q12014form10q.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 
For the quarterly period ended March 31, 2014

 
OR

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from
 
to
   

 
Commission file number:  1-3247

 
CORNING INCORPORATED
 
 (Exact name of registrant as specified in its charter)

New York
 
16-0393470
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)

One Riverfront Plaza, Corning, New York
 
14831
(Address of principal executive offices)
 
(Zip Code)

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

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.
 
Yes
x
 
No
¨
 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
Yes
x
 
No
¨
 

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.
 
Large accelerated filer
x
 
Accelerated filer
¨
 
 
Non-accelerated filer
¨
 
Smaller reporting company
¨
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes
¨
 
No
x
 

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

Class
 
Outstanding as of April 15, 2014
Corning’s Common Stock, $0.50 par value per share
 
1,308,476,050 shares


 
 

 


INDEX

PART I – FINANCIAL INFORMATION
   
Page
Item 1. Financial Statements
   
     
Consolidated Statements of Income (Unaudited) for the three months ended March 31, 2014 and 2013
 
3
     
Consolidated Statements of Comprehensive Income (Unaudited) for the three months ended March 31, 2014 and 2013
 
4
     
Consolidated Balance Sheets (Unaudited) at March 31, 2014 and December 31, 2013
 
5
     
Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 2014 and 2013
 
6
     
Notes to Consolidated Financial Statements (Unaudited)
 
7
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
30
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
55
     
Item 4. Controls and Procedures
 
55
     
PART II – OTHER INFORMATION
   
     
Item 1. Legal Proceedings
 
56
     
Item 1A.  Risk Factors
 
56
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
57
     
Item 6. Exhibits
 
58
     
Signatures
 
59


 
-2-

 

CORNING INCORPORATED AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited; in millions, except per share amounts)


 
Three months
ended March 31,
 
2014
 
2013
           
Net sales
$
2,289 
 
$
1,814 
Cost of sales
 
1,354 
   
1,044 
           
Gross margin
 
935 
   
770 
           
Operating expenses:
         
Selling, general and administrative expenses
 
395 
   
259 
Research, development and engineering expenses
 
198 
   
178 
Amortization of purchased intangibles
 
   
Restructuring, impairment and other charges (Note 2)
 
17 
     
Asbestos litigation charge
 
   
           
Operating income
 
315 
   
324 
           
Equity in earnings of affiliated companies
 
86 
   
173 
Interest income
 
12 
   
Interest expense
 
(30)
   
(36)
Transaction-related gain, net (Note 10)
 
74 
     
Other income, net (Note 1)
 
24 
   
65 
           
Income before income taxes
 
481 
   
528 
Provision for income taxes (Note 5)
 
(180)
   
(34)
           
Net income attributable to Corning Incorporated
$
301 
 
$
494 
           
Earnings per common share attributable to Corning Incorporated:
         
Basic (Note 6)
$
0.21 
 
$
0.33 
Diluted (Note 6)
$
0.20 
 
$
0.33 
           
Dividends declared per common share
$
0.10 
 
$
0.09 

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





 
-3-

 

CORNING INCORPORATED AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited; in millions)


 
Three months ended
March 31,
 
 
2014
 
2013
           
Net income attributable to Corning Incorporated
$
301 
 
$
494 
           
Other comprehensive income (loss), net of tax:
         
Foreign currency translation adjustments
 
(132)
   
(505)
Net unrealized gains on investments
 
13 
   
Unamortized gains (losses) and prior service costs for postretirement benefit plans
 
   
(1)
Net unrealized (losses) gains on designated hedges
 
(4)
   
11 
   
(114)
   
(488)
Comprehensive income attributable to Corning Incorporated
$
187 
 
$

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



 
-4-

 

CORNING INCORPORATED AND SUBSIDIARY COMPANIES
CONSOLIDATED BALANCE SHEETS
(Unaudited; in millions, except share and per share amounts)

 
March 31,
2014
 
December 31,
2013
Assets
         
           
Current assets:
         
Cash and cash equivalents
$
4,968 
 
$
4,704 
Short-term investments, at fair value (Note 7)
 
644 
   
531 
Total cash, cash equivalents and short-term investments
 
5,612 
   
5,235 
Trade accounts receivable, net of doubtful accounts and allowances - $32 and $28
 
1,588 
   
1,253 
Inventories (Note 8)
 
1,395 
   
1,270 
Deferred income taxes (Note 5)
 
321 
   
278 
Other current assets
 
697 
   
855 
Total current assets
 
9,613 
   
8,891 
           
Investments (Note 9)
 
1,976 
   
5,537 
Property, net of accumulated depreciation - $8,141 and $7,865 (Note 11)
 
13,344 
   
9,801 
Goodwill and other intangible assets, net (Note 12)
 
1,665 
   
1,542 
Deferred income taxes (Note 5)
 
2,180 
   
2,234 
Other assets
 
766 
   
473 
           
Total Assets
$
29,544 
 
$
28,478 
           
Liabilities and Equity
         
           
Current liabilities:
         
Current portion of long-term debt (Note 4)
$
468 
 
$
21 
Accounts payable
 
732 
   
771 
Other accrued liabilities (Note 3)
 
846 
   
954 
Total current liabilities
 
2,046 
   
1,746 
           
Long-term debt (Note 4)
 
3,224 
   
3,272 
Postretirement benefits other than pensions
 
766 
   
766 
Other liabilities (Note 3)
 
1,789 
   
1,483 
Total liabilities
 
7,825 
   
7,267 
           
Commitments and contingencies (Note 3)
         
Shareholders’ equity (Note 16):
         
Convertible preferred stock, Series A – Par value $100 per share; Shares authorized 3,100; Shares issued: 2,300
 
2,300 
     
Common stock – Par value $0.50 per share; Shares authorized 3.8 billion; Shares issued: 1,667 million and 1,661 million
 
833 
   
831 
Additional paid-in capital – common stock
 
13,072 
   
13,066 
Retained earnings
 
11,465 
   
11,320 
Treasury stock, at cost; Shares held: 361 million and 262 million
 
(5,950)
   
(4,099)
Accumulated other comprehensive (loss) income
 
(70)
   
44 
Total Corning Incorporated shareholders’ equity
 
21,650 
   
21,162 
Noncontrolling interests
 
69 
   
49 
Total equity
 
21,719 
   
21,211 
           
Total Liabilities and Equity
$
29,544 
 
$
28,478 

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

 
-5-

 

CORNING INCORPORATED AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; in millions)
 
 

 
Three months ended
March 31,
 
2014
 
2013
Cash Flows from Operating Activities:
         
Net income
$
301 
 
$
494 
Adjustments to reconcile net income to net cash provided by operating activities:
         
Depreciation
 
289 
   
248 
Amortization of purchased intangibles
 
   
Restructuring, impairment and other charges
 
17 
     
Stock compensation charges
 
15 
   
11 
Equity in earnings of affiliated companies
 
(86)
   
(173)
Dividends received from affiliated companies
 
1,610 
   
161 
Deferred tax expense (benefit) provision
 
22 
   
(30)
Restructuring payments
 
(11)
   
(16)
Employee benefit payments (in excess of) less than expense
 
(17)
   
15 
Gains on translated earnings contracts
 
(2)
   
(24)
Changes in certain working capital items:
         
Trade accounts receivable
 
21 
   
17 
Inventories
 
(3)
   
(138)
Other current assets
 
28 
   
(2)
Accounts payable and other current liabilities
 
(413)
   
(112)
Other, net
 
(42)
   
165 
Net cash provided by operating activities
 
1,737 
   
623 
           
Cash Flows from Investing Activities:
         
Capital expenditures
 
(246)
   
(194)
Acquisitions of business, net of cash received
 
66 
     
Investment in unconsolidated entities
 
(109)
     
Short-term investments – acquisitions
 
(445)
   
(291)
Short-term investments – liquidations
 
338 
   
469 
Premium on purchased collars
       
(107)
Realized gains on translated earnings contracts
 
89 
     
Other, net
 
   
Net cash used in investing activities
 
(301)
   
(122)
           
Cash Flows from Financing Activities:
         
Retirement of long-term debt
       
(498)
Net repayments of short-term borrowings and current portion of long-term debt
 
(8)
   
(9)
Principal payments under capital lease obligations
       
(1)
Proceeds from issuance of commercial paper
 
418 
     
Proceeds from issuance of preferred stock
 
400 
     
Proceeds from the exercise of stock options
 
50 
   
12 
Repurchases of common stock for treasury
 
(1,901)
     
Dividends paid
 
(136)
   
(133)
Net cash used in by financing activities
 
(1,177)
   
(629)
Effect of exchange rates on cash
 
   
(63)
Net increase (decrease) in cash and cash equivalents
 
264 
   
(191)
Cash and cash equivalents at beginning of period
 
4,704 
   
4,988 
           
Cash and cash equivalents at end of period
$
4,968 
 
$
4,797 
 
In the first quarter of 2014, Corning issued 1,900 shares of Preferred Stock to Samsung Display Co., Ltd. in connection with the acquisition of their equity interests in Samsung Corning Precision Materials Co., Ltd. (Note 10).

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

 
-6-

 

CORNING INCORPORATED AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


1.      Significant Accounting Policies

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 U.S. GAAP for interim financial information.  Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. 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, 2013 (“2013 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.

Samsung Corning Precision Materials Co., Ltd. (“Samsung Corning Precision Materials”)

As further discussed in Note 10 (Acquisition), on January 15, 2014, Corning completed a series of strategic and financial agreements to acquire the common shares of Samsung Corning Precision Materials (“Acquisition”) previously held by Samsung Display Co., Ltd. (“Samsung Display”). As a result of these transactions, Corning is now the owner of 100% of the common shares of Samsung Corning Precision Materials, which we have consolidated into our results beginning in the first quarter of 2014.  Operating under the name of Corning Precision Materials Co., Ltd., (“Corning Precision Materials”), the former Samsung Corning Precision Materials organization and operations was integrated into the Display Technologies segment in the first quarter of 2014.

Other Income, Net

“Other income, net” in Corning’s consolidated statements of income includes the following (in millions):
 
Three months ended
March 31,
 
2014
 
2013
Royalty income from Samsung Corning Precision Materials
     
$
15
Foreign currency exchange and hedge (loss) gain, net
$
(6)
   
31
Net loss attributable to noncontrolling interests
 
   
1
Other, net
 
27 
   
18
Total
$
24 
 
$
65

Beginning in the first quarter of 2014, due to the Acquisition and subsequent consolidation of Samsung Corning Precision Materials (now Corning Precision Materials), royalty income from Corning Precision Materials is no longer recognized in Corning’s consolidated statement of income.

