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, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

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:

 

1,554,327,448 shares of Corning’s Common Stock, $0.50 Par Value, were outstanding as of October 15, 2008.

 

INDEX

 

 

 

 

CORNING INCORPORATED AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited; in millions, except per share amounts)

 

 

 

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

 

Certain amounts for 2007 were reclassified to conform with the 2008 presentation.

 

 

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.

 

 

CORNING INCORPORATED AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited; in millions)

 

 

 

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

 

Certain amounts for 2007 were reclassified to conform with the 2008 presentation.

 

 

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, 2007 (2007 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 (Expense) Income, Net

 

“Other (expense) income, net” in Corning’s consolidated statements of income includes the following:

 

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 GAAP, 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 adopted SFAS 157 effective January 1, 2008, for all financial assets and liabilities as required. Refer to Note 14 (Fair Value Measurements) to the consolidated financial statements for additional information about adoption. In November 2007, the FASB provided a one-year deferral for implementation of this standard for certain non-financial assets and liabilities. Corning does not expect the standard to have a material impact on its consolidated results of operations and financial condition when the standard is fully adopted in 2009.

 

 

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 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 has not elected the fair value option for any assets or liabilities under SFAS 159.

 

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations (revised - 2007)” (SFAS 141(R)). SFAS 141(R) is a revision to previously existing guidance on accounting for business combinations. SFAS 141(R) retains the fundamental concept of the purchase method of accounting, and introduces new requirements for the recognition and measurement of assets acquired, liabilities assumed and noncontrolling interests. SFAS 141(R) is effective for fiscal years beginning after December 15, 2008. Corning does not expect adoption of this standard to have a material impact on its consolidated results of operations and financial condition.

 

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (SFAS 160). SFAS 160 requires that noncontrolling interests be reported as stockholders equity, a change that will affect Corning’s financial statement presentation of minority interests in its consolidated subsidiaries. The statement also establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary as long as that ownership change does not result in deconsolidation. SFAS 160 is required to be applied prospectively in 2009, except for the presentation and disclosure requirements which are to be applied retrospectively. The statement is effective for fiscal years beginning after December 15, 2008. Corning is currently evaluating the impact of SFAS 160 and, except for certain reclassifications required upon adoption of this standard, does not expect the adoption of the standard to have a material impact to its consolidated results of operations and financial condition.

 

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities.” This statement is effective for financial statements issued for periods beginning after November 15, 2008, with early application encouraged. This statement amends and expands the disclosure requirements in SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, and other related literature. Corning believes that the updated disclosures will not have a material impact on its consolidated results of operations and financial condition.

 

In April 2008, the FASB issued FASB Staff Position (FSP) FAS 142-3, “Determination of the Useful Life of Intangible Assets.” This statement is effective for financial statements issued for periods beginning after December 15, 2008. This statement conforms certain assumption requirements between SFAS 142, “Goodwill and Intangibles” with SFAS 141(R), “Business Combinations” with respect to estimating the useful life of an intangible asset. In addition, the statement requires certain additional disclosures about intangible assets. Corning believes that the adoption of this FSP will not have a material impact on its consolidated results of operations and financial condition.

 

In June 2008, the FASB issued Emerging Issue Task Force (EITF) Issue No. 03-6-1 “Determining Whether Instruments Granted in Share-Based Transactions are Participating Securities”, effective for financial statements issued for fiscal years beginning after December 15, 2008. Under this EITF, the FASB addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting, thereby impacting the calculation of earnings per share. If it is determined that the share-based payment is a participating security, the two-class method of calculating EPS may be required. Corning believes that the adoption of this EITF will not have a material impact on its consolidated financial statements.

 

In June 2008, the FASB issued EITF Issue No.08-3, “Accounting by Lessees for Nonrefundable Maintenance Deposits”, effective for financial statements issued for fiscal years beginning after December 15, 2008. This EITF applies to a lessee’s accounting for maintenance deposits paid by a lessee under an arrangement accounted for as a lease that are refunded only if the lessee performs specified maintenance activities. Corning believes that the adoption of this EITF will not have a material impact on its consolidated results of operations and financial condition.

