

Our most significant hedge contracts are for the Japanese yen, which support our Yen Core Rate of JPY 107 through the end of 2024. As we look beyond 2024, our goal is to maintain an appropriate return on our Display business through a combination of currency hedges and industrial solutions like price increases. First, on hedging, we are actively working to improve our hedge coverage for 2025 and into the future. The yen forward curve works in our favor, so if you go out a year, the forward rate is about JPY 8 stronger than today's spot rate. Out two years, it's approximately 14, and so on. The current yen spot rate is significantly weaker than the 30-year average of approximately JPY 110.

We have made some progress on our hedges and are now partially hedged for 2025, and we'll continue to look for attractive opportunities to increase our hedges. Second, our customers sell panels in US dollars, and they buy glass from us in yen. They are benefiting from the current weak yen rate. We plan to share the economics more appropriately with our customers by raising glass prices in yen. We successfully took a first step in this direction in the second half of 2023. We will continue to keep you updated as we make progress. Moving to Specialty Materials, sales in the first quarter were $454 million, up 12% year-over-year, driven by strong demand for our premium smartphone cover materials, as well as semiconductor-related products. Net income was $44 million, up 13% year-over-year, driven by higher volume.

Our More Corning approach will continue to help us win as handheld and IT markets recover. Additionally, over time, we anticipate growth from new innovations such as bendable glass and augmented reality as they are adopted more broadly. Environmental Technologies first quarter sales were $455 million, up 6% year-over-year, driven by increased GPF adoption in China, which more than offset a decline in heavy duty diesel in North America, an impact we expect to continue through 2024. Net income was $105 million, up 28% year-over-year, driven by higher volume and improved operating performance. In Life Sciences, sales in the first quarter were $236 million, down 8% versus the first quarter of 2023, as customers in North America and Europe continue to draw down their inventory.

Net income was $13 million, up 44% year-over-year, reflecting improved productivity. Turning to Hemlock and Emerging Growth Businesses, sales in the first quarter were $311 million, down 19% year-over-year, reflecting lower pricing for solar-grade polysilicon and lower sales in Pharmaceutical Technologies from the completion of volume commitments for COVID-related products. Now, let's turn to our outlook. Last quarter, we shared our expectation that the first quarter would be the low quarter of the year, and we're even more confident that that is the case. In the second quarter, we expect sales to grow sequentially to approximately $3.4 billion, with strong incremental profit and EPS in the range of $0.42-$0.46.

We also anticipate free cash flow to grow sequentially by approximately $300 million in the second quarter, and we expect CapEx of approximately $1.2 billion for the year. Wendell outlined our framework to drive strong returns on our existing innovation and capacity investments and shared our expectations for powerful incremental profit and cash flow. Given this opportunity, we've begun to think about our approach to the allocation of that cash going forward. As a reminder, we prioritize investing for organic growth opportunities. And as we've shared today, in the midterm, we have the capabilities and capacity in place to add more than $3 billion in annualized sales with minimal cash investment. You can see that reflected in our CapEx expectations for 2024. This contributes to the strong free cash flow we expect to generate.

Additionally, we maintain a strong and efficient balance sheet, and we're in great shape. We have one of the longest debt tenors in the S&P 500. Our current average debt maturity is about 23 years, with about only $1 billion in debt coming due over the next 5 years, and we have no significant debt due coming due in any given year. So as our cash flow increases, we remain committed to providing returns to our shareholders. We have grown our dividend 40% since 2019, and our dividend yield is top quartile in the S&P 500, and we will continue to be opportunistic on share repurchases. I look forward to sharing more in the coming months as we continue to make progress building a solid foundation for durable, profitable, long-term growth. Now, I'll turn things back over to Ann.

Ann Nicholson (VP of Investor Relations)

Great. Thank you, Ed. We're ready for our first question.

Operator (participant)

Thank you. As a reminder, to ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Wamsi Mohan with Bank of America. Your line is now open.

Wamsi Mohan (Senior Equity Research Analyst)

Yes, thank you so much. If I could, one for Wendell, one for Ed. Wendell, on the commentary around the data center opportunity, around AI, was wondering if you could just share some color on when you think these incremental orders and revenue will flow into Corning and these low hundreds of dollars per GPU. Can you just break that down into how, maybe just a little bit more color on where exactly that's coming from? Is this rack-to-rack connections in optical and data center? And how large do you think the TAM for that is? And I have a follow-up for Ed, please.

