Corning Incorporated: 2014 Third-Quarter Form 10-Q Summary
Business context and reporting period
Corning Incorporated is a materials-science company operating in Display Technologies, Optical Communications, Environmental Technologies, Specialty Materials, Life Sciences and related development activities. This unaudited Form 10-Q covers the three and nine months ended September 30, 2014, with comparisons to the same periods in 2013 and to December 31, 2013 for balance-sheet data.
Results include the consolidation, beginning January 15, 2014, of Samsung Corning Precision Materials, renamed Corning Precision Materials, after Corning acquired the remaining equity interests. The business was integrated into Display Technologies.
Financial performance and liquidity
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Net sales | $2,540 million | $2,067 million | $7,311 million | $5,863 million |
| Gross margin | $1,089 million; 43% | $901 million; 44% | $3,056 million; 42% | $2,554 million; 44% |
| Operating income | $620 million | $439 million | $1,395 million | $1,187 million |
| Net income attributable to Corning | $1,014 million | $408 million | $1,484 million | $1,540 million |
| Diluted EPS | $0.72 | $0.28 | $1.03 | $1.04 |
| Operating cash flow | Not separately provided | Not separately provided | $3,597 million | $1,503 million |
Sales increased 23% in the quarter and 25% for the first nine months. GAAP net income rose 149% in the quarter but declined 4% for the nine months. Core earnings, excluding specified currency, acquisition, tax, restructuring, litigation and other unusual items, increased 17% to $568 million in the quarter and 12% to $1,556 million for the nine months. Core diluted EPS was $0.40 in the quarter and $1.08 for the nine months, compared with $0.33 and $0.94, respectively, in the prior-year periods.
Quarterly and nine-month net margins were approximately 40% and 20%, respectively, compared with approximately 20% and 26% in the prior-year periods. The significant quarterly margin improvement was driven primarily by foreign-exchange hedge gains and acquisition-related effects rather than solely by recurring operations.
At September 30, 2014, cash, cash equivalents and short-term investments totaled $6.1 billion, compared with $5.2 billion at December 31, 2013. Total debt was approximately $3.7 billion, comprising $455 million of current debt and $3.2 billion of long-term debt. Debt-to-capital was 14%, versus 13% at year-end 2013. Corning had no borrowings under its new $2.0 billion unsecured revolving credit facility, expiring September 30, 2019, and was in compliance with its covenants. Outstanding commercial paper was $424 million.
Operating cash flow benefited substantially from an approximately $1.6 billion dividend received from Samsung Corning Precision Materials. Investing cash flow used $753 million, including $740 million of capital expenditures. Financing cash flow used $1.846 billion, principally due to $2.3 billion of common-stock repurchases and $439 million of dividends paid. Management expected 2014 capital spending of approximately $1.1 billion, including approximately $500 million for Display Technologies.
Material changes versus the prior comparable periods
- Display Technologies sales increased 56% in the quarter and 52% for the nine months, primarily because of the Corning Precision Materials consolidation. However, LCD glass price declines in the mid-teens outpaced volume growth in the quarter and reduced segment profitability.
- Optical Communications sales increased 7% in the quarter and 15% for the nine months, driven by carrier-network and enterprise-network demand. Nine-month segment net income declined 10% because of price declines, unfavorable mix, higher expenses and the absence of prior-year inventory-build benefits.
- Environmental Technologies sales increased 25% in the quarter and 24% for the nine months, while segment net income increased 78% and 55%, respectively, reflecting stronger heavy-duty diesel demand, regulatory-driven demand and improved manufacturing efficiency.
- Specialty Materials sales were essentially flat, while segment net income declined 34% in the quarter and 30% for the nine months, primarily due to Gorilla Glass pricing pressure, production-line closure charges and higher production costs.
- Life Sciences sales increased 1% for the nine months, while segment income declined 5%, reflecting mix pressure and the absence of a prior-year pension mark-to-market benefit.