Included in the line item Foreign currency exchange and hedge (loss) gain, net for the three months ended March 31, 2014 and 2013 is the impact of the purchased collars and average forward contracts, which hedge our exposure to movements in the Japanese yen and its impact on our net earnings, in the amount of $2 million and $24 million, respectively.

 
-7-

 


New Accounting Standards

At March 31, 2014, there are no recently issued accounting standards that will have a material impact on Corning when adopted in a future period.

2.      Restructuring, Impairment and Other Charges

2014 Activity

In the first quarter of 2014, we recorded charges of $17 million, pre-tax, for employee related costs and assets impairment charges associated with some minor restructuring activities in the Optical Communications and Specialty Materials segments, with total cash expenditures estimated to be $3 million. Annualized savings from these actions are anticipated to be approximately $5 million and will be reflected primarily in gross margin and operating expenses.

To better align our 2014 cost position in several of our businesses, Corning implemented a global restructuring plan within several of our segments in the fourth quarter of 2013, consisting of workforce reductions, asset disposals and write-offs, and exit costs.  We recorded charges of $67 million associated with these actions, with total cash expenditures expected to be approximately $40 million.  Annualized savings from these actions are estimated to be approximately $40 million and will be reflected largely in selling, general, and administrative expenses.

The following table summarizes the restructuring, impairment and other charges for the three months ended March 31, 2014 (in millions):
 
Reserve at
January 1,
2014
 
Net
Charges/
Reversals
 
Cash
payments
 
Reserve at
March 31,
2014
Restructuring:
                     
Employee related costs
$
36
 
$
3
 
$
(11)
 
$
28
Other charges
 
8
               
8
Total restructuring activity
$
44
 
$
3
 
$
(11)
 
$
36
                       
Impairment charges and disposal of long-lived assets
     
$
14
           
                       
Total restructuring, impairment and other charges
     
$
17
           

Cash payments for employee-related costs related to the 2014 and 2013 restructuring actions are expected to be substantially completed in 2014.

2013 Activity

The following table summarizes the restructuring reserve activity related to the 2012 corporate-wide restructuring plan for the three months ended March 31, 2013 (in millions):
 
Reserve at
January 1,
2013
 
Cash
payments
 
Reserve at
March 31,
2013
Restructuring:
               
Employee-related costs
$
38
 
$
(15)
 
$
23
Other charges (credits)
 
4
   
(1)
   
3
Total restructuring activity
$
42
 
$
(16)
 
$
26

Cash payments for the above restructuring activities were substantially completed in 2013.

 
-8-

 


3.      Commitments, Contingencies, and Guarantees

Dow Corning Corporation

Corning and The Dow Chemical Company (“Dow”) each own 50% of the common stock of Dow Corning Corporation (“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 included releases for Corning and Dow as shareholders in exchange for contributions to the Plan.

As a separate matter arising from its 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.  As of March 31, 2014, Dow Corning has estimated the liability to commercial creditors to be within the range of $94 million to $309 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 $94 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.

Pittsburgh Corning Corporation and Other Asbestos Litigation

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 11,800 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.

PCC Plan of Reorganization

Corning, with other relevant parties, has been involved in ongoing efforts to develop a Plan of Reorganization that would resolve the concerns and objections of the relevant courts and parties.  On November 12, 2013, the Bankruptcy Court issued a decision finally confirming an Amended PCC Plan of Reorganization (the “Amended PCC Plan” or the “Plan”). 

Under this Plan, Corning is required to contribute its equity interests in PCC and Pittsburgh Corning Europe N.V. (“PCE”), a Belgian corporation, and to contribute $290 million in a fixed series of payments, recorded at present value.  Corning has the option to use its shares rather than cash to make these payments, but the liability is fixed by dollar value and not the number of shares.  The Plan requires Corning to make: (1) one payment of $70 million one year from the date the Plan becomes effective and certain conditions are met; and (2) five additional payments of $35 million, $50 million, $35 million, $50 million, and $50 million, respectively, on each of the five subsequent anniversaries of the first payment, the final payment of which is subject to reduction based on the application of credits under certain circumstances.

 
-9-

 


The Bankruptcy Court’s confirmation of the Plan must be affirmed by the District Court, and one objector to the Plan continues to appeal the Bankruptcy Court’s confirmation of the Plan to the District Court.  Assuming the District Court affirms the confirmation, that decision may be appealed.  If that occurs, it could take many months for the confirmation of the Plan to be finally affirmed. 

Other Asbestos Litigation

In addition to the claims against Corning related to its ownership interest in PCC, Corning is also the defendant in approximately 9,700 other cases (approximately 37,400 claims) alleging injuries from asbestos related to its Corhart business and similar amounts of monetary damages per case.  When PCC filed for bankruptcy protection, the Court granted a preliminary injunction to suspend all asbestos cases against PCC, PPG and Corning – including these non-PCC asbestos cases (the “stay”).  The stay remains in place as of the date of this filing.  Under the Bankruptcy Court’s order confirming the Amended PCC Plan, the stay will remain in place until the Amended PCC Plan is finally affirmed.  These non-PCC asbestos cases have been covered by insurance without material impact to Corning to date.  As of March 31, 2014, Corning had received for these cases approximately $19 million in insurance payments related to those claims.  If and when the Bankruptcy Court’s confirmation of the Amended PCC Plan is affirmed, these non-PCC asbestos claims would be allowed to proceed against Corning.  Corning has recorded in its estimated asbestos litigation liability an additional $150 million for these and any future non-PCC asbestos cases.

Total Estimated Liability for the Amended PCC Plan and the Other Asbestos Litigation

The liability for the Amended PCC Plan and the other asbestos litigation was estimated to be $692 million at March 31, 2014, compared with an estimate of liability of $690 million at December 31, 2013.  The entire obligation is classified as a non-current liability as installment payments for the cash portion of the obligation under the Amended PCC Plan are not scheduled to commence until more than 12 months after the Plan becomes effective 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).

Non-PCC Asbestos Cases Insurance Litigation

Several of Corning’s insurers have commenced litigation in state courts for a declaration of the rights and obligations of the parties under insurance policies affecting the non-PCC asbestos cases, including rights that may be affected by the potential resolutions described above.  Corning is vigorously contesting these cases, and management is unable to predict the outcome of the litigation.

Other Commitments and Contingencies

We are required, at the time a guarantee is issued, to recognize a liability for the fair value or market value of the obligation it assumes.  In the normal course of our business, we do not routinely provide significant third-party guarantees.  Generally, any 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.  When provided, these guarantees have various terms, and none of these guarantees are individually significant.

As of March 31, 2014 and December 31, 2013, contingent guarantees totaled a notional value of $174 million and $152 million, respectively.  We believe a significant majority of these contingent guarantees will expire without being funded.  Included in these contingent guarantees is a credit facility of $25 million to Dow Corning.  The funding of the Dow Corning credit facility will be required only if Dow Corning is not otherwise able to meet its scheduled funding obligations in its confirmed Bankruptcy Plan.  We also were contingently liable for purchase obligations of $123 million and $126 million, at March 31, 2014 and December 31, 2013, respectively.

Product warranty liability accruals were considered insignificant at March 31, 2014 and December 31, 2013.

 
-10-

 


Corning is a defendant in various lawsuits, including environmental litigation, product-related suits, the Dow Corning and PCC matters, 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.  Other than certain asbestos related claims, there are no other material loss contingencies related to litigation.

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 16 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 March 31, 2014, and December 31, 2013, Corning had accrued approximately $34 million (undiscounted) and $15 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.

4.      Debt

Based on borrowing rates currently available to us for loans with similar terms and maturities, the fair value of long-term debt was $3.5 billion at March 31, 2014 and December 31, 2013, compared to recorded book values of $3.2 billion at March 31, 2014 and $3.3 billion at December 31, 2013.  The Company measures the fair value of its long-term debt using Level 2 inputs based primarily on current market yields for its existing debt traded in the secondary market.

2014
At March 31, 2014, Corning had $418 million in outstanding commercial paper as part of the Company’s commercial paper program established in the second quarter of 2013.  The estimated fair value of this commercial paper approximates its carrying value due to the short-term maturities.

2013
In the first quarter of 2013, we amended and restated our existing revolving credit facility.  The amended facility provides a $1.0 billion unsecured multi-currency line of credit that expires in March 2018.  The facility includes a leverage test (debt to capital ratio) financial covenant.  As of March 31, 2014, we were in compliance with this covenant.

In the first quarter of 2013, Corning repaid the aggregate principal amount and accrued interest outstanding on the credit facility entered into in the second quarter of 2011 that allowed Corning to borrow up to Chinese Renminbi (RMB) 4.0 billion.  The total amount repaid was approximately $500 million.  Upon repayment, this facility was terminated.

5.      Income Taxes

Our provision for income taxes and the related effective income tax rates were as follows (in millions):
 
Three months ended
March 31,
 
2014
 
2013
           
Provision for income taxes
$
(180)
 
$
(34)
Effective tax rate 
 
37.4%
   
6.4%


 
-11-

 


For the three months ended March 31, 2014, the effective income tax rate differed from the U.S. statutory rate of 35% primarily due to the following benefits:

·  
Rate differences on income (loss) of consolidated foreign companies, including the benefit of excess foreign tax credits attributable to a deemed distribution to the U.S. of a portion of foreign current year earnings;
·  
Equity in earnings of nonconsolidated affiliates reported in the financials net of tax; and
·  
Tax incentives in foreign jurisdictions, primarily Taiwan.

These benefits were more than offset principally by a discrete tax charge in the first quarter of 2014 in the amount of $102 million related to South Korean withholding tax on a dividend paid by Samsung Corning Precision Materials to Corning wholly owned foreign subsidiaries.

For the three months ended March 31, 2013, the effective income tax rate differed from the U.S. statutory rate of 35% primarily due to the following benefits:

·  
Rate differences on income (loss) of consolidated foreign companies;
·  
Equity in earnings of nonconsolidated affiliates reported in the financials net of tax;
·  
$54 million to record the impact of the American Taxpayer Relief Act enacted on January 3, 2013 retroactive to 2012; and
·  
Tax incentives in foreign jurisdictions, primarily Taiwan.

Corning’s subsidiary in Taiwan is operating under tax holiday arrangements.  The benefit of the arrangement phases out through 2018.  The impact of the tax holiday on our effective tax rate is a reduction in the rate of 1.2 and 1.5 percentage points for the three months ended March 31, 2014 and 2013, respectively.