 

 

On October 10, 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a Financial Asset in a Market That Is Not Active.” The FSP was effective upon issuance, including periods for which financial statements have not been issued. The FSP clarified the application of SFAS 157 in an inactive market and provided an illustrative example to demonstrate how the fair value of a financial asset is determined when the market for that financial asset is inactive. The adoption of this FSP did not have a material impact on Corning’s consolidated results of operations and financial condition.

 

 

2008 Activities

 

The following table summarizes the restructuring, impairment, and other charges and (credits) as of and for the nine months ended September 30, 2008 (in millions):

 

Cash payments for employee-related costs will be substantially complete by the end of 2008, while payments for exit activities will be substantially complete by the end of 2012.

 

2007 Activities

 

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):

 

 

 

 

Asbestos Settlement

 

Pittsburgh Corning Corporation. Corning and PPG Industries, Inc. (PPG) each own 50% of the capital stock of Pittsburgh Corning Corporation (PCC). Over a period of more than two decades, PCC and several other defendants have been named in numerous lawsuits involving claims alleging personal injury from exposure to asbestos. On April 16, 2000, PCC filed for Chapter 11 reorganization in the U.S. Bankruptcy Court for the Western District of Pennsylvania. At the time PCC filed for bankruptcy protection, there were approximately 12,400 claims pending against Corning in state court lawsuits alleging various theories of liability based on exposure to PCC’s asbestos products and typically requesting monetary damages in excess of one million dollars per claim. Corning has defended those claims on the basis of the separate corporate status of PCC and the absence of any facts supporting claims of direct liability arising from PCC’s asbestos products. Corning is also currently named in approximately 10,300 other cases (approximately 41,500 claims) alleging injuries from asbestos and similar amounts of monetary damages per claim. Those cases have been covered by insurance without material impact to Corning to date. As described below, several of Corning’s insurance carriers have filed a legal proceeding concerning the extent of any insurance coverage for these claims. Asbestos litigation is inherently difficult, and past trends in resolving these claims may not be indicators of future outcomes.

 

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

 

On December 21, 2006, the Bankruptcy Court issued an order denying confirmation of the 2003 Plan for reasons it 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.

 

On January 10, 2008, some of the parties in the proceeding advised the Bankruptcy Court that they had made substantial progress on an amended plan of reorganization (the Amended PCC Plan) that resolved issues raised by the Court in denying the confirmation of the 2003 Plan and that would therefore make it unnecessary for the Bankruptcy Court to decide the motion for reconsideration. On March 27, 2008 and May 22, 2008, the parties further informed the Bankruptcy Court on the progress toward the Amended PCC Plan. The Bankruptcy Court ordered the parties to submit the Amended PCC Plan on July 25, 2008 and on that date the parties informed the Court that they were making progress on the Amended PCC Plan and filed a tentative plan on August 8, 2008. On August 20, 2008 and October 24, 2008, the parties informed the Bankruptcy Court of the status of their discussions on the Amended PCC Plan. Additional documents ancillary to the Amended PCC Plan were also filed with the Court. Other documents and issues continue to be negotiated by the parties.

 

As a result of progress in the parties’ continuing negotiations, Corning believes the Amended PCC Plan now represents the most probable outcome of this matter and expects that such a proposed Amended PCC Plan will be filed with the Court. At the same time, Corning believes the probability that the 2003 Plan will become effective has diminished and that plan no longer serves as the basis for the Company’s best estimate of liability. Key provisions of an Amended PCC Plan that have been discussed appear to be acceptable to the parties and address the concerns expressed by the Bankruptcy Court. Accordingly, in the first quarter of 2008, Corning adjusted its Asbestos Settlement Liability to reflect components of the Amended PCC Plan. The proposed settlement under the Amended PCC Plan requires Corning to contribute its equity interest in PCC and PCE and to contribute a fixed series of cash payments, recorded at present value on September 30, 2008. Corning will have the option to use its shares rather than cash to settle the liability, but the liability is fixed by dollar value and not the number of shares.

