FORM 10-Q

 

SECURITIES AND EXCHANGE COMMISSION

 

WASHINGTON, DC 20549

 

 

 

OR

 

 

For the transition period from ___________to____________

 

Commission file number 1-3247

 

CORNING INCORPORATED

(Exact name of Registrant as specified in its charter)

 

 

 

 

Registrant’s telephone number, including area code: 607-974-9000

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

1,575,834,092 shares of Corning’s Common Stock, $0.50 Par Value, were outstanding as of October 15, 2007.

 

---

INDEX

 

 

 

-2-

 

---

CORNING INCORPORATED AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited; in millions, except per share amounts)

 

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

-3-

 

---

CORNING INCORPORATED AND SUBSIDIARY COMPANIES

CONSOLIDATED BALANCE SHEETS

(Unaudited; in millions, except per share amounts)

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

Certain amounts for 2006 were reclassified to conform with the 2007 presentation.

 

-4-

 

---

CORNING INCORPORATED AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited; in millions)

 

 

 

The accompanying notes are an integral part of these statements.

 

 

-5-

 

---

CORNING INCORPORATED AND SUBSIDIARY COMPANIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

Basis of Presentation

 

In these notes, the terms “Corning,” “Company,” “we,” “us,” or “our” mean Corning Incorporated and subsidiary companies.

 

The accompanying unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) and in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been omitted or condensed. These interim consolidated financial statements should be read in conjunction with Corning’s consolidated financial statements and notes thereto included in its Annual Report on Form 10-K for the year ended December 31, 2006 (2006 Form 10-K).

 

The unaudited consolidated financial statements reflect all adjustments which, in the opinion of management, are necessary for a fair statement of the results of operations, financial position and cash flows for the interim periods presented. All such adjustments are of a normal recurring nature. The results for interim periods are not necessarily indicative of results which may be expected for any other interim period or for the full year.

 

Other Income, Net

 

Royalty income represents the largest item included in “Other income, net”, in Corning’s consolidated statements of operations. Royalty income for the third quarter of 2007, and 2006, was $41 million and $30 million, respectively. For the nine months ended September 30, 2007, and 2006, royalty income was $125 million and $81 million, respectively.

 

Short-Term Investments

 

The following is a summary of the fair value of available-for-sale securities (in millions):

 

Asset-backed securities are collateralized by credit card loans, auto loans, mortgages, and student loans. At September 30, 2007, our exposure to sub-prime mortgages was $50 million. Unrealized losses on securities backed by sub-prime mortgages, which are rated as investment grade, were $2 million at September 30, 2007, and are expected to recover in the short-term. Losses realized in the quarter amounted to $2 million.

 

-6-

 

---

New Accounting Standards

 

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in applying generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies whenever an entity is measuring fair value under other accounting pronouncements that require or permit fair value measurement. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. Corning does not expect the adoption of SFAS 157 to have a material impact on its consolidated results of operations and financial condition.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities including an amendment of FASB Statement No. 115” (SFAS 159). SFAS 159 allows all entities a one-time election to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value (the “fair value option”). SFAS 159 is effective for fiscal years beginning after November 15, 2007. Corning does not expect to elect the fair value option available under SFAS 159.

 

In March 2007, the FASB ratified Emerging Issues Task Force (EITF) Issue No. 06-10 “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Collateral Assignment Split-Dollar Life Insurance Arrangements” (EITF 06-10). EITF 06-10 requires that an employer recognize a liability for the postretirement benefit obligation related to a collateral assignment arrangement in accordance with SFAS 106 (if deemed part of a postretirement plan) or APB 12 (if not part of such a plan). Corning is required to adopt EITF 06-10 effective January 1, 2008. Corning does not expect the adoption of EITF 06-10 to have a material impact on its consolidated results of operations and financial condition.

 

In April 2007, the FASB issued FASB Staff Position FIN 39-1, “Amendment of FASB Interpretation No. 39” (FSP FIN 39-1). FSP FIN 39-1 amends FASB Interpretation (FIN) 39 “Offsetting of Amounts Related to Certain Contracts—an interpretation of APB Opinion No. 10 and FASB Statement No. 105,” (FIN 39) to replace the terms “conditional contracts” and “exchange contracts” with the term “derivative instruments.” It also amends FIN 39 to permit a reporting entity to offset fair value amounts recognized for the right to reclaim or obligation to return cash collateral (receivable or payable) against fair value amounts recognized for derivative instruments executed with the same counterparty under the same master netting arrangement. Corning is required to adopt FSP FIN 39-1 effective January 1, 2008. Corning does not expect the adoption of FSP FIN 39-1 to have a material impact on its consolidated results of operations and financial condition.

 

In June 2007, the FASB issued EITF Issue No. 06-11 “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards” (EITF 06-11). EITF 06-11 relates to the accounting for income tax benefits related to the payment of dividends on equity-classified employee share-based payment awards. Corning is required to adopt EITF 06-11 effective January 1, 2008. Corning does not expect the adoption of EITF 06-11 to have a material impact on its consolidated results of operations and financial condition.