Corning continues to indefinitely reinvest substantially all of its foreign earnings, with the exception of approximately $7 million of current earnings in 2014 that have very low or no tax cost associated with their repatriation.  Our current analysis indicates that we have sufficient U.S. liquidity, including borrowing capacity, to fund foreseeable U.S. cash needs without requiring the repatriation of foreign cash.  One time or unusual items that may impact our ability or intent to keep our foreign earnings and cash indefinitely reinvested include significant U.S. acquisitions, stock repurchases, shareholder dividends, changes in tax laws or the development of tax planning ideas that allow us to repatriate earnings at little or no tax cost, and/or a change in our circumstances or economic conditions that negatively impact our ability to borrow or otherwise fund U.S. needs from existing U.S. sources.  While it remains impracticable to calculate the tax cost of repatriating our total unremitted foreign earnings, such cost could be material to the results of operations of Corning in a particular period.

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.

 
-12-

 


6.      Earnings per Common Share

The following table sets forth the computation of basic and diluted earnings per common share (in millions, except per share amounts):
 
Three months ended
March 31,
 
2014
 
2013
Net income attributable to Corning Incorporated
$
301 
 
$
494
Less:  Series A convertible preferred stock dividend
 
(21)
     
Net income available to common stockholders - basic
 
280 
   
494
Net income available to common stockholders - diluted
$
280 
 
$
494
           
Weighted-average common shares outstanding - basic
 
1,359 
   
1,472
Effect of dilutive securities:
         
Stock options and other dilutive securities
 
11 
   
9
Weighted-average common shares outstanding - diluted
 
1,370 
   
1,481
Basic earnings per common share
$
0.21 
 
$
0.33
Diluted earnings per common share
$
0.20 
 
$
0.33
           
Antidilutive potential shares excluded from diluted earnings per common share:
         
Series A convertible preferred stock
 
97 
     
Employee stock options and awards
 
29 
   
47
Accelerated share repurchase forward contract
 
12 
     
Total
 
138 
   
47

7.      Available-for-Sale Investments

The following is a summary of the fair value of available-for-sale investments (in millions):
 
Amortized cost
 
Fair value
 
March 31,
2014
 
December 31,
2013
 
March 31,
2014
 
December 31,
2013
Bonds, notes and other securities:
                     
U.S. government and agencies
$
637
 
$
530
 
$
637
 
$
531
Equity securities
$
6
       
$
7
     
Total short-term investments
$
643
 
$
530
 
$
644
 
$
531
Asset-backed securities
$
45
 
$
46
 
$
40
 
$
38
Total long-term investments
$
45
 
$
46
 
$
40
 
$
38

We do not intend to sell, nor do we believe it is more likely than not that we would be required to sell, the long-term investment asset-backed securities (which are collateralized by mortgages) before recovery of their amortized cost basis.  It is possible that a significant degradation in the delinquency or foreclosure rates in the underlying assets could cause further temporary or other-than-temporary impairments in the future.

 
-13-

 


The following table summarizes the contractual maturities of available-for-sale securities at March 31, 2014 (in millions):
Less than one year
$468
Due in 1-5 years
169
Due in 5-10 years
 
Due after 10 years (1)
40
Total
$677

(1)
Includes $40 million of asset-based securities that mature over time and are being reported at their final maturity dates.

Unrealized gains and losses, net of tax, are computed on a specific identification basis and are reported as a separate component of accumulated other comprehensive (loss) income in shareholders’ equity until realized.

The following tables provide the fair value and gross unrealized losses of the Company’s investments aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2014 and December 31, 2013 (dollars in millions):
     
March 31, 2014
     
12 months or greater
 
Total
 
Number of
securities
in a loss
position
 
Fair
value
 
Unrealized
losses (1)
 
Fair
value
 
Unrealized
losses
Asset-backed securities
20
 
$
39
 
$
(5)
 
$
39
 
$
(5)
Total long-term investments
20
 
$
39
 
$
(5)
 
$
39
 
$
(5)

(1)
Unrealized losses in securities less than 12 months were not significant.

     
December 31, 2013
     
12 months or greater
 
Total
 
Number of
securities
in a loss
position
 
Fair
value
 
Unrealized
losses (1)
 
Fair
value
 
Unrealized
losses
Asset-backed securities
20
 
$
38
 
$
(8)
 
$
38
 
$
(8)
Total long-term investments
20
 
$
38
 
$
(8)
 
$
38
 
$
(8)

(1)
Unrealized losses in securities less than 12 months were not significant.

As of March 31, 2014 and December 31, 2013, for securities that have credit losses, an other than temporary impairment loss of $4 and $6 million, respectively, is recognized in accumulated other comprehensive (loss) income.

Proceeds from sales and maturities of short-term investments totaled approximately $0.3 billion and $0.5 billion for the three months ended March 31, 2014 and 2013, respectively.

 
-14-

 


8.      Inventories

Inventories comprise the following (in millions):
 
March 31,
2014
 
December 31,
2013
Finished goods
$
535
 
$
486
Work in process
 
238
   
234
Raw materials and accessories
 
317
   
311
Supplies and packing materials
 
305
   
239
Total inventories
$
1,395
 
$
1,270

9.      Investments

Samsung Corning Precision Materials

Prior to December 2013, Corning owned 50% of its equity affiliate, Samsung Corning Precision Materials, Samsung Display owned 42.5% and three shareholders owned the remaining 7%. In the fourth quarter of 2013, in connection with a series of strategic and financial agreements with Samsung Display announced in October 2013, Corning acquired the minority interests of three shareholders in Samsung Corning Precision Materials for $506 million, which included payment for the transfer of non-operating assets and the pro-rata portion of cash on the Samsung Corning Precision Materials balance sheet at September 30, 2013. The resulting transfer of shares to Corning increased Corning’s ownership percentage of Samsung Corning Precision Materials from 50% to 57%. Because this transaction did not result in a change in control based on the governing articles of this entity, Corning did not consolidate this entity as of December 31, 2013.

As further discussed in Note 10 (Acquisition), on January 15, 2014, Corning completed the series of strategic and financial agreements to acquire the common shares of Samsung Corning Precision Materials previously held by Samsung Display. As a result of these transactions, Corning is now the owner of 100% of the common shares of Samsung Corning Precision Materials, which we have consolidated into our results beginning in the first quarter of 2014.  Operating under the name of Corning Precision Materials, the former Samsung Corning Precision Materials organization and operations was integrated into the Display Technologies segment in the first quarter of 2014.

Dow Corning Corporation (“Dow Corning”)

Summarized income statement information for Dow Corning is as follows for the three months ended March 31, 2014 and prior year comparative period: net sales $1,524 million (2013: $1,264 million), gross profit $483 million (2013: $324 million) and net income attributable to Dow Corning $191 million (2013: $62 million).  Dow Corning’s net income in the first quarter of 2014 includes a pre-tax gain on a derivative instrument of $99 million (after tax and non-controlling interests, Corning’s share was approximately $32 million).

10.      Acquisition

On January 15, 2014, Corning entered into a series of strategic and financial agreements pursuant to the Framework Agreement with Samsung Display, previously announced on October 22, 2013, to acquire the remaining common shares of Samsung Corning Precision Materials. The transaction is expected to strengthen product and technology collaborations between the two companies and allow Corning to extend its leadership in specialty glass and drive earnings growth.

 
-15-

 


The Acquisition was accounted for under the purchase method of accounting in accordance with business combination accounting guidance.  Accordingly, the preliminary purchase price was allocated to the assets acquired and liabilities assumed based on their fair value on the date of Acquisition.  The fair value was determined based on the fair value of consideration transferred for the 42.5% of Samsung Display’s shares.  Corning recognized a gain in the amount of $394 million in current period earnings, which was calculated from the pre-acquisition fair value of its previously held equity investment.

The following table summarizes the consideration transferred to acquire Samsung Corning Precision Materials, as well as the fair value of the non-controlling interest in Samsung Corning Precision Materials at the acquisition date.

Fair Value of Samsung Corning Precision Materials on Acquisition Date (in millions):
Corning Preferred Shares
$
1,911 
Settlement of pre-existing contract
 
(136)
Contingent consideration
 
(196)
Total consideration transferred
 
1,579 
Fair value of equity investment
 
2,139 
Total
$
3,718 

In connection with the purchase of Samsung Display’s equity interest in Samsung Corning Precision Materials pursuant to the Framework Agreement, the Company designated a new series of its preferred stock as Fixed Rate Cumulative Convertible Preferred Stock, Series A, par value $100 per share (“Preferred Stock”).  As contemplated by the Framework Agreement, Samsung Display became the owner of 2,300 shares of Preferred Stock (with an issue price of $1 million per share), of which 1,900 shares were issued in connection with the Acquisition and 400 shares were issued for cash.

Corning issued 1,900 Preferred Shares as consideration in the Acquisition of Samsung Corning Precision Materials which had a fair value of $1.9 billion on the acquisition date. The fair value was determined using an option pricing model based on the features of the instrument.  That measure is based on Level 2 inputs observable in the market such as Corning’s common stock price and dividend yield.

At Acquisition, in addition to the $394 million gain on our previously held equity investment, the Company also recorded the effective settlement of a pre-existing contract with Samsung Corning Precision Materials related to a technology license agreement.  The contract was valued using the Income Approach, specifically a relief from royalty method.  As a result, a loss of $320 million was recorded in the first quarter of 2014.

The Acquisition also includes a contingent consideration arrangement that potentially requires additional consideration to be paid between the parties in 2018: one based on projections of future revenues generated by the business of Samsung Corning Precision Materials for the period between acquisition date and December 31, 2017, which is subject to a cap of $665 million; and another based on the volumes of certain sales during the same period, which is subject to a separate cap of $100 million. The fair value of the potential receipt of the contingent consideration in 2018 in the amount of $196 million recognized on the acquisition date was estimated by applying an option pricing model using the Company’s projections of future revenues generated by Corning Precision Materials.

As of March 31, 2014, there were no significant changes in the recognized amounts or range of outcomes for the contingent consideration recognized as a result of the Acquisition of Samsung Corning Precision Materials.

The following table summarizes the amounts of identified assets acquired and liabilities assumed at acquisition date.  Corning has not completed its accounting for the Acquisition and its review of deferred taxes; therefore, amounts are subject to change.

 
-16-

 


Recognized amounts of identified assets acquired and liabilities assumed (in millions):
Cash and cash equivalents (1)
$
133 
Trade Receivables
 
353 
Inventory
 
119 
Property, plant and equipment
 
3,603 
Other current and non-current assets
 
80 
Debt – current
 
(32)
Accounts payable and accrued expenses
 
(343)
Other current and non-current liabilities
 
(278)
Total identified net assets
 
3,635 
Non-controlling interests
 
15 
Fair value of Samsung Corning Precision Materials on acquisition date
 
(3,718)
Goodwill (2)
$
68 

(1)
Cash and cash equivalents acquired is presented net of the 2014 dividend distribution subsequent to the Acquisition, in the amount of $2.8 billion.
(2)
The goodwill recognized is not deductible for U.S. income tax purposes.  The goodwill was allocated to the Display segment.

