Corning Inc’s (GLW) fourth quarter 2010 earnings missed the Zacks Consensus Estimate by a penny (2.3%). Revenue growth was strong however, enabling the company to exceed the Zacks Consensus by 9.5%.
Investors discounted the earnings miss, and viewed very positively the solid revenue growth that signaled the end of the inventory correction in the LCD TV market (currently Corning’s biggest market). As a result, share prices went up 7.99%.
Revenue
Corning reported revenue of $1.77 billion, which was up 10.2% sequentially and 15.2% year over year. At the beginning of the quarter, Corning expected both glass volumes and glass prices to decline and revised these expectations in early December. Therefore the double-digit increase in glass volumes and mid single-digit decline in glass prices were in line with management’s revised expectations.
Revenue by Segment
The Display Technologies segment generated around 43% of total revenue. The segment increased 16.3% sequentially and 4.6% year over year. The wholly-owned business saw a 20% increase in volumes, while Samsung Precision (“SCP”) declined 15%. This was because of higher utilization rates at Taiwanese manufacturers that usually serve the Chinese market.
Manufacturers in Korea on the other hand lowered utilization rates in an effort to control inventory. Prices were down across the board. The bulk of the increase in Corning’s Display volumes was due to a very strong LCD TV market, with Japan seeing the strongest growth, followed by emerging markets in Asia and South America, the U.S. and then Europe.
LCD TV units for the year exceeded Corning’s initial expectations by about 5 million, despite the inventory correction that impacted third quarter results. Other Display markets, such as monitors, notebooks and netbooks, grew in line with Corning’s expectations.
Telecommunications (25% of revenue) declined 4.5% sequentially, but grew 9.4% from the year-ago quarter. While there was seasonal softness in both fiber & cable and hardware & equipment product lines, the decline in the latter was much more pronounced. On a year-over-year basis, fiber & cable saw a very small decline, while hardware increased double-digits.
There was increasing demand across all product lines in North America and Europe that offset the slowdown in Chinese 3G spending. Corning’s EDGE products for enterprise networks and FTTP networks grew strongly from last year.
The Environmental Technologies segment, which generated 13% of revenue grew 11.5% sequentially and 28.2% year over year. The diesel business was very strong, growing 29.2% sequentially and 57.5% from last year. Diesel products were helped by increasing demand for Corning’s light duty filters, which have become compulsory under Euro 5 regulations.
Heavy duty filters also did well in the last quarter. The automotive side of the business was slower, declining 1.7% sequentially and growing 8.3% from the December quarter of 2009. The gasoline automotive business is benefiting from increased automotive production this year versus 2009 and the ceramic substrate business did particularly well in the last quarter.
Specialty Materials generated around 11% of revenue, up 23.9% sequentially and 79.1% year over year. The stronger-than-expected 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. So far, Corning’s Gorilla Glass has been designed into 350 different models under 29 different brands and more than 200 million devices currently use this glass.
The Life Sciences business accounted for around 8% of revenue. The business was up 12.0% sequentially and up 19.7% from a year ago. Although there was some growth in the core business, two recently- closed acquisitions accounted for most of the increase in the last quarter.
The pro forma gross margin was 43.5%, down 174 bps from 45.2% reported in the September 2010 quarter. Corning’s gross margin was up 109 bps from last year. While volumes clearly helped the year-over-year comparison, the sequential decline was mostly on account of weaker glass prices. Overall, Display, Telecom, Environmental and Specialty Materials all posted improvements from last year, the Life Sciences gross margin was flat.
The operating expenses of $450 million were up 13.1% sequentially. However, the 239 bp decline in the operating margin to 18.0% was mostly on account of the gross margin decline. Both R&D and SG&A increased slightly as a percentage of sales.
Net Income
Corning’s pro forma net income was $727 million or 41.2% of sales compared to $792 million or 49.4% in the previous quarter and $698 million or 45.6% of sales in the year-ago quarter. Our pro forma estimate excludes restructuring gains, intangibles amortization charges, asbestos litigation gains and other adjustments on a tax-adjusted basis in the last quarter.
Including these special items, the GAAP net income was $1.04 billion ($0.66 per share), compared to $785 million ($0.50 per share) in the previous quarter and $740 million (0.47 per share) in the year-ago quarter.
Balance Sheet
Inventories were up just 3.7% during the quarter, since the stronger demand did not allow too much internal inventory builds. As a result, inventory turns increased from 4.9X to 5.4X. DSOs went from 49 to around 50 during the quarter.
Corning ended the quarter with $6.35 billion in cash and short -erm investments, up $1.32 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 $1.87 billion, up from $495 million at the start of the quarter. Cash generated from operations was $2.09 billion, of which $473 million was spent on capex, $768 million on acquisitions, $100 million on debt repayment and $78 million on dividends.
Guidance
In the first quarter, Corning expects Display glass volumes to be up mid single-digits in both the wholly owned and SCP businesses. Glass price declines are expected to be lower than in the last quarter. Telecom and Environmental Technologies segment sales are expected to be flat sequentially. Corning expects the Specialty Materials segment to increase 20-25% sequentially, again driven by Gorilla Glass.
The Life Sciences segment is expected to be up slightly. Beginning in the first quarter of 2011, Corning will see a higher tax rate (15%), due to the expiry of foreign tax credits. The gross margin is expected to be up slightly, R&D down slightly and SG&A down substantially as a percentage of sales.
Our Take
Corning’s fourth quarter results were encouraging, pointing to the fact that the inventory correction has largely run its course. However, there were some one-time market dynamics that helped results in the last quarter (regulations in Japan and Chinese New Year builds).
While China should continue to drive growth, the situation in Japan will moderate. In view of the changed circumstances, the guidance appears achievable. However, utilization rates in Korea will be important to watch, as they would be more indicative of what is going on 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.
However, we think that higher costs and a higher tax rate will 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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