- Equity earnings from affiliates declined to $95 million in the quarter and $243 million for the nine months, from $138 million and $477 million, respectively, because Samsung Corning Precision Materials was consolidated rather than accounted for under the equity method. Dow Corning equity earnings increased materially.
- Common-share repurchases reduced weighted-average basic shares to 1,284 million in the quarter and 1,315 million for the nine months, compared with 1,454 million and 1,465 million in the prior-year periods.
Guidance, outlook, unusual items and risks
- Management expected 2014 LCD glass retail-market growth of approximately 10%, stable Corning market share and more moderate fourth-quarter price declines. Fourth-quarter LCD glass volume was expected to be flat to slightly down sequentially.
- Fourth-quarter Optical Communications sales were expected to increase by a mid-single-digit percentage year over year. Environmental Technologies sales were expected to increase by a high-single-digit percentage, driven by heavy-duty diesel products. Specialty Materials sales were expected to decline by a low-to-mid-teens percentage sequentially, and Life Sciences sales were expected to be broadly consistent with the prior-year quarter.
- Yen-denominated hedging programs generated pre-tax gains of $764 million in the quarter and $621 million for the nine months, compared with a $46 million loss in the prior-year quarter. The gains were driven by the significant weakening of the Japanese yen and materially increased reported earnings.
- Corning recorded a $77 million pre-tax gain in the third quarter from remeasuring contingent consideration associated with the Corning Precision Materials acquisition. The related contingent-consideration asset had a reported fair value of $273 million at September 30, 2014.
- The effective tax rate was 28.0% in the quarter and 33.5% for the nine months, versus 25.7% and 19.2% in the prior-year periods. Nine-month 2014 tax expense included a $102 million South Korean withholding-tax charge and a $146 million charge related to the realizability of foreign deferred tax assets.
- Corning recorded $51 million of restructuring, impairment and other charges for the nine months, with estimated related cash expenditures of $11 million. Employee-related restructuring payments were expected to be substantially completed in 2015.
- Asbestos-related liabilities for the Pittsburgh Corning plan and other asbestos litigation totaled an estimated $701 million at September 30, 2014. The amended plan required Corning to contribute its equity interests in Pittsburgh Corning and Pittsburgh Corning Europe and make a fixed series of payments totaling $290 million at present value. The plan remained subject to possible appeal.
- Dow Corning had recorded a $1.7 billion liability for future breast-implant settlement-trust funding. Its estimate could materially change, although management stated that the recorded amount represented the plan’s maximum capped amount and that any revision was expected to lower the liability.
- Major risks include LCD demand and excess capacity, pricing pressure, customer concentration, foreign-exchange volatility, specialized-facility disruptions in Asia, acquisition integration, derivatives-related earnings volatility, asbestos and environmental claims, regulatory developments and changes in tax assumptions.
Most important facts for an investor to verify
- Separate recurring operating performance from the $764 million quarterly pre-tax yen-hedge gain, acquisition-related items and other nonrecurring adjustments.
- Assess the sustainability of Display Technologies earnings given mid-teens LCD glass price declines, concentrated customers and expected fourth-quarter volume trends.
- Reconcile the unusually strong operating cash flow to the approximately $1.6 billion Samsung Corning Precision Materials dividend.
- Monitor leverage, commercial-paper maturities, share repurchases and the remaining $182.8 million authorization under the 2014 repurchase program.
- Evaluate potential changes in asbestos liabilities, the Pittsburgh Corning plan, Dow Corning contingencies and insurance coverage.
- Review derivative notional exposure: translated-earnings contracts totaled $13.9 billion, and a hypothetical 10% adverse yen movement could have produced an estimated $1.059 billion unrealized fair-value loss at September 30, 2014.
- Confirm the final accounting for the Corning Precision Materials acquisition, which remained subject to measurement-period adjustments, and the potential impact of the new revenue-recognition standard that Corning was still assessing.