The goodwill is primarily attributable to the workforce of the acquired business and the synergies expected to arise after the Acquisition of Samsung Corning Precision Materials. Acquisition-related costs of $90 million in the three months ended March 31, 2014 included costs for post combination compensation expense, legal, accounting, valuation and other professional services and were included in selling, general and administrative expenses in the Consolidated Statements of Income.  In the first quarter of 2014, the consolidation of Corning Precision Materials added $428 million to Net sales and $113 million to Net income attributable to Corning Incorporated.

Unaudited Pro Forma Financial Information

The unaudited pro forma combined consolidated statement of income for the quarter ended March 31, 2013, was derived from the unaudited financial statements of Corning and Samsung Corning Precision Materials for the quarter ended March 31, 2013, and is presented to show how Corning might have looked had the Acquisition occurred as of January 1, 2013.

The unaudited pro forma combined consolidated financial information was prepared pursuant to the rules and regulations of the Securities and Exchange Commission.  The unaudited pro forma adjustments reflecting the Acquisition have been prepared in accordance with the business combination accounting guidance and reflect the preliminary allocation of the purchase price to the acquired assets and liabilities based upon the preliminary estimate of fair values, using the assumptions set forth above.

(in millions, except per share data)
Three months
ended
March 31, 2013
Net sales
$
2,388
Net income from continuing operations - basic
$
620
Net income from continuing operations - diluted
$
644
Earnings per common share attributable to common shareholders
   
Basic
$
0.42
Diluted
$
0.40
Shares used in computing per share amounts
   
Basic
 
1,472
Diluted
 
1,596

There were no other significant acquisitions for the three months ended March 31, 2014, and for the year ended December 31, 2013.

 
-17-

 


11.      Property, Net of Accumulated Depreciation

Property, net of accumulated depreciation follows (in millions):
 
March 31,
2014
 
December 31,
2013
Land
$
496 
 
$
121 
Buildings
 
5,619 
   
4,175 
Equipment
 
13,683 
   
12,286 
Construction in progress
 
1,687 
   
1,084 
   
21,485 
   
17,666 
Accumulated depreciation
 
(8,141)
   
(7,865)
Total
$
13,344 
 
$
9,801 

The increase in Property, net of accumulated depreciation, in the first quarter of 2014 is entirely driven by the Acquisition of Samsung Corning Precision Materials, which added $3.6 billion to this balance.

In the three months ended March 31, 2014 and 2013, interest costs capitalized as part of Property, net of accumulated depreciation, were $10 million and $9 million, respectively.

Manufacturing equipment includes certain components of production equipment that are constructed of precious metals.  At March 31, 2014 and December 31, 2013, the recorded value of precious metals each totaled $3.3 billion and $2.2 billion, respectively.  Depletion expense for precious metals in the three months ended March 31, 2014 and 2013 totaled $8 million and $6 million, respectively.  The consolidation of Corning Precision Materials added approximately $1.1 billion in precious metals and approximately $2 million of depletion expense in the first quarter of 2014.

12.      Goodwill and Other Intangible Assets

The carrying amount of goodwill by segment for the periods ended March 31, 2014 and December 31, 2013 is as follows (in millions):
 
Optical
Communications
 
Display
Technologies
 
Specialty
Materials
 
Life
Sciences
 
Total
                             
Balance at December 31, 2013
$
240
 
$
9
 
$
150
 
$
603
 
$
1,002
Acquired goodwill (1)
       
68
   
54
         
122
Foreign currency translation adjustment
                   
1
   
1
Balance at March 31, 2014
$
240
 
$
77
 
$
204
 
$
604
 
$
1,125

(1)  
The Company recorded the acquisition of Samsung Corning Precision Materials and a small acquisition in the Specialty Materials segment in the first quarter of 2014.  Refer to Note 10 (Acquisition) to the Consolidated Financial Statements for additional information on the Acquisition of Samsung Corning Precision Materials.

Corning’s gross goodwill balances for the periods ended March 31, 2014 and December 31, 2013 were $7.6 billion and $7.5 billion, respectively.  Accumulated impairment losses were $6.5 billion for the periods ended March 31, 2014 and December 31, 2013, and were generated entirely through goodwill impairments related to the Optical Communications segment recorded primarily in 2001.

 
-18-

 


Other intangible assets are as follows (in millions):
 
March 31, 2014
 
December 31, 2013
 
Gross
 
Accumulated
amortization
 
Net
 
Gross
 
Accumulated
amortization
 
Net
Amortized intangible assets:
                                 
Patents, trademarks, and trade names 
$
307
 
$
141
 
$
166
 
$
290
 
$
138
 
$
152
Customer lists and other 
 
427
   
53
   
374
   
436
   
48
   
388
                                   
Total
$
734
 
$
194
 
$
540
 
$
726
 
$
186
 
$
540

Corning’s amortized intangible assets are primarily related to the Optical Communications and Life Sciences segments.  The net carrying amount of intangible assets remained the same during the first three months of 2014, primarily due to amortization of $8 million offset by a small acquisition and foreign currency translation adjustments.

Amortization expense related to these intangible assets is estimated to be $34 million for 2014, $33 million for 2015 and $32 million annually from 2016 to 2019.

13.      Employee Retirement Plans

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):
 
Pension benefits
 
Postretirement benefits
 
Three months ended
March 31,
 
Three months ended
March 31,
 
2014
 
2013
 
2014
 
2013
                       
Service cost
$
16 
 
$
19 
 
$
 
$
Interest cost
 
38 
   
34 
   
   
10 
Expected return on plan assets
 
(43)
   
(42)
           
Amortization of net loss
                   
Amortization of prior service cost (credit)
 
   
   
(1)
   
(2)
Total pension and postretirement benefit expense
$
13 
 
$
12 
 
$
11 
 
$
16 

14.      Hedging Activities

Undesignated Hedges
The table below includes a total gross notional value for the translated earnings contracts of $11.6 billion at March 31, 2014 (at December 31, 2013: $6.8 billion), comprising purchased collars of $4.5 billion (at December 31, 2013: $5.9 billion) and average rate forwards of $7.1 billion (at December 31, 2013: $0.9 billion).  With respect to the purchased collars, the gross notional amount includes the value of both the put and call options.  However, due to the nature of the purchased collar instruments, either the put or the call option can be exercised at maturity.  As of March 31, 2014, the total net notional value of the purchased collars was $2 billion (at December 31, 2013: $3 billion). 

 
-19-

 


The following tables summarize the notional amounts and respective fair values of Corning’s derivative financial instruments on a gross basis for March 31, 2014 and December 31, 2013 (in millions):
 
U.S. Dollar
 
Asset derivatives
 
Liability derivatives
 
Gross notional amount
 
Balance
sheet location
 
Fair value
 
Balance
sheet location
 
Fair value
 
2014
 
2013
   
2014
 
2013
   
2014
 
2013
                               
Derivatives designated as hedging instruments
                             
                               
Foreign exchange contracts
$   388
 
$   433
 
Other current assets
 
$    2
 
$    8
 
Other accrued liabilities
 
$ (3)
 
$ (3)
Interest rate contracts
$   550
 
$   550
             
Other liabilities
 
$(23)
 
$(28)
                               
Derivatives not designated as hedging instruments
                             
                               
Foreign exchange contracts
$  1,100
 
$   804
 
Other current assets
 
$    9
 
$  20
 
Other accrued liabilities
 
$ (4)
 
$ (3)
Translated earnings contracts
$11,615
 
$6,826
 
Other current assets
 
$248
 
$344
 
Other accrued liabilities
 
$ (1)
 
$ (3)
         
Other assets
 
$120
 
$  90
           
                               
Total derivatives
$13,653
 
$8,613
     
$379
 
$462
     
$(31)
 
$(37)


 
-20-

 


The following tables summarize the effect of derivative financial instruments on Corning’s consolidated financial statements for the three months ended March 31, 2014 and 2013 (in millions):
 
Effect of derivative instruments on the consolidated financial statements
for the quarter ended March 31
Derivatives in hedging relationships
Gain/(loss)
recognized in other
comprehensive income
(OCI)
 
Location of gain/(loss)
reclassified from
accumulated OCI into
income (effective)
 
Gain reclassified from
accumulated OCI into
income (effective) (1)
2014
 
2013
   
2014
 
2013
                   
Interest rate hedges
       
Cost of sales
 
$0
 
$  8
Foreign exchange contracts
$(7)
 
$37
 
Other income, net
 
$0
 
$13
                   
Total cash flow hedges
$(7)
 
$37
     
$0
 
$21

(1)
The amount of hedge ineffectiveness at March 31, 2014 and 2013 was insignificant.

     
Gain (loss) recognized in income (1)
 
Undesignated
derivatives
Location
 
2014
 
2013
 
               
Foreign exchange contracts – balance sheet
Other income, net
 
$
(12)
 
$
47
 
Foreign exchange contracts – loans
Other income, net
   
   
58
 
Translated earnings contracts
Other income, net
   
   
24
 
                 
Total undesignated
   
$
(6)
 
$
129
 

(1)
Certain amounts for prior periods were reclassified to conform to the current presentation.  The gain (loss) on foreign exchange contracts is now disclosed in two categories, Foreign exchange contracts – balance sheet, and Foreign exchange contracts – loans.

15.      Fair Value Measurements

Fair value standards under U.S. GAAP define fair value, establish a framework for measuring fair value in applying generally accepted accounting principles, and require disclosures about fair value measurements.  The standards also identify 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, the inputs are prioritized into one of three broad levels (provided in the table below) used to measure fair value.  Fair value standards apply whenever an entity is measuring fair value under other accounting pronouncements that require or permit fair value measurement and require the use of observable market data when available.

 
-21-

 


The following tables provide fair value measurement information for the Company’s major categories of financial assets and liabilities measured on a recurring basis (in millions):
     
Fair value measurements at reporting date using
 
March 31,
2014
 
Quoted prices in
active markets for
identical assets
(Level 1)
 
Significant other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
                       
Current assets:
                     
Short-term investments
$
644
 
$
644
           
Other current assets (1)
$
259
       
$
259
     
Non-current assets:
                     
Other assets (1)(2)
$
160
       
$
160
     
                       
Current liabilities:
                     
Other accrued liabilities (1)
$
8
       
$
8
     
Non-current liabilities:
                     
Other liabilities (1)
$
23
       
$
23
     

(1)
Derivative assets and liabilities include foreign exchange forward and purchased collar contracts, and interest rate swaps which are measured using observable quoted prices for similar assets and liabilities.
(2)
Other assets include asset backed securities which are measured using observable quoted prices for similar assets.

