Corning Incorporated — 2017 Second-Quarter Form 10-Q Summary
Business context and reporting period
Corning is a materials-science company with reportable segments in Display Technologies, Optical Communications, Environmental Technologies, Specialty Materials, and Life Sciences. This unaudited Form 10-Q covers the three and six months ended June 30, 2017, compared with the corresponding 2016 periods.
Key financial metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $2,497 million | $2,360 million | $4,872 million | $4,407 million |
| Gross margin | $985 million; 39% | $951 million; 40% | $1,942 million; 40% | $1,715 million; 39% |
| Operating income | $381 million | $247 million | $805 million | $424 million |
| Net income attributable to Corning | $439 million | $2,207 million | $525 million | $1,839 million |
| Diluted EPS | $0.42 | $1.87 | $0.50 | $1.53 |
| Core earnings | $431 million; $0.42 per diluted share | $434 million; $0.37 per diluted share | $838 million; $0.80 per diluted share | $774 million; $0.64 per diluted share |
| Operating cash flow | Not separately provided | Not separately provided | $471 million | $455 million |
Q2 net margin was approximately 18%, versus 94% in the prior-year quarter; six-month net margin was approximately 11%, versus 42%. The comparisons are distorted by the $2.676 billion non-taxable gain on the 2016 Dow Corning equity realignment and related tax benefits recorded in the prior-year period.
- Q2 sales increased 6%; six-month sales increased 11%. Optical Communications and Specialty Materials were the principal growth drivers.
- Q2 operating income increased $134 million, supported by lower selling, general and administrative expenses, favorable translated-earnings-contract results, and higher segment earnings.
- SG&A declined 24% in Q2 to $379 million and 13% for the first half to $695 million, primarily because 2016 included Dow Corning-related acquisition costs and higher litigation, regulatory, and legal expenses.
- Research, development, and engineering expense increased 8% in Q2 and 7% for the first half, reflecting investment in emerging businesses and higher employee benefit costs.
- Effective tax rates were 25.8% in Q2 and 14.2% for the first half, compared with tax benefits of 29.6% and 78.4% in the comparable 2016 periods.
Segment performance and material changes
| Segment | Q2 2017 sales | Change vs. Q2 2016 | Six-month 2017 sales | Change vs. 2016 |
|---|---|---|---|---|
| Display Technologies | $748 million | (7%) | $1,484 million | (1%) |
| Optical Communications | $882 million | 13% | $1,700 million | 22% |
| Environmental Technologies | $263 million | 2% | $538 million | 3% |
| Specialty Materials | $337 million | 27% | $637 million | 29% |
| Life Sciences | $221 million | 3% | $431 million | 3% |
- Display Technologies experienced LCD glass price declines of approximately 10% in Q2 and slightly above 10% for the first half, partly offset by high-single-digit to slightly-above-10% volume growth.
- Optical Communications benefited from North American fiber-to-the-home demand and the absence of 2016 manufacturing-software implementation issues.
- Specialty Materials benefited from strong Gorilla Glass and advanced-optics sales.
- Environmental Technologies grew modestly from automotive demand but faced higher expenses related to new product launches and lower heavy-duty diesel sales in North America.
- Core diluted EPS increased to $0.42 in Q2 from $0.37 and to $0.80 for the first half from $0.64, aided by substantially lower share count from repurchases.
Cash flow, debt, liquidity, and capital allocation
- Six-month operating cash flow was $471 million, compared with $455 million in 2016.
- Capital expenditures were $761 million, up $228 million year over year. Management expected approximately $1.5 billion of 2017 capital expenditures, primarily for Optical Communications, a Gen 10.5 glass facility in China, Environmental Technologies, and Specialty Materials.
- Investing cash flow was an outflow of $634 million, compared with a $4.238 billion inflow in 2016 that included $4.818 billion received from the Dow Corning realignment.
- Financing cash flow was an outflow of $1.138 billion, including $1.045 billion of common-stock repurchases and $333 million of dividends paid.