 

 

The Amended PCC Plan does not include non-PCC asbestos claims that may be or have been raised against Corning. Corning has recorded an additional amount for such claims in its estimated asbestos settlement liability. The liability for non-PCC claims was estimated based upon industry data for asbestos claims since Corning does not have recent claim history due to the injunction issued by the PCC Bankruptcy Court. The estimated liability represents the undiscounted projection of claims and related legal fees over the next 20 years. The amount may need to be adjusted in future periods as more Company-specific data becomes available.

 

The liability for the Amended PCC Plan and the non-PCC asbestos claims was estimated to be $690 million at September 30, 2008, compared with an estimate of liability under the original 2003 Plan of $1,002 million at December 31, 2007. In the first quarter of 2008, Corning recorded a credit to asbestos settlement expense of $327 million as a result of the increase in likelihood of a settlement under the Amended PCC Plan and a corresponding decrease in the likelihood of a settlement under the 2003 Plan. In the second and third quarters of 2008, Corning recorded charges of $9 million and $6 million, respectively, to reflect the change in value of the estimated liability under an Amended PCC Plan. That entire settlement obligation is classified as a non-current liability as installment payments for the cash portion of the obligation are not planned to commence until more than 12 months after the Amended PCC Plan is ultimately confirmed and the PCE portion of the obligation will be fulfilled through the direct contribution of Corning’s investment in PCE (currently recorded as a non-current other equity method investment).

 

In the three and nine months ended September 30, 2007, Corning recorded asbestos settlement expense under the terms of the 2003 Plan of $16 million and $170 million, respectively, to adjust the estimated fair value of the components of the proposed asbestos settlement at that time. Of the $1,002 million estimated liability at December 31, 2007 based on the 2003 Plan, $833 million was included in other accrued liabilities as a current liability, and $169 million was recorded within the other liabilities component in our consolidated balance sheets.

 

The Amended PCC Plan is subject to a number of contingencies. The parties have yet to reach final agreement on a number of terms and conditions that must be negotiated before the Amended PCC Plan and its related documents are acceptable to the parties. The amounts required to fund the Amended PCC Plan from insurance and other sources may not be available. There may be objections from opposing parties once the Amended PCC Plan is filed. The approval of the Amended PCC Plan by the Bankruptcy Court is not certain. For these and other reasons, Corning’s liability for these asbestos matters may be subject to changes in subsequent quarters. The estimate of the cost of resolving the non-PCC asbestos claims may also be subject to change as developments occur. Management continues to believe that the likelihood of the uncertainties surrounding these proceedings causing 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 potential settlement arrangement described above. Corning is vigorously contesting these cases. Management is unable to predict the outcome of this insurance litigation.

 

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 adjustments 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 7 (Investments) to the consolidated financial statements in our 2007 Form 10-K for a discussion of contingent liabilities associated with Dow Corning.

 

 

As of September 30, 2008, contingent guarantees totaled a notional value of $291 million, compared with $325 million at December 31, 2007. We believe a significant majority of these contingent guarantees will expire without being funded. We also were contingently liable for purchase obligations of $293 million and $81 million, at September 30, 2008 and December 31, 2007, respectively.

 

Product warranty liability accruals at September 30, 2008 and December 31, 2007 were $26 million and $19 million, respectively.

 

Corning is a defendant in various lawsuits, including environmental, product-related suits, the Dow Corning and PCC matters, discussed in Note 7 (Investments) to the consolidated financial statements in our 2007 Form 10-K and in Part II – Item 1, Legal Proceedings, 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 18 active hazardous waste sites. Under the Superfund Act, all parties who may have contributed any waste to a hazardous waste site, identified by such 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, 2008, and December 31, 2007, Corning had accrued approximately $21 million 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.

 

 

There were no significant debt transactions in the first, second and third quarters of 2008.

 

In the first quarter of 2007, we paid $238 million to redeem $223 million principal amount of our 6.25% Euro notes due 2010. We recognized a loss of $15 million upon the early redemption of these notes.

