GLW Corning Inc

Corning Inc’s (GLW) second quarter 2011 earnings beat the Zacks Consensus Estimate by a penny, or 1.5%. Revenue growth slowed down in the last quarter, exceeding the consensus estimates by just 2.3%. Gross, operating and net margins all declined and even the tax rate was a shade higher.

The lack-luster demand in the consumer electronics market (particularly TVs) had investors expecting the worst, so share prices traded down 7.23% during the day. However, with Corning managing to exceed expectations, shares were up 0.06% in after-market trade.

Revenue

Corningreported revenue of $2.00 billion, which was up 4.3% sequentially and 17.1% year over year. Corning stated that the supply chin was looking more cautious ahead of the 2011 holiday season and build rates at this time of the year were lower than may be considered typical.

This could be because all the major LCD TV makers, including Samsung, LGE, Sony, Sharp, Toshiba, Panasonic, Phillips and Vizio, as well as Chinese makers have lowered their build plans from December 2010 to June 2011.

However, inventory at distributors appears stable, which could be a good thing, since it means that the chances of another inventory adjustment are small. 

Revenue by Segment

The Display Technologies segment generated around 38% of total revenue. The segment declined 3.8% sequentially and 8.9% year over year. The wholly-owned business performed better than expected, as Sharp started ramping its generation 8 and generation 10 fabs sooner than expected and utilization rates at Taiwanese and Chinese panel makers were also better than expected.

Samsung Precision (“SCP”) volumes increased 10% sequentially, slightly lower than the low-to-mid teens rate guided by management. Corning stated that its overall volume increase of 5% from the March 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 demand for LCD TVs appeared to be significantly lower than management’s initial expectations, although IT products and handhelds were in line with expectations. Corning expects 2011 LCD TV retail sales growth rate to average at 10%, compared to the previous estimate of 16%.

Japan is likely to be the only region performing better than previous expectations (down 33% compared to down 45% expected previously). Europe (forecast down 7 points), China (down 8 points), North America (down 2 points) and rest of the world (down 9 points) were responsible for the downward revision in the estimated growth rate.

However, PC unit estimates were unchanged, with PC units (excluding tablets) expected to be up 6% for the year and tablets to increase from 20 million units in 2010 to 60 million units in 2011. Consequently, worldwide glass demand for the year is now slightly lower at 3.3-3.4 billion square feet, compared to 3.5-3.7 billion square feet.

Telecommunications (27% of revenue) increased 15.6% sequentially and 24.3% from the year-ago quarter. Corning said that the growth in the last quarter was driven by strength across geographies and product lines. Although the sequential increase was lower than expected, Corning attributed it to the timing of projects.

Fiber-to-the-home volumes were up more than 60% and optical fiber volumes up 40% from last year. This resulted in a 6.9% sequential and 16.7% year-over-year increase in Corning’s fiber and cable products. Additionally, hardware and equipment sales jumped 25.2% and 32.2% from the previous and year-ago quarters, respectively.

The Environmental Technologies segment, which generated 13% of revenue, was flat sequentially and up 40.2% year over year. The diesel business was the stronger of the two, growing 0.7% sequentially and 82.7% from last year. However, the automotive business, while down 1.6% sequentially, was up 11% from last year.

Specialty Materials generated over 14% of revenue, up 11.4% sequentially and 124.6% 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 sales were up 24% sequentially and excluding TV (which declined) they were up 35%. Gorilla Glass remain the major driver of Corning’s specialty materials sales this year, since sales of $190 million in the last quarter is expected to go up to $800 million by year-end (previous expectation $1 billion, pulled down on account of weaker sales into TVs).

The Life Sciences business accounted for around 8% of revenue. The business was up 7.6% sequentially and 24.0% from a year ago.

Margins

The pro forma gross margin was 44.3%, down 111 bps from 45.4% reported in the March 2011 quarter and down 397 bps from last year. Higher-than-expected 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 $456 million were up 12.3% sequentially. The greatest contributor to the 274 bp contraction in the operating margin to 21.6% was the 116 bp increase in SG&A as a percentage of sales (merit bonus kicking in), a 111 bp increase in cost of sales and a 47 bp decline in R&D expenses (as a percentage of sales).

Net Income

Corning’s pro forma net income was $757 million or 37.8% of sales compared to $754 million or 39.2% in the previous quarter and $856 million or 50.0% 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 slightly, though it was lower than the projected 15%.

Including these special items, the GAAP net income was $750 million ($0.47 per share), compared to $748 million ($0.47 per share) in the previous quarter and $848 million (0.54 per share) in the year-ago quarter.

Balance Sheet

Inventories were up 9.0% during the quarter, with inventory turns dropping from 5.0X to 4.9X. DSOs went from around 53 to around 57 during the quarter.

Corningended the quarter with $6.36 billion in cash and short term investments, up $54 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 $1.89 billion, flat from the start of the quarter. Cash generated from operations was $546 million, with $494 million being spent on capex, $962 million on acquisitions and $79 million on dividends.

Guidance

In the third quarter, Corning expects Display glass volumes to be flat sequentially, due to weaker retail expectations for the second half and caution in the supply chain. This will result in a mid-to-upper single-digit percent volume increase in the wholly-owned business and a mid-single-digits percent volume decline at SCP. Glass price declines are expected to moderate.

Telecom segment sales are expected to be increase slightly on a sequential basis and grow 20% from the year-ago quarter. The Environmental business is expected to be flat sequentially.

Corning expects the Specialty Materials segment to increase in the high single-digit percentage range, driven by Gorilla Glass, which is expected to grow 20% sequentially and offset by declines in other product lines.

The gross margin is expected to be up two percentage points, due to higher Display volumes and Gorilla Glass manufacturing improvements. R&D is expected to be roughly 9% of sales and SG&A down slightly as a percentage of sales. Management expects this to be around 15% for both the third quarter and for the rest of the year. All this is expected to result in a high single-digit sequential decline in earnings.

Capex expectations were lowered and are now expected to be in the low end of the previously guided range of $2.4-$2.7 billion for the year. Capex for 2012 is expected to be $1.9-$2.0 billion.

Our Take

Corning’s second quarter results were satisfactory, although there were some high and low points. The fact that TV demand is down is very disappointing, forcing the company to lower its expectations for total glass demand and also the demand for Gorilla Glass. However, the computing market did better, with projections indicating that Corning is gaining from the growth in the tablet market.

Other areas were more or less in line with expectations, so with long term drivers in place, should continue to display strong growth. Japan being not as bad as anticipated is also a positive sign.

Additionally, although utilization rates at TV makers remain low, they are bound to pick up as we move through the year, because of the build for the holiday season.

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.

Therefore, higher glass volumes and moderating price declines will have a positive impact on margins.

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 years. Similar to the last two quarters, we think that higher volumes an manufacturing efficiencies would improve margins in this business.

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

The shares carry a Zacks #3 Rank, implying a short-term Hold recommendation.

Corning (NYSE:GLW)
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