Corning’s (GLW) first quarter 2012 earnings beat the Zacks Consensus Estimate by 3 cents, or 10.7%. Estimates dropped a penny over the last couple of months making the comparison easier. The positive earnings surprise, positive display market trends and a strengthening Gorilla Glass (GG) business drove shares up 7.1%.
Corning reported revenue of $1.92 billion, which was up 1.7% sequentially and flat year over year. The stronger yen helped results in the last quarter.
Revenue by Segment
The Display Technologies segment generated around 37% of total revenue. The segment was down 9.6% sequentially and 10.8% year over year. Samsung Precision (“SCP”) LCD glass volumes were down less than 10% sequentially (better than the guidance of a low-double-digit decline), as a major customer purchased below the committed amount. V
olumes in the wholly-owned business were up mid-single-digits (better than expectations of its being flat). Glass price declines continued in the first quarter, but management appeared optimistic about their moderation in the second.
Telecommunications (27% of revenue) increased 3.7% sequentially and 7.2% from the year-ago quarter. The sequential increase was below Corning’s guidance of a 5-10% increase, attributable to slight weakness in cable products. FTTH and optical fiber were up sequentially, with the enterprise segment coming in flat.
Fiber and cable products declined 3.1% sequentially, while hardware and equipment sales grew 11.4%. Compared to the year-ago quarter, sales in the two categories were up 2.4% and 12.4%, respectively.
The Environmental Technologies segment generated 14% of revenue, up 12.4% sequentially and 1.5% year over year. Both automotive and diesel businesses were up double-digits on a sequential basis, although automotive was stronger. Automotive was also stronger on a year-over-year basis, growing 4.9% compared to diesel’s decline of 1.5%. North America auto was particularly strong, with stronger gasoline substrate and heavy duty product demand.
Specialty Materials generated 15% of revenue, up 21.0% sequentially and 13.4% year over year, significantly better than expected. The quarter benefited from a pickup in demand for GG, driven by finishing of new product models. Gorilla Glass 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 up 8.4% sequentially and 7.6% from a year ago.
The pro forma gross margin was 42.4%, down 132 bps from 43.7% reported in the December 2011 quarter and down 305 bps from last year. The sequential decline was mainly on account of higher volumes that were however insufficient for offsetting weakness in glass prices.
The operating expenses of $466 million were up 1.3% sequentially. The greatest contributor to the 122 bp sequential contraction in the operating margin to 18.1% was the 132 bp increase in cost of sales, helped by the 36 bp increase in R&D (as a percentage of sales). The 47 bp decline in SG&A was an offsetting factor.
Corning’s pro forma net income was $468 million or 24.4% of sales compared to $633 million or 33.5% in the previous quarter and $754 million or 39.2% of sales in the year-ago quarter. Our pro forma estimate excludes intangibles amortization charges and asbestos litigation charges in the last quarter. A much higher tax rate impacted results.
Including these special items, the GAAP net income was $462 million ($0.30 per share), compared to $491 million ($0.31 per share) in the previous quarter and $748 million (0.47 per share) in the year-ago quarter.
Inventories were down 2.1% during the quarter, with inventory turns increasing from 4.4X to 4.6X. DSOs were up slightly to almost 53.
Corning ended the quarter with $6.84 billion in cash and short term investments, down $1.0 billion 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 $1.47 billion, down from $1.18 billion at the beginning of the quarter.
Cash generated from operations was $762 million, with $412 million being spent on capex, $528 million on acquisitions, $72 million on share repurchases and $4 million on dividends.
Corning provided guidance for the second quarter. Accordingly, the company expects much stronger results in the Display business, with wholly-owned volumes coming in flat sequentially and those at SCP increasing slightly.
The volume expectations are based on the assumption that there remains some inventory in the TV market, which should take a quarter to burn off. Volumes are expected to pick up thereafter. Price declines are however expected to moderate going forward.
Telecom segment sales are expected to be increase at a low-to-mid-teen percentage rate sequentially, driven by growth across all product categories. With heavy-duty filters remaining strong and offset by light-duty filters for cars in the European market, Environmental Technologies segment sales are expected to come in flat sequentially. Specialty Materials are expected to be up 10-15%, with GG remaining the major driver. Life Sciences sales are expected to be up 5-10%.
Corning expects the gross margin to shrink one percentage point, as slightly higher margins in Telecom and Specialty Materials is more than offset by lower margins in Environmental and Display. SG&A and R&D will be consistent as a percentage of sales on a sequential basis.
Equity earnings excluding special items, will be up slightly, with higher volumes of both silicon and polysilicon resulting in a 40% increase in earnings from Dow Corning. The tax rate is expected to be 20%.
Corning’s first quarter results were better than expected and its outlook for steadier glass prices in the next quarter is encouraging. We believe 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. At the same time, GG picked up toward the end of the quarter, which is an encouraging sign, given its stronger margin profile.
With glass volumes expected to start growing in the second half of the year, glass prices stabilizing (an indication of better demand/supply balance) and GG demand accelerating, the second quarter could be the trough for Corning.
Corning’s results have suffered due to the same economic pressures that are impacting other players with consumer exposure such as Hewlett Packard Company (HPQ) and Intel Corp (INTC). However, it has suffered more than these players because it is significantly dependent on the LCD TV market, where the inventory correction is not yet over.
We also think that there will be more investment in the business (new technologies, China, India), which will drive up costs. The higher costs and higher tax rate will negatively impact the bottom line.
Corning shares therefore carry a Zacks Rank of #4, implying a Sell rating in the next 1-3 months. However, our long term (3-6 month) recommendation remains Neutral, since we expect a stronger second half.
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