 

 

Our provision for income taxes and the related effective income tax rates were as follows (in millions):

 

For the three months ended September 30, 2008, the effective income tax rate differed from the U.S. statutory rate of 35% primarily due to the following items:

 

 

In addition to the items noted above, the tax provision for the nine months ended September 30, 2008 reflected the impact of the release of $2.4 billion of valuation allowances attributable to a change in judgment about the realizability of certain deferred tax assets and other discrete items for which no tax expense was recorded including an asbestos settlement credit of $312 million and litigation–related items totaling $12 million. For the nine months ended September 30, 2008, discrete items and the valuation allowance releases decreased our effective tax rate by 164.7 percentage points. Refer to Note 3 (Commitments and Contingencies) for additional information about asbestos settlement litigation.

 

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

 

In addition to the items noted above, the tax provision for the nine months ended September 30, 2007 reflected the release of a $17 million reserve related to a favorable tax ruling from the Taiwanese government. The tax provision also included discrete items for which no tax benefit was recorded including asbestos settlement expense of $186 million, a loss on the repurchase of debt of $15 million, and a gain on the sale of our European submarine cabling business. For the nine months ended September 30, 2007, discrete items increased our effective tax rate by 2.2 percentage points.

 

As more fully described in Note 6 (Income Taxes) to the consolidated financial statements in our 2007 Form 10-K, all of our U.S. deferred tax assets had full valuation allowances at December 31, 2007. In the second quarter of 2008, we concluded that it was more likely than not that we will realize substantially all of our U.S. deferred tax assets because we expect to generate sufficient levels of income in the U.S. As a result, we released $2.4 billion of valuation allowances on our U.S. deferred tax assets in the second quarter of 2008.

 

In accordance with SFAS 109, “Accounting for Income Taxes” (SFAS 109), we considered all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance was needed. The evaluation of the realizability of deferred tax assets is inherently subjective. Following are the key items that provided positive evidence to support the release of the valuation allowance for a large portion of our deferred tax assets in the second quarter of 2008:

 

 

 

 

 

In accordance with SFAS 109, for the remainder of 2008 we must continue to adjust the remaining valuation allowance to offset U.S. income tax expense (or benefit) that would otherwise be recorded on income (or losses) in the U.S. and therefore, reflect no net U.S. income tax expense in the third and fourth quarters of 2008. As our income for the third quarter and our forecasted fourth quarter income are lower than our forecast for these periods at June 30, 2008, we released an additional $70 million of valuation allowances in the third quarter. A further adjustment will be required if fourth quarter results differ from our expectations.

 

 

Certain shorter-lived deferred tax assets such as those represented by capital loss carry forwards and state tax net operating loss carry forwards, as well as other federal and state tax credits, will remain with a valuation allowance recorded against them as of September 30, 2008, as it is not more likely than not that we will earn income of the character required to utilize these assets before they expire. The amount of deferred tax assets that have remaining valuation allowances at September 30, 2008 was $252 million.

 

The net deferred tax assets are included in our balance sheet as follows (in millions):

 

For the three months ended September 30, 2008 and 2007, we recorded tax expense on income generated in the U.S. of $8 million and $42 million, respectively, which was fully offset by releases of valuation allowance. For the nine months ended September 30, 2008 and 2007, we recorded tax expense on income generated in the U.S. of $218 million and $30 million, respectively, which was fully offset by releases of valuation allowance. All amounts include the impact of discrete items described above.

 

Certain foreign subsidiaries in China and Taiwan are operating under tax holiday arrangements. The nature and extent of such arrangements vary, and the benefits of such arrangements phase out in years (2008 through 2013) 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 12 and 10 percentage points for the three months ended September 30, 2008 and 2007, respectively, and a reduction in the rate of 8 and 13 percentage points for the nine months ended September 30, 2008 and 2007, respectively.