     
Fair value measurements at reporting date using
 
December 31,
2013
 
Quoted prices in
active markets for
identical assets
(Level 1)
 
Significant other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
                       
Current assets:
                     
Short-term investments
$
531
 
$
531
           
Other current assets (1)
$
372
       
$
372
     
Non-current assets:
                     
Other assets (1)(2)
$
128
       
$
128
     
                       
Current liabilities:
                     
Other accrued liabilities (1)
$
9
       
$
9
     
Non-current liabilities:
                     
Other liabilities (1)
$
28
       
$
28
     

(1)
Derivative assets and liabilities include foreign exchange forward and purchased collar contracts, and interest rate swaps which are measured using observable quoted prices for similar assets and liabilities.
(2)
Other assets include asset backed securities which are measured using observable quoted prices for similar assets.

 
-22-

 


As a result of the Acquisition of Samsung Corning Precision Materials, the Company has contingent consideration that was measured using unobservable (Level 3) inputs.  This contingent consideration arrangement potentially requires additional consideration to be paid between the parties in 2018: one based on projections of future revenues generated by the business of Samsung Corning Precision Materials for the period between acquisition date and December 31, 2017, which is subject to a cap of $665 million; and another based on the volumes of certain sales during the same period, which is subject to a separate cap of $100 million.  The fair value of the potential receipt of the contingent consideration in 2018 in the amount of $196 million recognized on the acquisition date was estimated by applying an option pricing model using the Company’s projection of future revenues generated by Corning Precision Materials.  Changes in the fair value of the contingent consideration in future periods will be valued using an option pricing model and will be recorded in Corning’s results in the period of the change.  As of March 31, 2014, there were no significant changes in the recognized amounts or range of outcomes for the contingent consideration recognized as a result of the Acquisition of Samsung Corning Precision Materials.  As of December 31, 2013, the Company did not have any financial assets or liabilities that were measured on a recurring basis using unobservable (or Level 3) inputs.

16.      Shareholders’ Equity

Fixed Rate Cumulative Convertible Preferred Stock, Series A

On January 15, 2014, Corning designated a new series of its preferred stock as Fixed Rate Cumulative Convertible Preferred Stock, Series A, par value $100 per share, and issued 1,900 shares of Preferred Stock at an issue price of $1 million per share, for an aggregate issue price of $1.9 billion, to Samsung Display in connection with the Acquisition of their equity interests in Samsung Corning Precision Materials.  Corning also issued to Samsung Display an additional amount of Preferred Stock at closing, for an aggregate issue price of $400 million in cash.
 
Dividends on the Preferred Stock are cumulative and accrue at the annual rate of 4.25% on the per share issue price of $1 million.  The dividends are payable quarterly as and when declared by the Company’s board of directors.  The Preferred Stock ranks senior to our common stock with respect to payment of dividends and rights upon liquidation.  The Preferred Stock is not redeemable except in the case of a certain deemed liquidation event, the occurrence of which is under the control of the Company.  The Preferred Stock is convertible at the option of the holder and the Company upon certain events, at a conversion rate of 50,000 shares of Corning’s common stock per one share of Preferred Stock, subject to certain anti-dilution provisions.  Following the seventh anniversary of the closing of the Acquisition, the Preferred Stock will be convertible, in whole or in part, at the option of the holder.  The Company has the right, at its option, to cause some or all of the shares of Preferred Stock to be converted into Common Stock, if, for 25 trading days (whether or not consecutive) within any period of 40 consecutive trading days, the closing price of Common Stock exceeds $35 per share.  If the aforementioned right becomes exercisable before the seventh anniversary of the closing, the Company must first obtain the written approval of the holders of a majority of the Preferred Stock before exercising its conversion right.  The Preferred Stock does not have any voting rights except as may be required by law.

Share Repurchases

On October 31, 2013, as part of the previously authorized share repurchase program announced on April 24, 2013, Corning entered into an accelerated share repurchase (“ASR”) agreement with JP Morgan Chase Bank, National Association, London Branch (“JPMC”).  Under the ASR agreement with JPMC, Corning agreed to purchase $1 billion of its common stock, in total, with an initial delivery by JPMC of 47.1 million shares based on the current market price, and payment of $1 billion made by Corning to JPMC.  The payment to JPMC was recorded as a reduction to shareholders’ equity, consisting of an $800 million increase in treasury stock, which reflects the value of the initial 47.1 million shares received upon execution, and a $200 million decrease in other-paid-in capital, which reflects the value of the stock held back by JPMC pending final settlement.  On January 28, 2014, the ASR agreement with JPMC was completed.  Corning received an additional 10.5 million shares on January 31, 2014 to settle the ASR agreement.  In total, Corning purchased 57.6 million shares based on the average daily volume weighted-average price of Corning’s common stock during the term of the ASR agreement with JPMC, less a discount.  The program announced on April 24, 2013 was finalized in the first quarter of 2014.

 
-23-

 


On March 3, 2014, as part of the $2.0 billion share repurchase program announced on October 22, 2013 and made effective concurrent with the closing of Corning’s Acquisition of Samsung Corning Precision Materials on January 15, 2014, Corning entered into an ASR agreement with Citibank N.A. (“Citi”).  Under the ASR agreement with Citi, Corning agreed to purchase $1.25 billion of its common stock, in total, with an initial delivery by Citi of 52.5 million shares based on the current market price, and payment of $1.25 billion made by Corning to Citi.  The payment to Citi was recorded as a reduction to shareholders’ equity, consisting of a $1.0 billion increase in treasury stock, which reflects the value of the initial 52.5 million shares received upon execution, and a $250 million decrease in other-paid-in capital, which reflects the value of the stock held back by Citi pending final settlement.  The ASR agreement with Citi is expected to be completed in the second quarter of 2014.

In addition to the ASR agreements, during the first quarter of 2014, we repurchased 26.7 million shares of common stock on the open market for approximately $484 million as part of the share repurchase program announced on April 24, 2013, and 8.7 million shares of common stock on the open market for approximately $167 million as part of the share repurchase program made effective on January 15, 2014.

Accumulated Other Comprehensive Income

In the first three months of 2014 and 2013, the primary changes in accumulated other comprehensive income (“AOCI”) were related to the foreign currency translation component.  In the first three months of 2014, a $136 million cumulative foreign currency translation gain was released to income as a result of the step acquisition of Samsung Corning Precision Materials and included in the gain on previously held equity investment.  In the first three months of 2013, foreign currency translation losses of $505 million were recognized in AOCI (Corning: $329 million; equity method affiliates: $176 million).  There are no material tax effects related to foreign currency translation gain and losses.

17.      Share-based Compensation

Stock Compensation Plans

The Company measures and recognizes compensation cost for all share-based payment awards made to employees and directors based on estimated fair values.  Fair values for stock options were estimated using a multiple-point Black-Scholes valuation model.  Share-based compensation cost was approximately $15 million and $11 million for the three months ended March 31, 2014 and 2013, respectively.  Amounts for all periods presented included compensation expense for employee stock options and time-based restricted stock and restricted stock units.

Stock Options

Corning’s stock option plans provide non-qualified and incentive stock options to purchase authorized but unissued shares, 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.

 
-24-

 


The following table summarizes information concerning stock options outstanding including the related transactions under the stock option plans for the three months ended March 31, 2014:
 
Number
of Shares
(in thousands)
 
Weighted-
Average
Exercise
Price
 
Weighted-
Average
Remaining
Contractual
Term in
Years
 
Aggregate
Intrinsic
Value
(in thousands)
Options Outstanding as of December 31, 2013
57,139
 
$17.83
       
Granted
     528
 
  20.80
       
Exercised
  (4,571)
 
  11.75
       
Forfeited and Expired
     (161)
 
  15.85
       
Options Outstanding as of March 31, 2014
52,935
 
  18.39
 
4.95
 
$201,401
Options Expected to Vest as of March 31, 2014
52,817
 
  18.40
 
4.95
 
  200,454
Options Exercisable as of March 31, 2014
40,470
 
  19.78
 
3.90
 
  114,511

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 March 31, 2014, which would have been received by the option holders had all option holders exercised their “in-the-money” options as of that date.

As of March 31, 2014, there was approximately $17 million of unrecognized compensation cost related to stock options granted under the plans.  The cost is expected to be recognized over a weighted-average period of 1.4 years.  Compensation cost related to stock options was approximately $6 million and $5 million for the three months ended March 31, 2014 and 2013, respectively.

Proceeds received from the exercise of stock options were $50 million and $12 million for the three months ended March 31, 2014 and 2013, 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 three months ended March 31, 2014 and 2013 was approximately $32 million and $13 million, respectively, which is currently deductible for tax purposes.  However, these tax benefits were not fully recognized due to net operating loss carryforwards available to the Company.  Refer to Note 5 (Income Taxes) to the consolidated financial statements.

The following inputs were used for the valuation of option grants under our stock option plans:
 
Three months ended March 31,
 
2014
 
2013
Expected volatility
46.2
-
46.2%
 
47.1
-
47.4%
Weighted-average volatility
46.2
-
46.2%
 
47.1
-
47.4%
Expected dividends
2.09
-
2.09%
 
3.02
-
3.02%
Risk-free rate
2.2
-
2.2%
 
1.1
-
1.5%
Average risk-free rate
2.2
-
2.2%
 
1.4
-
1.4%
Expected term (in years)
7.2
-
7.2
 
5.8
-
7.2
Pre-vesting departure rate
0.5
-
0.5%
 
0.4
-
4.1%

Expected volatility is based on a blended approach defined as the weighted average of the short-term implied volatility, the most recent volatility for the period equal to the expected term, and the most recent 15-year historical volatility.  The expected term assumption is the period of time the options are expected to be outstanding, and is calculated using a combination of historical exercise experience adjusted to reflect the current vesting period of options being valued, and partial life cycles of outstanding options.  The risk-free rate assumption is the implied rate for a zero-coupon U.S. Treasury bond with a term equal to the option’s expected term.  The ranges in the table above reflect results from separate groups of employees exhibiting different exercise behavior.

 
-25-

 


Incentive Stock Plans

The Corning Incentive Stock Plan permits restricted stock and restricted stock unit grants, either determined by specific performance goals or issued directly, in most instances, subject to the possibility of forfeiture and without cash consideration.  Restricted stock and restricted stock units under the Incentive Stock Plan are granted at the closing market price on the grant date, contingently vest over a period of generally one to ten years, and generally have contractual lives of one to ten years.  The fair value of each restricted stock grant or restricted stock unit awarded under the Incentive Stock Plan was estimated on the date of grant.