Wendell Weeks (Chairman and CEO)

So the timing of when we'll start to see it in our financials. So we start with a pretty large business and enterprise, all related to the sort of front end, what you think about as a front-end network, which is all connecting the CPUs. So on top of that base, you'll start to see sort of relatively robust revenue growth, assuming the orders that we've closed here all ship in the back half of this year. You're just gonna start to see that momentum begin to build. Where does it come from? Well, the simplest way to think about this is let's just start at the rack level.

Typical front-end rack filled with CPUs has about 32 fibers that sort of come into that top of the rack switch, right? About 16 ports, two fibers per port. There's different ways to do it, but assuming one of these back-end network GPU racks will tend to have on the order of a couple of H100 servers. To service those, you need more like 256 fibers on that same rack. So you've got about an eight times increase in the amount of fibers per rack. So this is what leads to the demand for us to do a More Corning innovation. How do you fit eight times as many light pipes into fundamentally the same area? And that's why you see all of our new product innovation, what we've been working on the last few years, is aimed at that.

So as you start to see those large cluster GPU installations begin, is when you should start to see it in our numbers, Wamsi. Was that, did that answer your question?

Wamsi Mohan (Senior Equity Research Analyst)

Yeah, it did. I, I wonder, Wendell, if you might also comment on the B100, which seems to be a much more higher density solution than the H100, and the need for bandwidth, probably order of magnitude higher between racks.

Wendell Weeks (Chairman and CEO)

Yes. So you, that is a great observation, and it is in line with the sort of, secular trend that we see, that basically says we have plenty of innovation left to get done because density continues to increase, as well as the bandwidth requirements increase. And so what that does is it reduces the amount of distance with which you can travel in an electron, and therefore pushes the photons closer and closer to sort of the beachfront of those GPUs, which is opening up an entire new set of categories for us, for our flat glass, for our ability to cut the light into various formats. And so in a way, what you're describing is what's leading to a whole new family of innovations upon which we are working diligently, Wamsi.

Wamsi Mohan (Senior Equity Research Analyst)

Okay. Thank you, Wendell. Appreciate the answer. And maybe quickly for Ed. Appreciate the yen commentary here as we look into 2025. There seem to be a lot of moving pieces for Display between the yen rate and the pricing you alluded to. How large is the partial hedge, or where do you expect to exit this year, where do you think you will be hedged for 2025? What do you think is the sort of, you know, core rate that if we were to shift next year to a different core rate, where would you think that would be using all the tools that you have?

If you could perhaps just roll it up at the high level, including the price changes that you spoke about, how should we think about Display at sort of the top line level, given all these different changes?

Ed Schlesinger (EVP and CFO)

Yeah, thanks for the question, Wamsi, and I understand the desire to have all that information. I think the simplest way to think about it is we are committed to generating an appropriate return in this business, and we think we will do that in 2024. We did that in 2023, and our goal is to get the economics to be similar as we go forward, regardless of where the yen winds up and, you know, where we are able to hedge. You know, we're good at hedging. We've got a long-standing program. We will look for attractive opportunities to build our 2025 hedge portfolio, and if the yen breaks our way, we'll go out beyond that.

I think it's too early to talk about core rate or that kind of, discussion, but I think you should just think about our Display economics that we'll deliver in 2024 as being the way to think about our Display business. So we'll raise price to offset the impact of the yen, and the net of those two things get you to the same place. That's the way we're thinking about it. We've made some nice progress on hedging, and we'll continue to keep you updated as we go. I think that's, that's the way you all should think about it.

Wamsi Mohan (Senior Equity Research Analyst)

Okay. Thank you, Ed.

Ed Schlesinger (EVP and CFO)

Yep.

Ann Nicholson (VP of Investor Relations)

Operator, we're ready for our next question.

Operator (participant)

Our next question comes from the line of Meta Marshall with Morgan Stanley. Your line is now open.

Meta Marshall (Executive Director and Senior Equity Analyst)

Great, thanks. Maybe a question from me. You know, you noted that you have the capacity kind of today with capital you've already built to have $3 billion of additional revenue, yet you noted that you expect to kind of grow over the next three years by more than that $3 billion. And so just trying to get a sense of, you know, where you think that the biggest opportunities or investments will be over the next couple of years. And then maybe a second question. You know, there's been obviously a lot made of the timing, and understanding that you're seeing kind of improving demand trends on service provider as they come out of inventory digestion, but just kind of what your latest thoughts are around kind of BEAD timing as an enhancement to the Optical business. Thanks.

