GLW Corning Inc

Corning Inc’s (GLW) first quarter 2011 earnings beat the Zacks Consensus Estimate by 4 cents, or 9.1%. Revenue growth was also strong, exceeding the Zacks Consensus by 5.3%. The revenue growth and margin expansion helped offset a higher tax rate to deliver the results in the last quarter.

Revenue

Corningreported revenue of $1.92 billion, which was up 9.0% sequentially and 23.8% year over year. Corning stated that the crisis in Japan did not affect its operations or supply chain in the last quarter and those suppliers that had been affected had made arrangements for second sourcing.

Second quarter results will however be impacted by an inventory correction at Sharp, which intends to lower utilization rates for the purpose. Corning currently does not expect the inventory correction to continue into the third quarter. 

Revenue by Segment

The Display Technologies segment generated around 41% of total revenue. The segment increased 5.3% sequentially and 1.0% year over year. The wholly-owned business saw a high single-digit increase in volumes, driven by increased demand at Japanese and Taiwanese panel makers. Samsung Precision (“SCP”) volumes were flattish sequentially.

Corning had guided to mid single-digit volume increase at both businesses, so while the wholly-owned business exceeded expectations, SCP fell slightly short. Management stated that Corning’s overall volume increase of 5% from the December quarter was better than the market growth rate of 2%, indicating that the company was probably gaining back some share that it lost in 2009. Glass price declines also moderated in line with expectations.

Corningstated that the increase in demand for LCD TVs and monitors were in line with expectations, while demand for notebooks had taken a hit. This is consistent with reports from other companies, such as Microsoft Corp (MSFT) and Intel Corp (INTC) that also cater to the notebook market.

Retail sales of LCD TVs in China, other emerging Asian countries, South America and Europe were up double-digits in January. February sales moderated across most regions other than the emerging markets. Japan was not as strong, as government regulations impacted results in the quarter.

Corning also lowered its 2011 expectations for the notebook market from 212 million units to around 196 million units. Consequently worldwide glass demand for the year is now expected to be 100 million square feet lower at 3.5-3.7 billion square feet.

Telecommunications (25% of revenue) increased 7.0% sequentially and 30.2% from the year-ago quarter. Corning attributed the increase from the year-ago quarter to increased demand for fiber-to-the-home- technology, which grew 70% and enterprise networks, which grew 20%.

This resulted in an 8.3% sequential and 30.5% year-over-year increase in Corning’s fiber and cable products. Additionally, hardware and equipment sales jumped 5.6% and 29.9% from the previous and year-ago quarters, respectively.

The Environmental Technologies segment, which generated 14% of revenue grew 11.6% sequentially and 34.9% year over year. The diesel business was very strong, growing 18.3% sequentially and 81.3% from last year, fueled by a recovery in demand for heavy-duty filters.

Light-duty filters, which have become compulsory under Euro 5 regulations also remained strong in the last quarter. The automotive side of the business was slower, growing 5.1% from both the previous and year-ago quarters. The ceramic substrate business did relatively better in the last quarter.

Specialty Materials generated over 13% of revenue, up 26.9% sequentially and 164.6% year over year. The strong growth in the quarter was on account of increased demand for Gorilla Glass, a special quality glass pioneered by Corning that is currently being used by branded consumer electronics manufacturers across the world as cover material for handhelds, notebooks, tablets and TVs.

Gorilla Glass will be the major driver of Corning’s specialty materials sales this year, since sales of $150 million in the last quarter is expected to go up to $1 billion by year-end.

The Life Sciences business accounted for around 7% of revenue. The business was up 2.9% sequentially and 22.0% from a year ago.

Margins

The pro forma gross margin was 45.4%, up 199 bps from 43.5% reported in the December 2010 quarter, but down 162 bps from last year. Higher glass volumes and manufacturing efficiencies across the Display, Telecom and Environmental Technologies segments were responsible for the gross margin expansion. Prices, although stabilizing, remained a negative in the last quarter.

The operating expenses of $406 million were up 9.8% sequentially. The greatest contributor to the 638 bp expansion in the operating margin to 24.3% was the 309 bp decline in SG&A as a percentage of sales, which was helped by the 199 bp decline in cost of sales and the 129 bp decline in R&D expenses (as a percentage of sales).

Net Income

Corning’s pro forma net income was $754 million or 39.2% of sales compared to $727 million or 41.2% in the previous quarter and $745 million or 48.0% of sales in the year-ago quarter. Our pro forma estimate excludes intangibles amortization charges and asbestos litigation gains on a tax-adjusted basis. The tax rate increased substantially, as expected.

Including these special items, the GAAP net income was $748 million ($0.47 per share), compared to $1.04 billion ($0.66 per share) in the previous quarter and $797 million (0.50 per share) in the year-ago quarter.

Balance Sheet

Inventories were up 14.0% during the quarter, with inventory turns dropping from 5.4X to 5.0X. DSOs went from 50 to around 53 during the quarter.

Corningended the quarter with $6.30 billion in cash and short term investments, down $47 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 $1.87 billion, flat from the start of the quarter. Cash generated from operations was $573 million, of which $532 million was spent on capex, $148 million on acquisitions and $79 million on dividends.

Guidance

In the second quarter, Corning expects Display glass volumes to be flat sequentially, the combined effect of higher demand from Korea, where utilization rates are expected to increase and softer demand from Taiwan and Japan, where utilization rates will be lowered.

This will result in a low-to-mid-teens percent volume decline in the wholly-owned business and a low-to-mid-teens percent volume increase at SCP. Glass price declines are expected to be even less than in the last quarter.

Telecom segment sales are expected to be up 20% and 30%, respectively from the previous and year-ago quarters. The Environmental business is expected to see a slight sequential decline, given the strength in the first quarter, although sales will be up 35% from the year-ago quarter.

Corning expects the Specialty Materials segment to increase 20% sequentially, again driven by Gorilla Glass. The Life Sciences segment is expected to be up slightly on a sequential basis and 20% from last year.

The gross margin is expected to be down slightly, due to lower glass volumes, R&D to be roughly 9% of sales and SG&A up slightly as a percentage of sales. The expiry of foreign tax credits will result in a tax rate similar to the first quarter. Management expects this to be around 15% for both the second quarter and for the rest of the year. All this is expected to result in a 10% sequential increase in earnings.

Our Take

Corning’s first quarter results were encouraging, as there was broad-based strength across all segments. However, management stated that the utilization rate at Taiwanese customers shot up in the last quarter, resulting in some excess inventory (Taiwan serves the Chinese market).

Additionally, one of the company’s largest customers (Sharp) has decided to reduce utilization at its Japanese facilities. It is possible that the Chinese New Year and regulations in Japan resulted in significant builds in the last quarter, requiring the correction in the second quarter. In any case, this is expected to result in a temporary setback to the wholly-owned business.

We believe China will remain an important growth market (although possibly sluggish near-term). However, higher utilization rates in Korea are a positive, as they are indicative of strength in markets outside China.

We also like what Corning is doing with its Gorilla Glass and it looks as if this business will grow in leaps and bounds over the next few months. Similar to the last two quarters, we think that higher volumes would improve margins in this business.

Judging from management guidance, it appears that there will be more significant investment in the business, which will drive up costs. Also, the conversion of some LCD operations to Gorilla Glass will also impact costs. The higher costs and higher tax rate will negatively impact the bottom line.

Corning shares have a Zacks #3 Rank, which translates to a short-term Hold recommendation. Our longer-term (3-6 months) rating is also Neutral.

 
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