Corning Inc.‘s (GLW) second quarter 2010 earnings exceeded the Zacks Consensus Estimate of 53 cents by a penny, or 2.1%. The earnings surprise was the result of higher volumes across all segments and expanding gross margins.
Analyst estimates have been going up over the last 30 days, reflective of improving sentiments. However, although 2 analysts raised estimates for the June quarter as well as for the rest of the year, and 4 analysts raised estimates for 2011, we see no changes to the average estimates in 2010 and a mere 1 cent advance in estimates for 2011.
Corning’s surprise history is good, with the company reporting an average 16.6% positive surprise in the preceding 4 quarters. Therefore, another positive surprise in the June quarter was only to be expected.
Revenue
Revenue of $1.71 billion was up 10.2% sequentially and 22.7% year over year. It was also 3.9% better than Zacks Consensus expectations. As management pre-announced a few days ago, Corning started seeing much stronger demand for its Gorilla Glass, which positively impacted the Specialty Materials segment. Telecom showed strong sequential improvement, while growth in the largest segment (Display) moderated somewhat. All segments, except telecom, grew double-digits from the year-ago quarter.
Revenue by Segment
The Display Technologies segment generated over 49% of total revenue. The segment grew 6.6% sequentially and 23.9% year over year. Segment results were the result of continued strong demand for LCD TVs all over the world, partially offset by slightly weaker LCD panel pricing. The wholly-owned business grew more than 10% sequentially and 25% year over year, while the Samsung Precision LCD glass business (which the company reports as equity earnings) pulled down segment revenues, growing just 5% sequentially and 15% from the year-ago quarter. Comparisons from the year-ago quarter have become more difficult, since the U.S. went digital roughly a year ago.
Telecommunications (26% of revenue) was up 21.2% sequentially and 0.9% from the year-ago quarter. The sequential improvement was attributable to fiber-to-the-home (FTTH) deployments in Canada. Fiber & cable (up 19.5% sequentially, down 3.4% year over year) was the softer of the two product lines, although results improved considerably compared to the March 2010 quarter. The hardware and other equipment line did better, growing 23.0% sequentially and 5.9% year over year.
The Environmental Technologies segment, which generated 11% of revenue, declined 4.2% sequentially and increased 39.4% year over year. The sequential performance was negatively impacted by European currency issues. The automotive product line declined 6.8% sequentially, although it still grew 28.2% from the year-ago quarter. The diesel business fared slightly better, as revenue was flat sequentially but up 59.6% year over year.
Specialty Materials generated over 7% of revenue, up 31.3% sequentially and 77.5% year over year. The stronger-than-expected growth was driven by Gorilla Glass, a special quality glass pioneered by the company and now designed into over 200 consumer devices across multiple brands. There was also some strength in advanced optics products in the last quarter.
The Life Sciences business accounted for the remaining 7% of revenue, representing sequential and year-over-year increases of 5.9% and 54.3%, respectively. The company saw positive comps in this segment, since the last quarter included the contribution from Axygen Bioscience, which was only acquired in September last year and so not included in the year-ago results.
Margins
The pro forma gross margin was 48.3%, up 124 bps from 47.1% reported in the March 2010 quarter. The main reason for the gross margin improvement was higher volumes, which spread out fixed costs over a larger sales base. Production efficiencies that resulted from previously-implemented restructuring actions also contributed.
The operating expenses of $390 million were up 2.6% sequentially. The operating leverage enabled the company to report an operating margin of 25.5%, which was a 291 bp increase over the previous quarter. The higher gross margin was the biggest contributor to the increase, although both R&D and SG&A also declined as a percentage of sales.
Net Income
Pro forma net income was $856 million or 50.0% of sales compared to $745 million or 48.0% in the March 2010 quarter and $617 million or 44.2% of sales in the June quarter of 2009. Our pro forma estimate excludes intangibles amortization charges, impairment charges and asbestos litigation charges in the last quarter.
Including these special items, the GAAP net income was $848 million ($0.54 per share), compared to $797 million ($0.50 per share) in the previous quarter and $611 million (0.39 per share) in the year-ago quarter.
Balance Sheet
Inventories were up marginally by 0.5% during the quarter, yielding inventory turns of 5.8X, up from 5.4X at the end of the previous quarter. DSOs were down slightly from 51 to 50.
Corning ended the quarter with $4.26 billion in cash and short term investments, up $386 million during the quarter. However, the company has a huge debt balance. Including long term liabilities, the net cash position at quarter-end was only $217 million, a slight improvement during the quarter. Cash generated from operations was $672 million, of which $136 million was spent on capex, $670 million on acquisitions and $78 million on dividends.
Guidance
Management did not provide guidance for the next quarter, although capex expectations provided for 2010 was $1.2 billion (from previous expectations of $1 billion) and was $2 billion or more for 2011.
Corning previously stated that it intended to use these funds to expand its Taichung LCD glass facility in Taiwan and also retrofit a section of its facility in Shizuoka (Japan). Additional capex builds are intended for the new Chinese facility, which is expected to break ground later this year and start operations in the first half of 2012. The new facility will cater to secular growth in the LCD market, as well as the upsurge in demand for Gorilla Glass.
In Conclusion
Analysts have been showing increasing optimism about demand for Corning’s new Gorilla Glass, expecting adoption at leading LCD TV manufacturers such as Samsung and Sony Corp. (SNE). However, they have expressed concern regarding other aspects of the business.
For example, the core glass business could see a temporary slowdown because there appears to be some inventory accumulation at retail, fueled by the softness in the consumer PC market, which is impacting demand for LCD panels.
Moreover, demand for LCD TVs is also undergoing a temporary slowdown, with year-over-year comps in the U.S. getting difficult, due to the digital transition in the year-ago quarter.
The increase in capex could also be viewed negatively by investors, given the recent news regarding softer demand.
Consequently, we reiterate our Neutral recommendation on shares. The company is a Zacks #3 Rank, implying a short term Hold recommendation.
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