Corning Incorporated — Q2 2014 Form 10-Q Summary
Business context and reporting period
Corning designs and manufactures specialty glass, ceramics, optical fiber, telecommunications components, emissions-control products, laboratory products, and related materials. The filing covers the quarter and six months ended June 30, 2014, with unaudited results compared with the corresponding 2013 periods.
Effective January 15, 2014, Corning acquired the remaining interests in 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 | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $2,482 million | $1,982 million | $4,771 million | $3,796 million |
| Gross margin | $1,032 million; 42% | $883 million; 45% | $1,967 million; 41% | $1,653 million; 44% |
| Operating income | $460 million | $424 million | $775 million | $748 million |
| Net income attributable to Corning | $169 million | $638 million | $470 million | $1,132 million |
| Diluted EPS | $0.11 | $0.43 | $0.32 | $0.76 |
| Operating cash flow | Not separately provided | Not separately provided | $2,480 million | $1,012 million |
- GAAP net income declined 74% in the quarter and 58% year to date, despite sales growth of 25% and 26%, respectively.
- Core earnings, excluding specified non-GAAP items, increased 12% to $527 million in Q2 and 10% to $988 million for the first half. Core diluted EPS was $0.37 and $0.68, respectively.
- Equity earnings from affiliates declined to $62 million in Q2 and $148 million year to date, primarily because Corning Precision Materials was consolidated rather than accounted for under the equity method. Dow Corning equity earnings increased to $54 million in Q2 and $146 million year to date.
- Research, development and engineering expense was $208 million in Q2 and $406 million year to date, representing 8% and 9% of sales, respectively.
- Restructuring, impairment and other charges totaled $51 million year to date, with anticipated annualized savings of approximately $75 million and estimated cash expenditures of $14 million.
Liquidity, cash flow, debt and capital allocation
- Cash, cash equivalents and short-term investments totaled $5.886 billion at June 30, 2014, versus $5.235 billion at December 31, 2013. Approximately 77% of consolidated cash was held outside the United States and was generally indefinitely reinvested.
- Recorded debt totaled approximately $3.688 billion, consisting of $450 million of current debt and $3.238 billion of long-term debt. The debt-to-capital ratio increased to 15% from 13% at year-end 2013.
- Corning had $416 million of commercial paper outstanding and access to a $1 billion unsecured revolving credit facility expiring in March 2018. The company was in compliance with its leverage covenant.
- Year-to-date operating cash flow of $2.480 billion was aided by approximately $1.6 billion of dividends received from Samsung Corning Precision Materials after the acquisition.
- Year-to-date capital expenditures were $478 million. Management expected approximately $1.3 billion of 2014 capital spending, including approximately $500 million for Display Technologies.
- Financing cash outflows included $2.076 billion of common-stock repurchases and $287 million of dividends paid. The January 2014 repurchase authorization had approximately $382.8 million remaining at June 30, 2014.
- Corning issued $2.3 billion of Series A convertible preferred stock to Samsung Display, including $1.9 billion as acquisition consideration and $400 million for cash. The preferred stock carries a cumulative 4.25% dividend and is convertible under specified conditions.
Material changes versus the prior comparable period
- Display Technologies sales increased 56% in Q2 and 50% year to date, substantially reflecting the acquisition. However, mid-teen percentage price declines, foreign exchange effects and restructuring costs pressured profitability. Display core earnings increased 9% in Q2 but only 2% year to date.
- Optical Communications sales increased 14% in Q2 and 19% year to date, led by carrier-network and enterprise-network products. Reported net income declined 20% and 21%, while core earnings increased 5% and 7%.
- Environmental Technologies sales increased 25% in Q2 and 23% year to date; reported net income increased 31% and 43%, supported by heavy-duty diesel demand, regulatory requirements and higher vehicle production.
- Specialty Materials sales were broadly flat, while reported net income declined 33% in Q2 and 28% year to date. Lower Gorilla Glass pricing and the absence of a prior-year inventory build were principal pressures.
- Life Sciences sales increased 2% in both periods, but reported net income declined 28% in Q2 and 5% year to date due to product mix and manufacturing efficiency.
- The gross margin percentage fell three percentage points in both the quarter and first half, primarily due to yen-related effects, Display Technologies pricing and the absence of prior-year inventory benefits.
Guidance, outlook, risks and unusual items
- Management expected 2014 sales growth across the consolidated company, including growth in Optical Communications, Life Sciences, Specialty Materials and Environmental Technologies. Display market share was expected to stabilize and price declines to moderate.
- For Q3 2014, management expected Display Technologies volume to increase by a mid-single-digit percentage sequentially, with further moderation in price declines; Optical Communications sales to increase by a mid-single-digit percentage year over year; Environmental Technologies sales to increase 20% to 25% year over year; Specialty Materials sales to increase approximately 10% sequentially; and Life Sciences sales to increase slightly year over year.
- GAAP results were significantly affected by yen hedge mark-to-market losses of approximately $145 million in Q2 and $143 million year to date, compared with gains of $229 million and $252 million in the 2013 periods. A hypothetical 10% adverse currency movement could have produced a $1.203 billion unrealized loss on yen-related instruments and an $86 million loss on Korean won instruments at June 30, 2014.
- Effective tax rates increased to 50.4% in Q2 and 42.8% year to date, reflecting discrete charges, including deferred-tax-asset valuation changes and a $102 million South Korean withholding-tax charge on a dividend.
- The acquisition generated a $394 million gain on the previously held equity investment and a $320 million loss from settlement of a pre-existing technology license contract. These and other acquisition-related items materially affected reported earnings.
- Corning recorded a $695 million estimated liability related to the Pittsburgh Corning plan and other asbestos litigation. The plan remained subject to court appeals, and non-PCC asbestos claims could proceed if the plan were finally affirmed. Dow Corning also faced potential creditor claims, with estimated liability of $97 million to $317 million.
- Corning had approximately $30 million accrued for environmental cleanup and related litigation at June 30, 2014, compared with $15 million at year-end 2013.
- Key operating risks include LCD market demand and excess capacity, customer concentration, pricing pressure, foreign currency volatility, specialized Asian manufacturing capacity, regulatory and antidumping proceedings, litigation, tax changes, acquisition integration, and the ability to realize restructuring savings.
- Management stated that disclosure controls were effective as of June 30, 2014. Internal-control review of the acquired Corning Precision Materials operations was ongoing.
Most important facts for investors to verify
- Separate sustainable operating performance from acquisition effects, currency hedge volatility, discrete tax charges and other non-GAAP adjustments.
- Verify whether Display Technologies can offset mid-teen pricing declines with volume growth, integration synergies and capacity actions.
- Monitor the timing and cash impact of the $695 million asbestos-related liability and related court and insurance litigation.
- Assess the concentration of cash outside the United States and the potential tax cost of repatriation.
- Track foreign-exchange derivative notional exposure, particularly the materially increased yen and new Korean won programs.
- Compare actual Q3 performance and full-year capital spending with management’s stated outlook and approximately $1.3 billion capital-spending expectation.