Wendell Weeks (Chairman and CEO)

I'll start with the second one, and then maybe, Ed, you can discuss the first. So on BEAD timing, we tend to be relatively conservative in our outlook of how effective the government can be in allocating resources to build networks. We're in strong support of this. It requires U.S. content, and we think it's aimed well, and it will be done. The funds have been allocated. But the process, we would tend to be a little, our expectations would be a little slower than what you see as the industry overall. We think they'll get allocated this year, and you won't really start to see spending until next year. That's our current point of view, Meta. Does that answer your question?

Meta Marshall (Executive Director and Senior Equity Analyst)

Yeah, that's helpful.

Wendell Weeks (Chairman and CEO)

Okay.

Ed Schlesinger (EVP and CFO)

Yeah, Meta, on your other question, you know, so first I would start with, we actually have capacity to do, you know, much more than $3 billion in sales. I think we're framing it up as we see it. Where those sales come from, where those opportunities come from, will depend on, you know, whether we need to add, you know, anything, you know, beyond what we have in place today. But we feel very confident in supporting a number well above $3 billion. You know, there are certainly a few places where we might spend a little money, but it's all encapsulated in the CapEx guide we gave for 2024, and we ramped our capital spend down in the back half of 2023. So sitting here today, I don't see any need for significant amount of capital.

A good example might be as we build out our Auto Glass business and we continue to win there, we might need to spend a little bit, but not the kind of capital you're used to when you build, like, melting capacity for glass, more on the finishing side. So I think our goal is to generate a significant amount of cash flow off of the existing capacity we have in place.

Meta Marshall (Executive Director and Senior Equity Analyst)

Great. Thank you.

Ann Nicholson (VP of Investor Relations)

Next question.

Operator (participant)

Our next question comes from the line of Martin Yang with Oppenheimer. Your line is now open.

Martin Yang (Executive Director and Senior Analyst)

Hi, good morning. Thank you for taking my question. I would like to ask about your opinion regarding newly announced subsidy programs for home appliance trading in China. I know your retail estimates on TV sales this year hasn't changed. Do you think this could be a new catalyst to drive, you know, upside to retail TV market and your glass volume in 2024?

Wendell Weeks (Chairman and CEO)

That's a great question. But they're relatively recent, and we're still in the midst of trying to understand how that will play out when it hits the consumer. Our expectations have been for China retail demand to be relatively muted this year. You're right to point it out. We're just a little early in being able to analyze and predict what its impact will be, Martin. We'll get back to you on that as our understanding evolves.

Martin Yang (Executive Director and Senior Analyst)

Got it. Thank you so much.

Ann Nicholson (VP of Investor Relations)

Thanks, Martin. Next, next question?

Operator (participant)

Our next question comes from the line of Samik Chatterjee with JP Morgan. Your line is now open.

Samik Chatterjee (Executive Director and Senior Analyst)

Hi. Thank you for taking my question. Maybe to sort of ask you another one on Display. Just a bit more longer term, I know you have a strong position in the Display market with the display glass, but traditionally or historically, the problem with this market has been the short cycle nature of the swings and the volume cycle. When you think about the duration of this current cycle, are you thinking about it any differently? How does the cycle track relative to some of the sort of volatility we've seen in the past? And then a bit more near term, I know you mentioned you're expecting a step-up in terms of industry volume into 2Q, but any more color there?

Because that does seem like 1Q panel maker utilization improved more late in the quarter than you expected. So, how are you thinking about 2Q now based on the sort of stronger exit of 1Q? Thank you.

Wendell Weeks (Chairman and CEO)

Right. That's a, let me take the first question. That is a wonderfully, deep question, Samik, on the first one. Mainly because as the locus of panel manufacturing has shifted, from Korea, Taiwan into China, and, that high concentration there has begun to lead to sort of different behavior between, set makers and panel makers. One of the things that led to the, you know, sort of classic crystal cycles would be that, A, you had a very strongly growing market, which meant predicting how much capacity you would need was challenging because you had to get the rate right. But then the second was that, set makers would tend to have very strong back half demand. Panel makers would tend to want to make pretty consistently, and therefore you'd have buildups of value chain inventory that added volatility.