 

 

 

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 due to their anti-dilutive effect or, in the case of stock options, because their exercise price was greater than the average market price for the periods presented (in millions):

 

 

 

 

The following is a summary of the fair value of short-term and long-term investments, which are comprised of available-for-sale securities (in millions):

 

 

Gross realized gains and losses in the third quarter of 2008 were $2 million and $41 million, respectively. Gross realized gains and losses in the nine months ended September 30, 2008, were $5 million and $46 million, respectively. Realized losses in the third quarter of 2008 included an other-than-temporary impairment of $26 million for securities of Lehman Brothers Holdings Inc., which filed for bankruptcy protection in mid-September. The remaining losses in the third quarter of 2008 resulted primarily from the sale of asset-backed debt securities and debt securities of financial institutions as Corning reduced its exposure to these sectors. Gross realized gains and losses for the three and nine months ended September 30, 2007, were not material.

 

Gross unrealized losses of $48 million at September 30, 2008 were included in accumulated other comprehensive income. Unrealized losses included temporary impairments of asset-backed securities with a fair value of $61 million at September 30, 2008. We believe the $95 million cost-basis of these asset-backed securities, which are collateralized by mortgages, is recoverable in the long-term. Because we have the ability and intent to hold these securities for a period of time sufficient to allow for a either a recovery in market value or the collection of cash flow from the underlying mortgages, we have reclassified the majority of these securities, totaling $55 million, from current assets to long-term assets. As of September 30, 2008, we believe these assets are recoverable, although it is possible that a significant degradation in the delinquency or foreclosure rates in the underlying mortgages could cause further temporary or other-than-temporary impairments in the future. Gross unrealized gains at September 30, 2008 were negligible. Gross unrealized gains and losses at December 31, 2007 were $4 million and $14 million, respectively.

 

 

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, 2008, balances due to and due from affiliates were $7 million and $46 million, respectively. As of December 31, 2007, balances due to and due from affiliates were $7 million and $35 million, respectively.

 

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

 

 

Summarized results of operations for our two 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 primarily 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.

 

As of September 30, 2008, balances due to and due from Samsung Corning Precision were $5 million and $43 million, respectively. As of December 31, 2007, balances due to and from Samsung Corning Precision were $6 million and $31 million, respectively.

 

On December 31, 2007, Samsung Corning Precision acquired all of the outstanding shares of Samsung Corning Co., Ltd. (Samsung Corning). After the transaction, Corning retained its 50% interest in Samsung Corning Precision. Samsung Corning Precision accounted for the transaction at fair value while Corning accounted for the transaction at historical cost.

 

As of September 30, 2008, Samsung Corning Precision was one of approximately thirty co-defendants in a lawsuit filed by Seoul Guarantee Insurance Co. and 13 other creditors. Refer to Part II – Item 1, Legal Proceedings.

 

 

Samsung Corning Co., Ltd. (Samsung Corning)

Samsung Corning was a South Korea-based manufacturer of glass panels and funnels for cathode ray tube (CRT) television and display monitors. Until December 31, 2007, Corning had a 50% interest in Samsung Corning. Samsung Electronics Company, Ltd. and affiliates owned the remaining 50% interest in Samsung Corning. On December 31, 2007, Samsung Corning Precision acquired all of the outstanding shares of Samsung Corning. After the transaction, Corning retained its 50% interest in Samsung Corning Precision.

 

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

 

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):

 

Balances due to Dow Corning were $2 million and $1 million as of September 30, 2008 and December 31, 2007, respectively.

 

At September 30, 2008, Dow Corning’s marketable securities included approximately $1.2 billion of auction rate securities, net of a temporary impairment of $101 million. As a result of the temporary impairment, unrealized losses of $77 million, net of $24 million for a minority interests’ share, were included in accumulated other comprehensive income in Dow Corning’s consolidated balance sheet. Corning’s share of this unrealized loss was $39 million and is included in Corning’s accumulated other comprehensive income.

 

 

In the third quarter of 2008, Dow Corning recorded an other-than-temporary impairment of $35 million, net of $13 million for a minority interests’ share which was included in Dow Corning’s net income for certain securities of Fannie Mae and Freddie Mac. Corning’s share of this loss was $18 million and is included in equity earnings in Corning’s consolidated statements of income. The majority of Dow Corning’s securities are collateralized by portfolios of student loans which are guaranteed by the U.S. government. Auctions for these securities have failed since the first quarter, reducing the immediate liquidity of these investments. Since Dow Corning does not know when a market will return or develop for these securities, Dow Corning has classified these securities as non-current at September 30, 2008. Market conditions could result in additional unrealized or realized losses for Dow Corning. Corning’s equity earnings from Dow Corning would be reduced by our 50% share of any future impairment that is considered to be other-than-temporary.

