Corning Incorporated — 2018 Q3 Form 10-Q Summary
Business context and reporting period
Corning Incorporated reported results for the three and nine months ended September 30, 2018. Its principal businesses were Display Technologies, Optical Communications, Specialty Materials, Environmental Technologies, Life Sciences, and All Other activities. The filing was signed October 24, 2018.
Corning adopted ASC Topic 606 revenue recognition, ASU 2016-15, and ASU 2017-07 effective January 1, 2018. Management stated that the effects were not material to the financial statements.
Financial performance and key metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Net sales | $3,008 million | $2,607 million | $8,255 million | $7,479 million |
| Gross margin | $1,232 million; 41% | $1,050 million; 40% | $3,259 million; 39% | $2,988 million; 40% |
| Operating income | $522 million | $442 million | $1,111 million | $1,240 million |
| Income before taxes | $758 million | $479 million | $1,157 million | $1,091 million |
| Net income attributable to Corning | $625 million | $390 million | $774 million | $915 million |
| Diluted EPS | $0.67 | $0.39 | $0.82 | $0.89 |
| Effective tax rate | 17.5% | 18.6% | 33.1% | 16.1% |
Core, non-GAAP earnings were $476 million, or $0.51 diluted EPS, in the third quarter and $1,134 million, or $1.20 diluted EPS, for the first nine months. Core earnings increased 18% in Q3 but declined 4% year to date.
Q3 segment sales increased in every segment: Display Technologies $852 million, Optical Communications $1,117 million, Specialty Materials $459 million, Environmental Technologies $331 million, Life Sciences $231 million, and All Other $55 million.
Cash flow, liquidity, debt, and capital allocation
- Net cash provided by operating activities was $1,978 million for the first nine months of 2018, compared with $1,116 million in 2017.
- Net cash used in investing activities was $2,266 million, including $1,629 million of capital expenditures and $804 million for acquisitions.
- Net cash used in financing activities was $2,116 million, including $1,880 million of share repurchases and $517 million of dividends paid.
- Cash and cash equivalents declined to $1,903 million from $4,317 million at December 31, 2017. Approximately 72% of cash was held outside the United States.
- Long-term debt was $5,056 million, versus $4,749 million at year-end 2017; current debt and short-term borrowings were $252 million.
- Total debt to total capital was 28%, compared with 25% at year-end 2017. Corning had no commercial paper outstanding.
- The amended revolving credit agreement provides a $1.5 billion unsecured multi-currency facility expiring August 15, 2023; no amounts were drawn at September 30, 2018. The maximum leverage covenant is 60%, while reported leverage was approximately 28%.
- Corning issued $596 million of net proceeds from Japanese yen-denominated notes with seven-, ten-, and twelve-year maturities.
- The company repurchased 63.4 million shares for approximately $1.9 billion during the first nine months and declared dividends of $0.18 per common share in Q3.
Material changes versus the prior comparable period
- Q3 sales increased 15% and nine-month sales increased 10%, driven by growth across all segments. Optical Communications contributed the largest increase, benefiting from carrier and enterprise demand and the June acquisition of 3M’s Communications Market Division.
- Q3 net income rose 60%, primarily because of a $154 million after-tax increase in translated earnings contract gains, higher segment earnings, and favorable discrete tax items.
- Nine-month net income declined 15%. The decrease reflected higher legal expenses, including a $172 million tax expense related to a preliminary IRS audit settlement, lower equity earnings, and weaker Display Technologies and All Other results.
- Display Technologies’ nine-month sales increased only 1% and segment income declined 13% as glass price declines and China expansion costs more than offset volume growth.
- Operating expenses increased: SG&A rose 17% in Q3 and 26% year to date, while research, development, and engineering expense rose 13% and 17%, respectively.
- The company acquired substantially all of 3M’s Communications Market Division for approximately $801 million, recording preliminary goodwill of $253 million and other intangible assets of $511 million.
- Customer deposits were approximately $1.0 billion at September 30, 2018, primarily related to long-term Display Technologies supply agreements.
Guidance, outlook, commentary, and risks
Management expected 2018 segment sales to exceed $11.3 billion. It projected high-teen sales growth in Optical Communications, mid-single-digit growth in Specialty Materials, mid-teen growth in Environmental Technologies, and mid-to-high single-digit growth in Life Sciences. Display glass volume was expected to grow faster than the market, supported by the Gen 10.5 facility ramp in China.
For the fourth quarter, management expected moderate Display Technologies price declines, low-single-digit sequential growth in Optical Communications, Specialty Materials sales comparable to the prior-year fourth quarter, high-single-digit year-over-year growth in Environmental Technologies, and low- to mid-single-digit growth in Life Sciences. Planned 2018 capital expenditures were slightly above $2.0 billion.
- Key exposures include foreign currency movements, particularly the Japanese yen, Korean won, Chinese yuan, New Taiwan dollar, euro, and British pound. Translated earnings contracts produced a $230 million Q3 gain and a $66 million nine-month gain, creating volatility in reported earnings.
- Corning had asbestos-related obligations, including $185 million of PCC payments due from 2019 through 2022 and a $147 million reserve for non-PCC asbestos claims.
- Corning may be required to indemnify Dow Corning for portions of certain breast implant and bankruptcy-related liabilities. Dow Corning estimated commercial creditor claims at $81 million to $260 million and had recorded an $81 million reserve.
- Environmental reserves were approximately $33 million for 15 active hazardous waste sites.
- The company had not completed its accounting for all effects of the 2017 Tax Cuts and Jobs Act; future tax guidance or revised estimates could materially affect tax expense.
- Management identified risks from demand, pricing, customer financial condition, tariffs, supply costs, capacity expansion, acquisitions, litigation, intellectual property, cyber or operational disruptions, regulation, and technology changes.
- Precious-metal assets had carrying values exceeding fair market value by $624 million. Management considered them recoverable based on segment cash flows, but impairment could arise if demand or profitability materially declines.
Important facts for investors to verify
- Reconcile GAAP earnings with core earnings and isolate the effects of translated earnings contracts, tax items, litigation, acquisition costs, and currency adjustments.
- Assess whether Display Technologies pricing and margins stabilize as Gen 10.5 capacity ramps and expansion spending moderates.
- Verify the contribution, integration costs, and customer demand associated with the 3M Communications Market Division acquisition.
- Monitor cash usage from capital expenditures, share repurchases, dividends, acquisitions, and debt service relative to operating cash flow.
- Review the potential range and timing of asbestos, Dow Corning indemnity, environmental, and other legal liabilities.
- Track unresolved tax accounting under the 2017 Tax Act and the final outcome of the IRS audit settlement.
- Confirm that currency-related gains and losses are not masking underlying operating performance.