Corning Incorporated — Form 10-Q Summary
Business context and reporting period
Corning filed its unaudited Form 10-Q for the three months ended March 31, 2014, with March 31, 2013 as the comparable period. The company operates in Display Technologies, Optical Communications, Environmental Technologies, Specialty Materials, Life Sciences, and other development activities.
On January 15, 2014, Corning acquired the remaining common shares of Samsung Corning Precision Materials, renamed Corning Precision Materials, and began consolidating the business within Display Technologies. The acquisition materially affects year-over-year comparability.
Financial performance and key metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Net sales | $2,289 million | $1,814 million | Up 26% |
| Gross margin | $935 million; 41% | $770 million; 42% | Margin down 1 point |
| Operating income | $315 million | $324 million | Down 3% |
| Income before taxes | $481 million | $528 million | Down 9% |
| Net income attributable to Corning | $301 million | $494 million | Down 39% |
| Diluted EPS | $0.20 | $0.33 | Down $0.13 |
| Operating cash flow | $1,737 million | $623 million | Up $1,114 million |
| Capital expenditures | $246 million | $194 million | Up $52 million |
Core, non-GAAP net income was $461 million, or $0.31 core diluted EPS, compared with $431 million, or $0.29, in the prior-year quarter. Core net sales were $2,389 million versus $1,814 million.
The effective tax rate increased to 37.4% from 6.4%, primarily because of a $102 million discrete South Korean withholding-tax charge related to a dividend from Samsung Corning Precision Materials. Q1 2013 also included a $54 million tax benefit related to the American Taxpayer Relief Act.
At March 31, 2014, cash, cash equivalents, and short-term investments totaled $5.6 billion, compared with $5.2 billion at December 31, 2013. Total debt was approximately $3.7 billion, including $418 million of commercial paper; long-term debt was $3.2 billion. Debt to total capital was 15%, compared with 13% at year-end 2013. Corning remained in compliance with its debt covenants and had access to a $1.0 billion revolving credit facility.
Approximately 76% of cash and short-term investments were held outside the United States and were generally indefinitely reinvested, subject to potentially significant repatriation tax consequences. The current ratio was 4.7:1, compared with 5.1:1 at December 31, 2013.
Material changes versus the prior comparable period
- Consolidation of Corning Precision Materials added approximately $428 million of reported sales and $113 million of net income attributable to Corning in Q1 2014.
- Display Technologies sales increased 43% to $929 million, but reported segment net income decreased 40% to $209 million. Mid-teens percentage price declines, the weaker Japanese yen, the absence of prior royalty income, and acquisition-related items offset the acquisition benefit.
- Optical Communications sales increased 26% to $593 million, while reported segment net income decreased 23% to $27 million; core segment net income increased 11% to $39 million.
- Environmental Technologies sales increased 21% to $275 million and segment net income increased 59% to $43 million, supported by heavy-duty diesel demand and improved manufacturing efficiency.
- Specialty Materials sales increased 1% to $261 million, while reported segment net income decreased 21% to $31 million, primarily due to lower Gorilla Glass pricing and the absence of a prior-year inventory build.
- Life Sciences sales increased 1% to $210 million; reported segment net income increased to $17 million from $12 million, while core net income declined to $21 million from $24 million.
- Equity earnings from affiliates fell to $86 million from $173 million because Samsung Corning Precision Materials was consolidated. This was partially offset by higher Dow Corning earnings, including Corning’s $32 million share of a derivative mark-to-market gain.
- SG&A increased 53% to $395 million, including approximately $90 million of acquisition-related costs, of which $72 million was post-combination compensation expense.
- Corning repurchased approximately $1.9 billion of common stock in financing activities. Total Q1 purchases were approximately 99.0 million shares, including accelerated share repurchases and open-market purchases.
Guidance, outlook, risks, contingencies, and unusual items
- Management expected 2014 capital spending of approximately $1.5 billion, including approximately $560 million for Display Technologies.
- For Q2 2014, Display Technologies expected volume to increase by a high-single-digit percentage sequentially, with price declines significantly lower than in Q1. The 2014 LCD glass retail market was expected to grow in the mid-to-high single digits.
- Q2 Optical Communications sales were expected to grow year over year by a mid-to-high single-digit percentage. Environmental Technologies sales were expected to grow by a low-to-mid teen percentage. Specialty Materials sales were expected to increase 20% to 25% sequentially, while Life Sciences sales were expected to remain consistent with Q2 2013.
- Management identified foreign-exchange movements, particularly the Japanese yen, as a significant earnings risk. A hypothetical 10% adverse yen movement could have produced an unrealized fair-value loss of approximately $989 million on open foreign-exchange instruments at March 31, 2014, although the underlying exposure would offset this over time.
- Display Technologies has concentrated Asian manufacturing capacity and a concentrated customer base; four customers represented approximately 72% of segment sales. Environmental Technologies, Specialty Materials, and Life Sciences also had significant customer concentration.
- Corning recorded $17 million of restructuring, impairment, and other charges in Q1, with estimated cash expenditures of $3 million and anticipated annualized savings of approximately $5 million. Prior restructuring actions were expected to generate approximately $40 million of annualized savings.
- The estimated liability for the Pittsburgh Corning Plan and other asbestos litigation was $692 million at March 31, 2014. Confirmation of the plan remained subject to court affirmation and possible appeals. Corning also accrued approximately $34 million for environmental cleanup and related litigation.
- Corning faced a Chinese anti-dumping investigation involving optical fiber preforms exported from the United States. A final determination was expected between March and September 2015; potential duties were described as 15% to 24%.
- The Samsung Corning Precision Materials acquisition included contingent consideration potentially payable in 2018, with revenue-based and volume-based caps of $665 million and $100 million, respectively. The recognized fair value of the potential consideration was $196 million.
- Preferred stock issued to Samsung Display totaled $2.3 billion, carries a cumulative 4.25% dividend, ranks senior to common stock, and is convertible into common shares under specified conditions.
Most important facts for investors to verify
- Separate the acquisition-driven sales and earnings contribution from organic operating performance, particularly in Display Technologies.
- Assess the sustainability of core earnings after excluding acquisition costs, foreign-exchange effects, restructuring, tax items, and other management adjustments.
- Monitor LCD glass pricing, capacity utilization, customer concentration, and the expected moderation of price declines.
- Review the $102 million withholding-tax charge and the tax implications of foreign earnings and cash held outside the United States.
- Evaluate cash-flow quality: Q1 operating cash flow included approximately $1.6 billion of dividends received from Samsung Corning Precision Materials and is not representative of recurring operating cash generation.
- Track share repurchases, preferred-stock conversion provisions, and the effect of repurchases and potential dilution on per-share results.
- Review asbestos, environmental, anti-dumping, insurance, and other litigation exposures, including the $692 million asbestos-related liability.
- Consider foreign-exchange exposure and the potential earnings volatility from the company’s large yen-related derivative portfolio.