Time-Based Restricted Stock and Restricted Stock Units:

Time-based restricted stock and restricted stock units are issued by the Company on a discretionary basis, and are payable in shares of the Company’s common stock upon vesting.  The fair value is based on the closing 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 non-vested time-based restricted stock and restricted stock units as of December 31, 2013, and changes which occurred during the three months ended March 31, 2014:
 
Shares
(000’s)
 
Weighted
Average
Grant-Date
Fair Value
Non-vested shares and share units at December 31, 2013
6,108 
 
$
14.58
Granted
1,270 
   
20.28
Vested
(1,011)
   
18.57
Forfeited
(7)
   
14.91
Non-vested shares and share units at March 31, 2014
6,360 
 
$
15.08

As of March 31, 2014, there was approximately $44 million of unrecognized compensation cost related to non-vested time-based restricted stock and restricted stock units compensation arrangements granted under the Plan.  The cost is expected to be recognized over a weighted-average period of 1.8 years.  Compensation cost related to time-based restricted stock and restricted stock units was approximately $9 million and $6 million for the three months ended March 31, 2014 and 2013, respectively.

18.      Significant Customers

For the three months ended March 31, 2014, Corning had one customer that individually accounted for 10% or more of the Company’s consolidated net sales.  For the three months ended March 31, 2013, Corning had no customers that individually accounted for 10% or more of the Company’s consolidated net sales.

 
-26-

 


19.      Reportable Segments

Our reportable segments are as follows:

·  
Display Technologies – manufactures liquid crystal display (“LCD”) glass for flat panel displays.
·  
Optical Communications – manufactures carrier network and enterprise network components for the telecommunications industry.
·  
Environmental Technologies – manufactures ceramic substrates and filters for automotive and diesel applications.  This 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.
·  
Specialty Materials – manufactures products that provide more than 150 material formulations for glass, glass ceramics and fluoride crystals to meet demand for unique customer needs.
·  
Life Sciences – manufactures glass and plastic labware, equipment, media and reagents to provide workflow solutions for scientific applications.

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

We prepared the financial results for our reportable segments on a basis that is consistent with the manner in which we internally disaggregate financial information to assist in making internal operating decisions.  We included the earnings of equity affiliates that are closely associated with our reportable segments in the respective segment’s net income.  We have allocated certain common expenses among segments differently than we would for stand-alone financial information prepared in accordance with U.S. GAAP.  Segment net income may not be consistent with measures used by other companies.  The accounting policies of our reportable segments are the same as those applied in the consolidated financial statements.

 
-27-

 


Reportable Segments (in millions)

 
Display
Technologies
 
Optical
Communications
 
Environmental
Technologies
 
Specialty
Materials
 
Life
Sciences
 
All
Other
 
Total
Three months ended
  March 31, 2014
                                       
 
Net sales
$
929 
 
$
593 
 
$
275 
 
$
261 
 
$
210 
 
$
21 
 
$
2,289 
 
Depreciation (1)
$
173 
 
$
36 
 
$
30 
 
$
27 
 
$
15 
 
$
 
$
286 
 
Amortization of purchased intangibles
     
$
             
$
       
$
 
Research, development and engineering expenses (2)
$
45 
 
$
37 
 
$
21 
 
$
33 
 
$
 
$
28 
 
$
169 
 
Restructuring, impairment and other charges
$
 
$
12 
                         
$
17 
 
Equity in earnings of affiliated companies
$
(9)
       
$
             
$
 
$
(6)
 
Income tax (provision) benefit
$
(198)
 
$
(19)
 
$
(21)
 
$
(16)
 
$
(8)
 
$
16 
 
$
(246)
 
Net income (loss) (3)
$
209 
 
$
27 
 
$
43 
 
$
31 
 
$
17 
 
$
(40)
 
$
287 
                                         
Three months ended
  March 31, 2013
                                       
 
Net sales
$
650 
 
$
470 
 
$
228 
 
$
258 
 
$
207 
 
$
 
$
1,814 
 
Depreciation (1)
$
124 
 
$
34 
 
$
31 
 
$
39 
 
$
14 
 
$
 
$
246 
 
Amortization of purchased intangibles
     
$
             
$
       
$
 
Research, development and engineering expenses (2)
$
19 
 
$
35 
 
$
23 
 
$
35 
 
$
 
$
36 
 
$
153 
 
Equity in earnings of affiliated companies
$
133 
 
$
                   
$
 
$
139 
 
Income tax (provision) benefit 
$
(80)
 
$
(17)
 
$
(13)
 
$
(19)
 
$
(5)
 
$
15 
 
$
(119)
 
Net income (loss) (3)
$
349 
 
$
35 
 
$
27 
 
$
39 
 
$
12 
 
$
(28)
 
$
434 

(1)
Depreciation expense for Corning’s reportable segments includes an allocation of depreciation of corporate property not specifically identifiable to a segment.
(2)
Research, development, and engineering expenses include direct project spending that is identifiable to a segment.
(3)
Many of Corning’s administrative and staff functions are performed on a centralized basis.  Where practicable, Corning charges these expenses to segments based upon the extent to which each business uses a centralized function.  Other staff functions, such as corporate finance, human resources and legal, are allocated to segments, primarily as a percentage of sales.

 
-28-

 


A reconciliation of reportable segment net income to consolidated net income follows (in millions):
 
Three months ended
March 31,
 
2014
 
2013
Net income of reportable segments
$
327 
 
$
462 
Non-reportable segments
 
(40)
   
(28)
Unallocated amounts:
         
Net financing costs (1)
 
(29)
   
(34)
Stock-based compensation expense
 
(15)
   
(11)
Exploratory research
 
(27)
   
(24)
Corporate contributions
 
(5)
   
(13)
Equity in earnings of affiliated companies, net of impairments (2)
 
92 
   
34 
Asbestos settlement
 
(2)
   
(2)
Purchased collars and average forward contracts
 
   
24 
Other corporate items (3)
 
(2)
   
86 
Net income
$
301 
 
$
494 

(1)
Net financing costs include interest income, interest expense, and interest costs and investment gains associated with benefit plans.
(2)
Primarily represents the equity earnings of Dow Corning, which includes our portion of a mark-to-market gain on a derivative instrument, totaling $32 million, for the three months ended March 31, 2014 and a $2 million restructuring charge for our share of costs for headcount reductions and asset write-offs for the three months ended March 31, 2013.
(3)
For the three months ended March 31, 2013, Corning recorded a $54 million tax benefit for the impact of the American Taxpayer Relief Act enacted on January 3, 2013 retroactive to 2012.

The sales of each of our reportable segments are concentrated across a relatively small number of customers.  In the first quarter of 2014, the following number of customers, which individually accounted for 10% or more of each segment’s sales, represented the following concentration of segment sales:

·  
In the Display Technologies segment, four customers accounted for 72% of total segment sales.
·  
In the Optical Communications segment, no customer accounted for 10% of total segment sales.
·  
In the Environmental Technologies segment, three customers accounted for 88% of total segment sales.
·  
In the Specialty Materials segment, three customers accounted for 50% of total segment sales.
·  
In the Life Sciences segment, two customers accounted for 43% of total segment sales.

A significant amount of specialized manufacturing capacity for our Display Technologies segment is concentrated in Asia.  It is at least reasonably possible that the operation of a facility could be disrupted.  Due to the specialized nature of the assets, it would not be possible to find replacement capacity quickly.  Accordingly, loss of these facilities could produce a near-term severe impact on our display business and the Company as a whole.


 
-29-

 


ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ORGANIZATION OF INFORMATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) provides a historical and prospective narrative on the Company’s financial condition and results of operations.  This interim MD&A should be read in conjunction with the MD&A in our 2013 Form 10-K. The various sections of this MD&A contain a number of forward-looking statements that involve a number of risks and uncertainties. Words such as “anticipates,” “expects,” “intends,” “plans,” “goals,” “believes,” “seeks,” “estimates,” “continues,” “may,” “will,” “should,” and variations of such words and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, uncertain events or assumptions, and other characterizations of future events or circumstances are forward-looking statements. Such statements are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this filing and particularly in “Risk Factors” in Part I, Item 1A of our 2013 Form 10-K, and as may be updated in our Forms 10-Q. Our actual results may differ materially, and these forward-looking statements do not reflect the potential impact of any divestitures, mergers, acquisitions, or other business combinations that had not been completed as of March 31, 2014.

Our MD&A includes the following sections:

·  
Overview
·  
Results of Operations
·  
Core Performance Measures
·  
Reportable Segments
·  
Capital Resources and Liquidity
·  
Critical Accounting Estimates
·  
New Accounting Standards
·  
Environment
·  
Forward-Looking Statements

OVERVIEW
Although Corning’s net sales increased by 26% in the first quarter of 2014 when compared to the same period last year, net income declined by 39% driven largely by the impacts of withholding tax on a dividend from Samsung Corning Precision Materials, the depreciation of the Japanese yen versus the U.S. dollar and price declines in our Display Technologies segment, slightly offset by higher net income in the Environmental Technologies segment and higher equity earnings from our equity affiliate Dow Corning.

Net sales in the first quarter of 2014 increased by $475 million to $2,289 million, when compared to the first quarter of 2013.  The increase in net sales was due to the following items:

·  
Higher sales in the Display Technologies segment, driven by the acquisition of the remaining equity interests in our affiliate Samsung Corning Precision Materials, now known as Corning Precision Materials, resulting in consolidation of this entity beginning in the first quarter of 2014, which increased sales by $428 million.  Price declines in the mid-teens in percentage terms somewhat offset the increase from Corning Precision Materials;
·  
An increase in net sales in the Optical Communications segment in the amount of $123 million, driven by an increase in sales of carrier network products in the amount of $98 million, largely due to growth in North America, China and Europe, and an increase of $25 million in enterprise network products; and
·  
An increase of $47 million in the Environmental Technologies segment, due mainly to an increase in demand for our heavy duty diesel products, driven by new governmental regulations in Europe and China and increased demand for Class 8 vehicles in North America.


 
-30-

 


In the first quarter of 2014, we generated net income of $301 million or $0.20 per share, compared to net income of $494 million or $0.33 per share for the same period in 2013.  When compared to the same period last year, the decrease in net income in the three months ended March 31, 2014 was due largely to the following items:

·  
A dividend withholding tax in the amount of $102 million on Corning’s share of the dividend from Samsung Corning Precision Materials distributed subsequent to the Acquisition of the remaining equity interests of the affiliate;
·  
Price declines in the Display Technologies segment in the mid-teens in percentage terms;
·  
The negative impact from the depreciation of the Japanese-yen versus the U.S. dollar in the amount of $89 million;
·  
Higher operating expenses, driven by the consolidation of Corning Precision Materials, an increase in acquisition-related costs and an increase in share-based and performance-based compensation expenses; and
·  
The absence of a tax benefit in the amount of $54 million recorded in the first quarter of 2013 related to the impact of the American Taxpayer Relief Act enacted on January 3, 2013 retroactive to 2012.