 

In June 2007, the FASB issued EITF Issue 07-3 “Accounting for Advance Payments for Goods or Services to Be Used in Future Research and Development Activities” (EITF 07-3). The scope of EITF 07-3 is limited to nonrefundable advance payments for goods and services related to research and development activities. EITF 07-3 requires that advanced payments be capitalized and subsequently expensed as the goods are delivered or services performed. Corning is required to adopt EITF 07-3 effective January 1, 2008. Corning does not expect the adoption of EITF 07-3 to have a material impact on its consolidated results of operations and financial condition.

 

 

2007 Actions

 

Second Quarter

In the second quarter of 2007, Corning recorded a net credit adjustment of $2 million for revisions to existing restructuring plans.

 

-7-

 

---

The following table summarizes the restructuring, impairment, and other charges and (credits) as of and for the nine months ended September 30, 2007 (in millions):

 

Cash payments for employee-related costs will be substantially completed by the end of 2007, while payments for exit activities will be substantially completed by the end of 2010.

 

2006 Actions

 

Third Quarter

In the third quarter of 2006, we approved a disinvestment plan related to certain manufacturing operations of our Life Sciences and Specialty Materials operating segments. As a result, we recorded a charge of $5 million which was comprised of severance and curtailment costs. We also recorded a $1 million credit related to prior period severance costs and a $2 million credit relating to the sale of previously impaired assets.

 

Second Quarter

In the second quarter of 2006, we recorded a $6 million impairment charge related to certain manufacturing operations of our Life Sciences and Specialty Materials operating segments. We also recorded a $1 million credit relating to the sale of a previously impaired asset.

 

First Quarter

In the first quarter of 2006, we recorded a $7 million charge for a revision to an existing restructuring plan for a German location in our Telecommunications segment.

 

The following table details the charges, credits, and balances of the restructuring reserves as of and for the nine months ended September 30, 2006 (in millions):

 

 

-8-

 

---

 

Asbestos Settlement

 

On March 28, 2003, Corning announced that it had reached agreement (the PCC Plan) with the representatives of asbestos claimants for the settlement of all current and future asbestos claims against it and Pittsburgh Corning Corporation (PCC), which might arise from PCC products or operations. The proposed settlement, if the PCC Plan is approved and becomes effective, will require Corning to relinquish its equity interest in PCC, contribute its equity interest in Pittsburgh Corning Europe N.V. (PCE), a Belgian corporation, and contribute 25 million shares of Corning common stock. Corning also agreed to pay a total of $140 million in six annual installments (present value $131 million at March 2003), beginning one year after the PCC Plan becomes effective, with 5.5 percent interest from June 2004, and to assign certain insurance policy proceeds from its primary insurance and a portion of its excess insurance at the time of settlement.

 

The PCC Plan received a favorable vote from creditors in March 2004. Hearings to consider objections to the PCC Plan were held in the Bankruptcy Court in May 2004. In February 2006, the Bankruptcy Court requested that the PCC Plan proponents delete references to Section 105(a) of the Bankruptcy Code and resubmit the PCC Plan. The final round of oral argument was held on July 21, 2006.

 

On December 21, 2006, the Bankruptcy Court issued an order denying confirmation of the PCC Plan for reasons set out in a memorandum opinion. Several parties, including Corning, filed motions for reconsideration. These motions were argued on March 5, 2007, and the Bankruptcy Court reserved decision. If the Bankruptcy Court does not approve the PCC Plan in its current form, changes to the PCC Plan are reasonably likely to occur.

 

The outcome of these proceedings is uncertain, and confirmation of the current PCC Plan or any amended PCC Plan is subject to a number of contingencies. However, apart from the quarterly mark-to-market adjustment in the value of the components of the settlement, management believes that the likelihood of a material adverse impact to Corning’s financial statements is remote.

 

Two of Corning’s primary insurers and several excess insurers have commenced litigation for a declaration of the rights and obligations of the parties under insurance policies, including rights that may be affected by the settlement arrangement described above. Corning is vigorously contesting these cases. Management is unable to predict the outcome of this insurance litigation.

 

In the third quarter of 2007, Corning recorded a credit to asbestos settlement expense of $16 million, which included a credit of $23 million reflecting the decrease in the value of Corning’s common stock from June 30, 2007 to September 30, 2007, and a charge of $7 million to adjust the estimated settlement value of the other components of the proposed asbestos settlement. In the third quarter of 2006, Corning recorded asbestos settlement expense of $13 million, including $6 million reflecting the increase in the value of Corning’s common stock from June 30, 2006 to September 30, 2006, and $7 million to adjust the estimated settlement value of the other components of the proposed asbestos settlement.

 

For the nine months ended September 30, 2007, Corning recorded asbestos settlement expense of $170 million, including $149 million reflecting the increase in the value of Corning’s common stock from December 31, 2006 to September 30, 2007, and $21 million to adjust the estimated settlement value of the other components of the proposed asbestos settlement. In the nine months ended September 30, 2006, Corning recorded asbestos settlement expense of $137 million, including $119 million reflecting the increase in the value of Corning’s common stock from December 31, 2005 to September 30, 2006, and $18 million to adjust the estimated settlement value of the other components of the proposed asbestos settlement.

 

If the book value of the assets to be contributed in the asbestos settlement remains lower than the carrying value of the settlement liability, a gain would be recognized at the time of settlement.

 

Since March 28, 2003, we have recorded total net charges of $987 million to reflect the initial settlement liability and subsequent adjustments for the change in the settlement value of the components of the liability.

