Corning’s (GLW) second quarter 2012 earnings were in line with the Zacks Consensus Estimate. This was better than the Zacks Expected Surprise Prediction (ESP) of -3.13% and worse than the positive trend of 6.67% in the four preceding quarters.
While Corning’s results were decent and its guidance indicated improvement in the Display segment (roughly a third of its business), investors discounted this positive amid growing concerns about consumer spending and Apple’s (AAPL) results. As a result, the shares plunged 7.71% during the day and recovered just 0.45% after hours.
Corning reported revenue of $1.91 billion, which was down 0.6% sequentially and 4.8% year over year. Display declined again and Environmental took a turn for the worse, impacted by slowdown in Europe.
Revenue by Segment
The Display Technologies segment generated around 34% of total revenue compared to 38% in the year-ago quarter. The segment was down 9.1% sequentially and 15.7% year over year. While unit demand continued to pick up in the U.S., declines moderated in China and Europe. Other regions continued to grow strongly.
Corning gained from the increase in panel sizes, which appears to have influenced consumer spending. Corning currently expects desktops to be flat in 2012, with notebooks/netbooks growing 7% and tablets 50%. While PC makers Hewlett Packard Company (HPQ) and Dell Inc (DELL), and chipmakers Intel Corp (INTC), Texas Instruments (TXN) and Advanced Micro Devices (AMD) have all cited weaker consumer spending, Corning is better positioned because its glass is used by multiple players across multiple segments.
Corning stated that lower utilization at major customers impacted volumes more than expected and FX did not help. However, price declines moderated, indicating better balance between demand and supply. Samsung Precision (“SCP”) glass volumes were up mid-single-digits (better than guided), helped by a new multi-quarter order. Corning’s earnings from the LCD side of the business went up 1%.
Telecommunications (29% of revenue) increased 10.0% sequentially and 2.0% from the year-ago quarter. The sequential increase was below Corning’s guidance of a low to mid-teen percentage increase, attributable to slightly softer hardware sales.
FTTH and infrastructure in emerging markets grew strongly however. Cable was also up in North America and China. Fiber & Cable revenue therefore increased 18.9% sequentially and 14.0% year over year. In comparison, Hardware & Equipment sales increased a mere 1.2% sequentially, while declining 9.2% from last year.
The Environmental Technologies segment generated 13% of revenue, down 5.3% sequentially and 3.5% year over year. Weakness in light-duty diesel filters and substrates in Europe were responsible for the sequential decline. Heavy-duty diesel declined slightly from the year-ago quarter.
Overall sales from the automotive segment were down 7.0% sequentially, while staying more or less flat with the year-ago quarter. The diesel business did slightly better, declining 3.7% sequentially and 5.8% year over year.
Specialty Materials generated 16% of revenue, up 2.8% sequentially and 4.6% year over year, significantly better than expected. Gorilla Glass (GG) growth was less than expected, which is the main reason for the miss versus guidance. GG remains the primary factor determining Corning’s performance in the specialty materials segment.
The Life Sciences business accounted for around 9% of revenue. The business was up 4.5% from both the previous and year-ago quarters.
The pro forma gross margin was 41.8%, down 62 bps from 42.4% reported in the March 2012 quarter and down 257 bps from last year. The sequential decline was mainly on account of weaker prices that more than offset margin improvements in the GG and diesel businesses.
The operating expenses of $479 million were up 2.8% sequentially. The greatest contributor to the 146 bp sequential contraction in the operating margin to 16.7% was the 174 bp increase in SG&A, helped by the 62 bp increase in cost of sales and an 11 bp increase in R&D (as a percentage of sales).
Corning’s pro forma net income was $471 million or 24.7% of sales compared to $468 million or 24.4% in the previous quarter and $757 million or 37.8% of sales in the year-ago quarter. Our pro forma estimate excludes intangibles amortization charges and asbestos litigation charges in the last quarter.
Including these special items, the GAAP net income was $462 million ($0.30 per share), compared to $462 million ($0.30 per share) in the previous quarter and $750 million (0.47 per share) in the year-ago quarter.
Inventories were up 4.6% during the quarter, with inventory turns going back to 4.4X from 4.6X. DSOs were up a couple of days to 55.
Corning ended the quarter with $6.35 billion in cash and short term investments, down $491 million 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 $856 million, down from $1.47 billion at the beginning of the quarter. Cash generated from operations was $570 million, with $441 million being spent on capex, $104 million on acquisitions, $314 million on share repurchases and $113 million on dividends.
Corning provided guidance for the third quarter. Accordingly, the company expects much stronger results in the Display business, with both wholly-owned and SCP volumes growing at low double-digit percentage rates. The volume expectations are based on the assumption of normal industry seasonality, particularly for tablets and larger TV sizes. Price declines are expected to remain moderate.
Telecom segment sales are expected to be flat sequentially with the Chinese optical fiber and cable business remaining strong. Environmental Technologies segment sales are also expected to be flat sequentially. Specialty Materials were expected to be the strongest, growing 10-15%.
Corning expects the gross margin to increase one percentage point, mainly on account of volume increases in Display. SG&A and R&D will be consistent as a percentage of sales on a sequential basis.
Equity earnings related to Dow Corning excluding special items will drop 10%. The tax rate is expected to be 19%.
Corning’s second quarter results may be called decent and its outlook also indicates stronger demand in key markets. We think that investor reaction to Apple’s results is overdone, particularly since Apple has been supply-constrained for some time and Corning’s own customers are gearing up to increase production.
We think it is notable that Corning expects 50% growth in tablets this year and is not limited to Apple alone. It has a solid long-standing relation with Samsung, which is growing very strongly in the tablet market. The current growth rates indicate that Corning’s expectations are reasonable.
The main negative at this point is the slowdown in Europe impacting its environmental business. Europe has been at the forefront of safety standards, so the current softness seems to indicate a slowdown in automotive production. Corning also hinted that the condition could worsen in the next quarter.
Corning’s GG, Lotus, Willow Glass and other innovations have ensured that it remains a major beneficiary of the move to mobile computing and smart phones. Therefore, irrespective of the level of competition in the market, it’s specialty materials business is likely to grow at least in line with overall market growth rates as more and more companies adopt its technology.
However, we continue to think that there will be more investment in the business (new technologies, China, India), which will drive up costs, which will negatively impact the bottom line. Additionally, the debt level remains quite high, which increases the risk of investing in the shares.
Corning shares therefore carry a Zacks Rank of #3, implying a Hold rating in the next 1-3 months. Our long term (3-6 month) recommendation is also Neutral.Read the Full Research Report on GLW
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