Corning Incorporated — 2016 Q3 Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2016. The interim financial statements are unaudited and prepared under U.S. GAAP.
Business Context and Key Financial Metrics
Corning operates through Display Technologies, Optical Communications, Environmental Technologies, Specialty Materials, Life Sciences, and All Other, which primarily includes Corning Pharmaceutical Technologies and emerging businesses. Management is concentrating approximately 80% of research, development and engineering spending and capital spending on three core technologies, four manufacturing and engineering platforms, and five market-access platforms.
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net sales | $2,507 million | $2,272 million | $6,914 million | $6,880 million |
| Gross margin | $1,041 million | $892 million | $2,756 million | $2,796 million |
| Gross margin percentage | 42% | 39% | 40% | 41% |
| Operating income | $535 million | $392 million | $959 million | $1,235 million |
| Net income attributable to Corning | $284 million | $212 million | $2,123 million | $1,115 million |
| Diluted EPS | $0.26 | $0.15 | $1.81 | $0.82 |
| Net cash from operating activities | Not separately provided | Not separately provided | $1,095 million | $1,845 million |
Q3 net margin was approximately 11%, compared with approximately 9% in the prior-year quarter. Nine-month net income and margin were materially affected by the $2.676 billion gain on the Dow Corning investment realignment and related tax benefits, as well as significant foreign-currency hedge losses.
- Cash and liquidity: Cash and cash equivalents were $4.821 billion at September 30, 2016, up from $4.500 billion at December 31, 2015. Working capital was $6.185 billion and the current ratio was 3.7:1.
- Debt: Current debt and short-term borrowings were $7 million and long-term debt was $3.916 billion. Total debt-to-total-capital was 18%. Corning had no commercial paper outstanding and had access to a $2 billion revolving credit facility expiring in 2019.
- Capital spending and financing: Nine-month capital expenditures were $815 million, versus $939 million in 2015; 2016 capital spending was expected to be approximately $1.2 billion. Financing cash outflows included $3.884 billion of common-stock repurchases and $493 million of dividends.
- Shareholder returns: The quarterly common dividend increased from $0.12 to $0.135 per share. Corning entered a $2 billion accelerated share repurchase transaction and also repurchased approximately $1.901 billion of shares in open-market transactions during the first nine months.
Material Changes Versus the Prior Comparable Period
- Q3 sales increased 10%, led by Display Technologies, up 19%, and Optical Communications, up 6%. All segments reported higher Q3 sales.
- Nine-month sales were essentially flat, with Display Technologies up 2% and All Other up $80 million, offset by declines in Optical Communications, Environmental Technologies, and Specialty Materials.
- Q3 gross margin improved by $149 million and three percentage points, supported by higher sales, cost reductions, and manufacturing-efficiency improvements. Nine-month gross margin declined by $40 million and one percentage point, primarily due to LCD glass price declines, the Taiwan power outage, and first-half Optical Communications production issues.
- Optical Communications experienced manufacturing software implementation problems that constrained production and customer fulfillment during the first half of 2016. Production returned to normal levels by the end of the second quarter.
- Nine-month operating income declined $276 million despite higher net income, reflecting foreign-currency hedge losses, lower equity earnings, restructuring and impairment charges, and higher legal, acquisition, and pension-related costs.
- Core, non-GAAP earnings were $466 million in Q3, up 4%, but $1.240 billion for nine months, down 15%. Core diluted EPS was $0.42 in Q3 and $1.06 for nine months.
- Operating cash flow declined $750 million year over year, primarily because of lower dividends from equity affiliates and increases in accounts receivable.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Outlook: Display Technologies expected continued moderate sequential LCD glass price declines in Q4, with full-year LCD glass market and demand growth in the mid-single digits. Q4 volume was expected to be flat to slightly down sequentially.
- Optical Communications sales were expected to grow at a high-single-digit year-over-year rate in Q4, driven by fiber-to-the-home demand, producing low-single-digit full-year growth.
- Environmental Technologies sales were expected to decline at a low-single-digit rate in Q4 because of continued weakness in heavy-duty truck markets. Specialty Materials sales were expected to grow at a high-single-digit rate, and Life Sciences sales at a low-single-digit rate.
- Management continued to target more than $12.5 billion of shareholder returns through 2019 and at least 10% annual dividend growth through 2019.
- The May 31, 2016 Dow Corning realignment generated approximately $4.8 billion of cash and a $2.676 billion non-taxable gain, plus a $105 million deferred-tax benefit. Corning exchanged its 50% Dow Corning interest for an entity holding an interest in Hemlock Semiconductor Group and cash.
- Foreign-currency translated-earnings hedge losses were $2.295 billion pretax for the first nine months, compared with a $42 million gain in 2015. The related hedge portfolio had $17.6 billion of gross notional value at September 30, 2016; a hypothetical 10% adverse yen movement could have produced an unrealized fair-value loss of approximately $1.8 billion.
- Corning recorded $78 million of restructuring, impairment, and other charges in the first nine months, including $62 million for disposal of long-lived assets. Cash expenditures for the restructuring activities were estimated at $15 million.
- Asbestos liabilities totaled $440 million at September 30, 2016, including $290 million of fixed PCC Plan payments and a $150 million reserve for non-PCC asbestos claims. The company also had $45 million of environmental reserves related to 17 active hazardous-waste sites.
- Management identified risks from LCD demand and pricing, customer and industry capacity, currency volatility, technology changes, major-customer concentration, manufacturing and IT disruptions, litigation, environmental matters, regulation, acquisitions, and the timing of cash flows supporting dividends and repurchases.
- Disclosure controls and procedures were deemed effective, and management reported no material change in internal control over financial reporting.
Most Important Facts for Investors to Verify
- Whether LCD glass pricing pressure and panel-maker utilization support the stated Display Technologies outlook.
- Whether Optical Communications production has fully recovered from the manufacturing software implementation issues.
- The recurring earnings impact of the Dow Corning realignment, including lower equity earnings and the shift to direct Hemlock Semiconductor ownership.
- The potential earnings volatility from the $17.6 billion foreign-currency hedge portfolio and yen exposure.
- The cash requirements and final share delivery or settlement under the $2 billion accelerated share repurchase transaction.
- The timing and ultimate cost of the $440 million asbestos liabilities, related insurer litigation, and environmental reserves.
- Whether operating cash flow rebounds from the nine-month decline while Corning continues capital spending, dividends, acquisitions, and share repurchases.
- The distinction between GAAP results, which include large unusual items, and management’s core non-GAAP measures.