 

-9-

 

---

The liability expected to be settled by contribution of our investment in PCE, assigned insurance proceeds, and the 25 million shares of our common stock, which totals $820 million at September 30, 2007, is recorded in the other accrued liabilities component in our consolidated balance sheets. This portion of the PCC liability is considered a “due on demand” obligation. Accordingly, this portion of the obligation has been classified as a current liability even though it is possible that the contribution could be made beyond one year. The remaining portion of the settlement liability, which totals $167 million at September 30, 2007, representing the net present value of the cash payments, is recorded in the other liabilities component in our consolidated balance sheets.

 

Other Commitments and Contingencies

 

In the normal course of our business, we do not routinely provide significant third-party guarantees. When provided, these guarantees have various terms, and none of these guarantees are individually significant. Generally, third party guarantees provided by Corning are limited to certain financial guarantees including stand-by letters of credit and performance bonds, and the incurrence of contingent liabilities in the form of purchase price adjustment related to attainment of milestones.

 

We have also agreed to provide a credit facility to Dow Corning Corporation (Dow Corning). The funding of the Dow Corning $150 million credit facility is subject to events connected to the Dow Corning Bankruptcy Plan. Refer to Note 8 (Investments) to the consolidated financial statements in our 2006 Form 10-K for a discussion of contingent liabilities associated with Dow Corning.

 

As of September 30, 2007, contingent guarantees totaled a notional value of $329 million, compared with $334 million at December 31, 2006. We also were contingently liable for purchase obligations of $299 million and $261 million, at September 30, 2007 and December 31, 2006, respectively. We believe a significant majority of these guarantees and contingent liabilities will expire without being funded.

 

Product warranty liability accruals at September 30, 2007 and December 31, 2006 were $21 million and $24 million, respectively.

 

Corning is a defendant in various lawsuits, including environmental, product-related suits, and the Dow Corning and Pittsburgh Corning Corporation (PCC) matters discussed in Note 8 (Investments) to the consolidated financial statements in our 2006 Form 10-K, and is subject to various claims which arise in the normal course of business. In the opinion of management, the likelihood that the ultimate disposition of these matters will have a material adverse effect on Corning’s consolidated financial position, liquidity, or results of operations, is remote.

 

Corning has been named by the Environmental Protection Agency (the Agency) under the Superfund Act, or by state governments under similar state laws, as a potentially responsible party for 20 active hazardous waste sites. Under the Superfund Act, all parties who may have contributed any waste to a hazardous waste site, identified by the Agency, are jointly and severally liable for the cost of cleanup unless the Agency agrees otherwise. It is Corning’s policy to accrue for its estimated liability related to Superfund sites and other environmental liabilities related to property owned by Corning based on expert analysis and continual monitoring by both internal and external consultants. At September 30, 2007, and December 31, 2006, Corning had accrued approximately $15 million (undiscounted) and $16 million (undiscounted), respectively, for the estimated liability for environmental cleanup and related litigation. Based upon the information developed to date, management believes that the accrued reserve is a reasonable estimate of the Company’s liability and that the risk of an additional loss in an amount materially higher than that accrued is remote.

 

-10-

 

---

 

The following table summarizes the activities related to our debt retirements (both current and long-term) for the nine months ended September 30, 2007 and 2006 (in millions):

 

 

 

Our provision for income taxes and the related tax rates follow (in millions):

 

For the three months ended September 30, 2007, the effective tax rate reflected the following items:

 

Discrete items and the change in the German tax rate increased our effective tax rate by 3.0 percentage points for the three months ended September 30, 2007.

 

In addition to the items noted above, the tax provision for the nine months ended September 30, 2007, reflected the following items:

 

-11-

 

---

For the nine months ended September 30, 2007, discrete items increased our effective tax rate by 2.2 percentage points.

 

For the three months ended September 30, 2006, the effective tax rate reflected the following items:

 

Discrete items increased our effective tax rate by 2.6 percentage points for the three months ended September 30, 2006.

 

In addition to the items noted above, the tax provision for the nine months ended September 30, 2006, reflected the impact of additional discrete items for which no tax benefit was recorded including asbestos settlement expense of $124 million and the release of $48 million of valuation allowances associated with German and Australian deferred tax assets because we had achieved an appropriate level of profitability. For the nine months ended September 30, 2006, discrete items decreased our effective tax rate by 4.6 percentage points.

 

As more fully described in Note 7 (Income Taxes) to the consolidated financial statements in the 2006 Form 10-K, all of our U.S. deferred tax assets had full valuation allowances at December 31, 2006 and this continues to be the case at September 30, 2007. We will maintain this valuation allowance until an appropriate level of profitability is sustained or we are able to develop tax planning strategies that enable us to conclude that it is more likely than not that our U.S. deferred tax assets are realizable. Until then, we do not expect to record net tax benefits (expenses) on losses (income) generated in the U.S. In the third quarter and nine months ended September 30, 2007, we recorded tax expense on income generated in the U.S. of $42 million and $30 million, respectively, which was fully offset by releases of valuation allowance in equal amounts resulting in zero net tax provision on income generated in the U.S. In the third quarter and nine months ended September 30, 2006, we recorded tax expense on income generated in the U.S. of $78 million and $53 million, respectively, which was fully offset by releases of valuation allowance in equal amounts resulting in zero net tax provision on income generated in the U.S.