The decrease in net income for the three months ended March 31, 2014 was offset somewhat by the following:

·  
Higher net income in the Environmental Technologies segment, driven by an increase in demand for our diesel products; and
·  
An increase in equity earnings from Dow Corning, due to a mark-to-market gain on a derivative instrument in the amount of $32 million, and an increase in volume and the settlement of a long-term sales agreement in the amount of $9 million in their polysilicon segment.

Our key priorities for 2014 remain similar to those from previous years:  protect our financial health and invest in the future.  During the first quarter of 2014, we made the following progress toward these priorities:

Protecting Financial Health
Our balance sheet remains strong, and we generated positive cash flow from operating activities:

We ended the first quarter of 2014 with $5.6 billion of cash, cash equivalents and short-term investments, an increase from the balance at December 31, 2013 of $5.2 billion, and well above our debt balance at March 31, 2014 of $3.7 billion.  The increase in cash was driven by the consolidation of Corning Precision Materials beginning in the first quarter of 2014, and the cash received from Samsung Display for the additional issuance of Preferred Stock in connection with the Acquisition, offset by the cash paid for our share repurchases.

·  
Our debt to capital ratio increased from 13% reported at December 31, 2013 to 15% at March 31, 2014, driven by an increase in the amount of outstanding commercial paper and our share repurchase program.
·  
Operating cash flow in the three months ended March 31, 2014 was $1,737, an increase of $1,114 million when compared to the first quarter of 2013, driven by a dividend from Samsung Corning Precision Materials distributed subsequent to the Acquisition of the remaining equity interests of the affiliate.

Investing In Our Future
Corning is one of the world’s leading innovators in materials science.  For more than 160 years, Corning has applied its unparalleled expertise in specialty glass, ceramics, and optical physics to develop products that have created new industries and transformed people’s lives.  During 2014, we will maintain our innovation strategy focused on growing our existing businesses, developing opportunities adjacent or closely related to our existing technical and manufacturing capabilities, and investing in long range opportunities in each of our market segments.  Our spending levels for research, development, and engineering declined slightly in the first quarter of 2014, from 10% to 9% of sales, when compared to the same period last year.

 
-31-

 


We continue to work on new products, including glass substrates for high performance displays and LCD applications, diesel filters and substrates, and the optical fiber, cable and hardware and equipment that enable fiber-to-the-premises, and next generation data centers.  In addition, we are focusing on wireless solutions for diverse venue applications, such as distributed antenna systems, fiber to the cell site and fiber to the antenna.  We have focused our research, development and engineering spending to support the advancement of new product attributes for our Corning® Gorilla® Glass suite of products.  We will continue to focus on adjacent glass opportunities which leverage existing materials or manufacturing processes, including Corning® Willow™ Glass, our ultra-slim flexible glass substrate for use in next-generation consumer electronic technologies.

Capital spending totaled $246 million and $194 million for the three months ended March 31, 2014 and 2013, respectively.  Spending in the first three months of 2014 was driven primarily by the Display Technologies segment, and focused on finishing line optimization and tank rebuilds.  We expect our 2014 capital spending to be approximately $1.5 billion.  We expect that approximately $560 million will be directed toward our Display Technologies segment, of which approximately $107 million is related to capital projects started in 2012 and 2013.

Corporate Outlook
Our recent acquisition of the remaining interest in our equity affiliate Samsung Corning Precision Materials will drive growth in 2014.  We also expect sales to grow in our Optical Communications, Life Sciences, Specialty Materials and Environmental Technologies segments, and, in our Display Technologies segment, for our market share to stabilize and for price declines to be moderate.  We anticipate a rise in global demand for Corning’s carrier network products, combined with growth of enterprise network products, that will increase sales in our Optical Communications segment.  We believe the overall LCD glass retail market in 2014 will increase in the mid-to-high single digits in percentage terms, driven by the combination of an increase in retail sales of LCD televisions and the demand for larger television screen sizes.  Net income may be negatively impacted by the impact of movements in foreign exchange rates.  We may take advantage of acquisition opportunities that support the long-term strategies of our businesses.  We remain confident that our strategy to grow through global innovation, while preserving our financial stability, will enable our continued long-term success.

 
-32-

 


RESULTS OF OPERATIONS

Selected highlights for the first quarter follow (dollars in millions):
 
Three months ended
March 31,
 
%
change
 
2014
 
2013
 
14 vs. 13
               
Net sales
$
2,289
 
$
1,814
 
26
               
Gross margin
$
935
 
$
770
 
21
(gross margin %)
 
41%
   
42%
   
               
Selling, general and administrative expenses
$
395
 
$
259
 
53
(as a % of net sales)
 
17%
   
14%
   
               
Research, development and engineering expenses
$
198
 
$
178
 
11
(as a % of net sales)
 
9%
   
10%
   
               
Equity in earnings of affiliated companies
$
86
 
$
173
 
(50)
(as a % of net sales)
 
4%
   
10%
   
               
Transaction-related gain, net
$
74
       
*
(as a % of net sales)
 
3%
         
               
Income before income taxes
$
481
 
$
528
 
(9)
(as a % of net sales)
 
21%
   
29%
   
               
Provision for income taxes
$
(180)
 
$
(34)
 
(429)
(as a % of net sales)
 
(8)%
   
(2)%
   
               
Net income attributable to Corning Incorporated
$
301
 
$
494
 
(39)
(as a % of net sales)
 
13%
   
27%
   
* Percent change not meaningful

Net Sales
For the three months ended March 31, 2014, net sales increased in all of our segments, improving by $475 million, when compared to the same period in 2013.  Driving the growth in net sales are the following items:

·  
The impact of the acquisition of the remaining equity interests of our affiliate Samsung Corning Precision Materials, and the subsequent consolidation of this entity, which added approximately $428 million in net sales;
·  
An increase of net sales in the Optical Communications segment of $123 million, or 26%, driven by an increase of $98 million for our carrier network products and an increase of $25 million for our enterprise network products.  Driving the growth in carrier network products are the following items:
o  
Higher sales of cable products in North America and Europe, up $31 million and $32 million, respectively;
o  
The impact of a small acquisition and the consolidation of an investment due to a change in control which occurred in the second quarter of 2013, which added approximately $22 million;
o  
An increase of $5 million in sales of wireless products; and
o  
An increase in sales of optical fiber, driven by higher demand for single-mode fiber in Europe and North America.

 
-33-

 


·  
An increase in Environmental Technologies segment net sales in the amount of $47 million, or 21%, driven by higher demand for our heavy duty diesel products, which increased by $33 million, propelled by new governmental regulations in Europe and China and increased demand for Class 8 vehicles in North America, and an increase of $6 million in net sales of light duty diesel products, driven by higher volume in Europe.
·  
An increase in net sales of $3 million in both the Specialty Materials and Life Sciences segments.

Although the impact of fluctuations in foreign currency exchange rates did not materially impact net sales in our Optical Communications, Environmental Technologies, Life Sciences and Specialty Materials segments, the impact of the fluctuation in the Japanese yen had a negative impact of approximately $60 million on net sales in our Display Technologies segment in the first quarter, when compared to the first quarter of 2013.

Cost of Sales
The types of expenses included in the cost of sales line item are: raw materials consumption, including direct and indirect materials; salaries, wages, and benefits; depreciation and amortization; production utilities; production-related purchasing; warehousing (including receiving and inspection); repairs and maintenance; inter-location inventory transfer costs; production and warehousing facility property insurance; rent for production facilities; and other production overhead.

Gross Margin
Gross margin dollars increased by $165 million, driven largely by the consolidation of Corning Precision Materials.  As a percentage of net sales, gross margin for the three months ended March 31, 2014 decreased slightly when compared to the same period last year, due primarily by the impact of the weakening of the Japanese yen in the amount of $45 million and price declines in our Display Technologies segment in the mid-teens in percentage terms, offset somewhat by the positive impact of Corning Precision Materials and improvements in manufacturing performance in the Environmental Technologies segment.

Selling, General and Administrative Expenses
For the three months ended March 31, 2014, selling, general and administrative expenses increased by $136 million, driven largely by the consolidation of Corning Precision Materials, which increased selling, general and administrative expenses by approximately $25 million, an increase of $10 million in share-based and performance-based compensation expenses and an increase of approximately $90 million in acquisition-related costs, including $72 million of post-combination compensation expense, offset somewhat by cost control measures implemented by our segments.  As a percentage of net sales, selling, general and administrative expenses increased by 3% when compared to the first quarter of 2013, driven by expenses related to the Acquisition.

The types of expenses included in the selling, general and administrative expenses line item are: salaries, wages and benefits; stock-based compensation expense; travel; sales commissions; professional fees; depreciation and amortization, utilities, and rent for administrative facilities.

Research, Development and Engineering Expenses
For the three months ended March 31, 2014, research, development and engineering expenses increased by $20 million, when compared to the same period last year, driven by the consolidation of Corning Precision Materials, offset slightly by lower spending in the Specialty Materials segment.  As a percentage of net sales, research, development and engineering expenses decreased slightly when compared to the same period in 2013.

 
-34-

 
 
 
Equity in Earnings of Affiliated Companies
The following provides a summary of equity in earnings of affiliated companies (in millions):
 
Three months ended
March 31,
 
2014
 
2013
Samsung Corning Precision Materials
     
$
133
Dow Corning Corporation
$
92 
   
35
All other
 
(6)
   
5
Total equity earnings
$
86 
 
$
173

Equity earnings of affiliated companies decreased in the three months ended March 31, 2014, when compared to the same period last year, reflecting the Acquisition and subsequent consolidation of Samsung Corning Precision Materials, offset somewhat by a substantial increase in equity earnings from Dow Corning.  Equity earnings from Dow Corning were positively impacted by the following items:

·  
Corning’s share of a mark-to-market gain on a derivative instrument in the amount of $32 million;
·  
An increase in equity earnings of $29 million in the polysilicon segment, driven by higher volume and the settlement of a long-term sales agreement in the amount of $9 million.

Other Income, Net
“Other income, net” in Corning’s consolidated statements of income includes the following (in millions):
 
Three months ended
March 31,
 
2014
 
2013
Royalty income from Samsung Corning Precision Materials
     
$
15
Foreign currency exchange and hedge (losses) gains, net
$
(6)
   
31
Net loss attributable to noncontrolling interests
 
   
1
Other, net
 
27 
   
18
Total
$
24 
 
$
65

Beginning in the first quarter of 2014, due to the Acquisition and subsequent consolidation of Samsung Corning Precision Materials (now Corning Precision Materials), royalty income from Corning Precision Materials is no longer recognized in Corning’s consolidated statement of income.

Included in the line item Foreign currency exchange and hedge (losses) gains, net for the three months ended March 31, 2014 and 2013 is the positive impact of the purchased collars and average forward contracts, which hedge our exposure to movements in the Japanese yen and its impact on our net earnings, in the amount of $2 million and $24 million, respectively.