To the markets. Two things have changed. First, we're now in the mature stage of the Display market, at least until such time as something like a very new format Display starts to move. So that end market has become easier to predict. Second, what we're seeing with the behavior of the, of the new, very strong panel makers is, they're seeking to optimize panel price, and they are reducing their utilization to match more closely with the actual orders from set makers. So this has begun to change that dynamic of how much inventory gets built up in the value chain. Now, this has only been, you know, a couple of quarters, couple, three quarters, and so it's, it's too early to tell, is this going to be, a more longer-term change?

If it is a longer-term change, that will reflect well on the health of the industry and the smoothing out of these cycles that you are pointing out. The pandemic was sort of a mega cycle, and we're sort of still dealing with some of the things that happened during that period. So that may be more color than you're looking for, Samik, but it is a question upon which obviously we are pondering.

Samik Chatterjee (Executive Director and Senior Analyst)

Any thoughts on 2Q, the step up from 1Q, 2Q, just given the exit run rate was higher in 1Q?

Ed Schlesinger (EVP and CFO)

Yeah, Samik, you know, as you, as you articulate, panel maker utilization was low generally in Q1. We certainly saw a step up towards the end of the quarter. We're expecting them to run, you know, at higher levels through the second quarter and really through the year, because if retail is flat, just to meet that flat unit demand, they would have to run at significantly higher levels for the remaining three quarters of the year to, to meet that demand. We're not guiding specific, you know, volume increase, from Q1 to Q2, but I think it's pretty meaningful.

Samik Chatterjee (Executive Director and Senior Analyst)

Good. Thank you. Thanks for all the insights. Very helpful.

Ed Schlesinger (EVP and CFO)

Yep.

Ann Nicholson (VP of Investor Relations)

Next question.

Operator (participant)

Our next question comes from the line of Tim Long with Barclays. Your line is now open.

Tim Long (Managing Director and Senior Equity Research Analyst)

Thank you. Maybe just a two-parter on the Optical Comms business. First, on the telco side, you talked about the inventory normalization, but there's also a lot of chatter out there and weakness, given 5G hasn't seemed to work all that successfully for the telcos. So could you just, you know, talk about that business in the context of, you know, 5G isn't really successful and what that means for some of these longer-term contracts that you have with some of the larger players? And then secondly, on the enterprise side, could you just touch on the opportunity for a lot of chatter about GPUs kind of chasing where there happens to be spare capacity for energy?

Do you see an opportunity for your Enterprise business with large data centers popping up in new areas, that will need to be connected? Thank you.

Wendell Weeks (Chairman and CEO)

Thank you, Tim. On the 5G piece, I think that the challenge that our customers in telco have faced is that, 5G, you move from a technology in 4G, which a wireless is very wireless, right? To 5G, which therefore takes wireless and starts to make it more wireline, and therefore taking a good amount of infrastructure to put in place. Now, interestingly, what they've taken advantage of is if they're going to do that, you see them combining their networks from wireline and wireless into one. And that allows them some significant cost savings and offers many different potential revenue opportunities for a given deployment of network. Now, so in a way, you're seeing their cost productivity improve, their ability to serve improved.

There is the challenge of how much revenue, incremental revenue, the 5G at this stage has generated, and that is something they have wrestled with. What you see reflected in our thoughts for the year is a relatively muted deployment outlook, but that we'll still see the pickup, because what's pushing us below sort of long-term deployment rates of fiber is been this eating through of the inventory, largely purchased during the pandemic and dealing with that step up. But it does incorporate a lower deployment outlook. So that's what we've sought to do for that, Tim. Does that address your question on that piece?

Tim Long (Managing Director and Senior Equity Research Analyst)

Yes, yes. And then just on the data centers popping up in other places, impact?

Wendell Weeks (Chairman and CEO)

The answer to your question is yes. It is an interesting opportunity, and it is coming back to, it's enhancing on a key capability we have that others don't, which is this ability for us to actually respond globally across a really big geographic footprint, not only in the U.S., but across the globe, because this search for energy is more than just finding the exact right communities here. And so, yes, it does offer a significant opportunity for us for both innovation as well as volume. But it's too early to factor that in because they haven't found all the energy sources yet that will be required, and they're still dealing with the infrastructure ramifications at their end.

Tim Long (Managing Director and Senior Equity Research Analyst)

Okay, great. Thank you.

Ann Nicholson (VP of Investor Relations)

Thanks, Tim. Our next question?