 

Certain foreign subsidiaries in China and Taiwan are operating under tax holiday arrangements. The nature and extent of such arrangements vary. The benefits of such arrangements phase out in various years (2006 through 2011) according to the specific terms and schedules of the relevant taxing jurisdictions. The impact of the tax holidays on our effective tax rate is a reduction in the rate of 10 and 9 percentage points for the third quarters ended September 30, 2007 and 2006, respectively, and a reduction in the rate of 13 percentage points for each of the nine months ended September 30, 2007 and 2006.

 

We adopted the provisions of FASB Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes,” (FIN 48) effective January 1, 2007. As a result of the implementation of FIN 48, we recognized a $25 million increase in the liability for unrecognized tax benefits and a decrease to the January 1, 2007, balance of retained earnings of $4 million. The amount of unrecognized tax benefits at January 1, 2007, was $56 million of which $38 million would impact the Company’s effective tax rate, if recognized.

 

We recognized accrued interest and penalties associated with uncertain tax positions as part of tax expense. As of January 1, 2007, we had $4 million of accrued interest and penalties.

 

Corning Incorporated, as the common parent company, and all 80%-or-more-owned U.S. subsidiaries join in the filing of consolidated U.S. federal income tax returns. All such returns for periods ended through December 31, 2004, have been audited by and settled with the Internal Revenue Service (IRS). We expect the IRS to begin the examination of our consolidated U.S. federal income tax returns for the years ended December 31, 2005 and December 31, 2006 in the first quarter of 2008.

 

Corning Incorporated and U.S. subsidiaries file income tax returns on a combined, unitary or stand-alone basis in multiple state and local jurisdictions, which generally have statutes of limitations ranging from 3 to 5 years. Various state income tax returns are currently in the process of examination or administrative appeal.

 

-12-

 

---

Our foreign subsidiaries file income tax returns in the countries in which they have operations. Generally, these countries have statutes of limitations ranging from 3 to 7 years. Years still open to examination by foreign tax authorities in major jurisdictions include Japan (2000 onward) and Taiwan (2004 onward).

 

While we expect the amount of unrecognized tax benefits to change in the next 12 months, we do not expect the change to have a significant impact on the results of operations or our financial position.

 

 

The reconciliation of the amounts used in the basic and diluted earnings per common share computations follows (in millions, except per share amounts):

 

 

The following potential common shares were excluded from the calculation of diluted earnings per common share because their inclusion would have been anti-dilutive. In addition, the following performance-based restricted stock awards have been excluded from the calculation of diluted earnings per common share because the number of shares ultimately issued is contingent on our performance against certain targets established for the performance period (in millions):

 

 

For the three months ended September 30, 2007 and 2006, Corning’s sales to AU Optronics Corporation (AUO), a customer of our Display Technologies segment, represented 12% and 13%, respectively, of the company’s consolidated net sales. For the nine months ended September 30, 2007 and 2006, Corning’s sales to AUO were 11% and 13% of the company’s consolidated net sales, respectively.

 

-13-

 

---

 

Inventories comprise the following (in millions):

 

 

Investments comprise the following (in millions):

 

 

Related party information for these investments in affiliates follows (in millions):

 

As of September 30, 2007, balances due to and due from affiliates were $4 million and $32 million, respectively. As of December 31, 2006, balances due to and due from affiliates were $8 million and $26 million, respectively.

 

We have contractual agreements with several of our equity affiliates which include sales, purchasing, licensing and technology agreements.

 

-14-

 

---

Summarized results of operations for our three significant investments accounted for by the equity method follow:

 

Samsung Corning Precision Glass Co., Ltd. (Samsung Corning Precision)

Samsung Corning Precision is a South Korea-based manufacturer of liquid crystal display glass for flat panel displays.

Samsung Corning Precision’s results of operations follow (in millions):

 

 

Corning and the Samsung Group each own 50% of the common stock of Samsung Corning Precision Glass Co., Ltd.

 

As of September 30, 2007, balances due to and due from Samsung Corning Precision were $2 million and $28 million, respectively. As of December 31, 2006, balances due to and from Samsung Corning Precision were $2 million and $19 million, respectively.

 

As of July 2007, Samsung Corning Precision and Samsung Corning Co., Ltd. are two of approximately thirty co-defendants in a lawsuit filed by Seoul Guarantee Insurance Co. and 13 other creditors. Refer to the Samsung Corning Co., Ltd. section of this note for additional information.

 

In February 2006, Corning made a capital contribution to Samsung Corning Precision in the amount of 75 billion Korean won (approximately $77 million). Our ownership percentage was not affected by this capital contribution.

 

Dow Corning Corporation (Dow Corning)

Dow Corning is a U.S. based manufacturer of silicone products. Dow Corning’s results of operations follow (in millions):

 

-15-

 

---

 

Balances due to Dow Corning were $1 million as of September 30, 2007 and December 31, 2006.

 

Corning and Dow Chemical each own 50% of the common stock of Dow Corning. In May 1995, Dow Corning filed for bankruptcy protection to address pending and claimed liabilities arising from many thousands of breast implant product lawsuits. On June 1, 2004, Dow Corning emerged from Chapter 11 with a Plan of Reorganization (the Plan) which provided for the settlement or other resolution of implant claims. The Plan also includes releases for Corning and Dow Chemical as shareholders in exchange for contributions to the Plan.