 

Dow Corning has borrowed the full amount under its $500 million revolving credit facility and believes it has adequate liquidity to fund operations, its capital expenditure plan, breast implant settlement liabilities, and shareholder dividends.

 

Corning and The Dow Chemical Company (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, 2008, Dow Corning had recorded a reserve for breast implant litigation of $1.6 billion and anticipates insurance receivables of $78 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 filed a petition for rehearing by the Court of Appeals, which was denied. It filed a petition of writ of certiorari with the U.S. Supreme Court, which has also been denied. As of September 30, 2008, Dow Corning has estimated the interest payable to commercial creditors to be within the range of $72 million to $246 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 $72 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 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 addition, the London Market Insurers (the “LMI Claimants”), have claimed a reimbursement right with respect to a portion of insurance proceeds previously paid by the LMI Claimants to Dow Corning. This claim is based on a theory that the LMI Claimants overestimated Dow Corning’s liability for the resolution of implant claims pursuant to the Plan. During the third quarter of 2008, the LMI Claimants offered two calculations of their claim amount; $54 million and $93 million, plus minimum interest of $67 million and $116 million, respectively. These estimates were explicitly characterized as preliminary and subject to change. Litigation regarding this claim is in the discovery stage. Dow Corning disputes the claim and is unable to reasonably estimate any potential liability.

 

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.

 

 

Variable Interest Entities

Corning leases certain transportation equipment from a trust that qualifies as a variable interest entity under FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51” (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 $27 million as of September 30, 2008 and $28 million as of December 31, 2007, are classified as long-term assets in the consolidated balance sheet.

 

Corning leases certain transportation equipment from two additional trusts that qualify as variable interest entities under FIN 46R which are not consolidated. 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 the nine months ended September 30, 2008 and 2007. Corning’s maximum exposure to loss as a result of its involvement with these two trusts is estimated at approximately $13 million at September 30, 2008 and $14 million at December 31, 2007.

 

 

There were no changes in the carrying amount of goodwill for the nine months ended September 30, 2008. 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 annually for 2008, $10 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. We received our last deposit of $105 million in July 2007 and do not expect to receive additional deposits related to these agreements.

 

Customer deposits received under these agreements were as follows (in millions):

 

 

 

Upon receipt of the cash deposits made by customers, we recorded 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.

 

During the three and nine months ended September 30, 2008, we issued $64 million and $202 million, respectively, in credit memoranda. During the three and nine months ended September 30, 2007, we issued $103 million and $169 million, respectively, in credit memoranda.

 

Customer deposit liabilities were $371 million and $531 million at September 30, 2008 and December 31, 2007, respectively, of which $240 million and $222 million, respectively, were recorded in the current portion of other accrued liabilities in our consolidated balance sheets. Because these liabilities are denominated in Japanese yen, changes in the balances include the impact of movements in the Japanese yen–U.S. dollar exchange rate.

 

In the event customers do not 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 upon retirement; however, these employees will pay 100% of the cost.

 

In the first quarter of 2008, we made a voluntary cash contribution of $50 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 foreign currency exposures relate to the Japanese yen, Korean won, New Taiwan 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 hedges are scheduled to mature coincident with the timing of the underlying foreign currency commitments and transactions. The objective of these contracts is to neutralize 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 rate movements 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.

 

Corning is also exposed to movements in interest rates on its cash, cash equivalents, and debt obligations. Corning uses interest rate derivatives, where appropriate, to manage this exposure.

 

The following table summarizes the notional amounts and respective fair values of Corning’s derivative financial instruments, which mature at varying dates (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 our counterparties are required to post collateral for these financial instruments.

 

Corning excludes the impact of credit risk from the assessment of hedge effectiveness. The amount of ineffectiveness, related to derivatives, for the three and nine months ended September 30, 2008 was $2 million.