Operator (participant)

Our next question comes from the line of Asiya Merchant with Citi. Your line is now open.

Asiya Merchant (Director and Equity Research Analyst)

Oh, great, and apologies if this question's been answered, but I did notice inventory was a little higher this quarter, and OpEx tracked a little bit higher as well. Just if you can provide some clarity on that. Thank you.

Ed Schlesinger (EVP and CFO)

Sure. Thanks, Asiya. On inventory, just think of it as we had a very low volume quarter. In general, our volume will go up through the year, so we still view inventory as an opportunity to take it down from the level we're at, and we think that'll be a catalyst for cash flow in 2024. With respect to OpEx, I'm gonna answer your question, but I'm gonna reframe it a little bit as well. So sequentially, our OpEx was up. The simplest way to think about it is that our variable compensation in 2023 was lower than normal because we didn't perform to target in 2023, so we just didn't pay out at target. We've reset our targets. We expect to perform in 2024, so our variable compensation is at a normal level.

But what I think is important to take away on OpEx is we are committed to keep our OpEx relatively flat to where it is. It'll move around in any given quarter, you know, it's. I think we're, you know, we were about $700 million in the first quarter. It could be in the $700 million-$725 million range. But if we're able to do that, over time, it creates another leverage point for us as our sales grow, and that's why we talk about powerful incrementals, gross margin expands, and operating margin expands as well, or profitability expands more than sales. So I feel good about OpEx overall.

Ann Nicholson (VP of Investor Relations)

Thanks, Asiya.

Asiya Merchant (Director and Equity Research Analyst)

Great. And thanks. Thanks.

Ann Nicholson (VP of Investor Relations)

Go ahead, Asiya.

Asiya Merchant (Director and Equity Research Analyst)

Well, I was just gonna ask. I know there was commentary on yen earlier, but, you know, investors have been asking when Corning would feel comfortable sharing sort of the new yen hedges. And perhaps this question's already been answered, but I did join late, so apologies if this is a repetitive question. But any color on this? Yeah.

Ed Schlesinger (EVP and CFO)

Yeah, no apologies necessary, Asiya. Yeah. You know, what I shared earlier was, the most important thing is to think about the return we generate in this business. Our goal is to generate an appropriate return. You could think of that as what we will deliver in 2024 or what we delivered in 2023. And, you know, we're, we're gonna use yen hedging and raising price in combination to generate that economics or those economics to, to generate that return. And so we have made progress on our hedges. We've made some nice progress, and we'll be, you know, opportunistic throughout the year, and we'll look to hedge at attractive rates. We're not sort of discussing the details, and I think it's too early to think about how to frame up core rate for 2025. So we'll keep you posted on that.

But just think of it as the overall profitability level or, you know, cash generation level in the Display business.

Asiya Merchant (Director and Equity Research Analyst)

Thank you.

Ann Nicholson (VP of Investor Relations)

The next question?

Operator (participant)

Our next question comes from the line of Joshua Spector with UBS. Your line is now open.

James Cannon (Associate Equity Analyst)

Hey, guys. Congrats on a solid quarter. This is James Cannon in for Josh. I just wanted to poke on the powerful incrementals you described when talking about the $3 billion sales opportunity. I mean, if I look back at kind of the last couple of quarters, your gross margin has held in pretty steady despite sales declining. I think there's some noise with Display pricing coming through. Can you just give me some color as to how we should think about the cadence of gross margins as we go through the rest of the year?

Ed Schlesinger (EVP and CFO)

Yeah, thanks for the question. You know, I think the way to think about it is if you go back to Q2 of, I'm sorry, Q4 of 2022, that was our low point. We've expanded our gross margin 300 basis points while our sales have come down almost $400 million. We've done that by improving our productivity ratios, running our factories better, and by raising price. So we're actually at a very nice baseline of 37%, and I'd remind you that 37% is closer to 39% when you think about the old math before we absorbed inflation and raised price, right? So we're starting from a very nice base, and we have the capacity in place to support a lot higher sales, which is not normally the way we would grow.

So as sales come back, we would expect our gross margin to march up along with those sales nicely each quarter. And then I mentioned just before, we also believe OpEx or on the operating margin line is another leverage point for us. So that's how we think about those powerful incrementals. I think you should just think of it as we will march up as our sales grow from 37%.