 

Under the terms of the Plan, Dow Corning has established and is funding a Settlement Trust and a Litigation Facility to provide a means for tort claimants to settle or litigate their claims. Inclusive of insurance, Dow Corning has paid approximately $1.5 billion to the Settlement Trust. As of September 30, 2007, Dow Corning had recorded a reserve for breast implant litigation of $1.7 billion and anticipates insurance receivables of $155 million. As a separate matter arising from the bankruptcy proceedings, Dow Corning is defending claims asserted by a number of commercial creditors who claim additional interest at default rates and enforcement costs, during the period from May 1995 through June 2004. On July 26, 2006, the U.S. Court of Appeals vacated the judgment of the District Court fixing the interest component, ruled that default interest and enforcement costs may be awarded subject to equitable factors to be determined, and directed that the matter be remanded for further proceedings. Dow Corning’s petition for rehearing by the Court of Appeals and its petition for a writ of certiorari with the U.S. Supreme Court were both denied. As of September 30, 2007, Dow Corning has estimated the interest payable to commercial creditors to be within the range of $71 million to $218 million. As Dow Corning management believes no single amount within the range appears to be a better estimate than any other amount within the range, Dow Corning has recorded the minimum liability within the range. Should Dow Corning not prevail in this matter, Corning’s equity earnings would be reduced by its 50% share of the amount in excess of $71 million, net of applicable tax benefits. There are a number of other claims in the bankruptcy proceedings against Dow Corning awaiting resolution by the U.S. District Court, and it is reasonably possible that Dow Corning may record bankruptcy-related charges or credits in the future. There are no remaining tort claims against Corning, other than those that will be channeled by the Plan into facilities established by the Plan or otherwise defended by the Litigation Facility.

 

In 1995, Corning fully impaired its investment in Dow Corning after it filed for bankruptcy protection. Corning did not recognize net equity earnings from the second quarter of 1995 through the end of 2002. Corning began recognizing equity earnings in the first quarter of 2003 when management concluded that Dow Corning’s emergence from bankruptcy was probable. Corning considers the $249 million difference between the carrying value of its investment in Dow Corning and its 50% share of Dow Corning’s equity to be permanent.

 

Samsung Corning Co., Ltd. (Samsung Corning)

Samsung Corning is a South Korea-based manufacturer of glass panels and funnels for cathode ray tube (CRT) television and display monitors.

 

Samsung Corning’s results of operations follow (in millions):

 

Corning and the Samsung Group each own 50% of the common stock of Samsung Corning Co., Ltd.

 

-16-

 

---

As of September 30, 2007 and December 31, 2006, the balance due from Samsung Corning was $10 million and $4 million, respectively.

 

In the three and nine months ended September 30, 2007, equity earnings for Samsung Corning included a charge of $18 million and $33 million, respectively, to reflect Corning’s share of restructuring and impairment charges. In the three and nine months ended September 30, 2006, equity earnings included a charge of $2 million and $26 million, respectively, due to an impairment of long-lived assets incurred by Samsung Corning. These charges also reduced Corning’s investment in Samsung Corning by the same amounts noted.

 

Since 2003, Samsung Corning recorded significant fixed asset and other impairment charges. As the conventional television glass market is expected to be negatively impacted by continued strong growth in the LCD glass market, we expect that Samsung Corning will incur additional restructuring or impairment charges or operating losses in the foreseeable future. We currently anticipate charges could be in the range of $20 million to $80 million ($10 million to $40 million impact to Corning) over the next twelve months. Samsung Corning continues to invest in its remaining businesses which Samsung Corning management believes will grow over time. If expected results are not achieved, additional operating losses, asset impairments, and restructuring charges are likely to occur. Corning’s investment in Samsung Corning was $220 million at September 30, 2007.

 

Corning reviews the recoverability of all long-lived assets, including equity investments, when events or changes in circumstances occur that indicate that the carrying value of the asset or asset group may not be recoverable. As a result of the impairment events described above, Corning made an assessment of whether its investment in Samsung Corning had incurred an other-than-temporary impairment in the third quarter of 2007 and concluded that it had not. Corning will continue to monitor this investment.

 

Samsung Corning Precision and Samsung Corning are two of approximately thirty co-defendants in a lawsuit filed by Seoul Guarantee Insurance Co. and thirteen other creditors (SGI and Creditors) for alleged breach of an agreement that approximately thirty affiliates of the Samsung group entered into with SGI and Creditors in September 1999. The lawsuit is pending in the courts of South Korea. According to the agreement, the Samsung affiliates agreed to sell 3.5 million shares of Samsung Life Insurance Co., Ltd. (SLI) by December 31, 2000, which were transferred to SGI and Creditors in connection with the petition for court receivership of Samsung Motor Inc. In the lawsuit, SGI and Creditors allege that, in the event that the proceeds of sale of the SLI shares is less than 2.45 trillion Korean won (approximately $2.7 billion), the Samsung affiliates allegedly agreed to compensate SGI and Creditors for the shortfall, by other means, including the sale of an additional 500,000 SLI shares and Samsung affiliates’ purchase of equity or subordinated debentures to be issued by SGI and Creditors. Any excess proceeds from the sale of the SLI shares are to be distributed to the Samsung affiliates. To our knowledge, the SLI shares have not been sold. The suit asks for total damages of 4.73 trillion Korean won (approximately $5.1 billion) plus penalty interest. Samsung Corning Precision and Samsung Corning combined guarantees should represent no more than 3.3% of the Samsung affiliates’ total financial obligation. Although noting that the outcome of these matters is uncertain, Samsung Corning Precision and Samsung Corning have stated that these matters are not likely to result in a material ultimate loss to their financial statements. Other than as described above, no claim in these matters has been asserted against Corning Incorporated or any of its affiliates.