 

Corning uses derivative instruments (forwards and options) to limit exposures to fluctuations related to certain monetary assets, monetary liabilities, and net earnings in foreign currencies. These derivative instruments are not designated as hedging instruments for accounting purposes and, as such, are referred to as undesignated derivatives. Changes in the fair value of undesignated derivatives are recorded in current period earnings in the other income, net component in the consolidated statements of income. The notional amount of the undesignated derivatives at September 30, 2008 and December 31, 2007 was $866 million and $717 million, respectively.

 

 

Cash Flow Hedges

Corning typically has cash flow hedges that are comprised of foreign exchange forward and option contracts. The critical terms of each cash flow hedge are identical to the critical terms of the hedged item. Therefore, Corning utilizes the critical terms test under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133), and the presumption is that there is no hedge ineffectiveness as long as the critical terms of the hedge and the hedged item do not change.

 

Corning defers net gains and losses from cash flow hedges into 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 statements of income as where the effects of the hedged item are recorded, typically sales, cost of sales, or royalty income. At September 30, 2008, the amount of net losses expected to be reclassified into earnings within the next 12 months is $23 million.

 

Fair Value Hedges

In October 2007, we entered into four interest rate swaps that are designated as fair value hedges and economically exchange a notional amount of $500 million of previously issued fixed rate long-term debt to floating rate debt. Under the terms of the swap agreements, we pay the counterparty a floating rate that is indexed to the three-month LIBOR rate.

 

No net gains or losses were recorded in the consolidated statements of income related to the Company’s underlying debt and interest rate swap agreements. At September 30, 2008 and December 31, 2007, the fair value of the interest rate swap agreements recorded in the other assets line item and offset in the long-term debt line item of the consolidated balance sheet, was $24 million and $13 million, respectively.

 

Each fair value hedge (swap) was entered into subsequent to the initial recognition of the hedged item; therefore these swaps do not meet the criteria to qualify for the shortcut method. Therefore, Corning utilizes the long haul method for effectiveness analysis, both retrospectively and prospectively. The analysis excludes the impact of credit risk from the assessment of hedge ineffectiveness.

 

Corning records net gains and losses from fair value hedges into the same line item of the consolidated statements of income as where the effects of the hedged item are recorded.

 

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 (loss) as part of the foreign currency translation adjustment. Net losses related to this investment included in the cumulative translation adjustment at September 30, 2008 and December 31, 2007, were $141 million and $143 million, respectively.

 

 

The Company adopted SFAS 157 effective January 1, 2008 for all financial assets and liabilities as required. The adoption of SFAS 157 was not material to Corning’s financial statements or results of operations. 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 identifies two kinds of inputs that are used to determine the fair value of assets and liabilities: observable and unobservable. Observable inputs are based on market data or independent sources while unobservable inputs are based on the company’s own market assumptions. Once inputs have been characterized, SFAS 157 requires companies to prioritize the inputs used to measure fair value into one of three broad levels (provided in the table below).

 

 

SFAS 157 applies whenever an entity is measuring fair value under other accounting pronouncements that require or permit fair value measurement and requires the use of observable market data when available. As of September 30, 2008, the Company did not have any financial assets or liabilities that were measured using unobservable (or Level 3) inputs. However, since the end of the second quarter of 2008, there has been a shift in the type of observable inputs used to determine the fair value of the majority of the Company’s short-term investments and other assets from Level 1 to Level 2. This shift resulted from the change in the markets for these items which were previously considered active to markets which have fewer transactions.

 

The following table provides fair value measurement information for the Company’s major categories of financial assets and liabilities measured on a recurring basis:

 

 

Certain non-financial assets and liabilities are measured at fair value on a non-recurring basis and are not currently required to be presented on an interim basis. The FASB deferred implementation of SFAS 157 for these items until 2009.

 

 

Stock Compensation Plans

 

Effective January 1, 2006, the Company adopted SFAS 123(R). SFAS 123(R) requires the measurement and recognition of compensation cost for all share-based payment awards made to employees and directors, including grants of employee stock options and employee stock purchases related to the Worldwide Employee Share Purchase Plan (WESPP), based on estimated fair values. The Company elected to use the modified prospective transition method upon adoption of SFAS 123(R).