- Cash and cash equivalents were $4.189 billion at June 30, 2017, down from $5.291 billion at December 31, 2016. Approximately 74% was held outside the United States.
- Current assets were $8.431 billion and current liabilities were $2.808 billion; working capital was $5.623 billion and the current ratio was 3.0:1.
- Long-term debt was $3.302 billion, current debt and short-term borrowings were $631 million, and total debt-to-capital was 18%. No commercial paper was outstanding.
- Corning had a $2 billion unsecured revolving credit facility and stated that it was in compliance with its 50% maximum leverage covenant and other debt provisions.
- The company paid $500 million under a second-quarter accelerated share repurchase agreement, receiving 17.1 million shares, and repurchased approximately $546 million of shares on the open market during the first half.
- The quarterly common-stock dividend increased to $0.155 per share from $0.135.
Guidance, outlook, risks, and unusual items
- Management targeted generating $26 billion to $30 billion of cash through 2019, returning more than $12.5 billion to shareholders, and investing $10 billion to sustain leadership positions and growth.
- For full-year 2017, management expected Display Technologies market and glass-demand growth in the mid-single digits, with LCD glass price declines of approximately 10% or less.
- Optical Communications sales were expected to increase at a low-teens rate, with potential for mid-teens growth; Environmental Technologies sales were expected to be flat to slightly higher; Life Sciences sales were expected to grow at a low-single-digit rate; and Specialty Materials growth depended on customer adoption of Gorilla Glass 5 and other innovations.
- For Q3, management expected Display Technologies volume to rise at a low-single-digit sequential rate with moderate price declines; Optical Communications sales to increase more than 10% year over year; Specialty Materials sales to grow at a low- to mid-teens rate; and Life Sciences sales to grow at a low-single-digit rate.
- Foreign-currency translated-earnings contracts produced a $219 million pretax gain in Q2, compared with a $1.201 billion loss in Q2 2016, and a $219 million pretax loss for the first half, compared with a $2.058 billion loss in 2016. The contracts had $14.3 billion of gross notional value at June 30, 2017.
- Corning recorded a $70 million payment under the Pittsburgh Corning asbestos reorganization plan in June 2017. Remaining payments due from 2018 through 2022 totaled $220 million.
- The reserve for non-Pittsburgh Corning asbestos claims was $149 million. Insurance litigation remains pending with certain insurers, and management could not predict the outcome.
- Environmental cleanup and related litigation reserves were approximately $40 million for 16 active hazardous-waste sites. Management considered a materially higher additional loss remote.
- Precious-metal assets exceeded fair market value by $861 million. Management considered the assets recoverable based on segment cash flows, but identified future impairment risk if Display Technologies or Specialty Materials demand or profitability declines materially.
- Management stated that no material changes occurred in reported risk factors, off-balance-sheet arrangements, or contractual obligations outside the ordinary course of business.
- The company adopted ASU 2016-09, recognizing $233 million of cumulative tax benefits in beginning retained earnings, and adopted the simplified goodwill-impairment standard on January 1, 2017. Revenue-recognition and lease standards were still under evaluation or scheduled for future adoption.
Most important facts for investors to verify
- Whether Optical Communications growth and customer-project timing support the company’s Q3 and full-year outlook.
- The sustainability of Specialty Materials growth and the effect of continuing LCD glass price declines on Display Technologies margins.
- The recurring cash-generation profile after excluding foreign-currency hedge gains and losses and other non-GAAP adjustments.
- Capital-spending execution and funding needs relative to the approximately $1.5 billion 2017 capital-expenditure expectation.
- The pace and pricing of share repurchases, dividend funding, and the effect of reduced share count on EPS.
- Potential changes in asbestos liabilities, insurance recoveries, environmental claims, and the $220 million of Pittsburgh Corning payments.
- Foreign-currency exposure, including the $14.3 billion translated-earnings-hedge notional and associated earnings volatility.
- Recoverability of precious-metal assets and other assets if Display Technologies or Specialty Materials operating conditions weaken.