 

Variable Interest Entities

Corning leases certain transportation equipment from a trust that qualifies as a variable interest entity under FIN 46R, “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51, Revised” (FIN 46R). The sole purpose of this entity is leasing transportation equipment to Corning. Since Corning is the primary beneficiary of this entity, the financial statements of the entity are included in Corning’s consolidated financial statements. The entity’s assets are primarily comprised of fixed assets which are collateral for the entity’s borrowings. These assets, amounting to approximately $28 million as of September 30, 2007 and $29 million as of December 31, 2006, are classified as long-term assets in the consolidated balance sheet.

 

-17-

 

---

Corning leases certain transportation equipment from two additional trusts that qualify as variable interest entities under FIN 46R. The sole purpose of the entities is leasing transportation equipment to Corning. Corning has been involved with these entities as lessee since the inception of the trusts. Lease revenue generated by these trusts was $2 million for both the nine months ended September 30, 2007 and 2006. Corning’s maximum exposure to loss as a result of its involvement with the trusts is estimated at approximately $14 million at September 30, 2007.

 

 

There were no changes in the carrying amount of goodwill for the nine months ended September 30, 2007. Balances by segment are as follows (in millions):

 

 

Other intangible assets follow (in millions):

 

Amortized intangible assets are primarily related to the Telecommunications segment.

 

Estimated amortization expense related to these intangible assets is $10 million for 2007, $11 million in 2008, $11 million in 2009, and insignificant thereafter.

 

 

In 2005 and 2004, several of Corning’s customers entered into long-term purchase and supply agreements in which Corning’s Display Technologies segment will supply large-size glass substrates to these customers over periods of up to six years. As part of the agreements, these customers agreed to advance cash deposits to Corning for a portion of the contracted glass to be purchased. During the three and nine months period ended September 30, 2007, we received an additional $105 million of deposit payments against orders. During the three and nine months ended September 30, 2006, we received a total of $24 million and $171 million, respectively, of deposits against orders.

 

Upon receipt of the cash deposits made by customers, we record a customer deposit liability. This liability is reduced at the time of future product sales over the life of the agreements. As product is shipped to a customer, Corning recognizes revenue at the selling price and issues credit memoranda for an agreed amount of the customer deposit liability. The credit memoranda are applied against customer receivables resulting from the sale of product, thus reducing operating cash flows in later periods as these credits are applied for cash deposits received in earlier periods.

 

-18-

 

---

Customer deposits have been received in the following periods (in millions):

 

We do not expect to receive additional deposits related to these agreements.

 

During the three and nine months ended September 30, 2007, we issued $103 million and $169 million, respectively, in credit memoranda. During the three and nine months ended September 30, 2006, we issued $12 million and $85 million, respectively, in credit memoranda. These credits are not included in the above table.

 

Customer deposit liabilities were $588 million and $633 million at September 30, 2007 and December 31, 2006, respectively, of which $198 million and $213 million, respectively, were recorded in the current portion of other accrued liabilities in our consolidated balance sheets. In 2007, we expect to issue total credits of approximately $222 million.

 

In the event customers elect not to purchase the agreed upon quantities of product, subject to specific conditions outlined in the agreements, Corning may retain certain amounts of the customer deposits. If Corning does not deliver agreed upon product quantities, subject to specific conditions outlined in the agreements, Corning may be required to return certain amounts of customer deposits.

 

 

The following table summarizes the components of net periodic benefit cost for Corning’s defined benefit pension and postretirement health care and life insurance plans (in millions):

 

Corning and certain of its domestic subsidiaries offer postretirement plans that provide health care and life insurance benefits for retirees and eligible dependents. Certain employees may become eligible for such postretirement benefits upon reaching retirement age and service requirements. In response to rising health care costs, we changed our cost-sharing approach for retiree medical coverage. For current retirees (including surviving spouses) and active employees eligible for the salaried retiree medical program, we placed a “cap” on the amount we will contribute toward retiree medical coverage in the future. The cap equals 120% of our 2005 contributions toward retiree medical benefits. Once our contributions toward salaried retiree medical costs reach this cap, impacted retirees will have to pay the excess amount in addition to their regular contributions for coverage. Further, employees hired or rehired on or after January 1, 2007 will be eligible for Corning retiree medical benefits upon retirement; however, these employees will pay 100% of the cost.

 

-19-

 

---

In the first quarter of 2007, we made a voluntary cash contribution of $106 million to our domestic defined benefit pension plan.

 

 

We operate and conduct business in many foreign countries and as a result are exposed to movements in foreign currency exchange rates. Our exposure to exchange rate effects includes:

 

 

Our most significant currency exposures relate to Japanese yen, Korean won, New Taiwanese dollar, and the Euro. We selectively enter into foreign exchange forward and option contracts with durations generally 18 months or less to hedge our exposure to exchange rate risk on foreign source income and purchases. The objective of these contracts is to reduce the impact of exchange rate movements on our operating results.