 

Share-based compensation cost recognized under SFAS 123(R) was approximately $104 million and $100 million for the nine months ended September 30, 2008 and 2007, respectively, and approximately $26 million and $29 million for the three months ended September 30, 2008 and 2007, respectively, and included (1) employee stock options, (2) time-based restricted stock, (3) performance-based restricted stock, and (4) the WESPP.

 

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.

 

 

The following table summarizes information concerning options outstanding including the related transactions under the option plans for the nine months ended September 30, 2008:

 

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 30, 2008, which would have been received by the option holders had all option holders exercised their options as of that date.

 

As of September 30, 2008, there was approximately $52 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 2.1 years. Compensation cost related to stock options was approximately $53 million and $49 million for the nine months ended September 30, 2008 and 2007, respectively, and approximately $14 million and $13 million for the three months ended September 30, 2008 and 2007, respectively.

 

Proceeds received from the exercise of stock options were $79 million and $89 million for the nine months ended September 30, 2008 and 2007, respectively, and $5 million and $20 million for the three months ended September 30, 2008 and 2007, 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 for the nine months ended September 30, 2008 and 2007 was approximately $124 million and $183 million, respectively, and $4 million and $42 million for the three months ended September 30, 2008 and 2007, 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), and the long-term historical volatility of Corning’s stock.

 

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 of 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.

 

 

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 grants, 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 granted “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 grant under the Incentive Stock Plans was estimated on the date of grant for performance based grants assuming that performance goals will be achieved. The expected term for grants 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 grant 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, 2007, and changes during the nine months ended September 30, 2008:

 

As of September 30, 2008, there was approximately $28 million of unrecognized compensation cost related to non-vested time-based restricted stock compensation arrangements granted under the Plan. The cost is expected to be recognized over a weighted-average period of 3.8 years. Compensation cost related to time-based restricted stock was approximately $8 million and $4 million for the nine months ended September 30, 2008 and 2007, respectively, and $3 million and $2 million for the three months ended September 30, 2008 and 2007, respectively.

 

 

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 grant 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 units as of December 31, 2007, and changes during the nine months ended September 30, 2008:

 

As of September 30, 2008, there was approximately $45 million of unrecognized compensation cost related to non-vested performance-based restricted stock compensation arrangements granted under the Plan. The cost is expected to be recognized over a weighted-average period of 1.7 years. Compensation cost related to performance-based restricted stock was approximately $40 million and $44 million for the nine months ended September 30, 2008 and 2007, respectively, and approximately $8 million and $13 million for the three months ended September 30, 2008 and 2007, 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 is 85% of the end-of-quarter closing market price. Compensation cost related to the WESPP for all periods presented is immaterial.

 

 

 

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

 

 

 

For the three months ended September 30, 2008, Corning’s sales to AU Optronics Corporation (AUO) and Chi Mei Optoelectronics Corporation (Chi Mei), two customers of our Display Technologies segment, represented 11% and 10%, respectively, of the Company’s consolidated net sales. For the three months ended September 30, 2007, Corning’s sales to AUO represented 12% of the Company’s consolidated net sales.

 

For the nine months ended September 30, 2008, Corning’s sales to AUO and Chi Mei, represented 12% and 11%, respectively, of the Company’s consolidated net sales. For the nine months ended September 30, 2007, Corning’s sales to AUO represented 11% of the Company’s consolidated net sales.

 

 

Effective January 1, 2008, Corning changed its internal reporting structure to better reflect the company’s focus on new business development and later-stage research projects and to provide more transparency on our Specialty Materials operating segment. As a result, our segment reporting includes the following changes which are in accordance with SFAS 131, “Disclosures about Segments of an Enterprise and Related Information:”

 

 

 

Our reportable operating segments are now as follows:

 

 

All other operating segments that do not meet the quantitative threshold for separate reporting have been grouped as “All Other.” This group is now primarily comprised of development projects and results for new product lines.

 

 

Operating Segments (in millions)