Corning Beats, Guidance Disappoints

Zacks

Corning’s (GLW) third quarter 2012 earnings beat the Zacks Consensus Estimate by 2 cents, or 7.1%. Despite the positive earnings surprise, softening demand for TVs and weaker pricing to support market share weighed on investor sentiments.

Revenue

Corning reported revenue of $2.04 billion, which was up 6.8% sequentially and down 1.8%  year over year. 

Revenue by Segment

The Display Technologies segment generated around 37% of total revenue. The segment was up 19.0% sequentially and down 6.4% year over year. Samsung Precision (“SCP”) LCD glass volumes were up mid single-digits sequentially (better than the guidance of a slight sequential increase).

Volumes in the wholly-owned business were up 20% (better than expectations of its being flat), as customers increased utilization rates. Glass price declines moderated in the last quarter, as expected.

Telecommunications (26% of revenue) declined 6.4% sequentially and 6.6% from the year-ago quarter. The sequential decline was below Corning’s guidance of a low to mid-teens percentage increase.

Both North America and Europe softened in the last quarter, the first impacted by project delays and drop-off in stimulus-driven spending and the second on account of macro-related weakness. China was an offsetting factor. Fiber and cable products declined 7.9% sequentially, while hardware and equipment sales declined 4.7%. The two categories were up 0.7% and down 13.7%, respectively from the year-ago quarter.

The Environmental Technologies segment generated 11% of revenue, down 6.4% sequentially and 6.6% year over year. The automotive business increased low single-digits from both the previous and year-ago quarters. Diesel on the other hand was very weak, declining double-digits from both quarters.

Light duty diesel was stronger sequentially, while pulling down the year-over-year comparison. Heavy-duty on the other hand was very weak sequentially due to slowing demand and resultant inventory corrections.

Specialty Materials generated 18% of revenue, up 22.6% sequentially and 21.4% year over year, significantly better than the guidance of a 10-15% sequential increase. The quarter benefited from a pickup in demand for Gorilla Glass (GG), which has emerged as the cover glass of choice.  GG remains the primary factor determining Corning’s performance in the specialty materials segment.

The Life Sciences business accounted for around 8% of revenue. The business was down 4.3% sequentially and up 1.3% from a year ago, weaker than guided. Economy-related concerns and caution at distributors impacted Corning’s performance in the last quarter.

Margins

The pro forma gross margin was 43.1%, up 136 bps from 41.8% reported in the June 2012 quarter and down 400 bps from last year. Higher volumes in Display and strong demand for GG offset moderating price declines in the last quarter.

The operating expenses of $479 million were flat sequentially. The greatest contributor to the 296 bp sequential expansion in the operating margin to 19.6% was the 136 bp decline in cost of sales, helped by the 78 bp decline in R&D (as a percentage of sales) and the 83 bp decline in SG&A.

Net Income

Corning’s pro forma net income was $528 million or 25.9% of sales compared to $471 million or 24.7% in the previous quarter and $772 million or 37.2% of sales in the year-ago quarter. Our pro forma estimate excludes intangibles amortization charges and asbestos litigation charges in the last quarter. The lower tax rate also helped results.

Including these special items, the GAAP net income was $521 million ($0.35 per share), compared to $462 million ($0.30 per share) in the previous quarter and $811 million (0.51 per share) in the year-ago quarter.

Balance Sheet

Inventories were up 0.4% during the quarter, with inventory turns increasing from 4.4X to 4.6X. DSOs were up slightly to almost 56.

Corning ended the quarter with $6.35 billion in cash and short term investments, up slightly during the quarter. However, the company has a huge debt balance. Including long term liabilities and short term debt, the net cash position was just $684 million, down $172 million during the quarter. Cash generated from operations was $634 million, with $422 million being spent on capex, $691 million on acquisitions, $194 million on share repurchases and $112 million on dividends.

Guidance

Corning provided guidance for the fourth quarter. Accordingly, the company expects the Display business to be down in the low- to mid single-digits, with both the wholly-owned and SCP volumes coming in flat to down low single-digits sequentially. The volume expectations are based on new agreements with customers and stable market share. Prices are expected to decline.

Telecom segment sales are expected to be flat sequentially, as the usual seasonal declines are more less offset by some orders that were pulled into the quarter. Environmental Technologies segment sales are expected to come in flat to down sequentially, with auto impacted by holiday shutdowns at customers.

Specialty Materials are expected to be flat, with GG for handhelds driving demand during the quarter. Life Sciences sales are expected to be down 5% (normal seasonality).

Corning expects the gross margin to shrink one percentage point, driven by weakness in Display pricing. SG&A and R&D will be consistent as a percentage of sales on a sequential basis.

Equity earnings excluding special items, will be down 5% sequentially, with equity earnings from Dow Corning increasing 25%. The tax rate for the year is expected to be 19%.

Our Take

Corning’s third quarter results were better than expected. However, with glass volumes remaining stable in the next quarter and glass prices deteriorating (due to new agreements), Corning’s guidance is disappointing.

We believe that the uncertainty in the core business remains, as visibility in the LCD TV market remains cloudy and utilization rates at customers have room to move up. LCD TV market penetration has increased significantly and upgrading to larger sizes is likely to be the major driver going forward.

GG growth is encouraging and should help absorb costs at the new Chinese facility. At the same time, we also think that there will be more investment in the business (new technologies, China, India), which will drive up costs. The higher costs will negatively impact the bottom line.

Corning shares therefore carry a Zacks Rank of #3, implying a Hold rating in the next 1-3 months. However, our long term (3-6 month) recommendation remains Neutral.

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