 

We engage in foreign currency hedging activities to reduce the risk that changes in exchange rates will adversely affect the eventual net cash flows resulting from the sale of products to foreign customers and purchases from foreign suppliers. The hedge contracts reduce the exposure to fluctuations in exchange rates because the gains and losses associated with foreign currency balances and transactions are generally offset with gains and losses of the hedge contracts. Because the impact of movements in foreign exchange rates on the value of hedge contracts offsets the related impact on the underlying items being hedged, these financial instruments help alleviate the risk that might otherwise result from currency exchange rate fluctuations.

 

The following table summarizes the notional amounts and respective fair values of Corning’s derivative financial instruments, which mature at varying dates, at September 30, 2007 and December 31, 2006 (in millions):

 

The forward and option contracts we use in managing our foreign currency exposures contain an element of risk in that the counterparties may be unable to meet the terms of the agreements. However, we minimize this risk by limiting the counterparties to a diverse group of highly-rated major domestic and international financial institutions with which we have other financial relationships. We are exposed to potential losses in the event of non-performance by these counterparties; however, we do not expect to record any losses as a result of counterparty default. Neither we nor the counterparties are required to place collateral for these financial instruments.

 

Corning uses derivative instruments to limit the exposure to foreign currency fluctuations associated with certain monetary assets and liabilities as well as operating results. These derivative instruments are not designated as hedging instruments for accounting purposes and, as such, are referred to as undesignated hedges. Changes in the fair value of undesignated hedges are recorded in current period earnings in the other income, net component, along with the foreign currency gains and losses arising from the underlying monetary assets or liabilities, in the consolidated statement of operations. At September 30, 2007 and December 31, 2006, the notional amount of the undesignated derivatives was $493 million and $836 million, respectively.

 

-20-

 

---

Cash Flow Hedges

Corning has cash flow hedges that are comprised of foreign exchange forward and option contracts. These contracts are designated and qualify as cash flow hedges under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133), and are recorded in the consolidated financial statements at fair value. The effective portion of unrealized gain or loss on these contracts is deferred and reported as a component of accumulated other comprehensive income on the consolidated balance sheet, until such time as the hedged item impacts earnings. At that time, Corning reclassifies net gains and losses from cash flow hedges into the same line item of the consolidated statement of operations as where the effects of the hedged item are recorded, typically sales, cost of sales, or royalty income. At September 30, 2007 and December 31, 2006, the amount of net gains or losses expected to be reclassified into earnings within the next 12 months was a loss of $23 million and a gain of $14 million, respectively.

 

Corning reviews its cash flow hedges on a regular basis to ensure that each hedge relationship continues to be highly effective. In circumstances where a hedge becomes ineffective, any deferred gain or loss is immediately reclassified into current earnings. Corning did not recognize any significant hedge ineffectiveness for the quarter ended September 30, 2007 and the amount of ineffectiveness for the year ended December 31, 2006 was a gain of $1 million.

 

Fair Value Hedges

Corning records net gains and losses from fair value hedges into the same line item of the consolidated statement of operations as where the effects of the hedged item are recorded. There were no outstanding fair value hedges as of September 30, 2007, or December 31, 2006.

 

Net Investment in Foreign Operations

We have issued foreign currency denominated debt that has been designated as a hedge of the net investment in a foreign operation. The effective portion of the changes in fair value of the debt is reflected as a component of other accumulated comprehensive income as part of the foreign currency translation adjustment. Net loss included in the cumulative translation adjustment at September 30, 2007 and December 31, 2006 was $142 million and $139 million, respectively.

 

 

Stock Compensation Plans

 

Share-based compensation cost recognized under SFAS 123(R) was approximately $100 million and $95 million for the nine months ended September 30, 2007 and 2006, respectively, and approximately $29 million and $33 million for the three months ended September 30, 2007 and 2006, respectively. Share-based compensation cost included (1) employee stock options, (2) time-based restricted stock, (3) performance-based restricted stock, and (4) the Worldwide Employee Share Purchase Plan described more fully below. No tax benefits were attributed to the share-based compensation cost because a valuation allowance was maintained for substantially all net deferred tax assets.

 

Stock Options

 

Our stock option plans provide non-qualified and incentive stock options to purchase authorized but unissued or treasury shares at the market price on the grant date and generally become exercisable in installments from one to five years from the grant date. The maximum term of non-qualified and incentive stock options is 10 years from the grant date.

 

-21-

 

---

The following table summarizes information concerning options outstanding including the related transactions under the option plans for the nine months ended September 30, 2007:

 

The aggregate intrinsic value (market value of stock less option exercise price) in the preceding table represents the total pretax intrinsic value, based on the Company’s closing stock price on September 28, 2007, which would have been received by the option holders had all option holders exercised their options as of that date.

 

As of September 30, 2007, there was approximately $48 million of unrecognized compensation cost related to stock options granted under the Plan. The cost is expected to be recognized over a weighted-average period of 1.86 years. Compensation cost related to stock options was approximately $49 million and $54 million for the nine months ended September 30, 2007 and 2006, respectively, and approximately $13 million and $18 million for the three months ended September 30, 2007 and 2006, respectively.