Income Before Income Taxes
Income before income taxes for the three months ended March 31, 2014, was negatively impacted in the approximate amount of $100 million by the significant depreciation of the Japanese yen versus the U.S. dollar when compared to the same period last year.

 
 
-35-

 

Provision for Income Taxes
Our provision for income taxes and the related effective income tax rates were as follows (in millions):
 
Three months ended
March 31,
 
2014
 
2013
           
Provision for income taxes
$
(180)
 
$
(34)
Effective tax rate
 
37.4%
   
6.4%

For the three months ended March 31, 2014, the effective income tax rate differed from the U.S. statutory rate of 35% primarily due to the following benefits:

·  
Rate differences on income (loss) of consolidated foreign companies, including the benefit of excess foreign tax credits attributable to a deemed distribution to the U.S. of a portion of foreign current year earnings;
·  
Equity in earnings of nonconsolidated affiliates reported in the financials net of tax; and
·  
Tax incentives in foreign jurisdictions, primarily Taiwan.

These benefits were more than offset principally by a discrete tax charge in the first quarter of 2014 in the amount of $102 million related to South Korean withholding tax on a dividend paid by Samsung Corning Precision Materials to Corning wholly owned foreign subsidiaries.

For the three months ended March 31, 2013, the effective income tax rate differed from the U.S. statutory rate of 35% primarily due to the following benefits:

·  
Rate differences on income (loss) of consolidated foreign companies;
·  
Equity in earnings of nonconsolidated affiliates reported in the financials net of tax;
·  
$54 million to record the impact of the American Taxpayer Relief Act enacted on January 3, 2013 retroactive to 2012; and
·  
Tax incentives in foreign jurisdictions, primarily Taiwan.

Refer to Note 5 (Income Taxes) to the consolidated financial statements for additional information.

Net Income Attributable to Corning Incorporated
As a result of the above, our net income and per share data is as follows (in millions, except per share amounts):
 
Three months ended
March 31,
 
2014
 
2013
Net income attributable to Corning Incorporated – basic
$
280
 
$
494
Net income attributable to Corning Incorporated – diluted
$
280
 
$
494
Basic earnings per common share
$
0.21
 
$
0.33
Diluted earnings per common share
$
0.20
 
$
0.33
Shares used in computing per share amounts
         
Basic earnings per common share
 
1,359
   
1,472
Diluted earnings per common share
 
1,370
   
1,481


 
-36-

 


CORE PERFORMANCE MEASURES
In managing the Company and assessing our financial performance, we supplement certain measures provided by our consolidated financial statements with measures adjusted to exclude certain items, to arrive at Core Performance measures.  We believe reporting Core Performance measures provides investors greater transparency to the information used by our management team to make financial and operational decisions.  Net sales, equity in earnings of affiliated companies, and net income are adjusted to exclude the impacts of changes in the Japanese yen, the impact of the purchased collars, average forward contracts and other yen-related transactions, acquisition-related costs, discrete tax items, restructuring and restructuring-related charges, certain litigation-related expenses, pension mark-to-market adjustments, and other items which do not reflect on-going operating results of the Company or our equity affiliates.  Management discussion and analysis on our reportable segments has also been adjusted for these items, as appropriate.  These measures are not prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP).  We believe investors should consider these non-GAAP measures in evaluating our results as they are more indicative of our core operating performance and how management evaluates our operational results and trends.  These measures are not, and should not be viewed as a substitute for U.S. GAAP reporting measures.  For a reconciliation of non-GAAP performance measures and a further discussion of the measures, please see “Reconciliation of Non-GAAP Measures” below.

RESULTS OF OPERATIONS – CORE PERFORMANCE MEASURES

Selected highlights from our continuing operations, excluding certain items, follow (in millions):
 
Three months ended
March 31,
 
%
change
 
2014
 
2013
 
14 vs. 13
Core net sales
$
2,389
 
$
1,814
 
32%
Core equity in earnings of affiliated companies
$
61
 
$
180
 
(66)%
Core net income
$
461
 
$
431
 
7%

Core Net Sales
Core net sales in the first quarter of 2014 and 2013, which excludes the impact of changes in the Japanese yen, totaled $2,389 million and $1,814 million, respectively, an increase of $575 million, or 32%.  Driving the growth in core net sales are the following items:

·  
The impact of the acquisition of the remaining equity interests of our affiliate Samsung Corning Precision Materials, and the subsequent consolidation of this entity, which added approximately $450 million in core net sales;
·  
An increase of core net sales in the Optical Communications segment of $123 million, or 26%, driven by an increase of $98 million for our carrier network products and an increase of $25 million for our enterprise network products.  Driving the growth in carrier network products are the following items:
o  
Higher sales of cable products in North America and Europe, up $31 million and $32 million, respectively;
o  
The impact of a small acquisition and the consolidation of an investment due to a change in control which occurred in the second quarter of 2013, which added approximately $22 million;
o  
An increase of $5 million in sales of wireless products; and
o  
An increase in sales of optical fiber, driven by higher demand for single-mode fiber in Europe and North America.
·  
An increase in Environmental Technologies segment core net sales in the amount of $47 million, or 21%, driven by higher demand for our heavy duty diesel products, which increased by $33 million, propelled by new governmental regulations in Europe and China and increased demand for Class 8 vehicles in North America, and an increase of $6 million in core net sales of light duty diesel products, driven by higher volume in Europe.
·  
An increase in core net sales of $3 million in both the Specialty Materials and Life Sciences segments.

 
-37-

 


Core Equity in Earnings of Affiliated Companies
The following provides a summary of core equity in earnings of affiliated companies (in millions):
 
Three months ended
March 31,
 
2014
 
2013
Samsung Corning Precision Materials
     
$
133
Dow Corning Corporation *
$
59
   
42
All other
 
2
   
5
Total equity earnings
$
61
 
$
180
*
In 2013, we excluded the operating results of Dow Corning’s consolidated subsidiary Hemlock Semiconductor, a producer of polycrystalline silicon to remove the impact of the severe unpredictability and instability in the polysilicon market.

Core equity earnings of affiliated companies decreased in the three months ended March 31, 2014, when compared to the same period last year, reflecting the Acquisition and subsequent consolidation of Samsung Corning Precision Materials, offset somewhat by an increase in equity earnings from Dow Corning.  Core equity earnings from Dow Corning in the first quarter of 2014 were positively impacted by the following item:
 
·  
An increase in equity earnings of $22 million from Dow Corning’s consolidated subsidiary Hemlock Semiconductor, a producer of polycrystalline silicon, driven by higher volume and the settlement of a long-term sales agreement in the amount of $9 million.  We excluded the operating results of Hemlock Semiconductor in 2013 to remove the impact of the severe unpredictability and instability in the polysilicon market.  Beginning in 2014, due to the stabilization of the market, Hemlock’s operating results are included in core equity earnings.

Slightly offsetting the positive impact from Hemlock Semiconductor is a decline in equity earnings in the amount of $5 million from the silicones segment, driven by the absence of contract settlements in the first quarter of 2013.

Core Net Income
When compared to the same period last year, core net income increased in the three months ended March 31, 2014 by $30 million, or 7%, driven by the following items:

·  
An increase in core net income of $16 million, or 59%, in the Environmental Technologies segment, driven by an increase in demand for our diesel products;
·  
An increase in core net income of $4 million, or 11%, in the Optical Communications segment, driven by an increase in demand carrier network products; and
·  
An increase in core equity earnings from Dow Corning.


 
-38-

 


Core Earnings per Common Share
The following table sets forth the computation of core basic and core diluted earnings per common share (in millions, except per share amounts):
 
Three months ended
March 31,
 
2014
 
2013
Core net income attributable to Corning Incorporated
$
461 
 
$
431
Less:  Series A convertible preferred stock dividend
 
(21)
     
Core net income available to common stockholders - basic
 
440 
   
431
Add:  Series A convertible preferred stock dividend
 
21 
     
Core net income available to common stockholders - diluted
$
461 
 
$
431
           
Weighted-average common shares outstanding - basic
 
1,359 
   
1,472
Effect of dilutive securities:
         
Stock options and other dilutive securities
 
11 
   
9
Series A convertible preferred stock
 
97 
     
Weighted-average common shares outstanding - diluted
 
1,467 
   
1,481
Core basic earnings per common share
$
0.32 
 
$
0.29
Core diluted earnings per common share
$
0.31 
 
$
0.29

Reconciliation of Non-GAAP Measures

We utilize certain financial measures and key performance indicators that are not calculated in accordance with GAAP to assess our financial and operating performance. A non-GAAP financial measure is defined as a numerical measure of a company’s financial performance that (i) excludes amounts, or is subject to adjustments that have the effect of excluding amounts, that are included in the comparable measure calculated and presented in accordance with GAAP in the statement of income or statement of cash flows, or (ii) includes amounts, or is subject to adjustments that have the effect of including amounts, that are excluded from the comparable measure as calculated and presented in accordance with GAAP in the statement of income or statement of cash flows.

Core net sales, core equity earnings of affiliated companies and core net income are non-GAAP financial measures utilized by our management to analyze financial performance without the impact of items that are driven by general economic conditions and events that do not reflect the underlying fundamentals and trends in the Company’s operations.

 
-39-

 


The following tables reconcile our non-GAAP financial measures to their most directly comparable GAAP financial measure.
 
Three months ended March 31, 2014
 
Net
sales
 
Equity
earnings
 
Income
before
income
taxes
 
Net
income
 
Effective
tax
rate
 
Per
share
As reported
$
2,289
 
$
86 
 
$
481 
 
$
301 
 
37.4%
 
0.20 
Constant-yen (1)
 
100
         
82 
   
61 
     
0.04 
Purchased collars and average forward contracts (2)
             
(2)
   
(10)
     
(0.01)
Acquisition-related costs (4)
             
48 
   
40 
     
0.03 
Discrete tax items (5)
                   
21 
     
0.01 
Asbestos settlement (6)
             
   
       
Restructuring, impairment and other charges (7)
             
17 
   
15 
     
0.01 
Liquidation of subsidiary (8)
                   
(3)
       
Equity in earnings of affiliated companies (9)
       
(25)
   
(25)
   
(24)
     
(0.02)
Gain on previously held equity investment (10)
             
(394)
   
(292)
     
(0.20)
Settlement of pre-existing contract (10)
             
320 
   
320 
     
0.22 
Post-combination expenses (10)
             
72 
   
55 
     
0.04 
Other items related to the Acquisition of Samsung Corning Precision Materials (10)
             
(24)
   
(24)
     
(0.02)
Core Performance measures
$
2,389
 
$
61 
 
$
577 
 
$
461 
 
20.1%
 
0.31 

 
Three months ended March 31, 2013
 
Net
sales