Corning Incorporated: FY2018 Form 10-K Summary
Business context and reporting period
Corning is a materials-science manufacturer operating in Display Technologies, Optical Communications, Environmental Technologies, Specialty Materials, Life Sciences and All Other. Products include display glass, optical fiber and connectivity products, emissions-control substrates and filters, specialty glass, and laboratory products. The filing covers the fiscal year ended December 31, 2018; fourth-quarter figures are included in the unaudited quarterly table.
Financial performance and key metrics
| Metric | FY2018 | FY2017 | Change |
|---|---|---|---|
| Net sales | $11.290 billion | $10.116 billion | +12% |
| Gross margin | $4.461 billion | $4.020 billion | +11% |
| Gross margin percentage | 40% | 40% | Stable |
| Operating income | $1.575 billion | $1.608 billion | Down modestly |
| Income before taxes | $1.503 billion | $1.657 billion | -9% |
| Net income attributable to Corning | $1.066 billion | $(497) million | Improved by $1.563 billion |
| Diluted EPS | $1.13 | $(0.66) | Improved by $1.79 |
| Core earnings, non-GAAP | $1.673 billion | $1.634 billion | +2% |
| Core diluted EPS, non-GAAP | $1.78 | $1.60 | +11% |
Operating margin was approximately 14% and GAAP net margin was approximately 9%. The effective tax rate was 29.1%, compared with 130.0% in 2017, when the 2017 Tax Act generated approximately $1.5 billion of tax reform charges.
Optical Communications was the largest segment by sales at $4.192 billion, up 18%, followed by Display Technologies at $3.276 billion, up 4%; Specialty Materials at $1.479 billion, up 5%; Environmental Technologies at $1.289 billion, up 17%; Life Sciences at $946 million, up 8%; and All Other at $216 million, up 15%. Segment net income was led by Display Technologies at $835 million and Optical Communications at $592 million.
Net cash provided by operating activities was $2.919 billion, compared with $2.004 billion in 2017. Capital expenditures were $2.242 billion, up from $1.804 billion, and cash used in investing activities was $2.887 billion, primarily reflecting capital spending and the $842 million acquisition of substantially all of 3M’s Communication Markets Division. Cash used in financing activities was $1.995 billion, including $2.227 billion of share repurchases and $685 million of dividends paid.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $2.355 billion at December 31, 2018, with approximately 56% held outside the United States.
- Working capital was $3.723 billion, down from $5.618 billion; the current ratio declined to 2.1 from 2.8.
- Long-term debt was $5.994 billion, compared with $4.749 billion; total debt to total capital increased to 30% from 25%.
- Corning issued approximately $596 million of yen-denominated debt and $900 million of U.S. dollar-denominated long-term notes during 2018, and redeemed $250 million of notes due 2019.
- The company had no commercial paper outstanding and had access to a $1.5 billion unsecured revolving credit facility expiring in 2023. Management reported compliance with the 60% leverage covenant.
- Corning repurchased 74.8 million shares for approximately $2.2 billion during 2018. The quarterly common dividend increased from $0.155 to $0.18 per share in 2018; a further increase to $0.20 was declared in February 2019.
- Customer deposits increased to approximately $1.0 billion from $0.4 billion, primarily reflecting non-refundable deposits under long-term display-glass supply agreements.
Fourth-quarter 2018 results
| Metric | Q4 2018 |
|---|---|
| Net sales | $3.035 billion |
| Gross margin | $1.202 billion |
| Equity earnings of affiliates | $288 million |
| Net income attributable to Corning | $292 million |
| Diluted EPS | $0.26 |
Material changes versus the prior comparable period
- Sales growth occurred across all segments, with the strongest increases in Optical Communications and Environmental Technologies.
- Optical Communications sales increased $647 million, including approximately $200 million from the CMD acquisition; segment net income increased $123 million.
- Display Technologies sales increased despite price declines, but segment net income decreased $53 million because of Gen 10.5 capacity expansion, production ramp costs and tank rebuilding.
- Gross margin percentage remained approximately 40%, while selling, general and administrative expense increased 22% to $1.799 billion. The increase included higher litigation and legal costs, acquisition-related expenses and corporate costs.
- Core earnings increased only 2% despite 11% core sales growth, partly because of capacity expansion spending, higher financing expense and corporate project costs.
- Research, development and engineering expense increased 15% to $993 million, reflecting continued investment in new products and emerging businesses.
- The company adopted ASC Topic 606 for revenue recognition in 2018; management reported that the transition impact was immaterial.
Guidance, outlook, commentary and risks
Management expected 2019 to be another year of growth and investment. Display Technologies pricing declines were expected to improve to a mid-single-digit percentage, with Corning’s volume growth exceeding expected market growth because of television size trends and the Gen 10.5 facility in China. Optical Communications sales were expected to grow at a low-teens percentage, including a full year of CMD sales. Environmental Technologies was expected to grow at a high-single-digit rate; Specialty Materials was expected to grow depending on customer adoption of innovations; and Life Sciences was expected to grow at a low- to mid-single-digit rate. Planned 2019 capital expenditures were expected to be slightly above $2.0 billion.
- Display glass pricing, industry overcapacity, competition and concentrated customers could materially affect profitability and cash flow.
- Four customers accounted for 70% of Display Technologies sales, one customer accounted for 18% of Optical Communications sales, and three customers accounted for 78% of Environmental Technologies sales.
- International operations expose Corning to foreign exchange, tariffs, trade restrictions, geopolitical events, supply-chain disruptions and regulatory risks. The company had $13.6 billion of translated-earnings hedge notional value at year-end.
- Manufacturing is dependent on uninterrupted power, industrial water, specialized equipment, precious metals, helium and other limited- or single-source materials.
- Goodwill and other intangible assets totaled approximately $3.2 billion; no goodwill impairment was required in 2018, but future impairment charges remain possible.
- Legal and contingent matters included intellectual-property and commercial litigation, non-Pittsburgh Corning asbestos claims, Pittsburgh Corning plan payments, environmental liabilities and potential indemnification obligations relating to former Dow Corning matters.
- Environmental reserves were approximately $30 million, and total contractual obligations and contingencies were reported at $13.209 billion, including debt, interest, leases, capital commitments, purchase obligations and the amended Pittsburgh Corning plan.
- The pension plans were underfunded by approximately $764 million at year-end, and the company expected 2019 pension contributions of $106 million.
Most important facts for investors to verify
- Whether Optical Communications growth, including CMD synergies, offsets capacity expansion costs and supports management’s 2019 low-teens sales outlook.
- Whether Display Technologies pricing declines continue to improve and whether Gen 10.5 capacity ramps without further margin pressure.
- The sustainability of operating cash flow after approximately $2.2 billion of annual capital spending and continued shareholder returns.
- Debt maturities, interest expense and leverage following the 2018 debt issuances, particularly the long-dated notes and yen-denominated obligations.
- The effect of customer deposits and long-term supply agreements on future revenue timing, working capital and tax expense.
- Potential changes in tax liabilities, including the preliminary IRS settlement, uncertain tax positions and approximately $1.5 billion of indefinitely reinvested foreign earnings.
- Exposure to major customers, foreign currency movements, tariffs, supply disruptions, litigation, asbestos claims and contingent indemnification obligations.