 

Proceeds received from the exercise of stock options were approximately $89 million and $280 million for the nine months ended September 30, 2007 and 2006, respectively, and approximately $20 million and $29 million for the three months ended September 30, 2007 and 2006, respectively. Proceeds received from the exercise of stock options were included in financing activities on the Company’s Consolidated Statements of Cash Flows. The total intrinsic value of options exercised was approximately $183 million and $333 million for the nine months ended September 30, 2007 and 2006, respectively, and $42 million and $55 million for the three months ended September 30, 2007 and 2006, respectively, which is currently deductible for tax purposes. However, these tax benefits were not realized due to net operating loss carryforwards available to the Company. Refer to Note 5 (Income Taxes) to the consolidated financial statements.

 

A lattice-based valuation model is used to estimate the fair values of option and restricted stock grants and incorporates the assumptions (including ranges of assumptions) noted in the table below. Expected volatility is based on the blended short-term volatility (the arithmetic average of the implied volatility and the short-term historical volatility), long-term historical volatility of Corning’s stock, and other factors.

 

Corning also uses historical data to estimate future option exercise and employee termination within the valuation model. Separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The expected time to exercise options granted is derived using a regression model and represents the period of time that options granted are expected to be outstanding. The range given below results from certain groups of employees exhibiting different behavior. The risk-free rates used in the lattice model are derived from the U.S. Treasury yield curve in effect from the grant date to the option’s expiration date. Since period-by-period calculations are employed in the lattice model, Corning uses risk-free rates that apply from one period to the next, generally quarter to quarter. Such rates are typically referred to as “forward” rates. Being essentially marginal rates, forward rates both vary during the contractual term of the option and exhibit greater variation than the yield curve from which they are derived.

 

-22-

 

---

The following inputs for the lattice-based valuation model were used for option grants under our Stock Option Plans:

 

Incentive Stock Plans

 

The Corning Incentive Stock Plan permits stock awards, either determined by specific performance goals or issued directly, in most instances, subject to the possibility of forfeiture and without cash consideration. Shares under the Incentive Stock Plan are generally awarded at-the-money, contingently vest over a period of 1 to 10 years, and have contractual lives of 1 to 10 years.

 

The fair value of each restricted stock award under the Incentive Stock Plan was estimated on the date of award for performance based awards assuming that performance goals will be achieved. The expected term for awards under the Incentive Stock Plans is 1 to 10 years.

 

Time-Based Restricted Stock:

 

Time-based restricted stock is issued by the Company on a discretionary basis, and is payable in shares of the Company’s common stock upon vesting. The fair value is based on the market price of the Company’s stock on the award date. Compensation cost is recognized over the requisite vesting period and adjusted for actual forfeitures before vesting.

 

The following table represents a summary of the status of the Company’s nonvested time-based restricted stock as of December 31, 2006, and changes during the nine months ended September 30, 2007:

 

As of September 30, 2007, there was approximately $7 million of unrecognized compensation cost related to non-vested time-based restricted stock compensation arrangements awarded under the Plan. The cost is expected to be recognized over a weighted-average period of 3.22 years. Compensation cost related to time-based restricted stock was approximately $4 million and $3 million for the nine months ended September 30, 2007 and 2006, respectively, and approximately $2 million for the three months ended September 30, 2007 and 2006, respectively.

 

-23-

 

---

Performance-Based Restricted Stock:

 

Performance-based restricted stock is earned upon the achievement of certain targets, and is payable in shares of the Company’s common stock upon vesting typically over a three-year period. The fair value is based on the market price of the Company’s stock on the award date and assumes that the target payout level will be achieved. Compensation cost is recognized over the requisite vesting period and adjusted for actual forfeitures before vesting. During the performance period, compensation cost may be adjusted based on changes in the expected outcome of the performance-related target.

 

The following table represents a summary of the status of the Company’s nonvested performance-based restricted stock as of December 31, 2006, and changes during the nine months ended September 30, 2007:

 

As of September 30, 2007, there was approximately $60 million of unrecognized compensation cost related to non-vested performance-based restricted stock compensation arrangements under the Plan. The cost is expected to be recognized over a weighted-average period of 1.63 years. Compensation cost related to performance-based restricted stock was approximately $44 million and $33 million for the nine months ended September 30, 2007 and 2006, respectively, and approximately $13 million and $12 million for the three months ended September 30, 2007 and 2006, respectively.

 

Worldwide Employee Stock Purchase Plan

 

In addition to the Stock Option Plan and Incentive Stock Plans, we have a Worldwide Employee Share Purchase Plan (WESPP). Under the WESPP, substantially all employees can elect to have up to 10% of their annual wages withheld to purchase our common stock. The purchase price of the stock was 85% of the lower of the beginning-of-quarter or end-of-quarter closing market price through September 30, 2006. Effective October 1, 2006, the purchase price of the stock is 85% of the end-of-quarter closing market price. Compensation cost related to the WESPP for all periods presented is immaterial.

 

-24-

 

---

 

Components of comprehensive income, on an after-tax basis where applicable, follow (in millions):

 

 

 

Our reportable operating segments include Display Technologies, Telecommunications, Environmental Technologies, and Life Sciences. The Environmental Technologies reportable segment is an aggregation of our Automotive and Diesel operating segments, as these two segments share similar economic characteristics, products, customer types, production processes and distribution methods. The following provides a brief description of the products and markets served by each reportable segment:

 

 

All other operating segments that do not meet the quantitative threshold for separate reporting have been grouped as “All Other.”

 

-25-

 

---

Operating Segments (in millions)