James Cannon (Associate Equity Analyst)

Okay. I guess just another way to think about it is, as that $3 billion comes through, like, I, I think 40% has typically been your target. Like, has that changed, or is that where you think, that's still where you think you can get to?

Ed Schlesinger (EVP and CFO)

Yeah, so, you know, I think we can get there, but just as a reminder, you know, the 40%, if you go back in time, you know, we've absorbed a significant amount of inflation and raised price, which brings our margin percentage down. So, you know, 38% is sort of the new 40% in old math. But I still think despite that new base, we can get back to that 40% level as we accrete our sales up.

James Cannon (Associate Equity Analyst)

Got it. Thanks.

Ann Nicholson (VP of Investor Relations)

Thanks, James. Next question?

Operator (participant)

Our next question comes from the line of Steven Fox with Fox Advisors. Your line is now open.

Steven Fox (Equity Research Analyst)

Hi, good morning. I guess I was just wondering on the Specialty Materials business, if you could provide some more detail. From my seat, it looks like it did much better than I would've thought for Q1. How much of that was due to Gorilla Glass? How do you sort of look at the rest of the year, given sort of, you know, mixed results in Q1 on the phone side? Like, what kind of seasonality, et cetera, are we looking at? Thanks.

Ed Schlesinger (EVP and CFO)

Yeah, I think, you know, it was more or less in line with how we would have expected it. I think it's a business that will grow as we add More Corning content. That's the way we think about it. For the year, you know, we don't see smartphone market being up that much in units, you know, maybe a point or two for the year. There certainly can be some growth in the IT space, but even that is, you know, single digit, maybe mid-single-digit level. So I think the growth catalyst here is for us to add content into the market.

Wendell Weeks (Chairman and CEO)

And we just don't see a lot of that happening this year, Steve. This is most of our newest innovation will be aimed at the model year following this. So, you know, we're not looking at MCE as being a big catalyst for near-term growth in terms of versus Q1, right, for this year, but future it will be.

Steven Fox (Equity Research Analyst)

That's helpful. Thank you.

Ann Nicholson (VP of Investor Relations)

Super. We've got time for another question.

Operator (participant)

Our next question comes from the line of George Notter with Jefferies. Your line is now open.

George Notter (Managing Director and Equity Research Analyst for Communications Equipment)

Hi there. Thanks very much, guys. I guess I'm curious about your comments on Display. I think you mentioned an appropriate level of profitability. You know, I get what that is. But when you go out and re-up the hedging portfolio, obviously, there's a cost that comes with that. Do you still insist? I think if I go back in the past, you know, you guys looked at the hedging portfolio as being pretty neutral in terms of cost between what you were long and what you were short. Is that still gonna be the case as we re-up the hedges going forward? And then when you talk about an appropriate level of profitability, are you including the cost of the hedging program when you make that statement? Thanks.

Wendell Weeks (Chairman and CEO)

The appropriate level of profitability would include any cost of hedging. We're long yen, right? And so you've heard in Ed's reporting out sort of over the sweep of time generated on the order of $2.5 billion of cash, positive cash arising from our hedges, right? That's us hedging that long yen position. And the way we think about this is that position is coming from the fact we sell in yen, and so we will resolve this either in the currency market, should the yen come back to more sort of reasonable levels, right? And we'll be opportunistic about that. But if not, our customers are picking up the gain in terms of lower cost glass because we sell in yen.

And so what we will do is just raise our price in yen to share some of that volatility that we're seeing in the yen. Does that make sense, George?

George Notter (Managing Director and Equity Research Analyst for Communications Equipment)

It does. I assume it's still fair to say that the cost of the hedging program is pretty minimal to shareholders or pretty balanced in terms of the two sides.

Wendell Weeks (Chairman and CEO)

Yes.

George Notter (Managing Director and Equity Research Analyst for Communications Equipment)

Thanks a lot. Appreciate it.

Wendell Weeks (Chairman and CEO)

Yep.

Ann Nicholson (VP of Investor Relations)

Thanks, George, and thank you everybody for joining us today. Before we close, I wanted to let you know that we will hold our annual meeting of shareholders on May 2nd. In addition, we'll also attend the JPMorgan Technology Conference on May 21st. And finally, we'll be hosting management visits to investor offices in select cities. There'll be a web replay of today's call on our site starting later this morning. Thank you all for joining us. Shannon, that concludes our call. Please disconnect all lines.

Operator (participant)

This concludes today's conference call. Thank you for your participation. You may now disconnect.