Corning Incorporated: Q3 2019 Form 10-Q Summary
Business context and reporting period
Corning Incorporated reported results for the three and nine months ended September 30, 2019. Its principal segments are Display Technologies, Optical Communications, Specialty Materials, Environmental Technologies, and Life Sciences. The filing was signed October 30, 2019.
Financial performance and key metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net sales | $2.934 billion | $3.008 billion | $8.686 billion | $8.255 billion |
| Gross margin | $1.017 billion; 35% | $1.232 billion; 41% | $3.181 billion; 37% | $3.259 billion; 39% |
| Operating income | $365 million | $522 million | $1.159 billion | $1.111 billion |
| Net income attributable to Corning | $337 million | $625 million | $928 million | $774 million |
| Diluted EPS | $0.38 | $0.67 | $1.03 | $0.82 |
| Operating cash flow | Not separately provided | Not separately provided | $1.013 billion | $1.978 billion |
Q3 net sales declined 2%, while nine-month sales increased 5%. Q3 net income declined 46%, primarily because translated earnings contract gains were $106 million lower after tax, and costs increased by $116 million after tax, principally from accelerated Display Technologies depreciation and asset write-offs in Display Technologies and Optical Communications.
Reported nine-month net income increased 20%. The improvement reflected higher translated earnings contract gains, stronger segment earnings, favorable tax-related items compared with 2018, and lower litigation-related costs. Core net income, a non-GAAP measure, was $397 million in Q3 and $1.172 billion for nine months, compared with $476 million and $1.134 billion, respectively.
Segment results
- Display Technologies: Q3 sales fell 7% to $793 million and segment income fell 15% to $185 million. Nine-month sales rose 3% to $2.459 billion.
- Optical Communications: Q3 sales fell 10% to $1.007 billion, including a $105 million decline in carrier products from market weakness and reduced major-carrier spending. Nine-month sales rose 4% to $3.161 billion.
- Specialty Materials: Q3 sales increased 1% to $463 million, but segment income declined 21% to $92 million. Management cited lower Gorilla Glass shipments in China and semiconductor-market weakness.
- Environmental Technologies: Q3 sales increased 20% to $397 million and segment income increased 32% to $79 million, driven largely by gasoline particulate filters.
- Life Sciences: Q3 sales increased 11% to $256 million and segment income increased 37% to $41 million, supported by volume growth and improved manufacturing efficiency.
Cash flow, liquidity, debt, and capital allocation
- Cash and cash equivalents were $971 million at September 30, 2019, down from $2.355 billion at December 31, 2018; approximately 73% was held outside the United States.
- Working capital was $2.556 billion and the current ratio was 1.7:1, compared with $3.723 billion and 2.1:1 at year-end 2018.
- Nine-month operating cash flow was $1.013 billion, versus $1.978 billion in 2018, primarily because of lower customer deposits and incentives and greater working-capital investment.
- Capital expenditures were $1.602 billion for nine months; management expected approximately $2.0 billion for full-year 2019.
- Total debt was approximately $6.530 billion, including $305 million of current debt and $6.225 billion of long-term debt, versus $5.998 billion at December 31, 2018. Debt to total capital was 33%, compared with 30% at year-end.
- Corning issued approximately $349 million of yen-denominated senior unsecured notes in Q3, consisting of 12-year and 20-year tranches.
- The company had no commercial paper outstanding and had full availability under its $1.5 billion revolving credit facility. It reported compliance with its 60% leverage covenant and other debt provisions.
- Corning repurchased 10.8 million shares for approximately $308 million in Q3 and 23.4 million shares for approximately $703 million in nine months. A $5 billion repurchase authorization was approved in July 2019.
- Dividends paid in the first nine months were $554 million. Management stated that liquidity was sufficient to fund operations, capital expenditures, acquisitions, debt repayments, dividends, and planned repurchases.
Material changes, outlook, and unusual items
- Gross margin declined to 35% in Q3 from 41%, and to 37% for nine months from 39%, largely due to accelerated depreciation and asset write-offs.
- SG&A declined 16% in Q3 and 12% for nine months, reflecting lower variable compensation, reduced operating costs, and the absence of certain 2018 legal charges. Research and development expense increased 5% in Q3 and 3% for nine months.
- The nine-month effective tax rate fell to 22.6% from 33.1% in 2018. The prior-year period included a $172 million IRS audit-related tax charge; 2019 included tax-reserve changes and the release of foreign valuation allowances.
- Corning adopted the new lease standard on January 1, 2019, recording approximately $449 million of operating lease right-of-use assets and liabilities at adoption. An equity affiliate’s adoption of the new revenue standard reduced beginning retained earnings by $186 million, with a related $53 million tax effect.
- For full-year 2019, management expected Display Technologies pricing to decline at a low-single-digit rate with slightly higher volume; Optical Communications sales to decline 3% to 5%; Specialty Materials sales to grow; Environmental Technologies sales to grow in the mid-teens; and Life Sciences sales to grow in the mid-single digits.
- Q4 expectations included a roughly 25% year-over-year decline in Optical Communications sales, mid-single-digit sequentially lower Display Technologies volume, stable Specialty Materials sales, low-teen Environmental Technologies growth, and mid-single-digit Life Sciences growth.
- Management’s strategy and growth framework for 2020–2023 contemplated $10 billion to $12 billion of growth investment and $8 billion to $10 billion of shareholder returns.
Risks, contingencies, and controls
- Key risks include global economic and political conditions, tariffs, currency movements, product demand and pricing, customer concentration and financing, technology changes, supply-chain costs, litigation, intellectual-property protection, cyber and operational disruptions, regulatory developments, and the timing of capital spending.
- Corning had approximately $135 million of remaining fixed payments under the Pittsburgh Corning asbestos plan through 2023, including $35 million due in 2020. The reserve for non-PCC asbestos claims was $99 million.
- Corning was potentially responsible for 15 active hazardous-waste sites and had accrued approximately $39 million for environmental cleanup and related litigation.
- In September 2019, Dow Corning notified Corning of environmental matters that could trigger a potential indemnification obligation. Corning could not estimate the fair value of any such obligation at September 30, 2019.
- Corning reported effective disclosure controls and procedures and no material change in internal control over financial reporting.
Investor verification checklist
- Verify whether the Q4 declines in Optical Communications and Display Technologies were temporary or indicative of sustained demand and pricing pressure.
- Assess the effect of accelerated depreciation and asset write-offs on future Display Technologies and Optical Communications margins.
- Reconcile reported GAAP results with core net income and evaluate the recurring nature of translated earnings contract gains.
- Monitor cash conversion, inventory growth, capital expenditures, and the reduction in cash balances relative to debt and shareholder distributions.
- Review the remaining share-repurchase authorization, dividend capacity, and compliance with the 60% leverage covenant.
- Track the Dow Corning environmental indemnification matter, asbestos obligations, environmental reserves, and the approximately $40 million IRS settlement payment expected in the first quarter of 2020.